Carretera Travels Inc Case Assignment

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Effect on objectives: This favours the CEO and senior management's objective of profit maximization because it recognizes some revenue earlier, rather than waiting a year for the rental service to finish.

3. Allowance for Doubtful Accounts

CTI extends credit to its rental customers, however it has been observed that accounts are growing over 120 days. This suggests an increased risk of accounts becoming doubtful. It has also been observed that the allowance for doubtful accounts has not been changed recently and is currently at 3% of credit sales. This means that their bad debts expense for the year and their allowance for doubtful accounts is understated and therefore, the company’s net income is overstated.

Recommendation: Since this is an issue of certain receivables becoming very long, the best treatment would be to implement an aging schedule. This would allocate more appropriate allowance rates for specific receivable terms. The longer the receivable, the higher the percentage rate of credit sales estimated to be uncollectible. The schedule can be researched and derived from related industry standards. As an alternative, we can look back at historical data (since the rate was not recently changed) to calculate a better estimate of the rate used for determining the allowance for doubtful accounts balance.

Effect on objectives: This would go against the CEO and senior management’s objective of profit maximization because a higher percentage of credit sales rate increases the allowance for doubtful accounts balance. This will result in more expenses and lower net income because there will be a debit to bad debts expense. The value debited will be the value needed to bring allowance for doubtful accounts up to the newly revised percentage of credit sales.

4. Asset Impairment

Currently, CTI’s rental vehicles (in distinction from its used car sales vehicles) are amortized with a residual value of $7000. However, most vehicles are being sold at a loss, and the average sale price for a used vehicle is $5000. This means that at the end of its useful life, the assets recoverable amount (or fair value) is not $7000 but $5000. This represents an impairment of $2000 because the carrying value is greater than its recoverable amount.

Alternatives/Recommendation: For the rental vehicles that are being disposed of now, CTI can either recognize a loss due to impairment or recognize a loss on the actual disposal of the asset, but it is recommended that they recognize a loss due to impairment. For the other rental vehicles that have not yet fully depreciated, it is recommended that their residual value be lowered from $7000 to $5000. Doing this more accurately reflects the proper carrying value of the asset and also better matches expenses to the correct period, as opposed to taking a loss on sale in the final period of the asset’s life. Refer to Appendix B for the recording of the impairment and selling for a loss.

Effect on objectives: Both the recommendation and alternative would increase expenses for CTI since depreciation expense increases and we are reporting a loss on sale or impairment. This lowers net income and does not favour the CEO and senior management’s objective of profit maximization.

5. Expense or Capitalize the Retrofit

CTI currently amortizes its vehicles over an eight-year period, but senior management has asked Antonia to extend the amortization of two-thirds of the vehicles over 10 years on an ongoing basis because they believe that a major retrofit, which includes only a vehicle inspection and adding car paint, of two-thirds of the vehicles increases its useful life. This creates the issue of whether adding paint and the inspection to the vehicles should be expensed or capitalized.

Recommendation: The major retrofit should be expensed because, since CTI is a commercial company that simply rents out vehicles to deliver products, adding the new company colours (paint) to the car will not result in a betterment for the car and the technical inspections are for regular maintenance. A betterment only occurs when expenditure on an asset can improve the existing asset and provide future benefits, it usually occurs infrequently, and involve large amounts of money. By painting its vehicles, we cannot conclude that it will extend the useful life by two more years as the future benefit is unknown. Therefore, since the painting of the vehicles and the inspections do not satisfy the criteria of being a betterment, these costs should be expensed. Similarly, the vehicle whose accelerator was fixed should be treated as a maintenance expense as it also does not represent a betterment.

Effect on objectives: Due to IFRS constraints, the expensing of painting the vehicles and technical inspections, would reduce net income by increasing expenses and therefore, this would not favour the CEO and senior management’s objective of profit maximization.

6. Potential Lawsuit:

FruitsVeggies Inc has filed a lawsuit against CTI for $1,000,000. CTI’s lawyer says that there is a 60% chance that CTI will be found guilty. This presents the issue of whether a contingent liability should be recorded and its related expense should be accrued.

Recommendation: According to IFRS, a contingent liability is only journalized when the contingency is both probable (50% rule) and the amount can be estimated. The lawyer believes that the claim is excessive and unrealistic, which means that the dollar value of the claim cannot be estimated yet; there is no specific amount that can be recorded on the financial statements. Although it is highly probable (60% > 50%) that CTI will be found guilty, the two conditions of a contingent liability are not satisfied and therefore, we can only disclose the lawsuit in the notes of the financial statements. CTI should consider inquiring a legal professional to evaluate the validity of the lawsuit amount. Refer to Appendix C for the recording of the lawsuit transaction assuming the amount of the claim can be reestimated.

Effect on objectives: Since we are not accruing an additional expense, net income will not change.

7. Finance or Operating Lease:

A third party, App Inc. has leased to CTI new, updated software for its routes and driver communication. It was recorded as an operating lease.

Recommendation: CTI should record the new software as a finance lease. For a lease to be capitalized, any of the 5 criteria to classify as a finance