Chapter 24, question #2
1.) The auditor was incorrect by stating the requirements of the agreement varied based on retained earnings. The retained earnings are stated as being $420,000, which was the balance of retained earnings when the agreement was arrived at. The reasons and amount of restrictions should be disclosed in the balance sheet, or at minimum as a note on the financial statements.

2) Common stock policies are typically understood as providing dividends on a discretionary basis. Ace Inc. is not required to explain the decision not to pay dividends in a specific time period however it would be to the company’s advantage to disclose the reason as a note in the financial statements. There was not a mentioned of preferred stocks being issued, but these shares are usually of a nature where dividends are accumulated even if dividends are not declared.
It is important to remember the SEC encourages companies to disclose their dividend policy in their annual report especially if the firm has recorded earnings, but does not dividends.

3) When Ace started producing the new product there were no competitors. With this understanding a notation of a subsequent event is presented in the reports. When this occurred an auditor might deduce that Ace’s competitive situation was evident at the end of the reporting period. The new competitive nature of the industry should be disclosed in the financial statements because the economic recoverability of the new plant and inventory are in doubt and Ace may have additional costs associated with the modification of the new facility. If the current value of the plant is determinable Ace should consider a disclosure of the company’s revised financial position in a pro-forma balance