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Mr. Denis Sonin


2000 Simcoe Street North
Oshawa, Ontario

Dear Mr. Sonin:

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

resolve the disputed financial issues.

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

CRA¶s objective is to determine the taxable net income amount.

While evaluating the information disclosed, we have assumed that HTL is using

International Financial Reporting Standards (IFRS) as a constraint to prepare their financial

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,

2014, the date the shipment was made to the customer.

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

the company¶s share selling price.

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

will help deflate the selling price of the shares.




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