On December 31, 20X5, Paper Co $\quad$ $\quad$ $\quad$

question 22

Essay

On December 31, 20X5, Paper Co. purchased 60% of the outstanding common shares of Book Ltd. for $760,000 in shares and $200,000 in cash. The statements of financial position of Paper and Book immediately before the acquisition and issuance of the notes payable were as follows (in 000s):
$\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$$\text {Paper}\quad\quad\quad\text {Book}$
$\begin{array}{lllll}&\text { Book } & \text { Fair } & \text { Book } & \text { Fair } \\&\text { Value } & \text { Value } & \text { Value } & \text { Value } \\\text { Cash } & \$ 360 & \$ 360 & \$ 200 & \$ 200 \\\text { Accounts receivable } & 520 & 500 & 380 & 380 \\\text { Inventory } & 800 & 880 & 400 & 360 \\\text { Property, plant, and equipment } & \underline{1,820} & 2,000 & \underline{1,420} & 1,640 \\& \$ 3,500 & & \$ 2,400 &\end{array}$

$\begin{array}{lllll}\text { Accounts payable } & \$ 380 & \$ 380 & \$ 260 & \$ 260 \\\text { Long-term liabilities } & 1,200 & 1,200 & 1000 & 1000 \\\text { Common shares } & 500 & & 600 & \\\text { Retained earnings } & \underline{1,420} & & \underline{540} & \\& \$ 3,500 & & \$ 2,400 &\end{array}$


The difference in the carrying value and the fair value of the property, plant, and equipment for Book relates to its office building. This building has an estimated 20 years remaining of useful life.
During 20X6, the year following the acquisition, the following occurred:
1. Throughout the year, Book purchased merchandise of $800,000 from Paper. Paper's gross margin is 35% of selling price. At December 31, 20X6, Book still owed Paper $250,000 on this merchandise; 75% of this merchandise was resold by Book prior to December 31, 20X6.
2. Throughout the year, Book sold merchandise to Paper totalling $500,000. The gross margin on these products is 25%. At the end of 20X6, Paper had not yet resold 60% of this merchandise.
3. Management fees were paid to Paper from Book totalling $250,000.
4. Book paid dividends of $250,000 at the end of 20X6 and Paper paid dividends of $500,000.
During 20X7, the following occurred:
1. Throughout the year, Book purchased merchandise of $1,000,000 from Paper. Paper's gross margin is 35% of selling price. At December 31, 20X6, Book still owed Paper $150,000 on this merchandise; 85% of this merchandise was resold by Book prior to December 31, 20X7.
2. Throughout the year, Book sold merchandise to Paper totalling $650,000. The gross margin on these products is 25%. At the end of 20X6, Paper had not yet resold 40% of this merchandise.
3. Management fees were paid to Paper from Book totalling $250,000.
4. Book paid dividends of $250,000 at the end of 20X7 and Paper paid dividends of $500,000.
Paper uses the cost method to report its investment in Book. $\begin{array}{c}\text {Statement of Financial Position}\\\text {December 31, 20X7}\\\text {(in thousands of \$'s)}\\\\\begin{array}{|l|r|r|}\hline & \text { Paper } & \text { Book } \\\text { Assets } & \$ & \$\\\hline \text { Cash } & 50 & 210 \\\hline \text { Accounts receivable } & 575 & 410 \\\hline \text { Inventories } & 825 & 430 \\\hline \text { Property, plant, and equipment, net } & 2,870 & 1,760 \\\hline \text { Investment in Book } & \underline{960} & \\\hline \text { Total assets } & \underline{5,280} & \underline{2}, 810 \\\hline\\\hline \text { Liabilities } & & \\\hline \text { Accounts payable } & 465 & 32 \\\hline \text { Long-term liabilities } & 1,290 & 950 \\\hline \text { Common shares } & 1,260 & 600 \\\hline \text { Retained earnings } & \underline{2,265} & \underline{935} \\\hline \text { Total liabilities and shareholders' equity } & \underline{5,280} & \underline{2,810} \\\hline\end{array}\end{array}$

$\begin{array}{c}\text {Statement of Comprehensive Income}\\\text { Year Ended December 31, 20X7}\\\text {(in thousands of \$'s)}\\\\\begin{array}{|l|r|r|} \hline & \text { Paper } & \text { Book } \\& \$ & \$\\\hline \text { Sales } & 2,520 & 2,400 \\\hline \text { Management fees } & 250 & \\\hline \text { Dividend income } & 150 & \\\hline & 2,920 & 2,400 \\\hline\\\hline \text { Cost of sales } & 800 & 1,200 \\\hline \text { Depreciation and amortization expenses } & 670 & 325 \\\hline \text { Management fees expense } & & 250 \\\hline \text { Other expenses } & \underline{460} & \underline{135} \\\hline & \underline{1,930} & \underline{1,910} \\\hline \text { Net income } & \underline{990} & \underline{\underline{490}} \\\hline \end{array}\end{array}$


$\begin{array}{c}\text { Statement of Changes in Equity-Retained Earnings Section}\\\text { Year Ended December 31, 20X7 }\\ \text { (in thousands of \$'s)}\\\\\begin{array}{|l|r|r|}\hline & \text { Paper } & \text { Book } \\& \$ & \$\\\hline \text { Retained earnings, December 31, 20X6 } & 1,775 & 695 \\\hline \text { Net income } & 990 & 490 \\\hline \text { Dividends declared } & \underline{(500)} & \underline{250}) \\\text { Retained earnings, December 31, 20X7 } & \underline{2,265} & \underline{235} \\\hline\end{array}\end{array}$

Required:
Paper has determined that it does not have control but only has significant influence over Book. Calculate the balance in the investment account at December 31, 20X7.
Calculate the investment income from this investee for 20X7 that Paper would show on its statement of comprehensive income.

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Definitions:

Liquidating

The process of closing a business and distributing its assets to claimants, often in the event of bankruptcy.

Assets

Resources or items of value owned by an individual or business, which can be used to cover liabilities or generate income.

Bankruptcy Code

The body of federal laws and statutes governing the process of bankruptcy in the United States, which allows individuals or entities facing financial distress to relieve their debts.

Creditors

Individuals or entities to whom money is owed by debtors.