Requirement:

Identification and Analysis of Issues	/80
Issue 1: Preferred Shares	/20
Issue 2: Compensatory Stock Option Plan	/10
Issue 3: Aluminum Forward Contract	/10
Issue 4: Revised Net Income	/10
Issue 5: Deferred Taxes	/15
Issue 6: Earnings Per Share Calculation	/15
Recommendation	/10
Provides appropriate recommendation given the case facts and analysis completed	/10

Car-Tunes Ltd. Car-Tunes Ltd. is a young company that recently completed its initial public offering. The company designs and develops leading-edge car stereo equipment, including MP4 compatible decks, speakers, amplifiers, and subwoofers. The company is investing heavily in research and development. In order to reduce strain on cash, the management team is compensated mostly through share-based compensation in the current year. In addition, the company has raised cash through the issuance of common shares in the open market, and by offering various complex financial instruments. Management believes that all cash should be diverted toward the research and development process in order for the company to become the leader in automotive stereo equipment In addition to the stock options, management receives a bonus of 5% of net income if diluted EPS is greater than $0.10. The bonus is the only cash compensation that management receives at this stage of the company's life cycle. Management is excited because this year's draft income statement (Exhibit I) shows diluted EPS in excess of $0.10, and therefore, a bonus will be paid. Lebeau and Liang LLP has been the auditor of Car-Tunes since the company's inception. You are a senior accountant with the firm, and have been assigned the year-end audit for Car-Tunes. The partner, Sharmila Chaudary, has just met with the company's management, and discussed various accounting issues. She has asked you to prepare a report to be provided to the client that addresses all of the accounting issues, along with any other issues that you feel are important. Sharmila's notes from the meeting can be found in Exhibit II. In addition, the company's current and future tax expenses must be calculated. Tax-related details can be found in Exhibit III. Required Prepare a report for Sharmila. IFRS is the appropriate accounting standards for Car-Tunes. EXHIBITI - DRAFT INCOME STATEMENT CAR-TUNES LTD. AS AT DECEMBER 31, 2017 REVENUE Cost of goods sold Gross margin $44,500,740 23,540,891 20,959,849 $ 175,000 1,575,000 1,276,758 87,500 85,000 EXPENSES Accounting and consulting fees Advertising and promotion Amortization Bad debt Insurance Interest on convertible bonds Legal fees Office and general expenses Rent Repairs and maintenance Research and development Travel Utilities Wages and benefits 80,000 225,500 750,850 325,000 450,755 11,345,000 133,750 333,565 325,000 $17,168,678 Earnings for the year before income taxes Income tax expense Earnings for the year $ 3,791,170 1,137,351 $ 2,653,819 $0.13 $0.11 Earnings per share-basic Earnings per share-diluted Weighted average shares outstanding-basic Weighted average shares outstanding-diluted 20,550,750* 25,880,750* EXHIBIT II - NOTES FROM THE PARTNER'S MEETING WITH CAR-TUNES LTD.'S MANAGEMENT 1. At the beginning of the year, the board of directors approved a compensatory stock option plan that grants options to the company's four executives to purchase 100,000 shares each of the company's common shares. The board expects that the period of benefit/service for these options is two years. The options can be exercised at a strike price of $1 per share any time over a three-year period com- mencing after the initial two-year service period ends. The fair value of the options, as determined using an option pricing model, is $1,550,000. 2. The company issued 500,000 preferred shares for $4 per share to an investment bank in June 2017. Each preferred share is convertible for a fixed number of common shares (6 common shares), and has a mandatory 7% annual dividend that must be paid on December 31 of each fiscal year. The shares must be redeemed by the company for cash if the market price of the common shares exceeds $4 per share. Currently, the common shares are in a trading range around $1.25 per share. The board declared and paid the mandatory cash dividend on December 31. 3. At the beginning of the current year, the company issued $2.5 million convertible bonds, of which $2 million was correctly allocated to debt. The bonds' market yield is 4% annually, pay interest semi- annually, mature in five years, and can be converted into common shares at the ratio of 1,500 shares per $1,000 bond. 4. Given the volatility of commodity prices, Car-Tunes entered into a forward contract with the Bank of Vancouver. On July 1, Car-Tunes locked the price of 5 million kg of aluminum at $1.25/kg. Alumi- num is important to the company's operation because it is used to create a cabinet that houses all of the components in the CD player deck. Upon its inception, Car-Tunes did not have to put forth any cash. All cash transfers will take place on settlements in two years. As at December 31, the price of aluminum is trading on the Chicago Board of Trade at $1.15/kg. EXHIBIT III - TAX-RELATED DETAILS 5. The company's tax rate is 30%. The income statement tax amount is calculated with the taxes pay- able method. 6. The office and general expense account contains $85,000 in meals and entertainment. 7. There are $175,000 in non-deductible expenses included in the accounting and consulting fees line item on the income statement EXHIBIT III TAX-RELATED DETAILS 5. The company's tax rate is 30%. The income statement tax amount is calculated with the taxes pay- able method. 6. The office and general expense account contains $85,000 in meals and entertainment. 7. There are $175,000 in non-deductible expenses included in the accounting and consulting fees line item on the income statement. 