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: 2014$170,000 20%.......................................
2015$210,000 20% ......................................
Amortization (see below): 2014 ......................................................
Amortization: 2015 ..........................................................................
Dividends: 2014$70,000 20% ...................................................
2015$70,000 20% ....................................................
Investment in Martes, December 31, 2015 .....................................

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

Acquisition price of Martes.............................................................

Acquired net assets (book value) ($3,000,000 20%) .................
Excess cost over book value to patent .........................................
Annual amortization (10 year remaining life) ...............................

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

8. B Purchase price of Johnson stock ..................

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

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$500,000
(360,000)
$140,000
Remaining Annual
life
amortization

56,000 7 yrs.
84,000 10 yrs.
$
-0-

$8,000
8,400
$16,400

Chapter 01 - The Equity Method of Accounting for Investments

Investment purchase price ............................................

Basic income accrual ($90,000 40%) ....................
Amortization (above) .................................................
Dividends declared ($30,000 40%) .......................
Investment in Johnson ...................................................

$500,000
36,000
(16,400)
(12,000)
$507,600

9. D The 2014 purchase is reported using the equity method.

Purchase price of Evan stock......................................................... $600,000
Book value of Evan stock ($1,200,000 40%) ............................... (480,000)
Goodwill ........................................................................................... $120,000
Life of goodwill ................................................................................ indefinite
Annual amortization ........................................................................
(-0-)
Cost on January 1, 2014 .................................................................
2014 Income accrued ($140,000 x 40%) .........................................
2014 Dividend ($50,000 40%) .......................................................
2015 Income accrued ($140,000 40%) .........................................
2015 Dividend ($50,000 40%) .......................................................
2016 Income accrued ($140,000 40%) .........................................
2016 Dividend ($50,000 40%) .......................................................
Investment in Evan, 12/31/16.....................................................

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

10. D
11. A Gross profit rate (GPR): $36,000 $90,000 = 40%
Inventory remaining at year-end ....................................................
GPR...................................................................................................
Unrealized gross profit ..............................................................
Ownership ........................................................................................
Intra-entity gross profitdeferred ............................................

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$20,000
40%
$8,000
30%
$ 2,400

Chapter 01 - The Equity Method of Accounting for Investments

12. B Purchase price of Steinbart shares ...............................................

Book value of Steinbart shares ($1,200,000 40%)......................
Trade name ......................................................................................
Remaining life of trade name..........................................................
Annual amortization ........................................................................
2014 Gross profit rate = $30,000 $100,000 = 30%
2015 Gross profit rate = $54,000 $150,000 = 36%
2015Equity income in Steinbart:
Income accrual ($110,000 40%) ...................................................
Amortization (above) .......................................................................
Recognition of 2014 unrealized gross profit
($25,000 30% GPR 40% ownership) ....................................
Deferral of 2015 unrealized gross profit
($45,000 36% GPR 40% ownership .....................................
Equity income in Steinbart2015 ............................................

$530,000
(480,000)
$ 50,000
20 years
$ 2,500

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

13. (6 minutes) (Investment account after one year)

Purchase price ..................................................................................... $1,160,000
Basic 2015 equity accrual ($260,000 40%) .....................................
104,000
Amortization of copyright:
Excess payment ($1,160,000 $820,000 = $340,000)
to copyright allocated over 10 year remaining life ..................
(34,000)
Dividends (50,000 40%) ....................................................................
(20,000)
Investment account balance at year end ........................................... $1,210,000
14. (7 minutes)
a. Purchase price ................................................................................. $ 2,290,000
Equity income accrual ($720,000 35%) .......................................
252,000
Other comprehensive loss accrual ($100,000 35%)...................
(35,000)
Dividends (20,000 35%) ................................................................
(7,000)
Investment in Steel at December 31, 2015 .................................... $2,500,000
b. Equity income of Steel = $252,000 (does not include OCI share which is
reported separately).

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Chapter 01 - The Equity Method of Accounting for Investments

15. (15 minutes) (Investment account after 2 years)

a. Acquisition price .................................................................................
Book value acquired ($5,175,000 20%) ...........................................
Excess payment ..................................................................................
Excess fair value: Computing equipment ($700,000 20%) ........
Excess fair value: Patented technology ($3,900,000 20%)........
Excess fair value: Trademark ($1,850,000 20%) ........................
Goodwill ...............................................................................................

$2,700,000
1,035,000
$1,665,000
140,000
780,000
370,000
$ 375,000

Amortization:
Computing equipment ($140,000 7) ....................................... $ 20,000
Patented technology ($780,000 3) ..........................................
260,000
Trademark (indefinite)................................................................
-0Goodwill (indefinite) ...................................................................
-0Annual amortization ........................................................................ $280,000
b. Basic equity accrual 2014 ($1,800,000 20%) ..................................
Amortization2014 (above) ...............................................................
Equity in 2014 earnings of Sauk Trail ................................................

$360,000
(280,000)
$ 80,000

Basic equity accrual 2015 ($1,985,000 20%) ..................................

Amortization2015 (above) ...............................................................
Equity in 2015 earnings of Sauk Trail ................................................

$397,000
(280,000)
$117,000

c.

