[kaki]

On January 1, Year 1, Mega Corp. acquired 10% of the outstanding voting stock of Penny, Inc. On January 2, Year 2, Mega gained the ability to exercise significant influence over financial and operating control of Penny by acquiring an additional 20% of Penny’s outstanding stock. The two purchases were made at prices proportionate to the value assigned to Penny’s net assets, which equaled their carrying amounts. For the years ended December 31, Year 1 and Year 2, Penny reported the following:

Year 1 Year 2

Dividends paid $ 200,000 $ 300,000

Net income 600,000 650,000

In Year 2, what amounts should Mega report as current year investment income and as an adjustment, before income taxes, to Year 1 investment income?

Year 2 Adjustment Year 1

Investment income investment income

a. $195,000 $100,000

b. $195,000 $160,000

c. $105,000 $40,000

d. $195,000 $40,000

Explanation

Choice “d” is correct, Year 2 investment income of $195,000 and an adjustment to Year 1 investment income of $40,000.

Rule: When two or more purchases of stock cause ownership to go from less than 20% to more than 20%, the equity method should be used and the periods during which the cost method was used are retroactively restated.

Year 2 investment income = 30% × $650,000 = $195,000

Year 2 adjustment to Year 1 investment income:

10% × $600,000 net income = $ 60,000

10% × $200,000 dividends paid = $(20,000)

adjustment to Year 1 $ 40,000 ?????

My questions is how come adjustment to year 1 is not $20,000???

[southern star]

Because under the equity method, you would have recognized 10% of the income (600K * .10) = 60K, but this amount would have been reduced by the dividend revenue received (200K * .10) = 20K. Hence, the adjustment in aggregate is 40K.

Thank goodness, this has been eliminated:

https://www.journalofaccountancy.com/news/2016/mar/fasb-equity-method-of-accounting-201614065.html

However, it is still tested the old way until Jan 17 believe.

[Author]

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