2013 Uniform Evaluation Report

Transcription

2013 Uniform Evaluation Report
Chartered Professional Accountants of Canada
UNIFORM EVALUATION
REPORT
2013
i
MEMBERSHIP OF 2013
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, CA, CMA
BDO Canada LLP
Toronto, Ontario
Mike Fitzpatrick, CA
Fitzpatrick & Company
Charlottetown , Prince Edward Island
Jason Hale, CA
Grant Thornton LLP
Halifax, Nova Scotia
Sylvie Héroux, Ph.D, M.Sc., CPA, CA
Université du Québec à Montréal-ESG
Montréal, Québec
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 2013 BOARD OF EVALUATORS
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
Marie-Andrée Caisse, CPA, CA, Exam Developer, 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.
© 2014, Chartered Professional Accountants of Canada. All Rights Reserved.
277 Wellington Street West
Toronto, Ontario M5V 3H2
iii
TABLE OF CONTENTS
Page
THE BOARD OF EVALUATORS’ COMMENTS
The Board of Evaluators’ Report on the 2013 Uniform Evaluation.......................
1
Comments on Candidate Performance on the 2013 Uniform Evaluation ..............
6
Exhibit 1
The Decision Model .....................................................................
15
Appendix A
Design, Guide Development, and Marking of
the 2013 Uniform Evaluation ......................................................
16
Candidates Performance on Primary Indicators by
Competency Area .........................................................................
20
2013 Simulations, Evaluation Guides and Sample Responses ....
25
Paper I ....................................................................................
Evaluation Guide .............................................................
Sample Response .............................................................
26
46
100
Paper II ...................................................................................
Simulation 1.....................................................................
Sample Response .............................................................
Simulation 2.....................................................................
Sample Response .............................................................
Simulation 3.....................................................................
Sample Response .............................................................
115
116
125
147
153
161
178
185
192
214
Paper III..................................................................................
Simulation 1.....................................................................
Sample Response .............................................................
Simulation 2.....................................................................
Sample Response .............................................................
Simulation 3.....................................................................
Sample Response .............................................................
219
220
228
248
254
260
277
283
289
304
Evaluation Booklet Tables .....................................................
309
Appendix B
Appendix C
Uniform Evaluation Report — 2013
1
THE BOARD OF EVALUATORS’ REPORT ON THE 2013 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 2013 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 2013 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 entrylevel 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 2013 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 2013 UFE met the Map coverage requirements.
The 2013 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 2013 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. Uniform Evaluation Report — 2013
5
After considerable discussion, the board concluded that the 2013 evaluation was easier than the 2012
evaluation. After taking into account that the 2013 UFE was easier, candidate performance on this
evaluation was assessed as weaker than that of 2012. Based on the weaker candidate performance, the
board set a Level 1 standard that yielded 3,032 successful candidates (3,077 candidates in 2012).
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 2013 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
6
Comments on Candidates’ Performance
COMMENTS ON CANDIDATE PERFORMANCE
ON THE 2013 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 2013 UFE. Overall, the Board
concluded that candidates’ performance in 2013 was weaker than in the prior year. Information on
candidates’ performance on the 2013 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 2012 UFE as well as common detracting characteristics identified by
the Board.
Last year, the Board cautioned candidates 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 was disappointed to see that some candidates continued to employ this exam-writing strategy this
year. This strategy can, and in some cases most certainly did, negatively affect candidates’ performance. 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 pre-conception 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 should attempt to address all the issues they identify that are relevant to
their role.
Two years ago, the Board noted evidence to suggest candidates were including large sections from the
CICA Handbook (now the CPA Canada Handbook, and referred to in this report as the Handbook) in
their responses but failing to apply the guidance to the case facts. The Board noted last year that this
practice was not as prevalent and is pleased to say it has continued to decline in the current year.
Candidates are doing a better job of applying guidance they have excerpted from the Handbook to the
relevant case facts to support their recommended accounting treatments. However, some candidates
continue to fail to provide any Handbook guidance at all to support their discussions. The Board reminds
candidates of the importance of supporting their discussions with technical knowledge and encourages
candidates to continue to apply that technical source material to the relevant case facts.
7
In 2012, the Board noticed an improvement in candidates’ performance on indicators that required quantitative analysis, but noted that candidates struggled when they were asked to quantitatively compare
different options. This observation remains true in 2013. On Paper III, Simulation 3, Primary Indicator
#1, candidates had a difficult time being consistent in their calculations of the two pension options. For
example, the CPP payments were the same regardless of what option was chosen by the client. Candidates
could either ignore the CPP payments or include them in both options because the payments did not have
an impact on the overall decision. However, some candidates included the CPP payments in one of the
options but not the other, thereby skewing their comparison of the options.
On the same indicator, candidates also struggled to take into account the time value of money. Some
candidates compared the present value of one option with the future value of the other option. Others
simply added all the payments together, completely ignoring the time value of money. These calculations
were not useful to the client because they did not provide enough information to compare the options.
While they weren’t required to perform a comparison, candidates also performed poorly on Paper I, Primary Indicator #3. Candidates were able to estimate the absolute amount of interest for the financing,
but did not convert the interest amount to a percentage based on the funds borrowed. Many incorrectly
concluded that the interest was excessive even though the interest rate was quite reasonable. The Board
encourages candidates to continue to strengthen their quantitative analysis skills, especially when it comes
to a comparison of different options.
Regarding major detractors, the Board would like to highlight the following issues.
Lack of Clarity and Documentation in Calculations
Although candidates generally performed reasonably well on indicators in which calculations were
needed, the Board noticed a decrease in the clarity of the calculations provided and the amount of
documentation provided by candidates to support their calculations.
Many candidates’ calculations were not well organized (for example, jumping from one calculation to another or lacking subtotals), which often resulted in candidates omitting items from their analyses. In
particular, on Paper II, Simulation 1, Primary Indicator #3, candidates had to calculate the amount
payable to Jean Perron as a result of the USA. In order to do so, they had to incorporate their findings
from Primary Indicator #1 and Primary Indicator #2, as well as a few more adjustments related to the
USA itself. Candidates had difficulty incorporating their findings in their calculations, but had an even
harder time organizing their calculations clearly to demonstrate they understood what needed to be
included versus what needed to be excluded. Candidates should take time to plan their calculations the
same way they take time to plan their written responses. Doing so would result in clearer calculations in
which candidates’ logic is easy to follow and would likely result in candidates committing fewer errors.
Candidates should also take time to show the details of their calculations and explain why they included
or excluded certain items. For example, on Paper III, Simulation 3, Primary Indicator #2, many candidates
made an adjustment to the tax returns without explaining why the adjustment was required, or they
provided minimal explanation. The same problem was observed on Paper II, Simulation 1, Primary
Indicator #2, where candidates recalculated the taxes payable (or tax loss) without sufficiently explaining
the adjustments they were performing. Candidates demonstrate competence not only in their capacity to
perform a calculation or adjust for an error made by a client, but also in their explanation of why an
adjustment was required. It becomes very difficult for the Board to assess candidates’ competence when given little evidence of their thought processes.
8
Lack of Comprehension and Integration of Case Facts
The Board would also like to draw candidates’ attention to what the members thought was evidence of
candidates reading simulations too fast, resulting in them misunderstanding simulations or failing to
integrate case facts. For example, on Paper III, Simulation 2, Primary Indicator #3, two reports are
described in the operational information section in Exhibit I. There is also a description of an alert that
goes out when a station is below or above the optimum number of bikes. Many candidates confused the
two reports and the alert and assumed that the alert was documented in a report. Candidates should read
simulations carefully and ensure they take the necessary time to understand all of the case facts. This
would also help candidates make links between the different case facts presented. For example, on Paper
III, Simulation 1, Primary Indicator #3, candidates were required to discuss the deficiencies in the control
environment. There were many facts in the simulation that pointed to the automated controls not working
properly. However, many candidates missed these because they did not integrate the information provided
in the system notes from the CFO with the information provided in the excerpts from the working paper
file. For example, when discussing the payroll system, the CFO explains that if the commission calculated
does not match the payroll system, the payment is suspended. In the same section, candidates were
provided with the May report, which showed that the commission calculated that month did not match the
payroll system. What most candidates failed to notice was there was evidence in the working paper file
that the May commission payment had cleared the bank and, therefore, that the control described by the
CFO was not working as intended. A similar lack of integration on the same indicator occurred when
candidates missed the fact that a purchase invoice that had not been approved had been paid. While the
Board acknowledges that these issues were difficult because they required a high level of integration,
candidates were provided with 90 minutes on this simulation, in part to give them additional reading time
to pick up on these subtleties. The Board reminds candidates that they need to take time to read the
simulations carefully to make sure they fully comprehend the case facts and identify any links between
the case facts before attempting to write a response.
Nature of the 2013 UFE
Overall, the 2013 UFE contained two fewer primary indicators than the 2012 exam, but the same number
of primary indicators as the 2011 UFE. The number of opportunities in Assurance, Taxation, and
Governance, Strategy, and Risk Management was the same as in 2012. There was one fewer indicator in
each of Management Decision-Making, Performance Measurement and Reporting, and Pervasive
Qualities and Skills, and one more indicator in Finance, compared to 2012. There was only one secondary
indicator on the UFE this year.
The overall level of direction provided on the 2013 UFE was comparable to that provided on the 2012
UFE. There was one fewer Pervasive Qualities and Skills indicator this year; however, the level of
direction provided in the other competency areas was slightly lower than in 2012. The Board believes that
candidates’ ability to identify hidden issues is important, and future exams will continue to have a mix of directed and non-directed indicators.
The Board did not see obvious evidence of time constraints on either the comprehensive or the noncomprehensive simulations again this year.
9
Unusual Roles and Simulation Settings
The roles assigned and scenarios presented to the candidates on the 2013 UFE continued to be varied,
with only two of the simulations presenting a traditional assurance role (Paper II, Simulation 3 and Paper
III, Simulation 1).
The other roles presented to the candidates included that of an external consultant hired by a familyowned funeral home to help in a time of transition after the loss of the CEO (Paper I); an advisor to the
remaining shareholders in a buyout situation (Paper II, Simulation 1); a co-owner of a business asked by
the fellow owner to deal with some pressing issues (Paper II, Simulation 2); a newly hired chief
accountant tasked with analyzing expansion options, accounting for new promotions, and recommending
reports and procedures for a government grant (Paper III, Simulation 2); and an advisor to a couple
considering retirement (Paper III, Simulation 3). Most candidates were able to adapt to the roles and
presented appropriate information. However, candidates appeared to struggle with some of the more
unique roles on the 2013 UFE. For example, on Paper II, Simulation 1, Primary Indicator #2, candidates
were expected to calculate a tax-payable amount for the 2012 fiscal year for use in the valuation
calculation as per the USA. Some candidates lost sight of their role and, in the process, provided tax
advice to Jean Perron. This was not consistent with their role since they had been hired by the remaining
shareholders to help with the valuation of Jean’s shares. In another example of how candidates lost sight of their role, on Paper III, Simulation 1, Primary Indicator #2, some candidates provided an auditplanning memo when the audit planning had clearly already been completed since the audit fieldwork had
already begun.
Specific Comments by Competency Area
Assurance
Candidates were asked to perform a variety of assurance-related tasks on the 2013 UFE, since most
simulations addressed Assurance in some way. In the examination, candidates were expected to
discuss weaknesses and recommend appropriate controls for a new computer system;
determine whether they could sign off on a particular audit report and recommend procedures to be
performed to provide the assurance needed for a client to obtain certification;
evaluate the internal control weaknesses and provide recommendations for mitigation;
draft an audit-planning memo for the year-end audit, focusing on risk areas;
review the audit work completed to date and comment on additional procedures required;
assess the IT control environment and discuss implications for the year-end audit; and
discuss reporting options and provide procedures related to a government grant.
10
Candidates’ performance in Assurance was weaker than in the prior year. The Board noted last year that
candidates’ performance in 2012 was down from the previous year due to them struggling with some of the unusual roles they were given in Assurance, and the same can be said this year. There were only two
indicators this year in which candidates were put in a traditional external auditor role, and arguably one of
those (Paper III, Simulation 1, Indicator #2) was in a different context because candidates were required
to review the audit work completed to date and comment on additional procedures required, as opposed to
the traditional role of completing the audit planning and proposing procedures from scratch. Although
most candidates were able to identify the areas in which there was a lack of audit evidence, they struggled
to explain why the procedures performed were not sufficient and to suggest additional procedures that
could be performed to cover unaddressed risks. Candidates performed better on the other traditional
assurance indicator (Paper II, Simulation 3, Primary Indicator #3).
Candidates generally performed well on the indicators that required them to discuss internal control
weaknesses. On Paper I, Primary Indicator #5, candidates were required to discuss weaknesses and
recommend appropriate IT controls related to a service bureau. Most candidates were able to identify and
explain a number of control deficiencies with the system as proposed, and they attempted to provide
recommendations on how to deal with those deficiencies. Candidates were not directed to the Assurance
indicator on Paper II, Simulation 2, but this 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 the implications of these, and suggest mitigating procedures. The exception was on
Paper III, Simulation 1, Primary Indicator #3, where in order to see that some controls were not working
properly, candidates had to integrate case facts from different sections of the simulation. Candidates
discussed some of the obvious internal control issues but had difficulty seeing the less obvious ones that
required integration on their part.
In contrast, candidates had difficulty dealing with the indicators on which they were asked to look into
reporting options and describe procedures that could be performed under the different reports. On Paper I,
Primary Indicator #6, candidates were expected to recognize that the wording in the report that was
presented in the case was not appropriate and were then expected to discuss alternative reporting options.
Many candidates failed to identify that the given report was inadequate even though they were explicitly
asked to do so. On Paper III, Simulation 2, Primary Indicator #3, candidates had to propose different
reporting options that would fulfill the needs of the ministry with regards to the grant requirements, as
well as provide procedures under each reporting option. Most candidates were able to identify valid
reporting options, but many provided only brief and shallow explanations of the differences between the
reports. Candidates also had difficulty proposing valid procedures. For example, many candidates
struggled with the timeline, not realizing that the Canada Games had already taken place and, therefore, it
wasn’t appropriate to verify that the bike stations were in place now. Candidates needed to propose a procedure that would give them evidence that the bike stations were in place for the dates stipulated in the
agreement.
Performance Measurement and Reporting
Most simulations contained accounting issues that required the understanding and ability to apply
technical accounting knowledge. Throughout the three days of the 2013 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 weaker than in 2012.
11
Most of the performance measurement and reporting indicators were traditional in nature, and candidates
were required to either discuss the accounting issues or provide accounting adjustments. Candidates
performed relatively well on these indicators. They generally were 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. Most did not support their discussions with relevant case facts
and Handbook guidance, but instead jumped to conclusions. Some candidates also performed poorly as a
result of not addressing a sufficient number of issues, as mentioned earlier in this report in the discussion
of the use of exam-writing strategies.
The Board also noticed that some candidates avoided the more complex issues and discussed the easy
ones from a technical perspective only. For example, on Paper II, Simulation 1, Primary Indicator #1,
candidates typically addressed accounts receivable, inventory obsolescence, and storage costs, which
were easier in nature than other issues, such as the research and development costs, investment tax
credits, or subsequent event (buyout).
In addition, there were instances where the Board saw evidence of a lack of technical knowledge, since
some candidates applied the wrong Handbook guidance to address an accounting issue. For example, on
Paper II, Simulation 1, Primary Indicator #1, many candidates used guidance from the pre-changeover
accounting standards (Handbook section 3020) to discuss accounts receivable, instead of realizing that
accounts receivable is a financial instrument and section 3856 should be applied. On Paper III, Simulation
2, Primary Indicator #2, many candidates discussed whether the Halifax bikes were impaired when a
more appropriate discussion would have focused on whether the bikes should be classified as assets held
for sale.
One indicator — Paper II, Simulation 3, Primary Indicator #1 — was quite different from the others.
Candidates were asked for an analysis of the factors to consider in determining which accounting
framework (ASPE or IFRS) was the most appropriate for the company to use. This was the first time
candidates were asked to compare ASPE and IFRS frameworks. Candidates seemed to be thrown by this
indicator, probably as a result of it being a different context for them. As a result, they struggled with how
to approach it, and most candidates were not able to provide the client with a useful analysis of the factors
to consider. The factors candidates provided were often pretty generic (such as cost or complexity) and
not specific to Deal and the case facts (whether or not Deal was planning on going public;; Deal’s expansion strategy and the impact of that on the timing of when to adopt IFRS). In addition, although the
simulation specifically stated that the client was not interested in a detailed comparison of the standards,
some candidates still provided that type of comparison.
Taxation
This year, the Board saw a slight decrease in candidates’ performance on the Taxation indicators. Candidates had their weakest performance on Paper I, Primary Indicator #7. Candidates were provided
with excerpts from the draft tax return of Kinfolk and were asked to provide advice on tax matters for the
year ended July 31, 2013, and going forward. Candidates were expected to discuss the tax implications of
the sale of the casket production facility assets and explain other corrections to the T2 as drafted. Many
candidates demonstrated incorrect or incomplete knowledge in the area of corporate taxation. Many did
not address the tax issues related to the sale of the casket facility (land, building, and equipment) or how it
had been treated in the draft tax return.
12
Candidates performed better on the remaining two tax indicators; however, there was still room for
improvement. Once again, candidates have a tendency to deal with the easy issues and leave the more
complex ones aside, instead of taking the opportunity to demonstrate their knowledge through a
discussion of issues requiring more depth of analysis. For example, on Paper II, Simulation 1, Primary
Indicator #2, most candidates discussed the CCA, life insurance, penalties and interest, meals, and the
limit on conventions, but ignored the several remaining issues that were presented to them.
In addition, mistakes were commonly made in the treatment of some tax issues, resulting in candidates
giving incorrect tax advice to their clients. For example, on Paper II, Simulation 1, Primary Indicator #2,
some candidates incorrectly concluded that because the company had a loss for tax purposes, it would
receive a refund. As another example, on Paper II, Simulation 1, Primary Indicator #2, candidates did not
seem to have a good understanding of the tax rules related to the yearly limit of the amount that could be
claimed for conventions. One of the conventions claimed by the company had been held in Las Vegas,
and candidates thought that the location was the deciding factor in concluding that the costs related to it
were not eligible when, in fact, there were other factors to consider.
Management Decision-Making
There were three opportunities to demonstrate competence in Management Decision-Making on the 2013
UFE. The Board was pleased to see that candidates continue to improve their performance in this area, as
there was an increase in performance this year over last. This year one indicator in Management
Decision-Making tested information technology (IT) competencies (Paper II, Simulation 2, Primary
Indicator #2). Candidates performed well on this indicator. Most candidates were able to compare both
systems using case-specific information and provide a reasonable conclusion based on their analyses.
Candidates also performed fairly well on Paper III, Simulation 2, Primary Indicator #1, which required
them to quantitatively and qualitatively compare the option of expanding in the Toronto region versus
expanding to a new market in Vancouver. Candidates seemed comfortable using the case facts provided,
and most were able to provide a meaningful quantitative analysis as well as a discussion of some of the
qualitative factors, followed by a recommendation on the best option to choose. However, while most
candidates appropriately performed a three-year quantitative analysis of each of the options, some
candidates performed only one-year analyses. In this scenario, it was important to perform a three-year
analysis to get the full picture because one option was more profitable in the first two years while the
other became more profitable in year three. Candidates were expected to realize that the data was
sufficiently different year over year that a three-year analysis was warranted.
Candidates’ performance in this area was weakest on the comprehensive simulation. On Paper I, Primary
Indicator #2, candidates were directed to prepare an analysis of the proposed biocremation facility. While
most candidates discussed the qualitative factors related to the biocremation facility and attempted a
quantitative analysis, they often struggled with how to incorporate the lost contribution from the
traditional cremations into their quantitative analysis.
Finance
Candidates performed significantly better in Finance on the 2013 UFE when compared to the 2012 UFE.
13
Candidates performed well on most of the Finance indicators this year. They performed particularly well
on Paper II, Simulation 1, Primary Indicator #3 and Paper II, Simulation 2, Primary Indicator #1, where in
both cases they were able to provide reasonable calculations and supported conclusions. On Paper II,
Simulation 1, in addition to providing a reasonable calculation of the buyout amount, candidates generally
recognized the cash-flow problems that would be caused by the buyout of Jean Perron’s shares. On Paper II, Simulation 2, candidates typically performed a reasonable cash flow and also discussed the company’s
financial capacity to support the proposed changes. However, although calculations were generally well
done, they were not always well organized. As a result, it was sometimes difficult to follow candidates’ logic, especially on Paper II, Simulation 1.
Candidates struggled a bit more on Paper III, Simulation 3, Primary Indicator #3, where they had to
prepare an analysis of the pension options available to John on retirement. Candidates struggled with two
main elements. First, they had a difficult time providing consistent calculations. Many candidates
included elements that applied to both options in their calculation for only one of the options, or they
included elements that applied to only one option in their calculations for both options. Second,
candidates had a difficult time accounting for the time value of money. The time value of money was
critical to this indicator because under one option the funds were received upfront in their entirety, while
under the other option they were spread out over several years.
On Paper I, Primary Indicator #3, candidates had a difficult time understanding how to analyze the
interest component of the proposed financing. Candidates were provided with information on a financing
proposal from John Kelly and were specifically directed to thoroughly assess the financing proposal in
order to explain the cost implications and any other relevant considerations. And while the qualitative
factors were discussed appropriately, most candidates did not understand the magnitude of the interest
component. Many candidates calculated an interest component but did not compare it to the financing
obtained (in other words, they did not calculate an interest rate). Many concluded that the interest
component was excessive when in reality it was quite reasonable given the nature of the financing and the
risks involved.
Governance, Strategy, and Risk Management
Candidates’ performance in this area was weaker than in the prior year. On Paper I, Primary Indicator #4,
candidates were asked to provide suggestions for a governance structure for KL. In general, candidates
were able to identify a number of weaknesses in the current format of KL’s board and its decision-making
practices, discuss the implications of these weaknesses, and suggest improvements. However, some
candidates struggled to recognize KL’s small-business environment and made recommendations that were
not suitable for a family-owned business. On Paper II, Simulation 3, Primary Indicator #4, candidates
were asked to do a preliminary analysis of the risks related to Deal’s business strategy. Candidates seemed comfortable discussing the risks and drawing on case facts to support their discussions. However,
there was still room for improvement, as candidates sometimes had difficulty explaining the implication
to the company of the risk they had identified or providing a viable recommendation to address the risk
identified.
14
Pervasive Qualities and Skills
The 2013 examination included four Pervasive Qualities and Skills indicators, one fewer than on the 2012
UFE. Candidates’ performance in this area was comparable to the prior year. This year, candidates
seemed to do a better job of identifying the issues; however, they had difficulty discussing them in
enough depth.
There was one Pervasive indicator on which candidates’ performance was very weak: Paper II,
Simulation 1, Primary Indicator #4. Candidates were required to discuss and advise on the unusual
activities going on at BCP that related to Perron or discuss the changes that should be made to the USA.
Some candidates missed this indicator altogether and were more concerned about the company losing a
strong salesperson like Perron. Other candidates were able to identify that something unusual was going
on with Perron’s behaviour, but they didn’t always support their suspicion or provide a recommendation of what the next course of action should be. Similarly, some candidates identified the fact that the USA
was outdated but did not provide insight on how to resolve this issue.
Candidates performed better on the other indicators, but their discussions generally still lacked depth. For
example, on Paper I, Primary Indicator #8, candidates were expected to discuss the conflicts between the
parties to the engagement and integrate the various issues facing KL. Overall, candidates performed
adequately, but many discussions about the conflicts were superficial and added little value beyond
restating case facts. As well, most candidates performed their integration within the quantitative analysis,
and very few candidates were able to qualitatively assess the impact an issue had on other issues. On
Paper III, Simulation 3, Primary Indicator #3, many candidates mentioned that the Browns’ retirement goals were expensive, but they failed to compare these goals to their financial means and stopped short of
advising their clients that they were not realizable given their current financial situation. In addition,
many candidates informed John that waiting a year to retire would result in him getting 20% more in
pension, which was merely a repetition of a case fact. Candidates needed to go a step further and clearly
recommend to John what he should do. On Paper II, Simulation 2, Primary Indicator #4, candidates often
failed to see the big picture. Most candidates recommended that one of the owners should be more
present, but in the context of solving an individual internal control (for example, segregation of duties).
What most candidates failed to realize was that the absence of the owners was the root cause of many of
the company’s other issues and would likely continue to cause problems in all of the projects recently
undertaken.
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
15
16
Appendix A
APPENDIX A
DESIGN, GUIDE DEVELOPMENT, AND MARKING
OF THE 2013 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 2013 UFE were identical to those in the prior year.
The coverage requirements and the actual percentage coverage on the 2013 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%
16%
Taxation
10 – 20%
14%
Assurance
25 – 35%
27%
Performance Measurement and Reporting
20 – 30%
23%
Management Decision-Making
10 – 20%
12%
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 2013 UFE by including one indicator in each of
Assurance and Management Decision-Making.
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.
17
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.
The development of evaluation guides and the provincial review centre
In May 2013, provincial reviewers met to examine the 2013 Uniform Evaluation and the preliminary
evaluation guides. The provincial reviewers’ comments on the 2013 Uniform Evaluation were considered
by the board when it finalized the evaluation set in June 2013 and again when the senior markers
reviewed the guides in the context of actual responses in September 2013.
Evaluation centre
From the marker applications received, the board carefully selected 170 chartered accountants to
participate in the 2013 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 8
and 10 markers in Montreal from October 10 to October 25, 2013. Paper II, Simulations 1 and 3 and
Paper III, Simulation 2 were marked in Montreal from October 10 to October 21, 2013, and Paper III,
Simulations 1 and 3 and Paper II, Simulation 2 were marked from October 14 to October 25, 2013. Each
non-comprehensive simulation was assigned marking teams of between 17 and 19 people, with each team
having a leader and an assistant leader, 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 26, 2013.
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.
18
Appendix A
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.
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 2013 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:
19
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.
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.
20
Appendix B
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
recognizes the conflicts between the
parties to this engagement and integrates
the various issues facing KL.
II-1 Primary Indicator #4: The candidate
recognizes that there are some unusual
activities going on at BCP that relate to
Perron, suggests that further information is
required to investigate the irregularities,
and suggests improvements to the USA.
identifies the need for at least one of the
owners to commit full-time to the
management of the business or for the
company to hire a general manager.
III-3 Primary Indicator #3: The
candidate considers whether John and
Sheila’s retirement plans are realistic and whether it makes sense for John to retire
now.
OVERALL
0.3%
25.0%
39.0%
35.7%
0.0%
15.8%
19.6%
48.4%
16.1%
0.1%
13.2%
19.5%
31.3%
35.6%
0.4%
7.0%
14.5%
42.7%
35.7%
0.1%
9.0%
19.6%
40.4%
30.8%
0.2%
GOVERNANCE, STRATEGY AND RISK MANAGEMENT
provides suggestions for appropriate
governance for Kinfolk Limited including
governance structure, decision making and
reports to shareholders and John Kelly.
discusses Deal’s risk management policy and strategy weaknesses and provides a
preliminary analysis of ways to mitigate
these risks.
OVERALL
0.5%
10.2%
38.6%
50.5%
0.2%
5.2%
11.6%
29.2%
53.9%
0.1%
2.8%
10.9%
33.9%
52.2%
0.2%
APPENDIX B
BY COMPETENCY AREA (CONT’D)
Not
addressed
%
Nominal
competence
%
Reaching
competence
%
Competent
%
Highly
competent
%
FINANCE
provides an analysis of the proposal from
John Kelly discussing the implications of
the financial terms and identifying the
significant risks and benefits.
II-1 Primary Indicator #3: The
candidate calculates a valuation figure for
the amount payable to Perron as a result of
the USA.
candidate assesses quantitatively and
qualitatively the projected cash flows of
Molly Sue Brews Inc.
candidate prepares an analysis of the
pension options available to John on
retirement.
OVERALL
0.1%
8.2%
69.4%
22.2%
0.1%
0.0%
6.2%
25.2%
68.4%
0.2%
0.1%
6.2%
25.7%
65.9%
2.1%
0.1%
20.7%
32.6%
46.5%
0.1%
0.1%
10.4%
38.2%
50.7%
0.6%
TAXATION
discusses the tax implications of the sale of
the assets of the casket production facility
and explains other corrections to the T2 as
drafted.
calculates a tax-payable amount (tax loss)
for the 2012 fiscal year end to use in the
valuation calculation as per the USA.
candidate analyzes the prior-year tax
returns of John and Sheila Brown, and
evaluates any errors and omissions.
OVERALL
0.7%
46.2%
29.9%
23.0%
0.2%
1.2%
15.7%
36.4%
46.7%
0.0%
0.2%
11.5%
43.2%
45.0%
0.1%
0.7%
24.5%
36.5%
38.2%
0.1%
21
22
Appendix B
APPENDIX B
Not
addressed
%
Nominal
competence
%
Reaching
competence
%
Competent
%
Highly
competent
%
ASSURANCE
discusses weaknesses and recommends
appropriate controls for the Specialized
Computer Consultants system. *
discusses the required report for the
Environmental Funeral Business
Certification and the procedures that will
be involved in conducting the audit.
candidate evaluates the internal control
weaknesses and provides
recommendations for mitigation.
drafts an audit planning memo for the
year-end audit of Deal, focusing on the
areas of risk.
candidate reviews the audit work
completed to date and comments on
procedures required.
candidate assesses the IT control
environment and discusses the implication
for the year-end audit.
0.3%
6.3%
30.3%
62.8%
0.3%
0.2%
18.9%
41.4%
39.4%
0.1%
1.2%
13.0%
33.6%
51.2%
1.0%
0.1%
12.3%
35.7%
51.8%
0.1%
0.0%
20.3%
38.8%
38.3%
2.6%
0.2%
17.6%
54.6%
26.3%
1.3%
candidate discusses the reporting options
and provides procedures related to the
ministry grant.
0.1%
13.1%
45.7%
40.6%
0.5%
OVERALL
0.3%
14.5%
40.0%
44.4%
0.8%
* Information and Information Technology indicator
APPENDIX B
Not
addressed
%
Nominal
competence
%
Reaching
competence
%
Competent
%
Highly
competent
%
PERFORMANCE MEASUREMENT AND REPORTING
provides appropriate accounting
adjustments regarding the financial
statements of Kinfolk Limited for the year
ended July 31, 2013.
candidate analyzes the draft financial
statements as provided by the client and
concludes on the accounting adjustments
required to be made to shareholders' equity
to be in compliance with the USA.
discusses the GAAP framework options
and why one might be chosen over the
other (ASPE versus IFRS).
candidate discusses the financial
accounting issues.
candidate identifies and discusses the
accounting issues for ETS (IFRS - revenue
recognition, convertible debt, deferred
income tax asset, inventory).
candidate discusses the new accounting
issues (ASPE - revenue recognition related
to promotions, grant, disposal of long lived
assets, change in estimate).
OVERALL
0.0%
13.3%
45.9%
40.7%
0.1%
0.0%
1.6%
33.9%
64.5%
0.0%
6.0%
29.0%
35.6%
29.3%
0.1%
0.6%
7.6%
44.5%
47.3%
0.0%
0.1%
9.9%
39.4%
48.6%
2.0%
0.1%
8.1%
45.7%
45.6%
0.5%
1.1%
11.6%
40.8%
46.0%
0.5%
23
24
Appendix B
APPENDIX B
MANAGEMENT DECISION-MAKING
prepares an analysis of the proposed
biocremation facility and discusses the
assumptions used and the risks involved.
analyzes the two proposed IT systems. *
0.0%
9.2%
44.0%
46.6%
0.2%
0.1%
5.9%
32.3%
58.1%
3.6%
candidate assesses quantitatively and
qualitatively the option of expanding in the
Toronto region versus expanding into a
new market in Vancouver.
0.6%
8.9%
30.1%
59.8%
0.6%
OVERALL
0.2%
8.0%
35.5%
54.8%
1.5%
* Information and Information Technology indicator
APPENDIX C
2013 SIMULATIONS, EVALUATION GUIDES,
AND SAMPLE RESPONSES
25
26
Appendix C — Paper I
UFE CANDIDATE NUMBER:
THE INSTITUTES OF CHARTERED ACCOUNTANTS
OF CANADA
2013 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 March 31, 2013, or in accordance
with the provisions proposed at March 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 CICA-provided 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 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 Uniform Evaluation (UFE) is still being developed and provided under the direction
of CICA until final offerings of the CA program are complete.
2013
277 Wellington Street West, Toronto, Ontario, Canada M5V 3H2
Printed in Canada
I
27
Today is September 10, 2013. You, CA, have been called into the office of Eric J. Thibault, the managing
partner at EJT and Partners (EJT), where you work. Eric tells you that he has an exciting consulting
assignment for a new client. Kinfolk Limited (KL) is a family owned and operated funeral home that has
been in business for generations. The company is facing a crisis because the chief executive officer
(CEO), Paul Kinfolk, died unexpectedly four months ago. KL’s board of directors is concerned about the
lack of experience of Paul’s successor, his daughter Margaret Kinfolk. They believe that they need an
outsider’s perspective and have decided to use professional accountants for the first time.
Eric has met with the following individuals:
Frank Kinfolk (Paul’s father), who is the chair of the board of directors (see Exhibit I).
Margaret Kinfolk and John Kelly (who has offered a financing proposal) (see Exhibit II).
28
INDEX TO EXHIBITS
Page
I
Eric’s Notes from Meeting with Frank ....................................................................................... 29
II
Eric’s Notes from Meeting with Margaret and John ................................................................... 31
III
Financing Proposal ...................................................................................................................... 33
IV
Draft Financial Statements .......................................................................................................... 34
V
Excerpts from Draft 2013 Tax Return ........................................................................................ 39
VI
Biocremation Facility Information Provided by John ................................................................. 42
VII
Summary of Draft Service Agreement from SCC ...................................................................... 43
VIII Environmental Funeral Business Certification ........................................................................... 45
29
EXHIBIT I
ERIC’S NOTES FROM MEETING WITH FRANK
Company and Industry Background
KL was founded by George Kinfolk in the early 1900s in Regina, Saskatchewan, as a funeral home. It
grew to include a casket production facility. KL prides itself on being a traditional family business firmly
rooted in the community.
The funeral industry has seen significant changes in the past decades, including corporate buyouts and
mergers. Pressure on prices has increased, profit margins have shrunk, and consumer demand has
evolved towards “green” funerals and less costly services like cremations. A large corporation purchased
several funeral homes in Regina, which has added to the price pressure in the local market.
Paul started in the business 25 years ago and had been CEO of the company for the last 10 years. Frank
was his predecessor. With previous generations, there was always a transition from one CEO to the next,
and the retiring CEO became the chair of the board of directors. The management of the company was
left to the CEO, without significant board involvement. Paul’s death came as a shock and necessitated changes in the family-run business because it disrupted the traditional succession process. Margaret was
working as Paul’s assistant and, under normal circumstances, would not have been CEO for another 10 years. Only two years ago she graduated from university and began working at KL on a full-time basis.
After Paul’s death, she assumed the role of CEO.
Frank understands that changes are sometimes required and sees the need to improve the processes the
company uses to make decisions that fundamentally impact the operations. He thinks it may be time to
add some external expertise rather than rely solely on family members, as has been done in the past. The
company has always had a family member as CEO. A family member with no formal accounting training
is the accountant on staff and prepares all financial statements and tax returns. KL’s management and decision-making processes have never been structured. For example, KL’s management made a major change in February 2013 by selling the casket production facility without consulting the board. EJT has
been asked for advice in three areas with respect to KL’s practices: an appropriate governance structure, its decision-making processes, and an appropriate reporting package for the board.
Frank explained that Margaret has lots of unconventional ideas about the future of KL and had been
working with Paul on them, but he is concerned that she does not fully appreciate the importance of
tradition. Frank went on to explain, “Margaret seems totally focused on change and growing the
company. She and John Kelly are really keen on this biocremation facility, but I am concerned about the
risk, both financially and in terms of our company image. It is fine to assume that the demand will be
there, but it is not guaranteed. I know Margaret thinks I am out of touch with the industry today, but I
think some caution is warranted. As chair of the board, I can veto decisions she makes. Between you and
me, I want your analysis to conclude that KL should not proceed with the biocremation facility. In the
past, traditional cremations generated a profit margin of $600 each and I don’t want to lose that.”
30
EXHIBIT I (continued)
ERIC’S NOTES FROM MEETING WITH FRANK John had discussed his financing proposal with Margaret and Paul (Exhibit III). Frank doesn’t know very much about this potential agreement. Changes to the terms could still be made since an agreement has not
yet been signed. KL has asked EJT to thoroughly assess the financing proposal in order to explain the cost
implications and any other relevant considerations.
Current Ownership
There are currently 13 shareholders with ownership ranging from 2% to 15%. Frank holds 15%, Paul’s estate holds 12%, and Margaret holds 8%. Shareholders must be family members.
By tradition, the company will redeem the shares of a deceased shareholder based on the book value of
the corporation at the year end prior to death and will handle all relevant filings for the deceased
individual. Frank thinks that Paul originally acquired the shares for $12,000. He is unsure of the tax filing
requirements that result from Paul’s death and may need EJT to help with these matters eventually.
Frank provided us with the internally prepared draft financial statements and the excerpts from the draft
tax return of KL (Exhibits IV and V). The July 31, 2013 statements must be completed under Accounting
Standards for Private Enterprises (ASPE) before John provides any financing. EJT needs to analyze
whether any adjustments are necessary in the event that the financing proposal is accepted. EJT must also
provide advice on tax matters for the year ended July 31, 2013, and going forward.
31
EXHIBIT II
ERIC’S NOTES FROM MEETING WITH MARGARET AND JOHN Margaret believes that maintaining status quo is not an option given industry changes. She thought Paul
had been agreeable to making changes and growing the company. She believes that, since Frank has been
retired for a decade, he is not in touch with what is going on in the industry. She wants us to help “sell” her changes to Frank and the other shareholders. Her vision is for KL to become a green funeral home
with a biocremation facility. John shares her ideas, and they are eager to move forward. John provided
details on the proposed facility (Exhibit VI).
Sale of Casket Production Facility
KL discontinued production of caskets in February 2013. The company had been facing increasing
competition in the industry, and remaining competitive would have required a substantial investment to
upgrade equipment. Margaret indicated that the casket production business nearly broke even in fiscal
2012. Casket sales and costs were recorded separately in the accounts and were reviewed regularly by
management. Casket production took place in a separate facility, and related costs were separately
recorded. Administrative and other expenses were allocated based on revenue.
KL expects to use or sell the remaining casket inventory in the normal course of business over the next
year. The company had a small gain on the sale of the casket production assets. The sale generated cash
that it placed into temporary investments.
Financing Proposal
John Kelly is an entrepreneur whose primary interest is environmentally friendly businesses. He has
drafted a financing proposal (see Exhibit III) for modernizing existing facilities and establishing a new
biocremation facility. After Paul’s death, the proposal was expanded to include the redemption of Paul’s shares. Margaret and John would like KL to buy out those shareholders who are against the introduction
of biocremation. John expanded the financing proposal to include the buyout of shareholders as well.
KL has always paid dividends and maintained them in recent years despite declining income.
Margaret thinks the financing proposal has many benefits, including no repayment of principal and
accrued interest for three years, by which time the biocremation facility should be well established.
32
EXHIBIT II (continued)
ERIC’S NOTES FROM MEETING WITH MARGARET AND JOHN Computer System
Margaret explained, “We desperately need to replace our computer technology. The system we are using is out of date and cumbersome. I want the new system to be fully integrated. This should help us reduce
administrative costs. We have a summary of a draft service agreement from SCC (Exhibit VII), which
sells hardware, software, and training as a complete package. SCC has a product specifically geared to the
funeral industry. We have selected SCC for many reasons, including not having to purchase hardware and
software ourselves. I think this route will also support our green initiative.” EJT has been asked to
comment on controls related to the SCC system.
Environmental Funeral Business Certification
Margaret and John firmly believe that becoming a green funeral home is the only way forward for KL.
KL has already begun a recycling program and has contracted garbage and recycling pickup. John has
provided us with information standards and reporting requirements (Exhibit VIII) to obtain certification,
for which KL has been collecting the data for the past year. EJT has completed engagement acceptance
procedures; however, EJT still needs to determine if it can sign off on the audit report as provided.
EJT will also need to recommend procedures that it can perform to provide the assurance needed for KL
to obtain certification.
Other
John had Margaret sign an agreement (on behalf of KL) with a company that licenses and supplies
equipment for biocremation technology. This agreement secures the rights to the technology in the
geographic region for an indefinite period, for a payment of $50,000.
John also provided some general thoughts on what is needed in terms of reporting, as well as on his role
in decision making going forward. He explained that his background includes serving on boards of
different organizations. He would like to see an active board with committees, including strategic
planning, finance, technology, human resources, and environmental. He wants non-family members
forming a majority of the board. He hopes this will not be a problem.
33
EXHIBIT III
FINANCING PROPOSAL
An agreement in principle has been reached with John Kelly, as detailed below.
Purpose of financing
Modernize funeral home and equipment
Establish biocremation facility
Redeem shares of Paul and others who wish to be bought out (maximum)
Total financing
$
500,000
1,000,000
500,000
$ 2,000,000
Terms
There are two interest components:
o “basic” interest at prime, and o “additional” interest calculated at the end of each year as follows:
EBITDA × 30%
where
EBITDA = KL ASPE earnings before interest, taxes, depreciation, and
amortization, excluding discontinued operations
Principal and interest (compounded annually) are due at the end of the third year after financing is
provided.
Dividends will not exceed 45% of net income.
John Kelly’s companies use the future income taxes method, and he will require KL to use the same method so that he can assess all of his business interests on a comparable basis.
John Kelly will be appointed to the board of directors.
Monthly reporting will be required and must include information on the number of biocremation
services provided.
If EBITDA is negative, only basic interest applies.
If EBITDA is negative for two consecutive years, John Kelly will be allowed, at his option, to convert
his loan to a 51% equity position in KL.
Before advancing funds, John Kelly must receive the following:
Financial statements for July 31, 2013, prepared in accordance with ASPE; and
Proof of Environmental Funeral Business Certification for 2013 for existing operations.
34
EXHIBIT IV
DRAFT FINANCIAL STATEMENTS
KINFOLK LIMITED
STATEMENT OF INCOME AND RETAINED EARNINGS
For the year ended July 31
(Prepared by management — in thousands of dollars)
2013
Revenue
Funerals (Note 1)
Caskets (Note 2)
Other (Note 3)
$
Expenses
Wages and benefits – burial
Wages and benefits – cremation
Directors’ fees (Note 4)
Cost of caskets
Other direct casket costs
Operating costs – burial
Operating costs – cremation
Interest on long-term debt
Depreciation
Administrative costs
3,232
567
47
3,846
$
1,139
102
46
368
142
1,332
125
20
123
335
3,732
114
26
88
(200)
1,082
Income before income tax
Income taxes
Net income
Dividends
Retained earnings, beginning of year
Retained earnings, end of year
2012
$
970
3,360
870
39
4,269
1,184
108
46
552
218
1,315
127
23
142
342
4,057
212
63
149
(200)
1,133
$
1,082
EXHIBIT IV (continued)
KINFOLK LIMITED
BALANCE SHEET
As at July 31
(Prepared by management — in thousands of dollars)
2013
2012
Assets
Current assets
Cash
Investments
Accounts receivable
Inventory (Note 5)
Prepaid expenses (Note 6)
$
Leased property (Note 7)
Property, plant and equipment, net (Note 8)
22
160
300
321
72
875
450
701
$
30
–
310
340
20
700
450
1,068
$ 2,026
$ 2,218
$
$
Liabilities
Current liabilities
Accounts payable and accruals
Income tax payable
Long-term debt (Note 9)
Due to (from) shareholders (Note 10)
593
26
619
318
19
956
647
63
710
342
(16)
1,036
Shareholders’ equity
Common shares
Retained earnings
100
970
1,070
100
1,082
1,182
$ 2,026
$ 2,218
35
36
KINFOLK LIMITED
ADDITIONAL INFORMATION
(Prepared by management)
Note 1 — Funeral revenue
Funeral revenue consists of revenue from burial and cremation services.
Note 2 — Casket revenue
Casket revenue is recognized when the product is shipped.
Note 3 — Other revenue (in thousands of dollars)
Rental income (Note 7)
Gain on sale of casket assets
Dividends on shares
Interest
2013
$
36
6
4
1
2012
$
36
–
–
3
Total
$
$
47
39
Note 4 —Directors’ fees
This amount represents fees of $3,500 per director. All directors are also shareholders. There is one
meeting each year, the annual general meeting, and attendance is voluntary.
37
KINFOLK LIMITED
Note 5 — Inventory
Inventory includes supplies and caskets. A perpetual inventory system with specific identification is used
for casket inventory.
Note 6 — Prepaid expenses
Prepaid expenses include rights to biocremation technology for the region for an indefinite period,
purchased during the year for $50,000.
Note 7 — Leased property
In July 2011, KL purchased rural property from a farmer to meet future demand for burial. The purchase
was for land, farmhouse, and barns. The cost of the purchase was $450,000, which represented fair
market value.
Because KL did not require the land for immediate use, it leased the property back to the farmer for a
total annual rental of $36,000 (payable at the end of the year) for 20 years. KL expects to use the property
at the end of the lease term, at which time it will demolish the farmhouse and barns.
Land
Buildings
Purchase
Price
$ 258,750
191,250
Annual
Rent
$ 20,700
15,300
$ 450,000
$ 36,000
38
KINFOLK LIMITED
Note 8 — Property, plant and equipment, net (in thousands of dollars)
Land
Buildings
Equipment and vehicles
Accumulated depreciation
2013
$
260
625
1,262
(1,446)
2012
$
360
950
1,674
(1,916)
$
$
701
1,068
The ending undepreciated capital cost allowance (UCC) for tax purposes is $185,000 (2012 – $415,000).
The details of the casket assets sold are as follows (in thousands of dollars):
$
Accumulated
Depreciation
100
$
–
325
225
412
368
$
837
Cost
Land
Building
Equipment
$
593
Net Book
Value
$
100
100
44
$
244
Proceeds
Gain (Loss)
$
53
172
25
$
(47)
72
(19)
$
250
$
6
KL sold the land and building for $225,000 to a third party who was only interested in the land and
demolished the building shortly after the purchase. For tax and accounting purposes, the proceeds were
allocated to the land and building based on the original costs (76.5% building and 23.5% land).
The equipment was sold for $25,000 to Rob Kinfolk (a family member and shareholder, and manager of
the casket production facility). Rob subsequently sold the equipment at auction for $56,000.
Note 9 — Long-term debt
Long-term debt consists of a mortgage, repayable in monthly payments of $2,000 principal plus interest,
calculated at 6% per annum, secured by leased property, maturing in 2021.
Interest paid on the mortgage during the year was $19,860 (2012 – $23,140).
Note 10 — Due to (from) shareholders
The amounts due to shareholders are non-interest-bearing and have no repayment terms.
EXHIBIT V
EXCERPTS FROM DRAFT 2013 TAX RETURN
(rounded to closest thousands of dollars)
Corporation Name:
Kinfolk Limited
Business Number
Tax Year End:
87678XXXX
2013/07/31
Corporate Tax Summary
Net income from Schedule 1
164
Less: Donations and gifts
-
Taxable dividends deductible
-
Other
-
Taxable income
164
Federal tax:
Tax on taxable income of
Less: Small business deduction
Federal tax abatement
Other deductions
164
at 38%
62
28
16
–
Subtotal
Part I tax payable
18
Part IV tax on taxable dividends
–
Add: Provincial taxes less credits
8
Subtotal
Less: Instalments
44
26
–
Dividend refund
–
Investment tax credits
–
Federal balance owing or refundable
26
39
40
EXHIBIT V (continued)
SCHEDULE 1
NET INCOME (LOSS) FOR INCOME TAX PURPOSES
Business
Corporation Name:
Number
Tax Year End:
Kinfolk Limited
87678XXXX
2013/07/31
Net income – financial statements
Add: Amortization of tangible assets
Recapture of CCA – Schedule 8
Non-deductible meals
114
123
36
10
169
Deduct: Biocremation technology rights
CCA – Schedule 8
69
119
Net income (loss) for income tax
purposes
169
50
119
164
41
SCHEDULE 8
CAPITAL COST ALLOWANCE (CCA)
Corporation Name:
Kinfolk Limited
1
Class
number
2
UCC at the
beginning
of the year
****
1
8
10
3
Cost of
acquisitions
4
Adjustments
5
Proceeds
of dispositions
6
UCC
(column 2
+ column
3 +/column 5)
136
172
-36
97
25
72
182
7
50%
rule
8
Reduced
UCC
Tax Year End:
87678XXXX
2013/07/31
9
CCA
rate %
-36
182
415
Business Number
182
197
10
Recapture
of CCA
4
11
Terminal
loss
12
CCA
13
UCC at the
end of the
year
36
20
14
58
30
55
127
69
185
36
Totals
****
Includes buildings related to funeral home and casket production facility.
SCHEDULE 6
SUMMARY OF DISPOSITIONS OF CAPITAL PROPERTY
Corporation Name:
Kinfolk Limited
1
Types of capital property
2
Date of
acquisition
Business Number
Tax Year End:
87678XXXX
2013/07/31
3
Proceeds of
disposition
4
Adjusted cost
base
5
Outlays and
expenses
6
Gain (or loss)
Part 4 – Other properties (do not include losses on depreciable property)
Land
2001/10/05
53
100
-47
Totals
53
100
-47
42
EXHIBIT VI
BIOCREMATION FACILITY INFORMATION PROVIDED BY JOHN
Biocremation takes about the same time as cremation, but uses far less energy and does not release any
chemicals into the atmosphere. At the end of the process, the ash that remains is placed in an urn and
returned to the family.
Biocremation has been used to dispose of animal and human remains in medical research facilities for
years. Margaret fully expects that biocremation will become increasingly popular and wants KL to be the
leader in its region. The equipment used in biocremation costs twice as much as conventional cremators,
however, it is less expensive to operate. Margaret and John believe that pursuing biocremation early on
would work to KL’s advantage since other funeral homes could use its service rather than investing in
their own equipment. They also anticipate that it will mean an increase in the number of customers and in
revenue for KL.
Margaret would like EJT to put together a five-year analysis that will prove to Frank and the shareholders
that this makes sense. She believes that such an analysis from an independent third party would be more
convincing than one that she would prepare.
She and John have gathered the following information:
The price for biocremation will be $1,400, which is 95% of the price for cremations.
Currently, KL performs approximately 650 funerals per year, and of these, 40% are cremations.
Approximately 50% of these cremations will change to biocremations.
Margaret predicts that KL will get about 175 biocremations from other funeral homes and about
$185,000 in other service revenue (medical research facilities and animals).
Revenue will increase 10% in year two and then 15% per year after that.
KL will have to pay a 7.5% royalty for the technology based on gross revenue.
Operating costs (including incidental costs related to other revenue) will approximate $200,000, plus
$300 per biocremation.
KL will spend $125,000 on marketing in the first year and $40,000 on staff training. These costs
should be much lower in subsequent years: $50,000 for marketing and $10,000 for training.
Capital costs are $1,000,000 for equipment and renovations required to the building.
43
EXHIBIT VII
SUMMARY OF DRAFT SERVICE AGREEMENT FROM SCC
Hardware
KL will access the computer system of SCC exclusively over the internet. Information will be stored and
backed up on SCC servers. This provides you with access to the most up-to-date equipment without the
cost of upgrading.
Software
SCC software is based on the needs of the funeral industry. It is designed to decrease paperwork, increase
efficiency, and present an online platform for obituaries and other important memorials. The software
includes all of the necessary modules (accounting and funeral tracking). All modules access the same data
files (customers, inventory, prices, etc.). The information in these files can be updated in real time from
any application in the system. SCC has built into the system all the controls needed and updates the
software as required. SCC provides detailed operating instructions for users online.
The software eliminates hours of tedious paperwork. Personal data can be entered once and is then stored
in the system for future use. The accounting and funeral tracking software modules are integrated, so you
will never have to re-type information again. All the biographical and personal information can be entered
at the time of arrangement so the system can prepare all government forms, including death certificates
and burial permits. Standard obituaries, religious cards, and books of condolences are included, and
customized formats can be programmed for a modest fee.
Access and Security
Users have unique passwords to access the entire system. You can decide who in your company will have
access.
Online Banking
The software can interface with any online banking program, allowing you to download information from
your bank to your accounting records.
Conversion
SCC will transfer information from your current system electronically. After the close of business, on the
agreed date, SCC will transfer all of the balances on your systems (including accounts receivable and
payable subledgers) to the new system. You may perform integrity checks after the balances are
transferred and notify SCC of any adjustments required. The system allows backdating of entries so that if
you discover errors, they can be adjusted in the correct period.
44
EXHIBIT VII (continued)
SUMMARY OF DRAFT SERVICE AGREEMENT FROM SCC
Technical Assistance
SCC will provide technical assistance over the internet and telephone. SCC staff will be able to access all
of your records to provide immediate assistance on any issues you may have.
Reports
The system provides many standard reports (including comparison of your company’s performance to industry data), so there is no need to create your own custom reports. The process is simple and draws on
data in the system, so it is always accurate and reliable. No testing of reports is required.
45
EXHIBIT VIII
ENVIRONMENTAL FUNERAL BUSINESS CERTIFICATION
The Canadian Funeral Association (CFA) defines standards necessary to obtain Environmental Funeral
Business Certification. A funeral home must meet at least four of these six standards:
Operational and Administrative Processes
Percentage of embalming fluid purchased that is biodegradable
Percentage of casket material purchased that is biodegradable
Percentage of funerals that are cremations or biocremations
Energy consumption per square metre of funeral home (in kilowatts per annum)
Gasoline consumption per 100 vehicle kilometres (in litres)
Average kilograms of garbage produced per funeral
Standard
Minimum 50%
Minimum 50%
Minimum 40%
Maximum 25
Maximum 10
Maximum 25
Reporting
The company must submit a report annually that has been independently audited. The audit report
template, provided by the CFA, reads as follows:
I have audited the report attached for [insert company name and time
period] and certify that [insert company name] meets the standards for
certification.
Firm Name:
Date:
City:
46
Appendix C — Paper I — Evaluation Guide
EVALUATION GUIDE
COMPREHENSIVE SIMULATION – KINFOLK LIMITED
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.
Overview
To:
From:
Subject:
Eric J. Thibault, Managing Partner, EJT and Partners (EJT)
CA
Information and analysis requested for Kinfolk Limited
As requested, I have drafted the information required for Kinfolk Limited (KL). My report contains the
following analysis:
Accounting adjustments for July 31, 2013, financial statements; Biocremation facility — projection
and analysis;
Analysis of the financing proposal from John Kelly;
Governance of KL;
Summary of Draft Service Agreement for computing services from SCC;
Environmental Funeral Business Certification Audit;
Corporate taxation issues for KL and suggestions on tax matters going forward;
An analysis of the overall direction of KL; and
Concerns and issues associated with potential conflicts of interest for both the shareholders of KL and
our firm.
Primary Indicator #1
The candidate provides appropriate accounting adjustments regarding the financial statements
of Kinfolk Limited for the year ended July 31, 2013.
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-2.4 – Accounts for the entity’s non-routine transactions (B)
V-2.6 – Prepares or evaluates financial statement note disclosure (A)
47
In the past, the users of KL’s financial statements were limited to its shareholders and the Canada Revenue Agency (CRA). The likely objective in selecting policies was tax optimization. With the
proposed involvement of John Kelly, the financial statements must now consider the needs of this user
and the implications of having external financing.
In choosing amongst alternatives allowed by ASPE, there may be conflicts among the needs of different
users: existing shareholders, John Kelly, and any shareholders who want to redeem their shares. This will
have to be considered when setting policies.
User Objectives
If financing is obtained in line with the current proposal, the amount of interest to be paid will be affected
to some degree by the accounting policies selected and the accounting estimates made. KL’s objectives will change from focusing solely on tax optimization to considering the impact on the interest payable to
John Kelly.
I have provided information on potential adjustments required to the financial statements for 2013, and
where policy choices are allowed by GAAP, I have discussed the alternatives and made
recommendations. I have also explained accounting policies for the proposed transactions for the current
year.
Rights to Biocremation Technology
Prepaid expenses currently include $50,000 that KL paid for the indefinite rights to biocremation
technology. In order to be considered a prepaid expense (and, therefore, a current asset), the expenditure
should have been paid in advance, typically for a service, and generally should be realizable within one
year of the balance sheet date or within the normal operating cycle (if longer than one year). Because the
rights relate to biocremation (an area that KL is just considering entering) and have an unlimited life, they
will not be fully realizable by July 31, 2014. The usefulness of the rights could extend far into the future,
depending upon the success of the biocremation technology. As a result, the $50,000 should not be
presented as part of current assets.
The rights acquired represent a non-monetary asset and can be identified as an intangible asset. To be
capitalized, the rights must meet the definition of an intangible asset (identifiability, control over a
resource, and existence of future economic benefits). According to HB 3064.12(b), an asset meets the
identifiability criterion in the definition of an intangible asset when it “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.” In this case, the rights were acquired under a contractual agreement that KL
entered into with the company that supplies the equipment and licenses the biocremation technology. The
agreement secures the rights to the technology in the geographic area for an indefinite period. HB 3064.13
states that “an entity controls an asset if the entity has the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits. The capacity of
an entity to control the future economic benefits from an intangible asset would normally stem from legal
rights that are enforceable in a court of law.” Because an agreement was signed in order to acquire
access to the technology and the geographic area, KL has an enforceable right to the technology. Future
economic benefits (being the revenue generated from biocremation sales, both to KL customers and to
other funeral homes) would flow to KL and, thus, the rights can be considered an intangible asset for KL.
48
The cost of the rights can be reliably measured ($50,000 paid). Also, it is probable that the expected
future economic benefits attributable to the rights will flow to KL, since we have secured rights to the
biocremation technology in our geographic area for an indefinite period of time and the results of our
analysis of the proposed biocremation facility indicate positive cash flows into the future. Therefore, the
intangible asset can be recognized on the balance sheet. Because the rights extend for an indefinite life, no
amortization is taken until its life is determined to no longer be indefinite. In future, KL should undertake
an annual review of the useful life of the rights to assess whether they continue to be indefinite (a new and
better technology having been developed in this area may have a negative impact on the useful life of the
technology) or whether the value has been impaired (at which time a loss should be recognized).
KL should remove $50,000 from 2013 prepaid expenses and reflect a $50,000 intangible asset on the
balance sheet. Note disclosure of the nature of the asset (description of the rights, et cetera) would provide
useful information to financial statement users.
The intangible asset must be tested for impairment “whenever events or changes in circumstances
indicate that its carrying amount may exceed its fair value” (HB 3064.65). If KL chooses not to proceed
with the biocremation facility, the continuing value of the rights would have to be assessed. If the rights
can be sold to another party for an amount equivalent to what KL paid for them, then no impairment
exists. However, if the rights cannot be sold to another party or are saleable for an amount less than the
$50,000 paid (perhaps due to newer biocremation technology), the intangible asset would have to be
written down to its fair value. The impairment loss cannot be reversed if there is a subsequent increase in
value.
(Most candidates were able to demonstrate an appropriate understanding of the intangible asset issue
with respect to the rights to biocremation technology. Candidates sufficiently integrated Handbook
criteria with case facts to provide thorough analyses in their responses. Many candidates went beyond
a discussion of the reclassification from prepaid expense to intangible asset and recognized that the
indefinite life of the rights must be reviewed annually or that impairment in value may occur.)
Leased Property
The $450,000 leased property asset arose in July 2011, when KL purchased property in a rural area from a
farmer. The property was purchased in anticipation of future demand for burial space. The property
encompassed land as well as buildings, both of which were subsequently leased back to the farmer since
KL did not anticipate having a need for the property for another 20 years (the term of the lease).
(Many candidates struggled with this issue. Although they recognized that the transaction was a lease,
they incorrectly viewed KL as the lessee, rather than the lessor. This perspective had an impact on the
remainder of their discussions on this issue, and often led to inappropriate discussions relating to saleleaseback transactions (KL was the purchaser of the property in this transaction, not the vendor). As a
result, many candidates spent time discussing aspects of the leased property issue that were not
relevant to KL.)
49
As the lessor, KL needs to consider whether the lease to the farmer represents an operating, directfinancing, or sales-type lease. There is specific accounting guidance for leases involving land and
buildings. HB 3065.72 states:
When a lease involving land and building(s) does not contain terms that allow the ownership to pass
or provide for a bargain purchase option, and the fair value of land at the inception of the lease is
significant in relation to the total fair value of the leased property, the land and building(s) are
considered separately for purposes of classification. The lessee and lessor allocate the minimum lease
payments between the land and building(s) in proportion to their fair values. Both parties classify the
portion of the lease applicable to land as an operating lease.
We will have to obtain the full terms of the lease, but from the information provided, there does not
appear to be a transfer of ownership to the farmer at the end of the term. KL has plans to demolish the
farmhouse and barns on the land when the lease with the farmer expires, and there is no bargain purchase
option. The fair value of the land ($258,750) represents 57.5% of the total fair value of the leased
property ($450,000), which is significant, and therefore the land and buildings should be considered
separately for purposes of classification. The lease of the land should be treated as an operating lease, as
presently recorded by KL.
(Many candidates did not recognize that the Handbook provides specific guidance for leases involving
land and buildings. As a result, candidates incorrectly grouped the land component of the leased
property with their analysis of the building when determining the proper accounting treatment. Few
candidates recognized that the portion relating to land was already appropriately recorded as an
operating lease.)
The cost of the land should be grouped with property, plant and equipment, rather than being presented
separately as leased property (since the land will ultimately be used for ongoing business operations). In
addition, disclosure should be made of the cost of the land held for leasing purposes (HB 3065.80).
(Most candidates who did note that the land should be recorded as an operating lease did not expand
this discussion to consider the proper presentation of the asset in the financial statements.)
We need to look at the lease for the building portion of the property and determine whether it is an
operating, direct-financing, or sales-type lease. An operating lease does not transfer substantially all the
benefits and risks of ownership to the farmer, while sales-type and direct-financing leases do. We must
determine whether the risks and benefits incident to ownership of property have been substantially
transferred to the farmer. HB 3065.07 and 3065.06 provide guidance in this area:
From HB 3065.07:
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:
From HB 3065.06:
(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.
50
Based on the information provided by KL, ownership of the buildings does not transfer to the farmer
at the end of the lease term, since there is no bargain purchase option noted and KL intends to use the
property when the 20-year term is finished. We would have to confirm this information with the lease
document, but at the present time, this criterion has not been satisfied.
(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.
While some farm outbuildings may have an economic life of 40 years or more (barns, for example, if
properly constructed, and depending upon construction materials used), the farmer will have full use
of the estimated life of the buildings because KL intends to demolish the buildings on the land at the
end of the 20-year lease term. Therefore, over the course of the lease term, the farmer will have 100%
of the economic benefit of the buildings. This satisfies the criteria (greater than 75% of the economic
life) and indicates that the building lease is not an operating lease. Only one criterion needs to be met
in order for the lease to be disqualified as an operating lease. Therefore, KL should reflect this as
either a sales-type or direct-financing lease.
