Exam 1: The Equity Method of Accounting for Investments

On January 4, 2013, Bailey Corp. purchased 40% of the voting common stock of Emery Co., paying $3,000,000. Bailey properly accounts for this investment using the equity method. At the time of the investment, Emery's total stockholders' equity was $5,000,000. Bailey gathered the following information about Emery's assets and liabilities whose book values and fair values differed: Book Value Fair Value Buildings (20-year life) \ 1,000,000 \ 1,800,000 Equipment (5-year life) 1,500,000 2,000,000 Franchises (10-year life) 0 700,000 Any excess of cost over fair value was attributed to goodwill, which has not been impaired. Emery Co. reported net income of $400,000 for 2013, and paid dividends of $200,000 during that year. What is the amount of excess amortization expense for Bailey's investment in Emery for the first year?

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

On January 1, 2012, Mehan, Incorporated purchased 15,000 shares of Cook Company for $150,000 giving Mehan a 15% ownership of Cook. On January 1, 2013 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, 2012, was $1,000,000. The book value of Cook on January 1, 2013, was $1,150,000. Any excess of cost over book value for this second transaction is assigned to a database and amortized over five years. Cook reports net income and dividends as follows. These amounts are assumed to have occurred evenly throughout the years: Net Income Dividends 2012 \ 200,000 \ 50,000 2013 225,000 50,000 2014 250,000 60,000 On April 1, 2014, just after its first dividend receipt, Mehan sells 10,000 shares of its investment. What is the balance in the investment account at December 31, 2012?

Which of the following results in an increase in the investment account when applying the equity method?

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?

An upstream sale of inventory is a sale:

Acker Inc. bought 40% of Howell Co. on January 1, 2012 for $576,000. The equity method of accounting was used. The book value and fair value of the net assets of Howell on that date were $1,440,000. Acker began supplying inventory to Howell as follows: $\begin{array}{llll}& \text { Cost to } & \text { Transfer } & \text { Amount Held by } \\\text { Year } & \text { Acker } & \text { Price } & \text { Howell at Year-End }\\\hline2012 & \mathbf{\$} 55,000 & \$ 75,000 & \$ 15,000 \\2013 & \$ 70,000 & \$ 110,000 & \$ 55,000\end{array}$ Howell reported net income of $100,000 in 2012 and $120,000 in 2013 while paying $40,000 in dividends each year. What is the balance in Acker's Investment in Howell account at December 31, 2013?

Luffman Inc. owns 30% of Bruce Inc. and appropriately applies the equity method. During the current year, Bruce bought inventory costing $52,000 and then sold it to Luffman for $80,000. At year-end, all of the merchandise had been sold by Luffman to other customers. What amount of unrealized intercompany profit must be deferred by Luffman?

On January 1, 2012, Mehan, Incorporated purchased 15,000 shares of Cook Company for $150,000 giving Mehan a 15% ownership of Cook. On January 1, 2013 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, 2012, was $1,000,000. The book value of Cook on January 1, 2013, was $1,150,000. Any excess of cost over book value for this second transaction is assigned to a database and amortized over five years. Cook reports net income and dividends as follows. These amounts are assumed to have occurred evenly throughout the years: Net Income Dividends 2012 \ 200,000 \ 50,000 2013 225,000 50,000 2014 250,000 60,000 On April 1, 2014, just after its first dividend receipt, Mehan sells 10,000 shares of its investment. How much income did Mehan report from Cook during 2012?

How would a change be made from the equity method to the fair value method of accounting for investments?

Wathan Inc. sold $180,000 in inventory to Miller Co. during 2012, for $270,000. Miller resold $108,000 of this merchandise in 2012 with the remainder to be disposed of during 2013. Required: Assuming Wathan owns 25% of Miller and applies the equity method, prepare the journal entry Wathan should have recorded at the end of 2012 to defer the unrealized intra-entity inventory profit.

Jarmon Company owns twenty-three percent 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?

Yaro Company owns 30% of the common stock of Dew Co. and uses the equity method to account for the investment. During 2013, Dew reported income of $250,000 and paid dividends of $80,000. There is no amortization associated with the investment. During 2013, how much income should Yaro recognize related to this investment?

