Bombardier Inc., Appellant, v. HER MAJESTY THE QUEEN,, 2011 TCC 48

Docket: 2008-1624(IT)G BETWEEN: Bombardier Inc., Appellant, and HER MAJESTY THE QUEEN, Respondent. [OFFICIAL ENGLISH TRANSLATION] ____________________________________________________________________ Appeals heard on September 13, 14, 15, 16 and 17, 2010, At Montreal, Quebec. Before: The Honourable Justice Pierre Archambault A ppearances : Counsel for the appellant: Wilfrid Lefebvre Dominic C.

Belley Counsel for the respondent: Pierre Cossette Annick Provencher ____________________________________________________________________ JUDGMENT The appeals from the assessments made by the Minister of National Revenue ( Minister ) for the 1990, 1991, 1992, 1993, 1994, 1995, 1996, 1997, 1998, 1999, 2000 and 2001 taxation years under

Part I.3 of the Income Tax Act , R.S.C., c. 1 (5th Supplement) ( Act ) are allowed with costs to the appellant and the assessments are referred back to the Minister for reconsideration and reassessment on the basis that the only advances to be included in the capital of the appellant under paragraph 181.2(3)(

c) of the Act are the following, in accordance with the attached reasons: 1990 taxation year: $ 73,781,000; 1991 taxation year: $ 66,463,000; 1992 taxation year: $ 207,820,000;

1993 taxation year: $ 224,301,347; 1994 taxation year: $ 423,237,117; 1995 taxation year: $ 477,658, 576; 1996 taxation year: $ 250,700,000; 1997 taxation year: $ 249,400,000; 1998 taxation year: $ 332,100,000; 1999 taxation year: $ 1,246,100,000; 2000 taxation year: $ 1,482,400,000; and 2001 taxation year: $ 1,304,100,000. In addition, in making the reassessments for the 1990, 1991, 1992, 1993, 1994, 1995, 1996, 1997 and 2000 taxation years, the Minister will make the adjustments set out in the consent to judgment dated September 13, 2010, a copy of which is attached.

Signed at Ottawa, Canada, this 28th day of January 2011. ​ Pierre Archambault ​ Archambault J. Translation certified true On this 27th day of May 2011 François Brunet, Revisor Citation: 2011 TCC 48 Date: 20110128 Docket: 2008-1624(IT)G BETWEEN: Bombardier Inc. , Appellant, and HER MAJESTY THE QUEEN, Respondent.

[OFFICIAL ENGLISH TRANSLATION] REASONS FOR JUDGEMENT Archambault, J. [ 1 ] The provisions concerning tax on large corporations, commonly referred to as capital tax, were added to the Income Tax Act as

Part I.3 as a result of the budget introduced by the Hon. Michael H. Wilson on April 27, 1989, to help reduce the federal deficit. The tax was abolished in 2006. Except for the parties themselves, for whom the amounts in issue are significant, there might be little interest for anyone in reading these reasons.

However, among studious readers of tax cases, they might generate some interest, since they will show how a judge who has rendered a decision in favour of the respondent in respect of the application of that tax to advances on contracts [1] can now render a decision against the same party, even though the facts are essentially the same. [ 2 ] In this case, Bombardier Inc. ( Bombardier ) has appealed from the assessments made by the Minister of National Revenue ( Minister ) for the 1990 to 2006 taxation years.

First, Bombardier informed the Court that it was restricting the dispute to the years from 1990 to 2001, because the parties had agreed that new notices of objection would be filed regarding 2002 to 2006. [2] [ 3 ] The notices of appeal raise a number of issues, some of which have been resolved by the mutual consent of the parties.

Accordingly, the appeals by Bombardier must be allowed, at least to give effect to the settlement negotiated by the parties. [ 4 ] Essentially, there is only one issue to be resolved, and that pertains to the inclusion of certain amounts received from customers as advances on contracts that had not yet been performed in full in Bombardier​s taxable capital. [ 5 ] Because Bombardier manufactures and sells aircraft and rail transport equipment, the amounts affected by the assessments are significant, as the following table shows: In $000 Years Aerospace Division Transportation Division Amount declared by Bombardier Total of advances added 1990 68,866 26,130 94,996 1991 190,706 10,428 201,134 1992 167,053 163,379 330,432 1993 270,171 172,942 443,113 1994 499,576 256,287 60,000 695,863 1995 545,126 223,439 60,000 708,565 1996 398,471 240,449 187,049 451,904 [3] 1997 313,328 209,399 40,500 482,734 [4] 1998 1,048,220 332,113 79,013 1,313,359 [5] 1999 2,042,772 598,497 204,871 2,440,002 [6] 2000 2,351,151 772,564 3,123,715 [7] 2001 2,117,015 571,840 1,304,029 1,384,826 [ 6 ] The parties stated the issue as follows in the partial agreement as to the facts [8] ( agreement as to the facts ), from which the figures in the preceding table were taken: [Translation] 93.

Did the amounts identified as ​advances​ or ​advances and progress billings​ as set out in the note regarding ​inventory​ in the appellant​s financial statements, comprise advances that appear on the appellant​s balance sheet for each of the years in issue, within the meaning of

subsection 181(3) and paragraph 181.2(3)(

c) of the Act? 94. In the affirmative, do these amounts and the amounts shown in liabilities in the balance sheet under ​advances​ or ​advances and progress billings in excess of related costs​ constitute items that must be excluded from taxable capital under paragraph 181.2(3)(

b) of the Act and that consequently may not be added to taxable capital under paragraph 181.2(3)(

c) of the Act? Contractual context [ 7 ] There is no dispute between the parties as to the facts that are relevant for the purposes of these appeals. Not only did the parties file an agreement as to the facts but, on the basis of the admissions of fact made by Bombardier during the trial, the respondent also considered that it was no longer necessary to call its auditor to testify. The dispute between the parties arises out of the application of the provisions of the Act and the application of accounting principles to determine the value of the advances that appear in the balance sheet.

Bombardier called its Vice-President responsible for financial agreements, whose role is to ensure that the financial statements comply with generally accepted accounting principles ( GAAP ), and its Vice-President in charge of tax affairs, who confirmed the figures relating to the amounts that Bombardier had reported as income for tax purposes, in particular under paragraph 12(1)(

a) of the Act, and in relation to the deductions Bombardier claimed under paragraph 20(1)(

m) of the Act. For 2000, the total amount of advances received by Bombardier, in particular, had been declared under paragraph 12(1)(

a) and deducted as a reserve under paragraph 20(1)(

m) of the Act. [ 8 ] This is the statement of facts taken from the agreement as to the facts: [ Translation ] FACTS 1. The appellant operates, inter alia , (

i) a business for the development, manufacture and sale of aircraft and aircraft parts and components; and (ii) a business for the manufacture and sale of public transportation equipment (train cars, etc.). [9] 2. Its fiscal year and taxation year run from February 1 to January 31 of each year. 3. The contracts that the appellant enters into with its customers for the sale of aircraft and aircraft parts and components and public transportation equipment cover the usual points found in agreements of that nature: (

i) a description of the item to be produced and delivered; (ii) the price and terms of payment; (iii) terms relating to delivery; (iv) the parties​ liability; and (

v) all of the other rights and obligations of the purchaser and the vendor. On this point, the parties agree that the contracts found at tabs 69 and 70 of the Compendium are standard form contracts that are representative of all contracts signed by the appellant during the period under appeal. 4. In accounting terms, the appellant recognizes its long-term contracts in accordance with the generally accepted accounting principles of Canada (​ GAAP ​), to the extent that there is a note to the financial statements that explains the calculation of the inventory. 5.

