Case 1 –

You are a staff accountant at the Ontario Securities Commission. Among your many
responsibilities, the most important is to review the accounting for merger and acquisition
transactions by firms listed on the Toronto Stock Exchange. This morning, your boss, Sara Lewin,
the Commission’s Chief Accountant, comes charging into your office with some documents. She
looks puzzled. You sense trouble.

Sara: Hi Sam. Have you seen this? (She points out some press clippings).

Sam: No. What is it?

Sara: Well, Diginet has just submitted their preliminary financial statements for 2018. As you
know, they acquired a major Internet firm and the figures they are planning to report in
their financial statements for that transaction look funny to me. Could you have a look
and report to me this afternoon? I am planning on calling their auditors tomorrow
morning and I would like to be able to grill them on that transaction. Specifically, I
want the following information:
 How a purchase price must be determined according to IFRS.
 An evaluation of whether the purchase price assigned by Diginet to the Interwip
acquisition is in accordance with IFRS.
(a) An evaluation of the Diginet purchase price allocation assumptions.
(b) The final purchase price allocation is said to be subject to further refinement.
What is implied by this statement?
(c) What is the impact of the current allocation on Diginet’s and Telnet’s future
consolidated financial statements?
 I am also interested in how the transaction affected Interwip and Telnet.

Sam: No problem!

Diginet, one of the world's largest suppliers of digital network solutions, and Interwip, a leader in
the worldwide data networking market, announced, in a press release dated June 15, 2018, that
they had entered into a definitive merger agreement through which Diginet would acquire
Interwip. The estimated $8.6 million transaction was to be the largest to date among Canadian
telecom and data network systems providers. That transaction enabled Diginet to accelerate the
implementation of its Internet strategy and to close the gap with its competitor. On
consummation of the merger, Interwip would continue to operate as a wholly-owned subsidiary
of Diginet.

Since Diginet is listed on the Toronto Stock, it must report its financial statements under IFRS.
Exhibit I is an excerpt from Diginet’s financial statements indicating how it is accounting for the
transaction under IFRS.

By issuing common shares to Interwip’ shareholders, Diginet decreased the ownership interest of
its major shareholder, Telnet, from 51% to 41%. Following this dilution in its interest, Telnet’s
management decided that it had lost control over Diginet. Therefore, from Telnet’s perspective,
Diginet became an associate instead of a subsidiary.

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Upon completion of the transaction, Diginet's business was integrated with Interwip' operations.
Scott Thomas, currently president and chief executive officer of Diginet, remained chief
executive officer and a director of the corporation. Tim Daley, chairman, chief executive officer
and president of Interwip, became president of Diginet and was appointed to the Diginet Board of
Directors. Interwip acts as the focal point for Diginet's current and future data networking
business.

The transaction, was expected to close late in the third quarter of 2018, would be tax-free to
Interwip shareholders and would be accounted for by Diginet in accordance with IFRS, using a
tax rate of 40%.

Diginet works with customers in more than 150 countries and territories to design, build and
integrate their communications products and advanced digital networks. Diginet had 2017
revenues of $15.5 million, and has approximately 7,300 employees worldwide. Diginet has
been a major player in the data market and 2017 revenues from its data and multimedia portfolio
totaled $785 million. Diginet has also become the leading provider of optical networks. Over 70
percent of Internet traffic in Canada is transmitted over Diginet optical systems. In addition,
Diginet is one of Canada’s largest providers of wireless systems infrastructure.

As a result of the merger, each outstanding share of Interwip common stock was converted into a
right to receive 0.60 of an Diginet common share and Interwip became a wholly-owned
subsidiary of Diginet. Interwip common stock will no longer trade on the Toronto Stock
Exchange. Diginet issued approximately 135 thousand common shares in connection with the
merger.

After reviewing this material, you decide to go on the Internet (making use of Diginet’s
technology) to your favorite site, so that you can obtain more information about Diginet (Exhibit
II).

Required : Prepare the report requested by Sara Lewin.

