In Plane View
Problem: Whiz Corporation overstated the value of shares given in exchange for an airplane and, thereby, understated its loss on disposition of the shares. Income was overstated. Whiz owned 160,000 Wing Company shares, carried on the books as an investment in the amount of $6,250,000. Whiz bought a used airplane from Wing, giving in exchange (1) $480,000 cash and (2) the 160,000 Wing shares. Even though the quoted market value of the Wing shares was $2,520,000, Whiz valued the airplane received at $3,750,000, indicating a share valuation of $3,270,000. Thus, Whiz recognized a loss on disposition of the Wing shares in the amount of $2,980,000.
Whiz justified the airplane valuation with another transaction. On the same day it was purchased, Whiz sold the airplane to the Mexican subsidiary of one of its subsidiary companies (two layers down; but Whiz owned 100% of the first subsidiary, which in turn owned 100% of the Mexican subsidiary). The Mexican subsidiary paid Whiz with US$25,000 cash and a promissory note for US$3,725,000 (market rate of interest).
Audit trail: The transaction was within the authority of the chief executive officer, and company policy did not require a separate approval by the board of directors. A contract of sale and correspondence with Wing detailing the terms of the transaction were in the files. Likewise, a contract of sale to the Mexican subsidiary, along with a copy of the deposit slip, and a memorandum of the promissory note were on file. The note itself was kept in the company vault. None of the Wing papers cited a specific price for the airplane.
Amount: Whiz overvalued the Wing shares and justified this with a related party transaction with its own subsidiary company. The loss on the disposition of the Wing shares was understated by $750,000.