Use descriptive words in your response, like since, however, because which will offer the marker more insight into your reasoning/thought patterns.

Transcription

1 FA4 Module 10 Solutions Case writing tips: Identify issues and prioritize them. Issues will centre around general business operations (running an efficient operation), financial reporting issues, management accounting/decision making (future orientated), finance, auditing, tax, information technology and strategy. Not all cases will have all of these components. Analyze exhibits to identify issues or to support an issue. For example, if you find short term liquidity is an issue, there would be little point suggesting the company expand by building more capacity, because if the short term cash flow issue is not resolved, then the company may become a going concern issue, which in turn would have tax, financial accounting and auditing issues. Use descriptive words in your response, like since, however, because which will offer the marker more insight into your reasoning/thought patterns. Discuss issues from multiple perspectives. Never use bullet point the meaning of your statement will become lost on the marker. Do make realistic and concrete recommendations ie not hire a consultant. Case The CGA accounting firm, Perry & Co, was engaged to prepare the consolidated financial statements for the fiscal year ending April 30, 2010, for Spectacular Shoes Limited (SSL). You, a CGA, are employed with Perry & Co. SSL is a publicly traded international online retailer of shoes sold through the Internet sites created and operated by SSL, which has operations in North America most recently Europe. On July 3, 2009, SSL completed the acquisition of 90% of the common shares of Snappy, a European retailer of shoes, for cash consideration of $9,770,000. The acquisition cost was allocated to the fair value of the identifiable assets and liabilities. The acquisition cost included two intangible assets that were not previously recorded in the records of Snappy a customer list and the trade name. To avoid any unnecessary reporting complications, the entire purchase discrepancy related to these intangibles was allocated to goodwill. SSL intends to keep the Snappy name and brand intact. All future sales and marketing efforts in Europe will be conducted using the Snappy name. Other than some initial financial help, SSL intends to let Snappy s management team make all the operational decision. SSL has just negotiated the purchase of a warehouse in France for 60 million Euros, which will be used for a distribution centre for European shoe sales. SSL has borrowed 60 million Euros from the Central Bank of England located in London, England, to finance the warehouse purchase. The loan, dated October 1, 2009, is at 8% and is

2 repayable in Euros in 20 equal annual installments commencing October 1, The interest is payable monthly in Euros by SSL. The ownership of the warehouse was transferred to Snappy on October 1, 2009, in exchange for a 60 million Euro note. The terms of the note are similar to the terms SSL negotiated with the Central Bank of England, except that SSL is not charging Snappy any interest. The warehouse has an estimated useful life of 20 years. In accordance with IFRS GAAP, Snappy revalued its land and building to fair-market value due to the significant difference between the historical cost and the fair-market value at year end. The fair-market value of the items have been independently verified by an expert in the real-estate field. Snappy issued retractable, non-voting, cumulative term preferred shares in Snappy had classified these shares as equity. In a meeting, Macy Morgan, the president of SSL, mentioned that with the acquisition of Snappy she had some concerns about integrating the two financial accounting and reporting systems. Macy commented, The inventory control systems we had prior to the acquisition were great, but with the acquisition, I am concerned about keeping track of the shoe shipments to the customers. After your meeting with Macy, you researched SSL on the Internet and discovered that the comments made by customers of SSL on a website devoted to customer feedback were primarily concerned with poor inventory controls. In fact, many customers commented that the shoes they had ordered were not in stock at the time of the online order. Required As a member of the team of Perry & Co., prepare a report identifying issues related to your engagement. Indicate the financial statement impacts for any reporting issues. Source: CGA PA1 Module 2 Assignment material modified

3 FA4 Module 10 Solution: Points to consider: Criteria SSL is a public company and must use IFRS (noted it is only 2010 and IFRS is not required until 2011, but comparatives would be required in 2011, thus 2010 IFRS adoption is required) Consolidation is required of Snappy due to % ownership question is since Snappy is already on IFRS, it may be cost effective for SSL to switch to IFRS and consolidate on this basis. Objective of reporting is useful information for investors of SSL. Issues: Errors and valuation issues (Goodwill, and preferred shares errors; inventory, sales and cogs valuation) are the greatest concern Goodwill must be separated into its identifiable components. Since the customer list and trademark are separately identifiable, they should be segregated out. This will result in lower goodwill. If the customer list and/or trademark have indefinite lives, they will need to be tested for impairment, otherwise they will be amortized over their useful life. Redeemable preferred shares should be classified as a liability as they are term (have an expiry date) and retractable (preferred shareholder can give back the share for a set predetermined price) if preferred shares were included in the calculation of goodwill as part of the NBV of Snappy, an adjustment will need to be made. Inventory issues inventory amounts may not be accurate, verification will be required. Strategic issues regarding customer satisfaction. Implications will need to be assessed for materiality and a note disclosure may be required. Given the autonomy afforded to Snappy by SSL and that SSL is only helping with financing, Snappy appears to be a foreign operation, and using the foreign operation method for translation would be the most appropriate translation method. This will result in a translation gain or loss to be reported in OCI, and thus equity of the consolidated statements. Net assets on the balance sheet will be translated at the current rate and income statement items at the average rate. The purchase of the warehouse exposes SSL to foreign currency risk. However, SSL provided a loan to Snappy which will create a natural hedge (loan receivable from Snappy vs Loan Payable to London Bank). Only the interest payments are fully exposed to exchange rate fluctuations they may want to consider using forward contracts to hedge against fair value risk. Gains or losses on the loans value will be reported in net income. The loan value should be reported at a discounted amount (ie there is no interest charged to Snappy, but in valuing the loan imputed interest should be included). The loan receivable and payable would be eliminated upon consolidation. The transfer of ownership has legal ownership implications, but from a consolidated view must be included in the consolidated balance sheet. Value of buildings of Snappy can be left at fair-value, if IFRS is applied to the consolidated entity, if not, then the gain on the fair value should be reversed to original cost before consolidated.

