Reference no: EM1380229

Question 1

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)

*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
for the year ended December 31, 2012

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 remaining 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 2

The IASB and FASB are jointly working on a revised standard in the leasing area, which is reasonably controversial. The proposed new standard involves far more lease capitalization in the financial statements of the lessee. 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 amortized 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

1. Econo Air Delivery 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 decisions 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 and comment on the differences or similarities.
4. Air Transfer 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 Air Transfer Corporation.  

1. Compare your results for Econo Air Delivery Ltd. and Air Transfer Corporation. Comment on the quality-of-earnings implications.  

Exhibit 3-1: Operating lease information for Econo Air Delivery Ltd.

Disclosure note 16
Commitments

The company is committed to the following future minimum lease payments under operating leases for flight equipment and base facilities:
(millions of dollars)

2013	$   165
2014	135
2015	138
2016	124
2017	116
2018 and thereafter	620
Total	$1,298

Exhibit 3-2: Condensed statement of financial position for Econo Air Delivery Ltd.

ECONO AIR DELIVERY LTD.
Condensed Statement of Financial Position
December 31, 2012
(millions of dollars)

		2012	2011
Assets
Current assets		$   447	$   353
Property and equipment		461	419
Goodwill		349	245
Intangible assets		485	422
		$1,742	$1,439
Liabilities and shareholders' equity
Current liabilities
	Accounts payable and accrued liabilities	$   306	$   356
	Current portion of long-term debt	157	-
Long-term debt (interest rates ranging from 3% to 10%)		388	515
Future income tax		110	27
Shareholders' equity
	Share capital	510	391
	Retained earnings	271	150
		$1,742	$1,439

Exhibit 3-3: Operating lease information for Air Transfer Corporation

Disclosure note 19
Commitments

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

2013	$  5,496
2014	6,172
2015	4,860
2016	4,194
2017	4,345
2018 and thereafter	13,542
Total	$38,609

Exhibit 3-4: Condensed statement of financial position for Air Transfer Corporation

AIR TRANSFER CORPORATION Condensed Statement of Financial Position December 31, 2012 (thousands of dollars)
		2012	2011
Assets
Current assets		$   6,843	$   5,044
Capital assets		39,345	36,912
Goodwill		19,135	19,220
Intangible assets		8,444	5,678
		$73,767	$66,854
Liabilities and shareholders' equity
Current liabilities
	Accounts payable and accrued liabilities	$   4,820	$   3,930
	Income tax payable	-	1,950
	Current portion of long-term debt	4,200	780
Long-term debt (interest rates ranging from 5% to 19.2%)		36,600	31,500
Future income tax		4,650	3,480
Shareholders' equity
	Share capital	23,288	23,876
	Contributed surplus	974	299
	Retained earnings (deficit)	(765)	1,039
		$73,767	$66,854