2014 uniform evaluation report - · pdf filei membership of 2014 board of evaluators christine...

2014 Uniform Evaluation Report

Chartered Professional Accountants of Canada

UNIFORM EVALUATION

REPORT

2014

i

MEMBERSHIP OF 2014

BOARD OF EVALUATORS

Christine Allison CPA, CA

MD Funds Management Inc.

Ottawa, Ontario

Pierre-Yves Desbiens, CPA, CA, CF, MBA

Institute NEOMED

Montréal, Québec

Cindy Ditner, FCPA, FCA, CMA

BDO Canada LLP

Toronto, Ontario

Mike Fitzpatrick, CPA, CA

Fitzpatrick & Company

Charlottetown , Prince Edward Island

Aline Girard, Ph.D., MBA, CPA, CA HEC Montréal

Montréal, Québec

Jason Hale, CA Grant Thornton LLP

Halifax, Nova Scotia

Jo-Ann Lempert, CPA, CA MNP SENCRL srl Montréal, Québec

Barbara Sainty, Ph.D, CPA, CA, CMA Brock University St. Catharines, Ontario

Rik Smistad, CA Mount Royal University

Calgary, Alberta

Dave Warren, CA

KPMG LLP

Vancouver, British Columbia

STAFF OF 2014 BOARD OF EVALUATORS

Marie-Andrée Caisse, CPA, CA, Principal, Evaluations and International Assessment

Kathy Létourneau, CPA, CA, Principal, Evaluations and International Assessment

Paule Massicotte, CPA, CA, Principal, Evaluations and International Assessment

Silka Millman, CPA, CA, Principal, Evaluations and International Assessment

Andy Thomas, CPA, CA, Principal, Evaluations and International Assessment

Wendy O. Yan, Administrative Coordinator

Linda Clarke, Administrative Assistant

ii

The Canadian Institute of Chartered Accountants (CICA) and Certified Management Accountants of

Canada (CMA) joined together January 1, 2013, to create Chartered Professional Accountants of Canada

(CPA) as the national organization to support unification of the Canadian accounting profession under the

CPA banner. The UFE Candidates’ Competency Map is still being maintained and provided under the

direction of CICA until final offerings of the CA program are complete.

Cataloguing information available from the National Library of Canada

All rights reserved. This publication is protected by copyright and written permission is required to

reproduce, store in a retrieval system or transmit in any form or by any means (electronic, mechanical,

photocopying, recording, or otherwise).

For information regarding permission, please contact [email protected]

CHARTERED PROFESSIONAL ACCOUNTANTS OF CANADA, CPA CANADA, CPA.

© 2015, Chartered Professional Accountants of Canada. All Rights Reserved.


277 Wellington Street West

Toronto, Ontario M5V 3H2

mailto:[email protected]

iii

TABLE OF CONTENTS

Page

THE BOARD OF EVALUATORS’ COMMENTS

The Board of Evaluators’ Report on the 2014 Uniform Evaluation ....................... 1

Comments on Candidate Performance on the 2014 Uniform Evaluation .............. 6

Exhibit 1 The Decision Model ..................................................................... 16

Appendix A Design, Guide Development, and Marking of

the 2014 Uniform Evaluation ...................................................... 17

Appendix B Candidates Performance on Primary Indicators by

Competency Area ......................................................................... 21

Appendix C 2014 Simulations and Evaluation Guides .................................... 26

Paper I .................................................................................... 27

Evaluation Guide ............................................................. 40

Paper II ................................................................................... 107

Simulation 1 ..................................................................... 108


Simulation 2 ..................................................................... 138


Simulation 3 ..................................................................... 166


Paper III.................................................................................. 187

Simulation 1 ..................................................................... 188


Simulation 2 ..................................................................... 213


Simulation 3 ..................................................................... 236


Evaluation Booklet Tables ..................................................... 260

Uniform Evaluation Report — 2014 1

THE BOARD OF EVALUATORS’ REPORT

ON THE 2014 UNIFORM EVALUATION

Objectives of the report

The objectives of this report are:

1. To assist education committees and councils of the provincial and Bermuda institutes and provincial

boards of examiners in their review of the results of the 2014 Uniform Evaluation (UFE).

2. To assist the profession in improving pre-examination educational and screening processes and, in

turn, the performance of candidates on the UFE.

The report sets out the responsibilities of the Board of Evaluators, the methods of guide development and

marking the UFE, and the results of the marking process. The report concludes with the recommendation

of the Board of Evaluators. Three appendices provide more detailed information on the design, guide

setting, and marking of the 2014 UFE, the evaluators’ comments and expectations of candidates on the

simulations, and sample responses. Readers are cautioned that the solutions were developed for the entry-

level candidate and that therefore all the complexities of a real life situation may not be fully reflected in

the content. The UFE report is not an authoritative source of GAAP.

Responsibilities of the Board of Evaluators

The Board of Evaluators (BOE or board) comprises a chair and nine members. The chair and one

bilingual member are appointed by the Professional Education Management Committee (PEMC); the

other eight are appointed by the provincial institutes. Board members are appointed for a three-year term

and the chair for a two-year term.

The BOE’s responsibilities, as set out in its terms of reference, include:

- Setting the UFE in accordance with the UFE Candidates’ Competency Map (the Map) and other

directions from the PEMC.

- Submitting the UFE and the evaluation guides to the provincial institutes for review.

- Marking the candidates’ responses and recommending to the provincial institutes the pass or fail

standing that should be given to each candidate.

- Reporting annually on the UFE to the provincial institutes, in such form and detail and at such time as is

satisfactory to the Education and Qualifications Advisory Committee (EQAC) and the PEMC.

Each board member is actively involved in the preparation of the UFE simulations, the setting of the

passing profile, the preparation of evaluation guides, and the supervision of the evaluation process. Board

members are jointly responsible for determining the passing standard.

2 Board of Evaluators’ Report

The UFE

The purpose of the UFE is to assess whether candidates possess the competencies required of an entry-

level CA through a uniform written evaluation that all CAs must pass in order to qualify for entry to the

profession.

The Decision Model

The pass/fail decision model used by the board is presented in Exhibit 1. Three key decision points, or

levels, are applied in reaching the pass/fail decision, as follows:

1. The response must be sufficient, i.e., the candidate must demonstrate competence on the primary

indicators (Level 1). In assessing sufficiency, the board considered the number of times that a

candidate achieved “Competent” and/or “Reaching Competence” across all primary indicators (both

specific competencies and pervasive qualities).

2. The response must demonstrate depth in the areas of Performance Measurement and Reporting and

Assurance (Level 2). In assessing depth the board considered the number of times that a candidate

achieved “Competent” in each of the Assurance and Performance Measurement and Reporting

primary indicators.

3. The response must demonstrate breadth across all areas of the Map (Level 3). In assessing breadth

the board considered the number of times that a candidate achieved “Reaching Competence” across

primary indicators in each of the specific competency areas, except for Assurance and Performance

Measurement and Reporting. If a candidate failed to demonstrate breadth on the basis of the primary

indicators, the board considered the information provided by the secondary indicators for the deficient

competency area.

Evaluation guides

An evaluation guide was prepared for each simulation included in the 2014 Uniform Evaluation. Besides

identifying the primary and secondary indicators of competence, each evaluation guide includes carefully

defined performance levels to assist markers in evaluating a candidate’s competence relative to the

indicators. Five categories of performance are given for each primary indicator. The candidate’s

performance must be ranked in one of the five categories, namely:

Not addressed

Nominal competence

Reaching competence

Competent

Highly competent

For each secondary indicator, the candidate’s performance is ranked in one of three categories:

Not addressed

Nominal competence

Competent


Preparation and structure of the UFE

The Evaluations and International Assessment staff of CPA Canada maintains a pool of simulations

sufficiently large and broad in scope to provide a variety of alternative simulations embracing all sections

of the Map. The board provides guidance as to the content and nature of simulations to be included in the

pool.

The board staff works in conjunction with authors to ensure that simulations achieve the overall intent and

design objectives while adhering to the competencies and the proficiency levels specified in the Map. The

board selects simulations from the pool maintained by the staff, and reviews and refines these simulations

to make up the annual three-paper evaluation.

Nature of the simulations

Taken as a whole, the three papers must meet the requirements laid down by the PEMC for Map coverage

and simulation type. Appendix A shows that the 2014 UFE met the Map coverage requirements.

The 2014 UFE comprised a balanced combination of comprehensive and multi-subject simulations, which

were both essential and effective in evaluating the candidates with regard to their readiness to practise

public accounting. The first paper was a five-hour paper consisting of a single, comprehensive simulation.

The board designed a four-hour comprehensive simulation, as it has done in past years, but allowed

candidates an extra hour in which to complete their responses. The second and third papers were four-

hour papers, each consisting of three simulations.

Detailed comments by the Board on each of the 2014 UFE simulations appear in Appendix C.

Primary and secondary indicators of competence

The board applies evaluation procedures that enable it to decide which candidates demonstrate readiness

to practise public accounting. Appendix A contains a comprehensive description of the evaluation

process.

To attain a pass standing, candidates must address the issues in the simulations that are considered

mission critical. The board distinguishes between the mission critical issues and other relevant issues by

classifying them as primary indicators and secondary indicators of competence respectively.

Primary indicators of competence answer the question: “What would a competent CA do in these

circumstances?” If the issues identified in primary indicators are not adequately addressed, the CA could,

in real life, be placed in professional jeopardy or could place the client in jeopardy.

Secondary indicators of competence answer the question: “What other issues could a CA raise?”

Although such issues are valid, it is not essential for a competent CA to address them.

Board members devote a great deal of time to reviewing and refining evaluation guides to ensure the

expectations for achieving competence are fair and reasonable for an entry-level CA.

4 Board of Evaluators’ Report

Marking-centre leaders and assistant leaders provide valuable input to the evaluation guides before live

marking begins. Board members hold regular meetings with the leaders and their assistants during both

the guide-setting and the marking process. In the board’s opinion, the commitment, energy, and skill

demonstrated by all the markers were outstanding, resulting in the sound application of marking

procedures and producing an appropriate evaluation of the candidates.

The marking results for the secondary indicators do not appear in the statistical reports (Appendix B), as

they reflect the performance of only that segment of the population whose responses were deemed

borderline. However, Appendix C does contain comments on the candidates’ performance for the

responses that were marked.

Setting the passing standard

In determining which candidates pass the UFE, the Board uses a passing profile. A candidate is judged in

relation to the board’s pre-established expectations of an entry-level chartered accountant. To meet the

passing profile, a candidate’s response must meet the three levels defined earlier (see Exhibit 1).

In setting the passing profile, the board considers the following:

- The competency area requirements.

- The level of difficulty of each simulation, as a whole.

- The level of difficulty of each individual competency indicator.

- The design and application of the evaluation guides.

- Comments from leaders and assistant leaders regarding any marking difficulties encountered or any

time constraints noted.

- Possible ambiguity of wording or of translation of a simulation.

Determining which candidates pass

Near the completion of the marking process, board members each read a sample of candidate responses

for their assigned simulation to satisfy themselves that the markers had applied the judgments as intended.

Based principally on these readings, and on the evaluation of each candidate made by the markers, the

board reviewed its pre-established passing profile and set preliminary requirements for Level 2-depth in

the areas of Performance Measurement and Reporting and Assurance, and for and Level 3-breadth across

all competency areas.

Prior to the fair pass meeting, board members each read another sample of candidate responses, this time

for their assigned competency area, to satisfy themselves as to the levels they had set for Levels 2 and 3.

They finalized those Level 2 and 3 requirements at their fair pass meeting, taking into account the number

of valid opportunities available to candidates to demonstrate their competence in each of the competency

areas. The board then established the Level 1 requirement for the three-paper set. In establishing the

Level 1 requirement, the board considered whether the results could be wholly or partly explained by any

inconsistency in the evaluation or in the board’s process.


After considerable discussion, the board concluded that the 2014 evaluation was slightly harder than the

2013 evaluation. After taking into account that the 2014 UFE was slightly harder, candidate performance

on this evaluation was assessed as stronger than that of 2013. Based on the stronger candidate

performance, the board set a Level 1 standard that yielded 3,577 successful candidates (3,032 candidates

in 2013).

In reaching its decision, the board determines which candidates pass on a national basis only, without

regard to provincial origin or language. Similarly, the detailed comments are based on analyses of the

performance of all candidates. The board leaves the interpretation of provincial results to the provincial

institutes.

Reporting

The board assigned a pass or fail standing to candidates for the three-paper set.

The board reported the following information to each province by candidate number:

- Overall pass/fail standing and pass/fail standing for each of Levels 1, 2 and 3. - For failing candidates at Level 1, a sufficiency grouping for Level 1 and a decile ranking for both the

comprehensive simulation and the non-comprehensive simulations.

- For failing candidates, a colour code (red, yellow, green) reflecting their performance for each of the

competency areas.

Recommendation

The Board of Evaluators recommended that only those candidates who succeeded at each of Levels 1, 2,

and 3 should earn a pass standing on the 2014 Uniform Evaluation.

In conclusion, all board members wish to express their warm and sincere appreciation for the outstanding

energy, support, and commitment of the small group of Board of Evaluators staff members whose

dedication and talent contributed in large measure to the achievement of our objectives and the fulfilment

of our responsibilities.

We also wish to acknowledge the contributions made by our markers, authors, translators, provincial

reviewers, and editors. Their commitment to the quality and fairness of the process is appreciated.

Christine Allison, CPA, CA

Chair

Board of Evaluators

6 Comments on Candidates’ Performance

COMMENTS ON CANDIDATE PERFORMANCE

ON THE 2014 UNIFORM EVALUATION

To attain a pass standing, candidates must demonstrate sufficient competence in all areas, as well as

appropriate depth and breadth in their responses.

A Message to Candidates

EXECUTIVE SUMMARY

The Board of Evaluators analyzed the performance of candidates on the 2014 UFE. Overall, the Board

concluded that candidates’ performance in 2014 was slightly stronger than in the prior year. Information

on candidates’ performance on the 2014 UFE is provided here, in summary format, to help candidates

understand how to continue to improve their performance. Detailed comments on performance on each

simulation can be found in the evaluation guides in Appendix C. The following paragraphs elaborate

further on improvements over the 2013 UFE, as well as common detracting characteristics identified by

the Board.

The Board has cautioned candidates for the past few years about a dangerous exam-writing strategy the

members believed was occurring. It appeared as though some candidates were assuming the Board was

looking for a specific number of issues on each indicator. As a result, candidates appeared to be

repeatedly choosing to address only a few issues on each indicator, even when numerous issues were

outlined in the simulations. The Board noticed an improvement in this area on the 2014 examination;

however, members still witnessed some candidates continuing to employ this exam-writing strategy. The

number of issues the Board is expecting candidates to discuss is not pre-set, but rather varies from

indicator to indicator and from simulation to simulation. Candidates should not limit the breadth of their

analyses based on a pre-conception of the Board’s expectations in terms of number of issues. This trend is

affecting the quality of candidates’ responses and, therefore, their ability to demonstrate competence

within each indicator. Candidates are reminded to attempt to address all the issues they identify that are

relevant to their role.

In 2013, the Board noted candidates were doing a better job of applying guidance they had excerpted

from the CPA Canada Handbook (the Handbook) to the relevant case facts to support their recommended

accounting treatments. In previous years, candidates often copied and pasted large sections of the

Handbook in their responses without applying the guidance to the case facts. Although in 2014 most

candidates applied the guidance to the case facts, some continued to copy guidance without analyzing it

and applying it to the specific situation they were dealing with. For example, when going through a list of

criteria, many candidates indicated whether or not a criterion was met by indicating “met” or “not met,”

following the guidance they had copied from the Handbook. This type of comment does not constitute an

analysis of a criterion. Candidates are expected to provide an analysis of the guidance they are quoting by

using case facts to support, for example, why a criterion was met or not met. The Board reminds

candidates of the importance of analyzing the technical guidance they provide in their responses by

applying it to the relevant case facts.


In addition, the Board noticed instances in which the analysis candidates provided immediately following

Handbook guidance they had excerpted was not in line with that excerpt. For example, related to the grant

revenue issue on Paper I, Primary Indicator #7, many candidates copied guidance from the Handbook that

suggested the grant revenue should be either deferred in its entirety or netted against the asset, but then

recommended leaving a portion of the grant revenue in the income statement. Candidates are reminded

that copying Handbook excerpts does not add any value to a response unless it is both analyzed with case

facts and in line with their conclusion.

In 2013, the Board noted that candidates struggled when they were asked to quantitatively compare

different options. This observation remains true in 2014. On Paper I, Primary Indicator #5, candidates had

a difficult time being consistent in their calculations of the two financing options. For example,

candidates could either include or exclude the annual operating and maintenance costs, since these were

common to both options. However, some candidates used the entire amount of the lease payment made to

JGC, which included the operating and maintenance costs, but did not include these costs in the option to

go with the loan, or vice-versa. This inconsistent treatment weakened the validity of their comparison of

the two options.

A similar situation occurred on Paper II, Simulation 2, Primary Indicator #2, where candidates had a

difficult time putting the two options they had to compare on equal footing. Candidates were asked to

compare their client’s current tax situation as an unincorporated individual owning a business to his tax

situation if he were incorporated. When calculating the applicable income taxes had their client been

incorporated, many candidates forgot to take into consideration the money their client would need to

withdraw from the company to live on ($100,000), and many of those who did consider it forgot to apply

taxes to it. As a result, these candidates were either taxing the $100,000 at the wrong rate (corporate

instead of personal) or not taxing it at all. This made the incorporation option look much better compared

to the status quo, which rendered the candidates’ analyses much less useful to the client, since the options

were not comparable.

On Paper III, Simulation 2, Primary Indicator #3, candidates had to analyze a lease proposition their client

had received. Candidates needed to calculate the contribution margins of both the hemp production and

the marijuana production and then compare those to the lease rate to see if leasing part of the land would

be profitable for the company. Candidates had a difficult time comparing the contribution margins for the

two activities due to a variety of errors made in their calculations. For example, some candidates took the

revenue into consideration but forgot about the costs. Others compared the contribution margin of one

hectare of one of the products (hemp or marijuana) to multiple hectares of the other product. Some

candidates also calculated the contribution margin using the revenue earned on one hectare but then

included expenses related to multiple hectares of production. As a result of candidates not comparing

items on an equal basis, their analyses were often not very useful to the client, who would not be able to

rely on this information to make a decision.

On Paper II, Simulation 2, Primary Indicator #3, candidates also struggled to take into account the time

value of money, which was one of the ways to make the options comparable to one another. Some

candidates did not calculate a present value for the different options, whereas others compared the present

value of one option with the total payments of the other options. These calculations were not useful to the

client because they did not provide a true comparison of the options. While in some cases the difference

between the costs of different options is so obvious that a comparison of the present value of each option

is not necessary, that was not the case in this specific situation.


In 2013, the Board saw evidence of candidates misunderstanding or failing to integrate various case facts.

Although this was not as prevalent this year, the Board still found evidence of candidates misinterpreting

case facts, which led them to provide faulty calculations or discussions. For example, on Paper II,

Simulation 3, Primary Indicator #1, some candidates confused the staff rates with the management rates

for overtime. These rates were clearly laid out in Exhibit IV of the simulation. On the same page of the

simulation, it was also clear that the number of overtime hours presented in the table was the number of

hours above 200 (which is when overtime started being paid at a different rate for the staff). Some

candidates missed that information and subtracted 200 hours from the total shown in the table. The Board

reminds the candidates once again of the importance of reading the simulations carefully and ensuring

they take the necessary time to understand all of the case facts.

Regarding major detractors, the Board would like to highlight the following issues.

Lack of Clarity and Documentation in Calculations

The Board continued to notice a lack of clarity in the calculations provided and an insufficient amount of

documentation provided by candidates to support their calculations. Many candidates’ exhibits did not

include enough documentation to explain the components of their calculations, which made it difficult to

evaluate the quality of the calculations. For example, on Paper I, Primary Indicator #5, candidates often

did not show the details of their calculation of the cost of each option, especially when a net present value

was used. On Paper III, Simulation 2, Primary Indicator #3, candidates’ responses also lacked details and

explanations when it came to the calculation provided. The same applied to Paper II, Simulation 2,

Primary Indicator #3, where many candidates input a formula into a cell without providing the details of

what was included in that calculation. It becomes very difficult for the Board to assess candidates’

competence when given little evidence of their thought processes. Candidates are reminded that they need

to not only show the details of their calculations but also explain the elements of their calculations.

Lack of Understanding of What Is Required

The Board would like to draw candidates’ attention to the importance of carefully reading the requireds

included in the simulations before starting to write their responses. The Board found that some candidates

were discussing items that were not relevant to the specific simulation they were presented with. For

example, on Paper III, Simulation 1, the partner on the engagement asked “that you send him a memo

discussing any accounting issues you’ve noted and outlining the procedures required to address the risk

areas of the audit.” Despite the clear required for procedures only, some candidates also provided a

planning memo, which was not necessary in this case. On Paper I, Primary Indicator #2, candidates were

asked to describe the actions MU could take to satisfy the financial and operating objectives outlined in

Exhibit I. Although candidates were specifically asked to discuss only the financial and operating

objectives, some candidates also discussed the other two categories (academic and governance objectives)

presented in Exhibit I. Still on Paper I, Primary Indicator #6, candidates were expected to analyze the

possible causes of the problems identified by the auditor general and explain what MU could do to

address these problems. Although it was clearly indicated that the causes of the problems needed to be

analyzed, candidates focused their analysis on the implications of the problems identified and often did

not discuss the causes, completely missing one of the requireds for this indicator.


On Paper III, Simulation 2, some candidates provided a discussion on which reports could be issued to the

government to ensure all requirements were complied with. However, they were asked for advice on how

Hemp Co. could meet all government requirements for both 2013 and 2014. On Paper III, Simulation 3,

some candidates spent time unnecessarily calculating income taxes, which was not required in this

simulation. In the same simulation, some candidates provided discussions on the various reports that

could be provided to the client related to due diligence work. Once again, this was not what the client had

asked for and was, therefore, not relevant. In this case, the client had asked what specific procedures

could be done in order to make sure BSL was getting what it was paying for. As another example, on

Paper II, Simulation 3, some candidates discussed accounting issues, although they were clearly told by

the controller that she was already working on the accounting issues. Candidates need to carefully read

the requireds within each simulation and develop a plan before starting to write their responses. This will

ensure they have a good understanding of what is required from them and what analysis they will perform

to answer the requireds. This kind of planning would reduce the risk of including unrelated discussions

and would also help candidates make sure they completely understand what is needed in terms of analysis

and discussions, and thereby allocate their time to the various requireds accordingly.

Overall Picture

It has always been a struggle for candidates to take a step back and see the big picture when responding to

a simulation. This year, the Board felt candidates were not only having a difficult time stepping back to

look at the overall situation, but also having a difficult time taking a step back within each issue they were

dealing with. For example, on Paper III, Simulation 1, Primary Indicator #4, candidates generally

calculated the debt covenant and concluded on whether or not it was breached, but then didn’t go further

to discuss the potential consequences of the breach, which were significant. On Paper III, Simulation 2,

Primary Indicator #3, candidates were asked for their advice on whether Joe should accept an offer to

lease a portion of land at the proposed price. In order to determine if the price was worth it, candidates

had to first calculate the contribution margins for both the hemp and the marijuana to see whether Joe was

better off renting out a portion used for growing hemp or a portion used for marijuana. Once this

calculation was done, candidates had to compare the lowest contribution margin of the two with the rate

offered on the lease. Some candidates calculated the contribution margins for hemp and for marijuana, but

then lost sight of the purpose of their analysis and did not compare the margins to the lease rate. They

simply concluded one was more lucrative than the other. These candidates did not answer Joe’s question

and did not provide him with useful information. Although these candidates performed an important part

of the analysis, it seems they might have lost sight of why they were performing the analysis in the first

place.

Another example of this lack of overall analysis was on Paper II, Simulation 1, Primary Indicator #1.

Most candidates, through a discussion of the internal control weaknesses, were able to identify the

indicators of fraud and discuss their implications for the company. However, when it came to taking a

step back to reflect on the impact this potential fraud could have outside of the control weaknesses,

candidates had a much more difficult time providing insightful comments. The Board was disappointed to

see that, in their role as auditor, candidates did not recognize the overall impact of this fraud on the audit

plan, which was that the audit plan would have to be adjusted following the discovery of a potential fraud

being perpetrated.


Nature of the 2014 UFE

Overall, the 2014 UFE contained one fewer primary indicator than the 2013 exam and three fewer than

the 2012 UFE. The number of opportunities in Performance Measurement and Reporting; Assurance;

Taxation; and Governance, Strategy, and Risk Management was the same as in 2013. Compared to 2013,

there was one fewer indicator in Finance and in Pervasive Qualities and Skills, and one more indicator in

Management Decision-Making. There was only one secondary indicator on the UFE this year, which was

the same number as last year.

The 2014 UFE provided an overall level of direction that was slightly greater than that provided on the

2013 UFE. There was one fewer Pervasive Qualities and Skills indicator this year; however, the level of

direction provided in the other competency areas was similar to 2013.

The Board did not find evidence of time constraints on either the comprehensive or the non-

comprehensive simulations again this year.

Roles and Simulation Settings

The roles assigned and scenarios presented to the candidates on the 2014 UFE continued to be varied,

with only two of the simulations presenting a traditional assurance role (Paper II, Simulation 1 and Paper

III, Simulation 1).

Other roles presented to candidates included those of an external consultant hired by a university to

provide advice on a number of issues (Paper I); an advisor to a self-employed contractor helping with his

tax situation and a decision he needs to make regarding his workshop (Paper II, Simulation 2); an internal

temporary controller asked to prepare a report on the financial contribution of a new project to the

company and to assess the problems encountered with this new project (Paper II, Simulation 3); an

external consultant asked to provide advice to the owners of a family-run hemp farm on how they can

meet specific government requirements and whether they should accept an offer to lease some land (Paper

III, Simulation 2); and an advisor to a business owner looking at acquiring another business (Paper III,

Simulation 3). The 2013 examination contained a few non-typical roles that turned out to be challenging

for the candidates. Candidates seemed to have an easier time adapting to the roles in 2014.

Specific Comments by Competency Area

Assurance

Candidates were asked to perform a variety of assurance-related tasks on the 2014 UFE, with most

simulations addressing Assurance in some way. Candidates were expected to

consider possible causes and implications of problems raised by the auditor general and provide

appropriate recommendations to address these problems;

prepare an audit planning memo and suggest procedures for significant areas;

discuss the control weaknesses presenting an opportunity for potential fraud;

discuss control weaknesses and whether proposed automations would address them, and recommend

additional controls that could be implemented;

provide audit procedures for risk areas of an audit;

provide advice on putting controls in place to meet government licence requirements and prepare for

a compliance audit; and

discuss due diligence procedures that should be done to give comfort on various balance sheet items.


Candidates’ performance in Assurance was stronger than in the prior year. The Board noted in the past

two years that candidates’ performance was weaker than in previous years due to their struggles with

some of the unusual roles they were given in Assurance. Although there were only two indicators this

year in which candidates were put in a traditional external auditor role, there were a few indicators related

to control weaknesses, which is generally a familiar role for candidates. In addition, other roles given to

candidates this year were not as challenging or unusual as the roles from 2013.

Candidates generally performed well on indicators requiring them to discuss internal control weaknesses.

On Paper II, Simulation 3, Primary Indicator #2, candidates were required to discuss existing control

weaknesses and whether proposed automations were going to address them, and to recommend additional

controls that could be implemented. Most candidates were able to identify and explain a number of

control deficiencies, indicate whether or not one of the proposed automations would address these control

weaknesses, and then attempt to provide additional controls that could be implemented. Although

candidates were not directed to the Assurance indicator on Paper II, Simulation 1, it did not seem to affect

the quality of their responses since they performed quite well on this indicator. Most candidates were able

to identify some of the control deficiencies, explain their impact on the company, and suggest better

controls. Most candidates were also able to recognize that one of the employees seemed to have taken

advantage of the control weaknesses, as there were signs of fraud. Candidates also performed adequately

on Paper III, Simulation 2, Primary Indicator #1, in which they had to help put controls in place to make

sure the licence requirements were met and the client was ready for a compliance audit. Candidates were

able to identify the areas where the company was not in compliance and were generally able to provide

valid controls for the company to implement.

However, candidates did not perform well on Paper I, Primary Indicator #6, where candidates were asked

to consider possible causes and implications of problems raised by the auditor general, as well as provide

appropriate recommendations to address these problems. Candidates struggled to identify the cause of the

problems, instead focusing on the implications. Candidates approached this indicator the same way they

approach the typical internal controls indicator: by identifying the weakness, discussing its implication,

and providing a recommendation on how to fix the weakness. However, this approach didn’t ensure that

candidates addressed the cause of the problem, as requested. Even when it came to implications,

candidates had a difficult time being specific (for example, by stating errors could be caused by a

particular weakness without specifying what kind of error could be created). In addition, the weakness

was already identified in the simulation as per the auditor general’s key inspection findings, so the

identification of the weakness did not add value to the candidates’ responses.

In contrast to the prior year, there were no indicators for which candidates were asked to discuss reporting

options, which seems to have helped them since candidates typically do not perform well on that type of

indicator. Candidates had to provide audit procedures on Paper III, Simulation 1, Primary Indicator #2

and due diligence procedures on Paper III, Simulation 3, Primary Indicator #2. Candidates performed

relatively well on these two indicators. Most were able to provide a sufficient number of relevant

procedures that targeted the identified risks. There is, however, still room for improvement, since some of

the procedures provided by candidates were either not specific enough or were not practical or plausible.


Performance Measurement and Reporting

Most simulations contained accounting issues that candidates were required to address. Throughout the

three days of the 2014 UFE, candidates were examined on a range of issues, some of which were

complex, while others were more straightforward. Overall, candidates’ performance on Performance

Measurement and Reporting was slightly stronger than in 2013.

Most of the performance measurement and reporting indicators were traditional in nature. Candidates

performed relatively well on these indicators. They were generally able to recognize a number of relevant

accounting issues and attempted to analyze them using case facts and Handbook guidance to support their

analyses. Candidates who were unable to demonstrate their competence in this area typically did not

provide in-depth discussions of the issues. As mentioned earlier in this report, some candidates provided

technical guidance in the body of their response, but they did not apply case facts to the guidance or they

made recommendations that were contradictory to the guidance provided.

The Board noticed that some candidates continued to avoid the more complex issues in favour of the

easier ones. For example, on Paper I, Primary Indicator #7, candidates avoided discussing the accounting

issue related to the pension when they were provided with a whole page of information on it. As another

example, most candidates avoided the issue of the treatment of the investment in Saddle Stables on

Paper II, Simulation 1, Primary Indicator #2. This was a non-typical accounting issue, and most

candidates chose not to discuss it. By doing so, they missed out on an opportunity to demonstrate their

accounting knowledge. In addition, many candidates who attempted to address the more difficult issues

were not very successful, showing a lack of technical knowledge.

Paper I, Primary Indicator #4 was a different type of indicator requiring candidates to discuss the

Enterprise Resource Planning (ERP) reporting weaknesses and recommend specific reporting

improvements to the ERP system to provide better information for decisions to be made by management,

faculties, and the board. Candidates did not perform well on this indicator. Although most were able to

address a sufficient number of weaknesses, their explanations of the implication of those weaknesses

were lacking, and many were unable to provide a recommendation that was practical and would actually

solve the issue they had identified. Candidates seemed to be able to touch on several weaknesses but had

a difficult time taking one discussion from start to finish. Discussions were often scattered and

incomplete. Weak candidates also focused on the implication on the audit or the financial statements,

instead of tying their discussion back to the ERP system. Candidates seemed to lose track of the purpose

of their analysis, which, as per the required, was to “provide better performance information, which is

critical for many of the decisions made by management, faculties, and the BOD.” This is consistent with

the observation made by the Board earlier, that candidates often lost sight of the purpose of their analysis.

Taxation

This year, the Board saw a significant improvement in candidates’ performance on the Taxation

indicators.


Candidates did quite well on Paper III, Simulation 3, Primary Indicator #3. Although they were not

specifically directed to this indicator, they were able to pick up on the comment from the client that he

wanted to put his hands on the tax losses as part of the acquisition. Most candidates were able to provide a

reasonable discussion of the different types of tax losses and the consequences of an acquisition of control

on those losses, as well as other tax consequences for the client that would result from the acquisition.

Weak candidates had some issues trying to sort out the types of losses and often got them confused. They

also had a hard time explaining the tax consequences of an acquisition of control for the client. Where

candidates struggled most was on Paper II, Simulation 2, Primary Indicator #2. They were asked to let the

client know what size of federal tax bill he would be facing and to tell him what his total 2013 federal tax

bill would have been if he had been incorporated. As previously mentioned, candidates seemed to have a

difficult time comparing different options. This indicator was definitely a struggle for them, since they

had to compare the client’s current tax situation with a situation in which he was incorporated. Candidates

had a difficult time putting the two options on equal footing and, as a result, had difficulty providing their

client with useful information.

Management Decision-Making

There were four opportunities to demonstrate competence in Management Decision-Making (MDM) on

the 2014 UFE, which is one more than in the prior year. Candidates’ performance in MDM was

significantly weaker this year compared to previous years. Candidates did perform quite well on one of

the MDM indicators, on Paper II, Simulation 3, Primary Indicator #1. On this indicator, they were

specifically asked to provide the controller with a report to shareholders on the financial contribution that

the EasyPark app made to the company. Candidates were able to pick up the different elements presented

in the simulation and build a reasonable calculation of EasyPark’s financial contribution. Strong

candidates were also able to provide qualitative comments to supplement their quantitative analysis. The

Board was quite pleased with candidates’ performance on this indicator.

Candidates’ performance on the other three MDM indicators on the examination was disappointing.

Paper I included two MDM indicators, Primary Indicators #2 and #3. On Primary Indicator #2, candidates

were asked to describe the actions that the university could take to satisfy the financial and operating

objectives set by the university and to suggest some key performance indicators (KPIs) for evaluating

achievement of those objectives. This request was not a typical request, and some candidates seemed to

have a difficult time understanding what the characteristics of a KPI should be, such as being precise and

measurable. On Primary Indicator #3, candidates had to prepare a variance analysis on financial results

and provide specific suggestions on how to improve financial performance. Candidates were able to

calculate the variance, but some struggled to explain the reason for the variance. Many focused on the fact

that the budgeting process was inadequate instead of attempting to explain the underlying reason for the

variance.

Where candidates struggled the most was on Paper III, Simulation 2, Primary Indicator #3, for which they

had to analyze a lease proposal that their client had received. The Board recognizes that this was a

difficult indicator, due to the fact that candidates had to perform multiple steps to arrive at a final

conclusion. As discussed previously, candidates had difficulty figuring out which analysis to prepare and

what steps to take to arrive at a conclusion on whether it was worth it for their clients to lease part of their

land. This is where candidates need to take time to think about the best way to perform their analysis

before starting to write their response, and to make sure they do not lose sight of the purpose of the

analysis, which in this case was to advise on whether leasing part of the land was a good idea. In addition,

as previously mentioned, candidates had difficulty putting all of their calculations on an equal footing to

make them comparable.


Finance

Candidates did not perform as well in Finance on the 2014 UFE when compared to the 2013 UFE.

Candidates struggled with Paper I, Primary Indicator #5, for which they had to evaluate alternative

financing methods for the construction of a new fitness facility. As mentioned earlier, candidates had a

difficult time putting both alternatives on an equal footing, with many including items in one calculation

and not the other when they should have been either included in or excluded from both. Candidates were

particularly weak in their quantitative analysis of the provincial loan. Many candidates included the

interest on the loan for the first two years only, since this information was provided to them at the bottom

of Exhibit III. They failed to calculate the interest for the remainder of the loan period. Candidates also

seemed to be confused with the outlay of funds. Many candidates showed an outflow of funds on the first

year, to account for the construction costs, instead of showing outflows for the repayment of the loan.

Some candidates also showed an inflow of funds coming from the loan, at the beginning of the loan

period, not understanding that the loan money would be used to pay for the construction costs and that the

loan would need to be repaid over the years. This showed a lack of fundamental finance knowledge.

Candidates also demonstrated a lack of finance knowledge on Paper II, Simulation 2, Primary

Indicator #3. Many were not able to take the time value of money into account in their analysis.

Candidates had to compare different options that their client was considering to expand his workshop. In

this case, the only way to determine which option was better from a quantitative perspective was to either

calculate a present value or compute an effective borrowing rate for each of the options. Many candidates

either did this for one of the options but not the others, or simply summed up the total cash flows of the

options and compared the totals of each option. In the first case, candidates were not able to appropriately

compare the options because their calculations were not made on the same basis and therefore not

comparable. In the second case, candidates could not come to a reasonable conclusion since the total of

the cash outflows had no meaning unless the time value of money was also taken into account. In both

cases, candidates demonstrated a lack of finance knowledge, which prevented them from providing their

client with useful information to make an informed decision.

Candidates performed better on Paper III, Simulation 3, Primary Indicator #1, for which they had to

calculate a purchase price for a company their client was contemplating buying and assess whether it was

a fair price. Candidates were able to incorporate adjustments to net income to calculate EBITDA, and

most were also able to incorporate adjustments to normalize net income. However, candidates performed

poorly when calculating an average normalized EBITDA. Some candidates did a good job of

incorporating all three years of data provided to them, even pro-rating the last year, since only nine

months of financial data was provided. However, many candidates used only one year of data, when it

was clearly stated the basis for the purchase price was “the industry standard of 3.5 times the normalized

average” EBITDA.


Governance, Strategy, and Risk Management

Candidates’ performance in this area was comparable to the prior year. They performed quite well on

Paper II, Simulation 3, Primary Indicator #3. While they were not specifically directed to this indicator,

candidates were told by the client that some of the owners were concerned about how EasyPark, the app

one of the owners had purchased without consulting with the other owners, was affecting the company’s

ability to meet its vision and mission statements. Candidates were expected to discuss the fact that the

acquisition was not aligned with the vision and mission statements. They were also expected to suggest

improvements to the decision-making process to ensure this situation did not happen again. In most cases,

candidates were able to comment on many of the mission statements and how the purchase of the app

conflicted with them. Strong candidates also discussed the flaws in the current decision-making process.

However, candidates did not perform as well on Paper I, Primary Indicator #1, for which they had to

evaluate how the university’s objectives would satisfy the performance outcomes (SPOs) and suggest

how the objectives could be improved. Some candidates seemed to have lost sight of the required and

provided actions to ensure the objectives would be met, instead of suggesting improvements to the

objectives themselves. Candidates also had a difficult time analyzing the reasons an objective would or

would not satisfy an SPO, instead simply matching up the objectives and the SPOs without any further

discussion.

Pervasive Qualities and Skills

The 2014 examination included three Pervasive Qualities and Skills indicators, one fewer than on the

2013 UFE. The quality of candidates’ performance in this area was slightly lower than in the prior year.

As identified last year, candidates seemed to be able to recognize the issues, but they had difficulty

discussing them in sufficient depth. In some cases, it appears this may have been caused by a lack of

integration of case facts, potentially due to the candidates’ inability to see the big picture.

On Paper III, Simulation 1, Primary Indicator #4, candidates were expected to discuss the impact of the

breach of covenants on the operations of their client’s business. While candidates were usually able to

identify the breach of covenant by calculating the revised ratio, most of them were unable to elaborate on

the impact of this breach on the company. Some of them appropriately discussed the impact of the breach

on the audit, but the Board hoped candidates would also discuss the consequences for the company itself

and provide actions the owners could take to mitigate the effects of this breach on the company.

Candidates performed slightly better on Paper III, Simulation 3, Primary Indicator #4. Here again

candidates did not have a difficult time identifying the issue that the purchase of shares might not be in

the best interest of their client, but they struggled to propose solutions. Candidates often ended their

discussion after questioning the purchase of the shares, leaving their client hanging in terms of what could

be done to mitigate his risks.

Candidates struggled on Paper I, Primary Indicator #8, where they were expected to question Jerry

Decker’s ability to meet expectations of the role of vice-president of finance and to also consider the

financial position of the university. While about half of the candidates were able to identify the concern

with Jerry’s competence, most of them were unable to support, using case facts, their discussion about

why this was a concern. Additionally, only a few candidates identified the issue with the university’s

financial position, and even fewer were able to discuss it sufficiently.

16 Exhibit 1 — The Decision Model

EXHIBIT 1

THE DECISION MODEL

F

A

I

L

P

A

S

S

Q U A L I T Y C O N T R O L

Was the aggregate competency

demonstrated sufficient?NO

YES

Were the PMR and A competencies

demonstrated deep enough?NO

YES

Was the competency demonstrated

broad enough?

NO

YES

Review additional information

from secondary indicators to

enhance the ability to assess

breadth – 2nd assessment of “Was

the competency demonstrated

broad enough?”

YESNO

Level 1

Level 2

Level 3

Secondaries

Primary

indicators

only


APPENDIX A

DESIGN, GUIDE DEVELOPMENT, AND MARKING

OF THE 2014 UNIFORM EVALUATION Design

The Professional Education Management Committee (PEMC) determines the policies for the minimum

coverage of the UFE Candidates’ Competency Map on each Uniform Evaluation. The coverage

requirements for the 2014 UFE were identical to those in the prior year.

The coverage requirements and the actual percentage coverage on the 2014 Uniform Evaluation for each

section of the Map when both the primary and the secondary indicators of performance are considered

together are set out below:

Specific competency Required

Relative weight

Actual

Relative weight

Governance, Strategy and Risk Management 5 – 10% 8%

Finance 10 – 20% 12%

Taxation 10 – 20% 14%

Assurance 25 – 35% 27%

Performance Measurement and Reporting 20 – 30% 23%

Management Decision-Making 10 – 20% 16%

*The BOE is required to include a minimum of two Information and Information Technology indicators

on the UFE. The board fulfilled its commitment on the 2014 UFE by including one indicator in each of

Assurance and Performance Measurement and Reporting.

All simulations were designed to fit within the “normal circumstances” in which all entry-level CAs are

expected to demonstrate the required competencies.

Normal circumstances are circumstances where:

The entity, situation, event or transaction is of a size or degree of complexity likely to be encountered by

an entry-level CA, and

The entity is a business in the private sector, formed as a proprietorship, as a partnership, as a private

corporation; or

The entity is a small public corporation, or a division of a large public corporation; or

The entity is in the public sector or is a not-for-profit organization or a division of either; or

The entity is an individual.

Type of simulation

The evaluation is made up of a comprehensive case and several multi-subject simulations. The indicators

on the comprehensive case are weighted so that the comprehensive case represents one third of the

evaluation.

18 Appendix A

The development of evaluation guides and the provincial review centre

In May 2014, provincial reviewers met to examine the 2014 Uniform Evaluation and the preliminary

evaluation guides. The provincial reviewers’ comments on the 2014 Uniform Evaluation were considered

by the board when it finalized the evaluation set in June 2014 and again when the senior markers

reviewed the guides in the context of actual responses in September 2014.

Evaluation centre

From the marker applications received, the board carefully selected approximately 200 chartered

accountants to participate in the 2014 evaluation centre. The criteria for selection included marking

experience, motivation, academic achievement, work experience, personal references, and regional

representation.

Before the opening of the evaluation centre, board members, leaders, and assistant leaders attended a five-

day meeting, the preliminary evaluation centre (PEC). Participants reviewed the evaluation guides,

applied them to randomly selected candidate responses, and made appropriate revisions. The written

comments on the evaluation guides received from provincial reviewers were carefully considered at this

meeting, with the board approving necessary changes.

The comprehensive simulation was marked by English-speaking and French-speaking teams of between

11 and 12 markers in Montreal from October 9 to October 24, 2014. Paper III was marked in Montreal

from October 9 to October 20, 2014, and Paper II was marked from October 13 to October 24, 2014.

Each non-comprehensive simulation was assigned marking teams of between 18 and 22 markers, with

each team having a leader and two assistant leaders, and both French-speaking and English-speaking

markers. Each team had one or more markers who were capable of marking in both languages. Borderline

marking took place on October 25, 2014.

At the beginning of the comprehensive and non-comprehensive centres, the leaders and the assistant

leaders presented the evaluation guides to their teams. The team undertook a two-phase test marking

procedure prior to actual marking. Phase one consisted of two steps: guide familiarization, during which

markers applied the guide for the primary indicators to copies of candidates’ responses, and joint review,

when markers collectively reviewed their results. Phase one thus ensured that all markers understood the

issues in the evaluation guide and the basis on which to apply each proficiency level Phase two was an

expanded test marking of another set of responses to establish marker congruence. When marker

congruence was achieved for a simulation, live marking of that simulation began. The start-up period

varied between two and three days for the various simulations.

After the training and test marking phases, live marking commenced. The simulations were marked by

English-speaking and French-speaking markers.

The BOE strives for the highest possible marking consistency and quality control. This means that

leaders and assistant leaders devoted much of their time to cross marking and other monitoring activities.

Markers’ statistics were reviewed to ensure that marking was consistent. Based on analysis of the

statistics, leaders reviewed papers marked by their team members to ensure that the indicators were

assessed fairly. Bilingual markers marked papers in both languages, and their results were compared to

ensure that the marking was consistent in both languages. Leaders also discussed, on a selective basis, the

results of arbitration with their markers once the second marking began.


Double marking

Each candidate’s paper was marked independently for the primary indicators by two markers. If the two

initial markings differed on any indicator, an arbitrator (the leader, assistant leader, or a senior marker)

compared the two initial markings and determined the final result for that indicator. Based on the results

of this marking, borderline responses that had met Level 1 and 2, but not Level 3, for the primary

indicators were identified and were marked for secondary indicators. Only the leaders and the assistant

leaders mark responses for secondary indicators.

As an added measure to ensure that markers are consistently applying the marking guide, a two-day rule

exists, which results in the second round of marking not beginning until two days have elapsed since the

first marking. Adherence to this rule ensured that any movement in the application of the guides due to

marker interpretations during the first two days of live marking were stabilized before the second marking

and arbitration procedures began.

Subsequent reviews of results and/or performance analyses Reviews of evaluation results are allowed by all provincial institutes. In addition, failing candidates may apply for a performance analysis review to assist them in assessing their performance on the 2014 UFE.

How to apply for a review of results

Applications for a review of a candidate’s evaluation results must be forwarded to the Board of Evaluators through the provincial institutes. If candidates wish to apply for such a review, they should notify their respective institutes within the specified time limit.

Candidates may only apply for review of their examination results as a whole.

Review approach

The following review procedures are applied to all three papers constituting the Uniform Evaluation:

Under the supervision of the Chair of the Board of Evaluators, and the Principals Evaluations and International Assessment, the papers are reviewed by the leaders and assistant leaders who did the original marking. The team leaders and assistant team leaders read the answers and compare them to the evaluation guides used at the original marking centre. In reviewing candidates’ results, two aspects are considered by the board. First, it must be determined that the basis of marking the papers has been consistent with that accorded other candidates who wrote the evaluation. Second, all papers reviewed are subjected to a careful check to ensure that the markers have indicated that consideration has been given to all material submitted by the candidate.

The results are then tabulated and the decision made whether any candidates have been treated unfairly and should be granted a pass in the examination. There have been a relatively insignificant number of changes made to reviewed papers over the years, which is attributable to the care exercised in the original marking and tabulating of the papers and results and to the consideration given to individual papers in the review procedure.

The results of the review are forwarded to the provincial institutes for approval and notification to the candidates.

20 Appendix A

How to apply for a performance analysis review

Applications for a performance analysis review must be forwarded to the Board of Evaluators through the provincial institutes. If candidates wish to apply for both a review of their examination results and a performance analysis review, they can do so. Should the review of a candidate’s paper result in his or her standing being changed to a pass, the performance analysis review will not be performed and any associated fees will be refunded.


APPENDIX B

CANDIDATE PERFORMANCE ON PRIMARY INDICATORS

BY COMPETENCY AREA

Not

addressed

%

Nominal

competence

%

Reaching

competence

%

Competent

%

Highly

competent

%

PERVASIVE QUALITIES AND SKILLS

I Primary Indicator #8: The candidate

questions the ability of Jerry Decker to

meet the expectations of the role of the

vice-president of finance while

considering the financial position of MU.

0.8% 33.2% 53.3% 12.7% 0.0%

III-1 Primary Indicator #4: The

candidate discusses the impact of the

breach of debt covenants on the

operations of LHT.

7.7% 15.0% 56.3% 20.9% 0.1%


candidate discusses how the purchase of

shares may not be in the best interest of

BSL and advises on factors that need to

be taken into account if a share purchase

is to be done.

8.1% 12.4% 52.6% 26.9% 0.0%

OVERALL 5.5% 20.2% 54.1% 20.2% 0.0%

GOVERNANCE, STRATEGY AND RISK MANAGEMENT


evaluates how MU’s objectives will

satisfy strategic performance outcomes

and suggests how the objectives could be

improved.

0.5% 15.1% 54.6% 29.5% 0.3%

II-3 Primary Indicator #3: The

candidate discusses the fact that the

rollout was not in line with RWD’s

mission statements.

2.0% 12.4% 15.9% 67.4% 2.3%

OVERALL 1.3% 13.7% 35.3% 48.4% 1.3%

22 Appendix B

APPENDIX B


BY COMPETENCY AREA (CONT’D)

Not

addressed

%

Nominal

competence

%

Reaching

competence

%

Competent

%

Highly

competent

%

FINANCE


evaluates the alternative financing

methods for the construction of the new

fitness facility.

0.4% 28.7% 44.0% 26.7% 0.2%


candidate analyzes Carl’s options for the

new building and advises him

accordingly.

1.7% 15.2% 54.8% 28.1% 0.2%


candidate calculates the purchase price

for SPI and assesses whether it is a fair

price.

0.2% 9.8% 43.2% 46.7% 0.1%

OVERALL 0.8% 17.9% 47.3% 33.8% 0.2%

TAXATION


candidate provides a reasonable

quantitative and qualitative analysis of

Carl’s tax situation.

0.1% 8.2% 58.0% 33.1% 0.6%


candidate recalculates the taxes payable

for the discontinued operations. 2.1% 19.2% 32.6% 45.9% 0.2%


candidate discusses the acquisition of

control rules and addresses other tax-

related issues in regards to the share

purchase.

0.6% 13.4% 21.0% 64.9% 0.1%

OVERALL 0.9% 13.6% 37.2% 48.0% 0.3%


APPENDIX B



Not

addressed

%

Nominal

competence

%

Reaching

competence

%

Competent

%

Highly

competent

%

ASSURANCE


considers possible causes and

implications of the problems raised by the

auditor general and provides appropriate

recommendations to address these

problems.

0.2% 20.4% 57.4% 21.9% 0.1%


candidate prepares an audit planning

memo and suggests procedures for the

significant areas.

0.1% 6.2% 34.7% 58.8% 0.2%


candidate discusses the control

weaknesses that provide an opportunity

for potential fraud.

0.3% 6.6% 27.2% 65.0% 0.9%


candidate discusses the internal control

weaknesses related to EasyPark and

whether the proposed automations are

going to address them, and recommends

additional controls that could be

implemented. *

0.2% 6.6% 23.9% 66.8% 2.5%


candidate provides audit procedures for

the risk areas of the audit. 0.5% 11.1% 29.1% 59.2% 0.1%


candidate provides advice on putting

controls in place to meet the licence

requirements and prepare for the

compliance audit.

0.6% 8.8% 37.9% 52.6% 0.1%


candidate discusses the due diligence

procedures that should be done to give

Mr. King comfort on various balance

sheet items of SPI.

0.2% 2.8% 35.3% 61.2% 0.5%

OVERALL 0.3% 8.9% 35.1% 55.1% 0.6%

* Information and Information Technology indicator

24 Appendix B

APPENDIX B



Not

addressed

%

Nominal

competence

%

Reaching

competence

%

Competent

%

Highly

competent

%

PERFORMANCE MEASUREMENT AND REPORTING


discusses Enterprise Resource Planning

(ERP) reporting weaknesses and

recommends specific reporting

improvements to the ERP system to

provide better performance information

for decisions by management, faculties,

and the board. *

0.4% 11.1% 47.9% 40.6% 0.0%


discusses accounting issues affecting MU. 0.2% 14.6% 43.4% 41.4% 0.4%


candidate discusses the accounting issues. 0.1% 7.5% 44.9% 46.9% 0.6%




candidate discusses the accounting issues

for LHT. 0.0% 5.1% 39.6% 55.2% 0.1%



OVERALL 0.2% 10.2% 40.2% 49.1% 0.3%

* Information and Information Technology indicator


APPENDIX B



Not

addressed

%

Nominal

competence

%

Reaching

competence

% Competent

%

Highly

competent

%

MANAGEMENT DECISION-MAKING


describes actions to satisfy MU’s

financial and operating objectives and

suggests key performance indicators to

evaluate achievement of those objectives.

1.1% 20.3% 36.3% 42.1% 0.2%


analyzes variances on financial results

and suggests ways to improve financial

performance.

0.9% 27.9% 22.2% 48.8% 0.2%


candidate assesses EasyPark’s

contribution to RWD’s financial results 1.8% 8.8% 18.2% 69.3% 1.9%


candidate analyzes the lease proposal.

0.9%

21.4%

50.8%

26.8%

0.1%

OVERALL 1.2% 19.6% 31.9% 46.7% 0.6%

26 Appendix C

APPENDIX C

2014 SIMULATIONS AND EVALUATION GUIDES


2014 Uniform Evaluation

PAPER I Time: 5 hours

NOTES TO CANDIDATES:

(1) Simulations that require knowledge of the Income Tax Act, the Income Tax Application Rules 1971,

and the Income Tax Regulations are based on the laws enacted at December 31, 2013, or in

accordance with the provisions proposed at December 31, 2013.

Provincial statutes, including those related to municipal matters, are not examinable.

(2) Tables of present values, certain capital cost allowance rates, and selected tax information are

provided at the end of the evaluation paper as quick reference tools. These tables may be used in

answering any simulation on the paper.

(3) Answers or parts of answers to simulations will not be evaluated if they are recorded on anything

other than the USB key or the writing paper provided. Rough notes will not be evaluated. You are

asked to dispose of them rather than submit them with your response.

* * * * * * * * * *

The Uniform Evaluation (UFE) is still being developed and provided under the direction of the Canadian Institute of Chartered Accountants

(CICA) until final offerings of the CA program are complete.

2014


277 Wellington Street West, Toronto, Ontario, Canada M5V 3H2 Printed in Canada

UFE CANDIDATE NUMBER:

THE INSTITUTES OF CHARTERED ACCOUNTANTS OF CANADA

I

28 Appendix C — Paper I

Today is July 15, 2014. You, CA, work in a CA firm that has been engaged by the Board of Directors

(BOD) of Millman University (MU) as a consultant to advise them on a number of issues. Your manager,

Susan Ng, has assigned you to the engagement. You and Susan are meeting with the new president of

MU, Dr. Sylvie Héroux, to gather background information relating to the engagement.

Dr. Héroux starts the meeting with a discussion of the BOD’s responsibilities to the provincial

government. She explains the issues she’d like you to consider:

1. “MU recently received a letter from the Ministry of Advanced Education (the Ministry) outlining its

2014/2015 funding commitment, as well as its performance expectations for the university. The letter

explicitly states four strategic performance outcomes (SPOs) that the government will use when

considering future funding commitments:

a) Provide greater choice of programs;

b) Provide high-quality and affordable education;

c) Create a climate of innovation, creativity, and collaboration (both internally and externally); and

d) Foster integrity and accountability through an appropriate governance structure.

“As you are aware, there were significant budget cuts to post-secondary education in the recent

provincial budget. In addition, the Ministry is limiting Canadian student tuition fee increases to 1.5%

and international student fee increases to 4% for the year ending June 30, 2015. I am concerned that

these budget cuts and tuition fee restrictions, combined with other financial issues, will result in MU

being unable to satisfy the Ministry’s SPOs. We receive an operating grant annually from the Ministry

based on Canadian student enrollment, and the amount has been confirmed as $95,465,000 for the year

ending June 30, 2015.

“This year, our management team assisted the BOD in developing objectives for MU (Exhibit I).

Could you look at the Ministry SPOs and explain how MU’s objectives will satisfy the SPOs? Also,

please suggest how our objectives could be improved and recommend additional ones the BOD should

consider, where necessary.

2. “Our management team would like to ensure it is meeting its financial and operating objectives as

outlined in Exhibit I. I’d like you to describe the actions MU could take to satisfy these two categories

of objectives and suggest some key performance indicators (KPIs) for evaluating achievement of those

objectives.

3. “I’d appreciate your review of the information that Jerry Decker, vice-president of finance, provided

(Exhibit II), although he may have more adjustments to make. Jerry has also provided some interesting

statistics on certain aspects of MU operations. Please prepare a variance analysis on financial results,

incorporating the additional information from Jerry where appropriate. Also, please provide specific

suggestions on how to improve our financial performance by optimizing sources of revenue or by

reducing costs.


4. “MU is not satisfied with both the financial and non-financial reports it is receiving. The Enterprise

Resource Planning (ERP) system was implemented three years ago and was intended to integrate

financial and non-financial data into a single reporting system, but there are still issues related to

it.Given the notes provided in Exhibit II, please analyze the reporting weaknesses and recommend

specific reporting improvements that can be made to our ERP system to provide better performance

information, which is critical for many of the decisions made by management, faculties, and the BOD.

5. “MU has been exploring community partnerships and has been approached by the Jenson Group of

Companies (JGC) with an opportunity. I’d like your comments on JGC’s proposal (Exhibit III).

6. “I received the key findings from the most recent inspection report of the auditor general (Exhibit IV)

from Jerry. The Ministry requires that MU responds to the auditor general’s inspection findings in a

timely manner. It is important to understand the underlying causes of the problems so that we can take

appropriate corrective action, as the auditor general report indicates that these problems have persisted

for several years. Therefore, could you please review the report to analyze possible causes of the

problems and their implications and explain what MU could do to address these problems?”

Susan concludes the meeting by advising Dr. Héroux that you will prepare a written response to address

her concerns.

Susan has also met with Natalie Saroya, chair of the Audit Committee; Jerry Decker; and certain staff of

the finance department. She provides you with her notes from those meetings in which accounting issues

were identified (Exhibit V) and mentions that Dr. Héroux wants you to provide recommendations on

these issues.

As you and Susan head back to the office, she tells you that MU has chosen to use International Financial

Reporting Standards (IFRS). The Ministry has approved MU’s use of IFRS. Susan also provides you with

the exhibits that were mentioned earlier.


INDEX TO EXHIBITS

Page

I. Draft 2014/2015 MU Objectives………………………………………………………….. 31

II. Information Provided by Jerry Decker, MBA…………………………………………….. 32

III. Details of Community Partnership Proposal……………………………………………… 34

IV. Key Inspection Findings of the Auditor General………………………………………… 35

V. Comments from Interviews………………………………………………………………..

36


EXHIBIT I

DRAFT 2014/2015 MU OBJECTIVES

The Post-secondary Learning Act specifies the mandate for MU. The Ministry communicates its

expectations to the university every year. It is the role of the BOD to develop objectives to ensure that

those expectations are satisfied.

MU has an Academic Governance Council (AGC) that is responsible for academic standards, ethics,

policies, and programs. The AGC makes recommendations to the BOD with respect to academic

objectives. The AGC also oversees all scholarship, research, and cultural activities of MU’s four

academic faculties:

Arts and Communications;

School of Business;

Math and Science; and

Health and Community.

Academic Objectives

Increase participation in current e-learning

courses by 10%.

Have each faculty develop at least two new

e-learning courses.

Perform well on national and international

rankings, as well as on student surveys.

Increase research publication requirements of

faculty members.

Improve student retention and program

completion rates.

Governance Objectives

Increase number of board committees to

enhance governance.

Enhance diversification and number of

individuals (from 10 to 15) who serve on the

board.

Consider board member expertise in committee

composition.

Financial Objectives

Secure funding commitments for various

initiatives, including $6 million for the new Arts

and Communications building and $500,000 for

the new Bachelor of Acadian Music degree

(which is not funded by the Ministry).

Increase student scholarships.

Limit annual tuition increases to 2%.

Eliminate deficits.

Operating Objectives

Optimize use of classroom space.

Maximize use of the ERP functionality to

integrate and optimize access to information

throughout MU.

Provide timely and accurate reporting of

financial and non-financial results.

Improve budgeting process.


EXHIBIT II

INFORMATION PROVIDED BY JERRY DECKER, MBA

FINANCIAL RESULTS

As at June 30

(in thousands of dollars)

2014 2013

Note Actual Budget Actual Budget

(draft) (audited)

Grant revenue – operating $ 102,820 $ 106,789 $ 106,233 $ 105,122

Grant revenue – capital 1 8,500 2,000 2,000 2,000

Tuition fees 56,201 55,261 53,176 52,133

Ancillary sales 2 10,907 12,531 12,592 12,225

Other revenue 3 40,712 48,997 38,120 50,763

219,140 225,578 212,121 222,243

Salaries and benefits 4 133,661 126,119 117,736 121,268

Other operating expenses 45,519 60,229 50,614 68,434

Total operating expenses 5 179,180 186,348 168,350 189,702

Cost of ancillary sales 7,561 9,282 9,327 9,056

Other non-operating expenses 6 31,199 29,948 40,229 23,485

217,940 225,578 217,906 222,243

Surplus (deficit) $

1,200 $ — $ (5,785) $ —

We use incremental budgeting using spreadsheet software, basing the current year’s budget on last year’s

budget since final results are not in before we have to approve the budget. We have always presented a

balanced budget to the BOD. We’ve had deficits in 2013 and 2012, but I’m confident that we will have a

surplus this year, as shown by our draft financial information above.

Notes:

1. Capital grants are received from the Ministry for specific capital projects.

2. Ancillary sales include bookstore, conference services, parking, and food service revenue.

3. Other revenue includes fundraising, donations, investment, and other income. Because fundraising

campaigns don’t get underway until later in the year and we never know how successful they will be,

we don’t know if we will achieve the budgeted number.

4. Salary costs always increase more than the budgeted 4% annual compensation increase as a result of

higher than expected student enrollment. Expected enrollment is difficult for my group to estimate due

to the timing of the budget and the delay in receiving final enrollment information from the Student

Portal database. We never receive enough funds from grants to cover all of our teaching salary costs.

Luckily, we’ve been able to find savings in other areas to allow us to keep our class sizes comparable

to previous years.

5. A standard financial performance measure is operating cost per full-time equivalent (FTE) enrollment.

This cost is $14,000 for the average Canadian public institution.

6. Interest on long-term debt and amortization of property, plant and equipment are included in this cost

category. Our actual interest expense is always very close to budget. Since amortization is a non-cash

expense, we are not overly concerned with the accuracy of the calculation.


EXHIBIT II (continued)

INFORMATION PROVIDED BY JERRY DECKER, MBA

Statistical Information for the Years Ended June 30

2014 2013 2012

Student enrollment:

Canadian FTE 10,984 10,683 10,382

International FTE 576 540 514

Total FTE enrollment 11,560 11,223 10,896

Total student headcount 14,400 13,846 13,187

Total applicants 17,671 18,681 19,200

Tuition fees:

Per Canadian student FTE $ 4,650 $ 4,559 $ 4,448

Per international student FTE $14,820 $14,305 $13,808

Employees:

Faculty FTE 685 635 620

Supervisory and administration FTE 1,041 948 945

Classroom space used 90% 88% 85%

Other Information

The ERP system can track financial information only for the university as a whole. Currently it

produces the same set of reports for distribution to the BOD, management, and faculties. Faculties

have expressed frustration over getting information that they don’t need and not getting enough

information on what they do need to manage their teaching loads. As well, some professors want to be

able to track alumni so that they can invite them to participate in mentoring and fundraising events.

Currently, professors are only able to contact alumni if they have them in their personal contact lists.

Enrollment information is not available in the ERP system and comes from each of the four faculties.

Each faculty uses different report-writing tools and formats, which creates a lot of work for our staff

when preparing this information. The FTE enrollment calculation is done outside the system using

spreadsheet software. It seems that each faculty has a different way of interpreting the definition of an

enrolled student. The finance staff then has to reconcile the data to ensure that student enrollment

information is not double counted (for example, by course and by program).

