What are the accounting and finance issues in the case?

Startec Protection Inc.

Scarborough Economic Development Corporation (SEDC), a local community-development office, operates a program called Business Assistance Service (BAS). It is a mentorship service for entrepreneurs. SEDC forms volunteer advisory boards of three to five knowledgeable business people with strengths in different areas. The advisory boards are paired up with businesses requesting BAS. The service is available to businesses within two to five years of inception and can be provided for up to five years. The volunteers meet with the entrepreneurs on a regular basis and critique the business and offer suggestions for improvement. All aspects of the business are considered: financial accounting, operational, strategic, marketing, finance, tax, and human resources.

You are a CPA with Yee and Lee, Chartered Professional Accountants. On July 30, 2020, you had your semi-annual performance review with your partner, Tom White. Tom noted that the firm values community service and thinks that, now that your studying is over, you should do more of it. As a result, you volunteered to become involved as a mentor with BAS. Tom thinks this will help you expand your business knowledge, and make useful contacts with fellow volunteers and with budding entrepreneurs that could become valuable clients. He said to come see him if you need help.

On August 5, you met with the volunteer board that you were assigned to. Your board has three other members: a lawyer, a marketing professor, and a successful small-business owner. Your first "client," Startec Protection Inc. (SP), operates a security business and is new to the BAS program. The volunteer board met briefly and was given some information from a meeting the account manager at SEDC had with David O'Connor, the owner of SP (Exhibit I) and some background information from SP's application to the BAS program (Exhibits II, III, and IV).

You are responsible for advising on the accounting, tax, and finance aspects of the business. This is important given that SEDC requires the financial statements to be in accordance with GAAP. The other volunteers will look at marketing, human resources, strategic, and operational issues. However, you are welcome to contribute your views on these other areas. The volunteers will get together for a group discussion before meeting with the client. You decide to consult with your partner on how to proceed. He suggests you draft a memo summarizing your observations for the upcoming meeting.

EXHIBIT I

NOTES FROM THE MEETING WITH

DAVID O'CONNOR

David thinks that, by the end of the current fiscal year, SP will have a large enough customer base to be profitable. He anticipates that he will install at least 425 new home alarm systems in the current year due to his competitive pricing. However, he noted that as profitability improves, it still seems that SP is often short of cash, which concerns him.

He is considering adding Health Alert, a service primarily for seniors who live alone. Customers would press a button on a portable device to call for medical assistance. David wants advice on how to price this service, both on its own and in combination with residential security. He would like to achieve the same contribution margin on Health Alert as he does on the security service contracts. The monitoring of the Health Alert service will be outsourced. David estimates that Health Alert's incremental monitoring cost will be $12 per customer per month. The portable device will cost approximately $30 and any installed equipment will have to be reprogrammed. The reprogramming can be done in about 15 minutes but will require a visit to the customer's residence, so the estimated cost of installation, at $50 per hour, is $12.50.

David mentioned that Apex Systems Inc. (Apex) has offered to provide SP with new customers. SP would have to pay Apex $50 up front per new customer, and agree to have Apex provide the security monitoring services.

SP's office is in David's home, and his wife often takes care of the administrative work. David also has a part-time bookkeeper, Nancy Wilson. Nancy prepares SP's financial statements and corporate tax return as well as David's personal tax return. Nancy is a friend of David's from college and does this work mostly as a favour. However, she does receive a small monthly salary. Nancy has always paid the installers as independent contractors but is not sure this is the correct treatment.

EXHIBIT II

EXCERPTS FROM THE BAS APPLICATION

Business name Startec Protection Inc. (SP)

Date of inception June 1, 2018

Form of business Corporation

Registration Date for GST

December 1, 2019

Owner(s)

David Rush

Background of owner(s)

Electronics Diploma, Eastern Memorial College, 2012; Warehouse supervisor, Electronics Superstore 2012-2017

Products and services

1. Installation and monitoring of security systems for residential customers. SP contracts with a national monitoring company to do the actual monitoring services.

2. Sale of security products (e.g. locks, bolts, and alarms for houses and cars). SP takes the orders and arranges for suppliers to ship directly to the customer. SP does not keep any inventory of this type. SP invoices and collects

the money from its customers, and pays the suppliers.

Additional Financial information

[Attach information on the pricing of your products and/or services]

Attached (Exhibit III)

Financial Statements for

last two years

Attached (Exhibit IV)

EXHIBIT III

ADDITIONAL FINANCIAL INFORMATION

1. Systems are advertised as free with a 36-month contract. If the contract is less than 36 months, the sales price of the system to the customer is $495. The same monthly rental fee of $33 is charged regardless of whether the customer signs up for the 36- month contract or a shorter period of time. David Rush noted the $33 monthly fee is in line with competitors' monthly pricing. To date, all customers have taken the free offer.

2. In fiscal 2020, there were 325 new systems sold. This was an increase over fiscal 2019 where 150 new systems were sold.

3. The cost to SP of providing the free system is:

a. System material cost is $230 per system in fiscal 2020; it was $225 in fiscal 2019.

b. Installation is $100 per system. To date, David has done approximately half of the installations himself at no cost to the company. Now that the sales volume has increased, he expects to have to pay for a greater percentage of the installations.

4. Demand for the systems is constant throughout the year.

5. Apex provides monitoring services for SP's customers. The alarm monitoring expense paid by SP was initially 15% of the monitoring revenue, but increased to 20% on January 1, 2020. This increase resulted in a combined rate of 17% of monitoring revenue for the year ended May 31, 2020. SP does not have a long-term contract with Apex.

6. Customers have the option of being billed monthly, quarterly, or annually, in advance. At the present time, the majority of customers are on the monthly billing option.

7. The $10,000 balance owing on the loan from the Bank of Eastern Canada was at a 6% annual interest rate and was repaid in 2020. A new loan was obtained from SEDC at an annual interest rate of 5%. The loan from SEDC is to be repaid in two annual installments of $10,000 each. The first installment is due May 31, 2021.

8. David borrowed $70,000 personally and invested this in the form of equity.

9. David has income from other sources.