Ch 4,9,7,8,10

CA4.1 As a reviewer for the Ontario Securities Commission, you are reviewing the
financial statements of public companies. The following items have come to your
attention:

A merchandising company overstated its ending inventory two years ago by a material
amount. Inventory for all other periods is correctly calculated.
An automobile dealer sells for $137,000 an extremely rare 1930 S-type Invicta, which it
purchased for $21,000 10 years ago. The Invicta is the only such display item that the
dealer owns.
During the current year, a drilling company extended the estimated useful life of certain
drilling equipment from 9 to 15 years. As a result, depreciation for the current year was
materially lowered.
A retail outlet changed its calculation for credit losses from 1% to 0.5% of sales because
of changes in its clientele.
A mining company sells a large foreign subsidiary that does uranium mining, although
the company continues to mine uranium in other countries.
A steel company changes from straight-line depreciation to accelerated depreciation in
accounting for its plant assets, stating that the expected pattern of consumption of the
future economic benefits has changed.
A construction company, at great expense to itself, prepares a major proposal for a
government loan. The loan is not approved.
A water pump manufacturer has large losses resulting from a strike by its employees
early in the year.
Depreciation for a prior period was incorrectly understated by $950,000. The error was
discovered in the current year.
A large sheep rancher suffered a major loss because the provincial government
required that all sheep in the province be killed to halt the spread of a rare disease.
Such a situation has not occurred in the province for 20 years.
A food distributor that sells wholesale to supermarket chains and to fast-food
restaurants (two major classes of customers) decides to discontinue the division that
sells to one of the two classes of customers.

Instructions
Discuss the financial reporting issues.

IC4.1 Snow Spray Corp. (SSC) recently filed for bankruptcy protection. The company
manufactures downhill skis and reports under ASPE. With the increased popularity of
other winter sports such as snowboarding and tubing, sales of skis are decreasing.
Therefore, the company has decided to start a new line of products targeting the
growing snowboarding and tubing industry. However, the company currently needs
interim financing to pay suppliers and its payroll. It also needs a significant amount of
cash so that it can reposition itself in the marketplace. Management is planning to go to
the bank with draft financial statements to discuss additional financing. The company’s
year end is December 31, 2022, and it is now January 15, 2023. Current interest rates
for loans are 5%, but because it is in bankruptcy protection, SSC believes that it will
likely have to pay at least 15% on any loan. There is concern that the bank will turn the
company down.
At a recent management meeting, the company decided to convert its ski manufacturing
facilities into snowboard manufacturing facilities. It will no longer produce skis.
Management is unsure if the company can recover the cost of the ski inventory.
Although the conversion will result in significant expenditures, the company believes
that this is justified if SSC wants to remain viable. The shift in strategic positioning will
not result in any layoffs, since most employees will work in the retrofitted plant. The
remaining employees will be trained in the new business.
The conversion to snowboard manufacturing facilities would not require the sale of any
ski manufacturing machines. These machines can be used to produce snowboards. The
company estimates that it will incur negative cash flows and a loss of $20 million from
discontinuing ski sales.
On December 15, 2022, the company entered into an agreement with Cashco Ltd. to
sell its entire inventory of ski bindings to Cashco. Under the terms of the deal, Cashco
paid $10 million cash for the inventory (its regular selling price at the time). The cost to
SSC of this inventory was $6 million and so a profit of $4 million was booked pre-tax. In
a separate deal, SSC agreed to buy back the inventory in January for $10,125,000.
Before filing for bankruptcy protection, the company was able to buy a large shipment of
snow tubes wholesale for a bargain price of $7 million from a supplier that was in
financial trouble. The value of the inventory is approximately $10 million. The inventory
was sitting in the SSC manufacturing facility consuming significant space. Given that the
manufacturing facility was being renovated, SSC reached an agreement with its leading
competitor, Alpine Gear Ltd. (AGL). According to the contract, AGL agreed to purchase
the snow tubes from SSC for $8 million, and SSC shipped the inventory on December
31 to arrive on January 5. The inventory was shipped f.o.b. shipping point. SSC
normally reimburses its customers if the inventory is damaged in transit. SSC has a
tentative verbal agreement that it will repurchase the snow tubes that AGL does not sell
by the time the renovations are complete (in approximately six months). The buyback
price will include an additional amount that will cover storage and insurance costs.

Instructions
Adopt the role of Rachel Glover—the company controller—and discuss the financial
reporting issues related to the preparation of the financial statements for the year ended
December 31, 2022.

CA7.1 An icon reads, Finance. An icon reads, Ethics. Hanley Limited manufactures
products that capture solar energy. The company plans to list its shares on the Venture
Exchange. To do so, it must meet all of the following initial listing requirements (among
others):

Net tangible assets must be at least $500,000.

