Reference no: EM132712310

Third Line Property Inc. (TLP) has been incorporated with the purpose to buy, develop and hold a commercial property on Third Line, Oakville, Ontario. TLP will buy the property for $900,000 and build a small office building at an expected cost of $2,100,000. Mr. Sanders is the owner of Sanders Developments Inc. (SDI). SDI will invest $900,000 in TLP for 30% of its common shares. It will finance this investment through a loan of $675,000 and the sale of common shares to Ms. Warren for $225,000. Mr. Biden, a private investor, will invest $2,100,000 in TLP for a 70% interest in TLP. According to the terms of the shareholders' agreement, Mr. Sanders and Mr. Biden must agree on all major operating, financing and investment decisions of TLP. If not, the property will be sold on the open market and TLP will be wound up. Mr. Sanders has approached you to advise him on how SDI should account for its investment in TLP. He was considering using the cost method. The bank that will provide the debt financing to SDI requires a debt-to-equity ratio of no more than 3:1.

REQUIRED:

Problem a. How should SDI's investment in TLP be reported on the financial statements of SDI? Provide arguments to support your recommendations.

Problem b. What impact will the adoption of the reporting method have on SDI's debt-to-equity ratio, relative to using the cost method?