Cringle Inc. (CI) has just had a planning meeting with its auditors. There were several concerns

Cringle Inc. (CI) has just had a planning meeting with its auditors. There were several concerns that had been raised during the meeting regarding the draft financial statements for the December 31, 2011 year end. CI is a public company whose shares list on the TSX. It has recently gone through a major expansion and, as a result, there are several financial reporting decisions that need to be made for the upcoming year-end financial statements. The expansion has been financed in the short term with a line of credit from the bank; however, the company plans to raise capital in the equity markets in the new year. It is hoped that the expansion will increase profitability, although it is too early to tell. Just before year end, the company purchased a number of investments as follows:

• 20% of the common shares of KL. CI was able to appoint one member to KL's board of directors (which has four members in total). CI is unsure as to whether it will hold on to this investment for the longer term or sell it if the share price increases. The company has currently set a benchmark that if the share price increases by more than 25%, it will liquidate the investment. KL has been profitable over the past few years and the share price is on an upward trend. The original reason for entering into this transaction was to create a strategic alliance with KL that will help ensure a steady supply of high-quality raw materials from KL to CI.

• Corporate bonds. These bonds are five-year bonds that bear interest at 5% (which is in excess of market interest rates). As a result, the company paid a premium for the bonds. The bonds are convertible to common shares of the company. It is CI's intent to hold on to these bonds to maturity, although if there were an unforeseen cash crunch, it might have to cash them in earlier.

The company completed a significant sale to a new U.S. customer on credit on December 31, 2011. Under the terms of the agreement, CI will provide services to the customer over a one-year period. The sales agreement includes a non refundable upfront fee for a significant amount, which the company has recognized as revenue. As part of the deal, CI will provide access to significant proprietary information (which it has already done) and then provide ongoing analysis and monitoring functions as a service to the customer. It is not specified in the contract whether the rights to the proprietary information are transferable but CI is taking the position that they are. The proprietary information is of no value as a separate item if not transferable. During the year, CI renewed service contracts for some of its other major customers under similar deals.

The receivable for this large sale is in U.S. dollars. Half of this has been hedged using a forward contract to sell U.S.

dollars at a fixed rate. The other half is hedged through a natural hedge since the company has some U.S. dollar payables.

The auditor has asked that the company prepare some notes analyzing the need for hedge accounting for this transaction and explaining the risks associated with the sales transaction and hedge transactions.

This has been a bad year for the company due to one-time charges on a lawsuit settlement, and currently the draft statements are showing a loss. The company's tax accountants have determined that the company will also have a loss for tax purposes.

Instructions

Assume the role of the controller and analyze the financial reporting issues.

-          Role – controller – potential bias towards making company look better since looking for new capital and to potentially refinance loan.

-          Bank and potential investors are key users who will be relying on statements to make decisions – need transparency.

-          Public company since shares trade on TSX – IFRSis a constraint.

-          For investments, company must decide whether to follow IFRS9 (early adopt) or IAS 39.

Analysis and recommendations

Issue: Investment in common shares

Equity method

At fair value with gains and losses through income or OCI

-          20% - borderline for significant influence. -          Representation on Board (1/4) may allow influence. -          Original intent was for strategic purposes.

-          20% inconclusive. -          No longer being held for strategic purposes – i.e. intent to sell/trade is share prices rise above certain point. -          If FVOCI – revalue to fair value and gains/losses to OCI (if following IFRS 9 must elect). -          If FVTPL (HFT) – revalue to fair value and gains/losses to net income. -          Option to treat as either (FVTPL and/or FVOCI) under IAS 39 or IFRS 9.

Recommendations:

Could select any of the options however, given the intent to sell if the shares reach a certain price, consider measuring at fair value with gains/losses through income (easier). This option is available under IFRS9 and IAS 39.

Issue: Investment in bonds

Amortized cost

Fair value (with gains/losses booked to income)

-          Under IAS 39 - Intent to hold to maturity expressed and ability to hold given new potential influx of cash (raising capital). -          Amortized cost – amortize premium as an adjustment to interest cost. -          Under IAS 39 – may have to segregate the conversion option and value at fair value (embedded derivative). NB. This is generally beyond the scope of the text.

-          Under IFRS 9 – use amortized cost only if company manages cash flows on the basis of yield to maturity and contractual cash flows include P and I. In this case it is not clear that the entire business model includes managing debt instruments on a yield to maturity basis and thus this would not be valued at amortized cost. -          In addition, since these are debt instruments, the option to value at FVOCI is not available under IFRS 9. IFRS 9 only allows this option for equity instruments. -          Under IAS 39 if classified as HTM (amortized cost) and sell prior to maturity, it may invoke tainting provisions (if significant). If this is the case, would no longer be able to value this and other debt securities at amortized costs. Therefore do not measure at amortized cost upfront and avoid risk of tainting. -          More transparent to value at FVTPL since business model seems to indicate the investments are incidental to main business.

Recommendations:

 To value at fair value with gains/losses through income.

Issue: Revenue recognition – Non-refundable fees

Recognize upfront fee

Do not

-          Multiple element arrangement? -          Proprietary info considered separable unit – transferable per company and therefore must have standalone value. -          Objective and reliable evidence of undelivered item since issued renewal contracts to others this year. -          Persuasive evidence of contract – since deal is done and likely documented. -          Measurable since no material uncertainties. -          Delivery of proprietary info already occurred. -          Would have to bifurcate.

-          Proprietary info may not be transferable separately and therefore considered an integral part of the whole transaction (has no value otherwise if not transferrable). -          Recognize over time – straight line unless other pattern. -          May use percentage of completion method.

Recommendations:

To recognize entire contract amount over time as more reflective of the bundled nature of the transaction.

Hedging

Hedge accounting – discussion of theory as requested by client

No hedge accounting

-           Meant to ensure that gains/losses from hedged items offset gains/losses from hedging items in income in same period. -          Must use if do not already do so. -          Modifies normal accounting. -          Must ID hedging relationship between hedged and hedging item -          Must ensure effective.

-          Optional. -          Costs and complexity are significant. -          No need to use hedge accounting since gains and losses of hedged  (US AR) and hedging items (forward contract) already essentially offset (forward contract recognized, valued at fair value and gains/losses to net income already. US AR revalued to spot rate with gains and losses to net income). -          Natural hedge does not require special accounting since US AP also revalued to spot rate with gains/losses to income.

Recommendations:

There is no need to use hedge accounting. Risk that counterparties will fail to complete transaction – forward contract – would mean still exposed to risk.

Issue: Recognize benefit of LCF

Yes	No
-          Due to a one time loss. -          Otherwise expected to be profitable.	- Not sure if company will be profitable next year.