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ATTACHMENT McCarthy’s Cafes Ltd
Issues raised by the Board of Directors
In April 2016 the company purchased a segment of another business from Karen’s Coffees Ltd and paid $ 950 000 for it. Karen’s Coffees is a coffee bean roasting business and the book value of the net assets acquired amounted to $ 620 000. We are unsure as to how we should record this transaction in our books of account. Margaret who used to write up the books for us mentioned that the difference was “goodwill” and that we should show it in our books as an asset, namely goodwill. However Kate thinks we should treat this quite differently and has told the board of directors that the business segment we purchased (namely, coffee bean roasting) may not be as successful as we think. She thinks that we may have overpaid for the business and is suggesting we evaluate the business segment as a cash generating unit and consider the need to impair it. The board is quite confused and would like very clear guidelines about this matter.
According to the revised budgeted profit and loss statement for the year ending 31 December 2016 it would appear that the company may not make the previously budgeted profit of $ 1,250,000 and will fall short by about 10% to 15%. One of the directors pointed out that the company had land (2 blocks) purchased in the 1960s and that the actual value of the land was very much more than the amount stated on the balance sheet. It was then suggested that the company revalue just the two blocks that were understated and increase the assets and profits by the difference which should amount to approximately $ 250 000. This would then increase the profits for the year and would allow us to achieve the budgeted profit and declare the projected proposed dividends without a problem.
Earlier this year in May 2016 we discovered that the depreciation on plant and machinery had been incorrectly calculated at 2% instead of 20%; similarly buildings were depreciated at 0.5% instead of 5% in calculating the depreciation for the year ended 31 December 2015. No adjustments have been made in respect of this incorrect calculation to date. As it is just a book entry can we just ignore the error and calculate this year’s depreciation correctly and record it accordingly in this year’s accounts. Do we have to correct last year’s depreciation? How do we account for it if we do? We have also miscalculated the useful life span of our computer systems (bought in February 2015) at 5 years (that’s what we were told when we bought the computer systems) when it should have been just 3 years (present information available to us). Do we need to worry about it or could we just ignore it and claim the extra amount at the end of the three years when the computer systems are replaced?
Hint: Remember that your firm plans to charge the client for your advice; as a check ask yourself if you would pay for the advice you have drafted!
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