MANAGEMENT’S RESPONSIBILITY

Management’s Report on Financial Statements and
Assessment of Internal Control Over Financial Reporting

Catalyst Paper Corporation’s management is responsible for the preparation, integrity and fair presentation of the accompanying consolidated financial statements and other information contained in this Annual Report. The consolidated financial statements and related notes were prepared in accordance with U.S. generally accepted accounting principles and reflect management’s best judgments and estimates. Financial information provided elsewhere in the Annual Report is consistent with that in the consolidated financial statements.

Management is responsible for designing and maintaining adequate internal control over financial reporting. The company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for reporting purposes. Internal control over financial reporting includes processes and procedures that:

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in condition, or that the degree of compliance with policies or procedures may deteriorate.

Management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2012. Management based this assessment on the criteria for internal control over financial reporting described in the “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of the company’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of the company’s Board of directors.

Based on this assessment, management determined that as of December 31, 2012 the company’s internal control over financial reporting was effective.

The company’s independent auditor, which audited and reported on the company’s consolidated financial statements, has also issued an auditors’ report on the company’s internal control over financial reporting.

The Board of directors is responsible for satisfying itself that management fulfills its responsibilities for financial reporting and internal control. The Audit Committee, which is comprised of four non-management members of the Board of directors, provides oversight to the financial reporting process. The Audit Committee meets periodically with management, the internal auditors and the external auditors to review the consolidated financial statements, the adequacy of financial reporting, accounting systems and controls, and internal and external auditing functions.

These consolidated financial statements have been audited by KPMG LLP, the independent auditors, whose report follows.

Kevin J. Clarke	Brian Baarda
President and	Vice-President, Finance
Chief Executive Officer	and Chief Financial Officer

Vancouver, Canada
March 5, 2013

Report of INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of Catalyst Paper Corporation

We have audited the accompanying consolidated balance sheets of Catalyst Paper Corporation as of December 31, 2012 (Successor), September 30, 2012 (Successor) and December 31, 2011 (Predecessor) and the related consolidated statements of earnings (loss), comprehensive income (loss), equity (deficiency) and cash flows for the three-month period ended December 31, 2012 (Successor), the nine-month period ended September 30, 2012 (Predecessor) and for each of the years in the two-year period ended December 31, 2011 (Predecessor). These consolidated financial statements are the responsibility of Catalyst Paper Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 2 to the consolidated financial statements, the Supreme Court of British Columbia and the Bankruptcy Court in US confirmed the Plan of Arrangement on June 28, 2012 and July 27, 2012, respectively, which became effective on September 13, 2012. Accordingly, the accompanying consolidated financial statements have been prepared in conformity with Accounting Standards Codification 852-10, Reorganizations, for the Successor Company as a new entity with assets, liabilities and a capital structure having carrying amounts not comparable with prior periods, as described in Note 1.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Catalyst Paper Corporation as of December 31, 2012 (Successor), September 30, 2012 (Successor) and December 31, 2011 (Predecessor), and its consolidated results of operations and its consolidated cash flows for the three-month period ended December 31, 2012 (Successor), the nine-month period ended September 30, 2012 (Predecessor) and for each of the years in the two-year period ended December 31, 2011 (Predecessor) in conformity with US generally accepted accounting principles.

Chartered Accountants

Vancouver, Canada

March 5, 2013

CATALYST PAPER CORPORATION

CONSOLIDATED BALANCE SHEETS

(In millions of Canadian dollars)

Going concern (note 1)

Commitments, guarantees and indemnities and contingent liabilities (notes 32, 33, and 34)

Subsequent events (notes 8, 9, and 19)

The accompanying notes are an integral part of the consolidated financial statements.

On behalf of the Board:
Kevin J. Clarke	Walter Jones
Director	Director

CATALYST PAPER CORPORATION

CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)

(In millions of Canadian dollars, except where otherwise stated)

The accompanying notes are an integral part of the consolidated financial statements.

CATALYST PAPER CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In millions of Canadian dollars)

The accompanying notes are an integral part of the consolidated financial statements.

CATALYST PAPER CORPORATION

CONSOLIDATED STATEMENTS OF EQUITY (DEFICIENCY)

(In millions of Canadian dollars)

The accompanying notes are an integral part of the consolidated financial statements.

