Reference no: EM132490449
Gillian Tool Ltd. (Gillian) is a small manufacturer of precision tools used by companies such as auto parts manufacturers. In November 2019 the owner of Gillian, Ms. Cook, agreed to sell the company to Deanna Tool Inc. (Deanna) another manufacturer of precision tools. Each company is owned and operated by a single individual who originally founded his company.
The two owners agreed on a complex selling price arrangement. They agreed the following terms:
1. The selling price of Gillian would be an amount equal to
- three times Gillian's net income for the year ended December 31, 2018 plus
- three times Gillian's net income for the year ended December 31, 2019.
2. The deal closes on December 20, 2019, at which time Deanna takes over management and operation of Gillian.
3. Any disagreements regarding the 2018 and 2019 financial statements are to be settled first by negotiation between the parties and, if necessary, by arbitration by an independent third party.
- It is now February 15, 2020. Ms. Cook called you to help her understand and assess a number of transactions that are reported in Gillian's December 31, 2019 financial statements. Based on her examination, along with information obtained from other sources, she is concerned about a number of transactions reported in Gillian's statements. Ms. Cook said issues in the 2018 financial statements were settled quickly and amicably between the parties. Now Ms. Cook thinks the new owner of Gillian isn't acting in good faith and is trying to cheat her.
- Ms. Cook asked you for a detailed report explaining the impact of each event on the purchase price of Gillian and your assessment of each of the issues. She would like a full explanation of the implications of each event, your evaluation of the accounting used by Gillian, and your supported recommendation of the appropriate treatment for each event. Your explanations are important because they will be used in negotiations with the owner of Gillian and, if necessary, presented to the arbitrator.
Ms. Cook is concerned about the following transactions and economic events:
Point a) In November 2019 Gillian received a large order for tools from a new customer. The customer's normal supplier was on strike and had to find an alternative supplier and so the customer came to Gillian. Production of the order was completed on December 8, 2019 and the inventory was delivered to the customer on December 21. Because the customer was new and the order so large, management decided to delay revenue recognition until cash was received. Management indicated it was trying to be conservative by avoiding overstating revenue and net income. A credit check of the customer indicated no significant credit problems.
Point b) During 2019 Gillian used some of its own employees to renovate the storage area of the manufacturing facility. The renovation repaired areas that were worn out and also improved and expanded the storage area. Materials were capitalized as property, plant, and equipment. Wages to Gillian employees were expensed as incurred.
Point c) Gillian's 2019 income statement report a large write down for inventory. While inventory write downs are not uncommon, this one was about five time larger than average. Management decided that the carrying levels of inventory were too high and it decided to reduce the amounts on hand. Any inventory above the new optimal level was written down or written off. The inventory can still be used or sold but management thinks this step will improve the efficiency of the company.
Point d) During 2019 Gillian was charged $120,000 in administrative, management, and consulting fees by Deanna for service provided to Gillian in the year. Deanna took over some of Gillian's administrative activities and provided assistance in integrating its systems with Deanna's. The amount was expensed in 2019.
Required :
Question 1: Analyse the issues