Maffin
Corp. owns 75% of Grey Inc. Both companies are in the mining industry. During
2011, Maffin Corp. purchased a building from Grey Inc. for $1,000. The
building's carrying amount in Grey Inc.'s financial statements is $700.
Maffin's contributed surplus account contains a credit balance of $200 from
previous related party transactions. Grey's contributed surplus account is nil.
There is no available independent evidence of the value of the building as it
is a unique building in a remote part of the country. Maffin subsequently sold
the building, during 2012, to an unrelated party for $1,100. Both Maffin and
Grey follow ASPE.
Instructions
Using
the related-party decision tree in Illustration 23-5, answer the following.
(a)
How would both Maffin and Grey record the purchase and sale of the building
during 2011?
(b)
Record the subsequent sale of the building by Maffin during 2011.
(c)
Assume that Maffin purchased the building from Grey for $500. How would your
answer to part (a) change?
(d)
Assume that the transaction is in the normal course of operations for both
Maffin and Grey and that it has commercial substance. How would your answers to
parts (a) and (b) change?
(e)
Calculate the total impact on income of the purchase and sale of the building
for 2011 and 2012 for the consolidated reporting unit of the two companies.
What can you conclude from your calculation?
(a)
Maffin Corp.:
|
Building
(net)..........................
|
700
|
|
|
Retained
Earnings.......................
|
100
|
|
|
Contributed
Surplus.....................
|
200
|
|
|
Cash...............................
|
|
1,000
|
The transaction is not in the
normal course of operations for the two companies and there is arguably no
material change in the ownership interest in the building. The transaction
would therefore be measured at its carrying amount.
The adjustment to contributed
surplus / retained earnings is considered to be a capital payment by Maffin
Corp. and a capital receipt by Grey Inc.
Grey Inc.:
|
Cash .....................................
|
1,000
|
|
|
Contributed Surplus..................
|
|
300
|
|
Building (net).......................
|
|
700
|
(b)
|
Cash .....................................
|
1,100
|
|
|
Gain on sale of building.............
|
|
400
|
|
Building (net).......................
|
|
700
|
A gain of $400 on sale of the
building is recognized as income by Maffin Corp. It is not appropriate to
reverse the original debit of $300 made to equity and recognize a gain in Grey
Inc. now that Maffin Corp. has sold the building.
(c) If Maffin could
purchase the building at an amount less than the carrying amount on Grey’s
financial statements, consideration should be given to whether the value of the
building is impaired and should be written down in Grey’s books prior to
transfer at the reduced carrying amount.
(d)
Maffin Corp.:
|
Building
(net)..........................
|
1,000
|
|
|
Cash...............................
|
|
1,000
|
The transaction is in the normal course of operations
for the two companies and there is commercial substance. It is therefore
appropriate for Grey to recognize a gain of $300. Maffin would record the
building at the exchange amount.
Grey Inc.:
|
Cash .....................................
|
1,000
|
|
|
Gain on sale of building.............
|
|
300
|
|
Building (net).......................
|
|
700
|
Maffin Corp. – Sale of building in 2012
|
Cash .....................................
|
1,100
|
|
|
Gain on sale of building.............
|
|
100
|
|
Building (net).......................
|
|
1,000
|
(e) Option 1: Transaction measured
at carrying amount:
2011:
Maffin Corp. – No impact on the
income statement $ 0
Grey Inc. – No impact on the income
statement 0
2012:
Maffin Corp. – Gain 400
Total income for 2011 and 2012 $ 400
Option 2: Transaction measured at exchange amount:
2011:
Maffin Corp. – No impact on the income statement $ 0
Grey Inc. – Gain of $300 300
2012:
Maffin Corp. – Gain of $100 100
Total income for 2011 and 2012 $ 400
Regardless of the method used, the combined income
for the consolidated reporting unit will be the same. The purchase and sale of
the building between Maffin and Grey become cancelled in the process of
eliminating intercompany balances. The transaction with the “unrelated”
external party provides the objective measurement of the gain to the reporting
unit.
Grey and, to the lesser extent, Maffin, however is
required to report to certain of their users as separate reporting units. In
this case, the measurement of intercompany transactions becomes important in
accurately reflecting economic substance.
We can see that under option two, a portion of the gain ($300) is earned
by Grey and the remainder is earned by Maffin, whereas under option one, the
entire amount of the gain is earned by Maffin. The method of reporting will
have significant impact on the income of each company.
