UFE Package 1 Simulations-2008

DENSMORE CONSULTING SERVICES INCORPORATED 2008 UFE Practice Simulations – Package 1

Table of Contents Page

Luxurious Hotels Inc. (5 hours)…………………..………………………………………… 2 Games and More Inc. (90 minutes)………………………………………………………. 16 Six4 Systems Inc. (90 minutes)….………………………..…………………………….… 22 Historical Canoe Museum (60 minutes)……….………………………………………… 27 Miguel Lambda (90 minutes)……………………..……………………………………… 33 Leblanc Pianos Inc. (80 minutes)…… …………………………………………………… 39 Wood-Place Inc. (70 minutes)…………………………………………………………….. 45 Present Value and Tax Tables……………………………………………………………. 51

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2008 UFE Practice Simulations - Package 1

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Richard Guy recently inherited $15.7 million from Walter Guy, his deceased grandfather. Up to this point in his life, Richard has been active in managing the family bottling business. However, the business was sold upon Walter’s death. Now, Richard is interested in getting involved in a different line of business and is exploring his options. Richard, who is 55 years old, is married to Helen, aged 52, and has two children: Tuff Guy, aged 14 and Ruff Guy, aged 23. Richard would like to learn and manage a new venture, and then pass the business on to his two sons when he retires by age 60. Ruff has recently graduated from Dalhousie University, and is in a position to work with his father in a new business. Richard has identified a potential investment opportunity that he is considering. It is a private hotel company, Luxurious Hotels Incorporated (LHI). LHI owns 3 upscale full service hotels. Full service hotels provide amenities such as restaurants, cleaning services, gym facilities, and other services, in addition to regular hotel rooms. The three hotels are located in Toronto, Montreal, and Vancouver. The asking price for the company’s shares is $18.5 million. Richard would like to know if the asking price for the business is reasonable. Full service hotels are typically valued in the market place based on a capitalization rate of 13.5% applied to normalized net operating income. Richard has approached Jim Murray, a partner at G&S, where you, CA, are a senior accountant. Richard, who has been a long-time client, has asked Jim for advice as to whether he should purchase LHI. Although Richard is approaching retirement within the next 5 years, he has indicated he is not risk adverse. It is now April 2, 2007. Jim would like you to prepare a draft report addressing Richard Guy’s investment requests. Information on the hotel industry in Canada was acquired from the Hotel Canada Association’s website (Exhibit I). The most recent financial statements of LHI have been given to G&S (Exhibit II) and background information on LHI was provided by Richard (Exhibit III). Excerpts from the sales offer were also provided (Exhibit IV). As the current asking price for LHI is greater than his inheritance, Richard will likely need additional financing. Richard has provided details on the available financing alternatives he would like you to evaluate (Exhibit V). He also asked Jim whether he should offer to purchase the company’s assets instead of its shares. Recent structural and environmental assessments of all three hotel assets were provided to G&S (Exhibit VI). G&S obtained other financial information on the specific hotel properties from LHI (Exhibit VII). Excerpts from the management agreement between LHI and its hotel management company, Beaumont Management Company (BMC), were also provided (Exhibit VIII). Richard would like G&S to conduct due diligence procedures in order to assess LHI. He would like to understand what procedures you would perform in connection with a due diligence engagement and why these procedures are relevant.

(CONTINUED ON PAGE 3)

© 2007 Densmore Consulting Services Inc.

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INDEX TO EXHIBITS

Exhibits

Page

I

Canadian Hotel Industry Information .............................................................................

4

II

LHI Financial Statements ..............................................................................................

6

III

Background Information on LHI ....................................................................................

9

IV

Excerpts of LHI Sale Offer ............................................................................................

11

V

Financing Offers .............................................................................................................

12

VI

Structural and Environmental Assessments of LHI Properties.......................................

13

VII

Other Financial Information on LHI Hotel Properties…………………………………… 14

VIII

Excerpts from Hotel Management Agreement with BMC……………………………… 15



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EXHIBIT I CANADIAN HOTEL INDUSTRY INFORMATION Demand in the Canadian hotel industry is generally cyclical, as hotel use is a leisure activity that is impacted by the population’s disposable income. The Canadian hotel industry has been plagued by Severe Acute Respiratory Syndrome (“SARS”), a deadly respiratory disease which spread through Canada in 2004. Also, the geopolitical repercussions of the war in Iraq, along with other events such as the spread of Mad Cow disease and the rising Canadian dollar relative to the U.S. dollar made 2005 a difficult year for the industry. In 2007, the majority of economists believe that demand is expected to increase to at least 2003 levels. This is the prevalent view in the Canadian hotel industry at this time. Demand will directly affect hotel revenues and direct expenses. Revenues and costs in the industry are usually subject to normal inflation. The current Canadian short-term and long-term inflation rate is 2%. The Canadian hotel industry has done its best to minimize costs in 2006 given the difficult operating environment. However, due to the high operating risk of the industry, maintaining profitability has been challenging. Hotel room supply has been consistent with demand growth in previous years. However, little to no supply growth is expected in 2007, as hotel investors in the industry have suffered large losses as a result of 2004 and 2005, and will rely on the results of the next few years to recover their losses. The hotel industry is typically subject to high financial risk and high operating risk. The financial risk is derived from the need for high debt leverage in order to finance the large scale cost of hotel purchases or hotel construction. The operating risk is derived from the large fixed cost structure relative to direct costs. There is little credit risk in the hotel industry. Rooms are typically paid upfront in cash or by credit card, which is authorized prior to the hotel guest getting the key to the hotel room. Some risk is derived from hotel guests who reserve a room, but fail to show up. Risk is also derived from rooms booked by tour operators, who book a block of rooms at a time and pay once their respective clients use the rooms. As tour operators book large blocks of rooms, they are usually subject to discounted rates. However, they are “on the hook” once they have booked the rooms. Once constructed, the physical hotel building structure normally lasts 35 to 75 years and chattels normally last 10 years due to high usage. Hotels typically require capital maintenance of approximately 5% of total revenues. Such capital maintenance is required for the hotels to meet code requirements with respect to local laws and regulations, as well as to maintain the properties in presentable condition to retain their status as a viable asset. It is also required to meet the standards dictated in the franchise agreements by the hotel brand companies, such as Delta and Hilton. Many full service hotels are managed by a hotel management company, which charge management fees of 2.5% to 3.5% of annual revenues.



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EXHIBIT I (continued) CANADIAN HOTEL INDUSTRY INFORMATION Unions play a large part in the hotel industry as they have an enormous amount of power based on their collective efforts in Canada. Employees in full service hotels are typically unionized. The most recent union agreements have demanded and succeeded in negotiating minimum wages of $14 per hour plus benefits across Canada, as the unions want to keep wages the same across the country. Benefits are typically 20% over and above the normal hourly salary.



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EXHIBIT II LUXURIOUS HOTELS INCORPORATED BALANCE SHEET As at December 31 (in thousands of dollars) 2006 (unaudited)

2005 (audited)

$ 1,225 471 1,035 2,731

$ 1,031 498 1,027 2,556

8,238 1,482 475

8,476 1,005 475

$12,926

$12,512

$ 1,025

$ 1,310

2,500 827 3,327

2,500 688 3,188

5,000 3,574 8,574

5,000 3,014 8,014

$12,926

$12,512

Assets Cash and cash equivalents Accounts receivable Inventory and other current assets

Hotel properties Deferred costs (Note 2) Other receivables (Note 3)

Liabilities Accounts payable and accrued liabilities Long-term debt (Note 4) Future income taxes

Shareholder’s equity Common shares Retained earnings



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EXHIBIT II (continued) LUXURIOUS HOTELS INCORPORATED INCOME STATEMENT For the year ended December 31 (in thousands of dollars) 2006 (unaudited) Room revenues Other revenues Total revenues

$ 10,712 2,790 13,502

2005 (audited) $

8,864 2,162 11,026

Room costs Costs relating to other revenues Total direct expenses

3,109 2,295 5,404

2,936 1,965 4,901

General and administrative Management fee Marketing and franchise fees Total non-direct expenses

4,150 405 681 5,236

4,485 330 551 5,366

Earnings before taxes

2,862

759

Current income tax Future income tax

1,173 139

311 (112)

Net operating income

$

1,550

$

560



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EXHIBIT II (continued) LUXURIOUS HOTELS INCORPORATED NOTES TO THE FINANCIAL STATEMENTS 1. Significant Accounting Policies Hotel Properties Hotel properties consist of three hotels: the Toronto Delta, the Montreal Sheraton and the Vancouver Hilton. All three properties were constructed in 2001 with the land and building in Toronto costing $4.0 million, Montreal costing $3.1 million, and Vancouver costing $3.9 million. The physical hotel buildings are depreciated over a period of 30 years. All chattels, which include furniture, fixtures, flooring and all other physical objects located in the hotel building, are depreciated over a period of 10 years. Inventory All hotel inventory is valued at the lower of cost and market. Revenue Recognition Revenue is recognized from a hotel guest at the time a guest can no longer cancel a room. Revenue from tour groups or other organizations that book a block of rooms is recognized when the order has been confirmed from the relevant organization. Expense Recognition of Room Cost, Franchise Fees and Management Fees Room costs, franchise fees and management fees are recognized on revenues earned once the hotel guest has checked out from the hotel. 2. Deferred Charges Deferred charges relate to indoor water parks being constructed in both the Toronto Delta and the Montreal Sheraton. The expected completion date of the construction is April 30, 2007. 3. Other Receivables Other receivables consist of an interest-free loan made to the sole shareholder for $475,000. The loan is due on demand, but the company has agreed not to request payment for a further twelve months. 4. Long-term Debt Long-term debt has an interest rate of 10% and matures on December 31, 2009. No principal repayment is due until the maturity date. All debt is with one lender who has all three hotel properties as security for the loan. The loan is subject to a maximum debt-to-equity covenant of 0.75, with debt being defined as long-term debt. Interest on long-term debt has been included in general and administrative expenses. (CONTINUED ON PAGE 9)


