4. Games By MailiDatabase Development MARKS) DSI has spent more than $425,000 to date researching and developing a patented database used to track orders and returns of video games from the Games by Mail program. The database is fully integrated with the website. Victor Ziegler has determined that other companies, in various lines of business, could make use of this technology. Essentially, DSI has developed an off-the-shelf packaged inventory tracking database that other businesses can purchase. It seems that DSI has spent $175,000 on research and an additional $250,000 on development. DSI capitalized the full $425,000 as an asset on the balance sheet. A breakdown of the costs is as follows: Development costs: Salaries of researchers $50,000 Salaries of ofce administration staff $20,000 Allocation of direct overhead utility cost $20,000 Allocation of building amortization (Note 1) $50,000 Amortization of equipment used in development process $60,000 Materials used in the lap during development w $250,000 w---,vvu Note lthe amortization of the building was based on a 20% allocation, since the development lab accounts for approximately 20% of the building. The present value of the revenues and expenses from database are $1.35 and $1.13 million, respectively. 5. Previously viewed DVDs (5 MARKS) In the past, a wholesaler purchased all of DSI's previously viewed DVDs. Now, due to its expansion, DSI rst sells all the previously viewed DVDs it can to the wholesaler. DSI then offers the remaining previously viewed DVDs for sale to its customers at discounted prices. Each of these remaining DVDs is scanned and its cost is transferred from "InventoryDVDS for Rent" to "Inventory Previously Viewed DVDs for Sale." When a new movie is released on DVD, DSI must order at least 20 copies of it for each store, at an average cost of $20 per DVD. Within two months, demand for the movie has diminished so that only ve copies per store are necessary. As a result, DSI must sell off 15 copies per store for about $10 each. 6. Foreign currency transaction (10 MARKS) Manufacturing equipment with a useful life of 10 years was purchased from a US. supplier for US$200,000 in November. At the time, the exchange rate in effect was US$1= C$L22 and the equipment and associated payable were recorded at $244,000. At year end, the payable was still outstanding and both it and the equipment were still recorded at $244,000. The year-end exchange rate was US$l = (3951.32. D31 is not sure if either the initial or year-end amounts were recorded correctly, but would like to get a better understanding of how to account for this transaction, as DSI expects TO engage in more transactions with US. suppliers in the future. 7. Customer list (l0 MARKS) In mid-December, the exclusive rights to a customer list were acquired for $75,000 from a competitor. The price paid for the customer list was based on a valuation prepared by a Chartered Business Valuator. This amount was expensed in the nancial statements. For the following issues. do not consider the nancial statements numbers, BUT the amounts in each issue. Put it dierently, Consider the followingproblems in isolation from the nancial statements' gures. Scenario (wooden DVD segment, Fire damage and depreciation) are separate om the above transactions. 8. wooden D VD segment (10 MARKS) Restructuring during the scal year led to the decision to discontinue the wooden DVD segment, on November 20, 2020. This segment represents a major line of business. Relevant information about this decision is as follows: 0 The segment incurred a loss of $233,500 for the year. 0 Estimated costs to dispose of the segment are $300,000. A broker has been hired for the transaction and the assets of the segment are currently advertised at prices that reect DSI's best estimate of fair value. 0 At the time the board decided to dispose of the segment, the fair value of its property, plant, and equipment (PP&E) was estimated to be $7 million and the carrying value of PP&E was $7.9 million. When this analysis was performed, management was surprised to nd that many xed asset acquisitions over the past couple of years were not prudent. Some assets had been purchased at excessive prices and others had been utilized far below capacity. 6 Carrying value of current assets and all liabilities were equal to fair value. Fair value estimates did not change between November 20 and December3l. 0 The income tax rate for D81 is 30%. 0 D81 wrote down the PP&E to $7,000,000 in the 2020 nancial statements. The$900,000 loss is reported under "other income and expenses" on the income statement. 