Chartered Professional Accountants of Canada

Transcription

UNIFORM EVALUATION
REPORT
2014
i
MEMBERSHIP OF 2014
BOARD OF EVALUATORS
Christine Allison CPA, CA
MD Funds Management Inc.
Ottawa, Ontario
Pierre-Yves Desbiens, CPA, CA, CF, MBA
Institute NEOMED
Montréal, Québec
Cindy Ditner, FCPA, FCA, CMA
BDO Canada LLP
Toronto, Ontario
Mike Fitzpatrick, CPA, CA
Fitzpatrick & Company
Charlottetown , Prince Edward Island
Aline Girard, Ph.D., MBA, CPA, CA
HEC Montréal
Montréal, Québec
Jason Hale, CA
Grant Thornton LLP
Halifax, Nova Scotia
Jo-Ann Lempert, CPA, CA
MNP SENCRL srl
Montréal, Québec
Barbara Sainty, Ph.D, CPA, CA, CMA
Brock University
St. Catharines, Ontario
Rik Smistad, CA
Mount Royal University
Calgary, Alberta
Dave Warren, CA
KPMG LLP
Vancouver, British Columbia
STAFF OF 2014 BOARD OF EVALUATORS
Marie-Andrée Caisse, CPA, CA, Principal, Evaluations and International Assessment
Kathy Létourneau, CPA, CA, Principal, Evaluations and International Assessment
Paule Massicotte, CPA, CA, Principal, Evaluations and International Assessment
Silka Millman, CPA, CA, Principal, Evaluations and International Assessment
Andy Thomas, CPA, CA, Principal, Evaluations and International Assessment
Wendy O. Yan, Administrative Coordinator
Linda Clarke, Administrative Assistant
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The Canadian Institute of Chartered Accountants (CICA) and Certified Management Accountants of
Canada (CMA) joined together January 1, 2013, to create Chartered Professional Accountants of Canada
(CPA) as the national organization to support unification of the Canadian accounting profession under the
CPA banner. The UFE Candidates’ Competency Map is still being maintained and provided under the
direction of CICA until final offerings of the CA program are complete.
Cataloguing information available from the National Library of Canada
All rights reserved. This publication is protected by copyright and written permission is required to
reproduce, store in a retrieval system or transmit in any form or by any means (electronic, mechanical,
photocopying, recording, or otherwise).
For information regarding permission, please contact permissions@cpacanada.ca
CHARTERED PROFESSIONAL ACCOUNTANTS OF CANADA, CPA CANADA, CPA.
© 2015, Chartered Professional Accountants of Canada. All Rights Reserved.
277 Wellington Street West
Toronto, Ontario M5V 3H2
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TABLE OF CONTENTS
Page
THE BOARD OF EVALUATORS’ COMMENTS
The Board of Evaluators’ Report on the 2014 Uniform Evaluation.......................
1
Comments on Candidate Performance on the 2014 Uniform Evaluation ..............
6
Exhibit 1
The Decision Model .....................................................................
16
Appendix A
Design, Guide Development, and Marking of
the 2014 Uniform Evaluation ......................................................
17
Candidates Performance on Primary Indicators by
Competency Area .........................................................................
21
2014 Simulations and Evaluation Guides ....................................
26
Paper I ....................................................................................
Evaluation Guide .............................................................
Paper II ...................................................................................
27
40
107
Simulation 1.....................................................................
Simulation 2.....................................................................
Simulation 3.....................................................................
Paper III..................................................................................
Simulation 1.....................................................................
Simulation 2.....................................................................
Simulation 3.....................................................................
Evaluation Booklet Tables .....................................................
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115
138
143
166
172
187
188
194
213
220
236
242
260
Appendix B
Appendix C
Uniform Evaluation Report — 2014
1
THE BOARD OF EVALUATORS’ REPORT
ON THE 2014 UNIFORM EVALUATION
Objectives of the report
The objectives of this report are:
1. To assist education committees and councils of the provincial and Bermuda institutes and provincial
boards of examiners in their review of the results of the 2014 Uniform Evaluation (UFE).
2. To assist the profession in improving pre-examination educational and screening processes and, in turn,
the performance of candidates on the UFE.
The report sets out the responsibilities of the Board of Evaluators, the methods of guide development and
marking the UFE, and the results of the marking process. The report concludes with the recommendation
of the Board of Evaluators. Three appendices provide more detailed information on the design, guide
setting, and marking of the 2014 UFE, the evaluators’ comments and expectations of candidates on the
simulations, and sample responses. Readers are cautioned that the solutions were developed for the entrylevel candidate and that therefore all the complexities of a real life situation may not be fully reflected in
the content. The UFE report is not an authoritative source of GAAP.
Responsibilities of the Board of Evaluators
The Board of Evaluators (BOE or board) comprises a chair and nine members. The chair and one bilingual
member are appointed by the Professional Education Management Committee (PEMC); the other eight are
appointed by the provincial institutes. Board members are appointed for a three-year term and the chair for
a two-year term.
The BOE’s responsibilities, as set out in its terms of reference, include:
- Setting the UFE in accordance with the UFE Candidates’ Competency Map (the Map) and other
directions from the PEMC.
- Submitting the UFE and the evaluation guides to the provincial institutes for review.
- Marking the candidates’ responses and recommending to the provincial institutes the pass or fail standing
that should be given to each candidate.
- Reporting annually on the UFE to the provincial institutes, in such form and detail and at such time as is
satisfactory to the Education and Qualifications Advisory Committee (EQAC) and the PEMC.
Each board member is actively involved in the preparation of the UFE simulations, the setting of the passing
profile, the preparation of evaluation guides, and the supervision of the evaluation process. Board members
are jointly responsible for determining the passing standard.
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Board of Evaluators’ Report
The UFE
The purpose of the UFE is to assess whether candidates possess the competencies required of an entry-level
CA through a uniform written evaluation that all CAs must pass in order to qualify for entry to the
profession.
The Decision Model
The pass/fail decision model used by the board is presented in Exhibit 1. Three key decision points, or
levels, are applied in reaching the pass/fail decision, as follows:
1. The response must be sufficient, i.e., the candidate must demonstrate competence on the primary
indicators (Level 1). In assessing sufficiency, the board considered the number of times that a candidate
achieved “Competent” and/or “Reaching Competence” across all primary indicators (both specific
competencies and pervasive qualities).
2. The response must demonstrate depth in the areas of Performance Measurement and Reporting and
Assurance (Level 2). In assessing depth the board considered the number of times that a candidate
achieved “Competent” in each of the Assurance and Performance Measurement and Reporting primary
indicators.
3. The response must demonstrate breadth across all areas of the Map (Level 3). In assessing breadth
the board considered the number of times that a candidate achieved “Reaching Competence” across
primary indicators in each of the specific competency areas, except for Assurance and Performance
Measurement and Reporting. If a candidate failed to demonstrate breadth on the basis of the primary
indicators, the board considered the information provided by the secondary indicators for the deficient
competency area.
Evaluation guides
An evaluation guide was prepared for each simulation included in the 2014 Uniform Evaluation. Besides
identifying the primary and secondary indicators of competence, each evaluation guide includes carefully
defined performance levels to assist markers in evaluating a candidate’s competence relative to the
indicators. Five categories of performance are given for each primary indicator. The candidate’s
performance must be ranked in one of the five categories, namely:
Not addressed
Nominal competence
Reaching competence
Competent
Highly competent
For each secondary indicator, the candidate’s performance is ranked in one of three categories:
Not addressed
Nominal competence
Competent
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Preparation and structure of the UFE
The Evaluations and International Assessment staff of CPA Canada maintains a pool of simulations
sufficiently large and broad in scope to provide a variety of alternative simulations embracing all sections
of the Map. The board provides guidance as to the content and nature of simulations to be included in the
pool.
The board staff works in conjunction with authors to ensure that simulations achieve the overall intent and
design objectives while adhering to the competencies and the proficiency levels specified in the Map. The
board selects simulations from the pool maintained by the staff, and reviews and refines these simulations
to make up the annual three-paper evaluation.
Nature of the simulations
Taken as a whole, the three papers must meet the requirements laid down by the PEMC for Map coverage
and simulation type. Appendix A shows that the 2014 UFE met the Map coverage requirements.
The 2014 UFE comprised a balanced combination of comprehensive and multi-subject simulations, which
were both essential and effective in evaluating the candidates with regard to their readiness to practise
public accounting. The first paper was a five-hour paper consisting of a single, comprehensive simulation.
The board designed a four-hour comprehensive simulation, as it has done in past years, but allowed
candidates an extra hour in which to complete their responses. The second and third papers were four-hour
papers, each consisting of three simulations.
Detailed comments by the Board on each of the 2014 UFE simulations appear in Appendix C.
Primary and secondary indicators of competence
The board applies evaluation procedures that enable it to decide which candidates demonstrate readiness to
practise public accounting. Appendix A contains a comprehensive description of the evaluation process.
To attain a pass standing, candidates must address the issues in the simulations that are considered mission
critical. The board distinguishes between the mission critical issues and other relevant issues by classifying
them as primary indicators and secondary indicators of competence respectively.
Primary indicators of competence answer the question: “What would a competent CA do in these
circumstances?” If the issues identified in primary indicators are not adequately addressed, the CA could,
in real life, be placed in professional jeopardy or could place the client in jeopardy.
Secondary indicators of competence answer the question: “What other issues could a CA raise?” Although
such issues are valid, it is not essential for a competent CA to address them.
Board members devote a great deal of time to reviewing and refining evaluation guides to ensure the
expectations for achieving competence are fair and reasonable for an entry-level CA.
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Board of Evaluators’ Report
Marking-centre leaders and assistant leaders provide valuable input to the evaluation guides before live
marking begins. Board members hold regular meetings with the leaders and their assistants during both the
guide-setting and the marking process. In the board’s opinion, the commitment, energy, and skill
demonstrated by all the markers were outstanding, resulting in the sound application of marking procedures
and producing an appropriate evaluation of the candidates.
The marking results for the secondary indicators do not appear in the statistical reports (Appendix B), as
they reflect the performance of only that segment of the population whose responses were deemed
borderline. However, Appendix C does contain comments on the candidates’ performance for the
responses that were marked.
Setting the passing standard
In determining which candidates pass the UFE, the Board uses a passing profile. A candidate is judged in
relation to the board’s pre-established expectations of an entry-level chartered accountant. To meet the
passing profile, a candidate’s response must meet the three levels defined earlier (see Exhibit 1).
In setting the passing profile, the board considers the following:
-
The competency area requirements.
The level of difficulty of each simulation, as a whole.
The level of difficulty of each individual competency indicator.
The design and application of the evaluation guides.
Comments from leaders and assistant leaders regarding any marking difficulties encountered or any time
constraints noted.
- Possible ambiguity of wording or of translation of a simulation.
Determining which candidates pass
Near the completion of the marking process, board members each read a sample of candidate responses for
their assigned simulation to satisfy themselves that the markers had applied the judgments as intended.
Based principally on these readings, and on the evaluation of each candidate made by the markers, the board
reviewed its pre-established passing profile and set preliminary requirements for Level 2-depth in the areas
of Performance Measurement and Reporting and Assurance, and for and Level 3-breadth across all
competency areas.
Prior to the fair pass meeting, board members each read another sample of candidate responses, this time
for their assigned competency area, to satisfy themselves as to the levels they had set for Levels 2 and 3.
They finalized those Level 2 and 3 requirements at their fair pass meeting, taking into account the number
of valid opportunities available to candidates to demonstrate their competence in each of the competency
areas. The board then established the Level 1 requirement for the three-paper set. In establishing the Level
1 requirement, the board considered whether the results could be wholly or partly explained by any
inconsistency in the evaluation or in the board’s process.
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After considerable discussion, the board concluded that the 2014 evaluation was slightly harder than the
2013 evaluation. After taking into account that the 2014 UFE was slightly harder, candidate performance
on this evaluation was assessed as stronger than that of 2013. Based on the stronger candidate performance,
the board set a Level 1 standard that yielded 3,577 successful candidates (3,032 candidates in 2013).
In reaching its decision, the board determines which candidates pass on a national basis only, without regard
to provincial origin or language. Similarly, the detailed comments are based on analyses of the performance
of all candidates. The board leaves the interpretation of provincial results to the provincial institutes.
Reporting
The board assigned a pass or fail standing to candidates for the three-paper set.
The board reported the following information to each province by candidate number:
- Overall pass/fail standing and pass/fail standing for each of Levels 1, 2 and 3.
- For failing candidates at Level 1, a sufficiency grouping for Level 1 and a decile ranking for both the
comprehensive simulation and the non-comprehensive simulations.
- For failing candidates, a colour code (red, yellow, green) reflecting their performance for each of the
competency areas.
Recommendation
The Board of Evaluators recommended that only those candidates who succeeded at each of Levels 1, 2,
and 3 should earn a pass standing on the 2014 Uniform Evaluation.
In conclusion, all board members wish to express their warm and sincere appreciation for the outstanding
energy, support, and commitment of the small group of Board of Evaluators staff members whose
dedication and talent contributed in large measure to the achievement of our objectives and the fulfilment
of our responsibilities.
We also wish to acknowledge the contributions made by our markers, authors, translators, provincial
reviewers, and editors. Their commitment to the quality and fairness of the process is appreciated.
Christine Allison, CPA, CA
Chair
Board of Evaluators
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Comments on Candidates’ Performance
COMMENTS ON CANDIDATE PERFORMANCE
ON THE 2014 UNIFORM EVALUATION
To attain a pass standing, candidates must demonstrate sufficient competence in all areas, as well as
appropriate depth and breadth in their responses.
A Message to Candidates
EXECUTIVE SUMMARY
The Board of Evaluators analyzed the performance of candidates on the 2014 UFE. Overall, the Board
concluded that candidates’ performance in 2014 was slightly stronger than in the prior year. Information
on candidates’ performance on the 2014 UFE is provided here, in summary format, to help candidates
understand how to continue to improve their performance. Detailed comments on performance on each
simulation can be found in the evaluation guides in Appendix C. The following paragraphs elaborate
further on improvements over the 2013 UFE, as well as common detracting characteristics identified by the
Board.
The Board has cautioned candidates for the past few years about a dangerous exam-writing strategy the
members believed was occurring. It appeared as though some candidates were assuming the Board was
looking for a specific number of issues on each indicator. As a result, candidates appeared to be repeatedly
choosing to address only a few issues on each indicator, even when numerous issues were outlined in the
simulations. The Board noticed an improvement in this area on the 2014 examination; however, members
still witnessed some candidates continuing to employ this exam-writing strategy. The number of issues the
Board is expecting candidates to discuss is not pre-set, but rather varies from indicator to indicator and from
simulation to simulation. Candidates should not limit the breadth of their analyses based on a preconception of the Board’s expectations in terms of number of issues. This trend is affecting the quality of
candidates’ responses and, therefore, their ability to demonstrate competence within each indicator.
Candidates are reminded to attempt to address all the issues they identify that are relevant to their role.
In 2013, the Board noted candidates were doing a better job of applying guidance they had excerpted from
the CPA Canada Handbook (the Handbook) to the relevant case facts to support their recommended
accounting treatments. In previous years, candidates often copied and pasted large sections of the Handbook
in their responses without applying the guidance to the case facts. Although in 2014 most candidates applied
the guidance to the case facts, some continued to copy guidance without analyzing it and applying it to the
specific situation they were dealing with. For example, when going through a list of criteria, many
candidates indicated whether or not a criterion was met by indicating “met” or “not met,” following the
guidance they had copied from the Handbook. This type of comment does not constitute an analysis of a
criterion. Candidates are expected to provide an analysis of the guidance they are quoting by using case
facts to support, for example, why a criterion was met or not met. The Board reminds candidates of the
importance of analyzing the technical guidance they provide in their responses by applying it to the relevant
case facts.
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In addition, the Board noticed instances in which the analysis candidates provided immediately following
Handbook guidance they had excerpted was not in line with that excerpt. For example, related to the grant
revenue issue on Paper I, Primary Indicator #7, many candidates copied guidance from the Handbook that
suggested the grant revenue should be either deferred in its entirety or netted against the asset, but then
recommended leaving a portion of the grant revenue in the income statement. Candidates are reminded that
copying Handbook excerpts does not add any value to a response unless it is both analyzed with case facts
and in line with their conclusion.
In 2013, the Board noted that candidates struggled when they were asked to quantitatively compare different
options. This observation remains true in 2014. On Paper I, Primary Indicator #5, candidates had a difficult
time being consistent in their calculations of the two financing options. For example, candidates could either
include or exclude the annual operating and maintenance costs, since these were common to both options.
However, some candidates used the entire amount of the lease payment made to JGC, which included the
operating and maintenance costs, but did not include these costs in the option to go with the loan, or viceversa. This inconsistent treatment weakened the validity of their comparison of the two options.
A similar situation occurred on Paper II, Simulation 2, Primary Indicator #2, where candidates had a
difficult time putting the two options they had to compare on equal footing. Candidates were asked to
compare their client’s current tax situation as an unincorporated individual owning a business to his tax
situation if he were incorporated. When calculating the applicable income taxes had their client been
incorporated, many candidates forgot to take into consideration the money their client would need to
withdraw from the company to live on ($100,000), and many of those who did consider it forgot to apply
taxes to it. As a result, these candidates were either taxing the $100,000 at the wrong rate (corporate instead
of personal) or not taxing it at all. This made the incorporation option look much better compared to the
status quo, which rendered the candidates’ analyses much less useful to the client, since the options were
not comparable.
On Paper III, Simulation 2, Primary Indicator #3, candidates had to analyze a lease proposition their client
had received. Candidates needed to calculate the contribution margins of both the hemp production and the
marijuana production and then compare those to the lease rate to see if leasing part of the land would be
profitable for the company. Candidates had a difficult time comparing the contribution margins for the two
activities due to a variety of errors made in their calculations. For example, some candidates took the
revenue into consideration but forgot about the costs. Others compared the contribution margin of one
hectare of one of the products (hemp or marijuana) to multiple hectares of the other product. Some
candidates also calculated the contribution margin using the revenue earned on one hectare but then
included expenses related to multiple hectares of production. As a result of candidates not comparing items
on an equal basis, their analyses were often not very useful to the client, who would not be able to rely on
this information to make a decision.
On Paper II, Simulation 2, Primary Indicator #3, candidates also struggled to take into account the time
value of money, which was one of the ways to make the options comparable to one another. Some
candidates did not calculate a present value for the different options, whereas others compared the present
value of one option with the total payments of the other options. These calculations were not useful to the
client because they did not provide a true comparison of the options. While in some cases the difference
between the costs of different options is so obvious that a comparison of the present value of each option is
not necessary, that was not the case in this specific situation.
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In 2013, the Board saw evidence of candidates misunderstanding or failing to integrate various case facts.
Although this was not as prevalent this year, the Board still found evidence of candidates misinterpreting
case facts, which led them to provide faulty calculations or discussions. For example, on Paper II,
Simulation 3, Primary Indicator #1, some candidates confused the staff rates with the management rates for
overtime. These rates were clearly laid out in Exhibit IV of the simulation. On the same page of the
simulation, it was also clear that the number of overtime hours presented in the table was the number of
hours above 200 (which is when overtime started being paid at a different rate for the staff). Some
candidates missed that information and subtracted 200 hours from the total shown in the table. The Board
reminds the candidates once again of the importance of reading the simulations carefully and ensuring they
take the necessary time to understand all of the case facts.
Regarding major detractors, the Board would like to highlight the following issues.
Lack of Clarity and Documentation in Calculations
The Board continued to notice a lack of clarity in the calculations provided and an insufficient amount of
documentation provided by candidates to support their calculations. Many candidates’ exhibits did not
include enough documentation to explain the components of their calculations, which made it difficult to
evaluate the quality of the calculations. For example, on Paper I, Primary Indicator #5, candidates often did
not show the details of their calculation of the cost of each option, especially when a net present value was
used. On Paper III, Simulation 2, Primary Indicator #3, candidates’ responses also lacked details and
explanations when it came to the calculation provided. The same applied to Paper II, Simulation 2, Primary
Indicator #3, where many candidates input a formula into a cell without providing the details of what was
included in that calculation. It becomes very difficult for the Board to assess candidates’ competence when
given little evidence of their thought processes. Candidates are reminded that they need to not only show
the details of their calculations but also explain the elements of their calculations.
Lack of Understanding of What Is Required
The Board would like to draw candidates’ attention to the importance of carefully reading the requireds
included in the simulations before starting to write their responses. The Board found that some candidates
were discussing items that were not relevant to the specific simulation they were presented with. For
example, on Paper III, Simulation 1, the partner on the engagement asked “that you send him a memo
discussing any accounting issues you’ve noted and outlining the procedures required to address the risk
areas of the audit.” Despite the clear required for procedures only, some candidates also provided a planning
memo, which was not necessary in this case. On Paper I, Primary Indicator #2, candidates were asked to
describe the actions MU could take to satisfy the financial and operating objectives outlined in Exhibit I.
Although candidates were specifically asked to discuss only the financial and operating objectives, some
candidates also discussed the other two categories (academic and governance objectives) presented in
Exhibit I. Still on Paper I, Primary Indicator #6, candidates were expected to analyze the possible causes of
the problems identified by the auditor general and explain what MU could do to address these problems.
Although it was clearly indicated that the causes of the problems needed to be analyzed, candidates focused
their analysis on the implications of the problems identified and often did not discuss the causes, completely
missing one of the requireds for this indicator.
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On Paper III, Simulation 2, some candidates provided a discussion on which reports could be issued to the
government to ensure all requirements were complied with. However, they were asked for advice on how
Hemp Co. could meet all government requirements for both 2013 and 2014. On Paper III, Simulation 3,
some candidates spent time unnecessarily calculating income taxes, which was not required in this
simulation. In the same simulation, some candidates provided discussions on the various reports that could
be provided to the client related to due diligence work. Once again, this was not what the client had asked
for and was, therefore, not relevant. In this case, the client had asked what specific procedures could be
done in order to make sure BSL was getting what it was paying for. As another example, on Paper II,
Simulation 3, some candidates discussed accounting issues, although they were clearly told by the controller
that she was already working on the accounting issues. Candidates need to carefully read the requireds
within each simulation and develop a plan before starting to write their responses. This will ensure they
have a good understanding of what is required from them and what analysis they will perform to answer
the requireds. This kind of planning would reduce the risk of including unrelated discussions and would
also help candidates make sure they completely understand what is needed in terms of analysis and
discussions, and thereby allocate their time to the various requireds accordingly.
Overall Picture
It has always been a struggle for candidates to take a step back and see the big picture when responding to
a simulation. This year, the Board felt candidates were not only having a difficult time stepping back to
look at the overall situation, but also having a difficult time taking a step back within each issue they were
dealing with. For example, on Paper III, Simulation 1, Primary Indicator #4, candidates generally calculated
the debt covenant and concluded on whether or not it was breached, but then didn’t go further to discuss
the potential consequences of the breach, which were significant. On Paper III, Simulation 2, Primary
Indicator #3, candidates were asked for their advice on whether Joe should accept an offer to lease a portion
of land at the proposed price. In order to determine if the price was worth it, candidates had to first calculate
the contribution margins for both the hemp and the marijuana to see whether Joe was better off renting out
a portion used for growing hemp or a portion used for marijuana. Once this calculation was done, candidates
had to compare the lowest contribution margin of the two with the rate offered on the lease. Some candidates
calculated the contribution margins for hemp and for marijuana, but then lost sight of the purpose of their
analysis and did not compare the margins to the lease rate. They simply concluded one was more lucrative
than the other. These candidates did not answer Joe’s question and did not provide him with useful
information. Although these candidates performed an important part of the analysis, it seems they might
have lost sight of why they were performing the analysis in the first place.
Another example of this lack of overall analysis was on Paper II, Simulation 1, Primary Indicator #1. Most
candidates, through a discussion of the internal control weaknesses, were able to identify the indicators of
fraud and discuss their implications for the company. However, when it came to taking a step back to reflect
on the impact this potential fraud could have outside of the control weaknesses, candidates had a much
more difficult time providing insightful comments. The Board was disappointed to see that, in their role as
auditor, candidates did not recognize the overall impact of this fraud on the audit plan, which was that the
audit plan would have to be adjusted following the discovery of a potential fraud being perpetrated.
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Nature of the 2014 UFE
Overall, the 2014 UFE contained one fewer primary indicator than the 2013 exam and three fewer than the
2012 UFE. The number of opportunities in Performance Measurement and Reporting; Assurance; Taxation;
and Governance, Strategy, and Risk Management was the same as in 2013. Compared to 2013, there was
one fewer indicator in Finance and in Pervasive Qualities and Skills, and one more indicator in Management
Decision-Making. There was only one secondary indicator on the UFE this year, which was the same
number as last year.
The 2014 UFE provided an overall level of direction that was slightly greater than that provided on the
2013 UFE. There was one fewer Pervasive Qualities and Skills indicator this year; however, the level of
direction provided in the other competency areas was similar to 2013.
The Board did not find evidence of time constraints on either the comprehensive or the non-comprehensive
simulations again this year.
Roles and Simulation Settings
The roles assigned and scenarios presented to the candidates on the 2014 UFE continued to be varied, with
only two of the simulations presenting a traditional assurance role (Paper II, Simulation 1 and Paper III,
Simulation 1).
Other roles presented to candidates included those of an external consultant hired by a university to provide
advice on a number of issues (Paper I); an advisor to a self-employed contractor helping with his tax
situation and a decision he needs to make regarding his workshop (Paper II, Simulation 2); an internal
temporary controller asked to prepare a report on the financial contribution of a new project to the company
and to assess the problems encountered with this new project (Paper II, Simulation 3); an external consultant
asked to provide advice to the owners of a family-run hemp farm on how they can meet specific government
requirements and whether they should accept an offer to lease some land (Paper III, Simulation 2); and an
advisor to a business owner looking at acquiring another business (Paper III, Simulation 3). The 2013
examination contained a few non-typical roles that turned out to be challenging for the candidates.
Candidates seemed to have an easier time adapting to the roles in 2014.
Specific Comments by Competency Area
Assurance
Candidates were asked to perform a variety of assurance-related tasks on the 2014 UFE, with most
simulations addressing Assurance in some way. Candidates were expected to
consider possible causes and implications of problems raised by the auditor general and provide
appropriate recommendations to address these problems;
prepare an audit planning memo and suggest procedures for significant areas;
discuss the control weaknesses presenting an opportunity for potential fraud;
discuss control weaknesses and whether proposed automations would address them, and recommend
additional controls that could be implemented;
provide audit procedures for risk areas of an audit;
provide advice on putting controls in place to meet government licence requirements and prepare for a
compliance audit; and
discuss due diligence procedures that should be done to give comfort on various balance sheet items.
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Candidates’ performance in Assurance was stronger than in the prior year. The Board noted in the past two
years that candidates’ performance was weaker than in previous years due to their struggles with some of
the unusual roles they were given in Assurance. Although there were only two indicators this year in which
candidates were put in a traditional external auditor role, there were a few indicators related to control
weaknesses, which is generally a familiar role for candidates. In addition, other roles given to candidates
this year were not as challenging or unusual as the roles from 2013.
Candidates generally performed well on indicators requiring them to discuss internal control weaknesses.
On Paper II, Simulation 3, Primary Indicator #2, candidates were required to discuss existing control
weaknesses and whether proposed automations were going to address them, and to recommend additional
controls that could be implemented. Most candidates were able to identify and explain a number of control
deficiencies, indicate whether or not one of the proposed automations would address these control
weaknesses, and then attempt to provide additional controls that could be implemented. Although
candidates were not directed to the Assurance indicator on Paper II, Simulation 1, it did not seem to affect
the quality of their responses since they performed quite well on this indicator. Most candidates were able
to identify some of the control deficiencies, explain their impact on the company, and suggest better
controls. Most candidates were also able to recognize that one of the employees seemed to have taken
advantage of the control weaknesses, as there were signs of fraud. Candidates also performed adequately
on Paper III, Simulation 2, Primary Indicator #1, in which they had to help put controls in place to make
sure the licence requirements were met and the client was ready for a compliance audit. Candidates were
able to identify the areas where the company was not in compliance and were generally able to provide
valid controls for the company to implement.
However, candidates did not perform well on Paper I, Primary Indicator #6, where candidates were asked
to consider possible causes and implications of problems raised by the auditor general, as well as provide
appropriate recommendations to address these problems. Candidates struggled to identify the cause of the
problems, instead focusing on the implications. Candidates approached this indicator the same way they
approach the typical internal controls indicator: by identifying the weakness, discussing its implication, and
providing a recommendation on how to fix the weakness. However, this approach didn’t ensure that
candidates addressed the cause of the problem, as requested. Even when it came to implications, candidates
had a difficult time being specific (for example, by stating errors could be caused by a particular weakness
without specifying what kind of error could be created). In addition, the weakness was already identified in
the simulation as per the auditor general’s key inspection findings, so the identification of the weakness did
not add value to the candidates’ responses.
In contrast to the prior year, there were no indicators for which candidates were asked to discuss reporting
options, which seems to have helped them since candidates typically do not perform well on that type of
indicator. Candidates had to provide audit procedures on Paper III, Simulation 1, Primary Indicator #2 and
due diligence procedures on Paper III, Simulation 3, Primary Indicator #2. Candidates performed relatively
well on these two indicators. Most were able to provide a sufficient number of relevant procedures that
targeted the identified risks. There is, however, still room for improvement, since some of the procedures
provided by candidates were either not specific enough or were not practical or plausible.
12
Performance Measurement and Reporting
Most simulations contained accounting issues that candidates were required to address. Throughout the
three days of the 2014 UFE, candidates were examined on a range of issues, some of which were complex,
while others were more straightforward. Overall, candidates’ performance on Performance Measurement
and Reporting was slightly stronger than in 2013.
Most of the performance measurement and reporting indicators were traditional in nature. Candidates
performed relatively well on these indicators. They were generally able to recognize a number of relevant
accounting issues and attempted to analyze them using case facts and Handbook guidance to support their
analyses. Candidates who were unable to demonstrate their competence in this area typically did not provide
in-depth discussions of the issues. As mentioned earlier in this report, some candidates provided technical
guidance in the body of their response, but they did not apply case facts to the guidance or they made
recommendations that were contradictory to the guidance provided.
The Board noticed that some candidates continued to avoid the more complex issues in favour of the easier
ones. For example, on Paper I, Primary Indicator #7, candidates avoided discussing the accounting issue
related to the pension when they were provided with a whole page of information on it. As another example,
most candidates avoided the issue of the treatment of the investment in Saddle Stables on Paper II,
Simulation 1, Primary Indicator #2. This was a non-typical accounting issue, and most candidates chose
not to discuss it. By doing so, they missed out on an opportunity to demonstrate their accounting knowledge.
In addition, many candidates who attempted to address the more difficult issues were not very successful,
showing a lack of technical knowledge.
Paper I, Primary Indicator #4 was a different type of indicator requiring candidates to discuss the Enterprise
Resource Planning (ERP) reporting weaknesses and recommend specific reporting improvements to the
ERP system to provide better information for decisions to be made by management, faculties, and the board.
Candidates did not perform well on this indicator. Although most were able to address a sufficient number
of weaknesses, their explanations of the implication of those weaknesses were lacking, and many were
unable to provide a recommendation that was practical and would actually solve the issue they had
identified. Candidates seemed to be able to touch on several weaknesses but had a difficult time taking one
discussion from start to finish. Discussions were often scattered and incomplete. Weak candidates also
focused on the implication on the audit or the financial statements, instead of tying their discussion back to
the ERP system. Candidates seemed to lose track of the purpose of their analysis, which, as per the required,
was to “provide better performance information, which is critical for many of the decisions made by
management, faculties, and the BOD.” This is consistent with the observation made by the Board earlier,
that candidates often lost sight of the purpose of their analysis.
Taxation
This year, the Board saw a significant improvement in candidates’ performance on the Taxation indicators.
13
Candidates did quite well on Paper III, Simulation 3, Primary Indicator #3. Although they were not
specifically directed to this indicator, they were able to pick up on the comment from the client that he
wanted to put his hands on the tax losses as part of the acquisition. Most candidates were able to provide a
reasonable discussion of the different types of tax losses and the consequences of an acquisition of control
on those losses, as well as other tax consequences for the client that would result from the acquisition. Weak
candidates had some issues trying to sort out the types of losses and often got them confused. They also
had a hard time explaining the tax consequences of an acquisition of control for the client. Where candidates
struggled most was on Paper II, Simulation 2, Primary Indicator #2. They were asked to let the client know
what size of federal tax bill he would be facing and to tell him what his total 2013 federal tax bill would
have been if he had been incorporated. As previously mentioned, candidates seemed to have a difficult time
comparing different options. This indicator was definitely a struggle for them, since they had to compare
the client’s current tax situation with a situation in which he was incorporated. Candidates had a difficult
time putting the two options on equal footing and, as a result, had difficulty providing their client with
useful information.
Management Decision-Making
There were four opportunities to demonstrate competence in Management Decision-Making (MDM) on the
2014 UFE, which is one more than in the prior year. Candidates’ performance in MDM was significantly
weaker this year compared to previous years. Candidates did perform quite well on one of the MDM
indicators, on Paper II, Simulation 3, Primary Indicator #1. On this indicator, they were specifically asked
to provide the controller with a report to shareholders on the financial contribution that the EasyPark app
made to the company. Candidates were able to pick up the different elements presented in the simulation
and build a reasonable calculation of EasyPark’s financial contribution. Strong candidates were also able
to provide qualitative comments to supplement their quantitative analysis. The Board was quite pleased
with candidates’ performance on this indicator.
Candidates’ performance on the other three MDM indicators on the examination was disappointing. Paper I
included two MDM indicators, Primary Indicators #2 and #3. On Primary Indicator #2, candidates were
asked to describe the actions that the university could take to satisfy the financial and operating objectives
set by the university and to suggest some key performance indicators (KPIs) for evaluating achievement of
those objectives. This request was not a typical request, and some candidates seemed to have a difficult
time understanding what the characteristics of a KPI should be, such as being precise and measurable. On
Primary Indicator #3, candidates had to prepare a variance analysis on financial results and provide specific
suggestions on how to improve financial performance. Candidates were able to calculate the variance, but
some struggled to explain the reason for the variance. Many focused on the fact that the budgeting process
was inadequate instead of attempting to explain the underlying reason for the variance.
Where candidates struggled the most was on Paper III, Simulation 2, Primary Indicator #3, for which they
had to analyze a lease proposal that their client had received. The Board recognizes that this was a difficult
indicator, due to the fact that candidates had to perform multiple steps to arrive at a final conclusion. As
discussed previously, candidates had difficulty figuring out which analysis to prepare and what steps to take
to arrive at a conclusion on whether it was worth it for their clients to lease part of their land. This is where
candidates need to take time to think about the best way to perform their analysis before starting to write
their response, and to make sure they do not lose sight of the purpose of the analysis, which in this case was
to advise on whether leasing part of the land was a good idea. In addition, as previously mentioned,
candidates had difficulty putting all of their calculations on an equal footing to make them comparable.
14
Finance
Candidates did not perform as well in Finance on the 2014 UFE when compared to the 2013 UFE.
Candidates struggled with Paper I, Primary Indicator #5, for which they had to evaluate alternative
financing methods for the construction of a new fitness facility. As mentioned earlier, candidates had a
difficult time putting both alternatives on an equal footing, with many including items in one calculation
and not the other when they should have been either included in or excluded from both. Candidates were
particularly weak in their quantitative analysis of the provincial loan. Many candidates included the interest
on the loan for the first two years only, since this information was provided to them at the bottom of Exhibit
III. They failed to calculate the interest for the remainder of the loan period. Candidates also seemed to be
confused with the outlay of funds. Many candidates showed an outflow of funds on the first year, to account
for the construction costs, instead of showing outflows for the repayment of the loan. Some candidates also
showed an inflow of funds coming from the loan, at the beginning of the loan period, not understanding
that the loan money would be used to pay for the construction costs and that the loan would need to be
repaid over the years. This showed a lack of fundamental finance knowledge.
Candidates also demonstrated a lack of finance knowledge on Paper II, Simulation 2, Primary Indicator #3.
Many were not able to take the time value of money into account in their analysis. Candidates had to
compare different options that their client was considering to expand his workshop. In this case, the only
way to determine which option was better from a quantitative perspective was to either calculate a present
value or compute an effective borrowing rate for each of the options. Many candidates either did this for
one of the options but not the others, or simply summed up the total cash flows of the options and compared
the totals of each option. In the first case, candidates were not able to appropriately compare the options
because their calculations were not made on the same basis and therefore not comparable. In the second
case, candidates could not come to a reasonable conclusion since the total of the cash outflows had no
meaning unless the time value of money was also taken into account. In both cases, candidates demonstrated
a lack of finance knowledge, which prevented them from providing their client with useful information to
make an informed decision.
Candidates performed better on Paper III, Simulation 3, Primary Indicator #1, for which they had to
calculate a purchase price for a company their client was contemplating buying and assess whether it was
a fair price. Candidates were able to incorporate adjustments to net income to calculate EBITDA, and most
were also able to incorporate adjustments to normalize net income. However, candidates performed poorly
when calculating an average normalized EBITDA. Some candidates did a good job of incorporating all
three years of data provided to them, even pro-rating the last year, since only nine months of financial data
was provided. However, many candidates used only one year of data, when it was clearly stated the basis
for the purchase price was “the industry standard of 3.5 times the normalized average” EBITDA.
15
Governance, Strategy, and Risk Management
Candidates’ performance in this area was comparable to the prior year. They performed quite well on Paper
II, Simulation 3, Primary Indicator #3. While they were not specifically directed to this indicator, candidates
were told by the client that some of the owners were concerned about how EasyPark, the app one of the
owners had purchased without consulting with the other owners, was affecting the company’s ability to
meet its vision and mission statements. Candidates were expected to discuss the fact that the acquisition
was not aligned with the vision and mission statements. They were also expected to suggest improvements
to the decision-making process to ensure this situation did not happen again. In most cases, candidates were
able to comment on many of the mission statements and how the purchase of the app conflicted with them.
Strong candidates also discussed the flaws in the current decision-making process.
However, candidates did not perform as well on Paper I, Primary Indicator #1, for which they had to
evaluate how the university’s objectives would satisfy the performance outcomes (SPOs) and suggest how
the objectives could be improved. Some candidates seemed to have lost sight of the required and provided
actions to ensure the objectives would be met, instead of suggesting improvements to the objectives
themselves. Candidates also had a difficult time analyzing the reasons an objective would or would not
satisfy an SPO, instead simply matching up the objectives and the SPOs without any further discussion.
Pervasive Qualities and Skills
The 2014 examination included three Pervasive Qualities and Skills indicators, one fewer than on the 2013
UFE. The quality of candidates’ performance in this area was slightly lower than in the prior year. As
identified last year, candidates seemed to be able to recognize the issues, but they had difficulty discussing
them in sufficient depth. In some cases, it appears this may have been caused by a lack of integration of
case facts, potentially due to the candidates’ inability to see the big picture.
On Paper III, Simulation 1, Primary Indicator #4, candidates were expected to discuss the impact of the
breach of covenants on the operations of their client’s business. While candidates were usually able to
identify the breach of covenant by calculating the revised ratio, most of them were unable to elaborate on
the impact of this breach on the company. Some of them appropriately discussed the impact of the breach
on the audit, but the Board hoped candidates would also discuss the consequences for the company itself
and provide actions the owners could take to mitigate the effects of this breach on the company.
Candidates performed slightly better on Paper III, Simulation 3, Primary Indicator #4. Here again
candidates did not have a difficult time identifying the issue that the purchase of shares might not be in the
best interest of their client, but they struggled to propose solutions. Candidates often ended their discussion
after questioning the purchase of the shares, leaving their client hanging in terms of what could be done to
mitigate his risks.
Candidates struggled on Paper I, Primary Indicator #8, where they were expected to question Jerry Decker’s
ability to meet expectations of the role of vice-president of finance and to also consider the financial position
of the university. While about half of the candidates were able to identify the concern with Jerry’s
competence, most of them were unable to support, using case facts, their discussion about why this was a
concern. Additionally, only a few candidates identified the issue with the university’s financial position,
and even fewer were able to discuss it sufficiently.
16
Exhibit 1 — The Decision Model
EXHIBIT 1
THE DECISION MODEL
NO
Was the aggregate competency
demonstrated sufficient?
F
YES
NO
A
I
L
Level 1
P
Were the PMR and A competencies
demonstrated deep enough?
Level 2
YES
Primary
indicators
only
Was the competency demonstrated
broad enough?
Level 3
A
YES
S
NO
NO
Review additional information
from secondary indicators to
enhance the ability to assess
YES
breadth – 2nd assessment of “Was
the competency demonstrated
Secondaries
broad enough?”
QUALITY
CONTROL
S
17
APPENDIX A
DESIGN, GUIDE DEVELOPMENT, AND MARKING
OF THE 2014 UNIFORM EVALUATION
Design
The Professional Education Management Committee (PEMC) determines the policies for the minimum
coverage of the UFE Candidates’ Competency Map on each Uniform Evaluation. The coverage
requirements for the 2014 UFE were identical to those in the prior year.
The coverage requirements and the actual percentage coverage on the 2014 Uniform Evaluation for each
section of the Map when both the primary and the secondary indicators of performance are considered
together are set out below:
Specific competency
Required
Relative weight
Actual
Relative weight
5 – 10%
8%
Finance
10 – 20%
12%
Taxation
10 – 20%
14%
Assurance
25 – 35%
27%
Performance Measurement and Reporting
20 – 30%
23%
Management Decision-Making
10 – 20%
16%
Governance, Strategy and Risk Management
*The BOE is required to include a minimum of two Information and Information Technology indicators on
the UFE. The board fulfilled its commitment on the 2014 UFE by including one indicator in each of
Assurance and Performance Measurement and Reporting.
All simulations were designed to fit within the “normal circumstances” in which all entry-level CAs are
expected to demonstrate the required competencies.
Normal circumstances are circumstances where:
The entity, situation, event or transaction is of a size or degree of complexity likely to be encountered by
an entry-level CA, and
The entity is a business in the private sector, formed as a proprietorship, as a partnership, as a private
corporation; or
The entity is a small public corporation, or a division of a large public corporation; or
The entity is in the public sector or is a not-for-profit organization or a division of either; or
The entity is an individual.
Type of simulation
The evaluation is made up of a comprehensive case and several multi-subject simulations. The indicators
on the comprehensive case are weighted so that the comprehensive case represents one third of the
evaluation.
18
Appendix A
The development of evaluation guides and the provincial review centre
In May 2014, provincial reviewers met to examine the 2014 Uniform Evaluation and the preliminary
evaluation guides. The provincial reviewers’ comments on the 2014 Uniform Evaluation were considered
by the board when it finalized the evaluation set in June 2014 and again when the senior markers reviewed
the guides in the context of actual responses in September 2014.
Evaluation centre
From the marker applications received, the board carefully selected approximately 200 chartered
accountants to participate in the 2014 evaluation centre. The criteria for selection included marking
experience, motivation, academic achievement, work experience, personal references, and regional
representation.
Before the opening of the evaluation centre, board members, leaders, and assistant leaders attended a fiveday meeting, the preliminary evaluation centre (PEC). Participants reviewed the evaluation guides, applied
them to randomly selected candidate responses, and made appropriate revisions. The written comments on
the evaluation guides received from provincial reviewers were carefully considered at this meeting, with
the board approving necessary changes.
The comprehensive simulation was marked by English-speaking and French-speaking teams of between 11
and 12 markers in Montreal from October 9 to October 24, 2014. Paper III was marked in Montreal from
October 9 to October 20, 2014, and Paper II was marked from October 13 to October 24, 2014. Each noncomprehensive simulation was assigned marking teams of between 18 and 22 markers, with each team
having a leader and two assistant leaders, and both French-speaking and English-speaking markers. Each
team had one or more markers who were capable of marking in both languages. Borderline marking took
place on October 25, 2014.
At the beginning of the comprehensive and non-comprehensive centres, the leaders and the assistant leaders
presented the evaluation guides to their teams. The team undertook a two-phase test marking procedure
prior to actual marking. Phase one consisted of two steps: guide familiarization, during which markers
applied the guide for the primary indicators to copies of candidates’ responses, and joint review, when
markers collectively reviewed their results. Phase one thus ensured that all markers understood the issues
in the evaluation guide and the basis on which to apply each proficiency level Phase two was an expanded
test marking of another set of responses to establish marker congruence. When marker congruence was
achieved for a simulation, live marking of that simulation began. The start-up period varied between two
and three days for the various simulations.
After the training and test marking phases, live marking commenced. The simulations were marked by
English-speaking and French-speaking markers.
The BOE strives for the highest possible marking consistency and quality control. This means that leaders
and assistant leaders devoted much of their time to cross marking and other monitoring activities. Markers’
statistics were reviewed to ensure that marking was consistent. Based on analysis of the statistics, leaders
reviewed papers marked by their team members to ensure that the indicators were assessed fairly. Bilingual
markers marked papers in both languages, and their results were compared to ensure that the marking was
consistent in both languages. Leaders also discussed, on a selective basis, the results of arbitration with
their markers once the second marking began.
19
Double marking
Each candidate’s paper was marked independently for the primary indicators by two markers. If the two
initial markings differed on any indicator, an arbitrator (the leader, assistant leader, or a senior marker)
compared the two initial markings and determined the final result for that indicator. Based on the results of
this marking, borderline responses that had met Level 1 and 2, but not Level 3, for the primary indicators
were identified and were marked for secondary indicators. Only the leaders and the assistant leaders mark
responses for secondary indicators.
As an added measure to ensure that markers are consistently applying the marking guide, a two-day rule
exists, which results in the second round of marking not beginning until two days have elapsed since the
first marking. Adherence to this rule ensured that any movement in the application of the guides due to
marker interpretations during the first two days of live marking were stabilized before the second marking
and arbitration procedures began.
Subsequent reviews of results and/or performance analyses
Reviews of evaluation results are allowed by all provincial institutes.
In addition, failing candidates may apply for a performance analysis review to assist them in assessing their
performance on the 2014 UFE.
How to apply for a review of results
Applications for a review of a candidate’s evaluation results must be forwarded to the Board of Evaluators
through the provincial institutes. If candidates wish to apply for such a review, they should notify their
respective institutes within the specified time limit.
Candidates may only apply for review of their examination results as a whole.
Review approach
The following review procedures are applied to all three papers constituting the Uniform Evaluation:
Under the supervision of the Chair of the Board of Evaluators, and the Principals Evaluations and
International Assessment, the papers are reviewed by the leaders and assistant leaders who did the original
marking. The team leaders and assistant team leaders read the answers and compare them to the evaluation
guides used at the original marking centre. In reviewing candidates’ results, two aspects are considered by
the board. First, it must be determined that the basis of marking the papers has been consistent with that
accorded other candidates who wrote the evaluation. Second, all papers reviewed are subjected to a careful
check to ensure that the markers have indicated that consideration has been given to all material submitted
by the candidate.
The results are then tabulated and the decision made whether any candidates have been treated unfairly and
should be granted a pass in the examination. There have been a relatively insignificant number of changes
made to reviewed papers over the years, which is attributable to the care exercised in the original marking
and tabulating of the papers and results and to the consideration given to individual papers in the review
procedure.
The results of the review are forwarded to the provincial institutes for approval and notification to the
candidates.
20
Appendix A
How to apply for a performance analysis review
Applications for a performance analysis review must be forwarded to the Board of Evaluators through the
provincial institutes. If candidates wish to apply for both a review of their examination results and a
performance analysis review, they can do so. Should the review of a candidate’s paper result in his or her
standing being changed to a pass, the performance analysis review will not be performed and any associated
fees will be refunded.
APPENDIX B
CANDIDATE PERFORMANCE ON PRIMARY INDICATORS
BY COMPETENCY AREA
Not
addressed
%
Nominal
competence
%
Reaching
competence
%
Competent
%
Highly
competent
%
PERVASIVE QUALITIES AND SKILLS
I Primary Indicator #8: The candidate
questions the ability of Jerry Decker to
meet the expectations of the role of the
vice-president of finance while
considering the financial position of MU.
III-1 Primary Indicator #4: The
candidate discusses the impact of the
breach of debt covenants on the
operations of LHT.
candidate discusses how the purchase of
shares may not be in the best interest of
BSL and advises on factors that need to
be taken into account if a share purchase
is to be done.
OVERALL
0.8%
33.2%
53.3%
12.7%
0.0%
7.7%
15.0%
56.3%
20.9%
0.1%
8.1%
12.4%
52.6%
26.9%
0.0%
5.5%
20.2%
54.1%
20.2%
0.0%
GOVERNANCE, STRATEGY AND RISK MANAGEMENT
evaluates how MU’s objectives will
satisfy strategic performance outcomes
and suggests how the objectives could be
improved.
II-3 Primary Indicator #3: The
candidate discusses the fact that the
rollout was not in line with RWD’s
mission statements.
OVERALL
0.5%
15.1%
54.6%
29.5%
0.3%
2.0%
12.4%
15.9%
67.4%
2.3%
1.3%
13.7%
35.3%
48.4%
1.3%
21
22
Appendix B
APPENDIX B
BY COMPETENCY AREA (CONT’D)
Not
addressed
%
Nominal
competence
%
Reaching
competence
%
Competent
%
Highly
competent
%
FINANCE
evaluates the alternative financing
methods for the construction of the new
fitness facility.
candidate analyzes Carl’s options for the
new building and advises him
accordingly.
candidate calculates the purchase price
for SPI and assesses whether it is a fair
price.
OVERALL
0.4%
28.7%
44.0%
26.7%
0.2%
1.7%
15.2%
54.8%
28.1%
0.2%
0.2%
9.8%
43.2%
46.7%
0.1%
0.8%
17.9%
47.3%
33.8%
0.2%
TAXATION
candidate provides a reasonable
quantitative and qualitative analysis of
Carl’s tax situation.
candidate recalculates the taxes payable
for the discontinued operations.
0.1%
8.2%
58.0%
33.1%
0.6%
2.1%
19.2%
32.6%
45.9%
0.2%
candidate discusses the acquisition of
control rules and addresses other taxrelated issues in regards to the share
purchase.
0.6%
13.4%
21.0%
64.9%
0.1%
OVERALL
0.9%
13.6%
37.2%
48.0%
0.3%
APPENDIX B
Not
addressed
%
Nominal
competence
%
Reaching
competence
%
Competent
%
Highly
competent
%
ASSURANCE
considers possible causes and
implications of the problems raised by the
auditor general and provides appropriate
recommendations to address these
problems.
candidate prepares an audit planning
memo and suggests procedures for the
significant areas.
candidate discusses the control
weaknesses that provide an opportunity
for potential fraud.
candidate discusses the internal control
weaknesses related to EasyPark and
whether the proposed automations are
going to address them, and recommends
additional controls that could be
implemented. *
candidate provides audit procedures for
the risk areas of the audit.
candidate provides advice on putting
controls in place to meet the licence
requirements and prepare for the
compliance audit.
candidate discusses the due diligence
procedures that should be done to give
Mr. King comfort on various balance
sheet items of SPI.
OVERALL
* Information and Information Technology indicator
0.2%
20.4%
57.4%
21.9%
0.1%
0.1%
6.2%
34.7%
58.8%
0.2%
0.3%
6.6%
27.2%
65.0%
0.9%
0.2%
6.6%
23.9%
66.8%
2.5%
0.5%
11.1%
29.1%
59.2%
0.1%
0.6%
8.8%
37.9%
52.6%
0.1%
0.2%
2.8%
35.3%
61.2%
0.5%
0.3%
8.9%
35.1%
55.1%
0.6%
23
24
Appendix B
APPENDIX B
Not
addressed
%
Nominal
competence
%
Reaching
competence
%
Competent
%
Highly
competent
%
PERFORMANCE MEASUREMENT AND REPORTING
discusses Enterprise Resource Planning
(ERP) reporting weaknesses and
recommends specific reporting
improvements to the ERP system to
provide better performance information
for decisions by management, faculties,
and the board. *
discusses accounting issues affecting MU.
0.4%
11.1%
47.9%
40.6%
0.0%
0.2%
14.6%
43.4%
41.4%
0.4%
candidate discusses the accounting issues.
0.1%
7.5%
44.9%
46.9%
0.6%
0.2%
15.1%
25.8%
58.2%
0.7%
0.0%
5.1%
39.6%
55.2%
0.1%
0.3%
7.8%
39.4%
52.4%
0.1%
OVERALL
0.2%
10.2%
40.2%
49.1%
0.3%
candidate discusses the accounting issues
for LHT.
* Information and Information Technology indicator
APPENDIX B
Not
addressed
%
Nominal
competence
%
Reaching
competence
%
Competent
%
Highly
competent
%
MANAGEMENT DECISION-MAKING
describes actions to satisfy MU’s
financial and operating objectives and
suggests key performance indicators to
evaluate achievement of those objectives.
analyzes variances on financial results
and suggests ways to improve financial
performance.
candidate assesses EasyPark’s
contribution to RWD’s financial results
1.1%
20.3%
36.3%
42.1%
0.2%
0.9%
27.9%
22.2%
48.8%
0.2%
1.8%
8.8%
18.2%
69.3%
1.9%
candidate analyzes the lease proposal.
0.9%
21.4%
50.8%
26.8%
0.1%
OVERALL
1.2%
19.6%
31.9%
46.7%
0.6%
25
26
Appendix C
APPENDIX C
2014 SIMULATIONS AND EVALUATION GUIDES
27
UFE CANDIDATE NUMBER:
THE INSTITUTES OF CHARTERED ACCOUNTANTS
OF CANADA
2014 Uniform Evaluation
PAPER I
Time: 5 hours
NOTES TO CANDIDATES:
(1) Simulations that require knowledge of the Income Tax Act, the Income Tax Application Rules 1971,
and the Income Tax Regulations are based on the laws enacted at December 31, 2013, or in
accordance with the provisions proposed at December 31, 2013.
Provincial statutes, including those related to municipal matters, are not examinable.
(2) Tables of present values, certain capital cost allowance rates, and selected tax information are
provided at the end of the evaluation paper as quick reference tools. These tables may be used in
answering any simulation on the paper.
(3) Answers or parts of answers to simulations will not be evaluated if they are recorded on anything
other than the USB key or the writing paper provided. Rough notes will not be evaluated. You are
asked to dispose of them rather than submit them with your response.
**********
The Uniform Evaluation (UFE) is still being developed and provided under the direction of the Canadian Institute of Chartered Accountants (CICA)
until final offerings of the CA program are complete.
2014
277 Wellington Street West, Toronto, Ontario, Canada M5V 3H2
Printed in Canada
I
Appendix C — Paper I
28
Today is July 15, 2014. You, CA, work in a CA firm that has been engaged by the Board of Directors
(BOD) of Millman University (MU) as a consultant to advise them on a number of issues. Your manager,
Susan Ng, has assigned you to the engagement. You and Susan are meeting with the new president of MU,
Dr. Sylvie Héroux, to gather background information relating to the engagement.
Dr. Héroux starts the meeting with a discussion of the BOD’s responsibilities to the provincial government.
She explains the issues she’d like you to consider:
1. “MU recently received a letter from the Ministry of Advanced Education (the Ministry) outlining its
2014/2015 funding commitment, as well as its performance expectations for the university. The letter
explicitly states four strategic performance outcomes (SPOs) that the government will use when
considering future funding commitments:
a)
b)
c)
d)
Provide greater choice of programs;
Provide high-quality and affordable education;
Create a climate of innovation, creativity, and collaboration (both internally and externally); and
Foster integrity and accountability through an appropriate governance structure.
“As you are aware, there were significant budget cuts to post-secondary education in the recent
provincial budget. In addition, the Ministry is limiting Canadian student tuition fee increases to 1.5%
and international student fee increases to 4% for the year ending June 30, 2015. I am concerned that
these budget cuts and tuition fee restrictions, combined with other financial issues, will result in MU
being unable to satisfy the Ministry’s SPOs. We receive an operating grant annually from the Ministry
based on Canadian student enrollment, and the amount has been confirmed as $95,465,000 for the year
ending June 30, 2015.
“This year, our management team assisted the BOD in developing objectives for MU (Exhibit I). Could
you look at the Ministry SPOs and explain how MU’s objectives will satisfy the SPOs? Also, please
suggest how our objectives could be improved and recommend additional ones the BOD should
consider, where necessary.
2. “Our management team would like to ensure it is meeting its financial and operating objectives as
outlined in Exhibit I. I’d like you to describe the actions MU could take to satisfy these two categories
of objectives and suggest some key performance indicators (KPIs) for evaluating achievement of those
objectives.
3. “I’d appreciate your review of the information that Jerry Decker, vice-president of finance, provided
(Exhibit II), although he may have more adjustments to make. Jerry has also provided some interesting
statistics on certain aspects of MU operations. Please prepare a variance analysis on financial results,
incorporating the additional information from Jerry where appropriate. Also, please provide specific
suggestions on how to improve our financial performance by optimizing sources of revenue or by
reducing costs.
29
4. “MU is not satisfied with both the financial and non-financial reports it is receiving. The Enterprise
Resource Planning (ERP) system was implemented three years ago and was intended to integrate
financial and non-financial data into a single reporting system, but there are still issues related to it.Given
the notes provided in Exhibit II, please analyze the reporting weaknesses and recommend specific
reporting improvements that can be made to our ERP system to provide better performance information,
which is critical for many of the decisions made by management, faculties, and the BOD.
5. “MU has been exploring community partnerships and has been approached by the Jenson Group of
Companies (JGC) with an opportunity. I’d like your comments on JGC’s proposal (Exhibit III).
6. “I received the key findings from the most recent inspection report of the auditor general (Exhibit IV)
from Jerry. The Ministry requires that MU responds to the auditor general’s inspection findings in a
timely manner. It is important to understand the underlying causes of the problems so that we can take
appropriate corrective action, as the auditor general report indicates that these problems have persisted
for several years. Therefore, could you please review the report to analyze possible causes of the
problems and their implications and explain what MU could do to address these problems?”
Susan concludes the meeting by advising Dr. Héroux that you will prepare a written response to address
her concerns.
Susan has also met with Natalie Saroya, chair of the Audit Committee; Jerry Decker; and certain staff of
the finance department. She provides you with her notes from those meetings in which accounting issues
were identified (Exhibit V) and mentions that Dr. Héroux wants you to provide recommendations on these
issues.
As you and Susan head back to the office, she tells you that MU has chosen to use International Financial
Reporting Standards (IFRS). The Ministry has approved MU’s use of IFRS. Susan also provides you with
the exhibits that were mentioned earlier.
30
INDEX TO EXHIBITS
Page
I. Draft 2014/2015 MU Objectives…………………………………………………………..
31
II. Information Provided by Jerry Decker, MBA……………………………………………..
32
III. Details of Community Partnership Proposal………………………………………………
34
IV. Key Inspection Findings of the Auditor General…………………………………………
35
V. Comments from Interviews………………………………………………………………..
36
31
EXHIBIT I
DRAFT 2014/2015 MU OBJECTIVES
The Post-secondary Learning Act specifies the mandate for MU. The Ministry communicates its
expectations to the university every year. It is the role of the BOD to develop objectives to ensure that those
expectations are satisfied.
MU has an Academic Governance Council (AGC) that is responsible for academic standards, ethics,
policies, and programs. The AGC makes recommendations to the BOD with respect to academic objectives.
The AGC also oversees all scholarship, research, and cultural activities of MU’s four academic faculties:
Arts and Communications;
School of Business;
Math and Science; and
Health and Community.
Academic Objectives
Increase participation in current e-learning
courses by 10%.
Have each faculty develop at least two new
e-learning courses.
Perform well on national and international
rankings, as well as on student surveys.
Increase research publication requirements of
faculty members.
Improve student retention and program
completion rates.
Governance Objectives
Increase number of board committees to
enhance governance.
Enhance diversification and number of
individuals (from 10 to 15) who serve on the
board.
Consider board member expertise in committee
composition.
Financial Objectives
Secure funding commitments for various
initiatives, including $6 million for the new Arts
and Communications building and $500,000 for
the new Bachelor of Acadian Music degree
(which is not funded by the Ministry).
Increase student scholarships.
Limit annual tuition increases to 2%.
Eliminate deficits.
Operating Objectives
Optimize use of classroom space.
Maximize use of the ERP functionality to
integrate and optimize access to information
throughout MU.
Provide timely and accurate reporting of
financial and non-financial results.
Improve budgeting process.
32
EXHIBIT II
INFORMATION PROVIDED BY JERRY DECKER, MBA
FINANCIAL RESULTS
As at June 30
(in thousands of dollars)
2014
Note
Grant revenue – operating
Grant revenue – capital
Tuition fees
Ancillary sales
Other revenue
Salaries and benefits
Other operating expenses
Total operating expenses
Cost of ancillary sales
Other non-operating expenses
Surplus (deficit)
1
2
3
4
5
6
Actual
(draft)
$ 102,820
8,500
56,201
10,907
40,712
219,140
133,661
45,519
179,180
7,561
31,199
217,940
$
1,200
2013
Budget
$
106,789
2,000
55,261
12,531
48,997
225,578
126,119
60,229
186,348
9,282
29,948
225,578
$
—
Actual
(audited)
$ 106,233
2,000
53,176
12,592
38,120
212,121
117,736
50,614
168,350
9,327
40,229
217,906
$
(5,785)
Budget
$
105,122
2,000
52,133
12,225
50,763
222,243
121,268
68,434
189,702
9,056
23,485
222,243
$
—
We use incremental budgeting using spreadsheet software, basing the current year’s budget on last year’s
budget since final results are not in before we have to approve the budget. We have always presented a
balanced budget to the BOD. We’ve had deficits in 2013 and 2012, but I’m confident that we will have a
surplus this year, as shown by our draft financial information above.
Notes:
1. Capital grants are received from the Ministry for specific capital projects.
2. Ancillary sales include bookstore, conference services, parking, and food service revenue.
3. Other revenue includes fundraising, donations, investment, and other income. Because fundraising
campaigns don’t get underway until later in the year and we never know how successful they will be,
we don’t know if we will achieve the budgeted number.
4. Salary costs always increase more than the budgeted 4% annual compensation increase as a result of
higher than expected student enrollment. Expected enrollment is difficult for my group to estimate due
to the timing of the budget and the delay in receiving final enrollment information from the Student
Portal database. We never receive enough funds from grants to cover all of our teaching salary costs.
Luckily, we’ve been able to find savings in other areas to allow us to keep our class sizes comparable to
previous years.
5. A standard financial performance measure is operating cost per full-time equivalent (FTE) enrollment.
This cost is $14,000 for the average Canadian public institution.
6. Interest on long-term debt and amortization of property, plant and equipment are included in this cost
category. Our actual interest expense is always very close to budget. Since amortization is a non-cash
expense, we are not overly concerned with the accuracy of the calculation.
