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You, CPA, work as a consultant on various engagements. Your client,...

You, CPA, work as a consultant on various engagements. Your client, Over The Edge Ltd. (OTE), has grown from a small custom snowboard manufacturer based in Whistler, British Columbia, servicing the local market, to a national success. Recently, OTE's snowboards were used by a gold medallist in the Winter Olympics!

It's Monday morning, and you are meeting with the company's owner and sole shareholder, Wutang Pan. Also in attendance is Misty Phung, OTE's VP of finance.

Wutang tells you:

Fun Consolidators Inc. (FCI), a public company and the largest competitor in the industry, has expressed an interest in acquiring OTE. It has made three similar acquisitions in the past two years — two of which were closed and manufacturing was moved to the United States. The other is operated consistent with pre-acquisition.

I hadn't been thinking about selling the company, but things have progressed very quickly with FCI. I'm getting older and I have worked hard for a long time building the business. While my children are still quite young, I don't anticipate that any of them will become involved with the business. So, this might be the right time to sell. As you know, the snowboard industry is cyclical, but it is at its peak right now.

I'm very proud to say that OTE has been named one of the "10 Best Small Businesses to Work for" for the past three years. The award is based on financial performance, customer surveys, and employee satisfaction. I have a very dedicated and loyal staff. Many of the staff members are like family to me. In the past seven years, we have not had to lay off any of our employees.

Misty then jumps in:

OTE operates in a stable industry and the results for the company have been relatively consistent over the past five years. The December 31 year-end statements are provided in Appendix I. There are a few outstanding accounting issues that may impact them, which I have included in Appendix II. I also put together a memo for you with some information on non-recurring or unusual items incurred by OTE. I will email it to you (Appendix III). Our weighted average capitalization rate is 12%.


In this case, I want you to assume that the present value of the tax shield associated with capital reinvestments is about 10% of the amount spent, which is projected to be $100,000 per year.

As FCI is public, it would not be able to claim a small business deduction for OTE. I would say that FCI could expect to pay corporate tax at the rate of 30%.

Wutang concludes:

I'd like to make sure I understand what my company is worth before the offer is received.


Question

Analyze the accounting issues described in Appendix II. OTE reports its financial statements in accordance with IFRS.


Appendix II Accounting issues

  1. Manufacturing equipment with a useful life of 10 years was purchased from a U.S. supplier for US$200,000 in November. At the time, the exchange rate in effect was US$1 = C$1.22 and the equipment and associated payable were recorded at $244,000. At year end, the payable was still outstanding and both it and the equipment were still recorded at $244,000.The year-end exchange rate was US$1 = C$1.32. Misty is not sure if either the initial or year-end amounts were recorded correctly, but she would like to get a better understanding of how to account for this transaction, as she expects OTE will engage in more transactions with U.S. suppliers in the future.
  2. In mid-December, the exclusive rights to a customer list were acquired for$75,000 from a competitor. The price paid for the customer list was based on a valuation prepared by a Chartered Business Valuator. This amount was expensed in the financial statements.

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