On January 1, 2017, Gillettey Company purchases an investment in Buffalo, Inc., a company whose stock...

On January 1, 2017, Gillettey Company purchases an investment in Buffalo, Inc., a company whose stock trades over the counter, for $2,700,000, representing 20% of the book value of Buffalo. During the year, Buffalo reports a net income of $942,000 and pays cash dividends of $294,000. The fair value of Buffalo’s stock on December 31, 2017, is $15,000,000. Gillettey has a calendar year-end. a. What amount does Gillettey report on its 2017 balance sheet for its investment in Buffalo, if 20% ownership does not imply any significant influence over Buffalo? b. What amount does Gillettey report on its 2017 balance sheet for its investment in Buffalo, if 20% ownership implies significant influence over Buffalo?

Solutions

Expert Solution

a). If 20% ownership does not imply any significant influence over Buffalo.
Here we have to use cost method of investment because there is no significant influence.
In Cost method, first investment is shown at the purchase price and then there will no change in the value of investment due to dividend and net Income declared by the investee until then there will change in fair value of that investment.

As the fair value of Buffalo’s stock on December 31, 2017, is $15,000,000, the amount to be reported by Gillettey on its 2017 balance sheet is the fair value which is $15,000,000.

b). If 20% ownership implies significant influence over Buffalo.
Here we have to use equity method of investment because of significant influence. Here we do not change value of investment due to its fair value instead, it is changed on the basis of dividend and net income. Dividend received is reduced from the value of investment and Investment is increased by the share of net income.

Calculation of amount to be reported in the 2017 balance sheet by Gillettey.
Investment amount on Jan 1, 2017 = $2,700,000
Less: Dividend share ($294,000 * 20%) = $58,800
Add: Share of Net Income ($942,000 * 20%) = $188,400
Amount to be reported in balance sheet as investment = $2,829,600

ekkarill92 answered 1 year ago

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