Simcoe Lawns Ltd. (SLL) was founded by Mike Evergreen on January 1, 2018. SLL is a small private corporation selling lawn equipment and specializing in do-it-yourself sprinkler systems. After beginning in Midland, Ontario with revenues in the first year of operations of $300,000, SLL now has three locations in Central Ontario. Revenues increased substantially during 2019. Mike Evergreen is the majority shareholder. Mike's cousin Matt owns some of the common shares after purchasing them this year. It is now March 2020 and Mike Evergreen has just left the office of one of the Senior Partners at BBJuP, the CPA firm that you work. You are a recently minted CPA and have been asked to assist the senior partner with this project. Mike had done his accounting on his own the past two years and thinks that he has done a really good job. He is looking to expand his operations but when he went to the bank in November of 2019 , they suggested he come to them with his financial statements at the end of the year. A friend of Mike suggested that he come and talk to your partner first and show her the statements. Mike is looking for a $100,000 loan in order to expand his operations and take advantage of the growing lawn irrigation industry and grass alternatives: The bank suggested to Mike that they typically offer a loan to companies such as his at prime +1.5%. Prime is currently 3.95% and the bank stated that the loan they would provide Mike would be no larger than 20% of SLL's receivables and inventories as of December 31,2019 . He would be required to maintain a current ratio of at least 1.4:1 or the loan may become would be required to maintain a current ratio of at least 1.4:1 or the loan may become immediately payable. Mike has provided your firm with his income statement for 2019 and his balance sheets for 2018 and 2019. He doesn't have his 2018 income statements but was able to tell you his 2018 revenues (see first paragraph) and his cost of goods sold was $160,000. He states that based on these statements, that it should be a 'slam dunk' that he will get the loan. In addition, although Mike believes he is doing a great job taking care of his own books, one of the things the bank mentioned was having an audit done and setting up accounting policies. As Mike stated in the meeting "my only sense of an audit is when those tax guys come in and make my life miserable looking for all the little pennies." As a result of his meeting in 2019 with the bank, Mike would also like your help in establishing accounting policies for his young growing company. He would like your firm to evaluate his accounting issues and provide recommendations on how to account for these items given the current situation. He would also like to know what an audit does for him and what GAAP is all about. After Mike leaves, your paitner takes a deep breath first before she speaks. "There's obviously lots to do here for Mike in a short period of time. Let's start by looking at the financial statement information that he has given us. I think we're going to have to adjust it based on what he has told us that he's done, so go ahead and do that. Makes sense to use a spreadsheet for that and for all the statement information. Given Mike size, we'll be setting up his stahrments folowing ASPE Rombe ber that when jou are andyong these enm, ae pe looking at establshing accourling polcet, so be aware of any that you need to focus en and support Aeer yooi done that, leis put a cash flow statement dogether alorng with the balance of the ndusted fenancia statnments. Finaly, a thoebugh andysis neets to be performed so prepare a report thal roaly looks an his siluation and the muset-semenbecit that the bark is looking at al of this. Required: Prepare the report ia the Partner - SLL inventory consists of items such as hoses, sprinklers, sprinkler heads, fertilizer and other types of lawn equipment. Information presented to you as of December 31st showed $346,000 in inventory at cost. Mike left you a note stating that the inventory actually has a market value of $356,000 and has adjusted his inventory on these preliminary, unaudited financial statements to this amount as he believes that his inventory should be represented on his balance sheet at fair market value given the high demand for equipment. Mike tells you that he put the $10,000 difference to Revenue. "Has to be right", he said "it's like I made money". - During the year SLl. signed a contract with a company that owns 10 hotels. SLL has agreed to supply them with lawn irrigation equipment for the next 5 years. The contract included an $80,000 upfront amount in order for SLL to begin to acquire the equipment and takes effect February 1, 2020. The cash was received January 15, 2020 and Mike has recorded this forthcoming contract in his December 31,2019 financial statements by debiting accounts receivable and crediting revenue. - In July, Mike began researching the potential for developing a revolutionary artificial nutdonr arass as a renlacement to real arass.After hearing the comnlaints from his In July, Mike began