Chapter 01 - The Equity Method of Accounting for Investments

CHAPTER 01
THE 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........................................................
Income accruals: 2010$170,000 20%.................
2011$210,000 20%.................
Amortization (see below): 2010................................
Amortization: 2011....................................................
Dividends: 2010$70,000 20%..............................
2011$70,000 20%..............................
Investment in Bremm, December 31, 2011..............

$700,000
34,000
42,000
(10,000)
(10,000)
(14,000)
(14,000)
$728,000

Acquisition price........................................................
Bremms net assets acquired ($3,000,000 20%)...
Excess cost to patent................................................
Annual amortization (10 year life) ...........................

$700,000
(600,000)
$100,000
$10,000

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Chapter 01 - The Equity Method of Accounting for Investments

8. B Purchase price of Baskett stock....................

Book value of Baskett ($900,000 40%).......
Cost in excess of book value....................
Payment identified with undervalued............
Building ($140,000 40%).........................
Trademark ($210,000 40%).....................
Total ................................................................

$500,000
(360,000)
$140,000 Life

Annual
Amortization
56,000 7 yrs.
$8,000
84,000 10 yrs.
8,400
$
-0$16,400

Cost of investment..........................................................
Basic income accrual ($90,000 40%).....................
Amortization (above).................................................
Dividend collected ($30,000 40%).........................
Investment in Baskett.....................................................

$500,000
36,000
(16,400)
(12,000)
$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.................................................................
2010 Income accrued ($140,000 x 40%)........................................
2010 Dividend collected ($50,000 40%)......................................
2011 Income accrued ($140,000 40%)........................................
2011 Dividend collected ($50,000 40%)......................................
2012 Income accrued ($140,000 40%)........................................
2012 Dividend collected ($50,000 40%)......................................
Investment in Goldman, 12/31/12.............................................

1-2

$600,000
56,000
(20,000)
56,000
(20,000)
56,000
(20,000)
$708,000

Chapter 01 - The Equity Method of Accounting for Investments

10. D
11. A Gross profit rate (GPR): $36,000 $90,000 = 40%
Inventory remaining at year-end....................................................
GPR..................................................................................................
Unrealized gain..........................................................................
Ownership.......................................................................................
Intra-entity unrealized gaindeferred.....................................
12. B Purchase price of Steinbart shares...............................................
Book value of Steinbart shares ($1,200,000 40%).....................
Trade name......................................................................................
Life of trade name...........................................................................
Annual amortization.......................................................................
2010 Gross profit rate = $30,000 $100,000 = 30%
2011 Gross profit rate = $54,000 $150,000 = 36%
2011Equity income in Steinbart:
Income accrual ($110,000 40%)..................................................
Amortization (above)......................................................................
Recognition of 2010 unrealized gain
($25,000 30% GPR 40% ownership)...................................
Deferral of 2011 unrealized gain
($45,000 36% GPR 40% ownership.....................................
Equity income in Steinbart2011............................................

1-3

$20,000
40%
$8,000
30%
$2,400
$530,000
(480,000)
$50,000
20 years
$2,500

$44,000
(2,500)
3,000
(6,480)
$38,020

Chapter 01 - The Equity Method of Accounting for Investments

16. (20 Minutes) (Equity entries for one year, includes conversion to equity
method)
The 2010 purchase must be restated to the equity method.
FIRST PURCHASEJANUARY 1, 2010
Purchase price of Denton stock............................................
Book value of Denton stock ($1,700,000 10%)..................
Cost in excess of book value................................................
Excess cost assigned to undervalued land
($100,000 10%).................................................................
Trademark...............................................................................
Life of trademark....................................................................
Annual amortization...............................................................

$210,000
(170,000)
$40,000
(10,000)
$30,000
10 years
$3,000

BOOK VALUEDENTONJANUARY 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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Chapter 01 - The Equity Method of Accounting for Investments

16. (continued)
SECOND PURCHASEJANUARY 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 OneTo record second acquisition of Denton stock.
Investment in Denton................................................
600,000
Cash......................................................................

600,000

Entry TwoTo restate reported figures for 2010 to the equity method for
comparability. Reported income will be $24,000 (10% of Dentons 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.
Investment in Denton................................................
Retained EarningsPrior Period Adjustment
2010 Equity Income..............................................