33
EXHIBIT II (continued)
INFORMATION PROVIDED BY JERRY DECKER, MBA
Statistical Information for the Years Ended June 30
2014
2013
2012
Student enrollment:
Canadian FTE
International FTE
Total FTE enrollment
10,984
576
11,560
10,683
540
11,223
10,382
514
10,896
Total student headcount
Total applicants
14,400
17,671
13,846
18,681
13,187
19,200
$ 4,650
$14,820
$ 4,559
$14,305
$ 4,448
$13,808
685
1,041
635
948
620
945
90%
88%
85%
Tuition fees:
Per Canadian student FTE
Per international student FTE
Employees:
Faculty FTE
Supervisory and administration FTE
Classroom space used
Other Information
The ERP system can track financial information only for the university as a whole. Currently it produces
the same set of reports for distribution to the BOD, management, and faculties. Faculties have expressed
frustration over getting information that they don’t need and not getting enough information on what
they do need to manage their teaching loads. As well, some professors want to be able to track alumni
so that they can invite them to participate in mentoring and fundraising events. Currently, professors are
only able to contact alumni if they have them in their personal contact lists.
Enrollment information is not available in the ERP system and comes from each of the four faculties.
Each faculty uses different report-writing tools and formats, which creates a lot of work for our staff
when preparing this information. The FTE enrollment calculation is done outside the system using
spreadsheet software. It seems that each faculty has a different way of interpreting the definition of an
enrolled student. The finance staff then has to reconcile the data to ensure that student enrollment
information is not double counted (for example, by course and by program).
The number of applicants is not available from the ERP system but is available from the Student Portal
database, which was intended to interface with the ERP system. Applications from international students
continue to be high for programs in the School of Business and in Math and Science. We are not
accepting new international students for these programs due to lack of space. I’m not sure how many
Canadian students are successful in their applications.
E-learning courses are not tracked separately from regular courses. Only the Arts and Communications
faculty and the School of Business offer e-learning courses at this time. The other faculties do not believe
their programs would be successful in an e-learning environment.
At the end of fiscal 2013, we still had some unreconciled differences from the transfer of information
from the old system to the new ERP’s financial modules, but I think we will find that everything is
reconciled when we complete our annual 2014 reconciliations.
34
EXHIBIT III
DETAILS OF COMMUNITY PARTNERSHIP PROPOSAL
Our students and faculty members have been requesting an upgraded fitness facility for a number of years.
However, applications for government infrastructure grants have been unsuccessful and debt financing has
been allocated to other projects deemed a higher priority by the BOD. We believe the construction of a new
facility will help us attract and retain more students. Additionally, we should be able to increase the
mandatory sport and wellness fee by $20 per FTE enrollment.
The following costs have been estimated in developing the budget for this two-year capital project (which
could be completed by December 2016):
Total design and construction costs beginning in 2015
Annual operating and maintenance costs beginning in 2017
$23,500,000
$ 2,050,000
An alumnus of MU, the president of the Jenson Group of Companies (JGC), which is a private company
with local owners, expressed interest in partnering with our institution for philanthropic reasons. We have
started negotiations with JGC, and the following funding arrangement has been proposed:
JGC will construct the building with a planned opening of January 1, 2017.
From opening until December 31, 2025 (nine years), MU will lease the building from JGC for
$5,250,000 per year, which includes the annual operating and maintenance costs.
On January 1, 2026, ownership of the building will transfer to MU for $1, at which time MU will cover
the annual costs.
The building will be named the Jenson Fitness Centre.
For each year of the lease, JGC will provide entrance scholarships to two students accepted into the
faculty of Health and Community.
An alternative is for MU to finance the construction with a 20-year loan provided by the province at a rate
of 4%. At the start of construction, 50% of the construction monies would be advanced, and the remaining
50% would be advanced after one year. Interest during the construction period is estimated to be $470,000
in year one and $940,000 in year two.
35
EXHIBIT IV
KEY INSPECTION FINDINGS OF THE AUDITOR GENERAL
The following key findings arising from the most recent inspection have been consistent over the past
several years. They have yet to be addressed in an acceptable manner.
1. University not ready for inspection.
Capital asset working papers, including continuity and amortization schedules, as well as details on
project costs, are incomplete.
Payroll and accounts payable accruals are incomplete.
2. Accounting policies are not always followed.
Revenue recognition policies are applied inconsistently, resulting in repeated audit adjustments.
3. Financial processes and controls are inadequate.
There are limited controls around vendor selection and set-up.
Accounts receivable staff has the ability to prepare deposits and write off accounts receivable.
4. Roles and responsibilities are not documented.
Financial staff members do not have up-to-date job descriptions.
5. Training is insufficient.
Staff (including management) has not been adequately trained on the new ERP system.
6. Management review is inadequate for identifying errors on a timely basis.
Management does not review financial statements on a monthly basis.
Reconciliations are only prepared annually.
7. Data entry restrictions are inadequate.
Staff members share passwords to access different financial system modules.
36
EXHIBIT V
COMMENTS FROM INTERVIEWS
Comments from Natalie Saroya, CA, Chair of the Audit Committee
I am new to the BOD and was recently appointed chair of the Audit Committee. I think I am the first
designated accountant they have had on the BOD. I had a lot of questions for Jerry during his most recent
report to the BOD. I was concerned about Jerry’s ability to meet his responsibilities and suggested we
engage your firm to help provide some clarity around our concerns. We’ve also had discussions at the BOD
about Jerry’s performance and are considering letting him go if our June 30, 2014, year-end financial
statements show another deficit. Luckily, right now the draft financial information shows a surplus. There
seems to be a lack of trust between the management team and the BOD. The BOD gets the same reports
that management uses and, therefore, spends a lot of time debating issues that may be better left to the
management team.
Comments from Jerry Decker, MBA, Vice-President of Finance
I am really glad you are here to help out. My staff tends to be sick or unmotivated. In addition to finalizing
the 2014 year-end financial statements, Natalie’s questions and the challenges we are facing in meeting the
budget have resulted in some late nights. I’ve also had two experienced staff leave and one retire in the past
six months. I’m not sure I’m up for another year of this. I can’t wait to leave on my annual four-week
vacation — I’ve got a trip planned from the end of July until the end of August! It’s too bad that, for the
third year in a row, I won’t be able to take professional development courses because of my vacation.
Speaking of retirement, it would be great if you could review the accounting for our Supplemental
Executive Retirement Plan (SERP). One of my experienced staff members prepared the financial statements
after receiving the information from the actuary. There are probably some other accounting issues — a
review of the auditor general’s inspection report should point you in the right direction. Feel free to get any
additional information you require from the staff. I hate to comment too soon, but it looks like we’ll see a
small surplus of $1.2 million this year. Maybe that will reduce Natalie’s requests for information every time
I give my report.
For its next meeting, the BOD wants an explanation of the accounting treatment of JGC’s proposed
financing for the new fitness facility. The members would like that information to assist them in deciding
whether to proceed with the opportunity. Could you provide that for me?
37
EXHIBIT V (continued)
Notes from Interviews with Finance Department Staff
Controller
The university maintains a supplemental pension plan for its senior executives. The plan is a
non-contributory defined benefit plan. No benefits have been paid out of the plan since inception. The
June 30, 2013, audited financial statements showed the following balances:
Defined Benefit Obligation
Plan Assets
Defined Benefit Liability
$550,000
$250,000
$300,000
During 2014, MU booked an entry to record the annual contribution to the plan assets, which occurred on
January 5, 2014:
Dr. Defined Benefit Liability
Cr. Cash
$125,000
$125,000
An actuarial valuation of the plan assets and supplemental benefit obligation was prepared as at June 30,
2014. The following information was provided to MU:
Discount Rate
Current Service Costs
Defined Benefit Obligation
Plan Assets
5% (same as at June 30, 2013)
$140,000
$710,000
$389,000
At the end of the year, I made the following entry to record the current service costs:
Dr. Pension Expense
Cr. Defined Benefit Liability
$140,000
$140,000
After this entry, the ending defined benefit liability is $315,000. I am not certain why this wouldn’t equal
the defined benefit obligation amount provided by the actuary. As well, I don’t know where the plan assets
are recorded, nor did Jerry when I asked him. Our treasury analyst went on stress leave just after year-end,
so I hope he took care of any entries related to that investment before he left. I’m glad you’re going to
review this for me because Jerry didn’t seem too concerned about it. I’ll get any required adjusting journal
entries posted right away.
38
Notes from Interviews with Finance Department Staff (continued)
Capital Asset Accountant
A new student residence was built over the past two years. The first two floors were opened in
January 2014, resulting in the building being 50% occupied for the remainder of the 2013/2014 academic
year. Some of the rooms will also be reserved for use by employees. Although the majority of the remaining
two floors was available for occupancy in March 2014, we don’t expect to be fully occupied until the new
academic year starts in September 2014. That will allow for the completion of some minor items over the
summer months. In March 2014, $43,300,025 was recorded in “construction in progress” for the student
residence project. The total project budget is $45 million. Since the project was first planned, real estate
values in the area have skyrocketed and the residence might now be worth $50 million.
The project manager said he’d have the final costs for me in September, when I’d have to record the asset.
I’m not sure whether it would be considered an investment property or not. Either way, I’d like to stick to
our usual practice of recording buildings using the cost model and therefore amortize it over 40 years, even
though private sector apartment-type buildings are usually amortized over 50 years. I’d like to get this
resolved in order to address the issues raised in the inspection report of the auditor general.
We also have another significant project on the go, the Community Learning Centre, which is funded
through government grants and donors. In July 2013, we received grant funds of $7.5 million in advance
of the project starting, but if we spend less on the project or if some expenses are deemed ineligible by the
government, we have to repay any unused or ineligible funds. At June 30, 2014, $600,000 in expenditures
was in construction in progress. The project is expected to be completed in May 2015.
Prior to year-end, MU and EventCo Ltd. (EventCo) jointly entered into an arrangement to construct a sports
field, with parking, on university land. A company (NewCo) was formed for the completion of this project,
with MU and EventCo each having two members on its board. Once the facility is operational, EventCo
will manage the day-to-day operations (including event bookings, staffing, and receipts). However, both
parties will jointly approve the annual budget for the facility. In order to fund the construction of the project,
NewCo obtained bank financing prior to June 30, 2014. Because NewCo had no assets to secure this
financing, MU and EventCo provided guarantees for the repayment of the loan. At this point, MU has not
recorded anything with respect to this project, and I’m not sure how to account for its interest.
39
Notes from Interviews with Finance Department Staff (continued)
Accounts Receivable (AR) Supervisor and Acting Accounts Payable (AP) Supervisor
All amounts received in the year are booked to revenue. The auditors advise us of any revenue recognition
errors. We have made adjustments in the past.
I am normally the AR supervisor, but since the AP supervisor is on a six-month maternity leave, Jerry asked
me to fill in for her as well, rather than hiring a replacement. I agreed as long as my salary was increased. I
delegated some review and reconciliation responsibilities to staff, but they are a bit behind. However, I
didn’t realize how many accruals were required at year-end — I wish I had asked for training too! To limit
the amount of accruals, we sent letters to all of our major vendors asking them to make sure they invoice
us before June 30.
AP staff members have been really busy during the first two weeks of July getting all of those invoices
entered. We changed the system controls to allow invoices that didn’t have matching purchase orders in the
system to be processed. However, any invoice over $50,000 needs to be approved by Jerry before being
entered. This has made it go much quicker than in the past, so I’m sure Jerry and the auditors will be happy
that we are ready for the audit at the end of July.
I gave Jerry invoices totalling $950,780 to approve. He approved all of them except for $400,000 in
contracted instructor invoices for corporate training that was provided in May and June. Jerry stated that he
was certain the instructors’ contracts specified that final invoices were not to be submitted until July. We
don’t create purchase orders for instructor contracts. I have a note to enter the invoices in the July monthend.
Payroll Supervisor
We pay all employees on a bi-weekly cycle (26 pay periods per year). Bi-weekly payroll approximates
$5,150,000. The last pay period for 2014 ended on June 26, 2014. Jerry has told us that because the amount
will be immaterial, we don’t need to set up an accrual for the end of June.
Corporate training instructors are paid by contract for courses taught at their corporate facilities. These
instructors tend to work for a number of different organizations and come from a variety of professional
backgrounds. We also have some information technology consultants on fee-for-service contracts. Some of
these consultants have been with MU for over three years and have designated workstations at MU, as well
as MU email addresses. I overheard one of them talking about the recent training program they had attended
that was paid for by MU. I wanted to prepare T4s for any consultants who had been here for a long time
(maybe two years or more), but when I discussed this with their supervisor, an MU employee, she said they
are not considered employees because they are not enrolled in the health benefit plan.
40
Appendix C — Paper I — Evaluation Guide
EVALUATION GUIDE
COMPREHENSIVE SIMULATION – MILLMAN UNIVERSITY (MU)
PRIMARY INDICATORS OF COMPETENCE
The reader is reminded that the solutions are developed for the UFE candidate; therefore, all the
complexities of a real-life situation may not be fully reflected in the following solution. The UFE Report
is not an authoritative source of GAAP.
In addition, the Handbook sections referenced in this suggested solution are intended for learning
purposes only. While candidates are expected to apply the guidance in the Handbook when analyzing
financial reporting and assurance issues, they are not expected to directly quote from the Handbook.
Candidates who choose to quote Handbook sections are reminded that no credit is given unless the
quotation is integrated into a meaningful analysis and applied to the relevant case facts.
Memo to:
From:
Subject:
Dr. Sylvie Héroux, President
CA
Report on Millman University (MU)
As requested, I have provided an analysis and recommendations on a number of issues. My report follows.
Primary Indicator #1
The candidate evaluates how MU’s objectives will satisfy strategic performance outcomes and
suggests how the objectives could be improved.
The candidate demonstrates competence in Governance, Strategy, and Risk Management.
Competencies
IV-2.7 – Evaluates the entity’s performance measurement and reporting strategy (A)
IV-4.1 – Evaluates decision making and accountability processes (B)
Strategic Performance Outcomes (Ministry) and Strategic Objectives (MU)
One of your primary objectives is to ensure MU meets its responsibilities and satisfies the performance
expectations of the Ministry of Advanced Education (the Ministry) as outlined in the recent letter regarding
the Ministry’s 2014/2015 funding commitment. The Board of Directors (BOD) is accountable to the
Ministry to achieve the following strategic performance outcomes (SPOs):
A.
B.
C.
D.
Provide greater choice of programs.
Provide high-quality and affordable education.
Create a climate of innovation, creativity, and collaboration (both internally and externally).
Foster integrity and accountability through an appropriate governance structure.
You have asked me to look at the Ministry SPOs, explain how MU’s objectives will satisfy them, and
suggest improvements to existing objectives, as well as suggest additional objectives that the BOD should
consider to ensure MU’s responsibilities to the Ministry have been fulfilled.
41
Ministry Strategic Performance Outcome:
A. Provide greater choice of programs.
MU Objective
Have each faculty develop at
least two new e-learning
courses.
How MU’s Objective Satisfies Ministry’s SPO
E-learning courses may increase the attractiveness of some
programs.
Makes existing programs accessible to a broader group of
applicants, thereby improving choices available to students.
New program offering presumably satisfies market demand,
thereby providing greater choice.
Could offer additional programs, depending upon participant
interest.
MU Objective
Secure funding commitments for
various initiatives, including…
the new Bachelor of Acadian
Music degree (which is not
funded by the Ministry).
Improvements to objectives:
Consider quantity of programs offered, as well as format of delivery (classroom, e-learning).
Changes in employment opportunities should also be considered when determining program
offerings, as well as trending events and their impact.
Search for partnerships/donors to fund other programs in order to provide greater choice.
All faculties should explore e-learning opportunities, even those that have not typically offered those
courses (e.g., Math and Science) to provide greater choice of courses.
This SPO is not satisfied by MU’s objectives, and additional objectives should be considered. While MU
has a stated objective to develop more e-learning courses, offering an additional course does not achieve a
greater choice of programs, since numerous courses are required to create a program.
Additional objectives MU should consider to achieve greater choice of programs:
MU’s emphasis seems to be on e-learning, yet it should also review existing courses and programs with
a view to continually improving course offerings while ensuring future viability.
MU should contemplate partnering with other universities or post-secondary institutions to provide
opportunities for participation in exchange programs between certain faculties to provide greater access
to programs.
(Most candidates were able to align a specific MU objective to this strategic performance outcome (SPO).
The most common objective discussed by candidates was having each faculty develop at least two new elearning courses. Most candidates attempted to explain how the objective they picked satisfied the
Ministry requirements (for example, offering greater online learning opportunities allows students to
have more flexibility and course choices). Some candidates also attempted to provide modifications to
the objective or propose new objectives that would provide greater choice of programs. However, some
candidates provided ways to achieve the objective rather than ways to improve it; in other words, they
provided actions instead of improvements. This was relevant to Primary Indicator #2, but not to this
indicator. Strong candidates achieved greater breadth in their responses by considering objectives from
different categories that would satisfy the SPO, explaining how those objectives would achieve
satisfaction, and then recommending improvements or new objectives to ensure satisfaction of the SPO.)
42
B. Provide high-quality and affordable education.
MU Objective
Increase participation in
e-learning courses by 10%.
current
E-learning provides state-of-the-art program delivery.
E-learning may be more affordable for participants than
classroom courses (tuition fees could be cheaper than inclass offerings; e-learning courses may be more accessible
for students than in-class courses, depending upon their
geographic location).
Improvements to objective:
Clarify how the objective will be achieved. Specific information on how this objective will be
achieved should be incorporated into the wording of the objective: for example, increasing
participation by 10% by meeting with current and potential students and employers to educate them
about e-learning course offerings, and updating the university website and using advertising to
improve awareness of e-learning course offerings.
Clarify the timeframe for measuring the participation increase, as well as how it will be tracked.
MU Objective
Perform well on national and
international rankings, as well as on
student surveys.
Allows comparability to other institutions.
Measures student satisfaction with MU.
This objective needs to be more specific and measurable — “perform well” is not defined. MU
should ensure the objective is achievable based on past results and specify its desired ranking (for
example, in the top 20 for rankings).
Determine specific survey metrics and tracking so that performance and improvement can be
monitored.
Also, “how” this objective will be achieved should be specified, to assist in business planning and
resource allocation. Will additional staff be hired to develop and deliver student surveys and to analyze
results? This may not be possible with the current deficit position.
Compare survey results with other benchmark institutions, if available, as well as compare year-overyear results.
One potential measurement of level of quality could be the ability of program graduates to achieve
accreditation from external bodies.
MU Objective
Increase
research
publication
requirements of faculty members.
43
Faculty who are on the leading edge of their areas of
expertise allow for the provision of high-quality learning.
Increased research helps MU stay relevant to prospective
students (but need to ensure that the pursuit of research is
properly balanced with in-class teaching commitments —
affects affordability of courses for students).
Interaction of faculty members with appropriate external
entities could be a measure of quality of programs.
Define “increase” — perhaps setting a target of two publications per year for each tenured faculty
member would be appropriate. Also need to establish initial baseline from which the increase will be
measured.
Specify the time frame for published research (e.g., annually; within research funding time frames).
Consider clarifying what constitutes “high-quality” education with respect to faculty — qualification
of faculty members (e.g., number of degrees held; level of education; professional designation;
annual student evaluations; research initiatives) should be specified.
MU Objective
Improve student retention and program
completion rates.
Returning students and graduates from programs are
reflection of quality of education (and possibly,
affordability of programs).
Objective as currently stated is not measurable and contains unclear terms.
Define “improve” — should specify what level of improvement would be considered sufficient (e.g.,
90% retention rate?) and the starting point (i.e., the baseline) from which the improvement will be
measured.
Define what an acceptable program completion rate is (e.g., 80% of students entering program
eventually graduate with a degree?).
Define “student retention” — is it retention within programs, faculties, or the university as a whole?
44
MU Objective
Secure funding commitments for
various initiatives, including…the new
Bachelor of Acadian Music degree
(which is not funded by the Ministry).
External funding and support of program reduce tuition for
participants, thereby increasing affordability.
While new programming improves access and choice, it must be introduced in a fiscally responsible
manner by MU and in response to adequate demand by potential students.
Creating a degree without having a source of funding may result in higher tuition fees for students. I
suggest examining the number of applicants for this new degree to ensure it is the most effective use
of funds.
Clarify how funding will be “secured” (e.g., determine the interest of employers in graduates to
ensure program offerings are relevant to the marketplace; ensure that all possible government grants
related to programs are applied for).
Specify time frame to obtain these commitments, as well as the amounts of the commitments sought.
Determine demand for various initiatives coupled with current expertise at MU to ensure program
quality and costs are key factors when considering program creation or expansion.
MU Objective
Increase in scholarships helps to offset tuition fees that
students pay, thereby making education more affordable.
Objective needs to be more specific and measurable:
o How many scholarships will be created?
o What is the expected dollar amount of scholarships raised?
o How will the scholarships be used to made education more affordable — what are the criteria upon
which they will be awarded (academic performance or financial-need basis)?
MU Objective
Limit annual tuition increases to 2%.
Due to the limits imposed by the province (1.5% on
Canadian students and 4.0% on international students), the
objective of limiting tuition increases is not controllable by
MU and should not be included.
Change the objective to be more specific with respect to Canadian and international student tuition
increases and within the guidelines set by the Ministry. (For example, the objective would be more
appropriate and achievable if it were set as “not to exceed Canadian student tuition increases of 1.5%
and international student tuition increases of 4.0%” or if MU clarified that the 2% increase is an
average.)
MU Objective
Eliminate deficits.
45
Balanced financial position may reflect good fiscal
decision-making for ability to provide affordable education.
Clarify how this objective will be measured — does it refer to the accumulated deficit or the current
year’s deficit? Over what time frame is the elimination to occur? Need to ensure the objective is not
achieved by exceeding the Ministry’s stipulated tuition fee increase maximums of 1.5% and 4% for
Canadian and international student fees respectively.
MU Objective
Class size may affect cost of program (e.g., large classes
could reduce costs; conversely, large class sizes may detract
from quality of programming delivered).
Effective use of space may limit the need for infrastructure
expansion, thereby controlling costs.
Clarify how this objective will be measured — what is the optimal classroom space utilization rate?
Also, consider what impact a change in class size may have on the quality of program delivery (whether
positive or negative).
This SPO is satisfied by MU’s objectives; however, this is an area in which an additional objective could
be considered.
Additional objectives that MU should consider to provide high-quality and affordable education:
Develop sub-objective relating to program admission to ensure incoming students are of sufficient
quality to maintain high quality of programs (e.g., academic averages of applicants).
Consider objectives that will allow faculty to achieve increases in research publications (e.g., provide
sabbaticals or additional research funding).
(Most candidates addressed SPO (b) and spent a significant portion of their response to Primary
Indicator #1 in this area. In general, they were able to adequately identify an objective, explain how it
satisfied the SPO (beyond a restatement of the objective itself), and suggest improvements to the wording
of the objective or provide an additional objective that should be considered. Candidates most often
identified the objectives relating to increasing participation in current e-learning courses by 10%,
increasing research publication requirements of faculty members, and increasing student scholarships
in their response.)
46
C. Create a climate of innovation, creativity, and collaboration (both internally and externally).
MU Objective
Increase participation in
e-learning courses by 10%.
current
E-learning courses are innovative because they use state-ofthe-art technology for delivery.
Emphasis seems to be on e-learning, yet MU should also review existing courses and programs with a
view to continuously improving course offerings and to developing objectives for traditional classroom
courses, ensuring future viability of the courses and programs.
Specify how to measure success of e-learning courses (e.g., enrollment).
MU Objective
Have each faculty develop at least two
new e-learning courses.
Development of new courses fosters creativity.
A better objective might be to increase development of courses by a stated percentage, with specific
guidance on how that increase might be achieved (since development of an e-learning course does not
necessarily equate to an increase in participation rate).
MU Objective
Increase
research
publication
requirements of faculty members.
Publication of research findings provides external
validation of MU’s innovation and creativity.
Some research projects may require collaboration between
instructors from complementary faculties in order to
achieve publication.
Define what the “increase” will be measured from (i.e., set a baseline for comparison of future
publications).
MU Objective
Secure funding commitments for various
initiatives, including $6 million for the
new Arts and Communications Building
and $500,000 for the new Bachelor of
Acadian Music degree (which is not
funded by the Ministry).
47
New facilities and programs are indications of forward
thinking and responding to the needs of stakeholders.
Consider if other faculties can collaborate to provide space needed for the delivery of new programs.
The requirement for a new facility should be re-examined based on the current funding shortages. There
is excess capacity of 10%, and a Community Learning Centre is being built that may serve the needs
of MU for the immediate term. As well, enrollment has not increased significantly and applications are
down from prior years. Given the objective of providing increased e-learning (through both
participation increases and new e-learning courses), MU could use existing available space rather than
construct a new facility. The wording of this objective may need to be amended.
MU Objective
Scholarships allow for creativity, innovation, and
collaboration, especially scholarships for new programs
created in response to student need and scholarships that
result from collaboration between alumni.
Define “increase” so that the objective can be measured.
Consider purpose of scholarship (e.g., is it tied to a new program or merely for financial need?).
MU Objective
Maximize use of the ERP functionality
to integrate and optimize access to
information throughout MU.
Collaboration between faculties is promoted through use of
the ERP system.
ERP represents innovation through the use of technology.
It would be beneficial to add the specific expectations to this objective to ensure it is monitored. For
example, to address sustainability issues for MU:
o Specify a long-term plan for a balanced budget.
o Address all of the findings of the auditor general (AG) by a specific date.
o Develop and maintain internal information system and processes to monitor and report on
achievement of those expectations.
This objective is necessary to improve accountability and meet performance outcomes, but it will likely
require a number of administrative resources. A decision should be made as to how this objective will
be achieved (through new staff or consultants), and an achievable date of completion should be
specified.
48
MU Objective
A variety of program-offering formats keeps MU at
forefront of innovations in education.
Determine future focus of program delivery (in-class, web-based, or combination) before determining
the optimal utilization percentage.
This SPO is satisfied by MU’s objectives; however, there are areas where additional objectives could be
considered.
Additional objectives that MU should consider to create a climate of innovation, creativity, and
collaboration (both internally and externally):
Develop objectives that promote collaboration of researchers with other faculties and institutions
Develop objectives that consider creativity through partnerships developed to market research ideas to
the community
(Most candidates who addressed this area considered only one objective (often the objective to increase
research publication requirements of faculty members) or tried to align objectives that were not
appropriate for this SPO (for example, perform well on national and international rankings and on
student surveys).)
D. Foster integrity and accountability through an appropriate governance structure.
MU Objective
Provide timely and accurate reporting of
financial and non-financial results.
Appropriate governance covers financial performance and
non-financial measures.
Specify how objective will be achieved (e.g., how many days after month end will information be
reported?).
Specify what financial and non-financial results will be reported on (e.g., financial statements by
faculty; enrollment data; application data; scholarship recipients).
MU Objectives
How MU’s Objectives Satisfy Ministry’s SPO
Increase number of board committees to
Committees allow for a deeper understanding of governance
enhance governance.
issues and will foster greater accountability.
Use of committees increases effective decision-making
Consider board member expertise in
through ability to debate issues and make recommendations
committee composition.
for approval, since small groups can often consider
information and facilitate effective decision-making more
rapidly than large groups with numerous viewpoints.
49
BOD should specify which committees are necessary for MU governance, as well as a timeline for
implementation (e.g., a Governance and Nominating Committee to establish performance expectations,
identify individuals qualified to become board members, establish and review governance policies, and
adopt a code of conduct and ethics; an External Relations Committee to allow MU to collaborate with
the community, with the objective of creating partnerships for further funding opportunities (including
the new Arts and Communications building, the Bachelor of Acadian Music degree, and student
scholarships); a Compensation Committee to oversee the salary and employee benefits paid to staff
since staff costs represent 74% of operating costs). More committees may not lead to better governance,
but the improvement of committees with subject matter experts, etc., may lead to better governance.
Guidelines should be established in writing regarding appointment to the committees (individuals
qualified to become members and/or chair based on expertise such as marketing or fundraising
experience would be useful for an External Relations Committee; appointment of Natalie Saroya as
chair of Audit Committee appropriately uses her professional expertise), length of term (such that only
a few members turn over each year), meetings (frequency and attendance requirements, such as a
requirement that members must attend 70% or more of meetings).
Committees should have charters that describe the responsibilities delegated to them. For example, the
Audit Committee terms of reference should include establishing financial policies, reviewing and
approving of risk management and information system policies with respect to establishing a proper
internal control environment, acting as liaison between management and the AG, and ensuring that
management addresses all of the AG inspection findings in a timely manner.
I also recommend allowing students, faculty, or both to participate on these committees as non-voting
members who provide insight. Not only will this leadership opportunity allow MU to foster an
environment of oversight and accountability through appropriate governance structure, but it also will
allow students and faculty to achieve a higher-quality education through a culture of collaboration.
MU Objective
Enhance diversification and number of
A broader experience base of board members provides for
individuals (from 10 to 15) who serve on
more appropriate governance structure and adds credibility
board.
to decision-making.
Improvements to objectives and additional objectives that MU should consider:
Specific objectives can be developed to identify areas of diversification (e.g., financial, the arts, etc.)
that should be represented on the board.
MU should first identify the knowledge, skills, and experience of existing directors to determine what
additional diversification is required from incoming board members (the BOD is moving in the right
direction with the appointment of Natalie Saroya, CA, as the first designated accountant to be on the
board of MU).
MU’s current BOD of 10 members could be of sufficient size to facilitate effective decision-making, if
members can meet the needs of committee work and provide a good diversity of views and experience
The objective to increase the number of individuals to 15 is not necessarily appropriate, since the
number of people involved does not matter, but rather the skill and experience they contribute.
50
(Candidates seemed to be most comfortable with SPO (d), which related to having an appropriate
governance structure, an area familiar to candidates. Their responses considered at least one of the
individual objectives listed in the governance category (diversification of individuals who serve on the
board of directors (BOD), dealing with board committees, board member expertise) and explained how
that objective satisfied the SPO. However, candidates struggled to recommend improvements to those
objectives or additional objectives that should be considered. Instead, many provided actions that should
be taken to ensure achievement of the objectives.)
Overall, it appears as though many of MU’s objectives align with the Ministry’s strategies and are realistic.
By making the objectives more specific, measurable, and timely, MU will improve the achievability of
these objectives and ensure it is accountable to the Minister for its performance. I have discussed specific
key performance indicators and information systems to measure financial and operating indicators further
in my report. The establishment of these systems will be necessary to assist the BOD in monitoring the
performance of management in achieving these objectives.
For Primary Indicator #1 (Governance, Strategy, and Risk Management), the
candidate must be ranked in one of the following five categories:
Percent
Awarded
Not addressed — The candidate does not address this primary indicator.
0.5%
Nominal competence — The candidate does not attain the standard of reaching
competence.
15.1%
Reaching competence — The candidate evaluates some of MU’s objectives that
will achieve strategic performance outcomes and suggests some improvements to
the objectives.
54.6%
Competent — The candidate evaluates several of MU’s objectives that will achieve
strategic performance outcomes and suggests several improvements to the
objectives.
29.5%
Highly competent — The candidate thoroughly evaluates MU’s objectives that will
achieve strategic performance outcomes and suggests many improvements to the
objectives.
0.3%
(Candidates were asked to evaluate how Millman University’s (MU’s) objectives would satisfy the
strategic performance outcomes (SPOs) set by the Ministry of Advanced Education (Ministry) and to
make suggestions as to how MU’s objectives could be improved. Candidates were clearly directed to this
indicator. To demonstrate competence, candidates were expected to select several MU objectives from
among those provided, address how they related to the SPOs set by the Ministry, and either suggest
improvements to the existing objectives or recommend additional objectives the board of directors should
consider.)
51
(Candidates performed poorly on this indicator. Candidates were expected to demonstrate breadth in
their response by addressing several individual objectives and covering several SPOs. Most were able to
align financial, academic and governance objectives to different SPOs (for example, e-learning,
scholarship, and board-related objectives) and explain how the SPOs were satisfied. However, when
candidates tried to suggest modifications to the objectives, their recommendations often were
insufficient, since they provided actions that should be carried out to satisfy the objective rather than
improvements to the objective itself.)
(Strong candidates structured their response to address most of the SPOs set by the Ministry, aligned
multiple objectives from each of the four areas set by MU, and explained how those objectives would
satisfy the Ministry requirements. Those candidates then completed their analysis by providing useful
recommendations for improvements to those objectives (or by suggesting new objectives), which were
clearly written and relevant to the SPO being addressed. Those candidates demonstrated an “objective”
mindset, rather than one that was action oriented. Many weak candidates performed an alignment of
MU’s objectives with few SPOs, without providing any additional analysis. These candidates failed to
provide either recommendations for improvement or additional objectives.)
The candidate describes actions to satisfy MU’s financial and operating objectives and suggests
key performance indicators to evaluate achievement of those objectives.
The candidate demonstrates competence in Management Decision-Making.
Competencies
VIII-1.1 Identifies management information needs (B)
VIII-1.2 Identifies the entity’s key performance indicators (B)
VIII-3.2 Considers implications of variances on the entity’s strategies (A)
You have asked me to describe the actions MU could take to satisfy financial and operating objectives and
suggest some key performance indicators (KPIs) to evaluate achievement of those objectives.
(Most candidates who addressed this indicator separately from their discussion of the Ministry SPOs
(Performance Indicator #1) performed better than those who tried to combine the discussion of these
two indicators. The primary difference between the two approaches was that many candidates who
combined Performance Indicators #1 and #2 addressed actions and key performance indicators (KPIs)
for all four quadrants of objectives (academic, governance, financial, and operating), when they were
only asked to comment on financial and operating objectives. As a result, they spent some time
addressing areas that were not required. Candidates are reminded to read the required as outlined in the
simulation carefully to ensure that their response focuses on the areas of concern to the recipient of that
information. In this case, the required was clear when it noted, “Our management team would like to
ensure it is meeting its financial and operating objectives as outlined in Exhibit I. I’d like you to describe
the actions MU could take to satisfy these two categories of objectives and suggest some key performance
indicators…for evaluating achievement of those objectives.”)
52
I have identified both financial and non-financial KPIs to assist MU in meeting its stated objectives. These
KPIs will assist management (including senior executives) in decision-making by providing relevant
information. These KPIs will also provide further information to the BOD for assessing senior executive
performance. It is important that the information for each KPI is reliable and timely.
MU Objective
Financial Objectives:
Secure funding
commitments for various
initiatives, including
$6 million for the new Arts
and Communications
building and $500,000 for
the new Bachelor of
Acadian Music degree
(which is not funded by the
Ministry).
Actions to Achieve Objective
Develop a strategy to solicit
corporate sponsors.
Ensure corporate sponsors
contacted appropriately link with
MU’s relationships/strategies.
Develop a strategy to solicit
individual and alumni donations.
Obtain agreements or
commitments from donors and
sponsors.
Recognize significant sponsors,
donations, or unique partnerships
through publication in various
media (print, TV, Internet).
Recognize significant sponsors or
donations through “naming” of
facilities/rooms/buildings.
Recognize long-term commitment
of sponsors and donors through
recognition in various media
sources.
Ensure appropriate staff in place to
execute both corporate sponsor
and alumni campaigns.
Ensure alumni office stays in touch
with graduates.
Identify specific interest in
program (low student enrollment
will affect future program
decisions – either program
discontinuance as a result of lack
of interest or enhanced marketing
to increase program visibility and
awareness).
Key Performance Indicator
(KPI)
$ of donations and
sponsorship by program
$ of donations and
sponsorship by faculty
# of contacts made with
potential program partners
% of donor/sponsor pledges
vs. requests for
donors/sponsor solicitations
(i.e., success rate of “asks” to
commitments)
# of donors and sponsors for
new building
# of donors and sponsors
approached for new building
# of recurring donors vs. # of
one-time donors
# of alumni responses to
contact requests
# of fundraising staff to
contacts list as compared to
national standards
# of students enrolled in new
Bachelor of Acadian Music
degree program
# of students enrolled in any
other new program
MU Objective
Pursue government or private
funding for capital or program
initiatives.
Assess relationship with
government to identify funding
opportunities.
Increase student
scholarships.
Limit annual tuition
increases to 2%.*
*Perhaps not a valid
objective (more like a
constraint), since tuition
increases are legislated and
government has stated
limitations on Canadian
tuition increase at 1.5% and
international tuition increase
at 4.0%.
Investigate opportunities for
community partnerships for
scholarships.
matching of scholarships (e.g.,
through matching government
funding or matching private
funding).
scholarship funding from alumni.
Consider scholarships honouring
influential people in the
community and develop
fundraising campaigns to augment
those scholarships.
Assess existing student
scholarships for continuation and
expansion; consider redirection
based on need and program
offerings.
Investigate relationship with
employers of MU graduates to
determine if they wish to support
student scholarships.
Review annual tuition increases to
ensure MU meets, but does not
exceed, Ministry tuition targets .
53
(KPI)
# of applications for
government or private
funding
success rate of funding
applications
# of student scholarships (as
compared to previous years)
# of scholarships by program
$ value of scholarships
awarded
# of different scholarship
donors
# of different scholarship
recipients
success rate of targeted
scholarship donors vs. those
who actually donated
(specific to alumni,
employers, government,
community partners,
influential persons)
success of matching
initiatives (% of scholarships
matched)
% tuition increases meet, but
do not exceed, Ministry
targets limitations of 1.5%
for Canadian tuition and
4.0% for international tuition
54
MU Objective
Eliminate deficits.
Increase revenue (through increase
in fundraising; maximizing
government grants; pricing of
ancillary services; maximization of
allowable tuition fees).
Reduce costs (per student; by
program; for ancillary services).
Review net costs per student,
programs, and for ancillary
services.
Ensure programs offered meet
demand.
Review high cost areas, such as
salaries and benefits, for cost
savings.
Consider offering early retirement
to senior faculty and staff.
Review hiring processes and
procedures and make amendments
as necessary (e.g., qualifications
sought; part-time vs. full-time
instructors; benefits offered;
student-instructors or contracted
instructors or full-time instructors).
Review existing staffing levels for
supervisory and administration
staff to make decisions about
hiring and programs.
(KPI)
revenue growth year over
year
revenue growth per full-time
equivalent (FTE)
revenue growth in
fundraising, government
grants, and ancillary services
reduction in deficit vs. prior
year
government grant $/FTE
operating cost/enrollment
FTE compared to university
standard performance
measure of $14,000
operating costs/program
compared across programs
and compared year over year
ancillary costs for various
services compared year over
year
cost recovery per program –
compare across programs to
determine most
efficient/profitable programs
gross margin on ancillary
services year over year
enrollment trends in all
programs
salary cost per FTE (as
compared to other
institutions)
number of employees who
accept early retirement
packages
part-time to full-time
instructional salary costs
# of supervisory and
administration staff per
instructor
# of support (supervisory and
administration) staff per
program, compared across
programs
MU Objective
Identify areas for improvement
and take steps to reduce costs (e.g.,
high ratio may indicate excess staff
levels that could be reduced to an
appropriate level, thereby realizing
cost savings; however, staff
reductions may be limited due to
union contracts; consider early
retirement options).
Examine program delivery
methods and make improvements
(e.g., if certain instructors require
more administrative staff,
determine if changes could be
made to the program delivery to
make it less instructor led and
more student led; increase class
size to reduce instructional costs).
Review capital projects to ensure
adherence to budgets.
Operating Objectives:
Optimize use of classroom
space.
Identify existing classroom
availability and usage (ensure
calculated correctly; identify
empty time slots).
Use ERP system to track
scheduling so that classroom
utilization is optimized.
Investigate opportunities to
convert unused or unproductive
space into usable classrooms (e.g.,
computer labs may no longer be
used since students have their own
computers).
Consider changes to scheduling to
take advantage of extended hours
(e.g., 8 a.m. start vs. 9 a.m. start).
Maximize classroom capacity.
Create opportunities to move
students out of the traditional
classroom yet retain them within
55
(KPI)
delivery costs per program,
year over year
Planned capital expenditures
compared to actual costs on a
cumulative basis for each
capital project
classroom utilization rate
(increased from current level
of 90%)
# of rooms repurposed into
classroom space
# of off-peak classroom
hours used
# of times ERP system is
used for classroom
scheduling
enrollment vs. classroom
capacity
# of e-learning courses
offered (perhaps by faculty
also if faculties are in
separate buildings)
56
MU Objective
Maximize use of the ERP
functionality to integrate
and optimize access to
information throughout
MU.
MU (offer webinars, e-learning
courses).
Consider alternating distance
learning with in-class attendance
so that more programs can be
offered.
Determine existing ratios of
students per instructor, considering
program (as some are more
conducive to a higher ratio without
affecting program delivery) to
assess efficiency of allocation of
faculty resources and physical
facilities (i.e., classrooms).
Compare existing ratios to other
public institutions.
Review knowledge level and
familiarity of employees with ERP
system and modules since
additional training may be
required.
Promote ERP module capabilities
to all faculties and departments.
Require full use of ERP system.
Determine which ERP modules are
not being used and could be.
Conduct ERP user satisfaction
survey.
Determine if modifications to ERP
system are required, including
integration of modules.
Conduct post-implementation
assessments to measure benefit of
ERP system.
(KPI)
# of webinars offered
# of students per instructor
% of ERP training sessions
offered (or attended) vs.
sessions available
% of employees who find
ERP easy to use
reduction in # of non-ERP
tools used over time (i.e.,
year over year)
# of ERP modules used vs. #
of ERP modules available for
use
# of support calls
successfully resolved
% of employees who find
ERP meets their needs
% user satisfaction with ERP
functionality
list of ERP modules used/not
used
success rate of response to
support calls
modules available vs.
modules used effectively
elimination of non-ERP
documents and systems
MU Objective
Provide timely and
accurate reporting of
financial and non-financial
results.
57
(KPI)
Identify user needs and system
capabilities (e.g., what areas MU
wants to report on, and whether
ERP system can do that).
Conduct ERP system
implementation satisfaction
survey.
Ensure effective integration of
modules (e.g., enrollment data
needs to be integrated to faculty
data so that the proper number of
instructors is hired).
Ensure ERP system can
accommodate all information
needs (e.g., enrollment; tuition;
human resources; student data;
faculty; government reporting;
research funding).
Reduce the number of days to
report in order to increase
timeliness and usefulness of
information for decision-making.
Streamline policies and processes
in place for monthly and quarterly
reporting (e.g., use month-end
checklist for actions; many steps
should become part of weekly
practices rather than only at month
end; ensure reconciliations
complete and errors corrected to
improve accuracy of financial
reporting).
Implement better training for
reporting process to improve speed
of reporting, as well as better
training for individuals responsible
for reporting-period closure.
Ensure full use of ERP system.
% satisfaction vs. projected
benefits of ERP use
% ERP implementation
completed within projected
implementation timeframe
% ERP implementation
completion within projected
cost of implementation
% user satisfaction with ERP
implementation
Streamline processes and policies
in place for year-end closure (e.g.,
# days to prepare financial
statements for audit
# days to report quarterly
results
# days to close month end
# of training sessions held (or
attendance at training
sessions)
# of requests for data that
have to be generated outside
ERP
58
MU Objective
regular internal reporting and
preparation of reports should be
able to reduce days to completion
for audit ).
Ensure senior executive and
finance department staff are
knowledgeable and capable of
performing their duties (e.g.,
perhaps AR supervisor should not
have been asked to act as AP
supervisor) by reviewing
professional qualifications and
work experience as well as training
programs that they have attended.
Improve
budgeting
process.
Could also be considered
as a financial objective –
eliminate deficits.
Review current budget processes
and procedures, with a view to
identifying areas where
improvements can be made (zerobased budgeting; activity-based
management).
Have a participative budget
process that involves faculty as
well as students .
Move to zero-based budgeting.
Compare actual performance to
budget on a regular basis
(monthly) and investigate
significant variances (requires
better integration of existing
information into budget process).
(KPI)
# and $ of financial statement
adjustments requested by
auditor
# of adjusting entries
prepared by management
(prior to auditor)
# of training hours attended
by finance department staff
# days to complete budget
process
# faculty/students on budget
committee
$ and % variance from
budget
(Most candidates were able to provide a specific action that MU should undertake in order to achieve its
objectives. Strong candidates contemplated more than one action for a number of the objectives and
clearly communicated how that action should be carried out and why (in other words, how it related to
satisfying that particular objective).)
(Some candidates were able to articulate a useful KPI that could assess how effectively MU was
achieving a specific objective. However, other candidates struggled to provide relevant KPIs, instead
providing KPIs that were not specific, not measurable, or not comparable. In addition, some candidates
provided a list of KPIs that were not related to any particular objective or specific to this simulation.
Other candidates repeated facts that were already stated in the simulation (for example, classroom
utilization rate of 90%), rather than suggesting new KPIs that would be useful for MU. Candidates who
reiterated an existing KPI were rewarded if they demonstrated why that standard would continue to be
59
useful in its current form.)
Impact of Financial and Operating Objectives on Academic Objectives
These financial and operating objectives also have an impact on academic objectives, which are the
responsibility of the Academic Governance Council (AGC). As a result, it would be useful for management
to be included in the determination of those academic objectives. For example, academic objectives related
to increased participation of 10% in current e-learning courses, as well as the objective that each faculty
must develop at least two new e-learning courses, should also take into consideration the financial cost and
benefit of providing those courses.
It would also be important for the AGC to be involved in the development of certain financial and operating
objectives, since there would be academic impacts that should be taken into consideration. For example,
the AGC (which oversees various activities of the four academic faculties) should work in conjunction with
management in the areas of scholarship and research activities (from a funding and cost perspective) to
ensure all funding opportunities are being pursued.
60
(Few candidates considered whether the Academic Governance Council and management should
collaborate on the development of objectives that affect both groups, in an effort to arrive at objectives
that are beneficial to MU as a whole.)
For Primary Indicator #2 (Management Decision-Making), the candidate must be
ranked in one of the following five categories:
Percent
Awarded
1.1%
competence.
20.3%
Reaching competence — The candidate addresses some actions that satisfy MU’s
financial and operating objectives or suggests some key performance indicators to
evaluate achievement of those objectives.
36.3%
Competent — The candidate discusses some actions that satisfy MU’s financial
and operating objectives and suggests some key performance indicators to evaluate
achievement of those objectives.
42.1%
Highly competent — The candidate discusses several actions that satisfy MU’s
financial and operating objectives and suggests several key performance indicators
to evaluate achievement of those objectives.
0.2%
(Candidates were asked to help the management team to ensure that MU was meeting its financial and
operating objectives and to suggest key performance indicators (KPIs) to evaluate achievement of those
objectives. Candidates were clearly directed to this indicator. They were provided with an exhibit that
outlined the draft MU objectives and were expected to focus on those objectives listed in the financial
and operating quadrants (each quadrant contained four individual objectives). To demonstrate
competence, candidates were expected to suggest actions to satisfy individual objectives within those two
quadrants and to provide KPIs to evaluate achievement of those objectives.)
(Candidates performed adequately on this indicator. They were able to consider several individual
objectives within the financial and operating categories and appropriately describe actions that should
be undertaken in order to achieve those objectives. However, some candidates struggled with stating
appropriate KPIs, since their suggestion often set a target rather than a way to measure achievement of
the objective.)
(Strong candidates discussed more individual objectives, providing several actions for each that could be
taken to ensure satisfaction of that item. Those candidates demonstrated their understanding of what a
KPI was by providing useful criteria and describing how they would be assessed or evaluated. Instead of
focusing on the specific individual objectives within the category, many weak candidates addressed the
overall category (financial or operating), which often did not allow them to propose specific actions that
should be taken. Weak candidates also addressed academic or governance objectives or both, although
they were not asked to do so. In addition, many did not seem to understand what a KPI was, struggling
to provide a KPI that was specific and measurable.)
61
The candidate analyzes variances on financial results and suggests ways to improve financial
performance.
Competencies
VIII-3.1 Computes and analyzes variances (A)
VIII-3.2 Considers implications of variances on the entity’s strategies (A)
You have asked me to analyze the results provided in Exhibit II and to provide specific suggestions to
improve financial performance, by optimizing sources of revenue or taking advantage of cost reductions.
During this process, it is important to remember that one of MU’s financial objectives is to eliminate
deficits. I noted that some adjustments should be made to the 2014 draft information (see discussion under
accounting issues later on in my memo) before we can begin this analysis.
It is also important to consider the budgeting process, which has shortfalls. For instance, Jerry noted that
the current budget is based on last year’s budget because final results aren’t in before the budget has to be
approved.
Based on the results of my interviews with various staff, I noted the following accounting adjustments that
should be made to the draft financial information as presented by Jerry:
Information Affected
Draft 2014 surplus per Jerry
$
AJE 1 – Pension
AJE 1 – Pension
AJE 2 – Capital Asset
AJE 3 – Revenue
AJE 4 – Contracted Instructors
AJE 5 – Payroll
Total adjustments/decrease in the surplus
Adjusted 2014 surplus (deficit)
1,200,000
(15,375)
9,375
(433,000)
(7,500,000)
(400,000)
(1,030,000)
(9,369,000)
$
Salaries & benefits
Salaries & benefits
Other non-operating expenses
Grant revenues – capital
Salaries & benefits
(8,169,000)
(Some candidates recognized that the financial results provided by Jerry had to be adjusted for errors
noted during their analysis of the accounting issues, and they made those corresponding adjustments
prior to calculating variances.)
62
Results of Financial Analysis
Financial Analysis
(in 000s)
Grant revenue – operating
Grant revenue – capital
Tuition fees
Ancillary sales
Other revenue
2014
$
2014
$
Draft
AJE’s
102,820
8,500
56,201
10,907
40,712
(7,500)
2013
$
2014 vs.
2014 vs.
2013
2013
$
Increase
%
(Decrease) Change
2014
$
Revised
Draft
Actual
102,820
1,000
56,201
10,907
40,712
106,233
2,000
53,176
12,592
38,120
(3,413)
(1,000)
3,025
(1,685)
2,592
(3%)
(100%)
6%
(13%)
7%
2014
$
2014
$
Budget
Variance
106,789
2,000
55,261
12,531
48,997
(3,969)
(1,000)
940
(1,624)
(8,285)
225,578
(13,938)
219,140
(7,500)
211,640
212,121
(481)
Salaries & benefits
133,661
45,519
1,036
400
134,697
45,919
117,736
50,614
16,961
(4,695)
14%
(9%)
126,119
60,229
8,578
(14,310)
Total operating expenses
Cost of ancillary sales
Other non-operating
expenses
179,180
7,561
1,436
180,616
7,561
168,350
9,327
12,266
(1,766)
(19%)
186,348
9,282
(5,732)
(1,721)
31,199
433
31,632
40,229
(8,597)
(21%)
29,948
1,684
217,940
1,869
219,809
217,906
1,903
225,578
(5,769)
-
(8,169)
Surplus (deficit)
1,200
(9,369)
(8,169)
(5,785)
(2,384)
(Many candidates focused on the inadequacies in the existing budgeting process, which provided little
value in the area of variance analysis. In other words, these candidates stated that the variances were
due to improper budgeting but offered no further reasons for the fluctuations.)
Grant Revenue — Operating
While the 2014 budget anticipated a slight increase in funding, there was actually a 3% decrease to the
operating grant revenue received, representing a decrease of $3,413,000 from 2013.
Grant per Canadian enrollment FTE decreased year over year (2014 was $9,361 ($102,820,000 ÷
10,984 Canadian enrollment FTE) versus 2013 of $9,944 ($106,233,000 ÷ 10,683 Canadian enrollment
FTE)). As a result, alternative funding will need to be obtained through ancillary sales and other
revenues. Perhaps sponsorships or fundraising amounts can be increased (see subsequent discussion
regarding new fitness facility).
Although the Canadian enrollment FTE increased from the prior year, the amount of associated grant
funding decreased, which seems contradictory. The finance department should ensure that the proper
information was used in the application for funding and that calculation errors were not made. While
any deficiency is likely not recoverable from the Ministry at this point, an enquiry as to consideration
for additional funding should be made. Future applications for operating grant funding from the
Ministry should be made with the best available information.
63
Operating grant revenue for 2014/2015 has been confirmed at $95,465,000. This is significantly less
than the 2014 level of $102,820,000 (a 7.2% decrease). If there have not been corresponding reductions
in student enrollment and salaries and benefits, this reduced funding is of significant concern for MU.
Grant Revenue — Capital
Once the correction is made for accounting for the Community Learning Centre grant of $7.5 million,
there is very little remaining in capital grant revenue. This may be reflective of fewer capital projects
being undertaken or perhaps demonstrates an inability to secure funding (consistent with the comment
that MU has been unsuccessful in applications for government infrastructure grants). Management
should ensure that they pursue all funding avenues, and that they invest the time to properly complete
infrastructure grant applications. Perhaps the ERP system has capabilities that could be used for this
purpose.
Tuition Fees
Tuition fees increased 5.7% ($56,201,000 versus $53,176,000) over the previous year while overall
student enrollment increased 3% (11,560 versus 11,223). The increase is consistent with other
information provided, which indicates that tuition fees for Canadian student FTE increased 2% from
the previous year ($4,650 versus $4,559) while tuition fees for international student FTE increased
3.6% ($14,820 versus $14,305).
The tuition fee information for Canadian and international programs was obtained from the Student
Portal database, and the FTE calculation is done outside the system using spreadsheet software, which
should be reviewed for accuracy of calculation.
The number of applicants to MU has dropped by 1,010 (5.4%) from the previous year (2014 – 17,671;
2013 – 18,681). In fact, the number of applicants has been on a steady decline since at least 2012, based
on the statistical information provided by Jerry, which is not a good situation for any university. The
reasons for the decline in applications should be investigated — is this a reflection of increasing tuition
fees or poor program quality, or is it due to other factors? — and actions should be taken to respond to
the reasons for the decline.
The total headcount has increased by 554 (4%) from 2013 to 2014, which is at a slightly slower pace
than the 2013 increase from 2012 (659 or 5%). Reasons for the slower increase in total headcount
should be identified and investigated further to determine whether MU should be concerned about this
decline.
Other Revenue
The actual increase in other revenue was 6.8% over the prior year ($40,712,000 versus $38,120,000),
yet the 2014 amount was 20.4% less than budgeted ($48,997,000 budgeted). These revenues include
fundraising, donations, investments, and other income. The budget for these items can be difficult to
estimate, and Jerry noted that MU never knows how successful fundraising campaigns will be because
they don’t get underway until later in the year. However, by setting specific objectives in the business
plan and then incorporating these into the budget, MU may be able to determine a better estimate.
Specific objectives relating to donations, fundraising from alumni, and planned giving would be one
method of increasing revenue in this area.
64
(Some candidates struggled to explain the reasons for the variances in revenue and instead qualitatively
restated the results of their calculations (for example, the operating grant revenue decreased by x%
because less money was received from the province). These statements did not provide any additional
information on why the variance occurred. Candidates were more successful in explaining the variances
when they used the statistical information provided in Exhibit II or incorporated facts from other areas
of the simulation to help them explain increases or decreases in revenue or why variances did not seem
logical given the non-financial information available.)
Salaries and Benefits
Salaries and benefits increased by 14.4% over the previous year ($134,697,000 versus $117,736,000)
and was 6.8% higher than budgeted. The increase may be a result of negotiated contract increases or
inefficient hiring processes. Further analysis should be done in this area to determine the specific
reasons for the increase (e.g., examination of faculty-to-student ratio; comparison to previous years and
other institutions).
In addition, the number of faculty increased by 7.9% (685 faculty FTE in 2014 versus 635 faculty FTE
in 2013), yet total student enrollment increased by only 3% (11,560 total enrollment FTE versus 11,223
total enrollment FTE). This suggests that enrollment data used in setting the budget and planning for
the instructional year needs to be more accurate at an earlier date. More collaboration between
departments is required since Jerry mentioned that his department sets the budgeted costs but there is a
delay in receiving final enrollment information from the Student Portal database.
The budget is currently based on a 4% compensation increase. However, adjustments to the budget
should also be made for changes to projected enrollment numbers (which may affect the level of
instructor staffing required) when planning, rather than just basing the budget increase on the annual
compensation increase. This will allow for more accurate decisions to be made regarding whether
required alternative funding is available to continue supporting the annual salary increase of 4% and
the smaller class size.
Additionally, the number of supervisory and administration positions is at 152% (supervisory and
administration FTE of 1,041 versus faculty FTE of 685) of faculty positions, with an increase of 9.8%
(1,041 versus 948) over the prior year. This level needs to be evaluated against other public institutions
for reasonableness. The duties of these positions and the need for them should be examined once the
data is verified as being accurate, since cost savings could be realized with a reduction in supervisory
and administration employees if the level is found to be too high. The increase of 9.8% over the prior
year doesn’t seem to have occurred in the finance department, since Jerry’s department seems to be
short staffed and pressed for time to properly complete their normal functions.
Other Operating Expenses
These costs were 23.8% less than budgeted, suggesting that MU does not have a good handle on its
costs to operate. A detailed review of these costs and related cost drivers should be conducted (see also
non-operating cost comment).
We need to better understand what is included in other operating expenses to ensure that costs are not
misclassified.
65
Total Operating Expenses
Operating cost per enrollment FTE is $15,624 ($180,616,000 ÷ 11,560 total enrollment FTE), which is
higher than the average Canadian public institution operating cost per enrollment FTE of $14,000.
Additionally, the average operating cost per FTE increased by $624 or 4.2% ($168,350,000 ÷ 11,223
total enrollment FTE = $15,000) over the prior year. This is higher than the allowable Canadian student
tuition fee increase of 1.5% that was recently announced by the province, which will contribute to
increased deficits over time. This increasing cost, coupled with the known decrease in the 2014/2015
operating grant revenue, indicates that cost per student may not be covered by revenue and needs to be
better monitored.
(Some candidates calculated the operating cost per enrollment full-time equivalent (FTE) for MU and
compared that to the $14,000 average for Canadian public institutions, concluding that it was in excess
of that amount. Many strong candidates integrated other information into their analysis, including the
historical trend of this comparison and comments on the future implications of that continuing trend for
MU.)
Other Non-operating Expenses
Jerry specified that because depreciation is a non-cash expense, his department is not overly concerned
with the accuracy of this calculation. However, it is important that the calculation be accurate because
the information can be used to estimate future asset management costs. Due to the surplus over budget
in this category (5.6%) and the large deficit from budget in other operating costs (-23.7%), there is a
chance that costs are not classified the same in the budget reports as they are in the actual reports. It is
likely that the misclassification is in the budget data due to the reasonableness of the operating cost per
enrollment FTE.
Deficit
Total revenue was 6.2% lower than budgeted ($211,640,000 versus $225,578,000), and although total
costs were 2.6% lower ($219,809,000 versus $225,578,000), the net result is a deficit. Therefore, better
budgeting of costs and a better understanding of enrollment data is required to achieve better financial
results in the future and meet the BOD objective of eliminating deficits.
(As noted previously with respect to candidates’ analysis of revenue variances, some candidates’ analysis
of variances in expenses similarly did not contemplate additional available information that could have
been used to assess why variances occurred.)
Suggestions for Optimizing Sources of Revenue or Taking Advantage of Cost Reductions
In my review of your processes and other information, I have identified the following potential revenue
sources and cost reductions to help you improve your financial performance and work towards achieving
your financial objective to eliminate deficits:
Gross margin on ancillary sales (including bookstore, conference services, parking, and food service
revenues) is currently 30.7%. By increasing the margin through a combination of increased pricing and
sourcing lower cost providers, you could generate additional cash flows. For example, if you were able
to increase the margin to 50%, you would generate an additional $4,215,000 (based on 2014 actual
revenue), which is substantial, considering the 2014 deficit was $8,610,000. Even an increase in the
margin to 40% would provide an additional $1,694,000 in revenue. However, you must also consider
that an increase in prices may result in a loss of customers and, therefore, revenue.
66
Since the annual international student tuition increase limit recently imposed by the provincial
government is not as low as the Canadian student limit (4% versus 1.5%), consider increasing the
enrollment of international students. In addition, MU receives more income per international student
($14,820) than total funding per Canadian student ($14,011, calculated as operating grant revenue per
Canadian enrollment FTE of $9,361 ($102,820,000 ÷ 10,984) plus Canadian program fee of $4,650).
Increase international student fees from $14,820 by the maximum amount allowed by the Ministry (4%)
to $15,413 for 2015 to be closer to the operating cost per student of $15,624 calculated under “Total
Operating Expenses” in order to generate profit (at least for international students).
Charge higher tuition fees for specialty programs compared to those leading to general degrees, since
participants may be willing to pay more for specialty programs. It is unclear whether a stratification of
fees is currently in place. In addition, these specialty program tuition fee increases may not be capped
by the Ministry (should investigate further).
Examine program profitability to determine which programs should be expanded to take advantage of
demand and which programs should be downsized or cancelled as a result of declining student interest
or demand (e.g., business and science degree program seems to be popular with international students;
however, there is not enough space to accept new international students into these programs).
Pursue other revenue sources to increase miscellaneous revenue — consider the introduction of planned
giving programs targeting alumni as donors; donations from estates; renting rooms in the new student
residence to non-students (e.g., conference attendees; families looking for reasonably priced vacation
accommodation in the area); summer camp revenue (e.g., science or sports camps, with related
accommodation revenue), etc.
Investigate opportunities for obtaining faculty grants or additional research funding (whether through
government sources or private partnerships), although MU would have to ensure that the impact on the
faculty teaching load is minimal.
(Candidates seemed more comfortable providing suggestions to optimize sources of revenue than they
were analyzing the variances. Some candidates were able to provide thoughtful suggestions in these
areas, particularly in the areas of tuition fee revenue (for example, by suggesting that more
international students be accepted since their tuition fees at $14,820 are higher per FTE than revenue
from Canadian students at $14,011 (being tuition fees for Canadian student FTE of $4,650 plus $9,361
of operating grant revenue for Canadian students)), other revenue (particularly with respect to
fundraising and donation revenues), and ancillary revenue (where candidates addressed bookstore,
parking, rental, and other revenue streams).)
Operating costs should at least be reduced to the average Canadian public institution operating cost per
enrollment FTE of $14,000, if not further. Currently, operating cost per enrollment FTE of $15,624
(calculated earlier) is higher than total funding per enrollment FTE, which is not sustainable. All
university faculties and departments should be encouraged to review their costs and budget submissions
to identify areas where cost reductions can be made.
Consider increasing class size (subject to available classroom space) without increasing faculty FTE to
reduce costs. MU should compare existing class sizes to similar institutions to ensure that class sizes are
comparable in the circumstances.
Compensation increase of 4% per year is higher than tuition increase of 1.5%. Need to determine what
portion of the compensation increase is offset by operating grant revenue. Consider reducing to at least
a level that aligns with inflation (estimated at approximately 2.5%). This may be difficult to achieve,
depending upon the nature of compensation agreements in place with various unions and others;
however, efforts should be made to identify opportunities for savings in this area of substantial cost
(perhaps a combination of reduction of staff and compensation increases resulting in lower costs in this
area could be achieved). There may be opportunities for staff reductions through early retirement
offerings and redeployment of job responsibilities upon retirements or departures of staff.
67
(On the expense side, candidates who suggested ways to take advantage of cost reductions focused on
the need to reduce salaries and benefits to a manageable level that was in line with changes in enrollment
levels, whether through limitations on annual wage increases, changing the faculty mix (moving towards
more contracted instructors rather than tenured faculty), or recognizing the need to bring staffing FTE
levels in line with increases in enrollment. Most of those candidates examined some of the statistical
information provided when making those suggestions. Others examined ways to increase use of physical
classroom space to either reduce costs or generate new revenue streams (for example, increase e-learning
offerings to free up existing classroom space for new program offerings or more students) in an effort
to improve MU’s financial performance.)
