good quality auto parts limited gq is a mediumsized privately owned producer of auto 737259
Good Quality Auto Parts Limited (GQ) is a mediumsized, privately owned producer of auto parts, which are sold to car manufacturers, repair shops, and retail outlets. In March Year 10, the union negotiated a new three year contract with the company for the 200 shop floor employees. At the time, GQ was in financial difficulty and management felt unable to meet the contract demands of the union. Management also believed that a strike of any length would force the company into bankruptcy.
The company proposed that in exchange for wage concessions, the company would implement a profit sharing plan whereby the shop floor employees would receive 10% of the company’s annual after tax profit as a bonus in each year of the contract. Although the union generally finds this type of contract undesirable, it believed that insisting on the prevailing industry settlement would jeopardize GQ’s survival. As a result, the contract terms were accepted.
The contract specifies that no major changes in accounting policies may be made without the change being approved by GQ’s auditor. Another clause in the contract allows the union to engage a chartered accountant to examine the books of the company and meet with GQ’s management and auditor to discuss any issues. Under the terms of the contract, any controversial accounting issues are to be negotiated by the union and managementto arrive at a mutual agreement. If the parties cannot agree, the positions of the parties are to be presented to an independent arbitrator for resolution.
GQ presented to the union its annual financial statements and the unqualified audit report, for the year ended February 28, Year 11, the first year during which the profit sharing plan was in effect. The union engaged you, the CA, to analyze these financial statements and determine whether there are any controversial accounting issues. As a result of your examination, you identified a number of issues that are of concern to you. You met with the controller of the company and obtained the following information:
1. GQ wrote off $250,000 of inventory manufactured between Year 4 and Year 7. The r e have been no sales f r om this inventory in over two years. The cont r oller explained that up until this year she had some hope that the inventory could be sold as r eplacement parts. Howeve r , she now believes that the parts cannot be sold.
2. The contracts GQ has with the large auto manufacturers allow the purchaser to return items for any reason. The company has increased the allowance for returned items by 10% in the year just ended. The controller contends that because of the weak economy and stiff competition faced by the auto manufacturers with whom GQ does business, there will likely be a significant increase in the parts returned
3. In April Year 10, GQ purchased $500,000 of new manufacturing equipment. T o r educe the financial strain of the acquisition, the company negotiated asixyear payment schedule. Management believed that the company would be at a serious competitive disadvantage if it did not eme r ge f r om the cu rr ent downturn with updated equipment. GQ decided to use accelerated dep r eciation at a rate of 40% for the new equipment. The cont r oller a r gued that because of the rapid technological changes occurring in the industr y , equipment pu r chased now is mo r e likely to become technologicall y , rather than operationall y , obsolete. The straight line dep r eciation method applied to the existing equipment has not been changed.
4. In Year 5, GQ purchased 100% of the shares of Brake Inc., a manufacturer of car brakes. At the time of acquisition, $35,000 of goodwill was reported on CG’s consolidated financial statements and was being amortized over35 years. The company has written off the goodwill in the year just ended. The controller explained that the poor performance of the auto parts industry, and of GQ in particular, has made the goodwill worthless.
5. During Year 11, Brake Inc. sold brakes to GQ for $800,000. Ten percent of this merchandise remains in CQ’s inventory at February 28, Year 11. On February 28, Year 10, the inventory of CQ contained $200,000 of merchandise purchased from Brake. Brake earns a gross margin of 35% on its intercompany sales. GQ has not made any adjustments for the intercompany transactions for Year 11.
6. In February Year 11, the president and the chairman of the board, who between them own 75% of the voting shares of the company, received bonuses of $250,000 each. GQ did not pay any dividends during the current year. In the prior year, dividends amounting to $650,000 were paid. The controller said that the board of directors justified the bonuses as a reward for keeping the company afloat despite extremely difficult economic times.
7. Until this year, GQ used the taxes payable method for accounting purposes. This year, the company has used the liability method of accounting for income taxes. The change has been made retroactively. The effect of the change has been to reduce net income for fiscal Year 11. The controller argued that, because the company is likely to need significant external financing from new sources in the upcoming year, the company should adopt policies under ASPE that are the same as IFRSs. The union has asked you to prepare a report on the position it should take on the issues identified when discussing them with management. The union also wants to know what additional information you require in order to support this position.
Prepare the report.