At the conclusion of the 9/30/20 audit engagement of Almax Advanced Communications, Ben Franklin, the audit partner

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Question:

At the conclusion of the 9/30/20 audit engagement of Almax Advanced Communications, Ben Franklin, the audit partner of the CPA firm of Franklin, Delaney & Ulster (FDU) was discussing subsequent events with Don Lassiter, president of Almax. Mr. Lassiter indicated that he was disappointed with the prior years’ results and although next years forecast looked better, there were some opportunities for expansion that had recently come to his attention, and he was interested in pursuing them if it made business and financial sense to the company and its shareholders. He felt that it would be a good idea to retain the consulting department of FDU to provide him with a preliminary analysis of the feasibility of acquiring certain companies that were available for acquisition.

Early in 2020, Mr. Lassiter was approached at a charity function by the chief operating officer of Cooperative Communications, Inc. (CCI). CCI was started by the Saunders family and is owned partially by them as well as a group of other investors. The largest ownership interest is by the employees of CCI through an ESOP plan. The principal founders of CCI are interested in an exit strategy, which would allow them to retire. Almax had made overtures a few years ago about acquiring CCI but the family interests were not interested in selling at that time. Mr. Lassiter feels that CCI may be a good fit since it will allow them to save costs by adding the significant customer base of CCI to their own communication customer base, in addition to the external profits generated by CCI. Their product mix is very similar to Almax.

Almax Advanced Communications (AAC), suppliers of wired communication services, was formed in 1985 and experienced moderate growth during the late 1980’s. A number of years ago they experienced significant growth by acquiring majority interests in two companies, Diamond Communications and ParagonTelecommunications, a Canadian company.

Adjusted trial balances of Almax, Diamond and Paragon for the recently concluded year end of September 30, 2020 as well as additional information about acquisition price and intercompany transactions is attached to this case.

Also attached are the financial statements of CCI for the last four fiscal years ending September 30, 2017-2020, as well as a five-year forecast of CCI for 2021-2026. Information about stock ownership and background of CCI is also included.

For all foreign exchange rate information needed, please go to www.x-rates.com/historical

INFORMATION RE ALMAX AND SUBSIDIARIES

The audit of Almax Company and its subsidiaries for the year ended September 30, 2020was completed and the adjusted trial balances on the attached spreadsheet was prepared. Diamond Distribution is a domestic subsidiary and Paragon Controls is a foreign subsidiary located in Toronto, Canada. Paragon conducts all of its transactions in Canadian Dollars, which constitute its functional currency.

Almax accounts for its investments using the equity method.

(1) Almax Company acquired 700,000 shares of Diamond (70%) common stock for $40 per share on 9/30/17. Any excess of purchase price over underlying book value was attributed 75% to property, plant and equipment with a remaining 10 year life and 25% to goodwill.

(2) Almax Company acquired 480,000 shares of Paragon Company’s stock (80%) on 9/30/18for $25 (USD) per share. Any excess of purchase price over underlying book value was attributed 100% to goodwill.

(3) Stockholders equity of Diamond on 9/30/16 and Paragon on 9/30/17 and 9/30/18 in U.S. dollars were as follows.

Diamond CompanyParagon Company

9/30/17 9/30/18 9/30/19

Common Stock ($10 par) 10,000,000 6,000,000 6,000,000

Paid in Capital 8,000,000 2,000,000 2,000,000

Retained Earnings 12,000,000 5,000,000 7,000,000

(4) Total dividends declared and paid during the last fiscal year were as follows:

Almax Company2,100,000

Diamond Company1,900,000

Paragon Company 500,000 CAD (declared 4/8/2020)

(5) Almax Company consistently sells to its subsidiaries at prices that realize a gross profit of 20% on sales. Diamond and Paragon companies sell to each other at cost. Neither Diamond nor Paragon sell to Almax. Prior to fiscal 2016 intercompany sales were negligible, but during 2018-2019 the following sales were made (in US Dollars).

TotalPurchasers Remaining

SalesInventory at 9/30/19

Almax Company to Diamond Company 8,500,0001,200,000

Almax Company to Paragon Company14,000,0003,000,000

(7) At 9/30/19 (all USD)

Almax Company owed Diamond Company900,000

Diamond Company owned Paragon Company700,000

Paragon Company owed Almax Company400,000

REQUIRED:

Prepare excel spreadsheets for the translation of the foreign subsidiary to U.S. dollars and the consolidation of all three companies. Supporting schedules (such as intercompany profit schedules and purchase price allocations) should be shown on your spreadsheets.

Remember: because Paragon financials are in CAD, they must be converted to USD before consolidation. (You can obtain fx rates online.) This results in Almax’s cumulative translation adjustment (CTA). Look at the fx rates for USD-CAD over the last 3 years. Based on the changes in the fx rate, since the investment was made in USD, do you expect a positive or negative CTA?

Hint on conversion: one way to verify that you are on the right track is to verify the income from Paragon and the investment in Paragon reported on Almax’s f/s. (Remember that Almax owns 80% of Paragon.)