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CARE
Chartered Accountant
Reciprocity Examination
2009
The Institutes/Ordre of Chartered Accountants in Canada
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Questions and Approaches to
Solutions
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TABLE OF CONTENT
Page
Summary of Results 2009, 2008, and 2007 .....................................................................................3
2009 Chartered Accountant Reciprocity Examination
Day One ...............................................................................................................................4
Day Two.............................................................................................................................20
Approaches to Solutions
Introduction ........................................................................................................................37
Day One .............................................................................................................................38
Day Two.............................................................................................................................57
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 2
SUMMARY OF RESULTS
Chartered Accountant Reciprocity Examination
Institute
British Columbia
Alberta
Saskatchewan
Manitoba
Ontario
Quebec
Total
Number of Successful Writers
2009
2008
2007
19
15
8
8
11
2
2
1
38
35
48
2
8
67
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
61
69
Page 3
2009 CA Reciprocity Examination – Day One
THE INSTITUTES/ORDRE OF CHARTERED ACCOUNTANTS IN CANADA
CA RECIPROCITY EXAMINATION
DAY ONE – 2009
(100 marks) (3 hours)
NOTES TO CANDIDATES:
1.
There are 12 questions and 16 pages in this examination (including the cover page and
the tables).
2.
DO NOT write your name on your examination envelope or answer papers. Use your
FOUR (4) DIGIT CANDIDATE NUMBER ONLY.
3.
To assist in budgeting time during the examination, the number of minutes available for
each question (calculated at approximately 1.8 minutes per mark) is shown at the
beginning of each question.
4.
Answers or parts of answers to examination questions will not be marked if they are
recorded on the question paper or on the back of your answer papers.
5.
Ensure that the answer sheet for question 1 is submitted with your other answer papers
in the examination envelope provided.
6.
It is recommended that you write your responses in ink and write on every other line.
7.
Two tables are attached to the examination paper. No other reference sources are
allowed.
************
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 4
2009 CA Reciprocity Examination – Day One
Question 1 (8 marks) (14 minutes)
The question consists of 4 parts worth 2 marks each. Select the best answer for each part by
making an “X” in the appropriate space on the separate answer sheet provided for Question 1.
If more than one answer is given for a part, that part will not be marked. Marks are not deducted
for wrong answers. Explanations given will not be taken into account. When you have
completed your answer sheet, submit it along with your other answer papers.
(i) Revenue Recognition
Freda Limited (FL) is a public company with many retail furniture outlets. FL offers layaway plans under which customers put a small non-refundable cash deposit towards the
purchase of some furniture, and the retail outlet sets aside the item in its warehouse. If the
customer decides to go ahead with the purchase, he or she makes the first of two instalments
two weeks later, at which point the furniture is shipped FOB shipping point. The customer
makes the second and last instalment two days after the receipt of the furniture.
Which one of the following accounting treatments best describes how the transaction should
be recorded?
a)
b)
c)
d)
As a sale when the cash deposit is received.
As a sale when the item is received by the customer.
As a sale when the first instalment is received.
As a sale when the cash deposit is received as long as other criteria for revenue
recognition are met.
(ii) Leases
Which one of the following “lease terms” is the most comprehensive definition according to
CICA s.3065?
The fixed non-cancellable period of the lease plus
a) All periods covered by bargain renewal options, periods for which failure to renew
imposes a significant penalty, and periods covered by ordinary renewal options when
renewal is at lessor’s option.
b) All periods for which failure to renew imposes a penalty, periods covered by ordinary
renewal options, and periods that precede the date on which a bargain purchase option
may be exercised.
c) All periods covered by bargain renewal options, periods for which failure to renew
imposes a significant penalty, and periods covered by ordinary renewal options where the
lessee guarantees the lessor’s debt or where a bargain renewal option exists at the end of
the ordinary renewal period; and renewal periods at the lessor’s option.
d) All periods covered by bargain renewal options, periods for which failure to renew
imposes a significant penalty, periods covered by ordinary renewal options where the
lessee guarantees the lessor’s debt related to the leased asset or that precede the date on
which a bargain purchase option may be exercised.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 5
2009 CA Reciprocity Examination – Day One
Question 1 (continued)
(iii)Audit of accounting estimates
Galliano Limited (GL) is a local waste management company that picks up kitchen waste
under a contract with the City of Husk and composts it into useable soil.
Five years ago, GL was charged with fraud by the local securities commission for
overstatement of revenues. The case was settled and GL reorganized its governance structure
to prevent the recurrence of that specific type of fraud. GL’s auditors are currently planning
their audit for the current year.
Which one of the following best describes the position the auditors should take with respect
to fraud?
a) The auditors should ordinarily presume that there are risks of fraud related to
overstatement of revenue.
b) The auditors should presume that there is a risk of fraud related to revenue recognition
due to the fact that GL was previously charged by the securities commission, but would
not otherwise presume risk of fraud related to revenues.
c) The auditors should not worry about fraud related to revenues since the prior fraud was
five years ago and the case has been settled with the securities commission.
d) The auditors need not worry about risk of fraud related to revenues since GL has
reorganized its governance structure to prevent the fraud from recurring.
(iv) Materiality
Which one of the following statements regarding materiality in the audit is correct?
The auditor considers materiality in terms of:
a) The largest aggregate level of misstatement that could be considered material to all
financial statements.
b) The smallest aggregate level of misstatement that could be considered material to any one
financial statement.
c) The average aggregate level of misstatement that could be considered material to all
financial statements.
d) The largest aggregate level of misstatement that could be considered material to any one
financial statement.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 6
2009 CA Reciprocity Examination – Day One
Question 2 (8 marks) (14 minutes)
Financial Instruments, Recognition and Measurement
Titan Inc. has recently made two investments as follows:
1. Investments in bonds of Gaia Inc.
2. Investments in common shares of Ocean Ltd.
Bonds and shares of all three companies trade on the local stock exchange. At year-end, the
market value of Ocean Ltd.’s shares is lower than their original cost.
Titan Inc. must classify the investments for purposes of subsequent measurements and
recognition of gains or losses.
Required:
a) Part A (6 marks)
Describe the options available to Titan Inc. to classify the investments, including initial
and subsequent measurement and recording requirements.
b) Part B (2 marks)
What must Titan Inc. consider when determining if the investment in Ocean Ltd.’s shares
is impaired?
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 7
2009 CA Reciprocity Examination – Day One
Question 3 (8 marks) (14 minutes)
Related Party and Non-Monetary Transactions
Herten Ltd. (HL) owns 90% of Sensen Innovations Ltd. (SIL). During the year, HL and SIL each
exchanged a building with each other, and agreed that the fair values of the buildings were equal
to $1,000,000 each. The carrying amount of the buildings before the transaction was $500,000
for HL and $200,000 for SIL. Neither HL nor SIL are in the real estate business.
Required:
a) Part A (3 marks)
Determine the nature of the transaction between HL and SIL and explain your reasoning.
b) Part B (5 marks)
Discuss how the transaction should be recorded in each of HL’s and SIL’s individual
records, and be presented at the consolidated level. In your discussion, indicate which
accounts are affected and by what amounts.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 8
2009 CA Reciprocity Examination – Day One
Question 4 (15 marks) (27 minutes)
Inventory, Intangible Assets and Accounting Changes
Winery Inc. (WI) is a private company that grows grapes, and produces wines and grape-related
products that it sells at its retail stores.
In 2009, WI obtained a fruit wine distribution licence from the government under which it is
authorized to sell the fruit wines it began making from small berries during the year. The licence
must be renewed every two years but is renewable indefinitely.
Since its beginnings, WI has conducted cloning research on various grape and vine types. By
spring 2009, WI had successfully cloned a new variety of Gamay grape and began developing
vine shoots to plant in its vineyard. WI immediately obtained a plant breeders right, which grants
WI an exclusive international right to plant this new Gamay variety and sell it to other vineyards.
In 2009, WI built a new manufacturing facility with 40% excess capacity to meet future growth
and the new requirements of the Vintage Label Association (VLA). All wines need not receive
the VLA label to be marketed, but it helps. To obtain the label, a sample from each wine batch
must pass VLA’s quality standards. The last sample of a Merlot wine from WI did not meet the
standards likely due to a production error from the vintner. As at January 31, 2009, the cost of
this batch was $1 million. Once in the past, WI was able to transform a rejected batch into a
grape-related product.
In WI’s January 31, 2008 financial statements, all inventories of raw materials, work-in-progress
and finished goods, and supplies are valued at the lower of cost and market on a last-in, last-out
basis. Market is defined as replacement cost. Costs for finished goods and work-in-progress
include direct materials, direct labour, and variable and fixed overhead calculated on the plant’s
total capacity.
Required:
a) Part A (7 marks)
WI must now apply CICA s.3031. Ignoring the results of the Merlot sample test, identify
and discuss the changes required (1) to WI’s inventory accounting policies, (2) to note
disclosure and (3) to other accounts.
b) Part B (8 marks)
Discuss the accounting alternatives available to WI regarding (1) the rejected Merlot
batch, (2) the fruit wine license and (3) the research and development costs related to the
plant breeders right. Provide a supported recommendation.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 9
2009 CA Reciprocity Examination – Day One
Question 5 (8 marks) (15 minutes)
Leases
You are preparing to teach a class on Leases and want to illustrate your lecture with the
following situation:
“PCI is a consulting firm that owns a 20-storey building where it has its headquarters.
Over the years, PCI gave its consultant staff the choice of working from the office or
from home. Soon the choice of working from home became most popular among staff,
and as a result, PCI’s offices have become too spacious for its needs. This and the
substantial increase in real estate values over the recent years prompted PCI’s decision to
sell the building.
“During the year, PCI completed the sales transaction with FI and entered into an
agreement with the new owner to lease five entire floors, as this office space was still
very suitable to PCI. FI will be leasing the remaining floors to other tenants.
“The building was sold for $10 million and its carrying amount was $2 million. The lease
was signed for the building’s remaining useful life of ten years. Under the lease
agreement, PCI must pay $500,000 at the beginning of the year and one half of one
percent (½ %) of PCI’s profit at the end of the year.
“PCI’s incremental borrowing rate is 10%.”
Your lecture notes should be concise, structured and clear. They should identify all the relevant
criteria that could be applied to this transaction, the result of their application, and the reasoning
behind a recommended solution to help your students understand how to properly account for
this type of transaction.
Required:
a) Part A (6 marks)
Prepare lecture notes that address PCI’s perspective (lessee).
b) Part B (2 marks)
Prepare lecture notes that address FI’s perspective (lessor).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 10
2009 CA Reciprocity Examination – Day One
Question 6 (7 marks) (13 minutes)
Income Taxes and Accounting Changes
Bottler Inc. (BI), a small private company, bottles plain and flavoured spring water. Until now,
its financial statements have been prepared for tax purposes only. BI now needs bank financing
because it has depleted its cash reserve to finance the development of new energy drinks, and the
replacement of its plastic bottle inventory due to a consumers’ health concern over the Bisphenol
A (BPA) content in plastic bottles.
The bank requires that BI’s financial statements as at December 31, 2009 be audited and
prepared according to generally accepted accounting principles (GAAP). As part of its financing
covenant, the bank requires that dividend distribution be restricted and that a specified debt-toequity ratio be maintained.
In 2009, BI sustained a loss of $2 million for tax purposes due to the new product development
and the write off of the bottle inventory. Over the past three years, BI reported small profits; for
the coming year, it anticipates a small profit thanks to its advertizing campaign on its BPA free
bottles. Once profits return to normal BI would like to go public.
Prior to 2009, BI used capital cost allowance (CCA) rates for amortization but changed its policy
to the straight-line method for 2009. At the end of 2009, the undepreciated capital cost (UCC)
balance of capital assets was $3,800,000 and their carrying amount was $4,000,000. The carrying
amount of development costs related to the new product capitalized in 2009 was $500,000.
The statutory tax rate for BI is 35%.
Required:
Identify and discuss the alternatives available to BI to account for income taxes under GAAP,
and any other accounting issues. Provide supporting calculations when needed, and a supported
recommendation.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 11
2009 CA Reciprocity Examination – Day One
Question 7 (8 marks) (15 minutes)
Audit of fair values and disclosures
Kleinen Inc. (KI) has numerous assets that it measures at fair value including a property that it is
holding for sale. There are no observable market prices for this property, and therefore KI has
used its own assumptions and a discounted cash flow model to estimate fair value. The auditors
are planning the year-end audit and may use a specialist to help audit these values.
