Report to President

To : President
From : CA
Re : Acquisition of Rammen Radiators

Overview

This report establishes the allocation of the purchase price in USD. I will examine if there are any
corrections that should be made to the book value of the net assets as of January 1, 2018.

In addition, this report will explain the effect on the financial statements of Claris after one year.

This appears to be a risky acquisition - the company has "significant" loss carryforwards and was
restructured during the year, conditional on new equity financing. Claris will presumably be required to
provide some of this equity, although this is unclear at this point. Note that the acquisition of 60% of
Rammen will not put more equity into Rammen. It merely puts cash in the hands of the former
shareholders.

Reporting implications for December 31, 2018:

Conversion to Canadian currency

The U.S. statements need to be converted to Canadian dollars in order to consolidate with Claris. Since
Claris owns 60% it is presumed that it has control over Rammen and since it is a public company
consolidation will be required.

This can be done using the current rate method or the temporal method, depending on the circumstances
surrounding the operations of Rammen. If the functional currency is the Canadian $, it should be
translated using the temporal method. If the functional currency is the US$, it should be translated using
the current rate method. The classification depends on factors such as degree to which day-to-day cash
flows are intermingled, how sales prices are set, the location of the sales market, the sourcing of inputs,
sources of financing, and degree of interrelationships. However, sales revenue is generated in the US.
This decision is a management decision, but rests largely on fact and circumstances.
Primary Indicators: Sale price will probably determined in USD, Purchases are mainly going to
be from CAD but other expenses will be in USD.
Secondary: Financing is a concern and will probably rely on Claris for financing CAD. Excess
funds will be sent to Canada to extent of Claris ownership.
Other Factors: Since Claris is interested in Rammen because it has a similar operation and Claris
plans to use the company to enter the US market. It seems likely that daily interrelationship will be
significant and the operation will be integrated. The primary economic activity will be in Canada,
therefore, the temporal method seems the best choice on the information given.

In the future, Claris will now have foreign subsidiary which will have to translated each year using the
temporal method. Any gain or loss will go through net income so it will impact the consolidated Claris
Statement.
Income Statement:
Monetary items at the current rate and non-monetary at the historical rate.

Revenues – avg rate 1.39

COGS – inventory at the HR at purchase, if FIFO is used, could use 1.39
 Purchases at the aveg rate 1.39
Depreciation would be at the HR when the asset was bought Jan 1/10 1.01
Other expenses – avg 1.39

Balance Sheet:
PPE, Inventory at HR Other assets probably at the year end rate
Liabilities – monetary so at the year end rate 1.33
Equity – historical rate ; Capital stock – day of acquisition 1.32; Retained earnings – NI as per I/S no
dividends paid.
If student gives reasonable argument for the current rate method full marks should be given.

Amortization of the FVA will be required on the F/S as at December 31, 2018. The LCF would be
written off as it is used. The capital assets would be written off over the remaining life of 10 years.
Assuming FIFO, the inventory would be written off this year. The goodwill would be tested annually for
impairment.

Allocation of the purchase price:

Gain on restructuring
It is correct, under IFRS, to record a gain on restructuring when debt forgiveness concessions are obtained
from creditors. Disclosure as a revenue item is inappropriate - the item should be disclosed separately as
an unusual item.
A condition of the debt forgiveness was that "Rammen begin a process of looking for new equity
investment". This condition has presumably been met, although as mentioned earlier, this proposed
purchase does not put more equity into Rammen. As part of the due diligence procedures, we should
determine whether this condition has been met. If not, this would represent a contingent gain that cannot
be recorded under IFRS since it is not likely.

Legal costs
Rammen has expensed this item. One could also argue that future periods receive benefit from the
restructuring (i.e. by establishing a viable firm) and thus the payment should be deferred and amortized
over the period of benefit. However, since the gain on debt forgiveness is on the income statement, it
seems more logical to treat this expense as part of the transaction and group it accordingly. This is also
consistent with our goal of reducing the purchase price.

Banking fees
Banking fees have been expensed, but are, in fact, part of the interest cost associated with the loan facility
and thus should be deferred and amortized over the life of the loan using effective interest rate method.
The rate of exchange used should reflect the allocation over the year.

Upon acquisition of the company the Loan will have to be fair valued. Since the market rate of interest is
higher this will represent a FV increase equal to the difference between 2% and 4% for 4 years.
PV (1,000,000)4%, 4 years = 854,800
PVA (20,000) 4%, 4 years = 72,598
Total 927,398

Income taxes
No tax is recorded on the income statement because the company has large accumulated tax loss
carryforwards that cannot be recognized without the criteria of “more likely than not” is not met.
These loss carryforwards may be an important asset of Rammen that is not included on the balance sheet
due to recognition criteria difficulties. When the purchase price is evaluated for reasonableness, the value
of these losses, acknowledging their expiry dates, should be considered.

