Air Force Technology Corporation
AIRFORCE TECHNOLOGY CORPORATION
ASSIGNMENT 2
ACTG 5100G WINTER 2015
AirForce Technology Corporation (AirForce) is a private company that manufactures heating, ventilating and air
conditioning (HVAC) control systems. Its customers are HVAC manufacturers and installers. The company operated
locally in the Greater Toronto market for many years, with net annual earnings in the $300,000 range. It launched
a new version of its control system in late 2013 and has expanded its market reach considerably. One of the key
selling features of the new system is that AirForceÕs technicians can access it over the Internet. The technicians can
collect data on system performance and adjust operating parameters to optimize the heating and cooling cycles,
delivering energy savings to the customer. This also generates a new service revenue stream for AirForce.
AirForce is owned by the Ruud family. The founder, Emily ÒTerriblyÓ Ruud, is now in her eighties. EmilyÕs motto,
drummed into her children from day one, has always been that Òa tax dollar saved is a dollar earned.Ó She is no
longer a shareholder. Her three children now run the company, having purchased all the shares from her.
When the new system was launched and the children decided to grow the company, they needed funding. Emily
was opposed to the plan, but rather than see her family risk losing control of the company, Emily offered to lend
the necessary money. AirForce issued a $2,000,000 bond to Emily on January 1, 2014. The bond had a coupon rate
of 10%, with interest payments to be made annually at the end of each year, and a maturity date of December 31,
2025. Rather than making the bond retractable, Emily insisted that if the debt-to-equity ratio of the company
exceeded 2.5:1 on any annual financial statements, a penalty fee of $500,000 would be payable to her.
Because the company is privately held, its financial statements have always been produced mainly for internal
purposes. The company has always followed generally accepted accounting principles, but departures from it are
made if the resulting information is more useful for its purposes. Emily has agreed to use these statements but has
insisted that she (or her representative) be allowed to review the annual statements to ensure that no accounting
choices have been made solely to manipulate the debt-to-equity ratio. Emily and the children have agreed to
meet each year specifically to review the statements in light of the covenants on the bond. Any disagreements will
be settled by an independent arbitrator. They all agree that any tax effects can be left out of the discussion.
It is now February 2015. Emily has hired you, an accountant, and asked you to review the December 31, 2014 draft
financial statements of AirForce. She would like you to prepare a report