solusi manual advanced acc zy chap002

Chapter 02 - Reporting Intercorporate Interests

CHAPTER 2

REPORTING INTERCORPORATE INTERESTS

ANSWERS TO QUESTIONS

Q2-1 (a) An investment in the voting common stock of another company is reported on an equity-method basis when the investor is able to significantly influence the operating and financial policies of the investee.

(b) The cost method normally is used for investments in common stock when the investor does not have significant influence and for investments in preferred stock and other securities. The amounts reported in the financial statements may require adjustment to fair value if they fall under the provisions of FASB Statement No. 115.

Q2-2 Significant influence occurs when the investor has the ability to influence the operating and financial policies of the investee. Representation on the board of directors of the investee is perhaps the strongest evidence, but other evidence such as routine participation in management decisions or entering into formal agreements that give the investor some degree of influence over the investee also may be used.

Q2-3 Equity-method reporting should not be used when (a) an investee is in reorganization or liquidation, (b) the investee has initiated litigation or complaints challenging the investor's ability to exercise significant influence, (c) the investor signs an agreement surrendering its ability to exercise significant influence, (d) majority ownership is concentrated in a small group that operates the company without regard to the investor's desires, (e) the investor is not able to acquire the information needed to use equity-method reporting, or (f) the investor tries and fails to gain representation on the board of directors.

Q2-4 The balances will be the same at the date of acquisition and in the periods that follow whenever the cumulative dividends paid by the investee equal or exceed the investee's cumulative earnings since the date of acquisition. The latter case assumes there are no other adjustments needed under the equity method for amortization of differential or other factors.

Q2-5 When a company has used the cost method and purchases additional shares which cause it to gain significant influence, a retroactive adjustment is recorded to move from a cost basis to an equity-method basis in the preceding periods. Dividend income is replaced by income from the investee and dividends received are treated as an adjustment to the investment account.

2-1


Q2-6 An investor considers a dividend to be a liquidating dividend when the cumulative dividends received from the investee exceed a proportionate share of the cumulative earnings of the investee from the date ownership was acquired. For example, an investor would consider a dividend to be liquidating if it purchases shares of another company in early December and receives a dividend at year-end substantially in excess of its portion of the investee's net income for December. On the other hand, the investee may have reported net income well in excess of the total dividends paid for the year and would not consider the dividends to be liquidating dividends.

Q2-7 Liquidating dividends decrease the investment account in both cases. All dividends are treated as a reduction of the investment account when equity-method reporting is used. When the cost method is used and dividends are received in excess of a proportionate share of investee earnings since acquisition, they are treated as a reduction of the investment account as well.

Q2-8 The carrying value of the investment is reduced under equity method reporting when (a) a dividend is received from the investee, (b) a differential is amortized, (c) an impairment of goodwill occurs, and (d) the market value of the investment declines and is less than the carrying value and it is concluded the decline is other than temporary.

Q2-9 A corporate joint venture is a company that is established and operated by a small group of investors, none of whom holds a majority of the ownership. Because there are only a few owners and each investor normally is expected to have significant influence, equity-method reporting generally is appropriate in accounting for ownership in a corporate joint venture.

Q2-10 A differential occurs when an investor pays more than or less than underlying book value in acquiring ownership of an investee.

(a) In the case of the cost method, no adjustments are made for amortization of the differential on the investor's books.

(b) Under equity-method reporting the difference between the amount paid and book value must be assigned to appropriate asset and liability accounts of the acquired company. If any portion of the differential is assigned to an amortizable or depreciable asset, that amount must be charged against income from the investee over the remaining economic life of the asset.

Q2-11 A dividend is treated as a reduction of the investment account under equity-method reporting. Unless it is a liquidating dividend, it is treated as dividend income under the cost method.

2-2


Q2-12 Amortization of a differential is the most common reason for investment income to be lower than a proportionate share of reported income of the investee. If Turner Company has paid more than book value for the shares of Straight Lace Company, the differential must be assigned to identifiable assets and liabilities of the investee, or to goodwill. Those amounts assigned to depreciable and identifiable intangible assets must be amortized and will reduce equity-method income over the remaining economic lives of the underlying assets. Amounts attributable to other items such as land or inventories must be treated as a reduction of income in the period in which Straight Lace disposes of the item. Income also will be lower if the investee has been involved in sales to related companies during the period and there are unrealized profits from those intercompany sales; the income of the selling affiliate must be reduced by the unrealized profits before equity-method income is computed. Finally, if Straight Lace has preferred stock outstanding, preferred dividends must be deducted before assigning earnings to common shareholders.

Q2-13 Dividends received by the investor are recorded as dividend income under both the cost and fair value methods. The change in the fair value of the shares held by the investor is recorded as an unrealized gain or loss under the fair value method. The fair value method differs from the equity method in two respects. Under the equity method the investor’s share of the earnings of the investee are included as investment income and dividends received from the investee are treated as a reduction of the investment account.

Q2-14 The change in the fair value of the shares held by the investor is reported as an unrealized gain or loss and dividends received from the investee are reported as dividend income.

Q2-15 Clear-cut measures of control are not always readily available. For example, a partner contributing a specified share of the partnership’s capital may have a different share of profits or losses, a different proportion of distributions, or a greater or lesser degree of control than indicated by the capital share.

Q2-16 There may be situations in which a company has significant influence over another without holding voting common stock. For example, a company might use operating agreements or other contracts to share in the profits of another company, guarantee a certain level of profitability of another company, or participate in the operating decisions of another company.

Q2-17* In general, tax allocation procedures should be used whenever there is a difference between dividends received from the investee and the amount of investment income recorded by the investor. Tax allocation is not needed if the companies file a joint tax return or if the investee's earnings can be transferred to the investor in a tax-free transfer.

Q2-18* The amount should be larger under the equity method. There should be no need to use tax allocation when the cost method is used in accounting for the investee. Dividends received and taxable income are likely to be the same. Tax allocation normally is needed under the equity method, due to the difference between income recorded and dividends received.

2-3


Q2-19* When the basic equity method is used, a proportionate share of subsidiary net income and dividends is recorded on the parent's books and an appropriate amount of any differential is amortized each period. No other adjustments are recorded. Under the fully-adjusted equity method, the parent's books also are adjusted for unrealized profits and any other items that are needed to bring the investor's net income into agreement with the income to the controlling interest that would be reported if consolidation were used.

Q2-20* One-line consolidation implies that under equity-method reporting the investor's net income and stockholders' equity will be the same as if the investee were consolidated. Income from the investee is included in a single line in the investor's income statement and the investment is reported as a single line in the investor's balance sheet.

Q2-21* The term basic equity method generally is used when the investor records its portion of the reported net income and dividends of the investee and amortizes an appropriate portion of any differential. Unlike the fully-adjusted equity method, no adjustment for unrealized profit on intercompany transfers normally is made on the investor's books. When an investee is consolidated for financial reporting purposes, the investor may not feel it is necessary to record fully-adjusted equity method entries on its books since income from the investee and the balance in the investment account must be eliminated in preparing the consolidated statements.

