Chapter 02 - Reporting Intercorporate Interests

CHAPTER 2 REPORTING INTERCORPORATE INTERESTS ANSWERS TO QUESTIONS Q2-1 (a) An investment in the voting common stock of another company is reported on an equity-method basis when the investor is able to significantly influence the operating and financial policies of the investee. (b) The cost method normally is used for investments in common stock when the investor does not have significant influence and for investments in preferred stock and other securities. The amounts reported in the financial statements may require adjustment to fair value if they fall under the provisions of FASB Statement No. 115. Q2-2 Significant influence occurs when the investor has the ability to influence the operating and financial policies of the investee. Representation on the board of directors of the investee is perhaps the strongest evidence, but other evidence such as routine participation in management decisions or entering into formal agreements that give the investor some degree of influence over the investee also may be used. Q2-3 Equity-method reporting should not be used when (a) an investee is in reorganization or liquidation, (b) the investee has initiated litigation or complaints challenging the investor's ability to exercise significant influence, (c) the investor signs an agreement surrendering its ability to exercise significant influence, (d) majority ownership is concentrated in a small group that operates the company without regard to the investor's desires, (e) the investor is not able to acquire the information needed to use equity-method reporting, or (f) the investor tries and fails to gain representation on the board of directors. Q2-4 The balances will be the same at the date of acquisition and in the periods that follow whenever the cumulative dividends paid by the investee equal or exceed the investee's cumulative earnings since the date of acquisition. The latter case assumes there are no other adjustments needed under the equity method for amortization of differential or other factors. Q2-5 When a company has used the cost method and purchases additional shares which cause it to gain significant influence, a retroactive adjustment is recorded to move from a cost basis to an equity-method basis in the preceding periods. Dividend income is replaced by income from the investee and dividends received are treated as an adjustment to the investment account.

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Chapter 02 - Reporting Intercorporate Interests

Q2-6 An investor considers a dividend to be a liquidating dividend when the cumulative dividends received from the investee exceed a proportionate share of the cumulative earnings of the investee from the date ownership was acquired. For example, an investor would consider a dividend to be liquidating if it purchases shares of another company in early December and receives a dividend at year-end substantially in excess of its portion of the investee's net income for December. On the other hand, the investee may have reported net income well in excess of the total dividends paid for the year and would not consider the dividends to be liquidating dividends. Q2-7 Liquidating dividends decrease the investment account in both cases. All dividends are treated as a reduction of the investment account when equity-method reporting is used. When the cost method is used and dividends are received in excess of a proportionate share of investee earnings since acquisition, they are treated as a reduction of the investment account as well. Q2-8 The carrying value of the investment is reduced under equity method reporting when (a) a dividend is received from the investee, (b) a differential is amortized, (c) an impairment of goodwill occurs, and (d) the market value of the investment declines and is less than the carrying value and it is concluded the decline is other than temporary. Q2-9 A corporate joint venture is a company that is established and operated by a small group of investors, none of whom holds a majority of the ownership. Because there are only a few owners and each investor normally is expected to have significant influence, equitymethod reporting generally is appropriate in accounting for ownership in a corporate joint venture. Q2-10 A differential occurs when an investor pays more than or less than underlying book value in acquiring ownership of an investee. (a) In the case of the cost method, no adjustments are made for amortization of the differential on the investor's books. (b) Under equity-method reporting the difference between the amount paid and book value must be assigned to appropriate asset and liability accounts of the acquired company. If any portion of the differential is assigned to an amortizable or depreciable asset, that amount must be charged against income from the investee over the remaining economic life of the asset. Q2-11 A dividend is treated as a reduction of the investment account under equity-method reporting. Unless it is a liquidating dividend, it is treated as dividend income under the cost method.

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Chapter 02 - Reporting Intercorporate Interests

Q2-12 Amortization of a differential is the most common reason for investment income to be lower than a proportionate share of reported income of the investee. If Turner Company has paid more than book value for the shares of Straight Lace Company, the differential must be assigned to identifiable assets and liabilities of the investee, or to goodwill. Those amounts assigned to depreciable and identifiable intangible assets must be amortized and will reduce equity-method income over the remaining economic lives of the underlying assets. Amounts attributable to other items such as land or inventories must be treated as a reduction of income in the period in which Straight Lace disposes of the item. Income also will be lower if the investee has been involved in sales to related companies during the period and there are unrealized profits from those intercompany sales; the income of the selling affiliate must be reduced by the unrealized profits before equity-method income is computed. Finally, if Straight Lace has preferred stock outstanding, preferred dividends must be deducted before assigning earnings to common shareholders. Q2-13 Dividends received by the investor are recorded as dividend income under both the cost and fair value methods. The change in the fair value of the shares held by the investor is recorded as an unrealized gain or loss under the fair value method. The fair value method differs from the equity method in two respects. Under the equity method the investors share of the earnings of the investee are included as investment income and dividends received from the investee are treated as a reduction of the investment account. Q2-14 The change in the fair value of the shares held by the investor is reported as an unrealized gain or loss and dividends received from the investee are reported as dividend income. Q2-15 Clear-cut measures of control are not always readily available. For example, a partner contributing a specified share of the partnerships capital may have a different share of profits or losses, a different proportion of distributions, or a greater or lesser degree of control than indicated by the capital share. Q2-16 There may be situations in which a company has significant influence over another without holding voting common stock. For example, a company might use operating agreements or other contracts to share in the profits of another company, guarantee a certain level of profitability of another company, or participate in the operating decisions of another company. Q2-17* In general, tax allocation procedures should be used whenever there is a difference between dividends received from the investee and the amount of investment income recorded by the investor. Tax allocation is not needed if the companies file a joint tax return or if the investee's earnings can be transferred to the investor in a tax-free transfer. Q2-18* The amount should be larger under the equity method. There should be no need to use tax allocation when the cost method is used in accounting for the investee. Dividends received and taxable income are likely to be the same. Tax allocation normally is needed under the equity method, due to the difference between income recorded and dividends received.

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Chapter 02 - Reporting Intercorporate Interests

Q2-19* When the basic equity method is used, a proportionate share of subsidiary net income and dividends is recorded on the parent's books and an appropriate amount of any differential is amortized each period. No other adjustments are recorded. Under the fullyadjusted equity method, the parent's books also are adjusted for unrealized profits and any other items that are needed to bring the investor's net income into agreement with the income to the controlling interest that would be reported if consolidation were used. Q2-20* One-line consolidation implies that under equity-method reporting the investor's net income and stockholders' equity will be the same as if the investee were consolidated. Income from the investee is included in a single line in the investor's income statement and the investment is reported as a single line in the investor's balance sheet. Q2-21* The term basic equity method generally is used when the investor records its portion of the reported net income and dividends of the investee and amortizes an appropriate portion of any differential. Unlike the fully-adjusted equity method, no adjustment for unrealized profit on intercompany transfers normally is made on the investor's books. When an investee is consolidated for financial reporting purposes, the investor may not feel it is necessary to record fully-adjusted equity method entries on its books since income from the investee and the balance in the investment account must be eliminated in preparing the consolidated statements. Q2-22* The investor reports a proportionate share of an investee's extraordinary item as an extraordinary item in its own income statement.

