Xian Accounting Unearned revenue Question

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Note: the cash flow portion to this question was added to the original question and would require
an extra 10 minutes of time. Your midterm will likely have ONE less issue. If you are budgeting
your time for this case, I would add an extra 10 minutes of time, ie 90 minutes NOT INCLUDING
upload/download time.
Today is March 15, 2021. The partner called you, CPA, into his office to discuss a new consulting
engagement. A group of investors, led by Jason Elliot, is interested in buying VCL Inc. (VCL) a
successful minor-league professional baseball team. The investors have owned a number of sporting
goods stores in the past and they feel that owning a professional ball team would be a great fit with their
business.
The partner tells you: “Please familiarize yourself with the information I have gathered on VCL. VCL’s
financial statements for the past two years are show in (Exhibit I). Notes from both meetings are collected
in Exhibit II.
Draft a memo to Mr. Elliot advising what specific due diligence procedures our firm will do as part of
giving comfort in their purchase of VCL. No credit will be given for just saying get an audit done. Please
calculate a preliminary purchase price for the shares for me to use in my meeting with the investors next
week. Bear in mind that an earnings multiple of between 4 is common for companies owning minorleague professional baseball teams.” It is agreed that the statements are to be in accordance with ASPE.
If there is anything else you can think would add value for Jason to consider, please include in your
analysis. Jason is wondering if you can provide any kind of assurance to provide comfort on the purchase.
1
EXHIBIT I
VCL INC.
BALANCE SHEET
As at December 31
(unaudited)
2020
Current assets
Cash
Temporary investments
Accounts receivable
Prepaid insurance
$
Property, plant and equipment (net)
Current liabilities
Accounts payable
Due to Stuart Jeffreys
30,000
145,000
316,400
25,000
516,400
2019
$
1,237,600
27,000
120,000
208,400
–
355,400
1,043,000
$
1,754,000
$
1,398,400
$
20,000
55,280
75,280
$
31,000
150,000
181,000
Share capital (common shares)
Retained earnings
10,000
1,668,720
1,678,720
$
1,754,000
10,000
1,207,400
1,217,400
$
1,398,400
2
EXHIBIT I (continued)
VCL INC.
INCOME STATEMENT
For the year ended December 31
(unaudited)
2020
Revenue
Season tickets
Game day tickets
Advertising – ballpark
Advertising – program
Promotional program
Concession royalties
$
216,000
980,000
200,000
70,000
150,000
540,000
2019
$
226,800
1,004,000
210,000
73,500
155,000
567,000
2,156,000
2,236,300
113,400
110,000
101,880
599,000
363,000
100,000
1,387,280
111,132
111,000
99,842
600,200
355,740
98,000
1,375,914
Income before taxes
768,720
860,386
Income taxes
307,400
344,200
Expenses
Game day
Promotion
Rental and grounds keeping
General and administrative (includes amortization expense)
Travel and accommodation
League fees
Net income
$
461,320
$
516,186
3
EXHIBIT II
NOTES FROM MEETINGS WITH JASON ELLIOT AND EMPLOYEES AT VCL
1. The baseball season runs from May to September, with the team playing 120 games—60 at home and
60 away. Attendance in the first part of the season is low but, by July, attendance for home games is
usually close to capacity of 6,000 seats. The off-season is spent obtaining advertising contracts for
the next season and completing maintenance projects at the stadium.
2. All tickets are general admission tickets, with single game seats selling for $6.00. Season ticket holders,
which number around 1,000, pay $220 for the 60 home games. VCL’s management does not anticipate
changing the price of the tickets in the foreseeable future.
3. Stuart Jeffries, the team’s general manager, has one year left on his contract before it is up for
renegotiation. Stuart has been known for his exceptional management abilities. Glenda, Stuart’s wife,
has
been
the
bookkeeper
since
VCL’s
inception.
Stuart and Glenda are each paid $120,000 per year by VCL.
