Business Case Analysis Of 123 Canada Inc: Accounting Issues, Alternatives And Recommendations

Main Issues

Discuss about the Business Case Analysis of 123 Canada Inc.

From the provided case study, it has been found that 123 Canada Inc is a private Canadian organisation, which has initiated its operations in 2008. The organisation is engaged in selling specialised accessories of mopeds like gloves, helmets and protective eyewear. John Smith and Karen Yen are the two owners of the organisation. With the passage of time, 23 Canada Inc has experienced a massive growth in market share around 90% and thus, it dominates the entire moped manufacturing industry in the nation.

As the organisation has focused on improving quality of its products, it has to borrow funds from a big bank for financing operations. Initially, the bank did not need audited financial statements; however, the bank has made it a mandatory requirement to provide the same for granting further loans. In addition, the firm is needed to maintain a debt-to-equity ratio of 1:1. Therefore, the current report discusses the various accounting issues along with the analysis approach, alternatives, recommendations and inferences for each issue identified.

It has been observed that the private Canadian enterprises could opt to prepare their financial statements by conforming to the “International Financial Reporting Standards (IFRS)” or “Accounting Standards for Private Enterprises (ASPE)” (Cpacanada.ca, 2017). The main accounting issues that have been identified from the provided case study include the following:

• Challenges in accessing equity and debt financing, in case, financial reporting comparability is not adequate under ASPE and IFRS
• Contracts like banking agreements might need to be renegotiated
• Recording of transactions in terms of fair value or given-up cost related to inventory exchange
• Testing of annual impairment would be complex and costly after entering into agreements with two of the biggest Canadian moped retailers
• Recording the government grant received as revenue for purchasing a machine, as the cheque has been received in May 2014

Issue 1 and Issue 2:

As observed from the case study, it has been found that 123 Canada Inc has planning to specialise its manufacturing process, which is highly capital intensive. Due to this, the firm is required to borrow funds for financing its operations. In addition, it has been found out that the organisation has minimised its debt burden over the years; however, it is heavily dependent on the bank and its suppliers for ensuring growth. In the beginning, the bank did not need audited financial statements to grant loans; however, they are now a necessity after a current routine meeting with the two business owners. Therefore, in order to meet the bank requirement, 123 Canada Inc needs to prepare such statements within three months starting from 31^st December 2014. In addition, the bank also requires the firms to maintain a debt-to-equity ratio of 1:1 for ensuring its security (Boritz & Carnaghan, 2017). Thus, this a significant accounting issue that the organisation needs to address for conducting its business operations in the Canadian market.

Analysis Approach to Each Issue

Issue 3:

As found out from the case study, 123 Canada Inc has exchanged cash of $1,000 and inventory in terms of moped helmet with Karting Supplies Limited. The given-up cost of inventory has been $85,000; while the fair value of the same has been $96,000. The buying price could vary from $25 to $38 per unit, while the organisation has sold identical products to its customers for $28 per unit. The controller of 123 Canada Inc has not made any record to this transaction, since there has been exchange of inventory. The only entry made was debiting inventory and crediting cash of $1,000. This has been a major accounting issue, as the transaction entry passed needs to be rectified (Brandão et al., 2013).

Issue 4:

123 Canada Inc has bought a lifetime agreement of exclusivity for $25,000 with two big retailers of moped in Canada. This amount has been recorded as expense in the financial statements of the organisation. Due to the lack of knowledge of the controller regarding annual impairment testing, the cost-benefit of setting up this agreement has not been recorded as an intangible asset. The reason shown behind expensing the cost is to maintain the existing debt-to-equity ratio of 0.80:1. Thus, this accounting error needs to be rectified for preparing the consolidated financial statements of the organisation (Edwards, 2014).

Issue 5:

As identified from the case study, 123 Canada Inc has received a grant of $50,000 from the special funding program of the Canadian government. This has helped in offsetting the amount spent in buying a machine used in the process of production. The controller has recorded the overall amount in revenue section, as the cheque was already received in May 2014. In addition, it amortises each asset using the straight-line method. This is another significant accounting error, which 123 Canada Inc is required to take into account in preparing its income statement.

Alternative to Issue 1 and Issue 2:

According to “Section 3856 Financial Instruments” of ASPE, 123 Canadian Inc could hold equity securities and it could measure the same at fair value without alteration for the cost of transactions (Cpacanada.ca, 2017). This is a compulsory treatment under ASPE and carrying amount changes due to re-measurement of these securities at fair value need to be recorded in income. On the other hand, transaction costs and financing fees are attributable to acquisition or issuance of financing arrangement related to funding debt and these could be subtracted when ascertaining the initial liability measurement. This is attributable if the instrument is gauged at amortised cost, according to “Financial Instruments, Paragraph 3856.07” of APES.  Thus, the debt amount needs to be shown as net in the balance sheet statement.

Alternatives to Each Issue

In accordance with IFRS 9, debt investments are accounted for either at “fair value through profit and loss (FVTPL)” or amortised cost (Bensadon & Praquin, 2016). In addition, 123 Canada Inc could hold equity investments at FVTPL, until the same is not hold for trading and the investor selects at acquisition for investment at “fair value through other comprehensive income (FVOCI)” (Cormier & Magnan, 2016).