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Chapter 02 - Reporting Intercorporate Interests

SOLUTIONS TO CASES C2-1 Choice of Accounting Method a. The equity method is to be used when an investor has significant influence over an investee. Significant influence normally is assumed when more than 20 percent ownership is held. Factors to be considered in determining whether to apply equity-method reporting include the following: 1. Is the investee under the control of the courts or other parties as a result of filing for reorganization or entering into liquidation procedures? 2. Does the investor have representation on the board of directors, or has it attempted to gain representation and been unable to do so? 3. Has the investee initiated litigation or complaints challenging the investor's ability to exercise significant influence? 4. Has the investor signed an agreement surrendering its ability to exercise significant influence? 5. Is majority ownership concentrated in a small group that operates the company without regard of the wishes of the investor? 6. Is the investor able to acquire the information needed to use equity-method reporting? b. When subsidiary net income is greater than dividends paid, equity-method reporting is likely to show a larger reported contribution to the earnings of Slanted Building Supplies. If 20X4 earnings are negative or less than dividends distributed in 20X4, the cost basis is likely to result in a larger contribution to Slanted's reported earnings. c. As the investor uses more of its resources to acquire ownership of the investee, and as the investor has a greater share of the investee's profits and losses, the success of the investee's operations may have more of an impact on the overall financial well-being of the investor. In many cases, the investor will want to participate in key decisions of the investee once the investor's ownership share reaches a certain level. Also, use of the equity method eliminates the possibility of the investor manipulating its own income by influencing investee dividend distributions, as might occur under the cost method.

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Chapter 02 - Reporting Intercorporate Interests

C2-2 Intercorporate Ownership MEMO To: Chief Accountant Most Company , CPA Equity Method Reporting for Investment in Adams Company

From: Re:

The equity method should be used in reporting investments in which the reporting company has a significant influence over the operating and financing decisions of another company. In this case, Most Company holds 15 percent of the voting common stock of Adams Company and Port Company holds an additional 10 percent. During the course of the year, both Most and Port are likely to use the cost method in recording their respective investments in Adams. However, when consolidated statements are prepared for Most, the combined ownership must be used in determining whether significant influence exists. Both direct and indirect ownership must be taken into consideration. [APB 18, Par. 17] A total of 15 percent of the voting common stock of Adams is held directly by Most Company and an additional 10 percent is controlled indirectly though Mosts ownership of Port Company. Equity-method reporting for the investment in Adams Company therefore appears to be required. If the cost method has been used by Most and Port in recording their investments during the year, at the time consolidated statements are prepared, adjustments must be made to (a) increase the balance in the investment account for a proportionate share of the investees reported net income (25 percent) and reduce the balance in the investment account for a proportionate share of the dividend paid by the investee, (b) include a proportionate share of the investees net income in the consolidated income statement, (c) delete any dividend income recorded by Most and Port, and (d) if ownership was purchased at an amount greater than a proportionate share of the fair value of the investees net assets at the date of purchase, it may be necessary to amortize a portion of the differential assigned to depreciable or amortizable assets. Primary citation APB 18, par. 17

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Chapter 02 - Reporting Intercorporate Interests

C2-3 Application of the Equity Method MEMO To: Controller Forth Company , CPA Equity Method Reporting for Investment in Brown Company

From: Re:

This memo is prepared in response to your request regarding use of the cost or equity methods in accounting for Forths investment in Brown Company. Forth Company held 85 percent of the common stock of Brown Company prior to January 1, 20X2, and was required to fully consolidate Brown Company in its financial statements prepared prior to that date [FASB 94]. Forth now holds only 15 percent of the common stock of Brown. The cost method is normally used in accounting for ownership when less than 20 percent of the stock is directly or indirectly held by the investor. Equity-method reporting should be used when the investor has significant influence over operating and financing policies of the investee. While 20 percent ownership is regarded as the level at which the investor is presumed to have significant influence, other factors must be considered as well. [APB 18, Par. 17] Although Forth currently holds only 15 percent of Browns common stock, the other factors associated with its ownership indicate that Forth does exercise significant influence over Brown. Forth has two members on Browns board of directors, it purchases a substantial portion of Browns output, and Forth appears to be the largest single shareholder by virtue of its sale of 10,000 shares to each of 7 other investors. These factors provide strong evidence that Forth has significant influence over Brown and points to the need to use equity-method reporting for its investment in Brown. Your office should monitor the activities of the FASB with respect to consolidation standards [www.fasb.org]. Active consideration is being given to situations in which control may be exercised even though the investor does not hold majority ownership. It is conceivable that your situation might be one in which consolidation could be required. Primary citations APB 18, par. 17 FASB 94

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Chapter 02 - Reporting Intercorporate Interests

C2-4 Complex Organizational Structures a. Atlas America is a corporation. Its operations involve the development, production, and distribution of natural gas, and to a lesser extent, oil. It also offers tax-advantaged investment programs for gas and oil investors. b. The subsidiaries of Atlas America include corporations, limited liability companies (LLCs), and both general and limited partnerships. The company fully consolidates its subsidiaries. In accordance with industry practice, the company reflects its interests in energy partnerships in its consolidated statements using pro rata consolidation. c. Atlas Pipeline Holdings is a subsidiary of Atlas America. It has complete ownership of Atlas Pipeline Partners GP, LLC, a limited liability company that is the general partner of Atlas Pipeline Partners, L.P. The only cash generating assets of Atlas Pipeline Holdings are its indirect interests in Atlas Pipeline Partners, L.P. d. Atlas Pipeline Partners, L.P. is a partnership, specifically a publicly-traded limited partnership. A limited partnership must have at least one general partner with unlimited liability, and it may have numerous limited partners whose liability is limited and may not participate in the management of the partnership. Atlas Pipeline Partners, L.P. has a number of subsidiaries, including general and limited partnerships, corporations, and limited liability companies. Limited liability companies, in general, have the advantages of corporations with less of the formalities. They often have certain tax advantages over corporations. Atlas Pipeline Partners, L.P. is managed by its general partner, Atlas Pipeline Partners GP, LLC. The executives responsible for Atlas Pipelines management are employees of Atlas America, as indicated in Atlas Pipelines Form 10-K, in the item entitled Directors and Executive Officers of the Registrant. These employees not only manage Atlas Pipeline Partners, L.P., but also Atlas America and its other affiliates. e. Atlas Pipeline Partners, L.P. presents consolidated financial statements in which it consolidates all of its wholly-owned and majority-owned subsidiaries. NOARK Pipeline System is a limited partnership that is 100 percent owned by Atlas Pipeline Partners. Prior to 2006, Atlas Pipeline Partners owned 75 percent of NOARK. Atlas consolidates 100 percent of NOARK, and previously also consolidated 100 percent of NOARK even though it was only 75 percent owned. f. Prior to 2004, Atlas America was a wholly owned subsidiary of Resource America, Inc. In 2004, Atlas America had an initial public offering of common stock, with the proceeds distributed to Resource America. Subsequently, Resource America spun off Atlas America by distributing its shares to its stockholders.

