University Of California Pet Project Expansion Report What compensatory damages, if any, are owed to Clyde Property Management? What additional factsmight

University Of California Pet Project Expansion Report What compensatory damages, if any, are owed to Clyde Property Management? What additional factsmight you need in order to fully answer this question?What punitive damages, if any, are owed to Clyde Property Management? What additional facts might you need in order to fully answer this question? PET PROJECT EXPANSION
“Crazy” Connor Cooper is a somewhat eccentric yet enthusiastic businessman who believes in the social
responsibility of business. Incidentally, he is also interested in making enough money to live a
comfortable life. As a supporter of the ecology movement, he is very concerned with the hunting of
animals for industrial purposes, such as the making of furs, shoes, and ladies’ handbags. As a
consequence, he formed Reptile Factory Enterprise (RFP), a company with a mission of promoting
crocodiles as household pets. (The choice of the animal was purely coincidental.) He plans to catch
crocodiles in Southeast Asia and sell them in the United States. 1
The senior leadership team of the company consists of Mr. Connor Cooper (President), Brian Chu (Vice
President of Production, who is in charge of catching crocodiles), Marco Diaz (Vice President of Sales),
and Shelley Maze (Vice President of Operations, who is in charge of administrative functions including
cash collection from customers).
Facilities Planning
The first task facing Mr. Cooper was to raise capital. This required estimating future capital needs by
projecting the physical facilities and working capital needed for the business. Mr. Cooper’s estimates
showed that he would need a fleet of boats to catch crocodiles in Southeast Asia and a holding tank in
the State of Gould to keep them alive in captivity after they are shipped. Because of the need to extend
liberal credit terms to skeptical customers, the company needed working capital to carry inventories and
receivables. Finally, the company needed a large start up investment for sales and an advertising
campaign. The firm also needed funds to hire new employees and to rent office space in the State of
Gould. Mr. Cooper asked Shelley Maze to prepare a forecast of activity to plan facility needs and to
translate it into capital needed to start the business.
First Year Results
Based on the forecast provided by Ms. Maze, Mr. Cooper and his ecology minded friends raised the
capital for acquiring the facilities. He leased ten boats in Southeast Asia, a 20,000 square foot
warehouse with a holding tank for the crocodiles in the State of Gould, and a 2,500 square foot office in
the State of Gould. Both the warehouse and the office were leased from Clyde Property Management
(CPM) for three years, beginning January 1, 2008.
The company opened its door for business on January 1, 2008. Marco Diaz launched an aggressive
sales and advertising campaign built around the slogan that crocodiles were warm, friendly and greatly
misunderstood creatures that deserved loving care. He designed a slick marketing campaign built initially
around the slogan: “Crocodiles — don’t handbag them, handle them with love.”
During its first year, the company spent approximately $300,000 to catch 500 crocodiles. Of these, 300
crocodiles were sold and shipped to customers at a selling price of $1,000 per crocodile. Shipping costs
of $50 per crocodile were paid for during the year. Customers were given liberal credit terms and only
$160,000 from an equivalent 200 customers was collected during the first year. Ms. Maze estimated that
as much as 20% of the sales price will be spent in collection costs and bad debts expenses.
At the end of the first year, Mr. Cooper consulted with his other two colleagues and estimated that he
could catch and sell 600 to 800 crocodiles for the next year. Because of the company’s apparent
success, Mr. Cooper wanted to expand its facilities. This meant getting funds to rent more boats and
warehouse space. He believed that he could now overcome the skepticism of banks and ask for a loan.
On January 2, 2009, Mr. Cooper notified Clyde Property Management that he no longer needed their
current warehouse and office space. He would be vacating the properties by January 30th in order to
move into larger facilities.
1
Assume that Mr. Cooper has somehow managed to obtain permits to sell live crocodiles legally.
He asked Ms. Maze to prepare an income statement for the bank in accordance with generally accepted
accounting principles (GAAP). In addition, since the executives were on a profit-sharing scheme, it was
necessary to determine profits in order to pay year-end bonuses.
