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TRANSCRIPT
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Copyright 2010 ICAO School of Accountancy
As per the March 2010 Technical update
Accounting Standards: For the 2010 SOA, candidates will be provided direction as to whichGAAP context to apply for each simulation. E.g.:
- Public company that has already adopted IFRS- Public company that is about to adopt IFRS- Private company that applies current Canadian GAAP*- Private company that has chosen to apply IFRS as it plans to go public in near future
*Candidates have the option, where told that current Canadian GAAP applies, to apply the newAccounting Standards for Private Enterprise (ASPE) instead. Where applying ASPE GAAPinstead of current Canadian GAAP, candidates must indicate that they have made that choice.
Assurance Standards: The new Canadian Auditing Standards (CASs) only apply to audits of years ending on or after December 14, 2010. However, candidates have the option on the 2010
SOA of applying them in all applicable circumstances, even outside of the applicable dates, i.e.audit of historical financial statements or other historical financial info. Existing Canadianstandards must be applied to all other engagement types on the UFE. Candidates must indicatewhen they have chosen to apply CASs instead of current Canadian auditing standards.
What this means
ASPE or CASs are not examinable on the SOA therefore questions on the SOA will not
specifically ask you about ASPE or CASs. You can however answer using ASPE or CASs but
you must specifically state that you are doing so and you must do so for all accounting and/or
assurance issues in the question.
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Copyright 2010 ICAO School of Accountancy
2010 SOA - 1 EXAMINATIONS
WRITTEN INSTRUCTIONS FOR
CANDIDATES USING LAPTOP COMPUTERS
At the exam start-up
Turn on your computer and make sure the booting process is complete.
Make sure your clock is set to the correct date and time.
Run Securexam.
Select the Language you wish to use and click “Ok”.
Select “Login and take an exam”.
Type in your user name (email address) and click “Ok”.
Run the USB Drive Backup Wizard. (A USB key is not required for SOA-1, however it is
recommended to help identify any potential problems with your USB port which may arise in
future exams.)
Once you get a “Passed” response, click “Continue to Exam”.
In the “Select Exam” box, tick the available box:
“SOA-1”. Click “Ok”.
Enter your 4-digit candidate number. Click “Ok”.
Type in the password “sums”.
Type in the word “start” and begin the exam. You have 4 hours to complete the exam from
this time.
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Copyright 2010 ICAO School of Accountancy
AT THE END OF THE EXAM (AFTER 4 HOURS):
BEFORE EXITING SECUREXAM
Go to the spreadsheet tab and select the “Show Printable Area” box. (When the “Show
Printable Area” box is selected, all the menu items and buttons are disabled.)
Review your spreadsheet visually and make sure that all text typed appears in the printable
area. If not, deselect the “Show Printable Area” box and manually reformat the cells.
EXITING SECUREXAM
To exit Securexam, make sure that the “Show Printable Area” box in the spreadsheet is
deselected.
Select “End Exam/Session” from the pull-down “File” menu.
Enter the exit password “adds”.
Click “Yes” to the question “Are you finished with this exam?”
Click “Ok” to the question “Confirm that you wish to end this exam.”
The program must complete its shutdown sequence.
Once the program has shut down, right click on “Start” at the bottom of your scr een andselect “Explore”.
Confirm that you can see the “Removable Disk E” (or it may be a different letter) and that
you see one file with today‟s date ending with “.ssi-response” and one folder labelled
“ExamIP”.
Check that the “.ssi-response” file on the USB key is not at zero bytes.
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Copyright 2010 ICAO School of Accountancy
UPLOADING EXAM
You are required to upload your SOA-1 exam files to the Software Secure upload site byMidnight on May 23, 2010. Note: Technical help is not available on weekends.
Any exams uploaded after May 23, 2010 will not be marked.
Upload instructions
1. Verify that you are connected to the internet.
2. Locate the .ssi-response file named Ontario_ICAO2010_1234_date_xxxxssi.response”
where instead of 1234 it has your candidate number. ( this file should be on your desktop
or on your usb key or both)
3. Go to the Securexam Exam registration site at http://cica.softwaresecure.com and log in
to your existing account. If necessary, you may use a different computer but you will
need to copy the .ssi-response file to that computer‟s Desktop beforehand.
4. Click the “Upload Exam” from the left hand column to upload the file.
5. Use the Browse button to select the file from your desktop. (ensure the date of the file is
the date you wrote the exam)
6. Click on upload.
7. After the upload has been completed, you will be taken back to your Account Home page
where you can verify that the uploaded file appears under your “Upload History”. If you
do not see this item, restart your computer and repeat the previous steps.
