Accouting assignment
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fancy_yachts_case_class.docxFancy Yachts - Case Study
On August 1, 2008, Fancy Yachts entered into a contract with Vistas, LLC to deliver a 70 foot yacht in exchange for consideration of $1,600,000. This boat was given the hull number 70-07. Fancy Yachts received a deposit of $163,000 with the signed contract. The yacht was manufactured and shipped from the Taiwanese factory on October 6, 2009 and arrived in the United States (Port of Everglades, Miami) on October 29, 2009. The buyer had 72 hours to inspect the boat and make arrangements for the final payment (less a small hold-out to be paid upon title transfer) due on October 31, 2009.
On the required date of final payment, the customer indicated that he was having difficulty with financing and asked for an extension of time. The owners of Fancy Yachts agreed. It was not uncommon for a customer to need additional time; a week or so to liquidate investments or transfer funds. They also had no other choice given the large sum of money involved!
Keep in mind, that this contract was entered into a month before the September, 2008 financial collapse. Even a year later, when the final balance was due, the economy had not yet recovered. The once available credit markets had all dried up. According to the principal of Vistas, LLC, his net worth decreased from $8 million to $2 million dollars. It was not a good time to liquidate investments and banks were not lending. Especially for luxury items.
Vistas, LLC continued to “string along” Fancy Yachts with small payments (see deposit schedule) along with promises to pay the entire balance. This continued until Fancy Yachts decided that although they wanted to avoid a costly lawsuit, they couldn’t wait any longer. They decided to sell the boat to a third party using a marine broker. A contract was signed by Fancy Yachts and a third party buyer on November 25, 2011.
When Vistas, LLC learned of the pending sale, the owner had liens placed on the boat. These liens prevented Fancy Yachts from selling the boat with clear title. To remove the liens, Fancy Yachts was required to take legal action. The liens were finally removed during the month of April, 2012 and the boat was finally sold to the third party buyer on December 1, 2012, over three years after the boat arrived in the U.S.
After a year, the sale to the third party buyer was finalized. During that time, many problems were addressed. The liens were cleared. The boat had substantial work done. It had been sitting in the water for a substantial amount of time until it was placed in dry dockage. The bottom was repainted, modifications and other repairs were made. Routine maintenance was performed. Batteries were checked regularly and changed when needed, the generator was checked, the boat was washed frequently, the lines were checked, the bottom was cleaned, and the stainless steel and teak was polished. Prospective buyers made appointments to view the boat. Some on very short notice. The boat had to be “show ready.” Lastly, extensive modifications were made to the interiors. The dancer’s pole was removed, the fabrics in the cabins, headliners, and the galley changed, and many other alterations were made to make it attractive to prospective buyers.
During those three years, Fancy Yachts made significant outlays of cash to have the boat docked, insured, maintained, and modified.
In addition, the company had an outstanding line of credit of $1.2 million dollars that they made required monthly interest payments. A sales commission was paid to a broker, legal fees were incurred to obtain clear title, and the company accepted a lower selling price due to the boat being a three year old model.
What was originally a profitable sale now turned into a substantial loss. The excel file provided has a worksheet that outlines the loss on the boat. However, many of the cost incurred weren’t classified as direct (inventoried) job costs. Some examples are, travel, interest, exchange rate fluctuations, and legal expenses. When incorporating these costs into the equation the loss is much higher than the job loss of $301,000 (inventoried costs) indicated on the worksheet.
Below is a summary of incremental expenses incurred by the company that are directly related to the default by the original buyer, Vistas, LLC.
· Lower selling price $210,000
· Broker commission 72,500
· Line of credit interest 234,000
· Additional interest 38,000
· Exchange rate losses 248,000
· Legal fees 150,000
· Travel 21,000
· Boat modifications 220,000
· Dockage & storage 60,000
· Boat insurance 21,000
· Routine maintenance 26,000
The owner of Vistas, LLC was a lawyer and involved in many business over the years. A “mover and shaker” of sorts. At one point, he owned a brokerage firm and a film company. It was rumored that he had a role in the development and distribution of a Kim Kardashian exercise video, entitled, “Fit in your Jeans by Friday”.