4. Accounts receivable consists of cash amounts due from advertisers as well as amounts recorded for
exchange transactions. For normal advertising revenue, Glenda reports the amount as advertising
revenue when the contract is signed, and she sets up a corresponding account receivable from the
advertiser. Sometimes Stuart negotiates advertising in exchange for products or services, Some clients
will give Stuarts things like televisions to give away to fans instead of paying for advertising spots.
Glenda does not record any amount for the promotional products or services received in exchange for
the advertising spots provided by VCL, she simply sets up a receivable and records an estimate of
revenue based on the value they think the goods they receive are worth.
During the season, Stuart estimates that the warehouse holds products worth about $75,000 that he still
needs to give away. During the off season, he often has products worth between $20,000 and $30,000
left over. Glenda estimates that roughly 40% of total advertising revenues come from these exchanges.
5. VCL’s largest advertiser is a division of a company owned by Stuart’s brother, Max. It has the
premier advertising space in left field. Max pays $60,000 for this advertising space, which is about
$40,000 more than what the space would cost in other minor-league fields. VCL is unsure whether
the advertising contract will be renewed next year in light of the sale of the company.
6. The stadium where the team plays is owned by the city and leased by VCL. The lease agreement,
which expires in two years, has a cheap annual rate of $100,000, compared to comparable leases
which would likely run about $150,000 per year. This year, Stuart took it upon himself to spend
about $150,000 on a variety of improvements, including a new roof, as well as painting and fixing
some of the stadium seating. All of the costs have been capitalized. Since the work should have been
done by the city, he is now battling with the city to recoup the costs from them. Glenda has set up a
receivable for $75,000 for the amount they feel the city should pay for replacing the roof. This has
been included in game day ticket revenues as she wasn’t sure where else to record it. Stuart is
frustrated because there is still another $100,000 of upgrades to go. If the stadium is not completely
upgraded, Stuart is fearful the league will step in and force the franchise to move to another city.
4
7. The investments owned by VCL are in a company with the cash flows below. Jason is interested in
your explanation about why there is such a difference between the net loss and the net cash used in
operating activities. He understands that depreciation and amortization are non-cash expenses but
isn’t sure why there is a subtraction regarding prepaids, inventory and accounts payable in 2020. He
would like you to note 4 reasons why there are differences.
5
To: Tracey Owner TWS
From: CPA
Layaway
At Issue: TWS sells wedding dresses on layaway and is unsure how to record the money received for the
payments
Criteria:
Measurement: Met- They know how much the dresses sell for and the payments are equal
Collectability: Met- There is no reason to suggest that collectability is an issue. They are unable to take
the dress until it is paid.
Performance: Not Met- TWS holds the dress until customers have paid the full amount owing on the
dress.
Conclusion: TWS should record the money received as deferred revenue until all payments are made at
which point, they should recognize the revenue and remove the liability.
Impact: This will cause TWS Debt to equity ratio to increase and so there may be a bias to record the
revenue earlier rather than as a liability so that the bank will agree to give them the loan.
Audit: Occurrence- Revenue is overstated and completeness- deferred revenue is understated
Procedure: Select a sample of revenues recorded in the sub ledger and compare to layaway contracts to
see if the six monthly payment dates have passed and then compare to the bank deposits to see that all
payments are actually made.
Select a sample of layaway contracts that are not complete and compare to bank deposits and deferred
revenue subledger to ensure that they are recorded as a liability and not as revenue for layaway
contracts that are not completed and dresses picked up.
Reality Tv Dresses
At Issue: TWS got an order for a reality Tv show and the order is complete but the dresses aren’t due to
be picked up until February. They currently have no revenue recorded for this order
Measurement: Met- TWS has a contract signed with the show that states the number of dresses and the
price and there are no returns once the brides have been fitted which happened in December.
Collectibility: Met- There is no reason to assume this is not met as they have a signed contract and the
show has been running for 5 seasons.
