Harrison, Inc. acquires 100% of the voting stock of Rhine Company on January 1, 2010 for $400,000 cash

QUESTION:

Harrison, Inc. acquires 100% of the voting stock of Rhine Company on January 1, 2010, for $400,000 cash. A contingent payment of $16,500 will be paid on April 15, 2011, if the Rhine generates cash flows from operations of $27,000 or more in the next year. Harrison estimates that there is a 20% probability that the Rhine will generate at least $27,000 next year, and uses an interest rate of 5% to incorporate the time value of money. The fair value of $16,500 at 5%, using a probability-weighted approach, is $3,142.

What will Harrison record as its Investment in the Rhine on January 1, 2010?

A. $400,000

B. $403,142

C. $406,000

D. $409,142

E. $416,500

ANSWER:

B. $403,142.

Harrison will record a contingent performance obligation for the amount of $3,142
Entry at the time of payment of 16,500 would have been
Contingent performance obligation Dr    3,142.00
Loss from the revaluation of the contingent performance obligation   13,358.00
To Cash A/C   16,500.00
Thus the amount of investment would be 400,000+ 3,142 = 403,142 since Harrison will record a contingent performance obligation for the amount of $3,142

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