solusi manual advanced acc zy Chap002

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.

2-1


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.

2-2


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 investor’s 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 partnership’s 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.

2-3


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.

2-4


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.

2-5


C2-2 Intercorporate Ownership
MEMO
To:

Chief Accountant
Most Company

From:
Re:

, CPA
Equity Method Reporting for Investment in Adams Company

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 Most’s 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 investee’s
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 investee’s 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 investee’s 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

2-6


C2-3 Application of the Equity Method
MEMO
To:

Controller
Forth Company

From:
Re:

, CPA
Equity Method Reporting for Investment in Brown Company

This memo is prepared in response to your request regarding use of the cost or equity
methods in accounting for Forth’s 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 Brown’s common stock, the other factors
associated with its ownership indicate that Forth does exercise significant influence over
Brown. Forth has two members on Brown’s board of directors, it purchases a substantial
portion of Brown’s 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

2-7


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 Pipeline’s management are employees of Atlas
America, as indicated in Atlas Pipeline’s 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.

2-8


C2-5 Evaluating Investments
a. Dow Chemical has well over 100 subsidiaries, as shown in its Form 10-K, Exhibit 21.
According to the company’s “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 Dow’s 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 Dow’s goodwill for impairment is performed in conjunction with the
company’s annual budgeting process.
d. Dow Chemical’s 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 Dow’s 2005 Form 10-K, the company wrote down the investment and
recognized a loss at the time of the bankruptcy.

2-9


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 affiliate’s 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 Dynegy’s common
stock. It accounts for its investment using the equity method. The carrying amount of
Chevron’s investment in Dynegy’s common stock is less that its proportionate interest in
Dynegy’s 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.

2-10


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

2-11


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.

70,000

Cash
Dividend Income
Record dividend income from Steam Company:
$5,000 x .20

1,000

20X6

Cash
Dividend Income
$15,000 x .20

3,000

20X7

Cash
Dividend Income
$35,000 x .20
Note: Cumulative dividends do not exceed cumulative
earnings to date.

7,000

2-12

70,000

1,000

3,000

7,000


E2-4 (continued)
b. Equity-method journal entries recorded by Roller Corporation:
20X5

Cash
Record purchase of Steam Company stock.

70,000

Cash
Record dividend from Steam Company.
Income from Steam Company
Record equity-method income.

3,000

Cash

3,000


8,000

Amortize differential.
20X7

4,000

Amortize differential:
[$70,000 - ($200,000 x .20)] / 10 years
20X6

1,000

3,000

Cash

7,000


4,000


3,000

2-13

70,000

1,000

4,000

3,000

3,000

8,000

3,000

7,000

4,000

3,000


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)

a

$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

$54,000 + $2,800 = $56,800

b. Equity method

$54,000 - $2,000 = $52,000

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

Dividends
$15,000
10,000
10,000

2-14

Change in Investment Account
Cost Method
Equity Method
$(2,800)
$(2,800)
800
______
4,000
$(2,800)
$ 2,000


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

12,000

9,000
3,000

(2) Equity method:
Cash

12,000

Income from Valley

12,000

3,000

3,000

E2-8 Impairment of Investment Value
The following amounts would be reported as the carrying value of Port’s 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)]

2-15


E2-9 Alternative Reporting for Investment in Partnership

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

Moss Company Balance Sheet
Pro Rata
Equity Method
Consolidation
$510,000
$622,500(d)

Full
Consolidation
$760,000(f)

90,000
$600,000

99,000(b)
$609,000

$622,500

$760,000

$ 40,000

$ 40,000

$ 53,500(e)

$ 70,000(g)

569,000(c)

121,000(h)
569,000(c)

560,000(a)
$600,000

569,000(c)
$609,000

$622,500

$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]

2-16

$760,000


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
Record dividend from Snow Corporation:
$20,000 x .35
Income from Snow Corporation
Record equity-method income:
$56,000 x .35

360,000

7,000

19,600

Income from Snow Corporation
[$360,000 - ($980,000 x .35)] / 8 years
20X3

2,125

Cash
Record dividend from Snow Corporation:
$10,000 x .35

3,500

Loss from Snow Corporation
Record equity-method loss:
$44,000 x .35

15,400

Loss from Snow Corporation

2,125

2-17

90,000
270,000

7,000

19,600

2,125

3,500

15,400

2,125


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.

