Group Assignment #2 due December 3rd Instructions: Prepare the report with a

Group Assignment #2 due December 3rd

Instructions:

Prepare the report with a maximum of 5 pages double-spaced and submit on eClass by the deadline.

The title page should include only members who have contributed to the assignment. There will be a peer evaluation form for you to fill out on eClass.

You should start with an overview of the major users of the financial statements and their needs, then followed by the identifying accounting issues and analyze them one by one. Remember to draw conclusions after analyzing each issue. There should be a concluding paragraph that summarizes your findings that will address the owners’ most pressing concerns.

You will be evaluated based on:

Number of issues addressed

Depth of analysis on each issue. Depth is measured by citing appropriate accounting criteria, discussing alternative accounting treatments when appropriate, supporting with case facts and calculations, and drawing a reasonable conclusion

Effectiveness in communication.

Burger’s Home Inc.

Burger’s Home Inc (BHI) is a private fast-food chain established ten years ago by two brothers – Frank and Malcolm. Frank is in charge of accounting and finance while Malcolm focuses on operations. BHI’s specialty is selling high-quality, organic burgers at competitive prices. The beef is sourced locally at an organic cattle farm which supplies to all of BHI’s restaurants. BHI has grown steadily over the years to fifteen corporately owned locations in Ontario. Prior to the pandemic, the brothers were gearing up to expand the chain into a franchise. Negotiations with potential franchisees halted when the pandemic hit but in May 2021, several interested parties came back to the negotiation table. Extracts of the Franchisor Agreement are presented in Exhibit I and Exhibit II.

BHI’s long-term loan with their local bank is coming due shortly after the end of the year. The brothers would like to refinance this debt with the bank but they were also contacted by a private investor who is interested in providing either equity or debt financing to BHI. The investor requires an audited set of financial statements before he makes the decision. In the current loan agreement with the bank, there are two covenants: the debt-to-equity ratio must be no higher than 0.7 and the current ratio must be greater than 2. It is likely that the bank will offer similar terms if they choose to refinance with the bank. The brothers are not sure if they are in compliance or not with the covenants and they also would like to know how the accounting impact of the events this year may affect their financing plan. BHI’s year-end is November 30th and it follows ASPE. Draft balance sheet is presented in Exhibit III.

It is now November 3, 2021. You, CPA, are the new controller at BHI and just joined the company in October. You have been asked to establish all the necessary accounting policies to complete this year’s financial statements because this is the first year the chain receives an audit. In particular, the brothers would like you to establish solid accounting policies pertaining to franchising with regard to revenue recognition and financing for franchisees. You also need to address the queries raised by the brothers and discuss the accounting implications of this year’s events. The brothers expect the report by December 3rd, 2021.

New Franchisee

In April 2021, Brad and Jenny Smith contacted Frank because they would like to join the franchise family of BHI. They are the first and only franchisee so far and BHI hopes to close a few more deals in early 2022. On top of paying for the initial franchise fees as stipulated in the agreement, they asked BHI to help with financing the construction and renovation of the new restaurant. The construction expenditure amounted to $850,000 and BHI agreed to provide $250,000 interest free over the term of the franchise. A loan of this nature normally carries an effective interest rate of 8%. The first annual payment is due March 31, 2022.

The new restaurant was up and running on July 1st, 2021. Brad and Jenny were on time with the initial franchise payments and advertising funds but missed the October payment for the continuing franchise fees.

Bad Burger?

In addition to being busy with getting everything done for the new franchise, the owners have been busy with another issue. About one week ago, the Vice President of Public Relations received an angry phone call from a customer who claimed to have purchased a big order of burgers for take-out for a party. Allegedly, half of the guests came down with food poisoning shortly after the party. The VP of Public Relations did not think much of the call until the customer’s lawyer contacted him just a day ago stating the customer is planning to file a claim in court. Having shared the news with management, the VP suggested to settle with the customer for $25,000 and to investigate the incident further to see if it has any merit. At the very least, the VP suggested to throw out all of the remaining burgers at that location since it is not a large restaurant anyway. While the VP is not convinced that the case has merit, he believes this would ‘look good’ if all the meat is disposed of in case this catches on with the public. The organic farm BHI deals with has recently switched to a new delivery service due to labour shortage in the province. Malcolm is going to test samples of meat in a lab to see if there is indeed any bacteria or other issues and have asked you not to book any journal entries pertaining to this complaint yet. Beef made up of about 50% of the chain’s inventory.

