On January 1, 2015, Fargo Company purchased 30% of the common stock of Fairly Company for $80,000. The purchase was made at book value. Additional information for Fairly Company follows:
On Fargo's books, what would be the balance of Investment in Fairly Company at December 31, 2016?

Question

On January 1, 2015, Fargo Company purchased 30% of the common stock of Fairly Company for $80,000. The purchase was made at book value. Additional information for Fairly Company follows:  
On Fargo's books, what would be the balance of Investment in Fairly Company at December 31, 2016?

Quizplus · Accepted Answer

Since Fargo purchased 30% of Fairly Company's common stock, it should use the equity method to account for its investment. Under the equity method, Fargo would record its share of Fairly Company's net income or loss on its own income statement, and adjust the investment account accordingly.

In 2015, Fargo's investment in Fairly Company was recorded at $80,000, which is equal to Fairly's book value at that time. We know that there was no goodwill or other intangible assets involved in the purchase, so we can assume that the book value of Fairly's net assets is equal to their fair value.

In 2016, we need to take into account Fargo's share of Fairly's net income or loss. We're not given this information directly, but we do know that Fairly's retained earnings increased from $200,000 to $240,000. This means that Fairly had net income of $40,000 in 2016 ($240,000 - $200,000 = $40,000). Since Fargo owns 30% of Fairly, it would record its share of that net income, or $12,000, on its own income statement.

To calculate Fargo's investment in Fairly at the end of 2016, we need to start with the original investment of $80,000 and add the share of net income from 2016, or $12,000. This gives us a balance of $92,000. However, we also need to adjust for any dividends received from Fairly. The problem doesn't give us this information, so we'll assume that Fairly paid no dividends in 2016. Therefore, Fargo's investment in Fairly at December 31, 2016 would be $92,000.

On January 1, 2015, Fargo Company Purchased 30% of the Common