Required:
a) Part A (3 marks)
Discuss management’s responsibilities and challenges when estimating fair value and
preparing the related disclosures.
b) Part B (5 marks)
Discuss the auditors’ responsibilities and challenges when gathering sufficient,
appropriate audit evidence about fair value estimates, measurements and disclosures, and
discuss the need, if any, for using a specialist to meet generally accepted auditing
standards.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 12
2009 CA Reciprocity Examination – Day One
Question 8 (8 marks) (15 minutes)
Auditor’s Responsibility to Consider Fraud
Tranny Ltd. (TL)’s year-end audit is currently underway. The auditors were unaware that TL’s
controller has been embezzling funds for the past year. To date, the controller has managed to
conceal the fraud from all, even from the accounting staff.
Required:
a) Part A (4 marks)
Explain the difference between “fraud” and “error” and discuss the types of fraud
identified in CICA s. 5135.
b) Part B (4 marks)
Discuss (1) the attitude toward fraud and errors that an auditor should adopt, (2) the fraud
risk factors that an auditor should consider, and (3) the responsibilities of an auditor for
detecting fraud.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 13
2009 CA Reciprocity Examination – Day One
Question 9 (8 marks) (14 minutes)
Use of Specialist
You are considering whether to accept the appointment as auditor of an independent paper mill
in northern Manitoba. One of your concerns is the need to understand the environmental
implications of the manufacturing process, especially the possibility of contingent liabilities and
site clean-up costs.
Required:
a) Part A (3 marks)
Before you accept the engagement, what should you consider regarding the need to use a
specialist and your ability to understand the subject matter?
b) Part B (4 marks)
Outline the steps you would take to meet the general standard about proper planning and
supervision of the work of a specialist.
c) Part C (1 mark)
What is the impact of your reliance on the work of the specialist when the audit opinion
is without reservation?
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 14
2009 CA Reciprocity Examination – Day One
Question 10 (8 marks) (14 minutes)
Review Engagements
Westgate Electrical Services Ltd (WESL) began operations in November 2008; its first year-end
is October 31, 2009. George Murphy, the sole shareholder of WESL, has asked for your help in
preparing the annual financial statements. The bank that provided loans to increase the working
capital and to purchase a truck will be the major user of the WESL’s financial statements. The
bank has agreed that a review engagement will provide sufficient assurance.
George is a master electrician with twenty years of experience, but he has never run his own
business. Joan, his wife, does WESL’s bookkeeping on George’s home computer using an offthe-shelf accounting software. Joan is a nurse who has no bookkeeping experience.
Required:
a) Part A (4 marks)
Describe, with support, how you would apply analytical procedures in this review.
b) Part B (4 marks)
Describe the report that will be issued if you have no reservations at the completion of the
engagement.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 15
2009 CA Reciprocity Examination – Day One
Question 11 (8 marks) (14 minutes)
Date of the Auditor’s Report and Documentation
You have finished the audit of Jiffy Construction Ltd (JCL), a Canadian private company, and
your clean audit report is dated February 20, 2009. The release date of your report is March 5,
2009. The file documentation is substantially complete.
Required:
a) Part A (3 marks)
Under generally accepted auditing standards (GAAS) effective up to March 31, 2009,
explain the difference between the date of the auditor’s report and the report release date.
Describe the date by which you should have assembled a complete and final audit file.
b) Part B (5 marks)
Describe, with examples, the reasons that audit documentation may be changed after the
date described in Part A if no new audit procedures are undertaken. What would be the
impact on the audit documentation if you performed new audit procedures after the
documentation completion date?
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 16
2009 CA Reciprocity Examination – Day One
Question 12 (6 marks) (11 minutes)
Reservations in the Auditor’s Report
In each of the following unrelated situations, the auditor may have to modify the standard audit
opinion.
For each of Part A and B, discuss the appropriate changes to the standard audit opinion that
could be required.
Part A (2 marks)
Your client Charity Work (CW) is a not-for-profit entity with average annual revenues of
$750,000. The operating expenses are mainly funded by Private Foundation (PF) and fund
raising for capital expenditures is the responsibility of CW.
During the year, a benefactor donated land and a building to CW that were recorded at a
nominal value because PF provides only operating funds and is not interested in seeing
amortization expense reflected in the financial statements. The cost of an appraisal of the fair
value of the property would not be funded by PF.
Part B (4 marks)
Your client Children’s Club (CC) is a registered charity with a November 30 year-end.
Revenue sources include fundraising events, donations from the United Appeal (UA) and
fee-for-service revenue from the provincial government.
An important fundraising method used each year is CC’s October door-to-door fundraising
campaign. Local volunteers are randomly assigned to teams of two canvassers and provided
with appropriate identification; they are instructed to issue receipts for all donations in excess
of $5.00. The funds raised in the community have not exceeded the materiality level you set
in prior years’ audits.
Another source of funding for CC is UA. CC forbid you to confirm the funds receivable
from UA because the bookkeeper at UA is a volunteer and is inundated with these requests.
The funds are distributed each year in January, but the amounts are determined on the basis
of the results of certain programs run by the recipient organization; the funding
announcements are made on December 24 of each year.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 17
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%
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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%
2009 CA Reciprocity Examination – Day One
TABLE I
Page 18
13.58
14.29
14.99
15.68
16.35
17.01
17.66
18.29
18.91
19.52
16
17
18
19
20
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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
14.03
14.45
14.86
15.25
15.62
11.65
12.17
12.66
13.13
13.59
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
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
5.24
6.00
6.73
7.44
8.11
11
12
13
14
15
5.42
6.23
7.02
7.79
8.53
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
0.98
1.94
2.88
3.81
4.71
1
2
3
4
5
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
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
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
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
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
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
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
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
PRESENT VALUE OF AN ANNUITY OF $1 RECEIVED AT THE END OF EACH PERIOD
No. of
Periods
Received 2%
3%
4%
5%
6%
7%
8%
9% 10%
11% 12% 13%
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%
2009 CA Reciprocity Examination – Day One
TABLE II
Page 19
2009 CA Reciprocity Examination – Day Two
THE INSTITUTES/ORDRE OF CHARTERED ACCOUNTANTS IN CANADA
CA RECIPROCITY EXAMINATION
DAY TWO – 2009
(100 marks) (3 hours)
NOTES TO CANDIDATES:
1.
There are 8 questions and 17 pages in this examination (including the cover page and
the tables).
2.
DO NOT write your name on your examination envelope or answer papers. Use your
FOUR (4) DIGIT CANDIDATE NUMBER ONLY.
3.
To assist in budgeting time during the examination, the number of minutes available for
each question (calculated at approximately 1.8 minutes per mark) is shown at the
beginning of each question.
4.
Answers or parts of answers to examination questions will not be marked if they are
recorded on the question paper or on the back of your answer papers.
5.
It is recommended that you write your responses in ink and write on every other line.
6.
Two tables are attached to the examination paper. No other reference sources are
allowed.
************
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 20
2009 CA Reciprocity Examination – Day Two
SECTION A – TAXATION
Question 1 (10 marks) (18 minutes)
Sofia, age 42, has asked for your assistance in preparing her 2008 tax return. Her husband, who
prepares his own, reported net income of $62,000 for 2008. Sofia provided you with the
following information:
In 2008, Sofia earned a salary of $84,000 from which the following amounts were deducted:
Income Tax withheld
Registered Pension Plan (RPP) contributions
Donation to United Way, a registered charity
Canada Pension Plan premiums
Employment Insurance premiums
$25,000
5,000
1,000
2,049
711
$33,760
Sofia’s employer provided her with the following benefits in 2008:
a) Life insurance coverage equal to three times her salary; annual premium $3,000;
b) Private medical insurance coverage; annual premium $2,000;
c) A car for Sofia’s personal use for which Sofia pays the operating costs; annual car lease
payments $10,800; and
d) The employer’s contributions to Sofia’s RPP $10,000.
During 2008, Sofia purchased 1,000 shares of her employer’s company (a public corporation) at
$10 each under a stock-option program. At the time of purchase the shares had a market value of
$14 each. When the stock option was granted two years ago, the market value of each share
was $8. Sofia sold the 1,000 shares in November 2008 at $20 each.
Sofia purchased a $10,000 compound interest Canada Savings Bond on November 1, 2007, the
issue date. The bond bears interest at 4% compounded annually. Sofia will not receive any
interest income until the bond matures in 2012.
In 2008, Sofia received the following cash dividends from taxable Canadian corporations:
a) Eligible dividends
b) Non-eligible dividends
$4,000
3,000
Sofia’s two children, Liz, age 21, and Philip, age 16, are both in school. In 2008, Liz attended a
Canadian university for eight months as a full-time student, earned net income for tax purposes
of $4,000 and paid tuition fees of $5,400. In 2009, Philip attended a private secondary school
that cost $4,400 in tuition fees, and earned $500 from babysitting on weekends.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 21
2009 CA Reciprocity Examination – Day Two
Question 1 (10 marks) (continued)
Required:
Calculate Sofia’s net income, taxable income and federal income tax for 2008 and indicate which
items and amounts are not taxable and not deductible. Assume Sofia wishes to pay the minimum
amount of tax possible and, thus, will claim all possible tax credits in respect of the children.
Ignore minimum tax and provincial tax.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 22
2009 CA Reciprocity Examination – Day Two
Question 2 (15 marks) (27 minutes)
SWK Ltd. is a Canadian-controlled private corporation. The taxable income for its year-ended
December 31, 2008 has been correctly calculated below.
Income from retail operations
Taxable capital gains
Eligible dividends received from Canadian public companies
Interest on five-year bonds
Net income for tax purposes
Dividends
Net capital losses
Non-capital losses
$652,000
50,000
30,000
8,000
740,000
( 30,000)
( 6,000)
( 4,000)
Taxable income
$700,000
SWK Ltd. paid taxable dividends of $120,000 and tax-free capital dividends of $44,000 in 2008.
Dividends were not paid in the previous year.
At December 31, 2007, SWK Ltd. had the following tax account balances:
Non-capital losses
Net capital losses (incurred in 2004)
Refundable dividend tax on hand (RDTOH)
Dividend refund
General rate income pool (GRIP)
$ 4,000
6,000
9,000
Nil
50,000
SWK Ltd. owns 80% of the shares of New Ltd., a Canadian private corporation. For the year
ended December 31, 2008, New Ltd. claimed the small-business deduction on $20,000 of its
active business income. The taxable capital of the two corporations, combined, is below
$10,000,000. New Ltd. did not pay dividends in 2008.
Required:
Part A (7 marks)
Calculate Part I tax payable for SWK Ltd. for its year ended December 31, 2008.
Part B (5 marks)
Calculate the dividend refund for SWK Ltd. for its year ended December 31, 2008.
Part C (3 marks)
Calculate the general rate income pool (GRIP) balance for SWK Ltd. at December 31, 2008.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 23
2009 CA Reciprocity Examination – Day Two
Question 3 (25 marks) (45 minutes)
This question consists of five (5) independent unrelated parts; marks are provided for each
part.
Part A (6 marks)
On April 1, 2009, Salt Ltd. purchased 80% of the voting shares of Pepper Ltd. from an
unrelated person. At that time, Pepper Ltd. owned the following assets:
Inventory
Class 8 Furniture and equipment
Land
Class 1 Building
Cost
$100,000
50,000
200,000
400,000
Undepreciated
Capital Cost
$
–
30,000
–
380,000
Fair Market
Value
$ 95,000
20,000
300,000
450,000
Pepper Ltd.’s tax return for its year ended January 31, 2009 showed the following losses
available for carry forward to future years:
Non-capital loss
Net capital loss (incurred in 2005)
$10,000
20,000
Required:
Assume that the business carried on by Pepper Ltd. will be continued and that it will generate
sufficient taxable income in 2010 for Pepper Ltd. to utilize all available losses. Determine the
tax value for each of the above assets on April 1, 2009, and provide supporting explanations.
Part B (6 marks)
Larry owns 100% of the issued shares of Livelong Ltd. His wife, Susan, owns 100% of the
issued shares of Suzi Ltd.
Livelong Ltd. owns 48% of the shares of Xeres Ltd. while Suzi Ltd. owns 5% of the shares
of Xeres Ltd. The remaining 47% of the shares are owned by non-related parties.
Larry’s and Susan’s 32-year-old son Bobby owns 100% of the issued shares of Bovet Ltd.
Bobby’s cousin Ben and Bovet Ltd. each own 50% of the issued shares of Zoro Ltd.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 24
2009 CA Reciprocity Examination – Day Two
Question 3 (25 marks) (continued)
All of the corporations are Canadian-controlled private corporations and all of the issued
shares are common shares.
Required:
Identify and explain which of the corporations are associated corporations, connected
corporations, and affiliated persons, as defined in the Income Tax Act?
Part C (5 marks)
Vern is the president of Hawthorne Enterprises Inc. (HEI), a Canadian-controlled private
corporation with a November 30 year-end. On April 1, 2008, Vern received a $100,000
interest-free loan from HEI that he used to increase his ownership in HEI from 20% to 30%
with the purchase of new treasury shares. The loan is repayable in full after five years or
earlier if Vern ceases to be president of Hawthorne Enterprises Ltd.
