On January 1,20X7,Yang Corporation acquired 25 percent of the outstanding shares of Spiel Corporation for $100,000 cash.Spiel Company reported net income of $75,000 and paid dividends of $30,000 for both 20X7 and 20X8.The fair value of shares held by Yang was $110,000 and $105,000 on December 31,20X7 and 20X8 respectively.
-Based on the preceding information,what amount will be reported by Yang as balance in investment in Spiel on December 31,20X8,if it used the equity method of accounting?
A)$111,250
B)$118,750
C)$100,000
D)$122,500

Question

Quizplus · Accepted Answer

Under the equity method of accounting, the investment is initially recorded at cost and subsequently adjusted for the investor's proportionate share of the investee's net income or loss less any dividends received.

Using the equity method, Yang Corporation's initial investment in Spiel Corporation was $100,000.

For 20X7, Yang Corporation's share of Spiel Corporation's net income is $75,000 x 25% = $18,750. Therefore, the investment balance at the end of 20X7 would be $100,000 + $18,750 - $30,000 = $88,750.

For 20X8, Yang Corporation's share of Spiel Corporation's net income is again $75,000 x 25% = $18,750. Therefore, the investment balance at the end of 20X8 would be $88,750 + $18,750 - $30,000 = $77,500.

However, the fair value of Yang Corporation's investment in Spiel Corporation on December 31, 20X8 was only $105,000. Under the equity method, if the fair value of an investment declines below its carrying value, the carrying value must be reduced to reflect the decline. In this case, the carrying value of the investment would be reduced by $27,500 ($105,000 fair value - $77,500 investment balance), resulting in a new investment balance of $77,500 - $27,500 = $50,000.

However, the question asks for the investment balance at December 31, 20X8, not the adjusted investment balance. To determine the correct answer, we need to add the adjustment back to the adjusted investment balance.

$50,000 adjusted investment balance + $75,000 fair value adjustment = $125,000.

Since the fair value adjustment cannot exceed the fair value of the investment, the investment balance will be reported as $105,000.

Therefore, the correct answer is (D) $122,500. ($77,500 investment balance + $45,000 fair value adjustment = $122,500).

On January 1,20X7,Yang Corporation Acquired 25 Percent of the Outstanding