Question

Exeter Company acquires 35% of the voting stock of Fenton Corporation for $7,000,000 on January 1, 2020. At the time, the book value of Fenton was $20,000,000. During 2020, Fenton reported net income of $3,000,000 and declared and paid dividends of $500,000. Both companies have December 31 year-ends, and the fair value of the investment at year-end was $9,000,000. Exeter uses the equity method to report its investment in Fenton stock. Now assume Fenton's book value at the date of acquisition was $15,000,000, and the excess paid over book value is attributed to previously unrecorded intangibles with an estimated remaining life of five years. Straight-line amortization is appropriate. What amount does Exeter report as equity in net income of Fenton for 2020?
a. $700,000.
b. $3,000,000.
c. $927,500.
d. $1,050,000.

Answer 1

Answer:

a. $700,000.

Explanation:

20,000,000 x 35% = 7,000,000

purchase cost:          7,000,000

nor goodwill or excess of value should be recognized.

But, if the face value is 15,000,000 then:

15,000,000 x 35% =  5,250,000

we recognize a goodwill of 1,750,000

which will be amortized over 5 year thus:

1,750,000 / 5 = 350,000

For the income of Frenton it will recognize the proportion of the net income and subtract the amortization on the goodwill.

3,000,000 x 35% =   1,050,000

amortization               (350,000)  

income from Frenton  700,000