Northwest Flights (NWF) is a regional airline that services most cities in the Northern Ontario, Canada. The company began in 2007 when three friends (Joe, Jack, and John) felt that Northern Ontario was an underserviced market. Joe, Jack and John each own one-third of all the issued common shares and exercise equal control over the company. After their start-up phase, management began to expand their services lines. Currently, NWF offers only short haul flights to and from Thunder Bay. However, NWF has planned an expansion of operations into the rest of Ontario as they received approval to fly into both Torontos Pearson Airport. NWF plans to offer their first flights into Toronto Ontario in early 2022.
In order to service the new routes into Ontario, NWF purchased a new airplane for $1,000,000. NWF obtained a 10-year mortgage from the Bank of Sydney in order to finance the acquisition of the plans. The terms and agreement of the mortgage can be found in Exhibit I.
Jack, who is responsible for the accounting functions of the company, has always prepared the financial statements for internal reporting purposes. The balance sheet, as at December 31, 2020, is included in Exhibit II.
As a result of the new bank loan, the financial statements must now be audited. As a result, NWF has hired Lebeau and Liang LLP (L&L), a Chartered Professional Accountant firm to complete the audit. You are the senior accountant at L&L, assigned to the audit.
You met with Jack as part of your auditing planning. Jack states I understand that there is Part I (IFRS) and Part II (ASPE) GAAP in Canada. Currently, the bank has not disclosed which set of standards must be used to prepare the financial statements. Therefore, could you help me understand the significant differences between ASPE and IFRS, as they relate to our financial statements? The notes from your meeting can be found in Exhibit III. It is now January 10, 2021. The partner has asked you to prepare a report addressing the clients concerns, and to discuss the policy differences between ASPE and IFRS.
Exhibit I - Mortgage Agreement with the Bank of Sydney Total Balance: $1,000,000 Term: 10 year amortization, blended annual payments due on December 31. Commencement Date: January 1, 2020 First Payment: Due December 31, 2020 Interest Rate: 8% fixed over the 10-year period Covenant: NWF shall maintain a debt-to-equity ratio that is no greater than 2:1. Collateral: Secured debt against the value of the aircrafts Compliance: Audited financial statements to be filed by January 31 of each year. EXTOLE Incers Financements BALANCE SHEET As At December 31 (unaudited) 2020 2019 Assets Current Cash Accounts receivable Inventory Prepaid insurance $151,764 334,894 86,800 4,720 578,178 $160,502 411,760 159,400 2.060 733,722 Capital 661,897 382,158 35,000 35,000 Future income tax asset Long-term note receivable 20,000 $1.295.075 $1,150,880 Liabilities and shareholders' equity Current Accounts payable Bank loan-current portion Income taxes payable $158,318 41,998 44,609 244,925 $130,146 72,000 92.920 295,096 Bank loan - FirstBank of Canada 93,434 130,664 Common shares Preferred shares Contributed surplus Retained earnings 900 20,300 4,000 931,516 956.716 900 20,300 4,000 699.950 725,150 $1.295.075 $150.890 Notes to the Balance Sheet 1. The balance sheet above does not include the impact of any of the issues related to: a) The new bank debt (mortgage with Bank of Sydney) or the related Aircraft. b) Flight No. 877 c) Common share redemption d) The convertible bonds Related to preferred share redemptions in the past. Purchase of Aircrafts & New Bank Debt Jack informed you of the fact that the December 31, 2020 balance sheet does not include the acquisition of the new aircraft, or the new bank debt. Jack did not even record the journal entry for the first payment made on December 31, 2020 Bank Loan with the FirstBank of Canada The total outstanding balance of $93,434 is due in full on January 15, 2021. Jack has left the total balance as long-term as at the December 31 year-end because on January 3, 2021 he was able to renegotiate the loan on a long-term basis. Jack has provided you with a copy of a non-cancellable agreement to refinance the debt as January 3, 2021. Flight No.877 On November 24, 2020, 26-passengers on Flight No. 877 were injured upon landing when the plane skidded off the runway. Fortunately, no one was injured seriously; however, personal injury suits were still filed on December 1, 2020 for damages totaling $50,000. Legal counsel has studied each suit and advised NWF management that it is probably about a 60% chance) that