Exam 1: The Equity Method of Accounting for Investments

You are auditing a company that owns twenty percent of the voting common stock of another corporation and uses the equity method to account for the investment. How would you verify that the equity method is appropriate in this case?

On January 1, 2021, Lee Company paid $1,870,000 for 80,000 shares of Thomas Co.'s voting common stock which represents a 45% investment. No allocation to goodwill or other specific account was necessary. Significant influence over Thomas was achieved by this acquisition. Thomas distributed a dividend of $2.00 per share during 2021 and reported net income of $720,000. What was the balance in the Investment in Thomas Co. account found in the financial records of Lee as of December 31, 2021?

Which of the following results in a decrease in the investment account when applying the equity method?

Which of the following results in an increase in the Equity in Investee Income account when applying the equity method?

On January 2, 2021, Barley Corp. purchased 40% of the voting common stock of Wheat Co., paying $3,000,000. Barley properly accounts for this investment using the equity method. At the time of the investment, Wheat's total stockholders' equity was $5,000,000. Barley gathered the following information about Wheat's assets and liabilities whose book values and fair values differed: Any excess of cost over fair value was attributed to goodwill, which has not been impaired. Wheat Co. reported net income of $400,000 for 2021, and paid dividends of $200,000 during that year.How much goodwill is associated with this investment?

When an investor appropriately applies the equity method, how should it account for any investee Other Comprehensive Income (OCI)?

Which of the following results in a decrease in the Equity in Investee Income account when applying the equity method?

On January 1, 2020, Mehan, Incorporated purchased 15,000 shares of Cook Company for $150,000 giving Mehan a 15% ownership of Cook. The fair value of the 15% investment was the same as the carrying value of the investment when, on January 1, 2021, Mehan purchased an additional 25,000 shares (25%) of Cook for $300,000. This last purchase gave Mehan the ability to apply significant influence over Cook. The book value of Cook on January 1, 2020 was $1,000,000. The book value of Cook on January 1, 2021, was $1,100,000. Any excess of cost over book value for this second transaction is assigned to a database and amortized over four years.Cook reports net income and dividends as follows. These amounts are assumed to have occurred evenly throughout the years: On April 1, 2022, just after its first dividend receipt, Mehan sells 10,000 shares of its investment.What was the balance in the investment account at April 1, 2022 just before the sale of shares?

On January 4, 2021, Mason Co. purchased 40,000 shares (40%) of the common stock of Hefly Corp., paying $560,000. At that time, the book value and fair value of Hefly's net assets was $1,400,000. The investment gave Mason the ability to exercise significant influence over the operations of Hefly. During 2021, Hefly reported income of $150,000 and paid dividends of $40,000. On January 2, 2022, Mason sold 10,000 shares for $150,000.What was the balance in the investment account before the shares were sold?

Chase Incorporated sold $260,000 of its inventory to Bartlett Company during 2021 for $400,000. Bartlett sold $300,000 of this merchandise in 2021 with the remainder to be disposed of during 2022. Assume Chase owns 35% of Bartlett and accounts for its investment using the equity method.What journal entry will be recorded in 2022 to recognize its share of the intra-entity gross profit that was deferred in 2021?

Jager Inc. holds 30% of the outstanding voting shares of Kinson Co. and appropriately applies the equity method of accounting. Amortization associated with this investment equals $11,000 per year. For 2021, Kinson reported earnings of $100,000 and paid cash dividends of $40,000. During 2021, Kinson acquired inventory for $62,400, which was then sold to Jager for $96,000. At the end of 2021, Jager still held some of this inventory at its intra-entity selling price of $50,000.Required:Determine the amount of Equity in Investee Income that Jager should have reported for 2021.

How does the use of the equity method affect the investor's financial statements?

On January 4, 2021, Snow Co. purchased 40,000 shares (40%) of the common stock of Walker Corp., paying $900,000. There was no goodwill or other cost allocation associated with the investment. Snow has significant influence over Walker. During 2021, Walker reported income of $240,000 and paid dividends of $75,000. On January 2, 2022, Snow sold 5,000 shares for $125,000. What was the balance in the investment account after the shares had been sold?

Jones, Incorporated acquires 15% of Anderson Corporation on January 1, 2020, for $105,000 when the book value of Anderson was $600,000. During 2020 Anderson reported net income of $150,000 and paid dividends of $50,000. On January 1, 2021, Jones purchased an additional 25% of Anderson for $200,000. Any excess cost over book value is attributable to goodwill with an indefinite life. The fair-value method was used during 2020 but Jones has deemed it necessary to change to the equity method after the second purchase. During 2021 Anderson reported net income of $200,000, and reported dividends of $75,000.The balance in the investment account at December 31, 2021, is

Tinker Co. owns 25% of the common stock of Harbor Co. and uses the equity method to account for the investment. During 2021, Harbor reported income of $120,000 and paid dividends of $40,000. Harbor owns a building with a useful life of twenty years, which was undervalued by $80,000 at the time that Tinker bought its shares of Harbor's common stock.Required:Prepare a schedule to show the equity income Tinker should recognize for 2021 related to this investment.

On January 3, 2020, Baxter, Inc. acquired 40% of the outstanding common stock of Anchor Co. for $2,800,000. This investment gave Baxter the ability to exercise significant influence over Anchor. Anchor's assets on that date were recorded at $11,700,000 with liabilities of $4,700,000. There were no other differences between book and fair values.During 2020, Anchor reported net income of $600,000. For 2021, Anchor reported net income of $900,000. Dividends of $350,000 were paid in each of these two years.What was the reported balance of Baxter's Investment in Anchor Co. at December 31, 2020?

On January 3, 2021, Roberts Company purchased 30% of the 100,000 shares of common stock of Thomas Corporation, paying $1,500,000. There was no goodwill or other cost allocation associated with the investment. Roberts has significant influence over Thomas. During 2021, Thomas reported net income of $300,000 and paid dividends of $100,000. On January 4, 2022, Roberts sold 15,000 shares for $800,000.What was the balance in the investment account before the shares were sold?

Jarmon Company owns twenty-three percent (23%) of the voting common stock of Kaleski Corp. Jarmon does not have the ability to exercise significant influence over the operations of Kaleski. What method should Jarmon use to account for its investment in Kaleski?

A company has been using the fair-value method to account for its investment. The company now has the ability to significantly influence the investee and the equity method has been deemed appropriate. Which of the following statements is true?

On January 1, 2021, Anderson Company purchased 40% of the voting common stock of Barney Company for $2,000,000, which approximated book value. During 2021, Barney paid dividends of $30,000 and reported a net loss of $70,000.What amount of equity income would Anderson recognize in 2021 from its ownership interest in Barney?