On January 2,20X1,Pencil Co.purchased 15 percent of Eraser,Inc.'s outstanding common shares for $500,000.Pencil is the largest single shareholder in Eraser and is able to exercise significant influence over Eraser.Eraser reported net income of $400,000 for 20X1 and paid dividends of $100,000.In its December 31,20X1,balance sheet,what amount should Pencil report as investment in Eraser?

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Pencil Co. should use the equity method since it can exercise significant influence over Eraser. Under this method, the investment is initially recorded at cost and subsequently adjusted for Pencil's share of Eraser's net income and dividends. Pencil's share of Eraser's net income is 15% of $400,000, which is $60,000. Pencil's share of dividends is 15% of $100,000, which is $15,000. The investment is adjusted by adding the share of net income and subtracting the share of dividends: $500,000 + $60,000 - $15,000 = $545,000.