researching the potential for developing a revolutionary artificial outdoor grass as a replacement to real grass. After hearing the complaints from his customers about the difficulty in maintaining a nice lawn and their dissatisfaction with how current artificial turf looks, Mike thought that he might have a new piece for his business. During July, August and September Mike spent $20,000 on fees for a consultant to research artificial turf and the market for it and another $10,000 looking at various materials to make it. Based on lots of hard work, Mike came up with a new protype grass in October. His protype feels and looks exactly like grass. It comes with the ability for the grass to turn colour using an app. Owners could go from summertime green to fall pale green to yellow - giving it a very realistic appearance. The product can be purchased and installed by the owners or installed by a professional. The market potential is significant. Mike intends to begin selling the new artificial grass next year and already has several potential customers ready to buy. In October, SLL completed the design of the mold for $72,000, salaries incurred to begin production amounted to $18,000 and $8,000 was spent on registering the patent. All costs are recorded under artificial lawn costs: - At December 31st of the year just ended, SLL recorded $65,000 of inventory on its books for miscellaneous lawn equipment. The inventory was shipped FOB destination. It physically arrived at SLL on January 2nd. - On December 28, 2019, SLL sold $25,000 of goods to a golf course. The goods were delivered on January, 2020 and Mike was responsible for the goods until the January, 2020 delivery (i.e. if there was damage to the goods before then Mike would have to replace). The $25,000 was included in the $124,600 December 31st accounts receivable balance. The entry Mike made was a debit to Accounts Receivable and a Credit to Revenue. He never removed the goods from inventory or made an entry to cost of goods sold. - Assume that Mike's income tax rate is 30% and that income taxes and accounting for last year were done correctly. Mike has not set up any journal entry yet to record his taxes. - SLL purchased the building in Orillia with money from the business for $300,000. This money was the capital that Mike brought in when he founded the company. He received the money as an inheritance - so he doesn't have the ability to finance the next expansion himself. The building was expected to have a useful life of 30 years with no salvage or residual value. In addition, SLL purchased $50,000 of equipment at the start of business with an estimated useful life of eight years and no residual value. A friend of Mike's accurately recorded the purchase and depreciation expense on a chart for Mike so you can assume that depreciation expense on these assets has been recorded correctly. - On July 1tt of 2019, Mike purchased $50,000 of equipment. He recorded the purchase of the equipment, but didn't know how to record the depreciation so he left it. He expects the equipment to have a useful life of seven years and he thinks he can sell it for $2,000 after seven years. Mike informed you that he forgot to make a journal entry for a bundled purchase he made from someone going out of business. On October 1st he spent $30,000 and bought a specialized machine that allows him to test the soli of his customer's lawns and a used truck. The fair market value of the machine was $20,000 and the truck $15,000. He expects the machine to last 8 years and the truck 5 years. All of this happened prior to year end. The owner of the equipment agreed to carry the loan. Terms of the loan are annual payments beginning September 30th,2020 of $10,000 each year plus 5% interest on the outstanding principal. - SLL is leasing space in both Barrie and the Collingwood as of January 1, 2020. Mike signed two year leases at each location and SLL was required to place a deposit of $2,500 (for each location) which will cover their last month's rent at both of those locations. When asked, Mike informed you that he paid this amount December 15th and expensed the $5,000, recording it under operating expenses. - Do-it-yourself lawn care continues to grow in Canada and is expected to continue to show strong growth despite the ongoing economic issues. Lawn stores exist in most towns and cities and can be very competitive. Some ratios for the industry are as follows: 2019 2018 Key Ratios and Analysis: Gross Profit Percentage of Sales Quick ratio Current ratio Inventory turnover 45.5%952:11.85:13.2345.6%902:11.21:13.11 Exhibit 2 Simcoe Lawns Income Statement December 31,2019 Exhibit 3 Simcoe Lawns My Balance Sheets December 31, 2019 2019 2018 Assets Cash Accounts Receivable Merchandise Inventory Property, Plant and Equipment Other Information: - Mike noted to you that he paid himself a cash dividend of $65,000 this year for all the work he did and expensed it under other expenses - During the year he was able to convince his cousin Matt to invest in SLL. Matt purchased common shares and paid $100,000 cash