Question

Problem 12-10 (Algo) Investment securities and equity method investments compared [LO12-6, 12-7] On January 4, 2021, Runyan Bakery paid $328 million for 10 million shares of Lavery Labeling Company common stock. The investment represents a 30% interest in the net assets of Lavery and gave Runyan the ability to exercise significant influence over Lavery's operations. Runyan received dividends of $2.50 per share on December 15, 2021, and Lavery reported net income of $170 million for the year ended December 31, 2021. The market value of Lavery's common stock at December 31, 2021, was $31 per share. On the purchase date, the book value of Lavery's identifiable net assets was $820 million and: The fair value of Lavery's depreciable assets, with an average remaining useful life of six years, exceeded their book value by $60 million. The remainder of the excess of the cost of the investment over the book value of net assets purchased was attributable to goodwill. Required: 1. Prepare all appropriate journal entries related to the investment during 2021, assuming Runyan accounts for this investment by the equity method. 2. Prepare the journal entries required by Runyan, assuming that the 10 million shares represent a 10% interest in the net assets of Lavery rather than a 30% interest.

Answer 1

Requirement 1

Purchase ($ in millions)

Investment in equity affiliate......................................................... 328
Cash ................................................................................................ 328

Net income

Investment in equity affiliate (30% × $170 million) .............................. 51
Investment revenue.......................................................................... 51

Dividends

Cash (10 million shares × $2.5 per share)..................................................... 25
Investment in equity affiliate............................................................ 25

Depreciation adjustment   

Investment revenue ([30% × $60 million] ÷ 6 years).................................. 3
Investment in equity affiliate............................................................ 3

Adjusting entry

No entry to recognize changes in the fair value of the Lavery investment, as Runyan is accounting for its investment under the equity method.

Requirement 2

Purchase ($ in millions)

Investment in equity securities....................................................... 328
Cash ................................................................................................ 328

Net income

No entry

Dividends

Cash (10 million shares × $2.5 per share)..................................................... 25
Dividend revenue............................................................................. 25

Adjusting entry

Need to move from a fair value adjustment from $0 to ($18 million):

	Fair Value Adjustment
Balance on 1/4/2021	$ 0
± Adjustment needed to update fair value	?
Balance needed on 12/31/2021 ([10 × $31] – $328 )	$ (18)

fair value adjustment
1/4/21 0
change needed	18
12/31/21	18

Loss on investments (unrealized, NI) (to balance).................... 18

Fair value adjustment ......................................................   18