Question

As a long-term investment at the beginning of the fiscal year, Joey Co. purchased 30% of Legoria Supplies, Inc.'s, (a total of 8 million shares) for $56 Million. The fair value and book value of the shares were the same at that time. During the year, Legoria Supplies Inc. earned net income of $50 million and distributed cash dividends of $1.25 per share. At the end of the fiscal year, the fair value of the shares acquired by Joey Co. is $64 million. Joey Co's 30% investment in Legoria Supplies Inc gives it significant influence. Required: 1) Prepare appropriate the appropriate journal entry(s) throughout the fiscal year for this investment using the Equity Method. 2) Prepare the journal entry(s) throughout the fiscal year if Joey Co. does not have significant influence (i.e. can't use Equity Method).

Answer 1

1. Using Equity Method

- Recording initial cost of investment

Equity Investment A/c Dr $56 million

To Cash A/c Cr $56 million

- Also since the fair value and book value of Legoria's assets is the same on acquisition, no goodwill exists

- Recording Share of net income

$50 million x 30% = $15 million

Equity Investment A/c Dr $15 million

To Equity Income A/c Cr $15 million

The investment income would increase the total carrying value of the investment ($56 million + $15 million= $71 million)

- Recording Dividend received from Legoria @ $1.25 per share on 7 million shares.

Total investment / Value of investment = 56/8 = 7 million shares

Cash A/c Dr $8.75 million

To Equity Investment A/c Cr $8.75 million

Also Dividend would reduce the carrying value of the investment, ($71 million - $8.75 million = $62.25 million)

At year end since the book value of assets is $62.25 million < and the fair value is $64 million, hence the difference is goodwill. Good will as per Equity method is not amortised.

2. No significant influence

The ownership of less than 20% creates an investment position carried at fair market value in the investor’s balance sheet and the cost method is used to account for the investment.

- Recording initial cost of investment

Investment in Legoria A/c Dr $56 million

To Cash A/c Cr $56 million

- Recording Dividend received from Legoria @ $1.25 per share on 7 million shares.

Total investment / Value of investment = 56/8 = 7 million shares

Dividend receivable A/c Dr $8.75 million

To Dividend Income A/c Cr $8.75 million

At year end since the book value of assets is $62.25 million < and the fair value is $64 million, hence the difference of changes in fair value are debited (for gains in fair value) to a fair value adjustment account reported on the balance sheet to adjust the investment account balance to its end of period fair value.