Jackson Capital Inc. ( JCI) is a new private investment company that provides capital to business ventures. JCI’s business mission is to support companies to allow them to compete successfully in domestic and international markets. JCI aims to increase the value of its investments, thereby creating wealth for its shareholders.

Funds to finance the investments were obtained through a private offering of share capital, conventional long- term loans payable, and a bond issue that is indexed to the TSX Composite. Annual operating expenses are expected to be $ 1 million before bonuses, interest, and taxes.

Over the past year, JCI has accumulated a diversified investment portfolio. Depending on the needs of the borrower, JCI provides capital in many different forms, including demand loans, short- term equity investments, fixed- term loans, and loans convertible into share capital. JCI also purchases preferred and common shares in new business ventures where JCI management anticipates a significant return. Any excess funds not committed to a particular investment are held temporarily in money market funds. JCI has hired three investment managers to review financing applications. These managers visit the applicant’s premises to meet with management and review the operations and business plans. They then prepare a report stating their reasons for supporting or rejecting the application. JCI’s senior executives review these reports at their monthly meetings and decide whether to invest and what types of investments to make.

Once the investments are made, the investment managers are expected to monitor the investments and review detailed monthly financial reports submitted by the investees. The investment managers’ performance bonuses are based on the returns generated by the investments they have recommended.

It is now August 20X6. JCI’s first fiscal year ended on June 30, 20X6. JCI’s draft statement of financial position and other financial information is included in Exhibits A, B, and C. An annual audit is required under the terms of the bond issue. Potter and Cook, Chartered

Accountants, has been appointed auditor of JCI. You are employed by Potter and Cook and are the in- charge accountant on this engagement. Mr. Potter has asked you to prepare a memo discussing the significant accounting issues, audit risks, and related audit procedures for this engagement.

Required

Prepare the memo requested by Mr. Potter.

Exhibit A

DRAFT SFP (JUNE 30, 20X6) (THOUSANDS)

Assets

Cash and marketable securities…………………………………………..… $   1,670

Investments (at cost)……………………………………………………………….   21,300

Interest receivable………………………………………………………………….           60

Furniture and fixtures (net of amortization) ………………………               50

……………………………………………………………………………………..         $  23,080

Liabilities

Accounts payable and accrued liabilities……………………………  $          20

Accrued interest payable…………………………………………………………..    180

Loans payable……………………………………………………………………..     12,000

…………………………………………………………………………………….           $ 12,200

Equity

Share capital……………………………………………………………………….   $ 12,000

Deficit……………………………………………………………………………..            (1,120)

…………………………………………………………………………………….           $ 23,080

SUMMARY OF INVESTMENT PORTFOLIO (JUNE 30, 20X6)

The SFP for June 30, 20X6, shows a total of $ 21.3 million in long- term investments. The breakdown of these investments is as follows:

Investments                                                                                                                         Cost

15% common share investment in Fairex Resource Inc., a company listed......... $ 3.8 million

on the TSX Venture Exchange. Management intends to monitor the

performance of this mining company over the next six months and to make a

hold/ sell decision based on reported reserves and production costs.

25% interest in common shares of Hellon Ltd., a private Canadian real............. $ 6.2 million

estate company, plus 7.5% convertible debentures with a face value of

$ 2 million acquired at 98% of maturity value. The debentures are

convertible into common shares at the option of the holder.

Five- year loan denominated in Brazilian currency (reals) to Ipanema Ltd........... $ 8 million

a Brazilian company formed to build a power generating station. Interest

at 7% per annum is due semiannually. 75% of the loan balance is secured

by the power generating station under construction. The balance is unsecured.

50% interest in Western Gas, a jointly owned gas exploration project................... $ 2 million

operating in Western Canada. One of JCI’s investment managers sits on the three- member board of directors.

50,000 stock warrants in Toronto Hydrocarbons Ltd., expiring March 22, 20X8..$ 1.3 million

The underlying common shares trade publicly.

Exhibit C

CAPITAL STRUCTURE (JUNE 30, 20X6)

The SFP for June 30, 20X6, shows a total of $ 12 million in share capital and $ 12 million in loans payable.

Loans Payable

The Company has $ 2 million in demand loans payable with floating interest rates, and $ 4 million in loans due September 1, 20X8, with fixed interest rates.

In addition, the Company has long- term 5% stock- indexed bonds payable. Interest at the stated rate is to be paid semiannually, commencing September 1, 20X6. The principal repayment on March 1, 20X9, is indexed to changes in the TSX Composite as follows: the $ 6 million original balance of the bonds at the issue date of March 1, 20X6, is to be multiplied by the stock index at March 1, 20X9, and then divided by the stock index as at March 1, 20X6. The stock- indexed bonds are secured by the Company’s investments.

Share Capital

Issued share capital consists of:

– 1 million 8% Class A (non- voting) shares redeemable at the holders’ option… $ 7 million on or after August 10, 20X8

– 10,000 common shares $ 5 million