On January 4, 2011, Mason Co. purchased 40,000 shares (40%) of the common stock of Hefly Corp., paying $560,000. At that time, the book value and fair value of Hefly's net assets was $1,400,000. The investment gave Mason the ability to exercise significant influence over the operations of Hefly. During 2011, Hefly reported income of $150,000 and paid dividends of $40,000. On January 2, 2012, Mason sold 10,000 shares for $150,000. What was the balance in the investment account before the shares were sold?

Question

Quizplus · Accepted Answer

After the purchase of 40% of Hefly's common stock paying $560,000, the book value of Hefly's net assets was ($1,400,000/100%) x 40% = $560,000, which is equal to the purchase price.

Thus, the initial entry to record the purchase would be:
Investment in Hefly Corp.  $560,000
  Cash  $560,000

During 2011, Mason would record their share of Hefly's income and dividends using the equity method (40% x $150,000 = $60,000 income from Hefly, 40% x $40,000 = $16,000 dividends from Hefly).

Thus, the entry to record the income and dividends would be:
Investment in Hefly Corp.  $60,000
  Equity in income of Hefly Corp.  $60,000
Investment in Hefly Corp.  $16,000
  Cash  $16,000

The balance in the investment account at the end of 2011 would be:
$560,000 (initial investment) + $60,000 (share of income) - $16,000 (share of dividends) = $604,000

After selling 10,000 shares for $150,000, the new ownership percentage would be 30% (30,000 shares/100,000 outstanding shares) and the investment account would be adjusted accordingly. However, the question asks for the balance in the investment account before the shares were sold, so the correct answer is D) $604,000.