Memorandum

Date: 20 June 2020

To: Financial Accounting Division (Senior Accountant)

From: Financial Accounting Division (Partner)

Subject: AAA Pharmaceuticals Limited Financial Statements and Analysis

Scope:

Our firm has recently been engaged to provide accounting and income tax services to AAA Pharmaceuticals Limited (AAA Pharmaceuticals) for the year ended 30 June 2020.

AAA Pharmaceuticals is based in Melbourne, Australia. The company is a pharmaceutical company dedicated to researching, developing and commercialising antiviral pharmaceutical medicines and vaccines. AAA Pharmaceuticals utilises in house research facilities and capabilities and has successfully developed and commercialised, via licensees, prescription pharmaceuticals which are available in Australia, the United Kingdom and the USA.

AAA Pharmaceuticals suffered a serious security breach in May 2020 in which the companys servers were hacked by an unknown agency. AAA Pharmaceuticals does not utilise cloud based storage options as the CEO believes cloud technology is too risky, as maintaining the security of the companys research data outweighs the potential benefits arising from moving to a cloud based system. The Chief Financial Officer is confident that all data is complete and accurate.

You have been tasked with preparing the key financial statements for the year ended 30 June 2020 as outlined below.

Corporate Profile and Background:

AAA Pharmaceuticals acquired 100 per cent of Bio Chem Solutions Pty Ltd (hereafter collectively referred to as the Group) on 1 July 2017. Bio Chem Solutions Pty Ltd is a research-based biopharmaceuticalcompanythatdiscovers,developsandcommercialisesinnovativemedicines. Due diligence records related to the acquisition have been supplied by the accounting firm that assisted with the acquisition. These records identify Bio Chem Solutions Pty Ltd had share capital of $250,000 and Retained Earnings of $1,300,000 as at the date of acquisition. The CEO has advised that the carrying value of assets and liabilities were consistent with fair value at the date of acquisition with the exception of the Land and an internally generated generic pharmaceutical brand. The brand relates to a generic medicine that has been highly successful in treating respiratory illnesses. The fair value of the Land had been assessed as $70,000 higher than the carrying value at the date of acquisition. Bio Chem Solutions Pty Ltd has not booked the revaluation in the accounting records. The fair value of the internally generated brand is $250,000. The company expects the brand to continue to provide economic benefits indefinitely. Bio Chem Solutions also has a licence which was granted on 1 July 2017, which is recorded in the financial statements at a fair value $200 000 at the date of acquisition. The licence period ends on 30 June 2022. of AAA Pharmaceuticals provides administration and research services to Bio Chem Solutions Pty Ltd.

ACCT13-301 Financial Accounting Assignment

A copy of the financial statements is provided to the bank as per AAA Pharmaceuticals lending agreement. Furthermore, the lending agreement requires that the Group maintain a minimum quick ratio of 2:1, interest coverage of 3.35 based on EBIT. The loan commenced on 1 May 2018, is repayable on 30 April 2022 and incurs fixed interest of 7.5%, payable monthly. The initial amount drawn down was $12,500,000. Whilst this interest rate seems high, the directors have advised that the rate is consistent with the companys incremental borrowing rate given the nature of the companys operations.

As AAA Pharmaceuticals is an unlisted public company, the directors have formed the view that special purpose financial statements are appropriate to meet their reporting obligations.

Financial Statements and Transactions:

The financial controller of AAA Pharmaceuticals advises the following transactions occurred throughout the year ended 30 June 2020:

• AAA Pharmaceuticals received regulatory approval on a new prescription pharmaceutical Decongestital which it had been developing for the last five years. Buoyed by the success of the commercialisation and approval of the new product the company capitalised $2,500,000 in research costs which had been expensed in prior periods as it was now certain the costs would be recouped. Additionally, the company incurred expenditure during the year to generate market research. As these costs are directly attributable to the new product they are being capitalised as part of the development costs in the accounting records. Expenses capitalised equate to at $225,000 at 30 June 2020.

• Bio Chem Solutions Pty Ltd pays administration and research facility fees of $20,000 and $35,000 respectively each month to AAA Pharmaceuticals. The research fees are payable on the 15th of each month in arrears, the administration fees are payable on the last day of each month

• Based on the success of the regulatory approval the company is confident its research into the development of a generic version of a leading prescription pharmaceutical will be successful, despite the project being in its early stages. The company has capitalised the full research expenditure to date of $1,500,000 at 30 June 2020 as they believe successful commercialisation of the medicine will occur no later than December 2022.

• AAA Pharmaceuticals lent Bio Chem Solutions $1,500,000 on 5 January 2018 to assist with the commercialisation of their revolutionary patented medical device. Interest is charged at 3.25 per cent per annum and paid on the last day of each month. The loan is expected to be repaid in full by 31 December 2020.

• A competitor of Bio Chem Solutions Pty Ltd released a new medication which has less severe side effects when compared to the generic branded medicine licenced by Bio Chem Solutions Pty Ltd. Despite the competition and potential decrease in sales, Bio Chem Solutions Pty Ltd believes demand will continue for their product as it is cheaper.

