Adjusting Entries

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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 various correcting entries should be made, and what the effects of those transactions will be on the company’s financial statements. Second, the case improves students’ ability to evaluate ethical consequences by introducing them to conflicting incentives regarding those corrections: the obligation to provide investors with high-quality financial statements that fairly present the company’s financial position versus the pressure to maintain a high stock price for investors. The case may be completed using either U.S. GAAP or IFRS. Keywords: adjusting entries; financial statement adjustments; accounting cycle; ratio analysis; IFRS.

BACKGROUND INFORMATION rosty Co. is a publicly traded, medium-sized manufacturing firm that produces refrigerators, freezers, ice makers, and snow cone machines. During the past three years, the company has struggled against increasing competition, sluggish sales, and a public relations scandal surrounding the departure of the former Chief Executive Officer (CEO) and Chief Financial Officer (CFO). The new CEO, Jane Mileton, and CFO, Doug Steindart, have worked hard to improve the company’s image and financial position. After several difficult years, the company now seems to be resolving its difficulties, and the management team is considering new investment opportunities. The team hopes that diversification into a line of professional ice cream makers, and perhaps a line of consumer products, will help the company continue its recent growth and effectively compete with future competitors. In order to raise the funds needed for these new investments, Frosty Co.’s Board of Directors has approved a seasoned equity offering (SEO). The discussions regarding the new investment opportunities and the equity offering have been kept quiet until a positive set of financial statements Jason C. Porter is an Associate Professor at the University of Idaho. I appreciate the comments of Marla Kraut, Teresa Gordon, Jeff Michelman, Angela Spencer, Michele O’Neill, and workshop participants at the 2007 Northwestern Accounting Research Group and the 2009 AAA Annual Meeting. I am also grateful for the comments and suggestions of the associate editor and reviewers.

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Published Online: January 2012

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can provide strong evidence that the company has turned around, leading to an increase in the company’s stock price. INTRODUCTION After a full week of carefully examining financial statements, Simon was exhausted. He had become Frosty Co.’s corporate controller only a month ago, after several years as an auditor at a public accounting firm, and was excited about the move to corporate accounting. The first few weeks had gone well, as Simon met his accounting staff and settled into his new responsibilities. Then, he had started reviewing Frosty Co.’s financial statements for the prior year to make sure they correctly followed GAAP, and to familiarize himself more with the company and industry. Unfortunately, his relative inexperience with the industry and Frosty’s accounting procedures had required him to spend more time on the review than he had anticipated. He still had a few questions about the financial statements, but he needed to start preparing for the upcoming SEO. He...
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