While the amount of amortization included in the draft financial results is unknown since it was not
provided by Jerry, it would be useful to have this information in order to assess MU’s cash flow situation.
Continued deficits over several years may have an impact on MU’s ability to pay its bills and discharge
its obligations in the normal course of operations and is an area where a review should also be
undertaken.
Percent
Awarded
0.9%
competence.
27.9%
Reaching competence — The candidate analyzes some of the variances on
financial results or provides suggestions to improve financial performance.
22.2%
Competent — The candidate analyzes some of the variances on financial results
and provides suggestions to improve financial performance.
48.8%
Highly competent — The candidate thoroughly analyzes the variances on financial
results and provides numerous suggestions to improve financial performance. The
candidate recognizes that MU faces continued deficits if suggestions are not
implemented now.
0.2%
(Candidates were asked to analyze variances on financial results and to suggest ways to improve
financial performance. Jerry provided candidates with financial information (along with notes related
to the financial results) and statistics on certain aspects of MU operations. Candidates were directly
asked to prepare a variance analysis on financial results, incorporating the additional information from
Jerry where appropriate, and to provide specific suggestions on how to improve financial performance
by optimizing sources of revenue or by reducing costs. To demonstrate competence, candidates were
expected to both provide an analysis of variances and suggest ways to improve financial performance.)
(Candidates performed adequately on this indicator. They were generally able to explain how or why a
variance had happened, and many recognized that the $14,000 operating cost per full-time equivalent
(FTE) enrollment measure for the average Canadian public institution was an important standard to
meet. In addition, they were able to provide several suggestions to increase sources of revenue or
decrease costs.)
(Strong candidates appropriately incorporated non-financial information into their explanation of why
or how variances occurred in several of their discussions. They also recognized the importance of the
68
$14,000 standard and suggested numerous ways to increase revenue or to reduce costs. Most weak
candidates restated the result of their quantitative analysis in the body of their response (for example, by
stating that salaries increased by 13.5% over the last year), without considering how other information
provided would have affected actual results. These candidates also provided few suggestions to improve
financial performance. Many of them spent time discussing the problems within the existing budgeting
process and concluded that variances were a result of errors in the process itself, rather than attempting
to analyze the variances.)
The candidate discusses Enterprise Resource Planning (ERP) reporting weaknesses and
recommends specific reporting improvements to the ERP system to provide better performance
information for decisions by management, faculties, and the board.
The candidate demonstrates competence in Performance Measurement and Reporting (IT).
Competencies
V-1.1 Analyzes financial reporting needs (A)
V-1.2 Develops or evaluates reporting processes to support financial reporting (A)
V-1.4 Establishes or enhances financial reporting using IT (B)
V-3.2 Recommends improvements to internal financial reporting systems (B)
V-4.3 Identifies and analyzes non-financial reporting needs (B)
You mentioned that an Enterprise Resource Planning (ERP) system was implemented three years ago that
was intended to integrate financial and non-financial data into a single reporting system, but that there are
still issues related to this system. In addition, you have expressed dissatisfaction with the financial and nonfinancial reports that you are receiving. From my review of the information that Jerry gathered for me, it
appears that the system is still not functioning as intended.
I have identified issues and recommended specific system reporting improvements that could be made to
provide better performance information, which is critical for decisions at various levels within MU (board,
management, and faculties).
ERP System Tracking of Information
A primary issue is that the ERP system only tracks financial information for the university as a whole. This
approach makes it difficult to analyze and assess performance of areas within MU, as separate financial
information is not readily available. It may be that the old systems (many of which still appear to be in use)
continue to provide disaggregated information, but the platforms seem to be different and at times
incompatible, thereby requiring the use of report writing tools and other software to transfer information
into a common format. In order to allow for the provision of relevant information for financial and nonfinancial reporting, the reporting needs of various users must be identified so that the ERP system can then
be tailored to capture and report that information. Some of these capabilities may already exist within the
ERP system, while others may require modifications to the system.
(Many candidates recognized that the Enterprise Resource Planning (ERP) system tracked financial
information for the university as a whole, discussed the need for separate reporting and for both financial
and non-financial information, and made appropriate recommendations for changes to the ERP system
to accommodate those needs.)
69
At a minimum, it seems that three primary groups at MU require financial and non-financial reports: the
board, management, and faculties. Within those groups, members themselves will have differing needs
depending upon their roles, and the reporting system should be able to provide them with information
relevant to their group.
I have identified several essential reporting needs for the various groups; however, this list is not exhaustive.
The groups should determine their specific information needs through consultation with their members.
They should then communicate those needs to the department responsible for ERP so that the required
information can be properly captured by the system using standardized templates and reported upon.
Board reporting needs include the following:
Directors would be concerned with obtaining reports containing information that would enable them to
determine whether MU is meeting Ministry’s SPOs through the objectives that have been set.
Committees of the BOD would require information relevant to their purpose (e.g., the Audit Committee
would require financial information for the university as a whole and also by faculty the human
resources department and the Compensation Committee would require information regarding staffing
and compensation levels, etc.).
Management reporting needs include the following:
Financial information by faculty as well as by area of operations (e.g., ancillary services — bookstore,
parking, etc.), so that management can assess financial performance (by faculty; by service).
Information useful for budgeting purposes (including preparation of budget as well as monitoring of
budget versus actual on a regular basis).
Alumni information (for use in fundraising).
Faculty reporting needs would include the following:
Enrollment information (currently tracked outside the ERP system).
Program information (e.g., course offerings, registration, application, etc.).
Alumni information (for use in communication, special events, and mentoring).
(While some candidates stated that the board, management, and faculties would need different
information, their discussions were often brief when contemplating what those different information
needs would be. For example, many candidates did not provide examples of what reports of specific
information each user group would require, nor did they explain why that information would be useful
to each group.)
Existing deficiencies in the ERP system have an impact on MU’s capability to operate to the best of its
abilities, and improvements are needed. The following comments relate to specific items in the information
provided by Jerry:
70
ERP System Deficiency
Impact on MU
ERP system tracks financial Non-financial information (e.g., application information, etc.) may
information only for the not be tracked. The best decisions cannot be made because
university as a whole.
information is not available.
Applicant information is tracked in the Student Portal (SP) database,
which is not integrated with the ERP system. Differences may occur
that could affect grant funding applied for, as well as acceptance of
students into various programs (e.g., new international students not
accepted into certain programs, yet international student tuition is a
potential source of increased revenue). Information on successful
applications from Canadian students is unavailable and may be
useful in determining the mix of programs to deliver to students.
Recommendations:
Full capabilities of ERP system should be determined so that relevant information can be tracked (on
both on a financial and a non-financial basis).
Modifications to ERP system should be made to provide for tracking of this information, in the event
that it is not currently possible.
ERP and SP systems should be integrated to prevent duplication of information and to improve
reliability of information.
Professors cannot track alumni Information on past graduates is not tracked, so contact with alumni
so that they can be contacted and is difficult to maintain (only if they had maintained contact with
invited
to
participate
in professors). By not maintaining alumni information, MU misses
mentoring
and
fundraising opportunities to reach out to graduates for a variety of purposes
events. Currently, professors are (fundraising, including donations and scholarships; special events,
only able to contact alumni if including
cultural
activities;
mentoring
opportunities;
they have them in their personal programming).
contact lists
Recommendations:
Key information needs to be tracked by the ERP system so a database can be developed from which
reports can be prepared for various user groups.
Build module (either in ERP system or in SP database) to track and report information on graduates by
program and faculty, using set input fields.
Information including name, address, degree, year of graduation, etc., should be gathered so that MU
faculty can reach out to alumni (e.g., mailings for current events; fundraising campaigns, such as those
for the new Arts and Communications building or the Bachelor of Acadian Music degree program).
Ensure programs are tracked by faculty in the ERP or SP database by assigning unique identification
codes to each program (e.g., School of Business uses program numbers beginning with 4).
Ensure all revenues are tracked using appropriate cost centre and subaccount information for each
program or fundraising campaign, which will allow the creation of custom reports within the ERP.
Investigate customer relationship management software as part of ERP or consider using a data sharing
tool between departments and campaign participants to gather contact data for analysis.
The ERP/SP system should have a field in its database that allows alumni to update information as
necessary (e.g., a change of address), perhaps through log-in to a university website.
71
Each faculty has a different way Different interpretations could lead to incorrect calculations of
of interpreting definitions for enrollment (information that is used for many purposes, including
student enrollment.
funding, programming, scheduling, etc.). MU may be missing
opportunities to receive funding or to deliver programs.
Recommendation:
Develop a standardized module within the ERP or SP system to allow for input of certain information
so that the definition of “enrollment” is standard across the university (e.g., fields for student name,
course, hours per course, faculty, etc.). Completion of the input fields will allow an automatic
calculation to be made by the ERP or SP system, so that “enrollment” is calculated consistently
amongst all faculties.
Enrollment information not Enrollment information provided may be inaccurate or not readily
available in ERP system, available, since errors, omissions, or differences may exist in the
resulting in different report- different report-writing tools that are used. For example, operating
writing tools and formats used by grant revenue may be affected if Canadian student enrollment is
each faculty.
improperly calculated. Improper enrollment information could also
affect the calculation of tuition fees for both Canadian and
international students.
Recommendations:
Modifications to ERP system should be made to provide for tracking of enrollment information (as per
the definition determined), if it is not currently possible.
If modifications cannot be made, consider having one report-writing group in the university to ensure
consistency.
Allow users access to only print, not change, reports, so that the report-writing group remains
responsible for changes.
Enrollment full-time equivalent FTE enrollment information is inefficient and may be inaccurate (this
(FTE) calculation is done outside information is used for budget purposes, as well as for program
the
ERP
system
using offerings and setting tuition fees), since there is no indication that
spreadsheet software.
accuracy checks are performed on this calculation before reporting.
Recommendations:
Create an interface between the SP database and ERP to allow reporting within the ERP (since the SP
database was intended to interface and presumably contains significant amounts of data pertaining to
students).
Alternatively, use a report-writing tool to create a custom report.
Create an automatic calculation within the SP database or ERP system.
Ensure calculation is tested for accuracy before relying on calculation.
Finance staff have to reconcile Reconciliation is a time-consuming process in an already
enrollment information provided overworked and understaffed finance department (as evidenced by
by faculties to ensure that sick staff; departure of two senior finance staff; recent retirement of
information is not double a senior finance staff person, etc.); potential errors (missed or doublecounted.
counted information) may not be identified during the reconciliation.
72
Recommendations:
As noted above, the ERP system should be modified to capture enrollment information (thereby
negating the need to perform a reconciliation, since information is obtained from the same database).
Alternatively, use a report-writing tool to convert specific data accumulated by various faculties into a
consistent enrollment calculation (through protected data input fields for users and programming of
calculation for reporting).
Database of student information used should be one that is for entire university (rather than a separate
one for each faculty), and student information should be specific to each individual student (i.e., unique
student number that remains with the student through all faculties) to prevent duplication between
faculties.
Enrollment reports should be used by board (for Ministry SPOs); management (e.g., calculation of
fees), and faculty (e.g., program delivery, including course offerings and scheduling).
Number of applicants not No information available to assess this (e.g., number of successful
available in ERP system (but is applicants, offers of admission, acceptances by country and program)
available from SP database).
other than the number of applicants, so difficult to determine optimal
mix of acceptances for Canadian and international students.
Number
of
successful Absence of this information makes it difficult to assess sufficiency
applications
and
other of program and course offerings (perhaps the Bachelor of Acadian
application information is not Music has only a few applicants, indicating less interest for this
tracked (Jerry is unsure of how specialized program, or e-learning applications are very high,
many
local
students
are indicating great demand for this method); therefore, required changes
successful in their application for to program delivery and availability are not made in a timely manner.
business and science degree
programs).
Recommendations:
Dedicate a resource to creating an interface of the SP database with the ERP to allow reporting within
the ERP.
Alternatively, add fields to the SP database to allow all applicants to be tracked; consider assigning a
unique identification to each applicant versus each student enrolled to track future applications.
Ensure a resource is dedicated to creating tools and databases to track required information in the
appropriate module using unique account identifiers, to make it easier to create custom reports.
Faculty and management should receive reports regarding applicants (both successful and
unsuccessful) so that programming can be optimized.
Number of e-learning courses is
not tracked separately from
regular courses (yet increasing
participation in current elearning courses is an objective
of MU that must be measurable,
since the target increase is 10%).
Difficult to measure if MU academic objective of increasing
participation in current e-learning courses by 10% is met by the two
faculties that offer e-learning (Arts and Communication; School of
Business) without this information being tracked. As a result, it may
impair MU’s ability to report back to the Ministry that the SPOs have
been satisfied.
Costs related to the delivery of e-learning courses may not be
appropriately tracked, thereby not allowing a proper analysis of the
costs and benefits of providing these courses.
Recommendation:
Ensure e-learning courses are separately indicated in the SP database and create an interface with the
ERP to allow reporting within the ERP. (Alternatively, if the interface cannot be developed, then use
a report writing tool to create a custom report on e-learning courses.)
All user groups would be interested in this information, albeit for different reasons (the BOD for
evaluation of compliance with Ministry SPOs; management for fiscal responsibility (could offer more
73
e-learning if profitable); faculty for development of courses of interest to existing and potential students).
At the end of fiscal 2013, Financial information (for reporting, budgeting, and fund application
unreconciled differences from purposes) may be inaccurate or incomplete, including revenue, costs,
the transfer of information from other financial information, and whether there is a surplus or deficit.
the old system to the ERP
financial modules remained.
Recommendations:
Confirm that financial information from the old system has been transferred appropriately and that
there are no significant unreconciled items remaining by reviewing testing plans and documentation of
test results as well as results of 2014 reconciliations.
For any new ERP module implementations, revisit original ERP implementation plan for the transfer
of information to the financial module and ensure information transferred from the old system is
accurate for reporting purposes (through reconciliation, investigation, and correction) so that
unreconciled items do not arise.
Budgeting is done using Budget is not prepared using best available information since no
spreadsheet software, basing actual results (whether final or year-to-date) are incorporated,
current year’s budget on last resulting in lost opportunities for revenue enhancements and cost
year’s budget since final results reductions (e.g., salary costs always increase more than 4% budgeted
are not in before budget must be compensation increase since student enrollment is higher than
approved.
expected, due to delays in receiving final enrollment information
from SP database).
Modifications to budget process must be made to allow for inclusion
of best actual information to date from financial module of ERP
system as part of calculations (to minimize current situation of grant
receipts not covering all teaching salary costs).
Operating cost per FTE enrollment is not measured by MU, so the
university does not know how it compares to the average Canadian
public institution.
Recommendations:
Accumulation of information used for preparation of the budget should be developed within ERP
system (rather than using spreadsheet software; alternatively, an interface could be developed) with
defined input fields for collection of data from all faculties to ensure consistency of information
submission.
ERP system should also incorporate year-to-date information from the financial module into the budget
calculation, particularly since the balanced budget presented over the past few years has differed from
the actual deficits reported, and should provide reports for various groups (board, management, and
faculty).
Standardized processes for certain types of accounting adjustments should be implemented (e.g.,
accruals for payroll straddling a month end), and calculations should be programmed into the financial
module so that year to date information is more accurate.
Automatic calculations should be programmed into ERP reporting tools to easily and accurately gather
key data (i.e., operating cost per FTE, salary cost per FTE, operating cost per program, and tuition per
program) for analysis of data from financial modules and the SP database. Other areas should be
defined within the ERP system (e.g., components of operating cost; calculation of FTE), and
standardized input processes, fields, and validation checks should be developed for all faculties, to
allow the ERP system to calculate and provide consistent and accurate output information useful for
decision-making.
Groups should receive different budget reports generated by the ERP system. Management would require
the budget for the university as a whole as well as by faculty. Faculty would only require budget
74
information for their programs and courses.
75
(Most candidates structured their response in a weakness-implication-recommendation format, which
was relatively successful in demonstrating breadth and depth within their discussions. However, some
candidates lost sight of the fact that the purpose of their discussion was related to the ERP system and
provided general audit and internal control discussions, rather than specifically considering the ERP
system with respect to financial and non-financial reporting.)
(Most candidates were able to achieve breadth in their response because they identified several reporting
weaknesses within the ERP system, including that the system does not currently track alumni, enrollment
information is not available in the ERP system, the number of applicants is only available from the
Student Portal database, and the ERP system does not track e-learning courses separately from other
courses.)
(Some candidates were able to adequately describe the impact of the specific ERP system shortfall so
that the impact on MU was clearly communicated. For example, when discussing tracking of alumni,
candidates noted that the president of JGC (an alumnus of MU) could be representative of a larger
network of alumni who may be interested in contributing towards fundraising, capital campaigns, and
mentoring opportunities for MU. However, if alumni were not tracked, valuable opportunities to have
alumni help with MU operations would be missed. In other cases, candidates’ comments on the impact
of the ERP system deficiency on MU were vague. They simply noted that not fixing the weakness would
result in errors or inefficiencies or could cause frustration, but did not specify or elaborate on what those
errors, inefficiencies, or frustrations would be (for example, errors could cause MU to lose students if
applicants aren’t properly tracked, thereby reducing tuition and operating grant revenue) and how they
could be harmful to MU.)
(Some candidates lost focus when attempting to provide recommendations that improved reporting
aspects of the ERP system and instead commented on internal control matters or suggested general
operational improvements.)
For Primary Indicator #4 (Performance Measurement and Reporting (IT)), the
Percent
Awarded
0.4%
competence.
11.1%
Reaching competence — The candidate discusses ERP reporting weaknesses or
suggests specific reporting improvements to the ERP system to provide better
performance information for decisions by management, faculties, and the board.
47.9%
Competent — The candidate discusses ERP reporting weaknesses and suggests
specific reporting improvements to the ERP system to provide better performance
information for decisions by management, faculties, and the board.
40.6%
Highly competent — The candidate thoroughly discusses ERP reporting
weaknesses and suggests specific improvements to the ERP system to provide
better performance information for decisions by management, faculties, and the
board.
0.0%
76
(Candidates were asked to analyze the reporting weaknesses and recommend improvements to the
Enterprise Resource Planning (ERP) system, since MU is not satisfied with both the financial and nonfinancial reports it is receiving. Candidates were provided with other information in Exhibit II, which
showed additional details regarding the ERP system. In order to demonstrate competence, candidates
were required to identify and discuss reporting weaknesses, and to also suggest specific reporting
improvements to the ERP system to provide better performance information for decisions by
management, faculties, and the board.)
(In general, candidates performed below expectations on this indicator. They were able to identify some
weaknesses within the ERP system that impaired the ability of MU’s board, faculties, and management
to make appropriate decisions, discuss the implications related to those weaknesses, and propose valid
recommendations for changes to the ERP system to make it more useful for financial and non-financial
reporting purposes. However, although many candidates recognized that the existing method for
tracking alumni and e-learning, as well as the fact that enrollment information was not available within
the ERP system, were issues, some struggled to describe the specific impact these weaknesses would have
on the financial or non-financial reporting of MU.)
(Strong candidates discussed several weaknesses in the system as outlined in the information provided
by Jerry, clearly stated the specific impact of those weaknesses on MU, and made appropriate
recommendations for modifications to the ERP system so that useful information would be provided to
users. Their discussions were generally complete and well developed. Weak candidates addressed fewer
weaknesses in the ERP system and failed to provide specific impacts for MU, merely stating that errors
or inefficiencies would occur. In addition, recommendations provided were often impractical and
unrelated to the reporting function of the ERP system (for example, professors’ personal contact lists for
alumni should be shared between faculties, or MU should hire more people to reconcile enrollment
information between the ERP system and report-writing formats used by faculties because the finance
department is overworked and understaffed).)
The candidate evaluates the alternative financing methods for the construction of the new fitness
facility.
The candidate demonstrates competence in Finance.
Competencies
VII-2.1 – Monitors cash flow (A)
VII-2.3 – Identifies the role of short-term, medium-term, long-term, and project financing (B)
VII-2.4 – Identifies and evaluates sources of funds (B)
VII-3 – Develops or analyzes investment plans, business plans, and financial proposals (B)
You have asked for our comments on a potential opportunity MU has with the Jenson Group of Companies
(JGC) to finance the construction of a new fitness facility. In particular, you mentioned that you have been
working with the community to explore partnership options, which would be beneficial in countering the
financial impact of declining government funding.
77
JGC has offered to pay for the cost of the facility construction as well as operating and maintenance costs
for the next nine years (January 1, 2017 to December 31, 2025), after which time ownership will transfer
to MU. MU will then be responsible for all future operating and maintenance costs. During the first nine
years of operations, MU will lease the building from JGC for an annual fee of $5.25 million which includes
annual operating and maintenance costs totalling $2.05 million.
Despite requests for an upgraded fitness facility, the BOD has not deemed this project a high priority and
has redirected debt financing to other projects. In addition, applications for government infrastructure
grants have been unsuccessful. Although the BOD has not been in favour of allocating debt funding to
upgrading this building in the past, debt financing remains a viable alternative. Due to the ability to obtain
debt at a low rate of 4% from the province over a 20-year period, this alternative may be favourable from
a financial perspective.
A discounted cash flow analysis comparing the JGC proposal to the loan from the province follows. Note
that inflation has not been factored into these calculations. Due to the time period covered by the analysis,
the rate of inflation could change those calculations considerably.
The results are as noted in the table that follows.
Note that the expected increase in revenue from the higher mandatory sport and wellness fee of $20 per
student has been excluded from the analysis since it is non-incremental (in other words, it will be the same
amount under any financing option).
With respect to JGC’s offer, the following factors would need to be considered:
For the nine-year term of the lease, JGC has committed to providing an entrance scholarship to two
students entering programs in the faculty of Health and Community, which meets MU’s strategic
objective to increase student scholarships (which can be used to generate new funding for various
programs). As provincial grant funding continues to decrease, MU must look for alternative funding to
support ongoing operating costs. It may be very beneficial to the university to establish a relationship
with JGC to promote further partnerships and funding opportunities. JGC’s unsolicited offer may be an
indication that a philanthropic environment may exist in the community surrounding MU that the
university may not have identified or approached for funding sources. At a minimum, MU should
follow up on this area for potential growth of revenue since other businesses like JGC may be willing
to donate but have not yet been asked to do so.
JGC’s offer may spur other businesses in the community to donate towards the new Arts and
Communications building, for which $6 million in donor and sponsor commitments is being sought.
If the offer is not accepted, JGC may direct its funds to another institution or organization.
MU may have the opportunity to sell naming rights at some point in the future (depending on the nature
of the agreement with JGC), which could provide an influx of funds.
MU would have to consider the reputation of JGC and the reception of JGC’s brand, product, or services
in the marketplace, since any negative connotations associated with the JGC name or reputation may
have an unfavourable impact on the university.
JGC assumes the risk of construction cost overruns, as well as the annual operating and maintenance
costs (which may be greater than the $2.05 million currently estimated). However, conversely, JGC
(and not MU) would benefit from any cost savings when building the facility and annually thereafter
until the end of the lease term.
The facility may not be exactly what MU wants, depending upon the level of input in the design process
that JGC allows MU to have.
The offer allows the institution to retain debt funding for other capital projects.
78
(Some candidates attempted a qualitative analysis of the JGC offer, and most of those who did recognized
that the entrance scholarship offered by JGC was a positive aspect of the proposal. Some candidates also
recognized that control over the design and construction of the proposed fitness facility could be out of
MU’s hands, and explained why this would be a positive or negative aspect of the JGC option.)
With respect to the loan from the province, the following factors would need to be considered:
The interest rate offered is attractive and perhaps lower than that offered by banks and other financial
institutions.
The terms could be advantageous both now and in the future (interest and principal repayments; grant
opportunities; debt forgiveness in the future).
Potentially ties up debt funding that could be available for other capital projects (e.g., planned Arts and
Communications building).
Project cost overruns must be considered — actual final costs could escalate and funds would be further
constrained (alternatively, construction efficiencies could be realized to MU’s benefit).
(Most candidates did not consider qualitative aspects related to the loan from the province. However
most of those who did recognized that the loan offered favourable interest and repayment terms that
should be considered when making a financing decision.)
(In general, the level of qualitative analysis of the two alternatives was poor. Candidates did not step
back from their quantitative calculations to consider pros and cons related to the two financing options.)
79
80
The total discounted cash outflows of $48,806,000 for MU are $1,050,000 (or 2.2%) more under the loan
option when compared to JGC’s offer. While the extra cost is not significant, it may not be acceptable when
there is continued pressure to find ways to reduce the deficits. Although the BOD has been reluctant to
approve debt for this project in the past, perhaps the obvious interest of the community combined with
increasing enrollment counts (total headcount and enrollment FTE) and potential revenue sources will lead
to a re-prioritization of this project.
(Most candidates who attempted a quantitative analysis of the JGC offer were able to perform a
reasonable calculation that incorporated the present value of the lease payments. Strong candidates
recognized that the $2.05 million annual operating and maintenance costs beginning in 2017 were the
same under the lease and loan alternatives, and they appropriately excluded that amount from both of
their calculations (therefore, using a net lease amount of $3.20 million when assessing the JGC offer).
The calculation related to the JGC offer was often reasonably performed when candidates attempted it.)
(Candidates struggled most with the quantitative assessment of the loan alternative. Common calculation
deficiencies included comparing the two alternatives on an unequal basis. For example, some candidates
included the $2.05 million annual operating and maintenance costs in the JGC lease when using the
$5.25 million lease payment in calculations, but omitted the annual costs of $2.05 million when
calculating the cost under the provincial loan option. Others considered the time value of money when
assessing the JGC option but did not for the loan from the province. Another common deficiency was
including only the first two years of interest cost on the loan (as provided in Exhibit III) and ignoring
interest in years 3 through 20 (which would have required a separate calculation). Some candidates also
forgot to consider the repayment of the $23.50 million loan principal or the fitness facility construction
costs (or both). As a result of numerous quantitative errors, many candidates were unable to provide a
reasonable analysis of the loan from the province, which would have been useful to the BOD in its
decision-making.)
Preliminarily, I recommend pursuing the partnership option with JGC due to the potential future funding
opportunities and the linkage to the BOD’s strategic objectives. The funding commitment provided by JGC
is known, as is the cost component to MU. The BOD could consider requesting a lower lease payment from
JGC, although that would provide JGC with a lower return on its investment. The long-term scholarship
benefits of a partnership with JGC certainly need to be considered.
However, MU should reconsider whether it should even proceed with this project at all, given the deficits
in the 2012 and 2013 years, as each of the above alternatives requires an outlay of funds in some manner.
Full cash inflows from the facility are currently unknown. In addition to revenue generated from the
mandatory sport and wellness fee (including the anticipated increase of $20), there may be opportunities to
generate funds through other program offerings (e.g., facility memberships to the general public, rental of
facilities to sports organizations for training purposes, providing sports camps during off-peak months,
etc.). Any of these options would require some background analysis to determine their feasibility prior to
implementation, including consideration of what is currently being offered in the neighbouring community.
While it is unlikely that the facility would be able to generate net cash on a stand-alone basis, it may be
necessary to construct a new facility to retain and attract students and faculty. MU should first assess the
age of the existing facility as well as the programs that it provides — perhaps an upgrade rather than a full
replacement should be undertaken for a lower capital outlay.
81
(Many candidates tried to address Dr. Héroux’s specific request for comments on the JGC proposal.
However, very few candidates took a step back to assess whether constructing a new fitness facility was
an astute move for MU at the present time.)
For Primary Indicator #5 (Finance), the candidate must be ranked in one of the
following five categories:
Percent
Awarded
0.4%
competence.
28.7%
Reaching competence — The candidate attempts a quantitative analysis of the
financing options for the new fitness facility and discusses some qualitative factors.
44.0%
Competent — The candidate performs a reasonable quantitative analysis of the
financing options for the new fitness facility and discusses some qualitative factors.
26.7%
Highly competent — The candidate performs a thorough quantitative analysis of
the financing options for the new fitness facility and discusses several qualitative
factors.
0.2%
(Candidates were required to comment on the proposal submitted by the Jenson Group of Companies
(JGC) and were provided with an exhibit outlining the details of the community partnership proposal for
a new fitness facility. In order to achieve competency, candidates were expected to quantitatively and
qualitatively compare the financing options for the proposed facility, both the JGC proposal and the loan
from the province.)
(Candidates did not perform well on this indicator. While most candidates were able to appropriately
calculate the present value of the JGC lease option, they struggled in their quantitative assessment of the
loan from the province. Many candidates failed to compare the two alternatives on an equal basis (for
example, by including operating and maintenance costs in one option but not the other), which lessened
the value of their comparison. Common quantitative deficiencies in candidates’ calculations included
the omission of interest for the full loan period (using only the first two years of interest provided in
Exhibit III), the inclusion of outlays for the $23.5 million total design and construction costs rather than
considering loan repayments, and the failure to properly consider the time value of money. On the
qualitative side, candidates were generally able to provide a few factors that should be considered when
making the decision whether to accept JGC’s offer, including their offer of entrance scholarships to two
students and concerns over control or participation in the design and construction process.)
82
(Strong candidates provided a reasonable quantitative analysis of both the JGC and the loan alternatives,
and also addressed more qualitative considerations in their analysis. Weak candidates provided a
quantitative assessment of the JGC offer but were unable to provide a useful analysis of the loan
alternative because either they omitted important components or their calculation did not use a basis
that made the results comparable to their analysis of the JGC offer. Those candidates also provided few,
if any, qualitative discussions beyond the recognition of the two scholarships being offered with the JGC
proposal.)
The candidate considers possible causes and implications of the problems raised by the auditor
general and provides appropriate recommendations to address these problems.
The candidate demonstrates competence in Assurance.
Competencies
VI-3.3 – Evaluates internal control (A)
VI-3.4- Evaluates IT-related elements of internal control (B)
The Ministry requires that MU respond to the AG’s inspection findings in a timely manner. Given the
upcoming departure of Jerry on his four weeks of vacation, it is important to respond to the AG findings as
soon as possible. In addition, the president, Dr. Héroux, has asked for help understanding the underlying
causes of the problems so that appropriate corrective actions can be taken. To assist Jerry in preparing a
response, which should be provided to the Audit Committee for their review prior to being presented to the
full BOD, I reviewed the key inspection findings in the AG report and have provided the following
summary:
(While many candidates recognized that Dr. Héroux had asked for an understanding of the underlying
causes of the problems identified by the Auditor General (AG) in the key inspection findings, their
responses did not include contemplation of those causes. Candidates generally responded to this
indicator using a weakness-implication-recommendation format, which prevented many of them from
incorporating a discussion of the cause. In addition, the weaknesses had already been provided to them
via the AG key inspection findings. Therefore, a mere restatement of that finding demonstrated no
additional understanding on the part of the candidates. Candidates who amended their response format
to consider weakness-cause-implication-recommendation had a greater opportunity to demonstrate
competence in assurance on this indicator.)
Finding
Incomplete capital
asset working papers,
including continuity
and amortization
schedules as well as
details on project costs
Cause
Management
doesn’t seem
concerned with
accuracy of
amortization
schedules since
amortization is a
non-cash
expense.
Costs are not
appropriately
tracked for
accounting and
funding
purposes. (This
could be a
problem with the
conditions
attached to grant
funding for the
Community
Learning Centre
and the
determination of
eligible versus
ineligible
expenditures.)
Problems may be
due to turnover
in finance
department
staffing, since
new staff (if staff
replacements
were made) may
not be properly
trained on
preparation of
these schedules.
Implication
May result in missed
opportunities for
revenue (e.g.,
improperly tracked
future project costs
related to Community
Learning Centre could
lead to non-compliance
with grant conditions
and require repayment
of funding; some
expenditures may be
eligible for other
government grants or
incentives.
Inaccurate financial
information provided
to BOD and senior
executive if
amortization schedules
(and possibly
calculations) are
incomplete resulting in
poor decisions for MU
(e.g., the level of
capital reinvestment
that is required
annually for
sustainable
operations).
Incomplete project cost
schedules could also
lead to GAAP
departures, resulting in
unreliable financial
information and
improper decisionmaking that could be
harmful to MU.
83
Recommendation
Guidelines should be
established to provide
for regular updating of
these schedules by
finance department staff
(perhaps on a monthly
basis), with review by
the capital asset
accountant (if not the
preparer) or senior
finance department
personnel.
This will ensure timely
and more accurate
completion of financial
information and reports
(e.g., application for
grant funding;
repayment of grant
funds; financial
statement preparation),
which provides the basis
for informed operating
and capital decisions.
Use the ERP system to
track project costs better
(or if ERP system isn’t
currently capable of
tracking this
information, make
necessary modifications
to that it is appropriately
captured) so that reliable
information is prepared
for making more
informed business
decisions.
84
Finding
Payroll and accounts
payable accruals not
completed.
From notes from staff
interviews, payroll
accrual and contracted
instructor accruals are
also incomplete in
2014.
Revenue recognition
policies are applied
inconsistently,
resulting in repeated
audit adjustments.
(For example, in 2014,
grant revenue was
recorded for the
Community Learning
Centre, yet all the
related expenses will
not be incurred until
2015.)
Cause
No set policies
in place for
liability and
expense
recognition leads
to confusion as
to when
expenditures
should be
recorded, as VP
of finance
advised to record
based on
contracted
billing date
rather than date
of provision of
service. In
addition, payroll
supervisor was
advised by VP of
finance not to
accrue last four
days of payroll
because amount
would be
immaterial.
Implication
Expenses are
understated, and BOD
and senior executives
are provided with
inaccurate drafts,
resulting in unrealistic
expectations of final
results. Decisions
relating to human
resources (hiring and
remuneration) may not
be optimized.
Incomplete accruals
affect the ability to
assess future cash
commitments and the
determination of
required cash inflows
and outflows.
Inefficiencies caused
by additional work
required from finance
staff at year end to
make corrections and
conflicting directives
issued by senior staff
may have a negative
impact on MU.
The finance
department
seems content to
continue
recognizing all
revenue in the
year it is
received (cash
basis for revenue
rather than
accrual basis),
despite policy to
the contrary, and
to have external
auditors provide
adjustments to
correct revenue
recognition
errors.
An improper
accounting policy
results in overstated
revenue, inaccurate
information for
decision-making, and
audit adjustments.
Recommendation
Processes should be
established to accrue
significant expenses on
a monthly (or at least
quarterly) basis to
identify process
efficiencies and reduce
error and time at year
end.
This will allow more
accurate quarterly
reporting to the BOD so
they can identify and
address overexpenditure concerns in
a timely manner.
Competent and capable
staff with proper
training should be in
senior positions.
Accruals should be
reviewed for
reasonableness by
someone more senior
than the preparer (adds
another level of control
and oversight) to ensure
that financial
information contains all
relevant data.
Revenue recognition
policies should be
reviewed by the audit
committee to ensure
they are up to date with
accounting standards.
Processes and training
programs must be
established to ensure
finance staff follow
policies.
Revenue entries should
be reviewed on a
monthly basis for
accuracy by a senior
accountant to ensure
timely reporting for
decision-making
purposes.
Finding
Cause
Implication
85
Recommendation
Limited controls
around vendor
selection and set-up.
Insufficient staff
in accounts
payable (AP),
since accounts
receivable (AR)
supervisor is
performing AP
supervisory
duties.
Modifications to
existing controls
(the system was
changed to
accommodate
the entering of
invoices without
matching
purchase orders
at year end).
Modifications to
other controls
(for 2014 yearend, only
invoices greater
than $50,000
require approval
before entry).
There is a risk that a
vendor invoice will be
recorded and paid
without a matching
receipt of a good or
service (vendors are
encouraged to invoice
before June 30
regardless of whether
the good or service has
been delivered).
There is a risk that
expenses could be
overstated, resulting in
improper financial
results being reported.
Provides opportunity
for fraud or error,
thereby compromising
entity resources.
Each invoice received
must be matched to a
purchase order and to a
receiving report in the
system to ensure proper
approval and receipt of
good.
An exception report
should be generated for
any invoices without an
approved purchase
order. Any invoice
without an approved
purchase order must be
manually approved as
the goods or services are
received and payable.
There should be a report
that summarizes new
vendors set up in a
particular month. The
report should be printed
and reviewed by
management (perhaps
there is already a
capability in the existing
ERP system that just
needs to be used).
Accounts receivable
staff have the ability to
prepare deposits and
write-off accounts
receivable.
Segregation of
duties is not
apparent in all
areas (people
preparing
deposits should
not also be able
to write-off
accounts
receivable).
Workload is too
much for AR
supervisor, who
has had to
delegate, and
staff have fallen
behind in
reconciliations.
Staff may be provided
with opportunities or
means to commit or
conceal fraud due to a
lack of segregation of
duties.
Staff who prepare
reconciliations (i.e., AR)
should not also review
the reconciliation since
there is no compensating
control to detect
possible fraud or error.
AR and AP supervisor
roles should be separate
since there is the
opportunity to receive
cash and create a
fictitious vendor.
Vendor selection and
set-up should be
performed by a
purchasing specialist,
not accounts payable,
86
Finding
Cause
Implication
Insufficient
staffing at senior
levels (AR
supervisor is also
acting AP
supervisor) may
contribute to
breakdown or
circumventing of
existing control
environment.
Data entry restrictions
are inadequate — staff
share passwords to
access different
modules of the
financial system.
Recent turnover
in staffing has
been significant:
two experienced
finance staff left,
one retired, and
another is on
maternity leave
(AP supervisor),
which may lead
to sharing of
passwords so
that work can be
completed
despite fewer
staff.
Staff are often
sick or otherwise
unmotivated,
which could lead
to password
sharing.
Sharing of passwords
prevents system
tracking of users who
enter or change
financial information.
Existing situation
provides opportunity
for fraud or error.
Recommendation
and should be
authorized.
Access to systems for
AR write-offs must be
password protected and
be performed by staff
who do not have access
to cash.
Should have periodic
approval of AR writeoffs (e.g., tuition and
other AR arising from
ancillary sales) by senior
personnel.
Each system user must
be assigned a unique
password. The password
must follow appropriate
naming conventions and
be changed on a regular
basis.
Passwords must be kept
private, and there must
be different levels of
access to data controlled
by passwords.
Regularly review which
employees have access
to which modules and
amend as necessary
(e.g., as roles and
responsibilities change).
Finding
Training is insufficient
and job descriptions
are not current.
Cause
Fairly high level
of turnover in
experienced staff
(AR supervisor
was asked to fill
in for AP
supervisor rather
than filling that
position with a
hired individual)
leaves
replacements
unfamiliar with
job
responsibilities
in new role.
There seem to be
staff shortages,
so all job
responsibilities
aren’t being
satisfied and
duties aren’t
completed in a
timely manner.
Could also be
indicative of a
lack of training
materials for
existing staff
(e.g., on how to
use ERP
system).
Implication
Turnover often results
in untrained staff
filling in for others,
which can lead to
errors in financial
information that is
relied upon for
decision-making.
87
Recommendation
Roles, duties, and
processes must be
reviewed, documented,
updated, and
communicated to staff
on a regular basis.
Cross training should
occur on a regular basis.
Employee hiring
policies and procedures
should be established to
ensure properly
qualified individuals are
hired.
Need to assess job
responsibilities and
improvements that could
be made to increase
efficiency (i.e. perhaps
align job duties better to
satisfy needs or hire to
fill positions rather than
reallocate duties).
88
Finding
Financial statements
are not reviewed by
management on a
monthly basis, and
reconciliations are only
prepared annually.
Cause
Review and
reconciliation
delegated to staff
who are behind
in duties (AR
supervisor
delegated some
functions).
Staff shortages
and
absences (Jerry’s
comment that
staff tend to be
sick or otherwise
unmotivated;
several
experienced staff
have left in past
six months)
contribute to
lack of clarity
over roles and
responsibilities
with respect to
review of
information and
preparation of
reconciliations.
Implication
:Lack of review of
detective controls and
irregular financial
analysis results in
undetected errors and
decisions made based
on inaccurate
information.
Recommendation
The VP of finance must
perform a high-level
financial analysis on a
monthly basis to identify
variances and
inconsistencies that
should be followed up
so that information
being used for decisionmaking and reporting to
the BOD is reliable and
relevant.
Reconciliations for
significant accounts
must be prepared and
reviewed monthly, and
reconciling items must
be followed up on in a
timely manner to detect
and correct errors.
(Candidates approached their response either by addressing the AG key findings in the seven areas
(university is not ready for inspection; accounting policies are not always followed; financial processes
and controls are inadequate; etc.) or by discussing each specific finding individually (capital asset
working papers are incomplete; payroll and accounts payable accruals are incomplete; etc.) While
candidates using either approach had a similar opportunity to demonstrate competence, it was noted that
those candidates who discussed specific findings individually often provided more thorough discussions
overall.)
(Many candidates who attempted to identify and discuss the underlying causes of the AG findings
restated facts from the simulation without providing additional useful discussion (in other words, they
did not demonstrate how those facts led to the weakness occurring) or restated the AG finding as the
cause (when, in actuality, it was merely a restatement of the problem). Strong candidates stepped back
to analyze the underlying cause of the finding and then used multiple examples from the simulation to
support their discussion.)
89
(With respect to the discussion of implications, many candidates made non-specific statements about
what could happen if the underlying cause was not corrected. For example, candidates stated that “errors
could occur” or that, if the problem was left uncorrected, “inefficiencies could occur.” Candidates failed
to elaborate on what those specific errors or inefficiencies might be (for example, errors in financial
reporting could occur and improper decisions could be made by management and the BOD as a result
of reliance on those reports, which could result in losses to MU if, for example, that erroneous
information was used for funding applications). As a result, their discussions were not useful to the
president. In addition, a number of candidates were inappropriately concerned about the implications
for the cost or the timely completion of an audit, and it was at times unclear whether their concern was
with the AG work or with the external audit of MU. Since the AG work had already been performed,
concern with the impact upon its cost or completion was not relevant. In addition, since the AG findings
had been consistent over the past several years, those findings would not have had a different impact on
the current year’s external financial statement audit.)
(On occasion, candidates were able to provide useful recommendations to address the underlying cause
of the finding, most frequently in the areas of insufficient staff training and inadequate data entry
restrictions.)
For Primary Indicator #6 (Assurance), the candidate must be ranked in one of the
Percent
Awarded
0.2%
competence.
20.4%
Reaching competence — The candidate discusses some of the causes of the
problems raised by the auditor general or provides some appropriate
recommendations to address these problems.
57.4%
Competent — The candidate discusses some of the causes of the problems raised
by the auditor general and provides some appropriate recommendations to address
these problems.
21.9%
Highly competent — The candidate thoroughly discusses most of the causes of
the problems raised by the auditor general and provides some appropriate
recommendations to address these problems.
0.1%
(Candidates were required to review the report of the auditor general (AG) and respond to findings from
the most recent inspection. Candidates were expected to consider possible causes and implications of the
problems raised by the AG and to provide appropriate recommendations to address those problems.
Candidates were directed to this indicator because they were specifically asked by the president of MU
to review the AG report to analyze possible causes of the problems and their implications and to explain
what MU could do to address those problems. Candidates were provided with an exhibit outlining the
ten key inspection findings of the AG in seven different areas.)
90
(Candidates performed poorly on this indicator. Most candidates attempted to address many of the
individual findings of the AG. However, many candidates did not consider the underlying causes of the
problems, despite being specifically requested to do so. Instead, candidates frequently considered only
the implications of the weaknesses identified by the AG and made recommendations that were useful for
the weakness rather than addressing the cause of the problem. Candidates who did attempt to analyze
the causes of the problems often merely restated the AG weakness as the cause, without providing any
additional insight. As with the responses to Performance Indicator #4, candidates continued to provide
vague implications in their discussions, stating that errors or inefficiencies could occur without
elaborating on what those errors specifically could be.)
(Strong candidates addressed more key individual findings of the AG and were able to sufficiently
analyze the causes underlying those findings, provide clearer discussions of the implications on MU, and
make appropriate recommendations to fix the causes of the problems that had led to the findings. Weak
candidates addressed fewer individual findings, ignored causes entirely, provided imprecise implications,
or focused on the impact of the deficiency on the timely completion of the work of the AG or the external
auditor, and they made recommendations that were not useful.)
The candidate discusses accounting issues affecting MU.
The candidate demonstrates competence in Performance Measurement and Reporting.
Competencies
V-2.2 – Develops or evaluates accounting policies in accordance with GAAP (A)
V-2.3 – Accounts for the entity’s routine transactions (A)
V-2.6 – Prepares or evaluates financial statement note disclosure (A)
Jerry has asked us to review the accounting or the Supplemental Executive Retirement Plan (SERP) and
address other accounting issues. A review of the accounting for the SERP and other financial reporting
issues as identified in the inspection report of the auditor general as well as through interviews with staff
are provided below, under International Financial Reporting Standards (IFRS) as mentioned by Susan.
I have also addressed the accounting for the lease payments in the event the partnership with JGC is pursued.
Pension
MU’s supplementary pension plan for its senior executives is a defined benefit plan. In accordance with
IAS 19 — Employee Benefits, a defined benefit liability is presented on the statement of financial position,
and a corresponding pension expense, net interest cost, and net actuarial gain is presented on the statement
of operations (and other comprehensive income). While MU appropriately recorded the contributions to the
plan assets and current service costs, they neglected to account for the net actuarial gain and net interest.
The adjusting entry is:
Dr. Pension Expense
Cr. Other Comprehensive Income
Cr. Defined Benefit Liability
91
15,375
9,375
6,000
(Many candidates were able to recognize that the supplemental pension plan for senior executives was
an accounting issue that had to be addressed. However, the extent of their responses was usually limited
to including excerpts of technical guidance from the Handbook that described how a defined benefit
plan would be accounted for. Their responses contained little, if any, application of that technical
knowledge to case facts and, as a result, were generally not useful to Dr. Héroux or the controller since
they contained no information specific to MU.)
The controller was uncertain why the defined benefit liability did not equal the defined benefit obligation
provided by the actuary. It is important to recognize that the defined benefit liability is presented in the
statement of financial position on a “net” basis. It is the difference between the defined benefit obligation
(the present value of expected future benefit payments) less the plan assets (the present value of the assets
available to pay out those future benefit payments).
IAS 19 states that a reconciliation from the opening balance to the closing balance of the net defined benefit
liability (DBL), plan assets (PA), and present value of defined benefit obligation (DBO) must be shown in
the notes to the financial statements. I have provided this reconciliation to help explain the appropriate
accounting treatment below.
Cash
Other
(Statement
Pension Comprehensive of Financial
Expense
Income
Position)
$
$
$
Beginning
Current service
costs
Contributions
Interest cost on
DBO1
Interest income
on PA2
Gain on DBO3
Loss on PA4
Ending
140,000
(125,000)
Defined Benefit
Defined
Liability
Benefit
(Statement of Plan Assets Obligation
Financial
(Note
(Note
Position)
Disclosure) Disclosure)
$
$
$
(300,000)
250,000
(550,000)
(140,000)
(140,000)
125,000
(31,000)
125,000
31,000
(15,625)
15,625
15,625
155,375
(11,000)
1,625
(9,375)
(125,000)
11,000
(1,625)
(321,000)
(31,000)
11,000
(1,625)
389,000
(710,000)
92
Interest Cost on DBO
DBO, beginning
Current service
Weighted average DBO
Discount rate
Interest cost on DBO
1
$(550,000)
(70,000) weighted for “earned evenly” $140,000 × 1/2
(620,000)
5%
$ (31,000)
2
Interest Income on PA
PA, beginning
Contributions
Average balance
Discount rate
Interest income on PA
$250,000
62,500 6 ÷ 12 months × $125,000
312,500
5%
$ 15,625
3
Actuarial Gain on DBO
DBO, beginning
Current service
Interest cost on DBO
Expected DBO, ending
Actual DBO, ending
Actuarial gain on DBO
$(550,000)
(140,000)
(31,000)
(721,000)
(710,000)
$ 11,000
4
Actuarial Loss on PA
PA, beginning
Contributions
Interest income on PA
Expected PA, ending
Actual PA, ending
Actuarial loss on PA
$250,000
125,000
15,625
390,625
389,000
$ (1,625)
(Some candidates who were familiar with accounting for employee benefits were able to calculate the
required adjusting entry (in response to the request of the controller) or were able to provide the
controller with specific information with respect to the recording of plan assets. Those candidates showed
their calculations and supported any assumptions made when performing their quantitative analysis.)
Capital Asset
In accordance with IAS 16 — Property, Plant and Equipment, MU is appropriately recognizing the cost of
the student residence project as a capital asset at June 30, 2014, because it is probable that future economic
benefits associated with the item will flow to the university (rental revenue will be received for 100% of
the rooms beginning September 2014) and the cost of the item can be measured reliably (actual costs to
date have been tracked). However, MU continues to recognize the asset as construction in progress rather
than as a depreciable capital asset at year end, even though the building was 50% occupied in January 2014.
93
IAS 16 states that depreciation of an asset begins when it is available for use; in other words, when it is in
the location and condition necessary for it to be capable of operating in the manner intended by
management. Since the building was 50% occupied in January 2014, with the majority of the remaining
two floors available for occupancy in March, it appears as though the asset was in use and that the asset
costs to that date should have been depreciated over the period of use. We would have to determine what
portion of the $43,300,025 had been incurred to January 2014 when calculating depreciation, but for
purposes of calculations below, we have treated the full amount as having been incurred by January.
(Although most candidates addressed this issue, only a few considered when the student residence
became available for use. As a result, most provided little discussion in this area. Those candidates who
demonstrated knowledge were generally able to apply simulation facts relating to the January 2014
occupancy date for two of the floors as a determining factor in the “available for use” decision. Other
candidates incorrectly focused on the planned September 2014 date for full occupancy as the date on
which the residence became available for use.)
In addition, we would have to determine what portion of the cost represents furniture and fixtures (e.g.,
student beds, desks, and dressers that may be provided in the residence rooms, as well as common area
furniture and appliances, etc.) because these assets likely have a shorter useful life than the building itself
and would therefore require a different period for depreciation (perhaps a five-year useful life would be
more appropriate for these types of assets). In the absence of this information, we have allocated the full
construction costs incurred to building.
(Few candidates considered that different components of the residence (such as furniture and fixtures)
may have different useful lives and, therefore, some components would be depreciated over a shorter
useful life than others.)
While we do not have information on the useful life of the separate components of the building, we have
been told that MU typically uses a 40-year depreciation period for buildings, which would result in a
current-year depreciation expense of $541,250 ($43,300,025 ÷ 40 years × 6 ÷ 12 months). However, if MU
decides to use a 50-year useful life to align with similar private-sector apartment-type buildings, the currentyear depreciation expense would be $433,000 ($43,300,025 ÷ 50 years × 6 ÷ 12 months). Finance
department staff should determine what the useful life of this type of building is (which may differ from
the useful life of other MU buildings). A longer useful life results in a lower expense. For the time being, I
have used a 50-year useful life (on the basis that 50 years can be supported), which results in a decrease to
operating surplus (net income) of $433,000.
Dr. Property, Plant and Equipment
Cr. CIP
43,300,025
Dr. Depreciation
Cr. Property, Plant and Equipment
433,000
43,300,025
433,000
94
IAS 16 suggests that the useful life of an asset should be reviewed at least at each financial year end. If
expectations differ from previous estimates, the change would be accounted for as a change in an accounting
estimate in accordance with IAS 8 — Accounting Policies, Changes in Accounting Estimates and Errors.
If MU decides that a useful life of 50 years is a reasonable estimate of the useful life of the building, and if
it is determined that the useful life of other buildings is now more appropriately set at 50 years (rather than
the existing 40-year depreciation period), the change would be applied prospectively, in accordance with
IAS 8, and would increase profit and reduce loss (because of the longer useful life) in the period of the
change and in future periods.
(Some candidates recognized that the useful life of the student residence may be more in line with a
50-year period and were able to support their discussion by drawing on simulation facts relating to
similar private sector apartment-type buildings. Most of those candidates considered the advantages and
disadvantages of the two different useful lives (40 years versus 50 years) and came to a conclusion as to
the preferred period of time that should be chosen.)
After recognition as an asset, IAS 16 provides guidelines for measurement after recognition (either the cost
model or a revaluation model). Under the cost model (as discussed earlier) that MU currently uses, the
residence would be carried at its cost less any accumulated depreciation and accumulated impairment
losses. Under the revaluation model, if the fair value of the residence can be measured reliably, it can be
carried at a revalued amount (fair value less subsequent accumulated depreciation and subsequent
accumulated impairment losses). IAS 16, paragraph 36 indicates that an entire class of assets should be
valued in the same manner (either cost or revaluation model). This would indicate that the residence should
be valued at cost, since that is MU’s usual practice. Paragraph 37 provides that a “class” of assets is a
grouping of assets of a similar nature and use in an entity’s operations. While all buildings could be
considered the same class, an argument could be made that residence-type buildings have a different nature
and use than classroom-type buildings or even fitness-type buildings. Therefore, a reasoned argument could
be made supporting the student residence as a different class of building; hence, the revaluation model could
be used.
The capital asset accountant has indicated that the residence might now be worth $50 million, which is
greater than the projected final cost amount of $45 million. A higher fair value may lead management to
want to apply the revaluation model. However, the BOD remains concerned with repeated deficits, and a
higher asset value would also result in higher depreciation costs, which would increase the deficit. In
addition, other considerations must be taken into account when applying the revaluation model that add
more work and complexity to the accounting process. At this point, the cost method seems the most
appropriate model for MU to use to record the student residence asset and is consistent with MU’s usual
practice.
(While many candidates noted that there were alternatives for measurement after the asset was
recognized (cost or revaluation models), most of them quickly concluded that the cost model should be
chosen in order to be consistent with past practices at MU. Strong candidates recognized that the fair
value of the residence had increased (and drew upon simulation facts to quantify that increase),
recognized MU’s current financial position (showing a deficit in the current year when various
accounting adjustments are made), and incorporated these facts when concluding on whether the cost
model or the revaluation model should be chosen.)
95
There may be some argument that the residence could be considered investment property (IAS 40 —
Investment Property provides guidance in this area) since the property is a building (student residence) held
by the owner (MU) to earn rentals. IAS 40 states that “investment property is held to earn rentals or for
capital appreciation or both. Therefore, an investment property generates cash flows largely independently
of the other assets held by an entity. This distinguishes investment property from owner-occupied property.”
The student residence may also be considered “owner-occupied property” since it is likely occupied by
students who could be considered similar to employees, and will have some rooms reserved for use by
employees. As the student residence likely generates cash flows from tuition-paying students attending
MU, it is not independent of the other assets held by MU, so IAS 40 would not apply. However, more
information would have to be obtained in order to determine the nature of the cash flows generated by the
student residence.
(Most candidates began their analysis by considering whether the residence represented investment
property. Many candidates quickly concluded that because the residence was used to generate rental
income, it would qualify as investment property. Those candidates then continued their discussion to
consider whether the cost method or fair value method was an appropriate basis for measurement.
However, some candidates did consider whether the residence generated cash flows largely
independently from other assets held. They appropriately concluded that since most of the residence
rentals came from tuition-paying students and since ancillary rentals are likely low, it is not independent
from other assets held and, therefore, would not be considered investment property. Some candidates
also contemplated whether the student residence would be “owner-occupied” property and presented
reasonable arguments to support their final conclusions.)
Joint Arrangement
Prior to year end, MU and EventCo Ltd. (EventCo) jointly entered into an arrangement to construct a sports
field with parking facilities on university land. They formed NewCo to complete this project. The
arrangement between the two participants, MU and EventCo, has the characteristics of a joint arrangement
and falls under the guidance of IFRS 11. Furthermore, both parties seem to have entered into a joint
arrangement, since MU is allowing the facilities to be built on its property, while EventCo will manage the
day-to-day operations. The arrangement gives the two parties joint control, since decisions about the
relevant activities require the unanimous consent of the parties sharing control.
In this case, both MU and EventCo have equal representation on the board (two members each), so
presumably all decisions would have to be unanimous to proceed. An examination of the agreement (if
there is an actual agreement in place) would be useful to determine whether any one party has more
power over relevant decisions than another, since this would indicate that one party actually controls
instead of having joint control.
However, since both parties jointly approve the annual budget for the facility, it seems like this is
another indication that both MU and EventCo need unanimous consent when making operational and
financial decisions for NewCo. Therefore, joint control exists.
(While a number of candidates recognized that there was an accounting issue relating to MU and
EventCo, not all of them first considered whether the two parties had entered into a joint arrangement
before they got into a discussion of how to account for MU’s interest. Most candidates who did address
the question of whether a joint arrangement had been entered into were able to apply relevant simulation
facts to their discussion to provide a useful analysis.)
96
Further analysis is required (for example, we need to examine the framework agreement between the two
parties) to determine whether this arrangement is classified as a joint operation or a joint venture, since the
accounting for their interest would differ based on the conclusion. A joint arrangement can either be a joint
operation (rights to assets and obligations for liabilities relating to the arrangement) or a joint venture (rights
to net assets of the arrangement). Several areas must be considered to determine whether this is a joint
operation or a joint venture:
1. Legal form of the joint arrangement structured through a separate vehicle and terms of the contractual
agreement:
(a) Structure and legal form of the arrangement through a separate vehicle
In this instance, MU and EventCo have structured their arrangement through an incorporated
company (NewCo). An incorporated company meets the definition of a separate vehicle.
(b) Legal right
In this case, NewCo is an incorporated entity, which indicates that the assets and liabilities held
within NewCo are the assets and liabilities of NewCo. The arrangement has the characteristic of a
joint venture since the incorporation enables the separation of the entity from its owners. As a
consequence, the assets and liabilities held in the entity are the assets and liabilities of the
incorporated entity. Therefore, the assessment of the rights and obligations conferred upon the parties
by the legal form of the separate vehicle indicates that the parties have rights to the net assets of the
arrangement.
(c) Contractual rights
Details of the joint arrangement would have to be obtained to determine whether the parties modified
the features of the corporation through their contractual arrangement so that each has an interest in
the assets of NewCo, as well as whether each is liable for the liabilities of NewCo in a specified
proportion.
However, because the arrangement is structured through a corporation, it unlikely that a contract will
override the legal form. Therefore, this supports a joint venture.
2. Other facts and circumstances:
It is also necessary to consider whether MU and EventCo have designed the arrangement so that
NewCo’s activities primarily aim to provide both participants with rights to substantially all of the
economic benefits of the assets in NewCo and if it depends on MU and EventCo on a continuous basis
for settling the liabilities relating to the facility’s activities. While each party has provided a guarantee,
paragraph B27 of IFRS 11 indicates that guarantees should not be taken into account when determining
obligations for liabilities. Since the assets do not generate an output (like, for example, oil or gold),
neither party obtains the rights to substantially all of the economic benefits of the assets. This is further
supported by the fact that NewCo must settle its debts with funds generated by its operations, and those
debts are not satisfied on a continual basis by the investors (MU and EventCo).
97
Thus, MU’s interest is a joint venture, and the investment in NewCo should be accounted for using the
equity method.
(Many candidates quickly concluded that MU’s interest represented a joint venture, strictly because of
the existence of NewCo. Those candidates did not consider contractual rights or other facts and
circumstances related to the joint arrangement. Their analysis was very brief. In addition, some
candidates used the existence of the loan guarantee as a reason for supporting joint venture
classification, contrary to technical guidelines that they provided in their response.)
Further information would have to be obtained to determine whether MU had in fact contributed anything
to NewCo by June 30, 2014 (for example, the land that the sports field and parking facility are to be
constructed on). Such a contribution would have to be reflected as a sale of assets in MU’s financial
statements, and MU would recognize a portion of any gain arising as a result of that transaction.
(Few candidates considered that additional information should be sought in order to assist with
accounting for this venture.)
Revenue
Per the accounts receivable supervisor, all amounts received in the year are recorded as revenue.
Specifically, it is likely that the $7.5 million grant funds received for the Community Learning Centre in
July 2013 were recorded fully as revenue in the year. However, IAS 20 — Government Grants states that
receipt of a grant itself does not provide conclusive evidence that the conditions attached to the grant have
been or will be fulfilled. Furthermore, a government grant is not recognized under IAS 20 until there is
reasonable assurance that the entity will comply with the conditions attached to it.
It appears that the grant has certain conditions attached to it (per Capital Accountant, “if we spend less on
the project, or if some expenses are deemed ineligible by the government, we have to repay any unused or
ineligible funds”). With an expected project completion date of May 2015, it is too early to determine if all
conditions will be met.
(Some candidates recognized that there were conditions attached to the grant funding provided by the
government. However, many of them concluded that since the monies had been received by MU, the
conditions had been fulfilled. Those candidates did not consider that if the government deemed some
items as “ineligible,” then the grant funds would have to be repaid. As a result, candidates’ analysis of
the conditions attached to the grant was incomplete since reasonable assurance did not exist that MU
would comply with all of the conditions attached to the grant for the Community Learning Centre.)
IAS 20 also states that government grants should be recognized over the periods in which the expenses for
the grant-related costs are recognized. At June 30, 2014, only $600,000 in construction expenditures had
been incurred and will remain in construction in progress until the asset is put in use in May 2015, so no
expense amount for the grant-related cost has yet been recognized.
98
IAS 20 offers two presentation methods:
1. Reduce the cost of the asset by the grant, subsequently reducing depreciation expense in future
periods; or
2. Recognize the grant as deferred income upon receipt and subsequently in income, matching the
income to the depreciation expense.
Under IAS 20, revenue is overstated by the full $7.5 million because the asset is not yet in use and there is
no depreciation expense in the current period. An adjusting entry is provided.
Dr. Revenue
7,500,000
Cr. Deferred Revenue
7,500,000
(Many candidates were able to provide appropriate technical guidance from IAS 20 of the Handbook in
their responses, particularly in the area regarding presentation methods. However, subsequent
discussions demonstrated that candidates were unclear as to the proper accounting treatment for the
$7.5 million that had been received. A common error made by candidates was to remove $6.9 million
from the capital grant revenue, thereby leaving $600,000 to offset the $600,000 of expenditures in
construction in progress, which was incorrect. Candidates did not seem to understand that amounts
included in construction in progress for the Community Learning Centre represented an asset rather
than an expense. It was interesting to note that candidates were clear in their understanding that the
new student residence (also recorded in “construction in progress” at $43,300,025) was recorded as an
asset.)
Expense Accruals
According to the IFRS Conceptual Framework, a liability is a present obligation of the entity arising from
past events, the settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits. Obligations may be legally enforceable as a consequence of a binding
contract or statutory requirement, which is normally the case for services received from contracted
instructors and employees.
Since the contracted instructor invoices are a result of a past event (instruction service was provided in May
and June 2014) and are expected to result in an outflow of MU resources regardless of when the amount is
payable, a liability must be recorded. Similarly, because MU has received four days of “service” from its
employees resulting in a past event and a future expected cash outflow, it would be appropriate to record a
reasonable estimate for the unpaid period. Adjusting entries for the contracted instructor invoices and
payroll accrual follow, resulting in a decrease to net income of $400,000 and $1,030,000 respectively (being
$5,150,000 × 2 ÷ 10 business days).
Dr. Contract Expense
Cr. Accounts Payable
400,000
Dr. Salary
Cr. Accounts Payable
1,030,000
1,030,000
400,000
99
(Some candidates recognized that accruals for payroll or contracted instructor invoices or both were
incomplete, and they proposed an adjustment that should be recorded for the June 30, 2014, year end to
include those amounts. However, not all of those candidates were able to explain why the accruals should
have been recorded as liabilities, and some did not support their adjusting entries with a discussion of
what past event had given rise to the liability or recognize that an outflow of cash would be required to
settle the liability.)
