Question

Sharpson, Inc.

Treatment under the ASC Codification

Facts:

You are a first-year associate at the accounting firm, Wesson & Richardson LLP (WR or the Firm). One of the Firm’s clients is Sharpson, Inc., (the Company), which is located in Detroit, Michigan.  It designs, manufactures and sells a broad range of automotive components.

The Company’s primary sources of liquidity are internally generated cash flows, its debt and revolving credit facilities, and the sale of its trade accounts receivables. The Company’s liquidity and capital requirements are primarily a function of its working capital needs, capital expenditures, and debt service requirements.

According to the Company’s financial manager, the Company has several transactions, as described below, that need to be analyzed before the Company’s statement of cash flows can be prepared. The financial manager has asked your Firm for guidance on how these transactions should be reflected in the Company’s Statement of Cash Flows for this year. Your partner, Martice Jones, has asked you to write a letter to the client to address their concerns.   

The Company’s transactions are:

1.  Acquisition of Property, Plant, and Equipment on Account:

In December of this year, the Company incurred $10 million of capital expenditures related to the acquisition of manufacturing equipment and machinery. The terms of the related invoice were 2%/15, net 45. At the end of this year, the Company had not paid the invoice and included the invoice amount in its accounts payable balance. In accordance with the terms of the invoice, the Company intends to (and will) pay this invoice early next year.

2.  Insurance Settlement Proceeds:  

This year, the Company reached a settlement with its insurance carrier, Mutual Insurance (Mutual), related to a claim from a tornado that destroyed one of the Company’s manufacturing facilities. During the year, the Company received proceeds of $23 million from Mutual in connection with its claim for reimbursement for the destroyed building. The Company plans to use the insurance proceeds to fund its defined-benefit pension plan, rather than to rebuild the destroyed facility.

3.  Sale of Accounts Receivables:

The Company sells its account receivables (A/R) to a non-consolidated multi-seller securitization vehicle and receives proceeds from those sales that consist of cash and beneficial interest in the transferred receivables, which is classified as an available-for-sale security. The Company uses “securitization” as a financing technique in order to reduce more expensive bank debt, which means that the interest cost on the securitization financing is less than the Company could get on its own bank debt. The Company services administer and collect the A/R on behalf of the non-consolidated multi-seller securitization vehicle. During this year, the Company sold some of its inventory as part of the above agreement and generated $14 million of A/R, which is then sold to the non-consolidated multi-seller securitization vehicle. As part of this transaction, the Company received cash and beneficial interest in the A/R transferred to the non-consolidated multi-seller securitization vehicle.

Issues:

On the Company’s statement of cash flows for this year:

1. How should the capital expenditures for the equipment be reported, even though the Company paid the invoice early next year, rather than at the end of this year?
2. How should the Company’s insurance proceeds be reported?
3. How should the sale of the A/R by the Company to the nonconsolidated multi-seller securitization vehicle and receipt in return of cash proceeds and a beneficial interest be reported?  

Answer these issues to the client in letter to client format

Answer 1

1) Acquisition of property, plant, and equipment account:

capital expenditure incurred for the month of December = $ 10 million

   As if company follows accrual system of accounting then company can enter the entries on accrual basis no actual payment is required. in the given case the company not yet cleared invoices and it is willing to clear the invoices in the next month for this the company has to create an accounts payable account for the amount of invoice to be paid .

Entry for : Plant, property and equipment    a/c Dr    $10 million

To Accounts payable a/c $10 million

[being plants, property, and equipment purchased on credit]

Accounts payable    a/c Dr    $10 million

   To Cash/Bank a/c    $10 million

2. Insurance settlement proceeds:

If there is any contractual agreement between the company and the insurance company then the proceeds from the insurance company are used for that purpose only or else u can use to any other purpose which is beneficial to you.

In the given question there is no such contractual agreement for usage of insurance proceeds. so, the company can use the insurance proceeds for pension plan.

Entry: Damage a/c Dr    $23 million

To manufacturing facilities a/c $ 23 million

Cash/Bank a/c Dr    $23 million

   To Damage a/c    $23 million

3) Sale of Accounts Receivable:

   Entry: Accounts receivable a/c Dr $14 million

   To Inventory a/c    $14 million

( being inventory sold)

   Multi seller securitization Vehicle a/c Dr    $14 million

   To accounts receivable a/c $ 14 million

(Being company sold its accounts receivable to multi seller securitization vehicle a/c)

   Cash a/c Dr    $14 million

To Multi seller securitization Vehicle a/c   $14 million

   (Being company received cash )