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Question 1
 
Estimated time to complete: 2¼ hours
Yellow Communications Limited is a public company whose shares are traded on the TSX. The company is a diversified Canadian communications company whose core operations include cable, Internet, and satellite distribution systems. The consolidated statement of shareholders’ equity is presented in Exhibit 1-1, and extracts from various disclosure notes are presented in Exhibit 1-2.
 
Required
 
Based on the information in this question and the course material, answer the following questions
 

1. What characteristics must the convertible bonds display in order to justify the accounting treatment followed on initial recognition?

 

2. How was the portion of the bonds assigned to debt on initial recognition valued?

 

3. A portion of the bonds was converted to common shares in 2012. What financial statement elements changed as a result, and by what dollar value? Be as specific as possible.

 

4. Describe the financial statement impact for the $276 of options recognized in 2012. (That is, what accounts changed because of this amount?) How was the recorded amount measured?

 

5. What amounts appear on the statement of cash flow (section, description, and amount) as a result of the transactions in shareholders’ equity in 2012? Assume that the company uses the indirect presentation method for operating activities, and that dividends are included in operating activities. (Disregard cash flow disclosure for interest paid.)

 
Exhibit 1-1: Consolidated statement of shareholders’ equity
 
YELLOW COMMUNICATIONS LIMITED
 
Consolidated Statement of Shareholders’ Equity
 
for the year ended December 31, 2012
(in thousands)
 

	Class A shares	Class B shares	Contributed surplus — options	Contributed surplus — share retirement	Equity element re: convertible debentures	Retained earnings	Treasury stock
Opening balances	$12,487.00	$2,112.60	$1,480.20	—	$72.20	$4,657.30	$(120.30)
Partial conversion of convertible bond		490.40	(43.30)
Net profit and comprehensive income		1,270.80
Dividends	110.00					(455.00)
Disposal		(16.00)	40.90*
Shares purchased for cancellation		(422.40)		$161.30
Recognition during the year			276.00
Issuance	642.40		(362.00)
Closing balances	$13,239.40	$2,180.60	$1,394.20	$161.30	$28.90	$5,457.10	$(79.40)

 
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*Treasury stock is a contra account in equity and decreased by $40.90.
 
Exhibit 1-2: Extracts from disclosure notes
 
YELLOW COMMUNICATIONS LIMITED
 
Selected Disclosure Notes
 
Note 17
 
Convertible debentures

 

Convertible debentures are classified according to their liability and equity elements using the residual approach, whereby the company estimates the fair value of the liability element, both principal and interest, based on reference prices for debt that is not convertible. The residual value of the convertible debentures is assigned to the equity element. The liability element is classified as long-term debt, and the equity element is classified as a conversion option and recorded in the contributed surplus component of shareholders’ equity. Upon conversion of debentures to common shares, a pro rata portion of the long-term debt, conversion option, and the unamortized discount will be transferred to share capital. If any convertible debentures mature without being converted, the residual conversion-option balance will remain in contributed surplus. The discount is amortized using the effective interest rate method over the term of the related debt. The unamortized discount is included in long-term debt and the amortization of the discount is included in interest expense.

 

Note 22
 
Stock-based compensation
 
The company uses the fair value-based method to account for stock options granted to employees and the Black-Scholes option-pricing model to measure the compensation expense. Compensation expense is recognized over the applicable vesting period with a corresponding increase to contributed surplus. When the options are exercised, the proceeds received, together with the amount in contributed surplus, are credited to common share capital.

 

The following table is a summary of the plan during the year.
(Comparative data have been omitted.)
 

	Number of options	2012 Weighted-average exercise price $
Outstanding, beginning of year	1,452,000	1.16
Issued	590,000	3.15
Exercised	(305,000)	0.92
Forfeited	(75,000)	4.52
Outstanding, end of year	1,662,000
Exercisable	650,000	1.95

The following table shows the assumptions used to determine the stock-based compensation expense using the Black-Scholes option-pricing model:

		2012
Compensation expense ($ thousands)		276
Fair value per option granted ($)		0.47
Assumptions:
	Risk-free interest rate	3.11%
	Expected dividend yield	0.05%
	Expected volatility	32.40%
	Expected time until exercise	5 years

 
Question 3
 
Estimated time to complete: 3 hours
 
The IASB and FASB are jointly working on a revised standard in the leasing area, which is somewhat controversial. The proposed new standard would increase lease capitalization in the lessee’s financial statements. Additional capitalization would potentially alter the basic relationships in the financial statements of companies that rely on what are now operating leases as a primary financing method.