Performance:Met- For this we will need to consider this a Bill and Hold since the dresses have not been
picked up yet. We will consider the bill and hold factors below:
Risk of ownership have passed to the buyer- Met- The dresses and non returnable once the fittings have
been completed. This was done in December.
Customer has fixed commitment to purchase goods in written document- Met- There is a signed
contract with the show.
Buyer requests that the transaction be on a bill and hold basis- Met- Love Island films in February and
the show has asked them to keep the dresses until then.
Seller hasn’t retained any specific performance obligations- Met- The dresses were completed in
December and the brides have been fitted for the dresses.
Ordered goods segregated and not subject to being used to fill other orders- Met- The dresses have had
the Love Island logo and silver hearts sewn throughout the train of the dress which means the product
can’t be sold to anyone else
Product is complete and ready for shipment- This is met. The case states that all dresses were
completed in late December.
Since all of these factors have been met performance has also been met.
Conclusion: TWS should record the revenue for the Love Island dresses in fiscal 2019.
Impact: Since the revenue for the Love Island Dresses can be recorded in 2019 this could increase their
Net Income which could increase their Retained Earnings and could lower their debt to equity ratio
potentially putting TWS in a better place to get the loan from the bank.
Audit: Occurrence of Revenue
Procedure: Inspect the contract with Love Island to be sure that they have met all the obligations of the
contract and review the point that the show has asked them to hold the dresses until February.
Compare the prices on the contract to the revenue sub ledger to ensure the correct amount has been
recorded. Inspect the dresses at TWS to see that they are complete and that the custom work has been
done and the dresses are ready to ship to Love Island.
Custom Dresses for Large wedding Party
At Issue: Tracey sold wedding dresses and dresses for the wedding party to a large family with a nonrefundable deposit of 10,000. The wedding has since been cancelled and they refuse to pay the
remaining amount for the dresses. The supplier does not accept returns for the dresses. Should the
accounts receivable for these dresses be written down for impairment?
When a financial instrument shows indicators of impairment the following factors are considered and
the carrying amount of the asset is reduced to the highest of the following factors:
Present values of the cash flows expected to be generated by holding the asset: This is likely 0 as they
are refusing to pay the remaining amount for the dresses and Tracey does not want to pursue legal
action against the family.
Amount that could be realized by selling the receivable: This is also likely 0 as no one is going to want to
buy a receivable that the people are not willing to make the payments for.
Amount that could be received for any collateral: The case gives no amount for what this could possibly
be but the market for these dresses is likely to be small as the family was short and slim and regular
sizing wouldn’t work. These custom-made dresses are likely hard to sell to another customer unless they
are the correct size.
Conclusion: The asset should be reduced to the amount that TWS expects it can get for these custom
dresses and an impairment loss should be recorded on the Income statement.
Impact: This impairment loss will decrease net income and increase the debt to equity ratio making it
harder for TWS to get the loan from the bank.
Audit: Valuation of Accounts receivable
Procedure: Select the accounts receivable related to this wedding party from the AR sub ledger and
inquire as to how much can be expected to be collected by selling these dresses to another party and
compare to what is recorded.
Cream Inventory
At Issue: TWS has a few thousand in cream inventory that Tracey has found out contains a substance
that can cause break outs in sensitive skin. Is the cream inventory impaired?
Inventory is recorded at the lower of cost and NRV. In this case it is likely that people are not going to
want to buy this cream since it can cause break outs. A Bride is causing bad publicity for TSW and their
cream line. In this case Tracey may wish to write off the inventory all together if she wants to improve
TSW image in which case the NRV of the cream may be 0. This is lower than the cost of the creams. If
Tracey believes she can inform people that it can cause a reaction on sensitive skin she may be able to
get some money for the cream but likely less than the cost. This would however help her re coup her
costs.
Conclusion: Due to this issue it is likely that the cream inventory is impaired and should be written down
to the NRV of the creams.
