Review Materials for INTERM2 – Problem Solving

Topic: Investments in Associates

Answers on Problem 2: Multiple Choice - Theory
1. C 6. D
2. D 7. C
3. C 8. A
4. C 9. C
5. C 10. C

Answers in Problem 4 – Computational (Selected Problems)

7. On January 1, 2002, Mets Inc. purchased 30% of the outstanding common stock of Pirates Corporation
for P516,000 cash. Mets is accounting for this investment using the equity method. On the date of
acquisition, the fair value of Pirates net assets was P1,240,000. Mets has determined that the excess of
the cost of investment over its shares of Pirates net assets is attributable to goodwill, which will be
amortized over the maximum allowable period. Pirates net income for the year ended December 31,
2002, was P360,000. During 2002, Pirates declared and paid cash dividends of P40,000. There were no
other transactions between the 2 companies. On Dec. 31, 2002, the investments in Pirates should be
recorded as
a. 392,400
b. 608,400
c. 612,000
d. 624,000
Solution:

Investment in associate
Purchase price 516,000
Share in profit 108,000 12,000 Dividends
612,000 end.

Note: The “excess” is not amortized because it pertains to goodwill. Goodwill arising from investment
in associate is not accounted for separately, meaning it is neither amortized nor tested for
impairment separately.

8. Hot Co. owns 50,000 shares out of the 300,000 total outstanding shares of Cold, Inc. The investment in
Cold’s shares has a carrying amount of P1,200,000 on Jan. 1 , 20x1. Hot also owns bonds issued by Cold
that are convertible into 30,000 ordinary shares. The bonds are currently convertible; however Hot Co.
does not intend to convert them. Cold does not have any other outstanding convertibles bonds aside
from those held by Hot Co. Cold reported profit pf P3,300,000 and declared and paid cash dividends of
P180,000 in 20x1. How much is the carrying amount of Hot Co.’s investment in Cold shares as of Dec. 31,
20x1?
a. 1,720,000
b. 1,872,363
c. 1,956,364
d. 1,980,000
Solution:
Shares presently held 50,000
Potential voting rights 30,000
Total shares 80,000
Divide by: Outstanding shares after conversion of bonds (300K + 30K) 330,000
Assumed ownership interest 24.24%

 Significant influence is presumed to exist because the assumed ownership interest

meets the 20% threshold. Accordingly, the investment will be accounted for under the
equity method.
 Investment in associate
Jan. 1, 20x1 1,200,000
Sh. in profit (a) 550,000 30,000 Dividends (b)
1,720,000 Dec. 31, 20x1

(a)
Share in profit of associate: ₱3,300,000 x 16.666667%* = 880,000
(b)
Share in cash dividends: ₱180,000 x 16.666667%* = 30,000
* 50,000 actual shares held ÷ 300,000 actual outstanding shares = 16.666667%

9. Joe Co. owns 25% of the outstanding ordinary shares of Monkey Co. Monkey has outstanding non-
cumulative preference shares with aggregate par value of P5,000,000 and fixed dividend rate of 5% none
of which is held by Joe. Monkey reported P2,800,000 profit for the year and declared dividends of
P800,000 to preference shareholders and P900,000 to ordinary shareholders. How much investment
income should Joe recognize for the year?
a. 225,000
b. 500,000
c. 637,500
d. 1,050,000
Solution:
Profit of Monkey 2,800,000
Dividends on noncumulative preference sh. (800,000)
Adjusted profit of associate 2,000,000
Multiply by: Ownership interest 25%
Share in profit of associate 500,000

