Question

On January 4, 2013, Watts Co. purchased 40,000 shares (40%) of the common stock of Adams Corp., paying $800,000. There was no goodwill or other cost allocation associated with the investment. Watts has significant influence over Adams. During 2013, Adams reported an income of $200,000 and paid dividends of $80,000. On January 2, 2014, Watts sold 5,000 shares for $125,000. What was the balance in the investment account after the shares had been sold?

Answer 1

Answer:

Investment balance is $742,000

Explanation:

The treatment of associates will be in-accordance with equity method:

The equity method says that the investment must reflect its fair value.

The fair value of the investment = Cost of shares - Dividend's share Received  + Share of Profit invested

Value of Investment = $800,000 - $32000 ($80,000 Total Dividend * 40%)  + Reinvestment through Net Income $80,000 ($200,000 * 40%) = $848,000

The value of the investment after sale of shares will fall by 5000 share out of 40000 shares, this means the fall in value is:

Fall in value of investment = 5,000 / 40,000 × $848,000 Value of investment = $106,000

New Value = $848,000 - $106,000 = $742,000