Scott s Real Estate Investment Trust. Consolidated Financial Statements December 31, 2011, December 31, 2010 and January 1, 2010

Transcription

1 Scott s Real Estate Investment Trust Consolidated Financial Statements 2011, and January 1,

2 March 7, 2012 Independent Auditor s Report To the Unitholders of Scott s Real Estate Investment Trust We have audited the accompanying consolidated financial statements of Scott s Real Estate Investment Trust (Scott s REIT) and its subsidiaries, which comprise the consolidated statements of financial position as at 2011 and and January 1, and the consolidated statements of net income and comprehensive income, unitholders equity and cash flows for the years ended 2011 and, and the related notes, which comprise a summary of significant accounting policies and other explanatory information. Management s responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor s responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. PricewaterhouseCoopers LLP, Chartered Accountants PwC Tower, 18 York Street, Suite 2600, Toronto, Ontario, Canada M5J 0B2 T: , F: PwC refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership.

3 Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Scott s REIT and its subsidiaries as at 2011 and and January 1, and their financial performance and their cash flows for the years ended 2011 and in accordance with International Financial Reporting Standards. (Signed) PricewaterhouseCoopers LLP Chartered Accountants, Licensed Public Accountants

4 Consolidated Statements of Financial Position (in thousands of Canadian dollars) Assets Approved by 2011 John G. Jakolev Director and Trustee Don Biback Director and Trustee Lewis S. Allen Director and Trustee The accompanying notes are an integral part of these consolidated financial statements. January 1, (note 5) (note 5) Current assets Cash and cash equivalents (note 9) 3,280 4,846 16,004 Accounts receivable Due from related parties (note 15) Other assets (note 8) 1,019 1, Current assets 4,667 6,724 17,118 Non-current assets Investment properties (note 7) 291, , ,175 Intangible assets Other assets (note 8) 3,002 2,915 2,829 Non-current assets 294, , ,056 Total assets 299, , ,174 Liabilities Current liabilities Accounts payable and accrued liabilities (note 13) 1,742 1,348 1,393 Due to related parties (note 15) Distributions payable to unitholders Land lease liability (note 19) Mortgages payable and term debt (note 10) 33,609 86,004 66,137 Convertible debentures (note 11) 19, Current liabilities 55,924 87,846 68,001 Non-current liabilities Mortgages payable and term debt (note 10) 122,029 44,753 45,463 Convertible debentures (note 11) 31,540 41,150 39,698 Class B Exchangeable Units (note 12) - 17,859 17,025 Accounts payable (note 13) Land lease liability (note 19) 5, Non-current liabilities 159, , ,236 Total liabilities 215, , ,237 Unitholders Equity Class A Units (note 14) 74,044 58,830 44,676 Contributed surplus 2,588 2,588 2,588 Retained earnings 7,743 10,755 3,673 Total equity 84,375 72,173 50,937 Total liabilities and equity 299, , ,174

5 Consolidated Statements of Net Income and Comprehensive Income For the years ended (in thousands of Canadian dollars) 2011 (note 5) Revenue Revenue from investment properties 23,301 22,342 Operating income (expenses) Operating expenses (3,949) (3,688) General and administrative (4,100) (1,689) Fair value gains (losses) on investment properties (3,193) 10,091 Depreciation (29) (58) Operating income (expenses) (11,271) 4,656 Income (loss) from operations 12,030 26,998 Other income (expenses) Interest income Interest expense (13,378) (11,906) Fair value gain (loss) on Class B Exchangeable Units 2,729 (834) Fair value gain (loss) on convertible debentures 1,810 (1,452) Other income (expenses) (8,782) (14,126) Net income and comprehensive income for the year 3,248 12,872 The accompanying notes are an integral part of these consolidated financial statements.

6 Consolidated Statements of Unitholders Equity (in thousands of Canadian dollars) Class A units Contributed surplus Retained earnings Total Balance - January 1, ,830 2,588 10,755 72,173 Conversion of Class B Exchangeable Units, net of issue costs 15, ,116 Unit-based compensation Comprehensive income for the year - - 3,248 3,248 Distributions (note 14) - - (6,260) (6,260) Balance ,044 2,588 7,743 84,375 Balance - January 1, (note 5) 44,676 2,588 3,673 50,937 Unit-based compensation Issuance of equity 14, ,054 Comprehensive income for the year ,872 12,872 Distributions - - (5,790) (5,790) Balance - (note 5) 58,830 2,588 10,755 72,173 The accompanying notes are an integral part of these consolidated financial statements.