9. Fire damage (10 MARKS) On February 1, 2021, a re broke out in one of DSI's manufacturing buildings. By the time the re was contained, there was signicant property damage and some manufacturing assets were unrecognizable. DSI's management has spent considerable time trying to gure out what was lost in order to quantify and support a claim for insurance purposes. Nothing has been reected in the 2020 nancial statements because the event occurred well after year end. 10. Depreciation (10 MARKS) During December, when depreciation expense was being calculated, it was discovered that several manufacturing assets had been coded to the wrong general ledger account by the accounts payable clerk in the prior scal year. The assets had a total cost of $100,000 and, based on being coded as furniture and xtures, were being depreciated straight-line over 10 years. DSl's claims a full year of depreciation in the year of acquisition. After detecting the issue, management recorded depreciation expense of $30,000 on these assets in 2020 because manufacturing assets should be depreciated straight-line over ve years at DSI's. This means the cumulative depreciation is now $40,000, as required, and the assets are reported at net book value of $60,000. As changes in depreciation are treated as changes in accounting estimates, the change was made prospectively and there was no need to adjust the prior period nancial statements Exhibit III Notes from Meeting with Victor Ziegler on Possible Future Initiative D51 is evaluating the purchase of 20 Rent Boxes, which would be located in highly populated areas within the City of Toronto. Rent Boxes allow for the rental of DVDs and video games via rental kiosks. Rent Boxes allow a customer to select a DVD or video game, pay for the rental, and receive the physical copy of the DVD or game all from a self-serve rental kiosk. It is similar to a vending machine but for renting DVDs and video games. Customers must return the DVD or video game to the same Rent Box after a specied number of days. The Rent Boxes would be located in popular areas such as grocery stories, Big Box stores, and subway terminals. Victor has compiled the following nancial information related to the Rent Boxes: I Initial, up-front capital costs of $2,250,000 are required to purchase the 20 Rent Boxes. - The project is expected to generate future cash ow of $2,500,000 per annum over a ve-year period. c The project is capital intensive, and therefore has relatively little variable costs. Direct variables costs are expected to be $350,000 per annum over the ve-year period. - Advertising costs are expected to increase by 5% from 2020. . Wages and Benets costs are expected to increase by 7% from 2020. . The Rent Boxes will have a CCA rate of 20%. - DSI has a cost of equity of 12%. "I also met with DSI's Chief Information Ofcer, Nick Nightingale. He provided a description of DSI's expansion during 2020 into the Internet-based video game rental market through a program called Games By Mail. Here are my notes from my meeting with Nick (Exhibit IV). Please review them and provide your recommendations for improving the system. I will pass on your cements to our Information Technology (IT) partner so that she can include them in a report she is preparing for Victor. Victor has asked our IT partner to meet with him to discuss the information technology issues related to the Internet-based rental system." Exhibit IV Notes from Meeting with Nightingale Nick Nightingale is the Chief Information Ofcer for D81 and was responsible for the implementation of the Games By Mail system. He answers the D81 help desk phone, so he has been extremely busy lately because Games By Mail customers have been calling for assistance. He said the following: "The Games By Mail concept is great, but it has been difcult to get going. Moonwatcher Web Designers (MWD) programmed both the front-end, which is the part the customer sees, and the back-end, which is the database that tracks the games. MWD programmed the website very quickly but has not been available very much since the website went live six months ago. We have had several crashes of the website, and the only advice MWD has provided is to reboot the server. Considering all the money we paid to MWD to develop the site, which at last count was over $8.5 million, I hoped for better service. "We were able to save money by hosting www.GamesByMail.ca on an existing server. Because the website needs to transfer credit card sales information daily to the accounting system, we used the same server that runs our accounting system. "Since MWD also prograrmned an antivirus component right into the website software, we did not have to purchase separate antivirus software for the server. I have been after MWD to provide us with updates to the antivirus software. MWD keeps promising us that updates will arrive shortly. Thank goodness, we have a great rewall, so viruses cannot get access to the system in the rst place. "I am also not too worried because we have a backup that I store off-site, because I know how important that is for disaster recovery. The back up now does both the accounting data and the video game title database. I change the tape every week and whenever I do a backup, it nishes in about 10 seconds and ejects the tape right away. It used to take much longer to do the back up, but the MWD people must have done more than just tweaking when they installed the website. "One matter I