What if no significant influence?

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  • #188850
    Anonymous
    Inactive

    I am just wondering, what would be different if Larkin has 10% (instead of 25%) of Devon Co? i.e. no significant influence


    Larkin Co. has owned 25% of the common stock of Devon Co. for a number of years, and has the ability to exercise significant influence over Devon. The following information relates to Larkin’s investment in Devon during the most recent year:

    Carrying amount of Larkin’s investment in Devon

    at the beginning of the year $200,000

    Net income of Devon for the year 600,000

    Total dividends paid to Devon’s stockholders

    during the year 400,000

    What is the carrying amount of Larkin’s investment in Devon at year-end?

    A. $100,000

    B. $200,000

    C. $250,000

    D. $350,000

    C. When a company owns 20% or more of the voting stock of another corporation, the company is presumed to have significant influence over the decisions of the corporation, and is required to account for the investment in the other corporation using the equity method.

    The equity method requires the investing company to recognize its share of the owned corporation’s earnings, and to increase the carrying amount of its stock in the owned corporation by the same amount.

    When the investing corporation is paid dividends by the owned corporation, this is not income under the equity method, but it does lower the investment carrying amount.

    The investing corporation’s initial price in buying the stock of the owned corporation is the carrying amount of the investment, and this is increased by the share of earnings and decreased by the share of dividends.

    Thus, the carrying amount of Larkin’s investment in Devon at year-end is the beginning balance $200,000, plus 25% of the $600,000 Devon income, and minus 25% of the Devon dividends:

    $200,000 + (0.25 × $600,000) – (0.25 × $400,000)

    $200,000 + (0.25 x $600,000) – (0.25 x $400,000) =

    $200,000 + $150,000 – $100,000 = $250,000

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  • #610061
    Anonymous
    Inactive

    If it only owned 10% of the stock, the investment would be treated under the cost method. Under the cost method, no flow through income or loss is recorded and dividends are treated as income (debit cash, credit income). The investment balance would need to be tested for impairment.

    Edit to add: If 10% ownership: investment balance would be $200,000 and dividend income of $100,000 would be recorded.

    #610062
    Anonymous
    Inactive

    Oh my gosh that helps so much. Thanks.

    #610063
    CPA soon
    Member

    You mean 40K dividend income? 400K*10% ownership??

    FAR - 71, 68, 74, (8/31/14) 78 ✔
    REG - 67, 71, 71, (10/18/14) 78 ✔
    BEC - (11/29/14) 86 ✔
    AUD - 73, (4/4/15) 86 ✔

    I can't believe this is over! 2 years and 3 months..

    #610064
    Anonymous
    Inactive

    CPA soon – Yup, thanks for the correction. I was reading the question again when I was doing the cost method calc. But those are the misreads that will get “trick” people in the exams!!

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