ACC 642 - CH 01 Solutions

Chapter 01 - The Equity Method of Accounting for Investments

CHAPTER 01THE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS

Answers to Problems

1. D

2. B

3. C

4. B

5. D

6. A Acquisition price.............................................................................. $1,600,000

Equity income ($560,000 × 40%)..................................................... 224,000

Dividends (50,000 shares × $2.00).................................................. (100,000)

Investment in Harrison Corporation as of December 31............. $1,724,000

7. A Acquisition price........................................................ $700,000

Income accruals: 2010—$170,000 × 20%................. 34,000

2011—$210,000 × 20%................. 42,000

Amortization (see below): 2010................................. (10,000)

Amortization: 2011..................................................... (10,000)

Dividends: 2010—$70,000 × 20%.............................. (14,000)

2011—$70,000 × 20%............................... (14,000)

Investment in Bremm, December 31, 2011............... $728,000

Acquisition price........................................................ $700,000

Bremm’s net assets acquired ($3,000,000 × 20%)... (600,000)

Excess cost to patent................................................ $100,000

Annual amortization (10 year life) ............................ $10,000

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8. B Purchase price of Baskett stock.................... $500,000

Book value of Baskett ($900,000 × 40%)....... (360,000)

Cost in excess of book value.................... $140,000 Life Annual

Payment identified with undervalued............ Amortization

Building ($140,000 × 40%)......................... 56,000 7 yrs. $8,000

Trademark ($210,000 × 40%)..................... 84,000 10 yrs. 8,400

Total ................................................................. $ -0- $16,400

Cost of investment.......................................................... $500,000

Basic income accrual ($90,000 × 40%)..................... 36,000

Amortization (above).................................................. (16,400)

Dividend collected ($30,000 × 40%)......................... (12,000)

Investment in Baskett...................................................... $507,600

9. D The 2010 purchase is reported using the equity method.

Purchase price of Goldman stock.................................................. $600,000

Book value of Goldman stock ($1,200,000 × 40%)....................... (480,000)

Goodwill............................................................................................ $120,000

Life of goodwill................................................................................ indefinite

Annual amortization........................................................................ (-0-)

Cost on January 1, 2010.................................................................. $600,000

2010 Income accrued ($140,000 x 40%)......................................... 56,000

2010 Dividend collected ($50,000 × 40%)...................................... (20,000)

2011 Income accrued ($140,000 × 40%)......................................... 56,000


2012 Income accrued ($140,000 × 40%)......................................... 56,000


Investment in Goldman, 12/31/12.............................................. $708,000

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10. D

11. A Gross profit rate (GPR): $36,000 ÷ $90,000 = 40%

Inventory remaining at year-end.................................................... $20,000

GPR................................................................................................... × 40%

Unrealized gain........................................................................... $8,000

Ownership........................................................................................ × 30%

Intra-entity unrealized gain—deferred...................................... $2,400

12.B Purchase price of Steinbart shares................................................ $530,000

Book value of Steinbart shares ($1,200,000 × 40%)..................... (480,000)

Trade name....................................................................................... $50,000

Life of trade name............................................................................ 20 years

Annual amortization........................................................................ $2,500

2010 Gross profit rate = $30,000 ÷ $100,000 = 30%

2011 Gross profit rate = $54,000 ÷ $150,000 = 36%

2011—Equity income in Steinbart:

Income accrual ($110,000 × 40%)................................................... $44,000

Amortization (above)....................................................................... (2,500)

Recognition of 2010 unrealized gain

($25,000 × 30% GPR × 40% ownership).................................... 3,000

Deferral of 2011 unrealized gain

($45,000 × 36% GPR × 40% ownership..................................... (6,480)

Equity income in Steinbart—2011............................................ $38,020

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16. (20 Minutes) (Equity entries for one year, includes conversion to equity method)

The 2010 purchase must be restated to the equity method.

FIRST PURCHASE—JANUARY 1, 2010

Purchase price of Denton stock............................................ $210,000

Book value of Denton stock ($1,700,000 × 10%).................. (170,000)

Cost in excess of book value................................................. $40,000

Excess cost assigned to undervalued land

($100,000 × 10%).................................................................. (10,000)

Trademark................................................................................ $30,000

Life of trademark..................................................................... 10 years

Annual amortization................................................................ $3,000

BOOK VALUE—DENTON—JANUARY 1, 2010

January 1, 2010 book value (given)....................................... $1,700,000

2010 Net income...................................................................... 240,000

2010 Dividends........................................................................ (90,000)

January 1, 2011 book value................................................ $1,850,000

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16. (continued)

SECOND PURCHASE—JANUARY 1, 2011

Purchase price of Denton stock........................................ $600,000

Book value of Denton stock (above) ($1,850,000 × 30%) (555,000)

Cost in excess of book value............................................. $45,000

Excess cost assigned to undervalued land

($120,000 × 30%).............................................................. (36,000)

Trademark............................................................................ $9,000

Life of trademark................................................................. 9 years

Annual amortization............................................................ $1,000

Entry One—To record second acquisition of Denton stock.

