REFERENCE: Ref.03_07
Following are selected accounts for Green Corporation and Vega Company as of December 31,2010.Several of Green's accounts have been omitted.
Green obtained 100% of Vega on January 1,2006,by issuing 10,500 shares of its $10 par value common stock with a fair value of $95 per share.On January 1,2006,Vega's land was undervalued by $40,000,its buildings were overvalued by $30,000,and equipment was undervalued by $80,000.The buildings have a 20-year life and the equipment has a 10-year life.$50,000 was attributed to an unrecorded trademark with a 16-year remaining life.There was no goodwill associated with this investment.
-Compute the equity in Vega's income reported by Green for 2010.

Question

REFERENCE: Ref.03_07
Following are selected accounts for Green Corporation and Vega Company as of December 31,2010.Several of Green's accounts have been omitted.
  Green obtained 100% of Vega on January 1,2006,by issuing 10,500 shares of its $10 par value common stock with a fair value of $95 per share.On January 1,2006,Vega's land was undervalued by $40,000,its buildings were overvalued by $30,000,and equipment was undervalued by $80,000.The buildings have a 20-year life and the equipment has a 10-year life.$50,000 was attributed to an unrecorded trademark with a 16-year remaining life.There was no goodwill associated with this investment.
-Compute the equity in Vega's income reported by Green for 2010.

Quizplus · Accepted Answer

First, we need to adjust the values of Vega Company's assets based on the information provided.

Land: Undervalued by $40,000
Buildings: Overvalued by $30,000, with a 20-year life, so the annual depreciation expense is $1,500 ($30,000 / 20)
Equipment: Undervalued by $80,000, with a 10-year life, so the annual depreciation expense is $8,000 ($80,000 / 10)
Trademark: Recorded as $50,000, with a remaining life of 16 years, so the annual amortization expense is $3,125 ($50,000 / 16)

Adjusted total assets = $500,000 land + ($120,000 buildings - $1,500 depreciation) + ($220,000 equipment - $8,000 depreciation) + ($50,000 trademark - $3,125 amortization) 
= $837,375

Next, we need to compute the equity in Vega's income reported by Green for 2010. Since Green Corporation owns 100% of Vega Company, we need to consolidate the financial statements.

We can start with Vega Company's income statement:

Sales revenue: $1,000,000
Cost of goods sold: $600,000
Gross profit: $400,000
Operating expenses: $150,000
Depreciation expense: $9,500 ($1,500 for buildings + $8,000 for equipment)
Amortization expense: $3,125
Operating income: $237,375 ($400,000 - $150,000 - $9,500 - $3,125)
Interest expense: $0
Income before taxes: $237,375
Income tax expense: $47,475 (assuming a tax rate of 20%)
Net income: $189,900 ($237,375 - $47,475)

Since Green owns 100% of Vega, we can simply add Vega's net income to Green's net income:

Green Corporation's net income = $1,200,000 (given in the question)
Vega Company's net income = $189,900 (computed above)
Total consolidated net income = $1,389,900

Equity in Vega's income reported by Green for 2010 would be Vega Company's net income of $189,900.

REFERENCE: Ref.03_07 Following Are Selected Accounts for Green Corporation and Vega Company