Carretera Travels Inc Case Assignment

Carretera Travels Inc Case Assignment

October 8th, 2015

ACTG 2011 Section E

Ralf Reyes 213553995

Sid Dey 213446273

To: Maurice Scotty, CEO of Carretera Travels Inc.

From: CPA, auditor at Sanchez Garcia LLP

My Role: To review the financial accounting policies for Carretera Travels Inc. (CTI) and to determine whether any changes are required for the quarter ended March, 31 2015.

Users and Objectives:

Maurice Scotty, CEO -  Maurice Scotty, the CEO of CTI, would be a primary user because he is a significant shareholder owning 30% of the business and would require the annual financial statements and information from senior management to assess the company’s operations. His primary objective is to evaluate the performance of the company in order to see increased profitability and continuous overall growth. Thus, profit maximization is a priority given the new economic events favouring the company’s bottom line, but wants to ensure that the underlying economic activity of the company are accurately and faithfully represented.

Senior Management - The senior management of CTI would be a primary user because they are operating the day-to-day business activities of the company. Since management bonuses and their performance evaluation are based on the profitability of the company, the senior management’s primary objective is to maximize profit.

Other Shareholders/Investors - the other shareholders and investors of CTI would be a secondary user because they hold 70% of the shares of the company and since they would have a long position, they would want the company to be profitable. Therefore, their primary objective is in accordance with the CEO in maximizing profit and evaluating overall performance of the company.

Bank - The bank would be a secondary user because they have provided a loan of $50,000 to CTI and thus, they would want to evaluate the company’s recent financial statements to determine the entity’s ability to pay back the principal and interest of the loan. From this, their primary objective is the evaluation of future cash flows and liquidity through accurate and unbiased reporting.

Constraints:

IFRS must be abided by for financial reporting because CTI is a public company, having 70% of its shares widely held.

Issues:

1.       Revenue Recognition of a Pre-Paid Service

Senior management has asked that revenue from Carretera-Complete, paid six months in advance, be recognized as soon as the payment is made. Antonia objected and believes that revenue can only be recognized on a quarterly basis, meaning that payments made three months in advance would be recognized immediately. Both of these methods of revenue recognition violate the matching principle, and with IFRS revenue recognition principles; performance simply has not occurred at the time of payment for the prepaid asset.

Alternatives/Recommendation: The customers of Carretera-Complete are paying for services that we are assuming will begin only after six months. The appropriate treatment of this payment is to recognize the revenue only after the six months have passed. If we further assume that Carretera-Complete is usually a long term service, then once the service begins, we can recognize revenue on a passage-of-time basis through either the percentage of completion method or the zero-profit method depending on whether costs can be estimated. The alternative would be to recognize revenue at the end of the service period. The option of recognizing revenue based on the passage-of-time would be most beneficial to the primary users and would adhere to the revenue recognition criteria under IFRS; the risks and rewards of the commercial services are transferred to the customers and the company will have done its performance to be entitled to payment, collection is satisfied through the prepayment made 6 months in advance, and the revenue and costs incurred can be estimated as we recognize the revenue gradually.

Effect on objectives: The percentage of completion method will favour the CEO and senior management objective of profit maximization because it will result in more revenue to be recognized earlier, whereas recognizing revenue when the performance criteria is completely met at the end of the service period or through the zero-profit would be too conservative as the primary users would not be receiving timely information about the occurring economic activity and most importantly, it does not satisfy the objectives of increased profitability of the company. Refer to Appendix A for the journal transaction of recognizing the revenue for the prepaid service.

2.       Revenue Recognition for Car Rental

Currently, CTI recognizes the revenue from its car rental service only when a car is returned to the garage. However, according to the product description of Carretera-Rent, their rentals range from one day to one year. This creates a disparity between revenue recognition in long and short term rentals.

Recommendation: For rentals that are greater than one month (long term) CTI should recognize revenue on a monthly passage-of-time basis. This way, they can accurately match revenues to the appropriate period. Under the IFRS criteria, CTI has transferred the risks and rewards of the rental services for the specific month, collection for the payment of the rental service is probable since the services are provided on credit, the amount of revenue will be known as it is recognized gradually each month and we can assume that costs can be estimated. However, the performance aspect will be satisfied only gradually through a long term period. For rentals less than one month (short term), CTI can continue to recognize revenue when a car is returned to the garage. Under the IFRS criteria, the risks and rewards of their rental service is transferred to their customers, collectability for payment is probable once the short-term rental period is complete, and the amount of revenue and costs can be measured since the company has performed the services for their customers.