Assume that an investor owns 30% of an investee, and accounts for its investment using the equity method. At the beginning of the year, the Equity Investment was reported on the investor's balance sheet at $300,000. During the year, the investee reported net income of $105,000 and paid dividends of $20,000 to the investor. In addition, the investor sold inventory to the investee, realizing a gross profit of $42,000 on the sale. At the end of the year, 20% of the inventory remained unsold by the investee. Required:a. How much equity should the investor report for the year?b. What is the balance of the Equity Investment at the end of the year?c. Assume that the remaining inventory is sold in the following year and that the investee reports $150,000 of net income. How much equity income will the investor report for the following year?

a.34,020

b.314,020

c.42,600

Explanation:

The equity method is applied when a company's ownership interest in another company is valued at 20–50% of the stock in the investee. The equity method requires the investing company to record the investee's profits or losses in proportion to the percentage of ownership

DATA

Net Income = $105,000

Investor's share = 30%

Inventory unsold = 20%

Gross profit = $42,000

Dividends = $20,000

Requirement 1

Equity to be reported = (investor's share of net income)  − (Share of unrealized profit on inventory at the end)

Equity to be reported = ($105,000 × 30%) − ($42,000 × 20% × 30%)

Equity to be reported = $31,500 + $2,520

Equity to be reported = $34,020

Requirement 3

Equity investment at end of year = (Equity investment at the beginning of the year)  + (Investor's share of net income)  − (Dividendsdeclared)

Equity investment at end of year  = $300,000 + $34,020 − $20,000

Equity investment at end of year  =$314,020

Requirement 2

Equity to be reported = (Investor′ s share of net income)  -(Share of unrealized profit on inventory at the year end)

Equity to be reported =($150,000×30%)−($40,000×20%×30%)

Equity to be reported =$45,000−$2,400

Equity to be reported =$42,600

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