Omega Properties Limited (OPL) is a public corporation that manages 63 hotels under 3 brand names in 5 countries. The main shareholder is Isadora Duncan, who owns 10% of the total outstanding shares in the form of multiple voting shares that carry 15 votes per share. All other shares carry one vote per share. Isadora Duncan is OPL’s founder and chief executive officer. Omega Properties Limited has three operating divisions, each of which is a wholly owned subsidiary of OPL:
• Omega Hotels, Ltd., which operates midrange hotels;
• Xanadu Hotels and Resorts Corporation, a group of luxury hotels; and
• Alpha Express Inc., a small chain of low- cost hotel properties. The divisions operate largely autonomously, each setting its own operating policies that best suit conditions for its market segment. The senior executives of each division report directly to their counterparts in OPL’s head office. The subsidiaries’ financial results are fully consolidated with those of OPL. It is now early December 20X7. OPL Chief Financial Officer Gary Drabinsky is considering how to reflect certain events and transactions that have occurred during the fiscal year ending 31 December 20X7. He has requested your advice as an external professional accountant, and has provided you with the information shown in Exhibit 1.
1. Alpha Express Inc. was purchased by OPL in late 20X3 for $ 227 million cash. he fair value of OPL’s net assets at that time was $ 192 million. For the first two years that OPL owned Alpha, Alpha achieved the expected profit and cash low returns. In 20X6, how-ever, the low- cost hotel segment suffered a downturn due to a mild recession. As well, 20X6 saw increased competition from big chains in that market, such as Holiday Inn Express. Now OPL and Alpha executives believe that Alpha will be underperforming for the foreseeable future. Indeed, it is quite possible that the OPL Board of Directors will decide to sell or dismantle Alpha during 20X8. As an alternative, OPL is thinking of combining Alpha with the main Omega Hotel chain, which continues to be quite profitable.
2. In early 20X7, Xanadu entered into a 10- year contract to manage a luxury hotel in Mumbai. OPL agreed to provide $ 63 million in loans to the hotel’s owners to obtain the contract. The loans are to be used by the hotel’s owners for remodelling and upgrading of facilities to meet Xanadu’s standards. By the end of 20X7, OPL had paid $ 54 million, of which $ 23 million related to obtaining the management contract and $ 31 million was part of the loan.
3. During the year, OPL sold a hotel in Hawaii for net proceeds of $ 140 million. The property had a net book value of $ 93 million. OPL recorded a gain of $ 47 million before taxes. The sales contract stipulates that if the hotel’s net operating cash flow over the
next three years falls below certain benchmarks, as specified in the sales contract, OPL will be required to refund up to 20% of the sales proceeds. OPL senior management believes that it is highly unlikely that any repayment will be necessary.
4. Omega owns and manages a hotel in New Orleans. The hotel was badly damaged by a severe hurricane in late October 20X6. Just prior to the hurricane, the hotel was enjoying high occupancy and was very profitable. Its net book value was $ 144 million but its esti-mated fair value was well over $ 200 million. The hotel was closed immediately after the hurricane and remained closed through the remainder of 20X6 pending an opportunity for engineers and others to assess the extent of the damage. In 20X7, it became apparent that although the damage could be repaired at a tolerable cost, the future business pros-pects were not good due to the almost complete absence of either business or leisure travellers. Therefore, in April 20X7, the OPL Board of Directors decided to sell the property and engaged a commercial real estate broker for that purpose. The broker estimated that OPL should expect the property to sell for no more than $ 37 million in its present condition. 5. The Xanadu division owns no hotels. The division operates exclusively through management contracts. In many cases, the hotels are owned by an investor who also owns 22% of OPL’s limited voting shares.
6. In addition to managing hotels under its own brand, OPL also earns fee revenue in both its Omega Hotels and Xanadu divisions by designing and supervising the construction and fitting out of hotels that OPL will neither own nor operate. OPL also earns com-missions as a percentage of the cost of goods and materials purchased by these clients through OPL’s centralized purchasing system. These fees are treated as a reduction in the cost of operating the central purchasing system.
7. Xanadu entered into a five- year contract for $ 20 million that permits an unrelated party to use the Xanadu brand name for a new hotel in Japan. Xanadu can cancel the contract if the hotel does not hold to Xanadu’s high standards of maintenance and service; no money need be refunded if Xanadu cancels the contract. The contract is renewable by mutual consent. Xanadu has received half of the money, with the rest due in annual instalments of $ 2 million. The agreement also permits the hotel to use the Xanadu central reservation system at a fee that is half of the fee normally charged to non- OPL properties.
Prepare a report for Mr. Drabinsky in which you point out any reporting problems and recommend appropriate reporting and disclosure, based on the information that you received from him.