niagra group ltd ngl designs develops

Question

Niagra Group Ltd. (NGL) designs, develops, manufactures, and sells photonics-based solutions, including lasers, laser systems and electro-optical components. The company has manufacturing operations in British Columbia, Ontario, and Nova Scotia and sells primarily in North American markets.

The company has prepared its financial statements in accordance with ASPE, and is planning to comply with IFRS for the 2012 financial statements in conjunction with a planned public offering. The public offering is being negotiated, and the outcome depends on the stability of financial markets. The company's management has decided to draft financial statements that comply with IFRS to ensure that they are prepared for the eventuality of the offering.

The company has prepared a draft statement of financial position (Exhibit 1-1) and is satisfied that the format of this statement is compliant with IFRS. However, some differences in measurement between ASPE and IFRS have yet to be recorded (Exhibit 1-2). Additional information on financial statement elements is provided in Exhibit 1-3.

At this stage in the analysis, the company is concerned only with the statement of financial position, not earnings. As part of its bond agreement, NGL is required to maintain a minimum current ratio of 1-to-1 and a maximum debt-to-equity ratio of 5-to-1. (Debt in this ratio is defined as "total liabilities.") Since a number of the outstanding items affect debt and/or equity, the CFO wants to ensure that these key financial targets continue to be met.

NGL's current concern is covenant compliance in 2012. Because the focus is on the statement of financial position, all impact of any adjustment to earnings, whether related to the current year or a prior year, will be recorded as an increase or decrease to retained earnings. NGL will further analyze these changes and restate comparative numbers for 2011 at a later date.

Required

Put yourself in the shoes of the CFO for NGL and do the following:

1. Prepare journal entries to account for the transactions and information described in Exhibits 1-2 and 1-3.
2. Prepare a revised statement of financial position after the journal entries prepared in Required 1 have been recorded.
3. Evaluate the key financial targets and suggest action for the coming year if there are any concerns.

Exhibit 1-1: Niagra Group Ltd. - Draft statement of financial position as at December 31, 2012 (in thousands)

NIAGRA GROUP LTD.
Statement of Financial Position
December 31, 2012
(in thousands)

ASSETS
		December 31, 2012
Current assets:
	Bank: Current account	$1,736
	Accounts receivable	49,490
	Inventory	63,560
	Prepaid expenses and deposits	3,948
		118,734
Non-current assets:
	Capital assets net	41,020
	Intangible assets	30,300
		71,320
Total assets		$190,054
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
	Accounts payable and accrued liabilities	$39,020
	Dividends payable	1,464
	Current bank loan	54,264
		94,748
Non-current liabilities:
	Long-term debt	70,000
	Discount	-7,174
		62,826
Equity:
	Share capital - common shares	10,290
	Stock options outstanding	2,324
	Retained earnings	19,866
		32,480
Total liabilities and equity		$190,054

Exhibit 1-2: Niagra Group Ltd. - Outstanding items

Note: Amounts are in thousands.

1. The $70,000 bond payable was issued on July 1, 2010. It was an 8.4%, 15-year bond that paid interest semi-annually on December 31 and June 30. The bond was sold to yield 10%. Straight-line amortization of the discount is reflected in the financial statements over the 30-period life of the bond. IFRS requires use of effective interest amortization.
2. During 2012, the company discovered an environmental issue at its manufacturing site in British Columbia. After consultation with environmental engineers and the relevant government departments, the company learned that it would cost approximately $800, spread evenly at $200 a year for four years, to remediate the site. NGL also learned that remediation is not required under government legislation. However, in late 2012, NGL announced plans to remediate the site, beginning in January of 2015. Planning has begun, and the community affected has been involved in consultation and the planning process. Under ASPE, no liability needs to be recorded; this situation creates a constructive liability under IFRS.
3. NGL leases equipment under operating leases. Analysis indicates that one of these lease contracts, signed on May 1, 2012, is a financial lease under IFRS because the lease is for (specialized) equipment using technology under patent with NGL. The lease must therefore be capitalized under IFRS even though it was not a capital lease under ASPE. Payment of $2,520 was made on this lease in May 2012, of which $840 is recorded as a prepaid asset on the SFP at the end of 2012. Details of the lease are in Exhibit 1-3.
4. Interest on both general borrowing and the bond is expensed as $9,214 in 2012 before any adjustments. In early September 2012, the company placed a $1,700 deposit on manufacturing equipment that will be delivered in 2013. A long-term prepaid account was created for $1,700, and grouped with capital assets on the statement of financial position. (Separate disclosure will be provided in the disclosure notes.) The $1,700 payment was financed out of general borrowing. Under IFRS, related interest must be capitalized.
5. Compensation expense of $350 was recorded with respect to stock options outstanding in 2012. All stock options are held by senior administrative staff. Under IFRS, forfeiture is estimated in advance, and, as a result, the compensation expense recorded annually is lower. Valuation models indicate that the amount of compensation expense recorded for 2012 should be reduced to $290.
6. IFRS requires depreciation of capital assets by component, whereas ASPE deals with whole assets. The approach to impairment tests is also different. The accounting group of NGL has ascertained that an additional $710 of accumulated depreciation and $1,900 of impairment of intangible assets are required.

Exhibit 1-3: Niagra Group Ltd. - Additional information

Note: Amounts are in thousands.

1. Lease obligation

The following terms are associated with the lease:

Inception date		May 1, 2012
Lease term #1 (first 3 years)
	Duration	3 years
	Annual lease payment due at the beginning of each lease year	$2,520
Lease term #2 (remainder of lease)(renewed at option of lessor)
	Duration	2 years
	Annual lease payment due at the beginning of each year	$1,140
Residual value at the end of lease		Unknown; leased asset reverts to lessor
Implicit interest rate		6%
Annual maintenance costs, paid by lessor in each of Years 1-5		$120