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Chapter 02 - Reporting Intercorporate Interests

C2-5 Evaluating Investments a. Dow Chemical has well over 100 subsidiaries, as shown in its Form 10-K, Exhibit 21. According to the companys Principles of Consolidation and Basis of Presentation in its 10K, Dow consolidates all majority-owned subsidiaries over which it has control and also entities for which Dow has a controlling financial interest. Intercompany transactions and balances are eliminated. b. Dow reports investments in nonconsolidated affiliates using the equity method. It includes joint ventures, partnerships, and companies that are 20 to 50 percent owned in the category of nonconsolidated affiliates. Several of Dows nonconsolidated affiliates are 50-percent owned and several are 49-percent owned. Excluding several special-situation investments, the total differential was $65 million at December 31, 2006, and $61 million at December 31, 2005. The differentials relating to MEGlobal, Equipolymers, and EQUATE Petrochemical were negative differentials resulting from a difference in valuations between U.S. and foreign accounting principles. c. The evaluation of Dows goodwill for impairment is performed in conjunction with the companys annual budgeting process. d. Dow Chemicals 50-percent investment in Dow Corning suffered a significant loss in value judged to be other than temporary in 1995 when Dow Corning declared bankruptcy. As discussed in Dows 2005 Form 10-K, the company wrote down the investment and recognized a loss at the time of the bankruptcy.

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Chapter 02 - Reporting Intercorporate Interests

C2-6 Reporting Significant Investments in Common Stock Answers to this case can be found in the annual reports to stockholders of the companies mentioned and in their 10-K filings with the SEC (available at www.sec.gov). a. Before 1998, Harley-Davidson reported its investment in the common stock of Buell Motorcycle Company using the equity method. The 49 percent investment that Harley held since 1993 gave it the ability to significantly influence Buell. In 1998, Harley purchased substantially all remaining shares of Buell and, therefore, Harley fully consolidates Buell in its general-purpose financial statements. b. Chevron fully consolidates its controlled subsidiaries that are majority owned and variable interest entities of which it is the primary beneficiary. The company uses pro rata consolidation in reporting its undivided interests in oil and gas joint ventures. Chevron uses the equity method to report its investments in affiliates over which the company exercises significant influence or has an ownership interest of 20 to 50 percent. In applying the equity method, Chevron recognizes in income gains and losses from changes in its proportionate dollar share of an affiliates equity resulting from issuance of additional stock by the affiliate. Chevron analyses any difference between the carrying value of an equity-method investment and its underlying book value and, to the extent that it can, assigns that differential to specific assets and liabilities. The company adjusts quarterly its equity-method income recognized from affiliates for any write-off or amortization of the differential. Chevron assesses it equity investments for possible impairment when events indicate a possible impairment. If an investment has declined in value, the company evaluates the situation to determine if the decline is other than temporary. If the decline in value is judged to be other than temporary, the investment is written down to its fair value and a loss recognized in income. Subsequent recoveries in value are not recognized. Chevron owns approximately 19 percent (as of December 31, 2006) of Dynegys common stock. It accounts for its investment using the equity method. The carrying amount of Chevrons investment in Dynegys common stock is less that its proportionate interest in Dynegys net assets because the investment was written down in 2002 for a decline in value that was judged to be other than temporary. c. PepsiCo reports investments in unconsolidated affiliates over which it exercises significant influence using the equity method. Prior to 1999, equity-method income or loss from these affiliates was included in selling, general and administrative expenses. Obviously, this is not an appropriate classification for equity-method income from affiliates, but it could be justified if the amounts are considered to be immaterial. In 1999, PepsiCo started reporting its income from equity-method investments separately in the income statement. Equity-method income from affiliates currently is reported in the consolidated income statement as bottling equity income. d. Sears has investments in the voting securities of a number of companies that it accounts for using the equity method. Where these investments are reported is difficult to tell from the financial statements and notes. Apparently the amounts involved are relatively small, and the investments are included in other assets on the balance sheet, with the income reported in other income on the income statement.

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Chapter 02 - Reporting Intercorporate Interests

SOLUTIONS TO EXERCISES E2-1 Multiple-Choice Questions on Use of Cost and Equity Methods [AICPA Adapted] 1. a 2. a 3. d 4. a 5. b 6. d 7. d

E2-2 Multiple-Choice Questions on Intercorporate Investments 1. b 2. c 3. d 4. a 5. a

E2-3 Multiple-Choice Questions on Applying Equity Method [AICPA Adapted] 1. c 2. d $250,000 + ($100,000 x .30) [($200,000 x .30)/15 years)] 3. c 4. d 5. d

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Chapter 02 - Reporting Intercorporate Interests

E2-4 Cost versus Equity Reporting a. Cost-method journal entries recorded by Roller Corporation: 20X5 Investment in Steam Company Stock Cash Record purchase of Steam Company stock. Cash Dividend Income Record dividend income from Steam Company: $5,000 x .20 20X6 Cash Dividend Income Record dividend income from Steam Company: $15,000 x .20 Cash Dividend Income Record dividend income from Steam Company: $35,000 x .20 Note: Cumulative dividends do not exceed cumulative earnings to date. 70,000 70,000

1,000

1,000

3,000

3,000

20X7

7,000

7,000

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Chapter 02 - Reporting Intercorporate Interests

E2-4 (continued) b. Equity-method journal entries recorded by Roller Corporation: 20X5 Investment in Steam Company Stock Cash Record purchase of Steam Company stock. Cash Investment in Steam Company Stock Record dividend from Steam Company. Investment in Steam Company Stock Income from Steam Company Record equity-method income. Income from Steam Company Investment in Steam Company Stock Amortize differential: [$70,000 - ($200,000 x .20)] / 10 years 20X6 Cash Investment in Steam Company Stock Record dividend from Steam Company. Investment in Steam Company Stock Income from Steam Company Record equity-method income. Income from Steam Company Investment in Steam Company Stock Amortize differential. 20X7 Cash Investment in Steam Company Stock Record dividend from Steam Company. Investment in Steam Company Stock Income from Steam Company Record equity-method income. Income from Steam Company Investment in Steam Company Stock Amortize differential. 70,000 70,000

1,000

1,000

4,000

4,000

3,000

3,000

3,000

3,000

8,000

8,000

3,000

3,000

7,000

7,000

4,000

4,000

3,000

3,000

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Chapter 02 - Reporting Intercorporate Interests

E2-5 Cost versus Equity Reporting a. Winston Corporation net income cost method: 20X2 20X3 20X4
a

$100,000 $ 60,000 $250,000

+ + +

.40($30,000) .40($60,000) .40($20,000

$25,000)

$112,000 84,000 268,000

Dividends paid from undistributed earnings of prior years ($70,000 + $40,000 - $30,000 - $60,000 = $20,000) and $25,000 earnings of current period.

