Vol. 26, No. 4
American Accounting Association
Home Heaters: A Holistic View of the
M. Cathy Claiborne and Kirkland A. Wilcox
ABSTRACT: In this case, two start-up companies in the same industry have identical economic transactions. Although both companies follow generally accepted accounting principles (GAAP), each manager makes different choices and estimates when applying GAAP. By preparing the financial statements, calculating ratios, and comparing and contrasting the two companies, students see how choices and estimates made by management affect the financial statements. They also see the challenge faced by users of financial information when trying to interpret the financial statements and compare companies. Students really experience an ‘‘aha!’’ moment while analyzing this case. The case refutes their commonly held assumptions that accounting always has a right answer and that financial statements represent the truth.
Keywords: accounting alternatives; accounting choices; accounting estimates; economic transactions; ﬁnancial statements; ﬁnancial ratios; ﬁnancial statement analysis.
t the beginning of the year 20X1, two companies began operations to sell home heating units. Eads Heater, Inc. is located in Eads, Colorado, and Glenwood Heating, Inc. is in Glenwood Springs, Colorado. The companies operate under similar economic conditions and have identical operations during the year. However, each manager makes different accounting choices and estimates when applying generally accepted accounting principles (GAAP) in preparing the company’s ﬁnancial statements.
Both companies have completed identical transactions during the ﬁrst year of operations, 20X1. The transactions for each company are listed:
1. On January 2, each company issued 3,200 shares of capital stock for $160,000 and commenced operations.
M. Cathy Claiborne is an Associate Professor and Kirkland A. Wilcox is an Associate Professor Emeritus, both at the University of Colorado.
Published Online: November 2011
Claiborne and Wilcox
2. On January 2, each company borrowed $400,000 on a 20-year, 7 percent note payable. Interest plus $20,000 principal is due September 30 each year, beginning 20X1. 3. On January 3, each company purchased land and a building for $420,000. Both managers assigned $70,000 to the land and $350,000 to the building. Each company paid cash for the land and building.
4. On January 5, each company purchased delivery equipment at a cost of $80,000. Both purchases were made with cash.
5. Each company sells one model of home heating unit, and made the following credit purchases during the year. (You may record all the purchases in one transaction.) Date
Number Of Units
Cost Per Unit
6. Each company sold 160 units for $398,500 during the year. All sales were on credit; 90 days, same as cash. You will just record the sales piece of this transaction for now. Management has not yet determined how inventory and cost of goods sold will be valued. Therefore, this year, management will use the periodic inventory system and record cost of goods sold at the end of the year (in Part B).
7. $299,100 was collected during the year on the sales described in Transaction 6 above. 8. $213,360 was paid on the purchases made in Transaction 5 above. 9. On September 30, the ﬁrst $20,000 principal payment plus nine months’ interest was made on the note payable described in Transaction 2.
10. A total of $34,200 was paid for a variety of expenses, such as advertising, supplies, insurance, and wages. These expenses are recorded in an account called ‘‘other operating expenses.’’
11. Dividends of $7.25 per share were paid to the stockholders on December 1. 12....