Posthorn Corporation acquired 20,000 of the 100,000 outstanding common shares of Stamp Company on January 1, 2010, for a cash consideration of $200,000 at a time when its shareholders’ equity amounted to $1,000,000. The shares of both companies were traded on the national stock exchange. During 2010, Stamp Company had net income of $120,000 and paid dividends of $80,000. At the end of 2010, shares of Stamp Company were trading for $11 each. During 2011, Stamp Company had a loss of $60,000 and paid dividends of $40,000. Income for the first half of the year was $80,000 and the loss in the second half of the year was $140,000.
The dividends were paid on June 30. On July 2, 2011, Posthorn Corporation sold 5,000 shares of Stamp Company for a consideration of $12 per share. At the end of 2011, the share price of Stamp Company had fallen to $6 per share. The average of market analysts’ forecasts was that the share price could be expected to rise to $8 per share over the next five years. Posthorn Corporation has not elected early adoption of the new standards for financial instruments which become effective on January 1, 2015.
For each of the following independent assumptions, state the amounts that Posthorn Corporation would include in its 2011 financial statements, with respect to its investment in Stamp Company for (i) its investment in Stamp Company; (ii) net income; and (iii) other comprehensive income. a) Posthorn Corporation accounts for its investment in Stamp Company as a fair value through profit and loss investment; b) Posthorn Corporation accounts for its investment in Stamp Company as an available for sale investment; c) Posthorn Corporation accounts for its investment in Stamp Company as a significant influence investment; d) Posthorn Corporation accounts for its investment in Stamp Company using the cost method.
a) Assume that the number of shares held by Blake is enough to give it significant influence over Stergis. Prepare all the journal entries that Blake should make regarding this investment in Year 5 and Year 6. b) Assume that Blake uses the cost method to account for its investment. Prepare all the journal entries that Blake should make regarding this investment in Year 5 and Year 6.
Question 3 (15 marks) (Text, Chapter 2, Case 4)
On January 1, Year 6, Progress Technologies Inc. acquired 40 percent (10,000 shares) of the voting shares of the Calgana Corp. Toward the end of Year 6, it seemed likely that Progress would have earnings for the year of approximately $10,000 (exclusive of earnings attributed to its investment in Calgana) and that Calgana would have earnings of approximately $50,000. The CEO of Progress was disappointed in the forecast earnings of both companies. Prior to Year 6, Progress had increased its earnings by 10 percent each year, and Progress would have to report total earnings in Year 6 of $45,000 if the trend was to continue.
a) Suppose Progress Technologies Inc. reports its interest in Calgana Corp. using the equity method. i) If Calgana is to declare its usual dividend of $0.50 per share, what would be the total reported income of Progress? ii) The CEO of Progress suggested that Calgana be directed to declare a special dividend of $3 per share. What impact would the additional dividend have on the reported earnings of Progress? b) Suppose that Progress Technologies Inc. reports its investment in Calgana Corp. using the cost method. iii) What would be the total reported earnings of Progress if Calgana declared its regular dividend of $0.50 per share? iv) What impact would the additional dividend of $3 per share have on reported earnings of Progress? c) Explain fully why the equity method (rather than the cost method) is appropriate for firms that can exert significant influence over other companies in which they have an interest.
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