b. Winston Corporation net income equity method: 20X2 20X3 20X4 $100,000 $ 60,000 $250,000 + + + .40($70,000) .40($40,000) .40($25,000) $128,000 76,000 260,000

E2-6 Acquisition Price Balance at date of acquisition: a. Cost method b. Equity method $54,000 + $2,800 = $56,800 $54,000 - $2,000 = $52,000 Dividends $15,000 10,000 10,000 Change in Investment Account Cost Method Equity Method $(2,800) $(2,800) 800 ______ 4,000 $(2,800) $ 2,000

Year Net Income 20X1 $ 8,000 20X2 12,000 20X3 20,000 Change in account balance

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Chapter 02 - Reporting Intercorporate Interests

E2-7 Investment Income a. (1) Ravine Corporation net income under Cost Method: 20X6 20X7 20X8 20X9 $140,000 $ 80,000 $220,000 $160,000 + + + + .30($20,000) .30($40,000) .30($30,000) .30($20,000) = = = = $146,000 $ 92,000 $229,000 $166,000

(2) Ravine Corporation net income under Equity Method: 20X6 20X7 20X8 20X9 $140,000 $ 80,000 $220,000 $160,000 + + + + .30($30,000) .30($50,000) .30($10,000) .30($40,000) = = = = $149,000 $ 95,000 $223,000 $172,000

b. Journal entries recorded by Ravine Corporation in 20X8: (1) Cost method: Cash Dividend Income Investment in Valley Stock (2) Equity method: Cash Investment in Valley Stock Investment in Valley Stock Income from Valley 12,000 3,000 12,000 3,000 12,000 9,000 3,000

E2-8 Impairment of Investment Value The following amounts would be reported as the carrying value of Ports investment in Sund: 20X2 20X3 20X4 $184,500 $193,500 $135,000 = = = $180,000 + ($40,000 x .30) - ($25,000 x .30) $184,500 + ($30,000 x .30) $4.50 x 30,000 shares; prior to adjustment, the carrying value at the end of 20X4 would be $195,000 [$193,500 + ($5,000 x .30)]

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Chapter 02 - Reporting Intercorporate Interests

E2-9 Alternative Reporting for Investment in Partnership Moss Company Balance Sheet Pro Rata Equity Method Consolidation $510,000 $622,500(d) 99,000(b) $609,000 $ 40,000 569,000(c) $609,000 $622,500 $ 53,500(e) 569,000(c) $622,500 Full Consolidation $760,000(f) $760,000 $ 70,000(g) 121,000(h) 569,000(c) $760,000

Assets Investment in TF Partnership Total Assets Liabilities Interest of Outside Partners Owners Equity Total Liabilities and Equity (a) (b) (c) (d) (e) (f) (g) (h)

Cost Method $510,000 90,000 $600,000 $ 40,000 560,000(a) $600,000

$560,000 = $510,000 + $90,000 - $40,000 $99,000 = $90,000 + [($220,000 - ($90,000/.45)) x .45] $569,000 = $560,000 + [($220,000 - ($90,000/.45)) x .45] $622,500 = $510,000 + ($250,000 x .45) $53,500 = $40,000 + ($30,000 x .45) $760,000 = $510,000 + $250,000 $70,000 = $40,000 + $30,000 $121,000 = [($250,000 - $30,000) x .55]

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Chapter 02 - Reporting Intercorporate Interests

E2-10 Differential Assigned to Patents Journal entries recorded by Power Corporation: 20X2 Investment in Snow Corporation Stock Common Stock Additional Paid-In Capital Record purchase of Snow Corporation stock. Cash Investment in Snow Corporation Stock Record dividend from Snow Corporation: $20,000 x .35 Investment in Snow Corporation Stock Income from Snow Corporation Record equity-method income: $56,000 x .35 Income from Snow Corporation Investment in Snow Corporation Stock Amortize differential: [$360,000 - ($980,000 x .35)] / 8 years 20X3 Cash Investment in Snow Corporation Stock Record dividend from Snow Corporation: $10,000 x .35 Loss from Snow Corporation Investment in Snow Corporation Stock Record equity-method loss: $44,000 x .35 Loss from Snow Corporation Investment in Snow Corporation Stock Amortize differential. 360,000 90,000 270,000

7,000

7,000

19,600

19,600

2,125

2,125

3,500

3,500

15,400

15,400

2,125

2,125

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Chapter 02 - Reporting Intercorporate Interests

E2-11 Differential Assigned to Copyrights Journal entries recorded by Best Corporation: 20X7 Investment in Flair Company Stock Cash Bonds Payable Record purchase of Flair Company stock. Cash Investment in Flair Company Stock Record dividend from Flair Company: $24,000 x .25 Loss from Flair Company Investment in Flair Company Stock Record equity-method loss: $88,000 x .25 Loss from Flair Company Investment in Flair Company Stock Amortize differential: Book value of assets Book value of liabilities Net book value Fair value increment Fair value of net assets Portion of ownership purchased Fair value of assets acquired Amount paid Differential Period of amortization (years) Amortization per period 20X8 Cash Investment in Flair Company Stock Record dividend from Flair Company: $24,000 x .25 Investment in Flair Company Stock Income from Flair Company Record equity-method income: $120,000 x .25 Income from Flair Company Investment in Flair Company Stock Amortize differential. 196,000 26,000 170,000

6,000

6,000

22,000

22,000

5,250 $740,000 (140,000 ) $600,000 16,000 $616,000 x .25 $154,000 196,000 $ 42,000 8 $ 5,250 6,000

5,250

6,000

30,000

30,000

5,250

5,250

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Chapter 02 - Reporting Intercorporate Interests

E2-12 Differential Attributable to Depreciable Assets a. Journal entries recorded by Capital Corporation using the equity method: 20X4 Investment in Cook Company Stock Cash Record purchase of Cook Company Stock. Cash Investment in Cook Company Stock Record dividend from Cook Company: $6,000 x .40 Investment in Cook Company Stock Income from Cook Company Record equity-method income: $10,000 x .40 Income from Cook Company Investment in Cook Company Stock Amortize differential: $16,000 / 10 years 20X5 Cash Investment in Cook Company Stock Record dividend from Cook Company: $9,000 x .40 Investment in Cook Company Stock Income from Cook Company Record equity-method income: $20,000 x .40 Income from Cook Company Investment in Cook Company Stock Amortize differential. b. Journal entries recorded by Capital Corporation using the cost method: 20X4 Investment in Cook Company Stock Cash Record purchase of Cook Company Stock. Cash Dividend Income Record dividend income from Cook Company. 20X5 Cash Dividend Income Record dividend income from Cook Company. 136,000 136,000 136,000 136,000

2,400

2,400

4,000

4,000

1,600

1,600

3,600

3,600

8,000

8,000

1,600

1,600

2,400

2,400

3,600

3,600

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Chapter 02 - Reporting Intercorporate Interests

