FAR: Equity Investments: 3/20/2018

Question 1

When the equity method is used to account for investments in common stock, which of the following affects the investor’s reported investment income?

Goodwill amortization related to purchase
Cash dividends from investee
1) Yes        Yes
2) No         Yes
3) No         No
4) Yes        No

Answer 1

No, No

Dividends from the investee are not recognized as income; rather, they reduce the investment account. The equity method treats all dividends as a return of investment.

Question 2

Sage, Inc. bought 40% of Adams Corp.’s outstanding common stock on January 2, 2004 for $400,000. The investment gave Sage significant influence over Adams.

The carrying amount of Adams’ net assets at the purchase date totaled $900,000. Fair values and carrying amounts were the same for all items except for plant and inventory, for which fair values exceeded their carrying amounts by $90,000 and $10,000, respectively. The plant has an 18-year life. All inventory was sold during 2004. Goodwill, if any, is expected to have a useful life of 40 years. During 2004, Adams reported net income of $120,000 and paid a $20,000 cash dividend.

What amount should Sage report in its Income Statement from its investment in Adams for the year ended December 31, 2004?

1) $48,000
2) $42,000
3) $36,000
4) $32,000

Answer 2

$42,000 ($120K X .4 = $48K Adams Net Income - [$10K COGS X .4 = $4K] - [($90K PP&E X .4)/18yr life = $2K])

This answer reduces the net investment income by the full $10,000 of excess of fair value over book value of the inventory. But Sage owns only 40% of Adams and should reduce income by only 40% of that amount.

Question 3

Pal Corp.’s 2004 dividend income included only part of the dividend received from its Ima Corp. investment. The balance of the dividend reduced Pal’s carrying amount for its Ima investment. This reflects that Pal accounts for its Ima investment by the:

1) Fair Value method, and only a portion of Ima’s 2004 dividends represent earnings after Pal’s acquisition.
2) Fair Value method, and its carrying amount, exceeded the proportionate share of Ima’s market value.
3) Equity method, and Ima incurred a loss in 2004.
4) Equity method, and its carrying amount exceeded the proportionate share of Ima’s market value.

Answer 3

Fair Value method, and only a portion of Ima’s 2004 dividends represent earnings after Pal’s acquisition.

The wording of the question implies that dividends are normally treated as dividends under the method used by the investor. Thus, the equity method could not be the method used by the firm.

Under the equity method, all dividends are treated as a reduction in the investment account. No dividends received are treated as income under the equity method.

Question 4

Information pertaining to dividends from Wray Corp.’s common stock investments for the year ended December 31, 2004 are as follows:

On September 8, 2004, Wray received a $50,000 cash dividend from Seco, Inc., in which Wray owns a 30% interest. A majority of Wray’s directors are also directors of Seco.
On October 15, 2004, Wray received a $6,000 liquidating dividend from King Co. Wray owns a 5% in King Co.
Wray owns a 2% interest in Bow Corp., which declared a $200,000 cash dividend on November 27, 2004 to stockholders of record on December 15, 2004, payable on January 5, 2005.

What amount should Wray report as dividend income in its Income Statement for the year ended December 31, 2004?

1) $60,000
2) $56,000
3) $10,000
4) $4,000

Answer 4

$4,000

This answer includes the Seco dividend.

However, the Seco dividend is a reduction in the investment account because Wray owns 30% and must use the equity method. This method treats all dividends as reductions in the investment account-a return of investment.