Question

At a total cost of $6,300,000, Herrera Corporation acquired 195,000 shares of Tran Corp. common stock as a long-term investment. Herrera Corporation uses the equity method of accounting for this investment. Tran Corp. has 750,000 shares of common stock outstanding, including the shares acquired by Herrera Corporation. Required: A. Journalize the entries by Herrera Corporation on December 31 to record the following information (refer to the Chart of Accounts for exact wording of account titles): 1. Tran Corp. reports net income of $928,000 for the current period. 2. A cash dividend of $0.26 per common share is paid by Tran Corp. during the current period. B. Why is the equity method appropriate for the Tran Corp. investment

Answer 1

1)

Journal entry to record the investment in Tran. Corp.

Dr Investment in Tran Corp 6,300,000

Cr Cash 6,300,000

Journal entry to record distributed dividends

Dr Cash 50,700

Cr Investment in Tran Corp 50,700

under the equity method, distributed dividends reduce the investment account

Journal entry to record Tran. Corp.'s net income

Dr Investment in Tran Corp 241,280

Cr Revenue from investment in Tran. Corp. 241,280

since Herrera owns 26% of Tran Corp.'s stock, then 26% of its net income increases the investment account

B)

The equity method is appropriate when a company owns 20% or more of another company or exercises significant influence in the decisions of the other company.