Intermediate Accounting: Tranquil Lotus Ltd Case Study Evaluation

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This case study analyzes the financial statements of Tranquil Lotus Ltd, examining accounting violations and providing recommendations for improvement. The document reviews the balance sheet and statement of income and retained earnings, identifying non-disclosure issues, incorrect depreciation treatments, and improper handling of interest expenses. It suggests adjustments to the financial statements, including journal entries to correct errors related to preference shares, lotus points, short-term investments, and membership fees. The analysis includes adjusted financial statements, a computation of adjusted income for tax purposes, and journal entries for deferred taxes. The study provides a final audited balance sheet and income statement, along with references to relevant accounting standards.
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Tranquil Lotus Ltd Case Study 1
TRANQUIL LOTUS LTD CASE STUDY
By (Your Name)
Intermediate Accounting
Professor’s Name
MacEwan University
Location of Institution
Date
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Tranquil Lotus Ltd Case Study 2
Tranquil Lotus Ltd Case Study
Memo
TO: Roger Smith, Engagement Partner
FROM: Senior Accountant
DATE: 15th July 2015
SUBJECT: Observations and Recommendations Regarding Tranquil Lotus Limited
Following your request to review the notes you made the financial statements of Tranquil
Lotus Limited(TLL), I am hereby writing to make my observations on certain transactional
and procedural issues in regard to the treatment during the preparation of TLL’s unaudited
financial statements (Balance sheet and Statement of Income and Retained Earnings) As at
June 30, 2015.
Observations
During my review, I observed a number of violations of accounting rules and
regulations in the preparation of the accounting records of Tranquil Lotus Ltd. Some of the
violations are.
ï‚· Non-disclosure of certain items on the balance sheet and income statement. For
instance, in the balance sheet, the preference shares is just shown as share capital.
This is against the principle of disclosure which requires that all pertinent information
should be described during the preparation of financial statements as per IAS 32
(Iasplus.com, 2018)
ï‚· The redeemed Lotus points of 500 at a cost of $ 100 have not been included in the
books and if not so, it has not been disclosed whether it has been added to the cost of
goods sold or not.
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Tranquil Lotus Ltd Case Study 3
ï‚· Depreciation on Property Plant and equipment of $ 9259 has not been shown on the
balance sheet. Instead, the net amount is shown. This is against the requirements of
IAS 15 that stipulates that depreciation charged for the year for Property plant and
Equipment should be included in the Incomes statement and at the same time the
accumulated depreciation shown in the balance sheet for clarity (Iasplus.com, 2018).
ï‚· The cash interest payable on the bonds payable is a capital expense and should not be
included in the income statement as an accrual. The interest should be charged in the
distribution of profits section before tax. Since payment has not been made, no entry
should be done against the cash account until the interest is actually paid.
Recommendations
ï‚· In regard to revenues earned from the sale of yoga, meditation and stress management
merchandise. Each service should have been shown separately for the purposes of
ascertaining which merchandise brings more revenue than another as per IAS 18
requirements which recommend that each revenue item should be shown separately.
ï‚· The customer reward program (lotus points) program should not be dropped since it
might be a contribution to the increased annual subscriptions witnessed in January and
September. Despite the low redemption rate at $ 100, the programme might pick
considering that the company is just one month old (Ifrs.org, 2018).
ï‚· The preference shares should be shown as preference shares and not just shares.
Shares earn dividends and preferences shares earn interest, therefore showing
preference shares as shares are against IAS 32(Disclosure and presentations)
(Iasplus.com, 2018).
ï‚· Lance and Katrina should consider converting the long-term debt (convertible bonds)
into shares as it acceptable under the terms of the bond so that Angel Investors can
earn dividends rather than interest. Common Shares have no prior claim on the profits
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Tranquil Lotus Ltd Case Study 4
of the company and it is good as compared to the debt since the leverage ratio for the
company will become low if the debt is converted into ownership.
ï‚· In regard to lawsuit not yet determined, the company should consider providing both
oral and written warnings for new participants who might want to take part in
advanced classes so as to avoid future lawsuit expenses.
ï‚· The short terms investment should always be recorded at fair values rather than cost
value in the books.
ï‚· In regard to the lawsuit, no entry should be made since the case has not yet started and
no expense I regard to it has accrued.
Adjusting Journal Entries
Date Details Debit $ Credit$
15th July 2015 Share Capital 1000
Preference shares( Lance and Katrina) 50
Preferences Shares account 1050
Being record of preference shares recorded as share capital with the
accumulated interest of $ 50
15th July 2015 Lotus points 100
Bank 100
Being record of lotus points redeemed and paid for by bank not
earlier recorded.( Assumption)
15th July 2015 Short-term investments 4798
Revaluation Reserve 4798
Being record to correct the short-term investments account earlier
recorded at book value rather than fair value at $ 24 798
1st Sept 2014h Bank 93 750
Annual membership fee 93750
Being record of membership fees received of$ 93 750 not earlier
indicated
1st Jan 2015 Bank 93750
Annual membership fee 93 750
Being record of receipt of membership fees not earlier recognized
as earned revenue for accounting purposes
15th July 2015 Accounts payable 7500
Interest payable on Bonds 7500
Being record to correct the error made by recording interest payable
on bonds as accounts payable account.
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Tranquil Lotus Ltd Case Study 5
Adjusted Financial Statements
In regard to the above adjusting journal entries, the financial statements have to be
prepared afresh to factor in the errors and adhere to the relevant accounting standards
earlier violated.
