Required Prepare the memo.

Case 4 Dunstan Electric (40 minutes)17 Dunstan Electric Inc. is a private company specializing in the sale of high-end home appliances and consumer electronics with over 40 stores across Canada. Dunstan Electric is known for its guaranteed delivery within 24 hours. The company has been owned and operated by the Dunstan family for over 30 years.

Tyler & Perry (T&P), Chartered Accountants, has audited Dunstan Electric for over 20 years. You are the audit senior on the engagement. It is now December 11, 2019, and Jack Dunstan, founder and chief executive officer (CEO), called you to say that one of the companys largest stores was completely destroyed in a fire on December 7. With less than a month until the year-end, this fire has happened at a bad time.

Dunstan Electric is insured for damage caused by fire. Inventory and capital assets that were destroyed in the fire are insured at their replacement cost, assuming that the replacement is of the same make and model as the asset destroyed or, if it is no longer available, the closest substitute. The insurance policy states that the insured will receive the fair value of the building that was destroyed whether or not it is rebuilt. There is no business interruption insurance policy.

The statement of claim is currently being prepared. Once the insurers receive the claim, it will be validated, approved, and then paid within 60 days of approval. The accounting staff started working on the claim but have not yet completed it.

Anne Cooper, the engagement partner, has just met with Mr. Dunstan to obtain more information about the incident and the losses sustained (Exhibit I). You also obtain the November 2019 financial statements to help you plan for this years audit engagement (Exhibit II). Anne would like you to prepare a memo outlining the financial accounting considerations and any other issues resulting from the fire.

ExhibitI Information from Dunstan Electric According to the records at head office, the book values of the destroyed capital assets are as follows:

Building = Cost $722,000 & Net book value 545,000 Fixtures, computer hardware, and software = Cost & 495000 & Net bookvalue $221000

Preliminary estimates include the following:

Building

Since the building was completely destroyed in the fire, a new one must now be built. As required by the insurance company, estimates from two contractors have already been received.

Contractor A Contractor B Labour $ 652,000 $ 523,000 Material 963,000 942,000 $1,615,000 $1,465,000 Jack Dunstan has never dealt with Contractor A, but the contractor has assured Jack that the building can be rebuilt similar to the newer, more modern Dunstan Electric stores. Contractor B was used for the construction of the last six Dunstan Electric stores. It is estimated to take six to eight months to rebuild the burnt store.

Jack and the insurers are currently negotiating which contractor to select. Jack has decided not to record any insurance proceeds until the negotiations are complete, and instead has booked a loss of $545,000 on the building for the year ended December 31, 2019.

Sales

No goods were sold or received after the fire. The salespeople estimated the weeks worth of sales before the fire took place, since the weekly update to the main server was lost. Ninety percent of Dunstans sales are on cash or credit card basis. For the cash and credit card sales, bank deposits are made on a daily basis by the stores. A printout of the web-based bank statement is made at head office to confirm the deposit information. The remaining 10% of sales are financed in-house. The financing application is approved at the time of the purchase by the store and the information is transferred to head office as part of the weekly update.

Inventory

The destruction of the IT systems also created havoc in determining year-end inventory for the destroyed store. Since it is the holiday season, inventory levels of electronic goods are kept at higher levels than normal. To expedite the receipt of proceeds from the insurers, Jack went ahead and estimated the ending inventory by obtaining the inventory levels as at the date of the fire for the other three similar-sized Dunstan Electric stores:

(in $ millions) Store #26 Store #8 Store #37 Store #23 (destroyed) InventoryDec. 7, 2019 (estimated) 1.6 1.3 1.9 Unavailable InventoryNov. 30, 2019 1.5 1.2 1.8 1.6 Year-to-date revenuesDec. 7, 2019 (estimated) 16.4 12.9 17.4 Unavailable Year-to-date revenuesNov. 30, 2019 15.3 12.0 15.8 15.5 Jack recorded insurance proceeds receivable of $1.9 million since he believes that Store #37 best approximates the destroyed stores activities. Jack noted, however, that some broken and older electronics items were being set aside at each of the stores in preparation for the year-end inventory count. He has no idea of the value of these items in the burnt store and has not attempted to back out an amount from the other stores figures.

Other fire-related costs

The loss of the store has meant additional costs will be incurred:

Salaries still to be paid while employees are not able to work: $110,000

Estimated site-demolition and clean-up cost: $500,000

Municipal bylaws require a demolition of the building within 30 days. These costs will be expensed for accounting purposes.

Other

Dunstan Electric just refinanced its operating line of credit with its bank in November. As a result of this agreement, the bank now requires the audited financial statements for 2019 to be finalized no later than February 5, 2020.

Jack was reviewing the draft financial statements and noticed the gross margin went up 6%. Jack believes that the increase is directly related to sales of electronic goods. Other staff believe otherwise. They do not have much management information on hand to help them analyze the reason for the increase.

ExhibitII Draft income statement for Dunstan Electric For the periods ended November 30 (in $000s) 2019 (11 months) 2018 (11 months) Sales $352,653 $262,935 Cost of goods sold Opening inventory 45,644 49,885 Purchases 229,587 179,225 Closing inventory (44,254) (44,569) 230,977 184,541 Gross profit 121,676 78,394 Operating expenses Salaries and commissions 23,568 16,555 Bonuses 5,522 2,215 Advertising 10,555 8,855 Freight and transportation 3,556 1,950 Amortization 7,587 5,963 Professional fees 2,559 1,754 Office 2,998 1,335 Utilities 4,659 3,445 Miscellaneous 4,445 1,442 65,449 43,514 Income from operations 56,227 34,880 Other income and expenses 2,558 1,778 Income before taxes 53,669 33,102 Income taxes 21,468 13,240 Net income $ 32,201 $ 19,862 Required Prepare the memo to Anne Cooper.

Building Fixtures, computer hardware, and software Cost $722,000 $495,000 Net book value 545,000 221,000 Contractor A Contractor B Labour $ 523,000 $ 652,000 Materials 963,000 942.000 $1,615,000 $1,465,000 (in S millions) Store Store Store Store #23 #26 #8 #37 (destroyed) Inventory-Dec. 7, 2019 (estimated) 1.6 1.3 1.9 Unavailable Inventory-Nov. 30, 2019 1.5 1.2 1.8 1.6 Year-to-date revenues-Dec. 7, 2019 16.4 12.9 17.4 Unavailable (estimated Year-to-date revenues-Nov. 30, 2019 15.3 12.0 15.8 15.5 Building Fixtures, computer hardware, and software Cost $722,000 $495,000 Net book value 545,000 221,000 Contractor A Contractor B Labour $ 523,000 $ 652,000 Materials 963,000 942.000 $1,615,000 $1,465,000 (in S millions) Store Store Store Store #23 #26 #8 #37 (destroyed) Inventory-Dec. 7, 2019 (estimated) 1.6 1.3 1.9 Unavailable Inventory-Nov. 30, 2019 1.5 1.2 1.8 1.6 Year-to-date revenues-Dec. 7, 2019 16.4 12.9 17.4 Unavailable (estimated Year-to-date revenues-Nov. 30, 2019 15.3 12.0 15.8 15.5