Leeds and Faster intercompany transactions
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Scenario:
Scenario A
Emily and Richard are majority shareholders and President and Vice President respectively of Leeds Holding Company Incorporated. A holding company is set up to own other companies and provide management and expertise.
Recently, Emily and Richard have invested in Faster Distribution Company Incorporated, a small publicly traded company. They each own 40% of the stock of Faster Distribution. Leeds is a U.S. corporation with its common stock traded on the New York Stock Exchange. The Leeds' home office is in London, and Faster Distributing Company is registered and located in Germany.
You are the financial analyst for Leeds Holding Company, and you answer directly to Emily and Richard. Over the next few weeks, you will advise them on several issues.
Details Surrounding Tax-Free Sale
Emily and Richard have invested in Faster Distribution, a small publicly traded company. They each own 40% of the stock of Faster Distribution. They want to sell Faster to Leeds but do not want to pay any tax on the sale.
According to Section 368 of the IRS Code, there are seven allowed types of tax-free reorganizations:
• Type A - Statutory merger
• Type B - Exchange of stock for stock
• Type C - Exchange of stock for property
• Type D - Transfer of assets between commonly controlled corporations
• Type E - Recapitalization
• Type F - Change of identity or form or organization
• Transfer in bankruptcy
Emily and Richard have controlling interest in both Leeds and Faster, so their goal of selling Faster to Leeds would qualify as a tax-free reorganization of either a type B or type D reorganization. In addition, Emily and Richard are considering how to report the combination. It is their intent to build a vertically integrated corporation to provide value to all shareholders.
Partnership Formation and Dissolution
Emily and Richard are interested in purchasing a large 140-unit apartment complex using a partnership. They are wondering how to go about forming the partnership, whether Leeds should be one of the partners, and the general advantages and disadvantages of partnership formation.
At the end of the year, Emily has retired from the partnership and Frank has joined it. However, the partnership is not going well. Leeds, Richard, and Frank have decided to liquidate the partnership.
Details Surrounding the Purchase of Ownership
Leeds has decided to purchase Emily and Richard's 80% ownership of Faster Distribution Company for $90,000 in excess of book value.
Faster's financial statement is as follows:
Faster Distribution Company Incorporated
Financial Statements
as of 12/31/XX
Assets
During their review of the Leeds' purchase of Faster, it is revealed that Faster paid $125,000 to a German politician to allow the purchase to proceed. Moreover, Faster's plant manager paid $2,000 to a German port official to allow a rice shipment to be completed.
Intercompany Transactions Between Leeds and Faster
Leeds has completed the purchase of Faster. During the year, Leeds sells a wrapping machine to Faster. In addition, Leeds has sold one of its products to Faster for resale to its customers.
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Solution Summary
Leeds and Faster intercompany transactions are examined. A report to Richard is given outlining information.
Solution Preview
Given that Leeds Holding Company now owns 80 per cent of Faster Distribution Company Incorporated from the sale of the combined stock ownership of Emily and Richard, any related-party transactions would have consolidation issues.
Issue at hand is the previous year's sale of a previously purchased wrapping machine by Leeds to Faster. Given the information and circumstances of the issue, the following are the computation of Leeds' gain and the required journal and consolidated worksheet entries.
Leeds' calculation of gain
Book value of wrapping machine 6/30/05 - the date of sale
Original purchase price $150,000
Less: MARCS accumulated depreciation $80,000
Book value $70,000
Sale price to Faster $90,000
Less: Book value $70,000
Gain on sale of wrapping machine $20,000
Leeds' journal entry
Date General Journal Debit Credit
6/30/05 Accounts receivable $90,000
Accumulated Depreciation $80,000
Wrapping machine $150,000
Gain on sale of wrapping machine $20,000
Faster's journal entry
Date General Journal Debit Credit
6/30/05 Wrapping machine $90,000
Accounts payable $90,000
Consolidated worksheet entry
Date General Journal Debit Credit
12/31/05 Accumulated Depreciation $2,000
Depreciation expense $2,000
To eliminate excess depreciation expense
Gain on sale of wrapping machine $20,000
Wrapping machine $20,000
To eliminate ...
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