Question

On January 4, 2018, Runyan Bakery paid $362 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 chose the fair value option to account for this investment. Runyan received dividends of $4 per share on December 15, 2018, and Lavery reported net income of $340 million for the year ended December 31, 2018. The market value of Lavery's common stock on December 31, 2018, was $33 per share. On the purchase date, the book value of Lavery's net assets was $990 million and:

The fair value of Lavery's depreciable assets, with an average remaining useful life of [a(27)] 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.

Required:
1-a. Prepare all appropriate journal entries related to the investment during 2018, assuming Runyan accounts for this investment under the fair value option, and accounts for the Lavery investment in a manner similar to what it would use for securities for which there is no significant influence.
1-b. Calculate the effect of these journal entries on 2018 net income, and the amount at which the investment is carried in the December 31, 2018, balance sheet.
2-a. Prepare all appropriate journal entries related to the investment during 2018, assuming Runyan accounts for this investment under the fair value option, but uses equity method accounting to account for Lavery’s income and dividends, and then records a fair value adjustment at the end of the year that allows it to comply with GAAP.
2-b. Calculate the effect of these journal entries on 2018 net income, and the amount at which the investment is carried in the December 31, 2018, balance sheet.

Answer 1

1-a	Journal Entries related to the investment during 2018 under fair value option
		Amount in millions
4-Jan	Investment in Lavery company	$362
	Cash		$362
	(To record investment at cost)
15-Dec	Cash	$40
	Investment Income		$40
	(To record dividend income received)
31-Dec	Unrealized loss on fair value adjustment	$32
	Investment in Lavery Company		$32
	(To record fair value adjustment)
	(362 million-(10 million x $33))
1-b	Effect of journal entries on net income
	Investment income	$40
	Unrealized loss on fair value adjustment	($32)
	Net effect on net income	$8
	Amount at which investment is carried in balance sheet on Dec 31, 2018
	Investment in Lavery company	$362
	Fair value adjustment	($32)
	Net value of Investment		$330
2-a	Journal Entries related to the investment during 2018 under fair value option
	Equity method for income and dividends
		Amount in millions
4-Jan	Investment in Lavery company	$362
	Cash		$362
	(To record investment at cost)
15-Dec	Cash	$40
	Dividend Income		$40
	(To record dividend income received)
15-Dec	Dividend income	$40
	Investment in Lavery Company		$40
31-Dec	Investment in Lavery Company	$101
	Income from Lavery company		$101
	(To record 30% income share)
31-Dec	Unrealized loss on fair value adjustment	$32
	Investment in Lavery Company		$32
	(To record fair value adjustment)
	(362 million-(10 million x $33))
	Working Note:
	Cost paid for 30% stock	$362
	Fair value of 70% stock	$845
	Total Fair value	$1,207
	Book value of net assets	$990
	Excess of fair value over cost	$217
	Excess allocated to:
	Depreciable assets	$90
	Goodwill	$127
	Net income of Lavery for 2018	$340
	Less: excess Depreciation	$3.33
	Adjusted net income	$336.67
	Runyan share (30%)	$101.00
2-b	Effect of journal entries on net income
	Income from Lavery Company	$101
	Unrealized loss on fair value adjustment	($32)
	Net effect on net income	$69
	Amount at which investment is carried in balance sheet on Dec 31, 2018
	Investment in Lavery company at cost	$362
	Add: Income from Lavery Company	$101
	Less: Dividend Income	($40)
	Fair value adjustment	($32)
	Net value of Investment		$391