they will lose the lawsuit. The loss could range anywhere between $20,000 and $50,000. If the lawsuit is lost, there is a 20% chance that NWF will have to pay $20,000, a 55% chance that they will have to pay $50,000 and a 25% chance that NWF will pay $35,000. Cancellation of Common Shares On September 15, the company reacquired and cancelled 9 shares (3 from each of Jack, Joe, and John). The redemption price was $1,035 per share. Jack was unsure of how to account for this transaction, and therefore did not make any entries as at year-end for the redemption. Prior to the reacquisition, there were 900 shares outstanding. Convertible Bonds In order to obtain additional capital to finance the expansion, NWF issued $500,000 in 8%, 10-year convertible bonds on January 1, 2020 for $500,000 cash. Each $1,000 bond includes the right to purchase 1 share for $750 during the life of the bond. The current market rate for similar non- convertible bonds is 9%. The fair value of the option using an option pricing model is $49,760. Exhibit I - Mortgage Agreement with the Bank of Sydney Total Balance: $1,000,000 Term: 10 year amortization, blended annual payments due on December 31. Commencement Date: January 1, 2020 First Payment: Due December 31, 2020 Interest Rate: 8% fixed over the 10-year period Covenant: NWF shall maintain a debt-to-equity ratio that is no greater than 2:1. Collateral: Secured debt against the value of the aircrafts Compliance: Audited financial statements to be filed by January 31 of each year. EXTOLE Incers Financements BALANCE SHEET As At December 31 (unaudited) 2020 2019 Assets Current Cash Accounts receivable Inventory Prepaid insurance $151,764 334,894 86,800 4,720 578,178 $160,502 411,760 159,400 2.060 733,722 Capital 661,897 382,158 35,000 35,000 Future income tax asset Long-term note receivable 20,000 $1.295.075 $1,150,880 Liabilities and shareholders' equity Current Accounts payable Bank loan-current portion Income taxes payable $158,318 41,998 44,609 244,925 $130,146 72,000 92.920 295,096 Bank loan - FirstBank of Canada 93,434 130,664 Common shares Preferred shares Contributed surplus Retained earnings 900 20,300 4,000 931,516 956.716 900 20,300 4,000 699.950 725,150 $1.295.075 $150.890 Notes to the Balance Sheet 1. The balance sheet above does not include the impact of any of the issues related to: a) The new bank debt (mortgage with Bank of Sydney) or the related Aircraft. b) Flight No. 877 c) Common share redemption d) The convertible bonds Related to preferred share redemptions in the past. Purchase of Aircrafts & New Bank Debt Jack informed you of the fact that the December 31, 2020 balance sheet does not include the acquisition of the new aircraft, or the new bank debt. Jack did not even record the journal entry for the first payment made on December 31, 2020 Bank Loan with the FirstBank of Canada The total outstanding balance of $93,434 is due in full on January 15, 2021. Jack has left the total balance as long-term as at the December 31 year-end because on January 3, 2021 he was able to renegotiate the loan on a long-term basis. Jack has provided you with a copy of a non-cancellable agreement to refinance the debt as January 3, 2021. Flight No.877 On November 24, 2020, 26-passengers on Flight No. 877 were injured upon landing when the plane skidded off the runway. Fortunately, no one was injured seriously; however, personal injury suits were still filed on December 1, 2020 for damages totaling $50,000. Legal counsel has studied each suit and advised NWF management that it is probably about a 60% chance) that they will lose the lawsuit. The loss could range anywhere between $20,000 and $50,000. If the lawsuit is lost, there is a 20% chance that NWF will have to pay $20,000, a 55% chance that they will have to pay $50,000 and a 25% chance that NWF will pay $35,000. Cancellation of Common Shares On September 15, the company reacquired and cancelled 9 shares (3 from each of Jack, Joe, and John). The redemption price was $1,035 per share. Jack was unsure of how to account for this transaction, and therefore did not make any entries as at year-end for the redemption. Prior to the reacquisition, there were 900 shares outstanding. Convertible Bonds In order to obtain additional capital to finance the expansion, NWF issued $500,000 in 8%, 10-year convertible bonds on January 1, 2020 for $500,000 cash. Each $1,000 bond includes the right to purchase 1 share for $750 during the life of the bond. The current market rate for similar non- convertible bonds is 9%. The fair value of the option using an option pricing model is $49,760