7 Consolidated Statements of Cash Flows For the years ended (in thousands of Canadian dollars) Cash provided by (used in) 2011 (note 5) Operating activities Net income for the year 3,248 12,872 Adjustments for Depreciation on intangible assets Fair value of change in investment properties 3,193 (10,091) Fair value change on Class B Exchangeable Units (2,729) 834 Fair value change in convertible debentures (1,810) 1,452 Amortization of mortgage financing costs Distributions on Class B Exchangeable Units 1,755 1,916 Unit-based compensation Straight-line revenue adjustment (19) (286) Amortization of tenant allowances Write-off of acquisition costs 56 - Write-off of tenant allowances Tenant allowance and leasing commissions (128) (179) Changes in non-cash working capital balances Accounts receivable (140) 185 Due from (to) related parties (52) (116) Other assets (381) 377 Accounts payable and accrued liabilities Net cash generated from operating activities 4,598 7,695 Investing activities Acquisition of investment properties (34,066) (42,184) Construction-in-progress - (482) Acquisitions-in-progress Additions to investment properties (1,080) (318) Computer software (26) (29) Restricted cash - (115) Net cash used in investing activities (35,172) (42,785) Financing activities Class A shares - 15,002 Issuance costs (14) (948) Gross proceeds of convertible debentures 12,000 - Mortgage holdbacks received Mortgage financing costs (2,069) (1,582) Proceeds on issuance of debt 81,081 20,000 Repayments of debt (54,265) (1,008) Land lease payments (21) - Distributions on Class B Exchangeable Units (1,755) (1,916) Distributions to unitholders (6,099) (5,651) Net cash generated from financing activities 29,008 23,932 Decrease in cash and cash equivalents during the year (1,566) (11,158) Cash and cash equivalents - Beginning of year (note 9) 4,846 16,004 Cash and cash equivalents - End of year (note 9) 3,280 4,846 Supplemental disclosure Interest paid 10,133 9,412 Accrued costs relating to acquisition of investment properties in progress - 30 Accrued capital expenditures - 1 Accruals of construction-in-progress - 3 Addition to investment property through finance lease 5,682 - The accompanying notes are an integral part of these consolidated financial statements.

8 1 General information Scott s Real Estate Investment Trust (Scott s REIT or the REIT) is an open-ended property real estate investment trust established under the laws of the Province of Ontario that was created pursuant to a Declaration of Trust dated August 23, 2005 and as further amended from time to time (Declaration of Trust). Scott s REIT primarily owns single tenant retail real estate and some small unenclosed shopping centres and plazas in primary, secondary and tertiary markets across Canada. On October 6, 2005, Scott s REIT completed its initial public offering of 5,000,000 Class A Units of 10 per Unit for proceeds, net of offering costs, of 45,043. Scott s REIT used the proceeds of the offering to subscribe, indirectly, for 5,000,000 Class A LP Units of Scott s LP. On September 30, 2005, Scott s LP arranged a fixed rate mortgage in the amount of 65,000 for a term of five years, bearing interest at a fixed rate of 4.9%, which was held in escrow until October 6, Scott s LP used the net proceeds of the subscription, together with the mortgage of 65,000 and the issuance of 2,254,909 Scott s LP Class B Exchangeable LP Units, to pay the expenses of the offering and to acquire 190 investment retail properties from Obelysk Inc. (Obelysk) and Yum! Brands Canada Management LP (Yum!) and/or their subsidiaries. Immediately after the initial public offering, Scott s REIT held all of the Class A LP Units, representing a 68.9% interest in Scott s LP, and Obelysk held all of the Class B Exchangeable LP Units representing a 31.1% interest in Scott s LP. On March 31, 2007, Obelysk exercised an option acquiring 410,527 Class A Units in Scott s REIT, which were subsequently sold on February 24,. On October 28, 2011, Obelysk, now restructured as PBI Enterprises Inc. (PBI) completed the exchange of 2,254,909 Class B Exchangeable LP Units for 2,254,909 Units of the REIT. The exchange was made pursuant to exchange rights granted to PBI as part of the REIT s initial public offering. With the exchange, PBI has a 24.4% direct interest in the REIT. As a result of the exchange, 2,254,909 Special Voting Units associated with the Class B Exchangeable Units were also cancelled. Scott s REIT owned, as at 2011, 100% of Scott s LP and PBI owned 24.4% of Scott s REIT. The address of the registered office of the REIT is 161 Bay Street, Suite 2300, TD Canada Trust Tower, Brookfield Place, Toronto, Ontario, M5J 2S1. 2 Significant tenant matter a) Priszm Income Fund (the Fund or Priszm) On October 19,, Priszm, a significant tenant of the REIT, operating KFC, Taco Bell and Pizza Hut restaurants at 188 of the REIT s 220 properties at that time, and guarantor of three of the REIT s properties that operate as KFC restaurants, announced its third quarter financial results and cautioned that there are circumstances that raise significant doubt as to the ability of the Fund to meet its obligations as they come due and accordingly the ultimate appropriateness of the use of accounting principles applicable to a going concern. Further, the Fund announced it was unable to comply with a minimum level of earnings before interest, income taxes, depreciation and amortization (EBITDA) as required by its lender, with the consequence that its senior facility with an outstanding amount of 65,000 became due on demand. In addition, the Fund did not pay its franchise renewal fee with respect to certain (1)

