Reference no: EM132695516
Forestry Limited (FL) is a private company incorporated in Canada. Its head office is in Toronto but its primary operations are in China and include owning and managing tree plantations, sales of trees and logs, and manufacturing of wood products. In addition to the above, the company also holds tree-cutting rights for several large areas of government-owned forest. The company is currently at the centre of a major media debate. Another company has accused them of grossly overstating their estimated land and forest holdings. FL is denying all charges and maintains that it had qualified consultants estimate the value of the holdings. Due to an economic recession, sales are down this year.
In order to maximize the quality and quantity of trees harvested from the plantations, the company must manage the forest, including feeding the trees, using herbicides where necessary, managing water supply to trees, and thinning out trees so that the remaining trees have sufficient light and space to grow. In order to manage the water supply, the company builds terraces on the land on which the trees are standing. This helps hold the water but is very labour intensive and costly as it must be done by hand. All the materials needed must be trucked in and then carried to the worksite for installation. The trees are less susceptible to damage from bugs and/or other insects when they are well watered. It has been a very dry year and 25% of the forests are suffering from drought and insect infestation. FL is hopeful that with additional care, it can reverse any potential damage from this so that the value of the wood is not affected.
FL has just purchased the rights to cut down trees in a large forest in Northern China. The agreement allows it to harvest the trees for a five-year period. Although not written in the contract, it is understood that it will replant the area when finished. In order to access the trees, the company has had to build a major road into the forest. After the harvest is completed, the road will not be used by FL but the government has indicated that it would like to consider buying the road. The acquisition was financed by the issuance of noninterest-bearing convertible debt to an institutional investor. Under the terms of the debt, FL must maintain a debt to equity ratio of no greater than 2:1.
On December 31 (year end), the company signed an agreement to buy a plantation in New Zealand for $20 million from NZL. Immediately thereafter, FL agreed to sell the property to Gray Trees Limited (GL) for $22 million. GL had been unsuccessful in acquiring the plantation directly and had enlisted FL to negotiate on its behalf. In the December 31 financial statements, FL has booked the transaction as two separate transactions: a purchase and a sale (resulting in revenues for the current year showing a significant increase). The deal with GL closes on January 1 and GL will pay cash of $22 million to FL at that time. The $20-million payment to NZL is due January 1. GL is an established company that deals with FL all the time. GL is very profitable.
On December 15, FL signed an agreement with Logs Limited (LL) under which FL will harvest timber from a forest owned by LL and "sell" the logs back to LL. The agreement is worded such that FL "buys" the cutting rights for $7 million and then sells the cut logs for $14 million (market price). No money will change hands until the job is done, at which point, LL will pay FL the net amount of $7 million upon delivery of the logs. The harvesting was completed by year end and FL booked $14 million as revenues.
FL is not sure whether it should follow IFRS or ASPE.
Required
Problem 1: Adopt the role of the company's auditors and discuss the financial reporting issues