Big Bath Emporium (BBE), a private company based in Toronto, is the city's largest manufacturer and vendor of bathtubs, showers, and sinks. The company sells products direct to consumers, and also sells whole- sale to other retailers.
BBE is owned by Bob Bresher, who runs the operations side of the business. His brother, Thomas Bresher, manages all of the accounting functions. Bob performed market research and determined that the next step for BBE is to expand sales to Quebec. BBE has slowly reduced its debt load over the years, but still relies on creditors and bankers to finance its operations. BBE went to the bank to obtain additional financing to expand to Quebec. The bank agreed to provide $1.5 million in financing at face value, at a rate of 9%, interest payable annually. The bank indicated that audited financial statements would be required this year, and BBE would need to maintain a debt to equity ratio of 1:1, where debt is defined as all liabilities.
Brayden LLP is a local audit firm engaged to per- form the December 31, 2017 year-end audit to satisfy the bank requirements. You are the senior accountant assigned to this audit engagement. It is January 2018, and Thomas Bresher has asked that the work be performed as soon as possible. You meet with Bob and Thomas and note the following transactions that occurred during the year.
1. During 2017, BBE sold 100 warranties for $5,000 each on its bathtubs. The warranty period is five years. Historically, the warranties have resulted in a cost of approximately $500 per year. BBE uses the cash basis to recognize the warranty expense and revenue. During 2017, no warranty costs were incurred.
2. On December 31, 2017, BBE was notified that its plant will need to perform a cleanup every 10 years of the area surrounding the plant. BBE estimated that the costs of the cleanup will be approximately $500,000 in 10 years. Thomas indicated that because the amount is not due for years, there is no need to recognize anything at this point.
3. BBE bought inventory on January 1, 2017. The purchase was financed through an interest-free vendor take-back loan, with a promise to repay $200,000 in two years. Thomas recorded the loan on the balance sheet at $200,000. As at December 31, 2017, the inventory's net realizable value was $100,000.
4. On June 30, 2017, an employee launched a wrongful dismissal suit against BBE for $150,000. BBE's lawyers have indicated that they expect a payment of $100,000 to $120,000, but the lawsuit is still in court proceedings. Thomas didn't recognize any amount for this because he believes that BBE will be able to successfully defend the suit.
5. On December 31, 2017, BBE issued 10,000 redeem- able and retractable preferred shares at $50 per share, for tax planning purposes. The shares are redeem-able and retractable at any date up to December 31, 2022, at which point the redeemable and retractable feature expires. The preferred shares pay a mandatory dividend of $10 per share per year until the end of the redeemable and retractable period, after which the dividends are not cumulative and not mandatory. Thomas recorded these shares as equity, and the first dividend payment on December 1, 2017 was recorded through equity.
BBE's balance sheet shows that the company has $1.3 million in debt and $2.4 million in equity. Because the equity is so much higher than the debt and the debt to equity ratio is easily met, Bob indicated that a dividend will be declared this year for $800,000.
Instructions
Provide a report to your manager indicating the accounting issues you anticipate facing once the audit begins. Note where there are differences between ASPE and IFRS.