Tully's Outdoors Inc. Tully's Outdoors Inc. (TOI) was founded in 1965 by Robert Bit. Over the next two decades, TOI became a leader in wood fireplaces and natural gas fireplaces. In 1998. TOI began to focus exclusively on natural gas fireplaces and gas barbeques. By 2005, TOI had grown to the point that increased production was necessary Products were now in demand across North America. In order to obtain the financing needed for expansion Robert decided to take the company public in 2006. The initial public offering resulted in Robert maintain ing 60% ownership in TOI, with 40% of the company being widely held. Robert completed the first expan sion in 2007 TOT has been a client of your accounting firm since 2013. Sales have steadily increased since you began as the audit senior. You are now manager on the annual audit. TOlis traded on the TSX and there have never been any major issues with the annual audit. In early 2017, Robert decided it was time to step away from some of the day-to-day operational activities of TOI. He wanted to focus on production and take some time off and travel with his wife. In order to ensure that operations ran smoothly, Robert hired a controller, Danica Waine, to oversee the financial operations of TOL. He also wanted Danica to increase sales of Tol in order to take advantage of the increased production capacity and to utilize sunk costs. Danica was a recent CPA, gaining most of her articling hours at a non-profit organization in a small town about an hour away. In addition to Danica's base salary, Robert offered her a bonus of 8% of income before tax that exceeded $5 million. Robert chose $5 million as the baseline amount because that has been the average over the last four years and he really wanted to motivate Danica to do well in his absence. Danica signed the contact and began working in March 2017 Robert went ahead with another expansion plan during 2017 in order to meet the increasing produc tion demand. In order to finance the expansion, Robert entered into several agreements and asked Danica to ensure that the amounts were recorded correctly. These transactions are detailed in Exhibit I. It is now early February 2018 and you are working on the audit for TOI's 2017 fiscal year end. In discus- sions with Danica, you have found out that the second expansion completed in the middle of June has been very favourable. "Our sales have really increased as a result of the expanded facilities," Danica comments. "In fact I have managed to sign some interesting contracts this year, even with Robert away so much." The unaudited income before tax for the year ended December 31, 2017, is currently at $6.2 million. As a result of this favourable outcome, Danica has booked a bonus liability in the amount of $96,000. You have been asked by the partner in charge of the audit to examine the transactions in Exhibit I and provide her with your recommendations on the accounting treatment along with any other concerns you may have. Assume an income tax rate of 40% and that it has been Tol's policy to take a year's worth of de preciation in the year of acquisition and none in the year of disposal. Required Prepare the report for the partner in charge of the audit. EXHIBITI - TULLY'S OUTDOORS INC. TRANSACTIONS Section 7: Capstone Cases 265 Danica dete deduction (there qualifies asa de 10 Nickelback Fire In October 2017. TOI purchased 18% of Nickelback Fire (NF) for $630,000. NF is a private company pro- ducing piping for natural gas fireplaces. TOI felt that NF's production facilities would be a good match for che company. TOI has one member on the 12-member board of directors NF declared a $100.000 dividend in November 2017 and recorded net income and comprehensive income of $600,000 for its December 31, 2017. year end. Danica believes that NF is a very important investment for Tol and hopes to persuade NE to put more TOI members on the board in the future. Danica recorded the investment in NF by picking up TOT's share of NFS income for the year. Your quick research shows that there is very little information regarding similar types of companies. Plant Expansion The plant expansion involved the building of a new 9.200 square metre (100,000 square-foot) facility. The total cost of the building was 54.5 million. The building qualifies as a dass asset for capital cost allowance (CCA) purposes with the enhanced deduction (therefore allowing it a 10% CCA rate). The building was put in use July 1, 2017. Danica determined that the new building had a useful life of 30 years. Danica re- corded depreciation in the amount of $75,000. You note that no deferred taxes have been recorded. Research showed that a typical facility of this nature generally has a 20-year useful life. Financing In order to finance the entire plant expansion, TOI issued $3 million of bonds on July 1, 2017. The bonds are five-year bonds with semi-annual interest payments of 3%. The current market rate was 4% at the time of is. suance. Robert mentioned to Danica that they would watch interest rates and if things changed, he would be investigating the possibility of redeeming them. TOI does have the ability to redeem the bonds at any time without any penalty. At year end, Danica recorded the interest expense and payment made on December 31. 