Question
IBM acquires 80% of ABC, Inc. for $40 million on January 1, 2013. At the time of acquisition, ABC has total net assets with a
IBM acquires 80% of ABC, Inc. for $40 million on January 1, 2013. At the time of acquisition, ABC has total net assets with a fair value of $25 million. For the years ending December 31, 2013, and December 31, 2014, ABC, Inc. reports net income (loss) and pays dividends as shown here:
Net Income (loss)Dividends PaidNet Income (loss)Dividends Paid$2,000,000$1,000,000 (2014)$(600,000)$800,000 (2013)
The excess of the acquisition price over the fair value of net assets acquired is assigned to goodwill.Since goodwill has an indefinite life, it is not amortized.
Required:
- Compute the value of IBM's investment in ABC, Inc. as of December 31, 2014, under the equity method.
- Discuss the strengths and weaknesses of the income statement and balance sheet in reflecting the economic substance of this transaction and subsequent business activities using the equity method.
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