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EXHIBIT III BACKGROUND INFORMATION ON LHI LHI’s hotel guests must provide credit card information when making a reservation ahead of time. Even if payment is made in cash, a credit card number must be provided to the front desk upon check-in to cover any potential damage the hotel guest may incur upon the room. The hotel guest has up to 3 days prior to the reservation date to cancel a hotel reservation without being charged. LHI has a hotel management company named Beaumont Management Company (BMC), who manages the hotels on LHI’s behalf for a fee of 3% of total revenue. It is customary in the hotel industry for there to be an independent third party hotel manager who can be held accountable for the performance of the hotel company. BMC also manages 47 other hotels. Hotels pay franchise fees when they are affiliated with a hotel brand company. All of LHI’s hotels have a franchise fee arrangement with their respective hotel brand company, whereby 5% of total revenues are paid. All three of LHI’s hotels are unionized. The risk of unions striking requires great efforts to maintain amicable relations with the unions. The Toronto Delta employees are currently earning $12.50 per hour. The Montreal Sheraton employees are currently earning $14.50 per hour. The Vancouver Hilton employees are currently earning $11.50 per hour. All hotel employees receive standard benefits of 20%. Staff employees work approximately 2,000 hours per year and overtime is prohibited under the union agreements. The Toronto Delta and Vancouver Hilton union agreements are up for renewal in May 2007. No capital reserve has been taken by LHI, as management considers the properties to be new and no significant capital improvements will be needed in the next few years. Any repairs and maintenance to the hotels have been charged through room costs, which have not been significant to date. The water parks being constructed in the Toronto and Montreal hotels are expected to increase occupancy by 3% for each respective hotel and to increase the average daily rate by $1.75 over and above inflation. Utility costs are included in general and administrative expenses and totaled $1.2 million in 2006. Utility costs are broken down as follows for hotels in LHI: Water –10%, Hydro – 50%, and Natural Gas – 40%. The sole shareholder of LHI has taken a salary of $500,000 for the past three years. This amount and all other corporate costs are included in general and administrative expenses. LHI’s working capital amount stays constant throughout the year. A new wireless network was implemented at the Vancouver Hilton during 2006 and will be rolled out to the other LHI hotels in late 2007. The new network allows all employees to access all servers anywhere in the building. The server containing guest information is not connected to the Internet to prevent hacking of sensitive data. LHI considered file encryption of guest information unnecessary because it would take too much computer processing time to decrypt the files. LHI has a firewall to prevent hacker attacks, which has not yet been integrated with the new wireless network due to cost constraints. (CONTINUED ON PAGE 10)


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EXHIBIT III (continued) BACKGROUND INFORMATION ON LHI LHI’s current tax rate of 36% is normal for Canadian hotel companies. Given LHI’s profitability in the past, the company has no carry forward losses. LHI has purchase contract commitments extending into 2010 with suppliers of toiletries, coffee makers, and cable/pay-per-view. These contracts were entered into in order to obtain more favourable pricing. The minimum amounts of such purchases are $2.3 million per year. Currently, LHI is facing a lawsuit from a hotel guest who stayed at the Vancouver Hilton in January 2007. The guest claims that she suffered identity theft as her personal information, including her credit card number, was stolen while she was staying at the hotel. She claims that a hacker broke into the hotel’s computer system and stole her personal information. As a result, she has suffered identity theft and is suing for $2.0 million. The insurance company has stated it will not cover the damage, as they were represented to by LHI that all computer systems have adequate security features to prevent hacking. LHI’s position is that the theft did not occur at the hotel, as LHI has a firewall to prevent such attacks. The parties have not settled, as management’s position is that the claim is without merit. The matter will be brought to court in June 2007. LHI’s legal counsel has stated the likelihood of the guest winning is 60% and the likely claim, if successful, will be for $1.0 to $1.5 million. However, the legal counsel does not rule out the possibility of a $2.0 million settlement award.



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EXHIBIT IV EXCERPTS OF LHI SALE OFFER 1. LHI is currently owned by one shareholder, Alex Quinn, who is a Canadian resident. 2. The asking price is $18,500,000 for the shares of LHI with a proposed share transfer date of May 1, 2007. 3. All debt, liabilities, and commitments are to be assumed by the purchaser, without exception. 4. All residual construction costs incurred after April 30, 2007 relating to the two water parks will be borne by the purchaser.



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EXHIBIT V FINANCING OFFERS Richard Guy has been approached by Tweedy Blue Bank to loan a maximum of $5.0 million at a 5-year fixed interest rate of 10%. No principal repayment will be due until April 30, 2010. Interest payments are to be made at the end of each year. Alex Quinn has offered to finance any shortfall resulting from the final purchase price. No principal payments would be due until maturity, which is April 30, 2010. Interest would be at prime plus 3% and interest payments would be made at the end of each year. In addition, Alex Quinn would require that the current management fee of BMC be increased from 3% to 3.5%. Both loan offers are to be secured by second mortgages on the three hotel properties. Both offers are at interest rates at or below the current 10% rate on LHI’s existing debt, even though they have decreased security on the loan. This is because interest rates have decreased since 2001, the year the initial loan was acquired. Currently, the Bank of Canada rate is 5%.



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EXHIBIT VI STRUCTURAL AND ENVIRONMENTAL ASSESSMENTS OF LHI HOTEL PROPERTIES The Toronto Delta Structural Assessment:

No problems noted. The water park was not assessed as it is still being constructed.

Environmental Assessment:

Due to new clean water regulations imposed by the province of Ontario as a result of the Walkerton tragedy, the plumbing system of the hotel will require upgrading at a cost of $200,000. These upgrades must be completed by December 31, 2007. If LHI fails to do so, penalties of up to $50,000 could be assessed and/or the hotel could be shut down.

The Montreal Sheraton Structural Assessment:

No problems noted. The water park was not assessed as it is still being constructed.


The hotel operates on forced air natural gas. Some of the air ducts were found to be deformed, causing the potential for heat leakage. While there are no environmental laws being breached as a result of this, the incremental heating cost on a per annum basis is expected to be 20%. The cost of repairing the ducts is $60,000.

The Vancouver Hilton Structural Assessment:

Due to new fire regulations in the province of British Columbia as a result of the Kelowna forest fires, additional fire exits and other safety guards are now required in the hotel at an estimated cost of $75,000.


No problems noted.

Note These assessments were provided to Richard Guy by a third party consulting company, We Assess Limited (WAL), which had been hired by BMC. WAL assumes no liability for its findings, or lack thereof, in their report.



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EXHIBIT VII OTHER FINANCIAL INFORMATION ON LHI PROPERTIES Room Revenue:

Number of Rooms (1) Available Rooms (2) Occupied Rooms Occupancy (3) Average Daily Rate (4) (1) (2) (3) (4)

2006

2005

2004

2003

470 171,550 116,343 67.8% $92.07

470 171,550 105,160 61.3% $84.29

470 171,550 104,411 61.0% $83.72

470 171,550 123,001 71.7% $100.23

The Toronto Delta has 176 rooms, the Montreal Sheraton has 154 rooms, and the Vancouver Hilton has 140 rooms. Available rooms are determined by taking the total number of rooms and multiplying it by 365 days. Occupancy is a percentage representing the number of occupied rooms divided by the number of available rooms. Average daily rate (“ADR”) is the average rate charged to hotel guests of the rooms, which were occupied throughout the year.

Occupancy Statistics:

Toronto Delta Montreal Sheraton Vancouver Hilton

2006

2005

2004

2003

62.5% 69.7% 72.4%

50.0% 65.0% 71.4%

49.8% 64.5% 71.2%

67.5% 71.7% 77.0%

2006

2005

2004

2003

$87.55 $91.40 $97.70

$81.00 $84.00 $87.48

$80.30 $83.50 $86.95

$93.00 $96.00 $112.53

Average Daily Rate Statistics:

Toronto Delta Montreal Sheraton Vancouver Hilton



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EXHIBIT VIII EXCERPTS FROM HOTEL MANAGEMENT AGREEMENT WITH BEAUMONT MANAGEMENT COMPANY 1. BMC is owned by Alex Quinn, who is also the President. He is 38 years old, and has worked in the hotel industry all of his life. BMC has acquired a wealth of business experience in the Canadian hotel industry. Since the company’s inception 12 years ago, BMC has entered into 50 management contracts with hotels located throughout Canada. 2. BMC is allowed to charge LHI, in addition to its 3% management fee, the following costs of managing the hotel properties: a)

Cost of wages and salaries of all employees who work at the hotel properties.

b)

Cost of wages and salaries of all employees who work at the corporate office of LHI, which is located in the Toronto Delta Hotel.

3. At the corporate office, BMC has 15 employees, including Alex Quinn. A marketable salary for a president of a management company is currently $250,000. Alex Quinn also acts as the operations head for the Toronto Delta. The operations heads for the Montreal Sheraton and the Vancouver Hilton are each paid $175,000. 4. BMC also has staff working at the hotels in such positions as front desk employees, restaurant employees, cleaning staff, and security. There are 25 staff at the Toronto Delta (excluding the corporate employees in the building), 21 staff at the Montreal Sheraton and 17 staff at the Vancouver Hilton. 5. The cost of terminating the agreement with BMC is equal to 4 times the average 3% management fee of the two most recently ended fiscal years.


