Question

Phillips Company bought 40 percent ownership in Jones Bag Company on January 1, 20X1, at underlying...

Phillips Company bought 40 percent ownership in Jones Bag Company on January 1, 20X1, at underlying book value. During the period of January 1, 20X1, through December 31, 20X3, the market value of Phillips' investment in Jones' stock increased by \$2,000 each year. In 20X1, 20X2, and 20X3, Jones Bag reported the following:

 Year Net Income Dividends 20X1 \$ 8,000 \$ 15,000 20X2 12,000 10,000 20X3 20,000 10,000

The balance in Phillips Company’s investment account on December 31, 20X3, was \$54,000.

Required:
In each of the following independent cases, determine the amount that Phillips paid for its investment in Jones Bag stock assuming that Phillips accounted for its investment by carrying the investment at fair value, or using the equity method.

 Fair value Equity method

Solution:

Fair value method:

The balance in Phillips Company’s investment account on December 31, 20X3 = \$54,000

Market value of investment increased each year = \$2,000

Total increase in market value = \$2,000*3 = \$6,000

Amount that Phillips paid for its investment in Jones Bag stock = Carrying value on Dec 31, 20X3 - Increase in fair value

= \$54,000 - \$6,000 = \$48,000

Equity method:

The balance in Phillips Company’s investment account on December 31, 20X3 = \$54,000

Share of income recognized during 3 years = (\$8,000 + \$12,000 + \$20,000)* 40% = \$16,000

Carrying value of investment reduced on receipt of dividend = (\$15,000 + \$10,000 + \$10,000)*40% = \$14,000

Net Increase in investment carrying value in 3 years = \$16,000 - \$14,000 = \$2,000

Amount that Phillips paid for its investment in Jones Bag stock = Carrying value on Dec 31, 20X3 - Increase in carrying value

= \$54,000 - \$2,000 = \$52,000

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