On January 4, 2013, Runyan Bakery paid $334 million for 10 million shares of Lav
ID: 2445202 • Letter: O
Question
On January 4, 2013, Runyan Bakery paid $334 million for 10 million shares of Lavery Labeling Company common stock. The investment represents a 30% interest in the net assets of Lavery and gave Runyan the ability to exercise significant influence over Lavery's operations. Runyan received dividends of $4.0 per share on December 15, 2013, and Lavery reported net income of $200 million for the year ended December 31, 2013. The market value of Lavery's common stock at December 31, 2013, was $31 per share. On the purchase date, the book value of Lavery's net assets was $850 million and:
The fair value of Lavery's depreciable assets, with an average remaining useful life of nine years, exceeded their book value by $90 million.
The remainder of the excess of the cost of the investment over the book value of net assets purchased was attributable to goodwill.
Prepare all appropriate journal entries related to the investment during 2013, assuming Runyan accounts for this investment by the equity method. (Enter your answers in millions. If no entry is required for a particular event, select "No journal entry required" in the first account field.)
Prepare the journal entries required by Runyan, assuming that the 10 million shares represent a 10% interest in the net assets of Lavery rather than a 30% interest, and that Runyan accounts for the investment as available for sale. (Enter your answers in millions. If no entry is required for a particular event, select "No journal entry required" in the first account field.)
On January 4, 2013, Runyan Bakery paid $334 million for 10 million shares of Lavery Labeling Company common stock. The investment represents a 30% interest in the net assets of Lavery and gave Runyan the ability to exercise significant influence over Lavery's operations. Runyan received dividends of $4.0 per share on December 15, 2013, and Lavery reported net income of $200 million for the year ended December 31, 2013. The market value of Lavery's common stock at December 31, 2013, was $31 per share. On the purchase date, the book value of Lavery's net assets was $850 million and:
Explanation / Answer
A company uses the equity method of accounting when it has significant influence over a company in which it has invested. Influence generally exists if the investing company owns between 20 and 50 percent of the investee’s voting shares. Ownership of more than 50 percent normally requires a different accounting method called the subsidiary method.
In equity method, investment in Lavery Labeling by Runyan is considered as investment, though it has majority of share holding in Runyan (30%) but not substantial holding (more than 50%). As explained above investment of more than 50% are treated and accounted differently. Hence investment in Lavery by Runyan is treated as non-current asset and entries to be passed are.
(All Figures are in Million)
January 4, 2013.
Investment in Lavery Labeling A/c Dr. $334
To Cash / Bank A/s $334
In equity method we give direct effect to Investment account in case of any income from received from Investee Company, like dividend income or share in the earning of the investee company. (Here Lavery Labeling).
Hence receipt of dividend and share in the income will be treated in investment account.
December 15, 2013
Cash / Bank A/c Dr. $40
To Investment in Lavery Labeling A/c $40
($4 per share x 10million shares)
Similarly, share in income will not be recorded in Profit or Loss or in income statement.
December 31, 2013
Investment in Lavery Labeling A/c Dr. $60
To Equity Income in Lavery Labelling A/c $60
(30% of $200million)
Now, on purchase date the book value of lavery Labeling’s net asset was $850 million and Runyan purchased the same for $334 million. Runyan paid $79 Million ($850 x 30% - 334) more than the net value of Lavery’s asset. In this case as per GAAP accounting procedure, we have to assign this extra payment to one or more of the Lavery’s assets and then amortize the extra amount over the remaining depreciable lifetime of the asset.
Here, some part of the excess payment was also because of the goodwill of the investee company. Therefore, we will also account the goodwill of the investee company and will write off the goodwill account over the investment period.
December 31, 2013
Equity Income in Lavery Labelling A/c Dr. $3
To Investment in Lavery Labeling A/c $3
($90x30% = 27 divided by remaining life of nine years, 27/9)
December 31, 2013
Goodwill of Lavery Labelling A/c 52
To Investment in Lavery Labeling A/c $3
($79-$27)
2. Journal entries treating the same as 10% invetment
In case of Investment method
(All Figures are in Million)
January 4, 2013.
Investment in Lavery Labeling A/c Dr. $334
To Cash / Bank A/s $334
Here dividend income will be treated as income.
December 15, 2013
Cash / Bank A/c Dr. $40
To Dividend income from Lavery Labeling A/c $40
($4 per share x 10million shares)
No entry needed for Share in profit and difference in the net asset and goodwill as it is a short term investment and can be sold any time.
But we will adjust the change in the market price of the Lavery company and will adjust the investment accordingly. Hence the entry to adjust the same would be
Here, at 31st December 2013, price per share of Lavery is $31, and Rynyan has purchased it for $33.4 ($334/10million). There is decline of $2.4 per share, total impact is $24 ($2.4 x 10). Hence the journal entry for the same would be.
December 31, 2013
Unrealised Loss/Gain on Lavery Labeling Dr. $24
To Investment in Lavery Labeling A/c $24
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