KPMG/ALPFA 2007 CASE STUDY COMPETITION. Case 1: Professor Kornberg Takes a Sabbatical Leave

Size: px

Start display at page:

Download "KPMG/ALPFA 2007 CASE STUDY COMPETITION. Case 1: Professor Kornberg Takes a Sabbatical Leave"

Darrell George
5 years ago
Views:

1 Case 1: Professor Kornberg Takes a Sabbatical Leave Henry Kornberg has been a biology professor at Southwestern University, a not-for-profit private university, for the past 15 years. Henry graduated from Milford University and went on to work for the government for several years before deciding to move to Southwestern and pursue his passion of teaching 15 years ago. He is always prepared for class and possesses a positive attitude when passing on extensive knowledge of DNA to his students. On January 15, 2007, Henry was informed by his brother, Roger Kornberg, of a project he was working on that he believed would change the entire field of science. He offered Henry a once in a lifetime opportunity to join his research team. Although Henry was reluctant to leave his students and teaching responsibilities, he decided to take a year off from Southwestern University so that he could contribute to the development of this project and expand his knowledge in that area. Southwestern University s policy states that should members of the faculty take time off of work primarily for the purpose of enabling them to acquire additional knowledge and competency in their respective fields, the University will maintain them on the payroll for a maximum of one year. One prerequisite of this policy is that the professor must be a member of the faculty for a minimum for ten years in order to be eligible. However, professors are not required to engage in research or public service that would strengthen the reputation of the University. Henry completed the semester and his last day of work was on May 31, He was scheduled to return to Southwestern and continue serving as a Professor on June 1, What are the important accounting issues that are associated with this case? 2. Based on the information provided, how should Southwestern University account for the costs associated with Henry Kornberg s leave of absence, as well as other professors who may decide to also take time off to pursue research in their field? 3. In what industries is this situation common, and does the accounting treatment differ across industries?

2 Case 2: Miller & Rhaim, P.C. Prepares to Open John Miller recently graduated from law school and passed the Bar exam. He partnered with a fellow graduate, Steve Rhaim, to open a law firm. Together they have limited funds to start a new firm due the student loans they still owe from law school. They found an older building that they believe would be perfect for their new law firm, Miller & Rhaim, P.C. Unfortunately, the building needs to undergo minor construction before it can be used for their law offices. On July 1, 2006, Miller & Rhaim entered into a 10-year lease arrangement with Corporate Suites, LLC, for the building they plan to use for their law firm. The lease was effective as of January 1, 2007 until December 31, 2016 when they plan on opening their law firm after construction is complete. Upon signing the lease, Miller & Rhaim are given control of the building so that they can complete the necessary construction. Because the building was inoperable during the construction period, lease payments also do not start until January 1, 2007 when the law firm will be open for operations. Corporate Suites believed it would be more cost efficient to give Miller & Rhaim control of the building six months early and forego lease payments than performing construction themselves and making them pay in January. Thus, Miller & Rhaim control the building for six months without having to make any rental payments. In addition, they incurred $50,000 in construction costs while upgrading the building. 1. What is the appropriate time period to use when accounting for the lease? 2. How should Miller & Rhaim account for the lease payments on their financial statements? 3. What if instead of leasehold improvements, the law firm began operation on July 1, 2006 but received one free year of rent (i.e., only 9 years of payments recorded)? 4. Should the landlord decide to split the construction costs with Miller & Rhaim as an incentive to enter the lease agreement, how would Miller & Rhaim account for the construction costs? How would the landlord account for the construction costs?

3 Case 3: The Launch of InfoMemo InfoMemo is an IT start-up company based out of Silicon Valley, California. The company s main focus is to create computers so small that they are half of the size of regular laptop, yet much bigger than a handheld PDA. The owners of this company believe that InfoMemo has incredible potential and will grow to be the size of leading computer manufacturers. The product already has been developed and is ready to be launched. Financing the launch of the company, however, has been a significant issue. InfoMemo needs approximately $15 million in order to mass produce the mini-computers, advertise them, and launch several retail stores. The owners of InfoMemo have considered several financing options. After a meeting with a local bank, the company was declared eligible for a 10-year loan. However, the interest rate for the loan is 20% because so many start-up companies default. The owners were unwilling to realistically consider this option because they believe that the interest expense resulting from the loan would be too high for them to sustain operations profitably, leading to default by design. Another, more promising option is to receive financing from a local millionaire who believes that the company has potential. InfoMemo was given $15 million from the millionaire in exchange for a 10-year convertible bond with 10% annual interest. The bond can be converted to 1,5000,000 shares of stock at $10 per share. 1. What is a convertible bond, and how should InfoMemo account for the convertible bond on its financial statements? 2. Should the millionaire decide to convert the bond in five years, how would InfoMemo account for that transaction? 3. Suppose that the stock is traded at $12 per share at the date the convertible bond is issued and after seven years, InfoMemo goes through an initial public offering. How should InfoMemo account for the conversion feature of the bond? 4. Why would an individual or a company be willing to accept the risk associated with a convertible bond?

