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com

SPECIAL APPENDIX 2

UNDERSTANDING THE ISSUES

1. (a) Company E net income ......................... $ 40,000

Parents share ....................................... 30%
$ 12,000
Less: Equipment amortization
[$200,000 ($500,000 30%)] 10 ..... (5,000)
Investment income ................................ $ 7,000
(b) Beginning balance ................................. $200,000
Investment income ................................ 7,000
Less dividends ($10,000 30%) ........... (3,000)
Investment balance ............................... $204,000
(c) The investment balance is the cost of the investment plus the investors share of the investees
undistributed income, less the amortization of the excess of the price paid over the investors
share of book value.
2. (a) Company E income ............................... $ 50,000
Gain on sale of equipment..................... (20,000)
Realized gain ($20,000 5) .................. 4,000
$ 34,000
Parents share ....................................... 30%
Investment income ................................ $ 10,200
There is no further adjustment for the profit on the equipment.
(b) Investment income = $50,000 30% = $15,000
Adjustment for equipment profit:
Gain on Sale of Equipment
($20,000 30%) ............................... 6,000
Deferred Gain ................................ 6,000
Deferred Gain ($6,000/5) .................... 1,200
Realized Gain on Equipment Sale 1,200
3. (a) Investment income = $10,000 dividends 10% = $1,000
(b) Investment income = [($100,000 ) 10%] + [($100,000 ) 25%] = $17,500
(c) Investment income = [($100,000 ) 30%] + ($10,000 dividends 10%) = $16,000
4. Cost of investment ....................................... $ 20,000
20X020X4 income, 25% $200,000 ......... 50,000
20X520X9 loss, 25% ($300,000) ............ (75,000)
Unrecorded loss ........................................... $ (5,000)
20Y0 income (25% $30,000 reported income) unrecorded $5,000 prior loss = $2,500
Investment balance = ($5,000 unrecorded loss) (25% $30,000 reported income) = $2,500

SA-7
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SA2Exercises

EXERCISES

EXERCISE SA2-1

Investment in Like .................................................................................. 4,000

Investment Income ........................................................................... 4,000
To record 20X7 investment income.
Investment in Like .................................................................................. 3,500
Dividends Receivable ............................................................................ 1,250
Investment Income ........................................................................... 4,750
To record 20X8 investment income and dividends receivable
(20,000 shares 25% $0.25 per share).
20X7 20X8
Like Company income ..................................................................... $20,000 $24,000
Adjustment for inventory profit ($5,000 profit 20%)....................... (1,000)
Adjusted income .............................................................................. $20,000 $23,000
Ownership percentage ..................................................................... 25% 25%
$ 5,000 $ 5,750
Less amortization of excess:
Equipment ($10,000 10 years) ................................................ (1,000) (1,000)
Investment income ........................................................................... $ 4,000 $ 4,750

EXERCISE SA2-2

Determination and Distribution of Excess Schedule

Price paid for investment ........................ $90,000
Less book value of interest acquired:
Common stock ($10 par)................... $100,000
Paid-in capital in excess of par ......... 20,000
Retained earnings ............................. 130,000
Total stockholders equity ............ $250,000
Interest acquired ............................... 30% 75,000
Excess of cost over book value (debit) ... $15,000

Building, amortized over 20 periods, $750 per year

SA-8
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SA2Exercises

Exercise SA2-2 Concluded

Minnie Company Income Distribution

Profit in ending inventory Internally generated net
(40% $40,000) ...................... $16,000 income ..................................... $60,000
Realized profit on beginning
inventory (40% $10,000) ...... 4,000

Adjusted income ............................ $48,000

Turfs ownership interest ............... 30%
Share of income ............................ $14,400
Less building depreciation ............. (750)
Turfs net share of income ............. $13,650

Investment in Minnie ........................................................................ 13,650

Investment Income ..................................................................... 13,650

Gain on Sale of Machine ($5,000 30%) ........................................ 1,500

Deferred Gain............................................................................. 1,500

Deferred Gain ($1,500 5) .............................................................. 300

Realized Profit on Machine Sale ................................................ 300

EXERCISE SA2-3

Werl Corporation Income Distribution

Profit in ending inventory Internally generated net
(30% $30,000) ...................... $9,000 income .................................... $90,000
Gain on sale of machine ............... 5,000 Realize 1/5 of machine
profit ........................................ 1,000
Realize profit on beginning
inventory (30% $20,000) ...... 6,000

