Plastics Ontario (PO) has recently been incorporated under federal legislation. All the shares are owned by one man, Jimmy Arbuckle. PO will be active in the molded plastics industry, making everything from custom lettered signs to consumer products (e.g., toys) and industrial products (e.g. car dashboards). They will also supply chemicals to other, smaller plastic molding operations.

Arbuckle has 20 years of experience in both production and sales with a large Canadian plastics firm. He took advantage of several recent bankruptcy sales to acquire the manufacturing and molding equipment necessary to start his own firm. He has obtained a 10-year, fixed interest loan from the Federal Business Development Bank, a line of credit from a chartered bank for working capital, and has invested $400,000 of his own money. Both banks required audited financial statements.

The major pieces of equipment acquired cost $700,000. Another $60,000 will be spent transferring them to PO’s new leased facility. Arbuckle estimates another $80,000 will be spent “debugging” the equipment.

Sales are expected to be made on three bases:

Custom signs on a prepaid basis. Signs would normally be completed within five business days but could take up to a month for a large order or if the volume was high.
Direct sales to distributors and manufacturers on terms of 2/10, n/30. Interest on overdue accounts will be 1.4 percent per month. Customers can return defective goods for full credit, and, in common with the industry, goods carry a six-month warranty.

Customer goods to retail outlets on a consignment basis. Arbuckle does not expect to be able to run his molding equipment at full capacity from “outsider” orders for at least two years. Therefore, he plans to design and market a few consumer products (e.g., dollhouses) to keep his operation busy. Several large retail chains have expressed interest in carrying these items but only on a consignment basis. Arbuckle estimates that it will cost him $40,000 to design and develop these items.

Arbuckle hopes to break even in the second year of operation and show a profit in the third year. Losses are anticipated for the first year. He has planned to take an extremely low salary for the first three years until he is satisfied that the company can prove its viability. Arbuckle has established relatively low salary levels for his management team but has promised them a generous bonus based on net income.

Arbuckle has approached you, CPA, to act as a financial advisor. He has requested advice on accounting policies and other relevant issues.

Required:
Adopt the role of adviser to Mr. Arbuckle and draft a report responding to his request.

1. Assessment of the Reporting Environment/Framework/Overview

Who are the users and the decisions they are making?

What are we trying to reflect in the financial statements? (Performance?)

Is there a potential for bias?

Is GAAP (IFRS or ASPE) a constraint?

What is your role in the case?

Will financial reporting be more aggressive or conservative or somewhere in between?

2. Identification and Analysis of Financial Reporting Issues

For example, should revenue on custom signs, direct sales, and consignment sales be recognized when cash is collected, at delivery or delayed until later?

What does GAAP recommend?

What is the Impact on financial statements?

What policies should be adopted for capital assets? (Which costs to capitalize or expense, which depreciation method to use, impact on financial statements, net income, in particular?)

Consider only the relevant alternatives

3. Recommendations

After the analysis of each issue, make a recommendation on the preferred alternative to accounting for the item. Ensure that your conclusions are based on your role, constraints, and financial reporting objectives identified earlier.