Question

On January 2, 2018, Baltimore Company purchased 9,000 shares of the stock of Towson Company at $14 per share. Baltimore did NOT obtain significant influence as the purchase represents a 5% ownership stake in Towson Company. On August 1, 2018, Towson Company paid cash dividends of $21,000. Baltimore Company intended this investment to a long-term investment. On December 31, 2018, Towson Company reported $65,000 of net income for FY 2018. Additionally, the current market price for Towson Company's stock increased to $20 per share at the end of the year. Use this information to determine, how much Baltimore Company should report for its investment in Towson Company on December 31, 2018. (Round to the nearest dollar.)

Answer 1

NOTES

• Companies sometimes accumulate excess cash and look outside the business to make investments and earn a return. This might be to purchase a minority stake in another company, acquire another operation entirely, invest in debt securities or purchase real estate.
• In addition to earning a return on its investments, a company might want to make an equity investment in another company to diversify or expand its business through vertical or horizontal acquisitions.
• Accounting principles allow two methods to record the value and income from these minority long-term investments on a balance sheet: equity or cost.

Accounting for short-term stock investments and for long-term stock investments of less than 20 percent

• Accountants use the cost method to account for all short-term stock investments.
• When a company owns less than 50% of the outstanding stock of another company as a long-term investment, the percentage of ownership determines whether to use the cost or equity method. A purchasing company that owns less than 20% of the outstanding stock of the investee company, and does not exercise significant influence over it, uses the cost method.
• A purchasing company that owns from 20% to 50% of the outstanding stock of the investee company or owns less than 20%, but still exercises significant influence over it, uses the equity method.
• Thus, firms use the cost method for all short-term stock investments and almost all long-term stock investments of less than 20%.
• For investments of more than 50%, they use either the cost or equity method because the application of consolidation procedures yields the same result.

ANSWER

Baltimore Company should report $126,000 for its investment in Towson Company on December 31, 2018

EXPLANATION TO THE ANSWER

• In the given case of Baltimore Company, the company intends to hold this investment as a long-term investment and it is also seen that that purchase does not result in obtaining significant influence as the purchase represents a 5 % ownership stake.
• In such a case, the cost method is being used to record the investment.

As per the cost method, the investment is recorded at its cost of acquisition, and any income from dividends is recognized when received.

Therefore,

• Cost of acquisition => 9,000 shares * $14 = $126,000

Note: The revised price (i.e given in the question that the market price for Towson Company's stock increased to $20 per share at the end of the year) of a share is not considered under the cost method.