Equity method mechanics An investor owns 25 of the outstandi

Equity method mechanics
An investor owns 25% of the outstanding common stock of an investee company. The Equity Investment was reported at $500,000 as of the end of the previous year. During the year, the investee pays dividends of $50,000 to the investor. The investee reports the following income statement for the year:

Required
a. How much equity income should the investor report in its income statement?

$Answer

b. What amount should the investor report for the Equity Investment in its balance sheet at the end of the year?

$Answer

c. Assume that the fair value of the investee company is $1.7 million at the end of the year (approximately five times reported earnings). How should the fair value of the investee company be reflected in the investor’s financial statements?

be adjusted to fair value.

remain at adjusted cost.

remain at the adjusted cost plus a gain should be reported in AOCI.

Solution

Dividend paid by the investee for the year = $50,000

Share of investor in this = $12,500 (25%)

Net income of the investee = $430,000

Share of investor in the net income = $107,500.

a. The investor should report $107,500 as equity income for the year.

b. The investor should report $595,000 ($500,000 + $107,500 - $12,500) as the equity investment in the balance sheet.

Investment account at the beginning $500,000

Equity income for the year $107,500

Dividends received during the year -$12,500

Investment account at the end $595,000

c. Fair value of the investee company will remain at adjusted cost.