UNIVERSITY OF TORONTO. Faculty of Arts and Science and Rotman School of Management FINAL EXAMINATION, April 2018 RSM320H1S - Intermediate Financial Accounting Ill Duration - 3 hours Examination Aids: Non-Programmable Calculator THIS EXAMINATION CONSISTS OF THREE PARTS AND 17 PAGES. PART A, WORTH 35 MARKS, INCLUDES FIVE COMPULSORY SHORT ESSAY-TYPE QUESTIONS. PART B, ‘WORTH 25 MARKS, CONSISTS OF TWO COMPULSORY TECHNICAL QUESTIONS. PART C, WORTH 40 MARKS, CONTAINS A CHOICE: OF THE THREE AVAILABLE QUESTIONS IN PART C, DO ONLY TWO. PART A OF THE EXAMINATION: FIVE ‘COMPULSORY QUESTIONS ] ‘A TOTAL OF 35 MARKS ARE AVAILABLE IN THIS PART OF THE EXAMINATION QUESTION 1A [7 MARKS] Briefly identify the following and explain their individual role in financial reporting: -CD&A; -MD&A; Sustainability reporting; -Notes accompanying audited annual financial statements; QUESTION 2A [7 MARKS) On August 5, 2015, the Securities and Exchange Commission in the United States issued the following, press release: ‘SEC Adopts Rule for Pay Ratio Disclosure FOR IMMEDIATE RELEASE. RSM 320H1S — Final Exam Page 1 of 17[2013-160 Washington D.C., Aug. 5, 2015 — | ‘The Securities and Exchange Commission today adopted a final rule that requires a public company | to disclose the ratio of the compensation of its chief executive officer (CEO) to the median compensation of its employees. The new rule, mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, provides companies with flexibility in calculating this pay ratio, and helps inform shareholders when voting on “say on pay.” The Washington Post newspaper reported the following on February 21, 2018: ‘As companies reveal gigantic CEO-to-worker pay ratios, some worry how low-paid workers might take the news At industrial giant Honeywell, the largest company to disclose how the pay of its CEO compares with that of its median employee, the ratio was 333 to 1. A potentially embarrassing math calculation employers have long hoped to escape — one that pay experts thought was dead following President Trump's election — can no longer be avoided. In recent weeks, a few public companies have begun disclosing a ratio, required for the first time this year, that compares the pay of their chief executive with the pay of their median employee. At industrial giant Honeywell, currently the largest company to disclose, the ratio was 333 to 1. At Teva Pharmaceuticals, the Isracl-based generic pharmaceutical company, it's 302 to I. And at the regional bank Umpqua Holdings, it's about 55 to 1 As of Wednesday morning, companies had disclosed the figure for only about 20 CEOs, according to the research firm Proxy Insights. But with Corporate America's annual meeting season getting. underway — the majority of public companies release their annual reports and proxy voting documents in the coming months — investors, the public and employees are about to get a much closer look at how their pay compares not only with that of their CEO but that of their peers. It's that ast comparison that has employers most concerned, say consultants who work with them on executive pay issues. | Pay consultants say employees may be bothered not only by how many multiples higher the chief | executive is paid but by where they fit in with their peers. At most companies, compensation remains pretty opaque, and a company-endorsed median figure would provide some additional transparency. RSM 320H1S - Final Exam Page 2 of 17‘Compounding that concem is timing. The ratios are being disclosed just after corporations have received a massive windfall in the form of a corporate tax cut, which could add to questions about inequality. “There may very well be heightened expectations from employees who are paid in the bottom half that incremental tax cut dollars are going to be used to enhance companywide pay programs,” Wise said. “That would be a very understandable reaction given the timing of everything.” A recent survey of 356 public companies by Equilar, an executive compensation and governance research firm, found that the median CEO pay ratio was 140 to 1. But it also suggested that the figure for Honeywell, which is No. 73 on the Fortune 500, would not be that out of line with other similar size companies. Companies above $15 billion in annual sales had a ratio of 263 to 1 and those with the greatest number of employees (43,000 or more) also had the largest ratio, at 318 to 1. Honeywell had 2017 sales of $40 billion and has more than 143,000 employees. Israel-based Teva Pharmaceuticals, which announced roughly 14,000 job cuts and the suspension of its dividend in December, said in its filing that its CEO pay ratio (302 to 1) would be closer to Equilar’s median number if it weren't for a one-time award the CEO received in 2017, valued at $10.2 million, “Excluding the sign-on equity awards, the ratio would have been 143 to 1,” a company spokeswoman said. REQUIRED: In your supported opinion, is the SEC’s Pay Ratio Disclosure requirement a good rule? QUESTION 3A [7 MARKS) Explain why the CEO letter accompanying a company’s annual report is important. QUESTION 4 [7 MARKS) Do you agree with the accounting for taxation loss carryforwards under the deferred income tax method of accounting? Why or why not? Explain some of the benefits of accounting for loss carryforwards. QUESTION SA [7 MARKS] CPA Canada defines social media as follows: Social Media Is Twitter, Facebook, LinkedIn, YouTube, blogs used for IR