Question

Review of pre-consolidation equity method (controlling investment in affiliate, fair value differs from book value) Assume an investee has the following financial statement information for the three years ending December 31, 2019: (At December 31) 2019 2018 2017 Current assets $285,000 $277,500 $207,000 Tangible fixed assets 662,500 575,000 563,000 Intangible assets 40,000 45,000 50,000 Total assets $987,500 $897,500 $820,000 Current liabilities $120,000 $110,000 $100,000 Noncurrent liabilities 266,250 242,500 220,000 Common stock 100,000 100,000 100,000 Additional paid-in capital 100,000 100,000 100,000 Retained earnings 400,000 345,000 300,000 Stockholders' equity 600,000 545,000 500,000 Total liabilities and equity $986,250 $897,500 $820,000 (For the years ended December 31) 2019 2018 2017 Revenues $970,000 $920,000 $850,000 Expenses 875,000 840,000 775,000 Net income $95,000 $80,000 $75,000 Dividends $40,000 $35,000 $25,000 Assume that on January 1, 2017, an investor company purchased 100% of the outstanding voting common stock of the investee. On the date of the acquisition, the investee’s identifiable net assets had fair values that approximated their historical book values, except for tangible fixed assets, which had fair value that was $112,500 higher than the investee’s recorded book value. The tangible fixed assets had a remaining useful life of 6 years. In addition, the acquisition resulted in goodwill in the amount of $218,750 recognized in the consolidated financial statements of the investor company. Assuming that the investor company uses the equity method to account for its investment in the investee, what is the balance in the “income from investee” account in the investor company’s pre-consolidation income statement for the year ended December 31, 2019? $95,000 $36,250 $76,250 $55,000

Answer 1

NAV as on 31-Dec-2017 as per book values
Common stock	100,000
Additional paid-in capital	100,000
Retained earnings	300,000
Book value NAV as on 31-Dec-2017	500,000
Less: 2017 profit	(75,000)
Add: 2017 dividend	25,000
Book value NAV as on 1-Jan-2017	450,000
Book value adjustments
Tangible assets	112,500
Goodwill	218,750
Price paid	781,250
Profit for 3 years
2017	75,000
2018	80,000
2019	95,000
Total	250,000
Dividend for 3 years
2017	(25,000)
2018	(35,000)
2019	(40,000)
Total	(100,000)
Profits net of dividend	150,000
Pre-consolidation investment value
Price paid	781,250
Net profit net of dividend	150,000
Less: Tangible asset depreciation on value adjustment	(56,250)
Since 6 years of life so the additional value will be depreciated 50% for 3 years
Investment value	875,000

The Company Pre-Consolidated Income for the year ended Dec 31, 2019

            = Income for the year 2019 – Tangible Asset depreciation for the year 2019

= 95000 – 112500/6

= 95000 – 18750

= $76,250

Option C is correct.

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