Question

On January 1, 2022 Squash Company recorded a $40,000 profit on the upstream sale of some equipment that had a remaining four-year life under the straight-line depreciation method. The effect of this transaction on the amount recorded in 2022 by the parent company Pumpkin as its investment income in the Squash was

a decrease of $36,000 if the Squash was 90% owned.
a decrease of $24,000 if the Squash was 80% owned.
an increase of $40,000 if the Squash was wholly owned.
an increase of $30,000 if the Squash was wholly owned.

Answer 1

The effect on the parent company's investment income from the sale of equipment by Squash Company depends on the ownership percentage. For 90% ownership, it would be a decrease of $36,000. For wholly-owned, it would be an increase of $40,000.

Step-by-step explanation:

The effect of the upstream sale of equipment on the investment income recorded by the parent company Pumpkin depends on the ownership percentage in Squash. When an asset is sold between a parent and a subsidiary, profits from the sale must be eliminated from the investment income to prevent overstatement of income due to intercompany transactions.

If Squash is 90% owned, the investment income will decrease by the parent's share of the profit not yet realized externally, which is 90% of the $40,000 profit minus the depreciation for the year: $40,000 x 90% = $36,000.

If Squash is 80% owned, the decrease in investment income will be 80% of the $40,000 profit minus the same year's depreciation: $40,000 x 80% = $32,000. As the equipment has a four-year life and uses straight-line depreciation, a year's depreciation is $40,000 / 4 = $10,000. Thus, the decrease is $32,000 - $10,000 = $22,000 (not $24,000).

If Squash is wholly owned (100%), the increase in investment income will simply be the reported profit of $40,000 as there is no need to account for a minority interest.