(Equity Investment) On July 1, 2014, Selig Company purchased for cash 40% of the
ID: 447196 • Letter: #
Question
(Equity Investment)
On July 1, 2014, Selig Company purchased for cash 40% of the outstanding capital stock of Spoor Corporation. Both Selig and Spoor have a December 31 year-end. Spoor Corporation, whose common stock is actively traded on the American Stock Exchange, paid a cash dividend on November 15, 2014, to Selig Company and its other stockholders. It also reported its total net income for the year of $920,000 to Selig Company.
Instructions
Prepare a one-page memorandum of instructions on how Selig Company should report the above facts in its December 31, 2014, balance sheet and its 2014 income statement. In your memo, identify and describe the method of valuation you recommend. Provide rationale where you can. Address your memo to the chief accountant at Selig Company.
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Explanation / Answer
To: Chief Accountant
Selig Company
Memo on accounting treatment to be accorded Investment in Spoor Corporation:
Selig Company should follow the equity method of accounting for its investment in Spoor Corporation because Selig Company is presumed to be able to exercise significant influence over the operating and financial policies of Spoor Corporation due to the size of its investment (40%).
In 2012, Selig Company should report its interest in Spoor Corporation’s outstanding capital stock as a long-term investment. Following the equity method of accounting, Selig Company should record the cash purchase of 40 % of Spoor Corporation at acquisition cost.
40% of Spoor Corporation’s total net income from July 1, 2012, to December 31, 2012, should be added to the carrying amount of the investment in Selig Company’s balance sheet and shown as revenue in its income statement to recognize Selig Company’s share of the net income of Spoor Corporation after the date of acquisition. This amount should reflect adjustments similar to those made in preparing consolidated statements, including adjustments to eliminate intercompany gains and losses.
The cash dividends paid by Spoor Corporation to Selig Company should reduce the carrying amount of the investment in Selig Company’s balance sheet and have no effect on Selig Company’s income statement.
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