01 Chapter - The Equity Method of Accounting for Investments Chapter 01 The Equity Method of Accounting for Investments Multiple

Choice Questions 1 !a" Company o"ns 1#$ of the common stoc% of Trace Corporation and used the fairvalue method to account for this investment Trace reported net income of &110'000 for (011 and paid dividends of &)0'000 on *cto+er 1' (011 ,o" much income should !a" recogni-e on this investment in (011. B. $9,000. ( /aro Company o"ns 00$ of the common stoc% of 1e" Co and uses the equity method to account for the investment 1uring (011' 1e" reported income of &(#0'000 and paid dividends of &20'000 There is no amorti-ation associated "ith the investment 1uring (011' ho" much income should /aro recogni-e related to this investment. B. $75,000. 0 *n 3anuary 1' (011' 4acer Company paid &1'5(0'000 for )0'000 shares of 6ennon Co 7s voting common stoc% "hich represents a 8#$ investment 9o allocation to good"ill or other specific account "as made :ignificant influence over 6ennon "as achieved +y this acquisition 6ennon distri+uted a dividend of &( #0 per share during (011 and reported net income of &);0'000 <hat "as the +alance in the Investment in 6ennon Co account found in the financial records of 4acer as of 1ecem+er 01' (011. E. $2,071,500. 8 A company should al"ays use the equity method to account for an investment if= A. it has the ability to exercise significant influence over the o erating olicies of the investee. # *n 3anuary 1' (005' 1ermot Company purchased 1#$ of the voting common stoc% of ,orne Corp *n 3anuary 1' (011' 1ermot purchased (2$ of ,orne7s voting common stoc% If 1ermot achieves significant influence "ith this ne" investment' ho" must 1ermot account for the change to the equity method. !. "t #ust restate the financial state#ents for 2010 an$ 2009 as if the e%uity #etho$ ha$ been use$ for those t&o years ) 1uring 3anuary (010' <ells' Inc acquired 00$ of the outstanding common stoc% of <ilton Co for &1'800'000 This investment gave <ells the a+ility to e>ercise significant influence over <ilton <ilton7s assets on that date "ere recorded at &)'800'000 "ith lia+ilities of &0'000'000 Any e>cess of cost over +oo% value of <ells7 investment "as attri+uted to unrecorded patents having a remaining useful life of ten years In (010' <ilton reported net income of &)00'000 ?or (011' <ilton reported net income of &;#0'000 1ividends of &(00'000 "ere paid in each of these t"o years <hat "as the reported +alance of <ells7 Investment in <ilson Co at 1ecem+er 01' (011. A &1')05'000 ; *n 3anuary 1' (011' @angle Company purchased 00$ of the voting common stoc% of :leat Corp for &1'000'000 Any e>cess of cost over +oo% value "as assigned to good"ill 1uring (011' :leat paid dividends of &(8'000 and reported a net loss of &180'000 <hat is the +alance in the investment account on 1ecem+er 01' (011. A &5#0'200 2 *n 3anuary 1' (011' 3ordan Inc acquired 00$ of 9ico Corp 3ordan used the equity method to account

for the investment *n 3anuary 1' (01(' 3ordan sold t"o-thirds of its investment in 9ico It no longer had the a+ility to e>ercise significant influence over the operations of 9ico ,o" should 3ordan have accounted for this change. E 3ordan should use the fair-value method for (01( and future years +ut should not ma%e a retrospective adAustment to the investment account 5 To"er Inc o"ns 00$ of /ale Co and applies the equity method 1uring the current year' To"er +ought inventory costing &))'000 and then sold it to /ale for &1(0'000 At year-end' only &(8'000 of merchandise "as still +eing held +y /ale <hat amount of intra-entity inventory profit must +e deferred +y To"er. @ &0'(80 10 *n 3anuary 8' (011' <atts Co purchased 80'000 shares B80$C of the common stoc% of Adams Corp ' paying &200'000 There "as no good"ill or other cost allocation associated "ith the investment <atts