Special Appendix—Equity Method for Unconsolidated Investments
Key
1. Per the FASB, all but the following are characteristics of an influential investment:
2. Company P Company uses the equity method to account for its January 1, 20X1, purchase of 30% of
Company S’s common stock. On January 1, 20X1, the market values of Company S’s FIFO inventory and land
exceed their book values. How do these excesses of market values over book values affect Company P’s
reported equity in Company S’s 20X1 earnings?
Inventory Excess Land Excess
3. Under the equity method of accounting, items affecting the investment income account include all but the
investor’s portion of:
4. On January 1, 20X1, Company P purchased a 30% interest in the Company S for $345,000. At that time,
Company S had stockholders’ equity of $1,000,000. Any excess cost over book value was attributed to a patent
with a 15-year life. During 20X1, Company S earned $60,000 and paid dividends of $15,000. What is the
balance in the investment account on December 31, 20X1, using the sophisticated equity method?
5. Company P owns a 30% interest in Company S and accounts for the investment under the sophisticated
equity method. The investment was purchased at underlying book value, and there is no excess of cost or book
value. Company S sells merchandise to Company P at cost plus 25%. Intercompany sales during 20X1 were
$100,000. There were $20,000 worth of such goods in Company P’s beginning inventory and $30,000 worth of
such goods in Company P’s ending inventory. Company S’s reported income for 20X1 is $40,000, and no
dividends were paid. What amount will Company P record as investment income in 20X1?
6. Company P uses the sophisticated equity method of accounting for its 30% investment in Company S’s
common stock. During 20X9, Company S reported net earnings of $650,000 and paid dividends of $150,000.
Assume that all the undistributed earnings of Company S will be distributed as dividends in future periods. The
dividends received from Company S are eligible for the 80% dividends received deduction. Company P’s 20X9,
tax rate is 30%. In its December 31, 20X9, balance sheet, the increase in the deferred tax liability from these
transactions would be ____.
7. If the market value of an equity method investment falls below its book value:
8. Company P purchased a 30% interest in Company S on January 1, 20X1, for $100,000. The price was equal
to the book value of the equity acquired. The reported income (loss) and dividends paid by the Company S are
as follows:
Income
Dividends
Year
(loss)
Paid
20X1
$ 5,000
$5,000
20X2
(270,000)
0
20X3
(100,000)
0
20X4
50,000
5,000
Investment income reported in 20X4 under the sophisticated equity method would be ____.
9. All but the following are required disclosures for equity method investors:
10. Assume that Company P purchases a 10% common stock interest in Company S for $12,000 on January 1,
20X2, and an additional 20% interest on January 1, 20X3, for $26,000. There was no excess of cost or book
value on either investment. The balance sheets of Company, S which pays no dividends, follow:
12/31/X3
01/01/X2
Total assets
$160,000
$120,000
Common stock
$100,000
$100,000
Retained earnings
60,000
20,000
Total equity
$160,000
$120,000
For 20X3, Company P reports investment income of ____.
11. Company P acquired 30% of Company S’s common stock on January 1, 20X8, for $100,000. Company P’s
30% interest constitutes significant influence. There is no excess of cost over book value. During 20X8,
Company S earned $40,000 and paid dividends of $25,000. During 20X9, Company S’s $50,000 income was
earned evenly, and the company paid dividends of $15,000 on April 1 and $15,000 on October 1. On July 1,
20X9, Company P sold half of its interest in Company S for $66,000 cash; thus, Company P no longer had
significant influence The gain on the sale of the investment in Company P’s 20X9 income statement should be
____.
12. For each of the following accounting methods, indicate how the investor’s investment account will be
affected by the investor’s share of the investee’s earnings after the date of acquisition
Fair Value Option Equity Method
13. Company P purchased a 30% interest in Company S for $120,000 on January 1, 20X7, when Company S
had the following stockholders’ equity:
Common stock ($10 par)
$100,000
Paid-in capital in excess of par
200,000
Retained earnings (deficit)
(20,000)
Total
$280,000
Any excess cost was due to equipment that is being depreciated over 5 years using straight-line depreciation.
Since the investment, Company P has consistently sold goods to Company S to realize a 30% gross profit. Such sales totaled $50,000 during 20X9.