purposes, to convey press releases, earnings results, to engage investors, convey IR related meetings or presentations? (“IR” refers to Investor Relations] RSM 320H1S — Final Exam Page 3 of 17Social media is now viewed as a top source of risk to businesses. Social media can magnify the threat of other risks, including reputational risk. It is important for companies to understand what is out there about the company. The impact of technology trends and managing data released to the public will be very important. REQUIRED: Explain the impact that social media will have on the overall quality of financial reporting, if any. Provide support for your answer. Explain why financial reporting via the Intemet is an integral part of corporate accountability. Explain the benefits and challenges of such a reporting medium to both companies and users. PART B OF THE EXAMINATION: TWO COMPULSORY TECHNICAL QUESTIONS ; | A TOTAL OF 25 MARKS ARE AVAILABLE IN THIS PART OF THE EXAMINATION QUESTION 1B [15 MARKS] ABC Incorporated (henceforth, ABC), a Canadian public company which began operations in early 2018, produces products on a contract basis. ABC has a December 31 year-end. Each contract has a gross profit ‘of $80,000. Some customers are permitted to pay ABC on the installment basis, paying 20% in the year of sale and the remainder at the rate of 20% in each of the following four years. For income tax filing purposes, ABC uses the installment approach, but the completed contract approach is used for financial reporting. ‘The company reported net income before income taxes of $475,000 in 2018, and tax rate that year was 40%. The government had passed legislation reducing the tax rate for future years to 30%. In 2018, ABC completed seven contracts under installment arrangements, resulting in gross profit of 7 x {$80,000 or $560,000. Total contract price for these seven was $1,500,000. ABC purchased $540,000 of depreciable fixed assets near the start of 2018; for tax-filing purposes, the assets qualify for an 8% declining, balance CCA, and the half-year rule isin effect. For financial reporting, the fixed assets are depreciated on a straight-line basis over six years with no salvage value. ‘ABC guarantees its products for one year. In 2018, ABC put the following entry through its general journal: DR — Warranty expense 200,000 CR Accrued warranty liability 200,000 The tax authority only permits ABC to deduct the $60,000 it actually expended in 2018, ABC received $40,000 in dividends from another company. These dividends qualify as never taxable under tax legislation; however, ABC had recorded them in its accounts, ABC paid non-deductible penalties and fines of $50,000, and recorded these payments as business expenses in its books of account. RSM 320H1S — Final Exam. Page 4 of 17REQUIRED: ABC follows IFRS. Prepare all journal entries relating to income taxes for 2018, and present the bottom of the income statement for that year beginning with “Income before income taxes”, in compliance with IFRS. QUESTION 2B [10 MARKS ABC Inc. set up an ESOP under which employees may purchase shares of the company for $25 per share. ‘The option premium (the price the buyer pays) is $.75 per share and ABC Inc. set aside 30,000 shares. On January 1, 2018, 15,000 options are purchased by employees. On December 1, 2018, all 15,000 options are exercised. Instruetions 1. Prepare the journal entries to record the above events. (5 marks) 2. Discuss the advantages and disadvantages of offering stock options to employees as a means of compensation. (5 marks) PART C OF THE EXAMINATION: DO ONLY TWO OF THE AVAILABLE THREE QUESTIONS _ = ‘A TOTAL OF 40 MARKS ARE AVAILABLE IN THIS PART OF THE EXAMINATION QUESTION 1C (20 MARKS) BERKSHIRE HATHAWAY 2017 INCOME TAX FINANCIAL REPORTING Berkshire Hathaway...is a holding company owning subsidiaries engaged in a number of diverse business activities. The most important of these are insurance businesses conducted on both a primary basis and a reinsurance basis, a freight rail transportation business and a group of utility and energy generation and distribution businesses. Berkshire also owns and operates a large number of other businesses engaged in a variety of activities, as identified herein. Its corporate headquarters are located in Omaha, Nebraska... Berkshire and its consolidated subsidiaries employ approximately 377,000 people worldwide. [From the company’s 2017 annual report] Note 16, “Income taxes”, from the 2017 Berkshire Hathaway audited financial statements is as. follows: RSM 320H1S — Final Exam Page 6 of 17(16) Income taxes “The liabiies for income taxes reflected in our Consolidated Balance Sheets area follows (n millions Currently payable (receivable (129) Dofered ne ‘ 56,182 Other ae es 554 ‘On December 22,2017, President Trump signed into law the Tax Cuts and Jobs Act of 2017 (“TCIA"). Among its provisions, ‘he TCIA reduces the statutory U.S. Corporate income tax rate from 35% to 21% effective January 1, 2018, The TCIA also provides for a one-time tax on certain accumulated undistributed pos-1986 earnings of foreign subsidiaries, Furber the TCJA inches provisions that in certain instances, impose U.S. income tax Habiies on future earings of foreign subsidiaries and limit the deductibility of fru interest expenses. The TCIA also provides fr accelerated deductions of certain capital expenditures made after September 27, 2017 trough bonus depreciation. The