8. You will receive an email notification from Software Secure that your file has been
received. If you do not receive a notification within 1 hour, contact Securexam at 1-866-
401-7758.
Please note this number will not be monitored on weekends!
9. The copy of your response sent to ICAO contains only your candidate number as a
reference. All other personal information provided to Software Secure through the
uploading process or email will be kept confidential by them so please ensure your
candidate number is correct.
10. If you have any questions or need assistance, please refer back to the email regarding
Securexam help or the user guides
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Copyright 2010 ICAO School of Accountancy
2010 ICAO SCHOOL OF ACCOUNTANCY
SOA-1 EXAMINATION
Instructions to Students
1. This examination is 4 hours in length and consists of 3 questions. There are 23 pagesincluding this one.
2. To assist in budgeting time during the examination, a suggested number of minutes for eachquestion is shown at the beginning of the question. The marks available for each questionwill be based on the relative amount of time suggested.
3. Tables of present values and selected tax information have also been included in thispackage. These tables may be used in answering any question on the examination.
4. You are not permitted to use the printed version of the CICA Handbooks nor the CCH‟sIncome Tax Act with Regulations nor Carswell‟s Practitioner‟s Income Tax Act. You arerequired to use a laptop computer to access these reference materials electronically using theapproved Securexam (CA) software. No other reference sources are allowed.
5. Answers or parts of answers to examination questions will not be marked if they are recordedon the question paper.
6. Rough notes will not be marked.
7. Questions answered in word or excel rather than Securexam (CA) will not be marked.
* * * * * * *
KEEP THIS EXAMINATION FOR DEBRIEFING PURPOSES.
EXTRA COPIES WILL NOT BE AVAILABLE.
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2 Copyright 2010 ICAO School of Accountancy
Question 1 (80 minutes)
The Home Company (THC) is a retailer of home maintenance products, including small tools andaccessories, home décor items and small appliances. Although THC‟s founders, the Madisonfamily, still hold the majority of the shares, 5% of the common shares were offered publicly in2007. Since that time, the publicly offered shares have been widely held.
THC has reported their financial statements for the year ended December 31, 2009 in accordancewith Canadian GAAP. However, consistent with CICA requirements, THC intends to adopt IFRSin fiscal 2011. THC has planned the transition carefully, and will be ready to apply IFRS asrequired to provide 2010 comparative results. THC‟s former auditors resigned during 2009, asthey did not have the adequate level of knowledge required to audit companies reporting usingIFRS.
On November 1, 2009, the Board of Directors of THC appointed Rashed & MacDougall LLP(R&M) as their financial statement auditors for the year ended December 31, 2009. You, CA, arethe senior on the THC engagement. This engagement also includes the review of THC‟s quarterly financial statements. In November, you completed the interim work and planning for the
upcoming audit engagement and at year-end you attended THC‟s inventory counts. Preliminarymateriality was set at $30,000.
Today is January 4, 2010. At a meeting with Sarah Brightman-Rashed, the audit engagementpartner, you received a draft of the Management Discussion & Analysis (MD&A) (Exhibit I) to beincluded in THC‟s annual report. Sarah informed you that she recently met with Brian Madison,the newly appointed CFO, to get an update on activities of THC since the interim field work. Notesfrom her meeting are included in Exhibit II. Sarah has asked you to review the MD&A and thesenotes to identify any financial accounting issues that have arisen since the interim work. For eachissue identified, she would like you to describe any measurement and presentation differencesbetween Canadian GAAP and IFRS. Further, Sarah requested that you discuss any additional
year-end audit procedures that should be added to the audit programs based on the new issuesidentified. Based on the new information provided, Sarah would also like you to update thedocumentation of R&M‟s understanding of THC and its environment in the audit file by preparinga SWOT (strengths, weaknesses, opportunities and threats) analysis of THC‟s five-year strategicplan.
As he is new to the role of CFO, Brian admitted to Sarah that he does not fully understand whatservices R&M will provide to THC in addition to the audit. To help Brian, Sarah has asked thatyou prepare a draft report to him clarifying R&M‟s obligations and the procedures involved inregards to the annual report and the first quarter review of THC‟s financial statements. Sarahwould like you to use the draft MD&A to provide a specific example of these procedures.
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3 Copyright 2010 ICAO School of Accountancy
EXHIBIT I
2009 MANAGEMENT DISCUSSION & ANALYSIS - EXCERPTS
Our Company
THC operates 45 retail stores in Ontario, 27 of which can be found in the Greater Toronto Area
and 18 stores located in Southwestern Ontario.
