MULTI-COMPETENCY SIMULATION (120 minutes)

Geoff Great has developed an innovative, cost-effective and more environmentally-friendly process for
producing recycled plastic for use in the manufacture of plastic products and components of products.
Great developed the process while he was an employee of Plastics Inc. (PI). Great has applied for a
patent covering the process he developed.

Great subsequently resigned from PI and incorporated Great Plastic Products Inc. (GPP) and set up a
plastics recycling and manufacturing plant. The facilities were developed over a six month period from
June 30 to December 31, 2018 and commercial operations commenced on January 1, 2019.

GPP’s fiscal year end is December 31 and the first fiscal period was for the six months ended December
31, 2018. These financial statements are unaudited. McAudit and Ronald LLP, Chartered Accountants
(McAudit), has been appointed auditor of GPP’s financial statements for the year ending December 31,
2019.

You, CPA, are in charge of the GPP audit engagement, and recently met with Geoff Great and other
management employees to obtain information in order to plan the audit engagement. It is now late
August, 2019, and you have obtained GPP’s interim financial statements for the seven months ended July
31, 2019 (Exhibit I), and have obtained information pertaining to the preparation of these statements
(Exhibit II). You have also obtained information about GPP’s operations (Exhibit III). The company uses
ASPE to report their financial statements.

Great informed you of five concerns he has for which he wants McAudit to provide advice. His first
concern is whether GPP’s interim financial statements for the seven months ended July 31, 2019 have
been prepared properly by GPP’s accountant. He has asked McAudit to evaluate the preparation of these
statements. His second concern is the legal action threatened by PI against Great and GPP regarding
ownership of the process developed by Great (Exhibit IV). He is concerned about the financial impact on
GPP and its viability should PI’s claim be successful and has asked McAudit to analyze this matter for
him. Great’s third concern is that he believes that a financial statement value should be assigned to the
recycling process asset he contributed to GPP which is presently not reflected on GPP’s balance sheet.
He has asked for advice about how GPP should account for this asset. Great transferred the recycling
process that he developed personally to GPP and his fourth concern is what the taxation considerations
are pertaining to this transfer assuming that PI’s claim that it owns the recycling process is unsuccessful.
He has asked for taxation advice about the implications of this asset transfer for both himself and for
GPP. His fifth concern pertains to the distribution agreement that GPP has entered into with Outsource
Distribution Inc. (ODI), the exclusive distributor of GPP’s products. Information about the distribution
agreement is provided in Exhibit V. He is uncomfortable about the lack of control exercised by GPP over
ODI. Information about the initial financing of GPP is provided in Exhibit VI.

The partner responsible for the GPP engagement has asked you to prepare a memo for her review that
discusses the financial accounting issues and that identifies the general audit planning considerations and
discusses the audit strategy for the areas of significant risk pertaining to the audit of GPP’s financial
statements for the year ending December 31, 2019, and that provides the advice requested by Geoff Great.

 2008 The Institute of Chartered Accountants of Ontario

Required:

Prepare the memo to the partner that addresses the requests made by the partner and the requests made by
Great.

 2008 The Institute of Chartered Accountants of Ontario

 EXHIBIT I

GREAT PLASTIC PRODUCTS INC.

BALANCE SHEET
At July 31, 2019

(in thousands of dollars)

Assets

Cash $ 15
Receivable from ODI 1,600
Inventory 1,000
Other 35
2,650

Land 275
Recycling facilities 2,500
Office equipment 225
3,000

Deferred development expenditures 450

$ 6,100
Liabilities

Bank operating loan, prime plus 2% $ 1,400

Accounts payable 490
1,890

Long-term bank loan, 6%, due December 31, 2023 2,000

Debentures, due December 31, 2023 500
2,500

$ 4,390
Shareholder’s Equity

Common shares $ 50
Retained earnings 1,660
1,710

$ 6,100

 2008 The Institute of Chartered Accountants of Ontario

 EXHIBIT I (continued)

GREAT PLASTIC PRODUCTS INC.

INCOME STATEMENT
For The Seven Months Ended July 31, 2019

(in thousands of dollars)

Revenue
Plastic products and components $ 3,000
Recycled plastic resin 1,000
4,000

Cost of sales
Plastic products and components 1,560
Recycled plastic resin 320
Shipping 120
ODI fee 360
2,360

Gross margin 1,640

Expenses
Operating and administration 910
Interest on long-term bank loan 70
980

Net income $ 660

 2008 The Institute of Chartered Accountants of Ontario

 EXHIBIT II

GREAT PLASTIC PRODUCTS INC.