am a little worried about, though, is the shipping report produced by the new system. Each day, the system generates and prints a shipping report and the addressed envelopes. The report indicates which video game gets sent to which customer, and there is one envelope for each customer listed on the report. The idea is that the inventory picker can nd the video game and immediately put it in the matching addressed envelope to be shipped. However, I have noticed that sometimes the customer names that the system prints on the shipping report are different from the names it prints on the envelopes. Usually, it is not a big deal because we can correct the information in the system and just reprint the envelope. However, it causes the shipping people to do additional manual work. "We were also having a problem with the customer login screen. Customers would be denied access, even if they were using their correct username and password. After repeatedly calling MWD, they dialed in to the system last night and applied a service pack to the website to x the problem. Today, the login screen seems to be working ne." "Lastly, I met with the Chair of DSI's board of directors, Malcolm Brodie. He discussed how the board is trying to transform itself in light of DSI's recent expansion efforts and the disruptive forces in the industry. There are no minutes from the board's meeting in the current year; however, I was able to put together some rough notes based on my meeting with Malcolm (Exhibit V). Please review the board composition and prepare a separate report for me to provide to Malcolm that outlines any issues and your recommendations for improvement." Exhibit V Notes from Meeting with Malcom Brodie Malcolm lamented the fact that the board has not been able to meet more frequently during the year because Victor has been so busy overseeing DSI' expansion plans. The board formally meets twice during the past year~once in February to review Victor's expansion plan and another time in July to approve dividends that Victor wanted to be declared. Victor is the board's secretary and was unable to prepare minutes because of his hectic schedule. The board of directors comprises the following individuals: Name Board Role Descrigtion Malcolm Brodie Board Chair Minority shareholder and long-time friend of Victor Ziegler. Malcolm is an active lawyer. Victor Ziegler Board Secretary Controlling Shareholder and Chief Executive Officer Nick Nightingale Director Chief Information Officer Muhammad Sanuta Director Controller Malcolm stated that DSI adopted a whistleblower policy in the current year but was unsure if it was working properly as Victor had not received any anonymous calls during the year. The board is functioning as DSI's audit committee. Malcolm would like to better understand an audit committee's purpose and composition. Required 1. Prepare a report for any accounting transactions according to our class /CPA model. (90 MARKS); Please ignore Management, Audit, Taxation request in this case. 2. Prepare a one-page document outlining the various treatments for wooden DVD segment, Fire damage and depreciation under ASPE (10 MARKS) Development System International. (DSI) Development System International. (DSI) is a privately held chain of DVD rental stores headquartered in Toronto. The company was incorporated in 1992 and has gone from a single store in Toronto to over 30 stores throughout Ontario. Harford & Harford and LLP (H&H), a mid-sized professional services firm, have been the auditors for DSI since its inception. You, CPA, are the audit senior on the DSI audit for the year ending December 31, 2020. On December 1, 2020, Alice Harford, the engagement partner, calls you into her office to explain that the audit will need to begin in early January 2021 because DSI's bank is eager to see the audited financial statements. "I would like you to prepare the audit planning memo for the DSI audit. DSI has experienced some changes, and I want to make sure we consider those in our audit plan. The controller of DSI has faxed us the interim financial statements for the 11 months ended November 30, 2020 (Exhibit D). These should help you in your audit plan. Please be sure to consider DSI's financial reporting issues when drafting your audit planning memo and suggest ways to audit them. Exhibit I Development System International.November 30 December 31 2020 2019 Assets (Unaudited) (Audited) Current assets Cash 21 35 Accounts receivable (no late fees) 3,210 Inventory - DVDs for rent 7,935 6,545 Inventory - New DVDs for sale 2,315 2,119 Inventory - Previously viewed DVDs for sale 3,526 Inventory - video games for rent 2,849 1,517 19,856 10,216 Property, plant, and equipment 40,355 31,105 Database development costs 425 Website 8,512 69,148 41,321 Liabilities Current liabilities Accounts payable 652 3,569 Current portion of long-term debt 2,937 3,589 3,569 Long-term debt 26,430 Due to shareholders 4,532 6,483 34,551 10.052Shareholders' equity Common shares 100 100 Retained earnings 34.497 31,169 34,597 