Dr Ray Coolgate (2)

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Wilfrid Laurier University *

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486

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Accounting

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Feb 20, 2024

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Question 2 (80 minutes) Dr. Ray Coolgate, DDS is a dentist and owns his own dental practice, Coolgate Dental Inc. (Coolgate) located in downtown Toronto. His practice commenced operations on July 1, 2008. In August of 2010, his practice entered into an arrangement with Solo-Smile Inc. (Solo) whereby his practice obtained use of a device named E4D Dentist (E4D). This is a scanning, designing and milling device for chair side use and same day fabrication and installation of dental crowns. This process represents a vast improvement over the traditional method of installing dental crowns. Details of the arrangement between Coolgate and Solo are presented in Exhibit I. Ray is extremely pleased with his patients’ experience with using E4D, and will be exercising his option to purchase the device. Ray is also considering establishing a separate business, Dental Cloud Inc. (Dental Cloud), which would make the E4D available to other dental practices by charging them for each crown installed rather than the cost of the E4D, as not all practices are able to afford the upfront costs of the device. Information relating to Dental Cloud is presented in Exhibit II. Ray has contacted Marr and Marr LLP, Chartered Accountants (M&M), and asked M&M to prepare an assessment of the Dental Cloud idea, showing the estimated number of crowns that would have to be installed by the dentistry practices in order to avoid a cash shortfall for Dental Cloud. Ray also wants M&M to perform a review of the financial statements of Coolgate for the year ended April 30, 2011. The review is required as part of the discussions with the bank regarding the potential new borrowing by Ray. Ray will also need M&M to perform a review of the financial statements for Dental Cloud if he decides to go ahead with it. It is now May 25, 2011. You, CA, are employed by M&M, and have been assigned to these engagements. The partner responsible for this new client, Petra Marr, has asked you to prepare a draft report to Ray assessing the financial and operating viability of the new business by preparing a cash flow projection and an income projection for Dental Cloud. Petra would also like you to prepare a memo containing the planning considerations for the review engagements for the financial statements of both Coolgate and Dental Cloud, keeping in mind that the initial engagement acceptance procedures have been completed. Petra emphasizes that she wants you to address only the significant elements and high risk areas of these review engagements. She provides you with a chart outlining the organizational structure of the various parties involved (Exhibit V). In addition, Petra has asked you to discuss the accounting treatments and the effect on the financial statements for two events, assuming that the financial statements are to be prepared using ASPE. The first is the accounting in the financial statements of Coolgate for the agreement with Solo regarding the E4D. The second is the accounting in Dental Cloud’s financial statements for the potential contracts between Dental Cloud and the individual dental practices for the use of the E4D. Copyright © 2011 ICAO School of Accountancy
EXHIBIT I AGREEMENT BETWEEN COOLGATE DENTAL INC. AND SOLO-SMILE INC. In order to get into the Canadian market, in August of 2010, Solo made a one-time offer to dentists, which Coolgate took advantage of. This agreement includes the following terms and conditions: Solo will provide Coolgate with the E4D Dentist for a one-year trial period commencing August 1, 2010, with lease payments in the amount of $2,275 to be paid monthly; Coolgate may purchase the E4D Dentist at the end of the trial period for the retail price of $125,000, less the total lease payments ($27,300); and Coolgate is required to send a technician to attend E4D University to receive the training needed to operate the E4D Dentist , and to pay the tuition fee of $2,500. Copyright © 2011 ICAO School of Accountancy
