Anybody know what are the accounting issues for the following case, and what are the steps to address the notice of reassessment from CRA?
Just Juice Inc.
It is February 28, 20X3, and you, CPA, have just been hired as the controller of Just Juice Inc. (JJI). JJI is a privately held company that operates 100 juice bars throughout Canada as well as a manufacturing plant in Mississauga that processes concentrated juice products. JJI was founded 10 years ago in Halifax by Tim Brown who wanted to capitalize on the growing demand for health-conscious food choices. Tim is the majority shareholder and president of JJI.
In a recent meeting with Tim, he informed you that he has been working on growing the business and he is certain that some of his initiatives have created accounting issues (appendix) that will impact the December 31, 20X2, financial statements.
Tim is considering taking JJI public in the future and for this reason, the financial results are reported under IFRS. Based on the great reputation and financial success of JJI, Tim believes that there is potential for a very successful initial public offering (IPO).
Tim, who previously relied on a bookkeeper to perform all accounting functions, hired you when he realized that it made sense to have a professional accountant on staff. Tim would like you to prepare a memo for him that analyzes the accounting issues at JJI.
JJI also just received a Notice of Reassessment from the Canada Revenue Agency (CRA) for the December 31, 20X1, tax year, which worries Tim. He would like your thoughts on what steps he should take to address it, as well as the implications to JJI.
Potential accounting issues
A few years ago, JJI invested in an initiative called Juice Jets. JJI purchased 10 used
vans and outfitted them for juice making, so that mobile juice bars could attend
community events, concerts, and parks during the warm weather months. As at
December, 31, 20X2, the vans have a total net book value of $400,000 and a remaining
useful life of five years. JJI had expected the Juice Jets, which were piloted in
Charlottetown and St John’s, to contribute positively to net income. However, this has
not been the case. The 10 Juice Jets together barely sell enough juice to cover
operating costs (which include fruit and vegetables, fuel costs and other vehicle
expenses, vendor fees to attend events, and employee wages). Tim is disappointed that
Juice Jets is not doing well, especially because capital costs to start up the project were
significant. Operating cash flows for each of the next five years are estimated to be
$85,000. The appropriate discount rate for the risk of the vans is 10%. The vans could
be sold immediately for $250,000 or at the end of five years for $90,000.
Lease of refrigerators
JJI entered into a contract with Carlin’s Inc. for the use of heavy-duty refrigerators. The
refrigerators will be used by JJI in its juice bars to store the fresh ingredients used for its
juices. Once JJI has received the refrigerators, JJI will then set them up for its purposes
and put them into use in the business. The refrigerators are used solely by JJI for its
operations. The term is for six years and the estimated useful life of the refrigerators is
nine years. Annual lease payments of $22,000 are to be made at the beginning of each
year and are expensed by JJI. The interest rate implicit in the contract is 10%.
At the end of the lease, JJI has the option of purchasing the refrigerators for fair market
value. Although not written in the lease, JJI has indicated to Carlin’s Inc. that it does
plan to purchase the refrigerators. As per the lease agreement, a $20,000 penalty is
payable to Carlin’s Inc. if the purchase option is not exercised.
Prior to the current year, JJI concentrated juices were produced solely for use in the
juice bars. These juices are the base ingredients for JJI’s smoothies, which are
trademarked as Smoothtreats. In June of 20X2, JJI decided to utilize the excess
capacity in its manufacturing plant by selling its concentrated juices to a North American
chain of family restaurants. The restaurant chain, The Tasty Spoon, signed an
agreement that granted it exclusive rights to some of the Smoothtreats recipes for
purposes of providing these drinks in its restaurants.
The terms of this supply agreement are as follows:
• JJI made five of its Smoothtreats recipes available to The Tasty Spoon. The Tasty
Spoon is only permitted to use these recipes in the making of Smoothtreats using JJI
concentrated juice. This is so that JJI can control the quality of the inputs because all
smoothies are sold under its name. As well, this provision prevents The Tasty Spoon
from taking the recipes and making its own smoothies. JJI’s legal counsel spent a lot
of time on this clause to ensure that the recipes could only be used in the manner
intended by JJI.
• Upon delivery of the Smoothtreats recipes, The Tasty Spoon paid an up-front nonrefundable
fee of $250,000 which JJI recorded as revenue.
• The Tasty Spoon restaurants order JJI concentrated juices directly from JJI’s
manufacturing plant. The first shipments were delivered in late August. The Tasty
Spoon negotiated a general right of return because it was uncertain as to how much
product it would be able to sell. From date of shipment, The Tasty Spoon has three
months to return the product. Payments are to be made on the 10th of each month
for the juice used in the previous month. On the 10th of the month, The Tasty Spoon
restaurants notify JJI as to juice used and payment becomes due.
• The initial agreement covers the period from September 1, 20X2, to August 31,
20X5. Upon expiry of the initial agreement, it can be renewed for an additional five
years upon agreement by both parties.
Notice of Reassessment
JJI has received a Notice of Reassessment from the CRA for the 20X1 fiscal year. The
CRA is disputing $100,000 of repairs and maintenance expenses to its building and has
assessed them as improvements to the building.
In addition to the additional taxes payable, the reassessment includes arrears interest.
Tim disagrees that the amounts are betterments and would like to know what the
implications are to JJI as well as what steps to take to address the reassessment.
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