The appellant​s financial statements for the years in issue were prepared in accordance with GAAP . Aerospace Division (aircraft sale contracts) 6. The income from contracts for aircraft sales is recognized as work progresses, on the basis of the delivery date . 7. Contracts for aircraft sales provide that amounts calculated on the basis of the purchase price must be paid by the purchaser on predetermined dates , according to a timetable that generally starts when the contract is signed and ends with delivery. [10] 8.

Subject to the additional details and information to be provided by the ordinary and expert witnesses called to testify, where applicable, the parties also state that the appellant presents those contracts as follows in its financial statements: 1990-1995 FISCAL YEARS [11] (

a) Before delivery , the amounts received from customers for all contracts are applied against the costs incurred ; (

b) The amount by which the costs incurred exceed the amounts received from customers for all contracts is shown in assets on the balance sheet under the item ​inventory ​. The amounts received from customers are shown in the note in the financial statements concerning inventory on the ​advances received​ line ; (

c) At delivery : (

i) the total proceeds of the sale are recognized as income on the profit statement; and (ii) total costs of manufacturing are shown under the item ​cost of sales and operating expenses​ in the profit statement; 1996-2001 FISCAL YEARS (

d) Before delivery , the amounts received from customers for a particular contract are applied against the costs incurred for the contract;

(

e) For a particular contract, if the costs incurred are greater than the amounts received from the customers, the excess is shown in assets on the balance sheet under the item ​inventory​ . The amounts received from customers are shown in the note in the financial statements concerning inventory on the ​advances​ or ​advances and progress billings​ line; (

f) If the amounts received from the customers for a particular contract are greater than the costs incurred for the contract, the excess is shown in liabilities on the balance sheet under the item ​advances​ or ​advances and progress billings in excess of related costs​; and (

g) At delivery : (

i) the total proceeds of the sale are recognized as income on the profit statement; and (ii) the total manufacturing costs are entered under the item ​costs of sales and operating expenses​ in the profit statement. ... Transportation Division (public transportation equipment) and aircraft parts and components 10. Income from long-term contracts is recognized as work progresses, on the basis of costs incurred . 11.

The sales contracts for public transportation equipment and aircraft parts and components provide that amounts must be paid by the purchaser on predetermined dates or at the occurrence of predetermined events generally referred to as ​milestones​. 12. Subject to the additional details and information to be provided by the ordinary and expert witnesses called to testify, where applicable, the parties also state that the appellant presents those contracts as follows in its financial statements: 1990-1995 FISCAL YEARS (

a) Before delivery , the amounts received from the customers for all contracts are applied against the costs incurred and the associated profit , where the funds are received; (

b) The amount by which the costs incurred and the associated profit exceed the amounts received from the customers for all contracts is shown in assets on the balance sheet under the item ​inventory ​. The amounts received from customers are shown in the note in the financial statements concerning inventory on the ​advances received​ line; (

c) Income is recognized in the profit statement as work progresses on the basis of the costs incurred . The related costs are entered under the item ​cost of sales and manufacturing expenses​ in the profit statement, generally as costs are incurred; 1996-2001 FISCAL YEARS (

d) Before delivery , the amounts received from customers for a particular contract are applied against the costs incurred for and profits associated with the contract, when the money is received; (

e) For a particular contract, if the costs incurred and the associated profits are greater than the amounts received from the customers , the excess is shown in assets on the balance sheet under the item ​inventory ​. The amounts received from customers are shown in the note in the financial statements concerning inventory on the ​ advances ​ or ​advances and progress billings​ line; (

f) For a particular contract, if the amounts received from the customers are greater than the costs incurred and the associated profits , the excess is shown in liabilities on the balance sheet under the item ​advances​ or ​advances and progress billings in excess of related costs​; and (

g) Income is recognized in the profit statement as work progresses on the basis of the costs incurred . The related costs are entered under the item ​costs of sales and operating costs​ and the associated profit is shown in the profit statement, generally as costs are incurred. [Emphasis added.] [ 9 ] The trial lasted three and a half days, two days of which were devoted to the testimony of two eminent accounting experts. The expert who testified at the request of Bombardier is Nadi Chlala, fca, fcma, an academic consultant; the expert who testified for the respondent is Daniel B.

Thornton, Ph d, fca, a professor of accounting at Queen​s University. Both have impressive backgrounds in terms of both education and professional experience. As was, of course, to be expected, the two experts had different opinions regarding the amount of the advances that had to be included in the calculation of Bombardier​s taxable capital. Both submitted written expert opinions. Mr. Chlala​s was 23 pages long, and Mr. Thornton​s was 57. The differences between the opinions stated by the two experts can perhaps be explained in part by the nature of the questions put to them. The questions put to Mr.

Chlala were as follows: [12] [TRANSLATION] Question 1: Please identify and describe: (

a) The conceptual bases of the financial statements; (

b) The components of the financial statements ; (

c) The role of the supplementary notes ;

(

d) The principles relating to the recognition , measurement and disclosure of the information comprising the components of the balance sheet. Question 2: How are the assets and liabilities associated with long-term contracts (shown in accordance with GAAP) recognized , measured and shown in the financial statements of Bombardier Inc.? Question 3: What is the book value of the advances paid to Bombardier Inc. at the end of the year that appear in its balance sheet , shown in accordance with GAAP, for each of the 1990 to 2006 taxation years?

Question 4: For any of the 1990 to 2006 taxation years, does the amount shown in the supplementary notes to the financial statements of Bombardier Inc. represent the book value of the advances paid to it at the end of the year that must appear in liabilities on the balance sheet of Bombardier Inc., shown in accordance with the GAAP? Question 5: How is International Standard IAS 11 from before 1995 different from U.S. standard SOP 81-1 which Bombardier Inc. used for presenting its balance sheets on the closing dates in the 1990 to 2006 fiscal years?

Question 6: Is there a connection between the method of recognizing income associated with long-term contracts and the characterization of the amounts received from customers as advances ? [Emphasis added.] [ 10 ] The questions put to Mr. Thornton, which he answered in his report (Exhibit I-1), were as follows: Opinion Sought by Justice 05. Justice has asked me for an opinion as to the nature of the Amounts [13] for accounting purposes , In particular, Justice has asked me to respond to the following four Questions: 1.

According to GAAP, what is the nature and substance of the payments made by Bombardier​s customers pursuant to the contracts ? 2. Were the Appellant​s balance sheets (and financial statements) in accordance with GAAP with respect to those payments ? 3. Are the advances , as detailed in the notes to the financial statements, "reflected" in the balance sheets of Bombardier? 4.

Are the notes to the financial statements an integral part of the balance sheets ? [Emphasis added.] [ 11 ] I will come back to this, but to summarize, the position stated by each of the expert witnesses on the central issue, the amount or the value of the advances shown in Bombardier​s balance sheet, is different. According to Mr. Chlala, the value of the advances is the value shown in liabilities in the body of the balance sheet; according to Mr.

Thornton, it is the value found in the ​advances​ account, the amount of which is shown in the supplementary notes. [ 12 ] It is important to note that for the purposes of this proceeding, the parties have agreed that Bombardier​s financial statements were prepared in accordance with GAAP. Not only is that a fact agreed to in the agreed statement of facts (Exhibit A-6, para. 5), but in their testimony and their respective reports, the two experts agreed to that. Mr. Thornton wrote the following in his report, at page 55, for

example, when he answered the question ​Was the accounting for advances in accordance with GAAP?​: ​Yes, at least until 2003 when the definition of GAAP changed in Canada. Even after 2003, I have no reason to assert that the financial statements did not comply with GAAP​. [14] [ 13 ] When Parliament enacted

Part I.3 of the Act, concerning the capital tax on large corporations, it chose to use financial statements, in particular corporations​ balance sheets, to determine the values and items that must be included in calculating a corporation​s capital. [15] For that reason, it is important to have a clear understanding both of the accounting approach adopted and of GAAP, to decide the issue raised by this litigation: the amount of the advances that must be included in calculating the capital. Mr.

