Multiple Choice Questions

      1.   Gaw Company owns 15% of the common stock of Teal Corporation and used the fair-value method to account for this investment.  Teal reported net income of $110,000 for 2002 and paid dividends of $60,000 on October 1, 2002.  How much income should Gaw recognize on this investment in 2002?

            A)  $16,500

            B)   $  9,000

            C)   $25,500

            D)  $  7,500

            E)   $50,000

      2.   Yult Company owns 25% of the common stock of Dent Co. and uses the equity method to account for the investment.  During 2002, Dent reported income of $220,000 and paid dividends of $80,000.  There is no amortization associated with the investment.  During 2002, how much income should Yult recognize related to this investment?

            A)  $20,000

            B)   $75,000

            C)   $55,000

            D)  $35,000

            E)   $46,000

      3.   On January 1, 2003, Pacer Company paid $1,920,000 for 60,000 shares of Lennon Co.’s voting common stock which represents a 45% investment.  No allocation to goodwill or other specific account was made.  Significant influence over Lennon was achieved by this acquisition.  Lennon distributed a dividend of $2.50 per share during 2003 and reported net income of $670,000.  What was the balance in the Investment in Lennon Co. account found in the financial records of Pacer as of December 31, 2003?

            A)  $2,040,500

            B)   $2,212,500

            C)   $2,260,500

            D)  $2,171,500

            E)   $2,071,500

      4.   A company should always use the equity method to account for an investment if

            A)  it has the ability to exercise significant influence over the operating policies of the investee.

            B)   it owns 30% of another company’s stock.

            C)   it has a controlling interest (more than 50%) of another company’s stock.

            D)  the investment was made primarily to earn a return on excess cash.

            E)   it does not have the ability to exercise significant influence over the operating policies of the investee.

      5.   On January 1, 2002, Dermot Company purchased 12% of the voting common stock of Horne Corp.  On January 1, 2004, Dermot purchased 18% of Horne’s voting common stock.  If Dermot achieves significant influence with this new investment, how must Dermot account for the change to the equity method?

            A)  It must use the equity method for 2004 but should make no changes in its financial statements for 2002 and 2005.

            B)   It should prepare consolidated financial statements for 2004.

            C)   It must restate the financial statements for 2002 and 2003 as if the equity method had been used for those two years.

            D)  It should record a prior period adjustment at the beginning of 2004 but should not restate the financial statements for 2002 and 2003.

            E)   It must restate the financial statements for 2003 as if the equity method had been used then.

      6.   During January 2002, Webb, Inc. acquired 30% of the outstanding common stock of Wilson Co. for $1,200,000.  This investment gave Webb the ability to exercise significant influence over Wilson.  Wilson’s assets on that date were recorded at $6,400,000 with liabilities of $3,000,000.  Any excess of cost over book value of Webb’s investment was attributed to unrecorded patents having a remaining useful life of ten years.

            In 2002, Wilson reported net income of $600,000.  For 2003, Wilson reported net income of $750,000.  Dividends of $200,000 were paid in each of these two years.  What was the reported balance of Webb’s Investment in Wilson Co. at December 31, 2003?

            A)  $1,449,000

            B)   $1,485,000

            C)   $1,269,000

            D)  $1,305,000

            E)   $   854,300

      7.   On January 1, 2003, Bangle Company purchased 30% of the voting common stock of Sleat Corp. for $1,000,000.  Any excess of cost over book value was assigned to goodwill.  During 2003, Sleat paid dividends of $24,000 and reported a net loss of $140,000.  What is the balance in the investment account on December 31, 2003?

            A)  $950,800

            B)   $945,800

            C)   $939,300

            D)  $990,100

            E)   $956,400

      8.   On January 1, 2002, Jordan Inc. acquired 30% of Nico Corp.  Jordan used the equity method to account for the investment.  On January 1, 2000, Jordan sold 2/3 of its investment in Nico.  It no longer had the ability to exercise significant influence over the operations of Nico.  How should Jordan have accounted for this change?

            A)  Jordan should continue to use the equity method to maintain consistency in its financial statements.

            B)   Jordan should restate the prior years’ financial statements and change the balance in the investment account as if the fair-value method had been used since 2002.

            C)   Jordan has the option of using either the equity method or the fair-value method for 2004 and future years.

