Hope Company bought 30% of Faith Corporation in the beginning of 2016.Hope's purchase price equaled 30% of the book value of Faith's net identifiable assets,which also equaled 30% of the fair value of Faith.During 2016,Faith reported net income in the amount of $4,000,000 and declared and paid dividends in the amount of $500,000.Hope mistakenly accounted for the investment as available for sale instead of using the equity method.What effect would this error have on the investment account and net income,respectively,for 2016?

Question

Quizplus · Accepted Answer

The investment account is understated by $1,050,000 because Hope did not recognize its share of Faith's net income ($4,000,000 * 30% = $1,200,000) and did not reduce the investment by its share of dividends ($500,000 * 30% = $150,000). Net income is understated by $1,050,000 because Hope did not recognize its share of Faith's net income.

Hope Company Bought 30% of Faith Corporation in the Beginning