E2-13 Investment Income Brindle Company reported equity-method income of $13,000, computed as follows: Proportionate share of reported income ($68,000 x .25) Amortization of differential: Land ($7,500: not amortized) Equipment ($20,000 / 5 years) Goodwill ($19,500: not amortized) Investment Income Assignment of differential Purchase price Proportionate share of book value of net assets [($690,000 - $230,000) x .25] Differential Differential assigned to land ($30,000 x .25) Differential assigned to equipment ($80,000 x .25) Differential assigned to goodwill $162,000 (115,000) $ 47,000 (7,500) (20,000) $ 19,500 $17,000 $ -04,000 -0-

(4,000) $13,000

E2-14 Determination of Purchase Price Investment account balance December 31, 20X6 Increase in account balance during 20X5: Proportionate share of income ($110,000 x .30) Amortize differential ($28,000 / 8 years) Dividend received ($50,000 x .30) Decrease in account balance during 20X6: Proportionate share of income ($20,000 x .30) Amortize differential ($28,000 / 8 years) Dividend received ($40,000 x .30) Investment account balance at date of purchase $161,000

$ 33,000 (3,500) (15,000) $ 6,000 (3,500) (12,000)

(14,500)

9,500 $156,000

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Chapter 02 - Reporting Intercorporate Interests

E2-15 Correction of Error Required correcting entry: Investment in Case Products Stock Dividend Income Income from Case Products Retained Earnings Computation of correction of investment account Addition to account for investment income: 20X6: $40,000 x .40 20X7: $60,000 x .40 20X8: $80,000 x .40 Deduction for dividends received: 20X6: $15,000 x .40 20X7: $20,000 x .40 20X8: $20,000 x .40 Amortization of differential: Purchase price Proportionate share of book value of net assets [.40($60,000 + $40,000)] Amount of differential Amortization for 3 years [($16,000 / 8) x 3] Required correction of investment account Computation of correction of retained earnings of Grand Corporation Dividend income recorded in 20X6: $15,000 x .40 20X7: $20,000 x .40 Equity-method income in 20X6: ($16,000 - $2,000) 20X7: ($24,000 - $2,000) Required correction of retained earnings $ 6,000 8,000 $14,000 22,000 ($14,000) 36,000 $22,000 $16,000 24,000 32,000 $ 6,000 8,000 8,000 $56,000 (40,000) $16,000 (6,000) $44,000 44,000 8,000

30,000 22,000

$72,000

(22,000)

2-21

Chapter 02 - Reporting Intercorporate Interests

E2-16 Differential Assigned to Land and Equipment Journal entries recorded by Rod Corporation: (1) Investment in Stafford Corporation Stock Cash Record purchase of Stafford Stock. (2) Cash Investment in Stafford Corporation Stock Record dividend from Stafford: $15,000 x .30 (3) Investment in Stafford Corporation Stock Income from Stafford Record equity-method income: $40,000 x .30 (4) Income from Stafford Investment in Stafford Corporation Stock Amortize differential assigned to equipment. 65,000 65,000

4,500

4,500

12,000

12,000

1,000

1,000

2-22

Chapter 02 - Reporting Intercorporate Interests

E2-17 Equity Entries with Goodwill Journal entries recorded following purchase: (1) Investment in Turner Corporation Stock Cash Record purchase of Turner stock. (2) Cash Investment in Turner Corporation Stock Record dividend from Turner: $8,000 x .40 (3) Investment in Turner Corporation Stock Income from Turner Corporation Record equity-method income: $40,000 x .40 (4) Income from Turner Corporation Stock Investment in Turner Corporation Write off differential assigned to inventory carried on FIFO basis: $10,000 x .40 (5) Income from Turner Corporation Stock Investment in Turner Corporation Amortize differential assigned to buildings and equipment: [$240,000 - ($300,000 - $150,000)] x .40 10 years 175,000 175,000

3,200

3,200

16,000

16,000

4,000

4,000

3,600

3,600

2-23

Chapter 02 - Reporting Intercorporate Interests

E2-18 Income Reporting Journal entry recorded by Grandview Company: Investment in Spinet Corporation Stock Income from Spinet Corporation Extraordinary Gain (from Spinet Corporation) 36,000 24,000 12,000

E2-19 Fair Value Method a. Cost method: Operating income reported by Mock Dividend income from Small ($15,000 x .20) Net income reported by Mock b. Equity method: Operating income reported by Mock Income from investee ($40,000 x .20) Net income reported by Mock b. Fair value method: Operating income reported by Mock Unrealized gain on increase in value of Small stock Dividend income from Small ($15,000 x .20) Net income reported by Mock $90,000 16,000 3,000 $ 9,000 $90,000 8,000 $98,000 $90,000 3,000 $93,000

E2-20 Fair Value Recognition a. Journal entries under the equity method: (1) Investment in Lomm Company Stock Cash Record purchase of Lomm Company stock. (2) Cash Investment in Lomm Company Stock Record dividends from Lomm Company: $20,000 x .35 140,000 140,000

7,000

7,000

2-24

Chapter 02 - Reporting Intercorporate Interests

(3) Investment in Lomm Company Stock Income from Lomm Company Record equity-method income: $80,000 x .35

28,000

28,000

b.

Journal entries under fair value method: (1) Investment in Lomm Company Stock Cash Record purchase of Lomm Company stock. (2) Cash Dividend Income Record dividends from Lomm Company: $20,000 x .35 (3) Investment in Lomm Company Stock Urealized Gain on Increase in Value of Lomm Stock Record increase in value of Lomm stock: $174,000 - $140,000 140,000 140,000

7,000

7,000

34,000

34,000

E2-21* Investee with Preferred Stock Outstanding Journal entries recorded by Reden Corporation: (1) Investment in Montgomery Co. Stock Cash Record purchase of Montgomery Co. stock. (2) Cash Investment in Montgomery Co. Stock Record dividend from Montgomery Co.: [$40,000 - ($250,000 x .10)] x .45 (3) Investment in Montgomery Co. Stock Income from Montgomery Co. Record equity-method income: [$95,000 - ($250,000 x .10)] x .45 288,000 288,000

6,750

6,750

31,500

31,500

2-25

Chapter 02 - Reporting Intercorporate Interests

E2-22* Other Comprehensive Income Reported by Investee Journal entries recorded by Callas Corp. during 20X9: (1) Investment in Thinbill Co. Stock Cash (2) Cash Investment in Thinbill Co. Stock Record dividend from Thinbill: $9,000 x .40 (3) Investment in Thinbill Co. Stock Income from Thinbill Co. Record equity-method income: $22,000 = ($45,000 + $10,000) x .40 (4) Investment in Thinbill Co. Stock Unrealized Gain on Investments of Investee (OCI) Record share of OCI reported by Thinbill: $8,000 = $20,000 x .40 Closing entries recorded at December 31, 20X9: (5) Income from Thinbill Co. Retained Earnings (6) Unrealized Gain on Investments of Investee (OCI) Accumulated Other Comprehensive Income from Investee-Unrealized Gain on Investments 22,000 8,000 8,000 22,000 380,000 380,000

3,600

3,600

22,000

22,000

8,000

8,000

E2-23* Other Comprehensive Income Reported by Investee Investment account balance reported by Baldwin Corp. Add decrease in account recorded in 20X8: Equity-method loss ($20,000 x .25) Dividend received ($10,000 x .25) Deduct increase in account recorded in 20X9: Equity-method income ($68,000 x .25) Dividend received ($16,000 x .25) Other comprehensive income reported by Gwin Company ($12,000 x .25) Purchase price $ (5,000) (2,500) $17,000 (4,000) 3,000 (16,000) $58,500 $67,000

7,500

2-26

Chapter 02 - Reporting Intercorporate Interests

E2-24* Deferred Income Taxes a. Income tax expense: Operating income of Power Company Taxable income from Special Corporation ($250,000 x .40) x (1.00 - .80) Income subject to taxation Effective tax rate Income tax expense $300,000 20,000 $320,000 x .35 $112,000

b.

