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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.
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?

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


  1. 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.


  1. 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?


  1. 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
Consolidated Statement of Shareholders’ Equity
for the year ended December 31, 2012
(in thousands)

  Class A shares Class B
surplus —
surplus —
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
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
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:

Compensation expense ($ thousands) 276
Fair value per option granted ($) 0.47
  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.

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


    1. 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
    Condensed Statement of Financial Position

      2012 2011
    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
    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

    Condensed Statement of Financial Position
      2012 2011
    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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