Ch Ip 2 - Grade: A - Accounting Analysis And Audit Discussion PDF

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To: Owen Starr From: CPA Subject: accounting analysis and audit discussion Note receivable (NR) Issue Doyle Games is a local game company that needed some new computers and virtual reality studio equipment. In January, All Starr entered into an agreement with Doyle Games, selling it $80,000 in equipment but agreeing not to collect for three years. Doyle Games is expecting a grant from the government that will be paid in three years’ time. All Starr would normally charge interest of 8%, but has agreed to waive interest for this contract. The controller included the balance in accounts receivable at $80,000. Analysis As per IFRS 9 and ASPE 3856.05: An entity shall recognise a financial asset or a financial liability in its statement of financial position when, and only when, the entity becomes party to the contractual provisions of the instrument. As per the agreement All Starr has sold an equipment to Doyle Games in exchange of a note receivable. Therefore, it is considered as a financial instrument (financial asset). ASPE Initial recognition Subsequent measurement

Adjusting Journal entries

IFRS

Recognized at cost or Fair value

Recognized at cost or fair value

Amortized cost Interest Income can be recorded using either the effective interest method or straight-line method  ASPE 3856.11 states if initial recognition is at cost then it shall subsequently measure the instrument using the cost method less any reduction for impairment.  ASPE requires that AR be assessed for impairment at the end of each reporting period. However, there needs to be a “triggering event” for the recognition of an impairment loss. Dr Equipment $80,000 Cr Accounts receivable $80,000 (to record reversal entry)  

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Interest Income is recorded using the effective interest method only. Impairment- As per IFRS 9 All Starr must recognize a loss allowance for expected credit losses on the NR. At each reporting date, the credit risk of the customer is assessed, as well as the future amount and timing of expected future CF. it follows the expected loss model of recording impairment. Any gain/loss are recorded in P&L account.

Dr Equipment $80,000 Cr Accounts receivable (to record reversal entry)

$80,000

Dr Note receivable $80,000 Cr Equipment $63,507 Cr Discount on NR $16,493 (to record the exchange of equipment for NR)

Dr Note receivable $80,000 Cr Equipment $63,507 Cr Discount on NR $16,493 (to record the exchange of equipment for NR)

Dec 31 Dr Discount on NR $5,081 Cr interest revenue $5,081 (to record interest income earned)

Dec 31(Exhibit I) Dr Discount on NR $5,081 Cr interest revenue $5,081 (to record interest income earned)

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Audit discussion  Risk(s) of material misstatement (RMM) One of the major risks associated with notes receivable is the collectability. Doyle games is expecting a grant from the government which will be used to pay the receivable. There is a possibility that Doyle Games may default on the payment of equipment. Therefore, we must make an estimate of collectability and reduce their balance by an allowance for doubtful accounts. This increases the overall risks of material misstatement for notes receivable. Another major risk is that estimates of the expected future cash flows from impaired financial assets reflect management’s best judgment, based on reasonable assumptions and also take into account the range of possible outcomes.  Procedure The most common audit procedure involving the notes receivable balance is confirmation. To test that notes receivable, exist, the auditor can send a positive confirmation to Doyle games asking them to verify the amount that is owed to the All Starr as well as the terms of agreement. Recommendation The above transaction should be classified as note receivable rather than accounts receivable on the financial statements. Therefore, a reversal entry should be made. Moreover, there is a risk that Doyle games might not receive the grant and default on payment, therefore an allowance for doubtful account to be created for NR based on estimation of collectability. We must also determine whether our methodology for the estimate is reasonable as well as audit the underlying information used to make the estimate. Impact Since Owen Starr is planning to go public, this could majorly impact the financial statements as there is a risk of fraud of presenting misleading financial statements. Warranty Issue Per our sales contracts, we offer a one-year warranty covering defects in the games. Customers have the option to return the game cartridge for replacement or repair. Analysis As per IFRS 9 and ASPE 3856.05: An entity shall recognise a financial asset or a financial liability in its statement of financial position when, and only when, the entity becomes party to the contractual provisions of the instrument. Warranties are not considered to be a financial instrument because the probable outflow of economic benefits associated with them is the delivery of goods and services rather than cash or financial asset. Under ASPE, the most likely value is used. In the case of warranty liability, the best estimate within a possible range of values is used or the lowest value in the range. Although under ASPE there is no warranty liability a disclosure can be made by the auditor to inform the users of potential liability arising in future. Under IFRS, probabilities and expected values must be determined and a probability weighted average value is used to create a provision for warranty which needs to be accrued in the period. Therefore, adjusting entry will be: Dr Warranty Expense Cr Provision for warranty. Audit Discussion  risk(s) of material misstatement Warranty provision is an accounting estimate of future liability that will arise because of the promise made by the company to its customers. The risk of material misstatement of the financial statements is generally greater when account balances and classes of transactions are subject to estimation rather than precise measurement because of the subjectivity in estimating future events. Therefore, RMM is high for this transaction.  Procedure 2

One of the procedures that could be performed to check the reasonability of the warranty estimate would be to review and test management’s process in making the estimate. Recommendation & impact Since Owen Starr is planning to take All Starr public, we will have to record a provision for warranty on financial statements which could affect the IPO negatively. Securities Issue In March, All Starr purchased Pacific Loans and Savings (Pacific) securities, which are listed on the Toronto Stock Exchange. Pacific was selected as a good investment based on its history of dividends and analyst predictions for capital appreciation in the short term. Unfortunately, Pacific has dropped in value. These investments were acquired with the intention of selling them in the short term if price increased. No. of shares 1,500 – Cost, $22 – Sell price, N/A – FV, 18.95 Analysis As per IFRS 9 and ASPE 3856.05: An entity shall recognise a financial asset or a financial liability in its statement of financial position when, and only when, the entity becomes party to the contractual provisions of the instrument. In this case, the investment in pacific shares would be considered as passive investments (financial asset) as the investment was acquired with the intention of selling the security and earning a return on the investment. ASPE Initial recognition Subsequent measuremen t Journal entries

IFRS

Recognized at fair value of asset

Recognized at fair value of asset

Recognized at Fair value and any gain/loss recorded in net income in the period incurred. March Dr Investments $33,000 Cr Cash $33,000 (to record purchase of investment) December 31 No Entry

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Dividend income – in p&L Change in FV – loss/gain recorded in P&L

March Dr FV-NI investments $33,000 Cr Cash $33,000 (to record purchase of investment) December 31 Dr Unrealized Loss - NI $4,575 Cr FV-NI Investments $4,575 (to recognize unrealized loss on investment)

Audit Discussion  risk(s) of material misstatement All Starr is planning to go public which increases the inherent risk as all Starr is inexperienced with dealing in the stock market and there is a high possibility of recording complex transactions incorrectly. Moreover, understanding the assurance of the reasonable estimations of securities, including the appropriateness of various types of valuation models and the reasonableness of key factors and assumptions, requires a sound knowledge of valuation concepts. Therefore, the risks of material misstatement are high.  Procedure The required procedure to audit these investments would be to inquire with the management and review supporting documents as to possible pledging of securities for appropriate disclosure purposes. Recommendation & impact If All Starr does go public they would have to record an unrealized loss on investments at year-end on income statement which could negatively affect the financial statements. Therefore, Owen should weigh the overall pros and cons before taking the company public. 3...