Simcoe Lawns Ltd. (SLL) was founded by Mike Evergreen on January 1, 2018. SLL is a small private corporation selling lawn equipment and specializing in do-it-yourself sprinkler systems. After beginning in Midland, Ontario with revenues in the first year of operations of $300,000, SLL now has three locations in Central Ontario. Revenues increased substantially during 2019. Mike Evergreen is the majority shareholder. Mike's cousin Matt owns some of the common shares after purchasing them this year. It is now March 2020 and Mike Evergreen has just left the office of one of the Senior Partners at BBJuP, the CPA firm that you work. You are a recently minted CPA and have been asked to assist the senior partner with this project. Mike had done his accounting on his own the past two years and thinks that he has done a really good job. He is looking to expand his operations but when he went to the bank in November of 2019 , they suggested he come to them with his financial statements at the end of the year. A friend of Mike suggested that he come and talk to your partner first and show her the statements. Mike is looking for a $100,000 loan in order to expand his operations and take advantage of the growing lawn irrigation industry and grass alternatives: The bank suggested to Mike that they typically offer a loan to companies such as his at prime +1.5%. Prime is currently 3.95% and the bank stated that the loan they would provide Mike would be no larger than 20% of SLL's receivables and inventories as of December 31,2019 . He would be required to maintain a current ratio of at least 1.4:1 or the loan may become would be required to maintain a current ratio of at least 1.4:1 or the loan may become immediately payable. Mike has provided your firm with his income statement for 2019 and his balance sheets for 2018 and 2019. He doesn't have his 2018 income statements but was able to tell you his 2018 revenues (see first paragraph) and his cost of goods sold was $160,000. He states that based on these statements, that it should be a 'slam dunk' that he will get the loan. In addition, although Mike believes he is doing a great job taking care of his own books, one of the things the bank mentioned was having an audit done and setting up accounting policies. As Mike stated in the meeting "my only sense of an audit is when those tax guys come in and make my life miserable looking for all the little pennies." As a result of his meeting in 2019 with the bank, Mike would also like your help in establishing accounting policies for his young growing company. He would like your firm to evaluate his accounting issues and provide recommendations on how to account for these items given the current situation. He would also like to know what an audit does for him and what GAAP is all about. After Mike leaves, your paitner takes a deep breath first before she speaks. "There's obviously lots to do here for Mike in a short period of time. Let's start by looking at the financial statement information that he has given us. I think we're going to have to adjust it based on what he has told us that he's done, so go ahead and do that. Makes sense to use a spreadsheet for that and for all the statement information. Given Mike size, we'll be setting up his stahrments folowing ASPE Rombe ber that when jou are andyong these enm, ae pe looking at establshing accourling polcet, so be aware of any that you need to focus en and support Aeer yooi done that, leis put a cash flow statement dogether alorng with the balance of the ndusted fenancia statnments. Finaly, a thoebugh andysis neets to be performed so prepare a report thal roaly looks an his siluation and the muset-semenbecit that the bark is looking at al of this. Required: Prepare the report ia the Partner - SLL inventory consists of items such as hoses, sprinklers, sprinkler heads, fertilizer and other types of lawn equipment. Information presented to you as of December 31st showed $346,000 in inventory at cost. Mike left you a note stating that the inventory actually has a market value of $356,000 and has adjusted his inventory on these preliminary, unaudited financial statements to this amount as he believes that his inventory should be represented on his balance sheet at fair market value given the high demand for equipment. Mike tells you that he put the $10,000 difference to Revenue. "Has to be right", he said "it's like I made money". - During the year SLl. signed a contract with a company that owns 10 hotels. SLL has agreed to supply them with lawn irrigation equipment for the next 5 years. The contract included an $80,000 upfront amount in order for SLL to begin to acquire the equipment and takes effect February 1, 2020. The cash was received January 15, 2020 and Mike has recorded this forthcoming contract in his December 31,2019 financial statements by debiting accounts receivable and crediting revenue. - In July, Mike began researching the potential for developing a revolutionary artificial nutdonr arass as a renlacement to real arass.After hearing the comnlaints from his In July, Mike began