Lease
If the partnership with JGC is approved by the BOD, MU will need to account for the lease in accordance
with IAS 17. A lease is classified as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership. Since the lease transfers ownership of the asset to MU for $1 on January 1, 2026,
with no conditions at the end of the lease term, we can conclude that this lease is a finance lease.
At the commencement of the lease term, MU must recognize the finance lease as an asset with an offsetting
liability in its statement of financial position at an amount equal to the fair value of the leased property or,
if lower, the present value of the minimum lease payments, each determined at the inception of the lease.
The discount rate to be used in calculating the present value of the minimum lease payments is the interest
rate implicit in the lease, if this is practicable to determine; if not, MU’s incremental borrowing rate shall
be used.
The fair value of the asset at the inception of the lease is equal to the construction costs of $23,500,000.
Any initial direct costs of JGC are unknown, but if they are presumed to be nil, then the interest rate implicit
in the lease can be calculated as 5.46%. If the interest rate implicit in the lease is not practicable to
determine, the present value of the minimum lease payments is equal to $23,808,000 calculated as
$3,200,000 (being $5,250,000 lease payment less annual operating and maintenance costs of $2,050,000) ×
7.44 (PV factor of an annuity at 4% — the rate that MU could obtain from the province— for nine years).
Since the fair value of the asset at $23,500,000 is lower than the PV of the minimum lease payments, it
would be used.
On an ongoing basis, a finance lease gives rise to depreciation expense (and corresponding reduction in the
capital asset) as well as a finance expense for each accounting period. The same depreciation policy as used
for other similar assets should be applied by MU.
(Many candidates addressed the accounting treatment of JGC’s proposed financing for the new fitness
facility, in response to the direct request of the BOD. Many of those candidates included extensive
excerpts of technical guidance from the Handbook, tied relevant simulation facts to those criteria, and
concluded that the lease would be a finance lease for MU. Some candidates continued their discussion
to demonstrate an understanding of the impact that a finance lease would have on the financial
statements of MU. Strong candidates recognized that the transfer of ownership of the building for $1 on
January 1, 2026, represented satisfaction of a criterion for a finance lease (the asset would be purchased
at a price that is expected to be sufficiently lower that the fair value at the date of transfer), which means
that the lease should be accounted for as a finance lease. Candidates spent a significant amount of time
discussing this issue, to the detriment of the breadth and depth of their analysis on other accounting
issues of concern.)
100
For Primary Indicator #7 (Performance Measurement and Reporting), the candidate
must be ranked in one of the following five categories:
Percent
Awarded
0.2%
competence.
14.6%
Reaching competence — The candidate identifies some of the relevant accounting
issues affecting MU.
43.4%
Competent — The candidate discusses some of the relevant accounting issues
affecting MU.
41.4%
Highly competent — The candidate thoroughly discusses most of the relevant
accounting issues affecting MU.
0.4%
(Candidates were provided with notes from meetings with various individuals in which accounting issues
were identified and were advised that Dr. Héroux wanted recommendations on these issues. Since a
number of issues were provided that could have been discussed, candidates were expected to provide a
reasonable analysis of several of the issues in order to be assessed as competent.)
(Candidates performed below expectations on this indicator, often discussing several issues but
frequently not in sufficient depth. While most candidates recognized that the supplemental pension plan
was an issue, their discussions of this issue were weak, providing excerpts of technical guidance only,
without tying case facts to that information. As a result, their analysis was not useful for the specific
concerns raised by the controller of the finance department. Candidates were able to sufficiently discuss
the student residence issue, the board’s request for the accounting treatment of JGC’s proposed
financing for the new fitness facility (although some did not consider the impact on the financial
statements), and the accruals.)
(Strong candidates provided responses that were well organized and covered most of the issues,
particularly the components of the student residence and joint arrangement, and provided an appropriate
analysis of the government grant for the Community Learning Centre as well as the JGC lease. Their
responses were also strong from a technical and an application perspective, since these candidates were
integrating simulation facts appropriately into their response. Many weak candidates provided several
Handbook excerpts without applying them to the specifics of this simulation or without applying them
correctly. In particular, in the discussion of the government grant issue, many candidates provided a
discussion that contradicted the technical guidance they had included in their response. For example,
several candidates provided technical guidance that suggested the grant monies should be recorded as a
reduction of the cost of the asset, but then recommended leaving the $600,000 in grant monies in revenue
to offset the $600,000 in expenditures in construction in progress.)
101
The candidate questions the ability of Jerry Decker to meet the expectations of the role of the
vice-president of finance while considering the financial position of MU.
The candidate demonstrates competence in Pervasive Qualities and Skills.
Competencies (lists the Pervasive Qualities and Skills for the entire simulation):
I-1 – Protects the public interest
I-4 – Maintains objectivity and independence
II-2 – Demonstrates leadership and initiative
II-6 – Treats others in a professional manner
III-1.1 – Gathers or develops information and ideas
III-1.2 – Develops an understanding of the operating environment
III-1.3 – Identifies the needs of stakeholders and develops a plan to meet those needs
III-2.1 – Analyzes information or ideas
III 2.2 – Performs computations
III-2.3 – Verifies and validates information
III-2.4 – Evaluates information and ideas
III-2.5 – Integrates ideas and information from various sources
III-2.6 – Draws conclusions/forms opinions
III-3.1 – Identifies and diagnoses problems and/or issues
III-3.2 – Develops solutions
III-3.3 – Decides/recommends/provides advice
III-4.1 – Seeks and shares information, facts, and opinions through written discussions
III-4.2 – Documents in written and graphic form
III-4.3 – Presents information effectively
In light of the information I have gathered and comments BOD members have made, I have outlined in this
report my particular concerns with Jerry Decker’s ability to facilitate the solutions outlined. While Jerry
alone is not responsible for controlling costs and revenues (the BOD must take some responsibility for not
having established proper policy, controls, and financial oversight), it is expected that he will perform his
duties with the public interest in mind.
Jerry has been facing increased pressure to ensure a surplus, as evidenced by the BOD desire to eliminate
deficits stated in their financial objectives. In addition, some BOD members have suggested that the BOD
is consider letting Jerry go if MU’s June 30, 2014, year-end financial statements show another deficit. The
elimination of a deficit is not without its challenges, as evidenced by continued provincial funding cuts and
a lack of an integrated information system for staff and salary planning purposes.
The combined total of the accounting adjustments I have summarized earlier suggest that MU will once
again realize a deficit for financial reporting purposes in the 2014 fiscal year (a revised deficit of $8,169,000
rather than a draft initial surplus of $1,200,000). This is prior to any additional adjustments that the
university’s auditors may identify during the completion of their audit work. These results, combined with
the BOD pressures, suggest that Jerry may be trying to present more favourable financial results. In
addition, some of Jerry’s actions and comments further suggest a motivation to ensure a surplus (i.e.,
decision to delay expense of contractor invoices, plus his comment that the surplus should limit the audit
committee requests for more information).
102
Some of Jerry’s decisions with respect to accounting issues and his inability to deal with the auditor general
recommendations in a timely manner suggest that he may simply be unqualified or uncommitted to fill his
current role as vice-president of finance. He plans to take four weeks’ vacation soon after the June 30 year
end and will be unavailable to assist with the completion of year-end adjustments for a significant period
of time. I’m not sure of the timing of MU’s year-end audit (but expect it to be near the end of July, as per
the AR supervisor’s comments), but Jerry’s absence could result in significant delays in getting that
completed. In addition, Jerry mentioned that due to the timing of his annual vacation, he hasn’t taken any
professional development courses for several years, so his technical knowledge may not be at the level that
is required for someone in such a senior position in management. Also, the recent departure of two
experienced finance department staff and the retirement of another may have contributed to some of the
issues that have occurred, or their absence may just have brought those issues to light. It would be useful
to enquire about the reasons for the departures of those individuals, as well as the results of exit interviews
with them.
In light of Jerry’s possible actions, the BOD comments, auditor general findings, and high turnover in his
department, at a minimum I recommend a review of Jerry’s qualifications to determine if he has the
sufficient skills, knowledge, and desire to continue in his current role. If it is determined that Jerry
deliberately manipulated the financial results for his own benefit of continued employment, you will want
to work with a human resources or legal expert in order to determine your options for termination.
(The simulation contained numerous facts about Jerry, his lack of commitment to his position, and his
instructions to various finance department staff, which candidates were required to identify and take into
consideration when discussing Jerry’s performance. Some candidates were able to make those
identifications, but many struggled to provide any additional insight beyond a repetition of simulation
facts and a quick conclusion that Jerry should be fired from his position.)
(Strong candidates were able to select a variety of individual facts and tie them together in their
discussion, in which they questioned Jerry’s competence as the vice-president of finance, including his
commitment to that role and his supervisory abilities with respect to the finance department staff.)
The problems within the finance department may be indicative of a broader range of organizational structure
problems within MU. Jerry’s somewhat casual tone at the top of the finance department is ineffective and
has led to problems with financial reporting and procedures. The recent staff retirement, sick and
demotivated staff, lack of competence, and the resulting increased workload for remaining staff have
created an unhealthy environment and raises concern over the effectiveness of that area. A larger review of
the organization and how it is structured may be necessary, since these issues may extend beyond the
finance department into other areas of MU as well. The BOD must take some responsibility for the current
situation at MU since they do not seem to have established proper policies and controls, nor have they
implemented an appropriate financial oversight structure. Proper policies will allow the BOD and staff to
have a better direction, which will enable them to focus their attention on priorities that will create a more
robust organization better suited to adapt to the changing financial climate and operating areas. Once proper
policies are in place, it is vital that adequate controls be implemented to ensure that policies are adhered to
and also to create an appropriate tone at the board level, which will be communicated down to department
heads.
103
It is imperative that a vision for the continued viability of MU be established and communicated to all
stakeholders. Many recent events have brought information to the BOD’s attention that can have a
significant impact on future operations, including communication of 2014/2015 Ministry funding (at its
lowest level in the past three years, despite increasing enrollment); auditor general findings (problems
identified in prior reports seemingly not addressed satisfactorily); community partnership opportunity (MU
deciding on financing for a facility it hasn’t assessed the need for); and organizational issues (problems and
staffing shortages within the finance department; declining applications from prospective students).
MU also has to consider the long-term funding implications of repeated deficits, particularly when the
budget applications present a break-even position to the Ministry when funding is applied for. Declining
operating grant revenue, as demonstrated by the financial information provided by Jerry showing a decrease
of 3.2% from 2013 to 2014, is also a concern, since it seems to be a downward trend (2014/2015 operating
grant revenue will be $95,465,000, a decrease of 7.1%). While governments traditionally have continued
to provide funding to universities experiencing deficits, at some point those funds could be provided with
restrictions attached (for example, the Ministry may appoint someone to oversee operations at MU or to
complete a financial review in order to improve oversight and accountability), which could have an impact
on MU’s operations and the ability to satisfy its objectives.
In addition, MU seems to be entertaining the JGC offer to construct a new fitness facility, without first
assessing whether a new facility would be necessary. The viability of the project should be assessed first,
before the method of financing is agreed upon. It may be that an upgrade of existing facilities would be
sufficient to satisfy users, rather than a completely new facility.
Overall, by implementing the solutions I have recommended in this report, MU may be able to meet the
SPOs that the government uses when considering future funding commitments. The improvement of
controls and information systems to track and report performance measures in an accurate and timely
manner will assist MU in budgeting and decision-making to reduce future deficits. However, this is merely
the beginning of the process that MU should undertake to evaluate its continued future.
(Few candidates took the time to step back and consider the larger issues related to MU overall, such as
existing oversight and accountability on aspects of MU operations, repeated past deficits combined with
a decrease in anticipated 2014-2015 operating grant funding, and repeated concerns expressed by the
AG. When combined and not addressed in some manner, these issues could have a detrimental effect on
the future operations of MU.)
104
For Primary Indicator #8 (Pervasive Qualities and Skills), the candidate must be
Percent
Awarded
0.8%
competence.
33.2%
Reaching competence — The candidate questions the ability of Jerry Decker to
meet the expectations of the role of vice-president of finance or considers the
financial position of MU.
53.3%
Competent — The candidate discusses the ability of Jerry Decker to meet the
expectations of the role of the vice-president of finance and considers the financial
position of MU.
12.7%
Highly competent — The candidate thoroughly discusses the ability of Jerry Decker
to meet the expectations of the role of the vice-president of finance and considers
the financial position of MU.
0.0%
(Candidates were not specifically directed to this indicator. The purpose of this indicator was to reward
those candidates who could properly identify and assess the big-picture issues related to MU. Candidates
were expected to question Jerry’s ability to meet the expectations of the role of vice-president of finance
and consider MU’s financial position. There were many obvious hints throughout the simulation that
should have led candidates to question Jerry’s competence and commitment, as well as less obvious hints
about MU’s financial position (for example, repeated deficits; lack of trust between management team
and the board). Candidates were expected to identify these issues within MU and to discuss them.)
(Candidates performed poorly on this indicator. Most candidates did not perform an assessment of the
overall situation at MU. While some were able to recognize a number of the problems with Jerry, their
discussions tended to repeat case facts, adding little value, and they quickly recommended that he should
be fired. Many candidates did not consider the big picture in MU’s situation at all. Candidates are
encouraged to always step back and perform an overall analysis of any simulation or business situation
that they encounter.)
(Overall, candidates performed below expectations on the comprehensive simulation. On the
Governance indicator (SPOs) and one of the Management Decision-Making indicators (actions and
KPIs for financial and operating objectives), candidates grappled with atypical requests that required
them to appropriately plan their approach before they began to write. On the Finance indicator,
candidates struggled with the quantitative aspects of a comparison of two financing alternatives,
performing adequately on the simpler calculation involving the JGC lease and poorly on the loan option,
and many made comparisons between the two alternatives on an unequal basis. On the Assurance
indicator, which requested help with understanding the underlying causes of problems, candidates did
not appropriately structure the format of their response to contemplate the causes.)
(As in prior years, candidates were provided with five hours to respond, while the comprehensive
simulation was developed to be a four-hour exam. There was no evidence of significant time constraints.)
105
EVALUATION GUIDE
MILLMAN UNIVERSITY (MU)
SECONDARY INDICATORS OF COMPETENCE
Secondary Indicator #1
The candidate discusses whether training instructors and consultants are employees or selfemployed individuals.
The candidate demonstrates competence in Taxation.
Competencies
IX-1.2 – Identifies and advises on compliance and filing requirements (A)
IX-3.1 – Identifies, analyzes, and advises on specific tax-planning opportunities for individuals (B)
Employees versus Self-Employed Individuals
Canada Revenue Agency (CRA) provides guidance on determining if a worker is an employee or a selfemployed individual. If it is determined that a worker is an employee, MU would be responsible for
deducting and remitting Canada Pension Plan (CPP) contributions, Employment Insurance (EI) premiums,
and income tax from remuneration or other amounts paid, similar to the requirements for other employees.
MU would also need to prepare T4s for those workers determined to be employees.
From discussions with the payroll supervisor, two groups of individuals have been identified in which the
relationship between the worker and MU should be reviewed to determine if the status is that of an employee
or of a self-employed individual:
Corporate training instructors:
o paid by contract for courses taught at their corporate facilities
o tend to work for a number of different organizations
o come from a variety of professional backgrounds
Information technology (IT) consultants:
o paid by fee-for-service contracts
o some have been with MU for over three years
o some have designated workstations at MU and MU email addresses
o some have recently attended a training program that was paid for by MU
o not enrolled in MU health benefit plan
It is necessary to determine what the intent of the individual and MU was when both parties entered into
their working arrangement — was it meant to be a contract of service (therefore, employee/employer) or a
contract for services (a business relationship; therefore, self-employed individual)? MU should review any
written agreements for these services as a starting point in determining the intent of both parties, as well as
specifics related to the provision of services and compensation.
106
Factors to consider in making the assessment include
Corporate Training Instructors
IT Consultants
How much control does MU have over the worker in terms of how and what work will be done?
The manner in which the instructor teaches the
Consultant has a supervisor at MU who may
training program may be primarily up to the
oversee their activities, including directing what
instructor (suggesting self-employment, since MU
jobs the consultant will do as well as training or
may not direct the content of the program).
direction on how to do the work (suggesting
they are an employee since a subordinate
They work for a number of different
relationship exists).
organizations, indicating the instructor is free to
work when and for whom they chose (suggesting
self-employment, since MU doesn’t control who
they work for).
Does MU provide tools and equipment to do the work?
Courses are taught at the trainer’s corporate
Some have designated workstations and email
facilities (suggesting self-employment since the
addresses at MU (suggesting employee, since
venue of program delivery is up to the instructor
MU supplies space and access to the
rather than determined by MU).
consultant, retains right of use, and would
likely be responsible for repairs to equipment
Not sure if the instructor provides their own
used).
equipment (e.g., audio-visual equipment, program
materials), but if they do, then they are more likely
to be self-employed individuals.
Who is responsible for investment and management?
Come from a variety of professional backgrounds,
MU has paid for a recent training program (and
so keeping up to date with their technical
may have paid for others), which represents an
proficiency is likely their responsibility, rather
investment in the consultant (suggesting
than MU’s (suggesting self-employed).
employee).
Work for a number of different organizations, so
There has been no capital investment, since MU
responsible for own management and have
provides designated workstations to some
developed a business presence (suggesting selfconsultants and may provide access to other
employed).
equipment necessary for completion of their
tasks (suggesting employee).
What is the opportunity for profit to the worker?
Compensated on a contract basis (suggesting selfNot enrolled in health benefit plan available to
employed) rather than on an hourly/daily/weekly
employees (suggesting self-employed).
or similar basis (suggesting employee).
Compensated on fee-for-service basis (if a type
of “flat rate” arrangement, then suggests selfemployed).
Would need to know if there are expenses that
they incur in performing their services that
aren’t reimbursed (suggesting self-employed).
107
(Some candidates who addressed this area recognized that there were two different types of contract
workers at MU (corporate training instructors and information technology (IT) consultants) and were
able to tie simulation facts to some of the specific considerations that Canada Revenue Agency (CRA)
takes into account when determining whether those workers would be considered employees or selfemployed individuals.)
There are also other factors that must be considered, but I would need more information (such as a written
agreement for services and discussions with the instructors and consultants) before I could provide any
comments:
Can the work be subcontracted or can assistants be hired? If yes and MU has no say in who is hired,
then the relationship would be that of a self-employed individual. If the work has to be performed
personally by that specific individual, then they are likely an employee.
What is the level of financial risk taken on by the worker? Employees wouldn’t be responsible for
covering their own extra expenses in providing those services, whereas self-employed persons would
be. For example, who pays for replacement of equipment (audio-visual or computer) — MU or the
worker? Who pays assistants, if they are able to be hired?
It is my preliminary conclusion that the IT consultants would be considered employees primarily because
of the length of contract (some have been with MU for over three years), but also because they have a
subordinate relationship as they are supervised by an MU employee and because MU has provided some
of them with workstations, emails, and training.
After reviewing the contracts for support of this conclusion, I would suggest discussing this matter with the
consultants and making changes to the relationship to support self-employment or putting the consultants
on MU’s payroll, reflecting the status of the relationship as that of employee/employer. For prior years, you
should be aware that if the relationship with the consultants is determined to be that of an
employee/employer, MU would be responsible for paying and remitting both the employee and the
employer portions of CPP and EI premiums, plus CRA could assess penalties and interest on those amounts
for not reporting the consultants as employees and, as well, for not remitting required payroll deductions.
The corporate training instructors would be considered self-employed individuals because they provide
their own work facilities, seem to be responsible for their own training and professional development and
tend to work for a number of different employers. Therefore, no changes to remuneration or T4 reporting
are required by MU for those individuals.
(Strong candidates considered both types of workers in their analysis, tying relevant simulation facts to
CRA considerations to provide a supported assessment of the appropriate treatment for each type. Some
of those candidates extended their discussion to identify potential consequences to MU of such a
determination by CRA (for example, penalties, interest, and late filing issues related to withholding of
payroll deductions and required remittances).)
108
For Secondary Indicator #1 (Taxation), the candidate must be ranked in one of the following
three categories:
Not addressed — The candidate does not address this secondary indicator.
Nominal competence — The candidate does not attain the standard of competence.
Competent — The candidate discusses whether training instructors and consultants are
employees or self-employed individuals.
(Candidates were provided with notes from a meeting with the payroll supervisor regarding corporate
training instructors and information technology consultants. Candidates who addressed this indicator
were expected to consider whether the training instructors and consultants should be treated as
employees or self-employed individuals for tax purposes.)
(Most candidates who did address this indicator were able to provide appropriate tax advice on whether
these individuals would be considered employees or self-employed individuals. They did so by tying
specific simulation facts to the technical considerations when making this distinction. Weak candidates
provided a brief assessment of how these individuals would be categorized for taxation purposes, and
they only considered the instructors or consultants in their analysis.)
109
OF CANADA
PAPER II
Time: 4 hours
(2) To help you budget your time during the evaluation, an estimate of the number of minutes required
for each simulation is shown at the beginning of the simulation.
**********
2014
Printed in Canada
(CONTINUED ON PAGE 2)
II
110
Appendix C — Paper II
SIMULATION 1 (80 minutes)
PonyUp Stables Inc. (PonyUp) has been a small family-run business and a fixture in the horse world of
Smalltown, Nova Scotia, for many years, offering everything a horse enthusiast could want. In the winter
of 2013, PonyUp announced it was shutting down. Despite appearing to be a busy operation, PonyUp was
unable to turn a significant profit, and the owners wanted out.
Sarah, her sister-in-law Megan, and their friend Lori have used the stables for years and were determined
to keep PonyUp open. They pooled their resources and acquired the shares of PonyUp on April 1, 2013.
The purchase was impulsive, but the friends were sure they could make the business a success. Information
on the new owners and notes from discussions with them are provided in Exhibit I.
Because PonyUp is under new ownership, the bank has requested audited financial statements. The owners
have approached your firm to conduct a first-time year-end financial statement audit.
It is now April 25, 2014, and you, CA, have just been assigned as the senior on the audit. You have obtained
draft financial statements for the year ended March 31, 2014 (Exhibit II), and have gathered other
information from PonyUp’s administrator and bookkeeper, Mrs. Devanney, as well as from the receptionist
(Exhibit III).
The engagement partner asks you to prepare the audit planning memo, including suggested procedures for
significant areas. He also asks you to address any accounting issues you identify.
111
SIMULATION 1 (continued)
EXHIBIT I
INFORMATION ON NEW OWNERS AND NOTES
FROM DISCUSSIONS WITH THEM
Lori is the town veterinarian and runs her own practice.
Sarah manages a pet store called Animal Galaxy Inc. (Animal Galaxy), which specializes in premium foods
and products for animals. She has a 20% stake in Animal Galaxy, with the remainder split equally between
her brother and her sister-in-law, Megan.
Although Megan is a co-owner in Animal Galaxy, she is not involved in its operations. She is a school
teacher and teaches horse riding lessons in her free time.
Lori, Sarah, and Megan have each purchased an equal number of common shares in PonyUp. Things have
been hectic so far, and the new owners have not had a lot of time to focus on the operations. However, all
three have faith in Mrs. Devanney, whom they have known for years. Sarah noted that there seem to be
fewer controls at PonyUp than she is used to at Animal Galaxy. When Sarah inquired, Mrs. Devanney said
she did not think it was a problem because, as the administrator of PonyUp, she is always there and never
takes a vacation.
The three owners think things are going well so far, but had a few concerns when you met with them.
“There seems to be some confusion about lesson rates,” says Megan. “Lessons are $30 an hour for all
instructors, but one of the clients mentioned that she has been paying the office $40 an hour. I’m not sure
if that’s an issue, since that money belongs to the outside instructors and we’re just collecting it on their
behalf.”
“PonyUp is bringing in a lot of cash, but it seems to go right back out again!” notes Sarah. “Mrs. Devanney
is always getting me to sign cheques. Sometimes I don’t see the related invoice, but I know Mrs. Devanney
will have it. I know there are a lot of expenses in running a business, but there are so many that it is hard to
keep up. All three of us are able to sign cheques and only one signature is required, which sometimes gets
confusing. Once, Megan and I both signed different cheques to pay the same computer supplier. When we
called the supplier to ask for a refund, he told us he had sold us two computers, although we have only one
in the office.
“These issues would not have happened at Animal Galaxy, and I’m wondering if improvements could be
made at PonyUp.”
112
EXHIBIT II
PONYUP STABLES INC.
DRAFT BALANCE SHEET
As at March 31
2014
(unaudited)
2013
(unaudited)
Assets
Cash
Accounts receivable
Income taxes receivable
Inventory (Note 2)
$
Investment in Saddle Stables Inc.
Property, plant and equipment (Note 3)
77,907
15,563
2,687
312,270
408,427
$
10,000
480,700
98,820
17,445
955
315,480
432,700
—
497,810
$
899,127
$
930,510
$
58,580
24,000
82,580
$
60,300
24,000
84,300
Liabilities
Accounts payable
Current portion of long-term debt
Long-term debt
552,000
634,580
576,000
660,300
100
264,447
264,547
100
270,110
270,210
Shareholders’ equity
Share capital
Retained earnings
$
899,127
$
930,510
PONYUP STABLES INC.
DRAFT INCOME STATEMENT
For the year ended March 31
Revenue — boarding fees
Revenue — horse riding
Revenue — service fees
2014
(unaudited)
2013
(unaudited)
$
$
Expense — service fees
Veterinary expenses
Salaries and wages
Selling, general, and administrative expenses
55,440
71,050
95,000
74,738
296,228
(6,988)
1,325
Earnings before income tax
Income tax recovery
Net loss
30,000
200,200
59,040
289,240
$
(5,663)
27,600
191,100
76,260
294,960
71,610
62,350
89,000
74,052
297,012
(2,052)
390
$
(1,662)
113
114
PONYUP STABLES INC.
EXCERPTS FROM THE NOTES TO THE DRAFT FINANCIAL STATEMENTS
For the year ended March 31, 2014
1. Accounting Policies
Financial statements are prepared in accordance with Accounting Standards for Private Enterprises
(ASPE).
2. Inventory
2014
Food and supplies
$
Horses
39,270
2013
$
42,480
273,00
0
$
315,48
0
273,000
$
312,270
Food and supplies include items used in the stables. Horses included in inventory are owned by PonyUp
and are ridden by clients. Horses are available for sale at any time.
3. Property, Plant and Equipment
Land
Building
Fencing
Riding gear
Trucks and trailers
Office equipment
Cost
$ 200,000
151,576
17,122
89,842
94,155
12,303
Accumulated
Amortization
$
—
41,099
2,671
7,811
22,750
9,967
2014
Net Book
Value
$ 200,000
110,477
14,451
82,031
71,405
2,336
$
$
$
564,998
84,298
480,700
2013
Net Book
Value
$ 200,000
114,123
15,306
81,502
83,125
3,754
$
497,810
115
EXHIBIT III
NOTES FROM DISCUSSIONS WITH MRS. DEVANNEY AND THE RECEPTIONIST
1. Boarding Fee Revenue — PonyUp has 25 stalls on site for horses. Fourteen stalls are occupied by horses
belonging to PonyUp. The other 11 are rented out to individuals who own horses and need a place to
board them. An individual wishing to board his or her horse must sign a 24-month contract and pay an
initial fee of $1,000. This fee is non-refundable and is recorded as revenue when received. In addition,
there is a monthly boarding fee of $350, which includes all food and care, as well as the stall rental. The
contract continues on a month-to-month basis after the first 24 months have passed, at which time the
rate increases to $400 a month.
2. Horse Riding Revenue — PonyUp makes each of its 14 horses available to its clients for one three-hour
riding session per day, at a cost of $50 per session. To maintain the horses’ health, PonyUp’s policy
states that a horse should not be ridden for more than three hours per day.
Megan noted that some horses seemed tired and that one had definitely been ridden for more than three
hours that day. Megan checked the schedule, and only one three-hour session had been scheduled for
that horse, so she concluded it must have been an anomaly.
3. Service Fee Revenue and Expense — PonyUp can match the 11 boarded horses with frequent riders,
allowing the horses’ owners to offset the cost of boarding their horses through riding revenue. Frequent
riders pay $1,230 per month per horse. They receive daily riding access to the same horse for a maximum
of three hours per day. PonyUp keeps $75 of this amount as a service fee and remits the remaining
$1,155 to the boarded horse’s owner.
4. Riding Lessons — Lessons are not a source of revenue for PonyUp because outside instructors provide
them directly to riders. Lesson fees are paid to PonyUp’s office and are handed over to the instructors.
5. Payments from Customers — All payments are accepted in cash or cheque only.
6. Shoeing Expense — Horses require regular shoeing. A local groomer checks all 25 horses every two
weeks and replaces shoes as necessary. His daughter has been boarding her horse at PonyUp for four
years. In exchange for his services, his daughter is not charged a boarding fee. Typically, it costs $100
to replace all four shoes on a horse; a horse has its shoes replaced on average four times a year.
7. Riding Gear — PonyUp had two sets of gently used riding gear with a cost of $14,000 that it wanted to
sell to a potential buyer, but the buyer offered too little for them. Although PonyUp does not normally
sell riding gear, it sold the sets to Animal Galaxy for $11,000.
116
EXHIBIT III (continued)
NOTES FROM DISCUSSIONS WITH MRS. DEVANNEY AND THE RECEPTIONIST
8. Saddle Stables Inc. (Saddle Stables) — During the year, PonyUp was approached by Saddle Stables,
which was experiencing financial difficulty. Because of a long-standing relationship, PonyUp agreed to
lend Saddle Stables $10,000, interest-free, under the following terms:
PonyUp must approve any major capital expenditures and significant operational decisions of Saddle
Stables.
The loan matures in five years and requires fixed annual principal payments of $2,000.
In the event Saddle Stables misses a payment, PonyUp is entitled to convert the current payment
amount into common shares of Saddle Stables. Each $2,000 converts into 10% of Saddle Stables’
common shares, up to a maximum of 50% of the stables’ outstanding common shares.
Mrs. Devanney mentioned that she’s confused by this transaction. Since it can be converted into shares,
she has classified it as an investment.
9. Staff — Mrs. Devanney is the main employee on site. A part-time receptionist works evenings and
weekends, and there are part-time stables cleaners.
10. Administrator and Bookkeeper — Mrs. Devanney opens the mail, prepares deposits for monies received,
and updates the accounting records. She makes deposits daily. She prepares bank reconciliations on a
monthly basis, but notes that she may stop doing them because the owners don’t review them anyway.
11. Receptionist — The receptionist collects all payments made on site and hands them over to Mrs.
Devanney for deposit and updating of the records. Since a horse can be ridden for a three-hour session
per day, a calendar is maintained that shows the riding schedule for each horse. Occasionally, Mrs.
Devanney asks the receptionist to collect money from a rider who is not listed on the schedule. When
this occurs, the money is collected and a note is made for Mrs. Devanney. The receptionist has been
instructed to not make the note directly on the schedule “so as not to confuse things.”
117
EVALUATION GUIDE
PAPER II, SIMULATION 1 — PONYUP STABLES INC.
To:
From:
Subject:
Partner
CA
PonyUp Stables Inc. audit planning memo, accounting issues, and recommendations to new
owners
The candidate prepares an audit planning memo and suggests procedures for the significant
areas.
Competencies
VI-2.3 – Evaluates the implications of risks for the assignment (A)
VI-2.4 – Develops guidelines to set the extent of assurance work, based on the scope and expectations of
the assignment (A)
VI-2.5 – Designs appropriate procedures based on the assignment’s scope, risk, and materiality guidelines
(A)
Potential Fraud and Overall Impact
Based on a review of the activities at PonyUp during our discussions for the audit planning, there are
indicators of fraud with respect to Mrs. Devanney’s behaviour. This has an overall impact on the audit, as
discussed throughout this memo.
(Despite the fact that most candidates identified the potential fraud, only a few of them discussed the
impact of it on the audit plan.)
118
Appendix C — Paper II — Evaluation Guide
Client Acceptance
Although there is a possibility of fraudulent activity, it appears to be related only to Mrs. Devanney and not
the owners. However, if during the audit we come across evidence that the owners might also be involved
in fraudulent activity, we should consider whether we want to withdraw from the engagement.
(Very few candidates addressed this issue.)
Risk Assessment
In assessing the risk of the audit, we need to consider factors that affect the overall risk as well as the risk
of material misstatement at the financial statement level and at the assertion level for classes of transactions,
account balances, and disclosures. Based on the following factors, the overall audit risk is assessed as high.
Factors that Affect Overall Audit Risk
PonyUp is a first-time audit for our firm, and we have no previous experience with the client or its owners.
In addition, PonyUp has never been audited before. A lack of previous scrutiny of its financial statements
makes it more likely that there will be errors in its processes and account balances, including opening
balances. As well, we are unfamiliar with its operations, which may result in us not detecting material
misstatements. All of these factors increase the overall audit risk.
On the other hand, PonyUp is a private company and the number of users (the owners, the bank, and the
Canada Revenue Agency) is limited. This decreases the overall audit risk.
Risk of Material Misstatement at the Financial Statement Level
Given our understanding of the nature of the business, its operating environment, and its control
environment, the following financial statement–level risks have been identified:
Potential fraud: Given that Mrs. Devanney may be engaging in fraud, there is a higher potential for
misstatement in the financial statements since account balances may have been manipulated to cover up
her questionable behaviour. This may make it harder for us to detect material misstatements, and Mrs.
Devanney may not be willing to provide full information or access to accounting records. Furthermore,
PonyUp only accepts cash and cheques, so misappropriation is more likely. The result is a significant
risk of material misstatement at the financial statement level.
Change in ownership: Due to the change in ownership in the current year, PonyUp has undergone some
operational changes (e.g., different people are now signing cheques), which can result in increased
likelihood of errors. Since the owners are not involved in the daily operations and are new to PonyUp,
the risk that they may not detect material misstatements in the financial statements is increased.
Lack of segregation of duties and other controls: The accounting function is largely performed by one
individual, and there are limited to no financial controls. Considering that the business only accepts cash
and cheques, this situation provides the opportunity for errors and fraud to occur without detection.
119
Risk of Material Misstatement at the Assertion Level
We also need to assess the risk of material misstatement at the assertion level for classes of transactions,
account balances, and disclosures.
Potential fraud: Because of the fraud risk I’ve identified, the completeness of revenue and occurrence of
expenses are significant risks.
Unusual and complex transactions: PonyUp has had a related-party transaction, non-monetary
transactions, new investments, and issues related to valuation and classification of the horses. The nature
of these transactions increases the risk that they may not be accounted for properly.
(Virtually all candidates addressed audit risk and provided sufficient depth in their discussions, using
multiple case facts to support their assessment that audit risk should be assessed as high.)
Materiality
CAS 320 Materiality in Planning and Performing an Audit, provides guidelines for materiality and
emphasizes the need for professional judgment. The new owners purchased the stables with the hopes of
turning it around. An income benchmark, therefore, seems to be most appropriate to use when considering
what will influence PonyUp’s future business decisions. However, given the losses in the prior and current
years, materiality calculated using profit as a benchmark is not appropriate. In addition, the bank is the main
user of the financial statements, given its request to have the financial statements audited. The bank would
also be interested in income statement performance, which would allow the bank to assess PonyUp’s cash
flow from operations and, consequently, its ability to pay. Because using profit is not feasible, using revenue
as the basis for materiality might be an acceptable alternative. However, there is some indication that
revenue may be understated due to potential fraud, so it is not ideal to use revenue as a basis for the
materiality calculation in this case. I suggest using total assets as the basis since they are fairly stable and
the majority of the assets (inventory and capital assets) are not as susceptible to manipulation.
A typical range to use for calculating materiality on a benchmark such as total assets is 0.5% to 2%. I
recommend using 1% of total assets for planning materiality. The owners and the bank will be more
sensitive to errors in this year’s audit, given the fact this is a first-year audit. However, this is counteracted
by the fact that there are not a significant number of users of the financial statements. I would, therefore,
set planning materiality at $8,991, or roughly $9,000 ($899,127 × 1%).
When performing the audit, we must consider performance materiality. Per paragraph 9 of CAS 320,
“performance materiality means the amount or amounts set by the auditor at less than materiality for the
financial statements as a whole to reduce to an appropriately low level the probability that the aggregate
of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.”
Given the risks within the organization, setting performance materiality at a fairly low level will reduce the
likelihood of missing misstatements that in aggregate would be material to the users. I suggest setting
performance materiality to 60% of planning materiality, or roughly $5,400 (60% × $9,000).
120
We may want to decrease our materiality for areas most likely affected by fraud, such as cash, revenue, and
expenses.
(Most candidates addressed materiality in their responses. However, weak candidates did not recognize
that net losses are not an appropriate basis to use to calculate materiality. In addition, some candidates
did not apply appropriate percentages to their selected benchmarks. For example, some candidates
calculated materiality using 5% of total assets.)
Approach
The audit approach will be substantive in nature since there appear to be few effective controls at present
in the operation and there are indications of potential fraud. CAS 240, The Auditor’s Responsibilities
Relating to Fraud in an Audit of Financial Statements, states that although it is not the auditor’s
responsibility to detect fraud, given the indications of possible fraud and the other risks at the financial
statement level that exist, we will be required to use increased skepticism and place less reliance on evidence
provided or prepared by Mrs. Devanney. More work will also need to be performed to quantify the impact
of any suspected fraud. In addition, if we obtain evidence of suspected fraud, we will have to reassess our
previous risk assessment on other areas of the audit where we have relied on evidence provided by Mrs.
Devanney because it may have been tampered with.
We will also need to consider the impact of unaudited opening balances. There appears to have been no due
diligence work performed related to the acquisition, and PonyUp has never been audited before, which calls
opening numbers into question. With additional substantive work, we should be able to gain comfort over
most numbers. However, due to the amount of time that has passed since the beginning of the fiscal year
and the limited number of controls surrounding inventory, we likely cannot perform procedures to preclude
a material misstatement. Because inventory is material ($39,270 after excluding horses, as discussed in the
next section), we will have to qualify our opinion for a scope limitation on the opening balance.
(The majority of candidates discussed the approach as part of their audit plan. Most of them recognized
that the lack of effective internal controls would lead to a substantive approach. Some candidates also
recognized that opening balances would need to be audited since this is a first-time audit. However, few
candidates discussed the impact that the suspected fraud would have on their audit approach.)
Procedures
Cash and Revenue — Fraud Risk
Cash and revenue are significant risk areas since most payments are received in either cash or cheque. Given
the potential fraud that may be occurring, the biggest risk is that cash is received but not recorded in the
general ledger or deposited in the bank (completeness). This may be the case, since the revenue figure
appears low even though the stables seem to be a “busy operation”.
121
It is very difficult to design procedures to determine the completeness of cash and revenue when the business
operations are cash-based. Although some procedures can be performed, it is likely that no set of procedures
can determine the full extent of any missing cash or revenue. However, some procedures can determine
whether a problem exists, such as the following:
Revenue — horse riding: We should obtain the calendar that shows the riding schedule. From that, we
can select a sample of days and ensure that the revenue resulting from the scheduling of each day was
recorded in the general ledger, and that the related cash and cheques were deposited into the bank
account. In addition, because we suspect some horse riding appointments were not on the schedule, we
should also select a sample of customers and contact them to determine which days they have scheduled
horse riding during a specific period. Then we can trace the related revenue amount to the general ledger
and the related cash or cheques deposited into the bank account. If we find discrepancies, we should
extend our testing.
Revenue — service fee: We should obtain a listing of payments remitted to third-party horse owners.
From that listing, we should select a sample and ensure the gross amount received by PonyUp and the
related payment to the boarders have been recorded in the general ledger. We also need to trace the
deposit of the gross receipt and the outflow of cash to the boarders from the bank account. However, this
test will not detect if the gross receipt was kept and no payment was made to the horse owner. Therefore,
we should ask the receptionist how many monthly horse rental agreements there are and agree that to
what is recorded in the books.
Revenue — lesson fees: Although this amount does not appear in the financial statements, we should
confirm that all monies received have been remitted to instructors, since there is a risk that Mrs.
Devanney is pocketing the fees. We should contact a sample of instructors to confirm with them that
they have received the funds related to the hours they taught in a particular period. We should also
confirm with a sample of customers how much they paid for the lessons and investigate any differences
from $30 an hour. Again, if we find potential fraud from this procedure, we will need to extend our
testing.
In addition, substantive analytical procedures could be performed over revenues to determine
reasonableness. For example, given that we know the number of stalls available for boarding, we could
determine what the maximum revenue per year would be if PonyUp were at maximum capacity. We could
also obtain an estimate of occupancy rates during the year from the owners to determine whether the revenue
recorded is reasonable.
(Very few candidates identified the need to provide procedures related to the cash and revenue fraud risk.
However, those who did provided relevant procedures to address the risk.)
122
Expenses — Fraud Risk
In one instance during the year, two computer invoices were paid, but it appears that only one computer is
being used at the office. This may be an indication of fraudulent use of business funds for personal expenses.
Therefore, there is a significant risk that expenses recorded are not all business expenses. In order to
determine whether theft occurred and to quantify it, we will need to do detailed expense testing. This may
involve selecting a sample of expenses from a listing of cheques issued and vouching the amounts back to
the invoice, paying specific attention to the nature of each expense. If an expense item is found to be of a
personal nature, we should attempt to quantify the amount by extending our investigation in the areas in
which personal expenses were identified.
(Virtually no candidates provided procedures related to potential fraudulent expenses.)
Related-Party Transactions
A related-party transaction occurred when PonyUp sold riding gear to Animal Galaxy Inc. (Animal Galaxy).
The risk is that it is not recorded at the proper amount in accordance with ASPE (accuracy). We first need
to ensure that Animal Galaxy is in fact a related party by confirming with Sarah and Megan their percentage
ownership of Animal Galaxy through inquiry or a written confirmation. We should then confirm that
PonyUp does not in fact sell riding gear in its normal course of operations. This can be done by either
inquiring with the owners or reviewing the general ledger to ensure there are no transactions related to the
sale of riding gear. We can also recalculate the change in ownership for the gear to ensure it meets the 20%
threshold for substantive change in ownership interest (see discussion under “Accounting Issues”). Finally,
we need to determine if the $11,000 exchange amount can be confirmed by independent evidence. We could
attempt to determine the value of the riding gear by reviewing the rejected offer from the potential buyer or
researching the cost of used gear online.
If we confirm that the accounting criteria to record the gear at the exchange amount are not met and the
transaction should be recorded at carrying amount, we should vouch the $14,000 to supporting
documentation, such as an agreement or an invoice. We should also vouch the $11,000 received from
Animal Galaxy.
There is a risk that other transactions with related parties (completeness) have also not been properly
identified. For example, it is possible that Lori is providing vet services to PonyUp, since she may be the
only vet in Smalltown. It is also possible that the owners might board their own horses, if they own any, at
PonyUp. We should ask the owners if there are other transactions of this nature and be alert when testing
other balances in case other related-party transactions come to light.
(Fewer than half of the candidates attempted to address this risk area, but the majority of those who did
provided relevant procedures that addressed some of the key risks. Weak candidates tended to focus on
the existence of the transaction, rather than how to measure the transaction or determine whether there
were other related-party transactions.)
123
Non-monetary Transactions
The non-monetary transaction in which the horse groomer exchanged boarding for shoeing of the horses
requires that we understand the correct measurement of the transaction to ensure it is properly recorded in
accordance with ASPE and at the correct amount (accuracy). We should obtain support for what PonyUp
has provided in services by confirming with the groomer that his daughter has had a horse boarding with
PonyUp for the past year. The value of the boarding service should also be vouched to a price list or invoice.
In addition, we should research the market price for shoeing a horse in the Smalltown area by inquiring of
the horse groomer or checking online. We should also obtain support that the transaction has commercial
substance by recalculating the cash flows for both the horse boarding and the shoeing.
(Fewer than half of the candidates addressed the non-monetary transactions. However, most of the
candidates who did provided specific and relevant procedures. Weak candidates did not provide
procedures that were linked to the most significant risks. For example, many recommended that the
general ledger be reviewed to ensure the transaction had been recorded. However, the more significant
risks related to this transaction were around the ASPE criteria being met or the amount the transaction
should be recorded at.)
Revenue — Non-refundable Fee (Boarding Fees)
The risk associated with boarding revenue is that the non-refundable fee has not yet been earned but has
been recognized (existence and accuracy). We should perform audit procedures to ensure revenue is
recorded in accordance with ASPE. We should obtain the contract and review it to assess if any additional
products or services are provided as a result of the fee. This will help to assess when PonyUp transfers risks
and rewards to the boarders (see discussion under “Accounting Issues”). If services are not provided, we
should ensure the deferred revenue calculation is accurate by reviewing the start dates of the contract,
recalculating the deferred amount, and comparing it to the general ledger.
(This area was the one most frequently addressed by candidates. Most candidates were able to provide
adequate procedures related to the non-refundable fee. Weak candidates focused on providing
procedures surrounding the existence and accuracy of the $1,000, without recognizing that only a portion
of the $1,000 should appear on the financial statements as revenue.)
Revenue – Gross versus Net (Service Fees)
In addition to the fraud risk discussed above, there is a risk that service fees are recorded at gross instead of
net amounts (presentation). We should review the contracts for service fees for terms that relate to inventory
risk, credit risk, et cetera, to ensure the ASPE criteria have been met (see discussion under “Accounting
Issues”). In addition, the contract should be reviewed to ensure the $75 service fee retained by PonyUp is
accurate.
(Approximately half of the candidates attempted to address this area. While most of them were able to
provide a valid procedure, weak candidates struggled with how to audit the gross versus net criteria and
only focused their procedures on verifying the accuracy of the $75 fee.)
124
Investment in Saddle Stables Inc. (Saddle Stables)
The investment in Saddle Stables is a new transaction that occurred during the year. In order to determine
whether the amount is recorded appropriately under ASPE and at the correct amount (accuracy), we should
review the agreement between PonyUp and Saddle Stables to confirm the amount, as well as the terms and
conditions of the transaction. We can also confirm the terms and the amount directly with Saddle Stables.
(Approximately one-third of the candidates provided procedures in this area, and they were generally
well done.)
Horse Inventory (versus Property, Plant and Equipment)
The main risks regarding the horses owned by PonyUp are related to classification and valuation. We will
need to discuss with management the primary use of the horses (whether to provide riding services or to be
sold) to determine if property, plant and equipment is the appropriate classification (see discussion under
“Accounting Issues”). We can corroborate management’s response by checking if any horses have been
sold in the last few years.
We will also need to look at the valuation of the horses. Most likely the amount currently recorded in the
books is the cost of the horse. We can verify this by vouching to purchase documentation. We will need to
calculate an appropriate depreciation rate and method. We will also need to support the client’s estimates
by obtaining an independent estimation of each horse’s useful life by, for example, hiring a veterinarian.
The veterinarian could also help determine the value of the horses and whether there is any impairment of
them, particularly since there are indications that they are being overworked.
(Fewer than half of the candidates provided procedures in this area. Most of those who did were able to
provide procedures that would cover the risk related to this asset.)
Communication with Those Charged with Governance
If the results of the procedures above indicate Mrs. Devanney is involved in potential fraud, it will be
important to discuss the issue with those charged with governance (the three owners), assuming there is no
indication that they are involved in the potential fraud as well.
(Candidates rarely addressed the need to communicate the potential fraud to those charged with
governance.)
125
Internal Control Recommendations
We have made suggestions to the owners regarding internal control improvements at PonyUp (see “Control
Breakdowns and Recommendations for Improvement” later in this memo). If any of the controls are
implemented and create a self-review threat to independence, we will have to ensure we put safeguards in
place for next year’s audit of the financial statements.
(Candidates generally did not discuss this issue.)
Percent
Awarded
0.1%
competence.
6.2%
Reaching competence — The candidate attempts to discuss some of the planning
elements of the engagement and provides some audit procedures for the identified
risk areas.
34.7%
Competent — The candidate discusses some of the planning elements of the
engagement and discusses some audit procedures for the identified risk areas.
58.8%
Highly competent — The candidate discusses some of the planning elements of
the engagement and discusses some audit procedures for the identified risk areas,
including a discussion of the implications of potential fraud on the audit.
0.2%
(Candidates were asked to prepare an audit planning memo, including suggested procedures for the
significant areas. To achieve competence, candidates were expected to provide a reasonable audit plan
and valid procedures to address some of the significant risk areas of the audit.)
(Most candidates performed adequately on this indicator. More than half of the candidates were able to
address all of the components of the audit plan (risk, approach, and materiality) in sufficient depth and
provide specific procedures relevant to PonyUp.)
(Weak candidates provided audit plans that were generic, often including comments that could apply to
any scenario. Weak candidates also struggled to provide a good explanation of the significant risks of
the audit, or they provided procedures that wouldn’t address the most significant risks.)
(Strong candidates were able to provide good coverage of the issues and suggested procedures that were
specific to the risk they had identified. Strong candidates also provided a good audit plan that included
a discussion of risk factors that were specific to PonyUp. Many of these candidates did a good job of
integrating their procedures and their analysis of the accounting issues. Although this approach was not
required, it seemed to help candidates provide a better coverage of the areas at risk.)
126
(However, the Board was disappointed that most candidates did not address how the potential fraud
would affect the audit plan. Many case facts pointed towards Mrs. Devanney’s potential commitment of
fraud, such as lack of vacation, double-booking of horses, overcharging for riding lessons, and personal
expenses possibly being paid by PonyUp. While most candidates picked up on this potential fraud, the
vast majority did not think of adjusting the audit plan to take it into consideration.)
The candidate discusses the accounting issues.
Competencies
Accounting Issues
Related-Party Transactions
During the year, PonyUp sold riding gear to Animal Galaxy for $11,000. Animal Galaxy is owned by Sarah,
who has a 20% stake, and the remainder is held by Megan (her sister-in-law) and Megan’s husband. Per
Handbook Section 3840, Related Party Transactions, Sarah and Megan are both related to PonyUp because
they are both “an individual having ownership interest in the reporting enterprise that results in significant
influence or joint control” (paragraph 4(e)). Furthermore, Megan’s husband is considered a related party as
a spouse of Megan, since he is a “member of the immediate family of individuals described in (e)
(immediately family comprises an individual’s spouse and those dependents on either the individual or the
individual’s spouse)” (paragraph 4(f)). Finally, Animal Galaxy is considered a related party to PonyUp
because it is “an enterprise that directly or indirectly, through one or more intermediaries, controls, or is
controlled by, or is under common control with, the reporting enterprise” (paragraph 4(a)).
Related-party transactions must follow the guidance laid out in Section 3840. Following the decision tree
for determining appropriate measurement, we must first consider whether the transaction is in the normal
course of operations for PonyUp, since paragraph 18 states, “a monetary related party transaction, or a
non-monetary related party transaction that has commercial substance, shall be measured at the exchange
amount when it is in the normal course of operations, unless paragraph 3840.22 applies.” In this case, the
transaction is not in the normal course of operations since PonyUp does not typically sell riding gear.
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Next, we must consider whether the change in ownership interest of the item transferred is substantive and
whether the exchange amount is supported by independent evidence per paragraph 29: “When a monetary
related party transaction or a non-monetary related party transaction that has commercial substance is not
in the normal course of operations, it shall be measured at the exchange amount when (a) the change in
ownership interests in the item transferred or the benefit of a service provided is substantive; and (b) the
exchange amount is supported by independent evidence.” Per paragraph 35, “A change in the equity
ownership interest in an item transferred, or the benefit of the service provided, is presumed to be
substantive when a transaction results in unrelated parties having acquired or given up at least 20 percent
of the total equity ownership interests in the item or service benefits, unless persuasive evidence exists to
the contrary.” The only unrelated party in this transaction is Lori. Lori, before the riding gear was sold,
owned 33% of the gear, since PonyUp owned the gear and she owns 33% of PonyUp. After the sale, she
owns 0%, since Animal Galaxy now owns the gear and she has no ownership in Animal Galaxy. This would
indicate that the change in ownership is substantive, since it is over 20%.
In addition, we must consider whether the amount of the exchange ($11,000 in this case) is supported by
independent evidence. On the one hand, independent evidence might suggest the value to be close to
$14,000, since that is the cost of the gear and the gear is in good condition. On the other hand, the potential
buyer did not offer enough for PonyUp to sell to them. It is unclear whether there would be independent
support for this value. We will need to determine at what price the used gear can be sold. If it is an amount
other than $11,000, the transaction should be measured and recorded at the carrying amount of $14,000.
Otherwise, the transaction should be measured and recorded at the exchange amount of $11,000.
Assuming the transaction is recorded at the carrying amount, the difference between the carrying amount
and the cash received ($3,000) would be recorded in retained earnings.
(Approximately half of the candidates attempted to address this accounting issue, but their analysis of
the Handbook criteria was generally weak. Many candidates did not consider all of the relevant criteria
that should have been applied when determining the appropriate accounting treatment for this
transaction. In particular, candidates struggled with the concept of substantive change in ownership
interest, since they didn’t appear to know how to determine whether there was a change in ownership.)
Non-monetary Transaction
PonyUp entered into a non-monetary transaction relationship with a local horse groomer for the shoeing of
its horses. In exchange for his services, his daughter does not pay the rental fee on the boarding of her horse.
The rental fee would be $400 per month (given she has been using the services for four years and thus the
initial two-year fee of $350 per month would have passed), or $4,800 per year. The cost of shoeing a horse
is $100, and it needs to be done an average of four times a year. For PonyUp, this equates to at least 14
horses owned by PonyUp plus a maximum of 11 horses boarding, since this is the maximum capacity. At
the most, it would mean 25 horses at $400 each, or $10,000.
Handbook Section 3831, Non-monetary transactions, indicates in paragraph 6 that
An entity shall measure an asset exchanged or transferred in a non-monetary transaction at the
more reliably measurable of the fair value of the asset given up and the fair value of the asset
received, unless:
(a) the transaction lacks commercial substance;
(b) the transaction is an exchange of a product or property held for sale in the ordinary course
of business for a product or property to be sold in the same line of business to facilitate
sales to customers other than the parties to the exchange;
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(c)
neither the fair value of the asset received nor the fair value of the asset given up is reliably
measurable; or
(d) the transaction is a non-monetary non-reciprocal transfer to owners to which paragraph
3831.14 applies.
Paragraph 11 further states that “a non-monetary transaction has commercial substance when the entity’s
future cash flows are expected to change significantly as a result of the transaction.”
The exchange has commercial substance because the difference between the asset received and the asset
given up is significant in value. As a result of this transaction, PonyUp is improving its cash flow by $5,200
per year ($10,000 − $4,800) by not having to pay for shoeing. Criterion (a) is, therefore, not met. The
services being exchanged are not interchangeable, so criterion (b) is not met. Both fair values are known
and can be reliably measured, so criterion (c) is not met. The transaction is not a non-reciprocal transfer to
owners since it is a reciprocal exchange with an unrelated party, so criterion (d) is not met.
Because none of the exceptions are met, the transaction should be recorded at the more reliably measured
of the fair value of the asset given up and that of the asset received. Per paragraph 10, when an entity is able
to reliably determine the fair value of both the asset received and the asset given up, the fair value of the
asset given up is used to measure the asset received unless the fair value of the asset received is more reliably
measurable.
PonyUp is able to measure the fair value of both the asset given up and the asset received. In addition, it
does not appear that the fair value of the asset received is more reliably measurable. Therefore, the
transaction should be recorded at the $4,800 value of the boarding fees that PonyUp has given up during
the year.
(Most candidates attempted a discussion of this accounting issue, but once again their analysis of the
Handbook criteria was generally weak. Many candidates were confused by the concept of commercial
substance and struggled to explain it appropriately using case facts. In addition, some candidates did not
demonstrate their knowledge of the Handbook criteria in their accounting conclusion and incorrectly
recommended that the assets received and the assets given up be recorded at their respective fair values,
with the difference recorded as a gain or loss.)
Revenue — Non-refundable Fee
PonyUp charges for boarding with a $1,000 initial fee due at the beginning of the contract, plus $350 per
month. The initial fee is non-refundable. The $350 fee is for 24 months, after which the fee increases to
$400 per month. The question is around the recognition of the $1,000 initial fee, which at present is recorded
as revenue when received.
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Handbook Section 3400, Revenue, indicates that
.04 Revenue from sales and service transactions shall be recognized when the requirements as to
performance […] are satisfied, provided that at the time of performance ultimate collection is
reasonably assured.
.06 In the case of rendering of services and long-term contracts, performance shall be determined
using either the percentage of completion method or the completed contract method, whichever
relates the revenue to the work accomplished. Such performance shall be regarded as having been
achieved when reasonable assurance exists regarding the measurement of the consideration that
will be derived from rendering the service or performing the long-term contract.
.07 Performance would be regarded as being achieved under paragraphs 3400.05-.06 when all
of the following criteria have been met:
(a) persuasive evidence of an arrangement exists;
(b) delivery has occurred or services have been rendered; and
(c) the sellers’ price to the buyer is fixed or determinable.
Persuasive evidence of an arrangement exists since a contract is signed at the beginning of the 24-month
period. The sellers’ price is determinable, since we know it is $1,000. The question surrounds whether
services have been rendered for that amount. Because the initial fee of $1,000 is non-refundable and it is
unclear whether it is directly linked to any additional services, PonyUp may be able to support that it is
earned at the time it is received. However, PonyUp must demonstrate that its performance related to the
$1,000 is complete at the point of payment. If, at this point, PonyUp is not obligated to provide anything
else to the boarder directly related to the fee, then revenue can be recorded assuming collection is assured,
since the amount is known.
However, looking at the substance of the transaction, it appears that the $1,000 initial fee results in a reduced
boarding rate for the term of the contract that it relates to. The monthly fee is lower for the 24-month period
that the $1,000 relates to and then increases subsequently. In substance, this would seem to be a pre-payment
of boarding fees for the course of the 24 months. It would, therefore, appear that the risks and rewards
related to the $1,000 will transfer over the course of the contract and not at initial receipt of payment, since
at that time PonyUp is still obligated to fulfill the boarding agreement.
The $1,000 should be deferred and recognized into revenue over the 24 months, at $42 per month, bringing
the monthly boarding fee to $392, which is close to the amount charged once the contract has passed the
first 24 months.
(This was the accounting issue most often addressed by candidates. Most candidates discussed this issue
well, tying in case facts, such as the fact that the service is to be delivered over 24 months and that the
monthly fee increases after the 24-month period.)
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Revenue – Gross versus Net
PonyUp organizes the riding schedule for some of the 11 horses that are owned by individuals but boarded
at PonyUp. PonyUp collects $1,230 per month for each horse. Of that, $1,155 is paid to the owner and $75
is retained as a fee for the service. Currently, the $1,230 per month per horse appears to be recorded in the
financial statements under “Revenue — service fee” and the $1,155 per month per horse is recorded as
“Expense — service fee.”
Handbook Section 3400, Revenue, indicates in paragraph 23 that “revenue includes only the gross inflows
of economic benefits received and receivable by the entity on its own account. Amounts collected on behalf
of third parties such as sales taxes and goods and services taxes are not economic benefits that flow to the
entity and do not result in increases in equity.”
Paragraph 24 further states:
.24 An entity is acting as a principal when it has exposure to the significant risks and rewards
associated with the sale of goods or the rendering of services. Features that indicate that an entity
is acting as a principal include:
(a) the entity has the primary responsibility for providing the goods or services to the customer
or for fulfilling the order (for example, by being responsible for the acceptability of the
products or services ordered or purchased by the customer);
(b) the entity has inventory risk before or after the customer order, during shipping or on return;
(c)
the entity has latitude in establishing prices, either directly or indirectly (for example, by
providing additional goods or services); and
(d) the entity bears the customer’s credit risk for the amount receivable from the customer.
One feature indicating that an entity is acting as an agent is that the amount the entity earns is
predetermined, being either a fixed fee per transaction or a stated percentage of the amount billed
to the customer.
PonyUp does not have the primary responsibility for providing the horse for riding; it is at the discretion of
the owners. PonyUp also has no inventory risk, given that the horses do not belong to it. It is unclear whether
PonyUp sets the prices for the riding, but this might be the case to ensure consistency of fees. It appears the
owners bear the majority of the credit risk, since they do not get the $1,155 if a customer doesn’t pay, but
PonyUp would only miss out on the $75 fee. Finally, the fee that PonyUp earns is fixed per transaction.
It appears that PonyUp is merely collecting and remitting the funds to the owners of the horses and bears
only a small portion of the risks and rewards of the transaction. If this is the case, the monies collected
should be established as a liability, and only the $75 fee should be recorded as revenue. Therefore, $55,440
should be removed from both the “Revenue — service fee” and the “Expense — service fee” lines on the
income statement. However, consideration should be given to whether PonyUp is taking on the credit risk
of a customer not paying. If PonyUp has to pay the horse owner regardless of whether the frequent rider
pays, there may be some argument to record the amounts on a gross basis.
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(Most candidates attempted a discussion of this accounting issue but were not able to provide sufficient
depth in their discussion. Many candidates addressed only one of the relevant factors when considering
whether PonyUp was a principal or an agent, and then concluded on the accounting treatment without
further analysis.)
Investment in Saddle Stables
During the year, PonyUp provided an interest-free loan to Saddle Stables in the amount of $10,000. The
loan contains certain terms that allow PonyUp to exert a significant amount of influence on Saddle Stables.
In addition, it contains the ability for PonyUp to convert a portion of the loan into equity if any payment is
in default.
There is a question of whether this transaction is a loan or an investment. It is important in this case to
consider the substance of the transaction over the form, as paragraph 18 (a) of Handbook Section 1000,
Financial Statement Concepts, requires that transactions be faithfully represented, and states that “the
substance of transactions and events may not always be consistent with that apparent from their legal or
other form. To determine the substance of a transaction or event, it may be necessary to consider a group
of related transactions and events as a whole. The determination of the substance of a transaction or event
will be a matter of professional judgment in the circumstances.”
The first consideration is whether this transaction contains the elements of a loan, consistent with its form.
Section 3856, Financial Instruments, defines a financial asset as “a contractual right to receive cash or
another financial asset from another party.” The transaction would appear to meet this definition because
it is a right to receive cash from Saddle Stables.
However, the transaction also appears to have elements of an investment, given that there is an option to
convert a portion of the loan into shares if Saddle Stables defaults on a payment. PonyUp also has a fair
amount of influence over the decisions of Saddle Stables, since they must approve any major capital
expenditures and significant operational decisions, which may indicate control (defined as “the continuing
power to determine its strategic operating, investing and financing policies without the co-operation of
others”). However, paragraph 3 of Handbook Section 3051, Investments, as well as paragraph 2 of Section
1582, Business Combinations, scopes out any transactions that qualify as a financial instrument, so these
sections would not apply to this transaction.
Therefore, the above analysis, along with the fact that the loan can only be converted into shares if Saddle
Stables defaults on a payment (which is outside of the control of PonyUp) suggests that the transaction is
more similar to a loan than an investment. The $10,000 currently recorded as an investment should be
reclassified as a loan on the balance sheet. As per Section 3856, the loan should be recorded at fair value.
