Mock Common Final Examination Day 3 Page 1 MARKING GUIDE MEAN GREEN MACHINES ASSESSMENT OPPORTUNITIES MEMO To: Dale Thompson From: CPA Subject: Various Operational Matters ‘There were a number of issues noted with the calculation of the expected profit for the H2MOW line by Turbo Turf Inc. (TTI). Per Exhibit |, the expected first-year profit for the H2MOW line is, $4,543,750. This is significantly lower than the amount estimated by TTI of $12,560,000. For Assessment Opportunity #1, the candidate must be ranked in one of the following five categories: Not addressed — The candidate does not address this assessment opportunity. Nominal competence — The candidate does not meet the standard of reaching competence. Reaching competence — The candidate attempts to recalculate the expected first-year profit for the H2MOW line. Competent ~ The candidate performs a reasonable recalculation of the expected first-year profit for the H2MOW line. Competent with distinction — The candidate performs an accurate recalculation of the expected first-year profit for the H2MOW line. © 2018, Densmore Consulting Services Inc. All Rights Reserved.Mock Common Final Examination Day3 Page 2 Per Exhibit ll, based on the valuation method proposed, a full-value offer to purchase TTI by Mean Green Machines Inc. (MGM) would be $21,180,022. Normalizing adjustments have been made to ensure that pre-tax income is representative of typical business operations based on TTI's history and also industry benchmarks. As noted below, there are a number of risks to consider with this purchase, especially considering the share-based nature. It should be noted that a significant portion (approximately 65%) of the $21,180,022 valuation amount comprises the value assigned to the H2MOW line, which is yet to be proven in the market. Even minor changes to any of the estimates provided, such as the actual unit sales, could cause a significant reduction in the profits for this product, which would reduce its value. Unless there is a specific reason for undertaking the transaction quickly, it might be best to wait until the product has been launched, so that a more accurate picture of its expected future value can be derived, based on market perception and actual costs of production. As you mentioned, the industry has yet to see a product like this, and while it could be a game-changer, there is no guarantee of success. Further, it appears that the owners/management of TTI have made several decisions in the past year that were guided by a motivation to increase pre-tax income for the purposes of increasing the company’s perceived value, which could actually serve to reduce future profits, These include: ‘+ Contractually obligating TTI to purchase parts from a lesser-known, new supplier, which could result in lower quality products being manufactured, and would impair TTI’s competitive advantage in the industry and could significantly impact future warranty costs. ‘© Spending significantly less than is typical within the industry on product advertising. This is especially concerning given the pending launch of the H2MOW line, which would benefit from increased promotional efforts in the build-up to market entry. ‘+ Not providing bonuses to senior management at year-end, despite having done this for the past five years. This has upset employees and could result in productivity issues in the future, lowering profitability, Ultimately, based on the actions above, TTI might not be worth the proposed valuation multiple given the negative impact that these recent decisions may have on future profits. It may be better to consider a different valuation method, such as one based on net assets, or perhaps considering an asset-specific purchase (see Assessment Opportunity #6) should you wish to continue with some form of acquisition. ©2018, Densmore Consulting Services Inc. All Rights Reserved,Mock Common Final Examination Day 3. Page 3 For Assessment Opportunity #2, the candidate must be ranked in one of the following five categories: Not addressed — The candidate does not address this assessment opportunity. Nominal competence - The candidate does not meet the standard of reaching competence. Reaching competence ~ The candidate attempts to calculate an amount to offer for the purchase of TTI using a multiple of normalized pre-tax income and/or expected first-year profit for the H2MOW line. ‘Competent ~ The candidate reasonably calculates an amount to offer for the purchase of TTI using a multiple of normalized pre-tax income and expected first-year profit for the H2MOW line. Competent with distinction - The candidate accurately calculates an amount to offer for the purchase of TTI using a multiple of normalized pre-tax income and expected first-year profit for the H2MOW line, and discusses why TTI may not be worth the proposed valuation multiple. The acquisition of TTI by MGM would constitute a business combination under IFRS 