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of which were the:

July 2001 acquisition of two cold storage facilities in Calgary and Vancouver for $31.3

million known as the Blue Star acquisition;

March 2002 purchase of some of the assets of TCT logistics, a trucking firm in

receivership for $5.2 million - TCT was renamed Atlas Supply Chain Services Limited

("Supply Chain");

September 2002 purchase of some of the assets of CoolStor Warehousing Services for

US$25 million; and

October 2002 purchase of the majority of CS Integrated LLC's U.S. distribution network

for $218 million (US$137.5 million).

All of these acquisitions and the internal expansions were expensive. To finance them, Atlas

entered into 5 successive equity issues in excess of $356 million including:

4,250,000 unit issue announced in March 2001 at $8.70 per unit

1,935,062 unit issue to Gouveia and TD Bank in March 2001 at $8.70 per unit

4,197,500 unit issue announced in July 2001 at $9.60 per unit

6,054,750 unit issue announced November 2001 at $10.45 per unit

7,460,000 unit issue announced August 2002 at $11.40 per unit

9,803,000 unit issue announced October 2002 at $11.55 per unit

Atlas also entered into a credit facility with a syndicate of Canadian and US banks in July 2001

for $191 million and a further facility in October 2002 topping out at $306 million.

Income Trust

An income trust is a special purpose entity that sells equity to the public in the form of units and

uses the proceeds to purchase an operating company that holds a set of income-generating

assets.

Legally, income trusts are a subset of the broader category of 'mutual fund trusts' within the

meaning of the Canadian Income tax Act. An income trust is designed to maximize the cash

distributions paid to the unit holders by eliminating the corporate income taxes paid by the

operating company. An income trust is a 'flow-through' vehicle that allows income to flow

through it and be taxes in the hands of the investor only.

9

Income trusts may be an appropriate investment for individuals and institutions whose focus is

on current cash flow rather than long-term growth. This is because an income trust pays out up

to 90% of its net income plus non-cash expenses such as depreciation and amortization. An

Income trust is an appropriate structure for mature companies in non-cyclical industries that

require minimum capital expenditures to maintain the productivity of assets.

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Due to their

structure income trusts' growth prospects through the investment in future growth is limited.

This is because profits that might otherwise have been invested in future growth initiatives are

used up to achieve the short-term goal of cash distributions.

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Should an income trust become

focused on growth, the cash flow to finance the growth would need to come from either reducing

distributions to current unit holders or new debt and/or additional equity financing.

There are a number of issues that an investor should consider an income trust. From a legal

perspective, as a consequence of being a unit holder rather than a shareholder, investors do not

enjoy limited liability protection offered to those who invest in incorporated companies. Unit

holders are potentially on the hook for liabilities related to debt or company actions.

12

The unit

holder's liability is being addressed in some provinces.

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One of the benefits of trust ownership

is that distributions are made to unit holders in a pr-tax basis thus eliminating the possibility of

double taxation that can happen under share ownership. Unit holders treat the income as other

investment income so the tax rate would be the same as for income such as interest.

The Fall Out

On June 2, 2004 the OSC filed a statement of allegations against Patrick Gouviea, President,

Director, President and CEO and second largest unit holder of Atlas at 8.1%, Andrew Peters

CMA, Executive vice-president and CEO, Ronald Perryman CA, VP Finance and Paul Vickery

CA, Corporate controller and interim VP of Supply Chain.

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In addition, the Institute of

Chartered Accountants of Ontario began an investigation into possible wrongdoing by

members.

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The Charges

The following allegations have been made by the OSC:

1. Inappropriate capitalizing of expenses from 2001 through the second quarter of 2003 -

Atlas's actual quarterly financial results were usually lower than the unreasonably high

target presented by Gouveia to the market. Gouveia would instruct accounting staff to

find more earnings. With his knowledge, accounting staff reviewed all expenses over

$1,000 and reclassified invoices previously classified as expenses as capital expenditures.

Many of these capitalizations were not in accordance with GAAP.

