Question

BuyCo Inc. holds 25 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 $10,000 per year. For 2017, Marqueen reported earnings of $100,000 and declares cash dividends of $30,000. During that year, Marqueen acquired inventory for $50,000, which it then sold to BuyCo for $80,000. At the end of 2017, BuyCo continued to hold merchandise with a transfer price of $32,000. a. What Equity in Investee Income should BuyCo report for 2017? b. How will the intra-entity transfer affect BuyCo's reporting in 2018? C. If BuyCo had sold the inventory to Marqueen, how would the answers to (a) and (b) have changed? 2018? inventory to Morting

Answer 1

a.	Equity in investee income	$12,000
b.	Equity accrual for 2018 will be	increased	by	$3,000
c.	If the inventory was sold, would your answer above change ?	No

Calculation/Feedback:

a.

Equity in investee income:
Equity income accrual ($100,000 × 25%)	$25,000
Less: Deferral of intra­entity gross profit (below)	($3,000)
Less: Patent amortization (given)	($10,000)
Equity in investee income	$12,000

b. In 2018, the deferral of $3,000 can be recognized by BuyCo’s use or sale of this inventory. Thus, the equity accrual for 2018 will be increased by $3,000 in that year. Recognition of this amount is simply being delayed from 2017 until 2018, the year when the goods are sold to customers outside the affiliated entity.

c. The direction (upstream versus downstream) of the intra­entity transfer does not affect the above answers. However asdiscussed in Chapter Five, a controlling interest calls for a 100% gross profit deferral for downstream intra­entity transfers.In the presence of only significant influence, however, equity method accounting is identical regardless of whether an intra ­entity transfer is upstream or downstream.