Calculation, allocation, and amortization of acquisition differential

Cost of 80% investment in Spruce Ltd., Jan. 2, Year 1 2,000,000

Implied value of 100% 2,500,000

Carrying amounts of Spruce's net assets:

Common shares 500,000

Retained earnings 1,250,000

Total shareholders' equity 1,750,000

Acquisition differential 750,000

Allocation: FV – CA

Mineral rights 750,000

Balance 0

Balance Amortization Balance

Jan. 1/1 Years 1 to 3 Year 4 Dec. 31/4

Mineral rights 750,000 (a) 0 (b) 0 750,000 (c)

Intercompany sales and purchases 1,000,000 (d)

Unrealized intercompany profits

Before tax 40% tax After tax

Equipment Jan. 2/2 – Spruce selling

(500,000 – 400,000) 100,000 (e)

Depreciation Years 2 and 3 40,000

Balance, Dec. 31, Year 3 60,000 24,000 36,000 (f)

Depreciation, Year 4 20,000 8,000 12,000 (g)

Balance, Dec. 31, Year 4 40,000 16,000 24,000 (h)

Inventory Jan. 1, Year 4 – Spruce selling 200,000 80,000 120,000 (i)

Inventory Dec. 31, Year 4 – Spruce selling 120,000 48,000 72,000 (j)

Intercompany bonds

Before tax 40% tax After tax

Cost of bonds Jan. 2, Year 4 242,500

Carrying value of bonds purchased

Par 500,000

Issue premium

(14,000 – [14,000 / 7  2]) 10,000

510,000

Intercompany portion 50%

255,000

Gain to entity, Jan. 1, Year 4 12,500 5,000 7,500 (k)

Interest elimination loss, Year 4* 2,500 1,000 1,500

Net gain to entity, Dec. 31, Year 4 10,000 4,000 6,000 (l)

Allocation:

Cost 242,500

Par value (500,000  50%) 250,000

Gain to Spruce, Jan. 1, Year 4 7,500 3,000 4,500

Interest elimination loss, Year 4* 1,500 600 900

Net gain to Spruce, Dec. 31, Year 4 6,000 2,400 3,600 (m)

Par value 250,000

Carrying value 255,000

Gain to Poplar, Jan. 1, Year 4 5,000 2,000 3,000

Interest elimination loss, Year 4* 1,000 400 600

Net gain to Poplar, Dec. 31, Year 4 4,000 1,600 2,400 (n)

* 5 years remaining to maturity.

Spruce’s accumulated depreciation, date of acquisition 600,000 (o)

Deferred income tax – Dec. 31, Year 4

Equipment (h) 16,000

Inventory (j) 48,000

Deferred income tax asset 64,000

Less: deferred tax liability – bonds (l) 4,000

Net deferred income tax asset 60,000 (p)

Intercompany interest revenue and expense

Interest revenue – Spruce

8%  250,000 20,000

Discount amortization (7,500 / 5) 1,500 21,500

Interest expense – Poplar

8%  500,000 40,000

Premium amortization (14,000 / 7) 2,000

38,000

Intercompany portion 50% 19,000 (q)

Interest elimination loss – Year 4 (before tax) 2,500

Calculation of consolidated net income – Year 4

Income of Poplar 1,100,000

Less: Dividend from Spruce (250,000  80%) 200,000

900,000

Add: bond gain (net) (n) 2,400

Adjusted net income 902,400

Income of Spruce 521,500

Less: Amortization of acquisition differential (b) 0

Closing inventory profit (j) 72,000

449,500

Add: Opening inventory profit (i) 120,000

Equipment profit realized (g) 12,000

Bond gain (net) (m) 3,600 135,600

Adjusted net income 585,100 (r)

Consolidated net income 1,487,500

Attributable to:

Shareholders of Poplar 1,370,480

NCI (20% x 585,100) 117,020

1,487,500

(a) (i) Poplar Ltd.