10. Art Co. owns 25,000 out of the 10,000 outstanding voting shares of Ritz Co. Art accounts for the
investment, which has a carrying amount of P1,300,000 on January 1, 20x1, under the equity method. On
September 1, 20x1, Art sells 75% of the investment at P140 per share – the fair value on this date. Art
incurs transaction costs of P120,000 on the sale. Ritz reports profit of P4,200,000 for the year and
declares cash dividends of P1,200,000 on December 31, 20x1. The profit is earned evenly during the year.
Ritz’s shares are selling at P130 per share on Dec. 31, 20x1. How much is the net effect of the investment
in Art Co.’s profit or loss in 20x1?
a. 2,092,500
b. 2,289,500
c. 2,356,500
d. 2,420,500
Solution:

Share in profit of associate (4.2M x 8/12 x 25%) 700,000

1,005,0
Gain on sale (a)
00
Gain on reclassification (b) 375,000
Dividend income (1.2M x 25% x 25% unsold) 75,000
Unrealized loss (₱130 – ₱140) x 25,000 sh. x 25%
unsold (62,500)
2,092,5
Net effect in 20x1 profit
00

(a)

Investment in associate
Jan. 1, 20x1 1,300,000
Share in profit 700,000
2,000,000 Sept. 1, 20x1
 Sept. 1, Cash [(25,000 sh. x 75% x ₱140) – 120,000] 2,505,000
20x1
Investment in associate (2M x 75%) 1,500,000
Gain on sale of investment (squeeze) 1,005,000
to record the partial sale of investment

(b)

Sept. 1, Held for trading securities 875,000

20x1 (25,000 sh. x ¼ unsold x ₱140)
Investment in associate (2M x ¼) 500,000
Gain on reclassification (squeeze) 375,000
to reclassify the remaining investment

Fact pattern for the Questions 11 and 12:

Lim Co. sells one-fourth of its 20% investment in Teg Co.’s ordinary shares for P500,000. Information on
the date of sale is as follows:
 Investment in Teg’s shares (equity method) 1,200,000
 Cumulative share in Teg’s exchange differences on
Translation of a foreign operation 100,000 Cr

11. What would be the effect of the sale transaction on Lim Co.’s profit or loss if after the sale:
(1) Lim Co. loses significant influence over Teg Co., and
(2) Lim Co. retains significant influence over Teg Co.?
a. (1) 225,000; (2) 300,000
b. (1) 300,000; (2) 275,000
c. (1) 300,000; (2) 225,000
d. (1) 275,000; (2) 300,000
Solution:
(1)
Date Cash 500,000
Investment in associate (1.2M x ¼) 300,000
Gain on sale of investment 200,000
to record the sale
Date Translation of foreign operation 100,000
Gain on reclassification – P/L 100,000
to record the reclassification adjustment of the OCI to profit or loss

(1) Net effect in P/L = (200,000 + 100,000) = 300,000

(2)
Date Cash 500,000
Investment in associate (1.2M x ¼) 300,000
Gain on sale of investment 200,000
to record the sale
Date Translation of foreign operation (100K x ¼) 25,000
Gain on reclassification – P/L 25,000
to record the reclassification adjustment of the OCI to profit or loss

(2) Net effect in P/L = (200,000 + 25,000) = 225,000

12. What would be the effect of the sale transaction on Lim Co.’s profit or loss if the accumulated Other
Comprehensive Income represents revaluation gain (rather than translation gain) and Lim Co. retains
significant influence over Teg Co. after the sale?
a. 175,000
b. 200,000
c. 225,000
d. 275,000
Solution

Date Cash 500,000

Investment in associate (1.2M x ¼) 300,000
Gain on sale of investment 200,000
to record the sale
Date Revaluation surplus – associate (100K x ¼) 25,000
Retained earnings 25,000
to record the reclassification adjustment of the OCI to profit or
loss

Net effect in P/L = 200,000

Topic: Property, Plant and Equipment (Part 1)

Answers on Problem 2: Multiple Choice - Theory
1. D 6. C
2. D 7. A
3. D 8. D
4. B 9. D
5. D 10. C

Answers in Problem 4 – Computational (Selected Problems)

