Penron Limited (PL) is in the energy business of buying and selling gas and oil and related derivatives. It is a public company whose shares are widely held. It recently underwent a tremendous expansionary period over the past decade, and revenues quadrupled and continue to climb. Executives are remunerated using stock options, and the employee pension plan invests heavily in the company's stock. It is currently October 2011. The year end is December 31, 2011. Many of the benefit plans of the top executives vest at the end of the year (i.e., the executives will have legal entitlement to the benefits even if they leave the company). As a matter of fact, there is a concern that several of these top executives will announce that they plan to leave the company right after the year-end financial statements are released.
PL was seen as a "hot stock" by the marketplace. Numerous analysts followed the stock carefully and had been advising their clients to buy the stock as long as revenues and profits kept increasing. The third-quarter results had shown steadily increasing revenues and profits. The company had been signalling that this trend would continue through the fourth quarter.
During the fourth quarter, PL sold some of its pipelines to LPL Corporation. The pipelines had not been in use for some time and were seen as non-essential assets. Over the past two years, PL has steadily been divesting itself of non essential assets. PL had not written the pipelines down in the financial statements since they were able to sell them and recover twice their cost. This one deal was responsible for substantially all of the fourth-quarter profits. Under the terms of the deal, the pipelines were sold for $15 million cash.
LPL Corporation was owned by the president of PL. The company had been established just before the pipeline deal was signed. Since LPL was a new company and otherwise had very few assets, it borrowed the money for the deal from the bank. The bank had requested that PL guarantee the loan, which it did.
During the year, PL issued Class A shares to certain executives of the company. The shares participate in the earnings of the entity much like the common shares of the company (i.e., dividends accrue to the shareholders out of the residual earnings after the preferred dividends have been paid). They are mandatorily redeemable if a triggering event occurs, such as the resignation or termination of the shareholder. The shares are otherwise similar to common shares in that they have no preferential rights.
During the year, the company also began the planning stages for development of a new website that will allow customers to transact with the company. A significant amount of time was spent in this planning phase to determine the feasibility and desirability of this type of customer interface. Toward the end of the year, after lengthy discussion about whether or not to go down this path, the company began to acquire software and hardware to facilitate the new website.
A large amount was spent on the site's graphic design and on its content.
Assume the role of Penron's auditors and discuss the financial reporting issues for the year ended December 31, 2011.