Ferrari Group Case

Chunying Ma

Jose Debernardi Castaneda

Mehakpreet Kaur

Theresa Blair

Lafontaine automotive classic cars Co.

ACCT3201 – Fall 2023
APPENDIX 3 – GENERAL JOURNAL FOR CORRECTING AND ADJUSTING ENTRIES

DATE ACCOUNTS DEBIT CREDIT

Warranties
Cash 125,000
Warranty expense 125,000
(To Eliminate wrong entry)

Extended warranty revenue 450,000

Cash 450,000
(To Eliminate wrong entry)

Cash 450,000
Unearned warranty revenue 450,000
To Record extra warranty sales ($9,000,000 x
10% x 50%)

Warranty expense 450,000

Warranty liability 450,000
To Record estimate warranty expense (5% x
$9,000,000)

Warranty liability 125,000

Cash 125,000
(To Record actual warranty repairs made)

Contingencies
Liability due to lawsuits 300,000
Expense due to lawsuits 300,000
To correct entry made for estimated contingent
loss on lawsuits ($325,000 recorded to $25,000
+ $ 0)

Lease
Lease liability 100,000

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 Rental expense 100,000
DATE ACCOUNTS DEBIT CREDIT
(To correct the 1st payment made on the leased
assets, where the lease liability should be
debited instead of rental expense)

Right to use land (50% x $ 808,090) 404,045

Right to use building (50% x $ 808,090) 404,045
Current portion of lease liability 57,515
Lease liability – long term portion 750,575
(To record capital lease on leased land and
buildings)

Interest expense 42,485

Current portion of lease liability 42,485
st
(To Record interest from the 1 payment)

Depreciation expense ($404,045/20) 20,202

Accumulated depreciation 20,202
(To Record building depreciation)

Current tax payable 200,000

Income tax expense 200,000
(To Reverse income tax registered)

Income tax expense 149,503

Current tax payable 149,503
(To Record tax expense and liability)

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 LaFontaine Automotive

Lease Amortization Schedule

Date Payment Interest Principal Balance

$808,089
Jan 1, 2023 $100,000 $0 $100,000 $708,089
Jan 1, 2024 $100,000 $42,485 $57,515 $650,574
Jan 1, 2025 $100,000 $39,034 $60,966 $589,609
Jan 1, 2026 $100,000 $35,377 $64,623 $524,985
Jan 1, 2027 $100,000 $31,499 $68,501 $456,484
Jan 1, 2028 $100,000 $27,389 $72,611 $383,873
Jan 1, 2029 $100,000 $23,032 $76,968 $306,906
Jan 1, 2030 $100,000 $18,414 $81,586 $225,320
Jan 1, 2031 $100,000 $13,519 $86,481 $138,839
Jan 1, 2032 $100,000 $8,330 $91,670 $47,170
Jan 1, 2032 $50,000 $2,830 $47,170 $0
$808,089
Reconciliation between Accounting Income and Taxable Income

Income before income tax Expense 562,313

Less: Dividend Revenue (15,000)

Expense due to Lawsuits 25,000

Warranty Expense included 450,000

Actual warranty Expense included (125,000)

Depreciation included 230,202

CCA (400,000)

Larry’s membership 20,000

Taxable income 747,515

Taxes (20%) (149,503)

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APPENDIX 4 - MEMO TO LARRY LaFontaine

To: Larry LaFontaine, President, and CEO - LaFontaine Automotive Class Cars Co.

From: CPA, Controller

I hope this memo finds you well. Thank you for allowing us the opportunity to work for your

company. I wanted to bring to your attention certain accounting entries related to warranty

transactions recorded in 2023 that may require further clarification and adjustment. After

reviewing the entries, it appears that there might be misunderstanding in the recording of these

transactions. The entry suggests that $ 125,000 in cash was debited to the warranty expense

account. The credit to cash accounts suggests immediate cash payment for warranty repairs.