Required:
Explain the tax consequences for Vern over the duration of the loan if the loan is received (1)
as a result of being a shareholder of HEI, and (2) as a result of being an employee of HEI.
Part D (3 marks)
A Ltd. is a public corporation with a July 31 year-end.
B Ltd. is a Canadian-controlled private corporation with an October 31 year-end. For its
2007 year-end, all of the income was eligible for the small business deduction.
C Ltd. is a Canadian-controlled private corporation with a May 30 year-end. Its 2007 taxable
income was $650,000. C Ltd. claimed the small business deduction in both 2007 and 2008.
Required:
For each of the above corporations, explain when the income tax return for the 2008 taxation
year is due and when any balance of tax owing is due.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 25
2009 CA Reciprocity Examination – Day Two
Question 3 (25 marks) (continued)
Part E (5 marks)
Stile & Rail Ltd. (SRL) is a Canadian-controlled private corporation. SRL’s federal tax
liability was $12,000 for 2007, $24,000 for 2008, and is expected to be $36,000 for 2009.
Federal tax instalments are calculated on formulas specific to instalment options that may be
available if certain conditions are met.
Required:
Explain (1) whether SRL is required to make federal tax instalments for 2009; (2) the options
available to SRL and the conditions that it must meet to elect a given option, and (3) the
amounts and timing of instalments under each option (show all calculations).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 26
2009 CA Reciprocity Examination – Day Two
SECTION B – LAW
Question 4 (8 marks) (15 minutes)
The Blue Star Hotel and Resort is a popular destination for weddings and summer corporate
events. One of the main attractions is an outdoor cooking demonstration where the chef prepares
the Blue Star flambé dessert. For the purpose of preparing this dish, the hotel places a large gas
powered barbeque with a custom stovetop on the patio. Nothing else is erected on the patio to
surround the barbeque. The three largest banquet rooms have access to this section of the patio
so the patio can become quite crowded depending on the number of ongoing events on a
particular evening.
To create the Blue Star flambé, the chef cooks several portions of fruit on the barbeque, pours a
large quantity of alcohol over the dessert and lights it on fire to create a spectacular display of
flames. Since the hotel is normally very busy, there are sometimes not enough employees to
help manage this demonstration. The banquet manager may stop by occasionally throughout the
evening to supervise, but normally the chef is the only hotel employee at the barbeque. In such
circumstances, each guest is asked to approach the barbeque to pick up his or her serving of the
Blue Star flambé dessert.
On one particularly busy evening when there were three wedding banquets to serve, there was a
long line of guests and some were standing very close to the barbeque. As the chef created the
spectacular flambé effect, a sudden gust of wind went through the patio and the flame was blown
onto Mary and Daniel who were standing closest to the barbeque: their clothes and hair caught
on fire. By the time someone retrieved the fire extinguisher from inside one of the banquet
rooms, Mary and Daniel had suffered serious burns.
In the panic that ensued, many of the other guests ran back into the banquet rooms. Alison, an
elderly lady who was standing in line, was accidentally knocked over by some of the guests. She
suffered a broken hip and was hospitalized.
Required:
Prepare a memorandum discussing the rights and liabilities of the parties involved in this
situation. Your memorandum should clearly identify the various defendants and discuss in detail
what would have to be proven, along with any defences that could be put forward.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 27
2009 CA Reciprocity Examination – Day Two
Question 5 (8 marks) (14 minutes)
Doug owns a large farm on which he grows flowers that he sells wholesale to a variety of flower
markets and florists in Toronto. On July 15, 2009, Fresh Flower Market called Doug and offered
to purchase 5,000 white roses from him for a fixed price. The roses were needed for a wedding
on August 15, 2009. Doug told the owner of the Fresh Flower Market that the price was fine but
he did not know if he would have enough roses for the August 15, 2009 wedding. He told Fresh
Flower Market he could guarantee 2,500 white roses and that he would confirm in two weeks if
he could supply an additional 2,500 white roses. The owner of Fresh Flower Market said “ok”
and hung up the phone.
A few days later, Doug learned that a number of flower farms had gone bankrupt; that the
demand for white roses had significantly increased this year; and that the price for white roses
had followed the demand. The going price was significantly higher than the amount offered by
Fresh Flower Market. Doug went on buying the inventory of a few of the local bankrupt flower
farms from the receiver and figured that he could have 8,000 white roses by the middle of
August. He promptly sold all 8,000 of them at three times the price offered by Fresh Flower
Market to Tim, a florist in Toronto who needed them for a celebrity event on August 14, 2009.
On July 30, Fresh Flower Market called Doug to find out if he could supply the 5,000 white
roses it needed for the August 15, 2009 wedding. Doug refused to sell any white roses to Fresh
Flower Market and told the owner he had already sold them to another florist.
Fresh Flower Market decided to commence a legal action against Doug.
Required:
Prepare a memorandum discussing the rights and liabilities of the parties involved in this
situation. Clearly identify the various defendants, the nature of the negotiations that went on
between them, and discuss in detail what would have to be proven and any defences that could
be put forward.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 28
2009 CA Reciprocity Examination – Day Two
Question 6 (4 marks) (7 minutes)
The MacDonald Business Centre (MBC) purchased a high production photocopier from a local
distributor. The owner of MBC was impressed with the machine’s ability to produce up to 250,000
copies a day as stated on an ad located on the distributor’s website. However, after the photocopier
was purchased and installed at MBC, the owner was dismayed to find out that after only 100,000
copies per day, the photocopier would overheat and shut down. Several complaints were sent to the
distributor. One of the questions the distributor asked MBC’s owner was whether MBC was
running the machine in three 8-hour shifts or just one. MBC’s owner advised the distributor that
MBC was only running one shift.
Required:
Prepare a memorandum outlining the legal contractual issues and discuss the strength of MBC’s
case against the distributor and possible remedies.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 29
2009 CA Reciprocity Examination – Day Two
SECTION C – RULES OF PROFESSIONAL CONDUCT
Question 7 (27 marks) (49 minutes)
Required:
In each of the following unrelated situations, Rules of Professional Conduct may have been
breached or inappropriately applied.
For each of Part A, B, C, and D identify and discuss the relevant Rules of Professional Conduct
and Council Interpretations along with related guidelines, which should have guided the actions
of the involved CA(s) or CA firm, or both.
Part A (5 marks) (9 minutes)
Hugh Bischof, CA, is the corporate controller for Kinter Manufacturing Ltd. (Kinter), a fastgrowing private company providing automotive parts to retailers. Due to rapid growth, Kinter's
working capital needs have increased proportionately, requiring Kinter to obtain a bank loan with
an audit requirement and restrictive debt covenants that impose a maximum debt-to-equity ratio
of 2:1. To meet this covenant requirement for the year ended June 30, 2009, Bischof recorded a
sales invoice of $100,000 to a related company on June 28, 2009. Bischof subsequently recorded
a $100,000 return of goods from the related company in July 2009.
Worthington Chartered Accountants (Worthington) has audited Kinter since its audit requirement
began in fiscal 2008. Bischof was the Manager on Kinter's first audit for the June 30, 2008 yearend before he joined Kinter in December 2008. Amie Ciampa, CA, took over as Manager for the
2009 audit of Kinter. Bischof and Ciampa started at Worthington together in 2002 and became
close friends as they went through the CA qualifying exams together. Bischof convinced
Ciampa that Kinter could not afford to be in violation of its debt covenants. Ciampa concluded
that the $100,000 sale recorded on June 28, 2009 was not material to the audit and excluded any
mention of the sale in the audit file.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 30
2009 CA Reciprocity Examination – Day Two
Question 7 (continued)
Part B (6 marks) (11 minutes)
Several months ago, Preston Breyer, CA, started his own CA firm after spending four years in
Assurance with a national firm where he articled to obtain his CA. He incorporated the business
as Breyer Professional Corporation and practices under the name of Breyer & Kearl Chartered
Accountants (B&K). Sharron Kearl is Breyer's wife, a non-CA, who does the firm's billing,
advertising and client communications. To avoid losses during the start-up phase, B&K had no
employees other than Breyer and Kearl.
To build the practice, B&K advertizes itself as a ‘one-stop shop’ for all client needs: assurance
services, accounting assistance, business valuation, corporate finance, tax planning and
compliance, general business consulting, financial and estate planning, and succession planning.
Breyer believes that clients are attracted by the ability of one accounting firm to provide all
services. B&K has been quite successful so far in obtaining clients. Breyer attributes that
success to an aggressive mail and telephone campaign that targeted lucrative potential clients by
touting B&K as the best CA firm in the city. Breyer believes his perseverance during initial
rejections eventually paid off. He also believes that providing a binding price for audit services
in his mail campaign reduced cost uncertainty for clients.
B&K pays Kearl $90,000 per year for her work that varies from week to week, but averages
approximately 10 hours per week.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 31
2009 CA Reciprocity Examination – Day Two
Question 7 (continued)
Part C (9 marks) (16 minutes)
Landsman Zauner (LZ) Chartered Accountants is a large local firm with 35 staff, of whom
sixteen are CAs, ten are CA students, and nine are staff members. LZ has grown rapidly over the
past three years due to its reputation for good service at a reasonable price. However, due to the
rapid growth, LZ constantly finds itself very short of professional staff to complete its
engagements and is running out of space at its current location. To reclaim the needed working
space, LZ recently decided to keep only the current and prior year assurance files; all other prior
year files were destroyed.
LZ assigned Sofia Cortinas to the audit engagement of Portwood Lumber, a local multi-location
building materials supplier. Sofia has been a staff accountant with LZ for one year, and was
chosen for this engagement because the owner is a friend of her family. Portwood Lumber lent
Sofia $60,000 to complete her university education. The loan bears interest at prime plus 3%
and payable over a ten-year period following her graduation. Sofia made her first year of
payments on time. The loan has not been reported to LZ since LZ has no policy in place
requiring staff to report borrowing from clients. Sofia felt pride that she was able to complete
the field work in one week and within one month of year-end. To increase her efficiency, she
simply rolled forward all of the audit planning documentation from the previous year's file.
Further, she avoided sending accounts receivable confirmations because she did not think she
would get them all back within her week of field work. All accounts receivable were solid with
construction companies that had good reputations for prompt payment.
Claudine Sheckler, the LZ engagement partner, was overwhelmed with client files that required
review and sign-off around the same time the Portwood Lumber engagement did. Consequently,
Claudine was unable to approve the release of the financial statements until three months after
year-end. Portwood Lumber's banking agreement requires that financial statements be filed
within 60 days of year-end. Further, Claudine was unable to find time to accommodate the
Institute's request to visit LZ for a practice inspection.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 32
2009 CA Reciprocity Examination – Day Two
Question 7 (continued)
Part D (7 marks) (13 minutes)
Agile Technologies Inc. (Agile) develops and markets project management software for mid-size
industrial companies. It is rolling out its next generation of software that promises substantial
savings over previous versions and other competing products. Due to Agile's success,
Wheatsheaf Inc. (Wheatsheaf), the former dominant project management software firm, has been
steadily losing market share.
Milliken Chartered Accountants (Milliken), a full-service accounting firm, recently took over as
Agile's audit firm; the former audit firm, Whiteside Chartered Accountants (Whiteside), had
resigned when Agile's Chairman of the Board was replaced. Milliken contacted Whiteside to
inquire whether any reasons existed that Milliken should not accept Agile's audit engagement;
however, Whiteside did not respond. Further, Whiteside did not respond to Agile's request that
Milliken be permitted access to the prior year audit files. Milliken has nearly completed this
year's audit, with financial statements expected to be released in two weeks.
Over the past several years, Milliken has been trying to build up its corporate finance practice by
engaging a professional marketing firm to market and sell Milliken’s services in exchange for a
5% commission that is paid when an engagement letter is signed. Through this firm, Milliken
recently obtained an engagement to represent Wheatsheaf in its attempt to purchase Agile. To
avoid any conflict, Milliken ensured that no Agile audit staff was involved in the Wheatsheaf
engagement and documented potential independence problems. Wheatsheaf promised that
Milliken would be appointed as the consolidated Wheatsheaf-Agile auditor if its purchase is
successful, and will be paid a $75,000 success fee. During audit work at Agile, Milliken became
aware of a pending copyright infringement lawsuit that targeted Agile's core software. To
properly assess Agile's acquisition value, Milliken included the potential effect of the lawsuit in
its analysis of Agile's value for Wheatsheaf.
Agile wanted Milliken's assistance in assessing whether Wheatsheaf's offer was adequate and a
separate engagement letter was signed for the value assessment.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 33
2009 CA Reciprocity Examination – Day Two
Question 8 (3 marks) (5 minutes)
Rule of Professional Conduct 208, “Confidentiality of Information”, requires that members
refrain from disclosing confidential client information, but situations may arise where members
must disclose confidential information.
