Question

Northwest Paperboard Company, a paper and allied products manufacturer, was seeking to gain a foothold in Canada. Toward that end, the company bought 40% of the outstanding common shares of Vancouver Timber and Milling, Inc., on January 2, 2018, for $420 million.

At the date of purchase, the book value of Vancouver's net assets was $785 million. The book values and fair values for all balance sheet items were the same except for inventory and plant facilities. The fair value exceeded book value by $5 million for the inventory and by $30 million for the plant facilities.

The estimated useful life of the plant facilities is 15 years. All inventory acquired was sold during 2018.

Vancouver reported net income of $160 million for the year ended December 31, 2018. Vancouver paid a cash dividend of $30 million.

Required:
1. Prepare all appropriate journal entries related to the investment during 2018.
2. What amount should Northwest report as its income from its investment in Vancouver for the year ended December 31, 2018?
3. What amount should Northwest report in its balance sheet as its investment in Vancouver?
4. What should Northwest report in its statement of cash flows regarding its investment in Vancouver?

Answer 1

Question 1:

Since the investment results in a 20-50% share in Vancouver, equity method of accounting is used. The Journal entries for Northwest are given below

Sl.No	Journal Entry	Debit	Credit
1	Investment in Vancouver	$420 mn
	Cash		$420 mn
2	Investment in Vancouver	=($160 *0.4) = $64 mn
	Equity in earnings of affiliate		$64 mn
3	Cash (from dividend paid)	=($30 *0.4) = $12 mn
	Investment in Vancouver		$12 mn
4	Equity in earnings of affiliate (from sale of inventory)	$5
	Investment in Vancouver		$5 mn
5	Equity in earnings of affiliate (since FV>BV for Plant)	=($30/15) = $2 mn
	Investment in Vancouver		$2 mn

In sl.no 1, Entire investment in Vancouver is assumed to be paid from Cash of the Northwest company

In Sl.no 2, share of net income in Vancouver is considered as increase in investment as net income is added to the Retained Earnings in Shareholders Equity

In Sl.no 3, Dividends are paid out of Retainined Earnings, So share of dividends is reduced from Investment in company and dividend received is added to cash of Northwest

In Sl.no 4, Northwest paid an excess of $5 mn for the inventory over the Book Value (BV). Since the entire inventory is sold in the same year, we assign the loss to the equity in earnings of affiliate during the same year. The debit to the equiaccount reduces revenue -- in effect, it's an expense.

In Sl.no 5, Northwest paid an excess of $30 mn for the plant facilities over the Book Value (BV). Since the usefule life is 15 years, the GAAP accounting procedure is to assign the extra payment amount to the plant facilities and then amortize the extra amount over the remaining depreciable lifetime of the asset.

The questions 2,3,4 can be answered from the Jornal Entries itself:

Question 2:

Income from investment in Vancouver = ($64 - $5 - $2) = $57mn

Question 3:

Ending balance in investment in Vancouver = ($420 + $64 - $12 - $5 - $2) = $465 mn

Question 4:

$420 mn outflow to be recorded in Cash Flow from Investing

$12 mn inflow to be recorded in Cash Flow from Operations