Chapter AH, Problem H.4P

(a)

To determine

Cost method: It refers to an accounting technique used by an investor to determine the income earned on investments made in short-term equity securities of a company.  Thus, the investor who own a non-significant interest by having less than 20% of ownership, accounts for investments in short-term equity securities under this method.

Equity method:  It refers to an accounting technique used by an investor to determine the income earned on investments made in long-term equity securities of a company.  Thus, the investor who owns a significant interest by having more than 20%, but less than 50% of ownership, accounts for investments in long-term equity securities under this method.

To Record: The stock transactions for the investment in Incorporation G for Company W using cost method.

Explanation of Solution

Record the purchase of common stock by Company W.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
January 1	Stock Investments		1,800,000
	Cash			1,800,000
	(To record the purchase of stock investments.)

Table (1)

Description:

• Stock Investments is an asset account. The amount has increased due to purchase of stock investment. Therefore, debit Stock Investments account with $180,000.
• Cash is an asset account. The amount has decreased because the stock investment is purchased for cash. Therefore, credit Cash account with $180,000.

Record the journal entry for the receipt of dividend revenue for Company W.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
June 30, 2017	Cash		30,000
	Dividend Revenue			30,000 (1)
	(To record the receipt of dividend revenue.)

Table (2)

Working Note:

Compute the amount of dividend received.

$\begin{array}{c}\text{Dividend received = Number of shares × Dividend per share}\\ \text{= 60,000 shares × \$0}\text{.50}\\ \text{= \$30,000}\end{array}$ (1)

Description:

• Cash is an asset account. The amount has increased because interest is received; therefore, debit Cash account with $30,000.
• Dividend Revenue is a revenue account. Revenue increases stockholders’ equity account. Therefore, credit Dividend Revenue account with $30,000.

Record the journal entry for the receipt of dividend revenue for Company W.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
December 31, 2017	Cash		30,000
	Dividend Revenue			30,000 (2)
	(To record the receipt of dividend revenue.)

Table (3)

Working Note:

Compute the amount of dividend received.

$\begin{array}{c}\text{Dividend received = Number of shares × Dividend per share}\\ \text{= 60,000 shares × \$0}\text{.50}\\ \text{= \$30,000}\end{array}$ (2)

Description:

• Cash is an asset account. The amount has increased because interest is received; therefore, debit Cash account with $30,000.
• Dividend Revenue is a revenue account. Revenue increases stockholders’ equity account. Therefore, credit Dividend Revenue account with $30,000.

(b)

To determine

To Record: The stock transactions for the investment in Incorporation G for Company W using equity method.

Explanation of Solution

Explanation

Record the purchase of common stock by Company W.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
January 1	Stock Investments		1,800,000
	Cash			1,800,000
	(To record the purchase of stock investments.)

Table (4)

Description:

• Stock Investments is an asset account. The amount has increased due to purchase of stock investment. Therefore, debit Stock Investments account with $180,000.
• Cash is an asset account. The amount has decreased because the stock investment is purchased for cash. Therefore, credit Cash account with $180,000.

Record the journal entry for the dividends recognized by Company W.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
June 30	Cash		30,000
	Stock Investments			30,000 (3)
	(To record the dividend received.)

Table (5)

Working Note:

Compute amount of dividends received.

$\begin{array}{c}\text{Dividend received = Number of shares × Dividend per share}\\ \text{= 60,000 shares × \$0}\text{.50}\\ \text{= \$30,000}\end{array}$ (3)

Description:

• Cash is an asset account. Since cash is received as dividends, cash amount has been increased. Therefore, debit Cash account with $30,000.
• Stock Investments is an asset account. Since Stock investment account is reduced, credit Stock Investments account with $30,000.

Record the journal entry for the dividends.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
December 31	Cash		30,000
	Stock Investments			30,000 (4)
	(To record the dividend received.)

Table (6)

Working Note:

Compute amount of dividends received.

$\begin{array}{c}\text{Dividend received = Number of shares × Dividend per share}\\ \text{= 60,000 shares × \$0}\text{.50}\\ \text{= \$30,000}\end{array}$ (4)

Description:

• Cash is an asset account. Since cash is received as dividends, cash amount has been increased. Therefore, debit Cash account with $30,000.
• Stock Investments is an asset account. Since Stock investment account is reduced, credit Stock Investments account with $30,000.

Record the journal entry for the equity on net income.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
December 31	Stock Investments		240,000
	Revenue from Stock Investments			240,000 (5)
	(To record the equity on the net income of the investee company.)

Table (7)

Description:

• Stock Investments is an asset account. The asset is increased as the stock investment is increased. Therefore, debit Stock Investments account with $240,000.
• Revenue from Stock Investments is a revenue account. Revenue increases the value of stockholders’ equity account. Therefore, credit Revenue from Stock Investments account with $240,000.

Working Note:

Compute amount of income received.

$\begin{array}{c}\text{Income reported = }\left\{\begin{array}{l}\text{Net inocme reported by investee in 2017}\\ \text{× Percentage share of ownership of investor}\end{array}\right\}\\ \text{= \$800,000×30\%}\\ \text{= \$240,000}\end{array}$ (5)

(c)

To determine

To Prepare: A memorandum and explain each method, and show the account balance under each method at December 31, 2017 in a tabular form.

Explanation of Solution

Prepare a memo to the board of directors explaining the differences between cost and equity methods.

MEMORANDUM

Date:    December 31, 2017

To:    The Board of Directors, Company W

From:    Miss S

Subject:  Differences between cost and equity methods

Cost method: It refers to an accounting technique used by an investor to determine the income earned on investments made in short-term equity securities of a company.  Thus, the investor who own a non-significant interest by having less than 20% of ownership, accounts for investments in short-term equity securities under this method.

Equity method:  It refers to an accounting technique used by an investor to determine the income earned on investments made in long-term equity securities of a company.  Thus, the investor who owns a significant interest by having more than 20%, but less than 50% of ownership, accounts for investments in long-term equity securities under this method.

The distinction between the cost and equity methods of accounting for investment in stocks is stated below:

Title: Distinguish between cost method and equity method
Basis of Difference	Cost Method	Equity Method
Type of stock investment	This method is used for accounting short-term investments or readily marketable investments.	This method is used for accounting long-term investments.
Ownership interest	An investor has less than 20% of ownership interest in common stock of investee’s company.	An investor has more than 20% but less than 50% of ownership interest in common stock of investee’s company.
Recognition of dividends reported by investee	Dividends are reported as revenue when cash dividends are received.	Dividends are reported as a reduction from the investment account.
Recognition of net income of the investee	Investor does not recognize the net income or loss reported by the investee’s company.	Investor recognizes its share of revenue or losses from the net income or loss reported by the investee’s company.

Table (8)

Account balances under cost and equity methods as at December 31, 2017.

Accounts	Cost Method ($)	Equity Method ($)
Stock Investments	1,800,000	1,980,000 (6)
Dividend Revenue	60,000	0
Revenue From Stock Investments	0	240,000

Table (9)

Working Note:

Prepare Stock Investments account under equity method.

Stock Investments
Date	Details	Debit ($)		Date	Details	Credit ($)
January 1	Cash	1,800,000		June 30	Cash	30,000
December 31	Revenue from stock investments	240,000		December 31	Cash	30,000
				December 31	Balance	1,980,000
December 31	Total	2,040,000		December 31	Total	2,040,000

Table (10)

(6)

Thanking you,

Miss S