MGAC02 – Case Assignment 1

2019 Fall
Due Date : February 16, 2020 (11:59 pm)
Page 1

Forbes Forest Inc. (FFI) is a private company that is engaged in the forest industry 30 years ago.
It has two divisions. The Firrst division is the forest operations where the company owns and grows
large tracts of timber. The second division is the sawmill operations where it manufactures lumber
and building materials. FFI has a stock option plan to compensate its top employees based on net
income.

At the start of 2020 FFI had a bank loan with Scarborough Bank. FFI is restricted from declaring
dividends until this loan is repaid.

In 2019, the owners were approached by a public company to buy the shares of the corporation.
The owners are considering this offer as well as going public and offering more shares to investors
as a public company. The shares currently are owned only by the owners, a few private investors
and employees through the stock option plan.

You have recently been hired to develop new accounting policies for FFI’s December 31 year-
end. You have been asked by the board to discuss alternatives and provide recommendations on
the appropriate accounting policies for events that have occurred during 2020. In addition, the
board would like to know the impact on their accounting policies if they decided to adopt IFRS
for these issues and their financial statements. Where possible, you have been asked to quantify
the impact of the accounting policies. The incremental borrowing rate for FFI is 10%.

In 2020, FFI was able to renegotiate its bank loan and replace it with a new loan without a
restrictive covenant. The new bank requires annual audited financial statements. The loan is
payable immediately if FFI exceeds a debt to equity ratio of .65. At the end of 2020 the debt to
equity ratio was .60. The old loan had unamortized transaction costs and financing fees of
$800,000. The transaction costs and financing fees associated with the new loan are $1.2 million.
The new loan is substantially larger than the old loan to assist with the construction of a new
sawmill facility.

In 2020, a lawsuit was filed by residents near one of the timberlands that were sprayed with
pesticide to prevent a beetle infestation. The residents claim that the pesticides contain a cancer-
causing ingredient. FFI consulted its lawyers who agree that medical studies support those claims.

Construction of the new sawmill started in February 2020. At the end of 2020 costs of $6 million
had been incurred. Construction is anticipated to take until November 2021. Construction costs
are estimated to be $100 million. In October 2020, one of the trades went on a strike. The strike
shut down construction and lasted two months.

FFI has long-term supply contracts with a number of large building centres where the company is
required to deliver a set amount of lumber each month. If the minimum quantity of lumber is not
delivered, FFI is required to pay a penalty. In 2020, FFI has not been able to fulfill all orders
because of a shortage of lumber due to a beetle infestation; FFI anticipates incurring penalty costs
of $250,000 until the new sawmill is completed. Once the new plant is completed, FFI anticipates
being able to meet the demands of its long-term supply contracts and regular customers.
 MGAC02 – Case Assignment 1
2019 Fall
Due Date : February 16, 2020 (11:59 pm)
Page 2

FFI sells its lumber to local building centres as well as through agents. FFI is paid for the lumber
30 days after delivery. FFI uses an agent to sell its lumber overseas. FFI pays a set fee to the agent.
The agent sells the lumber and deposits the money electronically in FFI’s account net of its fee.

Government legislation requires FFI to reforest all lands in 15 years when the timber is harvested.
FFI estimated the cost will be $2.5 million to reforest the timber harvested in 2020.

FFI discovered a beetle infestation at the sawmill when employees went to convert the timber into
lumber. FFI anticipates that $5 million of timber was infested. The timber could not be used for
lumber but it could be sold to be processed into wood chips for fuel. The estimated value of the
timber being sold for wood chips is $1 million.

FFI issued bonds for $10,000,000 on January 1, 2020, to help fund the construction of the new
sawmill. The five-year bond pays interest of 8% semi-annually each June 30 and December 31.

Required:
Prepare the report for the board.