Acquisition price ................................................................................. $2,700,000

Equity in 2014 earnings of Sauk Trail (above) ..................................
80,000
Dividends2014 ($150,000 20%) ....................................................
(30,000)
Investment in Sauk Trail, 12/31/14 ..................................................... $2,750,000
Investment in Sauk Trail, 12/31/14 ..................................................... $2,750,000
Equity in 2015 earnings of Sauk Trail (above) .................................. $117,000
Dividends2015 ($160,000 20%) ....................................................
(32,000)
Investment in Sauk Trail, 12/31/15 ..................................................... $2,835,000

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Chapter 01 - The Equity Method of Accounting for Investments

16. (10 minutes) (Investment account after 2 years with fair value accounting
included)
a. Acquisition price .................................................................................
$60,000
Book valueassets minus liabilities ($125,000 40%) ...............
50,000
Excess payment .........................................................................
$10,000
Value of patent in excess of book value ($15,000 40%) ............
6,000
Goodwill ...........................................................................................
$ 4,000

b.

Amortization:
Patent ($6,000 6) ......................................................................
Goodwill ......................................................................................
Annual amortization .............................................................

$1,000
-0$1,000

Acquisition price .............................................................................

Basic equity accrual 2014 ($30,000 40%) ...................................
Dividends2014 ($10,000 40%) ..................................................
Amortization2014 (above) ...........................................................
Investment in Holister, 12/31/14 .....................................................
Basic equity accrual 2015 ($50,000 40%) ................................
Dividends2015 ..............................................................................
Amortization2015 (above) ...........................................................
Investment in Holister, 12/31/15 .....................................................

$60,000
12,000
(4,000)
(1,000)
$67,000
20,000
(6,000)
(1,000)
$80,000

Dividend income ($15,000 40%) ..................................................

Increase in fair value ($75,000 $68,000) ......................................
Investment income under fair value accounting2015 ...............

$6,000
7,000
$13,000

17. (10 minutes) (Equity entries for one year, includes intra-entity transfers but no
unearned gross profit)
Purchase price of Burks stock ....................................................... $210,000
Book value of Burks stock ($360,000 40%) ................................ (144,000)
Unidentified asset (goodwill) .......................................................... $ 66,000
Life .................................................................................................... indefinite
Annual amortization ........................................................................ $
-0No unearned intra-entity profit exists at years end because all of the transferred
merchandise was used during the period.

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Chapter 01 - The Equity Method of Accounting for Investments

17. (continued)
Investment in Burks, Inc. ..........................................
210,000
Cash (or a Liability) ..............................................
To record acquisition of a 40 percent interest in Burks.

210,000

Investment in Burks, Inc. ..........................................

32,000
Equity in Investee Income ...................................
32,000
To recognize 40 percent income earned during period by Burks, an equity
method investment.
Dividend Receivable ..................................................
Investment in Burks, Inc. .....................................
To record investee dividend declaration.

10,000

Cash ............................................................................
Dividend Receivable. ...........................................
To record collection of dividend from investee.

10,000

10,000

10,000

18. (20 Minutes) (Equity entries for one year, includes conversion to equity
method)
The 2014 purchase must be restated to the equity method.
FIRST PURCHASEJANUARY 1, 2014
Purchase price of McKenzie stock..................................................
Book value of McKenzie stock ($1,700,000 10%) ........................
Cost in excess of book value ..........................................................
Excess cost assigned to undervalued land ($100,000 10%) ......
Trademark .........................................................................................
Remaining life of trademark ...........................................................
Annual amortization .........................................................................

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

BOOK VALUEMCKENZIEJANUARY 1, 2015 (before second purchase)

January 1, 2014 book value (given) ................................................ $1,700,000
2014 Net income ...............................................................................
240,000
2014 Dividends .................................................................................
(90,000)
January 1, 2015 book value ............................................................. $1,850,000

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Chapter 01 - The Equity Method of Accounting for Investments

18.

(continued)
SECOND PURCHASEJANUARY 1, 2015
Purchase price of McKenzie stock...............................................
Book value of McKenzie stock (above) ($1,850,000 30%) .......
Cost in excess of book value .......................................................
Excess cost assigned to undervalued land
($120,000 30%).......................................................................
Trademark ......................................................................................
Remaining life of Trademark ........................................................
Annual Amortization .....................................................................
Journal Entries:
To record second acquisition of McKenzie stock.
Investment in McKenzie ............................................
Cash ......................................................................
Investment in McKenzie ............................................
Retained EarningsPrior Period Adjustment
2014 Equity Income .......................................

$600,000
(555,000)
$45,000
(36,000)
$ 9,000
9 years
$ 1,000

600,000
600,000
12,000
12,000

To restate reported figures for 2014 to the equity method. Reported income
is $24,000 (10% of McKenzies income) less $3,000 (amortization on first
purchase) = $21,000. Originally, Austin reported $9,000 (10% of the
dividends). The adjustment increases the $9,000 to $21,000 for 2014.
Investment in McKenzie ............................................
120,000
Equity IncomeInvestment in McKenzie...........
120,000
To record income for the year: 40% of the $300,000 reported income.
Dividend Receivable ..................................................
44,000
Investment in McKenzie.......................................
To record dividend declaration from McKenzie (40% of $110,000).

44,000

Cash ............................................................................
Dividend Receivable. ...........................................
To record collection of dividend from investee.

44,000

44,000

Equity IncomeInvestment in McKenzie ................

4,000
Investment in McKenzie.......................................
4,000
To record 2015 amortization: $3,000 for first purchase, $1,000 for second.

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Chapter 01 - The Equity Method of Accounting for Investments

19. (7 minutes) (Deferral of unrealized gross profit)

Ending inventory ($225,000 $105,000) .............................................
Gross profit percentage (GP $75,000 Sales $225,000)...................
Unrealized gross profit .........................................................................
Ownership .............................................................................................
Intra-entity unrealized gross profitdeferred ....................................

