Question

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Potato acquired 100% of Salad for $200. At acquisition date Salad had equity of $170, comprised...

Potato acquired 100% of Salad for $200.

At acquisition date Salad had equity of $170, comprised as follows:

Capital

100

Asset revaluation reserve

20

Retained earnings

50

Equity

170

The book value of net assets was considered to be close to fair value,

except for the following:

Cost

Carrying amount

Fair value

Land

40

40

50

Equipment

100

50

60

140

90

110

The tax rate is 30%.

What is the amount of the business combination reserve (also known as revaluation surplus)?

Select one:

a. 20    CR

b. 0

c. 7    DR

d. 13    DR

e. 10    CR

f. 10 DR

g. 14    CR

h. 7    CR

i. 13    CR

Solutions

Expert Solution

The answer is g. 14 CR

Explanation: Potato acquired 100% of Salad at $200 the equity of which was at $170. This does not create any change in business combination reserve i.e. revaluation surplus.

For the assets other than Land and Equipment, book values of assets were close to fair value i.e. the values were nearly the same therefore no difference.

Here: Carrying value is the book vale of an asset based on company’s balance sheet, which considers cost of the asset and subtracts depreciation over a period. Fair value is the asset value determined by market and agreed upon by willing buyer and seller.

In above scenario for Land and Equipment, the asset cost when initially acquired was $140 (40 +100), the Carrying Cost as existing in books is $90 (40 +50). The Fair value is $110 (50 +60). There is therefore an increase in value of the assets by $20 (110 – 90) as compared to current value in books.

Also, the tax rate is 30%. Therefore, the revaluation surplus of $20 is subject to tax and creates a deferred tax liability of $6. The net revaluation surplus is therefore $14 CR.

This therefore have to be recorded in books as following:

Land                                  $10 DR

Equipment                         $10 DR

Revaluation Surplus $14 CR

Tax                                     $6 CR

jeff jeffy answered 1 year ago
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