Solution Manual for Advanced Accounting, 13th Edition

Chapter 2 STOCK INVESTMENTS — INVESTOR ACCOUNTING AND REPORTING Answers to Questions 1 Only the investor’s accounts are affected when outstanding stock is acquired from existing stockholders. The investor records the investment at its cost. Since the investee company is not a party to the transaction, its accounts are not affected. Both investor and investee accounts are affected when unissued stock is acquired directly from the investee. The investor records the investment at its cost and the investee adjusts its asset and owners’ equity accounts to reflect the issuance of previously unissued stock. 2 Goodwill arising from an equity investment of 20 percent or more is not recorded separately from the investment account. Under the equity method, the investment is presented on one line of the balance sheet in accordance with the one-line consolidation concept. 3 Dividends received from earnings accumulated before an investment is acquired are treated as decreases in the investment account balance under the fair value/cost method. Such dividends are considered a return of a part of the original investment. 4 The equity method of accounting for investments increases the investment account for the investor’s share of the investee’s income and decreases it for the investor’s share of the investee’s losses and for dividends received from the investee. In addition, the investment and investment income accounts are adjusted for amortization of any investment cost-book value differentials related to the interest acquired. Adjustments to the investment and investment income accounts are also needed for unrealized profits and losses from transactions between the investor and investee companies. A fair value adjustment is optional under SFAS No. 159. 5 The equity method is referred to as a one-line consolidation because the investment account is reported on one line of the investor’s balance sheet and investment income is reported on one line of the investor’s income statement (except when the investee has discontinued operations). In addition, the investment income is computed such that the parent company’s income and stockholders’ equity are equal to the consolidated net income and consolidated stockholders’ equity that would result if the statements of the investor and investee were consolidated. 6 If the equity method is applied correctly, the income of the parent company will generally equal the controlling interest share of consolidated net income. 7 The difference in the equity method and consolidation lies in the detail reported, but not in the amount of income reported. The equity method reports investment income on one line of the income statement whereas the details of revenues and expenses are reported in a consolidated income statement. 8 The investment account balance of the investor will equal underlying book value of the investee if (a) the equity method is correctly applied, (b) the investment was acquired at book value which was equal to fair value, the pooling method was used, or the cost-book value differentials have all been amortized, and (c) there have been no intercompany transactions between the affiliated companies that have created investment account-book value differences. 9 The investment account balance must be converted from the cost to the equity method when acquisitions increase the interest held to 20 percent or more. The amount of the adjustment is the difference between the investment income reported under the cost method in prior years and the income that would have been reported if the equity method of accounting had been used. Changes from the cost to the equity method of accounting for equity investments are changes in the reporting entity that require restatement of prior years’ financial statements when the effect is material. Copyright © 2018 Pearson Education, Inc. 2-1 2-2 Stock Investments — Investor Accounting and Reporting 10 The one-line consolidation is adjusted when the investee’s income includes gains or losses from discontinued operations. In this case, the investor’s share of the investee’s ordinary income is reported as investment income under a one-line consolidation, but the investor’s share of gains and losses from discontinued operations is combined with similar items of the investor. 