IC4.2 Brave Maven Inc. (BMI) operates in challenging economic times. It currently manufactures trucks and
equipment used for construction, as well as off-road automobiles and automotive parts. During t
losses from off-road automobiles and parts totalled $1 million (net of tax). Future losses are expe
net
increase by an additional $1 million. BMI's management team is contemplating selling off this unp.
able
business segment. In December, BMI's board of directors authorized a sale transaction.
Add-
Management would also like to expand the production of trucks and construction equipment. BMI's lenders
are not willing to provide additional financing, so BMI will need to explore equity financing. Management is
preparing the necessary documentation for an initial public offering.
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The carrying value of the facility and equipment used to manufacture the automobiles and parts is $2 million.
Two years ago, some modifications were made to the equipment. The equipment is now specialized for use by
the company. BMI needs to spend $500,000 to disassemble the previous modifications to sell the equipment.
By year end, management had hired a contractor to begin disassembling the equipment.
BMI has been in sale negotiations with one of its automotive parts suppliers interested in expanding its own
automotive parts business. Negotiations are expected to continue, but the two companies are not able to agree
on a price. The supplier indicated it is only willing to pay up to 90% of the asking price, since it would have to
make its own modifications to the equipment first. The purchase would only go ahead if BMI completed the
disassembly of the equipment's existing modifications and the supplier's engineer subsequently inspected and
approved the equipment. Management thinks that 90% of the asking price is less than it would be willing to
sell the assets for.
BMI is also in a dispute with one of its suppliers of truck parts. To get a discounted price, BMI had to commit
to purchasing $500,000 of spare parts each year for three years. BMI recently upgraded its safety standards
and consequently made modifications to its construction trucks in the current year. As a result, management
did not accept delivery from this supplier for the spare parts in the current year. There is a provision in the
contract that stipulates an annual penalty of $250,000 for failure to take delivery. One more year remains in
the contract. BMI's lawyers are reviewing the contract. They have suggested that BMI may qualify for
exemption from the penalty for not taking delivery because its refusal resulted from a change in the safety
specification for the part and not because of a change in sales demand. The supplier is willing to modify its
spare parts to conform to BMI's new safety standard.
Just before year end, management purchased an additional building. BMI plans to use 50% of the building
and move the current sales team to the new location. It does not plan to use the other 50% for its current
operations. BMI's real estate agent inspected the property and believes the unoccupied portion of the building
can be sold or leased separately. Management does not want BMI to use fair value as its basis for
measurement because it is concerned that changes in fair value will create too much volatility in the income
statement. This may lower the price that BMI sells it shares for in the future public offering.
Instructions
Audit It is now two months after year end. Assume the role of BMI's auditor and discuss the financial
reporting issues.
