Question

1. The Big company spent $1,000,000 to obtain a 25% stake in Little. At that date, the net book value of Little’s assets and liabilities was $3,900,000. Little also had machines with remaining lives of 4 years, which had a fair value in total $100,000 higher than their book values. Big accounts for its investment under the equity method. Which of the following is correct?
   1. Each year, Big will record its 25% share of Little’s income, and will make no special adjustment related to these machines.
   2. Each year, Big will record its 25% share of Little’s income, and will also make an adjustment for its 25% share of $25,000 of extra equipment depreciation for the next four years.
   3. Little will change its books, and will increase the carrying cost of the machines, and also the depreciation. Big will then record its 25% share of the income of Little, as computed under this new basis.
2. Assume Big bought a small amount of stock in Little in Year 1, and properly used the fair value method to account for this investment. In Year 2, it bought enough extra stock that it should use the equity method. True or false: Big should restate its Year 1 financial statements to show the investment as if it had used the equity method.
3. True/False: Under the equity method of accounting for investments, an investor must record an impairment loss when there is a permanent decline in the value of the investment.
4. True/False: A company can choose to use the fair value method, rather than the equity method, as long as the fair value of the shares are readily available.

Answer 1

1)

b) Each year big will record its 25% share of little's income and also make adjustments for it's 25% share of $25000 of extra equipment depreciation for next 4 years.

2) True/False

• True, if equity method is used than investment should be recorded in financials statement.
• True , because when there is permanent decline in investment it will be recoded as goodwill impairment.
• False, its upto company to choose which method . If the influence on investee is full choose equity method and if there is no significant influence on investee than fair value method