The number of applicants is not available from the ERP system but is available from the Student Portal

database, which was intended to interface with the ERP system. Applications from international

students continue to be high for programs in the School of Business and in Math and Science. We are

not accepting new international students for these programs due to lack of space. I’m not sure how

many Canadian students are successful in their applications.

E-learning courses are not tracked separately from regular courses. Only the Arts and Communications

faculty and the School of Business offer e-learning courses at this time. The other faculties do not

believe their programs would be successful in an e-learning environment.

At the end of fiscal 2013, we still had some unreconciled differences from the transfer of information

from the old system to the new ERP’s financial modules, but I think we will find that everything is

reconciled when we complete our annual 2014 reconciliations.


EXHIBIT III

DETAILS OF COMMUNITY PARTNERSHIP PROPOSAL

Our students and faculty members have been requesting an upgraded fitness facility for a number of

years. However, applications for government infrastructure grants have been unsuccessful and debt

financing has been allocated to other projects deemed a higher priority by the BOD. We believe the

construction of a new facility will help us attract and retain more students. Additionally, we should be

able to increase the mandatory sport and wellness fee by $20 per FTE enrollment.

The following costs have been estimated in developing the budget for this two-year capital project (which

could be completed by December 2016):

Total design and construction costs beginning in 2015 $23,500,000

Annual operating and maintenance costs beginning in 2017 $ 2,050,000

An alumnus of MU, the president of the Jenson Group of Companies (JGC), which is a private company

with local owners, expressed interest in partnering with our institution for philanthropic reasons. We have

started negotiations with JGC, and the following funding arrangement has been proposed:

JGC will construct the building with a planned opening of January 1, 2017.

From opening until December 31, 2025 (nine years), MU will lease the building from JGC for

$5,250,000 per year, which includes the annual operating and maintenance costs.

On January 1, 2026, ownership of the building will transfer to MU for $1, at which time MU will

cover the annual costs.

The building will be named the Jenson Fitness Centre.

For each year of the lease, JGC will provide entrance scholarships to two students accepted into the

faculty of Health and Community.

An alternative is for MU to finance the construction with a 20-year loan provided by the province at a rate

of 4%. At the start of construction, 50% of the construction monies would be advanced, and the remaining

50% would be advanced after one year. Interest during the construction period is estimated to be

$470,000 in year one and $940,000 in year two.


EXHIBIT IV

KEY INSPECTION FINDINGS OF THE AUDITOR GENERAL

The following key findings arising from the most recent inspection have been consistent over the past

several years. They have yet to be addressed in an acceptable manner.

1. University not ready for inspection.

Capital asset working papers, including continuity and amortization schedules, as well as details on

project costs, are incomplete.

Payroll and accounts payable accruals are incomplete.

2. Accounting policies are not always followed.

Revenue recognition policies are applied inconsistently, resulting in repeated audit adjustments.

3. Financial processes and controls are inadequate.

There are limited controls around vendor selection and set-up.

Accounts receivable staff has the ability to prepare deposits and write off accounts receivable.

4. Roles and responsibilities are not documented.

Financial staff members do not have up-to-date job descriptions.

5. Training is insufficient.

Staff (including management) has not been adequately trained on the new ERP system.

6. Management review is inadequate for identifying errors on a timely basis.

Management does not review financial statements on a monthly basis.

Reconciliations are only prepared annually.

7. Data entry restrictions are inadequate.

Staff members share passwords to access different financial system modules.


EXHIBIT V

COMMENTS FROM INTERVIEWS

Comments from Natalie Saroya, CA, Chair of the Audit Committee

I am new to the BOD and was recently appointed chair of the Audit Committee. I think I am the first

designated accountant they have had on the BOD. I had a lot of questions for Jerry during his most recent

report to the BOD. I was concerned about Jerry’s ability to meet his responsibilities and suggested we

engage your firm to help provide some clarity around our concerns. We’ve also had discussions at the

BOD about Jerry’s performance and are considering letting him go if our June 30, 2014, year-end

financial statements show another deficit. Luckily, right now the draft financial information shows a

surplus. There seems to be a lack of trust between the management team and the BOD. The BOD gets the

same reports that management uses and, therefore, spends a lot of time debating issues that may be better

left to the management team.

Comments from Jerry Decker, MBA, Vice-President of Finance

I am really glad you are here to help out. My staff tends to be sick or unmotivated. In addition to

finalizing the 2014 year-end financial statements, Natalie’s questions and the challenges we are facing in

meeting the budget have resulted in some late nights. I’ve also had two experienced staff leave and one

retire in the past six months. I’m not sure I’m up for another year of this. I can’t wait to leave on my

annual four-week vacation — I’ve got a trip planned from the end of July until the end of August! It’s too

bad that, for the third year in a row, I won’t be able to take professional development courses because of

my vacation.

Speaking of retirement, it would be great if you could review the accounting for our Supplemental

Executive Retirement Plan (SERP). One of my experienced staff members prepared the financial

statements after receiving the information from the actuary. There are probably some other accounting

issues — a review of the auditor general’s inspection report should point you in the right direction. Feel

free to get any additional information you require from the staff. I hate to comment too soon, but it looks

like we’ll see a small surplus of $1.2 million this year. Maybe that will reduce Natalie’s requests for

information every time I give my report.

For its next meeting, the BOD wants an explanation of the accounting treatment of JGC’s proposed

financing for the new fitness facility. The members would like that information to assist them in deciding

whether to proceed with the opportunity. Could you provide that for me?


EXHIBIT V (continued)


Notes from Interviews with Finance Department Staff

Controller

The university maintains a supplemental pension plan for its senior executives. The plan is a

non-contributory defined benefit plan. No benefits have been paid out of the plan since inception. The

June 30, 2013, audited financial statements showed the following balances:

Defined Benefit Obligation $550,000

Plan Assets $250,000

Defined Benefit Liability $300,000

During 2014, MU booked an entry to record the annual contribution to the plan assets, which occurred on

January 5, 2014:

Dr. Defined Benefit Liability $125,000

Cr. Cash $125,000

An actuarial valuation of the plan assets and supplemental benefit obligation was prepared as at June 30,

2014. The following information was provided to MU:

Discount Rate 5% (same as at June 30, 2013)

Current Service Costs $140,000

Defined Benefit Obligation $710,000

Plan Assets $389,000

At the end of the year, I made the following entry to record the current service costs:

Dr. Pension Expense $140,000

Cr. Defined Benefit Liability $140,000

After this entry, the ending defined benefit liability is $315,000. I am not certain why this wouldn’t equal

the defined benefit obligation amount provided by the actuary. As well, I don’t know where the plan

assets are recorded, nor did Jerry when I asked him. Our treasury analyst went on stress leave just after

year-end, so I hope he took care of any entries related to that investment before he left. I’m glad you’re

going to review this for me because Jerry didn’t seem too concerned about it. I’ll get any required

adjusting journal entries posted right away.




Notes from Interviews with Finance Department Staff (continued)

Capital Asset Accountant

A new student residence was built over the past two years. The first two floors were opened in

January 2014, resulting in the building being 50% occupied for the remainder of the 2013/2014 academic

year. Some of the rooms will also be reserved for use by employees. Although the majority of the

remaining two floors was available for occupancy in March 2014, we don’t expect to be fully occupied

until the new academic year starts in September 2014. That will allow for the completion of some minor

items over the summer months. In March 2014, $43,300,025 was recorded in “construction in progress”

for the student residence project. The total project budget is $45 million. Since the project was first

planned, real estate values in the area have skyrocketed and the residence might now be worth $50

million.

The project manager said he’d have the final costs for me in September, when I’d have to record the asset.

I’m not sure whether it would be considered an investment property or not. Either way, I’d like to stick to

our usual practice of recording buildings using the cost model and therefore amortize it over 40 years,

even though private sector apartment-type buildings are usually amortized over 50 years. I’d like to get

this resolved in order to address the issues raised in the inspection report of the auditor general.

We also have another significant project on the go, the Community Learning Centre, which is funded

through government grants and donors. In July 2013, we received grant funds of $7.5 million in advance

of the project starting, but if we spend less on the project or if some expenses are deemed ineligible by the

government, we have to repay any unused or ineligible funds. At June 30, 2014, $600,000 in expenditures

was in construction in progress. The project is expected to be completed in May 2015.

Prior to year-end, MU and EventCo Ltd. (EventCo) jointly entered into an arrangement to construct a

sports field, with parking, on university land. A company (NewCo) was formed for the completion of this

project, with MU and EventCo each having two members on its board. Once the facility is operational,

EventCo will manage the day-to-day operations (including event bookings, staffing, and receipts).

However, both parties will jointly approve the annual budget for the facility. In order to fund the

construction of the project, NewCo obtained bank financing prior to June 30, 2014. Because NewCo had

no assets to secure this financing, MU and EventCo provided guarantees for the repayment of the loan. At

this point, MU has not recorded anything with respect to this project, and I’m not sure how to account for

its interest.




Notes from Interviews with Finance Department Staff (continued)

Accounts Receivable (AR) Supervisor and Acting Accounts Payable (AP) Supervisor

All amounts received in the year are booked to revenue. The auditors advise us of any revenue

recognition errors. We have made adjustments in the past.

I am normally the AR supervisor, but since the AP supervisor is on a six-month maternity leave, Jerry

asked me to fill in for her as well, rather than hiring a replacement. I agreed as long as my salary was

increased. I delegated some review and reconciliation responsibilities to staff, but they are a bit behind.

However, I didn’t realize how many accruals were required at year-end — I wish I had asked for training

too! To limit the amount of accruals, we sent letters to all of our major vendors asking them to make sure

they invoice us before June 30.

AP staff members have been really busy during the first two weeks of July getting all of those invoices

entered. We changed the system controls to allow invoices that didn’t have matching purchase orders in

the system to be processed. However, any invoice over $50,000 needs to be approved by Jerry before

being entered. This has made it go much quicker than in the past, so I’m sure Jerry and the auditors will

be happy that we are ready for the audit at the end of July.

I gave Jerry invoices totalling $950,780 to approve. He approved all of them except for $400,000 in

contracted instructor invoices for corporate training that was provided in May and June. Jerry stated that

he was certain the instructors’ contracts specified that final invoices were not to be submitted until July.

We don’t create purchase orders for instructor contracts. I have a note to enter the invoices in the July

month-end.

Payroll Supervisor

We pay all employees on a bi-weekly cycle (26 pay periods per year). Bi-weekly payroll approximates

$5,150,000. The last pay period for 2014 ended on June 26, 2014. Jerry has told us that because the

amount will be immaterial, we don’t need to set up an accrual for the end of June.

Corporate training instructors are paid by contract for courses taught at their corporate facilities. These

instructors tend to work for a number of different organizations and come from a variety of professional

backgrounds. We also have some information technology consultants on fee-for-service contracts. Some

of these consultants have been with MU for over three years and have designated workstations at MU, as

well as MU email addresses. I overheard one of them talking about the recent training program they had

attended that was paid for by MU. I wanted to prepare T4s for any consultants who had been here for a

long time (maybe two years or more), but when I discussed this with their supervisor, an MU employee,

she said they are not considered employees because they are not enrolled in the health benefit plan.

40 Appendix C — Paper I — Evaluation Guide

EVALUATION GUIDE

COMPREHENSIVE SIMULATION – MILLMAN UNIVERSITY (MU)

PRIMARY INDICATORS OF COMPETENCE

The reader is reminded that the solutions are developed for the UFE candidate; therefore, all the

complexities of a real-life situation may not be fully reflected in the following solution. The UFE

Report is not an authoritative source of GAAP.

In addition, the Handbook sections referenced in this suggested solution are intended for learning

purposes only. While candidates are expected to apply the guidance in the Handbook when analyzing

financial reporting and assurance issues, they are not expected to directly quote from the Handbook.

Candidates who choose to quote Handbook sections are reminded that no credit is given unless the

quotation is integrated into a meaningful analysis and applied to the relevant case facts.

Memo to: Dr. Sylvie Héroux, President

From: CA

Subject: Report on Millman University (MU)

As requested, I have provided an analysis and recommendations on a number of issues. My report

follows.

Primary Indicator #1 The candidate evaluates how MU’s objectives will satisfy strategic performance outcomes and suggests how the objectives could be improved. The candidate demonstrates competence in Governance, Strategy, and Risk Management.

Competencies

IV-2.7 – Evaluates the entity’s performance measurement and reporting strategy (A)

IV-4.1 – Evaluates decision making and accountability processes (B)

Strategic Performance Outcomes (Ministry) and Strategic Objectives (MU)

One of your primary objectives is to ensure MU meets its responsibilities and satisfies the performance

expectations of the Ministry of Advanced Education (the Ministry) as outlined in the recent letter

regarding the Ministry’s 2014/2015 funding commitment. The Board of Directors (BOD) is accountable

to the Ministry to achieve the following strategic performance outcomes (SPOs):

A. Provide greater choice of programs.

B. Provide high-quality and affordable education.

C. Create a climate of innovation, creativity, and collaboration (both internally and externally).

D. Foster integrity and accountability through an appropriate governance structure.

You have asked me to look at the Ministry SPOs, explain how MU’s objectives will satisfy them, and

suggest improvements to existing objectives, as well as suggest additional objectives that the BOD should

consider to ensure MU’s responsibilities to the Ministry have been fulfilled.


Ministry Strategic Performance Outcome:

A. Provide greater choice of programs.

MU Objective How MU’s Objective Satisfies Ministry’s SPO

Have each faculty develop at

least two new e-learning courses. E-learning courses may increase the attractiveness of some

programs.

Makes existing programs accessible to a broader group of

applicants, thereby improving choices available to students.


Secure funding commitments for

various initiatives, including…

the new Bachelor of Acadian

Music degree (which is not

funded by the Ministry).

New program offering presumably satisfies market demand, thereby

providing greater choice.

Could offer additional programs, depending upon participant

interest.

Improvements to objectives:

Consider quantity of programs offered, as well as format of delivery (classroom, e-learning).

Changes in employment opportunities should also be considered when determining program offerings,

as well as trending events and their impact.

Search for partnerships/donors to fund other programs in order to provide greater choice.

All faculties should explore e-learning opportunities, even those that have not typically offered those

courses (e.g., Math and Science) to provide greater choice of courses.

This SPO is not satisfied by MU’s objectives, and additional objectives should be considered. While MU

has a stated objective to develop more e-learning courses, offering an additional course does not achieve a

greater choice of programs, since numerous courses are required to create a program.

Additional objectives MU should consider to achieve greater choice of programs:

MU’s emphasis seems to be on e-learning, yet it should also review existing courses and programs

with a view to continually improving course offerings while ensuring future viability.

MU should contemplate partnering with other universities or post-secondary institutions to provide

opportunities for participation in exchange programs between certain faculties to provide greater

access to programs.

(Most candidates were able to align a specific MU objective to this strategic performance outcome

(SPO). The most common objective discussed by candidates was having each faculty develop at least

two new e-learning courses. Most candidates attempted to explain how the objective they picked

satisfied the Ministry requirements (for example, offering greater online learning opportunities allows

students to have more flexibility and course choices). Some candidates also attempted to provide

modifications to the objective or propose new objectives that would provide greater choice of programs.

However, some candidates provided ways to achieve the objective rather than ways to improve it; in

other words, they provided actions instead of improvements. This was relevant to Primary Indicator #2,

but not to this indicator. Strong candidates achieved greater breadth in their responses by considering

objectives from different categories that would satisfy the SPO, explaining how those objectives would

achieve satisfaction, and then recommending improvements or new objectives to ensure satisfaction of

the SPO.)



B. Provide high-quality and affordable education.


Increase participation in current

e-learning courses by 10%. E-learning provides state-of-the-art program delivery.

E-learning may be more affordable for participants than

classroom courses (tuition fees could be cheaper than in-

class offerings; e-learning courses may be more accessible

for students than in-class courses, depending upon their

geographic location).

Improvements to objective:

Clarify how the objective will be achieved. Specific information on how this objective will be achieved

should be incorporated into the wording of the objective: for example, increasing participation by 10%

by meeting with current and potential students and employers to educate them about e-learning course

offerings, and updating the university website and using advertising to improve awareness of e-

learning course offerings.

Clarify the timeframe for measuring the participation increase, as well as how it will be tracked.


Perform well on national and

international rankings, as well as on

student surveys.

Allows comparability to other institutions.

Measures student satisfaction with MU.


This objective needs to be more specific and measurable — “perform well” is not defined. MU should

ensure the objective is achievable based on past results and specify its desired ranking (for example, in

the top 20 for rankings).

Determine specific survey metrics and tracking so that performance and improvement can be

monitored.

Also, “how” this objective will be achieved should be specified, to assist in business planning and

resource allocation. Will additional staff be hired to develop and deliver student surveys and to analyze

results? This may not be possible with the current deficit position.

Compare survey results with other benchmark institutions, if available, as well as compare year-over-

year results.

One potential measurement of level of quality could be the ability of program graduates to achieve

accreditation from external bodies.



Increase research publication

requirements of faculty members. Faculty who are on the leading edge of their areas of

expertise allow for the provision of high-quality learning.

Increased research helps MU stay relevant to prospective

students (but need to ensure that the pursuit of research is

properly balanced with in-class teaching commitments —

affects affordability of courses for students).

Interaction of faculty members with appropriate external

entities could be a measure of quality of programs.


Define “increase” — perhaps setting a target of two publications per year for each tenured faculty

member would be appropriate. Also need to establish initial baseline from which the increase will be

measured.

Specify the time frame for published research (e.g., annually; within research funding time frames).

Consider clarifying what constitutes “high-quality” education with respect to faculty — qualification

of faculty members (e.g., number of degrees held; level of education; professional designation; annual

student evaluations; research initiatives) should be specified.


Improve student retention and program

completion rates. Returning students and graduates from programs are

reflection of quality of education (and possibly,

affordability of programs).


Objective as currently stated is not measurable and contains unclear terms.

Define “improve” — should specify what level of improvement would be considered sufficient (e.g.,

90% retention rate?) and the starting point (i.e., the baseline) from which the improvement will be

measured.

Define what an acceptable program completion rate is (e.g., 80% of students entering program

eventually graduate with a degree?).

Define “student retention” — is it retention within programs, faculties, or the university as a whole?




various initiatives, including…the new

Bachelor of Acadian Music degree


External funding and support of program reduce tuition for

participants, thereby increasing affordability.


While new programming improves access and choice, it must be introduced in a fiscally responsible

manner by MU and in response to adequate demand by potential students.

Creating a degree without having a source of funding may result in higher tuition fees for students. I

suggest examining the number of applicants for this new degree to ensure it is the most effective use of

funds.

Clarify how funding will be “secured” (e.g., determine the interest of employers in graduates to ensure

program offerings are relevant to the marketplace; ensure that all possible government grants related to

programs are applied for).

Specify time frame to obtain these commitments, as well as the amounts of the commitments sought.

Determine demand for various initiatives coupled with current expertise at MU to ensure program

quality and costs are key factors when considering program creation or expansion.


Increase student scholarships. Increase in scholarships helps to offset tuition fees that

students pay, thereby making education more affordable.


Objective needs to be more specific and measurable:

o How many scholarships will be created?

o What is the expected dollar amount of scholarships raised?

o How will the scholarships be used to made education more affordable — what are the criteria upon

which they will be awarded (academic performance or financial-need basis)?


Limit annual tuition increases to 2%. Due to the limits imposed by the province (1.5% on

Canadian students and 4.0% on international students), the

objective of limiting tuition increases is not controllable by

MU and should not be included.


Change the objective to be more specific with respect to Canadian and international student tuition

increases and within the guidelines set by the Ministry. (For example, the objective would be more

appropriate and achievable if it were set as “not to exceed Canadian student tuition increases of 1.5%

and international student tuition increases of 4.0%” or if MU clarified that the 2% increase is an

average.)



Eliminate deficits. Balanced financial position may reflect good fiscal

decision-making for ability to provide affordable education.


Clarify how this objective will be measured — does it refer to the accumulated deficit or the current

year’s deficit? Over what time frame is the elimination to occur? Need to ensure the objective is not

achieved by exceeding the Ministry’s stipulated tuition fee increase maximums of 1.5% and 4% for

Canadian and international student fees respectively.


Optimize use of classroom space. Class size may affect cost of program (e.g., large classes

could reduce costs; conversely, large class sizes may detract

from quality of programming delivered).

Effective use of space may limit the need for infrastructure

expansion, thereby controlling costs.


Clarify how this objective will be measured — what is the optimal classroom space utilization rate?

Also, consider what impact a change in class size may have on the quality of program delivery

(whether positive or negative).

This SPO is satisfied by MU’s objectives; however, this is an area in which an additional objective could

be considered.

Additional objectives that MU should consider to provide high-quality and affordable education:

Develop sub-objective relating to program admission to ensure incoming students are of sufficient

quality to maintain high quality of programs (e.g., academic averages of applicants).

Consider objectives that will allow faculty to achieve increases in research publications (e.g., provide

sabbaticals or additional research funding).

(Most candidates addressed SPO (b) and spent a significant portion of their response to Primary

Indicator #1 in this area. In general, they were able to adequately identify an objective, explain how it

satisfied the SPO (beyond a restatement of the objective itself), and suggest improvements to the

wording of the objective or provide an additional objective that should be considered. Candidates most

often identified the objectives relating to increasing participation in current e-learning courses by 10%,

increasing research publication requirements of faculty members, and increasing student scholarships

in their response.)



C. Create a climate of innovation, creativity, and collaboration (both internally and externally).


Increase participation in current

e-learning courses by 10%. E-learning courses are innovative because they use state-

of-the-art technology for delivery.


Emphasis seems to be on e-learning, yet MU should also review existing courses and programs with a

view to continuously improving course offerings and to developing objectives for traditional

classroom courses, ensuring future viability of the courses and programs.

Specify how to measure success of e-learning courses (e.g., enrollment).


Have each faculty develop at least two

new e-learning courses. Development of new courses fosters creativity.


A better objective might be to increase development of courses by a stated percentage, with specific

guidance on how that increase might be achieved (since development of an e-learning course does not

necessarily equate to an increase in participation rate).


Increase research publication

requirements of faculty members. Publication of research findings provides external

validation of MU’s innovation and creativity.

Some research projects may require collaboration between

instructors from complementary faculties in order to

achieve publication.


Define what the “increase” will be measured from (i.e., set a baseline for comparison of future

publications).




various initiatives, including $6 million

for the new Arts and Communications

Building and $500,000 for the new

Bachelor of Acadian Music degree


New facilities and programs are indications of forward

thinking and responding to the needs of stakeholders.


Consider if other faculties can collaborate to provide space needed for the delivery of new programs.

The requirement for a new facility should be re-examined based on the current funding shortages.

There is excess capacity of 10%, and a Community Learning Centre is being built that may serve the

needs of MU for the immediate term. As well, enrollment has not increased significantly and

applications are down from prior years. Given the objective of providing increased e-learning

(through both participation increases and new e-learning courses), MU could use existing available

space rather than construct a new facility. The wording of this objective may need to be amended.


Increase student scholarships. Scholarships allow for creativity, innovation, and

collaboration, especially scholarships for new programs

created in response to student need and scholarships that

result from collaboration between alumni.


Define “increase” so that the objective can be measured.

Consider purpose of scholarship (e.g., is it tied to a new program or merely for financial need?).


Maximize use of the ERP functionality

to integrate and optimize access to

information throughout MU.

Collaboration between faculties is promoted through use

of the ERP system.

ERP represents innovation through the use of technology.


It would be beneficial to add the specific expectations to this objective to ensure it is monitored. For

example, to address sustainability issues for MU:

o Specify a long-term plan for a balanced budget.

o Address all of the findings of the auditor general (AG) by a specific date.

o Develop and maintain internal information system and processes to monitor and report on

achievement of those expectations.

This objective is necessary to improve accountability and meet performance outcomes, but it will

likely require a number of administrative resources. A decision should be made as to how this

objective will be achieved (through new staff or consultants), and an achievable date of completion

should be specified.



Optimize use of classroom space. A variety of program-offering formats keeps MU at

forefront of innovations in education.


Determine future focus of program delivery (in-class, web-based, or combination) before determining

the optimal utilization percentage.

This SPO is satisfied by MU’s objectives; however, there are areas where additional objectives could be

considered.

Additional objectives that MU should consider to create a climate of innovation, creativity, and

collaboration (both internally and externally):

Develop objectives that promote collaboration of researchers with other faculties and institutions

Develop objectives that consider creativity through partnerships developed to market research ideas

to the community

(Most candidates who addressed this area considered only one objective (often the objective to increase

research publication requirements of faculty members) or tried to align objectives that were not

appropriate for this SPO (for example, perform well on national and international rankings and on

student surveys).)


D. Foster integrity and accountability through an appropriate governance structure.


Provide timely and accurate reporting of

financial and non-financial results.

Appropriate governance covers financial performance and

non-financial measures.


Specify how objective will be achieved (e.g., how many days after month end will information be

reported?).

Specify what financial and non-financial results will be reported on (e.g., financial statements by

faculty; enrollment data; application data; scholarship recipients).

MU Objectives How MU’s Objectives Satisfy Ministry’s SPO

Increase number of board committees to

enhance governance.

Consider board member expertise in

committee composition.

Committees allow for a deeper understanding of

governance issues and will foster greater accountability.

Use of committees increases effective decision-making

through ability to debate issues and make recommendations

for approval, since small groups can often consider

information and facilitate effective decision-making more

rapidly than large groups with numerous viewpoints.



BOD should specify which committees are necessary for MU governance, as well as a timeline for

implementation (e.g., a Governance and Nominating Committee to establish performance expectations,

identify individuals qualified to become board members, establish and review governance policies, and

adopt a code of conduct and ethics; an External Relations Committee to allow MU to collaborate with

the community, with the objective of creating partnerships for further funding opportunities (including

the new Arts and Communications building, the Bachelor of Acadian Music degree, and student

scholarships); a Compensation Committee to oversee the salary and employee benefits paid to staff

since staff costs represent 74% of operating costs). More committees may not lead to better

governance, but the improvement of committees with subject matter experts, etc., may lead to better

governance.

Guidelines should be established in writing regarding appointment to the committees (individuals

qualified to become members and/or chair based on expertise such as marketing or fundraising

experience would be useful for an External Relations Committee; appointment of Natalie Saroya as

chair of Audit Committee appropriately uses her professional expertise), length of term (such that only

a few members turn over each year), meetings (frequency and attendance requirements, such as a

requirement that members must attend 70% or more of meetings).

Committees should have charters that describe the responsibilities delegated to them. For example, the

Audit Committee terms of reference should include establishing financial policies, reviewing and

approving of risk management and information system policies with respect to establishing a proper

internal control environment, acting as liaison between management and the AG, and ensuring that

management addresses all of the AG inspection findings in a timely manner.

I also recommend allowing students, faculty, or both to participate on these committees as non-voting

members who provide insight. Not only will this leadership opportunity allow MU to foster an

environment of oversight and accountability through appropriate governance structure, but it also will

allow students and faculty to achieve a higher-quality education through a culture of collaboration.


Enhance diversification and number of

individuals (from 10 to 15) who serve

on board.

A broader experience base of board members provides for

more appropriate governance structure and adds credibility

to decision-making.

Improvements to objectives and additional objectives that MU should consider:

Specific objectives can be developed to identify areas of diversification (e.g., financial, the arts, etc.)

that should be represented on the board.

MU should first identify the knowledge, skills, and experience of existing directors to determine what

additional diversification is required from incoming board members (the BOD is moving in the right

direction with the appointment of Natalie Saroya, CA, as the first designated accountant to be on the

board of MU).

MU’s current BOD of 10 members could be of sufficient size to facilitate effective decision-making, if

members can meet the needs of committee work and provide a good diversity of views and experience

The objective to increase the number of individuals to 15 is not necessarily appropriate, since the

number of people involved does not matter, but rather the skill and experience they contribute.


(Candidates seemed to be most comfortable with SPO (d), which related to having an appropriate

governance structure, an area familiar to candidates. Their responses considered at least one of the

individual objectives listed in the governance category (diversification of individuals who serve on the

board of directors (BOD), dealing with board committees, board member expertise) and explained how

that objective satisfied the SPO. However, candidates struggled to recommend improvements to those

objectives or additional objectives that should be considered. Instead, many provided actions that

should be taken to ensure achievement of the objectives.)

Overall, it appears as though many of MU’s objectives align with the Ministry’s strategies and are

realistic. By making the objectives more specific, measurable, and timely, MU will improve the

achievability of these objectives and ensure it is accountable to the Minister for its performance. I have

discussed specific key performance indicators and information systems to measure financial and operating

indicators further in my report. The establishment of these systems will be necessary to assist the BOD in

monitoring the performance of management in achieving these objectives.

For Primary Indicator #1 (Governance, Strategy, and Risk Management), the candidate must be ranked in one of the following five categories:

Percent Awarded

Not addressed — The candidate does not address this primary indicator. 0.5% Nominal competence — The candidate does not attain the standard of reaching competence.

15.1%

Reaching competence — The candidate evaluates some of MU’s objectives that will achieve strategic performance outcomes and suggests some improvements to the objectives.

54.6%

Competent — The candidate evaluates several of MU’s objectives that will achieve strategic performance outcomes and suggests several improvements to the objectives.

29.5%

Highly competent — The candidate thoroughly evaluates MU’s objectives that will achieve strategic performance outcomes and suggests many improvements to the objectives.

0.3%

(Candidates were asked to evaluate how Millman University’s (MU’s) objectives would satisfy the

strategic performance outcomes (SPOs) set by the Ministry of Advanced Education (Ministry) and to

make suggestions as to how MU’s objectives could be improved. Candidates were clearly directed to

this indicator. To demonstrate competence, candidates were expected to select several MU objectives

from among those provided, address how they related to the SPOs set by the Ministry, and either

suggest improvements to the existing objectives or recommend additional objectives the board of

directors should consider.)


(Candidates performed poorly on this indicator. Candidates were expected to demonstrate breadth in

their response by addressing several individual objectives and covering several SPOs. Most were able to

align financial, academic and governance objectives to different SPOs (for example, e-learning,

scholarship, and board-related objectives) and explain how the SPOs were satisfied. However, when

candidates tried to suggest modifications to the objectives, their recommendations often were

insufficient, since they provided actions that should be carried out to satisfy the objective rather than

improvements to the objective itself.)

(Strong candidates structured their response to address most of the SPOs set by the Ministry, aligned

multiple objectives from each of the four areas set by MU, and explained how those objectives would

satisfy the Ministry requirements. Those candidates then completed their analysis by providing useful

recommendations for improvements to those objectives (or by suggesting new objectives), which were

clearly written and relevant to the SPO being addressed. Those candidates demonstrated an “objective”

mindset, rather than one that was action oriented. Many weak candidates performed an alignment of

MU’s objectives with few SPOs, without providing any additional analysis. These candidates failed to

provide either recommendations for improvement or additional objectives.)

Primary Indicator #2 The candidate describes actions to satisfy MU’s financial and operating objectives and suggests key performance indicators to evaluate achievement of those objectives. The candidate demonstrates competence in Management Decision-Making.

Competencies

VIII-1.1 Identifies management information needs (B)

VIII-1.2 Identifies the entity’s key performance indicators (B)

VIII-3.2 Considers implications of variances on the entity’s strategies (A)

You have asked me to describe the actions MU could take to satisfy financial and operating objectives

and suggest some key performance indicators (KPIs) to evaluate achievement of those objectives.

(Most candidates who addressed this indicator separately from their discussion of the Ministry SPOs

(Performance Indicator #1) performed better than those who tried to combine the discussion of these

two indicators. The primary difference between the two approaches was that many candidates who

combined Performance Indicators #1 and #2 addressed actions and key performance indicators (KPIs)

for all four quadrants of objectives (academic, governance, financial, and operating), when they were

only asked to comment on financial and operating objectives. As a result, they spent some time

addressing areas that were not required. Candidates are reminded to read the required as outlined in

the simulation carefully to ensure that their response focuses on the areas of concern to the recipient

of that information. In this case, the required was clear when it noted, “Our management team would

like to ensure it is meeting its financial and operating objectives as outlined in Exhibit I. I’d like you to

describe the actions MU could take to satisfy these two categories of objectives and suggest some key

performance indicators…for evaluating achievement of those objectives.”)


I have identified both financial and non-financial KPIs to assist MU in meeting its stated objectives.

These KPIs will assist management (including senior executives) in decision-making by providing

relevant information. These KPIs will also provide further information to the BOD for assessing senior

executive performance. It is important that the information for each KPI is reliable and timely.

MU Objective Actions to Achieve Objective Key Performance Indicator

(KPI)

Financial Objectives:

Secure funding

commitments for various

initiatives, including

$6 million for the new Arts

and Communications

building and $500,000 for

the new Bachelor of

Acadian Music degree

(which is not funded by the

Ministry).

Develop a strategy to solicit

corporate sponsors.

Ensure corporate sponsors

contacted appropriately link with

MU’s relationships/strategies.

Develop a strategy to solicit

individual and alumni donations.

Obtain agreements or commitments

from donors and sponsors.

Recognize significant sponsors,

donations, or unique partnerships

through publication in various

media (print, TV, Internet).

Recognize significant sponsors or

donations through “naming” of

facilities/rooms/buildings.

Recognize long-term commitment

of sponsors and donors through

recognition in various media

sources.

Ensure appropriate staff in place to

execute both corporate sponsor and

alumni campaigns.

Ensure alumni office stays in touch

with graduates.

$ of donations and

sponsorship by program

$ of donations and

sponsorship by faculty

# of contacts made with

potential program partners

% of donor/sponsor pledges

vs. requests for

donors/sponsor solicitations

(i.e., success rate of “asks” to

commitments)

# of donors and sponsors for

new building

# of donors and sponsors

approached for new building

# of recurring donors vs. # of

one-time donors

# of alumni responses to

contact requests

# of fundraising staff to

contacts list as compared to

national standards

Identify specific interest in program

(low student enrollment will affect

future program decisions – either

program discontinuance as a result

of lack of interest or enhanced

marketing to increase program

visibility and awareness).

# of students enrolled in new

Bachelor of Acadian Music

degree program

# of students enrolled in any

other new program

Pursue government or private

funding for capital or program

initiatives.

Assess relationship with

government to identify funding

opportunities.

# of applications for

government or private funding

success rate of funding

applications



(KPI)

Increase student

scholarships.

Investigate opportunities for

community partnerships for

scholarships.


matching of scholarships (e.g.,

through matching government

funding or matching private

funding).


scholarship funding from alumni.

Consider scholarships honouring

influential people in the community

and develop fundraising campaigns

to augment those scholarships.

Assess existing student scholarships

for continuation and expansion;

consider redirection based on need

and program offerings.

Investigate relationship with

employers of MU graduates to

determine if they wish to support

student scholarships.

# of student scholarships (as

compared to previous years)

# of scholarships by program

$ value of scholarships

awarded

# of different scholarship

donors

# of different scholarship

recipients

success rate of targeted

scholarship donors vs. those

who actually donated (specific

to alumni, employers,

government, community

partners, influential persons)

success of matching initiatives

(% of scholarships matched)

Limit annual tuition

increases to 2%.*

*Perhaps not a valid objective

(more like a constraint), since

tuition increases are legislated

and government has stated

limitations on Canadian

tuition increase at 1.5% and

international tuition increase

at 4.0%.

Review annual tuition increases to

ensure MU meets, but does not

exceed, Ministry tuition targets .

% tuition increases meet, but

do not exceed, Ministry

targets limitations of 1.5% for

Canadian tuition and 4.0% for

international tuition

Eliminate deficits. Increase revenue (through increase

in fundraising; maximizing

government grants; pricing of

ancillary services; maximization of

allowable tuition fees).

revenue growth year over year

revenue growth per full-time

equivalent (FTE)

revenue growth in

fundraising, government

grants, and ancillary services

reduction in deficit vs. prior

year

government grant $/FTE



(KPI)

Reduce costs (per student; by

program; for ancillary services).

operating cost/enrollment

FTE compared to university

standard performance

measure of $14,000

operating costs/program

compared across programs

and compared year over year

ancillary costs for various

services compared year over

year

Review net costs per student,

programs, and for ancillary

services.

Ensure programs offered meet

demand.

cost recovery per program –

compare across programs to

determine most

efficient/profitable programs

gross margin on ancillary

services year over year

enrollment trends in all

programs

Review high cost areas, such as

salaries and benefits, for cost

savings.

Consider offering early retirement

to senior faculty and staff.

Review hiring processes and

procedures and make amendments

as necessary (e.g., qualifications

sought; part-time vs. full-time

instructors; benefits offered;

student-instructors or contracted

instructors or full-time instructors).

Review existing staffing levels for

supervisory and administration staff

to make decisions about hiring and

programs.

Identify areas for improvement and

take steps to reduce costs (e.g., high

ratio may indicate excess staff

levels that could be reduced to an

appropriate level, thereby realizing

cost savings; however, staff

reductions may be limited due to

union contracts; consider early

retirement options).

salary cost per FTE (as

compared to other

institutions)

number of employees who

accept early retirement

packages

part-time to full-time

instructional salary costs

# of supervisory and

administration staff per

instructor

# of support (supervisory and

administration) staff per

program, compared across

programs

delivery costs per program,

year over year



(KPI)

Examine program delivery methods

and make improvements (e.g., if

certain instructors require more

administrative staff, determine if

changes could be made to the

program delivery to make it less

instructor led and more student led;

increase class size to reduce

instructional costs).

Review capital projects to ensure

adherence to budgets.

Planned capital expenditures

compared to actual costs on a

cumulative basis for each

capital project

Operating Objectives:

Optimize use of classroom

space.

Identify existing classroom

availability and usage (ensure

calculated correctly; identify empty

time slots).

Use ERP system to track

scheduling so that classroom

utilization is optimized.

Investigate opportunities to convert

unused or unproductive space into

usable classrooms (e.g., computer

labs may no longer be used since

students have their own computers).

Consider changes to scheduling to

take advantage of extended hours

(e.g., 8 a.m. start vs. 9 a.m. start).

Maximize classroom capacity.

classroom utilization rate

(increased from current level

of 90%)

# of rooms repurposed into

classroom space

# of off-peak classroom hours

used

# of times ERP system is used

for classroom scheduling

enrollment vs. classroom

capacity

Create opportunities to move

students out of the traditional

classroom yet retain them within

MU (offer webinars, e-learning

courses).

Consider alternating distance

learning with in-class attendance so

that more programs can be offered.

# of e-learning courses

offered (perhaps by faculty

also if faculties are in separate

buildings)

# of webinars offered

Determine existing ratios of

students per instructor, considering

program (as some are more

conducive to a higher ratio without

affecting program delivery) to

assess efficiency of allocation of

faculty resources and physical

facilities (i.e., classrooms).

Compare existing ratios to other

public institutions.

# of students per instructor



(KPI)

Maximize use of the ERP

functionality to integrate

and optimize access to

information throughout MU.

Review knowledge level and

familiarity of employees with ERP

system and modules since

additional training may be required.

Promote ERP module capabilities

to all faculties and departments.

Require full use of ERP system.

% of ERP training sessions

offered (or attended) vs.

sessions available

% of employees who find

ERP easy to use

reduction in # of non-ERP

tools used over time (i.e., year

over year)

# of ERP modules used vs. #

of ERP modules available for

use

# of support calls successfully

resolved

Determine which ERP modules are

not being used and could be.

Conduct ERP user satisfaction

survey.

Determine if modifications to ERP

system are required, including

integration of modules.

Conduct post-implementation

assessments to measure benefit of

ERP system.

% of employees who find

ERP meets their needs

% user satisfaction with ERP

functionality

list of ERP modules used/not

used

success rate of response to

support calls

modules available vs.

modules used effectively

elimination of non-ERP

documents and systems

Identify user needs and system

capabilities (e.g., what areas MU

wants to report on, and whether

ERP system can do that).

Conduct ERP system

implementation satisfaction survey.

Ensure effective integration of

modules (e.g., enrollment data

needs to be integrated to faculty

% satisfaction vs. projected

benefits of ERP use

% ERP implementation

completed within projected

implementation timeframe

% ERP implementation

completion within projected

cost of implementation

% user satisfaction with ERP



(KPI)

data so that the proper number of

instructors is hired).

Ensure ERP system can

accommodate all information needs

(e.g., enrollment; tuition; human

resources; student data; faculty;

government reporting; research

funding).

implementation

Provide timely and accurate

reporting of financial and

non-financial results.

Reduce the number of days to

report in order to increase

timeliness and usefulness of

information for decision-making.

Streamline policies and processes

in place for monthly and quarterly

reporting (e.g., use month-end

checklist for actions; many steps

should become part of weekly

practices rather than only at month

end; ensure reconciliations

complete and errors corrected to

improve accuracy of financial

reporting).

Implement better training for

reporting process to improve speed

of reporting, as well as better

training for individuals responsible

for reporting-period closure.

Ensure full use of ERP system.

# days to report quarterly

financial and non-financial

results

# days to close month end

# of training sessions held (or

attendance at training

sessions)

# of requests for data that

have to be generated outside

ERP

Streamline processes and policies

in place for year-end closure (e.g.,

regular internal reporting and

preparation of reports should be

able to reduce days to completion

for audit ).

# days to prepare financial

statements for audit

Ensure senior executive and finance

department staff are knowledgeable

and capable of performing their

duties (e.g., perhaps AR supervisor

should not have been asked to act

as AP supervisor) by reviewing

professional qualifications and

work experience as well as training

programs that they have attended.

# and $ of financial statement

adjustments requested by

auditor

# of adjusting entries prepared

by management (prior to

auditor)

# of training hours attended

by finance department staff



(KPI)

Improve budgeting process.

Could also be considered as

a financial objective –

eliminate deficits.

Review current budget processes

and procedures, with a view to

identifying areas where

improvements can be made (zero-

based budgeting; activity-based

management).

Have a participative budget process

that involves faculty as well as

students .

Move to zero-based budgeting.

# days to complete budget

process

# faculty/students on budget

committee

Compare actual performance to

budget on a regular basis (monthly)

and investigate significant

variances (requires better

integration of existing financial and

non-financial information into

budget process).

$ and % variance from budget

(Most candidates were able to provide a specific action that MU should undertake in order to achieve

its objectives. Strong candidates contemplated more than one action for a number of the objectives and

clearly communicated how that action should be carried out and why (in other words, how it related to

satisfying that particular objective).)

(Some candidates were able to articulate a useful KPI that could assess how effectively MU was

achieving a specific objective. However, other candidates struggled to provide relevant KPIs, instead

providing KPIs that were not specific, not measurable, or not comparable. In addition, some candidates

provided a list of KPIs that were not related to any particular objective or specific to this simulation.

Other candidates repeated facts that were already stated in the simulation (for example, classroom

utilization rate of 90%), rather than suggesting new KPIs that would be useful for MU. Candidates

who reiterated an existing KPI were rewarded if they demonstrated why that standard would continue

to be useful in its current form.)

Impact of Financial and Operating Objectives on Academic Objectives

These financial and operating objectives also have an impact on academic objectives, which are the

responsibility of the Academic Governance Council (AGC). As a result, it would be useful for

management to be included in the determination of those academic objectives. For example, academic

objectives related to increased participation of 10% in current e-learning courses, as well as the objective

that each faculty must develop at least two new e-learning courses, should also take into consideration the

financial cost and benefit of providing those courses.

It would also be important for the AGC to be involved in the development of certain financial and

operating objectives, since there would be academic impacts that should be taken into consideration. For

example, the AGC (which oversees various activities of the four academic faculties) should work in

conjunction with management in the areas of scholarship and research activities (from a funding and cost

perspective) to ensure all funding opportunities are being pursued.


(Few candidates considered whether the Academic Governance Council and management should

collaborate on the development of objectives that affect both groups, in an effort to arrive at objectives

that are beneficial to MU as a whole.)

For Primary Indicator #2 (Management Decision-Making), the candidate must be ranked in one of the following five categories:

Percent Awarded


20.3%

Reaching competence — The candidate addresses some actions that satisfy MU’s financial and operating objectives or suggests some key performance indicators to evaluate achievement of those objectives.

36.3%

Competent — The candidate discusses some actions that satisfy MU’s financial and operating objectives and suggests some key performance indicators to evaluate achievement of those objectives.

42.1%

Highly competent — The candidate discusses several actions that satisfy MU’s financial and operating objectives and suggests several key performance indicators to evaluate achievement of those objectives.

0.2%

(Candidates were asked to help the management team to ensure that MU was meeting its financial and

operating objectives and to suggest key performance indicators (KPIs) to evaluate achievement of those

objectives. Candidates were clearly directed to this indicator. They were provided with an exhibit that

outlined the draft MU objectives and were expected to focus on those objectives listed in the financial

and operating quadrants (each quadrant contained four individual objectives). To demonstrate

competence, candidates were expected to suggest actions to satisfy individual objectives within those

two quadrants and to provide KPIs to evaluate achievement of those objectives.)

(Candidates performed adequately on this indicator. They were able to consider several individual

objectives within the financial and operating categories and appropriately describe actions that should

be undertaken in order to achieve those objectives. However, some candidates struggled with stating

appropriate KPIs, since their suggestion often set a target rather than a way to measure achievement of

the objective.)

(Strong candidates discussed more individual objectives, providing several actions for each that could

be taken to ensure satisfaction of that item. Those candidates demonstrated their understanding of

what a KPI was by providing useful criteria and describing how they would be assessed or evaluated.

Instead of focusing on the specific individual objectives within the category, many weak candidates

addressed the overall category (financial or operating), which often did not allow them to propose

specific actions that should be taken. Weak candidates also addressed academic or governance

objectives or both, although they were not asked to do so. In addition, many did not seem to understand

what a KPI was, struggling to provide a KPI that was specific and measurable.)


Primary Indicator #3 The candidate analyzes variances on financial results and suggests ways to improve financial performance. The candidate demonstrates competence in Management Decision-Making.

Competencies

VIII-3.1 Computes and analyzes variances (A)

VIII-3.2 Considers implications of variances on the entity’s strategies (A)

You have asked me to analyze the results provided in Exhibit II and to provide specific suggestions to

improve financial performance, by optimizing sources of revenue or taking advantage of cost reductions.

During this process, it is important to remember that one of MU’s financial objectives is to eliminate

deficits. I noted that some adjustments should be made to the 2014 draft information (see discussion

under accounting issues later on in my memo) before we can begin this analysis.

It is also important to consider the budgeting process, which has shortfalls. For instance, Jerry noted that

the current budget is based on last year’s budget because final results aren’t in before the budget has to be

approved.

Based on the results of my interviews with various staff, I noted the following accounting adjustments

that should be made to the draft financial information as presented by Jerry:

Information Affected

Draft 2014 surplus per Jerry $ 1,200,000

AJE 1 – Pension (15,375) Salaries & benefits

AJE 1 – Pension 9,375 Salaries & benefits

AJE 2 – Capital Asset (433,000) Other non-operating expenses

AJE 3 – Revenue (7,500,000) Grant revenues – capital

AJE 4 – Contracted Instructors (400,000) Other operating expenses

AJE 5 – Payroll (1,030,000) Salaries & benefits

Total adjustments/decrease in the surplus (9,369,000)

Adjusted 2014 surplus (deficit) $ (8,169,000)

(Some candidates recognized that the financial results provided by Jerry had to be adjusted for errors

noted during their analysis of the accounting issues, and they made those corresponding adjustments

prior to calculating variances.)


Results of Financial Analysis

Financial Analysis 2014 2014 2014 2013

2014 vs.

2013

2014 vs.

2013 2014 2014

(in 000s) $ $ $ $ $ $ $

Revised Increase %

Draft AJE’s Draft Actual (Decrease) Change Budget Variance

Grant revenue – operating

102,820 102,820 106,233 (3,413) (3%)

106,789 (3,969)

Grant revenue – capital 8,500 (7,500) 1,000 2,000 (1,000) (100%) 2,000 (1,000)

Tuition fees 56,201 56,201 53,176 3,025 6% 55,261 940

Ancillary sales 10,907 10,907 12,592 (1,685) (13%) 12,531 (1,624)

Other revenue 40,712 40,712 38,120 2,592 7% 48,997 (8,285)

219,140 (7,500) 211,640 212,121 (481)

225,578 (13,938)

Salaries & benefits

133,661 1,036 134,697 117,736 16,961 14%

126,119 8,578

Other operating expenses 45,519 400 45,919 50,614 (4,695) (9%) 60,229 (14,310)

Total operating expenses

179,180 1,436 180,616 168,350 12,266

186,348 (5,732)

Cost of ancillary sales 7,561 7,561 9,327 (1,766) (19%) 9,282 (1,721)

Other non-operating

expenses 31,199 433 31,632 40,229 (8,597) (21%) 29,948 1,684

217,940 1,869 219,809 217,906 1,903

225,578 (5,769)

Surplus (deficit) 1,200 (9,369) (8,169) (5,785) (2,384) - (8,169)

(Many candidates focused on the inadequacies in the existing budgeting process, which provided little

value in the area of variance analysis. In other words, these candidates stated that the variances were

due to improper budgeting but offered no further reasons for the fluctuations.)

Grant Revenue — Operating

While the 2014 budget anticipated a slight increase in funding, there was actually a 3% decrease to

the operating grant revenue received, representing a decrease of $3,413,000 from 2013.

Grant per Canadian enrollment FTE decreased year over year (2014 was $9,361 ($102,820,000 ÷

10,984 Canadian enrollment FTE) versus 2013 of $9,944 ($106,233,000 ÷ 10,683 Canadian

enrollment FTE)). As a result, alternative funding will need to be obtained through ancillary sales and

other revenues. Perhaps sponsorships or fundraising amounts can be increased (see subsequent

discussion regarding new fitness facility).

Although the Canadian enrollment FTE increased from the prior year, the amount of associated grant

funding decreased, which seems contradictory. The finance department should ensure that the proper

information was used in the application for funding and that calculation errors were not made. While

any deficiency is likely not recoverable from the Ministry at this point, an enquiry as to consideration

for additional funding should be made. Future applications for operating grant funding from the

Ministry should be made with the best available information.


Operating grant revenue for 2014/2015 has been confirmed at $95,465,000. This is significantly less

than the 2014 level of $102,820,000 (a 7.2% decrease). If there have not been corresponding

reductions in student enrollment and salaries and benefits, this reduced funding is of significant

concern for MU.

Grant Revenue — Capital

Once the correction is made for accounting for the Community Learning Centre grant of $7.5 million,

there is very little remaining in capital grant revenue. This may be reflective of fewer capital projects

being undertaken or perhaps demonstrates an inability to secure funding (consistent with the comment

that MU has been unsuccessful in applications for government infrastructure grants). Management

should ensure that they pursue all funding avenues, and that they invest the time to properly complete

infrastructure grant applications. Perhaps the ERP system has capabilities that could be used for this

purpose.

Tuition Fees

Tuition fees increased 5.7% ($56,201,000 versus $53,176,000) over the previous year while overall

student enrollment increased 3% (11,560 versus 11,223). The increase is consistent with other

information provided, which indicates that tuition fees for Canadian student FTE increased 2% from

the previous year ($4,650 versus $4,559) while tuition fees for international student FTE increased

3.6% ($14,820 versus $14,305).

The tuition fee information for Canadian and international programs was obtained from the Student

Portal database, and the FTE calculation is done outside the system using spreadsheet software, which

should be reviewed for accuracy of calculation.

The number of applicants to MU has dropped by 1,010 (5.4%) from the previous year (2014 –

17,671; 2013 – 18,681). In fact, the number of applicants has been on a steady decline since at least

2012, based on the statistical information provided by Jerry, which is not a good situation for any

university. The reasons for the decline in applications should be investigated — is this a reflection of

increasing tuition fees or poor program quality, or is it due to other factors? — and actions should be

taken to respond to the reasons for the decline.

The total headcount has increased by 554 (4%) from 2013 to 2014, which is at a slightly slower pace

than the 2013 increase from 2012 (659 or 5%). Reasons for the slower increase in total headcount

should be identified and investigated further to determine whether MU should be concerned about

this decline.

Other Revenue

The actual increase in other revenue was 6.8% over the prior year ($40,712,000 versus $38,120,000),

yet the 2014 amount was 20.4% less than budgeted ($48,997,000 budgeted). These revenues include

fundraising, donations, investments, and other income. The budget for these items can be difficult to

estimate, and Jerry noted that MU never knows how successful fundraising campaigns will be

because they don’t get underway until later in the year. However, by setting specific objectives in the

business plan and then incorporating these into the budget, MU may be able to determine a better

estimate. Specific objectives relating to donations, fundraising from alumni, and planned giving

would be one method of increasing revenue in this area.


(Some candidates struggled to explain the reasons for the variances in revenue and instead

qualitatively restated the results of their calculations (for example, the operating grant revenue

decreased by x% because less money was received from the province). These statements did not provide

any additional information on why the variance occurred. Candidates were more successful in

explaining the variances when they used the statistical information provided in Exhibit II or

incorporated facts from other areas of the simulation to help them explain increases or decreases in

revenue or why variances did not seem logical given the non-financial information available.)

Salaries and Benefits

Salaries and benefits increased by 14.4% over the previous year ($134,697,000 versus $117,736,000)

and was 6.8% higher than budgeted. The increase may be a result of negotiated contract increases or

inefficient hiring processes. Further analysis should be done in this area to determine the specific

reasons for the increase (e.g., examination of faculty-to-student ratio; comparison to previous years

and other institutions).

In addition, the number of faculty increased by 7.9% (685 faculty FTE in 2014 versus 635 faculty

FTE in 2013), yet total student enrollment increased by only 3% (11,560 total enrollment FTE versus

11,223 total enrollment FTE). This suggests that enrollment data used in setting the budget and

planning for the instructional year needs to be more accurate at an earlier date. More collaboration

between departments is required since Jerry mentioned that his department sets the budgeted costs but

there is a delay in receiving final enrollment information from the Student Portal database.

The budget is currently based on a 4% compensation increase. However, adjustments to the budget

should also be made for changes to projected enrollment numbers (which may affect the level of

instructor staffing required) when planning, rather than just basing the budget increase on the annual

compensation increase. This will allow for more accurate decisions to be made regarding whether

required alternative funding is available to continue supporting the annual salary increase of 4% and

the smaller class size.

Additionally, the number of supervisory and administration positions is at 152% (supervisory and

administration FTE of 1,041 versus faculty FTE of 685) of faculty positions, with an increase of 9.8%

(1,041 versus 948) over the prior year. This level needs to be evaluated against other public

institutions for reasonableness. The duties of these positions and the need for them should be

examined once the data is verified as being accurate, since cost savings could be realized with a

reduction in supervisory and administration employees if the level is found to be too high. The

increase of 9.8% over the prior year doesn’t seem to have occurred in the finance department, since

Jerry’s department seems to be short staffed and pressed for time to properly complete their normal

functions.

Other Operating Expenses

These costs were 23.8% less than budgeted, suggesting that MU does not have a good handle on its

costs to operate. A detailed review of these costs and related cost drivers should be conducted (see

also non-operating cost comment).

We need to better understand what is included in other operating expenses to ensure that costs are not

misclassified.


Total Operating Expenses

Operating cost per enrollment FTE is $15,624 ($180,616,000 ÷ 11,560 total enrollment FTE), which

is higher than the average Canadian public institution operating cost per enrollment FTE of $14,000.

Additionally, the average operating cost per FTE increased by $624 or 4.2% ($168,350,000 ÷ 11,223

total enrollment FTE = $15,000) over the prior year. This is higher than the allowable Canadian

student tuition fee increase of 1.5% that was recently announced by the province, which will

contribute to increased deficits over time. This increasing cost, coupled with the known decrease in

the 2014/2015 operating grant revenue, indicates that cost per student may not be covered by revenue

and needs to be better monitored.

(Some candidates calculated the operating cost per enrollment full-time equivalent (FTE) for MU and

compared that to the $14,000 average for Canadian public institutions, concluding that it was in excess

of that amount. Many strong candidates integrated other information into their analysis, including the

historical trend of this comparison and comments on the future implications of that continuing trend

for MU.)

Other Non-operating Expenses

Jerry specified that because depreciation is a non-cash expense, his department is not overly

concerned with the accuracy of this calculation. However, it is important that the calculation be

accurate because the information can be used to estimate future asset management costs. Due to the

surplus over budget in this category (5.6%) and the large deficit from budget in other operating costs

(-23.7%), there is a chance that costs are not classified the same in the budget reports as they are in

the actual reports. It is likely that the misclassification is in the budget data due to the reasonableness

of the operating cost per enrollment FTE.

Deficit

Total revenue was 6.2% lower than budgeted ($211,640,000 versus $225,578,000), and although total

costs were 2.6% lower ($219,809,000 versus $225,578,000), the net result is a deficit. Therefore,

better budgeting of costs and a better understanding of enrollment data is required to achieve better

financial results in the future and meet the BOD objective of eliminating deficits.

(As noted previously with respect to candidates’ analysis of revenue variances, some candidates’

analysis of variances in expenses similarly did not contemplate additional available information that

could have been used to assess why variances occurred.)

Suggestions for Optimizing Sources of Revenue or Taking Advantage of Cost Reductions

In my review of your processes and other information, I have identified the following potential revenue

sources and cost reductions to help you improve your financial performance and work towards achieving

your financial objective to eliminate deficits:

Gross margin on ancillary sales (including bookstore, conference services, parking, and food service

revenues) is currently 30.7%. By increasing the margin through a combination of increased pricing

and sourcing lower cost providers, you could generate additional cash flows. For example, if you were

able to increase the margin to 50%, you would generate an additional $4,215,000 (based on 2014

actual revenue), which is substantial, considering the 2014 deficit was $8,610,000. Even an increase in

the margin to 40% would provide an additional $1,694,000 in revenue. However, you must also

consider that an increase in prices may result in a loss of customers and, therefore, revenue.


Since the annual international student tuition increase limit recently imposed by the provincial

government is not as low as the Canadian student limit (4% versus 1.5%), consider increasing the

enrollment of international students. In addition, MU receives more income per international student

($14,820) than total funding per Canadian student ($14,011, calculated as operating grant revenue per

Canadian enrollment FTE of $9,361 ($102,820,000 ÷ 10,984) plus Canadian program fee of $4,650).

Increase international student fees from $14,820 by the maximum amount allowed by the Ministry

(4%) to $15,413 for 2015 to be closer to the operating cost per student of $15,624 calculated under

“Total Operating Expenses” in order to generate profit (at least for international students).

Charge higher tuition fees for specialty programs compared to those leading to general degrees, since

participants may be willing to pay more for specialty programs. It is unclear whether a stratification of

fees is currently in place. In addition, these specialty program tuition fee increases may not be capped

by the Ministry (should investigate further).

Examine program profitability to determine which programs should be expanded to take advantage of

demand and which programs should be downsized or cancelled as a result of declining student interest

or demand (e.g., business and science degree program seems to be popular with international students;

however, there is not enough space to accept new international students into these programs).

Pursue other revenue sources to increase miscellaneous revenue — consider the introduction of

planned giving programs targeting alumni as donors; donations from estates; renting rooms in the new

student residence to non-students (e.g., conference attendees; families looking for reasonably priced

vacation accommodation in the area); summer camp revenue (e.g., science or sports camps, with

related accommodation revenue), etc.

Investigate opportunities for obtaining faculty grants or additional research funding (whether through

government sources or private partnerships), although MU would have to ensure that the impact on the

faculty teaching load is minimal.

(Candidates seemed more comfortable providing suggestions to optimize sources of revenue than they

were analyzing the variances. Some candidates were able to provide thoughtful suggestions in these

areas, particularly in the areas of tuition fee revenue (for example, by suggesting that more

international students be accepted since their tuition fees at $14,820 are higher per FTE than revenue

from Canadian students at $14,011 (being tuition fees for Canadian student FTE of $4,650 plus $9,361

of operating grant revenue for Canadian students)), other revenue (particularly with respect to

fundraising and donation revenues), and ancillary revenue (where candidates addressed bookstore,

parking, rental, and other revenue streams).)

Operating costs should at least be reduced to the average Canadian public institution operating cost per

enrollment FTE of $14,000, if not further. Currently, operating cost per enrollment FTE of $15,624

(calculated earlier) is higher than total funding per enrollment FTE, which is not sustainable. All

university faculties and departments should be encouraged to review their costs and budget

submissions to identify areas where cost reductions can be made.

Consider increasing class size (subject to available classroom space) without increasing faculty FTE to

reduce costs. MU should compare existing class sizes to similar institutions to ensure that class sizes

are comparable in the circumstances.

Compensation increase of 4% per year is higher than tuition increase of 1.5%. Need to determine what

portion of the compensation increase is offset by operating grant revenue. Consider reducing to at least

a level that aligns with inflation (estimated at approximately 2.5%). This may be difficult to achieve,

depending upon the nature of compensation agreements in place with various unions and others;

however, efforts should be made to identify opportunities for savings in this area of substantial cost

(perhaps a combination of reduction of staff and compensation increases resulting in lower costs in

this area could be achieved). There may be opportunities for staff reductions through early retirement

offerings and redeployment of job responsibilities upon retirements or departures of staff.


(On the expense side, candidates who suggested ways to take advantage of cost reductions focused on

the need to reduce salaries and benefits to a manageable level that was in line with changes in

enrollment levels, whether through limitations on annual wage increases, changing the faculty mix

(moving towards more contracted instructors rather than tenured faculty), or recognizing the need to

bring staffing FTE levels in line with increases in enrollment. Most of those candidates examined some

of the statistical information provided when making those suggestions. Others examined ways to

increase use of physical classroom space to either reduce costs or generate new revenue streams (for

example, increase e-learning offerings to free up existing classroom space for new program offerings

or more students) in an effort to improve MU’s financial performance.)

While the amount of amortization included in the draft financial results is unknown since it was not

provided by Jerry, it would be useful to have this information in order to assess MU’s cash flow situation.

Continued deficits over several years may have an impact on MU’s ability to pay its bills and discharge

its obligations in the normal course of operations and is an area where a review should also be

undertaken.


Percent Awarded


27.9%

Reaching competence — The candidate analyzes some of the variances on financial results or provides suggestions to improve financial performance.

22.2%

Competent — The candidate analyzes some of the variances on financial results and provides suggestions to improve financial performance.

48.8%

Highly competent — The candidate thoroughly analyzes the variances on financial results and provides numerous suggestions to improve financial performance. The candidate recognizes that MU faces continued deficits if suggestions are not implemented now.

0.2%

(Candidates were asked to analyze variances on financial results and to suggest ways to improve

financial performance. Jerry provided candidates with financial information (along with notes related

to the financial results) and statistics on certain aspects of MU operations. Candidates were directly

asked to prepare a variance analysis on financial results, incorporating the additional information

from Jerry where appropriate, and to provide specific suggestions on how to improve financial

performance by optimizing sources of revenue or by reducing costs. To demonstrate competence,

candidates were expected to both provide an analysis of variances and suggest ways to improve

financial performance.)

(Candidates performed adequately on this indicator. They were generally able to explain how or why a

variance had happened, and many recognized that the $14,000 operating cost per full-time equivalent

(FTE) enrollment measure for the average Canadian public institution was an important standard to

meet. In addition, they were able to provide several suggestions to increase sources of revenue or

decrease costs.)


(Strong candidates appropriately incorporated non-financial information into their explanation of why

or how variances occurred in several of their discussions. They also recognized the importance of the

$14,000 standard and suggested numerous ways to increase revenue or to reduce costs. Most weak

candidates restated the result of their quantitative analysis in the body of their response (for example,

by stating that salaries increased by 13.5% over the last year), without considering how other

information provided would have affected actual results. These candidates also provided few

suggestions to improve financial performance. Many of them spent time discussing the problems

within the existing budgeting process and concluded that variances were a result of errors in the

process itself, rather than attempting to analyze the variances.)

Primary Indicator #4 The candidate discusses Enterprise Resource Planning (ERP) reporting weaknesses and recommends specific reporting improvements to the ERP system to provide better performance information for decisions by management, faculties, and the board. The candidate demonstrates competence in Performance Measurement and Reporting (IT).

