[bryceallant]

On January 1, 20X4, Griffin, Inc. purchased 12% of Hydra Co.’s common stock. On September 1, 20X4, Griffin purchased additional Hydra shares, bringing its ownership up to 35% of Hydra’s common stock outstanding. During December 20X4, Hydra declared and paid a cash dividend on all of its outstanding common stock. Griffin uses the equity method to account for its investment in Hydra. How much income from the Hydra investment should Griffin’s 20X4 income statement report?

A. 35% of Hydra’s 20X4 income.

B. 12% of Hydra’s income for January 1 to August 31, 20X4, plus 35% of Hydra’s income for September 1 to December 31, 20X4.

C. Amount equal to dividends received from Hydra.

D. 35% of Hydra’s income for September 1 to December 31, 20X4 only.

Answer is B. However, with the 2017 changes where change from cost to equity method is now only applied prospectively, shouldn’t the answer be D?

Thanks!

[Hurricane]

The question says that Griffin iss the equity method to account for the investment. Just because they originally owned only 12% does not automatically mean that they use the cost method. There are other circumstances that could result in a less than 20% owned investment being accounted for under the equity method. In this example the question flat out state that the equity method is used, so you have to take it at face value and not make any other assumptions.

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[bryceallant]

Thanks for the response! I forgot to post what the answer explanation says:

Correct! When changing from the cost to the equity method, the investor must retroactively apply the equity method, but only for the percentage previously owned. Therefore, Griffin should report on its 20X4 income statement 12% of Hydra’s income for January – August 20X4 and 35% of Hydra’s income for September – December 20X4. Under the equity method, the journal entry to record investee dividends received affects only the balance sheet (Debit Cash / Credit Investment).

I had originally assumed what you said as well, but the answer explanation states they were changing from cost to equity, and it should be applied retroactively?

[Author]

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