P Ltd acquired 35% of the equity share of A Ltd on 1 January 2021 for $272,000.
P Ltd prepares consolidated financial statements and applies the equity method to account for its investment in A Ltd. Johnny, a junior accountant working at P Ltd, suggests that a ‘line by line’ approach to consolidation should be adopted in respect of A Ltd. The net profits of A Ltd are $50,000 during 2021
A Ltd sold goods that cost $100,000 to P Ltd at a price of $120,000 during the year ended 31 December 2021.
On 31 December 2021, 20% of these goods remained in P Ltd’s inventories. In its financial records, P Ltd originally entered “Debit Inventories $120,000” and “Credit Cash $120,000”, among other entries.
(a) Considering P Ltd’s shareholding in A Ltd (i.e. 35%), advise if Johnny’s proposed approach to consolidation of the accounts of the two entities is appropriate in the context of equity accounting.
(b) Prepare journal entries related to the net profits of A Ltd during the year ended 31 December 2021.
(c) Prepare journal entries for the unrealized profits of A Ltd during the year ended 31 December 2021.
(d) In the context of equity accounting, explain the difference that may arise when the cost of investment in an associate is greater than the investor’s share of net assets of the associate and the accounting treatment of such a difference.