MEMORANDUM To: From: Date: Re: Jane Doe CGA, Audit Partner Jacob Tutu CGA July 17,

2008 Smiths Farm Market Year End Issues Review

This memo will address the relevant accounting and ethical issues and their impact on the Smiths Farm Market (Smiths) financial presentation for the year end. Capitalizing and Amortizing Research and Development (R&D) Costs Smiths has elected to capitalize instead of expensinge the R&D costs for development of new products over their expected lives. This includes the capitalization of the partners salary, costs of materials used in practice batches and all associated costs to develop new recipes. This practice is in accordance with GAAP as the Smiths are in the process of developing commercially feasible products with an intention to sell them. They also have adequate resources to complete product development. R&D costs can be deferred and amortized over future periods in which the benefits from the product are expected to arise. If the development costs exceed the expected related revenue, the excess should be written off as an expense of the period. The portion of the partners salary that includes administration and general costs should be expensed in the current period as general and administration expenses do not meet the criteria for R&D costs. The cost of materials used in practice batches will be allowed to be treated as R&D cost as they were incurred as a result of the activities undertaken to develop new products to take to market. Only the costs of successful new recipes that meet the definition of R&D costs should be capitalized. Pending Lawsuit The Smiths are being sued for loss of wages and enjoyment of life from customers who became ill after consuming a jam containing tainted fruit. The pending lawsuit could have a negative impact the Smiths reputation and affect future sales from tourists and locals. The probability of contingent losses resulting from the lawsuit is likely, and the accrual of these losses and disclosure in the financial statements is required if the amount of loss can be reasonably estimated. A meeting with the Smiths and their lawyer will be necessary to evaluate the nature and amount of the contingency. All documents pertaining to the lawsuit will need to be examined in order to disclose the contingent loss in the year-end financial statements as per the CICA handbook. Guarantee Obligations In response to the lawsuit, the Smiths offered a double your money back guarantee on all products sold. Smiths also recorded a sufficient amount of warranty expense on their books to cover all products sold in the past year.

Because the revenues from product sales are recognized in the current period, the estimated warranty costs must be matched to these revenues in order to determine profit. The related tax savings occur in future periods as the actual warranty costs are incurred. Thus, a future tax asset needs to be established in order to reflect the anticipated future tax benefit that arises from a temporary difference existing in the current period. It is my opinion that thise provision of double your money back guarantee may be excessive and should be reviewed more thoroughly. It may be advisable to study what a comparable company offering a guarantee sets up as their provision. Ethical Consideration Because of the number of years we have completed the audit, I believe a familiarity threat has affected our independence More recently the relationship has been closer and the Smiths have generously offered our firms office staff a free lunch and tour in recognition of our ongoing relationship. Due to these factors I feel that the firm should reconsider continuing with this engagement as it would be a violation of the CGAs Code of Ethical Principals and Rules of Conduct R202. As a CGA firm, we should be free of any relationship in respect of clients affairs which may impair our professional judgment or objectivity, or which may be perceived as such by the public. Therefore, even though the office staff is not involved in the audit engagements we should not accept the generous offer from Smiths and resign as auditors of the firm. However we may continue our relationship in a consulting capacity. Please contact me at your earliest convenience to review this case.