• AAA Pharmaceuticals sold laboratory equipment to Bio Chem Solutions Pty Ltd on 15 January 2020. The laboratory equipment was originally acquired for $150,000 on 15 July 2017 and was sold for $80,000. The laboratory equipment was being depreciating by AAA Pharmaceuticals on a straight-line basis over five years. Bio Chem Solutions Pty Ltd has assessed that the laboratory equipment acquired has a remaining useful life of two years. The Group has adopted the accounting policy of measuring plant and equipment using the cost model.

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ACCT13-301 Financial Accounting Assignment

• Goodwill on acquisition was impaired by $25,000 in the year ended 30 June 2019, however the directors have determined that no impairment arises in the current year and have reversed the impairment as the group is performing well in the current year.

• AAA Pharmaceuticals owns the land and buildings which house the administration offices and major research facility, however, recently leased research facilities in Sydney. The lease is for a period of five years and commenced on 1 July 2019. The CFO confirmed the lease is an operating lease with an annual lease payment of $150,000 paid on 30 June of each year. The company paid direct costs of $10,000 related to the lease.

• No contingent liabilities were identified when Bio Chem Solutions was acquired.

• During the year the company booked a revaluation gain of $250,000 based on a directors valuation of the land held in Melbourne. The company adopts the revaluation model in

  accounting for Land.

• Due to the worldwide impact of COVID-19, a strategic review undertaken during May and June

  has identified several areas in the business where efficiencies can be improved. The Board is currently considering the implementation of several of the proposed recommendations, including staff restructures and redundancies. Consequently, a provision for $100,000 had been recorded by Bio Chem Solutions Pty Ltd to recognise the potential redundancies that may arise if the Board resolve to implement the proposed changes. The final decision is expected to be made and communicated to staff in August 2020.

• Following successful initial trials Bio Chem Solutions believes one of its medicines is successful at reducing the severity of symptoms experienced by COVID-19 patients. Consequently, the company has booked a $300,000 revaluation gain on the brand as it expects, if successful, the company will experience a significant increase in demand for the product.

• On 30 November 2019, AAA Pharmaceuticals received legal notification action has commenced against the company alleging patent infringement. The plaintiff is seeking $10,000,000 in damages plus costs. The companys lawyers have advised the claim against the company is spurious in nature. The Company denies any wrongdoing, however to be prudent a provision of $250,000 has been included in the year-end trial balance. As the action is in its early stages, no court dates have been set as yet.

• The group receives a tax deduction for all research and development expenditure incurred.

• The tax rate is 30%.

  Draft Financial Statements:

  The financial information for AAA Pharmaceuticals Limiteds are included in Appendix A (attached).

  Bio Chem Solutions Pty Ltd has also provided a copy of their financial information for the year ended 30 June 2020. These statements are attached at Appendix B.

  Scope of Engagement:

  A summary of the engagement as agreed with the client is included on the following page. The Scope of Work outlines the requirements of the engagement.

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ACCT13-301 Financial Accounting Assignment

You have been tasked with preparing the information requested, which is to be presented to the Board of Directors of AAA Pharmaceuticals Limited.

ENGAGEMENT SCOPE OF WORK: [TOTAL MARKS: 85] PART A: Financial Statement Preparation [50 MARKS]

You are to prepare the following draft financial statements for your client (AAA Pharmaceuticals Limited):

1. Consolidated Statement of Financial Position1 of AAA Pharmaceuticals Limited and its subsidiary Bio Chem Solutions Pty Ltd as at 30 June 2020;

2. Consolidated Statement of Profit and Loss and Other Comprehensive Income1 of AAA Pharmaceuticals Limited and its subsidiary Bio Chem Solutions Pty Ltd for the year ended 30 June 2020;

3. Consolidated Statement of Changes in Equity of AAA Pharmaceuticals Limited and its subsidiary Bio Chem Solutions Pty Ltd for the year ended 30 June 2020; and

4. Note disclosures2 supporting the balances included in the consolidated financial statements prepared in (1) (3) above.

5. You are also required to provide a copy of your work papers. The work papers should include (i) a final trial balance for the consolidated group and the parent entity, (ii) adjusting journal entries required to be processed (excel / word) and (iii) any related workings / calculations. These work papers should also include notes explaining workings / calculations and adjusting journal entries. The work papers should clearly identify the entity the adjustments relate to (ie. AAA Pharmaceuticals Limited, Bio Chem Solutions Pty Ltd, Consolidation Entries).

The draft consolidated financial statements should portray the Groups financial results and the Parent entitys financial results for the year ended 30 June 2020.

Note: Taxation entries are only required to the extent the adjusting journal entries affect taxation balances recorded in the financial statements. A detailed tax calculation is not required.

PART B: Analysis and Report [35 MARKS]

You are required to present the draft Financial Statements and work papers, together with your report of key matters to the Finance Director.

Your report should outline key issues the Group should consider and their impact / potential impact on the draft financial statements. These key issues should include discussion of relevant matters you identify during your review of the Groups operations and preparation of the Groups draft financial statements for the year ended 30 June 2020. The report may include discussion of areas / transactions where more information or clarification is required in order to finalise the draft financial statements.