 

The view of the proposed standard is that if a lessee obtains the right to use a leased item, over any term, the lessee would have an asset for the “right of use” and a liability for the rental payments. The present value of these payments, discounted using the lessee incremental borrowing rate, would be capitalized and the asset depreciated over the period of use. Therefore, essentially all leases would be financing leases, large (for longer lease contracts) or small (for shorter lease contracts). The judgmental review to determine lease classification, resting on transfer of title, length of lease, and present value, would be eliminated.
 
Required
 

Express Flight Ltd. has operating leases as of December 31, 2012, as described in Exhibit 3-1. The company’s condensed December 31, 2012 statement of financial position is shown in Exhibit 3-2. Calculate the amount of additional capital assets and lease liability that the company would record if all these operating lease obligations were capitalized as of December 31, 2012.

2. State and justify two assumptions made in order to make the capitalization calculation in Requirement 1.

3. Calculate the debt-to-equity ratio (total debt ÷ total equity) before and after your calculation in Requirement 1.

 
Continent Jet Corporation describes its commitments under operating leases in the 2012 financial statements. See Exhibit 3-3. The company’s condensed December 31, 2012 statement of financial position is shown in Exhibit 3-4. Repeat Requirements 1 and 3 for Continent Jet Corporation.

 

4. Compare your results for Express Flight Ltd. and Continent Jet Corporation. Comment on the quality-of-earnings implications.

 
Exhibit 3-1: Operating lease information for Express Flight Limited

 

Disclosure note 19

 

The company is committed to the following annual minimum lease payments under operating leases for its fleet of aircraft, office premises, and certain equipment
 
(millions of dollars)
 

2013	$   1,920
2014	1,876
2015	1,854
2016	1,827
2017	1,759
2018 and thereafter	7,494
Total	$16,730

 
Exhibit 3-2: Condensed statement of financial position for Express Flight Limited
 
EXPRESS FLIGHT LIMITED
 
Condensed Statement of Financial Position
 

		2012	2011
Assets
Current assets		$   2,960	$   1,705
Property and equipment		6,207	7,340
Goodwill		1,310	417
Intangible assets		1,220	897
		$11,697	$10,359
Liabilities and shareholders’ equity
Current liabilities
	Accounts payable and accrued liabilities	$   1,723	$   862
	Current portion of long-term debt	730	970
Long-term debt (interest rates ranging from 4% to 12%)		5,297	5,045
Future income tax		985	896
Shareholders’ equity
	Share capital	1,641	1,275
	Contributed surplus	1,210	880
	Retained earnings	111	431
		$11,697	$10,359

 
Exhibit 3-3: Operating lease information for Continent Jet Corporation

 
Disclosure note 19
 
Commitments
 
The corporation has entered into operating leases and commitments for aircraft, land, buildings, equipment, computer hardware, software licenses, and satellite programming. Commitments are as follows
 
(millions of dollars)
 

2013	$  1,491
2014	1,103
2015	792
2016	863
2017	911
2018 and thereafter	2,502
Total	$7,662

 
Exhibit 3-4: Condensed statement of financial position for Continent Jet Corporation
 

CONTINENT JET CORPORATION Condensed Statement of Financial Position
		2012	2011
Assets
Current assets		$ 1,513	$   718
Property and equipment		1,906	2,388
Goodwill		358	462
Intangible assets		710	514
		$4,487	$4,082
Liabilities and shareholders’ equity
Current liabilities
	Accounts payable and accrued liabilities	686	267
	Current portion of long-term debt	378	369
Long-term debt (interest rates ranging from 2% to 12%)		1,440	1,249
Future income tax		398	312
Shareholders’ equity
	Share capital	3,133	2,845
	Contributed surplus	278	260
	Deficit	(1,826)	(1,220)
		$4,487	$4,082

 
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