Problem
Significant Influence Investments
P Corp. paid $500,000 for a 40% interest in S Limited on January 1, Year 6. This purchase gives P significant influence in S.
During Year 6, S paid dividends of $100,000 and reported profit as follows:
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Profit before discontinued operations
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$385,000
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Discontinued Operations loss (net of tax)
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(30,000)
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OCI (unrealized gain on FV-OCI investment)
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20,000
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Comprehensive Income
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$375,000
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P's profit for Year 6 consisted of $1,200,000 in sales, operating expenses of $500,000, income tax expense of $210,000, and its investment income from S. Both companies have an income tax rate of 30%.
Task
I. Assume that P reports its investment using the equity method.
i. Prepare all journal entries necessary to account for P's investment for Year 6.
ii. Determine the correct balance in P's investment account at December 31, Year 6.
iii. Prepare a statement of comprehensive income for P for Year 6. Use an appropriate 3-line title.
II. Assume that P uses the cost method.
i. Prepare all journal entries necessary to account for P's investment for Year 6.
ii. Determine the correct balance in P's investment account at December 31, Year 6.
iii. Prepare an income statement for P for Year 6. Use an appropriate 3-line title.
III. If P wants to show the lowest debt-to-equity ratio at the end of year 6, would it prefer to use the cost or equity method to report its investment in S? Explain why.