DAPHNE’S CATERING LTD.

CASE

To: Joe Insalcco (buyer)

From: Guneet Kaur, Accounting Consultant

Re: Issues of concern regarding the purchase of Daphne’s Catering Ltd Business

Overview

Users & Objectives:

 Joe (You) – You are looking to purchase the shares of DCL and wish to discuss the
purchase price. The purchase price will be determined by 5 times the average net
income of the last two fiscal years. Your objective is to at least identify the fair net
income or possibly minimize net income, in order to minimize the purchase price.
 Daphne Flatt – Daphne is also a user because she is a current owner of the company.
She is looking to sell all her shares and her objective is maximize the net income, in
order to gain the most profit from the transaction price (5 times the average net income
of the past two fiscal years).
 Canadian Revenue Agency – The CRA is looking to avoid bias and ensure the financial
statements reported by DCL were accurate and ethical. They ensure if the business has
accurately paid their taxes and are producing fair financial statements.
 Employees – We are assuming that the employees will be a user as well. Their
objectives will be aligned with Daphne’s because their benefits and compensation will
be tied to the net income.
 Auditors – The financial statements reviewed by auditors must be accurately and
ethically prepared.

Constraints:
 ASPE – I will assume ASPE because DCL is a small private company that only had one
location in Ontario. The owner also has possession of all the shares of the company.
 IFRS – In the case that DCL or you upon purchase wish to expand, then IFRS principles
will be used instead as it is easier and cost effective to expand through this method.

Conflict/Ethical Considerations:
 There is a conflict between Joe and Daphne’s objectives. You wish to minimize net
income, while it would benefit Daphne to maximize the net income.
 ASPE is also an ethical consideration, because the accounting principles must be
followed throughout the reporting of statements.

Primary Users and Objectives:

Primary User: Joe, you are the purchaser and you asked us to prepare this report. Your
objective is to minimize net income, so that your purchase price can be minimized. To a fair
extent, I will minimize the net income and satisfy your objective. However, I will be fair and
remain unbiased and ethical to produce a fair result. I will also be following the CPA guidelines
to remain ethical.

Accounting Issues:
Issue 1: Whether the cost associated with the remaining 60% of brochures that are stored
should be capitalized or expensed
Analysis: There are 2 alternatives: considering this an asset or expense
Expense – You will benefit if this is expensed, decreasing net income
Capitalize Asset –
Present control?
 Yes, DCL has control over the brochures
Result of past transaction?
 Yes, the transaction has already occurred in October 2019
Future probable benefit?
 No, there is no future benefit, as the brochures were only designed
specifically for the year 2019. At the end of this year, the brochures will not
be effectively used.
Is the good/service measurable?
 Yes, 60% of the brochures are in question currently
The brochures do not meet the criteria of being classified as an asset

Conclusion: Since the brochures do not classify as an asset, this cost should be expensed. This
will benefit Joe as it would decrease the net income by $19,000, ultimately reducing the
purchase price for Joe, saving him money.

Issue 2: Revenue recognition of $45,000 regarding the corporate event

Analysis: There are 2 alternatives: whether it is reported as revenue or unearned revenue
Unearned revenue – You will benefit from this, as this will decrease the net income.

Revenue – revenue recognition criteria under ASPE

Has the performance obligation been satisfied?
 No, the performance obligations have not been met
Can the amount be measured?
 Yes, the amount in question is $445,000
Is the collection probable?
 Yes, a deposit of $445,000 has been received
Have the risk and rewards been transferred?
 No, the event has not occurred yet
The criteria for revenue recognition has not been met
Conclusion: Since the criteria was not met for revenue recognition, the $45,000 amount should
be recognized as unearned revenue. By not recognizing it as revenue, the net income
decreases, benefiting you because it decreases the purchase price.
Issue 3: Accounting the $18,000 cost for the maintenance program
Analysis: There are 2 alternatives: accounting for the cost in September or October
Expense the cost when it is incurred – the expense was incurred in October
 This would not benefit you, because it would increase your net income, and
increase the purchase price
Conclusion: Since the cost was incurred in October, the cost should be accounted then.
Although this does not benefit Joe, it is the fairest method, that in turn increases the net
income.

