Typo in Question or Brain Cramp?

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  • #187643
    Iggy1985
    Member

    Hey all, hoping someone can take a look at this for me.

    The separate condensed balance sheets and income statements of Purl Corp. and its wholly owned subsidiary, Scott Corp., are as follows:

    BALANCE SHEETS

    December 31, year 2

    Purl Scott

    Assets

    Current assets:

    Cash $ 80,000 $ 60,000

    Accounts receivable (net) 140,000 25,000

    Inventories 90,000 50,000

    Total current assets 310,000 135,000

    Property, plant, and equipment (net) 625,000 280,000

    Investment in Scott (equity method) 400,000 —

    Total assets $1,335,000 $ 415,000

    Liabilities and Stockholders’ Equity

    Current liabilities:

    Accounts payable $ 160,000 $ 95,000

    Accrued liabilities 110,000 30,000

    Total current liabilities 270,000 125,000

    Stockholders’ equity:

    Common stock ($10 par) 300,000 50,000

    Additional paid-in capital — 10,000

    Retained earnings 765,000 230,000

    Total stockholders’ equity 1,065,000 290,000

    Total liabilities and stockholders’ equity $1,335,000 $ 415,000

    INCOME STATEMENTS

    For the year ended December 31, year 2

    Purl Scott

    Sales $2,000,000 $750,000

    Cost of goods sold 1,540,000 500,000

    Gross margin 460,000 250,000

    Operating expenses 260,000 150,000

    Operating income 200,000 100,000

    Equity in earnings of Scott 70,000 —

    Income before income taxes 270,000 100,000

    Provision for income taxes 60,000 30,000

    Net income $ 210,000 $ 70,000

    Additional information:

    • On January 1, year 2, Purl purchased for $360,000 all of Scott’s $10 par, voting common stock. On January 1, year 2, the fair value of Scott’s assets and liabilities equaled their carrying amount of $410,000 and $160,000, respectively, except that the fair values of certain items identifiable in Scott’s inventory were $10,000 more than their carrying amounts. These items were still on hand at December 31, year 2. Goodwill is determined to be unimpaired at December 31, year 2.

    • During year 2, Purl and Scott paid cash dividends of $100,000 and $30,000, respectively. For tax purposes, Purl receives the 100% exclusion for dividends received from Scott.

    • There were no intercompany transactions, except for Purl’s receipt of dividends from Scott and Purl’s recording of its share of Scott’s earnings.

    • Both Purl and Scott paid income taxes at the rate of 30%.

    In the December 31, year 2 consolidated financial statements of Purl and its subsidiary, total assets should be

    $1,460,000

    This answer is correct. In the consolidated balance sheet, the parent company’s investment account is eliminated and replaced with the specific assets of the acquiree. Therefore, the total consolidated assets include Purl’s assets (less the investment account), Scott’s assets (adjusted to reflect FMVs at date of purchase), and any goodwill purchased at time of investment. This computation is illustrated below.

    Purl’s assets $ 1,335,000

    Less: Investment in Scott (400,000)

    $ 935,000

    Scott’s assets ($415,000 + $10,000) 425,000

    $1,360,000

    Goodwill 100,000

    $1,460,000

    Scott’s assets are increased by $10,000 to reflect the excess market value at 1/1/Y2 of inventory items, purchased as a part of the investment in Scott, which are still on hand at 12/31/Y2. Goodwill purchased at 1/1/Y2 is the excess of the cost of the investment ($360,000) over the FV of the net assets purchased ($410,000 – $160,000 + $10,000), or $100,000.

    If the investment in Scott was $360,000, why are we deducting $400,000 from assets? I keep getting 1.5 mil for the answer which isn’t one of the options. ($1.335 mil parents assets – investment $360,000 + $100,000 Goodwill + $425,000 sub’s assets marked up to FV = $1.5mil). I am doing so bad on business combinations in general.. My scores for 3 rounds of 20 MCQs have been 50%, 50%, and 55% 🙁

    FAR - 89 (8/19/14) Wiley TB, Wiley Book, Books from School, Ninja Audio/Notes
    AUD - 92 (10/14/14) Wiley TB, Wiley Book, Ninja Audio
    BEC - 82 (5/8/15) Mostly Ninja MCQ, sprinkles of Becker lectures and Ninja Audio
    REG - (8/14/15)

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  • #585831
    Anonymous
    Inactive

    Because the investment was accounted for under equity method during the year:

    Investment in Scott (equity method) 400,000 —

    360+70-30=400

    #585832
    Iggy1985
    Member

    I just noticed the actual B/S says investment in Scott 400k, but later in the question it says Scott paid 360k for all of the outstanding shares. Don't you have to use consolidation and not equity method for a 100% owned subsidiary, and equity method for 20%-50% ownership? With the investment account being the consideration paid (360k)? If it was equity method wouldn't we not have consolidated balance sheets at all and just debit investment, credit cash, then for equity in income it would be say 40% of equity in income credit and debit investment etc. But that's not what this answer is saying. Now I'm extra confused!

    FAR - 89 (8/19/14) Wiley TB, Wiley Book, Books from School, Ninja Audio/Notes
    AUD - 92 (10/14/14) Wiley TB, Wiley Book, Ninja Audio
    BEC - 82 (5/8/15) Mostly Ninja MCQ, sprinkles of Becker lectures and Ninja Audio
    REG - (8/14/15)

    #585833
    Iggy1985
    Member

    Okay I THINK I got it.. They accounted for it under the equity method of consolidation (I was confused about this!) by recording the purchase price of 360,000 and adding to the investment the equity in earnings 70,000 and subtracting dividends paid 30,000. I guess I forgot more than I thought I did from advanced accounting.. oh boy >_< Thanks anjanja

    FAR - 89 (8/19/14) Wiley TB, Wiley Book, Books from School, Ninja Audio/Notes
    AUD - 92 (10/14/14) Wiley TB, Wiley Book, Ninja Audio
    BEC - 82 (5/8/15) Mostly Ninja MCQ, sprinkles of Becker lectures and Ninja Audio
    REG - (8/14/15)

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