Frays Case Analysis
Advance financial account
Frays is a private company thinking about going public. As an advisor to the management I strongly suggest that Frays comply to IFRS. This recommendation is based on the fact that financial statement should be prepared according to the needs of the reader. That being said, in context where a company is operating globally and is thinking about going public the readers of the statement is most likely going to change in a near future. Consequently, it is to Frays advantage to make their financial statements comparable and easily understandable globally. In this sense, the following analysis will assume that all recommendations for the December 31 2011 financial statements are done according to IFRS regulations. It is important to understand what functional currency is Frays using before proceeding any further. Assuming that Frays sales to Mostress Inc (MI) are only a portion of their total sales and that MI is their only international distributor is it safe to believe most of Frays sales are done in Canada and in Canadian dollars. Additionally, labour, materials and all other cost associated with production along with managerial cost are also done in Canada and most likely denominated in Canadian dollars. Based on these two primary indicators we have to considering the Canadian dollar as the functional currency.
The first step to understanding the accounting implication of the MI transaction is to determine if the transaction gave Frays control over MI. In this case, the only two plausible answer are either Frays has control or significant influence over MI. The answer will have considerable impact on the accounting implications for Frays.
First, Frays purchased 49% of voting common share, generally this is not sufficient to have control over another company since more than 50% is usually required. However, there are secondary indicators to consider. For example, if the remaining shareholders covey voting rights to Frays or the ownership of convertible debts that would dilutes ownership of MI and give Frays more than half of the ownership. However, no evidence of this is explicitly mentioned in the case.
The power to dictate operating and financing policies of MI would also constitute evidence of control. This can be established by the existence of contractual agreements or the composition of MI’s board of director. In this case, the only note worthy fact is the right given to Frays to elect 3 of the 12 board members on MI’s board of directors. In consequence, this does not give them enough weight on the board of directors to control MI’s operating and financial policies.
These indicators does not point towards Fray having control over MI however, the high voting share percentage and the position on the board of directors does allow them to have significant influence of the course of MI’s business.
The direct consequences of such a conclusion is the obligation to report the investment in MI using the equity method on Frays financial statements. Investment with significant influences are “initially recorded at cost and then adjusted thereafter to include the investors pro rata share of earnings or losses of the investee corporation adjusted for the acquisition differential and the elimination and subsequent recognition of all unrealized intercompany profits that occur as a result of transactions between the two companies”.
“IAS 21 requires that individual transactions be translated into the functional currency of the reporting entity”. In this case because there is no parent subsidiary relationship, the reporting entity is automatically Frays.
Although never explicitly stated, if we assume that sales are denominated in Canadian dollars along with the fact that labour and material are obtained in Canada Frays functional currency is the Canadian dollar. As a result, any transaction in foreign currency will have to be translated to...
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