Required:
Briefly describe situations where such disclosure does not violate the Rules of Professional
Conduct.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 34
2009 CA Reciprocity Examination – Day Two
TABLE I
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
(
1 + Rate of Return
2
+ Rate of Return
)
)
MAXIMUM
CAPITAL COST ALLOWANCE RATES
FOR SELECTED CLASSES
Class 1 .................................................................................. 4%
Class 8 ................................................................................ 20%
Class 9 ................................................................................ 25%
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 29 .............................................................................. 50% straight-line
Class 39 .............................................................................. 25%
Class 43 .............................................................................. 30%
Class 44 .............................................................................. 25%
Class 45 .............................................................................. 45%
Class 50 .............................................................................. 55% **
*
Increased CCA rates for certain assets acquired after March 18, 2007:
 Separate Class 1 manufacturing building not used prior to March 19, 2007 10%
 Separate Class 1 non-residential building not used prior to March 19, 2007 6%
** 100% no half-year rule for computers and systems software acquired from January 28, 2009 until January 31,
2011.
SELECTED PRESCRIBED AUTOMOBILE AMOUNTS
Maximum depreciable cost - Class 10.1
Maximum monthly deductible lease cost
Maximum monthly deductible interest cost
Operating cost benefit - employee
Non-taxable car allowance benefit limits
- first 5,000 km
- balance
$30,000 + GST
$800 + GST
$300
24¢ per kilometre of personal use
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
52¢ per kilometre
46¢ per kilometre
Page 35
2009 CA Reciprocity Examination – Day Two
TABLE II
INDIVIDUAL FEDERAL INCOME TAX RATES
Taxable Income
Tax
$ 40,726 or less
$ 40,727 to $ 81,452
$ 81,453 to $126,264
$126,265 or more
15%
$ 6,109 + 22% on next $40,726
$15,069 + 26% on next $44,812
$26,720 + 29% on remainder
SELECTED NON-REFUNDABLE TAX CREDITS
PERMITTED TO INDIVIDUALS
FOR PURPOSES OF COMPUTING INCOME TAX
The tax credits are 15% of the following amounts:
Basic personal amount .......................................................................
Spouse or common-law partner amount ............................................
Net income threshold for spouse or common-law partner amount ....
Child under 18 ....................................................................................
Age 65 or over in the year ..................................................................
Disability amount ...............................................................................
Infirm dependants who reach 18 in the year ......................................
Children’s fitness credit .....................................................................
Canada employment amount .............................................................
Education and textbook credit per month – full-time ........................
– part-time ..........................................................................................
Child tax benefit ................................................................................
GST credit ..........................................................................................
OAS clawback....................................................................................
Medical expense – 3% of net income ceiling.....................................
Amount
$ 10,320
10,320
NIL
2,089
6,408
7,196
4,198
up to
500
1,044
465
140
Threshold
$32,312
5,956
38,832
32,312
66,335
2,011
CORPORATE FEDERAL INCOME TAX RATE
The tax payable by a corporation on its taxable income under Part I of the Income Tax Act
is 38% before any additions and/or any deductions.
PRESCRIBED INTEREST RATES
Year
Jan. 1 - Mar. 31
Apr. 1 - June 30 July 1 - Sept. 30 Oct. 1 - Dec. 31
2009
4
3
3
3
2008
6
6
5
5
2007
7
7
7
7
2006
5
6
6
7
2005
5
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.
**********
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 36
2009 CA Reciprocity Examination – Approaches to Solutions
Introduction
The solutions outlined in the following material represent comprehensive approaches to
questions and are based on the full range of available marks. They do not represent responses
that candidates could realistically expect to produce in the prescribed time limits. The solutions
provide examples of how issues can be dealt with and do not represent the only acceptable
responses.
References to sections of the CICA Handbook, the Income Tax Act and the Rules of Professional
Conduct have been included solely to assist candidates in their review.
Candidates are cautioned when using this material that the examinations and the approaches to
solutions reflect standards in effect as at March 31, 2009 and are not updated for subsequent
changes.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 37
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 1 (8 marks) (14 minutes)
i. Revenue Recognition (2 marks)
The correct answer is C. According to CICA HB EIC-141, since Freda Limited does not
require the customer to commit to a fixed payments schedule at the time of the deposit, no
sales occur at that time. As a result, the risks and rewards of ownership are still with the
seller and the earnings process is not complete. There is no evidence that a sale has occurred
until the customer returns and agrees to complete the sale. At this point, delivery occurs and
the risks and rewards pass.
ii. Leases (2 marks)
The correct answer is C. According to CICA HB s. 3065.03 (o), the lease term is the fixed
non-cancellable period plus any renewal/extension periods where there is an inducement to
renew or where renewal is beyond the control of the lessee. Periods in answers A and D are
correct but not as comprehensive as in answer C; periods in answer B are not all correct.
iii. Fraud (2 marks)
The correct response is A. According to CICA HB s. 5135.060, the auditor should normally
presume that there are risks of fraud in revenue recognition and should identify the types of
transactions or revenues more susceptible to fraud. Answers B and C are not correct; the fact
that Galliano Limited has been charged with fraud in the past, while adding to the risk, is not
the determining factor in presuming risk of fraud in revenue recognition. Answer D is not
correct; the reorganization of the governance structure, while lowering the risk, does not
change the presumption of risk of fraud.
iv. Materiality (2 marks)
The correct answer is B. According to CICA HB s. 5142.09, “[m]ateriality is initially
determined in the context of the financial statements taken as a whole. Because individual
financial statements are interrelated, for planning purposes the auditor ordinarily considers
materiality in terms of the smallest aggregate level of misstatement that could be considered
material to any one of the financial statements. For example, if the auditor believes that
misstatements totalling $100,000 would have a material effect on income but that such
misstatements would have to total $200,000 to materially affect financial position, he or she
would design auditing procedures to detect misstatements that in total exceed $100,000.1”
1
CICA HB s. 5142.09 italics added.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 38
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 2 (8 marks) (14 minutes)
Financial Instruments, Recognition and Measurement (CICA HB s. 3855)
Part A – Classification, Initial and Subsequent Measurements and Recording (6 marks)
According to CICA HB s. 3855, the bonds may be classified as



held for trading;
available for sale; or
held to maturity.
The common shares may be classified as


held for trading; or
available for sale.
Those classified as held for trading would be continuously re-measured at fair value with gains
and losses recognized in net income; those classified as available for sale would be continuously
re-measured at fair value with gains and losses recognized in other comprehensive income; and
those held to maturity investments would be measured at amortized cost with any gains or losses
on disposal recognized when disposed of.
Part B – Recording (2 marks)
If the investment in Ocean Ltd.’s shares is classified as held for trading, the investment would
already be measured at fair value with losses recognized in net income and no additional
consideration would be needed. However, if this investment is classified as available for sale,
Titan Inc. must determine whether there is objective evidence of impairment and then determine
whether the decline in value is other than temporary. Titan should look at observable data or
factors that could indicate impairment; for example:



Significant financial difficulty Ocean Ltd. may be facing, such as possible bankruptcy or
court protection against creditors;
Breaches of contract such as defaulting on a loan or interest payment; and
A prolonged decline in the fair value of the investment below its cost.
A single factor on its own may not be sufficient evidence of impairment; all factors should be
considered in relation to each other and to the economic environment in which the investee
operates.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 39
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 3 (8 marks) (14 minutes)
Related Party and Non-Monetary Transactions (CICA HB s. 3840 and s. 3831)
Part A – Nature of the Transaction (3 marks)
According to the CICA Handbook, control exists when an entity has the continuing ability to
determine the strategic policies of another entity on its own (operating, investing and financing).
With ownership of 90%, Herten Ltd. (HL) has control over Sensen Innovations Ltd. (SIL).
As a result, the exchange of the buildings between HL and SIL are related-party transactions.
The exchange of the buildings occurred without any cash exchange because the buildings had a
value of $1,000,000 each. As a result, the exchange is a non-monetary transaction.
Part B – Recording (5 marks)
Related-party transactions should be measured at the carrying amounts and differences should be
debited or credited to equity unless the transaction is in the normal course of business; since
neither of HL nor SIL are in the real estate business, one must determine if the non-monetary
related-party transaction has commercial substance, that is, if the expected cash flows to be
derived from the new asset are significantly changed as a result of the transaction.
Assuming that there is no commercial substance to this exchange, HL will record the acquired
building at SIL’s book value; the difference shall be credited or debited to equity (retained
earnings or contributed surplus). According to CICA HB s. 3840.17, SIL will apply the same
treatment.
HL
Building (new)
Retained earnings
Building (old)
$200,000
300,000
Building (new)
Contributed surplus
Building (old)
$500,000
$500,000
SIL
$300,000
200,000
According to CICA HB s. 3840.09, any tax consequences should be taken into account when
measuring the carrying amount.
The transaction would be eliminated in the consolidated financial statements, with the noncontrolling interest being credited with its share in the contributed surplus.
(Evaluators’ comments: The Evaluators also considered a line of arguments supporting other
treatments).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 40
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 4 (15 marks) (27 minutes)
Inventories, Intangible Assets, and Accounting changes (CICA HB s. 3031, 3064, and 1506)
Part A (7 marks)
Changes Required to the Inventories Accounting Policy
Measurement of Inventories
Winery Inc. (WI) must change its definition of market when measuring inventories at the lower
of cost and market; according to CICA HB s. 3031, the replacement cost is no longer allowed as
a definition of market. The use of the net realizable value (NRV) is now required. However,
there are circumstances where the use of the replacement cost is allowed as a surrogate to the net
realizable value (e.g., cost of materials used in the production of inventories).
One could argue that CICA HB s. 3031 does not apply to WI because it derives its revenue from
agricultural products. However, similar companies in the winery industry have adopted this HB
section.
Cost of Inventories
The cost of inventories shall include the cost of purchase, the cost of conversion and other costs
needed to bring the inventories to the needed location and condition. In the case of wine
production, most costs are costs that require allocation. Unless purchased from another grower,
the grapes used to produce the juice are harvested from a long-lived asset - the vine plants.
Conversion costs include direct costs, such as labour and supplies, and overhead costs.
While, variable overhead is not difficult to apply because it varies with the level of production,
fixed overhead will require estimating the normal production capacity levels. With excess
capacity of 40%, allocation of fixed overhead should be based on 60% for the time being unless
normal capacity is lower.
Cost Formula
No change in cost formula is required because the last-in, last-out (LILO) is equivalent to the
first-in, first-out (FIFO), which is an acceptable cost formula under CICA HB s. 3031. WI also
has the choice of using the weighted average or the specific cost applied to each batch.
Depending on the processes involved in crafting wines in a given year, a combination of specific
cost and average cost could be more reliable and relevant than FIFO (or LILO); if it is the case, a
change in accounting policy would be warranted.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 41
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 4 (continued)
Accounting Change
CICA HB s. 3031 is a new primary source of GAAP (CICA HB s. 1506) that requires change to
the measurement of inventories as described above. Accordingly, the opening balance of
inventories shall be adjusted to reflect the balance as if the new measurement policy had been in
effect then, with either an adjustment to the opening balance of retained earnings and no
restatement of prior year periods, or retrospectively with restatements of prior periods. The
election depends on WI’s ability to obtain reliable information at a reasonable cost.
Changes Required to Note Disclosure
Should WI change its cost formula from LILO to the weighted average or specific cost
(voluntary change), it will have to disclose the nature of, and reasons for, the change; the amount
of the adjustment for the current and comparative years; and details as to the reasons for a catchup adjustment when retrospective application is not practicable.
The change in the application of the measurement method (NRV) requires similar disclosure as a
voluntary change in accounting policy (CICA HB s. 3031.40A and 1506.28).
Changes Required to Other Accounts
Costs related to the excess capacity (40% or more) shall be expensed in the period. If WI matures
its wines over a long period of time, cost of inventories could also include the cost of borrowings
(CICA HB s. 3031.17A).
Part B (8 marks)
Rejected Merlot Batch
The value of the Merlot batch rejected by the Vintage Label Association may require adjustment
if its current cost of $1 million is not recoverable as at January 31, 2009. WI must determine the
value of grape-related products that can be derived from this batch using the NRV and taking
into account the current stage of production and costs required to complete the grape-related
products.
It should be determined if the rejection of the Merlot batch by VLA prevents WI from bottling
without the VLA label. This option will require an assessment of the NRV of the current value of
the Merlot batch. Any adjustment should be accounted for as a subsequent event for conditions
existing at year-end.
Any reduction in the value of the Merlot batch will be written off and expensed.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 42
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 4 (continued)
Fruit Wine Licence
Depending on materiality, the amount paid to obtain the fruit wine licence could be capitalized or
expensed; if it is capitalized, this cost should be amortized over the validity period of two years.
