Iskra Vremec and Colin McFee are experienced scuba divers who have spent many years in the salvage business. About a year ago, they decided to start their own company to recover damaged and sunken vessels and their cargoes off the east coast of Canada. They incorporated Atlantic Explorations Limited (AEL) on February 1, 2019. Iskra (president) and Colin (vice-president) each own 30% of AEL’s shares. The remaining 40% of the shares were purchased by a group of 10 investors who contributed $50,000 each so that AEL could acquire the necessary equipment and cover other start-up costs. AEL carries on two types of activities. The first is a commercial salvage operation. The second is treasure hunting. To date, commercial salvage operations have generated all of AEL’s revenues. The demand for these services is strong, and there are few competitors because of the unpredictable nature of the business and the long hours. Colin manages the commercial salvage operations. Customers pay in three instalments, including an upfront fee, a fee payable approximately midway through the contract, and a fee at the end once the items in question have been salvaged (found and brought to land). If the item is never found or AEL cannot bring the item to the surface and to land, then the final payment is not made.

Iskra spends most of her time locating and recovering underwater artifacts and, where possible, sunken treasure. Her research shows that numerous vessels carrying gold, silver, and other valuables to the “Old World” were wrecked off the shores of Nova Scotia. AEL has permits to investigate three target areas. As compensation for the permits, AEL agrees to remit 1% of the fair value of any treasure found. These funds are to be invested in the local economy by AEL (subject to government approval). The company also pays an upfront fee that allows it to search a given area. AEL recently made a potentially lucrative discovery in the first of these target areas. It is now September 5, 2019. AEL has engaged your auditing firm to provide advice on the accounting for the ongoing operations and the discovery that AEL has just made. You (as audit manager) and Alex Green, the partner assigned to the engagement, met with Colin and Iskra.

During your meeting, Iskra said that she believes that finding treasure is like winning a lottery, as all revenues would accrue to AEL and thus should be treated accordingly. If this discovery proves to be as substantial as preliminary results suggest, AEL will require additional financing of $1.5 million to acquire equipment and an on-shore laboratory and lease a specially equipped vessel needed to salvage the wreck and its treasures. The bank has said that it is not willing to advance further funds. However, Iskra and Colin know of other individuals who are interested in investing in AEL.

AEL receives grants from the government to help find treasure and salvage sunken vessels. Iskra and Colin have just found out that they are likely to receive a grant in connection with the recent discovery.

Instructions

Audit Draft a memo for the audit partner, Alex Green, analyzing all financial reporting issues and providing recommendations.