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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Equity method for stock investment

At a total cost of $5,600,000, Herrera Corporation acquired 280,000 shares of Tran Corp. common stock as a long-term investment Herrera. Corporation uses the equity method of accounting for this investment. Tran Corp. has 800,000 shares of common stock outstanding, including the shares acquired by Herrera Corporation.

a. Journalize the entries by Herrera Corporation to record the following information:

1. Tran Corp. reports net income of $600,000 for the current period.

2. A cash dividend of $0.50 per common share is paid by Tran Corp. during the current period.

b. Why is the equity method appropriate for the Tran Corp. investment?

(a) 1.

To determine

Equity investment: Equity investments are stock instruments which claim ownership in the investee company and pay a dividend revenue to the investor company.

Equity method: Equity method is the method used for accounting equity investments which claim a significant influence of above 20% but less than 50% in the outstanding stock of the investee company.

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

  • Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
  • Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

To journalize: The stock investment transactions for Company H, under the equity method

Explanation

  • Investment in Company T is an asset account. Since stock investments are purchased, asset value increased, and an increase in asset is debited.
  • Income of Company T is a revenue account. Revenues increase stockholders’ equity value, and an increase in stockholders’ equity is credited.

Working Notes:

Compute amount of income received from Company T.

Income reported = {Net income reported by Company T × Percentage share of 

(b)

To determine

To mention: The reason as to why equity method is appropriate for Company H

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