Question

West Corp. owns 70% of the voting common stock of East Co. East owns 60% of Compass Co. West and East both use the initial value method to account for their investments. The following information is available from the financial statements and records of the three companies:
Operating income included unrealized intra-entity gains (which are related to inventory transfers) but did not include dividend income from investment in subsidiary. The accrual-based income of East Co. is calculated to be. Please provide detailed calculation.

A. $385,700.

B. $581,000.

C. $557,000.

D. $551,000.

E. $707,000.

Answer 1

Answer:

D. $551,000

Explanation:

Since we need the accrual-based income of East Company -

Given,

West Company's net income = $860,000

East Company's net income = $600,000

Compass Company's income = $120,000

Intra-entity gain (Unrealized) = $96,000 (West), $70,000 (East), $15,000 (Compass)

Excess Amortization = $30,000 (West), $20,000 (East)

As East owns 60% of Compass Co., the Compass Income of East Co. share

= (Net income of Compass - Excess Amortization of East - Unrealized Gains (Intra-Entity) of Compass) x Percentage of share owned by East

= $(120,000 - 20,000 - 15,000) x 0.60

= $85,000 x 0.60

= $51,000

However, as West and East both use the initial value method to account for their investments, therefore, the net income of West share cannot be added -

Excess Amortization of West + Unrealized Gains (Intra-Entity) of West

= $(30,000 + 70,000) = $100,000

Total accrual-based income of East Co. = the Compass Income of East Co. share + The net income of East Company - West company's excess part

= $(51,000 + 600,000 - 100,000)

= $551,000