What FASB code should we use for this case? Does it violate the GAAP? I need to mention codes in my letter. Please advise
Case 2
A Liquidation Dilemma
Polar Bear, Inc. (Polar) is a small-sized publicly traded company engaged in the production and distribution of ice cream. Polar has been using the LIFO inventory cost flow assumption for many years, and at the beginning of the year had a LIFO layer of 800,000 gallons of sweetener (high-fructose corn syrup HFCS-42) at an average LIFO price of $1.08 per gallon. Except for the dairy products used to produce the ice cream, the sweetener is Polar's largest and most costly inventory item.
Polar requires approximately 150,000 to 200,000 gallons of sweetener to service its customers for a month. Polar's sales have been unexpectedly high as the companyapproached the end of the year. Consequently, by the time the December 31 year-end
arrives, Polar anticipates having only an inventory of 200,000 gallons of sweetener.
Polar is concerned because it expected to have a year-end inventory above the current LIFO layer of 800,000 gallons.
Polar's Controller, Gladys Notus, stated in a recent Staff Accounting meeting: "From a cash flow point of view the company must maintain - and possibly increase - the LIFO layer in order to avoid a LIFO liquidation nightmare" resulting in higher taxes for which
Polar does not have additional cash readily available. Unfortunately, Polar's normal supplier is also currently experiencing shortages and cannot deliver the required quantities of sweetener before the end of the year.
The issue has generated considerable debate among top management. At a second meeting called to discuss this problem, Notus reported that at a recent CalCPA luncheon, Ben Real, the controller of another ice cream producer, Pleasant, Inc. shared
with her that Pleasant, Inc. had not been as profitable as Polar during the year, and that its earnings were going to fall just slightly short of Wall Street and internal targets. Nowthat summer is over, Ben told Gladys, Pleasant Inc.'s ice cream sales "were not going to
be high enough to put them over the top - and there goes the performance bonuses and value of Pleasant's stock." As a result, Pleasant was actually going to have a surplus of sweetener that will not be needed until production demand increases in the
new year. Pleasant was also having a severe cash flow problem caused by its purchase of too much raw material inventory (especially the sweetener) and its inability to obtain additional financing due to covenants on existing debt that limits future borrowing. As
the controllers discussed their respective problems, the following plan began to develop: Polar would purchase 700,000 gallons of sweetener from Pleasant prior to year-end at$2.50 per gallon (the current wholesale price). Pleasant would agree to repurchase the
sweetener for $2.65 a gallon within six months. The sweetener would not be shipped to Polar, but would be stored in a public warehouse. To help Pleasant with its cash flow problem, Polar would use the sweetener as collateral to obtain a 6-month loan, which
would be given to Pleasant as payment for the inventory. The cash paid by Pleasant to repurchase the sweetener would be used by Polar to repay the loan plus interest and the cost of storage. In the new year, Polar would get an extra boost in earnings when
the inventory was repurchased by Pleasant.
Upon learning the details, Polar's CEO, Thatis A. Winninghand, declared: "this plan is a win-win for all" because Polar would be able to obtain its much-needed inventory layer and Pleasant would solve its cash flow and earnings problems.
While the other Polar executives celebrated the Notus plan, the CFO, Mary Skeptic, is not as enthusiastic. Skeptic is concerned about whether this transaction should be accounted for as a purchase, and seeks your advice in order to obtain assurance that
the proposed transaction does not violate GAAP. Skeptic also is concerned about the Sarbanes-Oxley requirement that she and Winninghand eventually need to certify Polar's financial statements.
Skeptic would like you to provide her with your conclusions and recommendation(s) on the issues her stated concerns raise. Skeptic would also like you to prepare a schedule that calculates the cash Polar will need for additional taxes if Polar decides not to adopt
the Notus plan (using "With Purchase" and "Without Purchase" tables).
You are provided with projections from Skeptic (below) and are told to assume that the inventory levels of the other ice cream ingredients will remain constant.
Revenue (projected)
$15,400,000
Operating expenses (projected)
$ 6,000,000
Tax rate (federal and state)
40%
Sweetener Inventory Records:
Beginning inventory
Purchases
Ending inventory (without purchase)
Proposed purchase
800,000 gal.
1,900,000 gal.
200,000 gal.
700,000 gal.
@ $1.08 (LIFO)
@ $2.35 (LIFO)
@ $1.08 (LIFO)
@ $2.50
[For this case only, ignore the Pending Content in the Codification for any standard you might use.]