Question

BuyCo, Inc. holds 21 percent of the outstanding shares of Marqueen company and appropriately applies the equity method of accounting. Excess cost amortization (related to a patent) associated with this investment amounts to $11,800 per year. For 2017, Marqueen reported earnings of $101,000 and declares cash dividends of $30,000. During that year, Marqueen acquired inventory for $45,000, which it then sold to BuyCo for $90,000. At the end of 2017, BuyCo continued to hold merchandise with a transfer price of $35,000.

1. What Equity in Investee Income should BuyCo report for 2017?

2. How will the intra-entity transfer affect BuyCo's reporting in 2018?

3. If BuyCo had sold the inventory to Marqueen, how would the answers to (a) and (b) have changed?

Answer 1

Equity income and transfer
a) Equity in investee income :
	Amount ($)
Equity income accrual (101000*21%)	21,210
Less: Deferral of intra entity unrealized gross profit (mentioned below)	(2,450)
Less: Patent amortization (given)	(11,800)
Equity in investee income	6,960
Deferral of intra entity unrealized gross profit
Remaining inventory end of the year	35,000
Gross profit percentage (30000/90000)	33.33%
Profit within remaining inventory	11,666
ownership Percentage	21%
Intra entity unrealized gross profit(11666*21%)	2,450

Answer b) In 2018, the deferral of $2,450 will likely become realized by Buyco's use of sale of this inventory.Thus the equity accrual for 2018 will be increased by $ 2,450 in that year,.Recognition of this amount is simply being delayed from 2017 untill 2018, the year actually earned.

Answer c) The direction upstream vs downstream of intra entity transfer does not effect the above answer.However as discussed in chapter five, a controlling interest call for a 100% gross profit deferral for downstream intra entity transfer.In the presence of only signification influence , however equity method accounting is identical regardless of whether an intra entity transfer is upstream or downstream.