ISLAND FARMS INC. INTRODUCTION Island Farms Inc. (IFI) is a large private company complying with the Accounting Standards for Private Enterprises (ASPE). The shareholder group is concentrated, with the majority shareholder acting as an integral part of the leadership team of IFI. The company currently employs over 1,300 people, and operates four potato processing plants. Two plants are located in Prince Edward Island (PEI), the remaining plants are located in Alberta and North Dakota. In 2011, IFI acquired the land rights for 900 tillable acres located in Hartland, NB to be used as a seed potato farm. IFI's primary business activity is to produce French fries for sale to large grocery retailers or food service businesses. IFI grows 5% of its crop and the remaining 95% is contracted out to independent farmers. Founded in PEI, IFI was established in 1975 and has been extremely successful in capturing market share. You have just been hired as the Assistant Controller at Island Farms and are excited to apply what you have learned in University. You report to Conor Boyd, Chief Financial Officer, who has been with the company since its inception. Because of this, Mr. Boyd has a strong understanding of the financial reporting environment at IFI; however, he does not have any formal training in accounting. As you gather more information for your role, you have determined that some policies in place at IFI are inconsistent with ASPE guidelines. Mr. Boyd has requested you summarize these inconsistencies, and provide a summary of recommendations required to correct the financial statements. Some background notes of IFI's operations which you have uncovered are found below. Raw Production Land legislation in place on Prince Edward Island does not permit a corporation to own more than 3,000 acres of land; as a result, IFI must rely on private growers to supply their potatoes. Prices are set and fluctuate with the market for demand. Over the past few years, the company has experienced declining yields compared to other regions. The average yield in PEI is 330 hundredweight (CWT)/ acre vs other regions which are generating 630 CWT/ acre. Global competitiveness is the largest business risk for IFI as the purchasing of raw potatoes is IFI's main cost to produc the remaining 95% is contracted to Island farmers. Key contract terms from a sample contract tion, IFI operates one commercial farm themselves, producing 5% of their product; are found in Appendix A. All potatoes are harvested between October to December and ship ped to IFI warehouses where they can be stored for up to one year. The shelf life of fresh potatoes is due to state of the art warehousing technologies which ensures temperatures are kept both cool and dry. In the past year, IFI has uncovered an issue with their temperature control sy have discussed the financial statement impact of this occurrence. Notes from your manager are found in Appendix B issue with the warehouse manager. Mr. Boyd has requested you assess the conversation with the warehouse Manufacturing The Company maintains large warehouses for storing raw potatoes at each manufacturing facility. These warehouses have the ability to store up to 10 million CWT. throughout the 4 manufacturing facilities; the Company is able to process over 1.2 billion pounds of potatoes in a year. Potatoes are moved from the warehouses to the manufacturing facility, where they are processed into French fries and shipped out to customers. The core of IFI's fry manufacturing operations is the Fry10008; purchased in 2002, this machine is capable of washing, peeling, and cutting potatoes into French fries. From here, the fries are transferred into a steam blancher before moving to a commercial fryer. Despite the fact the Fry 10008 is reaching the end of its useful life, Evan MacLean, Operations Manager, has been very happy with his team's ability to keep maintenance costs low. This has helped them perform favourably against budget as they allocate all of the Fry10008 maintenance costs to the balance sheet. In doing this, maintenance costs do not affect their bottom line on the income statement. Mr. MacLean has indicated that anything that isn't patch work should certainly be capitalized to the piece of equipment since it's making the equipment operate as if it's new again!. You are curious as to what types of expenses are being capitalized. As a result you have requested an email from Mr. MacLean detailing expenses, see Appendix C. Mr. Boyd bas requested you perform an analysis of the eligibility of these expenses for capitalization. As the company was investigating ways to maximize profitability, IFI management recently obtained figures on the lease of the Fry30008 equipment. Working in line with the Fry10008, the new piece of equipment would allow the company to ensure cost savings through increasing both their efficiency and output. IFI has the option to purchase the equipment for a price of $35 Million but in the interest of meeting cash flow goals they have opted for a lease. You are aware that there are two different ways to handle leases under ASPE guidelines, and have offered to provide a review of appropriate treatment to Mr. Boyd The lease agreement for the Fry30008 has a 10 year term, with IF I having the opportunity to purchase the equipment for $1,000 at the end of the agreement. The Fry30008 has a useful life of 15 years, and has been manufactured specifically for IFI production. For full use of the equipment, stated in the