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Games and More Incorporated (90 minutes) You were recently hired as a Financial Analyst at Games and More Incorporated (GMI) and were assigned to the new expansion team. Yesterday, you met with Sara Moore, the owner and CEO of GMI. To help get you up to speed in your new position, Sara provided you with a folder of background information on GMI (Exhibit I), a draft income statement (Exhibit II), extracts from the expansion proposal (Exhibit III), and a forecasted income statement (Exhibit IV). Sara made the following comments during your meeting. “The past couple of years have been tough for us due to heavy competition. Historically, we have been opening two new locations per year. For the first time in 2006, we did not have sufficient cash to open a new location. As a result, we have put together an expansion plan that we need you to evaluate. This will be a major project for us. We will be using the forecast to raise financing for the expansion. Specifically, I would like you to identify the business risks that may impact on our expansion plans. You should also evaluate the financing method proposed to fund the expansion. Keep in mind that I want to retain control of the company.” “Before you get started on this project, there is one task that needs to be completed as soon as possible. As part of a cost efficiency program, GMI has developed and patented a new electronic games card. It has been tested in a couple of our locations and is functioning as we had hoped. Since you were not involved in this project, we need an unbiased assessment of the internal controls associated with the games card (Exhibit V). Once I have that information, we will make any required changes before the card is implemented at all of our locations.”



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Games and More Incorporated (continued) EXHIBIT I BACKGROUND INFORMATION ON GMI GMI is a private corporation in the entertainment industry that operates 10 locations in Western Canada. The locations, which operate 7 days a week, are targeted to be in cities with a population over 200,000. The majority of customers are from the immediate area. At each location, customers have the option of eating a meal, playing billiards and shuffleboard or entering the games area. The games area contains games of skill, interactive simulators and virtual reality systems. GMI’s business is very seasonal. The peak time of the year is the fourth quarter with the holiday party season. The third quarter is the company’s slowest period. Based on historical performance, the average revenue per store decreases by approximately 10% after the initial year of operation. The breakdown of average annual revenue per store for the first year of operation is as follows: Food and beverage Amusement and special events

$ 285,000 $ 210,000

Historical figures show that operating costs as a percentage of revenues are as follows:

Cost of revenues and other store operating costs Payroll

2006

2005

45% 30%

48% 30%

Operating costs as a percentage of revenue decreased in 2006 due to cost efficiencies, which are expected to remain stable. These percentages have been very reliable in the past. To date, GMI is not unionized. During 2006, there were rumblings of a union forming due to dissatisfaction over pay raises. For that reason, management promised no wage cutbacks in 2007.



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Games and More Incorporated (continued) EXHIBIT II GAMES AND MORE INCORPORATED DRAFT INCOME STATEMENT For the years ended December 31 (in thousands of dollars)

Revenues Food and beverage Amusement and special events

2006 (unaudited)

2005 (audited)

$ 2,591 1,985 4,576

$ 2,565 1,890 4,455

2,059 1,373 550 437 4,419

2,138 1,337 570 406 4,451

Expenses Cost of revenues and other store operating costs Payroll General and administration Amortization

Income before income taxes

$

157

$

4



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Games and More Incorporated (continued) EXHIBIT III EXTRACTS FROM THE EXPANSION PROPOSAL During 2006, GMI focused on cost reduction and operating efficiencies to try to increase net income. The expansion plan focuses on revenue growth to be achieved in the following ways: • • •

Opening new locations Adding new games to existing locations Marketing initiatives

New Locations In 2006, GMI purchased an existing location that had been operated independently through a previous licensing agreement. The decision was made to purchase a location due to the time and cost involved in starting up a new location. The purchase was financed through a bank loan, which requires the company to maintain a maximum debt-to-equity ratio. The interest rate on the loan is 8%. In 2007, GMI intends to start up one new location by leasing the property and purchasing the necessary fixtures. In 2008 and future years, two new locations are scheduled to be opened per year. All new locations will be leased for a period of 5 years. The leases are being arranged through Leasing Incorporated (LI), which is owned by one of the directors of GMI. LI has provided GMI with a list of available property to consider for expansion. The agreements will require GMI to pay property taxes, insurance and maintenance. The lease payments are anticipated to be $100,000 plus a contingency payment of 1% of revenues for each location. The lessor wants GMI to sign the lease for the new location next week. The lease contains a clause that GMI must provide assurance each year on the amount of revenues for the location. Before GMI agrees to the lease terms, the CEO would like to understand what type of report could be provided to satisfy the lease clause. New Games In 2007, GMI plans to introduce $200,000 of new games at its existing locations. This will increase the incentive for repeat visits by adding variety. Two of the new games to be introduced are a horse racing game, where players buy a horse and then compete against each other, and a pro golf virtual reality game. The last time the company introduced new games, amusement revenue increased by 5%. GMI hopes that these games will be popular with their customers but GMI has not conducted any formal research. Marketing Initiatives In 2007, 2% of revenues will be spent on a new marketing program to promote the new games and special events. Food and beverage consumption remains relatively constant regardless of GMI’s marketing efforts. Previously, annual marketing spending had been equal to 1% of revenues. Marketing costs are included in general and administrative costs.



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Games and More Incorporated (continued) EXHIBIT IV FORECASTED INCOME STATEMENT For the years ended December 31 (in thousands of dollars)

Revenues (1) Food and beverage Amusement and special events

2008

2007

$ 3,769 3,118 6,887

$ 3,020 2,414 5,434

3,099 1,722 550 437 5,808

2,445 1,359 550 437 4,791

Expenses Cost of revenues and other store operating costs (2) Payroll (3) General and administration (4) Amortization (4)

Income before income taxes

$ 1,079

$

643

Assumptions: (1) Revenues have been increased for one new store in 2007 and two new stores in 2008. Food and beverage revenue will increase 5% annually due to the new marketing campaign. Amusement and special events revenue will increase 10% annually due to the implementation of new games and the marketing campaign. (2) Cost of revenues and other store operating costs are anticipated to remain at 2006 levels. (3) Payroll is anticipated to decrease to 25% of revenues due to cost efficiencies. (4) General and administration expenses and amortization are expected to remain at 2006 levels.



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Games and More Incorporated (continued) EXHIBIT V INFORMATION ON THE NEW GAMES CARD In 2006, GMI developed and patented a new games card. When a customer enters the games area, they have the option of purchasing a card in various denominations (e.g. $25, $50). The card has an initial cost of $2 but can be retained and reused by the customer in subsequent visits. The card can be recharged at any time for additional play time. If a customer does not use the entire value of the card, they can save it for another visit. For special events (e.g. birthday parties), cards can be purchased in advance for specified amounts for the guests. This game card will replace the need for change to be input into machines by customers. All coin activated machines will be replaced with the new system. This means that it will be easier for customers to access machines and it will reduce the time that machines are out of order for repairs and maintenance. This system will also increase the flexibility of adjusting the pricing of games. The development costs for the game card were $125,000. These costs were appropriately capitalized as development costs in 2006 and amortization will begin in 2007 when the system is operational. The cost for conversion of the games as well as the new computer system is anticipated to be $275,000 in 2007. Using the Game Card Each card has an embedded computer chip. This chip can be programmed by the GMI computer system on site. It provides a unique code to identify that specific card. When the card is initially purchased, the customer specifies the dollar amount and then the card is swiped at the GMI computer. This loads the amount purchased by the customer onto the card’s computer chip. The customer then takes the card with them to the games area. A sign beside each game indicates the amount that each game costs. The customer slides their card through a card reader beside the game. The chip is read and the information is sent to the computer system. The customer is then allowed to play the game for the specified amount of time provided there is sufficient credit available on the card. Once there is no dollar value left on the card, the customer can recharge the card by paying additional money or keep the card for their next visit.

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Six4 Systems Inc. (90 minutes) Six4 Systems Inc. (SS) is a small military contract company that is located in Ottawa, Ontario. It develops custom military defence systems for clients in Canada and around the world. The company was a subsidiary of a large U.S. defence contractor, Gunman Inc., until a management buyout took place on September 30, 2006. The President, Burgess Yee, purchased the company’s active assets for $15.1 million. Yee is an American who has settled in Canada and is now a Canadian citizen. The company prepared a business plan to obtain financing for the management buyout. The Philips Bank financed a large portion of the buyout, despite losing Gunman Inc.’s guarantee of SS’s existing loan. However, the Philips Bank account manager said she will “hold the company to the business plan projections” and expects to see a clean audit opinion. It is now March 2, 2007. SS has a March 31 year end. You, CA, were recently hired as the Controller of SS. You have been able to gather some background information (Exhibit I) but are still finding your way around the company and its accounting practices. The Chief Financial Officer (CFO) is also new to SS. You received an email from the President this morning, which detailed some of his future plans for SS (Exhibit II). The CFO has asked you to prepare a memo to her detailing any year end financial accounting issues. She does not want any surprises with the audit. She provided the most recent income statement for you to review (Exhibit III). She also wants you to address any relevant tax issues. The CFO also provided you a summary of a proposal from the company’s IT Manager (Exhibit IV) to purchase a new access control system and would like you to include an assessment of the request in your memo.



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Six4 Systems Inc. (continued) EXHIBIT I BACKGROUND INFORMATION ABOUT SIX4 SYSTEMS INC. All of SS’s long-term contracts are accounted for using percentage completion accounting. Percentage completion is determined by the actual direct labour cost divided by the estimated total direct labour cost. The direct labour cost is calculated using standard rates to date. These rates are updated each quarter. Contract 34223 involves the development of a radar system data bank. During the early stages of this contract, one of SS’s business development managers saw a business development opportunity. The customer needed to integrate two types of weapon systems. However, SS had no immediate way of solving this problem and did not want to promise something that might not work. SS started researching a solution to the problem three months ago. The design team says a solution has been found and the work will be completed by September 2007. A full proposal to sell this customer-specific software will be presented to the customer in October 2007. The direct costs to date have totaled $467,933, after deducting $127,233 of Scientific Research & Experimental Development (SRED) investment tax credits. The SRED was calculated at 20% of labour and overhead costs on the project for tax purposes. According to the Accounting Manager, this is the only SRED claim the company plans to make for fiscal 2007. Contract 67053 will supply a license for a major suite of military software to one of SS’s customers. There are no other services related to the contract. The contract is worth $2.8 million and it is the first such contract the company has entered into. The license to the software can only be used by that customer. It is estimated that the contract will take nine months to complete and work started in December 2006 when the contract was signed. At February 28, 2007, Contract 67053 had $430,000 of direct labour costs booked against it. The latest estimate of the cost to complete the contract was $623,922. Revenue has been recognized on a percentage completion basis. The company has never deferred any of its development costs. All of the company’s 120 computer terminals are connected to SS’s network, which supports its engineering, development, accounting and financial applications. The company is required to have much higher computer and information technology security than normal for most companies because it works in the defence sector and supplies the Canadian military. The premises are locked and an armed guard patrols at night. Only authorized employees are allowed in the secure parts of the facility.