The owner of Vistas, LLC also had a dark side. Criminal charges brought against him in a fraud case. He was a defendant in a case in the United States District Court for the District of Connecticut. The criminal charge was one count of knowingly executing a scheme to defraud a financial institution by means of false representations. The thrust of the government's case was that the defendant, an attorney and businessman, induced, an employee of a Connecticut bank, to authorize payment of a check despite insufficient funds in his account by falsely representing that he would provide funds to cover the check.
The check at issue was written for $82,500 on June 5, 1989. The check was drawn on the film company’s business account held at a Connecticut bank. The check was payable to Wall Street Clearing Co., a clearinghouse for the defendant’s brokerage firm. In mid-May 1989, the defendant purchased $1,000,000 face value of bonds issued by a Savings and Loan Association for $82,500. At that time, he also held $1,266,000 face value of the savings and loan’s bonds that he had purchased previously through his brokerage firm. On June 5, he received a telegram from Wall Street Clearing Co. demanding that he either pay the $82,500 by the following day or face liquidation of his bonds.
To pay for the bonds, the defendant sent a check for $82,500 drawn on the Connecticut bank account, although that account held only $610. The following day, he wrote a second check for $82,500 drawn on his personal account at Citibank, payable to his business. The government alleged that the defendant was aware that neither the Connecticut bank account nor the Citibank account had adequate funds to cover either check.
On June 9, 1989, the defendant called the interim branch manager of the Connecticut bank. The manager testified that she was familiar with the defendant, who “always kept very, very high balances” and was an “excellent customer.” When asked about the phone conversation, she testified at trial that the defendant “said that he had written a check for $82,500, he asked me to pay the check, and said he was wiring me money” from his available funds. She also stated that she believed the wire would arrive shortly, and that he never asked her to “hold” the check, which would have been impossible and contrary to bank regulations.
The defendant did not wire any funds to the Connecticut bank. On June 12, however, the Citibank check was deposited at the Connecticut branch, although the funds were unavailable at that time. On the same day, the Connecticut check was presented for payment to Connecticut. Because the account lacked sufficient funds to cover the check, it appeared on the bank’s overdraft list prepared on the morning of June 13. The list indicated that $82,500 in unavailable funds had been deposited. Although the interim bank manager was aware that the Connecticut account contained insufficient funds, she authorized payment on the check. She testified that she did so because of the defendant’s request on June 9 and his assurance that he would wire funds. The manager testified that she knew that he had not wired the funds, but was not concerned because she assumed that he simply deposited the funds. Had the defendant wired the funds, she testified, they would have been available for deposit and the check would not have appeared on the overdraft list. The interim manager ordered payment on the check even though she knew she was authorized to pay only up to $5,000 on accounts with insufficient funds.
Several days later, Citibank refused to honor the Citibank check because the defendant had insufficient funds in that account. He had also written a check for $82,500 dated June 12 on his account at a third bank, for deposit at Citibank. The third bank refused to make payment on this check because of insufficient funds in that account. On June 20, he wrote another check on the third bank account for the same amount for deposit with Citibank, which again was not honored because of insufficient funds.
Accordingly, the only bank to make payment on any of the four checks was the Connecticut bank. On June 20, the defendant, the interim bank manager, and the new branch manager, met to discuss the check. The new manager testified that the defendant said that his broker had purchased the bonds without his permission, and that he had to make immediate payment to avoid trouble with the SEC. According to the new branch manager, the defendant stated that he planned on covering the check with a large interest payment that was scheduled on the bonds on June 15. Those interest payments were never made, however, because on June 14 federal regulators seized the bonds, which was insolvent. An assistant vice-president at the Connecticut bank, testified that at a subsequent meeting on June 23, the defendant said that he did not ask the interim branch manager to pay the check, but instead asked her to hold it.
The defendant never covered the Connecticut bank check, and the bank thereby incurred a loss of $82,500.
At trial, in addition to proof of the June 9 phone conversation and surrounding events, the government produced substantial evidence regarding allegedly false exculpatory statements that the defendant made to bank employees and to FBI officials. The defendant, who did not testify or present any witnesses, was convicted after a three-day trial on the single count in the indictment. He was sentenced to twelve months' imprisonment, subject to appeal.
Note: The notes to Fancy Yacht’s 2011 financial statements are presented below.
