On January 1, 2010, Mehan, Incorporated purchased 15,000 shares of Cook Company for $150,000 giving Mehan a 15% ownership of Cook. On January 1, 2011 Mehan purchased an additional 25,000 shares (25%) of Cook for $300,000. This last purchase gave Mehan the ability to apply significant influence over Cook. The book value of Cook on January 1, 2010, was $1,000,000. The book value of Cook on January 1, 2011, was $1,150,000. Any excess of cost over book value for this second transaction is assigned to a database and amortized over five years. Cook reports net income and dividends as follows. These amounts are assumed to have occurred evenly throughout the years: On April 1, 2012, just after its first dividend receipt, Mehan sells 10,000 shares of its investment.
How much of Cook's net income did Mehan report for the year 2012?

Question

On January 1, 2010, Mehan, Incorporated purchased 15,000 shares of Cook Company for $150,000 giving Mehan a 15% ownership of Cook. On January 1, 2011 Mehan purchased an additional 25,000 shares (25%) of Cook for $300,000. This last purchase gave Mehan the ability to apply significant influence over Cook. The book value of Cook on January 1, 2010, was $1,000,000. The book value of Cook on January 1, 2011, was $1,150,000. Any excess of cost over book value for this second transaction is assigned to a database and amortized over five years. Cook reports net income and dividends as follows. These amounts are assumed to have occurred evenly throughout the years:  On April 1, 2012, just after its first dividend receipt, Mehan sells 10,000 shares of its investment.
How much of Cook's net income did Mehan report for the year 2012?

Quizplus · Accepted Answer

Mehan purchased 25% of Cook on January 1, 2011, giving it significant influence over Cook. Therefore, Mehan must use the equity method to account for its investment in Cook. Under the equity method, Mehan records its share of Cook's net income each period.

Mehan sold 10,000 shares on April 1, 2012, which means it held 30,000 shares for 3 months (January 1, 2012 to April 1, 2012) and 25,000 shares for the remaining 9 months of the year.

Mehan's share of Cook's net income for 2012 is calculated as follows:

Share of net income = Ownership percentage x Cook's net income

Ownership percentage = Average ownership percentage for the year

Average ownership percentage for the year = [(Ownership percentage as of January 1, 2012 x Number of months held) + (Ownership percentage as of December 31, 2012 x Number of months held)] / 12 months

Ownership percentage as of January 1, 2012 = 25%

Ownership percentage as of December 31, 2012 = 20% (due to the sale of 10,000 shares)

Number of months held with 25% ownership = 9 months

Number of months held with 20% ownership = 3 months

Average ownership percentage for the year = [(25% x 9) + (20% x 3)] / 12 = 23.75%

Cook's net income for 2012 = $310,000

Mehan's share of net income = 23.75% x $310,000 = $73,625

However, Mehan amortizes the excess of cost over book value from the second transaction over five years. The excess of cost over book value is $300,000 - ($1,150,000 x 25%) = $62,500.

The amount of excess of cost over book value amortized in 2012 is $62,500 / 5 = $12,500.

Thus, Mehan's reported net income from Cook for 2012 is $73,625 - $12,500 = $61,125.

Since the question asks for the amount of Cook's net income that Mehan reported (not its reported net income from Cook), we add back the excess of cost over book value amortization:

$61,125 + $12,500 = $73,625, which is closest to answer choice B.

On January 1, 2010, Mehan, Incorporated Purchased 15,000 Shares of Cook