6. Sebastian Co. acquired a piece of equipment. The invoice price was P2,500,000 subject to prompt
discount of 3% which was not taken. Installation costs amounted to P50,000. Legislation requires
Sebastian Co. to decommission the asset at the end of the asset’s useful life of 10 years. Sebastian Co.
estimated that the decommissioning activities would cost P200,000. The appropriate discount rate on
initial recognition was 12%. How much is the initial cost of the equipment?
a. 2,550,000
b. 2,539,394
c. 2,614,394
d. 2,750,000
Solution:
Invoice Price (2,500,000 x 97%) 2,425,000
Add: Installation Cost 50,000
Decommissioning Cost
(200K x PV of 1 @12%, n=10)
(200K x 0.32197) 64,394
Total initial cost of equipment 2,539,394

Use the following information for Questions 7 and 8

Liempo Co. exchanged equipment with Monggo Co. Information on the assets exchanged is as follows:

Equipment Carrying Amount Fair Value

- Relinquished by Liempo 3,500,000 1,875,000
- Relinquished by Monggo 1,200,000 1,000,000

Monggo paid Liempo an additional cash of P700,000.

7. If the exchange transaction has commercial substance, what amounts are recognized in Liempo’s and
Monggo’s books for (1) the equipment received and (2) the gain (loss) on the exchange?

Liempo’s Books Monggo’s Books

a. 300,000; (1,125,000) 1,175,000; (200,000)
b. 1,175,000; 0 1,700,000; 0
c. 1,175,000; (1,625,000) 1,700,000; (200,000)
 d. 2,575,000; (1,625,000) 300,000; (200,000)
Solution:
Liempo:
1) Equipment received: (1,875,000 – 700,000) = 1,175,000
2) Gain (loss) on exchange: (1,875,000 – 3,500,000) = (1,625,000)
Monggo:
1) Equipment received: (1,000,000 + 700,000) = 1,700,000
2) Gain (loss) on exchange: (1,000,000 – 1,200,000) = (200,000)

8. If the exchange transaction has no commercial substance, what amounts are recognized in Liempo’s and
Monggo’s books for (1) the equipment received and (2) the gain (loss) on the exchange?
Liempo’s Books Monggo’s Books
a. 2,800,000; 0 1,900,000; 0
b. 1,175,000; 0 1,700,000; 0
c. 4,200,000; 0 500,000; 0
d. 2,800,000; (1,125,000) 1,900,000; (200,000)
Solution:
Liempo:
1) Equipment received: (3,500,000 – 700,000) = 2,800,000
2) Gain (loss) on exchange: 0
Monggo:
1) Equipment received: (1,200,000 + 700,000) = 1,900,000
2) Gain (loss) on exchange: 0
9. Rub Co. exchanged equipment with Liniment Co. Rub’s equipment has a historical cost of P100,000 and
an accumulated depreciation of P70,000. The fair value of Rub’s equipment cannot be determined
reliably. The equipment received from Liniment has a fair value of P40,000. Rub paid Liniment P8,000.
The exchange has commercial substance. What amounts are recognized in Rub’s books for (1) the
equipment received and the (2) gain (loss) on the exchange?
a. 40,000; 2,000
b. 40,000; 10,000
c. 48,000; (10, v000)
d. 48,000; 2,000
Solution:
1) Equipment received: 40,000, the fair value of the asset received
2) Gain (loss) on exchange:
Date Equipment – new (FV of asset received) 40,000
Accumulated depreciation 70,000
Equipment - old 100,000
Cash 8,000
Gain on exchange (squeeze) 2,000

Topic: Property, Plant and Equipment (Part 2)

Answers on Problem 2: Multiple Choice - Theory
1. D 6. D
2. B 7. D
3. A 8. B
4. D 9. D
5. D 10. D

Answers in Problem 4 – Computational (Selected Problems)