THC is primarily run as a family business that prides itself on training and promoting fromwithin. Many of the senior management team members have been working with THC since itopened its doors twenty-three years ago. As a result, our senior management team is extremelyfamiliar with the business of home maintenance products. In 2009, the THC family proudlywelcomed Brian Madison to the senior management team in the role of Chief Financial Officer.
Consumer Preferences
In 2009, THC conducted a survey of our customers. The results of the survey include thefollowing:
75% of customers surveyed select stores for convenience of location
65% of customers surveyed prefer “mega-store” layouts that offer a variety of retailproducts in one place (i.e., clothing, houseware, etc.)
55% of customers trust the THC brand and describe themselves to be more likely to buy aproduct endorsed by THC staff
78% of customers describe themselves as loyal to THC
2009 Financial Performance
Over the past three years, the retail sector has operated in a challenging economic environment,
with economic conditions not expected to improve significantly until at least 2012. Areas of thecountry most affected by the economic climate are Southwestern Ontario, Northern Alberta andNewfoundland. Despite the poor economic conditions in the market place, THC is pleased toreport that it has performed extremely well in 2009. We are thrilled to report that we haveearned more revenue this year than in each of the past three years of operations!
THC Superstore
As a pilot project, THC opened a Superstore in Mississauga, Ontario, a city just west of Torontoin late 2009. The store is roughly three times the size of the traditional THC stores and featuresmany more products and services. The Superstore is housed in our newest acquisition – a large
retail building located just south of the 401 highway.
In December 2009, THC completed negotiations to purchase a plot of land in the east end of Toronto which is ideal for the next THC Superstore. The closing date for this purchase isJanuary 25, 2010.
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4 Copyright 2010 ICAO School of Accountancy
EXHIBIT I (continued)
2009 MANAGEMENT DISCUSSION & ANALYSIS – EXCERPTS
Future Growth Initiatives
THC‟s five-year strategic plan is focused on expansion of the THC retail business.
Growth initiatives include the following:
Ongoing store expansions and upgrades
Diversify existing retail business
Continued introduction of the “THC Superstore” into the retail marketplace
Attracting new customers, while maintaining existing ones
In 2010, in addition to the traditional THC products, management has decided to introduce asmall grocery section into select locations. The grocery section would include a commercial-size
freezer to house frozen food such as prepared meals and a commercial-size fridge to houseperishable goods such as milk, eggs, and fruit.
The forecasted profitability of the new grocery section is as follows (in „000‟s):
2010 2011 2012
Grocery sales $1,050 $1,155 $1,271
Operating income 50 55 61
Net income 31 33 37
Summary of Operating Results
The operating results for the past three years are as follows (in „000‟s):
2009 2008 2007
Revenue from operations $5,669 $5,556 $5,679
Operating costs 4,985 4,935 4,992
Operating income 684 621 687
Net income 598 576 599
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5 Copyright 2010 ICAO School of Accountancy
EXHIBIT II
NOTES FROM MEETING WITH BRIAN MADISON, CFO
THC Stores
When the THC Superstore opened, THC closed their three existing retail stores in Mississauga.
THC continues to own the buildings where the stores were located and has leased all threepremises to a local grocery chain for a period of two years. The grocery chain pays quarterlylease payments of $15,000 to THC for each building. THC spends an average of $550 per monthto maintain each building and pays monthly property taxes of $2,250 for the buildings combined.Next summer, THC plans to upgrade all three properties in preparation for sale. THC willresurface the parking lots at an expected total cost of $125,100; replace the storefront windows atan expected total cost of $96,325; and resurface the roofs at an expected total cost of $83,670.
At the end of the lease contract, THC intends to sell the buildings for $1,250,000 each. AtJanuary 2010, the fair market value of the three buildings together was estimated to be$3,300,000. The buildings are currently included in the noncurrent assets section of THC‟s
balance sheet at book value of $3,859,000.
Vacant Land
As part of their growth initiative, THC plans on opening a retail store in Barrhaven. In January2009, at a cost of $275,000, THC acquired a large parcel of land in Barrhaven adjacent to wherea highway exit was scheduled to be built. In June 2009, THC incurred costs of $31,000 inarchitectural fees for store design plans. In December 2009, the government abandoned plans tobuild the highway exit and THC decided that the location was no longer optimal for theirBarrhaven store.
