On January 1, 2019, Hanson Inc. purchased 54,000 voting shares out of Marvin Inc.'s 90,000 outstanding voting shares for $240,000. On that date, Marvin's common shares and retained earnings were valued at $60,000 and $90,000, respectively. Marvin's book values approximated its fair values on the acquisition date with the exception of the company's equipment, which was estimated to have a fair value that was $50,000 in excess of its recorded book value. The equipment was estimated to have a useful life of eight years. Both companies use straight line amortization exclusively. On January 1, 2020, Hanson purchased an additional 9,000 shares of Marvin Inc. on the open market for $45,000. On this date, Marvin's book values were equal to its fair values with the exception of the company's equipment, which is now thought to be undervalued by $60,000. Moreover, the equipment's estimated useful life was revised to 5 years on this date.
Marvin's net income and dividends for 2019 and 2020 are as follows:
$$\begin{array} { | l | r |r |}
\hline & \mathbf { 2 0 1 9 } & \mathbf { 2 0 2 0 } \
\hline \text { Net Incorne } & \mathbf { \$ 6 0 , 0 0 0 } & \mathbf { \$ 8 0 , 0 0 0 } \
\hline \text { Dividends } & \mathbf { \$ 9 , 0 0 0 } & \mathbf { \$ 1 4 , 0 0 0 } \
\hline
\end{array}$$ Marvin's goodwill suffered an impairment loss of $5,000 during 2019. Hanson Inc. uses the equity method to account for its investment in Marvin Inc.
What effect would the purchase at January 1, 2020 have on the consolidated equity of Hanson?

Question

On January 1, 2019, Hanson Inc. purchased 54,000 voting shares out of Marvin Inc.'s 90,000 outstanding voting shares for $240,000. On that date, Marvin's common shares and retained earnings were valued at $60,000 and $90,000, respectively. Marvin's book values approximated its fair values on the acquisition date with the exception of the company's equipment, which was estimated to have a fair value that was $50,000 in excess of its recorded book value. The equipment was estimated to have a useful life of eight years. Both companies use straight line amortization exclusively. On January 1, 2020, Hanson purchased an additional 9,000 shares of Marvin Inc. on the open market for $45,000. On this date, Marvin's book values were equal to its fair values with the exception of the company's equipment, which is now thought to be undervalued by $60,000. Moreover, the equipment's estimated useful life was revised to 5 years on this date.
Marvin's net income and dividends for 2019 and 2020 are as follows:
$$\begin{array} { | l | r |r |} 
\hline & \mathbf { 2 0 1 9 } & \mathbf { 2 0 2 0 } \
\hline \text { Net Incorne } & \mathbf { \$ 6 0 , 0 0 0 } & \mathbf { \$ 8 0 , 0 0 0 } \
\hline \text { Dividends } & \mathbf { \$ 9 , 0 0 0 } & \mathbf { \$ 1 4 , 0 0 0 } \
\hline
\end{array}$$ Marvin's goodwill suffered an impairment loss of $5,000 during 2019. Hanson Inc. uses the equity method to account for its investment in Marvin Inc.
What effect would the purchase at January 1, 2020 have on the consolidated equity of Hanson?

Quizplus · Accepted Answer

The purchase of additional shares on January 1, 2020, would result in a reduction in consolidated retained earnings of $1,025. This is because the fair value of the equipment is now thought to be undervalued by $60,000, which would result in a decrease in the carrying value of the equipment on Marvin's books. This decrease in carrying value would then flow through to Hanson's equity in Marvin's earnings, resulting in a reduction in consolidated retained earnings.

On January 1, 2019, Hanson Inc Marvin's Goodwill Suffered an Impairment Loss of $5,000 During 2019