Ms. Maze entrusted this task to her young staff accountant, Luis Norman, who had only recently
graduated from college and was on his first job. After he familiarized himself with the facts, Norman
realized that he needed to look up the GAAP accounting rules for preparing an income statement. At that
same moment, he also realized with some consternation that he had sold his college accounting textbook
when the course was over. Norman headed to his college library to find the relevant reference material.
A review of his old accounting textbook told him that two GAAP principles were particularly relevant for his
current task. The first was the matching principle, which requires that costs and revenues be matched by
time periods. The other was the principle of revenue recognition. His next step was to copy and read the
relevant sections of these principles from the pronouncements of the Financial Accounting Standards
Board. Attachment 1 shows the results of Norman’s research into the appropriate GAAP rules for
preparing income statements.
On first reading the material, Norman thought it was going to be easy to prepare an income statement.
He remembered learning that for most businesses’ revenue was earned when good were sold (that is,
when title passed from the seller to the buyer). However, as he read the statements of the FASB, he
realized that revenues could be recognized when production was complete or when cash was collected.
According to the FASB standard, “revenues are considered to have been earned when the entity has
substantially accomplished what it must do to be entitled to the benefits represented by the revenues.” 2
Norman realized that in order to determine the revenues for 2008, he must first determine when the
earning process is complete. This, however, was not a usual business. Therefore, Norman was not sure
when Reptile Factory Enterprise was “entitled to the benefits represented by the revenues”. In order to
determine the critical point in the operations cycle when the business could do this, he decided to talk to
the three top executives.
His first conversation was with Brian Chu, V.P. Production. Brian told him that catching crocodiles was
the most critical activity for the business since “it is difficult to trap them suckers and you can lose a few
limbs in the process if you are not careful.”
Norman next spoke to Marco Diaz, V.P. Sales. Marco pointed out that while catching may be a
dangerous activity, no one is likely to buy a crocodile because it is risky for us to catch them. He felt the
company’s success this year was largely due to his clever holiday season advertising campaign with its
theme of: “this year give that special someone something live! Someday they can produce their own
shoes, handbags, and belts.”
Norman’s final conversation was with Shelley Maze, V.P. of Operations. She told Norman that, in her
opinion, the crucial activity for the business was cash collection. As she put it: “Brian and Marco have
never tried collecting cash. If they did, they would find out in a hurry that it is difficult to collect cash from
people who keep crocodiles as pets. Besides, we don’t have a collection agency that is willing to
repossess live crocs!”
2Financial
Accounting Standards Board, Statement of Concepts # 5, Paragraph 83.
The Lawyers Call
Even as Norman was puzzling over how to proceed, he received a call from Ms. Shelley Maze. “Luis, I
just heard from our lawyers. Apparently, Clyde Property Management (the property management
company that leased us the warehouse and office space) is claiming that we had no right to break the
lease. We are being sued for an amount equal to the balance of the lease term and for punitive
damages. Later that day Luis received the memo from the lawyers that is summarized in Attachment 2.
Required
Assume that you have been hired as a consultant by Shelley Maze to help her and Luis Norman. She
has asked you for your help on the GAAP income statements and the legal issues arising from the lease
cancellation. Please write a business report using the case writing guidelines and report format guide
from the Gateway website.
To prepare an answer to this case you may want to review the following top ten concepts from the LDC
Review material:
1. Financial Accounting # 3. Know the basic concepts underlying financial reporting (e.g.
matching, consistency, etc.).
2. Financial Accounting # 4. Know how to record and read a simple business transaction.
3. Financial Accounting # 8. Understand the timing of revenue and expense recognition.
4. Business Law # 5. Understand the duty to mitigate damages.
5. Business Law # 9. Understand the differences between compensatory and punitive damages.
Attachment 1
Excerpt of Relevant GAAP Principles for Income Statement Preparation
I – ACCOUNTING PRINCIPLES STATEMENT # 4. GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES– PERVASIVE PRINCIPLES2
Footnote 43. The term matching is often used in the accounting literature to describe the entire process
of income determination. The term is also often applied in accounting, however, in more limited sense to
the process of expense recognition or in an even more limited sense to the recognition of expenses by
associating costs with revenue on a cause and effect basis.