This means the payments will have to be discounted based on an appropriate interest rate (a rate that would
reflect the risk of a loan to another entity similar to Saddle Stables). The difference between $10,000 and
the fair value of the loan would be recorded as an expense. Subsequently, each $2,000 payment would have
its principal component recorded against the loan asset and its interest component recorded as interest
revenue.
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(Candidates struggled with this accounting issue. Fewer than half of the candidates addressed the issue,
and most of them struggled to apply the correct Handbook sections. Many candidates were confused and
discussed this from the perspective of the borrower, and as such discussed concepts such as bifurcation,
which was not relevant in this case.)
Inventory versus Property, Plant and Equipment
Horses
PonyUp is currently recording its horses as inventory. Inventory must typically be presented at the lower of
cost and net realizable value. However, we must consider whether the horses have the characteristics of
inventory as defined by ASPE. Handbook Section 3031, Inventory, defines inventory as follows:
Inventories are assets:
(i)
held for sale in the ordinary course of business;
(ii)
in the process of production for such sale; or
(iii)
in the form of materials or supplies to be consumed in the production process or in the
rendering of services.
PonyUp appears to have classified the horses as inventory because it is willing to sell them. Although the
horses are available for sale at any time, they are held in the business for the main purpose of being ridden
as part of regular operations.
It would appear that property, plant and equipment may be a more appropriate classification. Again,
referring to the Handbook, the definition of property, plant and equipment is as follows:
Property, plant and equipment are identifiable tangible assets that meet all of the following
criteria:
(i)
are held for use in the production or supply of goods and services, for rental to others, for
administrative purposes or for the development, construction, maintenance or repair of
other property, plant and equipment;
(ii)
have been acquired, constructed or developed with the intention of being used on a
continuing basis; and
(iii)
are not intended for sale in the ordinary course of business.
The horses have been acquired for rental purposes, since this is the primary revenue source from these
horses for PonyUp. They were purchased with the intention of being rented out on a continuing basis since
horses have been maintained at the stables for years. Although the horses may be sold, the intention in
acquiring them was not for resale, so sales of horses are not intended to be in the ordinary course of business.
The horses should, therefore, be classified as property, plant and equipment and recorded at cost.
PonyUp will need to record depreciation on the horses. An appropriate measure of the estimated useful life
of these assets would seem to be the expected remaining useful life of each horse. The horses will also have
to be tested for impairment if indicators of impairment exist, which is likely since the horses appear to be
tired.
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Food and Supplies
The food and supplies appear to be appropriately recorded as inventory, since they are assets that are
consumed while providing boarding services, and thus are assets “in the form of materials or supplies to be
consumed in the production process or in the rendering of services,” as stated in Handbook Section 3031,
Inventory, paragraph 7.
(Fewer than half of the candidates addressed this issue. However, the majority who did were able to use
the relevant Handbook guidance to determine whether the horses should be recorded as inventory or
property, plant and equipment.)
For Primary Indicator #2 (Performance Measurement and Reporting), the
Percent
Awarded
0.1%
competence.
7.5%
Reaching competence — The candidate identifies some of the accounting issues.
44.9%
Competent — The candidate discusses some of the accounting issues.
46.9%
Highly competent — The candidate thoroughly discusses most of the accounting
issues.
0.6%
(Candidates were required to address the accounting issues at PonyUp. To achieve competence, the
Board expected candidates to address some of the accounting issues in sufficient depth.)
(Candidates struggled with some of the accounting issues in this indicator. While discussions
surrounding the recognition of boarding-fee revenue and whether the horses should be recorded as
inventory versus property, plant and equipment were generally well done, candidates struggled with the
more complex issues, such as related-party transactions, non-monetary transactions, and the investment
in Saddle Stables. Strong candidates were able to identify the correct accounting criteria and provide a
good discussion, applying specific case facts. Many weak candidates just provided the Handbook criteria
without taking the time to explain how the criteria would apply to PonyUp. Weak candidates also did not
identify as many of the relevant accounting issues, thereby limiting their ability to demonstrate
competence in Performance Measurement and Reporting.)
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The candidate discusses the control weaknesses that provide an opportunity for potential fraud.
Competencies
VI-2.8 – Evaluates the evidence and the results of analysis (A)
Control Breakdowns and Recommendations for Improvement
Segregation of Duties
Weakness: There is currently no segregation of duties. Although PonyUp has a receptionist who collects
cash payments to provide some segregation, she simply passes on the amounts collected to Mrs. Devanney,
which completely negates the segregation. Mrs. Devanney receives all payments — either through the mail
or as they are handed over to her by the receptionist — completes the deposit, and has full access to the
accounting records.
Implication: Mrs. Devanney would be able to pocket payments received and adjust the accounting records
(such as the bank reconciliation, which is not reviewed) to hide this.
Recommendation: At a minimum, she should not have the ability to access cash without the knowledge
of someone else. A simple fix for this in a small organization like PonyUp would be for the receptionist to
continue to collect the cash and to also start opening the mail. The receptionist should also prepare the
deposit and provide a listing of all monies received, which should be given to the owners. The monies may
then be given to the bookkeeper, who should record the receipts and complete the deposit. The owners
should then compare the amount deposited to the listing prepared by the receptionist. This will detect
whether the bookkeeper is skimming money before the deposit.
It may also be advisable for PonyUp to cease the acceptance of cash. Cash carries with it a high risk of
theft. Acceptance of credit cards and cheques would prevent cash from being stolen. If this is not possible,
the implementation of a receipt system, whereby a receipt is issued by the receptionist for all cash received,
would decrease the risk associated with accepting cash.
(Virtually all candidates addressed the segregation of duties issue. Most of them were able to identify the
incompatible duties and recommended that these duties be separated. Strong candidates recognized that
the cash-based nature of PonyUp’s business further increased the risk of the lack of segregation of
duties. Weak candidates, however, had a difficult time explaining the implication of the lack of
segregation of duties for PonyUp. Many of them simply stated in generic terms that there was an issue
with segregation of duties, without explaining specifically which duties were incompatible and what
might be the result (for example, that Mrs. Devanney could steal cash and cover it up in the accounting
records).)
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Approval of Expenses
Weakness: It was noted that two computers were purchased by PonyUp, but there appears to be only one
in the office. It seems that there are very few controls surrounding the approval of expenses. Occasionally,
cheques are signed without the owners having access to the appropriate support for the expenses they are
paying for.
Implication: This provides an opportunity for expenses to be incurred on behalf of the company that are
not legitimate (personal expenses, for example) or not in accordance with PonyUp’s policy (pricing may
be too high, for example). When cheques are signed without appropriate supporting documentation, it
increases the risk that funds are being paid to fictitious vendors. In addition, it does not provide a proper
control for reviewing the payment to ensure it is a good use of company funds.
Recommendation: All expenses over a certain limit should be approved by an owner prior to purchase,
and for all other transactions, all invoices should be approved prior to the cheques being prepared. In
addition, all invoices should be marked “paid with cheque #XXX” once a payment has been issued. That
way, the possibility of an expense being suspicious or duplicated without the owners noticing will be
reduced. Every cheque should have an invoice or other appropriate documentation attached to it at the time
of signing so that the owners can verify the validity of the expenses.
(Most candidates addressed this issue. They were able to explain why this was an issue and provide a
recommendation that addressed the situation.)
Scheduling of Horses
Weakness: The receptionist noted that sometimes riders are paying for horses when they are not on the
schedule, which suggests that not all riders are being scheduled.
Implication: It is possible that Mrs. Devanney is scheduling more riders in addition to what is expected
and keeping the payments herself. In addition, horses that are being ridden monthly are not being tracked,
providing an opportunity for Mrs. Devanney to pocket the monthly riding fee without anyone noticing.
Recommendation: The schedule should be maintained by one person, perhaps the receptionist, so that all
changes are known and documented. Monthly and daily riders should be tracked, and any additional riders
should be added to the schedule. A copy of the schedule should be posted at the stables, where riders would
be required to sign in and out to access the horses. This will allow for a record of all riding and prevent any
rides from occurring without documentation, as well as identify any riders not recorded on the schedule.
(Most candidates addressed this issue, but many were not able to provide a valid recommendation to
address the weakness. For example, many candidates suggested that Mrs. Devanney be asked to update
the schedule. Given that there were many signs that Mrs. Devanney may be committing fraud, that was
not considered an appropriate recommendation.)
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Lesson Fees
Weakness: It was noted that at least one customer was being charged a rate higher than the usual rate. This
indicates that there are no controls surrounding what rates are being charged to clients.
Implication: This may lead to clients being charged incorrect amounts, which could lead to loss of
reputation, or worse, possibility of fraudulent activity, since higher amounts can be charged to customers
than are being paid to the instructors.
Recommendation: A price list should be posted at the reception desk so that all clients are aware of what
the prices are for services.
(About one-third of the candidates addressed this issue. Although most of them were able to explain the
implication, some candidates struggled to provide a recommendation to solve this issue. For example,
some candidates suggested that Mrs. Devanney be reminded that she should charge the correct amount,
which does not address the issue, since she is likely the one who is exploiting the internal control
weakness.)
Approval of Bank Reconciliations
Weakness: Bank reconciliations are currently not being reviewed and Mrs. Devanney is considering not
doing them anymore.
Implication: As discussed above, one of the intentions of a bank reconciliation review is to allow for a
control over cash, in that an additional person is looking at the cash account. The bank reconciliation has
not been reviewed by anyone recently, which may allow Mrs. Devanney to cover her tracks if she is stealing
cash from the company, without any knowledge by the ownership group.
Recommendation: One of the owners should be responsible for reviewing the bank reconciliations and the
supporting documentation on a monthly basis.
(About half of the candidates addressed this issue. While most of them were able to provide a valid
recommendation, many explanations of the implication of the control weakness were weak. For example,
some candidates simply stated that a review of bank reconciliations is important, without explaining why
(i.e., the fact that a review allows the owners to catch errors or anomalies in the bank reconciliations).)
Cheque Signing
Weakness: Currently, only one signature is required on cheques issued by PonyUp.
Implication: Having only one signature on cheques provides an opportunity for any one of the owners to
take a significant amount of money from the company without the agreement of at least one other owner.
In addition, this provides an opportunity for Mrs. Devanney to give the same invoice to two different owners
without the owners noticing.
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Recommendation: Each cheque should be signed by two owners. This will prevent owners from being
able to withdraw money by themselves and will also ensure that if Mrs. Devanney submits a duplicate
invoice, at least one owner will see it twice.
(The majority of candidates addressed this issue, and most of those who did were able to explain the
implication and provide a valid recommendation.)
Indicators of Fraud
The owners mentioned that there seems to be a lot of cash coming in, and yet the business seems to be short
on cash. The issue may be caused by fraud occurring at PonyUp.
Mrs. Devanney’s questionable behaviour is evident throughout the organization:
1. Double-booking of horses: Megan noted some horses seemed tired and that one of them had definitely
been ridden for more than three hours that day. Megan confirmed that only one three-hour session had
been scheduled, so she concluded it must have just been an anomaly. It is possible that Mrs. Devanney
is allowing horses to be ridden more than expected based on the schedule and keeping the payments
herself. In addition, the receptionist noted there are times when money is collected from riders not
scheduled for horse riding and that she is not to note this on the schedule.
2. Overcharging for lessons: Lessons are charged at $30 an hour, but one client mentioned that she has
been paying $40 an hour to the office. It is possible that Mrs. Devanney is charging $40 and then
pocketing the $10 difference from the approved $30 rate that is forwarded to the instructor.
3. Not taking any vacation: Mrs. Devanney does not appear to take vacation. Although this may provide
the appearance of a committed employee, it is also a means of controlling what is happening and what
is being recorded in the books at all times. It is often a clue to fraudulent behaviour.
4. Possible personal expenses being paid by PonyUp: It was noted that two computers were purchased
from a supplier, but there is only one computer in the office. It is possible that Mrs. Devanney purchased
two computers but took one home, indicating another possible area of fraud.
5. Revenue recorded appears low: PonyUp appears to be a “busy operation.” Therefore, revenue should
reflect operations that are almost at full capacity. At full capacity, boarding fees would bring in $46,200
(11 stalls × $350 per month × 12 months, assuming a conservative estimate that all boarders have not
been with PonyUp for over two years), and horse riding fees would bring in $255,500 (14 horses × $50
per day × 365 days). However, amounts recorded for the year ended on March 31, 2014, are $30,000
(65% of full capacity) and $200,200 (78% of full capacity), respectively. I am not sure what percentage
of horses owned by individuals is used by frequent riders, but this revenue also appears low. If 100%
of these horses were matched with frequent riders, the revenue related to this would amount to $162,360
(11 horses × $1,230 per month × 12 months). The current revenue associated with this is $59,040,
which means four horses are being ridden by frequent riders. This may be reasonable if there are not
many frequent riders, but it may also be low. It is possible that the lower percentages are reflective of
seasonality, since there would likely be fewer riders in the winter compared to the summer months.
However, it may also be another indication that Mrs. Devanney is stealing revenue from PonyUp. I
have not come across any evidence of fraud on the boarding fees, but this is an area we may want to
investigate further, given that revenue amounts are lower than expected.
With the number of opportunities Mrs. Devanney has to commit fraud, PonyUp should conduct a full
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investigation. If we are hired for the special investigation, we should consider the need to involve a forensic
specialist. If evidence of fraud is found, PonyUp should consult legal counsel to consider whether firing
Mrs. Devanney is appropriate. In addition, PonyUp should try recouping any stolen funds it can from her.
(Almost all candidates identified that Mrs. Devanney may have committed fraud and supported their
claim with specific examples from the simulation. However, fewer than half of the candidates provided
a recommendation on the next steps for the owners to take.)
Percent
Awarded
0.3%
competence.
6.6%
Reaching competence — The candidate addresses some of the control
weaknesses, including recommendations to address them.
27.2%
Competent — The candidate discusses some of the control weaknesses, including
recommendations to address them, and recognizes the indicators of potential
fraud.
65.0%
Highly competent — The candidate discusses several of the control weaknesses,
including recommendations to address them, and discusses the indicators of
potential fraud.
0.9%
(Candidates were not specifically directed to this indicator. However, one of the owners noted that there
seemed to be fewer controls at PonyUp than she was used to at Animal Galaxy, the pet store she managed.
Also, later in the simulation she wondered if improvements could be made at PonyUp, which was a hint
to discuss controls. To achieve competence, candidates were required to address the internal control
weaknesses present at PonyUp and provide valid recommendations. Candidates were also expected to
recognize that it was possible Mrs. Devanney had already exploited some of these control weaknesses
and was committing fraud.)
(Most candidates performed well on this indicator. They were able to identify some of the control
weaknesses, explain their impact on PonyUp, and provide valid recommendations. Most candidates also
identified that Mrs. Devanney had likely exploited the lack of internal controls, and they supported the
claim with relevant case facts.)
(Many weak candidates did not provide recommendations that would address the internal control
weakness, or they suggested recommendations that were clearly impractical. In addition, weak
candidates did not always identify the fact that fraud had likely already occurred; instead, they concluded
that Mrs. Devanney may have been overworked and was simply making errors. Given the nature and
volume of case facts provided regarding Mrs. Devanney, candidates should have realized that there were
definitely indicators of fraud and addressed this concern in their response. Strong candidates recognized
the potential fraud and made recommendations as to how PonyUp’s owners should address it.)
III-1.2
III-1.3
III-2.1
III-2.3
III-2.4
III-2.5
III-2.6
III-3.1
III-3.2
III-3.3
III-4.1
III-4.2
III-4.3
139
– Develops an understanding of the operating environment
– Identifies the needs of stakeholders and develops a plan to meet those needs
– Analyzes information or ideas
– Verifies and validates information
– Evaluates information and ideas
– Integrates ideas and information from various sources
– Draws conclusions/forms opinions
– Identifies and diagnoses problems and/or issues
– Develops solutions
– Decides / recommends/provides advice
– Seeks and shares information, facts, and opinions through written discussion
– Documents in written and graphic form
– Presents information effectively
There were no secondary indicators in this simulation.
(Candidates performed well on this simulation. The requireds and issues were fairly straightforward,
and candidates were able to sufficiently incorporate case facts into the majority of their analyses.
Candidates performed the best on Primary Indicator #3, since most of them were able to identify the
control weaknesses and provide adequate recommendations for several areas, as well as identify the
potential fraud. For Primary Indicator #1, candidates tended to struggle most often in providing relevant
procedures that would address the specific risks, and they often failed to describe how the suspected
fraud would affect the audit. For Primary Indicator #2, candidates did well on the more basic issues
(recognition of boarding-fees revenue and whether the horses should be recorded as inventory versus
property, plant and equipment), but struggled with the more complex ones (related-party transactions
and non-monetary transactions). Candidates are expected to understand the technical guidance related
to the accounting issues presented and apply the relevant case facts to their analysis.)
140
It is February 20, 2014. You, a new CA in the firm of Lebarre & Laramie, have just received a visit from
Carl Carlson, a new personal tax client.
“Hey, CA, I guess it’s that time of year when the government comes knocking for all my hard-earned
money, eh? Anyways, I was hoping you could help me out. I’ve been doing my own thing for the past few
years as a contractor building homes under the business name of Carlson Contracting, and it’s been good.
But this past year, I did so well that I’m a little nervous about my taxes. Could you take a look at my
numbers and let me know what size of federal tax bill I’ll be facing? My contractor buddies at the coffee
shop have been bragging about their corporations and how they’ve been saving taxes. I’m starting to wonder
if it’s time for me to do something. Could you tell me what my total 2013 federal tax bill would have been
if I had been incorporated? I wonder if it would really save me that much in taxes. I would say that my
family and I need $100,000 in pre-tax salary a year to live on. Here is my balance sheet and income
statement (Exhibit I), as well as some tax stuff and other notes about my business (Exhibit II).
“I was also wondering if you could help me with some decisions I need to make. With the growth in my
business, I need to get my own workshop. My wife is really tired of me having all my equipment in the
garage. I have been weighing a few options (Exhibit III). Maybe you can help me out?”
After the visit, you go back to your office, and your manager happens to stop by. “I heard you were just
talking to Carl. He spoke to me as well. Because his business is expanding, he is exploring bigger projects,
which will require him to be bonded. The insurance company that provides bonding to contractors requires
reviewed financial statements using Accounting Standards for Private Enterprises (ASPE). Can you look at
the financial statements and let me know what accounting issues need to be addressed for a review? His
wife does all the bookkeeping, but she has no formal accounting training, so the statements likely need
some adjustments.”
141
EXHIBIT I
CARLSON CONTRACTING
DRAFT BALANCE SHEET
As at December 31, 2013
Assets
Note
Cash
Inventory
Property, plant and equipment
$
58,449
100,000
704,987
$
863,436
$
22,898
57,664
80,562
1
2
Liabilities
Bank indebtedness
Accounts payable
Equity
Owner’s equity
782,874
$
863,436
Notes:
1. The inventory represents construction in progress for a house I am building for a customer. The selling
price is $300,000, and the customer has paid my usual deposit and signed the purchase agreement. The
house will be two storeys and is going to cost me about $225,000 to build. So far I have excavated the
land and poured the foundation at a cost of $100,000.
2. Included in property, plant and equipment is a small piece of land I purchased during the year. I am
certain I can make a lot of money from it — it is in an excellent location and would be a prime spot for
an apartment building. The city by-laws in the area restrict buildings to 10 storeys high unless the land
owner purchases a licence from the city, which I did after I bought the land. I can now build up to 28
storeys on the land. Shortly after, the city stopped issuing licences in that location for buildings taller
than 10 storeys, so the licence is especially valuable now. I paid $400,000 for the land and $100,000 for
the city licence. I plan on just holding onto the land until a developer approaches me and offers me lots
of money. I may build on it myself if I have the money down the road, but I would rather sell.
142
EXHIBIT I (continued)
CARLSON CONTRACTING
DRAFT INCOME STATEMENT
For the year ended December 31, 2013
Sales
Cost of sales:
Materials
Labour
$ 1,265,622
465,222
356,398
821,620
Gross profit
444,002
Expenses:
Insurance
Meals and entertainment
Bad debt
Bank charges and interest
Advertising
Office
Association dues
Professional fees
Repairs and maintenance
Phone and utilities
Vehicle operating costs
Miscellaneous
Net income
Note
1
3,900
3,456
4,200
4,322
5,467
2,575
500
750
25,428
3,556
37,879
84,500
176,533
$
2
3
4
5
267,469
Notes:
1. I record sales when I receive cash. I typically get 20% of the sale price up front and the remainder when
the house is complete and ownership has transferred to the buyer.
2. Included in bank charges is a $200 late-payment penalty for payroll remittances that I paid to the Canada
Revenue Agency.
3. Included in advertising are donations I made of $1,000 to United Way and $750 to a federal political
party. This is the first time either my wife or I have made charitable donations.
4. During the year, I replaced the motor in a piece of excavation equipment for $10,000. I think we can get
another five years out of the machine now.
5. Included in miscellaneous expenses are the following:
a) A new truck I purchased for $45,000. I use the truck solely for transporting tools, supplies, and my
employees to job sites.
b) A new trailer for $27,000.
c) Various small tools totalling $12,500. About $5,000 of this is for small tools worth less than $500
each. The rest are tools typically costing between $500 and $1,500 each.
143
EXHIBIT II
OTHER INFORMATION COLLECTED FROM CARL
Personal information:
o Carl: 40 years old
o Spouse: Erin, 39 years old, no income
o Children: twins Josh and Jessica, 15 years old
Carl’s notes on the business:
o At the beginning of 2013, I started offering warranties on the homes I build for a period of two years
after the sale, at no charge to the customers. This is not part of the actual agreement I sign with the
homeowners, but I am doing it to keep my great reputation. I estimate that the costs of doing such
warranty work are about 4% of the sale price of the house. In 2013, I incurred $21,333 of costs related
to the warranty, which have been included in the cost of sales recorded during the year.
o I have an issue with one homeowner. He is threatening to sue me over a foundation that cracked after
a minor earthquake. He thinks I should pay because no one else in the neighbourhood had a cracked
foundation, but I know that my workmanship was good. I have no intention of paying him the
$100,000 he is asking for. However, my lawyer says that, at a minimum, I will have to fix it, which
could cost between $10,000 and $50,000.
The 2012 tax return is showing the following undepreciated capital cost (UCC) balances:
o Class 8: $33,654
o Class 10: $37,669
o Class 12: nil
Carl has a receipt from the Marlin Swim Club for Josh, showing fees of $350 paid in 2013 for swimming
lessons, and a receipt from the Royal Conservatory for Jessica, showing fees of $750 paid in 2013 for
piano lessons.
Carl’s 2012 Notice of Assessment showed registered retirement savings plan (RRSP) contribution room
available of $75,671.
144
EXHIBIT III
FINANCING OPTIONS
I need a new building. I could either build one myself or lease one. I think it would cost me about $450,000
for land, materials, and labour to build it, and I would need to finance the cost, given I spent most of my
cash on the land purchase in 2013. If I lease a building, I will not need to borrow. I have listed my options
below. I would like your evaluation of each of them, as well as comments on any other issues I should
consider.
Option #1: Build it myself with 90% of the cost financed by the bank at 5.25% annual interest over a 15-year
term. Equal payments would be made at the end of each month. I can obtain financing for the remaining
10% by borrowing on my account at the same terms, but at a 6% annual interest rate. This bank would
require reviewed financial statements and would take a general security agreement over all assets of the
business, as well as personal guarantees. The bank would also require Carlson Contracting’s debt-to-equity
ratio to be no higher than 1:1 and would restrict the amount I take out of the business to $100,000 per year.
Option #2: Build it myself with my brother-in-law funding 100% of the cost of the building. The repayment
terms would be annual payments equal to 15% of Carlson Contracting’s net income before taxes, calculated
in accordance with ASPE, for 20 years, at which point the debt would be considered completely repaid.
The salary that could be included in the calculation of net income would be limited to $100,000 per year.
Option #3: I could lease a building that is somewhat suitable for my needs. It is a little smaller than what I
want and is at the other end of town. However, I would not need to borrow. I would need to sign a 20-year
lease at a fixed rate of $33,000 per year. The lease payments would be due at the beginning of each month.
I would have an option to buy it out at the end of the lease for $1. The building is already old, so it would
likely last only another five years or so after the lease period ends. The owner has a recent appraisal that
indicates the building has a value of $425,000.
145
EVALUATION GUIDE
PAPER II, SIMULATION 2 — CARLSON CONTRACTING
Competencies
V-2.2 – Develops or evaluates accounting policies in accordance with GAAP (A)
To: Manager
From: CA
Re: Carl Carlson accounting issues
I have taken a look at Carl’s financial statements and the notes he left me. From this preliminary perspective,
I have identified the following accounting areas that will likely require adjustments in order to comply with
ASPE.
Revenue
Carl currently records revenue on a cash basis. This is not in compliance with ASPE, which requires that
revenue be recorded on an accrual basis. ASPE criteria will need to be looked at to determine the appropriate
method of revenue recognition for house building, as well as for the other services he provides.
146
Per Handbook Section 3400, Revenue:
.05
In a transaction involving the sale of goods, performance shall be regarded as having been
achieved when the following conditions have been fulfilled:
(a)
the seller of the goods has transferred to the buyer the significant risks and rewards of
ownership, in that all significant acts have been completed and the seller retains no
continuing managerial involvement in, or effective control of, the goods transferred to a
degree usually associated with ownership; and
(b)
reasonable assurance exists regarding the measurement of the consideration that will be
derived from the sale of goods, and the extent to which goods may be returned.
The transfer of significant risks and rewards of ownership only occurs at the transfer of the building title to
the buyer. The measurement of the consideration is known at the time of sale. However, given this is a
long-term contract, additional guidance needs to be considered.
.06
In the case of rendering of services and long-term contracts, performance shall be determined
using either the percentage of completion method or the completed contract method, whichever relates the
revenue to the work accomplished. Such performance shall be regarded as having been achieved when
reasonable assurance exists regarding the measurement of the consideration that will be derived from
rendering the service or performing the long-term contract.
Since Carl is in the business of building and selling homes, this would constitute performing a long-term
contract. Our options are the percentage of completion method or the completed contract method.
.17
The percentage of completion method is used when performance consists of the execution of more
than one act, and revenue would be recognized proportionately by reference to the performance of each
act. Revenue recognized under this method would be determined on a rational and consistent basis such as
on the basis of sales value, associated costs, extent of progress, or number of acts. For practical purposes,
when services are provided by an indeterminate number of acts over a specific period of time, revenue
would be recognized on a straight line basis over the period unless there is evidence that some other method
better reflects the pattern of performance. The amount of work accomplished would be assessed by
reference to measures of performance that are reasonably determinable and relate as directly as possible
to the activities critical to the completion of the contract. (Measures of performance include output
measures, such as units produced and project milestones, or input measures, such as labour hours or
machine use.) Amounts billed are not an appropriate basis of measurement unless they reflect the work
accomplished.
.18
The completed contract method would only be appropriate when performance consists of the
execution of a single act or when the enterprise cannot reasonably estimate the extent of progress toward
completion.
Given that Carl should be able to reasonably determine the extent of his progress towards completion of a
house, the most appropriate accounting policy would be the percentage of completion method. The
percentage completed of all houses or other projects in progress at year end would need to be estimated,
and an equivalent percentage of the sales price would need to be reported as revenue on the income
statement.
147
In the case of the 2013 financial statements, Carl has indicated that he has partially completed a house he
is selling for $300,000. He would have recorded $60,000 on this house, since he records revenue as he
receives the cash, and he would have received 20% of the selling price upfront (20% × $300,000 = $60,000).
However, the amount of revenue to record should be based on costs incurred as a percentage of total costs.
So we need to analyze how much of the building is actually complete. Typically, this assessment is based
on costs. We know that the cost of the house is estimated to be $225,000, and the cost to build the foundation
was $100,000. Therefore, the house is about 44% done in terms of costs. On that basis, we should recognize
44%, or $133,333, in revenue for this house in progress at year end, so an additional $73,333 will need to
be recorded in revenue. However, if Carl can provide evidence that there is a better way to measure the
progress of the house, that driver should be taken into account to assess percentage completed.
(Most candidates recognized that the percentage of completion method was the most appropriate method
to use to record the revenue from the building contracts, and they used the relevant case facts to compute
the necessary adjustment to revenue.)
Regarding the $100,000 in costs currently recorded as inventory, Handbook Section 1000, Financial
Statement Concepts, paragraph 45 states that “expenses are recognized in the income statement on the basis
of a direct association between the costs incurred and the earning of specific items of income. This process,
commonly referred to as the matching of costs with revenues, involves the simultaneous or combined
recognition of revenues and expenses that result directly and jointly from the same transactions or other
events.” Therefore, the $100,000 related to the foundation that is associated with the $133,333 in recognized
revenue should be removed from inventory and expensed.
(Only a few candidates were able to address both the revenue and cost issues as they related to the
revenue recognition and cost of sales of building houses for Carlson Contracting. Most candidates
focused their entire revenue recognition discussion on whether the better method was the percentage of
completion or completed contract method and omitted discussing the related costs.)
Land and Licence
Licence
The issue is how the licence should be classified on the balance sheet. Per Handbook Section 3064,
Goodwill and Intangible Assets, an intangible asset is an identifiable non-monetary asset without physical
substance. Section 3064 further clarifies that an intangible asset must be identifiable, the entity must have
control over the resource, and the intangible asset must provide future economic benefits.
Paragraph 12 states:
An asset meets the identifiability criterion in the definition of an intangible asset when it:
(a) is separable (i.e., is capable of being separated or divided from the entity and sold, transferred,
licensed, rented or exchanged, either individually or together with a related contract, asset
or liability); or
(b)
arises from contractual or other legal rights, regardless of whether those rights are
transferable or separable from the entity or from other rights and obligations.
148
The licence meets the definition of “identifiable” because it is separable from Carlson Contracting, so
criterion (a) is met. It also arises from legal rights; thus, criterion (b) is met.
The criterion of control, as stated in paragraph 13, is met because Carl owns the licence and can keep or
sell it as he wishes. The criterion of future economic benefits is also met, since there is an expectation that
Carl will be able to sell the licence to a developer. Therefore, Carl should classify the $100,000 spent on
the licence as an intangible asset on the balance sheet.
The asset would be considered to have an indefinite estimated useful life, since “no legal, regulatory,
contractual, competitive, economic or other factors limit the useful life of an intangible asset to the
enterprise.” Therefore, no amortization would be taken on the asset. Instead, the asset should be tested for
impairment whenever events or changes in circumstances indicate that its carrying amount may exceed its
fair value.
(Only about a third of the candidates addressed this issue; however, most who did provided a thorough
discussion of the issue, appropriately tying case facts to the criteria from the Handbook and concluding
on the accounting for the licence in accordance with their analysis.)
Land
There is also a question of how the land should be classified. Land would typically be classified as property,
plant and equipment. Per Handbook Section 3061, Property, plant and equipment, paragraph 3:
Property, plant and equipment are identifiable tangible assets that meet all of the following criteria:
(iv)
are held for use in the production or supply of goods and services, for rental to others, for
administrative purposes or for the development, construction, maintenance or repair of other
property, plant and equipment;
(v)
have been acquired, constructed or developed with the intention of being used on a continuing
basis; and
(vi)
are not intended for sale in the ordinary course of business.
However, the land purchased does not meet this definition. It is not being held for use (criterion (i)), nor is
it being acquired with the intention of being used on a continuing basis (criterion (ii)). Given the first two
criteria are not met, the asset cannot be considered property, plant and equipment.
The land could potentially be considered inventory. Per Handbook Section 3031, Inventories, paragraph 7:
Inventories are assets:
(i)
held for sale in the ordinary course of business;
(ii)
in the process of production for such sale; or
(iii)
in the form of materials or supplies to be consumed in the production process or in the
rendering of services.
149
Whether the land is held for sale in the ordinary course of business is debatable. Since Carl is not in the
business of buying and selling land, the purchase of the land may not be considered the normal course of
operations. However, Carl is in the business of construction, and purchasing land could be considered an
ordinary transaction in the construction industry since others in the industry are likely buying and selling
land often. It is not known whether Carl has done this type of transaction before. Therefore, criterion (i)
may be met. The land could also be an asset in the process of production (criterion (ii)) if Carl intends to
build on the land and then sell the land and building. The land would not be an asset to be consumed in the
production process or in the rendering of services (criterion (iii)), but given that criterion (i) or (ii) may be
met, there is also some argument for classification of the land as inventory. As inventory, the land would
have to be carried at the lower of cost or net realizable value.
The other option is to account for the land as an investment. Handbook Section 3051, Investments, applies
to “measuring and disclosing certain other non-financial instrument investments (such as works of art and
other tangible assets held for investment purposes)”. Because the land is a tangible asset, if it is held for
investment purposes, it would be classified as an investment. Paragraph 17 states that “the cost method
shall be used in accounting for investments within the scope of this Section other than those for which the
investor is able to exercise significant influence over an investee”. In addition, paragraph 18 states that
“these types of investments include certain other non-financial instrument investments such as works of art
and other tangible assets held for investment purposes.” Therefore, the land would be recorded at cost.
Ultimately, whether the land is classified as inventory or investment depends on Carl’s intention for the
land. If he intends to build on the land and sell the building, then it would be inventory. If he intends to
hold onto the land as an investment, it would be accounted for as investment. As either inventory or
investment, the concept of asset held for sale under Handbook Section 3475, Disposal of Long-Lived Assets
and Discontinued Operations, does not apply.
(Only a few candidates addressed this issue, and most of those who did jumped to a conclusion, simply
stating that land should not be included in property, plant and equipment without analyzing any case
facts first. Many candidates provided a discussion of the “asset held for sale” concept, which did not
apply in these circumstances.)
Warranty Liability
A liability for the two-year warranty should be set up. Even though Carl is not legally obligated to provide
a warranty on his work, he has demonstrated that he does, in practice, provide such a warranty through his
past actions. Paragraph 30 of Handbook Section 1000, Financial Statement Concepts, states that “liabilities
do not have to be legally enforceable provided that they otherwise meet the definition of liabilities; they
can be based on equitable or constructive obligations. An equitable obligation is a duty based on ethical
or moral considerations. A constructive obligation is one that can be inferred from the facts in a particular
situation as opposed to a contractually based obligation.” Thus, the fact that Carl informally offers this to
all his clients supports a constructive obligation. This would require that a liability be accrued for the
estimated amount of this expenditure.
150
There are two ways to account for the warranty. The first is to record the full amount of the revenue
associated with the warranty, and to record the related warranty expense and warranty liability. As an
estimate, we could calculate the liability by taking 4% of 2013 revenue, since the costs of doing the warranty
work are about 4% of the sale price of the house. We know Carl’s revenue is $1,265,622 in 2013, and 4%
of this equals $50,625, which should be recorded as a provision. Since Carl has spent $21,333 during the
year related to the warranty offered, this amount would offset the provision. Thus, there is a net income
impact of $29,292.
Alternatively, it can be argued that revenue recognition criteria have not been met because a portion of the
selling price is related to delivery of the warranty. The service has not been provided at the time of sale, but
instead is being provided over the two-year period. Thus, the revenue associated with the warranty can be
deferred and recognized evenly over the two-year period. The liability in this case would be deferred
revenue.
(About half of the candidates addressed this issue, and many of them were able to provide an in-depth
discussion, recognizing the particular nature of the warranty commitment made by Carlson Contracting
towards its clients. Most candidates who addressed this issue were able to use the appropriate case facts
to conclude on the accounting treatment. However, some failed to carry their analysis forward and adjust
net income accordingly.)
Contingent Liability
Carl has mentioned that one of his customers is threatening legal action against him. Carl does not believe
that he should have to pay anything, but we will need to assess whether there should be a contingent liability
recorded for an amount he may potentially need to pay. Per Handbook Section 3290, Contingencies:
.02
Contingencies would include, but are not limited to, pending or threatened litigation, threat of
expropriation of assets, guarantees of the indebtedness of others and possible liabilities arising from
discounted bills of exchange or promissory notes.
.12 The amount of a contingent loss shall be accrued in the financial statements by a charge to income
when both of the following conditions are met:
(a) it is likely that a future event will confirm that an asset had been impaired or a liability incurred at
the date of the financial statements; and
(b) the amount of the loss can be reasonably estimated.
151
Although we do not have enough information to determine the outcome of this potential litigation, it may
be argued that if none of the other houses experienced a cracked foundation after an earthquake, the crack
could be due to a default in the work done by Carl. In addition, the lawyer has mentioned that, at a minimum,
Carl will have to fix the foundation. Thus, the first criterion is met and settlement is likely. In addition, the
loss can be reasonably estimated. Paragraph 13 states that “the estimation of the amount of a contingent
loss to be accrued in the financial statements may be based on information that provides a range of the
amount of loss. When a particular amount within such a range appears to be a better estimate than any
other, that amount would be accrued. However, when no amount within the range is indicated as a better
estimate than any other, the minimum amount in the range would be accrued.” There is a range of amounts
that Carl may need to pay, from the low end of $10,000 to fix the foundation, to the full $100,000 asked for
by the homeowner. Because no value is more likely than any other, the minimum should be accrued. More
work would be required to assess this, but a minimum of $10,000 will have to be accrued and a contingent
liability set up.
(Most candidates addressed this issue in sufficient depth, applying the relevant criteria from the
Handbook and concluding logically based on their analysis. However, some candidates provided a
conclusion using case facts without supporting their analysis with the relevant Handbook criteria.)
Capital Asset Issues
Miscellaneous Expenses
Carl has currently recorded $84,500 of miscellaneous expenses, which include a new truck ($45,000), a
new trailer ($27,000), and various small tools ($12,500). Per Section 3061, the definition of property, plant
and equipment has been met, since (i) these items are held for use in the production of goods (buildings in
this case); (ii) they have been acquired with the intention of being used on a continuing basis; and (iii) they
are not intended for sale in the ordinary course of business. These items provide future economic benefit
and thus should be capitalized and not expensed. The items will be subsequently depreciated over their
estimated useful lives.
(Most candidates did not address these issues from an accounting perspective, and as a result did not
refer to the guidance from the Handbook. They discussed these items from a tax perspective only,
recognizing that they could not be deducted for tax purposes. Only a few candidates provided a
reasonable discussion of the accounting guidelines and recommended an appropriate adjustment to net
income.)
Betterment
Carl indicated that he had replaced a motor on a piece of excavation equipment for $10,000, which will
now extend the life of the equipment by five years. Per Section 3061:
.14
The cost incurred to enhance the service potential of an item of property, plant and equipment is a
betterment. Service potential may be enhanced when there is an increase in the previously assessed physical
output or service capacity, associated operating costs are lowered, the life or useful life is extended, or the
quality of output is improved. The cost incurred in the maintenance of the service potential of an item of
property, plant and equipment is a repair, not a betterment. If a cost has the attributes of both a repair and
a betterment, the portion considered to be a betterment is included in the cost of the asset.
152
Given the replacement of the motor has enhanced the service potential because it has extended the life of
the asset, this cost is a betterment and should be capitalized. The amount should be amortized on the same
basis as the related asset in the financial statements.
(Most candidates addressed this issue, appropriately referring to the Handbook criteria and analyzing
the relevant case facts to conclude on the necessary accounting adjustment. Most candidates also
adjusted net income accordingly.)
Amortization
Carl will need to establish a reasonable amortization policy for the capital assets of the business. Per Section
3061:
.16
Amortization shall be recognized in a rational and systematic manner appropriate to the nature of
an item of property, plant and equipment with a limited life and its use by the enterprise. The amount of
amortization that shall be charged to income is the greater of:
(a)
the cost less salvage value over the life of the asset; and
(b)
the cost less residual value over the useful life of the asset.
More discussion with Carl will be needed here to establish a reasonable amortization policy. Given the type
of assets he has, realistic estimates will be available to use based on similar businesses.
Building
Carl mentioned that he needs a new building and will need to spend $450,000 for the land, materials, and
labour to build it. We must ensure that all costs are captured in the capitalization of this asset, including the
labour costs to build it if he is doing it himself. Per Section 3061:
.08
The cost of an item of property, plant and equipment includes direct construction or development
costs (such as materials and labour), and overhead costs directly attributable to the construction or
development activity.
We will have to ask Carl how much time his employees will spend on building this new asset, as well as
whether there are any overhead costs associated with its construction. In addition, the interest incurred on
the loan taken to build the building can be capitalized during the construction period.
Loan from Bank
If Carl decides to take on a loan with the bank to build the new building, then he will have to account for
that loan in the financial statements. Per Section 3856:
.05 (j) A financial liability is any liability that is a contractual obligation:
(i) to deliver cash or another financial asset to another party; or
(ii) to exchange financial instruments with another party under conditions that are potentially
unfavourable to the entity.
153
A loan meets the above criteria, since it is a contractual obligation to deliver cash to another party (the
bank). Per paragraph 7, the loan would first be recognized at fair value (present value of future payments).
Per paragraph 11, financial liabilities are subsequently measured at amortized cost. Carl would account for
the principal portion of the loan as a non-current liability on the balance sheet, with the exception of the
principal payments in the next 12 months, which would be classified as a current liability. At each payment
date, the portion related to the principal of the loan would be recorded against the loan, and the remainder
as interest expense.
Loan from Brother-in-Law
If Carl decides to take the loan from his brother-in-law, he will have to consider whether it is a liability or
equity. As with the bank loan, this loan meets the financial liability criteria because it is a contractual
obligation to deliver cash to another party. However, this loan differs from a bank loan in that there also
appear to be elements of equity. Section 1000 defines equity as “the ownership interest in the assets of a
profit-oriented enterprise after deducting its liabilities. While equity of a profit-oriented enterprise in total
is a residual, it includes specific categories of items (for example, types of share capital, contributed surplus
and retained earnings).” Therefore, it is important to consider whether Carl’s brother-in-law would have a
residual interest in Carlson Contracting. On the one hand, it can be argued that he would have residual
interest because he would take on the risks and rewards of the company’s profit or loss (if the company
loses money, the brother-in-law will not get his return on capital). However, the loan payments would be
an obligation the company could not avoid (if the company makes a profit, Carl must pay his brother-inlaw); Carl’s brother-in-law would have access to only 15% of the company’s net income (not full residual
interest); and payments to him would end after 20 years, once again limiting his access to the residual
interest of the company. Therefore, the loan would be more of a liability in substance than equity.
Capital Lease
Carl may enter into a long-term lease for a new building. We will need to assess how to report this lease
and if it qualifies as a capital lease. If it does, Carl would need to record an asset under a capital lease with
an offsetting obligation. Per Handbook Section 3065, Leases:
.06
From the point of view of a lessee, a lease normally transfers substantially all of the benefits and
risks of ownership to the lessee when, at the inception of the lease, one or more of the following conditions
are present:
(a)
There is reasonable assurance that the lessee will obtain ownership of the leased property by
the end of the lease term. Reasonable assurance that the lessee will obtain ownership of the
leased property is present when the terms of the lease result in ownership being transferred to
the lessee by the end of the lease term or when the lease provides for a bargain purchase option.
154
(b)
The lease term is of such a duration that the lessee will receive substantially all of the economic
benefits expected to be derived from the use of the leased property over its life span. Although
the lease term may not be equal to the economic life of the leased property in terms of years,
the lessee is normally expected to receive substantially all of the economic benefits to be
derived from the leased property when the lease term is equal to a major portion (usually 75
percent or more) of the economic life of the leased property. This is due to the fact that new
equipment, reflecting later technology and in prime condition, may be assumed to be more
efficient than old equipment that has been subject to obsolescence and wear.
(c)
The lessor is assured of recovering the investment in the leased property and of earning a
return on the investment as a result of the lease agreement. This condition exists if the present
value, at the beginning of the lease term, of the minimum lease payments, excluding any portion
thereof relating to executory costs, is equal to substantially all (usually 90 percent or more) of
the fair value of the leased property, at the inception of the lease. In determining the present
value, the discount rate used by the lessee is the lower of the lessee’s rate for incremental
borrowing and the interest rate implicit in the lease, if known.
Carl has said he has the option to buy out the building at the end of the lease term for $1. This would be
considered a bargain purchase option. Therefore, criterion (a) is met.
Criterion (b) is met because Carl expects this building to last only five years past the term of the lease. The
lease term is for 20 years, or 80% of the remaining economic life, so it would appear that Carl is getting
substantially all of the economic benefit out of this property.
Finally, criterion (c) would also be met. Carl’s incremental rate of borrowing is 6%, and the rate implicit in
the lease is 4.81%. Using the lower of the two rates, the lessor would receive minimum lease payments with
a net present value of $425,000, which is 100% of the current fair value.
Since at least one of the three tests is met, this lease would qualify as a capital lease if Carl were to go ahead
with it. An asset under capital lease would need to be set up with an offsetting obligation under capital
lease.
(Only a few candidates addressed the above issues (building, loan from bank, loan from brother-in-law,
capital lease) because they only related to future events involving the new building (workshop) that Carl
was considering. Most of the candidates who did address these issues only briefly discussed the rules for
capital leases, generally providing a limited analysis of the criteria from the Handbook and referring to
some of the relevant facts of the simulation (in most cases, the fact that the lease provided for a bargain
purchase option).)
155
Summary of Adjustments
After the accounting adjustments discussed above, Carlson Contracting’s revised net income is as follows:
Net income per income statement:
$
Construction in progress revenue
Construction in progress expense
Net warranty provision
Legal claim provision
Expenses to be capitalized
Net income after accounting adjustments
267,469
73,333
(100,000)
(29,292)
(10,000)
94,500
$
296,010
(Most candidates adjusted Carlson Contracting’s net income for the items discussed in their accounting
analysis and used the adjusted net income in their tax analysis.)
For Primary Indicator #1 (Performance Measurement and Reporting), the
Percent
Awarded
0.2%
competence.
15.1%
Reaching competence — The candidate discusses some of the accounting
issues.
25.8%
Competent — The candidate discusses several of the accounting issues.
58.2%
Highly competent — The candidate discusses most of the accounting issues.
0.7%
(Candidates were directed to this indicator when they were asked by the manager, “Can you look at the
financial statements and let me know what accounting issues need to be addressed for a review?”)
(Most candidates performed well on this indicator and were able to identify the relevant accounting
issues, provide a reasonable ASPE analysis, and conclude on the appropriate adjustments to make to the
financial statements. The most significant accounting issue related to revenue recognition. Weak
candidates either did not discuss the revenue recognition issue, did not realize the percentage of
completion method should be used in their revenue recognition discussion, or did not include Handbook
guidance in their discussion. Strong candidates tackled the revenue recognition issue and were able to
come to a reasonable conclusion. They also provided good coverage of the other issues and supported
their analysis with the appropriate ASPE guidance and relevant case facts.)
156
The candidate provides a reasonable quantitative and qualitative analysis of Carl’s tax situation.
Competencies
IX-2.1 – Calculates income taxes payable for an individual in routine situations (A)
IX-2.3 – Calculates income taxes payable for a corporation in routine situations (A)
IX-3.1 – Identifies, analyzes, and advises on specific tax-planning opportunities for individuals (A)
To: Carl
From: CA
Re: Income taxes and shop financing options
You asked me to calculate what your federal tax bill will be for the current year. I have done so with the
information you have given me. Please see the calculations that follow. As you can see, some expenses are
not deductible, and other adjustments must be made for tax purposes.
Currently, you have a tax bill owing of $66,699.
I took it a step further, as you had requested, by comparing the above figure to what you would have paid
if you had been incorporated in the prior year and had taken a $100,000 salary. Under this scenario, you
would have had to pay $14,360 in personal taxes and $20,272 in corporate taxes. This total of $34,632 is
$32,067 less than what you currently owe.
In addition to the corporate taxes paid, it should be noted that any income left in the corporation would be
taxable if you took it out. The corporation can use it in the business as needed, but any amount taken out or
spent on personal expenditures would be taxable personally to you. However, given that your current
personal tax rate is higher than the corporate tax rate applicable to your company, leaving income in the
company will mean that you can defer a portion of the taxes you would have otherwise paid if you had not
been incorporated.
157
Personal and Corporate Tax Calculations
Sole
Proprietor
Personal
Net income after accounting adjustments
(see report to manager)
$
296,010
Incorporated
Personal
$ 100,000
Corporate
$
Note
196,010
Tax adjustments:
50% of meals and entertainment
1,728
1,728
1
200
200
2
50,625
50,625
3
(21,333)
(21,333)
3
1,750
1,750
4
(5,250)
(5,250)
5
Capital cost allowance deduction
(36,082)
(36,082)
6
Net income for tax purposes
287,648
Non-deductible penalty
Warranty expense – provision
Warranty expense – actual
Donations
Cumulative eligible capital deduction
100,000
187,648
Deductions:
Canada Pension Plan (CPP) deduction
(2,356)
Donations
Taxable income
285,292
100,000
(2,356)
7
(1,000)
4
184,292
Taxes:
Personal taxes
From
To
Rate
–
43,561
15%
6,534
6,534
43,562
87,123
22%
9,584
9,584
87,124
135,054
26%
12,462
3,348
135,055
and over
29%
43,569
Corporate taxes @ 11%
20,272
Taxes before credits
Credits:
Basic personal amount
Spouse or common-law partner amount
CPP contributions
Employment insurance premiums
Amount for children born 1996 or later
72,149
19,466
8
20,272
Full amount
$ 11,038
9
11,038
9
2,356
7
–
10
4,468
11
Children’s arts amount
500
12
Children’s fitness amount
350
12
29,750
158
Credits @ 15%
(4,463)
(4,463)
Canada employment amount ($1,117) @
15%
(168)
Donations and gifts
Federal political party
From
To
Rate
–
400
75%
400
750
50%
Credit
$
300
175
475
(475)
(475)
United Way
From
To
Rate
–
200
40%
200
1,000
54%
Credit
$
80
432
512
(512)
$
66,699
(a)
Total personal, no incorporation (a)
Total corporate and personal if incorporated (b) + (c)
$
66,699
34,632
Cost of not incorporating
$
32,067
4
$
14,360
(b)
$
20,272
(c)
Notes:
1. Meals and entertainment are only 50% deductible per 67.1(1) of the Income Tax Act.
2. Penalties paid to the Canada Revenue Agency are non-deductible under 18(1)(t).
3. Provisions for warranty cannot be deducted under 20(7); however, actual costs incurred can be
deducted.
4. Donations are added back and claimed as a tax credit for personal income taxes and as a deduction for
corporate income taxes.
For personal income taxes, since the donations are the first ones made by you and your wife, they are
eligible for the First Time Donor’s Super Credit, which is available to individuals who have not made
charitable donations in the last five years. This credit gives an extra 25% tax credit on donations up to
$1,000. The first $200 credit is at 40% (15% + 25%) and the remaining $800 credit is at 54% (29% +
25%).
For corporate income taxes, all donations can be considered a deduction against net income. However,
you should be aware that corporations are not able to donate to federal political parties. Therefore, we
assume that donation amount ($750) has been donated in your personal name and not under the
corporation.
159
5. The amount spent to purchase the licence allowing you to build up to 28 storeys on the land is
considered eligible capital property and thus is eligible for the cumulative eligible capital (CEC)
deduction, calculated as follows:
Cumulative Eligible Capital
Opening balance, CEC
Eligible additions (75% of actual)
CEC for the year
CEC deduction (@ 7%)
$
−
75,000
75,000
$ 5,250
6. No deduction is allowed for capital expenditures under 18(1)(b), but a deduction for capital cost
allowance (CCA) is allowed under 20(1)(a).
a) Since the truck is used solely for the transportation of goods, equipment, and passengers to earn
income, it would not be considered a passenger vehicle and would therefore be a Class 10 asset.
b) The trailer and motor for the excavation equipment are Class 10 assets.
c) The tools worth less than $500 each (totalling $5,000) are included as Class 12 assets. All other
tools are considered Class 8 assets.
d) The half-year rule applies to all net additions to Class 8 and 10 assets, but not to Class 12 tools.
Class
Opening
UCC
balance
8
10
12
$33,654
$37,669
$
−
Additions
7,500
82,000
5,000
94,500
Halfyear
rule
3,750
41,000
−
Ending
UCC
balance
with halfyear rule
37,404
78,669
5,000
Ending
UCC
balance
Rate
CCA
20%
30%
100%
7,481
23,601
5,000
36,082
$33,673
$96,068
$
−
7. As a sole proprietor, you will be paying CPP contributions and are allowed both a deduction and a tax
credit under 118.7. Under the incorporation scenario, you will be responsible for the employee portion
of CPP and your corporation will be responsible for the employer portion. The amount to be deducted
is 4.95% of salaries over $3,500, to a maximum salary of $51,100.
8. A corporation owned by you would be considered a Canadian-controlled private corporation and would
be eligible for the small business rate. This is calculated as follows:
Federal tax rate
Abatement
Small business deduction
Effective Canadian-controlled private corporation rate
38%
(10%)
(17%)
11%
160
9. You are allowed your basic personal tax credit. Since your spouse has no income, you can claim her
amount as well under 118(1).
10. There is no credit for employment insurance because you would not have paid these premiums as a
self-employed individual. In addition, you are exempted from paying employment insurance under the
incorporation scenario because you would be a shareholder of the company. In either case, there is no
credit for employment insurance.
11. You can claim a child tax credit for each child younger than 18 years old under 118(1)(b.1).
12. You can claim a fitness tax credit for Josh’s swimming lessons under 118.03. You can also claim an
arts tax credit for Jessica’s piano lessons, but it is capped at $500 under 118.031.
(Most candidates were able to provide a reasonable calculation of Carl’s taxable income, appropriately
adjusting the income for tax purposes for most of the items discussed in the simulation, including meals,
penalties, CCA, and donations. Generally, candidates who adjusted the accounting income for the
warranty provision or the contingent liability also adjusted the net income for tax purposes, recognizing
that only the outlays in the taxation year with respect to these items were currently deductible. As well,
most candidates were able to provide a reasonable calculation of the corporate income tax payable,
taking into account the fact that Carlson Contracting, as a corporation, would be entitled to the small
business deduction. However, many candidates did not consider Carl’s needs (his $100,000 salary) when
comparing the two scenarios. As a result they did not deduct Carl’s remuneration from the corporate
income before comparing the results under both scenarios. When they did, some candidates simply took
the $100,000 out, forgetting to tax it at the personal rates. As well, many candidates struggled with the
impact of the personal credits on the calculation of Carl’s income taxes payable, sometimes deducting
the full amount of the personal credits from taxable income or deducting the amounts of the credits
without applying the 15% rate applicable to those amounts.)
Aside from the tax advantages of incorporating, there are other items to consider:
Deferral — As discussed above, there is an opportunity to defer taxes to the extent money is left inside
the corporation. As the corporation earns income, the corporation will be subject to corporate tax at a
lower rate than the personal tax rate. This will allow you to pay taxes only on amounts you take out and
defer the rest until you need the cash.
Income splitting — As a corporation, you can pay dividends to your family members who own shares
in the corporation. This provides a way to split the income from the corporation amongst your family
members, who may be taxed at a lower rate. In addition, as discussed following this list, you can pay
reasonable salaries to family members for work they perform for the corporation.
Financial protection — Corporations provide a way to limit your liability to the net assets of the
company. If there are issues in the future that you may be liable for (for example, if a house you build
collapses), your liability would be limited to the assets you have in the company, while right now you
are personally financially liable for any legal claims.
Capital gains exemption — Because you are a shareholder of a corporation, any future sale of your
shares may be eligible for a capital gains exemption, which is not available as a sole proprietor.
Typically, when you sell a business, the difference between the selling price and what you initially put
into the business is considered a capital gain, and 50% of it is taxed at your marginal tax rate. However,
if you incorporate, your shares would most likely qualify as qualified small business corporation shares,
which would allow the capital gain (up to $750,000) to be exempt from taxes.
161
Cost — Additional costs are associated with incorporating (incorporation fees, lawyer fees, etc.), as
well as increased administrative requirements. For example, you would require separate bank accounts
and thus would incur additional bank fees. Having to submit two sets of tax returns (personal and
corporate) will also increase costs to you.
Complexity — Incorporating increases the complexity of your operations. There are additional
deadlines, remittance requirements, and such that you will need to track. The increased complexity can
cause additional burdens on your business, and it can often be frustrating to track compliance
requirements.
Salary versus dividends — Incorporating gives you the ability to pay a dividend from your corporation,
which could be used as a way to withdraw funds from the company instead of taking a salary. At the
current level of income you require ($100,000), the tax advantages of paying a dividend over a salary
are minimal; however, should your income requirements change in the future, incorporating would
allow you to issue a dividend if it is more advantageous to do so. As well, income earned as dividends
is not subject to CPP contributions, thereby saving on employer and employee contributions.
(Most candidates discussed some of the qualitative factors to consider in Carl’s decision of whether to
incorporate. Candidates most frequently addressed the benefits of income tax deferral, the possibility of
splitting income with other family members, and the protection that the corporation offered to Carl from
creditors and potential lawsuits.)
As noted in the tax calculation, you would not be able to make a donation to a federal political party under
the corporation. Instead, to take advantage of the associated tax credit, you would need to make the donation
in your personal name.
Assuming you do not plan to take out all the money you earn from Carlson Contracting every year, I suggest
you incorporate your business due to the tax advantages and qualitative considerations. The cost and
complexity of incorporating are offset by the advantages I’ve discussed. However, if you do take out all the
money your company earns instead of the minimum you need of $100,000, the tax advantage largely
disappears.
(Most candidates provided a valid conclusion as to whether Carl should consider incorporating based
on their analysis.)
Regardless of whether you incorporate, a few options are available to you to reduce your tax bill:
You could pay your spouse a wage for the bookkeeping work. This would act to split your income.
Paying a wage would provide a deduction for the business and income for your spouse. Since your
spouse has no other income, we can use her low tax brackets and personal tax credits. You could still
accrue a bonus to her as at December 31, 2013, which would be income to her in 2014. You need to
pay this amount no later than six months after December 31, 2013.
You could pay your children a wage as well, as long as they do work for the business. The amounts
paid must be reasonable in relation to the work performed. Just like paying a wage to your spouse,
paying your children would provide a tax deduction for the business and at the same time take advantage
of their low tax brackets and available tax credits.
You still have time to contribute money to your registered retirement savings plan. You have more than
$75,000 in contribution room available. I would encourage you to maximize this to the extent that you
can, since it will reduce your income and therefore lower your income tax liability. You can contribute
to your RRSP in the first 60 days of 2014 and claim this contribution on your 2013 tax return.
(Only a few candidates provided comments on the fact that Carl could reduce his overall tax liability by
either paying a salary to his wife or kids or contributing to his RRSP. Most candidates limited their
162
comments to a general discussion of income splitting as part of their discussion of the benefits of
incorporating the business.)
For Primary Indicator #2 (Taxation), the candidate must be ranked in one of the
Percent
Awarded
0.1%
competence.
8.2%
Reaching competence — The candidate attempts a quantitative analysis of Carl’s
tax situation.
58.0%
Competent — The candidate prepares a reasonable analysis of Carl’s tax
situation.
33.1%
Highly competent — The candidate prepares a thorough quantitative and
qualitative analysis of Carl’s tax situation.
0.6%
(Candidates were directed to this indicator when they were asked by the client to take a look at the
numbers, determine what size of federal tax bill Carl was facing, and tell him what his total 2013 federal
tax bill would have been if he had been incorporated.)
(Candidates did not perform well on this indicator. Most attempted an analysis of Carl’s tax situation,
but struggled to compare his current situation to a scenario in which his business would have been
incorporated. Most candidates were able to calculate the corporate income taxes owing had Carl been
incorporated, but many forgot to consider the fact that he’d have to pay personal income taxes on the
$100,000 salary he would need to draw from the company to live on. By forgetting to do so, candidates
were not comparing the two scenarios on equal ground. Strong candidates provided a reasonable
computation of the business income, as part of the corporate scenario analysis, and taxed the $100,000
that was distributed to Carl, either as salary or a dividend. These candidates made the appropriate
adjustments in computing net income for tax purposes (for example, penalties, meals and entertainment,
CCA) and also adjusted the accounting income with the lawsuit/contingent liability. Most of these
candidates also understood that donations made by corporations are treated differently than those made
by individuals. In general, it was clear that strong candidates recognized the benefits of tax deferral.
Weak candidates provided a corporate calculation only or made significant errors in computing the
personal income taxes, such as deducting the personal credit amounts in computing taxable income or
applying the top marginal rate to compute the amount of taxes payable. Many candidates did not take
into account the different tax brackets when calculating the personal income taxes.)
163
The candidate analyzes Carl’s options for the new building and advises him accordingly.
Competencies
VII-2.4 – Identifies and evaluates sources of funds (B)
VII-5 – Analyzes the purchase, expansion, or sale of a business (B)
You asked me to analyze and compare the options you have regarding the building you require so that you
can have your own shop.
Quantitative Considerations
In order to be able to compare the options, I have calculated the net present value of future cash flows for
each option based on the incremental borrowing rate available to you (6% from the bank).
Option #1
The payment each month on the 90% portion of the loan is $3,256, calculated as follows:
Present value
Number of periods (15 years × 12 months/year)
Interest rate (5.25% ÷ 12 months)
$405,000
180
0.4375%
Payment per month (calculated based on above inputs)
$ 3,256
The remaining 10% would be financed by you personally with monthly payments of $380, calculated as
follows:
Present value
Interest rate (6%÷ 12 months)
$ 45,000
180
0.50%
Payment per month (calculated based on above inputs)
$
380
The combined monthly payments of $3,636 ($3,256 + $380) result in a net present value of $430,879 for
this option, calculated as follows:
Total loan
Payment per month
$450,000
180
$ 3,636
Present value of loan payments (discounted at 6% annually)
$430,879
164
Option #2
Before calculating the effective interest rate of this option, we will need to determine the payments required.
The payments will be dependent on Carlson Contracting’s actual net income; therefore, it is important to
take the net income after accounting adjustments discussed in the report to the manager. We also must take
into account the salary you would need to pay yourself to cover your personal needs:
Net income after accounting adjustments (see report
to manager)
Salary
$
296,010
(100,000)
Net income after salary
$
196,010
The agreement calls for payments equal to 15% of the net income before taxes on a yearly basis. This
amounts to $29,402 per year, assuming net income does not change. The net present value of the payments
under this option would be $337,233, calculated as follows:
Total loan
Number of periods
Payment per year
$450,000
20
$ 29,402
Present value of loan payments (discounted at 6%
annually)
$337,233
Note that the adjustments to net income do not include amortization adjustments. This will further decrease
net income and thus the effective interest rate of this option.
Option #3
The net present value of the payments under this option is $385,766, calculated as follows:
Value of building and land
Payment per month ($33,000 ÷ 12; paid beginning of month)
$425,000
240
$ 2,750
Present value of lease payments (discounted at 6% annually,
payments at the beginning of the period)
$385,766
(Most candidates struggled to provide a comparable analysis of the scenarios presented in the simulation.
Quite often, candidates would compare the net present value of the cash outflows under a particular
option (generally the loan from the bank) to the total undiscounted cash outflows under another option,
thereby reducing the usefulness of the calculation for Carl.)
