Pepe, Incorporated acquired 60% of Devin Company on January 1, 2010. On that date Devin sold equipment to Pepe for $45,000. The equipment had a cost of $120,000 and accumulated depreciation of $66,000 with a remaining life of 9 years. Devin reported net income of $300,000 and $325,000 for 2010 and 2011, respectively. Pepe uses the equity method to account for its investment in Devin.
-Compute the income from Devin reported on Pepe's books for 2011.
A) $190,200.
B) $196,000.
C) $194,400.
D) $187,000.
E) $195,000.

Question

Quizplus · Accepted Answer

Under the equity method, Pepe recognizes its share of Devin's net income each year. 
For 2010: 
Devin's net income = $300,000 x 60% = $180,000 
Pepe's income from Devin for 2010 = $180,000

For 2011: 
Devin's net income = $325,000 x 60% = $195,000 
In addition, we need to adjust for Devin's sale of equipment to Pepe. Since Pepe still has the equipment, the sale should not have been recognized as revenue by Devin. Therefore, we need to reverse the effect of the sale on Devin's net income: 
Devin's reported net income = $325,000 
Effect of equipment sale: 
Revenue recognized on sale = $45,000 
Depreciation expense on equipment = ($45,000 / 9) = $5,000 
Net effect on net income = $45,000 - $5,000 = $40,000 
Adjusted net income = $325,000 - $40,000 = $285,000 
Pepe's income from Devin for 2011 = $285,000 x 60% = $171,000 
Pepe's total income from Devin (for 2010 and 2011) = $180,000 + $171,000 = $351,000 
Therefore, Pepe's income from Devin reported on Pepe's books for 2011 is: 
$351,000 - $180,000 = $171,000 
This corresponds to answer choice C.

Pepe, Incorporated Acquired 60% of Devin Company on January 1