lease is 8%. IFI will pay the manufacturer $500,000 in lease payments per year. The implicit rate At present,the accounting department has been accruing the annual lease payment under "Lease Expense" on the Income Statement. Seed Breeding One area of IFI operations which is unique to their business model is seed breeding. As part of your orientation, you had a discussion with the lead technologist at the seed breeding farm, M Kate Horne. Ms. Home explained to you that seed breeding is the process in which her team assesses the genetic traits from multiple potato plants, selecting the exact traits which would best naturally combat poor growing conditions. This multi-year project started in 2015, and is created with the intention of providing the best seed to IFI growers. You found it interesting to hear Ms. Horne say all costs on the program have been capitalized since inception. As a result, you have also brought this issue to the attention of Mr. Boyd; he believes IFI is correct to capitalize all costs associated with the program. An excerpt of your conversation with Mr. Boyd, as well as additional details provided from Ms. Home is found in Appendix D. Other Activities 1. On your first day with IFI, you were getting to know your coworkers. As you were discussing the roles within the accounting team and getting to know staff members, Mrs. Sarah Kearsley stated she could not chat for long - it was the start of the month and prepayments from all large retailers were just received! This meant she had to perform all revenue entries in the books before the end of the week. You were confused on this process, and therefore booked a meeting with Sarah to discuss the accounting treatment for these prepayments; notes from your eeting are found in Appendix E. When you performed a review of IFI's financial statement package, you noticed that goodwill is currently recorded on the balance sheet. Being an intangible asset, you understand that this item needs to be tested for impairment. When you brought this to Mr. Boyd's attention, he explained the amount recorded was calculated by your predecessor details on this conversation are found in Appendix F As you were passing the reception desk on your way into work last Thursday, you heard the receptionist discussing with the janitor about a call she received from the company lawyers. Further chatting around the office has led you to believe that the company is engaging in a lawsuit with one of their contractors. Knowing that nothing was recorded in your review of the financial statements, you booked a meeting with Mr. Boyd to discuss the legal position of IFI. Details from your conversation are found in Appendix G. 2. 3. 4. In addition to this discovery, you also have decided to discuss financial ratios with Mr. Boyd; since starting, there are a lot of concems as to how costs are classified on the IFI financial statements. Looking to impress your new boss, you believe that showing him the impact on financial ratios after policy changes would provide a good illustration of the importance of following ASPE guidelines. The most recent financial statements have been provided to you in Exhibit I. APPENDIX A Key contract terms as agreed upon by Island Farms Inc.and independent contractors who grow potatoes for the company Product: All potatoes delivered to IFI by contractors must be grown using seed purchased from IFI's seed breeding operation. Additionally, the fertilizer used in contractor's farms must be purchased from IFI. Failure to comply with these terms will result in a breach of contract. Pricing: On average, a price of $13.00/CWT is agreed upon. Fresh potatoes are available to be purchased in an open market, historically; the price has fluctuated between S8/CWT to S20/CWT - all dependent on supply. The average yield from an acre of potatoes is 330/CWT Delivery Contractors to IFI are responsible for the delivery of potatoes to IFI warehouses where they will later send the potatoes for processing. Amounts which are to be delivered from farmers are agreed upon based on the farmers harvesting capabilities. All contractors are required to fill their yields with IFI before selling in an open market; contract terms permit IFI inspectors to review farm operations at any time. APPENDIX B In October of this year, the potato harvest was in full swing and IFI was receiving deliveries from contractors to fill their warehouse. IFI ran into an issue as they filled the warehouses, the temperature control system stopped working- rather than providing a cool and dry environment, the system actually increased temperatures in a portion of the warehouse. This went unnoticed for one week. When the warchouse manager investigated the issue, he estimated that 200,000lbs of potatoes were spoiled and had to be disposed as a result. All inventories are recorded at cost on the balance sheet when product is delivered to IFI APPENDIX C Email received from Mr. Evan MacLean, IFI Operations Manager From: 0: Ce: Subject: MacLean, Evan Student Boyd, Conor 2018 Maintenance Costs Hi Student, Please see below for a detail of costs which I have had accounting allocated to the Fry1000 on the balance sheet. I am certain with your review you will understand why these costs should not be expensed-they're crucial to the operation of the machinery! It certainly should not impact the compensation my team's annual bonus, based off of company net income. Type of Maintenance Maintenance Cost Conveyor belts that are worn out are switched