Question

ICP 2

On January 1, 20X1, Investor Inc. purchased 25% of the common shares of Associate Ltd. for $50,000. It was determined that Investor had significant influence over the operating and financial policies of Associate. On the date of acquisition, the net assets of Associate totalled $180,000 (common shares of $100,000 and retained earnings of $80,000), and the carrying values of the identifiable assets and liabilities approximated their fair values. Both companies’ income tax rate is 20%.

The following information was available for the year ended December 31, 20X1:

• Associate reported net income of $60,000 for the year.

• Associate paid a dividend totalling $40,000 to its shareholders on December 31, 20X1.

• During the year, Associate sold merchandise totalling $50,000 to Investor. Associate reported a gross profit of 40% on its sales to Investor. At the end of the year, $5,000 of this merchandise remained in Investor’s inventory.

• During the year, Investor sold goods totalling $20,000 to Associate. Investor recorded a gross profit of 60% on its sales to Associate. At December 31, $4,000 of this inventory remained in Associate’s inventory.

• Investor tested its investment in Associate for impairment, and an impairment of $1,000 was indicated.

• During the year, Associate sold land to Investor at a gain of $20,000. Investor still held the land at December 31.

The following information was available for the year ended December 31, 20X2:

• Associate reported a net loss of $10,000 for the year.

• Associate paid a dividend totalling $8,000 to its shareholders on December 31, 20X2.

• During the year, Associate sold merchandise totalling $60,000 to Investor. Associate reported a gross profit of 40% on its sales to Investor. At the end of the year, $10,000 of this merchandise remained in Investor’s inventory.

• During the year, Investor sold goods to Associate totalling $80,000. Investor recorded a gross profit of 60% on its sales to Associate. At December 31, $2,000 of these goods remained in Associate’s inventory.

Associate’s retained earnings at December 31, 20X2, were $82,000.

Required:

a) Calculate the goodwill on the purchase of Associate Ltd.

b) Prepare journal entries on the books of Investor Inc. to record transactions related to its investment in Associate Ltd. for the year ended December 31, 20X1.

c) Prepare journal entries on the books of Investor Inc. to record transactions related to its investment in Associate Ltd. for the year ended December 31, 20X2.

d) What is the net balance in the Investment in Associate Ltd. account at December 31, 20X2?

Answer 1

Solution to ICP 2

a)	Goodwill:
Purchase price	$50,000
Share of net assets acquired ($180,000 × 25%)	45,000
Acquisition differential	5,000
Goodwill*	$5,000

 

As FV = BV for identifiable net assets, the entire acquisition differential is allocated to goodwill.

 

b)	Journal entries 20X1:
Investment income:
Associate’s net income	$60,000
Unrealized after-tax upstream profit — inventory	-1,600
($5,000 × 40%) × (1 – 20%)
Unrealized after-tax upstream profit — land [$20,000 × (1 – 20%)]	-16,000
	42,400
Investor’s percentage ownership	× 25%
	10,600
Unrealized after-tax downstream profit — inventory	-480
($4,000 × 60%) × 25% × (1 – 20%)**
Impairment loss*	-1,000
Investment income	$9,120

 

Particulars	Debit	Credit
Investment in Associate Ltd.	50,000
To Cash		50,000
To record initial investment.
Investment in Associate	9,120
To Investment income in Associate		9,120
To record investment income.
Cash ($40,000 × 25%)	10,000
To Investment in Associate		10,000
To record dividend income.

 

Recall that the journal entry above to record the investment income can be broken down into its component parts as per the following three journal entries:

 

Particulars	Debit	Credit
Investment in Associate Ltd.	15,000
To Investment income in Associate (60,000 × 25%)		15,000
To record Investor’s share of Associate’s income.
Investment income in Associate	4,880
To Investment in Associate Ltd.
To remove Investor’s share of unrealized after-tax profits		4,880

 

Unrealized after-tax profits		After-tax	Investor’s	Investor’s
	Pre-tax	(1 – 20%)	% owned	share
Unrealized after-tax upstream profit — inv.	-2,000	-1,600	25%	-400
Unrealized after-tax upstream profit — land	-20,000	-16,000	25%	-4,000
Unrealized after-tax downstream profit — inv.	-2,400	-1,920	25%	-480
Total to be adjusted				-4,880

 

Particulars	Debit	Credit
Investment income in Associate	1,000
To Investment in Associate Ltd.		1,000
To record the impairment loss on the investment in Associate.

 

c)	Journal entries 20X2:
Investment income:
Associate’s net loss	($10,000)
Realized after-tax upstream profit — inventory	1,600
Unrealized after-tax upstream profit — inventory	-3,200
(10,000 × 40%) × (1 – 20%)
	-11,600
Investor’s percentage ownership	× 25%
	($2,900)
Realized after-tax downstream profit — inventory	480
($4,000 × 60%) × 25% × (1 – 20%)
Unrealized after-tax downstream profit — inventory	-240
($2,000 × 60%) × 25% × (1 – 20%)
Investment loss	($2,660)

 

Particulars	Debit	Credit
Investment loss in Associate	2,660
To Investment in Associate		2,660
To record investment loss.
Cash ($8,000 × 25%)	2,000
To Investment in Associate		2,000

 

Recall that the journal entry above to record the investment income can be broken down into its component parts as per the following two journal entries:

 

Particulars	Debit	Credit
Investment loss in Associate	2,500
To Investment in Associate (10,000 loss × 25%)		2,500
To record Investor’s share of Associate’s loss.
Investment income in Associate	160
To Investment in Associate Ltd.		160

 

