Treetop Pharmaceuticals (TP) researches, develops, and produces over- the-counter drugs. During the year, it acquired 100% of the net assets of Treeroot Drugs Limited (TDL) for $200 million. The fair value of the identifiable assets at the time of purchase was $!50 million (which included 5120 million for patents). The company plans to sell the patents to a third party at the end of seven years even though, at that time, the remaining legal life of the patents will be five years. TP already has a commitment from a specific third party that has agreed to pay $50 million for the patents (in seven years).
In January, in an unrelated deal, the company acquired a trademark that has a remaining legal life of three years. The trademark is renewable every 10 years at little cost. TP is unsure if it will renew the trademark or not. Because of the two acquisitions, TP was short of cash and entered into an arrangement with Drug Development Corporation (DDC) whereby DDC paid S30 million to TP up front when the contract was signed. Under the terms, the money is to be used to develop drugs and new distribution channels. TP has already spent a considerable portion of this money. TP agreed that it will pay DDC 2% of the revenues from the subsequent sale of the drugs (which are now close to the point of commercial production).
Because of the cash shortage, the company entered into negotiations with its bank to increase its line of credit. The bank is concerned about the company's liquidity. TP's top management has graciously agreed to take stock options instead of any bonuses or raises for the next two years in order to reduce cash flow constraints.
It is now yearend and TP is preparing its financial statements. It is concerned because one of its major competitors has just come out with several new drugs that will compete directly with the drugs that TDL sells. Management is worried that this may erode the market for TDL's products. In fact, TP is considering selling TDL and has contacted a consultant to help find a buyer.
Jacinth Kimble, the controller, is preparing for a planning meeting with TP's auditors. The auditors are analyzing TP's draft financial statements to identify critical and high-risk areas. The draft financial statements show the company as barely breaking even. The CFO has commented that the company's share price is likely to "take a tumble" since the company has always been profitable in past years and its competitors seem to be doing well. Kin1ble is also debating the latest news from TP's lawyers- apparently, the company is being sued in a class action lawsuit (by a significant number of people) for an illness that was allegedly caused by one of TP's main pharmaceutical products. The claim is for an amount equal to revenues from last year. At this point, the lawyers are concerned that the case against TP may be successful and they are trying to estimate the potential loss to the company.
Instructions
Adopt the role of the controller and prepare an analysis of all the financial reporting issues that TP is facing.