Asset Exchange (Drafting an Issues Memo) Facts: Paper Paper, Inc. transferred equipment to Achoo, Inc. in exchange for the receipt of $1.5 million cash and a 20% equity ownership stake in Achoo. Paper’s book basis in the transferred equipment was $7 million, and the equipment was recently appraised for $7.5 million. The fair value of the investment in Achoo is $6 million, and this fair value was reliably determined. The investment gives Paper significant influence over Achoo but is not a controlling financial interest in Achoo. Achoo is in the business of making and selling tissues (such as Kleenex) and will use the equipment for tissue production.
Prior to transferring the equipment, Paper used the equipment to produce paper plates and napkins. However, significant overseas competition has caused profit margins and demand for the domestic production of paper plates and napkins to fall. Production using the equipment had recently been cut down to only 1 × 8-hr shift per day. Tissues are expected to be a more profitable output, with steady consumer demand. Achoo expects to run the equipment for 3 × 8-hr shifts per day. Paper hopes the investment in Achoo will revive its slowing growth prospects.
Required: You are in the controller’s group of Paper and need to prepare an accounting issues memo 1) evaluating the scope of the applicable topic, and 2) documenting the appropriate accounting for this transaction. Include in your memo the journal entries for this transaction, and explain the authoritative basis for all journal entries recorded. Consider including a picture to enhance the Facts section of the memo. Assume that Paper will account for the ownership stake in Achoo using the equity method.