CATALYST PAPER CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions of Canadian dollars)

The accompanying notes are an integral part of the consolidated financial statements.

CATALYST PAPER CORPORATION

CONSOLIDATED BUSINESS SEGMENTS

(In millions of Canadian dollars)

The accompanying notes are an integral part of the consolidated financial statements.

CATALYST PAPER CORPORATION

CONSOLIDATED GEOGRAPHIC BUSINESS SEGMENTS

(In millions of Canadian dollars)

The accompanying notes are an integral part of the consolidated financial statements.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

Catalyst Paper Corporation, together with its subsidiaries and partnerships (collectively, the “company”) is a significant specialty mechanical printing papers and newsprint producer in North America. The company operates in three business segments.

The business segments of the company are strategic business units that offer different products. They are managed separately because each business requires different technology, capital expenditures, labour expertise and marketing strategies. Each segment is a significant component of the company’s sales and operating earnings.

The company owns and operates three manufacturing facilities located in the province of British Columbia (B.C.), Canada. On September 30, 2012 the company permanently shut down its recycle mill operations located in Snowflake, Arizona (note 9). Two other facilities, including a paper recycling facility, were permanently shut down during 2010. Inter-segment sales consist of pulp transfers at market prices. The primary market for the company’s paper products is North America. The primary markets for the company’s pulp products are Asia and Australasia.

Creditor protection proceedings

On January 31, 2012, Catalyst Paper Corporation and certain of its subsidiaries obtained an Initial Order from the Supreme Court of British Columbia (the Court) under the Companies’ Creditors Arrangement Act (CCAA). The company applied for recognition of the Initial Order under Chapter 15 of Title 11 of the US Bankruptcy Code. The company entered into a Debtor-In-Possession (DIP) Credit Agreement, pursuant to which a DIP Credit Facility of approximately $175 million was confirmed by the Court.

Emergence from Creditor Protection Proceedings

Catalyst Paper Corporation and all of its subsidiaries and partnership successfully emerged from creditor protection proceedings under CCAA and Chapter 15 of Title 11 of the US Bankruptcy Code on September 13, 2012 (emergence date). The company met all of the conditions to implement the second amended plan of arrangement (Plan) on the emergence date by securing exit financing consisting of a new asset-based loan facility (ABL Facility) and new floating rate senior secured notes (Floating Rate Notes). For additional information on the company’s emergence from creditor protection proceedings, see note 2, Creditor protection proceedings.

In accordance with FASB ASC 852, fresh start accounting was required upon the company’s emergence from the creditor protection proceedings because:

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

FASB ASC 852 requires that fresh start accounting be applied on the latter of the date of approval of the plan of arrangement, or the date that all material conditions to implement the plan are met. The company’s application date for fresh start accounting was September 13, 2012, when exit financing was secured. However, the company elected to apply fresh start accounting effective September 30, 2012, to coincide with the timing of the third quarter close. The company evaluated events, transactions, and fluctuations in product prices, exchange rates and inflation rates between September 13, 2012, and September 30, 2012, and concluded that the use of an accounting convenience date of September 30, 2012 (convenience date) did not have a material impact on the company’s financial position, results of operations and cash flows. The application of fresh start accounting was therefore reflected in the company’s consolidated balance sheet as of September 30, 2012, and related fresh start accounting adjustments were included in the company’s consolidated statements of earnings (loss) for the nine months ended September 30, 2012.

The implementation of the Plan and the application of fresh start accounting materially changed the carrying amounts and classifications reported in the company’s financial statements, and resulted in the company effectively becoming a new entity for financial reporting purposes. Accordingly, the company’s consolidated financial statements for periods prior to September 30, 2012 are not comparable to consolidated financial statements prepared for periods subsequent to September 30, 2012. References to Successor or Successor company refer to the company on or after September 30, 2012, and references to Predecessor or Predecessor company refer to the company prior to September 30, 2012. Additionally, references to periods on or after September 30, 2012, refer to the Successor, and references to periods prior to September 30, 2012, refer to the Predecessor.

Going concern

The audited consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The creditor protection proceedings raised substantial doubt about the company’s ability to continue as a going concern. During these proceedings, the company’s ability to continue as a going concern was dependent on obtaining creditor and Court approval of a plan of arrangement, successful implementation of the plan of arrangement that would improve profitability, reduce the company’s debt burden and improve liquidity, and securing exit financing to replace the debtor in possession financing available to the company during the creditor protection proceedings. Management believes that the implementation of the Plan and the company’s emergence from creditor protection proceedings have resolved the substantial doubt regarding the appropriateness of the going concern basis of accounting.

