Question

On January 2, 2018, All Good Company purchased 5,000 shares of the stock of Big Bad Company, and DID obtain significant influence. The investment is intended as a long-term investment. The stock was purchased for $12 per share, and represents a 30% ownership stake. Big Bad Company made $450,000 of net income in 2018, and paid dividends to All Good Company of $20,000 on December 15, 2018. Big Bad Company's stock was trading on the open market for $17 per share at the end of the year. Use this information to determine the book value of the investment that should be reported at year end by All Good Company. Round to nearest whole dollar.

Answer 1

Here, All Good company is having 30% ownership in Big bad company. It means All Good company is having significant influence over Big bad company. Hence, All Good company should use equity method.

And under equity method, net income of investee company will be added to the portion of holding and dividend received reduced from investment.

So, in given question, All good company having share of 30% over net income $450000 i.e. $135,000. And dividend of $20,000.

Hence book value of investment at year end will be $60,000 (purchase price 12 x5000) + $135,000 (net income of Big bad company) - $20,000 (dividend received) which will be $175,000.

I hope this clarifies you question. Pls rate and comment in case of any query.