3. Spiro Corp. uses the sum-of the-years’ digit method to depreciate equipment purchased in January 20x1
for P20,000. The estimated residual value of the equipment is P2,000 and the estimated useful life is 4
years. What should Spiro report as the asset’s carrying amount as of December 31, 20x3?
a. 1,800
b. 2,000
c. 3,800
 d. 4,500,3

Solution:
SYD denominator = Life x [(Life + 1) / 2] = 4 x [(4+1) / 2] = 10
Historical cost 20,000
Estimated residual value (2,000)
Depreciable amount 18,000

Depreciation - 20x1 (18,000 x 4/10) 7,200

Depreciation - 20x2 (18,000 x 3/10) 5,400
Depreciation - 20x3 (18,000 x 2/10) 3,600
Accumulated depreciation - 12/31/20x3 16,200

Historical cost 20,000

Accumulated depreciation - 12/31/20x3 (16,200)
Carrying amount - 12/31/20x3 3,800

4. BPM Co. acquired a machine for P100,000. The machine has an estimated useful life of 5 years and a
residual value of P10,000. In what year of the machine’s useful life would the straight line method and
the sum-of-the-years’ digit method result in the same amount of depreciation?
a. Year 2
` b. Year 3
c. Year 4
d. Never
Solution:

Acquisition Cost 100,000 – Residual Value 10,000 = 90,000 Depreciable Cost

SYD denominator = Life x [(Life + 1) / 2] = 5 x [(5+1) / 2] = 15
5. On January 2, 20x1, Lem Corp. bought machinery under a contract that required a down payment of
P10,000 plus twenty-four monthly payments of P5,000 each, for total cash payments of P130,000. The
cash equivalent price of the machinery was P110,000. The machinery has an estimated useful life of ten
years and estimated residual value of P5,000. Lem uses straight line depreciation. In its 20x1 income
statement, what amount should Lem report as depreciation for this machinery?
a. 10,500
b. 11,000
c. 12,500
d. 13,000
Solution:
Cash equivalent price of machine 110,000
Less: Estimated residual value 5,000
Depreciable Value 105,000
Divided by: Useful Life 10 years
Depreciation of machine 10,500

6. Vore Corp. bought equipment on January 2, 20x1 for P200,000. This equipment had an estimated useful
life of five years and a residual value of P20,000. Depreciation was computed by the 150% declining
balance method. The accumulated depreciation balance at December 31, 20x2, should be
a. 102,000
b. 98,000
c. 91,800
d. 72,000
Solution:
 150% declining balance rate = 1.5/Life = 1.5/5 = 30%
Depreciation - 20x1 (200,000 x 30%) 60,000
Depreciation - 20x2 (200,000 - 60,000) x 30% 42,000
Accumulated depreciation - 12/31/x2 102,000

8. Parallel Universe Co.’s small tools had a balance of P300,000 at the beginning of the year. Acquisitions
and disposals of small tools during the year were as follows:

The balance of small tools per physical count at year end were P352,000. How much is the depreciation
expense for the year under the following methods?

Retirement Method Replacement Method Inventory Method

a. 56,800 88,200 58,600
b. 62,600 84,300 66,200
c. 67,400 83,400 67,400
d. 71,200 88,200 74,300
Solution:
Retirement method:
Cost of disposals (12,000 + 24,000 + 36,000) 72,000
Net disposal proceeds (1,000 + 1,600 + 2,000) (4,600)
Depreciation expense 67,400

Replacement method:
Cost of additions as replacements (20,000 + 44,000) 64,000
Cost of disposals but not replaced 24,000
Proceeds from sale of old tools (1,000 + 1,600 + 2,000) (4,600)
Depreciation expense 83,400

Inventory method:
Tools
beg. bal. 300,000 4,600 Proceeds from asset disposals
Additions 124,000 67,400 Depreciation (squeeze)
352,000 end. bal. (per physical count)