Reorganization process

The Canadian Court and U.S. Court issued a variety of orders throughout the restructuring process. These orders include, among other things, authorization to (a) make payments relating to certain employees’ pre-petition wages, salaries and benefit programs in the ordinary course of business; (b) ensure the continuation of existing cash management systems; (c) honour certain ongoing customer obligations; and (d) enter into a DIP Credit Agreement that effectively replaced the former ABL Facility.

The terms of the Initial Order named PricewaterhouseCoopers Inc. (PwC) as the court-appointed monitor (the Monitor), who assisted the company in formulating a restructuring plan.

Shortly after the commencement of the creditor protection proceedings, the company began notifying all known creditors regarding these filings. Pursuant to the Initial Order, and subject to certain exceptions, the continuation of any judicial or administrative proceedings or other actions against the company or its property to recover, collect or secure a pre-petition claim were automatically stayed. Most creditor actions to obtain possession of the company’s property, or to create or enforce any lien against the company’s property, or to collect pre-petition amounts owed or otherwise exercise rights or remedies with respect to a pre-petition claim were enjoined.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

The company reached new labour agreements, effective from May 1, 2012 to April 30, 2017, with all six union locals at its Crofton, Port Alberni and Powell River mills. The new labour agreements were entered into with the Communications, Energy and Paperworkers Union of Canada (CEP) locals 1, 76, 592, 686 and 1132 and the Pulp, Paper and Woodworkers Union of Canada (PPWC) local 2. Specific terms of the new labour agreements include a 10% reduction in hourly wage rates, various adjustments to vacation, health benefits and work rules, maintaining hourly retiree health benefits, and providing for no wage inflation for the first three years and 2% increases in the fourth and fifth year that these agreements are in effect.

On March 9, 2012, the company entered into a Restructuring and Support Agreement (RSA) with certain holders of its 11% senior secured notes due 2016 (2016 Notes) and its 7.375% notes due 2014 (2014 Notes) that outlined a plan of arrangement under the CCAA. On May 15, 2012, the company announced that the original terms of the plan of arrangement, as disclosed in the interim consolidated financial statements for the three months ended March 31, 2012, had been amended.

On May 23, 2012, the company announced that it did not receive the necessary creditor approval for its amended plan of arrangement. Approval of not less than 66 2/3% of the principal amount of each creditor class voting on the plan was required. While 99.5% of the principal amount of the secured creditor class voted in favour of the plan, only 64% of the principal amount of the unsecured creditor class voted in favour. With the amended plan of arrangement not being approved, the company was required to commence a sales process in accordance with certain agreed sale and investor solicitation procedures (SISP).

On June 14, 2012, the company announced a second amended plan of arrangement after receiving consent from a requisite number of holders of 2016 Notes to move forward to a vote. Proposed changes under the Plan included the compromise of certain extended health benefits, modifications to the salaried pension plan and application for additional solvency deficit funding relief. On June 25, 2012 the company announced that it had received the necessary creditor approval for the Plan. Approval of more than 99% of secured and unsecured creditors was received. The company also received confirmation of regulatory approval by provincial order in council of the proposed modifications to the salaried pension plan and the application for additional funding relief. The Court sanctioned the Plan on June 28, 2012 and the US Court in Delaware confirmed the Plan under the Chapter 15 process in a confirmation hearing on July 27, 2012.

Emergence from creditor protection proceedings

The Plan became effective on September 12, 2012 and the restructuring under the Plan completed on September 13, 2012. Upon implementation of the Plan, the company was reorganized through the consummation of several transactions pursuant to which, among other things:

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

The company distributed $1.0 million to unsecured creditors in November 2012 as full and final settlement of claims comprising the Cash Convenience Pool. The company issued 127,571 common shares to unsecured creditors in December as full and final settlement of claims comprising the Unsecured Creditor Share Pool. The company agreed to the sale of its interest in PREI for proceeds of $33.0 million, expects to complete the sale in the first quarter of 2013, and will subsequently pay out the PREI Proceeds Pool to applicable unsecured creditors. The company is required under the Plan to offer its portion of the proceeds from the sale of PREI to the holders of Floating Rate Notes (see note 8, Variable interest entities).

