UNCONVENTIONAL AND GROWING, INC.Show the journal entry to record the legal liability arising from the potential lawsuit.
Crazy? Craig Cravath is a somewhat eccentric yet enthusiastic businessman who believes in the social
responsibility of business. Incidentally, he is also interested in making enough money to live a
comfortable life. As a supporter of the ecology movement, he is very concerned with the hunting of
animals for industrial purposes, such as the making of furs, shoes, and ladies? handbags. As a
consequence, he formed Unconventional and Growing, Inc., a company with a mission of promoting
crocodiles as household pets. (The choice of the animal was purely coincidental.) He plans to catch
crocodiles in Southeast Asia and sell them in the United States.1
The senior leadership team of the company consists of Mr. Craig Cravath (President), Bubba Gump (Vice
President of Production, who is in charge of catching crocodiles), Wiley Lowman (Vice President of
Sales), and Nikita La Femme (Vice President of Operations, who is in charge of administrative functions
including cash collection from customers).
The first task facing Mr. Cravath was to raise capital. This required estimating future capital needs by
projecting the physical facilities and working capital needed for the business. Mr. Cravath’s estimates
showed that he would need a fleet of boats to catch crocodiles in Southeast Asia and a holding tank in
the State of Gould to keep them alive in captivity after they are shipped. Because of the need to extend
liberal credit terms to skeptical customers, the company needed working capital to carry inventories and
receivables. Finally, the company needed a large start up investment for sales and an advertising
campaign. The firm also needed funds to hire new employees and to rent office space in the State of
Gould. Mr. Cravath asked Nikita La Femme to prepare a forecast of activity to plan facility needs and to
translate it into capital needed to start the business.
First Year Results
Based on the forecast provided by Ms. La Femme, Mr. Cravath and his ecology minded friends raised the
capital for acquiring the facilities. He leased ten boats in Southeast Asia, a 20,000 square foot
warehouse with a holding tank for the crocodiles in the State of Gould, and a 2,500 square foot office in
the State of Gould. Both the warehouse and the office were leased from Pauly Property Management
Services for three years, beginning January 1, 2008.
The company opened its door for business on January 1, 2008. Wiley Lowman launched an aggressive
sales and advertising campaign built around the slogan that crocodiles were warm, friendly and greatly
misunderstood creatures that deserved loving care. He designed a slick marketing campaign built initially
around the slogan: “Crocodiles — don’t handbag them, handle them with love.”
During its first year, the company spent approximately $300,000 to catch 500 crocodiles. Of these, 300
crocodiles were sold and shipped to customers at a selling price of $1,000 per crocodile. Shipping costs
of $50 per crocodile were paid for during the year. Customers were given liberal credit terms and only
$160,000 from an equivalent 200 customers was collected during the first year. Ms. La Femme estimated
that as much as 20% of the sales price will be spent in collection costs and bad debts expenses.
At the end of the first year, Mr. Cravath consulted with his other two colleagues and estimated that he
could catch and sell 600 to 800 crocodiles for the next year. Because of the company?s apparent
success, Mr. Cravath wanted to expand its facilities. This meant getting funds to rent more boats and
warehouse space. He believed that he could now overcome the skepticism of banks and ask for a loan.
On January 2, 2009, Mr. Cravath notified Pauly Property Management Services that he no longer needed
? Copyright 2009, Dr. Shahid Ansari, Dr. Bruce Zucker, and Dr. Richard Gunther
1 Assume that Mr. Cravath has somehow managed to obtain permits to sell live crocodiles legally.
their current warehouse and office space. He would be vacating the properties by January 30th in order
to move into larger facilities.
He asked Ms. La Femme to prepare an income statement for the bank in accordance with generally
accepted accounting principles (GAAP). In addition, since the executives were on a profit sharing
scheme, it was necessary to determine profits in order to pay year-end bonuses.
