Reference no: EM132595781
Woodland Furniture Ltd. is a Canadian manufacturer of public site furniture products. Woodland's products are designed for use in public places such as parks, malls, town squares-high-traffic locations that require high-quality, durable, and attractive furniture. Woodland's products include benches, bike racks, planters, recycling bins, and trash containers. Woodland has a loan outstanding from the Bank of Ontario and is looking to increase the loan to help finance its ongoing expansion.
It's late October 2017. You are an accountant with the Bank of Ontario's regional office in Durham Region. You received a call from the loan officer responsible for the Woodland loan regarding its 2017 third-quarter unaudited financial statements (the end of the quarter was September 30). The loan agreement requires that Woodland maintain a current ratio greater than 1.25 and a debt-to- equity ratio below 1.6 at the end of each quarter. Woodland is onside with the ratios, but just by a small amount. If Woodland violates either of the covenants, the terms of the loan will be subject to renegotiation and perhaps repayment. In addition, violation would make it significantly less likely that the bank would provide Woodland with the additional financing it's looking for.
The loan officer expressed some concern to you about Woodland's accounting for three transactions and the impact on the covenants. She asked you to prepare a report that reviews the transactions and assesses the accounting Woodland used. She would like full explanations of whether the accounting used was appropriate or inappropriate.
The loan officer provided you with the following information:
1. Summarized balances at the end of Woodland's third quarter:
Current assets $6,500,000
non-current assets 23,500,000
Current liabilities 5,100,000
Non-current liabilities 13,100,000
Shareholders equity 11,800,000
2. Though Woodland has been very successful in Canada, it hasn't had much success in foreign markets, particularly the United States. This year, Woodland tried a different strategy. It made arrangements with a well-established U.S. distributor who agreed to market and distribute its products in the southern United States. In late July 2016, (during the third quarter) Woodland shipped $250,000 worth of furniture to the U.S. distributor. The distributor agreed to pay $400,000 for the furniture. The distributor isn't required to pay for the furniture until it sells it to a customer. The distributor is also allowed to return up to 75 percent of the furniture at no cost. Woodland recognized the revenue from this sale in the 3rd quarter.
3. During the third quarter, Woodland completed a deal with one of the Canadian territories to supply outdoor recycling bins. The final design is based on an existing Woodland product that has been modified to meet the rigours of the cold Canadian winters in the far north. No Woodland product has ever been used under these conditions but the company tested the product extensively in the extreme-weather facility at the University of Ontario Institute of Technology, and management is confident that the product is well designed for the conditions. Woodland has provided the territory a two-winter guarantee that it will replace any bins that are broken or damaged due to weather conditions. The contract price is $750,000 and the bins cost $475,000. The revenue was recognized in the third quarter. Woodland expects payment for the bins within 60 days of the end of the quarter.
4. During the third quarter Woodland spent $125,000 trying to win a large contract to supply a city in Mexico. The $125,000 includes costs for executives to meet and entertain representatives of the city, development of a sophisticated marketing campaign, and preparation of information packages for politicians in the city. A final decision is expected in late October, but the information being received from Woodland's advisor in the city isn't favourable. It appears that the city is going to select a Mexican producer. Woodland recorded the $125,000 as a non-current asset and is amortizing it over three years, beginning after the contract result is announced.
Required:
Question 1: Report to the bank lending officer