Issue 4: Whether to capitalize or expense the development costs for $55,000

Analysis: There are 2 alternatives: capitalize the cost or expense it
Expense – this would benefit Joe, as it would decrease the net income and purchase
price
Capitalize the cost into an asset
Is it a result of a past transaction?
- Yes, DCL has spent the $55,000 for the development of a new product line over the
past 18 months
- The cost was reported on their statements on September 30, 2020
Who has control over the goods/services?
- Yes,
Is the future benefit for the goods/services measurable?
- No, while Daphne is confident in the future profitability of the product, there are still
significant issues with production, development, and marketing obstacles

Since the criteria for capitalizing the cost is not met, it should be expensed
Conclusion: The $55,000 R&D cost should be expensed, because it does not meet the asset
criteria. This would decrease the net income by $55,000 and in turn benefit Joe by reducing the
purchase price.

Conclusion:
Net income in 2019 - $160,000
Net income in 2020 - $275,000
Current Purchase Price = 550,000 + 5[1/2(160,000 + 275,000)]
= 1,637,500
Net Income for 2020 after adjustments made in the report
= 275,000 – 19,000 – 45,000 – 55,000
= 56,000
Final Price = 550,000 + 5[1/2(160,000 + 56,000)]
= ????????
 DISCOUNT STORES LTD CASE
To: Ruth Bogan

From: Guneet Kaur, Accounting Consultant

Re: Assessment of the current accounting issues of Discount Stores Ltd

Overview

Users & Objectives:

 The Bogans, Ruth Bogan (you) – to ensure that the new accounting policies adapted by
the CO is fair. You also want to reduce Harry’s bonus, which means you want to lower
net income, in order to maximize their own personal cash flows. The Bogans might also
want to minimize tax payments and increase cash flow, thus reducing the net income.
 Harry – He is also a user, because he is the CO, he prepares the financial statements. His
objective is to maximize the net income in order to receive the highest bonus. His
reputation of a well-known business is on the line as well.
 Canadian Revenue Agency – The CRA is looking to avoid bias and ensure the financial
statements reported by DCL were accurate and ethical. They ensure if the business has
accurately paid their taxes and are producing fair financial statements.
 Employees – We are assuming that the employees will be a user as well. Their
objectives will be aligned with Harry’s because their benefits and wage compensation
will be tied to the net income.
 Auditors – The financial statements reviewed by auditors must be accurately and
ethically prepared.

Constraints:
 ASPE – I will assume ASPE because Discount Stores Ltd is a medium sized private
company that is wholly owned by the Bogans. They have several medium sized locations
in Ontario, but the owners have possession of all the shares.
 IFRS – In the case that DCL or you upon purchase wish to expand, then IFRS principles
will be used instead as it is easier and cost effective to expand through this method.

Conflict/Ethical Considerations:
 There is a conflict between Harry and Ruth’s objectives. You wish to minimize net
income, while it would benefit Harry to maximize the net income.
 ASPE is also an ethical consideration, because the accounting principles must be
followed throughout the reporting of statements.

Primary Users and Objectives:

Primary User: The Bogans, their objective is to maximize cash flow, pay less bonus and tax
payments thus decreasing net income. To a fair extent, I will minimize the net income and
satisfy your objective. However, I will be fair and remain unbiased and ethical to produce a fair
result. I will also be following the CPA guidelines to remain ethical.