has significant influence over Adams 1uring (011' Adams reported income of &(00'000 and paid dividends of &20'000 *n 3anuary (' (01(' <atts sold #'000 shares for &1(#'000 <hat "as the +alance in the investment account after the shares had +een sold. @ &;8('000 *n 3anuary 0' (011' Austin Corp purchased (#$ of the voting common stoc% of !ainsville Co ' paying &('#00'000 Austin decided to use the equity method to account for this investment At the time of the investment' !ainsville7s total stoc%holders7 equity "as &2'000'000 Austin gathered the follo"ing information a+out !ainsville7s assets and lia+ilities= ?or all other assets and lia+ilities' +oo% value and fair value "ere equal Any e>cess of cost over fair value "as attri+uted to good"ill' "hich has not +een impaired 11 <hat is the amount of good"ill associated "ith the investment. 1 &000'000 1( ?or (011' "hat is the total amount of e>cess amorti-ation for Austin7s (#$ investment in !ainsville. C &00'000 10 Clu+ Co appropriately uses the equity method to account for its investment in Chip Corp As of the end of (011' Chip7s common stoc% had suffered a significant decline in fair value' "hich is e>pected to +e recovered over the ne>t several months ,o" should Clu+ account for the decline in value. @ 9o accounting +ecause the decline in fair value is temporary 18 An upstream sale of inventory is a sale= E made +y the investee to the investor Atlarge Inc o"ns 00$ of the outstanding voting common stoc% of Tic%er Co and has the a+ility to significantly influence the investee7s operations and decision ma%ing *n 3anuary 1' (011' the +alance in the Investment in Tic%er Co account "as &80('000 Amorti-ation associated "ith the purchase of this investment is &2'000 per year 1uring (011' Tic%er earned an income of &102'000 and paid cash dividends of &0)'000 4reviously in (010' Tic%er had sold inventory costing &(2'200 to Atlarge for &82'000 All +ut (#$ of this merchandise "as consumed +y Atlarge during (010 The remainder "as used during the first fe" "ee%s of (011 Additional sales "ere made to Atlarge in (011D inventory costing &00')00 "as transferred at a price of &)0'000 *f this total' 80$ "as not consumed

until (01( 1# <hat amount of equity income "ould Atlarge have recogni-ed in (011 from its o"nership interest in Tic%er. A &15';5( @ &(;')80 C &((');( 1 &(8'800 E &(1';82 1) <hat "as the +alance in the Investment in Tic%er Co account at the end of (011. A &801'10) @ &810'2;( C &812'280 1 &81('80( E &810'182 *n 3anuary 1' (011' 1euce Inc acquired 1#$ of <i- Co 7s outstanding common stoc% for &)('800 and categori-ed the investment as an availa+le-for-sale security <i- earned net income of &5)'000 in (011 and paid dividends of &0)'000 *n 3anuary 1' (01(' 1euce +ought an additional 10$ of <i- for &#8'000 This second purchase gave 1euce the a+ility to significantly influence the decision ma%ing of <i- 1uring (01(' <i- earned &1(0'000 and paid &82'000 in dividends As of 1ecem+er 01' (01(' <i- reported a net +oo% value of &8)2'000 ?or +oth purchases' 1euce concluded that <i- Co 7s +oo% values appro>imated fair values and attri+uted any e>cess cost to good"ill 1; *n 1euce7s 1ecem+er 01' (01( +alance sheet' "hat +alance "as reported for the Investment in <i- Co account. A &105'#)0 @ &180'800 C &010'100 1 &12)'020 E &12('(#0 12 <hat amount of equity income should 1euce have reported for (01(. A &00'000 @ &1)'8(0 C &02'080 1 &12'000 E &0('280 15 In a situation "here the investor e>ercises significant influence over the investee' "hich of the follo"ing entries is not actually posted to the +oo%s of the investor. 