Associating cause and effect. Some costs are recognized as expenses on the basis of a presumed
direct association with specific revenue . . . Although direct cause and effect relationships can seldom be
conclusively demonstrated, many costs appear to be related to particular revenue and recognizing them
as expenses accompanies recognition of the revenue. Examples of expenses that are recognized by
associating cause and effect are sales commissions and costs of products sold or services provided.
II – STATEMENT OF CONCEPTS # 5. RECOGNITION AND MEASUREMENT IN FINANCIAL
STATEMENTS OF BUSINESS ENTERPRISES3
Revenues and Gains — Paragraph 83. Revenues and gains of an enterprise during a period are
generally measured by the exchange values of the assets (goods or services) or liabilities involved, and
recognition involves consideration of two factors (a) being realized or realizable and (b) being earned,
with sometimes one and sometimes the other being the more important consideration.
a) Realized or realizable. Revenues and gains generally are not recognized until realized or realizable.
Revenues and gains are realized when products (goods or services), merchandise, or other assets
are exchanged for cash or claims to cash. Revenues and gains are realizable when related
assets received or held are readily convertible to known amounts of cash or claims to cash.
b) Earned. Revenues are not recognized until earned. An entity’s revenue-earning activities involve
delivering or producing goods, rendering services, or other activities that constitute its ongoing major
or central operations, and revenues are considered to have been earned when the entity has
substantially accomplished what it must do to be entitled to the benefits represented by the
revenues.
Paragraph 84. In recognizing revenues and gains:
a) The two conditions (being realized or realizable and being earned) are usually met by the time
product or merchandise is delivered or services are rendered to customers, and revenues from
manufacturing and selling activities and gains and losses from sales of other assets are commonly
recognized at time of sale (usually meaning delivery).
b) If sale or cash receipt (or both) precedes production and delivery (for example, magazine
subscriptions), revenues may be recognized as earned by production and delivery.
2
Financial Accounting Standards Board, APS 4: Basic Concepts and Accounting Principles Underlying Financial
Statements of Business Enterprises, APS 4, October 1970.
3
Financial Accounting Standards Board, Statement of Concepts # 5, Paragraph 83, December 1984.
c) If product is contracted for before production, revenues may be recognized by a percentage-ofcompletion method as earned–as production takes place–provided reasonable estimates of results at
completion and reliable measures of progress are available.
d) If products or other assets are readily realizable because they are salable at reliably determinable
prices without significant effort (for example, certain agricultural products, precious metals, and
marketable securities), revenues and some gains or losses may be recognized at completion of
production or when prices of the assets change
e) If collectability of assets received for product, services, or other assets is doubtful, revenues and
gains may be recognized on the basis of cash received.
Attachment 2
Lawyer’s Memo on Reptile Factory’s Legal Liability
MEMORANDUM
TO:
Shelley Maze
Reptile Factory Enterprise
FROM:
Matt Green, Esq.
RE:
Reptile Factory Enterprise
DATE:
January 3, 2009
I just spoke with Keith Fox, the attorney for Clyde Properties. According to Mr. Fox, his client
leased to Reptile Factory Enterprise 2,500 square feet of office space and 20,000 square feet of
warehouse space.
According to Mr. Fox, Clyde is prepared to sue Reptile Factory Enterprise for $372,000. [This
amount includes $72,000 in lost rent and $300,000 in punitive damages.] The claim is itemized
below:
Warehouse:
Monthly rent
Balance of the lease
Total rent for warehouse
$2,000
24 months
Office space:
Monthly rent
Balance of the Lease
Total rent for warehouse
1,000
24 months
TOTAL RENT
PUNITIIVE DAMAGES
TOTAL RENT AND PUNITIVE DAMAGES
48,000
24,000
72,000
300,000
_______
372,000
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