11 The remaining 15 percent interest in the investee is accounted for under the fair value/cost method, and the investment account balance immediately after the sale becomes the new cost basis. 12 Yes. When an investee has preferred stock in its capital structure, the investor has to allocate the investee’s income to preferred and common stockholders. Then, the investor takes up its share of the investee’s income allocated to common stockholders in applying the equity method. The allocation is not necessary when the investee has only common stock outstanding. 13 Goodwill impairment losses are calculated by business reporting units. For each reporting unit, the company must first determine the fair values of the net assets. The fair value of the reporting unit is the amount at which it could be purchased in a current market transaction. This may be based on market prices, discounted cash flow analyses, or similar current transactions. This is done in the same manner as is done to originally record a combination. The first step requires a comparison of the carrying value and fair value of all the net assets at the business reporting level. If the fair value exceeds the carrying value, goodwill is not impaired and no further tests are needed. If the carrying value exceeds the fair value, then we proceed to step two. In step two, we calculate the implied value of goodwill. Any excess measured fair value over the net identifiable assets is the implied fair value of goodwill. The company then compares the goodwill’s implied fair value estimate to the carrying value of goodwill to determine if there has been an impairment during the period. 14 Yes. Impairment losses for subsidiaries are computed as outlined in the solution to question 13. Companies compare fair values to book values for equity method investments as a whole. Firms may recognize impairments for equity method investments as a whole, but perform no separate goodwill impairment tests. SOLUTIONS TO EXERCISES Solution E2-1 1 2 3 4 5 d c c d b Copyright © 2018 Pearson Education, Inc. Chapter 2 2-3 Solution E2-2 [AICPA adapted] 1 2 3 4 5 6 7 8 d b d b Pop’s investment is reported at its $600,000 cost because the equity method is not appropriate and because Pop’s share of Son’s income exceeds dividends received since acquisition [($520,000  15%) > $40,000]. c Dividends received from Sun for the two years were $10,500 ($70,000  15% – all in 2017), but only $9,000 (15% of Sun’s income of $60,000 for the two years) can be shown on Pam’s income statement as dividend income from the Sun investment. The remaining $1,500 reduces the investment account balance. c [$100,000 + $300,000 + ($600,000  10%)] a d Investment balance January 2 $250,000 30,000 Add: Income from Sun ($100,000  30%) Investment in Sun December 31 $280,000 Solution E2-3 1 Pop’s percentage ownership in Son Pop’s 20,000 shares/(60,000 + 20,000) shares = 25% 2 Goodwill Investment cost Book value ($1,000,000 + $500,000)  25% Goodwill $500,000 (375,000) $125,000 Solution E2-4 Income from Sun for 2016 Share of Sun’s income ($100,000  1/2 year  30%) Copyright © 2018 Pearson Education, Inc. $ 15,000 Stock Investments — Investor Accounting and Reporting 2-4 Solution E2-5 1 Income from Son Share of Son’s reported income ($200,000  30%) Less: Excess allocated to inventory Less: Depreciation of excess allocated to building ($50,000/4 years) Income from Son 2 $ 60,000 (25,000) (12,500) $ 22,500 $ 500,000 22,500 (15,000) 507,500 Investment account balance at December 31 Cost of investment in Son Add: Income from Son Less: Dividends ($50,000 x 30%) Investment in Son December 31 $ Alternative solution Underlying equity in Son at January 1 ($375,000/.3) Income less dividends Underlying equity December 31 Interest owned Book value of interest owned December 31 Add: Unamortized excess Investment in Son December 31 $1,250,000 150,000 1,400,000 30% 420,000 87,500 $ 507,500 Solution E2-6 Journal entry on Pam’s books Investment in Sun ($1,200,000 x 40%) Loss from discontinued operations Income from Sun 480,000 80,000 To recognize income from 40% investment in Sun. Copyright © 2018 Pearson Education, Inc. 560,000 Chapter 2 2-5 Solution E2-7 1 a Dividends received from Son ($120,000  15%) Share of income since acquisition of interest 2016 ($20,000  15%) 2017 ($80,000  15%) Excess dividends received over share of income Investment in Son January 3, 2016 Less: Excess dividends received over share of income Investment in Son December 31, 2017 2 b Cost of 10,000 of 40,000 shares outstanding Book value of 25% interest acquired ($4,000,000 stockholders’ equity at December 31, 2016 + $1,400,000 from additional stock issuance)  25% Excess fair value over book value(goodwill) 3 d The investment in Son balance remains at the original cost. 4 c Income from continuing operations Percent owned Income from Son Products Copyright © 2018 Pearson Education, Inc. $ 18,000 $ (3,000) (12,000) 3,000 $ $ 50,000 (3,000) 47,000 $1,400,000 1,350,000 $ 50,000 $ $ 200,000 40% 80,000 Stock Investments — Investor Accounting and Reporting 2-6 Solution E2-8 Preliminary computations Cost of 40% interest January 1, 2016 Book value acquired ($4,000,000  40%) Excess fair value over book value Excess allocated to Inventories $100,000  40% Equipment $200,000  40% Goodwill for the remainder Excess fair value over book value Pam’s underlying equity in Sun ($5,500,000  40%) Add: Goodwill Investment balance December 31, 2019 Alternative computation Pam’s share of the change in Sun’s stockholders’ equity ($1,500,000  40%) Less: Excess allocated to inventories ($40,000  100%) Less: Excess allocated to equipment ($80,000/4 years  4 years) Increase in investment account Original investment Investment balance December 31, 2019 $2,400,000 (1,600,000) $ 800,000 $ $ 40,000 80,000 680,000 800,000 $2,200,000 680,000 $2,880,000 $ 600,000 (40,000) (80,000) 480,000 2,400,000 $2,880,000 Solution E2-9 1 2 Income from Son Share of income to common ($400,000 – $30,000 preferred dividends)  30% Investment in Son December 31, 2017 NOTE: The $50,000 direct costs of acquiring the investment must be expensed when incurred. They are not a part of the cost of the investment. Investment cost Add: Income from Son Less: Dividends from Son ($200,000 dividends – $30,000 dividends to preferred)  30% Investment in Son December 31, 2017 Copyright © 2018 Pearson Education, Inc. $ 111,000 $1,200,000 111,000 (51,000) $1,260,000 Chapter 2 2-7 Solution E2-10 1 2 Income from Sun ($200,000 – $150,000)  25% Investment income October 1 to December 31 Investment balance December 31 Investment cost October 1 Add: Income from Sun Less: Dividends Investment in Sun at December 31 12,500 $ 300,000 12,500 –312,500 $ December 31 $ 600,000 400,000 $200,000 Sales Expenses Net Income $ October 1 $450,000 300,000 $150,000 Solution E2-11 Preliminary computations Goodwill from first 10% interest: Cost of investment Book value acquired ($210,000  10%) Excess fair value over book value Goodwill from second 10% interest: Cost of investment Book value acquired ($250,000  10%) Excess fair value over book value 1. 2 Correcting entry as of January 2, 2017 to convert investment to the equity method Accumulated gain/loss on stock available for Sale Valuation allowance to record Son at fair value To remove the valuation allowance entered on December 31, 2016 under the fair value method for an available for sale security. Investment in Son Retained earnings To adjust investment account to an equity basis computed as follows: Share of Son’s income for 2016 Less: Share of dividends for 2016 $ $ $ $ 25,000 (21,000) 4,000 50,000 (25,000) 25,000 25,000 25,000 4,000 4,000 $ $ 10,000 (6,000) 4,000 Income from Son on original 10% investment $ 5,000 Income from Son on second 10% investment 2017 Income from Son $ 5,000 10,000 Income from Son for 2017 Copyright © 2018 Pearson Education, Inc. Stock Investments — Investor Accounting and Reporting 2-8 Solution E2-12 Preliminary computations Stockholders’ equity of Sun on December 31, 2016 Sale of 12,000 previously unissued shares on January 1, 2017 Stockholders’ equity after issuance on January 1, 2017 Cost of 12,000 shares to Pam Book value of 12,000 shares acquired $630,000  12,000/36,000 shares Excess fair value over book value $380,000 250,000 $630,000 $250,000 210,000 $ 40,000 Excess is allocated as follows Buildings $60,000  12,000/36,000 shares Goodwill Excess fair value over book value $ 20,000 20,000 $ 40,000 Journal entries on Pam’s books during 2017 January 1 Investment in Sun Cash To record acquisition of a 1/3 interest in Sun. During 2017 Cash Investment in Sun To record dividends received from Sun ($90,000  1/3). 