BLAZING SADDLES

BLAZING SADDLES

Blazing Saddles is a small, privately owned company that specializes in selling bicycles and provides bicycle repair services. Tiffany Montrose, a CGA, has been involved in the audit of Blazing Saddles for the past three years and has arranged a meeting with the owner, Jerome Montagne, to discuss the upcoming audit.

Jerome has ushered Tiffany into his office and has started to pull out some notes for discussion. He tells Tiffany about the latest developments in his business: “When I was in France 2 months ago, I signed up for a 4 day bike tour. What a great experience that was! I met several interesting people who were members of the bike tour and it was wonderful to cycle through such beautiful countryside. I realized that we could provide bike tours as a new service in Blazing Saddles. Many of our customers are regulars at the store, either buying new bikes, bike parts or coming in for repairs and our staff members have established good relationships with our regular customers. I told several of our customers about the tour I took in France and most of them expressed an interest in participating in a local tour if one was available. We do have some very scenic areas around here and I already have 3 staff members willing to lead a tour each month. Of course, that would only be in the warmer months since none of us is that crazy that we would want to have a “snow” tour!”

“That sounds like fun,” Tiffany exclaimed. She was quite active and believed strongly that regular physical exercise helped her think more clearly when she was working on difficult problems. “Have you decided to offer tours in spring?”

“Absolutely! In fact, I have already set up two bike tours starting next month and I have collected revenue from most of the customers who have signed up. There is already a waiting list and I have to arrange for 3 more tours. If this continues we will make a lot of money from these tours with a minimal expense. I have agreed to pay a premium over their regular wage to staff members who sign up to lead a tour to reflect the additional responsibilities. The customers will use their bikes and will pay for their own food and accommodation so I don’t expect we will have many other costs. In anticipation of significant interest in this new service, I have purchased 40 bikes. I thought I could make these available for rent to be used in the bike trips. If there isn’t a lot of interest here, then I will put the bikes back into the shop inventory to sell.”

“I purchased a subscriber list about six months ago from a national magazine which targets readers who are interested in active living. The subscriber list has 500 names and we have mailed flyers each month to all of the subscribers on the list, providing a list of the bicycles and related products we sell., offering these through mail order. We have been able to sell some product to these subscribers but we have not yet generated enough sales to cover the production and postage costs of the flyers. I believe that it will take time to cultivate a market for mail order purchases and we need to look at offering specific promotions targeted to these subscribers. The $5,000 cost of the subscriber list has been capitalized and one of my business acquaintances has mentioned this would be considered eligible capital property for tax purposes. I don’t really know what that means so I will rely on you to figure this out.”

Jerome smiled broadly as he reached into his briefcase. “I have brought some information for you since I know you will be in to our office next month for the annual audit.” His smile faded away as he looked at the top page.

“There is another point I wanted to mention. The bank has a concern about the interim statements we submitted last week. We have been sending in our monthly draft statements for the past 3 years and this is the first time that the bank manager has asked me to come in. I am surprised because we have a BLAZING SADDLES large increase in income this month and we are forecasting a significant increase in net income next year. Can you help me understand why the bank would have any questions? I have to see the bank manager tomorrow afternoon.”

Tiffany is aware that the bank loan was secured by inventory and that there was a restrictive debt- equity covenant. There had been no unusual concerns identified at the interim audit. The fiscal year end was coming up in 2 weeks and Tiffany had already scheduled the employees who would be on the Blazing Saddles audit. She reached over to pick up the draft 11-month financial statements that Jerome had taken out of his briefcase. (Refer to Exhibit 1)

“I will need more time to look at the statements. I will call you early this afternoon to ask any questions and I will have some draft comments for you by the end of the day.”

Required:

Draft a memo (approximately 900 words) for Jerome outlining key accounting, tax and management issues. BLAZING SADDLES

Exhibit 1

Draft 11 month financial statements for Blazing Saddles

11 months TY 12 months LY Revenues: Bike sales 250,000 275,000 Cost of sales 150,000 110,000 Gross margin 100,000 165,000

Other revenue: Bike repairs 2,000 2,200 Bike Trips 20,000 -

Expenses: Salaries & wages 60,000 70,000 Rent 22,000 24,000 Occupancy costs 2,000 25,000 Travel costs (1) 6,000 - net income 32,000 48,200

Tiffany’s notes:

1) Travel costs relate to Jerome’s trip to France

2) Bike purchase (40 bikes @ $900 = $36,000) has been funded through Accounts Payable. There has been no significant change in the other liability balance sheet accounts from the prior year.