out on an annual basis Replacement bolts to change out the stripped ones A new high powered engine that will double the output on the automated potato cutting machine New lubricant for the gears Protective shields attached to the assembly line to avoid product remnants from getting out Brand new blades on the potato slicer expected to extend the useful life an additional 3 years The exterior panel on the side of the forklift had a crack that needed to be filled$1,000 $150,000 $35,000 $550,000 $2,500 $25,000 $700,000 If you happen to have any questions, please let me know. Cheers, Evan Operations Manager | Island Farms Inc. APPENDIX D Excerpt from phone conversation with Mr. Boyd Student: "I wanted to ask you Mr. Boyd - have you had a review of the costs capitalized under the seed breeding program? I was surprised to learn that all costs from the program are on the balance sheet since the program inception?" Mr. Boyd: Absolutely I have had a review! All costs have been capitalized because we are generating new information. I see the seed breeding program as crucial to the longevity of IFI. Every bit of research which we have done since the start of that program is new to the industry, and gives us a competitive advantage against any other farm. The long term value it adds to our company? Not a chance that type of work should hit my bottom line!" Student: "I understand. Perhaps I will gather a list of expenses from Ms. Horne to ensure you're correct. I know there is specific criteria under ASPE for the treatment of these expenses." Mr. Boyd: "If you think there are any required changes, please let me know." Email received from Ms. Kate Horne, Lead Technologist - IFI Seed Breeding rom: To: Cc: Subject: Home, Kate Student Boyd, Conor 2018 Program Costs Hi Student, As requested, please see below for cost details as they pertain to the seed breeding program. I started up the program when I was hired with IFI in September 2015; because the work my team is doing is new to the industry, we had to engage in extensive research. I would say our biggest headway was experienced in May 2017 when we were able to first release seed produced in our lab to farmers. It was an extremely important milestone for the program, as at this point we knew we had established processes which will benefit the company for years to come -now, our program is focused on using our processes to ensure that each year we are providing the best seed potatoes possible! I have talked with Sarah in Accounting and she provided the account details for the seed breeding program, as reported on the balance sheet. APPENDIX D (cont.) Description Cost Initial test process documentation Developing the machine capable of measuring the quality of the strains Test product spoilage Research consultants Implementing information system software to track inputs and outputs Engineering documentation Test material $50,000 $1,500,000 $50,000 $120,000 $1,000,000 $50,000 $25,000 If you require any additional information, please let me know. Thanks, Kate Lead Technologist | Island Farms Inc. -Seed Breeding Program APPENDIX E Notes from conversation with Sarah Kearsley-IFI Accountant IFI earns revenue on French fry sales through contracts with local businesses as well as large retailers in Canada and the United States. Local businesses agree to purchase a pre-determined amount of product every month and pay when the goods are delivered to their stores. The retailers require larger amounts of product at a time, so they pay in advance to help IFI cover costs and secure the output they want. IFI recognizes revenue from retailers when cash is received. Large retailers submit 25% of their payment amount one month in advance to E. The remaining revenue is recognized when the product is delivered. APPENDIX F Excerpt of a conversation with Mr. Boyd regarding Goodwill Student: "Good afternoon Mr. Boyd, I am almost finished my first review of the financial statements here at IFI and I wanted to raise concern over the Goodwill which we are reporting on the balance sheet- what does this pertain to?" Mr. Boyd: "Ah. In 2015, IFI purchased a local competitor FryGuy. They were the only other French fry manufacturer in Atlantic Canada and therefore we saw the acquisition as a way to knock out our competition while expanding our capabilities. I do not totally understand Goodwill, but I remember it having something to do with a customer list we received from FryGuy." Student: "Right. That would make sense, so when you purchased FryGuy you were able to expand your customer base by contacting their old customers." "Well not exactly... after about six months of operations we realized that the customer lists were dated. It wasi total flop -I don't think we had one new customer out of it! Mr. Boyd: Student: "Right. Valuing an intangible is usually pretty difficult. So, I assume we adjusted our books when we discovered the customer list had no value?" "Oh god no! We bought the company. I'm not about to decrease the value on our books just because of a silly list. We paid good money for FryGuy!" Mr. Boyd: After finishing the discussion, you walk back to your desk and decide to investigate the Goodwill calculation from 2015. On the company server, you find the following calculation from your predecessor IFI acquired Fry Guy's Inc. (FryGuy). Through purchasing the shares of the company, the company calculated goodwill as follows: Purchase Price of Equity Less: Book Value of Equity Less: Equipment Value above FMV Less: