Cathys School Of Dance Case Study

Introduction

Cathy’s School Of Dance is facing serious expansion issues making it necessary to have high quality financial statements for purposes of decision-making. The company, being a private company that offers dance lessons in ballet, jazz, tap and recreational services will have to comply with the Canadian GAAP’s. The financial statements that comply with the standards will be useful in getting additional finances to finance the proposed expansion. The financial statements that are presented relate to the year ended March 31, 2014 with the accompanying notes to the financial statements which require interpretation in addition to determining whether they comply with the applicable financial reporting standards.

The proposed expansion would have to be financed by a bank loan, and this will hence affect the company’s liquidity. In providing the loan, the bank will have to analyze the company’s liquidity which will depict its ability to repay its loan amount by using the financial statements that are presented as at the date of reporting. These financial statements must have to comply with the required financial reporting standards in relation to the recognition, measurement and disclosure of accounting information. The company’s debt: assets ratio equals 0.45, which means that the debt must always be less than 50% of the assets which will improve the company’s liquidity position. This memo assesses the financial reporting measures adopted by CSOD with regards to some specific items of revenues, expenses, assets and liabilities.

Competition registration fees

The Canadian Accounting Standard requires that items of revenue be recognized when earned and not when actual cash is received. Competition registration fees are treated as an item of the revenue from sales and service in the income statement. The amount recorded amounts to $63400 and $62500 for year 2014 and 2013 respectively. The policy of Cathy’s School of Dance with regards to this item is to recognize and record the revenue from competition registration fees when the actual payment is collected. In this regard, the company uses the cash-based method to recognize this item of revenue. There is, therefore, a great departure from the matching concept which states that items of expenses should be matched against the revenues in the year in which they arose. The competition registration fees expense amounted to $62500 at the financial year-end on July 31ST, 2013. The respective amount in the following year amounted to zero.

The company’s policy of recognizing the competition registration fees when actual cash has been received rather than when earned may lead to the company not portraying a true financial position. The financial statements that are prepared using the cash based accounting do not present the correct financial position given that they do not adhere to the International financial reporting standards and Canadian GAAP. The impact of such a policy is to lead to the understatement of incomes. The alternative measure that is available to CSOD is for the company to adopt the matching principle and accrual-based accounting. The company should, therefore, disclose revenues that arise from competition registration fees when earned rather than when actual cash is to be received/collected from the clients. 

 

The impact of this change is to increase the amount of revenues that will be reported in the income statement as at the financial reporting date. The change will also improve the firm’s liquidity thus improving its cash flow position. The financial statement will be seen to portray a true and fair view financial position given that such a requirement will comply with the Canadian GAAP and IFRS. The firm will increase its ability to repay the loan amount given that the cash flows generated will be used to pay the interest and loan amounts thus increasing compliance with the terms of the loan agreement.

Costume fees

The applicable Canadian GAAPs require that items of revenues be recognized when the income is earned rather than when actual cash is received. CSOD records costume fees when the actual payments are collected. For the year ended 31ST March 2014, costume fees revenue amounted to $89000 while that for the previous year was recorded as $75000. It is the company’s policy the revenues of this nature when such amounts had been collected from the receivables rather than when such a transaction that led to the revenue being earned took place. The company has therefore accounted for the revenue using the cash-based accounting. The concept states that items of revenues and expenses should be recognized when actual cash has been received or paid rather than when such items of incomes are earned or when expenses are incurred. The cash-based concept adopted by the company does not comply with the applicable standards and the Generally Accepted Accounting Standards (GAAP’s).

This method of accounting for costume fees may be misleading to the company’s shareholders and creditors given that it results in the understatement of incomes. The net effect is to have a low profit figure thus reflecting the conservatism nature of the company’s accounting practice. The alternative accounting practice that is available with regards to the recognition, measurement and disclosure of revenue from costume fees is for CSOD to disclose such incomes when earned rather than when actual cash is received. Such a measure fully complies with the Generally Accepted Accounting Practices and the relevant Canadian GAAP. The effect of such a change on the financial statements is to improve the financial statement quality by increasing the transparency and accountability of the financial statements. It will also reflect the true financial position of the company given the cash-based approach that is being used does not adhere to the applicable standards of financial reporting.

