Kelly’s
Shoes Limited used to be a major store in Canada before it went bankrupt and
was bought by Bears Shoes Limited. Many of the stores were anchor tenants in
medium- to large-sized retail shopping malls. This space was primarily leased
under non-cancellable real estate leases as disclosed in note 16 to the
consolidated financial statements. Aggregate commitments under both capital and
operating leases amounted to over $1.3 million. As part of Kelly’s
restructuring and downsizing plans prior to its bankruptcy, the company
announced at the beginning of the year that it planned to close down 31 of its
85 stores by June 30. Subsequently, it announced that it might keep certain
stores open until February in the following year if the landlords were prepared
to provide an appropriate level of financial support. Kelly’s also announced
that landlords who allowed the stores to close June 30 (the earlier date) would
be given a bonus of three months of rent.
Instructions
Assume
the role of Kelly’s management and discuss the financial reporting issues that
the company had to deal with before its bankruptcy. Discuss any differences
between IFRS and ASPE.
Overview
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Not clear whether GAAP is a constraint but
users will likely want GAAP financial statements since they provide more useful
information. Differences between IFRS
and ASPE are provided as requested.
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Landlords in particular might want to see
the financial statements in order to help negotiate the restructuring.
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In addition, creditors and shareholders
would be interested in transparent statements.
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As management – would want to show a
realistic picture of the state of affairs. May be biased to make the situation
look at bit worse so as to be in a better negotiating situation.
Analysis and
Recommendations
Issue: How to account for the three months bonus of free
rent/costs of cancellation. Not clear as to whether operating or capital leases
(termination of a capital lease would result in removal of assets/liabilities
with a gain/loss recognized).
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Accrue costs
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Do not
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If likely that the costs would be
incurred and measurable. Per IAS 37 – present obligation as a result of past
transaction, probable outflow and measurable (essentially the same as ASPE).
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In this case— the leases are
non-cancellable and therefore, it is likely that there would be costs to
break the lease.
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The key would be whether these are
measurable – would depend on stage that negotiations were in.
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Measurement may be an issue since each
landlord might make a different deal.
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Some landlords may even be willing to
provide financial support to the company to keep the stores open as long as
possible— cannot accrue this benefit until received (contingency accounting).
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An exit plan by itself does not
necessarily create an obligation.
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Would wait until contracts are actually
terminated.
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Recommendation:
It would appear that the negotiations were at a very preliminary stage and that
the landlords might have been willing to offer some inducements/concessions to
the company to stay longer. Therefore, the outcome of the uncertainty was not yet
determinable and recognition would not be recommended. This would be further
supported since, even if it were argued that the costs were likely, it is
difficult to measure the cost. At the one end of the spectrum, the landlords
could require the full commitment to the end of the lease be honoured. At the
other end, the landlord might agree to a lesser amount, i.e., the company would
pay rent until a new tenant is found.
