[JT]

Pare, Inc., purchased 10% of Tot Co.’s 100,000 outstanding shares of common stock on January 2, 20X1, for $50,000. On December 31, 20X1, Pare purchased an additional 20,000 shares of Tot for $150,000. There was no goodwill as a result of either acquisition, and Tot had not issued any additional stock during 20X1. Tot reported earnings of $300,000 for 20X1. What amount should Pare report in its December 31, 20X1, balance sheet as investment in Tot?

A. $170,000

B. $200,000

C. $230,000

D. $290,000

Answer is C.

I’m confused on why it isn’t D.

The explanation is provided:

Since Pare purchased the additional shares on December 31, Pare records only 10% of Tot’s net income (for the 10% of the shares held during the year). However, because Pare owned a 30% share on December 31, the equity method is used, and the investment in Tot is adjusted for Pare’s share of net income:

Acquisition cost of first 10,000 shares $ 50,000

Acquisition cost of additional 20,000 shares 150,000

Pare’s share of Tot Co.’s 20X1 earnings

under equity method (10% x $300,000) 30,000

---

Total $230,000

========

My question is that hypotheticallu, if he acquired the additional 20k shares July 1, would that mean you would include half of the net income because it’s half the year? (An additional 30k in my example) I thought since it’s now being accounted for at year end using the equity method, you would pretend they accounted for the investment using the equity method the whole year.

REG-80-1X
BEC-80-1X
FAR-73-1X
FAR-75-2X
AUD-September 2016

[Excel14]

Dab,

Just re-read the question, and it appears that they purchased the additional 20,000 shares on 12/31, Had they purchased the shares on 7/01 for example, they would recognize earnings according to the Equity Method (the full $90,000). It appears because they bought the additional shares on the last day, they weren't required to account for the investment via the Equity Method. Otherwise, their share of the income would have been $90,000 (30,000 x 30%). Instead, it appears they only reported their 10% share, based on the percentage owned throughout the year. Why the explanation talks about using the Equity Method to account for the investment is beyond me, since it is clear they don't utilize it.

BEC (2/28/16) ----- 78
FAR (09/10/16)-----
AUD
REG

CIA, CGAP, CFE

[JT]

Well,…. They do utilize the equity method, but only for the 10% originally owned.

I found this which helped me understanding it.

https://www.another71.com/cpa-exam-forum/topic/far-question-equity-method

I guess you use the portion of the equity method based on a percentage of investment owned during the year.

Thanks for your response @excel14

REG-80-1X
BEC-80-1X
FAR-73-1X
FAR-75-2X
AUD-September 2016

[Excel14]

That is “dirty pool”, when they give you a question that Involves meeting Equity Method criteria on the very last day of the fiscal year, but I guess that anything is fair game on these tests. Lol. Just looked this up in my Gleim book, and it does say this…”The investor's share of the investee's earnings or losses is recognized only for the portion of the year that the investment was held under the Equity Method”. So it does appear that ownership of 30% for merely one day, is not significant enough to change the % of investee's earning portion, to utilize the 30% versus the 10%. So you're right, they change to the Equity Method on the last day, but the original 10% is used. I learned something too. 🙂

BEC (2/28/16) ----- 78
FAR (09/10/16)-----
AUD
REG

CIA, CGAP, CFE

[Author]

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