Smith and Stewart (Stewart) is a partnership of lawyers. It was recently formed from a merger of Becker and Brackman (Becker) and Copp and Copp ( Copp). Stewart has 38 partners— including 6 from Becker and 32 from Copp— and 75 employees. At the date of the merger, Stewart purchased land and an office building for $ 2 million, and fully computerized its offices. The partners have agreed to have the annual financial statements audited even though this was not done in the past.

The partnership agreement requires an annual valuation of the assets and liabilities of the firm. This valuation will be used to determine the amount an existing partner will receive from the partnership when exiting the partnership and the amount a new partner will pay to enter the partnership.

The partners have been busy getting the new partnership up and running and have paid little attention to accounting policies. Prior to the merger, Becker recorded revenue when it invoiced the client. Daily time reports were used to keep track of the number of hours worked for each client. This information was not recorded in the accounting system and in general the accounting records were not kept up- to- date.

Copp also recorded revenue at the time the client was invoiced. This was based on partner hours, which were determined based on work in progress and recorded for employees at their regular billing rate, based on the hours worked. At year- end, an adjustment was made to reduce work in progress to reflect the actual costs incurred by Copp.

The new partnership agreement requires a valuation of work in progress at the merger date. This amount, which has yet to be determined, will be recorded as goodwill.

Stewart has arranged a line of credit with a bank that allows the partnership to borrow up to 75% of the carrying value of accounts receivable and 40% of the carrying value of work in progress based on the partnership’s monthly financial statements. The bank has also provided mortgage financing of $ 950,000 for Stewart’s land and building. The bank requires unaudited monthly financial statements as well as the annual audited financial statements.

As at the date of the merger, capital assets owned by the predecessor firms were transferred to the new partnership.

Each partner receives a monthly “draw” payment, which is an advance on his or her share of annual profit.

Your auditing firm has been hired by Stewart to prepare a report advising the partnership on accounting policies— identifying alternatives and making specific supported recommendations. A partner in your auditing firm has asked you to prepare the report. In addition, the partner has asked you to prepare a memo detailing the important auditing issues that are likely to arise and how they could be resolved.

Required

Prepare the requested report and the memo.