What are the accounting and tax issue in the case?

HELP (the Home and Eastern Local Partnership) is a local government funded initiative that operates a program called Business Assistance Service (BAS). It is a mentorship service for entrepreneurs. HELP 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, and is free. The volunteers meet with the entrepreneurs on a regular basis and critique the business and offer suggestions for improvement.

You are David Dogood, a newly qualified a CA with Black and White, Chartered Accountants. On 30 January 2010 you had your performance review with your partner, Bill Black. Bill noted that Black and White values community service and thinks that, now that your studying is over and as this is a quiet time in the office, you should do some community service. As a result, you were encouraged to volunteer to become involved as a mentor with BAS. Bill 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 and see him if you need help, although HELP are not and will not become clients of Black and White, and you will be doing this in a personal capacity, with any time during the workday coded to TOIL (Time Off In Lieu), as agreed with Bill.

On 5 February 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," Security Plus Limited. (SPL), 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 HELP had with Joe Rush (who is in his late 30s), the owner of SPL (Exhibit I) and some background information from SPLs application to the BAS program (Exhibits II, III, and IV).

You are responsible for advising on the accounting, tax, and finance aspects of the SPL business. This is important given that HELP requires the financial statements to be in accordance with IFRS. The other volunteers will look at marketing, human resources, strategic, and operational issues. The volunteers will get together for a group discussion before meeting with Joe Rush from SPL. You decide to consult with Bill Black on how to proceed. He suggests you draft a position paper summarizing your observations for the upcoming meeting. Bill agreed it was a good idea if you separately made a note in relation to potential ethical issues that could arise from this work, including follow up points.

Joe has said that he is delighted that there is a CA on the team, as he is really unsure as when I should recognise sales in SPL, is it when I install the system or when it is finally paid for at the end of the three years - it is not as simple as say, a shop, where it is crystal clear when the item is sold, and what about the security products, I never even take delivery of those'?

NOTE TO STUDENTS: THIS FINANCIAL REPORTING INDICATOR IS LONGER, MORE DETAILED AND MORE TECHNICALLY COMPLEX THAN WOULD BE EXPECTED IN THE EXAM, BUT DOES REPRSENT GOOD PRACTICE FOR YOU, SUBJECT TO THAT 'HEALTH WARNING'

EXHIBIT I

NOTES FROM THE MEETING WITH JOE RUSH

Joe would like you to alert him to any tax issues on the basis of what you have seen to date.

Joe is considering adding Health Alert, a service primarily for older people who live alone. Customers would press a button on a portable device to call for medical assistance. Joe wants advice on how to price this service, both on its own and in combination with residential security, including the marketing aspects of the price to be set. He would like to achieve the same contribution margin percentage on Health Alert as he does on the security service contracts. The monitoring of the Health Alert service will be outsourced. Joe estimates that Health Alerts 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 customers residence, so the estimated cost of installation, at /50 per hour, is /12.50. Joe does not charge for travelling time.

SPLs office is in Joes home, and his wife (who does not work outside the home) often takes care of the administrative work. Joe also has a part-time bookkeeper, Anna Sharp. Anna prepares SPLs financial statements and PAYE/RSI and VAT returns as well as Joes personal tax return. Anna is a friend of Joes from college and does this work mostly as a favour. However, she does receive a small monthly salary. Anna has always paid the installers as independent contractors but is not sure this is the correct treatment and knows she does not have the technical knowledge to advise Joe on when he should recognise the sale. SPL has availed of the small companies audit exemption.

EXHIBIT II

EXCERPTS FROM THE BAS APPLICATION

Business name

Security Plus Limited. (SPL)

Date of incorporation

1 December 2008

Form of business

Private Limited Company

Registration Date for Corporation Tax

1 December 2008

Owner(s)

Joe Rush

Background of owner(s)

Electronics Diploma, Eastern Memorial College, 2001; Warehouse supervisor, Electronics Superstore 2001-2007

Products

and services

1. Installation and monitoring of approach lighting and door intercom systems for residential customer, with a door mounted panic button. SPL 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). SPL takes the orders and arranges for suppliers to ship directly to the customer. SPL does not keep any inventory of this type. SPL invoices and collects the money from its customers, pays the suppliers. and keeps the margin as commission.

