FROM: Company Controller (LSL)
DATE: December 10, 2010
SUBJECT: LumberSell Limited—Financial Reporting Issues (Fiscal Year 2010)
This memo will analyze significant financial reporting issues relating to LSL’s financial statement for 2010.
LUMBERSELL LIMITED (LSL)
LSL is a public company in lumber business and has decided to report financial issues under IFRS for the year of 2010. Based on the expectation that the company will only have a break even this year, we are seeking to increase the company’s line of credit, which depends on the company’s net income and liquidity ratios for 2010. The financial statement users and their objectives, including the following: •As the CFO of the company, you want to demonstrate good debt paying ability in order to get the increased line of debt and therefore have the incentive to maximize net income and liquidity. •The bank, as a potential debtor, holds a conservative attitude and wants to see the true picture about the company’s financial situation to ensure LSL can repay its debts. •The auditors verify the reliability of our financial statements as neutral parties with fair reporting objective, and will audit fairly and truthfully. As a company controller, my job is to help the CFO with preparing standard financial statements that will hopefully let the company get an increased line of credit from the bank. With an aggressive financial reporting objective, I am responsible for reporting the financial statements with a view to the best interests of our company within IFRS.
ISSUE #1: ACCOUNTING FOR ROYALTIES PAYMANTS
During the year of 2010, LSL has signed a licensing agreement with Bowman Inc. (BI) and promises to pay BI royalties each year. Alternative #1: record royalties of $1,750,000 for five years as expenses. According to the licensing agreement, LSL has to pay BI loyalties each year with a minimum payment of $350,000 for at least five years. Because the payment of $1,750,000 is unavoidable and enforceable, we should recognize it as increasing on liabilities and expenses. Following this alternative decreases net income and worsens liquidity. Alternative #2: record the minimum payment of $350,000 as current year expenses. CICA HB 311.94 states that “expenses are recognised when a decrease in future economic benefits can be measured reliably”. In this case, the only expense that we are sure about is the minimum payment of $350,000. We should only report the minimum royalty and wait to make a year-end adjustment with respect to the actual sales. Reporting in this way leaves us at a higher net income and liquidity ratios. Alternative #3: record royalties as 3% of the estimated sales. The matching principle under IFRS states “expenses are recognized in the period when they are incurred and related revenue is earned”. Based on the popularity of BI’s technology, it is very likely we will have to pay more than $350,000. As a result, the expenses will be higher and therefore will have a lower net income and liquidity. Conclusion:
Because it is our first year of selling BI’s technology, there is not enough historical data to estimate sales. Alternative #2 is the most appropriate choice. It makes our company look better and it is more likely we will get the increased line of credit from the bank.
ISSUE #2: ACCOUNTING FOR FEES CHARGED BY GOVERNMENT
The U.S. government has levied anti-dumping fees and countervailing duties on LSL and in order to continue to sell in the U.S. LSL has deposited $4 million. Alternative #1: fully account the fees and duties as liabilities at the amount of $4 million. CICA HB 311.49 defines liability as “a present obligation of the entity arising from past events”. The fees and duties are resulted from our past shipment to the U.S. and they are enforceable future obligations. The $4 million is considered as duty owed to U.S. government. This option leads to higher liability and lower liquidity....