P Corp. owns 800 voting common shares out of Q Corp.'s 1,000 outstanding voting common shares, which it accounts for using the equity method. On December 31, 2018, the shareholder's equity section of Q Corp. was comprised of $15,000 in common shares and retained earnings of $450,000. Q Corp. reported net income and paid dividends of $120,000 and $20,000 respectively for the year ended December 31, 2019.
There have been no goodwill impairment losses since acquisition.
On January 1, 2020, P Corp. sold 200 shares of its investment in Q Corp. for $125,000.
On January 1, 2019, the investment account had a balance of $420,000. The acquisition differential was to be allocated as follows:
60% to patents (6 year remaining life).
30% to equipment (9 year remaining life).
What is the gain or loss on P's sale of its shares on Q Corp.?
A) A $3,000 loss.
B) A $2,000 loss.
C) A $1,600 gain.
D) A $3,000 gain.

Question

Quizplus · Accepted Answer

Step 1: Calculate the initial investment cost and the allocation of acquisition differential:
Initial investment cost = 800/1000 x $15,000 = $12,000
Allocation of acquisition differential:
Patents: 60% x $300,000 = $180,000
Equipment: 30% x $300,000 = $90,000
Goodwill: $30,000

Step 2: Calculate the investment balance at December 31, 2019:
Initial investment cost + equity in earnings - dividends = $12,000 + 60% x $120,000 - $20,000 = $74,000

Step 3: Calculate the gain or loss on sale of shares:
Sale price - carrying value of shares sold = $125,000 - (800/1000 x $15,000 + $74,000 x 200/800) = $125,000 - $90,000 = $35,000

Step 4: Allocate the gain or loss to the initial investment cost and the allocation of acquisition differential:
Initial investment cost: $12,000 x 200/800 = $3,000 gain
Allocation of acquisition differential:
Patents: $180,000 x 200/800 = $45,000 gain
Equipment: $90,000 x 200/800 = $22,500 loss
Goodwill: $30,000 x 200/800 = $7,500 gain

Step 5: Net the allocation of acquisition differential amounts to arrive at the total gain or loss on sale:
Total gain or loss on sale = $45,000 - $22,500 + $7,500 = $30,000

Therefore, the answer is C) A $1,600 gain.

P Corp Owns 800 Voting Common Shares Out of Q Corp