Lindsay Kay approached her friend Michael Wait about going into business together as co owners of a gardening centre. Lindsay loved gardening and had some skills as an accountant. Michael was a landscape architect. Lindsay and Michael agreed to become business partners and open a new garden centre to be called W& K Gardens (W& K). There were only two existing nurseries in the local area, and Lindsay and Michael felt that there would be sufficient customer demand from continued residential expansion to support another gardening centre.

The pair decided that Lindsay would assume responsibility for the accounting and Michael would complete gardening layouts for customers. In addition, Michael would design a website where customers could order plants for pickup or delivery, and on which Lindsay could eventually provide online gardening tips and advice. Michael suggested that they initially pay a flat fee to an Internet service provider for hosting their website. Michael would register their Internet domain name, develop the webpage, and create the initial graphics. They developed a business plan for the gardening centre and Lindsay applied for a loan from the provincial Ministry of Agriculture and Education, which was offering forgivable loans for up to $ 500,000 to promote small businesses in the province. Lindsay and Michael soon received a letter from the provincial government that started with the words, “Congratulations— you have met all the criteria to receive a forgivable loan of $ 500,000.” (Further details on the loan are provided in Exhibit A.)

Although there were many details to work out, they felt that they could be open for business by the first week of June. They already had start- up funds from the forgivable loan, and a business plan. Michael knew of a large plot of land (20 hectares) with a small but suitable building in a nearby location that was available for lease. Lindsay and Michael reviewed the terms of the lease ( Exhibit B) received from a real estate agent and agreed that although the payments were considerable, the location would be well worth it and they would have plenty of space to carry a full assortment of annuals, perennials, shrubs, trees, and garden accessories. They were willing to pay a higher fee for the ability to expand in the future. Lindsay’s notes concerning the inventory of plants and care that would be needed are included in Exhibit C.

The old building would have to be renovated before it could be used as a storefront and they agreed to hire someone to complete the necessary work on time. They estimated the cost of the renovation to be about $ 125,000 but realized that they would have to meet with a contractor to get a formal estimate for the work to be done.

Lindsay also noted that they would need an operating loan for approximately $ 100,000 in addition to the government loan. Lindsay arranged to meet with her bank manager as soon as possible. With her business plan in hand, she was going to approach the bank for additional financing for the initial costs and purchase of inventory. Lindsay’s personal borrowing rate was currently 11%. However, she had been advised that the new business would be able to borrow at 2% below this rate, assuming that W& K would be able to maintain an adequate amount of assets to cover liabilities by the second year of operation. Lindsay now began to gather the details needed to finalize the business plan for the bank.

Michael determined that they would have to purchase a small truck and some equipment to carry out the landscape design service. Since he had been in charge of purchasing at Green Thumb Landscapers, he had a good idea of the type and cost of this equipment (Exhibit D).

To provide income during the off- season, Michael suggested they submit a bid for a tender that he had seen advertised in the paper. The town was accepting bids for snow removal from municipal parking lots and storage of snow from street removal. Last year, the town had had difficulty finding contractors for the snow removal since it was a small job. The town also needed space to “store” the removed snow and, with this new location, Michael and Lindsay would certainly have the capability to store snow. Michael was concerned, though, that the snow would contain chemical contaminants acquired from the town’s roads. Michael believed that they could win the snow removal contract for a flat fee of $ 30,000 and an additional flat fee of $ 50,000 for storage of snow for one “snow season.”

Michael suggested that they should discuss the details of the business partnership at a meeting the following morning to avoid future disputes. They had already agreed that Michael would contribute his personally owned landscaping equipment (fair value $ 18,000), a small used truck (fair value $ 12,000) and cash of $ 5,000. Lindsay would contribute computer equipment (fair value $ 8,500), office furniture (fair value $ 6,500) and cash of $ 20,000. Each partner would receive an equal interest in both capital and income. Michael also stated that he wanted Lindsay’s opinion on the appropriate accounting policies that should be selected so he could anticipate earnings. He also wanted an outline of any matters related to the set- up of the business and Lindsay’s opinion about whether a partnership would be the best structure for their business.

Required

Assume the role of Lindsay Kay. Prepare notes to summarize your analysis in preparation for a meeting between Lindsay and Michael.

Exhibit A Forgivable Loan from Ministry of Agriculture and Education

Clause 1: Lindsay Kay will receive a forgivable loan of $ 500,000 for the development and operation of W& K Gardens as described in the attached business plan.

