Question

On January 4, 2018, Runyan Bakery paid $324 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 chose the fair value option to account for this investment. Runyan received dividends of $2.00 per share on December 15, 2018, and Lavery reported net income of $160 million for the year ended December 31, 2018. The market value of Lavery's common stock at December 31, 2018, was $31 per share. On the purchase date, the book value of Lavery's net assets was $800 million and:

The fair value of Lavery's depreciable assets, with an average remaining useful life of six years, exceeded their book value by $80 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-a. Prepare all appropriate journal entries related to the investment during 2018, assuming Runyan accounts for this investment under the fair value option, and accounts for the Lavery investment in a manner similar to what it would use for securities for which there is not significant influence.
1-b. Calculate the effect of these journal entries on 2018 net income, and the amount at which the investment is carried in the December 31, 2018, balance sheet.
2-a. Prepare all appropriate journal entries related to the investment during 2018, assuming Runyan accounts for this investment under the fair value option, but uses equity method accounting to account for Lavery’s income and dividends, and then records a fair value adjustment at the end of the year that allows it to comply with GAAP.
2-b. Calculate the effect of these journal entries on 2018 net income, and the amount at which the investment is carried in the December 31, 2018, balance sheet.

Answer 1

04-Jan-18 Investment in Lavery          324,000,000

To Cash        (324,000,000)

(Being investment in associate recorded)

15-Dec-18 Cash            20,000,000

To Investment in Lavery         (20,000,000)

(Being dividend received)

31-Dec-18 Investment in Lavery            48,000,000

To Share in income of associate          (48,000,000)

(Being share in income recorded)

31-Dec-18 Goodwill            24,000,000

To Investment in Lavery         (24,000,000)

(Being upward revaluation on assets recorded)

31-Dec-18 Fair value adjustments (P&L)            28,666,667

To Investment in Lavery         (28,666,667)

(Being investment valued on fair value)

Calculation of Fair value adjustments

Value of investment in Lavery

Initial Investment         324,000,000

Less: Dividend paid         (20,000,000)

Add: Share in income            48,000,000

Less: Depreciation on revaluation   (13,333,333)

Closing book value of investment        338,666,667

Fair value of investment (10,000,000*31)         310,000,000

Fair value adjustments           28,666,667