Epi Policy Case

Monday, June 6,2011

Energy Positive Inc. Case

Alan W. Foerster – BU397

Memo

Upon reviewing the information that was presented to us, we conclude that Energy Positive Inc. must adopt some changes in accounting procedures to depict a more accurate picture of their financial position, as required under the new IFRS standards.

We have concluded that if all the recommendations we are making are implemented, then the loan covenants will still remain intact. We have projected a current ratio of 1.18:1 and a debt to equity ratio of 1.1:1 for the year of 2010, so Energy Positive Inc.’s relationship with the bank should remain unaffected in terms of their ability to access loans. This report will describe the accounting errors that we have detected, along with the proposed changes.

Part 1______________________________________

Recognition of Warranty Revenue and Expense

RE: Sale of Extended Warranties

During June of this year, the company began selling optional extended warranties on its products. These extended warranties covered a period of 3 years after the manufacturers’ warranty expires. The sale of 255 warranties during 2010 amounted to $38,250 and this amount was recognized as revenue. Furthermore, the 2011 pro-forma financial statements include the estimated sale of 300 warranties, which amounts to $45,000 and forecasted as revenue for the mentioned year.

There are two alternatives to reporting warranties: the revenue approach and the expense approach (Energy Positive Inc. currently uses the expense approach).

Using the expense approach, Energy Positive Inc. recognizes warranties as revenues in the year they are sold. The sales were recognized as per appendix A

Under the Revenue approach, the proceeds received for the warranty are unearned at the point of sale. The sales are recognized as per appendix B.

When the expense approach is used to account warranty cost, the revenue will be higher because it considered as earned at the moment of...