Annapolis Group Ltd. (AGL) designs, develops, manufactures, and sells photonics-based solutions, including lasers, laser systems, and electro-optical components. The company has manufacturing operations in British Columbia, Ontario, and Nova Scotia, and sells primarily in North American markets.
In the past, the company has prepared its financial statements in accordance with ASPE, but is looking to comply with IFRS for the 2012 financial statements, in conjunction with a planned public offering. The public offering is still being negotiated, and depends on the stability of financial markets. However, the company has decided to draft financial statements that comply with IFRS to ensure that they are prepared for the eventuality.
The company has prepared a draft statement of financial position (Exhibit 1-1) and is satisfied that the format of this statement is compliant with IFRS. However, some differences in measurement between ASPE and IFRS have yet to be recorded (Exhibit 1-2). Additional information on financial statement elements is provided in Exhibit 1-3.
At this stage in the analysis, the company is concerned only with the statement of financial position, not earnings. AGL is required, as part of its bond agreement, to maintain a minimum current ratio of 1-to-1 and a maximum debt-to-equity ratio of 5-to-1. (Debt in this ratio is defined as "total liabilities.") Since a number of the outstanding items affect debt and/or equity, the CFO wants to ensure that these key financial targets continue to be met.
AGL's current concern is covenant compliance in 2012. Because the focus is on the statement of financial position, all of the impact of any adjustment to earnings, whether related to the current year or a prior year, will be recorded as an increase or decrease to retained earnings. AGL will further analyze these changes and restate comparative numbers for 2011 at a later date.
Required
Assume the role of the CFO for AGL and do the following:
1. Prepare journal entries to account for the transactions and information described in Exhibits 1-2 and 1-3.
2. Prepare a revised statement of financial position after the journal entries prepared in Required 1 have been recorded.
3. Evaluate the key financial targets and suggest action for the coming year, if there are any concerns.
Exhibit 1-1: Annapolis Group Ltd. - Draft Statement of Financial Position as at December 31, 2012 (in thousands)
ANNAPOLIS GROUP LTD.
Statement of Financial Position
December 31, 2012
(in thousands)
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ASSETS
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December 31, 2012
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Current assets:
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Bank: Current account
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1,240
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Accounts receivable
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35,350
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Inventory
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45,400
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Prepaid expenses and deposits
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2,820
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84,810
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Non-current assets:
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Capital assets net
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29,300
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Intangible assets
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21,643
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50,943
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Total assets
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135,753
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LIABILITIES AND SHAREHOLDERS' EQUITY
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Current liabilities:
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Accounts payable and accrued liabilities
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31,742
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Dividends payable
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1,060
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Current bank loan
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38,760
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71,562
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Non-current liabilities:
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Long-term debt
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50,000
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Discount
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(9,010)
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40,990
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Equity:
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Share capital - common shares
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7,350
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Stock options outstanding
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1,660
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Retained earnings
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14,191
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23,201
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Total liabilities and equity
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135,753
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Exhibit 1-2: Annapolis Group Ltd. - Outstanding items
Note: Amounts are in thousands.
1. The $50,000 bond payable was issued on July 1, 2010. It was a 7.6%, 20-year bond that paid interest semi-annually on December 31 and June 30. The bond was sold to yield 10%. Straight-line amortization of the discount is reflected in the financial statements, over the 40-period life of the bond, but IFRS requires use of effective interest amortization.
2. During 2012, the company discovered an environmental issue at their manufacturing site in Nova Scotia. After consultation with environmental engineers and the relevant government departments, the company learned that it would cost approximately $300 per year for four years to remediate the site. AGL also learned that remediation is not required under government legislation. However, in late 2012, AGL announced plans to remediate the site, beginning in January of 2014. Planning has begun, and the community affected has been involved in consultation and the planning process. Under ASPE, no liability needed to be recorded, but this situation creates a constructive liability under IFRS.
3. AGL leases equipment under operating leases. Analysis indicates that one of these lease contracts, signed on March 1, 2012, is a financial lease under IFRS, because the lease is for (specialized) equipment using technology under patent with AGL. Accordingly, the lease must be capitalized under IFRS even though it was not a capital lease under ASPE. Payment of $3,150 was made on this lease in March 2012, of which $525 is recorded as a prepaid asset on the SFP at the end of 2012. Details of the lease are in Exhibit 1-3.
4. Interest on both general borrowing and the bond is expensed; this expense is $6,405 in 2012 before any adjustments. In early August of 2012, the company placed a $1,400 deposit on manufacturing equipment that will be delivered in 2013. A long-term prepaid account was created for $1,400 and grouped with capital assets on the statement of financial position. (Separate disclosure will be provided in the disclosure notes.) The $1,400 payment was financed out of general borrowing. Under IFRS, related interest must be capitalized.
5. Compensation expense of $320 was recorded with respect to stock options outstanding in 2012. All stock options are held by senior administrative staff. Under IFRS, forfeiture is estimated in advance, and, as a result, the compensation expense recorded annually is lower. Valuation models indicate that the amount of compensation expense recorded for 2012 should be reduced to $275.
6. IFRS requires depreciation of capital assets by component, whereas ASPE deals with whole assets. The approach to impairment tests is also different. The accounting group of AGL has ascertained that an additional $620 of accumulated depreciation and $2,200 of impairment of intangible assets are required.
Exhibit 1-3: Annapolis Group Ltd. - Additional information
Note: Amounts are in thousands.
1. Lease obligation
The following terms are associated with the lease:
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Inception date
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March 1, 2012
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Lease term #1 (first 2 years)
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Duration
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2 years
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Annual lease payment due at the beginning of each lease year
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$3,150
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Lease term #2 (remainder of lease)(renewed at option of lessor)
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Duration
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1 year
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Annual lease payment due at the beginning of each year
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$1,050
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Residual value at the end of lease
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Unknown; leased asset reverts to lessor
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Implicit interest rate
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6%
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Annual maintenance costs, paid by lessor in each of years 1-3
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$75
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Notes: A formal entry is needed to reclassify part of the lease liability as a short-term liability at December 31, 2012. Include the short-term amount in accrued liabilities.
The company uses straight-line depreciation for all manufacturing assets and claims a full year of depreciation in the year of acquisition and no depreciation in the year of disposal.