In the course of the audit of King Limited (King), you, the CA, while reviewing the draft financial statements for the year ended August 31, Year 17, noticed that King’s investment in Queen Limited (Queen) was measured on the cost basis. In Year 16, it had been measured on the equity basis. Representing a 22% interest in Queen, this investment had been made 10 years ago to infuse fresh equity, with a view to protecting King’s source of supply for drugs.
King’s controller informed you that Queen had suffered a large loss in Year 17, as shown by the May interim financial statements. King’s representative on Queen’s board of directors had resigned because King’s purchases from Queen now constitute less than 5% of its total purchases. In addition, Queen had been uncooperative in providing profit data in time to make the year-end equity adjustment. Consequently, King’s controller had revised the method of accounting for the investment in Queen.
Discuss how King should report its investment in Queen, and describe what should be disclosed in the notes to the Year 17 financial statements. Assume that King and Queen are public companies.