Income taxes payable: Operating income of Power Company Taxable dividends received from Special Corporation ($50,000 x .40) x (1.00 - .80) Taxable income Effective tax rate Income taxes payable $300,000 4,000 $304,000 x .35 $106,400

2-27

Chapter 02 - Reporting Intercorporate Interests

SOLUTIONS TO PROBLEMS P2-25 Multiple-Choice Questions on Applying the Equity Method [AICPA Adapted] 1. a 2. a 3. c 4. d P2-26 Amortization of Differential Journal entries recorded by Ball Corporation: (1) Investment in Krown Company Stock Preferred Stock Additional Paid-In Capital Preferred Stock Record purchase of Krown Company stock. (2) Cash Investment in Krown Company Stock Record dividend from Krown Company: $10,000 x .30 (3) Investment in Krown Company Stock Income from Krown Company Record equity-method income: $40,000 x .30 (4) Income from Krown Company Stock Investment in Krown Company Stock Amortize differential assigned to buildings and equipment: [($360,000 - $300,000) x .30] / 15 years (5) Income from Krown Company Stock Investment in Krown Company Amortize differential assigned to copyrights: $27,000 / 8 years Computation of copyrights Purchase price Fair value of Krown's: Total assets Total liabilities Proportion of stock held by Ball Amount assigned to copyrights 120,000 50,000 70,000

3,000

3,000

12,000

12,000

1,200

1,200

3,375

3,375

$120,000 $560,000 (250,000) $310,000 x .30

(93,000) $ 27,000

2-28

Chapter 02 - Reporting Intercorporate Interests

P2-27 Computation of Account Balances a. Easy Chair Company 20X1 equity-method income: Proportionate share of reported income ($30,000 x .40) Amortization of differential assigned to: Buildings and equipment [($35,000 x .40) / 5 years] Goodwill ($8,000: not impaired) Investment Income Assignment of differential Purchase price Proportionate share of book value of net assets ($320,000 x .40) Proportionate share of fair value increase in buildings and equipment ($35,000 x .40) Goodwill $150,000 (128,000) $ (14,000) 8,000 $ 12,000 (2,800) -0$ 9,200

b. c.

Dividend income, 20X1 ($9,000 x .40) Cost-method account balance (unchanged): Equity-method account balance: Balance, January 1, 20X1 Investment income Dividends received Balance, December 31, 20X1

3,600

$150,000 $150,000 9,200 (3,600) $155,600

2-29

Chapter 02 - Reporting Intercorporate Interests

P2-28 Retroactive Recognition Journal entries recorded by Idle Corporation: (1) Investment in Fast Track Enterprises Stock Cash Record purchase of Fast Track stock. (2) Investment in Fast Track Enterprises Stock Retained Earnings Record pick-up of difference between cost and equity income: 20X2 .10($40,000 - $20,000) 20X3 .10($60,000 / 2) .15[($60,000 / 2) - $20,000] 20X4 .15($40,000 - $10,000) Amount of increase (3) Cash Investment in Fast Track Enterprises Stock Record dividend from Fast Track Enterprises: $20,000 x .25 (4) Investment in Fast Track Enterprises Stock Income from Fast Track Enterprises Record equity-method income: $50,000 x .25 34,000 34,000

11,000

11,000

$3,000 1,500

$ 2,000 4,500 4,500 $11,000 5,000 5,000

12,500

12,500

2-30

Chapter 02 - Reporting Intercorporate Interests

P2-29 Multistep Acquisition Journal entries recorded by Jackson Corp. in 20X9: (1) Investment in Phillips Corp. Stock Cash Record purchase of Phillips stock. (2) Investment in Phillips Corp. Stock Retained Earnings Record pick-up of difference between cost and equity income. Computation of equity pick-up 20X6 .10($70,000 - $20,000) 20X7 .10($70,000 - $20,000) 20X8 .15($70,000 - $20,000) 20X6 amortization of differential 20X7 amortization of differential 20X8 amortization of differential Amount of increase Amortization of differential 20X6 purchase [$25,000 - ($200,000 x .10)] 5 years 20X8 purchase [$15,000 - ($300,000 x .05)] 20X9 purchase [$70,000 - ($350,000 x .20)] Total annual amortization (3) Cash Investment in Phillips Corp. Stock Record dividend from Phillips Corp: $20,000 x .35 (4) Investment in Phillips Corp. Stock Income from Phillips Corp. Record equity-method income: $70,000 x .35 (5) Income from Phillips Corp. Investment in Phillips Corp. Stock Amortize differential. $ 5,000 5,000 7,500 (1,000) (1,000) (1,000) $14,500 70,000 70,000

14,500

14,500

$1,000 0 0 $1,000 7,000 7,000

24,500

24,500

1,000

1,000

P2-30 Investment in Joint Venture a. b. 25 percent = ($60,000 - $52,000) / [($330,000 - $50,000) ($293,000 - $45,000)]

$782,500 = $700,000 + ($330,000 x .25)

2-31

Chapter 02 - Reporting Intercorporate Interests

P2-31 Investment in Partnership Down Corporation Balance Sheet Pro Rata Equity Method Consolidation $800,000 $ 914,000(d) 105,000(b) $905,000 $175,000 730,000(c) $905,000 $ 914,000 $ 184,000(e) 730,000(c) $ 914,000 Full Consolidation $1,180,000 (f) $1,180,000 $ 205,000(g) 245,000(h) 730,000(c) $1,180,000

Assets Investment in DF Partnership Total Assets Liabilities Interest of Outside Partners Owners Equity Total Liabilities and Equity (a) (b) (c) (d) (e) (f) (g) (h)

Cost Method $800,000 96,000 $896,000 $175,000 721,000(a) $896,000 = = = = = = = =

$721,000 $105,000 $730,000 $914,000 $184,000 $1,180,000 $205,000 $245,000

$730,000 given given $800,000 $175,000 $800,000 $175,000 $350,000

- $105,000 + $96,000 + ($380,000 x .30) + ($30,000 x .30) + $380,000 + $30,000 x .70