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2. Timing errors - Atlas recorded expenses of $950,000 in 2002 which related to activities

of 2001;

3. Inappropriate recording of refunds - Atlas accounted for a refund of $600,000 related to

the purchase of assets of TCT as a reduction of expense rather than a reduction in the

purchase price of the assets; and

4. Failed to disclose a breach of covenants - As part of Atlas's lending agreement they were

not permitted to invest more that $10 million or lend more than $500,000 to Supply

Chain. Although Supply chain only began operation is March 2002, the covenant was

breached by May 2002. Atlas did not disclose this fact to their lenders and instead

covered it up through two means.

a. Supply Chain paid funds to Atlas at quarter end to bring them back into

compliance. These funds were repaid to Supply Chain the next day.

b. Atlas entered into a sale leaseback agreement at December 31, 2002, whereby

Supply Chain's vehicles were sold to Atlas and leased back. But, Supply Chain's

vehicles were already secured under a general security agreement and therefore

were not available for sale. This agreement allowed Atlas to infuse cash into

Supply Chain and thereby give the appearance of being in compliance with the

debt covenants. In fact, there were no written sale leaseback agreements, no

transfer documents for the vehicles and no lease payments were made.

The OSC concluded that the purpose of these activities was to improperly present an improved

picture of Atlas's financial performance in order to enhance earnings and conceal the extent of

losses at Supply Chain. As a result of the overstated earnings Atlas overpaid the distributed cash

to the unit holders and the bonuses paid to management.

The People

Andrew Peters CMA was terminated as executive VP and CFO on September 19, 2003. Ronald

Perryman CA, VP of Finance who was responsible for public filings was terminated for cause on

November 13, 2003. Patrick Gouveia resigned on November 21, 2003. Effective January 30,

2004 the board of directors were replaced including:

J. Nicholas Ross CA, Chairman of the board since inception in 1997

Joseph P. Wiley who had been TD Capital's representative since the merger in 2000

Jack H. Scott had been involved since inception and had acted as interim President or

CEO during the late 1990s

Jeffrey L. Rosenthal had been involved with Associated Freezers since inception and had

been on the board since the merger in 2000

Patrick Gouveia had joined the board with the merger between Atlas and Associated

Freezers, resigned November 21, 2003

Andrew Peters CMA had joined the had board with the merger between Atlas and

Associated Freezers, terminated September 19, 2003

Two of the existing board member would continue until the next annual meeting being Wes

Voorheis a new member and Robert Gillespie who is Chairman and CEO of GE Canada and had

been on the board since 1998.

Ernst and Young who had audited Atlas since the inception of Associate Freezers Income Trust

were replaced with Deloitte and Touche.

The Investors

Prior to the announcement on August 29, 2003 of the need to restate the financial statements,

investors in Atlas could expect a steady increase in unit value. At the time of the August 2000

merger the units were valued at $7.55. The market value increased steadily to over $13 in

August 2003. Immediately following the announcement of the restatement the units dropped to

$8.50. The decline has continued to below $5.00 in the autumn of 2004.

The unit holders could also rely on a steady flow of cash each quarter of approximately $0.24

per unit. These distributions were discontinued subsequent to the second quarterly payment of

2003.

The Beneficiaries

Gouveia and Peters were well compensated for their management of Atlas. In 2002 Gouveia

received salary and cash bonus of $1.359 million while Peters received $885,000. They also

received 100,000 and 60,000 trust unit options, respectively, in each of 2001 and 2002.

As a unique form of further executive compensation, Gouveia and Peters received "restricted

phantom" units ("RPU"). These units entitled the recipient to receive a cash payment equal to

the increase in market value of Atlas plus the cash distributions paid over the intervening period.

Gouveia's RPU totalled $602,000 by December 31, 2002 while Peters' totalled $361,000.

Because of the structure of Gouveia's and Peters' employment agreements, their bonuses were

guaranteed. In 2003 prior to resigning, Gouveia earned salary and cash bonus of $1.12 million

while Peters earned $603,000 prior to termination.

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Assignment#4 ACC 621

DATE: Nov. 17, 2015

DUE NEXT

CLASS

Hard Copy Only

INSTRUCTOR Richard Deklerk

Required

What "red flags" were present at Atlas? How should an auditor assessing the risk factors

of this engagement have handled these red flags?

List five "red flags"

1.

2.

3.

4.

5.