$120,000
33%
$40,000
25%
$10,000

Entry to Defer Unrealized Gross Profit:

Equity Income from Schilling .......................................
Investment in Schilling ............................................

10,000
10,000

20. (10 minutes) (Reporting of equity income and transfers)

a. Equity in investee income:
Equity income accrual ($100,000 25%)..................................
Less: deferral of intra-entity unrealized gross profit (below)
Less: patent amortization (given) ............................................
Equity in investee income ....................................................

$25,000
(3,000)
(10,000)
$12,000

Deferral of intra-entity unrealized gross profit:

Remaining inventoryend of year ......................................
Gross profit percentage (GP $30,000 Sales $80,000)......
Profit within remaining inventory ........................................
Ownership percentage .........................................................
Intra-entity unrealized gross profit ...............................................

$32,000
37%
$12,000
25%
$ 3,000

b. In 2015, the deferral of $3,000 will likely become realized by BuyCos

use or sale of this inventory. Thus, the equity accrual for 2015 will be
increased by $3,000 in that year. Recognition of this amount is simply being
delayed from 2014 until 2015, the year actually earned.
c. The direction (upstream versus downstream) of the intra-entity transfer
does not affect the above answers. However as discussed in Chapter Five,
a controlling interest calls for a 100% gross profit deferral for downstream
intra-entity transfers. In the presence of only signification influence,
however, equity method accounting is identical regardless of whether an
intra-entity transfer is upstream or downstream.

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Chapter 01 - The Equity Method of Accounting for Investments

21. (25 minutes) (Conversion from fair-value method to equity method with a
subsequent sale of a portion of the investment)
Equity method income accrual for 2015
30 percent of $644,000 for year = .....................................
24 percent of $644,000 for year = .....................................
Total income accrual (no amort. or unearned gross profit) ..........
Gain on sale (below) .......................................................................
Total income statement effect 2015

$ 96,600
77,280
$173,880
31,000
$204,880

Gain on sale of 9,000 shares of Marion:

Cost of initial acquisition2013 ....................................................
$435,000
10% income accrual (conversion made to equity method) ..........
35,900
10% of dividends .............................................................................
(10,700)
Cost of second acquisition2014 ................................................. 1,000,000
30% income accrual2014 .............................................................
150,300
30% of dividends2014 ..................................................................
(39,750)
30% income accrual for year2015 ...........................................
96,600
30% of dividends for year2015................................................
(22,350)
Book value of 45,000 shares on July 1, 2015 .......................... $1,645,000
Cash proceeds from the sale: 9,000 shares $40 .......................
Less: book value of shares sold: $1,645,000 (9,000 45,000) ..
Gain on sale ................................................................................

$360,000
329,000
$ 31,000

22. (25 minutes) (Verbal overview of equity method, includes conversion to equity
method)
a. In 2014, the fair-value method (available-for-sale security) was appropriate.
Thus, the only income recognized was the dividends declared. Collins
should originally have reported dividend income equal to 10 percent of
Mertons dividends.
b. The assumption is that Collins level of ownership now provides the
company with the ability to exercise significant influence over the operating
and financial policies of Merton. Factors that indicate such a level of
influence are described in the textbook and include representation on the
investees board of directors, material intra-entity transactions, and
interchange of managerial personnel.

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Chapter 01 - The Equity Method of Accounting for Investments

22.

(continued)
c. Despite holding 25 percent of Mertons outstanding stock, application of the
equity method is inappropriate absent the ability to apply significant
influence. Factors that indicate a lack of such influence include: an
agreement whereby the owner surrenders significant rights, a concentration
of the remaining ownership, and failure to gain representation on the board
of directors.
d. The equity method attempts to reflect the relationship between the investor
and the investee in two ways. First, the investor recognizes investment
income as soon as it is earned by the investee. Second, the Investment
account reported by the investor is increased and decreased to indicate
changes in the underlying book value of the investee.
e. Criticisms of the equity method include
its emphasis on the 20-50% of voting stock in determining significant
influence vs. control
allowing off-balance sheet financing
potential biasing of performance ratios
Relative to consolidation, the equity method will report smaller amounts for
assets, liabilities, revenues and expenses. However, income is typically the
same as reported under consolidation. Therefore, companies that use the
equity method, and avoid consolidation, often show enhanced debt-to
equity ratios, as well as ratios for returns on assets and sales.
f. When an investor buys enough additional shares to gain the ability to exert
significant influence, accounting for any shares previously owned must be
adjusted to the equity method on a retrospective basis. Thus, in this case,
the 10 percent interest held by Collins in 2014 must now be reported using
the equity method. In this manner, the 2014 statements will be more
comparable with those of 2015 and future years.
g. The price paid for each purchase is first compared to the equivalent book
value on the date of acquisition. Any excess payment is then assigned to
specific assets and liabilities based on differences between book value and
fair value. If any residual amount of the purchase price remains
unexplained, it is assigned to goodwill.

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Chapter 01 - The Equity Method of Accounting for Investments

22.

(continued)
h. Investee dividends reduce its book value. Because the investors
Investment account tracks the investees book value, Collins records the
dividend as a reduction in its Investment account. This method of recording
also avoids double-counting of the revenue since the investor has already
recorded the amount when earned by the investee. Under the equity
method, revenues are recognized when earned by the investee but not
through dividends as a distribution of the same earnings.
i. The Investment account will show the costs to obtain ownership of Merton.
In addition, an equity accrual equal to 10 percent of the investees income
for 2014 and 25 percent for 2015 is included. The investment balance will be
reduced by 10 percent of any of Mertons dividends during 2014 and 25
percent for 2015 dividends. Finally, the Investment account will be
decreased by any amortization expense for both 2014 and 2015.

