Company A purchased a certain number of Company B's outstanding voting shares at $27 per share as a long-term investment. Company B had outstanding 40,000 shares of $13 par value stock.

Company A purchased a certain number of Company B's outstanding voting shares at $27 per share as a long-term investment. Company B had outstanding 40,000 shares of $13 par value stock.

 

	Fair Value Method				Equity Method
For b, e, f, and g, assume the following:
Number of shares acquired of Company B stock		6,000				16,000
Net income reported by Company B in first year	$	71,000			$	71,000
Dividends declared by Company B in first year	$	24,000			$	24,000
Market price at end of first year, Company B stock	$	24			$	24

Complete the following table relating to the measurement and reporting by Company A after acquisition of the shares of Company B stock.

a. What level of ownership by Company A of Company B is required to apply the method?

Answer

b. At acquisition, the investment account on the books of Company A should be debited at what amount?
 
c. When should Company A recognize revenue earned on the stock of Company B?
 
d. After the acquisition date, how should Company A change the balance of the investment account with respect to the stock owned in Company B (other than for disposal of the investment)?
  

e. What is the balance in the investment account on the balance sheet of Company A at the end of the first year?

 

Explanation:

Questions	Method of Measurement
	Fair Value Method		Equity Method
a.	Less than 20%.		At least 20% but not more than 50%.
b.	At cost: 6,000 shares × $27 = $162,000.		At cost: 16,000 shares × $27 = $432,000.
c.	When Co. B declares a cash dividend; not for any holding gains and losses on available-for-sale securities.		When Co. B reports income or loss for the period; not when dividends are declared or paid.
d.	Company A should increase and decrease the investment account based on stock price changes (to fair value).		Increase the investment account for proportionate part of income, less proportionate part of dividends and losses of Co. B.
e.	6,000 shares × $24 = $144,000 fair value.		Cost of $432,000 plus 28,400 ($71,000 × 40%) equity in affiliate’s earnings minus $9,600 ($24,000 × 40%) dividends received equals $450,800.
f.	Company A owns 15.0% of Company B (6,000 shares ÷ 40,000 shares outstanding). $24,000 dividends declared × 15.0% = $3,600 dividend revenue for Company A.		$71,000 Company B net income × 40% = $28,400 equity in earnings of affiliate.
g.	6,000 × ($27 – $24) = $18,000  net unrealized loss reported in stockholders’ equity.		None.