Temple
Limited is in the real estate business. After several years of economic growth,
most of the company’s assets are now worth significantly more than the amount
that is recognized on the financial statements. Wanting to capitalize on this
positive trend, the company is ready to expand and is looking at developing a
new property in the Bahamas that will cost $300 million. Currently, the
company’s debt-to-equity ratio is 5:1 and the company needs to raise funds for
the expansion. Lendall Bank, the company’s primary lender, understands that
there is hidden value in the balance sheet and is willing to finance the
project.
Temple
is now concerned about how the capital markets will react to this increase in
debt. The company’s shares list on the TSX and, therefore, GAAP is a
constraint. Terry Temple, the company’s CEO, attended a conference on international
GAAP where the speakers noted that Canadian companies that are publicly accountable
will move to IFRS for fiscal years beginning on or after January 1, 2011.
Under
IFRS, fair value accounting is permitted for real estate as an accounting policy
choice. The following handout was given to conference attendees. It represents
a tentative timeline for the rollout of international standards in Canada for
Canadian companies (the handout was modified and taken from a publication
issued by the CICA on transitioning to IFRS).
December
31, 2008 Possible disclosure of an enterprise’s plan for convergence and what
effects the enterprise anticipates will arise with the change to IFRS.
December
31, 2009 Same disclosure required as in 2008, but with a greater degree of
quantification of the effects of the change to IFRS.
January
1, 2010 First year for collection of comparative information for inclusion with
2011 financial statements under new IFRS-based requirements. Opening balance
sheet for 2010 on IFRS basis required.
Valuations
on certain items may be advisable for the opening balance sheet preparation, depending
on accounting policy choices under IFRS 1.
December
31, 2010 Last year of reporting under current Canadian GAAP.
January
1, 2011 Changeover. First year reporting under new IFRS-based standards.
Opening balance sheet for 2011 on IFRS basis required.
March
31, 2011 Enterprises issuing interim financial statements prepare their first
IFRS-based statements for the three months ended March 31, 2011
December
31, 2011 End of first annual reporting period in accordance with new IFRS-based
requirements including IFRS-based comparatives for 2010.
Instructions
Adopt
the role of Temple Limited’s controller and write a memo to address the CEO’s
concerns. Hint: review Chapters 10 and 11 regarding asset valuation. You might
also wish to review IFRS 1 to see what choices the company has regarding valuing
its assets at January 1, 2010 (opening balance sheet date for comparative
balance sheet for 2011 financial statements).
Overview
- The
company is expanding and assets are recorded at historical costs, which do not
reflect its true value.
- The
company is looking for a loan, yet its
debt to equity ratio is already high at 5:1—the concern is that the asset value
does not reflect true value and also the negative impact of this and the new
loan on the debt to equity ratio. There may be some bias to attempt to “manage”
these numbers.
- Investors
and creditors (Lendall Bank) would appreciate statements that reflect true
value and risk (reflect the hidden value).
- It is a
public company (shares list on TSX) and therefore IFRS is a constraint.
- Controller
should ensure that statements are transparent.
Analysis and recommendations
- Using
fair values to value real estate assets is acceptable under IFRS. It provides
greater transparency and more relevant information. Gains and losses are booked
through income.
- The
company is currently constrained by pre-2011 Canadian GAAP however, which does
not allow comprehensive revaluation of assets except if change of ownership or
financial reorganization.
- Canada
will be transitioning over to IFRS for years beginning on or after January 1
2011, for public companies.
- Will need
to gather information for comparative balance sheet (including opening balance
sheet and closing balance sheet for 2010), so should start to collect this
information. IFRS will be accounted for retrospectively and IFRS 1 is the
standard that governs the transition.
- Not
allowed to early adopt but should provide note disclosure regarding market
values as this represents more relevant information and will allow users to
recalculate the debt to equity ratio— a key ratio in a capital intensive
industry such as this.
