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Hello,
P acquired 80% of S on 1 July 20X1. S’s retained earnings at
31 December 20X1 are $15,000 and S’s profit for the year was $8,000.
Immediately after acquisition, P made a loan to S of $40,000 which
carried interest at 10%.what are’ s ‘ retained earnings at acquisition.. I have a doubt in this question that what will be the effect of loan in calculation of retained earnings of s at acquisition.
Thank you.
Firstly I would start by working out what S’s profit by for year would be without loan.Since loan interest equals $40000 X 0.1 X 6/12 = $2000. This means $10000 profit would have been earned in absence of loan which is important as profit for year will be unevenly earned as result of loan interest $8000 + $2000 =$10000. If this ten thousand were earned evenly apart from interest on loan which only applies to second half of year, then $5000 dollars would be earned in pre-acquisition period and $5000 in post-acquisition period. However, we know $2000 cost is only applicable to post-acquisition. This means that $5000 is earned pre-acquisition and $3000 post-acquisition. The above assumes that profit is earned evenly across year apart from interest on loan which can be fair assumption if stated and not contradicted by information in question. Hopefully, I have got the above right and I hope it helps you.
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