Competencies

V-1.1 Analyzes financial reporting needs (A)

V-1.2 Develops or evaluates reporting processes to support financial reporting (A)

V-1.4 Establishes or enhances financial reporting using IT (B)

V-3.2 Recommends improvements to internal financial reporting systems (B)

V-4.3 Identifies and analyzes non-financial reporting needs (B)

You mentioned that an Enterprise Resource Planning (ERP) system was implemented three years ago that

was intended to integrate financial and non-financial data into a single reporting system, but that there are

still issues related to this system. In addition, you have expressed dissatisfaction with the financial and

non-financial reports that you are receiving. From my review of the information that Jerry gathered for

me, it appears that the system is still not functioning as intended.

I have identified issues and recommended specific system reporting improvements that could be made to

provide better performance information, which is critical for decisions at various levels within MU

(board, management, and faculties).

ERP System Tracking of Information

A primary issue is that the ERP system only tracks financial information for the university as a whole.

This approach makes it difficult to analyze and assess performance of areas within MU, as separate

financial information is not readily available. It may be that the old systems (many of which still appear to

be in use) continue to provide disaggregated information, but the platforms seem to be different and at

times incompatible, thereby requiring the use of report writing tools and other software to transfer

information into a common format. In order to allow for the provision of relevant information for

financial and non-financial reporting, the reporting needs of various users must be identified so that the

ERP system can then be tailored to capture and report that information. Some of these capabilities may

already exist within the ERP system, while others may require modifications to the system.

(Many candidates recognized that the Enterprise Resource Planning (ERP) system tracked financial

information for the university as a whole, discussed the need for separate reporting and for both

financial and non-financial information, and made appropriate recommendations for changes to the


ERP system to accommodate those needs.)

At a minimum, it seems that three primary groups at MU require financial and non-financial reports: the

board, management, and faculties. Within those groups, members themselves will have differing needs

depending upon their roles, and the reporting system should be able to provide them with information

relevant to their group.

I have identified several essential reporting needs for the various groups; however, this list is not

exhaustive. The groups should determine their specific information needs through consultation with their

members. They should then communicate those needs to the department responsible for ERP so that the

required information can be properly captured by the system using standardized templates and reported

upon.

Board reporting needs include the following:

Directors would be concerned with obtaining reports containing information that would enable them

to determine whether MU is meeting Ministry’s SPOs through the objectives that have been set.

Committees of the BOD would require information relevant to their purpose (e.g., the Audit

Committee would require financial information for the university as a whole and also by faculty the

human resources department and the Compensation Committee would require information regarding

staffing and compensation levels, etc.).

Management reporting needs include the following:

Financial information by faculty as well as by area of operations (e.g., ancillary services —

bookstore, parking, etc.), so that management can assess financial performance (by faculty; by

service).

Information useful for budgeting purposes (including preparation of budget as well as monitoring of

budget versus actual on a regular basis).

Alumni information (for use in fundraising).

Faculty reporting needs would include the following:

Enrollment information (currently tracked outside the ERP system).

Program information (e.g., course offerings, registration, application, etc.).

Alumni information (for use in communication, special events, and mentoring).

(While some candidates stated that the board, management, and faculties would need different

information, their discussions were often brief when contemplating what those different information

needs would be. For example, many candidates did not provide examples of what reports of specific

information each user group would require, nor did they explain why that information would be useful

to each group.)

Existing deficiencies in the ERP system have an impact on MU’s capability to operate to the best of its

abilities, and improvements are needed. The following comments relate to specific items in the

information provided by Jerry:


ERP System Deficiency Impact on MU

ERP system tracks financial

information only for the

university as a whole.

Non-financial information (e.g., application information, etc.) may

not be tracked. The best decisions cannot be made because

information is not available.

Applicant information is tracked in the Student Portal (SP) database,

which is not integrated with the ERP system. Differences may occur

that could affect grant funding applied for, as well as acceptance of

students into various programs (e.g., new international students not

accepted into certain programs, yet international student tuition is a

potential source of increased revenue). Information on successful

applications from Canadian students is unavailable and may be useful

in determining the mix of programs to deliver to students.

Recommendations:

Full capabilities of ERP system should be determined so that relevant information can be tracked (on

both on a financial and a non-financial basis).

Modifications to ERP system should be made to provide for tracking of this information, in the event

that it is not currently possible.

ERP and SP systems should be integrated to prevent duplication of information and to improve

reliability of information.

Professors cannot track alumni so

that they can be contacted and

invited to participate in

mentoring and fundraising

events. Currently, professors are

only able to contact alumni if

they have them in their personal

contact lists

Information on past graduates is not tracked, so contact with alumni

is difficult to maintain (only if they had maintained contact with

professors). By not maintaining alumni information, MU misses

opportunities to reach out to graduates for a variety of purposes

(fundraising, including donations and scholarships; special events,

including cultural activities; mentoring opportunities; programming).

Recommendations:

Key information needs to be tracked by the ERP system so a database can be developed from which

reports can be prepared for various user groups.

Build module (either in ERP system or in SP database) to track and report information on graduates by

program and faculty, using set input fields.

Information including name, address, degree, year of graduation, etc., should be gathered so that MU

faculty can reach out to alumni (e.g., mailings for current events; fundraising campaigns, such as those

for the new Arts and Communications building or the Bachelor of Acadian Music degree program).

Ensure programs are tracked by faculty in the ERP or SP database by assigning unique identification

codes to each program (e.g., School of Business uses program numbers beginning with 4).

Ensure all revenues are tracked using appropriate cost centre and subaccount information for each

program or fundraising campaign, which will allow the creation of custom reports within the ERP.

Investigate customer relationship management software as part of ERP or consider using a data sharing

tool between departments and campaign participants to gather contact data for analysis.

The ERP/SP system should have a field in its database that allows alumni to update information as

necessary (e.g., a change of address), perhaps through log-in to a university website.


Each faculty has a different way

of interpreting definitions for

student enrollment.

Different interpretations could lead to incorrect calculations of

enrollment (information that is used for many purposes, including

funding, programming, scheduling, etc.). MU may be missing

opportunities to receive funding or to deliver programs.

Recommendation:

Develop a standardized module within the ERP or SP system to allow for input of certain information

so that the definition of “enrollment” is standard across the university (e.g., fields for student name,

course, hours per course, faculty, etc.). Completion of the input fields will allow an automatic

calculation to be made by the ERP or SP system, so that “enrollment” is calculated consistently

amongst all faculties.

Enrollment information not

available in ERP system,

resulting in different report-

writing tools and formats used by

each faculty.

Enrollment information provided may be inaccurate or not readily

available, since errors, omissions, or differences may exist in the

different report-writing tools that are used. For example, operating

grant revenue may be affected if Canadian student enrollment is

improperly calculated. Improper enrollment information could also

affect the calculation of tuition fees for both Canadian and

international students.

Recommendations:

Modifications to ERP system should be made to provide for tracking of enrollment information (as per

the definition determined), if it is not currently possible.

If modifications cannot be made, consider having one report-writing group in the university to ensure

consistency.

Allow users access to only print, not change, reports, so that the report-writing group remains

responsible for changes.

Enrollment full-time equivalent

(FTE) calculation is done outside

the ERP system using

spreadsheet software.

FTE enrollment information is inefficient and may be inaccurate (this

information is used for budget purposes, as well as for program

offerings and setting tuition fees), since there is no indication that

accuracy checks are performed on this calculation before reporting.

Recommendations:

Create an interface between the SP database and ERP to allow reporting within the ERP (since the SP

database was intended to interface and presumably contains significant amounts of data pertaining to

students).

Alternatively, use a report-writing tool to create a custom report.

Create an automatic calculation within the SP database or ERP system.

Ensure calculation is tested for accuracy before relying on calculation.

Finance staff have to reconcile

enrollment information provided

by faculties to ensure that

information is not double

counted.

Reconciliation is a time-consuming process in an already overworked

and understaffed finance department (as evidenced by sick staff;

departure of two senior finance staff; recent retirement of a senior

finance staff person, etc.); potential errors (missed or double-counted

information) may not be identified during the reconciliation.


Recommendations:

As noted above, the ERP system should be modified to capture enrollment information (thereby

negating the need to perform a reconciliation, since information is obtained from the same database).

Alternatively, use a report-writing tool to convert specific data accumulated by various faculties into a

consistent enrollment calculation (through protected data input fields for users and programming of

calculation for reporting).

Database of student information used should be one that is for entire university (rather than a separate

one for each faculty), and student information should be specific to each individual student (i.e., unique

student number that remains with the student through all faculties) to prevent duplication between

faculties.

Enrollment reports should be used by board (for Ministry SPOs); management (e.g., calculation of

fees), and faculty (e.g., program delivery, including course offerings and scheduling).

Number of applicants not

available in ERP system (but is

available from SP database).

Number of successful

applications and other application

information is not tracked (Jerry

is unsure of how many local

students are successful in their

application for business and

science degree programs).

No information available to assess this (e.g., number of successful

applicants, offers of admission, acceptances by country and program)

other than the number of applicants, so difficult to determine optimal

mix of acceptances for Canadian and international students.

Absence of this information makes it difficult to assess sufficiency of

program and course offerings (perhaps the Bachelor of Acadian

Music has only a few applicants, indicating less interest for this

specialized program, or e-learning applications are very high,

indicating great demand for this method); therefore, required changes

to program delivery and availability are not made in a timely manner.

Recommendations:

Dedicate a resource to creating an interface of the SP database with the ERP to allow reporting within

the ERP.

Alternatively, add fields to the SP database to allow all applicants to be tracked; consider assigning a

unique identification to each applicant versus each student enrolled to track future applications.

Ensure a resource is dedicated to creating tools and databases to track required information in the

appropriate module using unique account identifiers, to make it easier to create custom reports.

Faculty and management should receive reports regarding applicants (both successful and unsuccessful)

so that programming can be optimized.

Number of e-learning courses is

not tracked separately from

regular courses (yet increasing

participation in current e-learning

courses is an objective of MU

that must be measurable, since

the target increase is 10%).

Difficult to measure if MU academic objective of increasing

participation in current e-learning courses by 10% is met by the two

faculties that offer e-learning (Arts and Communication; School of

Business) without this information being tracked. As a result, it may

impair MU’s ability to report back to the Ministry that the SPOs have

been satisfied.

Costs related to the delivery of e-learning courses may not be

appropriately tracked, thereby not allowing a proper analysis of the

costs and benefits of providing these courses.

Recommendation:

Ensure e-learning courses are separately indicated in the SP database and create an interface with the

ERP to allow reporting within the ERP. (Alternatively, if the interface cannot be developed, then use a

report writing tool to create a custom report on e-learning courses.)

All user groups would be interested in this information, albeit for different reasons (the BOD for

evaluation of compliance with Ministry SPOs; management for fiscal responsibility (could offer more

e-learning if profitable); faculty for development of courses of interest to existing and potential students).


At the end of fiscal 2013,

unreconciled differences from the

transfer of information from the

old system to the ERP financial

modules remained.

Financial information (for reporting, budgeting, and fund application

purposes) may be inaccurate or incomplete, including revenue, costs,

other financial information, and whether there is a surplus or deficit.

Recommendations:

Confirm that financial information from the old system has been transferred appropriately and that there

are no significant unreconciled items remaining by reviewing testing plans and documentation of test

results as well as results of 2014 reconciliations.

For any new ERP module implementations, revisit original ERP implementation plan for the transfer of

information to the financial module and ensure information transferred from the old system is accurate

for reporting purposes (through reconciliation, investigation, and correction) so that unreconciled items

do not arise.

Budgeting is done using

spreadsheet software, basing

current year’s budget on last

year’s budget since final results

are not in before budget must be

approved.

Budget is not prepared using best available information since no

actual results (whether final or year-to-date) are incorporated,

resulting in lost opportunities for revenue enhancements and cost

reductions (e.g., salary costs always increase more than 4% budgeted

compensation increase since student enrollment is higher than

expected, due to delays in receiving final enrollment information

from SP database).

Modifications to budget process must be made to allow for inclusion

of best actual information to date from financial module of ERP

system as part of calculations (to minimize current situation of grant

receipts not covering all teaching salary costs).

Operating cost per FTE enrollment is not measured by MU, so the

university does not know how it compares to the average Canadian

public institution.

Recommendations:

Accumulation of information used for preparation of the budget should be developed within ERP

system (rather than using spreadsheet software; alternatively, an interface could be developed) with

defined input fields for collection of data from all faculties to ensure consistency of information

submission.

ERP system should also incorporate year-to-date information from the financial module into the budget

calculation, particularly since the balanced budget presented over the past few years has differed from

the actual deficits reported, and should provide reports for various groups (board, management, and

faculty).

Standardized processes for certain types of accounting adjustments should be implemented (e.g.,

accruals for payroll straddling a month end), and calculations should be programmed into the financial

module so that year to date information is more accurate.

Automatic calculations should be programmed into ERP reporting tools to easily and accurately gather

key data (i.e., operating cost per FTE, salary cost per FTE, operating cost per program, and tuition per

program) for analysis of data from financial modules and the SP database. Other areas should be

defined within the ERP system (e.g., components of operating cost; calculation of FTE), and

standardized input processes, fields, and validation checks should be developed for all faculties, to

allow the ERP system to calculate and provide consistent and accurate output information useful for

decision-making.

Groups should receive different budget reports generated by the ERP system. Management would require

the budget for the university as a whole as well as by faculty. Faculty would only require budget

information for their programs and courses.


(Most candidates structured their response in a weakness-implication-recommendation format, which

was relatively successful in demonstrating breadth and depth within their discussions. However, some

candidates lost sight of the fact that the purpose of their discussion was related to the ERP system and

provided general audit and internal control discussions, rather than specifically considering the ERP

system with respect to financial and non-financial reporting.)

(Most candidates were able to achieve breadth in their response because they identified several

reporting weaknesses within the ERP system, including that the system does not currently track

alumni, enrollment information is not available in the ERP system, the number of applicants is only

available from the Student Portal database, and the ERP system does not track e-learning courses

separately from other courses.)

(Some candidates were able to adequately describe the impact of the specific ERP system shortfall so

that the impact on MU was clearly communicated. For example, when discussing tracking of alumni,

candidates noted that the president of JGC (an alumnus of MU) could be representative of a larger

network of alumni who may be interested in contributing towards fundraising, capital campaigns, and

mentoring opportunities for MU. However, if alumni were not tracked, valuable opportunities to have

alumni help with MU operations would be missed. In other cases, candidates’ comments on the impact

of the ERP system deficiency on MU were vague. They simply noted that not fixing the weakness

would result in errors or inefficiencies or could cause frustration, but did not specify or elaborate on

what those errors, inefficiencies, or frustrations would be (for example, errors could cause MU to lose

students if applicants aren’t properly tracked, thereby reducing tuition and operating grant revenue)

and how they could be harmful to MU.)

(Some candidates lost focus when attempting to provide recommendations that improved reporting

aspects of the ERP system and instead commented on internal control matters or suggested general

operational improvements.)

For Primary Indicator #4 (Performance Measurement and Reporting (IT)), the candidate must be ranked in one of the following five categories:

Percent Awarded


11.1%

Reaching competence — The candidate discusses ERP reporting weaknesses or suggests specific reporting improvements to the ERP system to provide better performance information for decisions by management, faculties, and the board.

47.9%

Competent — The candidate discusses ERP reporting weaknesses and suggests specific reporting improvements to the ERP system to provide better performance information for decisions by management, faculties, and the board.

40.6%

Highly competent — The candidate thoroughly discusses ERP reporting weaknesses and suggests specific improvements to the ERP system to provide better performance information for decisions by management, faculties, and the board.

0.0%


(Candidates were asked to analyze the reporting weaknesses and recommend improvements to the

Enterprise Resource Planning (ERP) system, since MU is not satisfied with both the financial and

non-financial reports it is receiving. Candidates were provided with other information in Exhibit II,

which showed additional details regarding the ERP system. In order to demonstrate competence,

candidates were required to identify and discuss reporting weaknesses, and to also suggest specific

reporting improvements to the ERP system to provide better performance information for decisions by

management, faculties, and the board.)

(In general, candidates performed below expectations on this indicator. They were able to identify

some weaknesses within the ERP system that impaired the ability of MU’s board, faculties, and

management to make appropriate decisions, discuss the implications related to those weaknesses, and

propose valid recommendations for changes to the ERP system to make it more useful for financial

and non-financial reporting purposes. However, although many candidates recognized that the

existing method for tracking alumni and e-learning, as well as the fact that enrollment information

was not available within the ERP system, were issues, some struggled to describe the specific impact

these weaknesses would have on the financial or non-financial reporting of MU.)

(Strong candidates discussed several weaknesses in the system as outlined in the information provided

by Jerry, clearly stated the specific impact of those weaknesses on MU, and made appropriate

recommendations for modifications to the ERP system so that useful information would be provided to

users. Their discussions were generally complete and well developed. Weak candidates addressed fewer

weaknesses in the ERP system and failed to provide specific impacts for MU, merely stating that errors

or inefficiencies would occur. In addition, recommendations provided were often impractical and

unrelated to the reporting function of the ERP system (for example, professors’ personal contact lists

for alumni should be shared between faculties, or MU should hire more people to reconcile enrollment

information between the ERP system and report-writing formats used by faculties because the finance

department is overworked and understaffed).)

Primary Indicator #5 The candidate evaluates the alternative financing methods for the construction of the new fitness facility. The candidate demonstrates competence in Finance.

Competencies

VII-2.1 – Monitors cash flow (A)

VII-2.3 – Identifies the role of short-term, medium-term, long-term, and project financing (B)

VII-2.4 – Identifies and evaluates sources of funds (B)

VII-3 – Develops or analyzes investment plans, business plans, and financial proposals (B)

You have asked for our comments on a potential opportunity MU has with the Jenson Group of

Companies (JGC) to finance the construction of a new fitness facility. In particular, you mentioned that

you have been working with the community to explore partnership options, which would be beneficial in

countering the financial impact of declining government funding.


JGC has offered to pay for the cost of the facility construction as well as operating and maintenance costs

for the next nine years (January 1, 2017 to December 31, 2025), after which time ownership will transfer

to MU. MU will then be responsible for all future operating and maintenance costs. During the first nine

years of operations, MU will lease the building from JGC for an annual fee of $5.25 million which

includes annual operating and maintenance costs totalling $2.05 million.

Despite requests for an upgraded fitness facility, the BOD has not deemed this project a high priority and

has redirected debt financing to other projects. In addition, applications for government infrastructure

grants have been unsuccessful. Although the BOD has not been in favour of allocating debt funding to

upgrading this building in the past, debt financing remains a viable alternative. Due to the ability to obtain

debt at a low rate of 4% from the province over a 20-year period, this alternative may be favourable from

a financial perspective.

A discounted cash flow analysis comparing the JGC proposal to the loan from the province follows. Note

that inflation has not been factored into these calculations. Due to the time period covered by the analysis,

the rate of inflation could change those calculations considerably.

The results are as noted in the table that follows.

Note that the expected increase in revenue from the higher mandatory sport and wellness fee of $20 per

student has been excluded from the analysis since it is non-incremental (in other words, it will be the

same amount under any financing option).

With respect to JGC’s offer, the following factors would need to be considered:

For the nine-year term of the lease, JGC has committed to providing an entrance scholarship to two

students entering programs in the faculty of Health and Community, which meets MU’s strategic

objective to increase student scholarships (which can be used to generate new funding for various

programs). As provincial grant funding continues to decrease, MU must look for alternative funding

to support ongoing operating costs. It may be very beneficial to the university to establish a

relationship with JGC to promote further partnerships and funding opportunities. JGC’s unsolicited

offer may be an indication that a philanthropic environment may exist in the community surrounding

MU that the university may not have identified or approached for funding sources. At a minimum,

MU should follow up on this area for potential growth of revenue since other businesses like JGC

may be willing to donate but have not yet been asked to do so.

JGC’s offer may spur other businesses in the community to donate towards the new Arts and

Communications building, for which $6 million in donor and sponsor commitments is being sought.

If the offer is not accepted, JGC may direct its funds to another institution or organization.

MU may have the opportunity to sell naming rights at some point in the future (depending on the

nature of the agreement with JGC), which could provide an influx of funds.

MU would have to consider the reputation of JGC and the reception of JGC’s brand, product, or

services in the marketplace, since any negative connotations associated with the JGC name or

reputation may have an unfavourable impact on the university.

JGC assumes the risk of construction cost overruns, as well as the annual operating and maintenance

costs (which may be greater than the $2.05 million currently estimated). However, conversely, JGC

(and not MU) would benefit from any cost savings when building the facility and annually thereafter

until the end of the lease term.

The facility may not be exactly what MU wants, depending upon the level of input in the design

process that JGC allows MU to have.

The offer allows the institution to retain debt funding for other capital projects.


(Some candidates attempted a qualitative analysis of the JGC offer, and most of those who did

recognized that the entrance scholarship offered by JGC was a positive aspect of the proposal. Some

candidates also recognized that control over the design and construction of the proposed fitness facility

could be out of MU’s hands, and explained why this would be a positive or negative aspect of the JGC

option.)

With respect to the loan from the province, the following factors would need to be considered:

The interest rate offered is attractive and perhaps lower than that offered by banks and other financial

institutions.

The terms could be advantageous both now and in the future (interest and principal repayments; grant

opportunities; debt forgiveness in the future).

Potentially ties up debt funding that could be available for other capital projects (e.g., planned Arts

and Communications building).

Project cost overruns must be considered — actual final costs could escalate and funds would be

further constrained (alternatively, construction efficiencies could be realized to MU’s benefit).

(Most candidates did not consider qualitative aspects related to the loan from the province. However

most of those who did recognized that the loan offered favourable interest and repayment terms that

should be considered when making a financing decision.)

(In general, the level of qualitative analysis of the two alternatives was poor. Candidates did not step

back from their quantitative calculations to consider pros and cons related to the two financing

options.)


The total discounted cash outflows of $48,806,000 for MU are $1,050,000 (or 2.2%) more under the loan

option when compared to JGC’s offer. While the extra cost is not significant, it may not be acceptable

when there is continued pressure to find ways to reduce the deficits. Although the BOD has been reluctant

to approve debt for this project in the past, perhaps the obvious interest of the community combined with

increasing enrollment counts (total headcount and enrollment FTE) and potential revenue sources will

lead to a re-prioritization of this project.

(Most candidates who attempted a quantitative analysis of the JGC offer were able to perform a

reasonable calculation that incorporated the present value of the lease payments. Strong candidates

recognized that the $2.05 million annual operating and maintenance costs beginning in 2017 were the

same under the lease and loan alternatives, and they appropriately excluded that amount from both of

their calculations (therefore, using a net lease amount of $3.20 million when assessing the JGC offer).

The calculation related to the JGC offer was often reasonably performed when candidates attempted

it.)

(Candidates struggled most with the quantitative assessment of the loan alternative. Common

calculation deficiencies included comparing the two alternatives on an unequal basis. For example,

some candidates included the $2.05 million annual operating and maintenance costs in the JGC lease

when using the $5.25 million lease payment in calculations, but omitted the annual costs of

$2.05 million when calculating the cost under the provincial loan option. Others considered the time

value of money when assessing the JGC option but did not for the loan from the province. Another

common deficiency was including only the first two years of interest cost on the loan (as provided in

Exhibit III) and ignoring interest in years 3 through 20 (which would have required a separate

calculation). Some candidates also forgot to consider the repayment of the $23.50 million loan

principal or the fitness facility construction costs (or both). As a result of numerous quantitative errors,

many candidates were unable to provide a reasonable analysis of the loan from the province, which

would have been useful to the BOD in its decision-making.)

Preliminarily, I recommend pursuing the partnership option with JGC due to the potential future funding

opportunities and the linkage to the BOD’s strategic objectives. The funding commitment provided by

JGC is known, as is the cost component to MU. The BOD could consider requesting a lower lease

payment from JGC, although that would provide JGC with a lower return on its investment. The long-

term scholarship benefits of a partnership with JGC certainly need to be considered.

However, MU should reconsider whether it should even proceed with this project at all, given the deficits

in the 2012 and 2013 years, as each of the above alternatives requires an outlay of funds in some manner.

Full cash inflows from the facility are currently unknown. In addition to revenue generated from the

mandatory sport and wellness fee (including the anticipated increase of $20), there may be opportunities

to generate funds through other program offerings (e.g., facility memberships to the general public, rental

of facilities to sports organizations for training purposes, providing sports camps during off-peak months,

etc.). Any of these options would require some background analysis to determine their feasibility prior to

implementation, including consideration of what is currently being offered in the neighbouring

community. While it is unlikely that the facility would be able to generate net cash on a stand-alone basis,

it may be necessary to construct a new facility to retain and attract students and faculty. MU should first

assess the age of the existing facility as well as the programs that it provides — perhaps an upgrade rather

than a full replacement should be undertaken for a lower capital outlay.


(Many candidates tried to address Dr. Héroux’s specific request for comments on the JGC proposal.

However, very few candidates took a step back to assess whether constructing a new fitness facility was

an astute move for MU at the present time.)

For Primary Indicator #5 (Finance), the candidate must be ranked in one of the following five categories:

Percent Awarded


28.7%

Reaching competence — The candidate attempts a quantitative analysis of the financing options for the new fitness facility and discusses some qualitative factors.

44.0%

Competent — The candidate performs a reasonable quantitative analysis of the financing options for the new fitness facility and discusses some qualitative factors.

26.7%

Highly competent — The candidate performs a thorough quantitative analysis of the financing options for the new fitness facility and discusses several qualitative factors.

0.2%

(Candidates were required to comment on the proposal submitted by the Jenson Group of Companies

(JGC) and were provided with an exhibit outlining the details of the community partnership proposal

for a new fitness facility. In order to achieve competency, candidates were expected to quantitatively

and qualitatively compare the financing options for the proposed facility, both the JGC proposal and

the loan from the province.)

(Candidates did not perform well on this indicator. While most candidates were able to appropriately

calculate the present value of the JGC lease option, they struggled in their quantitative assessment of

the loan from the province. Many candidates failed to compare the two alternatives on an equal basis

(for example, by including operating and maintenance costs in one option but not the other), which

lessened the value of their comparison. Common quantitative deficiencies in candidates’ calculations

included the omission of interest for the full loan period (using only the first two years of interest

provided in Exhibit III), the inclusion of outlays for the $23.5 million total design and construction

costs rather than considering loan repayments, and the failure to properly consider the time value of

money. On the qualitative side, candidates were generally able to provide a few factors that should be

considered when making the decision whether to accept JGC’s offer, including their offer of entrance

scholarships to two students and concerns over control or participation in the design and construction

process.)


(Strong candidates provided a reasonable quantitative analysis of both the JGC and the loan

alternatives, and also addressed more qualitative considerations in their analysis. Weak candidates

provided a quantitative assessment of the JGC offer but were unable to provide a useful analysis of the

loan alternative because either they omitted important components or their calculation did not use a

basis that made the results comparable to their analysis of the JGC offer. Those candidates also

provided few, if any, qualitative discussions beyond the recognition of the two scholarships being

offered with the JGC proposal.)

Primary Indicator #6 The candidate considers possible causes and implications of the problems raised by the auditor general and provides appropriate recommendations to address these problems. The candidate demonstrates competence in Assurance.

Competencies

VI-3.3 – Evaluates internal control (A)

VI-3.4- Evaluates IT-related elements of internal control (B)

The Ministry requires that MU respond to the AG’s inspection findings in a timely manner. Given the

upcoming departure of Jerry on his four weeks of vacation, it is important to respond to the AG findings

as soon as possible. In addition, the president, Dr. Héroux, has asked for help understanding the

underlying causes of the problems so that appropriate corrective actions can be taken. To assist Jerry in

preparing a response, which should be provided to the Audit Committee for their review prior to being

presented to the full BOD, I reviewed the key inspection findings in the AG report and have provided the

following summary:

(While many candidates recognized that Dr. Héroux had asked for an understanding of the underlying

causes of the problems identified by the Auditor General (AG) in the key inspection findings, their

responses did not include contemplation of those causes. Candidates generally responded to this

indicator using a weakness-implication-recommendation format, which prevented many of them from

incorporating a discussion of the cause. In addition, the weaknesses had already been provided to them

via the AG key inspection findings. Therefore, a mere restatement of that finding demonstrated no

additional understanding on the part of the candidates. Candidates who amended their response

format to consider weakness-cause-implication-recommendation had a greater opportunity to

demonstrate competence in assurance on this indicator.)


Finding Cause Implication Recommendation

Incomplete capital asset

working papers,

including continuity and

amortization schedules

as well as details on

project costs

Management

doesn’t seem

concerned with

accuracy of

amortization

schedules since

amortization is a

non-cash

expense.

Costs are not

appropriately

tracked for

accounting and

funding

purposes. (This

could be a

problem with the

conditions

attached to grant

funding for the

Community

Learning Centre

and the

determination of

eligible versus

ineligible

expenditures.)

Problems may be

due to turnover

in finance

department

staffing, since

new staff (if staff

replacements

were made) may

not be properly

trained on

preparation of

these schedules.

May result in missed

opportunities for

revenue (e.g.,

improperly tracked

future project costs

related to Community

Learning Centre could

lead to non-compliance

with grant conditions

and require repayment

of funding; some

expenditures may be

eligible for other

government grants or

incentives.

Inaccurate financial

information provided to

BOD and senior

executive if

amortization schedules

(and possibly

calculations) are

incomplete resulting in

poor decisions for MU

(e.g., the level of capital

reinvestment that is

required annually for

sustainable operations).

Incomplete project cost

schedules could also

lead to GAAP

departures, resulting in

unreliable financial

information and

improper decision-

making that could be

harmful to MU.

Guidelines should be

established to provide for

regular updating of these

schedules by finance

department staff (perhaps

on a monthly basis), with

review by the capital

asset accountant (if not

the preparer) or senior

finance department

personnel.

This will ensure timely

and more accurate

completion of financial

information and reports

(e.g., application for

grant funding; repayment

of grant funds; financial

statement preparation),

which provides the basis

for informed operating

and capital decisions.

Use the ERP system to

track project costs better

(or if ERP system isn’t

currently capable of

tracking this information,

make necessary

modifications to that it is

appropriately captured)

so that reliable

information is prepared

for making more

informed business

decisions.



Payroll and accounts

payable accruals not

completed.

From notes from staff

interviews, payroll

accrual and contracted

instructor accruals are

also incomplete in

2014.

No set policies in

place for liability

and expense

recognition leads

to confusion as

to when

expenditures

should be

recorded, as VP

of finance

advised to record

based on

contracted

billing date

rather than date

of provision of

service. In

addition, payroll

supervisor was

advised by VP of

finance not to

accrue last four

days of payroll

because amount

would be

immaterial.

Expenses are

understated, and BOD

and senior executives

are provided with

inaccurate drafts,

resulting in unrealistic

expectations of final

results. Decisions

relating to human

resources (hiring and

remuneration) may not

be optimized.

Incomplete accruals

affect the ability to

assess future cash

commitments and the

determination of

required cash inflows

and outflows.

Inefficiencies caused by

additional work

required from finance

staff at year end to

make corrections and

conflicting directives

issued by senior staff

may have a negative

impact on MU.

Processes should be

established to accrue

significant expenses on a

monthly (or at least

quarterly) basis to

identify process

efficiencies and reduce

error and time at year

end.

This will allow more

accurate quarterly

reporting to the BOD so

they can identify and

address over-expenditure

concerns in a timely

manner.

Competent and capable

staff with proper training

should be in senior

positions.

Accruals should be

reviewed for

reasonableness by

someone more senior

than the preparer (adds

another level of control

and oversight) to ensure

that financial information

contains all relevant data.

Revenue recognition

policies are applied

inconsistently, resulting

in repeated audit

adjustments.

(For example, in 2014,

grant revenue was

recorded for the

Community Learning

Centre, yet all the

related expenses will

not be incurred until

2015.)

The finance

department

seems content to

continue

recognizing all

revenue in the

year it is

received (cash

basis for revenue

rather than

accrual basis),

despite policy to

the contrary, and

to have external

auditors provide

adjustments to

correct revenue

recognition

errors.

An improper

accounting policy

results in overstated

revenue, inaccurate

information for

decision-making, and

audit adjustments.

Revenue recognition

policies should be

reviewed by the audit

committee to ensure they

are up to date with

accounting standards.

Processes and training

programs must be

established to ensure

finance staff follow

policies.

Revenue entries should

be reviewed on a

monthly basis for

accuracy by a senior

accountant to ensure

timely reporting for

decision-making

purposes.



Limited controls around

vendor selection and

set-up.

Insufficient staff

in accounts

payable (AP),

since accounts

receivable (AR)

supervisor is

performing AP

supervisory

duties.

Modifications to

existing controls

(the system was

changed to

accommodate

the entering of

invoices without

matching

purchase orders

at year end).

Modifications to

other controls

(for 2014 year-

end, only

invoices greater

than $50,000

require approval

before entry).

There is a risk that a

vendor invoice will be

recorded and paid

without a matching

receipt of a good or

service (vendors are

encouraged to invoice

before June 30

regardless of whether

the good or service has

been delivered).

There is a risk that

expenses could be

overstated, resulting in

improper financial

results being reported.

Provides opportunity

for fraud or error,

thereby compromising

entity resources.

Each invoice received

must be matched to a

purchase order and to a

receiving report in the

system to ensure proper

approval and receipt of

good.

An exception report

should be generated for

any invoices without an

approved purchase order.

Any invoice without an

approved purchase order

must be manually

approved as the goods or

services are received and

payable.

There should be a report

that summarizes new

vendors set up in a

particular month. The

report should be printed

and reviewed by

management (perhaps

there is already a

capability in the existing

ERP system that just

needs to be used).

Accounts receivable

staff have the ability to

prepare deposits and

write-off accounts

receivable.

Segregation of

duties is not

apparent in all

areas (people

preparing

deposits should

not also be able

to write-off

accounts

receivable).

Workload is too

much for AR

supervisor, who

has had to

delegate, and

staff have fallen

behind in

reconciliations.

Staff may be provided

with opportunities or

means to commit or

conceal fraud due to a

lack of segregation of

duties.

Staff who prepare

reconciliations (i.e., AR)

should not also review

the reconciliation since

there is no compensating

control to detect possible

fraud or error.

AR and AP supervisor

roles should be separate

since there is the

opportunity to receive

cash and create a

fictitious vendor.

Vendor selection and set-

up should be performed

by a purchasing

specialist, not accounts

payable, and should be

authorized.



Insufficient

staffing at senior

levels (AR

supervisor is also

acting AP

supervisor) may

contribute to

breakdown or

circumventing of

existing control

environment.

Access to systems for

AR write-offs must be

password protected and

be performed by staff

who do not have access

to cash.

Should have periodic

approval of AR write-

offs (e.g., tuition and

other AR arising from

ancillary sales) by senior

personnel.

Data entry restrictions

are inadequate — staff

share passwords to

access different

modules of the financial

system.

Recent turnover

in staffing has

been significant:

two experienced

finance staff left,

one retired, and

another is on

maternity leave

(AP supervisor),

which may lead

to sharing of

passwords so

that work can be

completed

despite fewer

staff.

Staff are often

sick or otherwise

unmotivated,

which could lead

to password

sharing.

Sharing of passwords

prevents system

tracking of users who

enter or change

financial information.

Existing situation

provides opportunity

for fraud or error.

Each system user must

be assigned a unique

password. The password

must follow appropriate

naming conventions and

be changed on a regular

basis.

Passwords must be kept

private, and there must

be different levels of

access to data controlled

by passwords.

Regularly review which

employees have access to

which modules and

amend as necessary (e.g.,

as roles and

responsibilities change).



Training is insufficient

and job descriptions are

not current.

Fairly high level

of turnover in

experienced staff

(AR supervisor

was asked to fill

in for AP

supervisor rather

than filling that

position with a

hired individual)

leaves

replacements

unfamiliar with

job

responsibilities

in new role.

There seem to be

staff shortages,

so all job

responsibilities

aren’t being

satisfied and

duties aren’t

completed in a

timely manner.

Could also be

indicative of a

lack of training

materials for

existing staff

(e.g., on how to

use ERP

system).

Turnover often results

in untrained staff filling

in for others, which can

lead to errors in

financial information

that is relied upon for

decision-making.

Roles, duties, and

processes must be

reviewed, documented,

updated, and

communicated to staff on

a regular basis.

Cross training should

occur on a regular basis.

Employee hiring policies

and procedures should be

established to ensure

properly qualified

individuals are hired.

Need to assess job

responsibilities and

improvements that could

be made to increase

efficiency (i.e. perhaps

align job duties better to

satisfy needs or hire to

fill positions rather than

reallocate duties).



Financial statements are

not reviewed by

management on a

monthly basis, and

reconciliations are only

prepared annually.

Review and

reconciliation

delegated to staff

who are behind

in duties (AR

supervisor

delegated some

functions).

Staff shortages

and

absences (Jerry’s

comment that

staff tend to be

sick or otherwise

unmotivated;

several

experienced staff

have left in past

six months)

contribute to lack

of clarity over

roles and

responsibilities

with respect to

review of

information and

preparation of

reconciliations.

:Lack of review of

detective controls and

irregular financial

analysis results in

undetected errors and

decisions made based

on inaccurate

information.

The VP of finance must

perform a high-level

financial analysis on a

monthly basis to identify

variances and

inconsistencies that

should be followed up so

that information being

used for decision-making

and reporting to the BOD

is reliable and relevant.

Reconciliations for

significant accounts must

be prepared and

reviewed monthly, and

reconciling items must

be followed up on in a

timely manner to detect

and correct errors.

(Candidates approached their response either by addressing the AG key findings in the seven areas

(university is not ready for inspection; accounting policies are not always followed; financial processes

and controls are inadequate; etc.) or by discussing each specific finding individually (capital asset

working papers are incomplete; payroll and accounts payable accruals are incomplete; etc.) While

candidates using either approach had a similar opportunity to demonstrate competence, it was noted

that those candidates who discussed specific findings individually often provided more thorough

discussions overall.)

(Many candidates who attempted to identify and discuss the underlying causes of the AG findings

restated facts from the simulation without providing additional useful discussion (in other words, they

did not demonstrate how those facts led to the weakness occurring) or restated the AG finding as the

cause (when, in actuality, it was merely a restatement of the problem). Strong candidates stepped back

to analyze the underlying cause of the finding and then used multiple examples from the simulation to

support their discussion.)


(With respect to the discussion of implications, many candidates made non-specific statements about

what could happen if the underlying cause was not corrected. For example, candidates stated that

“errors could occur” or that, if the problem was left uncorrected, “inefficiencies could occur.”

Candidates failed to elaborate on what those specific errors or inefficiencies might be (for example,

errors in financial reporting could occur and improper decisions could be made by management and

the BOD as a result of reliance on those reports, which could result in losses to MU if, for example,

that erroneous information was used for funding applications). As a result, their discussions were not

useful to the president. In addition, a number of candidates were inappropriately concerned about the

implications for the cost or the timely completion of an audit, and it was at times unclear whether their

concern was with the AG work or with the external audit of MU. Since the AG work had already been

performed, concern with the impact upon its cost or completion was not relevant. In addition, since the

AG findings had been consistent over the past several years, those findings would not have had a

different impact on the current year’s external financial statement audit.)

(On occasion, candidates were able to provide useful recommendations to address the underlying cause

of the finding, most frequently in the areas of insufficient staff training and inadequate data entry

restrictions.)

For Primary Indicator #6 (Assurance), the candidate must be ranked in one of the following five categories:

Percent Awarded


20.4%

Reaching competence — The candidate discusses some of the causes of the problems raised by the auditor general or provides some appropriate recommendations to address these problems.

57.4%

Competent — The candidate discusses some of the causes of the problems raised by the auditor general and provides some appropriate recommendations to address these problems.

21.9%

Highly competent — The candidate thoroughly discusses most of the causes of the problems raised by the auditor general and provides some appropriate recommendations to address these problems.

0.1%

(Candidates were required to review the report of the auditor general (AG) and respond to findings

from the most recent inspection. Candidates were expected to consider possible causes and implications

of the problems raised by the AG and to provide appropriate recommendations to address those

problems. Candidates were directed to this indicator because they were specifically asked by the

president of MU to review the AG report to analyze possible causes of the problems and their

implications and to explain what MU could do to address those problems. Candidates were provided

with an exhibit outlining the ten key inspection findings of the AG in seven different areas.)


(Candidates performed poorly on this indicator. Most candidates attempted to address many of the

individual findings of the AG. However, many candidates did not consider the underlying causes of the

problems, despite being specifically requested to do so. Instead, candidates frequently considered only

the implications of the weaknesses identified by the AG and made recommendations that were useful

for the weakness rather than addressing the cause of the problem. Candidates who did attempt to

analyze the causes of the problems often merely restated the AG weakness as the cause, without

providing any additional insight. As with the responses to Performance Indicator #4, candidates

continued to provide vague implications in their discussions, stating that errors or inefficiencies could

occur without elaborating on what those errors specifically could be.)

(Strong candidates addressed more key individual findings of the AG and were able to sufficiently

analyze the causes underlying those findings, provide clearer discussions of the implications on MU,

and make appropriate recommendations to fix the causes of the problems that had led to the findings.

Weak candidates addressed fewer individual findings, ignored causes entirely, provided imprecise

implications, or focused on the impact of the deficiency on the timely completion of the work of the AG

or the external auditor, and they made recommendations that were not useful.)

Primary Indicator #7 The candidate discusses accounting issues affecting MU. The candidate demonstrates competence in Performance Measurement and Reporting.

Competencies

V-2.2 – Develops or evaluates accounting policies in accordance with GAAP (A)

V-2.3 – Accounts for the entity’s routine transactions (A)

V-2.6 – Prepares or evaluates financial statement note disclosure (A)

Jerry has asked us to review the accounting or the Supplemental Executive Retirement Plan (SERP) and

address other accounting issues. A review of the accounting for the SERP and other financial reporting

issues as identified in the inspection report of the auditor general as well as through interviews with staff

are provided below, under International Financial Reporting Standards (IFRS) as mentioned by Susan.

I have also addressed the accounting for the lease payments in the event the partnership with JGC is

pursued.

Pension

MU’s supplementary pension plan for its senior executives is a defined benefit plan. In accordance with

IAS 19 — Employee Benefits, a defined benefit liability is presented on the statement of financial

position, and a corresponding pension expense, net interest cost, and net actuarial gain is presented on the

statement of operations (and other comprehensive income). While MU appropriately recorded the

contributions to the plan assets and current service costs, they neglected to account for the net actuarial

gain and net interest. The adjusting entry is:


Dr. Pension Expense 15,375

Cr. Other Comprehensive Income 9,375

Cr. Defined Benefit Liability 6,000

(Many candidates were able to recognize that the supplemental pension plan for senior executives was

an accounting issue that had to be addressed. However, the extent of their responses was usually

limited to including excerpts of technical guidance from the Handbook that described how a defined

benefit plan would be accounted for. Their responses contained little, if any, application of that

technical knowledge to case facts and, as a result, were generally not useful to Dr. Héroux or the

controller since they contained no information specific to MU.)

The controller was uncertain why the defined benefit liability did not equal the defined benefit obligation

provided by the actuary. It is important to recognize that the defined benefit liability is presented in the

statement of financial position on a “net” basis. It is the difference between the defined benefit obligation

(the present value of expected future benefit payments) less the plan assets (the present value of the assets

available to pay out those future benefit payments).

IAS 19 states that a reconciliation from the opening balance to the closing balance of the net defined

benefit liability (DBL), plan assets (PA), and present value of defined benefit obligation (DBO) must be

shown in the notes to the financial statements. I have provided this reconciliation to help explain the

appropriate accounting treatment below.

Pension

Expense

$

Other

Comprehensive

Income

$

Cash

(Statement

of Financial

Position)

$

Defined Benefit

Liability

(Statement of

Financial

Position)

$

Plan Assets

(Note

Disclosure)

$

Defined

Benefit

Obligation

(Note

Disclosure)

$

Beginning (300,000) 250,000 (550,000)

Current service

costs

140,000 (140,000) (140,000)

Contributions (125,000) 125,000 125,000

Interest cost on

DBO1

31,000 (31,000) (31,000)

Interest income

on PA2

(15,625) 15,625 15,625

Gain on DBO3 (11,000) 11,000 11,000

Loss on PA4 1,625 (1,625) (1,625)

Ending 155,375 (9,375) (125,000) (321,000) 389,000 (710,000)


1 Interest Cost on DBO

DBO, beginning $(550,000)

Current service (70,000) weighted for “earned evenly” $140,000 × 1/2

Weighted average DBO (620,000)

Discount rate 5%

Interest cost on DBO $ (31,000)

2 Interest Income on PA

PA, beginning $250,000

Contributions 62,500 6 ÷ 12 months × $125,000

Average balance 312,500

Discount rate 5%

Interest income on PA $ 15,625

3 Actuarial Gain on DBO

DBO, beginning $(550,000)

Current service (140,000)

Interest cost on DBO (31,000)

Expected DBO, ending (721,000)

Actual DBO, ending (710,000)

Actuarial gain on DBO $ 11,000

4Actuarial Loss on PA

PA, beginning $250,000

Contributions 125,000

Interest income on PA 15,625

Expected PA, ending 390,625

Actual PA, ending 389,000

Actuarial loss on PA $ (1,625)

(Some candidates who were familiar with accounting for employee benefits were able to calculate the

required adjusting entry (in response to the request of the controller) or were able to provide the

controller with specific information with respect to the recording of plan assets. Those candidates

showed their calculations and supported any assumptions made when performing their quantitative

analysis.)

Capital Asset

In accordance with IAS 16 — Property, Plant and Equipment, MU is appropriately recognizing the cost

of the student residence project as a capital asset at June 30, 2014, because it is probable that future

economic benefits associated with the item will flow to the university (rental revenue will be received for

100% of the rooms beginning September 2014) and the cost of the item can be measured reliably (actual

costs to date have been tracked). However, MU continues to recognize the asset as construction in

progress rather than as a depreciable capital asset at year end, even though the building was 50% occupied

in January 2014.


IAS 16 states that depreciation of an asset begins when it is available for use; in other words, when it is in

the location and condition necessary for it to be capable of operating in the manner intended by

management. Since the building was 50% occupied in January 2014, with the majority of the remaining

two floors available for occupancy in March, it appears as though the asset was in use and that the asset

costs to that date should have been depreciated over the period of use. We would have to determine what

portion of the $43,300,025 had been incurred to January 2014 when calculating depreciation, but for

purposes of calculations below, we have treated the full amount as having been incurred by January.

(Although most candidates addressed this issue, only a few considered when the student residence

became available for use. As a result, most provided little discussion in this area. Those candidates who

demonstrated knowledge were generally able to apply simulation facts relating to the January 2014

occupancy date for two of the floors as a determining factor in the “available for use” decision. Other

candidates incorrectly focused on the planned September 2014 date for full occupancy as the date on

which the residence became available for use.)

In addition, we would have to determine what portion of the cost represents furniture and fixtures (e.g.,

student beds, desks, and dressers that may be provided in the residence rooms, as well as common area

furniture and appliances, etc.) because these assets likely have a shorter useful life than the building itself

and would therefore require a different period for depreciation (perhaps a five-year useful life would be

more appropriate for these types of assets). In the absence of this information, we have allocated the full

construction costs incurred to building.

(Few candidates considered that different components of the residence (such as furniture and fixtures)

may have different useful lives and, therefore, some components would be depreciated over a shorter

useful life than others.)

While we do not have information on the useful life of the separate components of the building, we have

been told that MU typically uses a 40-year depreciation period for buildings, which would result in a

current-year depreciation expense of $541,250 ($43,300,025 ÷ 40 years × 6 ÷ 12 months). However, if

MU decides to use a 50-year useful life to align with similar private-sector apartment-type buildings, the

current-year depreciation expense would be $433,000 ($43,300,025 ÷ 50 years × 6 ÷ 12 months). Finance

department staff should determine what the useful life of this type of building is (which may differ from

the useful life of other MU buildings). A longer useful life results in a lower expense. For the time being,

I have used a 50-year useful life (on the basis that 50 years can be supported), which results in a decrease

to operating surplus (net income) of $433,000.

Dr. Property, Plant and Equipment 43,300,025

Cr. CIP 43,300,025

Dr. Depreciation 433,000

Cr. Property, Plant and Equipment 433,000


IAS 16 suggests that the useful life of an asset should be reviewed at least at each financial year end. If

expectations differ from previous estimates, the change would be accounted for as a change in an

accounting estimate in accordance with IAS 8 — Accounting Policies, Changes in Accounting Estimates

and Errors. If MU decides that a useful life of 50 years is a reasonable estimate of the useful life of the

building, and if it is determined that the useful life of other buildings is now more appropriately set at

50 years (rather than the existing 40-year depreciation period), the change would be applied

prospectively, in accordance with IAS 8, and would increase profit and reduce loss (because of the longer

useful life) in the period of the change and in future periods.

(Some candidates recognized that the useful life of the student residence may be more in line with a

50-year period and were able to support their discussion by drawing on simulation facts relating to

similar private sector apartment-type buildings. Most of those candidates considered the advantages

and disadvantages of the two different useful lives (40 years versus 50 years) and came to a conclusion

as to the preferred period of time that should be chosen.)

After recognition as an asset, IAS 16 provides guidelines for measurement after recognition (either the

cost model or a revaluation model). Under the cost model (as discussed earlier) that MU currently uses,

the residence would be carried at its cost less any accumulated depreciation and accumulated impairment

losses. Under the revaluation model, if the fair value of the residence can be measured reliably, it can be

carried at a revalued amount (fair value less subsequent accumulated depreciation and subsequent

accumulated impairment losses). IAS 16, paragraph 36 indicates that an entire class of assets should be

valued in the same manner (either cost or revaluation model). This would indicate that the residence

should be valued at cost, since that is MU’s usual practice. Paragraph 37 provides that a “class” of assets

is a grouping of assets of a similar nature and use in an entity’s operations. While all buildings could be

considered the same class, an argument could be made that residence-type buildings have a different

nature and use than classroom-type buildings or even fitness-type buildings. Therefore, a reasoned

argument could be made supporting the student residence as a different class of building; hence, the

revaluation model could be used.

The capital asset accountant has indicated that the residence might now be worth $50 million, which is

greater than the projected final cost amount of $45 million. A higher fair value may lead management to

want to apply the revaluation model. However, the BOD remains concerned with repeated deficits, and a

higher asset value would also result in higher depreciation costs, which would increase the deficit. In

addition, other considerations must be taken into account when applying the revaluation model that add

more work and complexity to the accounting process. At this point, the cost method seems the most

appropriate model for MU to use to record the student residence asset and is consistent with MU’s usual

practice.

(While many candidates noted that there were alternatives for measurement after the asset was

recognized (cost or revaluation models), most of them quickly concluded that the cost model should be

chosen in order to be consistent with past practices at MU. Strong candidates recognized that the fair

value of the residence had increased (and drew upon simulation facts to quantify that increase),

recognized MU’s current financial position (showing a deficit in the current year when various

accounting adjustments are made), and incorporated these facts when concluding on whether the cost

model or the revaluation model should be chosen.)


There may be some argument that the residence could be considered investment property (IAS 40 —

Investment Property provides guidance in this area) since the property is a building (student residence)

held by the owner (MU) to earn rentals. IAS 40 states that “investment property is held to earn rentals or

for capital appreciation or both. Therefore, an investment property generates cash flows largely

independently of the other assets held by an entity. This distinguishes investment property from owner-

occupied property.” The student residence may also be considered “owner-occupied property” since it is

likely occupied by students who could be considered similar to employees, and will have some rooms

reserved for use by employees. As the student residence likely generates cash flows from tuition-paying

students attending MU, it is not independent of the other assets held by MU, so IAS 40 would not apply.

However, more information would have to be obtained in order to determine the nature of the cash flows

generated by the student residence.

(Most candidates began their analysis by considering whether the residence represented investment

property. Many candidates quickly concluded that because the residence was used to generate rental

income, it would qualify as investment property. Those candidates then continued their discussion to

consider whether the cost method or fair value method was an appropriate basis for measurement.

However, some candidates did consider whether the residence generated cash flows largely

independently from other assets held. They appropriately concluded that since most of the residence

rentals came from tuition-paying students and since ancillary rentals are likely low, it is not

independent from other assets held and, therefore, would not be considered investment property. Some

candidates also contemplated whether the student residence would be “owner-occupied” property and

presented reasonable arguments to support their final conclusions.)

Joint Arrangement

Prior to year end, MU and EventCo Ltd. (EventCo) jointly entered into an arrangement to construct a

sports field with parking facilities on university land. They formed NewCo to complete this project. The

arrangement between the two participants, MU and EventCo, has the characteristics of a joint

arrangement and falls under the guidance of IFRS 11. Furthermore, both parties seem to have entered into

a joint arrangement, since MU is allowing the facilities to be built on its property, while EventCo will

manage the day-to-day operations. The arrangement gives the two parties joint control, since decisions

about the relevant activities require the unanimous consent of the parties sharing control.

In this case, both MU and EventCo have equal representation on the board (two members each), so

presumably all decisions would have to be unanimous to proceed. An examination of the agreement

(if there is an actual agreement in place) would be useful to determine whether any one party has

more power over relevant decisions than another, since this would indicate that one party actually

controls instead of having joint control.

However, since both parties jointly approve the annual budget for the facility, it seems like this is

another indication that both MU and EventCo need unanimous consent when making operational and

financial decisions for NewCo. Therefore, joint control exists.

(While a number of candidates recognized that there was an accounting issue relating to MU and

EventCo, not all of them first considered whether the two parties had entered into a joint arrangement

before they got into a discussion of how to account for MU’s interest. Most candidates who did address

the question of whether a joint arrangement had been entered into were able to apply relevant

simulation facts to their discussion to provide a useful analysis.)


Further analysis is required (for example, we need to examine the framework agreement between the two

parties) to determine whether this arrangement is classified as a joint operation or a joint venture, since

the accounting for their interest would differ based on the conclusion. A joint arrangement can either be a

joint operation (rights to assets and obligations for liabilities relating to the arrangement) or a joint

venture (rights to net assets of the arrangement). Several areas must be considered to determine whether

this is a joint operation or a joint venture:

1. Legal form of the joint arrangement structured through a separate vehicle and terms of the contractual

agreement:

(a) Structure and legal form of the arrangement through a separate vehicle

In this instance, MU and EventCo have structured their arrangement through an incorporated

company (NewCo). An incorporated company meets the definition of a separate vehicle.

(b) Legal right

In this case, NewCo is an incorporated entity, which indicates that the assets and liabilities held

within NewCo are the assets and liabilities of NewCo. The arrangement has the characteristic of a

joint venture since the incorporation enables the separation of the entity from its owners. As a

consequence, the assets and liabilities held in the entity are the assets and liabilities of the

incorporated entity. Therefore, the assessment of the rights and obligations conferred upon the

parties by the legal form of the separate vehicle indicates that the parties have rights to the net

assets of the arrangement.

(c) Contractual rights

Details of the joint arrangement would have to be obtained to determine whether the parties

modified the features of the corporation through their contractual arrangement so that each has an

interest in the assets of NewCo, as well as whether each is liable for the liabilities of NewCo in a

specified proportion.

However, because the arrangement is structured through a corporation, it unlikely that a contract

will override the legal form. Therefore, this supports a joint venture.

2. Other facts and circumstances:

It is also necessary to consider whether MU and EventCo have designed the arrangement so that

NewCo’s activities primarily aim to provide both participants with rights to substantially all of the

economic benefits of the assets in NewCo and if it depends on MU and EventCo on a continuous

basis for settling the liabilities relating to the facility’s activities. While each party has provided a

guarantee, paragraph B27 of IFRS 11 indicates that guarantees should not be taken into account when

determining obligations for liabilities. Since the assets do not generate an output (like, for example,

oil or gold), neither party obtains the rights to substantially all of the economic benefits of the assets.

This is further supported by the fact that NewCo must settle its debts with funds generated by its

operations, and those debts are not satisfied on a continual basis by the investors (MU and EventCo).


Thus, MU’s interest is a joint venture, and the investment in NewCo should be accounted for using the

equity method.

(Many candidates quickly concluded that MU’s interest represented a joint venture, strictly because of

the existence of NewCo. Those candidates did not consider contractual rights or other facts and

circumstances related to the joint arrangement. Their analysis was very brief. In addition, some

candidates used the existence of the loan guarantee as a reason for supporting joint venture

classification, contrary to technical guidelines that they provided in their response.)

Further information would have to be obtained to determine whether MU had in fact contributed anything

to NewCo by June 30, 2014 (for example, the land that the sports field and parking facility are to be

constructed on). Such a contribution would have to be reflected as a sale of assets in MU’s financial

statements, and MU would recognize a portion of any gain arising as a result of that transaction.

(Few candidates considered that additional information should be sought in order to assist with

accounting for this venture.)

Revenue

Per the accounts receivable supervisor, all amounts received in the year are recorded as revenue.

Specifically, it is likely that the $7.5 million grant funds received for the Community Learning Centre in

July 2013 were recorded fully as revenue in the year. However, IAS 20 — Government Grants states that

receipt of a grant itself does not provide conclusive evidence that the conditions attached to the grant have

been or will be fulfilled. Furthermore, a government grant is not recognized under IAS 20 until there is

reasonable assurance that the entity will comply with the conditions attached to it.

It appears that the grant has certain conditions attached to it (per Capital Accountant, “if we spend less on

the project, or if some expenses are deemed ineligible by the government, we have to repay any unused or

ineligible funds”). With an expected project completion date of May 2015, it is too early to determine if

all conditions will be met.

(Some candidates recognized that there were conditions attached to the grant funding provided by the

government. However, many of them concluded that since the monies had been received by MU, the

conditions had been fulfilled. Those candidates did not consider that if the government deemed some

items as “ineligible,” then the grant funds would have to be repaid. As a result, candidates’ analysis of

the conditions attached to the grant was incomplete since reasonable assurance did not exist that MU

would comply with all of the conditions attached to the grant for the Community Learning Centre.)

IAS 20 also states that government grants should be recognized over the periods in which the expenses

for the grant-related costs are recognized. At June 30, 2014, only $600,000 in construction expenditures

had been incurred and will remain in construction in progress until the asset is put in use in May 2015, so

no expense amount for the grant-related cost has yet been recognized.


IAS 20 offers two presentation methods:

1. Reduce the cost of the asset by the grant, subsequently reducing depreciation expense in future

periods; or

2. Recognize the grant as deferred income upon receipt and subsequently in income, matching the

income to the depreciation expense.

Under IAS 20, revenue is overstated by the full $7.5 million because the asset is not yet in use and there is

no depreciation expense in the current period. An adjusting entry is provided.

Dr. Revenue 7,500,000

Cr. Deferred Revenue 7,500,000

(Many candidates were able to provide appropriate technical guidance from IAS 20 of the Handbook

in their responses, particularly in the area regarding presentation methods. However, subsequent

discussions demonstrated that candidates were unclear as to the proper accounting treatment for the

$7.5 million that had been received. A common error made by candidates was to remove $6.9 million

from the capital grant revenue, thereby leaving $600,000 to offset the $600,000 of expenditures in

construction in progress, which was incorrect. Candidates did not seem to understand that amounts

included in construction in progress for the Community Learning Centre represented an asset rather

than an expense. It was interesting to note that candidates were clear in their understanding that the

new student residence (also recorded in “construction in progress” at $43,300,025) was recorded as an

asset.)

Expense Accruals

According to the IFRS Conceptual Framework, a liability is a present obligation of the entity arising from

past events, the settlement of which is expected to result in an outflow from the entity of resources

embodying economic benefits. Obligations may be legally enforceable as a consequence of a binding

contract or statutory requirement, which is normally the case for services received from contracted

instructors and employees.

Since the contracted instructor invoices are a result of a past event (instruction service was provided in

May and June 2014) and are expected to result in an outflow of MU resources regardless of when the

amount is payable, a liability must be recorded. Similarly, because MU has received four days of

“service” from its employees resulting in a past event and a future expected cash outflow, it would be

appropriate to record a reasonable estimate for the unpaid period. Adjusting entries for the contracted

instructor invoices and payroll accrual follow, resulting in a decrease to net income of $400,000 and

$1,030,000 respectively (being $5,150,000 × 2 ÷ 10 business days).

Dr. Contract Expense 400,000

Cr. Accounts Payable 400,000

Dr. Salary 1,030,000

Cr. Accounts Payable 1,030,000


(Some candidates recognized that accruals for payroll or contracted instructor invoices or both were

incomplete, and they proposed an adjustment that should be recorded for the June 30, 2014, year end

to include those amounts. However, not all of those candidates were able to explain why the accruals

should have been recorded as liabilities, and some did not support their adjusting entries with a

discussion of what past event had given rise to the liability or recognize that an outflow of cash would

be required to settle the liability.)

Lease

If the partnership with JGC is approved by the BOD, MU will need to account for the lease in accordance

with IAS 17. A lease is classified as a finance lease if it transfers substantially all the risks and rewards

incidental to ownership. Since the lease transfers ownership of the asset to MU for $1 on January 1, 2026,

with no conditions at the end of the lease term, we can conclude that this lease is a finance lease.

At the commencement of the lease term, MU must recognize the finance lease as an asset with an

offsetting liability in its statement of financial position at an amount equal to the fair value of the leased

property or, if lower, the present value of the minimum lease payments, each determined at the inception

of the lease. The discount rate to be used in calculating the present value of the minimum lease payments

is the interest rate implicit in the lease, if this is practicable to determine; if not, MU’s incremental

borrowing rate shall be used.

The fair value of the asset at the inception of the lease is equal to the construction costs of $23,500,000.

Any initial direct costs of JGC are unknown, but if they are presumed to be nil, then the interest rate

implicit in the lease can be calculated as 5.46%. If the interest rate implicit in the lease is not practicable

to determine, the present value of the minimum lease payments is equal to $23,808,000 calculated as

$3,200,000 (being $5,250,000 lease payment less annual operating and maintenance costs of

$2,050,000) × 7.44 (PV factor of an annuity at 4% — the rate that MU could obtain from the province—

for nine years). Since the fair value of the asset at $23,500,000 is lower than the PV of the minimum lease

payments, it would be used.

On an ongoing basis, a finance lease gives rise to depreciation expense (and corresponding reduction in

the capital asset) as well as a finance expense for each accounting period. The same depreciation policy as

used for other similar assets should be applied by MU.

(Many candidates addressed the accounting treatment of JGC’s proposed financing for the new fitness

facility, in response to the direct request of the BOD. Many of those candidates included extensive

excerpts of technical guidance from the Handbook, tied relevant simulation facts to those criteria, and

concluded that the lease would be a finance lease for MU. Some candidates continued their discussion

to demonstrate an understanding of the impact that a finance lease would have on the financial

statements of MU. Strong candidates recognized that the transfer of ownership of the building for $1

on January 1, 2026, represented satisfaction of a criterion for a finance lease (the asset would be

purchased at a price that is expected to be sufficiently lower that the fair value at the date of transfer),

which means that the lease should be accounted for as a finance lease. Candidates spent a significant

amount of time discussing this issue, to the detriment of the breadth and depth of their analysis on

other accounting issues of concern.)


For Primary Indicator #7 (Performance Measurement and Reporting), the candidate must be ranked in one of the following five categories:

Percent Awarded


14.6%

Reaching competence — The candidate identifies some of the relevant accounting issues affecting MU.

43.4%

Competent — The candidate discusses some of the relevant accounting issues affecting MU.

41.4%

Highly competent — The candidate thoroughly discusses most of the relevant accounting issues affecting MU.

0.4%

(Candidates were provided with notes from meetings with various individuals in which accounting

issues were identified and were advised that Dr. Héroux wanted recommendations on these issues.

Since a number of issues were provided that could have been discussed, candidates were expected to

provide a reasonable analysis of several of the issues in order to be assessed as competent.)

(Candidates performed below expectations on this indicator, often discussing several issues but

frequently not in sufficient depth. While most candidates recognized that the supplemental pension

plan was an issue, their discussions of this issue were weak, providing excerpts of technical guidance

only, without tying case facts to that information. As a result, their analysis was not useful for the

specific concerns raised by the controller of the finance department. Candidates were able to

sufficiently discuss the student residence issue, the board’s request for the accounting treatment of

JGC’s proposed financing for the new fitness facility (although some did not consider the impact on

the financial statements), and the accruals.)