9 operating locations, which expired, and had put required capital upgrades specified in the franchise agreement on hold. The Fund also announced it was pursuing a refinancing strategy, which may have included the disposition of the Fund s operating restaurants and use of the proceeds to pay down its obligations. On March 31, 2011, the Fund announced it had successfully received court protection under the Companies Creditors Arrangement Act (CCAA) and named FTI Consulting Canada Inc. (FTI) the courtappointed monitor of Priszm. The Fund announced the filing was done to facilitate the sale of the operating restaurants to Soul Restaurants Canada Inc. (Soul), a subsidiary of a pre-existing franchisee in the United Kingdom. On September 14, 2011, the court approved a motion from the secured creditors of Priszm to appoint RSM Richter Inc. (Richter) as receiver of all of the assets, undertakings and property of Priszm. At the same time, FTI was discharged as the court-appointed monitor and Richter was appointed the receiver (the Receiver) effective September 21, Subsequently, on December 9, 2011, the assets used by Richter in Toronto, Ontario, were acquired by Duff & Phelps Canada Restructuring Inc. (Duff & Phelps) and Duff & Phelps were substituted in place of Richter as the Receiver for Priszm. b) Priszm sales of restaurant operations On June 1, 2011, Priszm announced it has successfully closed the sale of 204 restaurants to Soul located in Ontario, British Columbia and Quebec, which included 63 restaurants operated on the properties of the REIT. In accordance with the assignment terms under their leases, 32 stores were assigned to Soul immediately and on December 16, 2011, the remaining 31 leases were assigned. Soul is responsible for paying rent on all 63 leases. On September 7, 2011, the court approved Priszm s sale of equipment located at a store on Kipling Avenue in Toronto, Ontario to an existing KFC franchisee. This location represented the last property of the REIT s Ontario locations that was leased to Priszm. On September 19, 2011, Priszm disclaimed the lease of the Kipling Avenue location and the REIT simultaneously leased the property directly to the same Ontario franchisee for a new ten-year term. On September 19, 2011, the court approved the purchase and sale agreements between Priszm and FMI Atlantic Inc. (FMI), a New Brunswick based company that owns approximately 70 Pizza Hut restaurants in New Brunswick, Nova Scotia, Ontario and Manitoba, with respect to the sale of 43 operating restaurants in Nova Scotia and New Brunswick. Of the 43 locations sold, the REIT is the landlord for 19 locations. Of the 19 locations, the REIT provided the consent agreement to assign 16 of the leases of which such consent and assignment was executed on December 16, The remaining three leases were simultaneously disclaimed by Priszm and released immediately by the REIT to FMI directly. FMI is responsible for paying rent on all 19 leases. Priszm continues to market for sale their remaining restaurant operations in Quebec, Manitoba and Alberta, of which 66 of the REIT s properties continue to be leased to, and rent paid by, Priszm, as at the date of these consolidated financial statements. (2)

10 c) Disclaimed Priszm leases Since June 2011, a total of 43 leases have been disclaimed by Priszm representing 87,409 square feet of gross leasable area (GLA) of the REIT. Included in the 43 leases are 11 leases which were disclaimed subsequent to the year ended 2011, with effect from January 27, As of the date of these consolidated financial statements, a total of 28 properties have been re-leased to new tenants. A summary of disclaimed leases by province is as follows: Province Number of Priszm leases disclaimed GLA of disclaimed Priszm leases Number of properties re-leased GLA of re-leased properties Remaining Priszm disclaimed leases GLA of remaining Priszm disclaimed leases New Brunswick 2 3, , ,580 Nova Scotia 5 10, , ,382 Quebec 13 28, , ,929 Ontario 15 28, , Manitoba 3 5, , ,272 Alberta 2 4, , British Columbia 3 5, , , , , ,915 For purposes of the fair valuation of the investment properties, the REIT recorded a reduction of 3,937 of value for the year ended 2011, with respect to all 43 properties that have had Priszm leases disclaimed to date. d) The REIT s claim on sales proceeds On May 30, 2011, the REIT asserted a claim on the sale proceeds with respect to the 63 REIT properties that were the subject of the sale transaction with Soul. Subsequently, in September 2011, the REIT asserted a further claim on the sale proceeds with respect to the 16 REIT properties that were the subject of the sale transaction with FMI. The Receiver has set aside a total of 13,400 of sale proceeds, representing the sale proceeds less certain court ordered payments, until the REIT s claim could be heard in courts. The timing of the court review and ultimate direction of the funds is not yet determinable and no amounts have been recognized by the REIT in connection with this contingency. e) Summary Although no assurances can be provided in respect of Priszm s efforts to sell its remaining restaurant operations and the impact on the REIT s liquidity (note 10), the REIT continues to consider all options available to it under the terms of its leases with Priszm and the laws governing the receivership of Priszm to minimize any potential negative impacts on the REIT. (3)

