Key issues and Findings

1.Wally Watchmaker requires financial statements be prepared for the year ended December 31, 2020, using IFRS standards. The auditors will want to see these in conjunction with their audit work early in 2021. The accounting department has prepared draft financial statements that can be found in EXHIBIT 1.But you recall that numerous accounting issues may have not been handled properly by the accounting staff. Wally would like you to tell him what accounting areas were not treated properly in accordance with IFRS. You will need to identify what areas the accounting was deficient, and you will need to make corrections before final, accurate financial statements can be provided to the auditors.

2.Wally is particularly keen to make sure that the Earning Per Share (EPS) amounts are properly calculated and presented in the income statement. "Our accountant is quite inexperienced and has never calculated EPS before and so it's likely that the amount has been incorrectly calculated. As you know, this number is hugely important and so we need to get it absolutely right", states Wally.

1. Capital Structure of CCC

i.The company issued 500,000 common shares for $10 a share on January 2, 2020, the date of its incorporation. Another 340,000 common shares were issued for $30 each on March 1, 2020. On November 1, 2020 the company repurchased 60,000 of its own shares.

ii.100,000 warrants were issued for $20 each on April 1, 2020. One warrant permits the owner to purchase one common share of CCC for $30 any time before December 31, 2024.

iii.On September 1, 2020 the company issued $2,400,000, 5%, convertible bonds at par value. Each $1,000 bond is convertible into 20 common shares.

iv.The average market value of the common shares in 2020 was $40 per share based on private sales of the shares during the year.

v.No dilutive securities were converted into common shares during 2020.

vi.Note that the accounting for all of the above items has been done properly.

4.The company's tax rate for 2020 is 20%. New tax laws were enacted at the end of 2020 that will result in a tax rate of 30% for 2021 and later years.

5.CCC intends to have the best warranty terms in the watch industry. Every watch sold has a complete three warranty. Customers have the option to buy an extended warranty for an additional three years. The cost to the customer for the extended warranty is 5% of the watch sales price. The total amount received in 2020 for the extended warranties was $300,000. Actual repairs made to watches in 2020 amounted to $50,000.

Based on past sales, Wally estimates that required repairs on the original three-year warranty will be 2% of sales revenue.

Actual correct warranty expense is 2% x 10,000,000 = 200,000

During 2020, the accountant made the following entries for warranties:

DEBIT

CREDIT

Warranty expense

50,000

Cash

50,000

(to record actual warranty repairs made on defective watches)

Cash

300,000

Extended warranty revenue

300,000

(to record amount received for extended warranties)

You remind yourself that estimated warranty expenses are not permitted to be deducted on the tax return. Only actual amounts paid under warranty coverage can be deducted as an expense on the tax return.

6.CanLux Connected Corporation entered into a 15-year lease agreement on January 1, 2020 for a head office. The company is required to make annual payments of $500,000 starting on January 1, 2020. The remaining economic life of the building is 35 years, at which time there will be a $3,000,000 expected residual value.CCC has the option to purchase the building at the end of the lease for $5,000,000, considerably less than the expected fair value at that time. A real estate appraiser determined that the fair value of the building was $7,233,800 on January 1, 2020. The implicit interest rate in the lease is 6% and CCC has an incremental borrowing rate of 7.5%. The only lease accounting entry made by Christina Credit in 2020 was:

DEBIT

CREDIT

Rental expense

500,000

Cash

500,000

(to record first payment)

7.Two former employees of CCC, Benny Bruiser and Doogie Daze, started legal action against the company for wrongful termination. Benny is seeking $300,000 and Doogie wants $200,000. Legal counsel for CCC believes that Benny is likely to get around $30,000 but is unable to determine the outcome for Doogie's lawsuit. The lawsuits will be heard in court sometime during 2021. Christina Credit recorded the following entry for the loss:

DEBIT

CREDIT

Expense due to lawsuit ($300,000+$200,000)

500,000

Liability due to wrongful termination

500,000

(to record the maximum possible loss)

Note that for tax purposes, amounts for lawsuit losses can only be claimed as anexpense on the tax return when the actual payment is made and not before.

8.The following capital assets have been correctly recorded and depreciated in 2020:

Capital asset

Cost

Accumulated

Depreciation

Book value at

Dec. 31, 2020

Manufacturing facilities

$ 9,000,000

$750,000

$ 8,250,000

Office equipment

1,200,000

50,000

1,150,000

Vehicles

400,000

75,000

325,000

$ 10,600,000

$875,000

$ 9,725,000

Note for 2020: CCA on the above assets was $1,675,000.

9.In calculating income tax expense, Daniel Debit simply multiplied the 2020 tax rate (20%) by the income before tax amount on the original income statement.

Required: Wally Watchmaker, President and CEO of CanLux Connected Corporation, has asked you to do the following:

1. Discuss the areas where the accounting was not done properly and make sure to indicate what should have been done instead.
2. Based on 1. above, prepare the appropriate correcting journal entries to correct the errors. Also, don't forget the necessary adjusting entries at year end.
3. Prepare the corrected financial statements once you have done the entries in 2. Above. Use the template in the formatted excel spreadsheet for your work.
4. Compute the required earnings per share amounts to be included on the income statement.

STATEMENT OF RETAINED EARNINGS For the year ended December 31, 2020 2020 Retained earnings, January 1, 2020 $ 0 Net income 860,000 Retained earnings, December 31, 2020 $ 860,000 BALANCE SHEET As at December 31, 2020 2020 Assets Current assets Cash* $ 1,850,000 Accounts receivable * 1,600,000 Inventory * 8,000,000 11,450,000 Capital assets (net) (see note 9)* 9,725,000 Total assets $ 21,175,000 Liabilities and shareholder's equity Current liabilities Accounts payable * $ 250,000 Accrued liabilities* 450,000 700,000Long-term liabilities' Liability due to lawsuits (see note 8) Long-term bank loan* Convertible bonds payable (see Exhibit 1) * Total liabilities Shareholders' equity Common shares, 780,000 shares issued and outstanding * Contributed surplus 200,000 warrants (see Exhibit 1) * Retained earnings Total shareholder's equity * The accounting for these items on the balance was done correctly. 500,000 600,000 2,400,000 3,500,000 4,200,000 14,115,000 2,000,000 860,000 16,975,000 $ 21,175,000