You, the CPA, an audit senior at Green & Co., CPAs, are in charge of this years audit of SuperFlix Corporation (SFC). SFC is a rapidly expanding, diversified, and publicly owned entertainment company with operations throughout Canada and the United States. SFCs operations include movie theatres, live theatre production, and television production. It is June 22, Year 7, the week before SFCs year-end.

You meet with the chief financial officer of SFC to get an update on current developments and learn the following. SFC 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 ten-theatre complex for SFC in Stratford. 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. Germaine, 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. SFC started receiving advance bookings in November, Year 6, and the first 40 weeks of the shows run are completely sold out. As at June 22, Year 7, SFC 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. SFC has retained Modale Inc. (Modale), a company that specializes in entertainment-related advertising and promotion, to promote SFCs activities. Modale bills SFCs corporate office for all advertising and promotion related to SFCs activities. Advertising and promotions have significantly increased this year, in part due to large costs associated with the forthcoming opening of Rue St. Germaine. Modale has billed SFC $12 million this year for advertising and promotion, an increase of $7 million over the preceding year.

SFC 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 companys syndicated loan of US$25 million. At the time the loan agreement was signed, SFC 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 come due. SFC 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 companys balance sheet.

SFC started selling movie theatres a couple of years ago. Each theatres contribution 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 companys operations, proceeds from the sale of theatres are recorded as revenue in the income statement.

On May 31, Year 7, SFC and an unrelated company, Oprahh Inc. (Oprahh), formed a partnership, Bestview.

Oprahh contributed $40 million in cash. SFC contributed the assets of its TV production company, which had a carrying amount of $65 million. The $90 million value assigned to SFCs contribution may be adjusted if the net income of Bestview earned between July 1, Year 7, and June 30, Year 8, does not meet expectations. SFC has recorded a gain of $25 million. The partnership agreement states that SFC is permitted to withdraw the $40 million for its own use, and it has done so. As a result, Oprahh has a 45% interest in the partnership and SFC has the remaining 55% interest. The profits are split according to the ownership interests. Although all major operating and financing decisions are discussed by both parties, SFC has the final say in any contentious issues.

SFCs bank operating loan in the amount of $200 million is well within its maximum of $240 million. The loan agreement calls for a maximum debt-to-equity 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, SFC meets the restriction because its debt is $1,490 million while its shareholders equity is $780 million. SFCs consolidated income before tax was $147 million for the 11 months ended May 31, Year 7. SFC hopes to maintain its recent trend of reporting a minimum 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 SFC 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).

You are encouraged to refer to CPA Handbook for guidance.