Reporting Intercorporate Interests

Multiple Choice Questions

On January 1, 2007, Rotor Corporation acquired 30 percent of Stator Company’s stock for $150,000. On the acquisition date, Stator reported net assets of $450,000 valued at historical cost and $500,000 stated at fair value. The difference was due to the increased value of buildings with a remaining life of 15 years. During 2007 and 2008 Stator reported net income of $25,000 and $15,000 and paid dividends of $10,000 and $12,000, respectively. Rotor uses the equity method.

Based on the preceding information, what amount of differential will be amortized annually?

A. $0 B. $750 C. $1,000 D. $2,000

Based on the preceding information, what will be the balance in the investment account on Dec 31, 2007?

A. $150,000 B. $157,500 C. $154,500 D. $153,500

Based on the preceding information, what amount of investment income will be reported by Rotor for the year 2007?

A. $6,500 B. $7,500 C. $7,000 D. $25,000

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Chapter 02 – Reporting Intercorporate Interests

Based on the preceding information, what amount will Rotor report as the balance in the investment account on Dec 31, 2008?

A. $150,000 B. $157,500 C. $153,400 D. $153,500

Based on the preceding information, what amount of investment income will be reported by Rotor for 2008?

A. $6,500 B. $7,500 C. $3,500 D. $4,500

Based on the preceding information, had Rotor Corporation used the cost method, what would have been the balance in the investment account on Dec 31, 2008?

A. $150,000 B. $157,500 C. $153,400 D. $153,500

On January 1, 2007, Firewire Company acquired 40 percent of Browser Company’s common stock. For this acquisition, Firewire paid $45,000 above book value. The full differential was attributed to equipment with a remaining life of ten years and zero salvage value at the date of acquisition. During 2007 and 2008, Browser reported net income of $90,000 and $50,000 and paid dividends of $40,000 and $60,000, respectively. Firewire reported a balance in its investment account of $230,000 on December 31, 2008. It uses the equity method in accounting for this investment.

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Chapter 02 – Reporting Intercorporate Interests

Based on the preceding information, what is the annual amount of amortization of differential over the ten year period?

A. $0

B. $1,800 C. $4,500 D. $8,500

Based on the preceding information, during 2007, Firewire will report:

A. an increase in the investment account balance of $15,500.

B. a decrease in the investment account balance of $20,000.

C. an increase in the investment account balance of $36,000.

D. a decrease in the investment account balance of $31,500.

Based on the preceding information, during 2008, Firewire will report: A. an increase in the investment account balance of $8,000.

B. a decrease in the investment account balance of $15,500. C. an increase in the investment account balance of $20,000. D. a decrease in the investment account balance of $8,500.

Based on the information provided, what would be the amount paid by Firewire for this acquisition?

A. $254,000 B. $223,000 C. $230,000 D. $174,000

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Chapter 02 – Reporting Intercorporate Interests

On January 1, 2009 Athlon Company acquired 30 percent of the common stock of Opteron Corporation, at underlying book value. For the same year, Opteron reported net income of $55,000, which includes an extraordinary gain of 40,000. It did not pay any dividends during the year. By what amount would Athlon’s investment in Opteron Corporation increase for the year, if Athlon used the equity method?

A. $0

B. $16,500 C. $4,500 D. $12,000

On January 1, 2008, William Company acquired 30 percent of eGate Company’s common stock, at underlying book value of $100,000. eGate has 100,000 shares of $2 par value, 5 percent cumulative preferred stock outstanding. No dividends are in arrears. eGate reported net income of $150,000 for 2008 and paid total dividends of $72,000. William uses the equity method to account for this investment.

Based on the preceding information, what amount would William Company receive as dividends from eGate for the year?

A. $62,000 B. $21,600 C. $18,600 D. $54,000

Based on the preceding information, what amount of investment income will William Company report from its investment in eGate for the year?

A. $45,000 B. $42,000 C. $62,000 D. $35,000

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Chapter 02 – Reporting Intercorporate Interests

Based on the preceding information, what amount would be reported by William Company as the balance in its investment account on December 31, 2008?

