Question

intermediate accounting 1

Case

WINERY INC.

Winery Inc. (WI) is a private corporation formed in 2018. Prior to 2018, WI had been operating as a partnership by the Verity family. Due to their success and desire to expand, they have made the decision to incorporate so that they will have additional sources of financing. They are just establishing their accounting policies for their first year-end as a corporation. Their previous financial statements as a partnership were used for filing their tax returns and management purposes. They were not audited or reviewed.WI is considering adopting GAAP for public companies to be comparable with its competitors.

WI grows grapes and produces wines in Ontario. The company also produces beer, spirits, and juices. It has a small store on the property where staff operate winery tours and sell wine. WI incorporated to raise additional capital to expand the operations by planting additional vines and expanding operations to produce organic wines.

In 2018, WI obtained a bank loan with Big Bank. Previously, when WI operated as a partnership, the bank had provided a line of credit, and the owners had provided personal guarantees. The loan now has the personal guarantees removed, and instead, the bank requires annual audited financial statements and has a financial covenant that stipulates a minimum current ratio.

You have recently been hired to develop new accounting policies for WI’s 31 December year-end. Previously, the partnership used the cash basis of accounting. The owners know this will no longer be suitable for their corporation. You have been asked by the owners to discuss alternatives and provide recommendations on the appropriate accounting policies for events below that have occurred during 2018.

1.     WI spent $500,000 expanding its operations by planting new vines that were purchased in France. These vines are certified as being organic and will produce a red wine. The vines will produce grapes indefinitely as long as they are properly taken care of during the year.

2.     WI obtained a winery license during 2018 from the Ministry. This license allows WI to distribute wine in Western Canada. The license does not have an expiry date.

3.     Wine can take over two years to mature. Premium wine is stored in oak casks to age.

4.     A customer can purchase WI’s wine in the store at the winery, at the LCBO, or starting in 2018 through WI’s new website. WI invested $70,000 in acquiring software for its computer system. WI spent an additional $10,000 on the following costs to develop the website—consulting fees to a website consultant, graphics design, and costs for training employees on the use of a website and for the company’s web domain.

5.     A customer can become a member of WI’s new wine club. To join the club, a $200 annual fee is paid. In return, the member is shipped one bottle of red wine and one bottle of white wine a month. If a member likes the wine, it can be ordered by the case through the website at a 10% discount. As part of the annual fee, members receive a free subscription to Wine Digest, which could be purchased on its own.

6.     Early in 2018, WI’s winemaker in error added too much yeast to the wine in the vats (large containers that the juice ferments in to make the wine). Initial tasting of samples from those vats indicates that the wine is spoiled. WI fired the winemaker since the wine had a market value of $1 million. The winemaker has sued WI for wrongful dismissal.

7.     Until the new vines are producing crops in 2019, WI entered into an agreement to purchase grapes from Chile for production. To protect itself from foreign exchange fluctuations, WI entered into a hedge. If hedge accounting was elected, this would be a cash flow hedge.

8.     WI received a forgivable loan of $1 million. This loan is forgiven if WI hires five additional employees for the next two years and produces a specified amount of organic fruit each season for use in its organic wines.

Required:

Prepare the report, assuming that WI prepares their financial statements in accordance with IFRS.

Answer 1

A report for alternatives and provide recommendations on the appropriate accounting policies for events occurred during 2018

1. New vines purchased in France and later on certified as being organic and will produce red wine, will be come into scope of IAS 16 "Property,Plant and Equipment ". As per IAS 16 WI has two options : 1. cost model , 2. revaluation model . WI should recognise purchased vines on cost model i.e.$500,000.

2. As per IAS 38 "Intangible Assets " , Entity can recognise an expense as Intangible assets if they follow criteria specified under IAS 38 which includes but not limied to Asset can generate economic benefits to owner. WI has obtained a license to distribute wine in Western Canada. So, WI should recognise winery license as an intangible assets as per IAS 38 because it is giving economic benefit in form of opportunity to sale in western canada.

3. As per IAS 2 "Inventories" , Inventory should be recorded as the lower of cost or market value(Net realizable value). WI should value wines that can take 2 years to mature and required to store at lower of cost of produce and market value.

4. As per IAS 38  "Intangible Assets " , Expenditure for an intangible item can be recognised as an intangible asset if it is probable that there will be future economic benefits from the assets and cost of the asset can be reliably measured. WI has purchased software for $70,000 and incurred $10,000 for website development. These expenses are made for launch of Online platform to buy wines by customer. so it can be said that future economic benefits are expected and cost can be abe measured for such intangible asset i.e.$80,000. So, WI should recognise it as an Intangible asset and should follow IAS 38.

5. WI should bifurcate the annual membership fees of $200 between cost of benefits member will get after payment of fees. As WI is giving monthly shipping to member, giving free subscription to wine digest etc. WI should recognise that part of $200, for which they have already provided the service or goods. WI should differ it on proper basis rather than to recognise on cash basis.

6. Winemaker has done mistake and WI has to bear a loss of $1 million. WI has to book it as an abnormal loss and should disclose in report to make into attention of stakeholders. As winemaker has sued WI for wrong dismissal , WI should prudently disclose the fact of the case and should make a provision or contingency if WI can measure the value of future loss.

7. As per IFRS 9 , any gain or loss on hedging instrument should be cumulated to "cash flow hedge reserve". WI should account any gain and loss from foreign fluctuation transaction to cash flow hedge reserve and if at any point of time cash flow hedge accounting is discontinued , amount accumulated should be reclassified to profit and loss.

8. For accounting purpose, Forgivable loans should be consider as a revenue with fulfillment of certain conditions. WI should differ the forgivable loan on the basis of fulfillment of condition like hire of 5 additional employees for two years and produce specified amount of organic fruit. WI should recognise portion of the forgivable loan as an current period revenue on the basis of fulfillment of to the extent condition of the loan.