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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881

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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881
Textbook Problem
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Fair Value and Equity Methods

Nadal Corporation purchased 10.000 shares of Cutler Inc.’s common stock, on January 1, 2019, for S 100.000. During 2019, Cutler declared and paid cash dividends to Nadal in the amount of S8.000. Nadal’s share of Cutler’s net income for 2019 was $12,400. At December 31, 2019, the fair value of 10.000 shares of Cutler’s common stock, was S120.000. This is Nadal’s only investment.

Required:

1. Assume that Cutler has 75.000 shares of common stock outstanding. What journal entries will Nadal make during 2019 relative to this investment?

2. Assume that Cutler has 40.000 shares of common stock outstanding. What journal entries will Nadal make during 2019 relative to this investment?

To determine

Concept introduction:

Fair Value Method: Fair market value method is applied when there is less than 20% share in company. In fair market value method we value the investment on its market value and difference is recorded in the income statement as a profit or loss.

Equity Method: In equity method we value the investment on the basis of their proportionate share in the assets of the investee company. Equity method applies when there is at least 20% share holding in the company. When there is 20% holding in any company then we have a significant control over the company.

Requirement 1:

To calculate:

Journal entry to record the investment.

Explanation

Investment % = 10000/75000

= 13.33%

Cash A/c 8000

Dividend income A/c 8000

(Being dividend received in cash)

To determine

Concept introduction:

Fair Value Method: Fair market value method is applied when there is less than 20% share in company. In fair market value method we value the investment on its market value and difference is recorded in the income statement as a profit or loss.

Equity Method: In equity method we value the investment on the basis of their proportionate share in the assets of the investee company. Equity method applies when there is at least 20% share holding in the company. When there is 20% holding in any company then we have a significant control over the company.

Requirement 2:

To calculate:

Journal entry to record the investment.

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