Chlala​s report is very instructive on these issues, and I will quote extensively from it: [Translation] Answer to question 1 : [16] Financial statements comprise the main method of communicating financial information. They contain financial information relating to transactions and facts both past and present. The main purpose of financial statements is to enable users to assess, compare and predict the profitability, solvency and liquidity of a business.

Generally accepted accounting principles (GAAP) are ​general principles and conventions of general application, as well as rules and procedures that determine what accepted accounting practices are at a particular point in time​. GAAP are constantly evolving . [Emphasis by Mr. Chlala.] Canadian GAAP are prescribed by Accounting Standards Board (AcSB), which publishes its recommendations in the Handbook of the Canadian Institute of Chartered Accountants (CICA Handbook). The AcSB makes its recommendations using a frame of reference (conceptual accounting framework).

The AcSB​s recommendations deal with rules and procedures (standards) for recognizing, measuring (assessing) and presenting information (disclosure or information to be provided). To prepare its financial statements in accordance with GAAP, the business must refer to the CICA Handbook.

Because the Handbook does not provide answers to all accounting questions, the accounting standards provide for the possibility of consulting other references sources, including those published by the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA), and by the International Accounting Standards Board (IASB).

The financial statements contain the following four tables (which comprise the ​ body of the financial statements ​): 2 ____________ ▪ A balance sheet , which is a representation, as of a particular date, of the financial situation of a business in the form of assets (economic resources), liabilities (obligations) and equity (including share capital, surplus capital contributions and undistributed profits). ... Financial statements are supported by explanatory and supplementary information shown in the supplementary notes , to make the financial statements more intelligible. (

a) Conceptual bases of financial statements The conceptual bases of financial statements consist of a framework on which accounting standards are based. The framework relates to (1) accounting principles, (2) the objective of financial statements, (3) nature of the information in financial statements, and (4) the components of financial statements. 1. The basic principles for the recognition, measurement and presentation of information in financial statements include:

a. Going concern , which assumes that the business ordinarily carries on business, that is, that it has no intention or obligation to cease carrying on business or substantially reduce the scope of its business. This convention holds that the business is considered to be able to carry out the transactions in question and honour its commitments [17] in the foreseeable future. Otherwise, the financial statements must be prepared on a different basis.

For instance, unless there is evidence to the contrary, a corporation recognizes a long-term contract currently being performed for the manufacture and delivery of a good to a customer in its books on the hypothesis that it will meet its commitments and is not in default at the end of the contract. ... c. Complete information , which requires that the financial statements provide all necessary information about events or accounting practices that have a significant impact on changes in the future profits and situation of the business. d.

Precedence of substance over form is stated because the substance of the transactions and other events is not always consistent with what the apparent legal structure indicates.

In order for the information to provide a reliable representation of the transactions and other events it is meant to represent, it is necessary that they be recognized and measured in a manner consistent with their substance and with the real economic or commercial situation and not only with their legal form . [18] This means, for example, that the business measures the book value of its assets and liabilities on the balance sheet on the basis of the commercial substance of the underlying transaction or event.

For accounting purposes, there is no other commercial substance to be ​discovered​ in supplementary information. 2. The objective of financial statements is to facilitate economic decision-making by investors and creditors. To achieve that objective, it is necessary that the financial statement tables be complete. For example, the balance sheet must present all of a corporation​s economic resources, obligations and equity. 3. In addition, in order for the information presented in financial statements to be useful, it must have certain qualitative characteristics.

For example, the information presented in the balance sheet must be (1) understandable, (2) relevant (influence decisions by users), (3) reliable and (4) comparable. The CICA Handbook specifies that ​reliable​ statements are: a. Faithful : this means that the recognition, measurement and presentation (disclosure) of facts and events in financial statements is consistent with their commercial substance , which may call for ​examining a set of related transactions and facts taken as a whole.​ b. Verifiable: ... c. Neutral: ​ d.

Prepared in accordance with concepts of prudence : this means that ​in situations of uncertainty, prudent estimates are done in order to avoid any over-valuation of assets, proceeds and profits, or, conversely, any under-valuation of assets , [19] charges and losses.​ e. In accordance with the commercial or economic substance and reality of the transactions and other events and not merely with their legal form (see also the accounting principle supra ). 4. The components (elements, headings or items) to be included in financial statement tables are defined in the next section.

An amount that does not meet the definition of a component may not beshown as such in the tables (body of financial statements) and vice versa. For example, an account in credit may not be included in the balance sheet as a liability if it does not meet the definition of a liability. As well, an account in credit that meets the definition of a liability may not be omitted from the balance sheet . [20] In both cases, the total liabilities in the balance sheet would be incorrect and would not represent the total amount of the obligations of the business on a specified date.

Mere presentation of a liability in a note that is omitted from the balance sheet would not comply with GAAP and would create confusion. (

b) Components of financial statements Components (or headings) are the main categories of elements (or items) that are included in the four financial statement tables. The only components of the balance sheet are: assets, liabilities and equity . [Emphasis by Mr. Chlala.] 1. The CICA Handbook defines the three components of the balance sheet as follows: a. Assets are ​economic resources controlled by an entity as a result of past transactions or events and from which future economic benefits may be obtained​. b.

Liabilities are ​ obligations of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets , provision of services or other yielding of economic benefits in the future.​ c. Equity is ​the ownership interest in the assets of a profit-oriented enterprise after deducting its liabilities. While equity of a profit- oriented enterprise in total is a residual, it includes specific categories of items, for example, types of share capital, contributed surplus and retained earnings.​ ...

3. Transactions or events that do not meet the definition of a component are excluded from the balance sheet or profit statement. [21] However, they must be described in the supplementary notes to the financial statements where that information allows for better understanding of the financial statements. The amounts shown in the supplementary notes do not constitute assets and liabilities that have been omitted from the balance sheet prepared in accordance with GAAP. 4. To present a component in the financial statement tables, the business must: a.

Identify the transactions or events that meet the definition of a component. b. Establish the nature and economic substance of the transaction or events to be recognized and comply with the standards prescribed by the AcSB for those transactions in terms of recognition, measurement and disclosure of information. For example, the applicable accounting standards for recognizing a loan from a financial institution and for recognizing an advance from a customer on a long-term contract are not the same, given that the substance of the two transactions is different : i.

A loan from a financial institution is a financial liability that must be settled (repaid) by payments in cash (that is, the debtor has a financial obligation ). ii. An advance from a customer on a long-term contract is a non-financial liability that is settled (repaid) by performance of the services provided for in the contract, not by payment of a cash amount (that is, the debtor has an obligation of ​performance​ or of ​results​ and not an obligation to repay in cash). Accordingly, the financial statement tables must include all of the components as defined in the CICA Handbook.

For example, the balance sheet must include all assets, all liabilities and all equity as defined in the CICA Handbook. The balance sheet must include, on its face, all of the financial resources of the business . [Emphasis by Mr. Chlala.] (

c) Role of the supplementary notes The presentation (disclosure) of additional information by supplementary notes allows for better understanding of the content of the tables . For example, a note relating to an amount shown as a component in the balance sheet could enable the reader of the financial statements to understand the context of the transactions of the business, assess the risk of operating the business and be informed about the scope of the accounting estimates and the uncertainties associated with the measurement of that component.

