Can someone please help me to understand this problem below? Why is the investment $435,000? Wouldn't it be $365,000 = $400,000 – 10%(50,000-15,000)?
On January 2, 20X1, Well Co. purchased 10% of Rea, Inc.'s, outstanding common shares for $400,000. Well is the largest single shareholder in Rea, and Well's officers are a majority on Rea's board of directors. Rea reported net income of $500,000 for 20X1, and paid dividends of $150,000. In its December 31, 20X1, balance sheet, what amount should Well report as investment in Rea?
A.
$450,000
B.
$435,000
Incorrect C.
$400,000
D.
$385,000
You answered C. The correct answer is B.
The issue here is whether Well Co. should apply the equity method to its investment in Rea, Inc. According to FASB ASC 323-10-15-6, if the investor can exercise significant influence over financial and operating policies of the investee, the equity method should be used.
Significant influence may be indicated by “representation on the board of directors” as well as “the extent of ownership…in relation to the concentration of other shareholdings….”
It appears that Well Co. does exercise significant influence over Rea, Inc. Therefore, the equity method should be used in accounting for the investment. Even though the amount of stock ownership is less than 20%, the investment account balance as of December 31, 20X1, would be computed:
Unadjusted balance $400,000
10% of Rea's $500,000 income 50,000
10% of $150,000 dividends (15,000)
Adjusted balance $435,000
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