4 Case 4: BM Motor Company s Acquisition of its Supplier BM Motor Company is becoming one of the fastest growing automobile manufacturers. In the past two years, BM has nearly doubled its revenues from $500 million to over $1.1 billion, quickly closing the gap between itself and competitors. CEO of BM, Harold Sullivan, is under constant pressure to reduce costs and increase profits. Sullivan s strategy for reducing costs for the upcoming fiscal year is to acquire the Company s main supplier of tires, Goodtire. By acquiring this company, Harold will be able to eliminate all costs associated with having an intermediary, such as shipping costs, ordering costs, and will reduce the amount of time and work spent on ordering tires for several departments. Furthermore, once Goodtire s operations are integrated into BM s operations, the entire process will become customized towards BM s daily needs. This acquisition is set to take place on January 1, However, at that time, BM will still owe Goodtire approximately $15 million for tires purchased under the supply contract, which also has a settlement amount of $19 million for the contract. There are no cancellation provisions in the contract. Furthermore, the measured loss on that contract is estimated to be approximately $18 million based on current market pricing for the same items. Harold strongly believes that once Goodtire is fully integrated into BM Motor Company, it will generate the company enough revenue to boost it ahead of its competitors. 1. Since BM has a pre-existing relationship with the supplier, should the pre-existing liability be combined with the acquisition or accounted for separately? 2. What should BM Motor Company account for these transactions on its income statement? What information should BM Motor Company disclose on its financial statements? 3. How relevant are supplier integration issues in other industries? Argue whether you expect these issues to become more or less prevalent in other industries.

5 Case 5: Oxford Mining & Manufacturing Company s Grand Opening Two brothers, Steve and Josh Wynstein, decided to open a mining company in Oxford, Ohio due to the large quantities of anorthosite in the ground. Anorthosite is a mineral that can be manufactured into a building material used in cement. The brothers agreed on naming their company Oxford Mining & Manufacturing Company. In the two years it took to construct the mine, they spent approximately $20 million removing overburden and waste materials, as well as developing the mining site. Although this is a hefty investment, the Wynstein brothers believe that they will become very successful within the next ten years. Operations began six months ago and have been extremely successful. During this time period, Oxford Mining & Manufacturing Co. generated $5 million in revenues. The Wynstein brothers believe that revenues will triple over the next year once their company develops its name and improves its operations. During the same six-month period, there were additional costs totaling $2 million in removing overburden and waste materials. 1. How should Oxford Mining & Manufacturing account for the money spent on developing the mine? 2. How should Oxford Mining & Manufacturing account for the additional costs incurred once the company began production? How would Oxford Mining & Manufacturing account for additional future costs expected to be incurred to remove overburden once production has begun? 3. If a similar scenario occurred with a software development company that is in the process of developing a new computer software program that will be sold upon completion, how would that company account for the money spent before and during production?

6 Case 6: Real State Realty Reaps Rewards from the Time-Share Business Real State Realty (RSR) sells various forms of real estate. They have operated along the southeastern coastline for more than thirty years. One of RSR s primary competitive advantages is its large inventory of land located throughout its region of operation. The land s value has substantially increased over several decades, creating highly lucrative business opportunities for RSR. The company s most recent venture is the development of housing along a portion of land along the inland waterway in North Carolina. While the housing will add additional value to the property, the majority of the property s value is still attributable to the land itself. RSR plans to sell one-quarter interests in the property to residential owners. Each purchaser will own access to the property for one quarter of the year. RSR will not retain any continuing interest in the properties once they are fully sold (i.e., once four purchasers have acquired a one-quarter interest each in the property) and purchasers would be allowed to sell or lease their interests at any time. Also, as owners, they may rent or lease out their share. The contract specifies that the purchaser will pay for the property rights in-full at the time of closing. All closings will occur only after property has been fully developed. 1. What criteria should be applied to determine if the proposed sales transactions meet the criteria for a sale? Do the proposed sales transactions meet the criteria? If so, how should RSR account for the revenues generated by this new venture? 2. How would your answer to Question 1 differ if RSR sold its land undeveloped? 3. What if the land is developed for purposes other than time-shares?

