Alexander Electronics Ltd. (AEL) is a retailer of home electronics, software, music, and video games in a medium-sized Canadian city. The store has been in business for many years and has grown along with the community. Recently, AEL’s owner decided to sell the store because he felt he was too old for the rigours of operating it.
Ryan Evans has expressed interest in buying AEL and he and the current owner have been negotiating for several months. Mr. Evans has worked for AEL as a marketing manager and he is confident it will continue to be successful. Buying AEL will also fulfill a lifelong ambition of Mr.
Evans to own his own business. The current owner and Mr. Evans have agreed in principle to base the selling price on AEL’s net income before unusual items for the year ended December 31, 2009.It’s late January 2010.
Mr. Evans has just received AEL’s 2009 financial statements. For the most part he’s satisfied with the statements but he has some concerns and has approached you for advice regarding these. He would like a report evaluating the appropriateness of the treatments used in AEL’s 2009 income statements for purposes of determining the price he should pay.1) AEL has been given exclusive distribution rights in the region for a new video game called Zordef of the Deep (Zordef).
Zordef is scheduled to be released on February 5, 2010. When AEL learned in early December 2009 it would have exclusive distribution rights it set up a program that would allow people to guarantee themselves a copy of Zordef as soon as it is released. Under the program a customer would purchase the game in advance by paying the full retail price. When they paid the customer would receive a certificate that could be exchanged for Zordef when it was released. As of December 31, 2009 over 4,000 people signed up and paid $69.
99 for Zordef. AEL’s cost per copy will be $45.00. AEL will have to pay the manufacturer of Zordef 30 days after the game is delivered to the store.
AEL recognized the revenue when a customer signed up for the program, paid for the game, and received their certificate.2) During 2009 AEL began offering service contracts to customers who wanted support with any technical problems they had with their electronic equipment. Customers can buy one, two, or three year service contracts. Payment must be made in full at the beginning of the contract and the price is discounted for the longer term arrangements. Customers can cancel their contracts at the end of the first year (for two and three year contracts) and receive a refund for the unused portion. AEL recognized the revenue when customers signed up and paid for their contracts.
3) In previous years AEL’s current owner took an annual salary of between $75,000 and $100,000 per year. In 2009 he received no salary, opting instead to receive a dividend.4) In November, AEL launched a major advertising campaign in the city. The campaign ran until just before Christmas.
The purpose of the campaign was to promote AEL for the Christmas season as well as to create awareness of the store in parts of the city that historically had not shopped at AEL. AEL capitalized the costs and is amortizing them over 12 months.
