On January 1, 2019, Monroe, Inc., purchased 15,600 shares of Brown Company for $270,000, giving Monroe...
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On January 1, 2019, Monroe, Inc., purchased 15,600 shares of Brown Company for $270,000, giving Monroe 13 percent ownership of Brown. On January 1, 2020, Monroe purchased an additional 19,200 shares for $590,210. This latest purchase gave Monroe the ability to apply significant influence over Brown. The original 13 percent investment was categorized as an available for-sale security. Any excess of cost over book value acquired for either investment was attributed solely to goodwill.
Brown reports net income and dividends as follows. These amounts are assumed to have occurred evenly throughout these years.
Net Income Cash Dividends (paid quarterly)
2019 $300,000 $160,000
2020 360,000 140,000
2021 468,000 172,000
On May 1, 2021, Monroe sells 6,000 shares of this investment for $26 per share, thus reducing its interest in Brown. However, the company retains the ability to significantly influence Brown. Using the equity method what amounts appear on Monroe’s 2021 income statement?
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Total income accrual.
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Gain or loss on sale of investment.
Homework Answers
Investment in Equity Securities
The method of accounting for common stock depends on the % stock owned by the investor.
- No influence - (less than 20%) - Fair Value Through Net Income (FVTNI)
- Significant Influence (20%-50%) Equity Method is used
- Control (over 50%) Consolidation
In the given question,
In 2019, Monroe Inc. purchased 15,600 shares of Brown Company, which amounts to 13% stake. Since the holding of Monroe Inc. is less than 20%, the same shall be treated as No Influence and FVTNI method shall be used.
So the entire dividend of $20,800 ($160,000*13%) shall be recorded as income on Income statement and value of investment shall be recorded at fair value. But since in the given question, the fair value of investment is not mentioned as on 12/31/2019, the value of investment shall be considered to be $ 270,000.
In 2020, Monroe Inc. Purchased further 19200 shares (16% stake), its total stake in Brown Company is 29%, which amounts to significant influence. Thus Monroe Inc needs to adopt Equity Method.
Therefore the 29% of the income earned by Brown Company in 2020 i.e. $360,000 * 29% = $75,400 shall be recorded as Equity in Earnings on Income Statement and 29% of the amount of dividend received i.e. $140,000 * 29% = $40,600 shall be reduced from the amount of investment.
Therefore the value of investment at the end of 2020 would be $270,000 + $590,210 - $40,600 = $819,610 for 34800 shares
In 2021, Monroe Inc. sold 6000 shares of Brown Company on May 1, however it retained the ability to significantly influence Brown. Thus Equity method of accounting shall be used.
Since dividends are paid quarterly by Brown, the dividend for the 1st Quarter i.e. for Jan- March shall be reduced from Investment. Therefore 29% of (172,000 /4) = $12470 shall be reduced from the value of investment.
Thus value of Investment as on May 1, 2021 would be $819,610 - $12,470 = $807,140 for 34800 shares
Gain on sale = 6000 * 26 - 807140/34800*6000 = $16,838
Income to be recorded in Income statement = $468000 * 4/12 * 29% + $468000 * 8/12 * 24% = $ 120,120.
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