Tranquil Lotus Ltd.
Adjusted Statement of Income and Retained Earnings
As at June 30, 2015
Revenue
$
Annual Membership 187 500
Drop ins 20 545
Sales Revenue 14423
Total Revenue 223, 468
Expense
Meals 2610
Depreciation 9259
Bank charges 196
Cost of goods sold( 9254 +100) 9354
Insurance 8078
Utilities 4678
Office expenses 624
Interest expense 7500
Salaries, wages and benefits 62425
Repairs and maintenance 1731
Business license and property 4379
Total Expenses 110834
Earnings from
operations Taxable Income 112 634
Tax at 30% Tax at 30 % (33 790.2)
Net Income after attributable to shareholders 78, 843.8
Dividends
100 @ 10 5 % Preferece dividends 50
Earnings after tax and preference dividends 78,793.80
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Tranquil Lotus Ltd Case Study 6
Tranquil Lotus Ltd.
Adjusted Balance sheet
As at June 30, 2015
Non Current
Assets Cost $
Accumulated Depreciation
$
Net Book Value
$
Buidlings 250 000 9259 240 741
Land 50 000 - 50 000
Short term Investment 24 798
Total 315 539
Current Assets
Inventory 18 648
Accounts Receivabe 3 558
Cash and Cash Equivalents 40 683 62 889
Total Assets 378 428
Financed by
Shareholders
equity 50 common shares @ $1 50
100 @ 10 preference shares 1000
Retained Earnings 78, 793.80
Longterm Debt
3 % 500 @ 500 convertible
bonds 250 000
Current Liabilities Accounts payable 7500
Accruals 2445
Deffered taxes 38 639.2
Total Liabilities and Owners equity 378, 428
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Tranquil Lotus Ltd Case Study 7
Computation of Adjusted Income for Tax Purposes and Income Tax Payable
$ $
Retained profits for the year 112 634
Add back Non-Allowable expesnes Meal Costs 2610
Depreciation 9259
Unearned revenue 3558
Loyalty Programme 100 15 527
Deduct Allowable expenses
Capital Allowance 5000 -500
Ajusted taxable income 123, 161
Tax at 30% 36, 948.3
Net Income 86, 212.7
The capital allowance of $ 5000 for the building is arrived by calculating using a rate
of 4% per annum but it has been allowed for half just half year only
½ ×4/100 × 250 000 = 5000
Meal costs are a non-allowable expense for tax purposes because it was not incurred
in the process of delivering services for the realization of the profits which are to be taxed.
This cost is not attributable to the company's revenue (Iasplus.com, 2018).
The income tax act provides that income received but not yet paid is not taxed.
Therefore, the accounts receivable is not taxable income.
Journal Entries to Record payment of deferred taxes
Date Details Dr. Cr.
15th July 2015 Deferred tax account 36, 948.3
Tax Payable 36, 948.3
Being record of income tax payable but not yet paid
15th July Depreciation account 9259
Capital allowance 5000
Income statement account 4259
Being record of adjusting entries to replace depreciation
with capital allowance for tax purpose
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Tranquil Lotus Ltd Case Study 8
Adjusted Financial Statements-After Factoring in Tax Payable and Deferred Taxes
Tranquil Lotus Ltd.
Adjusted Statement of Income and Retained Earnings
As at June 30, 2015
Revenue
$
Annual Membership 187 500
Drop ins 20 545
Sales Revenue 14423
Total Revenue 223, 468
Expense
Meals 2610
Depreciation 9259
Bank charges 196
Cost of goods sold( 9254 +100) 9354
Insurance 8078
Utilities 4678
Office expenses 624
Interest expense on bonds 7500
Salaries, wages and benefits 62425
Repairs and maintenance 1731
Business license and property 4379
Total Expenses 110834
Earnings from operations Taxable Income 112 634
Tax at 30% Tax at 30 % (36 948.3)
New Net Income after tax 75, 685.7
Dividends
100 @ 10 5 % Preferece
dividends 50
Earnings after tax and preference dividends 75 635.7
Tranquil Lotus Ltd.
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Tranquil Lotus Ltd Case Study 9
Audited Balance sheet
As at June 30, 2015
Non Current Assets Cost $
Accumulated Depreciation
$
Net Book Value
$
Buidlings 250 000 9259 240 741
Land 50 000 - 50 000
Short term Investment 24 798
Total 315 539
Current Assets
Inventory 18 648
Accounts Receivabe 3 558
Cash and Cash Equivalents 40 683
Deffered taxes
(4
799.3) 58, 089.7
Total Assets 373 628.7
Financed by
Shareholders
equity 50 common shares @ $1 50
100 @ 10 preference shares 1000
Retained Earnings 75, 685.7
Longterm Debt 3 % 500 @ 500 convertible bonds 250 000
Current Liabilities Accounts payable 7500
Accruals 2445
Deffered taxes 36 948.
Total Liabilities and Owners equity 373, 628.7
References
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Tranquil Lotus Ltd Case Study 10
Iasplus.com. (2018). International Accounting Standards. [online] Available at:
https://www.iasplus.com/en/standards/ias [Accessed 3 Mar. 2018].
Ifrs.org. (2018). IFRS. [online] Available at: http://www.ifrs.org/ [Accessed 3 Mar. 2018].
Tovsultanova, Lyubov G. "Management Reporting As A Basis For Transformation Of The
Financial Reporting System In Accordance With The International Financial
Reporting Standards." Russian Journal of Entrepreneurship 16.5 (2015): 755. Web.
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