Brian believes that THC obtained a fantastic price on the purchase and intends to have the landre-zoned as residential and sold to a developer at a significant profit within the next two to threeyears. THC has commenced the lengthy re-zoning application and by December 31, 2009 hadincurred $18,000 in legal costs. Interest expense for the mortgage on the land was $12,000 in2009. Similar residential parcels of land in the area have sold for upwards of $500,000 andproperty values are expected to increase in the next few years.
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6 Copyright 2010 ICAO School of Accountancy
EXHIBIT II (continued)
NOTES FROM MEETING WITH BRIAN MADISON, CFO
New Supplier of Inventory
In December 2009, THC began purchasing some small kitchen appliances from a new supplier.During the month, THC purchased three different appliance lines. The unit costs for the threedifferent products were:
ProductNumber
Total UnitsPurchased
UnitCost inCdn. $
26-5 25,000 $10.00
26-8 30,000 $12.50
26-9 20,000 $9.75
Once the inventory was received from the supplier, THC booked the entire cost of the purchase($820,000) to the inventory account. All three products are to be sold at a markup of 20% of theabove unit cost.
For all orders placed in December, THC received a volume discount of 5% off the unit cost. Thediscount was not recognized by THC at the time of purchase. At year-end, THC had not soldany of the new inventories and all products were included in the year-end inventory countattended by R&M audit staff.
THC incurred a number of additional costs associated with this inventory purchase, which were
expensed in December. These costs include:
- $65,000 per appliance line for transport from shipping docks to a Markham warehouse- $46,000 for temporary warehouse storage costs (in total)- $5,000 per appliance line for transport to retail stores in Ontario- Import duties of 6% of the Canadian dollar unit cost- Other administrative costs of $24,000
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7 Copyright 2010 ICAO School of Accountancy
Question 2 (70 minutes)
Melissa Chong is a successful interior designer located in Toronto who has operated herbusiness, Design One, as a sole proprietor for the past four years. After a slow start in the firstyear where she incurred losses, Melissa received her first big break with a project for a highprofile real estate development in Yorkville, a trendy area in downtown Toronto. Since then, shehas completed many award-winning design projects which has resulted in the steady growth of
her business. Design One operates on a seasonal basis and as a result, Melissa enjoys the lesshectic times during the summer months.
You, CA, are a senior tax specialist for L‟Abbe and Associates (L‟Abbe), a local accountingfirm. L‟Abbe has prepared Melissa‟s personal tax returns since she started Design One. Theengagement partner, Andreas L‟Abbe, met with Melissa recently and excerpts from this meeting(which you also attended) are provided in Exhibit I. Several of Melissa's colleagues haverecently incorporated their businesses and have suggested that she do the same. Melissa isreceptive to this idea but thinks that the process is complicated, which is why today she hasapproached L‟Abbe for advice. She would like L‟Abbe to pr ovide her with a detailed analysis asto how such a process would occur from a tax perspective. Melissa has provided you with a
balance sheet of Design One (Exhibit II), along with the corresponding fair market valueinformation determined by a professional valuator.
Being unsure whether she should go through with incorporating her business or if she shouldremain as a sole proprietor, Melissa has requested that L‟Abbe provide her with an analysis of the two options from a tax perspective, including any necessary calculations to support itsconclusions. You have asked the junior staff accountant to compile some tax information(Exhibit III) to help with the analysis.
Her colleagues have also told her that she will need annual financial statements if she plans toseek bank financing for future business expansion. It is now May 17, 2010. Andreas has
requested that you prepare a memo to him as a basis for discussion at his next meeting withMelissa. This memo should address the tax issues raised by her as well as the treatment of theaccounting issues under current Canadian GAAP in Exhibit I that could arise if she decides toincorporate Design One.
(For ease in performing any necessary calculations, use the relevant rates provided in Exhibit II.)
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EXHIBIT I
EXCERPTS FROM PARTNER’S MEETING WITH MELISSA CHONG
Melissa began; “I look forward to hearing your response to my tax queries because I would like
to pay as little tax as possible. Please keep this in mind with regards to any personal andcorporate tax planning suggestions that you provide to me.
“For the past two years, I have earned about $225,000 per year from Design One after deductingall business-related expenses. I think I could expand my business to the point of doubling thatamount in a few years. However, given that my husband and I are looking to start a family bythen, I don‟t think I could expand the business any further beyond that point. His income isnegligible at this point as he is in the first year of a part-time four year degree program atuniversity.
