Question

3. Georgia, Inc. bought 30% of Carolina Company on January 1, 2016 for $225,000. The equity method was used. No amortization was required. In 2016, Carolina shipped to Georgia merchandise with a cost of $12,000 and a selling price of $15,600. One-third of the merchandise remained in Georgia’s inventory at year-end and was sold in 2017. In 2017, Carolina received merchandise from Georgia, who recorded a gross profit of $18,000 on the sale. One-fourth of the merchandise remained in ending inventory. Carolina reported net income of $50,000 in 2016 and $62,000 in 2017. Dividends of $8,000 were paid to Georgia each year. Required: Prepare all equity method entries for 2016 and 2017

Answer 1

First we have to understand the equity method of consolidation. In this method the holding company shows it's investment in the subsidiary at cost. It recognises revenue basis it's share in the profits earned by the subsidiary.

Thejournal entries that will be passed for the year 2016 are:

1. Investment in Carolina company Dr. $250,000

To Cash account. $250,000

2. Cash account Dr. $8,000

To investment in Carolina company. $8,000

3. Investment in Carolina company Dr. $13,920

To Revenue account. ( Refer WN 1). $13,920

4. Revenue account Dr. $1,200

To inventories account. (refer WN 2). $1,200

Working note 1:- Profits of Carolina company for the year 2016 are $50,000. But this includes the profit made on sale of goods to Georgia company, which is a national profit. Hence we eliminate this profit ($15,600 - $12,000 = $3,600) from the profit of Carolina. So divisible profit = $50,000 - $3600 = $46,400. Now Georgia holds 30% shares of Carolina, hence Georgia's share in profits = 46,400*30% = $13,920

Working note 2:- At the end of 2016 Georgia has in it's closing inventory 1/3rd of the stock it purchased from Carolina. It contains notional profit made by Carolina amounting to $3,600. Hence we have eliminate 1/3rd of $3,600 ,I.e., $1,200 from the inventory.

Entries for the year 2017

1. Cash account Dr. $8,000

To investment in Carolina company. $8,000

2. Investment in Carolina company Dr. $17,250

To Revenue account (Refer WN 3). $17,250

Working note 3:- The profits for the year 2017 of Carolina company are $62,000. But during the year Georgia has sold goods to Carolina at a gross profit of $18,000. 1/4th of such goods are appearing in the Closing inventory of Carolina. Hence the profits made by Georgia on this closing inventory has to be eliminated before adding Georgia's share in the profits of Carolina. Hence the divisible profit of Carolina = $62,000 - 18000/4 = $57500. Georgia's share is 30% in this profit which is = 57500*30% = $17,250.