Discuss the impact on the audit report of the proposed treatment of the following items in the financial statements.
(a) Beak Co sells land to a property investment company, Wings Co. The sale price is $20 million and the current market value is $30 million. Beak Co can buy the land back at any time in the next five years for the original selling price plus an annual commission of 1% above the current bank base rate. Wings Co cannot require Beak Co to buy the land back at any time.
The accountant of Beak Co proposes to treat this transaction as a sale in the financial statements. You may assume that the amounts involved are material.
(b) A car manufacturer, Gocar Co, supplies cars to a car dealer, Sparks Co, on the following terms.
Sparks Co has to pay a monthly fee of $100 per car for the privilege of displaying it in its showroom and is also responsible for insuring the cars. When a car is sold to a customer, Sparks Co has to pay Gocar Co the factory price of the car when it was first supplied. Sparks Co can only return cars to Gocar Co on the payment of a fixed penalty charge of 10% of the cost of the car. Sparks Co has to pay the factory price for the cars if they remain unsold within a four-month period. Gocar Co cannot demand the return of the cars from Sparks Co.
The accountant of Sparks Co proposes to treat the cars unsold for less than four months as the property of Gocar Co and not show them as inventory in the financial statements. At the year end the value of car inventory shown in the statement of financial position was $150,720. The total assets on the statement of financial position are $1.3m. The cars unsold for less than four months have a factory cost of $22,500.