COOL TRUCKS INC.
Cool Trucks Inc. (CTI) is a private company in the business of manufacturing and distributing freezer vans. The vans are used for transporting frozen goods by CTI's customers. Eric Blyth is the sole shareholder, chief employee and is the brains behind the technology. Eric developed a thin insulated wall (ideal for small vehicles) that will not let warm air inside. Hence, frozen foods stay frozen. Eric sells the product with a three year guarantee that food will not spoil. If it does during this "warranty period" he will reimburse the customer for lost product as well as repair the problem free of charge.
To date, operations have been close to breakeven. This is partially due to the fact that CTI spent a significant amount of money developing this new technology. Given current market conditions Eric estimates that this technology will give CTI a competitive advantage for many years.
A contract with Sara Lee Foods was signed in October 1995 to revamp their existing trucks with this new technology. This will be a very profitable contract for CTI. The problem is Sara Lee does not want to pay for the vans until they are delivered, and each van has considerable costs involved in their production. The first delivery is not expected until January 1996. It therefore became clear to Eric that, to fulfil the contract, he would have to go the bank for a line of credit. CTI has been able to avoid using the bank during their first three years of operation.
It is now early December, 1995 and Eric has come to you, CA, his trusted accountant, to provide him with advice concerning how to present financial statements for the bank. You are aware that he has essentially been using the cash method for the tax returns and otherwise has had no need for formal financial statements. CTI has a calendar year end and Eric is very excited about finally having a "guaranteed contract to take the bank". Eric wants you to be thorough in discussing how CTI should account for its assets, costs of production, and all other aspects of its operation that you consider relevant.
In November 1995 one of CTI's customers initiated a lawsuit against CTI for allegedly providing unsafe vehicles. It seems one of the drivers could not open the freezer from the inside and suffered severe frostbite to his hands and feet. Eric maintains that it was driver error and not his fault.
Assume the role of CA and prepare a report for Eric concerning the advice he requested.