Question

Alpha Company has purchased 10,000 shares of stock of Beta Company for $50,000,000. This represents 20% ownership. What journal entry, if any would Alpha make in the following situation:

Beta declares and immediately pays a dividend of $1 per share. Assume Alpha uses the equity method of accounting for its investment? (3 points)

22) Refer to the same facts as the previous problem.  

What would be the journal entry be if Alpha learns that the value of Beta’s stock has increased by $2 per share, and Alpha uses the equity method of accounting for this investment? (3 points)

23)

Use the same facts as the prior problems. What journal entry, if any, would make in this situation?

Alpha learns that Beta had a loss of $1 million. Assume Alpha uses the fair value method of accounting for its investment. (3 points)

Answer 1

Solution:

When an investor invests in the shares of another business (investee) and is in a position to exert significant influence over the investee but does not have a controlling interest, then it uses the equity method to account for the investment.

In the instant case, significant influence refers to the ability of the investor to participate in the policy making decisions of the investee business. Here Major indicator of significant influence is an equity interest of more than 20% but less than 50%.

The investor Alpha records the initial cost of the shares in a balance sheet investment account.The equity accounting method seeks to reflect any subsequent changes in the value of the investee Beta business in this investment account.

Account Dr. Cr

Equity method investment $50000000

Cash. $50000000

(being recorded initial cost equity-method investment for purchase)

Equity method dividend

After that immediately, Beta pays dividend of $1 per share of which Alpha is entitled @20% = $1*10000*20%=$2000

Alpha records the receipt of its share of dividend with the following bookkeeping journal entry

Account Dr. Cr.

Cash $2000

Equity method investment . $2000

If increase in value of share of Beta for $2 per share,then the following bookkeeping journal entry will come

Equity method investment A/c Dr. $4000

Equity method income A/c $4000

The carrying value of the investment shown on investor's balance sheet is summarised as under.

Initial investment cost. $50000000

Increase in value of share $4000

--loss of share. Note below $200000

--dividend received . $2000

Carrying value . $49802000

Note:

Similarly, the share of loss of $1 million of which the Alpha's share of loss is

$1 million * 20%= $ 200000

Account Dr . Cr.

Equity method investment. $200000

Equity method income $200000