Question

1. In Year 1, Major bought 5% of the shares of Minor when they were worth a total of $300,000. By the end of Year 3, the shares were worth $325,000. It accounted for this investment in years 1, 2, and 3 on the fair value method. On Day 1, Year 4, Major bought another 40% of the shares of Minor for $2,600,000, and switches to the equity method of accounting for this investment. Which of the following is correct about the appropriate accounting under GAAP?

   		The Year 4, Day 1 balance for the Investment in Minor account should equal $2,900,000, equal to the cost of $300,000 for the first 5% plus the cost of the remaining 40%. No adjustments are needed to the Years 1, 2, and 3 financial statements
   		The Year 4, Day 1 balance for the Investment in Minor account should equal $2,925,000, equal to the carrying value at the end of Year 3 of $325,000 for the first 5% (which includes the adjustment to fair value) plus the cost of the remaining 40%. No adjustments are needed to the Years1, 2, and 3 financial statements
   		Adjustments are needed to Years 1, 2, and 3 results to assume that the equity method had been used for all three years. The Year 4, Day 1 Investment in Minor would then be found by adding the equity basis carrying amount for the 5% of stock to the $2,600,000 cost of the 40% bought in Year 4. The financial statements of Years 1, 2, and 3 would be restated.
   		Same as answer 3, except that the financial statements of years 1, 2, and 3 would not be restated. Instead, Year 4’s statements would include a Prior Period Adjustment in the shareholder’s equity statement to record the difference between what the retained earnings would have been in the equity basis had been used, and what had been reported in the prior years.

1. Assume that Major owns 25% of Minor, and uses the equity method. Also assume that during the year, Major bought $1 million in products from Minor. Minor recorded gross profits of $60,000 on this sale to Major. Major still has these items in inventory at the end of the year. Which of the following statements is correct?

   		Major’s accounting will be the same as if Minor had sold these items to third parties. No adjustment is needed to either the equity in investee income account or to the Investment in Minor account.
   		Major will defer its 25% share of the $60,000 gross profits until the products are eventually sold to outsiders. This will affect the reported equity in investee income account, and either the investment in Minor account, or inventory.
   		Major will defer all of the $60,000 gross profits until the products are eventually sold to outsiders. This will affect the reported equity in investee income account, and either the investment in Minor account, or inventory.
   		Major may choose any of the above options.

Answer 1

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Answer :

Q2 :

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