Equity Method: Exercise

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In Class Exercises Using Equity Method SOLUTION

Example 1 : Assume B (the investee) has the following simplified balance sheet:
Assets $100,000 Liabilities $ 60,000 Equity $ 40,000
Prepare journal entries for the INVESTOR (A) for the following events:

(a) A (the investor) pays $10,000 for a 25% interest in B. A has significant influence.

Dr. Cr.

(b) In the first year after the investment, the investee earns $20,000.

Dr. Cr.

(c) At the end of the first year, B pays total dividends of $8,000 to its shareholders.

Dr. Cr.

(d) At the end of the first year, A sells 30% of its investment for $9000. (Make ‘T’ acct & take 30% of the total in the account at end of year… = $
Dr.
Cr. Cr.

(e) Instead of (d), A decides to keep its investment. In year 2, B has a loss of $100,000.

Dr. Cr.
EXPLAIN your answer….

(f) After recording entry (e), how much will the investee need to earn before the investor can return to using equity method accounting.

Important points to note:
1. Under equity method accounting, the investor uses only 2 accounts, the investment asset account and the equity earnings P&L account.
2. Positive earnings increase the investment account; dividend decreases it.
3. The required entries by the investor mirror what the investee is recording in earnings and stockholders equity…..for the % ownership by the investor.
4. On sale of a partial interest, use “T accounts” to update the investment balance to date of sale and remove only the percentage sold.
5. The investor reflects

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