A. $100,000 B. $123,400 C. $120,400 D. $142,000

Denver Corporation owns 25 percent of the voting shares of Alamos Corporation. In 2008, Alamos reported net income of $120,000 and paid dividends of $30,000. Denver uses the equity method to account for this investment. Denver reported taxable income of $160,000 on its separate operations and has an effective tax rate of 40 percent. There is an 80 percent exemption on intercompany dividends.

Based on the preceding information, income tax expense for Denver for the year 2008 will

be:

A. $67,000 B. $64,600 C. $64,000 D. $66,400

Based on the preceding information, income taxes payable for Denver for the year 2008 will be:

A. $67,000 B. $64,600 C. $64,000 D. $76,000

Connector Corporation invested in an unincorporated joint venture and elected to use pro rata consolidation in preparing its financial statements. Connector reported income of $120,000 from its separate operations and net income of $150,000 for the year ended December 31, 2008. The joint venture reported assets of $150,000 and liabilities of $60,000 on January 1, 2008, and assets of $240,000 and liabilities of $75,000 on December 31, 2008. It made no distributions to owners during the year. Connector reports total assets (excluding its investment in the unincorporated joint venture) of $550,000 at December 31, 2008.

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Chapter 02 – Reporting Intercorporate Interests

Based on the preceding information, what is Connector’s percentage ownership in the joint venture?

A. 20 percent B. 50 percent C. 40 percent D. 25 percent

Based on the preceding information, what amount of total assets will Connector report in its balance sheet on December 31, 2008?

A. $646,000 B. $625,000 C. $610,000 D. $628,000

Based on the preceding information, Connector’s total assets at the end of the year will be highest if it were able to use:

A. pro rata consolidation. B. equity-method reporting. C. cost-method reporting. D. full consolidation.

On January 1, 2008, Gulfstream Corporation acquired 40 percent of the voting shares of Hunter Company for $65,000. Hunter reported net income of $45,000 and paid dividends of $10,000 in 2008. Gulfstream reported operating income of $50,000 for the year. There is 80 percent exemption of intercompany dividends and the effective tax rate is 35 percent. Assume that the equity method is being used.

Based on the preceding information, what would Gulfstream report as income tax expense for the year?

A. $17,500 B. $18,760 C. $23,800 D. $22,540

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Chapter 02 – Reporting Intercorporate Interests

Based on the preceding information, what amount would Gulfstream report as net income (after taxes) for the year?

A. $49,240 B. $68,000 C. $64,000 D. $67,500

On January 1 2007, Wheeley Company issued common shares with a par value of $20,000 and a market value of $172,000 in exchange for 40 percent ownership of Twain Company. Balance sheet information reported by Twain on that date is given below:

Twain reported net income of $56,000 and paid dividends of $25,000 during the year. Wheeley uses the equity method of accounting. The estimated economic life of the patents held by Twain is 8 years. The buildings and equipment are expected to last 6 more years on average with zero salvage value.

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Chapter 02 – Reporting Intercorporate Interests

Based on the information provided, differential assigned by Wheeley to inventory for the year is:

A. $0

B. $12,000 C. $4,800 D. $22,000

Based on the information provided, what amount of differential assigned to buildings and equipment will be amortized for the year?

A. $0

B. $4,800 C. $2,000 D. $3,800

Based on the information provided, what amount of differential assigned to patents will be amortized for the year?

A. $0

B. $4,800 C. $2,000 D. $3,800

Based on the information provided, what amount of income will be reported by Wheeley from its investment in Twain for the year 2007?

A. $22,400 B. $11,800 C. $4,800 D. $12,400

Based on the information provided, what will be the balance in the investment account on December 31, 2007 reported by Wheeley?

A. $172,000 B. $173,800 C. $183,800 D. $194,400

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Chapter 02 – Reporting Intercorporate Interests

On January 1, 2007, Yang Corporation acquired 25 percent of the outstanding shares of Spiel Corporation for $100,000 cash. Spiel Company reported net income of $75,000 and paid dividends of $30,000 for both 2007 and 2008. The fair value of shares held by Yang was $110,000 and $105,000 on December 31, 2007 and 2008 respectively.

