On April 1, 2018, GMR Company purchased 30% of the outstanding voting stock of the Victory Corporation for $960,000. Victory's net assets on April 1, 2018 totaled $2,500,000. Victory's equipment was undervalued by $500,000 and its inventory was undervalued by $200,000 as of the date of purchase. The equipment has a ten-year remaining life as of April 1, 2018; the inventory was sold during 2018. Victory reported $450,000 of net income during 2018 and paid dividends of $75,000. Assume that net income was recognized evenly during 2018 and dividends were declared and paid evenly during 2018. Required:
Prepare a schedule to determine the amount of investment income to be reported by GMR during 2018 assuming that the equity method of accounting is applicable. Prepare a schedule to determine the balance in the investment account as of December 31, 2018 assuming that the equity method is applicable.
Describe how the financial accounting and reporting would have differed if the equity method was not applicable.
Describe how equity method investments are accounted for if GMR uses the fair value option of accounting for its investment.
What will be an ideal response?
1.
| GMR's share of Victory's reported income | $ | 101,250 | ($450,000 × 9/12 × 30%) | |
| Adjustment due to the equipment differential | (11,250 | )* | ||
| Adjustment due to the inventory differential | (60,000 | ) | ($200,000 × 30%) | |
| 2018 Investment income | $ | 30,000 | ||
2.
| Initial cost | $ | 960,000 | ||
| 2018 investment income | 30,000 | |||
| 2018 share of dividends | (16,875 | ) | ($75,000 × 9/12 × 30%) | |
| December 31, 2018 investment balance | $ | 973,125 | ||
4. Unrealized gains and losses arising from fair value changes are reported in the investor's income statement; the investor also reports its share of the investee's declared dividends as income. The investment account is reported on the balance sheet at fair value.
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