Question

Assume that an investor owns 35% of an investee, and accounts for its investment using the equity ethod. At the beginning of the year, the Equity investment was reported on the investor's balance sheet at $360,000. During the year, the investeee reported net income of $110,000 and paid dividends of $20,000 to he investor. In addition, the investor sold inventory to the investee, realizing a gorss profit of $36,000 on the sale. At the end of the year, 15% of the inventory remained unsold by the investee.

a) How much equity income should the investor report for the year?
b) What is the balance of the Equity Investment at the end of the year?
c) Assume that the inventories are all sold in the following year, The investeee reports $160,000 of net income. How much equity income will the investor report for the following year?

Answer 1

a. Investors shares in Net Income = Net Income * Share percentage

= $110,000 * 35%

= $38,500

Share of unrealized gain = Gross profit * Percentage of remaining inventory * Share percentage

= $36,000 * 15% * 35%

= $1,890

Hence, Equity Income = Investors share in Net income - Investor share in unrealized gain on ending inventory

= $38,500 - $1,890

= $38,610

b. Equity investment balance at year end = Equity Investment in the beginning during the time+ Equity income to be reported - Dividend paid

= $360,000 + $36,610 - $20,000

= $376,000

c. Investor share in Net Income = Net income * Share percentage

= $160,000 * 35%

= $56,000

Share of unrealized gain = Gross profit * Percentage of remaining inventory * Share percentage

= $36,000 * 15% * 35%

= $1,890

Hence, Equity Income = Investor share in Net Income + Investor share in unrealized gain on beginnging inventory

= $56,000 + $1,890

= $57,890