Question

Intermediate financial accounting1

Higgins Dairy Limited

Higgins Dairy Limited (Higgins) is a dairy company operating in South Western Ontario. The company’s founder, Karen Binev, owns 70 percent of the shares. Three other private individuals, who have very little involvement in operating decisions, each own 10 percent. Higgins produces milk, yogurt, ice cream, etc. that it sells through grocery stores and chains throughout Ontario.

Over the years, labour and management have had a taxing relationship. Over the past ten years, the union representing Higgins’s employees have made significant wage concessions to avoid job losses. In the last contract negotiations, Higgins and the union agreed that the union would have access to the company’s financial statements. The upcoming negotiation will be the first time the union will receive the financial statements.

You have been hired by the union representing Higgins’s employees to prepare a report on how to account for a number of controversial issues that arose on the union’s review of Higgins’s December 31, 2018 financial statements and its preliminary discussions with Higgins’s management. The union will use your report in its assessment of Higgins’s financial position and performance, and its ability to pay higher wages and benefits to employees.

Up until now, the company has followed ASPE, however, the union leader has asked whether IFRS would be more beneficial for the employees.

The union leader has asked for your report to fully explain your recommendations, discuss arguments that Higgins’s management might use to counter your recommendations, and identify and discuss alternative treatments that Higgins might present for the outstanding issues:

1. In September 2018, Higgins signed an agreement with a health organization that provided its “seal of approval” on certain products. The seal of approval provides assurance to consumers that the products meet the health standards of the organization and allows Higgins to use the health organization’s logo on the products. As part of the agreement, Higgins donated $520,000 to the health organization. The amount was paid in October 2018. Higgins is allowed to use the seal of approval for four years. Higgins expensed the amount when it paid the health organization.

2. In November 2017, the company signed an agreement a well-known professional athlete to endorse the Higgins product line. In September 2018, the athlete was found to be a user of performance-enhancing drugs and has been suspended from his sport for at least two years. Higgins has decided not to use the athlete’s endorsement anymore, although the company’s lawyer advises that the contract doesn’t provide any way to avoid paying the agreed $12,000 per month until December 31, 2020. Higgins expensed the full amount of the contract owing, $288,000, in 2018.

3. On December 31, 2018, Higgins shipped a large order to a customer. Normally, Higgins recognizes revenue on delivery to the customer. The goods shipped weren’t included in the year-end inventory count. Higgins uses a periodic inventory control system. The goods were delivered on January 2, 2019.

4. Early in 2018, Karen loaned Higgins $150,000 to provide the cash to repair some of their processing equipment. As a result of the changes, the equipment is now likely going to be able to produce double the amount of ice cream and other products. The loan is to be paid back in 2022. Higgins expensed both the $150,000 in repairs and the $20,000 in interest on the loan in 2018.

5. In January 2019, a large customer suffered a catastrophic fire that may put the customer out of business. Higgins doesn’t expect to collect any of the $55,000 it’s owed by the customer and accrued an additional expense for the amount in 2018.

Required:

Provide the report to the head of the union.

Answer 1

Situation 1:

In substance, the amount of 520,000 paid as donation to the Health Organisation tantamounts to payment for the right to use the seal of approval of the Health Organisation for 4 years. Therefore, this payment provides the company a right to use the asset and therefore, this payment should not be expensed out but recognised as an asset and amortised over the period of 4 years that the seal can be used by the company. Considering that the agreement was signed in September and assuming that the 4 year period began on 1 September, the amortisation for the current year will be for 4 months, i.e. 13,333 (Annual amortisation 520,000/4=130,000; for current year, 130,000*4/12)

Situation 2

The contract with athlete effectively becomes an onerous contract as the company can no longer avail the benefits of endorsement from the athlete (it does not intend to) but will have to pay a minimum amount as prescribed in the contract. In case of onerous contracts, the standard on provisions requires full amount to be provisioned in the period the contract becomes onerous. Therefore, the accounting treatment in this case is correct.

Situation 3

As the revenue is recognised only on delivery, and the consignment in question is not delivered, the company should not recognise revenue on this transaction. Any revenue, if booked, should be reversed. Also, considering that the inventory does not include this consignment, the cost of this consignment should be added to inventory as goods in transit.

Situation 4

The repair expense of 150,000 incurred is clearly capital in nature as this expenditure enhances the original production capacity of the machine. Therefore, this needs to be added to the cost of the machine and depreciation should be charged on this incremental amount, depending on when the repairs were complete and the machine with enhanced capacity was ready to use.

Situation 5

This event is an event occurring after the balance sheet date. Events after the balance sheet date are recorded in the financial statements only when they provide additional evidence of a condition existing as on balance sheet date. In the given case, there is no condition existing on 31 December 2018 that the customer may default in his payment. The fire incident occurred only in 2019, which implies that the receivable was impaired by an event in 2019 and that there were no preceding events in 2018 which could possibly indicate that a default would happen. Therefore, the accounting treatment of providing for the loss in 2018 is not correct. This loss should be provided for in 2019.

Please comment for any further clarifications