The Red Hen Company produces, processes, and sells fresh eggs. The company is in the process of preparing financial statements at the end of its first year of operations and has asked for your help in determining the appropriate treatment of the cost of its egg-laying flock. The estimated life of a laying hen is approximately two years, after which they are sold to soup companies.
The controller considers the company's operating cycle to be two years and wants to present the cost of the egg-producing flock as inventory in the current asset section of the balance sheet. He feels that the hens are "goods awaiting sale." The chief financial officer does not agree with this treatment. He thinks that the cost of the flock should be classified as property, plant, and equipment because the hens are used in the production of product - the eggs.
1. What are the difinitions of (1) inventory and (2) property, plant, and equipment? Cite the appropriate Codification topic number(s) in your discussion (e.g.,[FASB ASC 220-25-45]).
2. What is the definition of a current asset? Would the hens be considered "current assets"? Cite the Codification topoic number(s) relevant to classifying an item as a current asset.
3. How would your team recommend the presentation of the cost of the egg-producing flock in the balance sheet? Discuss in details the following two scenarios and give your recommendation:
a. If your team believes that the hens should be presented as "inventory," what are your reasons? When should Red Hen Company recognize "cost of goods sold" and of what amount? What other disclosures in financial statements are required?
b. If your team believes that the hens should be initially recognized as "property, plant, and equipment," what are your justifications? What are the "useful life" and the expected salvage value of the egg-producing flock?