“Also, I just started receiving an annual annuity of $130,000 from a trust fund set up by my
grandfather. I am not sure if we will need all of my business income to live on each year. Iwould, however, like the flexibility of being able to pay myself a bit of extra remuneration at theend of the year should I require it.
“Although I am primarily interested in your numerical analysis of the incorporation decision, feelfree to provide me with any other relevant points that I should consider.
“As you know, when I began Design One four years ago, I borrowed $50,000 from the bank tocover my start-up costs. Since it is a line of credit, I have not paid back any of the loan yet but Ihave been paying the interest at the rate of 4% per annum.
New design projects
“Because I have a university degree in commerce, I have been doing the bookkeeping for DesignOne. I have recorded the transactions for the past four years on a cash basis, which you havealways adjusted as required for tax purposes. As you know, all of my previous design projectswere always completed within the year and never spanned any year-ends. However, I now haveseveral new projects that span two or even three years! Because these projects are so long, I dorequire an upfront deposit payment of 20% of the contract price and for some clients, I will haveto bill and collect funds from them on an interim basis. In the past, I have not been the best atmonitoring the progress of my projects because they were quite short so I know I will need toimprove in that area. One strength of my design projects is that I plan them out to have very
definitive stages.”
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9 Copyright 2010 ICAO School of Accountancy
EXHIBIT I (continued)
EXCERPTS FROM THE PARTNER’S MEETING WITH MELISSA CHONG
Leasing new system
“I think I will eventually need a new computer system to deal with the increasing complexity of my projects. This new system will also help me to monitor the level of completion for eachproject. One system that I have been considering would cost $60,000 to purchase outright whichis too expensive but I could enter into a five-year lease with an option to purchase at fair marketvalue at the end. The system is very specialized so it is not prone to early obsolescence and hasan estimated useful life of ten years. Lease payments would be $11,800 (inclusive of all costs)and would be made at the beginning of each year.
Lawsuit
“Unfortunately, one of my projects this year did not go well and although I agreed to waive my
design fees and refund the deposit to the client, they are still going to take me to court for$20,000 in estimated damages. My lawyer is very sure that there is no basis for the client tosucceed in court but I am still concerned about the matter.
Atrium design
“At the beginning of the year, I did some design work for the atrium of a high profile advertisingagency. My design rates vary and so I would have charged them anywhere from $10,000 to$15,000 for my services. However, they were having some cash flow problems due to the sloweconomy and proposed that we exchange services – my design work for half a year of variousprint and media advertising exposure for Design One. They are a well-known agency so I
jumped at the opportunity! The increased exposure has really helped my business grow this pastyear. For my information, they provided me with a detailed invoice of the services rendered anda bill that would have otherwise been $17,000. I did not bother recording this transaction sincethere was no cash involved.”
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10 Copyright 2010 ICAO School of Accountancy
EXHIBIT II
BALANCE SHEET
Design One
As at April 30, 2010
(unaudited)
Assets Recorded amount Fair market value
Cash $ 27,000 $ 27,000
Accounts receivable (note 1) 33,000 28,000
Prepaid expense (note 2) 5,000 5,000
Land (note 3) 215,000 300,000
Building (notes 3 and 4) 150,000 220,000
Furniture and fixtures (note 5) 44,000 30,000
Goodwill 0 250,000
$474,000 $860,000
Liabilities
Accounts payable $ 26,000 $ 26,000
Bank loan 50,000 50,00076,000 $ 76,000
Equity 398,000
$474,000
Notes:
1. Includes an $8,000 allowance for doubtful accounts2. Prepaid expense represents the unexpired portion of the business insurance policy
3. The land and building are used exclusively for Melissa‟s business operations
4. The building was acquired at a cost of $150,000. UCC is $118,000.
5. The furniture and fixtures were acquired at a cost of $44,000. UCC is $36,000.
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11 Copyright 2010 ICAO School of Accountancy
EXHIBIT III
2010 TAX RATES GATHERED BY JUNIOR STAFF ACCOUNTANT
Federal - lowest marginal personal tax rate 15%
Federal - highest marginal personal tax rate 29%
Ontario - lowest marginal personal tax rate 5%
Ontario - highest marginal personal tax rate 17%
Combined (federal and Ontario) low corporate tax rate (note 1) 16.5%
Combined high corporate tax rate (note 1) 33%
Combined tax rate for eligible dividends 31%
Combined tax rate for non-eligible dividends 23%
Gross-up for eligible dividends 45%
Gross-up for non-eligible dividends 25%
Note:
1. Rates as of today (May 17, 2010).
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12 Copyright 2010 ICAO School of Accountancy
Question 3 (90 minutes)
Dr. Mateo Case is an optometrist and the sole shareholder of Quality Contacts Inc. (QCI), anoptical company that sells prescription disposable contact lenses and eye glasses out of itslocation in Cabbagetown, a neighbourhood in Toronto. QCI is managed by Mateo and has aMay 31 year end.