Investment in Denton................................................. 600,000

Cash....................................................................... 600,000

Entry Two—To restate reported figures for 2010 to the equity method for comparability. Reported income will be $24,000 (10% of Denton’s income) less $3,000 (amortization on first purchase) for a net figure of $21,000. Originally, $9,000 would have been reported by Walters (10% of the dividends). The adjustment increases the $9,000 to $21,000 for 2010.


Retained Earnings—Prior Period Adjustment—

2010 Equity Income.............................................. 12,000

Entry Three—To record income for the year: 40% of the $300,000 reported income.


Equity Income—Investment in Denton............... 120,000

Entry Four—To record collection of dividends from Denton (40%).

Cash............................................................................. 44,000

Investment in Denton........................................... 44,000

Entry Five—To record amortization for 2011: $3,000 from first purchase and $1,000 from second.

Equity Income—Investment in Denton.................... 4,000

Investment in Denton........................................... 4,000

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19. (20 minutes) (Conversion from fair-value method to equity method with a subsequent sale of a portion of the investment)

Equity method income accrual for 2011

30 percent of $500,000 for ½ year = ..................................... $ 75,000

28 percent of $500,000 for ½ year = ..................................... 70,000

Total income accrual (no amortization or unearned gains).. . . $145,000

Gain on sale of 2,000 shares of Brown:

Cost of initial acquisition—2009.................................................... $250,00010% income accrual (conversion made to equity method)...... 35,000

10% of dividends............................................................................. (10,000)

Cost of second acquisition—2010................................................. 590,000

30% income accrual (conversion made to equity method)....... 144,000

30% of dividends—2010.................................................................. (33,000)

30% income accrual for ½ year...................................................... 75,000

30% of dividends for ½ year........................................................... (18,000)

Book value on July 1, 2011 ....................................................... $1,033,000

Cash proceeds from the sale: 2,000 shares × $46....................... $ 92,000

Less: book value of shares sold: $1,033,000 × 2,000 ÷ 30,000... 68,867

Gain on sale................................................................................ $ 23,133

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24. (20 Minutes) (Equity method balances after conversion to equity method. Must determine investee’s book value)

Part a

1. Allocation and annual amortization—first purchase

Purchase price of 15 percent interest........................................ $62,000

Net book value ($280,000 × 15%)............................................... (42,000)

Franchise agreements................................................................. $20,000

Life of franchise agreements...................................................... ÷ 10 years

Annual amortization............................................................... $2,000

Allocation and annual amortization—second purchase

Purchase price of 10 percent interest........................................ $43,800

Net book value ($330,000 × 10%)............................................... (33,000)

Franchise agreements................................................................. $10,800

Life of franchise agreements...................................................... ÷ 9 years

Annual amortization............................................................... $1,200

Investment in Bellevue account

January 1, 2010 purchase........................................................... $62,000

2010 basic equity income accrual ($80,000 × 15%).................. 12,000

2010 amortization on first purchase (above)............................ (2,000)

2010 dividend payments ($30,000 × 15%)................................. (4,500)

January 1, 2011 purchase........................................................... 43,800

2011 basic equity income accrual ($100,000 × 25%)................ 25,000


2011 amortization on second purchase (above)...................... (1,200)

2011 dividend payments ($40,000 × 25%)................................. (10,000)

Investment in Bellevue—December 31, 2011...................... $123,100

2. Equity Income—2011

2011 basic equity income accrual ($100,000 × 25%)................ $25,000


2011 amortization on second purchase (above)...................... (1,200)

Equity income—2011............................................................. $21,800

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24. (continued)

3. The January 1, 2011 retrospective adjustments to convert the Investment in Bellevue to the equity method is as follows:

Unrealized holding gain—shareholders’ equity 3,700

Fair value adjustment (available-for-sale securities) 3,700

To eliminate AFS fair value adjustment account balances for the investment in Bellevue (15% × $438,000 = $65,700 less $62,000 = $3,700)

Investment in Bellevue 5,500

Retaining earnings (January 1, 2011) 5,500

Retrospective adjustment to retained earnings to record 2010 equity method income for 15% investment (15% × $80,000 less $2,000 excess amortization less $4,500 dividend income recognized in 2010)

Part b

1. Dividend income (25% × 40,000) $10,000

Increase in fair value (25% × $30,000) 7,500

Reported income from Investment in Bellevue $17,500

2. Investment in Bellevue (25% × 468,000) $117,000

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27. (25 Minutes) (Preparation of journal entries for two years, includes losses and intra-entity transfers of inventory)

Journal Entries for Hobson Co.