196,000

Cash
Record dividend from Flair Company:
$24,000 x .25
Loss from Flair Company
Record equity-method loss:
$88,000 x .25

22,000

Loss from Flair Company
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

6,000

5,250

Cash
Record dividend from Flair Company:
$24,000 x .25
Income from Flair Company
$120,000 x .25
Income from Flair Company

2-18

26,000
170,000

6,000

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

30,000

5,250

6,000

30,000

5,250


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.

136,000

Cash
Record dividend from Cook Company:
$6,000 x .40
Income from Cook Company
$10,000 x .40

4,000

$16,000 / 10 years

1,600

Cash
Record dividend from Cook Company:
$9,000 x .40

3,600

$20,000 x .40

8,000


20X5

2,400

1,600

136,000

2,400

4,000

1,600

3,600

8,000

1,600

b. Journal entries recorded by Capital Corporation using the cost
method:
20X4

Cash
Record purchase of Cook Company Stock.

136,000

Cash
Dividend Income
Record dividend income from Cook Company.
20X5

2,400

Cash
Dividend Income
Record dividend income from Cook Company.

3,600

2-19

136,000

2,400

3,600


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

$17,000
$

-04,000
-0-

(4,000)
$13,000

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

E2-14 Determination of Purchase Price
Investment account balance December 31, 20X6

$161,000

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)

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

(14,500)

Decrease in account balance during 20X6:
Proportionate share of income ($20,000 x .30)
Amortize differential ($28,000 / 8 years)

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

9,500

Investment account balance at date of purchase

2-20

$156,000


E2-15 Correction of Error
Required correcting entry:
Investment in Case Products Stock
Dividend Income
Income from Case Products
Retained Earnings

44,000
8,000

30,000
22,000

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

$16,000
24,000
32,000

$72,000

Deduction for dividends received:
20X6: $15,000 x .40
20X7: $20,000 x .40
20X8: $20,000 x .40

$ 6,000
8,000
8,000

(22,000)

Purchase price
Proportionate share of book value of net assets
[.40($60,000 + $40,000)]
Amount of differential

$56,000
(40,000)
$16,000

Amortization for 3 years [($16,000 / 8) x 3]
Required correction of investment account

(6,000)
$44,000

Computation of correction of retained earnings of Grand Corporation
Dividend income recorded in 20X6: $15,000 x .40
20X7: $20,000 x .40

$ 6,000
8,000

Equity-method income in 20X6: ($16,000 - $2,000)
20X7: ($24,000 - $2,000)
Required correction of retained earnings

$14,000
22,000

2-21

($14,000)
36,000
$22,000


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
$40,000 x .30
(4) Income from Stafford
Investment in Stafford Corporation Stock
Amortize differential assigned to equipment.

2-22

65,000

4,500

12,000

1,000

65,000

4,500

12,000

1,000


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

175,000

3,200

(3) Investment in Turner Corporation Stock
Income from Turner Corporation
$40,000 x .40

16,000

(4) Income from Turner Corporation Stock
Investment in Turner Corporation
Write off differential assigned to
inventory carried on FIFO basis:
$10,000 x .40

4,000

(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

3,600

2-23

175,000

3,200

16,000

4,000

3,600


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.

$90,000
3,000
$93,000

Equity method:
Income from investee ($40,000 x .20)

b.

$90,000
8,000
$98,000

Fair value method:
Unrealized gain on increase in value of Small stock
Dividend income from Small ($15,000 x .20)

$90,000
16,000
3,000
$ 9,000

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

2-24

140,000

7,000

140,000

7,000


Income from Lomm Company
$80,000 x .35

b.

