Oustanding – Internal Controls

Principle Residence
1) Capital gain per year to see allocation
2) Cap Gain – Cap gain (1+designation/Total years)

Capital Lease
1) Lease term is 75% of useful life?
2) PV is 90% of FMV?
3) Bargain purchase option? Less than FMV?
4) Auto Transfer?

Why is asset worth more than shares to a purchaser?

 Can choose assets
 Don’t assume responsibility of liabilities
 FV bump up
Good will, can depreciate

Whats better for the seller?

 Taxed twice – personal (dividend) and corporate
 Only personal tax paid
 Less complex (less accounting and legal fees) – 1 transaction
 Not responsible for liabilities
 Capital gain exception
o Small Business Corporation
o No previous owner in last 2 years
o During those 2 years, 50% assets are used for active business in canada
o 90% of assets are used to generated ABI
o 750k

Valuation:
 Tax implications of sales of shares
 Capital exemption of 750k
 Capital gain is 50%
 Only personal tax

Tax implications of sales of assets

 Capital Assets – AII, ABI, CDA, TDTOH
 Non-capital – AII
 Coporate
 Deemd dividend is personal
ABI – Recapture/Loss [ UCC less lower of prceeds and original cost], AFDA
AII – cap gain/loss (depreciable cap asset no cap loss)
CECA Recapture = CEC less 3/4 (original cost)

Windup
1) Goodwill – Proceeds less FMV
2) Available for cash
a. ABI, AII, CDA, RDTOH 26 2/3% of AII
b. Capital (non capital loss)
c. Goodwill and intangible
i. CEC Less ¾ of proceeds
ii. Recapture = CEC less lower of proceeds or Cost (ABI)
iii. 2/3 of remaining (ABI, CDA
d. Bonus Down (500k)
Proceeds +RDTOH-Bonus-TAX – Liabilities
3) Deemed Dividend less PUC= Deemed less CDA = taxable
4) Determine Tax on Bonus (personal) and Dividend (non-eligible)
5) Cash avail less tax + bonus

Sale of shares:
 Proceeds
 Less: Share Capital
 =Gain
 Less 750k
 =gain
 1/2gain
 Tax (44%)
 Proceeds less tax = cash avail.

Adjusted Net Asset = FMV = floor value

 FMV = floor value = lowest value that the company should accept = FMV
 Going concern
 Non-active operations OR non-excess earnings

Earnings-based appoarch
Representative method to value the ocmpany

Part I Tax
For Non-Residents, only Canadian employment income, Canadian business income
and gains on the disposition of taxable Canadian property will apply to Part I tax.
Consolidated B/S
 Acquire over 50% of subsidiary, need to consolidate S+P
 Consolidating entries are for internal purpose only.
 Only required to present a consolidated statement.
 Dr Investment
 Cr cash/loans

 Proceed less NBV

 =PPD
 Less FV increment
 = Goodwill

Residency
 Primary ties – spouse, dependent, dwelling
 Secondary – economic ties
 Resident = worldwide income, and cpay dof cpp and EI
 Non-resident= only Canadian income is taxed (cpp and RRSP)

Subsequent event
 Amount relating to before or after year end?
 Bankruptcy, the amount occurred before
 Flood, amount was after

2 Types of Liquidation
1. Orderly
The sale of the assets and the wind-up of operations
that is controlled by the owners of the business, and where the residual value normally is
expected to be realized by the owners
2. Forced
The sale of the asset where an immediate cessation of the
business and disposition of the assets is assumed on an ‘as is/where is’ basis
 
Adjusted Net Assets
 Going concern
 Non-active operations OR non excess earnings over capital investment
 
3 Types of Earnings-Based Valuation
1. Discounted Cash Flow
2. Capitalized Cash Flow
3. Capitalized Earning
 
Discounted Cash Flow
  Past performance of company does not reflect future peformance
 New company
 Going concern
 
Capitalized Cash Flow
 Past performance reflects future performance
 Operations are capital intensive
 Depreciation expense does not reflect annual capital expenditure
 
Capitalized Earning
 Past performance reflects future performance
 Operations are not capital intensive
 Depreciation expense reflects annual capital expenditure
 Unlevered earnings (WACC)
 Levered Earnings (Equity Approach)

Audit Planning Memo:

1- OFSR:
F2F

 PPL selling the business – valuation of net income, bias to overstate income
 Private company – limited number of users – decrease
 Bank reliance on F/S to provide financing – increase risk
 Control weaknesses identified in PPP cycle – Increase Risk
 Maureen Carter is a part-time book keeper, lacks knowledge, increased errors –
Increased Risk

