Reference no: EM132658400

Dr. Kobe James a former surgeon is the president and owner of James Medical (JM), a private Los Angeles company that focuses on the design and implementation of various medical and pharmaceutical products. With the recent success of various products put to market by JM, Dr James has decided that this would be a good opportunity to sell his company and retire to the California desert. Dr James has found a potential buyer for the business and an agreement has been put in place that would see JM being sold at five times the Dec 31 2019 net income. The buyer is extremely interested in an JM product that is curently in the development stage - the JM Drill.

• During 2019, JM launced into prodution a special latex glove for use dring surgery. This glove is laced with a special antibacterial agent that signifcantly reduces the risk of infection during surgey. The product has been in the development phase since 2016, and in early 2018, it was approve by Health Canada for prodcuction and use.

• Dr. James was pleased with the initial demand for the product after trials runs conducted by surgeons during late 2018. After the success of the trial testing, JM landed contracts with several hospitals in the province and early feedback was favourable. Dr. James was surpised, however , with how small the quantity of orders placed by hospitals actually was. He was certain that hospitals would quickly run out of the gloves and was beginning to fear that they would buy a competitior's product.

• Since Dr. James wanted to prevent hospitals from buying elsewhere, as it would result in a loss of sales for JM, for each purchase order received from a hospital, Dr. James shipped several more units than were ordered. He was certain that all of the extra inventory would eventually be consumed and this was inventory, he allowed them eight months to either pay for the entire shipment or return any unused gloves in excess of the initial amount that was ordered. Dr. James's first priority is always getting the product out of a purchase order. Because JM is dealing with hopsitals, there is little concern over collectibility. During 2016, under the supervision of Dr. James, JM begin the research and development of a special surgical drill ( the drill mentioned earlier) that would allow for more precise handling than any other drill. The development of this product grew from various market surveys conducted in hosptials throught Ontario that showed that surgeons were unhappy with the drills that were currently unavailable.

COSTS FOR 2019 AS FOLLOWS:

Cost of setting up prod lab $30 000
Testing of drill 100 000
Design of moulds 17 500
Testing to evaluate product alternatives 12 500
Marketing and promotion 15 000

• Dr. Morrow Intends to capitalize all of these costs for the Dec 31 year end. In addition, $25 000 of tool design costs that were expensed in 2019 will be capitalized in 2019. JM has the tech resources available to complete the surgical drill project, and since testing to date has been successful, management intends to bring this product to market in early 2021, JM has been faced with cash flow problems in the past few months but hopes that , once JM is sold, additional funding will be available to see this product into its production stage. In early 2019, an engineer testing the surgical drill was injured as a result of a production malfunction. This glitch was subsequently fixed. JM has recently been sued. The claim is for 500 000 and alleges that JM was responsible for the injuries. JM's lawyer's best estimate of what the company will end up paying is $100 000 to $200 000. As the trail does not begin until 2020, JM has no intention of recording this in its December 31, 2019 financial statements.

Problem 1: Adopt the role of the auditor hired by JM'S potential buyer and analyze the financial reporting issues