Love Your Pet, Inc. (LPI) is a pet food company located in rural Quebec. LPI has been operating for years as a distributor of pet food but in the last year has begun to manufacture raw dog food. In the current year, LPI has been certified by the Canadian Association of Raw Pet Food Manufacturers, (CARPFM). This organization believes that companion animals benefit greatly from a diet more closely related to their hereditary and biological makeup. Certification was completed in the third quarter. Sales of raw dog food literally doubled in the fourth quarter.

Prices have been on the rise for raw meat used in production. Dog food is primarily made from the organs of cattle, lamb, duck, or, in some cases, bison. LPI purchases its raw materials only from other companies that have received CARPFM certification. Accordingly, there are a limited number of suppliers that can provide raw materials as needed. Raw materials for manufacturing either raw dog food or dry dog food are turned over quickly to reduce spoilage. Raw foods are freeze dried immediately once produced. Dry dog food is immediately packaged. Both freeze dried and packaged raw food has a shelf life of one year if the product is unopened.

To meet CARPFM standards, LPI has made a significant investment in equipment, financed in part through an increased term loan plus a line of credit from its bank. The bank has tied the maximum line of credit amounts to 50% of inventory and 70% of accounts receivable.

You have been hired as the new controller for LPI. Your boss, Stuart Mack, needs guidance on proper treatment of several accounting issues, since the new arrangements with the bank will now necessitate an audit. LPI has not needed assurance on its financial statements in the past, and simply had a Notice to Reader prepared to assist with tax return preparation. LPI will be preparing its statements in accordance with IFRS.

Facts to note:
• Under specific identification, periodic and perpetual always give the same result because the cost of each specific item sold is identified. Therefore, the same inventory amount is shown for both.

• Average cost yields different results under the periodic and perpetual methods because the numbers of items and their costs are averaged together differently under a moving average (perpetual) than under a historical tabulation of purchases (periodic).

• FIFO always yields the same result under both periodic and perpetual methods.

1. LPI sells bags of dry dog and cat food in its retail stores throughout Canada. Customers can collect stamps on an LPI frequent buyer card, and for every 10 similar bags purchased, LPI will provide an 11th bag for free. The price of a bag of dog food ranges between $15.00 and $70.00, depending on the size of the bag. This program has been in operation for the past two years. LPI has been tracking the extent of redemptions, and to date the program has attracted roughly 60% of customers who buy packaged dry food. This program is ignored in the accounting system the product “given out for free” is simply expensed in the period it is distributed as part of cost of goods sold.
2. LPI has an agreement with a large farm in Quebec that gives LPI a rebate of 10% on purchases of raw meat as long as volume reaches a certain level. Volumes have been met, and in fact are increasing in every quarter since the agreement was signed. This rebate is paid to LPI in the quarter following purchases. LPI has always recorded this discount as a credit to cost of goods sold in the quarter received.

3. With the exception of direct materials and direct labour, all costs of operating the manufacturing operation are expensed in the period incurred.

4. LPI is a distributor of dry food for other suppliers. Recently, a manufacturer in the United States began a recall of several significant batches of its dry pet food products due to possible contamination with salmonella. There have been U.S. reports of some older small breed dogs dying after allegedly consuming this brand of dog food. The manufacturer has since gone out of business. Unfortunately, this product line had previously made up 20% of LPI’s dry dog food sales. LPI had four months of inventory on hand, only some of which were from the recalled batches. However, all products from this supplier have been removed from the shelves and are essentially unsaleable because of concerns over pet health.

5. LPI has always used FIFO for all types of inventory, but Stuart is wondering if LPI should switch to the average cost method. A number of competitors use this method and he has asked you what the impact might be on gross margin and the current ratio as a result of the switch. 

6. One of Stuart’s friends, Carly Jetson, the owner of a local boutique holistic health store, has started a holistic line of rabbit food. LPI does not currently manufacture or sell rabbit food so Stuart has allowed Carly to have free shelf space for her product. Stuart pays Carly 80% of the retail price when the food sells.

Required:

Prepare a memo to Stuart in which you identify and analyze the accounting implications of each of these issues. Include a clear conclusion for the accounting treatment that should be adopted.