250,000 250,000 30,000 December 31 Investment in Sun 38,000 Income from Sun To record investment income from Sun computed as follows: Share of Sun’s income ($120,000  1/3) Depreciation on building ($20,000/10 years) Income from Sun Copyright © 2018 Pearson Education, Inc. 30,000 38,000 $ 40,000 (2,000) $ 38,000 Chapter 2 2-9 Solution E2-13 1 Journal entries on Pop’s books for 2017 Cash 120,000 Investment in Son (30%) To record dividends received from Son ($400,000  30%). 120,000 Investment in Son (30%) 240,000 Discontinued operations loss (from Son) 24,000 Income from Son To record investment income from Son computed as follows: Share of income from continuing operations $680,000  30% Add: Excess fair value over cost realized in 2017 $200,000  30% Income from Son before discontinued operations 2 264,000 $ 204,000 60,000 $ 264,000 $ 780,000 240,000 (120,000) $900,000 Investment in Son balance December 31, 2017 Investment cost Add: Income from Son after discontinued operations Less: Dividends received from Son Investment in Son December 31 Check: Investment balance is equal to underlying book value ($2,800,000 + $600,000 – $400,000)  30% = $900,000 3 Pop Corporation Income Statement for the year ended December 31, 2017 Sales Expenses Operating income Income from Son (before discontinued operations) Income from continuing operations Discontinued operations loss (net of tax effect) Net income Copyright © 2018 Pearson Education, Inc. $4,000,000 2,800,000 1,200,000 264,000 1,464,000 24,000 $1,440,000 Stock Investments — Investor Accounting and Reporting 2-10 Solution E2-14 1 Income from Sun for 2017 Equity in income ($108,000 – $8,000 preferred)  40% 2 $ 40,000 $ 290,000 40,000 (16,000) 314,000 Investment in Sun December 31, 2017 Cost of investment in Sun Add: Income from Sun Less: Dividends ($40,000* x 40%) Investment in Sun December 31 * $48,000 total dividends less $8,000 preferred dividend $ Solution E2-15 Since the total fair value of Son has declined by $60,000 while the fair value of the net identifiable assets is unchanged, the $60,000 decline is the impairment in goodwill for the period. The $60,000 impairment loss is deducted in calculating Pop’s income from continuing operations. Solution E2-16 Goodwill impairments are calculated at the business reporting unit level. Increases and decreases in fair values across business units are not offsetting. Pam must report an impairment loss of $5,000 in calculating 2017 income from continuing operations. Copyright © 2018 Pearson Education, Inc. Chapter 2 2-11 SOLUTIONS TO PROBLEMS Solution P2-1 1 Goodwill Cost of investment in Son on April 1 $686,000 Book value acquired: Net assets at December 31 $2,000,000 80,000 Add: Income for 1/4 year ($320,000  25%) Less: Dividends paid March 15 (40,000) Book value at April 1 2,040,000 Interest acquired ________30% 612,000 Goodwill from investment in Son $ 74,000 2 Income from Son for 2016 Equity in income from continuing operations ($240,000  3/4 year  30%) 3 4 5 Investment in Son at December 31, 2016 Investment cost April 1 Add: Income from Son plus discontinued operations gain Less: Dividends ($40,000  3 quarters)  30% Investment in Son December 31 Equity in Son’s net assets at December 31, 2016 Son’s stockholders’ equity January 1 Add: Net income Less: Dividends Son’s stockholders’ equity December 31 Investment interest Equity in Son’s net assets $ $ 686,000 78,000 (36,000) $ 728,000 $2,000,000 320,000 (160,000) 2,160,000 30% $ 648,000 Discontinued operations gain for 2016 to be reported by Pop $ Son’s discontinued operations gain  30% Copyright © 2018 Pearson Education, Inc. 54,000 24,000 Stock Investments — Investor Accounting and Reporting 2-12 Solution P2-2 1 Cost method Investment in Sun July 1, 2016 (at cost) Dividends charged to investment Investment in Sun balance at December 31, 2016 July 1, 2016 Investment in Sun Cash To record initial investment for 80% interest. November 1, 2016 Dividends receivable Dividend income To record receipt of dividends ($32,000  80%). $440,000 (17,600) $422,400 440,000 440,000 25,600 25,600 December 31, 2016 Dividend income 17,600 Investment in Sun To reduce investment for dividends in excess of earnings ($32,000 dividends – $10,000 earnings)  80%. 