Ms. La Femme entrusted this task to her young staff accountant, Harry Dim, who had only recently
graduated from college and was on his first job. After he familiarized himself with the facts, Dim realized
that he needed to look up the GAAP accounting rules for preparing an income statement. At that same
moment, he also realized with some consternation that he had sold his college accounting textbook when
the course was over. Dim headed to his college library to find the relevant reference material.
A review of his old accounting textbook told him that two GAAP principles were particularly relevant for his
current task. The first was the matching principle, which requires that costs and revenues be matched by
time periods. The other was the principle of revenue recognition. His next step was to copy and read the
relevant sections of these principles from the pronouncements of the Financial Accounting Standards
Board. Attachment 1 shows the results of Dim’s research into the appropriate GAAP rules for preparing
On first reading the material, Dim thought it was going to be easy to prepare an income statement. He
remembered learning that for most businesses revenue was earned when good were sold (that is, when
title passed from the seller to the buyer). However, as he read the statements of the FASB, he realized
that revenues could be recognized when production was complete or when cash was collected.
According to the FASB standard, “revenues are considered to have been earned when the entity has
substantially accomplished what it must do to be entitled to the benefits represented by the revenues.?2
Dim realized that in order to determine the revenues for 2008, he must first determine when the earning
process is complete. This, however, was not a usual business. Therefore, Dim was not sure when
Unconventional and Growing was “entitled to the benefits represented by the revenues”. In order to
determine the critical point in the operations cycle when the business could do this, he decided to talk to
the three top executives.
His first conversation was with Bubba Gump, V.P. Production. Gump told him that catching crocodiles
was the most critical activity for the business since ?it is difficult to trap them suckers and you can lose a
few limbs in the process if you are not careful.?
Dim next spoke to the Wiley Lowman, V.P. Sales. Lowman pointed out that while catching may be a
dangerous activity, no one is likely to buy a crocodile because it is risky for us to catch them. He felt the
company?s success this year was largely due to his clever holiday season advertising campaign with its
theme of: ?this year give that special someone something live! Someday they can produce their own
shoes, handbags, and belts.?
Dim’s final conversation was with Nikita La Femme, V.P. of Operations. She told Dim that, in her opinion,
the crucial activity for the business was cash collection. As she put it: ?Bubba and Wiley have never tried
collecting cash. If they did, they would find out in a hurry that it is difficult to collect cash from people who
keep crocodiles as pets. Besides, we don’t have a collection agency that is willing to repossess live
2Financial Accounting Standards Board, Statement of Concepts # 5, Paragraph 83.
The Lawyers Call
Even as Dim was puzzling over how to proceed, he received a call from Ms. Nikita La Femme. “Harry, I
just heard from our lawyers. Apparently, Pauly Property Management Services (the property
management company that leased us the warehouse and office space) is claiming that we had no right to
break the lease. We are being sued for an amount equal to the balance of the lease term and for punitive
damages. Later that day Harry received the memo from the lawyers that is summarized in Attachment 2.
Assume that you have been hired as a consultant by Nikita La Femme to help her and Harry Dim. She
has asked you for your help on the GAAP income statements and the legal issues arising from the lease
cancellation. Please write a business report using the case writing guidelines and report format guide
from the Gateway website.
To prepare an answer to this case you may want to review the following top ten concepts from the LDC
1. Financial Accounting # 3. Know the basic concepts underlying financial reporting (e.g.
matching, consistency, etc.).
2. Financial Accounting # 4. Know how to record and read a simple business transaction.
3. Financial Accounting # 8. Understand the timing of revenue and expense recognition.
4. Business Law # 5. Understand the duty to mitigate damages.
5. Business Law # 9. Understand the differences between compensatory and punitive damages.
Excerpt of Relevant GAAP Principles for Income Statement Preparation
I – ACCOUNTING PRINCIPLES STATEMENT # 4. GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES– PERVASIVE PRINCIPLES2
Footnote 43. The term matching is often used in the accounting literature to describe the entire process
of income determination. The term is also often applied in accounting, however, in more limited sense to
the process of expense recognition or in an even more limited sense to the recognition of expenses by
associating costs with revenue on a cause and effect basis.