Sales Revenues Expenses Income from Partnership Income to Outside Partners Net Income (a) (b) (c) (d) (e) (f)

Cost Method $500,000 (345,000)

Down Corporation Income Statement Pro Rata Equity Method Consolidation $ 500,000 $620,000 (b) (345,000) (456,000)(c) 9,000(a)

Full Consolidation $900,000 (d) (715,000)(e)

$155,000 = = = = = =

$164,000

$164,000

(21,000) (f) $164,000

$ 9,000 $620,000 $456,000 $900,000 $715,000 $ 21,000

[($400,000 - $370,000) x .30] $500,000 + ($400,000 x .30) $345,000 + ($370,000 x .30) $500,000 + $400,000 $345,000 + $370,000 [($400,000 - $370,000) x .70]

2-32

P2-32 Complex Differential a. Essex Company 20X2 equity-method income: Proportionate share of reported net income ($80,000 x .30) Deduct increase in cost of goods sold for purchase differential assigned to inventory ($30,000 x .30) Deduct amortization of differential assigned to: Buildings and equipment [($320,000 - $260,000) x .30] / 12 years] Patent [($25,000 x .30) / 10 years] Equity-method income for 20X2 b. Computation of investment account balance on December 31, 20X2: Purchase Price Investment income for 20X2 Dividends received in 20X2 ($9,000 x .30) Investment account balance on December 31, 20X2 $12,750 (2,700) $165,000 10,050 $175,050 $24,000 (9,000) (1,500) (750) $12,750

2-33

P2-33 Equity Entries with Differential a. Journal entry recorded by Hunter Corporation: Investment in Arrow Manufacturing Stock Common Stock Additional Paid-In Capital Record acquisition of Arrow Manufacturing stock. b. 210,000 60,000 150,000

Equity-method journal entries recorded by Hunter Corporation in 20X0: (1) Investment in Arrow Manufacturing Stock Common Stock Additional Paid-In Capital Record acquisition of Arrow Manufacturing stock. (2) Cash Investment in Arrow Manufacturing Stock Record dividends from Arrow Manufacturing: $20,000 x .45 (3) Investment in Arrow Manufacturing Stock Income from Arrow Manufacturing Record equity-method income: $80,000 x .45 (4) Income from Arrow Manufacturing Investment in Arrow Manufacturing Stock Amortize differential assigned to buildings and equipment: ($30,000 x .45) / 10 years 210,000 60,000 150,000

9,000

9,000

36,000

36,000

1,350

1,350

2-34

P2-33 (continued) Equity-method journal entries recorded by Hunter Corporation in 20X1: (1) Cash Investment in Arrow Manufacturing Stock Record dividends from Arrow Manufacturing: $40,000 x .45 (2) Investment in Arrow Manufacturing Stock Income from Arrow Manufacturing Record equity-method income for period: $50,000 x .45 (3) Income from Arrow Manufacturing Investment in Arrow Manufacturing Stock Amortize differential assigned to buildings and equipment. c. Investment account balance, December 31, 20X1: Purchase price on January 1, 20X0 20X0: Income from Arrow Manufacturing ($36,000 - $1,350) Dividends received Income from Arrow Manufacturing ($22,500 - $1,350) Dividends received $34,650 (9,000) $21,150 (18,000) $210,000 18,000 18,000

22,500

22,500

1,350

1,350

25,650

20X1:

3,150 $238,800

Investment account balance, December 31, 20X1

2-35

P2-34 Equity Entries with Differential a. Equity-method journal entries recorded by Ennis Corporation: (1) Investment in Jackson Corporation Stock Common Stock Additional Paid-In Capital Record acquisition of Jackson Corporation stock. (2) Cash Investment in Jackson Corporation Stock Record dividend from Jackson Corporation: $10,000 x .35 (3) Investment in Jackson Corporation Stock Income from Jackson Corporation Record equity-method income: $70,000 x .35 (4) Income from Jackson Corporation Investment in Jackson Corporation Stock Record expiration of differential assigned to inventory: $20,000 x .35 (5) Income from Jackson Corporation Investment in Jackson Corporation Stock Record amortization of differential assigned to buildings and equipment (net): ($80,000 x .35) / 20 years b. $212,600 = $200,000 + $24,500 - $3,500 - $7,000 - $1,400 200,000 50,000 150,000

3,500

3,500

24,500

24,500

7,000

7,000

1,400

1,400

2-36

P2-35 Additional Ownership Level a. Operating income of Amber for 20X3 Operating income of Blair for 20X3 Add: Equity income from Carmen [($50,000 - $6,000) x .25) Blair net income for 20X3 Proportion of stock held by Amber Amortization of differential: Equipment [($30,000 x .40) / 8 years] Patents [($25,000 x .40) / 5 years) Net income of Amber for 20X3 Investment in Blair Corporation Stock Common Stock Additional paid-In Capital Purchase of Blair Corporation Stock. Cash Investment in Blair Corporation Stock Record dividend from Blair: $30,000 x .40 Investment in Blair Corporation Stock Income from Blair Corporation Record equity-method income: $111,000 x .40 Income from Blair Corporation Investment in Blair Corporation Stock Amortize differential: $3,500 = $1,500 + $2,000 $100,000 11,000 $111,000 x .40 $220,000

44,400 (1,500) (2,000) $260,900

b.

130,000

40,000 90,000

12,000

12,000

44,400

44,400

3,500

3,500

2-37

P2-36 Fair Value Method 20X6 20X7 $ 6,000 $70,000 20X8 $ 4,000 $70,000

a. Cost method:
Dividend income Balance in investment account b. Equity method: Investment income: $40,000 x .20 $35,000 x .20 $60,000 x .20 Balance in investment account: Balance at January 1 Investment income Dividends received Balance at December 31 c. Fair value method: Investment income: Dividends received Gain (loss) on fair value Total income reported Balance in investment account $ 8,000 $ 3,000 $70,000

$ 7,000

$12,000 $76,000 12,000 (4,000) $84,000

$70,000 8,000 (3,000) $75,000

$75,000 7,000 (6,000) $76,000

20X6 $ 3,000 19,000 $22,000 $89,000

20X7 $ 6,000 (3,000) $ 3,000 $86,000

20X8 $ 4,000 11,000 $15,000 $97,000

2-38

P2-37 Fair Value Journal Entries Journal entries under fair value method for 20X8: (1) Investment in Brown Company Stock Cash Record purchase of Brown Company stock. (2) Cash Dividend Income Record dividends from Brown Company: $10,000 x .40 (3) Investment in Brown Company Stock Urealized Gain on Increase in Value of Brown Company Stock Record increase in value of Brown stock: $97,000 - $85,000 Journal entries under fair value method for 20X9: (1) Cash Dividend Income Record dividends from Brown Company: $15,000 x .40 (3) Unrealized Loss on Decrease in Value of Brown Company Stock Investment in Brown Company Stock Record decrease in value of Brown stock: $97,000 - $92,000 6,000 6,000 85,000 85,000

