Great Plastics Products Inc.

Multi – Test #2
Winter 2012
 Environment
• 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.
 Environment
• Great subsequently resigned from PI and
incorporated Green 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, 2010 and commercial
operations commenced on January 1, 2011.
 Role
• You, CA, 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, 2011,
and you have obtained GPP’s interim financial
statements for the seven months ended July 31, 2011
(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).
Timeline for Great Plastics Products Inc.(GPP)
Jan 1,
December 2011 July 7, August 31,
31, 2010 2011 2011 December
June 30,
2010 31, 2011

Year end of
Facilities were 7 month Housing Solutions
Developed Interim Ltd.
Facilities Began
f/s

Commercial
Operations
commenced
NOW –
Geoff Great was an Meeting with Geoff
Employee of Plastics Iinc. Great and other
When he developed Management
The process
 Required #1
• His first concern is whether GPP’s interim
financial statements for the seven months
ended July 31, 2011 have been prepared
properly by GPP’s accountant. He has
asked McAudit to evaluate the preparation
of these statements.
 Required #2
• His second concern is the legal action
threatened by PI against Green and
GPP regarding ownership of the
process developed by Green (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.
 Required #3
• Green’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. Green transferred the
recycling process that he developed
personally to GPP
 Required #4
• 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.
 Required #5
• 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.
 HOOK
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.
 Evaluation Guide
1- PM - The student discusses the overall audit planning considerations and the specific significant areas of
risk, and the student describes appropriate audit strategies and procedures.

The student demonstrates competence in Assurance.

Competent - The student discusses the overall audit planning issues in sufficient depth by demonstrating a good
understanding of risk at the financial statement level, materiality, and first-time audit considerations.
 Evaluation Guide
Evaluation Indicator #2
 
The student discusses the significant financial accounting issues.
 
The student demonstrates competence in Performance Measurement and
Reporting.

3 diagnostic indicators required

 Performance Measurement
• Need to establish the use of standard
– ASPE
Or
- IFRS
Must link to case facts
 Evaluation Guide
Evaluation Indicator #2A – Revenue Recognition

Discussion of the revenue when the goods are shipped to ODI

Competent  The student applies the applicable revenue recognition

considerations and simulation facts provided for the “sale of goods using a
sales agent” arrangement in sufficient depth by describing the appropriate
accounting treatments for revenue, accounts receivable, and inventory with
adequate support provided.
 Revenue Recogniton
Exhibit II
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, 2011, 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, 2011.

Exhibit V
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.
 Revenue Recognition
• GPP retains risk re the sale of inventory
and performance until the goods are sold
to ODI – Consignment Sales
• Need to reference s 3400
• Tie to the impact on net income
 Evaluation Guide
Evaluation Indicator #2B – Recycling Process Asset

You need to recognize an intangible asset and amortization

Competent  The student discusses recognition and valuation of the

recycling process asset in sufficient depth to demonstrate a good
understanding of how to account for both of the “debit” and “credit entries” for
this transaction. And, the student discusses either amortization of this asset or
two alternative “credit entries” for this transaction.
 Recycling Process Asset
Exhibit 2
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.

The value and account for this asset depends on the outcome
Of the litigation
1)PI is successful – GPP purchases the process from PI
Or
2) GPP agrees to out-of-court-settlement and value is equal to
The amount paid
OR
3) Great is successful – will need a specialist to determine FV
 Recycling Process Asset
• Recognition of intangible asset
• Amortization of the intangible asset
– The cost/fair value of this limited-life asset
should be amortized using the method that best
matches the cost of this asset to the revenue
recognized

• Discuss the impact on the inventory and the

operating loan limit
 Evaluation Guide
Evaluation Indicator #2C - Inventory

Discuss: Standard Cost Variance

Transportation cost re Shipment
Cost to Dispose
Discuss: impact on operating line limit

Competent  The student discusses the appropriate accounting

treatment for the standard cost variances, including the unfavourable
standard labour cost variance, in sufficient depth to demonstrate a good
understanding of how to account for inventory and standard cost variances.
 Inventory
Exhibit II
Inventory
Inventory on hand at GPP at July 31, 2011, 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

Standard cost variance can’t be allocated all to inventory must be

Split between inventory and cost of good sales
 Inventory
Income Statement
Cost of sales
Plastic products and components 1,560
Recycled plastic resin 320
Shipping 120
ODI fee 360
2,360

Transportation cost - include in inventory cost because they are a cost

Necessary to get the goods to the point of sale
 Inventory
Exhibit III
• 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.

Cost to dispose of hazardous waste – include in inventory

Because this is a variable conversion overhead that is directly
Related to production
 Evaluation Guide
Evaluation Indicator #2D – Government Assistance;
Deferred Development Expenditures; Debentures;

•Recognition of issue
•Reference to standard
•Impact on operating bank loan

Competent  The student discusses the appropriate accounting treatment for

either government assistance or deferred development expenditures in sufficient depth by
describing the appropriate accounting treatment with adequate support provided and by
describing the impact on the financial statements. And, the student discusses the appropriate
accounting treatment for one of government assistance or deferred development
expenditures, and debentures, in sufficient depth by describing the appropriate accounting
treatment with adequate support provided and by describing the impact on the financial
statements.
 Government Assistance
Exhibit VI
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.

