Teleflix Inc Financial Accounting Issues Assignment

Assignment Task

Accounting Policies

The company licenses rights to stream TV shows, movies, and original content to members for unlimited viewing. These licenses are for a fixed fee and specify license "windows" (time periods in which the content may be shown) that generally range from six months to five years. Payment terms may extend over the license window, or may require more payments, as is typically the case for original content.

The company capitalizes the fee per title and records a corresponding liability when the license period begins, the cost of the title is known, and the title is accepted and available for streaming. For example:

Current Content Library XXX
Content Liability or Cash XXX

The portion available for streaming within one year is recognized as "Current content library" and the remaining portion as "Noncurrent content library." If the cost per title cannot be reasonably estimated, the license fee is not capitalized and costs are expensed as payments are made. However, this does not occur often.

DVD Content Library

The company acquires DVD content for the purpose of renting such content to its members and earning membership rental revenues, and, as such, the company considers its direct purchase DVD library to be a productive asset. Accordingly, the company presents some of its DVD library in "Noncurrent content library, net." The company amortizes its direct purchase DVDs on a straight-line basis over their estimated useful lives, which range from one year to three years. DVDs in the library that have a useful life of one year or less are presented in "Current content library, net" as they will be sold for their salvage value to a discount DVD retailer.

Earnings per Share

Basic earnings per share is calculated using the weighted-average number of outstanding common shares during the period. Diluted earnings per share is calculated using the weighted-average number of outstanding common shares and, when dilutive, potential common shares outstanding during the period.

Potential common shares consist of incremental shares issuable upon the assumed exercise of stock options issued to the executives of companies that have been previously acquired. The calculation of earnings per share is as follows: Basic earnings per share:

Teleflix, Inc.

Teleflix, Inc. is one of the world's leading Internet television networks, with millions of subscribers across the globe. Teleflix's library of digital content offers subscribers millions of hours of TV shows and movies per month, including original series. Members can watch as much as they want, anytime, anywhere, on nearly any Internet-connected screen. Members can play, pause, and resume watching, all without commercials or commitments. The Montreal-based company is organized into three operating segments:

Domestic Streaming: This segment focuses on revenues generated from Canadian subscribers. Subscribers pay $9.99 per month for unlimited content streaming on any two devices.

International Streaming: This segment focuses on revenues generated from the United States, United Kingdom, and Australian subscribers. Subscribers purchase a monthly plan that ranges from $7.99 to $14.99 to receive unlimited content.

Domestic DVD: This segment derives its revenue predominantly from DVD-by-mail subscriptions. The DVD mail service is offered because it is difficult, if not impossible, to obtain a license for new, blockbuster releases in a streaming format. The price per plan varies from $4.99 to $19.99 per month. The plans vary based on the number of DVDs that can be received per month and the overall quality of the video (DVD, Blu-ray, or Blu-ray 3D). Due to the logistics costs, this plan is available only in Canada.

Teleflix is preparing for its 2020 year-end audit. The company is under some financial pressure to meet or exceed analysts' forecast estimates. (Analysts expect that diluted EPS will be $1.75 per share.) Investors are focusing on reported earnings because streaming content is becoming more accessible and competition is heating up. In addition to earnings, analysts will have a close eye on the company's debt to equity ratio, which is currently above industry standards. Considering all that has taken place in the industry, the company's share price has experienced volatility rates of 35% over the past year and is currently trading at $180 per share.

You have recently been hired as an assistant to the controller. The accounting group has put together a draft statement of financial position and operations based on all routine and recurring transactions (Exhibit I). Your first assignment is to help the controller determine the appropriate reporting for the current year's new and nonroutine transactions.

Accounting Issues

The Domestic DVD segment has seen significant declines in recent years. The number of DVD subscribers has declined by 56% and 24% over the last two years, respectively. The declining trend is likely due to the availability of many blockbusters through pay-per-view offered by cable providers and the availability of DVDs through different mediums.

Since the Domestic DVD segment has provided a strong contribution to the overall profitability of Teleflix, management decided to explore different options for revamping the service offering. Accordingly, on July 1, 2020, the company launched TeleBox, a digitally automated distribution system that allows subscribers to rent DVDs and Blu-rays at various locations across Canada. The TeleBox is similar to a candy-vending machine, but it allows subscribers to receive and return discs. Discs can be returned at any TeleBox location. During the year, the company launched the concept in several large Canadian cities.

Useful Life of Discs Inventory

Due to the increased wear and tear on the discs from the use of the vending machine system, the useful life of the assets is expected to be reduced. As of year end 2020, approximately $150 million worth of DVD inventory has been transferred to the TeleBoxes. Approximately $60 million of the discs are classified as current. Approximately $90 million of the discs transferred are noncurrent assets that had an average remaining useful life of four years at the beginning of the year and amortization of $22.5 million has been recorded in the financial statements. The useful life of the assets has been revised to three years.

Lease Agreement

Teleflix entered into a lease agreement with Grasshopper Ltd. in order to offset the large, upfront capital costs of the disc vending machines. Grasshopper Ltd. worked with Teleflix to design and develop customized vending machines that are fully integrated into Teleflix's IT systems. Without the lease agreement, the machines would have required an upfront price tag of $10.5 million. However, the lease agreement allows Teleflix to make annual payments of $1,857,717.61 over a six-year period. The first payment is to be made on July 1, 2021. The vending machines have a 10- year useful life. At the end of the lease term, Teleflix can purchase the equipment for a cost equal to their fair market value. The interest rate implicit in the lease is 6% (which also reflects marginal borrowing rates).
No journal entries have been recorded in regards to the leased assets because no payment has been made.

Long-Term Debt

At the beginning of the year, the company refinanced its long-term debt and related-party debt (of $123,039,000 each) for a new debt issuance with a face value of $300,000,000, coupon rate of 5% (paid annually), and 10-year maturity. The bond yields a market rate of 4.6771% (2% risk-free rate plus a 2.6771% risk premium) and has been recorded at $307,598,000.
The bond offers holders the right to convert $150 in bond face value into a common share. Currently, Page 166 Go. 

Commitments and Contingencies

In June 2020, ClickFlixes filed a complaint against Teleflix Inc. for patent infringement in the United States District Court. The complaint alleges, among other things, that the company's payment technology used by the TeleBox machines infringes on a patent owned by ClickFlixes. Specifically, Click Flixes purports that the TeleBox infringes on "Integrated Customer-to-Business Video Rental Automation Payment System" (U.S. Patent No. 123456789) and is seeking monetary damages of $10 million, and the cost of legal fees (approximately $500,000).

The court's decision on the lawsuit is pending the outcome of the U.S. Patent and Trademark Office's re-examination of the patent. The company's lawyers are disputing the allegations of wrongdoing and intend to defend the company vigorously in this matter. Therefore, nothing has been recognized or disclosed in the financial statements.

The company is constantly involved in litigation related to patent infringement. Experience suggests that 55% of the cases are successfully defended, while 35% of the cases result in 50% of damages and costs being paid, and 10% of the cases result in 100% of the damages and costs being paid. The current team of lawyers considers this lawsuit to be in the similar nature of past claims.

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