Question

The partner asked you to prepare a report to be provided to the client that addresses some of the accounting issues occurred in 2019. These accounting issues are listed as follows:

1) During 2019, SWO purchased the 15% equity of an electronic supplier. SWO provides technical support to the supplier’s operations and participates in its policy making. Recently the supplier’s business costs were significantly increased, resulting in substantial losses and shortage of cash flows

2) SWO provides a ten-year warranty with all equipment sales. The warranty covers all defects and breakdowns that are not directly related to regular wear and tear. Based on the experience, SWO estimates the probability of an equipment making a warranty claim during the next 10 year of coverage is as follows:

Year 1	2	3	4	5	6	7	8	9	10
1%	2%	2%	5%	5%	10%	12%	15%	18%	20%

. The average retail value per claim is $100 currently and increases by 3% every year. The average cost of parts and service at SWO is about 60% of the retail value. The effective interest rate is 6%

3. At the beginning of 2019, the company granted options to the management to purchase 80,000 common shares. The options can be exercised any time within the next five years at a strike price of $5 per share. The company expects that the period of benefit/service for these options is three years. The fair value of the options, as determined using an option pricing model, is $900,000.

4. On July 1, 2019, the company issued 20,000 preferred shares for $10 per share to an investment bank. Each preferred share is convertible for a fixed number of common shares and has a mandatory 5% annual dividend that must be paid on December 31 of each fiscal year. These preferred shares must be redeemed by the company for cash if the market price of common shares exceeds $10 per share. Currently, the common shares are in trading range around $6 per share.

5. On September 15, 2019, the company entered into a forward contract with the Bank of Vancouver by locking the price of 600,000 kg of aluminum at $1.50/kg. Aluminum is used in the production of stereo equipment. As at December 31, the price of aluminum is trading on the Chicago Board of Trade at $1.25/kg.

Required Prepare a report on your analyses of the company’s accounting issues. Add supporting calculations if need be. Urgently needed(before 18th May 9pm), please answer whatever you can, I will positively rate your answer.

Answer 1

I am not an expert in these topics and still, I share whatever I know as you have mentioned that in the question. Hope this would help you.  

1. Here SWO purchased 15% equity of a supplier. So, SWO does not exercise significant influence over it. Still, as SWO supports the supplier in operation and policymaking, SWO can understand the business situation of the supplier.

There are different options for the company. One is to concentrate more on policies that would help the supplier to reduce the cost and improve efficiency to make more profit and SWO will get a part of it. As the company holds only 15%, the other option is to keep the share for trade or use it for speculation. SWO can easily get the information before getting into the market. So, it would be a good opportunity to make some profit.

2. Warranty estimates show that the company is going to have some percentage of warranty claims every year. The company can charge a price for the warranty if that will work in the market. Practices like providing 3,4 years free warranty and charging a price for additional would be an option. Whether the company charge or not, it is important to make provision for warranty claims as estimate shows claims every year. The percentage of provision should be optimum as it blocks the fund and too less provision will not help.

3. Option pricing shows $9,00,000 fair value for the option and the company expects that the employees exercise the option in 3 years. The company has to be ready to give shares to the employees at the agreed price. It all depends on the price of the share of the company.

4. Company issued 20,000 preference shares at $10 per share. Here common shares are in the trade for $6. Changing the preference share to a common share wouldn’t be a good option for the investors. After converting to common share it is not possible to give 5% fixed dividend. Fixed dividend is given to Preferred shares only.

5. In this scenario, Company has the obligation to buy the Aluminum at $1.5/kg. As the rate of Aluminum declined to $1.25/kg, Company is going to lose $.25/kg. Company must see this loss and take precautions. As forward is an over the counter contract there is an option to settle with the seller outside.