One can question whether a portion of the licence cost has an indefinite life because the licence
is renewable indefinitely; if it is determined to be the case, the other portion of the licence cost
would be a maintenance cost that should be expensed over the validity period, or immediately if
not material.



Any capitalized portion should be tested annually for impairment, and any impairment
written off as an expense.
Should WI cease to produce and distribute fruit wines, or should it fail to renew the
licence, the carrying amount of the capitalized licence should be written off.
WI may opt out of the annual impairment test under differential reporting.
R&D Costs – Plant Breeders Right
According to CICA HB s. 3064.37, the costs related to the research, the experimentation, and the
cloning that lead to the new variety should be expensed.
However, it is difficult to determine when the research phase is completed and the development
phase begins.
It could be argued that the granting of the Plant Breeders Right is the differentiation point
between research and development. At that point in time, WI has evidence of a completed
product that can be used or sold, of its technical feasibility and of WI’s ability to use or sell the
right.
However, the differentiation point may arguably occur earlier; at the time of the application for
the right, the product is quite well defined and tested and the development phase must be almost
completed. In addition, there may be varieties that are researched and developed that may never
be granted a similar right, yet these new varieties could have commercial value and be exploited
profitably by WI.
In order to capitalize the costs of the development activities, WI should determine if it intends to
continue developing the vine shoots and if it has the financial and technical resources to
complete the development activities (CICA HB s. 3064.40).
(Evaluators’ comments: The Evaluators also considered a line of arguments supporting other
treatments).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 43
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 5 (8 marks) (15 minutes)
Leases (CICA HB s. 3065 and EIC-25)
Part A – Lecture Notes – PCI’s Perspective (6 marks)
To properly account for this transaction, one must determine whether the benefits and risks of
ownership of the leased property were transferred to PCI when PCI decided to lease back a
portion of the building it previously owned and sold to FI. The benefits are viewed as the ability
to exclusively use the economic resource during its economic life; the risks are viewed as the
losses that could arise as a result of obsolescence, uninsured damage to the property, inability to
use the property to its full capacity.
Since PCI does not lease back all of the property, one must determine if PCI retains more than a
minor portion of the property sold. The CICA HB EIC-25 indicates that if the present value (PV)
of the minimum lease payments as defined in CICA HB s. 3065 represents 10 percent or less
than the fair value (FV) of the asset sold, PCI would be presumed to have retained only a minor
portion of the use of the asset.
The PV of the minimum lease payments is $3,380,000 (500,000 + 500,000 9|10%), which
represents 33.8% of the FV of the asset. In this case, PCI is presumed to have retained more than
a minor portion of the use of the asset. As a result, not all the gain on the sale of the property can
be recognized.
The leaseback of a portion of the property qualifies as a capital lease because the lease term is
greater than 75% of the remaining economic life of the leased-back portion. The leaseback also
qualifies as a capital lease because the PV of the minimum lease payments is equal to or greater
than 90% of the FV of the leased property at the inception of the lease.
Actually, the PV of the minimum lease payments is larger than the proportionate FV of the
building, assuming that all floors have the same commercial value. It is not possible to determine
if this assumption is correct, given that there is insufficient information about the relative
commercial value of each floor; as well, there is no information about the value that should have
been assigned to the land and the building.
The other criteria regarding the transfer of the benefits and risks of the leased property do not
apply in this situation: the reasonable assurance that the property title will pass to the lessee at
the end of the lease term, because of the existence of either an automatic transfer of the title or
the existence of a purchase option at a price so low that the exercise of the option is reasonably
assured at the inception of the lease.
According to CICA HB s. 3065.19, the contingent payment of ½ % of PCI’s profit should not be
included in the minimum lease payments; it should be expensed as incurred.
According to CICA HB EIC-25, the gain on the sale of the property should be deferred to the
extent that more than a minor portion of the sold property is retained.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 44
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 5 (continued)
Gain on the sale of the property:
Sales price
Carrying amount:
Gain
$10,000,000
2,000,000
$8,000,000
Gain to recognize immediately
Gain
PV of minimum lease payments:
Gain to recognize immediately
$8,000,000
3,380,000
$4,620,000
CICA HB s. 3065 and EIC-25 require that the deferred gain be amortized in proportion to the
leased asset over the lease term. If a portion of the minimum lease payments (hence the leased
asset) is attributable to leased land, the gain should be apportioned between the land and the
building, and the deferred gain related to the land should be amortized over the lease term on a
straight-line basis.
Part B – Lecture Notes – FI’s Perspective (2 marks)
For FI (the current owner of the building and the lessor), the criteria for determining if the
benefits and risks of the leased property have been transferred to the lessee are the same criteria
as for the lessee, but with the addition of two other criteria that tie into CICA HB s. 3400 on
revenue recognition.
1. The credit risk associated with the lease is normal when compared to the collection risk
related to similar accounts receivable; and
2. The amounts of any unreimbursable costs that are likely to be incurred by the lessor
under the lease can be reasonably estimated.
Since FI is not a manufacturer or builder, the lease should be classified as a direct financing
lease; essentially the business in which the lessor is engaged determines the classification and the
treatment of some initial lease costs.
FI will use the interest rate implicit in the lease to capitalize the net amount receivable from PCI
(net investment in a lease) and to calculate the interest income to be recognized annually from
this “loan.”
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 45
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 6 (7 marks) (13 minutes)
Accounting Changes and Income Taxes (CICA HB s. 1506 and 3465)
CICA HB s. 3465 requires the use of the Future Income Tax Assets and Liabilities (FITA/L)
approach by all publicly accountable entities. Bottler Inc. (BI) could currently qualify for the use
of the Taxes Payable (TP) approach (CICA HB s. 3465.105), under differential reporting
provided that all three owners unanimously consent to the use of the provisions in CICA HB s.
1300.
Under the TP approach, differences between the carrying amounts and tax bases are not
accounted for (under the FITA/L approach, they are).
However, when BI goes public all balances will have to be restated as if differential reporting
provisions had not been used (HB s. 1300.18). It is recommended that all the relevant
information related to FITA/L be kept to ease the restatement at the time of change.
2009 Loss for Tax Purposes
The $2 million loss for tax purposes could be carried back against the small profits BI realized
over the past 3 years; the remainder should be carried forward to future years.
Under both the FITA/L and the TP approaches, the tax benefits arising from the carry back
should be recorded as amounts receivable in the current year. However, under the TP approach,
the potential benefits that could arise from the loss carry-forward cannot be reported in 2009,
while under the FITA/L approach, they can be recorded provided that the benefits are more
likely than not to accrue to BI.
 In determining whether the benefits are more likely than not to accrue, BI should
consider the new product launch, the BPA-free bottle advertizing campaign, the size of
the remaining loss (after carry backs), etc.
 If it is determined that the benefits are more likely than not to accrue to BI, a total benefit
$700,000 should be recorded, a portion as an amount receivable and the balance as a
Future Income Tax Asset (FITA).
 The FITA related to the unused tax loss will subsequently be adjusted to reflect changes
in enacted income tax rates, changes in the ability of BI to realize the benefit in the
future (write-up or down).
Capital Assets
Under the FITA/L approach, a temporary difference of $200,000 exists that translates into a
Future Income Tax Liability (FITL) of $70,000 ($200,000 × 35%).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 46
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 6 (continued)
Development costs
Under the FITA/L approach, a temporary difference of $500,000 exists that translates into a
FITL of $175,000 ($500,000 × 35%).
Classification
The FITA or the FITL should be classified according to the balance sheet items (asset or
liability) they relate to.
Other criteria
While it appears that BI may benefit from the use of the FITA/L approach for purposes of the
debt-to-equity ratio, the benefit may disappear if the benefits arising from the tax loss carryforward were not, or ceased to be, more-likely-than-not.
 If it is the case, BI could amend its tax return by not claiming CCA and a deduction for
development costs; as a result, the tax bases of the capital assets and the development
costs would be closer to their carrying amounts, hence reducing the FITL on BI’s balance
sheet.
Other Accounting Issues – Change in Accounting Policy
CICA HB s. 3061 requires that amortization be recognized in a rational and systematic manner
that is related to the nature of assets and its use by the entity.
To be acceptable under current GAAP, BI’s change in accounting policy must result in more
relevant and reliable information about BI’s use of the capital assets.
In this case, CICA HB s. 1506.19(b) requires that the effect of the change be applied
retrospectively with adjustments to prior years’ financial statements presented as comparative,
provided that it is practicable to obtain the needed information.
Recommendation
It is recommended that BI use the TP approach to record its taxes until it has returned to
profitability and has firmed up its plans to go public. This will help BI meet the debt-to-equity
ratio requirement imposed by the bank given the uncertainty about BI’s ability to materialize the
benefits from the tax loss carry-forward.
(Evaluators’ comments: The Evaluators also considered a line of arguments supporting other
treatments).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 47
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 7 (8 marks) (15 minutes)
Audit of Fair Values and Disclosures (HB s. 5306)
Part A – Management’s Responsibilities and Challenges (3 marks)
According to CICA HB s. 5306.06, management is responsible for estimating fair values and
preparing related disclosures in the financial statements. Management must establish accounting
and reporting processes for determining fair values, select the valuation methods and formulate
the assumptions that are most appropriate in the circumstances. Management must also make
sure that the fair value measurements are in accordance with GAAP.
The challenges that management faces include the selection of appropriate valuation methods
and the formulation of the significant assumptions about future cash flow, future conditions, and
transactions, whose outcome are uncertain at the present time. The availability of observable
market information in Kleinen Inc.’s (KI) case and the trade-off of cost over the benefit of the
information are other challenges (inherent in any estimation process).
Part B – The Auditor’s Responsibilities and Challenges (5 marks)
According to CICA HB s. 5306.04 and .66, the auditor should obtain sufficient appropriate audit
evidence that fair value measurements and disclosures are in accordance with GAAP, under the
presumption that KI is a going concern.
While the auditor is not responsible for predicting future conditions, the auditor’s consideration
of management’s assumptions should be based on the information available at the time of the
audit (CICA HB s. 5306.07).
Challenges for the auditor include evaluating the assumptions that market place participants
would use in the absence of observable market prices as in KI’s situation. Some of the challenges
are:








understanding the valuation processes used by management, especially when they are
complex;
estimating the risk of material misstatement at the assertion level given the selected
valuation process;
determining the appropriateness of the valuation processes (assumptions, method, data);
determining the appropriateness of the fair value measurements and disclosure;
developing independent fair value estimates for corroborative purposes, whether or not
management's assumptions are used;
evaluating management’s intent and ability to carry out assumed courses of action;
evaluating consistent application of the valuation methods/processes used by KI; and
considering subsequent events.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 48
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 7 (continued)
The auditor may not need to hire a specialist if he or she is sufficiently skilled and
knowledgeable to plan and perform the audit procedures related to the fair value measurements;
however, if a specialist is used, the auditor must determine if the specialist’s understanding of the
assumptions, valuation processes/methods, and fair value measurements are consistent with that
of management and the requirement of GAAP, for purposes of determining the extent of his or
her reliance on such work.
(Evaluators’ comments: The Evaluators also considered different examples of challenges for
both management and the auditor).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 49
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 8 (8 marks) (15 minutes)
Auditor’s Responsibility to Consider Fraud (CICA HB s. 5135)
Part A – Difference Between Fraud and Error (4 marks)
Errors are unintentional misstatements in the financial statements (CICA HB s. 5135.005); for
example, the omission of an amount, an incorrect estimate arising from misinterpreting facts, or
an incorrect application of an accounting principle related to measurement or recognition.
Fraud is an intentional act perpetrated by one or more individuals at various levels in an entity’s
hierarchy or outside the entity, that involves the use of deception to obtain an unjust or illegal
advantage (CICA HB s. 5135.006).
The auditor is mainly concerned with fraud that causes a material misstatement in the financial
statements. The auditor does not make legal determinations of whether fraud has actually
occurred.
CICA HB s. 5135 distinguishes between two types of fraud: fraudulent financial reporting and
misappropriation of assets.
Fraudulent financial reporting includes manipulation, falsification or alteration of accounting
records, and misapplication of accounting principles related to the recording, the classification,
the presentation and the disclosure of transactions.
Typically, fraudulent financial reporting requires management to override controls that may
otherwise appear to function effectively throughout a period. The most common example is the
recording of fictitious journal entries around year-end to manipulate operating results.
More subtle ways of overriding controls would be the hiding of facts that would affect the
amounts at which certain transactions are recorded, or inappropriate adjustments to assumptions
related to estimates. In this latter case, however, intent is often difficult to determine.
Misappropriation of assets relates to actual theft of assets and is often accompanied by false or
altered documents that help conceal the theft of assets. Misappropriation can be perpetrated by
employees at all levels.
