Clark Corporation purchased 40% of IT corporation for $125,000 on January 1.On May 20 of the same year,IT Corporation declared total cash dividends of $30,000.At year-end,IT Corporation reported net income of $150,000.The balance in Clark Corporation's Long-Term Investment in IT Corporation account as of December 31 should be:
A)$77,000
B)$125,000
C)$173,000
D)$197,000
E)$370,000

Question

Quizplus · Accepted Answer

Since Clark Corporation purchased 40% of IT corporation, it has significant influence over IT Corporation. Therefore, Clark Corporation must use the equity method to account for its investment in IT Corporation.

Under the equity method, Clark Corporation records its share of IT Corporation's net income and deducts its share of any dividends declared by IT Corporation.

Clark Corporation's initial investment of $125,000 represents 40% of IT Corporation's initial book value, which means that IT Corporation's initial book value is $312,500 ($125,000 ÷ 40%). We can set up the following table to track Clark Corporation's investment in IT Corporation:

At acquisition:
Investment in IT Corporation: $125,000
Plus: Share of IT Corporation's net assets: $187,500 ($312,500 × 60%)
Equals: Total cost of investment: $312,500

During the year, IT Corporation declared dividends of $30,000. Clark Corporation's share of those dividends is 40%, or $12,000. Thus, Clark Corporation's investment in IT Corporation would be:

Investment in IT Corporation (as of December 31) =
Investment in IT Corporation (at acquisition)
+ Share of IT Corporation's income
- Share of IT Corporation's dividends
= $312,500 + ($150,000 × 40%) - $12,000
= $173,000

Therefore, the answer is (C) $173,000.

Clark Corporation Purchased 40% of IT Corporation for $125,000 on January