(Strong candidates provided responses that were well organized and covered most of the issues,

particularly the components of the student residence and joint arrangement, and provided an

appropriate analysis of the government grant for the Community Learning Centre as well as the JGC

lease. Their responses were also strong from a technical and an application perspective, since these

candidates were integrating simulation facts appropriately into their response. Many weak candidates

provided several Handbook excerpts without applying them to the specifics of this simulation or

without applying them correctly. In particular, in the discussion of the government grant issue, many

candidates provided a discussion that contradicted the technical guidance they had included in their

response. For example, several candidates provided technical guidance that suggested the grant

monies should be recorded as a reduction of the cost of the asset, but then recommended leaving the

$600,000 in grant monies in revenue to offset the $600,000 in expenditures in construction in

progress.)


Primary Indicator #8

The candidate questions the ability of Jerry Decker to meet the expectations of the role of the vice-president of finance while considering the financial position of MU.

The candidate demonstrates competence in Pervasive Qualities and Skills.

Competencies (lists the Pervasive Qualities and Skills for the entire simulation):

I-1 – Protects the public interest

I-4 – Maintains objectivity and independence

II-2 – Demonstrates leadership and initiative

II-6 – Treats others in a professional manner

III-1.1 – Gathers or develops information and ideas

III-1.2 – Develops an understanding of the operating environment

III-1.3 – Identifies the needs of stakeholders and develops a plan to meet those needs

III-2.1 – Analyzes information or ideas

III 2.2 – Performs computations

III-2.3 – Verifies and validates information

III-2.4 – Evaluates information and ideas

III-2.5 – Integrates ideas and information from various sources

III-2.6 – Draws conclusions/forms opinions

III-3.1 – Identifies and diagnoses problems and/or issues

III-3.2 – Develops solutions

III-3.3 – Decides/recommends/provides advice

III-4.1 – Seeks and shares information, facts, and opinions through written discussions

III-4.2 – Documents in written and graphic form

III-4.3 – Presents information effectively

In light of the information I have gathered and comments BOD members have made, I have outlined in

this report my particular concerns with Jerry Decker’s ability to facilitate the solutions outlined. While

Jerry alone is not responsible for controlling costs and revenues (the BOD must take some responsibility

for not having established proper policy, controls, and financial oversight), it is expected that he will

perform his duties with the public interest in mind.

Jerry has been facing increased pressure to ensure a surplus, as evidenced by the BOD desire to eliminate

deficits stated in their financial objectives. In addition, some BOD members have suggested that the BOD

is consider letting Jerry go if MU’s June 30, 2014, year-end financial statements show another deficit.

The elimination of a deficit is not without its challenges, as evidenced by continued provincial funding

cuts and a lack of an integrated information system for staff and salary planning purposes.

The combined total of the accounting adjustments I have summarized earlier suggest that MU will once

again realize a deficit for financial reporting purposes in the 2014 fiscal year (a revised deficit of

$8,169,000 rather than a draft initial surplus of $1,200,000). This is prior to any additional adjustments

that the university’s auditors may identify during the completion of their audit work. These results,

combined with the BOD pressures, suggest that Jerry may be trying to present more favourable financial

results. In addition, some of Jerry’s actions and comments further suggest a motivation to ensure a surplus

(i.e., decision to delay expense of contractor invoices, plus his comment that the surplus should limit the

audit committee requests for more information).


Some of Jerry’s decisions with respect to accounting issues and his inability to deal with the auditor

general recommendations in a timely manner suggest that he may simply be unqualified or uncommitted

to fill his current role as vice-president of finance. He plans to take four weeks’ vacation soon after the

June 30 year end and will be unavailable to assist with the completion of year-end adjustments for a

significant period of time. I’m not sure of the timing of MU’s year-end audit (but expect it to be near the

end of July, as per the AR supervisor’s comments), but Jerry’s absence could result in significant delays

in getting that completed. In addition, Jerry mentioned that due to the timing of his annual vacation, he

hasn’t taken any professional development courses for several years, so his technical knowledge may not

be at the level that is required for someone in such a senior position in management. Also, the recent

departure of two experienced finance department staff and the retirement of another may have contributed

to some of the issues that have occurred, or their absence may just have brought those issues to light. It

would be useful to enquire about the reasons for the departures of those individuals, as well as the results

of exit interviews with them.

In light of Jerry’s possible actions, the BOD comments, auditor general findings, and high turnover in his

department, at a minimum I recommend a review of Jerry’s qualifications to determine if he has the

sufficient skills, knowledge, and desire to continue in his current role. If it is determined that Jerry

deliberately manipulated the financial results for his own benefit of continued employment, you will want

to work with a human resources or legal expert in order to determine your options for termination.

(The simulation contained numerous facts about Jerry, his lack of commitment to his position, and his

instructions to various finance department staff, which candidates were required to identify and take

into consideration when discussing Jerry’s performance. Some candidates were able to make those

identifications, but many struggled to provide any additional insight beyond a repetition of simulation

facts and a quick conclusion that Jerry should be fired from his position.)

(Strong candidates were able to select a variety of individual facts and tie them together in their

discussion, in which they questioned Jerry’s competence as the vice-president of finance, including his

commitment to that role and his supervisory abilities with respect to the finance department staff.)

The problems within the finance department may be indicative of a broader range of organizational

structure problems within MU. Jerry’s somewhat casual tone at the top of the finance department is

ineffective and has led to problems with financial reporting and procedures. The recent staff retirement,

sick and demotivated staff, lack of competence, and the resulting increased workload for remaining staff

have created an unhealthy environment and raises concern over the effectiveness of that area. A larger

review of the organization and how it is structured may be necessary, since these issues may extend

beyond the finance department into other areas of MU as well. The BOD must take some responsibility

for the current situation at MU since they do not seem to have established proper policies and controls,

nor have they implemented an appropriate financial oversight structure. Proper policies will allow the

BOD and staff to have a better direction, which will enable them to focus their attention on priorities that

will create a more robust organization better suited to adapt to the changing financial climate and

operating areas. Once proper policies are in place, it is vital that adequate controls be implemented to

ensure that policies are adhered to and also to create an appropriate tone at the board level, which will be

communicated down to department heads.


It is imperative that a vision for the continued viability of MU be established and communicated to all

stakeholders. Many recent events have brought information to the BOD’s attention that can have a

significant impact on future operations, including communication of 2014/2015 Ministry funding (at its

lowest level in the past three years, despite increasing enrollment); auditor general findings (problems

identified in prior reports seemingly not addressed satisfactorily); community partnership opportunity

(MU deciding on financing for a facility it hasn’t assessed the need for); and organizational issues

(problems and staffing shortages within the finance department; declining applications from prospective

students).

MU also has to consider the long-term funding implications of repeated deficits, particularly when the

budget applications present a break-even position to the Ministry when funding is applied for. Declining

operating grant revenue, as demonstrated by the financial information provided by Jerry showing a

decrease of 3.2% from 2013 to 2014, is also a concern, since it seems to be a downward trend (2014/2015

operating grant revenue will be $95,465,000, a decrease of 7.1%). While governments traditionally have

continued to provide funding to universities experiencing deficits, at some point those funds could be

provided with restrictions attached (for example, the Ministry may appoint someone to oversee operations

at MU or to complete a financial review in order to improve oversight and accountability), which could

have an impact on MU’s operations and the ability to satisfy its objectives.

In addition, MU seems to be entertaining the JGC offer to construct a new fitness facility, without first

assessing whether a new facility would be necessary. The viability of the project should be assessed first,

before the method of financing is agreed upon. It may be that an upgrade of existing facilities would be

sufficient to satisfy users, rather than a completely new facility.

Overall, by implementing the solutions I have recommended in this report, MU may be able to meet the

SPOs that the government uses when considering future funding commitments. The improvement of

controls and information systems to track and report performance measures in an accurate and timely

manner will assist MU in budgeting and decision-making to reduce future deficits. However, this is

merely the beginning of the process that MU should undertake to evaluate its continued future.

(Few candidates took the time to step back and consider the larger issues related to MU overall, such

as existing oversight and accountability on aspects of MU operations, repeated past deficits combined

with a decrease in anticipated 2014-2015 operating grant funding, and repeated concerns expressed by

the AG. When combined and not addressed in some manner, these issues could have a detrimental

effect on the future operations of MU.)


For Primary Indicator #8 (Pervasive Qualities and Skills), the candidate must be ranked in one of the following five categories:

Percent Awarded


33.2%

Reaching competence — The candidate questions the ability of Jerry Decker to meet the expectations of the role of vice-president of finance or considers the financial position of MU.

53.3%

Competent — The candidate discusses the ability of Jerry Decker to meet the expectations of the role of the vice-president of finance and considers the financial position of MU.

12.7%

Highly competent — The candidate thoroughly discusses the ability of Jerry Decker to meet the expectations of the role of the vice-president of finance and considers the financial position of MU.

0.0%

(Candidates were not specifically directed to this indicator. The purpose of this indicator was to reward

those candidates who could properly identify and assess the big-picture issues related to MU.

Candidates were expected to question Jerry’s ability to meet the expectations of the role of vice-

president of finance and consider MU’s financial position. There were many obvious hints throughout

the simulation that should have led candidates to question Jerry’s competence and commitment, as

well as less obvious hints about MU’s financial position (for example, repeated deficits; lack of trust

between management team and the board). Candidates were expected to identify these issues within

MU and to discuss them.)

(Candidates performed poorly on this indicator. Most candidates did not perform an assessment of the

overall situation at MU. While some were able to recognize a number of the problems with Jerry, their

discussions tended to repeat case facts, adding little value, and they quickly recommended that he

should be fired. Many candidates did not consider the big picture in MU’s situation at all. Candidates

are encouraged to always step back and perform an overall analysis of any simulation or business

situation that they encounter.)

(Overall, candidates performed below expectations on the comprehensive simulation. On the

Governance indicator (SPOs) and one of the Management Decision-Making indicators (actions and

KPIs for financial and operating objectives), candidates grappled with atypical requests that required

them to appropriately plan their approach before they began to write. On the Finance indicator,

candidates struggled with the quantitative aspects of a comparison of two financing alternatives,

performing adequately on the simpler calculation involving the JGC lease and poorly on the loan

option, and many made comparisons between the two alternatives on an unequal basis. On the

Assurance indicator, which requested help with understanding the underlying causes of problems,

candidates did not appropriately structure the format of their response to contemplate the causes.)

(As in prior years, candidates were provided with five hours to respond, while the comprehensive

simulation was developed to be a four-hour exam. There was no evidence of significant time

constraints.)


EVALUATION GUIDE

MILLMAN UNIVERSITY (MU)

SECONDARY INDICATORS OF COMPETENCE

Secondary Indicator #1 The candidate discusses whether training instructors and consultants are employees or self-employed individuals. The candidate demonstrates competence in Taxation.

Competencies

IX-1.2 – Identifies and advises on compliance and filing requirements (A)

IX-3.1 – Identifies, analyzes, and advises on specific tax-planning opportunities for individuals (B)

Employees versus Self-Employed Individuals

Canada Revenue Agency (CRA) provides guidance on determining if a worker is an employee or a self-

employed individual. If it is determined that a worker is an employee, MU would be responsible for

deducting and remitting Canada Pension Plan (CPP) contributions, Employment Insurance (EI)

premiums, and income tax from remuneration or other amounts paid, similar to the requirements for other

employees. MU would also need to prepare T4s for those workers determined to be employees.

From discussions with the payroll supervisor, two groups of individuals have been identified in which the

relationship between the worker and MU should be reviewed to determine if the status is that of an

employee or of a self-employed individual:

Corporate training instructors:

o paid by contract for courses taught at their corporate facilities

o tend to work for a number of different organizations

o come from a variety of professional backgrounds

Information technology (IT) consultants:

o paid by fee-for-service contracts

o some have been with MU for over three years

o some have designated workstations at MU and MU email addresses

o some have recently attended a training program that was paid for by MU

o not enrolled in MU health benefit plan

It is necessary to determine what the intent of the individual and MU was when both parties entered into

their working arrangement — was it meant to be a contract of service (therefore, employee/employer) or a

contract for services (a business relationship; therefore, self-employed individual)? MU should review

any written agreements for these services as a starting point in determining the intent of both parties, as

well as specifics related to the provision of services and compensation.


Factors to consider in making the assessment include

Corporate Training Instructors IT Consultants

How much control does MU have over the worker in terms of how and what work will be done?

The manner in which the instructor teaches the

training program may be primarily up to the

instructor (suggesting self-employment, since

MU may not direct the content of the program).

They work for a number of different

organizations, indicating the instructor is free to

work when and for whom they chose (suggesting

self-employment, since MU doesn’t control who

they work for).

Consultant has a supervisor at MU who may

oversee their activities, including directing

what jobs the consultant will do as well as

training or direction on how to do the work

(suggesting they are an employee since a

subordinate relationship exists).

Does MU provide tools and equipment to do the work?

Courses are taught at the trainer’s corporate

facilities (suggesting self-employment since the

venue of program delivery is up to the instructor

rather than determined by MU).

Not sure if the instructor provides their own

equipment (e.g., audio-visual equipment, program

materials), but if they do, then they are more

likely to be self-employed individuals.

Some have designated workstations and email

addresses at MU (suggesting employee, since

MU supplies space and access to the

consultant, retains right of use, and would

likely be responsible for repairs to equipment

used).

Who is responsible for investment and management?

Come from a variety of professional

backgrounds, so keeping up to date with their

technical proficiency is likely their responsibility,

rather than MU’s (suggesting self-employed).

Work for a number of different organizations, so

responsible for own management and have

developed a business presence (suggesting self-

employed).

MU has paid for a recent training program (and

may have paid for others), which represents an

investment in the consultant (suggesting

employee).

There has been no capital investment, since

MU provides designated workstations to some

consultants and may provide access to other

equipment necessary for completion of their

tasks (suggesting employee).

What is the opportunity for profit to the worker?

Compensated on a contract basis (suggesting self-

employed) rather than on an hourly/daily/weekly

or similar basis (suggesting employee).

Not enrolled in health benefit plan available to

employees (suggesting self-employed).

Compensated on fee-for-service basis (if a type

of “flat rate” arrangement, then suggests self-

employed).

Would need to know if there are expenses that

they incur in performing their services that

aren’t reimbursed (suggesting self-employed).


(Some candidates who addressed this area recognized that there were two different types of contract

workers at MU (corporate training instructors and information technology (IT) consultants) and were

able to tie simulation facts to some of the specific considerations that Canada Revenue Agency (CRA)

takes into account when determining whether those workers would be considered employees or self-

employed individuals.)

There are also other factors that must be considered, but I would need more information (such as a written

agreement for services and discussions with the instructors and consultants) before I could provide any

comments:

Can the work be subcontracted or can assistants be hired? If yes and MU has no say in who is hired,

then the relationship would be that of a self-employed individual. If the work has to be performed

personally by that specific individual, then they are likely an employee.

What is the level of financial risk taken on by the worker? Employees wouldn’t be responsible for

covering their own extra expenses in providing those services, whereas self-employed persons would

be. For example, who pays for replacement of equipment (audio-visual or computer) — MU or the

worker? Who pays assistants, if they are able to be hired?

It is my preliminary conclusion that the IT consultants would be considered employees primarily because

of the length of contract (some have been with MU for over three years), but also because they have a

subordinate relationship as they are supervised by an MU employee and because MU has provided some

of them with workstations, emails, and training.

After reviewing the contracts for support of this conclusion, I would suggest discussing this matter with

the consultants and making changes to the relationship to support self-employment or putting the

consultants on MU’s payroll, reflecting the status of the relationship as that of employee/employer. For

prior years, you should be aware that if the relationship with the consultants is determined to be that of an

employee/employer, MU would be responsible for paying and remitting both the employee and the

employer portions of CPP and EI premiums, plus CRA could assess penalties and interest on those

amounts for not reporting the consultants as employees and, as well, for not remitting required payroll

deductions.

The corporate training instructors would be considered self-employed individuals because they provide

their own work facilities, seem to be responsible for their own training and professional development and

tend to work for a number of different employers. Therefore, no changes to remuneration or T4 reporting

are required by MU for those individuals.

(Strong candidates considered both types of workers in their analysis, tying relevant simulation facts to

CRA considerations to provide a supported assessment of the appropriate treatment for each type.

Some of those candidates extended their discussion to identify potential consequences to MU of such a

determination by CRA (for example, penalties, interest, and late filing issues related to withholding of

payroll deductions and required remittances).)


For Secondary Indicator #1 (Taxation), the candidate must be ranked in one of the following three categories:

Not addressed — The candidate does not address this secondary indicator. Nominal competence — The candidate does not attain the standard of competence. Competent — The candidate discusses whether training instructors and consultants are employees or self-employed individuals.

(Candidates were provided with notes from a meeting with the payroll supervisor regarding corporate

training instructors and information technology consultants. Candidates who addressed this indicator

were expected to consider whether the training instructors and consultants should be treated as

employees or self-employed individuals for tax purposes.)

(Most candidates who did address this indicator were able to provide appropriate tax advice on whether

these individuals would be considered employees or self-employed individuals. They did so by tying

specific simulation facts to the technical considerations when making this distinction. Weak candidates

provided a brief assessment of how these individuals would be categorized for taxation purposes, and

they only considered the instructors or consultants in their analysis.)


(CONTINUED ON PAGE 2)


THE INSTITUTES OF CHARTERED ACCOUNTANTS OF CANADA 2014 Uniform Evaluation

PAPER II Time: 4 hours






(2) To help you budget your time during the evaluation, an estimate of the number of minutes required

for each simulation is shown at the beginning of the simulation.







* * * * * * * * * *



2014

Chartered Professional Accountants of Canada 277 Wellington Street West, Toronto, Ontario, Canada M5V 3H2

Printed in Canada

II

108 Appendix C — Paper II

SIMULATION 1 (80 minutes)

PonyUp Stables Inc. (PonyUp) has been a small family-run business and a fixture in the horse world of

Smalltown, Nova Scotia, for many years, offering everything a horse enthusiast could want. In the winter

of 2013, PonyUp announced it was shutting down. Despite appearing to be a busy operation, PonyUp was

unable to turn a significant profit, and the owners wanted out.

Sarah, her sister-in-law Megan, and their friend Lori have used the stables for years and were determined

to keep PonyUp open. They pooled their resources and acquired the shares of PonyUp on April 1, 2013.

The purchase was impulsive, but the friends were sure they could make the business a success.

Information on the new owners and notes from discussions with them are provided in Exhibit I.

Because PonyUp is under new ownership, the bank has requested audited financial statements. The

owners have approached your firm to conduct a first-time year-end financial statement audit.

It is now April 25, 2014, and you, CA, have just been assigned as the senior on the audit. You have

obtained draft financial statements for the year ended March 31, 2014 (Exhibit II), and have gathered

other information from PonyUp’s administrator and bookkeeper, Mrs. Devanney, as well as from the

receptionist (Exhibit III).

The engagement partner asks you to prepare the audit planning memo, including suggested procedures for

significant areas. He also asks you to address any accounting issues you identify.


SIMULATION 1 (continued)

EXHIBIT I

INFORMATION ON NEW OWNERS AND NOTES

FROM DISCUSSIONS WITH THEM

Lori is the town veterinarian and runs her own practice.

Sarah manages a pet store called Animal Galaxy Inc. (Animal Galaxy), which specializes in premium

foods and products for animals. She has a 20% stake in Animal Galaxy, with the remainder split equally

between her brother and her sister-in-law, Megan.

Although Megan is a co-owner in Animal Galaxy, she is not involved in its operations. She is a school

teacher and teaches horse riding lessons in her free time.

Lori, Sarah, and Megan have each purchased an equal number of common shares in PonyUp. Things have

been hectic so far, and the new owners have not had a lot of time to focus on the operations. However, all

three have faith in Mrs. Devanney, whom they have known for years. Sarah noted that there seem to be

fewer controls at PonyUp than she is used to at Animal Galaxy. When Sarah inquired, Mrs. Devanney

said she did not think it was a problem because, as the administrator of PonyUp, she is always there and

never takes a vacation.

The three owners think things are going well so far, but had a few concerns when you met with them.

“There seems to be some confusion about lesson rates,” says Megan. “Lessons are $30 an hour for all

instructors, but one of the clients mentioned that she has been paying the office $40 an hour. I’m not sure

if that’s an issue, since that money belongs to the outside instructors and we’re just collecting it on their

behalf.”

“PonyUp is bringing in a lot of cash, but it seems to go right back out again!” notes Sarah. “Mrs.

Devanney is always getting me to sign cheques. Sometimes I don’t see the related invoice, but I know

Mrs. Devanney will have it. I know there are a lot of expenses in running a business, but there are so

many that it is hard to keep up. All three of us are able to sign cheques and only one signature is required,

which sometimes gets confusing. Once, Megan and I both signed different cheques to pay the same

computer supplier. When we called the supplier to ask for a refund, he told us he had sold us two

computers, although we have only one in the office.

“These issues would not have happened at Animal Galaxy, and I’m wondering if improvements could be

made at PonyUp.”



EXHIBIT II

PONYUP STABLES INC.

DRAFT BALANCE SHEET

As at March 31

2014 2013

(unaudited) (unaudited)

Assets

Cash $ 77,907 $ 98,820

Accounts receivable 15,563 17,445

Income taxes receivable 2,687 955

Inventory (Note 2) 312,270 315,480

408,427 432,700

Investment in Saddle Stables Inc.

10,000

—

Property, plant and equipment (Note 3) 480,700 497,810

$

899,127

$

930,510

Liabilities

Accounts payable $ 58,580 $ 60,300

Current portion of long-term debt 24,000 24,000

82,580 84,300

Long-term debt 552,000 576,000

634,580 660,300

Shareholders’ equity

Share capital 100 100

Retained earnings 264,447 270,110

264,547 270,210

$

899,127

$

930,510




PONYUP STABLES INC.

DRAFT INCOME STATEMENT

For the year ended March 31

2014 2013

(unaudited) (unaudited)

Revenue — boarding fees $ 30,000 $ 27,600

Revenue — horse riding 200,200 191,100

Revenue — service fees 59,040 76,260

289,240 294,960

Expense — service fees 55,440 71,610

Veterinary expenses 71,050 62,350

Salaries and wages 95,000 89,000

Selling, general, and administrative expenses 74,738 74,052

296,228 297,012

Earnings before income tax (6,988) (2,052)

Income tax recovery 1,325 390

Net loss

$

(5,663)

$

(1,662)




PONYUP STABLES INC.

EXCERPTS FROM THE NOTES TO THE DRAFT FINANCIAL STATEMENTS

For the year ended March 31, 2014

1. Accounting Policies

Financial statements are prepared in accordance with Accounting Standards for Private Enterprises

(ASPE).

2. Inventory

2014 2013

Food and supplies $ 39,270 $ 42,480

Horses 273,000 273,000

$

312,270

$

315,480

Food and supplies include items used in the stables. Horses included in inventory are owned by

PonyUp and are ridden by clients. Horses are available for sale at any time.

3. Property, Plant and Equipment

Cost

Accumulated

Amortization

2014

Net Book

Value

2013

Net Book

Value

Land $ 200,000 $ — $ 200,000 $ 200,000

Building 151,576 41,099 110,477 114,123

Fencing 17,122 2,671 14,451 15,306

Riding gear 89,842 7,811 82,031 81,502

Trucks and trailers 94,155 22,750 71,405 83,125

Office equipment 12,303 9,967 2,336 3,754

$

564,998 $

84,298 $

480,700 $

497,810



EXHIBIT III

NOTES FROM DISCUSSIONS WITH MRS. DEVANNEY AND THE RECEPTIONIST

1. Boarding Fee Revenue — PonyUp has 25 stalls on site for horses. Fourteen stalls are occupied by

horses belonging to PonyUp. The other 11 are rented out to individuals who own horses and need a

place to board them. An individual wishing to board his or her horse must sign a 24-month contract

and pay an initial fee of $1,000. This fee is non-refundable and is recorded as revenue when received.

In addition, there is a monthly boarding fee of $350, which includes all food and care, as well as the

stall rental. The contract continues on a month-to-month basis after the first 24 months have passed, at

which time the rate increases to $400 a month.

2. Horse Riding Revenue — PonyUp makes each of its 14 horses available to its clients for one three-

hour riding session per day, at a cost of $50 per session. To maintain the horses’ health, PonyUp’s

policy states that a horse should not be ridden for more than three hours per day.

Megan noted that some horses seemed tired and that one had definitely been ridden for more than

three hours that day. Megan checked the schedule, and only one three-hour session had been scheduled

for that horse, so she concluded it must have been an anomaly.

3. Service Fee Revenue and Expense — PonyUp can match the 11 boarded horses with frequent riders,

allowing the horses’ owners to offset the cost of boarding their horses through riding revenue.

Frequent riders pay $1,230 per month per horse. They receive daily riding access to the same horse for

a maximum of three hours per day. PonyUp keeps $75 of this amount as a service fee and remits the

remaining $1,155 to the boarded horse’s owner.

4. Riding Lessons — Lessons are not a source of revenue for PonyUp because outside instructors provide

them directly to riders. Lesson fees are paid to PonyUp’s office and are handed over to the instructors.

5. Payments from Customers — All payments are accepted in cash or cheque only.

6. Shoeing Expense — Horses require regular shoeing. A local groomer checks all 25 horses every two

weeks and replaces shoes as necessary. His daughter has been boarding her horse at PonyUp for four

years. In exchange for his services, his daughter is not charged a boarding fee. Typically, it costs $100

to replace all four shoes on a horse; a horse has its shoes replaced on average four times a year.

7. Riding Gear — PonyUp had two sets of gently used riding gear with a cost of $14,000 that it wanted

to sell to a potential buyer, but the buyer offered too little for them. Although PonyUp does not

normally sell riding gear, it sold the sets to Animal Galaxy for $11,000.



EXHIBIT III (continued)

NOTES FROM DISCUSSIONS WITH MRS. DEVANNEY AND THE RECEPTIONIST

8. Saddle Stables Inc. (Saddle Stables) — During the year, PonyUp was approached by Saddle Stables,

which was experiencing financial difficulty. Because of a long-standing relationship, PonyUp agreed

to lend Saddle Stables $10,000, interest-free, under the following terms:

PonyUp must approve any major capital expenditures and significant operational decisions of

Saddle Stables.

The loan matures in five years and requires fixed annual principal payments of $2,000.

In the event Saddle Stables misses a payment, PonyUp is entitled to convert the current payment

amount into common shares of Saddle Stables. Each $2,000 converts into 10% of Saddle Stables’

common shares, up to a maximum of 50% of the stables’ outstanding common shares.

Mrs. Devanney mentioned that she’s confused by this transaction. Since it can be converted into

shares, she has classified it as an investment.

9. Staff — Mrs. Devanney is the main employee on site. A part-time receptionist works evenings and

weekends, and there are part-time stables cleaners.

10. Administrator and Bookkeeper — Mrs. Devanney opens the mail, prepares deposits for monies

received, and updates the accounting records. She makes deposits daily. She prepares bank

reconciliations on a monthly basis, but notes that she may stop doing them because the owners don’t

review them anyway.

11. Receptionist — The receptionist collects all payments made on site and hands them over to Mrs.

Devanney for deposit and updating of the records. Since a horse can be ridden for a three-hour session

per day, a calendar is maintained that shows the riding schedule for each horse. Occasionally, Mrs.

Devanney asks the receptionist to collect money from a rider who is not listed on the schedule. When

this occurs, the money is collected and a note is made for Mrs. Devanney. The receptionist has been

instructed to not make the note directly on the schedule “so as not to confuse things.”


EVALUATION GUIDE

PAPER II, SIMULATION 1 — PONYUP STABLES INC.










To: Partner

From: CA

Subject: PonyUp Stables Inc. audit planning memo, accounting issues, and recommendations to

new owners

Primary Indicator #1 The candidate prepares an audit planning memo and suggests procedures for the significant areas. The candidate demonstrates competence in Assurance.

Competencies

VI-2.3 – Evaluates the implications of risks for the assignment (A)

VI-2.4 – Develops guidelines to set the extent of assurance work, based on the scope and expectations of

the assignment (A)

VI-2.5 – Designs appropriate procedures based on the assignment’s scope, risk, and materiality

guidelines (A)

Potential Fraud and Overall Impact

Based on a review of the activities at PonyUp during our discussions for the audit planning, there are

indicators of fraud with respect to Mrs. Devanney’s behaviour. This has an overall impact on the audit, as

discussed throughout this memo.

(Despite the fact that most candidates identified the potential fraud, only a few of them discussed the

impact of it on the audit plan.)

116 Appendix C — Paper II — Evaluation Guide

Client Acceptance

Although there is a possibility of fraudulent activity, it appears to be related only to Mrs. Devanney and

not the owners. However, if during the audit we come across evidence that the owners might also be

involved in fraudulent activity, we should consider whether we want to withdraw from the engagement.

(Very few candidates addressed this issue.)

Risk Assessment

In assessing the risk of the audit, we need to consider factors that affect the overall risk as well as the risk

of material misstatement at the financial statement level and at the assertion level for classes of

transactions, account balances, and disclosures. Based on the following factors, the overall audit risk is

assessed as high.

Factors that Affect Overall Audit Risk

PonyUp is a first-time audit for our firm, and we have no previous experience with the client or its

owners. In addition, PonyUp has never been audited before. A lack of previous scrutiny of its financial

statements makes it more likely that there will be errors in its processes and account balances, including

opening balances. As well, we are unfamiliar with its operations, which may result in us not detecting

material misstatements. All of these factors increase the overall audit risk.

On the other hand, PonyUp is a private company and the number of users (the owners, the bank, and the

Canada Revenue Agency) is limited. This decreases the overall audit risk.

Risk of Material Misstatement at the Financial Statement Level

Given our understanding of the nature of the business, its operating environment, and its control

environment, the following financial statement–level risks have been identified:

Potential fraud: Given that Mrs. Devanney may be engaging in fraud, there is a higher potential for

misstatement in the financial statements since account balances may have been manipulated to cover

up her questionable behaviour. This may make it harder for us to detect material misstatements, and

Mrs. Devanney may not be willing to provide full information or access to accounting records.

Furthermore, PonyUp only accepts cash and cheques, so misappropriation is more likely. The result is

a significant risk of material misstatement at the financial statement level.

Change in ownership: Due to the change in ownership in the current year, PonyUp has undergone

some operational changes (e.g., different people are now signing cheques), which can result in

increased likelihood of errors. Since the owners are not involved in the daily operations and are new to

PonyUp, the risk that they may not detect material misstatements in the financial statements is

increased.

Lack of segregation of duties and other controls: The accounting function is largely performed by one

individual, and there are limited to no financial controls. Considering that the business only accepts

cash and cheques, this situation provides the opportunity for errors and fraud to occur without

detection.


Risk of Material Misstatement at the Assertion Level

We also need to assess the risk of material misstatement at the assertion level for classes of transactions,

account balances, and disclosures.

Potential fraud: Because of the fraud risk I’ve identified, the completeness of revenue and occurrence

of expenses are significant risks.

Unusual and complex transactions: PonyUp has had a related-party transaction, non-monetary

transactions, new investments, and issues related to valuation and classification of the horses. The

nature of these transactions increases the risk that they may not be accounted for properly.

(Virtually all candidates addressed audit risk and provided sufficient depth in their discussions, using

multiple case facts to support their assessment that audit risk should be assessed as high.)

Materiality

CAS 320 Materiality in Planning and Performing an Audit, provides guidelines for materiality and

emphasizes the need for professional judgment. The new owners purchased the stables with the hopes of

turning it around. An income benchmark, therefore, seems to be most appropriate to use when considering

what will influence PonyUp’s future business decisions. However, given the losses in the prior and

current years, materiality calculated using profit as a benchmark is not appropriate. In addition, the bank is

the main user of the financial statements, given its request to have the financial statements audited. The

bank would also be interested in income statement performance, which would allow the bank to assess

PonyUp’s cash flow from operations and, consequently, its ability to pay. Because using profit is not

feasible, using revenue as the basis for materiality might be an acceptable alternative. However, there is

some indication that revenue may be understated due to potential fraud, so it is not ideal to use revenue as

a basis for the materiality calculation in this case. I suggest using total assets as the basis since they are

fairly stable and the majority of the assets (inventory and capital assets) are not as susceptible to

manipulation.

A typical range to use for calculating materiality on a benchmark such as total assets is 0.5% to 2%. I

recommend using 1% of total assets for planning materiality. The owners and the bank will be more

sensitive to errors in this year’s audit, given the fact this is a first-year audit. However, this is

counteracted by the fact that there are not a significant number of users of the financial statements. I

would, therefore, set planning materiality at $8,991, or roughly $9,000 ($899,127 × 1%).

When performing the audit, we must consider performance materiality. Per paragraph 9 of CAS 320,

“performance materiality means the amount or amounts set by the auditor at less than materiality for the

financial statements as a whole to reduce to an appropriately low level the probability that the aggregate

of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.”

Given the risks within the organization, setting performance materiality at a fairly low level will reduce

the likelihood of missing misstatements that in aggregate would be material to the users. I suggest setting

performance materiality to 60% of planning materiality, or roughly $5,400 (60% × $9,000).


We may want to decrease our materiality for areas most likely affected by fraud, such as cash, revenue,

and expenses.

(Most candidates addressed materiality in their responses. However, weak candidates did not recognize

that net losses are not an appropriate basis to use to calculate materiality. In addition, some candidates

did not apply appropriate percentages to their selected benchmarks. For example, some candidates

calculated materiality using 5% of total assets.)

Approach

The audit approach will be substantive in nature since there appear to be few effective controls at present

in the operation and there are indications of potential fraud. CAS 240, The Auditor’s Responsibilities

Relating to Fraud in an Audit of Financial Statements, states that although it is not the auditor’s

responsibility to detect fraud, given the indications of possible fraud and the other risks at the financial

statement level that exist, we will be required to use increased skepticism and place less reliance on

evidence provided or prepared by Mrs. Devanney. More work will also need to be performed to quantify

the impact of any suspected fraud. In addition, if we obtain evidence of suspected fraud, we will have to

reassess our previous risk assessment on other areas of the audit where we have relied on evidence

provided by Mrs. Devanney because it may have been tampered with.

We will also need to consider the impact of unaudited opening balances. There appears to have been no

due diligence work performed related to the acquisition, and PonyUp has never been audited before,

which calls opening numbers into question. With additional substantive work, we should be able to gain

comfort over most numbers. However, due to the amount of time that has passed since the beginning of

the fiscal year and the limited number of controls surrounding inventory, we likely cannot perform

procedures to preclude a material misstatement. Because inventory is material ($39,270 after excluding

horses, as discussed in the next section), we will have to qualify our opinion for a scope limitation on the

opening balance.

(The majority of candidates discussed the approach as part of their audit plan. Most of them recognized

that the lack of effective internal controls would lead to a substantive approach. Some candidates also

recognized that opening balances would need to be audited since this is a first-time audit. However, few

candidates discussed the impact that the suspected fraud would have on their audit approach.)

Procedures

Cash and Revenue — Fraud Risk

Cash and revenue are significant risk areas since most payments are received in either cash or cheque.

Given the potential fraud that may be occurring, the biggest risk is that cash is received but not recorded

in the general ledger or deposited in the bank (completeness). This may be the case, since the revenue

figure appears low even though the stables seem to be a “busy operation”.


It is very difficult to design procedures to determine the completeness of cash and revenue when the

business operations are cash-based. Although some procedures can be performed, it is likely that no set of

procedures can determine the full extent of any missing cash or revenue. However, some procedures can

determine whether a problem exists, such as the following:

Revenue — horse riding: We should obtain the calendar that shows the riding schedule. From that, we

can select a sample of days and ensure that the revenue resulting from the scheduling of each day was

recorded in the general ledger, and that the related cash and cheques were deposited into the bank

account. In addition, because we suspect some horse riding appointments were not on the schedule, we

should also select a sample of customers and contact them to determine which days they have

scheduled horse riding during a specific period. Then we can trace the related revenue amount to the

general ledger and the related cash or cheques deposited into the bank account. If we find

discrepancies, we should extend our testing.

Revenue — service fee: We should obtain a listing of payments remitted to third-party horse owners.

From that listing, we should select a sample and ensure the gross amount received by PonyUp and the

related payment to the boarders have been recorded in the general ledger. We also need to trace the

deposit of the gross receipt and the outflow of cash to the boarders from the bank account. However,

this test will not detect if the gross receipt was kept and no payment was made to the horse owner.

Therefore, we should ask the receptionist how many monthly horse rental agreements there are and

agree that to what is recorded in the books.

Revenue — lesson fees: Although this amount does not appear in the financial statements, we should

confirm that all monies received have been remitted to instructors, since there is a risk that Mrs.

Devanney is pocketing the fees. We should contact a sample of instructors to confirm with them that

they have received the funds related to the hours they taught in a particular period. We should also

confirm with a sample of customers how much they paid for the lessons and investigate any

differences from $30 an hour. Again, if we find potential fraud from this procedure, we will need to

extend our testing.

In addition, substantive analytical procedures could be performed over revenues to determine

reasonableness. For example, given that we know the number of stalls available for boarding, we could

determine what the maximum revenue per year would be if PonyUp were at maximum capacity. We could

also obtain an estimate of occupancy rates during the year from the owners to determine whether the

revenue recorded is reasonable.

(Very few candidates identified the need to provide procedures related to the cash and revenue fraud

risk. However, those who did provided relevant procedures to address the risk.)


Expenses — Fraud Risk

In one instance during the year, two computer invoices were paid, but it appears that only one computer is

being used at the office. This may be an indication of fraudulent use of business funds for personal

expenses. Therefore, there is a significant risk that expenses recorded are not all business expenses. In

order to determine whether theft occurred and to quantify it, we will need to do detailed expense testing.

This may involve selecting a sample of expenses from a listing of cheques issued and vouching the

amounts back to the invoice, paying specific attention to the nature of each expense. If an expense item is

found to be of a personal nature, we should attempt to quantify the amount by extending our investigation

in the areas in which personal expenses were identified.

(Virtually no candidates provided procedures related to potential fraudulent expenses.)

Related-Party Transactions

A related-party transaction occurred when PonyUp sold riding gear to Animal Galaxy Inc. (Animal

Galaxy). The risk is that it is not recorded at the proper amount in accordance with ASPE (accuracy). We

first need to ensure that Animal Galaxy is in fact a related party by confirming with Sarah and Megan

their percentage ownership of Animal Galaxy through inquiry or a written confirmation. We should then

confirm that PonyUp does not in fact sell riding gear in its normal course of operations. This can be done

by either inquiring with the owners or reviewing the general ledger to ensure there are no transactions

related to the sale of riding gear. We can also recalculate the change in ownership for the gear to ensure it

meets the 20% threshold for substantive change in ownership interest (see discussion under “Accounting

Issues”). Finally, we need to determine if the $11,000 exchange amount can be confirmed by independent

evidence. We could attempt to determine the value of the riding gear by reviewing the rejected offer from

the potential buyer or researching the cost of used gear online.

If we confirm that the accounting criteria to record the gear at the exchange amount are not met and the

transaction should be recorded at carrying amount, we should vouch the $14,000 to supporting

documentation, such as an agreement or an invoice. We should also vouch the $11,000 received from

Animal Galaxy.

There is a risk that other transactions with related parties (completeness) have also not been properly

identified. For example, it is possible that Lori is providing vet services to PonyUp, since she may be the

only vet in Smalltown. It is also possible that the owners might board their own horses, if they own any, at

PonyUp. We should ask the owners if there are other transactions of this nature and be alert when testing

other balances in case other related-party transactions come to light.

(Fewer than half of the candidates attempted to address this risk area, but the majority of those who did

provided relevant procedures that addressed some of the key risks. Weak candidates tended to focus on

the existence of the transaction, rather than how to measure the transaction or determine whether

there were other related-party transactions.)


Non-monetary Transactions

The non-monetary transaction in which the horse groomer exchanged boarding for shoeing of the horses

requires that we understand the correct measurement of the transaction to ensure it is properly recorded in

accordance with ASPE and at the correct amount (accuracy). We should obtain support for what PonyUp

has provided in services by confirming with the groomer that his daughter has had a horse boarding with

PonyUp for the past year. The value of the boarding service should also be vouched to a price list or

invoice. In addition, we should research the market price for shoeing a horse in the Smalltown area by

inquiring of the horse groomer or checking online. We should also obtain support that the transaction has

commercial substance by recalculating the cash flows for both the horse boarding and the shoeing.

(Fewer than half of the candidates addressed the non-monetary transactions. However, most of the

candidates who did provided specific and relevant procedures. Weak candidates did not provide

procedures that were linked to the most significant risks. For example, many recommended that the

general ledger be reviewed to ensure the transaction had been recorded. However, the more significant

risks related to this transaction were around the ASPE criteria being met or the amount the transaction

should be recorded at.)

Revenue — Non-refundable Fee (Boarding Fees)

The risk associated with boarding revenue is that the non-refundable fee has not yet been earned but has

been recognized (existence and accuracy). We should perform audit procedures to ensure revenue is

recorded in accordance with ASPE. We should obtain the contract and review it to assess if any additional

products or services are provided as a result of the fee. This will help to assess when PonyUp transfers

risks and rewards to the boarders (see discussion under “Accounting Issues”). If services are not provided,

we should ensure the deferred revenue calculation is accurate by reviewing the start dates of the contract,

recalculating the deferred amount, and comparing it to the general ledger.

(This area was the one most frequently addressed by candidates. Most candidates were able to provide

adequate procedures related to the non-refundable fee. Weak candidates focused on providing

procedures surrounding the existence and accuracy of the $1,000, without recognizing that only a

portion of the $1,000 should appear on the financial statements as revenue.)

Revenue – Gross versus Net (Service Fees)

In addition to the fraud risk discussed above, there is a risk that service fees are recorded at gross instead

of net amounts (presentation). We should review the contracts for service fees for terms that relate to

inventory risk, credit risk, et cetera, to ensure the ASPE criteria have been met (see discussion under

“Accounting Issues”). In addition, the contract should be reviewed to ensure the $75 service fee retained

by PonyUp is accurate.

(Approximately half of the candidates attempted to address this area. While most of them were able to

provide a valid procedure, weak candidates struggled with how to audit the gross versus net criteria and

only focused their procedures on verifying the accuracy of the $75 fee.)


Investment in Saddle Stables Inc. (Saddle Stables)

The investment in Saddle Stables is a new transaction that occurred during the year. In order to determine

whether the amount is recorded appropriately under ASPE and at the correct amount (accuracy), we

should review the agreement between PonyUp and Saddle Stables to confirm the amount, as well as the

terms and conditions of the transaction. We can also confirm the terms and the amount directly with

Saddle Stables.

(Approximately one-third of the candidates provided procedures in this area, and they were generally

well done.)

Horse Inventory (versus Property, Plant and Equipment)

The main risks regarding the horses owned by PonyUp are related to classification and valuation. We will

need to discuss with management the primary use of the horses (whether to provide riding services or to

be sold) to determine if property, plant and equipment is the appropriate classification (see discussion

under “Accounting Issues”). We can corroborate management’s response by checking if any horses have

been sold in the last few years.

We will also need to look at the valuation of the horses. Most likely the amount currently recorded in the

books is the cost of the horse. We can verify this by vouching to purchase documentation. We will need to

calculate an appropriate depreciation rate and method. We will also need to support the client’s estimates

by obtaining an independent estimation of each horse’s useful life by, for example, hiring a veterinarian.

The veterinarian could also help determine the value of the horses and whether there is any impairment of

them, particularly since there are indications that they are being overworked.

(Fewer than half of the candidates provided procedures in this area. Most of those who did were able to

provide procedures that would cover the risk related to this asset.)

Communication with Those Charged with Governance

If the results of the procedures above indicate Mrs. Devanney is involved in potential fraud, it will be

important to discuss the issue with those charged with governance (the three owners), assuming there is

no indication that they are involved in the potential fraud as well.

(Candidates rarely addressed the need to communicate the potential fraud to those charged with

governance.)


Internal Control Recommendations

We have made suggestions to the owners regarding internal control improvements at PonyUp (see

“Control Breakdowns and Recommendations for Improvement” later in this memo). If any of the controls

are implemented and create a self-review threat to independence, we will have to ensure we put

safeguards in place for next year’s audit of the financial statements.

(Candidates generally did not discuss this issue.)


Percent Awarded


6.2%

Reaching competence — The candidate attempts to discuss some of the planning elements of the engagement and provides some audit procedures for the identified risk areas.

34.7%

Competent — The candidate discusses some of the planning elements of the engagement and discusses some audit procedures for the identified risk areas.

58.8%

Highly competent — The candidate discusses some of the planning elements of the engagement and discusses some audit procedures for the identified risk areas, including a discussion of the implications of potential fraud on the audit.

0.2%

(Candidates were asked to prepare an audit planning memo, including suggested procedures for the

significant areas. To achieve competence, candidates were expected to provide a reasonable audit plan

and valid procedures to address some of the significant risk areas of the audit.)

(Most candidates performed adequately on this indicator. More than half of the candidates were able to

address all of the components of the audit plan (risk, approach, and materiality) in sufficient depth and

provide specific procedures relevant to PonyUp.)

(Weak candidates provided audit plans that were generic, often including comments that could apply to

any scenario. Weak candidates also struggled to provide a good explanation of the significant risks of

the audit, or they provided procedures that wouldn’t address the most significant risks.)

(Strong candidates were able to provide good coverage of the issues and suggested procedures that

were specific to the risk they had identified. Strong candidates also provided a good audit plan that

included a discussion of risk factors that were specific to PonyUp. Many of these candidates did a good

job of integrating their procedures and their analysis of the accounting issues. Although this approach

was not required, it seemed to help candidates provide a better coverage of the areas at risk.)


(However, the Board was disappointed that most candidates did not address how the potential fraud

would affect the audit plan. Many case facts pointed towards Mrs. Devanney’s potential commitment of

fraud, such as lack of vacation, double-booking of horses, overcharging for riding lessons, and

personal expenses possibly being paid by PonyUp. While most candidates picked up on this potential

fraud, the vast majority did not think of adjusting the audit plan to take it into consideration.)

Primary Indicator #2 The candidate discusses the accounting issues. The candidate demonstrates competence in Performance Measurement and Reporting.

Competencies


Accounting Issues

Related-Party Transactions

During the year, PonyUp sold riding gear to Animal Galaxy for $11,000. Animal Galaxy is owned by

Sarah, who has a 20% stake, and the remainder is held by Megan (her sister-in-law) and Megan’s

husband. Per Handbook Section 3840, Related Party Transactions, Sarah and Megan are both related to

PonyUp because they are both “an individual having ownership interest in the reporting enterprise that

results in significant influence or joint control” (paragraph 4(e)). Furthermore, Megan’s husband is

considered a related party as a spouse of Megan, since he is a “member of the immediate family of

individuals described in (e) (immediately family comprises an individual’s spouse and those dependents

on either the individual or the individual’s spouse)” (paragraph 4(f)). Finally, Animal Galaxy is

considered a related party to PonyUp because it is “an enterprise that directly or indirectly, through one

or more intermediaries, controls, or is controlled by, or is under common control with, the reporting

enterprise” (paragraph 4(a)).

Related-party transactions must follow the guidance laid out in Section 3840. Following the decision tree

for determining appropriate measurement, we must first consider whether the transaction is in the normal

course of operations for PonyUp, since paragraph 18 states, “a monetary related party transaction, or a

non-monetary related party transaction that has commercial substance, shall be measured at the

exchange amount when it is in the normal course of operations, unless paragraph 3840.22 applies.” In

this case, the transaction is not in the normal course of operations since PonyUp does not typically sell

riding gear.


Next, we must consider whether the change in ownership interest of the item transferred is substantive and

whether the exchange amount is supported by independent evidence per paragraph 29: “When a monetary

related party transaction or a non-monetary related party transaction that has commercial substance is

not in the normal course of operations, it shall be measured at the exchange amount when (a) the change

in ownership interests in the item transferred or the benefit of a service provided is substantive; and (b)

the exchange amount is supported by independent evidence.” Per paragraph 35, “A change in the equity

ownership interest in an item transferred, or the benefit of the service provided, is presumed to be

substantive when a transaction results in unrelated parties having acquired or given up at least 20

percent of the total equity ownership interests in the item or service benefits, unless persuasive evidence

exists to the contrary.” The only unrelated party in this transaction is Lori. Lori, before the riding gear

was sold, owned 33% of the gear, since PonyUp owned the gear and she owns 33% of PonyUp. After the

sale, she owns 0%, since Animal Galaxy now owns the gear and she has no ownership in Animal Galaxy.

This would indicate that the change in ownership is substantive, since it is over 20%.

In addition, we must consider whether the amount of the exchange ($11,000 in this case) is supported by

independent evidence. On the one hand, independent evidence might suggest the value to be close to

$14,000, since that is the cost of the gear and the gear is in good condition. On the other hand, the

potential buyer did not offer enough for PonyUp to sell to them. It is unclear whether there would be

independent support for this value. We will need to determine at what price the used gear can be sold. If it

is an amount other than $11,000, the transaction should be measured and recorded at the carrying amount

of $14,000. Otherwise, the transaction should be measured and recorded at the exchange amount of

$11,000.

Assuming the transaction is recorded at the carrying amount, the difference between the carrying amount

and the cash received ($3,000) would be recorded in retained earnings.

(Approximately half of the candidates attempted to address this accounting issue, but their analysis of

the Handbook criteria was generally weak. Many candidates did not consider all of the relevant

criteria that should have been applied when determining the appropriate accounting treatment for this

transaction. In particular, candidates struggled with the concept of substantive change in ownership

interest, since they didn’t appear to know how to determine whether there was a change in ownership.)

Non-monetary Transaction

PonyUp entered into a non-monetary transaction relationship with a local horse groomer for the shoeing

of its horses. In exchange for his services, his daughter does not pay the rental fee on the boarding of her

horse. The rental fee would be $400 per month (given she has been using the services for four years and

thus the initial two-year fee of $350 per month would have passed), or $4,800 per year. The cost of

shoeing a horse is $100, and it needs to be done an average of four times a year. For PonyUp, this equates

to at least 14 horses owned by PonyUp plus a maximum of 11 horses boarding, since this is the maximum

capacity. At the most, it would mean 25 horses at $400 each, or $10,000.

Handbook Section 3831, Non-monetary transactions, indicates in paragraph 6 that

An entity shall measure an asset exchanged or transferred in a non-monetary transaction at the

more reliably measurable of the fair value of the asset given up and the fair value of the asset

received, unless:

(a) the transaction lacks commercial substance;


(b) the transaction is an exchange of a product or property held for sale in the ordinary course

of business for a product or property to be sold in the same line of business to facilitate

sales to customers other than the parties to the exchange;

(c) neither the fair value of the asset received nor the fair value of the asset given up is reliably

measurable; or

(d) the transaction is a non-monetary non-reciprocal transfer to owners to which paragraph

3831.14 applies.

Paragraph 11 further states that “a non-monetary transaction has commercial substance when the entity’s

future cash flows are expected to change significantly as a result of the transaction.”

The exchange has commercial substance because the difference between the asset received and the asset

given up is significant in value. As a result of this transaction, PonyUp is improving its cash flow by

$5,200 per year ($10,000 − $4,800) by not having to pay for shoeing. Criterion (a) is, therefore, not met.

The services being exchanged are not interchangeable, so criterion (b) is not met. Both fair values are

known and can be reliably measured, so criterion (c) is not met. The transaction is not a non-reciprocal

transfer to owners since it is a reciprocal exchange with an unrelated party, so criterion (d) is not met.

Because none of the exceptions are met, the transaction should be recorded at the more reliably measured

of the fair value of the asset given up and that of the asset received. Per paragraph 10, when an entity is

able to reliably determine the fair value of both the asset received and the asset given up, the fair value of

the asset given up is used to measure the asset received unless the fair value of the asset received is more

reliably measurable.

PonyUp is able to measure the fair value of both the asset given up and the asset received. In addition, it

does not appear that the fair value of the asset received is more reliably measurable. Therefore, the

transaction should be recorded at the $4,800 value of the boarding fees that PonyUp has given up during

the year.

(Most candidates attempted a discussion of this accounting issue, but once again their analysis of the

Handbook criteria was generally weak. Many candidates were confused by the concept of commercial

substance and struggled to explain it appropriately using case facts. In addition, some candidates did

not demonstrate their knowledge of the Handbook criteria in their accounting conclusion and

incorrectly recommended that the assets received and the assets given up be recorded at their respective

fair values, with the difference recorded as a gain or loss.)

Revenue — Non-refundable Fee

PonyUp charges for boarding with a $1,000 initial fee due at the beginning of the contract, plus $350 per

month. The initial fee is non-refundable. The $350 fee is for 24 months, after which the fee increases to

$400 per month. The question is around the recognition of the $1,000 initial fee, which at present is

recorded as revenue when received.


Handbook Section 3400, Revenue, indicates that

.04 Revenue from sales and service transactions shall be recognized when the requirements as to

performance […] are satisfied, provided that at the time of performance ultimate collection is

reasonably assured.

.06 In the case of rendering of services and long-term contracts, performance shall be determined

using either the percentage of completion method or the completed contract method, whichever

relates the revenue to the work accomplished. Such performance shall be regarded as having

been achieved when reasonable assurance exists regarding the measurement of the consideration

that will be derived from rendering the service or performing the long-term contract.

.07 Performance would be regarded as being achieved under paragraphs 3400.05-.06 when all

of the following criteria have been met:

(a) persuasive evidence of an arrangement exists;

(b) delivery has occurred or services have been rendered; and

(c) the sellers’ price to the buyer is fixed or determinable.

Persuasive evidence of an arrangement exists since a contract is signed at the beginning of the 24-month

period. The sellers’ price is determinable, since we know it is $1,000. The question surrounds whether

services have been rendered for that amount. Because the initial fee of $1,000 is non-refundable and it is

unclear whether it is directly linked to any additional services, PonyUp may be able to support that it is

earned at the time it is received. However, PonyUp must demonstrate that its performance related to the

$1,000 is complete at the point of payment. If, at this point, PonyUp is not obligated to provide anything

else to the boarder directly related to the fee, then revenue can be recorded assuming collection is assured,

since the amount is known.

However, looking at the substance of the transaction, it appears that the $1,000 initial fee results in a

reduced boarding rate for the term of the contract that it relates to. The monthly fee is lower for the 24-

month period that the $1,000 relates to and then increases subsequently. In substance, this would seem to

be a pre-payment of boarding fees for the course of the 24 months. It would, therefore, appear that the

risks and rewards related to the $1,000 will transfer over the course of the contract and not at initial

receipt of payment, since at that time PonyUp is still obligated to fulfill the boarding agreement.

The $1,000 should be deferred and recognized into revenue over the 24 months, at $42 per month,

bringing the monthly boarding fee to $392, which is close to the amount charged once the contract has

passed the first 24 months.

(This was the accounting issue most often addressed by candidates. Most candidates discussed this

issue well, tying in case facts, such as the fact that the service is to be delivered over 24 months and

that the monthly fee increases after the 24-month period.)

http://www.knotia.ca/Knowledge/Home.aspx?productid=126


Revenue – Gross versus Net

PonyUp organizes the riding schedule for some of the 11 horses that are owned by individuals but

boarded at PonyUp. PonyUp collects $1,230 per month for each horse. Of that, $1,155 is paid to the

owner and $75 is retained as a fee for the service. Currently, the $1,230 per month per horse appears to be

recorded in the financial statements under “Revenue — service fee” and the $1,155 per month per horse is

recorded as “Expense — service fee.”

Handbook Section 3400, Revenue, indicates in paragraph 23 that “revenue includes only the gross inflows

of economic benefits received and receivable by the entity on its own account. Amounts collected on

behalf of third parties such as sales taxes and goods and services taxes are not economic benefits that

flow to the entity and do not result in increases in equity.”

Paragraph 24 further states:

.24 An entity is acting as a principal when it has exposure to the significant risks and rewards

associated with the sale of goods or the rendering of services. Features that indicate that an

entity is acting as a principal include:

(a) the entity has the primary responsibility for providing the goods or services to the

customer or for fulfilling the order (for example, by being responsible for the

acceptability of the products or services ordered or purchased by the customer);

(b) the entity has inventory risk before or after the customer order, during shipping or on

return;

(c) the entity has latitude in establishing prices, either directly or indirectly (for example, by

providing additional goods or services); and

(d) the entity bears the customer’s credit risk for the amount receivable from the customer.

One feature indicating that an entity is acting as an agent is that the amount the entity earns is

predetermined, being either a fixed fee per transaction or a stated percentage of the amount

billed to the customer.

PonyUp does not have the primary responsibility for providing the horse for riding; it is at the discretion

of the owners. PonyUp also has no inventory risk, given that the horses do not belong to it. It is unclear

whether PonyUp sets the prices for the riding, but this might be the case to ensure consistency of fees. It

appears the owners bear the majority of the credit risk, since they do not get the $1,155 if a customer

doesn’t pay, but PonyUp would only miss out on the $75 fee. Finally, the fee that PonyUp earns is fixed

per transaction.

It appears that PonyUp is merely collecting and remitting the funds to the owners of the horses and bears

only a small portion of the risks and rewards of the transaction. If this is the case, the monies collected

should be established as a liability, and only the $75 fee should be recorded as revenue. Therefore,

$55,440 should be removed from both the “Revenue — service fee” and the “Expense — service fee”

lines on the income statement. However, consideration should be given to whether PonyUp is taking on

the credit risk of a customer not paying. If PonyUp has to pay the horse owner regardless of whether the

frequent rider pays, there may be some argument to record the amounts on a gross basis.


(Most candidates attempted a discussion of this accounting issue but were not able to provide sufficient

depth in their discussion. Many candidates addressed only one of the relevant factors when considering

whether PonyUp was a principal or an agent, and then concluded on the accounting treatment without

further analysis.)

Investment in Saddle Stables

During the year, PonyUp provided an interest-free loan to Saddle Stables in the amount of $10,000. The

loan contains certain terms that allow PonyUp to exert a significant amount of influence on Saddle

Stables. In addition, it contains the ability for PonyUp to convert a portion of the loan into equity if any

payment is in default.

There is a question of whether this transaction is a loan or an investment. It is important in this case to

consider the substance of the transaction over the form, as paragraph 18 (a) of Handbook Section 1000,

Financial Statement Concepts, requires that transactions be faithfully represented, and states that “the

substance of transactions and events may not always be consistent with that apparent from their legal or

other form. To determine the substance of a transaction or event, it may be necessary to consider a group

of related transactions and events as a whole. The determination of the substance of a transaction or

event will be a matter of professional judgment in the circumstances.”

The first consideration is whether this transaction contains the elements of a loan, consistent with its form.

Section 3856, Financial Instruments, defines a financial asset as “a contractual right to receive cash or

another financial asset from another party.” The transaction would appear to meet this definition because

it is a right to receive cash from Saddle Stables.

However, the transaction also appears to have elements of an investment, given that there is an option to

convert a portion of the loan into shares if Saddle Stables defaults on a payment. PonyUp also has a fair

amount of influence over the decisions of Saddle Stables, since they must approve any major capital

expenditures and significant operational decisions, which may indicate control (defined as “the continuing

power to determine its strategic operating, investing and financing policies without the co-operation of

others”). However, paragraph 3 of Handbook Section 3051, Investments, as well as paragraph 2 of Section

1582, Business Combinations, scopes out any transactions that qualify as a financial instrument, so these

sections would not apply to this transaction.

Therefore, the above analysis, along with the fact that the loan can only be converted into shares if Saddle

Stables defaults on a payment (which is outside of the control of PonyUp) suggests that the transaction is

more similar to a loan than an investment. The $10,000 currently recorded as an investment should be

reclassified as a loan on the balance sheet. As per Section 3856, the loan should be recorded at fair value.

This means the payments will have to be discounted based on an appropriate interest rate (a rate that

would reflect the risk of a loan to another entity similar to Saddle Stables). The difference between

$10,000 and the fair value of the loan would be recorded as an expense. Subsequently, each $2,000

payment would have its principal component recorded against the loan asset and its interest component

recorded as interest revenue.


(Candidates struggled with this accounting issue. Fewer than half of the candidates addressed the

issue, and most of them struggled to apply the correct Handbook sections. Many candidates were

confused and discussed this from the perspective of the borrower, and as such discussed concepts such

as bifurcation, which was not relevant in this case.)

Inventory versus Property, Plant and Equipment

Horses

PonyUp is currently recording its horses as inventory. Inventory must typically be presented at the lower

of cost and net realizable value. However, we must consider whether the horses have the characteristics of

inventory as defined by ASPE. Handbook Section 3031, Inventory, defines inventory as follows:

Inventories are assets:

(i) held for sale in the ordinary course of business;

(ii) in the process of production for such sale; or

(iii) in the form of materials or supplies to be consumed in the production process or in the

rendering of services.

PonyUp appears to have classified the horses as inventory because it is willing to sell them. Although the

horses are available for sale at any time, they are held in the business for the main purpose of being ridden

as part of regular operations.

It would appear that property, plant and equipment may be a more appropriate classification. Again,

referring to the Handbook, the definition of property, plant and equipment is as follows:

Property, plant and equipment are identifiable tangible assets that meet all of the following

criteria:

(i) are held for use in the production or supply of goods and services, for rental to others, for

administrative purposes or for the development, construction, maintenance or repair of

other property, plant and equipment;

(ii) have been acquired, constructed or developed with the intention of being used on a

continuing basis; and

(iii) are not intended for sale in the ordinary course of business.

The horses have been acquired for rental purposes, since this is the primary revenue source from these

horses for PonyUp. They were purchased with the intention of being rented out on a continuing basis

since horses have been maintained at the stables for years. Although the horses may be sold, the intention

in acquiring them was not for resale, so sales of horses are not intended to be in the ordinary course of

business. The horses should, therefore, be classified as property, plant and equipment and recorded at

cost.

PonyUp will need to record depreciation on the horses. An appropriate measure of the estimated useful

life of these assets would seem to be the expected remaining useful life of each horse. The horses will also

have to be tested for impairment if indicators of impairment exist, which is likely since the horses appear

to be tired.


Food and Supplies

The food and supplies appear to be appropriately recorded as inventory, since they are assets that are

consumed while providing boarding services, and thus are assets “in the form of materials or supplies to

be consumed in the production process or in the rendering of services,” as stated in Handbook Section

3031, Inventory, paragraph 7.

(Fewer than half of the candidates addressed this issue. However, the majority who did were able to use

the relevant Handbook guidance to determine whether the horses should be recorded as inventory or

property, plant and equipment.)


Percent Awarded


7.5%

Reaching competence — The candidate identifies some of the accounting issues.

44.9%

Competent — The candidate discusses some of the accounting issues. 46.9% Highly competent — The candidate thoroughly discusses most of the accounting issues.

0.6%

(Candidates were required to address the accounting issues at PonyUp. To achieve competence, the

Board expected candidates to address some of the accounting issues in sufficient depth.)

(Candidates struggled with some of the accounting issues in this indicator. While discussions

surrounding the recognition of boarding-fee revenue and whether the horses should be recorded as

inventory versus property, plant and equipment were generally well done, candidates struggled with the

more complex issues, such as related-party transactions, non-monetary transactions, and the

investment in Saddle Stables. Strong candidates were able to identify the correct accounting criteria

and provide a good discussion, applying specific case facts. Many weak candidates just provided the

Handbook criteria without taking the time to explain how the criteria would apply to PonyUp. Weak

candidates also did not identify as many of the relevant accounting issues, thereby limiting their ability

to demonstrate competence in Performance Measurement and Reporting.)


Primary Indicator #3 The candidate discusses the control weaknesses that provide an opportunity for potential fraud. The candidate demonstrates competence in Assurance.

Competencies

VI-2.8 – Evaluates the evidence and the results of analysis (A)


Control Breakdowns and Recommendations for Improvement

Segregation of Duties

Weakness: There is currently no segregation of duties. Although PonyUp has a receptionist who collects

cash payments to provide some segregation, she simply passes on the amounts collected to Mrs.

Devanney, which completely negates the segregation. Mrs. Devanney receives all payments — either

through the mail or as they are handed over to her by the receptionist — completes the deposit, and has

full access to the accounting records.

