Question

On January 2, 20X7, Victory Co. acquired 60% of the shares of Sauce Ltd. by issuing shares valued at $1,200,000. On this date, Sauce’s building and machinery had estimated remaining useful lives of 10 years and 5 years respectively. Both Victory and Sauce use straight-line depreciation. The separate-entity statements of financial position for Victory and Sauce just prior to the acquisition are presented below.

Statements of Financial Position
As of January 1, 20X7

                   Victory Co. Sauce Ltd.

	(Carrying Value)	(Carrying Value)	(Fair Value)
Noncurrent assets:
Land	$ -	$ 360,000	$ 640,000
Building	2,080,000	1,200,000	1,040,000
Accumulated depreciation	(320,000)	(400,000)
Machinery	1,400,000	1,040,000	80,000
Accumulated depreciation	(560,000)	(640,000)
Total noncurrent assets	2,600,000	1,560,000
Current assets:
Inventories	640,000	240,000	240,000
Accounts receivable	560,000	160,000	160,000
Cash	400,000	80,000	80,000
Total current assets	1,600,000	480,000
Total assets	$4,200,000	$2,040,000
Shareholders’ Equity:
Common shares	$1,760,000	$ 800,000
Retained earnings	1,800,000	520,000
Total shareholders’ equity	3,560,000	1,320,000
Noncurrent liabilities:
Long-term bank loan	-	400,000	400,000
Current liabilities:
A/P and accrued liabilities	640,000	320,000	320,000
Total liabilities	640,000	720,000
Total liabilities and shareholders’ equity	$4,200,000	$2,040,000

The separate-entity financial statements for Victory and Sauce at the end of 20X7 are presented below.

Statements of Financial Position

As of December 31, 20X7

                              Victory Co. Sauce Ltd.

Noncurrent assets:
Long-term loan receivable	$ 400,000	$ -
Land	-	1,080,000
Building	2,400,000	1,200,000
Accumulated depreciation	(360,000)	(480,000)
Machinery	1,600,000	1,040,000
Accumulated depreciation	(640,000)	(720,000)
Investment in Sauce Ltd.	1,200,000	____-___
Total noncurrent assets	4,600,000	2,120,000
Current assets:
Inventories	1,280,000	480,000
Amounts receivable	480,000	240,000
Cash	224,000	80,000
Total current assets	1,984,000	800,000
Total assets	$6,584,000	$2,920,000
Shareholders’ Equity:
Common shares	$2,960,000	$ 800,000
Retained earnings	2,784,000	1,080,000
Total shareholders’ equity	5,744,000	1,880,000
Noncurrent liabilities:
Long-term loans	520,000	800,000
Current liabilities:
Accounts payable	320,000	240,000
Total liabilities	840,000	1,040,000
Total liabilities and shareholders’ equity	$6,584,000	$2,920,000

Statements of Comprehensive Income

For the year ended December 31, 20X7

                          Victory Co. Sauce Ltd.

Sales	$16,000,000	$8,000,000
Dividend income	192,000	-
Other income	56,000	____-____
	16,248,000	8,000,000
Cost of sales	8,000,000	4,800,000
Other operating expenses	7,088,000	2,240,000
Interest expense	16,000	80,000
Total expenses	15,104,000	7,120,000
Net income and comprehensive income	$ 1,144,000	$ 880,000

Statements of Change in Equity – Retained Earnings Section

For the year ended December 31, 20X7

                           Victory Co. Sauce Ltd.

Retained earnings, December 31, 20X6	$1,800,000	$ 520,000
Net income	1,144,000	880,000
Dividends declared	(160,000)	(320,000)
Retained earnings, December 31, 20X7	$2,784,000	$1,080,000

During 20X7, Victory and Sauce had the following transactions between them:

On June 30, 20X7, Sauce borrowed $400,000 from Victory at an interest rate of 10% (simple interest). Interest is to be paid at the end of each calendar year. Sauce did not pay the 20X7 interest.

During 20X7, Sauce sold $3,200,000 of goods to Victory. At the end of 2007, $800,000 of those goods were still in Victory’s ending inventory. Sauce charged Victory the same price it charges all its other customers.

During 20X7, Victory sold $1,600,000 of goods to Sauce. At the end of 20X7, $320,000 of those goods were still in Sauce’s ending inventory. Victory charged
Sauce the same price it charges all its other customers.

There was no impairment of goodwill for 20X7.

The separate-entity financial statements for Victory and Sauce at the end of 20X8 are presented below.

Statements of Financial Position

As of December 31, 20X8

                           Victory Co. Sauce Ltd.      