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 Exhibit I

Excerpts from Diginet December 31, 2018, Financial Statements ($000)

3. SUPPLEMENTARY MEASURES OF NET EARNINGS AND EARNINGS PER SHARE

As a measure to assess financial performance, management utilizes supplementary measures of
net earnings and earnings per common share which exclude the impact of amortization of the
Interwip intangible assets and purchased in-process R&D from other acquisitions, and
one-time gains and charges. The supplementary measures of net earnings and
earnings per share are as follows:
2018 2017 2016
Net earnings (loss) applicable to common shares $(569) $812 $619
Add back:
Acquisition-related amortization
 Purchased in-process R&D 241
 Acquired technology 228
 Goodwill impairment 161
One-time gains (441) (102)
One-time charges 447 95
Net tax impact (2) 1
Supplementary measure of net earnings $1,065 $804 $619
Supplementary measure of earnings per common share 1.86 1.54 1.20
Weighted average number of common shares outstanding 572 522 516
(thousands)

4. BUSINESS COMBINATIONS

INTERWIP
On August 31, 2018, the Corporation acquired Interwip, a Saskatchewan corporation which
provides networking products and services. The acquisition was consummated by way of a
merger of Interwip with Diginet. The aggregate purchase price was approximately $9.6 million,
which was based on the closing market price of the Corporation’s common shares on the closing
day of the Interwip Merger, the value of the assumed Interwip stock options, and the merger-
related costs. At closing, the Corporation issued approximately 135 thousand common shares and
assumed 39.4 million options to purchase Interwip common stock, which were equivalent to 23.6
thousand options to purchase common shares of the Corporation. The fair value attributable to
these options was $18. The acquisition was accounted for using the acquisition method. The total
book value of Interwip assets at August 31, 2018 was $1,240 and the total book value of the
liabilities was $400. The allocation of the purchase price was to tangible assets of $1,881,
assumed liabilities of $475, acquired technology assets of $2,050, purchased in-process R&D
assets of $1,000, and goodwill of $7,177. This allocation is subject to refinement. The tangible
assets and the liabilities are not amortized. The acquired technology assets are being charged to
earnings on a straight-line basis over six years and the purchased in-process R&D assets are being
charged to earnings over a nine-year period using an accelerated amortization method.

6. GOODWILL IMPAIRMENT

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Total goodwill impairment charged to operations for the years ended December 31, 2018 was
$240 based on the impairment test on December 31, 2018.

The Corporation’s financial statements for the year ended December 31, 2018, include four
months of financial results of Interwip.

18. Preferred shares and common shares

COMMON SHARES
The Corporation is authorized to issue an unlimited number of common shares without nominal
or par value.
On August 31, 2018, pursuant to the Interwip Merger, the Corporation issued approximately 135
thousand common shares. Legal and Other Fees amounted to $2.5 million. At December 31,
2018 and 2017, TELNET Inc. owned 40.7 percent and 51.7 percent of the outstanding common
shares, respectively.

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 Exhibit Il

History of Diginet Networks’ Stock Price from the week starting April 27,
2018, until the week starting September 28, 2018

Week of Open High Low Close

28-Sep- 41.37 41.62 30.87 31.06
21-Sep- 38.57 41.00 38.01 40.25
14-Sep- 47.33 47.70 38.88 40.37
7-Sep- 51.18 53.67 45.96 46.28
31-Aug- 51.60 51.85 47.14 49.69
24-Aug- 53.09 53.90 49.06 49.74
17-Aug- 50.24 54.21 49.74 53.09
10-Aug- 54.02 54.39 50.11 50.24
3-Aug- 58.36 58.36 53.96 54.27
27-Jul- 56.81 58.86 55.88 58.43
20-Jul- 56.07 59.48 55.32 57.56
13-Jul- 58.05 58.05 54.58 54.95
6-Jul- 57.31 58.05 56.38 58.05
29-Jun- 55.51 56.38 55.08 55.94
22-Jun- 52.60 55.82 51.79 55.51
15-Jun- 57.56 58.55 52.22 52.53
8-Jun- 63.02 63.70 61.53 63.20
1-Jun- 63.50 64.49 61.78 62.77
25-May- 66.91 66.91 63.44 63.44
18-May- 64.00 67.40 63.75 67.03
11-May- 61.46 64.12 61.46 64.00
4-May- 60.90 62.14 59.84 61.15
27-Apr- 59.97 61.77 58.54 60.90

Source: Yahoo!.Finance

Information on the acquired intangibles:

Acquired technology : internally developed technology reflected on the Interwip financial

statements at $2 million of capitalized costs. An external appraisal indicated that the value on the
market if sold separately, would be $5 million. The life of the technology is approximately 3
years. Diginet has allocated an amount of $2,050,000 net to the technology.

In-process R&D: Interwip capitalized $1 million in development costs for its networking system.
The total expected costs are $8 million. It requires another 4 years to complete development. An
appraiser has estimated that for Diginet to have reached this level of development, would cost
them $2.5 million. Once completed the networks should last 4 years. Diginet allocated $1
million to the in-process R&D.

Government contracts: Interwip has contracts with the federal government for the next 10 years
which an appraiser valued at $800,000.