Razor's Edge Laser Cutting Inc. (Razor) is a private company that specializes in metal fabrication. Razor is located in Winnipeg and reports under International Financial Reporting Standards (IFRS). The company uses sophisticated computer-operated laser cutting machines to provide precise metal fabrication to a number of significant customers, particularly in the farm equipment manufacturing industry and to military suppliers. Razor has a June 30 year end and has been a client of the accounting firm Dion & Garrett (D&G) for a number of years.

It is August 20, 2020, and after a series of delays, Razor is now ready for D&G to perform the annual audit. The chief financial officer, Kris Munroe, wants to proceed quickly because the bank, which normally requires audited financial statements within 90 days of year end, has asked if it would be possible for D&G to complete the audit sooner. The partner on the engagement, Lionel Majors, has asked you, CPA, to lead the audit after the staff person originally scheduled became ill. Lionel has provided you with the notes from his meeting last week with Kris (Appendix I). He has also provided you with the draft balance sheet he received from Kris (Appendix II) and some planning notes that the original staff member in charge had made (Appendix III). Finally, he has provided you with excerpts from the banking agreement (Appendix IV).

The overall financial statement risk assessment, materiality, and approach have been addressed by the original staff member.

Kris acknowledges that it has been a difficult year but is optimistic about the future and is prepared to provide you with whatever documentation is required to support her point of view.

Appendix I

Notes from Lionel's meeting with Kris

During the meeting, Kris made the following comments:

It has been a difficult year for Razor. Customers have been slow to pay. Our accounts receivable greater than 90 days are higher than they were in the past. One customer in particular, Mann Farm Equipment (Mann), has caused us difficulties. Mann is one of our key customers and provides us with steady business. This year, they began paying us based on the most recent price of steel that they have in their system, rather than the price indicated on our invoice. As a result, Mann has short-paid our invoices, and we have spent a lot of time tracking the difference. Those small amounts add up, and we now have $225,000 in the over-180-days category related to Mann. We are hesitant to pursue collection of this amount given that Mann is such an important customer.

You will recall that last year, despite a small net loss of $340,000, we supported the recoverable amount of our patent, which has protected our state-of-the-art technology, with a forecast of profits related to the patent. We bought the patent in fiscal 2018 for $4 million and have been amortizing it using the straight-line method over its 20-year useful life.

As a result of new competing technology on the market, we have heard of at least one key customer that has purchased a laser machine and moved its metal fabrication in-house. Our business with that customer has slowly declined over the past year, and we filled our last order from them in June 2020.

Given the loss of this key customer, we adjusted our forecast of profits and now estimate the discounted value of future cash flows related to the patent to be $2.8 million. We are not sure what the fair value of the patent would be, as there is no active market.

We were offside on our financial covenant, a minimum current ratio, in the second and third quarters of 2020, but we managed to get back onside for year end. Taking into account the anticipated financial performance of the company over the next 12 months, we expect that Razor will be relatively profitable. We want to ensure that the bank gets the financial statements on a timely basis so it can see the improvement. Timely statements are also important because two of our major suppliers have expressed an interest in receiving copies of our audited financial statements. These are important relationships that we can't afford to ignore.

Assets Appendix II Razor's Edge Laser Cutting Inc. draft balance sheet Balance sheet As at June 30 (in '000s) Current assets Accounts receivable Income taxes recoverable Inventories Prepaid expenses Property and equipment Intangible asset - patent Liabilities 2020 (unaudited) 2019 (audited) $ 4,975 425 $ 3,565 213 3,776 2,766 200 255 9,376 6,799 4,784 5,080 3,400 3,600 $17,560 $15,479 Current liabilities Bank overdraft $ 432 165 Trade payables and accrued liabilities 3,865 2,784 Bank loan 3,365 1,730 Current portion of long-term debt 1,585 1,950 9,247 6,629 Long-term debt Shareholders' equity Share capital 4,548 5,219 13,795 11,848 Common shares 3,000 3,000 Preferred shares 2,000 Retained earnings (deficit) (1,235) 631 Total equity 3,765 3,631 $17,560 $15,479