You, CA, are a manager with Lark & Bell LLP (L&B). Yesterday, you and Tony Bell, theengagement partner, met with Mateo at QCI. Mateo asked for this meeting to discuss the futureof QCI‟s operations. L&B has performed review engagements for QCI for the past three years.
Mateo began, “I have decided to live year round at my cottage in northern Ontario and havetherefore been considering two options regarding the future of QCI. I believe I could sell QCIand live off the proceeds or I could oversee the operations of QCI from my cottage, as a web-based company selling contact lenses only. I would like your help in determining the bestalternative for me.
“I will require an audit of QCI for 2010, as I believe a buyer would require audited statements. I
need your assistance in determining a reasonable selling price for the shares of QCI. I havebrought you a draft income statement for the 2010 year end. I believe the last three months of sales are the best indicator of future sales potential so I have included information for that periodas well (Exhibit I). I have also included some background information on QCI which may beuseful to you (Exhibit II).
“I have notes on how the web-based operations would work (Exhibit III) and would like to knowhow much cash I would be able to generate if I were to pursue this option. I am only concernedwith my cash flows for the next four years, until I am eligible to access my pension income in2014. I estimate I will need between $300,000 and $400,000 to cover my expenses until 2014.
“I met with a web consultant who provided me with information on a system that cou ld be usedif I were to operate QCI as a web-based company (Exhibit IV). I am concerned about thesecurity with this kind of operation and would like you to identify the significant risks that theweb-based company would be exposed to as well as any practical recommendations to mitigatethese risks.”
After the meeting you reviewed some of the accounting records and further discussed thebusiness with Mateo. A summary of some of the issues that you discovered while out at QCI arein Exhibit V. It is now June 4, 2010 and you are meeting with Tony to discuss the QCIengagement. Tony asks that you prepare a memo to him addressing the issues raised by Mateoin the meeting and asks that you discuss the accounting issues you discovered while at QCI and
identify the related audit procedures that should be performed. For now, he would like you toignore the personal income tax implications of the sale of QCI and any first time auditconsiderations.
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13 Copyright 2010 ICAO School of Accountancy
EXHIBIT I
QCI
EXCERPTS FROM FINANCIAL STATEMENTS*
FOR THE PERIODS ENDED
3 months to 12 months to 12 months toMay 31, 2010 May 31, 2010 May 31, 2009
(Draft) (Draft) (Reviewed)**
Revenues:Contact lenses $228,764 $805,306 $720,678Glasses and frames 63,892 356,970 365,094Other 10,200 38,000 35,100
302,856 1,200,276 1,120,872
Cost of goods sold 90,689 420,770 412,593
Gross profit 212,167 779,506 708,279
Operating expenses:Selling 21,479 99,660 97,720General and administration 98,236 455,055 446,024Depreciation 3,000 12,000 12,000Lease 9,000 36,000 36,000Interest 2,000 4,000
131,715 604,715 595,744
Income before taxes 80,452 174,791 112,535
Income taxes 13,275 28,841 18,568Net income $ 67,177 $ 145,950 $ 93,967
* Other than inventory, the balance sheet has no significant assets or liabilities.** The financial statements of QCI follow CICA HB- Accounting- Part V, XFI, without
differential reporting options.
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14 Copyright 2010 ICAO School of Accountancy
EXHIBIT II
BACKGROUND INFORMATION PROVIDED BY MATEO
QCI has a regular customer base which I anticipate will make it an attractive acquisition
for another business in the same industry.
I have been in communication with the owners of two other optical stores which operatein similar markets and learned that on average they made about a 10% after tax return ontheir investments.
I believe that any purchaser would have their existing staff place all orders. This wouldeliminate the salary currently being paid to QCI‟s order clerk of $60,000.
In recent years QCI has not invested much in advertising as its current customer baseconsists of mostly repeat customers. Other optical stores spend around $85,000 annually
to attract new customers.
The current store location is leased at a rate of $3,000 per month. It is located withinwalking distance from several apartments and businesses making it convenient forcustomers to access.
QCI had a bank loan which they entered into in 2008 with a fixed interest rate of 5% thatwas secured by a personal guarantee I provided. This loan was repaid in full in January2010.
