65 MacKay Industries Limited (MIL) is a Canadian company that manufactures leather furniture. Sales in 20X3 were $265 million, with strong exports to the United States. MIL is the leading Canadian manufacturer of leather furniture, and is ranked fourth in this category in the U.S. market. While MIL has, in the past, had manufacturing facilities in the United States, difficulties in quality control and logistics have recently convinced the owner to centralize all operations in Niagara Falls, Canada. The plant employs 250 workers.
MIL is a private company. The majority of shares are held by the president and CEO, Jeff MacKay, who inherited the business from his father. The firm was founded by Mr. MacKay’s grandfather. The remainder of the shares are held by members of the MacKay family. MIL has substantial long-term bank financing in place, secured by company assets and the personal guarantees of Jeff MacKay and key family members.
MacKay himself is a graduate of Harvard Business School and is well regarded in the industry. He focuses on marketing and strategy, and usually leaves operations to his pro- duction managers, all of whom receive a bonus based on overall company profits.
You, a professional accountant in public practice, review the annual financial state- ments of the company, prepare the tax returns, and provide advice on a wide range of issues, including financing, tax, personnel, and accounting policy.
You have been asked to look at the investment portfolio of MIL, and comment on appropriate accounting. Mr. Mackay is aware that rules have recently changed in the invest- ments area, and he’d like a summary of how his investments should be accounted for.
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Investments can be summarized as follows:
1. Short-term investments MIL has excess cash tied up in short-term investments at various times of the year. This money is often invested in Treasury bills, but may also be invested in common shares of public companies, if MacKay feels there is an opportunity to earn capital appreciation.
2. Hyperion MIL bought 4,000 shares of Hyperion, an aircraft engine manufacturer, two years ago, for $43 per share. The investment is recorded at cost. Hyperion has 490,000 common shares outstanding, of which 20,000 to 40,000 change hands annually. Mr. MacKay is a personal friend of the president and CEO of this small public company. No dividends have been declared on the shares. The stock price quoted at the end of last year was $42. This year, market values have been in the $33–$35 range. Mr. MacKay has stated that he would not consider selling the investment unless market values return to $43. Mr. MacKay is confident that this will be the case sometime in the next five years.
3. March Limited Mr. MacKay (personally) is the sole shareholder of March Limited, which he incorporated two years ago. The Boards of Directors for March Limited and MIL are almost identical. March is engaged in researching new imitation leather fabrics, and ways of chemically treating real leather to improve its quality. Throughout the last two years, March has spent $216,000 on these activities. All this amount is financed by MIL; Mr. MacKay himself has put no money into March Limited other than a token investment to create share capital. MIL reports the $216,000 as a long-term receivable. It has no stated interest rate or term, and will be repaid only when marketable fabrics are developed by March Limited.
4. Kusak Limited MIL owns a $500,000, 10-year bond issued by Kusak Limited. Kusak is a public company and this bond is publicly traded. MIL bought the bond for $412,700, plus accrued interest. MIL will hold the bond until maturity, although if funds are needed for operating or capital purposes during that time, the bond would certainly be sold.
5. DML Corporation MIL owns 19,975 (2%) of the voting common shares of DML Corporation, a French furniture manufacturer that MacKay may use to enter the European market sometime in the future. Five years ago, MIL bought notes payable and preferred shares in the company. This year, the notes and preferred shares were exchanged for the common shares pursuant to an agreement signed when the notes and preferred shares were acquired. On the exchange date, the notes and preferred shares had a book value of $175,000, and this value was used to record the common shares. Their market value was indeterminable on that date because the securities were never traded. Common shares, thinly traded over the counter, have sold for $7–$9 in the last 12 months. MIL has one member on the 18-seat Board of Directors of DML Corporation. Mr. MacKay himself attends these meetings, and reports that he is well regarded in debate. Mr. MacKay usually takes a bilingual advisor with him, as proceedings take place in French, a language in which Mr. MacKay is not fluent. In the past year, DML reported a marginal net income; the company has never declared dividends.
Required:
Prepare a report summarizing investment accounting policies as they apply to MIL’s investments
