Chapter 16 - Solution Manual

Bevos advance was not an operating loan to an

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Bevo's advance was not an operating loan to an affiliate in need of working capital or temporary liquidity. It served only to clear Bevo's title to the property, plant and equipment of Algo's division. Also, the fact that Casco was formed for this purpose implies that the advance would not be paid back except perhaps through an exchange of the Algo shares purchased from the minority stockholder, an exchange which could be made at will by Bevo and therefore has little substance. Finally, accounts receivable generally are related to receivables from normal trade with customers. ii. Treating the entire $75,000 advance as an investment in Casco is not appropriate even though stock of Algo was purchased by Casco with the $75,000 because the underlying value of the related assets was only about one half of this cost. In addition Bevo's board would not invest in Algo as a purchase agreement with Algo and had nothing to gain in the way of control of the majority. It also would not be likely to invest more in an entity managed by a management with divergent views. Therefore, one half of the $75,000 should be treated as an investment in Casco (the value of the Algo stock purchased by Casco) with the remainder treated as a cost of property, plant and equipment. iii. Treating the entire $75,000 advance to Casco as a cost of property, plant and equipment purchased from Algo does not seem appropriate although in substance the transaction was an attempt to obtain clear title to the property, plant and equipment. It is of course true that had the minority stockholder not intended to exercise his right to prevent the purchase, Casco would not have been formed and the advance would not have been made. To the extent that a portion of the $75,000 cost of the Algo stock can be attributed to the market value of the Algo stock, Bevo should treat that amount as an investment in Casco. After this allocation all that remains of the $75,00 advance should be treated as a part of the cost of property, plant and equipment of the manufacturing division purchased from Algo. If it is assumed that the original negotiated price reflected the fair market value of the property, plant and equipment purchased, that part of the $75,000 which is in excess of the fair market value should be treated as an intangible asset and classified as goodwill. iv. Treating the $75,000 advance as a loss does not seem appropriate because a loss is a reduction of equity, other than withdrawals of capital, for which no compensating value had been or is expected to be received. It was not an expired cost, one without benefits to the revenue producing activities of the enterprise. The $75,000 advance served a useful purpose: removing probable future actions to prevent the purchase or, failing that, to seek equity. This treatment might be appropriate if the $75,000 raised the cost of the property, plant and equipment far beyond its economic usefulness. However, this condition is unlikely in this situation because Bevo's board would not have pursued the agreement or taken the action it did unless the additional costs of obtaining clear title were economically justifiable.
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