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 is the gain/loss on the sale of the 10,000 shares?

Question

Quizplus · Accepted Answer

The investment in Hefly Corp. was accounted for using the equity method since Mason Co. had the ability to exercise significant influence over the operations of Hefly. The initial investment was recorded at cost ($560,000) and subsequently adjusted each year for Mason's share of Hefly's earnings (income) and dividends.

Year 2011:
Mason's share of Hefly's income = 40% x $150,000 = $60,000
Mason's share of Hefly's dividends = 40% x $40,000 = $16,000
Mason's ending balance in Hefly = $560,000 + $60,000 - $16,000 = $604,000

On January 2, 2012, Mason sold 10,000 shares for $150,000. The shares sold represent 25% (10,000/40,000) of Mason's original investment. The total gain/loss on the sale is calculated as follows:

Sale price of 10,000 shares = $150,000
Mason's original cost of 10,000 shares = 25% x $560,000 = $140,000
Mason's ending balance in Hefly after the sale = $604,000 - $150,000 = $454,000
Carrying value of Mason's remaining 30,000 shares = $454,000 / 30,000 = $15.13 per share

Gain/loss on sale of 10,000 shares = Sale price - Original cost = $150,000 - $140,000 = $10,000 loss.