Biofuel Inc. (BI) is a private company that just started up this year. The company's owner, Sarah Biorini, created a process whereby carbon dioxide (CO,) emissions are converted into biofuel. Specifically, the C02 is pumped into a pond where algae is grown. The algae feeds on the C02 and releases oxygen. The algae is harvested, dried, and sold as fuel. The fuel is used by cement manufacturing companies to heat their kilns (ovens). Sarah contributed the prototype and idea to the newly formed company in return for common shares. She estimated that the prototype was worth about $500,000. BI spent the first year developing the idea and by year end was producing and selling the fuel to several cement production companies. Cement companies not only produce large amounts of CO,, but also need large amounts of fuel to heat their kilns.
One of the critical success factors for BI is that the algae-producing pond be close to the source of C02• This reduces transportation costs. After much consideration, BI decided to build pipelines to pump CO, from the source (the cement company) into an adjacent algae-filled pond. The pond is excavated by BI but it sits on the cement company's land (close to the source of CO,). Once a month, BI harvests the algae and ships it to its manufacturing plant to process it into biofuel. It then sells the biofuel back to the cement companies. The cost of constructing the pipelines is funded by the bank, as is the excavation of the ponds. The construction is done by BI and generally takes about three to six months. The finished biofuel made from algae is priced to recover patent costs and the cost of building the pipe and the ponds as well as any other costs. It is sold back to the cement companies. The cement companies are both suppliers of the CO, and customers.
The bank is quite happy to continue funding additional projects as long as BI sends its financial statements to the bank every quarter starring next year. In addition, the bank would like to see audited annual financial statements beginning with the current year. The bank and BI have agreed that the debt to equity ratio cannot exceed 3:1, otherwise the loans become immediately due. BI's accountant is looking to produce the annual financial statements for the first year of operations. He has not yet decided whether to follow IFRS or ASPE and is interested in the differences between the two.
Instructions
Assume the role of BI's accountant and discuss the financial reporting issues relating to the above. Use the case analysis framework presented in class, including an overview, analysis, and recommendations.