WHY does P Company report $320,000, which is more than their actual investment?
ID: 2429939 • Letter: W
Question
WHY does P Company report $320,000, which is more than their actual investment?A - How would this answer differ if P Company owned < 20%? B -What about if P Company owned > 51% C - What about if P Company did not use the Equity method? D - What about if there HAD been goodwill?
How wortd tmis nongned Use the following information to answer questions 9 and 10, Assume that P Company owns 40% of S Company and uses the Equity Method to account for its Investment in S Co. When P Co. originally bought the investment, it paid an amount equal to 40% of the book value of S Co.'s net assets, so there was no goodwill. The following information was included in P Co.'s balance sheet 12/31/X0 12/31/X1 $100,000 $150,000 Investment in S Co. uring the year 20X1, P Co. received $270,000 in cash from S Co., representing its share of S Diidand Co.'s dividends declared during the year. Ravenue 9. How much will P statement? Co. report as revenue related to this investment on its 20X2 income a. $270,000 b. $ 50,000 $320,000 d. $220,000 e. $675,000 f. cannot tell from the information given
Explanation / Answer
Solution: The correct option is " c" i.e $ 3,20,000(see working note below)
Working Note:
Dividend Received = $ 2,70,000
Cash a/c --------Dr $2,70,000
To Investments in associates----$ 2,70,000
P Co records the net income from S Co as an increase to its investment account
Let the Net Income of S Co= $ x
Investments in associates--------Dr 0.4 x
To Investment Revenue----------------------0.4x
The increase in Investments cost = $ 50,000
Net balance in investments in associates=0.4x-$ 2,70,000= $50,000
X= $ 3,20,000/0.4= $ 8,00,000
Therefore P Co will report as revenue to this investment=40%($800,000)=$3,20,000
P reports more than the actual investment because the share of P Co in the income of S Co that is earned during the year records an increase in the investment a/c which when set off against the Dividend received which is a reduction to the investment a/c as this is outflow of cash from the investee as reflected in the reduced investment account gives us the Increase in the investment cost .
A. If P Co owned less than 20% share then the Equity method is not used because this method is used only when the investment in the associate is in the range of 20% -50% of the ownership as this is considered as an asset by the investor(i.e P Co) and it is reported accordingly.
B. If the company owned greater than 50% shares becomes a majority interest which helps them to make substantial decisions regarding the organization itself. Equity method is used the investor will have a significant influence on the investee company but will still not have full control over it. Here in this case since there is full control equity method I not used and the consolidation method is used.
C. If the company doesn’t use equity method then it means that inspite of having an ownership share in the range of 20% to 50% ,it still doesn’t have a significant influence on the investee company or control over that investee company.
D.If there had been goodwill in the company (i.e the difference between the cost of investments and the book value of the investee assets). .When the investment is acuired it is recorded at cost taking into account the goodwill at the time of acquisition.
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