Reference no: EM133496534

Question: RAD Communications Ltd. (RAD), a public company, started a new company called Linden Inc. (Linden) to break into the cellular phone industry in 2015. Their first product, the M-One, was a modular cell phone in which customers may buy the base phone for $300 and subsequently purchase modules to customize and upgrade the phone. The idea was that instead of releasing a new phone every year the company would only upgrade modules in which customers could purchase and upgrade the phones themselves. Modules include a swappable larger screen, more memory, and a supersize battery. Unfortunately, the M-One was plagued with technical problems and RAD wanted to shut down Linden and cut its losses. Solving all the technical problems RAD made a final attempt to make Linden a success by hiring Mr. Holmes as the new CEO. As part of his hiring condition, Mr. Holmes had to meet performance objectives for the 2016 - 2018 years. At which point Mr. Holmes would receive a $5,000,000 bonus if by the end of 2018, Linden's net income exceeded $50 million. As it turned out Mr. Holmes was able to meet all the performance objectives for the 2016 and 2017 fiscal years.

It is now February 1st, 2019. Linden's financial statements for the year ended December 31, 2018, have been received at RAD's corporate offices. Linden's net income for 2018 is reported to be $50,600,000. RAD's CFO has examined the financial statements and is satisfied with most aspects of them but is concerned with the reporting of some transactions and economic events listed below. The CFO has asked you, an accountant in RAD's finance department, to present a report evaluating the issues. Mr. Holmes has already called the CFO to arrange a meeting to discuss the financial statements and the payment of his bonus. The CFO wants your report to explain the problem in each issue, identify reasonable alternatives, and provide full support for your recommendations. (Please attempt the question within these guidelines)

1. On July 29, 2018, the company made a payment of $280,000 to a computer programmer who managed to duplicate the computer software that allows the M-One modules to operate with the base phone. The programmer had given the company fourteen days to pay, or she would sell the information to a competitor. Management believed that if the information were obtained by a competitor, it would have significant negative consequences for the company. Linden has capitalized the payment amount and amortized it over the remaining life of the related asset. Subsequently, Linden applied for a patent to protect against similar situations from arising in the future.

2. In the last week of December 2018, Linden shipped a $1,000,000 order to a new customer with the new super battery. The customer has been having financial difficulties, so Linden provided special financing terms that gave the customer six months to pay instead of the usual 30 days. Payment is guaranteed by the company that owns the customer. The super battery M-Ones sold came with a six-month warranty, the standard warranty offered to all customers. The order was scheduled to be shipped in early January, but because of an opening in the production schedule, Linden was able to complete the order several weeks early. Once the order was completed, it was shipped to the customer. The customer agreed to accept early delivery before Linden shipped the order. The cost of the order was $650,000. The goods were received by the customer on December 31, 2018. Linden recognized revenue when the goods were delivered, as it normally does.

3. In late January 2019 one of Linden's customers filed for bankruptcy, which Linden had suspected might occur because the customer was already four months behind on payments. Linden's management thinks it's very unlikely that it will collect any of the $75,000 owed by the customer. Linden has not adjusted the financial statements for the event but there is a note describing the event and its impact.

4. Following a review in December 2018 of the useful lives of the M-one production facility, management extended the life of Linden's production facility and some of its equipment. Mr. Holmes claims that given the success of the M-One the product life for the M-One is now longer than expected so therefore it was natural to also extend the life of the production facility. The change reduced the depreciation expense in each of the next four years by $28,000.

5. Linden Inc. has just implemented and sponsored a defined benefit plan for its employees in fiscal 2018. No past service benefits have been granted.

The following additional information was obtained from an actuarial report that has been prepared as at the yearend:

Service cost for 2020: $95,000

Discount for settlement rate: 8%

Actual return on plan assets for 2020: 8%

Contribution (plan funding) in 2020 $87,000

Expected rate of return for 2020: 8%

The initial contribution of $87,000 was made on August 1, 2018. Currently, Linden Inc. has expensed the contribution as part of the management salaries and benefits (on the income statement).

6. Linden Inc. sign an agreement on November 1, 2017, to lease equipment from Zeden Leasing. The following information relates to the agreement:

a) The term of the non-cancellable lease is five years, at which time the asset is expected to have a residual value of $7,000, which is not guaranteed.

b) The asset's fair value, at November 1, 2017, is 80,000, with an economic life of seven years.

c) The asset will revert to Zeden Leasing at the end of the lease term, at which time the asset is expected to have a residual value of $7,000, which is not guaranteed.

d) Zeden Leasing assumes direct responsibility for the executory costs.

e) The agreement requires equal annual rental payments of $18,143, beginning of November 1, 2017.

f) The lessor's implicit rate is 10% and is known to Linden Inc. Linden Inc. has recorded this is an operating lease and expensed the annual payment during the fiscal year.