Pre-tax earnings must be $50,000.
The company must have adequate working capital.

Hanley has experienced significant growth in sales and is having difficulty estimating its
related loss on impairment. During the year, the sales team extended credit more
aggressively in order to increase their commission compensation. Under the
percentage-of-receivables approach using past percentages, the estimate is $50,000.
Hanley has performed an aged receivables analysis and estimates the loss on
impairment at $57,000. Finally, performing a percentage-of-sales analysis results in an
estimated expense of $67,000. Before booking the allowance, net tangible assets are
approximately $550,000. The controller decides to accrue $50,000, which results in
pre-tax earnings of $60,000.
Instructions
Adopt the role of the Venture Exchange financial analyst and decide whether the
company meets the financial aspects of the initial requirements for listing on the Venture
Exchange.

CA7.2 An icon reads, Real World Emphasis. TELUS Corporation is one of Canada’s
largest telecommunications companies and provides both products and services. Its
shares are traded on the Toronto and New York stock exchanges, and its credit facilities
contain certain covenants relating to the amount of debt the company is allowed to
carry.
The following are selected excerpts from the 2019 audited financial statements:
Note 22 – SHORT-TERM BORROWINGS
On July 26, 2002, one of our subsidiaries, TELUS Communications Inc., entered into an
agreement with an arm’s-length securitization trust associated with a major Schedule I
bank under which it is able to sell an interest in certain of its trade receivables up to a
maximum of $500 million (2018 – $500 million). This revolving-period securitization term
ends December 31, 2021, and it requires minimum cash proceeds of $100 million from
monthly sales of interests in certain trade receivables. TELUS Communications Inc. is
required to maintain a credit rating of at least BB (2018 – BB) from DBRS Limited or the
securitization trust may require the sale program to be wound down prior to the end of
the term.
Sales of trade receivables in securitization transactions are recognized as collateralized
short-term borrowings and thus do not result in our de-recognition of the trade
receivables sold. When we sell our trade receivables, we retain reserve accounts, which
are retained interests in the securitized trade receivables, and servicing rights. As at
December 31, 2019, we had sold to the trust (but continued to recognize) trade
receivables of $124 million (2018 – $120 million). Short-term borrowings of $100 million
(2018 – $100 million) are comprised of amounts advanced to us by the arm’s-length
securitization trust pursuant to the sale of trade receivables.
The balance of short-term borrowings (if any) is comprised of amounts drawn on our
bilateral bank facilities.
Instructions
Assume the role of a financial analyst with a private company in the same business as
TELUS that is considering going public. Discuss the differing accounting treatment
options regarding the securitization transactions under IFRS and ASPE.
ntegrated Cases
(Hint: If there are issues here that are new, use the conceptual framework to help you
support your analysis with solid reasoning.)

IC7.1 Fritz’s Furniture (FF) is a mid-sized owner-operated business that was started 25
years ago by Fred Fritz. The retail furniture business is cyclical, with business dropping
off in times of economic downturn, as is the case currently. To encourage sales, the
store offers its own credit cards to good customers. FF has run into a bit of a cash
crunch and is planning to go to the bank to obtain an increase in its line of credit in order
to replenish and expand the furniture stock. At present, the line of credit is limited to
70% of the credit card receivables and inventory. The receivables and inventory have
been pledged as security for the loan.
Fred has identified two possible sources of the cash shortage: outstanding credit card
receivables and a build-up in old inventory. He has come up with two strategies to deal
with the problem:

Credit card receivables: For the existing receivables, Fred has found the company
Factors Inc., which will buy the receivables for 93% of the face value. The two
companies are currently negotiating the terms of the deal. So far, FF has agreed to
transfer legal title of the receivables to Factors Inc., and FF will maintain and collect the
receivables. The remaining outstanding item being discussed is whether Factors Inc.
will have any recourse to FF if the amounts become uncollectible.
Excess inventory: A new sales promotion has been advertised in the newspaper for the
past two months. Under the terms of the promotion, customers do not pay anything up
front and will be able to take the furniture home and begin payments the following year.
Response to the advertisement has been very good and a significant amount of
inventory has been sold to date, leaving room for new inventory once the bank financing
comes through.