Impact: This impairment loss will lower Net Income and cause their debt to equity ratio to be higher and
lower their chances of getting the loan.
Audit: Valuation of inventory
Procedure: Inspect the research on the substance in the creams to see if in fact it does cause breakouts
and review the products for any warnings. If the research is true then compare the amount recorded on
the inventory subledger to what the NRV of the creams is.
Tracey’s Body Designs
At Issue: Tracey has recorded an asset equal to 50,000 for a new project she is working on. She has also
purchase computer equipment and special cameras for 20,000 to work on the project. Should Tracey
Capitalize these development costs or should they have been expensed?
The development costs can be capitalized if the following criteria are all met:
Technical feasibility- Met- It appears this is met as she has started a testing phase. She also states that
she needs to hire a computer savy designer to help. It does appear to need more work as a handful of
brides have said the process wasn’t accurate.
Intention to complete it- Met- Tracey has put a lot of effort into the project already and has purchased
equipment.
Ability to use or sell it- Met- She has had some brides interested in the process and Tracey is confident
that it will increase sales.
Probable future economic benefit- Not Met- Tracey has said that some brides aren’t willing to spend
extra money for this process so it is unclear if she will make enough money from it. She also hasn’t done
any market research to see if people are really interested in this process.
Availability of resources- Not Met- While she has a potential loan from the bank she doesn’t have it yet
since her financial statements aren’t complete and it is unknown what her debt to equity ratio is. It also
states that this project will only be able to be completed if they get the loan.
Ability to measure reliable the expenditures- Not Met- This is not met as Tracey has just recorded an
amount of half of what she took out as a salary. She doesn’t appear to be tracking expenditures carefully
except for the computer equipment and cameras.
Conclusion: Since these are all not met Tracey should not Capitalize the 50,000 and should instead
expense it.
Impact: This increase in expense will lower Net Income and cause Retained earnings not to increase as
much. This will increase their debt to equity ratio and lower their chance of getting the loan. There is
bias to capitalize these costs to get the loan.
Name___________________________
Issue
Revenue Recognition – Layaway
Handbook Criteria:
• Measurement, support
• Collectability, support
• Performance, support
• Impact- considers impact
on debt to equity ratio
2020 Midterm Marking Rubric
Procedure
Strong NC
Weak RC
Attempt but poor, no
assertion(.5)
1 criteria
w/case facts
2 criteria
w/case facts
Poor attempt with correct
assertion (1)
Exact procedure, incorrect
assertion (1.5)
Or
Or
2
criteria no
case facts
3
criteria no case
facts
Strong RC
All of
All of
3 criteria
Case facts
3 criteria
Case facts
and
Correctly
concludes
All of
All of
3 criteria
Case facts
AND
Considers
bill and hold
3 criteria
Case facts
Attempt but poor, no
assertion(.5)
1 criteria
w/case facts
2 criteria
w/case facts
• Performance, support
• Measurement, support
• Collectability, support
Considers bill and hold (no
criteria under ASPE BUT
should consider: inventory
segregated, substantive
reason for not delivering,
customer requested,
complete/ready for
shipment
Poor attempt with correct
assertion (1)
Or
Or
2
criteria no
case facts
3
criteria no case
facts
OR bill and
hold with 1
factor
considered
OR bill and hold
with 2 factors
considered
Exact procedure, incorrect
assertion (1.5)
Exact procedure with
correct assertion (2)
OR bill and
hold with 3
factors
considered
• Impact- considers impact
on debt to equity ratio
Handbook Criteria:
• Measurement, support
• Collectability, support
• Performance, support
Impact- considers impact
on debt to equity ratio
Inventory Impairment-Family
Group
Recognizes the inventory may
be impaired
Handbook Criteria:
• Lower of cost and NRV
N/A
CD
Considers
impact on
D/E ratio
Exact procedure with
correct assertion (2)
Revenue Recognition – Love
Island
Handbook Criteria:
Revenue Recognition – Family
Group Deposit
C
Attempt but poor, no
assertion(.5)
Poor attempt with correct
assertion (1)
Exact procedure, incorrect
assertion (1.5)
Exact procedure with
correct assertion (2)
procedure can be for Fin
instrument issue
Attempt but poor, no
assertion(.5)
Poor attempt with correct
assertion (1)
Exact procedure, incorrect
assertion (1.5)
Exact procedure with
correct assertion (2)
1 criteria
w/case facts
Or
2
criteria no
case facts
OR considers
if Fin
instrument
impaired
Identifies the
issue but
provides little
analysis.