11 3 Significant accounting policies, judgments and estimation uncertainty a) Statement of compliance Scott s REIT prepares its consolidated financial statements in accordance with Canadian generally accepted accounting principles defined in The Canadian Institute of Chartered Accountants (CICA) Handbook. In, the CICA Handbook was revised to incorporate International Financial Reporting Standards (IFRS) and requires publicly accountable enterprises to apply such standards effective for years beginning on or after January 1, Accordingly, these are Scott s REIT s first annual consolidated financial statements prepared in accordance with IFRS as issued by the IASB. In these consolidated financial statements, the term Canadian GAAP refers to Canadian GAAP before the adoption of IFRS. These consolidated financial statements have been prepared in compliance with IFRS. Subject to certain transition exemptions and exceptions discussed in note 5, Scott s REIT has consistently applied the same accounting policies in its opening IFRS consolidated statement of financial position as at January 1, and throughout all periods presented, as if these policies had always been in effect. Note 5 discloses the impact of the transition to IFRS on Scott s REIT s consolidated statements of financial position, net income and comprehensive income, unitholders equity and cash flows, including the nature and effect of significant changes in accounting policies from those employed in Scott s REIT s consolidated annual financial statements as at and for the year ended prepared in accordance with Canadian GAAP. These consolidated financial statements were approved by Scott s REIT s Board of Trustees on March 7, After such date, the consolidated financial statements may be amended with Board of Trustees approval. b) Basis of presentation and measurement These consolidated financial statements have been presented in Canadian dollars rounded to the nearest thousand dollars and have been prepared on a going concern basis and historical cost basis except for investment properties and certain financial instruments (convertible debentures and Class B Exchangeable Units), which are measured at fair value. c) Consolidation The consolidated financial statements of Scott s REIT include the accounts of the REIT and its subsidiaries. All inter-entity transactions, balances and unrealized gains and losses from inter-entity transactions are eliminated on consolidation. Subsidiaries are those entities (including special purpose entities) the REIT controls by having the power to govern their financial and operating policies. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the REIT controls another entity. Subsidiaries are fully consolidated from the date on which control is obtained by the REIT and are de-consolidated from the date control ceases. (4)

12 d) Investment properties Investment properties include commercial properties held to earn rental income or held for capital appreciation or both and properties that are being constructed or developed for future use as investment properties. Investment properties are measured initially at cost, including related transaction costs in connection with asset acquisitions and borrowing costs, and excluding the costs of day-to-day servicing and maintenance of the property. Borrowing costs incurred for the purpose of acquiring or constructing a qualifying investment property are capitalized as part of its cost. The amount of borrowing costs capitalized is determined first by reference to borrowings specific to the project, where relevant, and otherwise by applying a weighted average cost of borrowings to eligible expenditures after adjusting for borrowings associated with other specific developments. Borrowing costs are capitalized while acquisition or construction is actively underway and ceases once the asset is substantially complete, or suspended if the development of the asset is suspended. Investment properties are subsequently measured at fair value at the consolidated statements of financial position date. Related fair value gains and losses are recorded in the consolidated statements of net income and comprehensive income in the period in which they arise. The fair value of the investment properties is determined based on available market evidence and management estimates and reflects, among other things, rental income from current leases and assumptions about rental income from future leases in light of current market conditions. The fair value also reflects, on a similar basis, any cash outflows that could be expected in respect of the properties. Fair value measurement on property under construction is only applied if the fair value is considered to be reliably measurable. Certain land leases held under an operating lease are classified as investment property when the definition of an investment property is met. At inception these leases are recognized at the lower of fair value of the property and the present value of the minimum lease payments and an equivalent is recognized as a land lease liability. Each lease payment is allocated between the liability and finance charges. The corresponding rental obligations, net of finance charges are included in land lease liability. The interest element of the finance cost is charged to the income statement over the lease period so as to produce a constant periodic rate of interest on the balance of the liability for each period. The fair value of investment properties is determined by a combination of appraisals prepared by qualified independent accredited valuation experts on a periodic basis on specific properties, or by using external market data provided by the external appraiser and applying such market data to derive internallydeveloped valuations. Management regularly undertakes a review of its investment properties valuation between external appraisal dates to assess the continuing validity of the underlying assumptions such as cash flows, capitalization rates and discount rates. These assumptions are tested against market information obtained from an independent appraiser. See note 7 for a discussion of the significant assumptions, estimates and valuation methods used. Subsequent capital expenditures are capitalized to investment property only when it is probable that future economic benefits of the expenditure will flow to the REIT and the cost can be measured reliably. (5)

13 Initial direct leasing costs incurred by the REIT in negotiating and arranging tenant leases are added to the carrying amount of the investment property. e) Cash and cash equivalents Cash and cash equivalents include cash on hand, deposits held with banks, and other short-term highly liquid investments with original maturities of three months or less. f) Intangible assets The REIT s intangible assets include computer software with finite useful lives. These assets are capitalized and amortized on a straight-line basis in the consolidated statement of net income over the period of their expected useful lives as follows: Computer software 2 to 5 years g) Tenant allowances Incentives such as cash, rent free periods and leasehold improvement allowances may be provided to lessees to enter into a lease. These incentives are capitalized and amortized on a straight-line basis over the term of the lease as a reduction of rental revenue. The carrying amounts of the tenant inducements are included in other assets. h) Financial instruments i) Financial assets and financial liabilities Financial assets and financial liabilities are initially recognized at fair value and are subsequently accounted for based on their classification as described below. Their classification depends on the purpose for which the financial instruments were acquired or issued, their characteristics and Scott s REIT s designation of such instruments. The standards require all financial assets and financial liabilities to be classified as fair value through profit or loss (FVTPL), loans and receivables, availablefor-sale, other liabilities or held-to-maturity. ii) Classification of financial instruments The following summarizes the classification and measurement Scott s REIT has elected to apply to each of its significant categories of financial instruments: (6)

