Question

On May 1, 2008, Hico, Inc. acquired 20% of the voting securities of Lowco, Inc. for $400,000 cash. The investment did not give Hico significant influence over Lowco and was classified as an available-for-sale investment. On July 1, 2009, Hico acquired the remaining 80% of Lowco's voting securities for $1,800,000 cash. At that time, Hico's original 20% investment in Lowco had a carrying value and a fair value of $450,000. Which one of the following is the amount of gain that Hico should recognize in July, 2009 net income as a result of the effect of the business combination on Hico's original investment in Lowco?

A. $- 0 - (no gain)
B. $40,000
C. $50,000
D. $400,000

Answer 1

Hico, Inc. should recognize a gain of $50,000 in the net income for July 2009 on its available-for-sale investment in Lowco, Inc., as a result of the business combination.

Step-by-step explanation:

The investment scenario described involves Hico, Inc.'s acquisition of Lowco, Inc. securities at different times. Initially, Hico acquired 20% of Lowco's voting securities for $400,000, categorized as an available-for-sale investment. Later, Hico bought the remaining 80% for $1,800,000. The carrying and fair value of the initial 20% investment appreciated to $450,000 by the time of the second acquisition. The gain on the investment is calculated by subtracting the original cost of the investment from its fair value at the time of acquiring the additional 80%.

Gain = Fair Value of Original Investment - Cost of Original Investment
Gain = $450,000 - $400,000
Gain = $50,000

Thus, the amount of gain that Hico should recognize in July 2009 net income as a result of the effect of the business combination on Hico's original investment in Lowco is $50,000, making the correct answer Option C.