28,000

28,000

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

140,000

7,000

34,000

140,000

7,000

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.
[$95,000 - ($250,000 x .10)] x .45

2-25

288,000

6,750

31,500

288,000

6,750

31,500


E2-22* Other Comprehensive Income Reported by Investee
Journal entries recorded by Callas Corp. during 20X9:
(1) Investment in Thinbill Co. Stock
Cash

380,000

(2) Cash
Investment in Thinbill Co. Stock
Record dividend from Thinbill:
$9,000 x .40

3,600

Income from Thinbill Co.
$22,000 = ($45,000 + $10,000) x .40

22,000

Unrealized Gain on Investments of Investee (OCI)
Record share of OCI reported by Thinbill:
$8,000 = $20,000 x .40

8,000

380,000

3,600

22,000

8,000

Closing entries recorded at December 31, 20X9:
(5) Income from Thinbill Co.
Retained Earnings

22,000

(6) Unrealized Gain on Investments of Investee (OCI)
Accumulated Other Comprehensive Income from
Investee-Unrealized Gain on Investments

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)
Deduct increase in account recorded in 20X9:
Equity-method income ($68,000 x .25)
Other comprehensive income reported by Gwin
Company ($12,000 x .25)
Purchase price

$67,000
$ (5,000)
(2,500)

7,500

$17,000
(4,000)
3,000

(16,000)
$58,500

2-26


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

b.

$300,000
20,000
$320,000
x
.35
$112,000

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

2-27

$300,000
4,000
$304,000
x
.35
$106,400


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

120,000

3,000

(3) Investment in Krown Company Stock
Income from Krown Company
$40,000 x .30

12,000

(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

1,200

(5) Income from Krown Company Stock
Investment in Krown Company
Amortize differential assigned to copyrights:
$27,000 / 8 years

3,375

Computation of copyrights
Purchase price
Fair value of Krown's:
Total assets
Total liabilities

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

Proportion of stock held by Ball
Amount assigned to copyrights

2-28

(93,000)
$ 27,000

50,000
70,000

3,000

12,000

1,200

3,375


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

$ 12,000
(2,800)
-0$ 9,200

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

b.

Dividend income, 20X1 ($9,000 x .40)

$

c.

Cost-method account balance (unchanged):

$150,000

Equity-method account balance:
Balance, January 1, 20X1
Investment income
Dividends received
Balance, December 31, 20X1

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

2-29

3,600


P2-28 Retroactive Recognition
Journal entries recorded by Idle Corporation:
(1) Investment in Fast Track Enterprises Stock
Cash
Record purchase of Fast Track stock.

34,000

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

11,000

(3) Cash
Investment in Fast Track Enterprises Stock
Record dividend from Fast Track
Enterprises: $20,000 x .25
Income from Fast Track Enterprises
$50,000 x .25

2-30

$3,000
1,500

34,000

11,000

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

12,500

5,000

12,500


P2-29 Multistep Acquisition
Journal entries recorded by Jackson Corp. in 20X9:
(1) Investment in Phillips Corp. Stock
Cash
Record purchase of Phillips stock.

70,000

Retained Earnings
Record pick-up of difference between
cost and equity income.

14,500

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
Amount of increase

(3) Cash
Investment in Phillips Corp. Stock
Record dividend from Phillips Corp:
$20,000 x .35
Income from Phillips Corp.
$70,000 x .35
(5) Income from Phillips Corp.
Investment in Phillips Corp. Stock

P2-30 Investment in Joint Venture
25 percent

b.

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

= ($60,000 - $52,000) / [($330,000 - $50,000) –
($293,000 - $45,000)]

2-31

14,500

$ 5,000
5,000
7,500
(1,000)
(1,000)
(1,000)
$14,500

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

a.

