Hip Hop Ltd acquired a 30 per cent interest in Rock Ltd on 1 July 2004 for a cash consideration of $984,000. Rock Ltd's assets and liabilities were recorded at fair value at the time of purchase and were represented by equity as follows:

Additional information relating to the period ended 30 June 2006:
The opening balance of Rock's retained earnings was $1,100,000. Rock Ltd had paid a dividend out of pre-acquisition profits of $80,000 during the 2003/2004 period.
Rock Ltd had an after-tax profit of $260,000 for the 2004/2005 period.
Rock Ltd declared an $80,000 dividend out of post-acquisition profits. This dividend will not be paid until the following period.
Hip Hop Ltd accrues the dividends of associates as revenue when they are proposed. What is the amount of the investment in Rock Ltd and the income that will be recorded in the books of Hip Hop Ltd as at 30 June 2006 under (i) the cost method and (ii) the equity method?

Question

Hip Hop Ltd acquired a 30 per cent interest in Rock Ltd on 1 July 2004 for a cash consideration of $984,000. Rock Ltd's assets and liabilities were recorded at fair value at the time of purchase and were represented by equity as follows:

Additional information relating to the period ended 30 June 2006:
The opening balance of Rock's retained earnings was $1,100,000. Rock Ltd had paid a dividend out of pre-acquisition profits of $80,000 during the 2003/2004 period.
Rock Ltd had an after-tax profit of $260,000 for the 2004/2005 period.
Rock Ltd declared an $80,000 dividend out of post-acquisition profits. This dividend will not be paid until the following period.
Hip Hop Ltd accrues the dividends of associates as revenue when they are proposed. What is the amount of the investment in Rock Ltd and the income that will be recorded in the books of Hip Hop Ltd as at 30 June 2006 under (i) the cost method and (ii) the equity method?

Quizplus · Accepted Answer

Under the cost method, the investment in Rock Ltd will continue to be recorded at the initial cost of $984,000. Since no dividends were received during the period, there will be no income recognized.

Under the equity method, the investment in Rock Ltd will be recorded at 30% of Rock Ltd's net assets. Using the information provided, the net assets of Rock Ltd as at 1 July 2004 were $3,280,000 (total equity). Thus, the investment in Rock Ltd under the equity method as at 30 June 2005 will be $984,000 + 30% x ($3,280,000 + $260,000 - $80,000) = $1,068,000.

The income to be recognized under the equity method will be the share of Rock Ltd's profit after tax and after deducting the proposed dividend of $80,000. This is calculated as: 30% x ($260,000 - $80,000) = $54,000. However, since the dividend has not been paid yet, it needs to be added back to the income recognized. Therefore, the income to be recorded in the books of Hip Hop Ltd as at 30 June 2006 is $54,000 + $24,000 (accrued dividend) = $78,000.

Hip Hop Ltd Acquired a 30 Per Cent Interest in Rock