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SALTWATER IMPORTS”Crazy” Henry Mason is a somewhat eccentric yet enthusiastic businessman who believes in the social
responsibility of business. Incidentally, he is also interested in making enough money to live a
comfortable life. As a supporter of the ecology movement, he is very concerned with the hunting of
animals for industrial purposes, such as the making of furs, shoes, and ladies’ handbags. As a
consequence, he formed Saltwater Imports Enterprise (SIE), a company with a mission of promoting
crocodiles as household pets. (The choice of the animal was purely coincidental.) He plans to catch
crocodiles in Southeast Asia and sell them in the United States.1
The senior leadership team of the company consists of Mr. Henry Mason (President), Michael Lee (Vice
President of Production, who is in charge of catching crocodiles), Bruno Santos (Vice President of Sales),
and Mary Grace (Vice President of Operations, who is in charge of administrative functions including cash
collection from customers).
Facilities Planning
The first task facing Mr. Mason was to raise capital. This required estimating future capital needs by
projecting the physical facilities and working capital needed for the business. Mr. Mason’s estimates
showed that he would need a fleet of boats to catch crocodiles in Southeast Asia and a holding tank in
the State of Gould to keep them alive in captivity after they are shipped. Because of the need to extend
liberal credit terms to skeptical customers, the company needed working capital to carry inventories and
receivables. Finally, the company needed a large start-up investment for sales and an advertising
campaign. The firm also needed funds to hire new employees and to rent office space in the State of
Gould. Mr. Mason asked Mary Grace to prepare a forecast of activity to plan facility needs and to
translate it into capital needed to start the business.
First Year Results
Based on the forecast provided by Ms. Grace, Mr. Mason and his ecology minded friends raised the
capital for acquiring the facilities. He leased ten boats in Southeast Asia, a 20,000 square feet
warehouse with a holding tank for the crocodiles in the State of Gould, and a 2,500 square feet office in
the State of Gould. Both the warehouse and the office were leased from Andrew Property Management
(APM) for three years, beginning January 1, 2008.
The company opened its door for business on January 1, 2008. Bruno Santos launched an aggressive
sales and advertising campaign built around the slogan that crocodiles were warm, friendly and greatly
misunderstood creatures that deserved loving care. He designed a slick marketing campaign built initially
around the slogan: “Crocodiles — don’t handbag them, handle them with love.”
SALTWATER IMPORTS
“Crazy” Henry Mason is a somewhat eccentric yet enthusiastic businessman who believes in the social
responsibility of business. Incidentally, he is also interested in making enough money to live a
comfortable life. As a supporter of the ecology movement, he is very concerned with the hunting of
animals for industrial purposes, such as the making of furs, shoes, and ladies’ handbags. As a
consequence, he formed Saltwater Imports Enterprise (SIE), a company with a mission of promoting
crocodiles as household pets. (The choice of the animal was purely coincidental.) He plans to catch
crocodiles in Southeast Asia and sell them in the United States.1
The senior leadership team of the company consists of Mr. Henry Mason (President), Michael Lee (Vice
President of Production, who is in charge of catching crocodiles), Bruno Santos (Vice President of Sales),
and Mary Grace (Vice President of Operations, who is in charge of administrative functions including cash
collection from customers).
Facilities Planning
The first task facing Mr. Mason was to raise capital. This required estimating future capital needs by
projecting the physical facilities and working capital needed for the business. Mr. Mason’s estimates
showed that he would need a fleet of boats to catch crocodiles in Southeast Asia and a holding tank in
the State of Gould to keep them alive in captivity after they are shipped. Because of the need to extend
liberal credit terms to skeptical customers, the company needed working capital to carry inventories and
receivables. Finally, the company needed a large start-up investment for sales and an advertising
campaign. The firm also needed funds to hire new employees and to rent office space in the State of
Gould. Mr. Mason asked Mary Grace to prepare a forecast of activity to plan facility needs and to
translate it into capital needed to start the business.
First Year Results
Based on the forecast provided by Ms. Grace, Mr. Mason and his ecology minded friends raised the
capital for acquiring the facilities. He leased ten boats in Southeast Asia, a 20,000 square feet
warehouse with a holding tank for the crocodiles in the State of Gould, and a 2,500 square feet office in
the State of Gould. Both the warehouse and the office were leased from Andrew Property Management
(APM) for three years, beginning January 1, 2008.
