Question

At a total cost of $6,360,000, Herrera Corporation acquired 285,000 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 750,000 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 $802,000 for the current period.
2.	A cash dividend of $0.39 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

SOLUTION

(A) Journal Entries

S.No.	Account titles and Explanation	Debit ($)	Credit ($)
1.	Investment in Tran Corp	304,760
	Investment Income (285,000/750,000*$802,000)		304,760
	(To record the investment in Tran corp.)
2.	Cash (285,000 * $0.39)	111,150
	Investment in Tran Corp		111,150
	(To record the payment of cash dividend)

(B) Equity method is appropriate for the Tran Corp. investment because Herrera owns 38% (285,000 / 750,000) of Tran Corp.