INFORMATION OBTAINED BY CA PERTAINING TO THE PREPARATION
OF GPP’S INTERIM FINANCIAL STATEMENTS

Revenue and Cost of Sales

All sales are made through a distributor, Outsource Distribution Inc. (ODI). Revenue of $4,000,000
represents the selling price to customers of the products shipped to ODI. At July 31, 2019, ODI had sold
goods to customers in the amount of $2,800,000 and is holding inventory received from GPP that is
valued at $1,200,000 based on selling prices. This inventory consists of $900,000 of plastic products and
components and $300,000 of recycled plastic resin. Accounts receivable pertaining to sales made to
customers by ODI are reported to GPP by ODI to be $400,000 at July 31, 2019.

Cost of sales is calculated using standard costs determined by management based on an analysis of
manufacturing costs. Cost of sales includes ODI’s fee of 15% of the revenue from sales made by ODI.
This fee totaled $360,000 for the seven months ended July 31, 2019. Cost of sales also includes costs
incurred to ship goods to ODI’s premises. Shipping costs amount to 3% of the selling price of the goods.

The receivable from ODI consists of the sales value of the inventory shipped to ODI minus the payments
received from ODI and ODI’s fee.

Inventory

Inventory on hand at GPP at July 31, 2019, valued at cost, consists of the following:

Reclaimed raw plastic $ 555,000

Work in process 50,000
Plastic products and components and recycled plastic resin 320,000
925,000
Standard cost variances 75,000
$1,000,000

Reclaimed raw plastic has not been processed into recycled plastic resin. Recycled plastic resin is held in
liquid form in storage tanks. The plastic products and components and recycled plastic resin inventory
have a combined sales value of $720,000.

Recycling Facilities and Office Equipment

Amortization for the recycling facilities and office equipment assets will be recorded in the same amount
as capital cost allowance claimed for income tax purposes for the particular fiscal year. No amortization
has been recognized to date.

Deferred Development Expenditures

This asset is comprised of all of the costs incurred during GPP’s development stage from June 30 to
December 31, 2018. No revenue was earned during this period.

 2008 The Institute of Chartered Accountants of Ontario

 EXHIBIT II (continued)

GREAT PLASTIC PRODUCTS INC.

INFORMATION OBTAINED BY CA PERTAINING TO THE PREPARATION
OF GPP’S INTERIM FINANCIAL STATEMENTS

Bank operating loan

The bank operating loan has a limit which is calculated as 75% of accounts receivable, net of an
appropriate allowance for uncollectible accounts, plus 60% of the cost of inventory, determined in
accordance with Canadian generally accepted accounting principles. GPP is required to repay to the
bank, within 30 days of the end of each fiscal quarter, the amount by which the operating loan exceeds
this limit. Interest pertaining to this loan is included in operating and administration expense.

Retained earnings

Retained earnings at July 31, 2019 has been determined as follows:

July 1 to December 31, 2018

Forgivable government development loan $1,000,000

January 1 to July 1, 2019

Net income 660,000
$1,660,000

Recycling process asset

Great transferred ownership of the recycling process to GPP as part of his initial investment in addition to
the $50,000 cash he invested to acquire the common shares issued by GPP. No value has as yet been
assigned to the transfer of the process from Great to GPP in the financial statements.

 2008 The Institute of Chartered Accountants of Ontario

 EXHIBIT III

INFORMATION OBTAINED BY CA ABOUT GPP’S OPERATIONS

Manufacturing

GPP operates in leased premises. The lease is for a term of 10 years with a renewal option for a further
10 years.

GPP commenced commercial production of recycled plastic and plastic products on January 1, 2019, after
six months of start-up activities which included equipment set-up and testing, training of employees and
trial production runs.

GPP purchases reclaimed plastic and recycles the plastic into resin which is sold or used in the
manufacture of plastic products and components of products.

The standard cost of producing recycled plastic resin is 32% of the selling price and the standard cost of
manufactured plastic products and components is 52% of the selling price. The actual manufacturing
costs exceeded the standard costs by $75,000 for the seven months ended July 31, 2019.

