Question

Blank Co. acquired 25% of the 500,000 shares of outstanding common stock of Overload Inc. on December 31, 2014. The purchase price was $3,600,000. Overload declared and paid $1.20 per share cash dividends on June 18, 2015, and on November 29, 2015. Overload reported net income of $1,200,000 for 2015. The fair value of Overload common stock was $27 per share at December 31, 2015.

Instructions (a) Prepare the journal entries for Blank Co. for 2015, assuming that Blank cannot exercise significant influence over Overload. The securities should be classified as available-for-sale.
(b) Prepare the journal entries for Blank Co. for 2015, assuming that Blank can exercise significant influence over Overload.
(c) At what amount is the investment in securities reported on the balance sheet under each of these methods at December 31, 2015? What is the total net income reported in 2015 under each of these methods?

Answer 1

Blank Co.'s accounting for a 25% investment in Overload Inc. differs if the investment is classified as available-for-sale or reflects significant influence. Available-for-sale investments adjust to fair value, while significant influence invokes equity method accounting. Both methods impact the investment carrying amount and total net income reported.

Step-by-step explanation:

The student's query is about the accounting treatment for a 25% investment in another company's common stock by Blank Co. and revolves around the classification of the investment as available-for-sale or exercising significant influence over the investee, which would be treated as an equity method investment. The answer would include journal entries under both scenarios and the impact on the balance sheet and total net income. When an investment is classified as available-for-sale, Blank Co. would record dividend income and adjust the investment to its fair value at the end of the year, with changes in fair value reported in other comprehensive income (OCI). If the investment allows Blank Co. to exercise significant influence, it would use the equity method, under which it would recognize its share of Overload's net income and dividends as changes in the investment's carrying amount. The investment's carrying amount on the balance sheet and the total net income reported for the year would differ under each method. The available-for-sale method would show the investment at its fair value, while the equity method would show it at the original cost adjusted for Blank Co.'s share of Overload's net income and dividends received.