2 17,600 Equity method Investment in Sun July 1, 2016 Add: Share of reported income Deduct: Dividends charged to investment Deduct: Excess Depreciation Investment in Sun balance at December 31, 2016 July 1, 2016 Investment in Sun Cash To record initial investment for 80% interest of Sun. November 1, 2016 Dividends receivable Investment in Sun To record receipt of dividends ($32,000  80%). $440,000 8,000 (25,600) (13,200) $409,200 440,000 440,000 25,600 25,600 December 31, 2016 Income from Sun 5,200 Investment in Sun 5,200 To record income from Sun computed as follows: Share of Sun’s income ($20,000  1/2 year  80%) less excess depreciation ($264,000/10 years  1/2 year). Copyright © 2018 Pearson Education, Inc. Chapter 2 2-13 Solution P2-3 Preliminary computations Cost of investment in Son Book value acquired ($1,000,000  30%) Excess fair value over book value $331,000 300,000 $ 31,000 Excess allocated Undervalued inventories ($30,000  30%) Overvalued building (-$60,000  30%) Goodwill for the remainder Excess fair value over book value $ 9,000 (18,000) 40,000 $ 31,000 1 2 3 Income from Son Share of Son’s reported income ($100,000  30%) Less: Excess allocated to inventories sold in 2016 Add: Depreciation of excess allocated to overvalued building $18,000/10 years Income from Son — 2016 $ 30,000 ( 9,000) 1,800 $ 22,800 Investment balance December 31, 2016 Cost of investment Add: Income from Son Less: Share of Son’s dividends ($50,000  30%) Investment in Son balance December 31 $331,000 22,800 (15,000) $338,800 Pop’s share of Son’s net assets Share of stockholders’ equity ($1,000,000 + $100,000 income – $50,000 dividends)  30% $315,000 Copyright © 2018 Pearson Education, Inc. Stock Investments — Investor Accounting and Reporting 2-14 Solution P2-4 Preliminary computations Investment cost of 40% interest Book value acquired [$250,000 + ($50,000  1/2 year)]  40% Excess fair value over book value Excess allocated Land $15,000  40% Equipment $25,000  40% Remainder to goodwill Excess fair value over book value July 1, 2016 Investment in Sun Cash To record initial investment for 40% interest in Sun. November 2016 Cash (other receivables) Investment in Sun To record receipt of dividends ($25,000  40%). $190,000 110,000 $ 80,000 $ 6,000 10,000 64,000 $ 80,000 190,000 190,000 10,000 10,000 December 31, 2016 Investment in Sun 10,000 Income from Sun To record share of Sun’s income ($50,000  1/2 year  40%). 10,000 December 31, 2016 Income from Sun Investment in Sun To record depreciation on excess allocated to Undervalued equipment ($10,000/5 years  1/2 year). 1,000 1,000 Copyright © 2018 Pearson Education, Inc. Chapter 2 2-15 Solution P2-5 1 Schedule to allocate fair value — book value differentials Investment cost January 1 Book value acquired ($3,900,000 net assets  30%) Excess fair value over book value $1,680,000 1,170,000 $ 510,000 Allocation of excess Inventories Land Buildings — net Equipment — net Bonds payable Assigned to identifiable net assets Remainder to goodwill Excess fair value over book value 2 3 Fair Value — Percent Book Value Acquired $200,000 30% 800,000 30% 500,000 30% (700,000) 30% (100,000) 30% Income from Son for 2016 Equity in income ($1,200,000  30%) Less: Amortization of differentials Inventories (sold in 2016) Buildings — net ($150,000/10 years) Equipment — net ($210,000/7 years) Bonds payable ($30,000/5 years) Income from Son Investment in Son balance December 31, 2016 Investment cost Add: Income from Son Less: Dividends ($600,000  30%) Investment in Son December 31 Check: Underlying equity ($4,500,000  