Alternative to Issue 3:

According to “Section 3031 of ASPE and IFRS 2”, inventory is recognised at either the cost price or net realisable value, whichever is lower. In case of 123 Canada Inc, the controller has debited the inventory account and credited the cash account by $1,000. In accordance with the above-mentioned standards, these need not be treated as an expense in the income statement; instead, the given-up cost of inventory of $85,000 needs to be represented in the balance sheet statement, since it is lower compared to the fair value (Flood, 2014). 

Alternative to Issue 4:

According to “Sections 3063 and 3064 of ASPE”, this standard requires an intangible asset to have an indefinite life for impairment testing, whenever any change denotes that fair value might be lower than the carrying amount. “IAS 36”, on the other hand, needs an impairment test for an intangible asset having an indefinite life each year. ASPE computes the impairment loss as the excess of carrying amount above fair value. IAS 36, on the other hand, ascertains the impairment loss as the excess of carrying amount above recoverable amount 9 Gray, Coenenberg & Gordon, 2013). Thus, the exclusivity agreement of 123 Canada Inc should not be expensed as cost. 

Alternative to Issue 5:

According to “Section 3800 of ASPE”, the government grants need to be included in ascertaining the net profit of the specific entity. The entity could either deduct such grant from the aggregate expenses or represent the same as revenue. According to “IAS 20”, such grant is also needed to arrive at the overall net income of the organisation. However, it could not be depicted as revenue or deducted from aggregate expenses; instead, it needs to be shown as “income from other sources” in the income statement of the organisation (Thornton, 2015).

Issue 1 and Issue 2:

It is highly recommended to 123 Canada Inc to adopt IFRS 9 and IFRS 2 in settling these two accounting issues. This is because there is lack of clarity and absence of plans to access both public debt and public equity markets in ASPE standard. On the other hand, IFRS would provide an opportunity to the organisation to issue equity for assuring diversification and growth through initial public offerings. In addition, such accounting policies would enable 123 Canada Inc in forming effective partnerships with foreign firms, public firms and investors.

Recommendations for Each Issue

Issue 3:

Despite similar accounting treatment for inventory, it is suggested to 123 Canada Inc to follow IFRS 2. This is because ASPE standards necessitate the need for an organisation to prepare financial statements principally for the lenders, owners and tax compliance. On the other hand, IFRS maintains financial reporting on similar basis like public firm competitors. As a result, 123 Canada Inc could benchmark its performance with the other public firms in Canada.

Issue 4:

In order to resolve this issue, the application of IAS 36 would be extremely beneficial to 123 Canada Inc in conducting its asset impairment testing at the right value. This is because the global financial executives generally support this standard, while ASPE lays greater emphasis on historical cost with lesser disclosures. Thus, the organisation needs to adopt IFRS in developing its financial statements for reaching the global investors.

Issue 5:

The application of “IAS 20” is recommended to 123 Canada Inc to follow the path of the public organisations in Canada. In addition, this standard would help in depicting the segregation of income statements more accurately. As a result, it would help the organisation to provide long-term benefits related to financial reporting.

Conclusion:

It has been observed that the private Canadian enterprises could opt to prepare their financial statements by conforming to the “International Financial Reporting Standards (IFRS)” or “Accounting Standards for Private Enterprises (ASPE)”. The main accounting issues involved challenges in accessing equity and debt financing, contracts like banking agreements, recording of transactions in terms of fair value or given-up cost, testing of annual impairment and recording the government grant. Based on detailed analysis and alternatives, it is recommended to 123 Canada Inc to adopt IFRS.

References:

Bensadon, D., & Praquin, N. (Eds.). (2016). IFRS in a Global World: International and Critical Perspectives on Accounting. Springer.

Boritz, J. E., & Carnaghan, C. (2017). Competence-based Education and Assessment in the Accounting Profession in Canada and the USA. In Competence-based Vocational and Professional Education (pp. 273-296). Springer International Publishing.

Brandão, M., Levasseur, A., Kirschbaum, M. U., Weidema, B. P., Cowie, A. L., Jørgensen, S. V., ... & Chomkhamsri, K. (2013). Key issues and options in accounting for carbon sequestration and temporary storage in life cycle assessment and carbon footprinting. The International Journal of Life Cycle Assessment, 18(1), 230-240.

Cormier, D., & Magnan, M. L. (2016). The Advent of IFRS in Canada: Incidence on Value Relevance. Journal of International Accounting Research, 15(3), 113-130.

Cpacanada.ca. (2017).  Retrieved 30 March 2017, from https://www.cpacanada.ca/en/business-and-accounting-resources/financial-and-non-financial-reporting/accounting-standards-for-private-enterprises-aspe/publications/aspe-summary-resource-guide

Edwards, J. R. (2014). Twentieth Century Accounting Thinkers (RLE Accounting). Routledge.

Flood, B. (2014). The case for change in accounting education. The Routledge companion to accounting education, 81.

Gray, S.J., Coenenberg, A. & Gordon, P. (2013). International Group Accounting (RLE Accounting): Issues in European Harmonization (Vol. 37). Routledge.

Thornton, D. B. (2015). Different Conceptual Accounting Frameworks for Public and Private Enterprises: An Analysis of Canada's IFRS Transition and Suggestions for International Empirical Work.