Exit Financing

On September 13, 2012, the company entered into a new ABL Facility and issued new Floating Rate Notes. The $175.0 million ABL Facility, which was a pre-condition for the company to implement the Plan and exit from creditor protection, matures on the earlier of July 31, 2017, and 90 days prior to maturity of any significant debt. The Floating Rate Notes, which mature on September 13, 2016, were issued for US$35 million. The terms and covenants of the ABL Facility and the Floating Rate Notes are disclosed in note 18, Long-term debt.

The consolidated financial statements of the company are prepared in accordance with United States (U.S.) generally accepted accounting principles (U.S. GAAP).

The consolidated financial statements include the accounts of the company and, from their respective dates of acquisition of control or formation, its wholly-owned subsidiaries and partnerships. In addition, the consolidated financial statements include the accounts of the company’s joint venture, Powell River Energy Inc. (PREI), a variable interest entity. All inter-company transactions and amounts have been eliminated on consolidation.

Variable interest entities (VIE) are entities in which equity investors do not have a controlling financial interest or the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by other parties. The company consolidates the accounts of VIEs where it has been determined that the company is the primary beneficiary, defined as the party that has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and has an obligation to absorb losses and receive benefits of that VIE.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

The consolidated financial statements have been prepared in conformity with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the year. On an ongoing basis, management reviews its estimates, including those related to inventory obsolescence, estimated useful lives of assets, environmental and legal liabilities, impairment of long-lived assets, derivative financial instruments, pension and post-retirement benefits, bad debt and doubtful accounts, income taxes, restructuring costs, and commitment and contingencies, based on currently available information.

The enterprise value that was established as of the valuation date of September 30, 2012 incorporated numerous major assumptions including, but not limited to, the following:

Actual amounts could differ from estimates.

The company recognizes revenues upon shipment when persuasive evidence of an arrangement exists, prices are fixed or determinable, title of ownership has transferred to the customer and collection is reasonably assured. Sales are reported net of discounts, allowances and rebates.

The company classifies shipping and handling costs to Cost of sales, excluding depreciation and amortization as incurred.

The majority of the company’s sales are denominated in foreign currencies, principally U.S. dollars (US$). Revenue and expense items denominated in foreign currencies are translated at exchange rates prevailing during the period. Monetary assets and liabilities denominated in foreign currencies are translated at the period-end exchange rates. Non-monetary assets and liabilities are translated at exchange rates in effect when the assets are acquired or the obligations are incurred. Foreign exchange gains and losses are reflected in net earnings (loss) for the period.

Up to September 30, 2012, the company had a foreign subsidiary that was considered to be self-contained and integrated within its foreign jurisdiction, and accordingly, used the U.S. dollar as its functional currency. Foreign exchange gains and losses arising from the translation of the foreign subsidiary’s accounts into Canadian dollars (CDN$) were reported as a component of other comprehensive income (loss), as discussed in note 23, Accumulated other comprehensive income (loss). Subsequent to the permanent closure of the Snowflake recycle mill operations on September 30, 2012, the company ceased to have a self-contained foreign operation and therefore no longer reports foreign exchange gains and losses as a component of other comprehensive income (loss).

The company uses derivative financial instruments in the management of foreign currency and price risk associated with its revenues, energy costs and long-term debt. It also uses interest rate swaps to manage its net exposure to interest rate changes.  The company’s policy is to use derivatives for managing existing financial exposures and not for trading or speculative purposes. The company accounts for its derivatives at fair value at each balance sheet date.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

In a cash flow hedge, the changes in fair value of derivative financial instruments are recorded in Other comprehensive loss. These amounts are reclassified in the consolidated statement of earnings (loss) in the periods in which results are affected by the cash flows of the hedged item. Any hedge ineffectiveness is recorded in the consolidated statement of earnings (loss) when incurred. In a fair value hedge, hedging instruments are carried at fair value, with changes in fair value recognized in the consolidated statement of earnings (loss).  The changes in fair value of the hedged item attributable to the hedged risk is also recorded in the consolidated statement of earnings (loss) by way of a corresponding adjustment of the carrying amount of the hedged items recognized on the balance sheet. In hedges of the foreign currency exposure of net investments in foreign subsidiaries that are self-contained and integrated within a particular country, gains and losses on translation are deferred in a separate component of shareholders’ equity to be recognized in net earnings (loss) upon sale or upon complete or substantially complete liquidation of the net investment in the foreign subsidiary. Cash flows from derivative financial instruments are classified, in general, to “Operations” on the consolidated statement of cash flows consistent with the hedged transaction.  Cash flows resulting from termination of interest rate swaps are classified as “Investing activities.”