23. (20 minutes) (Verbal overview of intra-entity transfers and their impact on
application of the equity method)
a. An upstream transfer goes from investee to investor whereas a
downstream transfer is made by the investor to the investee.
b. The direction of an intra-entity transfer has no impact on reporting when
the equity method is applied. The direction of the transfers was introduced
in Chapter One because it does have an important impact on consolidation
accounting as explained in Chapter Five.
c. To determine the intra-entity unrealized gross profit when applying the
equity method, the transferred inventory that remains at years end is
multiplied by the gross profit percentage. This computation derives the
unrealized gross profit. The intra-entity portion of this gross profit is found
by multiplying it by the percentage of the investee that is owned by the
investor.
d. Parrot, as the investor, will accrue 42 percent of the income reported by
Sunrise. However, this equity income will then be reduced by the amount of
the unrealized intra-entity gross profit. These amounts can be combined
and recorded as a single entry, increasing both the Investment account and
an Equity Income account. As an alternative, separate entries can be made.
The equity accrual is added to these two accounts while the deferral of the
unrealized gross profit serves as a reduction.

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Chapter 01 - The Equity Method of Accounting for Investments

23. (continued)
e. In the second year, Parrot again records an equity accrual for 42 percent of
the income reported by Sunrise. The intra-entity portion of the unrealized
gross profit created by the transfers for that year are delayed in the same
manner as for 2014 in (d) above. However, for 2015, the gross profit
deferred from 2014 must now be recognized. This transferred merchandise
was sold during this second year so that the earnings process has now
been culminated.
f.

If none of the transferred merchandise remains at year-end, the intra-entity

transactions create no impact on the recording of the investment when
applying the equity method. No gross profit remains unrealized.

g. The intra-entity transfers create no direct effects for Sunrise, the investee.
However, as related party transactions, the amounts, as well as the
relationship, must be properly disclosed and labeled.
24. (15 minutes) (Verbal overview of the sale of a portion of an investment being
reported on the equity method and the accounting for any shares that remain)
a. The equity method must be applied up to the date of the sale. Therefore, for
the current year until August 1, Einstein records an equity accrual
recognizing 40 percent of Brooks reported income for that period. In
addition, Einstein records any dividends declared by Brooks as a reduction
in the carrying amount of the investment account. Finally, amortization of
acquisition-date excess fair over book values are recorded through August
1. These entries establish an appropriate book value as of the date of sale.
Then, an amount of that book value equal to the portion of the shares sold
is removed to compute a gain or loss on sale.
b. Subsequent accounting for the remaining shares depends on the influence
retained post-sale. If Einstein maintains the ability to apply significant
influence to the operating and financial decisions of Brooks, the equity
method is still applicable based on the smaller new ownership percentage.
However, if significant influence has been lost, Einstein should report the
remaining shares by means of the fair-value method.
c. In this situation, three figures would be reported by Einstein. First, an equity
income balance is recorded that includes both the accrual and amortization
prior to August 1. Second, a gain or loss should be shown for the sale of the
shares. Third, any investee dividends declared after August 1 must be
included in Einsteins income statement as dividend revenue.

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Chapter 01 - The Equity Method of Accounting for Investments

24. (continued)
d. No, the ability to apply significant influence to the investee was present
prior to August 1 so that the equity method was appropriate. No change is
made in those figures. However, after the sale, the remaining investment
must be accounted for by means of the fair-value method.
25. (12 minutes) (Equity balances for one year includes intra-entity transfers)
a. Equity income accrual2015 ($90,000 30%) .........................
Amortization2015 (given) ........................................................
Intra-entity profit recognized on 2014 transfer*........................
Intra-entity profit deferred on 2015 transfer** ...........................
Equity income recognized by Matthew in 2015 ...................
*Gross profit rate (GPR) on 2014 transfer ($16,000/$40,000) ...
Unrealized gross profit:
Remaining inventory (40,000 25%) ....................................
GPR (above) ...........................................................................
Ownership percentage ..........................................................
Intra-entity profit deferred from 2014 until 2015 .................
**GPR on 2015 transfer ($22,000/$50,000) .................................
Unrealized gross profit:
Remaining inventory (50,000 40%) ....................................
GPR (above) ...........................................................................
Ownership percentage ..........................................................
Intra-entity profit deferred from 2015 until 2016 .................
b. Investment in Lindman, 1/1/15 ...................................................
Equity income2015 (see [a] above) ........................................
Dividends2015 ($30,000 30%) ..............................................
Investment in Lindman, 12/31/15 ...............................................

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$27,000
(9,000)
1,200
(2,640)
$16,560
40%
$10,000
40%
30%
$ 1,200
44%
$20,000
44%
30%
$ 2,640
$335,000
16,560
(9,000)
$342,560

Chapter 01 - The Equity Method of Accounting for Investments

26. (20 Minutes) (Equity method balances after conversion to equity method. Must
determine investees book value)
Part a
1. Allocation and annual amortizationfirst purchase 1/1/2014
Purchase price of 15 percent interest .......................................
$62,000
Net book value ($280,000 15%) ...............................................
(42,000)
Franchise agreements ................................................................
$20,000
Remaining life of franchise agreements ................................... 10 years
Annual amortization ..............................................................
$ 2,000
Allocation and annual amortizationsecond purchase 1/1/2015
Purchase price of 10 percent interest .......................................
Net book value $280,000 + $80,000 - $30,000 = $330,000.
($330,000 10%)..........................................................................
Franchise agreements ................................................................
Remaining life of franchise agreements ...................................
Annual amortization ..............................................................

