MEMORANDUM

TO: THE CONTROLLER

FROM: CLYDE IAN BRETT PENA, JUNIOR ACCOUNTANT

SUBJECT: PREPARATION OF ANNUAL AUDIT

DATE: APRIL 2, 2020

I have read through the issues you have sent on matters involving accounts in preparation for our
year-end audit. I have compiled my response to the matters below, including their impact on the
financial statements. I have also provided explanations regarding technical matter, making it as
brief and understandable as possible, based on the limited information provided on some of the
matters.

1. Inventory Errors. For the identified items, I have provided an analysis of the effects of
the errors on our income and suggested some correcting entries to address them (errors).
Some explanations are provided here, followed by a summary of the effects on the
accounts.
a. We received a late invoice for a purchase with terms FOB Shipping. These
purchases were shipped out by our supplier on December 26, where no entry was
made, thus Accounts payable (and purchases) is understated by $61,000. Since
the goods were received on January 3, 2020, they were not included in our year-
end count, understating the Inventory account.
b. We received goods from our customer labeled “Return for Credit”. This wasn’t
included in our count and a Credit Memo has been issued on January 4, 2020. In
addition, of the inventory returned, a certain portion is damaged beyond repair.
Because of this, Inventory is understated by $16,000, Sales and Accounts
Receivable is overstated by $16,000, and expenses are understated by $2,000
(due to loss from damaged inventory).
c. Goods sold with terms FOB Shipping were awaiting pick-up by the freight
company. The goods were included in our inventory count. This is correct
because we still own the goods since the freight company still hasn’t picked it up
yet. However, an invoice was sent to the customer on December 31, 2019.
Because of this, Sales and Accounts Receivable is overstated by $14,000.
d. Purchases with terms FOB Destination were entered into the system on
December 31, even though the goods were received on January 2. This makes an
overstatement of $6,000 in our Accounts Payable and Purchases accounts.
 The following is a summary of the effects of the identified errors on Net Income and
Balance Sheet Accounts
Accounts Accounts Cost of
Error Inventory Sales Purchases Net Income
Receivable Payable Goods Sold
A. Understated Understated Understated No Effect No Effect
$61,000 $61,000 $61,000 (Net) (Net)
B. Overstated Understated Overstated Understated Overstated
$24,000 $16,000 $24,000 $2,000 $10,000
C. Overstated Overstated Overstated
$14,000 $14,000 $14,000
D. Overstated Overstated Understated
$6,000 $6,000 $6,000

In response to these errors, the following entries are suggested:

Error Account Debit Credit
A. Purchases $61,000.00
Accounts Payable $61,000.00

Inventory $61,000.00
Cost of Goods Sold $61,000.00

B. Sales Returns $24,000

Accounts Receivable $24,000

Inventory $16,000
Cost of Goods Sold $16,000

Cost of Goods Sold $16,000

Inventory $16,000
NOTE: If loss from damaged inventory becomes frequent in the
subsequent years, it would be wise to set up a Loss from Damaged
Inventory account

C. Sales $14,000
Accounts Receivable $14,000

D. Accounts Payable $6,000

Purchases $6,000

2. Repairs, restoration, and impairment. Normally, repair costs are expensed outright as
they do not add long-lasting value to the asset, only enables them to continue working at
the current level. As these do not add long-lasting value, the benefit they give do not earn
the company incremental income (in future periods), thus the expense is not scattered
across periods (depreciated). However, since additional components must be acquired (to
replace damaged parts), we must consider if these components have a separate/different
useful life from the existing asset. If so, it should be accounted for as a separate
component of the asset and depreciated accordingly based on the useful life. Failure to
 consider these points could result in bloated expenses for the year, instead of depreciating
it over its useful life.

The cost of restoring the asset is part of the cost of the plant. It will inevitably be incurred
once the plant is decommissioned so we must consider these future expenses as part of
the cost of the asset. The bigger question is how much to charge for it. The estimate
given, $2 Million to $4 Million is a pretty wide range. We must consider asking for more
reliable estimates, mainly from engineers and experts who have more experience in the
field. In addition, we also must discount those estimates as they do not reflect the present
value of the expenses to be incurred. Further, costs to be incurred all throughout the
remediation period should be taken into consideration as well, since it will take several
years, and additional costs might be incurred beyond the current estimate. Again, if we
fail to account for such a costly future expense now, our investors might question such a
large expense in the future.

In light of the recent explosion, it would be good practice to test the assets for
impairment, The asset might not be operating as efficiently as it previously had and the
investors would most likely question what happened during the incident and the effects it
has on the assets. To address this, we test the asset for impairment, and in addition,
include a disclosure in the notes to the financial statements regarding the incident.

3. Gold Inventory. Two points need to be considered regarding the gold inventory: gold
still being processed (work in process/refinery) and finished goods. Gold inventory still
undergoing refinement procedures are recognized as assets when a reliable assessment of
mineral content is possible, or when costs can be reliably determined. Since items in the
refinery are enclosed in vessels and it may pose a difficulty in estimating the contents, we
may have to consider using the costs of processing as the basis for the cost of the Work in
Process Inventory.

Our company reports under IFRS and under guidance for accounting Inventory, we
should measure our Finished Goods Inventory at Lower of Cost and Net Realizable
Value, instead of the considered Net Realizable Value only. From the Work in Process
Inventory, we add the additional costs incurred to finish the refinement process of the
gold inventory, and normal moving costs, if any, into the cost.

Another matter that we should also consider into is the accounting for the costs of gold
mining equipment. Since our operations focus mainly on oil and gas, the recent discovery
of gold might be significant enough to consider setting up a separate operating segment if
the operation prospers and continues in subsequent years. A disclosure on the Notes to
the Financial Statements might be necessary since this is an important matter that has
attached risks that investors might want to investigate.