Effective April 1, 2010, the company no longer designates its U.S. dollar revenue risk management instruments as cash flow hedges for accounting purposes. The effective portion of gains or losses accumulated as at March 31, 2010 on its previously designated U.S. dollar revenue risk management instruments were recorded in the same income statement line items as the hedged item in Sales. Prior to April 1, 2010, the company designated the hedge relationship and formally documented, at its inception, the particular risk management objective and strategy, the specific asset, liability or cash flow being hedged, as well as how effectiveness was assessed.  Risk management strategies and relationships were assessed on an ongoing basis to ensure each derivative instrument was effective in accomplishing the objective of offsetting either changes in the fair value or cash flow attributable to the exposure being hedged both at inception and over the term of the hedging relationship.

Effective October 1, 2011, the company no longer designates the foreign currency revaluation of a portion of its long-term debt as a hedge against the foreign currency exposure arising on the net investment in its foreign subsidiary. As described in note 7, Measurement uncertainty – impairment of long-lived assets, certain assets of the foreign subsidiary were impaired on September 30, 2011. Subsequent to the recognition of this impairment, the revaluation of the company’s foreign currency denominated debt was no longer an effective hedge against the foreign exchange gains and losses that arose on the net investment in the company’s foreign subsidiary. Subsequent to the permanent closure of the Snowflake recycle mill operations on September 30, 2012 the company ceased to have a self-contained foreign operation.

Cash and cash equivalents include cash and short-term investments with original maturities of less than three months when acquired and are presented at fair value.

Restricted cash is segregated and presented separately in the balance sheet, classified as current or non-current based on the facts pertaining to the restricted cash, and is excluded from cash and cash equivalents in the statement of cash flows.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

Specialty printing papers, newsprint and pulp inventories are valued at the lower of three-month moving average cost or market. Wood chips, pulp logs and other raw materials are valued at the lower of cost or market. For raw materials to be used in the production of finished goods, market is determined on an as-converted-to-finished-goods basis. Work-in-progress and operating and maintenance supplies and spare parts inventories are valued at cost. Cost is defined as all costs that relate to bringing the inventory to its present condition and location under normal operating conditions and includes manufacturing costs, such as raw materials, labour and production overhead, and depreciation and amortization costs. In addition, cost includes freight costs to move inventory offsite.

Repairs and maintenance, including costs associated with planned major maintenance, are charged to Cost of sales, excluding depreciation and amortization as incurred.

Property, plant and equipment are stated at cost, less accumulated depreciation and amortization, including asset impairment charges. Interest costs for capital projects are capitalized. Buildings, machinery and equipment are generally amortized on a straight-line basis at rates that reflect estimates of the economic lives of the assets. The rates for major classes of assets based on the estimated remaining economic lives are:

Effective December 31, 2011, the remaining useful lives of the company’s pulp machinery were revised from approximately 7 years to 11 years. The company concluded that, based on the physical condition of these assets, 11 years more fairly reflected the remaining useful lives of these assets and adopted these change in estimate prospectively.

No depreciation is charged on capital projects during the period of construction. Start-up costs incurred in achieving normal operating capacity on major capital projects are expensed as incurred.

Leasehold improvements are normally amortized over the lesser of their expected average service life and the term of the lease.

When property, plant and equipment are sold by the company, the historical cost less accumulated depreciation and amortization is netted against the sale proceeds and the difference is included in Other income (expense), net.

Assets and liabilities that meet the held-for-sale criteria are reported separately from continuing operations in the consolidated balance sheet. Assets held for sale and liabilities associated with assets held for sale are reported separately under current assets and current liabilities, and are not offset and reported as a single amount in the consolidated balance sheet. Assets and liabilities are classified prospectively in the consolidated balance sheet as held for sale. 