Adjusted net income ..................... $83,000

Ownership interest ........................ 30%
Interest on adjusted income .......... $24,900
Less equipment depreciation ........ (3,2
Net investment income ................. $21,700

Investment in Werl ........................................................................... 21,700

Investment Income ..................................................................... 21,700

Cash................................................................................................. 6,000
Investment in Werl (30% $20,000 dividends) ......................... 6,000

SA-9
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SA2Exercises

EXERCISE SA2-4

Determination and Distribution of Excess Schedule

10% purchase:
Price paid ................................................................. $80,000
Less interest acquired:
Total stockholders equity................................... $750,000
Interest acquired ...................................................... 10% 75,000
Goodwill ................................................................... $ 5,000 Dr.

15% purchase:
Price paid ................................................................. $110,000
Less interest acquired:
Total stockholders equity................................... $800,000
Interest acquired ...................................................... 15% 120,000
Excess of book value over cost (credit balance) ...... $(10,000)
Decrease in equipment (4-year life) ......................... 10,000 Cr.
$ 0

(1) Investment in Novic .................................................................. 5,000

Retained Earnings .............................................................. 5,000
To record equity catch-up entry.
Calculations:
Increase in retained earnings, January 1, 20X6,
to January 1, 20X8 ......................................................... $50,000
Ownership interest .............................................................. 10%
Equity catch-up adjustment .............................................. $ 5,000

(2) Investment in Novic .................................................................. 10,000

Cash (50,000 shares 25% $0.20 per share) ...................... 2,500
Investment Income ............................................................. 12,500
To record net share of subsidiary income and
dividends received.

Income Distribution for Investment in Novic Company

Reported income ........................... $40,000
Ownership interest ......................... 25%
Share of income............................. $10,000
Decrease in equipment
depreciation expense
($10,000 4)............................ 2,500
Investment income, net of
amortizations ........................... $12,500

SA-10
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SA2Exercises

EXERCISE SA2-5

Determination and Distribution of Excess Schedule

Price paid ................................................................. $200,000
Equity interest purchased, 30% $400,000 ............ 120,000
Excess of cost over book value (debit balance) ....... $ 80,000
Allocate to machinery, 30% $50,000, 5-year life,
$3,000 per year .................................................. 15,000 Dr.
Goodwill $ 65,000 Dr.
Calculation of investment account balance, January 2, 20X9:
Original cost ............................................................. $200,000
Share of income:
20X7 ................................................................... $50,000
20X8 ................................................................... 45,000
$95,000 30% 28,500
Dividends paid:
20X7 ................................................................... $10,000
20X8 ................................................................... 10,000
$20,000 30% (6,000)
Amortization of excess:
Machinery ($3,000 2 years) ............................ (6,000)
Balance .................................................................... $216,500

Entry:
Cash......................................................................... 230,000
Investment in Aluma-Boat Company.................. 216,500
Realized Gain on Sale of Investment ................. 13,500

SA-11
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SA2Problems

PROBLEMS

PROBLEM SA-1

Determination and Distribution of Excess Schedule

Price paid for investment in Fink .............................. $320,000
Less interest acquired:
Total stockholders equity................................... $1,000,000
Interest acquired ................................................ 25% 250,000
Excess of cost over book value (debit balance) . $ 70,000
Attributable to long-lived assets:
Less undervaluation of building
($40,000 0.25, 20 years, $500 per year) ... 10,000
Goodwill ................................................................... $ 60,000

20X6 Income Distribution for Investment in Fink Company

Reported net income ..................... $48,000

Adjusted net income ...................... $48,000

Ownership interest ........................ 25%
Share of income ............................ $12,000
Less excess amortization .............. 500
Net share of income ...................... $11,500

20X6 Entries:
Cash ($10,000 25%) ............................................................... 2,500
Investment in Fink ($11,500 $2,500 dividends) ...................... 9,000
Investment Income ............................................................... 11,500

Sales ($8,000 25%) ................................................................ 2,000

Realized Gross Profit (1/10 $2,000 year) ................... 100
Deferred Gross Profit ........................................................... 1,900

SA-12
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SA2Problems

Problem SA-1 Concluded

20X7 Income Distribution for Investment in Fink Company

Profit in ending inventory Reported net income ..................... $50,000
($2,000 25%) ........................ $500