3, Business Combinations, since the acquirer (MGM) would be purchasing all outstanding shares of the acquiree (TT!) and thereby obtaining control over the business. MGM would be required to use the acquisition method to account for the business combination, Which requires a four-step process be applied, as per IFRS 3.5: 1. Identification of the acquirer (MGM) 2. Determination of the acquisition date (expected to be March 1, 2018) 3. Recognition and measurement of the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquire (see below) 4, Recognition and measurement of goodwill or a gain from bargain purchase (see below) Steps 3 and 4 above dictate the accounting treatment for the acquisition, which will result in the consolidation of TI's financial statements with those of MGM's. The assets and liabilities assumed by MGM are to be measured at their fair values at the acquisition date, with each amount thereafter included in MGM's consolidated balance sheet. Goodwill is measured as the difference between the value of the consideration transferred (at fair value) and the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed (measured at fair value). © 2018, Densmore Consulting Services Inc. All Rights Reserved.‘Mock Common Final Examination Day 3 Page 4 Per Exhibit Ill, the preliminary expected goodwill amount based on the purchase price computed would be $7,888,522. This amount is not subject to amortization but must be tested annually for impairment (IAS 36.98, Impairment of Assets). Since the acquisition would be a 100% share purchase, there would be no non-controlling interest recorded at the time of acquisition. The expected acquisition costs of $225,000 must be expensed at the time of acquisition according to IFRS 3.53. For Assessment Opportunity #3, the candidate must be ranked in one of the following five categories: Not addressed ~ The candidate does not address this assessment opportunity. Nominal competence ~ The candidate does not meet the standard of reaching competence. Reaching competence — The candidate attempts to discuss how to account for the acquisition or attempts to calculate goodwill. Competent — The candidate discusses how to account for the acquisition and reasonably calculates goodwill. Competent with distinction — The candidate discusses in sufficient depth how to account for the acquisition and accurately calculates goodwill, With respect to the year-end order delivered to Grass 'R Us (GRU), IFRS 15.9, Revenue from Contracts with Customers, requires that several criteria be met in order to account for a contract. One of these is that itis probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. Dale thinks that revenue might be over-stated for this reason. However, the fact that GRU has @ poor collection history based on MGIV's past experiences is not relevant in this instance. GRU issued a certified cheque on delivery, which is effectively the same as cash. This sale was not made using credit and no receivable exists. Therefore, there are no concerns with collectability and MGM can record the revenue if al of the other criteria are met. The sale of these goods represents a performance obligation satisfied at a point in time per IFRS 15.38 as delivery occurred on a specific date and not over time. The issue is when the revenue should be recorded. © 2018, Densmore Consulting Services Inc. All Rights Reserved,Mock Common Final Examination Day 3 Page 5 IFRS 15.38 requires the following indicators of transfer of control to be met to record revenue on the sale of goods: a) The entity has a present right to payment for the asset - This is met since GRU issued a certified cheque on delivery, at the time when payment was due. b) The customer has legal title to the asset - GRU obtained legal title to the order when it was delivered, so this criterion is met on delivery. ©) The entity has transferred physical possession of the asset — MGM transferred physical possession of the order to GRU upon delivery and there is no return provision, so this, criterion is met on delivery. @) The customer has the significant risks and rewards of ownership of the asset ~ This criterion was met upon delivery since the goods were physically controlled by GRU on December 31, 2017 after delivery. Also, the order terms stipulate that returns are not permitted ) The customer has accepted the asset - GRU accepted the delivery and paid at that time, which indicates customer acceptance of the order. Therefore, this criterion was met on delivery. Although the motivation behind the transaction may be to increase pre-tax income for purposes of the expected share purchase at the expense of lower future profits, it has been recorded correctly under IFRS® Standards since each of the above criteria were clearly met on December 31. However, | would argue that it should be excluded from the normalized pre-tax income basis used to determine the purchase price, as explained