application ofthe TCJA may change duet regulations subsequently issued by the US. Treasury Department. Upon the enactment of the TCJA, we rconded a reduction in our deferred income tax liabilities of approximately $35.6 billion forthe effet of the aforementioned change inthe US, staitory income tax rte. As a result, we recorded an income tax benefit of approximately $29.6 bilion and we inereased rgulatory lailes of our regulated utility subsidiaries by approximately $60 billion forthe portion ofthe deferred income tax lability reduction that we willbe required to, effectively, refand to customers inthe rate sting process, We aso recognized an income tax charge of approximately $1.4 billion with respect othe deemed repatriation ofthe ccumlated undistributed post-1986 earings of ou foreign subsidiaries. Thus, upon the enaciment of the TCUA, we included net income tax benefit in our 2017 earings of approximately $282 tllon RSM 320H1S — Final Exam. Page 6 of 17Notes to Consolidated Financlal Statements (Continued) (16) Income taxes (Continued) In December 2017, the Securities and Exchange Commision issued StaT Accounting Bulletin 118 ("SAB 118") to provide clarification in implementing the TCJA when reistrants do not have the necessary information available to complet the ecounting for an element ofthe TCIA inthe period of ts enactment, SAB 118 provides fr tax amounts tobe classified as provisional and subject to remeesurement for up one yea fom the enactment date for uth elements when the accounting effet fs not complete, but can be reasonably estimated. We consider our estimate ofthe taxon accumulated undistributed earings of foreign subsidiaries to be provisional and subject to remessurment when we obtain the necessary additional infermation to complete the accountng. While we believe our estimate to be reasonable, it wil ake adaitinal time to validate the ipots to the foreign earings and profits calculations, the basis on which the repatriation tax is determined, and how the applinble stats will address the U.S. reputation tax. We curently expect that our ‘sccounting fr the eptriation tax under the TCIA willbe completed by the end of 2018. We have nt established deferred income axes on accumulated undistributed earings of certain foreign subsidiaries, whieh are ‘expected to be reinvested indefinitely. Repatiation of all accumulated earnings of foreign subsidiaries would be impracticable tothe txtet tha sch eamings represent capital to support normal busines operations. Although no U.S. federal taxes will be imposed ature distributions of foregn earnings, in certain jurisdictions the distibuions could be subject to withholding and other local taxes ‘The tax effects of ternporary differences that give rise to significant portions of deferred ax assets and deferred tx abilities are shown below Cn milion). Deforred tax ibis: Tavestnens ~ unrealized appreciation and cost basis difeenees $2451 Ss 27669 Deferred charges reinsurance assumed. ---o- +--+ LT 36 2876 Property, plant and equipment ......00. 0:0... 266 3935 Goodwill and ater intangible assis ———- 7204 13a Othe cove SIIIEEIIISI sae 5550 64.568 36,784 Deferred tax assets: ‘Unpaid losses and loss adjustment expenses sence O23) (1363) Unesrned premiums ..----se-evssersssccseooceee G45) ay ‘Accrued liabilities z 2300, xp Other aera . 514309 22) (6386 (10327) [et dered tax lability : 356,182 316457 Income tax expense reflected in our Consolidated Statements of Emings foreach ofthe thee years ending December 31,2017 {sas follows (in lions) 37796 $9253, 556 ‘S78 iy io $10,532 5 5426 51106, 310532 Federat State Foreign Curent Detered | RSM 320H1S — Final Exam Page 7 of 17Notes to Consolidated Financial Statements (Continued) (16) Income taxes (Continued) Income tax expense is reconciled to hypothetical amounts compute at the U.S, federal statutory rte foreach ofthe three years «ending December 31,2017 in the table below in millions), Earnings before income taxes reno 323858 Hypothetical income tax exponse computed athe US. federal statuory rate oS 838 Dividends received deduction and tx exempt interest ero (905) 465, State income taxes, es US. federal income tax benefit 5 Foreign tax rte diferences cette a 9) USS. income tax ereits : ‘ (66) [Non-taxable exchange of investmenis [Net benefit from the enactment ofthe TCIA Other diferences, net 5 SINT es20 : a 243) We file income tax retums inthe United States and in state, local and foreign jurisdictions. We are under examination by the taxing authorities in many ofthese jurisdictions. We have settled income tax liabilities with US. federal taxing authorities (the “IRS") for yeas before 2010. The IRS continues to audit Berkshire's consolidated U.S. federal income tx rtums forthe 2010 through 2013 ‘ax Years and we currently belive itis reasonably possible that these examination wil be settled during 2018, We ae also under audit ‘or subject to audit with respect to income taxes in many state and foreign jurisdictions. Iti teasonably possible that certain of hese income tax examinations wil be settled within the next twelve months, We curently do not Believe tat the outcome of unresolved issues or claims willbe material to our Consolidated Financial Statements ‘At December 31,2017 and 2016, net unrecognized tax benefits were $584 milion and $485 milion, respectively. Included in the balance at December 31, 2017, were $445 million of tx positions tha, if recognized, would impact