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5. Critical Assumptions
Critical Accounting Estimates
The preparation of financial statements in conformity with Canadian GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in the financial statements. We constantly evaluate these estimates and assumptions.
We base our estimates and assumptions on past experience and other factors that are deemed reasonable under the circumstances. This involves varying degrees of judgement and uncertainty, thus the amounts currently reported in the financial statements could prove to be inaccurate in the future.
Business combinations
YPG's acquisitions have been accounted for using the purchase method of accounting. Under the purchase method, the acquiring company adds to its balance sheet the estimated fair values of the acquired company's assets and liabilities.
There are various assumptions made by YPG in determining the fair values of the acquired companies' assets and liabilities. The most significant assumptions, and those requiring the most judgment, involve the estimated fair values of trademarks. To determine the fair value of these trademarks, we adopted the relief from royalty approach, a valuation technique based on the concept that the Company owns the trademark. The amount of the notional royalty payment is used as a surrogate for income attributable to the trademark. The fair value of the trademark is based upon the present value of the expected after-tax royalty or cash flow stream. Significant assumptions include, among others, the determination of royalty rates, discount rate, weighted average cost of capital and anticipated average income tax rates.
Intangibles and goodwill
Intangibles and goodwill represented 22.4% and 71% respectively (2005 – 22.3% and 71.6%), of the Company's consolidated assets as at December 31, 2006. If the Company's estimated useful lives of these assets were incorrect, the Company could experience increased or reduced charges for amortization of intangible assets with finite lives in the future. If the future was to adversely differ from management's best estimate of key economic assumptions and associated cash flows were to materially decrease, the Company could potentially experience future material impairment charges in respect of its intangible assets with indefinite lives. If intangible assets with indefinite lives were determined to have finite lives at some point in the future, the Company could experience increased charges for amortization of intangible assets. Such charges do not result in a cash outflow and would not affect the Company's liquidity.
Recoverability of intangible assets
Any potential intangible asset impairment is identified by comparing the fair value of the indefinite life intangible asset with its carrying value. If the fair value of the intangible asset exceeds its carrying value, the intangible asset is not considered to be impaired. If the carrying value of the intangible asset exceeds its fair value, impairment is identified as the difference between the fair value and the carrying value and will result in a reduction in the carrying value of the intangible assets on the consolidated balance sheet and in the recognition of a non-cash impairment charge in operating income. Consistent with current industry-specific valuation methods, the Company uses a discounted expected future cash flow model in determining the fair value of its intangible assets.
The most significant assumptions underlying the recoverability of intangible assets with indefinite lives include projected revenues and EBITDA, anticipated market share and projected renewal rates. The Company performs impairment tests of indefinite life intangible assets on an annual basis.
Recoverability of goodwill
Goodwill is not amortized and is assessed for impairment annually or more frequently should an event or change in circumstances indicate that the asset might be impaired. Any potential goodwill impairment is identified by comparing the fair value of the business to its carrying value. If the fair value exceeds its carrying value, goodwill is considered not to be impaired. If the carrying value exceeds its fair value, a more detailed goodwill impairment assessment would have to be undertaken. A goodwill impairment loss would be recognized to the extent that the carrying value of goodwill exceeds the implied fair value. Fair value of goodwill is estimated in the same manner as goodwill is determined at the date of acquisition in a business acquisition, that is, the excess of the fair value of the business over the fair value of the identifiable net assets of the reporting unit. Any goodwill impairment will result in a reduction in the carrying value of goodwill on the consolidated balance sheet and in the recognition of a non-cash impairment charge in operating income. The Company determines fair value by using a discounted expected future cash flow model in accordance with recognized valuation methods. The process of determining these fair values requires management to make estimates and assumptions including, but not limited to, projected future sales, cost of sales, earnings, market conditions and discount rates.
Following the recently proposed tax measures to income trusts, management performed a review for impairment of goodwill and concluded that no adjustment was required.
Allowance for doubtful accounts
We expect that a certain portion of required customer payments will not be made, and we maintain an allowance for these doubtful accounts based on our estimate of the likelihood of recovering accounts receivable. It incorporates current and expected collection trends. Accounts receivable represented approximately 30.8% (2005 – 27.9%) of the Company's consolidated tangible assets as at December 31, 2006. If economic conditions change or actual results or specific industry trends differ from our expectations, we will adjust our allowance for doubtful accounts and our bad debt expense accordingly. In addition, Bell Canada provides us with customer collection services with respect to advertisers who are also Bell Canada's customers. We rely on information provided by Bell Canada in determining the portion of required customer payments that will not be made, and we maintain an allowance for those accounts.
Employee future benefits
YPG provides eligible employees with pension benefits under various pension plans. Certain actuarial and economic assumptions used in determining pension costs, accrued pension benefit obligations and pension plan assets require significant judgment.
The accrued benefit obligation and expense are determined by independent actuaries on an annual basis, using the projected benefit method pro-rated on service, and based on management's best economic and demographic estimates and significant actuarial assumptions, including expected years of service of employees, retirement age and specified benefit levels. The discount rate, which is used to determine the accrued benefit obligation, is based on market interest rates on high-quality long-term bonds. Future increases in compensation are based upon current benefit policies and economic forecasts. Defined benefit pension costs are also affected by the quantitative methods used to determine estimated returns on pension plan assets.
The expected return on plan assets is determined by considering long-term historical returns, future estimates of long-term investment returns and asset allocation.
The significant actuarial assumptions adopted are internally consistent and reflect the long-term nature of employee future benefits. Significant changes in assumptions, because of updated historical information, or changes in the market conditions, for example, could materially affect the Company's employee benefit obligations and future expense, as well as its overall financial performance. Any immediate impact is lessened, however, as the net actuarial gains and losses in excess of 10% of the greater of the benefit obligation and the fair value of the plan assets would be amortized over the average remaining service period of active employees of the plan.
Change in Accounting Policies
Future accounting changes - Financial instruments
The CICA has issued three new accounting standards:
- Section 3855, Financial Instruments – Recognition and Measurement, effective for fiscal years beginning on or after October 1, 2006. This section describes the standards for recognizing and measuring financial instruments in the balance sheet and the standards for reporting gains and losses in the financial statements. Financial assets available for sale, assets and liabilities held for trading and derivative financial instruments, part of a hedging relationship or not, have to be measured at fair value. The impact of remeasuring our financial assets and liabilities at fair value will be recognized in opening deficit and opening accumulated other comprehensive income as appropriate. The impact of the adoption of this new section on the consolidated financial statements is not expected to be material.
- Section 1530, Comprehensive Income, effective for fiscal years beginning on or after October 1, 2006. It describes reporting and disclosure recommendations with respect to comprehensive income and its components. Comprehensive income is the change in Unitholders' equity, which results from transactions other than those resulting from investments by Unitholders and distributions to Unitholders. These transactions and events include unrealized gains and losses resulting from changes in fair value of certain financial instruments.
- Section 3865, Hedges, effective for fiscal years beginning on or after October 1, 2006. The recommendations expand the guidelines outlined in Accounting Guideline 13 (“AcG-13”), Hedging Relationships. This Section describes when and how hedge accounting can be applied as well as the disclosure requirements. Hedge accounting enables the recording of gains, losses, revenues and expenses from the derivative financial instruments in the same period as for those related to the hedged item. The impact of the adoption of this new section on the consolidated financial statements is not expected to be material.
These standards will be effective for the Fund as of January 1, 2007 and will be adopted on a retroactive without restatement basis.
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