14 Type Classification Measurement Financial assets Cash and cash equivalents FVTPL fair value Restricted cash FVTPL fair value Accounts receivable loans and receivables amortized cost Mortgage holdbacks loans and receivables amortized cost Deposits loans and receivables amortized cost Due from related parties loans and receivables amortized cost Financial liabilities Mortgages payable and term debt other liabilities amortized cost Convertible debentures FVTPL fair value Class B Exchangeable Units FVTPL fair value Accounts payable and accrued liabilities other liabilities amortized cost Due to related parties other liabilities amortized cost Distributions payable to unitholders other liabilities amortized cost Land lease liability other liabilities amortized cost iii) Fair value through profit or loss (FVTPL) Financial instruments in this category are recognized initially and subsequently at fair value. Gains and losses arising from changes in fair value are presented in the consolidated statements of net income and comprehensive income in the period in which they arise. Financial assets and liabilities at FVTPL are classified as current except for the portion expected to be realized or paid beyond 12 months of the consolidated statement of financial position date, which is classified as non-current. iv) Loans and receivables Loans and receivables are included in current assets, except for those with maturities more than 12 months after the consolidated statement of financial position date, which are classified as non-current assets. Loans and receivables are accounted for at amortized cost. v) Other liabilities Such financial liabilities are recorded at amortized cost and include all liabilities other than derivatives and liabilities that are designated to be accounted for at FVTPL. vi) Transaction costs Transaction costs related to financial assets and liabilities classified as FVTPL are expensed as incurred and included in general and administrative expenses. Transaction costs related to loans and receivables and other liabilities are netted against the carrying value of the asset or liability and amortized over the expected term of the instrument or over the amortization period of the mortgage using the effective interest rate method. (7)

15 vii) Embedded derivatives Derivatives embedded in other financial instruments or contracts are separated from their host contracts and accounted for as derivatives when: their economic characteristics and risks are not closely related to those of the host contract; the terms of the embedded derivative are the same as those of a free-standing derivative; and the combined instrument or contract is not measured at fair value. These embedded derivatives are measured at fair value with changes therein recognized in the consolidated statement of net income. i) Mortgages payable Mortgages payable are recognized at amortized cost using the effective interest rate method. Under the effective interest rate method, any transaction fees, costs and discounts directly related to the mortgage are recognized in the consolidated statement of net income over the expected term of the mortgage. Mortgage maturities and repayments due more than 12 months after the consolidated statement of financial position date are classified as non-current. j) Exchangeable Units The Class B LP Units of Scott s LP are exchangeable on demand for Trust Units (Exchangeable Units). As the Trust Units are redeemable at the holder s option, the Exchangeable Units are classified as long-term liabilities. The distributions on the Exchangeable Units are recognized in the consolidated statements of net income as interest expense under IFRS and the interest payable at the reporting date is reported under accounts payable and accrued liabilities on the consolidated statement of financial position. These Exchangeable Units are remeasured at each reporting date at fair value with changes in the carrying amount recognized in the consolidated statements of net income. On October 28, 2011, all Class B Exchangeable Units were exchanged for REIT Units (note 1). k) Convertible debentures Under IFRS, the REIT has classified its convertible debentures as financial liabilities measured at FVTPL. Scott s REIT has concluded that the convertible debentures include embedded derivatives under IFRS and accounts for the combined instrument at fair value. l) Revenue recognition Scott s REIT recognizes rental revenue using the straight-line method whereby the total amount of rental revenue to be received from all leases is accounted for on a straight-line basis over the term of the related leases. The difference between the rental revenue recognized and the amounts contractually due under the lease agreements are accrued as rent receivable, which is included as a component of other assets on the consolidated statements of financial position. (8)

16 Recoveries from tenants are recognized as revenue in the period in which the recoverable costs are incurred. Percentage participation rents are recognized when the minimum sales level has been achieved with each lease. m) Distributions on Trust Units Distributions represent the monthly cash distributions on outstanding Trust Units. Distributions are recognized as a deduction from retained earnings for the Trust Units classified as equity, and as interest expense for the Exchangeable Units classified as a liability in the Trust s financial statements in the period in which the distributions are approved by the Board of Trustees. n) Earnings per Unit As a result of the redemption feature of the REIT s Trust Units, these Units are considered financial liabilities under IAS 32 and they may not be considered equity for the purposes of calculating net income on a per Unit basis. Consequently, Scott s REIT has not reported an earnings per Unit amount. o) Unit-based compensations The REIT s Unit-based compensation plan grants units to eligible participants that vest immediately and are recognized in the consolidated statement of net income on the date of the grant. Restricted stock Units granted in accordance with a specific employee contract are recognized as compensation expense over the vesting period of the restricted Unit grant. The grant is recognized as a liability on the statement of financial position and measured at fair value each reporting period. When the grants are fully vested, Units will be issued and the fair value of the grant liability on that date will be reclassified to Class A Units within unitholder s equity. p) Provisions Provisions are recognized when Scott s REIT has: (i) a present legal or constructive obligation as a result of past events; (ii) it is probable that an outflow of resources will be required to settle the obligation; and (iii) the amount can be reliably estimated. Provisions are not recognized for future operating losses. The amount recognized as a provision is the best estimate of the consideration required to settle the present obligation at the statement of financial position date. Where a provision is measured using cash flows estimated to settle the present obligation, its carrying amount is the present value of the expected expenditures to settle the obligation using a discount rate that reflects current market assessments of the time value of money and the risks specific to the obligation. Provisions are re-measured at each reporting date using the current discount rate. The increase in the provision due to the passage of time is recognized as interest expense. Scott s REIT has not recognized any provisions as of the date of this report. (9)