Upon acquisition of the business Claris will record the FV of these LCFs.

Deferred product development costs

Deferral of development costs was appropriate if certain conditions were met at the time the deferral was
made. This is assumed, although it should be investigated more carefully (i.e. technological feasibility,
marketing feasibility, etc.). Deferral is easy to support with hindsight, given that the design is very
successful.
However, it is unlikely that the life is not determinable and the deferral must be amortized over a
reasonable period. An arbitrary period of twenty years has been chosen for these calculations. Lower
amortization periods result in lower assets and a lower purchase price. Therefore, this issue should be
pursued to ascertain a conservative life span.

Upon acquiring the company the development cost will be assigned a fair value of $300,000. Based on
the amortized value of $199,500 (210000 -10500) this represents a FVA of $100,500.

Student may choose not to amortize.

Deferred customer goodwill

Payment under a penalty clause does not create goodwill or future cash flow, despite any good client
relations that exist. The amount must be written off in 2017, reducing net assets and the purchase price.

Other: Consider the salaries of the previous managers. This should not be included in the
calculation of net income. However, Claris has agreed to pay it for the next 10 years so it is a
real expense.
- Adjust the Balance Sheet at January 1, 2018 in USD. Then calculate the FVA.

Book value as presented in USD: 3,000,000

Adjustments:
Restructuring (126,400)
Debt 1,000,000 – 927,398 72,602
Product Dev cost (10,500)
Goodwill (40,000)
Adjusted book value 2,895,702
Consideration transferred BV x 2 = USD 5,791,404

BV 2,895,702
FVA:
LCF 450,000 x .7 315,000
Capital assets 600,000 x .7 420,000
Inventory 400,000 x .7 (280,000)
3,350,702 x .6 2,010,421
Goodwill 3,780,983
Could use the full goodwill method or the partial goodwill method since Rammen is a public company.
Goodwill seems high which may mean that the purchase price is still too high.
Case 2 – 20 marks maximum

Primary indicator #1

Conclusion and required Excellent Very Good Good Weak Not

addressed

Pervasive Understood the Addressed most Addressed Mentioned the

need to address issues in terms of some issues in needs of the
 Understood that in terms of IFRS IFRS OR IFRS president but
the role was to all of the time little integration
act as a
in the answer
employee to Reduce the
Claris and Addressed the
purchase price if
report to the need to reduce
president. warranted
the purchase
price if possible

4 3 2 1 0

Primary Indicator #2

Conclusion Excellent Very Good Good Weak Not

and required addressed

Discussed the Discusses all of the Discusses at Discusses at Discusses at

calculation of following in least 3 of the least 3 of the least 2 of the
the BV of net sufficient depth: items in items in items in
assets and Gain on sufficient depth sufficient depth sufficient depth
recalculates restructuring
the BV Legal costs AND OR OR
Loan valuation
Deferred product Calculates a Calculates a Makes some
development revised BV even revised BV attempt at
Deferred goodwill though no correct even though correction of the
Manager salaries no correct book value

Calculates the
revised BV
6 5 4 2

Primary indicator #3
 Conclusion Excellent Very Good Good Weak Not
and required addressed

Calculates the Calculates the Calculates the Calculates the Calculates the
acquisition acquisition acquisition acquisition acquisition
analysis and analysis: analysis: analysis: analysis with
makes an little to no
assessment if Adjusts for: LCF, Makes at least 2 Makes at least 2 adjustmnets:
the price paid Capital Assets, adjustments adjustments
is too high Inventory,
calculates goodwill AND OR

Assesses goodwill recommendation recommendation

as high and makes re: purchase re: purchase price
recommendation price
re: purchase price

5 4 3 1 0

Primary indicator #4

Conclusion Excellent Very Good Good Weak Not

and required addressed

Discusses the Discusses that Discusses the Discusses the Discusses the
reporting consolidation will method of method of need to translate
implications be required translation in depth translation in the F/S but the
for 2018 AND based on the IFRS some depth discussion is
Discusses the factors AND superficial
method of AND Discusses few
translation in depth Discusses some of of the FC rates
based on the IFRS the FC rates to use to use OR
factors in sufficient OR Discusses the Discusses the
depth treatment of some treatment of
AND of the FVAs few of the
Discusses the FC FVAs
rates to use
AND
Discusses the
treatment of the
FVAs
6 5 3 1 0