Autotech Corp. (Autotech) is a federally incorporated public company formed in 2012 to manufacture and sell specialty auto products including paint protection and rust proofing. By 2011, the Autotech board of directors felt that the company's products had fully matured and that it needed to diversify. Autotech aggressively sought out new "concepts," and in November 2012 it acquired the formula and patent of a synthetic motor lubricant (Synlube) and 25% of the outstanding voting shares of JDP Ltd. (JDP) for $400,000 cash. The formula was developed by JDP, a company then owned 100% by Jack Douglas. Although some members of the board of directors felt and continue to feel some concern about Mr. Douglas's continuing ownership of JDP, Mr. Douglas became the president of Autotech in February 2019.

Synlube is unlike conventional motor oils. Its innovative molecular structure accounts for what management believes is its superior performance. Although it is more expensive to produce and therefore has a higher selling price than its conventional competitors, management believes that its use will reduce maintenance costs and extend the life of the equipment in which it is used.

Autotech's main competitor is a very successful multi-national conglomerate that has excellent customer recognition of its products and a large distribution network. To create a market niche for Synlube, management is targeting commercial businesses in western Canada that service vehicle fleets and industrial equipment.

Autotech's existing facilities were not adequate to produce Synlube in commercial quantities. Management believed that there was a growing market for this product in Western Canada, and in June 2018 Autotech commenced construction of a new blending plant in a western province. After lengthy negotiation it received a $900,000 grant from the provincial government. The terms of the grant require Autotech to maintain certain employment levels in that province over the next three years or the grant must be repaid. The new facilities became operational on December 1, 2018.

In addition to the grant monies received, Autotech has financed its recent expansion with a term bank loan. Management is considering a share issue later in 2019 to solve the company's cash flow problems. Autotech's March 31, 2019 draft balance sheet is provided in Exhibit 1.

Although they have been with the company since its inception, Autotech's auditors have just resigned. It is now April 22, 2019. You, CPA, and a partner in your firm met with Jack Douglas to discuss the services your firm can provide to Autotech for the year ended March 31, 2019. During your meeting, you collected the information contained in Exhibit II.

As you return to the office, the partner tells you that he is interested in having Autotech as an audit client. Before making a decision, however, he wants a memo from you covering in detail the accounting and audit issues that you see arising from this potential engagement.

EXHIBIT 1

AUTOTECH CORP. DRAFT BALANCE SHEET

as at March 31

(in thousand of dollars)

Assets

2019 (Unaudited)

2018 (Audited)

$ 195 615 30 840

716 1 686 835

$3,078

$ 462 476 98 - 1,036

650 1,686

2,766 (1,374) 1,392

$3,078

Current

Accounts receivable Inventories 1,650

Prepaid expenses

45 1,908

Capital assets Investment in JDP Deferred development costs Patent 835

Current

Liabilities

Bank indebtedness Account payable Current portion of long term debt Advances from shareholders

$6,843

$1,225 607 400 253 2,485

3,114 5,599

Long-term debt

Shareholders' Equity

Capital stock Deficit (1,522)

1,244 $6,843

$ 213

2,120 1 1,979

2,766

EXHIBIT II

INFORMATION COLLECTED BY CA

1. The "capital assets - new plant" account in the general ledger has increased by $1.435 million during the year. An analysis of this increase is as follows:

Land Building, net of grant of $900,000 Advertising (promotion of Synlube product) Relocation costs (moving plant management) Equipment Legal fees (Synlube patent-infringement lawsuit) Labour costs (amounts paid to employees during training period)

$

90,600 $1,435,000

200,000 416,000 125,500 216,300 319,200

67,400

As no significant orders of Synlube have been received to date, no amortization has been charged this year.

Autotech has commenced a lawsuit against its major competitor for patent infringement and industrial espionage. Management has evidence that it believes will result in a successful action, and wishes to record the estimated gain on settlement of $4 million. Although no court date has been set, legal correspondence shows that the competitor intends "to fight this action to the highest court in the land."

Deferred development costs represent material, labour, and subcontract costs incurred during 2019 and 2018 to evaluate the Synlube product and prepare it for market. Almost 80% of the subcontract costs were paid to JDP. Autotech has not taken any amortization to date but thinks that a period of 20 years would be appropriate.

Jack Douglas contacted your firm after Autotech's former auditors resigned. The previous auditors informed Mr. Douglas that they disagreed with Autotech's valuation of deferred development costs and believed that the balance should be reduced to a nominal amount of $1.

Royalties of $0.25 per litre of Synlube produced are to be paid annually to JDP.

Inventory consists of raw materials, semi-processed liquids, and finished goods. Approximately 60% of the value of inventory relates to Synlube production at the new plant. The fourth-quarter inventory count resulted in a significant book-to-physical adjustment. Management thinks that the standard costs used may have caused the problem.

The $3.514 million term bank loan is secured by a floating charge over all corporate assets. The loan agreement requires Autotech to undergo an annual environmental assessment of the old and new blending facilities. During your meeting, Mr. Douglas enquired whether your firm could provide such an assessment.

Autotech has incurred substantial losses during the past three fiscal years.

REQUIRED:

Prepare the memo to the partner.