2017, for $45,000. The current yield rate for very similar bonds remains at 4% as of year end. The balance of the financing was raised through the issuance of 10,000 cumulative preferred shares with a dividend rate of $5 per share. The preferred shares are retractable at the option of the holder at any time after 2020. Dividends were declared and paid by December 2017. The dividends were recorded through retained earnings. Production Contracts In an attempt to increase revenues, Danica entered into two production contracts in geographical areas pre- viously untapped by TOI TOI completed a contract for Birmingham Heat totalling $380,000. The contract called for the production of several hundred specialty fireplaces. Production of the fireplaces was completed on December 15, 2017, and shipped via Merck Liners FOB shipping point on December 28. On January 5, 2018, Danica found out that the fireplaces had still not arrived at Birmingham Heat due to a customs issue. Birmingham Heat hopes to have the issue resolved in two weeks The second contract called for the production of $420,000 of fireplaces and barbecues to Maldovia Heat Inc. located in a small country overseas. The products were delivered to the overseas company on December 18, 2017. On December 22, political unrest toppled the government in the country. The new government that was installed has refused to allow any monies to leave the country Danica has recorded the revenue and related receivable for both contracts for the year ended December 31, 2017 Production Accident In October 2017, TOI found out that one of the air tubes used in its barbecues was incorrectly made. As a result, several customers throughout Western Canada and the Northeastern United States became illor were injured. There is currently a lawsuit pending that may result in daims being paid out. When your partner asked Danica about insurance, she stated that she had downgraded the insurance this year, saving 266 Canadian Financial Accounting Cases SVOITOAZVA EXHIBITI (CONTINUED UT - 1 TIBHX TULLY'S OUTDOORS INC. TRANSACTIONS the company $100,000. In doing so, exposure of damages as a result of these tubes is not covered. Danica has not recorded any amount yet in the financial statements because the lawsuit has yet to go to trial. Documen. tation from the lawyers suggests that there is a 5% probability that there will be no amount payable for the claim, a 25% chance that $200,000 would have to be paid, a 50% chance that $500,000 would be due, and a 20% chance that $700,000 in claims will have to be paid. b arba de Tully's Outdoors Inc. Tully's Outdoors Inc. (TOI) was founded in 1965 by Robert Bit. Over the next two decades, TOI became a leader in wood fireplaces and natural gas fireplaces. In 1998. TOI began to focus exclusively on natural gas fireplaces and gas barbeques. By 2005, TOI had grown to the point that increased production was necessary Products were now in demand across North America. In order to obtain the financing needed for expansion Robert decided to take the company public in 2006. The initial public offering resulted in Robert maintain ing 60% ownership in TOI, with 40% of the company being widely held. Robert completed the first expan sion in 2007 TOT has been a client of your accounting firm since 2013. Sales have steadily increased since you began as the audit senior. You are now manager on the annual audit. TOlis traded on the TSX and there have never been any major issues with the annual audit. In early 2017, Robert decided it was time to step away from some of the day-to-day operational activities of TOI. He wanted to focus on production and take some time off and travel with his wife. In order to ensure that operations ran smoothly, Robert hired a controller, Danica Waine, to oversee the financial operations of TOL. He also wanted Danica to increase sales of Tol in order to take advantage of the increased production capacity and to utilize sunk costs. Danica was a recent CPA, gaining most of her articling hours at a non-profit organization in a small town about an hour away. In addition to Danica's base salary, Robert offered her a bonus of 8% of income before tax that exceeded $5 million. Robert chose $5 million as the baseline amount because that has been the average over the last four years and he really wanted to motivate Danica to do well in his absence. Danica signed the contact and began working in March 2017 Robert went ahead with another expansion plan during 2017 in order to meet the increasing produc tion demand. In order to finance the expansion, Robert entered into several agreements and asked Danica to ensure that the amounts were recorded correctly. These transactions are detailed in Exhibit I. It is now early February 2018 and you are working on the audit for TOI's 2017 fiscal year end. In discus- sions with Danica, you have found out that the second expansion completed in the middle of June has been very favourable. "Our sales have really increased as a result of the expanded facilities," Danica comments. "In fact I have managed to sign some interesting contracts this year, even with Robert away so much." The unaudited income before tax for the year