GPP is presently overstaffed by approximately 20% in order to comply with the conditions of the
forgiveable development loan and to have the trained employees needed when GPP operates at 80% of
capacity. GPP has operated at 60% of capacity to date. GPP’s standard costs are based on operating at
80% of capacity.

Management is presently investigating means for disposing of the hazardous waste generated by the
recycling process. Management is environmentally responsible and plans to dispose of the waste in a safe
manner. The waste is presently stored in drums. Management estimates that the disposal costs will be
5% of the selling price of the plastic products and components and recycled plastic resin produced.

Projected revenues and expenses

Great expects that revenue from sales to customers and expenses for the seven months ended July 31,
2019 are representative of revenue and expenses for the five months ending December 31, 2019.

Great has projected GPP’s revenues to be $6,000,000 in fiscal 2020 and to be $9,000,000 in fiscal 2021.
Revenue from the sale of recycled plastic resin is projected to account for 25% of these projected revenue
amounts.

Great has estimated that combined plastic products and components and recycled plastic resin inventory
held by GPP and by ODI will be equal to three months’ sales to customers by ODI at the end of each
fiscal year.

Great has estimated that operating and administration costs will total $1,400,000 in each of fiscal 2020
and fiscal 2021.

 2008 The Institute of Chartered Accountants of Ontario

 EXHIBIT IV

INFORMATION OBTAINED BY CA CONCERNING PI’S

LEGAL ACTION AGAINST GREAT AND GPP

PI claims ownership of the recycling process developed by Geoff Great because it was developed while
Great was an employee of PI.

Legal counsel for PI has advised GPP that PI is willing to transfer ownership of the process to Great
personally or to GPP in an out-of-court settlement, or if PI’s claim is upheld in court, in exchange for
Great or GPP agreeing to pay PI an amount of $1,000,000, payable in five annual payments of $200,000
plus 5% of the revenue generated from the sale of goods that are produced using this recycling process.
The 5% fee is applicable to the revenue earned by GPP commencing January 1, 2019, and the first
payment of $200,000 is due on December 31, 2019. If the claim goes to court and PI’s claim is
successful, Great or GPP will be required to pay an additional upfront amount of $250,000 to PI.

The position taken by Great and GPP’s legal counsel is that Great developed the process entirely on his
own time, in addition to fulfilling his employment responsibilities to PI. Accordingly, Great owns the
process and PI’s claim is unfounded.

 2008 The Institute of Chartered Accountants of Ontario

 EXHIBIT V

INFORMATION REGARDING THE DISTRIBUTION AGREEMENT BETWEEN GPP AND ODI

ODI is responsible for selling GPP’s products to customers (recycled plastic resin and plastic products)
and for managing the accounts receivable, including collection. ODI receives a fee of 15% of gross
revenue from the sale of GPP’s products for performing these services. ODI remits to GPP the amount
equal to the cash received for payments of GPP receivables for the reporting period less its 15% fee for
the reporting period.

ODI provides reports regularly to GPP. These reports provide details of the sales transactions, the
accounts receivable transactions and the inventory transactions. Supporting documentation for the sales
transactions and receivables is held by ODI at its premises. The distribution agreement provides GPP
with the right to inspect this documentation upon request.

By the end of each February, ODI is to advise GPP of the customer receivables that GPP should write off
as at December 31 of the year end just completed when preparing its year end financial statements.

 2008 The Institute of Chartered Accountants of Ontario

 EXHIBIT VI

INITIAL FINANCING OF GPP

Great’s initial investment

Geoff Great invested $50,000 cash in GPP and was issued 5,000 common shares with an assigned value
of $10 per share. Great also transferred ownership of the process to GPP. However, no value was
assigned to this asset and no consideration was provided by GPP to Great for the asset transferred.

Government assistance

GPP obtained a forgivable development loan from the provincial government in the amount of
$1,000,000 to finance the development of the recycling facilities. The loan is forgivable in equal amounts
over a five year period if two conditions are met: GPP must maintain a specified minimum employment
level and must not violate specified environmental protection standards. The recycling process produces
hazardous waste which must be carefully stored and disposed of.

Debentures

GPP obtained financing of $500,000 in the form of debentures on January 1, 2019. The debentures have
a maturity date of December 31, 2023 and interest of $63,025 is payable annually for three years
commencing December 31, 2021. No interest is payable in 2019 and 2020.

 2008 The Institute of Chartered Accountants of Ontario