That is why it is considered that the supplementary notes are an integral part of the financial statements . Notes to financial statements (supplementary notes) include: ▪ narrative descriptions or explanations concerning the amounts shown in the tables, ▪ schedules that provide details about the calculation of the book value of the components shown in the tables, and ▪ supplementary information including amounts that do not represent components and that are accordingly excluded from the tables, such as commitments and contingencies. 1.

The recommendations in the CICA Handbook (and other sources of GAAP, where applicable) require disclosure of supplementary information in notes. For example, the CICA Handbook requires the presentation of certain schedules in supplementary notes that show the detailed calculation of a component shown in the tables. A business that did not provide this additional information will be in violation of GAAP. [22] 2. Supplementary schedules may deal with measurement of a specific component (i.e. an asset, a liability or equity) by showing the details of: a. The similar elements grouped together . i. For example, a

schedule may identify separately the amounts used in calculating the component ​other liabilities​ shown in the balance sheet. In that situation, each of the amounts to be paid or incurred represents a liability in itself. In that case, the purpose of the

schedule is not to present liabilities not recognized in the balance sheet, since the balances of the various amounts to be paid are combined to determine a single amount under the heading ​other liabilities​ in the balance sheet, which is added to the other liability items to determine the total liabilities in the balance sheet. b. Debits and credits that comprise separate accounts in the books that were taken into account in calculating the book value of an asset,

a liability or an equity element. Those debits and credits are not themselves assets, liabilities or equity elements; they are simply taken into account in determining the measurement of the book value of an asset, a liability or an equity element. In this case, the measurement of the book value of elements shown in the balance sheet may be set out in a schedule, showing the details of the balances in debit and credit accounts.

For example, the balance of a capital account on the acquisition cost, and accumulated depreciation, must be disclosed, but only the net amount represents an asset shown in the balance sheet . 3. As set out in paragraph 1000.25 of the CICA Handbook, supplementary notes, ​which are useful for the purpose of clarification or further explanation of the items in financial statements, while an integral part of financial statements, are not considered to be an element ​. Paragraph 1000.41 states, concerning recognition, that ​ recognition is the process of including an item in the financial statements ​.

Paragraph 1000.42 adds that ​ recognition means inclusion of an item within one or more individual statements and does not mean disclosure in the notes to the financial statements ​. The CICA Handbook therefore stipulates unequivocally that the supplementary notes may not contain an asset, liability or equity element that is not recognized in the balance sheet . [Emphasis by Mr. Chlala.] To summarize: ▪ A business may not exclude components from the tables and simply disclose them in notes . For example, a business must present all elements in the balance sheet that meet the definition of asset or liability.

In other words, the balance sheet must be complete. The total assets and total liabilities appearing in the balance sheet may not be under-valued because that would give an incomplete picture and would skew the ratios used by investors and creditors to assess the financial health of a business. ▪ The schedules that explain the measurement of components in accordance with GAAP in no way replace the components.

For example, if a liability shown in the balance sheet refers specifically to a note that shows the detailed calculation of the liability, the information in that note does not provide another measurement of the book value of the liability. If there is a liability, it must be shown in the balance sheet and not merely disclosed in notes. The measurement of the book value of that liability element must be what is included in the total of the ​liability​ component in the balance sheet (total liabilities in the balance sheet) .

The balance sheet must provide information about the total economic resources and obligations of the business and may not be ​corrected​ by a note. [Emphasis by Mr. Chlala.] ▪ Paragraph 1000.42 of the CICA Handbook specifies that supplementary notes ​ either provide further details about items recognized in the financial statements, or provide information about items that do not meet the criteria for recognition and thus are not recognized in the financial statements ​. [Emphasis by Mr.

Chlala.] ▪ Notes may not be used to camouflage components omitted from the balance sheet or re-value a component in the balance sheet. Schedules and supplementary reconciliations shown in notes do not replace the components shown in the balance sheet and do not give another measurement of those components. In other words, as paragraph 1400.11 of the CICA Handbook provides, the notes ​ clarify or further explain the items in the financial statements.

They are not, however, to be used as a substitute for proper accounting treatment ​ and must not have the effect of rectifying accounting treatment that is not in accordance with GAAP. [Emphasis by Mr. Chlala.] (

d) Principles relating to recognition, measurement and disclosure of information about components of the balance sheet Presentation of the three components of the balance sheet (assets, liabilities and equity) is the result of application of GAAP relating to the recognition and measurement of transactions and events. 1. A business follows the following procedures when it prepares its balance sheet, in the order shown: ​ 2. Correct measurement of the components in the balance sheet is not sufficient for the assessment of the performance of a business.

The financial statements must also contain supplementary information, in particular schedules that present the detailed calculation of significant components. This is a requirement of the accounting rules, the purpose of which is to meet the criterion of complete information[.] However, presentation of these supplementary schedules should not serve as a pretext for underestimating an asset or a liability in the balance sheet. For example, the purpose of separate presentation of the debit account ​capital assets at cost​ and the corresponding credit account

​accumulated depreciation​ is not to correct the measurement of the ​capital assets​ component . 17 Whether that disclosure is made in a specific note or by presentation of the account and its counterpart side by side in the balance sheet, it does not alter either the amount of the capital assets or the total amount of assets (the economic resources) recognized in the balance sheet.

In other words, regardless of where the disclosure is made, the business must show an asset in its balance sheet measured as the net amount of the cost of capital assets less accumulated depreciation. ____________ 17 In English, the counterpart account is referred to as the ​contra account​[.] To summarize, ▪ Paragraph 1000.41 of the CICA Handbook provides that recognition ​is the process of including an item in the financial statements of an entity.

Recognition consists of the addition of the amount involved into statement totals together with a narrative description of the item (e.g., ​inventory​ ​).​ [Emphasis by Mr. Chlala.] ▪ Paragraph 1000.42 further provides that recognition ​means inclusion of an item within one or more individual statements and does not mean disclosure in the notes to the financial statements .

Notes either provide further details about items recognized in the financial statements, or provide information about items that do not meet the criteria for recognition and thus are not recognized in the financial statements.​ [Emphasis by Mr. Chlala.] ▪ Paragraph 1000.53 of the CICA Handbook stipulates that measurement is ​the process of determining the amount at which an item is recognized in the financial statements​. [Emphasis by Mr. Chlala.] Accordingly, the balance sheet must be complete and include all components as defined by the CICA Handbook.

The business may not recognize an asset or liability by supplementary notes . Presentation in supplementary notes provides details about the recognition and measurement of the book value of the components, for example an asset such as inventories. [Emphasis by Mr. Chlala.] Question 2: How are the assets and liabilities associated with long-term contracts (shown in accordance with GAAP) recognized, measured and shown in the financial statements of Bombardier Inc .?

Answer to question 2: Bombardier Inc. (Bombardier) measures the assets or liabilities associated with long-term contracts underway in accordance with Canadian GAAP, referring to the specific accounting standards in the American frame of reference, because the CICA Handbook does not contain any specific recommendation in this regard. 1.

To comply with Canadian GAAP, Bombardier has to measure the components of the balance sheet associated with long-term contracts underway on the basis of the American standard SOP81-1 and in accordance with the American recommendations in the Audit and Accounting Guide: Construction Contractors of the AICPA, as follows: a. assets, which represent amounts ultimately payable by customers for work done, are measured in the amount of the ​amounts by which costs exceed billings​, 19 and ____________ 19 Billings is a general term that includes amounts received from the customer and amounts to be received from the customer on a long-term contract.

The word ​advance​ is sometimes used to mean amounts received before work begins (see answer to question 3).

b. liabilities , which represent unearned amounts that will require that costs be incurred in future, are measured in the amount of the ​amounts by which billings exceed costs ​. [Emphasis by Mr. Chlala.] 2. SOP81-1 was developed to take into account the specific operating context of long-term contracts such as contracts performed by enterprises operating in the aeronautics industry.

