REQUIREMENT 7

It was a pretty autumn day in late October 20X4. Tom Fasbee had just returned from vacation.He was getting caught up on the many matters that no one else had handled while he was gone. Near the middle of a stack of messages, he found a note from Nick Riley. Nick requested an appointment with Tom and you. Tom arranged a meeting with Nick, Ray, Jerry, and you for 2:00 P.M. the next day at Aguamaint.

Once the meeting began, Nick reminded Tom of a pickleball engagement and then got down to business. First, Nick noted that maintenance work and merchandise sales were going like "gangbusters." To meet demand, Aguamaint now was running two crews at night and had also begun selling inventory parts separate from the maintenance work.

Tom asked what steps had been taken to expand their customer base.Ray replied that Aguamaint had acquired a 20 percent interest in the small dealership, PVCO, which carried their line of pumps and valves.Ray also had been appointed a member of PVCO's board.This new investment would give Aguamaint the opportunity to observe and learn the equipment supply business first hand. If things went well, Aguamaint would later consider acquiring the remaining interest in the dealership.

Ray indicated that Aguamaint had paid more than book value for the stock because PVCO owned an important patent that had been developed internally that was not included in their financial statements. The patent has a remaining life of 4 years. You also learned later from Linda Durkee that the equity method of accounting was not allowed for tax purposes. For tax purposes, such investments were recorded at cost, and the only income reported came from dividends.Linda Durkee also revealed that when equity ownership equals 20 percent or more, the dividends received deduction is 65 percent rather than 50 percent.

Nick then stated that because they had the expertise in-house, the Company had decided to take on the construction of a water treatment plant for a small town nearby. As it happened, a warehouse had come up for sale just a block away from the shop, and although it was larger than what they needed to house the inventory items, the extra space was perfect for setting up the facility needed to support construction projects. The warehouse was purchased on March 15, 20X4. All equipment needed to move and store the inventory and to perform the work related to the construction of the water treatment plant was purchased and put into use on the same date.

The financing for these investments was provided in part by a local investor who had been Nick's college roommate and was a trusted friend. He has been so impressed by the growth and potential of Aguamaint, that he was eager to negotiate a convertible bond, with the idea of becoming an owner in the future if the company continued on its current path. The bond was set up with the same covenants that the Bank had required on the note, and also required that the annual financial statements would be audited instead of reviewed as in the first three years. The bond was set up to convert to 3,400 shares of common stock any time after two years of the five year term.

Jerry hoped that Lake & Lock would accept the engagement and that you would conduct the audit.Although the thought of one more time crossed your mind, the engagement was accepted.In parting, you asked Jerry to furnish 20X4 financial statements in early January.Because of the large increase in the pump and valve inventory levels, you also requested that

Lake & Lock be involved with the year-end physical inventory. This prompted Jerry to ask whether expanding the line of merchandise and doing construction would put Aguamaint in two or three lines of business and whether this would impact the financial statements.

You observed the physical inventory in late December and found that the construction job was well underway. On January 16, 20X5, Jerry sent you copies of the financial statements and related schedules, and a pre-audit meeting was scheduled for January 19.

REQUIRED:

The journal entries and financial statements prepared by Jerry Loos are attached.Review these data and list of additional information needed from Jerry.Be as specific as possible and phrase your requests in the form of questions as they normally would be asked of a client. You should also be prepared to explain your reasons for asking specific questions. Once again, Jerry has asked you to prepare the statement of cash flows, statement of changes in stockholders' equity, financial statement notes, and earnings per share disclosures once the audit is complete. He also reminded you that the Bank wants comparative statements and requires the fair value of all financial instruments and information on major customers be disclosed.

AGUAMAINT, INC.

