Please identify the accounting issues and how these items should be handled for the following case.

HAPPY LUCK JEWELLERY INC.

As you are new to the firm, I wanted to start you off with something easy. HLJ is about the most straightforward client I have. The company has no debt other than current payables. The two brothers are not keen on expansion as they like the idea of personally running a small boutique shop. Even their taxes are pretty simple. For example, every year, Bruce and Tommy take a salary of $150,000 to $200,000 each. After such remuneration, the companys pre-tax income has, over the past few years, been around $250,000. At this years July 31 year-end, they are expecting similar results, even though sales will have increased to at least $6 million from last years $5.4 million. As HLJs taxable income is well below the small business deduction limit, we dont have to worry about accruing bonuses or other remuneration planning that is necessary for most clients.

Ive always been surprised that the Lees would want to pay extra for a review when HLJs financial statements are only used by them and the tax department. A couple of times, Ive tried to talk them down to a Notice to Reader, but they have always said that they like the idea of having experts look at their books at least once a year. As in other years, I dont see any independence problems in doing this work or any reason why HLJ shouldnt continue to meet our firms client acceptance policies. To make things even simpler, HLJs accounting policies are based on the Accounting Standards for Private Enterprises, and they have chosen to use the taxes payable method of accounting for the companys taxes.

Here are the notes that I took during my meeting today with Bruce and Tommy. (Jack hands you the attached Exhibit I). I would like you to prepare two engagement planning memos relating to this upcoming year-end. Firstly, I want a memo that I can pass along to the junior staff that will actually be doing the HLJ review work. In this memo, please discuss the accounting and income tax issues that you identify during our discussions or by reviewing my notes. Let us know how you think these items should be handled. Secondly, Id like you to prepare a memo solely for my purposes. This memo should outline any unusual review engagement issues resulting from the accounting issues or income tax issues identified.

Exhibit I

Notes from Meeting with Bruce and Tommy Lee

1. At HLJs 2013 year-end, the company held an inventory of 300 ounces of gold having a purchase cost of $1,150 U.S. per ounce (which at an exchange rate of $1 Canadian = $0.9388 U.S. resulted in a cost of $1,225 per ounce Canadian). At July 31, 2013, the market value for gold was $1,130 U.S. per ounce (also $1,130 Canadian). As a result, for fiscal 2013 year-end, gold inventory was written down by $28,500. Currently, gold has increased in value to $1,305 U.S. per ounce ($1,350 Canadian). 200 ounces of the gold in the 2013 inventory will still be held by HLJ at its fiscal 2014 year-end.

2. In August 2013, HLJ initiated a new promotional program called Engagement Embarrassment Insurance (EEI) intended for individuals who purchase surprise diamond engagement rings for their prospective partners. If the marriage proposal is not accepted (or for any other reason within three months of purchase), HLJ will repurchase the ring from the customer.

HLJ will refund the original sales price of the diamond portion of the ring (on average $2,000) but will not provide a refund for the gold component of the ring (which averages $1,000) as HLJ considers the rings band and setting to be custom-made for the customer, whereas each diamond has a grading certificate to ensure its individual features. The average cost of gold is $600, and $1,200 for diamond. Since beginning the EEI program, the company has had, on average, 60 customers in the potential repurchase period at any point in time. Total number of rings sold under this program in fiscal 2014 is expected to be 240.

3. To date in fiscal 2014, ten rings have been repurchased under EEI. All diamonds in HLJ inventory are separately identified, so the cost of the repurchased diamonds can be easily calculated. The Lees generally maintain a small inventory of diamonds, but if this program is successful, they may increase their inventory selection. However, the gold bands and settings are melted down into gold wafers for storage in inventory. As described above, HLJ does not pay the customer for that gold. The company uses the FIFO method to determine the year-end cost of its entire inventory.

4. As a result of the economic uncertainty in fiscal 2014, HLJ started holding an extra 100 ounces of gold. While this is clearly in excess of normal inventory requirements, it does protect HLJ from possible spikes in gold prices. This gold is currently shown in the companys records as inventory at cost.

5. In December 2013, grandfather Chin died. As a gesture intended to benefit both brothers, Chin bequeathed the land and building currently rented by HLJ to the company. The legal title to this property was transferred in April 2014.

6. As a new marketing strategy, in May 2014, the Lees created the Happy Luck Jewellery Financing Plan for its customers. Under this plan, any customer is able to obtain an exact prototype of the real jewellery piece for $200 when they put 10% of the total price as a down-payment. This plan gives customers 12 months to pay off the balance while being able to use the prototype. At the end of the 12 months, or after the balance is paid off, whichever is sooner, the prototype is returned for a $150 credit towards the balance of the price for the genuine piece. Because the real jewellery piece is not delivered until payment is complete, there is no chance of credit rejection and no interest is charged.

If the balance is not paid in full at the end of 12 months, the customer has to return the prototype. The payments made can be used as store credit towards a purchase of another piece.

Each prototype is unique and when returned it is unlikely to be reused by Lees to give to other customers.

The estimate for fiscal 2014 is that $45,000 worth of genuine jewellery will be sold through this plan, all of which will be pending final settlement of the balance. A total of 15 prototypes are expected to be provided under the plan.

7. The Lees nephew is getting engaged and the brothers wish to give him and his fiance an engagement ring as a wedding present prior to July 31. The ring that they have designed has a cost of $3,000 and a retail value of $5,000.

8. As HLJ has excess gold, they have asked if Gallifrey and Torchwood would consider accepting gold for payment of its 2014 assurance fees. Last years review fee was $7,900. To allow for a small fee increase, the brothers have offered to give the firm 6 ounces of gold in exchange for this years work.