Additional Financial information

]

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 customer wishes to pay upfront, the initial sales price of the system to the customer is /795. The same monthly rental fee of /33 is charged regardless of whether the customer signs up for the 36-month contract or a longer period of time. To date, all customers have taken the free offer. There have been no cancellations to date. In their marketing literature SPL make it clear they will install the system without the door mounted panic button if the customer wishes. If the customer takes the door mounted panic button the literature makes it clear they can also choose whether to take the monitoring service or not, although every customer has taken both the door mounted panic button and the monitoring service to date.

2. In calendar 2009, there were 325 new systems sold. This was an increase over calendar 2008 where 150 new systems were sold.

3. The cost to SPL of providing the system is:

a. System material cost is /230 per system in calendar 2009; it was /225 in calendar 2008.

b. Installation is /100 per system. To date, Joe 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. Gargantuan provides monitoring services for the door mounted panic buttons for SPLs customers, immediately calling the police once the alarm has been raised. The monitoring expense paid by SPL was initially 15% of the system revenue, but increased to 20% on 1 July 2009. This increase resulted in a combined rate of 17% of system revenue for the year ended 31 December 2009.

6. The /10,000 balance owing on the loan from the Bank of Eastern Ireland was at a 6% annual interest rate and was repaid in 2009. A new loan was obtained from HELP at an annual interest rate of 5%. The loan

from HELP is to be repaid in two annual instalments of /10,000 each. The first instalment is due 31 December 2010.

7. Joe borrowed /70,000 personally and invested this in the form of equity.

8. Joe has income from inherited investments.

9. The promotional material for SPL makes the point that the monthly billing option means that customers do not have to pay interest, typically 10% per annum for domestic borrowers.

EXHIBIT IV

SECURITY PLUS LIMITED.

BALANCE SHEET

As at 31December

(unaudited)

2009

2008

Assets

Current assets

Cash

/

-

/

2,552

Accounts receivable

27,883

6,211

Accounts receivable - shareholder

-

10,000

Inventory

2,300

2,300

30,183

21,063

Computer

2,500

2,500

Accumulated amortization - computer

(1,500)

(750)

1,000

1,750

Small tools

1,250

1,250

Accumulated amortization - small tools

(750)

(375)

500

875

Furniture and fixtures

3,320

3,320

Accumulated amortization - furniture fixtures

(1,992)

(996)

1,328

2,324

/

33,011

/

26,012

Liabilities

Current liabilities

Bank overdraft

/

2,150

/

-

Accounts payable

32,190

15,210

Payable to shareholder

19,000

-

VAT and PAYE/RSI payable

3,000

-

Corporate tax payable

-

-

Other current liabilities

34,021

9,355

HELP loan

20,000

-

Loan - Bank of Eastern Ireland

-

10,000

110,361

34,565

Shareholder's equity

Ordinary shares

70,000

70,000

Accumulated losses

(147,350)

(78,553)

(77,350)

(8,553)

/

33,011

/

26,012

EXHIBIT IV (continued)

SECURITY PLUS LIMITED.

INCOME STATEMENT(unaudited)

For the Year ended 31 December

2009

2008

Revenue

System sales

/

123,750

/

29,700

Security products commission

15,700

2,425

139,450

32,125

Expenses

System material

74,750

33,750

Alarm monitoring

21,038

4,455

Installer fees

16,000

7,000

Licenses and bonds

15,560

12,450

PR spending

10,990

1,819

Vehicle lease

8,000

8,000

Advertising

6,450

3,597

Miscellaneous

6,018

5,450

Meals and entertainment

5,590

4,370

Vehicle fuel

4,500

3,400

Communication

4,450

4,230

Supplies

4,200

4,390

Office

3,340

2,973

Insurance

3,300

3,100

Bank interest and charges

3,120

2,420

Salaries

3,000

3,000

Vehicle repairs

2,500

400

Amortization

2,121

2,121

Bad debts

1,820

2,253

Home office

1,500

1,500

Income tax

-

-

198,247

110,678

Net loss

58,797

78,553

Deficit, beginning of period

78,553

-

Dividends

10,000

-

Deficit, end of period

/

147,350

/

78,553