in Exhibit Il. For Assessment Opportunity #4, the candidate must be ranked in one of the following five categories: Not addressed — The candidate does not address this assessment opportunity. Nominal competence — The candidate does not meet the standard of reaching competence. Reaching competence — The candidate attempts to discuss whether the revenue from the Grass ‘R Us order can be recognized. ‘Competent — The candidate provides a reasonable discussion of whether the revenue from the Grass ‘R Us order can be recognized. Competent with distinction - The candidate provides an in-depth discussion of whether the revenue from the Grass 'R Us order can be recognized. © 2018, Densmore Consulting Services inc. All Rights Reserved.Mock Common Final Examination Day3 Page 6 There were a number of errors noted in TTI's tax filing information provided for 2017. As per Exhibit IV, revised taxable income should be $6,372,220, which is significantly higher than the amount of $2,921,640 calculated by TTI. For Assessment Opportunity #5, the candidate must be ranked in one of the following five categories: Not addressed - The candidate does not address this assessment opportunity. Nominal competence — The candidate does not meet the standard of reaching competence. Reaching competence — The candidate attempts to revise taxable income. Competent ~ The candidate provides a reasonable revision to taxable income, Competent with distinction - The candidate accurately revises taxable income. There are a number of risks to consider when structuring an acquisition through a share purchase. Essentially, MGM would be stepping into TT!'s position and continuing its business in its current form. Below | have discussed several risks that pertain specifically to this purchase, Assuming Liabilities ‘When shares are purchased, all existing, contingent and unknown liabilities of the acquiree are inherited by the acquirer. This represents a significant risk since TTI is currently subject to a personal injury lawsuit. Any payout, and resulting negative publicity, would be borne by MGM as the acquirer, representing a significant financial and reputational risk. This could damage your overall brand image, which goes against one of the objectives of the acquisition. Tax Filing Concems By purchasing TTI's shares, MGM would assume responsibility for any issues with prior tax filings made by TTI. This is 2 concern based on the errors noted in the tax filing summary provided, which indicates there could be issues in previous years as well. TTI has used the outsourced company for a few years now, and the company has been paying low tax amounts (© 2018, Densmore Consulting Services Inc. All Rights Reserved.Mock Common Final Examination Day 3 Page7 despite significant profits. Any additional tax liabilities and penalties arising in the future could significantly impact cash flows while posing major legal risks. Contracts All pre-existing contracts entered into by TTI will be assumed in a share purchase. This means that you would be committed to the low-cost, lesser-known part supplier for the duration of the one-year contract. This could impair TI's competitive advantage relating to quality since it cannot source parts from the reputable, high-quality supplier previously used. Redundant Assets You mentioned that most of TI's products and processes are very similar to MGM's and could cause redundancies. Since all assets are acquired in a share purchase, MGM may be paying for certain assets that are not needed. This reduces the company's existing cash position, and also future profits, through additional maintenance and operating costs, without adding value. One of the stated goals for the acquisition is to create cost synergies, yet the opposite impact may occur. For example, you would be paying $4,049,400 for TT's building, yet MGM has excess capacity at its own facility that could easily house TT's operations with minimal re- Configurations. This risk is somewhat mitigated by the fact that MGM could sell the building to generate cash. Employees MGM would be inheriting all of TTI’s employees in a share purchase. Given that many are upset about the lack of bonus payments for 2017, this could translate into poor performance after the acquisition, or departures of key personnel, which can lower profits. Further, if you wanted to terminate certain employees due to position redundancies, significant severance payments may be required to do so, and there could also be legal ramifications depending on employment laws, Overall! The risks noted above are significant and could have a major negative impact on future operations. Given that you are primarily interested in the H2MOW line and one of TTI's patented engine parts, | would recommend considering an acquisition of certain assets only, such as individual patents. This would alleviate the risks above, while reducing the purchase price. © 2018, Densmore Consulting