Question

Panache Inc. is a small specialty automobile manufacturer. The company's long-time controller, Celia Brown, retired on January 10, 2016, at the age of eighty-eight years, and the president of the company, Andrew Cartwright, has hired you to be the company's new controller.

Andrew would like to take Panache public in the near future, which will require audited financial statements. He has retained the public accounting firm of Booker and Helwig to audit the 2015 financial statements as a preliminary step. He knows that Celia was not always up to date on current issues, and he has asked you to review all of the company's accounting policies and procedures. Your first task is to identify problem areas and make any corrections needed before the audit begins.

Andrew wants to be kept informed at all times, and when any problems are identified, he wants to be made aware of the problem as well as your solution.

You've spent your first week on the job getting familiar with the company's products and processes. It's time to dig into the company's financial statements, and you decide to look at the company's investment accounting first.

The company purchased several securities in 2014, including 30,000 of the 100,000 outstanding shares of Lion Tire. Lion Tire supplies the tires used on all of Panache's vehicles. Mr. Cartwright was asked and agreed to become a member of Lion Tire's board. You find the detailed records for the investment transactions and the financial statements in the Lion Tire file. During your review, you find that all of the investment transactions were properly recorded and reported except for the investment in Lion Tire.

This Week's Task:

Based on your analysis of the Lion Tire transactions, draft the journal entries that should have been made in an Excel spreadsheet. Then, write a memo to Andrew explaining the accounting principles that should have been followed for Panache's investment in Lion Tire. In your memo:

• Illustrate how the investment will be reported in the company's balance sheet and income statement.
• Summarize how and why the accounting for this investment is different from the accounting for Panache's other investment securities.
• Devise three ways, based on past practices, that Panache can improve its future accounting principles for the Lion Tire transactions.
  Panache, Inc. The Lion Tire file contained the following 1/2/2007 Purchase advice for the purchase of 30,000 shares of Lion Tire at $12 per share The following balance sheet was also in the file, with a notation that the carrying values and fair values of Lion's assets were the same Lion Tire, Inc. Balance Sheet As of December 31, 2006 in thousands Assets Current Assets Property, Plant & Equipment, nt 600,000 Other Assets Liabilities and Stockholders' Equity $60,000Liabilities $300,000 180,000 420,000 600,000 $900,000 Total Liabilities and Stockholders' Equity $900,000 240,000 Common Stock, no par Retained Earnings Total Stockholders' Equity Total Assets 4/1/2007 Check stub and copy of deposit ticket with the notation "Dividend received from Lion Tire S.50 per share" 10/1/2007 Check stub and copy of deposit ticket with the notation "Dividend received from Lion Tire $.50 per share" 12/31/2007 Section of Wall Street Journal for December 31, 2007, showing Lion Tire stock closed at a price of $15 per share 12131/2007 Condensed income statement and statement of retained earnings for Lion Tire as of December 31, 2007 Lion Tire, Inc. Income Statement Lion Tire, Inc. Statement of Retained Earnings For the Year Ended December 31, 2007 For the Year Ended December 31, 2007 Revenues Expenses Net Income $600,000 408,000 $192,000 Beginning Retained Earnings Add Net Income $ 420,000 612,000 100.000 Less: Cash Dividends Ending Retained Earnings Page 1 of 2
  

Answer 1

As Panache had acquired 30000 shares of the total of 100000 shares of Lion Tire ,

ie. 30000/100000=30% of the total outstanding shares,

GAAP requires this investment to be considered investment in equity of the investee company--ie. Holding substantial ,ibut not majority of the quantum of outstanding shares--and hence recorded under equity method of accounting.

ie.,

holding above 20% of the shares of a company is considered as exerting significant influence in the financial affairs of the investee company.

So, they are not avavilable-for -sale securities , as had been understood & treated by Panache Inc.

Hence,Panache Inc.'s investment in Lion Tire is different from its other investments & need to be recorded under the equity method --which is as explained below:

1..At the time of investment:

Debit     Investment in Lion Tire

Credit    Cash

2..When Lion Tire reports income, the investment account increases by the holding % times the income   & the credit side goes to the income statement.

& the journal entry will be:

Debit     Investment in Lion Tire

Credit    Equity Investment Income in Lion Tire

In case of loss reported by Lion Tire , the investment account decreases by the holding % times the loss   & there is debit to the income statement for the loss

& the journal entry will be:

Debit    Equity Investment Loss in Lion Tire

Credit     Investment in Lion Tire

3.. When Lion Inc. declares /Pays dividends,the investment a/c decreases & dividends receivable or cash a/c is debited.

& the journal entry will be:

Debit     Dividends receivable/Cash

Credit     Investment in Lion Tire

Journal entries that should have been made in
Panache Inc.'s books
1/2/2007	Investment in Lion Tire	360000
	Cash		360000
4/1/2007	Cash	15000
	Investment in Lion Tire		15000
10/1/2007	Cash	15000
	Investment in Lion Tire		15000
12/31/2007	NO ENTRY REQUIRED
	Investment in Lion Tire	57600
	Equity Investment Income in Lion Tire		57600
	Income statement(Partial)
	For the year ended Dec 31, 2007
	Dividend revenues	30000
	Balance Sheet(Partial)
	As at Dec 31, 2007
	Assets
	Current assets
	Long-term assets
	Equity Investment in Lion Tire Inc.	417600
	(360000+57600)