The sale of a building by XYZ to LMN below its book value may raise concerns about fair value principles, impacting transparency in financial reporting.
The likely consequence of the transaction where XYZ Inc. transferred a building to LMN Corporation at a price ($45,000) lower than its book value ($50,000) is a potential accounting issue related to intercompany transfers. The accounting principle that may be relevant in assessing the fairness of the transfer is the principle of fair value.
Fair value accounting suggests that assets should be recorded at their current market value when transferred between related entities. In this case, the sale price is less than the carrying amount on XYZ's books, raising questions about the fairness of the transaction. The difference between the book value and the sale price could be viewed as a form of implicit subsidy or transfer of value from XYZ to LMN.
This scenario may trigger scrutiny from regulatory bodies and auditors, as transactions between related parties should be conducted at arm's length to ensure the integrity of financial reporting. The situation highlights the importance of adhering to fair value principles in intercompany transactions to maintain transparency and accuracy in financial statements.
Complete question:
XYZ Inc. owns 80 percent of LMN Corporation. On October 1, 20X4, XYZ transferred a building with a book value of $50,000 (original cost $70,000) to LMN for $45,000.
What is a likely consequence of this transaction, and what accounting principles might be relevant in assessing the fairness of the transfer?