Question

On January 4, 2018, Runyan Bakery paid $332 million for 10 million shares of Lavery Labeling Company common stock. The investment represents a 30% interest in the net assets of Lavery and gave Runyan the ability to exercise significant influence over Lavery's operations. Runyan chose the fair value option to account for this investment. Runyan received dividends of $4.50 per share on December 15, 2018, and Lavery reported net income of $190 million for the year ended December 31, 2018. The market value of Lavery's common stock at December 31, 2018, was $30 per share. On the purchase date, the book value of Lavery's net assets was $840 million and:

1. The fair value of Lavery's depreciable assets, with an average remaining useful life of 4 years, exceeded their book value by $80 million.
2. The remainder of the excess of the cost of the investment over the book value of net assets purchased was attributable to goodwill.

Required:
1-a. Prepare all appropriate journal entries related to the investment during 2018, assuming Runyan accounts for this investment under the fair value option, and accounts for the Lavery investment in a manner similar to what it would use for securities for which there is not significant influence.
1-b. Calculate the effect of these journal entries on 2018 net income, and the amount at which the investment is carried in the December 31, 2018, balance sheet.
2-a. Prepare all appropriate journal entries related to the investment during 2018, assuming Runyan accounts for this investment under the fair value option, but uses equity method accounting to account for Lavery’s income and dividends, and then records a fair value adjustment at the end of the year that allows it to comply with GAAP.
2-b. Calculate the effect of these journal entries on 2018 net income, and the amount at which the investment is carried in the December 31, 2018, balance sheet.

Answer 1

1.

Event	Account Titles	Debit	Credit
1	Investment in Lavery Labelling shares	332
	Cash		332
2	No entry
3	Cash	45
	Dividend revenue [10 million shares *4.5]		45
4	No entry
5	Unrealized holding loss - NI	32
	Fair value adjustment		32
	[332million/ 10million - 30] *10 million

1b.

Effect of these journal entries on 2018 net income	26	[45-19]
Investment	300	[332-32]

2a.

Event	Account Titles	Debit	Credit
1	Investment in Lavery Labelling shares	332
	Cash		332
2	Investment in Lavery Labelling shares	57
	Investment revenue [190 million*30%]		57
3	Cash	45
	Dividend revenue [10 million shares *4.5]		45
4	Investment revenue [80 /4 *30%]	6
	Investment in Lavery Labelling shares		6
5	Unrealized holding loss - NI	38
	Fair value adjustment		38
	[332+57-45-6] - 300 million

2b.

Effect of these journal entries on 2018 net income	25	[57-6-38]
Investment	300	[332-32]