(a) How should these two investments be reported on the financial statements of Holdco? Provide arguments to support your recommendations. 

(b) What impact will the adoption of the reporting methods suggested in part (a) have on Holdco's debt-to-equity ratio? Briefly explain.

Mr. Landman has spent the last 10 years developing small commercial strip malls and has been very successful. He buys a residential property in a high-traffic area, rezones the property, and then sells it to a contractor who builds the plaza and sells it to investors. Mr. Landman has often been hired to manage the commercial plazas for a fee. Now Mr. Landman wants to become a real estate baron.

Rather than just developing the plazas for resale, he wants to form partnerships with builders and/or investors to build commercial properties and keep them as long-term investments. He has found two properties suitable for development and made offers to the current owners to purchase these properties on January 1, Year 2. The offers are conditional upon arranging suitable financing for the acquisition.

Mr. Landman intends to set up two separate companies to buy, develop, and hold the properties. Elgin Company will purchase the property on Elgin Street for $1,200,000 and build a small office building at an expected cost of $2,800,000. Mr. Landman's holding company, Holdco, will invest $1,200,000 in Elgin for 30% of its common shares. Ms. Richer, a private investor, will invest $2,800,000 for a 70% interest in Elgin. According to the terms of the shareholders' agreement, Mr. Landman and Ms. Richer must agree on all major operating and financing decisions. Otherwise, the property will be sold in the open market and the company will be wound up. 

The second company, Metcalfe Inc., will buy a recently developed strip mall on Metcalfe Street for $2,000,000. The purchase will be financed with a first mortgage of $1,500,000 and $500,000 of equity. Mr. Landman's holding company will invest $200,000 in Metcalfe for 40% of its common shares and will manage the property. Ms. Richer will invest $300,000 for a 60% interest in Metcalfe. 

The shareholders' agreement contains the following terms:

• Ms. Richer is guaranteed a return of her investment of $300,000 plus cumulative dividends of $24,000 a year.

• Mr. Landman is responsible for making all key operating, investing, and financing decisions.

• Mr. Landman's holding company guarantees the payment of dividends to Ms. Richer on an annual basis. After both shareholders have received cumulative dividends equal to 8% of their initial investments, Ms. Richer will receive 10% and Mr. Landman's holding company will receive 90% of the undistributed profits. 

Holdco intends to use the cost method for internal purposes to account for these two investments. Holdco typically finances its acquisitions with 75% debt and 25% equity. The debt financing has a maximum debt-to-equity ratio of 3: 1.