Issue 1: Ringo Receivable
Ringo Pistachio Company owes KCN $77,000 for a computer system with its associated networking software, and installation that was purchased in March of 20X3. Ringo has run into financial difficulties due to dramatic decreases in the selling price of pistachios during recent years. In August of 20X3 Sam Best (president) and Loren Steele (controller) established a repayment schedule in which Ringo would repay $11,000 per month. While the first payment was made in September (bringing the debt down from $88,000 to $77,000) no further payments have been received. (Ringo has continued to make small purchases from KCN on a “cash” basis.)
Your discussion with Loren Steele indicates that Ringo received a “going concern” modification from its auditors for the year ended 8/30/X3 (the audit report was dated 10/22/X3). The going concern modification arose due to a question concerning whether Ringo can obtain new financing when needed, on June 30, 20X4. However, the situation is not entirely bleak for Ringo as layoffs of 1/3 of the company’s employees resulted in a situation in which Ringo operated at break even for the year ended 8/30X3. Ringo has discussed filing for bankruptcy with bankruptcy legal counsel and at this point does not believe such an action will be necessary. But, if it is, that counsel suggests that creditors should expect to receive approximately 40 cents on the dollar. Loren Steele has suggested to you (and Sam Best agrees) that 60 cents on the dollar is more likely if bankruptcy ensues. Your analysis of both the audited annual statements (8/30/X3) and the interim statements (11/30/X3) indicate that 50-60 cents on the dollar seems reasonable recovery if bankruptcy occurs, but, of course, it’s difficult to know what the situation will be in the future.
The sales agreement allows KCN to repossess the equipment at any time prior to bankruptcy. But, because the equipment is used, and because much of the networking software is specific to Ringo’s applications, Sam Best believes that the equipment could be sold for a (net) of between $25,000 and $35,000. Also, Sam points out that such an action would not be considered positively by either Ringo or a number of other companies that KCN is attempting to attract as clients. Accordingly, he and KCN have resisted this option and do not intend to pursue it at this time.
Your analysis of the interim statements (unaudited) reveals that Ringo operated at a slight profit during the first quarter and that pistachio prices have increased approximately 15 percent. However, experts disagree widely as to future pistachio prices as there is some concern that the likely ending of sanctions against Iraq might result in more pistachios entering the US market. Finally, Ringo’s management, although noncommittal on details, suggests that it believes that it will be able to continue repayments on the debt within the “next few months.”
No allowance for this account is currently included in the allowance for doubtful accounts.
What, if any, loss reserve (and/or note disclosure) should be reflected in the financial statements?
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