Canadian Computer Systems Limited (CCS) is a public company engaged in the development of computer software and the manufacturing of computer hardware. CCS is listed on a Canadian stock exchange and has a 40% non-controlling interest in Sandra Investments Limited (SIL), a U.S. public company that was de-listed by an American stock exchange due to financial difficulties. In addition, CCS has three wholly owned subsidiaries.
CCS is audited by Roth & Minch, a large public accounting firm. You, the CA, are the audit manager responsible for the engagement.
CCS has a September 30 fiscal year-end. It is now mid-November, Year 11, and the year-end audit is nearing completion. CCS's draft financial statements are included in Exhibit I . While reviewing the audit working papers (see Exhibit II ), you identify several issues that raise doubts about CCS's ability to realize its assets and discharge its liabilities in the normal course of business.
After you have reviewed the situation with the engagement partner, he asks you to prepare a memo for his use in discussing the going-concern problem with the president of CCS, and suggests that you look to IAS 1 for guidance. Your memo should include all factors necessary to assess CCS's ability to continue operations. You are also to comment on the accounting and disclosure implications.
Prepare the memo requested by the partner.
1. Cash receipts are collected by one of CCS's banks. This bank then releases funds to CCS based on operating budgets prepared by management. Demand loans bearing interest at 1% over the bank's prime rate are used to finance ongoing operations. The demand loans are secured by a general assignment of accounts receivable and a floating-charge debenture on all assets.
2. CCS accounts for its interest in SIL using the equity method. As a result of SIL's recurring losses in prior years, the investment account was written off in Year 9. In Year 10, CCS recorded in its accounts the amount of SIL's bank loan and accrued interest, as CCS guaranteed this amount. During Year 11, CCS made debt payments of $5.42 million and interest payments of $1.8 million on behalf of SIL. In October Year 11, SIL issued preferred shares in the amount of US$40 million, used the proceeds to pay down the bank loan, and was re-listed on the stock exchange. Interest expense on the debt obligation in Year 11 totaled $2.83 million and has been included in the income statement under "Loss from Sandra Investments Limited."
3. Current liabilities include mortgages payable of $21.6 million due currently. They have been reclassified from long-term debt because of CCS's failure to comply with operating covenants and restrictions. The prior year's financial statements have been restated for comparative purposes.
4. Long-term debt is repayable over varying periods of time. However, the banks reserve the right to declare the loans due and payable upon demand. The loan agreements require CCS to obtain advance approval in writing from the bank if it wishes to exceed certain limits on borrowing and capital expenditures. The agreements also prohibit the sale of certain plant assets, payment of dividends, and transfer of funds among related companies without prior written approval. One loan of $15 million was in default at September 30, Year 11.
5. During the year, CCS issued common shares to the directors and officers to satisfy amounts owing to them totaling $160,000. New equity issues are being considered for the Year 12 fiscal year.
6. On November 10, Year 11, a claim related to a breach of contract was filed against one of the company's subsidiaries in the amount of $3.7 million, plus interest and costs of the action. Management believes that this claim is without merit. However, if any amounts do have to be paid as a result of this action, management believes that the amounts would be covered by liability insurance.
7. In Year 11, operating expenses include $1 million in development costs relating to a computer software program. Sales of this software are expected to commence in Year 12.

  • CreatedJune 08, 2015
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