FMV Differential of Customer Lists $18,000,000 ($2,000,000) ($1,000,000) ($3,000,000) Goodwill $12,000,000 APPENDIX G An excerpt of your meeting on the lawsuit with a contractor with Mr. Boyd Student: "I couldn't help but overhear that we may be engaging in a lawsuit with one of our contractors? I have not seen anything disclosed in the financial statements. Are you aware of this?" Mr. Boyd: Ah yes. That's been a real to-do for management lately. I don't know the specifics, but one of our main contractors, Anne's Farm, has been selling their potatoes in the open market before fulfilling their contract with us. Inspectors discovered it when they visited the farm operations - apparently their production yields do not match what has been supplied to us. There is certainly an incentive for Anne's to sell outside of their contract - the market price is extremely high right now given the supply issues seen across North America "Right. So we're suing them for breach of contract -is it likely that this will be paid out?" Student: Mr. Boyd: "I'm not sure - you'd have to talk to our lawyer on that. I can give you their contract. But say... if there will be a payout, we can record that as a receivable before the year closes right?" Student: "Hard to say, but I will reach out to the lawyers and figure out if they have a better idea of whether we will win or not. With this, I will determine the appropriate accounting treatment." You send an email to IFI legal counsel and receive the following response From: To: Subject: Outstanding Lawsuit IFI MacDonald & Levesque LLP Student Hi Student, As requested, probable outcomes of the current lawsuit with Anne's Farm are detailed below. Anne's Farm will settle and pay Island Farm Inc. $500,000 in damages: Anne's Farm will fight the lawsuit in court, payout is unknown: Anne's Farm will issue a counterclaim against Island Famine, unknown payout 20% 60% 20% We hope this helps. Andre Levesque Partner MacDonald& Levesque LLP Exhibit I Island Farms Inc. Financial Statements December 31, 2018 Unaudited Island Farms Inc Balance Sheet (Unaudited) As at December 31, 2018 (in thousands of dolars) 2018 2017 Current assets Cash Accounts receivable 10,507 $ 13,706 Trade Inventories (note 2) Prepaid expenses 22,547 55,162 17.560 23,760 58,047 16,970 105,776 112,483 Goodwill 15,000 15,000 Fixed assets, net (note 3) 248,764 242,363 354,540 354,846 Liabilities Current liabilities Accounts payable Trade Income taxes payable Current portion of long-term debt 47,954 3,286 17,690 49,564 3,721 23.073 68,930 76,358 222,368 298,726 Long-term debt 204,803 Shareholders' Equity Capital Stock Retained earnings 80,806 80,807 56.119 56,120 354,540 354,846 Island Farms Inc. Statement of Income (Unaudited) Year Ended December 31, 2018 (in thousands of dollars) 2018 2017 342,903 253,748 89,155 7,133 82,022 318,900 230,911 87,989 Sales Cost of sales Operating and administrative expenses 6,776 81,213 Interest expense Long term debt Other 11,132 11,056 2.780 13,912 68,110 34,749 2,409 13,465 67,748 Amortization 33,361 Loss on disposal of fixed assets Income before taxes Income taxes Net income for the year 34,570 1,587 32,983 8,576 24.,407 33,361 8,674 Island Farms Inc. Statement of Cash Flows (Unaudited) Year Ended December 31.2018 (in thousands of dollars) 2018 2017 Cash provided (used) Operating activities Net income for the year Amortization Loss on disposal of fixed assets $ 24,687 34,749 $ 24,407 33,178 59,436 1463 60,899 (1,587) 55,998 3.987 Net change in non-cash working capital balances Investing activities Purchase of fixed assets Proceeds from sale of fixed assets (41,150) (42,242) 3,786 (41,150) (22.948) (22,948) (3,199) 13,706 10,507 Financing activities Repayment of long-term debt (23, 778) (23.778) (2.249) 15,955 Cash provided Opening cash balance Closing cash balance 5 S 13,706 Island Farms Inc. Notes to Financial Statements (Unaudited) December 31, 2018 1 Significant accounting policies Inventories are valued at the lower of cost, determined on an average cost basis, and market. Market is defined as replacement cost for raw materials and supplies and as net realzable value for finished goods. Property, plant & equipment Property, plant and equipment are recorded at cost. Depreciation of plant and equipment is calculated using the straight-line method at rates based upon the following estimated useful lives of the assets Buildings Machinery and equipment 10 years 10 years Revenue Revenue is recognized when tile and risk of loss are transfered to customers upon delivery based on terms of sale and collectability is reasonably assured. Revenue is recognized as the net amount to be received after dedudting estimated amounts for discounts, trade allowances, and returns of damaged and out-of-date products Foreign exchange Current assets and current liabilties denominated in foreign cumencies are translated at exchange rates prevaling at the balance sheet date or for hedged amounts, at the relevant forward cumency contract rake. Gains and losses arising on translation are included in the statement of operations 2 Inventories 2018 2017 (000's) Raw maternals Finished goods 40,028 41,150 6,426 7,102 9,796 8,708 $ 55,162 58.047 3 Fixed assets (000's) 2018 Accumulated 2017 Cost Net Cost depreciation Net 64,500 14.208 13.506$ 13,506 S 13506$ 13,506 Land Buildings Machinery and equipment Assets under construction 27,500 37,000 184,700 184,050 14.208 64 500 43,450 359,800 173600 368,750 460,964 $ 212.200 248,764 449,613 $242.363 