Sunlight Equipment Manufacturers (SEM) makes barbecue equipment. The company has historically been very profitable; however, in the last year and a half, things have taken a turn for the worse due to higher consumer interest rates and a slowdown in the economy. On its 2020 draft year-end statements, the company is currently showing a break-even position before any final year-end adjustments. The company had fired its CEO, Sam Lazano, at the beginning of the year and a turnaround specialist was hired—Agneta Lundstrom. Agneta has a reputation of being able to come into companies that are suffering and make them profitable within two years. Agneta has agreed with SEM’s board of directors that she will be paid a $1-million bonus if the company has a combined two-year profit of $5 million by the end of 2021.
Among other things, Agneta instituted a more aggressive sales policy for SEM’s customers, who are mainly retailers, as well as a new remuneration policy for sales staff. Agneta attributed the company’s poor performance to untrained sales staff whose remuneration and bonus scheme were not properly aligned to maximize sales. Under the new remuneration policy, sales staff members are paid salary as well as a bonus, which is a percentage of gross sales as at year end. The sales staff has responded well and sales have increased by 20%.
The new sales policy is as follows:
- Cash down payment of 20% with remaining payment for shipment once the barbecues are sold by the customer to a third party.
- If the customers double their normal order, no down payment is required.
- The barbecues may be stored on the premises of SEM. Many customers have taken the company up on this offer in order to double the size of their purchase.
- Any unsold barbecues are allowed to be returned after year end.
Under the new policy, sales have increased dramatically, with many customers taking advantage of the new terms. As at year end, legal title to all barbecues has passed to the customers. Only customers with an excellent credit history have been allowed to purchase under the new policy. The company has accrued bonuses for almost its entire sales staff.
The increased profits from these sales have been offset by the accrual of $500,000 of Agneta’s bonus. She is very confident that she will be able to turn the company around and so has accrued part of her bonus. She has also decided to change several accounting policies, including the following:
Depreciation on machinery switched to straight-line from double-declining-balance. Note that the equipment is about two years old with an estimated life of 10 years. Agneta felt that the double-declining-balance method was arbitrary and noted that several of SEM’s competitors use the straight-line method. Machinery is most useful when new because it requires less downtime for fixing.
Another problem that Agneta had identified was in inventory management. Agneta was convinced that inventory was being stolen and/or “lost” due to poor tracking. SEM had therefore hired a company, Software Limited, to install a new inventory tracking system during the year. Midway through the year, Software Limited went bankrupt and was not able to finish the installation. The installation was a customized job and, as at year end, the system was not functioning yet. SEM has not been able to find a company to replace Software Limited. To date, $2 million has been spent on the new system. Agneta had capitalized the costs and noted she was confident that she could find a company that could successfully complete the installation.
Instructions
Adopt the role of the company’s auditors and discuss the financial reporting issues for the 2020 year end. The company is a private company but would like the statements to be prepared in accordance with IFRS.