the effective tax rat. The fennaining balance in net unrecognized tax benefits pinepally relates to tax postions where the alimate recognition is highly eraln but there i uncertainty about the timing of such recognition. Because of the impact of defered income tx accounting the differences in recognition periods would not affect the annual elective tax rate bat would accelerate the payment of cash tothe taxing authority to an eatin period, As of December 31, 2017, we do not expect any material changes to the estimated amount of uneeeognized fa ‘benefits nthe next twelve ments REQUIRED: (a) Identify three important tax issues disclosed in the note and explain why they are important to the company and its stakeholders. [9 marks] (b) Explain why the table in the note with the following heading is important to a user interested in forecasting the company’s future earnings: “Income tax expense is reconciled to hypothetical amounts computed at the U.S. federal statutory rate for each of the three years ending December 31, 2017 in the table below (in millions).” [6 marks] (©) How sustainable going forward is the company’s 2017 net income, based upon the information provided? [5 marks} RSM 320H1S — Final Exam Page 8 of 17QUESTION 2C (20 marks) BCE NON-GAAP DISCLOSURE QUESTION BCE is Canada’s largest communications company, providing residential, business and wholesale customers with a wide range of products and services for their communications needs. BCE’s shares are publicly traded on the Toronto Stock Exchange and on the New York Stock Exchange (TSX, NYSE: BCE). The company describes itself as follows: “Our results are reported in three segments: Bell Wireless, Bell Wireline and Bell Media. Bell Wireless provides wireless voice and data communications products and services to our residential, small and medium-sized business and large enterprise customers across Canada, Bell Wireline provides data, including Internet access and Internet protocol television (IPTV), local telephone, Jong distance, as well as other communications services and products to our residential, small and medium- sized business and large enterprise customers, primarily in Ontario, Québec and the Atlantic provinces, while satellite television (TV) service and connectivity to business customers are available nationally across Canada. In addition, this segment includes our wholesale business, which buys and sells local telephone, long distance, data and other services from orto resellers and other carriers. Bell Media provides conventional, specialty and pay TV, digital media, radio broadcasting services and out- ‘of-home (OOH) advertising services to customers nationally across Canada.” BCE Ine. received the following audit opinion dated March 2, 2017: “In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of BCE Inc. and subsidiaries as at December 31, 2016 and December 31, 2015, and their financial performance and their cash flows forthe years then ended in accordance with International Financial Reporting, Standards as issued by the International Accounting Standards Board.” ‘The company reports non-GAAP financial measures and KPls (key performance indicators) “to explain our financial results” (dollar amounts in millions of Canadian dollars). 10.2 Non-GAAP financial measures and key performance indicators (KPIs) ‘hi section decerbes the non-GAAP financial mearures and KA we use inthis MOKA to explon our Francil resus. also provides ‘econeliation ofthe non-GAAP fnarialmeasures tothe most comparable IRS fennel measure, Adjusted EBITDA and adjusted EBITDA margin The terms adjusted EBITOR and aust BITOA margin do ot ve fy standordleed meaning under FRE. Thersfore, ay ore uy tobe comparable to similar measures preserted by other ier ‘We dene acted ETDA cx operating evenvesles operating cox, txshown n BCE consoidoted income statements Acjated EBITOA for Bs segreres isthe sore os segnerepoftes reported in Noted, ‘Segmontagivormoton in CE-2016 coraidated ironcel otemares We define adjusted ERTOA margin os adsted EBD diaded by eperating revere. RSM 320H1S - Final Exam We we xjsted EBMOA and ojsted EBITDA morginto evluate the performance of our businesres as they reflect thei ongoing rofitaty. We Beleve that certain investors ond anolyte vse ‘ejusted EBITDA to measure o company’s ably to service debt and ‘mat other payment abgatons a ox common meoruremare (0 ‘alu componier inthe telecommunicotors nua We beleve that ‘erin investors ond onolstr alo vie dusted EBA ond uted EBMDA morgito evaluate he perlormonen of our budnestes Aden EBITOA Isso one component in the determination of short-term ‘nemntve compensation Fra menagemant employees, Page 9 of 17[Adysxe4€B110A and adjisted BTA margin havea deactlycomparabie FRS fnonclotmaaaire Akamathely thefolowing abe orovdes ‘areconccion of net earings to adyuted EBTOA Oeerlncarserpeme en ® eon tons ssi0 2 epswe OR rr aa Rt opactng moon a9 nse Ajo OA merge “on id Adjusted net earnings and adjusted EPS The tem snd rt earings a agus FS do rot have any ‘andrdedecring under FES There yore ity be Comparaietesinier neaavespresetedby ter ksers We define egusted nat eamings 0 nt eariogs tviutale ‘oneonhereholdrsbeloreverenceoxuaiion ander cose ‘ec cates (gran tverinents nd ear attention cnt Wedel oted scouted cteameteperOcEconmonson Weuseodused et euriogs and adusted EPS ond we beteve thet cern mvestorsandondyst use these measures omangdther es, 12 sess ine performance of