Q2-22* The investor reports a proportionate share of an investee's extraordinary item as an extraordinary item in its own income statement.

2-4


SOLUTIONS TO CASES

C2-1 Choice of Accounting Method

a. The equity method is to be used when an investor has significant influence over an investee. Significant influence normally is assumed when more than 20 percent ownership is held. Factors to be considered in determining whether to apply equity-method reporting include the following:

1. Is the investee under the control of the courts or other parties as a result of filing for reorganization or entering into liquidation procedures?

2. Does the investor have representation on the board of directors, or has it attempted to gain representation and been unable to do so?

3. Has the investee initiated litigation or complaints challenging the investor's ability to exercise significant influence?

4. Has the investor signed an agreement surrendering its ability to exercise significant influence?

5. Is majority ownership concentrated in a small group that operates the company without regard of the wishes of the investor?

6. Is the investor able to acquire the information needed to use equity-method reporting?

b. When subsidiary net income is greater than dividends paid, equity-method reporting is likely to show a larger reported contribution to the earnings of Slanted Building Supplies. If 20X4 earnings are negative or less than dividends distributed in 20X4, the cost basis is likely to result in a larger contribution to Slanted's reported earnings.

c. As the investor uses more of its resources to acquire ownership of the investee, and as the investor has a greater share of the investee's profits and losses, the success of the investee's operations may have more of an impact on the overall financial well-being of the investor. In many cases, the investor will want to participate in key decisions of the investee once the investor's ownership share reaches a certain level. Also, use of the equity method eliminates the possibility of the investor manipulating its own income by influencing investee dividend distributions, as might occur under the cost method.

2-5


C2-2 Intercorporate Ownership

MEMO

To: Chief Accountant Most Company

From: , CPA

Re: Equity Method Reporting for Investment in Adams Company

The equity method should be used in reporting investments in which the reporting company has a significant influence over the operating and financing decisions of another company. In this case, Most Company holds 15 percent of the voting common stock of Adams Company and Port Company holds an additional 10 percent. During the course of the year, both Most and Port are likely to use the cost method in recording their respective investments in Adams. However, when consolidated statements are prepared for Most, the combined ownership must be used in determining whether significant influence exists. Both direct and indirect ownership must be taken into consideration. [APB 18, Par. 17]

A total of 15 percent of the voting common stock of Adams is held directly by Most Company and an additional 10 percent is controlled indirectly though Most’s ownership of Port Company. Equity-method reporting for the investment in Adams Company therefore appears to be required.

If the cost method has been used by Most and Port in recording their investments during the year, at the time consolidated statements are prepared, adjustments must be made to (a) increase the balance in the investment account for a proportionate share of the investee’s reported net income (25 percent) and reduce the balance in the investment account for a proportionate share of the dividend paid by the investee, (b) include a proportionate share of the investee’s net income in the consolidated income statement, (c) delete any dividend income recorded by Most and Port, and (d) if ownership was purchased at an amount greater than a proportionate share of the fair value of the investee’s net assets at the date of purchase, it may be necessary to amortize a portion of the differential assigned to depreciable or amortizable assets.

Primary citationAPB 18, par. 17

2-6


C2-3 Application of the Equity Method

MEMO

To: Controller Forth Company

From: , CPA

Re: Equity Method Reporting for Investment in Brown Company

This memo is prepared in response to your request regarding use of the cost or equity methods in accounting for Forth’s investment in Brown Company.

Forth Company held 85 percent of the common stock of Brown Company prior to January 1, 20X2, and was required to fully consolidate Brown Company in its financial statements prepared prior to that date [FASB 94]. Forth now holds only 15 percent of the common stock of Brown. The cost method is normally used in accounting for ownership when less than 20 percent of the stock is directly or indirectly held by the investor.

Equity-method reporting should be used when the investor has “significant influence over operating and financing policies of the investee.” While 20 percent ownership is regarded as the level at which the investor is presumed to have significant influence, other factors must be considered as well. [APB 18, Par. 17]

Although Forth currently holds only 15 percent of Brown’s common stock, the other factors associated with its ownership indicate that Forth does exercise significant influence over Brown. Forth has two members on Brown’s board of directors, it purchases a substantial portion of Brown’s output, and Forth appears to be the largest single shareholder by virtue of its sale of 10,000 shares to each of 7 other investors.

These factors provide strong evidence that Forth has significant influence over Brown and points to the need to use equity-method reporting for its investment in Brown. Your office should monitor the activities of the FASB with respect to consolidation standards [www.fasb.org]. Active consideration is being given to situations in which control may be exercised even though the investor does not hold majority ownership. It is conceivable that your situation might be one in which consolidation could be required.

Primary citationsAPB 18, par. 17FASB 94

2-7


C2-4 Complex Organizational Structures

a. Atlas America is a corporation. Its operations involve the development, production, and distribution of natural gas, and to a lesser extent, oil. It also offers tax-advantaged investment programs for gas and oil investors.

b. The subsidiaries of Atlas America include corporations, limited liability companies (LLCs), and both general and limited partnerships. The company fully consolidates its subsidiaries. In accordance with industry practice, the company reflects its interests in energy partnerships in its consolidated statements using pro rata consolidation.

c. Atlas Pipeline Holdings is a subsidiary of Atlas America. It has complete ownership of Atlas Pipeline Partners GP, LLC, a limited liability company that is the general partner of Atlas Pipeline Partners, L.P. The only cash generating assets of Atlas Pipeline Holdings are its indirect interests in Atlas Pipeline Partners, L.P.

d. Atlas Pipeline Partners, L.P. is a partnership, specifically a publicly-traded limited partnership. A limited partnership must have at least one general partner with unlimited liability, and it may have numerous limited partners whose liability is limited and may not participate in the management of the partnership. Atlas Pipeline Partners, L.P. has a number of subsidiaries, including general and limited partnerships, corporations, and limited liability companies. Limited liability companies, in general, have the advantages of corporations with less of the formalities. They often have certain tax advantages over corporations. Atlas Pipeline Partners, L.P. is managed by its general partner, Atlas Pipeline Partners GP, LLC. The executives responsible for Atlas Pipeline’s management are employees of Atlas America, as indicated in Atlas Pipeline’s Form 10-K, in the item entitled Directors and Executive Officers of the Registrant. These employees not only manage Atlas Pipeline Partners, L.P., but also Atlas America and its other affiliates.

e. Atlas Pipeline Partners, L.P. presents consolidated financial statements in which it consolidates all of its wholly-owned and majority-owned subsidiaries. NOARK Pipeline System is a limited partnership that is 100 percent owned by Atlas Pipeline Partners. Prior to 2006, Atlas Pipeline Partners owned 75 percent of NOARK. Atlas consolidates 100 percent of NOARK, and previously also consolidated 100 percent of NOARK even though it was only 75 percent owned.

f. Prior to 2004, Atlas America was a wholly owned subsidiary of Resource America, Inc. In 2004, Atlas America had an initial public offering of common stock, with the proceeds distributed to Resource America. Subsequently, Resource America spun off Atlas America by distributing its shares to its stockholders.