However, under the accounting principles, warranty expenses are accrued, and cash is not

immediately affected. They should have credited the warranty liability instead of cash to

represent the accrual of future warranty expenses in a correct way. Additionally, the recording of

actual warranty repairs as an expense in a lump sum doesn’t align with the estimated repair work

under the 5-year warranty coverage. Recognition of warranty expense should have spread over

the 5-year warranty period to match the estimated repair work. In the 2nd entry to record amount

received for the extended warranties, Cash has been debited appropriately for the amount

received, it’s crucial to review the recognition of extended warranty revenue. The recognition of

revenue for extended warranties should be spread over the coverage period, and the entire

amount should not be recognized at the time of sale. Should have credited unearned warranty

revenue instead of the extended warranty revenue.

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After reviewing the legal expenses accrual for the lawsuits brought by Tommy Tires and Edna

Engine, we found out that the entry has recorded the maximum possible loss for both lawsuits.

The assessment of Lawyer that Tommy is likely to receive between $25,000 and $50,000 was

not considered. Edna Engine’s case was deemed too unusual to establish an estimated outcome,

even then $250,000 was recorded. When the lawyer’s assessment is given. We need to recognize

a range of potential outcomes rather than recording the maximum possible loss. As Edna’s case

was too unusual to establish an estimated outcome, it’s recommended to disclose this uncertainty

in the financial statements and should not record any liability amount until the outcome is more

predictable.

While looking at the portion of the income statement affected by the lease, we noticed some

mistakes made by the new accountant and items that were missed. First, the accountant made an

incorrect payment on the lease; due to this mistake the rental expense was too high by $100,000

and the lease liability was too low by $100,000. This was corrected by decreasing the rental

expense and increasing the lease liability by $100,000 each. Next, the capital assets were too low

as the capital asset of land and building were not recorded so we increased capital assets by

$808,090 ($404, 045 for the value of the land, and $404, 045 for the value of the building). We

also recorded $57,515 for the current portion of the lease liability and $750,575 for the long-term

portion of the lease liability. The amortization table below shows the details. The accountant also

forgot to record a depreciation of $20,202 on the building which we have included.

Some mistakes were found regarding taxable income as well. Firstly, dividend income is not

taxable, so we need to eliminate the dividend income of $15,000 from the tax return. Secondly, a

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lawsuit is never allowed to be deducted as an expense on the tax return, the $25,000 lawsuit

incurred in this case needs to be added back. Thirdly, the $12500 actual warranty repair costs

incurred in a year can be deducted as an expense. In addition, the $20,200 depreciation of lease

property expenses also needs to be deducted from the tax return. Finally, the membership dues

are not deductible for tax purposes, we still need to add back $20,000.

After calculating the net income after taxes, the next step involved providing a comprehensive

breakdown of the Earnings Per Share (EPS) calculation in the recent financial statement. The

4.44 EPS calculated by the new accountant was wrong. Please find below the analysis of basic

and diluted EPS for your review.

Basic EPS:

Net Income: $412,810 – obtained from the adjusted Income Statement.

Less: Preferred Share Dividend: $50,000

Net Income after dividends: $ 362,810

Basic EPS Calculation: $362,810 / 150,000 = $2.42 per share

Based on the weighted average number of shares, both the dividends for preferred shares and the

number of common shares were calculated.

Dilution Analysis:

Preferred Shares:

Number of common shares increase: 25,000

Dilution effect: $50,000 / 25,000 = $2.00 per share

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Test: Basic EPS - Dilution effect = $2.42 - $2.00 = $0.42 per share

Convertible Bond:

Interest not paid on 6% bond: $72,000.