eur businesses wide Ow eects searorce ccqustionon oer casts netieses oon rvesiners ondecry debredemption casts nto ex ond NCL We excuse hase ams because they ffect the comparable of ou nancial ess (ond could potawally distort the onakjes ef trends in bushes performance. Exchding these tems dons nt Imply they ae non reaurng The most comparable FAS leancial meaiures ore net earning: otvoutcble to common shareholders and EPS. The folowing table ‘cecenction of net eamingsatrbutabe to common sharebeldes ond EPS to aused net earangs ona consoled bass and pa BCE commen she assed E5) especie oop avbce wo cormon Boclaes et tonesl gore on mesrent eo ‘202i tony ca edoretin es 2 002 Rapeeareccamge 2s 36 Free cash flow and dividend payout ratio The tema ree cechfow and divdend payout rt do nothave ony ‘Sondardned meaning veer FRS. Therefore, hey ove una t be ‘comporcbletosimfor meanies preseruad by ther vers We define Ir cath flow as cath fous hom cperating oeien eclaing acqustion and ater costs pad (which nde sgticont Itigaton cess) and voluntary pension funding, less capital ‘ependinues prefered share auidends ond dhicend pol! by ‘stares NCL Weexchde oxqusBion ad other cers pdr \obnur'y persion funding because Hey fect the compare ey of 1 franc reasoned coud peared dito the alg rence ‘m business performance Exchaing these Rems does nat ely they (re nonrecurring. RSM 320H1S — Final Exam ‘Wecansiberfreeceshfiow a bean inporiatndcta of hence! strength and performance of our businesses because k shows Pow much cash & avatableta pay dende.rapay debe and reinvest ‘urcompany Webbeleve batceran iestorscndaneyt te ree ‘eash(ow tovebe a business ons une ying eats 0S Re the Nnenci strengehand perlormance of ox busine sve. The moat comparable FRS financial measure & cashflows Fam operating cco Washoe rtendpayontratioas visendspaldan commen shares add by fae cosh flow, We constr dividend pao rth to be cn importantindiata ofthe eancaletrengih andperfomance of cu businesses becouse kshowsthesusainabhty ol te companys edend payments Page 10 of 17The fotowng tabels areconalanonot cash owstromaperatng caves 9 fee cash Nowon aconsohdared bass Gar eantaeprangeneens at Ceonategenteves ara Cam Svdentipaonprteret ee 4 con ensipaby sacar to NO wa Aegan ancber cana 16 Votan detnd nmetepeman en coarbuten oy ew cahtow Baze Net debt The term nee dete does no have any tandardoed meaning under IFRS Therefore irunlkey be comporade to sndae measures recanted by other tsuers Werdelinenetcdebtos dab de wehin one yea ps grt dete ‘ard SOK of preferred es cash ondessheaclens o520wn InBCEaconsokdcied stuns of farce pstion WeincdeSO% ‘ofexastading peered staresinour net debt one cone eh the treament by cerancrede ring ogc We conaider nt det 0 be on mporare dct of necomoanys inane everage because tpresnis the OnUNE of SE PE roteoveredsyavateblacachond cash equal, We believe tht Cevtanvetteront ancien eto dee mune cones Ioana leverage. Netdetehor ces eompareble FS fancrsimeaste bat toner Ie cokdoted ung severl ext and Nei carers am the seezemares offal potions shoun nthe folowing tle vores sr “aes So etatcemdngprterdsno 2002 2002 Ch endeaeqavces, ss mus Nevaete 22868 hare Net debt leverage ratio. “Te netdebleverage ti dows nathave any adorned nearing under FES Tarforeitwunthelytobe comparcie tomar mesures ‘presenta by cer kavers We wa. ondbeleve tat eerciinwezort cna oly wm het det verge a os emeasate nancial leverage. “The net debt overage ot epresants net det vised by adhted EBTDA Fo he purposes of eakedolng ou me debt Leverage ea, equated ITA broke anth voting edusted EBTOA. Adjusted EBITDA to net interest expense ratio “The ratio of outed FTA to et ntrest expense dows not hve ‘ony Hondrdved meaalng under IS Tevlore 1 they to be omparctle oso mecsurespreseted by other sues We we, ‘nd believe thar certain Imvesors ond eras use the outed FRITOA te net eeerstenpenser cto oko means of finance hadth ofthecomeany RSM 320H1S ~ Final Exam Thecchsad EBTDA tonetcarestexpans viorepresatsodnsied EBTOA vey rat xara enper Forte prpnes df eeustng ‘our odjsted EBTOAtonetintaret exer ao, sind EBTDA twebe-noneh rll hated BMA Netzer expense ele row walle net rarest expense os shown wou Saxemerts of cash lus Rol decocedpreterredshareuderd shown Page 11 of 17KPIs In addition to the non-GAAP financial measures described previously, we use a number of KPIs to measure the success of our strategic imperatives. These KPIs are not accounting measures and may not be comparable to similar measures presented by other issuers. ‘KPL DEFINITION [ARPU ‘Average revenue per user (ARPU) or subscriber is a measure used to track our recurring revenue streams. Wireless blended ARPU is calculated by dividing certain service revenue by the average subscriber base for the specified period and is expressed as a dollar unit per month, | Capital intensity Capital expenditures divided by operating revenues, Chum’ ‘Chum is the rate at which existing subscribers cancel their services. Itis a measure of our ability to retain our customers. Wireless chum is calculated by dividing the number of deactivations during a given period by the average number of subscribers in the base for the specified period and is expressed as a percentage per month. COA COA is also referred to as subscriber acquisition costs. COA represents, the total cost associated with acquiring a customer and includes costs such as hardware discounts, marketing and distribution costs. This measure