researching the potential for developing a revolutionary artificial outdoor grass as a replacement to real grass. After hearing the complaints from his customers about the difficulty in maintaining a nice lawn and their dissatisfaction with how current artificial turf looks, Mike thought that he might have a new piece for his business. During July, August and September Mike spent $20,000 on fees for a consultant to research artificial turf and the market for it and another $10,000 looking at various materials to make it. Based on lots of hard work, Mike came up with a new protype grass in October. His protype feels and looks exactly like grass. It comes with the ability for the grass to turn colour using an app. Owners could go from summertime green to fall pale green to yellow - giving it a very realistic appearance. The product can be purchased and installed by the owners or installed by a professional. The market potential is significant. Mike intends to begin selling the new artificial grass next year and already has several potential customers ready to buy. In October, SLL completed the design of the mold for $72,000, salaries incurred to begin production amounted to $18,000 and $8,000 was spent on registering the patent. All costs are recorded under artificial lawn costs: - At December 31st of the year just ended, SLL recorded $65,000 of inventory on its books for miscellaneous lawn equipment. The inventory was shipped FOB destination. It physically arrived at SLL on January 2nd. - On December 28, 2019, SLL sold $25,000 of goods to a golf course. The goods were delivered on January, 2020 and Mike was responsible for the goods until the January, 2020 delivery (i.e. if there was damage to the goods before then Mike would have to replace). The $25,000 was included in the $124,600 December 31st accounts receivable balance. The entry Mike made was a debit to Accounts Receivable and a Credit to Revenue. He never removed the goods from inventory or made an entry to cost of goods sold. - Assume that Mike's income tax rate is 30% and that income taxes and accounting for last year were done correctly. Mike has not set up any journal entry yet to record his taxes. - SLL purchased the building in Orillia with money from the business for $300,000. This money was the capital that Mike brought in when he founded the company. He received the money as an inheritance - so he doesn't have the ability to finance the next expansion himself. The building was expected to have a useful life of 30 years with no salvage or residual value. In addition, SLL purchased $50,000 of equipment at the start of business with an estimated useful life of eight years and no residual value. A friend of Mike's accurately recorded the purchase and depreciation expense on a chart for Mike so you can assume that depreciation expense on these assets has been recorded correctly. - On July 1tt of 2019, Mike purchased $50,000 of equipment. He recorded the purchase of the equipment, but didn't know how to record the depreciation so he left it. He expects the equipment to have a useful life of seven years and he thinks he can sell it for $2,000 after seven years. Mike informed you that he forgot to make a journal entry for a bundled purchase he made from someone going out of business. On October 1st he spent $30,000 and bought a specialized machine that allows him to test the soli of his customer's lawns and a used truck. The fair market value of the machine was $20,000 and the truck $15,000. He expects the machine to last 8 years and the truck 5 years. All of this happened prior to year end. The owner of the equipment agreed to carry the loan. Terms of the loan are annual payments beginning September 30th,2020 of $10,000 each year plus 5% interest on the outstanding principal. - SLL is leasing space in both Barrie and the Collingwood as of January 1, 2020. Mike signed two year leases at each location and SLL was required to place a deposit of $2,500 (for each location) which will cover their last month's rent at both of those locations. When asked, Mike informed you that he paid this amount December 15th and expensed the $5,000, recording it under operating expenses. - Do-it-yourself lawn care continues to grow in Canada and is expected to continue to show strong growth despite the ongoing economic issues. Lawn stores exist in most towns and cities and can be very competitive. Some ratios for the industry are as follows: 2019 2018 Key Ratios and Analysis: Gross Profit Percentage of Sales Quick ratio Current ratio Inventory turnover 45.5%952:11.85:13.2345.6%902:11.21:13.11 Exhibit 2 Simcoe Lawns Income Statement December 31,2019 Exhibit 3 Simcoe Lawns My Balance Sheets December 31, 2019 2019 2018 Assets Cash Accounts Receivable Merchandise Inventory Property, Plant and Equipment Other Information: - Mike noted to you that he paid himself a cash dividend of $65,000 this year for all the work he did and expensed it under other expenses - During the year he was able to convince his cousin Matt to invest in SLL. Matt purchased common shares and paid $100,000 cash