Solutions ch 2
Investor should use the equity method when it has the ability to exercise significant influence
over the investee. Twenty percent ownership test is used to determine the significant influence.
Investment of more than 20 percent of the investees voting stock shall lead to a presumption that
the investor has the ability to exercise significant influence over the investee otherwise there is
predominant evidence in the contrary. On the other hand, Investment of less than 20 percent
investees voting stock shall lead to a presumption that the investor doesnt have the ability to
exercise significant influence over the investee unless such ability can be demonstrated. If the
latter condition is met, investor should use the fair value method.
Under the fair value method, investments are recorded at cost and adjust it to the fair value at the
end of the reporting period. Dividends received are treated as dividend income, except dividends
received in excess of investor share of earnings are considered as return on of capital (liquidating
dividend). Liquidating dividend is treated as a deduction of investments account.
Under the equity method, investments are recorded at cost, but at the end of the reporting period
it is not adjusted to the fair value. Investments are adjusted with the profit or loss and the
dividends of the investee. Investor increases the investments account based on the share of the
investees profit or decrease the investments account based on the share of the investees loss.
Dividends are always treated as a disinvestments and always decrease the investments account.
The equity method of accounting for investments increases the investment account for the
investors share of the investees income and decreases it for the investors share of the investees
losses and for dividends received from the investee. In addition, the investment and investment
income accounts are adjusted for amortization of any investment cost-book value differentials
related to the interest acquired. Adjustments to the investment and investment income accounts
are also needed for unrealized profits and losses from transactions between the investor and
investee companies. A fair value adjustment is optional under SFAS No. 159.
13- Goodwill impairment losses are calculated by business reporting units. For each reporting
unit, the company must first determine the fair values of the net assets. The fair value of the
reporting unit is the amount at which it could be purchased in a current market transaction.
This may be based on market prices, discounted cash flow analyses, or similar current
transactions. This is done in the same manner as is done to originally record a combination.
The first step requires a comparison of the carrying value and fair value of all the net assets at
the business reporting level. If the fair value exceeds the carrying value, goodwill is not
impaired and no further tests are needed. If the carrying value exceeds the fair value, then we
proceed to step two. In step two, we calculate the implied value of goodwill. Any excess
measured fair value over the net identifiable assets is the implied fair value of goodwill. The
company then compares the goodwills implied fair value estimate to the carrying value of
goodwill to determine if there has been an impairment during the period.
Solution E2-13
1
Journal entries on BIPs books for 2012
Cash
120,000
Investment in Cow (30%)
To record dividends received from Cow
($400,000 30%).
Investment in Cow (30%)
Extraordinary loss (from Cow)
Income from Cow
To record investment income from Cow computed
as follows:
120,000
240,000
24,000
Share of income before extraordinary item
$680,000 30%
Add: Excess fair value over cost realized
in 2012
$200,000 30%
Income from Cow before extraordinary
loss
2
264,000
$ 204,000
60,000
$ 264,000
Investment in Cow balance December 31, 2012
Investment cost
Add: Income from Cow after extraordinary loss
Less: Dividends received from Cow
Investment in Cow December 31
$ 780,000
240,000
(120,000)
$900,000
Check: Investment balance is equal to underlying book value
($2,800,000 + $600,000 - $400,000) 30% = $900,000
3
BIP Corporation
Income Statement
for the year ended December 31, 2012
Sales
Expenses
Operating income
Income from Cow (before extraordinary item)
Income before extraordinary item
Extraordinary loss (net of tax effect)
Net income
$4,000,000
2,800,000
1,200,000
264,000
1,464,000
24,000
$1,440,000
Solution E2-14
1
Income from Wat for 2012
Equity in income ($108,000 - $8,000 preferred) 40%
$ 40,000
Investment in Wat December 31, 2012
Cost of investment in Wat common
Add: Income from Wat
Less: Dividends ($40,000* x 40%)
Investment in Wat December 31
$48,000 total dividends less $8,000 preferred dividend
$ 290,000
40,000
(16,000)
$ 314,000
Solution P2-1
1
Goodwill
Cost of investment in Tel on April 1
Book value acquired:
Net assets at December 31
Add: Income for 1/4 year ($320,000 25%)
Less: Dividends paid March 15
Book value at April 1
$2,000,000
80,000
(40,000)
2,040,000
30%
Interest acquired
$686,000
Goodwill from investment in Tel
612,000
$74,000
Income from Tel for 2011
Equity in income before extraordinary item
($240,000 3/4 year 30%)
$ 54,000
Investment in Tel at December 31, 2011
Investment cost April 1
Add: Income from Tel plus extraordinary gain
Less: Dividends ($40,000 3 quarters) 30%
Investment in Tel December 31
$ 686,000
78,000
(36,000)
$ 728,000
Equity in Tels net assets at December 31, 2011
Tels stockholders equity January 1
Add: Net income
Less: Dividends
Tels stockholders equity December 31
Investment interest
Equity in Tels net assets
$2,000,000
320,000
(160,000)
2,160,000
30%
$ 648,000
Extraordinary gain for 2011 to be reported by Rit
Tels extraordinary gain 30%
$ 24,000
Solution P2-5
1
Schedule to allocate fair value book value differentials
Investment cost January 1
Book value acquired ($3,900,000 net assets 30%)
Excess fair value over book value
$1,680,000
1,170,000
$ 510,000
Allocation of excess
Fair Value
Book Value
$200,000
800,000
500,000
(700,000)
(100,000)
Inventories
Land
Buildings net
Equipment net
Bonds payable
Assigned to identifiable netassets
Remainder to goodwill
Excess fair value over book value
2
Income from Tremor for 2011
Equity in income ($1,200,000 30%)
Less: Amortization of differentials
Inventories (sold in 2011)
Buildings net ($150,000/10 years)
Equipment net ($210,000/7 years)
Bonds payable ($30,000/5 years)
Income from Tremor
Investment in Tremor balance December 31, 2011
Investment cost
Add: Income from Tremor
Less: Dividends ($600,000 30%)
Investment in Tremor December 31
Check:
Underlying equity ($4,500,000 30%)
Unamortized excess:
Land
Buildings net ($150,000 - $15,000)
Equipment net ($210,000 - $30,000)
Bonds payable ($30,000 - $6,000)
Goodwill
Investment in Tremor account
Percent
Acquired
30%
30%
30%
30%
30%
Allocation
$ 60,000
240,000
150,000
(210,000)
(30,000)
210,000
300,000
$ 510,000
$ 360,000
(60,000)
(15,000)
30,000
6,000
$ 321,000
$1,680,000
321,000
(180,000)
$1,821,000
$1,350,000
240,000
135,000
(180,000)
(24,000)
300,000
$1,821,000
