Chapter 2
STOCK INVESTMENTS — INVESTOR ACCOUNTING AND REPORTING
Answers to Questions
1Only the investor’s accounts are affected when outstanding stock is acquired from existing stockholders.
The investor records the investment at its cost. Since the investee company is not a party to the
transaction, its accounts are not affected.
Both investor and investee accounts are affected when unissued stock is acquired directly from
the investee. The investor records the investment at its cost and the investee adjusts its asset and owners’
equity accounts to reflect the issuance of previously unissued stock.
2Goodwill arising from an equity investment of 20 percent or more is not recorded separately from the
investment account. Under the equity method, the investment is presented on one line of the balance sheet
in accordance with the one-line consolidation concept.
3Dividends received from earnings accumulated before an investment is acquired are treated as decreases
in the investment account balance under the fair value/cost method. Such dividends are considered a
return of a part of the original investment.
4The equity method of accounting for investments increases the investment account for the investor’s share
of the investee’s income and decreases it for the investor’s share of the investee’s losses and for dividends
received from the investee. In addition, the investment and investment income accounts are adjusted for
amortization of any investment cost-book value differentials related to the interest acquired. Adjustments
to the investment and investment income accounts are also needed for unrealized profits and losses from
transactions between the investor and investee companies. A fair value adjustment is optional under SFAS
No. 159.
5The equity method is referred to as a one-line consolidation because the investment account is reported on
one line of the investor’s balance sheet and investment income is reported on one line of the investor’s
income statement (except when the investee has extraordinary or cumulative-effect type adjustments). In
addition, the investment income is computed such that the parent company’s income and stockholders’
equity are equal to the consolidated net income and consolidated stockholders’ equity that would result if
the statements of the investor and investee were consolidated.
6If the equity method of accounting is applied correctly, the income of the parent company will generally
equal the controlling interest share of consolidated net income.
7The difference in the equity method and consolidation lies in the detail reported, but not in the amount of
income reported. The equity method reports investment income on one line of the income statement
whereas the details of revenues and expenses are reported in the consolidated income statement.
8The investment account balance of the investor will equal underlying book value of the investee if (a) the
equity method is correctly applied, (b) the investment was acquired at book value which was equal to fair
value, the pooling method was used, or the cost-book value differentials have all been amortized, and (c)
there have been no intercompany transactions between the affiliated companies that have created
investment account-book value differences.
9The investment account balance must be converted from the cost to the equity method when acquisitions
increase the interest held to 20 percent or more. The amount of the adjustment is the difference between
the investment income reported under the cost method in prior years and the income that would have been
reported if the equity method of accounting had been used. Changes from the cost to the equity method of
accounting for equity investments are changes in the reporting entity that require restatement of prior
years’ financial statements when the effect is material.
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2-1
2-2 Stock Investments — Investor Accounting and Reporting
10 The one-line consolidation is adjusted when the investee’s income includes extraordinary items, gains or
losses from discontinued operations, or cumulative-effect type adjustments. In this case, the investor’s
share of the investee’s ordinary income is reported as investment income under a one-line consolidation,
but the investor’s share of extraordinary items, cumulative-effect type adjustments, and gains and losses
from discontinued operations is combined with similar items of the investor.
11 The remaining 15 percent interest in the investee is accounted for under the fair value/cost method, and
the investment account balance immediately after the sale becomes the new cost basis.
12 Yes. When an investee has preferred stock in its capital structure, the investor has to allocate the investee’s
income to preferred and common stockholders. Then, the investor takes up its share of the investee’s
income allocated to common stockholders in applying the equity method. The allocation is not necessary
when the investee has only common stock outstanding.
13 Goodwill impairment losses are calculated by business reporting units. For each reporting unit, the
company must first determine the fair values of net assets. The fair value of the reporting unit is the
amount at which it could be purchased in a current market transaction. This may be based on market
prices, discounted cash flow analyses, or similar current transactions. This is done in the same manner as
is done to originally record a combination. Any excess measured fair value is the fair value of goodwill.
The company then compares the goodwill fair value estimate to the carrying value of goodwill to
determine if there has been an impairment during the period.
14 Yes. Impairment losses for subsidiaries are computed as outlined in the solution to question 13.
Companies compare fair values to book valuers for equity method investments as a whole. Firms may
recognize impairments for equity method investments as a whole, but perform no separate goodwill
impairment.
SOLUTIONS TO EXERCISES
Solution E2-1
1d
2c
3c
4d
5b
Solution E2-2 [AICPA adapted]
1d
2b
3d
4b
Gor’s investment is reported at its $600,000 cost because the equity
method is not appropriate and because Gor’s share of Med’s income
exceeds dividends received since acquisition [($520,000 ´ 15%) >
$40,000].
5c
Dividends received from Zef for the two years were $10,500 ($70,000 ´
15% – all in 2009), but only $9,000 (15% of Zef’s income of $60,000 for
the two years) can be shown on Two’s income statement as dividend income
from the Zef investment. The remaining $1,500 reduces the investment
account balance.