Instructions
Assume the role of FF’s controller and advise Fred about the impact of the strategies on
the company’s financial reporting. The company follows ASPE.
CA8.1 Tobacco Group Inc. (TGI) is in the consumer packaged goods industry. Its shares
are widely held, and key shareholders include several very large pension funds.
In the current year, 59% of the net revenues and 61% of operating income came from
tobacco product sales. Due to the health risks related to the use of tobacco products,
the industry is increasingly regulated by government and the company is implicated in
substantial tobacco-related litigation.
During the past three years, the company entered into agreements with the government
to settle asserted and unasserted health-care recovery costs and other claims. The
agreements, known as the Government Settlement Agreements, call for payments by
the domestic tobacco industry into a fund in the following amounts:

Current year
$10.9 billion

Following four years

$8 billion each year

Thereafter
$9 billion each year

The fund will be used to settle claims and aid tobacco growers. Each company’s share
of these payments is based on its market share, and TGI records its portion of the
settlement costs as cost of goods sold on shipment. These amounts may increase
based on several factors, including inflation and industry volume. In the past three
years, the company has accrued costs of more than $5 billion each year.
Another significant class action lawsuit is still in process. Last year, the jury returned a
verdict assessing punitive damages against various defendants, and TGI was
responsible for $74 billion. The company is contesting this, and the lawsuit continues.
As a result of preliminary judicial stipulations, the company has placed $500 million in a
separate interest-bearing escrow account. This money will be kept by the court and
distributed to the plaintiffs regardless of the outcome of the trial. The company also
placed $1.2 billion in another escrow account, and this amount will be returned to the
company if it wins the case.
Instructions
Assume the role of a financial analyst and discuss the related financial reporting issues.
Specifically, note alternative accounting treatments for each issue and recommend how
each issue should be treated in the financial statements.

CA8.2 Findit Gold Inc. (FGI) was created in 2015 and is 25% owned by Findit Mining
Corporation (FMC). FGI’s shares trade on the local exchange and its objective is to
become a substantial low-cost mineral producer in developing countries. FMC provided
substantial financial support to FGI when FGI was in the exploration stage.
Over the most recent five-year period, FGI carried its gold bullion inventory at net
realizable value and recognized revenues on the gold produced (net of refining and
selling costs) at net realizable value, when the minerals were produced. Gold is a
commodity that trades actively and whose price fluctuates according to supply and
demand.
Instructions
Assume the role of the controller of FMC and assess the financial reporting policies
relating to inventory valuation and revenue recognition at FGI.

Cases
Refer to the Case Primer in Wiley’s course resources to help you answer these cases.
CA9.1 Investment Company Limited (ICL) is a private company owned by 10 doctors.
The company’s objective is to manage the doctors’ investment portfolios. It began as an
investment club 10 years ago. At that time, each doctor invested equal amounts of cash
and the group met every other week to determine where the money should be invested.
Eventually, they decided to incorporate the company and each doctor now owns one
tenth of the voting shares. The company employs two managers who look after the
business full-time and make the investment decisions with input from the owners.
Earnings per year after taxes now average $1.5 million. During the year, the following
transactions took place:

Investment A (IA): Purchased common shares of IA for $1 million. IA allows researchers

to use expensive lab equipment (which is owned by the company) on a pay-per-use
basis. These shares represent 15% of the total outstanding common shares of IA.
Given its percentage ownership, ICL is permitted to appoint one member of IA’s board
of directors. There are three directors on the board. One of the ICL owners has also
been hired as a consultant to IA to advise on equipment acquisitions. The company is
unsure of how long it will keep the shares. At least two of the ICL owners are interested
in holding on to the investment for the longer term, since they use the services of IA.
The fair value of the shares of IA is determined annually by a valuation expert.
Investment B (IB): Purchased preferred shares of IB representing 25% of the total
outstanding shares. The shares will likely be resold within two months, although no
decision has yet been made. The fair value of this investment is known.
Investment C (IC): Purchased a 25% interest in voting common shares of IC for $1
million two years ago. The current carrying amount is $950,000, as a result of the
company’s research and development activities related to drug development. IC
develops drug delivery technology. In the past week, a major drug that the company has
spent large amounts (approximately $10 million) for research and development was
declined by the Food and Drug Administration for sale in the United States. Most of the
$10 million had previously been capitalized in the financial statements of IC. This is a
significant blow to IC, since it was projecting that 50% of its future revenues would come
from this drug. IC does not produce financial statements until two months after ICL’s
year end.
Although ICL’s investments have been mainly in private companies so far, the doctors
are thinking of revising their investment strategy and investing in more public
companies. They believe that the stock market is poised for recovery; therefore, they
are planning to borrow some funds for investment purposes. The accountant is currently
reviewing the above transactions in preparation for a meeting with the bank. The
company has never prepared GAAP statements before but is considering doing so. The
company has not decided which GAAP to follow (IFRS or ASPE).
Instructions
Adopt the role of the company’s accountant and analyze the financial reporting issues.