Implication: Mrs. Devanney would be able to pocket payments received and adjust the accounting

records (such as the bank reconciliation, which is not reviewed) to hide this.

Recommendation: At a minimum, she should not have the ability to access cash without the knowledge

of someone else. A simple fix for this in a small organization like PonyUp would be for the receptionist to

continue to collect the cash and to also start opening the mail. The receptionist should also prepare the

deposit and provide a listing of all monies received, which should be given to the owners. The monies

may then be given to the bookkeeper, who should record the receipts and complete the deposit. The

owners should then compare the amount deposited to the listing prepared by the receptionist. This will

detect whether the bookkeeper is skimming money before the deposit.

It may also be advisable for PonyUp to cease the acceptance of cash. Cash carries with it a high risk of

theft. Acceptance of credit cards and cheques would prevent cash from being stolen. If this is not possible,

the implementation of a receipt system, whereby a receipt is issued by the receptionist for all cash

received, would decrease the risk associated with accepting cash.

(Virtually all candidates addressed the segregation of duties issue. Most of them were able to identify

the incompatible duties and recommended that these duties be separated. Strong candidates recognized

that the cash-based nature of PonyUp’s business further increased the risk of the lack of segregation

of duties. Weak candidates, however, had a difficult time explaining the implication of the lack of

segregation of duties for PonyUp. Many of them simply stated in generic terms that there was an issue

with segregation of duties, without explaining specifically which duties were incompatible and what

might be the result (for example, that Mrs. Devanney could steal cash and cover it up in the accounting

records).)


Approval of Expenses

Weakness: It was noted that two computers were purchased by PonyUp, but there appears to be only one

in the office. It seems that there are very few controls surrounding the approval of expenses.

Occasionally, cheques are signed without the owners having access to the appropriate support for the

expenses they are paying for.

Implication: This provides an opportunity for expenses to be incurred on behalf of the company that are

not legitimate (personal expenses, for example) or not in accordance with PonyUp’s policy (pricing may

be too high, for example). When cheques are signed without appropriate supporting documentation, it

increases the risk that funds are being paid to fictitious vendors. In addition, it does not provide a proper

control for reviewing the payment to ensure it is a good use of company funds.

Recommendation: All expenses over a certain limit should be approved by an owner prior to purchase,

and for all other transactions, all invoices should be approved prior to the cheques being prepared. In

addition, all invoices should be marked “paid with cheque #XXX” once a payment has been issued. That

way, the possibility of an expense being suspicious or duplicated without the owners noticing will be

reduced. Every cheque should have an invoice or other appropriate documentation attached to it at the

time of signing so that the owners can verify the validity of the expenses.

(Most candidates addressed this issue. They were able to explain why this was an issue and provide a

recommendation that addressed the situation.)

Scheduling of Horses

Weakness: The receptionist noted that sometimes riders are paying for horses when they are not on the

schedule, which suggests that not all riders are being scheduled.

Implication: It is possible that Mrs. Devanney is scheduling more riders in addition to what is expected

and keeping the payments herself. In addition, horses that are being ridden monthly are not being tracked,

providing an opportunity for Mrs. Devanney to pocket the monthly riding fee without anyone noticing.

Recommendation: The schedule should be maintained by one person, perhaps the receptionist, so that all

changes are known and documented. Monthly and daily riders should be tracked, and any additional

riders should be added to the schedule. A copy of the schedule should be posted at the stables, where

riders would be required to sign in and out to access the horses. This will allow for a record of all riding

and prevent any rides from occurring without documentation, as well as identify any riders not recorded

on the schedule.

(Most candidates addressed this issue, but many were not able to provide a valid recommendation to

address the weakness. For example, many candidates suggested that Mrs. Devanney be asked to update

the schedule. Given that there were many signs that Mrs. Devanney may be committing fraud, that was

not considered an appropriate recommendation.)


Lesson Fees

Weakness: It was noted that at least one customer was being charged a rate higher than the usual rate.

This indicates that there are no controls surrounding what rates are being charged to clients.

Implication: This may lead to clients being charged incorrect amounts, which could lead to loss of

reputation, or worse, possibility of fraudulent activity, since higher amounts can be charged to customers

than are being paid to the instructors.

Recommendation: A price list should be posted at the reception desk so that all clients are aware of what

the prices are for services.

(About one-third of the candidates addressed this issue. Although most of them were able to explain the

implication, some candidates struggled to provide a recommendation to solve this issue. For example,

some candidates suggested that Mrs. Devanney be reminded that she should charge the correct

amount, which does not address the issue, since she is likely the one who is exploiting the internal

control weakness.)

Approval of Bank Reconciliations

Weakness: Bank reconciliations are currently not being reviewed and Mrs. Devanney is considering not

doing them anymore.

Implication: As discussed above, one of the intentions of a bank reconciliation review is to allow for a

control over cash, in that an additional person is looking at the cash account. The bank reconciliation has

not been reviewed by anyone recently, which may allow Mrs. Devanney to cover her tracks if she is

stealing cash from the company, without any knowledge by the ownership group.

Recommendation: One of the owners should be responsible for reviewing the bank reconciliations and

the supporting documentation on a monthly basis.

(About half of the candidates addressed this issue. While most of them were able to provide a valid

recommendation, many explanations of the implication of the control weakness were weak. For

example, some candidates simply stated that a review of bank reconciliations is important, without

explaining why (i.e., the fact that a review allows the owners to catch errors or anomalies in the bank

reconciliations).)

Cheque Signing

Weakness: Currently, only one signature is required on cheques issued by PonyUp.

Implication: Having only one signature on cheques provides an opportunity for any one of the owners to

take a significant amount of money from the company without the agreement of at least one other owner.

In addition, this provides an opportunity for Mrs. Devanney to give the same invoice to two different

owners without the owners noticing.


Recommendation: Each cheque should be signed by two owners. This will prevent owners from being

able to withdraw money by themselves and will also ensure that if Mrs. Devanney submits a duplicate

invoice, at least one owner will see it twice.

(The majority of candidates addressed this issue, and most of those who did were able to explain the

implication and provide a valid recommendation.)

Indicators of Fraud

The owners mentioned that there seems to be a lot of cash coming in, and yet the business seems to be

short on cash. The issue may be caused by fraud occurring at PonyUp.

Mrs. Devanney’s questionable behaviour is evident throughout the organization:

1. Double-booking of horses: Megan noted some horses seemed tired and that one of them had

definitely been ridden for more than three hours that day. Megan confirmed that only one three-hour

session had been scheduled, so she concluded it must have just been an anomaly. It is possible that

Mrs. Devanney is allowing horses to be ridden more than expected based on the schedule and

keeping the payments herself. In addition, the receptionist noted there are times when money is

collected from riders not scheduled for horse riding and that she is not to note this on the schedule.

2. Overcharging for lessons: Lessons are charged at $30 an hour, but one client mentioned that she has

been paying $40 an hour to the office. It is possible that Mrs. Devanney is charging $40 and then

pocketing the $10 difference from the approved $30 rate that is forwarded to the instructor.

3. Not taking any vacation: Mrs. Devanney does not appear to take vacation. Although this may provide

the appearance of a committed employee, it is also a means of controlling what is happening and what

is being recorded in the books at all times. It is often a clue to fraudulent behaviour.

4. Possible personal expenses being paid by PonyUp: It was noted that two computers were purchased

from a supplier, but there is only one computer in the office. It is possible that Mrs. Devanney

purchased two computers but took one home, indicating another possible area of fraud.

5. Revenue recorded appears low: PonyUp appears to be a “busy operation.” Therefore, revenue should

reflect operations that are almost at full capacity. At full capacity, boarding fees would bring in

$46,200 (11 stalls × $350 per month × 12 months, assuming a conservative estimate that all boarders

have not been with PonyUp for over two years), and horse riding fees would bring in $255,500

(14 horses × $50 per day × 365 days). However, amounts recorded for the year ended on March 31,

2014, are $30,000 (65% of full capacity) and $200,200 (78% of full capacity), respectively. I am not

sure what percentage of horses owned by individuals is used by frequent riders, but this revenue also

appears low. If 100% of these horses were matched with frequent riders, the revenue related to this

would amount to $162,360 (11 horses × $1,230 per month × 12 months). The current revenue

associated with this is $59,040, which means four horses are being ridden by frequent riders. This

may be reasonable if there are not many frequent riders, but it may also be low. It is possible that the

lower percentages are reflective of seasonality, since there would likely be fewer riders in the winter

compared to the summer months. However, it may also be another indication that Mrs. Devanney is

stealing revenue from PonyUp. I have not come across any evidence of fraud on the boarding fees,

but this is an area we may want to investigate further, given that revenue amounts are lower than

expected.


With the number of opportunities Mrs. Devanney has to commit fraud, PonyUp should conduct a full

investigation. If we are hired for the special investigation, we should consider the need to involve a

forensic specialist. If evidence of fraud is found, PonyUp should consult legal counsel to consider

whether firing Mrs. Devanney is appropriate. In addition, PonyUp should try recouping any stolen funds

it can from her.

(Almost all candidates identified that Mrs. Devanney may have committed fraud and supported their

claim with specific examples from the simulation. However, fewer than half of the candidates provided

a recommendation on the next steps for the owners to take.)


Percent Awarded


6.6%

Reaching competence — The candidate addresses some of the control weaknesses, including recommendations to address them.

27.2%

Competent — The candidate discusses some of the control weaknesses, including recommendations to address them, and recognizes the indicators of potential fraud.

65.0%

Highly competent — The candidate discusses several of the control weaknesses, including recommendations to address them, and discusses the indicators of potential fraud.

0.9%

(Candidates were not specifically directed to this indicator. However, one of the owners noted that

there seemed to be fewer controls at PonyUp than she was used to at Animal Galaxy, the pet store she

managed. Also, later in the simulation she wondered if improvements could be made at PonyUp, which

was a hint to discuss controls. To achieve competence, candidates were required to address the internal

control weaknesses present at PonyUp and provide valid recommendations. Candidates were also

expected to recognize that it was possible Mrs. Devanney had already exploited some of these control

weaknesses and was committing fraud.)

(Most candidates performed well on this indicator. They were able to identify some of the control

weaknesses, explain their impact on PonyUp, and provide valid recommendations. Most candidates

also identified that Mrs. Devanney had likely exploited the lack of internal controls, and they supported

the claim with relevant case facts.)

(Many weak candidates did not provide recommendations that would address the internal control

weakness, or they suggested recommendations that were clearly impractical. In addition, weak

candidates did not always identify the fact that fraud had likely already occurred; instead, they

concluded that Mrs. Devanney may have been overworked and was simply making errors. Given the

nature and volume of case facts provided regarding Mrs. Devanney, candidates should have realized

that there were definitely indicators of fraud and addressed this concern in their response. Strong

candidates recognized the potential fraud and made recommendations as to how PonyUp’s owners

should address it.)













III-3.3 – Decides / recommends/provides advice

III-4.1 – Seeks and shares information, facts, and opinions through written discussion



There were no secondary indicators in this simulation.

(Candidates performed well on this simulation. The requireds and issues were fairly straightforward,

and candidates were able to sufficiently incorporate case facts into the majority of their analyses.

Candidates performed the best on Primary Indicator #3, since most of them were able to identify the

control weaknesses and provide adequate recommendations for several areas, as well as identify the

potential fraud. For Primary Indicator #1, candidates tended to struggle most often in providing

relevant procedures that would address the specific risks, and they often failed to describe how the

suspected fraud would affect the audit. For Primary Indicator #2, candidates did well on the more

basic issues (recognition of boarding-fees revenue and whether the horses should be recorded as

inventory versus property, plant and equipment), but struggled with the more complex ones (related-

party transactions and non-monetary transactions). Candidates are expected to understand the

technical guidance related to the accounting issues presented and apply the relevant case facts to their

analysis.)



It is February 20, 2014. You, a new CA in the firm of Lebarre & Laramie, have just received a visit from

Carl Carlson, a new personal tax client.

“Hey, CA, I guess it’s that time of year when the government comes knocking for all my hard-earned

money, eh? Anyways, I was hoping you could help me out. I’ve been doing my own thing for the past

few years as a contractor building homes under the business name of Carlson Contracting, and it’s been

good. But this past year, I did so well that I’m a little nervous about my taxes. Could you take a look at

my numbers and let me know what size of federal tax bill I’ll be facing? My contractor buddies at the

coffee shop have been bragging about their corporations and how they’ve been saving taxes. I’m starting

to wonder if it’s time for me to do something. Could you tell me what my total 2013 federal tax bill

would have been if I had been incorporated? I wonder if it would really save me that much in taxes. I

would say that my family and I need $100,000 in pre-tax salary a year to live on. Here is my balance

sheet and income statement (Exhibit I), as well as some tax stuff and other notes about my business

(Exhibit II).

“I was also wondering if you could help me with some decisions I need to make. With the growth in my

business, I need to get my own workshop. My wife is really tired of me having all my equipment in the

garage. I have been weighing a few options (Exhibit III). Maybe you can help me out?”

After the visit, you go back to your office, and your manager happens to stop by. “I heard you were just

talking to Carl. He spoke to me as well. Because his business is expanding, he is exploring bigger

projects, which will require him to be bonded. The insurance company that provides bonding to

contractors requires reviewed financial statements using Accounting Standards for Private Enterprises

(ASPE). Can you look at the financial statements and let me know what accounting issues need to be

addressed for a review? His wife does all the bookkeeping, but she has no formal accounting training, so

the statements likely need some adjustments.”



EXHIBIT I

CARLSON CONTRACTING

DRAFT BALANCE SHEET

As at December 31, 2013

Assets

Note

Cash $ 58,449

Inventory 100,000 1

Property, plant and equipment 704,987 2

$

863,436

Liabilities

Bank indebtedness $ 22,898

Accounts payable 57,664

80,562

Equity

Owner’s equity 782,874

$ 863,436

Notes:

1. The inventory represents construction in progress for a house I am building for a customer. The selling

price is $300,000, and the customer has paid my usual deposit and signed the purchase agreement. The

house will be two storeys and is going to cost me about $225,000 to build. So far I have excavated the

land and poured the foundation at a cost of $100,000.

2. Included in property, plant and equipment is a small piece of land I purchased during the year. I am

certain I can make a lot of money from it — it is in an excellent location and would be a prime spot for

an apartment building. The city by-laws in the area restrict buildings to 10 storeys high unless the land

owner purchases a licence from the city, which I did after I bought the land. I can now build up to 28

storeys on the land. Shortly after, the city stopped issuing licences in that location for buildings taller

than 10 storeys, so the licence is especially valuable now. I paid $400,000 for the land and $100,000

for the city licence. I plan on just holding onto the land until a developer approaches me and offers me

lots of money. I may build on it myself if I have the money down the road, but I would rather sell.



EXHIBIT I (continued)

CARLSON CONTRACTING

DRAFT INCOME STATEMENT

For the year ended December 31, 2013

Note

Sales $ 1,265,622 1

Cost of sales:

Materials 465,222

Labour 356,398

821,620

Gross profit 444,002

Expenses:

Insurance 3,900

Meals and entertainment 3,456

Bad debt 4,200

Bank charges and interest 4,322 2

Advertising 5,467 3

Office 2,575

Association dues 500

Professional fees 750

Repairs and maintenance 25,428 4

Phone and utilities 3,556

Vehicle operating costs 37,879

Miscellaneous 84,500 5

176,533

Net income $

267,469

Notes:

1. I record sales when I receive cash. I typically get 20% of the sale price up front and the remainder

when the house is complete and ownership has transferred to the buyer.

2. Included in bank charges is a $200 late-payment penalty for payroll remittances that I paid to the

Canada Revenue Agency.

3. Included in advertising are donations I made of $1,000 to United Way and $750 to a federal political

party. This is the first time either my wife or I have made charitable donations.

4. During the year, I replaced the motor in a piece of excavation equipment for $10,000. I think we can

get another five years out of the machine now.

5. Included in miscellaneous expenses are the following:

a) A new truck I purchased for $45,000. I use the truck solely for transporting tools, supplies, and my

employees to job sites.

b) A new trailer for $27,000.

c) Various small tools totalling $12,500. About $5,000 of this is for small tools worth less than $500

each. The rest are tools typically costing between $500 and $1,500 each.



EXHIBIT II

OTHER INFORMATION COLLECTED FROM CARL

Personal information:

o Carl: 40 years old

o Spouse: Erin, 39 years old, no income

o Children: twins Josh and Jessica, 15 years old

Carl’s notes on the business:

o At the beginning of 2013, I started offering warranties on the homes I build for a period of two

years after the sale, at no charge to the customers. This is not part of the actual agreement I sign

with the homeowners, but I am doing it to keep my great reputation. I estimate that the costs of

doing such warranty work are about 4% of the sale price of the house. In 2013, I incurred $21,333

of costs related to the warranty, which have been included in the cost of sales recorded during the

year.

o I have an issue with one homeowner. He is threatening to sue me over a foundation that cracked

after a minor earthquake. He thinks I should pay because no one else in the neighbourhood had a

cracked foundation, but I know that my workmanship was good. I have no intention of paying him

the $100,000 he is asking for. However, my lawyer says that, at a minimum, I will have to fix it,

which could cost between $10,000 and $50,000.

The 2012 tax return is showing the following undepreciated capital cost (UCC) balances:

o Class 8: $33,654

o Class 10: $37,669

o Class 12: nil

Carl has a receipt from the Marlin Swim Club for Josh, showing fees of $350 paid in 2013 for

swimming lessons, and a receipt from the Royal Conservatory for Jessica, showing fees of $750 paid

in 2013 for piano lessons.

Carl’s 2012 Notice of Assessment showed registered retirement savings plan (RRSP) contribution

room available of $75,671.



EXHIBIT III

FINANCING OPTIONS

I need a new building. I could either build one myself or lease one. I think it would cost me about

$450,000 for land, materials, and labour to build it, and I would need to finance the cost, given I spent

most of my cash on the land purchase in 2013. If I lease a building, I will not need to borrow. I have listed

my options below. I would like your evaluation of each of them, as well as comments on any other issues

I should consider.

Option #1: Build it myself with 90% of the cost financed by the bank at 5.25% annual interest over a

15-year term. Equal payments would be made at the end of each month. I can obtain financing for the

remaining 10% by borrowing on my account at the same terms, but at a 6% annual interest rate. This bank

would require reviewed financial statements and would take a general security agreement over all assets

of the business, as well as personal guarantees. The bank would also require Carlson Contracting’s debt-

to-equity ratio to be no higher than 1:1 and would restrict the amount I take out of the business to

$100,000 per year.

Option #2: Build it myself with my brother-in-law funding 100% of the cost of the building. The

repayment terms would be annual payments equal to 15% of Carlson Contracting’s net income before

taxes, calculated in accordance with ASPE, for 20 years, at which point the debt would be considered

completely repaid. The salary that could be included in the calculation of net income would be limited to

$100,000 per year.

Option #3: I could lease a building that is somewhat suitable for my needs. It is a little smaller than what I

want and is at the other end of town. However, I would not need to borrow. I would need to sign a

20-year lease at a fixed rate of $33,000 per year. The lease payments would be due at the beginning of

each month. I would have an option to buy it out at the end of the lease for $1. The building is already

old, so it would likely last only another five years or so after the lease period ends. The owner has a recent

appraisal that indicates the building has a value of $425,000.


EVALUATION GUIDE

PAPER II, SIMULATION 2 — CARLSON CONTRACTING











Competencies

V-2.2 – Develops or evaluates accounting policies in accordance with GAAP (A)

To: Manager

From: CA

Re: Carl Carlson accounting issues

I have taken a look at Carl’s financial statements and the notes he left me. From this preliminary

perspective, I have identified the following accounting areas that will likely require adjustments in order

to comply with ASPE.

Revenue

Carl currently records revenue on a cash basis. This is not in compliance with ASPE, which requires that

revenue be recorded on an accrual basis. ASPE criteria will need to be looked at to determine the

appropriate method of revenue recognition for house building, as well as for the other services he

provides.


Per Handbook Section 3400, Revenue:

.05 In a transaction involving the sale of goods, performance shall be regarded as having been

achieved when the following conditions have been fulfilled:

(a) the seller of the goods has transferred to the buyer the significant risks and rewards of

ownership, in that all significant acts have been completed and the seller retains no

continuing managerial involvement in, or effective control of, the goods transferred to a

degree usually associated with ownership; and

(b) reasonable assurance exists regarding the measurement of the consideration that will be

derived from the sale of goods, and the extent to which goods may be returned.

The transfer of significant risks and rewards of ownership only occurs at the transfer of the building title

to the buyer. The measurement of the consideration is known at the time of sale. However, given this is a

long-term contract, additional guidance needs to be considered.

.06 In the case of rendering of services and long-term contracts, performance shall be determined

using either the percentage of completion method or the completed contract method, whichever relates

the revenue to the work accomplished. Such performance shall be regarded as having been achieved

when reasonable assurance exists regarding the measurement of the consideration that will be derived

from rendering the service or performing the long-term contract.

Since Carl is in the business of building and selling homes, this would constitute performing a long-term

contract. Our options are the percentage of completion method or the completed contract method.

.17 The percentage of completion method is used when performance consists of the execution of more

than one act, and revenue would be recognized proportionately by reference to the performance of each

act. Revenue recognized under this method would be determined on a rational and consistent basis such

as on the basis of sales value, associated costs, extent of progress, or number of acts. For practical

purposes, when services are provided by an indeterminate number of acts over a specific period of time,

revenue would be recognized on a straight line basis over the period unless there is evidence that some

other method better reflects the pattern of performance. The amount of work accomplished would be

assessed by reference to measures of performance that are reasonably determinable and relate as directly

as possible to the activities critical to the completion of the contract. (Measures of performance include

output measures, such as units produced and project milestones, or input measures, such as labour hours

or machine use.) Amounts billed are not an appropriate basis of measurement unless they reflect the work

accomplished.

.18 The completed contract method would only be appropriate when performance consists of the

execution of a single act or when the enterprise cannot reasonably estimate the extent of progress toward

completion.

Given that Carl should be able to reasonably determine the extent of his progress towards completion of a

house, the most appropriate accounting policy would be the percentage of completion method. The

percentage completed of all houses or other projects in progress at year end would need to be estimated,

and an equivalent percentage of the sales price would need to be reported as revenue on the income

statement.


In the case of the 2013 financial statements, Carl has indicated that he has partially completed a house he

is selling for $300,000. He would have recorded $60,000 on this house, since he records revenue as he

receives the cash, and he would have received 20% of the selling price upfront (20% × $300,000 =

$60,000). However, the amount of revenue to record should be based on costs incurred as a percentage of

total costs. So we need to analyze how much of the building is actually complete. Typically, this

assessment is based on costs. We know that the cost of the house is estimated to be $225,000, and the cost

to build the foundation was $100,000. Therefore, the house is about 44% done in terms of costs. On that

basis, we should recognize 44%, or $133,333, in revenue for this house in progress at year end, so an

additional $73,333 will need to be recorded in revenue. However, if Carl can provide evidence that there

is a better way to measure the progress of the house, that driver should be taken into account to assess

percentage completed.

(Most candidates recognized that the percentage of completion method was the most appropriate

method to use to record the revenue from the building contracts, and they used the relevant case facts

to compute the necessary adjustment to revenue.)

Regarding the $100,000 in costs currently recorded as inventory, Handbook Section 1000, Financial

Statement Concepts, paragraph 45 states that “expenses are recognized in the income statement on the

basis of a direct association between the costs incurred and the earning of specific items of income. This

process, commonly referred to as the matching of costs with revenues, involves the simultaneous or

combined recognition of revenues and expenses that result directly and jointly from the same transactions

or other events.” Therefore, the $100,000 related to the foundation that is associated with the $133,333 in

recognized revenue should be removed from inventory and expensed.

(Only a few candidates were able to address both the revenue and cost issues as they related to the

revenue recognition and cost of sales of building houses for Carlson Contracting. Most candidates

focused their entire revenue recognition discussion on whether the better method was the percentage of

completion or completed contract method and omitted discussing the related costs.)

Land and Licence

Licence

The issue is how the licence should be classified on the balance sheet. Per Handbook Section 3064,

Goodwill and Intangible Assets, an intangible asset is an identifiable non-monetary asset without physical

substance. Section 3064 further clarifies that an intangible asset must be identifiable, the entity must have

control over the resource, and the intangible asset must provide future economic benefits.

Paragraph 12 states:

An asset meets the identifiability criterion in the definition of an intangible asset when it:

(a) is separable (i.e., is capable of being separated or divided from the entity and sold,

transferred, licensed, rented or exchanged, either individually or together with a related

contract, asset or liability); or

(b) arises from contractual or other legal rights, regardless of whether those rights are

transferable or separable from the entity or from other rights and obligations.


The licence meets the definition of “identifiable” because it is separable from Carlson Contracting, so

criterion (a) is met. It also arises from legal rights; thus, criterion (b) is met.

The criterion of control, as stated in paragraph 13, is met because Carl owns the licence and can keep or

sell it as he wishes. The criterion of future economic benefits is also met, since there is an expectation that

Carl will be able to sell the licence to a developer. Therefore, Carl should classify the $100,000 spent on

the licence as an intangible asset on the balance sheet.

The asset would be considered to have an indefinite estimated useful life, since “no legal, regulatory,

contractual, competitive, economic or other factors limit the useful life of an intangible asset to the

enterprise.” Therefore, no amortization would be taken on the asset. Instead, the asset should be tested for

impairment whenever events or changes in circumstances indicate that its carrying amount may exceed its

fair value.

(Only about a third of the candidates addressed this issue; however, most who did provided a thorough

discussion of the issue, appropriately tying case facts to the criteria from the Handbook and

concluding on the accounting for the licence in accordance with their analysis.)

Land

There is also a question of how the land should be classified. Land would typically be classified as

property, plant and equipment. Per Handbook Section 3061, Property, plant and equipment, paragraph 3:

Property, plant and equipment are identifiable tangible assets that meet all of the following criteria:

(iv) are held for use in the production or supply of goods and services, for rental to others, for

administrative purposes or for the development, construction, maintenance or repair of other

property, plant and equipment;

(v) have been acquired, constructed or developed with the intention of being used on a

continuing basis; and

(vi) are not intended for sale in the ordinary course of business.

However, the land purchased does not meet this definition. It is not being held for use (criterion (i)), nor is

it being acquired with the intention of being used on a continuing basis (criterion (ii)). Given the first two

criteria are not met, the asset cannot be considered property, plant and equipment.

The land could potentially be considered inventory. Per Handbook Section 3031, Inventories, paragraph

7:

Inventories are assets:

(i) held for sale in the ordinary course of business;

(ii) in the process of production for such sale; or

(iii) in the form of materials or supplies to be consumed in the production process or in the

rendering of services.


Whether the land is held for sale in the ordinary course of business is debatable. Since Carl is not in the

business of buying and selling land, the purchase of the land may not be considered the normal course of

operations. However, Carl is in the business of construction, and purchasing land could be considered an

ordinary transaction in the construction industry since others in the industry are likely buying and selling

land often. It is not known whether Carl has done this type of transaction before. Therefore, criterion (i)

may be met. The land could also be an asset in the process of production (criterion (ii)) if Carl intends to

build on the land and then sell the land and building. The land would not be an asset to be consumed in

the production process or in the rendering of services (criterion (iii)), but given that criterion (i) or (ii)

may be met, there is also some argument for classification of the land as inventory. As inventory, the land

would have to be carried at the lower of cost or net realizable value.

The other option is to account for the land as an investment. Handbook Section 3051, Investments, applies

to “measuring and disclosing certain other non-financial instrument investments (such as works of art

and other tangible assets held for investment purposes)”. Because the land is a tangible asset, if it is held

for investment purposes, it would be classified as an investment. Paragraph 17 states that “the cost

method shall be used in accounting for investments within the scope of this Section other than those for

which the investor is able to exercise significant influence over an investee”. In addition, paragraph 18

states that “these types of investments include certain other non-financial instrument investments such as

works of art and other tangible assets held for investment purposes.” Therefore, the land would be

recorded at cost.

Ultimately, whether the land is classified as inventory or investment depends on Carl’s intention for the

land. If he intends to build on the land and sell the building, then it would be inventory. If he intends to

hold onto the land as an investment, it would be accounted for as investment. As either inventory or

investment, the concept of asset held for sale under Handbook Section 3475, Disposal of Long-Lived

Assets and Discontinued Operations, does not apply.

(Only a few candidates addressed this issue, and most of those who did jumped to a conclusion, simply

stating that land should not be included in property, plant and equipment without analyzing any case

facts first. Many candidates provided a discussion of the “asset held for sale” concept, which did not

apply in these circumstances.)

Warranty Liability

A liability for the two-year warranty should be set up. Even though Carl is not legally obligated to

provide a warranty on his work, he has demonstrated that he does, in practice, provide such a warranty

through his past actions. Paragraph 30 of Handbook Section 1000, Financial Statement Concepts, states

that “liabilities do not have to be legally enforceable provided that they otherwise meet the definition of

liabilities; they can be based on equitable or constructive obligations. An equitable obligation is a duty

based on ethical or moral considerations. A constructive obligation is one that can be inferred from the

facts in a particular situation as opposed to a contractually based obligation.” Thus, the fact that Carl

informally offers this to all his clients supports a constructive obligation. This would require that a

liability be accrued for the estimated amount of this expenditure.


There are two ways to account for the warranty. The first is to record the full amount of the revenue

associated with the warranty, and to record the related warranty expense and warranty liability. As an

estimate, we could calculate the liability by taking 4% of 2013 revenue, since the costs of doing the

warranty work are about 4% of the sale price of the house. We know Carl’s revenue is $1,265,622 in

2013, and 4% of this equals $50,625, which should be recorded as a provision. Since Carl has spent

$21,333 during the year related to the warranty offered, this amount would offset the provision. Thus,

there is a net income impact of $29,292.

Alternatively, it can be argued that revenue recognition criteria have not been met because a portion of the

selling price is related to delivery of the warranty. The service has not been provided at the time of sale,

but instead is being provided over the two-year period. Thus, the revenue associated with the warranty

can be deferred and recognized evenly over the two-year period. The liability in this case would be

deferred revenue.

(About half of the candidates addressed this issue, and many of them were able to provide an in-depth

discussion, recognizing the particular nature of the warranty commitment made by Carlson

Contracting towards its clients. Most candidates who addressed this issue were able to use the

appropriate case facts to conclude on the accounting treatment. However, some failed to carry their

analysis forward and adjust net income accordingly.)

Contingent Liability

Carl has mentioned that one of his customers is threatening legal action against him. Carl does not believe

that he should have to pay anything, but we will need to assess whether there should be a contingent

liability recorded for an amount he may potentially need to pay. Per Handbook Section 3290,

Contingencies:

.02 Contingencies would include, but are not limited to, pending or threatened litigation, threat of

expropriation of assets, guarantees of the indebtedness of others and possible liabilities arising from

discounted bills of exchange or promissory notes.

.12 The amount of a contingent loss shall be accrued in the financial statements by a charge to income

when both of the following conditions are met:

(a) it is likely that a future event will confirm that an asset had been impaired or a liability incurred at

the date of the financial statements; and

(b) the amount of the loss can be reasonably estimated.


Although we do not have enough information to determine the outcome of this potential litigation, it may

be argued that if none of the other houses experienced a cracked foundation after an earthquake, the crack

could be due to a default in the work done by Carl. In addition, the lawyer has mentioned that, at a

minimum, Carl will have to fix the foundation. Thus, the first criterion is met and settlement is likely. In

addition, the loss can be reasonably estimated. Paragraph 13 states that “the estimation of the amount of a

contingent loss to be accrued in the financial statements may be based on information that provides a

range of the amount of loss. When a particular amount within such a range appears to be a better

estimate than any other, that amount would be accrued. However, when no amount within the range is

indicated as a better estimate than any other, the minimum amount in the range would be accrued.” There

is a range of amounts that Carl may need to pay, from the low end of $10,000 to fix the foundation, to the

full $100,000 asked for by the homeowner. Because no value is more likely than any other, the minimum

should be accrued. More work would be required to assess this, but a minimum of $10,000 will have to be

accrued and a contingent liability set up.

(Most candidates addressed this issue in sufficient depth, applying the relevant criteria from the

Handbook and concluding logically based on their analysis. However, some candidates provided a

conclusion using case facts without supporting their analysis with the relevant Handbook criteria.)

Capital Asset Issues

Miscellaneous Expenses

Carl has currently recorded $84,500 of miscellaneous expenses, which include a new truck ($45,000), a

new trailer ($27,000), and various small tools ($12,500). Per Section 3061, the definition of property,

plant and equipment has been met, since (i) these items are held for use in the production of goods

(buildings in this case); (ii) they have been acquired with the intention of being used on a continuing

basis; and (iii) they are not intended for sale in the ordinary course of business. These items provide

future economic benefit and thus should be capitalized and not expensed. The items will be subsequently

depreciated over their estimated useful lives.

(Most candidates did not address these issues from an accounting perspective, and as a result did not

refer to the guidance from the Handbook. They discussed these items from a tax perspective only,

recognizing that they could not be deducted for tax purposes. Only a few candidates provided a

reasonable discussion of the accounting guidelines and recommended an appropriate adjustment to net

income.)

Betterment

Carl indicated that he had replaced a motor on a piece of excavation equipment for $10,000, which will

now extend the life of the equipment by five years. Per Section 3061:

.14 The cost incurred to enhance the service potential of an item of property, plant and equipment is

a betterment. Service potential may be enhanced when there is an increase in the previously assessed

physical output or service capacity, associated operating costs are lowered, the life or useful life is

extended, or the quality of output is improved. The cost incurred in the maintenance of the service

potential of an item of property, plant and equipment is a repair, not a betterment. If a cost has the

attributes of both a repair and a betterment, the portion considered to be a betterment is included in the

cost of the asset.


Given the replacement of the motor has enhanced the service potential because it has extended the life of

the asset, this cost is a betterment and should be capitalized. The amount should be amortized on the same

basis as the related asset in the financial statements.

(Most candidates addressed this issue, appropriately referring to the Handbook criteria and analyzing

the relevant case facts to conclude on the necessary accounting adjustment. Most candidates also

adjusted net income accordingly.)

Amortization

Carl will need to establish a reasonable amortization policy for the capital assets of the business. Per

Section 3061:

.16 Amortization shall be recognized in a rational and systematic manner appropriate to the nature

of an item of property, plant and equipment with a limited life and its use by the enterprise. The amount of

amortization that shall be charged to income is the greater of:

(a) the cost less salvage value over the life of the asset; and

(b) the cost less residual value over the useful life of the asset.

More discussion with Carl will be needed here to establish a reasonable amortization policy. Given the

type of assets he has, realistic estimates will be available to use based on similar businesses.

Building

Carl mentioned that he needs a new building and will need to spend $450,000 for the land, materials, and

labour to build it. We must ensure that all costs are captured in the capitalization of this asset, including

the labour costs to build it if he is doing it himself. Per Section 3061:

.08 The cost of an item of property, plant and equipment includes direct construction or development

costs (such as materials and labour), and overhead costs directly attributable to the construction or

development activity.

We will have to ask Carl how much time his employees will spend on building this new asset, as well as

whether there are any overhead costs associated with its construction. In addition, the interest incurred on

the loan taken to build the building can be capitalized during the construction period.

Loan from Bank

If Carl decides to take on a loan with the bank to build the new building, then he will have to account for

that loan in the financial statements. Per Section 3856:

.05 (j) A financial liability is any liability that is a contractual obligation:

(i) to deliver cash or another financial asset to another party; or

(ii) to exchange financial instruments with another party under conditions that are potentially

unfavourable to the entity.


A loan meets the above criteria, since it is a contractual obligation to deliver cash to another party (the

bank). Per paragraph 7, the loan would first be recognized at fair value (present value of future payments).

Per paragraph 11, financial liabilities are subsequently measured at amortized cost. Carl would account

for the principal portion of the loan as a non-current liability on the balance sheet, with the exception of

the principal payments in the next 12 months, which would be classified as a current liability. At each

payment date, the portion related to the principal of the loan would be recorded against the loan, and the

remainder as interest expense.

Loan from Brother-in-Law

If Carl decides to take the loan from his brother-in-law, he will have to consider whether it is a liability or

equity. As with the bank loan, this loan meets the financial liability criteria because it is a contractual

obligation to deliver cash to another party. However, this loan differs from a bank loan in that there also

appear to be elements of equity. Section 1000 defines equity as “the ownership interest in the assets of a

profit-oriented enterprise after deducting its liabilities. While equity of a profit-oriented enterprise in

total is a residual, it includes specific categories of items (for example, types of share capital, contributed

surplus and retained earnings).” Therefore, it is important to consider whether Carl’s brother-in-law

would have a residual interest in Carlson Contracting. On the one hand, it can be argued that he would

have residual interest because he would take on the risks and rewards of the company’s profit or loss (if

the company loses money, the brother-in-law will not get his return on capital). However, the loan

payments would be an obligation the company could not avoid (if the company makes a profit, Carl must

pay his brother-in-law); Carl’s brother-in-law would have access to only 15% of the company’s net

income (not full residual interest); and payments to him would end after 20 years, once again limiting his

access to the residual interest of the company. Therefore, the loan would be more of a liability in

substance than equity.

Capital Lease

Carl may enter into a long-term lease for a new building. We will need to assess how to report this lease

and if it qualifies as a capital lease. If it does, Carl would need to record an asset under a capital lease with

an offsetting obligation. Per Handbook Section 3065, Leases:

.06 From the point of view of a lessee, a lease normally transfers substantially all of the benefits and

risks of ownership to the lessee when, at the inception of the lease, one or more of the following

conditions are present:

(a) There is reasonable assurance that the lessee will obtain ownership of the leased property by

the end of the lease term. Reasonable assurance that the lessee will obtain ownership of the

leased property is present when the terms of the lease result in ownership being transferred

to the lessee by the end of the lease term or when the lease provides for a bargain purchase

option.


(b) The lease term is of such a duration that the lessee will receive substantially all of the

economic benefits expected to be derived from the use of the leased property over its life

span. Although the lease term may not be equal to the economic life of the leased property in

terms of years, the lessee is normally expected to receive substantially all of the economic

benefits to be derived from the leased property when the lease term is equal to a major

portion (usually 75 percent or more) of the economic life of the leased property. This is due

to the fact that new equipment, reflecting later technology and in prime condition, may be

assumed to be more efficient than old equipment that has been subject to obsolescence and

wear.

(c) The lessor is assured of recovering the investment in the leased property and of earning a

return on the investment as a result of the lease agreement. This condition exists if the present

value, at the beginning of the lease term, of the minimum lease payments, excluding any

portion thereof relating to executory costs, is equal to substantially all (usually 90 percent or

more) of the fair value of the leased property, at the inception of the lease. In determining the

present value, the discount rate used by the lessee is the lower of the lessee’s rate for

incremental borrowing and the interest rate implicit in the lease, if known.

Carl has said he has the option to buy out the building at the end of the lease term for $1. This would be

considered a bargain purchase option. Therefore, criterion (a) is met.

Criterion (b) is met because Carl expects this building to last only five years past the term of the lease.

The lease term is for 20 years, or 80% of the remaining economic life, so it would appear that Carl is

getting substantially all of the economic benefit out of this property.

Finally, criterion (c) would also be met. Carl’s incremental rate of borrowing is 6%, and the rate implicit

in the lease is 4.81%. Using the lower of the two rates, the lessor would receive minimum lease payments

with a net present value of $425,000, which is 100% of the current fair value.

Since at least one of the three tests is met, this lease would qualify as a capital lease if Carl were to go

ahead with it. An asset under capital lease would need to be set up with an offsetting obligation under

capital lease.

(Only a few candidates addressed the above issues (building, loan from bank, loan from brother-in-

law, capital lease) because they only related to future events involving the new building (workshop)

that Carl was considering. Most of the candidates who did address these issues only briefly discussed

the rules for capital leases, generally providing a limited analysis of the criteria from the Handbook

and referring to some of the relevant facts of the simulation (in most cases, the fact that the lease

provided for a bargain purchase option).)


Summary of Adjustments

After the accounting adjustments discussed above, Carlson Contracting’s revised net income is as

follows:

Net income per income statement: $ 267,469

Construction in progress revenue 73,333

Construction in progress expense (100,000)

Net warranty provision (29,292)

Legal claim provision (10,000)

Expenses to be capitalized 94,500

Net income after accounting adjustments $ 296,010

(Most candidates adjusted Carlson Contracting’s net income for the items discussed in their

accounting analysis and used the adjusted net income in their tax analysis.)


Percent Awarded


15.1%

Reaching competence — The candidate discusses some of the accounting issues.

25.8%

Competent — The candidate discusses several of the accounting issues. 58.2% Highly competent — The candidate discusses most of the accounting issues. 0.7%

(Candidates were directed to this indicator when they were asked by the manager, “Can you look at the

financial statements and let me know what accounting issues need to be addressed for a review?”)

(Most candidates performed well on this indicator and were able to identify the relevant accounting

issues, provide a reasonable ASPE analysis, and conclude on the appropriate adjustments to make to

the financial statements. The most significant accounting issue related to revenue recognition. Weak

candidates either did not discuss the revenue recognition issue, did not realize the percentage of

completion method should be used in their revenue recognition discussion, or did not include

Handbook guidance in their discussion. Strong candidates tackled the revenue recognition issue and

were able to come to a reasonable conclusion. They also provided good coverage of the other issues

and supported their analysis with the appropriate ASPE guidance and relevant case facts.)


Primary Indicator #2 The candidate provides a reasonable quantitative and qualitative analysis of Carl’s tax situation. The candidate demonstrates competence in Taxation.

Competencies

IX-2.1 – Calculates income taxes payable for an individual in routine situations (A)

IX-2.3 – Calculates income taxes payable for a corporation in routine situations (A)

IX-3.1 – Identifies, analyzes, and advises on specific tax-planning opportunities for individuals (A)

To: Carl

From: CA

Re: Income taxes and shop financing options

You asked me to calculate what your federal tax bill will be for the current year. I have done so with the

information you have given me. Please see the calculations that follow. As you can see, some expenses

are not deductible, and other adjustments must be made for tax purposes.

Currently, you have a tax bill owing of $66,699.

I took it a step further, as you had requested, by comparing the above figure to what you would have paid

if you had been incorporated in the prior year and had taken a $100,000 salary. Under this scenario, you

would have had to pay $14,360 in personal taxes and $20,272 in corporate taxes. This total of $34,632 is

$32,067 less than what you currently owe.

In addition to the corporate taxes paid, it should be noted that any income left in the corporation would be

taxable if you took it out. The corporation can use it in the business as needed, but any amount taken out

or spent on personal expenditures would be taxable personally to you. However, given that your current

personal tax rate is higher than the corporate tax rate applicable to your company, leaving income in the

company will mean that you can defer a portion of the taxes you would have otherwise paid if you had

not been incorporated.


Personal and Corporate Tax Calculations

Sole

Proprietor Incorporated

Personal Personal Corporate Note

Net income after accounting adjustments

(see report to manager) $ 296,010 $ 100,000 $ 196,010

Tax adjustments:

50% of meals and entertainment 1,728 1,728 1

Non-deductible penalty 200 200 2

Warranty expense – provision 50,625 50,625 3

Warranty expense – actual (21,333) (21,333) 3

Donations 1,750 1,750 4

Cumulative eligible capital deduction (5,250) (5,250) 5

Capital cost allowance deduction (36,082) (36,082) 6

Net income for tax purposes 287,648 100,000 187,648

Deductions:

Canada Pension Plan (CPP) deduction (2,356) (2,356) 7

Donations (1,000) 4

Taxable income 285,292 100,000 184,292

Taxes:

Personal taxes

From To Rate

– 43,561 15% 6,534 6,534

43,562 87,123 22% 9,584 9,584

87,124 135,054 26% 12,462 3,348

135,055 and over 29% 43,569

Corporate taxes @ 11% 20,272 8

Taxes before credits 72,149 19,466 20,272

Credits: Full amount

Basic personal amount $ 11,038 9

Spouse or common-law partner amount 11,038 9

CPP contributions 2,356 7

Employment insurance premiums – 10

Amount for children born 1996 or later 4,468 11

Children’s arts amount 500 12

Children’s fitness amount 350 12

29,750


Credits @ 15% (4,463) (4,463)

Canada employment amount ($1,117) @

15% (168)

Donations and gifts

Federal political party

From To Rate Credit

– 400 75% $ 300

400 750 50% 175

475 (475) (475)

United Way

From To Rate Credit

– 200 40% $ 80

200 1,000 54% 432

512 (512) 4

$ 66,699 $

14,360 $ 20,272

(a) (b) (c)

Total personal, no incorporation (a) $ 66,699

Total corporate and personal if incorporated (b) + (c) 34,632

Cost of not incorporating $

32,067

Notes:

1. Meals and entertainment are only 50% deductible per 67.1(1) of the Income Tax Act.

2. Penalties paid to the Canada Revenue Agency are non-deductible under 18(1)(t).

3. Provisions for warranty cannot be deducted under 20(7); however, actual costs incurred can be

deducted.

4. Donations are added back and claimed as a tax credit for personal income taxes and as a deduction for

corporate income taxes.

For personal income taxes, since the donations are the first ones made by you and your wife, they are

eligible for the First Time Donor’s Super Credit, which is available to individuals who have not made

charitable donations in the last five years. This credit gives an extra 25% tax credit on donations up to

$1,000. The first $200 credit is at 40% (15% + 25%) and the remaining $800 credit is at 54% (29% +

25%).

For corporate income taxes, all donations can be considered a deduction against net income.

However, you should be aware that corporations are not able to donate to federal political parties.

Therefore, we assume that donation amount ($750) has been donated in your personal name and not

under the corporation.


5. The amount spent to purchase the licence allowing you to build up to 28 storeys on the land is

considered eligible capital property and thus is eligible for the cumulative eligible capital (CEC)

deduction, calculated as follows:

Cumulative Eligible Capital

Opening balance, CEC $ −

Eligible additions (75% of actual) 75,000

CEC for the year 75,000

CEC deduction (@ 7%) $ 5,250

6. No deduction is allowed for capital expenditures under 18(1)(b), but a deduction for capital cost

allowance (CCA) is allowed under 20(1)(a).

a) Since the truck is used solely for the transportation of goods, equipment, and passengers to earn

income, it would not be considered a passenger vehicle and would therefore be a Class 10 asset.

b) The trailer and motor for the excavation equipment are Class 10 assets.

c) The tools worth less than $500 each (totalling $5,000) are included as Class 12 assets. All other

tools are considered Class 8 assets.

d) The half-year rule applies to all net additions to Class 8 and 10 assets, but not to Class 12 tools.

Class

Opening

UCC

balance Additions

Half-

year

rule

Ending

UCC

balance

with half-

year rule Rate CCA

Ending

UCC

balance

8 $33,654 7,500 3,750 37,404 20% 7,481 $33,673

10 $37,669 82,000 41,000 78,669 30% 23,601 $96,068

12 $ − 5,000 − 5,000 100% 5,000 $ −

94,500 36,082

7. As a sole proprietor, you will be paying CPP contributions and are allowed both a deduction and a tax

credit under 118.7. Under the incorporation scenario, you will be responsible for the employee

portion of CPP and your corporation will be responsible for the employer portion. The amount to be

deducted is 4.95% of salaries over $3,500, to a maximum salary of $51,100.

8. A corporation owned by you would be considered a Canadian-controlled private corporation and

would be eligible for the small business rate. This is calculated as follows:

Federal tax rate 38%

Abatement (10%)

Small business deduction (17%)

Effective Canadian-controlled private corporation rate 11%


9. You are allowed your basic personal tax credit. Since your spouse has no income, you can claim her

amount as well under 118(1).

10. There is no credit for employment insurance because you would not have paid these premiums as a

self-employed individual. In addition, you are exempted from paying employment insurance under

the incorporation scenario because you would be a shareholder of the company. In either case, there is

no credit for employment insurance.

11. You can claim a child tax credit for each child younger than 18 years old under 118(1)(b.1).

12. You can claim a fitness tax credit for Josh’s swimming lessons under 118.03. You can also claim an

arts tax credit for Jessica’s piano lessons, but it is capped at $500 under 118.031.

(Most candidates were able to provide a reasonable calculation of Carl’s taxable income, appropriately

adjusting the income for tax purposes for most of the items discussed in the simulation, including

meals, penalties, CCA, and donations. Generally, candidates who adjusted the accounting income for

the warranty provision or the contingent liability also adjusted the net income for tax purposes,

recognizing that only the outlays in the taxation year with respect to these items were currently

deductible. As well, most candidates were able to provide a reasonable calculation of the corporate

income tax payable, taking into account the fact that Carlson Contracting, as a corporation, would be

entitled to the small business deduction. However, many candidates did not consider Carl’s needs (his

$100,000 salary) when comparing the two scenarios. As a result they did not deduct Carl’s

remuneration from the corporate income before comparing the results under both scenarios. When

they did, some candidates simply took the $100,000 out, forgetting to tax it at the personal rates. As

well, many candidates struggled with the impact of the personal credits on the calculation of Carl’s

income taxes payable, sometimes deducting the full amount of the personal credits from taxable

income or deducting the amounts of the credits without applying the 15% rate applicable to those

amounts.)

Aside from the tax advantages of incorporating, there are other items to consider:

Deferral — As discussed above, there is an opportunity to defer taxes to the extent money is left

inside the corporation. As the corporation earns income, the corporation will be subject to corporate

tax at a lower rate than the personal tax rate. This will allow you to pay taxes only on amounts you

take out and defer the rest until you need the cash.

Income splitting — As a corporation, you can pay dividends to your family members who own shares

in the corporation. This provides a way to split the income from the corporation amongst your family

members, who may be taxed at a lower rate. In addition, as discussed following this list, you can pay

reasonable salaries to family members for work they perform for the corporation.

Financial protection — Corporations provide a way to limit your liability to the net assets of the

company. If there are issues in the future that you may be liable for (for example, if a house you build

collapses), your liability would be limited to the assets you have in the company, while right now you

are personally financially liable for any legal claims.

Capital gains exemption — Because you are a shareholder of a corporation, any future sale of your

shares may be eligible for a capital gains exemption, which is not available as a sole proprietor.

Typically, when you sell a business, the difference between the selling price and what you initially

put into the business is considered a capital gain, and 50% of it is taxed at your marginal tax rate.

However, if you incorporate, your shares would most likely qualify as qualified small business

corporation shares, which would allow the capital gain (up to $750,000) to be exempt from taxes.


Cost — Additional costs are associated with incorporating (incorporation fees, lawyer fees, etc.), as

well as increased administrative requirements. For example, you would require separate bank

accounts and thus would incur additional bank fees. Having to submit two sets of tax returns

(personal and corporate) will also increase costs to you.

Complexity — Incorporating increases the complexity of your operations. There are additional

deadlines, remittance requirements, and such that you will need to track. The increased complexity

can cause additional burdens on your business, and it can often be frustrating to track compliance

requirements.

Salary versus dividends — Incorporating gives you the ability to pay a dividend from your

corporation, which could be used as a way to withdraw funds from the company instead of taking a

salary. At the current level of income you require ($100,000), the tax advantages of paying a dividend

over a salary are minimal; however, should your income requirements change in the future,

incorporating would allow you to issue a dividend if it is more advantageous to do so. As well,

income earned as dividends is not subject to CPP contributions, thereby saving on employer and

employee contributions.

(Most candidates discussed some of the qualitative factors to consider in Carl’s decision of whether to

incorporate. Candidates most frequently addressed the benefits of income tax deferral, the possibility of

splitting income with other family members, and the protection that the corporation offered to Carl

from creditors and potential lawsuits.)

As noted in the tax calculation, you would not be able to make a donation to a federal political party

under the corporation. Instead, to take advantage of the associated tax credit, you would need to make the

donation in your personal name.

Assuming you do not plan to take out all the money you earn from Carlson Contracting every year, I

suggest you incorporate your business due to the tax advantages and qualitative considerations. The cost

and complexity of incorporating are offset by the advantages I’ve discussed. However, if you do take out

all the money your company earns instead of the minimum you need of $100,000, the tax advantage

largely disappears.

(Most candidates provided a valid conclusion as to whether Carl should consider incorporating based

on their analysis.)

Regardless of whether you incorporate, a few options are available to you to reduce your tax bill:

You could pay your spouse a wage for the bookkeeping work. This would act to split your income.

Paying a wage would provide a deduction for the business and income for your spouse. Since your

spouse has no other income, we can use her low tax brackets and personal tax credits. You could still

accrue a bonus to her as at December 31, 2013, which would be income to her in 2014. You need to

pay this amount no later than six months after December 31, 2013.

You could pay your children a wage as well, as long as they do work for the business. The amounts

paid must be reasonable in relation to the work performed. Just like paying a wage to your spouse,

paying your children would provide a tax deduction for the business and at the same time take

advantage of their low tax brackets and available tax credits.

You still have time to contribute money to your registered retirement savings plan. You have more

than $75,000 in contribution room available. I would encourage you to maximize this to the extent

that you can, since it will reduce your income and therefore lower your income tax liability. You can

contribute to your RRSP in the first 60 days of 2014 and claim this contribution on your 2013 tax

return.


(Only a few candidates provided comments on the fact that Carl could reduce his overall tax liability by

either paying a salary to his wife or kids or contributing to his RRSP. Most candidates limited their

comments to a general discussion of income splitting as part of their discussion of the benefits of

incorporating the business.)

For Primary Indicator #2 (Taxation), the candidate must be ranked in one of the following five categories:

Percent Awarded


8.2%

Reaching competence — The candidate attempts a quantitative analysis of Carl’s tax situation.

58.0%

Competent — The candidate prepares a reasonable analysis of Carl’s tax situation.

33.1%

Highly competent — The candidate prepares a thorough quantitative and qualitative analysis of Carl’s tax situation.

0.6%

(Candidates were directed to this indicator when they were asked by the client to take a look at the

numbers, determine what size of federal tax bill Carl was facing, and tell him what his total 2013

federal tax bill would have been if he had been incorporated.)

(Candidates did not perform well on this indicator. Most attempted an analysis of Carl’s tax situation,

but struggled to compare his current situation to a scenario in which his business would have been

incorporated. Most candidates were able to calculate the corporate income taxes owing had Carl been

incorporated, but many forgot to consider the fact that he’d have to pay personal income taxes on the

$100,000 salary he would need to draw from the company to live on. By forgetting to do so, candidates

were not comparing the two scenarios on equal ground. Strong candidates provided a reasonable

computation of the business income, as part of the corporate scenario analysis, and taxed the $100,000

that was distributed to Carl, either as salary or a dividend. These candidates made the appropriate

adjustments in computing net income for tax purposes (for example, penalties, meals and

entertainment, CCA) and also adjusted the accounting income with the lawsuit/contingent liability.

Most of these candidates also understood that donations made by corporations are treated differently

than those made by individuals. In general, it was clear that strong candidates recognized the benefits

of tax deferral. Weak candidates provided a corporate calculation only or made significant errors in

computing the personal income taxes, such as deducting the personal credit amounts in computing

taxable income or applying the top marginal rate to compute the amount of taxes payable. Many

candidates did not take into account the different tax brackets when calculating the personal income

taxes.)


Primary Indicator #3 The candidate analyzes Carl’s options for the new building and advises him accordingly. The candidate demonstrates competence in Finance.

Competencies

VII-2.4 – Identifies and evaluates sources of funds (B)

VII-5 – Analyzes the purchase, expansion, or sale of a business (B)

You asked me to analyze and compare the options you have regarding the building you require so that

you can have your own shop.

Quantitative Considerations

In order to be able to compare the options, I have calculated the net present value of future cash flows for

each option based on the incremental borrowing rate available to you (6% from the bank).

Option #1

The payment each month on the 90% portion of the loan is $3,256, calculated as follows:

Present value $405,000

Number of periods (15 years × 12 months/year) 180

Interest rate (5.25% ÷ 12 months) 0.4375%

Payment per month (calculated based on above inputs) $ 3,256

The remaining 10% would be financed by you personally with monthly payments of $380, calculated as

follows:

Present value $ 45,000


Interest rate (6%÷ 12 months) 0.50%

Payment per month (calculated based on above inputs) $ 380

The combined monthly payments of $3,636 ($3,256 + $380) result in a net present value of $430,879 for

this option, calculated as follows:

Total loan $450,000


Payment per month $ 3,636

Present value of loan payments (discounted at 6% annually) $430,879


Option #2

Before calculating the effective interest rate of this option, we will need to determine the payments

required. The payments will be dependent on Carlson Contracting’s actual net income; therefore, it is

important to take the net income after accounting adjustments discussed in the report to the manager. We

also must take into account the salary you would need to pay yourself to cover your personal needs:

Net income after accounting adjustments (see report

to manager) $ 296,010

Salary (100,000)

Net income after salary

$

196,010

The agreement calls for payments equal to 15% of the net income before taxes on a yearly basis. This

amounts to $29,402 per year, assuming net income does not change. The net present value of the

payments under this option would be $337,233, calculated as follows:

Total loan $450,000

Number of periods 20

Payment per year $ 29,402

Present value of loan payments (discounted at 6%

annually) $337,233

Note that the adjustments to net income do not include amortization adjustments. This will further

decrease net income and thus the effective interest rate of this option.

Option #3

The net present value of the payments under this option is $385,766, calculated as follows:

Value of building and land $425,000


Payment per month ($33,000 ÷ 12; paid beginning of month) $ 2,750

Present value of lease payments (discounted at 6% annually,

payments at the beginning of the period) $385,766

(Most candidates struggled to provide a comparable analysis of the scenarios presented in the

simulation. Quite often, candidates would compare the net present value of the cash outflows under a

particular option (generally the loan from the bank) to the total undiscounted cash outflows under

another option, thereby reducing the usefulness of the calculation for Carl.)


Qualitative Considerations

Option #1

The debt to equity ratio must be no higher than 1:1. It would be important to meet this; your debt to

equity ratio after the loan (on a pre-tax basis) will be 0.68 (($80,562 [existing liabilities] + $450,000 [loan

amount]) ÷ $782,874 [equity] = 0.68). This figure will change once you consider your taxes payable and

accounting adjustments. Depending on whether you choose to incorporate, the tax effect on the ratio will

be different, since your taxes payable are less under the incorporation scenario and thus your debt to

equity ratio would be lower. In addition, the ratio would also be affected if you choose to incorporate,

since you may elect to not transfer certain assets or liabilities into the corporation or they may be

transferred at different amounts than cost. Since it appears that the building will be your biggest

expenditure in the next several years (and therefore you will be unlikely to take on more debt), this

restriction should not significantly affect you.

A general security agreement and personal guarantees are required. This could put not only your business

at risk, but your personal assets as well. You may want to consider putting personal assets in your

spouse’s name if you are able to, but the bank may be required to sign off on that. The covenant

restricting your remuneration as it stands right now is adequate because your withdrawal is limited to

$100,000, which you indicated would be enough for you and your family to live on. However, this does

not appear to increase on a yearly basis. After several years, considering inflation, this amount would no

longer be adequate, since it would have much less purchasing power, especially at the end of 15 years. At

a minimum, if you take this option, you need to negotiate a clause for inflationary increases.

Another consideration with this option, as well as with Option #2, is that you will need to find the time

for you and your employees to build the building yourself, which might result in lost sales or delayed

construction projects.

Option #2

Based on the annual cash costs of $29,402, this appears to be the least expensive option. This option also

results in the lowest cash outflow per month, which is an important consideration for cash management

purposes. However, there is a lot of uncertainty surrounding your loan payments. Because your business

is growing, it is likely that the loan payments will increase year over year. Therefore, the annual cash cost

may not be as low as it first appears. In addition, you should be careful about entering into business with

your brother-in-law. You may find it uncomfortable to share your personal financial situation with him,

which you will be required to do since he will want to be aware of the financial situation of your business.

In addition, although many business relationships work with family members, if there are disagreements,

you may find that they have a more profound impact than if your business partner is a friend or stranger.

If you choose this option, you should have a discussion with your brother-in-law to ensure that you have a

mutual understanding of his role in the business — you would not want to be in a situation where the two

of you disagree on whether he is able to influence the business decisions you make.


Option #3

Having a lease may be better for you for tax purposes, as opposed to the CCA deduction allowed on

buildings, since lease payments are $33,000 per year but CCA would be approximately $27,000 (6% of

$450,000 as a Class 1 other non-residential building). A lease is also less expensive than the first two

options, and the building will likely be worth less at the end of the lease compared to a new self-

constructed building. However, this option does not appear to fully meet your needs for a new building,

so you may end up with the same problems that you have now in terms of storage. As well, it is already

an older building, so you may end up with more issues than if you build something new yourself

according to your own standards.

(Most candidates offered a relevant qualitative discussion of the options, generally recognizing the

following items: the bank covenants, the fact that the brother-in-law loan facility might prove quite

costly if Carlson Contracting’s net income continues to grow, and the fact that the building available

under Option #3 (lease) does not meet all of Carl’s requirements, whereas under Option #1 and Option

#2 the building would be customized to Carl’s requirements.)

Recommendation

Each option has its pros and cons when compared to the others. From a business perspective, I

recommend you get the building that you need so you can run your business the way you want. This

likely excludes Option #3. The building is old, smaller than you would like, and not in a location you

desire. Option #2 seems too risky given your relationship with the lender and the potential increase in

your business’s income. Therefore, Option #1 will likely be your best option overall. It will provide you

with a new building built to your needs and specifications. You currently have $58,449 in cash. You

probably need this amount for operational purposes, but if you can draw on this amount to fund the 10%

not provided under Option #1, it will lower your cost of borrowing and reduce your future cash flows.

Keep in mind that you will also have to determine what time of year you can best afford for your

employees to work on this project since it will take them away from other projects.

(Most candidates who performed a comparison of the options also offered a conclusion that was logical

based on their analysis, weighing both the qualitative factors and the quantitative factors.)


Percent Awarded


15.2%

Reaching competence — The candidate attempts a quantitative and qualitative comparison of the options OR performs a reasonable quantitative comparison of the options.

54.8%

Competent — The candidate performs a reasonable quantitative and qualitative comparison of the options and makes a recommendation.

28.1%

Highly competent — The candidate performs a thorough quantitative and qualitative comparison of the options and makes a recommendation.

0.2%


(Candidates were directed to this indicator when asked by Carl to help him with a decision he had to

make. Candidates were provided with an exhibit describing three options Carl was considering: to

either finance a new building with a bank loan, finance a new building with a family loan, or lease an

existing building.)

(Candidates did not perform well on this indicator. Many struggled with an approach that would allow

them to analyze the options on a comparable basis. For example, some candidates calculated the cost

of one option by determining net present value, but then calculated the costs of the other options by

either adding the future cash flows, without calculating the net present value, or calculating an implicit

interest rate. Although some of these techniques could have been valid, using a different technique to

calculate the cost of each option did not allow candidates to compare the options.)

(Strong candidates took into account the time value of money for all three options. Strong candidates

also took their qualitative discussion further by using more case facts and discussing the implications

for Carl (e.g., personal guarantee, might lose some or all of his personal assets if the company does not

do well, etc.). Many weak candidates presented values that were not comparable, as discussed in the

previous paragraph. In addition, the qualitative discussions of most weak candidates either were

missing or simply repeated the case facts without discussing the impact on Carl.)






III-2.2 – Performs computations












(Overall, the Board was disappointed with the quality of the responses on this simulation. Most

candidates addressed each of the indicators; however, many candidates’ discussions did not contain a

reasonable depth of analysis. Candidates generally performed better on the Performance Measurement

and Reporting indicator, discussing most of the significant issues, but failed to demonstrate the same

level of competence on the Taxation and Finance indicators.)



RWD Inc. (RWD) was created in 2008 and provides premium website design services and support. It is a

private company owned equally by Richard Atkinson, Wally Campbell, and Diane Charlevoix. RWD’s

vision is “to create interesting, intuitive website designs that are clean and easy to use.” The company

translates its vision into the following mission statements:

1. Put customers first.

2. Provide creative and artistic design services.

3. Respond to customer requests within 24 hours.

4. Employ only the best in the field and use them to the best of their abilities.

5. Make RWD a great place to work and ensure our employees have a good work-life balance.

In November 2013, Richard discovered a new smartphone application (app) called EasyPark, designed for

big cities with a shortage of parking spaces. EasyPark connects people who own available parking spaces

(Owners) with drivers who need parking spaces (Drivers). Exhibit I gives additional details on EasyPark.

