Alexander Electronics Limited

Alexander Electronics Limited
To: Ryan Evans
From: Accounting Consultant
Re: Report evaluating appropriateness of treatments used in AEL's 2017 income statement

Dear Mr. Evans,

Below is the report that you requested outlining the various issues that we found in the 2017 year-end financial statements from AEL as well as our recommendations on how these unresolved items can be fixed. We hope that this will help you in assessing the purchase of the AEL store and allow you to purchase it for a fair price.

If you have any further questions, please feel free to contact me.

Yours truly,

Accounting Consultant

Report to Mr. Evans

Role:

I am an accounting consultant that was hired to evaluate the appropriateness of the 2017 financial statements of Alexander Electronics Limited. This is for the purpose of the purchase of one of these stores by Ryan Evans.

Users and Objectives

1. Ryan Evans, the key user, is requesting a report on the 2017 financial statements of AEL as he is seeking to purchase one of their stores. His objective is income minimization as the selling price is based on the net income.
2. AEL current owner owns the business and is the one who will be selling to Ryan Evans. His objective is income maximization as he is looking to receive as much money as possible from this transaction.
3. (Possibly other users such as bank, CRA, suppliers etc?? This is question for you Cameron, do I need this stuff?)

This shows a conflict of interest as Ryan Evans has the objective of income minimization and the current owner has an objective of income maximization.

Key Facts

The current owner of the AEL store that Ryan Evans is seeking to purchase has agreed on a selling price based on the net income of the AEL for 2017.

Constraints

Based on this situation, it would be most appropriate follow the guidelines of ASPE due to the fact that ASPE is usually used for private companies, which we can assume AEL is due to their stores only being in a medium sized city.

Issues and Recommendations

Exclusive Distribution Rights to Zordef

The issue presented relates to the exclusive distribution rights that AEL has on the sale of this game. AEL is allowing customers to pre-purchase the game in 2017 even though the game is not being released until 2018. They are recognizing revenue when they come into contact with the money.

Under ASPE, revenue is not recognized until the following conditions are met:

• Transferred significant risks and rewards of ownership
• No longer have control over the good
• Collection of payment is probable
• Amount of revenue can be reasonably measured
• Cost of earning the revenue can be reasonably measured

AEL can either recognize revenue when they come into contact with the money or the time that the customers actually come into contact with the game. If revenue is recognized when AEL comes into contact with the money, it is following two of the above points: collection of payment is probable and amount of revenue can be reasonably measured. If AEL were to recognize the revenue when the game is delivered to the customers, each of the above points would be followed.

I recommend that the second option is followed because it is allowing for the revenue to be recognized when the product is actually being delivered. This will decrease the net income of 2017 as the revenue on this game will not be recognized until the following year. This satisfies Mr. Evans by lowering net income which lowers the purchasing price of the store.

Technical Problems Contracts

The issue presented pertains to the service contracts that are being offered to customers who want support with any technical problems they have on their electronic equipment. Essentially, the customers can buy contracts that last 1, 2 or 3 years. AEL is recognizing the revenue when they are coming into contact with the money paid for these contracts.

As stated earlier, under ASPE, revenue is not recognized until certain conditions are met. AEL can recognize revenue when they come into contact with the money. This only follows two of the ASPE conditions of collection of payment is probable and amount of revenue can be reasonably measured. With this they are recognizing revenue of all three types of contracts during the 2017 fiscal period. Another alternative would be that they can recognize 1 year contracts right away as customers are not allowed refunds on year 1 and use a gradual approach on recognizing revenue for the next year or two for the longer contracts.  This follows all the conditions of ASPE.

I recommend that AEL recognizes only the first year of the contracts right away as customers money is non-refundable and recognizing the longer contracts using a gradual approach meaning as the time passes. This will allow for AEL only to recognize the revenue they actually have rather than what they project they will have. This implicates that revenue, except for first year contracts, will be recognized in the following years, therefore decreasing the net income of this year. This will satisfy Ryan Evans as the purchase of the AEL store is based off of the net income of 2017.

Salary of Current Owner

During this year, the current owner of AEL received no salary and opted instead to receive a dividend of $65,000.

There are two alternatives as to how this can be counted on an income statement. Dividends are paid out of the retained earnings which increases the net income. By receiving the dividend rather than a salary, the owner is essentially increasing net income. If the owner was paid a salary like the previous years, the money would be considered an expense. An expense would decrease net income.