1C 1e+it to the Investment account' and a Credit to the Equity in Investee Income account (C 1e+it to Cash Bfor dividends received from the investeeC' and a Credit to 1ividend Eevenue 0C 1e+it to Cash Bfor dividends received from the investeeC' and a Credit to the Investment account 1 Entry ( only (0 All of the follo"ing "ould require use of the equity method for investments e>cept= C valuation at fair value (1 All of the follo"ing statements regarding the investment account using the equity method are true e>cept= @ 1ividends received are reported as revenue (( A company has +een using the fair-value method to account for its investment The company no" has the a+ility to significantly control the investee and the equity method has +een deemed appropriate <hich of the follo"ing statements is true. C A retrospective change in accounting principle must occur (0 A company has +een using the equity method to account for its investment The company sells shares and does not continue to have significant control <hich of the follo"ing statements is true. @ A prospective change in accounting principle must occur (8 An investee company incurs an e>traordinary loss during the period The investor appropriately applies the equity method <hich of the follo"ing statements is true. @ The e>traordinary loss "ould reduce the value of the investment (# ,o" should a permanent loss in value of an investment using the equity method +e treated. @ A loss is reported the same as a loss in value of other long-term assets () Fnder the equity method' "hen the company7s share of cumulative

losses equals its investment and the company has no o+ligation or intention to fund such additional losses' "hich of the follo"ing statements is true. C The investor should suspend applying the equity method and not record any equity in income of investee until its share of future profits is sufficient to recover losses that have not previously +een recorded (; <hen an investor sells shares of its investee company' "hich of the follo"ing statements is true. C A reali-ed gain or loss is reported as the difference +et"een selling price and carrying value (2 <hen applying the equity method' ho" is the e>cess of cost over +oo% value accounted for. C The e>cess is allocated to the difference +et"een fair value and +oo% value multiplied +y the percent o"nership of net assets (5 After allocating cost in e>cess of +oo% value' "hich asset or lia+ility "ould not +e amorti-ed over a useful life. 1 !ood"ill 00 <hich statement is true concerning unreali-ed profits in intra-entity inventory transfers "hen an investor uses the equity method. C The investor must defer do"nstream ending inventory profits 01 <hich statement is true concerning unreali-ed profits in intra-entity inventory transfers "hen an investor uses the equity method. @ The same adAustments are made for upstream and do"nstream transfers *n 3anuary 1' (010' 1a"son' Incorporated' paid &100'000 for a 00$ interest in :acco Corporation This investee had assets "ith a +oo% value of &##0'000 and lia+ilities of &000'000 A patent held +y :acco having a +oo% value of &10'000 "as actually "orth &80'000 "ith a si> year remaining life Any good"ill associated "ith this acquisition is considered to have an indefinite life 1uring (010' :acco reported income of &#0'000 and paid dividends of &(0'000 "hile in (011 it reported income of &;#'000 and dividends of &00'000 Assume 1a"son has the a+ility to significantly influence the operations of :acco 0( The amount allocated to good"ill at 3anuary 1' (010' is 1 &1)'000 00 The equity in income of :acco for (010' is @ &10'#00 08 The equity in income of :acco for (011' is @ &(1'000 0# The +alance in the investment in :acco account at 1ecem+er 01' (010' is 1 &10;'#00 E 180'000 0) The +alance in the investment in :acco account at 1ecem+er 01' (011' is A &115'#00 1odge' Incorporated acquires 1#$ of !ates Corporation on 3anuary 1' (011' for &10#'000 "hen the +oo% value of !ates "as &)00'000 1uring (011 !ates reported net income of &1#0'000 and paid dividends of &#0'000 *n 3anuary 1' (01(' 1odge purchased an additional (#$ of !ates for &(00'000 Any e>cess cost over +oo% value is attri+uta+le to good"ill "ith an indefinite life The fair-value method "as used during (011 +ut 1odge has deemed it necessary to change to the equity method after the second purchase 1uring (01( !ates reported net income of &(00'000 and reported dividends of &;#'000 0; The income reported +y 1odge for (011 "ith regard to the !ates investment is A &;'#00 02 The income reported +y 1odge for (01( "ith regard to the !ates investment is A &20'000 05 <hich adAustment "ould +e made to

