Question 1

A change from carrying securities at fair value to the equity method of accounting for an investment in common stock resulting from an increase in the number of shares held by the investor requires:

Accepted Answer

When an investor increases their shareholding in an investee to a level that grants them significant influence, the investor must begin using the equity method of accounting for that investment. This change is applied prospectively from the date significant influence is achieved, which means the investor starts accruing income earned by the investee under the equity method from the date of acquisition of the new shares. Retroactive restatement or showing the cumulative amount of the change on the income statement is not required for this transition.

Question 2

Usually,an investment of 20 to 50 percent in another company's voting stock is reported under the:

Accepted Answer

An investment of 20 to 50 percent in another company's voting stock is reported under the equity method. Under this method, the investor company accounts for the investment as a separate line item on its balance sheet, and recognizes its share of the investee's net income or loss in its income statement. The equity method is generally used when the investor has significant influence over the investee, but not control.

Question 3

If instead,Poke could not exercise significant influence over the investee,by what amount will Poke's 20X7 income increase due to its investment in Shove?

Accepted Answer

Poke's income will increase by the amount of Shove's net income, which is $17,500.

Question 4

On January 1,20X4,Pony Company acquired 25% of Stallion Company's common stock at underlying book value of $200,000.Stallion has 80,000 shares of $10 par value,6 percent cumulative preferred stock outstanding.No dividends are in arrears.Stallion reported net income of $270,000 for 20X4 and paid total dividends of $140,000.Pony uses the equity method to account for this investment.
-Based on the preceding information,what amount would Pony Company receive as dividends from Stallion for the year?

Accepted Answer

Pony Company owns 25% of Stallion Company. Stallion paid total dividends of $140,000. However, before calculating the dividends received by Pony, we must account for the preferred dividends. Stallion has 80,000 shares of preferred stock with a 6% dividend rate and a $10 par value, which equals $48,000 (80,000 shares * $10 * 6%). The remaining dividends for common shareholders are $140,000 - $48,000 = $92,000. Pony, owning 25% of the common stock, would receive 25% of $92,000, which is $23,000.

Question 5

On January 2,20X5,Park Co.purchased 10 percent of Sky,Inc.'s outstanding common shares for $400,000.Park is the largest single shareholder in Sky,and Park's officers are a majority on Sky's board of directors.As a result,Park is able to exercise significant influence over Sky.Sky reported net income of $500,000 for 20X5,and paid dividends of $150,000.In its December 31,20X5,balance sheet,what amount should Park report as investment in Sky?

Accepted Answer

Park should use the equity method to account for its investment in Sky because it can exercise significant influence over Sky. The investment is initially recorded at cost ($400,000). Park's share of Sky's net income ($500,000 * 10% = $50,000) increases the investment, and dividends received ($150,000 * 10% = $15,000) decrease the investment. Therefore, the investment amount at year-end is $400,000 + $50,000 - $15,000 = $435,000.

Question 6

On July 1,20X4,Pillow Corp.obtained significant influence over Sleep Co.through the purchase of 3,000 shares of Sleep's 10,000 outstanding shares of common stock for $20 per share.On December 15,20X4,Sleep paid $40,000 in dividends to its common stockholders.Sleep's net income for the year ended December 31,20X4,was $120,000,earned evenly throughout the year.In its 20X4 income statement,what amount of income from this investment should Pillow report?

Accepted Answer

Since Pillow Corp. obtained significant influence over Sleep Co., it must use the equity method to record its investment in Sleep. Under the equity method, Pillow Corp. needs to recognize its share of Sleep's net income and dividends as follows:
Share of net income = $120,000 × 30% (Pillow's ownership percentage) = $36,000
Share of dividends = $40,000 × 30% = $12,000
Since Sleep paid dividends only once during the year, this is the only amount of income that should be reported in Pillow Corp.'s income statement for the year ended December 31, 20X4. Therefore, the correct answer is (C) $18,000 (i.e., $12,000 in dividends plus $6,000 in unrealized income based on the share of net income earned through July 1, 20X4).

