Andrew Ltd. is a large private company owned by the Andrew family. It operates a number of ski resorts in a very competitive industry. Its main competition comes from a couple of public companies. Andrew has been using ASPE in the past but has come under pressure from its bank to convert to IFRSs. Its bank is particularly concerned with the debt to equity ratio and the return on total shareholders' equity.
Andrew reported the following on its preliminary Year 6 financial statements in compliance with ASPE:
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Net income
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$3,000
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Total debt
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$25,200
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Total shareholders' equity
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21,800
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You have identified four areas where Andrew's accounting policies could have differences between ASPE and IFRSs. Where choices exist under ASPE, Andrew has adopted allowable policies that maximize net income and shareholders' equity.
The controller at Andrew provides the following information for the four areas:
Intangible Assets
Andrew owns a number of intangible assets and depreciates them over their useful lives, ranging from 3 to 7 years. The patents are checked for impairment on an annual basis. Relevant values pertaining to these patents were as follows:
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Dec 31, Yr5
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Dec 31, Yr6
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Carrying amount before impairment
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$12,000
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$9,800
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Undiscounted future cash flows
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12,100
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9,840
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Value in use
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11,700
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9,400
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Fair value
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11,600
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8,600
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Property, Plant, and Equipment
Andrew acquired equipment at the beginning of Year 4 at a cost of $1,250. The equipment has an estimated useful life of 10 years, an estimated residual value of$50, and is being depreciated on a straight-line basis. At the beginning of Year 6, the equipment was appraised and determined to have a fair value of $1,090; its estimated useful life and residual value did not change. The company could adopt the revaluation option in IAS 16 to periodically revalue the equipment at fair value subsequent to acquisition.
Research and Development Costs
Andrew incurred research and development costs of $200 in Year 6. Of this amount, 40% related to development activities subsequent to the point at which criteria indicating that the creation of an intangible asset had been met. As of yearend, development of the new product had not been completed.
Redeemable Preferred Shares
In Year 4, Andrew issued redeemable preferred shares to the original founders of the company in exchange for their previously held common shares as part of a tax planning arrangement. The preferred shares were assigned a value of $100 and have been reported in shareholders' equity in the preliminary financial statements.
The common shares, which had a carrying amount of $100, were cancelled.
The preferred shares would be classified as long-term debt under IFRSs and would need to be reported at their redemption value of $1,800.
The CEO is concerned about the impact of converting Andrew's financial statements from ASPE to IFRSs.
Required:
(a) Calculate the two ratios first using ASPE and then using IFRSs. Prepare a schedule showing any adjustments to the numerator and denominator for these ratios. Ignore income taxes.
(b) Explain whether Andrew's solvency and profitability look better or worse under IFRSs after considering the combined impact of the four areas of difference.