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INVESTMENT IN ASSOCIATE 23-1 (AICPA Adapted) On January 1, 2011, Saxe Company purchased 20% of Lex Company’s ordinary shares outstanding for P6,000,000. The acquisition cost is equal to the carrying amount of the net assets acquired. During 2011, Lex reported net income of 7,000,000 and paid cash dividend of 4,000,000. What is the balance in the investment in Lex Company on December 21, 2011? a. 5,200,000 b. 6,000,000 c. 6,600,000 d. 7,400,000 Solution 23-1 Answer c Acquisition cost Add: Share in net income (20% x 7,000,000) Total Less: Share in cash dividend (20% x 4,000,000) Investment balance

6,000,000 1,400,000 7,400,000 800,000 6,600,000

PAS 28, paragraph 6, provides that if an investor holds, directly or indirectly through subsidiaries, 20% or more of the voting power of the investee, it is presumed that the investor does have significant influence, unless it can be clearly demonstrated that it is not the case. The equity method of accounting is used if the investment is 20% or more of the voting power of the investee. Under the equity method, the investment account is increased by the investor’s share of the investee’s earnings and decreased by the investor’s share of the investee’s losses. Dividend receives from the investee reduces the carrying amount of the investment. 23-2 (AICPA Adapted) In January 2011, Farley Company acquired 20% of the outstanding ordinary shares of Davis Company for 8,000,000. This investment gave Farley the ability to exercise significant influence over Davis. The carrying amount of the acquired shares was 6,000,000. The excess of cost over carrying amount was attributed to a depreciable asset which was undervalued on Davis’ statement of financial position and which had a remaining useful life of ten years. For the year ended, December 31, 2011, Davis reported net income of 1,800,000 and paid cash dividends of 400,000 and thereafter issued 5% stock dividend. What is the carrying amount of the investment in Davis Company on December 31, 2011?

a. b. c. d.

7,720,000 7,800,000 8,000,000 8,080,000

Solution 23-2 Answer d Original cost Share in net income (20% x 1,800,000) Share in cash dividends (20% x 400,000) Amortization of excess of cost (2,000,000/10) Carrying amount of investment – December 31,2011

8,000,000 360,000 ( 80,000) ( 200,000) 8,080,000

Acquisition cost Less: Carrying amount of interest acquired Excess of cost over carrying amount

8,000,000 6,000,000 2,000,000

The excess of cost over the carrying amount of the underlying equity acquired which is attributable to undervaluation of a depreciable asset should be amortized over the remaining useful life of the depreciable asset. Such amortization is recorded by debiting investment income and crediting investment in associate. 23-3 (AICPA Adapted) On January 1, 2011, Dell Company paid 18,000,000 for 50,000 ordinary shares of Case Company which represent a 25% interest in the net assets of Case. The acquisition of cost is equal to the carrying amount of the net assets acquired. Dell has the ability to exercise significant influence over Case. Dell received a dividend of P35 per share from Case in 2011. Case reported net income of P9,600,000 for the year ended December 31, 2011. In the December 31, 2011 statement of financial position, what amount should be reported as investment in Case Company? a. 22,150,000 b. 20,400,000 c. 18,650,000 d. 18,000,000 Solution 23-3 Answer c Acquisition cost – January 1 Add: Share in net income (25% x 9,600,000) Total Less: Cash dividend received (50,000x P35) Carrying amount of investment – December 31

18,000,000 2,400,000 20,400,000 1,750,000 18,650,000

Problem 23-4 (AICPA) On January 1, 2011, Well Company purchased 10% of Rea Company’s outstanding ordinary shares for P4,000,000. Well is the largest single shareholder in Rea and Well’s officers are a majority of Rea’s board of directors. Rea reported net income of P5,000,000 for 2011 and paid dividends of P1,500,000. In its December 31, 2011 statement of financial position, what amount should Well report as investment in Rea? a. b. c. d.

