Hogan Enterprises acquired Nelson Turf Company (NTC) at the beginning of 2018. As part of the purchase
Question:
Hogan Enterprises acquired Nelson Turf Company (NTC) at the beginning of 2018. As part of the purchase agreement, Byron Nelson, the owner and president of NTC, was hired to continue to run the Turf division of Hogan Enterprises. This agreement calls for Nelson to operate the Turf division for a minimum of five years and a maximum of 9 years. The purchase agreement also contains deferred payment provisions to Nelson based on the performance of the division while he runs it. Specifically, Hogan Enterprises has promised Nelson deferred payments when he leaves the Turf division based on the increase in the Turf division's revenues and profits over the 12/31/17 NTC revenues. The deferred payment based on revenues is computed as follows:
1. NTC's 12/31/17 revenues are subtracted from the most recent 12 months Turf division revenues at the time Nelson retires
2. This difference is divided by the number of years that have passed since 12/31/17
3. This amount is multiplied by 50% The payment of this deferred payment plan will begin one year after Nelson retires and will be paid in equal monthly installments over the next five years. The deferred payment based on profits is computed as follows:
4. NTC's 12/31/17 net income is subtracted from the most recent annual report net income at the time Nelson retires 4. This difference is multiplied by 20% times the number of years that have passed since 12/31/17 The payment of this deferred payment plan will be a lump-sum one year after Nelson retires.
At February 15, 2021, Hogan knows the following:
1. NTC's 12/31/17 revenues $4,500,000
2. The Turf Division's Revenues 12/31/18 4,800,000 12/31/19 5,600,000 12/31/20 5,200,000 3. NTC's 12/31/17 net income $500,000
4. The Turf Division's net income 12/31/18 510,000 12/31/19 580,000 12/31/20 550,000
5. The Turf Division's revenues for January 2020 and 2021, respectively, were $450,000 and $420,000.
6. Hogan has a line of credit at a local bank to ensure funds are available to make the deferred payments.
The current rate on the line of credit is 4%. Hogan Enterprises is a privately-held company but the owner is considering an initial public offering of the company's stock. The deferred payment agreement has not been shown on previous year's unaudited financial statements but Hogan wants the 12/31/20 statements audited and is concerned about the proper reporting of this agreement.
Required:
Prepare a report outlining the alternative accounting and reporting methods applicable to Hogan’s current situation including any necessary journal entries and financial statement effects and your determination of the proper method of accounting for and reporting this agreement in the 12/31/20 financial statements. Cite appropriate authoritative guidance for your answer.
Financial Reporting and Analysis
ISBN: 978-0078025679
6th edition
Authors: Flawrence Revsine, Daniel Collins, Bruce, Mittelstaedt, Leon