It is Monday, September 13, 2010. You, a PA, work at Fife & Richardson LLP, a PA firm. Ken Simpson, one of the partners, approaches you mid-morning regarding Brennan & Sons Limited (BSL), a private company client for which you performed the August 31, 20X9, year-end audit.

“It seems there have been substantial changes at BSL this year,” Ken explains. “I’m going there tomorrow, and since you will be on the audit again this year, it would be beneficial for you to come. I took the liberty of retrieving information from last year’s files so you can refresh your memory about this client (Exhibit DC11-12-1).”

The next day, you and Ken meet with Jack Wright, the accounting manager at BSL. Jack gives you the internally prepared financial statements (Exhibits DC11-12-2 and DC11-12-3). To your surprise, there are also financial statements for two new companies. Jack quickly explains that BSL incorporated two subsidiaries in January 20X0, each with the same year-end as BSL:

Brennan Transport Ltd. (Transport) – 100% owned by BSL Brennan Fuel Tank Installations Inc. (Tanks) – 75% owned by BSL

You diligently take notes during the meeting (Exhibit DC11-12-4). Jack states that BSL will prepare consolidated financial statements for audit based on Canadian Generally Accepted Accounting Principles (GAAP) to satisfy the bank’s request.
Ken asks that you work on the overall planning for these engagements. As part of your planning, he asks you to discuss the new accounting issues that arise as a result of the changes during the year, and to evaluate their implications for the engagements.
Nature of the business: BSL operates as a scrap metal dealer and processor. It buys used scrap metal from individuals and businesses, then bundles the different metals and sells them in larger quantities at a higher price to bigger recycling businesses. BSL’s revenue fluctuates significantly because of the volatility in the market rates for steel and non ferrous metals. To help control costs, BSL uses its own trucks and trailers to do the pickups. BSL earns additional revenue by providing transportation services to other businesses and by renting out the trucks during slower periods.
As part of BSL’s overall strategy, the owners admit a willingness to take risks. They monitor the marketplace and are always on the lookout for new business opportunities. They even found a piece of land on the outskirts of the city that they thought would be great for a dump they considered operating themselves. They decided not to make an offer, but may reconsider in 2010. For BSL’s 2009 audit, materiality was set at $70,000.

Required:
Prepare a memo to the audit engagement partner discussing the planning for the BSL audit engagement. Your memo should discuss planning considerations for the audit of the consolidated financial statements, the risk assessments, and materiality decisions for the overall audit strategy. As part of your planning, discuss the new revenue accounting issues that arise as a result of the changes during the year and evaluate their implications for the engagement. [Assume that BSL will use ASPE as its financial reporting framework. Given the timing of the case, ASPE can be adopted, and it will meet the bank’s requirement for “Canadian GAAP”.]

EXHIBIT DC11-12-4 Notes from Your Meeting with Jack Wright
BSL continues to operate the scrap metal business. BSL’s management thinks the price of metal is going to go up in the near future, and has therefore started stockpiling for the first time. Unfortunately, BSL does not really have an inventory tracking system in place. If, in fact, it turns out that stockpiling is a good way for BSL to make money, it will install a better system. The company did its best to log each of the amounts going into the stockpile as it was added, knowing that an amount for its year-end inventory balance would need to be determined. BSL also used a known engineering formula to come up with an estimate for year-end inventory and tried to measure the different piles of metal as a way of counting what was on hand at August 31, 2010. The different methods came up with different amounts, so management went with the initial amount based on the log. Jack noted that we would have had a good laugh at the different ways they tried to measure the piles if we’d been there to see it.
As soon as it was incorporated on January 1, 2010, Transport took over BSL’s transportation operations. Transport provides transportation services to BSL and external customers, the same as BSL did. BSL sold the trucks to Transport in late January at fair market value. However, Transport didn’t have the funds to buy the equipment, so BSL issued a note receivable at what Jack believed to be the market interest rate.
Tanks install and maintain pre-engineered, above-ground fuel storage tank systems, a new line of business for BSL. Sean Piper, a good friend of one of BSL’s owners, approached BSL last fall with the idea. Sean was willing to take the necessary training to become a certified fuel tank installer, and he wanted 50% ownership in Tanks. The owners of BSL agreed it was a great opportunity but wanted more control. The parties settled on Sean’s receiving 25% ownership of Tanks.
As part of the agreement, BSL was required to provide a guarantee pertaining to Tanks’ licensing application to the environmental authority, since Tanks was a newly formed corporation. Although other vendors sell the same tanks and installation services separately, Tanks only sells the tank combined with installation and service. The tank is marked up by 20% on the price paid and is sold including installation and a five-year maintenance package for a total of $40,000. One hundred percent of the revenue is recognized when the sales agreement is signed by the customer. The tank is then delivered and installed at the customer’s site within two to three weeks of signing. The fuel tanks need to be pressure tested every year, and the measurement gauge needs to be checked. Tanks will perform the maintenance services for customers for the first five years. Thereafter, Tanks will offer to continue to perform the maintenance for a contract price of $5000 ayear.

Transcribed Image Text:

EXHIBIT DC11-12-1 Date of incorporation Year end: Ownership Excerpt from Permanent File October 27, 1982 August 31 50 common shares 50 comm : Harold Thomas Kyle Stanton on shares EXHIBIT DC11-12-2 Internal Financial Statements-Balance Sheets BRENNAN & SONS LIMITED BALANCE SHEET AS AT AUGUST 31 IN THOUSANDS OF DOLLARS) 2010 (unaudited) Transport 2009 (audited) BSL BSL Tanks Assets Cash Accounts receivable Inventory 467 970 10 1,447 $ 75 603 500 1,178 $ 67 119 15 97 186 Note receivable Property, plant, & equipment Investment in subsidiaries Intangible asset 431 (note 1) 4,768 13,400 400 80 20 (note 2) $197 $6,215 $15,011 S586 Liabilities Accounts payable Note payable Mortgage payable 315 $ 813 $128 $166 431 (note 1) 100 415 6,500 7,313 559 166 Shareholders Equit Common stock Retained earnings 1 (note 3) 5,799 5,800 $6,215 7,697 7,698 $15,011 26 27 $586 30 31 $197 Notes: 1. Note receivable/payable for sale of trucks and trailers from BSL to Transport, interest at 8% 2. Training costs for Sean Piper, owner/installer 3. Includes Sean's equity interest EXHIBIT DC11-12-3 Internal Financial Statements- Income Statements BRENNAN&SONS LIMITED INCOME STATEMENT FOR THE YEAR ENDED AUGUST 31 IN THOUSANDS OF DOLLARS) 2009 2010 (audited) (unaudited) BSL (12 months) BSL (12 months)Transport Tanks (8 months) (8 months) Revenue $11,000 900 $10,003 Scrap metal Transportation services Fuel tank installations 300 (note 4) 700 (note 4) 320 320 11,900 10,303 700 Cost of sales 1,600 700 1,440 340 Scrap metal Transportation services 550 220 100 50 Fuel tank installations Gross margin General & administration (note 5) Interest expense Income before other income Other income 9,600 8,491 9 1,100 150 90 8,523 7,930 120 473 50 Gain on sale of equipment 84 Gain on sale of property 2,500 Interest income Property rental Income before income tax Income tax Net income Notes: 4. 490 (note 6) 1,100 440 $ 660 3,163 1,265 1,898 50 20 $30 18 $26 Transport took over transportation services in J 5. 20X0 General & administration includes amortization 6. $10,000 per month from Transport and $5,000 per month from Tanks for six months anuary