4,500,000 4,350,000 4,000,000 3,850,000

Solution 23-4 Answer b PAS 28, paragraph 6, provides that if the investor holds, directly or indirectly through subsidiaries, less than 20% of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. Well’s position as Rea’s largest single shareholder and the presence of Well’s officers as a majority of Rea’s board of directors demonstrate that Well does have a significant influence despite the 10% ownership. Accordingly, the equity method is used. Acquisition, January 1 Add: Share in net income (10% x 5,000,000)

4,000,000 500,000

Total Less: Share in cash dividends (10% x 1,500,000) Carrying value of investment, December 31

4,500,000 150,000 4,350,000

Problem 23-5 (AICPA Adapted) On January 1, 2011, Dyer Company acquired as a long-term investment a 20% ordinary share interest in Eason Company. Dyer paid P7,000,000 for this investment when the fair value of Eason’s net assets was P35,000,000. Dyer can exercise significant influence over Eason’s operating and financial policies. For the year ended December 31, 2011, Eason reported net income of P4,000,000 and declared and paid cash dividends of P1,600,000. What amount of revenue from the investment should Dyer report for 2011? a. 1,120,000 b. 480,000 c. 800,000 d. 320,000

Solution 23-5 Answer c Share in net income (20% x 4,000,000)

800,000

Under the equity method, the investor recognizes as net income its share of the investee’s earnings. Cash dividends are not recorded as income but a reduction of the investment account. Problem 23-6 (AICPA Adapted) On July 1, 2011, Denver Company purchased 30,000 shares of Eagle Company’s 100,000 outstanding ordinary shares for P200 per share. On December 15, 2011, Eagle paid P400,000 in dividends to its ordinary shareholders. Eagle’s net income for the year ended December 31, 2011 was P1,200,00, earned evenly throughout the year. In its 2011 income statement, what amount of income from the investment should Denver report? a. 360,000 b. 180,000 c. 120,000 d. 60,000 Solution 23-6 Answer b Share in net income from July 1 to December 31, 2011 (1,200,000 x 6/12 x 30%) Interest acquired (30,000/100,000)

180,000 30%

Problem 23-7 (AICPA Adapted) On April 1, 2011, Ben Company purchased 40% of the outstanding ordinary shares of Clarke Company for P10,000,000. On that date, Clarke’s net assets were P20,000,000 and Ben cannot attribute the excess of cost of its investment in Clarke over its equity in Clarke’s net assets to any particular factor. Clarke’s 2011 net income is P5,000,000. Ben plans to retain its investment in Clarke indefinitely. Ben accounts for its investment in Clarke by the equity method. What is the maximum amount which could be included in Ben’s 2011 income before tax to reflect the “equity in net income of Clarke”? a. 1,400,000 b. 1,500,000 c. 2,000,000 d. 1,850,000

Solution 23-7 Answer b Share in net income from April 1 to December 31, 2011 (5,000,000 x 9/12 x 40%) Acquisition cost Less: CA of net assets acquired (40% x 20,000,000) Goodwill – not amortized

1,500,000 10,000,000 8,000,000 2,000,000

Problem 23-8 (IAA) On January 1, 2011, Ronald Company purchased 40% of the outstanding ordinary shares of New Company, paying P6,400,00 when the carrying amount of the net assets of New Company equaled P12,500,000. The difference was attributed to equipment which has a carrying amount of P3,000,000 and a fair market value of P5,000,000 and to building which has a carrying amount of P2,500,000 and a fair value of P4,000,000. The remaining useful life of the equipment and building was 4 years and 12 years respectively. During 2011, New Company reported net income of P5,000,000 and paid dividends of P2,500,000. What amount should be reported as investment income for 2011? a. 2,000,000 b. 1,000,000 c. 1,800,000 d. 1,750,000 Solution 23-8 Answer d Acquisition cost Net assets acquired (40% x 12,500,000) Excess of cost Excess attributable to equipment (40% x 2,000,000) Excess attributable to building (40% x 1,500,000)

Share in net income (40% x 5,000,000) Amortization of excess: Equipment (800,000/4) Building (600,000/12) Investment Income

6,400,000 5,000,000 1,400,000

800,000 600,000 1,400,000 2,000,000 ( 200,000) ( 50,000) 1,750,000

Problem 23-9 (AICPA Adapted) On January 1, 2011, Kean Company purchased 30% interest in Pod Company for P2,500,000. On this date Pod’s shareholders’ equity was P5,000,000. The carrying amounts of Pod’s identifiable net assets approximated their fair values, except for land whose fair value exceeded its carrying amount by P2,000,000. Pod reported net income of P1,000,000 for 2011 and paid no dividends. Kean accounts for this investment using the equity method. In its December 31, 2011 statement of financial position, what amount should Kean report as investment in associate? a. 2,100,000 b. 2,200,000 c. 2,800,000 d. 2,760,000 Solution 23-9 Answer c Acquisition cost Less: Carrying amount of net assets acquired (30% x 5,000,000) Excess of cost over carrying amount Less: Amount attributable to undervaluation of land (30% x 2,000,000) Goodwill – not amortized