BALANCE SHEET

DECEMBER 31, 20X4

Current asset

cash 320423

Account receivable 392100

Allowance for doubtful accounts (36000)

Inventory 333748

supplies on hand 14845

Prepaid Insurance 427

Total current asset 1025543

Property , Plant, and Equipement

Land 134000

Equipement 190700

Accumulated depreciation equipement (49067)

Vehicles

258,000

Accumulated depreciation--vehicles

(126,400)

Warehouse

410,000

Accumulated depreciation--warehouse

(10,250)

Total Property, Plant, and Equipment

RIGHT OF USE ASSETS

806,983

Operating lease-building

235,379

Finance lease-trucks

73,442

Total Right of Use Assets

INTANGIBLE ASSETS

308,821

License agreement

35,200

Total Intangible Assets

OTHER ASSETS

35,200

Marketable equity investment

216,885

AFS bond investment

100,556

Long-term investment

415,000

Deferred income tax

56,186

20X4

Total Other Assets788,627

TOTAL ASSETS$2,965,174

STOCKHOLDERS' EQUITY

Common stock

150,000

Retained earnings

1,458,725

AGUAMAINT, INC.

STATEMENT OF INCOME

FOR THE YEAR ENDING DECEMBER 31, 20X4

Service contract revenue

$3,041,000

Sales revenue

1,242,000

Construction revenue (Note 14)

167,000

Total revenue

4,450,000

Cost of services sold

1,251,944

Cost of goods sold

864,810

Construction cost of goods sold (Note 14)

176,221

20X4

Cost of goods sold2,292,975

Gross profit2,157,025

Other income (expense)

Investment income (loss)

14,340

Interest expense

(25,475)

Total other income (expense)

(11,135)

Operating income before income taxes

1,065,601

Income tax expense

(223,776)

Net income

$841,825

Service contract revenue

$3,041,000

Sales revenue

1,242,000

Construction revenue (Note 14)

167,000

Total revenue

4,450,000

Cost of services sold

1,251,944

Cost of goods sold

864,810

Construction cost of goods sold (Note 14)

176,221

20X4

Cost of goods sold2,292,975

Gross profit2,157,025

Operating expenses

Selling and administrative

968,386

Depreciation and amortization

111,902

Total operating expenses1,080,289

Operating income1,076,736

Accumulated other comprehensive income

(145,176)

Total Stockholders' Equity

1,463,549

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$2,965,174

AGUAMAINT, INC.

JOURNAL ENTRIES

DECEMBER 31, 20X4

1

1/1/X4

410

LEASE PAYABLE-BUILDING

39,000

101

CASH

39,000

To record operating lease payment on shop and office building.

2

2/1/X4

412

LEASE PAYABLE-TRUCKS

26,198

101

CASH

26,198

To record finance lease payment on truck.

3

2/1/X4

311

INTEREST PAYABLE-NOTES

9,627

401

LONG-TERM DEBT-NOTES

50,400

101

CASH

60,027

To record annual payment on note.

4

2/1/X4

132

PREPAID INSURANCE

160

610

SELLING & ADMIN-INSURANCE

4,960

101

CASH

5,120

To purchase annual insurance policy.

5

523

COST OF GOODS SOLD-WAREHOUSE RENT

7,500

101

CASH

7,500

To record payment of rent on warehouse.

6

3/15/X4

151

LAND

134,000

161

BUILDINGS

410,000

171

EQUIPMENT

148,000

101

CASH

692,000

To record purchase of warehouse, forklifts, conveyor belts, and construction equipment.

7

6/1/X4

202

EQUITY SECURITIES-EQUITY METHOD INTEREST

415,000

101

CASH

415,000

To record purchase of investment in affiliate PVCO.

8

6/30/X4

101

CASH

1,500

750

INTEREST REVENUE-AFS DEBT SEC

1,500

To record receipt of semi-annual interest on AFS bond investment.

9

7/1/X4

101

CASH

535,163

754

DEBT ISSUE EXPENSE

1,750

404

DISCOUNT AND DEBT ISSUE COSTS ON BOND PAYABLE

7,087

403

LONG-TERM DEBT-BONDS

544,000

To record convertible bond issue.

10

108

ALLOWANCE FOR DOUBTFUL ACCOUNTS

46,000

105

ACCOUNTS RECEIVABLE

46,000

To write off uncollectible accounts.

