File: Chapter 01 - The Equity Method of Accounting for Investments
Multiple Choice:
[QUESTION]
1. Gaw Company owns 15% of the common stock of Trace Corporation and used the fair-
value method to account for this investment. Trace reported net income of $110,000 for
2018 and paid dividends of $60,000 on October 1, 2018. How much income should Gaw
recognize on this investment in 2018?
A) $16,500.
B) $ 9,000.
C) $25,500.
D) $ 7,500.
E) $50,000.
Answer: B
Learning Objective: 01-01
Topic: Investments―Fair-value method
Difficulty: 1 Easy
Blooms: Apply
AACSB: Knowledge Application
AICPA: BB Critical Thinking
AICPA: FN Measurement
Feedback: $60,000 × .15 = $9,000
[QUESTION]
2. Yaro Company owns 30% of the common stock of Dew Co. and uses the equity method to
account for the investment. During 2018, Dew reported income of $250,000 and paid
dividends of $80,000. There is no amortization associated with the investment. During
,2018, how much income should Yaro recognize related to this investment?
A) $24,000.
B) $75,000.
C) $99,000.
D) $51,000.
E) $80,000.
Answer: B
Learning Objective: 01-03
Topic: Equity method―Investment income
Difficulty: 1 Easy
Blooms: Apply
AACSB: Knowledge Application
AICPA: BB Critical Thinking
AICPA: FN Measurement
Feedback: $250,000 × .30 = $75,000
[QUESTION]
3. On January 1, 2018, Pacer Company paid $1,920,000 for 60,000 shares of Lennon Co.’s
voting common stock which represents a 45% investment. No allocation to goodwill or
other specific account was necessary. Significant influence over Lennon was achieved by
this acquisition. Lennon distributed a dividend of $2.50 per share during 2018 and reported
net income of $670,000. What was the balance in the Investment in Lennon Co. account
found in the financial records of Pacer as of December 31, 2018?
A) $2,040,500.
B) $2,212,500.
C) $2,260,500.
D) $2,171,500.
E) $2,071,500.
,Answer: E
Learning Objective: 01-03
Topic: Equity method―Investment account balance
Difficulty: 2 Medium
Blooms: Apply
AACSB: Knowledge Application
AICPA: BB Critical Thinking
AICPA: FN Measurement
Feedback: $1,920,000 + ($670,000 × .45) – ($2.50 × 60,000) = $2,071,500
[QUESTION]
4. An investor should always use the equity method to account for an investment if:
A) It has the ability to exercise significant influence over the operating policies of the
investee.
B) It owns 30% of an investee’s stock.
C) It has a controlling interest (more than 50%) of an investee’s stock.
D) The investment was made primarily to earn a return on excess cash.
E) It does not have the ability to exercise significant influence over the operating policies of
the investee.
Answer: A
Learning Objective: 01-02
Topic: Equity method―Significant influence criterion
Difficulty: 1 Easy
Blooms: Remember
AACSB: Reflective Thinking
AICPA: BB Critical Thinking
AICPA: FN Measurement
, [QUESTION]
5. On January 1, 2016, Dermot Company purchased 15% of the voting common stock of
Horne Corp. On January 1, 2018, Dermot purchased 28% of Horne’s voting common stock. If
Dermot achieves significant influence with this new investment, how must Dermot account
for the change to the equity method?
A) It must use the equity method for 2018 but should make no changes in its financial
statements for 2017 and 2016.
B) It should prepare consolidated financial statements for 2018.
C) It must restate the financial statements for 2017 and 2016 as if the equity method had
been used for those two years.
D) It should record a prior period adjustment at the beginning of 2018 but should not
restate the financial statements for 2017 and 2016.
E) It must restate the financial statements for 2017 as if the equity method had been used
then.
Answer: A
Learning Objective: 01-05a
Topic: Report change to equity method
Difficulty: 2 Medium
Blooms: Understand
AACSB: Analytical Thinking
AICPA: BB Critical Thinking
AICPA: FN Measurement
[QUESTION]
6. During January 2017, Wells, Inc. acquired 30% of the outstanding common stock of
Wilton Co. for $1,400,000. This investment gave Wells the ability to exercise significant
influence over Wilton. Wilton’s assets on that date were recorded at $6,400,000 with
liabilities of $3,000,000. Any excess of cost over book value of Wells’ investment was
attributed to unrecorded patents having a remaining useful life of ten years.
