Question 2 (25 marks)

On July 1, 2013 Party Inc. acquired 75% of the outstanding shares of Stag Ltd. for a cash consideration of

$2,250,000. On that date, the shareholders' equity of Stag Ltd. consisted of common shares of

$1,600,000, contributed surplus of $200,000 and retained earnings of $400,000. The book values of

Stag's identifiable assets and liabilities approximated their fair values except that inventories were

overvalued by $50,000, capital assets with a cost of $1,200,000 and accumulated amortization of

$400,000 had a fair value of $1,000,000, and long-term debt had a book value that was $100,000 higher

than its fair value. In addition, Stag had unrecorded intangible assets with a fair value of $240,000. The

inventories on hand on the acquisition date were all sold before the end of 2013. The capital assets had

a remaining useful life of eight years and the long-term debt matured on June 30, 2018. The unrecorded

intangibles had an economic life of six years. Amortization of intangibles is included in other expenses.

Party Inc. decided to account for its investment in Stag using the cost method and to value the

noncontrolling interest in Stag based on the fair value of its identifiable net assets on the acquisition

date (parent company extension approach). Goodwill was tested for impairment each year and

impairment of $42,500 was identified in 2014 and a further impairment of $40,000 was identified in

2016.

The following transactions took place between the acquisition date and January 1, 2016:

?

On April 1, 2014, Stag Ltd. sold a fixed asset to Party Inc. for $150,000. The asset had a book value

of $90,000 on Stag's books immediately before the sale. The asset had a useful life of six years on

the date of the sale.

?

In 2015, Stag Ltd. sold inventory to Party Inc. for $200,000. The inventory was priced to provide a

gross margin of 20%. At the end of 2015, $50,000 of this inventory was unsold. Also, during 2015,

Party Inc. sold inventory to Stag Ltd. for $130,000. This inventory was sold at a markup on cost of

30%. At the end of 2015, $65,000 of this inventory was in Stag Ltd.'s inventory. All of these

inventories were sold to outside customers by the end of 2016.

The following transactions took place during the year ended December 30, 2016:

?

Stag Ltd. sold inventory to Party Inc. for $240,000. The inventory was priced to provide a gross

margin of 20%. At the end of 2016, $60,000 of this inventory was in Party Inc.'s inventory. Also,

Party Inc. sold inventory to Stag Ltd. for $168,000. This inventory was sold at a markup on cost of

40%. At the end of 2016, $49,000 of this inventory was in Stag Ltd.'s inventory.

?

On October 1, 2016, Party sold a plot of land to Stag for $250,000. The land cost Party $200,000

when it was acquired in late 2013. (The gain on sale is included in total revenues for the year.)

?

Party charged Stag $90,000 in management fees during 2016.

?

Stag Ltd. paid dividends on common shares totaling $60,000. (Dividend income is included in total

revenues for the year.)

Following are the condensed financial statements of the two companies at December 31, 2016 and for

the year then ended:

File Home Insert D raw Design Layout Assignment 5 References Mailings Review View Help ue Februaw 7),1 , Protected View , Saved to this PC ,0 Tell me what you want to do PROTECTED VIEW Be carefulfiles from the Internet can contain viruses. Unless you need to edit, it's safer to stay in Protected View, Enable Editing Page 3 ol 4 1361 words as at December 31, 2016 Balance Sheets Party Inc, Cash 5 200,000 Accounts receivable 500,000 Inventory 1,500,000 Capital assets 5,350,000 Investment in Stag (at cost) 2,250,000 S 9,800,000 Current liabilities 5 2,755,000 Long-term debt 2,000,000 Common shares 3,000,000 Contributed surplus 1,000,000 Retained earnings 1,045,000 5 9,800,000 Income Statements for the year ended December 31, 2016 Total revenues Cost of sales Amortization expense Other expenses Income tax expense Net income for the year 5 2,840,000 1,800,000 300,000 152,500 202,500 2,455,000 $ 335,000 Stag Ltd. 5 125,000 400,000 1,050,000 3,025,000 5 4,600,000 S 750,000 1,000,000 1,600,000 200,000 1,050,000 5 4,600,000 5 2,630,000 1,470,000 335,000 142,500 252,500 2,200,000 $ 430,000 a Tjamadi Fix - I+ 100%