You, the CA, an audit senior at Grey & Co., Chartered Accountants, are in charge of this year

You, the CA, an audit senior at Grey & Co., Chartered Accountants, are in charge of this year ’s audit of PlexFame Corporation (PFC). PFC is a rapidly expanding, diversified, and publicly owned entertainment company with operations throughout Canada and the United States. PFC’s operations include movie theatres, live theatre production, and television production. It is June 22, Year 7, the week before PFC’s yearend. You meet with the chief financial officer of PFC to get an update on current developments and learn

the following.

PFC acquires real estate in prime locations where an existing theatre chain does not adequately serve the market. After acquiring a theatre site, the company engages a contractor to construct the theatre complex. During the year, the company received a $2 million payment from one such contractor who had built a

10theatre complex for PFC in Montreal. This payment represents a penalty for not completing the theatre complex on time. Construction began in June Year 6 and was to have been completed by December Year 6. Instead, the complex was not completed until the end of May Year 7.

The company is staging a Canadian version of “Rue St. Jacques,” which is to open in November Year 7. The smash hit musical has been running in Paris for three years and is still playing to sold-out audiences. PFC started receiving advance bookings in November Year 6, and the first 40 weeks of the show’s run are completely sold out. As at June 22, Year 7, PFC has already collected $22 million from the advance bookings and invested the cash in interest-bearing securities. It included in revenue

$1.7 million of interest collected on the funds received from advance ticket sales. In addition to the substantial investment in advertising for this production ($4 million), the company will have invested $15 million in preproduction costs by November Year 7 and will incur weekly production costs of $250,000 once the show opens.

PFC has retained Media Inc. (Media), a company that specializes in entertainment related advertising and promotion, to promote PFC’s activities. Media bills PFC’s corporate office for all advertising and promotion related to PFC’s activities. Advertising and promotions have significantly increased this year, in part due to large costs associated with the forthcoming opening of “Rue St. Jacques.” Media has billed PFC $12 million this year for advertising and pro motion, an increase of $7 million over the preceding year.

PFC has $43 million invested in Government of Canada treasury bills. During the past year, $30 million of these treasury bills were set aside to cover interest and principal obligations on the company’s syndicated loan of US$25 million. At the time the loan agreement was signed, PFC entered into a forward contract to buy U.S. dollars for the same amounts as the obligations under the syndicated loan and for the same dates as the obligations came due. PFC considers that in substance the debt has been settled, and as a result, both the treasury bills and the syndicated loan have been removed from the company’s balance sheet.

PFC started selling movie theatres a couple of years ago. Each theatre’s con tribution to long run operating cash flow is assessed and, if the value of the real estate is greater than the present value of future theatre operating profits, the theatre is sold. In the past, revenue from these sales has been relatively minor, but this year 25% of net income (i.e., $6 million) came from the sale of theatres. Since these sales are considered an ongoing part of the company’s operations, proceeds from the sale of theatres are recorded as revenue in the income statement.

On May 31, Year 7, PFC and an unrelated company, Odyssey Inc. (Odyssey), formed a partnership, Phantom. Odyssey contributed $40 million in cash.

PFC contributed the assets of its TV production company, which had a carrying amount of $65 million. The $90 million value assigned to PFC’s contribution may be adjusted if the net income of Phantom earned between July 1, Year 7, and June30, Year 8, does not meet expectations. PFC has recorded a gain of $25 million. The partnership agreement states that PFC is permitted to withdraw the $40 million for its own use, and it has done so. As a result, Odyssey has a 45% interest in the partnership and PFC has the remaining 55% interest. PFC’s bank operating loan in the amount of $200 million is well within its maximum of $240 million. The loan agreement calls for a maximum debttoequity ratio of 2:1, where debt is defined as monetary liabilities. Failure to meet the loan covenant would cause the operating loan to become payable within 30 days. On the May 31, Year 7, interim financial statements, PFC meets the restriction because its debt is $1,490 million while its shareholders’ equity is $780 million.

PFC’s consolidated income before tax was $147 million for the 11 months ended May 31, Year 7. PFC hopes to maintain its recent trend of reporting a mini mum before tax return on shareholders’ equity of 20%.

When you return to the office, you discuss the aforementioned issues with the partner in charge of the PFC audit. She asks you to prepare a report on the accounting implications of the issues you have identified as a result of your meeting. When the accounting for an individual transaction has not been specified, you should indicate how it should be accounted for and the impact that the accounting would have had on the key metric(s)

Required:

Prepare the report to the partner. Ignore income taxes.

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