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?