9. Probiotics completed leasehold improvements on Dec. 31, 2001 for a total cost of P480,000. The
improvements have an estimated useful life of 20 years. The related lease will be terminated on Dec. 31,
2010 but is renewable for an additional five-year term. Probiotics Co. is reasonable certain to exercise
the renewal option. How much is the carrying amount of the leasehold improvements on Dec. 31, 2002?
a. 34,286
b. 53,333
c. 445,714
d. 426,667
Solution:
 Useful life = 20 years
 Remaining lease term as of 12/31/01 = (9* + 5 renewal) = 14
* Dec. 31, 2001 completion date of improvements to Dec. 31, 2010 end of original lease term = 9 yrs.
 Shorter = 14 years
 480,000 x 13/14 = 445,714

11. On January 2, 20x0, Union Co. purchased a machine for P264,000 and depreciated it by the straight-line
method using an estimated useful life of eight years with no residual value. On January 2, 20x3, Union
determined that the machine had a useful life of six years from the date of acquisition and will have a
 residual value of P24,000. An accounting change made in 20x3 to reflect the additional data. The
accumulated depreciation for this machine should have a balance of December 31, 20x3, of
a. 176,000
b. 160,000
c. 154,000
d. 146,000
Solution:
Historical cost 264,000
Original estimated useful life 8
Original depreciation per year 33,000

Historical cost 264,000

Accumulated depreciation - 1/1/x3 (33,000 x 3 yrs.) (99,000)
Carrying amount - 1/1/x3 165,000
Revised residual value (24,000)
Revised depreciable amount 141,000
Divide by: Revised useful life (6 yrs. - 3 yrs.) 3
Depreciation - 20x3 47,000

Accumulated depreciation - 1/1/x3 (33,000 x 3 yrs.) 99,000

Depreciation - 20x3 47,000
Accumulated depreciation - 12/31/x3 146,000

19. Haze Co.’s Dec. 31, 20x1 financial statements reported total accumulated depreciation of P971,065. In
20x2, Haze Co. recognized total depreciation of P599,035 and made some disposals of PPE. The total
accumulated depreciation on December 31, 20x2 was P854,102. How much were the accumulated
depreciation of the assets disposed of during 20x2?
a. 689,018
b. 715,998
c. 749,624
d. 802,238

Solution:
Accumulated depreciation
971,065 12/31/x1
Disposal (squeeze) 715,998 599,035 Depreciation - 20x2
12/31/x2 854,102

Topic: Depletion of Mineral Resources

Answers on Problem 5: Multiple Choice - Theory
1. B 6. A
2. A 7. D
3. A 8. C
4. D 9. D
5. C 10. A

Answers in Problem 4 – Computational (Selected Problems)

3. In 20x1, Newman Company paid P1,000,000 to purchase land containing a total estimated 160,000 tons
of extractable mineral deposits. Accumulated depletion was recorded at 100,000 in 1/1/x3. The
estimated value of the property after the mineral has been removed is P200,000. Extraction activities
began in 20x2 and by the end of the year, 20,000 tons have been recovered and sold. In 20x3, geological
studies indicated that the total amount of mineral deposits had been underestimated by 25,000 tons.
During 20x3, 20,000 tons were extracted, and 18,000 tons were sold. What is the depletion rate per ton
(rounded to the nearest cent) in 20x3?
a. 4.24
b. 4.32
c. 4.85
d. 5.19
Solution:
Purchase cost of mine 1,000,000
Accumulated depletion - 1/1/x3 (100,000)
Carrying amount - 1/1/x3 900,000
Residual value (200,000)
Revised depletion base - 1/1/x3 700,000
Divided by: Revised estimate of reserves a 165,000
Revised depletion rate - 20x3 4.24

a
The revised estimate of reserves is computed as follows:
Original estimate of reserves 160,000
Understatement of total estimate 25,000
Tons extracted in 20x2 (20,000)
Remaining reserves - 1/1/x3 165,000