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Lecture Notes

Financial Accounting Theory III

Prof. Alfred Liu

Chapter 1: Reporting Equity Investments in Other Companies  Example 1: The Cost/Equity Method and Increase of Investment
Company A made an investment in one of its local competitors, Company B. For the following events, use the appropriate accounting method and record journal entries for Company A. 1/2/2012 – A purchased 10% of B’s shares for $20,000. 12/31/2012 - B reported net income of $100,000 and declared and paid dividends $10,000 to its shareholders. 1/2/2013 - A purchases an additional 20% of B’s common shares for $45,000. 12/31/2013 - B reports net income of $120,000 for 2013 and declared and paid $11,000 dividends to all shareholders.

Analysis: The objective of retroactive adjustment – as if the equity method had been used from the first day of investment. Two accounts need to be adjusted: a) Investment account b) Retained earnings (historical equity income) or AOCI. Solution: In 2012, the cost method was appropriate because we didn’t know the market value of the investment. Record the investment on 1/2/2012 for A: Dr. Investment in B 20,000 Cr. Cash 20,000 Net income reported by B in 2012: No journal entry under the cost method. Record the dividends paid by B to A on 12/31/2012: Dr. Cash 1,000 Cr. Dividend income 1,000 Record the increase in investment on 1/2/2013: Dr. Investment in Ivanhoe Mines 45,000 Cr. Cash 45,000 Retroactive adjustments to investment and retained earnings on 1/2/2013: Dr. Investment in Ivanhoe Mines 9,000 Cr. Retained earnings 9,000 Calculation: Income under the cost method in 2012: $1,000 Income under the equity method in 2012: $10,000 Adjustment needed for all historical equity income: 10,000-1,000 = 9,000

Lecture Notes

Financial Accounting Theory III

Prof. Alfred Liu

Record dividends received from B in 2013: Dr. Cash 3,300 Cr. Investment in…...

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