The special accounting rules thus developed take into account the unique nature of the long-term contracts which may be spread over several fiscal years and which may call for the significant expenses to be incurred in order to perform the work provided for in the contracts. 3. Bombardier measures the book value of the assets and liabilities associated with each long-term contract underway in accordance with the rules in SOP 81-1 and discloses supplementary information in notes showing the detailed calculation of those values, taking into account the conceptual accounting framework in the CICA Handbook.

For example: a. Bombardier presents its balance sheet in accordance with the going concern hypothesis, which assumes that it has neither the intention nor obligation to terminate its long-term contracts and that it will be able to honour its commitments to its customers. Accordingly, it is entirely warranted for Bombardier, in a situation where it is not in default under the contract, to measure the liabilities associated with the long-term contracts underway using only the amounts that have not been used to provide services in connection with the underlying contracts.

Recognition in liabilities of advances on the net amount in accordance with GAAP is based on the fact that the advances, which are liabilities at the time they are received, are settled by the performance of the services provided for in the contract . If Bombardier could not have used the going concern assumption, it would not be able to honour its commitments to its customers, that is, the amounts received would become repayable.

In that situation, it would have shown: i. a financial liability corresponding to the total of the amounts received from customers that would reflect the fact that those amounts would then have to be repaid in cash; and ii. an inventory asset of products underway that would reflect the fact that those products are available for sale in the market (and not to the customer in question), which would be measured as the amount of the total costs incurred. b. Bombardier presents its balance sheet in accordance with the principle that substance prevails over legal form.

Accordingly, while from a strictly legal point of view the advance received could be considered to have been legally settled only at the time of delivery , the accounting treatment under GAAP, which considers the advance to be settled by performance of the services provided for in the contract, as costs are incurred, reflects the commercial substance of the transaction , established in the context of a going concern. 4. The measurement of the assets and liabilities associated with the long-term contracts underway used by Bombardier is also in accordance with accounting doctrine.

Accounting texts used in university instruction take the position that the components of the balance sheet for long-term contracts underway represent either: a. an asset that is measured in the net total costs incurred for work in progress (which represents an account and not a component of the balance sheet), less total billings (which represent a contra account and not a component of the balance sheet), or b. a liability that is measured in the net amount of total billings (which represents an account and not a component of the balance sheet), less total costs incurred for work in progress (which represents a contra account and not a component of the balance sheet). 5.

Bombardier measures the assets and liabilities associated with long-term contracts underway in accordance with the accounting practices used by enterprises operating in the aerospace industry. Those practices are mainly described in the financial statements of American corporations, since a large majority of corporations in the aerospace industry are American.

Those accounting practices: a. are consistent with the conceptual accounting framework in the CICA Handbook since they give precedence to commercial substance over legal form , b. draw heavily on the American frame of reference relating to recognition, measurement and presentation of assets and liabilities associated with long-term contracts, c. are based on standards that are firmly established and were formulated in the 1950s, d. are described in great detail in two American documents published by the AICPA: the Audit and Accounting Guide: Construction Contractors (which is updated annually), which includes the Statement of position 81-1, Accounting for Performance of Construction- Type and Certain Production-Type Contracts (SOP 81-1) , and e. were not challenged in the analysis by the Financial Accounting Standard [ sic ] Board (FASB) of the recognition of sale contracts (see, for example, the excerpt from Accounting Research Manager shown as an appendix).

Simplified example ​ Recognition of long-term contracts by Bombardier Assume that on January 31, 200X, Bombardier has the following two contracts for the manufacture and delivery of an aircraft: one contract with a credit balance (Contract

X) and one contract with a debit balance (Contract Y): (in $) Costs incurred Money rec​d Net debit amount (credit) Amount in assets in balance sheet Amount in liabilities in balance sheet Contract X 80 100 (20) 0

(20) Contract Y 80 50 30 30 0 Total 160 150 30

(20) The Audit and Accounting Guide: Construction Contractors , which includes standard SOP81-1 (American standard), in addition to requiring the net calculation of the book value of the assets and liabilities shown above, recommends disclosure of the figures that were used in the calculation of the asset ​inventory​ shown in the balance sheet. The supplementary note gives the extent of the costs incurred, $160, and the extent of the amounts received from customers, $130 ($20 being recognized in liabilities).

See the supplementary NOTE that presents the measurement of the book value of the ​inventory​ component in the balance sheet: INVENTORY Costs incurred ($80 + $80: $160 Less: Amounts of advances received ($150 - $20 shown in liabilities): $130 Inventory (shown in assets): $ 30 Thus, in accordance with the American standard used by Bombardier, the assets and liabilities associated with long-term contracts underway must be measured according to precise rules that specify how to calculate their respective book values. As a result:

▪ Only the $20 out of the total of $150 received represents the book value of the advance which must appear in liabilities in its balance sheet at 31/01/200X. ▪ Only the $30 out of the $160 in costs incurred represents the asset (​Inventory​ item) which must appear in its balance sheet at 31/01/200X ▪ The $130 received, shown in the supplementary note concerning inventory, is not a component of the balance sheet and is not part of the liabilities or part of the assets. ▪ Net measurement is mandatory and was confirmed in the analysis of the sale contracts by the American standard-setter, which has provided a specific exception for long-term construction contracts. ▪ Net measurement reflects the fact that Bombardier has two contracts underway that involve rights and obligations in relation to the manufacture and delivery of aircraft.

These are not executory contracts (or an exchange of promises).

Thus, in accordance with GAAP: o For Contract Y, the advance (which is initially measured as the amount of money received from the customer) is completely settled (it is nil) since Bombardier has used those funds to perform the work provided for in the clauses of the contract, incurring costs for the manufacture and delivery of an aircraft that exceed the amount of the initial advance received from the customer. o For Contract X, the advance is settled in part only (there is a balance of $20 in non-financial liabilities in the balance sheet) because Bombardier has used only a portion of those funds for the costs of manufacturing the aircraft. [Emphasis by Mr.

Chlala.] Note that if at January 31, 200X, Bombardier had been in default on those two contracts, it would have shown two components in the balance sheet : (1) an asset representing inventory of products underway (non-financial asset) measured at minimum value (the lower of the cost of $160 and the production value) and (2) a liability representing the amount that would be claimed by its two customers that would include the money already paid, $150 (financial liabilities) plus, where applicable, a penalty.

That presentation would result in a very different measurement of Bombardier​s economic resources (assets) and obligations (liabilities) in its balance sheet at January 31, 200X, and would reflect the commercial substance of the situation, which is the obligation to repay in cash the money received from the customers (an obligation that does not exist in the situation where there is no default creating a legal right to that claim). Accordingly: ▪ The initial advance, recognized as a liability, loses its character and nature as an advance and a liability as costs are incurred.

Thus, for Contract Y, there is no advance left, since the measurement in accordance with GAAP of the obligation in relation to the advances is nil at the date of the balance sheet. ▪ Bombardier recognizes its long-term contracts in accordance with GAAP by correctly reflecting its operations that call for not only delivery of an aircraft but also manufacture of the aircraft for an identified customer.

