108 Appendix C — Paper II

SIMULATION 1 (80 minutes)

PonyUp Stables Inc. (PonyUp) has been a small family-run business and a fixture in the horse world of
Smalltown, Nova Scotia, for many years, offering everything a horse enthusiast could want. In the winter
of 2013, PonyUp announced it was shutting down. Despite appearing to be a busy operation, PonyUp was
unable to turn a significant profit, and the owners wanted out.

Sarah, her sister-in-law Megan, and their friend Lori have used the stables for years and were determined
to keep PonyUp open. They pooled their resources and acquired the shares of PonyUp on April 1, 2013.
The purchase was impulsive, but the friends were sure they could make the business a success.
Information on the new owners and notes from discussions with them are provided in Exhibit I.

Because PonyUp is under new ownership, the bank has requested audited financial statements. The
owners have approached your firm to conduct a first-time year-end financial statement audit.

It is now April 25, 2014, and you, CA, have just been assigned as the senior on the audit. You have
obtained draft financial statements for the year ended March 31, 2014 (Exhibit II), and have gathered
other information from PonyUp’s administrator and bookkeeper, Mrs. Devanney, as well as from the
receptionist (Exhibit III).

The engagement partner asks you to prepare the audit planning memo, including suggested procedures for
significant areas. He also asks you to address any accounting issues you identify.
 Uniform Evaluation Report — 2014 109

SIMULATION 1 (continued)

EXHIBIT I

INFORMATION ON NEW OWNERS AND NOTES

FROM DISCUSSIONS WITH THEM

Lori is the town veterinarian and runs her own practice.

Sarah manages a pet store called Animal Galaxy Inc. (Animal Galaxy), which specializes in premium
foods and products for animals. She has a 20% stake in Animal Galaxy, with the remainder split equally
between her brother and her sister-in-law, Megan.

Although Megan is a co-owner in Animal Galaxy, she is not involved in its operations. She is a school
teacher and teaches horse riding lessons in her free time.

Lori, Sarah, and Megan have each purchased an equal number of common shares in PonyUp. Things have
been hectic so far, and the new owners have not had a lot of time to focus on the operations. However, all
three have faith in Mrs. Devanney, whom they have known for years. Sarah noted that there seem to be
fewer controls at PonyUp than she is used to at Animal Galaxy. When Sarah inquired, Mrs. Devanney
said she did not think it was a problem because, as the administrator of PonyUp, she is always there and
never takes a vacation.

The three owners think things are going well so far, but had a few concerns when you met with them.

“There seems to be some confusion about lesson rates,” says Megan. “Lessons are $30 an hour for all
instructors, but one of the clients mentioned that she has been paying the office $40 an hour. I’m not sure
if that’s an issue, since that money belongs to the outside instructors and we’re just collecting it on their
behalf.”

“PonyUp is bringing in a lot of cash, but it seems to go right back out again!” notes Sarah. “Mrs.
Devanney is always getting me to sign cheques. Sometimes I don’t see the related invoice, but I know
Mrs. Devanney will have it. I know there are a lot of expenses in running a business, but there are so
many that it is hard to keep up. All three of us are able to sign cheques and only one signature is required,
which sometimes gets confusing. Once, Megan and I both signed different cheques to pay the same
computer supplier. When we called the supplier to ask for a refund, he told us he had sold us two
computers, although we have only one in the office.

“These issues would not have happened at Animal Galaxy, and I’m wondering if improvements could be
made at PonyUp.”
110 Appendix C — Paper II

SIMULATION 1 (continued)

EXHIBIT II

PONYUP STABLES INC.

DRAFT BALANCE SHEET
As at March 31

2014 2013
(unaudited) (unaudited)

Assets

Cash $ 77,907 $ 98,820

Accounts receivable 15,563 17,445
Income taxes receivable 2,687 955
Inventory (Note 2) 312,270 315,480
408,427 432,700

Investment in Saddle Stables Inc. 10,000 —

Property, plant and equipment (Note 3) 480,700 497,810

$ 899,127 $ 930,510

Liabilities

Accounts payable $ 58,580 $ 60,300

Current portion of long-term debt 24,000 24,000
82,580 84,300

Long-term debt 552,000 576,000

634,580 660,300

Shareholders’ equity

Share capital 100 100

Retained earnings 264,447 270,110
264,547 270,210

$ 899,127 $ 930,510
 Uniform Evaluation Report — 2014 111

SIMULATION 1 (continued)

EXHIBIT II (continued)

PONYUP STABLES INC.

DRAFT INCOME STATEMENT
For the year ended March 31

2014 2013
(unaudited) (unaudited)

Revenue — boarding fees $ 30,000 $ 27,600

Revenue — horse riding 200,200 191,100
Revenue — service fees 59,040 76,260
289,240 294,960

Expense — service fees 55,440 71,610

Veterinary expenses 71,050 62,350
Salaries and wages 95,000 89,000
Selling, general, and administrative expenses 74,738 74,052
296,228 297,012
Earnings before income tax (6,988) (2,052)
Income tax recovery 1,325 390

Net loss $ (5,663) $ (1,662)

112 Appendix C — Paper II

SIMULATION 1 (continued)

EXHIBIT II (continued)

PONYUP STABLES INC.