2-8


C2-5 Evaluating Investments

a. Dow Chemical has well over 100 subsidiaries, as shown in its Form 10-K, Exhibit 21. According to the company’s “Principles of Consolidation and Basis of Presentation” in its 10-K, Dow consolidates all majority-owned subsidiaries over which it has control and also entities for which Dow has a controlling financial interest. Intercompany transactions and balances are eliminated.

b. Dow reports investments in nonconsolidated affiliates using the equity method. It includes joint ventures, partnerships, and companies that are 20 to 50 percent owned in the category of nonconsolidated affiliates. Several of Dow’s nonconsolidated affiliates are 50-percent owned and several are 49-percent owned. Excluding several special-situation investments, the total differential was $65 million at December 31, 2006, and $61 million at December 31, 2005. The differentials relating to MEGlobal, Equipolymers, and EQUATE Petrochemical were negative differentials resulting from a difference in valuations between U.S. and foreign accounting principles.

c. The evaluation of Dow’s goodwill for impairment is performed in conjunction with the company’s annual budgeting process.

d. Dow Chemical’s 50-percent investment in Dow Corning suffered a significant loss in value judged to be other than temporary in 1995 when Dow Corning declared bankruptcy. As discussed in Dow’s 2005 Form 10-K, the company wrote down the investment and recognized a loss at the time of the bankruptcy.

2-9


C2-6 Reporting Significant Investments in Common Stock

Answers to this case can be found in the annual reports to stockholders of the companies mentioned and in their 10-K filings with the SEC (available at www.sec.gov).

a. Before 1998, Harley-Davidson reported its investment in the common stock of Buell Motorcycle Company using the equity method. The 49 percent investment that Harley held since 1993 gave it the ability to significantly influence Buell. In 1998, Harley purchased substantially all remaining shares of Buell and, therefore, Harley fully consolidates Buell in its general-purpose financial statements.

b. Chevron fully consolidates its controlled subsidiaries that are majority owned and variable interest entities of which it is the primary beneficiary. The company uses pro rata consolidation in reporting its undivided interests in oil and gas joint ventures. Chevron uses the equity method to report its investments in affiliates over which the company exercises significant influence or has an ownership interest of 20 to 50 percent. In applying the equity method, Chevron recognizes in income gains and losses from changes in its proportionate dollar share of an affiliate’s equity resulting from issuance of additional stock by the affiliate.

Chevron analyses any difference between the carrying value of an equity-method investment and its underlying book value and, to the extent that it can, assigns that differential to specific assets and liabilities. The company adjusts quarterly its equity-method income recognized from affiliates for any write-off or amortization of the differential.

Chevron assesses it equity investments for possible impairment when events indicate a possible impairment. If an investment has declined in value, the company evaluates the situation to determine if the decline is other than temporary. If the decline in value is judged to be other than temporary, the investment is written down to its fair value and a loss recognized in income. Subsequent recoveries in value are not recognized.

Chevron owns approximately 19 percent (as of December 31, 2006) of Dynegy’s common stock. It accounts for its investment using the equity method. The carrying amount of Chevron’s investment in Dynegy’s common stock is less that its proportionate interest in Dynegy’s net assets because the investment was written down in 2002 for a decline in value that was judged to be other than temporary.

c. PepsiCo reports investments in unconsolidated affiliates over which it exercises significant influence using the equity method. Prior to 1999, equity-method income or loss from these affiliates was included in selling, general and administrative expenses. Obviously, this is not an appropriate classification for equity-method income from affiliates, but it could be justified if the amounts are considered to be immaterial. In 1999, PepsiCo started reporting its income from equity-method investments separately in the income statement. Equity-method income from affiliates currently is reported in the consolidated income statement as bottling equity income.

d. Sears has investments in the voting securities of a number of companies that it accounts for using the equity method. Where these investments are reported is difficult to tell from the financial statements and notes. Apparently the amounts involved are relatively small, and the investments are included in other assets on the balance sheet, with the income reported in other income on the income statement.

2-10

http://www.sec.gov/


SOLUTIONS TO EXERCISES

E2-1 Multiple-Choice Questions on Use of Cost and Equity Methods [AICPA Adapted]

1. a

2. a

3. d

4. a

5. b

6. d

7. d

E2-2 Multiple-Choice Questions on Intercorporate Investments

1. b

2. c

3. d

4. a

5. a

E2-3 Multiple-Choice Questions on Applying Equity Method [AICPA Adapted]

1. c

2. d $250,000 + ($100,000 x .30) – [($200,000 x .30)/15 years)]

3. c

4. d

5. d

2-11


E2-4 Cost versus Equity Reporting

a. Cost-method journal entries recorded by Roller Corporation:

20X5 Investment in Steam Company Stock 70,000 Cash 70,000 Record purchase of Steam Company stock.

Cash 1,000 Dividend Income 1,000 Record dividend income from Steam Company: $5,000 x .20

20X6 Cash 3,000 Dividend Income 3,000 Record dividend income from Steam Company: $15,000 x .20

20X7 Cash 7,000 Dividend Income 7,000 Record dividend income from Steam Company: $35,000 x .20 Note: Cumulative dividends do not exceed cumulative

earnings to date.

2-12


E2-4 (continued)

b. Equity-method journal entries recorded by Roller Corporation:

20X5 Investment in Steam Company Stock 70,000 Cash 70,000 Record purchase of Steam Company stock.

Cash 1,000 Investment in Steam Company Stock 1,000 Record dividend from Steam Company.

Investment in Steam Company Stock 4,000 Income from Steam Company 4,000 Record equity-method income.

Income from Steam Company 3,000 Investment in Steam Company Stock 3,000 Amortize differential: [$70,000 - ($200,000 x .20)] / 10 years

20X6 Cash 3,000 Investment in Steam Company Stock 3,000 Record dividend from Steam Company.


Income from Steam Company 3,000 Investment in Steam Company Stock 3,000 Amortize differential.

20X7 Cash 7,000 Investment in Steam Company Stock 7,000 Record dividend from Steam Company.


Income from Steam Company 3,000 Investment in Steam Company Stock 3,000 Amortize differential.

