Reference no: EM132962927
Soon after beginning the year-end audit work on December 26, 2020 at Magnificent Corporation, the auditor has the following conversation with the accountant.
Accountant: The year ended December 31st should be our most profitable since the company's inception and, as a consequence, the board of directors has just awarded the officers generous bonuses.
Auditor: Thought profits were down this year in the industry, according to your latest interim report.
Accountant: Well, they were down, but 5 days ago we closed a deal that will give us a substantial increase for the year.
Auditor: Oh, what was it?
Accountant: Well, you remember a few years ago our former CEO bought land in a prime location, Golden Circle, because he planned on constructing a commercial building there. For 5 years we have not been able to materialize the plan. The land has been carried in our books at its cost of P3,000,000 ever since. Last week, we sold this land to Wealth Inc. for P4,000,000. So, we will have a gain of P700,000 (P1,000,000 pretax) which will increase our net income for the year to P4,000,000, compared with last year's P3,800,000. 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 the stock!
Auditor: Do you expect to receive the P4,000,000 in cash by December 31st, your calendar year-end?
Accountant: No. Although Wealth Inc. is an excellent company, they are a little tight for cash as of this time because of their rapid growth. Consequently, they are going to give us a P4,000,000 zero-interest-bearing note with payments of P800,000 per year for the next 5 years. The first payment is due on December 31 of next year.
Auditor: Why is the note zero-interest-bearing when the current interest rate in the market is at 8%?
Accountant: Because that's what everybody agreed to. Since we don't have any interest-bearing debt, the funds invested in the note do not cost us anything and besides, we were not getting any income on the land purchased.
Problem 1: Do you agree with the way the accountant has accounted for the transaction? Why or why not? If not, how should the transaction be accounted for? Provide the necessary journal entries with schedules/amortization tables.
Problem 2: Identify the inherent problems in this scenario and discuss its impact on the financial statements of the company.
Problem 3: What is the problem all about? Is this problem is all about note receivable?