Your firm has recently been chosen as the auditor of Timmy Unlimited, a company which was formed on October 15, 2018. Mr. Horton owns 70% of the voting shares of Timmy Unlimited

and his wife owns the remaining 30%. On October 31, 2019, Timmy Unlimited acquired all of the voting shares of Roll Up Rim, a company which was founded by Mr. Hortons wife four

years ago. Roll Up Rim will sell Timmy coffee making supplies to Timmy Unlimited at a gross profit of 25%. In a meeting with Mr. Horton, he asks your audit partner the following questions.

a) Why do accounting standards require that profits on sales of inventory between a subsidiary and its parent must be eliminated? My wife is working hard to ensure that

Roll Up Rim is a profitable company and it seems unfair that the profits of this company will not be reflected in Timmy financial statements. (3 marks)

b) Roll Up Rim owns some packaging equipment with a net book value of $45,000. At the time that Timmy Unlimited bought Roll Up Rim was estimated to be worth $45,000.

However, our tax advisor has suggested that Roll Up Rim should sell the equipment to Timmy Unlimited for $40,000. The equipment is really only currently worth $40,000

because it is becoming obsolete due to the recent introduction of superior technology. Roll Up Rim can use the tax loss that the sale will generate because the company has

been paying a lot of income taxes since it was formed. Assuming the sale takes place, how should we account for this equipment? (3 marks)

c) An intercompany gain on the sale of land is eliminated in the preparation of the consolidated statements in the year that the gain was recorded. Will the gain be

eliminated in the preparation of subsequent consolidated statements? Explain (3 marks)

REQUIRED

Draft responses to each of Mr. Hortons questions, for use by your audit partner in a follow-up meeting with Mr. Horton to discuss his concerns.