For example, a common way to embezzle cash is the write off of accounts receivable combined
with the diverting of the actual receipt to a personal account, or kick backs from suppliers to an
employee in charge of the purchasing function, or the stealing of items from inventory by
employees.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 50
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 8 (continued)
Part B – Auditor’s Attitude, Risks Factors, and Auditor’s Responsibilities (4 marks)
(1)
The auditor should maintain an attitude of professional scepticism regardless of his or her
past experience with the client, its management team and those in charge of governance.
When obtaining sufficient and appropriate evidence that the financial statements are free
from material misstatements, the auditor should consider the potential for management
override or collusion and the existence of circumstances that could lead to fraud;
(2)
The likelihood of not detecting material misstatement due to fraud is higher than that due to
error because of possible management override, manipulation or falsification.
Risks factors related to fraudulent financial reporting or misappropriation of assets include
pressure to achieve expected earnings targets, the pressure to maintain certain ratios for
financing purposes, the belief that internal controls can be overridden because an individual
in a management position has knowledge of weaknesses in internal control, a situation that
may create an incentive for fraudulent financial reporting or misappropriation of assets.
(3)
The auditor is not responsible for detecting fraud; rather the auditor is responsible for
considering fraud in the conduct of the audit work when planning the audit, gaining an
understanding of the entity and its environment, determining materiality, assessing known
risks, etc.
The auditor’s responsibility is to obtain reasonable assurance that the financial statements
are free from material misstatements due to both error and fraud. Absolute assurance
cannot be obtained because of the inherent limitations of the testing performed by the
auditor and internal controls that management has put in place. The nature of audit
evidence is persuasive rather than conclusive.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 51
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 9 (8 marks) (14 minutes)
Use of Specialists in Assurance Engagements (CICA HB s. 5049)
Part A – Limits on Acceptance of an Engagement (CICA HB s.5049.21 to .24) (3 marks)
Prior to accepting an engagement, an auditor should consider whether his or her knowledge of
the client’s business and environment is sufficient to enable him or her to perform the
engagement according to generally accepted auditing standards (GAAS); the auditor is not an
expert in another field or profession, nor is he or she expected to be.
If some technical issues are beyond the auditor’s knowledge, the use of a specialist to understand
and assess the relevant issues might be required; however, if the contribution of the specialist to
the assurance conclusion is so pervasive that the auditor’s involvement is limited, the auditor
should not accept the engagement as a result.
The auditor should consider alternative sources of evidence that are more cost-effective and his
or her ability to understand the specialist’s work and findings; for this purpose, the auditor
considers the nature of the subject matter, terminology, methods and assumptions used by the
specialist, the criteria and their degree of acceptance, and whether the information in the report is
comprehensible to the non-specialists.
The auditor should also consider the availability of sufficient appropriate evidence so as to allow
for intelligent questions about, and corroboration of, the findings of the specialist. The auditor
should consider whether reporting on the subject matter is established practice and what level of
credibility users will attach to the assurance report.
Part B – Planning and Supervision (CICA HB s. 5049.49 to .52) (4 marks)
As planning involves the development of a strategy and an audit approach, the auditor and the
specialist should agree on the nature, timing and extent of the specialist work, including matters
concerning communication with the specialist, such as the objectives and nature of each party’s
involvement including the significance of the engagement to the auditor and the risk aspects,
each party’s responsibilities, the nature of the specialist’s report, and the requirements about due
care, objectivity and confidentiality.
The auditor should fully document the planning and the requirements with the specialist and
have the specialist agree to the terms of the engagement whenever possible.
When the specialist is part of an assurance team, his or her role in planning encompasses the
entire engagement; in such cases, the supervision requirement is similar to that of other team
members.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 52
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 9 (continued)
When a specialist is at arm’s length, he or she must agree on the level and the frequency of the
supervision; however, when the specialist is engaged or employed by the client, there may not be
an opportunity to supervise his or her work.
Part C – Impact on the Auditor’s Report (CICA HB s. 5049.78) (1 mark)
The auditor should not refer to the use of a specialist in the auditor’s report.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 53
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 10 (8 marks) (14 minutes)
Review Engagement (CICA HB s. 8100 and 8200)
Part A – Analytical Procedures in a Review Engagement (4 marks)
Since there are no prior year financial statements to use as comparative, the application of
analytical procedures is limited. If budgets or business plans are available, they could be
compared to the financial statements and used to design appropriate analytical procedures.
It should be possible to analyze the inter-relationships that exist between various financial data.
For example, one could compare interest expense to debt, or assess the working capital and debtto-equity, or perform a break-even and/or a trend analysis. It would be important to calculate any
ratios that are specified as restrictive covenants in the loan agreements, and to look for any ratios
that would bring the going concern assumption into question.
There may be industry standards that could also be useful in this situation. If possible, one could
compare the results to other clients in the same industry.
Part B – Report (CICA HB s. 8200.42) (4 marks)
The report will be titled “Review Engagement Report” and will be addressed to the shareholder
of Westgate Electrical Services Ltd. (WESL) as the person who engaged the public accountant
(PA). The report will have three paragraphs.
The scope paragraph identifies the financial statements that were reviewed, and specifies that the
review was made in accordance with generally accepted standards for review engagements, and
that the review consisted primarily of enquiry, analytical procedures and discussion.
The disclaimer paragraph states that the review is not an audit and that no audit opinion is
expressed.
The negative assurance paragraph states nothing has come to the PA’s attention that causes him
or her to believe that the financial statements are not, in all material respects, in accordance with
GAAP.
If differential reporting options were used, the scope paragraph would be modified to draw the
readers’ attention to this fact and refer them to the financial statements’ note about these options.
Each page of the financial statements will be conspicuously marked as being unaudited.
The date of the report should be the day of substantial completion of the review work, which is
the date when the PA has performed sufficient procedures to support the content of the report.
The report should state the name of the city in which the PA practises and be signed.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 54
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 11 (8 marks) (14 minutes)
Date of the Auditor’s Report and Documentation (CICA HB s. 5405 and 5145)
Part A – (CICA HB s. 5405.14 and 5145.24 – .25) (3 marks)
The date of the auditor’s report is intended to tell the reader when the auditor has expressed the
audit opinion; normally it is the date of substantial completion of the examination, which means
that the auditor has identified, gathered and examined sufficient appropriate evidence to support
his or her opinion. After this date, the auditor is no longer seeking new audit evidence, but makes
sure that all evidence previously requested is obtained for documenting the file.
The report release date is the date the auditor grants permission to use the audit report attached to
the financial statements.
The final audit file should be completed not more than 45 days after the audit report release date.
The 45 day rule applies from the date the examination was substantially complete if a report is
not issued in connection with the engagement. If the auditor is unable to complete the
engagement, then the 45 day rule applies from the date the engagement ceased (CICA HB s.
5145.02(b)).
Part B – Changes to Audit Documentation (CICA HB s. 5145.26 – .28) (5 marks)
The audit documentation may be changed during the final assembly process for changes that are
administrative in nature. Examples of such administrative changes include:




file clean up (deleting or discarding unnecessary information);
file organization (sorting, collating and cross-referencing);
sign-off on completion checklists; and
documenting audit evidence and information obtained, discussed and agreed before the
report release date.
Regardless of the nature of any additions (e.g., new evidence, conclusions) after the report
release date, the auditor should document:




when additions were made and reviewed;
who made the additions and who reviewed them;
why the additions were made; and
the effect of the additions on the auditor’s conclusions.
The auditor should not delete or discard any audit documentation after the file completion date.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 55
2009 CA Reciprocity Examination – Approaches to Solutions – Day One
Question 12 (6 marks) (11 minutes)
Reservations in the Auditor’s Report (CICA HB s. 5510 and 4430)
Part A – (CICA HB s. 5510 and 4430) (2 marks)
Charity Work (CW) should have recorded the contributed assets (land and building) at their fair
value, unless the values could not be reasonably determined (CICA HB s. 4430.06). It seems that
an appraisal was possible but at a cost that CW may not have been able to afford or recover.
CW is not entitled to limit the application of CICA HB s. 4430 because its revenues exceed
$500,000 annually. However, an organization that is not entitled to limit the application of the
section, and for which the cost of obtaining the needed information outweighs the benefits,
should disclose the information required in section 4430.40 (CICA HB s. 4430.04).
The auditor should determine if the departure from GAAP, even with additional information
disclosure (CICA HB s. 4430.39), is such that it renders the financial statements misleading or
virtually useless; this determination is difficult to quantify because no appraisal has been done. If
it is the case and relevant information cannot be obtained, a denial of opinion might be warranted
(CICA HB s. 5510.15 and .22).
However, if reliable information can be obtained at a reasonable cost and management maintains
its decision to record the contributed assets at a nominal value, a qualified opinion should be
issued with an explanation in an additional paragraph if the departure does not impair the overall
usefulness of the financial statements (CICA HB s. 5510.16, .19 and 5510.E). If the departure is
such that the financial statements as a whole are misleading or useless, the auditor should express
an adverse opinion (CICA HB s. 5510.17 and .19) explaining how the departure affects the
overall usefulness.
Part B – (CICA HB s. 5510) (4 marks)
A scope limitation exists on revenues from the door-to-door campaign, despite the attempt to
place controls on this fundraising activity by randomly assigning canvassers to a team and the
issuance of receipts for donations exceeding $5.00; a weakness in internal control still remains.
There is no alternate way to gather sufficient appropriate audit evidence about the completeness
of this campaign’s revenues. While the level of local fundraising may not exceed materiality,
there is no way to identify the total unrecorded revenue, if any, at the national level. The scope
and opinion paragraphs should be qualified.
CC’s request not to positively confirm the amounts receivable from United Appeal (UA)
represents a scope limitation. However, this limitation can be overcome with alternative
procedures: for example, an examination of subsequent receipts from UA in January, a review of
the funding announcements in December, a review of the results of the programs that qualify for
funding. If this limitation is overcome, it will not impact the opinion.
(Evaluators’ comments: The Evaluators also considered a line of arguments supporting other
treatments).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 56
2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 1 (10 marks) (18 minutes)
Personal Income Tax Determination
Salary
Life insurance premium
Car lease payments – 2/3 × $10,800
Stock option benefit ($14 - 10) × 1,000
RPP
$ 84,000
3,000
7,200
4,000
(5,000)
$ 93,200
Employment income
CSB interest $10,000 × 4%
Eligible dividends $4,000 × 145%
Non-eligible dividends $3,000 × 125%
400
5,800
3,750
9,950
Property income
Taxable capital gains on the stock option
shares ($20 - $14) × 1,000 × 1/2
3,000
106,150
( 2,000)
Net income
Stock option deduction ($4,000 × 1/2)
$ 104,150
Taxable income
Income tax
st
on 1
on next
(or on 1st)
on next/remaining
$40,726
40,726
81,452
22,698
Income tax credits
Basic
Child under 18 (Philip)
Canada Pension Plan Contributions
Employment Insurance Premiums
Canada Employment credit
Transferred from Liz
- Tuition
- Education & textbook ($465 × 8 months)
Transferable amount
But limited to
Non-refundable tax credits
Donations
26%
$ 6,109
8,960
$ 15,069
5,901
$ 20,970
$ 10,320
2,089
2,049
711
1,044
$5,400
3,720
$9,120
on 1
on remaining
$1,000
200
800
on eligible dividends
$1,800
on non-eligible dividends
750
st
15%
22%
× 15%
× 29%
$
5,000
21,213
× 15%
(
3,182)
30
232
(
262)
(
1,100)
(
500)
Dividend tax credits
Federal income tax
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
×
11/18
× 2/3
$ 15,926
Page 57
2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 1 (continued)
Amounts that are not taxable nor deductible
Medical insurance premium
Registered Pension Plan - employer contributions
Philip tuition fees are not deductible in 2008 (nor in 2009)
$ 2,000
10,000
4,400
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 58
2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 2 (15 marks) (27 minutes)
Part A – Part I Tax Payable (7 marks)
Income tax on taxable income
Refundable tax on Canadian-controlled private
corporation investment income (Note 1)
$700,000
× 10%
$ 52,000
$700,000
380,000
2. Aggregate Investment Income
Net taxable capital gains
Net capital losses
Interest income
3. Income Eligible for SBD
Least of:
Business Limit (shared with New Ltd.)
