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J&C Co. (J&C) is a manufacturer of women’s outerwear. Most…
J&C Co. (J&C) is a manufacturer of women’s outerwear. Most of J&C’s merchandise in manufactured in Canada. Although production costs are higher in Canada, the company finds that the high quality of the clothes allows it to remain profitable. J&C was founded in 2006 by John Hogan and Christine Murker. Each shareholder owns 50 percent of the shares of the company. In late 2019, John and Christine had a major disagreement on the direction of the company, and they have not spoken since. John is no longer involved in the day-to-day operations of the company and any input he provides is done through his lawyer. In April 2020, John and Christine agreed (through their lawyers) that Christine would buy John’s shares at fair market value, where fair market value would equal three times net income for the year ended December 31, 2020, with the financial statements prepared in accordance with Accounting Standards for Private Enterprises (ASPE) consistently applied.
You are John’s long-time accountant and financial advisor. On February 15, 2021, John storms into your office in a rage. He has just received the 2020 financial statements from Christine, and they showeda that net income was $142,000, well below the average reported in recent years. John blasts that this is ” a complete and utter ripoff” because he’s not going to get nearly enough for his shares, and he isn’t going to stand for it.
You tell John to calm down and he gives you the financial statements to examine. John points out a number of issues he is concerned about, and you tell him you will analyze them and a report explaining any problems with the accounting treatments used and the impact on the agreement. The issues are described in Exhibit A, which follows.
Required:
Prepare the report for John Hogan.
EXHIBIT A: Issues Identified on Your Review of J&C’s 2020 Financial Statements
1. In November 2020, J&C received an order from an outerwear distributor in Chile. The goods were produced and shipped on December 15. This is the first time J&C has shipped to this distributor and the first time it has shipped outside of North America. J&C’s credit department received a report from a credit rating agency in Chile that indicated the customer had a credit rating of “good.” The goods shipped are standard models that have been modified to meet the tastes of the Chilean market. These designs have always been popular in the North American market. The customer isn’t allowed to return any of the goods but J&C has agreed to provide a rebate of 30 percent of the price the customer paid for any goods that it is unable to sell. J&C has not recognized the revenue as of December 31, 2020, because it’s waiting until the goods are sold by the Chilean distributor.
2. In 2016, J&C took advantage of an opportunity to buy large supply of fasteners (buttons and zippers) from a supplier that was going out of business. At the time, John and Christine estimated that the supply of pins purchased would last about four years. Since then, styles and technology have changed so that the items purchased in 2016 can only be used on lower-quality items and/or on the less-stylish garments J&C makes. Christine now thinks this supply of fasteners can be used, but it will take much longer than originally thought. Christine has been trying to sell the fasteners but has only managed to dispose of about 30 percent of the remaining amount. For accounting purposes, Christine has written off the remaining unsold inventory in the year ending December 31, 2020.
3. In November 2020, J&C purchased a two-year license to produce garments with the logos of professional sports teams. The license goes into effect on January 1, 2021 (meaning that J&C can begin selling products with the logos starting on January 1, 2021). J&C paid the sports leagues a non-refundable fee of $100,000 when the IAF640 – Term 2227 – Fall 2022 Midterm Page 2 of 2 agreement was signed in November 2020 and agree to pay a royalty of 3 percent of sales for each item sold with the logo on it. J&C expensed the $100,000 non-refundable fee in 2020.
4. In early December 2020 one of J&C’s customers declared bankruptcy. The customer owed J&C $22,000. The customer is trying to reorganize but it’s clear that J&C will collect little if any of the money it’s owed. The customer is trying to reorganize the company and it is currently negotiating with its major creditors. J&C has always recorded bad debts on a direct write-off basis. For the year ended December 31, 2020, no adjustment to the financial statements was made for this receivable.
