Chapter SA1, Problem 1UTI

a.

To determine

Business combination:

Business combination refers to the combining of one or more business organizations in a single entity. The business combination leads to the formation of combined financial statements. After business combination, the entities having separate control merges into one having control over all the assets and liabilities. Merging and acquisition are types of business combinations.

Consolidated financial statements:

The consolidated financial statements refer to the combined financial statements of the entities which are prepared at the year-end. The consolidated financial statements are prepared when one organization is either acquired by the other entity or two organizations merged to form the new entity. The consolidated financial statements serve the purpose of both the entities about financial information.

The criteria for determining whether the investor should apply the equity method of accounting to this investment or not is as follows:

• The investor should invest at least 20% or it should acquire at least 20% of the investee’s share.

• The investor should be able to exercise the significant influence over the investee.

If the above two conditions are fulfilled then the organization can use the equity method.

To Compute:

The investment income of Company R.

Explanation of Solution

Compute the investment income of Company R for 2015:

  $\begin{array}{c}Investmentincome=\left(\begin{array}{l}NetincomeofCompanyE\times Percentage\\ ofownership\end{array}\right)-Amortizationofequipment\\ =\left(\$35,000\times 30\%\right)-\$4,000\\ =\$6,500\end{array}$

Thus, the investment income of Company R for 2015 is $6,500.

Working note:

Compute the amortization on equipment:

  $\begin{array}{c}Amortization=\frac{Amountpaid-\left(Totalshareholdersequity\times Percentageofownership\right)}{Usefullifeofequipment}\\ =\frac{\$170,000-\left(\$500,000\times 30\%\right)}{5}\\ =\frac{\$20,000}{5}\\ =\$4,000\end{array}$

b.

To determine

Consolidated financial statements:

The consolidated financial statements refer to the combined financial statements of the entities which are prepared at the year-end. The consolidated financial statements are prepared when one organization is either acquired by the other entity or two organizations merged to form the new entity. The consolidated financial statements serve the purpose of both the entities about financial information.

To Compute:

The balance in investment as on December 31, 2015.

Explanation of Solution

Compute the investment balance of Company R as on December 31, 2015:

  $\begin{array}{c}Investmentbalance=\left(Openingbalance+Investmentincome-Dividendspaid\right)\\ =\left(\$170,000+\$6,500-\left(\$10,000\times 30\%\right)\right)\\ =\left(\$170,000+\$6,500-\$3,000\right)\\ =\$173,500\end{array}$

Thus, the investment balance of Company R as on December 31, 2015 is $173,500.

c.

To determine

Consolidated financial statements:

The consolidated financial statements refer to the combined financial statements of the entities which are prepared at the year-end. The consolidated financial statements are prepared when one organization is either acquired by the other entity or two organizations merged to form the new entity. The consolidated financial statements serve the purpose of both the entities about financial information.

To Explain:

The investment balance as on December 31, 2015, in words.

Explanation of Solution

The investment balance as on December 31, 2015 has been computed by adding the share of parent company’s income in the cost of investment. The amount of dividend has been deducted from the investment balance. The amount of dividend represents the amount of amortization which is in excess of book value.