Frangipani Ltd. (FL) is a new company that has just started up in January 2017. The company is the brainchild of Frank Frangi, who is working on developing a new process for a solar-powered car. To date, most of the year has been taken up with setting up the lab and working on the problem of how to power the vehicle using solar energy. The work has been financed equally by a government-sponsored bank loan and Frank's own personal capital, which he contributed to the company in return for 100% of the common shares upon incorporation. In addition, FL sold preferred shares to family members who are anxious to see how the project (and their investment) is progressing. Frank originally thought to take a salary from the company but has not yet done so this year due to the tight cash flow situation. FL has five scientists working for it. Instead of salary, the scientists have been awarded share appreciation rights that are settleable in cash or a variable number of shares at the option of the company.
Under the terms of the government-sponsored loan:
• FL must report to the government annually on its progress, including its ability to continue to operate;
• FL must maintain a debt to equity ratio of 1:1; and
• The debt is forgivable if FL generates the new process within three years. The government will instead take back preferred shares.
The preferred shares have the following characteristics:
• They are redeemable at the option of the company for common shares, and
• They are redeemable at the option of the holder (in cash) if the company does not make a profit this year.
During the year, FL has been selling advertising space on the company website. Frank is very interested in programming and has created a website that attracts a significant amount of traffic. The website includes several scientific and environmental blogs that many scientists and interested parties contribute to. As a matter of fact, many scientists help each other with practical and theoretical research questions. Since FL continually needs funds to further the work on the solar-powered vehicle, the advertising fees are paid upfront. FL has a clause in the advertising agreement that states the fees are non- refundable. In addition, the advertising fees are stipulated as being for one month's worth of advertising although it is commonly understood that FL displays the advertising for a year. At the end of November 2017, a significant amount of advertising dollars were received.
Frank and the scientists working on the car really feel that they have made significant breakthroughs this year and are close to reaching their goal and submitting the technology for patenting. On December 31, 2017, FL received a call from the company's patent lawyers stating that someone has already filed a patent for the technology that FL is developing. Frank was very angry to learn that it was one of the scientists who contributes to the FL blogs. Apparently someone had leaked critical information about the FL technology in an on-line discussion and the idea had been stolen. Frank has already contacted his friend who is a litigation lawyer and is confident he can prove the theft of the intellectual capital.
Instructions
Assume the role of FL's accountant and discuss the financial reporting issues for the year ended December 31, 2017. The company follows ASPE.