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Six4 Systems Inc. (continued) EXHIBIT II EMAIL FROM PRESIDENT To: From: Subject:

CA [[email protected]] Burgess Yee [[email protected]] Future Plans

I have been approached by another company to enter into a partnership to manufacture military hardware components. The deal is supposed to close on March 31, 2007. SS will contribute $500,000 for a 40% interest. The other partner will contribute a manufacturing plant, consisting of a building and equipment in exchange for a 60% share in the partnership. The plant has a book value of $400,000 and a fair market value of $800,000. The original cost of the plant was $850,000. I have reviewed the partnership agreement. Both partners will have the ability to veto any significant management decisions and will share in the net income and/or losses based on their ownership interest. I want to account for the investment using the cost method to avoid consolidation. Is that possible? The partnership will begin operations in May 2007. Hopefully, this partnership will help boost our fiscal 2008 results, especially since March results are expected to be weak this year. I am also going to send two engineers to work with a customer in Africa for a year and a half. They will rent out their houses here in Canada. In one case, the family will go with the engineer. While in the other, the family plans to remain in Canada but live with relatives in another province. Their salaries will be reduced because their expenses will be lower and the country has a simple 5% income tax rate.



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Six4 Systems Inc. (continued) EXHIBIT III SIX4 SYTEMS INC. INTERIM INCOME STATEMENT For the 11 months ended February 28, 2007 (unaudited, in thousands of dollars)

Revenue Cost of services

Expenses Administration, marketing and sales Research and development Amortization and depreciation Interest and other

Net income before income taxes Income taxes (Note 1) Net income

Actual

Business Plan

Variance

$13,922 8,977 4,945

$13,400 9,240 4,160

$ 522 263 785

1,666 1,779 76 104 3,625

1,640 1,050 81 101 2,872

(26) (729) 5 (3) (753)

1,320 502 $ 818

1,288 489 $ 799

32 13 19

$

Note 1: Income taxes are calculated using the historical tax rate for SS prior to the management buyout.



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Six4 Systems Inc. (continued) EXHIBIT IV ACCESS CONTROL SYSTEM PROPOSAL The company’s IT Manager is supporting a proposal to purchase the Palmcheck™ access control system, sold by Enter Technologies Inc. (ET). The cost of the system is $2,500 per work station. This system would control access to all computer terminals by a reader that scans the user’s palm before permitting access. Access is only permitted if the palm print matches that of an approved user. According to ET, palms are as unique as fingerprints and the system’s error rate of locking out a correct palm print is one in 3.7 million. Currently, personal computer (PC) access for all employees is secured through a special “key” that is placed in the PC’s USB port. The key unlocks the system once a password containing alphabetical, numerical, lower-case and upper-case codes is entered. Recently, two employees lost their keys and were not able to find them. They reported this to SS after three and four days respectively. Passwords have been shared with other employees or left on sticky notes in drawers.

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Historical Canoe Museum (60 minutes) In May 2005, the Historical Canoe Museum (HCM) was opened in one of the resort and camping districts of Canada. The initial idea for the museum came to Jack Smith after receiving frequent requests from camp directors for tours of his canoe making and repair facilities. He would often spend a summer afternoon explaining to the visitors from nearby camps how canoes were built and showing projects that were in progress. HCM was Jack’s idea, but it is run and organized by a Board of Directors. The Board is composed of Jack, his wife, Jill, and four camp directors from the nearby camping community. Further background information on HCM is provided in Exhibit I. The Board is very excited about a forgivable loan that they received in January 2007 from the Ministry of Culture. Details of the forgivable loan are provided in Exhibit II. The Board is concerned about the government’s requirement for audited financial statements as a stipulation for receiving the loan because HCM’s financial statements have never been audited. The Board is also concerned about the cost associated with preparing financial statements and any additional burden it may put on Jill. None of the Board members are familiar with not-for-profit accounting. Jill’s income statement for HCM is included in Exhibit III and notes from your discussions with Jack and Jill Smith are included in Exhibit IV. It is now June 2007. Your CA firm has been asked to provide accounting and other advice to HCM. HCM recently received a computer and the Board wants to make effective use of it. The Board is looking for your advice in setting up an information system for the museum. In addition, your firm has been asked to perform the April 30, 2007 year end audit. Your firm was approached because you are currently auditing a camp run by one of HCM’s Board members. In preparation for the next Board of Director’s meeting, you have been asked to prepare a draft report addressing the HCM issues. Your partner has also asked you to provide a separate memo identifying any potential audit issues with this engagement.



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Historical Canoe Museum (continued) EXHIBIT I BACKGROUND INFORMATION ON HISTORICAL CANOE MUSEUM Jack Smith developed a love of canoeing as a child at a summer camp. His passion continued as an adult, so he started a business that repairs and builds canoes. Jack’s business, Canoe Limited (CL), is located on the same property as his house and the museum. The museum was opened to the public in May 2005 after receiving a $100,000 grant from the provincial government to renovate a barn on Jack’s property to house the canoes and set up the displays. Other initial financing for HCM came from private donations and the local children’s camps. At the same time, Jack registered HCM as a charitable organization. The museum now contains the largest collection of canoes in Canada. Each canoe has a plaque identifying the donor and historical information on the canoe. Initially, there were ten canoes on display. For the 2007 season, there are already thirty canoes on display. HCM receives donations of canoes from individuals and these canoes are often unique and have historical importance. Ten of the canoes in HCM’s collection came as a result of Jack’s repair business. Jack received the canoes from individuals who no longer wanted them. He then repaired the canoes and donated them to HCM. In return, he received a tax donation receipt for the fair market value of the restored canoe. The remaining canoes were donated directly to HCM by individuals, summer camps and other organizations. In return, the donors were issued a tax receipt by Jill, based on Jack’s appraisal of the canoe. If minor repairs were needed, Jack made the repairs through CL and was paid for the work by HCM. In the first year, the museum was supervised entirely by Jack. Most of the visitors were campers from the summer camps in the area. At the end of the camping season, HCM receives $5 for each camper who visited the museum from the individual camps. For the 2007 season, HCM received a government grant from Youth Employment Hiring of $15,000 to hire a university student to supervise the museum. Jack is very relieved to have the additional help as he has found it difficult to manage the museum traffic and his repair work. The museum is open from 10:00 a.m. to 5:00 p.m. from May 1 until September 30. This coincides with the camping season. The entrance fee for non-campers is $5 per person or $10 per family. An annual membership can also be purchased for $20. This provides unlimited admission and 20% off all clinics and children’s programs. Revenue is recognized when received for entrance fees and cash donations. The university student will collect all admission fees and make a weekly bank deposit. Jack is very excited about no longer having those responsibilities. HCM keeps a record of attendance by having the visitors sign the guest book at the entrance to the museum. Jack noted that he is always amazed by where people come from. On some days, there were up to 80 visitors and on other days there were none.



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Historical Canoe Museum (continued) EXHIBIT I (continued) BACKGROUND INFORMATION ON HISTORICAL CANOE MUSEUM HCM also offers clinics and courses on canoe restoration. Individuals can register for a five-week course taught by Jack to learn how to repair their canoe. HCM pays Jack 75% of the course fee to teach the course. The university student hired through the government program will provide a weekly children’s workshop that includes a guided tour of the museum and building a miniature birch bark canoe. This workshop will cost $10 more than the normal entrance fee. All accounting records are kept manually by Jill. At the end of the year, she takes the HCM bank statements and isolates the deposits. She records these amounts as HCM revenue. She is familiar with bookkeeping and also keeps Jack’s business records for CL. Jack or Jill signs all of HCM’s cheques. No budgets are used at HCM because of the time it already takes to summarize the manual records. Jill issues all tax receipts on behalf of HCM for any donations received. This is also done on a manual basis using HCM’s letterhead.



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Historical Canoe Museum (continued) EXHIBIT II EXTRACTS FROM FORGIVABLE LOAN AGREEMENT

Clause 1

The Ministry of Culture will provide $400,000 in cash on January 1, 2007 to HCM.

Clause 2

The loan is non-interest bearing.

Clause 3

The $400,000 is forgiven if clauses 4 to 9 have been met by September 1, 2008. If the conditions have not been met, the loan is payable in full.

Clause 4

HCM will supervise the restoration of three canoes from different Indian bands. Each band will provide one of their artisans to work on the project at no cost to HCM.

Clause 5

The canoes will be on display in a protected environment at HCM starting May 1, 2008.

Clause 6

Admission to the museum will be provided free of charge for groups from the three Indian bands.

Clause 7

The restored canoes must receive the approval of the appropriate Indian band.

Clause 8

HCM will provide audited financial statements for the years ended April 30, 2007, April 30, 2008 and April 30, 2009.

Clause 9

HCM must provide access to the provincial auditors to review the organization’s records and ensure the terms of the agreement have been met.



