Reference no: EM132496921

Point 1: Archipelago Corporation owns 60% of Cavalier Corporation's common stocks. Archipelago Co. is an inter-island transportation company. Archipelago Co. just bought a medium-sized ship in January 1, 2010. Since the financial position of Archipelago Co. was marginal at that time, the acquisition of the ship was carried out by lease agreement with Cavalier Co. To maintain the favorable financial position, Archipelago Co. requested Cavalier Co. to structure the lease agreement so that it looked like an ordinary renting contract. By this scheme, Archipelago Co. would record each lease payment as Rent Expense that would appear in the income statement since the fiscal year of 2010.

Point 2: At the beginning of 2013, you were appointed as an independent auditor for 2012 finan- cial statements of Archipelago Co. Prior to your appointment, financial statements of Archi- pelago Co. were audited by other accounting firm. The annual lease payments were accounted for as an operating lease without any objection from predecessor auditor. You studied the lease contract and found the following facts.

Parties: The lease contract stated that Archipelago Co. was the lessee and Cavalier Co. was the lessor.

Lease term: 16 years (January 1, 2010 up to December 31, 2025).

From several reliable sources, at the time of contract the economic useful life of the ship was estimated to be 20 years.

Lease payments: Rp300.000.000 per year during the term of contract. The lease was paid at the end of each year. No advance payment was made at the time of contract. The last lease payment would be on December 31, 2025. The market interest rates at the date of contract were between 9% to 12% annually. These rates would be effective during the term of contract.

Market value: The market value of the ship at the inception of contract was Rp2.500.000.000

Question 1: Do you assume that Archipelago and Cavalier were related parties? Provide your argument completely! (Refer to relevant accounting standards)