[SOLVED] It is September 15, Year 8. The

It is September 15, Year 8. The partner has called you, CPA, into his office to discuss a special engagement related to a purchase agreement. John Toffler, a successful entrepreneur with several different businesses in the automotive sector, is finalizing the acquisition of Super Sports Limited (SSL). The seller, Carl Thomas, founded SSL over 20 years ago, and has decided to retire and sell his business. He has agreed to manage the business until the shares are transferred. SSL, a wholesale distributor of sports equipment and related products, is very profitable. The company originally sold summer sports items, such as jet skis and canoes, and recently acquired a wholesaler of winter sports items such as snowmobiles. SSL has loyal customers and good relationships with its suppliers. Excerpts from the purchase agreement are provided in Exhibit II. The purchase price for the SSL shares is the carrying amount of net assets, according to the approved audited financial statements as at August 10, Year 8, plus any increase in the fair value of the land and building. See Exhibit III for excerpts from the August 10, Year 8, statements submitted to Toffler for his approval. Toffler asked Jill Savage, who works for one of his companies, to review SSL's financial statements and the audit working papers provided by SSL's auditor. Jill raised several concerns as part of her review (see Exhibit IV). In the spirit of fairness, Thomas and Toffler have requested your firm's views on the accounting issues noted by Jill before continuing with the approval of the financial statements as per clause 29.1. The partner has asked you to draft a memo to his attention, supporting your views. Exhibit II:

Exhibit III:

Exhibit IV:

SSL applied the lower of cost and market using net realizable value as the definition of market value, in accordance with its accounting policy. I do not agree with the method used. GAAP requires conservatism, and using net realizable value less normal profit margin is more conservative and would ensure historic profit margins are maintained. A further write down of the inventory and a reduction in purchase price are necessary. The file noted that except for the custom snowmobile inventory, which SSL accounts for on an item-by-item basis, SSL applies the lower of cost and market by product line using a weighted average. As a result, increases in the value of some items offset declines in the value of others. The last shipment of snowmobiles received had a lower unit price than the units still in inventory purchased earlier in the season. I believe the snowmobile inventory, excluding the customized items, should be valued at the lower unit price based on a first-in-first-out cost formula. Applying the lower of cost or market in this way is in accordance with GAAP. The auditor tested the valuation of inventory by referencing purchase invoices to subsequent selling prices, reviewing sales margins after the cut-off date, and reviewing for obsolete or slow-moving items while attending the physical count. The auditor also tested the inventory tracking system and noted no errors or problems. I believe the auditor did not do enough work on inventory, and did not realize that the amount booked should have been increased from $75,000, as stated in Clause 10.2, to $82,000, as calculated by the auditor (see summary of unadjusted misstatements), plus the normal profit margin on an item-by-item basis. The audit working papers noted that a jet ski and accessories that were sitting in a separate area of the warehouse were included in the count. SSL received a layaway payment for the items from the customer on the day of the count and recorded a liability as of August 10. The audit file noted that the repeat customer picked up the items, worth $30,000, two weeks later. This is an obvious cut-off error. There should not be a liability. Since the items were sold the day of the count, the inventory on the August 10 statements should have been reduced and a receivable recorded.

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2.1 The effective date of the sale of SSL is August 10, Year 8. 10.2 The purchaser reviewed the inventory balance as at July 31, Year 8, and noted a general obso- lescence provision of $75,000, which the seller will update at the effective date. 13.1 Based on a review of the accounts receivable performed on July 31, both parties agree that $90,000 is a reasonable allowance for doubtful accounts to be booked in the August 10 finan- cial statements. 15.1 All amounts due to the shareholder will be paid before August 10. 29.1 As part of the final acceptance of this agreement, both the purchaser and the seller must approve the August 10 audited financial statements. 35.1 Both parties accept that unforeseen circumstances related to the agreement might arise that require an adjustment to the purchase price, and will work in good faith to arrive at a fair settlement. SUPER SPORTS LIMITED EXCERPTS FROM AUDITED BALANCE SHEET (in thousands of dollars) As At: Oct. 31, Aug. 10, Year 7 Year 8 (year-end) Assets Current assets: $ 996 2,098 Accounts receivable $1,459 Inventory 2,475 3,934 3,094 Property, plant, and equipment, net 451 504 Goodwill and intangibles 60 80 $4,445 $3,678 Liabilities Current liabilities: Bank overdraft $ 821 $ 9 Accounts payable 2,004 1,547 Salaries and bonuses payable Income tax payable 40 231 63 17 2,928 1,804 Due to shareholder 750 | 2,928 Shareholders' Equity 2,554 Common shares 100 100 Retained earnings 1,024 1,417 1,517 1,124 Summary of Writedowns August 10, Year 8 October 31, Year 7 Net Net Write- Write- Category Cost Realizable Cost Realizable down down Value Value Snowmobiles (stock and customized) $ 876 $ 449 $ 404 $ 865 $11 $ 45 Winter parts and accessories 387 450 229 265 Subtotal 1,263 1,315 11 678 669 45 Jet skis 420 386 34 499 474 25 Motorboats 478 466 12 539 531 8. Canoes and kayaks 263 325 280 345 Summer parts and accessories 126 101 25 202 180 22 Subtotal 1,287 1,278 71 1,520 1,530 55 Total $2,550 $2,593 $82 $2,198 $2,199 $100 Days' sales in inventory 60 days 63 days

Question: It is September 15, Year 8. The

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