(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.
Per HB 3065.07: “When assessing whether the condition set out in paragraph 3065.06(c) exists, the
discount rate used by the lessor is the interest rate implicit in the lease.”
The annual rental income for the building portion of the lease is $15,300. Given that the fair market value
of the building at the inception of the lease was $191,250 and the lease term is 20 years, the interest rate
implicit in the lease is 4.96%. Discounting the minimum lease payments using the interest rate implicit in
the lease yields a present value equal to the fair value of the leased property and is in excess of the 90%
threshold in the criteria. Therefore, this criterion is also satisfied.
From the point of view of the lessor, additional criteria must be considered. According to HB 3065.07(b),
“the credit risk associated with the lease is normal when compared to the risk of collection of similar receivables.”
There seems to be normal credit risk associated with this transaction and, in hindsight, the farmer appears
to have been able to pay the rent charged. There is no reason to believe that the credit risk is different than
that of similar receivables.
51
Finally, HB 3065.07(c) requires us to determine if “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.”
KL is unlikely to incur any costs under the lease, such as responsibility for ongoing maintenance and care
of the property, for example. We would have to confirm this with the terms contained within the lease
document.
(As noted earlier, most candidates thought that KL was the lessee in this transaction, and as a result,
the focus of their responses was from the perspective of a lessee rather than that of a lessor. While
some parts of that discussion were still somewhat useful to KL (for example, application of case facts to
criterion for operating versus sales-type or direct-financing lease), this misunderstanding kept
candidates from discussing other relevant aspects related to the leased property (such as use by the
lessor of the interest rate implicit in the lease and not the lower of that rate and the incremental
borrowing rate, the credit risk associated with the lease, and amounts of unreimbursable costs).)
Because KL is the lessor, we must determine whether the lease fits the criteria of a sales-type lease (HB
3065.03(b)) or whether it represents a direct-financing lease (HB 3065.03(c)). Since we know that
substantially all of the risks and rewards related to ownership of the buildings have been transferred to the
farmer (as demonstrated above), and the fair value of the leased property is close to the carrying value
($191,250 — the building portion) at the start of the lease because it was leased to the farmer immediately
after KL’s purchase, it is a direct-financing lease for KL.
(Most candidates who addressed this issue did not consider what type of lease this was to the lessor
(KL), but rather concluded on whether the leased property was an operating or a capital lease.)
At the inception of the lease in July 2011, KL should have recorded an asset for the net investment in the
lease in the amount of $191,250, rather than an asset for leased property. The net investment in the lease
represents the minimum lease payments receivable of $306,000 (20 years × $15,300/year) less unearned
finance income over the term of the lease. On an annual basis, the gross investment in the lease would be
reduced by the rent received ($15,300) and a portion of the unearned finance revenue would be
recognized into income.
The asset would be split between current and long-term portions on the balance sheet. Notes to the
financial statements should also be included, which provide information on the interest rate implicit in the
lease, along with the total minimum lease payments receivable for the next year ($15,300) and thereafter
less unearned finance income.
(Most candidates who properly identified that KL was the lessor attempted to provide guidance on the
financial statement impact of the corrected transaction.)
52
Transition Adjustment — Leased Property
The change in how the property is accounted for (the incorrect presentation of the initial transaction in the
2011 fiscal year) would be considered a transition adjustment on KL’s change to reporting under Accounting Standards for Private Enterprises (ASPE). The July 2013 financial statements should be
amended to present the current year’s activity and the July 2012 comparative financial information would also require adjustment (for 2012 activity). Since the adjustment should have occurred before the earliest
prior period presented (2012; transaction occurred in 2011), the affected opening balances for 2012
(assets and retained earnings) would have to be restated (HB 1500.07).
(Very few candidates addressed the adjustments that would be necessary to the financial statements as
a result of their conclusions relating to the treatment of the leased property. Therefore, most did not
mention that any change would be considered a transition adjustment on the change to reporting
under ASPE.)
Related-Party Transaction
The casket production equipment was sold to Rob Kinfolk, who is a shareholder and the former manager
of the casket production facility. There is no reason to think that he has control or significant influence
based on his shareholding (shareholdings range from 2% to 15% with 10 shareholders; after considering
Paul, Frank, and Margaret, who owned a total of 35% at the time of the sale, that leaves 65% among the
remaining 10 shareholders). However, it appears that he would be a related party based on his
management role. According to HB 3840.06, “The degree of influence that one party may exert on
another is a major factor in determining whether they are related.” Given that Rob was the manager of
the facility sold, it would be reasonable to think that he had significant influence in the decision to sell the
equipment to himself for $25,000, a value subsequently shown to be significantly below its fair market
value.
(Some candidates recognized the related-party transaction but struggled with the application of the
Handbook criterion. For example, many candidates concluded that this was a related-party
transaction as a result of Rob being a shareholder of KL. These candidates failed to consider that the
likely size of his shareholding alone (between 2% and 15%) would not be sufficient for him to have
control or significant influence, and, therefore, he likely would not be considered a related party based
solely on his shareholdings. Candidates who clearly understood the Handbook definition of a related
party supported their conclusion that Rob was a related party with case facts, such as his position as
manager of the facility and his partial ownership.)
The sale of capital assets is not a transaction in the normal course of operations. Therefore, HB 3840.29
applies:
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 the 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.
53
In this case it appears that (a) is met, but we have no independent evidence supporting (b). In fact, we
were told that Rob sold the equipment at auction for $56,000, which is a strong indication that the value is
higher than what he paid to KL. Given that both conditions have not been met, the transaction is
accounted for in accordance with paragraphs 3840.08 and 3840.09:
3840.08 A related party transaction shall be measured at the carrying amount, except as specified in
paragraphs 3840.18 and 3840.29.
3840.09 When a related party transaction is measured at the carrying amount, any difference
between the carrying amounts of items exchanged, together with any tax amounts related to the items
transferred, shall be included as a charge or credit to equity.
This means that the sale of the equipment is measured at the carrying amount of $44,000 and no loss is
recorded. The difference between the carrying value of $44,000 and the cash received of $25,000 is
recorded as a charge to equity (net of any tax consequences). This results in higher net income for KL but
no change in ending retained earnings or net assets.
The notes to the financial statements should include information about KL’s transaction with Rob (a related party). The accountant on staff seems to have included this, as well as the following (among
others):
A description of the nature of the relationship (“a family member and shareholder, and manager of the
casket production facility”);;
A description of the transaction (“equipment was sold for $25,000 to Rob Kinfolk”);; and
The measurement basis used (carrying amount).
In addition, any amounts due from Rob at July 31, 2013, as well as the terms and conditions relating to
those amounts, would also have to be disclosed.
(Most candidates who addressed this issue were able to identify the technical guidelines that should be
applied to this transaction, but they had difficulty applying them to case facts. Candidates’ conclusions were often inconsistent with their analyses, since they would recommend that the transaction be
recorded at fair value when their analyses supported the use of the carrying amount. In addition, many
candidates who attempted to comment on the impact of this issue on the financial statements only
addressed the income statement (the fact that the loss would be removed) and did not consider how to
account for the entire transaction (the charge to equity).)
Discontinued Operations
Discontinuance and sale of a part of the business (operating segment) is detailed in Handbook Section
3475. The casket production facility was sold in late February of the year ended July 31, 2013. We must
first determine if the facility meets the definition of an operating segment. HB 3475.03 states:
An operating segment is a component of an enterprise:
(i) that engages in business activities from which it may earn revenues and incur expenses (including
revenues and expenses relating to transactions with other components of the same enterprise);
(ii) for which operating results are regularly reviewed by the enterprise’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance;
and
54
(iii) for which discrete information is available.
[Handbook Section 3475 has subsequently been amended to refer to discontinued operation (rather
than an operating segment) and is now worded as follows (applies to fiscal years beginning on or after
January 1, 2014, although earlier application is permitted):
A discontinued operation is a component of an enterprise that either has been disposed of (by sale,
abandonment or spin-off) or is classified as held for sale, and:
(i) represents a separate major line of business or geographical area of operations;
(ii) is part of a single co-ordinated plan to dispose of a separate major line of business or
geographical area of operations; or
(iii) is a subsidiary acquired exclusively with a view to resale.
A component of an enterprise comprises operations and cash flows that can be clearly distinguished,
operationally and for financial reporting purposes, from the rest of the enterprise.]
It appears that the casket operation meets the definition of an operating segment, since it earns revenue
and incurs expenses (relating to caskets for sale to external parties as well as for internal use by KL) and
operating results are regularly reviewed by management. The only questionable item is (iii) because,
according to the information you had from Margaret, the revenue and product costs are tracked
separately, as are the expenses of the facility (which operates separately). It appears there is likely enough
information to meet the requirement of (iii), but we need more information to determine that with
certainty.
Going on the presumption that the casket production facility is an operating segment that was disposed of
during the year means that HB 3475.30 applies and “The results of discontinued operations, less
applicable income taxes, shall be reported as a separate element of income for both current and prior
periods.”
The sale was completed in the current year, so most of the information will be known. We will also have
to consider the related-party sale of the equipment discussed above. The other items that should be
reviewed are the valuation of the remaining accounts receivable and inventory. These amounts should be
recorded at the best estimate of their value at year-end. The remaining inventory from the casket
production facility is expected to be used or sold by KL in the normal course of business over the next
year. To the extent that the inventory represents caskets, it is likely that these can be used for upcoming
funerals or sold to outsiders. The net realizable value (NRV) would likely be in excess of the cost amount,
so no writedown in value would be required. Any inventory that represents materials used for making
caskets or related hardware would also have to be carried at a cost that is less than its NRV. KL would
have to ensure that these inventory amounts are properly valued at year-end.
HB 3475.31 states:
The results of discontinued operations include any gain or loss recognized in accordance with
paragraph 3475.19, and are reported in discontinued operations in the period(s) in which they occur.
In accordance with paragraph 3475.16, future losses associated with the operations of a discontinued
operation are not accrued.
55
(Many candidates identified and discussed the sale of the casket production facility appropriately as a
discontinued operation, performing useful analyses by applying case facts to technical knowledge and
concluding on the appropriate accounting treatment. Many candidates also attempted to quantify the
amount that would be presented separately as discontinued operations, although most did not consider
applicable income taxes in their calculations. Some candidates did not seem to recognize that the
facility had been sold in February 2013, since they incorrectly spent time assessing whether the facility
represented assets held for sale.)
A revised income statement for KL is presented below:
2013
Revenue
Funerals
Other – finance income
Other (1)
$
Expenses
Wages and benefits
Operating costs
Interest on long-term debt
Depreciation
Administrative costs
$
1,287
1,457
20
123
335
3,222
36
82
–
Income before income tax
Discontinued operations net of tax (2)
Income taxes (3)
Net income
3,232
–
26
3,258
2012
$
118
3,360
–
24
3,384
1,338
1,442
23
142
342
3,287
97
100
–
$
197
Notes
1. Other revenue:
2013
2012
Rental income – land
Dividends on shares
Interest
$
21
4
1
$
21
–
3
Total
$
26
$
24
56
2. Discontinued operations:
Revenue – caskets
Cost of caskets
Other direct casket costs
$
Gain on sale of land and building
Income taxes (3)
$
2013
567
(368)
(142)
57
25
–
82
$
$
2012
870
(552)
(218)
100
–
–
100
3. Income tax expense has not yet been calculated. Should reflect taxes on finance income and include
the current impact of temporary differences (related to the sale of the casket production facility and
finance income).
(Candidates were not expected to recast the income statement as illustrated here as part of their
response, although many of those who did incorporated their analyses of the various accounting
issues, which was useful in demonstrating their understanding of the issues and their impact on KL.)
Income Taxes
At the present time, the financial statements are prepared using the taxes payable method. If the financing
proposal is accepted, John has indicated that he would require KL to adopt the future income taxes
method to be consistent with his other investments. Also, given that payment to John Kelly will be based
in part on earnings before interest and taxes (EBITDA) and that the buyout of shares is based on the net
book value of the assets, it would be prudent to review this policy and determine the impact of switching
to the future income taxes method. This accounting policy change can be made without meeting the
normal requirements for an accounting policy change (HB 1506.09).
At the moment, capital assets appear to have a tax value different than the accounting value. The
undepreciated capital cost (UCC) at the end of 2013 is less than the net book value (NBV) of the capital
assets and, therefore, a future income tax liability exists. Using the future income taxes method, this
liability would be reflected on the balance sheet, reducing the NBV that will be paid for any shares
redeemed.
Going forward, with the investment in the biocremation unit and the planned spending to replace and
upgrade other capital assets, capital cost allowance (CCA) will likely be higher than depreciation and the
reported amount of net income after tax lower under the future income taxes method.
The intangible asset (rights to biocremation technology) will also have a tax value that is different than
the accounting value (see subsequent tax discussion). The cumulative eligible capital at the end of 2013 of
$34,875 is less than the accounting value of the intangible asset of $37,500 ($50,000 less the 25%
ineligible portion for tax). Therefore, a future income tax liability exists.
57
The lease income relating to the building portion of the farm property will also have an impact on future
income taxes. The $15,300 annual rental income would be treated as an operating lease for tax purposes
(included in taxable income in the year), which is higher than the accounting income recognized under the
direct-financing lease method.
In the future, there will be a timing difference created by compound interest on debt to John, since it is
deductible for accounting on an accrual basis but only deductible for tax when paid. This will give rise to
a debit in the future income tax account because accounting income will be less than taxable income.
Overall, the use of the future income taxes method appears to be fairer because it reflects the tax cost in
the same period as the income is reported. One alternative is to adopt the future income taxes method
staring in 2014.
Adoption of the change in accounting policy for the July 31, 2013, year would be applied retrospectively,
requiring that the comparative financial statements (July 31, 2012) be restated to reflect the switch to the
future income taxes method, as well as an adjustment to the opening retained earnings balance.
(Many candidates did not address this issue. Candidates who did recognized that a future tax liability
would exist, and most were able to provide some discussion of how the difference in tax versus
accounting values would affect the financial statements. In addition, most candidates supported their
analyses with specific examples of where an accounting value differed from a tax value, often by using
NBV of capital assets and UCC. While they typically made some errors or omissions in providing an
example (forgetting to remove land from NBV or omitting the application of an income tax rate in their
calculations), this still made for a strong discussion.)
Funds Provided by John Kelly — Convertible Debt
KL should also give consideration to the treatment of the funds provided by John Kelly. While the
proposal has not yet been accepted, there may be an impact on next year’s financial statements.
HB 3856 A23 states:
The critical feature in differentiating a financial liability from an equity instrument is the existence of
a contractual obligation of one party to the financial instrument (the issuer) either to deliver cash or
another financial asset to the other party (the holder) or to exchange another financial instrument with
the holder under conditions that are potentially unfavourable to the issuer. When such a contractual
obligation exists, that instrument meets the definition of a financial liability regardless of the manner
in which the contractual obligation will be settled.
Applying this to the funding provided by John Kelly, the obligation meets the definition of a liability.
Therefore, financial instrument Handbook Section 3856 applies:
3856.14 The issuer of a financial liability that is indexed to a measure of the entity’s financial performance or to changes in the value of the entity’s equity shall account for the instrument as follows:
(a) the liability is initially measured in accordance with paragraphs 3856.07 or 3856.08;
(b) interest expense is calculated using the stated interest rate, plus or minus the amortization of
any initial premium or discount; and
58
(c) at each reporting date, the entity adjusts the carrying amount of the liability to the higher of:
i) the amortized cost of the debt; and
ii) the amount that would be due at the balance sheet date if the formula determining the
additional amount was applied at that date (the conversion or intrinsic value).
The amount of the adjustment in accordance with paragraph (c) above shall be recognized in net
income and presented as a separate component of interest expense.
Interest will be calculated and accrued on an annual basis as per the agreement.
The loan has a conversion feature that allows John to convert his loan (at his option) to a 51% equity
position in KL if net income is negative for two consecutive years. Because of the conversion option, we
would need to assess, upon initial recording, whether the financing is a compound financial instrument,
which would require separate presentation of liability and equity elements. Each element should be
classified in accordance with its substance, taking into consideration the definitions of a financial liability
and equity instrument. Classification is not affected by John’s intentions (whether he would exercise the
option if KL experienced a loss for two consecutive years), but would be based on the substance of the
arrangements. Under HB 3856.22, KL can measure the equity component as zero and the loan would
remain a liability. Classification of the loan is not subsequently revised if KL experiences two consecutive
years of losses or if there is a change in the likelihood of John exercising his option to convert.
(Few candidates addressed the treatment of funds provided by John. Most candidates who did identify
and discuss this issue were able to identify appropriate alternatives for recording the obligation and
included relevant case facts to support their analyses.)
Purchase and Redemption of Shares
Handbook Section 3240 should be used to account for the purchase and redemption of shares. The cost to
acquire the shares will be equal to the book value of the corporation (in other words, the book value of net
assets). This will be higher than the original cost of the shares. The transaction will reduce the share
capital and the retained earnings of the company.
(Candidates rarely addressed the purchase and redemption of shares.)
For Primary Indicator #1 (Performance Measurement and Reporting), the
candidate must be ranked in one of the following five categories:
Percent
Awarded
Not addressed — The candidate does not address this primary indicator.
0.0%
Nominal competence — The candidate does not attain the standard of reaching
competence.
13.3%
Reaching competence — The candidate identifies some of the accounting
issues.
45.9%
Competent — The candidate discusses some of the accounting issues.
40.7%
Highly competent — The candidate thoroughly discusses most of the accounting
issues.
0.1%
59
(Candidates were clearly directed to this indicator since they were provided with internally prepared
draft financial statements and were informed that the July 31, 2013, financial statements must be
completed under ASPE before John provides any financing. To demonstrate competence, candidates
were expected to discuss some of the necessary accounting adjustments to the financial statements of
Kinfolk Limited.)
(Candidates performed adequately on this indicator. Most candidates were able to discuss some of the
accounting issues, most frequently intangible assets and discontinued operations, and to apply
simulation facts to their technical knowledge in these areas. Also, in general, their conclusions on the
impact of these issues on KL’s financial statements were consistent with their analyses. Where most
candidates fell short was in failing to provide such in-depth discussions for a sufficient number of
issues.)
(Strong candidates provided responses that were well organized and covered a greater number of
issues, particularly the complex lease issue. Their responses were also strong from both a technical and
an application perspective, integrating numerous simulation facts. Many weak candidates provided
technical knowledge but did not apply it to the specifics of the simulation, or they applied it incorrectly,
attempted to discuss irrelevant issues in some depth (for example, revenue recognition, even though
insufficient information was provided on this topic), or addressed the lease issue from the perspective
of the lessee.)
The candidate prepares an analysis of the proposed biocremation facility and discusses the
assumptions used and the risks involved.
The candidate demonstrates competence in Management Decision-Making.
Competencies
VIII-2.1 – Prepares, analyzes, and monitors financial budgets, forecasts, or projections (A)
VIII-2.3 – Determines and evaluates the entity’s cost-volume-profit relationships (A)
The biocremation facility is a major project both financially (initial costs and ongoing impact) and for the
operations of KL. I will discuss all aspects of this proposed project.
Projections by their nature are future looking and, therefore, involve a high degree of uncertainty. It is
important to consider the validity of the assumptions used in the projections and the impact on the
outcome that changes in the assumptions will have.
We have used the assumptions that were provided to us by Margaret Kinfolk and John Kelly and have
prepared a projection as requested. This projection indicates a very small contribution before considering
the capital costs in the first year, because of the high marketing and training costs, and then increasing
positive returns in subsequent years.
60
Units
Year 1
Outflows:
Operating costs (variable)
Royalty for technology
Operating costs (fixed)
Training staff
Marketing campaign
Total costs
Combined impact on
KL operations
115%
115%
Year 5
115%
130
175
305
$
$
1,400 $
300/event
7.5% of rev
Contribution from
biocremation facility
Lost cremation earnings*
Year 3
Year 4
(in thousands)
110%
percentage increase after year 1
Inflows/Revenue:
Own from cremations
(650 × 0.4 × 0.5)
From other homes
Estimated biocremations
Revenue per
biocremation
Other (animals, medical)
Total revenue
Year 2
$
600
$
427 $
185
612
470 $
204
674
540 $
234
774
621 $
714
269
309
890
1,023
92
46
200
40
125
503
101
50
200
10
50
411
116
58
200
10
50
434
133
67
200
10
50
460
153
77
200
10
50
490
109
263
340
430
533
78
86
99
113
130
31 $
177 $
241 $
317 $
403
177 $
241 $
317 $
403
Capital costs
Equipment and
renovations to building
$ 1,000
Net annual cash flow
$ (969) $
*Reflects lost cremation earnings as a result of the move to biocremations (130 events); lost earnings of
$600 per cremation, as noted by Frank.
A net present value (NPV) calculation could also be performed, using the above contribution information
to show the present value of the future cash inflows from the proposed biocremation facility.
61
The most difficult numbers to estimate in the projection are the revenue numbers, and in particular the
number of biocremations that will be performed. This number will have a huge impact on the ultimate
result because the operation has high fixed costs (capital and operating). The contribution margin per unit
is $995 ($1,400 − 7.5% − $300), which means that for each unit drop in the estimated number of biocremations, the bottom line will decrease by $995. Conversely, each unit increase in the estimated
number of biocremations will increase the bottom line by $995. Without considering the impact of other
costs related to the facility, this is significantly greater than the $600 profit margin generated by existing
traditional cremations noted by Frank.
The $50,000 cost for the rights to the biocremation technology in the geographic area is a sunk cost and
has not been incorporated in the above analysis since payment has already been made.
(Candidates were provided with most of the information relating to the proposed biocremation facility
in a very clear and direct format in Exhibit VI. Many candidates were able to appropriately incorporate
the various quantitative elements from that exhibit into their calculations. The lost cremation earnings
were an important consideration in the assessment of this facility. However, many candidates struggled
to consider the lost cremation earnings in their calculation. Candidates were provided with two
separate ways to calculate the lost cremation earnings (Frank’s comment on profit margin of traditional cremations as well as cremation activity details on the Statement of Income and Retained
Earnings), and either method was acceptable. Some candidates merely did a quick comparison of the
contribution margin for a biocremation to the lost profit margin from a traditional cremation
(potentially two different bases of comparison), while others attempted to use the Statement of Income
to recalculate the lost profit margin, but had errors or omissions in their calculations that had an
impact on the quality of their responses (for example, they removed lost cremation revenue but not a
related expense). Additionally, some candidates did not consider the impact of the $1.0 million required
to establish the biocremation facility in their calculations.)
There are some items that should be considered for which we did not have sufficient information to
incorporate them into the projections.
1. Margaret and John have provided a number of assumptions related to revenue. These include
The number of cremations that will change to biocremations;
Biocremations from other funeral homes and other service revenue (medical research facilities and
animals); and
An increase in revenue of 10% in the second year and 15% in following years.
These could be aggressive revenue assumptions. In particular, if the demand for biocremations is less
than anticipated, profits could turn into losses. Biocremations from other funeral homes may be affect
by improved biocremation technology, and despite KL having secured rights to the existing
technology for this geographic area, other funeral homes may be able to enter the market by
purchasing their own rights to a slightly different product. In addition, not meeting the anticipated
growth targets could have a significant impact on the projection (essentially, year 1 levels could
continue). The basis for Margaret’s revenue assumptions should be reviewed and more information should be obtained, or perhaps market research should be done.
62
2. In addition, there was no assumption on the increase in costs related to these revenue increases. This
needs to be reviewed, since the projected contribution could be lower.
3. Margaret did not provide information on increases in other costs (including operating and various
other costs after the first year, such as marketing and training). This is not realistic — an increase in
operating and administrative costs should be considered.
4. Equipment used in biocremation costs twice as much as conventional cremators, but is less expensive
to operate. Regardless of the lower operating costs, the high investment in biocremation equipment
may be detrimental to KL’s financial flexibility, since funds are tied up in this equipment, if the demand for services is not as anticipated.
5. Interest (on the funds used for the capital costs) has not been factored into the analysis above.
In addition to the previous considerations, the decision to proceed with this initiative should also consider
the risks involved. Tradition and customs are important in the funeral industry, and this change may have
a negative impact on KL for a segment of the population that may not support biocremation of their loved
ones using the same equipment as that used for biocremating medical research remains and animals.
Margaret and John appear to be focused on the potential benefits of the change, but do not appear to have
considered the potential negative impacts.
There are also opportunities that could be seized with the proposed facility. KL would be responding to
industry changes and consumer demand for “green” funerals with the biocremation project. Being an
early leader in biocremation could be a competitive advantage for KL since other funeral homes using
KL’s service may promote KL’s brand and image, which could result in increased demand for other services. In addition, biocremation uses less energy and does not release chemicals into the atmosphere,
which increases KL’s image as an environmentally conscious funeral provider. It could be a positive differentiating factor for the company in an industry marked by corporate buyouts, mergers, and price
pressures.
While this quantitative analysis shows the projected results of the proposed biocremation facility, you
would also have to consider the additional factors noted above when making your decision. For now, we
have provided the five-year analysis as Margaret requested.
(Candidates generally attempted some qualitative analysis relating to the biocremation facility,
primarily focusing on the revenue assumptions made by Margaret and John. While some candidates
also attempted to consider risks and opportunities related to the proposed facility, many of their
discussions were repetitions of case facts without any additional insight or opinion, or were
restatements of quantitative factors in qualitative terms.)
For Primary Indicator #2 (Management Decision-Making), the candidate must be
ranked in one of the following five categories:
63
Percent
Awarded
0.0%
competence.
9.2%
Reaching competence — The candidate prepares a reasonable analysis using
the information provided.
44.0%
Competent — The candidate prepares a reasonable analysis using the
information provided and discusses some other factors that should be considered.
46.6%
Highly competent — The candidate prepares a thorough analysis using the
information provided, discusses most other factors that should be considered, and
considers the overall risk of the initiative.
0.2%
(Candidates were asked to put together a five-year analysis that would prove that the biocremation
facility makes sense. Candidates were provided with an exhibit that outlined information related to the
proposed facility and were expected to use the case facts to perform an analysis (qualitative and
quantitative).)
(Candidates performed adequately on this indicator. Most candidates were able to quantitatively
incorporate the basic information provided in the exhibit into their analyses. They were also able to
discuss some of the qualitative considerations related to the facility. Many candidates recognized that
the introduction of biocremation would result in a loss of traditional cremations and attempted to
discuss the impact of this on KL (either quantitatively or qualitatively).)
(Strong candidates recognized the impact of the lost contribution margin on traditional cremations and
incorporated that directly into their financial analyses. They also addressed more qualitative
considerations and assessed the feasibility of the biocremation facility separately from the proposal for
financing. The separate analyses provided greater opportunity for consideration of the relative merits
and pitfalls of each decision, as well as recognition that the biocremation proposal should be assessed
as a separate business decision, regardless of the decision made with respect to John’s financing proposal. Weak candidates did not address (either quantitatively or qualitatively) the fact that some of
the traditional cremations would be cannibalized, simply restated case facts, or provided little
qualitative discussion in their analyses.)
The candidate provides an analysis of the proposal from John Kelly, discussing the implications
of the financial terms and identifying the significant risks and benefits.
The candidate demonstrates competence in Finance.
64
Competencies
VII-3 – Develops or analyzes investment plans, business plans, and financial proposals (B)
VII-5 – Analyzes the purchase, expansion, or sale of a business (B)
As requested, I have analyzed the proposal from John Kelly. I have prepared the following analysis, as
well as recommendations for improvements to the proposal.
The proposal is interesting and has both benefits and risks. Basic interest at prime is quite low at present
and there is no indication that it will rise significantly any time soon; however, there is a risk of it rising
over the three-year term. The risk is higher than with a fixed-rate loan. The cost may be lower if the prime
interest rate remains low; however, if rates rise, the cost may be substantially higher. KL appears to have
operated at a low risk level, so this type of arrangement would be a change for the company. However,
overall, the provision appears reasonable.
The “additional” interest is more difficult to estimate because it is dependent upon earnings before
interest, taxes, depreciation, and amortization (EBITDA). As per the terms of the proposal, it is calculated
based on 30% of EBITDA. It would take a significant increase in EBITDA before the additional interest
cost became detrimental.
(Some candidates quickly interpreted the additional interest of 30% to be an exorbitant rate. Those
candidates did not realize that since the 30% was based on EBITDA, the overall interest cost was not
unreasonable based on the estimated profit level and the risks involved.)
Below, I have calculated the cost of borrowing (compound interest on borrowing as interest is added to
the principal and there are no repayments for three years) based on an estimated profit level (existing
operations as well as the proposed biocremation facility) to show how it would work and its potential
impact. These simple calculations show that John benefits from the compounding of his investment and
has the benefit of accruing interest at least at the prime rate.
Assumptions
Investment by John Kelly
Prime rate (estimated; throughout term of
loan)
Year 1
$
Year 2
3%
Combined EBITDA
$
$
Basic interest
Additional interest at 30% × combined
EBITDA (above)
Total interest
$
Loan principal, beginning of year
Interest – basic plus additional
Loan principal, end of year
3%
Interest rate*
36,000
123,000
3%
Year 2
$
36,000
123,000
Year 3
$
36,000
123,000
20,000
20,000
20,000
31,600
176,260
241,699
210,600
$
355,260
$
420,699
60,000
63,695
68,804
63,180
106,578
126,210
123,180
$
2,000,000
123,180
$
Year 3
2,000,000
Year 1
Income from continuing operations before
tax (as revised)
Depreciation included in above
Interest on long-term debt included in above
(estimated using 2012 information)
EBITDA from biocremation facility (see
previous analysis)
65
2,123,180
170,273
$
2,123,180
170,273
$
6.16%
2,293,453
8.02%
195,014
2,293,453
195,014
$
2,488,467
8.50%
*Calculated as total interest over opening principal balance outstanding.
(Candidates struggled to provide an appropriate quantitative analysis for the financing proposal. As a
starting point, a calculation of both basic and additional interest based on EBITDA was necessary.
When determining EBITDA, candidates generally did not incorporate the impact of their accounting
discussions, except for discontinued operations, which was specifically mentioned in the definition of
EBITDA. The calculation of interest should have led candidates to the next step, providing a useful
discussion and, in particular, an explanation of the cost implications. The calculation was not complex
and some candidates attempted it; however, most of those candidates merely calculated a dollar
amount for interest (sometimes only for one year, despite the three-year financing proposal) and
concluded that it was significant. Candidates did not translate that dollar amount into an interest rate
that could be assessed for reasonableness in comparison with the amount of principal obtained or the
interest rate on existing debt.)
66
Having the interest compound and requiring no payment for three years is helpful at the start, but the big
risk is how the company will come up with the funds to repay John at the end of the three-year term.
Margaret and John are counting on the biocremation facility to provide significant income and cash by
that time, but there is no guarantee that this will take place. An alternative would be to pay the interest
annually rather than have it compound, and then have a negotiated repayment of capital starting at the end
of the three-year term or have the option of renewing the financing. This would better match the longterm biocremation facility investment with related financing. Another idea would be to set up the
biocremation facility in a separate company, with John providing funding separately for this company.
The restriction of dividends to a percentage of net income may be a change for KL because the company
is used to managing dividend policy and has consistently paid out dividends totalling $200,000 in each of
the past two years. However, this restriction may actually be a good thing since there appears to be a need
to control these payments to allow for better cash-flow management. The company should recognize that
with a positively performing entity (based on EBITDA), John will reap the benefits of KL doing well
through higher interest payments, while shareholders will still be subject to restricted dividend payments,
since interest expense is deducted in the determination of net income.
John would require KL to use the future income taxes method to allow comparable assessment of his
various business interests. Because KL does not currently use this method, additional costs will be
incurred to properly effect these changes, since the incumbent accountant on staff (a family member with
no formal accounting training) would need assistance to make the necessary adjustments to the financial
information.
The appointment of John as a director may be beneficial because he could bring valuable business
knowledge and expertise to KL’s board. However, John’s involvement at the board level may cause friction with existing board members, who seem to have functioned in the past on a very informal and
casual basis, while John seems to require a formal, structured arrangement. KL prides itself on being a
traditional family business firmly rooted in the community, and that could change with a more structured
board.
We have also noted that the details regarding the monthly reporting for John are to be worked out. There
should be agreement on the specific reports required within the final financing document, leaving room
for modification as required.
There are potential control issues only if KL experiences losses in two consecutive years, since John
would then have a say in management decisions if he decided to convert his loan to a 51% equity position
in KL. If he does acquire control, he has the ability to change the future direction of the company or to
close operations at his discretion. The introduction of the biocremation facility (see previous analysis),
along with the assumptions related to projections, will have a positive impact on future operating results,
so it seems unlikely that control would be lost.
(Most candidates addressed a few of the qualitative terms attached to the financing proposal,
incorporating case facts into their responses as well as providing analyses of the impact of those terms
on the future of KL. Candidates also tried to consider both positive and negative aspects of the
proposal.)
67
Since you have already acquired the geographic rights to the biocremation technology, there may not be a
sense of urgency in beginning the project. You should take some time to determine if there is interest
from other lenders (such as banks or government sources) in financing the facility, since their lending
terms may be more favourable than those presented by John, given the conditions attached to his
proposal. You do have some funds available in investments, from the sale of the casket production
facility, that could be put towards this facility. Additional funds could also be realized through the sale of
remaining casket inventory (it’s unclear what portion of the $321,000 inventory value relates to caskets)
or through the reduction of dividend payments to shareholders (currently at $200,000 annually).
Significant borrowing would still be required in order to finance the project without the funds provided by
John.
(Some candidates recognized that other avenues of financing should be investigated and provided
reasonable suggestions for alternative sources of funds. Those candidates also seemed to recognize
that the biocremation facility was a proposal worth pursuing and that it was a separate issue from the
financing proposal.)
For Primary Indicator #3 (Finance), the candidate must be ranked in one of the
following five categories:
Percent
Awarded
0.1%
competence.
8.2%
Reaching competence — The candidate provides an analysis of the proposal
from John Kelly, discussing the risks and benefits, or calculates the effective
interest rate.
69.4%
Competent — The candidate provides an analysis of the proposal from John
Kelly, discusses the risks and benefits, and calculates the effective interest rate.
22.2%
Highly competent — The candidate provides a complete analysis of the proposal
from John Kelly, discusses the risks and benefits and suggests ways to mitigate
them, and calculates the effective interest rate.
0.1%
(Candidates were provided with information on a financing proposal from John Kelly and were asked
to explain the cost implications and any other relevant considerations. Candidates were expected to
assess the quantitative impact of the proposal as well as to qualitatively address the terms attached to
the proposal.)
68
(Candidates performed poorly on this indicator. From a qualitative perspective, most candidates were
able to discuss some of the non-financial terms of the proposal and use case facts to support their
analyses. However, from a quantitative perspective, candidates performed poorly since most did not
progress beyond a basic calculation of EBITDA, as defined in the proposal, and as a result did not
adequately assess the interest being charged.)
(Strong candidates balanced a good qualitative discussion of the implications of the various nonfinancial terms with an assessment of the reasonableness of the interest term (converting the interest
cost into a rate and making a comparison to the rate KL had on its long-term debt). Weak candidates
only calculated EBITDA or provided no calculations at all, and provided qualitative content that
merely restated simulation facts without additional insight or opinion.)
The candidate provides suggestions for appropriate governance for Kinfolk Limited, including
governance structure, decision-making, and reports to shareholders and John Kelly.
The candidate demonstrates competence in Governance, Strategy, and Risk Management.
Competencies
IV-1.1 – Evaluates the entity’s governance structure (B)
IV-1.2 – Understands the leadership processes of the board or other governing body (C)
IV-1.4 – Identifies the importance of governance activities (B)
IV-2.1 – Understands the entity’s strategic plan and planning process (B)
IV-2.3 – Identifies and evaluates opportunities and risks (A)
IV-2.4 – Identifies key elements of the entity’s value system (B)
IV-4.1 – Evaluates decision-making and accountability processes (B)
IV-4.2 – Understands the need for access to information (B)
In the past, with the industry and company being very stable and profitable and with the involvement of
many family members, a formal structure, decision-making process, and reporting framework were not as
important. Recent changes in the industry and within the company, and now the potential involvement of
an outside investor, have made changes in these areas necessary. The declining revenue, pressure on fees,
and reduced profitability, along with Paul Kinfolk’s death, also make these issues more important.
Governance Structure
In the past, decisions have been made by the chief executive officer (CEO), with input from others,
without any real involvement of the board of directors (including the chair). There are no board
committees, and regular board meetings don’t seem to be held. The move to change this is coming from
both Frank Kinfolk and John Kelly. Frank stated that as chair of the board, he can veto any decisions that
Margaret makes, presumably ones that he believes are not in the best interest of the company. This is
correct, but to have an effective decision-making process, there should be more involvement in the
process than just the veto.
69
Under the current structure, the board consists of directors who are also shareholders. Because all
shareholders are family members, there are no non-family members on the board. By limiting board
composition to just family members, KL may be hindered by a lack of experience and expertise of
individuals in the funeral industry (for instance, if the shareholders are not active in operations) as well as
in general business operations. KL should consider including non-family members on the board and
should seek out individuals who can bring knowledge in areas that would be helpful to the company (for
example, an individual with a financial background) to complement and enhance the skill sets of existing
board members and aid in the future growth and development of operations. Irrespective of John’s involvement with KL, the inclusion of non-family members on the board should be considered.
Although directors are paid a directors’ fee, the only meeting is the annual general meeting (which is normally attended by shareholders), at which attendance is voluntary. As a result, the board is likely not
aware of decisions affecting KL operations that are being proposed or have been made by management
until the annual general meeting. It would be advisable for the board to meet on a more frequent basis
(perhaps monthly or at least quarterly) so that directors are better informed about the operations of the
business. In addition, attendance at meetings should be mandatory unless there are extenuating
circumstances that require the absence of a director. This will ensure that all directors are aware of what is
happening with the company (such as the sale of the casket production facility) on a timely basis.
There is no one right way to structure the company. John Kelly is proposing many board committees
(strategic planning, finance, technology, human resources, environmental). This structure appears
designed for a larger organization and may be more than the company requires or has the resources to fill
at the present time. However, having a more involved board of directors with some committees is a good
idea. In particular, a finance committee would be useful, given the errors that have been identified in
management’s internally prepared financial statements. This would be a big change for the company, and it is important that Margaret and Frank are in agreement and work together on any changes. Major
decisions could then be voted on by the full board, rather than setting up Frank as the de facto president
with a veto over Margaret’s decisions. The role that John Kelly plays on this board needs to be negotiated and written into the financing proposal.
The terms of the proposed financing provide John Kelly with involvement in the board and management
process as a single member, but if EBITDA is negative for two consecutive years, John could have
control of the company, depending on whether he decides to exercise his option to convert his loan into a
51% equity position in KL. However, the analysis of the proposed biocremation facility indicates that it
will be profitable in the future, even after interest costs of financing are factored in, so EBITDA will be
positive (if Margaret’s assumptions are appropriate). Without clarification of the governance structure and decision-making processes, there is potential for a great deal of conflict.
(Candidates were generally able to discuss several areas where improvements could be made to the
existing board structure, recognize weaknesses in the current structure, discuss implications, and make
suggestions for improvement. The areas most commonly addressed related to the composition of the
board and the frequency of meetings. Some candidates took issue with the fact that the board was
composed entirely of shareholders (or family members), and suggested replacement of the entire board
with outsiders to avoid a perceived bias. This recommendation was both impractical and inappropriate
for KL, a traditional family business whose existing directors are also shareholders and, as a result,
should be acting in the best interests of shareholders.)
70
Decision-Making
Frank mentioned that the decision to sell the casket production facility was made without consulting the
board. It does appear that it was made based on incomplete information. Margaret noted that there was
increasing competition and that the facilities would have required substantial investment to upgrade
equipment in order to remain competitive. In terms of the operations, she indicated that the casket
production business had a small gain last year. However, while casket sales and product costs were
recorded separately in the accounts, administrative and other expenses were allocated based on revenue.
Basing the decision on assumptions such as this may have resulted in unintended consequences. For
example, the expenses based on an allocation of revenue may have been incorrect and the facility may
have been contributing significantly to the overall profitability of the company. There is no indication that
the decision to close the casket production facility was considered in terms of the strategic direction and
future of the company. In this instance, the decision has been made, but going forward, the decisionmaking process should be improved. The company should design a policy that clarifies what types of
decisions should be approved by the board before they are undertaken. It may be that the decision to close
this facility was influenced by Margaret’s desire to expand in other directions, such as biocremation and environmental initiatives. This also ties into the decision regarding the new computer system and the need
for information for decision-making.
Margaret and John have a lot of ideas and plans for KL. John’s idea for a strategic planning committee may be appropriate. Such a committee could work on the strategic plans for KL, sorting through them to
see how they fit together and tie to the organization’s overall goals in more general terms, and how they
fit with existing strategies and one another.
In any event, KL would benefit from having written policies addressing decision-making structures.
While the traditional succession process worked as planned in the past (retiring CEO becomes chair of the
board of directors;; assistant to CEO transitions to CEO role in approximately 10 years), Paul’s unexpected death in 2013 caused a rapid and unexpected change to Margaret’s role, from assistant to CEO. The informally planned training period over 10 years did not materialize, and she was thrust into
the added responsibility with only two years’ experience. Her decision with respect to the sale of the casket production facility, as well as the biocremation proposal, has caused friction with Frank. A written
policy outlining succession arrangements to various positions would be useful to KL and would clarify
the requirements and experience needed to move from the position of assistant to CEO, as well as detail
the involvement of the board chair in the event of the CEO’s untimely death or departure from KL.
In addition, definition of the role and responsibilities of the CEO and the board chair would also be useful
to ensure smooth transition from one position to the next.
(Many candidates recognized the need for a more formalized decision-making process and that board
approval should be obtained for major business decisions. Candidates were able to use case facts to
enhance their discussions — for example, the fact that KL management sold the casket production
facility without consulting the board — and provided reasonable suggestions for improvement.)
71
Reports
The terms of the financing proposal from John Kelly require monthly financial reports, with details to be
worked out. This would be an excellent way to ensure that John is kept up to date and will assist with
KL’s governance structure. It will also tie in with Frank’s desire for a more formal decision-making
process, which also requires reports.
It would also be a good idea (and enhanced governance) to have these monthly reports circulated to all
board members and to hold quarterly board meetings. An appropriate report should include the following:
A complete set of financial statements — including a balance sheet, earnings statement, and cash flow
statement.
An analysis of actual versus budgeted results, including reasons for variances. Comparisons could also
be made to prior years.
A complete narrative analysis each month.
An activity report that may detail both financial and non-financial information, such as the information
required for the “green” certification, number of funerals by type (burial, cremation, and biocremation), and revenue information by funeral type.
Updates to major initiatives.
The final content of the monthly reporting package should be discussed with the board members and with
John Kelly to ensure it is as relevant as possible.
(Many candidates provided practical recommendations of reports to be provided to the board and
explained why they should be provided.)
Other
Margaret and John Kelly have indicated that they would like to have the company buy back shares from
shareholders who want to avail themselves of this option. This may require approval of the shareholders.
It is unclear whether there is a shareholders’ agreement in place. If none exists, KL should seek legal advice to have an agreement prepared. An existing agreement may provide information as to how the
buyout would be structured, as well as formalization of the calculation of the redemption price upon death
and buyouts so that potential future disagreements on these matters could be avoided.
(Few candidates addressed the share redemption and whether a shareholders’ agreement was in place.)
The hiring of family members in a variety of positions may have been effective for KL in the past, but
there is a need for more competent and experienced personnel in key areas. As an example, the number of
changes required to the financial statements in order to conform to ASPE and the number of deficiencies
noted in the corporate income tax excerpts indicate that the current accountant, who has no formal
accounting training, requires additional training. Alternatively, KL could hire an individual who has
greater knowledge and experience (even on a part-time basis, depending on the company’s activity level) to whom the existing accountant could report.
Whether or not KL decides to proceed with the biocremation facility, the competency of existing staff and
managers should be reviewed to ensure that individuals have the relevant skills needed for KL’s operations. Professional development and adequate training should be incorporated into the company’s culture.
72
Borrowing funds from John Kelly or likely any other source will require providing financial and other
information to an outside party. This is something that Frank and the other shareholders will have to
accept. It appears they are already moving in this direction by hiring us and discussing moving to more
professional management rather than exclusively family members.
(Some candidates considered the need for an experienced accounting professional, rather than the
incumbent family member acting as accountant, and supported their discussions with simulation facts
related to errors noted in the financial statements. Many candidates were concerned about Margaret,
focusing on her youth, her relatively short period of time with KL, and some of the decisions she had
made as indicators of her perceived incompetence. Careful reading of the simulation would show that
the sale of the casket production facility was done by KL management, at a time when Paul was still
alive and in his role as CEO, rather than by Margaret individually. In addition, John had discussed his
financing proposal with both Margaret and Paul, indicating Paul’s awareness of both the financing and the biocremation facility.)
For Primary Indicator #4 (Governance, Strategy, and Risk Management), the
Percent
Awarded
0.5%
competence.
10.2%
Reaching competence — The candidate discusses concerns with KL’s governance structure, decision-making, or reporting.
38.6%
Competent — The candidate discusses concerns with KL’s governance structure, decision-making, and reporting.
50.5%
Highly competent — The candidate thoroughly discusses concerns with KL’s governance structure, decision-making, and reporting.
0.2%
(Candidates were asked to provide advice in three areas with respect to KL’s practices: an appropriate governance structure, its decision-making processes, and an appropriate reporting package for the
board. In order to achieve competence, candidates were required to identify, discuss, and suggest
improvements in each of the three areas.)
(In general, candidates performed adequately on this indicator. They were able to identify a number of
weaknesses in the current format of KL’s board and its decision-making practices, discussed the
implications of these weaknesses, and suggested improvements. However, some candidates struggled to
recognize the small-business environment of KL, and at times made recommendations that were not
suitable for a family-owned business.)
73
(Strong candidates addressed all three areas, focused on governance issues rather than operational
issues, and kept the fact that KL was a family-owned business in mind when making recommendations.
Weak candidates did not identify or explain the implications of the current governance model and
made recommendations that were more suitable for large or public enterprises. Many candidates
focused on Margaret’s inexperience rather than considering the broader implications of the succession
process or the manner in which decisions had been made at KL (and how that process could be
improved).)
The candidate discusses weaknesses and recommends appropriate controls for the SCC
system.
The candidate demonstrates competence in Assurance (IT).
Competencies
VI-3.3 – Evaluates internal control (A)
VI-3.4 – Evaluates IT-related elements of internal control (B)
KL is planning on implementing a new computer system to handle all of its operations. It has a proposal
from SCC. As requested, I have reviewed the draft service agreement, focusing on the controls. There are
several areas in the draft agreement that do not provide sufficient information on the controls, so before
proceeding with the system, KL should obtain more detail. For example, the agreement states, “SCC has built into the system all the controls needed.” This is not usually possible because there will need to be controls specific to KL. The lack of detail may indicate that controls and documentation of controls is not
as strong as it should be at SCC.
Issue
General controls, relating to
outsourced services.
Controls over access to
data:
There do not appear to be
access controls at SCC to
prevent unauthorized access
by SCC personnel. It would
appear, according to the
following statement, that
Potential Impact
If SCC is not reliable or if its
control environment is not
strong, KL’s entire system could be at risk. This could
result in loss of data, breach of
confidentiality, costly
reconstruction of data, and
other problems.
Controls to Address
We should determine if there is a report
by an auditor on controls related to a
service organization; e.g., 5970
Changes could be made to data
(e.g., prices) in error or on
purpose. This could result in
incorrect information (both
financial and non-financial)
being provided to users and
Access should be authorized through
permission from KL. Each time access is
required, a log entry should be recorded
and a report should be available to KL on
a regular basis, identifying access by
SCC.
Auditor’s Report on Controls at a Service Organization (replaced by
CSAE 3416).
With respect to SCC, we should research
the background of the company and
gather basic information such as how
long it has been in business and whether
it is bonded. We should obtain this
information before KL accepts the
proposal.
74
Issue
they can access the data at
any time: “SCC staff will be able to access all of your
records to provide
immediate assistance on
any issues you may have.” What is to stop them from
accessing it for other
reasons?
Access over the internet
may allow for unauthorized
access to KL’s records (including downloads from
online banking).
On KL’s premises, it appears there may be only
one level of access control:
“Users have unique passwords to access the
entire system.”
The system is fully
integrated. Modules
(accounting and funeral
home software) and
reporting use shared
databases.
Potential Impact
improper business and
operational decisions being
made. For example, customers
could be billed the wrong
amount (either more or less) if
data has been changed without
authorization.
Unauthorized access may
result in confidential data
being used by KL’s competitors. As well,
confidential client information
may be compromised, leading
to damage to KL’s image and reputation.
Unauthorized access (e.g.,
online banking) could lead to
confidential data being
compromised and put KL’s financial resources at risk.
The issue is one of
confidentiality. Who can
access what is important in
this respect. The offer states,
“All modules access the same
data files (customers,
inventory, prices, etc.).” This raises the question as to who
can access the information
(confidentiality) and who can
change the information and the
audit trail. Individuals should
not have full system access.
For example, the accounts
receivable person should not
also have access to banking
information.
Information can be entered
incorrectly and could result in
errors across the system (e.g.,
funds entered under wrong
name, personal data, etc.,
which could affect accuracy of
death certificates).
Also, inappropriate changes to
Controls to Address
KL should also make sure that there are
confidentiality clauses in the agreement
that prevents SCC from using KL’s data for any unauthorized purpose.
Ensure that the internet connection is
secure and that information transmitted
is appropriately encrypted. Inquire about
the use of encryption software (if there is
any, if it is from a recognized provider,
etc.) and what other security measures
are in place.
Ensure that SCC has a secure connection
by inquiring about the procedures and
protocols SCC has in place to ensure
appropriate encryption, and then assess
whether those provide an appropriate
level of security.
Access to the various components of the
system should be restricted by
developing individual user profiles and
requiring the use of passwords. Each
user should have a profile that allows
access only to the functions required.
It will be important to make sure that the
information initially entered is done so
accurately. System checks may be able
to be implemented to ensure data is
entered accurately, such as validity
checks (dates of death and birth; Social
Insurance Number).
Controls will need to be implemented to
Issue
Data files (including prices)
can be updated “on the fly” from any application in the
system.
The system allows
backdating of entries.
Controls over access to
systems:
Access to the company’s records is exclusively over
the internet.
Other:
In the system conversion
that SCC has proposed, it
appears that only the
balances will be transferred
and not the details of
accounts.
Potential Impact
data could result in errors. For
example, there may be
processes in the funeral part of
the system that affect
accounting (price changes,
lack of audit trail, etc.).
Prices could be changed
without proper authorization
and may also be changed in
error, resulting in improper
quotation and billing.
Data could be changed in error
or manipulated after the fact
and KL would not have
knowledge of these changes.
Incorrect financial reports and
other errors (e.g., wrong date
of death) could occur.
75
Controls to Address
ensure there are appropriate
authorizations to delete and change data,
such as hierarchy of access and password
restrictions.
The system should require a separate
password to change information in data
files. On a regular basis, a list of such
changes should be printed and reviewed
by management (either signing or
initialing as evidence of their review).
Data should not be allowed to be entered
beyond a certain date. (i.e., once a month
is closed, the system should not allow
any further entries for that period).
Alternatively, a report could be
generated highlighting entries in prior
periods, which would then be reviewed
and approved by senior KL personnel
before posting.
There may be an interruption
during data entry or
processing. This may result in
a loss of data or delays in
processing, which could
hinder business operations.
KL should have some access to data to
serve clients in the event that the internet
is not functioning. Alternate
arrangements to access records should be
in place in the event of an interruption
that is other than temporary. We should
also ensure that SCC has appropriate
controls in place to manage outages at its
end (i.e., a recovery plan).
Having account details will be
useful for some data (e.g.,
accounts receivable and
accounts payable subledgers),
but in some cases, not having
account details will limit the
analysis KL can perform. For
example, KL would not be
able to generate reports that
compared this year’s activity to the prior year’s activity. A complete system conversion plan
needs to be designed, analyzed, and
performed. The conversion would
require pre- and post-conversion data
checks. Ideally, all historical information
from KL’s current system would be available in the new system.
This issue needs to be addressed in more
detail. Will the old system be disposed
of? Can files be converted so that KL can
access some previous years’ data for analysis? At the very least KL must print
the information so that it has hard copies.
KL will need details of pre-planned
funerals to be entered, as an example.
76
Issue
The proposal indicates that
SCC will perform backups
on its equipment.
Potential Impact
Regular backups are important
to ensure that, in the event of a
system failure, information
can be reloaded to a particular
point in time, so that historical
information is not
compromised and ongoing
business activities are not
severely affected.
Controls to Address
The proposal states “backed up on SCC servers,” but it is unclear what this entails. KL must ensure that there is
offsite storage of at least one copy.
KL needs more detail. How frequently
are backups done? Are they tested? How
are they stored and protected? Can KL
be provided with a copy (as offsite
storage)?
Reports
The system provides standardized reports, and SCC feels there is no need to create custom reports. If
custom reports are not available, information may not be accessible for appropriate decision-making,
leading to the potential for poor business decisions. KL should have the ability to customize reports
specific to its business needs so that good business decisions can be made.
We have identified a number of concerns with SCC’s draft service agreement. If controls as discussed above cannot be implemented, it may be necessary to look to another provider for the computer system
that KL requires.
(Most candidates identified a sufficient number of potential control deficiencies, explained what the
impact of those deficiencies could be on KL, and recommended ways to improve the control shortfalls
in a concise and understandable manner. Many candidates focused on the familiar issues of access
over the internet (such as addressing general concerns that information could be compromised by an
outsider if proper security measures were not in place) and access to the system at KL’s premises (such as recommending that passwords be implemented). More thorough responses discussed specific
implications of the SCC proposal for KL in the areas of access controls over data as well as systems.
For example, in the area of controls over access to data, candidates considered the specific
implications to KL and the proposed system in the area of data files and system module integration, in
addition to discussing access over the internet and the need for passwords.)
For Primary Indicator #5 (Assurance (IT)), the candidate must be ranked in one of
the following five categories:
77
Percent
Awarded
0.3%
competence.
6.3%
Reaching competence — The candidate identifies some of the controls that
should be considered.
30.3%
Competent — The candidate discusses some of the controls that should be
considered.
62.8%
Highly competent — The candidate discusses most of the controls that should
be considered.
0.3%
(Candidates were asked to comment on controls related to the SCC system. Candidates were expected
to assess the system controls as provided in the draft service agreement from SCC. Assessments should
have included identification of system control weaknesses and recommendations of appropriate
controls.)
(In general, candidates performed well on this indicator. Most candidates were able to identify and
explain a number of control deficiencies with the system as proposed and attempted to provide
recommendations on how to deal with those deficiencies. However, some recommendations were
inadequate in that they either were impractical given the circumstances or lacked specificity. Some
candidates addressed operational issues rather than control concerns.)
(Strong candidates addressed more of the control concerns and provided a thorough analysis of those
problems, accompanied by practical recommendations that fit KL’s business. In addition, those candidates considered controls at both SCC and KL that could be affected by the proposed system.
Many weak candidates assessed the pros and cons of the draft service agreement, provided
recommendations for changes to the agreement only, or had difficulty understanding an internet-based
server (and, accordingly, recommended that the system should be installed at KL’s premises or that
SCC staff should work on-site at KL on a full-time basis).)
The candidate discusses the required report for the Environmental Funeral Business
Certification and the procedures that will be involved in conducting the audit.
The candidate demonstrates competence in Assurance.
78
Competencies
VI-1 – Analyzes, evaluates, and advises on assurance needs (external or internal) (A)
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)
VI-2.9 – Draws conclusions and communicates results (A)
General Assurance and Auditing Standards
The general assurance standards are set out in Handbook Section 5025. Because the certification relates to
non-financial matters, we would look to the general standards as our starting point. These standards apply
to all assurance engagements, other than audits of financial statements and other historical financial
information performed by practitioners.
Section 5025.16 states: “Before undertaking an assurance engagement, the practitioner should have a
reasonable basis for believing the engagement can be completed in accordance with the standards in this
Section.” In this case, it appears that an engagement could be performed since there are standards and
criteria in place that could be used (HB 5025.32: “The practitioner should identify or develop criteria that
are suitable for evaluating the subject matter.”). The Canadian Funeral Association (CFA) has produced
a set of standards, of which a set number must be met in order to achieve an Environmental Funeral
Business Certification. The standards appear to be suitable criteria, since they have been set to meet
certain targets in order to be environmentally friendly. Characteristics of suitable criteria include that they
be relevant, reliable, free from bias, understandable, and complete. The standards established by CFA (for
example, 40% of funerals are cremations or biocremations) would result in comparability across the
industry when reported upon, since the expectation of the standard is clear. The engagement needs to be
carried out with due care and an objective state of mind (HB 5025.24) and must be carried out by
individuals having adequate proficiency (HB 5025.27). Staff assigned to the engagement should ensure
that they are objective and unbiased in the performance of their responsibilities, as well as free from
relationships that could impair their professional judgment. Because KL is a new client for us, we need to
ensure that any staff from EJT assigned to the engagement meet the objectivity requirements and that they
have no connection to KL. We should inquire about any independence or conflict-of-interest concerns
before assigning staff.
The auditor must also satisfy the performance standards, such as adequate planning and supervision
(HB 5025.43), sufficient appropriate evidence (HB 5025.53), and adequate documentation (HB 5025.58).
We need to ensure that the engagement is properly planned and supervised. We will have to develop an
overall strategy and approach, outlining procedures to be performed as well as ensuring that the
information to complete those procedures is available from KL or other sources (such as invoices,
kilowatt hours, et cetera). I have planned several procedures to assess whether the standards are being met
and have included these later in my report. Before we review the processes in place for tracking the
information, it is difficult to say whether we can verify the information. The calculations do not appear
complex, but the source of the data and the verification of the information may be a challenge. Our work
will have to be properly documented by field staff and reviewed by a manager.
(Some candidates briefly considered general assurance standards, specifically with respect to whether
the work could be completed, as well as planning, supervision, and staffing of the engagement.)
79
Section 5025.62 also sets out the minimum reporting standards that must be used for such general reports
and states:
As a minimum the practitioner’s report should:
(a) identify to whom the report is directed;
(b) describe the objective of the engagement and the entity or portion thereof, the subject matter
and the time period covered by the engagement;
(c) in an attest report, identify management’s assertion;;
(d) describe the responsibilities of management and the practitioner;
(e) identify the applicable standards in accordance with which the engagement was conducted;
(f) identify the criteria against which the subject matter was evaluated;
(g) state a conclusion that conveys the level of assurance being provided and/or any reservation
the practitioner may have;
(h) state the date of the report;
(i) identify the name of the practitioner (or firm); and
(j) identify the place of issue.
The report format presented by the Canadian Funeral Association is as follows:
I have audited the annual report attached for [insert company name and time period] and certify
that [insert company name] meets the standards for certification.
Firm Name:
Date:
City:
The wording of the report as presented indicates that an audit is required (“audited the annual report…and certify that…”). We cannot sign the above report to “certify” that KL meets CFA’s requirements. We can,
however, provide an opinion as to whether KL meets the certification standards and will report using the
standards (HB 5025.62) as noted above. The report would be addressed to the Canadian Funeral
Association and would include (among other items) a reference to the annual report on Environmental
Funeral Business Certification, a description of the responsibilities of management and EJT, and the
criteria against which KL is being evaluated (of the six standards available). It would also include a
conclusion with respect to compliance with the standards. We will have to check with the CFA to ensure
that our audit report will be acceptable, since the wording differs significantly from the format the
association has suggested. Assuming we can complete the procedures we determine are required (as
discussed in the following section) and do not encounter any problems, we would be able to issue a report
to the CFA.
(Many candidates failed to recognize that, as auditors, EJT would be unable to certify the report
presented by the CFA, or that, in fact, EJT would be unable to provide certification on any report. Of
greater concern was that some candidates thought that the report as proposed by CFA could be signed
by EJT with the performance of sufficient procedures to ensure that the standards were met.
Candidates were expected to recognize that, as auditors, EJT could provide an opinion, but it could not
“certify that KL meets the standard for certification.” Some candidates appropriately questioned the wording of the report provided by CFA and correctly concluded that EJT was unable to sign it as
currently worded (primarily as a result of the use of the word “certify”). However, many of those candidates did not suggest alternative reports that could be appropriate, and instead proceeded to
provide procedures that should be performed in order to determine whether the standards had been
met. Those candidates did not seem to recognize the limited usefulness of procedures if a report could
not be provided. Other candidates focused on the fact that the report was too short (it should have more
80
paragraphs), rather than considering the minimum reporting standards. As a result, those candidates
did not demonstrate depth.)
Other Possible Reports
Handbook — Assurance Section 5815, which discusses audit reports on compliance with agreements,
statutes, and regulations, may be a valid option if the CFA standards are within an agreement or form part
of a statute or regulation. If they are not, then Section 5815 may not be appropriate for our purposes. We
will have to get more information from KL on this area.
Further direction on the CFA request to “certify” is provided in HB 5800.07, which addresses a prescribed form of auditor’s report that may omit essential wording and advises that appropriate changes
should be made when necessary.
It is unlikely that the CFA would accept a report under HB 9100, which reports on the results of applying
specified auditing procedures to financial information other than financial statements, since this provides
no assurance. The CFA seems to require some level of assurance, by the use of the word “certify” in the proposed report. We would have to communicate with CFA to determine whether the association would
agree to accept alternative wording or a lower level of assurance before commencing any procedures.
(Some candidates did identify alternative reports to the one presented by CFA; however, many of those
candidates simply provided Handbook content in their responses, with no application of case facts or
analysis. As a result, those candidates were unable to demonstrate sufficient understanding of the
assurance issues in this simulation with respect to reporting. In addition, some candidates failed to
comment at all on the report provided by CFA, yet provided another report that could be used, leaving
the reader perplexed as to what the final decision on the report was. Other candidates recommended a
report under HB 9100 that would not be useful to CFA since the association clearly required some
level of assurance, hence the use of the word “certify.”)
Procedures
Standards
Margaret has indicated that KL has been tracking information for the past year with respect to the
standards. We would have to assess the adequacy of KL’s record keeping and ensure that it is sufficient to
provide the necessary data to complete the work. If the tracking is not sufficient, KL would have to
consider the impact on the ability to obtain financing from John, since one of the lending terms is
certification for 2013 for existing operations. In future, record keeping should not be an issue, but for
2013 it may be.
For all standards, we will start by checking the calculation performed by KL and the source of
information the company used. We will then need to verify the numbers used in the calculations. Potential
procedures to do this will vary by standard. I have listed some potential procedures that we can perform
for each standard.
Standard
Percentage of embalming fluid
purchased that is biodegradable
(minimum of 50%)
81
Potential Procedures
Determine if percentage is based on volume or dollars by
inquiring with CFA or examining explanation of standards.
