Case

Meltdown Incorporated (MI) recycles plastic and then sells it to manufacturing companies to produce toys, household items (such as coffee makers), and so on. MI was founded in 1998 by Samuel Abdesselam. Sam has maintained full ownership of MI, deciding not to take it public when so many other recycling companies were going public. While Sam is the only shareholder, MI does have a substantial bank loan and the bank requires an annual audit of MIs financial statements and MI follows ASPE. Sam has a background in operations, but is also very strong in accounting.

It is now early 2021 and you are the controller for MI, having been hired just days before the December 31, 2020, year end. In October 2020, Sam decided to step away from the business and spend more time at his second home in Florida. In order to ensure there was someone at the MI facility to oversee production and day-to-day operations, Sam hired a chief operating officer, Fred Finklestein. Freds background is sales and operations and he has limited knowledge of accounting. Fred tried to run the accounting side of MI when he was hired, but determined that it wasnt his area of strength. He received Sams permission to hire you to help him with accounting for some of the activities in preparation for year end, and to help him understand the accounting function better.

Required Sam has some very specific activities for you and has provided you with the information he requires in Exhibit I. Prepare a report to Sam that answers his questions and be sure to provide him with all the necessary backup and calculations to support your discussion.

Exhibit I Meltdown Information It is MIs policy to prorate depreciation in the year of acquisition and year of disposal (based on the month acquired or disposed). Depreciation is only calculated and recorded once per year, at year end, unless an asset is sold. On March 1, 2020, MM purchased a new delivery truck with a cost of $54,000, a residual value of $3,000, and a useful life of eight years. The truck is being depreciated on a straight-line basis. Fred would like you to calculate and prepare the journal entry to record the depreciation on the truck for the December 31, 2020, year end. Fred is also considering selling the truck on March 1, 2021. He expects to be able to get $45,000 cash for it and would like to know what the accounting implication would be if this happened. He feels that he would understand it better if you provided a journal entry with supporting calculations. During 2020, MI purchased a parcel of land with a building on it across the street from its current location. The purchase price was $450,000 for the land and the building. MI intends to build a new production warehouse on the land and demolished the old building on it. The cost of demolishing the building was $20,000 and MI was able to recoup $8,000 of these costs by selling the scrap to a recycler. Fred is unsure of how this should be accounted for and has asked you to provide the journal entry with support. MI also purchased new equipment on November 1, 2020. The equipment cost $125,000. In addition, MI had to pay $5,000 in shipping fees to have the equipment delivered and $8,000 to have a cement pad poured for the installation of equipment. Fred believes there was $15,000 of labour downtime as a result of the installation. The equipment has an expected salvage value of $8,000 and it is standard MI practice to depreciate equipment using a declining balance rate of 20%. Fred has asked you to set up the equipment on the books at the total cost of $153,000 and record the depreciation for the year end. Fred came to you and wanted to know why the land across the street that was purchased in 2020 could not be recorded at the estimated fair value of $800,000. Since we purchased that land, prices have skyrocketed in the area. Just yesterday, I had a call from a casino developer asking if they could buy it for $780,000. I think we could easily get $800,000 for it, but Sam doesnt want to sell it. I think we should record it at what we could get for it. What do you think? During 2020, Fred worked hard to attract new business. In November, he managed to sign a contract with Simcoe Toys (ST) that would see MI selling 500,000 kg of recycled plastic to ST over the next two years at a price of $2 per kilogram. Fred is quite excited about the contract and the fact that ST paid $200,000 in advance of the start of production. The amount was received December 1, 2020. As of December 31, 2020, MI had produced and delivered 50,000 kg of recycled plastic to ST. You noted to Fred that it appears that the $200,000 deposit was recorded as revenue. Fred has asked you if there is anything wrong with that entry. If there is, he would like to know why and for you to make any correcting entry that you feel is appropriate. MI sells to many customers on credit. MI employs a credit manager who reviews a clients financial history prior to allowing them to buy on credit. It is MIs policy to use the allowance for doubtful accounts method based upon the aging of receivables. The balance is adjusted yearly after taking into account any adjustments for customers accounts written off. A snapshot of MIs current accounts receivable balance at year end shows that it has a balance of $529,200 with an allowance for doubtful accounts debit balance of $6,000. (Note that this is prior to any adjusting journal entries that you would make.) A more detailed breakdown of the accounts receivable balance shows the following amounts aged:

030 days: $280,000 3160 days: $ 155,000 6190 days: $ 75,600 Greater than 90 days: $ 18,600 You note that included in the above aged balances is an amount of $30,000 from a customer, Cutthroat Kitchens. This customer went bankrupt in November 2020, and there is no possibility of receiving payment from it. Fred doesnt know what to do with this amount but knows that you will.

It is standard MI policy that 2% of receivables from 0 to 30 days will ultimately be uncollectible, 4% for 3160 days, 20% for 6190 days, and 80% greater than 90 days will be uncollectible. This policy is implemented after adjusting for any amounts at year end that will definitely not be collected.

In January, MI decided to stop using a significant piece of manufacturing equipment. The equipment, purchased in 2018, is still quite useful because it can be retrofitted to produce many different items, but it no longer fits within MIs strategic plan. Details of the disposal are as follows: Year: 2018 2019 2020 Cost: $750,000 $750,000 $750,000 Accumulated depreciation: (25,000) (50,000) (75,000) Net book value: $725,000 $700,000 $675,000 According to the board of directors meeting minutes, while management of MI intends to sell the machinery because it is only three years old and still has considerable life, the company may continue to use it to produce some units until a buyer is found.

Management is responsible for these asset disposal decisions. Assets can be ready within 30 days notice, and the marketing department has begun advertising on local websites in order to sell the equipment.

Based on the area in which MI is located, there are many manufacturers and a sale should occur in the short term. When it was advertised for sale in January 2020, MI posted an asking price of $450,000 for the equipment.

MI predicts that it will take approximately one month to disassemble the equipment. MI has had a number of interested buyers but one in particular has expressed some strong interest. A new company wanting to produce outdoor resin furniture is interested, but is unable to purchase the equipment immediately because it wont be opening up until February 2021. The potential buyer is, however, willing to place a 25% deposit on the equipment immediately.

As a means of cutting costs, Fred is considering revising the presentation of the financial statements to show just revenues and expenses instead of the current presentation of showing a full cost of goods sold statement. Fred is questioning the purpose of presenting such detail in the financial statements. You and I know what is going on in these books, why do we need to show all this stuff? He has also asked you to include in your report reasons why financial statements are prepared annually.

Questions

1) Is there a Big Picture item in the case? For example, there may be a debt covenant imposed by the bank for financing. This covenant will likely be based on maintaining a certain financial ratio, such as the current ratio or debt-to-equity ratio. As you identify issues in the case and recommend adjustments, this ratio will also require adjustments that could either better or worsen the ratio. Other common big picture items could be fraud, business acquisition/valuation, bonus payments, etc.

2) Based on the big picture issue noted in question 1, discuss and quantify the overall impact (if possible) of the adjustments required from the accounting issues.

3) What does this mean for the company? For example, if there is a restrictive covenant and after the suggested adjustments, it appears to be in breach, then the underlying bank debt would be repayable immediately!