Active Business Income (Note 5)
Taxable Income
$400,000
70,000
64,600
22,780
× 6 2/3%
157,380
$112,087
$3,467
$320,000
$50,000
(6,000)
4. Small Business Deduction
Business Limit (Note 3)
5. Active Business income
Net income
Deduct:
Net taxable capital gains
Property income:
– Interest
– Dividends
$266,000
3,467
269,467
Deduct:
– Abatement
– Small business deduction (SBD) (Note 4)
– General tax reduction (Note 6)
Part I tax payable
Notes:
1. Refundable tax on CCPC investment
income
6 2/3% of the lesser of:
a. Aggregate investment income (Note 2)
b. Taxable income
Less: Income eligible for SBD (Note 3)
× 38%
44,000
8,000
$52,000
- 20,000
$380,000
$652,000
$700,000
$380,000
× 17%
$64,600
$740,000
$(50,000)
$ 8,000
30,000
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
(38,000)
(88,000)
$652,000
Page 59
2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 2 (continued)
6. General Tax Reduction
Taxable income
Deduct:
– Income Eligible for SBD (Note 3)
– Aggregate Investment Income (Note 2)
$700,000
380,000
52,000
$268,000
× 8.5%
× 1/3
$40,000
$22,780
Part B – Dividend Refund (5 marks)
The dividend refund for 2008 is the lesser of
the following 2 amounts:
A. Taxable dividends paid
B. Balance of the Refundable dividend tax on
hand (RDTOH) at December 31, 2008
(Note 1)
Note:
1. Balance of RDTOH at December 31, 2008
Balance of RDTOH at December 31, 2007
Dividend refund for 2007
Refundable Part I tax
1. Least of:
a) Aggregate investment income
(Part A, Note 2)
$ 120,000
$32,867
$32,867
$ 9,000
0
9,000
$ 52,000
× 26 2/3%
$ 13,867
b) Taxable income
Income eligible for SBD
(Part A, Note 3)
$ 700,000
(380,000)
$ 320,000
× 26 2/3%
$ 85,333
c) Part I tax payable (Part A)
2. Part IV tax ($30,000 × 1/3)
$ 112,087
Balance of RDTOH at December 31, 2008
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
$ 13,867
10,000
23,867
$32,867
Page 60
2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 2 (continued)
Part C – General Rate Income Pool (GRIP) (3 marks)
GRIP balance at December 31, 2007
Add:
68% of:
Taxable income
Less:
Income subject to the SBD (Part A,
Note 3)
Aggregate investment income (Part A,
Note 2)
$ 50,000
$700,000
(380,000)
( 52,000)
$268,000
Eligible dividends paid in 2007
182,240
30,000
262,240
(
0)
GRIP balance at December 31, 2008
$ 262,240
Eligible dividends received
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
× 68%
Page 61
2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 3 (25 marks) (45 minutes)
Part A (6 marks)
Upon acquisition of control, there is a deemed year-end for Pepper Ltd. and the value of its
assets will be adjusted as follows:



The inventory must be valued at the lower of cost and market: $95,000;
The undepreciated capital cost (UCC) of Class 8 must be reduced to its fair market value
(FMV): $20,000; and
No adjustments downward should be made to the land or the building because their FMV
are higher than their adjusted cost base (ACB).
The write down in value of the inventory and the Class 8 UCC will reduce taxable income for the
two-month deemed year (February and March 2009), or may increase the balance of the noncapital loss of $10,000 if taxable income for the two months is insufficient to absorb the write
down.
While the non-capital losses can be utilized in 2010 (based on the assumptions that Pepper Ltd.’s
business will be carried on with expectation of taxable income), the $20,000 net capital loss will
expire on the acquisition of control on April 1, 2009 and will no longer be available to reduce
capital gains in the future.
An election can however be made to recognize a gain on the land or the building or both. With
the recognition of a gain of $40,000, the net capital loss will be used up.
The recognition of any portion of the gain on the building will result in the recapture of
previously claimed capital cost allowance (CCA) of $20,000.
The recaptured CCA will be added to the taxable income of the two months deemed year or used
to reduce the non-capital loss.


The increase in future CCA does not justify this election because the recovery will be
realized over more than 40 years.
In addition, Pepper Ltd. can use the non-capital loss to reduce taxable income in 2010.
As a result, no adjustment should be made to the building’s ACB ($400,000) or UCC
($380,000), but the land should be adjusted to $240,000 so as to use up the entire $20,000 net
capital.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 62
2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 3 (continued)
Part B (6 marks)
Associated (ITA 256(1)(b))
Livelong Ltd. (LL) and Xeres Ltd. (XL) are associated. LL is controlled by Larry, who is related
to the group of persons that control XL (LL and Suzi Ltd. (SL)) and Larry is deemed to own 48%
of the common shares of XL.
No other corporations are associated.
Connected (ITA 186(4))
Zoro Ltd. (ZL) is connected with Bovet Ltd. (BL) because BL owns more than 10% of the shares
in ZL, based on voting rights and FMV (ITA 186(4)(b)).
XL is connected with LL on the same basis and on the basis that more than 50% of the shares of
XL are controlled by corporations and persons not dealing at arm’s length.
XL is connected with SL on that basis as well (ITA 186(4)(a) and 186(2)).
Affiliated (ITA 251.1(1))
LL and SL are affiliated because Larry & Susan are affiliated persons and each control one of
these corporations.
LL and XL are affiliated because Larry controls LL and is affiliated with the group of persons
who control XL (LL and SL).
SL and XL are affiliated because Susan controls SL and is affiliated with the group of persons
who control XL (LL and SL).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 63
2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 3 (continued)
Part C (5 marks)
Shareholder’s Loan
If Vern received the loan by virtue of being a shareholder, the loan must be repaid by November
30, 2009. If it is not repaid by that date, the entire $100,000 loan must be included in his income
for 2008. Vern will be entitled to claim a deduction for the repayment of the loan each year a
repayment is made.
Employee’s Loan
If Vern received the loan by virtue of being an employee (Vern is the President of Hawthorne
Enterprises Inc.), the loan is not included in his income even if it is not repaid by November 30,
2009. The loan is made to allow Vern to acquire previously unissued shares from treasury, and at
the time the loan was made, a bona fide arrangement was made for the repayment of the loan
within a reasonable time.
The loan need not bear interest; however, Vern will have to include an imputed interest benefit
calculated using the interest rate prescribed by the Canada Revenue Agency at the end of each
quarter, less any interest paid according to the repayment agreement.
The imputed interest is, however, deemed to be interest paid for tax purposes and is deductible in
computing Vern’s annual income from property since the loan was used to purchase shares.
Part D (3 marks)
A Ltd.’s tax return is due on January 31, 2009, that is six months after the year-end (ITA
150(1)(a). The balance of tax owing, if any, is due by September 30, 2008, that is two months
after the year-end (ITA 248(1) “balance-due day” (d)(ii)).
B Ltd.’s tax return is due on April 30, 2009, that is six months after the year-end (ITA 150(1)(a).
The balance of tax owing, if any, is due by January 31, 2009, that is three months after the yearend because all of B Ltd.’s income is eligible for the Small Business Deduction (SBD) (ITA
248(1) “balance-due day” (d)(i)).
C Ltd.’s tax return is due on November 30, 2008, that is six months after the year-end (ITA
150(1)(a). The balance of tax owing, if any, is due by July 31, 2008, that is two months after the
year-end; despite C Ltd. being a Canadian-controlled private corporation (CCPC), C Ltd.
reported taxable income in excess of the SBD in the preceding year (2007) (ITA 248(1)
“balance-due day” (d)(i)(C)(I) and (d)(ii).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 64
2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 3 (continued)
Part E (5 marks)
Stile & Rail Ltd. (SRL) is required to make federal tax instalments for 2009 because the tax
liability for 2008 and the estimated tax liability for 2009 exceed $3,000.
The instalments are generally due at the end of each month (ITA 157(1)). Each instalment is
calculated using one of the following three formulas:
1. $3,000: 1/12 × estimated tax payable for 2009 (1/12 × $36,000).
2. $2,000: 1/12 × tax payable for 2008 (1/12 × $24,000).
3. $1,000 for the first two instalments: 1/12 × tax payable for 2007 (1/12 × $12,000); and
$2,200 for the remaining ten instalments: 1/10 × ($24,000 – $2,000).
If SRL is an eligible CCPC then quarterly tax instalments are permitted (ITA 157(1.1)). The
quarterly instalments are due by the last day of each quarter and are calculated using one of the
following three formulas:
1. $9,000: ¼ × estimated tax payable for 2009 (¼ × $36,000).
2. $6,000: ¼ × tax payable for 2008 (¼ × $24,000).
3. $3,000 for the March instalment: ¼ × tax payable for 2007 (¼ × $12,000); and $7,000 for
each of the June, September and December instalments: 1/3 × ($24,000 – $3,000).
To be eligible to use the quarterly method SRL must have remitted its instalments and filed its
returns on time, have claimed the small business deduction for the current or previous taxation
year, have not reported a taxable income in the current or previous year in excess of $400,000,
and have reported taxable capital employed in Canada of $10,000,000 or less. In applying these
criteria, SRL should consider any affiliated corporations in the calculations (ITA 157(1.2; 1.3, &
1.4)).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
Page 65
2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 4 (8 marks) (15 minutes)
Tort Law
Duty of Care
Blue Star has a duty of care toward its guests/patrons. Blue Star as an employer may be held
liable for the actions of the chef and the banquet manager (vicarious liability) as it is reasonably
foreseeable that guests that are standing or sitting in close proximity to a hot barbeque and to the
flambé demonstration could be at risk of injury from actions performed by the chef.
Arguably, Blue Star owed a duty of care to Alison, the elderly lady who was knocked over by
other guests who ran back into the dining room frightened by the accident on the patio. In fact,
the hotel encourages guests to watch the flambé demonstration on the patio; as a result, it is
reasonably foreseeable that a guest could get injured during the evacuation of the patio.
Breach of Duty of Care, Standard of Care and Reasonable Person
Blue Star, the chef and the banquet manager breached this duty of care because they failed to
maintain a standard of care that a reasonable person would demonstrate while cooking with an
open flame in a crowded area.
The reasonable person would also have anticipated the possibility of problems, such as a wind
gust or tipping over the barbeque or a single dish.
Blue Star and the banquet manager should have ensured that an appropriate number of
employees were available to keep the guests within a safe distance from the barbeque.
The chef should arguably limit the number of portions being prepared at once given the amount
of alcohol that needs to be used to create the flambé effect and the ensuing risk.
Blue Star, the chef and the banquet manager should also have taken extra precautions such as
erecting a protective barrier around the BBQ, placing a fire extinguisher beside the chef, or
serving the guests after the demonstration rather than allowing them to line up to pick up their
flambé dessert.
On a crowded patio, a reasonable person would expect that safety measures are in place in case
of an emergency, such as clearly indicated exit path and points, sufficient number of trained staff
to ensure an orderly evacuation of the patio.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 4 (continued)
Damages/Other
The parties who suffered pain and injuries are entitled to compensatory damages, including
Alison. However, one could argue that Alison, as an elderly lady, should have known that she
had some physical limitations and should have stayed in a safer area, possibly sitting in a chair
away from the crowd (contributory negligence).
Contributory negligence could also be argued for Mary and Daniel, who as adult guests of the
hotel should have known that they were standing too close to an open flame.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 5 (8 marks) (14 minutes)
Contract Law
In order to be binding and enforceable, a contract must meet a number of requirements:
Capacity and legality
All of the parties appeared to be capable of contracting and are experienced business persons. The
object of the contract is legal.
Intention
Intention to create a legal relationship refers to promises made by one party to another, how the
promises are made and how the parties conduct themselves with one another in relation to these
promises.
Intention is a presumption at law that must be disproved when one party denies its intention.
Consideration
Doug and Fresh Flower Market (FFM) appear to have agreed on a fixed price when FFM enquired
about the purchase of 5,000 white roses for August 15.
Offer and Acceptance
The terms of the offer must be clear and unambiguous (in this case, FFM made Doug an offer to
purchase 5,000 white roses) and the acceptance must be unequivocal.
In this case, it can be argued that Doug did not agree to the delivery of 5,000 white roses or that he
made a counter-offer by guaranteeing the supply of 2,500 white roses on August 15, and to confirm
in two weeks (by July 30) whether he could supply the additional 2,500 white roses.
Doug could argue that the “OK” on the phone does not represent acceptance because no other
evidence of acceptance was provided (such as the provision of a delivery address, a phone number
to call back). It can be argued that a client who is shopping for goods availability and price would
call businesses such as Doug’s and behave the same way FFM did when told that not all requested
goods could be delivered; the client would then go on with calls to other businesses until finding
one that can deliver on mutually agreeable terms. Arguably, no contract would exist until such time.
It can be argued that FFM accepted the counter-offer by saying “OK” on the phone and that Doug
was obligated to deliver at least 2,500 white roses to FFM on August 15, at the agreed price, and the
additional 2,500 white roses if they became available.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 5 (continued)
FFM could argue that following up on July 30 was evidence that it had agreed to the counter-offer
and was trying to find out if the additional 2,500 white roses had become available; had they been
available, it could be argued that they should have been delivered at the same price.
Assuming that a contract was formed and that the additional 2,500 white roses became available,
one could argue that the price should be the same as for the first 2,500 white roses. One could also
argue that the price should be the current price, depending on industry practices.