12,000
12,000

Entry ThreeTo record income for the year: 40% of the $300,000 reported
income.
Investment in Denton................................................
120,000
Equity IncomeInvestment in Denton...............
120,000
Entry FourTo record collection of dividends from Denton (40%).
Cash............................................................................
44,000
Investment in Denton...........................................

44,000

Entry FiveTo record amortization for 2011: $3,000 from first purchase and
$1,000 from second.
Equity IncomeInvestment in Denton....................
Investment in Denton...........................................

1-5

4,000
4,000

Chapter 01 - The Equity Method of Accounting for Investments

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 year = ....................................
28 percent of $500,000 for year = ....................................
Total income accrual (no amortization or unearned gains).....

$ 75,000
70,000
$145,000

Gain on sale of 2,000 shares of Brown:

Cost of initial acquisition2009.................................................... $250,000
10% income accrual (conversion made to equity method).......
35,000
10% of dividends.............................................................................
(10,000)
Cost of second acquisition2010.................................................
590,000
30% income accrual (conversion made to equity method)........
144,000
30% of dividends2010.................................................................
(33,000)
30% income accrual for year......................................................
75,000
30% of dividends for year...........................................................
(18,000)
Book value on July 1, 2011 ...................................................... $1,033,000
Cash proceeds from the sale: 2,000 shares $46.......................
Less: book value of shares sold: $1,033,000 2,000 30,000.. .
Gain on sale...............................................................................

1-6

$ 92,000
68,867
$ 23,133

Chapter 01 - The Equity Method of Accounting for Investments

24. (20 Minutes) (Equity method balances after conversion to equity method. Must
determine investees book value)
Part a
1. Allocation and annual amortizationfirst 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 amortizationsecond 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..........................................................
2010 basic equity income accrual ($80,000 15%)..................
2010 amortization on first purchase (above)............................
2010 dividend payments ($30,000 15%).................................
January 1, 2011 purchase..........................................................
2011 basic equity income accrual ($100,000 25%)................
2011 amortization on first purchase (above)............................
2011 amortization on second purchase (above)......................
2011 dividend payments ($40,000 25%).................................
Investment in BellevueDecember 31, 2011......................

$62,000
12,000
(2,000)
(4,500)
43,800
25,000
(2,000)
(1,200)
(10,000)
$123,100

2. Equity Income2011
2011 basic equity income accrual ($100,000 25%)................
2011 amortization on first purchase (above)............................
2011 amortization on second purchase (above)......................
Equity income2011............................................................

$25,000
(2,000)
(1,200)
$21,800

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Chapter 01 - The Equity Method of Accounting for Investments

24. (continued)
3. The January 1, 2011 retrospective adjustments to convert the Investment in
Bellevue to the equity method is as follows:
Unrealized holding gainshareholders equity
Fair value adjustment (available-for-sale securities)

3,700
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
Retaining earnings (January 1, 2011)

5,500
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)

Increase in fair value (25% $30,000)
Reported income from Investment in Bellevue

2.

Investment in Bellevue (25% 468,000)

1-8

$10,000
7,500
$17,500
$117,000

Chapter 01 - The Equity Method of Accounting for Investments

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

During
2010

12/31/10

12/31/10

Investment in Stokes Co..............

Cash.........................................
(To record initial investment)
Cash...............................................
Investment in Stokes Co.........
(To record receipt of dividend)

210,000
210,000
4,000

Equity in Stokes IncomeLoss...

16,000
Extraordinary Loss of Stokes......
8,000
Investment in Stokes Co.........
(To record accrual of income as earned by
equity investee, 40% of reported balances)
Equity in Stokes IncomeLoss...
3,300
Investment in Stokes Co.........
(To record amortization relating to acquisition
of Stokessee Schedule 1 below)

1-9

4,000

24,000

3,300

Chapter 01 - The Equity Method of Accounting for Investments

27. (continued)
12/31/10

During
2011

12/31/11

12/31/11

12/31/11

12/31/11

Equity in Stokes Income-Loss.....