2-13


E2-5 Cost versus Equity Reporting

a. Winston Corporation net income – cost method:

20X2 $100,000 + .40($30,000) $112,00020X3 $ 60,000 + .40($60,000) 84,00020X4 $250,000 + .40($20,000 + $25,000)a 268,000

a Dividends paid from undistributed earnings of prior years ($70,000 + $40,000 - $30,000 - $60,000 = $20,000) and $25,000 earnings of current period.

b. Winston Corporation net income – equity method:

20X2 $100,000 + .40($70,000) $128,00020X3 $ 60,000 + .40($40,000) 76,00020X4 $250,000 + .40($25,000) 260,000

E2-6 Acquisition Price

Balance at date of acquisition:

a. Cost method $54,000 + $2,800 = $56,800

b. Equity method $54,000 - $2,000 = $52,000

Change in Investment AccountYear Net Income Dividends Cost Method Equity Method20X1 $ 8,000 $15,000 $(2,800) $(2,800) 20X2 12,000 10,000 800 20X3 20,000 10,000 ______ 4,000

Change in account balance $(2,800) $ 2,000

2-14


E2-7 Investment Income

a. (1) Ravine Corporation net income under Cost Method:

20X6 $140,000 + .30($20,000) = $146,00020X7 $ 80,000 + .30($40,000) = $ 92,00020X8 $220,000 + .30($30,000) = $229,00020X9 $160,000 + .30($20,000) = $166,000

(2) Ravine Corporation net income under Equity Method:

20X6 $140,000 + .30($30,000) = $149,00020X7 $ 80,000 + .30($50,000) = $ 95,00020X8 $220,000 + .30($10,000) = $223,00020X9 $160,000 + .30($40,000) = $172,000

b. Journal entries recorded by Ravine Corporation in 20X8:

(1) Cost method:

Cash 12,000 Dividend Income 9,000 Investment in Valley Stock 3,000

(2) Equity method:

Cash 12,000 Investment in Valley Stock 12,000

Investment in Valley Stock 3,000 Income from Valley 3,000

E2-8 Impairment of Investment Value

The following amounts would be reported as the carrying value of Port’s investment in Sund:

20X2 $184,500 = $180,000 + ($40,000 x .30) - ($25,000 x .30)20X3 $193,500 = $184,500 + ($30,000 x .30)20X4 $135,000 = $4.50 x 30,000 shares; prior to adjustment, the

carrying value at the end of 20X4 would be $195,000 [$193,500 + ($5,000 x .30)]

2-15


E2-9 Alternative Reporting for Investment in Partnership

Moss Company Balance Sheet

Cost Method Equity MethodPro Rata

ConsolidationFull

ConsolidationAssets $510,000 $510,000 $622,500(d) $760,000(f)Investment in TF

Partnership 90,000 99,000 (b) Total Assets $600,000 $609,000 $622,500 $760,000

Liabilities $ 40,000 $ 40,000 $ 53,500(e) $ 70,000(g)Interest of

Outside Partners 121,000(h)Owners’ Equity 560,000 (a) 569,000 (c) 569,000 (c) 569,000 (c)Total Liabilities and Equity $600,000 $609,000 $622,500 $760,000

(a) $560,000 = $510,000 + $90,000 - $40,000(b) $99,000 = $90,000 + [($220,000 - ($90,000/.45)) x .45](c) $569,000 = $560,000 + [($220,000 - ($90,000/.45)) x .45](d) $622,500 = $510,000 + ($250,000 x .45)(e) $53,500 = $40,000 + ($30,000 x .45)(f) $760,000 = $510,000 + $250,000(g) $70,000 = $40,000 + $30,000(h) $121,000 = [($250,000 - $30,000) x .55]

2-16


E2-10 Differential Assigned to Patents

Journal entries recorded by Power Corporation:

20X2 Investment in Snow Corporation Stock 360,000 Common Stock 90,000 Additional Paid-In Capital 270,000 Record purchase of Snow Corporation stock.

Cash 7,000 Investment in Snow Corporation Stock 7,000 Record dividend from Snow Corporation: $20,000 x .35

Investment in Snow Corporation Stock 19,600 Income from Snow Corporation 19,600 Record equity-method income: $56,000 x .35

Income from Snow Corporation 2,125 Investment in Snow Corporation Stock 2,125 Amortize differential: [$360,000 - ($980,000 x .35)] / 8 years

20X3 Cash 3,500 Investment in Snow Corporation Stock 3,500 Record dividend from Snow Corporation: $10,000 x .35

Loss from Snow Corporation 15,400 Investment in Snow Corporation Stock 15,400 Record equity-method loss: $44,000 x .35

Loss from Snow Corporation 2,125 Investment in Snow Corporation Stock 2,125 Amortize differential.

2-17


E2-11 Differential Assigned to Copyrights

Journal entries recorded by Best Corporation:

20X7 Investment in Flair Company Stock 196,000 Cash 26,000 Bonds Payable 170,000 Record purchase of Flair Company stock.

Cash 6,000 Investment in Flair Company Stock 6,000 Record dividend from Flair Company: $24,000 x .25

Loss from Flair Company 22,000 Investment in Flair Company Stock 22,000 Record equity-method loss: $88,000 x .25

Loss from Flair Company 5,250 Investment in Flair Company Stock 5,250 Amortize differential: Book value of assets $740,000 Book value of liabilities (140,000 ) Net book value $600,000 Fair value increment 16,000 Fair value of net assets $616,000 Portion of ownership purchased x .25 Fair value of assets acquired $154,000 Amount paid 196,000 Differential $ 42,000 Period of amortization (years) ÷ 8 Amortization per period $ 5,250

20X8 Cash 6,000 Investment in Flair Company Stock 6,000 Record dividend from Flair Company: $24,000 x .25

Investment in Flair Company Stock 30,000 Income from Flair Company 30,000 Record equity-method income: $120,000 x .25

Income from Flair Company 5,250 Investment in Flair Company Stock 5,250 Amortize differential.

2-18


E2-12 Differential Attributable to Depreciable Assets

a. Journal entries recorded by Capital Corporation using the equity method:

20X4 Investment in Cook Company Stock 136,000 Cash 136,000 Record purchase of Cook Company Stock.

Cash 2,400 Investment in Cook Company Stock 2,400 Record dividend from Cook Company: $6,000 x .40

Investment in Cook Company Stock 4,000 Income from Cook Company 4,000 Record equity-method income: $10,000 x .40

Income from Cook Company 1,600 Investment in Cook Company Stock 1,600 Amortize differential: $16,000 / 10 years

20X5 Cash 3,600 Investment in Cook Company Stock 3,600 Record dividend from Cook Company: $9,000 x .40

Investment in Cook Company Stock 8,000 Income from Cook Company 8,000 Record equity-method income: $20,000 x .40

Income from Cook Company 1,600 Investment in Cook Company Stock 1,600 Amortize differential.

b. Journal entries recorded by Capital Corporation using the cost method:

20X4 Investment in Cook Company Stock 136,000 Cash 136,000 Record purchase of Cook Company Stock.

Cash 2,400 Dividend Income 2,400 Record dividend income from Cook Company.

20X5 Cash 3,600 Dividend Income 3,600 Record dividend income from Cook Company.