ended December 31, 2017, is currently at $6.2 million. As a result of this favourable outcome, Danica has booked a bonus liability in the amount of $96,000. You have been asked by the partner in charge of the audit to examine the transactions in Exhibit I and provide her with your recommendations on the accounting treatment along with any other concerns you may have. Assume an income tax rate of 40% and that it has been Tol's policy to take a year's worth of de preciation in the year of acquisition and none in the year of disposal. Required Prepare the report for the partner in charge of the audit. EXHIBITI - TULLY'S OUTDOORS INC. TRANSACTIONS Section 7: Capstone Cases 265 Danica dete deduction (there qualifies asa de 10 Nickelback Fire In October 2017. TOI purchased 18% of Nickelback Fire (NF) for $630,000. NF is a private company pro- ducing piping for natural gas fireplaces. TOI felt that NF's production facilities would be a good match for che company. TOI has one member on the 12-member board of directors NF declared a $100.000 dividend in November 2017 and recorded net income and comprehensive income of $600,000 for its December 31, 2017. year end. Danica believes that NF is a very important investment for Tol and hopes to persuade NE to put more TOI members on the board in the future. Danica recorded the investment in NF by picking up TOT's share of NFS income for the year. Your quick research shows that there is very little information regarding similar types of companies. Plant Expansion The plant expansion involved the building of a new 9.200 square metre (100,000 square-foot) facility. The total cost of the building was 54.5 million. The building qualifies as a dass asset for capital cost allowance (CCA) purposes with the enhanced deduction (therefore allowing it a 10% CCA rate). The building was put in use July 1, 2017. Danica determined that the new building had a useful life of 30 years. Danica re- corded depreciation in the amount of $75,000. You note that no deferred taxes have been recorded. Research showed that a typical facility of this nature generally has a 20-year useful life. Financing In order to finance the entire plant expansion, TOI issued $3 million of bonds on July 1, 2017. The bonds are five-year bonds with semi-annual interest payments of 3%. The current market rate was 4% at the time of is. suance. Robert mentioned to Danica that they would watch interest rates and if things changed, he would be investigating the possibility of redeeming them. TOI does have the ability to redeem the bonds at any time without any penalty. At year end, Danica recorded the interest expense and payment made on December 31. 2017, for $45,000. The current yield rate for very similar bonds remains at 4% as of year end. The balance of the financing was raised through the issuance of 10,000 cumulative preferred shares with a dividend rate of $5 per share. The preferred shares are retractable at the option of the holder at any time after 2020. Dividends were declared and paid by December 2017. The dividends were recorded through retained earnings. Production Contracts In an attempt to increase revenues, Danica entered into two production contracts in geographical areas pre- viously untapped by TOI TOI completed a contract for Birmingham Heat totalling $380,000. The contract called for the production of several hundred specialty fireplaces. Production of the fireplaces was completed on December 15, 2017, and shipped via Merck Liners FOB shipping point on December 28. On January 5, 2018, Danica found out that the fireplaces had still not arrived at Birmingham Heat due to a customs issue. Birmingham Heat hopes to have the issue resolved in two weeks The second contract called for the production of $420,000 of fireplaces and barbecues to Maldovia Heat Inc. located in a small country overseas. The products were delivered to the overseas company on December 18, 2017. On December 22, political unrest toppled the government in the country. The new government that was installed has refused to allow any monies to leave the country Danica has recorded the revenue and related receivable for both contracts for the year ended December 31, 2017 Production Accident In October 2017, TOI found out that one of the air tubes used in its barbecues was incorrectly made. As a result, several customers throughout Western Canada and the Northeastern United States became illor were injured. There is currently a lawsuit pending that may result in daims being paid out. When your partner asked Danica about insurance, she stated that she had downgraded the insurance this year, saving 266 Canadian Financial Accounting Cases SVOITOAZVA EXHIBITI (CONTINUED UT - 1 TIBHX TULLY'S OUTDOORS INC. TRANSACTIONS the company $100,000. In doing so, exposure of damages as a result of these tubes is not covered. Danica has not recorded any amount yet in the financial statements because the lawsuit has yet to go to trial. Documen. tation from the lawyers suggests that there is a 5% probability that there will be no amount payable for the claim, a 25% chance that $200,000 would have to be paid, a 50% chance that $500,000 would be due, and a 20% chance that $700,000 in claims will have to be paid. b arba de