ISLAND FARMS INC. INTRODUCTION Island Farms Inc. (IFI) is a large private company complying with the Accounting Standards for Private Enterprises (ASPE). The shareholder group is concentrated, with the majority shareholder acting as an integral part of the leadership team of IFI. The company currently employs over 1,300 people, and operates four potato processing plants. Two plants are located in Prince Edward Island (PEI), the remaining plants are located in Alberta and North Dakota. In 2011, IFI acquired the land rights for 900 tillable acres located in Hartland, NB to be used as a seed potato farm. IFI's primary business activity is to produce French fries for sale to large grocery retailers or food service businesses. IFI grows 5% of its crop and the remaining 95% is contracted out to independent farmers. Founded in PEI, IFI was established in 1975 and has been extremely successful in capturing market share. You have just been hired as the Assistant Controller at Island Farms and are excited to apply what you have learned in University. You report to Conor Boyd, Chief Financial Officer, who has been with the company since its inception. Because of this, Mr. Boyd has a strong understanding of the financial reporting environment at IFI; however, he does not have any formal training in accounting. As you gather more information for your role, you have determined that some policies in place at IFI are inconsistent with ASPE guidelines. Mr. Boyd has requested you summarize these inconsistencies, and provide a summary of recommendations required to correct the financial statements. Some background notes of IFI's operations which you have uncovered are found below. Raw Production Land legislation in place on Prince Edward Island does not permit a corporation to own more than 3,000 acres of land; as a result, IFI must rely on private growers to supply their potatoes. Prices are set and fluctuate with the market for demand. Over the past few years, the company has experienced declining yields compared to other regions. The average yield in PEI is 330 hundredweight (CWT)/ acre vs other regions which are generating 630 CWT/ acre. Global competitiveness is the largest business risk for IFI as the purchasing of raw potatoes is IFI's main cost to produc the remaining 95% is contracted to Island farmers. Key contract terms from a sample contract tion, IFI operates one commercial farm themselves, producing 5% of their product; are found in Appendix A. All potatoes are harvested between October to December and ship ped to IFI warehouses where they can be stored for up to one year. The shelf life of fresh potatoes is due to state of the art warehousing technologies which ensures temperatures are kept both cool and dry. In the past year, IFI has uncovered an issue with their temperature control sy have discussed the financial statement impact of this occurrence. Notes from your manager are found in Appendix B issue with the warehouse manager. Mr. Boyd has requested you assess the conversation with the warehouse Manufacturing The Company maintains large warehouses for storing raw potatoes at each manufacturing facility. These warehouses have the ability to store up to 10 million CWT. throughout the 4 manufacturing facilities; the Company is able to process over 1.2 billion pounds of potatoes in a year. Potatoes are moved from the warehouses to the manufacturing facility, where they are processed into French fries and shipped out to customers. The core of IFI's fry manufacturing operations is the Fry10008; purchased in 2002, this machine is capable of washing, peeling, and cutting potatoes into French fries. From here, the fries are transferred into a steam blancher before moving to a commercial fryer. Despite the fact the Fry 10008 is reaching the end of its useful life, Evan MacLean, Operations Manager, has been very happy with his team's ability to keep maintenance costs low. This has helped them perform favourably against budget as they allocate all of the Fry10008 maintenance costs to the balance sheet. In doing this, maintenance costs do not affect their bottom line on the income statement. Mr. MacLean has indicated that anything that isn't patch work should certainly be capitalized to the piece of equipment since it's making the equipment operate as if it's new again!. You are curious as to what types of expenses are being capitalized. As a result you have requested an email from Mr. MacLean detailing expenses, see Appendix C. Mr. Boyd bas requested you perform an analysis of the eligibility of these expenses for capitalization. As the company was investigating ways to maximize profitability, IFI management recently obtained figures on the lease of the Fry30008 equipment. Working in line with the Fry10008, the new piece of equipment would allow the company to ensure cost savings through increasing both their efficiency and output. IFI has the option to purchase the equipment for a price of $35 Million but in the interest of meeting cash flow goals they have opted for a lease. You are aware that there are two different ways to handle leases under ASPE guidelines, and have offered to provide a review of appropriate treatment to Mr. Boyd The lease agreement for the Fry30008 has a 10 year term, with IF I having the opportunity to purchase the equipment for $1,000 at the end of the agreement. The Fry30008 has a useful life of 15 years, and has been manufactured specifically for IFI production. For full use of the equipment, stated in the