(33,000)
$10,800
9 years
$ 1,200

Investment in Bellevue account

January 1, 2014 purchase...........................................................
2014 basic equity income accrual ($80,000 15%) ..................
2014 amortization on first purchase (above) ............................
2014 dividends ($30,000 15%) .................................................
Equity method balance 12/31/2014
January 1, 2015 purchase...........................................................
2015 basic equity income accrual ($100,000 25%) ................
2015 amortization on first purchase (above) ............................
2015 amortization on second purchase (above) ......................
2015 dividends ($40,000 25%) .................................................
Investment in BellevueDecember 31, 2015 ......................

$62,000
12,000
(2,000)
(4,500)
$67,500
43,800
25,000
(2,000)
(1,200)
(10,000)
$123,100

2. Equity Income2015
2015 basic equity income accrual ($100,000 25%) ................
2015 amortization on first purchase (above) ............................
2015 amortization on second purchase (above) ......................
Equity income2015 .............................................................

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

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$43,800

Chapter 01 - The Equity Method of Accounting for Investments

26. (continued)
3. The January 1, 2015 retrospective adjustments to convert the Investment in
Bellevue to the equity method is as follows:
Unrealized Holding GainShareholders 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
Retained Earnings (January 1, 2015)

5,500
5,500

Retrospective adjustment to retained earnings to record 2014 equity method

income for 15% investment (15% $80,000 less $2,000 excess amortization
less $4,500 dividend income recognized in 2014). [Alternative: Equity method
balance of investment $67,500 less cost $62,000 = $5,500.]
Part b
1.

Investment in Bellevue (25% 468,000)

$117,000

2.

Dividend income (25% 40,000)

$10,000
Increase in fair value (25% [$468,000 - $438,000])
7,500
Reported income from Investment in Bellevue
$17,500

27. (30 minutes) (Conversion to equity method, sale of investment, and unrealized
gross profit)
Part a
Allocation and annual amortizationfirst purchase
Purchase price of 10 percent interest .......................................
Net book value ($800,000 10%) ...............................................
Copyright .....................................................................................
Remaining life of Copyright .............................................................
Annual Amortization ........................................................................

1-23

$92,000
(80,000)
$12,000
16 yrs
$ 750

Chapter 01 - The Equity Method of Accounting for Investments

27. Part a (continued)

Allocation and annual amortizationsecond purchase
Purchase price of 20 percent interest ....................................... $210,000
Net book value ($800,000 is increased by $180,000
income but decreased by $80,000 in dividends)
($900,000 20%) ................................................................... (180,000)
Copyright .....................................................................................
$30,000
Remaining life of copyright ............................................................. 15 years
Annual amortization .........................................................................
$ 2,000
Equity income2013 (after conversion to establish comparability)
2013 basic equity income accrual ($180,000 10%) .....................
$18,000
2013 amortization on first purchase (above)..................................
(750)
Equity income2013 ..................................................................
$17,250
Equity income 2014
2014 basic equity income accrual ($210,000 30%) ................
2014 amortization on first purchase (above) ............................
2014 amortization on second purchase (above) ......................
Equity income 2014 ..........................................................................

$63,000
(750)
(2,000)
$60,250

Part b
Investment in Barringer
Purchase priceJanuary 1, 2013....................................................
2013 equity income (above) .......................................................
2013 dividends ($80,000 10%) .................................................
Purchase price January 1, 2014 ......................................................
2014 equity income (above) .......................................................
2014 dividends ($100,000 30%) ...............................................
2015 basic equity income accrual ($230,000 30%) ................
2015 amortization on first purchase (above) ............................
2015 amortization on second purchase (above) ......................
2015 dividends ($100,000 30%) ...............................................
Investment in Barringer12/31/15 ..................................................

$92,000
17,250
(8,000)
210,000
60,250
(30,000)
69,000
(750)
(2,000)
(30,000)
$377,750

1-24

Chapter 01 - The Equity Method of Accounting for Investments

27. Part b (continued)

Gain on sale of investment in Barringer
Sales price (given) ......................................................................
Book value 1/1/16 (above) ..........................................................
Gain on sale of investment ...................................................

$400,000
(377,750)
$ 22,250

Part c
Deferral of 2014 unrealized gross profit into 2015
Ending inventory .........................................................................
Gross profit percentage ($15,000 $50,000) ............................
Unrealized gross profit ..........................................................
Andersons ownership................................................................
Unrealized intra-entity gross profit ......................................

$20,000
30%
$6,000
30%
$ 1,800

Deferral of 2015 unrealized gross profit into 2016

Ending inventory .........................................................................
Gross profit percentage ($27,000 $60,000) ............................
Unrealized gross profit ..........................................................
Andersons ownership................................................................
Unrealized intra-entity gross profit ......................................

$40,000
45%
$18,000
30%
$ 5,400

Equity Income2015
2015 equity income accrual ($230,000 30%) ..........................
2015 amortization on first purchase (above) ............................
2015 amortization on second purchase (above) ......................
Realization of 2014 intra-entity profit (above)...........................
Deferral of 2015 intra-entity profit (above) ................................
Equity Income2015 .............................................................