1/1/10 Investment in Stokes Co.............. 210,000

Cash.......................................... 210,000

(To record initial investment)

During Cash............................................... 4,000

2010 Investment in Stokes Co......... 4,000

(To record receipt of dividend)

12/31/10 Equity in Stokes Income—Loss. . 16,000

Extraordinary Loss of Stokes...... 8,000

Investment in Stokes Co......... 24,000

(To record accrual of income as earned by

equity investee, 40% of reported balances)

12/31/10 Equity in Stokes Income—Loss. . 3,300


(To record amortization relating to acquisition

of Stokes—see Schedule 1 below)

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27. (continued)

12/31/10 Equity in Stokes Income-Loss..... 2,000


(To defer unrealized gain on intra-entity

sale see Schedule 2 below)

During Cash............................................... 4,800

2011 Investment in Stokes Co......... 4,800

(To record receipt of dividend)


Equity in Stokes Income......... 16,000

(To record 40% accrual of income as earned by

equity investee)

12/31/11 Equity in Stokes Income.............. 3,300


(To record amortization relating to acquisition

of Stokes)


Equity in Stokes Income......... 2,000

(To recognize income deferred from 2010)

12/31/11 Equity in Stokes Income.............. 3,600


(To defer unrealized gain on intra-entity

sale—see Schedule 3 below)

Schedule 1—Allocation of Purchase Price and Related Amortization

Purchase price ........................................................ $210,000

Percentage of book value acquired

($400,000 × 40%)..................................................... (160,000)

Payment in excess of book value.............................. $50,000

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27. (continued)

Annual

Excess payment identified with specific Life Amortization

assets

Building ($40,000 × 40%) 16,000 10 yrs. $1,600

Royalty agreement ($85,000 × 40%) $34,000 20 yrs. 1,700

Total annual amortization $3,300

Schedule 2—Deferral of Unrealized Gain—2010

Inventory remaining at end of year................................................. $15,000

Gross profit percentage ($30,000 ÷ $90,000).................................. × 33⅓%

Gross profit remaining in inventory........................................... $5,000

Ownership percentage..................................................................... × 40%

Unrealized gain to be deferred until 2011.................................. $2,000

Schedule 3—Deferral of Unrealized Gain—2011

Inventory remaining at end of year (30%)....................................... $24,000

Gross profit percentage ($30,000 ÷ $80,000).................................. × 37½%

Gross profit remaining in inventory........................................... $9,000

Ownership percentage..................................................................... × 40%

Unrealized gain to be deferred until 2012.................................. $3,600

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29. (30 Minutes) (Compute equity balances for three years. Includes

intra-entity inventory transfer)

Part a.

Equity Income 2009

Basic equity accrual ($550,000 × ½ year × 35%)....................... $96,250

Amortization (½ year—see Schedule 1).................................... (26,500)

Equity income—2009............................................................. $69,750

Equity Income 2010

Basic equity accrual ($575,000 × 35%)..................................... $201,250

Amortization (see Schedule 1).................................................. (53,000)

Deferral of unrealized gain (see Schedule 2)........................... (9,800)

Equity Income—2010............................................................ $138,450

Equity Income 2011

Basic equity accrual ($620,000 × 35%)..................................... $217,000

Amortization (see Schedule 1).................................................. (53,000)

Recognition of deferred gain (see Schedule 2)....................... 9,800

Equity Income—2011............................................................ $173,800

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29. (continued)

Schedule 1—Acquisition Price Allocation and Amortization

Acquisition price (75,000 shares × $12) $900,000

Book value acquired ($1,600,000 × 35%) 560,000

Payment in excess of book value $340,000

Excess payment identified with specific Annual

assets Life Amortization

Equipment ($150,000 × 35%) $52,500 7 yrs. $7,500

Copyright 227,500 5 yrs. 45,500

Goodwill 60,000 indefinite -0-

Total annual amortization (full year) $53,000

Schedule 2—Deferral of Unrealized Intra-entity Gain

Inventory remaining at December 31, 2010.................................. $70,000

Gross profit percentage ($60,000 ÷ $150,000)............................. × 40%

Total profit on intra-entity sale still held by affiliate................... $28,000

Investor ownership percentage.................................................... × 35%

Unrealized intra-entity gain (profit deferred from

2010 until 2011)......................................................................... $9,800

Part b.