The results of discontinued operations, net of tax, are presented separately from the results of continuing operations in the consolidated statements of earnings (loss). Per share information and changes to other comprehensive income (loss) related to discontinued operations are presented separately from continuing operations. Cash flows from discontinued operations are not presented separately from cash flows from continuing operations in the consolidated statements of cash flows. All comparative periods are restated in the period that a component is classified as a discontinued operation.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

Goodwill is measured at the amount that the company’s enterprise value exceeded the fair value of its identified assets and liabilities on the convenience date of September 30, 2012, that fresh start accounting was applied.

Government grants are recognized at fair value when there is reasonable assurance that the company will comply with the conditions attached to them and that the grants will be received. Government grants related to additions or betterments to property, plant and equipment are recognized as credits against the carrying values of the related assets, and subsequently recognized in net earnings (loss) over the useful lives of the related assets as reductions to the resulting depreciation expense.

Government grants were awarded to the company by the Canadian Forest Service (CFS) to invest in specified capital upgrades to property, plant and equipment. These government grants, called Green Transformation Credits, were awarded in accordance with CFS’s Pulp and Paper Green Transformation Program.

Long-lived assets are tested for recoverability when events or changes in circumstances indicate their carrying value may not be recoverable. A long-lived asset is potentially not recoverable when its carrying value is greater than the sum of the undiscounted cash flows expected to result from its use and eventual disposition. The impairment loss, if any, is measured as the amount by which the long-lived asset’s carrying amount exceeds its fair value.

Goodwill will not be amortized in subsequent periods, but will be tested for impairment using a two-step impairment test at the reporting unit level. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. A company may first assess certain prescribed qualitative factors to determine whether it is necessary to perform the two-step goodwill impairment test.

Environmental expenditures are expensed or capitalized depending upon their future economic benefit. Expenditures that prevent future environmental contamination are capitalized as part of Property, plant and equipment, and depreciation and amortization is subsequently charged to earnings over the estimated future benefit period of the assets. Expenditures that relate to an existing condition caused by past operations are expensed. Liabilities are recorded on a discounted basis when rehabilitation efforts are likely to occur and the costs can be reasonably estimated.

Asset retirement obligations are recognized at fair value in the period in which the company incurs a legal obligation associated with the retirement of an asset. The associated costs are capitalized as part of the carrying value of the related asset and amortized over its remaining useful life. The liability is accreted using a credit-adjusted risk-free interest rate.

The company’s obligations for the proper removal and disposal of asbestos products in its mills meet the definition of a conditional asset retirement obligation. That is, the company is subject to regulations that are in place to ensure that asbestos fibres do not become friable, or loose. The regulations require that friable asbestos be repaired or removed in accordance with the regulations.

The company’s asbestos can generally be found on steam and condensate piping systems throughout its facilities, as well as in transite cladding on buildings and in building insulation. As a result of the longevity of the company’s mills, due in part to the company’s maintenance procedures, and the fact that the company does not have plans for major changes that would require the removal of asbestos, the timing of the removal of asbestos in the company’s mills is indeterminate. As a result, the company is currently unable to estimate the fair value of its asbestos removal and disposal obligation.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

The company’s obligations to cover (cap) the surface areas of the landfills that are in operation at its mill sites meet the definition of an asset retirement obligation. Capping will prevent future environmental contamination when the landfills are no longer in active use. The company presently has active landfills at its Crofton, Powell River and Elk Falls mill sites.

Deferred costs related to the company’s long-term debt are included in Other assets and amortized over the legal life of the related liability. Financing costs associated with modifications of long-term debt are expensed as incurred. Financing costs associated with modifications to line-of-credit or revolving debt arrangements are deferred and amortized if the borrowing capacity of the new arrangement is greater than or equal to the borrowing capacity of the old arrangement and if the parties to the new arrangement are the same as the parties to the old arrangement. Borrowing capacity is defined as the product of the remaining term of the arrangement and the maximum available credit.

Stock options and restricted share units granted to the company’s key officers, directors and employees are accounted for using the fair value-based method. Under this method, compensation cost is measured at fair value at the date of grant, and is expensed over the award’s vesting period. Any consideration paid by plan participants on the exercise of share options or the purchase of shares is credited to Common stock together with any related stock-based compensation expense. Performance and time based share-based payments are amortized over their vesting periods when it is probable that the performance conditions will be satisfied.

