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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.
Problem 1: 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?
Problem 2: Following from 1 above, explain whether you think equity accounting or financial instrument accounting provides more useful information to the shareholders of Wu's Tea Ltd and why?
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