Services Inc. All Rights Reserved.Mock Common Final Examination Day 3 Page 8 For Assessment Opportunity #6, the candidate must be ranked in one of the following five categories: Not addressed — The candidate does not address this assessment opportunity. Nominal competence ~ The candidate does not meet the standard of reaching competence. Reaching competence — The candidate purchase of TI's shares. fiscusses some of the specific risks relating to a Competent — The candidate discusses several of the specific risks relating to a purchase of, TTI's shares. ‘Competent with distinction — The candidate discusses many of the specific risks relating to a purchase of TT's shares and suggests considering an asset purchase with support. Per Exhibit V, MGM would need to produce 25,774 units to begin saving money by producing the patented engine part for its own manufacturing purposes versus continuing to purchase it from the Australian company. Once this production level is reached, there are incremental cost savings of $1.94 per unit by producing internally. Note that any fixed costs associated with producing this engine part internally have not been considered here as they would be incurred regardless of this decision. The engine part would be produced anyways as part of normal operations for sale to other companies since TTI is the only North American supplier and this represents a key source of revenue that | am assuming ‘you would continue to eam post-acquisition. © 2018, Densmore Consulting Services Inc. All Rights Reserved,Mock Common Final Examination Day 3 Page 9 For Assessment Opportunity #7, the candidate must be ranked in one of the following five categorie: Not addressed ~ The candidate does not address this assessment opportunity. Nominal competence ~The candidate does not meet the standard of reaching competence. Reaching competence ~ The candidate attempts to calculate the production level required in order to save money by producing the patented engine part versus continuing to purchase it. Competent — The candidate reasonably calculates the production level required in order to save money by producing the patented engine part versus continuing to purchase it. Competent with distinction - The candidate accurately calculates the production level required in order to save money by producing the patented engine part versus continuing to purchase it. ©2018, Densmore Consulting Services Inc. All Rights Reserved.Mock Common Final Examination Day 3 EXHIBIT! Page 10 RECALCULATION OF EXPECTED FIRST-YEAR PROFIT FOR H2MOW LINE Purpose: To revise the calculation of expected profit in year one for the H2MOW ine. Analysis: Projected sales [1] $9,750,000 Variable costs: Parts [2] 2,640,000 Labour [3 780,000 Warranty [4] 633,750 ‘Advertising [5] 975,000 Uiiities [6] 52,500 5,081,250 Fixed costs: say Fulltime production supervisor [7] 2 75,000 Insurance [8] 50,000 : 725,000 Projected profit $4,543,750 Conclusion: The expected first-year profit for the H2MOW line is $4,543,750. © 2018, Densmore Consulting Services Inc. All Rights ReservedMock Common Final Examination Day 3 Page 11 EXHIBIT | (continued) RECALCULATION OF EXPECTED FIRST-YEAR PROFIT FOR H2MOW LINE Notes: [1] New product offerings typically sell an average of 2,500 units per month in the first year based on industry information. Therefore, | adjusted the calculation, which was based on 5,000 units per month. TTI may be able to substantiate that this is reasonable based on. the unique nature of the product, which has never been seen before in the industry. The logic for the assumption should be questioned as it has a significant impact on total profit, Note that | have assumed the selling price of $325 is reasonable, but this should be corroborated as well. Projected sales are calculated as 2,500 units per month x 12 months x $325 per unit = $9,750,000. [2] Adjusted to reflect lower average sales per month, calculated as 2,500 units per month x 12 months x $88 per unit = $2,640,000. [3] Adjusted to reflect lower average sales per month, calculated as 2,500 units per month x 12 months x $26 per unit = $780,000. Note that the combined variable parts and labour cost provided by TTI seems Feasonable since it produces a gross margin of 65% (calculated as [$19,500,000 - $6,840,000] / $19,500,000). This is consistent with industry information that indicates products in the first year of launch typically have gross margins in excess of 60%. [4] Warranty costs were not considered by TTI in the projection, Per industry information, warranty costs on new product offerings average 6.5% of sales in year one. Calculated as $9,750,000 x 6.5% = $633,750. [5] Adjusted to 10% of sales ($9,750,000 x 10% = $975,000) to reflect industry average, which is likely more representative of operations than the $100,000 estimate provided by TTI, which is unreasonably low at only 0.5% of projected sales ($19,500, 000) [6] Variable overhead