Case Study Athina free essay sample

Purpose: Recommendations for the CFO of Athina Building Supplies Ltd. We are writing to you on behalf of IV Consulting Group after closely examining the financial statements of your national retail and commercial building supplier chain, Athina Building Supplies Ltd. ’s. We have stumbled upon several issues, which will be discussed in detail below. We have prepared an insightful report on our findings and recommendations as asked for by the CFO of the national chain. Though the CFO is whom we are reporting too, we have considered how our advice will affect other key stakeholders of Athina such as the investors and CRA (assuming it is a Canadian firm), as it is inevitable to undermine the recommendations’ impact on them as well. First and foremost, even though Athina Building Supplies Ltd. is now a private business it was once linked to a national chain. Assuming the national chain complied under IFRS, it would prove more reasonable to incur less costs of switching to ASPE and also to continue using IFRS in case Athina requires a bank loan or ultimately plans for an IPO in the future (since investors currently are foreseeing success and growth for Athina). Athina was sold to its present investors for $1,000,000 as they believed that the stores would be more successful if they were managed by companies with expertise in the particular department. If Athina earns a net income of over $500,000, it must pay 25% to the national chain up until 2019 (2017-2019). Athina has recently closed their 2017 financial statements and have a new income of $510,000. This reveals that according to Athina investors, the national chain is presently owed $2,500. The users of the financial statements would most importantly be the CFO, followed by the investors. The CFO and investors have two very contradicting objectives, on one hand, the investors will want to minimize their income because if their income exceeds $500,000, 25% of it must be paid to the national chain for the next three years (from 2017 to 2019). On the other hand, the CFO will want to maximize Athina’s net income to guarantee receiving 25% from investors. The last objective, stewardship was also kept in mind while reaching to a conclusion because Athinas investors are responsible for managing it on behalf of the national chain thus they must report their financial statements to the national chain. In this report we will be focusing on income maximization as the main objective since the CFO is the primary user. We will also be considering income minimization and stewardship as secondary objectives to show opposite impacts. ISSUE 1 As a retail and commercial building supply dealer, Athina does business in cash and credit transactions. Customers are given up to 90 days to pay, and no customer has defaulted on any amounts they owe as of yet. As of December 31, 2017 customers owe $275,000 and costs associated with this revenue is $150,000 however Athina does not recognize these sales as revenue because cash has not been collected yet. In efforts to support the primary objective, the $275,000 should be recognized right away since all five IFRS criteria is met by doing so (Refer to Appendix 5). Once the sales have been made the risks and rewards of ownership are transferred to customers thus Athina no longer has control. The figure of the amount for revenue and cost is clear and collection is reasonable as Athina has mentioned no customer has ever defaulted. With all of this in mind, there is no reason Athina cannot recognize the $275,000 except that it will not meet their income minimization objective, but it will meet the CFO’s objective. Thus the $275,000 and the matching cost of $150,000 should be recorded right away. ISSUE 2 In 2017, it was discovered that certain assets purchased several years ago were not depreciated. It is inevitable to avoid expensing the depreciation cost of $175,000 for these assets, however in order to comply with the primary objective and still correctly report the depreciation expense in the 2017 financial statements, a solution has come to our attention. Generally, depreciation expenses with assets are recorded right away, yet Athina’s management failed to do so as an error and therefore this can be seen a usual/non-recurring item. The solution is to deduct the $175,000 as an unusual/non-recurring expense after a net income has been calculated for the business’s normal transactions (Refer to Appendix 1). Objectives of the investors will not be met with this solution as it maximizes income and pay out amount, but their method is still correct as well. ISSUE 3 In mid-2013 (assuming April), Athina obtained a five year dealership for kitchen cabinets, the contract was not renewed in 2017 but $210,000 were spent by Athina within 2013-2107 to set up displays to promote the line. $210,000 was capitalized and amortized over 10 years, and since it was discovered the products will not sell beyond April 2018, the unamortized portion was written off. The displays’ expense at December 31, 2017 becomes $105,000, meaning a remainder of another $105,000 is left to be expensed. (Refer to Appendix 2) In order to support the primary objective, and also provide a benefit for Athina’s management, the remaining $105,000 should have not been written off in 2017 but instead in 2018. This is beneficial in two ways, not expensing the amount in 2017 meets the CFO’s income maximization objective and for Athina’s management, because they are now aware they will not be able to sell the products beyond 2018, they should still use the remaining displays they have to sell as much of the product possible before April 2018 to attempt to cover or reduce the write-off cost. With this attempt, they are also not violating the matching principle in case they do make sales in 2018, then they will have the write-off cost to match with their revenue (Refer to Appendix 2). ISSUE 4 From examining the income statement and balance sheet for the year-end 2017, we learned that Athina purchased fairly old and poor condition heavy equipment at an auction for $225,000 