Freeburn Co

Subject:AccountingPrice: Bought3

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Freeburn Co. (Freeburn) is a manufacturer of women's outerwear. Most of Freeburn's merchandise in manufactured in Canada. Although production costs are higher in Canada, the company finds that the high quality of the clothes allows it to remain profitable. Freeburn was founded in 2004 by Sam Vander Bordem and Emily Flimsy. Each shareholder owns 50 percent of the shares of the company. In late 2017, Sam and Emily had a major disagreement on the direction of the company and they have not spoken since. Sam is no longer involved in the day-to-day operations of the company and any input he provides is done through his lawyer. In April 2018, Sam and Emily agreed (through their lawyers) that Emily would buy Sam's shares at fair market value, where fair market value would equal three times net income for the year ended December 31, 2018, with the financial statements prepared in accordance with Accounting Standards for Private Enterprises (ASPE) consistently applied. You are Sam's long-time accountant and financial advisor. On February 15, 2019, Sam storms into your office in a rage. He has just received the 2018 financial statements from Emily and they showed that net income was $142,000, well below the average reported in recent years. Sam blasts that this is "a complete nd utter ripoff" because he's not going to get nearly enough for his shares, and he isn't going to stand for it. You tell Sam to calm down and he gives you the financial statements to examine. Sam points out a number of issues he is concerned about and you tell him you will analyze them and prepare report explaining any problems with the accounting treatments used and the impact on the agreement. The issues are described in Exhibit A, which follows

 

1. In November 2018, Freeburn purchased a two-year licence to produce garments with the logos of professional sports teams. The licence goes into effect on January 1, 2019 (meaning that Freeburn can begin selling products with the logos starting on January 1, 2019). Freeburn paid the sports leagues a nonrefundable fee of $100,000 when the agreement was signed in November 2018 and agree to pay a royalty of 3 percent of sales for each item sold with the logo on it. Freeburn expensed the $100,000 non-refundable fee in 2018.
2. In early December 2018 one of Freeburn's customers declared bankruptcy. The customer owed Freeburn $22,000. The customer is trying to reorganize but it's clear that Freeburn will collect little if any of the money it's owed. The customer is trying to reorganize the company and it is currently negotiating with its major creditors. Freeburn has always recorded bad debts on a direct write off basis. For the year ended December 31, 2018 no adjustment to the financial statements was made for this receivable.