On January 1, 2013, Edie Ltd Acquired 25% of the Shares

question 8

Essay

On January 1, 2013, Edie Ltd acquired 25% of the shares of Gowan Ltd for $79,375. At this date, the equity of Gowan Ltd consisted of:
$$\begin{array} { l c } \text { Share capital } & \$ 150,000 \\\text { Retained earnings } & 80,000\end{array}$$ At the acquisition date, all the identifiable assets and liabilities of Gowan Ltd were recorded at fair value, except for plant for which the fair value was $15,000 greater than its carrying amount, and inventory whose fair value was $5,000 greater than its cost. The tax rate is 30%. The plant has a further 5-year life. The inventory was all sold by December 31, 2013.
In the reporting period ending December 31, 2013, Gowan Ltd reported a profit of $15,000.
The acquisition analysis at January 1, 2013 is as follows:
$\begin{array}{ll}\text { Cost of investment } &\underline{\$ 79,375}\\\text { Net fair value of the identifiable assets and } & =(\$ 150,000+\$ 80,000) \text { (equity)} \\\text { liabilities of Gowan Itd}\\&+\$ 15,000(1-30 \%) \text { (plant) } \\&+\$ 5,000(1-30 \%) \text { (inventory) } \\&=\$ 244,000 \\\text { Net fair value acquired by Edie Ltd }&=25 \% \times \$ 180,500 \\&=\$ 61.000\\ \\\text { Goodwill } & =\$ 18,375 \\\text { Depreciation (net of tax) of plant p.a. } & =1 / 5 \times(25 \% \times[\$ 15,000(1-30 \%)] \\& =\$ 525 \\\text { Effect of sale of inventory (net of tax) } & =25 \% \times \$ 5,000(1-30 \%) \\& =\$ 875\end{array}$ Required:
(a)What is the amount of the adjustment needed in applying equity accounting to the investment in the associate at December 31, 2013?
(b)What is the journal entry to reflect the application of the equity method to the investment?

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Definitions:

Income Statement

A financial report detailing a company's financial performance, including all income and expenses, ultimately showing the profit or loss over a defined time.

FICA Tax Rate

The percentage of an employee's gross earnings required by law to be withheld by the employer for Social Security and Medicare taxes in the United States.

Federal Income Tax

The tax levied by the IRS on the annual earnings of individuals, corporations, trusts, and other legal entities.

Net Pay

Gross earnings less payroll deductions.