Have client identify all suppliers of embalming fluid. Obtain
confirmation from supplier(s) of the total number of litres
purchased and classification as biodegradable or not.
Alternative procedure: Obtain client-prepared listing of
embalming fluid purchased (segregated by biodegradable or
not). Review purchase invoices related to fluid and
determine if properly categorized as biodegradable or not.
Agree litres purchased per supplier invoice to listing.
Determine whether classification is appropriate (may appear
on supplier invoice; may require inquiry with supplier; may
require use of an expert to determine).
If inventory of fluid on hand at year-end is significant,
review process used by the client to count and cost. If
significant, will need to perform a physical count and
substantiate the costs to supporting documentation, such as
supplier invoices.
Recalculate biodegradable fluid purchased and total
embalming fluid purchased and compare to 50%-minimum
standard.
Percentage of casket material
KL uses a perpetual inventory system with specific
purchased that is biodegradable
identification.
(minimum of 50%)
Obtain the calculation as performed by KL, and for a sample
of the caskets used, agree to invoice from supplier (or
internal records, for units manufactured by KL) on weight of
material and if identified as biodegradable.
On caskets that are purchased from vendors, obtain
information (e.g., a statement or report from the vendor) as
to the biodegradable material content in caskets
manufactured by them.
Recalculate biodegradable casket material purchased and
total casket material purchased and compare to 50%minimum standard.
(In some cases, where candidates believed they were providing audit procedures, they were in fact
merely providing an example of how to perform the calculation of the standard being considered. In
other cases, candidates did not substantiate their source of information (for example, how to
determine whether fluid or casket material is biodegradable) other than client classification.
Candidates also struggled with sampling and understanding how to determine an appropriate
population, while others preferred to rely on experts for the determination of all criteria.)
82
Percentage of funerals that are
cremations or biocremations
(minimum of 40%)
Obtain calculation as performed by KL.
Trace quantities to detailed funeral records, then trace a
sample to sales invoices and then to client funeral
arrangement documents to ensure properly categorized as
funeral or cremation (since there are no biocremations yet).
On a test basis, trace from sales invoices to the quantities of
funerals and ensures sample items are included and properly
classified as either funerals or cremations.
If KL has controls over the accuracy of entering funeral
arrangements into the system, we could choose to test the
controls to determine reliance.
Reperform calculation of cremations and total funerals and
compare to 40%-minimum standard.
(On occasion, candidates merely provided a procedure to mathematically recalculate the percentage
and noted that it must meet or exceed the 40% standard. Those candidates did not provide sufficient
audit procedures to ensure that the services recorded in client records as funerals or cremations were
appropriately classified (in other words, tracing back to source documentation).)
Energy consumption per square
metre of funeral home (maximum of
25 kilowatts)
For square metres:
Check measurements as provided by KL by reperforming
physical measurement of building (e.g., getting a tape
measure out) or reviewing the building plans.
After the first certification, we will only need to review for
additions or deletions to the building.
For energy consumption:
Confirm kilowatt hours used with the utility company.
If confirmation cannot be obtained, agree kilowatt hours
used to regular utility bills (probably issued monthly).
Reperform calculation of energy consumption (kilowatt
hours) and square metres and compare to 25-kilowattmaximum standard.
(Many candidates did not provide procedures that covered both parts of the standard (this standard
required procedures for both energy consumption as well as square metres) or did not incorporate
sufficient evidence sources to substantiate information that the client may have provided (for
example, obtaining the building plan for the funeral home to support square metres rather than
merely accepting information as provided by the client). As a result, their discussions of this issue
were incomplete.)
Gasoline consumption per 100
vehicle kilometres (maximum 10.0
litres)
83
For energy consumption:
Identify all suppliers of gasoline.
Confirm number of litres purchased with suppliers (likely
only available for bulk gasoline purchases).
If confirmation not possible, obtain supplier statements and,
on a test basis, check the composition of the numbers used
by KL in its calculation (could estimate using total of gas
receipts divided by average price of gas per litre), examine
purchase receipts for gasoline, and trace to listing provided
by KL.
For number of kilometres:
Need to obtain the starting and ending odometer reading for
each vehicle. We may be able to obtain these from vehicle
service records.
Examine driver/vehicle logs for kilometres driven (if they
have been maintained) and agree kilometres to calculation.
Reperform calculation of gasoline consumption (litres) and
100 vehicle kilometres and compare to 10-litre-maximum
standard.
Alternatively, examine automobile manufacturer industry
standards for consumption per kilometre. Ensure no
modifications have been made to vehicles that would result
in significant deviations from this standard and compare to
10-litre-maximum standard.
(As with the previous standard, some candidates dealt with only one portion of the standard when
providing procedures; for example, by providing procedures for gas consumed or kilometres driven.
Other candidates did not recognize that the procedures provided needed to ensure past compliance
with the standard, and provided suggestions for how to track this information in future. Some
candidates recognized that obtaining industry information regarding gas consumption for the
vehicles used by KL (subject to the impact of any vehicular modifications made) would be a concise
and relatively reliable method of determining compliance with this standard.)
84
Average kilograms of garbage
produced per funeral (maximum
25.0 kilograms)
For number of funerals:
Government reporting may allow confirmation (e.g., funeral
certificates).
May be able to substantiate the number of funerals by
reviewing the revenue information kept by KL (i.e., KL may
track revenue by funeral).
May be able to rely on number of funerals as determined
under a previous standard (40% of which are cremations —
see above).
For kilograms of garbage produced:
Because KL pays for waste disposal (likely on kilograms
collected), could confirm tonnage with city or contractor.
Alternatively, could vouch listing of tonnage provided by
client to invoices from waste-removal supplier.
Reperform calculation of average kilograms of garbage
produced per funeral and compare to 25-kilogram maximum.
(Candidates often provided creative procedures to determine the kilograms of garbage produced, but
most were future-focused. Most candidates did not realize that compliance with the standard needed
to be assessed for past funerals. Other candidates provided procedures to substantiate the kilograms
of garbage generated, but did not contemplate the number of funerals (either by providing procedures
here or referencing to their earlier discussion of the 40% standard) and so did not provide a full and
complete procedure for this particular area.)
(Overall, the procedures provided by candidates were frequently insufficient in some respect.)
For Primary Indicator #6 (Assurance), the candidate must be ranked in one of the
Percent
Awarded
0.2%
competence.
18.9%
Reaching competence — The candidate identifies alternative reporting options
and identifies procedures OR discusses reporting options OR discusses some
procedures.
41.4%
Competent — The candidate discusses reporting options and discusses some
procedures.
39.4%
Highly competent — The candidate discusses reporting options and
recommends an appropriate report. The candidate thoroughly discusses
procedures.
0.1%
85
(Candidates were required to discuss the report for the Environmental Funeral Business Certification
(EFBC) and the procedures involved in completing the audit, still they were informed that EJT still
needed to determine if it could sign off on the audit report as provided and would also need to
recommend procedures that it could perform to provide the assurance needed for KL to obtain
certification. In order to demonstrate competence, candidates were expected to discuss the report and
some of the procedures to be performed in order to ensure compliance with the standards as outlined.
Candidates were provided with an exhibit outlining the standards necessary to obtain certification, as
well as the wording of a report that must be submitted annually for EFBC.)
(Candidates did not perform well on this indicator. Some candidates were able to recognize that EJT
would not be able to sign off on the report as provided and proposed changes to the wording or
suggested another report that would be suitable for the CFA. In the area of procedures, many
candidates attempted procedures for four of the six standards; however, those procedures were
sometimes incomplete. They did not always address both parts of a standard (for example, for energy
consumption, a procedure to determine utility usage would be provided, but not one for determining
the square footage of the funeral home) or did not explain what source documents would be needed to
support information.)
(Strong candidates addressed the report sufficiently, not only recognizing and explaining that EJT
could not certify, as per the wording in the CFA report, but also identifying and discussing alternative
reporting options and concluding on which option would be appropriate given the circumstances.
Those candidates also provided thorough discussions of procedures for most of the standards and
occasionally provided multiple procedures that should be performed in order to ensure that compliance
with the standard was met. Weak responses did not address the report at all, simply indicated that it
could not be signed because audit work had not yet been performed, or focused on EJT’s multiple duties for KL (not recognizing that engagement acceptance procedures had already been completed).
Those candidates provided incomplete procedures, relied exclusively on the use of experts, or proposed
procedures that did not appropriately address the standard.)
The candidate discusses the tax implications of the sale of the casket production facility assets
and explains other corrections to the T2 as drafted.
The candidate demonstrates competence in Taxation.
Competencies
IX-2.3 – Calculates taxes payable for a corporation in routine situations (A)
IX-2.4 – Calculate taxes payable for a corporation in non-routine situations (B)
Sale of Assets — Casket Production Facility
I have reviewed the treatment of the sale of capital assets from the casket production facility on the
corporation’s tax return as prepared by KL. Adjustments need to be made and some areas require further review in order to define the correct treatment and determine if additional adjustments are required.
86
The gain on the sale of casket production assets as reported on the financial statements should be
deducted on Schedule 1 of the T2 — this transaction is included in taxable income based on the rules in
the Income Tax Act, and the accounting gain is deducted on Schedule 1 to reverse the inclusion in
accounting income.
The sale of the assets took place in two transactions:
a sale of the equipment; and
a sale of the land and building.
Equipment Sale
The equipment was sold to Rob Kinfolk, who is a shareholder and was also the manager of the facility.
The proceeds of the sale were $25,000, and this amount was credited to Class 8 on the Capital Cost
Allowance (CCA) schedule. A potential problem arises if Canada Revenue Agency (CRA) determines
that KL and Rob Kinfolk were not dealing with each other “at arm’s length.” The fact that Rob is a shareholder and part of a family group that owns KL may mean that they are not at arm’s length. We should get more information and have this reviewed by someone in our tax department. The risk of the
potential non-arm’s length transaction that arises is that CRA may adjust the proceeds to fair market value. The fact that Rob subsequently sold the equipment at auction for $56,000 is a strong indication that
the fair value was higher than the amount he paid KL and that he acquired those assets by virtue of his
relationship (whether as shareholder or as family) with KL.
As a result, CRA could deem the proceeds to be the fair value (FV) amount ($56,000), which will reduce
the undepreciated capital cost (UCC) pool for Class 8 assets by an additional $31,000 ($56,000 FV − $25,000 actually paid). The CCA claim would be decreased by $6,200, and taxable income and tax
payable would increase.
(Some candidates identified and explained that this transaction occurred with a non-arm’s length party, but many did not recognize that this resulted in the need to include the $56,000 deemed proceeds
amount on Schedule 8. Other candidates spent time discussing stop-loss rules in detail, which were not
applicable to this transaction.)
Land and Building Sale
The sale of the land and building creates the need to allocate the proceeds between the two assets. The
allocation was done by KL based on the allocation of the original percentage of the assets when they were
purchased by KL. This resulted in a loss on the land and the reduction in the balance of Class 1 and
reduced CCA in the current and future years. Alternative allocations should be considered.
We were told that the purchaser was interested in acquiring the land only. This is supported by the fact
that the purchaser demolished the building shortly after purchase. This would support allocating the entire
proceeds to the land. Because the casket facility was not the last remaining building in Class 1 (the
funeral home remains), proceeds of nil can be allocated to the building (since no terminal loss could
otherwise be triggered).
87
(While many candidates recognized that a sale of land and building had occurred, most did not
contemplate a reallocation of the proceeds. As a result, candidates were not acting in the best interest
of their client within the parameters provided by CRA.)
Doing this would result in a capital gain on the land of $125,000 (proceeds of $225,000 less cost of
$100,000), with one half of this capital gain ($62,500) included in taxable income as a taxable capital
gain. The CCA claimed would be higher than with the current treatment (low dollar impact because the
CCA rate is only 4%). The taxable capital gain would be included as property income and would not be
eligible for the small business deduction, so this would result in KL paying higher taxes. The non-taxable
portion of the capital gain would be included in the capital dividend account and could be paid out to the
shareholders on a tax-free basis. The ability to pay a capital dividend to shareholders would be beneficial,
since KL could pay a lower dividend to shareholders but maintain the same after-tax cash payment to
shareholders for one year. KL would also pay refundable Part I tax at the rate of 26.67% on the $62,500
taxable capital gain in 2013, but because it paid $200,000 in dividends, this would be refunded.
(For the most part, candidates demonstrated a general lack of understanding of the corporate income
tax concepts related to this transaction and frequently committed errors in either their application or
their understanding (for example, improper discussion of taxation of capital gains on depreciable
property or incorrect understanding of treatment of capital losses).)
It is possible that CRA may suggest other allocations, such as based on the market value of similar pieces
of land.
(Many candidates who contemplated a reallocation of the proceeds between land and building
demonstrated a greater understanding of the tax concepts related to this transaction and were able to
adequately identify and discuss taxable capital gains and the impact on Schedules 6 and 8.)
Eligible Capital Expenditures (ECE)
During the year, KL paid $50,000 to acquire biocremation technology rights for a specific geographic
area for an indefinite period of time. This expenditure was included by KL in prepaid expenses at yearend and was included as a deduction on the current Schedule 1. For tax purposes, this expenditure
qualifies as an outlay for eligible capital property (ECP), since the outlay was made in respect of a
business and for the purpose of gaining or producing income (from future biocremation operations).
Because the rights do not have a definite life, they do not qualify for inclusion in Class 14 for UCC
purposes. When ECP is purchased, 75% of the cost ($37,500) is included on Schedule 10 in a cumulative
eligible capital (CEC) account. On an annual basis, 7% of the balance in the account can be deducted
from income each year as a CEC deduction. KL will be able to deduct $2,625 on the 2013 tax return,
leaving a balance of $34,875 remaining in the pool.
(While most candidates addressed the rights in their Performance Measurement and Reporting
discussions, very few considered the related tax impact. Those candidates who did address this issue
were able to demonstrate their understanding of the rights as an eligible capital expenditure and
appropriately recognized the impact on Schedules 1 and 10.)
88
A revised Schedule 1 is as follows:
Corporation Name:
Kinfolk Limited
Net income - financial statements (36+82)
Add: Amortization of tangible assets
Taxable capital gain
Lease income – building – for tax
Non-deductible meals
Deduct:
CCA – Schedule 8
CEC – Schedule 10
Gain on sale of capital assets
Finance income - accounting
Business
Number
87678XXXX
118
123
62
15
10
210
210
68
3
25
–
96
Net income (loss) for income tax purposes
Tax Year End:
2013/12/31
96
232
(Some candidates attempted to recast Schedule 1; however, most omitted items that arose from their
corporate income tax analysis that should have been adjusted.)
Taxation of Lease Income
For tax purposes, the income related to the building lease ($15,300) would be treated as an operating lease
(included in taxable income in 2013). The lease income (for both land and building) is income from
property, not active business income, and would be taxed at a higher rate since it is not eligible for the
Small Business Deduction. It would be eligible for a Refundable Portion of Part 1 Tax.
(Very few candidates recognized the appropriate income tax treatment for the lease revenue or realized
that it would be considered income from property and, therefore, taxed at a higher corporate rate.)
89
A revised Schedule 8 is as follows:
SCHEDULE 8
CAPITAL COST ALLOWANCE (CCA)
Corporation Name:
Kinfolk Limited
1
Clas
s
num
ber
1*
8
10
2
UCC
at the
begin
ning
of the
year
3
Cost of
acquisit
-ions
Business Number
87678XXXX
4
Adjust
-ments
136
97
182
415
5
Procee
ds of
disposition
6
UCC
(colum
n2+
colum
n 3 +/colum
n 5)
56
41
182
7
50%
rule
8
Reduc
ed
UCC
12
CCA
13
UCC
at the
end of
the
year
182
4
20
30
5
8
55
131
33
127
318
Totals
68
291
136
9
CCA
rate
%
10
Recapt
ure of
CCA
11
Ter
mina
l loss
T
ax Year End:
2013/07/31
*Includes buildings related to funeral home and casket production facilities (at beginning of year);
buildings related to funeral home (at end of year).
Taxation of Dividends
Included in non-operating revenue on KL’s income statement are dividends of $4,000. This amount
should be deducted from taxable income on the T2 (deductible under Section 112/113, depending upon
their source). These dividends are not included in taxable income subject to Part I tax. Because KL is a
private corporation, they are subject to Part IV tax on these dividends at a rate of one-third of the amount
of the dividends — $1,333 (if the payor is connected to KL, then Part IV tax would not apply; since these
are short-term investments, it is unlikely the companies are connected). The tax payable under Part IV is
added to KL’s Refundable Dividend Tax on Hand (RDTOH) balance, and will be refunded at an equivalent rate — one-third — upon the payment of dividends to shareholders. Because KL paid
dividends of $200,000 to its shareholders for the year ended July 31, 2013, the full amount of $1,333 will
be refunded to it (or applied to reduce its tax payable for the 2013 year). In addition, a greater RDTOH
balance may be created by the sale of capital assets of the casket facility and from the leasing income.
(Few candidates identified this issue. Most candidates who recognized that KL had dividend income of
$4,000 were able to demonstrate an understanding of the corporate income tax treatment of this
income and were able to enhance their discussions by commenting on the inclusion of the tax paid in
RDTOH and the potential for a refund as dividends are paid.)
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Acquisition of Control
There is likely no acquisition of control on Paul’s death, since his share ownership was 12%; however,
this depends on the mix of the holdings of other shareholders and their relationship. An acquisition of
control would have an impact on the company since a year-end is deemed to occur immediately prior to
the date of acquisition and KL must file a corporate income tax return from August 1 to that date. Certain
amounts will be pro-rated for the short year-end (such as CCA claims and the Small Business Deduction).
In future, an acquisition of control would occur if John exercised his conversion option and acquires 51%
of KL’s shares. The acquisition of control has an impact on the company, as noted above. However, depending upon the amount of influence that John may have with the board of directors, he may have
de facto control (and an acquisition of control would be considered to have occurred) even before he
acquires a 51% ownership interest. CRA would consider the extent to which John has the power to elect
or influence the election of the majority of the board of directors in making such a determination.
(Few candidates addressed acquisition of control. For those candidates who did, their discussions were
appropriately brief and often covered the deemed year-end and related filing requirements.)
Repurchase of Own Shares
When a company redeems its own shares, it is deemed to have paid a dividend on those shares equal to
the amount that the payment exceeds the paid-up capital (ITA 84(3)). We should make sure that KL
knows this and informs the shareholders who are considering share redemptions.
Directors’ Fees
KL presently pays each director a fee of $3,500, whether they attend any meetings or not. From KL’s perspective, CRA may have some concerns over the deductibility of the $45,500 expense (13 directors ×
$3,500 each). While the amount itself is likely reasonable remuneration, KL should ensure that services
are being provided to support the deductibility of these payments. If a director receives $3,500 but
performs no work, CRA could challenge the nature of the payment and may treat it as a shareholder loan
(received by virtue of their position as a shareholder rather than their position as a director). CRA could
deny the deduction for director fees at the corporate level, resulting in potential double taxation (the
individual would have income inclusion as a shareholder loan and the company would lose the deduction
for wages and benefits). If CRA views the directors’ fees as a shareholder loan, there would be an income inclusion (at the personal level) if the loan amount is outstanding for two balance sheet dates.
Because attendance at meetings is voluntary and, at the present time, there seems to be only one meeting
per year, fees could be paid when no services are being provided, since directors will still receive their
fees even if they don’t attend any meetings. KL should ensure that directors attend a certain number of meetings annually in order to receive the fee.
(Very few candidates identified the issue related to directors’ fees. When candidates did address this issue, they generally questioned the deductibility of the expense and included case facts relating to
frequency of meetings and voluntary attendance in their discussions.)
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Structure of New Investment (John’s Financing) — Compound Interest
The preamble to ITA paragraph 20(1)(c) provides that taxpayers using the cash method deduct interest
expense on a cash basis. Similarly, taxpayers using the accrual method must deduct interest expense on an
accrual basis. However, all taxpayers may only deduct compound interest on a cash basis pursuant to
paragraph 20(1)(d). In addition, the preamble requires that all amounts must be paid or payable pursuant
to a legal obligation to pay interest.
(Very few candidates identified this issue.)
For Primary Indicator #7 (Taxation), the candidate must be ranked in one of the
Percent
Awarded
0.7%
competence.
46.2%
Reaching competence — The candidate identifies some of the relevant tax
issues relating to KL or discusses one of the significant issues.
29.9%
Competent — The candidate discusses some of the relevant tax issues relating
to KL.
23.0%
Highly competent — The candidate discusses most of the relevant tax issues
relating to KL.
0.2%
(Candidates were provided with excerpts from the draft tax return of KL and were asked to provide
advice on tax matters for the year ended July 31, 2013, and going forward. Candidates were expected
to discuss the tax implications of the sale of the casket production facility assets and explain other
corrections to the T2 as drafted. Because many issues were provided that could have been discussed,
candidates were expected to provide a correct analysis of several of the issues to be assessed as
competent.)
(Candidates performed poorly on this indicator and often demonstrated incorrect or incomplete
knowledge in the area of corporate taxation. Many candidates did not address the various tax issues
related to the sale of the casket facility (land, building, and equipment) or how it had been treated in
the draft tax return. Other issues were simple taxation issues that did not require a great deal of
analysis; however, most candidates failed to address enough of these issues to demonstrate
competence.)
(Strong candidates recognized and provided appropriate analysis of the casket facility sale, as well as
correctly discussed other issues that were relevant to Kinfolk’s circumstances. Weak candidates displayed a lack of competence by providing incorrect discussions with respect to the issues or by
discussing general taxation areas that were not mentioned in the simulation (for example, donations
and installments).)
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The candidate recognizes the conflicts between the parties to this engagement and integrates
the various issues facing KL.
The candidate demonstrates competence in Pervasive Qualities and Skills.
Competencies (lists the Pervasive Qualities and Skills for the entire simulation):
II-5 – Manages change
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-2.3 – 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
Generational Differences between Shareholders
Paul’s death and the change in roles within KL, along with changes in the company and the industry, are creating conflicts within KL.
Within the management of the company, intergenerational issues between Frank and Margaret need to be
addressed and a plan or structure put in place to resolve the conflict. Ideally, KL should strive to keep the
expertise and experience of Frank, but also be open to new ideas. The change in governance structure
discussed earlier should be helpful in this area. If this is not addressed, it may become very difficult for
decisions to be made and implemented in the company. While Margaret is CEO, Frank as chair of the
board can veto any decisions he is not in agreement with. If this happens often, it will undermine
Margaret’s position. Margaret may need greater guidance in the CEO role, given her lack of experience. Frank’s past experience would be useful in the transition to CEO, or it may be necessary to seek an
outsider for this role.
The involvement of John Kelly also appears to be creating conflict. It is a significant change for KL since
it has not had any significant involvement from non-family members in the past. There appears to be an
alliance of sorts developing between John and Margaret. It also appears that he is providing input and has
influence over decisions already (for instance, he had Margaret sign the deal for rights to biocremation on
KL’s behalf and has been investigating Environmental Certification). This is despite the fact that the deal
for financing is not yet in place. This may be an indication of his future intentions. It is important that the
details of the financing agreement put limits on John’s involvement in the decision-making process or the
family may lose control of the company.
93
It would also be useful for the shareholders to develop a shareholders’ agreement, since one does not appear to be in place. Frank frequently refers to things being done according to “tradition,” which raises questions as to whether there is any underlying legal structure to certain transactions and activities.
Overall, it appears that financing is needed to upgrade and update the physical assets and implement a
new computer system, at a minimum. In order for this to happen, KL needs to find a way to deal with the
conflicts and adjust to outside involvement in the company in one form or another. It appears that if this is
not done, the company will become stagnant.
(Many candidates did not identify any conflicts or may have tried to identify them, but only listed case
facts without explaining the implications of the conflict. Other candidates attempted to address the
conflicts, but their discussions were insufficient or did not consider the context of the scenario. For
example, some candidates identified the conflict between Frank and Margaret, but many candidates
chose either Frank’s side or Margaret’s side and discussed at length why the other party was in error. Some of these discussions were unprofessional, since the tone used was harsh and the advice provided
was frequently biased. Many candidates accused Frank of being too old and stubborn, or felt that
Margaret was too young and inexperienced and should be fired. Because KL was EJT’s client, advice of that nature would likely not be appreciated by all parties involved and would have negative
repercussions for the client relationship in the future.)
Implications for EJT and Partners
Our role in this consulting engagement creates challenges for us. KL has not used professional advisors in
the past and may have unrealistic expectations. We need to make it clear what we can do and the services
we will provide. If this is not done at the start of the engagement, we risk not meeting expectations and
may have difficulty collecting our fees. An engagement letter should be prepared setting out what we will
do and KL’s responsibilities in providing information.
We have been hired by the company, KL, and need to provide unbiased advice in the best interests of all
of its shareholders. As discussed in the previous section, there are conflicts within the company. As
advisors, we need to make sure that the impact of decisions on all groups is considered and discussed
openly. In some cases it may be appropriate to recommend that individuals obtain independent
professional advice. For example, shareholders need to decide independently whether to accept the offer
by KL to redeem their shares.
The conflict between Frank and Margaret also places us in a difficult situation in terms of confidentiality
of information. We have to make sure that we do not disclose information that we have been asked to
keep confidential, but at the same time we have to be able to work in the best interest of all of KL’s shareholders. We may want to make this clear to Frank and Margaret and try to get their understanding
and approval to have all issues openly discussed. For example, being told by Frank, “between you and me, I want your analysis to conclude that KL should not proceed with the biocremation facility,” may not be productive or fair to Margaret. His comment and concerns may reflect his recognition of the
importance of tradition; however, they may also be representative of fear of change.
94
Margaret asked us to prepare projections for the biocremation facility that “will prove to Frank and the shareholders that this makes sense.” She believes that a projection from an independent third party would mean more than one that she would prepare. This indicates that she may think we are adding some degree
of assurance on the projection. We have to be careful regarding association. We have to make sure that
our role here is clear. It appears that Margaret may be looking for support on a decision to go ahead with
the project, rather than a realistic evaluation of the project.
(Many candidates addressing this area were able to discuss the implications for EJT of multiple
engagements and the expectations of the various parties involved.)
Changes and Challenges Facing KL
There are a lot of changes and challenges facing KL, and we are coming into this in the middle of things.
Many of the decisions that need to be made are interrelated — a decision in one area has an impact on
decisions in others. I have made a list of the significant interdependencies:
Integration of Different Areas
Financing proposal
Requires 2013 financial statements to be completed — including selection
of accounting policies
Requires environmental certification for 2013
Compounding of interest will affect tax payable by KL
Potential for future loss of control if two consecutive years of losses (and
John exercises his option to convert loan to 51% equity)
Affects governance structure and decision-making going forward
Would necessitate a change in strategic direction for KL since John is
likely only interested in lending KL money if changes are made
Accounting policy
Affects EBITDA and the interest charged on financing provided
selection
Affects the amount that will be paid for share buyout and redemption
In turn, will affect amount of financing required and the number of shares
that can be repurchased (maximum $500,000)
Sale of casket
Provides an example of decision-making with incomplete information or
production
review due to the informal governance structure of KL
Ability to improve the decision-making process in future with SCC
proposal
Biocremation facility needs to be set up so direct costs are tracked
separately
Ineffective cash management on sale of casket assets (investment asset but
outstanding mortgage loan)
Biocremation facility
One of main reasons for needing financing and the interest that is based on
EBITDA
Should help with obtaining environmental certification
A significant change for KL that begins the change in strategic direction
for the company
SCC proposal
Should help provide information for decision-making
Should help track information for environmental certification
95
We need to integrate all of the changes that are being contemplated by KL to determine the overall impact
on the company’s risk profile and on a financial basis. Our analysis should take the following into consideration:
Removal of casket production
Addition of biocremation facility
Cost of financing proposal
Modernization of facilities and equipment
New computing contract
Costs of environmental initiative, including monitoring and verification
It is important to highlight to Margaret, Frank, and KL’s shareholders that several of the changes proposed increase KL’s business risk profile:
In financial structure — leverage in terms of debt increases risk.
The biocremation facility is also highly leveraged and carries high fixed costs — increases risk.
Outsourcing of the computer system also makes KL more dependent on others and likely carries a
substantial contractual commitment.
There may be options (other than the biocremation facility) that KL can consider if its desire is for future
growth and expansion, including the purchase of other funeral homes in Regina or outside of the region
(similar to other competitors in the area).
(Candidates did attempt to integrate some aspects of their analyses, often in the area of how the reports
available under the SCC system could be used for governance purposes, in the inclusion of
recommended accounting adjustments into the EBITDA calculation, and in the incorporation of the
biocremation facility proposal into the determination of EBITDA for the financing proposal. However,
in general, candidates did not consider the impact that one analysis or decision had on others.)
For Primary Indicator #8 (Pervasive Qualities and Skills), the candidate must be
Percent
Awarded
0.3%
competence.
25.0%
Reaching competence — The candidate recognizes the conflicts between the
parties to this engagement or integrates the various issues facing KL.
39.0%
Competent — The candidate discusses the conflicts between the parties to this
engagement and integrates the various issues facing KL.
35.7%
Highly competent — The candidate thoroughly discusses the conflicts between
the parties to this engagement and integrates the various issues facing KL.
0.0%
96
(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 the various
parties involved in the engagement. Candidates were expected to discuss the conflicts between the
parties to the engagement and integrate the various issues facing Kinfolk. There were many hints
throughout the simulation to indicate that conflicts existed in several areas. These hints included
Frank’s comment that Margaret has unconventional ideas and does not fully appreciate the
importance of tradition, his desire for the biocremation analysis to conclude that Kinfolk should not
proceed (when Margaret wants the analysis to prove to Frank that it makes sense), and the fact that
Frank doesn’t know about John’s financing proposal (which has terms attached that could have a significant impact on Kinfolk), among others. Candidates were expected to identify these issues and to
discuss them.)
(Candidates performed adequately on this indicator. While some candidates were able to recognize the
conflicts between various parties, many of their discussions repeated case facts with little value added.
For example, in the discussion of Frank and Margaret, some candidates recognized that they had
different perspectives with respect to the proposed biocremation facility, but their only concern was that
this would lead to arguments between the two. Candidates should have considered the impact of the
difference in outlook on KL, its operations, and future viability, and not merely on the interpersonal
conflicts that would arise. In addition, candidates struggled to recognize the links between the various
analyses in the simulation. For example, the proposed SCC system would help with enhanced reporting
requirements, as requested by John in his financing proposal, as well as reporting needs for Frank and
the board. In addition, the information required for compliance with EFBC standards might also be
captured by aspects of the SCC system. Candidates are encouraged to always step back and perform an
overall analysis of any simulation or business situation that they encounter.)
(Overall, candidates performed adequately on the comprehensive simulation, with the exception of
Primary Indicator #3 (Finance) and Primary Indicator #7 (Taxation), where they performed poorly.
On the Finance indicator, candidates struggled with the quantitative aspects of a relatively simple
calculation of interest cost. On the Taxation indicator, which focused on corporate taxation,
candidates did not adequately address the significant issues related to the sale of the casket production
facility, nor were they able to demonstrate sufficient correct tax knowledge in minor areas.)
(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.)
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EVALUATION GUIDE
KINFOLK LIMITED
SECONDARY INDICATORS OF COMPETENCE
Secondary Indicator #1
The candidate discusses the other tax issues associated with the shareholders of Kinfolk
Limited.
The candidate demonstrates competence in Taxation.
Competencies
IX-1.2 – Identifies and advises on compliance and filing requirements (A)
IX-2.2 – Calculates income taxes payable for an individual in non-routine situations (B)
IX-3.2 – Identifies, analyzes, and advises on specific tax planning opportunities for shareholders of
closely held corporations (B)
Personal Tax Filings Related to Paul’s Death
Frank mentioned that he is unsure of the filing requirements related to Paul’s death, but he did advise us that, by tradition, KL usually handles all such relevant filing. Multiple returns may need to be filed for
Paul. A terminal (or final) return must be filed for the period from January 1, 2013, to the date of death
(sometime in May) to report all income to that date. The due date for filing of that return is April 30, 2014
(being the later of six months after the date of death and April 30 of the following year).
Depending upon the nature of Paul’s assets at the time of death, KL may wish to file a return for rights or things: amounts that had not been paid to Paul at the time of his death and would have been included in
his income when received, had he been alive. Generally, this would include such things as salary or
vacation pay earned but not paid at the time of death, and unpaid dividends declared before the date of
death. We would have to find out if Paul was entitled to any of these amounts to determine if this return
should be filed. It would need to be filed by the later of (1) 90 days after receiving the Notice of
Assessment for the final return and (2) one year after the date of death. The filing of a return for rights or
things provides for an additional opportunity (in addition to claims on the final return) to claim certain
non-refundable tax credits (basic personal exemption, age amount, et cetera), which may reduce tax for
the deceased.
(Candidates addressing this indicator were familiar with the filing deadlines for a deceased taxpayer,
as well as the different returns that could be filed.)
Deemed Disposition at Death
By tradition, KL will redeem Paul’s shareholdings from his estate at an amount based on book value at the year-end prior to death. Frank thinks that Paul originally acquired the shares for $12,000, making that
his adjusted cost base (ACB).
98
Upon Paul’s death, there is a deemed disposition of his KL shares at their fair market value immediately prior to death (ITA 70(5)(a)). Using the 2012 financial statements provided by KL, the book value of his
12% ownership is approximately $130,000 (12% × $1,082,000 of retained earnings). If the book value of
the shares approximates the fair market value (FMV), then a capital gain of $118,000 results ($130,000
FMV of shares − $12,000 ACB). This gain could be reduced by any capital losses that Paul may have. One half of the gain (or $59,000) is included in income and reported on Paul’s terminal return.
It is unlikely that the gain would qualify for an exemption from tax, using the Capital Gains Exemption
(CGE), because the shares would not likely be qualified small business corporation shares since they must
meet the following three criteria to be eligible:
Shares must be held in a Canadian controlled private corporation at the time of disposition — this
criterion has likely been met.
Substantially all (90%) of the assets are used principally in an active business — initially, it would
appear that this criterion has not been met since investment assets of $610,000 (investments of
$160,000 and leased property of $450,000) is 30% of the book value of assets; however, a full
assessment of the assets should be considered before determining whether the 90% test is satisfied.
The shares have been held continuously for at least 24 months, and 50% of the assets are used in an
active business — this criterion has likely been met since Paul has been involved in the company for a
significant length of time and more than 50% of the assets are used in the funeral business.
As a result, the gain cannot be sheltered from tax.
We would have to ask our tax department to examine the $450,000 property transaction of 2011 to
determine whether the leased property qualifies as an asset used in an active business. If it does, then the
90% use test would be satisfied and the CGE may be used (and the lease income would be considered
active business income at the corporate level, taxed at a lower rate).
(Most candidates who addressed this area attempted to calculate a gain on the disposition of the shares
and quickly concluded that the full amount of the gain would be eligible for Paul’s Lifetime Capital Gains Exemption, without considering whether Paul’s shares would satisfy the criteria for eligibility as
qualified small business shares. Those candidates who did consider the eligibility of the shares
frequently used the balance sheet information as provided in the simulation, without questioning the
nature of some of the assets noted (investments and leased property) in their assessment of the 90%
test.)
Redemption of Paul’s Shares
Upon redemption of Paul’s shares, additional personal tax implications would need to be considered (for example, deemed dividend ITA 84(3)), similar to our earlier discussion regarding KL’s purchase of the shares of other shareholders considering share redemption.
99
Directors’ Fees
Regarding the directors’ fees of $3,500 each, the company should ensure that it files T4 Supplementaries
by February 28, 2014, for each of the individuals receiving these fees, since they are considered part of
employment income to the recipient. The fees are subject to Canada Pension Plan (CPP) and income tax
withholding requirements. The fee is equivalent to the basic exemption of $3,500 for CPP, so CPP may
not be payable, depending upon the individuals’ other sources of income from KL. For the individual, the fees are considered earned income for purposes of determining how much can be contributed to a
Registered Retirement Savings Plan.
The directors (who are also shareholders) may have come to expect these fees and use them to
supplement their personal income. Although the individual fee amounts are not significant, KL may wish
to review the remuneration package provided to consider some type of fee/dividend structure that is
beneficial to the individual as well as to the corporation. At the personal level, dividends have a
preferential tax treatment (as a result of the dividend tax credit), and amounts paid out of a capital
dividend account would be received tax free.
(Few candidates addressed this area.)
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 some of the tax consequences for the late Paul
Kinfolk and other shareholders.
(Candidates were provided with information about what the company traditionally does upon the death
of a shareholder (redeems shares and handles all relevant tax filing). Frank provided information on
Paul’s shares and indicated that he may eventually need EJT’s help with these matters. Candidates
who addressed this indicator were expected to discuss some of the tax consequences for the late Paul
Kinfolk and other shareholders.)
(Most candidates who did address this indicator were able to provide appropriate tax advice relating to
the redemption of shares as well as the multiple tax filings that might be required. Weak candidates
only provided information on the filing requirements and deadlines relating to deceased taxpayers.)
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Appendix C — Paper I — Sample Response
SAMPLE RESPONSE
PAPER 1 KINFOLK LIMITED (KL)
The following is a candidate response for Paper 1. Whereas the evaluation guide presents all the
elements of a complete response by indicator, this sample response shows how the case facts are
integrated into an analysis and how the competency areas are addressed in an actual response. It
demonstrates the degree of depth that can be achieved in an exam setting.
To: Margaret and Board of Directors of KL
From: CA
Re: Analysis of KL
Below I have prepared a quantitative and qualitative anlaysis of the project. There is some contention
regarding the prospects of biocremation amongst Margaret and Frank. Therefore, to avoid a potential
conflict of interest, I have prepared a balanced analysis of the project. However, it should be noted that
the quantitative analysis was prepared based on the estimates provided by Margaret. As discussed below,
I recommend that these estimates are investigated for appropriateness by conducting market research.
Quantitative Analysis of Biocremation Project
In Exhibit I, I have prepared a five-year quantitative analysis of the biocremation project. I have
determined that the project has a positive NPV of approximately negative $57,809. I have included the
following factors into my analysis:
I have based my estimate of revenue assuming that 50% of cremations performed will be
biocremations.
Additionally, I have based revenue growth on your projections of 10% in year two and 15%
thereafter.
I have included the royalty and operating costs associated with biocremation services.
I have included the marketing and training costs in year one and decreasing thereafter.
I have included the capital costs of $1,000,000 at time zero.
The opportunity cost of shifting to biocremations has been included as the profit margin on traditional
cremations of $600.
However, it is important to note that the five year analysis is prepared based on Margaret's estimates and
therefore, actual results could be different depending on the accuracy of the estimates. The following is a
summary of the risks included in the financial analysis:
There is a risk that the growth projections are ambitious, and as a result revenue may not be as high as
anticipated which will result in a lower cash flow and net present value.
Your ability to convert 50% of your current cremations into biocremations may not be realistic which
would result in lower revenue which increase the payback period and decrease the net present value.
There is a risk that there may be budget overruns and the initial capital investment may be greater
than $1,000,000 which would increase the payback period and decrease the net present value.
Next, I will discuss the qualitative factors associated with the project.
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Qualitative Analysis of Biocremation Project
Opportunities
Biocremation uses far less energy and does not release any chemicals into the atmosphere. This may
be attractice to customers whose demand has evolved towards "green" funerals. Therefore, this is an
opportunity to capitalize on changing consumer preferences.
There is an opportunity to utilize excess capacity by offering services to other funeral homes.
Competition in the market has increased and this may provide an opportunity for KL to differentiate
to reduce competitive pressures.
Risks
There is a risk that in KL’s market in Regina that the demand for biocremations and "green" funerals will not be as high as initially anticipated. I recommend that further market research is conducted in
KL’s region in order to determine if the esimates included in the quantitative anlaysis are reasonable.
There is a concern that other members of the board of directors are not willing to proceed with
biocremation, and therefore, there is a risk that this project will cause friction and conflict within the
family that could disrupt operations going forward. Specifically, Frank has voiced that he is opposed
to the biocremation project.
The price for biocremations will be $1,400 which is less then the price for traditional cremations
which means that the profit margin on traditional cremations is higher then biocremations. Therefore,
there will be a significant opportunity cost as biocremations will replace 50% of current traditional
cremations which will result in lower profit.
Recommendation
Based on the estimates provided, the five-year analysis as well as the opportunities of biocremation, I do
not recommend that KL proceed with the project. However, I recommend that further market research is
conducted in order to support the estimates included in the quantitative analysis. Furthermore, before
proceeding with the project, it is advised that all parties consider the impact of the business if any disputes
are to arise as a result of the project.
Accounting Adjustments under ASPE
Discontinued Operations
KL discontinued production of caskets and sold the casket production facility in 2013. The accounting
issue is whether or not this is conisdered a discontinued operations. ASPE states that:
The results of operations of a component of an enterprise that either has been disposed of (by sale,
abandonment or spin-off) or is classified as held for sale shall be reported in discontinued operations if
both of the following conditions are met:
(a) the operations and cash flows of the component have been (or will be) eliminated from the ongoing
operations of the enterprise as a result of the disposal transaction; and
(b) the enterprise will not have any significant continuing involvement in the operations of the
component after the disposal transaction.
Only items meeting the above criteria shall be reported in discontinued operations.
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ASPE further states that a component of an enterprise comprises operations and cash flows that can be
clearly distinguished, operationally and for financial reporting purposes, from the rest of the enterprise. It
appears that the casket production facility meets the definition of a component since the casket sales and
costs were recorded separetely in the accounts and were reviewed regularly by management.
The concern is that it could be argued that because KL expects to use or sell the remaining casket
inventory in the normal course of business over the next year that the operations and cash flows have not
been eliminated from the ongoing operations. However, the remaining inventory is marginal compared to
the disposition and the remaining inventory is expected to be used within one year. Therefore, it appears
that this criteria is met.
It appears that criteria (b) is met as KL has not and will not be involved in the casket operations after
disposal apart from the sale of the remaining casket inventory discussed above.
Therefore, in accordance with ASPE, the results of discontinued operations, less applicable income taxes,
shall be reported as a separate element of income on the income statement including the gain on disposal.
This is beneficial as if you are to proceed with the financing proposal from John then this should be
excluded from EBITDA which will reduce the interest expense in year one.
Intangible Asset
KL has paid $50,000 to a company that licenses and supplies the equipment for biocremation technology.
The agreement grants the rights to KL's geographic region for an indefinite period. Currently, KL has
recorded the payment as a prepaid expense. However, the accounting issue is whether this qualifies as an
intangible asset.
ASPE states that an intangible asset must be identifiable, the entity must control it, and their must be
future economic benefits.
Identifiability
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.
It appears this criteria is met as the asset has arose from contractual rights as granted by the licensing
company.
Control
An entity controls an asset if the entity has the power to obtain the future economic benefits flowing from
the underlying resource and to restrict the access of others to those benefits. The capacity of an entity to
control the future economic benefits from an intangible asset would normally stem from legal rights that
are enforceable in a court of law.
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It appears that this definition is met since KL will have legal rights as a result of signing the contract with
the licensing company. It appears the agreement gives KL exclusive rights which means that KL has the
power to obtain the future economic benefits from the license.
Future Economic Benefits
The future economic benefits flowing from an intangible asset may include revenue from the sale of
products or services, cost savings, or other benefits resulting from the use of the asset by the entity.
Based on the quantitative analysis performed in Exhibit I, it appears this criteria has been met. There is
evidence that demand exists for biocremations which the license enables KL to perform. Therefore, it
appears this criteria has been met.
Additionally, ASPE states that the reconigtion criteria must be met to recognize an intangible asset:
An intangible asset shall be recognized if, and only if:
(a) it is probable that the expected future economic benefits that are attributable to the asset will flow to
the entity; and
(b) the cost of the asset can be measured reliably
Both of these criteria appear to have been met. Similar to the above, it is likely the license meets the
probable expected future economic benefits criteria since it appears that the contract will give KL rights
to provide a service that is in demand and will generate significant future revenues. Additionally, the
second criteria is met since the cost of the license is known and is $50,000.
Based on the anlaysis above, it appears that the license meets the definition of an intangible asset and
recognition criteria. Therefore, the $50,000 cost should be reclassified from prepaid expense and recorded
as an intangible asset.
ASPE states that a recognized intangible asset shall be amortized over its useful life to an enterprise,
unless the life is determined to be indefinite. When an intangible asset is determined to have an indefinite
useful life, it shall not be amortized until its life is determined to be no longer indefinite. Since the license
has an indefinite useful life, it should not be amortized.
Inventory
KL has casket inventory remaining after the disposal of the casket production facility. However, there is a
concern that the inventory may be impaired since the casket operation was only breaking even. ASPE
states that inventory is to be carreid at the lower of cost or net realizable value. Therefore, the cost of the
inventory should be compared to recent selling prices to determine if net realizable value has fallen below
cost, and a writedown is required.
Sale-Leaseback Transaction
KL purchased a rural property and leased the property back to the farmer for a term of 20 years. KL
currently has recorded the property as an item of PP&E and records the lease payments as revenue. ASPE
states that in a sale-leaseback transaction, the lease shall be accounted for as a capital, direct financing or
operating lease, as appropriate, by the seller-lessee and by the purchaser-lessor.
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In order to determine the appropriate accounting treatment, we must determine if the lease qualifies as a
capital lease. I do not have all of the information to assess all of the criteria of a capital lease. However, I
do know that the fair market value of the property is $450,000 and the annual rent is $36,000 for 20 years.
Using a discount rate of 6% which is KL's borrowing rate, the present value of the lease payments is
$412,918 which represents approximately 92% of the fair market value of the leased assets. Therefore,
this means that the lease is a capital lease.
ASPE states that when the leaseback is classified as a capital lease, any profit or loss arising on the sale
shall be deferred and amortized in proportion to the amortization of the leased asset except for leases
involving land only, in which case it shall be amortized over the lease term on a straight-line basis.
Therefore, the loss on the sale should be amoritzed straight line over the 20 year term of the lease.
Therefore, the loss of $37,082 ($412,918 less $450,000) shall be recognized at $1,854 per year.
Analysis of Financing Proposal
Qualitative Anlaysis of Financing Proposal
Opportunities
Principal and interest are not due until the end of the third year. This alleviates the strain from a cash
flow perspective as it will allow time for the operations of the biocremation facility to start-up before
any debt servicing is required.
KL will only have to pay interest at the prime rate if it has negative EBITDA. This reduces the
financial risk if KL is not profitable initially.
Risks
The additional interest is based on 30% of EBITDA. This could be risky to KL as if KL is profitable,
KL may end up paying a higher rate of interest then it would otherwise had KL pursued other
financing alternatives.
John Kelly will have the option to convert his loan into 51% equity position in KL if EBITDA is
negative for two consecutive years. This is a significant risk as this means that John will acquire
control of KL which means the will be able to make the strategic, operating, and financing decisions
of KL. KL has historically been a family-owned and operated business and this means there is a risk
that this tradition and culture will be broken which other shareholders will likely disapprove of.
The proposal includes the buy out of all shareholders not willing to proceed with the project which is
a significant cost.
Dividends are not allowed to exceed 45% of net income. Dividends have been paid consistently
regardless of profitability in the past. In 2013, dividends were 227% of net income. Therefore, it is
likely that other shareholders will not be in agreement with this condition.
Quantitative Analysis of Financing Proposal
In Exhibit II, I have performed a quantitative analysis of the financing proposal. I have determined that
the effective interest rate in year one to be 6.4% increasing to 10.5% in year three. This is significantly
higher then KL’s current borrowing rate of 6%. Additionally, the total expected interest and principal repayment at the end of year three is approximately $2,546,000 which exceeds the total cash flows that
are expected to be generated from the biocremation project over the five years as presented in Exhibit I.
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Conclusion
The effective interest rate on the financing is projected to be 7.3% increasing to 9.6%. This is
significantly higher then KL’s current borrowing rate of 6%. Additionally, there is a risk that John could convert his loan into a majority interest in KL which would mean that the family will lose control.
Therefore, I do not recommend this financing proposal is accepted. If KL proceeds with the biocremation
facility, I recommend KL consider alternative sources of financing such as:
Approaching the bank for additional financing
Personal investments from the current shareholders
Procedures to Perform to Provide Assurance on Environmental Certification
Risk: There is a risk that the percentage of embalming fluid purchased that is biodegradable could fall
below 50%.
Procedure: Obtain purchase journal for embalming fluid and vouch purchases to supporting
documentation such as the purchase invoice. Assess invoice for indication that embalming fluid is
biodegradable. Assess total purchases of biodegradable and compare to total purchases to determine if
50% minimum threshold is met.
Risk: There is a risk that the percentage of funerals that are cremations or biocremations could fall below
40%.
Procedure: Obtain sales journal and vouch entries to invoices to determine if funeral included cremation.
Compare total of funerals including cremations to total funerals provided and determine if KL is in
compliance with minimum 40% condition.
Risk: There is a risk that the energy consumption per square metre of funeral home is greater then 25.
Procedure: Obtain utilities statements during the year to quantify the total energy consumption for the
year. Alternatively, could consider sending confirmation to utility provider to confirm total energy
consumption for the year. Obtain building information such as blueprints or evidence of square footage
from third party such as property tax assessment and perform calculation of energy consumption per
square metre of funeral home and compare to maximum of 25 to determine if KL is in compliance.
Risk: Obtain PP&E listing of vehicles owned and used in operations of KL. Enquire with managmenet if
a log is kept of vehicle usage. Additionally, obtain fuel expense account detail for the year. Quantify total
kilometres driven per the drivers log, and divide fuel expense by total kilometres driven. If drivers log is
not available, determine if you can estimate starting mileage based on maintenance documents and assess
mileage at year end to estimate total kilometres driven during the year.
CFA Audit Report
The current audit report prepared by the CFA is not sufficent. The audit report should state that the audit
was conducted by the independent auditors. Furthermore, the audit report should contain the following
information:
The introductory paragraph in the auditor's report shall: (Ref: Para. A17-A19)
(a) Identify the entity being audited
(b) State that the CFA reporting package has been audited;
(c) Identify the components of the CFA reporting document;
(d) Refer to the summary of the CFA criteria; and
(e) Specify the date or period covered by the reporting document to the CFA
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Additionally, the audit report should contain a section outlining management's responsibilities and the
auditor's responsibilities with respect to the reporting document for the CFA.
Additionally, the current audit report opinion is insufficient. CAS states that the audit report should
contain:
The auditor's report shall include a section with the heading "Opinion."
When expressing an unmodified opinion on financial statements prepared in accordance with a
fairpresentation framework, the auditor's opinion shall, unless otherwise required by law or
regulation, use one of the following phrases, which are regarded as being equivalent:
(a) The financial statements present fairly, in all material respects, … in accordance with [the applicable financial reporting framework]; or
(b) The financial statements give a true and fair view of … in accordance with [the applicable financial reporting framework]
Currently, the report states that the auditor certifies that the company meets the standard. This should be
replaced with one of the statements identified above. The statements should also state the CFA
requirements as the reporting framework.
Controls of the SCC System
Control Strengths
Strength: The accounting and funeral tracking software modules are integrated.
Implication: This means that the information will not have to be re-entered, eliminating the need for
manual entry means the risk of error is decreased.
Strength: The sytem can prepare all government forms, including death certificates and burial permits.
Implication: This will reduce time of processing all of the related paperwork which will improve
efficiency at KL.
Recommendation: I recommend that samples of the forms generated from the system are compared to the
source data to ensure that the system is functioning correctly.
Strength/Weakness: Users have unqiue passwords to access the entire system.
Implication: The information contained in the system is sensitive and confidential. Furthermore, not all
employees should have access to the entire system in order to achieve appropraite segregation of duties to
reduce the risk of fraud.
Recommendation: I recommend that access to the entire system is not granted to all employees. For
example, those responsible for the receipt and deposit of cash should not have access to the accounting
records.
Control Weaknesses
Weakness: The informatoin is stored on SCC servers and is accessed over the internet.
Implication: There is a risk that the information could be hacked and the integrity of the data comprised as
it is accessed over the internet. There is no information about the level of encryption. KL is responsible
for protecting the confidential information of its clients and failure to do so could result in legal action
and damaged reputation.
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Recommendation: I recommend that you enquire with SCC about the data enctryption used. KL should
verify if SCC uses 128 bit encryption which is the same level of encryption used by banks.
Weakness: SCC has indicated that no testing of reports is required.
Implication: There is no guarantee that the reports will be generated without error. Errors in reports can
have significant adverse effects since they will be used for decision making purposes.
Recommendation: I recommend that KL test the reports generated by the system by tracing the
information back to source data to confirm the accuracy of the data presented in the reports.
Weakness: SCC staff will be able to access all of KL records.
Implication: The information contained in the system is highly sensitive and confidential and it is not
necessary for all employees at SCC to be able to acess all of the information contained in the system. This
represents a risk to the confidentiality of SCC client's information.
Recommendation: Therefore, KL should ensure that there is appropriate controls in place at SCC over the
access of information.
Analysis of Governance Issues at KL
Governance Structure
Weakness: There is limited independence at the Board level as all board members are shareholders and
family members.
Implication: Lack of independence reduces the ability of the Board to provide an effective oversight role
which can have adverse effects to the business overall.
Recommendation: I recommend that the majority of board members be independent. This will improve
the oversight at the board level.
Weakness: Attendance is voluntary at board meetings:
Implication: Without regular attendance by board members at meetings, the meetings will not be effective
as not all members are present to provide their opinions and vote on important business decisions.
Recommendation: I recommend that board meeting attendance be mandatory.
Weakness: Board meetings are only held once annually.
Implication: One board meeting per year is not sufficient enough for the board members to discharge their
oversight responsibilities. KL is facing significant changes in their operating environment including
increased competition. KL is contemplating the acquisition of a biocremation facility which is a critical
business decision. Additionally, the change in CEO represents a risk to the company as Margaret was
promoted prematurely due to the death of Paul. Therefore, the Board needs to increase its oversight in
response to these recent changes.
Recommendation: I recommend that the board meet more frequently such as monthly, or at least
quarterly.
Weakness: There is a concern that the Board members do not possess adequate financial and legal
expertise.
Implication: In order to effectively discharge their responsibilities, the board needs to be literate in
finance, accounting, and law. This will ensure that they have the capacity to analyze issues facing KL
with the appropriate competency.
Recommendation: I recommend that a professional with financial expertise and legal expertise such as a
CA and a lawyer be recruited to the Board of Directors.
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Decision Making
Weakness: Margaret was able to sign an agreement on behalf of KL for the license for the biocremation
technology.
Implication: Margaret has proceeded to invest in biocremation project before board approval. It apperas
that there are not policies regarding the approval of significant business decisions.
Recommendation: I recommend that KL institute a policy whereby, all significant decisions require board
approval by way of vote before proceeding.
Reporting Package
Weakness: There is a concern that the Board of Directors does not receive accurate and timely financial
information.
Implication: Without accurate and timely financial information the Board is unable to assess
management's performance and the performance of the business. Therefore, this increases the risk that KL
could run into financial difficulty, as the Board is unable to identify and implement mitigated strategies to
financial risks that may arise.
Recommendation: I recommend that the Board receive monthly or quarterly financial statements for their
evaluation.
Tax Matters at Year End and Going Forward
Eligible Capital Property
KL has currently deducted the $50,000 cost of the license on Schedule 1 which is an intangible asset. This
is not correct, as this cost should be added to cumulative eligible capital property and CEC should be
deducted. The addition to eligible capital property occurs at 75% of the cost of the asset which is $37,500
($50,000 x 75%). The amount of CEC is calculated is 7% of the pool which is $2,625. Therefore, the
$50,000 cost of the license should be added back to taxable income, and the $2,625 of CEC should be
deducted. Please see Exhibit IV for calculation of NIFT and CEC.
Sale of Land and Building
The proceeds from the sale of the building and land were allocated based on the original cost. This is not
appropriate, as the allocation of the proceeds should be based on the fair market value of the land and
building at the time of the sale. It appears that most of the value is attributable to the land and not the
building, since the purchaser intends on demolishing the building. As more of the proceeds are allocated
to the land, the amount of CCA recapture will decrease and the amount of capital loss will increase.
Aggregate Investment Income
The rental income, dividends on shares, and interest income totaling $41,000 is considered aggregate
investment income (AII). Therefore, this income is not subject to the small business deduction. KL will
pay refundable part 1 tax at 26 2/3% of the AII in addition to additional refundable tax at 6 2/3% of the
AII. Additionally, the dividends on shares are conisdered non-connected corp dividends and are subject to
Part IV tax at a rate of 33.33%. In Exhibit III, I have performed a calculation of refundable part one tax,
additional refundable tax, and Part IV tax.
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KL has not recorded a dividend refund. In Exhibit III, I have also performed a caulcation of the RDTOH
balance and the dividend refund. I do not have the information on the opening RDTOH balance, however,
assuming that it is zero, the refundable part one tax and the part IV tax should have been added to
RDTOH. KL paid $200,000 in dividends, which exceeds the 3 to 1 rate required to receive the full
amount of RDTOH back as a dividend refund. Therefore, KL should receive a dividend refund of
$12,267.
Small Business Deduction
The small business deduction is calculated at 17% times the lesser of active business income and the
allocated business limit. There is no indication that KL has any associated companies that it must share
the small business limit of $500,000 with. Active business income, is the taxable income less the agregate
investment income of $41,000 which equals $170,375, see Exhibit IV for supporting calculation.
Therefore, the small business deduction should be calculated as $28,964 before considering any
adjustments to taxable income from the sale of the land and building. Currently it is calculted as $28,000.
It appears that it has been incorrectly calculated as 17% of Net Income for Tax.
Conclusion
There are a number of significant errors in the filing of KL’s 2013 corporate tax return. I recommend that the return be amended immediately to comply with the ITA. Furthermore, prior year returns should be
reviewed and adjusted to avoid future CRA reassessments which would result in penalties and interest
which could be significant.
Tax Implications of Paul's Death
Redemption of Shares
KL tradition is to redeem the shares of a deceased shareholder based on the book value at year end prior
to death. The redemption of Paul's shares could give rise to a dividend and a capital gain. The difference
between the redemption proceeds and the PUC of the shares is considered a deemed dividend.
Furthermore, the difference between the adjusted proceeds, which is the remption proceeds less the
deemed dividend, and the ACB of shares is conisdered a capital gain. However, as the redmeption is
occurring at the book value, and the PUC of the shares equals the ACB of $12,000, there will not be a tax
effect from the redemption as the deemed dividend and capital gain/loss will equal zero.
Filing Deadline
Paul is required to file a final return at the later of six months after the date of death and April 30th.
Rights and Things
There will be an optional additional return that can be filed for amounts subsequently paid to Paul such as
dividends that were declared but unpaid at the time of death. These amounts can be claimed on the rights
and things return. The advanatage to this is that a full basic personal amount can be claimed on this
return. Additionally, the income would otherwise be taxable to Paul's spouse who would otherwise be at a
higher marginal tax rate.
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Other Recommendations
There is a concern that KL does not have the financial expertise to successfully operate. This is evidenced
by the financial accounting and tax issues identified above. This is likely the result of KL’s tradition of being run by family members. However, it has become apparent that the operations of KL have grown
beyond the financial expertise and capabilities of its family members. Therefore, it is recommended that
in addition to restructuring the board of directors, that KL consider hiring individuals with sufficient
accounting and tax knowledge to internally prepare the accounting and tax records. This will improve
KL’s financial and tax reporting which will minimize the risk of CRA reassessments and improve the financial information avaialable for managment decision-making.
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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.
**********
January 1, 2013, to create Chartered Professional Accountants of Canada (CPA Canada) as the national organization to support unification of the
2013
Printed in Canada
(CONTINUED ON PAGE 2)
II
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Appendix C — Paper II
SIMULATION 1 (85 minutes)
It is January 20, 2013. Mr. Neely, a partner in your office, wants to see you, CA, about Bruin Car Parts
Inc. (BCP), a client requiring assistance. For the past eight years, your firm has performed review
engagements of BCP’s financial statements. BCP prepares its financial statements in accordance with Accounting Standards for Private Enterprises (ASPE). Richard (Rick) Bergeron, Lyle Chara, and Jean
Perron each own 100 common shares of BCP. Jean wants BCP to buy him out. You made some notes on
BCP during your discussion with Mr. Neely (Exhibit I).
Mr. Neely forwarded an email from Rick (Exhibit II) to you, along with excerpts from the Unanimous
Shareholders’ Agreement (USA) (Exhibit III), the draft financial statements for BCP for the year ended
November 30, 2012 (Exhibit IV), and some additional information regarding the draft financial
statements (Exhibit V).
Mr. Neely tells you, “CA, we need to establish a buyout value. The remaining shareholders need to know what they will have to pay Jean. Our valuation must take into account any accounting adjustments
required to comply with the USA requirements. Please also consider any other issues that may be relevant
to the other shareholders. As for the review engagement, another partner’s staff will complete it in about a
month. Since Rick and Lyle need to act quickly, work with BCP’s draft financial statements for now.”
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SIMULATION 1 (continued)
EXHIBIT I
NOTES ON BRUIN CAR PARTS INC.
BCP was founded in 1982. It manufactures car parts for the North American automotive industry. All
sales are made to Canadian-based companies. BCP had substantial growth in the 1990s and early 2000s.
In spite of a significant decline in sales in the last few years, BCP’s sales have recently recovered.
All three shareholders have known each other for over 35 years and have different roles within BCP. Rick
handles the financial and administrative duties, Lyle is in charge of product design and testing, and Jean is
in charge of sales.
BCP’s corporate tax rate is the small business rate of 12% for active business income and is 45% for
investment income. BCP applies the taxes payable method for accounting purposes.
BCP incurred operating losses in the last few years and as a result has accumulated non-capital losses
totalling $240,000, and these losses expire as follows:
2030
2031
$ 112,000
$ 128,000
BCP does research and development (R&D) every five years, on average. When it does, it files a
scientific research and experimental development (SR&ED) claim and receives a 35% refundable
investment tax credit on its eligible R&D expenses.
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EXHIBIT II
EMAIL FROM MR. BERGERON
Jean Perron told us on January 12 that he wants to be bought out of BCP. This request has shocked Lyle
and me. He said that BCP must buy him out, as per the USA. I knew Jean was having personal difficulties
after his divorce, and he took time off, but he seemed better lately. He started asking for a repayment of
his shareholder loan a few months ago to help with his cash flow, but we could not afford it. We were
planning to repay him soon, since 2012 was our best year in the past five years.
We need you to determine the impact of the buyout on me and Lyle, as well as the financial impact on
BCP. I pulled out the USA from our archived corporate files. It took me a while to find it, and I barely
remembered what it said.
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EXHIBIT III
EXCERPTS FROM BCP’S UNANIMOUS
SHAREHOLDERS’ AGREEMENT
This agreement made the 13th day of October, 1982
Between: Mr. Richard Bergeron, Mr. Lyle Chara, and Mr. Jean Perron (“the Shareholders”) and Bruin Car Parts Inc. (“BCP”)
Clause 3:
(a) Any of the Shareholders may give notice, within 90 days after the end of the fiscal year,
of the intent to sell their shares.
