Question

Bott Co acquired 500 shares of Barus Co at $53 per share as a long term investment. This represents 10% of the outstanding voting shares of Barus Co. During the year, Barus paid a dividend of $3 per share. At the year-end Barus reported net income of $60,000 and its are price had risen to $55 per share.

Required

1. What method should Bott use to account for its investment in Barus?

2. Prepare a journal for the acquisition of the 500 shares of Barus Co.

3. Prepare a journal to record the journal for the receipt of the dividend from Barus Co.

4. At the year-end what amount would Bott Co. report on its balance sheet and income

   statement in respect of its investment in Barus Co?

Answer 1

Here, Bott Co. has acquired 500 shares which represents 10% of the outstanding voting shares of Barus Co.

In case if the acquisition by purchasing the shares is less than 20%, then the fair value method also known as cost method is followed, Under this method , the shares are recorded at at the price of purchase and then adjusted with the fair value at the end of the period i.e at the fair value.

In fair value method, the dividend and income are not adjusted with the acquisition value, but the dividend received is treated as dividend income , and recorded as income.

Based on the above explanation the answer to the following question will be as follows:

1.  Bott use - Fair value Method also known as cost method to account for its investment in Barus.

2. Journal Entry for acquisition :

Date	Account title and Explanation	Debit ($)	Credit ($)
1	Investment in Barus Co	$26,500
	Cash		$26,500
	( To record shares acquisition @10%)

3. Journal Entry for Dividend Income :

Date	Account title and Explanation	Debit ($)	Credit ($)
1	Cash	$1,500
	Dividend Income		$1,500
	( To record dividend @3 per share)

Here the receipt entry is only made, as receipt is only asked in the question otherwise ,dividend receivable should be dividend.

4. At the year-end what amount would Bott Co. report on its balance sheet and income statement in respect of its investment in Barus Co?

Here, as discussed above the investment should be adjusted at fair value so the Balanace sheet should show the balance of Investement at fair value of $ 55 per share i.e $ 27,500.

The Difference in the acquisition and the fair value for Trading securities are treated as Income or loss depends on the positive or negative difference , here the fair value is increased at $ 27500 from $ 26500 so the positive increment is there.

This Income of $ 1000 ( 27500 - 26500 ) will also be treated as income and to be given effect in income statement along with the dividend income of $ 1500 .

Thus the Income statement will have a balance with respect to Investment in Barus Co. = $ 2500 ( 1500 + 1000).

NOTE : If the shares are assumed to be available for sale then the gain of $1000 in shares fair value should be recorded in other comprehensive income and shown under equity. and income statement will only show for dividend income.