You are engaged in the audit of Plex-Fame Corporation (PFC), a rapidly expanding, diversified, publicly traded entertainment company with operations throughout Canada and the United States. PFC’s operations include movie theatres, live theatre production, television production, and a 60% interest in Media Inc. (Media), a company that specializes in entertainment-related advertising and promotion.
It is June 22, 2012, the week before PFC’s year-end. You meet with the chief financial officer of PFC to get an update on current developments and learn the following.
PFC acquired 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 10-theatre complex for PFC in Montreal. This payment represents a penalty for not completing the theatre complex on time. Construction began in June 2011 and was to have been completed by December 2011. Instead, the complex was not completed until the end of May 2012.
The company is staging a Canadian version of “Rue St. Jacques,” which is to open in November 2012. 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 2011, and the first 40 weeks of the show’s run are completely sold out. Average ticket prices are $65; the show will play seven nights a week. The theatre used for production is relatively small, with about 1,200 seats. As at June 22, 2012, PFC had 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 pre-production costs by November 2012 and will incur weekly production costs of $250,000 once the show opens.
PFC started selling movie theatres a couple of years ago. Each theatre’s 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 company’s operations, proceeds from the sale of theatres are recorded as revenue in the income statement.
When you return to the office, you discuss these issues with the leader of the audit engagement. She asks you to prepare a report on the financial accounting issues you have identified as a result of your meeting with the chief financial officer.
Required:
Prepare the requested report.