Question

The following transactions have been encountered in practice. Assume that all amounts are material.

a. A company decided to put the assets of one product line up for sale (intended to be sold within next year) because management had decided to outsource production of that product to Mexico. The company established a plan of sale and engaged an industrial broker. The assets consisted of inventory with a carrying value of $80,000 and equipment with a carrying value of $840,000. The estimated recoverable amount was $60,000 for the inventory and $560,000 for the equipment, before deducting a 5% broker’s commission.

b. A company suffered damages due to heavy snow accumulation and an ice storm that caused one of their warehouses to collapse amounting to $800,000. The company has had damages due to heavy winds ripping off the roof of one of their warehouses but never due to an ice and snow storm.

c. A company paid $225,000 damages assessed by the courts as a result of an injury to an employee while working on heavy machinery two years earlier.

d. A company sold a capital asset and recorded a gain of $50,000. The asset originally had a carrying value of $660,000 but had been written down to $500,000 in the prior year.

e. A major supplier of raw materials to a company experienced a prolonged strike. As a result, the company reported a loss of $250,000. This is the first such loss; however, the company has three major suppliers, and strikes are not unusual in the industry. With the economic downturn it is anticipated that more strikes are likely next year.

f. A Canadian company owns a majority of the shares of a publicly traded subsidiary in India. The shares have been held for a number of years and are viewed as long term investments. During the past year, 10% of the shares were sold to meet an unusual cash demand. Additional disposals are not anticipated. In the process of translating the subsidiary’s financial statements from rupees to the Canadian dollar, a translation adjustment arose from exchange rate changes that had occurred over the year.

 

Required:

For each of the foregoing transactions, explain how financial statement elements will be affected and how the results of the transactions and events should be reported in each company’s year end financial statements.

Answer 1

a.            

This is the sale of an asset group. It is not a discontinued operation because the assets themselves are neither the discontinuance of a major product or geographic segment nor a cash-generating activity. The revenue stream will continue; it’s only the source of the product that will change.

 

The assets must be written down to their net recoverable value, which is as follows, after the 5% commission:

($60,000 + $560,000) × 95% = $589,000

The carrying values of the assets must be written down, recording a loss of $331,000 (i.e., $80,000 – $57,000 + $840,000 – $532,000). The loss must be reported within continuing operations but may be separately disclosed as a nonrecurring loss. The inventory and equipment must be segregated on the statement of financial position, grouped together, and reported as “assets held for sale”.

 

b.            

The loss due to the snow and ice storm may not be a normal business expense, because even though there has been damage due to high winds never due to snow and ice. The expense may be highlighted by a separate line item on the income statement, but must be included in expenses of continuing operations.

 

c.             

The payment of damages, assessed by a court, is a typical business risk. One assumes it is infrequent and thus unusual. The loss must be included in operating expenses, although it should be separately disclosed if the amount may significantly affect users’ perceptions of the profitability of the company’s normal operations. It may not be carried back as a restatement of prior years’ results.

 

d.            

The gain must be reported at $50,000 in the income statement. The fact that it had been written down in the prior year is irrelevant.

 

e.            

This transaction reflects is a normal business risk. Such a large loss may be infrequent, but it is still a part of normal continuing operations. The cause and extent of the loss can be disclosed in the notes.

 

f.             

The “gain” arose from translating the subsidiary’s statements from rupees to Canadian dollars. This was not a gain from foreign currency transactions. Therefore, the amount is reported as an item of other comprehensive income on the statement of comprehensive income. (It will also be reported in the “translation gain/loss” column or section of the parent company’s statement of changes in equity, but that is covered in Chapter 4, not in this chapter.)