Rick’s Rock n Roll Restaurant
Rick also owns 40% of the voting shares. The other 60% are owned equally by 3 non-related parties who do not take an active role in the Company’s operations but do monitor their investment by requiring an annual audit of the financial statements. Rick has an option to purchase their shares effective at the next fiscal year end, which is January 31. It is now January 10. Per the shareholder’s agreement the option price is to be based on the net book value of the shares as determined by the audited financial statements. Rick has made it clear that he would like to obtain control of the Company.
Rick is a former professional accountant and therefore knows the importance of being conservative in preparing financial statements.
Part of RRR’s success can be attributed to having great live music—specifically rock and roll. However—the competition to get the best “bar bands” is very intense. Rick has noticed if another bar in the area has a better band he loses business. Therefore, to help with the booking of bands during the current fiscal year RRR signed a contract with an entertainment agency to have first choice of the top-name bar bands. To earn this privilege RRR had to pay the agency $ 500,000 when they signed the contract in November. They will also give them a percentage of the bar sales on the nights the bands perform. This is in addition to what they pay the bands. The initial fee of $ 500,000 is for the duration of the contract which is for three years. Rick expensed the $ 500,000 under promotion expense due to the uncertainty of realizing any future benefits. His belief is that this expense is just to maintain the existing customer base. “It won’t necessarily mean new business”, he explained.
Another way to stimulate business was to get involved in the promotional book, Mississauga Music and Eats!, which is free to readers and offers descriptions of various restaurants to visit in Mississauga. RRR paid $ 100,000 to be featured in this publication, which comes out every January and June. They will be in the magazine this month for the first time—but have paid for the June issue in advance ($ 50,000 each issue). Rick expensed the $ 100,000 in the current year.
To further entice potential customers RRR also have provided three coupons in each book entitling the holder to a free drink of any kind with a maximum value of $ 10 each. It is hoped that the customer will have the free drink and then stay for many more—but there is no obligation for them to do so. There will be 100,000 books distributed in January and a further 100,000 in June. The coupons expire on December 31 of next year. Rick recorded a liability of $ 3,000,000 with an offset to promotion expense in the current year.
The final new promotion idea in the current fiscal year was a rewards program. Customers who enroll (no charge to enroll) would earn “points” for each purchase. The points could then be redeemed for anything at the restaurant. The customers earn 1 point for each $ 10 they purchase in the restaurant-not including taxes or tips. They can start redeeming when they get to 100 points which is worth about $ 10 at retail price. Rick has been pleased with this promotion. Many customers have signed up and have earned collectively about 900,000 points. But there have been no redemptions as of today. There is no expiration on the points—although customers must renew their membership each year.
In other events during the fiscal year RRR received some bad publicity in the last few months. There were several incidents of drug dealings and robbery both in and around the restaurant. In order to reassure its customers that the restaurant was safe, RRR replaced their security firm with a new firm. They then advertised this fact and stated it was now “safe again” to visit RRR. Unfortunately, this prompted a lawsuit in the amount of $ 1 million dollars from the previous security agency who did not like being considered the reason for the crime. The lawsuit was for breach of contract and libel. Rick has no idea at this time whether they will have to pay any damages. He wants to set up a liability to cover any possible future payouts from this lawsuit to be on the safe side.
Rick is anxious to open up another location under the RRR name to take advantage of the goodwill he has developed in the existing business. RRR has paid $ 100,000 to a restaurant development firm that will work to help RRR find a suitable location, help negotiate the lease and other details related to the opening. As of today no location has been identified but both parties are confident that a location will be found and a new restaurant will be opened in the next fiscal year.
Rick has approached you, CPA, an independent consultant, to help him prepare financial statements for the upcoming year end. Specifically, he would like your advice on how to account for the above issues and to anticipate any issues that may come up with the auditor.
Assume the role of CPA and advise Rick.