Question

Kross Company purchases an equity investment in Penno Company at a purchase price of $5 million,...

Kross Company purchases an equity investment in Penno Company at a purchase price of $5 million, representing 40% of the outstanding stock and book value of Penno. During the current year, Penno reports net income of $600,000 and pays cash dividends of $200,000. At the end of the year, the market value of Kross’s investment is $5.3 million. What amount of income does Kross report relating to this investment in Penno for the year?

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Answer #1

Answer: Income from investment for the year $ 240,000 (Shown in Income Statement)

Equity Method: To calculate the value & income from investments when the company invests 20% to 50% in equity of other companies.

Under this method,

Investment Value at the initial = $ 5 Million

Impact of Net Income of Penno = $ 600,000

40% of Penno Net Income = $ 240,000 (Journal Entry: Investment Acccount - Debit, Income from Investment - Credit)

Impact of Dividend of Penno - $ 200,000

40% of Penno Net Income = $ 80,000 (Journal Entry: Cash/Bank- Debit, Investment Acccount - Credit)

Impact of Market Value of $ 5.3 Million - To be ignored in Equity Method

Investment Value in the Balance sheet of Kross Company = $ 5,000,000 + $ 240,000 - $ 80,000 = $ 5,160,000

Income from Investment in Profit & Loss statement = $ 240,000

Cash flow impact = Outflow: $ 5 Million, Inflow: $ 80,000

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