a) Provide all the necessary Year 1 journal entries for Head Ltd. from purchase to all year-end adjustments, assuming they have significant influence.

Answer:

No	Date	General Journal	Debit	Credit
1	Jan 1, Year 1	Investment in Toe	800,000
		Cash		800,000
		To record the purchase of 40% of Toe
2	Dec 31, Year 1	Investment in Toe	80,000
		Investment income		80,000
		To record the share of Head in Toe's income
3	Dec 31, Year 1	Cash	32,000
		Investment in Toe		32,000
		To record the share of Head in Toe's dividend
4	Dec 31, Year 1	Investment income	12,000
		Investment in Toe		12,000
		To record the amortization of acquisition differential
5	Dec 31, Year 1	Investment income	13,440
		Investment in Toe		13,440
		To record the elimination of inventory profits

b) Show all calculations necessary to determine the end of Year 2 balance in Head’s “Investment in Toe” account. Use a table format with one line per item and label each item. Provide the ending balance.

Answer:

Balance at the beginning of Year 1	800,000
Add: Year 1 investment income from Toe	80,000
Less: Year 1 Dividends from Toe	(32,000)
Less: Accumulated Depreciation Amortization	(12,000)
Less: Intercompany inventory profits	(13,440)
Balance at the beginning of Year 2	822,560
Add: Year 2 investment income from Toe	96,000
Less: Year 2 Dividends from Toe	(56,000)
Less: Accumulated Depreciation Amortization	(12,000)
Balance at the end of Year 2	850,560

Calculation:

a.

Entry #2:

To record the share of Head in Toe's income

Net income of $200,000 x 40% share = 80,000

Entry #3:

To record the share of Head in Toe's dividend

Paid dividends of $80,000. So 80,000 x 40% share = 32,000

Entry #4:

To record the amortization of acquisition differential

Building has a market value $300,000 greater than book value

Life = 10 years

So, (300,000  x 40% share)/10 years = 12,000

Entry #5:

To record the elimination of inventory profits

Sale of merchandise = $240,000

Gross profit rate = 40%

Merchandise remained in Toe’s inventory = 50%.

Head’s tax rate = 30%.

Inventory profit elimination = 240,000 x 40% x (1-30%) x 50% x 30% = 13,440

b.

To calculate the  end of Year 2 balance in Head’s Investment in Toe, first we need to determine the Balance at the beginning of Year 2. For that we need to add the Year 1 investment income from Toe to the Balance at the beginning of Year 1. Then we need to deduct the Year 1 Dividends from Toe, Accumulated Depreciation Amortization and the Intercompany inventory profits.

Then we get the Balance at the beginning of Year 2. Next we need to add the Year 2 investment income from Toe.

Year 2 investment income from Toe = Net income of $240,000 x 40% share = 96,000

Then we need to deduct the Year 2 Dividends from Toe

Paid dividends of $140,000. So 140,000 x 40% share = 56,000

Then we need to deduct the Accumulated Depreciation Amortization of 12,000 which is same for all years