is expressed per gross activation during the period, Subscriber unit Wireless subscriber unit is comprised of an active revenue generating unit (eg. mobile device, tablet or wireless Intemet products) with a unique identifier (typically Intemational Mobile Equipment Identity (MED number), that has access to our wireless networks. We report wireless subscriber units in two categories: postpaid and prepaid, Prepaid subscriber units are considered active for a period of 120 days following the expiry of the subscriber’ prepaid balance. Wireless subscriber unit consists of an active revenue-generating unit with access to our services, including Internet, satellite TV, IPTV, and/or NAS. A subscriber is included in our subscriber base when the service has been installed and is operational at the customer premise and a billing relationship has been established. * Internet, IPTV and satellite TV subscribers have access to stand- alone services, and are primarily represented by a dwelling unit. © NAS subscribers are based on a line count and are represented by a unique telephone number REQUIRED: Assume the role of an advisor to a major pension investment fund, and critically assess the appropriateness of the non-GAAP and other measures that BCE wishes to be evaluated by. RSM 320H1S - Final Exam Page 12 of 17QUESTION 3C (20 marks) ALIBABA SHARE-BASED AWARDS NOTE, Alibaba Group Holding Limited is a Chinese multinational e-commerce, retail, Intemet, AI and technology conglomerate founded in 1999 that provides consumer-to-consumer, business-to- consumer and business-to-business sales services via web portals, as well as electronic payment services, shopping search engines and data-centrie cloud computing services. It owns and operates a diverse array of businesses around the world in numerous sectors, and is named as one of the world’s most admired companies by Fortune. REQUIRED: Develop an opinion as to the quality of Alibaba’s “Share-based awards” audited note which is shown below. "RMB" and "Renminbi" are the legal currency of China ALIBABA GROUP HOLDING LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED MARCH 31, 2015, 2016 AND 2017 8, Share-based awards Share-based awards such as incentive and non-statutory options, restricted shares, RSUSs, dividend equivalent rights, share appreciation rights and share payments may be granted to any directors, employees and consultants of the Company or affliated companies under the employee share option plans adopted in 1999, 2004, 2005, the share incentive plan adopted in 2007 and the equity incentive plan adopted in 2011, which govern the terms of the awards. In September 2014, the Company adopted a post-IPO equity incentive plan (the "2014 Plan"). Share-based awards are only available for issuance under our 2014 Plan. Ifan award under the previous plan terminates, expires of lapses, oF js cancelled for any reason, ordinary shares subject to the award become available for the grant of a new award under the 2014 Plan. On April l, 2015 and each anniversary thereof, an additional amount equal to the lesser of (A) 25,000,000 ordinary shares, and (B) such lesser number of ordinary shares determined by the board of directors will become available for the grant of a new award under the 2014 Plan. The 2014 Plan has a ten-year term. All share~ ‘based awards granted under the 2014 Plan are subject to dilution protection should the capital structure of the Company be affected by a share split, reverse share split, share dividend or other dilutive action. The 2014 Plan has substantially similar terms as the plan adopted in 2011 except that (3) the 2014 Plan is administered by the compensation committee of the board (or a subcommittee thereof), or such other committee of the board to which the board has delegated power to act, or the board in the absence of any such committee, and (fi) certain terms are adjusted for the purposes of compliance with the Sarbanes-Oxley Act of 2002, U.S. Securities Act of 1933 and the regulations thereunder, as, amended from time to time and U.S. Securities Exchange Act of 1934 and the regulations thereunder, as amended from time to time, among others. AS of March 31, 2017, the number of shares authorized but unissued was 29,079,770 ordinary shares. Share options and RSUs granted are generally subject to a four-year vesting schedule as determined by the ‘administrator ofthe plans. Under the four-year vesting schedule, depending on the nature and the purpose ofthe grant, share options and RSUS in general vest 25% or 50% upon the fist or second anniversary of the vesting commencement date, respectively, as provided in the grant agreement, and 25% every year thereafter. No outstanding share options (or RSUs will be exercisable or subject to vesting after the expiry of a maximum of six years from the date of grant. RSM 320H1S — Final Exam Page 13 of 17‘Starting from the year ended March 31, 2015, certain share options and RSUs granted to senior management members of the Company were subject to a six-year pro rata vesting schedule. No outstanding share options or RSUs will be exercisable or subject to vesting after the expiry of a maximum of eight years from the date of grant Early exereise of share options is allowable under all the aforementioned plans; however, any unvested shares are subject to repurchase by the Company at the lower of the original exercise price or the fair market value upon ‘termination of