Accounting Issues:
Issue 1: Whether the 50% of advertising costs should be capitalized or expensed
Analysis: There are 2 alternatives: considering this an asset or expense
Expense – You will benefit from this as it would decrease the net income
Capitalize Asset –
Present control?
 Yes, they have control over the advertising campaign
Result of past transaction?
 Yes, the transaction has already occurred
Future probable benefit?
 No, the company had success from the campaign, but in the past, there is no
promise for future benefit
Is the good/service measurable?
 Yes, 50% is the amount in question
The advertising cost does not classify as an asset

Conclusion: Since the advertising costs cannot be deemed as an asset, they cannot be
capitalized. Thus, 50% of the advertising costs will be expensed. Expensing this cost will
decrease net income and benefit you.

Issue 2: Should slow-moving inventory be written-off

Analysis: There are 2 alternatives: whether to write it off directly or upon Harry’s suggestion
Harry’s suggestion – Harry can adjust his net earnings and maximize his bonus, by
choosing to write off the inventory or not in his own judgement.
Writing it off directly – This will benefit you, because it would decrease the net income
- If the NRV is lower than the cost of the product, then write-off the inventory
recording this as an impairment loss

Conclusion: Since it is slow-moving inventory, while you may not be able to sell it there are still
chances you will. You cannot assume a NRV of 0. Harry’s judgement can result in a biased
approach. Therefore, I would recommend you collect more information and research further
and then design a detailed approach to handling slow moving inventory. This would limit bias
and easily and accurately product correct figures on the financial statements.

Issue 3: Allowance of doubtful accounts and bad debt

Analysis: There are 2 alternatives: whether to record it as a doubtful account or write-off when
the collection is not probable
Allowance of doubtful accounts – this will benefit you, because the net income would
decrease, maximizing your cash flows
Directly Writing off – This method is not allowed under ASPE or IFRS
Conclusion: Directly writing off is not allowed, Harry may be inflating the net income to benefit
himself. However, using bad debt expense calculations and aging charts to accurately predict
the allowance for doubtful accounts would be better. This will also benefit you, as an AFDA is
considered as an expense. Thus, favouring you and reducing net income and increasing your
cash flows.

Issue 4: Lease hold improvement capitalization vs depreciation of useful life

Analysis: There are 2 alternatives: should the company use 5 years for useful life or 10 years
Using a 5-year useful life –
- This is based on historical treatment and has always been done in the past. Thus, not
adding expenses will benefit you.
Using a 10-year useful life – this may be more updated and accurate method and would
better inform the users of the financial statements.

Since the criteria for capitalizing the cost is not met, it should be expensed
Conclusion: Therefore, you can use the 5 year method because it favours the Bogans.

Conclusion:
 SAMPLE CASE TEMPLATE

To: Joe Insalcco (buyer)

From: Guneet Kaur, Accounting Consultant

Re: Issues of concern regarding the purchase of Daphne’s Catering Ltd Business

Overview

Users & Objectives:

 Joe (You) – You are looking to purchase the shares of DCL and wish to discuss the
purchase price. The purchase price will be determined by 5 times the average net
income of the last two fiscal years. Your objective is to at least identify the fair net
income or possibly minimize net income, in order to minimize the purchase price.
 Daphne Flatt – Daphne is also a user because she is a current owner of the company.
She is looking to sell all her shares and her objective is maximize the net income, in
order to gain the most profit from the transaction price (5 times the average net income
of the past two fiscal years).
 Canadian Revenue Agency – The CRA is looking to avoid bias and ensure the financial
statements reported by DCL were accurate and ethical. They ensure if the business has
accurately paid their taxes and are producing fair financial statements.
 Employees – We are assuming that the employees will be a user as well. Their
objectives will be aligned with Daphne’s because their benefits and compensation will
be tied to the net income.
 Auditors – The financial statements reviewed by auditors must be accurately and
ethically prepared.

Constraints:
 ASPE – I will assume ASPE because DCL is a small private company that only had one
location in Ontario. The owner also has possession of all the shares of the company.
 IFRS – In the case that DCL or you upon purchase wish to expand, then IFRS principles
will be used instead as it is easier and cost effective to expand through this method.