change from the fair-value method to the equity method. 1 A credit to retained earnings for &1#'000 80 The +alance in the investment account at 1ecem+er 01' (01(' is A &0;0'000 Clancy Incorporated' sold &(10'000 of its inventory to Eeid Company during (011 for &0#0'000 Eeid sold &((8'000 of this merchandise in (011 "ith the remainder to +e disposed of during (01( Assume Clancy o"ns 00$ of Eeid and applies the equity method 81 <hat Aournal entry "ill +e recorded at the end of (011 to defer the unreali-ed intra-entity profits. C Entry C 8( <hat Aournal entry "ill +e recorded in (01( to reali-e the intra-entity profit that "as deferred in (011. 1 Entry 1 *n 3anuary 1' (010' Mehan' Incorporated purchased 1#'000 shares of Coo% Company for &1#0'000 giving Mehan a 1#$ o"nership of Coo% *n 3anuary 1' (011 Mehan purchased an additional (#'000 shares B(#$C of Coo% for &000'000 This last purchase gave Mehan the a+ility to apply significant influence over Coo% The +oo% value of Coo% on 3anuary 1' (010' "as &1'000'000 The +oo% value of Coo% on 3anuary 1' (011' "as &1'1#0'000 Any e>cess of cost over +oo% value for this second transaction is assigned to a data+ase and amorti-ed over five years Coo% reports net income and dividends as follo"s These amounts are assumed to have occurred evenly throughout the years= *n April 1' (01(' Aust after its first dividend receipt' Mehan sells 10'000 shares of its investment 80 <hat is the +alance in the investment account at 1ecem+er 01' (010. A &1#0'000 88 ,o" much income did Mehan report from Coo% during (010. C &;'#00 8# ,o" much income did Mehan report from Coo% during (011. 1 &2;'#00 8) <hat "as the +alance in the investment account at 1ecem+er 01' (011. A 1 &#80'000 8; <hat "as the +alance in the investment account at April 1' (01( Aust +efore the sale of shares. C &##2'0;# 82 ,o" much of Coo%7s net income did Mehan report for the year (01(. @ &21'(#0 *n 3anuary 8' (010' ,arley' Inc acquired 80$ of the outstanding common stoc% of @i%e Co for &('800'000 This investment gave ,arley the a+ility to e>ercise significant influence over @i%e @i%e7s assets on that date "ere recorded at &10'#00'000 "ith lia+ilities of &8'#00'000 There "ere no other differences +et"een +oo% and fair values 1uring (010' @i%e reported net income of &#00'000 ?or (011' @i%e reported net income of &200'000 1ividends of &000'000 "ere paid in each of these t"o years 85 ,o" much income did ,arley report from @i%e for (010. @ &(00'000 #0 ,o" much income did ,arley report from @i%e for (011. 1 &0(0'000 #1 <hat "as the reported +alance of ,arley7s Investment in @i%e Co at 1ecem+er 01' (010. C &('820'000 #( <hat "as the reported +alance of ,arley7s Investment in @i%e Co at 1ecem+er 01' (011. E &(')20'000 *n 3anuary 1' (011' Anderson Company purchased 80$ of the voting common stoc% of @arney Company for &('000'000' "hich appro>imated +oo% value 1uring (011' @arney paid dividends of &00'000 and reported a net loss of &;0'000 #0 <hat is the +alance in