            D)  Jordan should report the effect of the change from the equity to the fair-value method as a cumulative effect of a change in accounting principle.

            E)   Jordan should use the fair-value method for 2004 and future years but should not make a retroactive adjustment to the investment account.

      9.   Bowler Inc. owns 30% of Yarby Co. and applies the equity method.  During the current year, Bowler bought inventory costing $66,000 and then sold it to Yarby for $120,000.  At year-end, only $24,000 of merchandise was still being held by Yarby.  What amount of unrealized gain must be deferred by Bowler?

            A)  $  6,480

            B)   $  3,240

            C)   $10,800

            D)  $  5,920

            E)   $  6,610

    10.   On January 4, 2003, Watts Co. purchased 40,000 shares (40%) of the common stock of Adams Corp., paying $800,000.  There was no goodwill or other cost allocation associated with the investment.  Watts has significant influence over Adams.  During 2003, Adams reported income of $200,000 and paid dividends of $80,000.  On January 2, 2004, Watts sold 5,000 shares for $125,000.  What was the balance in the investment account after the shares had been sold?

            A)  $848,000

            B)   $742,000

            C)   $723,000

            D)  $761,000

            E)   $925,000

    11.   On January 4, 2003, Mason Co. purchased 35,000 shares (35%) of the common stock of Hefly Corp., paying $560,000.  At that time, the book value and fair market value of Hefly’s net assets was $1,400,000.  The investment gave Mason the ability to exercise significant influence over the operations of Hefly.  During 2001, Hefly reported income of $150,000 and paid dividends of $40,000.  Mason owned patents having a fair market value over book value of $200,000 that were to be amortized over 20 years.  On January 2, 2004, Mason sold 5,000 shares for $105,000.  On January 1, 2004, how much gain or loss should be recognized on the sale?

            A)  $20,000 gain

            B)   $19,500 gain

            C)   $20,000 loss

            D)  $19,500 loss

            E)   $25,000 loss

Use the following to answer questions 12-13:

On January 3, 2004, Austin Corp. purchased 25% of the voting common stock of Gainsville Co., paying $2,000,000.  Austin decided to use the equity method to account for this investment.  At the time of the investment, Gainsville’s total stockholders’ equity was $6,000,000.  Gainesville had franchise agreements with a fair market value of $400,000. Austin gathered the following information about Gainsville’s assets and liabilities:

Book Value

Fair Market Value

Buildings (10-year life)

$     400,000

     $     500,000

Equipment (5-year life)

1,000,000

         1,300,000

For all other assets and liabilities, book value and fair market value were equal.

    12.   What is the amount of goodwill associated with the investment?

            A)  $300,000

            B)   $500,000

            C)   $  0

            D)  $100,000

            E)   $400,000

    13.   Assuming that goodwill is amortized over a period of five years, what is the total amortization for 2004?

            A)  $27,500

            B)   $20,000

            C)   $90,000

            D)  $120,000

            E)   $70,000

    14.   Club Co. appropriately uses the equity method to account for its investment in Chip Corp.  As of the end of 2004, Chip’s common stock had suffered a significant decline in market value, which is expected to be recovered over the next several months.  How should Club account for the decline in value?

            A)  Club should switch to the fair-value method.

            B)   No accounting because the decline in market value is temporary.

            C)   Club should decrease the balance in the investment account to the current value and recognize a loss on the income statement.

            D)  Club should not record its share of Chip’s 2004 earnings until the decline in the market value of the stock has been recovered.

            E)   Club should decrease the balance in the investment account to the current value and recognize an unrealized loss on the balance sheet.

    15.   Dipato Inc. bought 40% of Twitcher Co. on January 1, 2002, for $636,000.  The equity method of accounting was used.  The net assets of Twitcher on that date were $1.44 million.  Twitcher immediately began supplying inventory to Dipato as follows:

Amount Held

by Dipato

Cost to

Transfer

at Year-End

Year

Twitcher

Price

(at Transfer Price)

2002

 $   84,000

 $ 120,000

         $ 30,000

2003

    115,200

    180,000

            54,000

            Inventory held at the end of one year by Dipato is sold at the beginning of the next.