Pandemic cubicles and pandemic patios

The brothers wanted to be ready when their restaurants were able to reopen in 2021 and thus they decided to permanently change the inside of their restaurants so that patrons felt safe. Early in the year, the brothers installed cubicles in all of their locations so that families can sit together comfortably while being physically separated from other patrons. This allowed the business to have more sitting available. Total cost of the cubicles was $225,000.

Where it was possible, the brothers also decided to open up patios. In summer 2021, this allowed some locations to serve customers earlier than others that did not have a patio. Setting up patios simply meant buying some fencing, extra chairs and tables and floor plant pots. The owners are not sure if they will be permitted to open up these temporary patios again next year. The owners firmly believed that opening up the ratios has made their offering to the customer a lot better in these turbulent times. In fact, management mentioned that the association of restaurant holders is lobbying the government to commit to keeping newly established patios for at least two more years. The total cost of opening up the patios was $60,000.

The brothers borrowed $100,000 to partially fund for the pandemic cubicles and patios from their uncle. While the uncle did provide the financing, he charged an interest rate above market of 10%. The uncle required the amount be paid on demand should he need the money for personal emergencies.

Fire Accident

Another issue that the brothers had to deal with this year was a fire at one of the restaurants in early October. Luckily, the fire was quickly contained and thus the damage was limited to some kitchen equipment only. The equipment could not be repaired or restored because of water damage but management did manage to arrange for a sale of the spare parts from the equipment. The sale will take place on December 1, 2021. Despite the fact that the damage was limited, the brothers knew that it would take some time to get the restaurant reopen again as the fire department has to do an investigation before giving the green light to reopen. Thus, the brothers decided to do some minor renovations including putting in new floors and repainting. They thought it might be a wise decision given that the fire accident did leave behind a bit of a smell. The minor renovation cost $25,000. According to Malcolm, the place looks so much more welcoming after the renovation.

All the monies spent on renovations due to the fire and the pandemic are included in long lived assets. The brothers would like to keep the damaged equipment on the books at their current carrying value until the sale takes place in December.

Investment

As outlined in the Franchisor Agreement, the Advertising and Sales Promotion Fund has been established and BHI has already contributed $30,000 into the fund. While the marketing strategy is still being finalized, the brothers decided to temporary invest in the stock market believing that they can earn a profit. All of the funds were invested in Tesla stock on October 1, 2021. You look up the Tesla stock price chart and it is presented below. [Assume that the chart is current and accurate for the purposes of the case.]

Exhibit I

Extracts from the franchisor agreement

The franchisee agrees to the Restaurant being designed, laid out, constructed, furnished, and equipped to meet the BHI standards.

The amount of franchise fees is specified in the Contract Data Schedule. The timing of initial franchise fees is as follows: payments must be received no later than 30 days after the receipt of invoice. The franchisor will invoice half of the initial franchisee fee at the contract signing. All initial training must be completed by the franchisor within 45 days of signing the contract.

The continuing franchise fee will be payable within 15 days after each month end. The amount due should be calculated by multiplying the Gross Sales of the Restaurant for the month by the Continuing Franchise Fee percentage stated in the Contract Data Schedule.

The Franchisor has established the Advertising and Sales Promotion Fund. All continuing advertising fees will be deposited in the Fund. The franchisees and franchisor will contribute to the fund. The franchisor will direct in its sole discretion direct the use of the monies in the Fund. If monies held in the Fund are not spent using a reasonable period of time, the Franchisor will invest the monies in limited-risk securities.

The Franchisor agrees to provide financing to the franchisee as specified in the Contract Data Schedule in exchange for shares equivalent to the amount of financing (in other words, 30% financing equals to 30% of common shares of the Franchisee corporation). Common shares will be redeemed by the franchisee as annual repayment is made.

Exhibit II

CONTRACT DATA SCHEDULE

Location of the Restaurant:

123 Amazing Street, Amazing Town, Ontario

Term: 3 years from the first date the Restaurant opens

Initial Franchise Fee: $150,000 which includes:

Initial Training Fee of $50,000

Initial Marketing Fee of $100,000 (for grand opening event)

Continuing Franchise Fee: 10% of gross revenue

Continuing Advertising fee: $1000 per quarter

Financing: no more than 30% of the initial investment in the building, site, equipment, signs.

Exhibit III

DRAFT BALANCE SHEET (Unaudited)

Note:

Short-term investment includes $30,000 (at cost) invested in Tesla.

Note payable represents $100,000 borrowed from the uncle payable on demand.