Question

On January 2, 2018, Miller Properties paid $19 million for 1 million shares of Marlon Company’s 6 million outstanding common shares. Miller’s CEO became a member of Marlon’s board of directors during the first quarter of 2018.
The carrying amount of Marlon’s net assets was $66 million. Miller estimated the fair value of those net assets to be the same except for a patent valued at $24 million above cost. The remaining amortization period for the patent is 10 years.

Marlon reported earnings of $12 million and paid dividends of $6 million during 2018. On December 31, 2018, Marlon’s common stock was trading on the NYSE at $18.50 per share.

Required:
When considering whether to account for its investment in Marlon under the equity method, what criteria should Miller’s management apply?

Assume Miller accounts for its investment in Marlon using the equity method. Ignoring income taxes, determine the amounts related to the investment to be reported in its 2018:
Income statement
Balance sheet
Statement of cash flows

Answer 1

Answer:

Cost Method

Explanation:

1. When considering whether to account for its investment in Marlon under the equity method, Miller’s management should apply 'Cost Method' because 'equity accounting method' is should only be used when the company has a significant interest in Marlon which is assumed to be 20% of its shareholding.

2. If we assume the use of equity method then.

investment to be reported in its 2018:

A.  Income statement : This will be a single line to show the 'share of associate's profit' which is derived by multiplying the percentage ownweship by the investee's profit amount: 16.67%* 12 = $2million

B.  Balance sheet : This will show the carrying value of the investment under long term assets, after fixed assets before current assets. The value will be:

1. The purchase consideration of $19m

(+)

2. The share of associate's profit of $2m

(-)

3. The amount of dividends received of $6m

Therefore the carrying value of the investment in the balance sheet will be $15 million

C.  Statement of cash flows: The statement of cashflows will only show the receipt of cash for the dividend of $6million from Marlon, in the 'investing activities' section, as an inflow.