Sturdy Furniture Ltd. is a Canadian manufacturer of public site furniture products. Sturdy’s products are designed for use in public places such as parks, malls, town squares—high-traffic locations that require high-quality, durable, and attractive furniture. Sturdy’s products include benches, bike racks, planters, recycling bins, and trash containers. Sturdy has a loan outstanding from the Bank of Ontario and is looking to increase the loan to help finance its ongoing expansion.

It’s late October 2019. You are a CPA with the Bank of Ontario’s regional office in Durham Region. You received a call from the loan officer responsible for the Sturdy loan regarding its 2017 third-quarter unaudited financial statements (the end of the quarter was September 30). The loan agreement requires that Sturdy maintain a current ratio greater than 1.25 and a debt-to-equity ratio below 1.6 at the end of each quarter. Sturdy is onside with the ratios, but just by a small amount. If Sturdy violates either of the covenants, the terms of the loan will be subject to renegotiation and perhaps repayment. In addition, violation would make it significantly less likely that the bank would provide Sturdy with the additional financing it’s looking for.

The loan officer expressed some concern to you about Sturdy’s accounting for three transactions and the impact on the covenants. She asked you to prepare a report that reviews the transactions and assesses the accounting Sturdy used. She would like full explanations of whether the accounting used was appropriate or inappropriate.

The loan officer provided you with the following information:

1. Summarized balances at the end of the third quarter of 2019 on September 30, 2019:
   1. Current assets                   $ 6,500,000
   2. Non-current assets           23,500,000
   3. Current liabilities                5,100,000
   4. Non-current liabilities       13,100,000
   5. Shareholders’ equity         11,800,000
2. In an effort to generate business in the south-western United States Sturdy planned to attend a large trade show in the southern US in September 2019. Because of a hurricane in late August the show had to be cancelled. In preparation for the show, Sturdy spent $225,000 on banners, handouts, videos, and other materials that were specifically branded for the show (the materials were all branded with the name, date, and location of the US show). The materials are currently being held in a storage room near the vice-president of marketing’s office.
3. During the third quarter, Sturdy completed a deal with one of the Canadian territories to supply outdoor recycling bins. The final design is based on an existing Sturdy product that has been modified to meet the rigours of the cold Canadian winters in the far north. No Sturdy product has ever been used under these conditions but the company tested the product extensively in the extreme-weather facility at the Ontario Tech University, and management is confident that the product is well designed for the conditions. Sturdy has provided the territory a two-winter guarantee that it will replace any bins that are broken or damaged due to weather conditions. The contract price is $750,000 and the bins cost $475,000. The revenue was recognized in the third quarter. Sturdy expects payment for the bins within 90 days of the end of the quarter. Sturdy recognized the revenue in the third quarter
4. During the year Surdy terminated a manager who had been with the company for many years. Surdy agreed to a $350,000 settlement to avoid a wrongful dismissal lawsuit. The $350,000 will be paid out in four equal installments over the next four years. Surdy expensed the $87,500 paid in the year when the 2019 payment was mailed in August 2019.
5. In early October 2019 (after the end of the third quarter) Sturdy cancelled a contract with a supplier. Cancellation is allowed under the contract but Sturdy is required to pay a cancelation penalty to the supplier of $150,000. The payment was made on October 10. The amount is not recorded in the third quarter financial statements.
6. What are the objectives of financial reporting of the loan officer/Bank of Ontario? Why do you think your client has these are the objectives?
7. Are the objectives of Sturdy and your client the same? Does it matter if the objectives of Sturdy and your client are different? Explain.
8. Explain why the objectives of financial reporting of Sturdy and your client are important to your analysis.