7 Case 7: Thadoo Drugs Faces Fire Disaster Thadoo Drugs is a pharmaceutical company that in January of 2006 began manufacturing and selling its own brand of face cleanser. Since the introduction of the product last year, its popularity has skyrocketed. This is due to both its effectiveness at reducing blemishes and the fact that they have been very successful in the development and marketing of related products to teenagers. Due to the increased popularity of the cleanser, in November 2006 Thadoo rented a relatively large storage building to store about $1 million of additional cleanser inventories that could not be kept at the main warehouse. Thadoo took out an insurance policy against the destruction or theft of the inventory. On December 1, 2006, the pharmacy received news that the storage facility was broken into by an employee of a competitor. A fire was started and the entire inventory was destroyed. Thadoo filed a claim for reimbursement from their insurance company and on December 15, 2006 received a monetary reimbursement of $1.2 million. Thadoo had been working on a new face cleanser formula that was even more effective and subsequently more costly and decided to take the insurance proceeds and invest this total in the production of the new product. However, preliminary research suggests that the new cleanser may cause side effects that Thadoo does not anticipate, which may lead to litigation. 1. How should Thadoo account for the difference between the total value of the original face cleanser and the proceeds received from the insurance company? 2. What are some common business risks associated with research and development activities? 3. Related to the possible side effects of the new cleanser, what accounting treatment guidance exists regarding the possibility of litigation by a customer?

8 Case 8: Emgoud Global Technologies Acquires Noutme Lokal Technologies Noutme Lokal Technologies (NLT) researches and develops biometric identification technologies. NLT has begun research and development on a portable device that can identify individuals through voice recognition. The device s application is primarily for intelligence and government purposes, but has some application in the commercial sector as well. NLT had to purchase specialized computer hardware and software in order to begin research and development on this device. Due to the specialization of these items, NLT foresaw no alternate use for these items. Emgoud Global Technologies (EGT) is an international researcher and developer of emerging technologies. By acquiring various technology-based companies EGT hopes to create new synergies to add more value than could be obtained through the acquired companies standalone operations. EGT foresaw future alternative uses for the specialized computer hardware and software owned by NLS and purchased it from them. In the following year, EGT purchased all of NLT s stock. EGT replaces the existing management and begins to actively manage the projects NLT undertakes, although NLT remains a separate legal entity. It transfers a project currently being worked on by EGT to NLT. EGT believes that NLT researchers have significant experience in the technology concerning this project and that the hardware and software that was purchased by NLT for research and development of the voice identification device has an applicable use in this project as well. 1. In the year of purchase, how should NLT account for the purchase of the hardware and software used in the research and development of the voice identification device? 2. How should EGT account for the same hardware and software in its consolidated financial statements? 3. What are some common business risks for this industry?

9 Case 9: Accounting for Famous Franks Franchising Activities Famous Franks (FF) is a fast food chain franchiser whose specialty is hot dogs. FF sells franchisees the right to use its name and likeness to sell hot dogs and various other fast food items. FF specifies what items are sold, how each of the items are prepared, supplies the ingredients and equipment, and provides national advertising services to its franchisees. FF charges its franchisees an initial franchise fee and additional yearly franchise fees for as long as the franchise remains in operation. The yearly franchise fees allow the franchisee to retain its right to operate a franchise. Title of the equipment is passed to the franchisee when the initial franchise fee is paid. The franchisee cannot begin business until after the fee is paid and the franchiser sends an inspector to ensure that the franchise meets franchiser specifications. This usually takes a month after the initial payment. Initial advertisement is provided through local venues by the franchiser over the next two months to build awareness of the new franchise. The franchisee has the option of buying supplies and ingredients from the franchiser. Due to quality concerns, FF incurs a small loss on these items in order to encourage their franchisees to purchase the items from them. 1. How should FF recognize both the initial and yearly revenues from its franchise operations? 2. How could FF restructure the elements within its franchising activities to alter the timing of revenue recognition?

10 Case 10: High Tech, Inc. (HIT) Acquires Outside Capital High Tech, Inc. (HIT) is a provider of bandwidth optimization and utilization services. On April 30, 2007, HIT finished the development of a technology that will allow them to redistribute idle or unused bandwidth to willing buyers. HIT does not possess the resources necessary to market and implement this technology and has decided to seek outside capital. HIT s CFO suggested a plan that would secure the necessary capital under these conditions: HIT establishes a new, separate entity, named TrustMe that it will consolidate. TrustMe will issue preferred stock shares to outside investors. It will use the capital received to purchase fixed-maturity loans from HIT. TrustMe will pay interest payments received from HIT to its preferred stock investors as the interest payments are received. TrustMe is required to redeem the preferred stock shares when the loans reach maturity. The loans and their related interest payments will not be present in the consolidated financial statements. The CFO believes that the preferred stock should be reported as a preferred stock equity issuance and that the payments from TrustMe to investors be reported as dividends. HIT implements this strategy prior to its fiscal year-end. 1. Is the CFO s proposed accounting treatment correct? 2. If TrustMe has total discretion regarding the redemption of the securities and interest payments will no longer be made, would the appropriate accounting treatment be different? That is, assume that there are no redemption provisions or requirements placed upon TrustMe. 3. What incentives exist that would encourage HIT to acquire outside capital in this manner?

The Federal Trade Commission s Guide to Buying a Franchise

The Federal Trade Commission s Guide to Buying a Franchise 727-455-0056 FranchiseMegaBrand.com Consumer Guide to Buying a Franchise Federal Trade Commission s Consumer Guide to Buying a Franchise The Benefits