2-19


E2-13 Investment Income

Brindle Company reported equity-method income of $13,000, computed as follows:

Proportionate share of reported income($68,000 x .25) $17,000

Amortization of differential: Land ($7,500: not amortized) $ -0- Equipment ($20,000 / 5 years) 4,000 Goodwill ($19,500: not amortized) - 0- (4,000 )Investment Income $13,000

Assignment of differential

Purchase price $162,000 Proportionate share of book value of net assets

[($690,000 - $230,000) x .25] (115,000)Differential $ 47,000 Differential assigned to land ($30,000 x .25) (7,500)Differential assigned to equipment ($80,000 x .25) (20,000 )Differential assigned to goodwill $ 19,500

E2-14 Determination of Purchase Price

Investment account balance December 31, 20X6 $161,000

Increase in account balance during 20X5: Proportionate share of income

($110,000 x .30) $ 33,000 Amortize differential ($28,000 / 8 years) (3,500) Dividend received ($50,000 x .30) (15,000 ) (14,500)

Decrease in account balance during 20X6: Proportionate share of income ($20,000 x .30) $ 6,000 Amortize differential ($28,000 / 8 years) (3,500) Dividend received ($40,000 x .30) (12,000 ) 9,500

Investment account balance at date of purchase $156,000

2-20


E2-15 Correction of Error

Required correcting entry:

Investment in Case Products Stock 44,000Dividend Income 8,000 Income from Case Products 30,000 Retained Earnings 22,000

Computation of correction of investment account

Addition to account for investment income: 20X6: $40,000 x .40 $16,000 20X7: $60,000 x .40 24,000 20X8: $80,000 x .40 32,000 $72,000

Deduction for dividends received: 20X6: $15,000 x .40 $ 6,000 20X7: $20,000 x .40 8,000 20X8: $20,000 x .40 8,000 (22,000)

Amortization of differential: Purchase price $56,000 Proportionate share of book value of net assets

[.40($60,000 + $40,000)] (40,000 ) Amount of differential $16,000

Amortization for 3 years [($16,000 / 8) x 3] (6,000 )Required correction of investment account $44,000

Computation of correction of retained earnings of Grand Corporation

Dividend income recorded in 20X6: $15,000 x .40 $ 6,000 20X7: $20,000 x .40 8,000 ($14,000)

Equity-method income in 20X6: ($16,000 - $2,000) $14,000 20X7: ($24,000 - $2,000) 22,000 36,000 Required correction of retained earnings $22,000

2-21


2-22


E2-16 Differential Assigned to Land and Equipment

Journal entries recorded by Rod Corporation:

(1) Investment in Stafford Corporation Stock 65,000 Cash 65,000 Record purchase of Stafford Stock.

(2) Cash 4,500 Investment in Stafford Corporation Stock 4,500 Record dividend from Stafford: $15,000 x .30

(3) Investment in Stafford Corporation Stock 12,000 Income from Stafford 12,000 Record equity-method income: $40,000 x .30

(4) Income from Stafford 1,000 Investment in Stafford Corporation Stock 1,000 Amortize differential assigned to equipment.

2-23


E2-17 Equity Entries with Goodwill

Journal entries recorded following purchase:

(1) Investment in Turner Corporation Stock 175,000 Cash 175,000 Record purchase of Turner stock.

(2) Cash 3,200 Investment in Turner Corporation Stock 3,200 Record dividend from Turner: $8,000 x .40

(3) Investment in Turner Corporation Stock 16,000 Income from Turner Corporation 16,000 Record equity-method income: $40,000 x .40

(4) Income from Turner Corporation Stock 4,000 Investment in Turner Corporation 4,000 Write off differential assigned to inventory carried on FIFO basis: $10,000 x .40

(5) Income from Turner Corporation Stock 3,600 Investment in Turner Corporation 3,600 Amortize differential assigned to buildings and equipment: [$240,000 - ($300,000 - $150,000)] x .40

10 years

2-24


2-25


2-26


E2-18 Income Reporting

Journal entry recorded by Grandview Company:

Investment in Spinet Corporation Stock 36,000 Income from Spinet Corporation 24,000 Extraordinary Gain (from Spinet Corporation) 12,000

E2-19 Fair Value Method

a. Cost method:

Operating income reported by Mock $90,000 Dividend income from Small ($15,000 x .20) 3,000 Net income reported by Mock $93,000

b. Equity method:

Operating income reported by Mock $90,000 Income from investee ($40,000 x .20) 8,000 Net income reported by Mock $98,000

b. Fair value method:

Operating income reported by Mock $90,000 Unrealized gain on increase in value of Small stock 16,000 Dividend income from Small ($15,000 x .20) 3,000 Net income reported by Mock $ 9,000

E2-20 Fair Value Recognition

a. Journal entries under the equity method:

(1) Investment in Lomm Company Stock 140,000 Cash 140,000 Record purchase of Lomm Company stock.

(2) Cash 7,000 Investment in Lomm Company Stock 7,000 Record dividends from Lomm Company: $20,000 x .35

2-27


(3) Investment in Lomm Company Stock 28,000 Income from Lomm Company 28,000 Record equity-method income: $80,000 x .35

b. Journal entries under fair value method:

(1) Investment in Lomm Company Stock 140,000 Cash 140,000 Record purchase of Lomm Company stock.

(2) Cash 7,000 Dividend Income 7,000 Record dividends from Lomm Company: $20,000 x .35

(3) Investment in Lomm Company Stock 34,000 Urealized Gain on Increase in Value of Lomm Stock 34,000 Record increase in value of Lomm stock: $174,000 - $140,000

E2-21* Investee with Preferred Stock Outstanding

Journal entries recorded by Reden Corporation:

(1) Investment in Montgomery Co. Stock 288,000 Cash 288,000 Record purchase of Montgomery Co. stock.

(2) Cash 6,750 Investment in Montgomery Co. Stock 6,750 Record dividend from Montgomery Co.: [$40,000 - ($250,000 x .10)] x .45

(3) Investment in Montgomery Co. Stock 31,500 Income from Montgomery Co. 31,500 Record equity-method income: [$95,000 - ($250,000 x .10)] x .45

2-28


E2-22* Other Comprehensive Income Reported by Investee

Journal entries recorded by Callas Corp. during 20X9:

(1) Investment in Thinbill Co. Stock 380,000 Cash 380,000

(2) Cash 3,600 Investment in Thinbill Co. Stock 3,600 Record dividend from Thinbill: $9,000 x .40

(3) Investment in Thinbill Co. Stock 22,000 Income from Thinbill Co. 22,000 Record equity-method income: $22,000 = ($45,000 + $10,000) x .40

(4) Investment in Thinbill Co. Stock 8,000 Unrealized Gain on Investments of Investee (OCI) 8,000 Record share of OCI reported by Thinbill: $8,000 = $20,000 x .40

Closing entries recorded at December 31, 20X9:

(5) Income from Thinbill Co. 22,000 Retained Earnings 22,000

(6) Unrealized Gain on Investments of Investee (OCI) 8,000 Accumulated Other Comprehensive Income from

Investee-Unrealized Gain on Investments 8,000

E2-23* Other Comprehensive Income Reported by Investee

Investment account balance reported by Baldwin Corp. $67,000

Add decrease in account recorded in 20X8: Equity-method loss ($20,000 x .25) $ (5,000) Dividend received ($10,000 x .25) (2,500) 7,500

