Integrated Problem 3 - Core 1 PDF

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To: Layla Mendez, CFOFrom: Controller, CPASubject: Potential Audit issues and their ImpactsAfter discussing the issues below, here is what I have found and the recommendations that I would advise.Design Contracts – Revenue RecognitionOTF charges a non-refundable fee of 1500$ to produce a customized ...

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To: Layla Mendez, CFO From: Controller, CPA Subject: Potential Audit issues and their Impacts After discussing the issues below, here is what I have found and the recommendations that I would advise. Design Contracts – Revenue Recognition OTF charges a non-refundable fee of 1500$ to produce a customized design plan. If customers continue with the design process the 1500$ becomes a credit on the final invoice. There is no time limit on the credit, whenever a client decides to proceed with the process the credit will always be applied. If a client doesn’t want to continue with the design process, they can buy the design plan for an additional 500$. Issue: Whether the non-refundable fee is recorded properly on the financials when a client chooses to proceed with the design process. It is not specified how the fee is recorded but based off deductions, revenue is increased when the 1500$ is collected for the design plan, but is it adjusted when the client continues with the process? Analysis: According to ASPE 3400, Criteria to recognize revenue:  Risks and rewards of ownership have transferred – Goods: seller has no continuing involvement or control. NOT MET: When the client continues the design process it doesn’t transfer the ownership of the furniture to the client.  Revenue can be measured reliably – if over time, uses percentage of completion method. NOT MET: the client has not paid for the furniture and no revenue has been measured.  Collection is reasonably assured. NOT MET: The client has not received their furniture at time of pursuing the process. Recommendation: OTF doesn’t meet any of the criteria when it comes to recognizing revenue. The initial fee should be debited from revenue and credited to deferred revenue (a liability account) until all the work is complete and the final invoice is paid, and the furniture has been delivered. By decreasing revenue and increasing a liability account it will affect the overall net income negatively and inevitably reduce the owners bonus at year end. Audit Impact: -

Risk: the revenue from initial design fee doesn’t meet the criteria for revenue recognition. Account and Assertion: Revenue - Classification

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Procedure: Increase the substantive testing by reviewing the accounts receivable subledger for customers with significant credit balances that would be more appropriately classified as a liabilitiy.

The impact of recording revenue incorrectly in an audit is the financials are misstated, and sales are overstated increasing the overall net income positively. Land – PPE OFT wanted to purchase a piece of land from a client that was appraised at 200,000$. The client agreed to sell the land for furniture. The furniture sold to client usually retails at 185,000$. OFT recorded the sale at lands market value. Issue: Was the purchase of land recorded properly? Analysis: According to ASPE 3831, An asset exchanged or transferred in an NMT is measured at the fair value of the asset given up or the fair value of the asset received, whichever is more reliable. When an entity can reliably determine the fair value of both the asset received and the asset given up, the fair value of the asset given up is used to measure the asset received. NOT MET: When the land was recognized OFT recognized it at its fair market value. Recommendation: I would update the purchase of land by decreasing the capital asset by 15000$ and subsequently increasing the gain/loss on capital asset expense. By increasing an expense, it will negatively impact the net income lowing the owners bonus at year end. Audit Impact: -

Risk: Asset recognition doesn’t meet the criteria for a Non-Monetary Transaction Account & Assertion: Asset – Valuation Procedure: Increase the substantive procedure by examining subsequent receipts for the accounts receivable balances older than 90 days, as these balances have a greater chance of non-collectability.

Leased Facility – Leases OTF entered a lease with LAW for a building used to spray paint their furniture. The fair value of the building at time of lease was 1,200,000$. OTF included the lease payments in rent expense for the current year. -

The terms of the lease are 98000$/yr for 15 years payment at Jan 1 of every year. LAW is responsible for the maintenance of the building. The building has a remaining life of 35 years, with a residual value at the end of the lease of 500,000$. OTF’s borrowing rate it 5%.

Issue: Are the lease payments recorded properly? Analysis: According to ASPE 3065, The criteria/consideration factors for the lessee can be summarized as follows: 1. There is a transfer of title at the end of the lease or the existence of a bargain purchase option. NOT MET: there is no transfer of title at the end of the lease and no bargain purchase option mentioned. 2. The lease term is a major portion of the asset’s useful life (usually 75% or more). NOT MET: The building currently has a remaining life of 35 years, with a 15-year lease is only 42% of the asset’s useful life. 3. The PV of the minimum lease payments is equal to substantially all the FV of the asset (usually 90% or more). MET: the total lease payments after 15 years are 1,470,000$ and the fair value of the building is 1,200,000$. Executory costs must be excluded from the minimum lease payments. Discount rate used is the lower of the rate implicit in the lease, if known, and the entity’s borrowing rate. The leased asset cannot be initially recognized at an amount higher than its FV. If this is the case, the discount rate used must be adjusted so that the PV of the minimum lease payments is equal to the FV of the leased asset. Recommendation: The criteria for recognizing the lease payments is to capitalize the lease. I would recommend adjusting the entry made to rent expense and capitalizing the payment up to the buildings fair value using the borrowing rate and then expense the difference. By reducing the expense and increasing the assets it will positively affect the overall net income increasing the owners bonus at year end. Audit Impact: -

Risk: Properly recording lease payments as an asset and not an expense. Account & Assertion: Asset – Valuation Procedure: Increase the substantive testing by making sure the asset is recorded properly and the value doesn’t exceed the asset fair market value....