Adjusting Entries Essay

Words: 14057
Pages: 57

ISSUES IN ACCOUNTING EDUCATION Vol. 27, No. 2 2012 pp. 493–524

American Accounting Association DOI: 10.2308/iace-50124

How Adjusting Entries Affect the Quality of Financial Reporting: The Case of Frosty Co.
Jason C. Porter
ABSTRACT: Recent accounting scandals have emphasized the need to think beyond debits and credits. Accounting students must understand the effects of transactions on a company’s financial position, as well as the pressures and incentives they will someday face to misrepresent that position. This case introduces students in intermediate financial accounting courses to both of these important objectives. First, the case improves students’ critical thinking skills in accounting by allowing them to determine if
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‘‘That’s the problem. I think we capitalized more than we should have. More specifically, it looks like we capitalized all of the interest on our most recent bank loan.’’ ‘‘We did,’’ Elsa replied. ‘‘Since we’re using all of the loan proceeds to build the new factory, we felt it was appropriate to capitalize all of the interest.’’ John nodded in agreement. ‘‘I disagree,’’ said Simon. ‘‘Here’s a breakdown of the payments we made on our new building and a list of our outstanding long-term debt (see Table 1). Did we take out any of these loans specifically for the new factory?’’ Elsa shook her head. ‘‘No, we took out the new loan, Loan 2, for general expansion, then decided the most appropriate use of the funds would be for the new factory.’’ Simon frowned. ‘‘Why are we capitalizing the interest on Loan 2 if it wasn’t originated specifically for the new factory?’’
Issues in Accounting Education Volume 27, No. 2, 2012

How Adjusting Entries Affect the Quality of Financial Reporting: The Case of Frosty Co.


TABLE 1 Avoidable Interest Information Panel A: Construction Payments on the New Factory
Payment Date Feb. 15 Apr. 1 Jun. 30 Oct. 1 Nov. 15 Amount $90,000 $125,000 $200,000 $300,000 $585,000

Panel B: Long-Term Debt Information
Type of Debt Bond A Loan 1 Loan 2 Amount $678,500 $650,000 $1,000,000 Interest Rate 7.1% 6.0% 7.0%

‘‘Well, if the capital from the loan is eventually used on a specific