On January 4, Year 1, Barber Company purchased 5,000 shares of Convell Company f

Question

On January 4, Year 1, Barber Company purchased 5,000 shares of Convell Company for $59,500 plus a broker's fee of $1,000. Convell Company has a total of 25,000 shares of common stock outstanding and it is presumed the Barber Company will have a significant influence over Convell. During each of the next two years, Convell declared and paid cash dividends of $0.85 per share, and its net income was $72,000 and $67,000 for Year 1 and Year 2, respectively. What is the book value of Barber's investment in Convell at the end of Year 2?

$87,300.

$52,000.

$79,800.

$60,500.

$88,300.

Explanation / Answer

Number of shares purchased =5000

Cost of the shares =$59,500.

Brokers fee=$1,000.

Total shares of convell company =25,000 shares.

% of holding Barber has in Convell =5000/25,000

=20%.

As Barber has significant influence over concell equity method of accounting is used for calculating value of holding in Convell.

Cost of purchase of shares =$59,500+broker's fee $1,000.

=$59,500+$1,000

=$60,500-------(1)

As the equity method is used income is recognized as it is earned by convell company for year1 =$72,000 * 20%

=$14,400.

This is credited to the investment account and when dividend is declared the same is reduced from the income = 5000*0.85

=$4,250.

=$14,400 -$4,250

=$10,150.-----------(2)

Therefore value of the investment at the end of year 1 = (1)+(2)

=$70,650.

Applying the same principle as above for year 2

Value of the investment = Value of the investment at end of Year 1+Income for year 2 - Dividend if any declared for year 2

=$70,650 +20% of$67,000 - $4,250

=$79,800.

Therefore answer is option c. i.e., =$79,800.

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