The change in accounting policy to accrual basis will improve the quality of the financial information that is presented. It will therefore improve the reliance that investors and creditors have on the financial statements that are prepared. The lending bank will place a lot of emphasis on the financial statements in addition to improving the nature and quality of financial reporting. Also, it will improve the profitability ratios of the company thus depicting the good financial standing of the company. The company’s credit rating will improve and thus ensuring that good credit terms are negotiated with the bank.

Used costumes

The company has an inventory of used costumes that are comprised of gently used costumes that have been used I prior competitions. The Canadian GAAPs which are in conformity with the IFRS require that inventories of used goods or services be properly disclosed in the financial statements at their fair market values that existed as at the date of acquisition. The Company accounts for the used costumes as a property of the dancers that they sell on behalf of the dancers. Given that CSOD does not have ownership of these items, the respective dancers are tasked with setting their own prices. This is a subjective measure of the costume’s fair market values given that it does not commensurate with what exists in the market. The inventories of used cloths are part of the company’s property. Such items should, therefore, be disclosed as part of the company’s inventory in the company’s balance sheet.

The company accounts for the used costumes as footnotes to the financial statements. Given that the company does not treat the property as their own, this may be misleading to the potential users of financial statement information. It results from the revenues from the sales of used costumes which accrue to the company do not relate to the company’s property. The consignment inventory revenue is recorded as $8000 for the year ended March 31, 2014. The impact of such an accounting practice is to minimize the net assets that are understated thus understating the company’s financial position. Also, it will lead to an overstatement of the company’s revenues in the financial statements given that the company does not own the items of inventory. The company should adopt a policy of recording items of incomes and expenses arising from transactions that the company has control. This will ensure the company reports a correct financial position.

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The impact of the measure is to enhance the financial reporting quality of the company. It will be enhanced by only recording items of revenues that accrue to the company as a result of sale of property that is owned by the company. The company will also disclose the relevant information as footnotes to the financial statements about the nature of goods sold and the commission that will accrue to CSOD due to the formal arrangement with the dancers. The impact of such a move on compliance with the lending agreement is to increase the dependability on the financial statements by the creditors. The liquidity ratios will also be adequately reflected and fully indicate the true and fair view of the firm’s financial position. Therefore, the company could be said to be in a stable financial condition and be able to meet its long-term debt obligations in time.

Dancer Accounts

The dancer accounts are maintained as accounts receivables by the company. In these accounts, relevant adjustments are made with regards to the differences in the actual costs of costumes and the initial costume fee that’s paid by the dancers. The company accounts for dancer accounts by issuing a credit to the respective dancer’s account when the actual costume cost exceeds the initial fee and debiting the account when the initial fee paid exceeds the actual costume cost. This measure adequately reflects the true financial position of Cathy’s School of Dance especially since it complies with the applicable Canadian GAAP and therefore this is the best possible measure of accounting for such. Such a measure will increase compliance in terms of debt repayments.

Inventory existence

The applicable Canadian GAAPs require that a company discloses inventories in the financial statements as they exist at the financial reporting date. The company has adequately followed this standard given that the inventories of shoes, tights, water bottles and school attire are recognized as at the reporting date. The current accounting measure adopted might not reflect the true financial position of CSOD given that inventories that belong to the company may not be disclosed in the books if the current accounting method were to be used. The company should adopt a historical based method of accounting at cost less accumulated depreciation. It will improve the financial standing of the company in terms of the turnover ratios and the overall liquidity.

Inventory Valuation

The Canadian GAAP provides that items of inventories be valued at cost as at the financial reporting date. CSOD has valued items of inventory at cost less the cost of goods sold. This method of current accounting may not adequately portray the true and fair view of the financial position of the company given that it is misleading as it incorrectly values inventories. The alternative accounting measure is to value inventory at the original purchase cost as at the date of acquisition. Valuation of such inventories at cost will increase the values of inventories recorded in the balance sheet in addition to increasing the value of net incomes reported. It will also ensure that the firm’s correct liquidity is captured thus increasing its ability to repay the loan amounts.

Conclusion

The key users of the financial statements that are prepared by the company are investors, creditors and lenders. The impact of these changes in the measurement and disclosure is to affect the degree of reliance that such users have on the financial statements. The compliance with Canadian Accounting standards and the Generally Accepted Accounting Standards will enhance the quality of financial reporting thus increasing dependability on the financial statements. Also, key users will increase the reliance on the financial statements for decision-making purposes.

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Mar 6, 2019 in Economics
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