SWO Ltd. (SWO) is a manufacturing company located in Southwestern Ontario, which is publicly traded on the Toronto Stock Exchange. The company designs and develops stereo equipment. Your accounting firm recently began to be the auditor of SWO. You are a senior accountant with the firm, and have been assigned the year-end audit for SWO. Your firm’s partner has just met with the company’s management in early January, 2018, and discussed various accounting issues. The partner asked you to prepare a report to be provided to the client that addresses some of the accounting issues occurred in 2017. These accounting issues are listed as follows:

During 2017, SWO purchased the 15% equity of an electronic supplier. SWO provides technical support to the supplier’s operations and participates in its policy making. Recently the supplier’s business costs were significantly increased, resulting in substantial losses and shortage of cash flows.

SWO provides a ten-year warranty with all equipment sales. The warranty covers all defects and breakdowns that are not directly related to regular wear and tear. Based on the experience, SWO estimates the probability of an equipment making a warranty claim during the next 10 year of coverage is as follows:

The average retail value per claim is $100 currently and increases by 3% every year. The average cost of parts and service at SWO is about 60% of the retail value. The effective interest rate is 6%.

At the beginning of 2017, the company granted options to the management to purchase 80,000 common shares. The options can be exercised any time within the next five years at a strike price of $5 per share. The company expects that the period of benefit/service for these options is three years. The fair value of the options, as determined using an option pricing model, is $900,000.

On July 1, 2017, the company issued 20,000 preferred shares for $10 per share to an investment bank. Each preferred share is convertible for a fixed number of common shares and has a mandatory 5% annual dividend that must be paid on December 31 of each fiscal year. These preferred shares must be redeemed by the company for cash if the market price of common shares exceeds $10 per share. Currently, the common shares are in trading range around $6 per share.

On September 15, 2017, the company entered into a forward contract with the Bank of Vancouver by locking the price of 600,000 kg of aluminum at $1.50/kg. Aluminum is used in the production of stereo equipment. As at December 31, the price of aluminum is trading on the Chicago Board of Trade at $1.25/kg.

Required

Prepare a report on your analyses of the company’s accounting issues.