Bright Lights Ltd. (Bright) is a private company incorporated five years ago by a group of friends who had recently graduated with business or engineering degrees. The group is interested in innovative designs to meet a variety of lighting needs and has been working with photovaltaics technology (PV). PV is a clean, sustainable method of converting solar energy into direct current electricity. PV incorporates solar cells in panels; however, solar panels have been expensive in smaller applications to date. Bright is modifying PV technology to result in lower cost and relatively lightweight building integrated photovoltaics (BIP) or solar panels that can be installed on residential and commercial rooftops.

At this point, the beginning of 20X6, Bright is still in start up mode, and has not commenced commercial production. The product is being fine tuned and re engineered to ensure it is cost effective and meets output specifications. The SCI shows expenses but as yet no revenue; the company has an accumulated deficit. Great progress has been made, though, and the company has sufficient cash from loans and private equity infusion to reach the commencement of commercial operation in 20X7.

Bright’s board of directors is in discussions with several potential investors who are interested in Bright’s proprietary technology. Additional equity financing options are being explored because Bright is interested in lowering its cost of borrowing, which is 9%. These investors will be using ratios such the debt to equity ratio when assessing risk, and return on assets to assess profitability. While return on assets is not meaningful in the development stage, it will become important when operations commence. Shareholders’ equity is currently a net positive number, despite accumulated losses, because of the encouraging but necessary level of equity investment to date.

It is now 25 February 20X6 and you, a CPA with a medium sized public accounting firm, have been engaged to provide accounting advice to Bright for its 20X5 fiscal year. Although a private company, Bright reports under International Financial Reporting Standards (IFRS) so as to better meet the information needs of its potential investors. You know that, in general, technology companies hope to be takeover targets when their technology is desirable.

You have met with Bright’s bookkeeper, Victoria Shugarue, who provided the information noted in Exhibit I. You realize that there are several accounting issues to discuss with respect to accounting policies for the 20X5 year end. You decide to prepare a brief report to use as a basis for discussion with the audit committee, which will meet next

week.

EXHIBIT I

BRIGHT LIGHTS LIMITED

Notes concerning accounting issues: 20X5 year-end On January 1, 20X4 Bright acquired a building from the local municipality at a cost of $210,000. Also on that date, Bright received $50,000 in government assistance from the regional economic board to be used toward the purchase of the building. The building had a remaining useful life of 25 years in 20X4. Depreciation on the full building has been recorded on a straight-line basis in 20X4 and 20X5. There is a balance of $46,000 in a deferred government assistance account at 31 December 20X5 that represents the original $50,000 amount less the charges to reduce depreciation expense for two years. Only 40% of the building is now used, because Bright is still in the development stage, but it will be large enough to support full-scale commercial development in 20X7. Manufacturing equipment is being rented on a modest scale, again consistent with development-stage activities. The entire operation will be scaled up and expanded for 20X7.

The 20X4 agreement with the municipality also provided Bright with access to land adjacent to the building. The land had been vacant for some time so Bright was able to obtain use of the land by agreeing to pay a nominal rent per year for 10 years. The municipality was pleased with the economic impact that will result when Bright advances its technology, begins production, and provides employment opportunities. While use of solar panels provides a clean energy source, the manufacturing process generates wastewater that may contain hazardous compounds. This has not been an issue to date, but must be addressed for 20X7. Bright will follow regulatory guidelines to treat and properly dispose of any toxic contaminants generated in the manufacturing process.
Later in 20X6, Bright plans to install waste management tanks on the land rented from the municipality. To alleviate the loudly expressed concerns of the community, Bright announced a commitment to remove the waste management tanks before 31 December 20X13 and also promised to carry out significant enhancements to the land with the same time line. Tank removal and creation of a park and playground area are activities that are estimated to cost $90,000 in 20X13. By the end of 20X13, management of Bright is confident that technology will have moved on to either allow production without the hazardous compounds issue, or a different decontamination process will be available.

This announcement was made in early 20X4, and the plan was disclosed in the notes to the 20X4 financial statements. The $90,000 will be expensed when the money is spent. Bright is spending large amounts of money to refine and re-engineer its technology and product lines to ensure they are cost-effective and meet output specifications. To date, all such expenditures have been expensed as research costs, but the question is whether expenditures can now be capitalized as a development asset for later amortization.

Required

Prepare the report.