To illustrate the application of the example given above, the following are the components of Bombardier​s balance sheet (assets, liabilities and equity) taken from the audited financial statements at January 31, 2000, prepared in accordance with GAAP (all figures in $millions): ASSETS Cash and cash equivalents $ 334.6 Customer accounts: Related corporations 365.9 Other 47.0 Inventories (note) 3,492.7 Capital assets 789.9 Investments 2,686.8 Other assets ___ 157.9 $ 7,874.8

LIABILITIES Accounts payable and accrued liabilities: Related corporations $ 289.2 Other 1,896.2 Advances and progress billings in excess of related costs 1,482.4 Long-term debt 960.4 Deferred income taxes __ 502.7 5,130.9 Shareholders​ equity _ 2,743.9 $ 7,874.8 The following is an excerpt from the supplementary note concerning inventories: Raw materials and products underway $ 115.9 Long-term contracts and aerospace programs 5,446.5 Finished products 461.0 6,023.4 Advances and progress billings (2,530.7) $ 3,492.7 Observations concerning the balance sheet and the supplementary note: Neither the amounts received shown in the note concerning inventories ($2,530.7) nor the costs incurred in the gross amount ($6,023.4) are part of total liabilities and assets, respectively.

Thus, at January 31, 2000: ▪ The liabilities amount representing advances is $1,482.4 . ▪ The cumulative amount received by Bombardier is $4,013.1 ($1,482.4 representing liabilities and $2,530.7 representing an amount deducted in calculating the book value of inventories). ▪ Details of the measurement of the Inventories component are shown in notes. Accordingly, the item Inventories, $3,492.7, is calculated on the basis of costs incurred on ​long-term contracts and aerospace programs​ amounting to $5,446.5, less the amount of the consideration received, $2,530.7.

This is not a grouping of components (i.e. assets or liabilities) in the balance sheet. The $ 2,530.7 shown in the note concerning inventories is not a liability and is not part of the total liabilities in the balance sheet . [Emphasis by Mr. Chlala.]

To summarize, Bombardier recognizes its rights and obligations under its long-term contracts by recognizing and measuring the liabilities or assets in accordance with GAAP applicable to long-term contracts. Under those GAAP, the amount of advances corresponds to the liabilities shown in the balance sheet and only to that amount.

The aim of the disclosure of the amounts received in the note concerning inventories is solely to present the background of the related transactions, and they cannot in any case represent a liability or alter the characterization of the money received from customers as advances . [Emphasis by Mr. Chlala.] Question 3: What is the book value of the advances paid to Bombardier Inc. at the end of the year that appear in its balance sheet, shown in accordance with GAAP, for each of the 1990 to 2006 taxation years ?

Answer to question 3 There is no definition of the word ​advance​ in the CICA Handbook in the context of recognition of long-term contracts in accordance with GAAP. Accordingly, we must consult other reference sources to determine the meaning of this word in that context. 1. There are

definitions of the word ​advance​ in the context of the presentation of long-term contracts on the balance sheet prepared in accordance with GAAP. Those

definitions include the following: a. Paragraph 41 of International Standard IAS 11 Construction Contracts which defines the word ​advances​ as ​ the amounts received by the contractor before the work has been executed​ (emphasis added). That definition provides as follows: i. advances and work executed form a unit and are a single component to be included in the balance sheet, ii. if any work has not been executed, the cost is nil and the amount of the advance is the gross amount received from the customer, and iii. if the corresponding ​work​ has been executed, there is no longer an advance. b.

Appendix 5 of the Construction Industry Audit Technique Guide (ATG) published by the Internal Revenue Service (US) , which defines two specific words in the context of long-term contracts as follows: i. ​Advance Payments: Payments generally made to a prime contractor prior to the performance of any work under a contract. These payments help the contractor cover developmental and preliminary costs incurred prior to commencement of work .​ [23] ii. ​Advance on Contracts: A current liability on the books of contractors where billings or contracts exceed accumulated cost​. Note that the foregoing two

definitions reflect the economic substance of long-term construction contracts, in accordance with which the work performed and payments from customers form a single ​accounting unit​, and accordingly the advance is determined and measured on tha basis of the work performed. 2. As well, under the theoretical framework and accounting standards in effect (GAAP), Bombardier must measure the book value of the advances that should appear in the balance sheet for a long-term contract underway as the amounts received from the customer net of the corresponding costs of the work.

3. Accordingly, if the costs exceed the amounts received on a long-term contract, Bombardier has no liability . However, if the amounts received exceed the cost of the corresponding work, only the excess represents the advance that must appear in liabilities, since for accounting purposes, performance of the work constitutes settlement of the advances . Thus in accordance with GAAP, the initial advance ceases to be an advance once the long-term contract is underway . 4.

Ménard​s Dictionnaire de la comptabilité [Dictionary of Accounting Terms], published by the CICA , provides the following general definition of the word ​advance​ in the context of a general contract of sale (in general): [ Translation ] ​A payment made on account of, but before completion of, a contract, or before receipt of goods or services​. a. The definition in Ménard​s Dictionary addresses the application of GAAP not in the specific context of long-term contract accounting, but in the more general context of the sale of goods .

However, GAAP, which apply to the measurement of the liability relating to advances received under long-term contracts, are not consistent with that definition. Thus in accordance with GAAP as they relate to long-term contracts , and as explained earlier, an advance is settled as work is performed and costs are incurred . Accordingly, only the amount by which the amounts received exceed the costs incurred correspond to [ Translation ] ​a payment made before completion of a contract or before receipt of services​.

In strictly legal terms , the contract could not be considered to have been completely performed before delivery of the goods , and this would provide a measurement of the obligation (i.e. the amount in liabilities in the balance sheet) relating to the advances received that is totally different from the measurement provided by GAAP. 5.

Bombardier would have presented a misleading balance sheet that would not comply with GAAP if it had measured the liability as net of the cumulative amount of the cash received from customers or the asset as gross of the cumulative costs incurred (two figures shown in the supplementary note concerning inventories). 6. Bombardier presents the long-term contracts in the balance sheet in accordance with accounting methods that are comparable to the other enterprises operating in the same industry in North America (see also point 4 in the answer to question 2 at page 12 of this report). 7.

According to Bombardier​s audited financial statements for the 1990 to 2006 fiscal years, prepared in accordance with GAAP, the amounts of the advances are shown in liabilities in the balance sheet, prepared in accordance with GAAP, at the closing date of the fiscal year in question.

Accordingly, a. for 1990 to 1996, no advance appears in Bombardier​s balance sheet since the costs incurred on the products underway exceed the amount of the advances; and b. for 1997 to 2006, the book value of the advances for each of the years is reflected by the figure for non-financial liabilities entitled ​Advances and progress billings in excess of related costs​ (APBEC).

Bombardier indicates in the note concerning the main accounting conventions relating to valuation of inventories and recognition of revenues (products) that ​advances and progress billings in excess of related costs are shown as liabilities​. 24 According to Bombardier​s financial statements, a single component of non-financial liabilities is shown in the balance sheet relating to advances and progress billings received on these long-term contracts, i.e. the APBEC.

The APBEC component of the balance sheet is: ____________ 24 Bombardier Inc. uses two word to refer to billings on its long-term contracts: proportional billings and progress billing [ sic ]. Fiscal years ended: Book value of APBEC component in the balance sheet: January 31, from 1990 to 199[5] Nil January 31, 1997 $ 249,400,000 January 31, 1998 $ 332,100,000 January 31, 1999 $1,246,100,000 January 31, 2000 $1,482,400,000

January 31, 2001 $1,304,100,000 January 31, 2002 $1,067,800,000 January 31, 2003 $1,025,900,000 January 31, 2004 $ 883,000,000 January 31, 2005 $1,084,000,000 January 31, 2006 $ 832,000,000 Question 4: For any of the 1990 to 2006 taxation years, does the amount shown in the supplementary notes to the financial statements of Bombardier Inc. represent the book value of the advances paid to it at the end of the year that must appear in liabilities on the balance sheet of Bombardier Inc., shown in accordance with the GAAP ?