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Historical Canoe Museum (continued) EXHIBIT III HISTORICAL CANOE MUSEUM INCOME STATEMENT For the years ended April 30 (unaudited) 2007 Provincial Government Grant Youth Employment Grant Contributions and fees Total revenues Salaries and benefits Purchased materials and services Management and general Total expenses Increase in resources

2006

$400,000 15,000 77,000 492,000

$100,000 43,000 143,000

80,000 72,000 43,000 195,000

65,000 40,000 25,000 130,000

$297,000

$ 13,000



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Historical Canoe Museum (continued) EXHIBIT IV NOTES FROM YOUR DISCUSSIONS WITH JACK AND JILL SMITH 1) All contributions are recorded as they are received. In fiscal 2007, no donations were restricted. HCM received the following contributions:

Cash donations Admission fees Course fees Memberships

2007

2006

$50,000 20,000 5,000 2,000

$30,000 10,000 2,000 1,000

2) The fair market value of the ten original canoes was estimated to be $175,000 by Jack. 3) The barn and land for the museum were donated by Jack and he was provided with a tax donation receipt for $40,000. This value was based on the average of three appraisals from real estate agents in the area. No amortization is taken on these assets. 4) In June 2006, a computer manufacturer donated a computer system to HCM with the most current version of Windows, valued at $2,500. 5) In fiscal 2007, a major automobile manufacturer donated a van and canoe trailer that holds ten canoes. The estimated fair market value of this donation was $48,000. 6) Jill prepares HCM’s financial statements at the end of each year, which are given to the Board of Directors. Jill also waits until year end to prepare the bank reconciliation. She said she often transfers funds from HCM to CL to pay for Jack’s repair fees. 7) Jack also noted that canoes from two of the Indian bands were received but the third canoe has not yet arrived. He heard through the grapevine that one of the band chiefs was holding up the transfer of the last canoe because his son was not hired in the university student position at the museum. Jack does not think this is true, but he wanted to be honest with you.

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Miguel Lambda (90 minutes) It is now October 18, 2007 and you, CA, are a sole practitioner offering services to the public, including tax and general advisory services, as well as audit and review engagements. Miguel Lambda is recognized as a brilliant software designer. He graduated at the top of his class in computer science in 1984 and is best known for the quality of his programming of embedded software code. His personal quirks are also well known and, like many eccentrics, he does not pay much attention to his personal finances. On May 1, 2007, Lambda started work for Code Inc. (CI), a high tech company. At the end of September 2007, CI was bought by a large American company. All hardware and software development work was moved to California. Lambda chose to stay in Canada and received a severance letter (Exhibit I). He has asked for your advice in understanding the implications of the terms contained in the severance letter he received. Lambda was immediately approached by a start-up technology company, Byte-Mark Inc. (BM), and is evaluating an employment offer from them (Exhibit II). BM is located 384 kilometres from where Lambda currently lives. He is concerned about BM’s financial stability as he does not want to move and subsequently have the company go bankrupt. Lambda gathered information on BM during his meeting with BM’s founder, Sergei Mikhov, who is also the company’s President and CEO (Exhibit III and IV). Lambda would like you to help him assess the employment offer from BM. Lambda is single, 44 years old and lives with his mother. His mother has very limited mobility due to a severe hip problem. He has always worked on a salary basis and has prepared his own tax returns without professional advice. You collected additional information from Lambda during your meeting with him (Exhibit V). Lambda has requested advice from you regarding his severance package, employment offer from BM and any other relevant taxation advice. You decide to draft a letter to him addressing his requests.



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Miguel Lambda (continued) EXHIBIT I CODE INC. SEVERANCE LETTER Mr. Miguel Lambda #23-500 End Street Canada October 12, 2007 Dear Mr. Lambda, We regret that you are unable, or unwilling, to move to California and work for Code Inc. As a result of that decision, the company will provide you with three (3) months of severance pay following your termination on October 31, 2007. The amount of severance pay will be based on your current annual salary of $60,000. We are prepared to give you the choice of when you would like to receive the funds but it must be within the next twelve months and in no more than three lump sum payments. You also have 30 days to transfer the funds in your company RRSP to another account. Please do not hesitate to ask me if you have any questions concerning the above. Yours sincerely, Jake Kwan Human Resources Director



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Miguel Lambda (continued) EXHIBIT II BYTE-MARK INC. OFFER LETTER Mr. Miguel Lambda #23-500 End Street Canada October 17, 2007 Dear Mr. Lambda, We are pleased to offer you the position of Senior Software Designer with Byte-Mark Inc., starting November 15, 2007. You will be paid an annual salary of $96,000 plus a $5,000 signing bonus. After completion of a mandatory three-month probation period, you will be covered by the company’s benefit plan. Your annual vacation will be four weeks, increasing to five weeks after 10 consecutive years of service. The company is prepared to provide you with a $6,000 allowance to cover expenses to find a new residence and move you and your personal effects to Canton. No receipts are required to support your allowance claim. You will be issued options to purchase 10,000 common shares of the company at $1.00 per share. The options must be exercised within 120 days of receipt and the shares cannot be sold until the end of one year of employment. If you leave the company’s employment within that year, the company will buy back your shares at a price of $1.00 per share. Your terms of employment will include signing the company’s standard agreements on non-competition and confidentiality (see Appendix A of this offer letter). Please indicate your acceptance of our offer by signing below within 14 days of the date of this letter. Yours sincerely,

Beverly Dwan Human Resources Coordinator

This offer has been accepted. _______________ Signature _______________ Date



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Miguel Lambda (continued) EXHIBIT III INFORMATION ABOUT BYTE MARK INC. 1. BM was incorporated on October 1, 2006 by Mikhov. The company has a September 30 year end and the draft financial statements, prepared by the part-time bookkeeper, are attached as Exhibit IV. Lambda noted that he was impressed to see the company had income on their financial statements given they have only been in business for one year. 2. The company has been funded primarily by the founder, two vice-presidents and certain relatives of Mikhov, who have purchased 3 million common shares at 50 cents a share. In two days, three outside investors will collectively purchase 200,000 shares at a cost of $200,000. The company is also actively seeking venture capital funding. 3. BM’s plan is to develop, manufacture and sell a product called the “network enhancer”. It will be a box with an LCD display containing hardware and software that will be plugged into a company’s network with between 20 and 200 computers in its system. It will streamline a number of network administration and maintenance features as well as provide advanced trouble-shooting capabilities. As a result, the network enhancer should save the average network administrator a significant amount of time. 4. The product is still in the design phase, but an engineering article on the product garnered a very favourable review in an industry publication. The product requires embedded software of the type that Lambda is an expert in programming. Mikhov told Lambda that there will be enough funds available for promoting and selling the product, but that the company’s approach to marketing the product has yet to be determined. 5. BM currently employs twenty-two people. Most of these employees have been carrying out development work and their salaries are included under that caption on the financial statements. The company has an impressive website that shows off the advantages of BM’s product. The website is primarily a recruiting vehicle at this stage. Approximately 15 to 20 hardware and software designers are still required to complete the product. 6. The company uses the MS Money™ personal financial banking software for accounting purposes. A spreadsheet is used to create the financial statements from this software. The company’s cash is deposited in Mikhov’s personal bank account. The bank account includes $150,000 of Mikhov’s personal funds. 7. Mikhov has received approval for an $800,000 federal government grant. The grant pays for specified expenditures detailed in a plan submitted to the government along with the grant application. Half of the grant has already been received based on a list of specified expenditures that was submitted. It is expected that there will be sufficient specified expenditures in the next two months to claim the remainder of the grant. 8. Mikhov showed Lambda newspaper clippings concerning a successful 2000 initial public offering of a telecom device company he founded in 1997. He also had documentation concerning the $44 million sale in 2004 of a software company he co-founded in 2003. Mikhov had only invested capital of $11 million in 2003. (CONTINUED ON PAGE 5)


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Miguel Lambda (continued) EXHIBIT IV EXCERPTS OF THE BYTE-MARK INC. FINANCIAL STATEMENTS Balance Sheet ($000's) Assets Cash in Mikhov’s account Trade receivables Share subscriptions receivable Inventory of test parts Development work to date

Property, plant and equipment Accumulated amortization

Liabilities Accounts payable and accruals Due to shareholder Other liabilities

Common shares subscriptions Common shares Retained earnings

Income statement ($000's) Revenue – Grant Cost of sales Expenses Administration and other Amortization and depreciation Interest

Income

September 30, 2007

841 400 200 26 902 2,369 242 (26) 216 2,585

138 44 23 205 200 1,500 530 2,230 2,435

For the year ended September 30, 2007 800 800 232 26 12 270 530 (CONTINUED ON PAGE 6)


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Miguel Lambda (continued) EXHIBIT V OTHER INFORMATION GATHERED FROM LAMBDA During January to April of 2007, Lambda traveled with his mother. employment insurance during that time.

He did not work or receive

Lambda previously worked for Smail Corp., a private company controlled by Canadian venture capitalists, for six years. He owned 600 shares in the company, which he purchased for a total of $19,200. He has heard the company went bankrupt recently, but he has not received any official notification. Lambda was paid a $15,000 death benefit as the result of the untimely death of his younger sister. Her previous employer paid the death benefit during 2007. Lambda owns a personal residence worth about $185,000. Lambda’s mother did not make any money this year, but did receive a $20,000 inheritance. She does not qualify for social assistance or senior’s benefits because she has not lived in Canada long enough. She plans to donate the entire inheritance to a Canadian charity that assists the poverty-stricken in the country where she was born. Lambda’s personal investment portfolio also includes $24,000 in Canada Savings Bonds, Series X with a 4.2% interest rate, payable in June 2009. The bonds were purchased in June 2005.

