Part A: Case Analysis:
Porto Waste Facilities Inc. (PWF) is a large, diversified Canadian-controlled private company
with several Canadian and US subsidiaries, operating mainly in the waste management and
disposal industry. PWF was incorporated in 1955 and has grown to become one of the top four
waste management firms in Canada. The business was started by the Porto family, but currently
no family members are actively involved in the management of the company. The shares are
owned by family members, family trusts, and a limited number of friends. In 2017, the Porto
family decided to sell the company to a third party within the next two or three years to realize
the value of their shareholdings. PWF has an August 31 year end. The company has elected to
report using International Financial Reporting Standards (“IFRS”).
It is now October 18, 2019.
You, CPA, work for Hoa LLP. You are currently in charge of the audit of Porto. You had a
meeting with PWF’s management and staff and have collected the following information. The
partner on the engagement has asked you to identify any financial accounting issues and discuss
them using IFRS and conclude on the appropriate treatment that you would expect PWF to follow
in preparation of its financial statements.
1. A team of provincial sales tax auditors has been auditing PWF for nearly six months, but the
audit is still not complete. The auditors are disputing certain expenses that PWF recognized
for tax purposes which resulted in PWF paying substantial less tax in the past two years that
the company would otherwise have to pay.
2. On June 23, 2019, PWF received a wire transfer of $10 million to its general Canadian dollar
bank account, assuming that this amount was to settle an outstanding customer invoice.
Days after, PWF realized that the amount was deposited in error. PWF has not informed the
bank of the error and has taken $10 million into income as a ‘gain’.
3. During 2019, PWF lost a decision in the Federal Court of Appeal in a lawsuit brought by
Waste Systems Integrated Limited for patent infringement. In an unusual award, the court
ordered PWF to pay $18 million for 100% shares of Waste Systems Integrated Limited, a
private company, which had been in some financial difficulty. PWF has decided not to
appeal the decision to the Supreme Court, and the shares were purchased before year end.
Since PWF now owns the patent, PWF is now considering how to best protect this
technology going forward and the board is interested in understanding the accounting
implication for this patent.
4. PWF purchased shares of a private company that is PWF’s equipment supplier. After the
purchase, PWF owned 18% of the shares outstanding. PWF invested in the company due to a
long-standing relationship with the company’s management, as well as the access to any new
equipment technologies that can help to enhance the nature of PWF’s future business. PWF
is able to appoint one out of five board members but PWF has not done so yet.
Required:
Prepare the report as required by your Partner. In discussing key financial issues, please make
sure to quote the proper section from the CPA handbook that is relevant to your discussion,
As the Porto family plans to sell the business in the future, you are also asked to assess and
address any issues regarding the integrity of their financial reporting. Any obvious management
biases in their financial reporting should be reviewed in your report.
Oh where to begin...
How about...
How much have you got written already?
To prepare the report as required by your partner, we need to analyze the key financial accounting issues identified in the given information and discuss the appropriate treatment using the relevant sections from the CPA Handbook. We also need to assess any issues regarding the integrity of the financial reporting and review any potential management biases.
1. Provincial Sales Tax Auditors Dispute:
The first issue involves the dispute with provincial sales tax auditors regarding certain expenses recognized by PWF for tax purposes. This dispute has resulted in PWF paying substantially less tax than it would have otherwise paid. In this case, we need to consider the implications of this dispute on PWF's financial statements.
According to the CPA Handbook, specifically in Section 3940 - Tax Implications in the Financial Statements, when a tax dispute arises, the treatment should be based on the likelihood of the dispute being resolved in favor of the company. If it is probable that the dispute will be resolved against PWF, a provision for the potential tax liability should be recognized in the financial statements. However, if it is probable that the dispute will be resolved in favor of PWF, no provision is necessary.
In this case, since the audit is still ongoing and the final resolution is uncertain, it may be appropriate to disclose the nature of the dispute and the potential impact on PWF's financial position and results of operations in the notes to the financial statements. It is necessary to assess the likelihood of the dispute being resolved in favor of PWF and make the appropriate provision if required.