CA9.3 Impaired Investments Limited (IIL) is in the real estate industry. Last year, the
company divested itself of some major investments in real estate and invested the funds
in several instruments, as follows:

investments in 5% bonds: currently carried at amortized cost

investments in common shares (no significant influence or control and not held for
trading)—Company A: currently carried at fair value, with gains and losses booked to
income
investments in common shares—Company B: currently carried at fair value, with gains
and losses booked to income
During the current year, similar bonds available in the marketplace are yielding 6%.
Although the company is not certain why this is the case, the controller thinks it may be
due to greater perceived risk associated with changes in the economy and specifically
the real estate industry. The investment in Company A shares is significantly below cost
at year end, according to current market prices (Company A’s shares trade on a stock
exchange). The investment in Company B shares is also below cost, but the controller
believes that this is just a temporary decline and not necessarily an impairment. The
controller plans to sell these shares as soon as the decline in price reverses and a 10%
return on investment is achieved. The shares of Company B also trade on a stock
exchange.
IIL is currently a private entity but has recently considered going public, perhaps in the
next five years, and plans to adopt IFRS this year.
Instructions
Adopt the role of the controller and discuss the financial reporting issues related to the
IIL financial statements.

CA10.1 Real Estate Investment Trust (RE) was created to hold hotel properties. RE
currently holds 15 luxury and first-class hotels in Europe. The entity is structured as an
investment trust, which means that the trust does not pay income taxes because it
directly distributes to unitholders taxable income from the assets that it holds directly.
Instead, income taxes are paid by the unitholders—those who own units in the trust.
The other key feature of the trust is that a certain percentage of the distributable income
is required to be paid to unitholders every year. The units of RE trade on a Canadian
stock exchange.
Distributable income is calculated as net income (according to GAAP) before special
charges, less a replacement reserve (which is an amount set aside to refurbish assets).
RE distributed 127% and 112% of its distributable income in 2023 and 2022,
respectively. Management calculates distributable income since this calculation is not
defined by GAAP. At the end of 2023, property and equipment was worth $1.7 billion
compared to $1.9 billion in total assets. Net income for the year was $55 million.
According to the notes to the financial statements, RE accounts for its property, plant,
and equipment at amortized cost.
Instructions
Assume the role of the entity’s auditor and discuss any financial reporting issues.

IC10.1 Iskra Vremec and Colin McFee are experienced scuba divers who have spent
many years in the salvage business. About a year ago, they decided to start their own
company to recover damaged and sunken vessels and lost cargoes off the east coast of
Canada. They incorporated Atlantic Explorations Limited (AEL) on February 1, 2022.
Iskra (president) and Colin (vice-president) each own 30% of AEL’s shares. The
remaining 40% of the shares were purchased by a group of 10 investors who
contributed $50,000 each so that AEL could acquire the necessary equipment and
cover other start-up costs.
AEL carries on two types of activities. The first is a commercial salvage operation. The
second is treasure hunting. To date, commercial salvage operations have generated all
AEL’s revenues. The demand for these services is strong, and there are few
competitors because of the unpredictable nature of the business and the long hours.
Colin manages the commercial salvage operations. Customers pay in three instalments,
including an upfront fee, a fee payable approximately midway through the contract, and
a fee at the end once the items in question have been salvaged (found and brought to
land). If the item is never found or AEL cannot bring the item to the surface and to land,
then the final payment is not made by the customer.
Iskra spends most of her time locating and recovering underwater artifacts and, where
possible, sunken treasure. Her research shows that numerous vessels carrying gold,
silver, and other valuables to the “Old World” were wrecked off the shores of Nova
Scotia. AEL has permits to investigate three target areas. As compensation for the
permits, AEL agrees to remit 1% of the fair value of any treasure found. These funds
are to be invested in the local economy by AEL (subject to government approval). The
company also pays an upfront fee that allows it to search a given area. AEL recently
made a potentially lucrative discovery in the first of these target areas.
It is now September 5, 2022. AEL has engaged your auditing firm to provide advice on
the accounting treatment for the ongoing operations and the discovery that AEL has just
made. You (as audit manager) and Alex Green, the partner assigned to the
engagement, met with Colin and Iskra.
During your meeting, Iskra said that she believes that finding treasure is like winning a
lottery, as all revenues accrue to AEL and thus should be treated accordingly. If this
discovery proves to be as substantial as preliminary results suggest, AEL will require
additional financing of $1.5 million to acquire equipment and an on-shore laboratory and
to lease a specially equipped vessel needed to salvage the wreck and its treasures. The
bank has said that it is not willing to advance further funds. However, Iskra and Colin
know of other individuals who are interested in investing in AEL.
AEL receives grants from the government to help find treasure and salvage sunken
vessels. Iskra and Colin have just found out that they are likely to receive a grant in
connection with the recent discovery.
Instructions
An icon reads, Audit. Draft a memo for the audit partner, Alex Green, analyzing all
financial reporting issues and providing recommendations.