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Leblanc Pianos Inc. (80 minutes) Marcia LeBlanc is the president and owner of M. LeBlanc Pianos Inc. (MLP), an internationally respected manufacturer of concert pianos. Marcia inherited the family business from her father, Marcus LeBlanc, 10 years ago. A renowned concert pianist herself, Marcia has worked hard to increase the prestige of the company’s instruments in music circles around the world. In the past 10 years, the company’s annual sales have increased from an average of 20 pianos to an average of 500 pianos. MLP has made several changes in the past decade as a result of the increased demand. However, Marcia has ensured that the quality of the company’s product was never compromised. All of MLP’s pianos are manufactured in Milton, Ontario. The company’s headquarters is in Mississauga, Ontario. It is now January 5, 2007. MLP has reappointed your firm, Benson and Marcus Chartered Accountants, as the auditors for the December 31, 2006 year-end. You met with Henry Doyle, the engagement partner, and he has requested that you prepare a memo assessing the impact of any changes made by MLP on this year’s audit, specific audit procedures required for the upcoming audit and details of any accounting concerns. He noted that MLP had some significant transactions this year and he is interested to know if there are any major tax implications of those transactions. You made your way to MLP’s office to gather some preliminary audit information. You met with Marcia LeBlanc, CEO (Exhibit I) and Chris Patrino, CFO (Exhibit II). You also obtained a copy of the Yomoho Company offer letter (Exhibit III) and draft financial statements for December 31, 2006 (Exhibit IV).



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Leblanc Pianos Inc. (continued) EXHIBIT I

NOTES FROM MEETING WITH MARCIA LEBLANC •

Yomoho, an internationally recognized musical instrument company, has recently indicated an interest in purchasing MLP. Marcia confides that although it will be hard to let the company go, there are no other family members willing to take over the business. She confesses that she would like to enjoy an early retirement and would be interested in getting out of the piano business.

•

During the year, MLP’s CFO resigned. MLP recently hired a new CFO, Chris Patrino. Marcia arranged for you to meet with him as well.

•

MLP, together with the Canadian Conservatory of Music, formed a company called LeBlanc Canadian Conservatories Inc. (LCC) on April 15, 2006. The purpose of LCC was to establish a chain of music schools across the country. Each music school uses only MLP pianos and the Canadian Conservatory of Music instruction materials, and has a showroom filled with various MLP pianos. Marcia proudly tells you that LCC has already provided an excellent opportunity to showcase her instruments and has increased the company’s exposure to young piano students and their parents. In exchange for its 50% interest in the shares of LCC, MLP contributed several pianos and two buildings. The pianos had a book and fair market value of $527,000. The two buildings, both located in downtown Toronto, had a combined book value of $1,325,000. The fair market value of the buildings was $4,473 000. Buildings are amortized on a straight-line basis over 20 years. A gain on the sale of the buildings of $1,574,000 was included in MLP’s revenue and accounts receivable.

•

Marcia noted that a former employee is taking legal action against MLP for wrongful dismissal. Marcia has hired a new legal firm, Benwick and Broadwick LLP, to handle the case. The legal team working on the case assures Marcia that the company has done everything correctly, and will not be liable for any losses. Marcia noted that Chris accrued a contingent liability of $100,000 in 2006 just in case.

•

On December 28, 2006, Marcia received a telephone call from the Dean of the University of Toronto Music Faculty. The purpose of the call was to place an order for 28 5-foot grand pianos and 2 12-foot concert grand pianos for the university’s new performing arts building, which will contain state of the art practice rooms and new concert halls. Marcia was thrilled to receive the order and entered it into the system immediately.



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Leblanc Pianos Inc. (continued) EXHIBIT II OBSERVATIONS AND NOTES FROM MEETING WITH CHRIS PATRINO, CFO •

In an effort to focus on its core competencies, MLP ceased production of the electric piano line in late 2005. Chris noted that there are still some parts in inventory that can only be used for this line of instruments. Marcia asked that these parts be kept in inventory in the event that an existing unit comes into the factory for repairs. The electric piano inventory is valued at its original cost of $250,000.

•

Chris provided you with a price list for the company’s pianos. You scanned the list and noted the following prices: 12-foot concert grand 8-foot concert grand 5-foot concert grand Upright piano Electric Piano (discontinued)

$125,000 $ 75,000 $ 50,000 $ 12,000 $ 5,000

•

Chris confirmed that the company’s payment terms are payment in full on delivery and that the selling price is set as a 100% mark-up on the cost of goods sold.

•

In the summer of 2006, MLP hired Antonia Margetti, an internationally respected Canadian concert pianist, to perform 10 concerts around the country on MLP pianos. During the concerts, the MLP advertising team photographed and video recorded the performances. MLP intends to launch an advertising campaign in early 2007 using the footage from the concerts. The ad campaign is expected to run until late 2008. The total cost of the summer concerts, including the creation of the advertisements, was $575,000. The costs attributed to the concerts of $100,000 have been expensed. The remainder of the advertising campaign has been included in prepaid expenses. Chris intends to expense the campaign costs equally in 2007 and 2008.

•

In August 2006, MLP delivered an order of two pianos to the Ottawa Metropolitan Orchestra. Upon review of the aged accounts receivable listing, you noted that the invoice of $200,000 had not yet been paid. You recall reading an article in the Arts Section of a national newspaper that the Ottawa Metropolitan Orchestra had recently filed for bankruptcy.

•

Chris confirmed that MLP obtained a signed purchase order for the University of Toronto Music Faculty order. The purchase order is dated December 31, 2006. The Music Faculty Dean has requested a delivery date of no earlier than April 28, 2007 since the new performing arts building is still under construction. Chris stated that the 2 12-foot concert grand pianos were placed in a secure area in the company’s warehouse on December 28, 2006 pending delivery. The Dean was sent an email reminding him that insurance should be placed on the 12-foot concert pianos while they are awaiting delivery. Since the company produces the standard 5-foot grand pianos on a regular basis, no inventory has been set aside to fill this order. Chris is confident that there will be sufficient stock of 5-foot grand pianos in inventory to fill the order when shipment is requested.



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Leblanc Pianos Inc. (continued) EXHIBIT III COPY OF LETTER TO MLP FROM THE YOMOHO COMPANY December 17, 2006 Dear Marcia, It was a pleasure meeting with you yesterday. As we discussed, Yomoho Company may be interested in purchasing your company as early as January 2007. Yomoho’s Merger and Acquisitions team feels that your company’s excellent line of pianos and elite reputation in the music world would be a welcome addition to the Yomoho Family. As I indicated to you earlier, Yomoho has the highest financial standards and will only consider the purchase of a company that meets the following criteria: • •

Minimum working capital ratio of 2.5:1 Minimum gross profit margin of 35%

The calculation of the above ratios must be based on the unconsolidated financial statements of M. LeBlanc Pianos Inc. (MLP). Yomoho is not interested in purchasing MLP’s share of LeBlanc Canadian Conservatories Inc. In addition, we will require your auditor to verify the revenue from piano sales for the fiscal year ending December 31, 2006 as well as the number of pianos sold in each category. At your earliest convenience, please forward me an audited copy of your December 31, 2006 financial statements as well as a report from your auditor providing the information required and a calculation of the ratio tests. Kindest regards, Bill Yomoho



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Leblanc Pianos Inc. (continued) EXHIBIT IV M. LEBLANC PIANOS INC. DRAFT FINANCIAL STATEMENTS BALANCE SHEET As at December 31, 2006 (unaudited, in thousands of dollars)

Assets Cash Accounts receivable Inventory Prepaid expenses

$

Long-term assets

125 3,525 1,250 825 5,725 6,219

$

11,944

$

1,027 625 350 2,002

Liabilities Accounts payable Accrued liabilities Other current liabilities

Long-term debt Future income taxes

530 24 2,556

Shareholder’s equity Common stock Retained earnings

500 8,888 $

11,944



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Leblanc Pianos Inc. (continued) EXHIBIT IV (continued) M. LEBLANC PIANOS INC. DRAFT FINANCIAL STATEMENTS INCOME STATEMENT For the year ended December 31, 2006 (unaudited, in thousands of dollars)

Revenue

$

Expenses Cost of goods sold Administration and operating

Net income

31,850

20,384 5,642 26,026 $

5,824

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Wood-Place Inc. (70 minutes) The Wood-Place Inc. (TWP) is a Canadian-controlled private corporation that mills and sells wood for residential and commercial construction purposes. TWP has a September 30 year-end. MacDonald and MacDonald, Chartered Accountants, LLP (M&M) provides financial and tax advice to TWP and its owners, the Dover brothers. It is now November 15, 2006. You, CA, and the M&M partner in charge of the TWP account, met with TWP’s president and controlling shareholder, Carleton Dover. He has requested M&M’s assistance in improving how he monitors the company’s performance. Carleton Dover is considering purchasing an information system to better manage TWP’s inventory. He knows of many other companies that have automated point of sale systems. However, Carleton recently read about manufacturing inventory systems and thought that one might meet TWP’s needs. He has provided you with general descriptions of the two types of systems (Exhibit I). He would like M&M’s advice on which type of information system he should purchase. He does not want to spend a lot of money on an information system that does not improve TWP’s operations. The Dover brothers also own the shares of an inactive company, Pacific Coast Inc. (PC). PC’s last significant asset was a rental property, which was sold in 2005. The Dover brothers want to shut down PC and have asked for your advice on how to minimize the amount of tax they will have to pay if they do so. The M&M partner has asked for a memo addressing the issues raised by Carleton Dover and any other relevant matters. You obtained general information on TWP’s operations (Exhibit II). You made notes during a visit to TWP (Exhibit III). Information from PC’s tax files was also obtained (Exhibit IV).



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Wood-Place Inc. (continued) EXHIBIT I COMPUTER INFORMATION SYSTEM DESCRIPTIONS Point of Sale System This type of system is designed for retail businesses where the inventory consists of large quantities of various products, typically coded with a bar code. This type of system is common in grocery and consumer retail stores. As the goods are sold, the items are scanned through the point of sale system and the sale price is automatically generated. Payment can be accepted at that point or the sale can be automatically updated to the customer’s account. A cost of goods sold, based on the gross margin percentage programmed into the system for the individual product, is automatically recorded in the accounting records. The item sold is automatically removed from the perpetual inventory records. Manufacturing Inventory System A manufacturing inventory system is normally used by a company manufacturing one, or more, products at its facility. Inventory costs accumulated include raw materials, labour and variable overhead. It is important to ensure all manufacturing costs are inputted into the system in order to calculate a proper cost of goods manufactured and selling price. Most manufacturing inventory systems can handle multiple product costing. Production costing can be based on standard labour and raw material rates. The system will normally generate inventory costs at various stages of production and calculate standard cost variances. This type of system requires a significant amount of effort to ensure accurate and timely input of costs and quantities.



