Farwell Company acquired 30% of the outstanding common stock of Ingold Inc. on J
ID: 2475884 • Letter: F
Question
Farwell Company acquired 30% of the outstanding common stock of Ingold Inc. on January 1, 2014, by paying $1,800,000 for 60,000 shares. Ingold declared and paid a $0.50 per share cash dividend on June 30 and again on December 31, 2014. Ingold reported net income of $800,000 for the year.
The board of directors of Farwell Company is confused about the differences between the cost and equity methods. Prepare a memorandum for the board that explains each method and shows in tabular form the account balances under each method at December 31, 2014.
Cost Method EquityMethod
Stock investments $ $
*Dividend revenue $ $
Revenue from stock investments
**
Please respond to at least two of your peers' posts, evaluating their opinion and including any details or additional information that you believe should be part of their work.
(c)The board of directors of Farwell Company is confused about the differences between the cost and equity methods. Prepare a memorandum for the board that explains each method and shows in tabular form the account balances under each method at December 31, 2014.
Cost Method EquityMethod
Stock investments $ $
*Dividend revenue $ $
Revenue from stock investments
**
Explanation / Answer
Memo to the Board of Directors:
Regarding method of accounting for investments in other companies.
Companies use two methods, namely, the cost method and the equity method to account for investments they make in other companies. In general, the cost method is used when the investment doesn't result in a significant amount of control or influence in the investee company whereas the equity method is used in substantial, more-influential investments.
The cost method
The cost method is used when the investment doesn't result in significant influence over the investee company. As a general rule the presumption is that less, than 20% stake in the investee company does not result in significant influence.
Under this method, the stock purchased is recorded as a non-current asset at the historical purchase price, and is not modified unless shares are sold, or additional shares are purchased. No adjustment is made for any loss or profit announced by the investee company. However, dividends’ received is recorded as income.
The equity method
This method is generally used when an investment results in a 20% to 50% stake in the investee, unless it can be clearly shown that the investment doesn't result in a significant amount of influence or control.
Here, the investment is initially recorded as in the cost method, but the account is adjusted to account for the share of the investee company's profits and losses. Dividends when received do not become income, but are considered as a return on the investment, thereby reducing its value.
Below would be account balances in the balance sheet under the two methods.
Cost Method Equity Method
Stock investments $1,800,000 $2,010,000
Dividend revenue $ 30,000 $ 0
Revenue from stock investments $ 0 $240,000
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