On January 1, 20X6, Loffer Limited purchased 35% of Ming’s common shares for a price of $ 575,000. The remainder of the shares in Ming are closely held by family members of the founder of the company. Loffer considers this a strategic invest-ment, acquired to get a toehold in a critical consumer goods market. Loffer is a supplier of components to Ming. On this date, the assets of Ming had a book value of $ 500,000, liabilities were $ 100,000, and equity was $ 400,000. Loffer paid significantly more than book value for its interest because of important patents held by Ming; the fair value of these patents is not recorded on the books. The patents give Ming a distinct competitive advantage, expected to last for at least 10 years before new technologies would develop to provide alternatives for customers. In the meantime, Ming is able to charge premium prices. Loffer was entitled to place two members on the 10- person Board of Directors as a result of its investment. Loffer’s Board members have felt that they were influential throughout 20X6 in strategic decisions. In 20X6, Ming reported earnings of $ 200,000 and paid divi-dends of $ 40,000.

1. Discuss whether significant influence is present.
2. Assuming that this is an investment in an associate, why is the dividend cash flow not considered the appropriate measure of investment earnings?
3. Will Loffer’s share of earnings be calculated as a simple percentage of earnings? Why not?
4. What value for the patents is implied by Loffer’s purchase price? Why does this impact future earnings?
5. If the investment is accounted for using the equity method, what will be the balance in the investment account at the end of the year? Assume all the excess paid over book value relates to patents and there are no intercompany unconfirmed profits at year- end. Does this balance represent fair value?

  • CreatedFebruary 17, 2015
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