You, CA, an audit senior at Grey & Co., Chartered Accountants, are in charge of this year's audit of Plex-Fame Corporation (PFC). PFC is a rapidly expanding, diversified, publicly owned entertainment company with operations throughout Canada and the United States. PFC's operations include movie theatres, live theatre production, television production, and a 60% interest in Media Inc., a company that specializes in entertainment-related advertising and promotion.
It is June 22, 2013, the week before PFC's year end. You meet with the chief financial officer of PFC to get an update on current developments and learn the following.
PFC acquires real estate in prime locations where an existing theatre chain does not adequately serve the market. After acquiring a theatre site, the company engages a contractor to construct the theatre complex. During the year, the company received a $2-million payment from one such contractor who had built a 10-theatre complex for PFC in Montreal. This payment represents a penalty for not completing the theatre complex on time. Construction began in June 2012 and was to have been completed by December 2012. Instead, the complex was not completed until the end of May 2013.
The company is staging a Canadian production of "Rue St. Jacques," which is to open in November 2013. The smash-hit musical has been running in Paris for three years and is still playing to sold-out audiences. PFC started receiving advance bookings in November 2012, and the first 40 weeks of the show's run are completely sold out. Average ticket prices are $65; the show will play seven nights a week. The theatre used for the production is relatively small, with about 1,200 seats. As at June 22, 2013, PFC had included in revenue $1.7 million of interest collected on the funds received from advance ticket sales. In addition to the substantial investment in advertising for this production ($4 million), the company will have invested $15 million in pre-production costs by November 2013 and will incur weekly production costs of $250,000 once the show opens.
About 80% of Media Inc.'s business is directly related to promoting PFC's activities. Media bills PFC's corporate office for all advertising and promotion related to PFC's activities. Advertising and promotions have significantly increased this year, in part due to large costs associated with the forthcoming opening of Rue St. Jacques. Media has billed PFC $12 million this year for advertising and promotion, an increase of $7 million over the preceding year.
PFC has $43 million invested in Government of Canada treasury bills. During the past year, a portion of these treasury bills was set aside to cover interest and principal obligations on the company's syndicated loan of U.S. $25 million. At the time the loan agreement was signed, PFC entered into a forward contract to buy U.S. dollars for the same amounts as the obligations under the syndicated loan and for the same dates as the obligations came due. PFC considers that in substance the debt has been settled and, as a result, both the treasury bills and the syndicated loan have been removed from the company's balance sheet.
PFC started selling some of its movie theatres a couple of years ago. Each theatre's contribution to long-run operating cash flow is assessed and, if the value of the real estate is greater than the present value of future theatre operating profits, the theatre is sold. In the past, revenue from these sales has been relatively minor, but this year 25% of net income (i.e., $6 million) came from the sale of theatres. Since these sales are considered an ongoing part of the company's operations, proceeds from the sale of theatres are recorded as revenue in the income statement.
On May 31, 2013, PFC and an unrelated company, Odyssey Inc., formed a partnership, Phantom. Odyssey contributed $40 million in cash. PFC contributed the assets of its TV production company, which had a net book value of $65 million. The $90 million value assigned to PFC's contribution may be adjusted if the net income of Phantom earned between July 1, 2013, and June 30, 2014, does not meet expectations. PFC has recorded a gain of $25 million. The partnership agreement states that PFC is permitted to withdraw the $40 million for its own use, and it has done so. As a result, Odyssey has a 45% interest in the partnership and PFC has the remaining 55% interest.
When you return to the office, you discuss these issues with the partner in charge of the PFC audit. She asks you to prepare a report on the accounting implications of the issues you have identified as a result of your meeting.
Required
Prepare the report to the partner.