Conflict/Ethical Considerations:
 There is a conflict between Joe and Daphne’s objectives. You wish to minimize net
income, while it would benefit Daphne to maximize the net income.
 ASPE is also an ethical consideration, because the accounting principles must be
followed throughout the reporting of statements.

Primary Users and Objectives:

Primary User: Joe, you are the purchaser and you asked us to prepare this report. Your
objective is to minimize net income, so that your purchase price can be minimized. To a fair
extent, I will minimize the net income and satisfy your objective. However, I will be fair and
remain unbiased and ethical to produce a fair result. I will also be following the CPA guidelines
to remain ethical.

Accounting Issues:
Issue 1: Whether the cost associated with the remaining 60% of brochures that are stored
should be capitalized or expensed
Analysis: There are 2 alternatives: considering this an asset or expense
Expense – You will benefit if this is expensed, decreasing net income
Capitalize Asset –
Present control?
 Yes, DCL has control over the brochures
Result of past transaction?
 Yes, the transaction has already occurred in October 2019
Future probable benefit?
 No, there is no future benefit, as the brochures were only designed
specifically for the year 2019. At the end of this year, the brochures will not
be effectively used.
Is the good/service measurable?
 Yes, 60% of the brochures are in question currently
The brochures do not meet the criteria of being classified as an asset

Conclusion: Since the brochures do not classify as an asset, this cost should be expensed. This
will benefit Joe as it would decrease the net income by $19,000, ultimately reducing the
purchase price for Joe, saving him money.

Issue 2: Revenue recognition of $45,000 regarding the corporate event

Analysis: There are 2 alternatives: whether it is reported as revenue or unearned revenue
Unearned revenue – You will benefit from this, as this will decrease the net income.

Revenue – revenue recognition criteria under ASPE

Has the performance obligation been satisfied?
 No, the performance obligations have not been met
Can the amount be measured?
 Yes, the amount in question is $445,000
Is the collection probable?
 Yes, a deposit of $445,000 has been received
Have the risk and rewards been transferred?
 No, the event has not occurred yet
The criteria for revenue recognition has not been met
Conclusion: Since the criteria was not met for revenue recognition, the $45,000 amount should
be recognized as unearned revenue. By not recognizing it as revenue, the net income
decreases, benefiting you because it decreases the purchase price.
Issue 3: Accounting the $18,000 cost for the maintenance program
Analysis: There are 2 alternatives: accounting for the cost in September or October
Expense the cost when it is incurred – the expense was incurred in October
 This would not benefit you, because it would increase your net income, and
increase the purchase price
Conclusion: Since the cost was incurred in October, the cost should be accounted then.
Although this does not benefit Joe, it is the fairest method, that in turn increases the net
income.

Issue 4: Whether to capitalize or expense the development costs for $55,000

Analysis: There are 2 alternatives: capitalize the cost or expense it
Expense – this would benefit Joe, as it would decrease the net income and purchase
price
Capitalize the cost into an asset
Is it a result of a past transaction?
- Yes, DCL has spent the $55,000 for the development of a new product line over the
past 18 months
- The cost was reported on their statements on September 30, 2020
Who has control over the goods/services?
- Yes,
Is the future benefit for the goods/services measurable?
- No, while Daphne is confident in the future profitability of the product, there are still
significant issues with production, development, and marketing obstacles

Since the criteria for capitalizing the cost is not met, it should be expensed
Conclusion: The $55,000 R&D cost should be expensed, because it does not meet the asset
criteria. This would decrease the net income by $55,000 and in turn benefit Joe by reducing the
purchase price.

Conclusion:
Net income in 2019 - $160,000
Net income in 2020 - $275,000
Current Purchase Price = 550,000 + 5[1/2(160,000 + 275,000)]
= 1,637,500
Net Income for 2020 after adjustments made in the report
= 275,000 – 19,000 – 45,000 – 55,000
= 56,000
Final Price = 550,000 + 5[1/2(160,000 + 56,000)]
= ????????