RWD is located in Montreal, a city with a major parking shortage. Even though RWD has never operated

a web-based app before, Richard was very excited about EasyPark and purchased it on behalf of RWD for

$7,500 in December 2013.

It is now September 10, 2014. You, CA, have been hired by RWD as a temporary controller. RWD’s

permanent controller, Veronica Black, will begin her maternity leave on October 1. Veronica gives you

some background information: “RWD purchased EasyPark with Richard’s approval, without the other

two shareholders being informed. They were upset because Richard did not consult them, and they are

concerned about how EasyPark is affecting RWD’s ability to meet its vision and mission statements.

“EasyPark was rolled out in January 2014 and was a huge hit. By February, our accounting and

information technology (IT) departments were swamped from dealing with EasyPark users. I don’t think

Richard expected it to take off the way it did. I made some notes about how it has affected my accounting

staff. I also met with Brian Weatherbee, our IT manager, to understand how EasyPark has affected his

staff. My notes are in Exhibit II.

“Richard really wants EasyPark to be a success. He is happy that EasyPark has generated significant

revenue in just eight months. He recognizes there are issues but believes they can be resolved. Brian just

presented his plan for how automation will address Richard’s concerns (Exhibit III).”

Veronica says she is already working on the accounting issues associated with EasyPark, but requests that

you provide her with a report to the shareholders on EasyPark’s contribution to RWD’s financial results.

She is also concerned about the number of problems related to EasyPark’s transactions. She wants an

assessment of the problems and an opinion on whether the proposed automations will address them, as

well as any additional controls that could be implemented.



EXHIBIT I

EASYPARK DESCRIPTION

Owners

Owners register with EasyPark by creating an account and then listing all parking spaces they would like

to offer. Owners enter details (address, availability schedule, price, etc.) about their parking spaces online,

and this information automatically updates RWD’s central database. Owners receive monthly payments

based on the actual usage of their parking spaces, as tracked by the central database, net of a 25%

administration fee retained by RWD.

Drivers

There are now a total of 65,000 Drivers using the app. A Driver must first buy the EasyPark app for $3

and install it on a smartphone, then create an account by providing his or her name and mailing address

through the app. Once an account has been successfully created, the Driver uses the app to search for

available spaces in a specific area. When the Driver selects a space, EasyPark indicates the hourly price.

If the location and rate are acceptable, the Driver uses the app to “check in” to the space, and the central

database is immediately updated. The maximum parking time is 24 hours, at which point the Driver has to

check in again to continue using the parking space. Drivers must “check out” of parking spaces through

the app when they leave. Once a Driver has checked out, EasyPark calculates the total charge for the

transaction and updates the central database. Drivers are mailed invoices for their monthly usage, based

on information from the database.

Because of the check-in and check-out process, parking space availability is always up to date in the

central database, although it relies on the honour system. If a Driver parks in a space but does not check in

to it, or leaves the vehicle in a space after checking out, the Driver risks being towed. However, the risk of

being towed is low because RWD does not monitor unauthorized parking.

RWD

At the end of each month, the accounting department obtains, from the IT department, a file downloaded

from the central database that details all of EasyPark’s users and the transactions for that month. The

accounting department organizes the data in a spreadsheet to determine the amounts due to Owners and

from Drivers.



EXHIBIT II

NOTES ON EASYPARK’S IMPACT ON ACCOUNTING AND IT DEPARTMENTS

Prepared by Veronica Black

Accounts Receivable

The accounts receivable clerk, Marcelle, is overwhelmed with extra work on top of her regular duties. At

each month-end, she spends approximately eight hours organizing the EasyPark file received from IT in

order to determine the total receivable per Driver. She then spends an additional ten hours manually

entering each receivable into the accounting system. Additionally, she has to process all credit card

transactions and cheques received from Drivers. Luckily, her niece was looking for a summer job, so

RWD hired her at $12 per hour for three months to help with the backlog of payments from Drivers.

Our aged accounts receivable listing has $138,000 over 90 days old. I’m becoming concerned about

collection. I believe up to 50% of this amount could be uncollectible. I’ve talked to Marcelle about it, but

she really has no time to follow up on these accounts. Part of the outstanding amount is likely a result of

manual errors made when information was entered into our accounting system, and we’ve also had

instances where Drivers used fictitious names and addresses in order to park for free.

Some Drivers have called us about their bills because they seemed high. After some investigation, we

determined that these Drivers forgot to check out of their parking spaces, so EasyPark had charged them

for 24 hours of parking.

Accounts Payable

Once she is done, Marcelle forwards the EasyPark spreadsheet to Ethel, the accounts payable clerk. The

spreadsheet is then re-organized to determine how much money is owed to Owners. Ethel manually enters

all the information into the accounting system and then issues cheques. She now cuts over 5,000

additional cheques per month. As a result, a full-time mail clerk had to be hired for six months, at a rate

similar to that paid to Marcelle’s niece.

The issue of Drivers not checking out has also caused problems with accounts payable because we only

found out about the check-out issue after we paid Owners for a full 24 hours. We’ve been trying to get the

money back from the various Owners and so far have been able to get almost $26,000 back; however,

there is still $17,000 outstanding.

Accounting Department

The entire accounting department has been suffering since EasyPark was rolled out in January. Everyone

has had to chip in and neglect, to some degree, their regular duties due to the massive amount of work that

EasyPark has created.

We’ve been fielding calls from Owners and Drivers looking for more detail on their statements. They are

unsure if they are being paid or charged the correct amounts because the invoices don’t provide

transaction details for the month. Right now, because the number of inquiries is so high, it takes us at

least two weeks to respond to them, and we often end up making adjustments because the invoices are

wrong.




NOTES ON EASYPARK’S IMPACT ON ACCOUNTING AND IT DEPARTMENTS

Prepared by Veronica Black

I also just found out that there is a significant discrepancy between what the IT department is reporting as

the total amount of transactions processed and what our accounting system is reporting. IT has a file

downloaded from the EasyPark central database indicating that just over $2 million in parking charges to

Drivers have occurred since EasyPark started. The accounting system shows only $1.85 million.

IT Department

The IT department is spending a lot of time dealing with increased maintenance and support related to

EasyPark. They are getting many calls from Drivers who seem to have problems installing the app or

establishing a connection with the EasyPark database. It’s taking most of two programmers’ time to

maintain the central database. Considering each programmer is paid over $80,000 per year, this is not a

good use of their time.

In fact, RWD turned away three new website design customers since March because our staff was too

busy dealing with EasyPark. These contracts would have brought in a total of $250,000 in profit.

The accounting department asked the IT department for reports that could summarize the transactions by

individual Drivers and Owners, to decrease time spent calculating receivables and payables. However, the

IT department has been too busy dealing with user support and database maintenance to design new

reports.

EasyPark has crashed twice since it was rolled out, and weeks of data had to be recreated from backups,

which took up a lot of our programmers’ time. Unfortunately, some data could not be recreated because

the employee in charge of running the nightly backup went on vacation and the backups weren’t done for

a few days.

EasyPark has been taking up way too much time. Our regular website design clients have been neglected

because it is taking us much longer to complete projects and respond to requests.

Overtime

I just received the overtime schedule from the Human Resources department (Exhibit IV) and was quite

surprised to see how high it was. Normally our staff works very minimal overtime. It’s not surprising that

they are feeling so stressed.



EXHIBIT III

IT DEPARTMENT’S PLAN TO FURTHER AUTOMATE EASYPARK

Brian proposes implementing all of the following automations:

1. Each Driver will be required to enter a valid credit card number when setting up an account in order to

verify his or her identity.

2. Users will be able to view the details of their accounts on their smartphones. Owners and Drivers will

view all parking transactions that have occurred, as well as the net balances of their accounts.

3. The EasyPark central database will automatically update accounts receivable and accounts payable

records.



EXHIBIT IV

OVERTIME SCHEDULE

FOR THE EIGHT-MONTH PERIOD ENDED

AUGUST 31, 2014

RWD’s policy is that for any overtime above 200 hours a year, staff-level employees are paid at 1.5 times

their regular hourly rate and management-level employees are paid at their regular hourly rate.

Rate for

regular hours

Number of overtime hours above 200

Accounting department IT department

Staff $17 1,900 2,150

Managers $35 450 575


EVALUATION GUIDE

PAPER II, SIMULATION 3 — EASYPARK










To: Veronica Black

From: CA

Subject: EasyPark analysis and impact on RWD

Primary Indicator #1 The candidate assesses EasyPark’s contribution to RWD’s financial results. The candidate demonstrates competence in Management Decision-Making.

Competencies

VIII-2.4 – Evaluates sourcing decision factors (A)

Financial Contribution

The shareholders are interested in the contribution that EasyPark has made to RWD’s financial results.

Even though EasyPark has generated significant revenue, as Richard has indicated, he also needs to factor

in the three lost contracts that RWD could have had, the possible uncollectible debt, and the additional

expenses related to EasyPark in order to determine EasyPark’s financial contribution. EasyPark has put a

strain on both the accounting and IT departments, which has resulted in a significant amount of overtime

that must be paid out. It has been necessary to hire Marcelle’s niece to help process payments and a mail

clerk to mail cheques. All of these costs must be taken into account.

Also, the EasyPark app was purchased for $7,500, and that cost needs to be considered as well.


EasyPark’s Contribution to RWD’s Financial Results

One-time Ongoing Note

Incremental revenue

Sale of the app $ 195,000 $ 1

Administration fee 500,000 2

Less: Opportunity cost of lost contracts (250,000) 3

Less: Doubtful accounts (69,000) 4

195,000 181,000

Incremental costs

Cost of EasyPark app 7,500 5

Salary – Marcelle’s niece 5,760 6

Salary – Mail clerk 11,520 7

Overtime – staff 103,275 8

Overtime – managers 35,875 8

Uncollected overpayments 17,000 9

7,500 173,430

Net financial contribution to RWD

$

187,500

$

7,570

Notes:

1. RWD sold the app to 65,000 Drivers for $3 each. Although there will be ongoing revenue from the

sales of the app, it will likely not be as high as when the app was first rolled out, since the number of

new users will have been at its highest when it was first introduced.

2. RWD processed $2 million in parking transactions and takes a 25% administration charge. This

assumes that the IT file downloaded from EasyPark is correct, rather than the amount shown in the

accounting system.

3. The IT manager stated that RWD lost three new contracts.

4. There is $138,000 in accounts receivable over 90 days old, and it is estimated that 50% will not be

collectible. Assuming these are due to customers with fictitious names or addresses, they should not

have been included in revenue in the first place.

5. The cost of the EasyPark app was $7,500.

6. Marcelle’s niece is paid $12 per hour (× 40 hours per week × 4 weeks × 3 months).

7. A mail clerk was hired; assume he is paid $12 per hour (× 40 hours per week × 4 weeks × 6 months).

8. RWD’s policy is that hours worked above 200 will be paid out. Since the overtime was incurred this

year as a result of EasyPark, it should be considered an incremental cost.


Staff

Accounting 1,900 $25.50 $48,450 [hourly rate $17 × 1.5]

IT 2,150 $25.50 $54,825 [hourly rate $17 × 1.5]

$103,275

Managers

Accounting 450 $35.00 $15,750

IT 575 $35.00 $20,125

$35,875

9. Veronica stated that $17,000 in overpayments had been made to Owners and had yet to be collected.

These are assumed to be uncollectible, as discussed previously.

In conclusion, once the incremental revenue and expenses are considered, EasyPark appears to have

contributed an extra $187,500 to RWD on a one-time basis and $7,570 on an ongoing basis so far in

2014. This amount is positive, which supports Richard’s view that the app is successful. However,

additional uncertain costs need to be considered.

(Candidates performed very well on the quantitative analysis, incorporating several valid adjustments

in their calculation of EasyPark’s contribution to RWD’s financial results. Candidates generally did a

good job of considering both the incremental revenues and the incremental expenses. They were able

to integrate case facts well when determining revenue from the sale of EasyPark, as well as the

ongoing administration fee. Most candidates were able to provide a valid adjustment for the majority of

the incremental expenses. However, some candidates struggled to compute the incremental costs

related to Marcelle’s niece, the mail clerk, and the overtime amounts, missing or misinterpreting one

or more case facts. For example, many of these candidates either forgot to take the different wage rates

into account or mixed them up. In addition, some candidates failed to recognize the opportunity cost of

$250,000 related to the lost profit on contracts the programmers could have worked on. Others

recognized the $250,000 opportunity cost but also included the programmers’ full wages in the

calculation, which was inconsistent.)

Additional Uncertain Costs

I have assumed that the total number of transactions processed is equal to the report that IT downloaded

from the EasyPark central database. If it turns out that the accounting report is the correct amount, then

revenue would decrease by $37,500 (($2 million − $1.85 million) × 25%). More work should be done to

determine the reasons for the difference.

Also, the costs associated with Brian’s automation plan have not been incorporated. IT implementations

can be costly and might result in a decrease in EasyPark’s financial contribution.

Veronica has stated that a significant number of receivables related to EasyPark are over 90 days old. She

also guessed that as much as 50% may not be collectible. For the time being, I have included the

estimated 50% as a reduction in revenue, but if these accounts aren’t followed up soon and dealt with, this

may get even higher.


Veronica also mentioned that there could be manual entry errors as well as customers with fictitious

names and addresses. This could lead to further collectability issues. At this stage, there is no way to

estimate the total amount of revenue that cannot be collected. All amounts that are outstanding need to be

reviewed to determine if they relate to actual customers, if the amounts have been entered correctly, and if

RWD will be able to collect the amounts. These amounts could further affect the financial impact that

EasyPark has had on RWD.

In addition, there is currently $17,000 in outstanding overpayments to be collected from Owners. It is not

known whether this amount is outstanding because there has been no time to follow up with the Owners

or because the Owners refuse to return the money. For now, I have assumed they are uncollectible.

However, more time spent on collecting these amounts may reduce the total outstanding. In addition, if

Owners continue to use EasyPark, there is a possibility of collecting these amounts by offsetting the

balances owing against future transactions.

Employees have worked a significant amount of overtime as a result of EasyPark. There may be

decreased employee morale leading to increased turnover, which would result in additional hiring and

training costs for RWD.

I have not included the cost related to the programmers’ time to run reports or fix crashes. These

programmers are on salary, so these costs would have been incurred regardless of whether the EasyPark

app had been rolled out. However, the programmers could have been working on other projects that could

have brought in additional revenue on top of the $250,000 of profit already lost, and the effects of that

need to be considered as well. However, it has not been included because it is not currently known.

Other Elements to Consider

RWD’s main business is premium website design services and support, and RWD has never operated a

web-based app before. Therefore, RWD’s employees may not possess the appropriate experience and

knowledge required to operate a web-based app. This is evidenced by the numerous problems the

acquisition has created. RWD may, therefore, need to hire additional staff with the appropriate experience

in this field, resulting in the need for a larger office space and increased fixed costs. Even though

EasyPark’s financial contribution to RWD is positive, the degree of success may be greater or less than

other RWD products. The shareholders need to look at the overall mix of RWD’s products and services in

order to assess whether the EasyPark app should be continued.

On the other hand, the acquisition of web-based apps has the potential to create new opportunities for

RWD to expand its services and thus access a new client base and additional revenue streams. EasyPark

in particular presents significant opportunities for RWD in cities with major parking shortages, such as

Montreal, as evidenced by how successful it has been thus far. If RWD can resolve the numerous

problems created by the hasty acquisition and integration of EasyPark and ensure that it is able to fit with

RWD’s vision and strategy going forward, EasyPark can contribute positively to the overall success of the

company.


The shareholders of RWD could consider entering into the app industry. If they determine this is a viable

opportunity, they could restructure operations in order to segregate the app services from their core web

design services in order to preserve the image of RWD’s premium website design services and support,

while taking full advantage of new business opportunities.

In addition, RWD needs to consider whether it is over capacity. For example, there may be a need to hire

additional support and maintenance staff so that the programmers can return to their day-to-day tasks.

However, this additional cost may be offset by no longer having to pay overtime for current staff.

(Only about one-third of candidates were able to provide a relevant qualitative analysis to support their

quantitative discussion. Many candidates provided an analysis of how the rollout of EasyPark was not

in line with the current mission statements as their qualitative analysis for this indicator, which was

rewarded under Primary Indicator #3. These candidates recognized the governance issues that

EasyPark had created. However, they did not supplement their quantitative analysis, which could have

been done, for example, by providing a discussion of potential threats and opportunities, such as the

ability to expand their current services and enter into the rapidly growing app space. Weak candidates

also tended to simply discuss the assumptions they made in their quantitative analysis.)


Percent Awarded


8.8%

Reaching competence — The candidate attempts a quantitative analysis of EasyPark’s contribution to RWD’s financial results.

18.2%

Competent — The candidate provides a reasonable quantitative analysis of EasyPark’s contribution to RWD’s financial results.

69.3%

Highly competent — The candidate provides a thorough quantitative and qualitative analysis of EasyPark’s contribution to RWD’s financial results.

1.9%

(Candidates were specifically asked by the controller to provide her with a report to the shareholders of

RWD Inc. (RWD) on EasyPark’s contribution to RWD’s financial results.)

(Most candidates did very well on this indicator. Almost all candidates attempted to compute

EasyPark’s contribution to RWD’s financial results, and did a good job of incorporating both the

relevant sources of incremental income and the costs directly attributable to EasyPark. Strong

candidates went beyond calculating the financial results and supplemented their quantitative analysis

with qualitative comments. Weak candidates either did not attempt to incorporate a sufficient number

of items or had errors in their calculations of specific items, and they failed to provide any qualitative

considerations.)


Primary Indicator #2 The candidate discusses the internal control weaknesses related to EasyPark and whether the proposed automations are going to address them, and recommends additional controls that could be implemented. The candidate demonstrates competence in Assurance (IT).

Competencies


VI-3.4 – Evaluates IT-related elements of internal control (B)

After reading through the notes regarding the accounting and IT departments, I noted a number of control

weaknesses.

Manual Processes

Control weakness: There are many manual processes relating to the accounting of EasyPark, including

the manual manipulation of data for accounts receivable and payable balances, as well as the manual

issuance of cheques.

Implication: EasyPark is an operation with a high volume of transactions. Manual processes are more

prone to error in general, but this effect is amplified when there are many transactions. There is already

evidence of errors, since entry errors are being made when the accounts receivable clerk enters the

information on accounts receivable into the accounting system. This has resulted in non-payment and

collectability issues. It also means that RWD’s revenue is incorrectly stated, and it could be either over-

or understated. Although there are no indications of errors to date on accounts payable or cheque runs, it

is likely that errors are being made due to employees being overworked and lacking time.

Will the automation plan address this weakness? Partially. The IT department is proposing that the

EasyPark system will automatically update the accounting records. This will fix the control weakness

related to manual entries of accounts receivable and payable, since the accounts receivable and payable

clerks will no longer have to manually enter the EasyPark receivables and payables into the accounting

system. However, it does not address the manual issuance of cheques.

Additional controls that could be implemented: Other manual processes could be automated to

increase efficiency and reduce risk. For example, we may want to consider setting up electronic fund

transfers to the Owners. This will reduce the manual labour involved in preparing and sending cheques, as

well as reduce risk of errors, such as a cheque being mailed to the wrong individual.

(Most candidates recognized that EasyPark’s use of many manual processes related to its accounting

was an issue, and they were able to recognize that the proposed automation plan would partially

address the issue. A few of these candidates also attempted to provide additional controls to remediate

the weaknesses.)


Driver Identity

Control weakness: There is no verification of a Driver’s identity before the Driver is allowed to check in

and park in a spot.

Implication: Drivers can enter fictitious names and addresses into the EasyPark system and then park for

free. Net income is overstated because there is no way to collect the money from these Drivers.

Will the automation plan address this weakness? Yes. The IT department is proposing that EasyPark

require a Driver to enter a valid credit card when setting up his or her account to verify the Driver’s

identity. This control will ensure that the Driver is a real person. However, this also increases risk since

there will be additional information security concerns to consider. This can be mitigated by ensuring we

have appropriate controls surrounding the collection and storing of personal and financial information.

Additional controls that could be implemented: The above control can be improved if EasyPark also

checks to ensure that a Driver has sufficient room on his or her card for the parking charge when the

Driver checks in to a parking space. In addition, the Driver’s credit card can be charged immediately after

check-out. This would not only help with verifying the Driver’s identity, but also reduce the amount of

work required after the fact (the issuance of invoices and the manual manipulation of data to determine

the invoice amount), which would free up the accounting department’s time and reduce the risk of error.

It would also reduce the time required to follow up on receivables and reduce the amount of bad debt.

(Most candidates identified the fact that the lack of driver identity verification was an issue and were

also able to recognize that the proposed automation plan would resolve this issue. About half of these

candidates also successfully provided an adequate additional control to remediate the weakness.)

Backups

Control weakness: EasyPark was not backed up regularly by IT.

Implication: Some revenue transactions were lost because IT could not recreate all the transactions that

had occurred on those days on which backups were not taken due to employee vacation. There was no

way to determine which Drivers should have been charged and which Owners were owed money by

RWD on those days, resulting in lost revenue.

Will the automation plan address this weakness? None of the automations proposed by the IT

department will address this issue.

Additional controls that could be implemented: IT must ensure that backups are done at least nightly,

perhaps even hourly due to the volume of transactions. Backups should not be a manual process. Instead,

they should occur automatically to prevent events such as employee absence from affecting the backup

process. Also note that implementing the charging of credit cards immediately after check-out would

provide another source of information to recreate data in the system in the event of a backup failure. In

addition, copies of the backup should be kept off-site.

(Many candidates recognized that the lack of regular back-ups was an issue. Most of these candidates

were able to propose a valid control that would resolve the issue, recognizing that the proposed

automation plan would not resolve it.)


Check-Out Process

Control weakness: Drivers can forget to check out of a space and be charged for parking for 24 hours.

Implication: This results in overstated revenue because the Driver did not actually park in the space for

the full 24 hours. This also results in overpayment of Owners, and it makes it difficult for RWD to get the

money back once Owners have already been paid.



Additional controls that could be implemented: The IT department should consider adding a control

whereby the Driver is prompted after a certain amount of time to check out of the space. If the Driver

does forget to check out, then perhaps there should be a way for the Driver to go back and specify what

time they actually left the parking space. Alternatively, RWD can consider implementing an electronic

chip system that requires any Driver who signs up for EasyPark to have a chip placed in their car. In

addition, Owners who register would need to have a sensor installed at their parking spot, which will

allow for automatic check-in and check-out of the car, thus avoiding the reliance on the Driver to

remember to do so. This would also prevent Drivers from not checking in even if they have occupied a

spot, or from continuing to park in a space even though they may have checked out in the system. It

would also help solve the Driver identity issue identified earlier, since the chip would be linked to an

individual who would have had his or her identity verified when the chip was issued.

At a minimum, the user acceptance agreement, to which a driver would have agreed when downloading

the app (EasyPark should have one if it is not already in place), should explicitly state that if a Driver

forgets to check out of a parking space, the Driver is charged for 24 hours of parking. This will ensure

Drivers are aware of the policy and thus will reduce disputes.

(Many candidates recognized that the existing check-out process was flawed. Most of these candidates

were able to propose a valid control to resolve the issue, recognizing that the proposed automation plan

would not resolve it. Some candidates erroneously discussed the implication from the driver’s

perspective rather than from EasyPark’s perspective.)

Accounting System and IT File Reconciliation

Control weakness: There is no check to make sure that the accounting system and the EasyPark database

agree.

Implication: Revenue, accounts receivable, and accounts payable could be either over- or understated.

Will the automation plan address this weakness? Partially. The IT department is proposing that the

EasyPark database automatically update accounts receivable and accounts payable records. This will help

to address issues that have occurred due to manual errors. However, this will not address the entire issue.

Even after automation, it is possible that other data could be entered into the accounting system that do

not agree with the EasyPark system.


Additional controls that could be implemented: I recommend that, on a monthly basis, the accounts

receivable and accounts payable clerks reconcile their accounting records to the EasyPark database.

Specifically, the accounts receivable clerk should compare monthly revenue to the total monthly

transactions from the EasyPark database. Revenue generated from the sale of the app should agree, and

revenue generated from parking transactions should be 25% of the transactions reported by the EasyPark

database. The accounts receivable clerk should also reconcile the credit card and cheque payments

received to what the accounts receivable system is showing as received on a monthly basis. Any

discrepancies should be investigated and resolved in a timely manner.

The accounts payable clerk should reconcile payments issued to the total transactions the EasyPark

database is reporting on a monthly basis.

(Approximately one-third of candidates were able to identify the fact that the accounting system and

the EasyPark database did not agree. However, only about half of these candidates recognized that the

proposed automation plan would only partially resolve this issue. Very few candidates were able to

provide additional controls to remediate this weakness.)

Transaction Details

Control weakness: Drivers are not provided with transaction details on their invoices.

Implication: Providing details on invoices is a good detective control, since Drivers will be able to see

how their balance owing is built and can easily identify any transactions in dispute if they do not agree

with the balance owing. Without the details, it is likely that revenue is over- or understated because

Drivers do not have the information required to review their balances.

Will the automation plan address this weakness? Yes. The IT department proposes pushing details of

accounts onto users’ smartphones. This will allow users to dispute transactions in a timely manner in

order to address any errors. It will reduce the amount of time spent with each Driver who has a dispute,

since the transactions in question can be easily identified. However, this is likely a better control for

identifying overcharges, since Drivers will be less likely to dispute a balance if they have been

undercharged.

Additional controls that could be implemented: RWD could implement a system whereby Drivers are

emailed electronic statements with transaction details at a frequency specified by the Driver. This will

create an additional layer of control because all Drivers will be provided with details of their transactions,

not just the ones who may be worried about errors.

(Most candidates identified the fact that there was an issue with drivers not being provided with

transaction details on their invoice, and most of these candidates recognized that the proposed

automation plan would resolve the issue. However, very few of these candidates were able to provide

valid additional controls to remediate the weakness.)


Accounts Receivable

Control weakness: Accounts receivable are not being reviewed and followed up on a regular basis.

Implication: Without regular review and follow-up of outstanding balances, revenue may be lost because

Drivers may not pay, knowing that RWD will not be asking for the funds. In addition, RWD will not be

able to gain a good understanding of the reasons for bad debts and thus will be unable to come up with

solutions to address the problems, ultimately leading to lost revenue.



Additional controls that could be implemented: The accounts receivable clerk should ensure that she

follows up on outstanding accounts receivable balances on a regular basis (perhaps weekly). If she does

not have the time to do it, another employee should be assigned the task. Again, if the charging of credit

cards is implemented, it will reduce the need to follow up on outstanding amounts, since accounts

receivable balances should be minimal.

(Very few candidates recognized that the lack of review and follow-up of accounts receivable balances

was an issue. However, most of the candidates who did were able to propose a valid control to resolve

the issue, recognizing that the proposed automation plan did not address it.)

Parking Space Monitoring

Control weakness: There is no monitoring of parking spaces throughout the city.

Implication: Without regular monitoring, Drivers can take advantage of the system by simply parking at

available spots without checking in or checking out. Drivers are more likely to do this if they know there

is no monitoring in place, leading to lost revenue.



Additional controls that could be implemented: At a minimum, RWD should hire an individual to

drive around the city daily and ensure that cars that are parked in EasyPark registered spaces have

checked in according to the EasyPark central database. The electronic chip system discussed earlier

would also be able to address this issue.

(Many candidates recognized that the fact that parking spaces throughout the city weren’t monitored

was an issue. Most of these candidates were able to propose a valid control to resolve the issue,

recognizing that the proposed automation plan did not address it.)


For Primary Indicator #2 (Assurance (IT)), the candidate must be ranked in one of the following five categories:

Percent Awarded


6.6%

Reaching competence — The candidate discusses some of the control weaknesses AND explains whether the proposed automations will address them or recommends some additional controls where necessary.

23.9%

Competent — The candidate discusses several of the control weaknesses, explains whether the proposed automations will address them, and recommends some additional controls where necessary.

66.8%

Highly competent — The candidate discusses many of the control weaknesses, explains whether the proposed automations will address them, and recommends many additional controls where necessary.

2.5%

(Candidates were asked by the controller to provide an assessment of the problems related to

EasyPark’s transactions and an opinion on whether the automations proposed by Brian would address

them, as well as any additional controls that could be implemented.)

(While most candidates did well on this indicator, some seemed to struggle to specifically discuss the

implication of the problems from RWD’s perspective, focusing instead on how they affected the

customers. Although most candidates were able to recognize that the proposed automations would

potentially resolve some of the problems and recommended additional controls where necessary, weak

candidates had a more difficult time providing valid explanations as to why these controls were

necessary and the implication of the lack of control for RWD. Moreover, some controls recommended

by candidates were not valid or practical. Strong candidates provided a clear discussion of how the

proposed automation plan would resolve some of the issues, and they also provided specific and

practical controls and explained why these were important for RWD’s operations.)

Primary Indicator #3 The candidate discusses the fact that the rollout was not in line with RWD’s mission statements. The candidate demonstrates competence in Governance, Strategy, and Risk Management.

Competencies

IV-2.2 – Gains an understanding of the entity’s mission, vision, and strategies (B)

IV-2.4 – Identifies key elements of the entity’s value system (B)

Although EasyPark is profitable for RWD, as calculated at the beginning of this report, I am concerned

about the negative impact this project might have had on RWD’s objectives.


Analysis of RWD’s Vision and Mission

It appears that EasyPark was rolled out very quickly, with little thought to determine whether it was in

line with RWD’s vision. RWD’s vision is “to create interesting, intuitive website designs that are clean

and easy to use.” EasyPark does not meet the spirit of this vision, since the company is not creating

websites as a result of this purchase.

EasyPark is also not consistent with RWD’s mission statements. The following table shows the negative

impact of EasyPark with respect to each one:

RWD Mission Statement EasyPark Impact

1. Put customers first. Veronica has indicated that it is taking much longer to complete

projects for RWD’s regular clients. Several clients had to be turned

away due to lack of time to devote to their projects.

2. Provide creative and

artistic design services.

RWD is in the business of designing websites. Running an app such

as EasyPark is a completely different line of business from website

design.

3. Respond to customer

requests within 24 hours.

Veronica stated that it was taking at least two weeks to respond to

EasyPark’s users when they requested more detail on their

statements. In addition, website design clients have been neglected,

and it is taking RWD longer to respond to their requests. This is not

consistent with RWD’s commitment to respond within 24 hours.

4. Employ only the best in the

field and use them to the

best of their abilities.

This is not being met at this time in the IT department because two

programmers are spending most of their time maintaining the

database instead of programming, which is their expertise. In

addition, Marcelle’s niece was hired to help out the accounting

department and is arguably not the best person RWD could have

hired in the field.

5. Make RWD a great place

to work and ensure our

employees have a good

work-life balance.

It is unlikely any employees in the accounting or IT departments

have any work-life balance right now, since overtime in these

departments has significantly increased since last year. Also,

Veronica states, “It’s not surprising that our staff members are

feeling so stressed.” These are both major indicators that this RWD

mission is not being achieved.

It does seem, however, that if the EasyPark automation can be done, most of these problems will be

resolved. Perhaps it would have made better business sense to have done the automation before rolling

out EasyPark to the residents of Montreal. I suggest that if the three shareholders are in agreement to

continue with EasyPark, the automation should occur as soon as possible.

Fortunately in this case, it turns out that the EasyPark app is actually making money for RWD. However,

I recommend that the shareholders spend some time determining what RWD’s strategy for the future

should be. They need to determine if they are going to take on any more apps or perhaps expand EasyPark

into other large cities. This is something for the shareholders to decide. After that, any new projects

should be analyzed to determine if they fit in with RWD’s vision and strategy. If a project does not, then

perhaps the project is not a good fit for RWD, or perhaps RWD’s vision needs amending.


(Candidates generally did a good job of discussing how the EasyPark rollout was not in line with

RWD’s current mission statement, integrating specific case facts to support their analysis. Most

candidates attempted to discuss several of the individual mission statement items and did a good job

assessing the issues related to putting customers first, responding within 24 hours, and providing a

good work-life balance. Candidates had more difficulty integrating the case facts to support their

discussion of the issues related to the vision of the company and its creative and artistic design

services.)

Decision-Making Process

I am concerned about the informal process surrounding the purchase of EasyPark. It seems that this app

was purchased by Richard with very little financial analysis. Also, it was purchased without the

agreement of the two other shareholders. As discussed in the previous section, the purchase does not align

well with RWD’s vision and mission statements. This leads me to believe that a proper evaluation of the

EasyPark app, in which the risks and opportunities were evaluated, was not undertaken. Had the

shareholders done a proper evaluation of EasyPark, they would likely have realized that RWD’s current

staffing levels were not sufficient to deal with the rollout of EasyPark in January 2014.

I suggest that in the future, any new projects that RWD is considering go through a rigorous evaluation

before being adopted. Risks and opportunities of each project should be considered and evaluated.

RWD’s shareholders should consider whether they are willing to accept the risks identified or if there is

any way to mitigate those risks.

Also, there should be an agreement in place between the three shareholders regarding what types of

decisions require consensus of all the shareholders and what types of decisions can be made by one

shareholder. For example, any new projects would likely need the approval of all three shareholders

before going ahead. There could also be dollar thresholds put in place in terms of approvals for items such

as expenditures, hiring of employees, etc.

(Approximately one-half of the candidates were able to identify that there was an issue with the

decision-making process. However, only two-thirds of those candidates were able to provide a complete

explanation of the implications for RWD and provide a valid recommendation to resolve the issue

going forward. Candidates appeared to struggle with their role in this area and, therefore, had

difficulty pointing out the operational issues that this decision made solely by Richard has created for

RWD.)


For Primary Indicator #3 (Governance, Strategy, and Risk Management), the candidate must be ranked in one of the following five categories:

Percent Awarded


12.4%

Reaching competence — The candidate discusses the fact that the rollout was not in line with some of RWD’s mission statements.

15.9%

Competent — The candidate discusses the fact that the rollout was not in line with several of RWD’s mission statements.

67.4%

Highly competent — The candidate discusses the fact that the rollout was not in line with most of RWD’s mission statements, and discusses a better decision-making process for the future.

2.3%

(Candidates were not specifically directed to this indicator. However, the controller noted that the other

shareholders were upset because Richard had not consulted them, and they were concerned about how

EasyPark was affecting RWD’s ability to meet its vision and mission statements.)

(Candidates performed well on this indicator. Most were able to recognize some of the relevant case

facts and integrate them into a discussion of how the purchase of EasyPark has affected RWD’s ability

to meet its vision and mission statements. Most were also able to discuss the impact the purchase was

having on a number of the individual mission statements or how it conflicted with the overall vision,

and also identified that the acquisition by Richard without the consent of the other shareholders was

an issue.)

(Strong candidates provided well-organized, concise discussions of issues related to several of the

mission statements and they either discussed the implications of Richard’s acquiring EasyPark on

RDW’s behalf without proper authorization and due diligence, or provided an insightful

recommendation to ensure future decisions were properly evaluated and approved. Weak candidates

did not address a sufficient number of issues, or their discussions did not properly integrate specific

case facts to support the argument that the acquisition was having a negative impact on RWD. Weak

candidates also had difficulty discussing the implication of Richard’s acquisition of EasyPark without

the consent of the other shareholders and were unable to provide a recommendation to avoid this from

occurring again in the future.)


Competencies (lists the Pervasive Qualities and Skills for the entire simulation): III-1.1 – Gathers or develops information and ideas
















(Candidates performed reasonably well on this simulation. Most candidates attempted to address all

three indicators. Candidates appeared to be most comfortable in their role on Primary Indicator #1 and

did a very good job of integrating the relevant case facts into their quantitative analysis of EasyPark’s

contribution to RWD’s financial results. However, the Board was disappointed that only a few

candidates were able to provide valid discussions of qualitative factors that would be relevant in their

analysis of EasyPark. Candidates who struggled on this simulation appeared to have difficulties with

their role on Primary Indicators #2 and #3. The Board recognizes that these two indicators were

somewhat unique in that candidates were expected to assess whether or not the proposed automation

plan would resolve the control issues, which required them to go beyond simply recommending manual

controls to resolve the issues on Primary Indicator #2. Likewise, for Primary Indicator #3, candidates

were required to integrate some case facts in order to discuss how the rollout of EasyPark was not in

line with RWD’s mission statements. Some candidates seemed to struggle with the integration required

in Primary Indicators #2 and #3.)



THE INSTITUTES OF CHARTERED ACCOUNTANTS OF CANADA 2014 Uniform Evaluation

PAPER III Time: 4 hours






(2) To help you budget your time during the evaluation, an estimate of the number of minutes required

for each simulation is shown at the beginning of the simulation.







* * * * * * * * * *



2014 Chartered Professional Accountants of Canada

277 Wellington Street West, Toronto, Ontario, Canada M5V 3H2

Printed In Canada

III

188 Appendix C — Paper III


Long Haul Trucking Inc. (LHT) is a transportation business that operates a fleet of long-haul trucks

transporting goods across Canada. LHT has one wholly owned subsidiary, Fix Fix Inc. (FFI). FFI is a

full-service mechanic shop that maintains the fleet of LHT and also has outside contracts for the

maintenance of other companies’ fleets. LHT is a private company with a June 30 year-end. The company

is owned by private equity investors and reports under International Financial Reporting Standards (IFRS)

because the owners require their significant investees to report under IFRS.

It is now September 9, 2014. You, CA, are an audit senior at William & Sully Chartered Accountants, and

LHT has been a client of your firm for a number of years. LHT has engaged your firm, as it has done in

the past, to perform an audit of its financial statements. The company’s bank has an annual audit

requirement as a condition of a loan. You met with the controller on Monday to begin the audit. Her

comments from that meeting can be found in Exhibit I.

The partner on the engagement asked that you send him a memo discussing any accounting issues you’ve

noted and outlining the procedures required to address the risk areas of the audit.



EXHIBIT I

CONTROLLER’S COMMENTS FROM MEETING

It’s been hectic getting ready for the audit because we are also finalizing the disposal of our subsidiary,

FFI. In the year ended June 30, 2014, the board of directors decided to sell FFI because it hadn’t been as

profitable as LHT’s owners required, and LHT wants to focus again on its transportation business to

increase its market share in that more profitable industry.

I have been very busy with due diligence requests from the purchaser. FFI made up nearly a third of our

operations, so there have been a lot of requests, and I’m sorry if my audit working papers are not as good

as in prior years. I have part of the draft financial statements prepared for you (Exhibit II), and part of the

tax working papers relating to FFI’s operations (Exhibit III). Can you take a look at these? I’m not sure

the new tax person properly made adjustments to calculate FFI’s taxable income and taxes payable.

LHT really needs to finish the audit on time this year because we’ve made a few late payments on our

long-term loan and the bank has indicated that it is not willing to forgive any more late payments or other

defaults. Thankfully, we’ve met our debt covenant this year, the interest coverage ratio of 10 (earnings

before interest, tax, and discontinued operations, divided by interest expense), because otherwise, the loan

would have become payable on demand.

We hired an outside fleet maintenance company to do some work on our trucks. Since we’re selling FFI

soon, we wanted to try the outside company out. They said it was regular maintenance work, but we felt

that it should be capitalized because $90,000 is an abnormal amount of work and obviously means our

trucks weren’t up to par.

We are subject to a new government-legislated transportation levy that imposes a fee applicable to the

kilometres driven by our fleet of trucks for each 12-month period ending September 30. We have driven

460,000 kilometres between October 1, 2013, and June 30, 2014. Since the levy is payable only in

October, we have not recorded any expense so far. I have provided the levy table in Exhibit IV.

We obtained a new contract from Bitter Sweet Co. that started August 1, 2013, the date we received our

first payment. They wanted the exclusive rights to two trucks and drivers, to incorporate them into their

fleet. They approached us because we have acquired new refrigerated trucks they want to use. These

trucks are hard to come by because of long lead times and the fact that they are costly, about $275,000

each. Since we can cover our regular deliveries using other trucks, and since Bitter Sweet Co. was willing

to lease the two trucks for a total of $8,000 a month at an implicit interest rate of 8% per year for a five-

year contract, we signed the agreement. That was a great win for our sales group: unexpected services

revenue of almost half a million dollars recorded this year. Also, we might be able to sell the two trucks to

Bitter Sweet Co. prior to the end of their useful lives, which is usually eight years, for $114,000 each.

That amount is LHT’s estimated fair market value for the trucks five years from now.



EXHIBIT I (continued)

CONTROLLER’S COMMENTS FROM MEETING

Like I said, we’ve been working hard because we’re about to close on the sale of FFI. We have an offer of

$5 million on the table now for our 100,000 shares, and we’re likely going to accept it. This offer is

$43,000 below our carrying value of FFI’s net assets at June 30, 2014. In addition, we’re going to take a

bit of a hit in the first quarter of 2015 because our costs to sell FFI are estimated at $55,000. We also

allocated an additional $100,000 of our head office salaries to FFI’s operations this year. While it’s not an

expense the purchaser will pay, I think we’re justified in showing it to the users of the financial

statements because we have been spending so much time on that project. We were so busy getting ready

for the sale that we didn’t collect some accounts receivable fast enough. An FFI client that owed $45,000

went out of business, so we wrote the receivable off during the year ended June 30, 2014. I prepared a

draft note disclosure for the disposal, but I wasn’t sure if we were supposed to show discontinued

operations in a separate line because we haven’t sold the business yet.



EXHIBIT II

LONG HAUL TRUCKING INC.

DRAFT CONSOLIDATED STATEMENT OF OPERATIONS

For the year ended June 30


2014 2013

Revenue $ 3,980 $ 4,250

Expenses 2,180 3,325

1,800 925

Administrative expenses 50 175

Selling expenses 300 460

Repairs and maintenance 50 60

Depreciation 530 800

Interest expense 75 79

Gain on disposal of asset (25) —

980 1,574

820 (649)

Tax expense (recovery) 150 (20)

Net income (loss) from continuing operations 670 (629)

Net income from discontinued operations (Note 1) 45 —

Net income (loss)

$

715

$

(629)

Note 1 – Discontinued Operations

On January 1, 2014, the board passed a resolution to dispose of the operations of FFI.

As a strategic decision, the company decided to focus on its core operation of

transportation services.

2014

Revenue $ 1,400

Expenses (1,290)

Net income 110

Impairment loss recognized on the measurement of

FFI’s fair value

(43)

Profit (loss) before tax from a discontinued operation 67

Tax at 20% (from tax working papers) (22)

Profit for the year from a discontinued operation

$

45

The capital cost allowance (CCA) we can claim for the fiscal year 2014 is $150,000.



EXHIBIT III

TAX WORKING PAPERS FOR FFI’S OPERATIONS


Tax calculation on regular profit

Revenue $ 1,400

Expenses:

Cost of sales (Notes 1 and 2) $ (770)

Allowance for doubtful receivables (95)

Share-based compensation (25)

Professional fees (Note 3) (30)

12 months depreciation of assets relating to FFI (270)

Allocation for LHT head office staff time (100) (1,290)

110

Tax at 20% $ 22

Notes:

1. The cost of sales includes an amount of $80,000 in labour and parts that was spent on refurbishing a

few engines that may be sold and installed in clients’ trucks. FFI expects to sell these engines at a

small profit.

2. FFI performed some repairs on LHT’s trucks. The parts were charged at their original cost, for a total

of $60,000. Generally, FFI generates a 25% mark-up on such sales.

3. Professional fees were incurred as part of a corporate restructuring. They include the issuance of

supplementary letters patent and legal fees to simplify the share structure of the company ($20,000).



EXHIBIT IV

TRANSPORTATION LEVY

12-MONTH PERIOD ENDING SEPTEMBER 30, 2014

LEVY TABLE

Basic

amount

Additional

rate per km Kilometres driven

0 - 500,000 — —

500,001 - 750,000 $ 25,000 $ 0.03

750,001 - 1,000,000 $ 32,500 $ 0.02

In excess of 1,000,000 $ 37,500 $ 0.01

The levy calculated for the 12-month period ending on September 30 of each year is payable

within 30 days of the end of the levy period.

Once a transportation company has reached a threshold, the levy is the total of the basic amount

and the amount determined by multiplying the “additional rate per km” for every kilometre driven

within a particular range.

194 Appendix C — Paper III — Evaluation Guide

EVALUATION GUIDE

PAPER III, SIMULATION 1 — LONG HAUL TRUCKING INC.










To: Partner

From: CA

Re: Long Haul Trucking Inc. (LHT)

Primary Indicator #1 The candidate discusses the accounting issues for LHT. The candidate demonstrates competence in Performance Measurement and Reporting.

Competencies


V-2.4 – Accounts for the entity’s non-routine transactions (B)

From my review of the working papers, I’ve determined there are a number of adjustments to make as a

result of the accounting performed by the client.

Discontinued Operations

The client is in the process of finalizing the disposal of its subsidiary Fix Fix Inc. (FFI). The client has

presented it as discontinued operations but wasn’t sure if that was correct, since the sale has not been

closed as of the current date.

In accordance with paragraph 6 of IFRS 5, Non-currents assets held for sale and discontinued operations,

“an entity shall classify a non-current asset (or disposal group) as held for sale if its carrying amount

will be recovered principally through a sale transaction rather than through continuing use.”

Paragraph 7 goes on to state that, “for this to be the case, the asset (or disposal group) must be available

for immediate sale in its present condition subject only to terms that are usual and customary for sales of

such assets (or disposal groups) and its sale must be highly probable.” Therefore, in order to be classified

as discontinued operations, FFI doesn’t need to have been sold. It just needs to be available for sale, and

its sale must be highly probable.


Paragraph 8 of the guidance indicates, “For the sale to be highly probable, the appropriate level of

management must be committed to a plan to sell the asset (or disposal group).” The board of LHT has

decided to sell the subsidiary because it has not been as profitable as the private equity investors required.

From the draft note disclosure, we can see that the board passed a resolution on January 1, 2014, to

dispose of the subsidiary. Therefore, it is reasonable to consider that there was a committed plan in place

at that time. In addition, guidance states that “an active programme to locate a buyer and complete the

plan must have been initiated” and “the asset (or disposal group) must be actively marketed for sale at a

price that is reasonable in relation to its current fair value. In addition, the sale should be expected to

qualify for recognition as a completed sale within one year from the date of classification.” It is now

September 9, 2014, and the controller has indicated LHT is in the process of finalizing FFI’s sale. There

is an offer of $5 million on the table that LHT is likely going to accept, so it is clear that the price is

reasonable in relation to its current fair value. We can, therefore, conclude that the criteria are met and

FFI would be classified as an asset held for sale in the statement of financial position.

Given that FFI meets the criteria of an asset held for sale, we must also consider the presentation and

disclosure requirements of IFRS 5. Paragraph 30 states that “an entity shall present and disclose

information that enables users of the financial statements to evaluate the financial effects of discontinued

operations and disposals of non-current assets (or disposal groups).” According to paragraph 31, “A

component of an entity comprises operations and cash flows that can be clearly distinguished,

operationally and for financial reporting purposes, from the rest of the entity. In other words, a

component of an entity will have been a cash-generating unit or a group of cash-generating units while

being held for use.” As well, under paragraph 32, “A discontinued operation is a component of an entity

that either has been disposed of, or is classified as held for sale, and…represents a separate major line of

business or geographical area of operations…” Paragraph 32 goes on to state that the component “is part

of a single co-ordinated plan to dispose of a separate major line of business…” FFI can be clearly

distinguished, operationally and functionally, since it is a separate line of business that generates distinct

cash flows from LHT and, therefore, meets the definition of a disposal group. FFI is a separate line of

business because it performs maintenance on trucks, while LHT is involved in transporting goods. The

board passed a resolution to dispose of the subsidiary, and management has been working towards

disposing of the subsidiary, so there is a coordinated plan for the disposal and we can conclude that FFI

should be classified as a discontinued operation. In accordance with paragraph 33, LHT is required to

disclose the post-tax profit or loss of FFI in the statement of comprehensive income.

From my preliminary review and discussion with the controller, I have identified a few issues with the

calculation of discontinued operations:

The measurement of the disposal group should be written down to fair value less costs to sell. The

controller indicated in our meeting that the selling costs of $55,000 were going to be recorded in Q1

of 2015, which would be in the wrong period; these should be recorded at the same time as the

impairment. As a result, the impairment amount is understated.

The controller allocated $100,000 in head office salaries that would not form part of the sale but she

thought would be useful information. Because this is not actually part of the net income of the

discontinued operations, it should not be allocated to FFI. As a result, there is a classification error

between discontinued operations and net income from continuing operations (administration

expenses). A requirement of held-for-sale assets is that depreciation ceases once the disposal group has met the

criteria (IFRS 5.25). The company has recorded depreciation for the full 12 months when it should

have ceased depreciating the assets at January 1, 2014. Therefore, the depreciation expense is

overstated by $135,000 ($270,000 ÷ 2). However, to the extent that there is still a requirement to

record an impairment, the amount adjusted for depreciation should be reflected in an additional

impairment.


An amount of $80,000 has been recorded in cost of sales. It seems that the amount should have been

added to the cost of inventory instead, since the engines that were refurbished will be available for

sale. IAS 2.10 indicates that the “cost of inventories shall comprise all costs of purchase, costs of

conversion and other costs incurred in bringing the inventories to their present location and

condition.” The amount in cost of sales is, therefore, overstated by $80,000. As for the adjustment for

depreciation, any increase to the assets of FFI will also result in a similar adjustment to the

impairment amount.

The discontinued operations should be shown net of tax. In my review of the tax working papers, I

found errors in the calculation. In addition, the tax impact of the impairment was not recorded

(deferred tax) as required by IFRS 5.33(b)(ii). The profit after tax for the year from discontinued

operations is understated by $88,000 ($133,000 − $45,000).

Further, the information required to be disclosed for the discontinued operations should also be disclosed

for the comparative period in the statement of operations, and the note should include information on the

expected timing of the sale.

(Almost all candidates addressed this issue. Most of them provided in-depth discussions of the

accounting principles under IFRS for discontinued operations and recommended accounting policies

that were appropriate and logical based on their discussions of the case facts. However, some

candidates failed to recognize the need to assess the assets held-for-sale criteria to support their

discussion of presenting the FFI operations as discontinued operations.)

Contract for Two Trucks

LHT entered into a new arrangement with Bitter Sweet Co. that started August 1, 2013. Bitter Sweet

wanted the exclusive rights to two new refrigerated trucks that LHT had acquired, as well as two drivers,

in order to incorporate them into its fleet. Bitter Sweet has leased the two trucks for a total of $8,000 a

month at an implicit interest rate of 8% per year for a five-year contract. LHT has recognized the full

amount of the contract in the year.

We must determine if the lease should be classified as an operating lease or a finance lease at the

inception of the agreement. According to IAS 17.10, “Whether a lease is a finance lease or an operating

lease depends on the substance of the transaction rather than the form of the contract.” We will need to

obtain the agreement and understand the substance of the agreement.

When applying IAS 17.10, we must consider whether the risks and rewards of ownership would transfer

to the lessee at the end of the lease term:

The controller indicated LHT may eventually sell the asset to the lessee. We need to understand

whether it may be either certain due to the agreement and the nature of the asset or virtually certain

due to the sales price being low enough that it makes economic sense for the lessee to exercise the

option. If any of these indicate that the asset would transfer to Bitter Sweet, the lease would be

considered a finance lease; otherwise, it would be an operating lease. From the information provided

on the terms of the lease, it seems that the sale would occur at the fair market value of the trucks, and

there is no certainty that Bitter Sweet will acquire the two trucks at the end of the lease. As a result,

this criterion is not met.


We would further consider whether the lease term is for a major part of the economic life of the asset.

From our discussion with the controller, it appears the non-cancellable portion of the lease is five

years. Because the trucks are new and a reasonably estimated useful life for the trucks is eight years,

the lease represents less than 75% of the estimated useful life (5 years ÷ 8 years = 63%). IAS 17 does

not specify a percentage threshold, but from my understanding of the industry, 63% does not

constitute a major part of the economic life of the asset.

An additional consideration is whether the present value of the minimum lease payments amounts to

at least substantially all of the fair value of the leased asset. There are a number of considerations in

determining the minimum lease payments. In addition to the monthly payment, minimum lease

payments for the calculation include any guaranteed residual value and bargain purchase options and

are reduced by contingent rent and any costs reimbursed by the lessor. From the available

information, the monthly lease payment is $4,000 for each truck over the five-year non-cancellable

term, and the company is making 8% per year on the lease, which is the rate implicit in the lease (8%

÷ 12 = 0.67% per month). The present value of each truck in the lease agreement is $197,274 (NPV,

0.67%, monthly payments of $4,000, 60 periods), which is 72% of the fair value ($197,274 ÷

$275,000), assuming the fair value is close to the $275,000 value of a new truck. The “substantially

all” criterion would, therefore, not be met.

Based on our understanding of LHT’s business, the trucks would otherwise be used in the company’s

own operations if they were not leased to Bitter Sweet, so the specialized equipment criterion would

not apply.

We must also consider the criteria in IAS 17.11 to determine whether the lease could be classified as a

finance lease:

Would Bitter Sweet assume any losses incurred by LHT upon cancellation of the lease? In this

particular case, there is no indication that the lessee can cancel the lease, and certainly no indication

that Bitter Sweet would assume LHT’s losses should the lease be cancelled, so this criterion is not

met.

Would the increase in the fair value of the residual accrue to Bitter Sweet? The terms of the lease do

not provide for any adjustment to the payments by Bitter Sweet that would be tied to the residual

value of the truck, so this criterion is not met.

Does the lease provide for a “secondary” period that would enable a reduced rent? The terms of the

lease do not provide for any renewal period, so this criterion is not met.

In summary, we conclude the lease is an operating lease. However, it appears that LHT’s income on this

particular lease was entirely recognized upfront. LHT should reverse the $480,000 sale recognized in the

current year ($8,000 × 60 months) and only recognize the lease payments applicable to its 2014 financial

year ($8,000 × 11 months = $88,000).

(Many candidates identified this issue and provided relevant accounting discussions, integrating case

facts to support their analysis of the relevant criteria and concluding that the transaction should be

accounted for as an operating lease. Weak candidates did not provide any analysis of the criteria,

failed to integrate appropriate case facts to support their analysis of the relevant criteria, or concluded

without providing adequate technical guidance to support their analysis.)

Truck Maintenance

In our meeting, the controller indicated that LHT had maintenance work in the amount of $90,000

performed by a new supplier to test that supplier out in anticipation of selling FFI. She has capitalized

these costs because they were much higher than usual, which she concluded meant they would qualify as

capital expenditures.


IAS 16.13 indicates that “under the recognition principle in paragraph 7, an entity recognises in the

carrying amount of an item of property, plant and equipment the cost of replacing part of such an item

when that cost is incurred if the recognition criteria are met.”

Paragraph 7 specifically states that “the cost of an item of property, plant and equipment shall be

recognised as an asset if, and only if: (a) it is probable that future economic benefits associated with the

item will flow to the entity; and (b) the cost of the item can be measured reliably.” Hence, if the work

performed resulted in the replacement of a specific significant component, LHT would derecognize the

old component and then capitalize and depreciate the new component.

However, if the costs relate to maintenance, IAS 16.12 supports that they be expensed as incurred,

regardless of the dollar amount and even if they were more expensive than anticipated, since they

represent the “costs of the day-to-day servicing of the item.”

From the limited information available, it appears that this relates to routine maintenance rather than an

overhaul. Therefore, the repairs and maintenance expense is understated by $90,000 and the capital asset

is overstated by $90,000. The amortization expense is also overstated due to amortization that would have

been taken during the year on the capitalized amount.

(Many candidates identified this issue and provided relevant accounting discussions, recognizing that

the maintenance costs should be expensed since they represented day-to-day servicing costs and did not

provide future economic benefits.)

Government Transportation Levy

The definition of a liability under the Conceptual Framework indicates that it is “a present obligation of

the entity arising from past events, the settlement of which is expected to result in an outflow from the

entity of resources embodying economic benefits.”

However, according to IAS 37.14, a provision should be recorded when

(a) an entity has a present obligation (legal or constructive) as a result of a past event;

(b) it is probable that an outflow of resources embodying economic benefits will be required to settle

the obligation; and

(c) a reliable estimate can be made of the amount of the obligation.

IAS 37.17 further defines a past event:

A past event that leads to a present obligation is called an obligating event. For an event to be an

obligating event, it is necessary that the entity has no realistic alternative to settling the obligation

created by the event. This is the case only:

(a) where the settlement of the obligation can be enforced by law; or

(b) in the case of a constructive obligation, where the event (which may be an action of the entity)

creates valid expectations in other parties that the entity will discharge the obligation.


Paragraph 19 further explains:

It is only those obligations arising from past events existing independently of an entity's future actions

(i.e., the future conduct of its business) that are recognised as provisions. Examples of such obligations

are penalties or clean-up costs for unlawful environmental damage, both of which would lead to an

outflow of resources embodying economic benefits in settlement regardless of the future actions of the

entity. Similarly, an entity recognises a provision for the decommissioning costs of an oil installation or a

nuclear power station to the extent that the entity is obliged to rectify damage already caused. In contrast,

because of commercial pressures or legal requirements, an entity may intend or need to carry out

expenditure to operate in a particular way in the future (for example, by fitting smoke filters in a certain

type of factory). Because the entity can avoid the future expenditure by its future actions, for example by

changing its method of operation, it has no present obligation for that future expenditure and no

provision is recognised.

The new transportation levy has created an obligation that arises both upon a certain threshold being

reached (500,000 kilometres) and as a result of the continuous use of the trucks. Because the kilometres

are driven over time and 460,000 kilometres had already been driven by June 30, 2014, it is very

reasonable to assume that LHT will have used its trucks for more than 500,000 kilometres by

September 30 and that it will be subject to the levy. However, this obligation only becomes one as a result

of future events — the continued use of the vehicles driving in excess of 500,000 kilometres. Because

LHT can avoid the expenditure in future by way of its actions, no obligation should be accrued at June 30,

2014, regardless of the likelihood it will exceed the threshold by September 30, 2014.

(Many candidates addressed this issue, and most of those who did provided a well-supported discussion

of the relevant criteria for the provision and applied case facts to arrive at an appropriate accounting

treatment. Those who did not provide in-depth discussions failed to use appropriate case facts to

analyze the relevant criteria. For example, some of these candidates concluded that the minimum basic

amount of $25,000 was payable if the entity did not reach the minimum 500,000 kilometre threshold,

while others failed to recognize the timing difference between LHT’s year end (June 30, 2014) and the

end of the levy calculation period (September 30, 2014). In both cases, the candidates limited the

usefulness of their analysis. Some candidates made reference to IFRIC Interpretation 21 — Levies in

their response to support their analysis. This interpretation is only effective for annual periods

beginning on or after January 1, 2014, and candidates were only responsible for Handbook updates in

effect as of December 31, 2013. Although candidates were in no way expected to reference this

interpretation, those who did were given credit due to the fact that early application is permitted.)

Classification of Debt

As noted below, LHT has breached its bank covenant as of the year-end date. As a result, according to

IAS 1.74, “when an entity breaches a provision of a long-term loan arrangement on or before the end of

the reporting period with the effect that the liability becomes payable on demand, it classifies the liability

as current…” Therefore, there is a change in the classification from a long-term debt to a current liability.

IAS 1.74 goes on to say that this would be current “even if the lender agreed, after the reporting period

and before the authorisation of the financial statements for issue, not to demand payment as a

consequence of the breach. An entity classifies the liability as current because, at the end of the reporting

period, it does not have an unconditional right to defer its settlement for at least twelve months after that

date.”


The bank would have had to agree not to call the loan for a period of at least 12 months by the end of the

reporting period. If LHT had been able to obtain such a waiver, the company would not be required to

classify the debt as current. According to IAS 1.75, “an entity classifies the liability as non-current if the

lender agreed by the end of the reporting period to provide a period of grace ending at least twelve

months after the reporting period, within which the entity can rectify the breach and during which the

lender cannot demand immediate repayment.” However, since it is past the reporting period (year-end

date of June 30), this is no longer an option.

LHT will need to discuss with the bank the implications of the debt covenant breach. It will also need to

make certain disclosures in the financial statements under IFRS 7. According to IFRS 7.18:

For loans payable recognised at the end of the reporting period, an entity shall disclose:

a) details of any defaults during the period of principal, interest, sinking fund, or redemption terms

of those loans payable;

b) the carrying amount of the loans payable in default at the end of the reporting period; and

c) whether the default was remedied, or the terms of the loans payable were renegotiated, before the

financial statements were authorised for issue.

(Few candidates were able to integrate their analysis of the breach in debt covenant with their

accounting discussions; therefore, candidates struggled to recognize that the breach in debt covenant

would require a reclassification of the long-term debt in the financial statements. In addition,

candidates who did address this issue generally failed to provide sufficient depth of discussion, only

identifying the need to reclassify the debt without providing proper support.)


Percent Awarded


5.1%

Reaching competence — The candidate discusses some of the accounting issues.

39.6%

Competent — The candidate discusses several of the accounting issues. 55.2% Highly competent — The candidate discusses most of the accounting issues. 0.1%

(Candidates were specifically directed to this indicator when they were asked by the partner to provide

a memo discussing any accounting issues they had noted.)


(Most candidates performed adequately on this indicator and provided in-depth discussions of some of

the relevant accounting issues, such as the presentation and measurement of the discontinued

operations (FFI) and the presentation of the lease transaction. These candidates provided appropriate

recommendations based on their analysis and discussed some of the more significant transactions.

Strong candidates were able to integrate the case facts into their analysis and provide logical

recommendations that flowed from their analysis. Weak candidates typically addressed the same

number of issues but focused on the less significant issues, such as truck maintenance or the

government levy, or recommended accounting treatments without supporting them with case facts or

reference to the relevant IFRS standard or both.)

Primary Indicator #2 The candidate provides audit procedures for the risk areas of the audit. The candidate demonstrates competence in Assurance.

Competencies VI-2.5 – Designs appropriate procedures based on the assignment’s scope, risk, and materiality guidelines (A)

Assets Held for Sale and Discontinued Operations

We should verify whether the criteria to classify the assets as held for sale and FFI as discontinued

operations were met as of June 30, 2014. The first step would be to determine if the sale was highly

probably at the June 30, 2014. As per IFRS 5, paragraph 8, “For the sale to be highly probable, the

appropriate level of management must be committed to a plan to sell the asset (or disposal group), and an

active programme to locate a buyer and complete the plan must have been initiated.” To test this, we

should obtain board minutes that indicate the approval of management’s plan, since we know that on

January 1, 2014, the board passed a resolution to dispose of FFI. To test that the disposal group was

available for immediate sale in its present condition, we should obtain management’s report or marketing

document that likely would have been prepared by a professional services firm to assist in selling the

company. We may also be able to obtain a signed letter of intent between the parties. These documents

would indicate that FFI was being marketed and would note if FFI was not available for immediate sale.

The letter of intent would also support management’s assertion that the sale was expected to close within

one year.

We should perform procedures on the costs included in the discontinued operations line to test that these

all pertain to FFI. Management has a bias to include more costs in discontinued operations because

discontinued operations are excluded from the bank covenant calculation. Earlier in this report we noted

that the controller had allocated $100,000 in costs that would not form part of the sale because she

thought the information would be useful to the financial statement user, and we proposed an adjustment.

We could test the costs allocated to discontinued operations by obtaining a schedule of the costs allocated

to FFI, selecting a sample from the list, and examining the support to test that the costs relate to FFI. In

addition, we should test the journal entries relating to the discontinued operations to identify any

additional amounts allocated from LHT that would not qualify to be part of the disposal group (similar to

the costs allocated for the head office salaries). In addition, we should ensure the assets and liabilities

relating to the disposal group are separately disclosed in the statement of financial position as held for

sale.


Earlier in this report, we noted LHT has incorrectly accounted for the measurement of the disposal group

since IFRS 5 requires the disposal group to be written down to the fair value less costs to sell. Therefore,

we propose an accounting adjustment of $55,000. We should assess the reasonableness of the costs to sell

by obtaining management’s estimate and reviewing it. Furthermore, we should test a sample of the costs

included in management’s schedule by agreeing them to supporting invoices where possible, as some of

these costs may not actually be selling costs pertaining to the sale of FFI.