Question 7

Which of the following observations is NOT consistent with the accounting for investments in equity securities where there is no significant influence?

Accepted Answer

Changes in the number of investment shares resulting from stock dividends, stock splits, or reverse splits would not need to be formally recorded by the investor if there is no significant influence. This is because changes in the number of shares would not impact the investor's ability to influence the investee's decisions.

Question 8

If instead,Poke could not exercise significant influence over the investee,by what amount will Poke's 20X8 income increase due to its investment in Shove?

Accepted Answer

If Poke could not exercise significant influence over the investee, it would need to account for the investment using the cost method. Under the cost method, the investment is initially recorded at cost and adjusted for any dividends received. The income recognized from the investment is limited to the dividends received. According to the question, Shove paid a $2,500 dividend in 20X8. Therefore, Poke's income from the investment would increase by $2,500.

Question 9

On January 1,20X9 Pathlon Company acquired 30 percent of the common stock of Sopteron Corporation,at underlying book value.For the same year,Sopteron reported net income of $55,000,which includes a gain from discontinued operations of $40,000.It did not pay any dividends during the year.By what amount would Pathlon's investment in Sopteron Corporation increase for the year,if Pathlon used the equity method?

Accepted Answer

Under the equity method, the investment is increased by the investor's share in the net income of the investee. In this case, Pathlon's share of Sopteron's net income is:

$55,000 x 30% = $16,500

Since Sopteron did not pay any dividends, there is no adjustment needed for dividends. Therefore, Pathlon's investment in Sopteron would increase by $16,500 for the year. The correct answer is B.

Question 10

On January 1,20X4,Pony Company acquired 25% of Stallion Company's common stock at underlying book value of $200,000.Stallion has 80,000 shares of $10 par value,6 percent cumulative preferred stock outstanding.No dividends are in arrears.Stallion reported net income of $270,000 for 20X4 and paid total dividends of $140,000.Pony uses the equity method to account for this investment.
-Based on the preceding information,what amount of investment income will Pony Company report from its investment in Stallion for the year?

Accepted Answer

Pony Company's share of Stallion's net income is 25% of $270,000, which equals $67,500. However, dividends paid on preferred stock must be considered. The preferred dividends are 6% of the $800,000 par value (80,000 shares at $10 each), totaling $48,000. This reduces the available net income for common shareholders to $222,000 ($270,000 - $48,000). Pony's share of this adjusted net income is 25% of $222,000, which equals $55,500.

Question 11

In the case of an investment in equity securities where the investor does not have significant influence and the investment is carried at fair value,a dividend from the investee is:

Accepted Answer

Since the investment is carried at fair value, any dividend declared by the investee is recognized as income to the investor in the period of declaration. Dividends are not a reduction of the carrying amount of the investment or an expense to the investor. Dividends also do not directly affect the retained earnings of the investor or the investee.

Question 12

On January 1,20X8,Pullman Company acquired 30 percent of Skate Company's common stock,at underlying book value of $100,000.Skate has 100,000 shares of $2 par value,5 percent cumulative preferred stock outstanding.No dividends are in arrears.Skate reported net income of $150,000 for 20X8 and paid total dividends of $72,000.Pullman uses the equity method to account for this investment.
-Based on the preceding information,what amount would Pullman Company receive as dividends from Skate for the year?

Accepted Answer

Pullman Company owns 30% of Skate Company. First, calculate the preferred dividends: 100,000 shares * $2 par value * 5% = $10,000. Total dividends paid were $72,000, so common dividends = $72,000 - $10,000 (preferred dividends) = $62,000. Pullman's share of common dividends = 30% * $62,000 = $18,600.

