James North and Leanne South have operated a small gardening centre and landscaping business for the past 10 years. Their business is incorporated as a private corporation. Since there is no market price for their shares, their shareholder agreement states that in the event a shareholder decides to buy or sell their shares the amount will be based on four times shareholders’ equity. The company has a December 31 year-end.
For the past year, Leanne has been managing all operations and making all accounting policy decisions, as James decided he wanted a career change and went back to school. Last week they met for coffee, and James mentioned he wanted to invoke the shareholders’ agreement. He felt it unfair that Leanne was doing all the work but not getting all the profits. He has no intention of returning to the business; he loves school and is in fact contemplating setting up his own advertising agency. Besides, he said, on a personal note he needs the money to pay back his school loans and set himself up in his new career.
Leanne has been happy with being able to make all the decisions and wants to buy James out rather than get a new partner. She has negotiated with their bank to obtain a loan with a personal guarantee to make the buyout. She is a little nervous, however, about the risk of having a lot of debt.
You have been the accountant for the business since they started. You know both the owners well. This morning you had your usual year-end meeting with the bookkeeper to go over anything new so you can start to prepare their financial statements. The following are notes from your meeting:
1. During the year, a significant amount of inventory of garden gnomes and animal statues were written off. They had been sitting in the gardening centre for the past two years with only a few being sold each year. The bookkeeper said that Leanne thought it was time to write off their bad decision in investing in that inventory.
2. The business has never offered a warranty to go along with their trees and shrubs. All their competitors offer a one-year money-back guarantee. If a shrub or tree dies within a year of purchase, the money is refunded. Leanne decided in the fall it was time to implement a similar policy. The bookkeeper was told by Leanne to recognize warranty expense and set up an estimated liability based on their past history that approximately 5% from the sales of all trees and shrubs this year would need to be replaced based
on her best guess.
3. Another decision made this year by Leanne was to finally invest in some new computer equipment in the gardening centre. A new computer system was installed that keeps track of all sales in the stores, on-line ordering, inventory values, and all sorts of information Leanne feels will be very useful for future decisions on the direction the business should take. The other assets in the business all use straight-line depreciation. Leanne feels that since computer equipment can get obsolete very quickly it would be more appropriate to use declining balance, and proposes a 40% rate with full depreciation in year 1.
You have a meeting with Leanne at the end of the week to discuss the new accounting policies she has proposed.
James was invited to the meeting but he has a class on that date that he cannot miss.
Prepare briefing notes for your discussion with Leanne. Consider if the proposed policy is appropriate, consider valid alternatives, and provide a recommendation for each policy.