Stock Car Auto Inc. (SCA) is a promoter and sponsor of motor-sport activities. Its shares trade on the Toronto Stock Exchange. The company owns two racing tracks where it hosts races (including those sponsored by NASCAR the National Association for Stock Car Auto Racing) and operates a driving school. In between races, it rents the facilities out.
SCA operates like a club. An upfront fee is charged, which gives the individual the right to belong to the club for his or her lifetime. SCA owns a fleet of high-performance stock cars that members may "adopt." All members adopt a car as this is a main reason for joining the club. Under the adoption agreement, individuals pay a monthly fee for access to the stock car and the rights to race the car on the race tracks for a certain number of hours a week (including unlimited gas). Individuals must get insurance in order to adopt a car but this is provided by SCA, which has a master insurance plan. Race car driving is risky and insurance premiums are very high (as is the injury and mortality rate). The master insurance plan is negotiated by SCA with an outside insurance company and covers all club members. The monthly fee covers the insurance. Adoptions are annual and individuals often switch cars each year. The company just completed a membership drive and has signed up 100 new members at $20,000 each. This amount has been paid upfront and received prior to year end. It is non-refundable. In order to become a member, individuals had to earn the rights to join by proving that they were capable of driving race cars safely. To this end, all members must take a two week racing course and qualify for the company's stringent insurance program. All new members had completed the requirements by year end.
Last year, oil and gas prices began to skyrocket. Given that the company uses a Jot of oil and gas in its business, Sam Stock (the president and CEO of the company) decided to strategically diversify the company's operations into the oil and gas sector. Sam hired two additional traders to deal with this part of the business. At first, they were entering into
advance gas purchase commitments to secure a steady supply of gas at a fixed price. However, the traders soon found that they were able to create profits by trading in the gas contracts. As a matter of fact, half of the company's net income for the current year came from trading gains. As part of their activities, the traders have purchased shares in three oil and gas companies. They have not decided whether they will keep these shares for the longer term. It really depends on the markets. Sam is currently in discussions with the traders as to what their job is supposed to be. Even though he likes the profits, he is not convinced that he likes the additional risk that this activity is exposing the company to. The company has a major shareholder who has declared that SCA should only be in the business of racing cars and nothing else.
The company is being sued by the surrounding community for alleged pollution from the racing activities.
Apparently, the racing cars produce a fair amount of airborne toxins, which settle in the surrounding area. Unknown to SCA, the nearby city had passed a bylaw stating that companies must clean up any pollution that they are responsible for. SCNs lawyers have argued on a preliminary basis that the alleged pollution in the surrounding area is due to the nearby superhighway and airport and that it is not possible to prove that SCA is the cause of the pollution. Even if they were responsible for a small fraction of it, it would be very difficult to determine just what that fraction was.
The lawyers are therefore denying that SCA has any responsibility with respect to cleanup. The lawyers for the surrounding community have asked for the financial statements of SCA to determine whether the company is profiting at their expense.
Assume the role of the auditors and discuss the financial reporting issues.