165
Qualitative Considerations
Option #1
The debt to equity ratio must be no higher than 1:1. It would be important to meet this; your debt to equity
ratio after the loan (on a pre-tax basis) will be 0.68 (($80,562 [existing liabilities] + $450,000 [loan amount])
÷ $782,874 [equity] = 0.68). This figure will change once you consider your taxes payable and accounting
adjustments. Depending on whether you choose to incorporate, the tax effect on the ratio will be different,
since your taxes payable are less under the incorporation scenario and thus your debt to equity ratio would
be lower. In addition, the ratio would also be affected if you choose to incorporate, since you may elect to
not transfer certain assets or liabilities into the corporation or they may be transferred at different amounts
than cost. Since it appears that the building will be your biggest expenditure in the next several years (and
therefore you will be unlikely to take on more debt), this restriction should not significantly affect you.
A general security agreement and personal guarantees are required. This could put not only your business
at risk, but your personal assets as well. You may want to consider putting personal assets in your spouse’s
name if you are able to, but the bank may be required to sign off on that. The covenant restricting your
remuneration as it stands right now is adequate because your withdrawal is limited to $100,000, which you
indicated would be enough for you and your family to live on. However, this does not appear to increase
on a yearly basis. After several years, considering inflation, this amount would no longer be adequate, since
it would have much less purchasing power, especially at the end of 15 years. At a minimum, if you take
this option, you need to negotiate a clause for inflationary increases.
Another consideration with this option, as well as with Option #2, is that you will need to find the time for
you and your employees to build the building yourself, which might result in lost sales or delayed
construction projects.
Option #2
Based on the annual cash costs of $29,402, this appears to be the least expensive option. This option also
results in the lowest cash outflow per month, which is an important consideration for cash management
purposes. However, there is a lot of uncertainty surrounding your loan payments. Because your business is
growing, it is likely that the loan payments will increase year over year. Therefore, the annual cash cost
may not be as low as it first appears. In addition, you should be careful about entering into business with
your brother-in-law. You may find it uncomfortable to share your personal financial situation with him,
which you will be required to do since he will want to be aware of the financial situation of your business.
In addition, although many business relationships work with family members, if there are disagreements,
you may find that they have a more profound impact than if your business partner is a friend or stranger. If
you choose this option, you should have a discussion with your brother-in-law to ensure that you have a
mutual understanding of his role in the business — you would not want to be in a situation where the two
of you disagree on whether he is able to influence the business decisions you make.
166
Option #3
Having a lease may be better for you for tax purposes, as opposed to the CCA deduction allowed on
buildings, since lease payments are $33,000 per year but CCA would be approximately $27,000 (6% of
$450,000 as a Class 1 other non-residential building). A lease is also less expensive than the first two
options, and the building will likely be worth less at the end of the lease compared to a new self-constructed
building. However, this option does not appear to fully meet your needs for a new building, so you may
end up with the same problems that you have now in terms of storage. As well, it is already an older
building, so you may end up with more issues than if you build something new yourself according to your
own standards.
(Most candidates offered a relevant qualitative discussion of the options, generally recognizing the
following items: the bank covenants, the fact that the brother-in-law loan facility might prove quite costly
if Carlson Contracting’s net income continues to grow, and the fact that the building available under
Option #3 (lease) does not meet all of Carl’s requirements, whereas under Option #1 and Option #2 the
building would be customized to Carl’s requirements.)
Recommendation
Each option has its pros and cons when compared to the others. From a business perspective, I recommend
you get the building that you need so you can run your business the way you want. This likely excludes
Option #3. The building is old, smaller than you would like, and not in a location you desire. Option #2
seems too risky given your relationship with the lender and the potential increase in your business’s income.
Therefore, Option #1 will likely be your best option overall. It will provide you with a new building built
to your needs and specifications. You currently have $58,449 in cash. You probably need this amount for
operational purposes, but if you can draw on this amount to fund the 10% not provided under Option #1, it
will lower your cost of borrowing and reduce your future cash flows. Keep in mind that you will also have
to determine what time of year you can best afford for your employees to work on this project since it will
take them away from other projects.
(Most candidates who performed a comparison of the options also offered a conclusion that was logical
based on their analysis, weighing both the qualitative factors and the quantitative factors.)
For Primary Indicator #3 (Finance), the candidate must be ranked in one of the
Percent
Awarded
1.7%
competence.
15.2%
Reaching competence — The candidate attempts a quantitative and qualitative
comparison of the options OR performs a reasonable quantitative comparison of the
options.
54.8%
Competent — The candidate performs a reasonable quantitative and qualitative
comparison of the options and makes a recommendation.
28.1%
Highly competent — The candidate performs a thorough quantitative and
qualitative comparison of the options and makes a recommendation.
0.2%
167
(Candidates were directed to this indicator when asked by Carl to help him with a decision he had to
make. Candidates were provided with an exhibit describing three options Carl was considering: to either
finance a new building with a bank loan, finance a new building with a family loan, or lease an existing
building.)
(Candidates did not perform well on this indicator. Many struggled with an approach that would allow
them to analyze the options on a comparable basis. For example, some candidates calculated the cost of
one option by determining net present value, but then calculated the costs of the other options by either
adding the future cash flows, without calculating the net present value, or calculating an implicit interest
rate. Although some of these techniques could have been valid, using a different technique to calculate
the cost of each option did not allow candidates to compare the options.)
(Strong candidates took into account the time value of money for all three options. Strong candidates
also took their qualitative discussion further by using more case facts and discussing the implications
for Carl (e.g., personal guarantee, might lose some or all of his personal assets if the company does not
do well, etc.). Many weak candidates presented values that were not comparable, as discussed in the
previous paragraph. In addition, the qualitative discussions of most weak candidates either were missing
or simply repeated the case facts without discussing the impact on Carl.)
III-2.2 – Performs computations
III-4.1 – Seeks and shares information, facts, and opinions through written discussion
(Overall, the Board was disappointed with the quality of the responses on this simulation. Most
candidates addressed each of the indicators; however, many candidates’ discussions did not contain a
reasonable depth of analysis. Candidates generally performed better on the Performance Measurement
and Reporting indicator, discussing most of the significant issues, but failed to demonstrate the same
level of competence on the Taxation and Finance indicators.)
168
RWD Inc. (RWD) was created in 2008 and provides premium website design services and support. It is a
private company owned equally by Richard Atkinson, Wally Campbell, and Diane Charlevoix. RWD’s
vision is “to create interesting, intuitive website designs that are clean and easy to use.” The company
translates its vision into the following mission statements:
1. Put customers first.
2. Provide creative and artistic design services.
3. Respond to customer requests within 24 hours.
4. Employ only the best in the field and use them to the best of their abilities.
5. Make RWD a great place to work and ensure our employees have a good work-life balance.
In November 2013, Richard discovered a new smartphone application (app) called EasyPark, designed for
big cities with a shortage of parking spaces. EasyPark connects people who own available parking spaces
(Owners) with drivers who need parking spaces (Drivers). Exhibit I gives additional details on EasyPark.
RWD is located in Montreal, a city with a major parking shortage. Even though RWD has never operated
a web-based app before, Richard was very excited about EasyPark and purchased it on behalf of RWD for
$7,500 in December 2013.
It is now September 10, 2014. You, CA, have been hired by RWD as a temporary controller. RWD’s
permanent controller, Veronica Black, will begin her maternity leave on October 1. Veronica gives you
some background information: “RWD purchased EasyPark with Richard’s approval, without the other two
shareholders being informed. They were upset because Richard did not consult them, and they are
concerned about how EasyPark is affecting RWD’s ability to meet its vision and mission statements.
“EasyPark was rolled out in January 2014 and was a huge hit. By February, our accounting and information
technology (IT) departments were swamped from dealing with EasyPark users. I don’t think Richard
expected it to take off the way it did. I made some notes about how it has affected my accounting staff. I
also met with Brian Weatherbee, our IT manager, to understand how EasyPark has affected his staff. My
notes are in Exhibit II.
“Richard really wants EasyPark to be a success. He is happy that EasyPark has generated significant
revenue in just eight months. He recognizes there are issues but believes they can be resolved. Brian just
presented his plan for how automation will address Richard’s concerns (Exhibit III).”
Veronica says she is already working on the accounting issues associated with EasyPark, but requests that
you provide her with a report to the shareholders on EasyPark’s contribution to RWD’s financial results.
She is also concerned about the number of problems related to EasyPark’s transactions. She wants an
assessment of the problems and an opinion on whether the proposed automations will address them, as well
as any additional controls that could be implemented.
169
EXHIBIT I
EASYPARK DESCRIPTION
Owners
Owners register with EasyPark by creating an account and then listing all parking spaces they would like
to offer. Owners enter details (address, availability schedule, price, etc.) about their parking spaces online,
and this information automatically updates RWD’s central database. Owners receive monthly payments
based on the actual usage of their parking spaces, as tracked by the central database, net of a 25%
administration fee retained by RWD.
Drivers
There are now a total of 65,000 Drivers using the app. A Driver must first buy the EasyPark app for $3 and
install it on a smartphone, then create an account by providing his or her name and mailing address through
the app. Once an account has been successfully created, the Driver uses the app to search for available
spaces in a specific area. When the Driver selects a space, EasyPark indicates the hourly price. If the
location and rate are acceptable, the Driver uses the app to “check in” to the space, and the central database
is immediately updated. The maximum parking time is 24 hours, at which point the Driver has to check in
again to continue using the parking space. Drivers must “check out” of parking spaces through the app
when they leave. Once a Driver has checked out, EasyPark calculates the total charge for the transaction
and updates the central database. Drivers are mailed invoices for their monthly usage, based on information
from the database.
Because of the check-in and check-out process, parking space availability is always up to date in the central
database, although it relies on the honour system. If a Driver parks in a space but does not check in to it, or
leaves the vehicle in a space after checking out, the Driver risks being towed. However, the risk of being
towed is low because RWD does not monitor unauthorized parking.
RWD
At the end of each month, the accounting department obtains, from the IT department, a file downloaded
from the central database that details all of EasyPark’s users and the transactions for that month. The
accounting department organizes the data in a spreadsheet to determine the amounts due to Owners and
from Drivers.
170
EXHIBIT II
NOTES ON EASYPARK’S IMPACT ON ACCOUNTING AND IT DEPARTMENTS
Prepared by Veronica Black
Accounts Receivable
The accounts receivable clerk, Marcelle, is overwhelmed with extra work on top of her regular duties. At
each month-end, she spends approximately eight hours organizing the EasyPark file received from IT in
order to determine the total receivable per Driver. She then spends an additional ten hours manually entering
each receivable into the accounting system. Additionally, she has to process all credit card transactions and
cheques received from Drivers. Luckily, her niece was looking for a summer job, so RWD hired her at $12
per hour for three months to help with the backlog of payments from Drivers.
Our aged accounts receivable listing has $138,000 over 90 days old. I’m becoming concerned about
collection. I believe up to 50% of this amount could be uncollectible. I’ve talked to Marcelle about it, but
she really has no time to follow up on these accounts. Part of the outstanding amount is likely a result of
manual errors made when information was entered into our accounting system, and we’ve also had
instances where Drivers used fictitious names and addresses in order to park for free.
Some Drivers have called us about their bills because they seemed high. After some investigation, we
determined that these Drivers forgot to check out of their parking spaces, so EasyPark had charged them
for 24 hours of parking.
Accounts Payable
Once she is done, Marcelle forwards the EasyPark spreadsheet to Ethel, the accounts payable clerk. The
spreadsheet is then re-organized to determine how much money is owed to Owners. Ethel manually enters
all the information into the accounting system and then issues cheques. She now cuts over 5,000 additional
cheques per month. As a result, a full-time mail clerk had to be hired for six months, at a rate similar to that
paid to Marcelle’s niece.
The issue of Drivers not checking out has also caused problems with accounts payable because we only
found out about the check-out issue after we paid Owners for a full 24 hours. We’ve been trying to get the
money back from the various Owners and so far have been able to get almost $26,000 back; however, there
is still $17,000 outstanding.
Accounting Department
The entire accounting department has been suffering since EasyPark was rolled out in January. Everyone
has had to chip in and neglect, to some degree, their regular duties due to the massive amount of work that
EasyPark has created.
We’ve been fielding calls from Owners and Drivers looking for more detail on their statements. They are
unsure if they are being paid or charged the correct amounts because the invoices don’t provide transaction
details for the month. Right now, because the number of inquiries is so high, it takes us at least two weeks
to respond to them, and we often end up making adjustments because the invoices are wrong.
171
NOTES ON EASYPARK’S IMPACT ON ACCOUNTING AND IT DEPARTMENTS
Prepared by Veronica Black
I also just found out that there is a significant discrepancy between what the IT department is reporting as
the total amount of transactions processed and what our accounting system is reporting. IT has a file
downloaded from the EasyPark central database indicating that just over $2 million in parking charges to
Drivers have occurred since EasyPark started. The accounting system shows only $1.85 million.
IT Department
The IT department is spending a lot of time dealing with increased maintenance and support related to
EasyPark. They are getting many calls from Drivers who seem to have problems installing the app or
establishing a connection with the EasyPark database. It’s taking most of two programmers’ time to
maintain the central database. Considering each programmer is paid over $80,000 per year, this is not a
good use of their time.
In fact, RWD turned away three new website design customers since March because our staff was too busy
dealing with EasyPark. These contracts would have brought in a total of $250,000 in profit.
The accounting department asked the IT department for reports that could summarize the transactions by
individual Drivers and Owners, to decrease time spent calculating receivables and payables. However, the
IT department has been too busy dealing with user support and database maintenance to design new reports.
EasyPark has crashed twice since it was rolled out, and weeks of data had to be recreated from backups,
which took up a lot of our programmers’ time. Unfortunately, some data could not be recreated because the
employee in charge of running the nightly backup went on vacation and the backups weren’t done for a few
days.
EasyPark has been taking up way too much time. Our regular website design clients have been neglected
because it is taking us much longer to complete projects and respond to requests.
Overtime
I just received the overtime schedule from the Human Resources department (Exhibit IV) and was quite
surprised to see how high it was. Normally our staff works very minimal overtime. It’s not surprising that
they are feeling so stressed.
172
EXHIBIT III
IT DEPARTMENT’S PLAN TO FURTHER AUTOMATE EASYPARK
Brian proposes implementing all of the following automations:
1. Each Driver will be required to enter a valid credit card number when setting up an account in order to
verify his or her identity.
2. Users will be able to view the details of their accounts on their smartphones. Owners and Drivers will
view all parking transactions that have occurred, as well as the net balances of their accounts.
3. The EasyPark central database will automatically update accounts receivable and accounts payable
records.
173
EXHIBIT IV
OVERTIME SCHEDULE
FOR THE EIGHT-MONTH PERIOD ENDED
AUGUST 31, 2014
RWD’s policy is that for any overtime above 200 hours a year, staff-level employees are paid at 1.5 times
their regular hourly rate and management-level employees are paid at their regular hourly rate.
Rate for
regular hours
Staff
Managers
$17
$35
Number of overtime hours above 200
Accounting department
1,900
450
IT department
2,150
575
174
EVALUATION GUIDE
PAPER II, SIMULATION 3 — EASYPARK
To:
From:
Subject:
Veronica Black
CA
EasyPark analysis and impact on RWD
The candidate assesses EasyPark’s contribution to RWD’s financial results.
Competencies
VIII-2.4 – Evaluates sourcing decision factors (A)
Financial Contribution
The shareholders are interested in the contribution that EasyPark has made to RWD’s financial results.
Even though EasyPark has generated significant revenue, as Richard has indicated, he also needs to factor
in the three lost contracts that RWD could have had, the possible uncollectible debt, and the additional
expenses related to EasyPark in order to determine EasyPark’s financial contribution. EasyPark has put a
strain on both the accounting and IT departments, which has resulted in a significant amount of overtime
that must be paid out. It has been necessary to hire Marcelle’s niece to help process payments and a mail
clerk to mail cheques. All of these costs must be taken into account.
Also, the EasyPark app was purchased for $7,500, and that cost needs to be considered as well.
175
EasyPark’s Contribution to RWD’s Financial Results
One-time
Incremental revenue
Sale of the app
Administration fee
Less: Opportunity cost of lost contracts
Less: Doubtful accounts
$
195,000
Ongoing
$
500,000
(250,000)
(69,000)
181,000
195,000
Incremental costs
Cost of EasyPark app
Salary – Marcelle’s niece
Salary – Mail clerk
Overtime – staff
Overtime – managers
Uncollected overpayments
7,500
5,760
11,520
103,275
35,875
17,000
173,430
7,500
Net financial contribution to RWD
$
187,500
$
Note
1
2
3
4
5
6
7
8
8
9
7,570
Notes:
1. RWD sold the app to 65,000 Drivers for $3 each. Although there will be ongoing revenue from the sales
of the app, it will likely not be as high as when the app was first rolled out, since the number of new
users will have been at its highest when it was first introduced.
2. RWD processed $2 million in parking transactions and takes a 25% administration charge. This assumes
that the IT file downloaded from EasyPark is correct, rather than the amount shown in the accounting
system.
3. The IT manager stated that RWD lost three new contracts.
4. There is $138,000 in accounts receivable over 90 days old, and it is estimated that 50% will not be
collectible. Assuming these are due to customers with fictitious names or addresses, they should not
have been included in revenue in the first place.
5. The cost of the EasyPark app was $7,500.
6. Marcelle’s niece is paid $12 per hour (× 40 hours per week × 4 weeks × 3 months).
7. A mail clerk was hired; assume he is paid $12 per hour (× 40 hours per week × 4 weeks × 6 months).
8. RWD’s policy is that hours worked above 200 will be paid out. Since the overtime was incurred this
year as a result of EasyPark, it should be considered an incremental cost.
176
Staff
Accounting
IT
1,900
2,150
$25.50
$25.50
Managers
Accounting
IT
450
575
$35.00
$35.00
$48,450 [hourly rate $17 × 1.5]
$54,825 [hourly rate $17 × 1.5]
$103,275
$15,750
$20,125
$35,875
9. Veronica stated that $17,000 in overpayments had been made to Owners and had yet to be collected.
These are assumed to be uncollectible, as discussed previously.
In conclusion, once the incremental revenue and expenses are considered, EasyPark appears to have
contributed an extra $187,500 to RWD on a one-time basis and $7,570 on an ongoing basis so far in 2014.
This amount is positive, which supports Richard’s view that the app is successful. However, additional
uncertain costs need to be considered.
(Candidates performed very well on the quantitative analysis, incorporating several valid adjustments in
their calculation of EasyPark’s contribution to RWD’s financial results. Candidates generally did a good
job of considering both the incremental revenues and the incremental expenses. They were able to
integrate case facts well when determining revenue from the sale of EasyPark, as well as the ongoing
administration fee. Most candidates were able to provide a valid adjustment for the majority of the
incremental expenses. However, some candidates struggled to compute the incremental costs related to
Marcelle’s niece, the mail clerk, and the overtime amounts, missing or misinterpreting one or more case
facts. For example, many of these candidates either forgot to take the different wage rates into account
or mixed them up. In addition, some candidates failed to recognize the opportunity cost of $250,000
related to the lost profit on contracts the programmers could have worked on. Others recognized the
$250,000 opportunity cost but also included the programmers’ full wages in the calculation, which was
inconsistent.)
Additional Uncertain Costs
I have assumed that the total number of transactions processed is equal to the report that IT downloaded
from the EasyPark central database. If it turns out that the accounting report is the correct amount, then
revenue would decrease by $37,500 (($2 million − $1.85 million) × 25%). More work should be done to
determine the reasons for the difference.
Also, the costs associated with Brian’s automation plan have not been incorporated. IT implementations
can be costly and might result in a decrease in EasyPark’s financial contribution.
Veronica has stated that a significant number of receivables related to EasyPark are over 90 days old. She
also guessed that as much as 50% may not be collectible. For the time being, I have included the estimated
50% as a reduction in revenue, but if these accounts aren’t followed up soon and dealt with, this may get
even higher.
177
Veronica also mentioned that there could be manual entry errors as well as customers with fictitious names
and addresses. This could lead to further collectability issues. At this stage, there is no way to estimate the
total amount of revenue that cannot be collected. All amounts that are outstanding need to be reviewed to
determine if they relate to actual customers, if the amounts have been entered correctly, and if RWD will
be able to collect the amounts. These amounts could further affect the financial impact that EasyPark has
had on RWD.
In addition, there is currently $17,000 in outstanding overpayments to be collected from Owners. It is not
known whether this amount is outstanding because there has been no time to follow up with the Owners or
because the Owners refuse to return the money. For now, I have assumed they are uncollectible. However,
more time spent on collecting these amounts may reduce the total outstanding. In addition, if Owners
continue to use EasyPark, there is a possibility of collecting these amounts by offsetting the balances owing
against future transactions.
Employees have worked a significant amount of overtime as a result of EasyPark. There may be decreased
employee morale leading to increased turnover, which would result in additional hiring and training costs
for RWD.
I have not included the cost related to the programmers’ time to run reports or fix crashes. These
programmers are on salary, so these costs would have been incurred regardless of whether the EasyPark
app had been rolled out. However, the programmers could have been working on other projects that could
have brought in additional revenue on top of the $250,000 of profit already lost, and the effects of that need
to be considered as well. However, it has not been included because it is not currently known.
Other Elements to Consider
RWD’s main business is premium website design services and support, and RWD has never operated a
web-based app before. Therefore, RWD’s employees may not possess the appropriate experience and
knowledge required to operate a web-based app. This is evidenced by the numerous problems the
acquisition has created. RWD may, therefore, need to hire additional staff with the appropriate experience
in this field, resulting in the need for a larger office space and increased fixed costs. Even though EasyPark’s
financial contribution to RWD is positive, the degree of success may be greater or less than other RWD
products. The shareholders need to look at the overall mix of RWD’s products and services in order to
assess whether the EasyPark app should be continued.
On the other hand, the acquisition of web-based apps has the potential to create new opportunities for RWD
to expand its services and thus access a new client base and additional revenue streams. EasyPark in
particular presents significant opportunities for RWD in cities with major parking shortages, such as
Montreal, as evidenced by how successful it has been thus far. If RWD can resolve the numerous problems
created by the hasty acquisition and integration of EasyPark and ensure that it is able to fit with RWD’s
vision and strategy going forward, EasyPark can contribute positively to the overall success of the company.
178
The shareholders of RWD could consider entering into the app industry. If they determine this is a viable
opportunity, they could restructure operations in order to segregate the app services from their core web
design services in order to preserve the image of RWD’s premium website design services and support,
while taking full advantage of new business opportunities.
In addition, RWD needs to consider whether it is over capacity. For example, there may be a need to hire
additional support and maintenance staff so that the programmers can return to their day-to-day tasks.
However, this additional cost may be offset by no longer having to pay overtime for current staff.
(Only about one-third of candidates were able to provide a relevant qualitative analysis to support their
quantitative discussion. Many candidates provided an analysis of how the rollout of EasyPark was not
in line with the current mission statements as their qualitative analysis for this indicator, which was
rewarded under Primary Indicator #3. These candidates recognized the governance issues that EasyPark
had created. However, they did not supplement their quantitative analysis, which could have been done,
for example, by providing a discussion of potential threats and opportunities, such as the ability to
expand their current services and enter into the rapidly growing app space. Weak candidates also tended
to simply discuss the assumptions they made in their quantitative analysis.)
Percent
Awarded
1.8%
competence.
8.8%
Reaching competence — The candidate attempts a quantitative analysis of
EasyPark’s contribution to RWD’s financial results.
18.2%
Competent — The candidate provides a reasonable quantitative analysis of
EasyPark’s contribution to RWD’s financial results.
69.3%
Highly competent — The candidate provides a thorough quantitative and
qualitative analysis of EasyPark’s contribution to RWD’s financial results.
1.9%
(Candidates were specifically asked by the controller to provide her with a report to the shareholders of
RWD Inc. (RWD) on EasyPark’s contribution to RWD’s financial results.)
(Most candidates did very well on this indicator. Almost all candidates attempted to compute EasyPark’s
contribution to RWD’s financial results, and did a good job of incorporating both the relevant sources
of incremental income and the costs directly attributable to EasyPark. Strong candidates went beyond
calculating the financial results and supplemented their quantitative analysis with qualitative comments.
Weak candidates either did not attempt to incorporate a sufficient number of items or had errors in their
calculations of specific items, and they failed to provide any qualitative considerations.)
179
The candidate discusses the internal control weaknesses related to EasyPark and whether the
proposed automations are going to address them, and recommends additional controls that
could be implemented.
The candidate demonstrates competence in Assurance (IT).
Competencies
VI-3.4 – Evaluates IT-related elements of internal control (B)
After reading through the notes regarding the accounting and IT departments, I noted a number of control
weaknesses.
Manual Processes
Control weakness: There are many manual processes relating to the accounting of EasyPark, including the
manual manipulation of data for accounts receivable and payable balances, as well as the manual issuance
of cheques.
Implication: EasyPark is an operation with a high volume of transactions. Manual processes are more
prone to error in general, but this effect is amplified when there are many transactions. There is already
evidence of errors, since entry errors are being made when the accounts receivable clerk enters the
information on accounts receivable into the accounting system. This has resulted in non-payment and
collectability issues. It also means that RWD’s revenue is incorrectly stated, and it could be either over- or
understated. Although there are no indications of errors to date on accounts payable or cheque runs, it is
likely that errors are being made due to employees being overworked and lacking time.
Will the automation plan address this weakness? Partially. The IT department is proposing that the
EasyPark system will automatically update the accounting records. This will fix the control weakness
related to manual entries of accounts receivable and payable, since the accounts receivable and payable
clerks will no longer have to manually enter the EasyPark receivables and payables into the accounting
system. However, it does not address the manual issuance of cheques.
Additional controls that could be implemented: Other manual processes could be automated to increase
efficiency and reduce risk. For example, we may want to consider setting up electronic fund transfers to the
Owners. This will reduce the manual labour involved in preparing and sending cheques, as well as reduce
risk of errors, such as a cheque being mailed to the wrong individual.
(Most candidates recognized that EasyPark’s use of many manual processes related to its accounting
was an issue, and they were able to recognize that the proposed automation plan would partially address
the issue. A few of these candidates also attempted to provide additional controls to remediate the
weaknesses.)
180
Driver Identity
Control weakness: There is no verification of a Driver’s identity before the Driver is allowed to check in
and park in a spot.
Implication: Drivers can enter fictitious names and addresses into the EasyPark system and then park for
free. Net income is overstated because there is no way to collect the money from these Drivers.
Will the automation plan address this weakness? Yes. The IT department is proposing that EasyPark
require a Driver to enter a valid credit card when setting up his or her account to verify the Driver’s identity.
This control will ensure that the Driver is a real person. However, this also increases risk since there will
be additional information security concerns to consider. This can be mitigated by ensuring we have
appropriate controls surrounding the collection and storing of personal and financial information.
Additional controls that could be implemented: The above control can be improved if EasyPark also
checks to ensure that a Driver has sufficient room on his or her card for the parking charge when the Driver
checks in to a parking space. In addition, the Driver’s credit card can be charged immediately after checkout. This would not only help with verifying the Driver’s identity, but also reduce the amount of work
required after the fact (the issuance of invoices and the manual manipulation of data to determine the invoice
amount), which would free up the accounting department’s time and reduce the risk of error. It would also
reduce the time required to follow up on receivables and reduce the amount of bad debt.
(Most candidates identified the fact that the lack of driver identity verification was an issue and were
also able to recognize that the proposed automation plan would resolve this issue. About half of these
candidates also successfully provided an adequate additional control to remediate the weakness.)
Backups
Control weakness: EasyPark was not backed up regularly by IT.
Implication: Some revenue transactions were lost because IT could not recreate all the transactions that
had occurred on those days on which backups were not taken due to employee vacation. There was no way
to determine which Drivers should have been charged and which Owners were owed money by RWD on
those days, resulting in lost revenue.
Will the automation plan address this weakness? None of the automations proposed by the IT department
will address this issue.
Additional controls that could be implemented: IT must ensure that backups are done at least nightly,
perhaps even hourly due to the volume of transactions. Backups should not be a manual process. Instead,
they should occur automatically to prevent events such as employee absence from affecting the backup
process. Also note that implementing the charging of credit cards immediately after check-out would
provide another source of information to recreate data in the system in the event of a backup failure. In
addition, copies of the backup should be kept off-site.
(Many candidates recognized that the lack of regular back-ups was an issue. Most of these candidates
were able to propose a valid control that would resolve the issue, recognizing that the proposed
automation plan would not resolve it.)
181
Check-Out Process
Control weakness: Drivers can forget to check out of a space and be charged for parking for 24 hours.
Implication: This results in overstated revenue because the Driver did not actually park in the space for
the full 24 hours. This also results in overpayment of Owners, and it makes it difficult for RWD to get the
money back once Owners have already been paid.
Additional controls that could be implemented: The IT department should consider adding a control
whereby the Driver is prompted after a certain amount of time to check out of the space. If the Driver does
forget to check out, then perhaps there should be a way for the Driver to go back and specify what time
they actually left the parking space. Alternatively, RWD can consider implementing an electronic chip
system that requires any Driver who signs up for EasyPark to have a chip placed in their car. In addition,
Owners who register would need to have a sensor installed at their parking spot, which will allow for
automatic check-in and check-out of the car, thus avoiding the reliance on the Driver to remember to do so.
This would also prevent Drivers from not checking in even if they have occupied a spot, or from continuing
to park in a space even though they may have checked out in the system. It would also help solve the Driver
identity issue identified earlier, since the chip would be linked to an individual who would have had his or
her identity verified when the chip was issued.
At a minimum, the user acceptance agreement, to which a driver would have agreed when downloading the
app (EasyPark should have one if it is not already in place), should explicitly state that if a Driver forgets
to check out of a parking space, the Driver is charged for 24 hours of parking. This will ensure Drivers are
aware of the policy and thus will reduce disputes.
(Many candidates recognized that the existing check-out process was flawed. Most of these candidates
were able to propose a valid control to resolve the issue, recognizing that the proposed automation plan
would not resolve it. Some candidates erroneously discussed the implication from the driver’s perspective
rather than from EasyPark’s perspective.)
Accounting System and IT File Reconciliation
Control weakness: There is no check to make sure that the accounting system and the EasyPark database
agree.
Implication: Revenue, accounts receivable, and accounts payable could be either over- or understated.
Will the automation plan address this weakness? Partially. The IT department is proposing that the
EasyPark database automatically update accounts receivable and accounts payable records. This will help
to address issues that have occurred due to manual errors. However, this will not address the entire issue.
Even after automation, it is possible that other data could be entered into the accounting system that do not
agree with the EasyPark system.
182
Additional controls that could be implemented: I recommend that, on a monthly basis, the accounts
receivable and accounts payable clerks reconcile their accounting records to the EasyPark database.
Specifically, the accounts receivable clerk should compare monthly revenue to the total monthly
transactions from the EasyPark database. Revenue generated from the sale of the app should agree, and
revenue generated from parking transactions should be 25% of the transactions reported by the EasyPark
database. The accounts receivable clerk should also reconcile the credit card and cheque payments received
to what the accounts receivable system is showing as received on a monthly basis. Any discrepancies should
be investigated and resolved in a timely manner.
The accounts payable clerk should reconcile payments issued to the total transactions the EasyPark database
is reporting on a monthly basis.
(Approximately one-third of candidates were able to identify the fact that the accounting system and the
EasyPark database did not agree. However, only about half of these candidates recognized that the
proposed automation plan would only partially resolve this issue. Very few candidates were able to
provide additional controls to remediate this weakness.)
Transaction Details
Control weakness: Drivers are not provided with transaction details on their invoices.
Implication: Providing details on invoices is a good detective control, since Drivers will be able to see how
their balance owing is built and can easily identify any transactions in dispute if they do not agree with the
balance owing. Without the details, it is likely that revenue is over- or understated because Drivers do not
have the information required to review their balances.
Will the automation plan address this weakness? Yes. The IT department proposes pushing details of
accounts onto users’ smartphones. This will allow users to dispute transactions in a timely manner in order
to address any errors. It will reduce the amount of time spent with each Driver who has a dispute, since the
transactions in question can be easily identified. However, this is likely a better control for identifying
overcharges, since Drivers will be less likely to dispute a balance if they have been undercharged.
Additional controls that could be implemented: RWD could implement a system whereby Drivers are
emailed electronic statements with transaction details at a frequency specified by the Driver. This will create
an additional layer of control because all Drivers will be provided with details of their transactions, not just
the ones who may be worried about errors.
(Most candidates identified the fact that there was an issue with drivers not being provided with
transaction details on their invoice, and most of these candidates recognized that the proposed
automation plan would resolve the issue. However, very few of these candidates were able to provide
valid additional controls to remediate the weakness.)
183
Accounts Receivable
Control weakness: Accounts receivable are not being reviewed and followed up on a regular basis.
Implication: Without regular review and follow-up of outstanding balances, revenue may be lost because
Drivers may not pay, knowing that RWD will not be asking for the funds. In addition, RWD will not be
able to gain a good understanding of the reasons for bad debts and thus will be unable to come up with
solutions to address the problems, ultimately leading to lost revenue.
Additional controls that could be implemented: The accounts receivable clerk should ensure that she
follows up on outstanding accounts receivable balances on a regular basis (perhaps weekly). If she does not
have the time to do it, another employee should be assigned the task. Again, if the charging of credit cards
is implemented, it will reduce the need to follow up on outstanding amounts, since accounts receivable
balances should be minimal.
(Very few candidates recognized that the lack of review and follow-up of accounts receivable balances
was an issue. However, most of the candidates who did were able to propose a valid control to resolve
the issue, recognizing that the proposed automation plan did not address it.)
Parking Space Monitoring
Control weakness: There is no monitoring of parking spaces throughout the city.
Implication: Without regular monitoring, Drivers can take advantage of the system by simply parking at
available spots without checking in or checking out. Drivers are more likely to do this if they know there is
no monitoring in place, leading to lost revenue.
Additional controls that could be implemented: At a minimum, RWD should hire an individual to drive
around the city daily and ensure that cars that are parked in EasyPark registered spaces have checked in
according to the EasyPark central database. The electronic chip system discussed earlier would also be able
to address this issue.
(Many candidates recognized that the fact that parking spaces throughout the city weren’t monitored
was an issue. Most of these candidates were able to propose a valid control to resolve the issue,
recognizing that the proposed automation plan did not address it.)
184
For Primary Indicator #2 (Assurance (IT)), the candidate must be ranked in one of
the following five categories:
Percent
Awarded
0.2%
competence.
6.6%
Reaching competence — The candidate discusses some of the control
weaknesses AND explains whether the proposed automations will address them or
recommends some additional controls where necessary.
23.9%
Competent — The candidate discusses several of the control weaknesses,
explains whether the proposed automations will address them, and recommends
some additional controls where necessary.
66.8%
Highly competent — The candidate discusses many of the control weaknesses,
explains whether the proposed automations will address them, and recommends
many additional controls where necessary.
2.5%
(Candidates were asked by the controller to provide an assessment of the problems related to EasyPark’s
transactions and an opinion on whether the automations proposed by Brian would address them, as well
as any additional controls that could be implemented.)
(While most candidates did well on this indicator, some seemed to struggle to specifically discuss the
implication of the problems from RWD’s perspective, focusing instead on how they affected the
customers. Although most candidates were able to recognize that the proposed automations would
potentially resolve some of the problems and recommended additional controls where necessary, weak
candidates had a more difficult time providing valid explanations as to why these controls were necessary
and the implication of the lack of control for RWD. Moreover, some controls recommended by candidates
were not valid or practical. Strong candidates provided a clear discussion of how the proposed
automation plan would resolve some of the issues, and they also provided specific and practical controls
and explained why these were important for RWD’s operations.)
The candidate discusses the fact that the rollout was not in line with RWD’s mission statements.
The candidate demonstrates competence in Governance, Strategy, and Risk Management.
Competencies
IV-2.2 – Gains an understanding of the entity’s mission, vision, and strategies (B)
IV-2.4 – Identifies key elements of the entity’s value system (B)
Although EasyPark is profitable for RWD, as calculated at the beginning of this report, I am concerned
about the negative impact this project might have had on RWD’s objectives.
185
Analysis of RWD’s Vision and Mission
It appears that EasyPark was rolled out very quickly, with little thought to determine whether it was in line
with RWD’s vision. RWD’s vision is “to create interesting, intuitive website designs that are clean and easy
to use.” EasyPark does not meet the spirit of this vision, since the company is not creating websites as a
result of this purchase.
EasyPark is also not consistent with RWD’s mission statements. The following table shows the negative
impact of EasyPark with respect to each one:
RWD Mission Statement
1. Put customers first.
2. Provide creative and
artistic design services.
3. Respond to customer
requests within 24 hours.
4. Employ only the best in the
field and use them to the
best of their abilities.
5. Make RWD a great place
to work and ensure our
employees have a good
work-life balance.
EasyPark Impact
Veronica has indicated that it is taking much longer to complete
projects for RWD’s regular clients. Several clients had to be turned
away due to lack of time to devote to their projects.
RWD is in the business of designing websites. Running an app such
as EasyPark is a completely different line of business from website
design.
Veronica stated that it was taking at least two weeks to respond to
EasyPark’s users when they requested more detail on their statements.
In addition, website design clients have been neglected, and it is taking
RWD longer to respond to their requests. This is not consistent with
RWD’s commitment to respond within 24 hours.
This is not being met at this time in the IT department because two
programmers are spending most of their time maintaining the database
instead of programming, which is their expertise. In addition,
Marcelle’s niece was hired to help out the accounting department and
is arguably not the best person RWD could have hired in the field.
It is unlikely any employees in the accounting or IT departments have
any work-life balance right now, since overtime in these departments
has significantly increased since last year. Also, Veronica states, “It’s
not surprising that our staff members are feeling so stressed.” These
are both major indicators that this RWD mission is not being achieved.
It does seem, however, that if the EasyPark automation can be done, most of these problems will be
resolved. Perhaps it would have made better business sense to have done the automation before rolling out
EasyPark to the residents of Montreal. I suggest that if the three shareholders are in agreement to continue
with EasyPark, the automation should occur as soon as possible.
Fortunately in this case, it turns out that the EasyPark app is actually making money for RWD. However, I
recommend that the shareholders spend some time determining what RWD’s strategy for the future should
be. They need to determine if they are going to take on any more apps or perhaps expand EasyPark into
other large cities. This is something for the shareholders to decide. After that, any new projects should be
analyzed to determine if they fit in with RWD’s vision and strategy. If a project does not, then perhaps the
project is not a good fit for RWD, or perhaps RWD’s vision needs amending.
186
(Candidates generally did a good job of discussing how the EasyPark rollout was not in line with RWD’s
current mission statement, integrating specific case facts to support their analysis. Most candidates
attempted to discuss several of the individual mission statement items and did a good job assessing the
issues related to putting customers first, responding within 24 hours, and providing a good work-life
balance. Candidates had more difficulty integrating the case facts to support their discussion of the issues
related to the vision of the company and its creative and artistic design services.)
Decision-Making Process
I am concerned about the informal process surrounding the purchase of EasyPark. It seems that this app
was purchased by Richard with very little financial analysis. Also, it was purchased without the agreement
of the two other shareholders. As discussed in the previous section, the purchase does not align well with
RWD’s vision and mission statements. This leads me to believe that a proper evaluation of the EasyPark
app, in which the risks and opportunities were evaluated, was not undertaken. Had the shareholders done a
proper evaluation of EasyPark, they would likely have realized that RWD’s current staffing levels were not
sufficient to deal with the rollout of EasyPark in January 2014.
I suggest that in the future, any new projects that RWD is considering go through a rigorous evaluation
before being adopted. Risks and opportunities of each project should be considered and evaluated. RWD’s
shareholders should consider whether they are willing to accept the risks identified or if there is any way to
mitigate those risks.
Also, there should be an agreement in place between the three shareholders regarding what types of
decisions require consensus of all the shareholders and what types of decisions can be made by one
shareholder. For example, any new projects would likely need the approval of all three shareholders before
going ahead. There could also be dollar thresholds put in place in terms of approvals for items such as
expenditures, hiring of employees, etc.
(Approximately one-half of the candidates were able to identify that there was an issue with the decisionmaking process. However, only two-thirds of those candidates were able to provide a complete
explanation of the implications for RWD and provide a valid recommendation to resolve the issue going
forward. Candidates appeared to struggle with their role in this area and, therefore, had difficulty
pointing out the operational issues that this decision made solely by Richard has created for RWD.)
For Primary Indicator #3 (Governance, Strategy, and Risk Management), the
187
Percent
Awarded
2.0%
competence.
12.4%
Reaching competence — The candidate discusses the fact that the rollout was not
in line with some of RWD’s mission statements.
15.9%
Competent — The candidate discusses the fact that the rollout was not in line with
several of RWD’s mission statements.
67.4%
Highly competent — The candidate discusses the fact that the rollout was not in
line with most of RWD’s mission statements, and discusses a better decisionmaking process for the future.
2.3%
(Candidates were not specifically directed to this indicator. However, the controller noted that the other
shareholders were upset because Richard had not consulted them, and they were concerned about how
EasyPark was affecting RWD’s ability to meet its vision and mission statements.)
(Candidates performed well on this indicator. Most were able to recognize some of the relevant case facts
and integrate them into a discussion of how the purchase of EasyPark has affected RWD’s ability to
meet its vision and mission statements. Most were also able to discuss the impact the purchase was having
on a number of the individual mission statements or how it conflicted with the overall vision, and also
identified that the acquisition by Richard without the consent of the other shareholders was an issue.)
(Strong candidates provided well-organized, concise discussions of issues related to several of the
mission statements and they either discussed the implications of Richard’s acquiring EasyPark on
RDW’s behalf without proper authorization and due diligence, or provided an insightful
recommendation to ensure future decisions were properly evaluated and approved. Weak candidates did
not address a sufficient number of issues, or their discussions did not properly integrate specific case
facts to support the argument that the acquisition was having a negative impact on RWD. Weak
candidates also had difficulty discussing the implication of Richard’s acquisition of EasyPark without
the consent of the other shareholders and were unable to provide a recommendation to avoid this from
occurring again in the future.)
188
(Candidates performed reasonably well on this simulation. Most candidates attempted to address all three
indicators. Candidates appeared to be most comfortable in their role on Primary Indicator #1 and did a
very good job of integrating the relevant case facts into their quantitative analysis of EasyPark’s
contribution to RWD’s financial results. However, the Board was disappointed that only a few candidates
were able to provide valid discussions of qualitative factors that would be relevant in their analysis of
EasyPark. Candidates who struggled on this simulation appeared to have difficulties with their role on
Primary Indicators #2 and #3. The Board recognizes that these two indicators were somewhat unique in
that candidates were expected to assess whether or not the proposed automation plan would resolve the
control issues, which required them to go beyond simply recommending manual controls to resolve the
issues on Primary Indicator #2. Likewise, for Primary Indicator #3, candidates were required to integrate
some case facts in order to discuss how the rollout of EasyPark was not in line with RWD’s mission
statements. Some candidates seemed to struggle with the integration required in Primary Indicators #2
and #3.)
189
OF CANADA
PAPER III
Time: 4 hours
(2) To help you budget your time during the evaluation, an estimate of the number of minutes required
for each simulation is shown at the beginning of the simulation.
**********
2014
Printed In Canada
III
190
Appendix C — Paper III
Long Haul Trucking Inc. (LHT) is a transportation business that operates a fleet of long-haul trucks
transporting goods across Canada. LHT has one wholly owned subsidiary, Fix Fix Inc. (FFI). FFI is a fullservice mechanic shop that maintains the fleet of LHT and also has outside contracts for the maintenance
of other companies’ fleets. LHT is a private company with a June 30 year-end. The company is owned by
private equity investors and reports under International Financial Reporting Standards (IFRS) because the
owners require their significant investees to report under IFRS.
It is now September 9, 2014. You, CA, are an audit senior at William & Sully Chartered Accountants, and
LHT has been a client of your firm for a number of years. LHT has engaged your firm, as it has done in the
past, to perform an audit of its financial statements. The company’s bank has an annual audit requirement
as a condition of a loan. You met with the controller on Monday to begin the audit. Her comments from
that meeting can be found in Exhibit I.
The partner on the engagement asked that you send him a memo discussing any accounting issues you’ve
noted and outlining the procedures required to address the risk areas of the audit.
191
EXHIBIT I
CONTROLLER’S COMMENTS FROM MEETING
It’s been hectic getting ready for the audit because we are also finalizing the disposal of our subsidiary, FFI.
In the year ended June 30, 2014, the board of directors decided to sell FFI because it hadn’t been as
profitable as LHT’s owners required, and LHT wants to focus again on its transportation business to
increase its market share in that more profitable industry.
I have been very busy with due diligence requests from the purchaser. FFI made up nearly a third of our
operations, so there have been a lot of requests, and I’m sorry if my audit working papers are not as good
as in prior years. I have part of the draft financial statements prepared for you (Exhibit II), and part of the
tax working papers relating to FFI’s operations (Exhibit III). Can you take a look at these? I’m not sure the
new tax person properly made adjustments to calculate FFI’s taxable income and taxes payable.
LHT really needs to finish the audit on time this year because we’ve made a few late payments on our longterm loan and the bank has indicated that it is not willing to forgive any more late payments or other defaults.
Thankfully, we’ve met our debt covenant this year, the interest coverage ratio of 10 (earnings before
interest, tax, and discontinued operations, divided by interest expense), because otherwise, the loan would
have become payable on demand.
We hired an outside fleet maintenance company to do some work on our trucks. Since we’re selling FFI
soon, we wanted to try the outside company out. They said it was regular maintenance work, but we felt
that it should be capitalized because $90,000 is an abnormal amount of work and obviously means our
trucks weren’t up to par.
We are subject to a new government-legislated transportation levy that imposes a fee applicable to the
kilometres driven by our fleet of trucks for each 12-month period ending September 30. We have driven
460,000 kilometres between October 1, 2013, and June 30, 2014. Since the levy is payable only in October,
we have not recorded any expense so far. I have provided the levy table in Exhibit IV.
We obtained a new contract from Bitter Sweet Co. that started August 1, 2013, the date we received our
first payment. They wanted the exclusive rights to two trucks and drivers, to incorporate them into their
fleet. They approached us because we have acquired new refrigerated trucks they want to use. These trucks
are hard to come by because of long lead times and the fact that they are costly, about $275,000 each. Since
we can cover our regular deliveries using other trucks, and since Bitter Sweet Co. was willing to lease the
two trucks for a total of $8,000 a month at an implicit interest rate of 8% per year for a five-year contract,
we signed the agreement. That was a great win for our sales group: unexpected services revenue of almost
half a million dollars recorded this year. Also, we might be able to sell the two trucks to Bitter Sweet Co.
prior to the end of their useful lives, which is usually eight years, for $114,000 each. That amount is LHT’s
estimated fair market value for the trucks five years from now.
192
EXHIBIT I (continued)
CONTROLLER’S COMMENTS FROM MEETING
Like I said, we’ve been working hard because we’re about to close on the sale of FFI. We have an offer of
$5 million on the table now for our 100,000 shares, and we’re likely going to accept it. This offer is $43,000
below our carrying value of FFI’s net assets at June 30, 2014. In addition, we’re going to take a bit of a hit
in the first quarter of 2015 because our costs to sell FFI are estimated at $55,000. We also allocated an
additional $100,000 of our head office salaries to FFI’s operations this year. While it’s not an expense the
purchaser will pay, I think we’re justified in showing it to the users of the financial statements because we
have been spending so much time on that project. We were so busy getting ready for the sale that we didn’t
collect some accounts receivable fast enough. An FFI client that owed $45,000 went out of business, so we
wrote the receivable off during the year ended June 30, 2014. I prepared a draft note disclosure for the
disposal, but I wasn’t sure if we were supposed to show discontinued operations in a separate line because
we haven’t sold the business yet.
EXHIBIT II
LONG HAUL TRUCKING INC.
DRAFT CONSOLIDATED STATEMENT OF OPERATIONS
For the year ended June 30
Tax expense (recovery)
Net income (loss) from continuing operations
Net income from discontinued operations (Note 1)
2014
$
3,980
2,180
1,800
50
300
50
530
75
(25)
980
820
150
670
45
2013
$
4,250
3,325
925
175
460
60
800
79
—
1,574
(649)
(20)
(629)
—
Net income (loss)
$
$
Revenue
Expenses
Administrative expenses
Selling expenses
Depreciation
Interest expense
Gain on disposal of asset
715
(629)
Note 1 – Discontinued Operations
On January 1, 2014, the board passed a resolution to dispose of the operations of FFI. As
a strategic decision, the company decided to focus on its core operation of transportation
services.
Revenue
Expenses
Net income
Impairment loss recognized on the measurement of
FFI’s fair value
Profit (loss) before tax from a discontinued operation
Tax at 20% (from tax working papers)
Profit for the year from a discontinued operation
2014
$
1,400
(1,290)
110
(43)
67
(22)
$
45
The capital cost allowance (CCA) we can claim for the fiscal year 2014 is $150,000.
193
194
EXHIBIT III
TAX WORKING PAPERS FOR FFI’S OPERATIONS
Tax calculation on regular profit
Revenue
Expenses:
Cost of sales (Notes 1 and 2)
Allowance for doubtful receivables
Share-based compensation
Professional fees (Note 3)
12 months depreciation of assets relating to FFI
Allocation for LHT head office staff time
Tax at 20%
$
$
(770)
(95)
(25)
(30)
(270)
(100)
1,400
(1,290)
110
$
22
Notes:
1. The cost of sales includes an amount of $80,000 in labour and parts that was spent on refurbishing a
few engines that may be sold and installed in clients’ trucks. FFI expects to sell these engines at a small
profit.
2. FFI performed some repairs on LHT’s trucks. The parts were charged at their original cost, for a total
of $60,000. Generally, FFI generates a 25% mark-up on such sales.
3. Professional fees were incurred as part of a corporate restructuring. They include the issuance of
supplementary letters patent and legal fees to simplify the share structure of the company ($20,000).
195
EXHIBIT IV
TRANSPORTATION LEVY
12-MONTH PERIOD ENDING SEPTEMBER 30, 2014
LEVY TABLE
Kilometres driven
0 - 500,000
Basic
amount
Additional
rate per km
—
—
500,001 - 750,000
$ 25,000
$
0.03
750,001 - 1,000,000
$ 32,500
$
0.02
In excess of 1,000,000
$ 37,500
$
0.01
The levy calculated for the 12-month period ending on September 30 of each year is payable within
30 days of the end of the levy period.
Once a transportation company has reached a threshold, the levy is the total of the basic amount
and the amount determined by multiplying the “additional rate per km” for every kilometre driven
within a particular range.
196
Appendix C — Paper III — Evaluation Guide
EVALUATION GUIDE
PAPER III, SIMULATION 1 — LONG HAUL TRUCKING INC.
To: Partner
From: CA
Re: Long Haul Trucking Inc. (LHT)
The candidate discusses the accounting issues for LHT.
Competencies
V-2.4 – Accounts for the entity’s non-routine transactions (B)
From my review of the working papers, I’ve determined there are a number of adjustments to make as a
result of the accounting performed by the client.
Discontinued Operations
The client is in the process of finalizing the disposal of its subsidiary Fix Fix Inc. (FFI). The client has
presented it as discontinued operations but wasn’t sure if that was correct, since the sale has not been closed
as of the current date.
In accordance with paragraph 6 of IFRS 5, Non-currents assets held for sale and discontinued operations,
“an entity shall classify a non-current asset (or disposal group) as held for sale if its carrying amount will
be recovered principally through a sale transaction rather than through continuing use.” Paragraph 7 goes
on to state that, “for this to be the case, the asset (or disposal group) must be available for immediate sale
in its present condition subject only to terms that are usual and customary for sales of such assets (or
disposal groups) and its sale must be highly probable.” Therefore, in order to be classified as discontinued
operations, FFI doesn’t need to have been sold. It just needs to be available for sale, and its sale must be
highly probable.
197
Paragraph 8 of the guidance indicates, “For the sale to be highly probable, the appropriate level of
management must be committed to a plan to sell the asset (or disposal group).” The board of LHT has
decided to sell the subsidiary because it has not been as profitable as the private equity investors required.
From the draft note disclosure, we can see that the board passed a resolution on January 1, 2014, to dispose
of the subsidiary. Therefore, it is reasonable to consider that there was a committed plan in place at that
time. In addition, guidance states that “an active programme to locate a buyer and complete the plan must
have been initiated” and “the asset (or disposal group) must be actively marketed for sale at a price that
is reasonable in relation to its current fair value. In addition, the sale should be expected to qualify for
recognition as a completed sale within one year from the date of classification.” It is now September 9,
2014, and the controller has indicated LHT is in the process of finalizing FFI’s sale. There is an offer of $5
million on the table that LHT is likely going to accept, so it is clear that the price is reasonable in relation
to its current fair value. We can, therefore, conclude that the criteria are met and FFI would be classified as
an asset held for sale in the statement of financial position.
Given that FFI meets the criteria of an asset held for sale, we must also consider the presentation and
disclosure requirements of IFRS 5. Paragraph 30 states that “an entity shall present and disclose
information that enables users of the financial statements to evaluate the financial effects of discontinued
operations and disposals of non-current assets (or disposal groups).” According to paragraph 31, “A
component of an entity comprises operations and cash flows that can be clearly distinguished, operationally
and for financial reporting purposes, from the rest of the entity. In other words, a component of an entity
will have been a cash-generating unit or a group of cash-generating units while being held for use.” As
well, under paragraph 32, “A discontinued operation is a component of an entity that either has been
disposed of, or is classified as held for sale, and…represents a separate major line of business or
geographical area of operations…” Paragraph 32 goes on to state that the component “is part of a single
co-ordinated plan to dispose of a separate major line of business…” FFI can be clearly distinguished,
operationally and functionally, since it is a separate line of business that generates distinct cash flows from
LHT and, therefore, meets the definition of a disposal group. FFI is a separate line of business because it
performs maintenance on trucks, while LHT is involved in transporting goods. The board passed a
resolution to dispose of the subsidiary, and management has been working towards disposing of the
subsidiary, so there is a coordinated plan for the disposal and we can conclude that FFI should be classified
as a discontinued operation. In accordance with paragraph 33, LHT is required to disclose the post-tax profit
or loss of FFI in the statement of comprehensive income.
From my preliminary review and discussion with the controller, I have identified a few issues with the
calculation of discontinued operations:
The measurement of the disposal group should be written down to fair value less costs to sell. The
controller indicated in our meeting that the selling costs of $55,000 were going to be recorded in Q1 of
2015, which would be in the wrong period; these should be recorded at the same time as the impairment.
As a result, the impairment amount is understated.
The controller allocated $100,000 in head office salaries that would not form part of the sale but she
thought would be useful information. Because this is not actually part of the net income of the
discontinued operations, it should not be allocated to FFI. As a result, there is a classification error
between discontinued operations and net income from continuing operations (administration expenses).
A requirement of held-for-sale assets is that depreciation ceases once the disposal group has met the
criteria (IFRS 5.25). The company has recorded depreciation for the full 12 months when it should have
ceased depreciating the assets at January 1, 2014. Therefore, the depreciation expense is overstated by
$135,000 ($270,000 ÷ 2). However, to the extent that there is still a requirement to record an
impairment, the amount adjusted for depreciation should be reflected in an additional impairment.
An amount of $80,000 has been recorded in cost of sales. It seems that the amount should have been
added to the cost of inventory instead, since the engines that were refurbished will be available for sale.
198
IAS 2.10 indicates that the “cost of inventories shall comprise all costs of purchase, costs of conversion
and other costs incurred in bringing the inventories to their present location and condition.” The
amount in cost of sales is, therefore, overstated by $80,000. As for the adjustment for depreciation, any
increase to the assets of FFI will also result in a similar adjustment to the impairment amount.
The discontinued operations should be shown net of tax. In my review of the tax working papers, I
found errors in the calculation. In addition, the tax impact of the impairment was not recorded (deferred
tax) as required by IFRS 5.33(b)(ii). The profit after tax for the year from discontinued operations is
understated by $88,000 ($133,000 − $45,000).
Further, the information required to be disclosed for the discontinued operations should also be disclosed
for the comparative period in the statement of operations, and the note should include information on the
expected timing of the sale.
(Almost all candidates addressed this issue. Most of them provided in-depth discussions of the accounting
principles under IFRS for discontinued operations and recommended accounting policies that were
appropriate and logical based on their discussions of the case facts. However, some candidates failed to
recognize the need to assess the assets held-for-sale criteria to support their discussion of presenting the
FFI operations as discontinued operations.)
Contract for Two Trucks
LHT entered into a new arrangement with Bitter Sweet Co. that started August 1, 2013. Bitter Sweet wanted
the exclusive rights to two new refrigerated trucks that LHT had acquired, as well as two drivers, in order
to incorporate them into its fleet. Bitter Sweet has leased the two trucks for a total of $8,000 a month at an
implicit interest rate of 8% per year for a five-year contract. LHT has recognized the full amount of the
contract in the year.
We must determine if the lease should be classified as an operating lease or a finance lease at the inception
of the agreement. According to IAS 17.10, “Whether a lease is a finance lease or an operating lease
depends on the substance of the transaction rather than the form of the contract.” We will need to obtain
the agreement and understand the substance of the agreement.
When applying IAS 17.10, we must consider whether the risks and rewards of ownership would transfer to
the lessee at the end of the lease term:
The controller indicated LHT may eventually sell the asset to the lessee. We need to understand whether
it may be either certain due to the agreement and the nature of the asset or virtually certain due to the
sales price being low enough that it makes economic sense for the lessee to exercise the option. If any
of these indicate that the asset would transfer to Bitter Sweet, the lease would be considered a finance
lease; otherwise, it would be an operating lease. From the information provided on the terms of the
lease, it seems that the sale would occur at the fair market value of the trucks, and there is no certainty
that Bitter Sweet will acquire the two trucks at the end of the lease. As a result, this criterion is not met.
199
We would further consider whether the lease term is for a major part of the economic life of the asset.
From our discussion with the controller, it appears the non-cancellable portion of the lease is five years.
Because the trucks are new and a reasonably estimated useful life for the trucks is eight years, the lease
represents less than 75% of the estimated useful life (5 years ÷ 8 years = 63%). IAS 17 does not specify
a percentage threshold, but from my understanding of the industry, 63% does not constitute a major
part of the economic life of the asset.
An additional consideration is whether the present value of the minimum lease payments amounts to at
least substantially all of the fair value of the leased asset. There are a number of considerations in
determining the minimum lease payments. In addition to the monthly payment, minimum lease
payments for the calculation include any guaranteed residual value and bargain purchase options and
are reduced by contingent rent and any costs reimbursed by the lessor. From the available information,
the monthly lease payment is $4,000 for each truck over the five-year non-cancellable term, and the
company is making 8% per year on the lease, which is the rate implicit in the lease (8% ÷ 12 = 0.67%
per month). The present value of each truck in the lease agreement is $197,274 (NPV, 0.67%, monthly
payments of $4,000, 60 periods), which is 72% of the fair value ($197,274 ÷ $275,000), assuming the
fair value is close to the $275,000 value of a new truck. The “substantially all” criterion would,
therefore, not be met.
Based on our understanding of LHT’s business, the trucks would otherwise be used in the company’s
own operations if they were not leased to Bitter Sweet, so the specialized equipment criterion would
not apply.
We must also consider the criteria in IAS 17.11 to determine whether the lease could be classified as a
finance lease:
Would Bitter Sweet assume any losses incurred by LHT upon cancellation of the lease? In this
particular case, there is no indication that the lessee can cancel the lease, and certainly no indication
that Bitter Sweet would assume LHT’s losses should the lease be cancelled, so this criterion is not met.
Would the increase in the fair value of the residual accrue to Bitter Sweet? The terms of the lease do
not provide for any adjustment to the payments by Bitter Sweet that would be tied to the residual value
of the truck, so this criterion is not met.
Does the lease provide for a “secondary” period that would enable a reduced rent? The terms of the
lease do not provide for any renewal period, so this criterion is not met.
In summary, we conclude the lease is an operating lease. However, it appears that LHT’s income on this
particular lease was entirely recognized upfront. LHT should reverse the $480,000 sale recognized in the
current year ($8,000 × 60 months) and only recognize the lease payments applicable to its 2014 financial
year ($8,000 × 11 months = $88,000).
(Many candidates identified this issue and provided relevant accounting discussions, integrating case
facts to support their analysis of the relevant criteria and concluding that the transaction should be
accounted for as an operating lease. Weak candidates did not provide any analysis of the criteria, failed
to integrate appropriate case facts to support their analysis of the relevant criteria, or concluded without
providing adequate technical guidance to support their analysis.)
Truck Maintenance
In our meeting, the controller indicated that LHT had maintenance work in the amount of $90,000
performed by a new supplier to test that supplier out in anticipation of selling FFI. She has capitalized these
costs because they were much higher than usual, which she concluded meant they would qualify as capital
expenditures.
200
IAS 16.13 indicates that “under the recognition principle in paragraph 7, an entity recognises in the
carrying amount of an item of property, plant and equipment the cost of replacing part of such an item
when that cost is incurred if the recognition criteria are met.”
Paragraph 7 specifically states that “the cost of an item of property, plant and equipment shall be recognised
as an asset if, and only if: (a) it is probable that future economic benefits associated with the item will flow
to the entity; and (b) the cost of the item can be measured reliably.” Hence, if the work performed resulted
in the replacement of a specific significant component, LHT would derecognize the old component and
then capitalize and depreciate the new component.
However, if the costs relate to maintenance, IAS 16.12 supports that they be expensed as incurred,
regardless of the dollar amount and even if they were more expensive than anticipated, since they represent
the “costs of the day-to-day servicing of the item.”
From the limited information available, it appears that this relates to routine maintenance rather than an
overhaul. Therefore, the repairs and maintenance expense is understated by $90,000 and the capital asset is
overstated by $90,000. The amortization expense is also overstated due to amortization that would have
been taken during the year on the capitalized amount.
(Many candidates identified this issue and provided relevant accounting discussions, recognizing that
the maintenance costs should be expensed since they represented day-to-day servicing costs and did not
provide future economic benefits.)
Government Transportation Levy
The definition of a liability under the Conceptual Framework indicates that it is “a present obligation of
the entity arising from past events, the settlement of which is expected to result in an outflow from the entity
of resources embodying economic benefits.”
However, according to IAS 37.14, a provision should be recorded when
(a)
an entity has a present obligation (legal or constructive) as a result of a past event;
(b)
it is probable that an outflow of resources embodying economic benefits will be required to settle
the obligation; and
(c)
a reliable estimate can be made of the amount of the obligation.
IAS 37.17 further defines a past event:
A past event that leads to a present obligation is called an obligating event. For an event to be an obligating
event, it is necessary that the entity has no realistic alternative to settling the obligation created by the
event. This is the case only:
(a)
where the settlement of the obligation can be enforced by law; or
(b)
in the case of a constructive obligation, where the event (which may be an action of the entity)
creates valid expectations in other parties that the entity will discharge the obligation.
201
Paragraph 19 further explains:
It is only those obligations arising from past events existing independently of an entity's future actions (i.e.,
the future conduct of its business) that are recognised as provisions. Examples of such obligations are
penalties or clean-up costs for unlawful environmental damage, both of which would lead to an outflow of
resources embodying economic benefits in settlement regardless of the future actions of the entity.
Similarly, an entity recognises a provision for the decommissioning costs of an oil installation or a nuclear
power station to the extent that the entity is obliged to rectify damage already caused. In contrast, because
of commercial pressures or legal requirements, an entity may intend or need to carry out expenditure to
operate in a particular way in the future (for example, by fitting smoke filters in a certain type of factory).
