Question: Wonder Amusements Ltd. (WAL) was incorporated over
Wonder Amusements Ltd. (WAL) was incorporated over 40 years ago as an amusement park and golf course. Over time, a nearby city has grown to the point where it borders on WAL’s properties. In recent years WAL’s owners, who are all members of one family, have seen WAL’s land values increase significantly. Majority shareholder Howard Smith owns 55% of the outstanding shares and is no longer active in WAL’s day-to-day activities. Last year Howard hired a new chief executive officer, Leo Titan. Leo has a reputation as an aggressive risk taker. Howard is committed to supporting Leo’s plans and has the personal financial resources required to do so. Eight months ago, WAL became the successful bidder for a new sports franchise, in conjunction with a minority partner. Under the terms of the franchise agreement, WAL is required to build a sports arena, which is currently being constructed. The arena is being built on a section of the amusement park. Another section of the amusement park is being relocated to ensure that the entrances to the arena are close to public transportation and parking. Consequently, some of the rides will be relocated. WAL is the sole owner of the arena at present. The sports franchise is separately incorporated as Northern Sports Ltd. (NSL); WAL holds 75% of the shares in the company. Another bid is being prepared by NSL to obtain a second sports franchise so that the arena can be used more often. NSL will be required to lease space from WAL when the arena is completed, in about 22 months. For the first two sports seasons, NSL will have to lease arena space from Aggressive Ltd. (AL). During this time, NSL does not expect to be profitable because: - It may take time to build a competitive team; - AL is charging a high rent and is not giving NSL a share of concession (e.g., hot dogs, drinks) revenue; - AL cannot make the better dates (e.g., Saturday night) available to NSL to attract sports fans; - As a newcomer to the league, NSL is restricted with regard to the players available to it and the days of the week it can play in its home city. Consequently, NSL has arranged to borrow funds from WAL and from others to finance costs and losses. Your employer, Fabio & Fox, Chartered Accountants, has conducted the audit of WAL for several years. WAL has tended to be marginally profitable one year and then have losses the next. The company has continued to operate because the directors knew that the real estate holdings were becoming increasingly valuable. For purposes of financial statements WAL uses Canadian ASPE. Leo is expected to oversee the expanded accounting and finance functions in the company. He has met with you and the partner in charge of the WAL audit and has discussed various issues related to the year ending 30 September 20X7. His comments are provided in Exhibit 1. Exhibit 1 Notes from Discussion with Leo Titan Table Summary: Summary 1. To build a road to the arena’s parking lot, two holes of the 18-hole golf course will be relocated next spring. Costs of $140,000 are expected to be incurred this year in design, tree planting, ground preparation, and grass seeding to ready the area for next spring. These costs are to be capitalized as part of the golf course lands, along with related property taxes of $13,000 and interest of $15,000. 2. Approximately $600,000 will be required to relocate the rides currently on land needed for the arena. This amount is to be capitalized, net of scrap recovery on dismantled and redundant equipment of $60,000. Virtually all the rides were fully depreciated years ago. 3. In May 20X7, WAL acquired, for $4.25 million, all of the shares of an amusement park in a different city, when its land lease expired. The amusement park company was wound up and the equipment, rides, concessions, and other assets are being transported to WAL at a cost of $350,000. According to Leo, the estimated fair market value of WAL’s net assets is $4.85 million, including liabilities of $1.20 million. WAL expects to spend approximately $400,000 in getting the assets in operating order and $500,000 on foundations and site preparations for the rides. Leo wants to “capitalize as much as possible.†4. To assist in financing the new ventures, WAL sold excess land to developers who intend to construct a shopping centre, office buildings, and expensive homes that will be adjacent to the golf course and away from the amusement park. The developers and WAL agreed to these terms: Paid to WAL on 1 May 20X7 $ 6,000,000 To be paid to WAL on 1 March 20X8 10,000,000 To be paid to WAL on 1 March 20X9 8,000,000 $24,000,000 The land is to be turned over to the developers on or about 1 February 20X8, but the sale is to be reported in fiscal 20X7. The land was carried on WAL’s books at $1.35 million; a pro-rata portion of the total land carrying value (at cost) will be allocated to the portion sold to the developers. 5. An additional “contingent profit†will accrue to WAL if the developers earn a return on investment of more than 25% when they resell the newly constructed buildings. Leo wants a note to the 20X7 financial statements that describes the probability of a contingent gain. 6. The golf course has been unprofitable in recent years. However, green fees are to be raised and specific tee-off times will be allotted to a private club, currently being organized. Members of the private club will pay a nonrefundable entrance fee of $2,000 per member plus $100 per month for five years. The $2,000 is to be recorded as revenue on receipt. Approximately $350,000 is to be spent to upgrade the club facilities. 7. Leo wants to capitalize all costs of NSL on NSL’s books until it has completed its first year of operations. In addition to the franchise fee, $20 million will have to be spent on the following: 
The value of players can change quickly, depending upon their performance, injuries, and other factors. 8. The new sports arena will have private boxes in which a company can entertain groups of clients. The boxes are leased on a five-year contract basis, and they must be occupied for a fixed number of nights at a minimum price per night. To date, 12 boxes have been leased for $15,000 per box for a five-year period, exclusive of nightly charges. A down payment of $3,000 was required; the payments have been recorded as revenue. 9. Three senior officers of WAL, including Leo, receive bonuses based on income before income taxes. The three have agreed to have their fiscal 20X7 bonuses accrued in fiscal 20X8 along with their fiscal 20X8 bonuses. Actual payments to them are scheduled for January 20X9. You have been asked by the partner to prepare a report for him, which will be used for the next meeting with Leo. He would like you to discuss the accounting implications related to your discussion with Leo. The partner wants a thorough analysis of all important issues as well as support for your position. In your review of documents, and as a result of various conversations, you have learned the following: 1. The arena will be mortgaged, but only for about 50% of its expected cost. Lenders are concerned about the special-use nature of the arena and whether it will be successfully rented for other events, such as concerts. 2. The mortgage lenders to WAL and the minority shareholders in NSL are both expected to want to see appraisals and financial statements before deciding whether to invest. Covenants will be required by the lenders to ensure that excessive expenditures are not undertaken and that cash is preserved. 3. Leo does not intend to consolidate NSL until it is profitable. The investment in NSL will be reported on WAL’s financial statements at cost. The WAL financial statements will be used for income tax purposes. 4. WAL’s minority shareholders are not active in the business and want quarterly financial statements to monitor progress and assess Leo’s performance. The minority shareholders have all expressed concern over Leo’s growth strategy over the past year. Most are approaching their retirement years and are relying on WAL to supplement their retirement income. Required: Prepare the report.
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