Afa 500 case 2 - Grade: B+ PDF

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second case problem ...

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Janathan Yoganathan, CPA Soccer Inc is a public company that uses IFRS standards. I have been hired by the players to evaluate the company’s accounting policies to be evaluated to determine if the players should receive a bonus or not. They receive a bonus if net income is above $25 million. It is currently at $24 million. In this situation the players wan to maximize the net income and Soccer inc management wants to keep the net income below $25 million. SI has a bank loan which has a covenant with a maximum debt-to-equity ratio. Therefore, management of SI will be senstive to any accounting policies that increase debt which could increase the debt to equity ratio and breach the covenant. Issues: Issue 1: Revenue Recognition Soccer inc’s current policy for revenue recognition is that they recognize revenue for tickets purchased online is when the ticket is used. The performance obligation is satisfied when the customer attends the game. Since ticket holder may not attend its har to recognize revune this way. A better accounting policy would be to recognize the revenue when the game is played. At this point there is no further performance obligation to the customer. Issue 2: Coupons Soccer inc expensed $200,000 which is the full amount of the coupons that they issued. Accordingly, the amount is simply reflected as rediced revenue and no accounting recognition is required, also no advertising expense should be recognized. Issue 3: Loan The bank loan for $100 million involves transaction costs of $2 million. These should not have been expensed. The $2 million should have been capitalized to the loan; this will reduce the value of the loan. Issue 4: Construction Stadium Foe the stadium it was appropriate to capitalize the $15 million for materials, labour and variable overhead. The construction is expected to take over two years therefore this would be a qualifying asset which takes a substantial amount of time to complete. Because of this the $2 million in interest costs should be capitalized not expensed. The strike is an unanticipated work stopage therefore costs should not be capitalized during the period of the strike. Therefore, interest costs for 8 months/10 months construction should be capitalized. $2 million x 8/10 is $1.6 million. This would increase net income. The interest costs during the strike would be expensed. Issue 5: preffered shares These shares are in substance debt since there is a mandatory redemption date for the principal in ten years and any unpaid dividends. SI’s accounting policy for these shares is appropriate. Issue 6: Share Issue Costs

SI has expensed $1 million of share issue costs. This accounting policy is incorrect. The share issue costs could have either reduced the proceeds from the sale of the shares or been charged directly to retained earnings. Either policy would be appropriate. Issue 7: Tax Losses SI has $10 million of unused tax losses that have not been recognized. It is assumed that any losses that can be, have been utilized this year. Soccer inc uses the liability method for income taxes. If the probable provision has been met Soccer inc could recognize these losses as a deferred tax asset. Therefore, the unused tax losses should be recognized as a deferred tax asset of $3 million. This increases net income. Issue 8: Stock Option Soccer inc recognized the entire expense this year which is incorrect. The expense should be recognized over the vesting period of five years not all in the current year which will reduce the amount of the stock option expense this year. My recommendation and conclusion: After adjustment to a few policies on how to apporpriatly recored for the the income statement the net income turned out to be $28.8 million which is over $25 million, therfore the players should receive a bonus. Conflict occurs when bonuses are based off net income since it can be easily manipuated through different acccounting policies. To avoid disagreements in the future it should be considered basing the bonus on revenue or something else than net income....