17 q) Income taxes Scott s REIT is taxed as a mutual fund trust for Canadian income tax purposes. The Trust intends to distribute all of its taxable income to its unitholders, which enables the Trust to deduct such distributions for income tax purposes. As the income tax obligations relating to the distributions are those of the unitholders, no provision for income taxes is required on such amounts. The Trust intends to continue to distribute its taxable income and continue to qualify as a real estate investment trust for the foreseeable future. As such, future income taxes have not been recorded in these consolidated financial statements. r) Future accounting changes As of March 7, 2012, the following new or amended IFRS have been issued by the International Accounting Standards Board and are expected to apply for fiscal periods beginning after 2011, or later as set out below: IAS 1, Presentation of Financial Instruments; IFRS 1, First-time Adoption of International Financial Reporting Standards; IFRS 7, Financial Instruments - Disclosures; IFRS 9, Financial Instruments; IAS 12, Income Taxes; IFRS 13, Fair Value Measurement; IFRS 10, Consolidated Financial Statements; IFRS 11, Joint Arrangements; and IFRS 12, Disclosure of Interest in Other Entities. Amendments to IFRS 1 relate to severe hyperinflation environments and remove fixed dates for first-time adopters. Amendments to IFRS 7 relate to disclosures with respect to the transfers of financial assets. The new requirements are effective for annual periods beginning on or after July 1, 2011, with earlier application permitted. The new IFRS 9 replaces the current IAS 39 and introduces new requirements for the classification and measurement of financial assets, to be measured at either amortized cost or fair value. The new requirements are effective for annual periods beginning on or after January 1, 2015, with earlier application permitted. The amendments to IAS 12 provide a solution to the issue of assessing whether the recovery of the carrying value of an asset will be through use or through sale when the asset is measured using the fair value model. The amendment introduces the rebuttable presumption that recovery of the carrying amount will normally be through sale. The new requirements are effective for annual periods beginning on or after January 1, 2012 with earlier application permitted. In June 2011, the IASB made amendments to IAS 1, Presentation of Financial Statements, which will require entities to group items presented in Other Comprehensive Income on the basis of whether they will or will not subsequently be reclassified to profit or loss. The amended version of IAS 1 is effective for annual periods beginning on or after July 1, 2012, with earlier adoption permitted. On May 13, 2011, the IASB issued IFRS 13, Fair Value Measurement. IFRS 13 defines fair value, sets out in a single IFRS a framework for measuring fair value and requires disclosures about fair value measurements. IFRS 13 applies when other IFRS require or permit fair value measurements. It does not introduce any new requirements to measure an asset or a liability at fair value, change what is measured at fair value in IFRS or address how to present changes in fair value. The new requirements are effective for annual periods beginning on or after January 1, 2013, with earlier application permitted. On May 13, 2011, the IASB issued IFRS 10, Consolidated Financial Statements, IFRS 11, Joint Arrangements, and IFRS 12, Disclosure of Interest in Other Entities. IFRS 10 provides a single consolidation model that identifies control as the basis for consolidation for all types of entities. IFRS 10 replaces IAS 27, Consolidated and Separate Financial Statements, and SIC-12, Consolidation - Special (10)

18 Purpose Entities. IFRS 11, Joint Arrangements, establishes principles for the financial reporting by parties to a joint arrangement. IFRS 11 supersedes IAS 31, Interests in Joint Ventures, and SIC-13, Jointly Controlled Entities - Non-monetary Contributions By Venturers. IFRS 12 combines, enhances and replaces the disclosure requirements for subsidiaries, joint arrangements, associates and unconsolidated structured entities. As a consequence of these new IFRS, the IASB also issued amended and retitled IAS 27, Separate Financial Statements, and IAS 28, Investments in Associates and Joint Ventures. The new requirements are effective for annual periods beginning on or after January 1, 2013, with earlier application permitted. Scott s REIT is assessing the impact to the consolidated financial statements of the above standards upon adoption in their current form. 4 Critical accounting estimates, assumptions and judgments The preparation of consolidated financial statements in accordance with IFRS requires the use of estimates, assumptions and judgment that in some cases relate to matters that are inherently uncertain and affect the amounts reported in the consolidated financial statements and accompanying notes. Areas of such estimation include, but are not limited to: valuation of investment properties, remeasurement at fair value of financial instruments, leases, compliance with REIT legislation, treatment of REIT Units and subsidiary redeemable units, business combinations, valuation of accounts receivable, capitalization of costs, and accounting accruals. Changes to estimates and assumptions may affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could also differ from those estimates under different assumptions and conditions. The estimates deemed to be more significant, due to subjectivity and the potential risk of causing a material adjustment within the next financial year to the carrying amounts of assets and liabilities, are discussed below. a) Valuation of investment properties Investment properties are measured at fair value as at the consolidated statements of financial position date. Any changes in the fair value are included in the consolidated statements of net income. Fair value is supported by periodic independent external valuations prepared by accredited valuation experts or detailed internal valuations using market based assumptions, each in accordance with recognized valuation techniques. The techniques used are the capitalized net operating income method, and the discounted cash flow method, and includes estimating, among other things, future stabilized net operating income, capitalization rates, reversionary capitalization rates, discount rates and other future cash flows applicable to investment properties. Valuation of investment properties is subject to significant judgment, estimates and assumptions about market conditions in effect as at the consolidated statements of financial position date. See note 7 for a discussion of valuation methods and the significant assumptions and estimates used. (11)

