Question

KCT Farms (KCT) is a private Canadian company that produces markets and distributes a variety of dairy products including cheese, milk, and extended life milk and cream products. The Farm is located in Southwestern Ontario, however, they currently ship products to retailers in Ontario and Quebec. KCT farms incorporated 30 years ago by the Kris Family. The company has a June 30 year-end.

You have been hired to work in KCT’s finance department. In a recent meeting with the CEO, she indicated that the company is looking to obtain additional financing to expand their current operations to other provinces. If that expansion is successful, KCT is hopeful that they will be able to gain attention of international investors and will be able to expand into the US, Europe and beyond. However, for the time being, the company has approached the bank for additional financing. The bank has requested that KCT provide GAAP compliant financial statement. The Kris family does not really know much about GAAP, and what their options are, and has asked that you provide some context.

It is now July 15, 2019 and you are preparing the year-end financial statements and note disclosures. You meet with the CEO and she has asked that you provide assistance prioritizing the issues facing KCT. In your discussion, following contentious issues were identified:

- During the year, KCT sold a parcel of land with a gain of $1.5million. The $4.8 million sales price has been included in sales and the $1.3 million carrying amount has been included in cost of goods sold.

- KCT accounts for its capital assets on an historical cost basis, but has not recorded depreciation on a few specific pieces of equipment. The assets in question include: Land costing $1.2 million a new state of the art manufacturing facility costing $10.5million, and 10 new processing machines costing $200,000 each. The Company’s owners have always felt that depreciation does not represent the true economic value of the equipment, and skewed the overall income in a way that is not meaningful to investors.

- During 2018, an ex-employee sued KCT in the amount of $450,000 for wrongful dismissal. Correspondence between the KCT legal team and the plaintiffs counsel indicates that a settlement of $125,000 would be acceptable to the employee. KCT has not yet agreed, but their legal counsel is suggesting that they go forward with the out of court settlement. If an agreement does not come about, court proceedings would not commence late until 2019. KCT plans to record the amount in the financial statements when the final amount is finalized.

Prepare your report to the CEO that addresses the contentious accounting issues. Provide support for your recommendations. Using the CPA way to solve this Case

Answer 1

ANSWER TO THE ISSUE

In short there are following issue which has to be address by accountant of KCT Farms (KCT):

1. Accounting of sale of land
2. Depreciation entry of fixed assets
3. Claim by ex-employee

Accounting of sale of land

In this case sale of land shown as sales and carrying value as cost of goods sold, which is not correct because fixed assets is used by KCT for the purpose use in production of goods in course of business.

Land is not inventory of the KCT. So it can not show sale of land as part of sales.

Therefor, correct accounting treatment would be gain on sale of land of $1.5 million after netting off carrying value of assets and it has to be shown under head income.(NOT part of sale)

Depreciation entry of fixed assets

Companies provide depreciation to show its asset use during the year to stakeholders. Deprecation reduces the historical value of assets over the useful life of assets. It is one kind of reserve which is made by company to accumulate fund and utilized that fund for the purpose buying new assets. There is tax benefit of depreciation save income in form of taxes.

There are different method of depreciation out of which Written Down Value (WDV) or Straight Line Method (SLM)are famous one. Under WDV method a specific rate has to be charged on carrying amount of assets but under SLM assets value will be depreciated at equal amount over life of the assets.

So, depreciation entry need to be passed to give true and fair picture of profit and loss.

Claim by ex-employee

Since claim by ex employee is sustainable in court of law and ex employee is agree for out of court settlement provision entry should be passed by debiting profit and loss amounting to $125,000 .