[cpa1988]

I don’t understand the journal entry of Dr Investment income and Cr Investment in sub. Can someone help me understand the decrease part of the answer?

Park Co. uses the equity method to account for its January 1, Year 1, purchase of Tun, Inc.’s common stock. On January 1, Year 1, the fair values of Tun’s FIFO inventory and land exceeded their carrying amounts. How do these excesses of fair values over carrying amounts affect Park’s reported equity in Tun’s Year 1 earnings?

Inventory excess / Land excess

a. Increase / Increase

b. Decrease / No effect

c. Increase / No effect

d. Decrease / Decrease

Explanation

Choice “b” is correct. Park would record the additional COGS associated with the undervalued beginning inventory by debiting Investment Income and crediting the Investment in Tun’s account. Since the difference between book value and fair market value on land is not amortized, the difference in the land value would have no effect on equity in earnings.

[Anonymous]

The excess of an assets fair value over its book value will be amortized over the life of the asset. Exception- land will not be amortized. Therefor the amortization causes investors share of the investees income to decrease. Instead of thinking of it as a reduction of income, I try to think of it as an expense. I know expenses are always a debit entry so it helps with the JE.

DR Investment Income ( decrease in income due to the amortization of fv in excess of bv)

Cr Investment in Sub ( reduction of balance sheet account, Investment asset)

[Author]

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