Breach and Damages
If a contract with FFM were deemed to exist, Doug would be in breach of this contract if he failed
to deliver the 2,500 white roses he guaranteed, and the 2,500 white roses that later became available.
Doug might only be found liable for the 2,500 white roses he guaranteed delivery.
In assessing and awarding damages, a judge would consider whether FFM tried to mitigate its
damages by attempting to purchase white roses from other sources.
Doug might have to cancel a portion of the sale to Tim to accommodate FFM if ordered to deliver
the additional 2,500 white roses. In this situation, Tim would be in a position to sue Doug for breach
of contract, if Doug is unable to find additional roses or to reach a settlement with FFM or Tim.
It is unlikely that a judge would grant either FFM or Tim punitive damages.
On July 30, Doug expressly repudiated the contract, if a contract existed, before the actual
performance date (express repudiation and anticipatory breach of contract).
Assuming the existence of a contract, FFM could elect to keep the contract alive and to wait until
August 15, the planned delivery date; if no performance occurs, FFM could sue for damages.
FFM could also terminate the contract and sue for damages on the basis of the express
repudiation.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 6 (4 marks) (7 minutes)
Contract, Misrepresentation, and Liability
The advertisement may have been misleading; however, it could be considered innocent
misrepresentation if the local distributor believed that the photocopier could do 250,000 copies a
day. If it is an innocent misrepresentation, the contract is voidable by the Macdonald Business
Centre (MBC); a rescission would entitle MBC to return the photocopier to the local distributor
and to a refund of its money.
It would be fraudulent misrepresentation if the local distributor knew that the photocopier could
not perform as advertized. In this situation, MBC could void the contract (rescission) and sue for
damages.
The local distributor’s question about the number of shifts MBC was running the photocopier may
be indicative of a misunderstanding about the photocopier’s abilities.
MBC may have entered into the contract based on a mistake; the word “day” may be ambiguous
because it has different meanings in the mind of different people (day vs. night, business hours,
24 hour cycle, etc.), and it is not defined in the advertisement.
MBC’s recourse in this situation where a mistake is involved is to void/rescind the contract. MBC
could also keep the machine and sue for damages on the basis that the photocopier does not
perform as intended and that MBC is losing money as a result; i.e., the frequent shut downs
required for the photocopier to cool off affect productivity and revenue levels.
MBC should also consider the manufacturer’s liability and ability to make good on the
photocopier’s performance (by replacing the weak part with a better one, or by adding better
cooling devices to the photocopier).
The parol evidence rule would normally apply in that, where the terms of a contract are clear and
unambiguous, no evidence that adds new terms or that contradicts the existing terms of a contract
may be brought forth unless it explains or rectifies the terms agreed upon. However, custom of the
trade or normal business practice may be used to get around the parol evidence rule (implied
terms).
In preparing its case, MBC should consider whether it mitigated its damages and how; it should
also consider how much additional research or information gathering it did to make sure the
photocopier would meet MBC’s specific needs.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 7 (27 marks) (49 minutes)
Part A – Kinter Manufacturing (5 marks)
Hugh Bischof
202 Integrity and Due Care
–
Hugh failed to perform his duties with the integrity expected of a CA by recording a fictitious
sales transaction at year-end to inflate revenues and current assets so as to meet a debt
covenant.
205 False or Misleading Documents and Oral Representations
–
Hugh is associated with financial statements that he knows are misleading, as he recorded the
fictitious sales transaction himself.
206 Compliance with Professional Standards
–
By recording fictitious sales, Hugh failed to comply with GAAP when preparing the financial
statements (RPC 206.2).
Amie Ciampa
204 Independence
–
Amie may not appear independent due to her close friendship with Hugh (CI 204 43).
–
She should consider the view of a reasonable observer (RPC 204.1).
–
She failed to identify the threats to independence and provide safeguards to overcome the
familiarity (self-interest) threat (RPC 204.2); as a result, Amie failed to document the
independence threat and related safeguards (RPC 204.3).
205 False or Misleading Documents and Oral Representations
–
Amie and the firm Worthington are associating themselves with financial statements that
they know are misleading to a known user, as Amie came across the recording of the
fictitious sales transaction and ignored it on the basis that it was not material to the audit.
206 Compliance with Professional Standards
–
Amie failed to perform her assurance services in accordance with GAAS by not documenting
her work on the $100,000 sale (RPC 206.1) and by knowingly ignoring a misstatement that
had significance to a known user of Kinter’s financial statements (RPC 202).
–
Amie failed to revise the materiality level in light of the effect of the fictitious sales
transaction on a known user.
–
Amie failed to report the fictitious sales transaction to management.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 7 (continued)
211 Duty to Report Breach of Rules of Professional Conduct
–
Amie has a duty to report Hugh to the Provincial Institute (Institute) for violating RPC 205
and RPC 206.
201 Maintenance of Reputation of Profession
–
As a result of the above breaches, Hugh, and/or Amie and/or the firm Worthington failed to
maintain the good reputation of the profession.
Part B – Bryer & Kearl (6 marks)
203.1 Professional Competence
–
Preston may lack the competence – or the additional professional staff – to provide all the
services that he promises.
204 Independence
–
Preston may not be able to provide all the services to a single client without violating the
requirements for independence.
–
RPC 204.4 (33) specifically prohibits the provision of corporate finance services to an
assurance client.
205 False or Misleading Documents and Oral Representations
–
Preston may be associated with the issuance of a T-4 form to the Canada Revenue Agency
for the payment of a salary to Sharron that is not commensurate with the level of services she
provided.
214 Fee Quotations
–
It is unclear whether Preston is providing a binding price for audit services after having first
obtained adequate information on the work that must be performed; if it is not so, Preston
would be in violation of RPC 214.
217.1 Advertising and Promotion
–
Preston made an unsubstantiated claim when he advertised that his firm was the best in the
city;
–
Even if the claim could be substantiated, it would be considered a claim in bad taste
(implying lack of competence or integrity of other firms).
217.2 Solicitation
–
Preston's solicitation approach to secure new clients could be construed as persistent and
harassing (aggressive mail and telephone campaigns).
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 7 (continued)
401 Practice Names
–
The name of the firm Breyer & Kearl Chartered Accountants is misleading because it implies
that Kearl is a CA, which she is not.
402 Use of Descriptive Styles and 403 Association with Firms
–
The description is misleading as it implies that Kearl is a partner, which she is not.
201 Maintenance of Reputation of Profession
–
As a result of the above breaches, Preston has failed to maintain the good reputation of the
profession.
Part C – Landsman Zauner (9 marks)
Sofia Cortinas
204 Independence
–
Sofia may not be independent due to her close friendship with the owners of Portwood
Lumber (CI 204 43) and/or her outstanding loan.
–
She should consider the view of a reasonable observer (RPC 204.1).
–
She failed to identify the threats to independence and provide safeguards to overcome the
familiarity (self-interest) threat (RPC 204.2); as a result, Sofia failed to document the
independence threat and related safeguards (RPC 204.3).
204.5 Members Must Disclose Prohibited Interests and Relationships
–
Sofia did not disclose her loan from Portwood Lumber in violation of RPC 204.5.
206 Compliance with Professional Standards
–
Sofia failed to perform the assurance services in accordance with GAAS by not updating the
planning documentation based on current information or client status and by reducing the
scope of her audit work without supporting evidence.
–
Sofia failed to perform the assurance services in accordance with GAAS by not sending
accounts receivable confirmations, nor performing alternative procedures.
209 Borrowing from Clients
–
Sofia borrowed money from a client that is not in the business of lending money, which is
contrary to RPC 209.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 7 (continued)
Claudine Sheckler
202 Integrity and Due Care
–
Claudine did not complete her review of the clients’ files in a timely manner, thus
demonstrating a lack of due diligence causing the late publication of the clients’ financial
statements on time.
203.2 Co-operation with Practice Inspections and Conduct Investigations
–
Claudine failed to co-operate with the Institute by not allowing for the visit of the practice
inspection team, nor making alternative arrangements.
Landsman Zauner Chartered Accountants (LZ)
204 Independence (Identification of Threats and Safeguards and Documentation)
–
LZ failed to identify the threat to independence and provide safeguards to overcome or
mitigate the threats caused by Sofia's friendship with the audit client’s family (RPC 204.2);
as a result, LZ failed to document the independence threat and related safeguards (RPC
204.3).
204.6 Firms to Ensure Compliance by Partners and Professional Employees
–
LZ failed to ensure Sofia’s independence by ignoring a known possible threat to
independence when assigning Sofia to the audit of Portwood Lumber. 206 Compliance with Professional Standards
–
LZ failed to comply with professional standards by assigning a person with inadequate
experience to complete the Portwood Lumber audit.
–
LZ failed to comply with professional standards by not supervising adequately Sofia during
the audit work and the completion the engagement.
218 Retention of Documentation and Working Papers
–
LZ failed to maintain a sufficient number of prior year files as evidence of the nature and the
extent of the work done in its professional engagements.
501 Firm’s Maintenance of Policies and Procedures for Compliance with Professional Standards
–
Given the many GAAS deficiencies noted in the engagements performed by LZ and its
professional staff, LZ may not have adequate policies and procedures to ensure compliance
with professional standards.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 7 (continued)
502 Firm's Maintenance of Policies and Procedures: Competence and Conduct of Firm Members
–
LZ does not have a policy to ensure that professional staff disclose relationships or financial
ties affecting independence.
201 Maintenance of Reputation of Profession
–
As a result of the above breaches, Sofia, Claudine and LZ failed to maintain the good
reputation of the profession.
Part D – Agile Technologies Inc. (7 marks)
Whiteside Chartered Accountants
302.2 Communication with Predecessor
–
Whiteside failed to reply promptly to Milliken's request regarding the audit of Agile
Technologies Inc. (Agile).
303.1 Co-operation with Successor
–
Whiteside failed to allow Milliken access to its working papers as requested by Agile.
Milliken Chartered Accountants
202 Integrity and Due Care
–
Milliken failed to act with integrity when failing to disclose its conflict in acting as advisors
for both Agile and Wheatsheaf, in the attempt of the latter to acquire the former.
208 Confidentiality of Information
–
Milliken violated the confidentiality of the affairs of its client Agile when it disclosed the
pending lawsuit to Wheatsheaf.
210 Conflict of Interest
–
Milliken placed itself in a conflict of interest situation when it began representing
Wheatsheaf in its attempt to acquire Agile (one of Milliken’s audit clients, and a competitor
of Wheatsheaf).
–
Milliken is also in a conflict of interest because it represents both Wheatsheaf and Agile in
reaching a purchase agreement, where Wheatsheaf wants the lowest purchase price while
Agile wants the highest.
–
Milliken is also in a conflict of interest because it has a vested interest (consolidated audit
engagement and a $75,000 success fee) in Wheatsheaf’s successful completion of the
purchase transaction.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 7 (continued)
–
Milliken must resign from the engagement unless:
o some conflict management techniques are used to mitigate the conflict;
o both parties are informed; and
o both parties consent to Milliken continuing on both engagements.
211 Duty to Report Breach of Rules of Professional Conduct
–
Milliken has a duty to report Whiteside to the Institute for ignoring its requests under RPC
302 and RPC 303.
216 Payment or Receipt of Commissions
–
Milliken cannot pay a commission to an outside party that is not a public accountant to obtain
clients.
201 Maintenance of Reputation of Profession
–
As a result of the above breaches, Whiteside and Milliken failed to maintain the good
reputation of the profession.
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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2009 CA Reciprocity Examination – Approaches to Solutions – Day Two
Question 8 (3 marks) (5 minutes)
208 Confidentiality of Information
Rule of Professional Conduct 208 provides that:
“.1
A member, student or firm shall not disclose any confidential information concerning the
affairs of any client, former client, employer or former employer except:
a) when properly acting in the course of carrying out professional duties;
b) when such information should properly be disclosed for purposes of Rule 211 or
Rule 302;
c) when such information is required to be disclosed by order of lawful authority or, in
the proper exercise of their duties, by the Council, the professional conduct
committee or any subcommittee thereof, the discipline committee, the appeal
committee, or the practice inspection committee;
d) when justified in order to defend the member, student or firm or any associates or
employees of the member, student or firm, as the case may be, against any lawsuit or
other legal proceeding or against alleged professional misconduct or in any legal
proceeding for recovery of unpaid professional fees and disbursements, but only to
the extent necessary for such purpose; or
e) when the client, former client, employer or former employer, as the case may be, has
consented to such disclosure.”2
2
Member’s Handbook, Institute of Chartered Accountants of Ontario, Rules of Professional Conduct 208,
http://www.icao.on.ca/Resources/Membershandbook/1011page2635.pdf
© 2010 The Institutes/Ordre of Chartered Accountants in Canada
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