service contracts with the grantees, (@) Share options relating to ordinary shares of the Company A summary of changes in the share options relating to ordinary shares granted by the Company during the year ended. March 31, 2017 is as follows: Weighted Weighted average Number ‘erage remaining share rere contracts options price Me ss 5) Outstanding at April 1, 2016 17,707,328 34.37 Granted 275,000 78.71 Exercised 6,262,533) 41.04 Cancelled/forfeited/expired (1,006,792) 42.68 Outstanding at Mareh 31,2017 (i) This ‘Vested and exercisable at March 31, 2017 “2144259 «S915. Vested and expected to vest at March 31, 2017 (i) 14,347,974 61.42 @ (Outstanding options as of March 31, 2017 include 1,141,875 unvested options early exercised. Gi) ‘Share options expected to vest are the result of applying the pre-vesting forfeiture rate assumptions to total outstanding share options, including early exercised options. As of March 31, 2016 and 2017, 384,116 and 347,513 outstanding share options were held by non-employees, respectively. These share options are subject to re-measurement through each vesting date to determine the appropriate amount of the expense. ‘As of March 31, 2017, the aggregate intrinsic value of all outstanding options was RMB3,704 million. As of the same date, the aggregate intrinsic value of options that were vested and exercisable and options that were vested and expected to vest is RMB719 million and RMB3,629 million, respectively. During the years ended March 31, 2015, 2016 and 2017, the weighted average grant date fair value of share options granted was US$23.07, USS28.65 and US$22.89, respectively, and the total grant date fair value of options vested during the same years was RMB134 million, RMBG02 million and RMB348 million, respectively. During the same years, the aggregate intrinsic value of share options exercised was RMB488 million, RMBSS6 million and RMB1,799 million, respectively. Cash received from option exercises under the share option plans, including repayment of loans and interest receivable ‘on employee loans for the exercise of vested options, for the years ended March 31, 2015, 2016 and 2017 was RMB313 million, RMB693 million and RMB287 million, respectively, RSM 320H1S — Final Exam Page 14 of 17The fair value of each option grant is estimated on the date of grant using the Black-Scholes model and the assumptions below: Risk-free interest rate () 38% 199% Expected dividend yield (ii) 0% Expected life (years) (il) 425-578 Expected volatility (iv) 35.0% — 40.8% 33.4% 35.7% o Risk-free interest rate is based on the yields of United States Treasury securities with maturities similar to the expected life of the share options in effect at tho time of grant w Expected dividend yield is assumed to be 0% as the Company has no history o expectation of paying a dividend on its ordinary shares, Gi) Expected life of share options is based on the average between the vesting period and the contractual term for ‘each grant. wy, Expected volatility is assumed based on the historical volatility of the Company's comparable companies in the period equal to the expected life of each grant. As of March 31, 2017, there were RMBS66 million of unamortized compensation costs related to these outstanding. share options, net of expected forfeitures and after re-measurement applicable to share options granted to non- employees. These amounts are expected to be recognized over a weighted average period of 2.4 years. ‘During the years ended March 31, 2015, 2016 and 2017, the Company recognized share-based compensation expense of RMB1,i52 million, RMBS78 million and RMBS24 million, respectively, in connection with the above share ‘options, net of cash reimbursement from related companies, including Ant Financial Services (Note 22) (b)RSUs relating to ordinary shares of the Company ‘A summary of changes in the RSUs related to ordinary shares granted by the Company during the year ended March 31, 2017 is as follows: Weighted. average amber rant date of RS fair value TSS ‘Awarded ind unvested at April 1, 2016 71,836,365 59.95 Granted 25,796,789 82.41 Vested (21,945,063) 54.74 Cancelled/forfeited (6,092,372) 66.06 ‘Awarded and unvested at March 31, 2017 8,595,719 69.18 Expected to vest at March 31, 2017 ()) 60,534,893 67.98 RSM 320H1S — Final Exam Page 16 of 17@ RSUs expected to vest are the result of applying the pre-vesting forfeiture rate assumptions to total outstanding RSUs, ‘As of March 31, 2016 and 2017, 5,880,443 and 4,594,874 outstanding RSUs were granted to non-employees, respectively. These awards are subject to re-measurement through each vesting date to determine the appropriate amount of the expense. ‘As of March 31, 2017, there were RMB12,847 million of unamortized compensation costs related o these outstanding RSUSs, net of expected forfeitures and after re-measurement applicable to these awards granted to non-employees. ‘These amounts are expected to be recounized over @ weighted average period of 2.0 years. During the years ended March 31, 2015, 2016 and 2017, the Company recognized share-based compensation expense of RMB7,767 million, RMB9,915 million and RMB12,322 million, respectively, in connection with the above RSUs, net of cash reimbursement from related companies, including Ant Financial Services (Note 22). (©) Partner Capital Investment Plan relating to ordinary shares of the Company Beginning in 2013, the Company offered selected members of