(14) Steven Company owns 40% of the outstanding voting common stock of Nicole Co
ID: 2464529 • Letter: #
Question
(14) Steven Company owns 40% of the outstanding voting common stock of Nicole Corp. and has the ability to significantly influence the investee's operations. On January 3, 2011, the balance in the Investment in Nicole Corp. account was $503,000. Amortization associated with this acquisition is $12,000 per year. During 2011, Nicole earned a net income of $120,000 and paid cash dividends of $40,000. Previously in 2010, Nicole had sold inventory costing $35,000 to Steven for $50,000. All but 25% of that inventory had been sold to outsiders by Steven during 2010. Additional sales were made to Steven in 2011 at a transfer price of $75,000 that had cost Nicole $54,000. Only 10% of the 2011 purchases had not been sold to outsiders by the end of 2011. Required: (B) What amount of unrealized intra-entity profit should be deferred by Steven at December 31, 2011?
Explanation / Answer
Net Income of Nicole for the year 2011 = $ 120,000
Share of Steven in this net income = $120,000 x 40% = $48,000
Nicole paid cash dividend for 2011 = $40,000
Steven's share of cash divided $40,000 x 40% = $16,000
Hence, Steven's investment in Nicole Corp increased by $48,000 and at the same time decreased by $16,000 i.e to the extent of Steven's proportion share in cash dividend;
Amortization expenses $12,000 per year. Steven's share of amortization is $4,800.
Unrealised profit for the year 2010:
Cost of the goods sold to Steven = $35,000
Sales price of these goods = $50,000; hence, gross profit rate = 50,000-35,000/50,000 = 15,000/50,000 = 0.3 = 30%
Unsold stock with Steven = 50,000 x 25% = $12,500:
Hence, unrealised profit in this stock is 30% ie. 12,500 x 30% = $3,750:
So, the proportionate share of unrealised profit of Steven is 40% of $3,750 = $1,500;
This unrealised profit of $1,500 is to differed by steven for 2010; and this profit is recognised when this stock is sold.
Unrealised profit for the year 2011
Additional sales made to Steven = $ 75,000
Cost of this additional stock to Nicole Corp= $ 54,000:
Hence, gross profit rate is 75,000-54,000/75,000 = 21,000/75,000= 28%.
Unsold stock with Steven = 10% of $75,000 = $7,500:
Unrealised profit on this stock is 28% of $7,500 = $2,100
Proportionate share of Steven in this unrealised profit is 40% of $2,100 = $840. This unrealised profit is to be deffered by Steven for the year 2011.
Since, Steven sold all the unsold stock of 2010, he can differ only unrealised profit on unsold stock of 2011 i.e $840 as calculated above.
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