Soon after beginning the year-end audit work on March 10 for the 2014 year end at Arkin Corp., the auditor has the following conversation with the controller:
Controller: The year ending March 31, 2014, should be our most profitable in history and, because of this, the board of directors has just awarded the officers generous bonuses.
Auditor: I thought profits were down this year in the industry, at least according to your latest interim report.
Controller: Well, they were down, but 10 days ago we closed a deal that will give us a substantial increase for the year.
Auditor: Oh, what was it?
Controller: Well, you remember a few years ago our former president bought shares of Hi-Tek Enterprises Ltd.
Because he had those grandiose ideas about becoming a conglomerate? They cost us $3 million, which is the current carrying amount. On March 1, 2014, we sold the shares to Campbell Inc., an unrelated party, for $4 million. So, we'll have a gain of $686,000, which results from $1 million pre-tax minus a commission of $20,000 for legal fees and taxes at 30%. This should increase our net income for the year to $5.2 million, compared with last year's $4.8 million. The transaction fees were higher than normal due to the setting up of the note receivable. As far as I know, we'll be the only company in the industry to register an increase in net income this year. That should help the market value of our shares!
Auditor: Do you expect to receive the S4 million in cash by March 31, your fiscal year end?
Controller: No. Although Campbell Inc. is an excellent company, they're a little tight for cash because of their rapid growth. We have a $4-million non-interest-bearing note with $400,000 due each year for the next 10 years, which Campbell signed. The first payment is due March I of next year and future payments are due on the same date every year thereafter.
Auditor: Why is the note non- interest-bearing? I thought the market rate of interest was closer to 8%?
Controller: Because that's what everybody agreed to. Since we don't have any interest-bearing debt, the funds invested in the note don't cost us anything, and we weren't getting any dividends on the Hi-Tek shares.
Instructions
Prepare the auditors written report to the controller on how this transaction should be accounted for, and how any corrections that are necessary will affect the reported results for the current year ending March 31, assuming that the company reports under IFRS. Make assumptions where required and make the appropriate journal entries at March 1 and March 31, 2014. What is the revised net income for the company for the year ending March 31? What changes would be necessary if the company reported under ASPE? (Assume that Arkin records the investment in Hi-Tek as an FV-NI Investment under both IFRS and ASPE, and that in all prior year’s fair value equalled cost).