SUNFLOWER SHIP BUILDING

Sunflower Ship Building began constructing two seagoing drilling rigs designed for service in North Sea oil
fields. When they had invested about $30 million in the two rigs they ran short of cash and realized that at
least $30 million more was necessary. Coincidentally it became apparent that there was a serious shortage
of drilling rigs and that their work in process had considerable value. Sunflower was approached by Cash
Inc., a personal investment company wholly owned by a wealthy individual. Cash Inc. offered to buy a 50
percent interest in the two drilling rigs under construction, to pay 50 percent of the cost incurred. In
addition, Cash offered to pay Sunflower a $5 million premium for the opportunity to buy in at this time.

The two parties negotiated a deal and formed a partnership. Sunflower donated its work-in-process
inventory as its capital contribution and Cash Inc. contributed $30 million in cash, and paid the promised $5
million directly to Sunflower. The partnership then negotiated a line of credit with a group of banks in order
to have sufficient funds to complete the rigs if construction costs should exceed the estimated $60 million.
The partnership agreement states the partners’ intention to lease the drilling rigs to independent
exploration companies--several already have expressed an interest in chartering the rigs. Sunflower is
responsible to complete the rigs if the costs exceed the estimated $60 million plus the amount provided by
the line of credit. Sunflower will also act as leasing agent, where it will earn a nominal fee.

As you review Sunflower's year-end financial statements, the controller explains that the cost of the work in
process was simply transferred to an account called "Drilling Rigs Partnership." The $5 million premium
has been included in this year's income: the controller smiles, "It's an ill wind that blows no good.”

DO YOU AGREE WITH THE CONTROLLER'S PROPOSED ACCOUNTING?

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