Question

Equity Method for Stock Investment At a total cost of $1,800,000, Herrera Corporation acquired 120,000 shares of Tran Corp. common stock as a long-term investment. Herrera Corporation uses the equity method of accounting for this investment. Tran Corp. has 300,000 shares of common stock outstanding, including the shares acquired by Herrera Corporation. a. Journalize the entries by Herrera Corporation to record the following information: 1. Tran Corp. reports net income of $3,240,000 for the current period. Investment in Tran Corp. Stock Income of Tran Corp. Feedback a. 1. Calculate the ownership percentage by dividing the acquired shares by the total Tran Corp. shares outstanding. Increase both the investment and income accounts by the ownership percentage times Tran Corp.’s net income. 2. A cash dividend of $1.10 per common share is paid by Tran Corp. during the current period. Cash Investment in Tran Corp. Stock Feedback a. 2. Reduce the investment and increase cash by the number of shares acquired times dividends paid per share. b. Why is the equity method appropriate for the Tran Corp. investment? An investment amount between 20% and 50% of the outstanding common stock of the investee is presumed to represent significant influence. The equity method is appropriate when the investor can exercise significant influence over the investee.

Answer 1

a. Ownership percentage of Herrera Corporation in Tran Corp. = 120,000/300,000 = 40%

No.	General Journal	Debit	Credit
1	Investment in Tran Corp. Stock	1296000
	Income of Tran Corp. ($3,240,000 x 40%)		1296000
	(To record share in net income of Tran Corp.)
2	Cash (120,000 x $1.10)	132000
	Investment in Tran Corp. Stock		132000
	(To record cash dividend received)

b. An investment amount between 20% and 50% of the outstanding common stock of the investee is presumed to represent significant influence. The equity method is appropriate when the investor can exercise significant influence over the investee.