Notes to the Financial Statements
December, 2011
General Background
Fancy Yachts is a custom yacht builder located in Massachusetts. The company sells custom-built sailing yachts in sizes ranging from 46 – 70 feet. The boats are manufactured by a contract firm located in Taiwan and sold to retail customers, brokers, and investors who reside in the United States and abroad. The boats may be purchased for personal use, investment, or resale.
Customer Deposits
The company generally requires a 10% deposit with a signed sales contract. Three weeks prior to shipping from Taiwan, another 10% is due. The balance of 80% is due within 72 hours of the arrival to the U.S. These requirements may be modified at management’s discretion.
Customers who fail to adhere to the terms of the contract are subject to forfeiture of their deposits.
Revenue Recognition
Revenue is recorded on the completed contract method at the time of closing. No progress billings are made. Deposits received are classified as Customer Deposits (unearned revenue) and are reflected as liabilities on the balance sheet until the sale is finalized. Closing is defined as when the risk and rewards of ownership pass to the customer.
Contingencies -Pending Litigation
At December 31, the Company was facing the prospect of pending litigation with the original prospective buyer of Hull 70-07. This buyer was unable to obtain financing for the purchase of the boat and the company ultimately found a third party to purchase it. Upon learning of this, the original prospective buyer filed Uniform Commercial Code (UCC) liens on the boat. It was then incumbent upon the Company to file a motion in US District Court to force the prospective buyer to terminate those UCC liens. The Company’s motion in US District Court was granted on April 30, 2012.
Legal costs associated with this matter were largely incurred in 2012, so no provision has been made for those costs in the financial statements. As it is not possible to determine the eventual economic impact of this legal decision with any degree of certainty, no consideration has been given to recognizing a gain or loss with respect to this decision in the accompanying financial statements.
Note – Subsequent Events
As discussed in the note above, the Company prevailed in its initial legal confrontation with the original prospective buyer of Hull Number 70-07. As a result, it was able to proceed with the sale of the Hull Number 70-07, and this was consummated on May 22, 2012. The Company used the proceeds from this sale to immediately reduce its outstanding line of credit by $1.2 million. With the sale completed, The Company has begun steps toward filing a lawsuit ($1.3m) against the original prospective buyer for breech of contract and other harmful acts that resulted in significant financial loss to the Company on this transaction.
Sequence of Events
August 1, 2008 Vistas, LLC entered into a contract to purchase a 70Ft yacht with Fancy Yachts for $1,600,000 and gave an initial deposit of $163,000. Note additional deposits were received. The total equaling $451,000. See the accompanying cash receipts journal for detail and dates.
October 6, 2009 Yacht shipped from Taiwan
October 29, 2009 Yacht arrived in the United States
October 31, 2009 Balance due on contract. Official default date.
December 31, 2009 Forfeit $451,000 deposit received by Vistas, LLC
November 11, 2011 Employed lawyer to eliminate UCC lien. Gave $5,000 retainer.
November 25, 2011 Negotiated a fixed price contract with a third party buyer.
December 1, 2012 Transferred risk and rewards of ownership to new buyer.
Read through the background information above and the supplementary information found on the excel file provided for this case and answer the questions below.
Case Questions
1. In general, identify the risks and rewards of ownership.
2. Did Fancy Yachts satisfy its performance obligation with Vistas, LLC?
3. What are changes in control indicators? In the case with Vistas, LLC were change of control indicators met?
4. Explain the accounting treatment difference between Vistas, LLC and the third party buyer.
5. If you were the business owner in this situation what different actions would you have taken to avoid the lawsuit and three years of “bleeding expenses.”
6. Was a loss or gain contingency reported in the 2011 financial statements? Discuss contingencies in general and the specifics in this case.
8. Explain the concept of the deposit forfeiture. Prepare a journal entry for the forfeiture of Vistas, LLC deposits.
9. Prepare a journal entry for the final sale of 70-07 to the third party buyer. Use the job loss worksheet to find the numbers and data needed.
Note: Questions 7-9 require journal entries. Use the following accounts.
· Cash (asset)
· Boat Sales (revenue)
· Cost of Goods Sold (expense)
· Customer Deposits (liability)
· Inventory (asset)
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