Question

Dodge, Incorporated acquires 15% of Gates Corporation on January 1, 2013, for $105,000 when the book value of Gates was $600,000. During 2013 Gates reported net income of $150,000 and paid dividends of $50,000. On January 1, 2014, Dodge purchased an additional 25% of Gates for $200,000. Any excess cost over book value is attributable to goodwill with an indefinite life. The fair-value method was used during 2013 but Dodge has deemed it necessary to change to the equity method after the second purchase. During 2014 Gates reported net income of $200,000 and reported dividends of $75,000.
1. Which adjustment would be made to change from the fair-value method to the equity method?

Answer 1

Answer:

Goodwill    35,000 debit

   Investment in Gates      25,000 credit

  Retained Earnings          10,000 credit

--to adjust for change of method--

Explanation:

600,000 x 15% = 90,000

purchased at     105,000

goodwill of 15,000

+ 150,000 x 15% of net income = 22,500

- 50,000 x 15% dividends          =   (7,500)

investment at the end of 2013:

90,000 + 22,500 - 7,500 = 105,000

Then we purchase 25%

105,000 represent 15%

thus 25% would be: 105,000 / 0.15 x 0.25 = 175,000

purchased at 200,000

goodwill of 25,000 to be recognized.

So, equity method will be:

105,000 + 175,000 = 280,000 for the proportional equity

and 15,000 + 25,000 = 35,000 goodwill

Total of 315,000

While fair value will not recognize goodwill. and also, the investment is not modified when dividends and the gain for the year are delcared.

It measure at cost unless the market value of the stock decrease so we got:

105,000 1st purchase + 200,000 2nd purchase = 305,000

To adjust we are going to decrease investment by 25,000 and increase goodwill by 35,000 the other will go into retained earnings to balance out.