Because the entity can avoid the future expenditure by its future actions, for example by changing its method
of operation, it has no present obligation for that future expenditure and no provision is recognised.
The new transportation levy has created an obligation that arises both upon a certain threshold being reached
(500,000 kilometres) and as a result of the continuous use of the trucks. Because the kilometres are driven
over time and 460,000 kilometres had already been driven by June 30, 2014, it is very reasonable to assume
that LHT will have used its trucks for more than 500,000 kilometres by September 30 and that it will be
subject to the levy. However, this obligation only becomes one as a result of future events — the continued
use of the vehicles driving in excess of 500,000 kilometres. Because LHT can avoid the expenditure in
future by way of its actions, no obligation should be accrued at June 30, 2014, regardless of the likelihood
it will exceed the threshold by September 30, 2014.
(Many candidates addressed this issue, and most of those who did provided a well-supported discussion
of the relevant criteria for the provision and applied case facts to arrive at an appropriate accounting
treatment. Those who did not provide in-depth discussions failed to use appropriate case facts to analyze
the relevant criteria. For example, some of these candidates concluded that the minimum basic amount
of $25,000 was payable if the entity did not reach the minimum 500,000 kilometre threshold, while others
failed to recognize the timing difference between LHT’s year end (June 30, 2014) and the end of the levy
calculation period (September 30, 2014). In both cases, the candidates limited the usefulness of their
analysis. Some candidates made reference to IFRIC Interpretation 21 — Levies in their response to
support their analysis. This interpretation is only effective for annual periods beginning on or after
January 1, 2014, and candidates were only responsible for Handbook updates in effect as of December
31, 2013. Although candidates were in no way expected to reference this interpretation, those who did
were given credit due to the fact that early application is permitted.)
Classification of Debt
As noted below, LHT has breached its bank covenant as of the year-end date. As a result, according to IAS
1.74, “when an entity breaches a provision of a long-term loan arrangement on or before the end of the
reporting period with the effect that the liability becomes payable on demand, it classifies the liability as
current…” Therefore, there is a change in the classification from a long-term debt to a current liability. IAS
1.74 goes on to say that this would be current “even if the lender agreed, after the reporting period and
before the authorisation of the financial statements for issue, not to demand payment as a consequence of
the breach. An entity classifies the liability as current because, at the end of the reporting period, it does
not have an unconditional right to defer its settlement for at least twelve months after that date.”
202
The bank would have had to agree not to call the loan for a period of at least 12 months by the end of the
reporting period. If LHT had been able to obtain such a waiver, the company would not be required to
classify the debt as current. According to IAS 1.75, “an entity classifies the liability as non-current if the
lender agreed by the end of the reporting period to provide a period of grace ending at least twelve months
after the reporting period, within which the entity can rectify the breach and during which the lender cannot
demand immediate repayment.” However, since it is past the reporting period (year-end date of June 30),
this is no longer an option.
LHT will need to discuss with the bank the implications of the debt covenant breach. It will also need to
make certain disclosures in the financial statements under IFRS 7. According to IFRS 7.18:
For loans payable recognised at the end of the reporting period, an entity shall disclose:
a)
details of any defaults during the period of principal, interest, sinking fund, or redemption terms of
those loans payable;
b)
the carrying amount of the loans payable in default at the end of the reporting period; and
c)
whether the default was remedied, or the terms of the loans payable were renegotiated, before the
financial statements were authorised for issue.
(Few candidates were able to integrate their analysis of the breach in debt covenant with their accounting
discussions; therefore, candidates struggled to recognize that the breach in debt covenant would require
a reclassification of the long-term debt in the financial statements. In addition, candidates who did
address this issue generally failed to provide sufficient depth of discussion, only identifying the need to
reclassify the debt without providing proper support.)
Percent
Awarded
0.0%
competence.
5.1%
Reaching competence — The candidate discusses some of the accounting
issues.
39.6%
55.2%
Highly competent — The candidate discusses most of the accounting issues.
0.1%
(Candidates were specifically directed to this indicator when they were asked by the partner to provide a
memo discussing any accounting issues they had noted.)
203
(Most candidates performed adequately on this indicator and provided in-depth discussions of some of
the relevant accounting issues, such as the presentation and measurement of the discontinued operations
(FFI) and the presentation of the lease transaction. These candidates provided appropriate
recommendations based on their analysis and discussed some of the more significant transactions.
Strong candidates were able to integrate the case facts into their analysis and provide logical
recommendations that flowed from their analysis. Weak candidates typically addressed the same number
of issues but focused on the less significant issues, such as truck maintenance or the government levy,
or recommended accounting treatments without supporting them with case facts or reference to the
relevant IFRS standard or both.)
The candidate provides audit procedures for the risk areas of the audit.
Competencies
VI-2.5 – Designs appropriate procedures based on the assignment’s scope, risk, and materiality
guidelines (A)
Assets Held for Sale and Discontinued Operations
We should verify whether the criteria to classify the assets as held for sale and FFI as discontinued
operations were met as of June 30, 2014. The first step would be to determine if the sale was highly probably
at the June 30, 2014. As per IFRS 5, paragraph 8, “For the sale to be highly probable, the appropriate level
of management must be committed to a plan to sell the asset (or disposal group), and an active programme
to locate a buyer and complete the plan must have been initiated.” To test this, we should obtain board
minutes that indicate the approval of management’s plan, since we know that on January 1, 2014, the board
passed a resolution to dispose of FFI. To test that the disposal group was available for immediate sale in its
present condition, we should obtain management’s report or marketing document that likely would have
been prepared by a professional services firm to assist in selling the company. We may also be able to
obtain a signed letter of intent between the parties. These documents would indicate that FFI was being
marketed and would note if FFI was not available for immediate sale. The letter of intent would also support
management’s assertion that the sale was expected to close within one year.
We should perform procedures on the costs included in the discontinued operations line to test that these
all pertain to FFI. Management has a bias to include more costs in discontinued operations because
discontinued operations are excluded from the bank covenant calculation. Earlier in this report we noted
that the controller had allocated $100,000 in costs that would not form part of the sale because she thought
the information would be useful to the financial statement user, and we proposed an adjustment. We could
test the costs allocated to discontinued operations by obtaining a schedule of the costs allocated to FFI,
selecting a sample from the list, and examining the support to test that the costs relate to FFI. In addition,
we should test the journal entries relating to the discontinued operations to identify any additional amounts
allocated from LHT that would not qualify to be part of the disposal group (similar to the costs allocated
for the head office salaries). In addition, we should ensure the assets and liabilities relating to the disposal
group are separately disclosed in the statement of financial position as held for sale.
204
Earlier in this report, we noted LHT has incorrectly accounted for the measurement of the disposal group
since IFRS 5 requires the disposal group to be written down to the fair value less costs to sell. Therefore,
we propose an accounting adjustment of $55,000. We should assess the reasonableness of the costs to sell
by obtaining management’s estimate and reviewing it. Furthermore, we should test a sample of the costs
included in management’s schedule by agreeing them to supporting invoices where possible, as some of
these costs may not actually be selling costs pertaining to the sale of FFI.
We should also perform procedures on the impairment calculation performed by management. The
controller indicated there is an offer on the table that LHT will likely accept. The offer would be evidence
of the fair value of the business. We should obtain the signed offer or letter of understanding and recalculate
management’s calculation of impairment to fair value (less costs to sell).
Lastly, according to IFRS 5, paragraph 38,
An entity shall present a non-current asset classified as held for sale and the assets of a disposal group
classified as held for sale separately from other assets in the statement of financial position. The liabilities
of a disposal group classified as held for sale shall be presented separately from other liabilities in the
statement of financial position. Those assets and liabilities shall not be offset and presented as a single
amount. The major classes of assets and liabilities classified as held for sale shall be separately disclosed
either in the statement of financial position or in the notes.
We should review the journal entries made to prepare the financial statements and their support to test that
the assets and liabilities relating to FFI are appropriately disclosed.
(Most candidates attempted to address this risk area, and most of those candidates were able to provide
valid procedures to address the presentation and measurement issues related to the disposition of FFI.
They provided specific procedures to apply to ensure the board was committed to selling FFI and the
sale was highly probable.)
Revenue Arrangement Containing a Lease
LHT entered into a new type of revenue arrangement in which the company is providing a client with
exclusive rights to two trucks and drivers, rather than simply providing transportation services. According
to the controller, the arrangement contains a lease. We should obtain the agreement and read it for terms
that could affect the classification of the lease. We should obtain support for the fair value of the asset from
either a blue book, an appraiser, or recent sales of similar assets. We should also test the calculation of the
discount rate because the rate used should be the implicit rate of the lease. We should perform a sensitivity
analysis of the inputs (useful life, residual value, fair value, discount rate) into the calculation to focus our
efforts on the areas of highest risk. As noted earlier, LHT included the entire amount in revenue in the
current year, so we proposed an audit adjustment of $392,000 ($480,000 − $88,000).
(Approximately two-thirds of the candidates attempted to provide a procedure to address the revenue
arrangement, with the majority of those candidates providing valid audit procedures. Strong candidates
recognized the need to review the terms and conditions of the revenue arrangement in order to
corroborate the data being used to assess the lease classification criteria. Weak candidates provided very
generic procedures and were not able to indicate why they were reviewing the revenue arrangement.)
205
Property, Plant and Equipment
A significant amount of repairs and maintenance was performed on LHT’s trucks during the year, and this
was capitalized. Our discussion with the controller indicates this appears to be regular maintenance, so we
proposed an adjustment of $90,000. We should test the additions to capital assets by obtaining the list of
additions, selecting a sample, obtaining the invoices and work orders, and understanding the nature of the
work to find out if there are more expenses that were capitalized when the capitalization criteria were not
met.
We should review the basis of depreciation and question whether the useful life is appropriate considering
that the vehicles on which the “abnormal amount of work” was performed might be impaired. We should
question whether the useful life of these trucks should be adjusted, and we should consider their state of
repair in assessing impairment.
Maintenance and repair work seemed to have been carried out on many trucks, so we should question
whether this is indicative of a similar problem on any of the other trucks in the fleet.
(Most candidates were able to provide a valid audit procedure for the presentation of the maintenance
work performed, focusing on the need to review amounts that had been capitalized during the year to
ensure that they could be capitalized.)
Government Levy
The following procedures should be performed relating to the levy:
Review the legislation and ensure that the rates applied are appropriate.
Verify the odometers on a sample basis. Review the safety inspection reports, maintenance logs, licence
renewal applications, or driver logs to verify the starting and ending kilometres and determine whether
the kilometres driven are reasonable.
(Most candidates were able to provide a valid audit procedure for the government levy.)
Income Taxes — Discontinued Operations
We should verify that the tax computation was done in accordance with the provisions of the ITA and IAS
12 Income Taxes of the CPA Canada Handbook. We should also compare it to prior years to determine if
all of the adjustments to the accounting income have been considered.
(Very few candidates considered the impact of the tax considerations on the accounting for discontinued
operations. As a result, the number of candidates who provided an audit procedure in this area was
negligible.)
Going Concern Considerations
As per IAS 1, the company is required to assess its ability to continue as a going concern. According to IAS
1.25, “When management is aware, in making its assessment, of material uncertainties related to events or
conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity
shall disclose those uncertainties.”
206
Although we review management’s assessment as part of our normal audit procedures, we have an
additional risk as per my discussion below, since LHT has breached the bank covenant and the loan is now
due on demand. In addition, the controller has informed us that LHT has been late with a few payments this
year, indicating it may have had difficulty with available cash during the year. As a result, we need to pay
even more attention to management’s assessment and consider the potential disclosure requirement. We
must understand the implications of the breach of the covenant since the bank now has the right to call the
loan. The bank may have provided a waiver or an alternative payment arrangement, and we should
determine whether LHT has made arrangements with the bank.
We have indications of a going concern issue as a result of the following facts: loss in prior year, sale of
the subsidiary to generate cash, late payments, and breach of the debt covenant. As a result, we need to ask
management to perform a going concern analysis, including preparing future cash flows. We thereafter
need to assess the reasonableness of the cash flows and the need for going concern disclosure. In the event
a going concern disclosure is required, we should test the disclosures made by management and, in addition,
include an emphasis of matter paragraph in our audit report.
(Few candidates attempted to provide an audit procedure to address the issue related to the covenant
breach, and only half of the candidates who did were able to provide a valid audit procedure in this area.)
Percent
Awarded
0.5%
competence.
11.1%
Reaching competence — The candidate provides some valid audit procedures for
the significant risk areas.
29.1%
Competent — The candidate provides several valid audit procedures for the
significant risk areas.
59.2%
Highly competent — The candidate provides valid audit procedures for most of the
significant risk areas.
0.1%
(Candidates were specifically directed to this indicator when they were asked by the partner to outline
procedures required to address the risk areas of the audit.)
(Most candidates performed well on this indicator. While most were able to provide relevant audit
procedures that addressed the specific risk areas identified in the simulation — in particular with regards
to discontinued operations, lease, maintenance on trucks, and the government levy — some candidates
provided procedures without properly identifying the relevant risk area being addressed, or they provided
procedures that were not clear or were too generic. Strong candidates did a good job of linking their
audit procedures directly to their accounting discussion, restating the relevant risk or assertion being
addressed and clearly identifying how to carry out the procedure. Candidates are reminded to always
support their procedures by explaining the objectives of developing them and the audit risks being
addressed, and to specifically state what information or documents need to be obtained in order to
perform the procedures.)
207
(Some candidates did not completely understand their role and provided an audit planning memo, despite
the fact that they were not asked to discuss the planning of the engagement. This had an impact on the
level of depth and breadth provided in discussions of the audit procedures — because of the time they
spent on the planning considerations, they had less time to address procedures.)
The candidate recalculates the taxes payable for the discontinued operations.
Competencies
IX-2.3 – Calculates taxes payable for a corporation in routine situations (A)
The controller has provided the draft tax calculations for the discontinued operations. Because she has been
busy with due diligence requests, the working papers this year have been rushed. She asked that we look at
the tax calculation. In addition to the accounting errors we noted above, the tax calculation appears to be
on an accounting basis rather than a tax basis. We therefore must calculate the adjustments required to go
from an accounting net income to a taxable income.
Allowance for Doubtful Receivables
The Income Tax Act (ITA) considers the impairment losses for trade receivables to be a reserve. ITA
18(1)(e) does not allow for the deduction of a reserve for impairment losses. Instead, the taxpayer is allowed
to deduct the actual losses resulting from debts written off as an expense (rather than those that are just
doubtful). As a result, the accounting impairment losses for trade receivables of $95,000 must be added
back and the actual losses resulting from debts written off in the amount of $45,000 should be deducted.
(Candidates struggled to differentiate the tax treatment of the impairment losses and the bad debts writeoff. Approximately half of the candidates were able to identify the non-deductibility of the accounting
impairment losses for trade receivables, while only one-quarter of the candidates were able to identify
the deductibility of the actual losses resulting from debts written off. Most of the candidates who
addressed this issue were able to provide a valid adjustment to the calculation of taxable income, but
many candidates struggled to support their adjustments with a valid explanation of the rules under the
Income Tax Act.)
208
Depreciation
The ITA has a specific set of rules applying to depreciable capital property, and the accounting depreciation
is not an allowable deduction under ITA 18(1)(b). Instead, it is added back in the calculation of taxable
income. ITA 13(21) groups depreciable property into classes and “undepreciated capital cost” for each
class, and a deduction up to the maximum capital cost allowance (CCA) is allowed under ITA 20(1)(a).
While the accounting rate of depreciation is consistent for a company from year to year, CCA prescribes
an allowable rate based on the category of depreciable property, and the company is allowed to deduct any
amount up to that rate. While there are prescribed rates for each class, the controller has informed us that
the deduction for tax purposes would have been $150,000.
(Most candidates were able to recognize the need to adjust the taxable income calculation for the impact
of accounting depreciation and capital cost allowance. However, approximately one-third of those
candidates were not able to provide a valid explanation of the rules under the Income Tax Act to support
their adjustment.)
Professional Fees
As part of a restructuring of share capital to simplify the share structure, professional fees of $20,000 were
incurred in 2014 to obtain the issuance of supplementary letters patent. Those fees should not currently be
deductible in computing FFI’s income because they relate to its capital structure and are therefore capital
in nature. They should be included in FFI’s eligible capital expenditures under Section 14 of the ITA, and
75% of the amount should be added to the cumulative eligible capital, for which FFI will be able to claim
a deduction equivalent to 7% of the balance in the account at year end.
(Approximately one-quarter of candidates were able to provide a valid adjustment in this area, and most
of those who did provided a good explanation of the rules under the Income Tax Act. However, many
candidates applied the rules under Section 20(1)(e), which deals with financing fees; therefore, they
incorrectly concluded that the amount was deductible evenly over five years for tax purposes.)
Share-Based Compensation
FFI recorded an expense of $25,000 with respect to share-based compensation for its 2014 fiscal year.
Paragraph 143.3(2) of the ITA prohibits the deduction of amounts recorded as an expense for accounting
purposes as a result of the issuance of shares to employees. Therefore, the $25,000 expense would have to
be added in computing FFI’s taxable income.
(Only a few candidates were able to properly adjust taxable income for the share-based compensation
and provide a valid explanation of the rules under the Income Tax Act.)
Transaction with LHT
FFI performed some repairs for LHT, but only charged the actual costs for rendering the services. As FFI
and LHT are not dealing at arm’s length, FFI should record the income at fair value, including the usual
mark-up of 25%. Therefore, FFI’s taxable income should be increased by $15,000.
(About half of the candidates provided a valid adjustment in this area and a valid explanation supporting
why the amount had to be adjusted for under the Income Tax Act.)
209
Revised Tax Calculation Relating to Discontinued Operations (in thousands of dollars)
Notes
Net income before tax (from tax working papers)
Correct allocation for staff time (accounting error)
Adjusted net income before tax
Add:
Unrecorded mark-up on sale to LHT
Allowance for doubtful receivables
Costs added to inventory
Depreciation
Share-based compensation
Professional fees
Deduct:
Actual bad-debt write-off
CCA
ECE
Taxable income
Tax at 20%
$
110
100
210
1
15
95
80
270
25
20
2
3
4
5
6
7
(45)
(150)
(1)
519
104
3
5
7
Notes:
1. As noted in the discussion of discontinued operations, there was an accounting error regarding salaries,
which we have added back to FFI’s net income. These costs are not deductible for tax purposes unless
they can be supported as relating to FFI and are an expense that FFI will actually pay.
2. As required under the Income Tax Act (ITA), FFI must record sales to parties with whom it does not
deal at arm’s length at their fair value, namely the mark-up of 25% on the $60,000 sale to LHT.
3. As required under the ITA, FFI must add back the accounting impairment losses for trade receivables
of $95,000 and deduct the actual bad debts written off, which was $45,000.
4. As required under the ITA, FFI must add the $80,000 in costs incurred to the cost of its inventory
because the engines have not yet been sold.
5. As required under the ITA, FFI must add back the accounting depreciation of $270,000 and deduct
CCA, which was $150,000.
6. The expense for the share-based compensation is not deductible for tax purposes because it is not an
actual outlay. Section 143.3 of the ITA prohibits its deduction.
7. Professional fees incurred with respect to reorganization of capital are not deductible, but they are
included as eligible capital expenditures under Section 14 of the ITA, and a deduction computed as 7%
of 75% of the costs incurred is allowed ($20,000 × 75% × 7%).
210
For Primary Indicator #3 (Taxation), the candidate must be ranked in one of the
Percent
Awarded
2.1%
competence.
19.2%
Reaching competence — The candidate attempts a calculation of the taxes
payable for the discontinued operations.
32.6%
Competent — The candidate prepares a reasonable calculation of the taxes
45.9%
Highly competent — The candidate prepares a thorough calculation of the taxes
0.2%
(Candidates were expected to address the taxation issues because the controller asked them to take a look
at the tax working papers related to FFI’s operations, since she was not sure the new tax person properly
made adjustments to calculate FFI’s taxable income and taxes payable.)
(Candidates struggled with this indicator. While most did a good job of identifying some of the required
adjustments, they struggled to explain why the adjustments were required under the Income Tax Act, in
particular for items like the share-based compensation and the transactions between FFI and LHT. In
addition, some candidates were unable to provide the corresponding adjustment for an accounting
expense that was not deductible for tax purposes (for example, the actual losses written off instead of the
allowance for doubtful accounts and CCA instead of the depreciation expense). In some cases,
candidates simply provided a revised calculation of taxable income without explaining any of their
adjustments.)
The candidate discusses the impact of the breach of debt covenants on the operations of LHT.
211
Competencies (lists the Pervasive Qualities and Skills for the entire simulation)
III-1.2 Develops an understanding of the operating environment
We are performing the audit of LHT because the company is required to send audited financial statements
to the bank. The controller stated that there is one covenant as part of the long-term loan agreement: an
interest coverage ratio (earnings before interest, tax, and discontinued operations divided by the interest
rate) of 10.
The controller indicated the covenant had been met, and we calculated the ratio to be 11.9 from the initial
draft financial statements. As part of my analysis in this report, I noted a number of adjustments that would
have an impact on the calculation: revenue, selling expenses, repairs and maintenance, and gain on disposal
of asset. From my calculation in the table that follows, which considers the accounting adjustments noted
in my revised tax calculation shown in the previous section, LHT’s interest coverage ratio is 4.5, which
would be a breach of the covenant.
LHT should inform the bank immediately and discuss whether the bank is willing to provide a period of
grace and would agree not to call the loan. The bank might agree to provide a period of grace since LHT
will be disposing of its investment in FFL, probably for $5 million, and therefore should be able to repay
some or all of its bank debt. In addition, LHT might be able to obtain some additional capital from its
current shareholders to repay some of the debt in order to satisfy the bank for the time being. However, it
is unclear whether LHT has the means to fully repay the bank loan at this point, although there are many
factors that indicate that LHT is already facing cash flow issues. As the controller has noted, LHT has been
late with a few payments and the bank is losing patience; there is, therefore, a risk that the bank may call
the loan. Should the bank decide to call the loan, LHT could potentially face significant cash flow issues.
This would have a detrimental impact on its operations.
212
Proposed Adjustments of the Draft Financial Statements (in thousands of dollars)
Notes
Earnings before tax from continuing operations, as
presented
Less: overstatement of lease revenue
Less: understatement of head office salaries
Less: understatement of repairs and maintenance
Less: overstatement of depreciation
Earnings before tax from continuing operations, as
revised
$
820
(392)
(100)
(90)
23
1
2
3
3
261
Add: interest expense
Earnings before interest, tax, and discontinued
operations, as revised
75
336
Divided by interest expense
Adjusted interest coverage ratio
75
4.5
Fail
Notes:
1. The adjustment to decrease revenue by $392,000 is to adjust for the revenue accounted for in the current
year that we concluded is an operating lease and relates to a five-year period. This revenue should be
recognized over the five-year period.
Calculated as:
Total contract recorded ($8,000 × 60 months)
Related to F14 (August 1, 2013 to June 30, 2014)
Adjustment, reduction to revenue
$480
(88)
$392
2. The adjustment to increase administrative expenses by $100,000 relates to the extra head office salaries
allocated to the discontinued operations.
3. The adjustment to increase repairs and maintenance expense is necessary because the amount was
inappropriately capitalized and should have been expensed as maintenance. Depreciation should be
adjusted accordingly for the amount that was capitalized and amortized. Depreciation is computed on
a straight-line basis, and for purposes of our analysis we have assumed that the remaining useful life of
the asset was four years (out of eight), so the adjustment is $22,500 ($90,000 ÷ 4 years).
For Primary Indicator #4 (Pervasive Qualities and Skills), the candidate must be
213
Percent
Awarded
7.7%
competence.
15.0%
Reaching competence — The candidate attempts to compute the adjusted interest
coverage ratio and concludes on whether the debt covenant has been breached.
56.3%
Competent — The candidate provides a reasonable computation of the adjusted
interest coverage ratio, identifies the breach of the debt covenant, and discusses its
impact on the company or suggests possible solutions to resolve the issue.
20.9%
Highly competent — The candidate provides a reasonable computation of the
adjusted interest coverage ratio, identifies the breach of the debt covenant,
discusses in depth its impact on the company, and suggests possible solutions to
resolve the issue.
0.1%
(Candidates were expected to compute an adjusted interest coverage ratio and to discuss the impact on
the company or suggest possible solutions to resolve the issue. Candidates were not directed to this
indicator; however, it was mentioned that the company had a debt covenant related to its loan with the
bank. Also, the controller noted that LHT needed to finish the audit on time this year because it had
made a few late payments on the loan and the bank was not willing to forgive any more late payments or
other defaults. In addition, she was under the impression that LHT had met its debt covenant this year.)
(Candidates struggled with this indicator. Most candidates attempted to compute the adjusted ratio, but
most who recognized that the covenant was in breach after the required accounting adjustments
addressed the implications from an audit perspective only, mentioning they may require a going-concern
note. While candidates were given credit for such a discussion within the assurance indicator, the Board
had hoped that candidates would also discuss the broader impact on the operations of LHT or provide
recommendations to management. Very few candidates did so, and the Board was disappointed that so
few candidates cautioned management with regard to the risk that the breach presented to the operations
of LHT.)
214
(Candidates performed reasonably well on some aspects of this simulation but struggled with others.
While most candidates addressed each of the indicators, they generally performed better on Primary
Indicators #1 and #2, where they seemed most comfortable in their role. Candidates performed
reasonably well when it came to discussing the various accounting issues, and they provided valid audit
procedures to address the key risk areas from an audit perspective. However, candidates seemed to have
difficulty discussing the taxation issues. While most candidates were able to identify some of the relevant
adjustments when computing revised taxable income, some had a difficult time discussing the rationale
for their adjustments from a taxation perspective. Candidates also struggled to critically evaluate the
results of their calculation of the debt covenant and, therefore, did not recognize the impact the breach
could have on the operations of LHT. The Board encourages candidates to always step back, evaluate
the results of their analysis, and raise any issues they feel should be brought to the client’s attention in
order to provide them with meaningful advice and guidance.)
215
Jane and Joe Smith have owned a family-run hemp farm, Hemp Co., in southern British Columbia since
1998. The Smiths are interested in hemp because of the crop’s environmental sustainability. Hemp Co. has
a good reputation in the hemp fibre production industry.
A few years ago, a close friend of the Smiths was diagnosed with cancer. Her doctor prescribed medicinal
marijuana, and the Smiths were impressed by how the marijuana helped her. In 2012, when the Canadian
government changed the regulations to allow for the commercial production of medicinal marijuana, the
Smiths jumped at the opportunity to become licensed medicinal producers and filed the prescribed
application.
During 2013, Hemp Co. was granted a licence to produce medicinal marijuana for the 2013 and 2014
calendar years. However, since the licence was granted in July of 2013, Hemp Co. could not benefit from
the 2013 growing season. The licence is subject to the following conditions: (i) that the licensee abides by
all requirements of the licence, and (ii) that the licensee produces financial statements in accordance with
Accounting Standards for Private Enterprises (ASPE). The government has notified Hemp Co. that it will
be audited for compliance with the licensing regulations prior to its licence being renewed. The medicinal
marijuana industry is heavily regulated. The Smiths already comply with all licensing requirements for
hemp fibre production, so they are comfortable that compliance with the new licence will not be an issue.
Information on their current business is provided in Exhibit I. Excerpts from the regulations for medicinal
marijuana are provided in Exhibit II.
It is now October 27, 2014. Hemp Co. has hired you, CA, as a consultant to advise on how it can meet all
government requirements for both 2013 and 2014, since year-end is fast approaching and the licence will
be due for renewal. Jane and Joe provided information on the company’s accounting practices and operating
costs during a recent meeting (Exhibit III). Hemp Co. has a December 31 year-end and, up until now, has
prepared its financial statements for tax purposes only.
The Smiths are also looking for your help with another matter. Exhibit IV provides the details of a proposed
rental agreement with a farmer who is looking for additional farmland. Joe would like your advice on
whether he should accept the offer and lease the land at the proposed price. He would also like to know
how Jane should account for the transaction.
216
EXHIBIT I
BACKGROUND ON HEMP CO.
Hemp is a tall, fibrous plant from the cannabis family. It is a renewable resource that produces seeds and
fibre annually. The seeds and fibre can be turned into a variety of commercial goods, including rope,
clothing, construction materials, food items, and health and beauty products. In the same family as
marijuana, hemp is bred to have low levels of tetrahydrocannabinol (THC), the hallucinogenic component
of marijuana, and therefore is not classified as a drug.
Hemp Co. produces a strain of hemp that provides large amounts of fibre. The crop is sold to a wholesaler
out of province, and is eventually turned into clothing.
Under hemp production regulations
all harvested inventory must be kept in a secure, locked location;
records must be kept of all hemp fibre sales, including names of purchasers and quantities; and
only the licensee and those under its direction may handle the hemp.
The hemp licence is in Hemp Co.’s name, with Jane and Joe listed as the corporate officers.
Hemp Co. currently employs four people, one of whom was hired at the beginning of 2014 to solely work
on the medicinal marijuana operations, while the other three work 100% on hemp operations. Joe notes the
employees are “like family,” and, except for the employee hired in 2014, have been with the Smiths for a
long time.
The operation consists of 20 hectares of farmable land, plus land on which there are two large buildings.
One is the barn, where the hemp is stored after harvesting and before shipment. The other building contains
the offices and a large space that Joe has converted into a drying and packaging facility for medicinal
marijuana. Both buildings are locked and each door has camera surveillance. Employees must use a key
and a security code to enter the buildings. The buildings are set well inside the property, and the perimeter
of the property is fenced. Joe is comfortable that access is limited.
Hemp Co. currently has a licence to grow one hectare of medicinal marijuana. It is possible the government
will authorize more hectares in the future. However, any future expansion of the medicinal marijuana is
expected to be limited and would be subject to approvals from the government authorities.
Jane maintains the accounting records. She uses basic accounting software to prepare the financial
statements.
217
EXHIBIT II
EXCERPTS FROM GOVERNMENT LICENSING REGULATIONS
FOR MEDICINAL MARIJUANA
A licensed producer must
provide a detailed description of the security measures at the proposed site;
provide a reconciliation of medicinal marijuana production with sales and inventories of medicinal
marijuana for the period reported on;
notify the Ministry of Agriculture (the Ministry) within five days after any change to the method used
for record keeping or the security of the site; and
destroy any marijuana in excess of the licensed amount, under the supervision of the Ministry.
Medicinal Marijuana Security Measures
An experienced person must be designated as in charge. Three other people must be designated as
assistants to the person in charge. These people must be identified with signage posted at the entrance
to the facilities.
The person designated as in charge or one of the assistants must be on site at all times, and any visitors
must be accompanied by the designated person in charge or one of the assistants. Designates must
account for the actions of other people (employees and visitors) when those people access the site and
the storage areas.
Access to the medicinal marijuana must be controlled by
o prevention of unauthorized access to fields and storage areas;
o surveillance cameras at all times on both fields and storage areas; and
o monitoring of surveillance at all times, with any intrusion or attempted intrusion reported to the
Ministry.
All officers, directors, and employees must have an annual criminal record check and have had no
criminal record for the past 10 years.
Reconciliation of Production with Inventory and Sales
A system is required to identify and track medicinal marijuana once harvested.
Sales must be tracked. A licensed producer may sell to
o other licensed producers;
o licensed sellers of medicinal marijuana;
o Ministry of Health representatives; and
o individuals with prescriptions for medicinal marijuana.
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EXHIBIT III
NOTES FROM MEETING WITH JANE AND JOE SMITH
1.
Hemp fibre has had a stable market value of $4.60 per kilogram. One hectare produces approximately
6,000 kilograms per year. Hemp Co. sells all its hemp fibre to one wholesaler. Economic dependence
is not a concern because there is a strong market for hemp fibre. With only a single client, no subledgers
for sales or accounts receivable have been maintained.
2.
To support hemp farming in the province, the government is providing a subsidy by guaranteeing a
minimum selling price of $5.80 per kilogram when the product is sold. Because this amount is
guaranteed by the government, Hemp Co. has been recording the minimum guaranteed selling price
immediately when the hemp is harvested.
3.
Revenue on the sale of medicinal marijuana is recognized on shipment, and all shipping costs are
assumed by the clients. The Smiths have set the price of their medicinal marijuana at $4 per gram.
Hemp Co.’s licence allows it to grow a maximum of 150,000 grams per hectare. Hemp Co. largely
sells to licensed sellers and maintains the name and address of each one.
4.
A number of individuals purchase medicinal marijuana directly from Hemp Co. Upon the first visit,
Jane verifies that each client has a valid doctor’s prescription, and she subsequently sells to them when
they request it.
5.
Sales are tracked in total in the accounting software. Jane segregates the medicinal marijuana sales
amount from hemp fibre sales by backing out the sales of hemp fibre to the wholesaler from the total
sales value.
6.
Although related products, hemp and marijuana plants need to be segregated by an unsown area
because cross-pollination can lead to reduced effectiveness of the medicinal marijuana. Joe has
segregated the fields, fenced in the marijuana, and included a buffer zone to ensure quality. Therefore,
one hectare of medicinal marijuana uses three hectares of land.
7.
Like many farms, Hemp Co. has undertaken research to develop better strains of hemp. Joe has been
working on seeds that are resistant to mildew from damp soil. Market research has shown that there is
a significant need for hardier seeds as the hemp production industry expands to different climates.
Joe’s test results have shown an ability to withstand wet soils, and he is very excited about the sale of
the seeds in the near future. The following costs related to Joe’s research have been capitalized in 2014:
Labour
$ 17,000
Market research
4,150
Seeds
3,500
Testing of seeds
8,450
Pesticides
4,950
Other
1,100
$
39,150
219
8.
In June of this year, Hemp Co. replaced its old septic tank system, which it had for 15 years. The
Smiths were surprised to learn that, under provincial regulations, the site had to be cleaned up. The
clean-up cost was $25,000, and an additional $15,000 was incurred to prepare the site for the new
septic tank system.
9.
Joe plans to capitalize the costs of your consulting fees and the start-up costs for the medicinal
marijuana as an intangible asset. He thinks Hemp Co. will farm medicinal marijuana for at least 10
years, and therefore believes this is an appropriate amortization period.
The start-up costs were incurred in 2013 and include the following:
Removal of hemp plants and purification of soil
Fence to surround marijuana field
Legal fees to obtain licence
Consultant fees
Labour costs for disposing of waste after harvest
Specialized equipment
$4,200
$9,000
$6,200
to be determined
$7,850
$82,000
10. Hemp plants are subject to regular testing for levels of THC. During the year, a batch of hemp was
found to exceed the maximum allowable amount and had to be destroyed. The affected plants were
isolated to one hectare of hemp that had been produced from the strain of seeds engineered as part of
Joe’s ongoing research.
11. The specialized equipment purchased for medicinal marijuana includes a $23,000 industrial dryer.
Hemp Co. currently owns a similar piece of equipment for hemp fibre; however, the equipment is old
and is not to the standard required for medicinal marijuana. Hemp Co. uses the new dryer for
marijuana, and any additional capacity is used for hemp fibre. To date, the new dryer has handled most
of the production, but Joe is maintaining the old equipment for peak harvest times in the future. The
old equipment has a book value of $10,500.
220
12. The projected farming costs for Hemp Co.’s 2014 financial year are as follows:
Note
Fertilizer
Water
Pesticides — hemp
Pesticides — marijuana
Crop insurance — hemp
Crop insurance — marijuana
Fuel costs
Labour
1
2
3
4
$ 10,350
$ 18,500
$
1,075
$ 13,000
$
1,600
$ 145,000
$ 35,000
$ 165,250
Notes:
1. The medicinal marijuana requires 50% of the water used.
2. Pesticide for medicinal marijuana has a higher cost than for hemp due to increased regulations, since the
product is for human consumption.
3. Insurance premiums for the medicinal marijuana are higher as a result of the greater risk associated with
growing this type of crop.
4. Since Hemp Co. started growing medicinal marijuana, its total cost of fuel for operating tractors and
other farming equipment has increased by 50%.
221
EXHIBIT IV
PROPOSED RENTAL AGREEMENT
Joe has been approached by a farmer who would like to rent land from the Smiths. Joe is open to the idea,
provided he will not lose money. Normally, Hemp Co. would use this land to produce either hemp or
medicinal marijuana.
Rental Request (As Proposed by the Farmer)
The farmer would rent two hectares for a period of 10 years.
The farmer would have the right to sub-let the land.
The rental payments would be set at $54,000 per annum for the extent of the rental agreement.
At the end of the lease, the land would revert to Hemp Co.
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EVALUATION GUIDE
PAPER III, SIMULATION 2 — HEMP CO.
The candidate provides advice on putting controls in place to meet the licence requirements and
prepare for the compliance audit.
Competencies
Although Hemp Co. has successfully abided by the terms of its licence for producing hemp fibre, Joe and
Jane appear to have significantly underestimated the more stringent requirements surrounding medicinal
marijuana. The government has notified Hemp Co. that it will be audited for compliance prior to its licence
being renewed. Hemp Co. has hired us as consultants to ensure that it is able to meet the government
requirements as the year end approaches and the licence comes due for renewal. It is important to tighten
up some of the required controls in preparation for the audit.
Reconciliation of Production with Inventory and Sales
The accounting process at Hemp Co. currently appears to be too simplistic. One of the criteria laid out by
the government is that the company must identify and track medicinal marijuana once harvested. Hemp Co.
does not seem to currently have the systems in place to allow this to happen.
In order to address this requirement, Hemp Co. will need to begin using the following tools:
Inventory Tracking
A perpetual inventory system should be put in place to track marijuana inventory as it is harvested. Dried
marijuana should be weighed, bagged, and identified with numerical tags and recorded in an inventory
subledger. This would allow for tracking of the product as it is produced. As the marijuana is sold, the
numerical tags should be tracked and removed from the inventory subledger.
223
A physical inventory count should be performed on a regular basis and compared to the amounts recorded
in the perpetual inventory system. This would allow Hemp Co. to determine whether any theft has occurred.
Sales Tracking
Currently, Jane segregates the medicinal marijuana sales from the hemp fibre sales by backing out the sales
of hemp fibre to the wholesaler from the total sales value. However, this is unlikely to be sufficient for the
government, which requires harvested marijuana to be tracked. In this case, the use of a sales subledger
could be helpful. A sales subledger is a detailed listing of all sales making up the total sales number on the
income statement. This subledger should include the date of the sale, the amount of the sale, and the
customer’s name. Depending on the system used, it should also include the quantity and price of the product
sold. It is important to account for all sales, including those made to individuals, not just to the wholesaler.
The tracking of both sales and inventory will allow Hemp Co. to reconcile what it produces, sells, and has
on hand at any point in time.
(Most candidates identified this as an issue to address but struggled to explain why the current method
is not sufficient. In addition, most candidates who addressed this issue were not able to provide a
recommendation that was specific enough for Joe and Jane to understand how to implement it.)
Restrictions on Sales
In addition to tracking sales, Hemp Co. must ensure that sales are made only to designated parties who have
permission to purchase marijuana under the government’s licensing regulations. Hemp Co. needs to be able
to support that it has complied with this requirement. Therefore, all parties that purchase from the company
should provide proof of eligibility. Evidence of eligibility should be kept on file and updated regularly by
Hemp Co.
The greatest risk for sales to inappropriate parties is to individuals. At present, it appears that a customer’s
prescription is checked the first time they make a purchase, but that no further support is obtained in future
purchases. For individuals, Hemp Co. should keep copies of prescriptions, and the quantity and expiration
of prescriptions should be monitored to ensure that no marijuana is provided to an unauthorized party and
that the amounts provided are not over the prescribed amounts. To ensure the prescriptions are valid, it may
be necessary to check with the pharmacist or the doctor. (Hemp Co. will need to obtain each purchaser’s
permission to verify their information.)
(Most candidates addressed this weakness and provided a reasonable explanation of its implication, as
well as a valid recommendation to address the issue.)
Security Measures
Under the regulations for selling marijuana, specific security measures must be in place. The criteria for
hemp appear to be reasonably straightforward: inventory must be maintained in a secured, locked location,
and only the licensee or those under their direction are allowed to handle it. The conditions for marijuana
may seem similar on the surface, but are far more stringent when the details are examined.
224
For marijuana, the following criteria must also be met:
Designated Responsible Person
Hemp Co. must, at all times, have on site one designated person or an assistant responsible for the marijuana.
Although Joe and Jane may assume they and the new marijuana employee have taken on these roles, the
two roles must be documented and the names of the designated people must be displayed at the entrance to
the facilities to support this criterion. They should also assess whether someone else is more appropriate for
either role, since the designated-in-charge person or an assistant must be on site at all times.
Access to Medicinal Marijuana
Employee Access
The marijuana must be secured at all times and should only be accessible when the designated person or an
assistant is present. Currently all employees have keys and the access code to the storage facilities, allowing
them unrestricted access. Both the perimeter and the buildings should be secured in such a way that the
presence of the designated person or one of the assistants is required for access to be obtained. Therefore,
the designated person and the assistants should be the only ones with keys and access codes to the areas
containing marijuana.
Third-Party Access
There is no indication of how access to the fields is controlled to prevent unauthorized access. While the
field is fenced, the fence should be high and secure enough to prevent intrusion. In addition, cameras on
the doors do not prevent access to the building through windows or other access points. Cameras should
provide views of the area surrounding the storage facility and the entire field, and should be monitored as
per the licence requirements. This may require hiring additional employees or an external security company.
Criminal Record Checks
There is currently no indication that criminal record checks have been performed or that records have been
maintained for any of the officers, directors, and employees. Regardless of the Smiths’ trust in their
employees, in order to meet the regulation from the government, Hemp Co. must obtain criminal record
checks on all officers, directors, and employees to verify that none have criminal records. This should be
done immediately, and a policy should be put in place to obtain annual criminal record checks for all
employees.
Destruction of Excess Medicinal Marijuana Production
Under the licensing regulations, Hemp Co. must destroy any marijuana in excess of the licensed amount,
which is currently 150,000 grams. There is no indication that excess marijuana was produced in 2014, but
we should ensure Hemp Co. maintains adequate records of production amounts and, in the event that excess
marijuana is destroyed, that the records reflect that and the representative of the Ministry of Agriculture
(the Ministry) signs a document or log book confirming that he or she has attended and supervised the
destruction of the excess production.
225
Hemp Co. could consider hiring an outside company to destroy the excess marijuana, as long as the
company is approved by the Ministry. Hemp Co. could maintain copies of the invoices and supporting
documentation so that we could confirm that the destruction was performed. By maintaining the log book
signed off by the representative of the Ministry, we would have evidence that the destruction was performed
under the supervision of the Ministry.
(Most candidates were able to identify several of the security measure requirements and provided
adequate recommendations to address them. The most frequently addressed issues were those related to
the designated responsible person, access to marijuana, and criminal record checks.)
Compliance with Licensing Regulations
Implementing these recommended controls will allow Hemp Co. to be in compliance with the licensing
regulations by the end of 2014. However, the Ministry may be concerned that the company was not in
compliance in both 2013 and 2014, as required. It is possible that the Ministry would be more lenient up to
this point, since the growing season had passed when Hemp Co. started in 2013 and the company is still in
its start-up phase. I would recommend Joe and Jane approach the Ministry to discuss this issue.
For Primary Indicator #1 (Assurance) the candidate must be ranked in one of the
Percent
Awarded
0.6%
competence.
8.8%
Reaching competence — The candidate discusses some of the areas in which
Hemp Co. is not complying with the licence and recommends improvements so that
Hemp Co. will be able to meet the licence requirements.
37.9%
Competent — The candidate discusses several of the areas in which Hemp Co. is
not complying with the licence and recommends improvements so that Hemp Co.
will be able to meet the licence requirements.
52.6%
Highly competent — The candidate discusses most of the areas in which Hemp
Co. is not complying with the licence and recommends improvements so that Hemp
Co. will be able to meet the licence requirements.
0.1%
(Candidates were asked to advise on how Hemp Co. could meet all the government requirements for both
2013 and 2014 in light of the upcoming renewal of the company’s medicinal marijuana licence.)
(Candidates were expected to address several of the licensing requirements and provide valid
recommendations on each. To achieve competence, the Board expected candidates to address several
areas of non-compliance and provide specific, valid recommendations. Candidates generally performed
satisfactorily on this indicator.)
226
(Weak candidates were able to identify the areas where Hemp Co. was currently not in compliance, but
they struggled to provide specific recommendations. As a result, their discussions lacked depth because
they regurgitated case facts, which did not provide much value to the client. In addition, many weak
candidates did not provide a balanced approach, choosing to focus on only one area of the licensing
requirements, such as the required security measures.)
(Some candidates unnecessarily spent time explaining the reporting options available should Hemp Co.
require an audit or review of its compliance with the licence requirements. There were no case facts in
the simulation to suggest that an audit or review of compliance would be required. As a result, these
candidates inappropriately allocated time to a discussion that was not useful given their role.)
Competencies
Accounting Issues
Government Subsidy
As part of its effort to support hemp farming in the province, the government is guaranteeing a minimum
selling price of $5.80 per kilogram, which currently generates a subsidy of $1.20 ($5.80 − $4.60) per
kilogram for Hemp Co.
Handbook Section 3800, Government Assistance, paragraph 17 provides that “government assistance
toward current expenses or revenues shall be included in the determination of net income for the period.”
Based on the guidelines provided in paragraph 18, the government subsidy should be presented as additional
revenue. As well, per paragraph 27, it should only be recorded when “there is reasonable assurance that
the enterprise has complied and will continue to comply with all the conditions.” Thus, based on the
discussion on revenue recognition in the following section and the guidelines for recording the government
subsidy, Hemp Co. should only record the subsidy of $1.20 per kilogram once the hemp has been sold,
since that is when the government condition has been met.
(This is the issue candidates addressed the least frequently on this indicator. However, most candidates
who did address it were able to provide a complete discussion.)
Revenue/Inventory Recognition
a) Hemp Fibre
Hemp Co. is currently recording the minimum selling price of $5.80 per kilogram when the hemp is
harvested. The company has likely booked the increase in value to revenue and the offset to inventory.
227
Handbook Section 3400, Revenue, paragraph 4 states that “revenue from sales and service transactions
shall be recognized when the requirements as to performance set out in paragraph 3400.05-.06 are
satisfied provided that at the time of performance ultimate collection is reasonably assured.”
Paragraph 5 specifically provides the following:
In a transaction involving the sale of goods, performance shall be regarded as having been achieved
when the following conditions have been fulfilled:
(a) the seller of the goods has transferred to the buyer the significant risks and rewards of
ownership, in that all significant acts have been completed and the seller retains no continuing
involvement in, or effective control of, the goods transferred to a degree usually associated with
ownership; and
(b) reasonable assurance exists regarding the measurement of the consideration that will be
derived from the sale of goods, and the extent to which goods may be returned.
Even though the government is providing a minimum guaranteed selling price of $5.80 per kilogram,
this guaranteed amount is only available upon the sale of the product. Performance has not been achieved
until the product is sold (in other words, the risks and rewards transfer to the wholesaler upon shipment).
Therefore, Hemp Co. should not record either the sale price or the subsidy (based on the minimum
guaranteed selling price) until the product is sold. If the subsidy started prior to 2014, the 2013 financial
statements will need to be restated to adjust for this change.
This issue can also be considered from the inventory perspective. Handbook Section 3031, Inventories,
paragraph 4 states that “this Section does not apply to the measurement of inventories: (a) held by
producers of agricultural and forest products, agricultural produce after harvest, and minerals and
mineral products, to the extent that they are measured at net realizable value in accordance with wellestablished practices in those industries; when such inventories are measured at net realizable value,
changes in that value are recognized in net income in the period of the change.” Therefore, if there is a
well-established practice in the hemp industry to measure the inventory at net realizable value, the hemp
could be measured at $5.80 per kilogram. Otherwise, the inventory should be carried at the lower of cost
or net realizable value. Given the contribution margin hemp provides (see later in this report), cost will
likely be the lower value, and inventory should be recoded at that amount, assuming no well-established
practices.
b) Medicinal Marijuana
The current revenue recognition policy for the medicinal marijuana is in accordance with Handbook
Section 3400, Revenue guidelines because the revenue is recorded only upon shipment of the product.
Since Hemp Co. does not cover shipping costs, it is reasonable to conclude that the risks and rewards
were transferred to the sellers at that time.
(More than half of the candidates addressed the recording of hemp at the minimum guaranteed selling
price and discussed the issue in sufficient depth. Candidates who addressed this issue did a good job of
discussing the revenue recognition criteria (performance, measurement, and collectability) and focused
their discussion on the criterion that had not been met (performance).)
228
Research and Development
Hemp Co. has been capitalizing the costs related to developing seeds that are more resistant to mildew from
damp soil.
Handbook Section 3064, Goodwill and Intangible Assets addresses the requirements to capitalize
development costs:
.41 An intangible asset arising from development (or from the development phase of an internal
project) is recognized if, and only if, an entity can demonstrate all of the following:
(a) the technical feasibility of completing the intangible asset so that it will be available for use
or sale;
(b) its intention to complete the intangible asset and use or sell it;
(c) its ability to use or sell the intangible asset;
(d)
the availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset;
(e) its ability to measure reliably the expenditure attributable to the intangible asset during its
development; and
(f) how the intangible asset will generate probable future economic benefits. Among other things,
the entity can demonstrate the existence of a market for the output of the intangible asset or the
intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
A market for the improved seeds, should they be viable, exists since market research has shown there is a
significant need for hardier seeds. It appears the intention to complete and ability to use or sell is met, as
Joe is clearly enthusiastic about their potential. The availability of resources does not appear to be a concern
given that marijuana is providing significant revenue (see later in this report) and Hemp Co. has measured
costs related to the development to date. Should the asset be produced, the ready market would suggest that
it will generate economic benefits.
The question surrounds technical feasibility. Given that the seeds appear to have produced hemp with a
higher THC level than is permitted, there is a concern that the process used to breed the seeds to be more
mildew resistant also elevated their THC levels. If Hemp Co. is not able to rectify this, it will not be able
to sell the seeds. At this stage, it would appear that Hemp Co. is unable to support technical feasibility and
is therefore still in the research phase. The full amount of $39,150 should be expensed.
(This was the topic most frequently addressed by the candidates. However, only roughly half of the
candidates who addressed this issue discussed it in sufficient depth. The Board expected candidates to
apply the research and development criteria and recognize the key case fact demonstrating that technical
feasibility would likely not be met, which was that THC levels were higher than what is permitted, and
thus the seeds could not be sold currently as is. Many candidates did not integrate this case fact into their
analysis. Instead, most candidates jumped immediately to conclude on whether the costs could be
capitalized, without supporting their conclusion with the appropriate analysis.)
Septic Tank System
As a result of provincial regulations, Hemp Co. had to spend $25,000 to clean up the site where the old
septic tank system was installed. That system had been built 15 years ago. Hemp Co. also incurred $15,000
to prepare the site for the new septic tank system.
a)
229
Asset Retirement Obligation (ARO)
Handbook Section 3110, Asset Retirement Obligations, paragraph 5 provides that “an entity shall
recognize a liability for an asset retirement obligation in the period in which it is incurred when a
reasonable estimate of the amount of the obligation can be made.” As well, such an ARO shall be
measured in accordance with paragraph 9 at the “best estimate of the expenditure required to settle
the present obligation at the balance sheet date,” with an equal amount to be recorded to the asset
upon initial recognition.
We recommend that Hemp Co. apply the guidelines of Handbook Section 1506, Accounting
Changes, so that paragraph 27 is applied to the amount and the error is corrected by correcting the
financial statements retrospectively and “restating the opening balances of assets, liabilities and
equity for the earliest period presented.”
The system would have been built in mid-1999 (15 years ago), and at that time, an amount of the
present value of the liability should have been recorded to property, plant and equipment (PP&E)
and ARO. Assuming a 5% discount rate, the amount that would have been recorded at that time is
$12,026 (FV = 25,000, rate = 5%, period = 15 years). As of the beginning of 2014, the net PP&E
balance will have been amortized to $401 remaining ($12,026 ÷ 15 years × 0.5 years) and the ARO
balance will have been accreted to $24,398. As a result, the 2014 opening balance of the net PP&E
account will be restated to $401, the ARO account to $24,398 (FV = 25,000, rate = 5%, period =
0.5 years), and the opening retained earnings to $23,997 ($11,625 amortization + $12,372 accretion
for the past 14.5 years).
As well, the 2013 comparative numbers would be adjusted, so that the ending balance of the net
PP&E account would be increased by $1,203 ($12,026 ÷ 15 years × 1.5 years) and the ARO balance
would be increased by $23,236 (FV = 25,000, rate = 5%, period = 1.5 years). Depreciation expense
would be increased by $802, accretion expense would be increased by $1,162, and the opening
retained earnings would be decreased by $22,033 ($10,823 amortization + $11,210 accretion for
the past 13.5 years).
Now that Hemp Co.’s management is aware of the obligation, it should set up a new ARO with
respect to the new septic tank system that was installed in the current year. The best estimate of the
net present value of the clean-up costs will be added to net PP&E, and a liability will be set up for
$12,026 (FV = 25,000, rate = 5%, period = 15 years), which would thereafter be amortized and
accreted.
Hemp Co. should review its other PP&E (e.g., drying equipment) to determine whether additional
ARO needs to be recorded.
230
b)
Site Preparation Costs for New Septic Tank
Handbook Section 3061, Property, Plant and Equipment, paragraph 5 indicates that the “site
preparation costs” shall be included in the cost of the related item of PP&E. Such costs should
therefore be added to the cost of the new septic tank and amortized over the useful life of the item
of PP&E to which it relates.
(A little over half the candidates addressed the ARO and site preparation costs issue. However, most
discussions contained technical weaknesses, such as not understanding that the obligation would be
measured at the present value of the estimated future cost, or that the offset to the liability is an amount
to be recorded to the asset.)
Start-Up Costs
Costs related to the start-up of a line of business should be assessed based on the nature of the cost and
capitalized or expensed accordingly. Several of the items included as start-up costs should be capitalized as
tangible assets. Handbook Section 3061, Property, Plant and Equipment identifies tangible capital assets
as items “that are held for use in the production or supply of goods or services, have been acquired
constructed or developed with the intention of being used on a continuing basis and are not intended for
sale in the ordinary course of business.”
Removal of Hemp Plants and Purification of the Soil
The cost incurred to enhance the service potential of an item of property, plant and equipment is a betterment
(Section 3061, paragraph 14). Although the land was already owned by Hemp Co., preparation costs of the
land were necessary to allow for the production of marijuana. This equates to a betterment because it
enhances the service potential and provides for future economic benefit as a result of sales of the crop. This
cost should be capitalized as a cost of the land.
Fence and Specialized Equipment
Both the fence and the specialized equipment are tangible capital assets. They have been acquired as longterm assets that are necessary for the production of the marijuana. These costs should be separately
capitalized and amortized over their useful lives.
Legal and Consultant Fees
The legal fees and consultant fees may be considered intangible assets.
Under Handbook Section 3064, Goodwill and Intangible Assets, paragraph 12:
An asset meets the identifiability criterion in the definition of an intangible asset when it
(a) is separable (i.e., is capable of being separated or divided from the entity and sold, transferred,
licensed, rented or exchanged, either individually or together with a related contract, asset or
liability); or
(b) arises from contractual or other legal rights, regardless of whether those rights are
transferable or separable from the entity or from other rights and obligations.
231
The legal fees surrounding the obtaining of the licence arise from a contractual right that Hemp Co. now
holds. If the fees are a required cost of the process, it is appropriate to capitalize them with the licence.
Because the initial licence is for only two years, Joe and Jane need to consider whether the legal advice
relates just to the two-year licence or if the benefit extends to licence renewals. To the extent that Hemp
Co.’s licence will be renewed, initial costs in acquiring it should be amortized over a reasonable lifetime
for the licences.
The consulting fee for my time, however, is not a cost directly attributable to the licence — the fee arose
after the licence was obtained and was not necessary to acquire the asset. The fee should be expensed.
Labour Costs for Disposing of Waste after Harvest
These costs were incurred once the first crop had been grown and harvested, so they are not considered
“pre-operating” costs. Therefore, in accordance with Section 3064, paragraph 53, they should be expensed.
Since the start-up costs were incurred in 2013, the changes discussed above will need to be made
retrospectively and the financial statement will need to be restated.
(Approximately half the candidates addressed the start-up costs issue in some capacity. However, most
candidates jumped to the correct treatment (for example, that the fence and specialized equipment should
be capital assets) without supporting their conclusion with the appropriate Handbook criteria or case
facts. Candidates often applied the intangible asset criteria to the entire start-up cost amount without
understanding that various components made up the amount. The most commonly discussed issues were
the fence and specialized equipment, and the legal and consulting fees.)
Drying Equipment
Hemp Co. purchased new drying equipment that is required for producing marijuana. As an added benefit,
this equipment can be used for most of the company’s hemp production too. During peak harvest times, the
old equipment can be used for the excess hemp.
Per Handbook Section 3063, Impairment of Long-Lived Assets, paragraph 9, “A long-lived asset shall be
tested for recoverability whenever events or changes in circumstances indicate that its carrying amount
may not be recoverable.”
Because the old equipment is now used only in high activity periods and will not be the primary dryer, there
has been a change in circumstances, which indicates that an impairment test is necessary.
In order to test for impairment, Hemp Co. will need to compare the carrying amount of the dryer ($10,500)
to the undiscounted cash flows it expects to receive from its use. Future cash flows are made up of the cash
flows generated by use of the equipment and by its eventual disposition.
If the carrying amount is recoverable (in other words, the undiscounted future cash flows are higher than
the carrying amount), no impairment exists. If the amount is not recoverable, the dryer must be written
down to its fair value, which is either the amount of the consideration that would be agreed upon in an arm’s
length transaction (its sale) between knowledgeable, willing parties who are under no compulsion to act, or
by determining the net present value of the future cash flows that can be generated by the old equipment,
including its residual value.
232
(Approximately half the candidates addressed this issue. Most candidates who addressed this issue were
able to tie relevant case facts to the correct Handbook criteria and conclude on the appropriate
treatment. Weak candidates confused the ASPE impairment criteria with the IFRS ones, leading to an
incorrect discussion.)
Lease
Hemp Co. is considering leasing out some land that it currently uses for producing hemp to a farmer. The
lease would involve two hectares for a proposed 10 years, and then the land would revert back to Hemp
Co. Per Handbook Section 3065, Leases, from the point of view of the lessor, this can be accounted for as
either a sales-type, a direct financing, or an operating lease:
.09
.10
A lease that transfers substantially all of the benefits and risks of ownership related to the
leased property from the lessor to the lessee shall be accounted for as a capital lease by the
lessee and as a sales-type or direct financing lease by the lessor.
A lease in which the benefits and risks of ownership related to the leased property are
substantially retained by the lessor shall be accounted for as an operating lease by the lessee
and lessor.
The Handbook provides several criteria to consider in determining whether substantially all of the benefits
and risks of ownership have been transferred:
.06
From the point of view of a lessee, a lease normally transfers substantially all of the benefits
and risks of ownership to the lessee when, at the inception of the lease, one or more of the
following conditions are present:
(a) There is reasonable assurance that the lessee will obtain ownership of the leased property
by the end of the lease term. Reasonable assurance that the lessee will obtain ownership
of the leased property is present when the terms of the lease result in ownership being
transferred to the lessee by the end of the lease term or when the lease provides for a
bargain purchase option.
(b)
The lease term is of such a duration that the lessee will receive substantially all of the
economic benefits expected to be derived from the use of the leased property over its life
span. Although the lease term may not be equal to the economic life of the leased property
in terms of years, the lessee is normally expected to receive substantially all of the
economic benefits to be derived from the leased property when the lease term is equal to
a major portion (usually 75 percent or more) of the economic life of the leased property.
This is due to the fact that new equipment, reflecting later technology and in prime
condition, may be assumed to be more efficient than old equipment that has been subject
to obsolescence and wear.
(c) The lessor is assured of recovering the investment in the leased property and of earning a
return on the investment as a result of the lease agreement. This condition exists if the
present value, at the beginning of the lease term, of the minimum lease payments,
excluding any portion thereof relating to executory costs, is equal to substantially all
(usually 90 percent or more) of the fair value of the leased property, at the inception of
the lease. In determining the present value, the discount rate used by the lessee is the lower
of the lessee's rate for incremental borrowing and the interest rate implicit in the lease, if
known.
233
.07
From the point of view of a lessor, a lease normally transfers substantially all of the benefits
and risks of ownership to the lessee when, at the inception of the lease, all the following
conditions are present:
(a) any one of the conditions in paragraph 3065.06;
(b) the credit risk associated with the lease is normal when compared to the risk of collection of
similar receivables; and
(c) the amounts of any unreimbursable costs that are likely to be incurred by the lessor under
the lease can be reasonably estimated. If such costs are not reasonably estimable, the
lessor may retain substantial risks in connection with the leased property. For example,
this may occur when the lessor has a commitment to guarantee the performance of, or to
effectively protect the lessee from obsolescence of, the leased property.
However, paragraph 6 also says: “In view of the fact that land normally has an indefinite useful life, it is
not possible for the lessee to receive substantially all the benefits and risks associated with its ownership,
unless there is reasonable assurance that ownership will pass to the lessee by the end of the lease term.”
Since the land will revert to Hemp Co. upon termination of the lease, there is no assurance the ownership
will pass. Therefore, the lease should be accounted for as an operating lease. The lease payment of $54,000
should be brought into income each year.
(Most candidates addressed this issue. Those who did provided sufficient depth in their discussion by
tying case facts to the appropriate Handbook criteria. Some candidates recognized the unique nature of
the land and were therefore able to be efficient in their analysis, going straight to the relevant Handbook
section that related to land.)
Percent
Awarded
0.3%
competence.
7.8%
Reaching competence — The candidate identifies some of the accounting issues.
39.4%
52.4%
Highly competent — The candidate thoroughly discusses most of the accounting
issues.
0.1%
(Candidates were directed to this indicator when they were told that one of the licence conditions was
the production of financial statements in accordance with ASPE. To achieve competence, the Board
expected candidates to address several of the accounting issues in sufficient depth.)
234
(About half of the candidates were able to identify some of the relevant accounting issues and discuss
them in sufficient depth. The most frequently addressed issues were revenue recognition, research and
development, and the capital lease. Strong candidates were able to provide the relevant Handbook
criteria and integrate case facts into their analyses for many of the issues. Weak candidates jumped
immediately to the correct accounting treatment without first explaining why the accounting treatment
was appropriate. Weak responses also contained technical errors or included an analysis of alternatives
that did not exist or were not relevant.)
The candidate analyzes the lease proposal.
Competencies
VIII-2.3 – Determines and evaluates the entity’s cost-volume-profit relationships (Level A)
Quantitative Considerations
In determining whether to accept the lease proposal, Hemp Co. needs to consider the opportunity cost of
what it is giving up. To rent out two hectares to the farmer, Hemp Co. either gives up one hectare from the
marijuana production and regains the buffer zone (which represents two hectares, of which only one is
returned to hemp production) or discontinues two hectares of hemp production. Below is the calculation of
the contribution margin per hectare for both hemp and marijuana.