2 criteria
w/case facts
Or
3
criteria no case
facts OR
considers if Fin
instrument
impaired using
3 criteria
All of
Jumps to a
conclusion
without analysis
or application of
case facts.
Uses HB
criteria
supported
by 1 case
facts:
custom
made
dresses/har
d to sell OR
supplier
3 criteria
Case facts
Cant get to
Strong RC
only by
discussing FI
issue
Considers
impact on
D/E ratio
And
Analyzes if
bill and
hold in
some
depth (2
case facts
interprete
d)
OR
Analyzes
bill/hold in
depth (4)
Correctly
concludes
All of
3 criteria
Case facts
and
Correctly
concludes
Uses HB
criteria
supported
by case
facts:
custom
made
dresses/ha
rd to sell
AND
Considers
impact on
D/E ratio
Considers
impact on
D/E ratio
(loss on
inventory)
Inventory Impairment-Creams
Recognizes the inventory may
be impaired OR talks about
possible contingent liability
Handbook Criteria:
• Lower of cost and NRV
Attempt but poor, no
assertion(.5)
Poor attempt with correct
assertion (1)
Exact procedure, incorrect
assertion (1.5)
Exact procedure with
correct assertion (2)
Identifies the
issue but
provides little
analysis.
Jumps to a
conclusion
without analysis
or application of
case facts on
either lawsuit or
inventory loss
won’t accept
returns
supplier
will not
accept
returns
Conclusion
Uses HB
criteria
supported
by 1 case
facts for
either
lawsuit or
inventory
loss
Uses HB
criteria
supported
by case
facts on
either
lawsuit or
inventory
loss
Conclusion
Considers
impact on
D/E ratio
OR
addresses
both issues
at “C” level
Tracey’s Body Designs
Considers if the new project
is an intangible asset.
Handbook Criteria –
definition of an intangible
asset:
• Identifiable – can be sold
to a third party
• Under the control of TWS
• Future economic benefit
Handbook Criteria –
recognition criteria:
• Probably that future
economic benefits will
flow to the entity
• The costs can be reliably
measured
OR
Handbook Criteria • All six of the deferred
development cost criteria.
Other capital costs
• Capitalize some assets
separately: cameras/equip
• Questions owners salary .
Comments:
Attempt but poor, no
assertion(.5)
Poor attempt with correct
assertion (1)
Exact procedure, incorrect
assertion (1.5)
Exact procedure with
correct assertion (2)
N/A
Identifies
some of the
asset issues,
but provides
little analysis.
Provides
handbook
criteria with no
analysis OR
jumps to a
conclusion
without
analysis.
3 points for
each criteria
discussed plus 1
extra point for
conclusion
Correctly
discusses
SOME (3 or
more)
intangible
asset criteria
OR deferred
developmen
t criteria w.
case facts.
OR
Considers
some costs
not
intangibles
(equipment
/cameras
are PPE;
owners
salary may
not be ok to
capitalize)
Conclusion
Correctly
discusses
ALL
intangible
asset
criteria OR
deferred
developme
nt criteria
w. case
facts.