Consolidated Income Statement

Year 4

Sales (4,900,000 + 2,000,000 – 1,000,000 (d)) 5,900,000

Gain on bond retirement (k) 12,500

Total revenues 5,912,500

Cost of goods sold

(2,400,000 + 850,000 – (d) 1,000,000 – (i) 200,000 + (j) 120,000) 2,170,000

Other expenses (962,000 + 300,000 – (g) 20,000) 1,242,000

Interest expense (38,000 – (q) 19,000) 19,000

Income tax expense

(600,000 + 350,000 + (i) 80,000 – (j) 48,000 + (g) 8,000 + (l) 4,000) 994,000

Total expenses 4,425,000

Net income 1,487,500

Attributable to:

Shareholders of Poplar 1,370,480

NCI (20% x 585,100) 117,020

1,487,500

Calculation of consolidated retained earnings – Jan. 1, Year 4

Retained earnings of Poplar, Jan. 1, Year 4 10,000,000

Retained earnings of Spruce, Jan. 1, Year 4 2,000,000

At acquisition 1,250,000

Increase 750,000

Less:

Opening inventory profit (i) 120,000

Net equipment profit (f) 36,000

Adjusted increase 594,000 (s)

Poplar's ownership % 80% 475,200

Consolidated retained earnings, Jan. 1 Year 4 10,475,200

(ii) Poplar Ltd.

Consolidated Statement of Retained Earnings

Year 4

Retained earnings, Jan. 1, Year 4 $10,475,200

Add: net income 1,370,480

11,845,680

Less: dividends 600,000

Retained earnings, Dec. 31, Year 4 $11,245,680

Calculation of non-controlling interest – Dec. 31, Year 4

Common shares of Spruce 500,000)

Retained earnings of Spruce, Jan. 1, Year 4 2,000,000)

Net income, Year 4 521,500)

Dividends, Year 4 (250,000)

Total shareholders' equity, Dec. 31, Year 4 2,771,500)

Less: Equipment profit (h) 24,000

Inventory profit (j) 72,000 96,000)

2,675,500)

Add: Unamortized acquisition differential (c) 750,000

Bond gain (net) (m) 3,600)

Adjusted shareholders' equity, Spruce 3,429,100)

Non-controlling interest’s share 20%

Non-controlling interest, Dec. 31, Year 4 685,820)

(iii) Poplar Ltd.

Consolidated Balance Sheet

Dec. 31, Year 4

Cash (1,000,000 + 500,000) 1,500,000)

Accounts receivable (2,000,000 + 356,000) 2,356,000)

Inventory (3,000,000 + 2,250,000 – (j) 120,000) 5,130,000)

Plant and equipment (14,000,000 + 2,900,000 – (e) 100,000 – (o) 600,000) 16,200,000)

Accumulated depreciation (4,000,000 + 1,000,000 – (f) 60,000 – (o) 600,000) (4,340,000)

Mineral rights (c) 750,000)

Deferred income taxes (p) 60,000)

Total assets 21,656,000)

Accounts payable (2,492,000 + 2,478,500) 4,970,500

Bonds payable (500,000  50%) 250,000

Premium on bonds payable (8,000  50%) 4,000

Common shares 4,500,000

Retained earnings 11,245,680

Non-controlling interest 685,820

Total liabilities and shareholders' equity 21,656,000

(b) Investment Account, Dec. 31, Year 4 - Equity Method

Balance, Dec. 31, Year 4 – cost method 2,000,000

Add: Adjusted increase in Spruce's retained earnings to

Jan. 1, Year 4 (s) 594,000

Poplar's ownership % 80% 475,200

2,475,200

Add: Adjusted income of Spruce, Year 4 (r) 585,100

Poplar's ownership % 80% 468,080

Bond gain (net) – Poplar (n) 2,400

2,945,680

Less: Dividend from Spruce (250,000  80%) 200,000

Balance, Dec. 31, Year 4 2,745,680

Alternative calculation:

Consolidated retained earnings, Dec. 31, Year 4 11,245,680

Retained earnings – Poplar Dec. 31, Year 4 – cost

method (10,000,000 + 1,100,000 – 600,000) 10,500,000

Difference 745,680

Investment in Spruce – cost method 2,000,000

Investment in Spruce – equity method, Dec. 31, Year 4 2,745,680

(c)

Gains should be recognized when they are realized i.e., when there has been a transaction with outsiders and consideration has been given/received. When the parent acquires the subsidiary’s bonds for cash in the open market, it is transacting with an outsider and giving cash as consideration. From the separate entity perspective, the parent is investing in bonds. However, from a consolidated point of view, the parent is retiring the bonds of the subsidiary when it purchases the bonds from the outside entity. Therefore, when the investment in bonds is offset against the bonds payable on consolidation, any difference in the carrying amounts is recorded as a gain or loss on the deemed retirement of the bonds.