Question

On January 1, 20X2, Pint Corporation acquired 80 percent of Size Corporation for $200,000 cash. Size reported net income of $25,000 each year and dividends of $5,000 each year for 20X2, 20X3, and 20X4. On January 1, 20X2, Size reported common stock outstanding of $160,000 and retained earnings of $40,000, and the fair value of the noncontrolling interest was $50,000. It held land with a book value of $90,000 and a market value of $100,000, and equipment with a book value of $40,000 and a market value of $48,000 at the date of combination. The remainder of the differential at acquisition was attributable to an increase in the value of patents, which had a remaining useful life of eight years. All depreciable assets held by Size at the date of acquisition had a remaining economic life of eight years. Pint uses the equity method in accounting for its investment in Size.

Based on the preceding information, what balance would Pint report as its investment in Size at January 1, 20X4?
A) $200,000
B) $224,000
C) $232,000
D) $240,000

Answer 1

The balance Pint Corporation would report as its investment in Size at January 1, 20X4 is $232,000. This includes the initial investment and Pint's share of Size's net income over two years, adjusted for the fair value amortization of assets.

Step-by-step explanation:

To calculate the balance Pint Corporation would report for its investment in Size at January 1, 20X4, we must consider the equity method accounting. Initially, Pint invested $200,000 for an 80% stake, with the fair value of the noncontrolling interest at $50,000. Therefore, the total value of Size at the acquisition date is calculated as $200,000 / 0.8 = $250,000. As Size reported net income of $25,000 for 20X2, 20X3, and 20X4, Pint's share of net income is $25,000 x 0.8 = $20,000 annually. However, we must also factor in the annual amortization of the fair value adjustments for land, equipment, and patents. The difference in fair values from the book values are as follows: land ($100,000 - $90,000), equipment ($48,000 - $40,000), and patents (remaining differential). These assets have remaining lives of eight years, so we amortize these differences over that period. The total annual amortization affecting Pint's investment is ($10,000 + $8,000 + patents differential) / 8. With the patents' differential not given explicitly, we assume it makes up the rest needed to reach the total value of Size, which is ($250,000 - (common stock $160,000 + retained earnings $40,000 + land $10,000 + equipment $8,000)). The differential attributable to patents would be $32,000, with annual amortization being $32,000 / 8 = $4,000. Summing up Pint's share of net income less amortization ($20,000 - $4,000) gives us an annual increase in investment of $16,000. Thus, over two years (20X2 and 20X3), we add ($16,000 x 2) to the initial investment to get the balance at January 1, 20X4, resulting in an investment balance of $200,000 + $32,000 = $232,000.