Investment in Stokes Co.........
(To defer unrealized gain on intra-entity
sale see Schedule 2 below)

2,000

Cash...............................................
Investment in Stokes Co.........
(To record receipt of dividend)

4,800

2,000

4,800

Investment in Stokes Co..............

16,000
Equity in Stokes Income.........
(To record 40% accrual of income as earned by
equity investee)
Equity in Stokes Income..............
3,300
Investment in Stokes Co.........
(To record amortization relating to acquisition
of Stokes)
Investment in Stokes Co..............
2,000
Equity in Stokes Income.........
(To recognize income deferred from 2010)
Equity in Stokes Income..............
Investment in Stokes Co.........
(To defer unrealized gain on intra-entity
salesee Schedule 3 below)

3,300

2,000

3,600

Schedule 1Allocation 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

1-10

16,000

3,600

Chapter 01 - The Equity Method of Accounting for Investments

27. (continued)
Excess payment identified with specific
assets
Building ($40,000 40%)
Royalty agreement ($85,000 40%)
Total annual amortization

Life

Annual
Amortization

16,000

10 yrs.

$1,600

$34,000

20 yrs.

1,700
$3,300

Schedule 2Deferral of Unrealized Gain2010

Inventory remaining at end of year.................................................
Gross profit percentage ($30,000 $90,000)..................................
Gross profit remaining in inventory..........................................
Ownership percentage.....................................................................
Unrealized gain to be deferred until 2011.................................

$15,000
33%
$5,000
40%
$2,000

Schedule 3Deferral of Unrealized Gain2011

Inventory remaining at end of year (30%)......................................
Gross profit percentage ($30,000 $80,000)..................................
Gross profit remaining in inventory..........................................
Ownership percentage.....................................................................
Unrealized gain to be deferred until 2012.................................

1-11

$24,000
37%
$9,000
40%
$3,600

Chapter 01 - The Equity Method of Accounting for Investments

29. (30 Minutes) (Compute equity balances for three years. Includes
intra-entity inventory transfer)
Part a.
Equity Income 2009
Basic equity accrual ($550,000 year 35%).......................
Amortization ( yearsee Schedule 1)....................................
Equity income2009............................................................

$96,250
(26,500)
$69,750

Equity Income 2010

Basic equity accrual ($575,000 35%).....................................
Amortization (see Schedule 1).................................................
Deferral of unrealized gain (see Schedule 2)...........................
Equity Income2010...........................................................

$201,250
(53,000)
(9,800)
$138,450

Equity Income 2011

Basic equity accrual ($620,000 35%).....................................
Amortization (see Schedule 1).................................................
Recognition of deferred gain (see Schedule 2).......................
Equity Income2011...........................................................

$217,000
(53,000)
9,800
$173,800

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Chapter 01 - The Equity Method of Accounting for Investments

29. (continued)
Schedule 1Acquisition Price Allocation and Amortization
Acquisition price (75,000 shares $12)
Book value acquired ($1,600,000 35%)
Payment in excess of book value
Excess payment identified with specific
assets
Equipment ($150,000 35%)
Copyright
Goodwill
Total annual amortization (full year)

$900,000
560,000
$340,000
Annual
Life Amortization
$52,500
7 yrs.
$7,500
227,500
5 yrs.
45,500
60,000 indefinite
-0$53,000

Schedule 2Deferral of Unrealized Intra-entity Gain

Inventory remaining at December 31, 2010.................................
Gross profit percentage ($60,000 $150,000).............................
Total profit on intra-entity sale still held by affiliate...................
Investor ownership percentage....................................................
Unrealized intra-entity gain (profit deferred from
2010 until 2011)........................................................................

$70,000
40%
$28,000
35%
$9,800

Part b.
Investment in MillerDecember 31, 2011 balance
Acquisition price...........................................................................
2009 Equity income (above).........................................................
2009 Dividends received during half year (75,000 shares $1.00)
2010 Equity income (above).........................................................
2010 Dividends received (75,000 shares $1.00 2)..................
2011 Equity income (above).........................................................
2011 Dividends received (75,000 shares $1.00 2)..................
Investment in Miller12/31/11............................................