Section 3800.21
Government assistance towards the acquisition of fixed assets shall be either: (a)   
 deducted from the related fixed assets with any depreciation calculated on the net
amount; or
(b)     deferred and amortized to income on the same basis as the related depreciable
fixed assets are depreciated.
 Deferred Development
Expenditures
Deferred Development Expenditures
 
This asset is comprised of all of the costs incurred during GPP’s
development stage from June 30 to December 31, 2010. No revenue
was earned during this period.
Recognition of an expense .
3064. 52     ¨ Expenditure on an intangible item shall be recognized as an expense
when it is incurred unless:
(a)     for an internally generated intangible asset in the development phase, the entity
has made an accounting policy choice to capitalize such expenditures (see paragraph
3064.40); and
(b)     it forms part of the cost of an intangible asset that meets the recognition criteria
(see paragraphs 3064.18-.51).
 Deferred Development
Expenditures
3064.53   
  In some cases, expenditure is incurred to provide future economic benefits to an
entity, but no intangible asset or other asset is acquired or created that can be
recognized. In the case of the supply of goods, the entity recognizes such expenditure
as an expense when it has a right to access those goods. In the case of the supply of
services, the entity recognizes the expenditure as an expense when it receives the
services. For example, expenditure on research is recognized as an expense when it
is incurred (see paragraph 3064.37) except when it is acquired as part of a business
combination. Other examples of expenditure that is recognized as an expense when it
is incurred include expenditure on:
(a)     start-up activities (i.e., start-up costs), unless this expenditure is included in the cost
of an item of property, plant and equipment in accordance with PROPERTY, PLANT
AND EQUIPMENT, Section 3061.
(b)     training activities;
(c)     advertising and promotional activities (including mail order catalogues and other
similar documents intended to advertise goods, services or events to customers); and
(d)     relocating or reorganizing part or all of an entity.
 Debentures
Exhibit VI
Debentures
GPP obtained financing of $500,000 in the form of debentures on January
1, 2011. The debentures have a maturity date of December 31, 2015 and
interest of $63,025 is payable annually for three years commencing
December 31, 2013. No interest is payable in 2011 and 2012.
The interest must be accrued in fiscal 2011 and 2012 based on the
Effective interest rate of 6% because the benefit was realized in these periods
Section 1000. 33     Expenses are decreases in economic resources, either by
way of outflows or reductions of assets or incurrences of liabilities, resulting
from an entity's ordinary revenue generating or service delivery activities
 Debentures
• Section 1000.45
• 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. For example, the various components of expense making up
the cost of goods sold are recognized at the same time as the income
derived from the sale of the goods. However, the application of the matching
concept does not allow the recognition of items in the balance sheet that do
not meet the definition of assets or liabilities.
 Evaluation Guide
Evaluation Indicator #3

The student calculates the total impact of the accounting treatments that require adjustment
and calculates the impact on net income and on the bank operating loan limit.
 
The student demonstrates competence in Pervasive Qualities.

Competent  The student calculates revised net income and the revised
bank operating loan limit in sufficient depth by including several of the
significant revisions required based on his/her discussion of the applicable
accounting treatments (income tax effects do not need to be considered). And,
the student provides appropriate conclusions on the revised amounts
calculated.
 Evaluation Guide
Evaluation Indicator #4
 
The student prepares a cash flow projection for GPP and makes an
appropriate conclusion on GPP’s future cash position and financial
viability.
 
The student demonstrates competence in Finance.

Competent  The student prepares a reasonable cash flow projection for fiscal 2012 and
fiscal 2013 that includes many of the relevant components. Overall, the cash flow projection is
useful for assessing GPP’s future cash position and financial viability. The student discusses
the revenue assumption in sufficient depth by providing a reasonable comparison of projected
revenue to actual (correct) revenue that should be recognized in fiscal 2011(i.e., revenue from
sales to end-customers). The student provides appropriate conclusions on the cash flow
calculated and on the financial viability of GPP.
 Evaluation Guide
Evaluation Indicator #5
 
The student discusses the control risks pertaining to the distribution
arrangement with ODI.
 
The student demonstrates competence in Assurance.

Competent  The student discusses the control risks resulting from

the arrangement with ODI and recommends control techniques that
GPP should implement in sufficient depth that the advice provided
would be useful in meeting the needs of GPP.
 Evaluation Guide
Evaluation Indicator #6
 
The student appropriately discusses the taxation considerations for the
transfer of the recycling process asset by Green to GPP.
 
The student demonstrates competence in Taxation.

Competent 
The student demonstrates good taxation knowledge by discussing both of:
•transfer at fair market value, and
•election to transfer at tax value
correctly and in sufficient depth by discussing the taxation implications of the asset
transfer for both Green and for GPP.
 Evaluation Guide
Evaluation Indicator #7
 
The student demonstrates professional skills and communication skills.
 
The student demonstrates competence in Pervasive Qualities and Skills.
 

Competent  The student demonstrates good professional and

communication skills.
 Evaluation Guide
NA NC RC C

1 AUD 0 2 4 8
2 PM 0 3 6 12
3 PQ 0 1.5 3 6
4 F 0 1.5 3 6
5 AUD 0 1.5 3 6
6 TAX 0 1.5 3 6
7 PQ 0 1.5 3 6
     
20 34 50