Using APB opinion 21 and IRC Sec. 1274 to evaluate accounting and tax issues for an unusual loan.
Coffee, David ; Lirely, Roger
CASE DESCRIPTION
This case considers the financial accounting and tax issues
associated with a loan made by a manufacturing company to the Atlanta
Braves baseball team. The case has a difficulty level of four/five and
is appropriate for an upper level financial accounting class or tax
class. It is designed to be taught in one hour and requires two hours
outside preparation by students.
CASE SYNOPSIS
A manufacturing company loans the Braves money at an interest rate
below market. The Braves donate 20 season tickets to the company.
Students are required to evaluate this transaction to determine: (1) how
it should be treated for financial reporting purposes by the lender; and
(2) the proper tax treatment of the transaction by the lender. The case
demonstrates how financial accounting issues and tax issues can be
similar as well as different in a business transaction.
JUST A SIMPLE LOAN OR NUCLEAR PHYSICS?
On January 1, 2003 the Georgia Products Company loaned the Atlanta
Braves baseball team $100,000 in cash. The Braves signed a 3-year, 2%
interest-bearing note due December 31, 2005. Interest is payable at the
end of each year on December 31 and the principal is due December 31,
2005. The Georgia Products Company recorded the transactions to the loan
as follows for 2003:
Georgia Product Books
January 1, 2003
Notes Receivable $100,000
Cash $100,000
December 31, 2003
Cash $2,000
Interest Income $2,000
As the partner in charge of the independent audit of Georgia
Products, Gary Gaines is concerned about the loan. Gary has scheduled a
lunch meeting with Linda Owens, Georgia Products Chief Financial Officer
to discuss the loan. Gary and Linda, long time friends, are candid and
to the point.
"Gary, the Board of Directors unanimously approved this loan
so I'm not sure why we need to discuss this. I'm sure
you've read the minutes. We feel the Braves have been an important
part of the community and we wanted to show our appreciation to the
Braves organization." Linda seemed just a little irritated, but
Gary was used to her approach. Linda did not beat around the bush. She
continued. "The Braves talked to us about increasing the interest
of disadvantaged kids in the team. They had some good ideas, some really
good stuff. But this kind of thing costs money. Roger (the Georgia
Products CEO) took it to the board. Just between us, Roger asked the
board for a gift. But you know the make-up of that group. They tabled
that. Roger was able to squeeze a low interest loan out of them. Hell,
I'm surprised he got that."
"Look Linda, I'm not questioning the right of the company
to make the loan, nor am I suggesting that this is a misuse of
stockholder money. My problem is how to properly account for this thing
in the financials. And I have to wonder about tax implications."
"Gary, you worry to much. You've seen the books. We have
a $100,000 note from the Braves, which we report as a $100,000 asset. We
recognize the $2,000 as interest revenue. This is not nuclear physics.
Fact is, everybody benefited. Heck, Roger had hoped for a gift and was
embarrassed to go back to the Braves with just an offer of a loan. Know
what? The Braves were genuinely grateful. They told Roger they are
paying 10% for their money right now and appreciated the support of
Georgia products. Going to mention us in the Braves promotions as a
supporter of the disadvantaged kids program. Good for the company, good
for the Braves, good for the kids, know what I mean?"
"Linda, your not listening. I'm not questioning the value
of this to Georgia Products. I'm concerned about reporting and tax
issues."
"Gary, I always listen. We couldn't make this thing any
easier for you. And the Braves? They are so pleased that they sent the
Company 20 season tickets. Did I mention that? We hope you can join us
on opening day.
Gary picked up the check. He was trying to remember whom the Braves
opened with. Maddox on the mound, no doubt. "Linda, count me in.
But now I have to go back to the office and figure out the financial
part of this thing. And I need to talk to Philip, our tax partner.
I'm not so sure. This might be nuclear physics after all.
David Coffee, Western Carolina University
Roger Lirely, Western Carolina University