(b) Effective the date the notice is given, the seller’s shares will be exchanged for non-voting
preferred shares, which BCP must then redeem. BCP shall redeem 10% of the shares
within sixty (60) days of receiving notice. The rest of the shares will be redeemed over
nine (9) years on an equal annual basis, with the first redemption one year after the initial
payment.
(c) To determine the value of the shares for redemption purposes, the starting point will be
the shareholders’ equity on BCP’s balance sheet, prepared in accordance with Canadian generally accepted accounting principles, as at the latest fiscal year end, with adjustments
made to recognize the following factors:
1. All capital assets and investments shall be at their fair market value.
2. The value of the shares of BCP shall include a liability for current taxes for the
latest fiscal year end.
3. Any goodwill shall not have any value.
4. Any non-capital losses shall be valued using the tax rate applicable at the date of
the notice of redemption.
(d) Each share shall be valued at a pro rata portion of the total value of the company.
(e) The following discount should be applied to the value of each share if the redemption
occurs during the period referred to:
Prior to the fifth anniversary of the USA: 50%
Prior to the tenth anniversary of the USA: 25%
After the tenth anniversary of the USA:
10%
(f) Upon notice of redemption, any balance due to the shareholder becomes payable on the
same terms as for the redemption of the shares.
120
EXHIBIT IV
BRUIN CAR PARTS INC.
BALANCE SHEET
As at November 30
(unaudited)
2012
2011
Assets
Cash
Accounts receivable
Taxes receivable
Inventories
Prepaids
Research and development
Investment
Property, plant and equipment
$
–
2,800,000
–
950,000
40,000
200,000
90,000
1,150,000
$
110,000
2,000,000
20,000
571,000
43,000
–
90,000
1,050,000
$
5,230,000
$
3,884,000
$
500,000
400,000
400,000
600,000
1,900,000
$
–
400,000
250,000
600,000
1,250,000
Liabilities
Bank indebtedness
Demand loan
Accounts payable
Shareholder loans
Share capital
300
300
Retained earnings, opening
Net income (loss)
Retained earnings, ending
2,633,700
696,000
3,329,700
2,856,700
(223,000)
2,633,700
3,330,000
2,634,000
$
5,230,000
$
3,884,000
BRUIN CAR PARTS INC.
INCOME STATEMENT
For the years ended November 30
(unaudited)
2012
Sales
$
Cost of goods sold
Material
Labour
Gross margin
Expenses
Salaries
Meals
Depreciation
Interest
Insurance
General and administrative
Professional fees
Repairs and maintenance
Travel
Net income (loss) before tax
Current taxes
Net income (loss) after tax
6,000,000
2011
$
4,200,000
500,000
1,300,000
2,400,000
300,000
300,000
250,000
15,000
30,000
100,000
70,000
58,000
15,000
10,000
–
56,000
604,000
250,000
1,000
30,000
75,000
60,000
59,000
14,000
10,000
–
24,000
523,000
696,000
to be determined
$
3,000,000
696,000
(223,000)
–
$
(223,000)
121
122
EXHIBIT V
ADDITIONAL INFORMATION FROM RICK
REGARDING BCP’S DRAFT FINANCIAL STATEMENTS
This year was much better due to advances in our product design and increased sales efforts. We gained
efficiencies in our production processes, so our gross margins were also much better. The notes below
explain some of the variances in the draft financials.
Accounts Receivable
Higher due to increased sales generated this year. Jean spent a lot more time travelling to conventions and
made many visits to new and existing clients, all of which appears to have paid off based on the sales he
generated. I wish we would get paid, though. Some of the sales Jean generated have been outstanding
since the summer or earlier. A receivable of about $500,000 is due from one of the clients Jean brought
in. Jean told us he visited their plant and they have a great operation. He figures it is a matter of time and
cash flow management, but I am skeptical. The mailing address appears to be a warehouse in downtown
Saskatoon. I phoned the number on file, and a recording said it was out of service. Jean is still confident
they will pay us. Yesterday, he brought in a cheque from them for $100,000.
Inventory
Inventory is carried at cost. However, due to recent legislative changes, about $200,000 of parts inventory
may be obsolete. Jean has identified a client that is willing to buy the parts at cost, so we left the
inventory on the books at year end. I am beginning to wonder about this deal, though. I have asked some
of our other clients if they would purchase the parts, and they replied that they believed the new
legislation would prohibit it. Besides these parts, the retail price of our inventory is about 20% higher than
what we show on the books.
In June, a customer placed a special order that we stored off-site once completed. These parts were still in
storage at year end, and we therefore capitalized the $15,000 storage costs to inventory.
Investment
The investment represents a 5% interest in shares of a company. The shares are not traded on the open
market. There is a rumour that the company is once again involved in some lawsuits, and we are not sure
if it is going to survive much longer. We have decided to sell our interest next week, based on an offer of
$30,000 we received from a private investment firm.
123
Research and Development
Costs of $200,000 have been capitalized. We do R&D every five years, on average, since that is the
average amount of time before a part becomes obsolete. This past year we were approached by an
engineering firm that proposed a new design to us. Prior to purchasing this design we incurred costs,
including some market research costs to ensure that it would generate additional sales. Subsequent to the
purchase we asked our lawyers to patent the design so we could use it for the foreseeable future. All this
work appears to be paying off as our sales have gone up. We expect to file a tax credit claim for the
maximum amount of eligible expenditures.
Included in R&D costs are the following items:
Costs incurred to modify and improve manufacturing equipment
to accommodate the design
Amount paid to engineering firm to acquire design
Legal fees for patent filings and registration (good for 17 years)
Market research costs related to the new design
$ 40,000
$ 125,000
$ 10,000
$ 25,000
Capital Assets
Item
Land
Building (Class 1)
Power equipment (Class 10)
Computers (Class 50)
Other equipment (Class 8)
Net Book
Value at
Nov. 30, 2012
$
100,000
100,000
350,000
40,000
560,000
Fair Market
Value at
Nov. 30, 2012
$
1,000,000
350,000
400,000
35,000
600,000
Undepreciated
Capital Cost at
Dec. 1, 2011
$
100,000
146,042
363,767
28,235
302,586
Total
$
$
$
1,150,000
2,385,000
940,630
The original cost of the building was $200,000. The fair market value of all other depreciable property is
less than the original cost.
Capital asset purchases made during the year:
Office furniture for $20,000
Computers for $15,000
124
Other
Short-term liabilities increased to help finance production of inventories while waiting for
payment from customers on account.
Shareholder loans are split equally between the three of us.
The increase in insurance expense is a $10,000 premium paid for life insurance on all three of
us. This insurance is not required as collateral for our bank financing.
Meals expense increased due to Jean’s increased travel and entertaining of clients. Travel expenses increased because Jean attended five conventions this year, all for about the same
cost per convention. We all attend a convention for Canadian suppliers every year, but the
ones Jean attended in Las Vegas account for the increase this year.
Interest expense includes late filing HST/GST interest and penalties of $1,500.
125
EVALUATION GUIDE
PAPER II, SIMULATION 1 - BRUIN CAR PARTS INC.
Memo to:
From:
Re:
Mr. Neely
CA
Bruin Car Parts Inc. (BCP)
BCP’s two remaining shareholders must address the fact that BCP’s third shareholder is exiting the business. Having the right to demand a buyout means there is a need to perform a share valuation in
accordance with the Unanimous Shareholders’ Agreement (USA). You have mentioned to me that our
valuation must take into consideration any accounting adjustments necessary to comply with the USA
requirements, so I addressed the accounting issues I identified in the information presented and restated
the financial statements accordingly. As well, I have computed the current taxes payable as per the terms
of the buyout valuation provisions of the USA.
Please find enclosed my analysis.
The candidate analyzes the draft financial statements as provided by the client and concludes
on the impact of the accounting adjustments required to be made to shareholders’ equity to be in compliance with the USA.
The candidate is demonstrating competence in Performance Measurement and Reporting.
Competencies
V-2.3 − Accounts for the entity’s routine transactions (A)
V-2.6 − Prepares financial statements using the identified basis of accounting (A)
126
Appendix C — Paper II — Evaluation Guide
First of all, you asked me to look into the accounting adjustments that may be required to BCP’s draft financial statements, since the statements are used as part of the buyout of shares, pursuant to the
provisions of the USA. The USA requires financial statements that are prepared in accordance with
Canadian generally accepted accounting principles. These principles have evolved over time. Currently
BCP prepares its financial statements in accordance with Accounting Standards for Private Enterprises
(ASPE), and we will consider those principles in our valuation. For now we are working with draft
financial statements so that we can respond quickly to Mr. Bergeron. We will need to go back after the
review is complete to see if any of the balances have changed, and if so, find out why, to assess the effect
on our estimated valuation.
Accounts Receivable
We need to determine if the $500,000 account receivable, booked from a client that Jean Perron brought
in, is actually collectible. From what Richard Bergeron says, the amount has been outstanding for several
months. There is, therefore, uncertainty about its collection. Perron is the only one who has had contact
with this client, and there are questions surrounding not just the ability to collect, but even some basic
knowledge of the client itself. We should ensure that the $100,000 collected and brought in by Perron
clears the bank in order to assess the amount to write down, if any, or before setting up an adequate
allowance for doubtful accounts. With Perron leaving and the fact that there is no working phone number
for the client, it is unlikely that the balance remaining will be collected (unless Perron is asked and able to
track the company down and collect it himself on behalf of BCP).
Therefore, we must look to Handbook Accounting — Part II Section 3856, Financial Instrument, which
states:
.16 At the end of each reporting period, an entity shall assess whether there are any indications that
a financial asset, or group of similar financial assets, measured at cost or amortized cost may be
impaired. When there is an indication of impairment, an entity shall determine whether a significant
adverse change has occurred during the period in the expected timing or amount of future cash flows
from the financial asset or group of assets. (Paragraphs 3856.A14-.A21 provide related application
guidance.)
.17 When an entity identifies a significant adverse change in the expected timing or amount of future
cash flows from a financial asset, or group of similar financial assets, it shall reduce the carrying
amount of the asset, or group of assets, to the highest of the following:
(a) the present value of the cash flows expected to be generated by holding the asset, or group of
assets, discounted using a current market rate of interest appropriate to the asset, or group of assets;
(b) the amount that could be realized by selling the asset, or group of assets, at the balance sheet
date; and
(c) the amount the entity expects to realize by exercising its right to any collateral held to secure
repayment of the asset, or group of assets, net of all costs necessary to exercise those rights.
The carrying amount of the asset, or group of assets, shall be reduced directly or through the use of an
allowance account. The amount of the reduction shall be recognized as an impairment loss in net
income.
127
Bergeron has strong doubts that the remaining $400,000 receivable will ever be collected, which is
supported by the amount of time it has been outstanding and the knowledge (or lack thereof) of the client.
BCP has the option to either write off the receivable to bad debts or set up an allowance for doubtful
accounts if BCP believes it might collect some of the balance. Given the facts presented, there is a strong
argument that this receivable has nil realizable value and should be written down accordingly at year-end.
(Most candidates who discussed this issue provided in-depth discussions of the relevant criteria
applicable for financial instruments and recommended appropriate accounting treatments based on the
relevant facts provided in the simulation. Candidates who failed to provide a complete response either
concluded on the accounting treatment without providing the relevant support or did not apply the
appropriate criteria. For example, some candidates questioned whether the sale and related account
receivable should be recorded at all, instead of questioning the value of it due to collectibility concerns.
This discussion was not valid under the circumstances, since there were no simulation facts to indicate
that the sale had not occurred and that the goods had not been delivered to the client.)
Inventory
Obsolete Inventory
It appears that there are valuation concerns regarding some inventory. There is about $200,000 of parts
inventory on the books that is no longer used in the market that BCP sells to, with the possible exception
of the client to whom Perron claims he can sell the inventory at cost. Given the fact that Perron is about to
cut ties with BCP and is the only one who has dealt with this client, this position is doubtful. Further to
this, since some of BCP’s other customers have stated they believe they are no longer allowed to purchase
these parts due to new legislation, there is strong evidence that the parts have no value at all. Therefore,
consideration should be given to reducing the value of this inventory as shown on the balance sheet. As
per HB Section 3031:
.10 Inventories shall be measured at the lower of cost and net realizable value.
Net realizable value
.27 The cost of inventories may not be recoverable if those inventories are damaged, if they have
become wholly or partially obsolete, or if their selling prices have declined. The cost of inventories
may also not be recoverable if the estimated costs of completion or the estimated costs to be incurred
to make the sale have increased. The practice of writing inventories down below cost to net realizable
value is consistent with the view that assets are not carried in excess of amounts expected to be
realized from their sale or use.
.28 Inventories are usually written down to net realizable value item by item. However, in some
circumstances, it may be appropriate to group similar or related items. This may be the case with
items of inventory relating to the same product line that have similar purposes or end uses, are
produced and marketed in the same geographical area, and cannot be practicably evaluated
separately from other items in that product line. It is not appropriate to write inventories down on the
basis of a classification of inventory (for example, finished goods, or all the inventories in a particular
industry or geographical segment).
128
Recognition as an expense
.33 When inventories are sold, the carrying amount of those inventories shall be recognized as an
expense in the period in which the related revenue is recognized. The amount of any write-down of
inventories to net realizable value and all losses of inventories shall be recognized as an expense in
the period the write-down or loss occurs. The amount of any reversal of any write-down of inventories,
arising from an increase in net realizable value, shall be recognized as a reduction in the amount of
inventories recognized as an expense in the period in which the reversal occurs.
Since these parts are now obsolete, we should group them together by nature as per 3031.28 and write
them down to their net realizable value (per 3031.27), which is nil (write off entire $200,000). This will
be included as an expense in the income statement in the period in which the write-down occurs, as per
3031.33, which would be in the November 30, 2012, financial statements.
Storage Costs
Section 3031.11 indicates what costs should be included in inventory:
11. 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.
However, Section 3031.16 indicates that “other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition.”
As well, Section 3031.17 provides examples of costs that should definitely not be included in inventory.
Namely, paragraph (b) refers to “storage costs.” Therefore, the $15,000 extra storage costs incurred as a
result of a special order should not have been capitalized to inventory and should be included in cost of
goods sold.
(Most candidates identified the issues with respect to the valuation of the inventory and provided
relevant accounting discussions, recognizing that the inventory value should be written down for both
the obsolete inventory and the extra storage costs. The inventory obsolescence issue was generally very
well done by candidates, whereas candidates’ discussions of the storage costs tended to lack depth.
Many candidates provided conclusions on an accounting treatment for the storage costs without first
providing relevant support, failing to refer to the accounting standards.)
Financial Instrument — Investment in Shares
There are doubts about the long-term prospects of the company BCP has invested in due to some
litigation. BCP is considering selling its investment in the very near future. Its value has dropped by twothirds since its acquisition. This investment is considered to be a financial asset as per Handbook Section
3856, Financial Instruments. When there is some indication that the value has been impaired, we must
consider the following:
129
Impairment
.16 At the end of each reporting period, an entity shall assess whether there are any indications that
a financial asset, or group of similar financial assets, measured at cost or amortized cost may be
impaired. When there is an indication of impairment, an entity shall determine whether a significant
adverse change has occurred during the period in the expected timing or amount of future cash flows
from the financial asset or group of assets. (Paragraphs 3856.A14-.A21 provide related application
guidance.)
.17 When an entity identifies a significant adverse change in the expected timing or amount of future
cash flows from a financial asset, or group of similar financial assets, it shall reduce the carrying
amount of the asset, or group of assets, to the highest of the following:
(a) the present value of the cash flows expected to be generated by holding the asset, or group of
assets, discounted using a current market rate of interest appropriate to the asset, or group of assets;
(b) the amount that could be realized by selling the asset, or group of assets, at the balance sheet
date; and
(c) the amount the entity expects to realize by exercising its right to any collateral held to secure
repayment of the asset, or group of assets, net of all costs necessary to exercise those rights.
The carrying amount of the asset, or group of assets, shall be reduced directly or through the use of an
allowance account. The amount of the reduction shall be recognized as an impairment loss in net
income.
Bergeron is fairly certain that this company will not be able to continue for long; thus, there is strong
evidence of impairment. BCP has an offer of $30,000 for the investment (we aren’t sure when this offer was received), and it is likely the shares will be sold next week. Therefore, under 3856.17(b), we will
write the investment down to this value as at year-end and record the reduction as an impairment loss on
the income statement.
(A little over half of the candidates identified this issue; however, many of those candidates missed the
impairment issues. Many candidates only considered the provision of the USA, which required that the
investment be recognized at its fair market value for purposes of determining the value of the shares of
BCP, without considering the relevant ASPE criteria.)
Research and Development Costs
BCP has done some R&D work this year for the first time in several years. As a result, it has acquired
new designs and made upgrades to its equipment. It is showing the full amount capitalized as R&D on the
balance sheet. Bergeron provided a breakdown of the various expenses.
Section 3064.09 recognizes that “entities frequently expend resources, or incur liabilities, on the
acquisition, development, maintenance or enhancement of intangible resources such as scientific or
technical knowledge, design, and implementation of new processes or systems.” These expenditures are
treated in accordance with Section 3064.21:
130
.21 An intangible asset shall be recognized if, and only if:
(a) it is probable that the expected future economic benefits that are attributable to the asset will flow
to the entity; and
(b) the cost of the asset can be measured reliably.
Since BCP is already selling the products related to the R&D expensed, (a) above is met. Further, since
the costs are readily ascertainable because they have been paid, (b) is also met. Therefore, there is a basis
for recognizing a potential asset here.
.27 The cost of a separately acquired intangible asset comprises:
(a) its purchase price, including import duties and non-refundable purchase taxes, after deducting
trade discounts and rebates; and
(b) any directly attributable cost of preparing the asset for its intended use.
.28 Examples of directly attributable costs are:
(a) costs of salaries, wages and employee benefits arising directly from bringing the asset to its
working condition;
(b) professional fees arising directly from bringing the asset to its working condition; and
(c) costs of testing whether the asset is functioning properly.
.29 Examples of expenditures that are not part of the cost of an intangible asset are:
(a) costs of introducing a new product or service (including costs of advertising and promotional
activities);
(b) costs of conducting business in a new location or with a new class of customer (including costs of
staff training); and
(c) administration and other general overhead costs.Determining the useful life of an intangible asset
.61 The estimate of the useful life of an intangible asset is based on an analysis of all pertinent
factors, in particular:
(a) the expected use of the asset by the enterprise;
(b) the expected useful life of another asset or a group of assets to which the useful life of the asset
may relate;
(c) any legal, regulatory or contractual provisions that may limit the useful life;
(d) any legal, regulatory or contractual provisions that enable renewal or extension of the asset’s
legal or contractual life without substantial cost (provided there is evidence to support renewal or
extension, and renewal or extension can be accomplished without material modifications to the
existing terms and conditions);
(e) the effects of obsolescence, demand, competition and other economic factors (such as the stability
of the industry, known technological advances, legislative action that results in an uncertain or
changing regulatory environment, and expected changes in distribution channels); and
(f) the level of maintenance expenditures required to obtain the expected future cash flows from the
asset.
When no legal, regulatory, contractual, competitive, economic or other factors limit the useful life of
an intangible asset to the enterprise, the useful life of the asset is considered to be indefinite. The term
“indefinite” does not mean infinite.
131
Cost of Acquiring Design and Legal Fees
Since the costs of acquiring the design and the legal fees incurred to patent the design meet the criteria for
intangible assets, they should be capitalized as such. Thus, the costs to acquire the design from an
engineering firm ($125,000) and the legal costs to have it patented ($10,000) should be recorded on the
balance sheet as an intangible asset.
Even though the patent provides legal protection for 17 years, Bergeron has mentioned that BCP usually
has to do R&D work every five years, on average, to keep up with the market before a product becomes
obsolete. It would seem logical, then, that any intangible asset would be amortized over this five-year
period. There may be an argument that this could be done over 17 years, but this may be optimistic given
what BCP has had to do in the past. Therefore, there appears to be a reliable way to measure the expense
associated with this asset, and in accordance with Section 3064.61(e), we would amortize it over a period
of five years.
Costs for Modifying and Upgrading Equipment
The modifications and upgrade to the equipment were done in order to integrate the new design, which
has already resulted in additional sales. BCP must decide whether the upgrade is a betterment or a
maintenance expense.
Handbook Section 3061.14 provides that “the cost incurred to enhance the service potential of an item of
property, plant and equipment is a betterment,” indicating that the service potential of a particular asset is
enhanced when there is an increase in the previously assessed physical output or service capacity. The
modifications to the equipment have definitely increased its service capacity, so the $40,000 costs
incurred should be added to the cost of the equipment.
The asset should then be amortized in a rational and systematic manner appropriate to its nature.
Market Research Costs
Section 3064.37 indicates that “No intangible asset arising from research (or from the research phase of an internal project) shall be recognized. Expenditure on research (or on the research phase of an internal
project) shall be recognized as an expense when it is incurred.”
Section 3064.39 provides examples of “research activities” which include “the search for, evaluation,
and final selection of applications of research findings or other knowledge.”
As such, the costs incurred to ensure that the design will be accepted by the market and generate future
sales should be expensed to salaries and selling and administration costs, respectively.
132
Therefore, the following adjustments should be made:
R&D expenses per draft statements
Less: Reclassify to property, plant and equipment
Reclassify to market research costs
$
200,000
(40,000)
(25,000)
Net deferred development costs (intangible asset)
$
135,000
One year of amortization, or $27,000, should be taken on this intangible since BCP is now about one year
into its five-year cycle.
Therefore, the carrying amount of the intangible asset at year-end will be $108,000.
As well, the net book value of the property, plant and equipment will be increased by a net amount of
$20,800, made up of the following:
Costs of modifications
Less: Investment tax credit
Amortization (assumed 5 years of useful life)
$
40,000
(14,000)
(5,200)
Net adjustment to PP&E
$
20,800
(Most candidates identified the research and development (R&D) issue. Although most candidates who
addressed this issue were able to provide fulsome discussions, many candidates failed to discuss the
appropriate accounting standards, sometimes discussing the issue from an internally generated
intangible asset perspective.)
(Most candidates failed to discuss the related amortization for the various components of R&D they
had appropriately concluded should be capitalized. In addition, candidates who recognized that the
asset had to be amortized generally did not provide the period over which it should be amortized and
the basis for choosing one period over another — five years as a result of the useful life or 17 years as
a result of the legal life of the patent.)
Investment Tax Credits Related to R&D
BCP expects to file a scientific research and experimental development (SR&ED) claim for its eligible
R&D expenditures. We know that it expects to earn an investment tax credit (ITC) at the rate of 35% on
its eligible expenditures. The costs incurred to improve the manufacturing equipment should qualify as
eligible expenditures. At $40,000, this results in an ITC of $14,000.
133
As per HB Section 3805:
.13 Investment tax credits shall be accounted for using the cost reduction approach.
.14 Investment tax credits related to the acquisition of assets shall be either:
(a) deducted from the related assets with any depreciation or amortization calculated on the net
amount; or
(b) deferred and amortized to income on the same basis as the related assets.
.15 Investment tax credits related to current expenses (for example, research expenses) shall be
included in the determination of net income for the period.
.17 Investment tax credits shall be accrued when the enterprise has made the qualifying expenditures,
provided there is reasonable assurance that the credits will be realized.
The $14,000 ITC should be netted against the PP&E recorded on the balance sheet and accrued as an ITC
receivable.
(Very few candidates addressed the investment tax credits related to R&D. Those who did seemed to
lack the necessary knowledge to discuss the appropriate accounting treatment of this issue.)
134
Restatement of Financial Statements
After the above factors have been taken into account, the revised financial statements will look like the
following:
BCP
BALANCE SHEET
As at November 30, 2012
2012
(per client)
Accounts receivable
Taxes receivable
Inventories
Prepaids
Investment
PP&E
$
$
Bank indebtedness
Demand loan
Accounts payable
Shareholder loans
$
Assets
2,800,000
–
950,000
40,000
200,000
90,000
1,150,000
5,230,000
Liabilities
500,000
400,000
400,000
600,000
Revisions
$
Notes
(400,000)
14,000
(215,000)
1
2
3
(92,000)
(60,000)
20,800
4
5
6
Revised
$
2,400,000
14,000
735,000
40,000
108,000
30,000
1,170,800
$
4,497,800
$
500,000
400,000
400,000
600,000
Equity
300
Share capital
Retained earnings, beginning of
year
Net income
Retained earnings, end of year
300
2,633,700
696,000
3,329,700
$
5,230,000
2,633,700
(36,200)
2,597,500
$
4,497,800
BCP
INCOME STATEMENT
For the year ended November 30, 2012
2012
Revenue
Sales
Cost of goods sold:
Material
Labour
Gross margin
$
Revised
$
$
15,000
–
30,000
–
100,000
70,000
58,000
15,000
10,000
250,000
–
56,000
604,000
696,000
Impairment loss
Current taxes
Notes
6,000,000
4,200,000
500,000
1,300,000
Expenses:
Meals
Bad debts
Depreciation
Amortization – intangible
Interest
Insurance
General and admin.
Professional fees
Repairs and maintenance
Salaries
R&D (market research)
Travel
Net income (loss) before tax
(Adjustments)
215,000
3
400,000
5,200
27,000
1
6
4
25,000
4
(60,000)
5
4,415,000
500,000
1,085,000
15,000
400,000
35,200
27,000
100,000
70,000
58,000
15,000
10,000
250,000
25,000
56,000
1,061,200
23,800
(60,000)
–
–
$
696,000
Notes:
1. Bad debt: write-off of $400,000
2. Investment tax credit: $14,000 ($40,000 × 35%)
3. Inventory: write-off of $215,000, expensed to COGS
6,000,000
$
(36,200)
135
136
4. R&D reclassified amounts:
PP&E: $40,000
Marketing costs write-off: $25,000
Development cost asset set up for $135,000, less first-year net amortization
Total development cost asset is as follows:
Development
$ 135,000
Amortization as above
$ (27,000)
Net asset balance – end of year $ 108,000
5. Investment written down to amount that can be realized (worth $30,000)
6. Net addition to PP&E: $40,000 − $14,000 − $5,200
(Most candidates performed a restatement of the draft financial statements, taking into account the
issues they had previously identified and the related adjustments they had recommended.)
Percent
Awarded
0.0%
competence.
1.6%
Reaching competence — The candidate discusses some of the relevant
accounting adjustments required to be made to shareholders’ equity to be in compliance with the USA.
33.9%
Competent — The candidate discusses some of the relevant accounting
adjustments and concludes on the accounting adjustments required to be made to
shareholders’ equity to be in compliance with the USA.
64.5%
Highly competent — The candidate discusses most of the relevant accounting
adjustments and computes a revised amount for shareholders’ equity.
0.0%
(Candidates were directed to this indicator since their valuation needed to “take into account any accounting adjustments required to comply with the USA requirements,” and the USA required that the company’s financial statements be prepared in accordance with GAAP. Candidates were provided with draft financial statements and were told that BCP prepares its financial statements in accordance
with ASPE.)
(Most candidates performed well on this indicator. They were able to provide in-depth discussions of
some of the relevant accounting issues, as well as appropriate recommendations based on their
analyses. The issues most frequently addressed by candidates were accounts receivable, inventory
obsolescence, inventory storage costs, and the classification of research and development costs. Strong
candidates were able to integrate the case facts in their analyses and provide logical recommendations
that flowed from their analyses, referring to the appropriate ASPE standards. Most weak candidates
discussed only a few of the simpler issues (most commonly accounts receivable and inventory) and
avoided in-depth discussions of the more complex issues, such as research and development costs.
Many weak candidates jumped to a conclusion without supporting it by referring to the relevant ASPE
standards.)
137
The candidate calculates a tax-payable amount for the 2012 fiscal year-end to use in the
valuation calculation as per the USA.
The candidate is demonstrating competence in Taxation.
Competencies
IX-2.3 – Calculates taxes payable for a corporation in routine situations (A)
In order to come up with a draft valuation figure for the USA, the next step is to perform some tax
calculations for the current year as per paragraph 3(c) of the USA.
Current Year
Based on the revised income statement, there are certain things to consider for the current-year taxes
payable:
1. Life insurance premiums: Since these premiums are not required as collateral for the bank financing,
under ITA 20(1)(e.2) they are not deductible and should be added back.
2. Penalties and interest on GST: Neither is deductible under the Income Tax Act since Section 67.6
prohibits the deduction of fines and penalties and paragraph 18(1)(t) does so with respect to interest.
3. Meals: These are considered entertainment expenses, and there is a general limitation of 50% of the
amount incurred per ITA 67.1(1), so 50%, or $7,500, must be added back into income.
4. Accounting amortization of capital amounts: Both depreciable and intangible assets are not deductible
for tax purposes; therefore, we have to add back both of these amounts.
(In general, candidates dealt quite well with the above minor adjustments. Most candidates were able to
apply the basic tax rules appropriately).
5. R&D costs: These are added to the scientific research and experimental development (SR&ED)
expenditure pool and are fully deductible for tax at the taxpayer’s discretion. Since we have already
capitalized for accounting the costs that also qualify for SR&ED for tax purposes, no additional
adjustment is necessary. However, the qualified expenditures that were added to PP&E ($40,000)
would in most cases be added to the SR&ED expenditure pool for the future.
6. Investment tax credits: The credits earned on the SR&ED amounts of $14,000 (35% × $40,000) can be
treated in different ways. Most of the time, they reduce the SR&ED claim in the next fiscal year,
essentially reducing an expense or increasing taxable income. In practice, these amounts come into
income in the next fiscal year.
138
(Very few candidates addressed the above two issues. Most candidates who attempted these issues
struggled with both the tax treatment of the R&D expenditures and the computation of the related
investment tax credit. Many candidates confused the R&D deduction and the investment tax credit and
deducted the investment tax credit in computing taxable income. Strong candidates deducted the R&D
costs and applied the investment tax credit as a reduction of the current income tax they had
computed.)
7. Conventions: There is a limit of two conventions per year for a business at a location that “may reasonably be regarded within the territorial scope of that organization,” per ITA 20(10). Although
BCP sells in Canada only, its market is North American producers, so Las Vegas as a location is
within BCP’s territorial scope. However, only two conventions can be deducted. Perron attended five
conventions this year, so the cost related to three of them has to be added back. Since one was a
convention BCP attends every year, the extra cost of $32,000 ($56,000 in 2012 versus $24,000 in
2011) is related to the four new conventions, for a price per convention of $8,000 ($32,000 ÷ 4).
Therefore, $24,000 ($8,000 × 3 conventions) needs to be added back.
(Fewer than half of the candidates discussed the conventions. Most of the candidates who addressed
this issue provided a reasonable computation of the amount that would not be deductible in computing
net income for tax purposes. However, many candidates got caught up on the location of the
conventions and challenged the deductibility of the convention expenses on that basis alone. The
location of a convention might result in its cost not being deductible; however, in this simulation, the
location of the convention (North America) was appropriate under the provisions of the Income Tax
Act. As such, its cost, within the limitation for the number of conventions, should be deductible.)
8. Impairment loss: The $60,000 impairment loss in the investment is not an actual loss, but an
accounting loss, and needs to be added back.
9. CCA: This should be recorded. CCA is an optional deduction, but usually taken to reduce income or
increase losses for carry-forward purposes. See the schedule that follows the current-year taxes
payable calculation for the CCA calculations by class. All additions are also subject to the half-year
rule, whereby only half the applicable CCA rate can be applied to any current-year additions.
(Most candidates computed a reasonable amount for CCA, considering the half-year rule for new
additions where applicable and recognizing that CCA might not be claimed since BCP has incurred
substantial losses. However, very few candidates addressed the issue related to the impairment loss on
investment. Overall, most candidates recognized that BCP would not have a tax liability for the
taxation year under review.)
Once we take these amounts into consideration, we have a loss for tax purposes. Therefore, there is no
current taxes payable balance to record.
139
BCP
CALCULATION OF CURRENT YEAR TAXES PAYABLE
Year ended November 30, 2012
$
Revised net income (loss)
Adjust for:
Life insurance
Non-deductible penalties and interest
Meals (50%)
Amortization
Amortization – intangible
Eligible R&D costs – accounting*
SR&ED tax credit – accounting
Conventions
Impairment loss
CCA (see below)
Taxable income (loss)
Reference ITA
(36,200)
10,000
1,500
7,500
35,200
27,000
–
–
24,000
60,000
(201,268)
$
20(1)(e.2)
S. 67.6/18(1)(t)
67.1(1)
18(1)(b)
18(1)(b)
No adjustment – All amount on B/S
No adjustment – All amount on B/S
20(10)
Generally, loss deductible when realized
(72,268) No current taxes payable since in loss position
*Usually taxed in year received, so should be in 2013, but would be okay to include here.
Class
1
8
10
50
total
UCC, beginning
of year
146,042
302,586
363,767
28,235
840,630
Additions
–
20,000
–
15,000
35,000
Available
for CCA
146,042
322,586
363,767
43,235
875,630
Assets bought:
furniture
computers
20,000
15,000
SR&ED pool:
Addition to SR&ED pool in 2012**
40,000
Balance
40,000
Rate
CCA
4%
5,842
20% 62,517
30% 109,130
55% 23,779
201,268
UCC, end of
year
140,200
260,069
254,637
19,456
674,362
**ITC on eligible expenditures usually reduces SR&ED pool in year received, so should be in 2013.
140
For Primary Indicator #2 (Taxation) the candidate must be ranked in one of the
Percent
Awarded
1.2%
competence.
15.7%
Reaching competence — The candidate attempts a calculation of current taxes
payable.
36.4%
Competent — The candidate prepares a reasonable calculation of current taxes
payable with several of the required adjustments.
46.7%
Highly competent — The candidate prepares a thorough calculation of current
taxes payable with most of the required adjustments.
0.0%
(Candidates were not specifically directed to this indicator, but the USA clearly stated that “the value of
the shares of BCP shall include a liability for current taxes,” and candidates were provided with the necessary tax information to perform this calculation.)
(Candidates performed below expectations on this indicator. Most candidates were able to discuss the
generic tax adjustments, such as the limitation on the deduction for meal expenses, life insurance
premiums, and penalties, as well as recognize the appropriate adjustments between accounting
depreciation and CCA. However, most candidates struggled to apply the appropriate tax rules for
conventions and for research and development costs and related tax credits.)
(Strong candidates provided added value by integrating simulation facts, using the adjusted net income
to determine the net income for tax, and concluding that BCP incurred a net loss for tax purposes, or
at least recognizing that BCP had unused non-capital losses and applied those losses to the net income
otherwise determined. Weak candidates included limited discussions of the tax rules in their responses,
and their computations of net income for tax purposes contained numerous errors.)
The candidate calculates a valuation figure for the amount payable to Perron as a result of the
USA.
The candidate is demonstrating competence in Finance.
Competencies
VII-4.2 – Estimates the value of the business (B)
VII-6 – Identifies or advises a financially troubled business (B)
141
In accordance with the USA, we must first start with the shareholders’ equity, back out the book values of the capital assets and investment, and adjust for the fair market values of these assets. It is important to
note that the financial statements have been adjusted for some of Perron’s questionable sales and inventory transactions. The value of the shares is based on the adjusted financial statements, which are
assumed to be a true representation of the results. However, a question arises as to whether other
transactions have been manipulated by Perron to achieve the “better” results. We also wonder if some of the business expenses incurred are legitimate. The conventions attended to drum up business, for
example, may have been more for personal interest rather than of a business nature. This may be difficult
to prove, so, for now, we have left these expenses in the business. However, should more information
come to light about Perron’s activities being less than legitimate, then an adjustment to the financial
statements, and to the valuation, may be required. In our opinion, it would be wise to consult with legal
counsel to see if an adjustment clause can be built into the buyout arrangements for any items not yet
identified, that end up being uncollectible, or that affect the value assigned to the shares.
BCP will have to pay Perron about $135,000 (ignoring any taxes) per year for the next 10 years. This will
end up adding to the debt that BCP has already started to accumulate. BCP may have trouble financing
this in the long term if it continues to have losses, as it has had. However, if it can collect some of its
receivables and continue to generate sales and tax refunds through its R&D work, it should be able to get
by. We will need to discuss the matter with Chara and Bergeron to see what options there are.
(Most candidates adjusted BCP’s shareholders’ equity with some required ASPE adjustments, and took into account the adjustments for at least one of the items that had to be adjusted for fair market value,
typically capital assets. However, some candidates missed the 10% discount that applied as a result of
the shares being bought after a certain period of ownership.)
142
BCP
DRAFT VALUATION
As at November 30, 2012
Shareholders’ equity per revised draft statements
Adjust for:
FMV of capital assets/investment
Book value of capital assets/investment
FMV adjustment per USA
Tax value of losses carried forward (Note 1)
2,597,800
2,415,000
1,200,800
1,214,200
37,472
Value of BCP common shares
3,849,472
Perron’s share (one-third)
1,283,157
Deduct: 10% discount per clause 3 (e)
Add: Shareholder loan
Net owing to Perron
(128,316)
200,000
1,354,841
Amount to pay per year (spread over 10 yrs)
135,484
Note 1: Apply tax rate to total of losses carried forward per tax information $240,000 and current year’s
tax loss: ($240,000 + $72,268) × 12% = $37,472.
Percent
Awarded
0.0%
competence.
6.2%
Reaching competence — The candidate attempts a calculation of the share
valuation of BCP and attempts to apply the terms of the USA.
25.2%
Competent — The candidate prepares a reasonable calculation of the share
redemption value of BCP, taking into account the requirements of the USA.
68.4%
Highly competent — The candidate prepares a thorough calculation of the share
redemption value of BCP as well as the total amount payable to Perron, and
discusses how BCP may have trouble meeting these payments in the future.
0.2%
143
(Candidates were expected to provide a value for the shares of BCP in accordance with the terms of the
USA. Candidates were directed to this indicator since the partner indicated that they “need to establish a buyout value” for BCP’s shares.)
(Most candidates performed well on this indicator. They were able to integrate the accounting
adjustments they made in Primary Indicator #1 and apply most of the provisions required by the USA
to determine a reasonable value for the shares of BCP as per the USA. Some candidates also provided
reasonable discussions of the cash-flow impact of the buyout on BCP, which was useful for the clients.
Strong candidates provided more comprehensive calculations in which they not only considered the
usual adjustments, but also took into account the value of the unused losses and discussed the
shareholder loan that becomes repayable. Most weak candidates demonstrated a lack of integration
because they did not use the revised financial statements (which included any accounting adjustments
they made in Primary Indicator #1) in their calculations of shareholders’ equity for purposes of the valuation. In addition, weak candidates made more mistakes. For example, some candidates seemed to
get confused between the 10% discount that had to be applied to the final value of the shares and the
1/10 factor applicable to the first payment owed to Jean Perron.)
The candidate recognizes that there are some unusual activities going on at BCP that relate to
Perron, suggests that further information is required to investigate the irregularities, and
suggests improvements to the USA.
The candidate is demonstrating competence in Pervasive Qualities and Skills.
III-2.2 – Performs computations
III-7 – Considers basic legal concepts
144
Perron Buyout
Some of Perron’s actions that occurred prior to triggering the USA buyout appear to have resulted in an
inflated balance sheet, which would have increased the amount being paid out to him if not adjusted for.
According to Bergeron, only Perron had access to some clients, and there seems to be some question as to
whether these clients exist. For instance, Perron made a $500,000 sale to a client this year. It is a brand
new client, and $500,000 is a significant amount of sales for this company. As mentioned earlier, it is
even more questionable now that Perron has suddenly come up with a $100,000 cheque from that
particular client. With such a significant number, there should be some basic checks and balances to
ensure others at BCP have contact with this client. Perhaps a policy should be put in place requiring that
more than one shareholder meets with all major new clients, for both control purposes and business
development reasons. Also, credit checks should be performed on new clients so that this kind of thing
does not happen again.
Perron also seems to have been up to some other questionable activities this year. For instance, he was
adamant that the $200,000 of obsolete inventory could be sold. The higher inventory balance inflates the
assets on the balance sheet. Also, it was mentioned that he was having personal difficulties and was not
around the office very much. Perhaps some of the expenses incurred for meals and travel were not for
business, but for personal reasons. If that is the case, these should be paid by him, not the corporation.
Better controls should be looked into over the payment of these types of expenses to see if they are valid
business expenses.
We could also question the nature of the time off he took during 2012 while he might still have received
remuneration from the company. Was he already preparing for his departure from the company and
looking for opportunities elsewhere?
We should consider legal options. The behaviour exhibited by Perron has been at times odd, especially his
defence of the new client with the warehouse address in Saskatoon. It may be possible that this client does
not exist at all, and that the merchandise has been misappropriated. Legal counsel should be contacted to
act further on this situation, unless Perron commits to collecting the funds in short order or making some
sort of allowance in the valuation of the shares.
(Most candidates only mentioned that, as a result of the transaction, Jean Perron might have a bias to
inflate the shareholders’ equity, supporting their discussions with some simulation facts (mostly tied to
their accounting discussions), but not providing any recommendations to the remaining shareholders
on how to investigate the issues further.)
USA
It sounds like the USA was written up and then never referred to again. There appear to be some
weaknesses in the current USA. I strongly recommend that a new USA be drawn up to avoid a forced
buyout from happening again with a new partner. Even though any redemption would be subject to the
relevant solvency test applicable under the Canada Business Corporations Act, this puts some serious
cash strains on BCP. You could continue to use the same USA with just the two remaining partners, but
we do not recommended doing so. We have noted some weaknesses in the current agreement that should
be rectified.
145
You are going to have a hard time finding the cash needed to buy out Perron. This situation could have
been avoided. Any clauses allowing for one shareholder to force the company to buy them out can put the
entire company at risk of failure. They should either be removed completely or modified so that the
company has more control, or at least so that the time to repay can be adjusted based on the total amount
of the redemption of the departing shareholder. As an example, if the amount exceeded $1 million, the
shares would be redeemed over 15 to 20 years, or based on a percentage of the earnings. A potential
alternative option is to keep such a clause in, but to have it subject to unanimous approval by
shareholders. Another possibility is that, if a shareholder needed to get out, a discount would be applied to
the overall value so that the payout would be less, allowing for more capital to be retained in the
company. This would reduce the attractiveness of the clause, while at the same time allowing for a
shareholder to leave if necessary.
Another option to consider is a long-term buyout, which would reduce the annual payment amount by
spreading it out over more years. A new agreement could also call for more notice to be given so that
appropriate steps could be taken to arrange financing and audit the statements. Having more notice would
allow for more time to make a proper decision, since hasty decisions can result in errors applied or other
oversights. This type of clause should be added to the USA for the future. Once a new agreement is
drafted, all shareholders should be made aware of it and told where it is located.
Because the remaining shareholders of BCP anticipate cash-flow issues as a result of the buyout, they
should consider negotiating immediately with Perron to try to avoid legal disputes.
With respect to the risk that Perron has tried to influence the financial results by inflating sales and asset
values, this type of situation may be avoided by requiring an audit of the financial results as part of the
USA, as well as requiring the results to be subject to an “adjustment clause” if there is evidence of manipulation.
(Only a few candidates raised some issues with and questioned the terms of the USA, usually stating
that it was outdated.)
Percent
Awarded
15.8%
competence.
19.6%
Reaching competence — The candidate recognizes that there are unusual
activities going on at BCP related to Perron or that the USA might need to be
revisited.
48.4%
Competent — The candidate discusses and advises on the unusual activities that
are going on at BCP related to Perron or discusses changes that should be made
to the USA.
16.1%
Highly competent — The candidate discusses and advises on the unusual
activities going on at BCP (including some legal concerns) and changes that
should be made to the USA.
0.1%
146
(Candidates were expected to warn the remaining shareholders about Jean’s suspicious behaviour or recognize that the USA was outdated and suggest that it should be revisited in order to avoid a similar
forced-buyout situation occurring again in the future. Candidates were not directed to this indicator,
but there was evidence throughout the case of actions committed by Jean that were at the very least
questionable, the most obvious of which was a $500,000 sale to what seemed like a fictitious customer.)
(Candidates performed poorly on this indicator. Most only mentioned that, as a result of the buyout
transaction, Jean might have a bias. Candidates generally used some case facts to support their
discussions, but did not provide any recommendations to the remaining shareholders on what they
should do as a result or how they could go about investigating these issues further.)
(Strong candidates went a step further and recommended relevant procedures that BCP’s remaining shareholders could perform, or suggested the shareholders consider pursuing legal action. Weak
candidates typically only identified the issues by, for example, simply stating that Jean had a bias or
mentioning that the USA was outdated, without providing any further discussion or recommendations.)
There were no secondary indicators in this simulation.
(Overall, the Board was somewhat disappointed with the quality of the responses on this simulation.
Most candidates addressed each indicator; however, they struggled to provide in-depth discussions with
respect to the Tax and Pervasive Qualities and Skills indicators. Only basic tax knowledge seemed to be
applied appropriately (specifically, the non-deductibility of meals and life insurance premiums), and
candidates had difficulty going beyond identifying the non-directed issues. The Board encourages
candidates to reflect on the simulation facts that raise significant unresolved issues and to always
provide recommendations to the client if it fits with their role. Most candidates demonstrated
appropriate knowledge in Finance and Performance Measurement and Reporting, properly identifying
the issues and providing in-depth discussions.)
147
SAMPLE RESPONSE
PAPER II-1 BRUIN CAR PARTS INC.
The following is a candidate response for Paper II-1. Whereas the evaluation guide presents all the
To: Shareholders of BCP
From: CA
Re:Analysis of BCP
Accounting Adjustments
Inventory
You have indicated that $200,000 of parts inventory may be obsolete due to recent legislative changes.
The concern is that this inventory is impaired and should be written down which will reduce the valuation
of the shares. ASPE states that inventory shall be carried at the lower cost or net realizable value.
Currently, the parts inventory is being carried at $200,000 because Jean has indicated that a client is
willing to purchase the parts at cost. However, this accounting treatment is consistent with Jean's bias to
maximize the valuation of the shares for the purposes of his buyout. You have indicated that other clients
have stated that it is likely that legislation would prohibit the sale and purchase of this parts inventory.
Therefore, I recommend that the inventory be written down to its net realizable value which appears to be
zero. This will reduce inventory by $200,000 and net income by $200,000.
Research and Development
$200,000 in development costs have been captialized relating to a design and patent that has been
purchased. The accounting issue is whether or not these costs have met the criteria stated in ASPE to be
capitalized. The capitalized costs do not appear to be related to an internally generated intangible asset as
the design was purchased from an engineering firm. Therefore, we would consider the definition and
recognition criteria of an intangible asset to determine if it has been accounted for appropriately. ASPE
states that in order to meet the definition of an intangible asset, the asset must be identifiable, BCP must
control the intangible asset, and there must be future economic benefits. I will discuss each of these
below:
Identifiability
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
Appendix C — Paper II — Sample Response
The costs related to the patent, the related legal fees, and the amount paid to the engineering firm for the
design appear to meet this criteria as they have arisen from contractual or other legal rights. However, the
market research costs related to the new design do not appear to meet this criteria as they are not capable
of being separated.
Control
ASPE states that an entity controls an asset if the entity has the power to obtain the future economic
benefits flowing from the underlying resource and to restrict the access of others to those benefits.
BCP controls the patent and the design which have resulted in increased sales. Additionally, the patent
and the ownership of the design restrict competitors from using the same design. Therefore, this criteria is
met for the patent, related legal costs, and costs of the design.
Future Economic Benefits
ASPE states that the future economic benefits flowing from an intangible asset may include revenue from
the sale of products or services, cost savings, or other benefits resulting from the use of the asset by the
entity.
This criteria appears to have been met for the costs of the patent, related legal costs, and costs of the
design. The future economic benefits are the increased sales that have resulted.
Recognition Criteria
ASPE states that an intangible asset shall be recognized if, and only if:
(a) it is probable that the expected future economic benefits that are attributable to the asset will flow to
the entity; and
These criteria have been met for the costs of the patent and related legal costs, and the costs of the design
as the intangible asset is increasing sales. Furthermore, the costs are known and are supported by
documentation so they can be measured reliably.
Therefore, the costs of the legal fees, patent, and design meet the definition and recognition criteria of an
intangible asset. However, the market research costs related to the new design do not meet the definition
of an intangible asset. Furthermore, ASPE specifically states that costs of introducing a new product or
service (including costs of advertising and promotional activities). This would include the market research
costs, and therefore, these should be expensed.
The costs to modify and improve the manufacturing equipment is not an intangible asset. This would be
conisdered a betterment under ASPE and should be added to the carrying amount of the underlying items
of PP&E.
149
Therefore, the total intangible asset is $135,000. As it has an approximate useful life of five years, it
should be amortized over this period. The $40,000 costs incurred to modify and improve manufacturing
equipment would qualify as a betterment and should be added to PP&E. The $25,000 related to market
research costs should be expensed.
Investments
There is indication that the investment is impaired as you have indicated that it is facing lawsuits and it’s not likely to survive much longer. ASPE states that when an entity identifies a significant adverse change
in the expected timing or amount of future cash flows from an investment, it shall reduce the carrying
amount of the investment to the higher of the following:
(a) the present value of the cash flows expected to be generated by holding the investment, discounted
using a current market rate of interest appropriate to the asset; and
(b) the amount that could be realized by selling the asset at the balance sheet date.
The carrying amount of the investment shall be reduced directly. The amount of the reduction shall be
recognized as an impairment loss in net income.
Therefore, the $30,000 offer from the private investment firm is a good indication of the value to be
received from selling the investment at the balance sheet date and is likely higher then the present value
of the cash flows expected to be generated by holding the investment. Therefore, I recommend that the
investment is written down to $30,000. This will result in a decrease in the investment of $60,000 and a
decrease in net income of $60,000.
Corporate Taxes
In Exhibit I, I have prepared a calculation of BCP’s net income for tax purposes, taxable income, and
corporate taxes payable. I have made the following adjustments:
The $10,000 premium paid for life insurance is not deductible for tax purposes as it is not required as
collateral for bank financing.
I have added back 50% of the meals expense as only 50% is deductible for tax purposes.
I have added back $1,500 of interest expense related to late filing HST/GST interest and penalties as
this is not deducitble for tax purposes.
I have calculated the SR&ED credit as 35% of eligible expenditures.
I have determined that there are no corporate taxes payable, and that BCP is eligible to receive a refund of
its SR&ED credit of $57,602.
Valuation of Shares
In Exhibit II, I have performed a valuation of Jean's shares based on the USA you have provided me. I
have calculated Jean's shares to be worth $1,301,281. Additionally, as stated in the USA, the shareholders
loan becomes payable under the same terms of the shares which totals $200,000. Therefore, Jean is due
the following:
$150,128 within sixty days of Jean's notice
$150,128 annually for nine years.
150
This is a significant amount of cash. Per BCP’s balance sheet, BCP does not have any cash on hand at November 30, 2012. Therefore, BCP should seek financing arrangements for the buyout of Jean. One
alternative would be to approach the bank for a loan.
Exchange of Shares
The exchange of shares as part of a corporate reorganization will occur, which will exchange Jean's
common shares for preferred shares. This election will allow the exchange to occur at a tax deferred basis
provided that all of the shares of the same class are exchanged for preferred shares. I am assuming that
each of the shareholders have been issued separate classes of shares in order to facilitate this election.
To: Rick and Lyle
From: CA
Re: Buyout of Jean
I should bring to your attention an area of concern relating to the buyout of Jean. As you know, Jean has
recently been divorced and has been experiencing difficulties. This has led to him requesting the
repayment of his shareholders loan which suggests he is also experiencing personal financial difficulty.
Jean has a bias to overstate the value of the company in order to maximize his personal gain from the
buyout. His personal issues and financial situation increase the risk that he would act on this bias.
Additionally, Jean is in charge of sales, which means he had the opportunity to inflate sales and overstate
the valuation. The $500,000 in sales from a client that you have had difficulty collecting and have been
unable to contact is a risk, and could be the result of a fictitious sale. Further evidence will need to be
gathered. Additionally, Jean’s treatment of the parts inventory is consistent with his bias to overstate the valuation.
The cash flow effect of the buyout to BCP is significant. Due to the increase in bank indebtness and cash
flow issues, it will be difficult for BCP to afford the buyout. Therefore, in order to ensure that BCP pays a
fair price for Jean's shares and that the valuation is not overstated by any manipulation of the financial
statements, I recommend that BCP considers obtaining a higher level of assurance over the financial
statements for the year ended November 30, 2012 than the review engagement that you have received in
the past. There is increased risk this year due to the buyout and the reasons mentioned above, therefore, in
order to mitigate this risk, BCP should seek a higher level of assurance. Therefore, I recommend that an
audit be performed on the financial statements which is a high level of assurance which will protect both
of you. In addition, I am not sure how the fair values of the capital assets were determined. Therefore, it
may be necessary to engage an independent valuator to perform valuations of the capital assets as this is a
significant component of the buyout.
151
152
153
You, CA, and your friend Peter are the owners of Molly-Sue Brews Inc. (MSB). You each own 50% of
the shares. You and Peter have full-time jobs in management and manage MSB in your spare time,
although you are both finding it increasingly difficult to oversee the business on a part-time basis.
It is now April 2013. You and Peter have received the draft MSB consolidated income statement for the
year ended December 31, 2012, that MSB’s bookkeeper prepared (Exhibit I). MSB began as a microbrewery. On January 1, 2012, to increase the distribution and sale of its beers, MSB acquired, from
Mr. Anthony Sorachi, Drinking Time Limited (DTL), for a total consideration of $2,750,000 (Exhibit II).
DTL is a popular brew pub in the heart of Vancouver’s craft beer district.
Since the acquisition of DTL, MSB’s beers have grown in popularity, and MSB is quickly outgrowing its
existing microbrewery. Peter sent you a file he has been working on with the details of expansion and a
potential move into a larger building (Exhibit III). While Peter was working on the building proposal, you
began searching for a technology-based solution for managing MSB remotely. MSB recently tendered
and received proposals for a new IT system. You and Peter have narrowed the choice down to two
vendors, and now need to determine which system will work best for MSB (Exhibit IV).
Peter calls you: “My wife is about to deliver our first baby and I will be away for a while. I am emailing
you some of my concerns about MSB (Exhibit V). In addition, can you prepare MSB’s cash flow projections for the next five years, on a pre-tax basis, to determine its financial capacity to make the
changes we are considering? I know a banker who is willing to provide financing for up to 75% of capital
investments.”
154
EXHIBIT I
CONSOLIDATED INCOME STATEMENT AND NOTES
MOLLY-SUE BREWS INC.
For the years ended December 31
(unaudited)
Note
Revenue
Bottle sales
Keg sales
Pub sales – beer
Pub sales – food
Expenses
Beer production costs
Pub costs – beer
Food costs
Delivery
Wages and benefits
Licences
Depreciation
Advertising
Management fee
General and
administrative
Lease
2012
2011
$ 1,796,578
468,220
2,234,225
362,245
4,861,268
$ 1,679,045
456,800
–
–
2,135,845
1,091,420
1,340,540
217,350
271,776
931,065
250,000
169,595
35,025
100,000
1,015,820
–
–
235,801
312,000
100,000
135,700
20,500
100,000
106,713
162,000
4,675,484
67,124
95,000
2,081,945
185,784
29,725
53,900
8,624
1
2
2
3
4
5
3
6
3
7
Income before income taxes
Income taxes
Net income
$
156,059
$
45,276
155
CONSOLIDATED INCOME STATEMENT AND NOTES
MOLLY-SUE BREWS INC.
For the years ended December 31
(unaudited)
Notes:
1. Production costs include all ingredients, bottling, and labelling, and are a steady 48% of total sales
revenue for the microbrewery.
2. Food and beer costs are stable at 60% of related revenue.
3. Delivery, advertising, and general and administrative costs are expected to increase 5% annually.
4. Wages and benefits are expected to increase 10% annually. Mr. Sorachi, the manager and former
owner of DTL, retired on December 31, 2012, and his salary was $175,000.
5. Capital additions were $35,000 in 2012 and $55,000 in 2011.
6. The management fee is split evenly between CA and Peter. Neither owner draws any other
remuneration from MSB.
7. The lease for the microbrewery expires on June 30, 2013, and the lease for the pub expires in 2019.
The lease costs for 2012 were $97,000 and $65,000, respectively.
156
EXHIBIT II
SUMMARY INFORMATION ON
PURCHASE AGREEMENT FOR
DRINKING TIME LIMITED
Fixed portion, payments totalling $1,100,000:
Payments of $250,000 on January 1 of 2012 and 2013
Payments of $150,000 on January 1 of 2014, 2015, 2016, and 2017
Variable portion:
Beginning June 30, 2013, MSB will pay 5% of the pub’s gross sales from the preceding fiscal year. Payments will continue annually until the $2,750,000 total purchase price has been repaid.
157
EXHIBIT III
PETER’S NOTES ON RELOCATION
AND EXPANSION
The owner offered a five-year lease starting July 1, 2013, at $255,000 per year, increasing 5% annually on
January 1.
Capital Additions
We will need to upgrade and expand our equipment capacity for the following estimated costs over the
next five years:
2013 $ 500,000
2014
400,000
2015
150,000
2016
350,000
2017
325,000
$ 1,725,000
Relocation costs are estimated at $200,000 (not included above).
Projected Gross Sales (in thousands of dollars)
Pub
2013
2014
2015
2016
2017
$
$
$
$
$
2,800
2,940
3,087
3,241
3,404
Microbrewery
$
$
$
$
$
2,641
3,450
3,900
4,400
4,750
Total
$
$
$
$
$
5,441
6,390
6,987
7,641
8,154
Cash Balance
MSB had a cash balance, as at the end of December 2012, of $50,000.
158
EXHIBIT IV
INFORMATION TECHNLOGY
SYSTEM PROPOSALS
HOPS Inc.
From the website: “Based in the heart of Silicon Valley, California, HOPS Inc. provides fully integrated IT and accounting systems to the wine-making and brewing industries. We have built systems for several
of the largest US breweries and vineyards.”
System Pricing and Maintenance Costs
$50,000 for initial set-up; 50% due on signing and 50% due December 31, 2013
Additional system modifications at $100 per hour
MSB is responsible for HOPS Inc.’s staff travel and accommodation costs
$10,000 annual licensing fee
$40,000 annual system maintenance costs, due in equal monthly installments
Maintenance includes
o one assistance call per month through our automated help desk (charges apply for additional calls)
o regular system upgrades, downloadable from HOPS Inc.’s website, with installation instructions for
your IT department
o access to software source code to allow your IT department to customize the programming after
initial installation
System Features
System is on a secure internal network
Integrates with HOPS Inc.’s perpetual inventory software and hardware, which allows for real-time
tracking of your inventory: raw materials, various in-production stages, and finished goods; inventory
software is free on a trial basis for the first 12 months, and $25,000 per year thereafter
Currently only handles US sales taxes
Other Points
HOPS Inc.’s system requires an upgrade to current hardware; estimated costs total $45,000
Next available project start date is September 10, 2013; estimated project completion time is four
months
Unclear if HOPS Inc.’s system will be compatible with MSB’s existing accounting software;; HOPS Inc. does not normally deal with off-the-shelf accounting software, so an assessment will be required
159
INFORMATION TECHNOLOGY
SYSTEM PROPOSALS
IPA Systems
From the website: “IPA Systems is based in Vancouver and has been serving local businesses’ IT needs since 1985. Our ability to attract and retain top talent helps us serve our customers’ needs, and our local
presence allows us to be hands-on throughout the lifetime of your system. We serve a wide variety of
clientele, including restaurants and small manufacturers, and specialize in cloud computing and mobile
platforms.”
Pricing and Maintenance Costs
$100,000 design and set-up costs; 25% due on contract signing, 25% due three months after start, and
50% due at project completion
$2,500 annual licensing fee
$75,000 annual system maintenance costs, due in equal monthly installments
Maintenance includes
o a dedicated consultant available for troubleshooting five days a week, with no charge for up to five
calls a month, and all service calls returned within 24 hours
o 24-hour online chat with support staff available
o semi-annual system upgrades — your dedicated consultant will arrive on site, install the updates,
and train your staff
Software program source code remains the property of IPA Systems
System Features
Remote access through secure login, on any computer, anywhere. Edit capabilities are limited to
computers with installed security software, but view and report capability is available through webbased user login (with password protection)
Inventory tracking is built in
Other Points
IPA’s system requires an upgrade to current hardware, at an estimated cost of $10,000 for servers and
firewalls; your existing accounting software can easily be integrated
Next available project start date is July 16, 2013; estimated project completion time is six months
160
EXHIBIT V
EMAIL TO CA FROM PETER
The year-end bank reconciliation was a mess when I got it. The previous couple of months’ reconciliations had not been done either. The bookkeeper said she was too busy to keep up with all the
accounting requirements for both businesses. The current process is to post DTL’s monthly operations through summary journal entries in MSB’s records. While posting the summary entries two months
ago, she forgot a week’s transactions, which she subsequently noticed and fixed.
We owe a significant amount to Welland Industries, which does not appear on the vendors’ list. When
I asked around the office, no one seemed to know anything about this vendor.
The sales manager sells to the clients and the bookkeeper bills them based on the planned weekly
production runs. When the warehouse fills the order, however, the inventory is not always there and
the order ends up short-shipped. The sales manager is frustrated with trying to reconcile the amount
actually being delivered to the amount billed so that the bookkeeper can issue credit notes. As a result
of these issues, the sales manager has shifted the payroll review and approval and the invoice approval
to the bookkeeper.
There is a loss in the bottled beer inventory volume, which I cannot explain, even when considering
that we allow our eight employees a free six-pack of beer every week.
The production log that we asked the employees to fill in is not being kept up to date. The employees
should at least record the broken bottles of beer. It would help if I knew what our actual production
volumes and inventory balances were.
You and I are supposed to stop by the microbrewery periodically to make sure everything is under
control. I haven’t been there during business hours in a long time. Have you?
I went in to do some work last Friday, after hours, and when I left I forgot to turn the lights off in the
warehouse, but I’d already set the alarm so I just left them on. When I went back Sunday night, the lights were still on and my code was the last entry in the alarm system, rather than Tim Smithe’s. I
thought we’d hired Tim to come in and clean on the weekends when no one is around. I know I saw
his approved timesheet in my email last week.
I found out that one of the warehouse guys borrowed the hydraulic lift to move a piano. Did you know
that MSB equipment is being borrowed? Do you think the warehouse supervisor was aware of it? It
came back damaged and the replacement part is on order. I’ve asked the bookkeeper to pay the bill but
to deduct the amount from the employee’s pay. The employee told her that he can only pay it back if
the amount is spread over the next six months.
161
EVALUATION GUIDE
PAPER II, SIMULATION 2 — MOLLY-SUE BREWS INC.
The candidate prepares the projected cash flows for Molly-Sue Brews Inc. and assesses
financial capacity.
