Asked by Miguel Angelo on Jun 13, 2024
Verified
P Corp. owns 800 voting common shares out of Q Corp.'s 1,000 outstanding voting common shares, which it accounts for using the equity method. On December 31, 2018, the shareholder's equity section of Q Corp. was comprised of $15,000 in common shares and retained earnings of $450,000. Q Corp. reported net income and paid dividends of $120,000 and $20,000 respectively for the year ended December 31, 2019.
There have been no goodwill impairment losses since acquisition.
On January 1, 2020, P Corp. sold 200 shares of its investment in Q Corp. for $125,000.
On January 1, 2019, the investment account had a balance of $420,000. The acquisition differential was to be allocated as follows:
60% to patents (6 year remaining life) .
30% to equipment (9 year remaining life) .
What is the gain or loss on P's sale of its shares on Q Corp.?
A) A $3,000 loss.
B) A $2,000 loss.
C) A $1,600 gain.
D) A $3,000 gain.
Gain or Loss
The financial result from the sale of an asset or investment, calculated as the difference between the selling price and the original purchase price.
Equity Method
An accounting technique used when a company holds significant influence over another (associate) but does not have full control, requiring the investment to be recorded at original cost and subsequently adjusted for the investor’s share of the associate's profits or losses.
Sale
is the transaction between two parties where the ownership of goods, services, or assets is transferred from the seller to the buyer for a specified price.
- Ascertain the financial outcome, be it earnings or losses, from equity method share dealings.
Verified Answer
RO
Raymond OfoegbuJun 14, 2024
Final Answer :
C
Explanation :
Step 1: Calculate the initial investment cost and the allocation of acquisition differential:
Initial investment cost = 800/1000 x $15,000 = $12,000
Allocation of acquisition differential:
Patents: 60% x $300,000 = $180,000
Equipment: 30% x $300,000 = $90,000
Goodwill: $30,000
Step 2: Calculate the investment balance at December 31, 2019:
Initial investment cost + equity in earnings - dividends = $12,000 + 60% x $120,000 - $20,000 = $74,000
Step 3: Calculate the gain or loss on sale of shares:
Sale price - carrying value of shares sold = $125,000 - (800/1000 x $15,000 + $74,000 x 200/800) = $125,000 - $90,000 = $35,000
Step 4: Allocate the gain or loss to the initial investment cost and the allocation of acquisition differential:
Initial investment cost: $12,000 x 200/800 = $3,000 gain
Allocation of acquisition differential:
Patents: $180,000 x 200/800 = $45,000 gain
Equipment: $90,000 x 200/800 = $22,500 loss
Goodwill: $30,000 x 200/800 = $7,500 gain
Step 5: Net the allocation of acquisition differential amounts to arrive at the total gain or loss on sale:
Total gain or loss on sale = $45,000 - $22,500 + $7,500 = $30,000
Therefore, the answer is C) A $1,600 gain.
Initial investment cost = 800/1000 x $15,000 = $12,000
Allocation of acquisition differential:
Patents: 60% x $300,000 = $180,000
Equipment: 30% x $300,000 = $90,000
Goodwill: $30,000
Step 2: Calculate the investment balance at December 31, 2019:
Initial investment cost + equity in earnings - dividends = $12,000 + 60% x $120,000 - $20,000 = $74,000
Step 3: Calculate the gain or loss on sale of shares:
Sale price - carrying value of shares sold = $125,000 - (800/1000 x $15,000 + $74,000 x 200/800) = $125,000 - $90,000 = $35,000
Step 4: Allocate the gain or loss to the initial investment cost and the allocation of acquisition differential:
Initial investment cost: $12,000 x 200/800 = $3,000 gain
Allocation of acquisition differential:
Patents: $180,000 x 200/800 = $45,000 gain
Equipment: $90,000 x 200/800 = $22,500 loss
Goodwill: $30,000 x 200/800 = $7,500 gain
Step 5: Net the allocation of acquisition differential amounts to arrive at the total gain or loss on sale:
Total gain or loss on sale = $45,000 - $22,500 + $7,500 = $30,000
Therefore, the answer is C) A $1,600 gain.
Learning Objectives
- Ascertain the financial outcome, be it earnings or losses, from equity method share dealings.