Delphina Solutions Inc. is an Ontario-based manufacturer. The company is listed on the TSX, but the family of founder David Delphina retains control through multiple voting shares. Delphina undertook the modernization of its production facilities during the fiscal year 2020. 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 Production equipment has been replaced by newer systems.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. Delphina’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 Delphina’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 Delphina 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 the 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 Delphina’s books of $4,600,000; Delphina is asking $4,000,000 for the equipment, which is less than the $5,000,000 value estimated by the company that is supplying Delphina’s new conveyor system.

4. Delphina 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 Irwin Corporation, an unrelated Halifax-based company. Delphina has negotiated to sell the assets to Irwin Corporation for $1,250,000, effective 1 December 2020. The equipment’s current book value is $900,000. Effective 2 January 2021, Irwin Corporation will produce Delphina’s products and also will maintain the inventory. Irwin will manage the sales force for the eastern region, although all sales and accounts receivable will continue to be invoiced and collected by Delphina. Delphina will reimburse Irwin Corporation for the cost of production and direct sales expense plus 50% of the gross margin.

Delphina’s general manager, Lindsey Martin, 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 Delphina’s financial statements. In addition, Delphina would like to determine the fair value of its manufacturing facility in London, Ontario, independent of modernization events 1 to 4 above. The facility consists of land, building, and manufacturing equipment.

You have recently been given a summer internship in Delphina’s general accounting department. The manager would like you to prepare a report in which you summarize the reporting consequences of the company’s reorganization activities and identify some of the considerations that are involved in a fair value measurement of the assets of the manufacturing facility and of the manufacturing facility altogether.

Required: In your report to Lindsey Martin, you should:

1. Explain fully how each of these modernization and reorganization events (1 to 4 above) should be accounted for by Delphina. To the extent possible, specify the numerical effect on Delphina’s income statement and SFP for 2020 and address the manager’s worries that the bank may reduce the line of credit.

2. Identify some of the considerations that are involved in a fair value measurement and using the fair value hierarchy, discuss the level 1, 2, and 3 types of inputs that Delphina could use to value each of the assets as well as its London manufacturing facility altogether.

Answer rating: 100% (QA)

The reorganization activities that companies engage in may alter the financial statements of a compa... View the full answer