May
require
assumptio
ns*
Conclusion
Considers
impact on
D/E ratio
Tracey’s Wedding Shop Inc. (TWS) has been in business for the last five years selling high quality
wedding and bridesmaid dresses. This year, TWS has entered into some new transactions for which your
accounting analysis is needed. You, CPA, are a friend of Tracey’s and have agreed to provide advice on
her new transactions. It is now February 13, 2020 and you are providing analysis for the December 31,
2019 year-end financial statements.
Tracey is hoping to borrow money from the bank for an exciting new project she is working on called
“Tracey’s Body Designs”. The bank is willing to lend money if the total debt to equity ratio is less than 2
to 1, based on the December 31, 2019 financial statements. This will be the first year that TWS is having
an audit performed so she’s not sure how to account for her transactions. Prior to fiscal 2019, TWS
recognized revenue on the cash basis. Tracey also wants to know the procedures the auditors will be
performing. She has asked you to provide her detailed substantive procedures with respect to the
accounting issues. She does not want you to prepare an audit planning memo at this time.
TWS sells wedding dresses on “layaway”. This means that customers put a deposit down on a dress and
make six equal monthly payments before they have paid the full amount owing on the dress. Customers
can’t take the dress until all of the payments are made. Many customers have taken advantage of the
layaway program. TWS is not sure how the money received should be recorded.
TWS has received a new order from a tv reality show that is marrying 20 couples all at once who have
met on their show over the last 5 seasons. TWS has a signed contract with the show which outlines the
number of dresses the show needs and the price per dress. TWS policy is no returns for the dresses once
the brides have been individually fitted for their dresses. The show has asked TWS to provide dresses
with “Love Island” on the front of the dress and silver hearts sewn in throughout the train of the dress.
TWS purchased the dresses from their manufacturer and had a local seamstress add in the Love Island
logo and the silver hearts. All dresses were completed in late December at which time all of the brides
had been fitted for their dresses. Love Island doesn’t film until February so the show has asked TWS to
keep the dresses until then. Currently, there is nothing recorded in revenue relating to this transaction.
In November, TWS sold wedding dresses and dresses for the wedding party to a large family group who
put down a non-refundable deposit of $10,000. Tracey has paid her merchandiser for the dresses and
has them in stock for the wedding party. The dresses were custom made because the bride and her
family are all very short and slim and regular sizing would not fit them. The supplier will not accept
returns of the dresses. Tracey recently found out that the wedding has been cancelled and the family is
refusing to pay the remaining amount for the dresses. Tracey is not sure what she is going to do with the
remaining dresses that were very expensive for TWS to purchase. She does not want to pursue legal
action against the family.
TWS also sells a variety of creams and lotions to enhance the wedding day experience. One of TWS’
customers is suing TWS for pain and suffering because she was allergic to the cream and broke out in
hives right before her wedding. Tracey found out that the creams include a substance that is known to
cause break outs in sensitive skin. The irate bride has gone public with this information which has
caused bad publicity for TWS’s cream line. Tracey estimates that TWS has a few thousand dollars in
inventory of creams.
TWS is working on a new project called “Tracey’s Body Designs”. She has spent a lot of her time working
on this project and has recorded an asset equal to $50,000 (half of the amount she took out as a salary
from the business this year.) She also has purchased computer equipment and special cameras to work
with the project in the amount of $20,000. She is trying to perfect a process that would allow her to
take a 3D scan of each bride to be able to ensure that the bride’s dress fits perfectly, but she needs to
hire a computer savvy designer to help with this which will be very expensive. TWS will be able to
complete this project only if it gets the bank loan. TWS has started a testing phase of this product. Some
brides who she asked to test the process have loved the results saying they are so happy they did this to
have the perfect fitting dress. However, there are a handful of brides that said that the process wasn’t
accurate as the fitting resulted in a dress that was too loose in some areas. Some other brides weren’t
willing to spend the extra $500 to have this done. Tracey is quite confident that once she spends more
time on the process that this will vastly increase her sales!

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