19 b) Fair value of financial instruments The fair value of a financial instrument on initial recognition is generally the transaction price, which is the fair value of the consideration given or received. Subsequent to initial recognition, the fair values of financial instruments are remeasured based on relevant market data. Scott s REIT classifies the fair value for each class of financial instrument based on the fair value hierarchy in accordance with IFRS 7. The fair value hierarchy distinguishes between fair value data obtained from independent sources and Scott s REIT s own assumptions about fair value. See note 18 for a discussion of valuation methods used for financial instruments quoted on an active market and instruments valued using observable data. c) Leases In applying the revenue recognition policy, judgments are made with respect to whether tenant improvements provided in connection with a lease enhance the value of the leased space, which impacts whether or not such amounts are treated as additions to the investment property. Judgments are also made in determining whether certain leases, in particular those with long contractual terms where the lessee is the sole tenant in a property and long-term ground leases where the REIT is the lessee, are operating or finance leases. The REIT has determined that all of its leases where the REIT is a lessor are operating leases. The REIT has chosen to account for certain land leases, where the REIT is the lessee, as finance leases. d) Compliance with REIT legislation In order to continue to be taxed as a mutual fund trust, the REIT needs to maintain its REIT status as defined by the Specified Investment Flow Through ( SIFT ) rules in the Canadian Income Tax Act. The REIT s current and continuing qualification as a REIT depends on its ability to meet the various requirements imposed under the SIFT rules, which relate to matters such as its organizational structure and the nature of its assets and revenues. The REIT applies judgment in determining whether it continues to qualify as a REIT under the SIFT rules. e) Treatment of REIT Units The REIT has considered the criteria in IAS 32 and has classified the REIT Units as equity because of the puttable exemption. f) Treatment of subsidiary redeemable units The REIT has considered the criteria in IAS 32 and has classified the subsidiary redeemable units as a liability because they do not have identical features to REIT Units and are not the most subordinated instrument. g) Business combinations Accounting for business combinations under IFRS 3, Business Combinations (IFRS 3), only applies if it is considered that a business has been acquired. Under IFRS 3, a business is defined as an integrated set of activities and assets conducted and managed for the purpose of providing a return to investors or lower (12)

20 costs or other economic benefits directly and proportionately to the REIT. A business generally consists of inputs, processes applied to those inputs, and resulting outputs that are, or will be, used to generate revenues. In the absence of such criteria, a group of assets is deemed to have been acquired. If goodwill is present in a transferred set of activities and assets, the transferred set is presumed to be a business. Judgment is used by management in determining if the acquisition of an individual property qualifies as a business combination in accordance with IFRS 3 or as an asset acquisition. When determining whether the acquisition of an investment property or a portfolio of investment properties is a business combination or an asset acquisition, the REIT applies judgment when considering the following: whether the investment property or properties are capable of producing outputs whether the market participant could produce outputs if missing elements exist In particular, the REIT considers the following: whether employees were assumed in the acquisition whether an operating platform has been acquired Currently, when the REIT acquires properties or a portfolio of properties, does not take on or assume employees, or does not acquire an operating platform, it classifies the acquisition as an asset acquisition. 5 Transition to IFRS The effect of the REIT s transition to IFRS is outlined below: a) Transition exemptions and exceptions i) Business combinations As part of its transition to IFRS, the REIT has elected to not restate those business combinations that occurred prior to January 1,. ii) Other transitional exemptions and guidance IFRS 1 allows for certain other optional exemptions; however, such exemptions were not deemed to be significant to the REIT s adoption of IFRS. iii) Mandatory exceptions In preparing these consolidated financial statements in accordance with IFRS 1, Scott s REIT applied certain mandatory exceptions from full retrospective application of IFRS. In accordance with IFRS 1, hindsight was not used to create or revise estimates and accordingly the estimates made by the REIT under IFRS are consistent with their application under Canadian GAAP. (13)

