Chapter 1, Problem 27E

a.

To determine

Prepare the journal entries to record the purchase of an equity investment by using equity method.

Explanation of Solution

Equity investment is capital that is invested in a company by buying the company's shares in the stock market.

The required journal entry to record the equity income is as follows:

Date	Account title and Explanation	Post Ref	Debit ($)	Credit ($)
	Equity investment Account		$\$100,000$
	Equity income Account			$\$100,000$
	(To recognize 25% of net income.)

Table (1)

Working Notes:

Net income is $\$400,000$.

Calculate investor’s share in net income:

$400,000\times 25\%=\$100,000$

The required journal entry to record the share of unrealized gain on closing inventory is as follows:

Date	Account title and Explanation	Post Ref	Debit ($)	Credit ($)
	Equity income Account		$\$9,000$
	Equity investment Account			$\$9,000$
	(To record defer profits in closing inventory.)

Table (2)

Working Notes:

Gross profit on sale of inventory is $\$120,000$.

Calculate the investee’s share of unrealized gain in closing inventory:

$120,000\times 25\%\times 30\%=\$9,000$

Dividend is usually a part of profit paid by the company to its shareholders. It may be given in a variety of forms, such as cash payment, stocks or any other form.

The required journal entry to record the receipt of the dividend is as follows:

Date	Account title and Explanation	Post Ref	Debit ($)	Credit ($)
	Cash Account		$\$25,000$
	Equity investment Account			$\$25,000$
	(To record receipt of the dividend.)

Table (3)

Working Notes:

Total amount of dividends paid by investee during the year is $\$100,000$.

Calculate the amount of dividend paid to investor

$100,000\times 25\%=\$25,000$

b.

To determine

Calculate the equity investment balance at the year end.

Answer to Problem 27E

The balance of the equity investment at the end of the year is $\underset{\_}{\$1,066,000}$.

Explanation of Solution

Equity investment is capital that is invested in a company by buying the company's shares in the stock market.

The equity to be reported for the year is as follows:

$\begin{array}{c}\text{Equity to be reported }=\text{Investor's share of net income }-\text{share of unrealized gain}\\ =(400,000\times 25\%)-(120,000\times 25\%\times 30\%)\\ =100,000-9,000\\ =\$91,000\end{array}$

Therefore, the equity income to be reported for the year is $\$91,000$.

The balance of the equity investment at the end of the year is as follows:

Particulars	Amount ($)
Equity investment at the beginning of the year	$\$1,000,000$
Add: Investor’s share of net income	$91,000$
Less: Dividends received by investee	$25,000$
Equity investment at the end of the year	$\$1,066,000$

Hence, the balance of the equity investment at the end of the year is $\underset{\_}{\$1,066,000}$.

c.

To determine

Calculate the equity income reported by the investor for the following year.

Answer to Problem 27E

The equity income to be reported for the following year is $\underset{\_}{\$121,500}$.

Explanation of Solution

Equity investment is capital that is invested in a company by buying the company's shares in the stock market.

The equity to be reported for the following year is as follows:

$\begin{array}{c}\text{Equity to be reported }=\text{Investor's share of net income }+\text{share of unrealized gain}\\ =(450,000\times 25\%)+(120,000\times 25\%\times 30\%)\\ =112,500+9,000\\ =\$121,500\end{array}$

Hence, the equity income to be reported for the following year is $\underset{\_}{\$121,500}$.