case: gmi, trey dobson

8/13/2019 Case: GMI, Trey Dobson

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Question #3

USERS & OBJECTIVES:

Trey Dobsonwants to ensure that he is able to transition to going public company without a problem

and for that reason, would also like higher net profit and assets.

Open market investorswant integrity of financial statements to make sound investment decision.

CESAll reporting should be per IFRS standards and financial information disclosed candidly.

CONFLIC OF INTEREST:

Trey might be motivated to inflate his earnings and assets as much as possible to get the best IPO for

GMI possible.

CONSTRAINTS:Must use IFRS because going public next year

ISSUE #1: Coupons

According to IFRS, coupons have to be accounted for if they are of cash in nature or are expected to

produce a loss. Since the vouchers that are being handed out are for $3 and the lowest priced item in

the store is worth $2, it is likely that customers will use the voucher for lower priced items.

Since gross margin is 80%, a $3 retail price would mean a cost of $0.60 to GMI. This means that as long

as on average, if the customers use the coupon for around $4 or more, GMI would still make a profit.We will assume that most of the customers will likely only use the coupon to get items for which they

dont pay anything themselves and hence the $3 coupon would result in a loos for GMI. GMI is required

by IFRS then, to estimate the breakage rate for the coupons issued as well as record a coupon

redemption liability. This would account for the loss that GMI would make on the issuing of the coupons.

Makes the business less attractive for future investors, but not very significantly.

ISSUE #2: Construction Costs

As per IFRS, construction & borrowing costs of a qualifying asset (one that takes a significant amount oftime to complete) can be capitalized. Since the kitchen construction can be expected to last several

months (6+), it is a qualifying asset. All costs that are directly associated with the construction (assuming

all $1,250,000 are related costs) can be capitalized. In addition, the interest of $225,000 can also be

capitalized, however, this can only be done once:

(1) Interest is being incurred, (2) construction costs are being incurred and (3) constructionactivities are under way.


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Furthermore, any income earned from temporarily investing the borrowed funds has to be netted out of

the capitalized amount. Since there was a profit in this case, not all the interest cost may be capitalized.

The capitalization of the interest cost will commence once construction starts (and the other 2

conditions are met as discussed before); but it must be halted during December when no work was

done. Capitalization must stop once the construction activities have substantially endedin this case,this would be May 1, 2013 (not March 1 because the kitchen did not serve its full purpose). So, the

$1,250,000 would have to be capitalized under IFRS (under ASPE, there would have been a choice b/w

cap or expense); interest would be capitalized (no choice again) from Nov 1 Nov 30. And then Jan1

May 1, i.e.: when the conditions for capitalization were met. This is 5/12 X $225,000 = $93,750

Total amount to capitalize:

$93,750(profit from investment) + $1,250,000.

This is very advantageous for GMI from the IPO viewpoint as it increases the assets as well as provides a

tax shield, hence increasing NI.

ISSUE #3: Onerous Contract

Since membership frees have fallen by 80% to $100,000; GMIs revenues would otherwise be

$100,000 X 5 = $500,000. With this contract, GMI is making $100,000 + $350,000 = $450,000 per year.

This means that the contract is causing GMI to incur a loss of $50,000 per year. According to IFRS, this

represents an onerous contract. GMI should consider the cost of terminating the contract to see what

the penalty is. If this is still causing a loss, IFRS would allow GMI to recognize a loss immediately in the

lower of the 2 amounts, i.e.: contract termination vs. future cash flows. Assuming that $50,000 is thelower of the 2, GMI would immediately recognize a loss of $50,000 even though GMI will try to

eliminate the loss next year. This will reduce GMIs NI, which is good for tax purposes, but not for the

IPO. The onerous contract should be disclosed in the notes to the F/S.

ISSUE #4: Investment Gain

The stick price appreciation from $78 to $85 represents a change in the value of the investment of GMI

in RAI. Since this is a passive investment, it was fine to record it at cost under ASPE, but under IFRS, it

should be recorded as FVTPL or FVTOCI (irrevocable). Since the investment is profitable, GMI wouldwant to use FVTPL so that the NI is increased from it. The FV of the investment has to be tested every

year, so GMI would record a gain on its income statement because of the appreciation in value. This is

good for NI and hence, for the IPO


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Based on all the financing options, (3) seems to be the best for GMI at this point as it would bear the

least burden in terms of dividend payments etc. One might argue that (2) would attract more

investment due to being attractive for the investors, but (3) will still attract investors if the company

shows promise of growth, i.e.: offers appreciation of stock price.

BUSINESS ISSUES:

1.

Issue:No Controller

Impact:This can be disastrous right before an IPO since there can be many irregularities in the financial

data.

Recommendation:Find a replacement controller immediately and conduct a detailed audit of books to

ensure no irregularity.

2.

Issue:Opeining too many MoveBars

Impact:Although the gross margin is high, it might not be profitable on a net level to open MoveBars

and so, so many at the same time can prove disastrous right before the IPO.

Recommendation:Should scale back on the investment in MoveBars until model is successful.

3.

Issue:Keeping an eye on HR issues

Impact:The lawsuit could be a big hit for GMI and it is concerning that some of the staff were involvedand they were likely not disciplined. This can deteriorate the culture of GMI if left unchecked.

Recommendation:Hire an HR Manager if Trey does not have timeresolve this issue ASAP.

case: gmi, trey dobson

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