You are the auditor of Vegatron Services Inc.,
a privately owned full-service cleaning company following ASPE that is
undergoing its first audit for the period ending September 30, 2011. The bank
has requested that Vegatron have its statements audited this year to satisfy a
condition of its debt covenant. It is currently October 1, 2011, and the
company’s books have been closed. As part of the audit, you have found the
following situations:
1. Despite having high receivables, Vegatron
has no allowance for doubtful accounts, and cash collections have slowed dramatically.
Unfortunately, Vegatron is owed $5,000 by Brad’s Fast Foods at the end of
fiscal 2011. Brad’s has received substantial media attention during the past
year due to Department of Health investigations that ultimately resulted in the
closure of the company’s operations; the owner has apparently moved to the
Bahamas. No adjustment has been made for this balance. Company management
estimates that an allowance for doubtful accounts of $47,000 is required.
During the 2011 fiscal year, the company wrote off $38,000 in receivables, and
it estimates that its September 30, 2010 allowance for doubtful accounts should
have been $30,000.
2. Vegatron’s only capital asset on its books
is an advanced cleaning system that has a cost of $35,000 and a carrying amount
of $20,825. Vegatron has been depreciating this asset using the capital cost
allowance used for tax purposes for the two years prior to the 2011 fiscal
year, at the rate of 30%. Useful life at the time of purchase was estimated to be
10 years. Vegatron would like to change to a straight-line approach to provide
more relevant information to its statement users. Management anticipates that
the asset will continue to be of use for four years after the September 30, 2011
year end and will have no residual value. Since the company’s accountant was
uncertain about how to deal with the change in policy, depreciation expense has
not been recorded for the fiscal year.
3. Vegatron purchased a computer at the beginning
of the fiscal year and immediately expensed its $3,000 cost. Upon questioning,
one of the owners said he thought the computer would likely not need to be
replaced for at least two more years.
4. You notice that there are no supplies on the
statement of financial position. Company management explains that it expenses
all supplies when purchased. The company had $1,500 of cleaning supplies on
hand at the end of September 2011, which is about $500 higher than the balance
that was on hand at the end of the previous year.
5. Vegatron started this year to keep a small
amount of excess cash in trading investments. At the end of September 2011, the
fair value of this portfolio was $15,000 and the cost of the investments was
$12,000.
Instructions
(a) Assuming that the company’s books are
closed, prepare any journal entries that are required for each of the transactions.
Ignore income tax considerations.
(b) For each of the items, discuss the type of
change that is involved and how it is accounted for on the current and comparative
financial statements.
(c) If Vegatron elected to follow IFRS, discuss
how this might change your answers to (a).
(d) Repeat part (a) assuming that the books are
open.
(a) and (b)
(1)
Retained Earnings.......................... 52,000
Allowance
for Doubtful Accounts........ 47,000
Accounts
Receivable.................... 5,000
This is a correction of an error.
The company must apply retrospective application in order to correct the
presentation of receivables and bad debts expense in its comparative financial
statements.
(2)
Note that there would be no
adjustment to opening retained earnings for any previous year since changes in
estimate are accounted for prospectively. There would also be no journal entry
to adjust the accounting records for accumulated depreciation due to the change
in method since a change from one depreciation method to another is a change in
estimate, not a change in accounting policy.
The change in estimate during 2011
for the remaining useful life is accounted for prospectively. Changes in
estimates are applied after any change in policy has been accounted for.
(3)
Computer................................... 3,000
Retained
Earnings...................... 3,000
Retained Earnings.......................... 1,000
Accumulated
Depreciation—Computer...... 1,000
($3,000
/ 3)
This is a correction of an error.
Since the error affects only 2011, no retrospective application is necessary.
(4)
Supplies................................... 1,500
Retained
Earnings...................... 1,500
This is a correction of an error.
Retrospective application is required for the 2010 balance in supplies. Since
this is a counter-balancing error, no journal entry is required, but the
opening balance in supplies of $1,000 will need to be adjusted on the
comparative financial statements.
(5)
Temporary Trading Investments
(FV-NI)...... 3,000
Investment
Income (FV-NI).............. 3,000
This is a correction of an error
that affects only the current year. Retrospective correction is not required.
(c) As
a privately held entity, Vegatron may choose to follows either accounting
standards for private enterprises (ASPE) or IFRS. Vegatron could possibly
account for its trading investment using the fair value through other
comprehensive income (FV-OCI) model under IFRS (provided that the investment
qualifies for the special election), which must be accounted for using the fair
value through net income (FV-NI) model under ASPE, This would allow the holding
gains and losses to bypass net income and be reporting in other comprehensive
income instead.
(d)
(1)
Retained Earnings*......................... 30,000
Bad Debts Expense.......................... 22,000
Allowance
for Doubtful Accounts........ 47,000
Accounts
Receivable.................... 5,000
*Beginning balance in the allowance
for doubtful accounts.
(2)
Note that this is considered to be a correction of an
accounting error since the company is changing from a non-GAAP method to a GAAP
method. The change in estimate is accounted for prospectively.
Accumulated Depreciation* 7,175
Retained
earnings 7,175
*($35,000 – $20,825) – 2 X
($35,000/10)
Depreciation Expense** 5,400
Accumulated
Depreciation 5,400
**($35,000 – $7,000) / 5
(3)
Computer................................... 3,000
Operating
Expenses..................... 3,000
Depreciation Expense....................... 1,000
Accumulated
Depreciation—Computer...... 1,000
($3,000
/ 3)
(4)
Supplies................................... 1,500
Supplies
Expense....................... 500
Retained
Earnings...................... 1,000
(5)
Temporary Trading Investments
(FV-NI)...... 3,000
Investment
Income (FV-NI).............. 3,000