Multiple Choice:
[QUESTION]
1. Gaw Company owns 15% of the common stock of Trace Corporation and used the fair-
value method to account for this investment. Trace reported net income of $110,000 for
2018 and paid dividends of $60,000 on October 1, 2018. How much income should Gaw
recognize on this investment in 2018?
A) $16,500.
B) $ 9,000.
C) $25,500.
D) $ 7,500.
E) $50,000.
Answer: B
Learning Objective: 01-01
Topic: Investments―Fair-value method
Difficulty: 1 Easy
Blooms: Apply
AACSB: Knowledge Application
AICPA: BB Critical Thinking
AICPA: FN Measurement
Feedback: $60,000 × .15 = $9,000
[QUESTION]
2. Yaro Company owns 30% of the common stock of Dew Co. and uses the equity method to
account for the investment. During 2018, Dew reported income of $250,000 and paid
dividends of $80,000. There is no amortization associated with the investment. During
,2018, how much income should Yaro recognize related to this investment?
A) $24,000.
B) $75,000.
C) $99,000.
D) $51,000.
E) $80,000.
Answer: B
Learning Objective: 01-03
Topic: Equity method―Investment income
Difficulty: 1 Easy
Blooms: Apply
AACSB: Knowledge Application
AICPA: BB Critical Thinking
AICPA: FN Measurement
Feedback: $250,000 × .30 = $75,000
[QUESTION]
3. On January 1, 2018, Pacer Company paid $1,920,000 for 60,000 shares of Lennon Co.’s
voting common stock which represents a 45% investment. No allocation to goodwill or
other specific account was necessary. Significant influence over Lennon was achieved by
this acquisition. Lennon distributed a dividend of $2.50 per share during 2018 and reported
net income of $670,000. What was the balance in the Investment in Lennon Co. account
found in the financial records of Pacer as of December 31, 2018?
A) $2,040,500.
B) $2,212,500.
C) $2,260,500.
D) $2,171,500.
E) $2,071,500.
,Answer: E
Learning Objective: 01-03
Topic: Equity method―Investment account balance
Difficulty: 2 Medium
Blooms: Apply
AACSB: Knowledge Application
AICPA: BB Critical Thinking
AICPA: FN Measurement
Feedback: $1,920,000 + ($670,000 × .45) – ($2.50 × 60,000) = $2,071,500
[QUESTION]
4. An investor should always use the equity method to account for an investment if:
A) It has the ability to exercise significant influence over the operating policies of the
investee.
B) It owns 30% of an investee’s stock.
C) It has a controlling interest (more than 50%) of an investee’s stock.
D) The investment was made primarily to earn a return on excess cash.
E) It does not have the ability to exercise significant influence over the operating policies of
the investee.
Answer: A
Learning Objective: 01-02
Topic: Equity method―Significant influence criterion
Difficulty: 1 Easy
Blooms: Remember
AACSB: Reflective Thinking
AICPA: BB Critical Thinking
AICPA: FN Measurement
, [QUESTION]
5. On January 1, 2016, Dermot Company purchased 15% of the voting common stock of
Horne Corp. On January 1, 2018, Dermot purchased 28% of Horne’s voting common stock. If
Dermot achieves significant influence with this new investment, how must Dermot account
for the change to the equity method?
A) It must use the equity method for 2018 but should make no changes in its financial
statements for 2017 and 2016.
B) It should prepare consolidated financial statements for 2018.
C) It must restate the financial statements for 2017 and 2016 as if the equity method had
been used for those two years.
D) It should record a prior period adjustment at the beginning of 2018 but should not
restate the financial statements for 2017 and 2016.
E) It must restate the financial statements for 2017 as if the equity method had been used
then.
Answer: A
Learning Objective: 01-05a
Topic: Report change to equity method
Difficulty: 2 Medium
Blooms: Understand
AACSB: Analytical Thinking
AICPA: BB Critical Thinking
AICPA: FN Measurement
[QUESTION]
6. During January 2017, Wells, Inc. acquired 30% of the outstanding common stock of
Wilton Co. for $1,400,000. This investment gave Wells the ability to exercise significant
influence over Wilton. Wilton’s assets on that date were recorded at $6,400,000 with
liabilities of $3,000,000. Any excess of cost over book value of Wells’ investment was
attributed to unrecorded patents having a remaining useful life of ten years.
