On January 2, 20X5, Well Co. purchased 10 percent of Rea, Inc.\'s outstanding co

Question

On January 2, 20X5, Well Co. purchased 10 percent of Rea, Inc.'s outstanding common shares for $400,000. Well is the largest single shareholder in Rea, and Well's officers are a majority on Rea's board of directors. As a result, Well is able to exercise significant influence over Rea. Rea reported net income of $500,000 for 20X5, and paid dividends of $150,000. In its December 31, 20X5, balance sheet, what amount should Well report as investment in Rea?

A) $385,000

B) $450,000

C) $400,000

D) $435,000

Explanation / Answer

Since there exists significant influence of Well Co over Rea Inc. application of equity method of accounting will be most suitable

under this method share in the profits of investee co ( Rea Inc. ) is added to the cost of investment by investor ( Well co.). If any dividend is received against such investment it will also be deducted from the investment only

So value of investment at end is

cost of investment = 400000

Add: share in profits = 500000 x 10 %, = 50000

Less share in dividend = 150000 x 10 % = 15000

value of investment = 435000 ( option d)

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