Investment in Miller—December 31, 2011 balance

Acquisition price............................................................................ $900,000

2009 Equity income (above).......................................................... 69,750

2009 Dividends received during half year (75,000 shares × $1.00) (75,000)


2010 Dividends received (75,000 shares × $1.00 × 2)................. (150,000)


2011 Dividends received (75,000 shares × $1.00 × 2)................. (150,000)

Investment in Miller—12/31/11............................................. $907,000

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30. (65 Minutes) (Journal entries for several years. Includes conversion to

equity method and a sale of a portion of the investment)

1/1/09 Investment in Sumter...................... 192,000

Cash............................................ 192,000

(To record cost of 16,000 shares of Sumter

Company.)

9/15/09 Cash.................................................. 8,000

Dividend Income........................ 8,000

(Annual dividends received from Sumter

Company.)

9/15/10 Cash.................................................. 8,000

Dividend Income........................ 8,000

(Annual dividends received from Sumter

Company.)


Cash............................................ 965,750

(To record cost of 64,000 additional shares of

Sumter Company.)


Retained Earnings—Prior Period

Adjustment—Equity in Investee Income 36,800

(Retroactive adjustment necessitated by change

to equity method. Change in figures previously

reported for 2009 and 2010 are calculated as

follows.)

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30. (continued)

2009 as reported

Income (dividends).........$8,000

Change in investment

Balance...................................-0-

2009—equity method (as restated)

Income (8% of $300,000

reported income)..............................$24,000

Change in investment balance (equity income less dividends)....................$16,000

2010 as reported

Income (dividends).........$8,000

Change in investment

Balance...................................-0-

2010—equity method (as restated)

Income (8% of $360,000

reported income)..............................$28,800

Change in investment balance (equity income less dividends)....................$20,800

2009 increase in reported income ($24,000 – $8,000)................. $16,000

2010 increase in reported income ($28,800 – $8,000)................. 20,800

Retroactive adjustment—income (above).................................... $36,800

2009 increase in investment in Sumter balance—equity method $16,000

2010 increase in investment in Sumter balance—equity method 20,800

Retroactive adjustment—Investment in Sumter (above)...... $36,800

9/15/11 Cash............................................................. 40,000

Investment in Sumter........................... 40,000

(Annual dividend received from Sumter

[40% × $100,000])

12/31/11 Investment in Sumter................................. 160,000

Equity in Investee Income.................... 160,000

(To accrue 2011 income based on 40%

ownership of Sumter)

12/31/11 Equity in Investee Income......................... 3,370


(Amortization of $50,550 patent

[indicated in problem] over 15 years)

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30. (continued)

7/1/12 Investment in Sumter................................. 76,000

Equity in Investee Income.................... 76,000

(To accrue ½ year income of 40% owner-

ship—$380,000 × ½ × 40%)

7/1/12 Equity in Investee Income......................... 1,685


(To record ½ year amortization of patent

to establish correct book value for invest-

ment as of 7/1/12)

7/1/12 Cash ............................................................ 425,000

Investment in Sumter (rounded)......... 346,374

Gain on Sale of Investment.................. 78,626

(20,000 shares of Sumter Company sold;

write-off of investment computed below.)

Investment in Sumter and cost of shares sold

1/1/09 Acquisition ..................................................................... $192,000

1/1/11 Acquisition...................................................................... 965,750

1/1/11 Retrospective adjustment............................................. 36,800

9/15/11 Dividends...................................................................... (40,000)

12/31/11 Basic equity accrual.................................................. 160,000

12/31/11 Amortization............................................................... (3,370)

7/1/12 Basic equity accrual...................................................... 76,000

7/1/12 Amortization................................................................... (1,685)

Investment in Sumter—7/1/12 balance.............................. $1,385,495

Percentage of shares sold (20,000 ÷ 80,000)..................... × 25%

Cost of shares sold (rounded)........................................... $346,374

9/15/12 Cash........................................................... 30,000

Investment in Sumter.......................... 30,000

(To record annual dividend received)

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30. (continued)

12/31/12 Equity in Sumter......................................... 57,000

Equity in Investee income.................... 57,000

(To record ½year income based on

remaining 30% ownership – $380,000 ×

6/12 × 30%)

12/31/12 Equity in Investee Income......................... 1,264 (rounded)


(To record ½ year of patent amortiza-

tion—computation presented below)

Annual patent amortization—original computation.................... $3,370

Percentage of shares retained (60,000 ÷ 80,000)......................... × 75%

Annual patent amortization—current .......................................... $2,527.50

Patent amortization for half year................................................... $1,263.75

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ACC 642 - CH 01 Solutions

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