lease is 8%. IFI will pay the manufacturer $500,000 in lease payments per year. The implicit rate At present,the accounting department has been accruing the annual lease payment under "Lease Expense" on the Income Statement. Seed Breeding One area of IFI operations which is unique to their business model is seed breeding. As part of your orientation, you had a discussion with the lead technologist at the seed breeding farm, M Kate Horne. Ms. Home explained to you that seed breeding is the process in which her team assesses the genetic traits from multiple potato plants, selecting the exact traits which would best naturally combat poor growing conditions. This multi-year project started in 2015, and is created with the intention of providing the best seed to IFI growers. You found it interesting to hear Ms. Horne say all costs on the program have been capitalized since inception. As a result, you have also brought this issue to the attention of Mr. Boyd; he believes IFI is correct to capitalize all costs associated with the program. An excerpt of your conversation with Mr. Boyd, as well as additional details provided from Ms. Home is found in Appendix D. Other Activities 1. On your first day with IFI, you were getting to know your coworkers. As you were discussing the roles within the accounting team and getting to know staff members, Mrs. Sarah Kearsley stated she could not chat for long - it was the start of the month and prepayments from all large retailers were just received! This meant she had to perform all revenue entries in the books before the end of the week. You were confused on this process, and therefore booked a meeting with Sarah to discuss the accounting treatment for these prepayments; notes from your eeting are found in Appendix E. When you performed a review of IFI's financial statement package, you noticed that goodwill is currently recorded on the balance sheet. Being an intangible asset, you understand that this item needs to be tested for impairment. When you brought this to Mr. Boyd's attention, he explained the amount recorded was calculated by your predecessor details on this conversation are found in Appendix F As you were passing the reception desk on your way into work last Thursday, you heard the receptionist discussing with the janitor about a call she received from the company lawyers. Further chatting around the office has led you to believe that the company is engaging in a lawsuit with one of their contractors. Knowing that nothing was recorded in your review of the financial statements, you booked a meeting with Mr. Boyd to discuss the legal position of IFI. Details from your conversation are found in Appendix G. 2. 3. 4. In addition to this discovery, you also have decided to discuss financial ratios with Mr. Boyd; since starting, there are a lot of concems as to how costs are classified on the IFI financial statements. Looking to impress your new boss, you believe that showing him the impact on financial ratios after policy changes would provide a good illustration of the importance of following ASPE guidelines. The most recent financial statements have been provided to you in Exhibit I. APPENDIX A Key contract terms as agreed upon by Island Farms Inc.and independent contractors who grow potatoes for the company Product: All potatoes delivered to IFI by contractors must be grown using seed purchased from IFI's seed breeding operation. Additionally, the fertilizer used in contractor's farms must be purchased from IFI. Failure to comply with these terms will result in a breach of contract. Pricing: On average, a price of $13.00/CWT is agreed upon. Fresh potatoes are available to be purchased in an open market, historically; the price has fluctuated between S8/CWT to S20/CWT - all dependent on supply. The average yield from an acre of potatoes is 330/CWT Delivery Contractors to IFI are responsible for the delivery of potatoes to IFI warehouses where they will later send the potatoes for processing. Amounts which are to be delivered from farmers are agreed upon based on the farmers harvesting capabilities. All contractors are required to fill their yields with IFI before selling in an open market; contract terms permit IFI inspectors to review farm operations at any time. APPENDIX B In October of this year, the potato harvest was in full swing and IFI was receiving deliveries from contractors to fill their warehouse. IFI ran into an issue as they filled the warehouses, the temperature control system stopped working- rather than providing a cool and dry environment, the system actually increased temperatures in a portion of the warehouse. This went unnoticed for one week. When the warchouse manager investigated the issue, he estimated that 200,000lbs of potatoes were spoiled and had to be disposed as a result. All inventories are recorded at cost on the balance sheet when product is delivered to IFI APPENDIX C Email received from Mr. Evan MacLean, IFI Operations Manager From: 0: Ce: Subject: MacLean, Evan Student Boyd, Conor 2018 Maintenance Costs Hi Student, Please see below for a detail of costs which I have had accounting allocated to the Fry1000 on the balance sheet. I am certain with your review you will understand why these costs should not be expensed-they're crucial to the operation of the machinery! It certainly should not impact the compensation my team's annual bonus, based off of company net income. Type of Maintenance Maintenance Cost Conveyor belts that are worn out are switched