4 Case 9-1 Holdco s 30% interest in Elgin Company should be reported using the equity method because Elgin Company is a joint venture. Although Ms. Richer owns 70% of the common shares of Elgin, he does not control Elgin. The shareholders agreement indicates that the two shareholders must agree on all major operating and financing decisions. Therefore, the two shareholders jointly control Elgin and Elgin should be accounted for as a joint venture. According to IFRS 10, the equity method should be used to report an investment in a joint venture. This accounting treatment will not affect the debt-to-equity ratio. Metcalfe Inc. should be consolidated with Holdco because Metcalfe is a variable-interest entity and Holdco is the primary beneficiary. Although Holdco only owns 40% of Metcalfe, it controls Metcalfe because Ms. Landman, the sole owner of Holdco, is responsible for all key operating, investing, and financing decisions. Furthermore, Holdco has the obligation to absorb Metcalfe s expected losses and the right to receive Metcalfe s expected residual returns if they occur. Debt will increase by $1,500,000 and equity will increase by $300,000, which is the fair value of the non-controlling interest. The incremental transaction has a debt-to-equity ratio of 5:1. Assuming that Holdco s debt-to-equity ratio is less than 3:1 prior to this transaction, the new acquisition will cause the debt-to-equity ratio to increase.

5 Case 12-3 To: Re: Board of Directors, Canoes Are Us Memorandum Financial Reporting and Stewardship Issues I have reviewed the issues of financial reporting and stewardship for Canoes Are Us for the current year. The following are my observations regarding these matters, along with suggestions for improvement. My suggestions have been made with two goals in mind: (1) ensuring that the financial statements will comply with generally accepted accounting principles (GAAP), and (2) providing information useful to users, such as board members and donors, for evaluating management s stewardship. I would be pleased to discuss my suggestions with you at the next board meeting and to participate in developing a plan for implementation. Basis of accounting The financial statements of Canoes Are Us are prepared on a modified accrual basis, which records cash receipts only when received but records expenditures when they are incurred, even if not yet paid. While Canoes Are Us has used this method for several years, its major disadvantage is that it may not report an accurate measure of the activities for a reporting period. Since expenditures might be made before funding for them is received, there is often a mismatching of receipts and expenditures in a reporting period. As a result, accrual accounting is recommended for both profit-oriented and not-for-profit organizations; in fact, it is required under GAAP for NFPOs such as Canoes Are Us. Accounting for government grant The contribution of $250,000 by the government should be accounted for as follows: The contribution of $200,000 for the truck, trailer, canoes and safety equipment should be recorded as deferred contributions and amortized into income over the useful lives of these assets to match the amortization expense on these assets. The contribution of $50,000 for operating costs should be recorded as deferred contributions and amortized into income as the operating costs to be funded by this grant are incurred.

6 Capital assets Previously, NFPOs could choose to expense, capitalize and amortize, or simply capitalize but not amortize their capital assets. However, GAAP now requires that NFPOs, with the revenue size of Canoes Are Us, capitalize and amortize capital assets over their useful life. As a result, the new truck, trailer, and canoes should be treated this way to ensure compliance with GAAP. Capitalization of capital assets will also help donors evaluate stewardship when their donations are designated for capital assets. All donors will be able to identify the use of the funds because capital assets will be classified separately in the financial statements, such as the statement of changes in fund balances, the statement of cash flows, the statement of changes in net assets, or the statement of financial position. Donated goods and services GAAP requires that donated capital assets must be recorded at fair value and that the nature and amount of donations be disclosed in the notes to financial statements. Thus, the donated canoe should be recorded at $2,500 and disclosed in the notes to financial statements. Pledges receivable There is $20,000 in pledges outstanding from this year s fundraising campaign. The relevant accounting issue is whether to recognize the revenue from the pledges this year and accrue the receivable or to simply disclose the pledges receivable in the notes to the financial statements. Contributions receivable are recognized as assets when they can be reasonably estimated and collection is reasonably assured. While pledges receivable have the same criteria, pledges are not a legally enforceable claim. Whether pledges are collected depends on factors beyond the organization s control. In cases where pledges do not meet the criteria for recognition, they would not be recognized as assets until received and disclosure of the pledges in the notes to the financial statements would be required until then. However, there may be circumstances where pledges receivable do meet the criteria for recognition. For example, the NFPO may have historical information that

7 allows it to estimate the realizable value of the pledges. If this is the case then the realizable value of the pledges could be recognized as assets. As Canoes Are Us has been in existence for several years, the historical data supports the position that the $20,000 in pledges outstanding can be reasonably estimated and collection is reasonably assured. Accordingly, the amount should be accrued on the financial statements Accounts receivable Action should be taken to collect the accounts receivable related to the canoe rentals. An allowance for doubtful accounts should be recorded for the receivable not expected to be collected or the accounts receivable should be written off. Fundraising costs When an organization classifies its expenses by function (i.e. educational costs) on the statement of operations, it can allocate fundraising costs to a number of functions to which the expenses relate. Since aggregate amounts reported for fundraising and general support functions are often of particular significance to financial statement users, Section 4470 of Part III of the CICA Handbook requires that the following be disclosed when these two types of expenses are allocated to other functions: the accounting policy for the allocation of expenses among functions, the nature of the expenses being allocated, and the basis on which such allocations have been made; and the amounts allocated from each of these two functions, and the amounts and the functions to which they have been allocated.