Air Canada is Canada’s largest airline, operating domestic and international flights on a full-service basis. During 2003, the company ran into financial difficulty and took steps to reorganize its operations and rethink its business model. The company needed to obtain significant additional financing and was looking to undergo a financial reorganization under which control of the company would likely change hands.
In March 2004, the company set up voluntary separation programs, which allowed for up to 300 non-unionized employees to “retire” with severance payments. Unionized employees were covered by a separate similar plan. In addition, it was planned that certain employees would be terminated and receive severance payments under pre-existing contracts. Many lease contracts were renegotiated and/or terminated. While operating under bankruptcy protection court orders, the company had ceased to pay its lessors. GE Capital Corporation and its subsidiaries leased, managed the leases of, or had an interest in 108 aircraft—the bulk of Air Canada’s aircraft. GE’s lawyers notified the airline that it must either pay the back rent or return the planes, noting that the company should not be allowed to hide behind the bankruptcy protection and use the planes for free. The company had many of its leased planes recorded as operating leases. Aircraft operating lease rentals over the lease term were amortized to operating expense on a straight-line basis. The difference between the straight-line aircraft rent expense and the payments as stipulated under the lease agreement was included in deferred charges and deferred credits ($1.8 billion).
The following is an excerpt from the financial statements:
11. Convertible Subordinated Debentures
In December 1999, the Corporation issued $150 convertible subordinated debentures which have an annual interest rate of 7.25%, payable quarterly, and are convertible at $16.00, at the holder’s option, into Air Canada common shares and Class A non-voting common shares (“Class A shares”) at any time up to and including maturity in December 2009. This equals a rate of 6.25 shares per $100.00 principal amount of convertible subordinated debentures. There are no principal payments until maturity in 2009. The Corporation can force conversion into common shares and Class A shares at any time following the seventh anniversary of the issue if the weighted average closing price of the shares of the Corporation for the 20 trading days prior to the date of the redemption provides the holder an internal rate of return of at least 12% for the period commencing from the date of issuance of the convertible subordinated debentures and ending on the redemption date. The internal rate of return calculation includes interest payments made by the Corporation under the convertible subordinated debentures and the excess of the weighted average closing price above $16.00.
The company entered into a new cobranding agreement with CIBC regarding Aeroplan points and the Aerogold Visa card. The agreement revised a prior agreement with CIBC increasing the amount that CIBC would pay for the Aeroplan points (by 24%). As a result of revising the old agreement, CIBC is seeking damages of $209 million. In addition, the new CIBC contract also provides the Company with a borrowing facility under which the Company received financing of $315.
During the year, at CIBC’s option, the principal portion of the loan was reduced through the offset of amounts owing from CIBC for Aeroplan miles purchased.
Instructions
Adopt the role of Air Canada’s auditors and discuss the financial reporting issues. For simplicity sake, use IFRS in the analysis.