and thus it needed repairs worth $125,000. These repairs prolonged its life for at least another ten years. The $225,000 was capitalized and $125,000 was expensed. Whether the $125,000 is a repair expense or betterment, is ambiguous therefore it is up to Athina to decide if capitalizing or expensing it is more beneficial to their reporting objectives. We as consultants believe, the repair cost of $125,000 should not have been expensed, but rather capitalized making the equipment worth $350,000 (225,000+125,000). Although the $125,000 was the cost to repair the old equipment, it was made to improve the asset and increase its useful life hence making it betterment. When this asset is capitalized, the cost would be spread out over ten years and just the yearly depreciation would be expensed. By eliminating the repair expense of $125,000, the net income and retained earnings are increased, subsequently, and comply with the CFO’s objective. Since income maximization is the primary objective, it is vital to capitalize the equipment for $350,000 and record a depreciation expense of $35,000 annually. Even though for Athina, the alternative of expensing the repair would mean a lower net income and compliance with their objective, it is a poor managerial decision because the equipment has more value now due to its extended life, which occurred only because of the repair and this must be acknowledged (Refer to Appendix 3). ISSUE 5 On July 15 2017, Athina signed a ten-year contract for $200,000 (non-refundable fee) with J. Alexander Songs Plumbing Ltd. to run their plumbing department. Capitalizing this asset is inappropriate because according to IFRS, it has no future benefit hence should be recorded as revenue. This revenue could be recorded in two ways. The first option is to recognize the $200,000 all at once or recognize it as unearned revenue and recognize the revenue over the term of the contract. Both are valid options and follow the five revenue recognition criteria set by IFRS (refer to Appendix 4). The alternative that maximizes the net income and meets the primary objective is recognizing all of $200,000 at once. Once the contract has been signed and the $200,000, non-refundable fee has been handed over to Athina, risks and rewards of ownership are transferred to J. Alexander Songs Plumbing Ltd. The figure of the amount for revenue and cost is clear and collection of the fee has already occurred, also displaying Athina no longer having control over the department. The second alternative meets the same criteria but does not match primary objective as you record portions of the $200,000 ($20,000 each year=$200,000/10years) as it is earned. Since the main objective is to increase net income, and all five revenue recognition criteria have been met under IFRS, there is no constraint forbidding Athina to record it in 2017. This is not ideal for investors, as they now have to pay a larger 25% from the net income, but legal for the CFO to request of Athina to report the total amount all at once. To conclude, the net income before unusual or non- recurring items after the recommendations have been implemented is $1,240,000. The payout to the national chain is $ 310,000 (25%) as opposed to the previous $2,500 (Refer to Appendix 5). This benefits the national chain in two ways- first, the increase of their net income and cash complies with the CFO’s main objective of increasing net income and secondly, an increase in revenue due to the success of Athina will attract other investors to invest in Athina, continuously making it a growing and prosperous business. Appendix 1 Entries performed by Athina Management: Dr. Depreciation Expense 175,000 Cr. Accumulated Depreciation 175,000 To record the depreciation expense Dr. Net Income175,000 Cr. Depreciation Expense175,000 To close the depreciation account for the period ending 2017 Recommended Entries by IV Consulting Group: Dr. Depreciation Expense 175,000 Cr. Unusual/Non-recurring Items 175,000 To record depreciation expense Dr. Net Income175,000 Cr. Depreciation Expense175,000 To close the depreciation account for the period ending 2017 Adjusted Net Income Before Unusual/ Non- Recurring Items (December 31st, 2017) $1,240,000 Athina’s Final Net Income After Unusual/ Non- Recurring Items (December 31st, 2017) $1,065,000 $1,240,000-$175,000= $1,065,000 Appendix 2 Cost of Displays: $210,000 (assumed to be bought April 2013, â€Å"mid-2013†) Number of Useful Years: 10 years Conjecture Residual Value: $0 Conjecture Depreciation Method: Straight-Line Depreciation Expense, Year Ended 2017= ($210,000/10 years) x 5 years = $105,000 Unamortized Amount, Year Ended 2017 = $210,000 -$105,000= $105,000 Write off Expense for 2017= $0 Write-off for 2018 (regardless of additional revenue made prior April 2018) = $105,000 Appendix 3 Correct Entry: Dr. Equipment 350,000 Cr. Cash 350,000 Record Purchase of Equipment Incorrect Entry: Dr. Equipment 225,000 Dr. Repair Expense 125,000 Cr. Cash 350,000 Record purchase of equipment Appendix 4 Criteria provided by IFRS for identifying the critical event for recognizing revenue on sale of goods is: a Significant risks and rewards of ownership have been transferred from the seller to the buyer—performance b The seller has no involvement or control over the goods sold—performance c Collection of payment is reasonably assured—collectability d Amount of revenue can be reasonably measured—measurability e Period/Product costs of earning the revenue can be reasonably measured (Freidlan, 171)1 Appendix 5 Net Income (December 31, 2017) $510,000 Adjustments Revenue from Builders and Contractors $275,000 Revenue: non-refundable contract fee 200,000 Cost of Goods Sold (150,000) Depreciation Expense Reversal, considered a unusual or non-recurring item 175,000 Write-off Reversal 105,000 Repair Expense Reversal 125,000 Net Income Before Unusual or Non- Recurring Items (December 31, 2017) $1,240,000 Payout to National Chain (25% of Net Income) 310,000 Unusual or Non- Recurring Items Expense (175,000) Net Income After Unusual or Non- Recurring Items (December 31, 2017) $1,065,000