Question

P17-8B (Fair Value and Equity Methods) Rodeo Corp. is a medium-sized corporation specializing in constructing high end retail establishments. The company has long dominated the market on the west coast, at one time achieving a 60% market penetration. During prosperous years, the company’s profits, coupled with a conservative dividend policy, resulted in funds available for outside investment. Over the years, Rodeo has had a policy of investing idle cash in equity securities. In particular, Rodeo has made periodic investments in the company’s principal supplier, Driveway Industries. Although the firm currently owns 14% of the outstanding common stock of Driveway Industries, Rodeo does not have significant influence over the operations of Driveway Industries.

Marcy Kringle has recently joined Rodeo as assistant controller, and her first assignment is to prepare the 2017 yearend adjusting entries for the accounts that are valued by the “fair value” rule for financial reporting purposes. Kringle has gathered the following information about Rodeo’s pertinent accounts.

Rodeo has trading securities related to LA Mixture and Hollywood Hills. During this fiscal year, Rodeo purchased 200,000 shares of LA Mixture for $3,460,000; these shares currently have a market value of $3,600,000. Rodeo investment in Hollywood Hills has not been profitable; the company acquired 80,000 shares of Hollywood in April 2017 at $26 per share, a purchase that currently has a value of $1,520,000.

Prior to 2017, Rodeo invested $36,600,000 in Driveway Industries and has not changed its holdings this year. This investment in Driveway Industries was valued at $35,350,000 on December 31, 2016. Rodeo’s 14% ownership of Driveway Industries has a current market value of $37,625,000.

Instructions

(a) Prepare the appropriate adjusting entries for Rodeo as of December 31, 2017, to reflect the application of the “fair value” rule for both classes of securities described above. Assume these are trading securities.

(b) For both classes of securities presented above, describe how the results of the valuation adjustments made in (a) would be reflected in the body of and notes to Rodeo’s 2017 financial statements.

(c) Prepare the entries for the Driveway investment, assuming that Rodeo owns 30% of Driveway’s shares. Driveway reported income of $650,000 in 2017 and paid cash dividends of $120,000.

Answer 1