Dodge, Incorporated acquires 15% of Gates Corporation on January 1, 2011, for $105,000 when the book value of Gates was $600,000. During 2011 Gates reported net income of $150,000 and paid dividends of $50,000. On January 1, 2012, Dodge purchased an additional 25% of Gates for $200,000. Any excess cost over book value is attributable to goodwill with an indefinite life. The fair-value method was used during 2011 but Dodge has deemed it necessary to change to the equity method after the second purchase. During 2012 Gates reported net income of $200,000 and reported dividends of $75,000. Which adjustment would be made to change from the fair-value method to the equity method?

Question

Quizplus · Accepted Answer

The adjustment involves recognizing the share of net income earned during the period when the fair-value method was used. Dodge's share of Gates' 2011 net income is 15% of $150,000, which is $22,500. Under the fair-value method, only dividends received would have been recognized as income, which is 15% of $50,000, or $7,500. The difference of $15,000 ($22,500 - $7,500) should be credited to retained earnings to adjust for the change to the equity method.

Dodge, Incorporated Acquires 15% of Gates Corporation on January 1