6c
[$100,000 + $300,000 + ($600,000 ´ 10%)]
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Chapter 2 2-3
7a
8d
Investment balance January 2 $250,000
Add: Income from Pod ($100,000 ´ 30%) 30,000
Investment in Pod December 31 $280,000
Solution E2-3
1Bow’s percentage ownership in Tre
Bow’s 20,000 shares/(60,000 + 20,000) shares = 25%
2Goodwill
Investment cost $500,000
Book value ($1,000,000 + $500,000) ´ 25% (375,000)
Goodwill $125,000
Solution E2-4
Income from Med for 2011
Share of Med’s income ($200,000 ´ 1/2 year ´ 30%) $ 30,000
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2-4 Stock Investments — Investor Accounting and Reporting
Solution E2-5
1Income from Oak
Share of Oak’s reported income ($800,000 ´ 30%) $ 240,000
Less: Excess allocated to inventory (100,000)
Less: Depreciation of excess allocated to building
($200,000/4 years)
(50,000)
Income from Oak $ 90,000
2Investment account balance at December 31
Cost of investment in Oak $2,000,000
Add: Income from Oak 90,000
Less: Dividends ($200,000 x 30%) (60,000)
Investment in Oak December 31 $2,030,000
Alternative solution
Underlying equity in Oak at January 1 ($1,500,000/.3) $5,000,000
Income less dividends 600,000
Underlying equity December 31 5,600,000
Interest owned 30%
Book value of interest owned December 31 1,680,000
Add: Unamortized excess 350,000
Investment in Oak December 31 $2,030,000
Solution E2-6
Journal entry on Man’s books
Investment in Nib ($600,000 x 40%) 240,000
Loss from discontinued operations 40,000
Income from Nib 280,000
To recognize income from 40% investment in Nib.
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Chapter 2 2-5
Solution E2-7
1a
Dividends received from Ben ($120,000 ´ 15%) $ 18,000
Share of income since acquisition of interest
2011 ($20,000 ´ 15%) (3,000)
2012 ($80,000 ´ 15%) (12,000)
Excess dividends received over share of income $ 3,000
Investment in Ben January 3, 2011 $ 50,000
Less: Excess dividends received over share of income (3,000)
Investment in Bennett December 31, 2012 $ 47,000
2b
Cost of 10,000 of 40,000 shares outstanding $1,400,000
Book value of 25% interest acquired ($4,000,000
stockholders’ equity at December 31, 2011 +
$1,400,000 from additional stock issuance) ´ 25% 1,350,000
Excess fair value over book value(goodwill) $ 50,000
3d
The investment in Moe balance remains at the original cost.
4c
Income before extraordinary item $ 200,000
Percent owned 40%
Income from Kaz Products $ 80,000
Solution E2-8
Preliminary computations
Cost of 40% interest January 1, 2011 $2,400,000
Book value acquired ($4,000,000 ´ 40%) (1,600,000)
Excess fair value over book value $ 800,000
Excess allocated to
Inventories $100,000 ´ 40% $ 40,000
Equipment $200,000 ´ 40% 80,000
Goodwill for the remainder 680,000
Excess fair value over book value $ 800,000
Ray’s underlying equity in Ton ($5,500,000 ´ 40%) $2,200,000
Add: Goodwill 680,000
Investment balance December 31, 2015 $2,880,000
Alternative computation
Ray’s share of the change in Ton’s stockholders’
equity ($1,500,000 ´ 40%) $ 600,000
Less: Excess allocated to inventories ($40,000 ´ 100%) (40,000)
Less: Excess allocated to equipment ($80,000/4 years ´ 4 years) (80,000)
Increase in investment account 480,000
Original investment 2,400,000
Investment balance December 31, 2015 $2,880,000
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2-6 Stock Investments — Investor Accounting and Reporting
Solution E2-9
1Income from Run
Share of income to common ($400,000 – $30,000 preferred
dividends) ´ 30% $ 111,000
2Investment in Run December 31, 2011
NOTE: The $50,000 direct costs of acquiring the investment
must be expensed when incurred. They are not a part of the
cost of the investment.
Investment cost $1,200,000
Add: Income from Run 111,000
Less: Dividends from Run ($200,000 dividends – $30,000
dividends to preferred) ´ 30% (51,000)
Investment in Run December 31, 2011 $1,260,000
Solution E2-10
1Income from Tee ($300,000 – $200,000) ´ 25%
Investment income October 1 to December 31 $ 25,000
2Investment balance December 31
Investment cost October 1 $ 600,000
Add: Income from Tee 25,000
Less: Dividends —
Investment in Tee at December 31 $ 625,000
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Chapter 2 2-7
Solution E2-11
Preliminary computations
Goodwill from first 10% interest:
Cost of investment $ 50,000
Book value acquired ($420,000 ´ 10%) (42,000)
Excess fair value over book value $ 8,000
Goodwill from second 10% interest:
Cost of investment $ 100,000
Book value acquired ($500,000 ´ 10%) (50,000)
Excess fair value over book value $ 50,000
1Correcting entry as of January 2, 2011 to
convert investment to the equity basis
Accumulated gain/loss on stock available for
Sale 50,000
Valuation allowance to record Fed at fair
50,000
