Case #2 Kute Kitties Inc. (KKI) is a private corporation and was established by the Simpson family in 2003 as a pet store. The Simpson family used to be involved in the operations of KKI but in order to spend more time together as a family they hired a CEO (Bob Puppy) and Controller (Sara Bird) five years ago. When Bob and Sara signed on, KKI agreed to pay them each a bonus which is based on net income before taxes each year. Bob and Sara handle everything in the day to day operations of the company, but the Simpson family (John, Julia, Jacob and Jessie) make up the entire Board of Directors. Bob and Sara ensure that they provide updates to the Board during their quarterly meetings. KKI have chosen to follow IFRS. John, Julia, Jacob and Jessie want to make sure that everything in KKI is still running smoothly, so they have hired the accounting firm of Arizona and Associates to review some information and provide them with an analysis. You are a staff accountant at Arizona and Associates. One of the partners at your firm, George Jungle, has asked you to review his notes from his meeting with the Simpson family, and draft up a letter to the Board of Directors discussing any potential issues noted or recommendations to suggest. The year-end of KKI was September 30, 2019. It is now October 24, 2019. Excerpts from Georges meeting with the Simpson family: During the 2019 year end, KKI started a new promotion in order to boost sales of kittens. As part of the promotion, customers pay $125 and receive a kitten and one free vet check up at the in-house vet clinic (part of KKIs operations). The vet check-up appointment must be booked within 18 months of the date the kitten was purchased. The normal retail price of a kitten is $100, and of a vet check-up is $75, so KKIs management is hopeful that this $50 savings will help boost sales. Since management is not sure when people will actually book the vet appointment, when the sale is made the entire amount is posted to the Kitten Sales account. For certain larger sales, such as bulk pet food sales made to local animal shelters, KKI allows the customer to pay on credit. Typically in the past KKI has had a very high collection rate, with only about 1% of sales being recorded to bad debts. However, in the last few years KKI has experienced a much lower collection rate, with about 15% of accounts receivable not being collected and being significantly overdue. Sara is responsible for following up with customers who have overdue accounts, and Sara has mentioned that she thinks the low collection rate is due to government funding not coming through for certain animal shelters, so theyve been unable to pay their bills. However, Bob and Sara think that it is still appropriate to only set up an allowance for doubtful accounts equal to 1% of sales. KKI currently uses a periodic inventory system, but recently there have been some large discrepancies between the amount of inventory per the inventory counts and the amount of inventory recorded in the system. Therefore, the Board is wondering if they should switch to a perpetual inventory system in order to keep better track of the amount of inventory on hand at all times. The Board is wondering what potential pros and cons are for each of the types of inventory systems (periodic versus perpetual) and they are hoping for a recommendations regarding what type of system they should be using. Page 2 of 2 Case #2 KKI uses the gross margin method of calculating their inventory cost. However, since its so much work to determine the estimated gross margin for each individual inventory item, KKI just calculates overall gross margin percentage and then applies that percentage estimate when determining inventory value. Over the last few years, the gross margin percentage for KKI has increased quite a bit, which the Board thinks is a good sign that business is doing well. In May 2019, KKI decided to invest in a dog walking company called Walks 4 You (W4Y). KKI purchased 75% of the shares of W4Y for only $1,000 since the company was just starting out. Since KKI has experience in the pet business, they are able to appoint all of the directors of W4Y, and they make most of the decisions regarding the operations of the company. Currently KKI has recorded this investment on their balance sheet for $1,000. On October 4, 2019 the Board received a legal letter from a local animal rights activist group stating that the activist group was suing KKI. Apparently, one of the vendors that KKI had purchased kittens from in July 2019 was an illegal operation which treated kittens poorly. The animal rights group thinks that KKI should be responsible for damages of $200,000, since they were not authorized to purchase from that vendor. KKIs lawyer has looked into the issue and thinks that KKI could be liable for the $200,000 settlement, but anticipates that there wont be any further damages. The Board is upset as they have always prided themselves on ensuring they only purchase from highly ethical vendors, so they arent sure how this occurred and are hoping it wont damage their reputation too much. Bank reconciliations are prepared by Sara every 4 months. Bob tries to review the bank reconciliations once Sara has prepared them, but since Bob is so busy making sure everything else is running smoothly he sometimes doesnt get a chance to review them right away (or at all) and doesnt get to devote much time to reviewing them in detail. Bob is hoping to hire another sales manager to help take on some of his duties as he is becoming quite overwhelmed with the amount of work that he has to do. Sara takes on most of the daily duties, such as counting the cash tills at the end of each day, taking the deposits to the bank, recording invoices due to vendors, recording payments received from customers who were approved to pay on credit, approving customers who can pay on credit, etc. Bob is glad that Sara has taken such ownership over the daily duties as it has allowed him to scale back the numbers of things he has to prepare/review each day. Cheques written by KKI to vendors can be done by Bob or Sara, and two signatures are required on each cheque. If the cheque is for an amount under $100,000 then Bob and Sara can be the two signatures on the cheque. However, if the cheque is for an amount over $100,000 then the two signatures must be Board of Director members, since they would like to be aware of any large purchases. Since the Board members are often busy, KKI keeps stamps of each board members signature in a drawer in the office. If a Board signature is needed on a cheque, then Sara just emails the Board member for their approval, and can stamp their signature on the cheque in order to save time.