Core 1 Integrated Problem 1

Scenario (120 minutes)

Lisa Jonas founded Modern Inc., a leading manufacturer of custom wood and upholstered furniture, in 1995. Its head office and main manufacturing facility are in Montreal. Modern reports under accounting standards for private enterprises (ASPE).

Ten years ago, Lisa's nephew, Darren Carter, became the controller of the company. At first, Darren was very focused on the company. He instituted many worthwhile changes and improved the financial reporting process. More recently, however, Darren's attention has shifted to a petroleum exploration venture that he and a couple of his university colleagues are pursuing.

On June 1 of this year, Darren resigned from Modern, acknowledging that he was spreading himself too thin. Lisa was understanding, but disappointed that none of her family wished to be actively involved in the business.

Lisa will be turning 64 this year and is starting to think about retirement. Currently, she personally guarantees the company's bank loans; however, she is in discussions with the bank to remove this personal guarantee. Lisa feels that the company is financially healthy and profitable, and she is hoping that the bank will see that when the financial statements and this year's review report are issued.

Lisa is also considering selling her business in the next six months or so. She has reached out to a valuations expert who indicated to her that the value of the company will be based on a multiplier of net income. Lisa's investment in the business is her primary source of savings for retirement.

Task #1

Lisa has come to you, CPA, for financial advisory services. Asha Patel, the accounting clerk who has been filling in for Darren, has some questions on financial reporting issues. She has sent over the draft financial statements (Appendix I) and her questions (Appendix II). Lisa has asked you to respond to Asha's queries.

Lisa has also asked you to determine whether Modern is in compliance with its term loan bank covenant and, if necessary, provide next steps regarding the results of your covenant calculation.

Appendix II

Asha's financial statement notes

Prepared by Asha Patel

Barbor sofa order

On December 11, we received an order from long-time customer Barbor Furniture Ltd. (Barbor) for 14 sofas, at a total price of $22,100. Barbor provided a deposit of $9,000, which I recorded as revenue when it was received on December 13. The order was completed on December 28, but because our delivery trucks were out of service, it wasn't delivered to Barbor until January 2. Our yard was broken into on December 29 and a number of items, including all of the delivery trucks, were vandalized and need repairs.

Barbor agreed to the January 2 delivery, at which time we billed them for the order. I recorded the remaining balance of the order ($13,100) as sales and accounts receivable on December 28. The sofas, which have a cost of $920 each, were excluded from the ending inventory count that was performed and completed on December 31.

Lumber inventory

We purchased lumber (raw materials) costing $4,410, which was received on December 31. The lumber was not put into production until January 3. The lumber arrived just after we had completed the inventory count so it was not included in the count and the invoice was not recorded in accounts payable. The terms of the purchase were "FOB destination."

Saw repair

In July, one of our saws broke down. The cost of $11,500 in repairs is included in repairs and maintenance. The repair company claims the repairs will increase the saw's service capacity, cut production time by 10%, and reduce waste by 5% to 10%. The manufacturing staff really did see a difference in the performance of the saw after the repairs. The saw is expected to last another five years beyond the date of repair. Modern uses the straight-line method for amortization purposes and pro-rates for the number of months the asset was owned in the year.

National retail chain agreement

On November 29, a sales agreement was signed between Modern and a large national retail chain; Modern agreed to sell $50,000 of furniture per month over the next three years, commencing March 1 the following year. Modern received a bonus of $75,000 as per the agreement at the time of signing the sales agreement, which I recorded as revenue. Modern is required to fulfil the contract requirements by ensuring an adequate supply of product for the $50,000 monthly purchase. Lisa was anxious to see the bonus in revenue for the year-end financial statements.