Question

International Corp. (IC) is a large Canadian company that has operations around the world that are very diverse. In the past few years they have acquired a number of different companies in a variety of businesses. They have decided this year that it is time to reorganize their operations by amalgamating similar businesses, shutting down operations that are not efficient, and upgrading to new facilities. IC has a December 31 year end.

You, CPA, have recently been hired as an accounting policy advisor. Your first job is to prepare a report for your manager identifying how the following events should be accounted for and the impact on the financial statements.

After the reorganization is complete IC hopes to issue shares to the public, so they are concerned about any impact on EPS. In addition, IC has financing from both Canadian and international banks with covenants based on a maximum debt to equity ratio.

Your manager provided you with a summary from the last board of directors meeting of the following sales that have been approved as part of the reorganizing. The company is in the process of trying to find a buyer for these assets.

1. IC plans to sell its head office building and relocate to a larger new building that will meet the needs of their expanded organization. The existing building will continue to be used until February of next year when the new building is expected to be completed.

2. IC plans to sell one of their manufacturing facilities and discontinue that product line, as sales have been low the past few years. Any uncompleted customer orders will be transferred to the buyer. The sale is anticipated within the next year.

3. IC has been operating their own power generating facilities for the past few years. They have decided to exit that operation entirely, as the cost of generating power for their manufacturing facilities was higher than buying power from hydro. The facility was only for IC’s own use, not to sell to others. The sale requires government approval, which could take up to two years once a firm commitment has been made by a buyer. It is anticipated that a buyer will commit within the next year because the facility is being put up for sale at a deeply discounted price.

4. In November IC announced plans to sell their research facility and move into a new building that has the latest technology and is ready for immediate occupancy. Prior to the sale, renovations need to be completed on the research facility to bring the standards up to the current building code. It is anticipated that these renovations will be completed within the next three months.

5. IC stopped using one of their manufacturing facilities in October of this year due to low demand for the products. Operations have ceased until demand recovers, at which time IC will resume production. The facility remains in workable condition.

 

Required:

Provide the requested report.

Answer 1

Dear Manager 

I have prepared the requested report identifying the appropriate treatment for the scenarios in the summary you have provided. Since IC is hoping to issue shares to the public we have an IFRS constraint. In addition, any accounting policies that increase debt will have a negative impact on our covenant with the bank. IC’s management is also concerned about EPB so there may be a bias to select accounting policies to meet this objective.

 

1. Sale of Head Office

The Board has made a decision to sell the head office building and relocate to a larger building. It should be considered if this is a held for sale asset and / or a discontinued operation. One of the criteria of a held for sale asset is that the building must be available for sale immediately. Since, the existing building will continue to be used until February when the new building is completed it could not be classified as held for sale. The building would remain on our books as usual and continue to be depreciated. It would not be reclassified on our Statement of Financial Position as a held for sale asset.

 

2. Sale of Manufacturing Facility

The Board has decided to sale their manufacturing facility and discontinue a product line. It should be considered if this is a held for sale asset and / or a discontinued operation. This meets the definition of a held for sale asset since a Board decision was made. The sale is expected within a year. The facility is immediately available for sale since the remaining unfulfilled orders are transferred to the buyer. Therefore the facility would be reclassified as a current held for sale asset on the Statement of Financial Position at the lower of its carrying amount and fair value less costs to sell. Depreciation would stop on the facility. In addition, this would also be considered a discontinued operation since they are getting out of a product line which would be considered a business segment and have no continuing involvement. Therefore, the net income or loss from the operation and write down of the facility would be shown below continuing operations net of tax.

 

3. Sale of Power Generating Facilities

The Board has decided to sell their power generating facilities and exit that operation. It should be considered if this is a held for sale asset and / or a discontinued operation. This meets the definition of a held for sale asset since a Board decision was made. Normally the sale is expected within a year. In this case the sale is not expected for two years but this is due to waiting for government approval. This is not in control of the company therefore it would not stop them from having a held for sale asset. The facility is immediately available for sale. The price is reasonable since it is deeply discounted. Therefore the facility would be reclassified as a current held for sale asset on the Statement of Financial Position at the lower of its carrying amount and fair value less costs to sell. Depreciation would stop on the facilities. In addition, this would also be considered a discontinued operation since they are exiting that operation which would be considered a business segment and have no continuing involvement. Therefore, the net income or loss would be shown below continuing operations net of tax.

 

4. Sale of Research Facility

The Board has made a decision to sell their research facility and move into a new building. It should be considered if this is a held for sale asset and / or a discontinued operation. One of the criteria of a held for sale asset is that the building must be available for sale immediately. The new building is ready for immediate occupancy so they could move in immediately. But the existing building needs to be renovated to bring it up to the building code before it can be sold which will not be by the year-end therefore it could not be classified as held for sale. The building would remain on our books as usual and continue to be depreciated. It would not be reclassified on our Statement of Financial Position as a held for sale asset.

 

5. Stopped Using Facility

In October the company stopped using one of their facilities due to low demand. Since they intend to start to use the asset again when demand increases this would not be considered a held for sale asset. This would be considered an idle asset. The asset would remain on the books. Depending on the method of depreciation it would continue unless it is based on units of production.

 

Overall, the potential write downs of the held for sale assets may decrease net income and overall EPS. However, it would be presented as a discontinued operation and EPS would be reported before and after discontinued operations.