70,000

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

24,500

1,000

7,000

24,500

1,000


P2-31 Investment in Partnership

Cost Method
$800,000

Assets
Investment in DF
Partnership
Total Assets

105,000(b)
$905,000

$ 914,000

$1,180,000

$175,000

$175,000

$ 184,000(e)

$ 205,000(g)

730,000(c)

245,000(h)
730,000(c)

721,000(a)
$896,000

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

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

Full
Consolidation
$1,180,000 (f)

96,000
$896,000

Liabilities
Interest of
Outside Partners
Owners’ Equity
Total Liabilities
and Equity
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)

Down Corporation Balance Sheet
Pro Rata
Equity Method
Consolidation
$800,000
$ 914,000(d)

=
=
=
=
=
=
=
=

730,000(c)
$905,000

$ 914,000

$1,180,000

$730,000 - $105,000 + $96,000
given
given
$800,000 + ($380,000 x .30)
$175,000 + ($30,000 x .30)
$800,000 + $380,000
$175,000 + $30,000
$350,000 x .70

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)

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

9,000(a)
$155,000

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

=
=
=
=
=
=

$164,000

[($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

$164,000

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

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

$24,000
(9,000)
(1,500)
(750)
$12,750

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

2-33

$12,750
(2,700)

$165,000
10,050
$175,050

P2-33 Equity Entries with Differential
a. Journal entry recorded by Hunter Corporation:
Investment in Arrow Manufacturing Stock
Common Stock
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
Record acquisition of Arrow Manufacturing stock.
(2) Cash
Record dividends from Arrow Manufacturing:
$20,000 x .45
Income from Arrow Manufacturing
$80,000 x .45
(4) Income from Arrow Manufacturing
Amortize differential assigned to buildings
and equipment:
($30,000 x .45) / 10 years

2-34

210,000

9,000

36,000

1,350

60,000
150,000

9,000

36,000

1,350

P2-33 (continued)
Equity-method journal entries recorded by Hunter Corporation in 20X1:
(1) Cash
Record dividends from Arrow Manufacturing:
$40,000 x .45

18,000

Income from Arrow Manufacturing
Record equity-method income for period:
$50,000 x .45

22,500

(3) Income from Arrow Manufacturing
Amortize differential assigned to buildings and
equipment.

1,350

18,000

22,500

1,350

c. Investment account balance, December 31, 20X1:
Purchase price on January 1, 20X0

$210,000

20X0: Income from Arrow Manufacturing
($36,000 - $1,350)
Dividends received

$34,650
(9,000)

25,650

20X1: Income from Arrow Manufacturing
($22,500 - $1,350)
Dividends received

$21,150
(18,000)

3,150

Investment account balance, December 31, 20X1

2-35

$238,800

P2-34 Equity Entries with Differential
a. Equity-method journal entries recorded by Ennis Corporation:
(1) Investment in Jackson Corporation Stock
Common Stock
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
$70,000 x .35

200,000

3,500

24,500

(4) Income from Jackson Corporation
Record expiration of differential assigned to
inventory: $20,000 x .35

7,000

(5) Income from Jackson Corporation
Record amortization of differential assigned to
buildings and equipment (net):
($80,000 x .35) / 20 years

1,400

b. $212,600 = $200,000 + $24,500 - $3,500 - $7,000 - $1,400

2-36

50,000
150,000

3,500

24,500

7,000

1,400

P2-35 Additional Ownership Level
a.

b.

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
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.