Company S had $10,000 of such goods in its beginning inventory and $40,000 in its ending inventory.
On January 1, 20X9, Company S sold a machine with a book value of $15,000 to Company P for $30,000. The machine has a 5-year life and is being
depreciated on a straight-line basis.
Company S reported income of $75,000 before taxes for 20X9 and paid dividends of $20,000.
Required:
1. Prepare all entries caused by Company P’s investment in Company S for 20X9 (ignoring tax ramifications). Company P has properly recorded the
investment in previous periods.
2. Determine the balance of the investment account.
Determination and Distribution of Excess Schedule:
Price paid
$120,000
Less interest acquired, $280,000 ´ .3
84,000
Excess cost attributable to equipment (5-year life, $7,200 per year)
$ 36,000
Deferred gain on machine
$15,000
Internally generated net income
$75,000
Realized gain on machine (15,000 / 5)
3,000
Adjusted income
$63,000
Share of income
$18,900
Less equipment depreciation
(7,200)
Company P’s share of income
$11,700
14. Company P purchased a 30% interest in Company S for $120,000 on January 1, 20X7, when Company S
had the following stockholders’ equity:
Common stock ($10 par)
$100,000
Paid-in capital in excess of par
200,000
Retained earnings (deficit)
(20,000)
Total
$280,000
Any excess cost was due to equipment that is being depreciated over 5 years using straight-line depreciation.
Since the investment, Company P has consistently sold goods to Company S to realize a 30% gross profit. Such sales totaled $50,000 during 20X9.
Company S had $10,000 of such goods in its beginning inventory and $40,000 in its ending inventory.
On January 1, 20X9, Company S sold a machine with a book value of $15,000 to Company P for $30,000. The machine has a 5-year life and is being
depreciated on a straight-line basis.
Company S reported income of $75,000 before taxes for 20X9. Both firms are subject to a 30% corporate tax rate. Company S paid no dividends in
20X9. An 80% dividend earned exclusion rate applies.
Required:
Prepare all entries caused by Company P’s investment in Company S for 20X9 (including tax ramifications). Assume that Company P has recorded
the tax on its internally generated income. Company P has properly recorded the investment in previous periods. Assume that sufficient previously
recorded tax liability exists to offset any deferred tax expense.
Determination and Distribution of Excess Schedule:
Price paid
$120,000
Less interest acquired, $280,000 ´ .3
84,000
Excess cost attributable to equipment (5-year life, $7,200 per year)
$ 36,000
Deferred gain on machine
$15,000
Internally generated net income
$75,000
Realized gain on machine (15,000 / 5)
3,000
Adjusted income
$63,000
Tax, 30%
18,900
After-tax income
$44,100
Share of income
$13,230
Less equipment depreciation
(7,200)
Company P’s share of income
$ 6,030
Investment in Company S
11,070
Investment Income
11,070
Sales Revenue
2,700
Deferred Gross Profit
2,700
($30,000 net increase ´ .3 ´ .3)
Cash (20,000 ´ 30%)
6,000
Investment
6,000
15. On January 1, 20X3, Company P purchased a 15% interest in Company S. On July 1, 20X6, Company P
purchased an additional 20% interest in Company S. Both purchases were at a cost in excess of underlying book
value. Company S paid dividends each December from 20X3 to 20X6.
Required:
a.
How would Company P record its investment in Company S in its financial statements originally issued for 20X3 to 20X5?
b.
Does a 35% ownership interest absolutely require the use of the equity method?
c.
How will Company P account for its investment in Company S in its 20X6 financial statements?
d.
How will Company P account for its investment in Company S in the 20X3 to 20X6 comparative statements published in March 20X7?
a.
The investment would be accounted for under the cost method. Only the dividends received would be recorded as income.
regulated industry or there is a powerful NCI, aside from Company P.
retroactively.
accounted for under the sophisticated equity method for all periods, 20X3 to 20X6.
Investment in Company S
6,030
Investment Income
6,030
Provision for Income Tax
794
Deferred Tax Liability
794
(20% ´ 30% ´ $13,230 – includes depreciation)
Sales Revenue
2,700
Deferred Gross Profit
2,700
($30,000 net increase ´ .3 ´ .3)
Deferred Tax Liability
810
Provision for Income Tax
810
($2,700 ´ 30%)