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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

On January 4, Year 1, Ferguson Company purchased 480,000 shares of Silva Company directly from one of the founders for a price of $50 per share. Silva has 1.200.000 shares outstanding, including the Daniels shares. On July 2, Year 1, Silva paid $750,000 in total dividends to its shareholders On December 31. Year 1, Silva reported a net income of $2,000,000 for the year. Ferguson uses the equity method in accounting for its investment in Silva.

a. Provide the Ferguson Company journal entries for the transactions involving its investment in Silva Company during Year 1.

b. Determine the December 31. Year 1, balance of the investment In Silva Company stock

(a)

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 F, under the equity method

Explanation

Prepare journal entry for the purchase of 480,000 shares of Company S at $30 per share.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
January 4 Investment in Company S   14,400,000  
             Cash     14,400,000
    (To record purchase of shares of Company S for cash)      

Table (1)

Explanation:

  • Investment in Company S is an asset account. Since stock investments are purchased, asset value increased, and an increase in asset is debited.
  • Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Working Notes:

Compute amount of cash paid to purchase Company S’s stock.

Cash paid = (Number of shares purchased× Price per share)(480,000 shares ×$30)= $14,400,000

Prepare journal entry for dividends received from Company S.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
July 2 Cash   300,000  
           Investment in Company S     300,000
    (To record dividends received from Company S)      

Table (2)

Explanation:

  • Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
  • Investment in Company T is an asset account. Since stock investments are reduced as an effect of receipt of dividends, asset value decreased, and a decrease in asset is credited.

Working Notes:

Compute amount of dividend received from Company S

(b)

To determine
The stock investment balance for Company F

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