Reference no: EM132622523

Your firm recently acquired a new client, Green Dreams, a proven leader in the golf club manufacturing industry and you were selected as senior in charge of Green Dreams' audit engagement. Green Dreams emerged as a leader in the industry when it introduced "Big Daddy," the ultimate oversized driver. Big Daddy was an immediate success because it allowed the average golfer to drive like the professionals. In the early '90s, Green Dream introduced the "Smackmaster Series" which was a line of oversized perimeter weighted irons. Like Big Daddy, these irons were met with immediate approval and Green Dreams continued achieving record-breaking profits. The most recent product line offered by Green Dreams is the "Fujihara," a putter designed by a famous Japanese scientist that claims to take five strokes off your score.

• After being assigned to the engagement, you asked for a tour of one of Green Dream's plants to better understand their business and manufacturing process. You were surprised to learn that their golf club manufacturing process was highly mechanized. Chip Shot, Green Dreams' plant manager, told you that one of Green Dreams critical success factors is its highly automated manufacturing process. This process allows Green Dreams to manufacture golf clubs at an extremely high rate in order to meet growing demand and provides for incredible precision. Chip told you the only manufacturing concern was the short life of the various assembly line components which were in need of continuous replacement.
• As the senior in charge of the engagement, you had the responsibility for testing the Company's various sales and use tax liabilities. Your first step in the process was to sit down with the Vice President of Tax, Sandy Wedge, and discuss the accounting processes and procedures used to calculate the liability in question.
• As you learned from your plant tour, Green Dreams purchases significant amounts of plant equipment to keep its assembly line running as efficiently as possible. You asked Sandy how the sales/use taxes were computed. She told you that Green Dreams accrues what they expect to pay in sales/use taxes every year. She explained that Green Dreams purchases almost 100% of its plant equipment outside of its home state. Because they take possession of the equipment outside of the state from which they purchased the equipment, they are not obligated to pay any sales tax on the equipment per se. However, they are required by law to pay a use tax in the state in which they use the item.
• You asked Sandy for a listing of property purchases that Green Dreams made during the year, and recomputed the use tax liability based on the company's current year's purchases. Unfortunately, there was something wrong with your estimation technique because your estimated tax liability was significantly higher than the amount that Green Dream has recorded.
• You asked Sandy if she could help you identify any flaws in your logic. She smiled and said, "I told you earlier that we accrue exactly what we expect to pay in use taxes every year. However, what I didn't tell you is that we don't expect to pay the full amount of taxes for all of our purchases. Sandy explained that Green Dreams' policy was not to remit any use taxes for out of state purchases. She said that Green Dreams regularly gets audited and they gladly pay any amount the auditors identify plus penalties and interest. The state and local auditors do not typically find 100% of the purchases made during the year under examination, and therefore, the amounts paid are far less than the actual liability owed for such items. She also assured you that Green Dreams is always cooperative and forthright with the state and local authorities whenever they arrive.
• Sandy believes that accrual and disclosure of the liability would not be in accordance with GAAP, since SFAC 6 defines a liability as a "probable" future sacrifice of benefits, and it is not probable that the company will pay the total amount, based on Green Dreams' experience.

Answer these questions on a group basis:

Problem 1. Use the Eight Elements of Reasoning we discussed in class and fill in all of the pieces for the main accounting issue: "How should Green Dreams account for the sales/use taxes?" Use the provisions of SFAC #6 and ASC 450-20 to reach a conclusion.