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Wood-Place Inc. (continued) EXHIBIT II INFORMATION ON TWP’S OPERATIONS The company purchases approximately 50 different grades, sizes and types of wood from five large suppliers. It rejects approximately 0.4% of wood purchased, with no right of return, because it does not meet quality control standards. This wood rejection rate is standard in the industry. About two thirds of TWP’s sales is wood that is not processed, but rather bought, held in inventory and then resold in the same form. The mark-up for all of these sales is 80% of original cost. The remaining third of the company’s sales is wood that is milled and moulded by TWP. Some common types and sizes of wood are moulded and kept ready for sale. Approximately half of the moulded wood sold is “custom-made” based on specifications provided by the customer. TWP processes between 30 and 40 custom orders each month. Custom orders can range in value from $50 to $100,000. There is a significant variation in the percentage of wood lost in milling these custom orders. The wood that is sold to the customer is only 50% to 80% of the wood that is put into the milling or moulding machines, the balance being ground to sawdust or cut off as scrap. For example, one 8 foot piece of 2” x 2” oak may become two four feet pieces of 1 ½” round oak railing, with a loss of about 50% of the original wood’s volume. Custom orders have been priced on an adhoc basis by Carleton Dover; although, he is finding it difficult to keep up with the volume of orders. He is hesitant to allow others to do the custom order pricing as it is easy to lose money on a job by under-pricing it. Inventory levels are not formally tracked, but the employees at the service counter generally have an idea of the inventory levels remaining in the warehouse by tracking sales on a large wipe board. Employees sometimes tell a customer at the service counter that the type and quantity of wood they want is available. However, when a staff member is sent to the warehouse to obtain the wood, they find there is a shortage. Employees are supposed to update the wipe board after each order. In reality, this is not always done during peak activity times when the employees are busy dealing with customers. The production manager wants to know what the wood inventory levels are without having to send a staff member to count the various piles of wood. The manager orders more wood inventory after visual inspection of the piles of wood remaining in inventory. The manager uses his gut feel to estimate projected sales volume and order delivery time when ordering. The sales and production managers would like more accurate information on which lines of wood are selling best. The company applies an estimated gross profit percentage to monthly sales to estimate profitability for that month. TWP counts inventory at year end and adjusts book inventory to actual count numbers. Prior to adjustment, the book inventory is sometimes above the actual count and sometimes it is below. Carleton Dover is always surprised by how much the book to actual inventory variance fluctuates. However, TWP does not prepare budgets and has not set up a standard costing system. Carleton Dover started his own company, Wood Creations Inc. (WCI), in September, 2006. The company produces custom wood furniture. WCI purchases all of its wood from TWP at a 25% discount from the company’s list prices.



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Wood-Place Inc. (continued) EXHIBIT II (continued) INFORMATION ON TWP’S OPERATIONS TWP uses the Quickie™ accounting system for its general ledger, accounts payable sub-ledger and accounts receivable sub-ledger. Quickie™ has a sales order and invoicing sub-system, which are not activated. This sub-system also has job-cost functionality. Invoices are manually prepared in duplicate at the counter, using carbonless paper, for most orders. One copy is given to the customer and one is kept at the counter. The bookkeeper enters the invoices into the accounting system, usually within one working day. All sales are booked in the general ledger account, Sales-General-1000. The service counter is staffed by five employees, of which four are normally there at any given time. Carleton Dover is there some of the time, but he often does works in his office on the premises. Carleton recently hired his son to work at the service counter. He works an average of 15 hours per week and is paid a monthly salary of $2,000. Vehicle lease payments for Carleton Dover and his wife have been charged to TWP’s general and administrative expense account since October 2006.



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Wood-Place Inc. (continued) EXHIBIT III NOTES FROM VISIT TO TWP Carleton Dover owns 75% of TWP’s common shares and Vanier Dover owns the remaining 25%. Vanier Dover is a silent partner with no interest in any involvement with the company’s operations. TWP is profitable and is expected to generate income of $450,000 before bonuses in fiscal 2006. Bonuses are normally paid to reduce taxable income and take advantage of the full Small Business Deduction. Under the terms of TWP’s agreement with its bankers, there is a debt-to-equity ratio that is tested quarterly. The company has always met the covenant, so Carleton Dover does not really bother monitoring TWP’s debt or equity balances. TWP’s bookkeeper prepares a full set of financial statements for the company at the end of each year. During the course of a conversation with her, the bookkeeper mentioned that Carleton Dover had built a large cottage in September 2006. She said the wood he used in the construction of the cottage was charged to the general ledger account, Cost of Sales-Other-2001. Carleton Dover’s executive assistant mentioned that Carleton has let her use his third family car, a Honda Civic since the fall of 2005. She drives his children home from school on a fairly regular basis. The vehicle cost $22,000 and Carleton personally pays all of the operating expenses. Carleton Dover mentioned that he reviews the cash balance on a monthly basis. “As long as there was enough cash in the bank, the business was doing well,” he mentioned. However, he noted that the company has had to draw on its line of credit to fund operations for the past 2 months. Carleton does not understand why TWP suddenly has cash flow concerns.



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Wood-Place Inc. (continued) EXHIBIT IV PACIFIC COST INC. TAX FILE INFORMATION Vanier and Carleton Dover each own 50% of Pacific Coast Inc. (PC). PC has a December 31 year end and a tax rate of 36.12%. PC has been inactive since 2005 when it sold its rental property. In the years before that, the company did some buying and selling of wood, but all of that business had moved to TWP by 2004. PC has no physical assets. All corporate tax returns have been filed and assessed. The September 30, 2006 tax balances for PC are as follows: RDTOH Capital Dividend Account UCC and CEC Non-Capital Loss Carry Forwards PUC and ACB

$ 4,322 37,951 Nil 1,604 1

PC’s balance sheet as at September 30, 2006 is as follows: Assets Cash Due from TWP

