On January 1, 2010, Franel Co. acquired all of the common stock of Hurlem Corp. For 2010, Hurlem earned net income of $360,000 and paid dividends of $190,000. Amortization of the patent allocation that was included in the acquisition was $6,000. How much difference would there have been in Franel's income with regard to the effect of the investment, between using the equity method or using the initial value method of internal recordkeeping?

Question

Quizplus · Accepted Answer

Using the initial value method, Franel would record the investment at its cost of acquisition, which is the initial price paid for the acquisition. In this case, the acquisition cost is not given, so we cannot determine the exact value using the initial value method.

Using the equity method, Franel would recognize its share of Hurlem's net income and dividends. The share of net income would be $360,000, and the share of dividends would be $190,000. Thus, Franel's income from the investment would be $170,000 ($360,000 - $190,000).

Therefore, the difference between using the equity method and initial value method would be $170,000 - $6,000 = $164,000.