Number of common shares increase: 22,500

Dilution effect: $72,000 / 22,500 = $3.20 per share

Test: Basic EPS - Dilution effect = $2.42 - $3.20 = ($0.78) per share (Antidilutive)

Warrants:

Cash proceeds: $4,500,000

Buy back shares: 50,000

Remaining shares: 10,000

Dilution effect: $0

Test: Basic EPS - Dilution effect = $2.42 - $0 = $2.42 per share

Options:

Cash proceeds: $1,500,000

Buy back shares: 16,667

Remaining shares: 13,333

Dilution effect: $0

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Test: Basic EPS - Dilution effect = $2.42 - $0 = $2.42 per share

Fully Diluted EPS:

Net Income: $362,810 + $50,000 + $0 + $0 = $412,810

Fully Diluted Weighted Average Shares: 150,000 + 25,000 + 10,000 + 10,000 = 195,000

Fully Diluted EPS: $412,810 / 195,000 = $2.12 per share

In summary, the basic EPS stands at $2.42 per share, and the fully diluted EPS, considering all

potential dilutive securities, is $2.12 per share.

Please feel free to reach out if you have any questions or need further clarification.

Thank you for your attention to this matter.

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APPENDIX 5 - EARNINGS PER SHARE CALCULATION

Item Net income Number of EPS

common shares
Basic EPS:
Net income: $ 412,810
Less: Preferred share dividend $4 x 25,000 ÷ 2 ($50,000)
# shares: (180,000 x 6 ÷ 12) + (120,000 x 6 ÷ 12) 150,000
Basic EPS $362,810 $2.42
Dilution
Preferred Shares: $50,000 25,000 Test: $2.00
Number of shares increase = 25,000 x 2 ÷ 2
Convertible Bond: $72,000 22,500 Test: $3.20
Interest would not be paid on 6% bond: Antidilutive
I = $2,000,000 x 6% 9 ÷ 12 x (1-20%) = $72,000
# of shares: $2,000,000 ÷ $1,000 x 15 x 9 ÷ 12 =
22,500
Warrants: $0 10,000 Test: $0
Cash proceeds = 60,000 x $75 =$4,500,000
Buy back shares = $4,500,000 ÷ $90 = 50,000
Shares remaining: 60,000 – 50,000 = 10,000
Options $0 10,000 Test: $0
Cash proceeds = 30,000 x $50 = $1,500,000
Buy back shares = $1,500,000 ÷ $90 = 16,667
Shares remaining: 30,000 – 16,667 = 13,333
Shares remaining: 13,333 x 9 ÷ 12 = 10,000
Fully diluted EPS $412,810 195,000 $2.12

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APPENDIX 6 - MARKING GUIDE

REQUIREMENTS MARKS EARNED

Individual responsibility to other group members
 EQUAL SHARING OF THE WORK
 Co-operation; mutual respect; take responsibility; resolve disputes
 KEEP IN TOUCH with team members – don’t disappear; acknowledge of
messages and calls of other group members 7
 Inform instructor in a timely manner if serious issues arise
 Complete the peer-to-peer evaluation – ONLY IF ALL GROUP MEMBERS
DID NOT CONTRIBUTE EQUALLY

Prepare the correcting and adjusting entries in Appendix 3 16

Prepare a memo to Larry LaFontaine in Appendix 4. Address the accounting

areas not done properly, the correct treatment according to IFRS, and the
impact on the financial statements; ensure the memo is professional

 Identify the accounting areas that were not done properly, why was it
wrong according to IFRS and what was the general impact on the financial
results
 Identify what the proper accounting treatment should be
 Professional appearance – appealing layout, use of headings and
subheadings, proper font type/size and margins, double spaced 17
 Proper grammar, no spelling mistakes
 Discussion is relevant, coherent, concise, logical, and flows smoothly
 Communicate to the audience – Larry is not a professional accountant so
do not use accounting jargon such as journal entries, debits, credits,
adjusting entries, accruals, matching principle, revenue recognition,
timing differences and so on.

Compute the required Earning Per Share (EPS) amounts in Appendix 5 7

Prepare the corrected financial statements by entering the correcting and

adjusting journal entries in the formatted Excel spreadsheet provided on your 8
Moodle site. Cells will automatically be updated from your entries.
TOTAL MARKS 55

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