Intermediate 1 – FARS Cases Fall 2019
For each of the following cases use the FARS database to find standards to support your answers. Be sure to list the standard you used in your answer and be as specific as you can when recording or quoting the standard.
Case 1:
Big Promises Exploration Company, a small independent oil company owns an oil field drilling rig. Big Promise purchased the rig new for $2.5 million during the height of the energy boom when prices for crude oil were high. The rig was taken out of service following a free fall in the world oil prices and has been out of service for years. Its carrying amount is $2 million.
Big Promises management believe that the undepreciated invested cost of the rig is recoverable because the downturn in oil prices is only temporary and prices will return to record highs once again. Unfortunately, the current price of oil is relatively low and there is virtually no market for used drilling rigs, although a scrap metal dealer recently offered Big Promises $100,000 for the rig.
Required:
How should Big Promises accurately record the value of its drilling rig? Should it be regarded as an impaired asset and carrying amount be written down? If so, to what amount?
Case 2:
Martin Cranshaw has been looking for a well-located site for a new restaurant that he plans to open. After an extensive search, he identified an ideal location at the intersection of A1A and a well-traveled road. Following some difficult negotiations, Martin bought the property for $750,000.
On the site was a vacant gasoline station, which was last rented out to an automobile mechanic who operated it as a transmission replacement shop. That tenant only used the service bays and the office space; no gasoline was sold nor were the underground gasoline tanks used.
Martin both the property with the intent of demolishing the gasoline station, which did not suit his needs for the restaurant; instead he planned to construct a new building on the site. Bids obtained for the demolition ranged from $15,000 to $25,000. The cost of the new building was estimated to be between $700,000 and $800,000.
In the process of obtaining the necessary permits for demolition, Martin learned of a governmental regulation that requires abandoned underground gasoline tanks to be removed and disposed of when former gasoline stations are demolished. In addition, the regulation requires that any soil contamination that might have eventuated from a leaking tank be treated by refining the soil. He also learned of new environmental regulations that would prevent him from building on the property, unless he could show that he was just renovating an existing structure. His architect informed him that the way this was usually done was by leaving one cement block wall of the building up and building around it or incorporating it into the plans. This additional architectural cost to allow for permits of an existing building renovation and reworking of the architectural plans would add an additional $75,000 to the cost of the restaurant.
The lowest cost estimate Martin was able to obtain for removing and disposing of the three underground takes totals $60,000 and if the refinement of the soil was necessary, another $40,000 would be required.
Required:
- How should Martin recognize the costs of demolishing the gas station, removing the abandoned underground tanks, refining the soil, and the added renovation permit and architectural changes?
- If you assume that Martin Cranshaw had been aware of the regulations when purchasing the property, how should he recognize the costs?
Case 3:
Rownan Corporation is a real estate development company. In addition to developing raw land, it constructs and rehabilitates office buildings, which it then sells.
Rownan recently acquired a building of a failed business for $5 million. The building has been vacant since last year when the business was declared to be insolvent and its assets were sold. Rownan bought the building with the intention of gutting most of the interior, and then remodeling it into a “class A” building, and then selling it.
Because the building was constructed a number of years ago, lead pipes were installed for its plumbing system. Since lead pipes have been found to contaminate the water they carry, the government has deemed them to be a health hazard and adopted regulations requiring their removal and replacement, whenever a building is renovated. Rownan was aware of the regulation when negotiating for the building’s purchase.
The total cost of remodeling the building will be $4 million, of which $500,000 is for removal of the lead pipes and replacement with copper plumbing. The remodeling will not increase the building’s expected useful life, although it will enhance its rental value.
Required:
- How should Rownan recognized the cost of removing and replacing the plumbing system?
- Assuming Rownan was not aware of either the regulation or the presence of the lead pipes, how should the company recognize the cost?
Case 4
As winter was approaching, Kendall’s Carpentry Company finished the framing and “drying-in” a new lake house for Dave Hampton, one of the company’s clients, who accepted the work as complete and satisfactory. Hampton is building the lake hours as a weekend and summer retreat for himself and his family on a lot he bought for $18,000 last spring with some inheritance money. The keep construction costs to a minimum, Hampton decided to be his own general contractor.
Although the lot is fully paid for, the house must be financed. Because local lenders do not make loans to individuals on dwelling that are not yet habitable, Hampton has had to work out some short-term financing arrangements. He arranged with a building supply company to buy all the materials needed on a six-month note and has made similar arrangements with Kendall’s Carpentry Company for the labor. Now that the house is “dried-in,” Hampton plans to spend his winter weekends doing all the finishing work so that the house will be ready for use by late spring. Once the lake house is completed, Hampton intends to get a conventional mortgage on it for about $40,000 and use the proceeds to pay the notes to the building supply company and Kendall’s Carpentry.
The job required a total of 310 hours of labor, for which Kendall’s Carpentry usually bills $50 an hour on a cash basis (the workers are paid an hourly rate of $30). However, because of Hampton’s good credit rating, the company has agreed to take a non-interesting-bearing note in the face amount of $15,500 due in 6 months. Collateral for the note is a lien on the lake property (the same as on the note to the building supply company). Based on inquiries to its own bank and a few others, Kendall’s carpentry knows the note can be discounted with recourse for about $14,100 or without recourse for about $12,900.
From its own experience with similar notes, Kendall’s Carpentry believes the risk of loss from default is about 5 %. Also, the company changes a 12% annual discount rate.
Required: How should Kendall’s Carpentry recognized the note receivable and the related service revenue?
Case 5:
Early in the year, Fabulous Recreation, a leading manufacturer of quality recreational equipment, put some idle cash to work by investing in marketable securities, so of which later advanced in price while others declined. The securities were recorded at cost.
In November, Mikhail Martinoff, president of Fabulous Recreation, decided to dispose of all the securities. The securities were actively traded on the Big Board, with Fabulous’ holdings only a minor fraction of the normal daily volume.
As of November 10, information showed:
| Cost | Market | |
| Appreciated securities | $40,000 | $70,000 |
| Depreciated securities | 40,000 | 27,000 |
| Total | $80,000 | $97,000 |
Because Fabulous prepares financial statement only at year-end, no gains or losses have been recognized for any of the securities.
President Martinoff is considering five possible means for disposing of the marketable securities:
- Sell for cash
- Use to satisfy liabilities
- Distribute to stockholders as a dividend
- Use to pay executive bonuses
- Donate to a charity
He has told the controller that his decision about which course of action to take will depend in part on how much gain or loss will be recognized as a result of the disposal option he chooses.
Required:
- How much gain or loss should Fabulous recognized under each of the five options for disposing of the assets?
- Should the amount depend on the means of disposal?
