Deluca Solutions Inc. is an Ontario- based manufacturer. The company is listed on the TSX, but the family of founder David Deluca retains control through multiple- voting shares.
Deluca undertook modernization of its production facilities during fiscal year 20X4. As part of the modernization process, the following events occurred:
1. Production equipment has been replaced by newer systems. The old equipment will be sold if a buyer can be found. The company has not yet identified a method for finding a likely buyer for the equipment. At the time its use was discontinued, the equipment had a carrying value of $ 1,000,000. Deluca’s production manager estimates that it could be sold for about half that price, at best.
2. The company discontinued using a small four- year- old building that has housed one part of a production process. Since the building is on Deluca’s property, among the company’s other buildings, it is not feasible to sell the building or to rent it to an outside organization However, it is quite possible that Deluca will find a use for it in some future year. The building originally cost $ 3,000,000 to construct and is being depreciated on a straight- line basis over 20 years.
3. A warehousing conveyor system is being replaced. A buyer for the old system, including supplies and spare parts, is actively being sought so that it can be dismantled to make room for the new system. The warehousing manager estimates that the cost of dismantling the system will be about $ 600,000. The buyer will be responsible for installation. It is expected that the buyer will cover the cost of shipping, although the relative cost of shipping (depending on the distance to the buyer’s facilities) will have an impact on the equipment’s realizable value. The equipment has a carrying value on Deluca’s books of $ 4,600,000; Deluca is asking $ 4,000,000 for the equipment, which is less than the $ 5,000,000 value estimated by the company that is supplying Deluca’s new conveyor system.
4. Deluca has decided that its production and sales for the Eastern Canada area would be more efficient and effective if the company transferred all of its assets in that region to Irving Corporation, an unrelated Halifax- based company. Deluca has negotiated to sell the assets to Irving Corporation for $ 1,250,000, effective 1 December 20X4. The equipment’s current book value is $ 900,000. Effective 2 January 20X5, Irving Corporation will produce Deluca’s products and also will maintain the inventory. Irving will manage the sales force for the eastern region, although all sales and accounts receivable will continue to be invoiced and collected by Deluca. Deluca will reimburse Irving Corporation for the cost of production and direct sales expense plus 50% of the gross margin.
5. The former employees in the Eastern Canada division were offered a choice of moving to the new Halifax owner or receiving six months of severance pay conditional on a promise not to seek employment from the new owner for at least one year. A survey of the affected employees indicated that 60% will elect to accept a transfer. The cost of severance pay for the other 40% is estimated to be $ 900,000, none of which will be paid out until after the end of the current fiscal year. Deluca’s general manager, Lindsey Adroit, is uncertain as to how the financial aspects of these changes will affect the company’s financial statements.
The company has a substantial line of credit with the bank, but the credit line is fully drawn, and the manager worries that the bank may reduce the credit line if the reorganization will have adverse effects on Deluca’s financial statements. You have recently been given a summer internship in Deluca’s general accounting department. The manager is aware that you are enrolled in some higher- level accounting courses and would like you to prepare a report in which you summarize the reporting consequences of the company’s reorganization activities.
Explain fully how each of these events should be accounted for by Deluca. What will be the impact on Deluca’s financial statements for 20X4? To the extent possible, specify the numerical effect on both the income statement and the SFP.