the Alibaba Partnership rights to acquire restricted shares of the Company. For the rights offered before 2016, such rights and the underlying restricted shares were subject toa non-compete provision, and the holders were entitled to purchase restricted shares a a price of US$14.50 per share during a four-year period. Upon the exercise of such rights, the underlying ordinary shares may not be transferred for a period of eight years from the date of subscription of the relevant rights. For the rights offered in 2016, such rights and the underlying restricted shares were subject to certain service provisions that were not related to employment, and holders were entitled to purchase restricted shares at a price of USS23.00 per share over a period of ten years from the vesting commencement date. ‘The number of ordinary shares underlying these rights is 18,000,000 shares, of which the rights to subscribe for 16,500,000 shares were offered and subscribed up to March 31, 2017. The rights offered before 2016 were accounted {for as a noncontrolling interest of the Company as such rights were issued by the subsidiaries and classified as equity at the subsidiary level. The rights offered in 2016 were accounted for as share options issued by the Company. As of March 31, 2017, there were RMBS45 million of unamortized compensation costs related to these rights. These ‘amounts are expected to be recognized over a weighted average period of 4.9 years. Share-based compensation expense of RMB211 million, nil and RMB241 million was recognized in connection with these rights for the years ‘ended March 31, 2015, 2016 and 2017, respectively. The fair value of each right to acquire restricted shares is estimated on the subscription date using the Black-Scholes ‘model and the assumptions below: Year ended March 31, aS 216 Riskefive interest rte ()_ = 1.50% 9 Expected dividend yield (i) (a Expected life (years) Gi). 0 5% 4.00 = Expected volatility (iv) 381% — Discount fér post:vestng sl restrictions (¥) 350%) @ Risk-free interest rate is based on the yields of United States Treasury securities with maturities similar to the expected life ofthe share-based awards in effect atthe time of grant. i) Expected dividend yield is assumed to be 0% as the Company has no history or expectation of paying a dividend on its ordinary shares. RSM 320H1S - Final Exam Page 16 of 17Gi) Expected life of the rights is based on management's estimate on timing of redemption for ordinary shares by the participants. (wy) Expected volatility is assumed based on the historical volatility of the Company's comparable companies in the period equal to expected life of each right. @) Discount for post-vesting sale restrictions applied on the underlying ordinary shares takes into consideration the restriction on sales of eight years (@ Share-based awards relating to Ant Financial Services Junhan, the general partner of which is controlled by the executive chairman of the Company and a major equity holder of Ant Financial Services, made grants of certain share-based awards similar to share appreciation awards linked to the valuation of Ant Financial Services to a substantial number of employees of the Company. The vesting of such awards is conditional upon the fulfillment of requisite service conditions to the Company, and such awards will be settled in cash by Junhan upon the disposal by the holders. Junhan has the right to repurchase the vested awards from the holders upon an initial public offering of Ant Financial Services or the termination of the employment of the ‘employees with the Company at a price to be determined based on the then fair market value of Ant Financial Services, ‘The Company has no obligation to reimburse Junhan, Ant Financial Services or its subsidiaries forthe cost associated with these awards. For accounting purposes, the cost relating to such share-based awards granted by the shareholder through Junban is recognized by the Company as a shareholder contribution as the awards will ultimately be settled in cash by Junhan. ‘The awards meet the definition of financial derivative and are initially measured at their fair value, Given the nature of this transaction, the related expense will be recognized over the requisite service period in the consolidated income, statements with a corresponding credit to additional paid-in capital, Subsequent changes in the fair value of the awards are recorded in the consolidated income statements through the date on which the underlying awards are settled by Junhan. As of March 31, 2017, there were RMB1,039 million of unamortized compensation costs related to these outstanding. share-based awards of Ant Financial Services granted by Junhan, net of expected forfeitures and after re-measurement applicable to these awards. These amounts are expected to be recognized over a weighted average period of 1.6 years. ‘During the years ended March 31, 2015, 2016 and 2017, the Company recognized expenses of RMB3,788 million, 'RMBS5,506 million and RMB2,188 million in respect of the share-based awards relating to Ant Financial Services ‘ranted by Junhan, respectively. (©) Share-based compensation expense by function ‘Year ended March 3, a war Cost ofreveniie 41764003 3,893 Product development expenses 387 5,703,712 Sales and marketing expenses 12351963 7m General and administrative expenses 371 4413618 Total TR Te 15995 ~-END OF EXMINATION— RSM 320H1S ~ Final Exam Page 17 of 17