Competencies
VII-2.1 – Monitors cash flow (A)
VII-4.1 – Analyzes the entity’s financial situation (A)
VII-5 – Analyzes the purchase, expansion, or sale of a business (B)
To:
Peter
From: CA
Re:
Projected cash flows, IT proposals, and other concerns
Attached are the projected cash flows for the consolidated operations of Molly-Sue Brews Inc. (MSB) for
five years beginning in 2013 (Exhibit I). I used our revenue projections and the combined results of MSB
and Drinking Time Limited (DTL) to form the basis for calculating the projected expenses. I assumed the
December 31, 2012, consolidated results are representative of the future financial results, and used your
projected sales increases and a 5% increase in expenses. I have also made a number of key adjustments in
determining our estimated pre-tax cash flows, which I explain further below.
Variable Production Costs
For both the brewery and the pub, production costs vary with sales dollars and historically are priced such
that costs for beer and food are 60% of the sales revenue for the pub and 48% of sales for the brewery.
Based on this, I have projected the production costs accordingly for the five years.
162
Fixed Costs
The following costs are fixed and will not change over the five-year projection: the lease for the brew pub
and the licences for the brew pub and the brewery. Delivery, advertising, and office and miscellaneous
costs are fixed costs, but we have estimated they will increase annually by 5%. As well, wages and
benefits are expected to increase annually by 10%, which I have also taken into account.
Management
I have excluded Mr. Sorachi’s management salary of $175,000 per year from our projections. We will not
be paying this amount going forward since he retired on December 31, 2012. However, as I’ll discuss later in this report, I recommend that we hire a general manager since we are currently both working fulltime outside of MSB. Therefore, I have included a $75,000 salary, for which I have also considered an
annual increase of 10%. Also, I have excluded our $100,000 management fee since it does not make sense
for us to continue to draw cash out of the company while we are trying to expand, particularly if there is
potential for a cash shortfall. We will have to survive on our salaries from our regular jobs. Admittedly,
this might be a bit harder for you if you are taking time off with the new baby (see later discussion about
the need for one of us to join the business full time).
Other Cash Payments — Capital and Leases
Included in my projections are our planned capital expansions for each year. I have excluded amortization
from the calculation because it is a non-cash item. The lease on our current brewery space expires June
30, 2013, so I have included half of the annual amount of $97,000 in the first year. Based on the
assumption that we will be entering into a lease for the new, larger building space near the brew pub, I
have included the cash flows from the new lease per your notes — half the first-year rate of $255,000 —
and included the 5% annual growth rate going forward. I have also included the $200,000 one-time costs
to move the brewery and set it up in the new location.
Acquisition of Drinking Time Limited
Based on our purchase agreement with Mr. Sorachi, we have both known (fixed) and unknown (variable)
payments to make to him. The fixed payments I have included as per the purchase agreement schedule. I
have calculated the variable payments at 5% of our projected gross sales going forward. Our first variable
payment is due June 30, 2013.
IT System
Based on my analysis of the two IT-system options, it appears that IPA Systems is our best choice, so I
have included the cash flows for that option in my projections.
Results and Comments
Based on my projections, we are going to have a cash deficit of about $428,000 at the end of 2013 and a
negative balance of about $312,000 by the end of 2014. The 2015 ending cash balance is positive. The
cash balance remains positive thereafter. Therefore, we need to figure out how to cover the two-year
shortfall.
163
We should sit down together and see if we can support MSB’s cash needs out of our salaries, but this will
likely be difficult with your wife not working for the next while. We could talk to our friends and
relatives to see if they would be willing to loan us the funds. It also might be worth doing research to find
out if there are any small-business grants available from the government. Finally, we could talk to our
bank about expanding our existing credit facilities. As you mentioned to me, we might be able to obtain a
financing facility from a banker that would cover 75% of our capital investments ($375,000 [$500,000 ×
75%] in 2013 and $300,000 [$400,000 × 75%] in 2014). We should be able to manage most of our cash
shortfall using this facility.
Beyond 2017, we will have to revisit our projections, but our cash flow situation should improve
significantly since we do not have any major capital investments planned. However, the remaining
balance of the DTL purchase price will still be due. We may have an option to purchase the building in
the future as well, but we can discuss this with the bank at the appropriate time.
164
EXHIBIT I
CONSOLIDATED PROJECTED FIVE-YEAR CASH FLOWS OF MOLLY-SUE BREWS INC.
165
Percent
Awarded
0.1%
competence.
6.2%
Reaching competence — The candidate attempts a quantitative analysis of the
projected cash flows for the operations.
25.7%
Competent — The candidate prepares a reasonable quantitative analysis of the
projected cash flows for the operations and assesses financial capacity.
65.9%
Highly competent — The candidate prepares a thorough quantitative analysis of
the projected cash flows for the operations and provides an in-depth assessment
of financial capacity.
2.1%
(Candidates were asked to prepare Molly-Sue Brews Inc.’s (MSB) cash flow projections for the next five years to determine its financial capacity. The Board expected candidates to provide a reasonable
cash flow projection and conclude on financial capacity.)
(Candidates performed well on this indicator. Most candidates were able to provide reasonable cash
flow projections that incorporated the major changes in the current year, such as the new projected
sales of MSB, the fixed costs, the retirement of Mr. Sorachi, the increased capital expenditures, the
Drinking Time Limited acquisition payout, and the new IT system that needs to be purchased. Of these
areas, candidates struggled the most with the calculations associated with the increased capital
expenditures and the DTL acquisition payout, since these items included several components. With
respect to the capital expenditures, many candidates forgot to include the one-time moving costs. With
respect to the DTL acquisition, many candidates forgot to include the fixed or variable portions of the
payments or both, causing their calculations to be incomplete. Most candidates also concluded on the
financial capacity of MSB, integrating their cash flow projection results and providing some financing
options.)
(Strong candidates were able to provide cash flow projections that included most items while
incorporating minimal errors. In addition, they were able to conclude on MSB’s financial capacity and include discussions of available financing options, such as the bank loan. Weak candidates often had
many calculation errors in their projections, or their calculations did not incorporate enough of the
necessary elements provided in the case. Most weak candidates also did not provide any analysis of
MSB’s financial capacity.)
The candidate discusses the two proposed IT systems and makes a recommendation.
The candidate is demonstrating competence in Management Decision-Making (IT).
166
Competencies
VIII-4.1 – Analyzes, selects, and suggests IT solutions to support processes and management’s information needs (B)
VIII-4.3 – Identifies and evaluates acquisition or sourcing decision factors (B)
HOPS Inc.
HOPS Inc. appears to be very experienced in providing integrated IT and accounting systems and has
experience building systems for some of the largest breweries and vineyards in the US. It appears to be a
large, stable organization, which reduces the risk that we would acquire a system with bugs or that the
company would be unavailable to support the system. It is likely that HOPS Inc.’s systems are extremely well designed for the intricacies of the brewing business and would provide us with many pre-packaged
reports to assist us in monitoring the business.
(Some candidates discussed the experience HOPS Inc. had compared to IPA Systems, which was
relevant given their different client bases.)
Inventory Management
HOPS Inc. has a perpetual inventory module available on a trial basis for the first year. This would be
beneficial to MSB; since the sales manager has been having problems tracking inventory levels, it would
allow us to implement controls to resolve inventory issues (for example, unexplained inventory
discrepancies). However, after that first year it would cost us $25,000 to continue using it. The risk, if we
start using it, would be the potential disruption to our operations if we switched to another inventory
module after the first year. It is unclear if there is an alternative or if the integrated system is the only
option, and thus we may be forced to use it and pay for it after the first year. I have included it in the
estimated costs.
(About two-thirds of candidates addressed MSB’s need for inventory management and how the two IT proposals met this requirement. This demonstrated good integration of case facts since this was one of
MSB’s biggest control weaknesses.)
Customization
The possibility of integrating the accounting and IT systems is attractive because it would likely greatly
increase the efficiency of our accounting functionality by reducing the amount of manual work, namely
reducing the number of journal entries required. In addition, we would have access to the source code,
which would allow us to further customize the software if required.
However, there are other considerations with the proposed HOPS Inc. system. The company has
experience designing systems for big brewing companies, but has not given any indication that its
systems are well suited to a small craft-brewing operation like ours, and it does not appear to have any
experience in the restaurant or pub industry, so its system may not be well suited to that side of our
business. As well, it is currently not set up for Canadian sales tax, which would increase the cost of
customizing the system. The uncertainty as to whether HOPS Inc. can integrate our existing off-the-shelf
accounting software leads me to believe that the company has little experience with our size of operation,
which concerns me.
167
(Most candidates discussed some aspect of customization of the HOPS Inc. software, such as the ability
to integrate with the accounting system, access to the source code, or the fact that HOPS Inc. can
handle US taxes only. However, some candidates were not able to sufficiently explain why these
aspects were important to MSB, and instead just regurgitated case facts. Strong candidates took it one
step further and explained not only the aspect of customization that was relevant, but also why MSB
should care about that particular factor.)
Maintenance and Support
The complexity of the HOPS Inc. system concerns me. Having support is critical for us given that the
company’s systems appear to be extremely large and complex and we do not have an IT department or other internal IT expertise. The company appears to think we have an IT department. Our company
currently does not have the expertise it appears that we would require to self-support our system once it is
installed, or to even do regular system upgrades. HOPS Inc. has indicated that we would require an
additional $45,000 in hardware upgrades, which leads me to believe that this system might be
significantly more than we actually need. I suppose we could hire an IT person. However, I think we need
to get our controls and management systems in place before we consider hiring someone.
In addition, the company is offering only one assistance call per month through an automated help desk.
This level of maintenance and support is likely insufficient given the complexity of the system, as
discussed previously.
(Most candidates discussed HOPS Inc.’s lack of support after the implementation of the software.)
Costs
The HOPS Inc. system is initially cheaper; however, when the necessary hardware upgrades are included,
it will be at least $95,000 upfront, which makes the overall costs comparable to those of IPA Systems.
The maintenance costs are slightly lower (I have included them in my calculations). Therefore, the costs
of the two systems are comparable. I do not know what the additional travel costs would be, but given
that the company is estimating a four-month project completion timeline and is based in California, we
need to consider this added cost. And if our existing accounting software cannot be integrated, there is the
unknown cost of acquiring new accounting software, on top of which we would have to learn an entirely
new system.
HOPS Inc.
IPA Systems
One-time cost
Design & Building
$
50,000
$
100,000
Initial hardware upgrades
45,000
10,000
Staff travel costs from California
???
–
Accounting software replacement
???
–
$
95,000
$
110,000
Ongoing cost
Annual maintenance
Annual licences
Annual inventory module
$
$
40,000
10,000
25,000
75,000
$
$
75,000
2,500
–
77,500
168
(Virtually all candidates addressed the cost of the systems in some capacity. Strong candidates
calculated both the one-time costs and the ongoing costs of both systems and discussed the
implications. Weak candidates simply stated that one system would cost more than the other by
referencing specific factors, such as the fact that HOPS Inc. would require more travel costs, without
integrating their discussions to assess the overall cost to MSB.)
Other Considerations
I also wonder if the system can handle our brew pub retail portion of the business, or if it is more focused
on the production side. There is no indication in the proposal, so we would have to find out.
These details aside, I believe there is a bigger issue with HOPS Inc. I am worried that the company has
failed to understand our business needs. Nothing in the proposal leads me to believe that this system is
going to help us better manage the business and monitor the operations remotely. The proposal
specifically states that the system is not connected to the internet, so we are going to be no better off once
it is installed than we are now.
(Surprisingly, only a little over half of the candidates addressed the issue of remote access. Given the
explicit case fact that MSB was looking for a technology-based solution to manage MSB remotely, the
Board expected more candidates to address this consideration.)
IPA Systems
It does not look like IPA Systems has done work in the brewing industry before, which is not ideal, but
the company lists restaurants and other manufacturing in its clientele. Combine that with the fact that it
appears to have a reputation for attracting and retaining top talent, and I have confidence that it should be
able to handle our small company easily.
Inventory Management
Inventory tracking is built into the IPA Systems software. As discussed previously, an inventory
management system is critical for resolving our current inventory issues. IPA Systems will allow us to
track inventory, and thus there is no risk that the functionality will cost us more in the future.
Customization
It seems the system can be tailored to our company and not just the industry, which is important since we
have both brewery and brew pub operations.
Maintenance and Support
I like the fact that once the system is installed, we would not be responsible for the coding of the system,
since we do not have the expertise within MSB for that. The company also seems to provide a full-service
model, offering substantial free support and a free 24-hour on-line chat alternative.
169
Costs
The system is comparable overall in cost to the HOPS Inc. option (see previous calculations), but the
upfront hardware upgrades cost significantly less than with the HOPS Inc. proposal. As the company is
based in Vancouver, there are likely no travel costs involved.
Remote Access
More importantly, IPA Systems seems to have understood our biggest need. Its system is portable and
remotely accessible, and would give us far more ability than we currently have to manage the business
remotely while keeping our day jobs, at least until the business really takes off and we can run the
brewery full time.
(Candidates who addressed the significant considerations typically did a good job comparing HOPS
Inc. and IPA Systems by highlighting the differences between the two systems.)
Recommendation
I believe IPA Systems is our best choice. Although HOPS Inc. appears to cost less (although this might
not be the case if we consider the unknown costs), IPA Systems’ software is remotely accessible, which is our biggest need right now. IPA Systems appears to be a stable, innovative company that can easily work
with the size of our business now and at the same time grow with us. As well, inventory tracking
functions and controls are built into the system, and it probably can handle Canadian sales taxes. We
would be able to keep our current accounting system, if it is appropriate to keep it, and I think we would
get value out of the higher annual maintenance costs, especially since we would be able to maintain our
relationship with the same consultant. The project timeline is a little longer, but the company can start
sooner.
(Almost all candidates recommended one of the two systems to MSB and supported their
recommendations with analysis.)
For Primary Indicator #2 (Management Decision-Making (IT)), the candidate must
be ranked in one of the following five categories:
Percent
Awarded
0.1%
competence.
5.9%
Reaching competence — The candidate addresses the two IT-system
proposals.
32.3%
Competent — The candidate discusses the two IT-system proposals and makes
a recommendation based on their analysis.
58.1%
Highly competent — The candidate thoroughly discusses the two IT-system
proposals and makes a recommendation based on their analysis.
3.6%
170
(Candidates were directed to this indicator since they were provided with information on two IT-system
proposals and were asked to determine which system would work best for MSB. Candidates were
expected to assess each of the systems in light of MSB’s needs and determine which system would be
more appropriate for the company.)
(In general, candidates performed well on this indicator. There were two main approaches candidates
took for this indicator. Some candidates chose to address one proposal at a time, discussing the pros
and cons of each. Others chose to focus on MSB’s needs (for example, remote access, inventory management, et cetera) and compare both systems with regards to each need. Both approaches were
valid, but candidates who approached this analysis by discussing each of MSB’s core needs individually and addressing how each system would meet that need tended to provide more effective
discussions because this format forced them to concentrate on the key factors. Regardless of the
approach taken, most candidates were able to identify some of the differences between the two systems
and discuss the strengths and weaknesses of each system. However, many candidates struggled to take
into account MSB’s specific needs and, as a result, sometimes failed to rank the various criteria
according to what would be most critical for MSB, such as the importance of remote access and
inventory management. Strong candidates focused their discussions on these important areas. Weak
candidates focused on minor issues, such as customization, maintenance and support, and costs. A few
candidates simply regurgitated case facts without providing any additional insight, and as a result their
analyses were of little value. A simple repetition of case facts would not have helped Peter understand
why one proposal would be better than the other.)
The candidate evaluates the internal control weaknesses and provides recommendations for
mitigation.
The candidate is demonstrating competence in Assurance.
Competencies
VI-3.3 – Evaluates internal control (A)
Based on your comments, it appears that a series of internal control issues have arisen either as a result of
our frequent absence from the operation or for other reasons (poor record-keeping, need for better
inventory control system, et cetera).
Segregation of Duties
We suddenly have a very serious segregation-of-duties issue. The sales manager is too busy and has
pushed some responsibilities onto the bookkeeper, resulting in one individual doing the accounting,
payroll approval, bank reconciliations, and invoice approval. We need to fix this immediately. The
preferred solution would be for one of us to visit the facilities more often; however, if we cannot do so, I
suggest we get the staff to scan and email all the invoices to us for approval (until our new computer
system is in place). We also need to ensure that one of us reviews and approves any reconciliations that
are prepared by the bookkeeper, and make it clear that she does not have the authority to approve invoices
for payment.
171
(A little over half of the candidates addressed the issue of the current lack of segregation of duties.
Most candidates who addressed this issue explained why the duties assigned to the bookkeeper were
incompatible. However, some candidates did not adequately explain what duties were incompatible or
why there was an issue with the tasks the bookkeeper had. Others did not necessarily explain how to
correct the issue, simply stating that the lack of segregation of duties should be “fixed,” without going into further detail.)
Bank Reconciliations
Bank reconciliations are a key control, and we need to ensure they are being done monthly. Someone
other than the bookkeeper needs to review them as well, since she prepares them. One of us should be
reviewing them. This control helps safeguard our cash assets, and will be even more important as we
grow and the amount of money flowing through the company increases. Monitoring our cash flow
position will be critical, and reviewing the bank reconciliation is a good way to monitor our cash balance.
(Most candidates recognized that bank reconciliations are an important internal control and should be
performed and reviewed regularly.)
Approval of Hours
The sales manager has shifted the review and approval of payroll to the bookkeeper. There is a problem
with the fact that the sales manager simply transferred these duties without checking with us first. We
have been relying on the sales manager to step in for us. This delegation resulted in a control breakdown.
Tim Smithe is submitting timesheets that have been approved, yet it appears he may not be working the
hours he claims to be. The sales manager has shifted the payroll review and approval over to the
bookkeeper. The approval process appears to have broken down. I am not sure who approved Tim’s timesheet. Either the bookkeeper is approving hours without the necessary supporting documentation to
legitimize them, or she is skipping the approval step (similar to how the bank reconciliations are not being
done).
I recommend we transfer the approval of Tim’s timesheet to someone who will know whether he worked and whether his submitted hours are reasonable. We should assess whether this issue could be happening
with other employees too, not just Tim. We may need to consider a formal payroll system (such as a
punch-card system), and we may need to reconcile Tim’s timesheet to the alarm-system entry and exit
reports.
(Approximately two-thirds of candidates recognized there was likely an issue with the approval of
Tim’s timesheets;; in other words, that either the approval was not being performed or the person approving it was not aware of what hours Tim was working. Most candidates who addressed this issue
were able to provide valid recommendations to address the control weakness.)
Accounts Payable
Our controls around maintenance and payments to our vendors need to be improved, as evidenced by the
fact that no one knows of Welland Industries, even though it is a significant vendor. The number of
vendors has increased due to the addition of DTL. We should be reviewing and approving all new
vendors before they are input into the accounts payable system as a way of controlling the risk of
fraudulent vendor arrangements being set up.
172
I recommend we implement a standardized process whereby new vendor details are recorded on a “new vendor” form. We should require all vendors within the system to have a supporting vendor form that one of us has signed off on before the vendor is added to an “approved vendors” list. To further strengthen the control, we should ensure that all accounts payable invoices are reviewed and approved and that all
cheque runs are reviewed and approved by someone other than the preparer. The bookkeeper is preparing
the bank reconciliations and doing the accounting, so she should not be approving invoices for payment
since this is a breach in our segregation of duties. We should be the ones signing off on them.
(Most candidates identified this issue; however, candidates struggled to interpret the case facts and
understand what internal controls might have broken down (for example, vendors that are not on the
vendor list are being paid, or an amount in the accounts payable subledger is unknown and therefore
was likely not approved). As a result, many candidates were not able to provide valid recommendations
to address the control weakness. Some candidates focused on fixing the problem related to the current
vendor (for example, calling Welland to see if goods were actually purchased from them) instead of
providing a recommendation that could fix the internal control weakness.)
Inventory Issues
The sales manager was having trouble reconciling planned production orders to actual shipments. The
sales manager sells based on our planned production runs, but when the warehouse fills orders, the
inventory is not always there to ship, and orders end up short shipped. MSB bills based on the sales
manager’s figures, who then has to issue credits to the customers.
We are not doing a very good job tracking our inventory. The inventory log we had asked the staff to fill
out was meant to help everyone track production and inventory levels. I am not sure why it is not being
used. Maybe we did not explain the purpose clearly enough. It would be better if we automated this
process rather than relied on a manual process.
I also realize that we have a problem with our billing process. We should be billing based on actual
shipments instead of planned production. This would prevent the need to issue credits. If the log were
being generated automatically, the sales manager could use it to adjust the billing (using actual instead of
planned).
(Less than a quarter of candidates addressed the billing issues MSB was having. This is surprising
given that the case facts were quite directed and the solution was straightforward (for example, billing
based on actual shipments).)
Warehouse and Delivery Controls
One explanation for why we’re not able to fill our orders is that our “take a six-pack home” policy has either gotten out of hand or is being abused. With only eight employees, we should not be having this
much trouble filling our orders on a regular basis. I do not want to stop letting people take beer home each
week, but I think we need to keep a better eye on it and make sure no one is abusing the program. We also
need to make sure we account for the reduction in our inventory. I recommend we require the staff to sign
out their beer each week; we can create a simple inventory control sheet with the date, employee, and beer
they took home, and get the warehouse supervisor to track it in the inventory reconciliation he should now
be preparing.
173
We should get the warehouse supervisor to reinstitute the inventory log (until we can get the
computerized system in place) to track the inventory flow. We need to get the warehouse to start filling in
the log again to show the amount that is being produced and the amount shipped out, but we also need to
start reconciling the delivery documents (proof of receipt by the customer) back to the shipments to make
sure all shipments are getting to the customers.
We have been delinquent in our duties, so it is possible that some of the shipments are being diverted by
the drivers for personal use, which could be why the inventory is not reconciling.
Once we have the new IT system, we should be able to use some of its information management
functionalities. The warehouse supervisor should be responsible for reconciling production volumes, sales
volumes, and ending inventory, including tracking all breakage (taking into account that we recently had
some problems with our bottling process). The sales manager should review this reconciliation.
Reviewing the reconciliation prepared by the warehouse supervisor will allow us to identify and resolve
inventory issues in a more timely fashion, ensure better safeguarding, and allow us to detect unusual
variances in inventory volumes.
Until we have a computer system to track inventory, I recommend we create and provide an inventory
form, which the production staff would fill out with final production volumes, breakage, and shipment
volumes. You or I should review actual production volumes versus planned production runs for each
batch because we will need to get a handle on our increased volumes if we move into a new building,
where our production volumes would change. This will allow us to ensure the production additions to
inventory are reasonable based on our knowledge and experience.
(Most candidates addressed this issue and provided good discussions. However, some candidates did
not provide practical solutions to mitigate the control weakness. For example, some candidates
suggested that the inventory be counted daily. Candidates should have recognized that this is
impractical given that the operation is a brewery and, therefore, there is a high volume of inventory at
any point in time.)
Property, Plant and Equipment — Safeguarding of Assets
We appear to have a control breakdown in the physical security of the company’s assets. Employees should not be taking company assets off the property to begin with, and certainly not without having
obtained approval. We need to discuss the matter with the supervisor and make it clear that this is not an
acceptable practice. We should put a formal policy in place to make it clear that company assets are not
for personal use.
Assets should be tagged and inventoried, which will then allow us to monitor their usage. There should be
a system in place that would allow us to see when an asset was purchased and when it was sold. As MSB
grows and the number of assets increases, we will not be able to rely on our memories to know what
assets we are supposed to have on hand.
(Most candidates identified and discussed this issue. Some weak candidates adequately discussed the
issue but failed to provide valid recommendations. For example, some candidates suggested that GPS
tracking tokens should be installed on each asset; this would not have been practical for MSB given its
size and the risk of assets being misused.)
174
For Primary Indicator #3 (Assurance), the candidate must be ranked in one of
Percent
Awarded
1.2%
Nominal competence — The candidate does not attain the standard of
reaching competence.
13.0%
control
33.6%
Competent — The candidate discusses some internal control weaknesses,
including recommendations for mitigating the risks.
51.2%
Highly competent — The candidate discusses most internal control
weaknesses, including recommendations for mitigating the risks.
1.0%
Reaching competence
weaknesses.
—
The
candidate
identifies
internal
(While candidates were not specifically directed to this indicator, they were provided with a listing of
Peter’s concerns and were expected to identify the control deficiencies present at MSB. To achieve
competence, the Board expected candidates to rank the issues, discuss some of the significant control
weaknesses in sufficient depth, and provide recommendations to address the risks.)
(Candidates performed adequately on this indicator. Most candidates were able to identify several of
the control deficiencies and provide an explanation to Peter of the impact of these internal control
weaknesses. The topics most commonly addressed by candidates were the safeguarding of assets and
the lack of regular bookkeeping related to bank reconciliations. It was important for candidates to
recognize that some deficiencies had a more pervasive impact on MSB than others. As a result, these
issues (weaknesses in billing, inventory management, and segregation of duties) were more significant
and should have been given priority over minor issues, such as the approval of hours, which had only
affected one employee so far. Most candidates ranked the deficiencies appropriately and addressed the
significant ones first.)
(Where candidates sometimes had more difficulty was in providing appropriate recommendations.
Candidates’ suggestions on how to fix the control weaknesses were at times impractical or did not adequately address the risk involved. Strong candidates focused their discussions on the significant
deficiencies, such as incorrect billing, lack of inventory tracking, and segregation of duties. Weak
candidates did not appear to have ranked the issues appropriately since most focused their discussions
on minor issues.)
The candidate identifies the need for at least one of the owners to commit full-time to the
management of the business or for the company to hire a general manager.
175
As I have noted, we have several internal control issues, and several of our key employees are
overworked and unable to perform the key controls required of them.
New Computer System
Many of the control weaknesses identified in the previous discussion are system-related. IPA Systems has
a built-in inventory tracking system. HOPS Inc. would require the purchase of a perpetual inventory
system. Either system would help resolve many of these weaknesses by providing a proper inventory
tracking system. Having the ability to sign into a system to review reports and approve invoices would
also help address some of the weaknesses. However, this alone is not sufficient.
(Very few candidates addressed the fact that the new computer system was unlikely to solve all of the
existing problems at MSB.)
Management
Regular absence from the business itself is something we need to address. We seem to be losing control.
Decisions are being made that we are not aware of, and they are potentially harming the business. The
fact that the sales manager had delegated duties without consulting us, the bookkeeper believes she has
the authority to approve invoices and payroll, and the warehouse supervisor believes he has the authority
to lend out company assets all lead me to believe that we need to get more involved in managing the
operations.
Given how much change MSB will be going through in the next few years, we need to regain control of
the management of our business or we will not be in a position to manage the changes that will result
from the move to a new building and continued growth in production. Short shipments to customers could
have an impact on future sales. Cash flow will be tight for the next few years, and we cannot afford to
lose customers unnecessarily. We also need to tighten our inventory control and ensure we are not losing
any inventory to fraudulent activities or inefficient operations (breakage, et cetera).
176
We need to decide whether the installation of a new computer system — one that allows remote access —
will give us the necessary oversight control, or whether we need to combine that with more time in the
office during the week rather than on weekends. Perhaps we could both commit to taking one day off
work every other month to spend the day with the staff and be seen to be a little more directly involved in
the company. It is likely that this change will still not be sufficient. I think we may be at the point where
at least one of us needs to commit full-time to this business for it to continue to succeed. Of course, we
will need to look at cash flow to see what salary is possible. Considering you are about to have a baby,
compensation will be an important consideration in your decision. I will give it some thought, too. I might
be willing to take a pay cut for a short time.
I think that it may not be enough for us to get more directly involved. The volume of activity has
increased considerably. We may still need to hire another clerical employee to assist with record keeping.
Having an extra person on staff would allow us to reconsider and reassign some duties to ensure key
controls and proper segregation of duties are in place. It would be a fairly economical solution.
If spending more time during the week on site is not an option we want to pursue, we may want to
consider hiring a general manager. The addition of a general manager will allow us to implement several
key controls. Let’s not forget that the introduction of a new computer system would allow us to monitor
the general manager’s activities. I am just not sure we can afford to hire someone, given our cash flow.
Percent
Awarded
13.2%
competence.
19.5%
Reaching competence — The candidate identifies that the owners are “losing control of the business.”
31.3%
Competent — The candidate discusses how the owners are “losing control of the business” and how more involvement is required from the owners.
35.6%
Highly competent — The candidate thoroughly discusses how the owners are
“losing control of the business” and how more involvement is required from the owners.
0.4%
(Candidates were expected to recognize that Peter and CA were losing control of the business and
needed to commit full-time to MSB or hire a general manager. Candidates were provided with many
hints in the simulation that suggested that Peter and CA were not present often and that they were not
aware of how the operations were going.)
177
(Candidates struggled with this indicator. While some candidates were able to step back, most
recognized only that the general internal control environment was deteriorating, without recognizing
that the problem would likely get worse with the new expansion, the recent acquisition, the birth of
Peter’s baby, and both Peter and CA being away more often. Strong candidates were able to integrate these case facts to explain why this was a significant issue, while weak candidates simply stated that
there was a problem and jumped immediately to a recommendation. It was important for Peter to
understand the urgency of the issue, and many candidates did not adequately explain it in order to
convey that urgency to Peter. Many weak candidates also failed to provide valid recommendations to
address the issue. Some recommendations (for example, having a monthly meeting or dropping by
more often) would not have solved the problem at hand because the real need was for someone to work
full-time to better monitor the operations.)
(Generally, candidates performed well on this simulation, with the exception of Primary Indicator #4.
The requireds and issues were fairly straightforward, and candidates were able to sufficiently
incorporate case facts into the majority of their analyses. Candidates performed below expectations on
the Pervasive Qualities and Skills indicator (Primary Indicator #4). They were expected to step back
and understand that the internal control weaknesses were symptoms of a larger problem, and that the
problem would likely get worse with the new events affecting MSB, such as the new acquisition, Peter
having a baby, and the expansion. In general, candidates were not able to demonstrate that they
understood the issue, since they did not adequately discuss the issue or provide a valid recommendation
to address the issue.)
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SAMPLE RESPONSE
PAPER II-2 MOLLY-SUE BREWS INC.
To: Paul
From: CA
Re: MSB
Systems Analysis
HOPS Inc.
Pros:
HOPS provides fully integrated systems to the wine-making and brewing industries. Therefore,
HOPS is familiar with MSB industry and therefore, has designed systems specific to the requirements
of the brewing industry.
HOPS will provide access to software code to allow IT department to customize the programming
after installation. This is beneficial since in the event MSB identifies an opportunity to customize the
system to meet a unique requirement of MSB it has the ability to do so.
HOPS integrates with perpetual inventory software and hardware which allows for real-time
inventory tracking at each stage of production.
As shown in Exhibit I, HOPS system is less expensive than the IPA system.
Cons:
HOPS inventory tracking costs $25,000 per year whereas it appears that IPA inventory tracking is
included.
HOPS currently only handles US sales tax where MSB sales are all Canadian. Therefore, the system
is not able to calculate Canadian sales tax. This may mean that MSB may have to manually calculate
and adjust the sales tax which is inefficient and increases the risk of error.
There is a risk that HOPS is not compatible with MSB’s accounting system. Therefore, if MSB chooses the HOPS system it will likely have to also replace its accounting system, which is costly and
time consuming. This should be investigated with HOPS as soon as possible.
HOPS system will not be ready until January 10, 2014 as its available start date is September 10,
2013 and it takes four months to implement.
HOPS system does not offer hands-on service. The maintenance provided by HOPS is limited as only
one assistance call per month is included.
IPA
Pros:
IPA has inventory tracking capability. However, we should enquire with IPA to determine if it can
track inventory at each stage of production like the HOPS system. The advantage of the IPA system is
that there is no annual fee for the inventory tracking feature.
179
IPA is based in Vancouver and provides hands-on service to its customers unlike the HOPS system.
IPA has a dedicated consultant available for troubleshooting 5 days a week, and a 24 hour online chat
with support staff available. This is significant as issues with the system could have adverse effect on
operations and records, therefore, issues need to be addressed immediately.
IPA consultant will arrive on site and install the updates. This is beneficial as we will not have to
worry about the installation of upgrades as they will take care of this for us.
The next available project date is July 16, 2013 with a completion time of six months. Therefore, it
can be implemented by November 16, 2013 which is sooner than the HOPS system.
Cons:
As shown in Exhibit I, the IPA system is more expensive then the HOPS system.
The software program source code remains the property of IPA systems unlike the HOPS system.
Therefore, this limits our ability to make customizations if they are needed.
IPA is a local company and this increases the risk that they will not be in business in the future to
provide upgrades. However, this risk is mitigated by the fact that they have been around since 1985.
Recommendation
I recommend that we proceed with the IPA system. The IPA maintenance and service is significantly
better than HOPS which ensures that our system will be functioning correctly and that any issues will be
addressed immediately through IPA support services. Additionally, IPA is familiar with serving
restaurants and small manufacturers which is consistent with our business.
Cash Flow Projection
In Exhibit II, I have performed a five-year cash flow projection before tax. I have determined that MSB
will be cash deficient in year one by approximately $196,000. This is under the assumption that the
banker is only willing to provide the financing of 75% of the capital additions at the time they are
purchased. Therefore, one alternative to cover the cash deficiency in 2013 would be to request that the
Banker provides us the financing upfront in 2013. This would eliminate the deficiency. Additionally, to
assist with cash flow issues we could consider not taking a management fee or reducing our management
in 2013. After 2013, I have projected significant net cash inflows. Therefore, the full financing from the
Banker is not required. We should negotiate with the Banker to receive only the financing needed to cover
the net cash outflow in 2013 which is approximately $246,000. This will leave us with $50,000 in cash in
case of any unforeseen occurrences going forward into 2014.
Control Weaknesses
I have noted the following control weaknesses and have presented the implications and recommendations
below:
Weakness: The year-end bank reconciliation was not performed correctly and the previous bank
reconciliations had not been completed.
Implication: Without the performance of accurate and timely bank reconciliations it increases the risk that
outstanding and non-reconciling items will not be followed up on. This increases the risk that fraud could
be perpetrated and remains undetected.
180
Recommendation: I recommend that the bank reconciliations be performed monthly and that they are
reviewed monthly. Since the bookkeeper seems overloaded with the accounting requirements for both
businesses, we should consider hiring an additional bookkeeper. Furthermore, we must consider hiring a
professional accountant to manage the accounting function and review the bank reconciliations.
Alternatively, one of us should review the bank reconciliations monthly.
Weakness: Employees are able to borrow equipment for personal use.
Implication: This increases the risk that the equipment will be returned damaged as was the case with the
hydraulic lift. Additionally, it increases the risk that the equipment may not be returned. Both of these
situations have the potential to impact operations since the equipment is likely necessary.
Recommendation: I recommend that MSB implements a policy whereby no equipment is allowed for
personal use.
Weakness: There is evidence that employees are being paid for hours they did not work as evidenced by
the cleaning staff that did not show up one weekend but was paid for those hours.
Implication: Absence of controls over payroll increases the risk that MSB will overpay wages to
employees who either do not exist or did not work all of the hours reported. This increases the risk that
cash will be fraudulently taken from MSB, which puts cash flow strain on MSB.
Recommendation: I recommend that employees’ time cards are reviewed regularly. Employees should be
required to punch in and punch out of a time card system. Additionally, these time cards should be
reviewed daily. Pay cheques should be physically handed out to ensure that all employees being paid exist
and that no fictitious employees have been created.
Weakness: The production log is not being filled out by employees.
Implication: This means that we do not have accurate information about the production volumes and
inventory balances. This increases the risk that inventory can be stolen and will go undetected.
Furthermore, this decreases the quality and availability of information required for decision making
regarding production volumes and costing which increases the risk that production issues will go
undetected which could cause cash flow problems.
Recommendation: I recommend that we implement the IPA system ASAP as it has an inventory tracking
feature. Until the system is implemented, someone will need to be assigned the responsibility of
reviewing the production log daily to ensure that it has been filled out correctly. One of us may need to
take this responsibility.
Weakness: There is a loss in the bottled beer inventory volume.
Implication: This may suggest that inventory has been stolen by employees. Due to the lack of
information and tracking of inventories and production, this provides an opportunity for employees to
misappropriate inventory and it not be detected. Therefore, once we enforce the review of the production
log and implement the new system this will help mitigate this risk.
Recommendation: In addition, I recommend that all bottled beer inventory be locked in a secure location
and that authorization be restricted to mitigate the risk of beer being stolen.
Weakness: There is inappropriate segregation of duties as the bookkeeper is responsible for payroll
review and approval, invoice approval as well as performing the accounting function.
Implication: This increases the risk that the bookkeeper can commit fraud as she can overpay herself or
create fictitious employees. Additionally, she could misappropriate cash and conceal it in the record
keeping.
181
Recommendation: I recommend that these duties be segregated from the bookkeeping function. This may
mean that we will have to perform the review and approval of payroll and invoices ourselves, or designate
this to another manager.
Other Concerns
After the acquisition of DTL, the operations of MSB have grown significantly. Additionally, our
expansion plans will add to the growth of MSB. There is a concern that MSB is suffering from a lack of
oversight and management. As we both manage MSB part-time, we have not been able to provide the
oversight and management of MSB that is required. However, due to the expansion plans and acquisition,
I believe it is time we commit ourselves to MSB. Our absence and off-hand approach has resulted in the
following issues:
The bookkeeper is overloaded and it has impacted her work. The bank reconciliations contain errors
and are not being performed which increases the risk that fraud could remain undetected and that
errors will remain undetected in the financial information.
Employees are not filling out the production log because it appears no one is there to review the log
and enforce its completion.
The bookkeeper is performing the accounting function in addition to the review and approval of
payroll and invoices which increases the risk of fraud.
MSB business is growing and a number of control deficiencies have been identified. Overall, MSB does
not have the level of oversight and review that is required. Therefore, I recommend that we consider
managing MSB full-time.
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183
184
185
Get-a-Deal.com Ltd. (Deal) is privately owned and operated by Luke Hardy and Cal Adarman. Based in
Toronto, Ontario, Deal is an online service that sells vouchers for discounted deals valid at Toronto’s hottest new restaurants, bars, theatres, and sporting events. Deal offers weekly promotions to its
membership base via email. The discount vouchers sold through Deal’s website are redeemed by the members at the vendors’ establishments.
Luke and Cal founded Deal on July 1, 2012 as a side project to combine their skills: Luke’s software development background and Cal’s experience in marketing and advertising. The business started with a few hundred members and only one deal per week. Over the past year, Deal’s voucher sales have more
than doubled each month. Due to Deal’s aggressive promotion and vendor strategies, it now offers over a dozen weekly deals and has over 20,000 members.
Because of its expected growth, Deal has asked PA&E, LLP (PA&E) to perform an audit for its first year
end of June 30, 2013. It is now August 7, 2013. The partner says to you, “CA, the engagement acceptance procedures are done and the firm has accepted Deal as a client. Please draft an audit planning memo that
includes the key audit procedures you think we should perform on the high-risk areas. I emailed you my
notes from my discussion with Luke and Cal (Exhibit I), the draft financial statements for the year ended
June 30, 2013, and notes prepared by Deal’s bookkeeper (Exhibit II).”
The partner continued: “Deal has become so lucrative that Luke and Cal recently left their full-time jobs
to operate the company. They are focused on expanding Deal’s network of vendors within the Toronto
area. They then want to expand to other provinces, and eventually to other countries. They have already
held discussions with businesses in the US and Europe.
“They have recruited an internal accountant who has bookkeeping experience but who needs help to
ensure Deal’s 2013 financial statements comply with Accounting Standards for Private Enterprises
(ASPE). They noticed that some European companies apply International Financial Reporting Standards
(IFRS). They want to know whether IFRS is a more appropriate framework for Deal to use and ask you to
explain the factors they should consider in their decision to either stay with ASPE or move to IFRS. They
do not want a detailed comparison of the standards.
“Although thrilled by Deal’s success and dreaming of eventually competing with larger international
companies, Luke and Cal are concerned about some of the recent problems they have encountered. I
wonder whether they have identified all the risks that are related to their current business strategy and
considered ways to manage these risks. I think our enterprise risk management group could provide
additional support services here, but before we take the matter any further, please do some preliminary
analysis to substantiate my thinking.”
186
EXHIBIT I
NOTES FROM DISCUSSION WITH LUKE AND CAL
How Deal Works
Deal allows local vendors to offer vouchers through Deal’s website. As an example, last week a restaurant offered a four-course meal for two for $75, compared to the regular price of $150.
To participate in a deal, a customer must have a free membership. Opening an online account on Deal’s website automatically generates weekly email notifications of time-limited offers on the hippest things to
do, see, eat, and drink in the Toronto area. Members purchase vouchers on Deal’s website by credit card. They download the vouchers, which have unique barcodes, and can redeem them, at the earliest, two days
after the closing of the weekly deal, assuming that a minimum number of vouchers, as agreed to with the
vendor, has been sold. Vouchers must be redeemed within three months of each promotion closing date.
By promising vendors a minimum number of sales, Deal is able to secure discounts that members won’t find elsewhere. If the minimum number of sales is not met, Deal notifies each purchasing member that the
voucher is invalid, and refunds the amount paid by the member. To date, there have been very few cases
where Deal has had to do this.
Within 48 hours of the weekly deal closing, Deal remits to vendors the detailed listing of vouchers sold
and 75% of the funds collected from the members. The remaining 25% of the funds are retained as Deal’s commission.
Industry statistics show that 80% of the vouchers are redeemed.
187
Vendor Strategy
Cal strives to get new vendors on board as quickly as possible. Deal actively encourages vendors to not
limit the number of vouchers that they allow to be sold as part of a deal.
Cal likes the current arrangement Deal has with vendors and members. Given that Deal receives payment
directly from members, there are no accounts receivable collection issues with vendors. As a result, Deal
does not have to perform reference or credit checks before accepting new vendors.
Website
Deal’s member database is maintained on a server hosted by a third party. Working with external
programmers, Luke developed the interface for the website, including the login and payment processing
screens and displays.
Luke also custom-designed the computer system to generate the unique bar-coded voucher for each deal,
as well as a detailed report of the vouchers issued, which is provided to vendors. The system also allows
Deal to produce internal reports on total transactions for each deal, which are reconciled to credit card
receipts and subsequently to revenues reported. On a weekly basis, a report of total receipts is
automatically generated and creates an entry to record revenue that downloads into the Deal accounting
system, which is an off-the-shelf package.
In the past two months, there have been four occasions when Deal has offered deals so popular that the
high volume of attempted purchases has caused the system to crash. This occurred while some members
were submitting their payments, which caused the payments to not register, and the members had to
reinitiate their transactions. Luke is confident that moving to a more powerful server will alleviate the
problem.
188
Recent Growing Pains
In recent months, three otherwise reputable vendors have been unable to fulfill their obligations to
members due to an extremely high number of vouchers being sold. In these cases, Deal reimbursed
members, upon their request, for the vendor’s portion of the deal (75%). Cal’s view is that Deal earned its 25% commission, so it is not reimbursable. To date, Deal has reimbursed $100,000. Those refunded
vouchers represented approximately half of the vouchers sold for the three vendors.
One other vendor went bankrupt within a week of Deal having sold 1,500 vouchers for $100
dinner-theatre tickets. Deal reimbursed the 75% portion to the 575 customers who requested refunds.
At the end of June, a vendor arranged two separate voucher deals, and then closed its restaurant for
extensive renovations the day after receiving its portion of the funds from Deal. Deal is not certain the
restaurant will re-open, and decided to refund the 75% portion for members who requested it. The number
of complaints on this matter has been overwhelming and has distracted Cal from bringing in more
vendors. Of the 2,000 vouchers sold at $20 each, 400 were refunded.
Deal intends to go back to these vendors to recoup all the refunds paid, where possible.
Litigation
Last winter, a 17-year-old using a voucher sold by Deal, which included dinner and drinks, drove home
from the vendor’s restaurant and was in a serious car accident. The family has since filed a $250,000
claim against both Deal and the vendor. After the accident, Cal discovered that this is the second time the
vendor has been involved in this type of litigation and that its liquor licence has been suspended.
EXHIBIT II
EXCERPTS FROM DRAFT FINANCIAL STATEMENTS
AND BOOKKEEPER’S NOTES
GET-A-DEAL.COM LTD.
BALANCE SHEET
As at June 30, 2013
(unaudited)
Assets
Note
Cash and cash equivalents
Short-term investments
Refunds to be collected
Website costs
Property and equipment
$
550,000
393,550
149,125
226,000
175,000
$
1,493,675
$
337,500
60,000
269,044
666,544
4
2
3
Liabilities
Amounts due to vendors
Trade payables and accruals
Current taxes payable
Common shares
Retained earnings
20,000
807,131
827,131
$
1,493,675
189
190
GET-A-DEAL.COM LTD.
INCOME STATEMENT
For the year ended June 30, 2013
(unaudited)
Note
Revenue
Voucher sales
Less: the cost of voucher sales
1
$
Gross margin on voucher sales
Website advertising
Interest income
1,865,300
100,000
1,500
1,966,800
Cost and expenses
Marketing and advertising
General and administrative
Depreciation
619,625
244,000
27,000
890,625
Income before taxes
Current tax expense (25%)
Net income
7,461,200
5,595,900
1,076,175
269,044
$
807,131
191
1. Revenue
Revenue from vouchers is recorded when the funds are received, and cost of sales (75%) is
immediately recorded.
2. Refunds To Be Collected
Refunds to be collected include $100,000 for the 75% relating to vendors that could not fulfill their
obligations and for which members requested refunds. Deal reimbursed $43,125 for dinner-theatre
tickets (bankruptcy) and $6,000 for lunch vouchers (renovations). A receivable has been recorded for
the refunds paid that we intend to collect from the vendors. However, no amounts have been collected
to date.
Since June 30, due to a variety of complaints, members have requested another $87,000 in refunds for
vouchers sold before year end. The refunds have not been accrued because Luke and Cal have not had
time to approve their payment.
3. Website Costs
Although Luke developed much of the website himself, Deal also used external consultants. Costs
related to the planning, development, and maintenance of the website totalled $226,000, all of which
has been capitalized. This includes server hardware that was purchased for $60,000; $16,000 related to
expenditures incurred in the planning stages; $80,000 incurred in the development stage (stress testing,
obtaining a domain name, graphic design consultants); and $70,000 in website maintenance fees.
4. Short-Term Investments
These funds are invested in guaranteed investment certificates, bearing interest at the rate of 1.75%,
that mature within the next 12 months. Interest income was accrued at year end.
192
EVALUATION GUIDE
PAPER II, SIMULATION 3 — GET-A-DEAL.COM
The candidate discusses the GAAP framework options and why one might be chosen over the
other (ASPE versus IFRS).
Competencies
V-2.1 – Identifies the appropriate basis of accounting (A)
Get-a-Deal.com Ltd. (Deal) is a private company, so it has the choice of adopting either Canadian
Accounting Standards for Private Enterprises (ASPE) or International Financial Reporting Standards
(IFRS). There are many factors a private enterprise should consider before deciding which set of
standards is the most appropriate and best suited to its needs.
Cal and Luke’s dream is to eventually compete with much larger international online voucher services.
Assuming these international competitors prepare their financial statements using IFRS, Deal’s financial statements would more easily be compared to theirs if the same basis of accounting is applied. Cal and
Luke also hope to build on Deal’s success in the Greater Toronto Area and expand into other provinces, then into other countries. Here again, if it expands into other countries, particularly European countries,
where it may be asked to meet certain reporting requirements, using IFRS will likely be better.
If management were to consider accessing international markets for financing or to attract more investors
as Deal grows, IFRS statements may allow for easier access to those markets, since IFRS is a more
widely used set of reporting standards in the investment community.
However, there is a cost to adopting IFRS right away. The financial statements are more detailed and will
take more time for the bookkeeper to prepare. IFRS demands more effort in preparing the financial
statements because in certain instances the accounting is more complex. In Deal’s case, we would have to look at the requirements for income taxes and financial instruments, for instance. Also, more disclosures
are typically required with IFRS, and that information would have to be collected in the accounting
records or tabulated, for example, for it to be built into the financial statement disclosure. Management
may, therefore, not wish to have to provide the additional disclosures if they do not serve a purpose to
Deal itself.
193
As a result of the greater complexity and added disclosure, the cost of Deal’s audit will likely be higher than under ASPE since the auditors will need to do more work to ensure the completeness and accuracy
of the financial statements.
Upon moving to IFRS, Deal will also have to prepare an “opening IFRS statement of financial position,” which presents its opening balance sheet in accordance with IFRS, including the comparative figures.
However, the transition provisions of IFRS 1 provide for specific exemptions and elections that may
render certain ASPE accounting policies acceptable under IFRS.
Deal’s growth has been significant, with monthly sales doubling. As I’ve mentioned, both Cal and Luke
appear to want to continue a growth strategy. If they plan to take Deal public, they should know that
public companies in Canada are required to apply IFRS. Although they have stated that they understand
ASPE would apply for 2013, it might not make sense to first apply ASPE and then convert to IFRS if
Deal believes its growth will continue and result in a decision to enter international markets or go public
soon. Adopting ASPE now would mean having to restate Deal’s financial statements later when IFRS is
adopted, and there is a possibility it will have to adopt different accounting policies to comply with IFRS.
Converting, therefore, could be more costly. It might make more sense to adopt IFRS immediately, in
2013.
It should be noted that if Deal were to go public, it would need to meet regulatory requirements and filing
deadlines. It would also need to have good controls in place around its financial statements and systems to
be able to meet the standards required for public-company reporting.
Percent
Awarded
6.0%
competence.
29.0%
Reaching competence — The candidate identifies some of the decision factors
in choosing between IFRS and ASPE.
35.6%
Competent — The candidate discusses some of the decision factors most
relevant to Deal.
29.3%
Highly competent — The candidate discusses most of the decision factors most
relevant to Deal.
0.1%
(Candidates were required to discuss the GAAP framework options, ASPE versus IFRS, and why Deal
might want to choose one over the other. Candidates were directed to this indicator when they were told
by the partner in charge that the client wanted to know whether IFRS was a more appropriate
framework for Deal to use. They were also directed to it when they were asked to explain the factors
the client should consider in the decision to either stay with ASPE or move to IFRS. It was clearly
noted that the client did not want a detailed comparison of the standards.)
194
(While the Board acknowledges that this was an unusual indicator because it required candidates to
provide a high-level and practical discussion of the frameworks, candidates struggled more than
anticipated on this indicator. Candidates were expected to discuss the factors the shareholders should
consider in determining which accounting framework was most appropriate for Deal. Candidates were
expected to use specific case facts to make the discussion relevant to Deal’s current situation. For example, candidates provided value to the client if they linked Deal’s plan to expand into other provinces and eventually other countries, including the US and Europe, with the fact that the use of
IFRS might provide the company with more comparable financial statements.)
(Strong candidates recognized that this was Deal’s first year of operations and noted that it would be advantageous to adopt IFRS now, given its expansion plans, rather than incur the costs involved in
transitioning to a new framework in the next few years. Strong candidates also provided brief
discussions of some of the other relevant factors, including costs, disclosures, complexity, and the
increased comparability of the financial statements with those of international competitors if Deal
adopted IFRS. Weak candidates failed to integrate specific case facts to support their analyses and
tended to provide generic lists of factors to consider. Some candidates failed to understand their role
and provided a detailed comparison of the standards.)
The candidate discusses the accounting issues.
Competencies
There appear to have been some errors made in the preparation of Deal’s financial statements, perhaps
due to the inexperience of Deal’s management and bookkeeper in developing accounting policies. They
are applying Canadian Accounting Standards for Private Enterprises (ASPE) for the first time since this is
Deal’s first year-end.
Revenue Recognition
Currently, all revenue is being recorded upon receipt of payment from a member by credit card. They
have not performed any analysis to determine whether “upon receipt” is the most appropriate time to
recognize the revenue.
Agent or Principal/Gross versus Net
Deal should question whether the full amount of revenue collected from members should be recognized
or only the portion that is retained solely by Deal. The vouchers sold by Deal could perhaps be considered
a “good” because the holder of the voucher has the legal right to exchange it for a specific service or
product. However, the voucher is honoured by the vendor, not by Deal. The voucher arguably represents
the discount, arranged by Deal with the vendor, on the vendor’s transaction. Deal’s revenue is the 25% it earns for arranging the deals between the vendors and customers. Therefore, Deal appears to earn its
revenue by providing a service more so than a good.
195
Handbook (ASPE) 3400.23 states that
Similarly, in an agency relationship, the gross inflows of economic benefits include amounts collected
on behalf of the principal that do not result in increases in equity for the entity. The amounts collected
on behalf of the principal are not revenue. Instead, revenue is the amount of commission.
As well, Handbook (ASPE) 3400.24 provides that
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.
Deal appears to be acting as an agent for the vendor, since there is no continuing responsibility for
providing the good or service that can be purchased using the voucher. Deal does not appear to have
appropriately recorded the net amount, its 25% commission, since it has recorded the gross revenue and a
related cost of sale.
(Most candidates addressed this issue and integrated some simulation facts into their discussions.
However, many candidates failed to also support their discussions with technical guidance from the
Handbook. These candidates did not provide sufficient analysis of the relevant criteria under ASPE,
and as a result were not able to demonstrate sufficient depth of analysis on this issue.)
Timing of Revenue Recognition
The next step is to determine when it is appropriate to recognize this revenue. Revenue from a sale should
be recognized in accordance with Handbook Section 3400.04: “Revenue from sales and service
transactions shall be recognized when the requirements as to performance set out in paragraphs
3400.05–.06 are satisfied, provided that at the time of performance ultimate collection is reasonably
assured.”
Handbook Section 3400 provides for the following:
3400.19 Recognition of revenue requires that the revenue is measurable and that ultimate collection
is reasonably assured. When there is reasonable assurance of ultimate collection, revenue is
recognized even though cash receipts are deferred. When there is uncertainty as to ultimate collection,
it may be appropriate to recognize revenue only as cash is received.
196
3400.20 When the uncertainty relates to collectability and arises subsequent to the time revenue was
recognized, a separate provision to reflect the uncertainty would be made. The amount of revenue
originally recorded would not be adjusted.
One possibility is to view the significant risks and rewards of ownership as being transferred to the buyer
upon email of the voucher to the member and upon the transfer of the list of vouchers outstanding to the
vendor. This step occurs after confirmation that the minimum number of vouchers has been sold. Using
this point in time to recognize revenue is also based on Deal’s role, that of a service provider, and the service being the “connection made between the vendor and the customer.” Therefore, it reflects when the obligation has been met. This appears to be Cal’s view because he believes that even when Deal has
issued refunds to customers, the 25% commission is earned and is not refundable.
However, these customers are members of Deal; they have purchased a voucher from Deal, not the
vendor; and they have paid Deal in full at the time of purchase. If the voucher is viewed as representing
the meal versus the discount negotiated, then it can be seen as a good. It can then be argued that until it is
certain that the vendor has fulfilled the obligation to the customer by delivering the good (the meal or
activity), the rewards of ownership of the voucher have not been transferred. It would then make sense to
wait until the vendor has honoured the voucher before recognizing the revenue. However, there is no
mention of the vendor’s reporting back on whether or when a voucher has been cashed in; therefore, it
might not be possible to even track this. Considering only 80% of vouchers get cashed in, Deal would
have to wait until the three-month offer period expires before being able to record the remaining 20%. Or,
conversely, it could record 20% upfront and the remainder as the vouchers are cashed in. Alternatively,
the revenue could be recognized evenly over the three-month offer period.
However, these alternative approaches may be unnecessarily conservative, given that all but a few of the
vendors fulfill their obligations, according to Deal. On the assumption that these few cases can be
estimated, they can then be allowed for, and the revenue can be recognized.
(Most candidates addressed this issue and it was generally well done. Candidates applied case facts to
their technical knowledge and concluded on appropriate treatments that were consistent with their
analyses.)
Refunds
An additional complication is the increased number of refunds that members are requesting from Deal in
cases where vendors are not fulfilling their obligations. These create uncertainty in the amount of
revenue. Because Deal collects the funds immediately from members, there is no uncertainty regarding
collection of the initial amount.
197
However, Deal has taken it upon itself to reimburse members “on behalf” of the vendors, arguably to preserve Deal’s business reputation. (See my recommendation later in this report regarding setting a
refund policy and clarifying the agreement with the vendors.)
It is questionable whether Deal’s practice of issuing refunds to members where vendors have not met their commitments could be considered a liability. Section 1000.30 of the Handbook refers to a liability as
follows:
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.
These refunds should be estimated and Deal’s revenue should be reported net of refunds. In addition, an accrual should be made for the $87,000 of additional refund requests, and reduction of revenue should be
recorded for this amount, even though Cal and Luke have not had an opportunity to review these claims.
The estimates should be based on historical information. However, at this point Deal does not have very
much history. Given that Deal’s refund history is short, management will have to perform a detailed
assessment of refunds on an individual basis, for each outstanding weekly deal at year-end. Going
forward, Deal should be able to use historical figures to perform this estimate of refunds.
With respect to the refunds granted, Deal has reimbursed customers for only 75% of what they paid for
the voucher, retaining the 25% commission that Deal earned. It is unclear whether a legal liability exists
for the remaining 25%, and Deal should consult with its lawyers. If it is determined that it is liable for the
full amount, the refund liability will need to be adjusted and revenue reduced.
(Few candidates addressed the refund issue, and those who did typically only discussed the need to
record revenue net of refunds based on historical information. These candidates failed to recognize
that Deal’s refund history was short, so, therefore, it was not sufficient to recommend using historical
information. As a result, their analyses lacked depth. In this situation, candidates were expected to
discuss the fact that Deal would have to perform a detailed assessment of refunds on an individual
basis given its lack of historical information.)
(Very few candidates recognized the potential constructive obligation resulting from Deal’s practice of issuing refunds to members where vendors had not met their commitments. Those who did provided
good discussions of the potential liability related to the refund requests that had been received but not
yet processed or of the potential liability to members for the remaining 25% of what they paid for the
voucher (representing Deal’s commission).)
Receivable from Vendors
At this point, Deal has set up the 75% refund paid out to members as a receivable from the vendors on the
basis that it plans on collecting the refunded amounts from the vendors.
198
In accordance with Handbook (ASPE) Section 1000.25, assets have three essential characteristics:
(a) They embody a future benefit that involves a capacity, singly or in combination with other assets,
in the case of profit-oriented enterprises, to contribute directly or indirectly to future net cash
flows;
(b) The entity can control access to the benefit; and
(c) The transaction or event giving rise to the entity’s right to, or control of, the benefit has already occurred.
It is unclear whether the agreement signed with vendors provides Deal with the legal right to collect these
amounts from the vendors. As a result, the third criteria may not be satisfied, in which case Deal would
not have a basis to record the receivable as at the balance sheet date. Deal should consult with its lawyers
because there may or may not be a legal basis for collecting these funds.
In addition, Handbook (ASPE) Section 3856 states that
3856.16 At the end of each reporting period, an entity shall assess whether there are any indications
that a financial asset, or group of similar financial assets, measured at cost or amortized cost may be
impaired.
It is noted that Deal refunded the 75% portion to 575 members ($43,125) who requested a refund because
a vendor went bankrupt within a week of Deal having sold the vouchers. It is doubtful that Deal will be
able to recover these funds, and the amount is likely impaired. At a minimum, this portion of the
receivable should be written-down to the revised expected amount to be collected in accordance with
Handbook (ASPE) Section 3856.
(A little over half of the candidates addressed this issue. When addressed, it was generally well done.
Candidates applied case facts to their technical knowledge and concluded on appropriate treatments
that were consistent with their analyses.)
Website Costs
Deal has incorrectly capitalized all website costs. The amounts included within the total of $226,000 in
capitalized costs must be separated into those that are classified as property and equipment (ASPE
Section 3061) and those that are considered intangibles, which should be assessed in accordance with
ASPE Section 3064, Intangible Assets, to determine whether they should be capitalized or expensed.
3064.21 An intangible asset shall be recognized if, and only if:
(a) it is probable that the expected future economic benefits that are attributable to the asset will
flow to the entity; and
As described by the bookkeeper, $60,000 of server hardware should be capitalized at cost and recorded on
the balance sheet, since it is property, plant and equipment. Assuming that Deal adopts the cost model, it
should estimate each asset’s useful life and record depreciation from the date that Deal started using the website for operations.
199
3064.35 To assess whether an internally generated intangible asset meets the criteria for recognition,
an entity classifies the generation of the asset into:
(a) a research phase; and
(b) a development phase.
The $16,000 in expenses that were incurred in the planning stages (which are similar to those incurred in
the research phase for intangible assets) should be expensed because they have no future benefit.
Similarly, the $70,000 in website maintenance expenses should also be expensed, since these were
incurred once the website was presumably in operation.
With respect to the $80,000 in development costs, in order to be capitalized, development costs must be
recognizable as intangible assets:
3064.50 The cost of an internally generated intangible asset comprises all directly attributable costs
necessary to create, produce and prepare the asset to be capable of operating in the manner intended
by management. Examples of directly attributable costs are:
(a) costs of materials and services used or consumed in generating the intangible asset;
(b) costs of employee salaries, wages and benefits arising from the generation of the intangible asset;
(c) fees to register a legal right;
(d) amortization of patents and licenses that are used to generate the intangible asset; and
(e) interest costs when the entity's accounting policy is to capitalize interest costs.
3064.51 The following are not components of the cost of an internally generated intangible asset:
(a) selling, administrative and other general overhead expenditure unless this expenditure can be
directly attributed to preparing the asset for use;
(b) identified inefficiencies and initial operating losses incurred before the asset achieves planned
performance; and
(c) expenditure on training staff to operate the asset.
The development costs identified as being incurred include stress testing, graphic design, and obtaining a
domain name. These costs would all be directly attributed to the development of the website.
For the development phase, specific criteria exist surrounding technical feasibility; intention to complete;
ability to use the asset; availability of adequate technical, financial, and other resources to complete the
development; and ability to reliably measure the related expenditures (see 3064.41). Given that the
website has been fully developed and has indeed provided a benefit to Deal, these criteria are supported
without difficulty and the $80,000 can be capitalized.
The next step is to determine whether the intangible asset has a finite or infinite useful life. Given that the
website will likely not be used forever, management should provide an estimate of its useful life, and the
development costs should be amortized over this period.
(Most candidates addressed this issue. Candidates generally applied some of the relevant simulation
facts to their analyses of the recognition criteria for internally generated intangible assets and the
components of cost. However, some candidates failed to discuss the specific technical criteria and
simply concluded on which costs were to be expensed and which were to be capitalized. These
candidates failed to demonstrate sufficient depth in their analyses because their conclusions were
lacking support.)
200
Litigation
Deal has currently not accrued the $250,000 claim in which it is a joint defendant. To determine whether
an accrual should be made, Deal will need to provide an assessment as to the likelihood it will have to
make a future payment (and the likely amount of this payment), and it will probably need to obtain input
from its legal counsel when making this assessment.
3290. 08 The treatment of contingent losses in financial statements depends upon the likelihood that
a future event will confirm that an asset had been impaired or liability incurred as at the financial
statement date.
3290.12 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.
If it is determined that it is unlikely Deal will need to make a payment, or that it is likely but the amount
cannot be estimated, or that the results will be confirmed only by the judgment of the lawsuit itself, then
no accrual will be required, in accordance with ASPE Section 3290, Contingencies. Disclosure, however,
is probably needed in the financial statement notes.
