Question

Equity method journal entries (price greater than book value) An investor purchases a 25% interest in an investee company, and the investor concludes that it can exert significant influence over the investee. The book value of the investee’s Stockholders’ Equity on the acquisition date is $500,000, and the investor purchases its 25% interest for $145,000. The investor is willing to pay the purchase price because the investee owns an unrecorded (internally developed) patent that the investor estimates is worth $80,000. The patent has a remaining useful life of 10 years. Subsequent to the acquisition, the investee reports net income of $100,000, and pays a cash dividend to the investor of $20,000. At the end of the first year, the investor sells the Equity Investment for $180,000. Prepare all of the required journal entries to account for this Equity Investment during the year.

Answer 1

Answer:

See answer an explanation below.

Explanation:

The journal entries will look as follows:

General Journal

Description                                          Debit ($)             Credit ($)          

Equity investment                               145,000

Cash                                                                                  145,000

(To record purchase of investment.)                                                      

Cash                                                      25,000

Income from equity investment (w.1)                              25,000

(To record equity income.)                                                                      

Cash                                                     20,000

Equity investment                                                            20,000

(To record receipt of cash dividend.)                                                      

Income from equity investment           2,000

Equity investment (w.2)                                                     2,000

(To record patent amortization expense.)                                            

Cash                                                   180,000

Gain on sale of equity invest. (w.4)                                 32,000

Equity investment (w.3)                                                  148,000

(To record sale of investment.)                                                              

Workings

w.1: Income from equity investment = Investee's net income * Percentage of interest = $100,000 * 25% = $25,000

w.2: Equity investment = (Patent value / Remaining useful life) * Percentage of interest = ($80,000 / 10) * 25% = $8,000 * 25% = $2,000

w.3: Equity investment = $145,000 + $25,000 - $20,000 - $2,000 = $148,000

w.4: Gain on sale of equity investment = Sales proceed - w.3 = $180,000 - $148,000 = $32,000