F5 M2

Moss Corp. owns 20 percent of Dubro Corp.'s preferred stock and 40 percent of its common stock. Dubro's stock outstanding at December 31, Year 1, is as follows: 10% cumulative preferred stock 100,000 Common stock 700,000 Dubro reported net income of $60,000 and paid dividends of $10,000 to its preferred shareholders for the year ended December 31, Year 1. How much total revenue should Moss record due to its investment in Dubro? A. $22,000 B. $20,000 C. $70,000 D. $50,000

Because Moss owns 40 percent of Dubro's common stock, the equity method is appropriate. Preferred stock: $100,000 × 10% = $10,000 dividends $10,000 dividends × 20% ownership = $2,000 dividends received Common stock: Net income $60,000 Less preferred dividends (10,000) = Net income available to common shareholders 50,000 × 40% Moss' percentage owned $20,000 equity in earnings Choice "A" is correct: $20,000 from equity in earnings plus $2,000 from dividend revenue.

Puff Co. acquired 40 percent of Straw Inc.'s voting common stock on January 2, Year 1 for $400,000. The carrying amount of Straw's net assets at the purchase date totaled $900,000. Fair values equaled carrying amounts for all items except equipment, for which fair values exceeded carrying amounts by $100,000. The equipment has a five-year life. During Year 1, Straw reported net income of $150,000. What amount of income from this investment should Puff report in its Year 1 income statement? A. $40,000 B. $52,000 C. $56,000 D. $60,000

Choice "B" is correct. Undervalued equipment $100,000 × 40% ownership = $40,000 / 5 years = $8,000 Puff's share of Straw's income: $150,000 × 40% = 60,000 Less: Excess fair value amortization (8,000) = Equity method investment income 52,000

On January 2, Year 3, Well Co. purchased 10 percent of Rea Inc.'s outstanding common shares for $400,000. Well is the largest single shareholder in Rea, and Well's officers are a majority on Rea's board of directors. Rea reported net income of $500,000 for Year 3 and paid dividends of $150,000. In its December 31, Year 3, balance sheet, what amount should Well report as investment in Rea? A. $450,000 B. $435,000 C. $400,000 D. $385,000

Choice "B" is correct. Even though Well has only a 10 percent ownership, one can presume that Well has significant influence on Rea because it is the largest single shareholder and has a majority on Rea's board of directors. The equity method is the appropriate accounting method. B: Beginning investment 400,000 A: Add % Rea's income (10% × $500,000) 50,000 S: Subtract % Rea's dividends/withdrawals (10% × $150,000) - 15,000 E: Ending investment 435,000 The investment account balance of $400,000 will be increased by the $50,000 equity in earnings (10% x $500,000 net income) and decrease by the $15,000 dividends received (10% x $150,000) for a year-end balance of $435,000.

Park Co. uses the equity method to account for its January 1, Year 1, purchase of Tun, Inc.'s common stock. On January 1, Year 1, the fair values of Tun's FIFO inventory and land exceeded their carrying amounts. How do these excesses of fair values over carrying amounts affect Park's reported equity in Tun's Year 1 earnings? Inventory excess; Land excess A. Decrease; Decrease B. Decrease; No effect C. Increase; Increase D. Increase; No effect

Choice "B" is correct. Park would record the additional COGS associated with the undervalued beginning inventory by debiting investment income and crediting the investment in Tun's account. Because the difference between book value and fair market value on land is not amortized, the difference in the land value would have no effect on equity in earnings.

Band Co. uses the equity method to account for its investment in Guard, Inc. common stock. How should Band record a 2% stock dividend received from Guard? A. As dividend revenue at Guard's carrying value of the stock. B. As dividend revenue at the market value of the stock. C. As a reduction in the total cost of Guard stock owned. D. As a memorandum entry reducing the unit cost of all Guard stock owned.

Choice "D" is correct. Bank should record the 2% stock dividend received from Guard with a memorandum entry that reduces the unit cost of all Guard stock owned. The total investment in Guard, Inc. will simply be spread over a larger amount of shares, thereby reducing the unit cost of all Guard stock owned.

Chatham Co. owned 25 percent of the voting stock of Boyrum Co. Chatham applied the equity method to account for this investment. Boyrum reported income of $100,000 and paid $30,000 in cash dividends during the period. What amount should Chatham report as investment income? A. $0 B. $7,500 C. $17,500 D. $25,000

Choice "D" is correct. Under the equity method of accounting, investment income is equal to the investor's proportional share of the investee's net income. Cash dividends are treated as a return of capital rather than investment income. Investment income earned by Chatham is equal to $25,000 ($100,000 income from Boyrum × 25%).

Birk Co. purchased 30 percent of Sled Co.'s outstanding common stock on December 31 for $200,000. On that date, Sled's stockholders' equity was $500,000, and the fair value of its identifiable net assets was $600,000. On December 31, what amount of goodwill should Birk attribute to this acquisition? A. $0 B. $20,000 C. $30,000 D. $50,000

Purchase price $200,000 Less: 30% Fair value (180,000) = Goodwill $20,000

The equity method of accounting for investments should be used when an investor owns: A. 1 percent to 9 percent of the voting common stock of a corporation and does not exercise significant influence over the corporation. B. 10 percent to 19 percent of the voting common stock of a corporation and exercises significant influence over the corporation. C. 20 percent to 50 percent of the voting common stock of a corporation and does not exercise significant influence over the corporation. D. More than 50 percent of the voting common stock of a corporation and exercises significant influence over the corporation.

