Slipshod Industries, Inc.
Fall 2013
As a member of the firm of Dewey, Billem & Howe, Certified Public Accountants, you have set up a breakfast meeting (complete with refreshments) to meet with the President of one of your newest and fastest growing clients, Slipshod Industries, Inc. (the “Company”). The President, Mr. Iman Ignoramus (“Mr. I”), has requested this meeting to provide assistance with both the tax and business structure. While tax planning is a significant part of this engagement, business planning and structuring are just as important and the two must be in harmony for the engagement to achieve its ultimate success. The previous accounting firms of Finkel, Nerd and Waffle, CPA’s were disengaged due to their inability to come up with creative ideas regarding tax and business structuring for the Company.
The Company is a manufacturer of products related to the passenger rail system. For the past ten years the Company has mainly produced wheels, axles, and spare parts for train cars. Recently, they have developed a new product (patented), which consists of a complete carriage and wheel system for passenger train cars. The new system, entitled Cloud Nine, provides an extremely smooth ride for rail passengers and has been heralded as a major breakthrough in the industry. The new product logo is “The ride is fine on Cloud Nine.”

Unlike the production cycles of the past, Cloud Nine takes approximately two months of production to manufacture and sells for approximately $1,000,000 per unit. This protracted production process requires the Company to incur significant cash outlays (material and labor) during the production process. While the major customers (Amtrak, Conrail, etc.) pay their bills within 45 to 60 days, the total working capital cycle is almost four months and as a result the Company is experiencing cash flow difficulties. (Their suppliers require payment in 30 days). The Company must also maintain a large spare parts inventory of older components to meet the replacement needs of their existing customers. A typical rail car will last 20 years if maintained properly.
As a little bit of history, Mr. I, an engineer by training, for the last ten years has built the business one step at a time. He has the entrepreneurial grit that comes with building a business. While an honest enough man, he hates to pay taxes and he doesn’t like bankers. He feels that both are drains on productivity and he is not afraid to voice his opinion. Mr. I, 65 years of age, wears bow ties and drives a Saab and just bought a Harley (does this guy sound familiar?). He believes that the Company should pay for everything and has tried to institute as many fringe benefits as possible. While he draws an annual salary of $275,000 not including benefits, his personal lifestyle is one of personal consumption. He belongs to a prestigious yacht club where he maintains his 45-foot sail boat, takes expensive vacations with his wife Muffy, and invests heavily in futures and options (the guy is a true capitalist pig!). Years ago he capitalized the business with a $100,000 equity infusion. He has been advised to personally lend additional funds to the business to help relieve the cash needs. He has available approximately $500,000 to do this but is concerned it would hamper his ability to play the market. He would rather take back stock in Slipshod with this money in lieu of debt, because to him, ownership is everything.

Since inception in 2000, the Company has been an S corporation. Each year the Company has been profitable and net income has ranged form $80,000 to $125,000 each year. Mr. I has taken distributions (S corp. distributions) out of the Company each year equal to about one half of the income in order to meet his personal tax obligations from the income flow through. The Company has experienced a decline in gross profit margins during the past five years, from about 25% down to about 20%. The industry norm is around 25%. Mr. I attributes this to increased competition and the need for his employees to get an annual raise. He also sights the damn health insurance companies and these HMO’s for driving up premiums including his own which costs about $1,250 per month.
He has also indicated to you that he is not exactly sure of the actual margins on the Cloud Nine system since it is so new and production has just begun. He has a gut feel that he is making money but he is not quite sure. The Company currently does not have an in-house cost accountant and Mr. I is resistant to hire another bean counter which would continue to add to his overhead. Annual sales for the Company have grown to about $6,000,000 last year. With the advent of Cloud Nine, it appears that sales may hit $12,000,000 this year since they expect to sell six units per year. In order to support this increase in production, the Company had to install several pieces of high tech equipment (expected to be used in the business for approximately five years) to produce the new systems. This resulted in the Company incurring several operating lease commitments of approximately $30,000 per month for three years. Some of these leases have interest rates of 12% to 15%. But Mr. I figured it was easier than dealing with those damn bankers.
The only debt that the Company has is a 20 year mortgage on their building which was bought five years ago for $500,000. The building is currently worth about $750,000 and has an outstanding mortgage balance of $450,000.
Mr. I and his wife each own 50% of the stock in the Company. They have three children ages 16 to 21, two of which are in college. None of the children work in the business. He has told you that he knows nothing about accounting or taxes, but then relates that the previous accounting firm had told him to report inventory as low as possible regardless of what the actual amount was. This has weakened his balance sheet as a result.
You had previously obtained a copy of his most recent balance sheet and income statement from the last fiscal year, which is attached. During your phone conversation last week he expressed to you that he was anxious to resolve his cash dilemma and had confidence that you could solve this problem. You are to prepare an outline (typed in bullet format) of recommendations to assist him. These recommendations are to be both tax and business oriented and should be separately listed under those headings.