Deduct increase in account recorded in 20X9: Equity-method income ($68,000 x .25) $17,000 Dividend received ($16,000 x .25) (4,000) Other comprehensive income reported by Gwin

Company ($12,000 x .25) 3,000 (16,000)

Purchase price $58,500

2-29


E2-24* Deferred Income Taxes

a. Income tax expense:

Operating income of Power Company $300,000Taxable income from Special Corporation ($250,000 x .40) x (1.00 - .80) 20,000 Income subject to taxation $320,000Effective tax rate x .35 Income tax expense $112,000

b. Income taxes payable:

Operating income of Power Company $300,000Taxable dividends received from Special Corporation ($50,000 x .40) x (1.00 - .80) 4,000 Taxable income $304,000Effective tax rate x .35 Income taxes payable $106,400

2-30


SOLUTIONS TO PROBLEMS

P2-25 Multiple-Choice Questions on Applying the Equity Method [AICPA Adapted]

1. a

2. a

3. c

4. d

P2-26 Amortization of Differential

Journal entries recorded by Ball Corporation:

(1) Investment in Krown Company Stock 120,000 Preferred Stock 50,000 Additional Paid-In Capital — Preferred Stock 70,000 Record purchase of Krown Company stock.

(2) Cash 3,000 Investment in Krown Company Stock 3,000 Record dividend from Krown Company: $10,000 x .30

(3) Investment in Krown Company Stock 12,000 Income from Krown Company 12,000 Record equity-method income: $40,000 x .30

(4) Income from Krown Company Stock 1,200 Investment in Krown Company Stock 1,200 Amortize differential assigned to buildings and equipment: [($360,000 - $300,000) x .30] / 15 years

(5) Income from Krown Company Stock 3,375 Investment in Krown Company 3,375 Amortize differential assigned to copyrights: $27,000 / 8 years

Computation of copyrightsPurchase price $120,000 Fair value of Krown's: Total assets $560,000 Total liabilities (250,000)

$310,000 Proportion of stock held by Ball x .30 (93,000 )Amount assigned to copyrights $ 27,000

2-31


P2-27 Computation of Account Balances

a. Easy Chair Company 20X1 equity-method income:

Proportionate share of reported income ($30,000 x .40) $ 12,000 Amortization of differential assigned to: Buildings and equipment [($35,000 x .40) / 5 years] (2,800) Goodwill ($8,000: not impaired) -0- Investment Income $ 9,200

Assignment of differential

Purchase price $150,000 Proportionate share of book value of

net assets ($320,000 x .40) (128,000)Proportionate share of fair value increase in

buildings and equipment ($35,000 x .40) (14,000 )Goodwill $ 8,000

b. Dividend income, 20X1 ($9,000 x .40) $ 3,600

c. Cost-method account balance (unchanged): $150,000

Equity-method account balance: Balance, January 1, 20X1 $150,000 Investment income 9,200 Dividends received (3,600 ) Balance, December 31, 20X1 $155,600

2-32


P2-28 Retroactive Recognition

Journal entries recorded by Idle Corporation:

(1) Investment in Fast Track Enterprises Stock 34,000 Cash 34,000 Record purchase of Fast Track stock.

(2) Investment in Fast Track Enterprises Stock 11,000 Retained Earnings 11,000 Record pick-up of difference between cost and equity income: 20X2 .10($40,000 - $20,000) $ 2,000 20X3 .10($60,000 / 2) $3,000

.15[($60,000 / 2) - $20,000] 1,500 4,500 20X4 .15($40,000 - $10,000) 4,500 Amount of increase $11,000

(3) Cash 5,000 Investment in Fast Track Enterprises Stock 5,000 Record dividend from Fast Track Enterprises: $20,000 x .25

(4) Investment in Fast Track Enterprises Stock 12,500 Income from Fast Track Enterprises 12,500 Record equity-method income: $50,000 x .25

2-33


P2-29 Multistep Acquisition

Journal entries recorded by Jackson Corp. in 20X9:

(1) Investment in Phillips Corp. Stock 70,000 Cash 70,000 Record purchase of Phillips stock.

(2) Investment in Phillips Corp. Stock 14,500 Retained Earnings 14,500 Record pick-up of difference between cost and equity income.

Computation of equity pick-up20X6 .10($70,000 - $20,000) $ 5,000 20X7 .10($70,000 - $20,000) 5,000 20X8 .15($70,000 - $20,000) 7,500 20X6 amortization of differential (1,000)20X7 amortization of differential (1,000)20X8 amortization of differential (1,000 )Amount of increase $14,500

Amortization of differential20X6 purchase [$25,000 - ($200,000 x .10)]

5 years $1,00020X8 purchase [$15,000 - ($300,000 x .05)] 020X9 purchase [$70,000 - ($350,000 x .20)] 0 Total annual amortization $1,000

(3) Cash 7,000 Investment in Phillips Corp. Stock 7,000 Record dividend from Phillips Corp: $20,000 x .35

(4) Investment in Phillips Corp. Stock 24,500 Income from Phillips Corp. 24,500 Record equity-method income: $70,000 x .35

(5) Income from Phillips Corp. 1,000 Investment in Phillips Corp. Stock 1,000 Amortize differential.

P2-30 Investment in Joint Venture

a. 25 percent = ($60,000 - $52,000) / [($330,000 - $50,000) –($293,000 - $45,000)]

b. $782,500 = $700,000 + ($330,000 x .25)

2-34


2-35


P2-31 Investment in Partnership

Down Corporation Balance Sheet


ConsolidationFull

ConsolidationAssets $800,000 $800,000 $ 914,000(d) $1,180,000 (f) Investment in DF Partnership 96,000 105,000 (b) Total Assets $896,000 $905,000 $ 914,000 $1,180,000

Liabilities $175,000 $175,000 $ 184,000(e) $ 205,000(g)Interest of Outside Partners 245,000(h)Owners’ Equity 721,000 (a) 730,000 (c) 730,000 (c) 730,000 (c)Total Liabilities and Equity $896,000 $905,000 $ 914,000 $1,180,000

(a) $721,000 = $730,000 - $105,000 + $96,000(b) $105,000 = given(c) $730,000 = given(d) $914,000 = $800,000 + ($380,000 x .30)(e) $184,000 = $175,000 + ($30,000 x .30)(f) $1,180,000 = $800,000 + $380,000(g) $205,000 = $175,000 + $30,000(h) $245,000 = $350,000 x .70

Down Corporation Income Statement


ConsolidationFull

ConsolidationSales Revenues $500,000 $ 500,000 $620,000 (b) $900,000 (d)Expenses (345,000) (345,000) (456,000)(c) (715,000)(e)Income from Partnership 9,000(a)Income to Outside Partners (21,000 ) (f)Net Income $155,000 $164,000 $164,000 $164,000