31,269 69,148 41,321 Excerpts from the Balance Sheet (in Thousands of Dollars)Excerpts from the Income and Retained Earnings Statement (in Thousands of Dollars) 11 months ended November 30 December 31 2020 2019 (Unaudited) (Audited) Revenues Rentals 15.477 14.613 Sales 6,321 5,946 Games by mail 7.432 No late fees 3.539 11 Government grant 50 1 1 Other 537 419 34,356 20,978 Expenses Advertising 3,124 2.460 Amortization 659 450 Bank charges Business and property taxes 140 149 Cost of goods sold 8.797 4.757 Insurance 125 105 Interest on long-term debt 1.325 Professional and consulting fees 691 710 Rent and office 1,286 1,246Repairs and maintenance 569 498 Utilities 1.542 1,612 Wages and benefits 10,540 8.465 28,809 20,463 Income before taxes 5,547 515 Income taxes 2,219 206 Net income 3,328 309 Retained earnings, beginning of the period 31.169 30.860 11 months ended November 30 December 31 2020 2019 Retained earnings, end of the period 34,497 31,169"I met with Victor Ziegler, the controlling shareholder and CEO of DSI, a few months ago, and he told me about DSl's new initiatives for the current year. Here are my notes from that meeting (Exhibit II]. Some new accounting issues have arisen as a result of these initiatives. I would like you to look at them and provide your recommendations on the accounting treatments to adopt. I would also like you to prepare a separate report that we can provide to Victor to help him decide regarding a new initiative that is being considered for next year (Exhibit III). EM Notes from Meeting with Victor Ziegler on Current Year Initiatives After years of slow and steady growth, DSI began expanding in two directions. First, DSI opened ten new video stores in 2020. In the past, DSI had only opened one store per year. Second, DSI moved into the Intemet-based video game rental business by launching a new website, www.GamesByMail.ca. The expansion was nanced by a 10-year term loan from DSl's bank. Victor noted that the bank now seems concerned with the protability of the company. Given all the extra hours worked this year, Victor will be receiving a bonus of 2% of net income. 1. No Late Fees (10 MARKS) DSI introduced a new program called "No Late Fees" during 2020. Since people are often reluctant to rent movies because they cannot return them on time, DSI eliminated late fees for its customers. However, to prevent abuse of this program, after 30 days, if the movie is not returned, the outstanding movie is considered sold to the customer who rented it. The next time the customer comes to the store, there will be a charge of $25, the price of purchasing a new DVD, on the customer's account, and they have the right to keep the DVD. The program has been "tremendously successful," according to Victor. It has both increased rental revenue and increased sales of DVDs, since many customers keep their DVDs beyond the 30 days. However, Victor conceded that it has upset some customers who believed that DSI had truly eliminated all forms of late fees. Most customers who were charged for an over-30-day DVD have refused to pay for it and simply returned the DVD to a DSI store. Others have yet to pay for the DVD and have yet to return it. 2. Exchange with Blockster Home Video (I 0 MARKS) During the year, DSI exchanged $1,000 cash and various New DVD inventory with a cost of $85,000 and a fair value of $96,000 with Blockster Home Video in exchange for 3,000 Model XT500 DVD players. DSI is going to sell the DVD players to its customers. The XTSOOS can be purchased from various suppliers, with a price range of $25 to $38 per unit. DSI sold DVDs similar to those traded to its customers for $15 per unit last month. DSI has not recorded this transaction; as Victor said, "its really like nothing happened," he tells you. "We gave them to inventory and they gave us inventory. That's why I didn't record anything." 3. Games by MailiRerztal Program(10 MARKS) When customers rst subscribe to the Games By Mail service at the store, they supply their credit card number and agree that it will be charged $30 at the end of each month until they cancel their subscription. To rent a video game, customers log on to the website using a user ID and password provided to them. Once logged on, customers can choose up to 40 video games to have in their "wish list." Customers can flag as urgent certain video game. The customer is mailed his or her initial four Video games from the DSI warehouse in Toronto. These are selected automatically by the system based on availability of video games in the rental inventory, while giving priority to those video games marked as urgent by the customer. Once the customer is nished playing a particular video game, he or she returns it by mail in a postage-paid envelope. DSI then sends the customer the next video game on the list. During the introduction period of May 2020, DSI offered new customers the option of paying $500 up front for three years of video games rentals by mail and 5,000 customers took advantage of this option due to its substantial savings