Quality Cabinets Inc. (Quality) manufactures custom kitchen cabinets from its location in Squamish, British Columbia. The cabinets are then sold to contractors who install them in kitchens. Bruce MacDonald is the owner and has approached you, a CPA with a local CPA firm, to advise on some accounting issues that arose during the year and to help prepare the corporate tax returns, including the associated accounting entries. It is January 31, 2024. Task #1 Bruce has asked for an analysis of the accounting issues described in Appendix I. Quality reports its financial statements in accordance with ASPE. Task #2 Bruce also requires a calculation of taxable income for the most recent year ended December 31, 2023. He has also requested that you prepare the year-end journal entry for taxes payable using a marginal rate of 14% on income less than the business limit. Bruce has provided you with the draft statement of income and retained earnings (Appendix II) and additional information you will need (Appendix III). Appendix I Description of accounting issues Quality entered into a leasing agreement with the provincial government at the beginning of fiscal 2023. Quality was granted access to the timber resources from a parcel of province-owned land for a period of five years. Quality commenced harvesting the timber right away and as of year end had harvested 10% of the land. A condition of this agreement is that Quality replant trees at the end of the five-year lease agreement. Quality estimates that it will cost $500,000 to reforest the full plot at the end of five years. Eight percent is the appropriate discount rate to reflect this transaction. This obligation has not been recorded in the financial statements. This lease has already been analyzed and is being properly treated as an operating lease in accordance with ASPE 3065. On February 1, 2023, Quality paid $400,000 for a 25% interest in the common shares of Hinge Buddy Inc. (HBI). HBI is one of Quality's main suppliers of kitchen hardware. Quality's board was very keen to acquire HBI shares as it was viewed as a "wise strategic move." The CFO and sales manager for Quality have been appointed to the board of directors of HBI. The remaining HBI shares are held by the founder and president of HBI. The journal entry recorded related to this acquisition was: Dr. Investment in HBI Cr. Cash $400,000 $400,000 HBI has a December 31 year end and reported net income of $1,400,000 for 2023, which is its typical profit level. Bruce is not sure if this investment is being accounted for appropriately. He would like to account for the investment in a way that makes his financial statements "look good." Appendix II Quality Cabinets Inc. Statement of income and retained earnings For the period ended December 31 (Draft) 2023 (Draft) Sales Cost of sales Gross profit $ 8,959,800 5,939,648 3,020,152 2022 (Audited) $ 8,834,000 6,129,709 2,704,291 Expenses: Advertising and promotion 357,900 266,500 Amortization 219,163 166,584 Automobile 140,800 102,600 Bad debts 17,250 19,110 Donations 1,200 1,000 Dues and fees 7,500 Insurance 69,600 57,200 Interest and bank charges 119,203 46,600 Office 101,200 108,700 Professional fees 67,700 34,800 Property taxes 44,700 40,900 Repairs and maintenance 207,100 155,100 Rent expense 84,654 - Salaries and wages 1,160,460 Travel 117,666 Utilities 67,600 1,175,600 103,900 70,200 Warranty 72,059 69,482 Income before taxes Income taxes Net income Retained earnings, opening Dividends Retained earnings, closing 48,750 $ 2,606,861 $2,561,214 164,397 286,015 70,000 76,754 94,397 209,261 2,561,214 2,360,953 9,000 Appendix III Tax information Prepared by Bruce MacDonald 1. Information regarding property, plant, and equipment at December 31: Additions to property, plant, and equipment: Manufacturing equipment Delivery trucks Office equipment Computer hardware Computer software Leased asset $ 313,888 169,370 14,230 12,110 13,670 1,068,067 $1,591,335 The manufacturing equipment and delivery trucks were acquired in February of the current year; the office equipment, computer hardware and software were acquired in November of the current year. All software additions this year were application software. Quality's building was purchased five years ago. At that time, Quality did not make an election to place the building in a separate Class 1. $325,625 of amortization is included in current-year cost of sales in the income statement. Lease payments related to the capitalized lease asset for the year amounted to $98,000 and interest on the lease liability (included in interest and bank charges) was $48,503. Lease payments under the provincial land agreement totalled $36,000 and were included in rent expense. 2. Undepreciated capital cost balances at the beginning of the year were as follows: Class 1 Class 8 Class 10 Class 12 Class 50 $ 416,400 131,800 76,300 4,360 $628,860 3. Bruce is a member of the Blue Ridge Golf and Country Club (BRGCC), where he entertains many of the company's customers and suppliers. Payments to BRGCC during the year are included in advertising and promotion and consisted of the following: monthly dues: $8,280 (total for the year) green fees: $4,360 restaurant and beverage costs: $10,290 Appendix III (continued) Tax information Prepared by Bruce MacDonald 4. Other meals and entertainment, which are included in advertising and promotion, included the following: business lunches and dinners: $9,010 tickets to sporting events: $2,870 Christmas dinner (for all of the company's employees): $3,790 5. Insurance includes premiums for Bruce's key person life insurance policy of $12,000. 6. Warranty expense is equal to the cash paid. 7. The company was late in filing its corporate tax return last year and deficient in its instalment payments during the year. Interest and penalties of $690 were charged to the company. These have been expensed on the current-year income statement. 8. The company has a net capital loss carried forward from five years ago in the amount of $4,100 ($8,200 capital loss). 9. During the year, Quality sold its portfolio investments for $35,000. Bruce was happy that a profit was made on the original cost of $29,850. The gain of $5,150 was recognized on the financial statements and included as a credit in interest and bank charges. One of the investments paid a capital dividend of $2,000 in the current year. The dividend was also included as a credit to interest and bank charges. 10. All donations made in the year were to registered charitable organizations. 11. Quality incurred $10,000 as a refinancing fee for the term loan. 12. The balances in the eligible refundable dividend tax on hand, non-eligible refundable tax on hand, and capital dividend accounts at the beginning of the year were nil. 13. Quality uses the taxes payable method for recording income tax. 14. Quality is a Canadian-controlled private corporation that is eligible for the small business deduction. The marginal rate for business income below the business limit is 14%. Quality is not associated with any other companies. 15. The marginal rate for income in excess of the business limit is 30%. The rate for aggregate investment income is 50%. 16. The $70,000 recorded as income tax expense represents instalment payments made for this tax year.