1-13

$900,000
69,750
(75,000)
138,450
(150,000)
173,800
(150,000)
$907,000

Chapter 01 - The Equity Method of Accounting for Investments

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

9/15/09

9/15/10

1/1/11

1/1/11

Investment in Sumter......................
192,000
Cash............................................
(To record cost of 16,000 shares of Sumter
Company.)
Cash.................................................
8,000
Dividend Income........................
(Annual dividends received from Sumter
Company.)
Cash.................................................
8,000
Dividend Income........................
(Annual dividends received from Sumter
Company.)
Investment in Sumter......................
965,750
Cash............................................
(To record cost of 64,000 additional shares of
Sumter Company.)
Investment in Sumter......................
36,800
Retained EarningsPrior Period
AdjustmentEquity in Investee Income
(Retroactive adjustment necessitated by change
to equity method. Change in figures previously
reported for 2009 and 2010 are calculated as
follows.)

1-14

192,000

8,000

8,000

965,750

36,800

Chapter 01 - The Equity Method of Accounting for Investments

30. (continued)
2009 as reported

2009equity method (as restated)

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

Income (8% of $300,000

reported income)..............................$24,000
Change in investment balance (equity
income less dividends)....................$16,000

Change in investment
Balance...................................-02010 as reported
Income (dividends).........$8,000
Change in investment
Balance...................................-0-

2010equity 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).................

2010 increase in reported income ($28,800 $8,000).................
Retroactive adjustmentincome (above)...................................

$16,000
20,800
$36,800

2009 increase in investment in Sumter balanceequity method

2010 increase in investment in Sumter balanceequity method
Retroactive adjustmentInvestment in Sumter (above).......

$16,000
20,800
$36,800

9/15/11

12/31/11

12/31/11

Cash............................................................
Investment in Sumter...........................
(Annual dividend received from Sumter
[40% $100,000])

40,000

Investment in Sumter................................
Equity in Investee Income....................
(To accrue 2011 income based on 40%
ownership of Sumter)

160,000

Equity in Investee Income.........................

Investment in Sumter...........................
(Amortization of $50,550 patent
[indicated in problem] over 15 years)

3,370

1-15

40,000

160,000

3,370

Chapter 01 - The Equity Method of Accounting for Investments

30. (continued)
7/1/12

7/1/12

7/1/12

Investment in Sumter................................
Equity in Investee Income....................
(To accrue year income of 40% ownership$380,000 40%)

76,000

Equity in Investee Income.........................

Investment in Sumter...........................
(To record year amortization of patent
to establish correct book value for investment as of 7/1/12)

1,685

Cash ...........................................................
Investment in Sumter (rounded)..........
Gain on Sale of Investment..................
(20,000 shares of Sumter Company sold;
write-off of investment computed below.)

76,000

1,685

425,000
346,374
78,626

Investment in Sumter and cost of shares sold

1/1/09 Acquisition ....................................................................
1/1/11 Acquisition.....................................................................
1/1/11 Retrospective adjustment.............................................
9/15/11 Dividends.....................................................................
12/31/11 Basic equity accrual..................................................
12/31/11 Amortization..............................................................
7/1/12 Basic equity accrual......................................................
7/1/12 Amortization..................................................................
Investment in Sumter7/1/12 balance..............................
Percentage of shares sold (20,000 80,000)....................
Cost of shares sold (rounded)...........................................
9/15/12

Cash..........................................................
Investment in Sumter..........................
(To record annual dividend received)

1-16

$192,000
965,750
36,800
(40,000)
160,000
(3,370)
76,000
(1,685)
$1,385,495
25%
$346,374

30,000
30,000

Chapter 01 - The Equity Method of Accounting for Investments

30. (continued)
12/31/12

12/31/12

Equity in Sumter........................................
Equity in Investee income....................
(To record year income based on
remaining 30% ownership $380,000
6/12 30%)

57,000
57,000

Equity in Investee Income......................... 1,264 (rounded)

Investment in Sumter...........................
1,264
(To record year of patent amortizationcomputation presented below)

Annual patent amortizationoriginal computation....................

Percentage of shares retained (60,000 80,000)........................
Annual patent amortizationcurrent ..........................................
Patent amortization for half year..................................................

1-17

$3,370
75%
$2,527.50
$1,263.75