Brian Smith has been the champion of the Pacific Rim market within Products R'Us for the past few years. The emerging buying power in this sector has led to an increasing amount of business for Products R'Us. Smith was finding himself at a growing competitive disadvantage due to comparative processing and freight costs. Smith had argued forcefully that without a Pacific Rim manufacturing facility, he would soon be unable to compete in this important market. Six months ago, a five million dollar facility to be situated in China focusing on basic products had been given the green light - provided he could justify the investment. Smith had been negotiating with the Chinese government and gathering both market and manufacturing data since that decision. He was now ready to compile it for a final report. First, from the company's construction group, process engineers and his own faceto-face negotiations, to get the plant built and running relatively smoothly, he drew up the following:
1) The Chinese government would waive all taxes for the first 5 years and donate the land use for the first 10 years.
2) Costs to build the facility, $2,000,000.
3) Machinery and equipment costs, $3,000,000.
4) Training and other start-up costs, $500,000.
After shake-down, from his discussions with marketing, manufacturing and accounting people, he estimated the following on an annual basis:
5) Sales, $15,000,000 with approximately 20% outstanding in receivables at the end of the year.
6) Sourced material purchases, $8,000,000, of which $1,500,000 will be unpaid at year end.
7) Variable cost of goods manufactured, (100% sourced materials) 50% of sales.
8) Fixed cost of goods manufactured excluding depreciation charges for plant and equipment, $2,500,000 (all of which will be paid by year end).
9) Variable distribution costs, 15% (all of which will be paid by year end).
10) Administration costs, $500,000 (all of which will be paid by year end).
11) Since this will be a JIT facility, no inventory of finished goods is expected (Amazing! Right?).
12) Development budget is set at $1,000,000 to adapt the product mix to local demands.
13) Tax accountant has noted that the building can be depreciated over 10 years, and the equipment over three.
14) Tax accountant has also noted that due to the uncertainty of future benefit, accounting rules state that the training and other start-up costs should be written off.
15) Historically, bad debts in this area of the globe are approximately 2% of sales.
Please note that these are summary transactions. Over the year there would be voluminous transactions taking place in a different chronological order. Of interest for this exercise is how the accountant would go about collating this data into financial statements, and how well the financial statements reflect what is happening in the business.