A La Mode Inc. (ALM) is a retailer of women and children’s clothing, with stores across Canada. ALM has been in operation for the past 35 years and is a public company with a year-end of January 31.

Currently, Mr. Jones and Mr. Grenier each own approximately 35% of the voting shares of ALM; the remaining outstanding shares are widely held. They founded ALM in the 1970s, when they were both in their late twenties. Their first store sold clothing for the working woman. It took only a few years until this first store became one of many successful stores. In 19X5, approximately two decades later, they launched a new children’s clothing chain.

Mr. Jones is always looking for new challenges. ALM is nearing completion in acquiring an American chain of women’s apparel, USA Chic Inc. (CI), to give ALM a gateway to the U.S. market.

ALM has almost completed the acquisition of CI. Mr. Jones and Mr. Grenier already personally own some shares in CI. Mr. Jones estimates that if ALM acquires an additional 3,500,000 Class B common shares of CI, ALM could gain control of CI. ALM intends to finance the acquisition of CI shares by issuing convertible debt to a pension fund. The pension fund has agreed to advance $20,055,000 of convertible debt, bearing interest at 8%. The debt will be convertible at the option of the pension fund into multiple-voting shares on May 1, 20X5. The exercise price on conversion is to be determined using the average of the 20X4 and 20X5 consolidated earnings per share (EPS) before discontinued operations, as reported in ALM’s audited financial statements, multiplied by the price–earnings ratio. The average EPS is $0.4228 and the average price–earnings multiplier is 12. Further information on the purchase of CI is included in Exhibit A.

Mr. Jones and Mr. Grenier would like an analysis of the number of ALM shares that need to be issued to complete the purchase of CI and any implications from the proposed financing arrangement. Mr. Jones is not sure whether ALM can consolidate the results of CI operations in ALM’s 20X5 financial statements. Mr. Jones was quoted as saying, “If possible, ALM would show better EPS, which is of utmost importance to the board.”

You work for a CA firm that will be completing the audit of ALM. Your partner has asked you to write a memo addressing the concerns raised by Mr. Jones and Mr. Grenier.

In addition, your partner wants you to identify, in a separate memo, audit concerns relating to the purchase of CI.

Required
Write the report to Mr. Jones and Mr. Grenier and the separate memo requested by the partner.