Question

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Problem 6-14 (AICPA Adapted) Pearl Company reported income before tax of P5,000,000 for the current year. The entity owned 40% of Cinn's share capital. The auditor questioned the following amounts that had been included in income before tax: Equity in earnings of Cinn Company 1,600,000 Dividend received from Cinn Company 320,000 Adjustment of profit of prior year for arithmetical error in depreciation (1,400,000) What amount should be reported as income before tax for the current year? a. 3,400,000 b. 4,680,000 c. 4,800,000 d. 6,080,000 00000 30.000 139

Answer 1

Solution

Answer (D) is correct.

Complete solution

Income Before Tax 5,000,000

Equity in earning of Cinn company (No treatment because it is correctly included in income)

Less-Dividend received from Cinn company (320,000)

Add-Adjustment of profit of prior year 14,00,000

for arithmetical error in depreciation

Income before tax to be reported = 60,80,000

  
Under the equity method, the investor’s share of the investee’s net income (adjusted for any acquisition differentials, such as impairment of goodwill) is accounted for as an addition to, and losses and dividends are reflected as reductions of, the carrying amount of the investment. Consequently, the equity in earnings of Cinn Co. was correctly included in income, but the dividends received should have been excluded. In addition, error corrections related to earlier periods are treated as prior-period adjustments and are not included in net income. Thus, income before taxes should have been 60,80,000 (5,000,000 – 320,000 dividends + 14,00,000 depreciation error).

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