Noncurrent assets:
Land	$ -	$1,080,000
Building	3,040,000	1,200,000
Accumulated depreciation	(449,600)	(560,000)
Machinery	1,840,000	1,500,000
Accumulated depreciation	(544,000)	(516,000)
Investment in Sauce	1,200,000	____-___
Total noncurrent assets	5,086,400	2,704,000
Current assets:
Inventories	1,040,000	440,000
Accounts receivable	960,000	616,000
Cash	510,400	420,000
Total current assets	2,512,400	1,476,000
Total assets	$7,598,800	$4,180,000
Shareholders’ Equity:
Common shares	$2,960,000	$ 800,000
Retained earnings	2,784,000	1,640,000
Total shareholders’ equity	5,744,000	2,440,000
Noncurrent liabilities:
Long-term loan	1,440,000	960,000
Current liabilities:
Accounts payable	414,800	780,000
Total liabilities	1,854,800	1,740,000
Total liabilities and shareholders’ equity	$7,598,800	$4,180,000

Statements of Comprehensive Income

For the year ended December 31, 20X8

                          Victory Co. Sauce Ltd.

Sales	$17,600,000	$8,800,000
Dividend income	288,000	-
Gain on sale of machine	80.000
Other income	96,000	____-____
	18,064,000	8,800,000
Cost of sales	10,400,000	5,280,000
Other operating expenses	6,912,000	2,336,000
Interest expense	160,000	144,000
Total expenses	17,472,000	7,760,000
Net income and comprehensive income	$ 592,000	$ 1,040,000

Statements of Change in Equity – Retained Earnings Section

For the year ended December 31, 20X8

                           Victory Co. Sauce Ltd.

Retained earnings, December 31, 20X7	$2,784,000	$1,080,000
Net income	592,000	1,040,000
Dividends declared	(592,000)	(480,000)
Retained earnings, December 31, 20X8	$2,784,000	$1,640,000

Additional information for 20X8:
   

During 20X8, Victory purchase $1,280,000 in goods from Sauce. At the end of the year, half of these goods were still in Victory’s inventory.

During December 20X8, Sauce purchased $320,000 in goods from Victory. At the end of the year, all of these goods were still in Sauce’s inventory.

Both Victory and Sauce’s gross margins for these goods were unchanged from previous years.

At the end of 20X8, Sauce did not pay the interest due on the loan from Victory, however, both companies had accrued the interest.

Required:

Prepare the consolidated income statements for December 31st, 20X7.

Answer 1

Consolidated Income Statement for the year ended Dec 31, 20X7

Particulars	Victory Co.	Sauce Limited	Adjustment	Amount($)
Revenue from Operations
Sales	16,000,000	8,000,000	(4,800,000)	19,200,000
Divident Income	192,000	-	(192000)	-
Other Income	56,000	-	(20000)	36,000
Total Revenue	16,248,000	8,000,000	(4,820,000)	19,236,000
Expenditures:
Cost of sales	8,000,000	4,800,000	(4,800,000)	8,000,000
Other Operating Expenses	7,088,000	2,240,000	(40000)	9,288,000
Interest Expense	16,000	80,000	(20,000)	76,000
Stock Reserve	320,000	160,000	-	480,000
Total Expenses	15,424,000	7,280,000	(4820,000)	17,844,000
Net income	$ 1,144,000	$ 880,000		$ 1,392,000
Dividend Declared	(160,000)	(320000)	(192000)	(288000)

1. Since the stock held includes the stock due to inter-company transactions, therefore the notional profit included needs to be deducted in the consolidated financial statement. The profit is to be calculated by reference to the normal gross margin made on the sales by the respective companies

Gross Profit Margin = (Sales - Cost of Sales)/Sales

GP Margin of Victory Co. = 16,000,000-8,000,000/16,000,000 =50%

Profit included in stock of $320000 held by Sauce Ltd= 320000*50%= $160000

GP Margin of Sauce Ltd= 8000,000-4800,000/8000,000=40%

Profit included in stock of $ 800,000 held by Victory Co. which was purchased from Sauce Limited

= 800000*40%= $320000

The amount of notional profit has been debited as Stock Reserve. Alternatively, the amount can also be included in the Cost of Sales

2. the interest income generated due to funds of $ 400,000 loaned to Sauce Ltd = 400000*10%*6/12= 20000 will be deducted from Other Income of Victory Co. and Interest Expense of Sauce Ltd

3. Dividend Declared by Sauce Ltd to the extent of 60%(being Victory Co.'s holding share in Sauce Ltd) shall be deducted from the Dividend income of Victory Co.

4. Consolidated Balance sheet and the related workings have not been prepared as only Consolidated Income statements for the year ended 31 Dec 20x7 were asked in the question

5. Calculation of Revaluation Profits

Carrying Value Fair Value Profit/(Loss)

Building 800000 1040,000 240000

Machinery 400000 80000 (320000)

Revaluation Profit on Building 240000

Revaluation Loss on Machinery (320000)

Additional Depreciation on Building= 240000/10=$24000 per annum

Saving in Depreciation on Machinery due to downward valuation = 320000/5 = $64000 per annum

Net Savings in Depreciation= $ 40000 per annum should be adjusted in Consolidated P&L statement by way of deduction from other operating expenses