Accounting Issues in Audit Planning and Procedures at Bachman

School: University of Ottawa - Course: ADM 4340 - Subject: Accounting

TO: Engagement partner - Henry Cuddy FROM: Auditor - Cuddy and McLachlan CPA SUBJECT: Bachman Pianos Inc (BPI) - Changes in audit planning, audit procedures, & accounting concerns DATE: January 5, 2023 ______________________________________________________________________________ As per request, please find below, a summary of potential accounting issues identified within the procedures performed by our new audit client, Bachman Pianos Inc, as well as the assessment of the impacts of changes made by our client on this year's audit planning, and finally the specific audit procedures required for the upcoming audit. With these issues being identified, I have also included recommendations for the client on potential improvements. ACCOUNTING ISSUES ISSUE #1 - IFRS 11.5 (paragraph 26,24) - When you use IFRS and there are investments, use the EQUITY method -Any transaction carried out with that party, you will only be able to recognize gain/revenue to the extent to the share of the other party oIf I have 30% and they have 70%, you can recognize 70% of gain oIf I have 50% and they have 50%, you can recognize 50% of gain -They've transferred assets to the related parties (not-dealing-at-arm's-length) ISSUE #2 - Revenue recognition -Date control has been transferred to buyer (significant risk of ownership) has been transferred is WHEN we recognize revenue -Client does not want to take possession of one of the pianos until NEXT FISCAL YEAR -They've COMPLETELY recognize sale of piano prior to -Recommendation: oReverse JE to derecognize revenue, derecognize sale Revenue Deferred revenue COGS must be taken out of inventory and recorded on income statement o*Maybe deferred revenue but this is aggressive oIFRS 15- Split up sale into multiple contracts treat both pianos as their own performance obligation (contract) some revenue can be accrued for the "later received" asset Bill and hold arrangement - transfer risk and rewards to client by getting the client to "take possession", they are responsible for any future damages in storing,insurance

ophysical inventory MUST be available and set aside; act genuinely as if it's really someone else's property oclient MUST ASK to hold and not completely fulfil the delivery of the order oif the client had set aside the full inventory, then you can recognize full inventory -this will impact the financial statements and the buyer's conditions ISSUE #3 - Advertising costs -Advertising have been added in prepaid expense; they've capitalized it -development costs/intangible asset: marketing costs cannot be capitalized, they must be expensed -Record expenses in the period in which they relate - can youmatchfuture benefit to these advertising capitals? this is difficult so should not be recorded like this -Recommended: oWrite them off in the period when incurred (period costs) ISSUE #4 - Inventory Obsolescence -Electric piano line was discontinued -recording of inventory: Lesser of cost OR net realizable value (net realizable value here is minimum NIL) oSO must be written off oRECOMMENDATION: NRV is 0 so write off the full amount oIf there's a second market, it needs to be at the lesser of the two conditions ISSUE #5 - Doubtful AR -Orchestra declared bankruptcy (they owe $200k) - unlikely to be received -Expected credit loss - accrue a loss for how much you think you'll lose: reduce net income/income from continuing operations * this one is important (UNDER BOTH ASPE AND IFRS) ISSUE #6 - Contingent liability -$100,000 liability was expensed "upfront" -IFRS requires: probable outcome: $0 fee oyou need to take the weighted average of possibilities and expense it oLawyers said you did nothing wrong, SO you don't need to accrue expense as of year end Disclose in the notes the details -ASPE: takes the most likely number (not the weighted); you only accrue the contingent liability if it's more likely than not MATERIALITY What makes a material statement more likely this year than last year: new users, new buyer, management bias; what increases the risk this year: -motivation to inflate revenue -New CFO: less use to the accounting treatment applied in this company

-new joint venture: measuring the equity method What will the client need to do -decrease materiality: users are more sensitive to changes in F/S oMore work, more testing, more scrutiny -What basis would you use for materiality: continuing operations (3-4%) AUDIT APPROACH: -Substantive approach: -Combined approach: new transactions that their controls did not catch (substantive); if last year's controls over their routine operations are working effectively; substantive approach this year will focus on their new operations AUDIT PROCEDURES: -High-risk accounts (what accounts are you going to write procedures about - what problem accounts are you going to focus on):the ones with the financial reporting issues(the ones with the financial reporting issues) -Sale of pianos: assertion (existence: you're going to ask for the signed purchase order, and the proof of request for bill and hold) oWhat are you doing to do with the purchase order: compare the dates, requested delivery date, insurance of asset -AR: assertion (existence, valuation:what document would you request : newspaper article that announced the bankruptcy, bank trustee to confirm) oWrite off the 200k bad debt -Lawsuit: you're going to ask the law firm the legal letter explaining their recommendation and the likeliness (completeness, cutoff of liabilities) Financial instruments An initial observation can be made regarding the recognition of the bad debt identified in August of 2022, where two pianos totalling an invoice of $200,000 unpaid aged accounts receivable are highly unlikely to be paid due to the recently filed bankruptcy for this owing client. Per IFRS 9, a financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit-impaired include observable data about the following events: (a) significant financial difficulty of the issuer or the borrower; (b) a breach of contract, such as a default or past due event; (c) the lender(s) of the borrower, for economic or contractual reasons relating to the borrower's financial difficulty, having granted to the borrower a concession(s) that the lender(s) would not otherwise consider; (d) it is becoming probable that the borrower will enter bankruptcy or other financial reorganisation; (e) the disappearance of an active market for that financial asset because of financial difficulties