            Twitcher reported net income of $96,000 in 2002 and $132,000 in 2003 while paying $36,000 in dividends each year.  What is the Equity in Twitcher Income that should have been reported by Dipato in 2003?

            A)  $45,624

            B)   $40,200

            C)   $66,360

            D)  $48,624

            E)   $49,800

    16.   An upstream sale of inventory is a sale

            A)  between subsidiaries owned by a common parent.

            B)   with the transfer of goods scheduled by contract to occur on a specified future date

            C)   in which the goods are physically transported by boat from a subsidiary to its parent.

            D)  made by the investor to the investee.

            E)   made by the investee to the investor.

Use the following to answer questions 17-18:

Surrell Inc. owns 30% of the outstanding voting common stock of Vicker Co. and has the ability to significantly influence the investee’s operations and decision making.  On January 1, 2003, the balance in the Investment in Vicker Co. account was $402,000.  Amortization associated with this acquisition is $10,800 per year.  During 2003, Vicker earned an income of $108,000 and paid cash dividends of $36,000.  Previously in 2002, Vicker had sold inventory costing $28,800 to Surrell for $48,000.  All but 25% of this merchandise was consumed by Surrell during 2002.  The remainder was used during the first few weeks of 2003.  Additional sales were made to Surrell in 2003; inventory costing $33,600 was transferred at a price of $60,000.  Of this total, 40% was not consumed until 2004.

    17.   What amount of equity income would Surrell have recognized in 2003 from its ownership interest in Vicker?

            A)  $  9,936

            B)   $24,840

            C)   $19,872

            D)  $21,114

            E)   $18,948

    18.   What was the balance in the Investment in Vicker Co. account at the end of 2003?

            A)  $401,136

            B)   $411,072

            C)   $416,040

            D)  $412,314

            E)   $410,148

Use the following to answer questions 19-20:

On January 1, 2002, Deuce Inc. acquired 15% of Wiz Co.’s outstanding common stock for $62,400 and categorized the investment as an available-for-sale security.  Wiz earned net income of $96,000 in 2002 and paid dividends of $36,000.  On January 1, 2003, Deuce bought an additional 10% of Wiz for $54,000.  This second purchase gave Deuce the ability to significantly influence the decision making of Wiz.  During 2003, Wiz earned $120,000 and paid $48,000 in dividends.  As of December 31, 2003, Wiz reported a net book value of $468,000.

    19.   On Deuce’s December 31, 2003 balance sheet, what balance was reported for the Investment in Wiz Co. account?

            A)  $139,560

            B)   $143,040

            C)   $310,130

            D)  $186,080

            E)   $182,250

    20.   What amount of equity income should Deuce have reported for 2003  ?

            A)  $30,000

            B)   $16,420

            C)   $38,340

            D)  $27,360

            E)   $32,840

    21.   In a situation where the investor exercises significant influence over the investee, which of the following entries is not actually posted to the books of the investor?

            A)  Debit to the Investment account, and a Credit to the Equity in Investee Income account.

            B)   Debit to Cash (for dividends received from the investee), and a Credit to Dividends Revenue.

            C)   Debit to Cash (for dividends received from the investee), and a Credit to the Investment account.

            D)  All of the above are posted to the investor’s books.

            E)   None of the above is posted to the investor’s books.

    22.   All of the following would require use of the equity method for investments except

            A)  material intercompany transactions.

            B)   investor participation in the policy-making process of the investee.

            C)   valuation at fair market value.

            D)  technonolgical dependency.

            E)   significant control.

    23.   All of the following statements regarding the investment account using the equity method are true except

            A)  The investment is recorded at cost.

            B)   Dividends received are reported as revenue.

            C)   Net income of investee increases the investment account.

            D)  Dividends received reduce the investment account.

            E)   Amortization of fair value over cost reduces the investment account.

    24.   A company has been using the fair-value method to account for its investment.  The company now has the ability to significantly control the investee and the equity method has been deemed appropriate.  Which of the following statements is true?

            A)  A cumulative effect change in accounting principle must occur.

            B)   A prospective change in accounting principle must occur.

            C)   A retroactive change in accounting principle must occur.

            D)  The investor will not receive future dividends from the investee.

            E)   Future dividends will continue to be recorded as revenue.

