Pacific Entity (PE) acquired 20% of ordinary shares of Atlantic Entity (AE) on January 15, 20X1 for $80,000. The purchase price is equal to 20% of FE's fair value of net identifiable assets. GE has significant influence over FE. For the year ended 20X1, FE reported a loss of $500,000 and no dividends were declared. On December 31, the fair value of this investment is $40,000 less estimated selling costs of 3% of the fair value. What should be the losses recognized in the financial statements by PE?

Question

Quizplus · Accepted Answer

Since PE has significant influence over AE, it should use the equity method. Under this method, PE recognizes its share of AE's loss, which is 20% of $500,000, equaling $100,000. However, the investment cannot be reduced below zero, so the maximum loss recognized is the initial investment of $80,000.

Pacific Entity (PE) Acquired 20% of Ordinary Shares of Atlantic