Heartfelt Company owns a 40% interest in the voting common stock of Candle Corporation, accounted for using the equity method. During 2014, Candle Corporation reported net earnings of $100,000 and declared and paid cash dividends of $10,000. The carrying value of the Candle investment was $500,000 on January 1, 2014. At what amount is the Candle investment reported on the December 31, 2014 statement of financial position?

Question

Quizplus · Accepted Answer

The equity method is used to account for investments in which a company has significant influence but not control over another company. Under this method, the investor initially records the investment at cost and then adjusts it for its share of the investee's earnings or losses and dividends paid.

In this case, Heartfelt Company owns a 40% interest in the voting common stock of Candle Corporation and reported net earnings of $100,000 and declared and paid cash dividends of $10,000 in 2014. This means that Heartfelt Company's share of Candle Corporation's net earnings is $40,000 ($100,000 x 40%) and its share of dividends is $4,000 ($10,000 x 40%).

To calculate the carrying value of the Candle investment on December 31, 2014, we start with the carrying value from January 1, 2014, which is $500,000. Then we add Heartfelt Company's share of net earnings ($40,000) and subtract its share of dividends ($4,000).

Carrying value on December 31, 2014 = Carrying value on January 1, 2014 + Heartfelt's share of net earnings - Heartfelt's share of dividends 
Carrying value on December 31, 2014 = $500,000 + $40,000 - $4,000 
Carrying value on December 31, 2014 = $536,000

Therefore, the Candle investment is reported at $536,000 on Heartfelt Company's statement of financial position as at December 31, 2014. The correct answer is B.

Heartfelt Company Owns a 40% Interest in the Voting Common