out on an annual basis Replacement bolts to change out the stripped ones A new high powered engine that will double the output on the automated potato cutting machine New lubricant for the gears Protective shields attached to the assembly line to avoid product remnants from getting out Brand new blades on the potato slicer expected to extend the useful life an additional 3 years The exterior panel on the side of the forklift had a crack that needed to be filled$1,000 $150,000 $35,000 $550,000 $2,500 $25,000 $700,000 If you happen to have any questions, please let me know. Cheers, Evan Operations Manager | Island Farms Inc. APPENDIX D Excerpt from phone conversation with Mr. Boyd Student: "I wanted to ask you Mr. Boyd - have you had a review of the costs capitalized under the seed breeding program? I was surprised to learn that all costs from the program are on the balance sheet since the program inception?" Mr. Boyd: Absolutely I have had a review! All costs have been capitalized because we are generating new information. I see the seed breeding program as crucial to the longevity of IFI. Every bit of research which we have done since the start of that program is new to the industry, and gives us a competitive advantage against any other farm. The long term value it adds to our company? Not a chance that type of work should hit my bottom line!" Student: "I understand. Perhaps I will gather a list of expenses from Ms. Horne to ensure you're correct. I know there is specific criteria under ASPE for the treatment of these expenses." Mr. Boyd: "If you think there are any required changes, please let me know." Email received from Ms. Kate Horne, Lead Technologist - IFI Seed Breeding rom: To: Cc: Subject: Home, Kate Student Boyd, Conor 2018 Program Costs Hi Student, As requested, please see below for cost details as they pertain to the seed breeding program. I started up the program when I was hired with IFI in September 2015; because the work my team is doing is new to the industry, we had to engage in extensive research. I would say our biggest headway was experienced in May 2017 when we were able to first release seed produced in our lab to farmers. It was an extremely important milestone for the program, as at this point we knew we had established processes which will benefit the company for years to come -now, our program is focused on using our processes to ensure that each year we are providing the best seed potatoes possible! I have talked with Sarah in Accounting and she provided the account details for the seed breeding program, as reported on the balance sheet. APPENDIX D (cont.) Description Cost Initial test process documentation Developing the machine capable of measuring the quality of the strains Test product spoilage Research consultants Implementing information system software to track inputs and outputs Engineering documentation Test material $50,000 $1,500,000 $50,000 $120,000 $1,000,000 $50,000 $25,000 If you require any additional information, please let me know. Thanks, Kate Lead Technologist | Island Farms Inc. -Seed Breeding Program APPENDIX E Notes from conversation with Sarah Kearsley-IFI Accountant IFI earns revenue on French fry sales through contracts with local businesses as well as large retailers in Canada and the United States. Local businesses agree to purchase a pre-determined amount of product every month and pay when the goods are delivered to their stores. The retailers require larger amounts of product at a time, so they pay in advance to help IFI cover costs and secure the output they want. IFI recognizes revenue from retailers when cash is received. Large retailers submit 25% of their payment amount one month in advance to E. The remaining revenue is recognized when the product is delivered. APPENDIX F Excerpt of a conversation with Mr. Boyd regarding Goodwill Student: "Good afternoon Mr. Boyd, I am almost finished my first review of the financial statements here at IFI and I wanted to raise concern over the Goodwill which we are reporting on the balance sheet- what does this pertain to?" Mr. Boyd: "Ah. In 2015, IFI purchased a local competitor FryGuy. They were the only other French fry manufacturer in Atlantic Canada and therefore we saw the acquisition as a way to knock out our competition while expanding our capabilities. I do not totally understand Goodwill, but I remember it having something to do with a customer list we received from FryGuy." Student: "Right. That would make sense, so when you purchased FryGuy you were able to expand your customer base by contacting their old customers." "Well not exactly... after about six months of operations we realized that the customer lists were dated. It wasi total flop -I don't think we had one new customer out of it! Mr. Boyd: Student: "Right. Valuing an intangible is usually pretty difficult. So, I assume we adjusted our books when we discovered the customer list had no value?" "Oh god no! We bought the company. I'm not about to decrease the value on our books just because of a silly list. We paid good money for FryGuy!" Mr. Boyd: After finishing the discussion, you walk back to your desk and decide to investigate the Goodwill calculation from 2015. On the company server, you find the following calculation from your predecessor IFI acquired Fry Guy's Inc. (FryGuy). Through purchasing the shares of the company, the company calculated goodwill as follows: Purchase Price of Equity Less: Book Value of Equity Less: Equipment Value above FMV Less: FMV Differential of Customer Lists $18,000,000 ($2,000,000) ($1,000,000) ($3,000,000) Goodwill $12,000,000 APPENDIX G An excerpt of your meeting on the lawsuit with a contractor with Mr. Boyd Student: "I couldn't help but overhear that we may be engaging in a lawsuit with one of our contractors? I have not seen anything disclosed in the financial statements. Are you aware of this?" Mr. Boyd: Ah yes. That's been a real to-do for management lately. I don't know the specifics, but one of our main contractors, Anne's Farm, has been selling their potatoes in the open market before fulfilling their contract with us. Inspectors discovered it when they visited the farm operations - apparently their production yields do not match what has been supplied to us. There is certainly an incentive for Anne's to sell outside of their contract - the market price is extremely high right now given the supply issues seen across North America "Right. So we're suing them for breach of contract -is it likely that this will be paid out?" Student: Mr. Boyd: "I'm not sure - you'd have to talk to our lawyer on that. I can give you their contract. But say... if there will be a payout, we can record that as a receivable before the year closes right?" Student: "Hard to say, but I will reach out to the lawyers and figure out if they have a better idea of whether we will win or not. With this, I will determine the appropriate accounting treatment." You send an email to IFI legal counsel and receive the following response From: To: Subject: Outstanding Lawsuit IFI MacDonald & Levesque LLP Student Hi Student, As requested, probable outcomes of the current lawsuit with Anne's Farm are detailed below. Anne's Farm will settle and pay Island Farm Inc. $500,000 in damages: Anne's Farm will fight the lawsuit in court, payout is unknown: Anne's Farm will issue a counterclaim against Island Famine, unknown payout 20% 60% 20% We hope this helps. Andre Levesque Partner MacDonald& Levesque LLP Exhibit I Island Farms Inc. Financial Statements December 31, 2018 Unaudited Island Farms Inc Balance Sheet (Unaudited) As at December 31, 2018 (in thousands of dolars) 2018 2017 Current assets Cash Accounts receivable 10,507 $ 13,706 Trade Inventories (note 2) Prepaid expenses 22,547 55,162 17.560 23,760 58,047 16,970 105,776 112,483 Goodwill 15,000 15,000 Fixed assets, net (note 3) 248,764 242,363 354,540 354,846 Liabilities Current liabilities Accounts payable Trade Income taxes payable Current portion of long-term debt 47,954 3,286 17,690 49,564 3,721 23.073 68,930 76,358 222,368 298,726 Long-term debt 204,803 Shareholders' Equity Capital Stock Retained earnings 80,806 80,807 56.119 56,120 354,540 354,846 Island Farms Inc. Statement of Income (Unaudited) Year Ended December 31, 2018 (in thousands of dollars) 2018 2017 342,903 253,748 89,155 7,133 82,022 318,900 230,911 87,989 Sales Cost of sales Operating and administrative expenses 6,776 81,213 Interest expense Long term debt Other 11,132 11,056 2.780 13,912 68,110 34,749 2,409 13,465 67,748 Amortization 33,361 Loss on disposal of fixed assets Income before taxes Income taxes Net income for the year 34,570 1,587 32,983 8,576 24.,407 33,361 8,674 Island Farms Inc. Statement of Cash Flows (Unaudited) Year Ended December 31.2018 (in thousands of dollars) 2018 2017 Cash provided (used) Operating activities Net income for the year Amortization Loss on disposal of fixed assets $ 24,687 34,749 $ 24,407 33,178 59,436 1463 60,899 (1,587) 55,998 3.987 Net change in non-cash working capital balances Investing activities Purchase of fixed assets Proceeds from sale of fixed assets (41,150) (42,242) 3,786 (41,150) (22.948) (22,948) (3,199) 13,706 10,507 Financing activities Repayment of long-term debt (23, 778) (23.778) (2.249) 15,955 Cash provided Opening cash balance Closing cash balance 5 S 13,706 Island Farms Inc. Notes to Financial Statements (Unaudited) December 31, 2018 1 Significant accounting policies Inventories are valued at the lower of cost, determined on an average cost basis, and market. Market is defined as replacement cost for raw materials and supplies and as net realzable value for finished goods. Property, plant & equipment Property, plant and equipment are recorded at cost. Depreciation of plant and equipment is calculated using the straight-line method at rates based upon the following estimated useful lives of the assets Buildings Machinery and equipment 10 years 10 years Revenue Revenue is recognized when tile and risk of loss are transfered to customers upon delivery based on terms of sale and collectability is reasonably assured. Revenue is recognized as the net amount to be received after dedudting estimated amounts for discounts, trade allowances, and returns of damaged and out-of-date products Foreign exchange Current assets and current liabilties denominated in foreign cumencies are translated at exchange rates prevaling at the balance sheet date or for hedged amounts, at the relevant forward cumency contract rake. Gains and losses arising on translation are included in the statement of operations 2 Inventories 2018 2017 (000's) Raw maternals Finished goods 40,028 41,150 6,426 7,102 9,796 8,708 $ 55,162 58.047 3 Fixed assets (000's) 2018 Accumulated 2017 Cost Net Cost depreciation Net 64,500 14.208 13.506$ 13,506 S 13506$ 13,506 Land Buildings Machinery and equipment Assets under construction 27,500 37,000 184,700 184,050 14.208 64 500 43,450 359,800 173600 368,750 460,964 $ 212.200 248,764 449,613 $242.363