costs were not considered by TTI in the projection, but are directly attributable to production and thus a relevant incremental cost. Per the income statement information, each unit produced uses $1.75 in utilities. Calculated as 2,500 units x 12 months x $1.75 per unit = $52,500. [7] Excluding the fixed manager salary is not reasonable since this is directly attributable to production of the H2MOW line and would otherwise not be incurred [8] New products require incremental insurance coverage, costing $50,000 annually, which must be factored in as a relevant cost. ©2018, Densmore Consulting Services Inc. All Rights Reserved.Mock Common Final Examination Day 3 Page 12 EXHIBIT Il CALCULATION OF PURCHASE PRICE TO OFFER FOR TTI Purpose: To compute the amount to offer for the purchase of TTI's shares. Analysis: Valuation based on normalized 2017 pre-tax income Pre-tax income $6,953,570 Normalizing adjustments: Fee [Revenue [1]_ aE (1,120,000) Cost of goods sold [1] 288,000 [ Gross margin [2] (2,596,790) ‘Advertising [3] (7,092,600) Management bonuses [4] (386,450) Bad debt accrual [5] (231,870) Refinancing [6] | 73,333 Normalized pre-tax income $1,887,193, Multiple 4 Valuation (A) S 7,548,772 Valuation based on expected first-year H2MOW profits First-year profits (Exhibit |) i - $ 4,543,750 Multiple 3 Valuation (8) $73,637,250 Total Valuation of TTI (A+B) $21,180,022 Conclusion: ‘The valuation method provided indicates that $21,180,022 should be offered for TTI © 2018, Densmore Consulting Services Inc. All Rights Reserved,Mock Common Final Examination Day 3 Page 13, EXHIBIT Il (continued) CALCULATION OF PURCHASE PRICE TO OFFER FOR TTI Notes: [1] The GRU order is not typical of TT's operations, described as being “unusual” both in terms of delivery speed and order size for the season as very few machines are sold in the winter months. It appears that this sale was pushed through as a one-time order to facilitate future sales and/or improve 2017 pre-tax income. This would not be expected to be a recurring source of annual revenue. Cost of goods sold associated with the GRU order must be added back since the corresponding revenue has been removed. (Note: Another acceptable assumption would be to adjust the gross margin on the contract from 74% to 55%] [2] TI's gross margin per the income statement information provided was 72% ($11,930,690 / $16,578,000), which is significantly higher than the industry average of 55% for mature products. Since TTI has not introduced a new product in five years, all of its product lines would likely be considered “mature” and thus the gross margin is not representative of typical market conditions. It appears that this is due to the decision to enter into a one-year contract with a lesser-known supplier to reduce its cost of goods sold, A normalizing adjustment has been made to reflect a gross margin of 55% on all of TTI's sales (excluding the GRU order removed above). Computed as Normalized revenue [A] $ 15,458,000 Normalized gross margin % 55% Normalized gross margin $8,507,900 Gross margin ~ per TT! [8] (11,098,690) Adjustment $ (2,596,790) [A] Computed as: Revenue ~ per TTI $16,578,000 Remove: GRU Order 20,000) $15,458,000 [B] Computed as: Gross margin ~ per TT! $11,930,690 Gross margin ~ GRU Order (C] (832,000) $17,098,690 [C] Computed as: Revenue $ 1,120,000 Cost of goods sold (288,000) Gross margin $832,000 © 2018, Densmore Consulting Services Inc. All Rights Reserved.Mock Common Final Examination Day 3 Page 14 BI [4] (5) [6] EXHIBIT Il (continued) CALCULATION OF PURCHASE PRICE TO OFFER FOR TTI As per industry information, advertising expenses are typically 10% of sales revenue, and can be even higher during product launches. Thus, we would expect advertising costs of at least 10% of sales given the pending H2MOW market introduction. | have conservatively adjusted advertising expense to 10% of normalized sales ($15,458,000), though it could arguably be a higher amount, which would further decrease pre-tax income. Expected advertising expense $1,545,800 Actual per TTI 453,200 Adjustment $1,092,600 TTI has an established pattern of paying its senior management bonuses at year-end, as this was done for five consecutive years prior to 2017. TTI's justification for not paying bonuses is that it is expecting to sell the company. TTI could argue this is a discretionary expense rather than an obligation, and thus should not be adjusted. However, the decision seemingly has nothing to do with operations (the company has been profitable and is in good financial shape), and employees are upset, which indicates it has become ‘an expected component of TI's compensation. Therefore, itis appropriate to adjust for a bonus expense equal to 2.5% of normalized sales ($15,458,000 x 2.5% = $386,450). The bad debt expense has averaged 3% of credit sales since inception, which is a more representative figure of TTI's operations than the 1.5% that management