Q15E_1 - Horngren'S Financial And Managerial Accounting

Question

Accounting for equity investments

Suppose that on January 6, 2018, East Coast Motors paid \(280,000,000 for its 35% investment in Boxcar Motors. East Coast has significant influence over Boxcar after the purchase. Assume Boxcar earned net income of \)90,000,000 and paid cash dividends of $45,000,000 to all outstanding stockholders during 2018. (Assume all outstanding stock is voting stock.) 

Requirements 

1. What method should East Cost Motors use to account for the investment in Boxcar Motors? Give your reasoning.

Step-by-Step Solution

Answer

East Coast Motors must account for investment using the equity method.

Definition of Equity Method

The method of recording investment in the company’s voting stock under which the investment is recorded at its acquisition cost and adjustments are made for net income, loss and dividend payment is known as the equity method.

Accounting for Investment

East Coast Motors company has purchased 35% voting stock of Boxcar Motors. When the investment purchased reflects the purchase of 20% to 50% of the voting stock of the investee company, then it must be accounted for using the equity method.