Misc

Question 1

Pare, Inc. purchased 10% of Tot Co.’s 100,000 outstanding shares of common stock on January 2, 2004, for $50,000.
On December 31, 2004, Pare purchased an additional 20,000 shares of Tot for $150,000. There was no goodwill as a result of either acquisition, and Tot had not issued any additional stock during 2004. Tot reported earnings of $300,000 for 2004.

What amount should Pare report in its December 31, 2004, Balance Sheet as investment in Tot?

A. $170,000
B. $200,000
C. $230,000
D. $290,000

Answer 1

A. $170,000
B. $200,000
This answer neglects to include the 10% of the investee’s income in the investor’s investment balance. At the time of the second investment, the equity method is required to be used for reporting by the investee and is retroactively applied, using the percentage ownership before the second investment.
C. $230,000
This question is difficult because it is easy to forget that once the investor has acquired a sufficient percentage of the stock to use the equity method, which is retroactively applied to earlier periods for which the holdings were not sufficient to use the equity method. In these earlier periods, only the actual ownership percentage is applied.
In this question, the equity method becomes the required method only at the very end of the year. So, only the 10% is used in applying the equity method for the purpose of recognizing income, which in turn increases the investment account.

The ending balance of the investment account is then: $50,000 (original investment) + $150,000 (second investment) + $30,000 (.10 x $300,000, which is the equity in earnings of the investee) = $230,000.
D. $290,000

Question 2

For accounting purposes, how many levels of influence, that an investor may have over an investee, are identified?
	A.  One.
	B.  Two.
	C.  Three.
	D.  Four.

Answer 2

A. One.
Accounting identifies three levels of influence that an investor may have over an investee, not one level. Those levels are: (1) no significant influence, (2) significant influence, but not control, and (3) control.
B. Two.
C. Three.
Accounting identifies three levels of influence that an investor may have over an investee. Those levels are: (1) no significant influence, (2) significant influence, but not control, and (3) control.
D. Four.

Question 3

Amar Farms produced 300,000 pounds of cotton during the 2005 season. Amar sells all of its cotton to Brye Co., which has agreed to purchase Amar’s entire production at the prevailing market price. Recent legislation assures that the market price will not fall below $.70 per pound during the next two years.
Amar’s costs of selling and distributing the cotton are immaterial and can be reasonably estimated.
Amar reports its inventory at expected exit value. During 2005, Amar sold and delivered to Brye 200,000 pounds at the market price of $.70. Amar sold the remaining 100,000 pounds during 2006 at the market price of $.72.
What amount of revenue should Amar recognize in 2005?

A.  $140,000 B.  $144,000
C.  $210,000 D.  $216,000

Answer 3

A. $140,000
B. $144,000
C. $210,000
The question is not completely unambiguous. The statement that Brye has agreed to purchase all of Amar’s production is not as strong a statement as would be hoped for in implying the use of the “completion-of-production” revenue recognition method.
The correct answer according to the AICPA is $210,000 = $.70 x (200,000 + 100,000). This is the total revenue on the cotton produced in 2005.

The “completion-of-production” method is appropriate when the sale of the output is assured and a definite price is also assured. Revenue is recognized at production, because there is no uncertainty as to the ultimate sale. Typically, the price used to measure the revenue is a market price that cannot be influenced by the producer, which is the case here.

A price of at least $.70 is assured. The additional $.02 received by Amar in 2006 is credited to revenue in that year.

Had the question said that the buyer was contractually obligated to purchase all the output, this answer would be more certainly correct. Likewise, if the question implied that there was a definite market for the cotton, rather than merely one buyer who had agreed to purchase all the output, then this answer would be unequivocally correct.

D.  $216,000