Answer to question 4: As noted earlier, to determine the amount of liabilities or the amount of assets arising out of Bombardier​s long-term contracts, we must refer to the balance sheet alone and not the supplementary note , which provides additional information concerning the measurement of the book value of the inventories that appear in assets. 1. Bombardier​s supplementary note a. relates to the details of the calculation of the book value of the assetsshown in the balance sheet, b. cannot , in accordance with GAAP, be intended to present a liability that was not recognized in the balance sheet. 2.

However, the supplementary note is useful since it enables users of the financial statements to assess the management​s hypotheses and estimates that are used in the calculation of the amount of the asset (inventories). 3. The practice in effect, of measuring assets and liabilities on a long-term contract net of cumulative advances and cumulative costs incurred, is consistent with GAAP. Accordingly, the supplementary notes do not provide information about liabilities that was omitted from the balance sheet.

The book value of the advances is shown in the balance sheet in the APBEC component and is added to the other liabilities to arrive at the total liabilities in the balance sheet . Cumulative advances and progress billings do not represent the book value of the advances it has been given at the end of the year and cannot appear as liabilities in Bombardier​s balance sheet. Cumulative advances and progress billings and cumulative costs incurred on long-term contracts and aerospace programs shown in the supplementary note concerning inventories [Emphasis by Mr.

Chlala.]: ▪ provide a ​historical​ indication of amounts received from customers and costs incurred by Bombardier, which are not a liability or asset, respectively, in themselves, [Emphasis by Mr. Chlala.] ▪ comprise a single ​accounting unit​, that is, the two cumulative totals cannot be separated and the net amount is the only liability and the only measurement of the book value of the liability relating to advances and progress billings received on long-term contracts and required to appear in the balance sheet.

Question 5: How is International Standard IAS 11 from before 1995 different from U.S. standard SOP 81-1 which Bombardier Inc. used for presenting its balance sheets on the closing dates in the 1990 to 2006 fiscal years ?

Answer to question 5: Bombardier Inc. (Bombardier) uses standard SOP 81-1 found in the AICPA​s Audit and Accounting Guide: Construction Contractors . That standard differs from the old version of IAS 11 Construction Contracts , but it is similar to the version of IAS 11 currently in effect in relation to recognition and measurement of liabilities and assets in the balance sheet for long-term contracts. The following is a brief overview of the history of standard IAS 11: 1.

IAS 11 Construction Contracts of the International Accounting Standards Committee (IASC), now the International Accounting Standards Board (IASB), was published in December 1993 and came into effect for fiscal years beginning on January 1, 1995. That standard replaced IAS 11 Accounting for Construction Contracts published in March 1979, which was in effect until 1994. 2.

Former standard IAS 11 (in effect before 1995) offered corporations a choice of (1) measuring liabilities gross of progress billings, and (2) measuring liabilities net of cumulative progress billings and cumulative costs incurred on work in progress. 3. The IASC decided to eliminate the option of presenting progress billings as a liability without taking costs incurred on a contract into account.

From my point of view, that decision was sound, since the option of measuring the liability (or performance obligation) as the amount of progress billings without taking costs incurred into account was inconsistent with the conceptual accounting framework and contradicted generally accepted accounting practices. ...

Accordingly, since 1995, GAAP in effect in the United States and on the international scene contain the same recommendations concerning measurement of assets and liabilities arising out of a long-term contract: both require that cumulative progress billings and cumulative costs incurred on work in progress be considered as an inseparable unit. There is therefore a consensus that requires corporations to measure assets or liabilities arising out of long-term contracts as net of the two cumulative totals, which are not in themselves assets and liabilities. ...

Question 6: Is there a connection between the method of recognizing income associated with long-term contracts and the characterization of the amounts received from customers as advances ? Answer to question 6: 1. Proceeds (revenues) constitute a component of the income statement, while an advance received on a long-term contract is an amount that is included in calculating a component of the balance sheet (an asset or liability, as discussed earlier)[.] 2. The income statement and the balance sheet have different objectives: a.

The balance sheet is a representation of a corporation​s financial situation at a particular date in the form of economic resources (assets), obligations (liabilities) and elements of equity (equity). The balance sheet provides information about the corporation​s resources and debt.

b. The income statement presents the income from transactions for a particular period . The income statement provides information about the corporation​s financial performance and profitability. 3. Given that the objectives of the balance sheet and the income statement are different , the accounting rules for recognizing and measuring the components presented in those two tables may also differ. For example, the accounting rules generally require that a liability be recognized in the balance sheet when the business contracts an obligation while income is generally recognized when a transaction is completed. 4.

SOP 81-1, which relates to recognition of long-term contracts, provides for two acceptable methods for recognizing income: a. the ​percentage of completion method​ under which income is recognized as work is performed, and b. the ​completed contract method​ under which income is recognized only when all work provided for in the contract is completed. 5.

ARB 45, on which SOP 81-1 is based, provides that whatever method is used for recognizing income , [24] the amount of the advances that comprise the liability must be measured using a single method, the net amount of advances received in excess of work performed on the contract. 6.

Accordingly, in the case where income is recognized when work is completed (​completed contract method​), the method followed by Bombardier for recognition of contracts relating to aerospace programs, ARB 45 provides as follows: When the completed-contract method is used, an excess of accumulated costs over related billings should be shown in the balance sheet as a current asset, and an excess of accumulated billings over related costs should be shown among the liabilities, in most cases as a current liability.

If costs exceed billings on some contracts, and billings exceed costs on others, the contracts should ordinarily be segregated so that the figures on the asset side include only those contracts on which costs exceed billings, and those on the liability side include only those on which billings exceed costs ​ [ARB 45.12] [ 14 ] It is also useful to reproduce certain passages from Mr. Thornton​s report (Exhibit I-1). Of course, there is considerable overlap between the two opinions and I will reproduce only the passages that differ from Mr. Chlala​s report that seem to me to be most significant. However, since Mr.

Thornton provided a

summary of his opinion, which appears at pages 4 to 8 of the report, I will reproduce it here. Emphasis is mine, except where otherwise indicated: Executive

Summary of Opinion 07. GAAP for long-term construction contracts has been a specialized area since 1955 and even before that. However, financial statement concepts in the CICA Handbook state that a major, general [25] objective of accounting for any phenomenon is to help investors predict the ability of a company to earn income and generate cash flows in the future in order to meet its obligations and to generate a return on its investment, by providing information about the company​s economic resources and obligations and by providing information about changes in those resources.

This objective is achieved when the company accounts for transactions and events and presents them in a manner that conveys their economic substance rather than necessarily their legal or other form . 08. In my opinion, a company​s accounting would not [26] comply with GAAP if it presented nothing but the difference between (

a) inventories and (

b) advances and progress billings. Paragraph 25 (page 13) illustrates why by showing financial statement excerpts of two hypothetical companies that both report $1 as inventories net of advances and progress billings. To summarize, a hypothetical Company A has work-in-process inventory of $1,000; it has advances and progress billings of $999; a hypothetical Company B has work-in-process inventory of only $2; it has advances and progress billings of only $1: Company A Company B Inventory 1,000 2

Less Advances and Progress Billings 999 1 Inventory Net of Advances and Progress Billings 1 1 09. I argue that Company A is more successful in generating contract business and has less inventory-based borrowing capacity than B; these inferences would not be possible unless the companies showed the components of the net $1 amounts, either on the face of their balance sheets or in notes to their financial statements. Disclosing only the net amount could also obscure changes in success and borrowing capacity over time for the same company.

Thus, to comply with the general standards of GAAP, the companies would need to disclose the component amounts (inventories; advances and billings) either on the face of their balance sheets or in the notes to the financial statements. If they did not [27] disclose the component amounts on the face of the statements, then disclosure in the notes would be required under GAAP; such financial statements would not [28] comply with GAAP if the notes were omitted .

