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minink limited ml is a subsidiary of a large public company federally incorporated 5 737159

Minink Limited (ML) is a subsidiary of a large public company, federally incorporated 50 years ago. Until this year, ML’s corporate structure consisted of three operating divisions and a corporate head office. Senior management receives financial reports on each division on a monthly basis. Bonuses are awarded annually to divisional managers based on the growth in net income on a year over year basis.

The corporate head office oversees the divisions and provides financial, payroll, legal, and administrative services. Corporate head office charges the divisions one half of the cost of providing these services and absorbs the other half.

The Ladium Extraction Division (Extraction) mines ladium, a metal used in many industrial chemical processes. This division also performs the first stage in the refining process. The Ladium Processing Division (Processing) buys ladium from Extraction and further refines the metal before selling it to customers in North and South Americas. Both stages of the refining process cause airborne pollutants whose levels the government regulates (see Exhibit II for new legislation).

Processing’s operations were sold to Donaz Integrated Limited (DIL) effective August 15, Year 4. An integral part of this sale is a long term contract for Extraction to supply ladium to DIL. The negotiations leading up to the sale lasted nearly a year. An agreement was finally reached after DIL threatenedto break off negotiations. Two offers were made by DIL, summarized in Exhibit III . ML management favoured the second offer but accepted the first offer under pressure from its parent company. The balance sheet of Processing

EXHIBIT III

LETTER CONCERNING SALE OF LADIUM PROCESSING DIVISION

May 2, Year 4

Mr. I. P. Labigne

President and Chief Executive Officer

Minink Limited

Dear Mr. Labigne,

For nearly a year now, we have been negotiating the purchase price of the operating assets of Minink Limited’s Ladium Processing Division and the related long term ladium supply contract. Following our telephone conversation yesterday, this letter confirms that Donaz Integrated Limited is not prepared to continue these negotiations.

We require a fax confirming acceptance of one of our two offers by midnight on May 4, Year

4. Our offers are summarized as follows, within the context of the detailed Purchase and Sale

Agreement already agreed to:

1) $398.6 million for the operating assets of the division and $3,450/tonne adjusted annually for inflation as the price for ladium under the long term supply contract.

2) $97.1 million for the operating assets of the division and $4,100/tonne adjusted annuallyfor inflation as the price for ladium under the long term supply contract.

I look forward to receiving your response by the deadline.

Yours sincerely,

Ms. S.N. Wong, CA

Vice President, Finance and Chief Financial Officer

Donaz Integrated Limited

at July 31, Year 4, is found in Exhibit IV , and selected information on Extraction is in Exhibit V .

The third division is the Mining Equipment Division (Equipment) which designs, builds, and sells sophisticated mining equipment. During Year 4, Equipment built six Crush ones. Crush ones are a new breed of open pit mining machines

EXHIBIT V

LADIUM EXTRACTION DIVISION

SELECTED INFORMATION

(in thousands of dollars)

Year 4/5 Fiscal Year Budget

Sales (volume 84,000 tones @ $3,700 per tonne)

$310,800

Variable cost of sales ($3,400 per tonne)

285,600

Contribution margin

25,200

Expenses

3,100

Head office charges

9,610

Fixed costs

12,710

Divisional income before taxes

$ 12,490

Additional information:

1. This budget was prepared on the basis that the Extraction Division would sell its ladium to the Processing Division.

2. When annual volumes exceed 90,000 tones, variable ladium extraction costs increase by $562/tonne on the additional volume. New extraction equipment with a useful life of 5 years must also be purchased, at a cost of approximately $58 million, to handle annual volumes over 85,000 tones.

3. The carrying amount of Extraction’s equipment and buildings that are dedicated to ladium extraction at July 31, Year 4, was $76 million.

that have a very high output relative to capital cost. The provincial government agreed to fund 90% of the total production costs of $165.46 million. In return, the provincial government is entitled to 90% of the net proceeds on sale of the Crush ones. Management expects that due to the nature of these machines, ML may have to wait several years to sell the Crush ones that have been built. As of late July Year 4 the six Crush ones were included in inventory and measured at their production cost of $165.46 million.

ML is the largest subsidiary of its parent and its financial statements are material to its parent’s financial statements. The parent company has reported losses for the past few years, and the price of its shares has dropped. The parent company plans to issue additional shares in the near future.

The request for proposal for the audit of ML and its parent company for the year ended August 31, Year 4, resulted in the appointment of your firm, Douglas & Co., Chartered Accountants (DC). DC has already sent out an engagement letter to ML and corresponded with the previous auditors, who said they knew of no reason why DC should not accept the engagement. You, the CA, have been selected as the audit senior for the assignment. The manager in charge of the audit has requested that you prepare a memo covering the major accounting issues arising from this year’s audit of ML. It is now early August Year 4. Ian Kao, the audit partner, has met with the CFO of ML who is in charge of coordinating the external audit. The partner’s notes from these meetings are summarized in Exhibit VI .

Required:

Prepare the memo requested by the audit manager.

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