Question 13

On January 1,20X4,Pony Company acquired 25% of Stallion Company's common stock at underlying book value of $200,000.Stallion has 80,000 shares of $10 par value,6 percent cumulative preferred stock outstanding.No dividends are in arrears.Stallion reported net income of $270,000 for 20X4 and paid total dividends of $140,000.Pony uses the equity method to account for this investment.
-Based on the preceding information,what amount would be reported by Pony Company as the balance in its investment account on December 31,20X4?

Accepted Answer

Pony Company's investment account balance on December 31, 20X4, can be calculated as follows: Initial investment at book value = $200,000. Pony's share of Stallion's net income (25% of $270,000) = $67,500. However, dividends received need to be subtracted. First, calculate the preferred dividends: 80,000 shares * $10 par value * 6% = $48,000. This leaves $140,000 - $48,000 = $92,000 for common shareholders. Pony's share of dividends (25% of $92,000) = $23,000. Therefore, the adjustment for dividends is subtracting $23,000. The net increase in the investment account is $67,500 - $23,000 = $44,500. Adding this to the initial investment gives $200,000 + $44,500 = $244,500. However, since this option is not available, it appears there was a mistake in the calculation or in the interpretation of the options provided. The correct approach to find the balance would involve adding Pony's share of Stallion's net income to the initial investment and then subtracting the dividends received. Given the options and the calculation error acknowledged, the closest correct approach without considering the miscalculation would ideally lead to an answer that reflects an increase from the initial investment due to the equity method accounting, which involves adding the share of net income and subtracting received dividends.

Question 14

On January 1,20X8,Pullman Company acquired 30 percent of Skate Company's common stock,at underlying book value of $100,000.Skate has 100,000 shares of $2 par value,5 percent cumulative preferred stock outstanding.No dividends are in arrears.Skate reported net income of $150,000 for 20X8 and paid total dividends of $72,000.Pullman uses the equity method to account for this investment.
-Based on the preceding information,what amount would be reported by Pullman Company as the balance in its investment account on December 31,20X8?

Accepted Answer

Pullman's share of Skate's net income is 30% of $150,000, which is $45,000. The preferred dividends must be subtracted from net income before calculating Pullman's share of dividends because they have priority. The preferred dividends are 100,000 shares * $2 * 5% = $10,000. Thus, the dividends available for common shareholders are $72,000 - $10,000 = $62,000. Pullman's share of these dividends is 30% of $62,000, which is $18,600. The equity method adds the share of net income and subtracts dividends received to/from the initial investment. Therefore, the balance is $100,000 + $45,000 - $18,600 = $126,400. However, the correct calculation should consider the initial investment and the correct share of net income and dividends, leading to the selection of the closest correct option provided.

Question 15

If Push Company owned 51 percent of the outstanding common stock of Shove Company,which method would be appropriate for financial reporting purposes?

Accepted Answer

The full consolidation method would be appropriate in this situation, as Push Company owns a majority (51%) of the outstanding common stock of Shove Company. This method involves combining the financial statements of both companies as if they were one entity.

Question 16

Under the equity method of accounting for a stock investment,the investment initially should be recorded at:

Accepted Answer

Under the equity method of accounting, the investment is initially recorded at cost. This cost includes any acquisition-related expenses such as brokerage fees or legal fees. The equity method requires the investor to record their proportionate share of the investee's income or loss on the income statement and adjust the investment account for their share of the investee's changes in equity. It does not involve fair value or book value adjustments at the time of the initial investment.

Question 17

On January 1,20X8,Pullman Company acquired 30 percent of Skate Company's common stock,at underlying book value of $100,000.Skate has 100,000 shares of $2 par value,5 percent cumulative preferred stock outstanding.No dividends are in arrears.Skate reported net income of $150,000 for 20X8 and paid total dividends of $72,000.Pullman uses the equity method to account for this investment.
-Based on the preceding information,what amount of investment income will Pullman Company report from its investment in Skate for the year?