$100,000
11,000
$111,000
x
.40

130,000

12,000

Income from Blair Corporation
$111,000 x .40

44,400

2-37

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

Cash
Record dividend from Blair:
$30,000 x .40

Income from Blair Corporation
$3,500 = $1,500 + $2,000

$220,000

3,500

40,000
90,000

12,000

44,400

3,500

P2-36 Fair Value Method
20X6

20X7

20X8

Dividend income

$ 3,000

$ 6,000

$ 4,000

Balance in investment account

$70,000

$70,000

$70,000

a. Cost method:

b. Equity method:
Investment income:
$40,000 x .20
$35,000 x .20
$60,000 x .20

$ 8,000

Balance in investment account:
Balance at January 1
Investment income
Dividends received
Balance at December 31

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

c. Fair value method:

20X6

$ 7,000

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

20X7

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

20X8

Investment income:
Dividends received
Gain (loss) on fair value
Total income reported

$ 3,000
19,000
$22,000

$ 6,000
(3,000)
$ 3,000

$ 4,000
11,000
$15,000

Balance in investment account

$89,000

$86,000

$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

85,000

4,000

12,000

85,000

4,000

12,000

Journal entries under fair value method for 20X9:
(1) Cash
Dividend Income
Record dividends from Brown Company:
$15,000 x .40

6,000

(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

5,000

2-39

6,000

5,000

P2-38 Correction of Error
Required correcting entry:
Retained Earnings
Income from Dale Company
Investment in Dale Company Stock

17,000
11,500

28,500

Adjustments to current books of Hill Company:
Retained
Earnings
1/1/20X4
$(14,000)

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

Dale Company
Investment
20X4
Balance
Income
12/31/20X4
$(10,000)

$(24,000)

(1,500)
$(11,500)

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

(3,000)
$(17,000)

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

2-40

$4,000
$164,000
(140,000)
$ 24,000
÷
8

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

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

$70,000
7,000
18,000
$95,000
x
.30
$28,500

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

$276,800
(245,000)
$ 31,800
6,000
$ 37,800

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.

$ 37,800
(28,500)
$ 9,300
.30
$ 31,000

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

2-41

$130,000
31,000
$161,000

P2-40* Equity-Method Income Statement
a.

Diversified Products Corporation
Income Statement
Year Ended December 31, 20X8

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

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

$400,000
(320,000)
$ 80,000
(15,000)
$ 65,000
29,000
$ 94,000
(5,000)
$ 89,000

Retained Earnings Statement
Retained Earnings, January 1, 20X8

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

20X8 Net Income
Dividends Declared, 20X8
Retained Earnings, December 31, 20X8

(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

Net Sales
Cost of Goods Sold
Gross Profit
Other Expenses
Income from Continuing Operations of
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

$(90,000)
26,000

$850,000
(670,000)
$180,000
(64,000)
$116,000

$ (6,000)
17,600

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

Wealthy Manufacturing Company
Retained Earnings Statement
Retained Earnings, January 1, 20X8
20X8 Net Income

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

Dividends Declared, 20X8
Retained Earnings, December 31, 20X8

(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)
Effective tax rate
Income tax expense

$50,000
200
$50,200
x
.40
$20,080

20X4 Net income
Dividend income from Computech
($4,000 x .25)
Income tax expense
Net income of Long Company

$50,000
1,000
$51,000
(20,080)
$30,920

Dividends received from Computech
($10,000 x .25) x (1.00 - .80)
Effective tax rate
Income tax expense

$64,000
500
$64,500
x
.40
$25,800

20X5 Net income
Dividend income from Computech
($10,000 x .25)
Income tax expense

$64,000
2,500
$66,500
(25,800)
$40,700

2-44

P2-42* (continued)
(b)

Equity method computations:
Equity method income from investment in Computech
subject to taxation ($20,000 x .25) x (1.00 - .80)
Effective tax rate
Income tax expense

$50,000
1,000
$51,000
x
.40
$20,400

20X4 Net income
Investment income from Computech
($20,000 x .25)
Income tax expense

$50,000
5,000
$55,000
(20,400)
$34,600

Equity method income from investment in Computech
subject to taxation ($8,000 x .25) x (1.00 - .80)
Effective tax rate
Income tax expense

$64,000
400
$64,400
x
.40
$25,760

20X5 Net income
Investment income from Computech
($8,000 x .25)
Income tax expense

$64,000
2,000
$66,000
(25,760)
$40,240

2-45

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