21 b) Reconciliation of unitholders equity as previously reported under Canadian GAAP to IFRS January 1, Canadian GAAP Adjustment IFRS Canadian GAAP Adjustment IFRS Assets Current assets Cash and cash equivalents 4,846-4,846 16,004-16,004 Accounts receivable Due from related parties Other assets (v) 1,931 (215) 1, (29) 766 Straight-line rent receivable (ii) 2,733 (2,733) - 2,446 (2,446) - 9,672 (2,948) 6,724 19,593 (2,475) 17,118 Non-current assets Investment properties (i) 202,703 51, , ,525 33, ,175 Intangible assets (i) 9,533 (9,511) 22 7,743 (7,691) 52 Prepaid expenses and other assets (ii), (v) - 2,915 2,915-2,829 2,829 Liabilities 212,236 44, , ,268 28, , ,908 42, , ,861 26, ,174 Current liabilities Accounts payable and accrued liabilities (v) 1, ,348 1, ,393 Due to related parties Distribution payable to unitholders (iii) 654 (160) (159) 354 Mortgages payable and term debt (v) - 86,004 86,004-66,137 66,137 Other liabilities (i) 3,879 (3,879) (151) - 5,850 81,996 87,846 2,065 65,936 68,001 Non-current liabilities Mortgages payable and term debt (v) 130,757 (86,004) 44, ,600 (66,137) 45,463 Convertible debentures (iv) 37,754 3,396 41,150 37,074 2,624 39,698 Class B Exchangeable Units (iii) 11,649 6,210 17,859 14,334 2,691 17,025 Accounts payable (v) ,160 (76,269) 103, ,008 (60,772) 102, ,010 5, , ,073 5, ,237 Equity Class A Units 58,830-58,830 44,676-44,676 Contributed surplus 2,588-2,588 2,588-2,588 Cumulative losses (vi) (2,437) 2,437 - (183) Cumulative distributions declared on Class A Units (vi) (24,348) 24,348 - (18,558) 18,558 - Convertible debentures (iv) 1,265 (1,265) - 1,265 (1,265) - Retained earnings (vi) - 10,755 10,755-3,673 3,673 35,898 36,275 72,173 29,788 21,149 50, ,908 42, , ,861 26, ,174 (14)

22 c) Reconciliation of net income (loss) and comprehensive income (loss) for the year as previously reported under Canadian GAAP to IFRS Year ended Canadian GAAP Adjustment IFRS Revenue Rental revenue 22, ,342 Amortization of (above) below-market rentals (i) 118 (118) - Straight-line rent (ii) 287 (287) - 22,489 (147) 22,342 Operating income (expenses) Direct operating (3,688) - (3,688) General and administrative (1,740) 51 (1,689) Amortization (i) (9,480) 9,422 (58) Fair value adjustment on investment properties (i) - 10,091 10,091 Operating income (expenses) (14,908) 19,564 4,656 Income from operations 7,581 19,417 26,998 Other income (expenses) Interest income (vii) Interest expense (iii) (10,604) (1,302) (11,906) Fair value adjustment on Class B Exchangeable Units (iii) - (834) (834) Fair value adjustment on convertible debentures (iv) - (1,452) (1,452) Other income (expenses) (10,604) (3,522) (14,126) Income (loss) before non-controlling interest (3,023) 15,895 12,872 Non-controlling interest of Class B Exchangeable Units (iii) 769 (769) - Net income (loss) and comprehensive income (loss) for the year (2,254) 15,126 12,872 (15)

23 Notes to the reconciliations i) Investment properties Under Canadian GAAP, investment properties were recorded at cost and amortized over their estimated lives. Under IAS 40, Investment Property (IAS 40), the REIT has elected to measure investment property at fair value and records changes in fair value in net income during the period of change. In addition, intangible assets and other liabilities acquired on the acquisition of investment properties under Canadian GAAP have been de-recognized on transition to IFRS as the fair value of intangible assets and other liabilities are deemed to be included in the fair value of investment properties. Accordingly, on the date of transition, intangible assets and other liabilities of 7,691 and (151), respectively, were de-recognized. In addition, a fair value adjustment of 10,091 is recorded in the net income for the year ended. Under IFRS, no amortization is recorded in respect of investment properties. As at January 1,, the excess of fair value of investment properties over net book value is recognized as an adjustment to retained earnings in the amount of 26,110. ii) Reclassification of straight-line rent receivable The straight-line rent balance has been excluded from the fair value of investment property balance and has been reclassified and presented as a non-current asset. The straight-line rent impact is included in rental revenue for IFRS rather than presented separately within revenue for Canadian GAAP. iii) Class B Exchangeable Units Under Canadian GAAP, the REIT accounted for its Class B Exchangeable Units as a non-controlling interest presented separately from unitholders equity. In accordance with IAS 32, Financial Instruments - Classification (IAS 32), these Units have been reclassified from unitholders equity to liabilities because they are not the least subordinated instrument of Units in issuance and because there is a redemption feature at the option of the holder. At each reporting period the Class B Exchangeable Units are measured at fair value, which is based on the fair value of the Class A REIT Units. Accordingly, on transition to IFRS, an adjustment is recorded to reclassify these Units from a non-controlling interest to a non-current liability and a fair value adjustment of 2,691 is recorded as a credit to opening retained earnings. In addition, the distributions on Class B Exchangeable Units in the amounts of 1,302 are recorded as interest expense in net income and a fair value remeasurement adjustment of (834) is recorded in net income for the year ended. On January 1, and, 159 and 160 have been reclassified from distributions payable to interest payable included in accounts payable and accrued liabilities and amounts payable. (16)