Question # 62 | Blueprint Area: 3 K : Fair Value Measurements
On January 1, year 1, Peabody Co. purchased an investment for $400,000 that represented 30% of Newman Corp.’s outstanding voting stock. For year 1, Newman reported net income of $60,000 and paid dividends of $20,000. At year end, the fair value of Peabody’s investment in Newman was $410,000. Peabody elected the fair value option for this investment. What amount should Peabody recognize in net income for year 1 attributable to the investment?
A. $6,000
B. $10,000
C. $16,000
D. $18,000
You are correct, the answer is C.
Entities may choose to measure eligible items at fair value (the “fair value option”) that are not currently required to be measured at fair value. The decision to elect the fair value option is applied instrument by instrument, is irrevocable, and is applied only to an entire instrument. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The Investment in Newman would be increased by 30% of the net income and decreased by 30% of the dividends, resulting in a year end carrying amount of $412,000 ($400,000 + 18,000 – 6,000). Since the fair value was $410,000, Peabody had an unrealized loss of $2,000. This loss is netted against the investment income previously recognized of $18,000 for a $16,000 net income impact. Dividends do not affect net income (they reduce the Investment account).
-The above is accounting for an investment with the equity method, but then subsequently revalues it to fair value. Is this correct treatment, if it was valued at fair value why would we apply the equity method (the gain from the income) then revalue to fair value and not just value at fair value for a loss of $2,000 and not a gain for $16,000?
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