30%) Unamortized excess: Land Buildings — net ($150,000 – $15,000) Equipment — net ($210,000 – $30,000) Bonds payable ($30,000 – $6,000) Goodwill Investment in Son account Copyright © 2018 Pearson Education, Inc. Allocation $ 60,000 240,000 150,000 (210,000) (30,000) 210,000 300,000 $ 510,000 $ 360,000 $ (60,000) (15,000) 30,000 6,000 321,000 $1,680,000 321,000 (180,000) $1,821,000 $1,350,000 240,000 135,000 (180,000) (24,000) 300,000 $1,821,000 Stock Investments — Investor Accounting and Reporting 2-16 Solution P2-6 1 2 Income from Sun Investment in Sun July 1, 2016 at cost Book value acquired ($130,000  60%) Excess fair value over book value $96,000 78,000 $18,000 Pam’s share of Sun’s income for 2016 ($20,000  1/2 year  60%) Less: Excess Depreciation ($18,000/10 years  1/2 year) Income from Sun for 2016 $ 6,000 900 $ 5,100 Investment balance December 31, 2016 Investment cost July 1 Add: Income from Sun Less: Dividends ($12,000  60%) Investment in Sun December 31 $96,000 5,100 (7,200) $93,900 Solution P2-7 Pop Corporation Partial Income Statement for the year ended December 31, 2018 Investment income Income from Son (equity basis) Income from continuing operations $90,000 90,000 Discontinued operations gain Share of Son’s discontinued opertions gain Net income 60,000 $150,000 Copyright © 2018 Pearson Education, Inc. Chapter 2 2-17 Solution P2-8 Preliminary computations Investment cost of 90% interest in Sun $1,980,000 Implied total fair value of Sun ($1,980,000 / 90%) Book value($2,525,000 + $125,000) Excess book value over fair value $2,200,000 (2,650,000) $ (450,000) Excess allocated Overvalued plant assets Undervalued inventories Excess book value over fair value $ (500,000) 50,000 $ (450,000) 1 2 3 Investment income for 2016 Share of reported income ($250,000  1/2 year  90%) Add: Depreciation on overvalued plant assets (($500,000 x 90%) / 9 years)  1/2 year Less: 90% of Undervaluation allocated to inventories Income from Sun — 2016 Investment balance at December 31, 2017 Underlying book value of 90% interest in Sun (Sun’s December 31, 2017 equity of $2,700,000  90%) Less: Unamortized overvaluation of plant assets ($50,000 per year  7 1/2 years) Investment balance December 31, 2017 Journal entries to account for investment in 2018 Cash (or Dividends receivable) 135,000 Investment in Sun To record receipt of dividends ($150,000  90%). $ 112,500 $ 25,000 (45,000) 92,500 $2,430,000 (375,000) $2,055,000 135,000 Investment in Sun 230,000 Income from Sun 230,000 To record income from Sun computed as follows: Pam’s share of Sun’s reported net income ($200,000  90%) plus $50,000 amortization of overvalued plant assets. Check: Investment balance December 31, 2017 of $2,055,000 + $230,000 income from Sun – $135,000 dividends = $2,150,000 balance December 31, 2018 Alternatively, Sun’s underlying equity ($2,000,000 paid-in capital + $750,000 retained earnings)  90% interest – $325,000 unamortized excess allocated to plant assets = $2,150,000 balance December 31, 2018. Copyright © 2018 Pearson Education, Inc. Stock Investments — Investor Accounting and Reporting 2-18 Solution P2-9 1 Market price of $24 for Pop’s shares Cost of investment in Son (40,000 shares  $24) The $80,000 direct costs must be expensed. Book value acquired ($2,000,000 net assets  40%) Excess fair value over book value $ 960,000 $ 800,000 160,000 Allocation of excess Fair Value — Book Value Inventories $ 200,000 Land 400,000 (400,000) Buildings — net 200,000 Equipment — net Assigned to identifiable net assets Remainder assigned to goodwill Total allocated 2 Percent Acquired 40% 40% 40% 40% Market price of $16 for Pop’s shares Cost of investment in Son (40,000 shares  $16) Other direct costs are $0 Book value acquired ($2,000,000 net assets  40%) Excess book value over fair value Excess allocated to Fair Value — Percent Book Value Acquired Inventories $200,000 40% Land 400,000 40% (400,000) 40% Buildings — net 200,000 40% Equipment — net Bargain purchase gain Allocation $ 80,000 160,000 (160,000) 80,000 (320,000) $(160,000) Copyright © 2018 Pearson Education, Inc. Allocation $ 80,000 160,000 (160,000) 80,000 160,000 0 $ 160,000 $ 640,000 800,000 $ (160,000) Chapter 2 2-19 Solution P2-10 1 2 3 4 Income from Sun — 2016 Pam’s share of Sun’s income for 2016 $40,000  1/2 year  15% $ Investment in Sun balance December 31, 2016 Investment in Sun at cost Add: Income from Sun Less: Dividends from Sun November 1 ($15,000  15%) Investment in Sun balance December 31 $ 48,750 3,000 (2,250) $ 49,500 Income from Sun — 2017 Pam’s share of Sun’s income for 2017: $60,000 income  15% interest  1 year $60,000 income  30% interest  1 year $60,000 income  45% interest  1/4 year Pam’s share of Sun’s income for 2017 $ 9,000 18,000 6,750 $ 33,750 Investment in Sun December 31, 2017 Investment balance December 31, 2016 (from 2) Add: Additional investments ($99,000 + $162,000) Add: Income for 2017 (from 3) Less: Dividends for 2017 ($15,000  45%) + ($15,000  90%) Investment in Sun balance at December 31 Alternative solution Investment cost ($48,750 + $99,000 + $162,000) Add: Share of reported income 2016 — $40,000  1/2 year  15% 2017 — $60,000  1 year  45% 2017 — $60,000  1/4 year  45% Less: Dividends 2016 — $15,000  15% 2017 — $15,000  45% 2017 — $15,000  90% Investment in Sun 3,000 $ 49,500 261,000 33,750 (20,250) $324,000 $309,750 $ 3,000 27,000 6,750 $ 2,250 6,750 13,500 36,750 (22,500) $324,000 Note: Since Pam’s investment in Sun consisted of 9,000 shares (a 45% interest) on January 1, 2017, Pam correctly used the equity method of accounting for the 15% investment interest held during 2016. The alternative of reporting income for 2016 on a fair value/cost basis and applying the equity method retroactively for 2017 is not appropriate in view of the overwhelming evidence of an ability to exercise significant influence by the time 2016 income is recorded. Copyright © 2018 Pearson Education, Inc. Stock Investments — Investor Accounting and Reporting 2-20 Solution P2-11 Income from Sun As reported Correct amounts Overstatement 2016 2017 2018 2019 Total $ 80,000 40,000a $120,000 $64,000 64,000b $ -0- $104,000 104,000c $ -0- $96,000 96,000d $ -0- $344,000 304,000 $ 40,000  1/2 year  40%)  40%) c($260,000  40%) d($240,000  40%) a($200,000 b($160,000 1 2 Investment in Sun balance December 31, 2019 Investment in Sun per books December 31 Less: Overstatement Correct investment in Sun balance December 31 $800,000 40,000 $760,000 Check Underlying equity in Sun ($1,800,000  40%) Add: Goodwill ($600,000-($1,400,000  40%)) Investment balance $720,000 40,000 $760,000 Correcting entry (before closing for 2019) Retained earnings 40,000 Investment in Sun 40,000 To record investment and retained earnings accounts for prior error. Copyright © 2018 Pearson Education, Inc. Chapter 2 2-21 Solution P2-12 1 Schedule to allocate excess cost over book value Investment cost (14,000 shares  $13) $10,000 direct costs must be expensed. Book value acquired $190,000  70% Excess fair value over book value $182,000 133,000 $ 49,000 Excess allocated Interest Fair Value — Book Value  Acquired = $ 50,000 $60,000 70% 50,000 30,000 70% 135,000 95,000 70% Inventories Land Equipment — net Remainder to goodwill Excess fair value over book value 2 Investment income from Son Share of Son’s reported income $60,000  70% Add: Overvalued inventory items Less: Depreciation on undervalued equipment ($28,000/4 years)  3/4 year Investment income from Son 3 Allocation $ (7,000) 14,000 28,000 14,000 $ 49,000 $ 42,000 7,000 (5,250) $ 43,750 Investment in Son account at December 31, 2016 Investment cost Add: Income from Son Less: Dividends received (14,000 shares  $2) Investment in Son balance December 31 Check Underlying equity at December 31, 2016 ($210,000*  70%) Add: Unamortized excess of cost over book value Land Equipment Goodwill Investment balance $182,000 43,750 (28,000) $197,750 $147,000 14,000 22,750 14,000 $197,750 * $100,000 (C/S) + $70,000 (R/E) + $80,000 (current earnings) -$40,000 (Dividends) = $210,000 Solution PR 2-1 Yes, since this is a noncontrolling interest, the equity method can be used. (ASC 323-10). Solution PR 2-2 (ASC 320-30-4) The initial basis under the new accounting method should be the amount carried over from the equity method amount at the date of the change. Copyright © 2018 Pearson Education, Inc.