tango_gs

On December 31, 2008 Company P invests $5,000 in Company S in exchange for 25% of the company. During 2009, Company S earns $2,000 and pays a dividend of $500. If Company P uses the equity method of accounting, what values will be reported on the balance sheet and income statement? How much cash will be recognized from the investment?

Balance Sheet

Income Statement

Cash

A) $5,500 $0 $0

B) $5,375 $125 $125

C) $5,375 $500 $125

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The carrying value on the balance sheet is $5,375, the income statement will show $500 of income, and the cash recognized is equal to the dividend of $125.
Using the equity method, for 2008, Company P will:

• Recognize $500 ($2000 × 0.25) on its income statement as equity in the net income of Company S.
• Increase the investment in the Company S account on the balance sheet to $5,500, reflecting its share of the net assets of Company S.
• Receive $125 in cash dividends from Company S and reduce its investment in Company S by that amount to reflect the decline in the net assets of Company S due to the dividend payment.

At the end of 2008, the carrying value of Company S on Company P’s balance sheet will be ($5,000 original investment + $500 proportional share of Company S earnings – $125 dividend received = $5,375).

tango_gs

Milburne Company purchased 1,000 shares of Marino Co. for $20 per share on January 1. By December 31, shares of Marino were trading at $15 per share in the open market. Marino Co. has 100,000 shares outstanding with a dividend yield of 2% at year end. Milburne plans to hold the shares of Marino for near-term trading purposes. The impact of the Marino holding on the Milburne income statement is:

A) -$4,700.

B) -$5,000.

C) $300.

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Since these securities are to be classified as trading securities, both the dividend received and the unrealized loss are posted to the income statement. The dividend is computed as 0.02 × $15 × 1,000 = $300 whereas the unrealized loss is $5,000 = ($15 - $20) × 1,000. The net income statement impact is $300 - $5,000 = -$4,700.

tango_gs

Milburne Company purchased 1,000 shares of Marino Co. for $20 per share on January 1. By December 31, shares of Marino were trading at $15 per share in the open market. Marino Co. has 100,000 shares outstanding with a dividend yield of 2% at year end. Milburne plans to hold the shares of Marino for longer-term investment and liquidity purposes. The impact of the Marino holding on the Milburne income statement is:

A) -$4,700.

B) -$5,000.

C) $300.

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These securities are to be classified as available for sale and hence, all unrealized gains and losses are posted to a securities valuation reserve on the balance sheet. Hence, the only income statement impact is the $300 dividend = 0.02 × $15 × 1,000.

tango_gs

A company reports an intercorporate investment using the acquistion method. Which of the following statements is most accurate?

A) The use of the acquistion method by a company will generally report the most favorable results.

B) The use of the proportionate consolidation method by a company will generally report the most favorable results.

C) The use of the acquistion method by a company will generally report the least favorable results.

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The equity method will provide the most favorable results, while the acquistion method will provide the least favorable results.

tango_gs

Which of the following methods of accounting for investments will reflect the highest net income on a company’s income statement?

A) Both methods report the same net income.

B) Acquisition method.

C) Equity method.

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Both methods will report the same net income

tango_gs

Which of the following methods of accounting for investments will reflect the highest assets and liabilities on a company’s balance sheet?

A) Acquisition method.

B) Equity method.

C) Both methods result in reporting the same balances for assets and liabilities.

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The consolidation method will reflect the highest assets and liabilities. The equity method would reflect the lowest.

tango_gs

Which of the following methods of accounting for investments will reflect the highest assets and liabilities on a company’s balance sheet?

A) Acquisition method.

B) Equity method.

C) Both methods result in reporting the same balances for assets and liabilities.

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The consolidation method will reflect the highest assets and liabilities. The equity method would reflect the lowest.

tango_gs

When comparing companies that hold equity investments in other corporations, which of the following statements is most accurate? All else being equal, return on asset measures for a firm using proportionate consolidation will appear:

A) more favorable than those for a comparable firm using consolidation, and less favorable than those for a comparable firm using the equity method.

B) less favorable than those for a comparable firm using consolidation, and less favorable than those for a comparable firm using the equity method.

C) less favorable than those for a comparable firm using consolidation, and more favorable than those for a comparable firm using the equity method.

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All else being equal, return on asset measures for a firm using proportionate consolidation will appear more favorable than those for a comparable firm using consolidation, and less favorable than those for a comparable firm using the equity method. This is because the choice of accounting method will affect the level of book assets, while the level of net income remains the same.

tango_gs

When comparing companies that hold equity investments in other corporations, which of the following statements is most accurate? All else being equal, net profit margin measures for a firm using proportionate consolidation will appear:

A) less favorable than those for a comparable firm using consolidation, and less favorable than those for a comparable firm using the equity method.

B) more favorable than those for a comparable firm using consolidation, and less favorable than those for a comparable firm using the equity method.

C) less favorable than those for a comparable firm using consolidation, and more favorable than those for a comparable firm using the equity method.

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All else being equal, net profit margin measures for a firm using proportionate consolidation will appear more favorable than those for a comparable firm using consolidation, and less favorable than those for a comparable firm using the equity method. This is because the choice of accounting method will affect the level of sales, while the level of net income remains the same.

tango_gs

When comparing companies that hold equity investments in other corporations, which of the following statements is most accurate? All else being equal, leverage measures for a firm using proportionate consolidation will appear:

A) less favorable than those for a comparable firm using consolidation, and less favorable than those for a comparable firm using the equity method.

B) more favorable than those for a comparable firm using consolidation, and less favorable than those for a comparable firm using the equity method.

C) less favorable than those for a comparable firm using consolidation, and more favorable than those for a comparable firm using the equity method.

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All else being equal, leverage measures for a firm using proportionate consolidation will appear more favorable than those for a comparable firm using consolidation, and less favorable than those for a comparable firm using the equity method. This is because the choice of accounting method will affect the value of the liabilities on the balance sheet, while the level of book equity remains the same.