Question

On 1/1/22 Big Co acquired 100% of Little Co voting stock for $500,000. On that date Little's book value was $350,000. Little had the following misvalued assets and liabilities at 1/1/22: Land, undervalued by $20,000 Inventory, FIFO basis, undervalued by $10,000 PPE, 5 year remaining life, undervalued by $80,000. Bonds payable, 10 year life, undervalued by $20,000 During 2022 Little reported earnings of $80,000 and paid dividends of $10,000.

How much goodwill was inherent in the purchase of Little?

Assuming Big uses the equity method, what would be the reported investment income for 2022?

What would be the balance in the "Investment in Little" after all of the 2022 entries?

Answer 1

Goodwill inherent in the purchase of Little is 60000

working Note:

Book value of Net Assets of LITTLE 350000

add undervalued Land 20000

Add under valued Inventory 10000

Add under valued PPE 80000

Less Under valued Bonds payable 20000

Actual worth of Net Assets of Little is 440000

value at which BIG Co takes over Little is at 500000

The excess amount paid (500000-440000) 60000 is the value of inherent goodwill.

under the Equity method amount invested in subsidiary co is considered as investment and it increases when there is an income from the subsidiary company.

the income from investment in Little is 80000 and divident of 10000 is paid.

so the investment value increases by 80000 and decreases by 10000

investment value at the end of 2022 is 500000 + 80000 - 10000 = 570000