If it is determined that it is likely Deal will have to make a payment, namely as a result of what happened
in the previous lawsuit against the same vendor, and a reliable estimate can be made, an accrual should be
made in the financial statements of the best estimate of the expenditure that will be required to settle the
lawsuit.
(Most candidates discussed the fact that the claim against Deal represented a contingent liability.
However, candidates’ discussions of this issue were very brief, usually addressing only one of the conditions listed above. Strong candidates identified both of the conditions that needed to be met. They
also concluded that the likelihood a future event would confirm a liability had been incurred as at the
balance sheet date was unknown, and that additional information would be required in order to
determine whether an accrual was required.)
Percent
Awarded
0.6%
competence.
7.6%
issues.
44.5%
Competent — The candidate discusses some of the significant accounting
issues.
47.3%
Highly competent — The candidate discusses most of the accounting issues.
0.0%
201
(Candidates were not specifically directed to this second indicator, but were told by the partner in
charge of the audit engagement that Deal’s bookkeeper needed help to ensure that Deal’s 2013 financial statements complied with ASPE. Candidates were also provided with excerpts from the draft
financial statements, which included a balance sheet, an income statement, and notes outlining some
of the significant accounting policies.)
(Candidates performed adequately on this indicator. About half of the candidates were able to provide
in-depth discussions of some of the relevant accounting issues, most frequently addressing the revenue
recognition policies to apply to the sale of vouchers, the contingent liability, and the website costs.
These candidates also provided logical recommendations that flowed from their analyses. Many
candidates who failed to reach competency were able to identify the relevant issues but jumped directly
to providing recommendations without supporting them with case facts or references to the relevant
ASPE standards.)
The candidate drafts an audit planning memo for the year-end audit of Deal, and provides audit
procedures that address the areas of high risk for the engagement.
Competencies
VI-2.3 – Evaluates the implications of the key risks and business issues 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)
Audit Planning Memo for Deal
Risk Assessment
As part of the audit planning, we need to assess the risk that Deal’s financial statements will be materially misstated.
CAS 200 A34 to 41 and CAS 315 establish the requirements and provide guidance on identifying and
assessing the risks of material misstatement at the financial statement and assertion levels.
Given our understanding to date of the Deal business (which we will have to expand upon further in our
audit planning stages) and its operating and control environment, the following risks have been identified:
Risk of material misstatement at the overall financial statement level
First year of operations: Since this is the first year of operations and the client is inexperienced in both
the development and application of accounting policies, the financial statements may contain errors
and will need to be scrutinized carefully.
202
Dramatic growth: Since Deal’s main focus was to quickly expand its business, which it achieved via
extensive vendor growth, it is possible that less focus was placed on policies, procedures, and controls,
increasing the risk of error and financial risk.
Untested system: The business is heavily reliant on an information technology system that has
primarily been developed in-house and that links into the accounting system. The system is hosted
offsite. Working with external programmers, Luke developed the interface for the website, including
the log-in and payment processing screens and displays. There is no indication that this system has
been tested by management, and four times during the past month the system has crashed. These
factors increase the risk of error and will need to be considered when developing audit procedures.
Bookkeeper knowledge of ASPE: The bookkeeper might have limited experience and knowledge of
ASPE since the owners said the bookkeeper needs help to ensure Deal’s 2013 financial statements comply with ASPE. This increases the risk of error in financial statements.
Based on the above factors, I assess the risk of material misstatement at the overall financial statement
level as high.
Risk of material misstatement at the assertion level
See table at the end of this section.
(Most candidates were able to provide good discussions on the impact of the nature of operations on
risk.)
Materiality
CAS 320 serves as a guideline in setting overall (for the financial statements as a whole) and performance
materiality. I recommend the use of 5% of “profit before tax from continuing operations” for overall
materiality. This decision is based on the users of the financial statements, which include Cal and Luke,
the vendors (who may use the statements to assess the health of Deal’s business before entering into a
business arrangement), and potential future lenders or investors.
After adjusting for the errors identified, the revised profit before tax would be as follows:
Unadjusted:
$
Adjustments identified:
Website costs to be expensed
Refunds due
1,076,175
(86,000)
(87,000)
$
903,175
As a result of the work we will perform, we might have to consider other adjustments to the above figure,
such as for revenue recognition policy change, if any; additional refunds that could be accrued; an amount
that would be recorded as a result of our assessment of the likely outcome of the lawsuit; and any
accounts receivable write-offs.
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Thus, at 5%, suggested overall materiality would be $45,000. Note that this amount would have to be
revisited upon management’s revisions to the financial statements, which may be significant.
As required by CAS 320 and to scope our audit work, we will use a performance materiality. We might
set it at 70% of overall materiality ($31,500), since this is the first-year audit, and also because there are
concerns about the reliability of Deal’s systems (crashes could have corrupted the data). Choosing this performance materiality level reduces the probability that the total of uncorrected and undetected
misstatements exceeds the overall materiality for the engagement.
(Some candidates were able to integrate their analyses of the accounting issues and recognized that
materiality would have to be revised. Strong candidates went a step further and calculated a revised
materiality level, in light of the accounting changes recommended. Weak responses did not attempt to
quantify materiality or did not provide a relevant benchmark on which to base materiality.)
Approach
It is important for us to assess not just the accounting system, but the complete web-driven orderprocessing and payment system that drives the Deal business.
The audit approach would need to be controls-based, to the greatest extent possible, given the high
number of routine transactions processed in the form of paperless vouchers that are emailed to members.
We will need to gain an understanding of how the system functions, document the processes, assess the
system controls in place, and determine whether a controls-based approach is reasonable given our
analysis.
There is some concern, due to the system having crashed several times, that the data may have been
corrupted. We will need to discuss this with Cal and Luke. We will also need to determine if the controls
have been appropriately designed and implemented. If they appear to be reliable, we may then test the key
controls. Regardless, a selection of substantive procedures will be performed on areas of high risk.
Deal has indicated that its members’ database is hosted by a third party. Additional information will have
to be obtained with respect to the service organization that hosts the database and used to determine what
access and change controls are in place.
(Few candidates recognized the impact that the highly automated and routine nature of operations or
the weaknesses in the IT system would have on the overall audit approach. Therefore, they were not
able to provide sufficient depth of discussion in this area. As a result, most candidates provided a
generic discussion without integrating any case-specific facts to support their analyses.)
Specific High-Risk Areas and Procedures To Be Performed
Our discussion with Luke and Cal and our review of the financial statements helped to identify the
following high-risk areas: revenue recognition, accounts receivable, refund liabilities, website costs, and
contingent liabilities. Note that additional high-risk areas may be added upon finding out more
information.
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The following table discusses the risk areas, assertions, and suggested related audit procedures:
Risk Area
Revenue
recognition
Assertion
Occurrence,
accuracy
Specific Risk
cut-off, There is a risk that
revenue is recognized
before the criteria for
revenue recognition has
been met (Deal has
been recording on a
cash basis).
Procedures
Review contracts to ensure
the criteria under Section
3400 have been met.
Completeness,
accuracy
cut-off, There is a risk that
funds were received but
the system did not
properly record sales
(due to system crashes).
The system that captures
revenue (the website) should
be tested. This should include
verifying the accuracy of the
voucher listing (to meet
minimum
voucher
requirement) and verifying
the total cash receipts to the
amounts recorded in the
accounting system. This will
involve comparing the deal
sold to the voucher emailed,
the inclusion on the list of
vouchers sent to the vendor,
the cash receipt, and the total
amount included on the
system report generated.
Perform cut-off to ensure
revenue
was
recorded
properly for the last two days
of the year.
Cut-off, accuracy
Specifically, there is a
risk that revenue is
recognized at year-end
after the cash has been
received but before the
vouchers have been
sent to the customer
and the listing to the
vendor.
The entry in the general
ledger (that should be posted
48 hours after a deal closes,
once vouchers have been
distributed) should be tested
for accuracy.
Risk Area
Refunds
(25%)/
potential
liability
Assertion
Completeness, accuracy
Specific Risk
There is a risk that the
25%
of
customer
payments that have
been retained by Deal
instead of refunded
have not been recorded
as accruals but should
be.
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Procedures
Examine
contracts
with
members to determine if there
is a requirement to reimburse
the 25%.
Review
legal
opinion
obtained from Deal’s lawyers.
For the additional $87,000
identified by the accountant,
assess whether the requests
appear to be within Deal’s refund policy and gain an
understanding of the legal
obligation to determine if an
accrual is required.
Refund
requests
outstanding
Cut-off, accuracy
Refunds not Completeness, accuracy
requested
Refunds to be Valuation
collected
Existence
Website costs
Existence,
classification
There is a risk of
material misstatement
for the refund requests
outstanding at June 30,
for
vouchers
sold
before year-end.
There is a risk that
there are unrecorded
refunds due to members
who hold vouchers but
have not requested
refunds for a promotion
that took place before
June 30.
Review all refunds granted
(approved or paid) post-yearend and determine whether
they related to fiscal 2013
sales and whether they have
been accrued at year-end.
Examine
contracts
with
members to determine if there
is a requirement to reimburse
the 25%.
Review
legal
opinion
obtained from Deal’s lawyers.
Assess if the accounting
estimates are reasonable.
There is a risk that the Examine vendor contracts to
refunds to be collected determine if the vendors are
from the vendors are obligated to repay the 75% to
uncollectible.
Deal.
Deal may have to get a legal
opinion on whether the
vendors are obligated to repay
the 75%. Examine any legal
opinion to that effect.
accuracy, There is a risk that Obtain a list of expenditures
amounts are incorrectly relating to what is considered
capitalized that should to be website hardware or
206
Risk Area
Assertion
Specific Risk
be expensed.
Procedures
development costs. Select a
sample of expenditures and
request support (e.g., receipts)
to assess whether the amounts
have been properly described
and as a result properly
capitalized.
Draft a letter to Deal’s legal counsel and obtain best
assessment of the case’s outcome.
Contingent
liability
Completeness, disclosure
There is a risk that the
lawsuit for $250,000
meets the definition of
a provision and should
be
accrued
(or
disclosed) but has been Perform procedures such as
improperly omitted.
reviewing the correspondence
between Deal and its legal
counsel and reviewing the
legal expense account.
(See CAS 501.09 to 501.12.)
(Most candidates were able to identify the high-risk areas of the audit, which flowed from their
discussions of the accounting issues, and develop specific audit procedures to cover off these areas.
For example, most candidates recommended a procedure to select a sample of expenditures related to
the website costs and review supporting documentation (such as invoices and contracts) to assess
whether amounts were properly classified. Most candidates were also able to identify effective
procedures for revenue recognition, the refunds to be collected, and the contingent liability.
Procedures provided were clear, effective, and related to specific risks. Candidates who struggled with
this indicator typically had difficulty explaining the specific risk the procedure was addressing. For
example, some candidates who discussed revenue recognition correctly suggested that the contract be
obtained and reviewed, but were more focused on verifying the amount of the sale versus examining
whether performance had been achieved.)
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Percent
Awarded
0.1%
competence.
12.3%
Reaching competence — The candidate discusses some of the planning
elements of the audit or provides some audit procedures that address the areas of
high risk for the engagement.
35.7%
Competent — The candidate discusses some of the planning elements of the
audit and provides some audit procedures that address the areas of high risk for
the engagement.
51.8%
Highly competent — The candidate discusses some of the planning elements of
the audit and provides several audit procedures that address the areas of high
risk for the engagement.
0.1%
(Candidates were directed to this third indicator when they were asked to draft an audit-planning
memo that included the key audit procedures that should be performed on the high-risk areas. To
demonstrate competence, candidates were expected to discuss some of the audit-planning issues and
provide some audit procedures. The simulation stated that the engagement acceptance procedures for
this new client had already been completed.)
(Candidates generally performed well on this indicator. Most candidates were able to provide
reasonable audit plans, including discussions of the risk assessment factors, the audit approach, and
materiality. They were also able to provide adequate audit procedures related to the key accounting
issues. Where candidates sometimes faltered was in explaining why the procedures they were
suggesting were required (in other words, what specific audit risk a procedure addressed).)
(Many strong candidates provided more complete planning discussions. They considered the impact of
both the nature of the operations and the accounting issues on the various components of the audit
plan. These candidates also provided more thorough discussions of the audit procedures for the
significant accounting issues. Most of these candidates combined this indicator with Primary Indicator
#2 by discussing each accounting issue and then providing procedures to address it. Weak candidates
provided vague, generic, or incomplete procedures with no explanations as to why they would be
required.)
The candidate discusses Deal’s risk management policy and strategy weaknesses.
The candidate is demonstrating competence in Governance, Strategy, and Risk Management.
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Competencies
IV-2.3 – Identifies and evaluates opportunities and risks (A)
IV-1.4 – Identifies the importance of governance activities (B)
Deal’s goal is to continue to grow, and to expand into other provinces and possibly other countries. In an
effort to achieve this goal, its priority is to focus on rapid expansion, and it has seen significant growth in
its first year of operations. This includes expanding both its customer/member base and its vendor base
and encouraging vendors to sell as many vouchers as possible.
Refunds
If Deal continues to bear the cost of issuing 75% refunds to members and to collect these member refunds
from vendors (or attempt to, at the present time), there could be a liability related to an “informal” policy being created that could create a precedence of payment. Given that Deal has no set refund policy, it is
acting of its own volition, and it is refunding members 75% of the full amount, members may expect a
full refund. The fact that Deal is giving a refund at all establishes a pattern that future members can expect
to apply to them as well. There is a risk to the success of the business since repeat business may decline if
unhappy members do not return. There is also a risk of hurting Deal’s reputation if these members speak badly about their experiences, so in terms of good business practice, it might be appropriate to offer
refunds.
Since Deal automatically remits the funds collected from members when vouchers are sold, there is no
recourse with the vendors. When refunds are provided, Deal is out of pocket for the costs and has to go
back to the vendors to try to collect the vendor portion of the refunds, which causes a significant cashflow and credit risk. If the vendor is bankrupt, there is likely little chance of collecting these funds. In
these instances, Deal may not be able to collect from the vendors and may have to write-off the
receivables.
Recommendation
To protect Deal against vendors that are unable to fulfill their obligations to customers, it should consider
withholding payment beyond the 48 hours after closing of the deal. Options Deal has for submitting the
cash to the vendors include
Payment plans based on voucher redemptions (for example, making weekly payments based on
weekly redemptions by customers);
Taking a standard hold-back percentage on a specific number of vouchers sold;
Payment plans based on a set time period (for example, making equal payments over a three-month
period and adjusting amounts for any refunds); and
Submitting payment at the end of the three-month period, once the voucher has expired, adjusted for
any refunds granted.
We strongly recommend that Deal negotiate with vendors regarding future refunds but also consult with
legal counsel to determine whom the refund obligation lies with for those cases where refunds have been
issued. Deal could consider defining a refund policy with vendors and including a “vendor responsibility” for refunds within its agreements.
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(Few candidates identified the fact that the current payment system to vendors presented a significant
cash-flow risk to Deal given the number of refunds it has issued to date.)
Legal Liability
Deal had issued a voucher that included “dinner and two drinks” to a 17-year-old. Further, that voucher
was issued on behalf of a vendor that had its liquor licence revoked due to Liquor Control Board
violations. Regardless of whether or not Deal is found to be at fault legally, the charges against it in the
drinking-and-driving case could be extremely detrimental to its reputation.
Recommendation
Deal should ensure that members accessing its website confirm that they are of legal age when they
participate in certain promotions that can only be offered to individuals of legal age, so that Deal will be
compliant with all applicable laws and regulations.
(Approximately one-third of candidates recognized that Deal could potentially be exposed to significant
risk resulting from litigation. However, some candidates had difficulty explaining the potential
reputational risk to Deal from being associated with such litigation.)
Lack of Vendor Acceptance Strategy
Since cash is collected from the customers directly, Cal does not feel that there is any need for Deal to
perform verification of the vendors that sell vouchers on its site. As a result, there are no vendor
acceptance policies in place.
The risk with accepting all new and “hot” vendors without performing any acceptance procedures is that the vendors may not be able to uphold their end of the bargain (to provide the goods or services promised
by the voucher). There is a particular risk with new businesses that have just opened, since their staff,
policies, and systems may be new and they may not fully understand the impact a Deal arrangement will
have on their businesses. Given that the restaurant and bar industry in Toronto experiences high ownermanager turnover, a number of Deal vendors may end up in this situation.
Recommendation
Deal should be performing basic due diligence procedures on new vendors, including reviewing
ownership and management, financial history (any bankruptcy in the past), and location of business. Deal
should also be checking whether they have any health inspection or liquor violations outstanding; and
verifying the most recent licencing requirements.
(Most candidates recognized that the lack of a vendor acceptance strategy was a significant risk to
Deal. When they addressed it, candidates generally did a good job of identifying the risk and discussing
the overall implications for Deal.)
210
Contract and Relationship with Vendor Unclear
Deal’s “informal” policy appears to be to refund only the 75% portion (not including its commission) to
customers because management believes the company has earned its commission and that the liability
rests with the vendor.
From a reputational perspective, this creates a significant risk in that consumers may become hesitant to
purchase from Deal and may begin purchasing from somewhere that has a formal guarantee and refund
policy to protect them. This would reduce Deal’s customer base, which is contrary to its goal of expansion.
A greater concern is that Deal may still be legally obligated to refund money for vouchers that vendors
are unable to support. Having no formal policy exposes Deal to a legal liability, since it is unclear whether
the liability belongs to Deal or to the vendor.
(Very few candidates recognized that Deal was lacking formal policies and procedures with regard to
establishing responsibility in the vendor agreements for refunds to members. Most candidates also
failed to see the potential liability and reputational risk that could result from this omission.)
Sales Tactic
Deal’s policy of encouraging vendors to not limit the number of vouchers they accept actively encourages vendors to accept more than they are potentially able to handle. Given that all vouchers expire three
months from the purchase date, it is theoretically possible that vendors may not have the physical capacity
or staffing capability to handle the volume of vouchers sold within that time period.
The above business policy choices are starting to result in negative consequences for Deal. Problems have
started to happen with Deal vendors, as evidenced by a vendor bankruptcy, a vendor closure for
renovations, three vendors in the past month being unable to fulfill their obligations to customers, and a
higher volume of requests for refunds from customers.
(Less than half of the candidates recognized that there was a risk related to Deal’s aggressive growth strategy and lack of due diligence on vendor capacity. However, when they did address it, most
candidates were able to provide good discussions of the implications for Deal.)
Recommendation
In order to mitigate the risk associated with over-extending vendors, Deal should adopt a policy with
respect to vendor acceptance.
In this policy, Deal should establish a maximum number of vouchers that can be sold for each deal, or at
least have vendors perform self-assessments as to the maximum number of vouchers that they could
support in the three-month period.
Deal should also consider providing information packages for new vendors explaining to them the impact
that selling vouchers may have on their businesses and advising them to adjust accordingly to prepare for
the increased volume (for example, increased phone calls, reservations, and traffic may result in more
staffing requirements).
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Refund Approval and Processing Policy
Given that Deal’s strategy is to continue to grow and perhaps eventually go public, management needs to ensure that their policies are adequate to accommodate this growth.
Specifically, they are lacking a detailed process for accepting and approving refunds and following up
with vendors to collect balances owing. The current process simply includes manual approval for refunds,
and there is no follow-up with individual vendors. As the business grows, this will become more and
more labour intensive for Luke and Cal and may not be the best use of their time. It will become even
more of an issue if the vendor acceptance policy is not amended.
Recommendation
Deal should establish a formal and detailed policy for refund requests to help members understand what
the terms of the purchase and refund policy are. This would allow for a more standardized approach for
approving refunds, and for following up with vendors or reducing the amounts from the vendor balance
due. Additional staff may be required in order to allow Cal and Luke to focus on their areas of expertise
and to support operational growth.
We recommend that with the new vendor acceptance policy, with which there will potentially be fewer
refunds, Deal consider refunding the full amounts to consumers to help maintain good member relations.
In order to be able to properly apply its refund policy, Deal will need to make sure its system is capable of
accurately tracking vouchers issued, refunds granted, and related amounts due to and from vendors
relating to each voucher.
(Very few candidates recognized that Deal’s lack of formal refund policies presented a significant risk to the company.)
Website Technology
Deal’s current website technology has been developed and maintained by Luke, based on his experience
with information technology. Given that the website and emails are Deal’s most important links to its member base, and since its website is its source of collecting revenue, it is critical that they be secure,
reliable, effective, and functioning properly at all times. Absence of these characteristics could result in
loss of current and future revenue and members, as well as loss of reputation.
(Few candidates recognized that there was a significant risk to Deal resulting from the lack of security
surrounding its website. However, most candidates who addressed it were able to provide good
discussions of the implications for Deal.)
The crashing of the server four times in the past month indicates that the system is unable to handle
current volumes and could pose even more of a problem if growth continues. If the system keeps
crashing, there is a risk losing the ability to generate revenue while the system is down. There may be a
risk of losing data or files, too. The crashes also hurt Deal’s reputation if members cannot access the website when they want to. The risk is that they will go to a competitor’s site instead.
212
(Half of the candidates recognized that the current IT system had deficiencies and presented a
significant operational risk to Deal.)
Recommendation
To mitigate these risks, Deal should ensure that the technology (including hardware and software) is
adequate to maintain increased growth and demand. One suggestion was that a larger server would
resolve the problem. Luke should immediately explore this option with the service provider.
For Primary Indicator #4 (Governance, Strategy, and Risk Management), the
Percent
Awarded
5.2%
competence.
11.6%
Reaching competence — The candidate identifies some risks associated with
Deal’s current strategy.
29.2%
Competent — The candidate discusses some risks associated with Deal’s current strategy and includes a discussion of the implications or suggestions of
appropriate solutions.
53.9%
Highly competent — The candidate discusses most risks associated with Deal’s current strategy and includes a discussion of the implications and suggestions of
appropriate solutions.
0.1%
(Candidates were directed to this indicator. The partner in charge stated that Deal’s shareholders were concerned about some of the recent problems they had encountered, and he wondered if the
shareholders had identified all the risks related to their current business strategy and considered ways
to manage them. He then asked CA to do a preliminary analysis to substantiate this thought. To
achieve competence, candidates were expected to discuss some of the operational risks and their
specific implications for Deal.)
(Candidates performed adequately on this indicator. Most candidates were able to recognize some of
the relevant risks for Deal and suggest ways to mitigate them. The most frequently discussed issues
were sales tactics used, website capabilities, and the lack of a vendor acceptance strategy. Strong
candidates provided well-organized, concise responses that identified risks in several areas, integrated
relevant case facts, and provided valid recommendations to mitigate the risks. Their discussions were
thoughtful and useful to the company. Weak candidates showed a lack of integration of case facts in
their responses, provided vague or incomplete discussions of the specific implications for Deal, failed
to provide reasonable recommendations to mitigate the risks, or repeated case facts without providing
additional insight or analysis.)
213
(With the exception of the first indicator, candidates performed reasonably well on this simulation.
Most candidates were able to discuss in depth a sufficient number of the IFRS accounting issues.
These candidates used case facts to support their analyses and conclusions. Candidates also did a good
job of discussing the various aspects of the audit plan, identifying the key risk areas, and providing
valid procedures to mitigate the risks. Further, most candidates were able to recognize the control
weaknesses and provide clear discussions of the implications for Deal.)
(Where the Board was disappointed was in candidates’ performance on the first indicator. The Board recognizes that this was a different type of indicator, but had hoped candidates would provide some
insightful discussion of the relevant factors that pertained to Deal because they believed this was a
scenario that a CA would encounter in real life. The Board purposely indicated to candidates that the
client was not looking for a detailed comparison of IFRS versus ASPE standards. Some candidates
appeared to ignore this and answered the simulation in a fashion similar to previous UFE simulations
that asked for a comparison or provided vague discussions of some of the factors to consider.
Candidates are reminded to critically analyze the case facts they are given and to provide meaningful
discussions by integrating specific case facts into their discussions of general considerations.)
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SAMPLE RESPONSE
PAPER II-3 GET-A-DEAL.COM
To: Partner
From: CA
Re: Deals Audit Planning Memo and Strategy Analysis
Accounting Issues and Audit Procedures
Revenue Recognition - Vouchers
Currently, Deals is recognizing the revenue on vouchers when the funds are received. The
accounting issue is that Deals may be recognizing this revenue prematurely. ASPE states that
revenue is recognized when collection is reasonably assured and performance has been achieved.
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
It does not appear that this criterion has been met at the time Deals collects payment. The
significant risks and rewards of ownership would have transferred once the vouchers have been
redeemed or after expiry which occurs three months after each promotion closing date.
(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.
This criterion is not met since Deals is not able to measure the extent to which goods may be
returned. Deals is currently providing refunds to all customers who were unable to redeem their
vouchers. Deals is a new business and does not have sufficient history in order to estimate
returns and set up a provision. Therefore, the revenue should not be recognized until the
vouchers have been redeemed and the services/goods provided or at the point in which the
voucher has expired.
Therefore, Deals has prematurely recognized revenue by recording it at the time they collect
payment.
215
Therefore, there is a risk that revenue is overstated. To test the occurrence of revenue, we should
perform the following audit procedures:
We should inquire with management regarding the number of vouchers that have not been
redeemed and that have not expired. We should obtain the detailed report of the vouchers
issued and for all vouchers that have not expired at year-end we should determine if the
vouchers have been redeemed and calculate the amount of revenue to be reversed. We should
inspect management's journal entry to reverse this revenue.
Gross Versus Net
Currently, Deals is reporting the revenue from vouchers sales on a gross basis. There is a concern
that Deals should be recording the revenue on a net basis and as a result has overstated revenue
and cost of sales. ASPE states 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. Therefore, they are excluded from revenue. Similarly, in an agency
relationship, the gross inflows of economic benefits include amounts collected on behalf of the
principal that do not result in increases in equity for the entity. The amounts collected on behalf
of the principal are not revenue. Instead, revenue is the amount of commission.
It appears that the vendors are the principal in the transaction. ASPE states that 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);
This suggests that Deals is the agent in the relationship. As the vendors are responsible for
providing the goods or services on redemption of the voucher, they are considered the principal.
(b) the entity has inventory risk before or after the customer order, during shipping or on return;
The vendors have the inventory risk since they are providing the services/goods to the customers
upon redemption of the voucher, not Deals. Therefore, this indicates that Deals is the agent, and
the vendors are the principal.
(c) the entity has latitude in establishing prices, either directly or indirectly (for example, by
providing additional goods or services); and
Deals takes a fixed percentage of the vouchers price. The vendors determine the vouchers price
which indicates that they are the principal and Deals is the agent.
216
(d) the entity bears the customer's credit risk for the amount receivable from the customer.
Deals currently retains customer's credit risk as they collect payment and remits the portion to
the vendors indicating that they are the principal.
Overall, factors (a) through (c) indicate that Deals is the agent in the relationship with the
vendors. Furthermore, ASPE states that one feature indicating that an entity is acting as an agent
is that the amount the entity earns is predetermined. This is the case for Deals as it earns a fixed
percentage of the voucher selling price. Therefore, I conclude that Deals is the agent in the
relationship with the vendors and therefore, should be recording the revenue on a net basis. This
means that revenue and cost of sale is overstated. Cost of sales is overstated by 75% of the
voucher sales which equates to $5,595,900 and revenue is overstated by an equal amount.
Therefore, there is a risk that revenue is overstated as a result of Deals inappropriately
recognizing revenue on a gross basis. As part of our audit procedures to test accuracy, we should
perform the following:
We should inquire with management regarding their assessment of the principal agent
relationship with the vendors. Additionally, we should inspect the journal entry for the
reversal of the overstated revenue and cost of sales.
Contingent Liability
Deals has been named in a lawsuit for $250,000. The accounting issue is whether or not a
liability should be accrued in the financial statements. ASPE states that the treatment of
contingent losses in financial statements depends upon the likelihood that a future event will
confirm that an asset had been impaired or liability incurred as at the financial statement date. If
it is likely that a contingency existing at the financial statement date will result in a loss, accrual
of its financial effects would be required.
Therefore, there is a risk that liabilities are understated since no amount has been accrued for the
litigation. Therefore, as part of our audit procedures to test the completeness assertion, we should
perform the following:
We should send legal confirmations to Deals’ legal counsel enquiring about this lawsuit and any other lawsuits including details of the amount likely to be settled and the likelihood of an
unfavourable result in order to determine if accrual is necessary.
Furthermore, we should perform a thorough search for unrecorded liabilities by examining
cash disbursements after year-end. We should sample these cash disbursements and vouch to
supporting documentation to determine if a liability existed at year-end and if it was correctly
recorded.
217
Refunds to be Collected
There is a concern that the refunds to be collected balance of $149,125 is impaired and is not
collectible. To test the valuation and existence assertion, we should perform the following audit
procedures:
We should send confirmations to the vendors to assess the existence of the receivables.
We should perform subsequent receipt testing by examining subsequent payments by
vendors to test the valuation and existence of the receivables at year-end.
Other Audit Planning Issues
Risk Assessment
Deals is a new business and a new client. Therefore, our unfamiliarity with Deals and the
lack of history increases the audit risk.
Deals is facing litigation of $250,000 which increases client business risk which increases the
audit risk.
Deals does not perform reference or credit checks before accepting new vendors. This has
resulted in Deals paying significant refunds for vouchers that have not been honoured as a
result. Therefore, this increases Deals’ client business risk which increases audit risk.
Overall, this is a high risk engagement and as a result we must increase the level of
substantive testing in order to reduce audit risk to an acceptable level.
Materiality
To set planning materiality we must consider the needs and sensitivity of the users. Currently,
the primary users of Deals financial statements are Luke and Cal. However, due to the expansion
plans there is a possibility of additional users in the future such as other investors or banks who
may provide financing for the expansion plans. As Deals is a profit-oriented business, an
appropriate metric to assess materiality is net income before tax. Therefore, I propose that
materiality is set as 5% of net income before tax. Therefore, preliminary planning materiality is
set as $54,000 (5% x $1,076,175). However, planning materiality should be reassessed as
accounting errors are discovered to determine if it is still appropriate. In order to mitigate the risk
of aggregation of immaterial errors, I recommend that we set performance materiality at 75% of
planning materiality.
Approach
We are required by CAS to gain an understanding of the design and implementation of the
controls in place at Deals. Where these controls are deemed to be designed and implemented
effectively, I recommend that we test them and perform a combined approach. However, due to
the accounting issues discussed above and the high risk of the engagement, we must increase the
level of substantive testing by performing substantive analytical procedures and substantive tests
of details, especially due to the system crashes.
218
Risks of Deals Current Strategy
Weakness: Deals does not perform any credit or reference checks of vendors.
Implication: This has resulted in Deals having to pay significant refunds on behalf of the vendors
which increases the financial risk to Deals. Additionally, this negatively affects Deals’ reputation which could reduce future sales.
Recommendation: Deals should perform background checks of the vendors to assess their ability
to honour the vouchers.
Weakness: Deals encourages vendors to not limit the number of vouchers that they allow to be
sold as part of a deal.
Implication: This increases the risk that the vendors may not be able to honour all of the
vouchers which increases the amount of refunds that Deals has to offer and decreases their
reputation which may result in decreased sales in the future.
Recommendation: I recommend that Deals encourages vendors to make an accurate assessment
of the number of vouchers that they can afford to honour.
Weakness: The member database is maintained on a server hosted by a third party.
Implication: This increases the risk that the data could become corrupt or lost as a result of
mismanagement by the third party. Additionally, this increases the risk that confidential
information may be misused by the third party.
Recommendation: I recommend that Deals inquire with the third party about the controls it has
in place to protect the integrity and confidentiality of the data stored on the server. If the controls
are deficient, then Deals should store the database on an in-house server as soon as possible to
mitigate the risk of loss or inappropriate use of customer information.
219
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.
**********
January 1, 2013, to create Chartered Professional Accountants of Canada (CPA) as the national organization to support unification of the
2013
Printed In Canada
III
220
Appendix C — Paper III
It is August 15, 2013, and you, CA, are called into the office of Patricia Gonsalves, a partner at Princess
& Gonsalves.
Patricia begins, “We have started our field work on the audit of Enterprise Technology Systems Inc.
(ETS), which operates across the country. ETS is primarily engaged in the sale of software and new and
refurbished hardware.
“During the audit, the staff person in charge of the engagement left the firm to pursue another
opportunity. I want you to look at the work done to date (Exhibit I) to identify additional procedures that
need to be performed and issues related to the procedures already done. Please also provide
recommendations on any accounting issues you identify in the June 30, 2013 year-end file.
“Although ETS has experienced losses in some years, management is expecting to be profitable going
forward due to the company’s new line of business selling refurbished servers. ETS has been trading on
the TSX-V (stock exchange for small venture companies) for about five years now and reports under
International Financial Reporting Standards (IFRS).
“Finally, the chief financial officer (CFO) implemented some new IT controls in an effort to make the
system more automated (Exhibit II). Please evaluate the effectiveness of the controls and explain how
they might affect our audit.”
EXHIBIT I
EXCERPTS FROM WORKING PAPER FILE
Cash
I have obtained copies of the bank reconciliation and the bank statement as at June 30, 2013.
ENTERPRISE TECHNOLOGY SYSTEMS INC.
BANK RECONCILIATION
As at June 30, 2013
Balance per bank statement
Less: outstanding cheques
Cheque #
Cheque Date
101008
10/15/2012
112233
6/15/2013
112244
6/16/2013
*112266
6/16/2013
*112277
6/16/2013
112288
6/25/2013
112299
6/25/2013
*112310
6/25/2013
112321
6/25/2013
$ 1,224,300 C
Bank balance per general ledger
(132,694)
(8,465)
(6,465)
(88,729)
(23,410)
(3,760)
(9,383)
(145,891)
(7,503)
$
798,000
C Agreed to bank confirmation
* Vouched to copy of cancelled cheque
Agreed to balance sheet
CENTRAL ONTARIO BANK OF MONEY
Receipts
Opening balance
Payroll – commissions
Payroll – regular
Cheque 112166
Frank’s Supermarket
Receiver General – GST/HST refund
Ending balance
Payments
$196,771
$566,792
$100,208
$54,233
$78,777
Date
06/21/2013
06/24/2013
06/24/2013
06/27/2013
06/27/2013
06/28/2013
06/30/2013
Balance
$1,955,061
$1,758,290
$1,191,498
$1,091,290
$1,145,523
$1,224,300
$1,224,300
221
222
Accounts Receivable
I reviewed the aged receivables and sent out confirmations as indicated below. I picked customers that,
according to management, would be quick to respond. All confirmations have been returned and no issues
were noted.
# of Days Outstanding
Customer Name
Frank’s Supermarket
We Sell Good Stuff
Randall Stevens Inc.
Cupcake Girls
Twins Therapeutics
Kay Plumbing
9841236 Inc.
Farrow & DeJaegher
Tools Tools Tools
Total
0 – 30
12,456
31 – 45
46 – 60
50,000
61 – 90
24,000
18,000
90+
765,999
48,000
1,750,000
280,868
3,250,000
499,999
6,559,322
135,678
299,000
349,000
135,678
42,000
48,000
Balance
per
Listing
36,456
68,000
765,999
48,000
1,750,000
416,546
3,250,000
499,999
299,000
7,134,000
Balance per
Confirmation
Difference
36,456
–
68,000
–
No confirmation sent
48,000
–
416,546
–
299,000
–
Therefore, we have obtained comfort over the existence and valuation of accounts receivable. There is no
allowance for doubtful accounts at year end and this appears reasonable.
Inventory
ETS buys used or broken point-of-sale items (cash registers, bar code scanners, etc.), which it then repairs
and sells. Any item that requires significant work or new parts is scrapped. Inventory is reclassified from
parts to scrap in the accounting records when ETS determines that the problems are not worth fixing.
223
I attended the inventory count on June 30, 2013, and completed test counts from sheet to floor with the
following results:
Units per
Units per
ETS
Total Cost
Test Count
Difference
Stationary scanners
2,007
$
404,842
2,009
(2)
Broken registers
626
585,934
623
3
Refurbished servers
372
208,994
372
0
Portable scanners
452
214,411
452
0
Debit machines
194
236,187
194
0
Scrap
403
199,101
403
0
Total Inventory
$
1,849,469
Given that my tests were relatively close to the figures provided, I concluded that there were no concerns
with the inventory. There were some piles of stuff that I didn’t count, but since they were not on the
listing, I assumed they were scrap items that had been written off.
Convertible Debt
ETS borrowed $4 million from PIC Investments (PIC), and recorded it as long-term debt on the balance
sheet. PIC can convert the debt into 10,000 ETS common shares at any time, which represents a minimal
shareholding of ETS. The debt was issued on January 1, 2013, and bears interest at 6%, payable annually.
The debt will mature on December 31, 2017. PIC was willing to provide the loan at 7% without the
conversion clause.
Deferred Income Taxes
Due to the profit generated this year, ETS has recognized an asset related to its existing loss
carryforwards.
Schedule of estimated deferred tax assets (in thousands of dollars):
Net Loss
Carryforward
for Tax
Purposes
$
5,003
7,170
8,485
1,597
Estimated
Deferred Tax
Assets at 29%
$
1,451
2,079
2,461
463
$
$
22,255
6,454
Expiry
Year
2014
2015
2031
2032
224
ETS provided me with the financial projection to support the deferred income tax balance. Management is
projecting a 21% annual increase in revenue. They stated that they believe a 3% improvement in gross
margin is sustainable. They also indicated that they would keep other expenses under control for the next
three years and, as a result, are projecting no increase in expenses. I took the following information from
their financial projection:
Income (Loss) before tax
(in thousands of dollars)
2012
(audited)
2013
(unaudited)
2014
(forecast)
2015
(forecast)
2016
(forecast)
$ (1,665)
$
$
$ 10,420
$ 17,047
1,316
5,286
New Line of Business
During the year, ETS started selling servers they had refurbished. This new line of business has proven to
be very popular and ETS has sold approximately 2,000 servers this year, with revenue totalling about
$5 million. Included in the price of the server is a two-year maintenance plan provided by ETS. Similar
maintenance plans retail for $500. ETS records the entire revenue when servers are shipped to customers.
After delivery, ETS installs the servers and asks the customers to sign an approval form acknowledging
that the servers interface properly with their system. On average, ETS spends two weeks installing each
server and ensuring it interfaces properly with the customer’s system.
ETS requires payment within 30 days of shipment. Collection rates have been strong thus far.
225
EXHIBIT II
SYSTEM NOTES PROVIDED BY
CHIEF FINANCIAL OFFICER
Payroll
We used to have an entire team reconciling commissions paid to our sales staff based on their monthly
sales, but have now automated this process. We implemented a control to ensure that the 2% commission
paid to everyone matches the amounts calculated by the system. If the commission calculated does not
match the payroll system, the system will automatically suspend the payment until variances are
explained.
Here is the May 2013 report. I haven’t had a chance to look into the variance. Sales for the month
Commission rate
Expected commission
Commission per payroll system
Variance
$ 8,559,322
2%
$
171,186
$
196,771
$
25,585
Result: Difference greater than zero. Do not process commission payment.
Purchasing
Only a few employees are authorized to sign cheques. We never found issues because all purchases have
to be approved, and accounts payable does a good job of tying invoices to shipping documents, but we
used to spend hours signing cheques and reviewing supporting documentation. Now accounts payable
uploads all approved invoices into the system and generates a report. I access the report through the
system and indicate “Yes” or “No” in the approved column. Once I enter “Yes,” my signature is printed automatically. If I enter “No” in the approved column, the invoice goes unpaid until I change the status. I included an example approval report below.
Company
Business Equipment Inc.
We R Furniture
Broken Units
Train the Trainer
Date
06/25/2013
06/27/2013
06/28/2013
06/28/2013
Amount
Invoice #
Approved
145,891
A14a63
No
4,651
B124T
Yes
1,762
123nht
Yes
9,414 BD1TH6573
Yes
Comment
Invoice not attached
226
Sales Process Description
We process sales on a system called Sell It. Once a customer places an order, the sales representative
enters the relevant information (customer name, address, item code, number of items, and discount, if
applicable) into the system. Then, the following automated checks are performed:
The customer name is checked against the master list to determine if it is a new customer. If
new, the system generates an email asking the sales manager to approve the transaction and
the addition of the customer to the master list.
If a discount is provided to the customer, the system notifies the sales manager and requests
their approval. The controller has also started reviewing every discount in detail at month end,
and has been noticing an unusually high volume of discounts.
If the sale pushes a customer over its approved credit limit, the system automatically denies
the sale. Credit limits are stored with the master customer list.
The master customer list is located on the server and its file path is detailed in the IT policy manual.
Once the sale has been approved, the system will send a message to the shipping department, which will
get the items ready for shipment.
After shipment occurs, a shipping number and date are added to the sales record and a notice is sent to the
sales representative. This allows the sales representative to inform the customer of the expected delivery
date.
Sales for shipped orders are run through batch invoicing every Friday, and until then the files are stored
on the server in a file folder called “Shipped but not invoiced.”
On Friday, the invoicing process extracts the data from the files and generates invoices and the necessary
accounting entries. The files are moved to the “Invoiced” folder. The system produces a report that lists
the time and date when a file was created or amended. However, the report is so long that we never look
at it.
All sales staff are made aware of the location of all the folders on the server in case they need to review
an invoice.
At the end of the month, the new amounts recorded in the “Invoiced” folder are totalled to determine the monthly sales for each sales representative. Sales commission is allocated to “Selling and marketing” for financial statement presentation purposes.
227
One of the benefits of the system is that it lets us track employee performance and update personnel files
each month. We keep the master personnel files in the same directory as the master customer list. That
way, all the information our controller needs is in one place.
We strongly believe that all employees, from clerks to vice presidents, should be treated the same, so we
have provided all of our employees with the same server and system access. We ask them to only change
data they are responsible for.
228
Appendix C — Paper III — Evaluation Guide
EVALUATION GUIDE
PAPER III, SIMULATION 1 — ETS INC.
The candidate discusses the accounting issues for ETS.
Competencies
You have asked me to provide recommendations on any accounting issues in the June 30, 2013, year-end
file. I have included my discussion of the accounting issues in this report.
Revenue Recognition
How to Treat Revenue on the Servers, Installation, and Maintenance Plan Bundle
ETS is offering a maintenance plan to customers buying its refurbished servers. This maintenance plan
provides the customer with two years of service; however, ETS is recognizing the entire revenue (related
to both the server and the maintenance plan) as soon as the server has been shipped to the customer. IAS
18 Revenue, paragraph 13, provides the following guidance:
The recognition criteria in this Standard are usually applied separately to each transaction.
However, in certain circumstances, it is necessary to apply the recognition criteria to the
separately identifiable components of a single transaction in order to reflect the substance of the
transaction. For example, when the selling price of a product includes an identifiable amount for
subsequent servicing, that amount is deferred and recognised as revenue over the period during
which the service is performed.
In ETS’s case, because the sale of the server and the sale of the maintenance plan are different in nature,
the revenue has to be recognized in relation to the nature of each item sold. Therefore, revenue
recognition criteria have to be applied separately to each portion, to better reflect the substance of each
component of the transaction; in this case, the server and the maintenance plan.
229
Since the maintenance plan has a retail value of $500, it is easy to identify which portion of the
transaction relates to the maintenance plan. Each unit is sold for approximately $2,500 ($5 million ÷
2,000 units). We can easily determine that $500 of this selling price should be allocated to the
maintenance plan, and the remainder should be allocated to the server. One could argue that the price
allocated to the maintenance plan could be less than $500 since ETS may sell the maintenance plan for
less when it’s sold with the server. However, since the server does not seem to be sold on its own, it would be difficult to determine a value other than $500 for the maintenance plan. The best estimation of
the value of the maintenance plan is, therefore, $500, which leaves $2,000 for the server.
It could also be argued that part of the $2,000 of revenue allocated to each server relates to installation
and that it should be recognized separately. However, there is no point in breaking down the revenue to be
recognized between the server and the installation since the recognition criteria would not be met for the
server until the end of the installation. As discussed below, the server would not be operational until
installed. Therefore, the critical point in this case is the signing of the approval form by the client, which
occurs after installation.
(Most candidates identified that there were multiple deliverables related to the revenue transactions.
However, many candidates simply concluded that the revenue recognition criteria needed to be applied
separately to each portion of the transaction without explaining how they reached that conclusion
based on case facts and Handbook guidance. For example, candidates could have used specific case
facts to support treating these two items as separately identifiable components of a single transaction,
such as the fact that the sale of the server and the maintenance plan are different in nature or that the
maintenance plan can be sold separately and retails for $500. As a result, the recognition criteria must
be applied to each individual component in accordance with IFRS in order to reflect the substance of
the transaction.)
Timing of Revenue Recognition for the Maintenance Plans
ETS has been recognizing the revenue for the server (which includes a maintenance plan) as soon as the
product has been shipped to the customer. However, IAS 18 Revenue, paragraph 20, provides the
following guidance:
When the outcome of a transaction involving the rendering of services can be estimated reliably,
revenue associated with the transaction shall be recognised by reference to the stage of
completion of the transaction at the end of the reporting period. The outcome of a transaction can
be estimated reliably when all the following conditions are satisfied:
a) the amount of revenue can be measured reliably;
The amount can be reliably estimated at $500, as discussed in the previous section. This criterion
is met.
b) it is probable that the economic benefits associated with the transaction will flow to the
entity;
Based on the information provided, collections have not been a significant issue for ETS. As a
result, it is likely that the economic future benefits will flow to ETS. Therefore, this criterion is
met.
230
c) the stage of completion of the transaction at the end of the reporting period can be measured
reliably; and
It is difficult in this case to assess the stage of completion since ETS does not know ahead of time
when services will be required. However, paragraph 25 of IAS 18 Revenue offers the following
guidance:
For practical purposes, when services are performed by an indeterminate number of acts
over a specified period of time, revenue is recognised on a straight-line basis over the
specified period unless there is evidence that some other method better represents the
stage of completion.
In this case, no other method would better represent the stage of completion; therefore, the
revenue could be recognized on a straight-line basis over the two-year duration of the
maintenance plan. This criterion is, therefore, met.
d) the costs incurred for the transaction and the costs to complete the transaction can be
measured reliably.
In this case, it is difficult to determine if ETS knows the costs to complete the transaction. This
service is new and has not yet been offered for a long period. However, management should be
able to provide us with this information for the past year, when ETS started providing this
service, and they should be able to reliably measure the costs related to this service. If this
information is available, this criterion would be met.
Therefore, the revenue related to the maintenance plan may be recognized on a straight-line basis over the
two years during which the maintenance service is provided. In 2013, 2,000 packs were sold. We assume
they were sold evenly throughout the year. Therefore, only $250,000 of revenue related to the
maintenance plans could be recognized (2,000 units × $500/per unit × 1 year ÷ 2 years × 0.5). The
following correcting entry needs to be booked ((2,000 units × $500/unit) − $250,000):
<Dr> Revenue
$750,000
<Cr> Deferred Revenue
$750,000
(Most candidates addressed this issue and were able to apply relevant simulation facts to their
discussions. However, some candidates failed to recognize the specific revenue recognition criteria for
transactions involving the rendering of services, and as a result provided discussions of the general
revenue recognition standard. Some candidates also combined their discussions of the servers and the
maintenance plans, not recognizing that these were different in nature, and applied the same revenue
recognition criteria for each stream. Although these candidates provided appropriate conclusions
based on their analyses, they often provided limited analysis of the maintenance plans and as a result
failed to provide sufficient depth of analysis to support their conclusions.)
231
Timing of Revenue Recognition for the Servers
During the year, ETS started selling refurbished servers. ETS has been recognizing revenue as soon as the
servers are shipped to customers. However, it takes an average of two weeks for ETS to install each
server. We should look at the revenue recognition criteria to decide whether they are all met and whether
revenue can actually be recognized at the time of shipping.
Per review of IAS 18 Revenue, paragraph 14, revenue from the sale of goods shall be recognized when all
the following conditions have been satisfied:
the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
Based on the information provided, it takes, on average, two weeks for ETS to install a server and make
sure it interfaces properly with the customer’s system. The customer only signs the approval form
acknowledging that the server properly interfaces with their system once the installation is complete. This
acknowledgement is a significant step in the process, and it is reasonable to think that ETS is responsible
for the server until this acknowledgement is obtained from the customer. Therefore, it does not look like
ETS has transferred the significant risks and rewards of ownership of the server until after the installation
is complete and the form has been signed.
the entity retains neither continuing managerial involvement to the degree usually associated with
ownership nor effective control over the goods sold;
Based on the information provided, ETS still has involvement after the product is shipped, since the
installation has not yet been completed. Therefore, this criterion is not met as of the date of shipment.
However, ETS has no involvement after the installation is complete and the form has been signed by the
customer, except for the portion of the transaction related to the maintenance plan, which is being treated
separately as per IAS 18 Revenue, paragraph 20, as discussed previously. Therefore, this criterion is met
once the installation has been done and the form has been signed by the customer.
the amount of revenue can be measured reliably;
Based on the information provided, the sale price of the server is fixed and, therefore, agreed upon before
the shipment occurs. Recording the revenue at the agreed-upon amount would ensure this criterion is met.
it is probable that the economic benefits associated with the transaction will flow to the entity;
Based on the information provided, collections have not been a significant issue for ETS, so it is likely
that the economic future benefits will flow to ETS. Therefore, this criterion is met.
the costs incurred or to be incurred in respect of the transaction can be measured reliably;
At the time of shipment, part of the costs of the refurbished servers might not be known since it is not
known how long the installation will take. Therefore, the costs incurred cannot be measured reliably.
However, these costs would be known after the installation is complete.
232
Because not all of the criteria have been met, ETS cannot recognize revenue once the goods have been
shipped. However, ETS would be able to recognize revenue once the installation is complete and the form
has been signed off by the customer because all criteria would be met at that point in time. An adjustment
will need to be done at year-end to decrease revenue for servers shipped before year-end for which the
installation and sign-off by the customer were not yet completed.
(Most candidates addressed this issue. When addressed, it was generally well done because candidates
were able to recognize that the significant risks and rewards of ownership of the goods do not transfer
to the buyer until the installation of the servers is complete. Candidates applied the relevant case facts
to their technical knowledge and concluded on an appropriate treatment that was consistent with their
analyses.)
Convertible Debt
Per review of IAS 32 Financial Instruments: Presentation, paragraphs 28 and 29:
The issuer of a non-derivative financial instrument shall evaluate the terms of the financial
instrument to determine whether it contains both a liability and an equity component. Such
components shall be classified separately as financial liabilities, financial assets or equity
instruments in accordance with paragraph 15. An entity recognises separately the components of
a financial instrument that (a) creates a financial liability of the entity and (b) grants an option to
the holder of the instrument to convert it into an equity instrument of the entity. For example, a
bond or similar instrument convertible by the holder into a fixed number of ordinary shares of the
entity is a compound financial instrument. From the perspective of the entity, such an instrument
comprises two components: a financial liability (a contractual arrangement to deliver cash or
another financial asset) and an equity instrument (a call option granting the holder the right, for
a specified period of time, to convert it into a fixed number of ordinary shares of the entity). The
economic effect of issuing such an instrument is substantially the same as issuing simultaneously
a debt instrument with an early settlement provision and warrants to purchase ordinary shares,
or issuing a debt instrument with detachable share purchase warrants. Accordingly, in all cases,
the entity presents the liability and equity components separately in its statement of financial
position.
Based upon the description of the loan included in our working paper files, ETS has issued to PIC a bond
and an option that permits PIC to convert the debt to 10,000 common shares at PIC’s option. Because the amount of shares in question is fixed, it would appear that the convertible debt is a compound financial
instrument that should be broken down into its components (liability and equity).
According to IAS 32 Financial Instruments: Presentation, paragraph 31:
When the initial carrying amount of a compound financial instrument is allocated to its equity
and liability components, the equity component is assigned the residual amount after deducting
from the fair value of the instrument as a whole the amount separately determined for the liability
component. The value of any derivative features (such as a call option) embedded in the
compound financial instrument other than the equity component (such as an equity conversion
option) is included in the liability component.
233
I have calculated the fair value of the loan using interest rates of a comparable instrument at market rates:
Discount rate:
Future value:
Term:
Interest payment
7%
$4,000,000 in 2017
5 years
6% annually
Net present value (NPV) of maturity value
NPV of interest payments
Total NPV
Fair value
$
2,851,945
$984,047
3,835,992
4,000,000
Difference
$
164,008
Therefore, the value of the option is approximately $164,000.
As a result, we should complete the following adjusting journal entry:
<Dr> Long-Term Debt
$164,000
<Cr> Equity Instrument
$164,000
In order to account for the debt, we should accrue interest using the effective interest rate (EIR) method.
Given that the debt will mature with a value of $4 million, we will have to write up the carrying value of
the bond to $4 million using the effective interest rate on the debt, so that the value of the debt is
$4 million by the end of the five-year term. The EIR of the debt is equal to its internal rate of return
(IRR), which has been calculated as 7%.
Therefore, we should accrue interest totalling 7% of the book value of the bond, or $3,835,992 × 7% =
$268,519. The difference between that and the interest payable of $240,000 is the accretion of the bond.
We do not know if any interest has been booked. Assuming the interest was not booked, the journal entry
as of June 30, 2013 (six months after the issuance of the debt) would be as follows:
<Dr> Interest Expense
<Cr> Interest Payable
<Cr> Bond Payable
$134,000
$120,000
$ 14,000
(Most candidates identified this issue and were able to correctly conclude that the convertible debt was
a compound instrument. However, they did so without any analysis of the relevant Handbook
standards. As a result, their discussions lacked depth. The Board recognizes that this was a complex
issue and was pleased to see that most candidates recommended the appropriate treatment and were
able to provide an accurate calculation of each component. However, they were surprised that only a
few candidates explained that the instrument contained both a liability and an equity component due to
the fact that it was convertible into a fixed number of shares.)
234
Inventory
It was noted in the inventory listing that we have 403 units of scrap inventory with a cost of $199,101. Per
review of IAS 2 Inventories, paragraph 9, inventory shall be measured at the lower of cost and net
realizable value.
According to the information provided, scrap inventory is not used by the company in its retrofitting
operations. As a result, the expected net realizable value of the inventory might be nil. Therefore, we may
need to adjust the inventory balance by $199,101 and increase cost of sales if we find that this inventory
has no value. The adjusting journal entry would be as follows:
<Dr> Cost of Sales
<Cr> Inventory
$199,000
$199,000
(A little over half of the candidates addressed this issue. Most candidates concluded that scrap
inventory should be written down to its net realizable value of nil; however, some were not able to
appropriately support their conclusions. Some candidates incorrectly thought that there was a
valuation issue with other components of inventory, such as the broken registers, since they did not
appear to fully understand that ETS was in the business of repairing and reselling these items. Others
simply provided vague, general discussions about inventory without any specific case facts to support
their concerns over valuation.)
Deferred Income Tax Asset
Per review of IAS 12 Income Taxes, paragraph 34:
A deferred tax asset shall be recognised for the carryforward of unused tax losses and unused tax
credits to the extent that it is probable that future taxable profit will be available against which
the unused tax losses and unused tax credits can be utilised.
Paragraph 35 further states:
The criteria for recognising deferred tax assets arising from the carryforward of unused tax
losses and tax credits are the same as the criteria for recognising deferred tax assets arising from
deductible temporary differences. However, the existence of unused tax losses is strong evidence
that future taxable profit may not be available. Therefore, when an entity has a history of recent
losses, the entity recognises a deferred tax asset arising from unused tax losses or tax credits only
to the extent that the entity has sufficient taxable temporary differences or there is convincing
other evidence that sufficient taxable profit will be available against which the unused tax losses
or unused tax credits can be utilised by the entity. In such circumstances, paragraph 82 requires
disclosure of the amount of the deferred tax asset and the nature of the evidence supporting its
recognition.
Based on the above, the entity may record a tax asset related to its unused tax losses; however, there must
be convincing evidence to support the fact that the entity will have sufficient profit against which the
unused tax losses may be claimed.
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Based on the review of the results for the year, it appears as though the company has made approximately
$1.3 million of income before tax and adjustments. After adjusting the financial statements for the issues
identified, the net income before tax will decrease by approximately $1,069,000 ($750,000 + $199,000 +
$120,000). Note that the adjustment for interest is made assuming that ETS has not booked the interest
expense. Also, it is done on the actual interest payment ($120,000) as opposed to the interest expense
($134,260), since the interest payment is the amount that will be used for tax purposes. This adjustment
does not take into account the potential adjustment for the early recognition of the revenue from the
servers that might have been shipped by year-end but for which the installation and the sign-off by the
customer had not yet been completed. If such an adjustment is required, the income before tax would be
even lower than stated.
Practically speaking, this means that the company will be able to use $72,000 (($1,316,000 − $1,069,000) × 29%) of deferred tax assets in the current period. Based on the projections provided by
management, the total income before tax to be generated in 2014 is $5,286,000, which would translate
into $1,533,000 of tax assets to be used. The income generated in 2013 and 2014 would be enough to be
able to use the deferred tax assets of $1,451,000 expiring in 2014. Based on the projections for 2015,
income before tax would be $10,420,000, which translates into $3,022,000 of tax assets and would be
enough to cover the deferred tax assets of $2,079,000 expiring in 2015. However, since the projections
were calculated using 2013 as a base year, they should be recalculated, taking into account the
adjustments made to 2013. The results will be lower than those presented, which means ETS might not be
able to use some of these tax assets.
The projections for 2016 show total revenue of $17,047,000. It would, therefore, appear relatively
reasonable that the company should be able to generate $10 million of profit (($2,441,000 + $483,000) ÷
29%) before 2031, when the rest of the losses start to expire, even if we take the adjustments made to
2013 into consideration. After recalculating the projections with the adjustments made to 2013, we should
be able to see if it is reasonable to believe that the tax assets will be used before they expire. If not, an
entry should be made to write down these assets to the amount that would be claimed according to the
revised projections.
(This was also a complex accounting issue, and less than half of the candidates addressed it. Many of
those who did address it failed to discuss the applicable technical standard, which requires that future
taxable profit against which the unused tax losses can be used be probable. Further, most candidates
failed to integrate the current financial results to support their conclusions or failed to call into
question the aggressive assumptions used by management in their financial projections to support
future taxable profit. As a result, most candidates failed to arrive at an appropriate conclusion or to
demonstrate sufficient depth of discussion on this issue.)
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Percent
Awarded
0.1%
competence.
9.9%
Reaching competence — The candidate discusses some of the accounting
issues relating to ETS.
39.4%
Competent — The candidate discusses several of the significant accounting
48.6%
Highly competent — The candidate discusses most of the significant accounting
2.0%
(Candidates were clearly directed to this indicator since the partner in charge asked CA to provide
recommendations on any accounting issues identified in the year-end file. Candidates were told in the
simulation that ETS reports under International Financial Reporting Standards (IFRS). There were
several accounting issues candidates could have discussed. To achieve competence, candidates were
expected to discuss some of these issues in sufficient depth.)
(Candidates performed as expected on this indicator. They attempted to discuss a sufficient number of
the relevant accounting issues, most frequently addressing the convertible debt, multiple deliverables,
revenue recognition for the servers, and revenue recognition for the maintenance plan. Most
candidates were able to adequately discuss the issues by applying simulation facts to their technical
knowledge and were able to recommend appropriate accounting treatments that were consistent with
their analyses. Strong candidates focused on the significant risk areas and provided responses that
were more skillful than those of other candidates from a technical perspective. Weak candidates did
not demonstrate sufficient technical knowledge or apply relevant case facts to their discussions.)
The candidate reviews the audit work completed to date and comments on additional
procedures required.
Competencies
VI-2.6 – Performs the work plan (A)
VI-2.7 – Documents the results of procedures performed (A)
VI-2.8 – Evaluates the evidence and the results of analysis (A)
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Review of the Audit Work Completed
Cash
It was noted on the outstanding cheque list that cheque #101008 has been outstanding for longer than six
months. Most banks will not cash a cheque that has been outstanding for longer than six months (staledated), so this cheque may not be valid anymore. We should investigate what has happened to the
company that was supposed to cash the cheque and determine if it is still in business, if it has any
intention of cashing the cheque, or why it has not done so. We should discuss this issue with management
to find out if they know anything about this cheque in case it needs to be reclassified to accounts payable.
(Most candidates addressed this issue and were able to recognize that no work had been completed on
the cheque in question. However, many candidates were unable to provide a valid procedure to perform
in order to determine if the cheque was still valid. Weak candidates simply suggested that the cheque
should have been included in the sample tested by the senior, due to its significant amount relative to
the other items tested, but did not address the fact that the cheque was stale-dated and needed to be
investigated further.)
Accounts Receivable
Based on the testing completed, it appears that we have confirmed some of the small balances that exist
on the accounts receivable sub-ledger. It is not appropriate to choose accounts to confirm based on
management’s indication that they would be quick to reply. The selection of balances to confirm should be based on performance materiality or specific qualitative considerations. We have obtained comfort in
the existence of 12% of the balance of accounts receivable. However, we have left out four customers,
which are the most significant ones. Therefore, we should complete testing on those balances specifically.
We should confirm those balances, which would provide comfort in the existence of the accounts
receivable or perform alternative procedures, such as vouching back to the original shipping documents
and invoices.
However, it should be noted that confirmation of receivables does not provide any comfort in the
valuation of those receivables and does not provide evidence regarding the appropriateness of the lack of
an allowance for doubtful accounts. As a result, we will need to complete subsequent receipt testing to
ensure that the cash was actually received. The aging of the accounts receivable should also be tested in
order to ensure all balances are in the appropriate categories, since we will be relying on this aging for the
purpose of subsequent receipt testing.
(Most candidates addressed this issue and generally did a good job because they recognized that
additional procedures needed to be performed on the existence assertion. However, some candidates
failed to provide valid procedures for the existence of accounts receivable because they recommended
agreeing the amounts to subsequent receipts. While this procedure provides evidence for the valuation
of accounts receivable, it is not sufficient in itself to cover the existence assertion. Strong candidates
recognized that additional confirmations could be sent out, or alternatively that review of the invoice
and shipping documents would be required. While most candidates properly identified the fact that no
work had been done on the valuation assertion, many failed to provide a procedure to obtain sufficient
appropriate audit evidence for this assertion or simply stated that inquiry of management would be
required to ensure that there were no collectability issues.)
238
Inventory
Existence
It was noted that during the audit work we attended the inventory count and completed sheet-to-floor
testing on the products. We found only marginal exceptions. However, it appears that we have counted
every piece of inventory, which may be over-auditing. Generally speaking, we should complete testing on
a sample basis, but the work has been completed.
Completeness
It does not appear as though we have done any completeness testing since the testing was completed from
sheet to floor only and not from floor to sheet. Especially given the comment that extra inventory piles
were assumed to be scrap, we may need to obtain more comfort in the inventory balance since it seems
there might be a risk regarding the completeness of the inventory.
