Freeburn Co. (Freeburn) is a manufacturer of women’s outerwear. Most of Freeburn’s merchandise is manufactured in Canada. Although production costs are higher in Canada, the company finds that the high quality of the clothes allows it to remain profitable. Freeburn was founded in 2004 by Sam Vander Bordem and Emily Flimsy. Each shareholder owns 50 percent of the shares of the company. In late 2017, Sam and Emily had a major disagreement on the direction of the company and they have not spoken since. Sam is no longer involved in the day-to-day operations of the company and any input he provides is done through his lawyer. In April 2018, Sam and Emily agreed (through their lawyers) that Emily would buy Sam’s shares at fair market value, where the fair market value would equal three times net income for the year ended December 31, 2018, with the financial statements prepared in accordance with Accounting Standards for Private Enterprises (ASPE) consistently applied.

You are Sam’s long-time accountant and financial advisor. On February 15, 2019, Sam storms into your office in a rage. He has just received the 2018 financial statements from Emily and they showed that net income was $142,000, well below the average reported in recent years. Sam blasts that this is “a complete and utter rip-off” because he’s not going to get nearly enough for his shares, and he isn’t going to stand for it.

You tell Sam to calm down and he gives you the financial statements to examine. Sam points out a number of issues he is concerned about and you tell him you will analyze them and prepare a report explaining any problems with the accounting treatments used and the impact on the agreement. The issues are described in Exhibit A, which follows.

Required:

Prepare the report for Sam Bardem.

____________________

In November 2018, Freeburn received an order from an outerwear distributor in Chile. The goods were produced and shipped on December 15. This is the first time Freeburn has shipped to this distributor and the first time it has shipped outside of North America. Freeburn’s credit department received a report from a credit rating agency in Chile that indicated the customer had a credit rating of “good.” The goods shipped are standard models that have been modified to meet the tastes of the Chilean market. These designs have always been popular in the North American market. The customer isn’t allowed to return any of the goods but Freeburn has agreed to provide a rebate of 30 percent of the price the customer paid for any goods that it is unable to sell. Freeburn has not recognized the revenue as of December 31, 2018, because it’s waiting until the goods are sold by the Chilean distributor.

In 2014, Freeburn took advantage of an opportunity to buy large supply fasteners (buttons and zippers) from a supplier that was going out of business. At the time, Sam and Emily estimated that the supply of fasteners purchased would last about four years. Since then, styles and technology have changed so that the items purchased in 2014 can only be used on lower-quality items and/or on the less-stylish garments Freeburn makes. Emily now thinks that this supply of fasteners can be used, but that it will take much longer than originally thought. Emily has been trying to sell the fasteners but has only managed to dispose of about 30 percent of the remaining amount. For accounting purposes, Emily has written off the remaining unsold inventory in the year ended December 31, 2018.

In November 2018, Freeburn purchased a two-year license to produce garments with the logos of professional sports teams. The license goes into effect on January 1, 2019 (meaning that Freeburn can begin selling products with the logos starting on January 1, 2019). Freeburn paid the sports leagues a non-refundable fee of $100,000 when the agreement was signed in November 2018 and agree to pay a royalty of 3 percent of sales for each item sold with the logo on it. Freeburn expensed the $100,000 non-refundable fee in 2018.

In early December 2018, one of Freeburn’s customers declared bankruptcy. The customer owed Freeburn $22,000. The customer is trying to reorganize but it’s clear that Freeburn will collect little if any of the money it’s owed. The customer is trying to reorganize the company and it is currently negotiating with its major creditors. Freeburn has always recorded bad debts on a direct write-off basis. For the year ended December 31, 2018, no adjustment to the financial statements was made for this receivable.
Hints:

The following questions may provide you with some guidance as you work through the case:

Describe your role. Who is your client? What does the client want you to do? What is your responsibility to the client (what does the client expect from you in exchange for the money she will pay you)?
What is (are) your client`s objective (what would your client like to see happen)? From an accounting perspective, how would your client`s objectives be affected by the financial statements?
Who is preparing the financial statements? What are the objectives of the person preparing the financial statements? How do the financial statements impact the objectives of the person preparing the financial statements? How do you think the person preparing the financial statements will approach the preparation of the statements (given the opportunity to make accounting choices, what kind of choices will he make)?
What are the terms of the contract? Are there any terms or conditions that need to be defined or clarified?
Are there any constraints you must consider? Explain why.
For each transaction/issue listed:
Identify the issue (for example, revenue recognition, classification as an asset or expense, etc.).
Explain the impact of the treatment currently used on your client. How does the accounting for each of the issues affect Sam Bordem and Ms. Flimsyd?
Do you think the existing treatment is appropriate (explain why or why not)? (To do this you need to apply your knowledge - the revenue recognition criteria, definitions of elements, etc.).
Is there a better (more appropriate, different) treatment that could be used for the transaction? Provide support for the alternative (if there is a better alternative). Support means referring to appropriate criteria, definitions, standards, etc. as well as to the facts defining the transaction/economic event. If the treatment currently used is appropriate, explain why. When thinking about the existing and alternative accounting treatments, be sure to keep in mind the interests of your client.
Provide a conclusion.