Moreover, the component amounts disclosed in the note under GAAP would have the same import as if they had been disclosed on the companies​ balance sheets directly . 10. I next perform a more technical analysis of GAAP relating to construction accounting. During the Period North American companies often referred to US accounting literature to justify the accounting policy of netting progress billings with work-in-progress inventories .

Their practice, in turn, constituted Canadian GAAP not [29] because the author of the US publication was an authoritative accounting standard setter but because, prior to 2003, a company could justify using an accounting principle that was ​generally accepted by virtue of its use by a significant number of Canadian companies.​ The US publication distinguished advances from progress billings, saying the advances are [ sic ] ​generally are made to provide a revolving fund and are not usually applied as partial payment until the contract is nearly or fully completed .

However, advances that are definitely regarded as payments on account of work in progress should be shown as a deduction from the related asset , and the amounts should be disclosed.​ This statement suggests that it is permissible to net the Amounts with inventories, provided the company discloses them separately from progress billings; but management would need to exercise judgment in ​definitely regarding​ the Amounts as being akin to progress payments . 11.

After 2003, Canadian companies could no longer justify using an accounting principle just because it was ​generally accepted by virtue of its use by a significant number of Canadian companies​ but there was little or no authoritative specific Canadian literature on how to apply accounting principles relating to construction accounting.

Henceforth, it would be preferable to refer to International Accounting Standard No. 11 Construction Contracts as a basis for complying with Canadian GAAP, because the International Accounting Standards Board was (and is) an authoritative standards setter, albeit not a Canadian one . (This will change in 2011 when Canada joins many other countries in adopting International Financial Reporting Standards as GAAP). International Accounting Standard No. 11 was much stricter in distinguishing advances from progress billings, requiring separate disclosure of advances.

It said progress billings but not advances should be netted with inventories, though it did not specifically prohibit advances from being netted with inventories . 12. The question of whether Bombardier​s financial statements complied with GAAP after 2003 then attains some saliency.

I would rely on the judgment of the auditors and the company and conclude that they did , even though Bombardier​s accounting for the contracts I reviewed did not comport strictly with the textbook accounting for contracts called the ​completed contract method​ or the ​percentage of completion method​ and Bombardier continued to aggregate advances and progress billings rather than making separate disclosures of the advances. Possibly, the auditors did not see any substance to the ​no-invoicing​ character of advances, which is one feature that distinguishes advances from progress billings .

Also, progress billings are normally made when progress is made; the advances would tend to flow to Bombardier regardless or the degree of progress on a contract. Still, I respect the judgment of the auditors on this point . I am uneasy, however, about Bombardier​s practice of aggregating progress billings with advances and not making separate disclosure of the advances. 13. Next I consider the meaning of the term ​ reflected in financial statements​ by performing some original research on the basis of contexts of the 382 occurrences of the term ​reflect​ as a root-word in the CICA Handbook.

I conclude that under GAAP the verb ​reflect​ generally means ​ represent, recognize, depict, include, convey, or incorporate.​ I also argue that any amounts disclosed in financial statement notes that give details about the components of amounts shown in the financial statements are also reflected in financial statements , as elements of the statements to which they are cross-referenced. 14. Finally, I elaborate on the role of financial statement notes. I show that the notes are integral to financial statements.

The notes themselves are not ​elements​ of the financial statements ; only items like assets, liabilities , revenues and expenses are financial statement elements . Financial statement notes, however, often provide additional information about elements, or set out the components of elements that are shown on the face of the statements.

The Amounts are elements even though they do not appear on the face of the balance sheet because in the notes they are disclosed as components of an element , or components of a difference between two elements (inventories net of advances and progress billings) and hence the Amounts are reflected on the balance sheet . 15. On page 33 (paragraph 55) I explain why I think that the Amounts are analogous to draw-downs of lending facilities, i.e., the

Amounts are substitutes for debt financing to support the manufacturing of work-in-progress inventory. 16. On page 55 I answer the four questions posed by Justice: 1. According to GAAP, what is the nature and substance of the payments made by Bombardier​s customers pursuant to the contracts? The Amounts are in substance debt financing to support the manufacturing of airplanes included in work-in-progress inventory. 2. Were the Appellant​s balance sheets (and financial statements) in accordance with GAAP with respect to those payments? Yes , at least until 2003 when the definition of GAAP changed in Canada.

Even after 2003, I have no reason to assert that the financial statements did not comply with GAAP. 3. Are the advances, as detailed in the notes to the financial statements, ​reflected​ in the balance sheets of Bombardier? Yes. The Amounts are reflected , incorporated, or depicted in the balance sheet by dint of the balance-sheet references to financial statement notes ; the notes, in turn, give details relating to the Amounts. 4. Are the notes to the financial statements an integral part of the balance sheets? Yes.

Relevant Statutory Provisions [ 15 ] The relevant statutory provisions read as follows: Determining values and amounts 181(3) For the purposes of determining the carrying value of a corporation​s assets or any other amount under this

Part in respect of a corporation​s capital , investment allowance, taxable capital or taxable capital employed in Canada for a taxation year or in respect of a partnership in which a corporation has an interest, (

a) the equity and consolidation methods of accounting shall not be used ; and (

b) subject to paragraph 181(3)(

a) and except as otherwise provided in this Part, the amounts reflected in the balance sheet (

i) presented to the shareholders of the corporation (in the case of a corporation that is neither an insurance corporation to which subparagraph 181(3)( b )(ii) applies nor a bank) or the members of the partnership, as the case may be, or , where such a balance sheet was not prepared in accordance with generally accepted accounting principles or no such balance sheet was prepared, the amounts that would be reflected if such a balance sheet had been prepared in accordance with generally accepted accounting principles, or ...

Limitations respecting inclusions and deductions

(4) Unless a contrary intention is evident , no provision of this Part shall be read or construed to require the inclusion or to permit the deduction, in computing the amount of a corporation​s capital , investment allowance, taxable capital or taxable capital employed in Canada for a taxation year, of any amount to the extent that that amount has been included or deducted , as the case may be, in computing the first-mentioned amount under, in accordance with or by reason of any other provision of this Part . Taxable capital 181.2

(2) The taxable capital of a corporation (other than a financial institution) for a taxation year is the amount , if any, by which its capital for the year exceeds its investment allowance for the year.

(3) The capital of a corporation ... for a taxation year is the amount, if any, by which the total of (

a) the amount of its capital stock (or, in the case of a corporation incorporated without share capital, the amount of its members​ contributions), retained earnings, contributed surplus and any other surpluses at the end of the year, (

b) the amount of its reserves for the year, except to the extent that they were deducted in computing its income for the year under

Part I, ... (

c) the amount of all loans and advances to the corporation at the end of the year , ... exceeds the total of ... Investment allowance

(4) The investment allowance of a corporation (other than a financial institution) for a taxation year is the total of all amounts each of which is the carrying value at the end of the year of an asset of the corporation that is (

a) a share of another corporation, (

b) a loan or advance to another corporation (other than a financial institution), ... [Emphasis added.] Position of Bombardier

[16] Counsel for Bombardier first noted that the purpose of the tax on large corporations announced in Finance Minister Wilson​sbudget on April 27, 1989, was the reduction of the federal deficit. At page 41 of the budget papers (Respondent​s Authorities, tab 1), thetax base is defined as including loans and advances: Tax on Non-Financial Corporations: Detailed Provisions The tax base will be calculated using the accounts of a corporation determined in accordance with generally-accepted accountingprinciples and presented on an unconsolidated basis. Current year-end balances will be used.

This base will include the corporation​s shareholders​ equity, surpluses, and reserves, as well as loans and advances to the corporation, andcertain other debts. Surpluses will includ

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