Question

At a total cost of $5,600,000, Herrera Corporation acquired 280,000 shares of Tran Corp. common stock as a long-term investment. Herrera Corporation uses the equity method of accounting for this investment. Tran Corp. has 800,000 shares of common stock outstanding, including the shares acquired by Herrera Corporation.
Required:

A. Journalize the entries by Herrera Corporation on December 31 to record the following information (refer to the Chart of Accounts for exact wording of account titles):

1. Tran Corp. reports net income of $600,000 for the current period.
2. A cash dividend of $0.50 per common share is paid by Tran Corp. during the current period.

B. Why is the equity method appropriate for the Tran Corp. investment?

Answer 1

A.
S.No.	Account titles and Explanation	Debit	Credit
1	Investment in Tran Corp	$210,000
	Investment Income (280,000/800,000*$600,000)		$210,000
	(To record the investment in Tran corp.)
2	Cash (280,000 * $0.50)	$140,000
	Investment in Tran Corp		$140,000
	(To record the payment of cash dividend)
(B) Equity method is appropriate for the Tran Corp. investment because Herrera owns 35% (280,000 / 800,000) of Tran Corp.An investment amount between 20 and 40 of the outstanding common stock of the investee is presumed to represent significant influence. The equity method is appropriate when the investor can exercise significant influence over the investee.