Associating cause and effect. Some costs are recognized as expenses on the basis of a presumed
direct association with specific revenue . . . Although direct cause and effect relationships can seldom be
conclusively demonstrated, many costs appear to be related to particular revenue and recognizing them
as expenses accompanies recognition of the revenue. Examples of expenses that are recognized by
associating cause and effect are sales commissions and costs of products sold or services provided.
II – STATEMENT OF CONCEPTS # 5. RECOGNITION AND MEASUREMENT IN FINANCIAL
STATEMENTS OF BUSINESS ENTERPRISES3
Revenues and Gains — Paragraph 83. Revenues and gains of an enterprise during a period are
generally measured by the exchange values of the assets (goods or services) or liabilities involved, and
recognition involves consideration of two factors (a) being realized or realizable and (b) being earned,
with sometimes one and sometimes the other being the more important consideration.
a) Realized or realizable. Revenues and gains generally are not recognized until realized or realizable.
Revenues and gains are realized when products (goods or services), merchandise, or other assets
are exchanged for cash or claims to cash. Revenues and gains are realizable when related
assets received or held are readily convertible to known amounts of cash or claims to cash.
b) Earned. Revenues are not recognized until earned. An entity’s revenue-earning activities involve
delivering or producing goods, rendering services, or other activities that constitute its ongoing major
or central operations, and revenues are considered to have been earned when the entity has
substantially accomplished what it must do to be entitled to the benefits represented by the
Paragraph 84. In recognizing revenues and gains:
a) The two conditions (being realized or realizable and being earned) are usually met by the time
product or merchandise is delivered or services are rendered to customers, and revenues from
manufacturing and selling activities and gains and losses from sales of other assets are commonly
recognized at time of sale (usually meaning delivery).
b) If sale or cash receipt (or both) precedes production and delivery (for example, magazine
subscriptions), revenues may be recognized as earned by production and delivery.
2 Financial Accounting Standards Board, APS 4: Basic Concepts and Accounting Principles Underlying Financial
Statements of Business Enterprises, APS 4, October 1970.
3 Financial Accounting Standards Board, Statement of Concepts # 5, Paragraph 83, December 1984.
c) If product is contracted for before production, revenues may be recognized by a percentage-ofcompletion
method as earned–as production takes place–provided reasonable estimates of results at
completion and reliable measures of progress are available.
d) If products or other assets are readily realizable because they are salable at reliably determinable
prices without significant effort (for example, certain agricultural products, precious metals, and
marketable securities), revenues and some gains or losses may be recognized at completion of
production or when prices of the assets change
e) If collectability of assets received for product, services, or other assets is doubtful, revenues and
gains may be recognized on the basis of cash received.
Lawyer’s Memo on Unconventional and Growing?s Legal Liability
M E M O R A N D U M
TO: Nikita La Femme
Unconventional and Growing, Inc.
FROM: Leonard Lawyer, Esq.
RE: Unconventional and Growing
DATE: January 3, 2009
I just spoke with Parker H. Larry, the attorney for Pauly?s Properties. According to Mr. Larry, his
client leased to Unconventional and Growing 2,500 square feet of office space and 20,000
square feet of warehouse space.
According to Mr. Larry, Pauly?s is prepared to sue Unconventional and Growing for $372,000.
[This amount includes $72,000 in lost rent and $300,000 in punitive damages.] The claim is
Monthly rent $2,000
Balance of the lease 24 months
Total rent for warehouse 48,000
Monthly rent 1,000
Balance of the Lease 24 months
Total rent for warehouse 24,000
TOTAL RENT 72,000
PUNITIIVE DAMAGES 300,000
TOTAL RENT AND PUNITIVE DAMAGES 372,000
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