8. The net book value (NBV) and undepreciated capital cost (UCC) for the capital assets are as follows: NBV UCC 2017 2016 2017 2016 n/a n/a Land Buildings Furniture and fixtures Machinery and equipment Leasehold improvements $ 1,250,000 4,500,750 650,000 12,567,000 2,456,000 $ 1,250,000 4,650,775 693,333 13,404,800 2,701,600 $ 2,767,211 412,533 7,975,856 1,607,452 $12,763,052 $ 3,255,543 485,333 9,383,360 1,891,120 $21,423,750 $22,700,508 $15,015,356 9. There were no capital asset additions or dispositions during the year. Car-Tunes Ltd. Car-Tunes Ltd. is a young company that recently completed its initial public offering. The company designs and develops leading-edge car stereo equipment, including MP4 compatible decks, speakers, amplifiers, and subwoofers. The company is investing heavily in research and development. In order to reduce strain on cash, the management team is compensated mostly through share-based compensation in the current year. In addition, the company has raised cash through the issuance of common shares in the open market, and by offering various complex financial instruments. Management believes that all cash should be diverted toward the research and development process in order for the company to become the leader in automotive stereo equipment In addition to the stock options, management receives a bonus of 5% of net income if diluted EPS is greater than $0.10. The bonus is the only cash compensation that management receives at this stage of the company's life cycle. Management is excited because this year's draft income statement (Exhibit I) shows diluted EPS in excess of $0.10, and therefore, a bonus will be paid. Lebeau and Liang LLP has been the auditor of Car-Tunes since the company's inception. You are a senior accountant with the firm, and have been assigned the year-end audit for Car-Tunes. The partner, Sharmila Chaudary, has just met with the company's management, and discussed various accounting issues. She has asked you to prepare a report to be provided to the client that addresses all of the accounting issues, along with any other issues that you feel are important. Sharmila's notes from the meeting can be found in Exhibit II. In addition, the company's current and future tax expenses must be calculated. Tax-related details can be found in Exhibit III. Required Prepare a report for Sharmila. IFRS is the appropriate accounting standards for Car-Tunes. EXHIBITI - DRAFT INCOME STATEMENT CAR-TUNES LTD. AS AT DECEMBER 31, 2017 REVENUE Cost of goods sold Gross margin $44,500,740 23,540,891 20,959,849 $ 175,000 1,575,000 1,276,758 87,500 85,000 EXPENSES Accounting and consulting fees Advertising and promotion Amortization Bad debt Insurance Interest on convertible bonds Legal fees Office and general expenses Rent Repairs and maintenance Research and development Travel Utilities Wages and benefits 80,000 225,500 750,850 325,000 450,755 11,345,000 133,750 333,565 325,000 $17,168,678 Earnings for the year before income taxes Income tax expense Earnings for the year $ 3,791,170 1,137,351 $ 2,653,819 $0.13 $0.11 Earnings per share-basic Earnings per share-diluted Weighted average shares outstanding-basic Weighted average shares outstanding-diluted 20,550,750* 25,880,750* EXHIBIT II - NOTES FROM THE PARTNER'S MEETING WITH CAR-TUNES LTD.'S MANAGEMENT 1. At the beginning of the year, the board of directors approved a compensatory stock option plan that grants options to the company's four executives to purchase 100,000 shares each of the company's common shares. The board expects that the period of benefit/service for these options is two years. The options can be exercised at a strike price of $1 per share any time over a three-year period com- mencing after the initial two-year service period ends. The fair value of the options, as determined using an option pricing model, is $1,550,000. 2. The company issued 500,000 preferred shares for $4 per share to an investment bank in June 2017. Each preferred share is convertible for a fixed number of common shares (6 common shares), and has a mandatory 7% annual dividend that must be paid on December 31 of each fiscal year. The shares must be redeemed by the company for cash if the market price of the common shares exceeds $4 per share. Currently, the common shares are in a trading range around $1.25 per share. The board declared and paid the mandatory cash dividend on December 31. 3. At the beginning of the current year, the company issued $2.5 million convertible bonds, of which $2 million was correctly allocated to debt. The bonds' market yield is 4% annually, pay interest semi- annually, mature in five years, and can be converted into common shares at the ratio of 1,500 shares per $1,000 bond. 4. Given the volatility of commodity prices, Car-Tunes entered into a forward contract with the Bank of Vancouver. On July 1, Car-Tunes locked the price of 5 million kg of aluminum at $1.25/kg. Alumi- num is important to the company's operation because it is used to create a cabinet that houses all of the components in the CD player deck. Upon its inception, Car-Tunes did not have to put forth any cash. All cash transfers will take place on settlements in two years. As at December 31, the price of aluminum is trading on the Chicago Board of Trade at $1.15/kg. EXHIBIT III - TAX-RELATED DETAILS 5. The company's tax rate is 30%. The income statement tax amount is calculated with the taxes pay- able method. 6. The office and general expense account contains $85,000 in meals and entertainment. 7. There are $175,000 in non-deductible expenses included in the accounting and consulting fees line item on the income statement EXHIBIT III TAX-RELATED DETAILS 5. The company's tax rate is 30%. The income statement tax amount is calculated with the taxes pay- able method. 6. The office and general expense account contains $85,000 in meals and entertainment. 7. There are $175,000 in non-deductible expenses included in the accounting and consulting fees line item on the income statement. 8. The net book value (NBV) and undepreciated capital cost (UCC) for the capital assets are as follows: NBV UCC 2017 2016 2017 2016 n/a n/a Land Buildings Furniture and fixtures Machinery and equipment Leasehold improvements $ 1,250,000 4,500,750 650,000 12,567,000 2,456,000 $ 1,250,000 4,650,775 693,333 13,404,800 2,701,600 $ 2,767,211 412,533 7,975,856 1,607,452 $12,763,052 $ 3,255,543 485,333 9,383,360 1,891,120 $21,423,750 $22,700,508 $15,015,356 9. There were no capital asset additions or dispositions during the year