Based on the preceding information, what amount will be reported by Yang as income from its investment in Spiel for 2008, if it used the equity method of accounting?

A. $7,500 B. $11,250 C. $18,750 D. $26,250

Based on the preceding information, what amount will be reported by Yang as balance in investment in Spiel on December 31, 2008, if it used the equity method of accounting?

A. $111,250 B. $118,750 C. $100,000 D. $122,500

Based on the preceding information, what amount will be reported by Yang as income from its investment in Spiel for 2007, if it used the fair value method of accounting?

A. $17,500 B. $12,500 C. $11,250 D. $7,500

Based on the preceding information, what amount will be reported by Yang as income from its investment in Spiel for 2008, if it used the fair value method of accounting?

A. $11,250 B. $2,500 C. $6,250 D. $7,500

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Chapter 02 – Reporting Intercorporate Interests

Based on the preceding information, what amount will be reported by Yang as balance in investment in Spiel on December 31, 2008, if it used the fair value method of accounting? A. $105,000

B. $118,750 C. $100,000 D. $122,500

A change from the cost method to the equity method of accounting for an investment in common stock resulting from an increase in the number of shares held by the investor requires:

A. only a footnote disclosure.

B. that the cumulative amount of the change be shown as a line item on the income statement, net of tax.

C. that the change be accounted for as an unrealized gain included in other comprehensive income.

D. retroactive restatement as if the investor always had used the equity method.

Under the equity method of accounting for a stock investment, the investment initially should be recorded at:

A. cost.

B. cost minus any differential.

C. proportionate share of the fair value of the investee company’s net assets. D. proportionate share of the book value of the investee company’s net assets.

From an investor’s point of view, a liquidating dividend from an investee is:

A. A dividend declared by the investee in excess of its earnings in the current year.

B. A dividend declared by the investee in excess of its earnings since acquisition by the investor.

C. Any dividend declared by the investee since acquisition.

D. A dividend declared by the investee in excess of the investee’s retained earnings.

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Chapter 02 – Reporting Intercorporate Interests

Under the cost method of accounting for a stock investment, the differential: A. is written off.

B. is amortized.

C. is written down if related to limited-life assets. D. is not amortized or written off.

Usually, an investment of 20 to 50 percent in another company’s voting stock is reported under the:

A. cost method. B. equity method.

C. full consolidation method. D. fair value method.

Which of the following observations is consistent with the equity method of accounting? A. Dividends declared by the investee are treated as income by the investor.

B. It is used when the investor lacks the ability to exercise significant influence over the investee.

C. It may be used in place of consolidation.

D. Its primary use is in reporting nonsubsidiary investments.

Which of the following observations is NOT consistent with the cost method of accounting?

A. Investee dividends from earnings since acquisition by investor are treated as reduction of investment.

B. Investments are carried by the investor at historical cost. C. Differential is not amortized or written off.

D. It is consistent with the treatment normally accorded noncurrent assets.

Essay Questions

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Chapter 02 – Reporting Intercorporate Interests

A cash dividend returns assets to the stockholders while reducing corporate liquidity. Why are not all cash dividends considered to be “liquidating dividends”? In your response include a discussion of how an investor accounts for a liquidating dividend.

In the absence of other evidence, common stock ownership of 20 percent or more is viewed as indicating that the investor is able to exercise significant influence over the investee. What are some of the other factors that could constitute evidence of the ability to exercise significant influence?

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Chapter 02 – Reporting Intercorporate Interests

On January 31, 2008, Argentine Company acquired 20 percent of Silver Corporation’s common stock at book value. During 2008 and 2009 Silver reported net income and dividends and Argentine reported operating income as follows:

Assume an 80 percent exemption of intercompany dividends. Argentine has an effective tax rate of 35 percent.

Required: Calculate the amount of income tax expense and net income Argentine Company

should report for 2008 and 2009 under the:

Cost method

Equity Method