(a) $ 9,000 = [($400,000 - $370,000) x .30](b) $620,000 = $500,000 + ($400,000 x .30)(c) $456,000 = $345,000 + ($370,000 x .30)(d) $900,000 = $500,000 + $400,000(e) $715,000 = $345,000 + $370,000(f) $ 21,000 = [($400,000 - $370,000) x .70]

2-36


P2-32 Complex Differential

a. Essex Company 20X2 equity-method income:

Proportionate share of reported net income($80,000 x .30) $24,000 Deduct increase in cost of goods sold for purchase differential assigned to inventory ($30,000 x .30) (9,000)Deduct amortization of differential assigned to: Buildings and equipment [($320,000 - $260,000) x .30] / 12 years] (1,500) Patent [($25,000 x .30) / 10 years] (750 )Equity-method income for 20X2 $12,750

b. Computation of investment account balance on December 31, 20X2:

Purchase Price $165,000Investment income for 20X2 $12,750 Dividends received in 20X2 ($9,000 x .30) (2,700 ) 10,050 Investment account balance on December 31, 20X2 $175,050

2-37


P2-33 Equity Entries with Differential

a. Journal entry recorded by Hunter Corporation:

Investment in Arrow Manufacturing Stock 210,000 Common Stock 60,000 Additional Paid-In Capital 150,000 Record acquisition of Arrow Manufacturing stock.

b. Equity-method journal entries recorded by Hunter Corporation in 20X0:

(1) Investment in Arrow Manufacturing Stock 210,000 Common Stock 60,000 Additional Paid-In Capital 150,000 Record acquisition of Arrow Manufacturing stock.

(2) Cash 9,000 Investment in Arrow Manufacturing Stock 9,000 Record dividends from Arrow Manufacturing: $20,000 x .45

(3) Investment in Arrow Manufacturing Stock 36,000 Income from Arrow Manufacturing 36,000 Record equity-method income: $80,000 x .45

(4) Income from Arrow Manufacturing 1,350 Investment in Arrow Manufacturing Stock 1,350 Amortize differential assigned to buildings and equipment: ($30,000 x .45) / 10 years

2-38


P2-33 (continued)

Equity-method journal entries recorded by Hunter Corporation in 20X1:

(1) Cash 18,000 Investment in Arrow Manufacturing Stock 18,000 Record dividends from Arrow Manufacturing: $40,000 x .45

(2) Investment in Arrow Manufacturing Stock 22,500 Income from Arrow Manufacturing 22,500 Record equity-method income for period: $50,000 x .45

(3) Income from Arrow Manufacturing 1,350 Investment in Arrow Manufacturing Stock 1,350 Amortize differential assigned to buildings and

equipment.

c. Investment account balance, December 31, 20X1:

Purchase price on January 1, 20X0 $210,000

20X0: Income from Arrow Manufacturing ($36,000 - $1,350) $34,650 Dividends received (9,000 ) 25,650

20X1: Income from Arrow Manufacturing ($22,500 - $1,350) $21,150 Dividends received (18,000 ) 3,150

Investment account balance, December 31, 20X1 $238,800

2-39


P2-34 Equity Entries with Differential

a. Equity-method journal entries recorded by Ennis Corporation:

(1) Investment in Jackson Corporation Stock 200,000 Common Stock 50,000 Additional Paid-In Capital 150,000 Record acquisition of Jackson Corporation stock.

(2) Cash 3,500 Investment in Jackson Corporation Stock 3,500 Record dividend from Jackson Corporation: $10,000 x .35

(3) Investment in Jackson Corporation Stock 24,500 Income from Jackson Corporation 24,500 Record equity-method income: $70,000 x .35

(4) Income from Jackson Corporation 7,000 Investment in Jackson Corporation Stock 7,000 Record expiration of differential assigned to inventory: $20,000 x .35

(5) Income from Jackson Corporation 1,400 Investment in Jackson Corporation Stock 1,400 Record amortization of differential assigned to buildings and equipment (net): ($80,000 x .35) / 20 years

b. $212,600 = $200,000 + $24,500 - $3,500 - $7,000 - $1,400

2-40


P2-35 Additional Ownership Level

a. Operating income of Amber for 20X3 $220,000 Operating income of Blair for 20X3 $100,000Add: Equity income from Carmen [($50,000 - $6,000) x .25) 11,000 Blair net income for 20X3 $111,000Proportion of stock held by Amber x .40 44,400 Amortization of differential: Equipment [($30,000 x .40) / 8 years] (1,500) Patents [($25,000 x .40) / 5 years) (2,000 )Net income of Amber for 20X3 $260,900

b. Investment in Blair Corporation Stock 130,000 Common Stock 40,000 Additional paid-In Capital 90,000 Purchase of Blair Corporation Stock.

Cash 12,000 Investment in Blair Corporation Stock 12,000 Record dividend from Blair: $30,000 x .40

Investment in Blair Corporation Stock 44,400 Income from Blair Corporation 44,400 Record equity-method income: $111,000 x .40

Income from Blair Corporation 3,500 Investment in Blair Corporation Stock 3,500 Amortize differential: $3,500 = $1,500 + $2,000

2-41


P2-36 Fair Value Method

20X6 20X7 20X8a. Cost method:

Dividend income $ 3,000 $ 6,000 $ 4,000

Balance in investment account $70,000 $70,000 $70,000

b. Equity method:

Investment income:$40,000 x .20 $ 8,000 $35,000 x .20 $ 7,000 $60,000 x .20 $12,000

Balance in investment account:Balance at January 1 $70,000 $75,000 $76,000 Investment income 8,000 7,000 12,000 Dividends received (3,000 ) (6,000 ) (4,000 )Balance at December 31 $75,000 $76,000 $84,000

c. Fair value method:20X6 20X7 20X8

Investment income:Dividends received $ 3,000 $ 6,000 $ 4,000 Gain (loss) on fair value 19,000 (3,000 ) 11,000 Total income reported $22,000 $ 3,000 $15,000

Balance in investment account $89,000 $86,000 $97,000

2-42


P2-37 Fair Value Journal Entries

Journal entries under fair value method for 20X8:

(1) Investment in Brown Company Stock 85,000 Cash 85,000 Record purchase of Brown Company stock.

