Baker Company Limited (BCL) was founded in 2009 and its first year of operations turned out to be a good one, as start-up years-go, since the company not only broke even but actually showed a very small profit. Just as the company was getting established in the market, however, a full-fledged recession hit in 2010 and had devastating effects.
Demand for BCL's products in retail markets declined as consumers tightened their purse strings. Through tight cost controls, however, BCL managed to hold its own and still recorded a small profit in 2010.
While the recession finally petered out by the end of 2011, BCL did end up feeling its effects, as the company was unable to remain profitable and suffered large operating losses that year. In fact, the losses were significantly greater than the profits that were reported in the previous two years. Despite this change, BCL management was not overly alarmed by the losses and had the following comments to make:
The losses were expected given the widespread recession. Since the bulk of our sales are in retail markets, and with unemployment levels being at record highs, it is not surprising that consumer demand has fallen off. If BCL is compared with the industry, you will see that we did much better than our competitors, some of whom went bankrupt.
Keep in mind that we are a relatively new company and managed to record a profit in two out of our first three years. We attribute this to our strong management team and our ability as a streamlined company to react to the recession with cost control measures and an aggressive, yet flexible sales staff.
We see ourselves positioned for a new growth spurt given that the economy seems to have recovered and a lot of "dead wood" (i.e., competition) has been cleared out. As a matter of fact, in that regard, the recession will have a positive impact on our short- to mid-term growth potential.
BCL is on the verge of introducing two new products that will revolutionize the industry and assure us a solid earnings base for the future. These products will be introduced in 2012 and we have already lined up sufficient buyers such that we predict we will at least break even in terms of net income in 2012. This is a very conservative forecast.
Although the effects of the recession were lessening, unemployment was still high in early 2012 and consumer spending had not increased significantly. Some economists were predicting that it would take two or three years for consumer confidence and spending to pick up to pre-recession levels.
Instructions
Adopt the role of the company's auditor and determine whether BCL should recognize the benefits of the losses suffered in the 2011 financial statements. Assume BCL is a private company.