4,000

4,000

12,000

12,000

5,000 5,000

2-39

P2-38 Correction of Error Required correcting entry: Retained Earnings Income from Dale Company Investment in Dale Company Stock Adjustments to current books of Hill Company: Retained Earnings 1/1/20X4 $(14,000) Dale Company Investment 20X4 Balance Income 12/31/20X4 $(10,000) $(24,000) 17,000 11,500

28,500

Item Adjustment to remove dividends included in investment income and not removed from investment account Adjustment to annual amortization of differential: 20X2 and 20X3 20X4 Required adjustment to account balance

(3,000) $(17,000)

(1,500) $(11,500)

(3,000) (1,500) $(28,500)

Computation of adjustment to annual amortization of differential Correct amortization of differential assigned to: Equipment [($120,000 - $70,000) x .40] / 5 years Patents: Amount paid Fair value of identifiable net assets ($300,000 + $50,000) x .40 Amount assigned Number of years to be amortized Annual amortization Correct amount to be amortized annually Amount amortized by Hill [($164,000 - ($300,000 x .40)] / 8 years Adjustment to annual amortization $4,000 $164,000 (140,000) $ 24,000 8

3,000 $7,000 (5,500) $1,500

2-40

P2-39* Other Comprehensive Income Reported by Investee a. Equity-method income reported by Dewey Corporation in 20X5: Amounts reported by Jimm Co. for 20X5: Operating income Dividend income Gain on investment in trading securities Net income Ownership held by Dewey Investment income reported by Dewey b. Computation of amount added to investment account in 20X5: Balance in investment account reported by Dewey: December 31, 20X5 January 1, 20X5 Increase in investment account in 20X5 Dividends received by Dewey during 20X5 Amount added to investment account in 20X5 c. Computation of other comprehensive income reported by Jimm Co.: Amount added to investment account in 20X5 Investment income reported by Dewey in 20X5 Increase due to other comprehensive income reported by Jimm Co. Proportion of ownership held by Dewey Other comprehensive income reported by Jimm Co. d. Computation of market value of securities held by Jimm Co. Amount paid by Jimm Co. to purchase securities Increase in market value reported as other comprehensive income in 20X5 Market value of available-for-sale securities at December 31, 20X5 $130,000 31,000 $161,000 $ 37,800 (28,500) $ 9,300 .30 $ 31,000 $276,800 (245,000) $ 31,800 6,000 $ 37,800 $70,000 7,000 18,000 $95,000 x .30 $28,500

2-41

P2-40* Equity-Method Income Statement a.

Diversified Products Corporation Income Statement Year Ended December 31, 20X8 $400,000 (320,000) $ 80,000 (15,000) $ 65,000 29,000 $ 94,000 (5,000) $ 89,000

Net Sales Cost of Goods Sold Gross Profit Other Expenses Gain on Sale of Truck Income from Continuing Operations Discontinued Operations: Operating Loss from Discontinued Division Gain on Sale of Division Income before Extraordinary Item Extraordinary Item: Loss on Volcanic Activity Net Income Diversified Products Corporation Retained Earnings Statement Year Ended December 31, 20X8 Retained Earnings, January 1, 20X8 20X8 Net Income Dividends Declared, 20X8 Retained Earnings, December 31, 20X8

$(25,000) 10,000 $(15,000) 44,000

$240,000 (1 ) 89,000 $329,000 (10,000) $319,000

(1) The Retained Earnings balance on January 1, 20X8, has been reduced by the $20,000 cumulative adjustment for change in inventory method on January 1, 20X8.

2-42

P2-40* (continued) b. Wealthy Manufacturing Company Income Statement Year Ended December 31, 20X8 $850,000 (670,000) $180,000 (64,000) $116,000

Net Sales Cost of Goods Sold Gross Profit Other Expenses Income from Continuing Operations of Diversified Products Corporation Income from Continuing Operations Discontinued Operations: Share of Operating Loss Reported by Diversified Products on Discontinued Division Share of Gain on Sale of Division Reported by Diversified Products Income before Extraordinary Item Extraordinary Item: Share of Loss on Volcanic Activity Reported by Diversified Products Net Income Wealthy Manufacturing Company Retained Earnings Statement Year Ended December 31, 20X8 Retained Earnings, January 1, 20X8 20X8 Net Income Dividends Declared, 20X8 Retained Earnings, December 31, 20X8

$(90,000) 26,000

$ (6,000) 17,600 11,600 $127,600 (2,000) $125,600

$412,000 (1) 125,600 $537,600 (30,000) $507,600

(1) The Retained Earnings balance of Wealthy Manufacturing Company on January 1, 20X8, has been reduced by $8,000 to reflect its proportionate share of the $20,000 cumulative adjustment for the change in inventory method recorded by Diversified Products Corporation on January 1, 20X8 ($20,000 x .40 = $8,000).

2-43

P2-41* Net Income after Tax Net Income reported by Baltic Corporation: Operating income of Baltic Corporation Investment income from Cumberland Company ($70,000 x .30) Income before tax expense Income tax expense [$95,000 + ($21,000 x .20)] x .40 Baltic Corporation net income $ 95,000 21,000 $116,000 (39,680) $ 76,320

P2-42* Income Tax Expense and Net Income (a) Cost method computations: 20X4 Income tax expense Operating income of Long Company Dividends received from Computech ($4,000 x .25) x (1.00 - .80) Income subject to taxation Effective tax rate Income tax expense 20X4 Net income Operating income of Long Company Dividend income from Computech ($4,000 x .25) Income before tax expense Income tax expense Net income of Long Company 20X5 Income tax expense Operating income of Long Company Dividends received from Computech ($10,000 x .25) x (1.00 - .80) Income subject to taxation Effective tax rate Income tax expense 20X5 Net income Operating income of Long Company Dividend income from Computech ($10,000 x .25) Income before tax expense Income tax expense Net income of Long Company $64,000 2,500 $66,500 (25,800) $40,700 $64,000 500 $64,500 x .40 $25,800 $50,000 1,000 $51,000 (20,080) $30,920 $50,000 200 $50,200 x .40 $20,080

2-44

P2-42* (continued) (b) Equity method computations: 20X4 Income tax expense Operating income of Long Company Equity method income from investment in Computech subject to taxation ($20,000 x .25) x (1.00 - .80) Income subject to taxation Effective tax rate Income tax expense 20X4 Net income Operating income of Long Company Investment income from Computech ($20,000 x .25) Income before tax expense Income tax expense Net income of Long Company 20X5 Income tax expense Operating income of Long Company Equity method income from investment in Computech subject to taxation ($8,000 x .25) x (1.00 - .80) Income subject to taxation Effective tax rate Income tax expense 20X5 Net income Operating income of Long Company Investment income from Computech ($8,000 x .25) Income before tax expense Income tax expense Net income of Long Company $64,000 2,000 $66,000 (25,760) $40,240 $64,000 400 $64,400 x .40 $25,760 $50,000 5,000 $55,000 (20,400) $34,600 $50,000 1,000 $51,000 x .40 $20,400

2-45