$69,000
(750)
(2,000)
1,800
(5,400)
$62,650

1-25

Chapter 01 - The Equity Method of Accounting for Investments

28. (40 Minutes) (Conversion to equity method and equity reporting after several
years)
a. Annual Amortization
October 1, 2013 purchase
Purchase price ............................................................................
Book value, 10/1/13:
As of 1/1/13 .........................................................
$100,000
Equity increase 1/1/13 to 10/1/13
($20,000 income less $8,000 dividends = $12,000)
year .........................................................
9,000
Book value of Barker, first purchase date
$109,000
Acquired percentage .............................................
5%
Intangible assets ....................................................
Remaining life.........................................................
Annual amortizationfirst purchase....................
July 1, 2014 purchase
Purchase price .......................................................
Book value, 7/1/14:
As of 1/1/14 ($100,000 + $20,000 - $8,000) ........
$112,000
Equity increase 1/1/14 to 7/1/14
($30,000 income less $16,000 dividends = $14,000)
year ........................................................
7,000
Book value of Barker, second purchase date
$119,000
Acquired percentage .............................................
10%
Intangible assets ....................................................
Remaining life.........................................................
Annual amortizationsecond purchase ..............
December 31, 2015 purchase
Purchase price .......................................................
Book value, 12/31/15:
As of 1/1/15 ($112,000 + $30,000 - $16,000) ......
Equity increase 1/1/15 to 12/31/15
($24,000 income less $9,000 dividends) ...........
Book value of Barker, third purchase
Acquired percentage .............................................
1-26

$7,475

5,450
$2,025
15 years
$ 135

$14,900

11,900
$3,000
15 years
$ 200

$34,200
$126,000
15,000
$141,000
20%

28,200

Chapter 01 - The Equity Method of Accounting for Investments

28. a (continued)
Intangible assets ....................................................
Remaining life.........................................................
Annual amortizationthird purchase ..................

$6,000
15 years
$ 400

Equity Income Reported by Smith

Reported for 2013 (3 months) after conversion
to equity method:
Accrual ($20,000 year 5%) ................
Amortization on first purchase ($135 year)
Equity income 2013................................

$250.00
(33.75)
$216.25

Reported for 2014 (5% for entire year and an additional 10%
for last 6 months) (after conversion to equity method):
Accrualfirst purchase ($30,000 entire year 5%) ......
Accrualsecond purchase ($30,000 year 10%) ..
Amortization on first purchase, entire year ...................
Amortization on second purchase ($200 year) .......
Equity income2014 ..................................................

1,500
1,500
(135)
(100)
$2,765

Reported for 2015 (15% for entire year; because final acquisition occurred
at year end, neither income nor amortization is recognized):
Basic equity accrual ($24,000 15%) .............................
Amortization on first purchase .......................................
Amortization on second purchase ..................................
Equity income2015 ..................................................

$3,600
(135)
(200)
$3,265

b. Investment in Barker
Costfirst purchase ................................................................... $ 7,475.00
Costsecond purchase ............................................................. 14,900.00
Costthird purchase .................................................................. 34,200.00
Equity Income (above)
2013 ..........................................................................................
216.25
2014 ..........................................................................................
2,765.00
2015 ..........................................................................................
3,265.00

1-27

Chapter 01 - The Equity Method of Accounting for Investments

28. b (continued)
Less: investee dividends
2013 ($8,000 5%)............................................................
2014 ($16,000 5% and $16,000 2/4 10%) .......................
2015 ($9,000 15%).................................................................
Balance ........................................................................................

(100.00)
(1,600.00)
(1,350.00)
$59,771.25

29. (25 Minutes) (Preparation of journal entries for two years, includes losses and
intra-entity transfers of inventory)
Journal Entries for Harper Co.
1/1/14

During
2014

12/31/14

12/31/14

Investment in Kinman Co. ............

Cash .........................................
(To record initial investment)

210,000
210,000

Dividends Receivable ...................

4,000
Investment in Kinman Co. ......
(To record dividend declaration: $10,000 x 40%)

4,000

Cash ...............................................
Dividends Receivable .............
(To record receipt of dividend)

4,000

4,000

Equity in Kinman IncomeLoss .

16,000
Other Comprehensive Loss of Kinman
8,000
Investment in Kinman Co. ......
(To record accrual of income and OCI from
equity investee, 40% of reported balances)
Equity in Kinman IncomeLoss .
3,300
Investment in Kinman Co. ......
(To record amortization relating to acquisition
of Kinmansee Schedule 1 below)

1-28

24,000

3,300

Chapter 01 - The Equity Method of Accounting for Investments

29. (continued)
12/31/14

During
2015

12/31/15

12/31/15

12/31/15

12/31/15

Equity in Kinman Income-Loss ...

2,000
Investment in Kinman Co. ......
(To defer unrealized gross profit on intra-entity
sale see Schedule 2 below)

2,000

Dividends Receivable ...................

4,800
Investment in Kinman Co. ......
(To record dividend declaration: $12,000 x 40%)

4,800

Cash ...............................................
Dividends Receivable..............
(To record receipt of dividend)

4,800

4,800

Investment in Kinman Co. ............

16,000
Equity in Kinman Income........
(To record 40% accrual of income as earned by
equity investee)
Equity in Kinman Income .............
3,300
Investment in Kinman Co. ......
(To record amortization relating to acquisition
of Kinman)
Investment in Kinman Co. ............
2,000
Equity in Kinman Income........
(To recognize income deferred from 2014)
Equity in Kinman Income .............
3,600
Investment in Kinman Co. ......
(To defer unrealized gross profit on intra-entity
salesee Schedule 3 below)

1-29

16,000

3,300

2,000

3,600

Chapter 01 - The Equity Method of Accounting for Investments

29. (continued)
Schedule 1Allocation of Purchase Price and Related Amortization
Purchase price ........................................................
Percentage of book value acquired
($400,000 40%).....................................................
Payment in excess of book value ..............................

