Exam 1: The Equity Method of Accounting for Investments

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, 2011, the balance in the Investment in Nicole Corp. account was $503,000. Amortization associated with this acquisition is $12,000 per year. During 2011, Nicole earned net income of $120,000 and paid cash dividends of $40,000. Previously in 2010, 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 2010. Additional sales were made to Steven in 2011 at a transfer price of $75,000 that had cost Nicole $54,000. Only 10% of the 2011 purchases had not been sold to outsiders by the end of 2011. What was the balance in the Investment in Nicole Corp. account at December 31, 2011?

Club Co. appropriately uses the equity method to account for its investment in Chip Corp. As of the end of 2011, 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?

An upstream sale of inventory is a sale:

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

On January 1, 2011, Anderson Company purchased 40% of the voting common stock of Barney Company for $2,000,000, which approximated book value. During 2011, Barney paid dividends of $30,000 and reported a net loss of $70,000. What is the balance in the investment account on December 31, 2011?

On January 3, 2011, 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 2011, Thomas reported income of $300,000 and paid dividends of $100,000. On January 4, 2012, Roberts sold 15,000 shares for $800,000. What is the balance in the investment account after the sale of the 15,000 shares?

On January 1, 2011, 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: 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 2011, and paid dividends of $100,000 during that year. What is the balance in Jackie Corp's Investment in Rob Co. account at December 31, 2011?

On January 4, 2011, 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: 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 2011, 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?

What is the primary objective of the fair value method of accounting for an investment?

In a situation where the investor exercises significant influence over the investee, which of the following entries is not actually posted to the books of the investor? 1) Debit to the Investment account, and a Credit to the Equity in Investee Income account. 2) Debit to Cash (for dividends received from the investee), and a Credit to Dividend Revenue. 3) Debit to Cash (for dividends received from the investee), and a Credit to the Investment account.

How should an investor account for, and report, an investee's extraordinary income or loss?

After allocating cost in excess of book value, which asset or liability would not be amortized over a useful life?

Which statement is true concerning unrealized profits in intra-entity inventory transfers when an investor uses the equity method?

Pursley, Inc. acquires 10% of Ritz Corporation on January 3, 2010, for $80,000 when the book value of Ritz was $800,000. During 2010 Ritz reported net income of $125,000 and paid dividends of $30,000. On January 1, 2011, Pursley purchased an additional 20% of Ritz for $325,000, giving Pursley the ability to significantly influence the operating policies of Ritz. Any excess of cost over book value is attributable to goodwill with an indefinite life. What journal entry(ies) is(are) required on January 1, 2011?

On January 1, 2010, Dawson, Incorporated, paid $100,000 for a 30% interest in Sacco Corporation. This investee had assets with a book value of $550,000 and liabilities of $300,000. A patent held by Sacco having a book value of $10,000 was actually worth $40,000 with a six year remaining life. Any goodwill associated with this acquisition is considered to have an indefinite life. During 2010, Sacco reported income of $50,000 and paid dividends of $20,000 while in 2011 it reported income of $75,000 and dividends of $30,000. Assume Dawson has the ability to significantly influence the operations of Sacco. The balance in the investment in Sacco account at December 31, 2011, is

An investee company incurs an extraordinary loss during the period. The investor appropriately applies the equity method. Which of the following statements is true?

On January 1, 2011, Spark Corp. acquired a 40% interest in Cranston Inc. for $250,000. On that date, Cranston's balance sheet disclosed net assets of $430,000. During 2011, Cranston reported net income of $100,000 and paid cash dividends of $30,000. Spark sold inventory costing $40,000 to Cranston during 2011 for $50,000. Cranston used all of this merchandise in its operations during 2011. Any excess cost over fair value is attributable to an unamortized trademark with a 20 year remaining life. Required: Prepare all of Spark's journal entries for 2011 to apply the equity method to this investment.

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

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, 2011, the balance in the Investment in Nicole Corp. account was $503,000. Amortization associated with this acquisition is $12,000 per year. During 2011, Nicole earned net income of $120,000 and paid cash dividends of $40,000. Previously in 2010, 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 2010. Additional sales were made to Steven in 2011 at a transfer price of $75,000 that had cost Nicole $54,000. Only 10% of the 2011 purchases had not been sold to outsiders by the end of 2011. What amount of equity income would Steven have recognized in 2011 from its ownership interest in Nicole?

How should a permanent loss in value of an investment using the equity method be treated?