CASE 10‐3 Equity Method and Disclosures On July 1, 2017, Dynamic Company purchased for cash 40...

CASE 10‐3 Equity Method and Disclosures

On July 1, 2017, Dynamic Company purchased for cash 40 percent of the outstanding capital stock of Cart Company. Both Dynamic and Cart have a December 31 year‐end. Cart, whose common stock is actively traded in the over‐the‐counter market, reported its total net income for the year to Dynamic and also paid cash dividends on November 15, 2017, to Dynamic and its other stockholders.

Required:

How should Dynamic report the foregoing facts in its December 31, 2017, balance sheet and its income statement for the year then ended? Discuss the rationale for your answer.
If Dynamic should elect to report its investment at fair value, how would its balance sheet and income statement differ from your answer to part (a)?

Solutions

Expert Solution

Part A

Considering the size of investment for exercising significant influence over the operating and financial policies of Cart Company, the equity method of accounting for investment in Cart Company should be followed by the Dynamic Company. The interest in outstanding capital stock of Cart Company as a long-term investment should be reported in 2017. The cash paid to purchase 40% of Cart Company should be recorded. Investment in Dynamic Company's balance sheet should be increased by the 40% Cart Company's total net income from July 1, 2017 to December 31, 2017. The proportionate is shown as revenue in the income statement of Dynamic Company and it is recognized as its share of Cart Company’s net income after acquisition. The carrying value of investment in Dynamic Company’s balance sheet is reduced by the amount of cash dividends declared by Cart Company. However the cash payment has no effect on the income statement. The reporting of deferred income taxes in balance sheet and income statement are required in case of the equity method of accounting.

Part B

If the fair value accounting method is elected by Dynamic Company, then the investment in the balance is reported at the fair value. According to SFAS No. 159, the reporting entity would get the fair value for selling assets and paying liabilities, as if it the exchange is being undertaken in the market place. Earnings should be reported considering all unrealized holding gains or losses. The assets and liabilities which would be treated using the fair value method should be present separately. Due to the implementation of SFAS No. 159 and fair value option together, it is important to record the available-for-sale and/or held-to-maturity as trading securities. Any gains and losses associated with these securities are to be reported as an adjustment to retained earnings.

ekkarill92 answered 1 year ago

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