Question

An investor company owns 30% of the common stock of an investee company. The investor has significant influence over the investee, and acquired its equity interest in the investee on January 1, 2018 for $525,000. On the date of acquisition, the investee’s stockholders equity was $1,500,000, and the fair values of the investee’s individual net assets were equal to their reported book values. During the year ended December 31, 2018, the investee reported net income of $50,000 and dividends of $10,000. During the year ended December 31, 2019, the investee reported net income of $60,000 and dividends of $15,000. The investor routinely sells inventory to the investee at a 25% profit margin. At December 31, 2018 and 2019, the investee held inventories purchased from the investor for $30,000 and $40,000, respectively. (At the end of each period, all of these inventories are sold by the investee to unaffiliated companies in the next period.) What amount of investment income from the investee did the investor recognize during the year ended December 31, 2019?

Answer 1

The investor recognized $17,250 as investment income from the investee for the year ended December 31, 2019, after adjusting for undistributed profits from inventory sold by the investor to the investee.

Step-by-step explanation:

The investment income that the investor recognized during the year ended December 31, 2019, is calculated by taking into account both the proportionate share of the investee's net income and the adjustments for undistributed profits from the inventory purchases.

1. Calculate the investor's share of the investee's net income: 30% of $60,000 = $18,000.
2. Adjust for the investor's share of undistributed profits in the ending inventory which is profit margin times investor's proportion: (25% profit margin) * (30% ownership) * ($40,000 inventory at end of 2019 - $30,000 inventory at end of 2018) = $750.
3. Deduct the undistributed profit to arrive at the recognized investment income: $18,000 - $750 = $17,250.

Therefore, the investor recognized $17,250 as investment income from the investee for the year ended December 31, 2019.