Question

Equity Method for Stock Investment

At a total cost of $2,800,000, Herrera Corporation acquired 160,000 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 400,000 shares of common stock outstanding, including the shares acquired by Herrera Corporation.

a. Journalize the entries by Herrera Corporation to record the following information:

1. Tran Corp. reports net income of $5,040,000 for the current period.

2. A cash dividend of $1.30 per common share is paid by Tran Corp. during the current period.

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

An investment amount   of the outstanding common stock of the investee is presumed to represent significant influence. The equity method is appropriate when the investor   exercise significant influence over the investee.

Answer 1

Percentage of ownership	40%	=160000/400000
a
1
Investment in Tran Corp. stock	2016000		=5040000*40%
Income of Tran Corp.		2016000
2
Cash	208000		=160000*1.30
Investment in Tran Corp. stock		208000
b
An investment amount between 20% and 50% 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.