Accepted Answer

Under the equity method, Pullman would recognize its share of Skate's net income adjusted for dividends received. Skate's net income is $150,000. Pullman owns 30% of Skate, so its share of the net income is 30% of $150,000 = $45,000. However, dividends paid reduce the carrying amount of the investment. The $72,000 in dividends includes preferred dividends. The preferred dividends are 5% of the $100,000 par value of the preferred stock, which equals $5,000 (5% of $100,000). Since there are 100,000 shares at $2 par, the total par value is $200,000, making the calculation for preferred dividends $200,000 * 5% = $10,000, not $5,000 as previously misstated. The common dividends would be the total dividends minus the preferred dividends ($72,000 - $10,000 = $62,000). Pullman's share of the common dividends is 30% of $62,000 = $18,600. Therefore, the investment income recognized is $45,000 (share of net income) - $18,600 (share of dividends received) = $26,400. However, none of the provided choices match this calculation, indicating a mistake in the dividend calculation or the interpretation of the question's details. Reevaluating the correct approach: Pullman's share of Skate's net income is indeed 30% of $150,000, which is $45,000. The error lies in the misinterpretation of how dividends are treated under the equity method. Under the equity method, the investor's share of dividends is subtracted from the carrying value of the investment, not from the investment income recognized. Therefore, the correct answer should reflect only the share of net income attributable to Pullman, which is $45,000, without adjusting for dividends in the calculation of investment income. This reevaluation points out a mistake in the initial explanation and calculation regarding the treatment of dividends under the equity method and the calculation of preferred dividends. Given the error in the explanation and the provided choices, the correct answer based on the initial information should be focused on the share of net income attributable to Pullman, which is $45,000, as none of the calculations for dividends correctly align with the standard approach for reporting investment income under the equity method. This highlights a critical oversight in the initial response.

Question 18

If instead,Poke could not exercise significant influence over the investee,what amount will be reported by Poke as balance in investment in Shove on December 31,20X8?

Accepted Answer

Poke does not have significant influence over Shove, so the investment in Shove should be reported at fair value. The fair value of the investment is $105,000 on December 31, 20X8.

Question 19

On January 1,20X7,Poke Corporation acquired 25 percent of the outstanding shares of Shove Corporation for $100,000 cash.Shove 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 Poke was $110,000 and $105,000 on December 31,20X7 and 20X8 respectively.
-Based on the preceding information,what amount will be reported by Poke as balance in investment in Shove on December 31,20X8,if it used the equity method of accounting?

Accepted Answer

Under the equity method, the investment in Shove is initially recorded at cost ($100,000). Then, the investment is adjusted for Poke Corporation's share of Shove's net income and dividends.

Shove's net income for 20X7 and 20X8 were both $75,000, and since Poke owns 25% of Shove, Poke's share of net income is $18,750 ($75,000 x 25%). Shove paid dividends of $30,000 in both years, so Poke's share of dividends is $7,500 ($30,000 x 25%) for each year.

Using these amounts, we can calculate the investment in Shove as follows:

Investment in Shove, 12/31/20X6: $100,000 
Add: Share of net income for 20X7: +$18,750 
Less: Share of dividends for 20X7: -$7,500 
Investment in Shove, 12/31/20X7: $111,250 ($100,000 + $18,750 - $7,500) 
Add: Share of net income for 20X8: +$18,750 
Less: Share of dividends for 20X8: -$7,500 
Investment in Shove, 12/31/20X8: $122,500 ($111,250 + $18,750 - $7,500)

Therefore, the answer is (D) $122,500.

Question 20

On January 1,20X7,Poke Corporation acquired 25 percent of the outstanding shares of Shove Corporation for $100,000 cash.Shove 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 Poke was $110,000 and $105,000 on December 31,20X7 and 20X8 respectively.
-Based on the preceding information,what amount will be reported by Poke as income from its investment in Shove for 20X8,if it used the equity method of accounting?

Accepted Answer

The answer of On January 1,20X7,Poke Corporation acquired 25 percent...

Quiz 2: Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries With No Differential