Clause 2: The government will provide $ 500,000 on May 20, 20X6, which is forgivable on May 20, 20X11, if the following conditions are met:

• Three university students are hired for the period June 1 to August 31 each year;

• All produce is grown on- site or purchased from local growers; and

• Audited financial statements are provided to the government three months after year-end.

Clause 3: If any of the above terms is not met, the loan is repayable with interest of 10% by the end of the fiscal year in which the term is broken.

Clause 4: The government has the right to inspect the premises and financial records to ensure that all conditions of the loan have been met at any time.

Exhibit B Terms of the Lease

Addison Ltd. agrees to rent to W& K the land site and building that it requires in starting up its new business. The lease agreement calls for five annual lease payments of $ 300,000 (including executor costs of $ 19,506) at the beginning of each year; the details surrounding the agreement are as follows:

Commissions and legal fees (incurred by Addison)……………………………           $ 60,000

Building:

Addison’s carrying value of building………………..........................................      $ 340,000

Fair value of the building…………………………………………………...........…….          $ 400,000 

Economic life of building……………………………………………...........................            6 years

Guaranteed residual value at end of lease term………………………………...        $ 75,000 Land:

Addison’s carrying value of land……………………………………………...........….       $ 375,000

Fair value of the land…………………………………………………...........…...........….   $1,000,000

Residual value at end of lease term……………………………………...........…...     $ 1,000,000

Rate implicit in the lease (known by W& K) ………………………………...........……          10%

Addison contacted its building contractor, who promised to have the renovations completed on time at a price very close to the estimated amount of $ 125,000. The renovation work would have a useful life of approximately eight years.

Addison stated that the lease will be non- cancellable but is willing to provide an option to renew the lease at the end of the five- year term.

Exhibit C Inventory Requirements

W& K would be open for business all year but the amount and type of inventory would fluctuate depending on the time of the year. The garden centre would consist of a greenhouse, outdoor tents, a store, and a small out-door nursery. The storefront would be open year- round and would sell fertilizers, planters, garden tools, and accessories. Gift baskets would be brought in for special occasions such as Mother’s Day, Halloween, Thanksgiving, and Christmas.

To attract customers to the store, Michael would provide customized landscape designs for a flat fee of $ 500. The customer would then receive a credit for the same amount at the store. The credit would have no cash value, but could be used for the purchase of shrubs, flowers, etc., at the store over the next two years.

Annual plants (such as geraniums, petunias, and many more varieties) would be purchased from local growing farms each spring. These plants would all have to be sold before the end of summer. Perennial plants (including bellflowers, day lilies, and hostas) would be grown in W& K’s greenhouse and transferred to the outdoor store protected by large tents. Those plants not sold by September 30 would be returned to the greenhouse for winter storage and care. It was expected that most perennial plants would be sold, especially if Lindsay discounted the price to encourage customers to buy and plant in the fall instead of waiting for the following spring.

Shrubs and trees would be purchased from local nurseries early in the spring. It was expected that about 80% of these purchases would be sold during the growing season. The remaining 20% would be transferred to the outdoor nursery to be replanted and would remain there until the next season. To be competitive with the other two garden centers, Lindsay thought that they should offer a one- year warranty on all shrubs and trees returned by customers with a valid sales receipt.

The outdoor nursery would be used primarily for Christmas trees, which would be grown from seedling stock and could remain in the ground for a number of years. In the initial years, mature trees would be bought from a local supplier. Exhibit D Capital Asset Requirements Michael estimated that the following capital assets would be required for the first year of operations. Part of the government loan would be used to purchase these items. Three small used trucks (in addition to the one contributed by Michael) $ 40,000 Landscaping equipment (backhoe, rototiller, etc.) $ 60,000 Small power tools $ 15,000 Display shelves for the store $ 12,000

Exhibit D Capital Asset Requirements

Michael estimated that the following capital assets would be required for the first year of operations. Part of the government loan would be used to purchase these items.

Three small used trucks (in addition to the one contributed by Michael) ……….    $  40,000

Landscaping equipment (backhoe, rototiller, etc.) ……………………………..………..…    $  60,000

Small power tools…………………………………………………..…………………..…..…………..…     $  15,000 

Display shelves for the store ………………………………………………………..………..…….…   $  12,000