chapter 2

CHAPTER 2

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

Q2-9 A corporate joint venture is a company that is established and operated by a small group of investors, none of whom hold 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.

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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.

Q2-20* 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.

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E2-1

1. a

2. a

3. d

4. a

5. b

6. d

7. d

E2-2

1. b

2. c

3. d

4. a

5. a

E2-3

1. c

2. d

3. c

4. d

5. d

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E2-4

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.

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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.

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

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

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

20X6 Investment in Steam Company Stock 8,000 Income from Steam Company 8,000 Record equity-method income.


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

20X7 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 purchase differential.

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E2-6 Acquisition Price

Balance at date of purchase:

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

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

Change in Investment Account Year Net Income Dividends Cost Method Equity Method

20X1 $ 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

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E2-7 Investment Income

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

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

(2) Ravine Corporation net income under Equity Method:

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

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

Cash 12,000 Investment in Valley Stock 12,000

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E2-12 Purchase 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.

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

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

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

20X5 Investment in Cook Company Stock 8,000 Income from Cook Company 8,000 Record equity-method income: $20,000 x .40

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

Income from Cook Company 1,600 Investment in Cook Company Stock 1,600 Amortize purchase 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

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

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

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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

E2-16 Purchase Differential Assigned to Land and Equipment

Journal entries recorded by Rod Corporation:

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

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

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

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

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P2-25

1. a

2. a

3. c

4. d

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P2-26 Amortization of Purchase 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) Investment in Krown Company Stock 12,000 Income from Krown Company 12,000 Record equity-method income.

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

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

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

Computation of copyrights

Purchase 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

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P2-32 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) Investment in Arrow Manufacturing Stock 36,000 Income from Arrow Manufacturing 36,000 Record equity-method income: $80,000 x .45

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

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

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P2-33 (continued)

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

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

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

(3) Income from Arrow Manufacturing 1,350 Investment in Arrow Manufacturing Stock 1,350 Amortize purchase 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

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chapter 2

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