11

101

CASH

355,000

105

ACCOUNTS RECEIVABLE

2,764,000

335

DEFERRED CONTRACT REVENUE

78,000

505

SERVICE REVENUE FROM CONTRACTS WITH CUSTOMERS

3,041,000

To record service revenue for 20X4.

12

121

MERCHANDISE INVENTORY

946,330

301

ACCTS PAY-INVENTORIABLE COSTS

946,330

To record purchase of inventory via air freight.

13

105

ACCOUNTS RECEIVABLE

1,242,000

501

SALES REVENUE

1,242,000

To record sales revenue for 20X4.

14

521

COST OF GOODS SOLD-INVENTORY

794,880

121

MERCHANDISE INVENTORY

794,880

To record cost of inventory sold.

15

101

CASH

1,146,900

105

ACCOUNTS RECEIVABLE

1,146,900

To record customer payments on account for merchandise sales.

16

101

CASH

2,624,000

105

ACCOUNTS RECEIVABLE

2,624,000

To record client payments on account for service contracts.

17

560

SERVICE COSTS-DIRECT-CREW WAGES

728,721

305

WAGES PAYABLE

15,140

305

WAGES PAYABLE

27,930

101

CASH

715,931

To record payment and accrual of wage expense.

18

561

SERVICE COSTS-INDIRECT-SHOP WAGES

308,700

305

WAGES PAYABLE

5,024

305

WAGES PAYABLE

8,870

101

CASH

304,854

To record payment and accrual of wage expense.

19

631

SELLING & ADMINISTRATIVE-OTHER

14,005

611

SELLING & ADMIN-OFFICERS SALARIES

202,800

612

SELLING & ADMIN-OTHER SALARIES

65,020

609

SELLING & ADMIN-PROFESSIONAL FEES

8,381

615

SELLING & ADMIN-PAYROLL AND OTHER TAXES

123,260

607

SELLING & ADMIN-SUPPLIES

12,980

101

CASH

426,445

To record payment of various selling and administrative expenses.

20

562

SERVICE COSTS-INDIRECT-SHOP UTILITIES

30,345

601

SELLING & ADMIN-UTILITIES

6,069

101

CASH

36,414

To record payment of utilities.

21

553

SERVICE COSTS-DIRECT-FUEL

82,050

101

CASH

82,050

To record fuel purchases.

22

129

SUPPLIES ON HAND

890

564

SERVICE COSTS-INDIRECT-SUPPLIES

54,869

302

ACCTS PAY-SUPPLIERS-OTHER COSTS

55,759

To record purchase of supplies and adjustment of year end balance.

23

302

ACCTS PAY-SUPPLIERS-OTHER COSTS

50,574

314

INCOME TAX PAYABLE

44,467

101

CASH

95,041

To record payment to suppliers and to IRS for taxes.

24

554

SERVICE COSTS-DIRECT-R AND M

14,760

101

CASH

14,760

To record payment of repairs and maintenance costs.

25

603

SELLING & ADMIN-MEDICAL BENEFITS

47,190

101

CASH

47,190

To record purchase of health insurance policy.

26

314

INCOME TAX PAYABLE

99,045

101

CASH

99,045

Record payment of estimated 20X4 taxes based on 90% of 20X3 current tax payable.

27

522

COST OF GOODS SOLD-AIR FREIGHT

62,430

101

CASH

62,430

To record payment of air freight bill.

28

613

SELLING & ADMIN-SALES SAL & COMM

37,260

101

CASH

37,260

To record payment of sales salaries and commissions.

29

614

SELLING & ADMIN- WAREHOUSE WAGES

241,540

101

CASH

241,540

To record payment of warehouse wages.

30

301

ACCTS PAY-INVENTORIABLE COSTS

828,230

101

CASH

828,230

To record payment to inventory supplier.

31

581

COST OF CONSTRUCTION

176,221

101

CASH

176,221

To record cost of water plant construction project to date.

32

101

CASH

167,000

511

CONSTRUCTION REVENUE FROM CONTRACTS WITH CUSTOMERS

167,000

To record receipt of monthly billings on water plant project.