EXCERPTS FROM THE NOTES TO THE DRAFT FINANCIAL STATEMENTS
For the year ended March 31, 2014

1. Accounting Policies

Financial statements are prepared in accordance with Accounting Standards for Private Enterprises
(ASPE).

2. Inventory
2014 2013

Food and supplies $ 39,270 $ 42,480

Horses 273,000 273,000

$ 312,270 $ 315,480

Food and supplies include items used in the stables. Horses included in inventory are owned by
PonyUp and are ridden by clients. Horses are available for sale at any time.

3. Property, Plant and Equipment

2014 2013
Accumulated Net Book Net Book
Cost Amortization Value Value
Land $ 200,000 $ — $ 200,000 $ 200,000
Building 151,576 41,099 110,477 114,123
Fencing 17,122 2,671 14,451 15,306
Riding gear 89,842 7,811 82,031 81,502
Trucks and trailers 94,155 22,750 71,405 83,125
Office equipment 12,303 9,967 2,336 3,754

$ 564,998 $ 84,298 $ 480,700 $ 497,810

 Uniform Evaluation Report — 2014 113

SIMULATION 1 (continued)

EXHIBIT III

NOTES FROM DISCUSSIONS WITH MRS. DEVANNEY AND THE RECEPTIONIST

1. Boarding Fee Revenue — PonyUp has 25 stalls on site for horses. Fourteen stalls are occupied by
horses belonging to PonyUp. The other 11 are rented out to individuals who own horses and need a
place to board them. An individual wishing to board his or her horse must sign a 24-month contract
and pay an initial fee of $1,000. This fee is non-refundable and is recorded as revenue when received.
In addition, there is a monthly boarding fee of $350, which includes all food and care, as well as the
stall rental. The contract continues on a month-to-month basis after the first 24 months have passed, at
which time the rate increases to $400 a month.

2. Horse Riding Revenue — PonyUp makes each of its 14 horses available to its clients for one three-
hour riding session per day, at a cost of $50 per session. To maintain the horses’ health, PonyUp’s
policy states that a horse should not be ridden for more than three hours per day.

Megan noted that some horses seemed tired and that one had definitely been ridden for more than
three hours that day. Megan checked the schedule, and only one three-hour session had been scheduled
for that horse, so she concluded it must have been an anomaly.

3. Service Fee Revenue and Expense — PonyUp can match the 11 boarded horses with frequent riders,
allowing the horses’ owners to offset the cost of boarding their horses through riding revenue.
Frequent riders pay $1,230 per month per horse. They receive daily riding access to the same horse for
a maximum of three hours per day. PonyUp keeps $75 of this amount as a service fee and remits the
remaining $1,155 to the boarded horse’s owner.

4. Riding Lessons — Lessons are not a source of revenue for PonyUp because outside instructors provide
them directly to riders. Lesson fees are paid to PonyUp’s office and are handed over to the instructors.

5. Payments from Customers — All payments are accepted in cash or cheque only.

6. Shoeing Expense — Horses require regular shoeing. A local groomer checks all 25 horses every two
weeks and replaces shoes as necessary. His daughter has been boarding her horse at PonyUp for four
years. In exchange for his services, his daughter is not charged a boarding fee. Typically, it costs $100
to replace all four shoes on a horse; a horse has its shoes replaced on average four times a year.

7. Riding Gear — PonyUp had two sets of gently used riding gear with a cost of $14,000 that it wanted
to sell to a potential buyer, but the buyer offered too little for them. Although PonyUp does not
normally sell riding gear, it sold the sets to Animal Galaxy for $11,000.
114 Appendix C — Paper II

SIMULATION 1 (continued)

EXHIBIT III (continued)

NOTES FROM DISCUSSIONS WITH MRS. DEVANNEY AND THE RECEPTIONIST

8. Saddle Stables Inc. (Saddle Stables) — During the year, PonyUp was approached by Saddle Stables,
which was experiencing financial difficulty. Because of a long-standing relationship, PonyUp agreed
to lend Saddle Stables $10,000, interest-free, under the following terms:
 PonyUp must approve any major capital expenditures and significant operational decisions of
Saddle Stables.
 The loan matures in five years and requires fixed annual principal payments of $2,000.
 In the event Saddle Stables misses a payment, PonyUp is entitled to convert the current payment
amount into common shares of Saddle Stables. Each $2,000 converts into 10% of Saddle Stables’
common shares, up to a maximum of 50% of the stables’ outstanding common shares.

Mrs. Devanney mentioned that she’s confused by this transaction. Since it can be converted into
shares, she has classified it as an investment.

9. Staff — Mrs. Devanney is the main employee on site. A part-time receptionist works evenings and
weekends, and there are part-time stables cleaners.

10. Administrator and Bookkeeper — Mrs. Devanney opens the mail, prepares deposits for monies
received, and updates the accounting records. She makes deposits daily. She prepares bank
reconciliations on a monthly basis, but notes that she may stop doing them because the owners don’t
review them anyway.

11. Receptionist — The receptionist collects all payments made on site and hands them over to Mrs.
Devanney for deposit and updating of the records. Since a horse can be ridden for a three-hour session
per day, a calendar is maintained that shows the riding schedule for each horse. Occasionally, Mrs.
Devanney asks the receptionist to collect money from a rider who is not listed on the schedule. When
this occurs, the money is collected and a note is made for Mrs. Devanney. The receptionist has been
instructed to not make the note directly on the schedule “so as not to confuse things.”