decided to use arbitrarily for 2017. An adjustment has been made based on normalized sales as follows’ Expected bad debt expense $463,740 (3% x $15,458,000) Actual per TTI 231,870 Adjustment $231,870 Refinancing costs occur every three years and thus the expenditure should be spread out over that time to reflect the annual cost. An adjustment to increase pre-tax income has been made ($110,000 / 3 x 2 = $73,333). © 2018, Densmore Consulting Services Inc. All Rights Reserved.Mock Common Final Examination Day 3 Page 15 EXHIBIT Ill CALCULATION OF GOODWILL USING ACQUISITION METHOD Purpose: To compute the expected goodwill amount at the acquisition date of March 1, 2018. Analysis: Purchase price ~ Exhibit I! $21,180,022 Less: Net assets acquired — carrying value [1] $(10,249,500) Fair value adjustments: Building (775,000) Patents (2,095,000) Bond liability 172,000) $ (3,042,000) Goodwill $_1.888,522 Conclusion: The expected goodwill arising on acquisition is $7,888,522. Notes: [1] Itis tikely that the tax liability recorded by TTI is under-stated based on the analysis in Exhibit IV. An adjustment would significantly impact the calculation by reducing the net assets. More information on the amount recorded by TTI is needed to assess the specific impact. © 2018, Densmore Consulting Services Inc. All Rights Reserved.Mock Common Final Examination Day3 Page 16 EXHIBIT IV REVISED TAXABLE INCOME CALCULATION Purpose: To revise TT's taxable income for 2017 based on errors noted Analysis: Pretax income $6,953,570 ‘Ada: Depreciation 7,027,500 Meals and entertainment [7] 11,600 Golf membership [1] 1,500) Bad debt accrual [2] 231,870 Financing fees [3] 110,000 Deduct: Bad debts written off [2] 306,870 Capital cost allowance [4] 7,634,950 Financing fees [3] 22,000 ‘Net income for income tax purposes 6,372,220 Deduct Net capital loss carry-forward [5] = Taxable income $6,372,220 Conclusion: TT's taxable income for 2017 is $6,372,220. © 2018, Densmore Consulting Services Inc. All Rights ReservedMock Common Final Examination Day 3 Page 17 Notes: a (2) 8 (4] (5) ©2018, EXHIBIT IV (continued) REVISED TAXABLE INCOME CALCULATION A full deduction is permitted for up to six events where all employees are invited Therefore, the expenses for the staff Christmas party and the employee appreciation barbecue are fully deductible ($9,750 + $7,250). Even though golf memberships are specifically denied under the Income Tax Act, the business luncheons at the golf course are 50% deductible. This means the expenses for the business luncheons have been treated correctly. The meals and entertainment deduction addback is calculated as $11,600 ($23,200 x 50%). In addition, the golf membership of $1,500 is added back as a non-deductible expense. A general reserve for “bad debts” (doubtful or impaired debts) based on a percentage of revenue is not permitted for tax purposes. Therefore, $231,870 is added back since this, amount was expensed for accounting purposes. Only specifically identifiable bad debts determined uncollectible at year-end may be deducted for tax purposes, and since none exist at year-end, no deduction is permitted Since there was no reserve claimed in 2016 (ie., no specifically identifiable uncollectible accounts for the 2016 year-end), no previously claimed reserve needs to be added back in calculating income for tax purposes for 2017. However, actual bad debts written off during the year may be deducted for tax purposes, calculated for 2017 as follows: Allowance for doubtful accounts at December 31, 2016 $405,650 Add: Bad debt accrual (2017) 231,870 637,520 Less: Allowance for doubtful accounts at December, 31, 2017 330,650 Bad debts written off during 2017 $306,870 Mortgage refinancing fees are considered financing costs for income tax purposes, and are deductible over five years under Income Tax Act paragraph 20(1)(e). Therefore, the $110,000 deducted is added back, and a corresponding deduction for 20% of the amount ($22,000) is included as an eligible deduction. [Note: the deduction is limited to 20% per year because even though the refinancing is for a three-year term, the “settlement” of the debt is part of a series of borrowings (ie., refinancing) requiring the continuation of the 20% annual deduction,] The capital cost allowance (CCA) amount computed for the Class 53 addition did not factor in the half-year rule. In the year of purchase, only 50% of the eligible CCA amount can be claimed. Therefore, only $208,750 ($835,000 x 50% x 50%) can be claimed for this machine, resulting in an overall CCA claim of $1,634,950 ($1,843,700 - $417,500 + $208,750). Further information should be obtained on the remaining CCA amounts in other classes to determine if any other errors exist Net capital losses can only be deducted against taxable capital gains, and not against business income. Densmore Consulting Services Inc. All Rights Reserved.