Thursday, July 10, 2008

 

BC Auditor-General explains the operating lease and the capital lease

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Thanks to another wonderful commentor, BC Mary was prompted to write to the BC Auditor General asking the following questions, re-posted here from May 14, 2008:


Question for BC Auditor General + a reply

To:
John Doyle, Auditor General of British Columbia, jdoyle@bcauditor.com
Cheryl Wenezenki Yolland, Comptroller General , Cheryl.WenezenkiYolland@gov.bc.ca


Greetings,

In the matter of B.C. Rail, I ask your assistance with the following question:

One of my readers is asking how the Auditor General of B.C. could have classified the BCR lease as operating .

He informs me that there are criteria that must be met in order to classify a lease this way. One of the criteria, a "bargain purchase" option, is where -- at the end of the lease -- there is no amount that is paid to purchase the asset (or in this case renew the lease).

When a lease is classified as operating, there is no need to disclose the total value of the lease.

But if the lease is capital , a liability must be set up in the financial statements in the amount of the total lease payments.

Your clarification (by email, please) of this question would be very much appreciated.


BC Mary, on behalf of:
The Legislature Raids
http://bctrialofbasi-virk.blogspot.com


On July 2nd, 2008, I received a very nice reply quoting from BCRail Corporation's Financial Statements for 2007/08 (prepared by BCRC according to Canadian generally accepted accounting principles (GAAP), audited by KPMG). Certain points seem to invite further questions so I hope others will comment. For example, does it answer the commentor's question? Here's the reply as received from the Comptroller-General:


"BCRC included information abut an operating lease in its 2006 Financial Statement Note 3" referring to "This operating lease [which] arose as a result of the CN transaction which completed in 2004." Financial Statement Not 3 is copied, for my information.

"Note 3, from the 2006 BCRC Audited Financial Statements, which describes the CN transaction

"The CN transaction was the main component of the Company's original plan to dispose of its residual assets and activities.

(a) On July 14, 2004, BCRC and BCRProperties Ltd completed a transaction with CN pursuant to an agreement signed between the parties on Nov 25, 2003 ("the CN Transaction") ... [Aha! So that's what it's called. - BC Mary]. Under the terms of the agreement, CN assumed the Company's industrial freight railway business by purchasing the shares of BC Rail Ltd., the partnership interests of BC Rail Partnership and railcars from a related entity (collectively "BC Rail").

(b) BCRC and BCRail Partnership entered into a Revitalization Agreement, under which BCRail Partnership leased the railway right-of-way land, railbed assets, and related track infrastructure from BCRC under a long-term lease. BC Rail Partnership prepaid all lease payments under the Revitalization Agreement. [What?] The lease of certain items included in railbed assets is being accounted for as an operating lease. The lease of the remaining railbed assets and track infrastructure has been treated as a capital lease. As a result of the CN Transaction, the Revitalization Agreement was assumed by CN. [Special attention needed here, please. - BC Mary.]

(c) As provided for in the Revitalization Agreement, certain aspects of the transaction were finalized in fiscal 2005 and as a result a $5.6 million reduction in the gain was recorded. [More help, please.]

(d) As part of the CN Transaction, CN committed to certain average transit times for rail traffic on the BC Railway system [Nice to see it still being referred to as "the BC Railway system". - BC Mary] Breach of the transit time commitments results in penalty payments made by CN to a trust fund held by BCRC and dedicated to upgrades of the BC railway system to improve reliability and transit times for the railway users. As at December 31, 2006, the trust fund held $0.3 million in CN penalty payments, which are not recognized in these financial statements. [End of Note #3.]

Important research note:

The Revitalization Agreement and the agreement between BCRC and BCR Properties Ltd. and Canadian National Railway Company, referred to in the financial statement note, are available on the Ministry of Transportation website at the following web address: www.th.gov.bc.ca/bcrail/ [That "th" isn't a typo -- it's in the original letter. But if the URL doesn't work, maybe remove the "th." - M.] This website also includes a link to the BCRC website which has links to the audited financial statements of BCRC.

GAAP guidance determines whether a lease is a capital or operating lease. It requires a lease to be recorded as a capital lease when substantially all of the risks and benefits of ownership are transferred to the lessee at the inception of the lease. From the lessee's point of view, the risks and benefits of ownership are substantially transferred when any one of the following conditions are present in the lease terms and conditions:

(a) There is reasonable assurance that the lessee will obtain ownership of the leased property at the end of the lease term.
(b) The lessee will receive substantially all of the economic benefit that can be derived from the leased property ...
(c) The lessor is assured of recovering its investment in the leased property. This is said to occur if, at the beginning of the lease, the minimum lease payments equal at least 90% of the fair value of the leased property.

GAAP also provides additional guidance when the lease involves land and states that it is not possible for the lessee to receive substantially all the benefits and risks associated with land ownership unless the lessee obtains ownership of the land at the end of the lease.

BCRC followed this guidance when it determined that part of the CN transaction should be reported as an operating lease. Note 4 in BCRC's 2006 audited financial tatements includes information about assets under operating lease.

Sincerely

Cheryl Wenezenki-Yolland
Comptroller-General

cc Auditor General of BC

Linda Shute, Vice President Finance and CFO
British Columbia Railway Corporation

Sheila Taylor, Assistant Deputy Minister
Ministry of Transportation.

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Good information, which bears thinking about. I would certainly welcome informed comment about some of the points raised by the Comptroller-General. - BC Mary.

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Comments:
BREAKING NEWS BCTV AND KEITH BALDREY:

THE APPEAL COURT IS AGREEING WITH THE DEFENCE. SPECIAL PROSECUTOR HAS LOST HIS APPEAL.

THIS MEANS MORE DELAY. BERARDINO MAY DROP THE CASE TO PROTECT SECRET WITNESS.

VERY BIG DEVELOPMENT.
 
Hi Mary,

I just watched the noon news and Keith baldrey has announced that the court of appeals has just sided with the defence, that they (the defence) should be allowed to hear evidence of the secret witness which lead to speculation the special prosecutor will move on to the supreme court of Canada and delay the start of the trial for months and even until after the next election
 
what if there never was a secert witness, and the SP was just BSing?
 
While Premier Gordon Campbell fiddles with selling off BC Rail, his Carbon tax counterpart in California, Governor Schwarzenegger, is on fire by making tracks to promote his bullet train from Sacramento to San Diego..... if somehow he can quell his $10 billion deficit.

North American gas prices are going sky-high and shipping costs via truck too, but by far the cheapest way (no rubber on asphalt... steel rims on steel rails) is by having bullet trains. Well, maybe sling-shot speed through British Columbia's mountain, but once out on the open plains beyond the Canadian Rockies, it should be bullet trains and not a CN Rail busy gouging passengers and freight.
 
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