EXHIBIT II DENTAL CLOUD INC. There are ten dental practices who are very interested in the E4D. Therefore, Dental Cloud would have to initially purchase ten E4Ds, which Solo has agreed to sell at a discounted price of $120,480 per unit. Each dental practice would install the E4D at their office. In order to track the use of the individual E4Ds, the Labworks system is required. Labworks communicates wirelessly with the individual E4Ds and records the number of crowns that have been fabricated. Dental Cloud would purchase Labworks from Solo at a cost of $420,000, which would include the hardware required to run the system, and it would remain onsite at Dental Cloud’s premises. Each dental practice would sign a five-year contract and pay a fee to Dental Cloud of $44,000 at the end of each year of the contract, which would cover the operating costs of the E4D and Labworks. Requiring payment at the end of the year would help alleviate the cash flow needs of the dental practices. Dental Cloud would also pay the course fee costs for two attendees from each dental practice to attend E4D University. The expected economic life of E4D is five years with no significant residual value. In addition to the annual fee, Dental Cloud would charge the participating dental practices a fee of $285 for each crown manufactured. Dental Cloud will purchase all materials to produce the crowns and will bear the costs of the inventory and shipping to the dental practices. This cost is estimated to be $45 per crown. Dental Cloud would initially hire two part-time technicians to be in charge of calibration, fine tuning and regular maintenance of the E4Ds and monitoring of Labworks, and one employee in charge of administrative functions. The annual salary and benefits for these employees would be $220,000 in total. All employees would be sent to E4D University. Travel and accommodation costs are estimated to be $7,500 in total for the three employees. Dental Cloud would be located in a rented space with an annual lease cost of $42,000. This space would be used to store supplies, the servers required to run Labworks, and would provide office space for the employees. Utility costs are estimated to be $13,200 annually. Dental Cloud would be structured as a corporation. A good friend of Ray’s, Andrew Gumm, is interested in investing in Dental Cloud, making Ray and Andrew the shareholders of the company. Copyright © 2011 ICAO School of Accountancy
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EXHIBIT III INFORMATION ABOUT RAY COOLGATE’S DENTAL PRACTICE AND THE PROPOSED DENTAL CLOUD BUSINESS Ray’s dental practice is of a size which is typical of the ten dental practices that would be using the E4D. He installs approximately 180 dental crowns annually. Solo would require Dental Cloud to have a $3.5 million cash contribution before they would proceed with the sale agreement. This $3.5 million would be financed by a combination of $500,000 invested by Ray in exchange for common shares; $500,000 invested by Andrew Gumm, who would not be involved in the business, in exchange for preferred shares; and a bank loan in the amount of $2,500,000. The loan would have an 8-year interest rate of 6% which would be paid annually on the anniversary date of the loan, and would require an annual principal payment of $312,500 on the anniversary date. To purchase the common shares, Ray would invest $200,000 of his savings and borrow $300,000 personally from his bank. The terms of this loan would require Ray to make annual payments on the anniversary date in the amount of $50,000 plus outstanding interest. The interest rate would be 6%. The preferred shares held by Andrew would receive an income participation payment in the amount of 40% of the income before the income participation payment and income taxes reported by Dental Cloud. Ray mentioned that a fee of $285 for a crown might meet resistance from dentists, and that he may have to consider a lower fee of $250 for a crown. Ray will not go ahead with Dental Cloud if he considers the risk of his “losing money on Dental Cloud” to be too high. He does not want to have to cover any cash shortfalls that Dental Cloud might incur. Copyright © 2011 ICAO School of Accountancy
EXHIBIT IV COOLGATE DENTAL INC. BALANCE SHEET As at April 30, 2011 Assets (unaudited) Cash $ 20,262 Inventory of supplies 18,214 38,476 Equipment, furnishings and leasehold improvements (1) 384,192 $422,668 Liabilities Accounts payable $ 11,812 Current portion of bank loan 50,000 61,812 Bank loan (7%) (2) 300,000 361,812 Shareholder’s Equity Share capital 100 Retained earnings 60,756 $422,668 (1) cost less accumulated capital cost allowance of $282,808 (2) annual principal payments in the amount of $50,000 are due on April 30 Copyright © 2011 ICAO School of Accountancy
EXHIBIT IV (continued ) COOLGATE DENTAL INC. INCOME STATEMENT For the year ended April 30, 2011 Revenue Dentist services (unaudited) $ 805,000 Hygienist services 241,500 1,046,500 Employee remuneration 210,812 Dental supplies 230,230 Office supplies 49,132 Rent and utilities 60,128 Professional insurance 120,000 Lease of E4D and training 26,100 Loan interest 24,500 Capital cost allowance 96,048 816,950 Income $ 229,550 Copyright © 2011 ICAO School of Accountancy
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EXHIBIT V ORGANIZATIONAL STRUCTURE Copyright © 2011 ICAO School of Accountancy Dental Cloud Inc. (will own the 10 E4D machines and the Labworks system) Ray Coolgate Coolgate Dental Inc. (dental practice) will own 1 E4D machine Solo-Smile Inc. (Solo) E4D (fabricates and installs dental crowns) Labworks (records number of dental crowns) Sell 1 E4D unit to Coolgate Sell 10 E4D units and Labworks to Dental Cloud Andrew Gumm 10 dental practices using E4D