Due to this increased risk, we should see if we can gain any comfort in the completeness of inventory by
discussing ETS’s inventory count process with management. This would avoid us having to ask the client
to count the inventory again and then complete rollback procedures to bring the inventory back to the
year-end balance. If we do have to ask ETS to count its inventory again, it would involve us using the
post-year-end inventory count as a starting balance and then reviewing both incoming and outgoing
shipping documents to understand which pieces of inventory were there at year-end. This is a process that
will only get more complicated with time, so we should look into it as soon as possible.
Valuation
Note that there is no evidence in the file of us having completed any inventory valuation testing. Given
that inventory should be recorded at the lower of cost or net realizable value, we are going to have to
complete a couple of tests at a minimum:
We should compare on a test basis the carrying costs of inventory with recent selling prices (by
reviewing recent sales invoices or similar documents) to ensure items are being carried at costs that
are no higher than their net realizable value. In particular, given that $199,000 of inventory has been
categorized as scrap, we need to ensure our testing of net realizable value covers this category.
During our inventory count, we noticed piles of stuff not on the listing and assumed it was scrap. We
need to follow up and make sure this scrap really has no value. Inquire with management to see what
is usually done with this scrap and corroborate evidence (see if inventory has been sold, disposed of,
et cetera).
Accuracy
I found no evidence in the file of tests being done to gain comfort in the accuracy of the inventory. As a
result, we should do the following:
Obtain some invoices to understand the costs of the inventory purchases, look at the labour and parts
costs incurred to refurbish the goods, and compare those with the unit cost of the inventory on the
books to ensure that the average cost of the inventory is relatively close to cost incurred.
Follow up on the difference found in the inventory count between the number of units counted and
the number of units indicated on the listing. The errors found should be carried to the summary of
audit differences to be accumulated, even if individually not material, unless clearly trivial, as per
CAS 450.05: “The auditor shall accumulate misstatements identified during the audit, other than those that are clearly trivial.”
239
(Most candidates addressed this issue and were able to provide a valid discussion of why the work
completed to date was deficient. However, many candidates failed to provide a valid procedure to
address the deficiency. For example, many candidates suggested attending the client’s premises and performing a floor-to-sheet count, failing to recognize that it was approximately 45 days past year-end
and that simply re-performing the inventory count, without rollback procedures, was not appropriate at
this time. In addition, some candidates simply suggested inquiring with management to ensure that no
items of inventory had been omitted from the list and that the extra inventory piles were in fact scrap.
These candidates did not recognize that inquiry alone would not provide sufficient audit evidence in
this case. As for the valuation assertion, many candidates recognized that inventory should be carried
at the lower of cost and net realizable value and suggested tracing the value back to the original
purchase invoice. This would allow them to verify the cost. However, many candidates did not provide
a procedure to determine the net realizable value (the current sales value).)
Convertible Debt
Since this debt is new this year, we need to get a copy of the agreement with PIC and verify the 6%
interest rate and the repayment terms, as well as the conversion clause. We also need to confirm with PIC
that it was willing to provide the loan at an interest rate of 7% without the conversion clause, since this
interest rate is used in the calculation of the fair value of the loan for accounting purposes.
We will also need to recalculate the interest calculation, as well as the NPV calculation, to make sure it is
accurate. We will ensure the breakdown between the debt and equity components is accurate, as well as
the write-up of the carrying value of the bond for the first year, by looking at the journal entries to record
the loan.
(Most candidates addressed this issue. While candidates were able to identify the relevant risk area,
and many recommended that the loan agreement be reviewed, many failed to identify which specific
terms and conditions of the loan agreement were relevant and needed to be verified, resulting in an
incomplete procedure. Candidates are expected to provide specific procedures that include enough
detail for the audit staff to be able to perform the procedure.)
Deferred Income Taxes
Based on the projection that has been provided, I am able to make the following comments:
1. Revenue growth: It should be noted that the company has assumed 21% growth for each year based
on actual growth from 2012 to 2013. While this may be achievable, it would be excellent
performance, especially given an uncertain economic environment and struggling economies. We
should discuss with management why they believe this revenue growth assumption is reasonable and
substantiate the assumptions as appropriate.
2. Margin: It was noted that gross margin is expected to increase by 3% every year. The increase in
margin this year would have been partially affected by the introduction of the new line of business.
Unless management has further plans to introduce new products, it would not be reasonable to expect
the same type of margin changes year over year. We should discuss with management what plan they
have to maintain margin expansion to determine whether this is a valid assumption for this item.
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3. Expenses: It was noted that the company will maintain expenses over the next couple of years.
However, the company has projected a 21% increase in sales each year and provides a 2%
commission on sales. Therefore, even if the company is able to keep all other expenses in line,
commissions will still increase with revenue. We should make sure that management is adjusting for
growth in commission relative to revenue growth.
If the company were to maintain its profit at its 2013 level, then it would earn approximately $741,000
over the next three years (($1,316,000 − $1,069,000) × 3 years), which would mean being able to use
$215,000 ($741,000 × 29%) in deferred tax assets. Therefore, it does not appear as though the company
will be able to earn the income to support the entire assets expiring in 2014 and 2015, and most of the loss
carry-forwards for these two years will likely be lost. It will, therefore, be very important to gather
evidence on the assumptions management made when preparing the projections in order to corroborate
their reasonability. If the projections are not assessed as reasonable, ETS will have to reverse a portion of
the tax asset that was booked.
(Less than half of the candidates addressed this issue. When addressed, it was generally well done, with
candidates recognizing that the assumptions used by management were aggressive and that additional
support needed to be obtained from management to ensure they were reasonable. Weak candidates
simply suggested inquiring with management, without stating that corroborating evidence would be
needed to support management’s assertions because there appeared to be some inconsistencies. For example, candidates could question the assumption that expenses would not increase despite the fact
that commissions were calculated based on sales that were projected to increase, or they could request
evidence to support the 21% yearly sales increase, such as plans for new product launches.)
New Line of Business
Because the sale of refurbished servers is new this year, we will need to ensure the $500 estimate of the
value of the maintenance component is accurate. To do so, we need to ask management how they arrived
at their $500 estimate and verify the source. For example, if ETS sells maintenance plans on their own,
we would need to confirm that $500 is indeed the maintenance plan selling price by looking at an invoice.
If not, we would need to compare this price to the market price by getting the selling price of a similar
maintenance plan sold by an outside source.
We will need to verify that the portion of revenue related to the maintenance plan is being recorded over
two years. We will also need to make sure the cut-off is right at year-end by looking at the dates on the
installation forms signed by customers, to ensure that revenue is only recorded when an installation is
complete and the customer has signed off on the form, confirming that the server interfaces properly with
their system, as opposed to when the server is shipped.
Lastly, we will need to make sure the revenue recognition policy for the server and maintenance plan is
properly disclosed in the financial statements.
(Most candidates addressed this issue, and it was generally well done, with candidates providing clear
discussions about the need to ensure appropriate revenue cut-off by reviewing the customer-signed
installation forms.)
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Percent
Awarded
0.0%
competence.
20.3%
Reaching competence — The candidate discusses some of the deficiencies in
the audit work completed to date and discusses additional procedures required.
38.8%
Competent — The candidate discusses several of the deficiencies in the audit
work completed to date and discusses additional procedures required.
38.3%
Highly competent — The candidate discusses most of the deficiencies in the
audit work completed to date and discusses additional procedures required.
2.6%
(Candidates were directed to this indicator. The simulation stated that the audit fieldwork had already
commenced, but the staff person in charge of the engagement had left the firm. Candidates were told
by the partner in charge to look at the audit work done to date to identify additional procedures that
needed to be performed and issues related to the procedures already done. To demonstrate competence,
candidates were expected to discuss the deficiencies in the audit work and provide additional
procedures to ensure that sufficient appropriate audit evidence would be obtained and the risks would
be covered.)
(Candidates struggled a bit with this indicator. Candidates had difficulty identifying the deficiencies in
the work that had already been performed. For example, some candidates attempted to address the
deficiencies in the audit work performed on the cash section, but focused on the fact that the sampling
technique used by the staff was incorrect, since one large cheque was not included in the sample.
These candidates failed to recognize that the cheque was stale-dated and additional procedures were
needed to determine whether it had already been cashed or a replacement cheque should be issued.
Similarly, many candidates recognized that the staff had not performed sufficient work on
completeness of inventory, but failed to recognize that it was a month and a half past year-end.
Therefore, they did not recognize that their recommendation to return to the client premises to perform
the count again was not possible. In contrast, candidates appeared to be more comfortable providing
audit procedures to address the key risks relating to the accounting issues, such as the new line of
business and the convertible debt.)
(Strong candidates were able to provide thorough audit procedures that specifically addressed the risks
identified and to explain why these procedures were necessary. Weak candidates tended to attempt
fewer issues or provided vague, generic, or incomplete procedures, with no explanations as to why they
would be required.)
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The candidate assesses the IT control environment and discusses the implications for the yearend audit.
The candidate is demonstrating competence in Assurance (IT).
Competencies
VI-2.9 – Draws conclusions and communicates results (A)
VI-3.2 – Identifies the role IT plays in an entity’s key operational controls (A)
VI-3.4 – Evaluates IT-related elements of internal control (A)
Regarding the information provided on “Sell It” and the processes in place, I have noted some internal
control weaknesses that could be corrected. I have also included recommendations so that we would be
able to rely on controls in the future.
1. Access Control Assessment
Weakness: It was noted that a number of important files are stored in public directories and that all
staff members have write access to those files and directories.
Implication: This will have numerous implications for different aspects of the operations. The sales
staff could alter files in order to close a sale or increase their compensation. There is also a risk of
introducing inadvertent errors into the system. The following are examples of implications for the
different systems:
Customer list: Sales representatives could potentially access the master customer list and add a
record, and thus avoid the review performed by the sales manager. This implies that sales
representatives could create fake companies and process sales to increase their commissions or
bypass the controls inherent in the system. This would increase the risk of errors in the
occurrence of revenue and is potentially a fraud risk.
Credit limits: The maximum credit limits could be altered by sales representatives in order to
make a sale. This would increase collection risk since a client’s credit might be over-extended;
therefore, it may also have an impact on the valuation of accounts receivable. It is also a potential
fraud risk.
Commission information: Sales representatives could access the commission folder and create
new records in an attempt to boost their sales for the month. This is a fraud risk.
Discounts and incentives: Sales representatives may be able to offer clients discounts and avoid
the approval process by amending files during the “shipped but not invoiced” stage. It means that sales representatives could not be acting in the best interests of ETS. This is also a fraud risk.
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Recommendation: The master customer list is an important document in the control process. As
such, it should be stored in a secure location on the server. The ability exists to restrict access to
folders, so this folder should only be accessible by authorized persons. In the example regarding
credit limits, it should be accessible only by someone outside the sales department to ensure proper
segregation of duties. With regard to maintenance of the customer list, this duty could be restricted to
the sales manager. As well, an alternate should be designated in order to cover for absences or
vacations. Lastly, the file path to the master customer list should definitely be removed from the IT
policy manual since only authorized individuals should be provided with this path for their reference.
With respect to the customer list, ETS could add in a very practical manual control whereby the sales
manager reviews additions to the list each month and investigates any odd additions.
For a more specific control for the commission amount, ETS could use the control in place, in which
actual sales are used to calculate expected commission, and compare that amount with the system to
identify differences. Only when everything has been reconciled would the commission payment be
released.
Regarding the discount item, the controller has started reviewing every discount in detail. Once the
access controls are fixed, the controller will be able to review discounts that are greater than a predefined percentage only. A business case must be put together to ensure there is justification and a
business purpose for significant discounts.
(Most candidates identified at least one access control weakness and generally addressed it well by
providing clear discussions of the weakness and the implication for ETS. The issues most frequently
discussed by candidates were the customer lists and the commission information.)
2. Private and Confidential Files
Weakness: It was noted that the personnel master files are included in the same directory as the
master customer list and that this directory is visible to anyone who has access to the server.
Implication: The private files of the company could be viewed by anyone who manages to access the
system. This could create any number of issues with employee privacy laws or could pose a
reputational risk regarding customer confidentiality.
Recommendation: These files should be stored in a location on the server that is separate from the
customer list and their access should be restricted only to those employees who require the
information.
(Approximately half of the candidates identified this issue and sufficiently addressed it.)
3. File Amendments
Weakness: There is a report that tracks amendments to files, but this report is not reviewed or used.
Implication: If the report is not reviewed, there is a risk that unauthorized changes can be made to
the files and that these changes would not be caught. For example, an invoice could be amended after
having been already authorized. Sales staff could provide unauthorized discounts to clients or make
changes to invoices, such as increasing a client’s order while ignoring that the client is over his or her credit limit.
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Recommendation: The report could be customized to only show “risky” transactions from an IT perspective (for example, amendments after an approval has been obtained or manual creation of a
file in a directory where there should be none), which would facilitate the review process.
(Approximately one-third of candidates identified this issue and sufficiently addressed it.)
4. Payroll Testing
Weakness: It was noted on the payroll report that the expected commission out of the automated
check was $171,000 but the number out of the payroll system was $197,000. Per discussion with the
CFO, this commission payment should not have been processed in the period. However, our review
of the bank statement indicates that the commission payroll was processed on June 24, 2013.
Implication: This provides some indication that the payroll automated control is not operating
effectively. There is a risk that the payroll could be processed without being approved and, therefore,
released with potential errors that could have a financial impact on ETS.
Recommendation: The control should be reviewed, since it is not currently effective. I would
recommend that, until the automated controls are working properly, ETS temporarily return to the
manual process to obtain comfort in the reasonability of the payroll amounts in order to avoid a loss
event.
(Candidates appeared to struggle with this issue since most failed to recognize that the automated
control was not operating effectively. This was a difficult issue for candidates to identify because
identification of the control deficiency required integration of case facts that were spread out on
different pages of the simulation. Unfortunately, some candidates who were not able to identify the
control deficiency stated that this was a strong control, and as a result did not demonstrate an
appropriate understanding of the issue. Candidates who were able to integrate the information
provided to them were able to present good discussions on the control deficiency and demonstrated a
higher level of competence.)
5. Purchasing Testing
Weakness: It was noted on the purchasing approval report that an invoice for Business Equipment
Inc. was not approved by the CFO for payment. However, according to the outstanding cheque list,
cheque #112310 has been issued for the same amount as the Business Equipment Inc. invoice.
Implication: It appears as though this automated control is not operating effectively. Invoices that are
not approved could be (and have been, according to our audit evidence) paid to suppliers without the
proper documentation or approval. This could cause financial loss to ETS if an illegitimate invoice is
paid.
Recommendation: A review of the system may be required in order to diagnose the problem. I
recommend that ETS temporarily return to the manual process until the automated controls are
working properly, to avoid a potential loss event.
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(Again, this was a difficult issue for candidates to identify because it required integration of case facts.
Candidates’ performance on this issue was similar to their performance on the previous issue.
Candidates are reminded to take into account all the case facts provided throughout the entire
simulation for a particular issue and to analyze these together before responding.)
Overall Implication for the Audit
Note that the CFO’s description of the process indicated some concerns with respect to certain controls around the revenue cycle and specifically around the potential existence of non-valid customers. This may
increase the risk surrounding occurrence of revenue, as well as valuation or existence of accounts
receivable, and we should consider doing more substantive testing in these areas than planned.
The automated controls around purchasing appear to not be operating effectively, based upon a limited
sample size. Specifically, there may be a concern regarding valid expenses and, as a result, the occurrence
of expenses on the income statement.
Payroll controls also do not look to be operating effectively, based upon a limited sample size. We should
investigate the gap between the expected and paid payroll amounts to understand the cause of the
variance. However, this may increase the risk of accuracy of payroll expense, specifically around
commissions. We should consider completing more substantive testing on this item than in previous
years, especially considering the reduction in staff related to this cycle.
Overall, it does not appear as though the IT control environment is adequate since there are access control
issues, poor data storage policies, poor standard control procedures (such as report reviews not being
completed), and poor payroll and purchasing controls and procedures. We could argue that the IT control
environment is not strong. This control risk could increase the risk of material misstatement in the
financial statements and might increase the need for a substantive approach.
(Candidates appeared to have difficulty understanding their role on this indicator. Most candidates did
not provide general discussions of the overall implications of the deficiencies in the IT control
environment for the year-end audit. Rather, many candidates provided specific audit procedures to
perform to address each control deficiency listed above, without stepping back and considering the
overall implications of the control deficiencies for the audit. Although this information added value to
their responses and candidates were rewarded for these types of discussions, what we were really
looking for was an overall conclusion on the impact of control deficiencies on the audit. This type of
approach made it more difficult for candidates to demonstrate their ability to integrate information and
see the big picture. For example, candidates were expected to recognize that the weak IT control
environment would increase the risk of material misstatement in the financial statements and might
increase the need for a substantive approach.)
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For Primary Indicator #3 (Assurance (IT)), the candidate must be ranked in one of
Percent
Awarded
0.2%
competence.
17.6%
Reaching competence — The candidate discusses some of the deficiencies in
the IT control environment or discusses the implications for the year-end audit.
54.6%
Competent — The candidate discusses some of the deficiencies in the IT control
environment and discusses the implications for the year-end audit.
26.3%
Highly competent — The candidate discusses several of the deficiencies in the
IT control environment and discusses the implications for the year-end audit.
1.3%
(Candidates were asked to assess the IT control environment and discuss the implications for the yearend audit. Candidates were directed to this indicator since the partner in charge noted that the CFO
had implemented new IT controls in an effort to make the system more automated, and then asked CA
to evaluate the effectiveness of these controls and explain how they might affect the audit.)
(Candidates had a very difficult time with this indicator. While they were able to identify some IT
control issues, most did not adequately explain the implication of the control deficiencies for ETS.
Moreover, many candidates failed to recognize that some of the automated controls were not
functioning as intended (for example, there was a variance in the commissions calculated for the
month, but commissions were paid out anyways, which was not supposed to occur). As a result of
failing to see that the automated control wasn’t working, candidates struggled with what to discuss with regards to commissions and suggested a review of commission variances, which was not the
issue.)
(Strong candidates were able to identify and discuss the known failures in the automated controls for
payroll (commissions paid despite the variance) and purchasing (cheque issued despite no approval in
the system) and provided good discussions of the access control deficiencies. Weak candidates provided
vague discussions of the implications of the control deficiencies they identified or provided
recommendations without any analysis of the implications whatsoever. They also generally did not
provide any discussion of the implications for the audit. As mentioned previously, some weak
candidates believed that the payroll and purchasing automated controls were effective and incorrectly
focused on manual controls as a result.)
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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
(Although candidates were placed in the role of an external auditor on this simulation, which is
common, the situation itself was somewhat unusual because candidates were required to analyze audit
work that was partially completed and to identify and discuss known failures in the automated controls.
Candidates performed well on the Performance Measurement and Reporting indicator (Primary
Indicator #1). Most candidates appeared to be familiar with IFRS and were able to discuss the
appropriate accounting treatments for the relevant issues in that context. Where candidates seemed to
have more difficulty was on the Assurance indicators (Primary Indicators #2 and #3). The main
struggle on Primary Indicator #2 was in specifically discussing the deficiencies in the work performed
to date and providing additional audit procedures to cover the specific risks identified in the
simulation. As for Primary Indicator #3, candidates struggled to identify some of the weaknesses in the
automated controls. As a result, they tended to provide vague discussions on the control weaknesses
and generally did not provide adequate discussions of the implications for the audit, as specifically
required.)
248
Appendix C — Paper III — Sample Response
SAMPLE RESPONSE
PAPER III-1 ETS INC.
The following is a candidate response for Paper III-1. Whereas the evaluation guide presents all
the elements of a complete response by indicator, this sample response shows how the case facts are
To: Partner
From: CA
Re: ETS Audit
Accounting Issues and Additional Audit Procedures
Convertible Debt
ETS has borrowed $4 million from PIC on January 1, 2013. The debt is convertible at the option
of PIC into 10,000 common shares at any time. ETS has recorded the loan as long-term debt. The
accounting issue is that a portion of this loan has an equity component and should be recognized
separately from the debt component. IFRS states that the issuer of a financial instrument shall
classify the instrument, or its component parts, on initial recognition as a financial liability, a
financial asset or an equity instrument in accordance with the substance of the contractual
arrangement and the definitions of a financial liability, a financial asset and an equity instrument.
The loan has both components of equity and a liability as there is a contractual right for the
payment of interest, but there is an equity component since PIC can convert, at their option, the
debt into a fixed number of shares in ETS, and as a result the interest rate on the convertible debt
is lower than it would otherwise be.
Therefore, in Exhibit I, I have performed a calculation to separate the debt and equity
components. I have determined that $164,000 needs to be reclassified from long-term debt to
equity.
Therefore, there is a risk that there is a classification error between debt and equity. As part of
our audit procedures, to test the accuracy and classification assertion, we should enquire with
management regarding the treatment of the long-term debt. Furthermore, we should obtain the
loan agreement and confirm the terms including the interest rate and the market rate for debt
without the conversion option. Next, we should inspect the journal entry posted by management
to reclassify the equity component from debt to equity.
249
Revenue Recognition - Maintenance Contracts
ETS sells refurbished servers including two-year maintenance contracts as a package and
recognizes the entire revenue when the servers are shipped to the customers. There is a concern
that the revenue recognition criteria need to be applied separately to the maintenance contract as
it is a separable component. IFRS states that the recognition criteria in this Standard are usually
applied separately to each transaction. However, in certain circumstances, it is necessary to apply
the recognition criteria to the separately identifiable components of a single transaction in order
to reflect the substance of the transaction.
The maintenance contract is the provision of services over the two-year time period. The issue is
at the time of delivery of the servers, it has not performed the services related to the maintenance
contract, and therefore, should not recognize the revenue that is attributable to the maintenance
contract. The performance of the services of the maintenance contract will occur over two years,
and therefore, it is appropriate to recognize the revenue related to maintenance on a straight-line
basis over this time period.
Therefore, as ETS sold 2,000 servers, and approximately $500 per sale relates to maintenance,
then revenue is potentially overstated by $1,000,000. The revenue relating to the portion of the
maintenance contract at the end of the year needs to be removed from revenue and set up as
deferred revenue on the balance sheet.
Therefore, as part of our audit procedures, to test the occurrence and classification assertions, we
should perform the following procedures:
We should obtain a copy of the sales agreement for refurbished servers and confirm the terms
of the sale including the terms of the maintenance contract.
We should inquire with management regarding the number of months of maintenance
contracts outstanding for the 2,000 refurbished servers that have been sold.
We should inspect the journal entry reclassifying the revenue associated with the remaining
portion of the maintenance contracts from revenue to deferred revenue.
Revenue Recognition - Refurbished Servers
ETS has also indicated that they are recognizing revenue associated with the sale of the
refurbished servers at the time they are shipped to the customers. In addition to the issue
discussed above, there is a concern that they are recognizing revenue on the sale of the servers
prematurely. This is because a 2 week installation period is required by ETS after delivery.
According to IFRS, one of the conditions for revenue recognition relating to the sale of goods is
that the entity has transferred to the buyer the significant risks and rewards of ownership of the
goods. There is a concern that this criterion has not been met until ETS installs the server. IFRS
further states specifically, that when the goods that are shipped are subject to installation and the
installation is a significant part of the contract which has not yet been completed by the entity
that the significant risks and rewards have not transferred.
250
It is likely that the installation is a significant part of the sale of the servers. Servers require a
significant amount of installation time as indicated by the two-week timeframe. Therefore, it is
not appropriate to recognize the revenue at the time of delivery, instead, it is appropriate to
recognize revenue at the time the servers have been installed.
Therefore, there is a risk that revenue has been overstated by the number of refurbished servers
shipped at year-end but not installed. Therefore, as part of our audit procedures, to test the
occurrence and cut-off assertions, we should perform the following:
We should inquire with management regarding the number of refurbished servers shipped at
year-end but not installed.
We should vouch sales of refurbished servers near year-end to supporting documentation to
determine if installation has occurred.
We should quantify the revenue associated with servers shipped but not installed and inspect
the journal entry prepared by management to reclassify this revenue to deferred revenue.
Issues with Current Audit Procedures
Outstanding Cheques
There is a balance of $168,270 of outstanding cheques that have not been tested on the bank
reconciliation. This balance is primarily composed of one individual cheque of $132,694 that
was not tested. It is not clear what sampling technique was used to determine the sample of
outstanding cheques to be tested as this item was left off. Furthermore, this cheque appears to be
stale dated as the cheque date was written October 15, 2012. Therefore, I recommend that we
vouch this cheque to the cancelled cheque. Furthermore, we should enquire with management
why this cheque was still outstanding at year-end, and if it has not cleared since year-end, why it
remains outstanding.
Accounts Receivable Confirmations
In Exhibit II, I have determined that only 12% of accounts receivable has been confirmed. There
are several significant balances that confirmations were not sent for. These items are likely
individually material. Therefore, the accounts receivable confirmations are currently not
sufficient. I recommend that we send additional accounts receivable confirmations to the
remaining customers as these balances are material. It appears that the previous auditor selected
the sample for AR confirmations based on management indicating which customers would be
quick to respond. This is not an appropriate basis to select a sample as it has been biased by
management.
Additionally, accounts receivable confirmations only test the existence assertion and do not
provide evidence over the valuation assertion. Therefore, I recommend that accounts receivable
confirmations are sent for the untested population to test the existence assertion. Additionally, I
recommend that subsequent receipt testing is performed by examining bank records subsequent
to year-end in order to test the valuation assertion.
251
Allowance for Doubtful Accounts
No allowance for doubtful accounts has been set up for accounts receivable. The previous
auditor has concluded that this is reasonable. However, after reviewing the aged accounts
receivable listing, there is a balance greater than 90 days outstanding of $48,000. As part of our
audit procedures, to test the valuation of accounts receivable, we should enquire with
management to determine if any of the accounts receivable are uncollectible. Furthermore, we
should analyze the payment history of the customers to assess the collectability of the accounts.
This is especially important for Cupcake Girls who have a balance greater than 90 days which
indicates uncollectability.
Inventory
At the inventory count, the auditor did not count certain piles of inventory that were not on the
listing as the auditor only tested the existence assertion by counting from sheet to floor. The
concern is that the amount of scrap inventory is not complete. Therefore, we attend an additional
inventory count to count these piles of inventory.
Additionally, IFRS states that inventory shall be carried at the lower of cost or net realizable
value. There is a concern that the net realizable value of scrap inventory is below its cost and
therefore, impairment should have been recognized at the time it is transferred from parts to
scrap inventory. Therefore, as part of our audit procedures, to test the completeness and
valuation of scrap inventory, we should test the completeness of scrap inventory by counting
from floor to sheet and enquire with management regarding any differences. Additionally, we
should enquire with management regarding the value of scrap inventory and corroborate this
with third party evidence such as recent sales invoices of scrap material. We should compare this
with the cost of the inventory and quantify the amount of write down required and inspect the
journal entry prepared by management to record the write-down to determine if it is reasonable.
Materiality
Due to the recent accounting issues identified above and their impact on key metrics such as net
income before tax, we should reassess materiality and determine if it is still appropriate or if it
should be changed.
Evaluation of the Effectiveness of New IT Controls
Weakness: All employees at ETS are given the same server and system access.
Implication: This increases the risk that employees are able to perpetrate and conceal fraud. For
example, employees could create or process fraudulent AP invoices and then access the
purchasing system and enter "Yes" for approval which would generate the signature of the CFO.
Additionally, it increases the risk that an angered employee could seriously compromise the
integrity of the data in the system.
Recommendation: I recommend that access to areas of the database are restricted based on the
employment duties of the individual employees. Access could be restricted by the requirement of
username and password verification to access areas of the system.
252
Weakness: The controller has been noticing an unusually high volume of discounts at year-end.
Implication: There is a concern that sales staff are offering higher discounts on year-end in order
to increase commissions. Therefore, there is a concern that the sales manager is not reviewing
the discounts.
Recommendation: Sales people should have an authorized discount amount and the sales
manager should review the discounts and indicate their review by signature or other evidence.
Weakness: Sales can be duplicated by sales staff manipulating the files in the invoiced folder and
the Shipped but not received folder in order to increase sales commissions.
Implication: This would result in the overstatement of revenue and the overstatement of
commission expense which increases the risk of material misstatement of the financial
statements.
Recommendation: Safeguards should be put in place to protect the invoiced and shipped but not
received folder. Specifically, the ability to manipulate files in these folders should be restricted.
Additionally, the system generated report that lists the time and date when a file was created or
amended should be reviewed. Specifically, since the invoices are batched every Friday, there
should only be movement between the folders on Friday.
As part of our audit procedures, we should inspect the system report and identify any potential
manipulation by inspecting the date and time of file creation and amendment. Specifically, we
should look for any potential duplication of sales.
253
254
It is September 13, 2013. You, CA, have recently accepted a position as the chief accountant for
Rent-a-Bike Inc. (RAB), which is a public bike rental system. RAB offers an alternate means of urban
transport through its networks of bike stations located throughout the downtown cores of Toronto,
Montreal, Ottawa and, most recently, Halifax. RAB bikes can be rented seven days a week, 24 hours a
day. Annual and monthly memberships are available, in addition to a pay-per-use option.
Your new boss, the CEO of RAB, Lochlyn Grace, comes into your office. “We’ve experienced strong growth since our opening just four years ago and have a number of exciting new projects on which I’m eager to get your input. As you know, our plan is to maintain our momentum. We’re currently debating either expanding in Toronto or breaking into the Vancouver market. We’ve prepared some financial
information and would like your analysis of each alternative (Exhibit I).
“We’re also hoping to increase the loyalty of our existing customer base as well as the visibility of our
bikes. To do so, we’ve launched two promotions this year. We have a planning meeting with our auditors
next week. Please make sure you address the new accounting issues encountered this year, including how
to account for the new promotions. Our accounting clerk has compiled a list of the accounting issues
(Exhibit II).
“There’s one other important thing we need to discuss with the auditors. This summer we received a grant from the Ontario Ministry of Tourism, Culture and Sport to install additional stations and provide extra
service during the Canada Games, which took place in Ottawa in June (Exhibit III). I know we are
supposed to report our compliance with the grant requirements. Is this covered as part of the regular
audit? If not, what do you think the Ministry will require? Please be specific, as I’d like to know which
potential reports could be prepared and what procedures our auditors would need to perform under each
type of report.”
255
EXHIBIT I
RENT-A-BIKE INC. BACKGROUND AND
INFORMATION ON EXPANSION ALTERNATIVES
Background
Using RAB Bikes
RAB bikes are parked in stations that are strategically located around the downtown core. Each station
has one pay meter and 10 individual slots for parking and locking bikes.
Customers can become members by purchasing annual or monthly memberships. Annual memberships
are based on the calendar year (no pro-ration is made for part years). A member is assigned an access
code to check out a bike and subsequently check it back into a station at their destination. Non-members
can use RAB bikes, but must use a credit card at the pay meter to secure a deposit before receiving the
access code.
Operational Information
RAB headquarters in Toronto is able to monitor in real time the number of bikes parked at every station
in Canada. An alert goes out when a station is either below or above the optimum number of bikes, which
is eight. Given how important it is to have no stations completely empty or full at any given time, RAB
has trucks that roam around each area, prepared to replenish empty stations or pick up bikes from full
stations based on either notification received from headquarters or the staff’s own visual inspections.
While roaming the RAB areas, the staff also checks on each station on a rotational basis to watch for
bikes that need servicing or customers who need assistance. A detailed log of the date and time the staff
visits each station is maintained for each truck. The logs are sent to RAB headquarters on a daily basis. In
addition to providing alerts to headquarters, the system generates an hourly report providing the number
of bikes parked at each station at that point in time. These reports are maintained at headquarters and
reviewed on a weekly basis by RAB supervisors.
256
RENT-A-BIKE INC. BACKGROUND AND
INFORMATION ON EXPANSION ALTERNATIVES
Expansion
RAB is currently considering expanding its operations by establishing 60 new bike stations, either in
Toronto, to extend northwest of the downtown core, or in Vancouver, to break into a new market. RAB
has therefore ordered the manufacture of 60 new stations and enough bikes to support the optimal
capacity of eight bikes per station.
Toronto
There are currently 100 stations located within a nine-square-kilometre area in the downtown core. The
additional stations would be spread over a further six square kilometres.
RAB’s sales and marketing team has estimated that in the first year these new stations would result in 600
additional monthly memberships each month (rate of $25/month) and 5,000 additional annual
memberships (rate of $100/year). The Toronto bikes are available 12 months of the year. RAB’s pay-peruse revenue in Toronto is typically about 50% of total annual and monthly membership fees combined.
Since RAB has an advertising agreement in Toronto allowing KingBank to put its logo on the bikes, it
would be able to generate an additional $175 per bike each year. Further bike usage growth of 10% is
anticipated to occur within one year, but growth beyond this would not be possible because capacity
would be reached.
In addition to the costs of the bikes and stations, annual costs associated with the new stations would
include bike maintenance of $50 per bike; truck operating costs and maintenance of $200,000; wages of
$160,000; general and administrative costs of $100,000; and rental of the space for each station of, on
average, $100 per month.
Vancouver
This would be RAB’s first foray into the western Canadian market, so all estimates provided by RAB’s sales and marketing team are considered uncertain.
RAB’s team anticipates that the bikes would operate for 12 months of the year in Vancouver. The team has estimated that installing the stations would generate 800 monthly memberships each month (rate of
$35/month) and 3,000 annual memberships (rate of $90/year) in the first year. RAB’s pay-per-use
revenue in new markets tends to be 75% of annual and monthly memberships combined. In the second
year of operations, RAB anticipates that overall revenue would increase by 25%, and then by 10% the
third year, but additional investment would be required for further growth.
In addition to the costs of the bikes and stations, annual costs associated with the new stations would
include bike maintenance of $100 per bike (moisture is tough on bikes); truck operating costs and
maintenance of $300,000; wages of $200,000; general and administrative costs of $100,000; and rental of
the space for each station of, on average, $50 per month.
257
EXHIBIT II
NOTES FROM ACCOUNTING CLERK ON ACCOUNTING ISSUES
In preparation for the December 31, 2013 audit, I have provided information on a number of new
promotions and transactions that have occurred (or will occur) this year. I would like your input on how
to account for each of the following items in accordance with Accounting Standards for Private
Enterprises (ASPE).
Promotions
Toronto
To increase RAB’s visibility during the winter months, when bike usage typically declines, RAB is
offering a new promotion to Toronto members. All annual members who check out a RAB bike more
than 75 times in total during December through March will receive a 25% refund of their 2013 annual
memberships. RAB anticipates that of the 10,500 annual Toronto members, 20% will attain the goal and
be eligible for the rebate. How do we account for this in 2013 and in future years if we continue to offer
this promotion?
Ottawa
To encourage long-term membership, RAB offered anyone purchasing a 2013 annual membership in
January 2013 a 50% discount on their 2014 annual membership, if purchased at the same time. Therefore,
the customer gets the benefit of a two-year membership for only $120. Annual membership in Ottawa is
$80, and 1,050 people took advantage of the promotion.
Ministry of Tourism, Culture and Sport Grant
In June 2013, RAB received a payment of $150,000 pertaining to a grant from the Ministry. This funding
relates to installing and servicing eight additional stations in the vicinity of the 2013 Canada Games
Sports Complex. Costs of $145,000 were incurred to purchase and install the stations and bikes. An
additional $10,000 in costs was incurred in relation to the service portion of the agreement. I have simply
recorded the $150,000 cash receipt as government grant revenue.
258
NOTES FROM ACCOUNTING CLERK ON ACCOUNTING ISSUES
RAB 1 Bikes
We own 120 bikes (model RAB 1) currently in use in Toronto that were purchased four years ago. We
originally believed these bikes would be used for eight years, but shortly after we bought them, we were
able to negotiate a contract with a different manufacturer to create a much less expensive and lighter bike
(model RAB 2). The RAB 1 bikes still work fine, but they feel heavier and are not nearly as nice as the
newer ones.
Last month, our operations manager obtained approval from Lochlyn and the board of directors to sell the
entire fleet of RAB 1s and replace them with RAB 2s. Last week, he negotiated a contract to sell all the
RAB 1s to a summer camp for $40,000, with the deal closing on June 1, 2014. The camp has agreed to let
us continue to use the bikes until then. As of right now, the fleet of bikes has a carrying amount of
approximately $45,000. Our cost to transport the bikes to the camp is estimated at $1,000.
Halifax RAB Bikes
Our Halifax RAB bikes have been in operation for just over a year. Our RAB 2 bikes, which cost
$90,000, were brought to Halifax last year. We assumed that they would have a useful life of six years,
similar to our bikes in Ontario and Quebec. However, after only a year, we’re already starting to see rust on some of the frames, and the wheels need repair much earlier than in other locations. Our operations
manager says that he can’t see them lasting longer than three more years. Currently we record straightline depreciation over the life of the asset, assuming minimal salvage value.
259
EXHIBIT III
EXCERPTS FROM MINISTRY GRANT AGREEMENT
The following excerpts have been taken from the agreement between Rent-a-Bike Inc. (“RAB”) and the
Ministry of Tourism, Culture and Sport (the “Ministry”), dated April 12, 2013.
1. RAB will install eight stations at specific locations in Ottawa, as dictated by the Ministry, by
June 1, 2013.
2. RAB will maintain a minimum of one bike and a maximum of nine bikes at each station
between the hours of 8:00 a.m. and 11:00 p.m. for the period from June 15 to June 30, 2013.
Any variations from the established minimum and maximum numbers shall last no more than
15 minutes.
3. RAB will provide a dedicated maintenance/service truck on call for the eight stations between
the hours of 8:00 a.m. and 11:00 p.m. for the period from June 15 to June 30, 2013.
4. Effective July 1, 2013, RAB will be permitted to maintain the stations at these locations
permanently, without rental charge by the City of Ottawa.
5. The Ministry agrees to provide RAB with a payment of $150,000 on June 1, 2013.
6. The Ministry requires a report from RAB’s auditor supporting that the terms in this agreement have been abided by. This report is due February 14, 2014.
260
EVALUATION GUIDE
PAPER III, SIMULATION 2 — RENT-A-BIKE (RAB)
The candidate assesses quantitatively and qualitatively the option of expanding in the Toronto
region versus expanding into a new market in Vancouver.
The candidate is demonstrating competence in Management Decision-Making.
Competencies
VIII-2.1 – Prepares, analyzes, and monitors financial budgets, forecasts, or projections (A)
To:
Lochlyn Grace
From: CA
Re:
Analysis of Toronto/Vancouver, new accounting issues, and report for the Ministry of Tourism,
Culture and Sport
You have asked for an analysis of the two options available in terms of placement of our new fleet of
bikes in either Toronto or Vancouver.
I have performed the following pre-tax cash flow analysis from operations for each location, based on the
information provided. Note that I did not include the cost for the purchase of the bikes or stations, since
these would be the same under both alternatives.
Year 1
Revenue
Annual memberships
Monthly memberships
Per usage
Sponsors
Costs
Bike maintenance
Trucks and maintenance
Wages
General and admin
Station space rental
Net cash flows
TORONTO
Year 2
Thereafter
Year 1
VANCOUVER
Year 2
$ 500,000
$ 180,000
$ 340,000
$
84,000
$ 1,104,000 $ 1,206,000 $ 1,206,000
$
$
$
$
$
270,000
336,000
454,500
1,060,500 $
$
$
$
$
$
$
24,000
200,000
160,000
100,000
72,000
556,000 $
26,400
200,000
160,000
100,000
72,000
558,400 $
26,400
200,000
160,000
100,000
72,000
558,400
$
$
$
$
$
$
48,000
300,000
200,000
100,000
36,000
684,000
$
548,000 $
647,600 $
647,600
$
376,500 $
$
$
$
$
$
$
Thereafter
1,325,625 $
60,000
300,000
200,000
100,000
36,000
696,000
261
Note 1
Note 2
Note 3
Note 4
1,458,188 Note 5
$
$
$
$
$
66,000
300,000
200,000
100,000
36,000
702,000
629,625 $
756,188
Note 6
Note 7
Note 7
Note 7
Note 8
Note 1: The annual membership revenue is calculated as follows:
Toronto: 5,000 memberships at $100/year = $500,000
Vancouver: 3,000 memberships at $90/year = $270,000
Note 2: The monthly membership revenue is calculated as follows:
Toronto: 600 memberships × 12 months × $25/month = $180,000
Vancouver: 800 memberships × 12 months × $35/month = $336,000
Note 3: The pay-per-use revenue is calculated as follows:
Toronto: 50% × ($500,000 + $180,000) = $340,000
Vancouver: 75% × ($270,000 + $336,000) = $454,500
Note 4: The revenue from the advertising agreement is calculated as follows:
Toronto: $175/bike × 60 stations × 8 bikes = $84,000
Note 5: The growth has been calculated on all revenue except for the sponsor revenue, as follows:
Toronto: 10% from year 1 to 2 and no further increase as per information provided
(($500,000 + $180,000 + $340,000) × 1.10) + $84,000 = $1,206,000
Vancouver: 25% from year 1 to 2 and 10% from year 2 to 3 as per information provided
$1,060,500 × 1.25 = $1,325,625 and $1,325,625 × 1.10 = $1,458,188
The calculation was done assuming that in Toronto, a 10% growth in bike usage would result in a
10% overall increase in revenue.
262
Note 6: An increase equivalent to the increase in revenue has been factored in, since bike maintenance
should increase at the same rate as usage. The bike maintenance expense is calculated as follows:
Toronto: $50/bike × 60 stations × 8 bikes × 1.10 = $26,400
Vancouver: $100/bike × 60 stations × 8 bikes × 1.25 = $60,000 and $60,000 × 1.10 = $66,000
Note 7: Assume these expenses remain the same as in the first year.
Note 8: The space rental expense is calculated as follows:
Toronto: $100/month × 12 months × 60 stations = $72,000
Vancouver: $50/month × 12 months × 60 stations = $36,000
Overall Assumptions
No increase in costs has been factored into this analysis, other than for bike maintenance, which is related
to the increase in usage. However, note that an increase in costs might occur over the years. Such an
increase could affect the choice between the two options, either due to the increase being higher in one
city or the fact that the Vancouver project includes more costs, which means an increase in costs would
have a greater impact on the Vancouver project.
Quantitative Analysis
The preceding quantitative analysis was based on the information provided by our sales and marketing
team. Clearly, in the first year of operations, the additional cash flows are higher for Toronto at $548,000
versus $376,500 for Vancouver. However, by year three, the cash flows are higher if the bikes are used in
Vancouver. The Toronto annual cash flows would be $647,600 by year three, compared to $756,188 in
Vancouver.
(Most candidates provided a reasonable, multi-year quantitative analysis of both options. In general,
candidates had more difficulty with the calculations surrounding the revenue related to the
sponsorship and the expense related to the station space rental. However, the overall calculations
contained minimal errors, and assumptions were generally supported. Strong candidates identified the
switch in profitability between Toronto and Vancouver after the second year and provided insightful
comments on how this might affect RAB’s decision.)
Qualitative Analysis
An important factor to take into consideration is that our sales and marketing team has indicated that there
is more uncertainty with respect to the Vancouver expansion. This makes sense, given that in Toronto we
have experience in the market and can rely on our past experience to some extent when making estimates.
The estimates for Vancouver are likely based on research alone. This means that the actual results could
be stronger or weaker than anticipated for Vancouver.
263
In addition, with our expansion into Halifax last year, we realized that there were some additional costs
that we had not anticipated, such as the need to replace bikes much more quickly due to climate
differences. Our quantitative analysis might not currently factor this in for Vancouver, but we should
consider whether this is applicable.
Other factors that we should consider, which may or may not have been accounted for in the quantitative
analysis, are the additional difficulties with having an expanded operation across the country. As of right
now, we are able to benefit from the close proximities of our locations; for instance, it would be easy to
ship bikes back and forth if needed. In addition, in Toronto we can benefit from our already trained
service staff.
On the contrary, there is certainly an opportunity in the Vancouver market, since our analysis does
indicate a positive net cash flow. In addition, a rental bike system may prove to be more popular in
Vancouver given the milder weather and the fact that Vancouver residents have a reputation for being
“greener.” Therefore, they may be more likely to take advantage of a rental bike system. We should also
look into the possibility of signing a publicity agreement in Vancouver, similar to the agreement we have
in Toronto with KingBank. This would bring in a significant amount of revenue and would make the
Vancouver option even more profitable. In addition, if we don’t expand into the market now, we may lose the opportunity to be the first to market in this region.
We might need to consider the fact that helmets may be required to be worn in some regions. This should
be further investigated before we make our final decision because we want to ensure we are always
operating in compliance with municipal and other applicable regulations.
(Most candidates identified several qualitative considerations for RAB to consider. The factors most
often discussed included the uncertainty of the Vancouver market, the experience RAB already has in
the Toronto market, and the potential for further growth in Vancouver. However, the factors identified
were not always discussed in sufficient depth. Strong candidates were able to not only identify the
relevant considerations, but also explain to Lochlyn why these considerations would affect the decision
to go with either Toronto or Vancouver.)
Recommendation
Overall, based on the quantitative and qualitative analysis provided, I recommend expanding our current
Toronto operations. Although there are higher cash flows by year three in Vancouver, these estimates are
not as certain and the potential additional cash flow of expanding into the new region is outweighed by
the risks.
However, because the two projects are interesting in different ways, I believe we should consider going
ahead with both projects if the required resources are available and sufficient financing can be obtained to
cover both projects.
(Most candidates provided supported recommendations, taking into account both their quantitative and
qualitative analyses.)
264
For Primary Indicator #1 (Management Decision-Making), the candidate must be
Percent
Awarded
0.6%
competence.
8.9%
Reaching competence — The candidate attempts a reasonable quantitative or
qualitative analysis of each option.
30.1%
Competent — The candidate prepares a reasonable quantitative and qualitative
analysis of each option and recommends one.
59.8%
Highly competent — The candidate prepares a comprehensive quantitative and
qualitative analysis of each option and recommends one.
0.6%
(Candidates were required to compare Rent-A-Bike Inc.’s (RAB) two options: expanding further in the Toronto region versus expanding to a new market in Vancouver. Candidates were directed to this
indicator when they were asked by the CEO to provide an analysis of each alternative, and were
provided with financial information on both options. The Board expected candidates to perform both a
reasonable quantitative and a reasonable qualitative analysis of the options in order to achieve
competence.)
(Candidates generally performed well on this indicator. Most candidates were able to provide
reasonable quantitative analyses that took into account the various differences between the two
options, such as membership revenues, sponsorship revenues, and the differences in costs. The
simulation was designed such that the quantitative analysis would show Toronto as being more
profitable in the first two years, but Vancouver being more profitable in year three. The quantitative
analyses provided by candidates were generally complete and contained few errors, allowing them to
see this switch in trend. However, some candidates performed only a one-year calculation and, as a
result, failed to see the full picture, which made their quantitative analyses of little use to the client.)
(Candidates were also expected to mention relevant qualitative considerations, such as the uncertainty
surrounding the Vancouver market, the proximity of the other locations, and the opportunity to break
into the Western Canada region. Most candidates were able to suggest several relevant qualitative
factors to consider in addition to their quantitative analyses. Many weak candidates, however, repeated
case facts with no explanation as to why the qualitative consideration they were mentioning would be
an important factor in deciding between the two options.)
The candidate discusses the new accounting issues.
265
Competencies
Please find below my recommendations in accordance with Accounting Standards for Private Enterprises
(ASPE) for each of the issues addressed.
Promotions
Toronto
For the Toronto promotion, it is estimated that 20% of members will meet the 75-plus ride hurdle by the
end of March. If this number is correct, it will result in 2,100 members (10,500 members × 20%)
receiving a rebate of 25% of their 2013 annual membership, which would be $52,500 (2,100 members ×
25% × $100).
According to ASPE 3400 Revenues, paragraph 7, one of the criteria that has to be met in order for
performance to be achieved is, “The seller’s price to the buyer is fixed or determinable.” Paragraph 10 of
ASPE 3400 provides the following guidance in trying to establish if the price to the buyer is fixed or
determinable:
In determining if the seller’s price to the buyer is fixed or determinable, an entity would consider the impact of the following factors:
(a) cancellable sales arrangements;
(b) right of return arrangements;
(c) price protections and/or inventory credit arrangements; and
(d) refundable fee for service arrangements.
In this case, the criteria would have been met until RAB decided to offer the promotion, at which time,
due to the potential refund related to the promotion, the seller’s price is no longer fixed or determinable.
In addition, paragraph 19 of ASPE 3400 states that “Recognition of revenue requires that the revenue is measurable and that ultimate collection is reasonably assured.” Paragraph 21 of ASPE 3400 discusses
uncertainties related to the measurement of revenue. Paragraph 21(b) specifically deals with uncertainty
due to significant and unpredictable amount of returns, and states that revenue would not be recognized in
such circumstances. By extension, it might not be appropriate to recognize the full revenue at year-end in
this case because the amount of refunds is unpredictable, due to the fact that we have no historical
information to support the estimation of the amount of refunds that will be provided since this is the first
year of the promotion.
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As we know that the maximum that could be refunded is 25% of the annual membership, it would be
appropriate to recognize 75% of all annual membership at year-end, which would represent $787,500
(10,500 members × $100 × 75%). Regarding the remaining 25%, which represents an amount of
$262,500 (10,500 members × $100 × 25%), two options could be contemplated. The first option would be
to defer the entire $262,500 until we know, at the end of March 2014, the actual number of members who
met the 75-plus hurdle by the end of the promotion. The second option would be to defer only $52,500,
which is 20% of $262,500, 20% being our estimation of the percentage of members who will be eligible
for the refund. In both cases, at the end of March, the amount sitting in deferred revenue ($262,500 or
$52,500, for the first and second option, respectively) would be reversed, cash would be credited for the
amount refunded, and the balance would be recognized as revenue. These options would result in revenue
being reduced by the refund provided to the customers, as per paragraph 28 of ASPE 3400: “Cash consideration given by a vendor to a customer is presumed to be a reduction of the selling prices of the
vendor’s products or services and, therefore, is normally recognized by the vendor as a reduction of
revenue.”
Because no historical information is available to support our estimation of the number of members who
will be eligible for the refund, I would recommend deferring the entire $262,500 until we obtain the
actual amount of the refund, at the end of March 2014. However, if we could obtain reliable industry
information to support the estimate of 20% of members taking advantage of this promotion (such as
ridership in winter months in Toronto for similar companies who have offered similar promotions), we
could choose the second option, to defer only $52,500 of the revenue. Note, however, that the likelihood
of being able to obtain this type of information is low.
Going forward, we should consider whether we should be deferring, throughout the year, part of the
annual membership revenue that we anticipate refunding as part of this promotion, now that we will have
historical data. For 2014, it is unclear whether reasonable assurance exists over the measurement of the
consideration, since it might be hard to predict the amount of rebates based on only one year. The
promotion may become more popular in its second year, so it may take a few years before we can
reasonably estimate the amount.
Therefore, it might be better to apply the same logic in 2014 as for 2013 and defer 25% of all annual
revenue until the actual refund amounts are known. In future years, historical data for the first two years
will be available and could be used to better estimate the refunds, which would allow RAB to recognize
all revenue with the percentage-of-completion method during the year, except for the estimated amount of
refund, which would be deferred until the end of the promotion. This estimation would be based on the
first two years of the promotion. This would result in higher revenue being recognized at year-end than in
the past, since a more accurate estimation would be applied in the recognition of revenue throughout the
year instead of having to defer 100% of the potential refunds until the amount is known.
(Most candidates recognized the issue of revenue recognition related to the refund, and applied the
relevant Handbook section in their discussions. Many candidates also quantified the revenue to be
deferred. Some candidates approached this issue from a liability perspective rather than a revenue
recognition perspective. This was acceptable, since the other side of the entry would have been to
deferred revenue. However, some candidates who took this approach incorrectly concluded that the
refund would be an expense, as opposed to a reduction in revenue, which prevented them from
demonstrating their competence on this issue.)
267
Ottawa
The actual number of members taking advantage of the 2014 Ottawa promotion is known prior to yearend because members need to purchase their membership by January 31, 2013. Therefore, the number of
new memberships at the reduced rate will be known. In the current year, 1,050 members took advantage
of the promotion. The difference with this promotion, compared to the Toronto promotion, is that the
discounts will relate to annual memberships for the following year, 2014.
From a business perspective, the promotion relates to 2014 because members get a $40 discount on the
2014 annual membership when they purchase it at the same time as the 2013 full-price annual
membership. It would seem reasonable to record the $80 in 2013 and defer the $40 to 2014, since it
relates to that year.
However, according to ASPE 3400, paragraph 11:
In certain circumstances, it is necessary to apply the recognition criteria to the separately
identifiable components of a single transaction in order to reflect the substance of the
transaction. A single sales transaction may involve the delivery or performance of multiple
products, services, or rights to use assets, and performance may occur at different points in time
or over different periods of time… Conversely, the recognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be
understood without reference to the series of transactions as a whole.
In this case, with the Ottawa promotion, there were two transactions (2013 membership and 2014
membership), but both transactions were linked since the promotion was only available to those who
purchased memberships for 2013 and 2014 at the same time, in January 2013. In substance, members who
took advantage of the promotion will be paying $120 for two years of membership. Therefore, the best
alternative is to record revenue for annual memberships of $60 for each year.
Accounting for this would require recognizing $60 of revenue in 2013 related to the 2013 membership
and recording $60 in deferred revenue to account for the 2014 membership. In 2014, the $60 would be
reversed from deferred revenue and recorded in revenue.
(Most candidates recognized the fact that the discount received on the 2014 membership when a
customer purchased a 2013 membership caused the memberships for both years to be linked, and that
therefore they should be considered as one transaction. Many candidates who identified this issue were
able to adequately explain the correct accounting treatment using Handbook sections as support.
However, some candidates recommended recognizing $80 of revenue in 2013, since the 2013
membership fees would have been earned by the end of 2013. These candidates missed the fact that the
members were getting something in addition to the 2013 membership for $80.)
Ministry Grant
The Ministry of Tourism, Culture and Sport grant for $150,000 should be treated as government
assistance in accordance with ASPE 3800 Government Assistance because it relates to governmental
actions that provide specific assistance to RAB in order to influence business decisions.
268
This grant funding primarily relates to the acquisition of bikes and stations, with the remainder
contributing to their servicing (current expenses). For this reason, I recommend allocating $145,000 to the
acquisition of fixed assets and the remainder of $5,000 to covering current expenses. [Note that an
acceptable alternative would be to allocate the total $150,000 received between the two categories on a
pro-rata basis, which would result in allocating $140,323 ($145,000 ÷ $155,000 × $150,000) to the bikes
and stations and $9,677 ($10,000 ÷ $155,000 × $150,000) to current expenses.]
For the $145,000 that relates to the acquisition of the equipment, we have two options for accounting for
it, in accordance with ASPE 3800, paragraph 22. One is to deduct the amount from the cost of the assets,
which would be the full amount (see ASPE 3800, paragraph 22(a)). The second is to defer and amortize to
income on the same basis as the related asset (see ASPE 3800, paragraph 22(b)).
I recommend the first alternative because it is much more straightforward from an accounting perspective
and would result in no need to record and amortize the asset, since the entire balance has been offset by
the grant.
For the balance of $5,000, the amount should be offset against the expenses incurred in servicing the
stations during the period in June.
A separate issue is when to recognize the grant of $150,000. According to ASPE 3800, paragraph 26,
“Provided there is reasonable assurance that the enterprise has complied and will continue to comply
with the conditions for receipt of the government assistance, the accrual basis of accounting for the
assistance is appropriate.” In this case, we have no reason to believe that RAB has not complied with the
conditions of the grant or that the auditor will not support that the terms of the agreement have been
abided by. Therefore, the $150,000 should be recognized.
(Most candidates addressed the issue of how to recognize the ministry grant. Many candidates were
able to provide sufficient depth in their discussions by using Handbook sections and addressing the
various considerations (for example, the revenue recognition associated with the operating and capital
portions of the grant, the allocation of the grant between the two components, and the conditions
associated with the grant before the revenue could be recognized). However, some candidates jumped
straight to recommending an accounting treatment for the grant without providing balanced
discussions or any analysis to support their decisions. For several of the considerations, there were
multiple acceptable alternatives (for example, the grant associated with the operating expenses could
be presented net of the expense or as a separate revenue item). Candidates are expected to discuss all
acceptable alternatives before recommending a specific accounting treatment where acceptable
alternatives are available.)
RAB 1 Bikes — Disposal of Long-Lived Assets
Even though the RAB 1 bikes will continue to be used, given that they are being sold to a camp in June
2014, they need to be assessed to determine whether they meet the criteria of ASPE 3475 Disposal of
long-lived assets and discontinued operations. Since the entire fleet would be disposed of together, the
fleet would be considered a disposal group.
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Consider the following criteria, which must be met in order for the asset to be classified as held for sale,
as stated in ASPE 3475, paragraph 8:
Management, having the authority to approve the action, commits to a plan to sell.
This criterion has been met, since Lochlyn and the board of directors have approved the plan.
It is available for immediate sale in its present condition subject only to terms that are usual and
customary for sales of such assets.
Although the bikes will have to be transported to the camp, this is not considered unusual;
therefore, the criterion has been met.
An active program to locate a buyer and other actions required to complete the sale plan have
been initiated.
Because a buyer has been found and a contract negotiated, this criterion has been met.
The sale is probable and is expected to qualify for recognition as a completed sale within one
year.
Given that the sale to the camp closes on June 1, 2014, within one year, this criterion has been
met.
It is being actively marketed for sale at a price that is reasonable in relation to its current fair
value.
Although there is no indication of current fair value, it is reasonable to assume that the price that
the camp, an unrelated party, has offered is reasonable.
Actions required to complete the plan indicate that it is unlikely that significant changes to the
plan will be made.
Because the remaining actions appear reasonable, there is no indication that significant changes to
the plan will be made.
Since all of the criteria have been met, the disposal group, or fleet of bikes, should be classified as held
for sale. This means that the fleet of bikes should be recorded at the lower of its carrying amount
($45,000) or fair value less cost to sell, which is the cost to transport the bikes to the camp location
($40,000 − $1,000 = $39,000). This means that the entire fleet of RAB 1 bikes should be reclassified from
property and equipment, and reported separately at $39,000. This would result in a loss of $6,000
recorded in the financial statements.
Although they will continue to be used, the RAB 1 bikes should no longer be amortized while classified
as held for sale.
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(About half of the candidates attempted to address the accounting issue related to the RAB 1 bikes.
However, of those, less than half recognized the correct issue; that is, assets held for sale. Some
candidates incorrectly addressed this issue from the perspective of asset impairment. Although there
are indications of impairment, the case facts suggest that the bikes were committed to a sale through a
contract. Therefore, discussion of the impairment of these assets was not appropriate because assets
held for sale are specifically excluded from the scope of ASPE 3063 — Impairment of long-lived
assets.)
Halifax Bikes — Change in Estimate
When the bikes costing $90,000 started being used in the Halifax operation last year, their estimated
useful life was based on the information available (past history), which was six years. This means that
their current carrying amount is likely $75,000 ($90,000 cost − $15,000 of amortization). However, the operation manager’s assessment that the bikes will last only another three years results from new information (perhaps we had not realized the effect that additional rain would have on the bikes). It is
considered a change in estimate in accordance with ASPE 1506 Accounting Changes, and not an error. As
a result, in accordance with ASPE 1506, paragraph 23, the change should be accounted for prospectively
in the period of change and future periods affected.
Effective immediately, the remaining estimated useful life should be changed to three years. This gives us
an annual amortization of $25,000 (or monthly of $2,083). Since the change of estimate just happened
and it is September 2013, the amortization should be calculated on the remaining four months of the year.
Applying the rate of $2,083 per month, the estimated carrying amount of the Halifax bikes would be
$66,668 ($75,000 − (4 × $2,083)) at December 31, 2013.
(About two-thirds of the candidates addressed the change in estimate related to the Halifax bikes.
Generally, when this issue was addressed, candidates understood the need to recognize the change on a
prospective basis and provided adequate discussions. Some candidates quickly concluded that the
change in estimate would affect amortization expense, but did not explain why this was a required
adjustment or what the impact would be on the financial statements. These candidates were not able to
provide sufficient depth in their discussions.)
Percent
Awarded
0.1%
competence.
8.1%
issues.
45.7%
Competent — The candidate discusses some of the accounting issues.
45.6%
Highly competent — The candidate discusses most of the accounting issues in
sufficient depth.
0.5%
271
(Candidates were directed to this indicator when Lochlyn asked CA to address the new accounting
issues encountered this year, including how to account for the new promotions. To achieve
competence, the Board expected candidates to address some of the accounting issues in sufficient
depth.)
(The Board was somewhat disappointed by candidates’ performance on this indicator. While most candidates were able to identify the relevant accounting issues, including revenue recognition for the
Toronto and Ottawa promotions, recognition of the Ministry of Tourism, Culture and Sport grant, the
held-for-sale RAB 1 bikes, and the change in estimated useful lives of the Halifax bikes, their
discussions often lacked depth. Strong candidates provided the relevant Handbook criteria and
integrated case facts into their analyses. Weak candidates tended to jump immediately to the correct
accounting treatment without first explaining to Lochlyn why that treatment was appropriate. Weak
responses also contained more technical errors, such as suggesting the change in estimate could be
accounted for on a retrospective basis. In addition, some candidates failed to identify the correct
accounting issues. For example, some candidates discussed general revenue recognition relating to
each stream of income. Since candidates were asked to address the new accounting issues and there
were no case facts to suggest the current treatment of these different revenue streams was incorrect,
these discussions were irrelevant.)
The candidate discusses reporting options and provides procedures related to the ministry
grant.
Competencies
V1-1 – Analyzes, evaluates, and advises on assurance needs (external or internal) (A)
Auditor Support Required
The agreement signed with the Ministry of Tourism, Culture and Sport requires documentation from
RAB’s auditor “supporting that the terms in this agreement have been abided by.” Although this is a vague statement, an audit of RAB’s financial statements alone will not provide sufficient information to
the Ministry, since it is based on an overall materiality level for the financial statements as a whole and
does not address the specific requirements of the agreement.
(Many candidates did not address whether RAB’s financial statement audit alone would address the Ministry’s needs.)
Since the requirement is not clear, RAB should clarify with the Ministry (preferably in writing) what type
of documentation it requires from the auditor to show that the terms of the agreement have been abided
by, and specifically whether the Ministry requires any form of assurance. This should be clarified before
any procedures commence; however, it is still useful to discuss the alternatives with the auditors at our
meeting next week.
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A few reports could be considered acceptable to the Ministry.
Potential Reports
Section 5815/8600 — Audit/Review of Compliance with Agreements
One type of report we could request our auditor issue would be a Section 5815 Special Report — Audit
reports on compliance with agreements, statutes and regulations (if the Ministry requires a high level of
assurance) or a Section 8600 — Reviews of compliance with agreements, statutes and regulations (if the
Ministry requires a moderate level of assurance). The audit engagement would provide a report stating
that RAB complied with the terms of the agreement, through procedures such as inspection, observation,
inquiry, confirmation, recalculation, and re-performance, as well as analytical procedures. The review
engagement report is similar in nature. However, the level of assurance is lower, and as a result the
procedures may be based more on inquiry, discussion, and analysis. Because of the higher level of
assurance, the Section 5815 report would be more costly.
