CHAPTER 2 - Page 30 Accounting Procedures Under the Fair...

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Page 30 Accounting Procedures Under the Fair Value/Cost and Equity Methods Assume that Pilzner Company acquires 2,000 of the 10,000 outstanding shares of Sud Corporation at $50 per share on July 1, equal to the book value and fair value of Sud’s net assets. Sud Corporation’s net income for the entire year is $50,000, and dividends of $20,000 are paid on November 1. If there is evidence of an inability to exercise significant influence, Pilzner should apply the fair value/cost method, revaluing the investment account to fair market value at the end of the accounting period. Otherwise, the equity method is required. Accounting by Pilzner Company under the two methods is as follows: Entry on July 1 to Record the Investment: Fair Value/Cost Method Equity Method Investment in Sud (+A) 100,000 Investment in Sud (+A) 100,000 Cash (−A)0 100,000 Cash (−A) 100,000 Entry on November 1 to Record Dividends: Fair Value/Cost Method Equity Method Cash (+A) 4,000 Cash (+A) 4,000 Dividend income (R, +SE) 4,000 Investment in Sud (−A) 4,000 Entry on December 31 to Recognize Earnings: Fair Values/Cost Method Equity Method None (Assume that the stock is either Investment in Sud (+A) 5,000 nonmarketable or has a market price = Income from Sud (−A) 5,000 $50 per share so that no revaluing is needed.) $50,000 × 1/2 year × 20%) Under the fair value/cost method, Pilzner recognizes income of $4,000 and reports its investment in Sud at its $100,000 cost. Under the equity method, Pilzner recognizes $5,000 in income and reports the investment in Sud at $101,000 (equal to $100,000 cost plus $5,000 income less $4,000 dividends received). Here is a summary of Pilzner’s equity method investment account activity: July 1 Initial cost $100,000 November 1 Dividends received (4,000) December 31 Recognize 20% of Sud’s net income for 1/2 year 5,000 December 31 Ending balance $101,000 The entries to illustrate the fair value/cost method reflect the usual situation in which the investor records dividend income equal to dividends actually received. An exception arises when dividends are received in excess of the investor’s share of earnings after the investment has been acquired. From the investor’s point of view, dividends in excess of the investor’s share of earnings since acquisition of the investment are a return of capital, or liquidating dividends. For example, if Sud’s net income for the year had been $30,000; Pilzner’s share would have been $3,000 ($30,000× 1/2 year × 20%). The $4,000 dividend received exceeds the $3,000 equity in Sud’s income, so the$1,000 excess would be considered a return of capital and credited to the Investment in Sud account. Assuming that Pilzner records the $4,000 cash received on November 1 as dividend income, a year-end entry to adjust dividend income and the investment account would be needed.
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The investor would record such an entry as follows: Dividend income (−R, −SE) 1,000 Investment in Sud (−A) 1,000 To adjust dividend income and investment accounts for dividends received in excess of earnings
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This note was uploaded on 09/21/2011 for the course ECON 101 taught by Professor Flah during the Spring '10 term at Punjab Engineering College.

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CHAPTER 2 - Page 30 Accounting Procedures Under the Fair...

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