National Computers (NC) and Hightech Ltd. (HT), two unrelated companies, agreed to share the latest technology in allowing individuals with visual impairments to use voice recognition software (either French or English) to complete their banking over the phone (e.g., transferring funds from one account to another, verifying bank balances, paying bills). Eventually they hope to expand the program to allow verbal inquiries about stock market quotes. The companies also plan to develop their software to encompass other languages.

On January 1, 20X5, NC and HT incorporated a new company, Voice Ltd. (VL). Two classes of VL common shares were issued. Each share in both classes participates equally in the company€™s earnings. Class A shares are non-voting, whereas Class B shares are voting. In return for 59 Class A shares and 1 Class B share, NC contributed land with a fair market value of $1,600,000 (NC€™s carrying value for the land was $800,000). In return for 39 Class A shares and 1 Class B share, HT contributed cash of $1,000,000.

Of the five-member board of directors of VL, three are nominees of NC and two are nominees of HT. Initially, it was decided that VL would conserve its cash by paying no dividends. Under a written agreement, any change in the dividend policy of VL, and any transactions between VL and either NC or HT, must be approved in advance by both NC and HT. NC has retained the right to select VL€™s chief executive officer. The primary activity of NC is the manufacturing of personal computers.
Extracts from the statements of comprehensive income and the statements of financial position for NC and VL are as follows, ignoring the impact of income taxes:

Additional Information

1. During 20X5, VL sold one-half of the land transferred from NC for proceeds of $1,100,000 and recorded a gain of $300,000.

2. A management fee of $150,000, paid to NC by VL during 20X5, is included in other operating expenses of VL and sales of NC in the above 20X5 statements of comprehensive income.

3. VL€™s ending inventory includes goods purchased from NC for $400,000. NC€™s cost for these goods was $275,000. NC€™s ending inventory includes goods purchased from VL for $250,000. VL€™s cost for these goods was $150,000.

Required

The following are four possible alternatives for accounting for NC€™s investment in VL:

a. cost;

b. equity;

c. proportionate consolidation; and

d. consolidation.

Discuss the appropriateness of using each of these four alternatives.

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Statements of Comprehensive Income December 31, 20X5 NC VL | Sales $3,300,000 $1,200,000 Cost of goods sold 1,600,000 600,000 1,700,000 600,000 Depreciation 600,000 200,000 Other operating expenses 700,000 300,000 500,000 1,300,000 Income before gain 400,000 100,000 Gain on sale of land 800,000 300,000 Net income and comprehensive income $ 400,000 $1,200,000 Statements of Financial Position December 31, 20X5 NC VL Cash $1,800,000 $1,100,000 Accounts receivable 400,000 300,000 Inventory 1,500,000 500,000 Investment in VL, at cost Building and equipment, net Land 1,600,000 1,800,000 600,000 800,000 800,000 $7,900,000 $ 200,000 $3,300,000 $ 300,000 Accounts payable Common shares 5,000,000 2,600,000 Retained earnings 2,700,000 400,000 $7,900,000 $3,300,000