The company opened its door for business on January 1, 2008. Bruno Santos launched an aggressive
sales and advertising campaign built around the slogan that crocodiles were warm, friendly and greatly
misunderstood creatures that deserved loving care. He designed a slick marketing campaign built initially
around the slogan: “Crocodiles — don’t handbag them, handle them with love.”
current warehouse and office space. He would be vacating the properties by January 30th in order to
move into larger facilities.
He asked Ms. Grace to prepare an income statement for the bank in accordance with generally accepted
accounting principles (GAAP). In addition, since the executives were on a profit-sharing scheme, it was
necessary to determine profits in order to pay year-end bonuses.
Ms. Grace entrusted this task to her young staff accountant, Omar Daniel, who had only recently
graduated from college and was on his first job. After he familiarized himself with the facts, Daniel
realized that he needed to look up the GAAP accounting rules for preparing an income statement. At that
same moment, he also realized with some consternation that he had sold his college accounting textbook
when the course was over. Daniel headed to his college library to find the relevant reference material.
A review of his old accounting textbook told him that two GAAP principles were particularly relevant for his
current task. The first was the matching principle, which requires that costs and revenues be matched by
time periods. The other was the principle of revenue recognition. His next step was to copy and read the
relevant sections of these principles from the pronouncements of the Financial Accounting Standards
Board. Attachment 1 shows the results of Daniel’s research into the appropriate GAAP rules for preparing
income statements.
I
On first reading the material, Daniel thought it was going to be easy to prepare an income statement. He
remembered learning that for most businesses’ revenue was earned when good were sold (that is, when
title passed from the seller to the buyer). However, as he read the statements of the FASB, he realized
that revenues could be recognized when production was complete or when cash was collected.
According to the FASB standard, “revenues are considered to have been earned when the entity has
substantially accomplished what it must do to be entitled to the benefits represented by the revenues.”2
Daniel realized that in order to determine the revenues for 2008, he must first determine when the earning
process is complete. This, however, was not a usual business. Therefore, Daniel was not sure when
Saltwater Imports Enterprise was “entitled to the benefits represented by the revenues”. In order to
determine the critical point in the operations cycle when the business could do this, he decided to talk to
the three top executives.
His first conversation was with Michael Lee, V.P. Production. Michael told him that catching crocodiles
was the most critical activity for the business since “it is difficult to trap them suckers and you can lose a
few limbs in the process if you are not careful.”
Daniel next spoke to Bruno Santos, V.P. Sales. Bruno pointed out that while catching may be a
dangerous activity, no one is likely to buy a crocodile because it is risky for us to catch them. He felt the
company’s success this year was largely due to his clever holiday season advertising campaign with its
theme of: “this year give that special someone something live! Someday they can produce their own
shoes, handbags, and belts.”
the three top executives.
His first conversation was with Michael Lee, V.P. Production. Michael told him that catching crocodiles
was the most critical activity for the business since “it is difficult to trap them suckers and you can lose a
few limbs in the process if you are not careful.”
Daniel next spoke to Bruno Santos, V.P. Sales. Bruno pointed out that while catching may be a
dangerous activity, no one is likely to buy a crocodile because it is risky for us to catch them. He felt the
company’s success this year was largely due to his clever holiday season advertising campaign with its
theme of: “this year give that special someone something live! Someday they can produce their own
shoes, handbags, and belts.”
Daniel’s final conversation was with Mary Grace, V.P. of Operations. She told Daniel that, in her opinion,
the crucial activity for the business was cash collection. As she put it: “Michael and Bruno have never
tried collecting cash. If they did, they would find out in a hurry that it is difficult to collect cash from people
who keep crocodiles as pets. Besides, we don’t have a collection agency that is willing to repossess live
crocs!”
a
2 Financial Accounting Standards Board, Statement of Concepts #5, Paragraph 83.
The Lawyers Call
Even as Omar Daniel was puzzled over how to proceed, he received a call from Ms. Mary Grace. “Omar,
I just heard from our lawyers. Apparently, Andrew Property Management (the property management
company that leased us the warehouse and office space) is claiming that we had no right to break the
lease. We are being sued for an amount equal to the balance of the lease term and for punitive
damages. Later that day, Omar received the memo from the lawyers that is summarized in Attachment 2.
What punitive damages, if any
are owed to Andrew Property managment
What additional facts
to fully answer the question.
you need
