Overview

Dr. Gary Morrow, a former surgeon, is the president and owner of Morrow Medical (MM), a private Ontario company that focuses on the design and implementation of various medical and pharmaceutical products. With the recent success of various products put to market by MM, Dr. Morrow has decided that this would be a good opportunity to sell his company and retire to the Arizona desert. Dr. Morrow has found a potential buyer for the business and an agreement has been put in place that would see MM being sold at five times the value of December 31, 2023 net income in accordance with ASPE. The potential buyer is extremely interested in an MM product that is currently in the development stagethe MM Surgical Drill.

During 2023, MM began production of a special latex glove for use during surgery. This glove is laced with an antibacterial agent that significantly reduces the risk of infection during surgery. The product had been in the development phase since 2020, and in early 2022, it was approved by Health Canada for production and use.

Dr. Morrow was pleased with the initial demand for the product after trial runs conducted with surgeons during late 2022. After the success of the trial testing, MM landed contracts with several hospitals in the province and early feedback was favourable. However, Dr. Morrow was surprised by the small the quantity of orders placed by hospitals. He was certain that hospitals would quickly run out of the gloves and was beginning to fear that they would buy a competitors product.

Dr. Morrow wanted to prevent hospitals from buying elsewhere, since it would result in a loss of sales for MM. Therefore, for each purchase order received from a hospital, Dr. Morrow shipped several more units than were ordered. He was sure that all of the extra inventory would eventually be consumed, and this was MMs way of helping prevent the hospitals from running out of inventory. To encourage hospitals to keep the extra inventory, MM allowed them eight months to either pay for the entire shipment or return any unused gloves in excess of the initial amount that was ordered. Dr. Morrows priority is always getting the product out of the warehouse and into the hospitals. Orders are generally filled and shipped within two days of receipt of a purchase order. Since MM is dealing with hospitals, there is little concern over collectibility.

During 2020, under the supervision of Dr. Morrow, MM began the research and development of a special surgical drill (the MM Surgical Drill mentioned above) that would allow for more precise handling by surgeons than any other drill currently on the market. The development of this product grew from various market surveys conducted in hospitals throughout Ontario, which showed that surgeons were unhappy with the drills that were currently available.

The following costs were incurred in 2023:

Cost of setting up production lab $30,000

Testing of Surgical Drill 100,000

Design of the moulds involved in Surgical Drill technology 17,500

Testing to evaluate product alternatives 12,000

Marketing and promotion costs in connection with launching the

surgical gloves 15,000

Dr. Morrow intends to capitalize all these costs for the December 31 year end. In addition, $25,000 of tool design costs that were expensed in 2022 will be capitalized in 2023.

MM has the technical resources available to complete the Surgical Drill project and, since testing to date has been successful, management intends to bring this product to market in early 2025. MM has been faced with cash flow problems in the past few months but anticipates that once MM is sold, the additional funding will be available to move this product into its production stage.

In early 2023, an engineer testing the Surgical Drill was severely injured as a result of a product malfunction. This glitch was subsequently identified and fixed. MM has recently been sued. The claim is for $500,000 and alleges that MM was responsible for the engineers injuries. MMs lawyers best estimate of what the company will end up paying is between $100,000 and $200,000. As the trial does not begin until 2024, MM has no intention of recording this in its December 31, 2023 financial statements.

Instructions

Adopt the role of the auditor hired by MMs potential buyer and analyze the financial reporting issues. (use the case analysis framework covered in the course, refer to the Discussion Section for reference if needed).