Realized and unrealized after-tax profits	Pre-tax	After-tax	Investor’s	Investor’s
		(1 – 20%)	% owned	share
Realized after-tax upstream profit — inventory	2,000	1,600	25%	400
Unrealized after-tax upstream profit — inv.	-4,000	-3,200	25%	-800
Realized after-tax downstream profit — inv.	2,400	1,920	25%	480
Unrealized after-tax downstream profit — inv.	-1,200	-960	25%	-240
Total to be adjusted				-160

 

d) Balance in the Investment in Associate account:
Initial investment		$50,000
Investment income — 20X1		9,120
Dividends — 20X1		-10,000
Investment loss — 20X2		-2,660
Dividends — 20X2		-2,000
Net balance in investment account as at Dec. 31, 20X2		$44,460
Alternatively:
Initial investment		$50,000
Associate R/E, Dec. 31, 20X2	$82,000
Less R/E at acquisition	80,000
Post-acquisition increase	2,000
Unrealized after-tax upstream profit — land	-16,000
Unrealized after-tax upstream profit — inventory	-3,200
	-17,200
Investor’s percentage	× 25%	-4,300
Unrealized after-tax downstream profit — inventory (prorated)		-240
Investment in Associate impairment loss		-1,000
Net balance in investment account as at Dec. 31, 20X2		$44,460

 

Solution to ICP 2

a)	Goodwill:
Purchase price	$50,000
Share of net assets acquired ($180,000 × 25%)	45,000
Acquisition differential	5,000
Goodwill*	$5,000

 

As FV = BV for identifiable net assets, the entire acquisition differential is allocated to goodwill.

 

b)	Journal entries 20X1:
Investment income:
Associate’s net income	$60,000
Unrealized after-tax upstream profit — inventory	-1,600
($5,000 × 40%) × (1 – 20%)
Unrealized after-tax upstream profit — land [$20,000 × (1 – 20%)]	-16,000
	42,400
Investor’s percentage ownership	× 25%
	10,600
Unrealized after-tax downstream profit — inventory	-480
($4,000 × 60%) × 25% × (1 – 20%)**
Impairment loss*	-1,000
Investment income	$9,120

 

Particulars	Debit	Credit
Investment in Associate Ltd.	50,000
To Cash		50,000
To record initial investment.
Investment in Associate	9,120
To Investment income in Associate		9,120
To record investment income.
Cash ($40,000 × 25%)	10,000
To Investment in Associate		10,000
To record dividend income.

 

Recall that the journal entry above to record the investment income can be broken down into its component parts as per the following three journal entries:

 

Particulars	Debit	Credit
Investment in Associate Ltd.	15,000
To Investment income in Associate (60,000 × 25%)		15,000
To record Investor’s share of Associate’s income.
Investment income in Associate	4,880
To Investment in Associate Ltd.
To remove Investor’s share of unrealized after-tax profits		4,880

 

Unrealized after-tax profits		After-tax	Investor’s	Investor’s
	Pre-tax	(1 – 20%)	% owned	share
Unrealized after-tax upstream profit — inv.	-2,000	-1,600	25%	-400
Unrealized after-tax upstream profit — land	-20,000	-16,000	25%	-4,000
Unrealized after-tax downstream profit — inv.	-2,400	-1,920	25%	-480
Total to be adjusted				-4,880

 

Particulars	Debit	Credit
Investment income in Associate	1,000
To Investment in Associate Ltd.		1,000
To record the impairment loss on the investment in Associate.

 

c)	Journal entries 20X2:
Investment income:
Associate’s net loss	($10,000)
Realized after-tax upstream profit — inventory	1,600
Unrealized after-tax upstream profit — inventory	-3,200
(10,000 × 40%) × (1 – 20%)
	-11,600
Investor’s percentage ownership	× 25%
	($2,900)
Realized after-tax downstream profit — inventory	480
($4,000 × 60%) × 25% × (1 – 20%)
Unrealized after-tax downstream profit — inventory	-240
($2,000 × 60%) × 25% × (1 – 20%)
Investment loss	($2,660)

 

Particulars	Debit	Credit
Investment loss in Associate	2,660
To Investment in Associate		2,660
To record investment loss.
Cash ($8,000 × 25%)	2,000
To Investment in Associate		2,000

 

Recall that the journal entry above to record the investment income can be broken down into its component parts as per the following two journal entries:

 

Particulars	Debit	Credit
Investment loss in Associate	2,500
To Investment in Associate (10,000 loss × 25%)		2,500
To record Investor’s share of Associate’s loss.
Investment income in Associate	160
To Investment in Associate Ltd.		160

 

Realized and unrealized after-tax profits	Pre-tax	After-tax	Investor’s	Investor’s
		(1 – 20%)	% owned	share
Realized after-tax upstream profit — inventory	2,000	1,600	25%	400
Unrealized after-tax upstream profit — inv.	-4,000	-3,200	25%	-800
Realized after-tax downstream profit — inv.	2,400	1,920	25%	480
Unrealized after-tax downstream profit — inv.	-1,200	-960	25%	-240
Total to be adjusted				-160

 

d) Balance in the Investment in Associate account:
Initial investment		$50,000
Investment income — 20X1		9,120
Dividends — 20X1		-10,000
Investment loss — 20X2		-2,660
Dividends — 20X2		-2,000
Net balance in investment account as at Dec. 31, 20X2		$44,460
Alternatively:
Initial investment		$50,000
Associate R/E, Dec. 31, 20X2	$82,000
Less R/E at acquisition	80,000
Post-acquisition increase	2,000
Unrealized after-tax upstream profit — land	-16,000
Unrealized after-tax upstream profit — inventory	-3,200
	-17,200
Investor’s percentage	× 25%	-4,300
Unrealized after-tax downstream profit — inventory (prorated)		-240
Investment in Associate impairment loss		-1,000
Net balance in investment account as at Dec. 31, 20X2		$44,460