Question

Jax Company uses the acquisition method for accounting for its investment in Saxton Company. Jax sells some of its shares to Saxton such that neither control not significant influence exists. Which of the following statements is true? A) The difference between selling price and acquisition value is recorded as a realized gain or loss.
B) The difference between selling price and acquisition value is recorded as an unrealized gain or loss.
C) The difference between selling price and carrying value is recorded as a realized gain or loss.
D) The difference between selling price and carrying value is recorded as an unrealized gain or loss.
E) The difference between selling price and carrying value is recorded as an adjustment to retained earnings.
C) The difference between selling price and carrying value is recorded as a realized gain or loss.

Answer 1

Answer:

A

Explanation:

In this question, we are to evaluate the validity of the options. We were told he used the acquisition method. When do we use the acquisition method?

The acquisition method is used when a company is taken in by another company by using a merger, acquisition or through a consolidation.

Now, out of all the options presented, we can see that the selling price less the acquisition value is recorded as a realized gain or loss.

Answer 2

Answer:

C) The difference between selling price and carrying value is recorded as a realized gain or loss.

Explanation:

US GAAP requires that when a company acquires another company it must record the transaction using the acquisition method. The purchasing company must record the value for:

1. tangible assets and liabilities that were acquired
2. intangible assets and liabilities that were acquired
3. noncontrolling interest in the acquired business
4. consideration paid to the seller
5. goodwill or gain on the transaction

Since the question focuses on realized gain or loss, we will skip the first four elements. Goodwill would be considered a loss since it represents the amount of money paid in excess of the company's fair market value. A gain would equal a negative goodwill.

• goodwill = acquisition price + noncontrolling interest - identifiable assets acquired  + identifiable liabilities acquired

In this case, since the buyer (Jax Company) decided to sell back stocks to Saxton Company, there is no more acquisition. But you can still determine if the operation resulted in a gain or a loss. The way you can do this is by taking the sale price of the stocks repurchased by Saxton and subtracting the carrying value of those stocks. Probably Jax used the acquisition method because its original intention was to purchase Saxton, but things happen and it couldn't be done.