33

422

WARRANTY LIABILITY

2,203

101

CASH

2,203

To record payment to repair and replace pump and valve inventory items.

34

101

CASH

3,700

805

INVESTMENT INCOME-INVEST IN AFFILIATE

3,700

To record receipt of affiliate PVCO dividends.

35

101

CASH

6,400

804

DIVIDEND INCOME-MKT EQ SEC-LT

6,400

To record receipt of dividends on AEP shares.

36

12/31/X4

101

CASH

1,500

750

INTEREST REVENUE-AFS DEBT SEC

1,500

To record receipt of semi-annual interest on AFS bond investment.

37

12/31/X4

701

TRUCK DEPRECIATION

43,867

182

VEHICLES-ACCUMULATED DEPRECIATION

43,867

To record annual depreciation expense on trucks.

38

12/31/X4

704

EQUIPMENT DEPRECIATION

6,100

172

EQUIPMENT-ACCUMULATED DEPRECIATION

6,100

To record annual depreciation expense on office equipment.

39

12/31/X4

710

AMORTIZATION OF LICENSING COSTS

3,200

197

LICENSE

3,200

To record annual amortization of licensing cost.

40

12/31/X4

708

AMORTIZATION OF RIGHT-OF-USE ASSETS

23,819

758

INTEREST EXPENSE-LEASE PAYABLE

3,270

193

RIGHT-OF-USE ASSET--LEASE-TRUCKS

23,819

312

INTEREST PAYABLE-FINANCE LEASE LIABILITY

3,270

To record amortization and interest expense on finance lease for truck.

41

12/31/X4

751

INTEREST EXPENSE-NOTE PAYABLE

6,855

311

INTEREST PAYABLE-NOTES

6,855

To accrue interest expense on note payable.

42

12/31/X4

616

SELLING & ADMIN-PENSION SERVICE COST

147,422

414

PENSION LIABILITY

37,422

101

CASH

110,000

To record annual pension expense and payment to pension trustee.

43

12/31/X4

401

LONG-TERM DEBT-NOTES

3,024

321

SHORT-TERM PORTION OF L-T NOTES

3,024

To reclassify needed amount to current portion per amortization schedule.

44

12/31/X4

205

DEBT SECURITIES-AFS MARKETABLE

1,856

473

ACCUM OCI-MARKET GAIN/LOSS-AFS DEBT SECURITES

1,856

To adjust bond investment to market.

45

12/31/X4

201

EQUITY SECURITIES-LONG TERM MARKETABLE

1,240

801

MARKET GAIN/LOSS-MKT EQ SEC

1,240

To adust AEP investment to market.

46

12/31/X4

704

EQUIPMENT DEPRECIATION

24,667

172

EQUIPMENT-ACCUMULATED DEPRECIATION

24,667

To record depreciation expense on new equipment.

47

12/31/X4

706

WAREHOUSE DEPRECIATION

10,250

162

BUILDINGS-ACCUMULATED DEPRECIATION

10,250

To record depreciation expense on new warehouse.

48

12/31/X4

753

INTEREST EXPENSE-BOND PAYABLE

13,600

101

CASH

13,600

To record payment of interest to bondholder.

49

12/31/X4

651

SELLING & ADMIN- BAD DEBTS

51,000

108

ALLOWANCE FOR DOUBTFUL ACCOUNTS

51,000

To adjust ADA to needed balance of $51,000.

50

12/31/X4

563

SERVICE COSTS-INDIRECT-LEASE EXPENSE-SHOP BLDG

32,500

602

SELLING & ADMIN-LEASE EXPENSE-OFFICE BLDG

6,500

191

RIGHT-OF-USE ASSET--LEASE-BUILDING

27,259

410

LEASE PAYABLE-BUILDING

11,741

To accrue lease expense and properly apply amortization and interest to balance sheet.

51

12/31/X4

821

INCOME TAX EXPENSE

223,776

314

INCOME TAX PAYABLE

223,776

To record income tax expense for 20X4.

Totals

15,753,173

15,753,173