$210,000
(160,000)
$50,000
Remaining Annual
Life Amortization

Excess payment identified with specific assets:

Building ($40,000 40%)
$16,000 10 yrs.
Royalty agreement ($85,000 40%)
34,000 20 yrs.
Total annual amortization

$1,600
1,700
$3,300

Schedule 2Deferral of Unrealized Gross Profit2014

Inventory remaining at end of year .................................................
Gross profit percentage ($30,000 $90,000) ..................................
Gross profit remaining in inventory ..........................................
Ownership percentage .....................................................................
Unrealized gross profit to be deferred until 2015 .....................

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

Schedule 3Deferral of Unrealized Gross Profit2015

Inventory remaining at end of year (30%) ......................................
Gross profit percentage ($30,000 $80,000) ..................................
Gross profit remaining in inventory ..........................................
Ownership percentage .....................................................................
Unrealized gross profit to be deferred until 2016 .....................

1-30

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

Chapter 01 - The Equity Method of Accounting for Investments

30. (35 Minutes) (Investment sale with equity method applied both before and
after. Includes other comprehensive loss and intra-entity inventory transfer)
Income effects for year ending December 31, 2015
Equity income in Seacrest, Inc. (Schedule 1) ...........................

$116,000

Other comprehensive lossSeacrest, Inc.

1/1/15 to 8/1/15 ($120,000 40% 7/12 year) ............. . (28,000)
8/1/15 to 12/31/15 ($120,000 32% 5/12 year) ......... (16,000)

$(44,000)

Gain on sale of 8,000 shares of Seacrest (Schedule 2) .................

$ 25,000

Schedule 1Equity Income in Seacrest, Inc.

Investee income accrualoperations
$342,000 40% 7/12 year....................................
$342,000 32% 5/12 year....................................
Amortization
$12,000 7/12 year .................................................
After 20 percent of stock is sold (8,000 40,000
shares): $12,000 80% 5/12 year .................
Recognition of unrealized gross profit
Remaining inventory12/31/14 ............................
Gross profit percentage on original sale
($20,000 $50,000)............................................
Gross profit remaining in inventory .....................
Ownership percentage ..........................................
Intra-entity gross profit recognized in 2015 .........
Equity income in Seacrest, Inc. .......................

1-31

$79,800
45,600

$125,400

$7,000
4,000

(11,000)

$10,000
40%
$4,000
40%
1,600
$116,000

Chapter 01 - The Equity Method of Accounting for Investments

30. (continued)
Schedule 2Gain on Sale of Investment in Seacrest, Inc.
Book valueinvestment in Seacrest, Inc.1/1/15 (given) ........
Investee income accrual1/1/15 8/1/15 (Schedule 1) .............
Investee other comprehensive loss 1/1/15 8/1/15 ....................
Amortization1/1/15 8/1/15 (Schedule 1) .................................
Recognition of deferred profit (Schedule 1) ................................
Investment in Seacrest book value 8/1/15........................................
Percentage of investment sold (8,000 40,000 shares) .............
Book value of shares being sold..................................................
Proceeds from sale of shares.......................................................
Gain on sale of 8,000 shares of Seacrest. ..............................

$293,600
79,800
(28,000)
(7,000)
1,600
$340,000
20%
$ 68,000
93,000
$ 25,000

31. (30 Minutes) (Compute equity balances for three years. Includes
intra-entity inventory transfer)
Part a.
Equity Income 2013
Basic equity accrual ($598,000 year 25%).......................
Amortization ( yearsee Schedule 1) ....................................
Equity Income2013 .............................................................

$74,750
(30,800)
$43,950

Equity Income 2014

Basic equity accrual ($639,600 25%) .....................................
Amortization (see Schedule 1) ..................................................
Deferral of unrealized profit (see Schedule 2) .........................
Equity Income2014 ............................................................

$159,900
(61,600)
(6,000)
$92,300

Equity Income 2015

Basic equity accrual ($692,400 25%) .....................................
Amortization (see Schedule 1) ..................................................
Recognition of deferred profit (see Schedule 2) .....................
Equity Income2015 ............................................................

$173,100
(61,600)
6,000
$117,500

1-32

Chapter 01 - The Equity Method of Accounting for Investments

31. (continued)
Schedule 1Acquisition Price Allocation and Amortization
Acquisition price (88,000 shares $13)
$1,144,000
Book value acquired ($2,925,600 25%)
731,400
Payment in excess of book value
$412,600
Excess payment identified with specific assets:
Equipment ($364,000 25%)
Copyright ($972,000 25%)
Goodwill
Total annual amortization (full year)

Remaining Annual
Life Amortization

$91,000
7 yrs.
243,000
5 yrs.
78,600 indefinite

$13,000
48,600
-0$61,600

Schedule 2Deferral of Unrealized Intra-entity Gross Profit

Intra-entity Gross Profit Percentage:
Sales
$152,000
Cost of goods sold
91,200
Gross profit
$ 60,800
Gross profit percentage: $60,800 $152,000 = 40%
Inventory remaining at December 31, 2014 .................................
Gross profit percentage ...............................................................
Total profit on intra-entity sale still held by affiliate ...................
Investor ownership percentage....................................................
Unrealized intra-entity gross profit deferred from
2014 until 2015..........................................................................