Choice "B" is correct. The equity method is used to account for investments when the investor can exercise significant influence over the investee. While 20 percent to 50 percent voting common stock ownership typically indicates the need for the equity method, the key is whether significant influence exists. Even when an investor owns less than 20 percent, if they exercise significant influence, they will use the equity method. Choice "D" is incorrect. The acquisition method is needed when an investor owns more than 50 percent of the voting stock, as this will require the preparation of consolidated financial statements.

On January 1, Year 2, Point Inc. purchased 10% of Iona Co.'s common stock. Point purchased additional shares bringing its ownership up to 40% of Iona's common stock outstanding on August 1, Year 2. During October, Year 2, Iona declared and paid a cash dividend on all of its outstanding common stock. How much income from the Iona investment should Point's Year 2 income statement report? A. 10% of Iona's dividends for January 1 to July 31, Year 2, plus 40% of Iona's income for August 1 to December 31, Year 2. B. 40% of Iona's income for August 1 to December 31, Year 2 only. C. 40% of Iona's Year 2 income. D. Amount equal to dividends received from Iona.

Choice "B" is correct. When significant influence is acquired, the equity method is adopted from that date and going forward. Retroactive adjustments are not required. Therefore, Point will use the equity method beginning on August 1, Year 2, and will recognize 40% of Iona's income from August 1 to December 31, Year 2, on its income statement.

An investor discontinued application of the equity method because the carrying amount of the investment was reduced to zero as a result of recording the investor's share of the investee's losses. At what point, if any, should the investor resume applying the equity method to the investment after the investee returns to profitability? A. Immediately, by reporting the resumption as a change in accounting principle B. When the investor has recorded its share of net losses that were not recognized during the equity-method suspension period C. When the investor's share of net income equals its share of net losses that were not recognized during the equity-method suspension period D. At no point should the investor resume application of the equity method

Choice "C" is correct. At the point at which the investor's carrying amount of the investment is reduced to zero due to investee losses, the application of the equity method is suspended. The investor can resume applying the equity method once the investee has returned to profitability and any net losses allocated to the investor during the suspension period are covered by the investor's share of the investee's net income.

In a business combination, the valuation of goodwill is a calculation: A. To offset the bargain purchase cost. B. Of all of the unlimited-life intangible assets. C. Of the residual paid above the fair value of the identifiable net assets. D. Of all of the increases in market valuation of the intangible assets acquired.

Choice "C" is correct. The amount of goodwill recorded on the balance sheet by an acquiring firm for a business combination represents the excess of the price paid over the fair value of the identifiable net assets acquired.

Larkin Co. has owned 25% of the common stock of Devon Co. for a number of years, and has the ability to exercise significant influence over Devon. The following information relates to Larkin's investment in Devon during the most recent year: Carrying amount of Larkin's investment in Devon at the beginning of the year 200,000 Net income of Devon for the year 600,000 Total dividends paid to Devon's stockholders during the year $400,000 What is the carrying amount of Larkin's investment in Devon at year end? A. $100,000 B. $200,000 C. $250,000 D. $350,000

Choice "C" is correct. Since Larkin is utilizing the equity method due to its ability to exercise significant influence over Devon, it will record a proportionate share of Devon's earnings (25% x $600,000 = $150,000) as an increases to the investment account and a proportionate share of Devon's dividends (25% × $400,000 = $100,000) as a reduction in the investment account: Initial carrying amount 200,000 + Share of earnings 150,000 - Share of dividends (100,000) Ending carrying amount 250,000

nformation pertaining to dividends from Wray Corp.'s common stock investments for the year ended December 31, Year 1, follows: On September 8, Year 1, Wray received a $50,000 cash dividend from Seco Inc., in which Wray owns a 30 percent interest. A majority of Wray's directors are also directors of Seco. On October 15, Year 1, Wray received a $6,000 liquidating dividend from King Co. Wray owns a 5 percent interest in King Co. Wray owns a 2 percent interest in Bow Corp., which declared a $200,000 cash dividend on November 27, Year 1, to stockholders of record on December 15, Year 1, payable on January 5, Year 2. What amount should Wray report as dividend income in its income statement for the year ended December 31, Year 1? A. $60,000 B. $56,000 C. $10,000 D. $4,000

Choice "D" is correct. $4,000 dividend income should be reported in income statement. Seco dividend (equity method): $50,000 reduction ofinvestments in balance sheet King Co. liquidating dividend 6,000 reduction ofinvestments in balance sheet Bow Corp. dividend receivable ($200,000 × 0.02) $4,000 An investment that represents between 20 percent and 50 percent ownership of another company where significant influence exists is accounted for under the equity method. As such, dividends received are recorded as a reduction of the investment balance, not dividend revenue. The dividends received from Seco will reduce Wray Corp.'s investment balance. The investments in King Co. and Bow Corp. are less than 20 percent and are carried at fair value through net income (FVTNI). Dividend income from an equity security investment is recognized in net income, unless the dividend is a liquidating dividend. The dividend from King Co. is a liquidating dividend and is therefore accounted for as a reduction of the investment account. The dividend from Bow Corp. is accounted for as dividend revenue based on the percentage of ownership, so $4,000 of dividend revenue is recorded in the income statement ($200,000 x 2 percent).

Palmetto Inc. is currently using the equity method to account for its 30% investment in Royal Company. In the acquisition last year of Royal Co. common stock, Palmetto calculated $1,000,000 of goodwill. The correct accounting for this goodwill during the current year is: A. Amortization over 40 years. B. Amortization over the anticipated holding period of the Royal Company stock. C. Test for impairment at year-end. D. No accounting necessary.

Choice "D" is correct. Any goodwill created in an investment accounted for under the equity method is ignored. It is neither amortized nor tested for impairment. The entire investment (using the equity method) is subject to the impairment test.