In early September Year 1, your firm’s audit client, D Ltd. (D) acquired in separate transactions an 80% interest in N Ltd. (N) and a 40% interest in K Ltd. (K). All three companies are federally incorporated Canadian companies and have August 31 year ends. They all manufacture small appliances, but they do not compete with each other.
You are the senior on the audit of D. The partner has just received the preliminary consolidated financial statements from the controller of D along with unconsolidated statements for the three separate companies. Extracts from these statements are summarized in Exhibit IV. The partner has requested that you provide him with a memorandum discussing the important financial accounting issues of D. Account balances for the consolidated financial statements should be recalculated to the extent that information is available.
D acquired the 80% interest in N for $4,000,000 paid as follows: (1) $2,000,000 in cash, and
(2) 160,000 common sha r es of D r eco r ded in the books of D at $2,000,000. D acquired its 40% interest in K at a cost of $2,100,000 paid as follows: (1) $100,000 in cash, and
(2) 160,000 common sha r es of D r eco r ded in the books of D at $2,000,000.
During the course of the audit, the following information was obtained:
1. The carrying amount of 80% of N’s net assets at the date of acquisition was $2,280,000. The acquisition di f fe r ential consisted of the following:
The excess of fair value of land over carrying amount
The excess of fair value of plant and equipment over carrying amount
20% noncontrolling interest’s share of excess of fair value over
Goodwill of N written off
Deferred research and development expenditures written off
The plant and equipment had a r emaining useful life of 10 years when D acqui r ed N.
2. The price paid by D for its investment in K was 10% lower than 40% of the fair value of K’s identifiable net assets.
3. During August Year 2, K sold goods to D as follows:
Cost to K
Normal selling price
1,250,000 Price paid by D
D had not sold these goods as of August 31, Year 2.
N also sold goods to D in August Year 2 and D had not sold them by August 31, Year 2.
Cost to N
Normal selling price
Price paid by D
4. For the year ended August 31, Year 2, D’s sales were $8,423,300 and N’s sales were $6,144,500.
5. The companies pay income tax at the rate of 40%.
Prepare the memorandum requested by the partner.