$60,000
40%
$24,000
25%
$ 6,000

Part b.
Investment in ShaunDecember 31, 2015 balance
Acquisition price ...........................................................................
$1,144,000
2013 Equity income (above) .........................................................
43,950
2013 Dividends declared during half year (88,000 shares $1.00)
(88,000)
2014 Equity income (above) .........................................................
92,300
2014 Dividends declared (88,000 shares $1.00 2) .................
(176,000)
2015 Equity income (above) .........................................................
117,500
2015 Dividends declared (88,000 shares $1.00 2) .................
(176,000)
Investment in Shaun12/31/15...........................................
$957,750

1-33

Chapter 01 - The Equity Method of Accounting for Investments

32. (65 Minutes) (Journal entries for several years. Includes conversion to
equity method and a sale of a portion of the investment)
1/1/13

Investment in Sumter .....................

192,000
Cash ...........................................
(To record cost of 16,000 shares of Sumter
Company.)

192,000

9/15/13

Cash .................................................
8,000
Dividend Income ........................
8,000
(Annual dividends declared and received from Sumter
Company. Because declaration and payment are on same
day, a dividend receivable account is unnecessary.)

9/15/14

Cash .................................................
8,000
Dividend Income ........................
8,000
(Annual dividends declared and received from Sumter
Company.)

1/1/15

1/1/15

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
(Retrospective adjustment necessitated by change
to equity method. Change in figures previously
reported for 2013 and 2014 are calculated as
follows.)

1-34

965,750

36,800

Chapter 01 - The Equity Method of Accounting for Investments

32. (continued)
2013 as reported

2013equity 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 .................................. -02014 as reported
Income (dividends)..........$8,000
Change in investment
Balance .................................. -0-

2014equity method (as restated)

Income (8% of $360,000
reported income) .............................. $28,800
Change in investment balance (equity
income less dividends).................... $20,800

2013 increase in reported income ($24,000 $8,000).................

2014 increase in reported income ($28,800 $8,000).................
Retrospective adjustmentincome (above) ...............................

$16,000
20,800
$36,800

2013 increase in investment in Sumter balanceequity method

2014 increase in investment in Sumter balanceequity method
Retrospective adjustmentInvestment in Sumter (above) ..

$16,000
20,800
$36,800

9/15/15

12/31/15

12/31/15

Cash............................................................
40,000
Investment in Sumter ...........................
(Annual dividend declared and received from Sumter
[40% $100,000])
Investment in Sumter ................................
Equity in Investee Income ...................
(To accrue 2015 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

1-35

40,000

160,000

3,370

Chapter 01 - The Equity Method of Accounting for Investments

32. (continued)
7/1/16

7/1/16

7/1/16

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 7/1/16)

1,685

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

76,000

1,685

425,000

Investment in Sumter and cost of shares sold:

1/1/13 Acquisition ....................................................................
1/1/15 Acquisition .....................................................................
1/1/15 Retrospective adjustment ............................................
9/15/15 Dividends .....................................................................
12/31/15 Basic equity accrual..................................................
12/31/15 Amortization ..............................................................
7/1/16 Basic equity accrual......................................................
7/1/16 Amortization ..................................................................
Investment in Sumter7/1/16 balance..............................
Percentage of shares sold (20,000 80,000) ....................
Cost of shares sold (rounded) ...........................................

346,374
78,626

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

Because 20,000 of 80,000, or , of shares are sold, the percentage retained is

of 40% = 30%.
9/15/16

Cash...........................................................
30,000
Investment in Sumter ..........................
(To record annual dividend declared and received)

1-36

30,000

Chapter 01 - The Equity Method of Accounting for Investments

32. (continued)
12/31/16

12/31/16

Equity in Sumter ........................................

57,000
Equity in Investee Income ...................
(To record year income based on
remaining 30% ownership: $380,000 1/2 30%)

57,000

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

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

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

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

$3,370
75%
$2,528.50
$1,263.75

33. (25 Minutes) (Equity income balances for two years, includes intra-entity
transfers)
Equity Income 2014
Basic equity accrual ($250,000 30%) ...................................
Amortization (see Schedule 1) ................................................
Deferral of unrealized gross profit (see Schedule 2) ............
Equity Income2014 ..........................................................

$75,000
(18,000)
(9,000)
$48,000

Equity Income (Loss2015)

Basic equity accrual ($100,000 [loss] 30%) ........................
Amortization (see Schedule 1) ................................................
Realization of deferred gross profit (see Schedule 2) ..........
Deferral of unrealized gross profit (see Schedule 3) ............
Equity Loss2015 ..............................................................

$(30,000)
(18,000)
9,000
(4,500)
$(43,500)

1-37

Chapter 01 - The Equity Method of Accounting for Investments

33. (continued)
Schedule 1
Purchase price ................................................... $770,000
Book value acquired ($1,200,000 30%) ......... 360,000
Payment in excess of book value .................... $410,000
Remaining Annual
Life Amortization

Excess payment identified with specific assets:

Customer list ($300,000 30%)
90,000
5 yrs.
$18,000
Excess not identified with specific accounts
Goodwill
$320,000 indefinite
-0Total annual amortization
$18,000
Schedule 2
Inventory remaining at December 31, 2014 .................................
Gross profit percentage ($60,000 $160,000) .............................
Total unrealized gross profit ........................................................
Investor ownership percentage....................................................
Unrealized intra-entity gross profit 12/31/14
(To be deferred until realized in 2015) ....................................
Schedule 3
Inventory remaining at December 31, 2015 .................................
Gross profit percentage ($35,000 $175,000) .............................
Total unrealized gross profit ........................................................
Investor ownership percentage....................................................
Unrealized intra-entity gross profit 12/31/15
(To be deferred until realized in 2016) ....................................

1-38

$80,000
37%
$30,000
30%
$ 9,000

$75,000
20%
$15,000
30%
$ 4,500