the investment account on 1ecem+er 01' (011. @ &1'5)0'000 #8 <hat amount of equity income "ould Anderson recogni-e in (011 from its o"nership interest in @arney. E &(2'000 loss ## 6uffman Inc o"ns 00$ of @ruce Inc and appropriately applies the equity method 1uring the current year' @ruce +ought inventory costing &#('000 and then sold it to 6uffman for &20'000 At year-end' all of the merchandise had +een sold +y 6uffman to other customers <hat amount of unreali-ed intercompany profit must +e deferred +y 6uffman. A &0 *n 3anuary 0' (011' Eo+erts Company purchased 00$ of the 100'000 shares of common stoc% of Thomas Corporation' paying &1'#00'000 There "as no good"ill or other cost allocation associated "ith the investment Eo+erts has significant influence over Thomas 1uring (011' Thomas reported income of &000'000 and paid dividends of &100'000 *n 3anuary 8' (01(' Eo+erts sold 1#'000 shares for &200'000 #) <hat "as the +alance in the investment account +efore the shares "ere sold. A &1'#)0'000 #; <hat is the gainGloss on the sale of the 1#'000 shares. E &(0'000 gain #2 <hat is the +alance in the investment account after the sale of the 1#'000 shares. C &;20'000 #5 <hat is the appropriate Aournal entry to record the sale of the 1#'000 shares. @ @ A+ove *n 3anuary 8' (011' Mason Co purchased 80'000 shares B80$C of the common stoc% of ,efly Corp ' paying &#)0'000 At that time' the +oo% value and fair value of ,efly7s net assets "as &1'800'000 The investment gave Mason the a+ility to e>ercise significant influence over the operations of ,efly 1uring (011' ,efly reported income of &1#0'000 and paid dividends of &80'000 *n 3anuary (' (01(' Mason sold 10'000 shares for &1#0'000 )0 <hat "as the +alance in the investment account +efore the shares "ere sold. 1 &)08'000 )1 <hat is the gainGloss on the sale of the 10'000 shares. 1 &1'000 loss )( <hat is the +alance in the investment account after the sale of the 10'000 shares. C &8#0'000 )0 <hat is the appropriate Aournal entry to record the sale of the 10'000 shares. C C A+ove *n 3anuary 8' (011' @ailey Corp purchased 80$ of the voting common stoc% of Emery Co ' paying &0'000'000 @ailey properly accounts for this investment using the equity method At the time of the investment' Emery7s total stoc%holders7 equity "as &#'000'000 @ailey gathered the follo"ing information a+out Emery7s assets and lia+ilities "hose +oo% values and fair values differed= Any e>cess of cost over fair value "as attri+uted to good"ill' "hich has not +een impaired Emery Co reported net income of &800'000 for (011' and paid dividends of &(00'000 during that year )8 <hat is the amount of the e>cess of purchase price over +oo% value. C &1'000'000 )# ,o" much good"ill is associated "ith this investment. 1 &(00'000 )) <hat is the amount of e>cess amorti-ation e>pense for @ailey7s investment in Emery for the first year. @ &28'000 *n 3anuary 1' (011' 3ac%ie Corp purchased 00$ of the voting common stoc% of Eo+ Co ' paying &('000'000 3ac%ie properly accounts for this

investment using the equity method At the time of the investment' Eo+7s total stoc%holders7 equity "as &0'000'000 3ac%ie gathered the follo"ing information a+out Eo+7s assets and lia+ilities "hose +oo% values and fair values differed= Any e>cess of cost over fair value "as attri+uted to good"ill' "hich has not +een impaired Eo+ Co reported net income of &000'000 for (011' and paid dividends of &100'000 during that year ); <hat is the amount of the e>cess of purchase price over +oo% value. E &1'100'000 )2 ,o" much good"ill is associated "ith this investment. C &)#0'000 )5 <hat is the amount of e>cess amorti-ation e>pense for 3ac%ie Corp7s investment in Eo+ Co for year (011. 1 &##'000 ;0 <hat is the +alance in 3ac%ie Corp7s Investment in Eo+ Co account at 1ecem+er 01' (011. @ &('00#'000 Ac%er Inc +ought 80$ of ,o"ell Co on 3anuary 1' (010 for &#;)'000 The equity method of accounting "as used The +oo% value and fair value of the net assets of ,o"ell on that date "ere &1'880'000 Ac%er +egan supplying inventory to ,o"ell as follo"s= ,o"ell reported net income of &100'000 in (010 and &1(0'000 in (011 "hile paying &80'000 in dividends each year ;1 <hat is the amount of unreali-ed intra-entity inventory profit to +e deferred on 1ecem+er 01' (010. A &1')00 ;( <hat is the amount of unreali-ed intra-entity inventory profit to +e deferred on 1ecem+er 01' (011. @ &2'000 ;0 <hat is the Equity in ,o"ell Income that should +e reported +y Ac%er in (010. 