Tony has been working for years in a large construction company performing diverse tasks, but lately has been specializing in plumbing. Being good at it with up to date certifications in the profession and having a large network of friends thanks to his involvement in the baseball landscape of the region, he is experiencing and increase demand for his services to perform small jobs on top of his activities as employee. After some potential jobs could not be performed because of his inability to issue official receipts, he decided to create his own company to provide small plumbing services that can be completed over one weekend (Saturday and Sunday).
Tony has accumulated savings but they might not be enough to cover the first expenses. None of the banks he approached offered him a reasonable answer; therefore he made the decision of using his credit card and accumulates debt there. However, his wife offered Tony short term loans at a cost of 1% per month, which is significantly cheaper than accumulating debts with the credit card. Both were happy with the proposed solution and agreed on it. Tony would let his wife know via e-mail the amount of money needed. This is done to leave a clean record to calculate the interest due.
Tony Thoron asked his cousin for advice about incorporating; his cousin is a lawyer that works for a well-known legal firm in the region. Tony had heard stories from friends about plumbing repairs going wrong and customers trying to sue the contractors and him certainly did not want to expose him to that kind of risk. The legal firm The 6 Law provided the necessary legal advice and did all the necessary paper work to incorporate as a Canada Business Corporation. Initial capitalization allowed for 100 no par value shares. Tony and his wife were named Directors of the Corporation which was called Tonys Plumbing Services Inc. The lawyers also checked that the name was not already registered and register his Internet domain.
Tony contributed his money in exchange for 50% of the shares. The bank account, a standard commercial chequing account that gave cheques returned with monthly statements for a monthly fee. This account does not allow for bank overdrafts and each returned cheque has a very high processing cost.
Tony’s interest was to work as much as he can during the week for his employer and on weekends for his own company, therefore he hired you to be his accountant. You have explained your fee and Tony has agreed to retain you for the whole year. You have prepared a document with the terms of engagement and payment on it.
Incorporation and Initial Capitalization
Tony needed to move around with equipment; therefore he needed to use his SUV. You, the accountant, informed Tony that if his company would use his SUV to conduct business, the company can pay rent to Tony for its use. Similarly if he uses part of his house to storage material, supplies and equipment, his company can pay rent for the use of that portion of the house. The rent has to be reasonable for the Canada Revenue Agency.
From the very beginning Tony realized his company needed some sort of third party liability insurance just in case a job went wrong and damages to property caused by his action or inactions. Tony reached out his insurance broker who suggested a product that was just for his needs, it was not expensive so Tony signed off on an annual contract.
His job can be optimized with some equipment that normally lasts two years when not used intensively as will be his case. Although he uses the same equipment as an employee, for his company and the jobs he performs is better for Tony to have and use his own equipment. He estimates than on average the equipment will last for 24 months with 20% of residual value.
Materials such as pipe insulation, cements, connectors, sealants, couplings, tape, adhesives and acetylene gas are very much needed for his job. The inventory of faucets, fixtures and other parts and accessories is zero because it is purchased for a certain job and when it is completed the customer would keep what was left. Tony was able to work out a deal with the supplier where he would make one payment at the end of each month covering all the supplies purchased during the month. Part of the deal was to secure a deposit at the beginning of operations. On April 1st Tony opens an account with the supplier by making a deposit. At the end of each month Tony would pay the supplies taken during the month (the deposit will remain with the supplier and will be returned only when Tony closes the account).
Seeing how well his activity was going, Tony decided to make his presence more noticeable by printing cards and flyers to be distributed at various baseball events. He also decided to place a series of ads in local magazines.
Under the company name, Tony signed a 25 months contract for a new phone. His use was not very intensive but you the accountant explained that a proportion can be claimed as a business expense.
Third Party Liability and Property Insurance
When a customer requires a fixture that is not carried by Tonys regular supplier, Tony would ask the customer to buy it. If the customer prefers not to do it, Tony would ask the customer for details (specifications, features, brand, etc.) and would hire his wife to do the search and go to the specific store that has the fixture to buy it.
At the end of the month when you, the accountant, had an idea of Tonys business size, you estimated the income tax liability of the month. To keep things simple Tonys received an e-mail with the details.
Tony knew most of the customers but he had the requirement of collecting a portion in advance to purchase all supplies needed for the job. He knew that everybody would pay eventually so he was comfortable in collecting some portion of his service fees latter. He accepted cheque or cash and kept a detailed record for tax purposes because his services included HST at 13%.
Tony decided to declare dividends for an amount reasonable that would not drain the remaining cash from the company. You explained to Tony that only net income that accumulates in Retained Earnings can be distributed as dividends. Tony understood and decided to distribute 25% of income if possible while the rest would be maintained within the company.
In terms of setting up his accounting system Tony’s sister decided on the following records:
Chart of Accounts
One event happened near the end of the month that left Tony somewhat distressed and depressed. A customer hired Tony to install a hot tube in a backyard. One night it was left with water and the neighbour dog drowned. The cover was not properly secured because Tony did not install the hooks that would hold it tight. The manufacturers booklet mentions this risk and requests its proper installation, but given the request of the customer they were not properly installed by Tony; Tony has no written document to back up his recollection of the story and the customer argues that at no point he required Tony not to install the safety features of the top cover. Tony had just received a letter from a lawyer stating that a lawsuit had been launched against him for a huge sum in punitive damages caused by the distress of having lost a loved pet. On consultation with The 6 Law, he was advised that an out of court settlement might be better because the suit would probably not be considered frivolous. A financial statement footnote would be appropriate until such time as an out of court settlement was reached. The 6 Law did inform him that the expected legal fee for his defence would be half the amount paid to incorporate his company but a billing would not be prepared until the expected court date. The out of court settlement is estimated to be around ten times the amount paid to incorporate the company.
Required: Prepare all the accounting records for Tony’s Plumbing Service
This task is based on the analysis of very extensive narrative and detailed project documents. The next pages have all the documents that Tony brought to you in a shoebox so you can prepare the financial statements of his company (use 2 decimal places, if needed round up the figures to the next cent).
1.Check and use the Chart of Accounts provided (do not create new accounts).
2.Prepare the General Journal for the month
3.Post all transactions to the T-accounts
4.Prepare a trial balance
5.Prepare the Financial Statements in good form including footnotes for a Summary of Significant Accounting Policies and for contingency disclosures that are exclusive of the transactions of this case (do not include general notes).
Each General Journal entry should have an explanation under.
Every place where the word Tony appears substitute with your own first name.
7.Based on all the information provided in this project, prepare a memo to Tony where you as a professional accountant evaluate the business. Specifically address his concerns:
a) How much can be paid in dividends?
b) With the data of the financial statements that you have completed, is the business sustainable?
c) Make two clear suggestions of how the business can improve its bottom line?