Boatsman Boats Limited (BBL) is a dealer in pleasure boats located in Kingston, Ontario. The company is incorporated under the Ontario Business Corporations Act and is wholly owned by its founder and president, Jim Boatsman. In 20X5, BBL had revenues of $ 2,500,000 with total assets of about $ 1,000,000 at year- end.

Late in 20X6, Jim Boatsman reached an agreement with Clyde Stickney for the combination of BBL and Stickney Skate Corporation (SSC). SSC is a manufacturer of ice skates and is located in Ottawa, Ontario. SSC’s 20X5 revenue totaled $ 2,000,000 and year- end assets totaled $ 1,500,000. Clyde Stickney is president and general manager of SSC, and he owns 65% of the SSC shares. The other 35% is owned by Clyde’s former partner, who left the business several years previously because of a policy disagreement with Clyde.

Clyde and Jim decided to combine the two businesses because their seasonal business cycles were complementary. Common ownership would permit working capital to be shifted from one company to the other, and the larger asset base and more stable financial performance of the combined company would probably increase the total debt capacity.

Under the terms of the agreement, BBL would issue common shares to Clyde Stickney in exchange for Clyde’s shares in SSC. As a result of the exchange, Jim’s share of BBL would drop to 60% of the outstanding BBL shares, and Clyde would hold the remaining 40%. Clyde and Jim signed a shareholders’ agreement that gave each of them equal representation on the BBL board of directors.

As the end of 20X6 approached, Jim, Clyde, and CA (the BBL auditor) were discussing the appropriate treatment of the business combination on BBL’s 20X6 financial statements. Clyde was of the opinion that CA should simply add together the assets and liabilities of the two companies at their carrying values (after eliminating intercompany balances and transactions, of course). Jim, on the other hand, thought that the combination had resulted in a new, stronger entity, and that the financial statements should reflect that fact by revaluing the net assets of both BBL and SSC to reflect fair values at the date of the combination. CA, however, insisted that only SSC’s net assets should be revalued, and then only to the extent of the 65% of the assets that were represented by BBL’s shareholdings in SSC.

While Jim and Clyde disagreed with each other on the appropriate valuation of the assets, both disagreed with CA’s proposal. Jim and Clyde clearly controlled SSC through BBL, they argued; that was the whole point of the combination. In their opinion it would be inappropriate to value the same assets on two different bases, 65% current value and 35% carrying value. If only SSC’s assets were to be revalued, then they reasoned that the assets at least should be valued consistently, at 100% of fair value.

In an effort to resolve the impasse that was developing, Jim and Clyde hired an independent consultant to advise them. The consultant was asked (1) to advise the shareholders on the pros and cons of each alternative in BBL’s specific case, and (2) to make a recommendation on a preferred approach. The consultant was supplied with the condensed statements of financial position of BBL and SSC as shown in Exhibit B, and with CA’s estimate of fair values (Exhibit C).

Required

Prepare the consultant’s report. Assume that the business combination took place on December 31, 20X6.

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Exhibit B Condensed Statements of Financial Position of BBL and SSC Condensed Statements of Financial Position December 31, 20X6 n Boats Ltd. Stickney Skate Corp 600,000 Current assets Land Buildings and equipment Accumulated depreciation Furniture and fixtures Accumulated depreciation Investment in Stickney Skate Corp. TOTALASSETS Current liabilities Long-term liabilities Common shares Retained earnings TOTAL LIABILITIES AND EQUITIES 350,000 250,000 2,500,000 (1,500,000) 300,000 (100,000) 800,000 (330,000) 1,300,000 $2,370,000 370,000 300,000 1,500,000 200,000 $2,370,000 1,800,000 400,000 900,000 200,000 300,000 $1,800,000 Exhibit C Estimated Fair Values of BBL and SSC Net Asset Fair Values December 31, 20X6 Boatsman Boats Ltd. 600,000 Stickney Skate Con S350 Current assets Land Buildings and equipment: 700,000 5,000,000 (3,000,000) estimated replacement cost new less depreciation Furniture and fixtures: 500,000 (240,000) (400,000) (930,000) 1980,000 estimated replacement cost new 1,300,000 (520,000) (370,000) (270,000) 740,000 less depreciation Current liabilities Long-term liabilities Net asset fair value Discounted at aurrent long-term interest rates