Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 12 Special Income and Investment Reporting Issues 547

Evidence of significant influence includes the percentage of ownership,

the existence of intercompany transactions, and the interchange of man-

agerial personnel. Generally, if the investor owns 20% or more of the vot-

ing stock of the investee, it is assumed that the investor has significant

influence over the investee.

Under the equity method, the stock purchase is recorded at cost but

isnotsubsequently adjusted to fair value. Rather, the book value of the

investment is adjusted as follows:

1. The investor’s share of the periodic net income of the investee is
   recorded as an increase in the investment accountand as income for the
   period. Likewise the investor’s share of an investee’s net loss is
   recorded as a decrease in the investment accountand as a loss for the
   period.


2. The investor’s share of cash dividends from the investee is recorded
   as an increase in the cash accountand a decrease in the investment account.

To illustrate, assume that on January 2, Hally Inc. pays cash of $350,000 for 40% of

the common stock and net assets of Brock Corporation. Assume also that, for the year

ending December 31, Brock Corporation reports net income of $105,000 and declares

and pays $45,000 in dividends. Using the equity method, Hally Inc. (the investor)

records these transactions as follows:

The combined effect of recording 40% of Brock Corporation’s net income and div-

idends is to increase Hally’s interest in the net assets of Brock by $24,000 ($42,000 

$18,000), as shown at the top of the following page.

The equity method causes the investment account to reflect the changes in the

book value of the investee. Thus, Brock Corporation’s book value increased by $60,000

($105,000$45,000), while the investment in Brock account increased by Hally’s share

of that increase, or $24,000 ($60,000 40%). Both the book value of Brock Corporation

and Hally’s investment in Brock increased at the same rate from the original cost.

Sale of Investments in Stocks

Accounting for the sale of stock is the same for both short- and long-term investments.

When shares of stock are sold, the investment account is credited for the carrying

amount (book value) of the shares sold. The cash or receivables account is debited for

the proceeds (sales price less commission and other selling costs). Any difference be-

tween the proceeds and the carrying amount is recorded as a gain or loss on the sale

and is included in determining net income.

Account for the

investment as an

available-for-sale

security

Account for the

investment by

using the equity

method

No Ye s

Accounting for Long-Term

Stock Investments

Is there a significant influence

over the investee?

Q.Assume that Hally Inc.
increased its ownership in
Brock Corporation to 45%
at the beginning of the
next year. If Brock
Corporation reported net
income of $80,000 and
declared dividends of
$50,000, by how much
would Hally Inc. adjust the
Investment in Brock
Corporation Stock?

A.$13,500 [($80,000 
45%)($50,000
45%)]

Jan. 2 Investment in Brock Corporation Stock 350,000

Cash 350,000

Purchased 40% of Brock Corporation Stock.

Dec. 31 Investment in Brock Corporation Stock 42,000

Income of Brock Corporation 42,000

Recorded 40% share of Brock Corporation

net income of $105,000.

Dec. 31 Cash 18,000

Investment in Brock Corporation Stock 18,000

Recorded 40% share of Brock Corporation

dividends.

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