Liabilities and Shareholders’ Equity $

10 24,576 $ 24,586

Share capital Retained earnings

$

1 24,585 $ 24,586

******


6

0.98 0.96 0.94 0.92 0.91

0.89 0.87 0.85 0.84 0.82

0.80 0.79 0.77 0.76 0.74

0.73 0.71 0.70 0.69 0.67

0.66 0.65 0.63 0.62 0.61

1 2 3 4 5

6 7 8 9 10

11 12 13 14 15

16 17 18 19 20

21 22 23 24 25

Periods Hence 2%

0.54 0.52 0.51 0.49 0.48

0.62 0.61 0.59 0.57 0.55

0.72 0.70 0.68 0.66 0.64

0.84 0.81 0.79 0.77 0.74

0.97 0.94 0.92 0.89 0.86

3%

0.44 0.42 0.41 0.39 0.38

0.53 0.51 0.49 0.47 0.46

0.65 0.62 0.60 0.58 0.56

0.79 0.76 0.73 0.70 0.68

0.96 0.92 0.89 0.85 0.82

4%

0.36 0.34 0.33 0.31 0.30

0.46 0.44 0.42 0.40 0.38

0.58 0.56 0.53 0.51 0.48

0.75 0.71 0.68 0.64 0.61

0.95 0.91 0.86 0.82 0.78

5%

0.29 0.28 0.26 0.25 0.23

0.39 0.37 0.35 0.33 0.31

0.53 0.50 0.47 0.44 0.42

0.70 0.67 0.63 0.59 0.56

0.94 0.89 0.84 0.79 0.75

6%

0.24 0.23 0.21 0.20 0.18

0.34 0.32 0.30 0.28 0.26

0.48 0.44 0.41 0.39 0.36

0.67 0.62 0.58 0.54 0.51

0.93 0.87 0.82 0.76 0.71

7%

0.20 0.18 0.17 0.16 0.15

0.29 0.27 0.25 0.23 0.21

0.43 0.40 0.37 0.34 0.32

0.63 0.58 0.54 0.50 0.46

0.93 0.86 0.79 0.74 0.68

8%

0.16 0.15 0.14 0.13 0.12

0.25 0.23 0.21 0.19 0.18

0.39 0.36 0.33 0.30 0.27

0.60 0.55 0.50 0.46 0.42

0.92 0.84 0.77 0.71 0.65

9%

0.14 0.12 0.11 0.10 0.09

0.22 0.20 0.18 0.16 0.15

0.35 0.32 0.29 0.26 0.24

0.56 0.51 0.47 0.42 0.39

0.91 0.83 0.75 0.68 0.62

10%

0.11 0.10 0.09 0.08 0.07

0.19 0.17 0.15 0.14 0.12

0.32 0.29 0.26 0.23 0.21

0.53 0.48 0.43 0.39 0.35

0.90 0.81 0.73 0.66 0.59

11%

PRESENT VALUE OF $1 RECEIVED AT THE END OF THE PERIOD

0.09 0.08 0.07 0.07 0.06

0.16 0.15 0.13 0.12 0.10

0.29 0.26 0.23 0.20 0.18

0.51 0.45 0.40 0.36 0.32

0.89 0.80 0.71 0.64 0.57

12%

0.08 0.07 0.06 0.05 0.05

0.14 0.13 0.11 0.10 0.09

0.26 0.23 0.20 0.18 0.16

0.48 0.43 0.38 0.33 0.29

0.88 0.78 0.69 0.61 0.54

13%

0.06 0.06 0.05 0.04 0.04

0.12 0.11 0.09 0.08 0.07

0.24 0.21 0.18 0.16 0.14

0.46 0.40 0.35 0.31 0.27

0.88 0.77 0.67 0.59 0.52

14%

0.05 0.05 0.04 0.03 0.03

0.11 0.09 0.08 0.07 0.06

0.21 0.19 0.16 0.14 0.12

0.43 0.38 0.33 0.28 0.25

0.87 0.76 0.66 0.57 0.50

15%

0.04 0.04 0.03 0.03 0.02

0.09 0.08 0.07 0.06 0.05

0.20 0.17 0.15 0.13 0.11

0.41 0.35 0.31 0.26 0.23

0.86 0.74 0.64 0.55 0.48

16%

0.04 0.03 0.03 0.02 0.02

0.08 0.07 0.06 0.05 0.04

0.18 0.15 0.13 0.11 0.09

0.39 0.33 0.28 0.24 0.21

0.85 0.73 0.62 0.53 0.46

17%

0.03 0.03 0.02 0.02 0.02

0.07 0.06 0.05 0.04 0.04

0.16 0.14 0.12 0.10 0.08

0.37 0.31 0.27 0.23 0.19

0.85 0.72 0.61 0.52 0.44

18%

0.03 0.02 0.02 0.02 0.01

0.06 0.05 0.04 0.04 0.03

0.15 0.12 0.10 0.09 0.07

0.35 0.30 0.25 0.21 0.18

0.84 0.71 0.59 0.50 0.42

19%

0.02 0.02 0.02 0.01 0.01

0.05 0.05 0.04 0.03 0.03

0.13 0.11 0.09 0.08 0.06

0.33 0.28 0.23 0.19 0.16

0.83 0.69 0.58 0.48 0.40

20%

TABLE I

9.79 9.25 8.76 8.31 10.58 9.95 9.39 8.86 11.35 10.63 9.99 9.39 12.11 11.30 10.56 9.90 12.85 11.94 11.12 10.38

13.58 14.29 14.99 15.68 16.35

17.01 17.66 18.29 18.91 19.52

11 12 13 14 15

16 17 18 19 20

21 22 23 24 25

15.42 15.94 16.44 16.94 17.41

12.56 13.17 13.75 14.32 14.88

5.42 6.23 7.02 7.79 8.53

14.03 14.45 14.86 15.25 15.62

11.65 12.17 12.66 13.13 13.59

5.24 6.00 6.73 7.44 8.11

12.82 13.16 13.49 13.80 14.09

10.84 11.27 11.69 12.09 12.46

5.08 5.79 6.46 7.11 7.72

0.95 1.86 2.72 3.55 4.33

5.60 6.47 7.33 8.16 8.98

0.96 1.89 2.78 3.63 4.45

6 7 8 9 10

0.97 1.91 2.83 3.72 4.58

5%

0.98 1.94 2.88 3.81 4.71

4%

1 2 3 4 5

3%

2%

No. of Periods Received

7.50 7.94 8.36 8.75 9.11

4.77 5.39 5.97 6.52 7.02

0.93 1.81 2.62 3.39 4.10

7%

11.76 12.04 12.30 12.55 12.78

10.84 11.06 11.27 11.47 11.65

10.11 9.45 10.48 9.76 10.83 10.06 11.16 10.34 11.47 10.59

7.89 8.38 8.85 9.29 9.71

4.92 5.58 6.21 6.80 7.36

0.94 1.83 2.67 3.47 4.21

6%

10.02 10.20 10.37 10.53 10.68

8.85 9.12 9.37 9.60 9.82

7.14 7.54 7.90 8.24 8.56

4.62 5.21 5.75 6.25 6.71

0.93 1.78 2.58 3.31 3.99

8%

9.29 9.44 9.58 9.71 9.82

8.31 8.54 8.76 8.95 9.13

6.81 7.16 7.49 7.79 8.06

4.49 5.03 5.53 6.00 6.42

0.92 1.76 2.53 3.24 3.89

9%

8.65 8.77 8.88 8.99 9.08

7.82 8.02 8.20 8.36 8.51

6.50 6.81 7.10 7.37 7.61

4.36 4.87 5.33 5.76 6.14

0.91 1.74 2.49 3.17 3.79

10%

8.08 8.18 8.27 8.35 8.42

7.38 7.55 7.70 7.84 7.96

6.21 6.49 6.75 6.98 7.19

4.23 4.71 5.15 5.54 5.89

0.90 1.71 2.44 3.10 3.70

11%

7.56 7.65 7.72 7.78 7.84

6.97 7.12 7.25 7.37 7.47

5.94 6.19 6.42 6.63 6.81

4.11 4.56 4.97 5.33 5.65

0.89 1.69 2.40 3.04 3.60

12%

7.10 7.17 7.23 7.28 7.33

6.60 6.73 6.84 6.94 7.02

5.69 5.92 6.12 6.30 6.46

4.00 4.42 4.80 5.13 5.43

0.88 1.67 2.36 2.97 3.52

13%

PRESENT VALUE OF AN ANNUITY OF $1 RECEIVED AT THE END OF EACH PERIOD

6.69 6.74 6.79 6.84 6.87

6.27 6.37 6.47 6.55 6.62

5.45 5.66 5.84 6.00 6.14

3.89 4.29 4.64 4.95 5.22

0.88 1.65 2.32 2.91 3.43

14%

6.31 6.36 6.40 6.43 6.46

5.95 6.05 6.13 6.20 6.26

5.23 5.42 5.58 5.72 5.85

3.78 4.16 4.49 4.77 5.02

0.87 1.63 2.28 2.85 3.35

15%

5.97 6.01 6.04 6.07 6.10

5.67 5.75 5.82 5.88 5.93

5.03 5.20 5.34 5.47 5.58

3.68 4.04 4.34 4.61 4.83

0.86 1.61 2.25 2.80 3.27

16%

5.67 5.70 5.72 5.75 5.77

5.41 5.47 5.53 5.58 5.63

4.84 4.99 5.12 5.23 5.32

3.59 3.92 4.21 4.45 4.66

0.85 1.59 2.21 2.74 3.20

17%

5.38 5.41 5.43 5.45 5.47

5.16 5.22 5.27 5.32 5.35

4.66 4.79 4.91 5.01 5.09

3.50 3.81 4.08 4.30 4.49

0.85 1.57 2.17 2.69 3.13

18%

5.13 5.15 5.17 5.18 5.20

4.94 4.99 5.03 5.07 5.10

4.49 4.61 4.71 4.80 4.88

3.41 3.71 3.95 4.16 4.34

0.84 1.55 2.14 2.64 3.06

19%

4.89 4.91 4.93 4.94 4.95

4.73 4.77 4.81 4.84 4.87

4.33 4.44 4.53 4.61 4.68

3.33 3.60 3.84 4.03 4.19

0.83 1.53 2.11 2.59 2.99

20%

TABLE II

TABLE III A FORMULA FOR CALCULATING THE PRESENT VALUE OF REDUCTIONS IN TAX PAYABLE DUE TO CAPITAL COST ALLOWANCE

×

Investment Cost

(

Rate of Return

Marginal Rate of Income tax +

×

Rate of Capital Cost Allowance

Rate of Capital Cost Allowance

( ) ( ×

1+

Rate f Return 2

×

1+

Rate of Return

) )

MAXIMUM CAPITAL COST ALLOWANCE RATES FOR SELECTED CLASSES Class 1 ..................................................... 4% Class 3 ..................................................... 5% Class 8 ..................................................... 20% Class 10 ................................................... 30% Class 10.1 ................................................ 30% Class 12 ................................................... 100% Class 13 ................................................... original lease period plus one renewal period (Minimum 5 years and Maximum 40 years) Class 14 ................................................... Length of life of property Class 17 ................................................... 8% Class 39 ................................................... 25% Class 43 ................................................... 30% Class 44 ................................................... 25% Class 45 ................................................... 45% SELECTED PRESCRIBED AUTOMOBILE AMOUNTS Maximum depreciable cost - Class 10.1 Maximum monthly deductible lease cost Maximum monthly deductible interest cost

$30,000 + GST $800 + GST $300

Operating cost benefit - employee 22¢ per kilometre of personal use Non-taxable car allowance benefit limits - first 5,000 km 50¢ per kilometre - balance 44¢ per kilometre

TABLE IV INDIVIDUAL FEDERAL INCOME TAX RATES Taxable Income

Tax

$37,178 or less $37,179 to $74,357 $74,358 to $120,887 $120,888 or more

15.5% $5,763 + 22% on next $37,179 $13,942 + 26% on next $46,530 $26,040 + 29% on remainder

SELECTED NON-REFUNDABLE TAX CREDITS PERMITTED TO INDIVIDUALS FOR PURPOSES OF COMPUTING INCOME TAX The tax credits are 15.5% of the following amounts: Basic personal amount Married and equivalent to spouse amount Net income threshold for married or equivalent amount Age 65 or over in the year Disability amount Disabled dependents who reach 18 in the year Net income threshold for disabled dependents 18 and over Basic amount for: Age credit and GST credit Child tax benefit OAS clawback

$8,929 7.581 759 5,177 6,890 4,019 5,702 30,936 37,178 63,511

CORPORATE FEDERAL INCOME TAX RATE The tax payable by a corporation under Part I of the Income Tax Act on its taxable income is 38% before any additions and/or any deductions. PRESCRIBED INTEREST RATES Year 2007 2006 2005 2004 2003

Jan. 1 - Mar. 31 7 5 5 5 5

Apr. 1 - June 30 7 6 5 5 5

July 1 - Sept. 30

Oct. 1 - Dec. 31

7 6 5 4 6

7 5 5 5

The rate is 2 percentage points higher for late or deficient income tax payments and unremitted withholdings. The rate is 2 percentage points lower for deemed interest on employee and shareholder loans.

***********

UFE Package 1 Simulations-2008

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