2,500,000

Acquisition cost, January 1 Add: Share in net income (30% x 1,000,000) Carrying amount of investment

2,500,000 300,000 2,800,000

1,500,000 1,000,000 600,000 400,000

The excess of cost attributable to the land is not amortized because the land is nondepreciable. Problem 23-10 (AICPA Adapted) Sage company bought 40% of Eve’s Company’s outstanding ordinary shares in January1, 2011 for P4,000,000. The carrying amount of Eve’s net assets at the purchase date totaled P9,000,000. Fair values and carrying amounts were the same for all items except for plant and inventory, for which fair values exceeded their carrying amounts by P900,000 and P100,000, respectively. The plant has an 18-year life. All inventory was sold during 2011. During 2011, Eve reported net income of P1,200,000 and paid a P200,000 cash dividend.

What amount should Sage report as investment income in its income statement for the year ended December 31, 2011? a. 480,000 b. 420,000 c. 360,000 d. 320,000 Solution 23-10 Answer b Acquisition cost Net assets acquired (40% x 9,000,000) Excess of cost over carrying amount The excess of cost is identified as follows: Understatement of plant (40% x 900,000) Understatement of inventory (40% x 100,000) Total excess of cost Share in net income (40% x 1,200,000) Less: amortization of excess of cost: Depreciation of plant (360,000/18) 20,000 Inventory (totally sold) 40,000 Investment income

4,000,000 (3,600,000) 400,000

360,000 40,000 400,000 480,000

60,000 420,000

Problem 23-11 (CGAC) On January 1, 2011, Anne Company purchased 20% of the outstanding shares of Dune Company for P4,000,000 of which P1,000,000 was paid in cash and P3,000,000 is payable with 12% annual interest on December 31, 2012. Anne also paid P500,000 to a business broker who helped find a suitable business and negotiated the purchase. At the time of acquisition, the fair values of Dune’s identifiable assets and liabilities were equal to their carrying amounts except for an office building which had a fair value in excess of carrying amount of P2,000,000 and an estimated life of 10 years. Dune’s shareholder’s equity on January 1, 2011 was P13,000,000. During 2011, Dune Company reported net income of P5,000,000 and paid dividend of P2,000,000. What amount of income should Anne Company report for 2011 as a result of investment? a. 810,000 b. 620,000 c. 960,000

d. 885,000 Solution 23-11 Answer c Acquisition cost (4,000,000 + 500,000) CA of net assets acquired (20% x 13m) Excess of cost Excess attributable to building (20% x 2m) Excess attributable to goodwill – not amortized Share in net income (20% x 5m) Amortization of excess of cost: Attributable to building (400k/10) Investment income

4,500,000 2,600,000 1,900,000 400,000 1,500,000 1,000,000 ( 40,000 ) 960,000

Problem 23-12 (IAA) On January 1, 2011, Occidental Company purchased 40% of the outstanding ordinary shares of Manapla Company for P3,500,000 when the net assets of Manapla amounted to P7,000,000. At acquisition date, the carrying amounts of the identifiable assets and liabilities of Manapla were equal to their fair value, except for equipment for which the fair value was P1,500,000 greater than its carrying amount and inventory whose fair value was P500,000 greater than its cost. The equipment has a remaining life of 4 years and the inventory was all sold during 2011. Manapla Company reported net income of P4,000,000 for 2011 and paid no dividends during 2011. What is the maximum amount of the “equity in earnings of Manapla Company”? a. 1,350,000 b. 1,250,000 c. 1,600,000 d. 1,700,000 Solution 23-12 Answer a Cost CA of interest acquired (40% x 7m) Excess of cost over carrying amount Excess applicable to equipment (40% x 1.5m) Excess applicable to inventory (40% x 500k) Excess of fair value over cost

3,500,000 2,800,000 700,000 ( 600,000) ( 200,000) ( 100,000)...