Adjusted net income ...................... $49,500

Ownership interest ........................ 25%
Share of income ............................ $12,375
Less excess amortization .............. 500
Net share of income ...................... $11,875

20X7 Entries:
Cash ($10,000 25%) ............................................................... 2,500
Investment in Fink ($11,875 $2,500 dividends) ...................... 9,375
Investment Income ............................................................... 11,875

Deferred Gross Profit ................................................................. 200

Realized Gross Profit ........................................................... 200

20X8 Income Distribution for Investment in Fink Company

Profit in ending inventory Reported net income ..................... $65,000
($3,000 25%) ........................ $750 Beginning inventory profit
($2,000 25%) ........................ 500

Adjusted net income ...................... $64,750

Ownership interest ........................ 25%
Share of income ............................ $16,187
Less excess amortization .............. 500
Share of income ............................ $15,687

20X8 Entries:
Cash ($10,000 25%) ............................................................... 2,500
Investment in Fink ($15,687 $2,500 dividends) ...................... 13,187
Investment Income ............................................................... 15,687

Deferred Gross Profit ................................................................. 200

Realized Gross Profit ........................................................... 200

SA-13
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SA2Problems

PROBLEM SA2-2

December 31, 20X6:

Investment in Cramer Company ................................................ 8,500
Cash (for dividends) ................................................................... 1,250
Investment Income ............................................................... 9,750
Reported income of Cramer
($60,000 $18,000 tax) ............................... $42,000
Ownership interest ............................................. 25% $10,500
Less amortizations of excess cost:
Equipment ($7,500 10 years) ............................................ 750
Adjusted income......................................................................... $ 9,750

Provision for Income Tax (30% 20%* $10,500) ......................... 630

Income Tax Payable (30% 20%* $1,250) ............................ 75
Deferred Tax Liability ................................................................. 555
To record provision for tax; amortizations of excess are
not deductible.
*100% 80% dividend exclusion.

December 31, 20X7:

Investment in Cramer Company ................................................ 9,963
Cash (for dividends) ................................................................... 2,500
Investment Income (See IDS, which follows) ....................... 12,463

Provision for Income Tax (30% 20%* $13,213) ......................... 793

Income Tax Payable (30% 20%* $2,500) ............................ 150
Deferred Tax Liability ................................................................. 643
*100% 80% dividend exclusion.

Sales ($4,000 40% 25% interest) income before amortization .. 400

Deferred Gross Profit on Sales to Investee................................ 400

Deferred Tax Liability ....................................................................... 120

Provision for Income Tax ........................................................... 120
Tax on deferred gross profit on ending inventory
(30% $400).

SA-14
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SA2Problems

Problem SA2-2, Continued

Cramer Company Income Distribution (20X7)

Gain on machine sale ................... $5,000 Reported net income ..................... $80,000
Realized gain on machine* ........... 500

Adjusted income ........................... $75,500

Income tax (30%) .......................... 22,650
Net income .................................... $52,850
Ownership interest ........................ 25%
Interest in income .......................... $13,213
Less amortization of excess
cost (as above)........................ 750

Net investment income.................. $12,463

*$5,000 year 1/5

December 31, 20X8:

Investment in Cramer Company ................................................ 14,425
Cash (for dividends) ................................................................... 2,500
Investment Income (See IDS, which follows) ....................... 16,925

Provision for Income Tax (30% 20%* $17,675) income before

amortization .................................................................................. 1,061
Income Tax Payable (30% 20%* $2,500) ............................ 150
Deferred Tax Liability ................................................................. 911
*100% 80% dividend exclusion.

Sales (net increase $1,000* 40% 25% interest) ........................ 100

Deferred Gross Profit on Sales to Investee................................ 100
*$5,000 ending inventory profit $4,000 beginning inventory profit = net increase

Provision for Income Tax ................................................................. 30

Deferred Tax Liability ................................................................. 30
Tax on increase in deferred gross profit on ending
inventory (30% $100).

SA-15
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SA2Problems

Problem SA2-2, Concluded

Cramer Company Income Distribution (20X8)

Reported net income ..................... $100,000
Realized gain on machine ............. 1,000

Adjusted income ............................ $101,000

Income tax (30%) .......................... 30,300
Net income .................................... $ 70,700
Ownership interest......................... 25%
Interest in income .......................... $ 17,675
Less amortization of excess
cost (as above) ........................ 750

Net investment income .................. $ 16,925

SA-16