Question

A parent company paid $500,000 for a 100% interest in a subsidiary. At the end of the first year, the subsidiary reported net income of $40,000 and paid $5,000 in dividends. The price paid reflected understated equipment of $70,000, which will be amortized over 10 years.

What would be the subsidiary income reported on the parent's unconsolidated income statement, and what would the parent's investment balance be at the end of the first year under each of these methods?

a. The simple equity method

b. The sophisticated equity method

c. The cost method

Answer 1

a.	The simple equity method
	The calculated investment in subsidiary company under simple equity method is $535,000
	Subsidiary income	$           40,000.00
	Investment in Subsidiary	=($500,000+$40,000-$5,000)
		$         535,000.00
b.	The sophisticated equity method
	Subsidiary Net Income	=($40000 - $7000) = $33,000
	Investment in Subsidiary	=[$500,000+($33,000-$5,000)]
		$         528,000.00
c.	The cost method
	Subsidiary Income	$                          -
	Dividend Income	$             5,000.00
	Investment in Subsidiary	$         500,000.00