On 1-1-2014 Sea Inc. purchased 40% of Gull Corporation for $30,000. At that time, Gull's owners' equity was $4,000, and Gull had the following assets with market values exceeding book value by the following amounts: Land $20,000
Buildings 30,000 (10 years life remaining)
Patent 10,000 (5 years life remaining) Gull earned $10,000 in 2014 and paid $20,000 dividends. We amortize all intangibles over 5 years. What is the 2014 ending balance in the Investment in Gull account?

Question

Quizplus · Accepted Answer

The initial investment cost for Sea Inc. was $30,000 for 40% of Gull Corporation. Therefore, the total value of Gull Corporation at the time of purchase was $75,000 (30,000/0.40).

After the purchase, the Investment in Gull account will increase by $30,000, and the share of Gull's net income for 2014 will be added to the account. Sea Inc.'s share of the net income is $4,000 (40% × $10,000).

Dividends paid by Gull Corporation will reduce the Investment in Gull account, so $8,000 (40% × $20,000) will be deducted.

The amortization of intangibles will also reduce the Investment in Gull account by $2,120 [$10,000 ÷ 5 years × 40% × (12/12)] + [$20,000 ÷ 10 years × 40% × (12/12)].

Therefore, the ending balance in the Investment in Gull account for 2014 is calculated as follows: $30,000 + $4,000 - $8,000 - $2,120 = $23,880. However, we need to adjust the investment account for the excess market values of assets purchased above their book value. The total excess market value is $50,000 ($20,000 + $30,000). The excess value is amortized over the remaining life of the asset. The annual amortization of excess market value is $5,000 ($50,000 ÷ 10 years). Therefore, the 2014 amortization of excess market value is $2,000 ($5,000 x 40% x 12/12). The ending balance in the Investment in Gull account is $23,880 - $2,000 = $21,880, which is closest to answer option B.