We should also perform procedures on the impairment calculation performed by management. The

controller indicated there is an offer on the table that LHT will likely accept. The offer would be evidence

of the fair value of the business. We should obtain the signed offer or letter of understanding and

recalculate management’s calculation of impairment to fair value (less costs to sell).

Lastly, according to IFRS 5, paragraph 38,

An entity shall present a non-current asset classified as held for sale and the assets of a disposal group

classified as held for sale separately from other assets in the statement of financial position. The

liabilities of a disposal group classified as held for sale shall be presented separately from other

liabilities in the statement of financial position. Those assets and liabilities shall not be offset and

presented as a single amount. The major classes of assets and liabilities classified as held for sale shall

be separately disclosed either in the statement of financial position or in the notes.

We should review the journal entries made to prepare the financial statements and their support to test

that the assets and liabilities relating to FFI are appropriately disclosed.

(Most candidates attempted to address this risk area, and most of those candidates were able to provide

valid procedures to address the presentation and measurement issues related to the disposition of FFI.

They provided specific procedures to apply to ensure the board was committed to selling FFI and the

sale was highly probable.)

Revenue Arrangement Containing a Lease

LHT entered into a new type of revenue arrangement in which the company is providing a client with

exclusive rights to two trucks and drivers, rather than simply providing transportation services. According

to the controller, the arrangement contains a lease. We should obtain the agreement and read it for terms

that could affect the classification of the lease. We should obtain support for the fair value of the asset

from either a blue book, an appraiser, or recent sales of similar assets. We should also test the calculation

of the discount rate because the rate used should be the implicit rate of the lease. We should perform a

sensitivity analysis of the inputs (useful life, residual value, fair value, discount rate) into the calculation

to focus our efforts on the areas of highest risk. As noted earlier, LHT included the entire amount in

revenue in the current year, so we proposed an audit adjustment of $392,000 ($480,000 − $88,000).

(Approximately two-thirds of the candidates attempted to provide a procedure to address the revenue

arrangement, with the majority of those candidates providing valid audit procedures. Strong candidates

recognized the need to review the terms and conditions of the revenue arrangement in order to

corroborate the data being used to assess the lease classification criteria. Weak candidates provided

very generic procedures and were not able to indicate why they were reviewing the revenue

arrangement.)


Property, Plant and Equipment

A significant amount of repairs and maintenance was performed on LHT’s trucks during the year, and this

was capitalized. Our discussion with the controller indicates this appears to be regular maintenance, so we

proposed an adjustment of $90,000. We should test the additions to capital assets by obtaining the list of

additions, selecting a sample, obtaining the invoices and work orders, and understanding the nature of the

work to find out if there are more expenses that were capitalized when the capitalization criteria were not

met.

We should review the basis of depreciation and question whether the useful life is appropriate considering

that the vehicles on which the “abnormal amount of work” was performed might be impaired. We should

question whether the useful life of these trucks should be adjusted, and we should consider their state of

repair in assessing impairment.

Maintenance and repair work seemed to have been carried out on many trucks, so we should question

whether this is indicative of a similar problem on any of the other trucks in the fleet.

(Most candidates were able to provide a valid audit procedure for the presentation of the maintenance

work performed, focusing on the need to review amounts that had been capitalized during the year to

ensure that they could be capitalized.)

Government Levy

The following procedures should be performed relating to the levy:

Review the legislation and ensure that the rates applied are appropriate.

Verify the odometers on a sample basis. Review the safety inspection reports, maintenance logs,

licence renewal applications, or driver logs to verify the starting and ending kilometres and determine

whether the kilometres driven are reasonable.

(Most candidates were able to provide a valid audit procedure for the government levy.)

Income Taxes — Discontinued Operations

We should verify that the tax computation was done in accordance with the provisions of the ITA and

IAS 12 Income Taxes of the CPA Canada Handbook. We should also compare it to prior years to

determine if all of the adjustments to the accounting income have been considered.

(Very few candidates considered the impact of the tax considerations on the accounting for

discontinued operations. As a result, the number of candidates who provided an audit procedure in this

area was negligible.)

Going Concern Considerations

As per IAS 1, the company is required to assess its ability to continue as a going concern. According to

IAS 1.25, “When management is aware, in making its assessment, of material uncertainties related to

events or conditions that may cast significant doubt upon the entity’s ability to continue as a going

concern, the entity shall disclose those uncertainties.”


Although we review management’s assessment as part of our normal audit procedures, we have an

additional risk as per my discussion below, since LHT has breached the bank covenant and the loan is

now due on demand. In addition, the controller has informed us that LHT has been late with a few

payments this year, indicating it may have had difficulty with available cash during the year. As a result,

we need to pay even more attention to management’s assessment and consider the potential disclosure

requirement. We must understand the implications of the breach of the covenant since the bank now has

the right to call the loan. The bank may have provided a waiver or an alternative payment arrangement,

and we should determine whether LHT has made arrangements with the bank.

We have indications of a going concern issue as a result of the following facts: loss in prior year, sale of

the subsidiary to generate cash, late payments, and breach of the debt covenant. As a result, we need to

ask management to perform a going concern analysis, including preparing future cash flows. We

thereafter need to assess the reasonableness of the cash flows and the need for going concern disclosure.

In the event a going concern disclosure is required, we should test the disclosures made by management

and, in addition, include an emphasis of matter paragraph in our audit report.

(Few candidates attempted to provide an audit procedure to address the issue related to the covenant

breach, and only half of the candidates who did were able to provide a valid audit procedure in this

area.)


Percent Awarded


11.1%

Reaching competence — The candidate provides some valid audit procedures for the significant risk areas.

29.1%

Competent — The candidate provides several valid audit procedures for the significant risk areas.

59.2%

Highly competent — The candidate provides valid audit procedures for most of the significant risk areas.

0.1%

(Candidates were specifically directed to this indicator when they were asked by the partner to outline

procedures required to address the risk areas of the audit.)

(Most candidates performed well on this indicator. While most were able to provide relevant audit

procedures that addressed the specific risk areas identified in the simulation — in particular with

regards to discontinued operations, lease, maintenance on trucks, and the government levy — some

candidates provided procedures without properly identifying the relevant risk area being addressed, or

they provided procedures that were not clear or were too generic. Strong candidates did a good job of

linking their audit procedures directly to their accounting discussion, restating the relevant risk or

assertion being addressed and clearly identifying how to carry out the procedure. Candidates are

reminded to always support their procedures by explaining the objectives of developing them and the

audit risks being addressed, and to specifically state what information or documents need to be

obtained in order to perform the procedures.)


(Some candidates did not completely understand their role and provided an audit planning memo,

despite the fact that they were not asked to discuss the planning of the engagement. This had an impact

on the level of depth and breadth provided in discussions of the audit procedures — because of the

time they spent on the planning considerations, they had less time to address procedures.)

Primary Indicator #3 The candidate recalculates the taxes payable for the discontinued operations. The candidate demonstrates competence in Taxation.

Competencies IX-2.3 – Calculates taxes payable for a corporation in routine situations (A)

The controller has provided the draft tax calculations for the discontinued operations. Because she has

been busy with due diligence requests, the working papers this year have been rushed. She asked that we

look at the tax calculation. In addition to the accounting errors we noted above, the tax calculation

appears to be on an accounting basis rather than a tax basis. We therefore must calculate the adjustments

required to go from an accounting net income to a taxable income.

Allowance for Doubtful Receivables

The Income Tax Act (ITA) considers the impairment losses for trade receivables to be a reserve. ITA

18(1)(e) does not allow for the deduction of a reserve for impairment losses. Instead, the taxpayer is

allowed to deduct the actual losses resulting from debts written off as an expense (rather than those that

are just doubtful). As a result, the accounting impairment losses for trade receivables of $95,000 must be

added back and the actual losses resulting from debts written off in the amount of $45,000 should be

deducted.

(Candidates struggled to differentiate the tax treatment of the impairment losses and the bad debts

write-off. Approximately half of the candidates were able to identify the non-deductibility of the

accounting impairment losses for trade receivables, while only one-quarter of the candidates were able

to identify the deductibility of the actual losses resulting from debts written off. Most of the candidates

who addressed this issue were able to provide a valid adjustment to the calculation of taxable income,

but many candidates struggled to support their adjustments with a valid explanation of the rules under

the Income Tax Act.)


Depreciation

The ITA has a specific set of rules applying to depreciable capital property, and the accounting

depreciation is not an allowable deduction under ITA 18(1)(b). Instead, it is added back in the calculation

of taxable income. ITA 13(21) groups depreciable property into classes and “undepreciated capital cost”

for each class, and a deduction up to the maximum capital cost allowance (CCA) is allowed under

ITA 20(1)(a). While the accounting rate of depreciation is consistent for a company from year to year,

CCA prescribes an allowable rate based on the category of depreciable property, and the company is

allowed to deduct any amount up to that rate. While there are prescribed rates for each class, the

controller has informed us that the deduction for tax purposes would have been $150,000.

(Most candidates were able to recognize the need to adjust the taxable income calculation for the

impact of accounting depreciation and capital cost allowance. However, approximately one-third of

those candidates were not able to provide a valid explanation of the rules under the Income Tax Act to

support their adjustment.)

Professional Fees

As part of a restructuring of share capital to simplify the share structure, professional fees of $20,000

were incurred in 2014 to obtain the issuance of supplementary letters patent. Those fees should not

currently be deductible in computing FFI’s income because they relate to its capital structure and are

therefore capital in nature. They should be included in FFI’s eligible capital expenditures under

Section 14 of the ITA, and 75% of the amount should be added to the cumulative eligible capital, for

which FFI will be able to claim a deduction equivalent to 7% of the balance in the account at year end.

(Approximately one-quarter of candidates were able to provide a valid adjustment in this area, and

most of those who did provided a good explanation of the rules under the Income Tax Act. However,

many candidates applied the rules under Section 20(1)(e), which deals with financing fees; therefore,

they incorrectly concluded that the amount was deductible evenly over five years for tax purposes.)

Share-Based Compensation

FFI recorded an expense of $25,000 with respect to share-based compensation for its 2014 fiscal year.

Paragraph 143.3(2) of the ITA prohibits the deduction of amounts recorded as an expense for accounting

purposes as a result of the issuance of shares to employees. Therefore, the $25,000 expense would have to

be added in computing FFI’s taxable income.

(Only a few candidates were able to properly adjust taxable income for the share-based compensation

and provide a valid explanation of the rules under the Income Tax Act.)

Transaction with LHT

FFI performed some repairs for LHT, but only charged the actual costs for rendering the services. As FFI

and LHT are not dealing at arm’s length, FFI should record the income at fair value, including the usual

mark-up of 25%. Therefore, FFI’s taxable income should be increased by $15,000.

(About half of the candidates provided a valid adjustment in this area and a valid explanation

supporting why the amount had to be adjusted for under the Income Tax Act.)


Revised Tax Calculation Relating to Discontinued Operations (in thousands of dollars)

Notes

Net income before tax (from tax working papers) $ 110

Correct allocation for staff time (accounting error) 100 1

Adjusted net income before tax 210

Add:

Unrecorded mark-up on sale to LHT 15 2

Allowance for doubtful receivables 95 3

Costs added to inventory 80 4

Depreciation 270 5

Share-based compensation 25 6

Professional fees 20 7

Deduct:

Actual bad-debt write-off (45) 3

CCA (150) 5

ECE (1) 7

Taxable income 519

Tax at 20% 104

Notes:

1. As noted in the discussion of discontinued operations, there was an accounting error regarding

salaries, which we have added back to FFI’s net income. These costs are not deductible for tax

purposes unless they can be supported as relating to FFI and are an expense that FFI will actually pay.

2. As required under the Income Tax Act (ITA), FFI must record sales to parties with whom it does not

deal at arm’s length at their fair value, namely the mark-up of 25% on the $60,000 sale to LHT.

3. As required under the ITA, FFI must add back the accounting impairment losses for trade receivables

of $95,000 and deduct the actual bad debts written off, which was $45,000.

4. As required under the ITA, FFI must add the $80,000 in costs incurred to the cost of its inventory

because the engines have not yet been sold.

5. As required under the ITA, FFI must add back the accounting depreciation of $270,000 and deduct

CCA, which was $150,000.

6. The expense for the share-based compensation is not deductible for tax purposes because it is not an

actual outlay. Section 143.3 of the ITA prohibits its deduction.

7. Professional fees incurred with respect to reorganization of capital are not deductible, but they are

included as eligible capital expenditures under Section 14 of the ITA, and a deduction computed as

7% of 75% of the costs incurred is allowed ($20,000 × 75% × 7%).



Percent Awarded


19.2%

Reaching competence — The candidate attempts a calculation of the taxes payable for the discontinued operations.

32.6%

Competent — The candidate prepares a reasonable calculation of the taxes payable for the discontinued operations.

45.9%

Highly competent — The candidate prepares a thorough calculation of the taxes payable for the discontinued operations.

0.2%

(Candidates were expected to address the taxation issues because the controller asked them to take a

look at the tax working papers related to FFI’s operations, since she was not sure the new tax person

properly made adjustments to calculate FFI’s taxable income and taxes payable.)

(Candidates struggled with this indicator. While most did a good job of identifying some of the required

adjustments, they struggled to explain why the adjustments were required under the Income Tax Act,

in particular for items like the share-based compensation and the transactions between FFI and LHT.

In addition, some candidates were unable to provide the corresponding adjustment for an accounting

expense that was not deductible for tax purposes (for example, the actual losses written off instead of

the allowance for doubtful accounts and CCA instead of the depreciation expense). In some cases,

candidates simply provided a revised calculation of taxable income without explaining any of their

adjustments.)

Primary Indicator #4 The candidate discusses the impact of the breach of debt covenants on the operations of LHT. The candidate demonstrates competence in Pervasive Qualities and Skills.


Competencies (lists the Pervasive Qualities and Skills for the entire simulation)


III-1.2 Develops an understanding of the operating environment














We are performing the audit of LHT because the company is required to send audited financial statements

to the bank. The controller stated that there is one covenant as part of the long-term loan agreement: an

interest coverage ratio (earnings before interest, tax, and discontinued operations divided by the interest

rate) of 10.

The controller indicated the covenant had been met, and we calculated the ratio to be 11.9 from the initial

draft financial statements. As part of my analysis in this report, I noted a number of adjustments that

would have an impact on the calculation: revenue, selling expenses, repairs and maintenance, and gain on

disposal of asset. From my calculation in the table that follows, which considers the accounting

adjustments noted in my revised tax calculation shown in the previous section, LHT’s interest coverage

ratio is 4.5, which would be a breach of the covenant.

LHT should inform the bank immediately and discuss whether the bank is willing to provide a period of

grace and would agree not to call the loan. The bank might agree to provide a period of grace since LHT

will be disposing of its investment in FFL, probably for $5 million, and therefore should be able to repay

some or all of its bank debt. In addition, LHT might be able to obtain some additional capital from its

current shareholders to repay some of the debt in order to satisfy the bank for the time being. However, it

is unclear whether LHT has the means to fully repay the bank loan at this point, although there are many

factors that indicate that LHT is already facing cash flow issues. As the controller has noted, LHT has

been late with a few payments and the bank is losing patience; there is, therefore, a risk that the bank may

call the loan. Should the bank decide to call the loan, LHT could potentially face significant cash flow

issues. This would have a detrimental impact on its operations.


Proposed Adjustments of the Draft Financial Statements (in thousands of dollars)

Notes

Earnings before tax from continuing operations, as

presented $ 820

Less: overstatement of lease revenue (392) 1

Less: understatement of head office salaries (100) 2

Less: understatement of repairs and maintenance (90) 3

Less: overstatement of depreciation 23 3

Earnings before tax from continuing operations, as

revised 261

Add: interest expense 75

Earnings before interest, tax, and discontinued

operations, as revised 336

Divided by interest expense 75

Adjusted interest coverage ratio 4.5

Fail

Notes:

1. The adjustment to decrease revenue by $392,000 is to adjust for the revenue accounted for in the

current year that we concluded is an operating lease and relates to a five-year period. This revenue

should be recognized over the five-year period.

Calculated as:

Total contract recorded ($8,000 × 60 months) $480

Related to F14 (August 1, 2013 to June 30, 2014) (88)

Adjustment, reduction to revenue $392

2. The adjustment to increase administrative expenses by $100,000 relates to the extra head office

salaries allocated to the discontinued operations.

3. The adjustment to increase repairs and maintenance expense is necessary because the amount was

inappropriately capitalized and should have been expensed as maintenance. Depreciation should be

adjusted accordingly for the amount that was capitalized and amortized. Depreciation is computed on

a straight-line basis, and for purposes of our analysis we have assumed that the remaining useful life

of the asset was four years (out of eight), so the adjustment is $22,500 ($90,000 ÷ 4 years).



Percent Awarded


15.0%

Reaching competence — The candidate attempts to compute the adjusted interest coverage ratio and concludes on whether the debt covenant has been breached.

56.3%

Competent — The candidate provides a reasonable computation of the adjusted interest coverage ratio, identifies the breach of the debt covenant, and discusses its impact on the company or suggests possible solutions to resolve the issue.

20.9%

Highly competent — The candidate provides a reasonable computation of the adjusted interest coverage ratio, identifies the breach of the debt covenant, discusses in depth its impact on the company, and suggests possible solutions to resolve the issue.

0.1%

(Candidates were expected to compute an adjusted interest coverage ratio and to discuss the impact on

the company or suggest possible solutions to resolve the issue. Candidates were not directed to this

indicator; however, it was mentioned that the company had a debt covenant related to its loan with the

bank. Also, the controller noted that LHT needed to finish the audit on time this year because it had

made a few late payments on the loan and the bank was not willing to forgive any more late payments

or other defaults. In addition, she was under the impression that LHT had met its debt covenant this

year.)

(Candidates struggled with this indicator. Most candidates attempted to compute the adjusted ratio, but

most who recognized that the covenant was in breach after the required accounting adjustments

addressed the implications from an audit perspective only, mentioning they may require a going-

concern note. While candidates were given credit for such a discussion within the assurance indicator,

the Board had hoped that candidates would also discuss the broader impact on the operations of LHT

or provide recommendations to management. Very few candidates did so, and the Board was

disappointed that so few candidates cautioned management with regard to the risk that the breach

presented to the operations of LHT.)



(Candidates performed reasonably well on some aspects of this simulation but struggled with others.

While most candidates addressed each of the indicators, they generally performed better on Primary

Indicators #1 and #2, where they seemed most comfortable in their role. Candidates performed

reasonably well when it came to discussing the various accounting issues, and they provided valid audit

procedures to address the key risk areas from an audit perspective. However, candidates seemed to

have difficulty discussing the taxation issues. While most candidates were able to identify some of the

relevant adjustments when computing revised taxable income, some had a difficult time discussing the

rationale for their adjustments from a taxation perspective. Candidates also struggled to critically

evaluate the results of their calculation of the debt covenant and, therefore, did not recognize the

impact the breach could have on the operations of LHT. The Board encourages candidates to always

step back, evaluate the results of their analysis, and raise any issues they feel should be brought to the

client’s attention in order to provide them with meaningful advice and guidance.)



Jane and Joe Smith have owned a family-run hemp farm, Hemp Co., in southern British Columbia since

1998. The Smiths are interested in hemp because of the crop’s environmental sustainability. Hemp Co.

has a good reputation in the hemp fibre production industry.

A few years ago, a close friend of the Smiths was diagnosed with cancer. Her doctor prescribed medicinal

marijuana, and the Smiths were impressed by how the marijuana helped her. In 2012, when the Canadian

government changed the regulations to allow for the commercial production of medicinal marijuana, the

Smiths jumped at the opportunity to become licensed medicinal producers and filed the prescribed

application.

During 2013, Hemp Co. was granted a licence to produce medicinal marijuana for the 2013 and 2014

calendar years. However, since the licence was granted in July of 2013, Hemp Co. could not benefit from

the 2013 growing season. The licence is subject to the following conditions: (i) that the licensee abides by

all requirements of the licence, and (ii) that the licensee produces financial statements in accordance with

Accounting Standards for Private Enterprises (ASPE). The government has notified Hemp Co. that it will

be audited for compliance with the licensing regulations prior to its licence being renewed. The medicinal

marijuana industry is heavily regulated. The Smiths already comply with all licensing requirements for

hemp fibre production, so they are comfortable that compliance with the new licence will not be an issue.

Information on their current business is provided in Exhibit I. Excerpts from the regulations for medicinal

marijuana are provided in Exhibit II.

It is now October 27, 2014. Hemp Co. has hired you, CA, as a consultant to advise on how it can meet all

government requirements for both 2013 and 2014, since year-end is fast approaching and the licence will

be due for renewal. Jane and Joe provided information on the company’s accounting practices and

operating costs during a recent meeting (Exhibit III). Hemp Co. has a December 31 year-end and, up until

now, has prepared its financial statements for tax purposes only.

The Smiths are also looking for your help with another matter. Exhibit IV provides the details of a

proposed rental agreement with a farmer who is looking for additional farmland. Joe would like your

advice on whether he should accept the offer and lease the land at the proposed price. He would also like

to know how Jane should account for the transaction.



EXHIBIT I

BACKGROUND ON HEMP CO.

Hemp is a tall, fibrous plant from the cannabis family. It is a renewable resource that produces seeds and

fibre annually. The seeds and fibre can be turned into a variety of commercial goods, including rope,

clothing, construction materials, food items, and health and beauty products. In the same family as

marijuana, hemp is bred to have low levels of tetrahydrocannabinol (THC), the hallucinogenic component

of marijuana, and therefore is not classified as a drug.

Hemp Co. produces a strain of hemp that provides large amounts of fibre. The crop is sold to a wholesaler

out of province, and is eventually turned into clothing.

Under hemp production regulations

all harvested inventory must be kept in a secure, locked location;

records must be kept of all hemp fibre sales, including names of purchasers and quantities; and

only the licensee and those under its direction may handle the hemp.

The hemp licence is in Hemp Co.’s name, with Jane and Joe listed as the corporate officers.

Hemp Co. currently employs four people, one of whom was hired at the beginning of 2014 to solely work

on the medicinal marijuana operations, while the other three work 100% on hemp operations. Joe notes

the employees are “like family,” and, except for the employee hired in 2014, have been with the Smiths

for a long time.

The operation consists of 20 hectares of farmable land, plus land on which there are two large buildings.

One is the barn, where the hemp is stored after harvesting and before shipment. The other building

contains the offices and a large space that Joe has converted into a drying and packaging facility for

medicinal marijuana. Both buildings are locked and each door has camera surveillance. Employees must

use a key and a security code to enter the buildings. The buildings are set well inside the property, and the

perimeter of the property is fenced. Joe is comfortable that access is limited.

Hemp Co. currently has a licence to grow one hectare of medicinal marijuana. It is possible the

government will authorize more hectares in the future. However, any future expansion of the medicinal

marijuana is expected to be limited and would be subject to approvals from the government authorities.

Jane maintains the accounting records. She uses basic accounting software to prepare the financial

statements.



EXHIBIT II

EXCERPTS FROM GOVERNMENT LICENSING REGULATIONS

FOR MEDICINAL MARIJUANA

A licensed producer must

provide a detailed description of the security measures at the proposed site;

provide a reconciliation of medicinal marijuana production with sales and inventories of medicinal

marijuana for the period reported on;

notify the Ministry of Agriculture (the Ministry) within five days after any change to the method used

for record keeping or the security of the site; and

destroy any marijuana in excess of the licensed amount, under the supervision of the Ministry.

Medicinal Marijuana Security Measures

An experienced person must be designated as in charge. Three other people must be designated as

assistants to the person in charge. These people must be identified with signage posted at the entrance

to the facilities.

The person designated as in charge or one of the assistants must be on site at all times, and any visitors

must be accompanied by the designated person in charge or one of the assistants. Designates must

account for the actions of other people (employees and visitors) when those people access the site and

the storage areas.

Access to the medicinal marijuana must be controlled by

o prevention of unauthorized access to fields and storage areas;

o surveillance cameras at all times on both fields and storage areas; and

o monitoring of surveillance at all times, with any intrusion or attempted intrusion reported to the

Ministry.

All officers, directors, and employees must have an annual criminal record check and have had no

criminal record for the past 10 years.

Reconciliation of Production with Inventory and Sales

A system is required to identify and track medicinal marijuana once harvested.

Sales must be tracked. A licensed producer may sell to

o other licensed producers;

o licensed sellers of medicinal marijuana;

o Ministry of Health representatives; and

o individuals with prescriptions for medicinal marijuana.



EXHIBIT III

NOTES FROM MEETING WITH JANE AND JOE SMITH

1. Hemp fibre has had a stable market value of $4.60 per kilogram. One hectare produces

approximately 6,000 kilograms per year. Hemp Co. sells all its hemp fibre to one wholesaler.

Economic dependence is not a concern because there is a strong market for hemp fibre. With only a

single client, no subledgers for sales or accounts receivable have been maintained.

2. To support hemp farming in the province, the government is providing a subsidy by guaranteeing a

minimum selling price of $5.80 per kilogram when the product is sold. Because this amount is

guaranteed by the government, Hemp Co. has been recording the minimum guaranteed selling price

immediately when the hemp is harvested.

3. Revenue on the sale of medicinal marijuana is recognized on shipment, and all shipping costs are

assumed by the clients. The Smiths have set the price of their medicinal marijuana at $4 per gram.

Hemp Co.’s licence allows it to grow a maximum of 150,000 grams per hectare. Hemp Co. largely

sells to licensed sellers and maintains the name and address of each one.

4. A number of individuals purchase medicinal marijuana directly from Hemp Co. Upon the first visit,

Jane verifies that each client has a valid doctor’s prescription, and she subsequently sells to them

when they request it.

5. Sales are tracked in total in the accounting software. Jane segregates the medicinal marijuana sales

amount from hemp fibre sales by backing out the sales of hemp fibre to the wholesaler from the total

sales value.

6. Although related products, hemp and marijuana plants need to be segregated by an unsown area

because cross-pollination can lead to reduced effectiveness of the medicinal marijuana. Joe has

segregated the fields, fenced in the marijuana, and included a buffer zone to ensure quality.

Therefore, one hectare of medicinal marijuana uses three hectares of land.

7. Like many farms, Hemp Co. has undertaken research to develop better strains of hemp. Joe has been

working on seeds that are resistant to mildew from damp soil. Market research has shown that there

is a significant need for hardier seeds as the hemp production industry expands to different climates.

Joe’s test results have shown an ability to withstand wet soils, and he is very excited about the sale of

the seeds in the near future. The following costs related to Joe’s research have been capitalized in

2014:

Labour $ 17,000

Market research 4,150

Seeds 3,500

Testing of seeds 8,450

Pesticides 4,950

Other 1,100

$

39,150





8. In June of this year, Hemp Co. replaced its old septic tank system, which it had for 15 years. The

Smiths were surprised to learn that, under provincial regulations, the site had to be cleaned up. The

clean-up cost was $25,000, and an additional $15,000 was incurred to prepare the site for the new

septic tank system.

9. Joe plans to capitalize the costs of your consulting fees and the start-up costs for the medicinal

marijuana as an intangible asset. He thinks Hemp Co. will farm medicinal marijuana for at least 10

years, and therefore believes this is an appropriate amortization period.

The start-up costs were incurred in 2013 and include the following:

Removal of hemp plants and purification of soil $4,200

Fence to surround marijuana field $9,000

Legal fees to obtain licence $6,200

Consultant fees to be determined

Labour costs for disposing of waste after harvest $7,850

Specialized equipment $82,000

10. Hemp plants are subject to regular testing for levels of THC. During the year, a batch of hemp was

found to exceed the maximum allowable amount and had to be destroyed. The affected plants were

isolated to one hectare of hemp that had been produced from the strain of seeds engineered as part of

Joe’s ongoing research.

11. The specialized equipment purchased for medicinal marijuana includes a $23,000 industrial dryer.

Hemp Co. currently owns a similar piece of equipment for hemp fibre; however, the equipment is old

and is not to the standard required for medicinal marijuana. Hemp Co. uses the new dryer for

marijuana, and any additional capacity is used for hemp fibre. To date, the new dryer has handled

most of the production, but Joe is maintaining the old equipment for peak harvest times in the future.

The old equipment has a book value of $10,500.





12. The projected farming costs for Hemp Co.’s 2014 financial year are as follows:

Note

Fertilizer $ 10,350

Water 1 $ 18,500

Pesticides — hemp $ 1,075

Pesticides — marijuana 2 $ 13,000

Crop insurance — hemp $ 1,600

Crop insurance — marijuana 3 $ 145,000

Fuel costs 4 $ 35,000

Labour $ 165,250

Notes:

1. The medicinal marijuana requires 50% of the water used.

2. Pesticide for medicinal marijuana has a higher cost than for hemp due to increased regulations, since

the product is for human consumption.

3. Insurance premiums for the medicinal marijuana are higher as a result of the greater risk associated

with growing this type of crop.

4. Since Hemp Co. started growing medicinal marijuana, its total cost of fuel for operating tractors and

other farming equipment has increased by 50%.



EXHIBIT IV

PROPOSED RENTAL AGREEMENT

Joe has been approached by a farmer who would like to rent land from the Smiths. Joe is open to the idea,

provided he will not lose money. Normally, Hemp Co. would use this land to produce either hemp or

medicinal marijuana.

Rental Request (As Proposed by the Farmer)

The farmer would rent two hectares for a period of 10 years.

The farmer would have the right to sub-let the land.

The rental payments would be set at $54,000 per annum for the extent of the rental agreement.

At the end of the lease, the land would revert to Hemp Co.


EVALUATION GUIDE

PAPER III, SIMULATION 2 — HEMP CO.










Primary Indicator #1 The candidate provides advice on putting controls in place to meet the licence requirements and prepare for the compliance audit. The candidate demonstrates competence in Assurance.

Competencies


Although Hemp Co. has successfully abided by the terms of its licence for producing hemp fibre, Joe and

Jane appear to have significantly underestimated the more stringent requirements surrounding medicinal

marijuana. The government has notified Hemp Co. that it will be audited for compliance prior to its

licence being renewed. Hemp Co. has hired us as consultants to ensure that it is able to meet the

government requirements as the year end approaches and the licence comes due for renewal. It is

important to tighten up some of the required controls in preparation for the audit.

Reconciliation of Production with Inventory and Sales

The accounting process at Hemp Co. currently appears to be too simplistic. One of the criteria laid out by

the government is that the company must identify and track medicinal marijuana once harvested. Hemp

Co. does not seem to currently have the systems in place to allow this to happen.

In order to address this requirement, Hemp Co. will need to begin using the following tools:

Inventory Tracking

A perpetual inventory system should be put in place to track marijuana inventory as it is harvested. Dried

marijuana should be weighed, bagged, and identified with numerical tags and recorded in an inventory

subledger. This would allow for tracking of the product as it is produced. As the marijuana is sold, the

numerical tags should be tracked and removed from the inventory subledger.


A physical inventory count should be performed on a regular basis and compared to the amounts recorded

in the perpetual inventory system. This would allow Hemp Co. to determine whether any theft has

occurred.

Sales Tracking

Currently, Jane segregates the medicinal marijuana sales from the hemp fibre sales by backing out the

sales of hemp fibre to the wholesaler from the total sales value. However, this is unlikely to be sufficient

for the government, which requires harvested marijuana to be tracked. In this case, the use of a sales

subledger could be helpful. A sales subledger is a detailed listing of all sales making up the total sales

number on the income statement. This subledger should include the date of the sale, the amount of the

sale, and the customer’s name. Depending on the system used, it should also include the quantity and

price of the product sold. It is important to account for all sales, including those made to individuals, not

just to the wholesaler.

The tracking of both sales and inventory will allow Hemp Co. to reconcile what it produces, sells, and has

on hand at any point in time.

(Most candidates identified this as an issue to address but struggled to explain why the current method

is not sufficient. In addition, most candidates who addressed this issue were not able to provide a

recommendation that was specific enough for Joe and Jane to understand how to implement it.)

Restrictions on Sales

In addition to tracking sales, Hemp Co. must ensure that sales are made only to designated parties who

have permission to purchase marijuana under the government’s licensing regulations. Hemp Co. needs to

be able to support that it has complied with this requirement. Therefore, all parties that purchase from the

company should provide proof of eligibility. Evidence of eligibility should be kept on file and updated

regularly by Hemp Co.

The greatest risk for sales to inappropriate parties is to individuals. At present, it appears that a customer’s

prescription is checked the first time they make a purchase, but that no further support is obtained in

future purchases. For individuals, Hemp Co. should keep copies of prescriptions, and the quantity and

expiration of prescriptions should be monitored to ensure that no marijuana is provided to an

unauthorized party and that the amounts provided are not over the prescribed amounts. To ensure the

prescriptions are valid, it may be necessary to check with the pharmacist or the doctor. (Hemp Co. will

need to obtain each purchaser’s permission to verify their information.)

(Most candidates addressed this weakness and provided a reasonable explanation of its implication, as

well as a valid recommendation to address the issue.)

Security Measures

Under the regulations for selling marijuana, specific security measures must be in place. The criteria for

hemp appear to be reasonably straightforward: inventory must be maintained in a secured, locked

location, and only the licensee or those under their direction are allowed to handle it. The conditions for

marijuana may seem similar on the surface, but are far more stringent when the details are examined.


For marijuana, the following criteria must also be met:

Designated Responsible Person

Hemp Co. must, at all times, have on site one designated person or an assistant responsible for the

marijuana. Although Joe and Jane may assume they and the new marijuana employee have taken on these

roles, the two roles must be documented and the names of the designated people must be displayed at the

entrance to the facilities to support this criterion. They should also assess whether someone else is more

appropriate for either role, since the designated-in-charge person or an assistant must be on site at all

times.

Access to Medicinal Marijuana

Employee Access

The marijuana must be secured at all times and should only be accessible when the designated person or

an assistant is present. Currently all employees have keys and the access code to the storage facilities,

allowing them unrestricted access. Both the perimeter and the buildings should be secured in such a way

that the presence of the designated person or one of the assistants is required for access to be obtained.

Therefore, the designated person and the assistants should be the only ones with keys and access codes to

the areas containing marijuana.

Third-Party Access

There is no indication of how access to the fields is controlled to prevent unauthorized access. While the

field is fenced, the fence should be high and secure enough to prevent intrusion. In addition, cameras on

the doors do not prevent access to the building through windows or other access points. Cameras should

provide views of the area surrounding the storage facility and the entire field, and should be monitored as

per the licence requirements. This may require hiring additional employees or an external security

company.

Criminal Record Checks

There is currently no indication that criminal record checks have been performed or that records have

been maintained for any of the officers, directors, and employees. Regardless of the Smiths’ trust in their

employees, in order to meet the regulation from the government, Hemp Co. must obtain criminal record

checks on all officers, directors, and employees to verify that none have criminal records. This should be

done immediately, and a policy should be put in place to obtain annual criminal record checks for all

employees.

Destruction of Excess Medicinal Marijuana Production

Under the licensing regulations, Hemp Co. must destroy any marijuana in excess of the licensed amount,

which is currently 150,000 grams. There is no indication that excess marijuana was produced in 2014, but

we should ensure Hemp Co. maintains adequate records of production amounts and, in the event that

excess marijuana is destroyed, that the records reflect that and the representative of the Ministry of

Agriculture (the Ministry) signs a document or log book confirming that he or she has attended and

supervised the destruction of the excess production.


Hemp Co. could consider hiring an outside company to destroy the excess marijuana, as long as the

company is approved by the Ministry. Hemp Co. could maintain copies of the invoices and supporting

documentation so that we could confirm that the destruction was performed. By maintaining the log book

signed off by the representative of the Ministry, we would have evidence that the destruction was

performed under the supervision of the Ministry.

(Most candidates were able to identify several of the security measure requirements and provided

adequate recommendations to address them. The most frequently addressed issues were those related to

the designated responsible person, access to marijuana, and criminal record checks.)

Compliance with Licensing Regulations

Implementing these recommended controls will allow Hemp Co. to be in compliance with the licensing

regulations by the end of 2014. However, the Ministry may be concerned that the company was not in

compliance in both 2013 and 2014, as required. It is possible that the Ministry would be more lenient up

to this point, since the growing season had passed when Hemp Co. started in 2013 and the company is

still in its start-up phase. I would recommend Joe and Jane approach the Ministry to discuss this issue.

For Primary Indicator #1 (Assurance) the candidate must be ranked in one of the following five categories:

Percent Awarded


8.8%

Reaching competence — The candidate discusses some of the areas in which Hemp Co. is not complying with the licence and recommends improvements so that Hemp Co. will be able to meet the licence requirements.

37.9%

Competent — The candidate discusses several of the areas in which Hemp Co. is not complying with the licence and recommends improvements so that Hemp Co. will be able to meet the licence requirements.

52.6%

Highly competent — The candidate discusses most of the areas in which Hemp Co. is not complying with the licence and recommends improvements so that Hemp Co. will be able to meet the licence requirements.

0.1%

(Candidates were asked to advise on how Hemp Co. could meet all the government requirements for

both 2013 and 2014 in light of the upcoming renewal of the company’s medicinal marijuana licence.)

(Candidates were expected to address several of the licensing requirements and provide valid

recommendations on each. To achieve competence, the Board expected candidates to address several

areas of non-compliance and provide specific, valid recommendations. Candidates generally performed

satisfactorily on this indicator.)


(Weak candidates were able to identify the areas where Hemp Co. was currently not in compliance, but

they struggled to provide specific recommendations. As a result, their discussions lacked depth because

they regurgitated case facts, which did not provide much value to the client. In addition, many weak

candidates did not provide a balanced approach, choosing to focus on only one area of the licensing

requirements, such as the required security measures.)

(Some candidates unnecessarily spent time explaining the reporting options available should Hemp Co.

require an audit or review of its compliance with the licence requirements. There were no case facts in

the simulation to suggest that an audit or review of compliance would be required. As a result, these

candidates inappropriately allocated time to a discussion that was not useful given their role.)


Competencies


Accounting Issues

Government Subsidy

As part of its effort to support hemp farming in the province, the government is guaranteeing a minimum

selling price of $5.80 per kilogram, which currently generates a subsidy of $1.20 ($5.80 − $4.60) per

kilogram for Hemp Co.

Handbook Section 3800, Government Assistance, paragraph 17 provides that “government assistance

toward current expenses or revenues shall be included in the determination of net income for the period.”

Based on the guidelines provided in paragraph 18, the government subsidy should be presented as

additional revenue. As well, per paragraph 27, it should only be recorded when “there is reasonable

assurance that the enterprise has complied and will continue to comply with all the conditions.” Thus,

based on the discussion on revenue recognition in the following section and the guidelines for recording

the government subsidy, Hemp Co. should only record the subsidy of $1.20 per kilogram once the hemp

has been sold, since that is when the government condition has been met.

(This is the issue candidates addressed the least frequently on this indicator. However, most candidates

who did address it were able to provide a complete discussion.)

Revenue/Inventory Recognition

a) Hemp Fibre

Hemp Co. is currently recording the minimum selling price of $5.80 per kilogram when the hemp is

harvested. The company has likely booked the increase in value to revenue and the offset to inventory.


Handbook Section 3400, Revenue, paragraph 4 states that “revenue from sales and service

transactions shall be recognized when the requirements as to performance set out in paragraph

3400.05-.06 are satisfied provided that at the time of performance ultimate collection is reasonably

assured.”

Paragraph 5 specifically provides the following:

In a transaction involving the sale of goods, performance shall be regarded as having been

achieved when the following conditions have been fulfilled:

(a) the seller of the goods has transferred to the buyer the significant risks and rewards of

ownership, in that all significant acts have been completed and the seller retains no continuing

involvement in, or effective control of, the goods transferred to a degree usually associated with

ownership; and

(b) reasonable assurance exists regarding the measurement of the consideration that will be

derived from the sale of goods, and the extent to which goods may be returned.

Even though the government is providing a minimum guaranteed selling price of $5.80 per kilogram,

this guaranteed amount is only available upon the sale of the product. Performance has not been

achieved until the product is sold (in other words, the risks and rewards transfer to the wholesaler upon

shipment). Therefore, Hemp Co. should not record either the sale price or the subsidy (based on the

minimum guaranteed selling price) until the product is sold. If the subsidy started prior to 2014, the

2013 financial statements will need to be restated to adjust for this change.

This issue can also be considered from the inventory perspective. Handbook Section 3031,

Inventories, paragraph 4 states that “this Section does not apply to the measurement of inventories:

(a) held by producers of agricultural and forest products, agricultural produce after harvest, and

minerals and mineral products, to the extent that they are measured at net realizable value in

accordance with well-established practices in those industries; when such inventories are measured at

net realizable value, changes in that value are recognized in net income in the period of the change.”

Therefore, if there is a well-established practice in the hemp industry to measure the inventory at net

realizable value, the hemp could be measured at $5.80 per kilogram. Otherwise, the inventory should

be carried at the lower of cost or net realizable value. Given the contribution margin hemp provides

(see later in this report), cost will likely be the lower value, and inventory should be recoded at that

amount, assuming no well-established practices.

b) Medicinal Marijuana

The current revenue recognition policy for the medicinal marijuana is in accordance with Handbook

Section 3400, Revenue guidelines because the revenue is recorded only upon shipment of the product.

Since Hemp Co. does not cover shipping costs, it is reasonable to conclude that the risks and rewards

were transferred to the sellers at that time.

(More than half of the candidates addressed the recording of hemp at the minimum guaranteed selling

price and discussed the issue in sufficient depth. Candidates who addressed this issue did a good job of

discussing the revenue recognition criteria (performance, measurement, and collectability) and focused

their discussion on the criterion that had not been met (performance).)


Research and Development

Hemp Co. has been capitalizing the costs related to developing seeds that are more resistant to mildew

from damp soil.

Handbook Section 3064, Goodwill and Intangible Assets addresses the requirements to capitalize

development costs:

.41 An intangible asset arising from development (or from the development phase of an internal

project) is recognized if, and only if, an entity can demonstrate all of the following:

(a) the technical feasibility of completing the intangible asset so that it will be available for use

or sale;

(b) its intention to complete the intangible asset and use or sell it;

(c) its ability to use or sell the intangible asset;

(d) the availability of adequate technical, financial and other resources to complete the

development and to use or sell the intangible asset;

(e) its ability to measure reliably the expenditure attributable to the intangible asset during its

development; and

(f) how the intangible asset will generate probable future economic benefits. Among other

things, the entity can demonstrate the existence of a market for the output of the intangible asset

or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.

A market for the improved seeds, should they be viable, exists since market research has shown there is a

significant need for hardier seeds. It appears the intention to complete and ability to use or sell is met, as

Joe is clearly enthusiastic about their potential. The availability of resources does not appear to be a

concern given that marijuana is providing significant revenue (see later in this report) and Hemp Co. has

measured costs related to the development to date. Should the asset be produced, the ready market would

suggest that it will generate economic benefits.

The question surrounds technical feasibility. Given that the seeds appear to have produced hemp with a

higher THC level than is permitted, there is a concern that the process used to breed the seeds to be more

mildew resistant also elevated their THC levels. If Hemp Co. is not able to rectify this, it will not be able

to sell the seeds. At this stage, it would appear that Hemp Co. is unable to support technical feasibility

and is therefore still in the research phase. The full amount of $39,150 should be expensed.

(This was the topic most frequently addressed by the candidates. However, only roughly half of the

candidates who addressed this issue discussed it in sufficient depth. The Board expected candidates to

apply the research and development criteria and recognize the key case fact demonstrating that

technical feasibility would likely not be met, which was that THC levels were higher than what is

permitted, and thus the seeds could not be sold currently as is. Many candidates did not integrate this

case fact into their analysis. Instead, most candidates jumped immediately to conclude on whether the

costs could be capitalized, without supporting their conclusion with the appropriate analysis.)

Septic Tank System

As a result of provincial regulations, Hemp Co. had to spend $25,000 to clean up the site where the old

septic tank system was installed. That system had been built 15 years ago. Hemp Co. also incurred

$15,000 to prepare the site for the new septic tank system.


a) Asset Retirement Obligation (ARO)

Handbook Section 3110, Asset Retirement Obligations, paragraph 5 provides that “an entity shall

recognize a liability for an asset retirement obligation in the period in which it is incurred when a

reasonable estimate of the amount of the obligation can be made.” As well, such an ARO shall be

measured in accordance with paragraph 9 at the “best estimate of the expenditure required to

settle the present obligation at the balance sheet date,” with an equal amount to be recorded to

the asset upon initial recognition.

We recommend that Hemp Co. apply the guidelines of Handbook Section 1506, Accounting

Changes, so that paragraph 27 is applied to the amount and the error is corrected by correcting the

financial statements retrospectively and “restating the opening balances of assets, liabilities and

equity for the earliest period presented.”

The system would have been built in mid-1999 (15 years ago), and at that time, an amount of the

present value of the liability should have been recorded to property, plant and equipment (PP&E)

and ARO. Assuming a 5% discount rate, the amount that would have been recorded at that time is

$12,026 (FV = 25,000, rate = 5%, period = 15 years). As of the beginning of 2014, the net PP&E

balance will have been amortized to $401 remaining ($12,026 ÷ 15 years × 0.5 years) and the

ARO balance will have been accreted to $24,398. As a result, the 2014 opening balance of the net

PP&E account will be restated to $401, the ARO account to $24,398 (FV = 25,000, rate = 5%,

period = 0.5 years), and the opening retained earnings to $23,997 ($11,625 amortization +

$12,372 accretion for the past 14.5 years).

As well, the 2013 comparative numbers would be adjusted, so that the ending balance of the net

PP&E account would be increased by $1,203 ($12,026 ÷ 15 years × 1.5 years) and the ARO

balance would be increased by $23,236 (FV = 25,000, rate = 5%, period = 1.5 years).

Depreciation expense would be increased by $802, accretion expense would be increased by

$1,162, and the opening retained earnings would be decreased by $22,033 ($10,823

amortization + $11,210 accretion for the past 13.5 years).

Now that Hemp Co.’s management is aware of the obligation, it should set up a new ARO with

respect to the new septic tank system that was installed in the current year. The best estimate of

the net present value of the clean-up costs will be added to net PP&E, and a liability will be set up

for $12,026 (FV = 25,000, rate = 5%, period = 15 years), which would thereafter be amortized

and accreted.

Hemp Co. should review its other PP&E (e.g., drying equipment) to determine whether additional

ARO needs to be recorded.


b) Site Preparation Costs for New Septic Tank

Handbook Section 3061, Property, Plant and Equipment, paragraph 5 indicates that the “site

preparation costs” shall be included in the cost of the related item of PP&E. Such costs should

therefore be added to the cost of the new septic tank and amortized over the useful life of the item

of PP&E to which it relates.

(A little over half the candidates addressed the ARO and site preparation costs issue. However, most

discussions contained technical weaknesses, such as not understanding that the obligation would be

measured at the present value of the estimated future cost, or that the offset to the liability is an

amount to be recorded to the asset.)

Start-Up Costs

Costs related to the start-up of a line of business should be assessed based on the nature of the cost and

capitalized or expensed accordingly. Several of the items included as start-up costs should be capitalized

as tangible assets. Handbook Section 3061, Property, Plant and Equipment identifies tangible capital

assets as items “that are held for use in the production or supply of goods or services, have been acquired

constructed or developed with the intention of being used on a continuing basis and are not intended for

sale in the ordinary course of business.”

Removal of Hemp Plants and Purification of the Soil

The cost incurred to enhance the service potential of an item of property, plant and equipment is a

betterment (Section 3061, paragraph 14). Although the land was already owned by Hemp Co., preparation

costs of the land were necessary to allow for the production of marijuana. This equates to a betterment

because it enhances the service potential and provides for future economic benefit as a result of sales of

the crop. This cost should be capitalized as a cost of the land.

Fence and Specialized Equipment

Both the fence and the specialized equipment are tangible capital assets. They have been acquired as long-

term assets that are necessary for the production of the marijuana. These costs should be separately

capitalized and amortized over their useful lives.

Legal and Consultant Fees

The legal fees and consultant fees may be considered intangible assets.

Under Handbook Section 3064, Goodwill and Intangible Assets, paragraph 12:

An asset meets the identifiability criterion in the definition of an intangible asset when it

(a) is separable (i.e., is capable of being separated or divided from the entity and sold,

transferred, licensed, rented or exchanged, either individually or together with a related contract,

asset or liability); or

(b) arises from contractual or other legal rights, regardless of whether those rights are

transferable or separable from the entity or from other rights and obligations.


The legal fees surrounding the obtaining of the licence arise from a contractual right that Hemp Co. now

holds. If the fees are a required cost of the process, it is appropriate to capitalize them with the licence.

Because the initial licence is for only two years, Joe and Jane need to consider whether the legal advice

relates just to the two-year licence or if the benefit extends to licence renewals. To the extent that Hemp

Co.’s licence will be renewed, initial costs in acquiring it should be amortized over a reasonable lifetime

for the licences.

The consulting fee for my time, however, is not a cost directly attributable to the licence — the fee arose

after the licence was obtained and was not necessary to acquire the asset. The fee should be expensed.

Labour Costs for Disposing of Waste after Harvest

These costs were incurred once the first crop had been grown and harvested, so they are not considered

“pre-operating” costs. Therefore, in accordance with Section 3064, paragraph 53, they should be

expensed.

Since the start-up costs were incurred in 2013, the changes discussed above will need to be made

retrospectively and the financial statement will need to be restated.

(Approximately half the candidates addressed the start-up costs issue in some capacity. However, most

candidates jumped to the correct treatment (for example, that the fence and specialized equipment

should be capital assets) without supporting their conclusion with the appropriate Handbook criteria

or case facts. Candidates often applied the intangible asset criteria to the entire start-up cost amount

without understanding that various components made up the amount. The most commonly discussed

issues were the fence and specialized equipment, and the legal and consulting fees.)

Drying Equipment

Hemp Co. purchased new drying equipment that is required for producing marijuana. As an added benefit,

this equipment can be used for most of the company’s hemp production too. During peak harvest times,

the old equipment can be used for the excess hemp.

Per Handbook Section 3063, Impairment of Long-Lived Assets, paragraph 9, “A long-lived asset shall be

tested for recoverability whenever events or changes in circumstances indicate that its carrying amount

may not be recoverable.”

Because the old equipment is now used only in high activity periods and will not be the primary dryer,

there has been a change in circumstances, which indicates that an impairment test is necessary.

In order to test for impairment, Hemp Co. will need to compare the carrying amount of the dryer

($10,500) to the undiscounted cash flows it expects to receive from its use. Future cash flows are made up

of the cash flows generated by use of the equipment and by its eventual disposition.

If the carrying amount is recoverable (in other words, the undiscounted future cash flows are higher than

the carrying amount), no impairment exists. If the amount is not recoverable, the dryer must be written

down to its fair value, which is either the amount of the consideration that would be agreed upon in an

arm’s length transaction (its sale) between knowledgeable, willing parties who are under no compulsion

to act, or by determining the net present value of the future cash flows that can be generated by the old

equipment, including its residual value.


(Approximately half the candidates addressed this issue. Most candidates who addressed this issue

were able to tie relevant case facts to the correct Handbook criteria and conclude on the appropriate

treatment. Weak candidates confused the ASPE impairment criteria with the IFRS ones, leading to an

incorrect discussion.)

Lease

Hemp Co. is considering leasing out some land that it currently uses for producing hemp to a farmer. The

lease would involve two hectares for a proposed 10 years, and then the land would revert back to Hemp

Co. Per Handbook Section 3065, Leases, from the point of view of the lessor, this can be accounted for as

either a sales-type, a direct financing, or an operating lease:

.09 A lease that transfers substantially all of the benefits and risks of ownership related to the

leased property from the lessor to the lessee shall be accounted for as a capital lease by the

lessee and as a sales-type or direct financing lease by the lessor.

.10 A lease in which the benefits and risks of ownership related to the leased property are

substantially retained by the lessor shall be accounted for as an operating lease by the

lessee and lessor.

The Handbook provides several criteria to consider in determining whether substantially all of the

benefits and risks of ownership have been transferred:

.06 From the point of view of a lessee, a lease normally transfers substantially all of the benefits

and risks of ownership to the lessee when, at the inception of the lease, one or more of the

following conditions are present:

(a) There is reasonable assurance that the lessee will obtain ownership of the leased property

by the end of the lease term. Reasonable assurance that the lessee will obtain ownership

of the leased property is present when the terms of the lease result in ownership being

transferred to the lessee by the end of the lease term or when the lease provides for a

bargain purchase option.

(b) The lease term is of such a duration that the lessee will receive substantially all of the

economic benefits expected to be derived from the use of the leased property over its life

span. Although the lease term may not be equal to the economic life of the leased

property in terms of years, the lessee is normally expected to receive substantially all of

the economic benefits to be derived from the leased property when the lease term is

equal to a major portion (usually 75 percent or more) of the economic life of the leased

property. This is due to the fact that new equipment, reflecting later technology and in

prime condition, may be assumed to be more efficient than old equipment that has been

subject to obsolescence and wear.

(c) The lessor is assured of recovering the investment in the leased property and of earning a

return on the investment as a result of the lease agreement. This condition exists if the

present value, at the beginning of the lease term, of the minimum lease payments,

excluding any portion thereof relating to executory costs, is equal to substantially all

(usually 90 percent or more) of the fair value of the leased property, at the inception of

the lease. In determining the present value, the discount rate used by the lessee is the

lower of the lessee's rate for incremental borrowing and the interest rate implicit in the

lease, if known.


.07 From the point of view of a lessor, a lease normally transfers substantially all of the benefits

and risks of ownership to the lessee when, at the inception of the lease, all the following

conditions are present:

(a) any one of the conditions in paragraph 3065.06;

(b) the credit risk associated with the lease is normal when compared to the risk of collection of

similar receivables; and

(c) the amounts of any unreimbursable costs that are likely to be incurred by the lessor under

the lease can be reasonably estimated. If such costs are not reasonably estimable, the

lessor may retain substantial risks in connection with the leased property. For example,

this may occur when the lessor has a commitment to guarantee the performance of, or to

effectively protect the lessee from obsolescence of, the leased property.

However, paragraph 6 also says: “In view of the fact that land normally has an indefinite useful life, it is

not possible for the lessee to receive substantially all the benefits and risks associated with its ownership,

unless there is reasonable assurance that ownership will pass to the lessee by the end of the lease term.”

Since the land will revert to Hemp Co. upon termination of the lease, there is no assurance the ownership

will pass. Therefore, the lease should be accounted for as an operating lease. The lease payment of

$54,000 should be brought into income each year.

(Most candidates addressed this issue. Those who did provided sufficient depth in their discussion by

tying case facts to the appropriate Handbook criteria. Some candidates recognized the unique nature

of the land and were therefore able to be efficient in their analysis, going straight to the relevant

Handbook section that related to land.)


Percent Awarded


7.8%

Reaching competence — The candidate identifies some of the accounting issues.

39.4%

Competent — The candidate discusses several of the accounting issues. 52.4% Highly competent — The candidate thoroughly discusses most of the accounting issues.

0.1%

(Candidates were directed to this indicator when they were told that one of the licence conditions was

the production of financial statements in accordance with ASPE. To achieve competence, the Board

expected candidates to address several of the accounting issues in sufficient depth.)

http://www.knotia.ca/Knowledge/Home.aspx?productid=126


(About half of the candidates were able to identify some of the relevant accounting issues and discuss

them in sufficient depth. The most frequently addressed issues were revenue recognition, research and

development, and the capital lease. Strong candidates were able to provide the relevant Handbook

criteria and integrate case facts into their analyses for many of the issues. Weak candidates jumped

immediately to the correct accounting treatment without first explaining why the accounting treatment

was appropriate. Weak responses also contained technical errors or included an analysis of

alternatives that did not exist or were not relevant.)

Primary Indicator #3 The candidate analyzes the lease proposal. The candidate demonstrates competence in Management Decision-Making.

Competencies

VIII-2.3 – Determines and evaluates the entity’s cost-volume-profit relationships (Level A)

Quantitative Considerations

In determining whether to accept the lease proposal, Hemp Co. needs to consider the opportunity cost of

what it is giving up. To rent out two hectares to the farmer, Hemp Co. either gives up one hectare from

the marijuana production and regains the buffer zone (which represents two hectares, of which only one is

returned to hemp production) or discontinues two hectares of hemp production. Below is the calculation

of the contribution margin per hectare for both hemp and marijuana.

Total Hemp Marijuana

Revenues

Sales $ 1,191,600 $ 591,600 $ 600,000 Note 1

Expenses

Fertilizer 10,350 9,775 575 Note 2

Pesticides 14,075 1,075 13,000

Insurance 146,600 1,600 145,000

Fuel costs 35,000 23,333 11,667 Note 3

Water 18,500 9,250 9,250 Note 4

Labour 165,250 123,938 41,312 Note 5

Total expenses 389,775 168,971 220,804

Contribution margin 801,825 422,629 379,196

Hectares required 17 3

Contribution margin per hectare $ 24,861 $ 126,398


Notes:

1. Hemp: 6,000 kilograms × $5.80/kilogram × 17 hectares (i.e., 20 hectares − 2 for buffer area − 1 for

marijuana production)

Marijuana: $4/gram × 150,000 grams/hectare × 1 hectare (farmed)

2. Hemp: $10,350 × 17/18

Marijuana: $10,350 × 1/18

3. Hemp: $35,000 × 100/150

Marijuana: $35,000 × 50/150

4. Water bill is $18,500 total: 50/50 split

5. Hemp: $165,250 × 3/4

Marijuana: $165,250 × 1/4

Hemp Co. has indicated that one additional employee was hired to work solely on the medicinal

marijuana operations. Therefore, for the purpose of our analysis, we have assumed that one-quarter of

the workforce was used for marijuana.

Marijuana produces a contribution margin of $379,196 for three hectares. If marijuana was discontinued,

Hemp Co. could re-sow hemp, which would generate $24,861 in contribution margin for each hectare

(assuming the two buffer hectares are rented out to the farmer, then only the third hectare could be sown

with hemp). The total cost of discontinuing the marijuana to lease the land would therefore be $354,335

($379,196 − $24,861). This accounts for the fact that the marijuana requires a two-hectare buffer zone to

separate it from the hemp.

Discontinuing two hectares of hemp would result in lost contribution of $49,722 ($24,861 × 2).

It is clear from the analysis that if Hemp Co. were to rent land, it would make sense to take the land from

the hemp side of the operations. A minimum amount of $49,722 for the two hectares per year would

cover the lost contribution margin; therefore, the $54,000 rental fee is sufficient.

(Most candidates attempted a quantitative analysis of the contribution margin for hemp and

marijuana. However, many of the calculations contained errors, such as comparing 1 hectare of

revenue to 17 hectares of expenses on the hemp side, or misallocating the common costs between hemp

and marijuana. Some weak candidates performed a contribution margin analysis on only one of the

two activities, not recognizing that an analysis of both hemp and marijuana was required to obtain the

necessary information for evaluating the lease proposal.)

Other Considerations

The rental fee offered is sufficient for the time being. However, Hemp Co. should assess whether there

may be an opportunity for the hemp land to be converted to marijuana in the coming years. Such analysis

should consider any increases in security costs that would be incurred as a result of our recommendations

to comply with the government licence. Joe and Jane may, therefore, wish to charge a premium on the

lease to compensate for this. In addition, it may make sense to try to negotiate a shorter lease term in

order to maintain flexibility should marijuana production limits be increased in the coming years.


Another consideration is that the lease would provide a steady stream of income for Hemp Co., whereas

there is uncertainty related to the other streams of income. For example, there may be no government

subsidy in the future for the hemp fibre, or medicinal marijuana sales may not be as good as expected.

The proposed lease agreement says that the lessee would have the right to sublet the land if desired. This

would mean that Hemp Co. would have no say in who could have access to the land. Regardless of

whether or not the land is subleased, Joe and Jane should consider the impact of leasing the land to a third

party on Hemp Co.’s ability to meet the security requirements set by the government, as well as the

possibility of cross-contamination of its products. In addition, given Hemp Co. does not know who the

sublessees might be, the condition of the land may be worse than expected at the end of the lease.

Finally, consideration should be given to Hemp Co.’s current relations with the wholesaler. Reducing the

quantity available to be purchased may upset the company’s only hemp customer, causing it to lose more

than just two hectares of revenue.

(Most candidates provided some qualitative considerations in addition to their quantitative analysis.)

Recommendation

Based on the quantitative analysis, as well as other considerations, I recommend that Hemp Co. accept the

lease proposal. However, Joe and Jane may want to consider increasing the rent amount or reducing the

lease term, as discussed in the previous section.

(Most candidates provided a recommendation on whether to accept the lease proposal. Candidates

usually started their analysis by calculating the contribution margin of the growing of hemp and

marijuana, followed by a comparison to the proposed rate for the lease. Weak candidates concluded on

the profitability of hemp versus marijuana but did not continue on to compare it to the rate included in

the lease proposal. This incomplete conclusion was not useful for helping the client assess whether the

lease proposal should be accepted.)


Percent Awarded


21.4%

Reaching competence — The candidate attempts a reasonable quantitative analysis of the lease proposal.

50.8%

Competent — The candidate performs a reasonable quantitative and qualitative analysis of the lease proposal and concludes on the offer. 26.8%

Highly competent — The candidate performs a thorough quantitative and qualitative analysis of the lease proposal and concludes on the offer.

0.1%


(Candidates were required to advise on whether Joe and Jane should accept the offer and lease the

land at the proposed price. The Board expected candidates to perform reasonable quantitative and

qualitative analyses of the lease proposal and conclude on the offer in order to achieve competence.)

(Candidates struggled with this indicator. Most candidates identified the need to perform a quantitative

analysis, but did not understand how to approach it. Many candidates did not recognize that it was

important to analyze the contribution margins for both hemp and marijuana before being able to

determine whether the lease proposal should be accepted. In addition, most candidates struggled with

how to allocate the common costs between the two activities. Many weak candidates performed a one-

sided analysis, either analyzing only the revenue or the expenses of both of the activities or calculating

the contribution margin for only one of the activities. Strong candidates not only recognized the need

to perform a quantitative analysis on both activities, but also provided some relevant qualitative

analysis before concluding. There were many important qualitative considerations that a candidate

could have pointed out, and the Board expected candidates to bring some of these to the client’s

attention as part of their analysis.)


III-1.1 − Gathers or develops information and ideas

III-1.2 − Develops an understanding of the operating environment

III-1.3 − Identifies the needs of stakeholders and develops a plan to meet those needs

III-2.1 − Analyzes information or ideas

III-2.2 − Performs computations

III-2.3 − Verifies and validates information

III-2.4 − Evaluates information and ideas

III-2.5 − Integrates ideas and information from various sources

III-2.6 − Draws conclusions/forms opinions

III-3.1 − Identifies and diagnoses problems and/or issues

III-3.2 − Develops solutions

III-3.3 − Decides/recommends/provides advice

III-4.1 − Seeks and shares information, facts, and opinions through written discussion

III-4.2 − Documents in written and graphic form

III-4.3 − Presents information effectively


(Candidates performed well on some aspects of this simulation but not others. Most candidates

performed well on Primary Indicator #1, identifying several areas where Hemp Co. was not in

compliance with the licensing requirements and providing recommendations to address them. For

Primary Indicator #2, candidates generally were able to identify most of the accounting issues, as they

were directed in the simulation. However, some candidates struggled to provide sufficient depth in their

analysis. Candidates performed below expectations on Primary Indicator #3. They were expected to

provide reasonable contribution margin calculations for both hemp and marijuana and compare them

to the lease proposal. They were also expected to provide a qualitative analysis before making a

recommendation. Candidates struggled to provide calculations that allowed for a reasonable

comparison of Hemp Co.’s two activities.)



It is October 13, 2014. You, a CA with the firm of Charles & Carry, LLP (C&C), are called into Tim

Carry’s office. Tim has been the partner in charge of the Bold Spice Ltd. (BSL) account since the

company became a client of the firm.