2010
 Shiela is lookgint sell VPL and relies on the F/S for valuation. There is a biase to
understate expense and overstate income
 Banks are relying on the F/S to provide loans – there is a bias to overstate the
income
 It is a private company – limited number of users - DECREASE RISKS
 Significant weakness in PPP cycle were identified – Increase RISK
 No BOD governance – Increase Risk

Free Meats
 Bank reliance on F/S for financing
 Control weakness were identified
 Sale

Summary:
 Bank reliance on F/S for financing
  Selling – Owner reliance on F/S for valuation
 Control weakness are identified
 No BOD Governance
 Private company

Materiality
 Lendor
 Bank
 Purchaser
 Owner

Extrapolation
Error /representative sample *representative population

Additional Procedures

A/R Procedures:
Existence – A/R confirmation, Subsequent Receipt
Valuation – subsequent receipt, analytics
Completeness – subsequent receipt
Rights – a/r confirmation

A/P
Existence – A/P confirmation, subsequent disbursement
Completeness – subsequent disbursement, A/R Confirmation with zero-sum accounts, review
legal
Valuation – trace invoice received to cheques written
Rights and obligation – A/P confirmation

Inventory
Existence – Inventory count Sheet to Floor
Completeness – Floor to Sheet inventory
Valuation – review subsequent sales to determine if inventory is selling, inventory count and
assess condition of inventory, review invoice received to determine cost of inventory
Rights and obligation – Trace invoice to cancelled cheques

PPE
Existence: examine assets, and agree to supporting documentation
Valuation: analytics on amortization rates, review amortization rates
Completeness – sheet to floor (?)
Rights – invoice to cancelled cheque, approval document on PPE purchase
Cash:
Existence – confirmations, outstanding deposit test
Completeness – outstanding cheques, outstanding cheque test, determine if all bank accounts
owned are included in Cash
Rights – confirmations
Valuation - confirmations

*pp&e: existence: physically examine additions, agree to supporting docs

valuation: amortization

Compare to materiality and conclude with an opinion

Prin

Internal Control Weaknesses

Internal Control Weakness

F2f
Purchase Payment Payable Cycle
Purchase order approval – occurrence of payment
Cheque signing –

2010
Receiving good – completeness
Approval of new vender - valuation
Approval of ordering - valuation

Free meats
Credit granting – a/r valuation
Invoice collection –

Order:
Order is based on notes for faxed documents – hard to read, missing sales invoice if forget to
send it
Implications – Missing invoices, incorrect anmount inputed
Accounts – Sales (accurancy, completeness) – A/R (valuation, cpmpletness)
Recommendation – if received by fax, followup phone call, if notes from rep, they input it
dierectly
Prorcued – Subsequent receipt trace to sales listing and a/r llisting to determin completeness –
A/R confirmation for valuation

Weakness – invoicing once a month

Sales are not recorded in same period, customers will not pay unless they are invoiced
Weakness
Shipping:

Credit Granting

Weakness – sales rep negotiate discounts

Implications – there is an incentive to grant credits and provide discounts due to the fact that
there is an incentive to make sales
Account affected – A/R (valuation), bad debt expense ( accurancy)
Recommendation - take away credit grantin ability from sales rep . give authority to credit
manager instead
Procedures – perform analytics – based on the industry and knowledge of business , have an
expectation of bad debt expense and compare it to own. If it is above threshold, obtain
edplanation from client and assess reasonability
A/R
Weakness

Sales rep negotiate credit limit

Overstate A/R, Understate bad debt
Asseration (A/R – valuation), bad debt (accuracy, completeness)
Credit manager should do it
Perform analytics on Bad Debt or AFDA and determine reasonaibility based on industry

Not following up on outstanding balance

Overstate A/R ( valuation ), understate bad debt, (accuracy, completeness)
Recommend – followup on confirmation so customes know
Perform analytics

Clerk does too much

Overstate A/R (existence, valuation)
Signed off and segregation of duties
Verify contract information with outsie source to tdeterin if customer is valud

Statements are sent non-frequently – customer doesn’t know if amount owing

A/r may be over/understated
(existence)
Procedures - confirmtions

A/P
No Spport for cheque
Implcaitions – fraudulent
Existence, valuation
Recommendation – support
Procedures – ap confirmation, agree invoice received to

Additional Procedures
Inventory
A/R
A/P
Cash
Sales