Question: Reliable Construction Inc. (RCI) is a public
Reliable Construction Inc. (RCI) is a public company that sells construction equipment to builders of primarily homes, office buildings, and highways. RCI has been in operation for over 30 years. Up until this year, the company has had profits with the real estate boom and large amounts of government funding for highway construction.
During the COVID-19 pandemic, things changed drastically and RCI has had to request increased financing from its bank. As a result, the bank has imposed a minimum current ratio and a minimum balance that must be maintained in one of its accounts.
It is now 5 March 20X1 and RCI is planning its first-quarter-end report of 20X1. Recently you were hired as an accounting policy analyst to assist RCI with its accounting policies. You have just finished a virtual meeting with Natalie, the majority shareholder and CEO, and Mario, the CFO. The following are comments and questions from the meeting.
Mario spoke first:
“The effects of COVID-19 have hit us hard. We have had profits for a number of years and never worried about having enough cash on hand. Cash is critical in our business where the manufacturing of this specialized equipment can take a long period of time. In addition, our customers are really struggling to be able to invest in new machinery and pay their bills.
“I am excited that you are able to join us and help out with a number of new situations that have arisen during the COVID-19 pandemic and possible solutions I have to solve our current cash crisis. Our bank has been very supportive but they are a little nervous about the repercussions of the economic downturn. I am not sure what, if anything, I need to do in the financial statements and notes about their recent covenant and restrictions. In addition, we have a number of bank accounts with our bank. Our line of credit has been in an overdraft position for over a year now. But we also have positive balances in our other accounts. All of these accounts are currently in cash and cash equivalents on our balance sheet. Is that okay?
“Some of our purchases for our manufacturing purchases are from the U.S. and we are required to pay in U.S. dollars. This has never been an issue for us before since the Canadian and U.S. dollar have been at par. The Canadian dollar has been dropping in value and is currently at an all-time low and may continue to drop. What is the appropriate accounting for this drop in value and what impact will this have on our financial statements?
“Some long-time customers who have been buying from us are having difficulty paying and are currently overdue. I know they are also struggling because of the COVID-19 pandemic. I believe they will pay eventually and I want to help them out. What Mario has done to make their life a little easier is to change their accounts receivable to a note. This note allows them a two-year period to pay with an interest rate of 4% even though the current market rate is 8%. Mario has just taken the $500,000 of accounts receivable and reclassified them as a note receivable since we are sure they will pay. Is this okay?
“To get some extra cash we were considering selling some of my high-quality receivables to a financial institution. RCI has $5,000,000 in these receivables. The financial institution will provide RCI with $4,800,000 in cash if we agree to make any payments that default. What would be the impact of this on RCI’s financial statements?
“RCI requires payment within 60 days of the invoice date. Terms are generous. Here are the details of the accounts receivable balance at March 5, 20X1 unrelated to the items we already told you about.â€
The following information was then presented on the virtual meeting shared screen:
Natalie continued:
“RCI normally allows for outstanding receivables greater than 60 days and less than 90 days at 5%, over 90 days and less than 100 days at 10%, greater than 100 and less than 130 days at 25% and over 130 days at 50%. The allowance for doubtful accounts currently has a balance of $8,900 and the items below have not been adjusted for. Can you consider each of these and figure out what we should do?
“Item A. Michael & Hannas has been complaining about the equipment received since the third quarter of fiscal 20X0. The owner has threatened us on multiple occasions about going to the media to report the terrible quality of equipment that RCI sells. We are afraid to follow up on outstanding payment given the situation. We have put this customer “on hold†and will not make any further sales to them right now.
“Item B. Training Co. faced a massive flood in late January 20X1 and due to an insurance policy lapse is now facing extreme financial difficulty. We have a close relationship with the CEO of Training Co. I believe there is a 50% chance that only half the outstanding balance can be collected by RCI. Mario thinks that a quarter of the outstanding balance will be collected at most.
“Item C. Yamto Housing contacted RCI in late February to report that its government funding for 20X1 has not yet come in and therefore it cannot pay its bill. Due to a glitch in the government funding portal, Yamto Housing may not be allocated any funds for 20X1.â€
Natalie then said:
“Mario, I think we should also talk about those cryptocurrencies. Remember how we recorded them as intangible assets when we acquired them a few years ago? Why don’t we reclassify them as cash? That will help boost our cash balance and the current ratio.
“We are running out of time and I just have one last thing on my agenda so let’s get to it. Mario was telling me that we can make great use of data analytics to manage our receivables. Given all the drama that has unfolded with the pandemic, do you see any merit in this? Just thought I would ask your opinion; I know it doesn’t quite fall under policy analysis.
“OK. I have to get to another meeting now. Wow. I have such screen fatigue from all these virtual meetings. Can you draft a report addressing my concerns? I’ll review the full written report but we can talk about it at a meeting. I’ll send you a calendar invitation for another meeting next week.â€
Required:
Prepare the requested report for Natalie
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