Tony has a great passion towards fitness training while he was attending high school; his dream is to establish a fitness business that allow people to work out anytime and anywhere. With his interest about personal fitness, he destined himself to be a fitness trainer. He chose the subjects in high school and college that helps him achieve his goal. After consulting his teachers and his brother, who is a fitness coach, Tony decided to enroll in the program that focus on business management and the relevant fitness training skills.
Having attended different workshops and seminars organized by the University located in Windsor, he decided to choose the undergraduate program with double major: Fitness Studies and Business Studies. Tony decided to work part-time while pursuing his undergraduate degree as he planned to establish his own business upon graduation. With his passion in being a fitness trainer, the on-campus fitness centre offered him a position and provided him a formal training to use all of the fitness equipment. It is essential for him to attend the training as it ensures that the clients are not injured by the equipment. Tony worked for the on-campus fitness centre for 2 years and accumulated considerable experience to provide one-on-one fitness training; he decided to look for another part-time job at some other larger fitness centre that operates under a franchise. With his dedication to provide fitness training so as to improving one's health; he got a job offer as a part-time trainer at a local gym. Tony also met with his friend, Paul, who has the same interest and both of them are graduating in two years. As Tony and Paul determined to establish their own business upon graduation, they saved a lot from their pay cheque. Even though they still lack of financial resources but their parents would like to borrow them the shortfall and finally, they established Fitness Anytime Anywhere Inc (FAA) in 2010.
The statement of financial position as at Dec 31, 2017 is presented in Exhibit I. Tony and Paul agreed to contribute each of their expertise in addition to providing fitness-training lessons. Tony is responsible for managing the financial records while Paul is responsible for business development and marketing. The business has been a success as FAA not only providing fitness training, but promoting a healthier lifestyle by developing a healthy habit of clients. Their popularity grew very fast and they have opened up 3 additional fitness centers in the Greater Toronto Area since inception.
Tony and Paul agreed to hire a Chief Financial Officer (CFO) in 2017 to manage the financial records of FAA as Tony would like to spend more time with his clients. They decided to appoint an employment agency to look for the most appropriate candidate as both of them would like to develop their business further and start selling the name of FAA as franchise. Having spent 2 months to interview 10 candidates; both of them would like to offer an employment to Michelle due to her experience in managing a franchising business.
With a view of encouraging and motivating Michelle; Tony remembered what he have learned from the subject "Performance Evaluation" during his last year of undergraduate study. He then decided to tie Michelle Bonus to the key performance indicator (KPI). As the revenue in their industry fluctuates with seasonal demand, for example, the revenue would be higher during the summer and lower during winter. Tony and Paul decided to tie Michelle's bonus to the net profit and the total revenue for the year. Michelle accepted the offer and she joined FAA in January 2017. FAA is having a December 31 fiscal year and Michelle has prepared the draft financial statement in early February 2018 and submitted to Tony and Paul for approval. Both Tony and Paul satisfied with the performance for 2017 as there were an increase in both the number of customers, revenue and net profit.
They then discussed the step they could take to start selling their fitness centre as a franchise. In order to help facilitate the strategic shift; Tony wanted to seek an independent advice regarding the pros and cons of initiating the franchise. Tony approached you, partner of a CPA firm, to provide a second opinion towards their expansion and also he would like to appoint you to perform a review engagement on their financial statement 2017. You have a meeting with Tony and identified the following issues that require attention:
2) Tony told you that most of the members of FAA are individual members but sometimes they do receive large contract with corporate clients due to the successful marketing efforts being made by Paul on different social media platforms. As it is the practice for Tony to accrue the revenue to the unearned revenue by the year end with number of months of service outstanding; Michelle has performed the appropriate procedure and the balance is shown on the financial statement as unearned revenue. During 2017, FAA only entered into one corporate contract to provide a wellness program offered by the corporation to their employees. Tony signed the agreement on March 1, 2017 and received full amount of $50,000. Under the contract terms, FAA has to provide fitness-training lessons over a two-year period with a maximum of 20 lessons per month. Tony would like to maintain a good relationship with this client as he predicted that the client would bring in additional business by either renewing the contract or referring other clients. Thus, he agreed to the term that any unused lessons would be refunded upon expiration of the contract. Since FAA does not provide refund for unused lessons normally; Tony sought consent from Paul before confirming the contract as both of them would like to retain this client. In view of this, Tony instructed his staff to maintain a record for the consumption of the lessons by this client and report to him every month. He calculated the average consumption rate for the fitness lessons was about 90% per month for the first 6 months and he expected that the monthly rate would remain constant throughout the contract period. In addition to this information; Tony also gave you the details of individual membership for the year: $
Revenue from training lessons 150,000
Training lessons consumed 140,000
Unused Training lessons 10,000
3) During the year, FAA purchased additional fitness equipment together with a commercial unit in a suburb area with a total cost of $200,000. FAA did not own any non-current assets previously as Tony and Paul would like to spend more resources on business development. This was considered a good deal as the seller
was in financial hardship and that FAA was able to complete the deal in 30 days. After the deal is closed; Michelle just allocated 10% to the fitness equipment and the remaining to the building. The fair value of the building and equipment was $800,000 and $200,000 respectively at the final closing date. FAA estimated that the equipment with a useful life of 5 years and the building with a 20-year life. It is the practice of the industry to record half-year depreciation at the year of acquisition. In order to finance for the purchase; FAA successfully obtained a bank loan with 8% annual rate but FAA has to maintain a debt-to-equity ratio of less than 1:1 and to submit a reviewed financial statement within 90 days after their year end.
. 4) Tony and Paul decided not to pay out the profit as dividends in 2017 and that a bonus of $10,000 has been recorded on the financial statement to be paid to Michelle in 2018. The bonus is being calculated by multiplying the net income of $100,000 by 10% and the threshold was that revenue has to reach the target of $200,000 and net income of $95,000.
What are the appropriate accounting treatments for FAA. As the report will be used as part of Tony's evaluation of Michelle's performance, offer various alternative accounting treatments. How can calculation of net profit be revised.
Fitness Anytime Anywhere
Statement of Financial Position as at December 31, 2017 $ $
Prepaid expense 5,000
Less: Accumulated Depreciation - Building 9,000
Less: Accumulated Depreciation - Equipment 4,000
Research and Development 126,605
Total Assets 605,000
Liabilities and Shareholder's Equity
Accounts Payable 30,000
Unearned Revenue 10,000
Long-term debt 200,000
Total liabilities 240,000
Share Capital 50,000
Retained Earnings 315,000
Total shareholder's equity 125,000
Total liabilities and shareholder's equity 605,000
Debt to equity ratio 1.92