Question

On January 1, 20x1, Patrick company purchased a 90% interest in Steven company for $350,000. Steven company had the following stockholders equity: Common stock and paid in capital: $200,000 Retained earnings: $100,000 The building was undervalued by $60,000 and is depreciated over 20 years. Steven company had income of $30,000 for 20x1 and $40,000 for 20x2. No dividends were paid. Patrick company sold its entire investment in Steven company on January 1, 20x3, for $340,000. Required: a. Equity method to reflect its investment in Steven company b. Partial equity method to reflect its investment in Steven company c. Initial value method to reflect its investment in Steven company d. Suppose Patrick company sold 20% of the 90% owned of Steven company for $120,000

Answer 1

The equity method acknowledges the substantive economic relationship between two entities. The investor records its share of the investee's earnings as revenue from investment on the income statement. When a company holds approximately 20% to 50% of a company's stock, it is considered to have significant influence. Companies with less than 20% interest in another company may also hold significant influence, in which case they also need to use the equity method.

Hence earnings from investment = 90% of net income

= 90% * 70000 = $63000

Owner's equity = 90% (200000 + 100000) = 270000

Partial equity method:

The investor recognizes its proportionate share of the investee’s net income or loss on its income statement but makes no other adjustments

Since there is no distribution of dividend, earnings from investment is reported in balance sheet as $63000 and no other adjustments are made.