‘Mock Common Final Examination Day 3 Page 18 EXHIBIT V BREAK-EVEN CALCULATION FOR ENGINE PART Purpose: To determine the production level required in order to save money by producing the engine part internally versus continuing to purchase the part from an Australian company. Analysis: Cost per unit to purchase [1] $20.00 Cost per unit to produce internally [2] 18.06 Incremental savings per unit from producing internally $1.94 By producing internally, MGM would be saving $1.94 per unit. However, a $50,000 penalty would have to be paid to the Australian supplier. This would be considered a fixed cost associated with producing internally, The number of units required to be produced internally in order to be in the same cost position as through purchasing can be determined by the following formula, where X represents units; $50,000 = $1.94x X = $50,000 / $1.94 X= 25,774 Conclusion: Therefore, intemal production in excess of 25,774 units will result in cost savings. Notes: [1] Calculated as $10,000 / 500 units = $20 per unit. The 5% additional shipping cost has been excluded since it is waived once $100,000 has been spent (equal to 5,000 units purchased), which would be met based on the production level computed above. [2] Calculated as $28 / 1.5 = $18.06, based on 55% mark-up over TTI's variable cost of production, © 2018, Densmore Consulting Services Inc. All Rights ReservedMEAN GREEN MACHINES INC. Candidate: Marker: ‘ROA ‘RO2 ‘AO3 ‘AOS ‘ROS ‘ROG ‘KOT MA F FR FR T F MA ‘OVERALL COMMENTS (Marker notes: Consider ranking, time management, writing style, format, use of case facts, role) © 2018, Densmore Consulting Services Inc. All Rights Reserved‘AOT- MA The candidate recalculates the expected first-year profit for the H2MOW Tine, RC — The candidate attempts to recalculate the expected first-year profit for the H2MOW line. © - The candidate performs a reasonable recalculation of the expected first-year profit for the H2MOW line. CD — The candidate performs an accurate recalculation of the expected frstyear profit for the H2MOW line ‘Marker Notes ‘Attempts = sales less 2 costs; minor errors OK Reasonable = adjusted sales less 4 correct costs (1 must be parts); calculations must be supported Accurate = adjusted sales less 5 correct costs (1 must be parts); calculations must be supported Costs: ‘© Parts ($88 per unit) Labour ($26 per unit) Warranty (6.5% of sales) Advertsing (10% of sales) Utilities ($1.75 per unit) Full-time production supervisor ($75K) Insurance ($50K) Ranking ‘Comments © 2018, Densmore Consulting Services Inc. All Rights Reserved.‘AO2=F The candidate calculates an amount to offer forthe purchase of TT/using a multiple of normalized pre-tax income and expected first-year profit for the H2MOW line. RG — The candidate attempts to calculate an amount to offer for the purchase of TT1 using a multiple of normalized pre-tax income and/or expected first-year profit for the H2MOW line. C - The candidate reasonably calculates an amount to offer for the purchase of TTl using a multiple of normalized pre-tax income and expected first-year profit for the H2MOW line, CD - The candidate accurately calculates an amount to offer for the purchase of TT using a multiple of normalized pre-tax income and expected first-year profit for the H2MOW line, and discusses why TTI may not be worth the proposed valuation multiple Marker Notes Attempts = either applies multiple 10 pretax income with 2 normalizing adjustments OR applies multiple to first-year profits consistent with AO’ Reasonably = applies multiple to pre-tax income with 3 correct normalizing adjustments AND applies multiple to first-year profits consistent with AO1; adjustments must be supported Accurately = Applies multiple to pre-tax income with 4 correct normalizing adjustments AND applies multiple to first-year profits consistent with AQT; adjustments must be supported Normalizing adjustments: + Revenue and cost of goods sold for GRU order (eliminated/adjusted) + Gross margin (reasonable attempt to adjust to industry rate) + Advertising (adjusted to 10% of sales) + Management bonuses (2.6% of sales) + Bad debt accrual (adjusted to 3% of sales) + Refinancing (annualized over 3 years) + Discusses = identifies at least 1 TTI owner/management action supported by case facts and explains how the action could reduce future profits with explicit link to the valuation of TT] * Actions - new supplier, product advertising, management bonuses Ranking ‘Comments © 2018, Densmore Consulting Services Inc. All Rights ReservedAO3-FR _| The candidate discusses how to account for the acquisition at March 7, 2078, including a calculation of goodwill RC — The candidate attempts to discuss how to account for the acquisition OR attempts to calculate goodwill C ~The candidate discusses how to account for the acquisition AND reasonably calculates goodwill, CD — The candidate discusses in sufficient depth how to account for the acquisition AND accurately calculates goodwill Marker