1 &02'800 ;8 <hat is the +alance in Ac%er7s Investment in ,o"ell account at 1ecem+er 01' (010. @ &#52'800 ;# <hat is the Equity in ,o"ell Income that should +e reported +y Ac%er in (011. @ &81')00 ;) <hat is the +alance in Ac%er7s Investment in ,o"ell account at 1ecem+er 01' (011. A &)(8'000 Cayman Inc +ought 00$ of Maya Company on 3anuary 1' (011 for &8#0'000 The equity method of accounting "as used The +oo% value and fair value of the net assets of Maya on that date "ere &1'#00'000 Maya +egan supplying inventory to Cayman as follo"s= Maya reported net income of &100'000 in (011 and &1(0'000 in (01( "hile paying &80'000 in dividends each year ;; <hat is the amount of unreali-ed intra-entity inventory profit to +e deferred on 1ecem+er 01' (011. A &500 ;2 <hat is the amount of unreali-ed inventory profit to +e deferred on 1ecem+er 01' (01(. @ &('800 ;5 <hat is the Equity in Maya Income that should +e reported +y Cayman in (011. 1 &(5'100 20 <hat is the +alance in Cayman7s Investment in Maya account at 1ecem+er 01' (011. @ &8);'100 21 <hat is the Equity in Maya Income that should +e reported +y Cayman in (01(. C &08'#00 2( <hat is the +alance in Cayman7s Investment in Maya account at 1ecem+er 01' (01(. @ &825')00 20 <hich of the follo"ing results in a decrease in the investment account "hen applying the equity method. 1 Fnreali-ed gain on intra-entity inventory transfers for the current year 28 <hich of the follo"ing results in an increase in the investment account "hen applying the equity method. A Fnreali-ed gain on intra-entity

inventory transfers for the prior year 2# <hich of the follo"ing results in a decrease in the Equity in Investee Income account "hen applying the equity method. C Fnreali-ed gain on intra-entity inventory transfers for the current year 2) <hich of the follo"ing results in an increase in the Equity in Investee Income account "hen applying the equity method. 1 Fnreali-ed gain on intra-entity inventory transfers for the prior year HHH Eenfroe' Inc acquires 10$ of :tanley Corporation on 3anuary 1' (010' for &50'000 "hen the +oo% value of :tanley "as &1'000'000 1uring (010' :tanley reported net income of &(1#'000 and paid dividends of &#0'000 *n 3anuary 1' (011' Eenfroe purchased an additional 00$ of :tanley for &0(#'000 Any e>cess of cost over +oo% value is attri+uta+le to good"ill "ith an indefinite life 1uring (011' Eenfroe reported net income of &0(0'000 and paid dividends of &#0'000 2; ,o" much is the adAustment to the Investment in :tanley Corporation for the change from the fair-value method to the equity method on 3anuary 1' (011. A A de+it of &1)'#00 22 <hat is the +alance in the Investment in :tanley Corporation on 1ecem+er 01' (011. 1 &#05'#00 *n 3anuary 8' (010' Tryc%er' Inc acquired 80$ of the outstanding common stoc% of In%+lot Co for &('800'000 This investment gave Tryc%er the a+ility to e>ercise significant influence over In%+lot In%+lot7s assets on that date "ere recorded at &2'000'000 "ith lia+ilities of &('000'000 There "ere no other differences +et"een +oo% and fair values 1uring (010' In%+lot reported net income of &#00'000 and paid dividends of &000'000 The fair value of In%+lot at 1ecem+er 01' (010 is &;'000'000 Tryc%er elects the fair value option for its investment in In%+lot 25 ,o" are dividends received from In%+lot reflected in Tryc%er7s accounting records for (010. E Increase 1ividend Income +y &1(0'000 50 At "hat amount "ill In%+lot +e reflected in Tryc%er7s 1ecem+er 01' (010 +alance sheet. 1 &('200'000