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You have contacted our agency, the Johnson and Johnson Accounting Consulting Firm,
to review and prepare a report analyzing some potential issues in the financial statements you
have been given by Allison Chhor, the sole shareholder of Hyperlon Tools Ltd. (HTL). Based on
the information disclosed, Hyperlon Tools Ltd. Manufactures precision tools for use by high-tech
companies. The precision tools are required to be made based on specific standards. If the
requirements are not met, the tools will be ineffective to the customers. To avoid this, the tools
are extensively tested by HTL and the results of the tests are submitted to the customer for
approval. As a final step, HTL ships the tools once the customer approves the test results.
Based on our understanding, in November 2014 Allison Chhor ,the sole shareholder of
HTL agreed to sell 100% of her shares to you. You and Ms. Chhor mutually agreed that the
selling price of HTL would equal to four times HTL¶s net income for the year ended December
31, 2014. However, it is imperative to state that the contract of the sale specified that you could
challenge any of the accounting that HTL used in the financial statements and that if you and Ms.
Chhor could not agree on what is deemed as an acceptable accounting method, an arbitrator will
It appears from the information disclosed in the statement that the objectives of the two
key financial statement users, Ms. Chhor and you, defer tremendously. Ms. Chhor has done her
best to recognize as many revenues as possible for HTL, seemingly with the intention of inflating
the net income earned by the manufacturer and thereby inflating the share price. On the
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contrary, your objective defers from Ms. Chhors¶ objective because you would prefer to get the
lowest net income price. This is a preferable objective for you as the value of the net income
determines the selling price of the shares (i.e., the selling price of HTL = four times of net
income).
Furthermore, there are objectives of other possible financial statement users including the
arbitrator and the CRA. The arbitrator is a potential financial statement user to the matter, as you
and Ms. Chhor have agreed that if you cannot resolve the financial statement issues, an arbitrator
would be involved to resolve the dispute. An arbitrator¶s objective would be to undertake a fair
representation of the net income and come to a decision based on the facts. In addition, the
While evaluating the information disclosed, we have assumed that HTL is using
statements and to record their transactions. We are under this assumption because as a private
entity, HTL has the right to choose IFRS as a reporting method. The IFRS ensures that the
revenue and expenses are matched and helps determine the fair value of the entity.
Based on the concerns you¶ve brought forth, we have categorized each financial statement issue
as follows:
Transaction 1
In late 2014, a large order was placed with HTL from a new customer. This was the first
time that HTL produced the type of tool requested. As a result, HTL was not equipped to test the
tools (as they normally would) before shipping out the order to the customer. Thus, shipping out
the order required the customer to do the testing to determine whether the tools meet their
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specifications. Although the customer is not required to accept or pay for the tools until it has
been decided whether they meet the specification, HTL recognized the revenue on December 20,
The underlying issue in this revenue recognition is that the customer did not verify the
purchase of the tools before the end of the fiscal year; as a result, it inflated the net income for
year ended December 31, 2014. To avoid possible inflation, our suggestion is to delay the
revenue recognition until the customer receives the shipment, does the testing, and decides to pay
for the tools. Based on the revenue recognition criteria, the risks and rewards have yet to be
transferred completely to the customer. Therefore, based on this criterion, a better alternative for
HTL would be to wait and recognize the revenue once the payment is received.
Transaction 2
In early 2014, an order was placed with HTL to produce tools by a customer. During the
testing stage, the customer filed for bankruptcy and was unable to purchase the tools.
Consequently, this left HTL with a problem of having tools that were very specialized and were
tailored to meet the needs of the customer. The primary issue is that the company recorded the
customized tools as an expense and as an asset by recording the tools under inventory.
This transaction should have not been recorded under inventory but rather as a bad debt
expense. For example, the IFRS states that an item must provide a future benefit to a company in
order to be recorded as an asset. However, the tools in question are specialized and do not serve
the company any future benefit. Therefore, the tools should be recorded under bad debt expense.
Transaction 3
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On May 15, 2014, HTL installed new equipment for its testing lab but was later deemed
unsafe in that location of the building by a building inspector. As a result, HTL had to move the
equipment to another part of the building adding further costs to the installation. HTL included
the costs of re-locating the equipment to the cost of the equipment to be depreciated over the
next five years. After analyzing this issue, we think the re-location cost is an appropriate
addition to the incurred equipment cost. For instance, all costs incurred as a result of purchasing
a capital asset (i.e., testing and installation) should be included in the costs under the balance
sheet. Furthermore, the depreciation should also be included in the balance sheet because the use
of the equipment means the value of the equipment decreases over time .This would be
beneficial for you because by including a depreciation expense, the net income decreases as does
Transaction 4
In the notes to the financial statements, it has been disclosed that HTL purchased
consulting services that were not included as an expense. There needs to be an in-depth analysis
on whether an expense was incurred and if so, the full amount must be accounted for. This is an
important factor because including the cost under the expense account (in the income statement)
will decrease the net income which would work in your favour.
To conclude this report, we suggest that many modifications be made to the financial
statements before purchasing the shares at the selling price. As we¶ve suggested in the first
transaction, the revenue must be recognized by HTL only after a payment is received. This is
imperative to follow as it complies with the IFRS. Additionally, in the second transaction, the
tools should not be recorded under inventory (as an asset) as it does not comply with the IFRS¶s
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requirement to provide a future benefit to the company because the specialized tools cannot be
sold.
Also, the cost of producing the tools should be recorded as a bad debt expense in the
income statement. Moreover, the issue in the third transaction is insignificant as the relocation of
the equipment and the manner in which it is being depreciated over the next five years is
appropriate and in compliance with the IFRS. Finally, the fourth and final transaction is
important to investigate to determine whether an expense has incurred and if so, the full amount.
By recording the expense in the income statement, this will help decrease the net income which