Chapter SA1, Problem 4UTI

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.

The investment income of Company R if it owns a 10% interest from July 1 to December 31.

Explanation of Solution

Compute the investment income of Company R if it owns a 10% interest from July 1 to December 31:

  $\begin{array}{c}Investmentincome=\left(Dividendpaid\times Percentageofownership\right)\\ =\left(\$10,000\times 10\%\right)\\ =\$1,000\end{array}$

The net income of the entity is earned evenly throughout the period. That is why the income from investment is computed by taking the percentage of the dividend. The dividend paid at the end is given as $10,000.

Thus, the investment income of Company R for 2015 is $1,000.

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.

The investment income of Company R if it owns a 10% interest from January 1 to June 30 and 25% interest from July 1 to December 31.

Explanation of Solution

Compute the investment income of Company R if it owns a 10% interest from January 1 to June 30 and 25% interest from July 1 to December 31:

  $\begin{array}{c}Investmentincome=\left(\begin{array}{l}NetincomeofCompanyE\\ \times Percentageofownership\\ \times PeriodfromJanuarytoJune\end{array}\right)+\left(\begin{array}{l}NetincomeofCompanyE\\ \times Percentageofownership\\ \times PeriodfromJulytoDecember\end{array}\right)\\ =\left(\$100,000\times 10\%\times \frac{1}{2}\right)+\left(\$100,000\times 25\%\times \frac{1}{2}\right)\\ =\$17,500\end{array}$

The dividend is not considered for computation of the income of Company R because the dividends are being paid on December 31. The net income of the company is given as $100,000 which is paid evenly throughout the year. Thus, the net income has been taken for computation of investment income of Company R. The company has achieved significant influence at the end of year.

Thus, the investment income of Company R for 2015 is $17,500.

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.

The investment income of Company R if it owns a 30% interest from January 1 to June 30 and 10% interest from July 1 to December 31.

Explanation of Solution

Compute the investment income of Company R if it owns a 30% interest from January 1 to June 30 and 10% interest from July 1 to December 31:

  $\begin{array}{c}Investmentincome=\left(\begin{array}{l}NetincomeofCompanyE\\ \times Percentageofownership\\ \times PeriodfromJanuarytoJune\end{array}\right)+\left(Dividendpaid\times Percentageofownership\right)\\ =\left(\$100,000\times 30\%\times \frac{1}{2}\right)+\left(\$10,000\times 10\%\right)\\ =\$16,000\end{array}$

The net income is taken for computation of investment income of Company R from January 1 to June 30 because the company is holding 30% interest here which is more than 20%. Thus, the company can have significant influence here. However, the share of interest decreased to 10% after June 30. It is 10% interest from July 1 to December 31and that is why the dividend is taken into account instead of net income for computation of investment income of Company R.

Thus, the investment income of Company R for 2015 is $16,000.