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15 Copyright 2010 ICAO School of Accountancy
EXHIBIT III
NOTES ON OPERATING QCI AS A WEB-BASED COMPANY
Ordering
The store location is only necessary for the glasses portion of the business as customerstypically want to try on frames before committing to a purchase. Since the sale of contactlenses could all be made via internet orders, I could oversee the operations from mycottage.
QCI would order the contact lenses from our suppliers as soon as the customer placestheir order. We would have the contact lenses delivered from our supplier directly to thecustomer within two days so there is no need to maintain an inventory of contact lenseson hand.
QCI would accept credit cards as the only form of payment from customers and wouldhave a no return policy as the lenses are for each customer‟s specific prescription.
Customers
To retain existing customers, QCI would send a mass mailing explaining the changes tothe business and providing the new contact information, etc. Such a campaign isestimated to cost around $12,000.
As a result of the mailing QCI should be able to retain approximately 75% of existing
contact lens customers. There are currently approximately 1,000 existing customers whopurchase an average of 30 pairs of disposable contact lenses each month. Although itvaries by brand, the average retail price per pair of lenses is $2.
The remaining contact lens customers may leave either because they do not trust thesecurity behind making online payments or because they would prefer to purchase bothcontacts and glasses from the same location.
I am not interested in spending a great deal of time and effort trying to grow the web-based business as the plan is to ease into semi-retirement. I estimate that sales willincrease slowly so I would expect only a 2% increase in annual sales.
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16 Copyright 2010 ICAO School of Accountancy
EXHIBIT III (continued)
NOTES ON OPERATING QCI AS A WEB-BASED COMPANY
Operating Costs
The cost of contact lenses will remain around 38% of their selling price.
Selling expenses are expected to be around 9%. This will include payment to advertise onsearch engine websites.
General and administration expenses are expected to be $108,000 in the first year andthen increase 2% annually. These costs will now include wages for only one part timestaff member to assist me in the business.
Currently customers pick up their lenses at QCI‟s store. However under the web-basedoption, QCI will pay shipping charges to have the suppliers‟ ship the lenses directly to the
customer. The additional shipping charges are expected to be approximately 10% of sales.
I anticipate the cost of setting up the web-based internet site will be around $30,000, withannual service and maintenance fees of $3,500.
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17 Copyright 2010 ICAO School of Accountancy
EXHIBIT IV
NOTES FROM MATEO’S DISCUSSIONS WITH WEB CONSULTANT
Ordering
All customer orders will be placed via the website that will be developed and maintained
by the web consultant.
As all orders will be placed online, customers must pay using a major credit card. Fundswill then be deposited into QCI‟s bank account directly from the credit card companies.
When an order is placed, the customer will be asked to enter the following informationonto the web page:
o brand and quantity of pairs of contact lenseso prescription requirement for each eyeo personal information including shipping address
o credit card information
All information will be entered on one page, making the order process quick and easy forthe customers. If the customer fails to enter the quantity of lenses, the system will notallow them to hit “Submit”. The system will prompt them with an error message andrequire them to enter the quantity of lenses to proceed. This is the only field that whennot completed will prevent customers from placing an order.
When the customer is done inputting information, they will click on “Submit” and theinformation will automatically transfer to QCI‟s sales tracking sheet and the generalledger will be updated concurrently.
Once the transaction is submitted the system will produce a sales receipt which indicatesthe total cost of the order with details of what was purchased.
Shipping
Once the orders are received by the system, QCI will take the information on the salestracking sheet and contact the suppliers to place the orders and arrange for their shipmentto the address input by the customer.
The part-time staff member will count the total number of orders on the sales trackingsheet and compare this to the total number of orders recorded in the general ledger forthat day. Although counting the orders daily may be time consuming, this will ensurethat the system is operating as it should.
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18 Copyright 2010 ICAO School of Accountancy
EXHIBIT IV (continued)
NOTES FROM MATEO’S DISCUSSIONS WITH WEB CONSULTANT
Information System
The mainframe will be located in the cottage where QCI‟s operations will be run.
The system will be setup to make automatic weekly back-ups of the sales trackinginformation which will be stored on a separate drive on the mainframe.
There will be logins and password setup on the computer for each user.
The web consultant can use an internet connection to remotely access the system toinstall updates and make any necessary changes to the system. The web consultant caneven fix a bug or perform an upgrade to the system while it is running so there will be nodowntime.
