On January 1, 2020, Mehan, Incorporated purchased 15,000 shares of Cook Company for $150,000 giving Mehan a 15% ownership of Cook. The fair value of the 15% investment was the same as the carrying value of the investment when, on January 1, 2021, Mehan purchased an additional 25,000 shares (25%)of Cook for $300,000. This last purchase gave Mehan the ability to apply significant influence over Cook. The book value of Cook on January 1, 2020 was $1,000,000. The book value of Cook on January 1, 2021, was $1,100,000. Any excess of cost over book value for this second transaction is assigned to a database and amortized over four years.Cook reports net income and dividends as follows. These amounts are assumed to have occurred evenly throughout the years: On April 1, 2022, just after its first dividend receipt, Mehan sells 10,000 shares of its investment.How much income did Mehan report from Cook during 2021?

Question

On January 1, 2020, Mehan, Incorporated purchased 15,000 shares of Cook Company for $150,000 giving Mehan a 15% ownership of Cook. The fair value of the 15% investment was the same as the carrying value of the investment when, on January 1, 2021, Mehan purchased an additional 25,000 shares (25%)of Cook for $300,000. This last purchase gave Mehan the ability to apply significant influence over Cook. The book value of Cook on January 1, 2020 was $1,000,000. The book value of Cook on January 1, 2021, was $1,100,000. Any excess of cost over book value for this second transaction is assigned to a database and amortized over four years.Cook reports net income and dividends as follows. These amounts are assumed to have occurred evenly throughout the years:  On April 1, 2022, just after its first dividend receipt, Mehan sells 10,000 shares of its investment.How much income did Mehan report from Cook during 2021?

Quizplus · Accepted Answer

Mehan purchased 25% of Cook on January 1, 2021, which gave Mehan significant influence over Cook. Therefore, Mehan should account for its investment in Cook using the equity method. The excess of cost over book value of the investment, which is $150,000 ($300,000 - 25% x $1,100,000), should be assigned to a database and amortized over four years ($37,500 per year).

To calculate Mehan's income from Cook during 2021, we need to determine Mehan's share of Cook's earnings for the year. Mehan owns 40% (15% + 25%) of Cook during 2021, so Mehan's share of Cook's net income is:

40% x $220,000 = $88,000

However, Mehan sold 10,000 shares of Cook on April 1, 2022, which means that Mehan owned only 30% (15% + 25% - 10%) of Cook for the first quarter of 2022. Mehan's share of Cook's net income for the first quarter of 2022 is:

30% x ($220,000/4) = $16,500

Therefore, Mehan's income from Cook during 2021 is:

$88,000 - $16,500 = $71,500

However, Mehan received dividends from Cook during the year, which are assumed to have occurred evenly throughout the year. Mehan's share of Cook's dividends for the year is:

40% x $60,000 = $24,000

Therefore, Mehan's total income from Cook during 2021 is:

$71,500 + $24,000 = $95,500

However, we need to subtract the amortization of the excess of cost over book value, which is $37,500.

Therefore, Mehan's income from Cook during 2021 is:

$95,500 - $37,500 = $58,000

The closest answer choice is D) $87,500, which is incorrect. The correct answer is D) $58,000.

On January 1, 2020, Mehan, Incorporated Purchased 15,000 Shares of Cook