Notes | How to Account for the Acquisition: + Attempts to discuss = applies case facts to 2 of the 4 steps of the acquisition method + Discusses = applies case facts to 3 of the 4 steps of the acquisition method + Sufficient depth = applies case facts to the 4 steps of the acquisition method + 4 of: annual impairment test, non-controlling interest, acquisition costs ‘+ Note: Step 3 and Step 4 could be implicit through the candidate's calculation. Calculation of goodwill: * Attempts = purchase price consistent with AQ2 less carrying value of net assets acquired * Reasonably = purchase price consistent with AO2 less carrying value of net assets acquired with at least 1 correct fair value adjustment * Accurately = purchase price consistent with AO2 less carrying value of net assets acquired with at least 2 correct fair value adjustments + Fair value adjustments — building, patents, bond liability Ranking ‘Comments T © 2018, Densmore Consulting Services Inc. All Rights Reserves.‘AO4-FR The candidate discusses whether the revenue from the Grass R Us order can be recognized, RG — The candidate attempts to discuss whether the revenue from the Grass ‘R Us order can be recognized - The candidate provides a reasonable discussion of whether the revenue from the Grass 'R Us order can be recognized. CD — The candidate provides an in-depth discussion of whether the revenue from the Grass 'R Us order can be recognized. Marker Notes ‘Attempts to discuss = applies case facts to 2 transfer of control criteria (minor technical errors OK) OR recognizes that collectabilty is not an issue for this order supported by case facts Reasonable = recognizes that collectabily is not an issue for this order supported by case facts + applies case facts to 3 transfer of control indicators + concludes ‘when to record revenue In-depth = recognizes that collectabilty is not an issue for this order supported by case facts + applies case facts to 4 transfer of control indicators + concludes to record revenue in 2017 Ranking ‘Comments ©2018, Densmore Consulting Services Inc. All Rights Reserved.‘AOS-T The candidate assesses TT latest tax fling summary and revises faxable income. RC — The candidate attempts to revise taxable income. C ~The candidate provides a reasonable revision to taxable income. CD — The candidate accurately revises taxable income. Marker Notes | Attempts = calculates taxable income with 2 adjustments, minor errors OK Reasonable = calculates taxable income with 3 correct adjustments, adjustments must be supported Accurately = caloulates taxable income with 4 correct adjustments, adjustments must be supported Adjustments: ‘+ MBE ~luncheons at golf course 50% deductible and full deduction for party and BBQ Golf club membership - added back Depreciation added back and CCA calculated with half year rule Bad debt — accrual added back and amount written off deducted Financing fees — add back $110K and deduct $22K Net capital loss carry-forward excluded Ranking ‘Comments © 2018, Densmore Consulting Services Inc. All Rights Reserved. 6‘R06 -F The candidate advises on the specific risks relating to a purchase of TT/'s shares. RG- The candidate discusses some (2) of the specific risks relaling to a purchase of TT's shares. (~The candidate discusses several (3) ofthe specific risks relating to a purchase of TT's shares. ‘GD - The candidate discusses many (4) of the specific risks relating to a purchase of TTI's shares AND suggests considering an asset purchase with support (must be explicit). WarkerNotes | Identifies = may not integrate specific case facts, does not explain the impact of the risk on MGM Discusses = identifies risk using specific case fact + expiains the impact ofthe risk on MGM Ranking ‘Comments: IDENTIFIES DISCUSSES ‘Assuming liabilities ‘Tax filing concerns | Contracts. Redundant assets Employees (Other valid © 2018, Densmore Consulting Services Inc. All Rights Reserved.‘AO7 = MA The candidate calculates the production level required in order to save money by producing the patented engine part versus continuing to purchase it. RC — The candidate attempts to calculate the production level required in order to save money by producing the patented engine part versus continuing to purchase it ~The candidate reasonably calculates the production level required in order to save money by producing the patented engine part versus continuing to purchase it (CD - The candidate accurately calculates the production level required in order to save money by producing the patented engine part versus continuing to purchase it Marker Notes ‘Attempts = BIE calculation including difference in cost to purchase vs. produce ‘and any fixed costs Reasonably = BIE calculation with correct difference in cost to purchase vs. produce and supported fixed costs Accurately = correct B/E calculation, all calculations supported Ranking ‘Comments © 2018, Densmore Consulting Services Inc. All Rights Reserved.