The criteria are not complex, so they appear to be within the professional competence of the auditors and
appropriate for these types of reports. Although the actual design of the audit plan and the related
procedures would be the responsibility of the auditors, they would likely go through each clause of the
agreement and determine how to obtain assurance to support each one.
(Virtually all candidates identified either the 5815 or the 8600 report as a reporting option, and many
candidates identified both. However, many of the discussions surrounding these reports lacked depth.
Many candidates simply stated that one report would provide more assurance than the other, without
further discussion. Since Lochlyn is not an accountant, an explanation of what these reports are and
what they entail was key to his understanding.)
Section 9100 — Report on the Results of Applying Specified Auditing Procedures
Another possible alternative, given that the ministry agreement does not specifically require assurance
from the auditor (it simply refers to a report from the auditor to support that the terms of the agreement
have been abided by), could be a Section 9100 Report on the results of applying specified auditing
procedures to financial information other than financial statements. This type of report does not provide
an audit opinion or negative assurance. Instead, the auditor would perform only those procedures that
RAB requests. Although the report is typically used for financial information other than financial
statements, we could engage the auditors to provide something very similar to a 9100 report as a
consulting engagement. This type of engagement would require us to provide the auditors with the
specific procedures to be performed. The cost to RAB for performing these procedures will vary
depending on how many procedures are selected, but should be less than a Section 5815/8600 report. This
report is also more flexible because we, along with the Ministry, can choose exactly which procedures
should be performed and which criteria to test.
(A little over half of the candidates also identified a 9100 report as an option. However, again, many
candidates did not discuss this report in sufficient depth. Many candidates simply told Lochlyn that the
report would provide no assurance, without further explanation or incorporation of case facts.)
273
Before providing any procedures for the auditors to perform, we would want to confirm with the Ministry
that it is comfortable with the procedures selected. We would want to make sure that the procedures
address each requirement in the agreement. Examples of the types of procedures we could request that the
auditors perform include the following:
Clause from the Agreement
Potential Procedures
7. RAB will install eight stations
at specific locations in Ottawa
as dictated by the Ministry by
June 1, 2013.
Review all invoices for the eight stations purchased for the
project to confirm that they were purchased by June 1, 2013.
Review all delivery receipts for the eight stations to see
whether they indicate that the stations were delivered before
June 1, 2013.
Review installation records to determine the locations where
the stations were installed to ensure they match the specific
locations in the agreement.
Inquire if there was an on-site supervisor from the Canada
Games (or a representative who worked at the Canada Games
complex), and if so, obtain a written confirmation that they
saw the bike stations in the correct locations on June 1, 2013.
Review the detailed logs maintained by the trucks to see that
they visited the eight new stations on June 1, 2013.
8. RAB will maintain a minimum
of one bike and a maximum of
nine bikes at each station
between the hours of 8:00 a.m.
and 11:00 p.m. for the period
from June 15 to June 30, 2013.
Any variations from the
established
minimum
and
maximum numbers shall last no
more than 15 minutes.
Review the hourly head office system-generated bike dock
monitoring reports on the eight stations during the period from
June 15, 2013, at 8:00 a.m. to June 30, 2013, at 11:00 p.m. to
confirm that none of the stations were outside of the
thresholds specified.
Obtain a written confirmation from management of the
Canada Games to confirm there were no complaints made to
them regarding unavailability of bikes or customers not being
able to return bikes due to the unavailability of slots in the
stations during that period.
See if there is a log available for the alerts provided to the
head office by the system on the number of bikes parked at
each station. If so, review the log to see if any of the eight
stations had a number of bikes outside of the threshold, and
review the log maintained by the trucks to see if the problem
was addressed within 15 minutes.
9. RAB will provide a dedicated
maintenance/service truck on
call for the eight stations
between the hours of 8:00 a.m.
and 11:00 p.m. for the period
from June 15 to June 30, 2013.
Review all timesheets for staff assigned to the eight stations to
confirm that they were approved for the period specified.
Review the truck log service schedule for notations of time
spent at each of the eight stations to support that they were on
call for the period specified.
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The engagement report would list each of these procedures, along with the auditors’ factual findings for each procedure.
The procedures performed under the Section 5815/8600 reports would be very similar to the ones
identified above. However, if an 8600 report is selected, the procedures would be more inquiry-based. For
example, instead of reviewing invoices for the eight stations purchased for the date, a procedure under
this report might have the auditor discuss with management whether the stations where installed in the
proper locations by June 1, 2013.
(Most candidates were able to provide valid procedures to verify that the minimum and maximum
numbers of bikes per station were met and that there was a dedicated maintenance truck on call.
However, many candidates struggled to provide valid procedures that would ensure the bike stations
were built at specific locations by June 1, 2013. Weak candidates were confused by the timing of the
simulation and thought it would be appropriate to check whether the bike stations were in place now.
These candidates failed to recognize that the Ministry required the bike stations to be built by a specific
date, which had already passed. Because of this, the procedures candidates provided often did not
address the most significant risk associated with that criterion: that the stations were not in place in
time for the Canada Games.)
Other Considerations
It may be difficult for the auditors to gain assurance on some of the specific criteria (for example,
clause 2, which requires that we maintain specific minimum and maximum numbers of bikes in each of
the stations at all times). Given that our system reports are generated hourly only, it may be difficult to
support that there were no variations that lasted more than 15 minutes. Further, the auditors may require
additional testing of our system if they want to rely on our reports for assurance purposes.
(Very few candidates addressed the difficulties the auditors may encounter during their engagement.)
Preliminary Recommendation
Although we must discuss the type of report with the Ministry before any work begins and we must
obtain input from our auditors, I believe that an engagement similar to the Section 9100 report would best
suit our needs in these circumstances.
(Only about half of the candidates wrapped up their discussion with a recommendation of a report to
provide to the Ministry.)
275
Percent
Awarded
0.1%
competence.
13.1%
Reaching competence — The candidate discusses reporting options or provides
valid procedures.
45.7%
Competent — The candidate discusses reporting options and provides valid
procedures.
40.6%
Highly competent — The candidate thoroughly discusses reporting options and
provides several valid procedures.
0.5%
(Candidates were asked to explain to Lochlyn what reports could be provided to the Ministry and what
procedures the auditors would need to perform under each type of report.)
(Candidates were expected to discuss the various reports available that would comply with the
Ministry’s grant requirements. Although most candidates were able to identify several reporting options, their discussions of these reports lacked depth. Candidates often struggled to explain to
Lochlyn how these reports differed from each other. Many candidates simply used terms like “high assurance” without explaining what those terms meant. Given that Lochlyn was not an accountant, the explanations candidates provided were not always adequate.)
(Candidates were also expected to provide procedures that would satisfy the requirements of the
Ministry. When procedures were provided for a report, they were generally relevant, with the exception
of criteria #2, where candidates struggled to provide relevant procedures to test that the criteria had
been met.)
276
(Candidates performed well on some aspects of this simulation, but not on others. Candidates generally
performed well on Primary Indicator #1, providing reasonable quantitative and balanced qualitative
analyses. For Primary Indicator #2, most candidates were able to identify most of the accounting
issues, since they were directed to them in the simulation. However, some candidates struggled to
provide sufficient depth in their analyses of the accounting issues. The same is true for Primary
Indicator #3. Most candidates attempted to provide reporting options for the Ministry and audit
procedures that could be performed; however, the discussions on reporting options often lacked depth.
Candidates are reminded that in order to demonstrate competence in Performance Measurement and
Reporting and Assurance, depth of analysis is always required.)
277
SAMPLE RESPONSE
PAPER III-2 RENT-A-BIKE (RAB)
To: Lochlyn Grace
From: CA
Re: RAB
Expansion Alternatives
Quantitative Analysis
In Exhibit I, I have performed a quantitative analysis of the expansion alternatives. I have determined that
the Vancouver alternative has a higher NPV and higher total cash flows after five years than the Toronto
option. I have based my NPV on a rate of 5%, however, further information is required to determine if
this is an appropriate discount rate.
However, the Toronto option has a faster payback period, as cash flows in the beginning years of the
project are greater than Vancouver.
Based on the information presented in Exhibit I, from a quantitative perspective, I would recommend
Vancouver since it has a higher NPV. However, we must consider the qualitative factors which will be
discussed next.
Qualitative Analysis
Toronto
Opportunities:
RAB has experience in Toronto and therefore, can leverage its existing operations in Toronto in its
expansion plans.
The estimates of the future cash flows of the projects are more precise due to RAB’s familiarity with the Toronto market which means there is less uncertainty of the future cash flows compared to
Vancouver which means there is less risk to RAB.
Risks:
Toronto has very cold temperatures and snow in the winter months. The projections in Exhibit I are
based on monthly memberships being purchased for 12 months of the year. However, this may not be
the case. Therefore, the projections in Exhibit I may need to be adjusted based on the history of
memberships purchased in the winter months in Toronto.
278
Vancouver
Opportunities:
Vancouver winters are generally very mild which means that monthly memberships in the winter are
likely to be higher which will result in higher cash flows compared to areas with harsh winters. This
reduces the seasonality impact on cash flows.
Risks:
Vancouver is a new market and RAB does not have experience in Vancouver. Therefore, the
estimates of the Vancouver cash flows are not precise which increases the risk that the cash flows will
not be as projected. Therefore, entering the Vancouver market is more risky.
Recommendation
I recommend that RAB enters the Vancouver market due to the milder winters which will improve cash
flows during these months. However, I recommend that RAB conducts market research in Vancouver to
determine the viability of the model in Vancouver and to confirm the estimates used in the cash flow
projection.
Accounting Issues
Revenue Recognition - Ottawa
RAB has offered a 50% discount on the 2014 membership if purchased at the same time as the 2013
membership. ASPE states that the recognition criteria in this Section are usually applied separately to
each transaction. However, in certain circumstances, it is necessary to apply the recognition criteria to the
separately identifiable components of a single transaction in order to reflect the substance of the
transaction. The discount provided on the 2014 membership should be allocated between both the 2013
and 2014 fiscal years since it is related to the revenues being earned in 2013. Total revenues related to this
offer are $168,000 ($80 x 1,050 x 2) which generated a discount of $42,000. Therefore, the discount
should be prorated by the fair value of the membership revenue of 2013 and 2014. Therefore, 50% of the
discount, $21,000 should be recorded in 2013.
Government Grant Revenue
RAB has received a $150,000 government grant from the Ministry relating to the installation and
servicing of eight additional stations in the vicinity of the 2013 Canada Games Sports Complex. RAB has
recorded the government grant as revenue. However ASPE states that:
Government assistance toward current expenses or revenues shall be included in the determination of net
income for the period.
Government assistance towards the acquisition of fixed assets shall be either:
(a) deducted from the related fixed assets with any depreciation calculated on the net amount; or
(b) deferred and amortized to income on the same basis as the related depreciable fixed assets are
depreciated.
279
Therefore, we must determine if the grant relates to capital expenditures or towards expenditures.
$145,000 of the grant was used to purchase and install the stations and bikes. Therefore, it is appropriate
to either defer $145,000 of the grant and recognize it as income over the useful lives of the stations and
bikes or record the $145,000 as a decrease in the carrying amount of the stations and bikes.
Costs of $10,000 were incurred in relation to the service portion of the agreement, therefore, the
remaining $5,000 should be recorded as income. This could either be done by recognizing it as other
income or as a direct reduction of the related expenses.
Assets Held for Sale
RAB has decided to sell all RAB 1 bikes to a summer camp for $40,000. The question is whether or not
these assets should be accounted for in accordance with ASPE 3475 as long-lived assets held for sale.
ASPE states that:
A long-lived asset to be sold shall be classified as held for sale in the period in which all of the
following criteria are met:
(a) management, having the authority to approve the action, commits to a plan to sell;
This criterion appears to have been met as the operations manager obtained approval from the CEO and
board of directors to sell the entire fleet of RAB 1s and replace them with RAB 2s.
(b) it is available for immediate sale in its present condition subject only to terms that are usual and
customary for sales of such assets;
There is a concern that this criterion may not be met. The camp has agreed to let RAB continue to use the
bikes until then. However, since the bikes are being replaced by RAB 2s, RAB may not be in fact using
them, and they may be available for immediately sale. Further information is required, but it appears that
this criterion is likely met.
(c) an active program to locate a buyer and other actions required to complete the sale plan have been
initiated;
This criterion has been met since RAB has located a buyer and has negotiated a closing date of sale of
June 1, 2014.
(d) the sale is probable, and is expected to qualify for recognition as a completed sale within one year,
except as permitted by paragraph 3475.09;
The sale is probable as it has been negotiated and the closing date is June 1, 2014 which is within one
year therefore this criterion has been met.
(e) it is being actively marketed for sale at a price that is reasonable in relation to its current fair value;
and
280
This criterion has been met since the sale has been negotiated.
(f) actions required to complete the plan indicate that it is unlikely that significant changes to the plan
will be made or that the plan will be withdrawn.
This criterion appears to have been met since the bikes are being replaced and the sale has been
negotiated.
Therefore, ASPE states that a long-lived asset classified as held for sale shall be measured at the lower of
its carrying amount or fair value less cost to sell. A long-lived asset shall not be amortized while it is
classified as held for sale. Therefore, the bikes should be written down to their fair value which is
$45,000 less the costs to sell of $1,000. The bikes held for sale shall be presented separately on the
balance sheet.
Assurance Services for Ministry
An audit is likely not sufficient for the Ministry. This is because the criteria that the Ministry have set out
are non-financial and therefore, are not audited as part of a financial statement audit. Therefore, we must
have a separate engagement conducted to satisfy the needs of the Ministry and present the report by
February 14, 2014.
I have identified the following reporting options for the Ministry:
We could perform an audit in accordance with HB 5025 which sets the standards for assurance
engagements other than audits of financial statements and other historical financial information. This
would provide a high, audit level assurance to the Ministry. The audit would be performed similar to
a financial statement audit except that audit procedures would be performed on the non-financial
information required by the conditions set by the Ministry.
Another alternative would be to perform a HB 5815 which is an audit report on compliance with
agreements, statutes, and regulations. This is similar to HB 5025 in that it provides a high level of
assurance. If a review level of assurance is satisfactory for the Ministry, we could have a review of
compliance with agreements and regulations conducted in accordance with HB 8600. This would
provide a moderate level of assurance and would be less expensive and time consuming compared to
a 5815.
Additionally, we could consider having a 9100 report conducted which is a report on the results of
applying specified audit procedures. This type of report does not provide any assurance. However, the
auditor could perform procedures as outline by us that would satisfy the Ministry. The auditor could
help interpret the findings of the procedures performed.
I recommend that we contact the Ministry and determine what level of assurance is required. If a high
level of assurance is required, I recommend that we engage an independent auditor to perform an audit of
compliance with the agreement with the Ministry in accordance with HB 5815. If the Ministry is satisfied
with a moderate level of assurance, I recommend we proceed with a less costly, less time consuming,
review of compliance with the agreement in accordance with HB 8600.
281
282
283
It is September 16, 2013, and you are just about to sit down at your desk at Geeky and Keener Chartered
Accountants when one of the partners, Mr. Keener, says, “CA, I need your help with new clients to our firm, John and Sheila Brown, who are looking for retirement planning advice.”
The partner proceeds to tell you that Sheila has health problems, so John is thinking of retiring without
waiting any longer. John sat down with the human resources manager at work to discuss his retirement.
The manager provided him with information relating to his two pension retirement options (Exhibit I).
John and Sheila are leaning towards option 2 because they don’t know if option 1 will provide them with the same amount of cash before tax. Mr. Keener informs you that John and Sheila are in a meeting room
down the hall right now. “CA, go meet with them and gather as much information as you can. As I said, they are new to our firm, and it’s important to me that we address any issues they might have.”
You proceed to meet with John and Sheila and take notes about their situation (Exhibit II).
The next day, Mr. Keener tells you he spoke with John the previous night. He wants you to put together a
report addressing which retirement option would be best for John, before tax. As the partner walks away,
he says, “John also mentioned they have always prepared and filed their own personal income tax returns.
He said they are always paying taxes and don’t know why. He gave me their most recent tax returns and notices of assessment” (Exhibits III and IV).
284
EXHIBIT I
EXCERPTS FROM JOHN’S 2013 ANNUAL PENSION STATEMENT
2013 ANNUAL PENSION STATEMENT
Employee Name: John Brown
Work Hard Ltd.
Dear John,
We are pleased to provide your annual pension statement.
On the following page you will find details about your defined benefit pension plan with the company and
the options available to you.
We would like to point out that upon advising us of your decision to retire, you will have 90 days to
inform us of which retirement option you are choosing. Your retirement date will be January 1 of the year
following your notice to retire.
A couple of facts about your annual pension:
Under a defined benefit plan, a set annual pension payment is defined when you retire. This
means you won’t have to worry about the state of the economy or fluctuations in the market.
If you die before your spouse, your spouse will receive a one-time payout of $20,000 on your
death and will not be entitled to any additional future annual pension payments.
If you have any questions about your retirement, we would be happy to help you. Just give us a call.
Jane Smith
Jane Smith
Vice President, Human Resources
285
EXCERPTS FROM JOHN’S 2013 ANNUAL PENSION STATEMENT
MY RETIREMENT BENEFITS
Your Accrued Pension Entitlement to December 31, 2013
Since you have been a member of the plan for 35 years, you are entitled to choose from the two
retirement pension options listed below.
OPTION 1
If you retire at age 60 or later, your annual pension of $42,997 will be payable for your lifetime
starting the year after you give notice of retirement. Should you choose to retire before age 60, your
annual pension will be reduced by 20%. This reduction stays in effect throughout your retirement.
If you retire before the point at which you choose to begin drawing your Canada Pension Plan (CPP)
benefit, you will receive an additional annual payment (bridge benefit) of $10,330 until you begin to draw
CPP.
OR
OPTION 2
If you retire at age 60 or later, you will receive a lump sum payment of $984,100 at the time of
retirement. Should you choose to retire before age 60, your lump sum payment will be reduced by 20%.
Other Information
Conventional wisdom suggests you need to consider economic uncertainty when making decisions about
retirement. Current investment portfolios average 3% growth annually.
We recommend using a life expectancy of age 90 for the purpose of financial planning.
286
EXHIBIT II
NOTES FROM YOUR MEETING WITH JOHN AND SHEILA BROWN
Client Details
John’s birthday: September 20, 1954 — he is currently 58.
Sheila’s birthday: May 30, 1959 — she is currently 54.
John and Sheila have two kids:
o Jane, age 20; attending Carleton University
o Harry, age 22;; attending Saint Mary’s University (graduate studies)
John and Sheila are planning to give each of their children a significant amount of money sometime in
the near future to assist with the cost of tuition.
Sheila was diagnosed with multiple sclerosis in 2011. It got progressively worse until she was no
longer able to work. Rather than going on long-term disability, Sheila felt that, at her age, retirement
was a better option. She retired in June 2012 after working for 15 years as a receptionist. Sheila hopes
they can soon purchase a vacation property somewhere exotic, where the weather and lifestyle will be
more beneficial to her health. They are thinking of Fiji.
John and Sheila are very excited about retiring. Once retired, John plans to replace his old car with a
new high-end convertible. They also showed you a brochure for the big trip they hope to take — a
five-month cruise departing in January.
John will begin to draw from the Canada Pension Plan (CPP) at age 65, and his estimated annual CPP
income will be $6,500. He will also begin drawing old age security at age 65, for an annual benefit of
$6,300.
John and Sheila told me that they don’t have a lot of savings put away, but they are currently able to cover all their annual living expenditures on the after-tax income they earn.
EXHIBIT III
SUMMARY 2012 PERSONAL INCOME TAX RETURNS
Employment
Other pensions
Split-pension amount
Taxable dividends
Taxable capital gains
Total income
Line
101
115
116
120
127
150
John
64,415
0
0
1,120
4,500
70,035
Sheila
18,000
7,000
0
0
0
25,000
RPP (Registered Pension Plan)
RRSP
Split-pension deduction
Net income
207
208
210
236
4,442
1,000
0
64,593
1,800
0
0
23,200
Losses of other years
Taxable income
253
260
0
64,593
0
23,200
Basic personal amount
Amount for children
CPP
EI (Employment Insurance)
Canada employment amount
Pension income amount
Disability amount
Transfers – disability
Transfers – education
Medical expenses
Subtotal
Credits at 15%
Donations and gifts
Non-refundable tax credits
300
367
308
312
363
314
316
318
324
332
335
338
349
350
10,822
4,382
2,306
840
0
0
0
0
0
0
18,350
2,753
0
2,753
10,822
0
891
311
0
0
0
0
0
0
12,024
1,804
28
1,832
Federal tax
404
350
Dividend tax credit
425
406
Net federal tax
Income tax deducted
437
Balance owing (refund)
Note: Provincial taxes not considered.
11,221
2,753
0
8,468
8,413
55
3,480
1,832
0
1,648
1,101
547
TOTAL TAXES FOR JOHN
AND SHEILA
602
287
288
EXHIBIT IV
EXCERPTS FROM THE NOTICES OF ASSESSMENT (2012)
FOR JOHN AND SHEILA
Notice of changes and summary of assessment or re-assessment 2012 income tax return — JOHN
BROWN
This notice explains the results of our assessment. Based on the information you provided, your elected
split-pension amount is $0.
As of the date of this notice, you have unused net capital losses from other years of $5,500. However, if
you apply this amount to any year other than the current tax year, your unused balance may have to be
recalculated.
----------------------------------------------------------Notice of changes and summary of assessment or re-assessment 2012 income tax return — SHEILA
BROWN
This notice explains the results of our assessment. Based on the information you provided, your elected
split-pension amount is $0.
As of the date of this notice, you have unused net capital losses from other years of $0.
Based on the information you provided, you have been approved for the Disability Tax Credit for the
years 2009–2017.
As of the date of this notice, you have undeducted Registered Retirement Savings Plan (RRSP)
contributions available for use of $500.
289
EVALUATION GUIDE
PAPER III, SIMULATION 3 — THE BROWNS
To: John and Sheila Brown
From: CA
Re: Retirement planning options and review of personal income tax returns
The candidate prepares an analysis of the pension options available to John on retirement.
Competencies
VII-1.1 – Establishes or evaluates financial objectives (B)
VII-2.4 – Identifies and evaluates sources of funds (B)
VII-3 – Develops or analyzes investment plans, business plans, and financial proposals (B)
As requested, we have prepared an analysis of the two pension options available to John upon retirement.
The following is our recommendation of the option we think would be best for you.
We have based our analysis on several assumptions that have an impact on our results. First, we needed to
determine John’s estimated lifespan to be able to assess the two retirement options over a fixed number of years. John’s annual pension statement recommended using the age of 90 for the purpose of financial
planning, so we chose that number as a base for our calculations. Had we used a different number, the
analysis and selection of the best option for John may have been different. Second, we needed to use a
discount rate in order to take into account the value of money over time. Again we relied on information
provided in John’s annual pension statement, which noted that current investment portfolios average 3%
growth annually. We selected this rate for our analysis. We also assumed that John would not be retiring
in the next five days. Although he is 58, his birthday is on September 20, so we considered his starting
age for the purpose of our calculations to be 59. John’s annual pension statement notes that his retirement
date would be January 1 of the following year, or January 1, 2014, in this case.
290
In order to determine which retirement option results in the most cash, before tax, we calculated the
annual pension income John would receive under option 1. Since John wants to retire at age 59, we
analyzed the annual pre-tax cash flow for this option for the years 2014 to 2045. Based on the terms of
John’s pension, since he is retiring before the age of 60, we have reduced his annual pension amount by 20% ($42,997 × 20%) or $8,599 per year. Additionally, he is entitled to an annual bridge benefit of
$10,330 until the year he begins drawing CPP. You noted in our meeting that John would begin taking
CPP at age 65, and, therefore, we calculated the bridge benefit for years 2014 to 2019. John will receive
his first CPP payment during the month of his 65th birthday, which will be on September 20, 2019.
Therefore, effective for years 2020 onward, John will receive his full CPP for the year and will no longer
be entitled to the bridge benefit.
Based on our calculations, John will earn $44,728 (($42,997 × 80%) + $10,330) per year once retired,
beginning January 1, 2014. This amount will remain the same for years 2015 through to 2019. Starting in
2020, John’s annual earnings from his pension will be reduced to $34,398. This is a reduction of $10,330
as a result of having turned 65 in 2019. Although it appears he will be earning less once he reaches the
age of 65, remember that he will then begin to receive CPP and Old Age Security benefits (OAS). We
have not factored these two income sources into the calculation because he will receive them regardless of
which retirement option he selects and, therefore, they are not a deciding factor between the two options.
The calculation of the net present value (NPV) of option 1 assuming that John retires at age 59 is as
follows:
Max Pension Income
Early Retirement Reduction
Bridge Amount
Total
$
$
$
$
Amount
42,997
(8,599)
34,398
10,330
Discount
Rate
Number
of Years
3%
3%
32
6
NPV
$
$
$
722,364
57,638
780,002
In order to analyze option 2, we begin with the lump-sum payment John will receive on January 1, 2014,
of $984,100 and reduce it by 20% as a result of his early retirement. This results in a lump-sum payment
of $787,280, which is slightly higher than the NPV of option 1.
The calculation of the NPV of option 1 assuming that John retires at age 60 is as follows:
Pension Income
Bridge Amount
Total
Amount
$
42,997
$
10,330
Discount
Rate
3%
3%
Number
of Years
31
5
NPV
$ 885,757
$
48,728
$ 934,485
291
As mentioned previously, under option 2 John would receive a lump sum of $984,100 if he retired at age
60. Thus, according to our quantitative analysis, John should select option 2 and retire at age 60 because
this would provide the greatest pension amount.
(Most candidates performed the calculations for both options assuming that John would retire at 59
since his wife had serious health problems and he indicated that he was “thinking of retiring without
waiting any longer.” Most candidates compared the two options;; however, many candidates either did not consider the bridge benefit or did not calculate the net present value of the amounts under option 1,
which meant their comparisons were not as useful as they could have been.)
The tax impacts should also be considered since they could produce very different results depending on
the timing of distributions and receipt of income. John should seek tax advice before making his final
decision so that he can review the tax implications of each option.
From a quantitative perspective, the options are relatively comparable. However, there are a number of
qualitative factors that you should also consider.
Lifespan
We have based the calculations on an estimated life for John of 90 years. If he lives to be older than 90,
you will need additional retirement funds. Under option 1, you won’t need to worry because he will continue to receive $34,398 annually past the age of 90. However, under option 2, the lump-sum payment
is a flat amount. If John lives to be older than 90, your annual retirement income will be reduced because
it will be spread out over more years.
(Most candidates did not raise the issue of lifespan and the fact that it gives an advantage to option 1
over option 2.)
Investment Return
You also have to consider that if John were to choose option 2, he would get a lump-sum payment that he
would have to invest himself in order to get a cash flow equivalent to what he would get if he had picked
option 1. Because we used a rate of return of 3%, for our calculation to be comparable John would have to
earn a 3% return on his investment. This rate is based on the average return John could expect to receive
based on current market rates and economic factors. However, should the economy and prevailing market
rates fluctuate over the years, the remaining amount of funds available to him from choosing option 2
could be significantly affected. If the average rate of return increases, it would be in John’s favour and would provide higher income on his lump-sum funds. However, if the return rates decline below 3%, it
will adversely affect how long John’s funds will be able to sustain the same level of pre-tax cash flow as
he’d receive if he chose option 1. The risk of market changes is not his to bear if he selects option 1, since
the annual pension amount he’ll receive is fixed at the date of retirement and there appears to be no indication that Work Hard will default.
292
Investment Comfort Level
If he chooses option 2, John will be responsible for the future growth of his retirement savings, instead of
his employer. This means he will likely have to rely on advisors to assist him in managing the funds,
unless he has the individual skills to manage his portfolio. This adds a level of risk, and John needs to
assess if he is comfortable with it.
(Very few candidates discussed financial risk and the other issues associated with selecting option 2.
Most candidates who did provided reasonable discussions; however, some candidates only raised the
issues without discussing how they could affect John and Sheila’s financial situation.)
Retirement Goals and Objectives
You have indicated that you are planning on giving each of your children a “significant” amount of money to assist them with their tuition. As well, Sheila would like to purchase a vacation property,
presumably in Fiji, while John would like to replace his old car with a new high-end convertible. In
addition, you are planning a five-month cruise next January.
Even though you might not be able to attain all of these goals, you might be able to fulfill some of them if
you choose option 2. The lump-sum payment would provide you with current funds, while option 1
would not provide you with any excess cash to use towards these goals.
(Most candidates who provided qualitative discussions considered which option would better allow
John and Sheila to fulfill their goals and objectives. They provided reasonable discussions and
identified some relevant simulation facts in support of their discussions.)
Available Funds after John’s Death
You have mentioned that Sheila has health concerns, but you have not considered what might happen if
John were to pass away before Sheila. As noted in John’s annual pension statement, if he were to pass away, Sheila would receive a one-time payout of $20,000 on John’s death, but she would not be entitled to any additional pension payments. This means that if John were to pass away young, Sheila would
receive only $20,000. You need to determine what annual income Sheila might require to live
independently if John were to pass away before her. Will she need access to John’s annual pension to assist with expenses such as her cost of living, mortgage payments, and vehicle payments? Also, since
Sheila has health issues, her medical bills will likely increase over time, and she may find herself needing
a higher annual income later in life. If John chooses option 1, there is a risk that Sheila may be left
without the funds to cover these expenses. If John has a life insurance policy, it could assist with Sheila’s cash-flow needs upon his death, so this situation should be reviewed in more detail.
If, however, John were to pass away after choosing option 2, Sheila would still have access to the same
annual income as she would have while John was alive, since the funds would be paid to John on
retirement and would be his to manage. This option reduces the risk of Sheila not having access to enough
income after John’s passing.
(Many candidates identified this issue and were able to provide reasonable discussions of the impact
upon Sheila if John were to choose option 1 and pass away before her.)
293
Recommendation
You need to assess the quantitative aspects of John’s retirement options along with the qualitative risks and benefits of each option. We have demonstrated that from a quantitative perspective, the options are
likely comparable at age 59, but there is a slight benefit in favour of option 2 if John retires at age 60.
However, there are some significant risks associated with option 1; namely, if John passed away at a
young age, Sheila would be left without access to John’s pension. Option 2 would provide John with the retirement funds upfront, reducing the risk of not providing for Sheila after John’s passing. However, option 2 requires that John be comfortable with managing his retirement funds. It is also affected
significantly by economic factors that are out of his control, which could create volatile returns for his
portfolio and put into question how long the money will last. If you have another source of funds that
would provide for Sheila upon John’s passing, such as a life insurance policy, then I would recommend option 1. It provides you with a guaranteed retirement amount until John’s passing, and a life insurance policy could then provide income for Sheila after John’s passing. However, if additional funds are not available, the risk of John passing away at a young age and leaving Sheila without access to income is too
great, in which case you should consider option 2.
(Even though about half of the candidates were able to compute a reasonable value for both retirement
options under one of the two scenarios (retirement at 59 or 60), most candidates did not provide clear
recommendations of which option the couple should select.)
Percent
Awarded
0.1%
competence.
20.7%
Reaching competence — The candidate prepares a reasonable quantitative or
qualitative analysis of the available retirement options.
32.6%
Competent — The candidate prepares a reasonable quantitative and qualitative
analysis of the available retirement options.
46.5%
Highly competent — The candidate prepares a reasonable quantitative and
qualitative analysis of the retirement option John should choose. The candidate
recognizes that without some other form of cash flow, the lack of pension funds
upon John’s death, if he passes away young, is too great a risk to select option 1.
0.1%
(Candidates were directed to this indicator since they were told that the clients needed retirement
planning advice. They were also provided with excerpts from John’s annual pension statement, which outlined the two retirement options available to him, and were asked to provide John with a report
addressing which retirement option would be best for him.)
294
(Only about half of the candidates were able to compute a reasonable net present value for the defined
benefit pension option, compare it to the lump-sum amount presented in the second option, and discuss
some of the qualitative factors. However, candidates seemed to struggle to provide a reasonable
quantitative analysis. Some did not take into consideration the time value of money, which was critical.
Many candidates made other quantitative errors, such as not taking into account the bridge benefit for
CPP/OAS. Some candidates also provided only limited qualitative discussions. While the quantitative
analysis suggested that the lump-sum payment option was the better option, several other factors
should have been considered, such as John’s lifespan and his risk tolerance level, before a decision
was made.)
The candidate analyzes the prior-year tax returns of John and Sheila Brown and evaluates any
errors and omissions.
The candidate is demonstrating competence in Taxation.
Competencies
IX-2.1 – Calculates income taxes payable for an individual in routine situations (A)
IX-3.1 – Identifies, analyzes, and advises on specific tax-planning opportunities for individuals (B)
You mentioned that you feel you are always paying personal taxes and you don’t know why. We
reviewed your 2012 personal income tax returns, and it appears there are a number of errors and
omissions on your returns. We have corrected the errors and omissions we noted, recalculated your
personal income taxes for 2012, and revised your taxes as a result.
Registered Retirement Savings Plan
Line 208 of Sheila’s return is currently blank; however, her notice of assessment for 2012 shows that she
has $500 in unused RRSP carry-forwards. This means she has made RRSP contributions in the past but
has not claimed some of these deductions for tax purposes. Because RRSP contributions directly reduce
taxable income, it is best to deduct them in years of high income. Since Sheila retired partway through
2012, her 2013 income will likely be lower than her 2012 income. If her future income will be
consistently lower than in 2012, we recommend claiming the RRSP deduction in 2012 or filing a T1
adjustment to claim it in a previous year, when her income was higher, if possible. Note that due to future
pension splitting (see discussion under “Pension Splitting and Pension Credit”), it could be possible that her future income will be higher than in the past. In that case, it would be best to keep that deduction for
the future. Until we are able to estimate whether it would be more beneficial to claim it in future years, we
will plan on claiming the RRSP deduction in 2012.
Although this does not affect the 2012 tax year, John should consider contributing to a spousal RRSP for
2013. This would allow John to get a deduction from his 2013 income, but Sheila will be the one taxed on
the income once the contributions are taken out. This would be beneficial because Sheila’s income will be lower than John’s after retirement.
295
(Less than half of the candidates recognized that there was an issue with the undeducted RRSP
contributions. Many candidates who did identify this issue were confused as to the nature of the
amount and incorrectly treated it as additional RRSP room.)
Losses in Other Years
Line 253 on John’s return is currently blank; however, we noted that his notice of assessment for 2012
refers to unused net capital losses from other years of $5,500. These available net capital losses can be
used to offset capital gains that John may report as a result of selling investments or real property, for
instance. John has reported taxable capital gains on line 127 of $4,500, so he would be able to use up to
$4,500 of the available losses carried forward from prior years to offset the income otherwise taxable as a
result of reporting the capital gains. There is an option to carry losses back three years from when they are
incurred, which he could do with the remaining $1,000 of losses. We should look into this and see if John
had any net capital gains in the past against which these carried-forward losses could be applied.
(Most candidates recognized this omission from John’s income tax return and recommended that the unused net capital losses be applied against the 2012 taxable capital gain. However, some candidates
considered only 50% of the amount of the net capital loss, not recognizing that the net capital loss had
already been subject to the 50% factor.)
Pension Splitting and Pension Credit
Line 210 of Sheila’s return and the corresponding line 116 on John’s return are both currently blank. It appears you have not considered that pension income is eligible to be split between spouses. There are
conditions that must be met for pension splitting to apply. First, we must determine if Sheila is eligible to
claim the pension income tax credit, line 314. In order to find out whether this tax credit may be claimed,
we must look at the age of the pensioner. In Sheila’s case, she is currently under 65 and receiving pension
income. For her to qualify, we must ensure her pension income is from life annuity payments from either
a superannuation or pension benefits. Since Sheila’s income is from her pension plan with her past employer, we have assumed it would qualify for the pension income tax credit.
Next, we must determine if you both meet the conditions for Sheila to be able to transfer up to 50% of her
pension income received during the year (for 2012 she received $7,000, resulting in a maximum possible
transfer of $3,500). The conditions necessary to split pension between the two of you are as follows:
The pensioner and spouse or common-law partner were not, because of a breakdown in marriage or
common-law partnership, living separate and apart from each other at the end of the year and for a
period of 90 days commencing in the year (if living apart at the end of the year for medical,
educational, or business reasons, pension income can still be split);
the pensioner and spouse or common-law partner are residents of Canada on December 31 of the
year; and
The pensioner received pension income that is eligible for the pension income tax credit.
It appears that you meet the three requirements since you were in a spousal relationship on December 31,
2012, and living together in Canada.
296
Therefore, we have to consider how much pension income of Sheila’s, up to the maximum, would be beneficial to transfer to John. Since John’s income is higher than Sheila’s, it will not be beneficial to move more pension income from Sheila to John than would be used by John claiming the pension income
tax credit of $2,000, since additional income over $2,000 would be taxable for John at a higher rate than it
would be for Sheila. Therefore, we suggest transferring $2,000 of pension income from Sheila to John.
This would require you both to complete and sign form T1032, “Joint Election to Split Pension Income.”
Note that if any taxes were withheld on Sheila’s pension, the portion related to the $2,000 of pension transferred to John should also be transferred to him. For the purpose of this calculation, we did not take
these taxes into consideration as we do not know whether taxes were withheld and if so, how much, but
we should ask if any taxes were withheld and incorporate these into our calculations.
In subsequent years, because John’s income (including his pension income) might be higher than Sheila’s, you should consider filing an election to transfer an amount of John’s pension to Sheila so that you balance your taxable income and as a result reduce your family’s overall income tax liability.
(Most candidates considered the planning around income splitting; however, many did not recognize
that splitting Sheila’s pension income in 2012 should be limited to $2,000 so that John could use his pension income credit, and that any excess election would generate more income tax for the family
because John’s income was higher than Sheila’s. Some candidates identified that electing to split John’s pension in the future would reduce the family’s overall tax liability. Only a few candidates
identified that Sheila had earned eligible pension but had not claimed her pension credit.)
Child Tax Credit
Line 367 of John’s return includes a non-refundable credit of $4,382. This tax credit is available to either
parent for all children under 18 years of age at the end of the calendar year. Since you mentioned that
your two children, Jane and Harry, are both over the age of 18, this credit is not available for either of you
to claim.
(Most candidates did not identify this error in John’s income tax return.)
Canada Employment Amount
There is a non-refundable tax credit available for the first $1,095 of employment income earned. The
credit is calculated as the lower of 1) the base amount of $1,095, and 2) total employment income
reported on lines 101 and 104. We note that both of you reported employment income on your 2012
personal income tax returns (John reported $64,415 and Sheila reported $18,000). You are both eligible to
claim the tax credit. For 2012, the maximum credit was $1,095.
(Only about a quarter of candidates were able to identify and discuss this omission in John and
Sheila’s income tax returns.)
297
Disability Tax Credit
Line 316 of both your returns is currently blank; however, you mentioned that Sheila suffers from
multiple sclerosis and has been approved as per her 2012 notice of assessment from the Canada Revenue
Agency for the disability tax credit. This tax credit is, therefore, available to Sheila and should be reported
on line 316. This tax credit is calculated by multiplying a prescribed fixed amount (in 2012 the amount is
$7,546) by the lowest prescribed federal tax rate (15% in 2012). This equates to a federal tax savings of
$1,132. You may transfer any portion of your tax credit that you cannot use to your spouse. We
determined that, after considering all the necessary changes, Sheila would not require all of her disability
tax credit and would need only $5,582 of it to bring her taxes payable down to nil. Therefore, we suggest
transferring the remaining amount of $1,964 ($7,546 − $5,582), indicated on line 318, to John to use against his federal taxes.
(Most candidates recognized this omission and offered adequate corrective measures. Many, however,
did not address the fact that Sheila might not need the full credit, and that as a result the unused
portion could be transferred to John.)
Charitable Donations
Line 349 of Sheila’s return includes a federal tax credit for donations and gifts of $28, which would translate into a donation of $187 ($28 ÷ 15%) since donations to qualified charities generate a federal tax
credit of 15% for the first $200 of charitable donations and a federal tax credit of 29% for amounts over
$200. As a result, if spouses combine their donations on one tax return, they can receive greater combined
tax savings. The allocation can be made to either spouse because the amount of the credit is not based on
income. In this case it would be more beneficial to allocate it to John since it is a non-refundable credit
and Sheila is using up all of her non-refundable tax credits in 2012.
Additionally, because charitable donations over $200 generate a larger federal tax credit, you should
assess whether it would be beneficial for you to pool your charitable donation tax credits for a few years
to maximize the savings by reporting charitable donations over $200. Donations may be used in any of
the five years following the date of donation, providing additional tax savings if you retain donations for a
period of years and report them together within the five-year period.
(Very few candidates discussed this issue.)
Dividend Tax Credit
Line 120 of John’s return reports taxable dividends of $1,120;; however, it appears you did not claim the required dividend tax credit, at line 425. This credit is available to offset the gross-up of dividends
reported on line 120 (assuming the amount included on line 120 was indeed grossed up). The dividend tax
credit is calculated as 15.0198% of the grossed-up amount, or $168 in this case. I have also made the
assumption that the dividend income John is reporting is a result of receiving eligible dividends; the
calculations would be different if he received ineligible dividends.
(Most candidates did not identify this omission. However, most candidates who did recognized that
there were two levels of taxation for the dividends: eligible and non-eligible dividends.)
298
Transfer of Tuition, Education, and Textbook Tax Credits
Line 324 of both of your returns is currently blank; however, I noted that both of your children, Jane and
Harry, are currently attending university. Both children would be eligible to deduct a portion of their
tuition on their personal income tax returns, and there is also a tax credit available for their education and
textbook amounts. If either or both of your children are not able to use all of their available tuition,
textbook, and education credits on their income tax returns, they can transfer the unused amounts, up to
$5,000, to either of you. This transfer could save you 15% of the amount transferred, up to a maximum
transfer of $5,000 per child, which represents savings of about $750 ($5,000 × 15%) per child.
(Most candidates addressed this issue and provided reasonable recommendations of the amounts that
could be claimed by the children or transferred to the parents as tuition tax credits.)
Medical Expenses
Line 332 of both of your returns is currently blank, either because you did not have any medical expenses
during the year or you were not aware that medical expenses could be deducted. You have mentioned that
Sheila suffers from multiple sclerosis, leading me to wonder whether she had medical expenses during the
year. Allowable expenses include out-of-pocket prescription drug costs, travel for medical appointments
in excess of 40 kilometres each way, dental services, hospital services, and a number of other services as
specified by the Canada Revenue Agency. Additionally, if you have medical insurance, the out-of-pocket
costs (amounts not covered by the insurance company) may also be eligible medical expenses. I do not
have enough information at this time to assess the impact on your taxes of any allowable medical
expenses you may have; however, I suggest you review your situation to determine whether you have
medical expenditures you can deduct.
In addition to your own medical expenses, you can also claim the medical expenses of your spouse.
Medical expenses are first reduced by the lesser of 3% of a taxpayer’s income or $2,109. Therefore, it is
usually more beneficial to report medical expenses on the lower-income earner to minimize the 3%
reduction. In this case, Sheila would benefit more from the medical deduction. However, the
consideration should be weighed in relation to other tax factors; for instance, whether the lower-income
earner owes any federal taxes. Note that there is also an opportunity to claim medical expenses for your
kids while they are university students.
(About half of the candidates at least questioned the fact that no medical expense credit had been
claimed on Sheila’s income tax return. However, many candidates who addressed this issue were not
able to provide sufficient information to the Browns; for example, information relating to the expenses
in excess of 3% of net income.)
RE-CALCULATED 2012 PERSONAL INCOME TAX RETURNS
JOHN & SHEILA BROWN
John
Sheila
Employment
101
64,415
18,000
Other pensions
115
0
7,000
Split-pension amount
116
2,000
0
Taxable dividends
120
1,120
0
Taxable capital gains
127
4,500
0
150
72,035
25,000
RPP (Registered Pension Plan)
207
4,442
1,800
RRSP
208
1,000
500
Split-pension deduction
210
0
2,000
236
66,593
20,700
Total income
Net income
Losses of other years
253
4,500
0
260
62,093
20,700
300
10,822
10,822
Amount for children
367
0
0
CPP
308
2,306
891
EI
312
840
311
363
1,095
1,095
Pension income amount
314
2,000
2,000
Disability amount
316
0
5,582
Transfers – Disability
318
1,964
0
Transfers – Education
324
???
???
Medical expenses
332
???
???
335
19,027
20,701
Credits at 15%
338
2,854
3,105
Donations and gifts
349
28
0
350
2,882
3,105
Federal tax
404
10,671
3,105
350
2,882
3,105
Dividend tax credit
425
168
0
406
7,621
0
437
8,414
(793)
1,101
(1,101)
Taxable income
Subtotal
Net federal tax
Income tax deducted
Balance owing (refund)
Note: Provincial taxes not considered
TOTAL TAXES FOR JOHN AND SHEILA
(1,894)
299
300
After noting a number of errors and omissions in your filed 2012 income tax returns, we made the
necessary adjustments to your taxes and re-calculated your revised income taxes. Your original filed
returns resulted in a combined tax payable balance of $602. After processing our adjustments, your
revised tax balance would be a refund of $1,894, resulting in overall savings to you of $2,496.
We would like to make you aware, however, that your personal tax returns are already filed for 2012. You
will need to file adjustments to your returns to correct the errors and add the additional deductions we
noted.
Additionally, we noted that Sheila’s notice of assessment confirmed she is eligible for the disability tax credit for the years 2009 to 2017. You should at least file a T1 adjustment request for your personal tax
returns of 2009 to 2011, since claiming the disability tax credit for past years will result in additional
taxes refundable to you.
Considering some of the omissions identified, we also recommend that we review your income tax returns
for the years prior to 2012 so that we can ensure you have maximized your personal non-refundable tax
credits.
(Less than half of the candidates attempted a recalculation of John and Sheila’s income tax liability, adjusting for the errors and omissions they had identified. Most candidates only recommended that
John and Sheila amend their prior-year returns, but usually as a result of the disability tax credit
notification from CRA, not recognizing that other issues should also trigger the review of prior years’ income tax returns.)
For Primary Indicator #2 (Taxation), the candidate must be ranked in one of the
Percent
Awarded
0.2%
competence.
11.5%
Reaching competence — The candidate identifies some of the errors and
omissions on the 2012 personal income tax returns of John and Sheila.
43.2%
Competent — The candidate discusses some of the errors and omissions on the
2012 personal income tax returns of John and Sheila.
45.0%
Highly competent — The candidate discusses most of the errors and omissions
on the 2012 personal income tax returns of John and Sheila Brown, calculates the
revised federal taxes as a result of their adjustments, recognizes that Sheila may
not need all her non-refundable tax credits as a result of her level of income, and
transfers the remaining balance to John.
0.1%
301
(Candidates were not specifically directed to this indicator but were told by their clients (the Browns)
that they “are always paying taxes and don’t know why.” They were also provided with a summary of the clients’ personal tax return information for 2012. Candidates were expected to analyze the prioryear returns and provide the Browns with recommendations on how to reduce their personal tax
liability.)
(Most candidates were able to identify areas of John’s and Sheila’s personal tax returns where either their filing position could be improved or errors had been made. Many candidates also attempted to
recalculate their taxable income and tax liability for 2012. Weak candidates identified the issues but
were not able to provide in-depth discussions or could not apply the tax rules appropriately, providing
misleading information to their clients. Most weak candidates also did not recalculate the taxes owed.)
The candidate considers whether John and Sheila’s retirement plans are realistic and whether it makes sense for John to retire now.
You noted in our meeting that there are a number of projects you intend to pursue once retired.
Although it is important to have financial goals, it is necessary to assess whether these goals are realistic
based on your level of available cash flow and savings. You have not currently provided me with details
of your investment savings, such as funds you have available in your RRSPs, TFSAs, and unregistered
savings accounts, for example, but you mentioned that you don’t have a lot of savings put away. Based on your level of income, it seems unreasonable to believe that you will be able to do all of the things you
want to do when John retires (for example, purchase a high-end convertible, go on a cruise, give money to
the kids, et cetera). It is important to recognize that during retirement you will be living on a fixed level of
income, and regardless of the retirement option chosen, whether annual fixed payments or a lump sum,
you need to budget accordingly and live within your means.
302
You mentioned that with your current after-tax income, you are able to cover all of your annual living
expenditures. Before retiring, John’s pre-tax income was $70,035. After John retires, should he choose
option 1, it will be $44,728 ($34,398 + $10,330) for the first six years and $47,198 ($34,398 + $6,500 +
$6,300) for the following years. Before Sheila retired, her pre-tax income was around $36,000 ($18,000 ×
12 ÷ 6). I don’t have the details of her pension payments, but from her 2012 tax return it looks like her pension will be around $14,000 per year ($7,000 × 12 ÷ 6). Your combined income before retirement
was, therefore, approximately $106,000 ($70,000 + $36,000). Once you are both retired, it will be
$58,728 ($44,728 + $14,000) for the first six years and $61,198 ($47,198 + $14,000) for the following
years, plus any CPP or Old Age Security that Sheila would be entitled to. This represents a decrease of
around $45,000 a year. Although your retirement income will be taxed at a lower rate, this is still a
significant decrease in your income after retirement. As a result, it is unlikely that you will be able to do
all of the things you have said you would like to do during your retirement.
I recommend you have a full retirement budget prepared that would take into account your sources of
non-pension retirement income to assess what plans you will be able to achieve. You should prioritize the
items on your wish list to determine which goals are most important, and you should also consider where
you are willing to compromise.
You mentioned that John would like to retire this year due to Sheila’s health consideration and other factors. However, in five days John will be 59 years old. If John retires immediately, as per the retirement
policy of his company his retirement date would be January 1, 2014. At that point he will still be 59, and
will therefore be penalized for retiring before age 60 (see the analysis of pension options).
With either option, he would be penalized 20% of his pension. This is a significant amount. In option 1,
this results in a difference of $8,599 per year, while in option 2 it’s an immediate reduction of your lump sum by $196,820.
This early retirement penalty could be eliminated if John deferred his retirement until January 1, 2015,
when he will be 60 years of age. The result would be a significant increase to his available pension. This
additional amount may even be enough to provide you with a cushion to achieve some of the things you
wish to do in the coming years that may otherwise not have been financially possible at your income
levels.
303
Percent
Awarded
7.0%
competence.
14.5%
Reaching competence — The candidate recognizes that the clients’ financial goals after retirement may be unrealistic or suggests that deferring John’s retirement until January 1, 2015, would result in the elimination of the early
retirement pension penalty.
42.7%
Competent — The candidate recognizes that the clients’ financial goals after retirement may be unrealistic and suggests that deferring John’s retirement until January 1, 2015, would result in the elimination of the early retirement pension
penalty.
35.7%
Highly competent — The candidate recognizes that the clients’ financial goals after retirement may be unrealistic, suggests that deferring John’s retirement until January 1, 2015, would result in the elimination of the early retirement pension
penalty, and recommends that they prepare a budget for their future plans.
0.1%
(Candidates were expected to warn the Browns that they would not be able to fulfill the retirement
objectives they had expressed. They were also expected to advise John to postpone his retirement by
one year to avoid the significant penalty that applied for retiring early (a 20% reduction).)
(Candidates performed poorly on this indicator. Most candidates addressed only one of these two issues
in appropriate depth, either recognizing that John should wait a year before retiring or recognizing
that Sheila and John’s goals might be unrealistic. Strong candidates were able to recognize and
discuss both issues. They indicated clearly to the Browns that they could not fulfill their goals, let alone
maintain their current living costs, as well as strongly recommended that John wait until age 60 to
retire to avoid the 20% penalty. Most weak candidates only identified the issues; for example, they
simply recognized that there was a penalty for retiring early (without emphasizing the significance of
that 20% penalty for the Browns) or that their goals were unrealistic.)
(Overall, the Board was satisfied with the quality of the responses on this simulation. Most candidates
addressed each of the indicators, and generally with reasonable depth of analysis. Where candidates
struggled the most was on the Pervasive Qualities and Skills indicator. While candidates were generally
able to identify the issues, their discussions were lacking. Candidates tended to perform better on the
Taxation indicator, addressing most of the relevant issues.)
304
SAMPLE RESPONSE
PAPER III-3 THE BROWNS
To: John and Sheila Brown
From: CA
Re: Retirement Planning and Tax Matters
Retirement Planning
Analysis of Options
In Exhibit I, I have performed an analysis of the two options. I have determined that Option 2 has a higher
present value if you choose to retire now or retire at age 60. Therefore, I recommend that you take Option
2. I have performed my analysis by comparing the present value of the options at the point of retirement,
which I have determined to either be age 60 or now at age 55.
As Option 2 provides the highest present value, I recommend that you pursue this option. However, it is
important that you invest the lump sum earnings and only make withdrawals on an as needed basis so you
can generate investment earnings which will grow your investment as time passes.
Retirement Needs
You have indicated that you are currently able to cover your annual living expenditures on the after-tax
income you earn. Therefore, I have estimated your annual living expenses going forward based on your
net income less your income taxes since this is the amount of cash you had available to pay for your
living expenses. In Exhibit II, I have taken the present value of your annual living expenses as if you
retired now or when John turns 60. I have determined the following:
If your retirement is for a period of 30 years, the present value of your living expenses is
approximately $1,522,000.
If your retirement is for a period of 32 years, the present value of your living expenses is
approximately $1,584,000.
Therefore, I have calculated the shortfall, which is the difference between the present value of your
retirement income sources and the present value of your future annual living expenses. I have determined
the following:
If you retire now, the shortfall is approximately $574,000.
If you retire when John turns 60, the shortfall is approximately $316,000.
However, the following factors need to be taken into consideration:
The above calculation does not consider the costs of giving money to your children to pay for tuition,
purchasing a vacation property in somewhere exotic, the purchase of a convertible, or booking the
five-month cruise.
305
Therefore, your actual retirement needs may be much greater if you plan to achieve all of these goals
in retirement, which would further increase the shortfall.
Therefore, I recommend that you postpone the purchase of the property, the cruise, and paying for
your children’s assistance since it appears that you do not have sufficient funds to finance both the
living costs of retirement and these other goals.
There is a possibility that Sheila's medical expenses will increase as a result of her medical condition.
I have not factored the increase in medical expenses into the calculation.
You have a number of alternatives available to you to cover the shortfall and assist in paying for the other
retirement goals discussed above, including:
Your children could consider obtaining student loans or part-time jobs in order to finance the tuition
or part of the tuition themselves.
You may have other assets that you are able to sell, such as your personal residence that could
provide further financing for your retirement goals.
I have not included the cash from your RRSPs which will increase your retirement income. This is
another source of financing for your retirement.
You may be able to reduce your annual living expenses by cutting discretionary spending which may
free up money to cover the shortfall and maybe assist with other retirement goals.
Conclusion
Therefore, from a financial perspective, it is beneficial to postpone retirement until age 60 in order to
reduce the shortfall. However, you and John may wish to retire now so that John is available to assist you
due to your health condition. Furthermore, you should reconsider some of the discretionary expenditures
such as the convertible, vacation property, and cruise in order to ensure that you have sufficient financing
for the living expenses for the duration of your retirement.
Tax Issues
Pension Income Splitting
You have not taken advantage of the ability to elect to split pension income. You are allowed to optimize
the split of eligible pension income by transferring it to your spouse. Sheila's pension income of $7,000
would be eligible for pension income splitting. However, as John is the higher income spouse, it would
not have been beneficial to split pension income since it would only increase the combined personal tax
expense.
Net-Capital Losses
John has unused net-capital losses from other years of $5,500 and had taxable capital gains of $4,500 in
2012. However, the net-capital losses were not applied against the taxable capital gains. The net capital
loss carryforward can be deducted against the $4,500 taxable capital gain and $1,000 of net capital loss
would carryforward. This would result in a personal tax savings of $990 ($4,500 x 22%). I recommend
that you amend your 2012 tax return and include this adjustment.
306
Tuition
You have indicated that both of your children are attending University. After reviewing your personal
income tax returns, I notice that no tuition credits have been transferred from your children. Your children
are able to transfer any unused tuition credits to a maximum of $5,000 each to you and Sheila. You
should determine if your children have any unused tax credits from 2012 and amend your return to
include a transfer of the tuition tax credits.
Medical Expenses
You have indicated that Sheila has been diagnosed with a medical condition in 2011. However, after
reviewing your 2012 personal income tax returns it appears that no medical expenses have been claimed.
If you have paid for any medical expenses that were not covered by a benefit plan, then these medical
expenses should be claimed on your personal tax return. The threshold is 3% of net income, therefore, any
medical expenses in excess of this amount should be claimed on your tax return and will be credited at
15%.
Amount for Children
John has claimed a non-refundable tax credit of $4,382 for the child amount. However, both of your
children are over the age of 18 during 2012. The amount for children is only for dependent children under
the age of 18. Therefore, this credit should not have been claimed. This will result in an increase in
personal taxes for John of $657. You should amend your return to make this change.
Results
I have presented a revised calculation of your taxes payable considering the adjustments above including
the reversal of the amount for children and the application of the net capital loss carryforward in Exhibit
III.
However, you should determine if you have any medical expenses to claim for 2012 and determine if
your children can transfer tuition credits as discussed above which will reduce taxes paid.
307
308
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%
TABLE I
309
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%
310
Evaluation Booklet Tables
TABLE II
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 50 .................................................... 55%
Class 52 .................................................... 100%
SELECTED PRESCRIBED AUTOMOBILE AMOUNTS FOR 2012
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
26¢ per kilometre of personal use
Non-taxable car allowance benefit limits
- first 5,000 kilometres
53¢ per kilometre
- balance
47¢ per kilometre
311
312
Evaluation Booklet Tables
TABLE IV
INDIVIDUAL FEDERAL INCOME TAX RATES
2012* Tax Rate
Taxable Income
$42,707 or less
$42,708 to $85,414
$85,415 to $132,406
$132,407 or more
15%
$6,406 + 22% on next $42,707
$15,802 + 26% on next $46,992
$28,020 + 29% on remainder
*
2013 rates increase by an indexing of 2%.
SELECTED NON-REFUNDABLE TAX CREDITS
PERMITTED TO INDIVIDUALS
FOR PURPOSES OF COMPUTING INCOME TAX
The 2012 tax credits are 15% of the following amounts:
Spouse or common-law partner amount
Net income threshold for spouse or common-law partner amount
Child
Age 65 or over in the year
Net income threshold for age credit
Disability amount
Amount for children under 18
Infirm dependants 18 and over
Net income threshold for infirm dependants 18 and over
Children’s fitness credit
Basic amount for:
GST credit
Child tax benefit
$10,822
10,822
NIL
2,191
6,720
33,884
up to $1,095
7,546
2,191
6,402
6,420
500
34,561
42,375
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
2013
2012
2011
2010
2009
1
1
1
1
2
1
1
1
1
1
1
1
1
1
1
Oct. 1 - Dec. 31
1
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.
The Canadian Institute of Chartered Accountants
277 Wellington Street West, Toronto ON M5V 3H2
Tel (416) 977-3222 Fax (416) 204-3423 www.cica.ca
For more information
The CA qualification process prepares future CAs to meet the challenges that await them.
For more information on the qualification process, the uniform evaluation, and your province’s
specific education requirements, contact your regional education director.
Regional Education Directors
Atlantic Canada and Bermuda:
Dan Trainor, FCA
Ontario:
Jacqui Mulligan, CPA, CA
Québec:
Diane Messier, FCPA, FCA
Western Canada
and the Territories:
Dr. Sheila Elworthy, CA
Atlantic School of Chartered Accountancy
Cogswell Tower, Suite 500
Scotia Square, P.O. Box 489
Halifax, Nova Scotia B3J 2R7
Tel:
(902) 425-7974
Fax:
(902) 423-9784
Web site: www.asca.ns.ca
E-mail:
theschool@asca.ns.ca
Vice-President, Qualification
Ordre des comptables
professionnels agréés du Québec
5, Place Ville Marie, bureau 800
Montréal, Québec H3B 2G2
Tel :
(514) 288-3256
1 800 363-4688
Fax :
(514) 843-8375
Web site : www.cpaquebec.ca
E-mail : dmessier@cpaquebec.ca
Chartered Professional
Accountants of Ontario
69 Bloor Street East
Toronto, Ontario M4W 1B3
Tel:
(416) 962-1841 ext. 296
Fax:
(416) 962-8900
Web site: www.cpaontario.ca
E-mail:
customerservice@cpaontario.ca
CA School of Business
500 – One Bentall Centre
505 Burrard Street
Vancouver, British Columbia V7X 1M4
Tel:
1 866 420-2350
Fax:
(604) 681-1523
Web site: www.casb.com
E-mail:
sheila.elworthy@casb.com
Provincial Institutes/Ordre
The Institute of Chartered
Accountants of Bermuda
Sofia House, 1st Floor
48 Church Street
Hamilton, Bermuda HM 12
(441) 292-7479
www.icab.bm
Accountants of Nova Scotia
5151 George Street, Suite 502
Halifax, Nova Scotia B3J 1M5
(902) 425-3291
www.icans.ns.ca
The New Brunswick Institute
of Chartered Accountants
55 Union Street, Suite 250
Mercantile Centre
Saint John, New Brunswick
(506) 634-1588
www.nbica.org
E2L 5B7
Accountants
of Prince Edward Island
97 Queen Street, Suite 600
Dominion Building
Charlottetown, PEI C1A 4A9
(902) 894-4290
www.icapei.com
Accountants of Newfoundland
and Labrador
95 Bonaventure Avenue, Suite 501
St. John’s, Newfoundland A1B 2X5
(709) 753-7566
www.icanl.ca
Ordre des comptables
professionnels agréés du Québec
Accountants of Saskatchewan
3621 Pasqua Street
Regina, Saskatchewan
(306) 359-1010
www.icas.sk.ca
S4S 6W8
Accountants of Alberta
5, Place Ville Marie, bureau 800
Montréal, Québec H3B 2G2
(514) 288-3256 1 800 363-4688
www.cpaquebec.ca
580 Manulife Place, 10180 – 101 Street
Edmonton, Alberta T5J 4R2
(780) 424-7391 1 800 232-9406
(for Alberta, outside Edmonton)
www.icaa.ab.ca
Chartered Professional
Accountants of Ontario
Accountants of British Columbia
69 Bloor Street East
Toronto, Ontario M4W 1B3
(416) 962-1841 1 800 387-0735
www.icao.on.ca
Accountants of Manitoba
1675 – One Lombard Place
Winnipeg, Manitoba R3B 0X3
(204) 942-8248 1 888 942-8248
www.icam.mb.ca
Suite 500, One Bentall Centre
505 Burrard Street, Box 22
Vancouver, British Columbia V7X 1M4
(604) 681-3264 1 800 663-2677
www.ica.bc.ca
If you are in the Yukon, please contact
the Institute of Chartered Accountants
of British Columbia.
If you are in the Northwest Territories
or Nunavut, please contact the Institute
of Chartered Accountants of Alberta.

2013 Uniform Evaluation Report

Transcription

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