Deferred share units are accounted for using the quoted market value at each reporting period until settlement, and are amortized over their vesting periods.

Income taxes are accounted for using the asset and liability method. Deferred income tax assets and liabilities are based on temporary differences (differences between the accounting basis and the tax basis of the assets and liabilities) and non-capital loss carry-forwards and are measured using the enacted tax rates and laws expected to apply when these differences reverse. Future tax benefits, including non-capital loss carry-forwards, are recognized to the extent that realization of such benefits is considered more likely than not. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period that enactment occurs.

Deferred credits represent the excess of amounts assigned to deferred income tax assets for tax losses acquired in other than business combinations over the consideration paid. Deferred credits are amortized to Income tax recovery in the consolidated statement of earnings (loss) during the period that the acquired tax asset is utilized.

The company maintains pension benefit plans for all salaried employees, which include defined benefit and defined contribution segments. The company also sponsors other post-retirement benefit plans, covering health and dental benefits. The company recognizes assets or liabilities for the respective overfunded or underfunded statuses of its defined benefit pension plans and other post-retirement benefit plans on its consolidated balance sheet. Changes in the funding statuses that have not been recognized in the company’s net periodic benefit costs are reflected in Accumulated other comprehensive income (loss) in the company’s consolidated balance sheet. Net periodic benefit costs are recognized as employees render the services necessary to earn the pension and other post-retirement benefits.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

The estimated cost for pensions and other employee future benefits provided to employees by the company is accrued using actuarial techniques and assumptions during the employees’ active years of service. The net periodic benefit cost includes:

The defined benefit plan obligations are determined in accordance with the projected benefit method, prorated on services.

Amounts paid to the company’s defined contribution plans for salaried employees and to multi-employer industry-wide pension plans are expensed as incurred.

Basic earnings (loss) per share is computed by dividing net earnings (loss) attributable to the company for the period by the weighted average number of company common shares outstanding during the reporting period. Diluted earnings (loss) per share is computed using the treasury stock method. When the effect of options and other securities convertible into common shares is anti-dilutive, including when the company has incurred a loss for the period, basic and diluted loss per share are the same.

FASB ASC 852, Reorganizations, was adopted for the duration of the CCAA proceedings. In accordance with this standard, transactions and events directly associated with the reorganization were distinguished and segregated from the ongoing operations of the business. Pre-petition obligations that were impaired under the reorganization process pursuant to the CCAA proceedings were classified as Liabilities subject to compromise in the balance sheet at the amounts expected to be allowed as claims by the Court. Professional fees, DIP-related financing costs, charges related to indefinite idlings and permanent closures and other provisions for losses directly associated with or resulting from the reorganization were recorded in Reorganization items, net in the consolidated statement of operations.

In accordance with FASB ASC 852, Reorganizations, fresh start accounting was applied as of the convenience date of September 30, 2012. See note 6, Creditor protection proceedings related disclosures, for a discussion of fresh start accounting.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

There were no new pronouncements issued by the FASB that may materially impact the company’s consolidated financial statements for future periods.

Fresh start accounting

As discussed in note 3, Summary of significant accounting policies, the company applied fresh start accounting as of September 30, 2012, pursuant to which the reorganization value derived from the enterprise value established for the company was assigned to the company’s assets and liabilities, which required recording assets and liabilities at fair value in conformity with the procedures specified in ASC 805, Business Combinations. Deferred income taxes and pension and other post-employment benefits (OPEB) projected benefit obligations are excluded from this requirement. In accordance with fresh start accounting, the Predecessor company’s common shares, additional paid-in-capital, deficit and accumulated other comprehensive loss were eliminated. Accumulated depreciation on property, plant and equipment was eliminated and estimated remaining useful lives were updated.

Enterprise valuation

We engaged an independent financial advisor to assist us in the determination of the enterprise value of the Successor company. The enterprise value was estimated using three valuation methods: (i) discounted cash flow analysis (DCF), (ii) comparable company analysis, and (iii) precedent transactions analysis. The enterprise value was determined primarily based on the DCF analysis.