Total
Revenues
Sales
$
1,191,600
Hemp
$
591,600
Marijuana
$
600,000
Note 1
Note 2
Expenses
Fertilizer
Pesticides
Insurance
Fuel costs
Water
Labour
10,350
14,075
146,600
35,000
18,500
165,250
9,775
1,075
1,600
23,333
9,250
123,938
575
13,000
145,000
11,667
9,250
41,312
Total expenses
389,775
168,971
220,804
Contribution margin
Hectares required
Contribution margin per hectare
801,825
422,629
17
24,861
379,196
3
126,398
$
$
Note 3
Note 4
Note 5
235
Notes:
1. Hemp: 6,000 kilograms × $5.80/kilogram × 17 hectares (i.e., 20 hectares − 2 for buffer area − 1 for
marijuana production)
Marijuana: $4/gram × 150,000 grams/hectare × 1 hectare (farmed)
2. Hemp: $10,350 × 17/18
Marijuana: $10,350 × 1/18
3. Hemp: $35,000 × 100/150
Marijuana: $35,000 × 50/150
4. Water bill is $18,500 total: 50/50 split
5. Hemp: $165,250 × 3/4
Marijuana: $165,250 × 1/4
Hemp Co. has indicated that one additional employee was hired to work solely on the medicinal
marijuana operations. Therefore, for the purpose of our analysis, we have assumed that one-quarter of
the workforce was used for marijuana.
Marijuana produces a contribution margin of $379,196 for three hectares. If marijuana was discontinued,
Hemp Co. could re-sow hemp, which would generate $24,861 in contribution margin for each hectare
(assuming the two buffer hectares are rented out to the farmer, then only the third hectare could be sown
with hemp). The total cost of discontinuing the marijuana to lease the land would therefore be $354,335
($379,196 − $24,861). This accounts for the fact that the marijuana requires a two-hectare buffer zone to
separate it from the hemp.
Discontinuing two hectares of hemp would result in lost contribution of $49,722 ($24,861 × 2).
It is clear from the analysis that if Hemp Co. were to rent land, it would make sense to take the land from
the hemp side of the operations. A minimum amount of $49,722 for the two hectares per year would cover
the lost contribution margin; therefore, the $54,000 rental fee is sufficient.
(Most candidates attempted a quantitative analysis of the contribution margin for hemp and marijuana.
However, many of the calculations contained errors, such as comparing 1 hectare of revenue to 17
hectares of expenses on the hemp side, or misallocating the common costs between hemp and marijuana.
Some weak candidates performed a contribution margin analysis on only one of the two activities, not
recognizing that an analysis of both hemp and marijuana was required to obtain the necessary
information for evaluating the lease proposal.)
Other Considerations
The rental fee offered is sufficient for the time being. However, Hemp Co. should assess whether there may
be an opportunity for the hemp land to be converted to marijuana in the coming years. Such analysis should
consider any increases in security costs that would be incurred as a result of our recommendations to comply
with the government licence. Joe and Jane may, therefore, wish to charge a premium on the lease to
compensate for this. In addition, it may make sense to try to negotiate a shorter lease term in order to
maintain flexibility should marijuana production limits be increased in the coming years.
236
Another consideration is that the lease would provide a steady stream of income for Hemp Co., whereas
there is uncertainty related to the other streams of income. For example, there may be no government
subsidy in the future for the hemp fibre, or medicinal marijuana sales may not be as good as expected.
The proposed lease agreement says that the lessee would have the right to sublet the land if desired. This
would mean that Hemp Co. would have no say in who could have access to the land. Regardless of whether
or not the land is subleased, Joe and Jane should consider the impact of leasing the land to a third party on
Hemp Co.’s ability to meet the security requirements set by the government, as well as the possibility of
cross-contamination of its products. In addition, given Hemp Co. does not know who the sublessees might
be, the condition of the land may be worse than expected at the end of the lease.
Finally, consideration should be given to Hemp Co.’s current relations with the wholesaler. Reducing the
quantity available to be purchased may upset the company’s only hemp customer, causing it to lose more
than just two hectares of revenue.
(Most candidates provided some qualitative considerations in addition to their quantitative analysis.)
Recommendation
Based on the quantitative analysis, as well as other considerations, I recommend that Hemp Co. accept the
lease proposal. However, Joe and Jane may want to consider increasing the rent amount or reducing the
lease term, as discussed in the previous section.
(Most candidates provided a recommendation on whether to accept the lease proposal. Candidates
usually started their analysis by calculating the contribution margin of the growing of hemp and
marijuana, followed by a comparison to the proposed rate for the lease. Weak candidates concluded on
the profitability of hemp versus marijuana but did not continue on to compare it to the rate included in
the lease proposal. This incomplete conclusion was not useful for helping the client assess whether the
lease proposal should be accepted.)
Percent
Awarded
0.9%
competence.
21.4%
Reaching competence — The candidate attempts a reasonable quantitative
analysis of the lease proposal.
50.8%
Competent — The candidate performs a reasonable quantitative and qualitative
analysis of the lease proposal and concludes on the offer.
26.8%
Highly competent — The candidate performs a thorough quantitative and
qualitative analysis of the lease proposal and concludes on the offer.
0.1%
237
(Candidates were required to advise on whether Joe and Jane should accept the offer and lease the land
at the proposed price. The Board expected candidates to perform reasonable quantitative and qualitative
analyses of the lease proposal and conclude on the offer in order to achieve competence.)
(Candidates struggled with this indicator. Most candidates identified the need to perform a quantitative
analysis, but did not understand how to approach it. Many candidates did not recognize that it was
important to analyze the contribution margins for both hemp and marijuana before being able to
determine whether the lease proposal should be accepted. In addition, most candidates struggled with
how to allocate the common costs between the two activities. Many weak candidates performed a onesided analysis, either analyzing only the revenue or the expenses of both of the activities or calculating
the contribution margin for only one of the activities. Strong candidates not only recognized the need to
perform a quantitative analysis on both activities, but also provided some relevant qualitative analysis
before concluding. There were many important qualitative considerations that a candidate could have
pointed out, and the Board expected candidates to bring some of these to the client’s attention as part of
their analysis.)
III-1.1 − Gathers or develops information and ideas
III-1.2 − Develops an understanding of the operating environment
III-1.3 − Identifies the needs of stakeholders and develops a plan to meet those needs
III-2.1 − Analyzes information or ideas
III-2.2 − Performs computations
III-2.3 − Verifies and validates information
III-2.4 − Evaluates information and ideas
III-2.5 − Integrates ideas and information from various sources
III-2.6 − Draws conclusions/forms opinions
III-3.1 − Identifies and diagnoses problems and/or issues
III-3.2 − Develops solutions
III-3.3 − Decides/recommends/provides advice
III-4.1 − Seeks and shares information, facts, and opinions through written discussion
III-4.2 − Documents in written and graphic form
III-4.3 − Presents information effectively
(Candidates performed well on some aspects of this simulation but not others. Most candidates performed
well on Primary Indicator #1, identifying several areas where Hemp Co. was not in compliance with the
licensing requirements and providing recommendations to address them. For Primary Indicator #2,
candidates generally were able to identify most of the accounting issues, as they were directed in the
simulation. However, some candidates struggled to provide sufficient depth in their analysis. Candidates
performed below expectations on Primary Indicator #3. They were expected to provide reasonable
contribution margin calculations for both hemp and marijuana and compare them to the lease proposal.
They were also expected to provide a qualitative analysis before making a recommendation. Candidates
struggled to provide calculations that allowed for a reasonable comparison of Hemp Co.’s two activities.)
238
It is October 13, 2014. You, a CA with the firm of Charles & Carry, LLP (C&C), are called into Tim Carry’s
office. Tim has been the partner in charge of the Bold Spice Ltd. (BSL) account since the company became
a client of the firm.
“I need your help in going through some issues raised by one of our clients, BSL. As you know, BSL
manufactures and distributes perfumes and colognes. The company is looking at acquiring Shiraz Pitstick
Inc. (SPI), a company that manufactures and distributes men’s deodorants. I will forward to you the email
I received from Jeff King, the owner of BSL, on the weekend. I told him that you would give him a call to
discuss this further.”
After you get back to your office, you review the email (Exhibit I), along with excerpts from SPI’s financial
statements (Exhibit II), and call Mr. King. He says, “While we haven’t been involved in the deodorant
market, I think that SPI’s business infrastructure lends itself very well to the perfume and cologne industry.
I’m sending you some additional information (Exhibit III). I want to make sure that I am paying a fair price
for this business. If there is anything I should know related to this purchase, please enlighten me.”
239
EXHIBIT I
EMAIL FROM MR. KING
Date: October 10, 2014
From: Jeff King, BSL
Subject: Shiraz Pitstick Inc. (SPI)
Hi Tim,
I think I have a pretty good business opportunity in front of me. I am looking at BSL purchasing the shares
of SPI. Since the recession in 2008, the company’s profits slumped, and it is not clear if it will ever fully
recover. However, what I really want is some of its productive assets. I think its plant and truck fleet would
fit in nicely with the expansion of BSL’s existing product lines. SPI’s owner is offering to sell the shares
only, not the assets. SPI’s owner has indicated that he is willing to sell his shares using the industry standard
of 3.5 times the normalized average earnings before interest, taxes, depreciation, and amortization
(EBITDA).
From the information provided by SPI, I have roughly figured the value of the assets of the business (Exhibit
IV). I have attached excerpts from the financial statements for the years ended December 31, 2012 and
2013, and for the first nine months ended September 30, 2014, to evaluate the offer. SPI’s financial
statements, just like those of BSL, are prepared in accordance with Accounting Standards for Private
Enterprises (ASPE). Please note that the closing of the transaction is planned for November 1, 2014.
SPI has some tax losses available that I would like to get my hands on. I am not interested in continuing
with the deodorant business, so my plan is to sell off any inventory or other assets that we do not need for
our existing business right after the acquisition.
If BSL buys the shares of this company, I want to make sure that BSL is actually getting the assets listed,
that the liabilities are complete, and that all amounts are accurate. What specific procedures could be done
in order to make sure BSL is getting what it is paying for?
Any other thoughts you may have are invited.
Thanks,
Jeff
240
EXHIBIT II
EXCERPTS FROM FINANCIAL
STATEMENTS
SHIRAZ PITSTICK INC.
BALANCE SHEET
Sept. 30, 2014
(unaudited)
Dec. 31,
2012
(audited)
Dec. 31, 2013
(audited)
Assets
Current assets
Cash
Accounts receivable
Inventory
$
Trademarks and trade names
Property, plant and equipment
—
1,348
5,221
6,569
$
1,000
5,194
$
12,763
—
1,029
4,882
5,911
$
1,000
5,003
100
1,278
4,323
5,701
1,000
5,876
$
11,914
$
12,577
$
122
678
68
113
981
$
—
587
47
115
749
Liabilities
Current liabilities
Bank indebtedness
Accounts payable
Sales taxes payable
Current portion of long-term debt
$
Long-term debt
111
711
71
112
1,005
5,224
6,229
5,332
6,313
5,433
6,182
100
5,501
5,601
100
6,295
6,395
Equity
Share capital
Retained earnings
100
6,434
6,534
$
12,763
$
11,914
$
12,577
EXCERPTS FROM FINANCIAL
STATEMENTS
SHIRAZ PITSTICK INC.
INCOME STATEMENT
Revenue
Sales
Cost of sales
Gross margin
Year-to-date
Sept. 30, 2014
Dec. 31, 2013
Dec. 31, 2012
$
$
$
Expenses
Advertising and donations
Depreciation and amortization
Bad debt
Bank charges and interest
Insurance
Office
Professional fees
Utilities
Management salaries
Wages
2,051
—
278
568
609
177
234
177
649
550
806
6,099
933
Income before other items
Other items
Loss on disposal
Other expenses
Net income (loss)
27,965
20,933
7,032
2,497
895
478
722
725
276
223
222
877
750
1,066
8,731
284
—
—
—
$
933
34,787
25,772
9,015
2,233
945
132
754
500
234
176
324
759
600
1,013
7,670
782
(178)
(900)
(1,078)
$
(794)
32,453
24,001
8,452
—
—
—
$
782
241
242
EXHIBIT III
ADDITIONAL INFORMATION FROM MR. KING
Inventory consists of 90% raw materials and 10% finished goods, per discussions with SPI. The bulk of
the raw materials consists of commodities, the prices of which fluctuate based on market prices. There
are a limited number of suppliers for these commodities. I want to make sure the inventory exists and is
valued correctly. I think I can sell it to other deodorant makers.
Included in fixed assets is the main production plant. The net book value per SPI’s accountant is
$3.5 million. It was purchased for a total of $5 million, including land for $750,000. I think its value
nowadays would be about $6 million, but I am not sure. Various pieces of equipment and a fleet of
trucks make up the rest of the capital assets. The trucks are spread out across the country and I am not
sure how many vehicles make up this fleet.
I am expecting a detailed listing of accounts receivable. From what I have learned from discussions with
SPI’s management, a few major customers make up the bulk of this amount.
SPI holds trademarks and trade names for its products. I am not sure about all the details of these
trademarks and trade names, but I believe their total market value equals their book value. I would sell
these along with the inventory.
Two separate parties filed lawsuits against SPI. One of the plaintiffs settled last year for $900,000. The
legal fees related to this were $100,000 in each of 2012 and 2013. I am unsure of the status of the second
plaintiff’s suit. I have no idea what these lawsuits were for.
The owner’s salary represents about 80% of total management salaries.
Based on my knowledge of our industry, I would expect that average repair and maintenance expenses
would be higher than what SPI has incurred in the past few years. When I discussed this with
management at SPI, they noted that some repairs and maintenance work were being postponed to future
years. They suggested that $350,000 per year would be a better average to use.
SPI sold a storage facility, including land, at a loss last year. This also created a capital loss and,
combined with previous years’ capital losses, adds up to $1.5 million in unused capital losses.
SPI has $2 million in non-capital loss carryforwards, plus unclaimed charitable donation deductions of
$120,000 from prior years. The non-capital losses were generated in 2008 and after, and the earliest ones
will expire in 2028. I would expect to fully use the losses well before they expire. The cumulative eligible
capital (CEC) account has a balance of $587,000.
SPI had the following amounts as undepreciated capital cost (UCC) balances in its 2013 tax return:
o Class 1: $3,917,776
o Class 8: $726,537
o Class 10: $855,923
EXHIBIT IV
ESTIMATED VALUE OF SPI’S ASSETS
Here is my estimate of what the assets might be worth (in thousands of dollars):
Accounts receivable (per financial statements, rounded)
Inventory (per financial statements, rounded)
Land and building (my estimate)
Equipment and vehicles (my estimate)
Trademarks and trade names (I assume this is the value)
Loss carryforward (tax rate 30%, my own calculation)
Undeducted donations (tax rate 30%, my own calculation)
$1,350
$5,000
$6,000
$2,000
$1,000
$1,050
$ 36
243
244
EVALUATION GUIDE
PAPER III, SIMULATION 3 — BOLD SPICE
Memo to: Jeff King, owner, Bold Spice Ltd. (BSL)
From: CA
Re: Shiraz Pitstick Inc. (SPI) Acquisition
The candidate calculates the purchase price for SPI and assesses whether it is a fair price.
Competencies
VII-4.2 – Estimates the value of the business (B)
VII-5 – Analyzes the purchase of a business (B)
You have mentioned that SPI’s owner is willing to sell his shares using the industry standard of 3.5 times
the normalized average EBITDA. We have calculated a draft valuation figure based on the financial
statements given, normalized by removing non-routine transactions, normalizing routine transactions, and
applying the standard industry multiple. As shown in the calculation that follows, the value calculated using
the normalized EBITDA method has resulted in a value for SPI shares of $9.3 million.
You made a comment on SPI’s profit trend and indicated that they were in a negative trend, even though
their results for 2014 seem to have recovered. We do not have enough information about SPI’s profit trend
for the previous years. You might want to gather additional information to ensure that the multiple applied
is appropriate in the circumstances, such as the industry trend compared to SPI’s performance, or perhaps
obtain information for the years prior to 2012, since the average EBITDA might prove more representative
over a five-year period.
245
According to your estimates of what the underlying assets of SPI might be worth, their total value is
approximately $16.436 million. However, as you will see in the tax section, the value of the loss
carryforward is $600,000 rather than $1.050 million, for a difference of $450,000, and the value of the
unclaimed donations has been revised to $0. The recalculated value is $15.950 million ($16.436 million −
$450,000 − $36,000).
If we adjust this for the liabilities of SPI, we arrive at $9.721 million ($15.950 million − $6.229 million).
Given that you are not going to continue with the deodorant business, an asset-based valuation would be
more appropriate. Using a valuation method whereby a multiplier is applied to a normalized earnings figure
would be a more appropriate way to value a business if it was going to continue on, which is not the case
here. If you were to buy the net assets of the company, using the numbers you provided you would pay
$9.721 million, so a $9.300 million price would be a good deal. This figure of $9.721 million would need
to be adjusted, of course, for any changes in value for the different assets and liabilities that we would come
across. To compute a value using an asset-based approach, we would need additional information.
(Almost all candidates performed a calculation to determine the purchase price. However, even though
Mr. King provided his estimates for the fair market value of SPI’s assets, fewer than half of the
candidates compared the purchase price they had calculated to the value they would obtain from an
asset-based valuation to determine whether the price for the shares would be fair.)
It should be mentioned that your estimated calculation of $9.721 million (adjusted for the liabilities and tax
items) may require some tweaking. The value of the loss carryforward amounts in your calculations may
not carry such a value, since these losses may or may not be usable to you in the future (see further
discussion on this). As well, you might want to consider applying a discount for the time value of money
to the extent that you are going to use the losses in future years. It is not certain if these losses would be
valued at all, since the timing of their use might prove difficult to determine. It is also not certain whether
the values you have used are true indicators of the underlying liquidation values. For instance, selling off
inventory in bulk would likely mean a discounted amount would be received. More work may be required
here.
246
SPI Share Value Based on Normalized Average EBITDA (in thousands of dollars)
Net income/(loss) per f/s
Adjustments to normalize:
Depreciation and
amortization
Interest
Professional fees
Repair and maintenance
Loss
Management salaries
Other expenses
Adjust for full year
Less: Repair and
maintenance
Normalized
Average
Multiplier
Fair market value
YTD
Sept. 30, 2014
Dec. 31, 2013
$
$
933
–
$
(794)
$
895
$
568
–
177
–
440
–
2,118
Dec. 31, 2012
Notes
782
945
1
754
100
(26)
–
480
–
3,035
1
2
3
4
5
4
$
722
100
(128)
178
600
900
2,473
2,824
6
(350)
3
2,474
2,473
3,035
2,661
3.5
9,314
Notes:
1. We must remove amortization and interest so that we are using EBITDA as the base for our calculations.
2. Professional fees were higher than normal due to the lawsuit. We must add back the extra costs
associated with this in order to normalize EBITDA.
3. Repair and maintenance expenses are too low, so we must adjust them to the $350,000 mark. For the
current year, we will add back the amount expensed so far, for the calculation to be an estimate for the
entire year, and then subtract the $350,000 thereafter. We will add $128,000 and $26,000 to the amounts
already expensed in 2013 and 2012 to make them each $350,000.
4. The loss and the lawsuit expenditures must be removed to normalize EBITDA.
5. The management salaries have been adjusted in order to remove the owner’s salary (2014: 80% ×
$550,000; 2013: 80% × $750,000; 2012: 80% × $600,000).
6. We must adjust for the current year by extrapolating the EBITDA for a full 12 months. We have 9
months of activity, and the purchase date will be after 10 months, but for purposes of the valuation
calculation, we need to extrapolate as if it were a full 12 months so that the 2014 year is comparable to
the others ($2,118 × (12 ÷ 9)).
247
(Most candidates included multiple periods (adjusting 2014 to bring it to 12 months) in their calculation
to compute a normalized average EBITDA. However, a large number of candidates only used one year
of data in their analysis, despite SPI’s owner saying that he was willing to sell his shares using the
industry standard of 3.5 times the normalized average EBITDA. Most of these candidates did not justify
why they used only one year (for example, audited numbers were a better basis, the most recent year was
more relevant, etc.), which weakened their analysis. Most candidates included and discussed a
reasonable number of normalization adjustments, providing good support for the adjustments
considered. The least discussed items were the loss on disposal and the lawsuit expense.)
For Primary Indicator #1 (Finance), the candidate must be ranked in one of the Percent
Awarded
0.2%
competence.
9.8%
Reaching competence — The candidate attempts a calculation of the purchase
price of SPI.
43.2%
Competent — The candidate prepares a reasonable calculation of the purchase
price of SPI, taking into account some of the normalization items, and concludes on
whether it is a fair price.
46.7%
Highly competent — The candidate prepares a thorough calculation of the
purchase price of SPI, taking into account the normalization items, and comments
on some of the flaws in Mr. King’s valuation of the underlying assets of the business.
0.1%
(Candidates were directed to this indicator because the client indicated that he wanted to acquire the
assets owned by another company (Shiraz Pitstick Inc.), but that the owner of the company “is offering
to sell the shares only, not the assets.” As well, the client stated that he wanted to make sure he was
“paying a fair price for this business.”)
(Candidates performed adequately on this indicator. The majority of candidates were able to provide
most components of the normalized average EBITDA. Strong candidates considered three years of
earnings (with the adjustment for nine months in 2014), as well as most of the normalizing adjustments.
These candidates also compared the normalized average EBITDA to a reasonable asset-based valuation
(net of liabilities) in order to determine whether the client would be paying a fair price for what he was
really looking to purchase. Many weak candidates considered income for only one year (usually 2014)
without necessarily adjusting for the short year (nine months). Weak candidates also made multiple
errors in the normalizing adjustments (for example, wrong direction, wrong year, or wrong calculation).)
248
The candidate discusses the due diligence procedures that should be done to give Mr. King
comfort on various balance sheet items of SPI.
Competencies
VI-1 – Analyzes, evaluates, and advises on assurance needs (A)
VI-2.5– Designs appropriate procedures based on the assignment’s scope, risk, and materiality guidelines
(A)
You asked what specific procedures could be done in order to make sure BSL is getting what it is paying
for. Because we are using some of the figures from the balance sheet to assess the reasonableness of the
value of the company, and because you intend to acquire certain assets for use in your own business, such
as the plant and equipment, and sell some of the assets to pay off much of the liabilities, you want to ensure
that the assets exist and have an appropriate value, and that liabilities listed are complete. We can perform
specific procedures to provide you with such comfort. The risks are that the values of the assets acquired
are less than expected, the assets do not exist, or there are more liabilities to pay off than what was
anticipated.
(Most candidates appropriately identified the assertions that had to be tested as a result of Mr. King’s
specific request. They provided procedures that would ensure that the assets existed and were valued
appropriately. As well, most candidates provided procedures to ensure that liabilities were complete.)
In addition to the work you have asked us to do, we would have to perform some additional work on the
components of the income statement to verify the determination of the purchase price under the normalized
average EBITDA computation.
Because we are dealing with a third party (SPI), we must obtain SPI’s authorization to communicate with
its customers, suppliers, and financial institution before we request various confirmations.
Accounts Receivable
You had mentioned that you were to receive a listing of the outstanding receivables to be collected. You
expect to be able to collect these receivables and use the funds to pay off the liabilities. We should ask to
review the subsequent receipts to verify the existence and collectability of these accounts. For any
remaining balances, since most of the receivables are from a few customers, we can send out confirmation
letters to these customers to ensure that the amounts listed are accurate in total and to determine how long
they have been outstanding. If there are significant differences in what SPI has on its books versus the
amount confirmed by the customer, more work would be required to follow up on this. This would involve
cross-referencing invoices issued and payments received to the customer history both from SPI’s statement
of accounts and from the client’s response.
249
(Most candidates addressed this item, providing at least one valid procedure to test for the assertion they
had identified.)
Inventory
You intend to sell the inventory after the share purchase to divest yourself of this asset and turn it into cash
for BSL’s operations. Since 90% of the inventory is in raw materials, most of the work in this area should
be focused there. In order to ascertain its existence, test counts would be done as close to October 31 as
possible. This would involve cross-referencing our own estimates of a certain amount of the raw materials
and comparing these estimates to what has been provided by SPI. The test counts would need to be designed
so that we are able to come up with proper estimates. We need to know how the raw material is stored, be
it in identifiable crates or other such packaging or in warehouses or bins with known storage limits. We can
then extrapolate our estimates to the total amounts and compare to determine if the total quantities are
similar. If there is a significant difference, further counts would be needed to determine where the difference
has come from.
We would also need to determine if the amount that the inventory is valued at is reasonable. We can collect
commodity prices on any given day by collecting such information from the open markets for these specific
commodities. If no such price exists, we can look at supplier invoices and determine the price. Once
determined, we would deduct any cost to sell to arrive at net realizable value. We would then compare the
values used by SPI and, together with our procedures on quantities, determine if the amount of inventory
provided is reasonable, or adjust accordingly.
As for the 10% of the inventory that is in finished goods, similar procedures should be taken in regards to
the quantities: we would perform test counts to determine if the sample quantities are accurate and
extrapolate that to the entire population, adjusting if necessary. As for the value of the finished goods, we
can take their suggested retail prices for this inventory and apply them to the quantities to see if the values
reported are indeed reasonable. We should then reduce this amount by a discount percentage that would
represent what would be appropriate given that the plan is to sell this in bulk.
(Many candidates recommended that an inventory count should be carried out by SPI; however some
did not discuss what procedures should be performed related to the inventory count. For example,
existence was one of the key concerns; therefore, candidates were expected to discuss how they would
test the existence of the inventory by performing sheet-to-floor counts. Many candidates also struggled
to determine the appropriate procedure to test the valuation of the inventory, even though the simulation
clearly stated that the commodity price was fluctuating based on market prices. In general when
discussing inventory, many candidates lost sight of their role and were focused on whether the inventory
was recorded at the lower of cost and net realizable value, when book value should not have been the
focus in this case.)
250
Building
You would like to acquire this building to have additional capacity for your existing business. The main
focus with respect to the building is its value. You think the value of both the land and building is about $6
million. I recommend we retain an appraiser experienced in the manufacturing sector to give us his or her
estimate of the actual value of the building. The appraiser or a separate building inspector would also be
able to give the building a quality inspection to ensure that the building is structurally sound and in proper
working condition. This is especially important given what we know about the lower amounts spent on
repairs and maintenance in the past years, which may have had a negative effect on the building’s value.
Trucks
You mentioned that SPI had a large fleet of trucks spread out across the country. We should get a listing of
these trucks from SPI, along with their serial numbers, and perform spot checks to confirm they exist. For
trucks in the immediate area, this should be relatively simple, but for trucks in other areas, we may need to
wait for them to come back to the plant. If these trucks do not come back to the main plant at all, we should
request either proof of insurance for these trucks or licence plate registrations in the relevant jurisdictions
where they were issued, along with their serial numbers. Having proof of insurance and registration will
show that these vehicles do exist and that they are owned by SPI, as well as insured, which would protect
your interests should something happen to these assets.
We may also want an experienced specialist to spot check some of these vehicles to ensure that they are in
proper working condition and do not require extensive and costly repair work. The specialist should focus
on the oldest trucks in this procedure.
(Because the building and the trucks were the assets that Mr. King really wanted to acquire, candidates
were expected to discuss these items and provide relevant procedures to test for their existence and
valuation. Many candidates provided a valid procedure to test the relevant assertions for the building;
however, they struggled to offer valid and practical procedures to test the same assertions for the trucks,
sometimes recommending that all the trucks be brought back to the plant, which was not practical
considering that they were spread out across the country.)
Trademarks and Trade Names
The trademarks and trade names are not something you intend to use, but rather sell and turn into cash. SPI
has trademarks and trade names for its products on the books that are an integral part of its business. We
need to see the legal and other documentation related to these trademarks and trade names. That will help
us determine what their remaining lives are and what exactly they relate to. We should also look into
competitors’ trademarks and trade names, if we are able, to see if they are significantly different. We need
to ensure that the trademarks and trade names on hand have actual long-term value and are not relatively
obsolete. The key is whether you can resell these trademarks and trade names to others and what value we
might be able to receive for these assets. Again, an expert in this specific area should be enlisted to
determine a fair value.
251
(About half of the candidates discussed the trademarks and trade names and were able to identify the
risks related to these accounts. However, only a little over half of these candidates were able to provide
a valid procedure. Many candidates did not recognize the particular nature of these intangible assets and
were not able to offer valid procedures to test for their existence (review legal documentation such as
patents and other regulatory filings) and value (use the services of an expert).)
Tax Assets
Only the non-capital losses that are being carried forward represent a tax asset that can be used to apply
against taxable income in the future. Capital losses expire upon the acquisition of control, and undeducted
charitable donations cannot be claimed in the years subsequent to the acquisition of control. We should be
able to verify that these non-capital losses exist by reviewing prior years’ tax returns and notices of
assessment, and also by confirming balances with the Canada Revenue Agency (CRA). By verifying the
amounts and years of expiry with the CRA, we can confirm that the losses exist and how long they are
available to be used. We should also ensure we review prior years’ tax returns to determine whether the
amounts calculated are reasonable, so we would want to check the numbers used in calculating taxable
income for those years as well. There is also a risk that this asset might have no value (see tax discussion).
(Most candidates did not recognize the significance of this item for Mr. King and did not discuss it in
their response. Those who did provided valid procedures that were appropriately focused on verifying
the completeness of the amounts available by reviewing correspondence from the CRA.)
Bank Indebtedness
Since you are considering purchasing the shares of the company, you would be assuming all of the debts.
Therefore, you should make sure that the financial statements report the extent of it. To ensure that the
amount of bank indebtedness is complete, we would request bank statements from SPI, as well as bank
reconciliations, and follow up on significant outstanding matters to determine if the amounts reported are
reasonable. We would also send the bank a confirmation letter so that we know the amount reported is
accurate and complete. A bank confirmation would also let us know the terms, including interest rates, as
well as any other indebtedness that may be in place.
Long-Term Debt
A listing of the debt amounts will be required. Once we have this list, we will send out confirmation letters
to determine if the amounts shown are complete. The confirmations will also tell us whether there are other
amounts not listed, in addition to the terms and rates of the loans.
(Only about a third of the candidates discussed the bank indebtedness and the long-term debt. Most of
those who did were able to provide a valid procedure to audit these items.)
252
Accounts Payable
Given that raw materials are based on commodity prices, and that there are a limited number of suppliers
of these commodities, we should be able to confirm with these major suppliers any amounts that SPI owes
to them (open confirmation with no amount specified). Once we obtain SPI’s accounts payable listing, I
expect to find that SPI deals with a few major vendors to acquire the raw materials needed to make its
products. We should also ask SPI’s management if any of its major suppliers are not on the accounts payable
listing.
We would send confirmation letters to various other vendors as part of a search for unrecorded liabilities,
and we would follow up on any not received or if major differences were noted. If there were differences,
further work would be needed. We would need to cross-reference purchase orders and amounts paid to SPI
records and request similar information from the vendor so that we can reconcile the amounts. Confirmation
letters should be sent to major suppliers even if there are no liabilities recorded in the books.
We should also perform some work to see if there are liabilities that are not recorded in the books. In
addition to confirming with major suppliers, as per above, there are several ways to look for unrecorded
liabilities, and it depends to a certain extent on how SPI records its liabilities. One way to search is to scan
significant cash outlays after October 31 to see if these should have been set up as liabilities for the period
end. Another way is to take a look at any purchase invoices that have been received in the recent term and
see if they have been set up yet in the system. If there are no invoices, perhaps a scan of recent shipping
documentation or vendor statements could be done. As well, we should see if there should be any accrued
wages set up, since this is a significant expense of the company. There may be bonuses or vacation payable
amounts that have not been calculated yet, so we would check with the payroll department to see if that is
the case.
(Very few candidates discussed this issue, but most of those who did were able to provide a valid
procedure to audit the accounts payable.)
Contingent Liabilities
You have noted that there were two lawsuits against SPI in recent years, and one was settled in the prior
year for $900,000. While the status of the other lawsuit is unclear, we need to correspond with the legal
counsel for SPI to determine the likelihood of the other one settling as well, to the extent we can. Legal
counsel would also help us determine the amount and details. We need more information to determine if
there is a liability here that is not listed on the balance sheet.
These are some of the procedures that could be done to give you some assurance over those assets and
liabilities that you have used in your own valuation calculations. We will need to determine what amount
constitutes a difference significant enough to follow up on, if we should encounter any, but we would need
more information to assess this.
253
(Most candidates provided valid procedures to test for the completeness of the liabilities, recognizing that
they could have a significant impact on Mr. King’s decision as to whether BSL should acquire SPI’s
shares (they could affect the value of the net assets). However, some candidates only provided procedures
for the liabilities that were already known and did not consider the risk for unrecorded liabilities.)
For Primary Indicator #2 (Assurance), the candidate must be ranked in one of the Percent
Awarded
0.2%
competence.
2.8%
Reaching competence — The candidate identifies some of the due diligence
procedures that should be done to give Mr. King comfort on various balance sheet
items of SPI.
35.3%
Competent — The candidate discusses some of the due diligence procedures that
should be done to give Mr. King comfort on various balance sheet items of SPI.
61.2%
Highly competent — The candidate discusses several of the due diligence
procedures that should be done to give Mr. King comfort on various balance sheet
items of SPI.
0.5%
(Candidates were directed to this indicator when the client said, “I want to make sure that BSL is actually
getting the assets listed, that the liabilities are complete, and that all amounts are accurate,” and then
asked “what specific procedures could be done in order to make sure BSL is getting what it is paying
for.”)
(Most candidates performed well on this indicator. They provided a good breadth of coverage of the
significant items (including the plant and trucks in which Mr. King had expressed interest) and offered
discussions with sufficient depth on most of the items they had identified. Strong candidates clearly
recognized that they were suggesting due diligence procedures, and as such did a good job of identifying
the appropriate risk or assertion they were addressing. Those candidates recognized that fair market
value, not book value, was the important measure for the client. Weak candidates identified fewer areas
of due diligence to explore and often failed to provide valid procedures for those areas identified. Many
of the procedures provided by weak candidates did not properly address the risk or assertion that had
been identified. For example, to test the existence of an asset, some candidates recommended reviewing
the purchase invoice; however, this would not ensure that the asset was still owned at the date of
acquisition.)
254
The candidate discusses the acquisition of control rules and addresses other tax-related issues
in regards to the share purchase.
Competencies
IX-3.5 – Identifies, analyzes, and advises on tax consequences or planning opportunities associated with
certain corporate transactions (B)
IX-3.6 – Describes the tax consequences of other corporation and partnership restructuring transactions
(C)
When a corporation is acquired by an unrelated party, we must look to certain tax rules that might apply as
a result of such a transaction. Where control of a corporation is acquired, there are restrictions on the usage
of losses, as well as other effects. There are also other tax considerations that should be taken into account
when purchasing the shares of a company versus its assets.
Acquisition of Control Rules
When control of a corporation like SPI is acquired by another party, certain rules come into play that restrict
the usage of losses and have other effects.
Deemed Year End
Any acquisition of control of a corporation would trigger a deemed year end for the company. This would
mean that SPI would be deemed to have a year end for tax purposes immediately before the day the actual
control is acquired by BSL. The purchase is planned for November 1, 2014, which would trigger a year end
of October 31, 2014. This may be an issue since SPI’s normal year end is December 31, and it may have
unintended adverse effects such as a pro-rated CCA calculation and impacts on capital losses, non-capital
losses, and donations.
(Most candidates were able to recognize that a deemed year end would occur upon BSL’s acquisition of
control of SPI. Many candidates recognized that the deemed year end would result in a short taxation
year for SPI and discussed its impact on certain deductions in computing net income for tax purposes
and taxes payable.)
Capital Losses
Per the tax rules, all capital losses SPI has would be lost once BSL acquired control. BSL would not be able
to carry forward these losses to future years.
255
As well, the rules dictate that if there are accrued capital losses on certain properties, they be recognized at
the deemed year end. If SPI had any non-depreciable capital property with a fair market value (FMV) less
than its original adjusted cost base (ACB), then the capital losses would need to be triggered and the
property written down to its true FMV.
The same logic is true of depreciable property if the FMV is less than the undepreciated capital cost (UCC);
if so, a writedown is required, which would increase non-capital losses carried forward (see further
discussion in the next section).
However, a relieving provision is available: election pursuant to paragraph 111(4)(e) of the Income Tax
Act. If there is depreciable or non-depreciable property with an accrued gain at the time of the deemed year
end, the Income Tax Act allows for it to be recognized. In the case of non-depreciable property, this would
result in a capital gain recognized to offset any capital losses. In the case of depreciable property, this would
result in a capital gain or recapture of CCA or both (see further discussion on non-capital losses on the next
page).
Looking at the assets of SPI, other than the land for the building, there appears to be no other nondepreciable capital property on the books. In addition to the land, there may be some depreciable property
that we could trigger a capital gain on. We do not know the original cost of the equipment and vehicles,
and it is likely that their FMV would not have increased beyond their original ACB, so we can ignore those
assets in our analysis. However, we have an estimated FMV for the land and building of $6 million, and it
has an ACB of $5 million, meaning it has an accrued capital gain of $1 million.
The land and building would then have an ACB of $6 million going forward. However, for UCC purposes,
only one-half of the excess amount over the original ACB of the building would be added to the CCA pool.
See further discussion on this under “Non-capital Losses”. For capital gains purposes, the $6 million would
be the ACB to use in future calculations.
By electing under these relieving provisions, SPI would be able to trigger this gain and use up $1 million
of the capital losses carried forward. However, the other $500,000 of capital losses being carried forward
would be lost upon acquisition of control.
(Most candidates were able to identify the fact that the net capital losses would expire as a result of the
acquisition of control. However, only about half of the candidates were able to provide tax planning
advice to address this, such as using the election to bump the value of certain assets to their fair market
value to generate capital gains, in order to mitigate the impact of the acquisition of control rules.)
Non-capital Losses
Unlike capital losses, non-capital losses can be carried forward to be used upon an acquisition of control.
However, there are restrictions on the use of these as well. They can only be carried forward if the
corporation continues to carry on a same or similar business as was being carried on before. Further, there
must be a reasonable expectation of generating a profit for that same or similar business. Finally, the losses
can only be used to reduce net income earned from the same or a similar business.
256
The question then becomes whether the manufacture of perfumes and colognes is a same or similar business
as the manufacture of deodorants. Perfumes and colognes, generally marketed as “cosmetics and
fragrances,” are designed to provide an appealing fragrance to those who wear them, or to cover up other
odors. Deodorants, marketed as “personal hygiene products,” can also provide appealing fragrances or
cover up other ones.
It is unclear if the businesses are the same or similar in nature. This can have a significant impact on the
acquisition of this company if BSL cannot use the losses available in SPI. Further research may be needed
to settle this issue.
(Most candidates were able to discuss the impact of the acquisition of control of SPI on the availability
of its non-capital losses. Most candidates appropriately questioned whether the businesses carried on by
BSL and SPI would be considered as same or similar.)
As well, if there are accrued losses on account of income at the time of the deemed year end, these too must
be recognized. As mentioned previously, however, relieving provisions are available to help offset these
losses or losses being carried forward, if there are accrued gains at the deemed year end.
For depreciable property, we can elect to trigger a recapture if the FMV of the assets in question is greater
than the UCC. From above, we have calculated the capital gain on the building, but this would also result
in some recapture of $4.25 million less the UCC of the particular assets. This would result in a recapture of
approximately $332,224 ($4,250,000 − $3,917,776) that would be offset by non-capital losses carried
forward. As for the equipment and vehicles, if we combine their FMV and UCC amounts, this could result
in an additional recapture amount of approximately $417,540 (FMV of $2 million less UCC of $726,537 +
$855,923 for Classes 8 and 10). Of course, this is a simplified calculation, and more work would be needed
on each class.
By triggering a recapture, you could use about $750,000 of the non-capital losses being carried forward.
Going forward, the UCC of these classes would be increased to the original capital cost of the assets plus
one-half of the excess of the elected value over the ACB. For the building, this would mean, assuming that
the FMV has increased proportionately (($4.25 million ÷ $5.00 million) × $6.00 million = $5.10 million),
that the new UCC would be $4.675 million, or $4.250 million + one-half of ($5.10 million − $4.25 million).
The ACB of the land would be increased to its FMV of $900,000 (($750,000 ÷ $5.00 million) × $6.00
million). For the Class 8 and 10 assets, more information would be needed to determine the new UCC.
(Only a few candidates were able to come up with a way to mitigate the impact of losing the non-capital
losses.)
Other Items
Other items affecting the non-capital losses being carried forward are the trademarks and trade names,
accounts receivable, and inventory. For eligible capital property (ECP), such as trademarks and trade
names, if their total FMV is less than the amount in the cumulative eligible capital balance, then the ECP
is written down to three-quarters of its FMV. Any writedown is considered a part of the non-capital loss
carryforwards. More information is needed to determine the FMV of the trademarks and trade names for
this calculation.
257
For accounts receivable, any debts must be written off to the largest amount possible if deemed to be bad
debts. No amount can be written off after the deemed year end.
While not specifically dealt with in the acquisition of control rules, if the inventory on hand needed to be
written down, it should be dealt with at the deemed year end as well.
Charitable Donations
As for the capital losses carryforward, the amount of the donations on hand will be lost upon the acquisition
of control.
(Only a few candidates addressed these other items, but when they did, they were generally able to provide
a reasonable discussion of the tax issues and how they would affect SPI’s tax attributes.)
Amalgamation/Wind-Up
In order to ultimately use the losses in BSL, an amalgamation of both BSL and SPI or a wind-up of SPI
would be needed. The amalgamation triggers a deemed year end, so care must be taken here so that the date
of amalgamation is selected at a time when a deemed year end is desired. This would affect the existing
year end of BSL, so that should be kept in mind since it is unlikely you want to change the year end at this
point. As for the wind-up of SPI, the available loss carryforward balances would only be available to reduce
BSL’s taxable income starting “in the taxation year commencing after the commencement of the windingup” as per Income Tax Act 88(1.1). Therefore, the date of acquisition and the subsequent wind-up should
be planned to mitigate any negative effect of this rule.
(Some candidates discussed the post-acquisition planning that would be required to allow BSL to use
SPI’s tax attributes, namely its non-capital losses. However, only about half of those candidates provided
a valid discussion of the relevant rules applicable upon an amalgamation or a wind-up.)
For Primary Indicator #3 (Taxation), the candidate must be ranked in one of the Percent
Awarded
0.6%
competence.
13.4%
Reaching competence — The candidate identifies some of the tax impacts that
result from an acquisition of control.
21.0%
Competent — The candidate discusses the impact of the acquisition of control rules
with regards to the losses in SPI or attempts some calculations to determine the
usage of such losses.
64.9%
Highly competent — The candidate discusses the impact of the acquisition of
control rules with regards to the losses in SPI, performs calculations to determine
the usage of such losses, and comments on the amalgamation with SPI.
0.1%
258
(Candidates were not specifically directed to this indicator. However, Mr. King stated, “SPI has some
tax losses available that I would like to get my hands on.”)
(Candidates performed well on this indicator. They were able to use the case facts appropriately and
discuss the acquisition of control rules in sufficient depth.)
(Strong candidates recognized that the acquisition of control of SPI would result in a deemed year end,
and that this might also restrict BSL’s ability to use SPI’s losses going forward. These candidates
correctly understood the loss limitation rules and demonstrated knowledge related to the deemed yearend rules (date, filing tax returns, pro-rating of CCA/SBD). As well, strong candidates recognized that
either a bump election could be made to use the losses that would otherwise expire or there was a
requirement to recognize any accrued losses on assets held at the time of the acquisition of control. Weak
candidates typically only discussed what was happening with the losses on the acquisition of control and
often mixed up the non-capital loss and capital loss limitation rules.)
The candidate discusses how the purchase of shares may not be in the best interest of BSL and
advises on factors that need to be taken into account if a share purchase is to be done.
While our preliminary calculations seem to show that this is a good deal for BSL, we need to take a step
back again and look at the big picture.
By valuing the shares from a multiplier perspective, we come up with a value of about $9.3 million. To the
extent that you do not appear to want to continue in the deodorant business, this approach to valuing the
company does not make the most sense.
259
If we use an asset-based approach, as you have done, we come up with a value of $15.95 million. However,
you are only interested in the building, equipment, vehicles, and tax-loss carryforward. Altogether, these
have a value of $8.60 million, according to your calculation. However, the losses in SPI may or may not be
usable and, at the minimum, would only act to increase the tax cost of the assets closer to their FMV. Since
you have already accounted for the FMV in your own calculations, the number shown for the tax losses
being acquired should be removed entirely. This would reduce the value to $8.00 million for the building,
equipment, and vehicles. Therefore, by purchasing the shares for $9.30 million, you are paying more than
what you are getting. You also have to deal with selling the assets you are not interested in and settling the
liabilities, and you bear the risk of unrecorded liabilities.
(Most candidates recognized that Mr. King should definitely reconsider the purchase of the shares, both
from a financial perspective and a non-financial perspective (since he would be acquiring assets he is
not interested in or that bear additional risks due to the potential for unrecorded liabilities).)
The owner made it clear that, for now, only the shares were up for sale. If we start with the value of $16.436
million you calculated and adjust it for the total liabilities on the books of $6.229 million and the net capital
losses ($450,000, as calculated earlier in this memo) and unclaimed charitable donations ($36,000), which
would not be transferable, we get to $9.721 million. However, I think it would be prudent to reduce this
value by the amount of a contingent liability for the second lawsuit. At a minimum, we should reduce the
value by the amount of the first settlement, or $900,000, assuming that these lawsuits are similar in nature.
There may also be adjustments needed for which we require more information first. The inventory would
likely need to be written down since the plan is to sell it off in bulk. This would likely mean selling it off
at a discounted value. There may be other liabilities we need to account for as well that would reduce the
value. Any accounts receivable writeoffs would need to be taken into account, as would the true FMV of
the trademarks and trade names.
Given this, the price of $9.3 million does not appear to be such a good deal after all. Taking out the tax
losses and subtracting the contingent liability amount results in a value of $8.821 million ($9.721 million
− $900,000). This does not include any other reductions relating to inventory or other assets, or increases
to liabilities. Given the risk of not using the losses available, the acquisition of this company becomes less
attractive.
An important point to keep in mind to limit your risk is in the drafting of the purchase agreement. You
should ensure that there are clauses outlining exactly what will be in SPI if you go through with the share
purchase. Things such as the inventory, building, vehicles, et cetera, should be listed as assets that are
included (basically any assets you are intending to “buy” through purchasing the shares of the corporation).
As well, if there are unknown liabilities at the time of purchase, the former shareholders should be
responsible for those — they can include unknown environmental liabilities or liabilities for income tax or
GST reassessments, for instance. Hence, part of the purchase price should be kept in escrow to provide for
any adjustment to the purchase price resulting from these unknown liabilities.
In addition, there may be transactions between the date of the financial statements and the closing date that
have an effect on the value of the company (for example, a dividend could be declared that would strip SPI
of value), and these potential transactions should be dealt with in the purchase agreement. A lawyer
experienced with these matters should be engaged to help draft and negotiate a purchase and sale agreement.
260
Based on the information that I have, I recommend that you do not purchase the shares of SPI. You have
no need for its trademarks and trade names or inventory, and you will spend time divesting yourself of
those. Further, you will likely not be able to use the losses available, which are a key part of the purchase.
You would be able to have higher CCA claims on an asset purchase. Finally, the risk to BSL of taking on
all liabilities, known and unknown, makes this share purchase unattractive.
(Many candidates discussed the acquisition by way of “pros” and “cons” of a share-versus-asset
purchase, without referring to the specific facts of the simulation. However, some candidates, once they
had mentioned to Mr. King that he should reconsider the share purchase transaction, went beyond and
provided Mr. King with appropriate advice as to what could be done to mitigate the risks should BSL
proceed with the acquisition of SPI’s shares.)
For Primary Indicator #4 (Pervasive Qualities and Skills), the candidate must be Percent
Awarded
8.1%
competence.
12.4%
Reaching competence — The candidate identifies that the purchase of shares
might not be in the best interest of BSL or that there are factors that need to be
taken into account if a share purchase were to be done.
52.6%
Competent — The candidate discusses that the purchase of shares might not be
in the best interest of BSL and advises on factors that need to be taken into account
if a share purchase were to be done.
26.9%
Highly competent – The candidate advises Mr. King not to buy the shares, provides
support to the conclusion, and comments on the legal agreement if a share
purchase were to be done.
0.0%
(Candidates were not directed to this indicator. They were expected to warn Mr. King that purchasing
the shares of SPI might not be in his best interest and were pointed in that direction when Mr. King said
that what he really wanted was some of SPI’s productive assets. Since SPI’s owner was willing to sell his
shares only, candidates were expected to provide advice on how Mr. King could mitigate his risks.)
(Candidates did a good job of questioning the share purchase; however, many ended their discussion
after mentioning to Mr. King that he should reconsider the transaction (in other words, not buy the
shares). Weak candidates stopped short of telling Mr. King what future actions or steps needed to be
taken. For example, candidates could have discussed how Mr. King could mitigate his risk in the case of
a share purchase by including a price adjustment clause in the agreement. Many weak candidates
provided a generic list of considerations (pros and cons) when debating whether to purchase assets versus
shares. Others questioned the share purchase from a purchase price perspective, simply because the
price to be paid using an earnings-based approach was higher than the fair market value of the assets
being acquired. This discussion was considered within the finance indicator.)
261
(Strong candidates provided a thorough discussion by addressing factors to consider assuming the client
went ahead with the share purchase. Some also recommended negotiating additional time to close the
transaction in order to adequately complete the due diligence. This was very useful advice to provide to
Mr King.)
(Overall, the Board was relatively pleased with the quality of the responses in this simulation. Most
candidates addressed each of the indicators in reasonable depth, except on the Pervasive Qualities
indicator, where candidates struggled to go beyond questioning whether the share purchase was
adequate. Candidates performed better on the Finance and Assurance indicators. They discussed most
of the significant issues, concluded logically on the Finance indicator, and provided adequate procedures
to verify the assertions they were testing on the Assurance indicator.)
0.98
0.96
0.94
0.92
0.91
0.89
0.87
0.85
0.84
0.82
0.80
0.79
0.77
0.76
0.74
0.73
0.71
0.70
0.69
0.67
0.66
0.65
0.63
0.62
0.61
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Periods
Hence 2%
0.54
0.52
0.51
0.49
0.48
0.62
0.61
0.59
0.57
0.55
0.72
0.70
0.68
0.66
0.64
0.84
0.81
0.79
0.77
0.74
0.97
0.94
0.92
0.89
0.86
3%
0.44
0.42
0.41
0.39
0.38
0.53
0.51
0.49
0.47
0.46
0.65
0.62
0.60
0.58
0.56
0.79
0.76
0.73
0.70
0.68
0.96
0.92
0.89
0.85
0.82
4%
0.36
0.34
0.33
0.31
0.30
0.46
0.44
0.42
0.40
0.38
0.58
0.56
0.53
0.51
0.48
0.75
0.71
0.68
0.64
0.61
0.95
0.91
0.86
0.82
0.78
5%
0.29
0.28
0.26
0.25
0.23
0.39
0.37
0.35
0.33
0.31
0.53
0.50
0.47
0.44
0.42
0.70
0.67
0.63
0.59
0.56
0.94
0.89
0.84
0.79
0.75
6%
0.24
0.23
0.21
0.20
0.18
0.34
0.32
0.30
0.28
0.26
0.48
0.44
0.41
0.39
0.36
0.67
0.62
0.58
0.54
0.51
0.93
0.87
0.82
0.76
0.71
7%
0.20
0.18
0.17
0.16
0.15
0.29
0.27
0.25
0.23
0.21
0.43
0.40
0.37
0.34
0.32
0.63
0.58
0.54
0.50
0.46
0.93
0.86
0.79
0.74
0.68
8%
0.16
0.15
0.14
0.13
0.12
0.25
0.23
0.21
0.19
0.18
0.39
0.36
0.33
0.30
0.27
0.60
0.55
0.50
0.46
0.42
0.92
0.84
0.77
0.71
0.65
9%
0.14
0.12
0.11
0.10
0.09
0.22
0.20
0.18
0.16
0.15
0.35
0.32
0.29
0.26
0.24
0.56
0.51
0.47
0.42
0.39
0.91
0.83
0.75
0.68
0.62
10%
0.11
0.10
0.09
0.08
0.07
0.19
0.17
0.15
0.14
0.12
0.32
0.29
0.26
0.23
0.21
0.53
0.48
0.43
0.39
0.35
0.90
0.81
0.73
0.66
0.59
11%
PRESENT VALUE OF $1 RECEIVED AT THE END OF THE PERIOD
0.09
0.08
0.07
0.07
0.06
0.16
0.15
0.13
0.12
0.10
0.29
0.26
0.23
0.20
0.18
0.51
0.45
0.40
0.36
0.32
0.89
0.80
0.71
0.64
0.57
12%
0.08
0.07
0.06
0.05
0.05
0.14
0.13
0.11
0.10
0.09
0.26
0.23
0.20
0.18
0.16
0.48
0.43
0.38
0.33
0.29
0.88
0.78
0.69
0.61
0.54
13%
0.06
0.06
0.05
0.04
0.04
0.12
0.11
0.09
0.08
0.07
0.24
0.21
0.18
0.16
0.14
0.46
0.40
0.35
0.31
0.27
0.88
0.77
0.67
0.59
0.52
14%
0.05
0.05
0.04
0.03
0.03
0.11
0.09
0.08
0.07
0.06
0.21
0.19
0.16
0.14
0.12
0.43
0.38
0.33
0.28
0.25
0.87
0.76
0.66
0.57
0.50
15%
0.04
0.04
0.03
0.03
0.02
0.09
0.08
0.07
0.06
0.05
0.20
0.17
0.15
0.13
0.11
0.41
0.35
0.31
0.26
0.23
0.86
0.74
0.64
0.55
0.48
16%
0.04
0.03
0.03
0.02
0.02
0.08
0.07
0.06
0.05
0.04
0.18
0.15
0.13
0.11
0.09
0.39
0.33
0.28
0.24
0.21
0.85
0.73
0.62
0.53
0.46
17%
0.03
0.03
0.02
0.02
0.02
0.07
0.06
0.05
0.04
0.04
0.16
0.14
0.12
0.10
0.08
0.37
0.31
0.27
0.23
0.19
0.85
0.72
0.61
0.52
0.44
18%
0.03
0.02
0.02
0.02
0.01
0.06
0.05
0.04
0.04
0.03
0.15
0.12
0.10
0.09
0.07
0.35
0.30
0.25
0.21
0.18
0.84
0.71
0.59
0.50
0.42
19%
0.02
0.02
0.02
0.01
0.01
0.05
0.05
0.04
0.03
0.03
0.13
0.11
0.09
0.08
0.06
0.33
0.28
0.23
0.19
0.16
0.83
0.69
0.58
0.48
0.40
20%
262
Evaluation Booklet Tables
TABLE I
15.42
15.94
16.44
16.94
17.41
12.56
13.17
13.75
14.32
14.88
14.03
14.45
14.86
15.25
15.62
11.65
12.17
12.66
13.13
13.59
12.82
13.16
13.49
13.80
14.09
10.84
11.27
11.69
12.09
12.46
17.01
17.66
18.29
18.91
19.52
5.08
5.79
6.46
7.11
7.72
21
22
23
24
25
5.24
6.00
6.73
7.44
8.11
0.95
1.86
2.72
3.55
4.33
13.58
14.29
14.99
15.68
16.35
5.42
6.23
7.02
7.79
8.53
0.96
1.89
2.78
3.63
4.45
5%
16
17
18
19
20
5.60
6.47
7.33
8.16
8.98
6
7
8
9
10
0.97
1.91
2.83
3.72
4.58
4%
9.79 9.25 8.76 8.31
10.58 9.95 9.39 8.86
11.35 10.63 9.99 9.39
12.11 11.30 10.56 9.90
12.85 11.94 11.12 10.38
0.98
1.94
2.88
3.81
4.71
1
2
3
4
5
3%
11
12
13
14
15
2%
No. of
Periods
Received
7.50
7.94
8.36
8.75
9.11
4.77
5.39
5.97
6.52
7.02
0.93
1.81
2.62
3.39
4.10
7%
11.76
12.04
12.30
12.55
12.78
10.84
11.06
11.27
11.47
11.65
10.11 9.45
10.48 9.76
10.83 10.06
11.16 10.34
11.47 10.59
7.89
8.38
8.85
9.29
9.71
4.92
5.58
6.21
6.80
7.36
0.94
1.83
2.67
3.47
4.21
6%
10.02
10.20
10.37
10.53
10.68
8.85
9.12
9.37
9.60
9.82
7.14
7.54
7.90
8.24
8.56
4.62
5.21
5.75
6.25
6.71
0.93
1.78
2.58
3.31
3.99
8%
9.29
9.44
9.58
9.71
9.82
8.31
8.54
8.76
8.95
9.13
6.81
7.16
7.49
7.79
8.06
4.49
5.03
5.53
6.00
6.42
0.92
1.76
2.53
3.24
3.89
9%
8.65
8.77
8.88
8.99
9.08
7.82
8.02
8.20
8.36
8.51
6.50
6.81
7.10
7.37
7.61
4.36
4.87
5.33
5.76
6.14
0.91
1.74
2.49
3.17
3.79
10%
8.08
8.18
8.27
8.35
8.42
7.38
7.55
7.70
7.84
7.96
6.21
6.49
6.75
6.98
7.19
4.23
4.71
5.15
5.54
5.89
0.90
1.71
2.44
3.10
3.70
11%
7.56
7.65
7.72
7.78
7.84
6.97
7.12
7.25
7.37
7.47
5.94
6.19
6.42
6.63
6.81
4.11
4.56
4.97
5.33
5.65
0.89
1.69
2.40
3.04
3.60
12%
7.10
7.17
7.23
7.28
7.33
6.60
6.73
6.84
6.94
7.02
5.69
5.92
6.12
6.30
6.46
4.00
4.42
4.80
5.13
5.43
0.88
1.67
2.36
2.97
3.52
13%
PRESENT VALUE OF AN ANNUITY OF $1 RECEIVED AT THE END OF EACH PERIOD
6.69
6.74
6.79
6.84
6.87
6.27
6.37
6.47
6.55
6.62
5.45
5.66
5.84
6.00
6.14
3.89
4.29
4.64
4.95
5.22
0.88
1.65
2.32
2.91
3.43
14%
6.31
6.36
6.40
6.43
6.46
5.95
6.05
6.13
6.20
6.26
5.23
5.42
5.58
5.72
5.85
3.78
4.16
4.49
4.77
5.02
0.87
1.63
2.28
2.85
3.35
15%
5.97
6.01
6.04
6.07
6.10
5.67
5.75
5.82
5.88
5.93
5.03
5.20
5.34
5.47
5.58
3.68
4.04
4.34
4.61
4.83
0.86
1.61
2.25
2.80
3.27
16%
5.67
5.70
5.72
5.75
5.77
5.41
5.47
5.53
5.58
5.63
4.84
4.99
5.12
5.23
5.32
3.59
3.92
4.21
4.45
4.66
0.85
1.59
2.21
2.74
3.20
17%
5.38
5.41
5.43
5.45
5.47
5.16
5.22
5.27
5.32
5.35
4.66
4.79
4.91
5.01
5.09
3.50
3.81
4.08
4.30
4.49
0.85
1.57
2.17
2.69
3.13
18%
5.13
5.15
5.17
5.18
5.20
4.94
4.99
5.03
5.07
5.10
4.49
4.61
4.71
4.80
4.88
3.41
3.71
3.95
4.16
4.34
0.84
1.55
2.14
2.64
3.06
19%
4.89
4.91
4.93
4.94
4.95
4.73
4.77
4.81
4.84
4.87
4.33
4.44
4.53
4.61
4.68
3.33
3.60
3.84
4.03
4.19
0.83
1.53
2.11
2.59
2.99
20%
TABLE II
263
264
Evaluation Booklet Tables
TABLE III
A FORMULA FOR CALCULATING THE PRESENT VALUE OF
REDUCTIONS IN TAX PAYABLE DUE TO CAPITAL
COST ALLOWANCE
Investment
Cost
(
×
Rate of
Return
Marginal
Rate of
Income Tax
+
×
Rate of
Capital Cost
Allowance
Rate of Capital
Cost Allowance
(
) (
×
1+
Rate of Return
2
×
1+
Rate of Return
)
)
MAXIMUM
CAPITAL COST ALLOWANCE RATES
FOR SELECTED CLASSES
Class 1 ...................................................... 4%
Class 8 ...................................................... 20%
Class 10 .................................................... 30%
Class 10.1 ................................................. 30%
Class 12 .................................................... 100%
Class 13 .................................................... Original lease period plus one
renewal period (minimum 5 years
and maximum 40 years)
Class 14 .................................................... Length of life of property
Class 17 .................................................... 8%
Class 29.................................................... 50% straight-line
Class 43 .................................................... 30%
Class 44 .................................................... 25%
Class 45 .................................................... 45%
Class 50 .................................................... 55%
SELECTED PRESCRIBED AUTOMOBILE AMOUNTS FOR 2013
Maximum depreciable cost — Class 10.1
$30,000 + GST or HST
Maximum monthly deductible lease cost
$800 + GST or HST
Maximum monthly deductible interest cost
$300
Operating cost benefit — employee
27¢ per kilometre of personal use
Non-taxable car allowance benefit limits
- first 5,000 kilometres
54¢ per kilometre
- balance
48¢ per kilometre
265
TABLE IV
INDIVIDUAL FEDERAL INCOME TAX RATES
Taxable Income
2013* Tax Rate
$43,561 or less
$43,562 to $87,123
$87,124 to $135,054
$135,055 or more
15%
$6,534 + 22% on next $42,707
$16,118 + 26% on next $46,992
$28,580 + 29% on remainder
*
2014 rates increase by an indexing of 0.9%.
SELECTED NON-REFUNDABLE TAX CREDITS
PERMITTED TO INDIVIDUALS
FOR PURPOSES OF COMPUTING INCOME TAX
The 2013 tax credits are 15% of the following amounts:
Basic personal amount
Spouse or common-law partner amount
Net income threshold for spouse or common-law partner amount
Amount for children under 18
Age 65 or over in the year
Net income threshold for age amount
Canada employment amount
Disability amount
Infirm dependants 18 and over
Net income threshold for infirm dependants 18 and over
Children’s fitness credit
Children’s art credit
Basic amount for:
GST credit
Child tax benefit
$11,038
11,038
NIL
2,234
6,854
34,562
up to $1,117
7,697
6,530
6,548
500
500
34,872
43,953
CORPORATE FEDERAL INCOME TAX RATE
The tax payable by a corporation on its taxable income under Part I of the Income Tax Act is 38%
before any additions and/or deductions.
PRESCRIBED INTEREST RATES (base rates)
Year
Jan. 1 – Mar. 31
Apr. 1 – June 30
July 1 – Sep. 30
2014
2013
2012
2011
2010
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
Oct. 1 – Dec. 31
2
1
1
1
This is the rate used for taxable benefits for employees and shareholders, low-interest loans, and other
related-party transactions. The rate is 4 percentage points higher for late or deficient income tax payments
and unremitted withholdings. The rate is 2 percentage points higher for tax refunds to taxpayers with the
exception of corporations, for which the base rate is used.

Chartered Professional Accountants of Canada

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