On January 1, 2013, Jackie Corp. purchased 30% of the voting common stock of Rob Co., paying $2,000,000. Jackie properly accounts for this investment using the equity method. At the time of the investment, Rob's total stockholders' equity was $3,000,000. Jackie gathered the following information about Rob's assets and liabilities whose book values and fair values differed: Book Value Fair Value Buildings (20-year life) \ 1,000,000 \ 1,500,000 Equipment (5-year life) 2,500,000 3,000,000 Franchises (10-year life) 0 500,000 Any excess of cost over fair value was attributed to goodwill, which has not been impaired. Rob Co. reported net income of $300,000 for 2013, and paid dividends of $100,000 during that year. How much goodwill is associated with this investment?

Steven Company owns 40% of the outstanding voting common stock of Nicole Corp. and has the ability to significantly influence the investee's operations. On January 3, 2013, the balance in the Investment in Nicole Corp. account was $503,000. Amortization associated with this acquisition is $12,000 per year. During 2013, Nicole earned net income of $120,000 and paid cash dividends of $40,000. Previously in 2012, Nicole had sold inventory costing $35,000 to Steven for $50,000. All but 25% of that inventory had been sold to outsiders by Steven during 2012. Additional sales were made to Steven in 2013 at a transfer price of $75,000 that had cost Nicole $54,000. Only 10% of the 2013 purchases had not been sold to outsiders by the end of 2013. What amount of unrealized intra-entity profit should be deferred by Steven at December 31, 2013?

Club Co. appropriately uses the equity method to account for its investment in Chip Corp. As of the end of 2013, Chip's common stock had suffered a significant decline in fair value, which is expected to be recovered over the next several months. How should Club account for the decline in value?

On January 4, 2013, Bailey Corp. purchased 40% of the voting common stock of Emery Co., paying $3,000,000. Bailey properly accounts for this investment using the equity method. At the time of the investment, Emery's total stockholders' equity was $5,000,000. Bailey gathered the following information about Emery's assets and liabilities whose book values and fair values differed: Book Value Fair Value Buildings (20-year life) \ 1,000,000 \ 1,800,000 Equipment (5-year life) 1,500,000 2,000,000 Franchises (10-year life) 0 700,000 Any excess of cost over fair value was attributed to goodwill, which has not been impaired. Emery Co. reported net income of $400,000 for 2013, and paid dividends of $200,000 during that year. How much goodwill is associated with this investment?

On January 1, 2013, Bangle Company purchased 30% of the voting common stock of Sleat Corp. for $1,000,000. Any excess of cost over book value was assigned to goodwill. During 2013, Sleat paid dividends of $24,000 and reported a net loss of $140,000. What is the balance in the investment account on December 31, 2013?

On January 4, 2012, Harley, Inc. acquired 40% of the outstanding common stock of Bike Co. for $2,400,000. This investment gave Harley the ability to exercise significant influence over Bike. Bike's assets on that date were recorded at $10,500,000 with liabilities of $4,500,000. There were no other differences between book and fair values. During 2012, Bike reported net income of $500,000. For 2013, Bike reported net income of $800,000. Dividends of $300,000 were paid in each of these two years. How much income did Harley report from Bike for 2013?

On January 2, 2012, Hull Corp. paid $516,000 for 24% (48,000 shares) of the outstanding common stock of Oliver Co. Hull used the equity method to account for the investment. At the end of 2012, the balance in the investment account was $620,000. On January 2, 2013, Hull sold 12,000 shares of Oliver stock for $12 per share. For 2013, Oliver reported income of $118,000 and paid dividends of $30,000. Required: (A.) Prepare the journal entry to record the sale of the 12,000 shares. (B.) After the sale has been recorded, what is the balance in the investment account? (C.) What percentage of Oliver Co. stock does Hull own after selling the 12,000 shares? (D.) Because of the sale of stock, Hull can no longer exercise significant influence over the operations of Oliver. What effect will this have on Hull's accounting for the investment? (E.) Prepare Hull's journal entries related to the investment for the rest of 2013.