“I need your help in going through some issues raised by one of our clients, BSL. As you know, BSL

manufactures and distributes perfumes and colognes. The company is looking at acquiring Shiraz Pitstick

Inc. (SPI), a company that manufactures and distributes men’s deodorants. I will forward to you the email

I received from Jeff King, the owner of BSL, on the weekend. I told him that you would give him a call to

discuss this further.”

After you get back to your office, you review the email (Exhibit I), along with excerpts from SPI’s

financial statements (Exhibit II), and call Mr. King. He says, “While we haven’t been involved in the

deodorant market, I think that SPI’s business infrastructure lends itself very well to the perfume and

cologne industry. I’m sending you some additional information (Exhibit III). I want to make sure that I

am paying a fair price for this business. If there is anything I should know related to this purchase, please

enlighten me.”



EXHIBIT I

EMAIL FROM MR. KING

Date: October 10, 2014

From: Jeff King, BSL

Subject: Shiraz Pitstick Inc. (SPI)

Hi Tim,

I think I have a pretty good business opportunity in front of me. I am looking at BSL purchasing the

shares of SPI. Since the recession in 2008, the company’s profits slumped, and it is not clear if it will ever

fully recover. However, what I really want is some of its productive assets. I think its plant and truck fleet

would fit in nicely with the expansion of BSL’s existing product lines. SPI’s owner is offering to sell the

shares only, not the assets. SPI’s owner has indicated that he is willing to sell his shares using the industry

standard of 3.5 times the normalized average earnings before interest, taxes, depreciation, and

amortization (EBITDA).

From the information provided by SPI, I have roughly figured the value of the assets of the business

(Exhibit IV). I have attached excerpts from the financial statements for the years ended December 31,

2012 and 2013, and for the first nine months ended September 30, 2014, to evaluate the offer. SPI’s

financial statements, just like those of BSL, are prepared in accordance with Accounting Standards for

Private Enterprises (ASPE). Please note that the closing of the transaction is planned for November 1,

2014.

SPI has some tax losses available that I would like to get my hands on. I am not interested in continuing

with the deodorant business, so my plan is to sell off any inventory or other assets that we do not need for

our existing business right after the acquisition.

If BSL buys the shares of this company, I want to make sure that BSL is actually getting the assets listed,

that the liabilities are complete, and that all amounts are accurate. What specific procedures could be done

in order to make sure BSL is getting what it is paying for?

Any other thoughts you may have are invited.

Thanks,

Jeff



EXHIBIT II

EXCERPTS FROM FINANCIAL

STATEMENTS

SHIRAZ PITSTICK INC.

BALANCE SHEET


Sept. 30, 2014 Dec. 31, 2013 Dec. 31, 2012

(unaudited) (audited) (audited)

Assets

Current assets

Cash $ — $ — $ 100

Accounts receivable 1,348 1,029 1,278

Inventory 5,221 4,882 4,323

6,569 5,911 5,701

Trademarks and trade names 1,000 1,000 1,000

Property, plant and equipment 5,194 5,003 5,876

$ 12,763 $ 11,914 $ 12,577

Liabilities

Current liabilities

Bank indebtedness $ 111 $ 122 $ —

Accounts payable 711 678 587

Sales taxes payable 71 68 47

Current portion of long-term debt 112 113 115

1,005 981 749

Long-term debt 5,224 5,332 5,433

6,229 6,313 6,182

Equity

Share capital 100 100 100

Retained earnings 6,434 5,501 6,295

6,534 5,601 6,395

$

12,763 $ 11,914 $

12,577




EXCERPTS FROM FINANCIAL

STATEMENTS

SHIRAZ PITSTICK INC.

INCOME STATEMENT


Year-to-date

Sept. 30, 2014 Dec. 31, 2013 Dec. 31, 2012

Revenue

Sales $ 27,965 $ 34,787 $ 32,453

Cost of sales 20,933 25,772 24,001

Gross margin 7,032 9,015 8,452

Expenses

Advertising and donations 2,051 2,497 2,233

Depreciation and amortization — 895 945

Bad debt 278 478 132

Bank charges and interest 568 722 754

Insurance 609 725 500

Office 177 276 234

Professional fees 234 223 176

Repairs and maintenance 177 222 324

Utilities 649 877 759

Management salaries 550 750 600

Wages 806 1,066 1,013

6,099 8,731 7,670

Income before other items 933 284 782

Other items

Loss on disposal — (178) —

Other expenses — (900) —

— (1,078) —

Net income (loss) $

933 $ (794) $ 782



EXHIBIT III

ADDITIONAL INFORMATION FROM MR. KING

Inventory consists of 90% raw materials and 10% finished goods, per discussions with SPI. The bulk

of the raw materials consists of commodities, the prices of which fluctuate based on market prices.

There are a limited number of suppliers for these commodities. I want to make sure the inventory

exists and is valued correctly. I think I can sell it to other deodorant makers.

Included in fixed assets is the main production plant. The net book value per SPI’s accountant is

$3.5 million. It was purchased for a total of $5 million, including land for $750,000. I think its value

nowadays would be about $6 million, but I am not sure. Various pieces of equipment and a fleet of

trucks make up the rest of the capital assets. The trucks are spread out across the country and I am not

sure how many vehicles make up this fleet.

I am expecting a detailed listing of accounts receivable. From what I have learned from discussions

with SPI’s management, a few major customers make up the bulk of this amount.

SPI holds trademarks and trade names for its products. I am not sure about all the details of these

trademarks and trade names, but I believe their total market value equals their book value. I would sell

these along with the inventory.

Two separate parties filed lawsuits against SPI. One of the plaintiffs settled last year for $900,000. The

legal fees related to this were $100,000 in each of 2012 and 2013. I am unsure of the status of the

second plaintiff’s suit. I have no idea what these lawsuits were for.

The owner’s salary represents about 80% of total management salaries.

Based on my knowledge of our industry, I would expect that average repair and maintenance expenses

would be higher than what SPI has incurred in the past few years. When I discussed this with

management at SPI, they noted that some repairs and maintenance work were being postponed to

future years. They suggested that $350,000 per year would be a better average to use.

SPI sold a storage facility, including land, at a loss last year. This also created a capital loss and,

combined with previous years’ capital losses, adds up to $1.5 million in unused capital losses.

SPI has $2 million in non-capital loss carryforwards, plus unclaimed charitable donation deductions of

$120,000 from prior years. The non-capital losses were generated in 2008 and after, and the earliest

ones will expire in 2028. I would expect to fully use the losses well before they expire. The cumulative

eligible capital (CEC) account has a balance of $587,000.

SPI had the following amounts as undepreciated capital cost (UCC) balances in its 2013 tax return:

o Class 1: $3,917,776

o Class 8: $726,537

o Class 10: $855,923



EXHIBIT IV

ESTIMATED VALUE OF SPI’S ASSETS

Here is my estimate of what the assets might be worth (in thousands of dollars):

Accounts receivable (per financial statements, rounded) $1,350

Inventory (per financial statements, rounded) $5,000

Land and building (my estimate) $6,000

Equipment and vehicles (my estimate) $2,000

Trademarks and trade names (I assume this is the value) $1,000

Loss carryforward (tax rate 30%, my own calculation) $1,050

Undeducted donations (tax rate 30%, my own calculation) $ 36


EVALUATION GUIDE

PAPER III, SIMULATION 3 — BOLD SPICE










Memo to: Jeff King, owner, Bold Spice Ltd. (BSL)

From: CA

Re: Shiraz Pitstick Inc. (SPI) Acquisition

Primary Indicator #1 The candidate calculates the purchase price for SPI and assesses whether it is a fair price. The candidate demonstrates competence in Finance.

Competencies

VII-4.2 – Estimates the value of the business (B)

VII-5 – Analyzes the purchase of a business (B)

You have mentioned that SPI’s owner is willing to sell his shares using the industry standard of 3.5 times

the normalized average EBITDA. We have calculated a draft valuation figure based on the financial

statements given, normalized by removing non-routine transactions, normalizing routine transactions, and

applying the standard industry multiple. As shown in the calculation that follows, the value calculated

using the normalized EBITDA method has resulted in a value for SPI shares of $9.3 million.

You made a comment on SPI’s profit trend and indicated that they were in a negative trend, even though

their results for 2014 seem to have recovered. We do not have enough information about SPI’s profit

trend for the previous years. You might want to gather additional information to ensure that the multiple

applied is appropriate in the circumstances, such as the industry trend compared to SPI’s performance, or

perhaps obtain information for the years prior to 2012, since the average EBITDA might prove more

representative over a five-year period.


According to your estimates of what the underlying assets of SPI might be worth, their total value is

approximately $16.436 million. However, as you will see in the tax section, the value of the loss

carryforward is $600,000 rather than $1.050 million, for a difference of $450,000, and the value of the

unclaimed donations has been revised to $0. The recalculated value is $15.950 million ($16.436 million −

$450,000 − $36,000).

If we adjust this for the liabilities of SPI, we arrive at $9.721 million ($15.950 million − $6.229 million).

Given that you are not going to continue with the deodorant business, an asset-based valuation would be

more appropriate. Using a valuation method whereby a multiplier is applied to a normalized earnings

figure would be a more appropriate way to value a business if it was going to continue on, which is not

the case here. If you were to buy the net assets of the company, using the numbers you provided you

would pay $9.721 million, so a $9.300 million price would be a good deal. This figure of $9.721 million

would need to be adjusted, of course, for any changes in value for the different assets and liabilities that

we would come across. To compute a value using an asset-based approach, we would need additional

information.

(Almost all candidates performed a calculation to determine the purchase price. However, even though

Mr. King provided his estimates for the fair market value of SPI’s assets, fewer than half of the

candidates compared the purchase price they had calculated to the value they would obtain from an

asset-based valuation to determine whether the price for the shares would be fair.)

It should be mentioned that your estimated calculation of $9.721 million (adjusted for the liabilities and

tax items) may require some tweaking. The value of the loss carryforward amounts in your calculations

may not carry such a value, since these losses may or may not be usable to you in the future (see further

discussion on this). As well, you might want to consider applying a discount for the time value of money

to the extent that you are going to use the losses in future years. It is not certain if these losses would be

valued at all, since the timing of their use might prove difficult to determine. It is also not certain whether

the values you have used are true indicators of the underlying liquidation values. For instance, selling off

inventory in bulk would likely mean a discounted amount would be received. More work may be required

here.


SPI Share Value Based on Normalized Average EBITDA (in thousands of dollars)

YTD

Sept. 30, 2014 Dec. 31, 2013 Dec. 31, 2012 Notes

Net income/(loss) per f/s $

933 $

(794) $

782

Adjustments to normalize:

Depreciation and

amortization $

–

$

895

$

945 1

Interest 568 722 754 1

Professional fees – 100 100 2

Repair and maintenance 177 (128) (26) 3

Loss – 178 – 4

Management salaries 440 600 480 5

Other expenses – 900 – 4

2,118 2,473 3,035

Adjust for full year 2,824 6

Less: Repair and

maintenance

(350)

3

Normalized 2,474 2,473 3,035

Average

2,661

Multiplier 3.5

Fair market value 9,314

Notes:

1. We must remove amortization and interest so that we are using EBITDA as the base for our

calculations.

2. Professional fees were higher than normal due to the lawsuit. We must add back the extra costs

associated with this in order to normalize EBITDA.

3. Repair and maintenance expenses are too low, so we must adjust them to the $350,000 mark. For the

current year, we will add back the amount expensed so far, for the calculation to be an estimate for the

entire year, and then subtract the $350,000 thereafter. We will add $128,000 and $26,000 to the

amounts already expensed in 2013 and 2012 to make them each $350,000.

4. The loss and the lawsuit expenditures must be removed to normalize EBITDA.

5. The management salaries have been adjusted in order to remove the owner’s salary (2014: 80% ×

$550,000; 2013: 80% × $750,000; 2012: 80% × $600,000).

6. We must adjust for the current year by extrapolating the EBITDA for a full 12 months. We have 9

months of activity, and the purchase date will be after 10 months, but for purposes of the valuation

calculation, we need to extrapolate as if it were a full 12 months so that the 2014 year is comparable to

the others ($2,118 × (12 ÷ 9)).


(Most candidates included multiple periods (adjusting 2014 to bring it to 12 months) in their

calculation to compute a normalized average EBITDA. However, a large number of candidates only

used one year of data in their analysis, despite SPI’s owner saying that he was willing to sell his shares

using the industry standard of 3.5 times the normalized average EBITDA. Most of these candidates did

not justify why they used only one year (for example, audited numbers were a better basis, the most

recent year was more relevant, etc.), which weakened their analysis. Most candidates included and

discussed a reasonable number of normalization adjustments, providing good support for the

adjustments considered. The least discussed items were the loss on disposal and the lawsuit expense.)


Percent Awarded


9.8%

Reaching competence — The candidate attempts a calculation of the purchase price of SPI.

43.2%

Competent — The candidate prepares a reasonable calculation of the purchase price of SPI, taking into account some of the normalization items, and concludes on whether it is a fair price.

46.7%

Highly competent — The candidate prepares a thorough calculation of the purchase price of SPI, taking into account the normalization items, and comments on some of the flaws in Mr. King’s valuation of the underlying assets of the business.

0.1%

(Candidates were directed to this indicator because the client indicated that he wanted to acquire the

assets owned by another company (Shiraz Pitstick Inc.), but that the owner of the company “is offering

to sell the shares only, not the assets.” As well, the client stated that he wanted to make sure he was

“paying a fair price for this business.”)

(Candidates performed adequately on this indicator. The majority of candidates were able to provide

most components of the normalized average EBITDA. Strong candidates considered three years of

earnings (with the adjustment for nine months in 2014), as well as most of the normalizing

adjustments. These candidates also compared the normalized average EBITDA to a reasonable asset-

based valuation (net of liabilities) in order to determine whether the client would be paying a fair price

for what he was really looking to purchase. Many weak candidates considered income for only one

year (usually 2014) without necessarily adjusting for the short year (nine months). Weak candidates

also made multiple errors in the normalizing adjustments (for example, wrong direction, wrong year,

or wrong calculation).)


Primary Indicator #2 The candidate discusses the due diligence procedures that should be done to give Mr. King comfort on various balance sheet items of SPI. The candidate demonstrates competence in Assurance.

Competencies

VI-1 – Analyzes, evaluates, and advises on assurance needs (A)

VI-2.5– Designs appropriate procedures based on the assignment’s scope, risk, and materiality

guidelines (A)

You asked what specific procedures could be done in order to make sure BSL is getting what it is paying

for. Because we are using some of the figures from the balance sheet to assess the reasonableness of the

value of the company, and because you intend to acquire certain assets for use in your own business, such

as the plant and equipment, and sell some of the assets to pay off much of the liabilities, you want to

ensure that the assets exist and have an appropriate value, and that liabilities listed are complete. We can

perform specific procedures to provide you with such comfort. The risks are that the values of the assets

acquired are less than expected, the assets do not exist, or there are more liabilities to pay off than what

was anticipated.

(Most candidates appropriately identified the assertions that had to be tested as a result of Mr. King’s

specific request. They provided procedures that would ensure that the assets existed and were valued

appropriately. As well, most candidates provided procedures to ensure that liabilities were complete.)

In addition to the work you have asked us to do, we would have to perform some additional work on the

components of the income statement to verify the determination of the purchase price under the

normalized average EBITDA computation.

Because we are dealing with a third party (SPI), we must obtain SPI’s authorization to communicate with

its customers, suppliers, and financial institution before we request various confirmations.

Accounts Receivable

You had mentioned that you were to receive a listing of the outstanding receivables to be collected. You

expect to be able to collect these receivables and use the funds to pay off the liabilities. We should ask to

review the subsequent receipts to verify the existence and collectability of these accounts. For any

remaining balances, since most of the receivables are from a few customers, we can send out confirmation

letters to these customers to ensure that the amounts listed are accurate in total and to determine how long

they have been outstanding. If there are significant differences in what SPI has on its books versus the

amount confirmed by the customer, more work would be required to follow up on this. This would

involve cross-referencing invoices issued and payments received to the customer history both from SPI’s

statement of accounts and from the client’s response.


(Most candidates addressed this item, providing at least one valid procedure to test for the assertion

they had identified.)

Inventory

You intend to sell the inventory after the share purchase to divest yourself of this asset and turn it into

cash for BSL’s operations. Since 90% of the inventory is in raw materials, most of the work in this area

should be focused there. In order to ascertain its existence, test counts would be done as close to October

31 as possible. This would involve cross-referencing our own estimates of a certain amount of the raw

materials and comparing these estimates to what has been provided by SPI. The test counts would need to

be designed so that we are able to come up with proper estimates. We need to know how the raw material

is stored, be it in identifiable crates or other such packaging or in warehouses or bins with known storage

limits. We can then extrapolate our estimates to the total amounts and compare to determine if the total

quantities are similar. If there is a significant difference, further counts would be needed to determine

where the difference has come from.

We would also need to determine if the amount that the inventory is valued at is reasonable. We can

collect commodity prices on any given day by collecting such information from the open markets for

these specific commodities. If no such price exists, we can look at supplier invoices and determine the

price. Once determined, we would deduct any cost to sell to arrive at net realizable value. We would then

compare the values used by SPI and, together with our procedures on quantities, determine if the amount

of inventory provided is reasonable, or adjust accordingly.

As for the 10% of the inventory that is in finished goods, similar procedures should be taken in regards to

the quantities: we would perform test counts to determine if the sample quantities are accurate and

extrapolate that to the entire population, adjusting if necessary. As for the value of the finished goods, we

can take their suggested retail prices for this inventory and apply them to the quantities to see if the values

reported are indeed reasonable. We should then reduce this amount by a discount percentage that would

represent what would be appropriate given that the plan is to sell this in bulk.

(Many candidates recommended that an inventory count should be carried out by SPI; however some

did not discuss what procedures should be performed related to the inventory count. For example,

existence was one of the key concerns; therefore, candidates were expected to discuss how they would

test the existence of the inventory by performing sheet-to-floor counts. Many candidates also struggled

to determine the appropriate procedure to test the valuation of the inventory, even though the

simulation clearly stated that the commodity price was fluctuating based on market prices. In general

when discussing inventory, many candidates lost sight of their role and were focused on whether the

inventory was recorded at the lower of cost and net realizable value, when book value should not have

been the focus in this case.)


Building

You would like to acquire this building to have additional capacity for your existing business. The main

focus with respect to the building is its value. You think the value of both the land and building is about

$6 million. I recommend we retain an appraiser experienced in the manufacturing sector to give us his or

her estimate of the actual value of the building. The appraiser or a separate building inspector would also

be able to give the building a quality inspection to ensure that the building is structurally sound and in

proper working condition. This is especially important given what we know about the lower amounts

spent on repairs and maintenance in the past years, which may have had a negative effect on the

building’s value.

Trucks

You mentioned that SPI had a large fleet of trucks spread out across the country. We should get a listing

of these trucks from SPI, along with their serial numbers, and perform spot checks to confirm they exist.

For trucks in the immediate area, this should be relatively simple, but for trucks in other areas, we may

need to wait for them to come back to the plant. If these trucks do not come back to the main plant at all,

we should request either proof of insurance for these trucks or licence plate registrations in the relevant

jurisdictions where they were issued, along with their serial numbers. Having proof of insurance and

registration will show that these vehicles do exist and that they are owned by SPI, as well as insured,

which would protect your interests should something happen to these assets.

We may also want an experienced specialist to spot check some of these vehicles to ensure that they are

in proper working condition and do not require extensive and costly repair work. The specialist should

focus on the oldest trucks in this procedure.

(Because the building and the trucks were the assets that Mr. King really wanted to acquire, candidates

were expected to discuss these items and provide relevant procedures to test for their existence and

valuation. Many candidates provided a valid procedure to test the relevant assertions for the building;

however, they struggled to offer valid and practical procedures to test the same assertions for the

trucks, sometimes recommending that all the trucks be brought back to the plant, which was not

practical considering that they were spread out across the country.)

Trademarks and Trade Names

The trademarks and trade names are not something you intend to use, but rather sell and turn into cash.

SPI has trademarks and trade names for its products on the books that are an integral part of its business.

We need to see the legal and other documentation related to these trademarks and trade names. That will

help us determine what their remaining lives are and what exactly they relate to. We should also look into

competitors’ trademarks and trade names, if we are able, to see if they are significantly different. We need

to ensure that the trademarks and trade names on hand have actual long-term value and are not relatively

obsolete. The key is whether you can resell these trademarks and trade names to others and what value we

might be able to receive for these assets. Again, an expert in this specific area should be enlisted to

determine a fair value.


(About half of the candidates discussed the trademarks and trade names and were able to identify the

risks related to these accounts. However, only a little over half of these candidates were able to provide

a valid procedure. Many candidates did not recognize the particular nature of these intangible assets

and were not able to offer valid procedures to test for their existence (review legal documentation such

as patents and other regulatory filings) and value (use the services of an expert).)

Tax Assets

Only the non-capital losses that are being carried forward represent a tax asset that can be used to apply

against taxable income in the future. Capital losses expire upon the acquisition of control, and undeducted

charitable donations cannot be claimed in the years subsequent to the acquisition of control. We should be

able to verify that these non-capital losses exist by reviewing prior years’ tax returns and notices of

assessment, and also by confirming balances with the Canada Revenue Agency (CRA). By verifying the

amounts and years of expiry with the CRA, we can confirm that the losses exist and how long they are

available to be used. We should also ensure we review prior years’ tax returns to determine whether the

amounts calculated are reasonable, so we would want to check the numbers used in calculating taxable

income for those years as well. There is also a risk that this asset might have no value (see tax discussion).

(Most candidates did not recognize the significance of this item for Mr. King and did not discuss it in

their response. Those who did provided valid procedures that were appropriately focused on verifying

the completeness of the amounts available by reviewing correspondence from the CRA.)

Bank Indebtedness

Since you are considering purchasing the shares of the company, you would be assuming all of the debts.

Therefore, you should make sure that the financial statements report the extent of it. To ensure that the

amount of bank indebtedness is complete, we would request bank statements from SPI, as well as bank

reconciliations, and follow up on significant outstanding matters to determine if the amounts reported are

reasonable. We would also send the bank a confirmation letter so that we know the amount reported is

accurate and complete. A bank confirmation would also let us know the terms, including interest rates, as

well as any other indebtedness that may be in place.

Long-Term Debt

A listing of the debt amounts will be required. Once we have this list, we will send out confirmation

letters to determine if the amounts shown are complete. The confirmations will also tell us whether there

are other amounts not listed, in addition to the terms and rates of the loans.

(Only about a third of the candidates discussed the bank indebtedness and the long-term debt. Most of

those who did were able to provide a valid procedure to audit these items.)


Accounts Payable

Given that raw materials are based on commodity prices, and that there are a limited number of suppliers

of these commodities, we should be able to confirm with these major suppliers any amounts that SPI

owes to them (open confirmation with no amount specified). Once we obtain SPI’s accounts payable

listing, I expect to find that SPI deals with a few major vendors to acquire the raw materials needed to

make its products. We should also ask SPI’s management if any of its major suppliers are not on the

accounts payable listing.

We would send confirmation letters to various other vendors as part of a search for unrecorded liabilities,

and we would follow up on any not received or if major differences were noted. If there were differences,

further work would be needed. We would need to cross-reference purchase orders and amounts paid to

SPI records and request similar information from the vendor so that we can reconcile the amounts.

Confirmation letters should be sent to major suppliers even if there are no liabilities recorded in the

books.

We should also perform some work to see if there are liabilities that are not recorded in the books. In

addition to confirming with major suppliers, as per above, there are several ways to look for unrecorded

liabilities, and it depends to a certain extent on how SPI records its liabilities. One way to search is to scan

significant cash outlays after October 31 to see if these should have been set up as liabilities for the period

end. Another way is to take a look at any purchase invoices that have been received in the recent term and

see if they have been set up yet in the system. If there are no invoices, perhaps a scan of recent shipping

documentation or vendor statements could be done. As well, we should see if there should be any accrued

wages set up, since this is a significant expense of the company. There may be bonuses or vacation

payable amounts that have not been calculated yet, so we would check with the payroll department to see

if that is the case.

(Very few candidates discussed this issue, but most of those who did were able to provide a valid

procedure to audit the accounts payable.)

Contingent Liabilities

You have noted that there were two lawsuits against SPI in recent years, and one was settled in the prior

year for $900,000. While the status of the other lawsuit is unclear, we need to correspond with the legal

counsel for SPI to determine the likelihood of the other one settling as well, to the extent we can. Legal

counsel would also help us determine the amount and details. We need more information to determine if

there is a liability here that is not listed on the balance sheet.

These are some of the procedures that could be done to give you some assurance over those assets and

liabilities that you have used in your own valuation calculations. We will need to determine what amount

constitutes a difference significant enough to follow up on, if we should encounter any, but we would

need more information to assess this.


(Most candidates provided valid procedures to test for the completeness of the liabilities, recognizing

that they could have a significant impact on Mr. King’s decision as to whether BSL should acquire

SPI’s shares (they could affect the value of the net assets). However, some candidates only provided

procedures for the liabilities that were already known and did not consider the risk for unrecorded

liabilities.)


Percent Awarded


2.8%

Reaching competence — The candidate identifies some of the due diligence procedures that should be done to give Mr. King comfort on various balance sheet items of SPI.

35.3%

Competent — The candidate discusses some of the due diligence procedures that should be done to give Mr. King comfort on various balance sheet items of SPI.

61.2%

Highly competent — The candidate discusses several of the due diligence procedures that should be done to give Mr. King comfort on various balance sheet items of SPI.

0.5%

(Candidates were directed to this indicator when the client said, “I want to make sure that BSL is

actually getting the assets listed, that the liabilities are complete, and that all amounts are accurate,”

and then asked “what specific procedures could be done in order to make sure BSL is getting what it is

paying for.”)

(Most candidates performed well on this indicator. They provided a good breadth of coverage of the

significant items (including the plant and trucks in which Mr. King had expressed interest) and offered

discussions with sufficient depth on most of the items they had identified. Strong candidates clearly

recognized that they were suggesting due diligence procedures, and as such did a good job of

identifying the appropriate risk or assertion they were addressing. Those candidates recognized that

fair market value, not book value, was the important measure for the client. Weak candidates identified

fewer areas of due diligence to explore and often failed to provide valid procedures for those areas

identified. Many of the procedures provided by weak candidates did not properly address the risk or

assertion that had been identified. For example, to test the existence of an asset, some candidates

recommended reviewing the purchase invoice; however, this would not ensure that the asset was still

owned at the date of acquisition.)


Primary Indicator #3 The candidate discusses the acquisition of control rules and addresses other tax-related issues in regards to the share purchase. The candidate demonstrates competence in Taxation.

Competencies

IX-3.5 – Identifies, analyzes, and advises on tax consequences or planning opportunities associated with

certain corporate transactions (B)

IX-3.6 – Describes the tax consequences of other corporation and partnership restructuring transactions

(C)

When a corporation is acquired by an unrelated party, we must look to certain tax rules that might apply

as a result of such a transaction. Where control of a corporation is acquired, there are restrictions on the

usage of losses, as well as other effects. There are also other tax considerations that should be taken into

account when purchasing the shares of a company versus its assets.

Acquisition of Control Rules

When control of a corporation like SPI is acquired by another party, certain rules come into play that

restrict the usage of losses and have other effects.

Deemed Year End

Any acquisition of control of a corporation would trigger a deemed year end for the company. This would

mean that SPI would be deemed to have a year end for tax purposes immediately before the day the actual

control is acquired by BSL. The purchase is planned for November 1, 2014, which would trigger a year

end of October 31, 2014. This may be an issue since SPI’s normal year end is December 31, and it may

have unintended adverse effects such as a pro-rated CCA calculation and impacts on capital losses, non-

capital losses, and donations.

(Most candidates were able to recognize that a deemed year end would occur upon BSL’s acquisition

of control of SPI. Many candidates recognized that the deemed year end would result in a short

taxation year for SPI and discussed its impact on certain deductions in computing net income for tax

purposes and taxes payable.)

Capital Losses

Per the tax rules, all capital losses SPI has would be lost once BSL acquired control. BSL would not be

able to carry forward these losses to future years.


As well, the rules dictate that if there are accrued capital losses on certain properties, they be recognized

at the deemed year end. If SPI had any non-depreciable capital property with a fair market value (FMV)

less than its original adjusted cost base (ACB), then the capital losses would need to be triggered and the

property written down to its true FMV.

The same logic is true of depreciable property if the FMV is less than the undepreciated capital cost

(UCC); if so, a writedown is required, which would increase non-capital losses carried forward (see

further discussion in the next section).

However, a relieving provision is available: election pursuant to paragraph 111(4)(e) of the Income Tax

Act. If there is depreciable or non-depreciable property with an accrued gain at the time of the deemed

year end, the Income Tax Act allows for it to be recognized. In the case of non-depreciable property, this

would result in a capital gain recognized to offset any capital losses. In the case of depreciable property,

this would result in a capital gain or recapture of CCA or both (see further discussion on non-capital

losses on the next page).

Looking at the assets of SPI, other than the land for the building, there appears to be no other non-

depreciable capital property on the books. In addition to the land, there may be some depreciable property

that we could trigger a capital gain on. We do not know the original cost of the equipment and vehicles,

and it is likely that their FMV would not have increased beyond their original ACB, so we can ignore

those assets in our analysis. However, we have an estimated FMV for the land and building of $6 million,

and it has an ACB of $5 million, meaning it has an accrued capital gain of $1 million.

The land and building would then have an ACB of $6 million going forward. However, for UCC

purposes, only one-half of the excess amount over the original ACB of the building would be added to the

CCA pool. See further discussion on this under “Non-capital Losses”. For capital gains purposes, the $6

million would be the ACB to use in future calculations.

By electing under these relieving provisions, SPI would be able to trigger this gain and use up $1 million

of the capital losses carried forward. However, the other $500,000 of capital losses being carried forward

would be lost upon acquisition of control.

(Most candidates were able to identify the fact that the net capital losses would expire as a result of the

acquisition of control. However, only about half of the candidates were able to provide tax planning

advice to address this, such as using the election to bump the value of certain assets to their fair market

value to generate capital gains, in order to mitigate the impact of the acquisition of control rules.)

Non-capital Losses

Unlike capital losses, non-capital losses can be carried forward to be used upon an acquisition of control.

However, there are restrictions on the use of these as well. They can only be carried forward if the

corporation continues to carry on a same or similar business as was being carried on before. Further, there

must be a reasonable expectation of generating a profit for that same or similar business. Finally, the

losses can only be used to reduce net income earned from the same or a similar business.


The question then becomes whether the manufacture of perfumes and colognes is a same or similar

business as the manufacture of deodorants. Perfumes and colognes, generally marketed as “cosmetics and

fragrances,” are designed to provide an appealing fragrance to those who wear them, or to cover up other

odors. Deodorants, marketed as “personal hygiene products,” can also provide appealing fragrances or

cover up other ones.

It is unclear if the businesses are the same or similar in nature. This can have a significant impact on the

acquisition of this company if BSL cannot use the losses available in SPI. Further research may be needed

to settle this issue.

(Most candidates were able to discuss the impact of the acquisition of control of SPI on the availability

of its non-capital losses. Most candidates appropriately questioned whether the businesses carried on

by BSL and SPI would be considered as same or similar.)

As well, if there are accrued losses on account of income at the time of the deemed year end, these too

must be recognized. As mentioned previously, however, relieving provisions are available to help offset

these losses or losses being carried forward, if there are accrued gains at the deemed year end.

For depreciable property, we can elect to trigger a recapture if the FMV of the assets in question is greater

than the UCC. From above, we have calculated the capital gain on the building, but this would also result

in some recapture of $4.25 million less the UCC of the particular assets. This would result in a recapture

of approximately $332,224 ($4,250,000 − $3,917,776) that would be offset by non-capital losses carried

forward. As for the equipment and vehicles, if we combine their FMV and UCC amounts, this could

result in an additional recapture amount of approximately $417,540 (FMV of $2 million less UCC of

$726,537 + $855,923 for Classes 8 and 10). Of course, this is a simplified calculation, and more work

would be needed on each class.

By triggering a recapture, you could use about $750,000 of the non-capital losses being carried forward.

Going forward, the UCC of these classes would be increased to the original capital cost of the assets plus

one-half of the excess of the elected value over the ACB. For the building, this would mean, assuming

that the FMV has increased proportionately (($4.25 million ÷ $5.00 million) × $6.00 million = $5.10

million), that the new UCC would be $4.675 million, or $4.250 million + one-half of ($5.10 million −

$4.25 million). The ACB of the land would be increased to its FMV of $900,000 (($750,000 ÷ $5.00

million) × $6.00 million). For the Class 8 and 10 assets, more information would be needed to determine

the new UCC.

(Only a few candidates were able to come up with a way to mitigate the impact of losing the non-capital

losses.)

Other Items

Other items affecting the non-capital losses being carried forward are the trademarks and trade names,

accounts receivable, and inventory. For eligible capital property (ECP), such as trademarks and trade

names, if their total FMV is less than the amount in the cumulative eligible capital balance, then the ECP

is written down to three-quarters of its FMV. Any writedown is considered a part of the non-capital loss

carryforwards. More information is needed to determine the FMV of the trademarks and trade names for

this calculation.


For accounts receivable, any debts must be written off to the largest amount possible if deemed to be bad

debts. No amount can be written off after the deemed year end.

While not specifically dealt with in the acquisition of control rules, if the inventory on hand needed to be

written down, it should be dealt with at the deemed year end as well.

Charitable Donations

As for the capital losses carryforward, the amount of the donations on hand will be lost upon the

acquisition of control.

(Only a few candidates addressed these other items, but when they did, they were generally able to

provide a reasonable discussion of the tax issues and how they would affect SPI’s tax attributes.)

Amalgamation/Wind-Up

In order to ultimately use the losses in BSL, an amalgamation of both BSL and SPI or a wind-up of SPI

would be needed. The amalgamation triggers a deemed year end, so care must be taken here so that the

date of amalgamation is selected at a time when a deemed year end is desired. This would affect the

existing year end of BSL, so that should be kept in mind since it is unlikely you want to change the year

end at this point. As for the wind-up of SPI, the available loss carryforward balances would only be

available to reduce BSL’s taxable income starting “in the taxation year commencing after the

commencement of the winding-up” as per Income Tax Act 88(1.1). Therefore, the date of acquisition and

the subsequent wind-up should be planned to mitigate any negative effect of this rule.

(Some candidates discussed the post-acquisition planning that would be required to allow BSL to use

SPI’s tax attributes, namely its non-capital losses. However, only about half of those candidates

provided a valid discussion of the relevant rules applicable upon an amalgamation or a wind-up.)


Percent Awarded


13.4%

Reaching competence — The candidate identifies some of the tax impacts that result from an acquisition of control.

21.0%

Competent — The candidate discusses the impact of the acquisition of control rules with regards to the losses in SPI or attempts some calculations to determine the usage of such losses.

64.9%

Highly competent — The candidate discusses the impact of the acquisition of control rules with regards to the losses in SPI, performs calculations to determine the usage of such losses, and comments on the amalgamation with SPI.

0.1%


(Candidates were not specifically directed to this indicator. However, Mr. King stated, “SPI has some

tax losses available that I would like to get my hands on.”)

(Candidates performed well on this indicator. They were able to use the case facts appropriately and

discuss the acquisition of control rules in sufficient depth.)

(Strong candidates recognized that the acquisition of control of SPI would result in a deemed year end,

and that this might also restrict BSL’s ability to use SPI’s losses going forward. These candidates

correctly understood the loss limitation rules and demonstrated knowledge related to the deemed year-

end rules (date, filing tax returns, pro-rating of CCA/SBD). As well, strong candidates recognized that

either a bump election could be made to use the losses that would otherwise expire or there was a

requirement to recognize any accrued losses on assets held at the time of the acquisition of control.

Weak candidates typically only discussed what was happening with the losses on the acquisition of

control and often mixed up the non-capital loss and capital loss limitation rules.)

Primary Indicator #4 The candidate discusses how the purchase of shares may not be in the best interest of BSL and advises on factors that need to be taken into account if a share purchase is to be done. The candidate demonstrates competence in Pervasive Qualities and Skills.

















While our preliminary calculations seem to show that this is a good deal for BSL, we need to take a step

back again and look at the big picture.

By valuing the shares from a multiplier perspective, we come up with a value of about $9.3 million. To

the extent that you do not appear to want to continue in the deodorant business, this approach to valuing

the company does not make the most sense.


If we use an asset-based approach, as you have done, we come up with a value of $15.95 million.

However, you are only interested in the building, equipment, vehicles, and tax-loss carryforward.

Altogether, these have a value of $8.60 million, according to your calculation. However, the losses in SPI

may or may not be usable and, at the minimum, would only act to increase the tax cost of the assets closer

to their FMV. Since you have already accounted for the FMV in your own calculations, the number

shown for the tax losses being acquired should be removed entirely. This would reduce the value to $8.00

million for the building, equipment, and vehicles. Therefore, by purchasing the shares for $9.30 million,

you are paying more than what you are getting. You also have to deal with selling the assets you are not

interested in and settling the liabilities, and you bear the risk of unrecorded liabilities.

(Most candidates recognized that Mr. King should definitely reconsider the purchase of the shares,

both from a financial perspective and a non-financial perspective (since he would be acquiring assets

he is not interested in or that bear additional risks due to the potential for unrecorded liabilities).)

The owner made it clear that, for now, only the shares were up for sale. If we start with the value of

$16.436 million you calculated and adjust it for the total liabilities on the books of $6.229 million and the

net capital losses ($450,000, as calculated earlier in this memo) and unclaimed charitable donations

($36,000), which would not be transferable, we get to $9.721 million. However, I think it would be

prudent to reduce this value by the amount of a contingent liability for the second lawsuit. At a minimum,

we should reduce the value by the amount of the first settlement, or $900,000, assuming that these

lawsuits are similar in nature.

There may also be adjustments needed for which we require more information first. The inventory would

likely need to be written down since the plan is to sell it off in bulk. This would likely mean selling it off

at a discounted value. There may be other liabilities we need to account for as well that would reduce the

value. Any accounts receivable writeoffs would need to be taken into account, as would the true FMV of

the trademarks and trade names.

Given this, the price of $9.3 million does not appear to be such a good deal after all. Taking out the tax

losses and subtracting the contingent liability amount results in a value of $8.821 million ($9.721 million

− $900,000). This does not include any other reductions relating to inventory or other assets, or increases

to liabilities. Given the risk of not using the losses available, the acquisition of this company becomes less

attractive.

An important point to keep in mind to limit your risk is in the drafting of the purchase agreement. You

should ensure that there are clauses outlining exactly what will be in SPI if you go through with the share

purchase. Things such as the inventory, building, vehicles, et cetera, should be listed as assets that are

included (basically any assets you are intending to “buy” through purchasing the shares of the

corporation). As well, if there are unknown liabilities at the time of purchase, the former shareholders

should be responsible for those — they can include unknown environmental liabilities or liabilities for

income tax or GST reassessments, for instance. Hence, part of the purchase price should be kept in

escrow to provide for any adjustment to the purchase price resulting from these unknown liabilities.

In addition, there may be transactions between the date of the financial statements and the closing date

that have an effect on the value of the company (for example, a dividend could be declared that would

strip SPI of value), and these potential transactions should be dealt with in the purchase agreement. A

lawyer experienced with these matters should be engaged to help draft and negotiate a purchase and sale

agreement.


Based on the information that I have, I recommend that you do not purchase the shares of SPI. You have

no need for its trademarks and trade names or inventory, and you will spend time divesting yourself of

those. Further, you will likely not be able to use the losses available, which are a key part of the purchase.

You would be able to have higher CCA claims on an asset purchase. Finally, the risk to BSL of taking on

all liabilities, known and unknown, makes this share purchase unattractive.

(Many candidates discussed the acquisition by way of “pros” and “cons” of a share-versus-asset

purchase, without referring to the specific facts of the simulation. However, some candidates, once

they had mentioned to Mr. King that he should reconsider the share purchase transaction, went beyond

and provided Mr. King with appropriate advice as to what could be done to mitigate the risks should

BSL proceed with the acquisition of SPI’s shares.)


Percent Awarded


12.4%

Reaching competence — The candidate identifies that the purchase of shares might not be in the best interest of BSL or that there are factors that need to be taken into account if a share purchase were to be done.

52.6%

Competent — The candidate discusses that the purchase of shares might not be in the best interest of BSL and advises on factors that need to be taken into account if a share purchase were to be done.

26.9%

Highly competent – The candidate advises Mr. King not to buy the shares, provides support to the conclusion, and comments on the legal agreement if a share purchase were to be done.

0.0%

(Candidates were not directed to this indicator. They were expected to warn Mr. King that purchasing

the shares of SPI might not be in his best interest and were pointed in that direction when Mr. King

said that what he really wanted was some of SPI’s productive assets. Since SPI’s owner was willing to

sell his shares only, candidates were expected to provide advice on how Mr. King could mitigate his

risks.)

(Candidates did a good job of questioning the share purchase; however, many ended their discussion

after mentioning to Mr. King that he should reconsider the transaction (in other words, not buy the

shares). Weak candidates stopped short of telling Mr. King what future actions or steps needed to be

taken. For example, candidates could have discussed how Mr. King could mitigate his risk in the case

of a share purchase by including a price adjustment clause in the agreement. Many weak candidates

provided a generic list of considerations (pros and cons) when debating whether to purchase assets

versus shares. Others questioned the share purchase from a purchase price perspective, simply because

the price to be paid using an earnings-based approach was higher than the fair market value of the

assets being acquired. This discussion was considered within the finance indicator.)


(Strong candidates provided a thorough discussion by addressing factors to consider assuming the

client went ahead with the share purchase. Some also recommended negotiating additional time to

close the transaction in order to adequately complete the due diligence. This was very useful advice to

provide to Mr King.)


(Overall, the Board was relatively pleased with the quality of the responses in this simulation. Most

candidates addressed each of the indicators in reasonable depth, except on the Pervasive Qualities

indicator, where candidates struggled to go beyond questioning whether the share purchase was

adequate. Candidates performed better on the Finance and Assurance indicators. They discussed most

of the significant issues, concluded logically on the Finance indicator, and provided adequate

procedures to verify the assertions they were testing on the Assurance indicator.)

260 Evaluation Booklet Tables

P

RE

SE

NT

VA

LU

E O

F $

1 R

EC

EIV

ED

AT

TH

E E

ND

OF

TH

E P

ER

IOD

P

erio

ds

Hen

ce

2%

3

%

4%

5

%

6%

7

%

8%

9

%

10%

1

1%

1

2%

1

3%

1

4%

1

5%

1

6%

1

7%

1

8%

1

9%

2

0%

1

0.9

8

0.9

7

0.9

6

0.9

5

0.9

4

0.9

3

0.9

3

0.9

2

0.9

1

0.9

0

0.8

9

0.8

8

0.8

8

0.8

7

0.8

6

0.8

5

0.8

5

0.8

4

0.8

3

2

0.9

6

0.9

4

0.9

2

0.9

1

0.8

9

0.8

7

0.8

6

0.8

4

0.8

3

0.8

1

0.8

0

0.7

8

0.7

7

0.7

6

0.7

4

0.7

3

0.7

2

0.7

1

0.6

9

3

0.9

4

0.9

2

0.8

9

0.8

6

0.8

4

0.8

2

0.7

9

0.7

7

0.7

5

0.7

3

0.7

1

0.6

9

0.6

7

0.6

6

0.6

4

0.6

2

0.6

1

0.5

9

0.5

8

4

0.9

2

0.8

9

0.8

5

0.8

2

0.7

9

0.7

6

0.7

4

0.7

1

0.6

8

0.6

6

0.6

4

0.6

1

0.5

9

0.5

7

0.5

5

0.5

3

0.5

2

0.5

0

0.4

8

5

0.9

1

0.8

6

0.8

2

0.7

8

0.7

5

0.7

1

0.6

8

0.6

5

0.6

2

0.5

9

0.5

7

0.5

4

0.5

2

0.5

0

0.4

8

0.4

6

0.4

4

0.4

2

0.4

0

6

0

.89

0.8

4

0.7

9

0.7

5

0.7

0

0.6

7

0.6

3

0.6

0

0.5

6

0.5

3

0.5

1

0.4

8

0.4

6

0.4

3

0.4

1

0.3

9

0.3

7

0.3

5

0.3

3

7

0.8

7

0.8

1

0.7

6

0.7

1

0.6

7

0.6

2

0.5

8

0.5

5

0.5

1

0.4

8

0.4

5

0.4

3

0.4

0

0.3

8

0.3

5

0.3

3

0.3

1

0.3

0

0.2

8

8

0.8

5

0.7

9

0.7

3

0.6

8

0.6

3

0.5

8

0.5

4

0.5

0

0.4

7

0.4

3

0.4

0

0.3

8

0.3

5

0.3

3

0.3

1

0.2

8

0.2

7

0.2

5

0.2

3

9

0.8

4

0.7

7

0.7

0

0.6

4

0.5

9

0.5

4

0.5

0

0.4

6

0.4

2

0.3

9

0.3

6

0.3

3

0.3

1

0.2

8

0.2

6

0.2

4

0.2

3

0.2

1

0.1

9

10

0.8

2

0.7

4

0.6

8

0.6

1

0.5

6

0.5

1

0.4

6

0.4

2

0.3

9

0.3

5

0.3

2

0.2

9

0.2

7

0.2

5

0.2

3

0.2

1

0.1

9

0.1

8

0.1

6

1

1

0.8

0

0.7

2

0.6

5

0.5

8

0.5

3

0.4

8

0.4

3

0.3

9

0.3

5

0.3

2

0.2

9

0.2

6

0.2

4

0.2

1

0.2

0

0.1

8

0.1

6

0.1

5

0.1

3

12

0.7

9

0.7

0

0.6

2

0.5

6

0.5

0

0.4

4

0.4

0

0.3

6

0.3

2

0.2

9

0.2

6

0.2

3

0.2

1

0.1

9

0.1

7

0.1

5

0.1

4

0.1

2

0.1

1

13

0.7

7

0.6

8

0.6

0

0.5

3

0.4

7

0.4

1

0.3

7

0.3

3

0.2

9

0.2

6

0.2

3

0.2

0

0.1

8

0.1

6

0.1

5

0.1

3

0.1

2

0.1

0

0.0

9

14

0.7

6

0.6

6

0.5

8

0.5

1

0.4

4

0.3

9

0.3

4

0.3

0

0.2

6

0.2

3

0.2

0

0.1

8

0.1

6

0.1

4

0.1

3

0.1

1

0.1

0

0.0

9

0.0

8

15

0.7

4

0.6

4

0.5

6

0.4

8

0.4

2

0.3

6

0.3

2

0.2

7

0.2

4

0.2

1

0.1

8

0.1

6

0.1

4

0.1

2

0.1

1

0.0

9

0.0

8

0.0

7

0.0

6

1

6

0.7

3

0.6

2

0.5

3

0.4

6

0.3

9

0.3

4

0.2

9

0.2

5

0.2

2

0.1

9

0.1

6

0.1

4

0.1

2

0.1

1

0.0

9

0.0

8

0.0

7

0.0

6

0.0

5

17

0.7

1

0.6

1

0.5

1

0.4

4

0.3

7

0.3

2

0.2

7

0.2

3

0.2

0

0.1

7

0.1

5

0.1

3

0.1

1

0.0

9

0.0

8

0.0

7

0.0

6

0.0

5

0.0

5

18

0.7

0

0.5

9

0.4

9

0.4

2

0.3

5

0.3

0

0.2

5

0.2

1

0.1

8

0.1

5

0.1

3

0.1

1

0.0

9

0.0

8

0.0

7

0.0

6

0.0

5

0.0

4

0.0

4

19

0.6

9

0.5

7

0.4

7

0.4

0

0.3

3

0.2

8

0.2

3

0.1

9

0.1

6

0.1

4

0.1

2

0.1

0

0.0

8

0.0

7

0.0

6

0.0

5

0.0

4

0.0

4

0.0

3

20

0.6

7

0.5

5

0.4

6

0.3

8

0.3

1

0.2

6

0.2

1

0.1

8

0.1

5

0.1

2

0.1

0

0.0

9

0.0

7

0.0

6

0.0

5

0.0

4

0.0

4

0.0

3

0.0

3

2

1

0.6

6

0.5

4

0.4

4

0.3

6

0.2

9

0.2

4

0.2

0

0.1

6

0.1

4

0.1

1

0.0

9

0.0

8

0.0

6

0.0

5

0.0

4

0.0

4

0.0

3

0.0

3

0.0

2

22

0.6

5

0.5

2

0.4

2

0.3

4

0.2

8

0.2

3

0.1

8

0.1

5

0.1

2

0.1

0

0.0

8

0.0

7

0.0

6

0.0

5

0.0

4

0.0

3

0.0

3

0.0

2

0.0

2

23

0.6

3

0.5

1

0.4

1

0.3

3

0.2

6

0.2

1

0.1

7

0.1

4

0.1

1

0.0

9

0.0

7

0.0

6

0.0

5

0.0

4

0.0

3

0.0

3

0.0

2

0.0

2

0.0

2

24

0.6

2

0.4

9

0.3

9

0.3

1

0.2

5

0.2

0

0.1

6

0.1

3

0.1

0

0.0

8

0.0

7

0.0

5

0.0

4

0.0

3

0.0

3

0.0

2

0.0

2

0.0

2

0.0

1

25

0.6

1

0.4

8

0.3

8

0.3

0

0.2

3

0.1

8

0.1

5

0.1

2

0.0

9

0.0

7

0.0

6

0.0

5

0.0

4

0.0

3

0.0

2

0.0

2

0.0

2

0.0

1

0.0

1

TABLE I


P

RE

SE

NT

VA

LU

E O

F A

N A

NN

UIT

Y O

F $

1 R

EC

EIV

ED

AT

TH

E E

ND

OF

EA

CH

PE

RIO

D

No

. o

f

P

erio

ds

Rec

eive

d

2%

3

%

4%

5

%

6%

7

%

8%

9

%

10%

1

1%

1

2%

1

3%

1

4%

1

5%

1

6%

1

7%

1

8%

1

9%

2

0%

1

0.9

8

0.9

7

0.9

6

0.9

5

0.9

4

0.9

3

0.9

3

0.9

2

0.9

1

0.9

0

0.8

9

0.8

8

0.8

8

0.8

7

0.8

6

0.8

5

0.8

5

0.8

4

0.8

3

2

1.9

4

1.9

1

1.8

9

1.8

6

1.8

3

1.8

1

1.7

8

1.7

6

1.7

4

1.7

1

1.6

9

1.6

7

1.6

5

1.6

3

1.6

1

1.5

9

1.5

7

1.5

5

1.5

3

3

2.8

8

2.8

3

2.7

8

2.7

2

2.6

7

2.6

2

2.5

8

2.5

3

2.4

9

2.4

4

2.4

0

2.3

6

2.3

2

2.2

8

2.2

5

2.2

1

2.1

7

2.1

4

2.1

1

4

3.8

1

3.7

2

3.6

3

3.5

5

3.4

7

3.3

9

3.3

1

3.2

4

3.1

7

3.1

0

3.0

4

2.9

7

2.9

1

2.8

5

2.8

0

2.7

4

2.6

9

2.6

4

2.5

9

5

4.7

1

4.5

8

4.4

5

4.3

3

4.2

1

4.1

0

3.9

9

3.8

9

3.7

9

3.7

0

3.6

0

3.5

2

3.4

3

3.3

5

3.2

7

3.2

0

3.1

3

3.0

6

2.9

9

6

5.6

0

5.4

2

5.2

4

5.0

8

4.9

2

4.7

7

4.6

2

4.4

9

4.3

6

4.2

3

4.1

1

4.0

0

3.8

9

3.7

8

3.6

8

3.5

9

3.5

0

3.4

1

3.3

3

7

6.4

7

6.2

3

6.0

0

5.7

9

5.5

8

5.3

9

5.2

1

5.0

3

4.8

7

4.7

1

4.5

6

4.4

2

4.2

9

4.1

6

4.0

4

3.9

2

3.8

1

3.7

1

3.6

0

8

7.3

3

7.0

2

6.7

3

6.4

6

6.2

1

5.9

7

5.7

5

5.5

3

5.3

3

5.1

5

4.9

7

4.8

0

4.6

4

4.4

9

4.3

4

4.2

1

4.0

8

3.9

5

3.8

4

9

8.1

6

7.7

9

7.4

4

7.1

1

6.8

0

6.5

2

6.2

5

6.0

0

5.7

6

5.5

4

5.3

3

5.1

3

4.9

5

4.7

7

4.6

1

4.4

5

4.3

0

4.1

6

4.0

3

10

8.9

8

8.5

3

8.1

1

7.7

2

7.3

6

7.0

2

6.7

1

6.4

2

6.1

4

5.8

9

5.6

5

5.4

3

5.2

2

5.0

2

4.8

3

4.6

6

4.4

9

4.3

4

4.1

9

11

9.7

9

9.2

5

8.7

6

8.3

1

7.8

9

7.5

0

7.1

4

6.8

1

6.5

0

6.2

1

5.9

4

5.6

9

5.4

5

5.2

3

5.0

3

4.8

4

4.6

6

4.4

9

4.3

3

12

10

.58

9.9

5

9.3

9

8.8

6

8.3

8

7.9

4

7.5

4

7.1

6

6.8

1

6.4

9

6.1

9

5.9

2

5.6

6

5.4

2

5.2

0

4.9

9

4.7

9

4.6

1

4.4

4

13

11

.35

10

.63

9.9

9

9.3

9

8.8

5

8.3

6

7.9

0

7.4

9

7.1

0

6.7

5

6.4

2

6.1

2

5.8

4

5.5

8

5.3

4

5.1

2

4.9

1

4.7

1

4.5

3

14

12

.11

11

.30

10

.56

9.9

0

9.2

9

8.7

5

8.2

4

7.7

9

7.3

7

6.9

8

6.6

3

6.3

0

6.0

0

5.7

2

5.4

7

5.2

3

5.0

1

4.8

0

4.6

1

15

12

.85

11

.94

11

.12

10

.38

9.7

1

9.1

1

8.5

6

8.0

6

7.6

1

7.1

9

6.8

1

6.4

6

6.1

4

5.8

5

5.5

8

5.3

2

5.0

9

4.8

8

4.6

8

16

13

.58

12

.56

11

.65

10

.84

10

.11

9.4

5

8.8

5

8.3

1

7.8

2

7.3

8

6.9

7

6.6

0

6.2

7

5.9

5

5.6

7

5.4

1

5.1

6

4.9

4

4.7

3

17

14

.29

13

.17

12

.17

11

.27

10

.48

9.7

6

9.1

2

8.5

4

8.0

2

7.5

5

7.1

2

6.7

3

6.3

7

6.0

5

5.7

5

5.4

7

5.2

2

4.9

9

4.7

7

18

14

.99

13

.75

12

.66

11

.69

10

.83

10

.06

9.3

7

8.7

6

8.2

0

7.7

0

7.2

5

6.8

4

6.4

7

6.1

3

5.8

2

5.5

3

5.2

7

5.0

3

4.8

1

19

15

.68

14

.32

13

.13

12

.09

11

.16

10

.34

9.6

0

8.9

5

8.3

6

7.8

4

7.3

7

6.9

4

6.5

5

6.2

0

5.8

8

5.5

8

5.3

2

5.0

7

4.8

4

20

16

.35

14

.88

13

.59

12

.46

11

.47

10

.59

9.8

2

9.1

3

8.5

1

7.9

6

7.4

7

7.0

2

6.6

2

6.2

6

5.9

3

5.6

3

5.3

5

5.1

0

4.8

7

21

17

.01

15

.42

14

.03

12

.82

11

.76

10

.84

10

.02

9.2

9

8.6

5

8.0

8

7.5

6

7.1

0

6.6

9

6.3

1

5.9

7

5.6

7

5.3

8

5.1

3

4.8

9

22

17

.66

15

.94

14

.45

13

.16

12

.04

11

.06

10

.20

9.4

4

8.7

7

8.1

8

7.6

5

7.1

7

6.7

4

6.3

6

6.0

1

5.7

0

5.4

1

5.1

5

4.9

1

23

18

.29

16

.44

14

.86

13

.49

12

.30

11

.27

10

.37

9.5

8

8.8

8

8.2

7

7.7

2

7.2

3

6.7

9

6.4

0

6.0

4

5.7

2

5.4

3

5.1

7

4.9

3

24

18

.91

16

.94

15

.25

13

.80

12

.55

11

.47

10

.53

9.7

1

8.9

9

8.3

5

7.7

8

7.2

8

6.8

4

6.4

3

6.0

7

5.7

5

5.4

5

5.1

8

4.9

4

25

19

.52

17

.41

15

.62

14

.09

12

.78

11

.65

10

.68

9.8

2

9.0

8

8.4

2

7.8

4

7.3

3

6.8

7

6.4

6

6.1

0

5.7

7

5.4

7

5.2

0

4.9

5

TABLE II

262 Evaluation Booklet Tables

TABLE III

A FORMULA FOR CALCULATING THE PRESENT VALUE OF REDUCTIONS IN TAX PAYABLE DUE TO CAPITAL

COST ALLOWANCE

Investment

Cost

×

Marginal

Rate of

Income Tax

×

Rate of

Capital Cost

Allowance

× (

1 +

Rate of Return

2 )

(

Rate of

Return

+

Rate of Capital

Cost Allowance )

× (

1 +

Rate of Return )

MAXIMUM

CAPITAL COST ALLOWANCE RATES

FOR SELECTED CLASSES

Class 1 ...................................................... 4%

Class 8 ...................................................... 20%

Class 10 .................................................... 30%

Class 10.1 ................................................. 30%

Class 12 .................................................... 100%

Class 13 .................................................... Original lease period plus one

renewal period (minimum 5 years

and maximum 40 years)

Class 14 .................................................... Length of life of property

Class 17 .................................................... 8%

Class 29.................................................... 50% straight-line

Class 43 .................................................... 30%

Class 44 .................................................... 25% Class 45 .................................................... 45%

Class 50 .................................................... 55%

SELECTED PRESCRIBED AUTOMOBILE AMOUNTS FOR 2013

Maximum depreciable cost — Class 10.1 $30,000 + GST or HST

Maximum monthly deductible lease cost $800 + GST or HST

Maximum monthly deductible interest cost $300

Operating cost benefit — employee 27¢ per kilometre of personal use

Non-taxable car allowance benefit limits

- first 5,000 kilometres 54¢ per kilometre

- balance 48¢ per kilometre


TABLE IV

INDIVIDUAL FEDERAL INCOME TAX RATES

Taxable Income 2013* Tax Rate

$43,561 or less 15%

$43,562 to $87,123 $6,534 + 22% on next $42,707 $87,124 to $135,054 $16,118 + 26% on next $46,992

$135,055 or more $28,580 + 29% on remainder *2014 rates increase by an indexing of 0.9%.

SELECTED NON-REFUNDABLE TAX CREDITS

PERMITTED TO INDIVIDUALS FOR PURPOSES OF COMPUTING INCOME TAX

The 2013 tax credits are 15% of the following amounts: Basic personal amount $11,038 Spouse or common-law partner amount 11,038 Net income threshold for spouse or common-law partner amount NIL Amount for children under 18 2,234 Age 65 or over in the year 6,854 Net income threshold for age amount 34,562 Canada employment amount up to $1,117 Disability amount 7,697 Infirm dependants 18 and over 6,530 Net income threshold for infirm dependants 18 and over 6,548 Children’s fitness credit 500 Children’s art credit 500 Basic amount for:

GST credit 34,872 Child tax benefit 43,953

CORPORATE FEDERAL INCOME TAX RATE The tax payable by a corporation on its taxable income under Part I of the Income Tax Act is 38% before any additions and/or deductions. PRESCRIBED INTEREST RATES (base rates)

Year Jan. 1 – Mar. 31 Apr. 1 – June 30 July 1 – Sep. 30 Oct. 1 – Dec. 31

2014 1 1 1 2013 1 1 1 2 2012 1 1 1 1 2011 1 1 1 1 2010 1 1 1 1

This is the rate used for taxable benefits for employees and shareholders, low-interest loans, and other related-party transactions. The rate is 4 percentage points higher for late or deficient income tax payments and unremitted withholdings. The rate is 2 percentage points higher for tax refunds to taxpayers with the exception of corporations, for which the base rate is used.

Chartered Professional Accountants of Canada 277 Wellington Street West, Toronto ON M5V 3H2Tel (416) 977-3222 Fax (416) 204-3423 www.cpacanada.ca

For more informationThe CA qualification process prepares future CAs to meet the challenges that await them. For more information on the qualification process, the uniform evaluation, and your province’s specific education requirements, contact your regional education director.

Provincial Institutes/OrdreCPA BermudaSofia House, 1st Floor48 Church StreetHamilton, Bermuda HM 12(441) 292-7479www.icab.bm

The Institute of Chartered Accountants of Nova Scotia5151 George Street, Suite 502Halifax, Nova Scotia B3J 1M5(902) 425-3291 www.icans.ns.ca

CPA New Brunswick860 Main Street, Suite 602 Moncton, NB E1C 1G2 (506) 830-3300www.cpanewbrunswick.ca

CPA Prince Edward IslandP.O. Box 301 97 Queen Street, Suite 600 Charlottetown, PEI C1A 7K7(902) 894-4290www.icapei.com

The Institute of Chartered Accountants of Newfoundland and Labrador95 Bonaventure Avenue, Suite 501St. John’s, Newfoundland A1B 2X5(709) 753-7566www.icanl.ca

Ordre des comptables professionnels agréés du Québec5, Place Ville Marie, bureau 800Montréal, Québec H3B 2G2(514) 288-3256 1 800 363-4688www.cpaquebec.ca

Chartered Professional Accountants of Ontario69 Bloor Street EastToronto, Ontario M4W 1B3(416) 962-1841 1 800 387-0735www.cpaontario.ca

The Institute of Chartered Accountants of Manitoba1675 – One Lombard PlaceWinnipeg, Manitoba R3B 0X3(204) 942-8248 1 888 942-8248www.icam.mb.ca

CPA Saskatchewan101-4581 Parliament Ave Regina, Saskatchewan S4W 0G3(306) 359-0272www.cpask.ca

The Institute of Chartered Accountants of Alberta580 Manulife Place, 10180 – 101 StreetEdmonton, Alberta T5J 4R2(780) 424-7391 1 800 232-9406 (for Alberta, outside Edmonton)www.albertacas.ca

The Institute of Chartered Accountants of British ColumbiaSuite 500, One Bentall Centre 505 Burrard Street, Box 22Vancouver, British Columbia V7X 1M4(604) 681-3264 1 800 663-2677www.ica.bc.ca

Institute of Chartered Accountants of the Northwest Territories & NunavutPO Box 2433 Yellowknife, NT X1A 2P8 (867) 873-3680www.icanwt.nt.ca

Yukon If you are in the Yukon, please contact the Institute of Chartered Accountants of British Columbia.

Regional Education Directors

Atlantic Canada and Bermuda:CPA Atlantic School of Business Anne-Marie Gammon, MBA, FCMA Cogswell Tower, Suite 1306Scotia Square, P.O. Box 489 Halifax, Nova Scotia B3J 2R7 Tel: (902) 334-1176Web site: www.cpaatlantic.ca E-mail: [email protected]

Québec:Ordre des comptables professionnels agréés du QuébecHélène Racine, FCPA, CA5, Place Ville Marie, bureau 800 Montréal, Québec H3B 2G2 Tel: (514) 982-4601 1 800 363-4688 ext. 4601Fax: (514) 843-8375 Web site: www.cpaquebec.caE-mail: [email protected]

Ontario:CPA OntarioJacqui Mulligan, CPA, CA 69 Bloor Street East Toronto, Ontario M4W 1B3Tel: (416) 962-1841 ext. 239Fax: (416) 962-8900 Web site: www.cpaontario.ca E-mail: [email protected]

Western Canada and the Territories:CPA Western School of Business (CPAWSB) Dr. Sheila Elworthy, EdD, CASuite 500, One Bentall Centre 505 Burrard Street, Box 22Vancouver, British Columbia V7X 1M4 Tel: 1 866 420-2350Web site: www.cpawsb.ca E-mail: [email protected]