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19 Copyright 2010 ICAO School of Accountancy
EXHIBIT V
ACCOUNTING AND OTHER ISSUES DISCOVERED WHILE AT QCI
In March 2010, as part of a special “pay now and get 5% off” promotion, sales orderswere placed by 140 customers for 30 pairs of contact lenses for each of the remainingnine months of 2010. QCI recorded the full amount of these sales as revenue in March as
these orders had been paid for in full. The contacts, however, are typically not orderedfrom the suppliers until closer to the month for which the orders relate, as customers pick up their orders on a monthly basis.
Mateo indicated that a significant number of frame styles are out dated with a book valueof $10,000. Mateo is hopeful that the frames will come back in style however there hasbeen no indication of this to date. The frames cannot be returned to the supplier. Mateois planning to sell these at 50% of cost in order to move them. It is typical in the industryto have to write down a portion of inventory annually as the styles change so frequently.QCI‟s inventory of frames is currently valued at $50,000.
QCI has 60 specialty sunglasses in inventory (separate from the frames) recorded at acost of $200 per pair. In January, 2010 Mateo decided to reduce the selling price of thesunglasses from $250 to $150 as this is the price he believes will guarantee their sale.QCI has never had to lower the price of sunglasses before as they typically sell quicklyand Mateo does not expect to have to lower the price of any other specialty frames in thefuture.
QCI is planning to count the inventory on June 6, 2010.
The current store location is leased over a five year term which commenced on June 1,2008. I requested a copy of the lease agreement and discovered that an obligation to pay
for the cost to restore the building to its original condition was built into the lease. Thecontractors who performed the leasehold improvements at the time estimated that cost torestore the building to its original condition would be $20,000. This obligation has not been recorded in QCI‟s financial statements.
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22 Copyright 2010 ICAO School of Accountancy
TABLE III
A FORMULA FOR CALCULATING THE PRESENT VALUE OF REDUCTIONS IN TAXPAYABLE DUE TO CAPITAL COST ALLOWANCE
Marginal Rate of Investment x Rate of x Capital Cost x 1 + Rate of ReturnCost Income tax Allowance 2
Rate of Rate of CapitalReturn + Cost Allowance x 1 + Rate of Return
MAXIMUMCAPITAL 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 yearsand Maximum 40 years)
Class 14 .................................................... Length of life of propertyClass 17 .................................................... 8%Class 39 .................................................... 25%Class 43 .................................................... 30%Class 44 .................................................... 25%Class 45…………………………….…... 45%
SELECTED PRESCRIBED AUTOMOBILE AMOUNTS
Maximum depreciable cost - Class 10.1 $30,000 + GSTMaximum monthly deductible lease cost $800 + GSTMaximum monthly deductible interest cost $300
Operating cost benefit - employee 24¢ per kilometre of personal useNon-taxable car allowance benefit limits- first 5,000 km 52¢ per kilometre- balance 46¢ per kilometre
) )( (
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* * * * * * * * * * *
TABLE IV
INDIVIDUAL FEDERAL INCOME TAX RATES
Income Tax Rate Schedule – Individuals2010 Taxation Year
Taxable Income Tax
$40,970 or less 15.0%$40,971 to $91,941 $ 6,146 + 22% on next $40,971$81,942 to $127,021 $15,160 + 26% on next $45,080$127,022 or more $26,881 + 29% on remainder
SELECTED NON-REFUNDABLE TAX CREDITSPERMITTED TO INDIVIDUALS
FOR PURPOSES OF COMPUTING INCOME TAX
The tax credits are 15% of the following amounts:
Basic personal amount $10,382Spouse or common-law partner amount 10,382Net income threshold for spouse or common-law partner amount nilChild 2,101Age 65 or over in the year 6,446Disability amount 7,239Infirm dependents who reach 18 in the year 4,223Net income threshold for infirm dependents 18 and over 5,992Basic amount for:
Age credit and GST credit 32,506Child tax benefit 40,970
Children‟s fitness credit up to 500
CORPORATE FEDERAL INCOME TAX RATE
The tax payable by a corporation under Part I of the Income Tax Act on is 38% before anyadditions and/or any deductions.
PRESCRIBED INTEREST RATE
Year Jan. 1 - Mar. 31 Apr. 1 - June 30 July 1 - Sept. 30 Oct. 1 - Dec. 31
2010 3 32009 4 3 3 32008 6 6 5 52007 7 7 7 72006 5 6 6 7
2005 5 5 5 5
The rate is 2 percentage points higher for late or deficient income tax payments and unremittedwithholdings.The rate is 2 percentage points lower for deemed interest on employee and shareholder loans.