Tropical Juices Limited (Tropical) was incorporated under Canadian federal legislation two years ago as a 50:50 joint venture of Citrus Growers Cooperative (Citrus) of the United States and Bottle Juices Corporation (Bottle) of Canada to sell Citrus’s juices in Canada. Excerpts from the joint venture agreement are pro-vided in Exhibit I . Both Citrus and Bottle produce and sell juices separately as well as through Tropical.
One year ago the owners of Bottle sold all their shares in Bottle to Douglas Investments Limited (DIL). The contract of sale between DIL and the former shareholders of Bottle included representations and warranties with respect to Tropical. Excerpts from the sale contract are provided in Exhibit II .
DIL required that representations and warranties about Tropical be written into the sale contract because Citrus and Bottle were still negotiating the accounting
Draft financial statements for Tropical for the years ended June 30, Year 1, and June 30, Year 2, were prepared, based on the accounting policies selected by Bottle’s controller. For the second year, the results were as follows:
Revenue............................ $2,959,000
Operating expenses, excluding depreciation, interest, and imputed charges. 2,128,500
Depreciation, interest, and imputed charges............... 643,500
The joint venture agreement between Citrus and Bottle permits the appointment of an arbitrator to resolve disputes over accounting policies. Your firm has been appointed arbitrator and has been asked by all three parties (owners of
Citrus and present and previous owners of Bottle) to submit a report containing binding decisions on all matters of contention. Each decision in this arbitration report must be supported by sound reasoning so that each party can fully under-stand the decisions.
Comments of Citrus
1. “We disagree with Bottle’s charge for the cost of returnable bottles. It charged the entire cost of the bottles (which it owns) to the first year in Tropical even though the bottles have a life of 20 to 25 months.”
2. “Bottle had to purchase new machinery for bottling Tropical juices because a different shape of bottle is used. It borrowed the necessary funds and charged the interest to Tropical. We reject this charge.”
3. “Bottle spent $360,800 training its employees to manufacture and sell Tropical juices. We disagree with this sum being expensed and charged to Tropical in the first year.”
4. “Bottle charged Tropical 16% on the capital investment being used to produce Tropical juices. We agree with the 16%, but we do not agree with the 16% being applied from the date that the first Tropical juices were produced.”
5. “Bottle charged Tropical fair value for the computer services it provided. We believe that Bottle should have charged Tropical for these services at cost.”
6. “Bottle had a three-week strike. When the strike was over, Bottle produced its own juices to replenish its own inventory, and did not produce Tropical juices for almost one month. We believe that Tropical should be credited in the first year for imputed gross profits during the months after the strike.”
Comments of Previous Owners of Bottle
7. “Tropical has benefited from Citrus’s advertising of the Citrus brand names in the United States. Citrus has charged Tropical for this advertising using the ratio of the Canadian population reached by the U.S. television-advertising signal to the combined Canadian and U.S. populations reached by the signal. In our opinion, this does not make sense.”
8. “We understand that Citrus is complaining that we were charging proportionate repair costs for the machinery and equipment being used to produce Tropical juices and our own juices. We consider this to be an appropriate charge.”
9. “We charged Tropical on the basis of our costs of producing Tropical juices. Citrus objects to our use of full absorption costing even though this was the method we used for our financial statements.”
Comments of DIL
10. “After completing the purchase of Bottle, we discovered that Bottle’s management had been manipulating the profits between years.”
11. “Tropical sells large quantities of juices to distributors who pay Tropical only when the juices are resold. However, Tropical has recorded revenue when the juices are shipped to the distributors. We disagree with this practice.”
12. “Citrus bought a new refrigerated tanker truck in the second year to deliver bulk concentrates to Tropical. It is charging the cost to Tropical at one-third per year, commencing in the second year. We disagree with this approach.”
13. “Citrus charges interest to Tropical on the account receivable from Tropical. We disagree.”
Required:
Prepare the report.