Question

Need help with this caseQuality Cabinets Inc. (Quality) manufactures custom kitchen cabinets from its

location in Squamish, B.C. 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.

It is January 31.

Task #1

Bruce has asked for an analysis of the accounting issues described in Appendix I. Quality reports its financial statements in accordance with Accounting Standards for Private Enterprises (ASPE).

Your response should not exceed four pages.

Task #2

Bruce also requires a calculation of taxable income for the most recent year ended December 31. The calculation should be prepared in Excel.

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 small business deduction. Bruce has provided you with the draft statement of income and retained earnings (Appendix II) and additional information you will need (Appendix III).

Your response, not including any Excel worksheets, should not exceed one half of a page.

Note: Unless otherwise noted, use the tax rates and tax regulations pertaining to the most recent calendar year end to your module.

Appendix I

Description of accounting issues

1. Quality entered into a leasing agreement with the provincial government at the beginning of the recently ended fiscal year. 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. A condition of this agreement is that Quality replant trees at the end of the five-year lease agreement. Quality estimates that this will cost $500,000 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.

2. On February 1 of the most recently ended fiscal year, 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 were:

Investment in HBI 400,000

Cash 400,000

HBI has a December 31 year end and reported net income of $1,400,000 for the most recent fiscal year, 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)

Current year

Prior year

(Draft)

(Audited)

Sales

$ 8,959,800

$ 8,834,000

Cost of sales

5,949,648

6,129,709

Gross profit

3,010,152

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

1,175,600

Travel

117,666

103,900

Utilities

67,600

60,200

Warranty

72,059

69,482

Income before taxes

154,397

296,015

Income taxes (Note 1)

70,000

76,754

Net income

84,397

219,261

Retained earnings, opening

2,571,214

2,360,953

Dividends

48,750

9,000

Retained earnings, closing

$ 2,606,861

$ 2,571,214

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

$ 513,888

Delivery trucks

169,370

Office equipment

14,230

Computer hardware

12,110

Computer software

13,670

Leased asset

1,068,067

$ 1,791,335

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 at the accelerated rate of 10%.

$326,625 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

$ 416,400

Class 8

131,800

Class 10

76,300

Class 12

15,300

Class 43

765,775

Class 50

4,360

$ 1,409,935

3. Bruce is a member of the Predator Ridge Golf and Country Club (PRGCC), where he entertains many of the company's customers and suppliers. Payments to PRGCC 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

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 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 refundable dividend 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 small business income is 14%.

15. The marginal rate for income in excess of the small business deduction is 30%. The rate for aggregate investment income is 50%.

16. The $70,000 recorded as income tax expense represents installment payments made for this tax year.