2. Error in Wire Transfer and Income Recognition:
The second issue involves a wire transfer of $10 million that was deposited into PWF's Canadian dollar bank account as payment for an outstanding customer invoice. However, it was later discovered that the amount was deposited in error. PWF has not informed the bank of the error and has taken the $10 million into income as a 'gain'.
According to Section 1000 - Financial Statement Concepts, revenues should be recognized when they are realized or realizable and have been earned. In this case, the $10 million was not earned by PWF, as it was a result of an error in the wire transfer. Therefore, it should not be recognized as a gain.
To correct this error, PWF should reverse the entry and remove the $10 million from income. It should be appropriately disclosed in the financial statements as a correction of an error. The correction should reflect the impact on the financial position and results of operations of PWF.
3. Lawsuit Settlement and Acquisition of Waste Systems Integrated Limited:
The third issue involves PWF losing a lawsuit in which it was ordered to pay $18 million for 100% shares of Waste Systems Integrated Limited due to patent infringement. PWF has decided not to appeal the decision and has purchased the shares. PWF is now considering the accounting implications for this patent and how to protect the technology going forward.
Under Section 3061 - Property, Plant and Equipment, patents are recognized as intangible assets and should be initially measured at cost. PWF should capitalize the cost of acquiring the patent as an intangible asset on its balance sheet. The cost should include the purchase price and any directly attributable costs incurred to acquire and protect the patent.
Going forward, PWF should assess the useful life of the patent and determine if any impairment indicators exist. If there is an indication of impairment, PWF should test the recoverability of the patent and recognize any impairment loss if necessary.
4. Investment in Equipment Supplier Company:
The fourth issue involves PWF purchasing shares of a private company, which is also PWF's equipment supplier. PWF currently owns 18% of the shares outstanding and has the ability to appoint one out of five board members but has not exercised this right yet.
According to Section 3051 - Investments, PWF should account for its investment in the equipment supplier company using the equity method. This method involves recognizing the investment initially at cost and subsequently adjusting the carrying amount based on its share of the investee's net income or loss and other comprehensive income or loss.
It is important for PWF to carefully assess its ability to exercise significant influence over the investee and determine if it meets the criteria for applying the equity method. If PWF has the ability to exercise significant influence, it should disclose the nature of the relationship, including the voting rights and any significant transactions between PWF and the investee company, in the notes to the financial statements.
Assessing Integrity of Financial Reporting:
As the Porto family plans to sell the business in the future, it is crucial to assess the integrity of their financial reporting. This assessment involves reviewing any potential management biases and ensuring that the financial statements provide a true and fair view of the company's financial position and results of operations.
To address this issue, a thorough review of PWF's financial reporting policies and procedures should be conducted. This includes examining the internal control environment, assessing the quality of financial information, and scrutinizing any related party transactions or potential conflicts of interest involving the Porto family or their associates.
To ensure transparency and integrity in financial reporting, PWF should comply with the relevant sections of the CPA Handbook, such as Section 1000 - Financial Statement Concepts, Section 3150 - Committee of Sponsoring Organizations of the Treadway Commission (COSO) Framework, and Section 3800 - Government Assistance. These sections provide guidance on fair presentation, internal control, and the disclosure of government assistance, respectively.
Concluding the Report:
In conclusion, the key financial accounting issues identified in the case are related to the tax dispute, the error in recognizing a wire transfer as income, the acquisition of Waste Systems Integrated Limited, and the investment in the equipment supplier company. These issues should be addressed in accordance with the relevant sections from the CPA Handbook, as discussed above.
Additionally, it is important to review the integrity of PWF's financial reporting, including any potential management biases. Compliance with the relevant sections of the CPA Handbook and other applicable accounting standards will help ensure the transparency and accuracy of the financial statements.
Please note that this report is a general analysis based on the provided case information, and a more detailed analysis may be required to reach a final conclusion.