LEO Inc. acquired a 60% interest in MARS Inc. on January 1, 2019 for $400,000. Unless otherwise stated, LEO uses the cost method to account for its investment in MARS Inc. On the acquisition date, MARS had common stock and retained earnings valued at $100,000 and $150,000 respectively. The acquisition differential was allocated as follows: $80,000 to undervalued inventory.
$40,000 to undervalued equipment. (to be amortized over 20 years)
The following took place during 2019:
▪ MARS reported a net income and declared dividends of $25,000 and $5,000 respectively.
▪ LEO's December 31, 2019 inventory contained an intercompany profit of $10,000.
▪ LEO's net income was $75,000.
The following took place during 2020:
▪ MARS reported a net income and declared dividends of $36,000 and $6,000 respectively.
▪ MARS' December 31, 2020 inventory contained an intercompany profit of $5,000.
▪ LEO's net income was $48,000.
Both companies are subject to a 25% tax rate. All intercompany sales as well as sales to outsiders are priced to provide the selling company with gross margin of 20%.
What would be the amount of changes to the acquisition differential during 2020?

A) $2,000
B) $40,000
C) $78,000
D) $82,000

Question

David Chang · Accepted Answer

Final Answer : A, Explanation :  The changes to the acquisition differential during 2020 would only be due to the amortization of the undervalued equipment, which was allocated $40,000 and is being amortized over 20 years. Therefore, the annual amortization expense would be $2,000 ($40,000/20). All the other information provided is not relevant to calculating the changes to the acquisition differential.

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