Application of the Equity Method
Forth Company owned 85,000 of Brown Company’s 100,000 shares of common stock until January 1, 20X2, at which time it sold 70,000 of the shares to a group of seven investors, each of whom purchased 10,000 shares. On December 3, 20X2, Forth received a dividend of $9,000 from Brown. Forth continues to purchase a substantial portion of Brown’s output under a contract that runs until the end of 20X9. Because of this arrangement, Forth is permitted to place two of its employees on Brown’s board of directors.
Required
Forth Company’s controller is not sure whether the company should use the cost or equity method in accounting for its investment in Brown Company. The controller asked you to review the relevant accounting literature and prepare a memo containing your recommendations. Support your recommendations with citations and quotations from the Accounting Standards Codification.
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