Imax
Corporation is a Canadian company whose shares trade on the TSX and NASDAQ. The
company files its statements in U.S. GAAP (as allowed by the Ontario Securities
Commission). The company is one of the world’s leading entertainment technology
companies, specializing in large-format and three-dimensional film
presentations. It designs, manufactures, sells, and leases projection systems.
Most IMAX theatres are operated by third parties under lease and licensing
agreements. The company also produces films.
The
following excerpts from the December 31, 2008 financial statements explain
various transactions that have been entered into:
The
Company enters into theater system arrangements with customers that contain
customer payment obligations prior to the scheduled installation of the theater
system. During the period of time between signing and the installation of the
theater system, which may extend several years, certain customers may be unable
to, or elect not to, proceed with the theater system installation for a number
of reasons including business considerations, or the inability to obtain certain
consents, approvals or financing. Once the determination is made that the
customer will not proceed with installation, the arrangement may be terminated
under the default provisions of the arrangement or by mutual agreement between
the Company and the customer (a “consensual buyout”). Terminations by default
are situations when a customer does not meet the payment obligations under an
arrangement and the Company retains the amounts paid by the customer. Under a
consensual buyout, the Company and the customer agree, in writing, to a
settlement and to release each other of any further obligations under the arrangement
or an arbitrated settlement is reached. Any initial payments retained or
additional payment received by the Company are recognized as revenue when the
settlement arrangements are executed and the cash is received, respectively. These
termination and consensual buyout amounts are recognized in Other revenues. The
company has various financing agreements that contain restrictive covenants,
including restrictions on debt levels.
Instructions
Adopt
the role of a potential investor and analyze the financial reporting issues.
Use IFRS for the analysis (as opposed to U.S. GAAP).
Overview:
-
A public company whose shares trade on the TSX and
NASDAQ so Canadian and US GAAP are a constraint.
-
Note that the OSC allows the company to file under US
GAAP.
-
NB – the case asks that IFRS
be used for the analysis for simplicity sake.
-
Debt covenants require monitoring several things
including debt levels and therefore debt levels will be important and there may
be some bias to keeping them low.
-
As a potential investor— will want conservative
transparent financial statements
Analysis and recommendations:
Issue: How to
account for conversion of contracts relating to older technology to new
contracts with IMAX digital
theatre systems
- Theses contracts for older systems are
sometimes converted to new contracts with newer technology
|
Treat as two contracts – cancel old
contract and set up new contract
|
Treat as one contract – both contracts are
part of the same overall deal
|
|
- Terminate old contract and
write-off/recognize any deferred revenues/costs.
- Set up new contract and recognize revenues
as earned.
|
- Review both contracts together and ensure
that revenues are equal to fair value of the new system.
- Continue to defer any revenues received in
advance under either contract and recognize only as earned.
- May recognize any excess revenues (over the
fair value of the new system) once contracts are signed and deal is
finalized. At that point, the transaction will be measurable.
|
Recommendation: Do
not recognize revenues even if cash received in advance. Unearned revenues
should be equal to the fair value of the new system and should be recognized as
earned. This is the position that the company has taken.
Issue:
Concessions/considerations given to a customer including free products and
services
|
Treat as multiple element arrangements (as
unearned revenues)
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Treat as costs and recognize liability
|
|
- These concessions are essentially part of
what is being sold to the customer.
- Therefore, part of the total revenues
should be separated and allocated to these services/products and recognized
when earned.
|
- These are costs of selling and should be
accrued and recognized as costs/liabilities when revenues are recognized
(matching).
- If revenues are deferred, may have to
recognize the costs up front unless they meet the definition of an asset.
Alternatively, recognize revenues equal to the costs (or with normal profit
margins).
|
Recommendation:
Treat as multiple element arrangements and separate units of account as the
company has done for the free products and services.
Issue: Fees for film
production where financing provided in exchange for rights in the film. The
company retains distribution rights. Therefore the company receives cash and
distribution rights and provides film production services.
|
Recognize as
revenues
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Recognize as
decrease in cost of producing film
|
|
- Recognize as revenues when significant
events completed as this is likely a long term contract with many significant
events.
- Significant events would occur as film is
being produced.
- Films are produced for third parties –
service provided.
- Consider also recognizing distribution
rights as an asset.
|
- Represents a source of cost reduction.
- Often the films are jointly owned by more
than one party including the company.
- This does not represent an investment in
the company, only in the film and therefore would not be presented as equity.
- Nor does it represent debt since it is not
repayable.
|
Recommendation: Okay
to treat financing as cost reduction. A third option would be to recognize as
debt— that would be the royalties owed to the third parties once the film is
sold. Due to the complexity—ensure adequate note disclosure.
Issue: How to
account for costs of digitally remastered films where film rights belong to
third party?
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Expense
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Capitalize
|
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- Underlying film
rights belong to a third party.
- Future benefits
uncertain as do not know if films will sell.
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- Will yield
future benefits when sold.
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Recommendation:
Acceptable to capitalize— would not do the work if did not think that it would
generate future benefits.
