Say Cheese Inc. (SCI) is a privately-owned cheesemaking company in Quebec. The company is located in a historic town 100km away from Quebec City and close to a vast pasture for raising cows and sheep. It is originally owned by two brothers, François and Pierre Gouda. In 2021, an Italian food company, Fromagii, agree to purchase 51% of the shares of SCI because it would like to use SCI’s sales channel to promote Italian cheese in Canada. The company has been raising cattle and making cheese for 100 years and its key success factors include the excellent pasture for raising cattle, experienced artisan cheesemakers, and a mature distribution network to restaurants and grocery outlets. They are very proud of the grass-fed cattle which in turn produce excellent quality of dairy for cheesemaking. The sale of the shares to Fromagii is pending on receiving the financial statements of SCI year ended December 31, 2021.

Cattle has average productive life of 10 years and SCI purchase new cattle every 3 years to ensure there will be steady supply of dairy for making cheese. The company produces different types of cheese, including fresh cheese such as mozzarella, aged cheese like cheddar, and specialty cheese like truffled cheese. Fresh cheese usually has short shelf life of one week, while aged and specialty cheese have best before dates up to 3 months after they hit the shelf.

The cheese making process also differs. Fresh cheese typically can be made in a day and will be ready for shipping in the next day; aged cheese takes much longer time to produce and must be stored in a temperature and humidity-controlled room during the aging process, which can take up to 5 years; specialty cheese varies in production time, with some fresh one that can be produced like fresh cheese and some that take a long time like aged cheese. Cheesemaking is a rather labour intensive process.

SCI has never prepared financial statements based on any accounting standards because there has never been any significant financing needs. SCI maintains a line of credit with a local credit union who have been doing business with SCI since1990. François and Pierre value the “partnership” with Fromagii because the Italian parent company promised to send experienced cheesemakers to SCI to teach them new skills in cheesemaking. 2021 is the first year that SCI will be preparing a proper set of financial statements.

François and Pierre asked a local accounting firm for help in preparation of the financial statements. Jenny Nagasaki, partner at the accounting firm met with the owners on October 31, 2021 and the following conversation took place.

F: Hi Jenny, thank you for helping out. Pierre and I are good at making cheese but have no knowledge of sophisticated accounting. We used to provide cashflows information to our local credit union and they are always happy to continue providing the line of credit to us.

J: No problem at all, François. I have always loved your cheese.I talked to some of the staff who tend to the cattle and they said you really spent quite a bit of money raising them, from maintaining the grass field to feed the cows to checking on their health regularly. In terms of accounting, we need to think about how to measure their value on the balance sheet. Do you mostly buy new calf or raise your own from birth at the farm?

F: Three quarters of our new cattle is purchased as calf, and the remaining one quarter is born right here. Is there a difference in the accounting?

J: Yes, there will be some differences and I’ll explain to you later. Are there any other things I need to know that happen this year?

P: Not sure if this is relevant to accounting or not, but demand for fresh cheese has decreased drastically this year due to COVID. The government encouraged people to minimize their trips to the grocery stores and customers did not buy as much fresh cheese because of the short shelf life. Demand from restaurants for both fresh and hard cheese also declined substantially. Meanwhile, we must continue to milk our cattle. Our milk storage facility is always operating at maximum capacity and occasionally we have to dump a lot of milk.

J: Do you still have a lot of cheese inventory?

P: The aged cheese is not too much of a concern because we can continue to age them for an extra year until demand comes back. Of course, this gives rise to another problem, which is storage. We need to rent a close-by facility to store the extra cheese that will continue to age for another year. As for fresh cheese, we do have a lot of those still in refrigeration. We may have to run some special promotion to sell them all before they turn bad.

J: I see. I have gathered enough information for now and will get back to you with some suggestions soon.

When Jenny went back to her office, she pondered the following questions:

Given the decrease in demand of cheese in the country, what will need to be considered when reporting inventory on the balance sheet?

Answer rating: 100% (QA)

Generally accepted accounting principles GAAP require that all inventory reserves be stated and valued using either the cost or the market value method whichever is lower However accountants who apply ... View the full answer