The DCF analysis is a forward-looking enterprise valuation methodology that estimates the value of an asset or business by calculating the present value of expected future cash flows to be generated by that asset or business. The company’s discount rate, defined as the blended rate of return required by debt and equity investors of the Successor company, was estimated to be 15%. A one percent change in the discount rate has an impact of approximately $40.0 million on the equity value of the company. Expected future cash flows were based on unlevered after-tax free cash flows, a five-year projection period, and an estimated value beyond the projection period known as a terminal value. Cash flow projections incorporated various assumptions, including future product sales prices and foreign exchange assumptions based on independent, published market forecasts, future cost trends based on the company’s operating history and realization of the cost reductions negotiated while in creditor protection. The enterprise value of the company calculated using the DCF analysis was $392.9 million.

The comparable company analysis estimates the value of the company based on a relative comparison with other publicly traded companies with similar operating and financial characteristics. Under this valuation methodology, the enterprise values of these publicly traded companies, calculated as the aggregate market value of their publicly traded equity securities plus the aggregate amount of net debt outstanding, are expressed as multiples of various measures of the respective company’s operating earnings such as earnings before interest, taxes, depreciation and amortization (EBITDA). These multiples are then applied to the company’s actual and projected operating results, after adjusting for differences in, among other things, product offerings, markets, size, risk profile, profitability, leverage and operating margins. The company’s implied multiple as of September 30, 2012 was estimated to be 4.9 X 2013 projected EBITDA.

The precedent transactions analysis estimates the value of the company based on a relative comparison with companies that were recent targets of merger and acquisition transactions. Under this valuation methodology, the purchase prices paid for these companies are expressed as multiples of various measures of the respective company’s operating earnings such as EBITDA. These multiples are then applied to the company’s actual and projected operating results, after adjusting for unique value considerations incorporated in purchase prices, as well as differences in, among other things, product offerings, markets, size, risk profile, profitability, leverage and operating margins. No recent precedent transactions were identified that were comparable on a relative basis to the company and, therefore, an implied multiple could not be estimated for the company in accordance with this valuation method.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

In addition, certain of the company’s non-operating assets were valued separately as follows: (i) tax attributes were valued based on a DCF analysis of the projected tax savings that will arise from the use of the company’s available post-emergence attributes, and (ii) assets marketed to be sold prior to emergence from creditor protection were valued based on the present value of estimated gross sales proceeds minus estimated sales costs. Income taxes in the DCF analysis were estimated based on the projected statutory tax rates in Canada and the United States during the forecasting period of 2012 to 2017.

Allocation of reorganization value to assets and liabilities

The reorganization value derived from the company’s enterprise value was assigned to assets and liabilities in accordance with the acquisition method of accounting for business combinations, which requires recording assets and liabilities other than deferred income taxes and pension and OPEB projected benefit obligations at fair value. The amount of deferred income taxes for the Successor company was determined in accordance with FASB ASC 740. See note 21, Income taxes, for additional information. The amount of pension and OPEB projected benefit obligations was determined in accordance with FASB ASC 715, which required that the actuarial present value of the company’s defined benefit pension and post-retirement benefit plan assets and benefit obligations be determined based on certain assumptions (see note 19, Employee future benefits).

Fair value estimates were based on the following approaches:

Reorganized consolidated balance sheet

The effects of the implementation of the Plan and the application of fresh start accounting on the company’s consolidated balance sheet as of September 30, 2012, are presented in the reorganized consolidated balance sheet below.

The adjustments set forth in the column labeled Plan of arrangement adjustments reflects the impact of implementing the Plan including, among other things, the discharge and settlement of liabilities subject to compromise based on claims allowed by the Courts, the issuance of Successor company common stock to holders of allowed claims in satisfaction of such claims, and the incurrence of new indebtedness related to secured notes issued to holders of the Predecessor company’s secured pre-petition debt and related to the company’s exit financing.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

The adjustments set forth in the column labeled Fresh start accounting adjustments reflect, among other things, adjustments to the carrying values of the company’s assets and liabilities to reflect their fair values, and the elimination of common stock, additional paid-in-capital, deficit and accumulated other comprehensive loss as a result of the application of fresh start accounting.

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

Plan of Arrangement Adjustments

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

CATALYST PAPER CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in millions of Canadian dollars, except where otherwise stated)

Fresh Start Accounting Adjustments

The following table summarizes the reconciliation of the enterprise equity value to the reorganization value, and the allocation of the reorganization value to the assets and liabilities of the Successor company based on their estimated fair values as of September 30, 2012.