Study Case – 1
Snow Spray Corp. (SSC) recently filed for bankruptcy protection.The company manufactures downhill skis and reports under ASPE. Withthe increased popularity of such alternative winter sports assnowboarding and tubing, sales of skis are sagging. The company hasdecided to start a new line of products that focuses on the growingindustry surrounding snowboarding and tubing. At present however,the company needs interim financing to pay suppliers and itspayroll. It also needs a significant amount of cash so that it canreposition itself in the marketplace. Management is planning to goto the bank with draft financial statements to discuss additionalfinancing. The company’s year end is December 31, 2019 and it isnow January 15, 2020. Current interest rate for loans are 5%, butbecause it is in Bankruptcy protection SSC feels that it willlikely have to pay at least 15% on any loan. There is concern thatthe bank will turn the company down.
At a recent management meeting, the company decided to convert itsski manufacturing facilities into snowboard manufacturingfacilities. It will no longer produce skis. Management is unsure ifthe company will be able to recover the cost of the ski inventory.Although the conversion will result in significant expenditure, thecompany feels that this is justified if SSC wants to remain aviable business. The shift in strategic positioning will not resultin any layoffs. As most employee will work in the retrofittedplant. The remaining employees will be trained in the newbusiness.
The conversion to snowboard manufacturing facilities would notrequire selling ski manufacturing machines, as these machines canbe used to produce snowboards. The company estimates the resultsand cash flows from its operations of selling skis to be a $20million loss.
On December 15, 2019, the company entered into an agreement withCashco Ltd. To sell its entire inventory in ski building to Cashco.Under the terms of the deal, Cashco paid $10 million cash for theinventory (its regular selling price at the time). The cost to SSCof this inventory was $6 million and so a profit of $4 million wasbooked pre-tax. In a separate deal, SSC agreed to buy back theinventory in January for $10,125,000.
Before filling for bankruptcy protection, the company was able tobuy a large shipment of snow tubes wholesale for a bargain price of$7 million from a supplier that was in financial trouble. The valueof the inventory is approximately $10 million. The inventory wassitting in the SSC manufacturing facility taking up a lot of space.Because the manufacturing facility was being renovated, SSC reachedan agreement with its leading competitors, Alpine Gear Ltd.According to the contract, AGL agreed to purchase the snow tubesfrom SSC for $8 million, and SSC shipped the inventory to December31 to arrive on January 5. The inventory was shipped f.o.b shippingpoint. SSC normally reimburses its customers if the inventory isdamaged in transit. SSC has attentive verbal agreement that it willrepurchase the snow tubes that AGL does not sell by the time therenovation are complete (in approximately six months). The buybackprice will include an additional amount that will cover storage andinsurance costs.
Instructions:
Adopt the role of Rachel Glover – the company controller – anddiscuss the financial reporting issues related to the preparationof the financial statements for the year ended December 31,2019.
