Question

On 1 January 2018, Wu’s Tea Ltd, a bubble milk tea chain, acquired a 20 per...

On 1 January 2018, Wu’s Tea Ltd, a bubble milk tea chain, acquired a 20 per cent interest in UnluckyCoffee Ltd for $120,000 in cash. As at the acquisition date, the assets of UnluckyCoffee Ltd were reported at fair value. For the year ending 31 December 2018, UnluckyCoffee Ltd recorded an after-tax loss of $20,000. Wu’s Tea Ltd accounts for its investment in UnluckyCoffee Ltd using the equity method of accounting.

  • The assets of Wu’s Tea Ltd, inclusive of its investment in UnluckyCoffee Ltd accounted for under equity accounting was $4,000,000 as at 31 December 2018.
  • The EBIT of Wu’s Tea Ltd, inclusive of its investment in UnluckyCoffee Ltd accounted for under equity accounting is $200,000 as at 31 December 2018.
  • The fair value of UnluckyCoffee Ltd was assessed to be only $70,000 at the end of the year.

What is the ROA for Wu’s Tea Ltd? What would their ROA be if their investment in Unlucky Coffee Ltd was accounted for as a financial instrument?

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Answer #1

Answer :

(i). ROA of Wu'e Ltd = EBIT / Assets of Wu's

= 200,000 / 4,000,000

= 5%

(ii). ROA when investment is tested for impairment

Total assets of Wu's before impairment = 4,000,000

Share of investment in Unluckey Coffee in total assets = [120000 - (20000*20%)] = $116,000

Share of investment in fair value of Unlucky coffee = 70000*20% = $14000

Therefore total assets of Wu's = $4,000,000 - $116,000 + $14,000 = $3,898,000

ROA = [(200000 - 106000)] / 3898000

= 2.41%

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