(2) Cash 4,000 Dividend Income 4,000 Record dividends from Brown Company: $10,000 x .40

(3) Investment in Brown Company Stock 12,000 Urealized Gain on Increase in Value of Brown Company Stock

12,000

Record increase in value of Brown stock: $97,000 - $85,000

Journal entries under fair value method for 20X9:

(1) Cash 6,000 Dividend Income 6,000 Record dividends from Brown Company: $15,000 x .40

(3) Unrealized Loss on Decrease in Value of Brown Company Stock

5,000

Investment in Brown Company Stock 5,000 Record decrease in value of Brown stock: $97,000 - $92,000

2-43


P2-38 Correction of Error

Required correcting entry:

Retained Earnings 17,000Income from Dale Company 11,500 Investment in Dale Company Stock 28,500

Adjustments to current books of Hill Company:

Dale Company

Item

Retained Earnings 1/1/20X4

20X4 Income

Investment Balance

12/31/20X4Adjustment to remove dividends

included in investment income and not removed from investment account $(14,000) $(10,000) $(24,000)

Adjustment to annual amortizationof differential: 20X2 and 20X3 (3,000) (3,000) 20X4 (1,500 ) (1,500 )Required adjustment to account balance $(17,000) $(11,500) $(28,500)

Computation of adjustment to annual amortization of differential

Correct amortization of differential assigned to: Equipment [($120,000 - $70,000) x .40] / 5 years $4,000 Patents: Amount paid $164,000 Fair value of identifiable net assets ($300,000 + $50,000) x .40 (140,000) Amount assigned $ 24,000 Number of years to be amortized ÷ 8 Annual amortization 3,000 Correct amount to be amortized annually $7,000 Amount amortized by Hill [($164,000 - ($300,000 x .40)] / 8 years (5,500 ) Adjustment to annual amortization $1,500

2-44


P2-39* Other Comprehensive Income Reported by Investee

a. Equity-method income reported by Dewey Corporation in 20X5:

Amounts reported by Jimm Co. for 20X5:Operating income $70,000Dividend income 7,000Gain on investment in trading securities 18,000 Net income $95,000Ownership held by Dewey x .30 Investment income reported by Dewey $28,500

b. Computation of amount added to investment account in 20X5:

Balance in investment account reported by Dewey: December 31, 20X5 $276,800 January 1, 20X5 (245,000)Increase in investment account in 20X5 $ 31,800 Dividends received by Dewey during 20X5 6,000 Amount added to investment account in 20X5 $ 37,800

c. Computation of other comprehensive income reported by Jimm Co.:

Amount added to investment account in 20X5 $ 37,800 Investment income reported by Dewey in 20X5 (28,500 )Increase due to other comprehensive income reported by Jimm Co. $ 9,300 Proportion of ownership held by Dewey .30 Other comprehensive income reported by Jimm Co. $ 31,000

d. Computation of market value of securities held by Jimm Co.

Amount paid by Jimm Co. to purchase securities $130,000Increase in market value reported as other comprehensive income in

20X5 31,000 Market value of available-for-sale securities at December 31, 20X5 $161,000

2-45


P2-40* Equity-Method Income Statement

a. Diversified Products Corporation

Income StatementYear Ended December 31, 20X8

Net Sales $400,000 Cost of Goods Sold (320,000)Gross Profit $ 80,000 Other Expenses $(25,000)Gain on Sale of Truck 10,000 (15,000 )Income from Continuing Operations $ 65,000 Discontinued Operations: Operating Loss from Discontinued Division $(15,000) Gain on Sale of Division 44,000 29,000 Income before Extraordinary Item $ 94,000 Extraordinary Item: Loss on Volcanic Activity (5,000 )Net Income $ 89,000

Diversified Products CorporationRetained Earnings Statement

Year Ended December 31, 20X8

Retained Earnings, January 1, 20X8 $240,000 (1)20X8 Net Income 89,000

$329,000 Dividends Declared, 20X8 (10,000 ) Retained Earnings, December 31, 20X8 $319,000

(1) The Retained Earnings balance on January 1, 20X8, has been reduced by the $20,000 cumulative adjustment for change in inventory method on January 1, 20X8.

2-46


P2-40* (continued)

b. Wealthy Manufacturing Company

Income StatementYear Ended December 31, 20X8

Net Sales $850,000 Cost of Goods Sold (670,000 )Gross Profit $180,000 Other Expenses $(90,000)Income from Continuing Operations of Diversified Products Corporation 26,000 (64,000 )Income from Continuing Operations $116,000 Discontinued Operations: Share of Operating Loss Reported by Diversified Products on Discontinued Division $ (6,000) Share of Gain on Sale of Division Reported by Diversified Products 17,600 11,600 Income before Extraordinary Item $127,600 Extraordinary Item: Share of Loss on Volcanic Activity Reported by Diversified Products (2,000 )Net Income $125,600

Wealthy Manufacturing CompanyRetained Earnings Statement

Year Ended December 31, 20X8

Retained Earnings, January 1, 20X8 $412,000 (1)20X8 Net Income 125,600

$537,600 Dividends Declared, 20X8 (30,000 )Retained Earnings, December 31, 20X8 $507,600

(1) The Retained Earnings balance of Wealthy Manufacturing Company on January 1, 20X8, has been reduced by $8,000 to reflect its proportionate share of the $20,000 cumulative adjustment for the change in inventory method recorded by Diversified Products Corporation on January 1, 20X8 ($20,000 x .40 = $8,000).

2-47


P2-41* Net Income after Tax

Net Income reported by Baltic Corporation:

Operating income of Baltic Corporation $ 95,000 Investment income from Cumberland Company ($70,000 x .30) 21,000 Income before tax expense $116,000 Income tax expense [$95,000 + ($21,000 x .20)] x .40 (39,680) Baltic Corporation net income $ 76, 320

P2-42* Income Tax Expense and Net Income

(a) Cost method computations:

20X4 Income tax expense

Operating income of Long Company $50,000 Dividends received from Computech ($4,000 x .25) x (1.00 - .80) 200 Income subject to taxation $50,200 Effective tax rate x .40 Income tax expense $20,080

20X4 Net income

Operating income of Long Company $50,000 Dividend income from Computech ($4,000 x .25) 1,000 Income before tax expense $51,000 Income tax expense (20,080)Net income of Long Company $30,920


Operating income of Long Company $64,000 Dividends received from Computech ($10,000 x .25) x (1.00 - .80) 500 Income subject to taxation $64,500 Effective tax rate x .40 Income tax expense $25,800

20X5 Net income

Operating income of Long Company $64,000 Dividend income from Computech ($10,000 x .25) 2,500 Income before tax expense $66,500 Income tax expense (25,800)Net income of Long Company $40,700

2-48


P2-42* (continued)

(b) Equity method computations:


Operating income of Long Company $50,000 Equity method income from investment in Computech subject to taxation ($20,000 x .25) x (1.00 - .80) 1,000 Income subject to taxation $51,000 Effective tax rate x .40 Income tax expense $20,400

20X4 Net income

Operating income of Long Company $50,000 Investment income from Computech ($20,000 x .25) 5,000 Income before tax expense $55,000 Income tax expense (20,400)Net income of Long Company $34,600


Operating income of Long Company $64,000 Equity method income from investment in Computech subject to taxation ($8,000 x .25) x (1.00 - .80) 400 Income subject to taxation $64,400 Effective tax rate x .40 Income tax expense $25,760

20X5 Net income

Operating income of Long Company $64,000 Investment income from Computech ($8,000 x .25) 2,000 Income before tax expense $66,000 Income tax expense (25,760)Net income of Long Company $40,240

2-49

solusi manual advanced acc zy chap002

Education

equity method

equitymethod reporting

cost method

equitymethod basis

investee equal

significant influence

dividend income

liquidating dividends