    25.   A company has been using the equity method to account for its investment.  The company sells shares and does not continue to have significant control.  Which of the following statements is true?

            A)  A cumulative effect change in accounting principle must occur.

            B)   A prospective change in accounting principle must occur.

            C)   A retroactive change in accounting principle must occur.

            D)  The investor will not receive future dividends from the investee.

            E)   Future dividends will continue to reduce the investment account.

    26.   An investee company incurs an extraordinary loss during the period.  The investor appropriately applies the equity method.  Which of the following statements is true?

            A)  Under the equity method, the investor only recognizes its share of investee’s income from continuing operations.

            B)   The extraordinary loss would reduce the value of the investment.

            C)   The extraordinary loss should be a reduction of equity in investee income.

            D)  The extraordinary loss would not appear on the income statement but would be a component of comprehensive income.

            E)   The loss would be ignored but shown in the investor’s notes to the financial statements.

    27.   How should a permanent loss in value of an investment using the equity method be treated?

            A)  The equity in investee income is reduced.

            B)   A loss is reported the same as a loss in value of other long-term assets.

            C)   The investor’s stockholders’ equity is reduced.

            D)  No adjustment is necessary.

            E)   An extraordinary loss would be reported.

    28.   Under the equity method, when the company’s share of cumulative losses equal its investment and the company has no obligation or intention to fund such additional losses, which of the following statements is true?

            A)  The investor should change to the fair-value method to account for its investment.

            B)   The investor should suspend applying the equity method until the investee reports income.

            C)   The investor should suspend applying the equity method and not record any equity in income of investee until its share of future profits is sufficient to recover losses that have not previously been recorded.

            D)  The cumulative losses should be reported as a prior period adjustment.

            E)   The investor should report these losses as extraordinary items.

    29.   When an investor sells shares of its investee company, which of the following statements is true?

            A)  A realized gain or loss is reported as the difference between selling price and original cost.

            B)   An unrealized gain or loss is reported as the difference between selling price and original cost.

            C)   A realized gain or loss is reported as the difference between selling price and carrying value.

            D)  An unrealized gain or loss is reported as the difference between selling price and carrying value.

            E)   Any gain or loss is reported as part as comprehensive income.

    30.   When applying the equity method, how is the excess of cost over book value accounted for?

            A)  The excess is allocated to the difference between fair market value and book value multiplied by the percent ownership of current assets.

            B)   The excess is allocated to the difference between fair market value and book value multiplied by the percent ownership of total assets.

            C)   The excess is allocated to the difference between fair market value and book value multiplied by the percent ownership of net assets.

            D)  The excess is allocated to goodwill.

            E)   The excess is ignored.

    31.   After allocating cost in excess of book value, which asset or liability would not be amortized over its useful life?

            A)  Cost of goods sold.

            B)   Property, plant, & equipment.

            C)   Patents.

            D)  Goodwill.

            E)   Bonds payable.

    32.   Which statement is true concerning unrealized gains in inventory transfers using the equity method?

            A)  The investee must defer upstream ending inventory profits.

            B)   The investee must defer upstream beginning inventory profits.

            C)   The investor must defer downstream ending inventory profits.

            D)  The investor must defer downstream beginning inventory profits.

            E)   The investor must defer upstream beginning inventory profits.

    33.   Which statement is true concerning unrealized gains in inventory transfers using the equity method?

            A)  The investor and investee make reciprocal entries to defer and realize inventory profits.

            B)   The same adjustments are made for upstream and downstream transfers.

            C)   Different adjustments are made for upstream and downstream transfers.

            D)  No adjustments are necessary.

            E)   None of the above.

Use the following to answer questions 34-38:

On January 1, 2003, Dawson, Incorporated, paid $100,000 for a 30% interest in Sacco Corporation.  This investee had assets with a book value of $400,000 and liabilities of $150,000.  A patent held by Sacco having a book value of $10,000 was actually worth $40,000 with a six year remaining life.  Any goodwill associated with this acquisition will not be amortized.  During 2003, Sacco reported income of $50,000 and paid dividends of $20,000 while in 2004 it reported income of $75,000 and dividends of $30,000.  Assume Dawson has the ability to significantly influence the operations of Sacco.

    34.   The amount allocated to goodwill at January 1, 2003, is

            A)  $25,000.

            B)   $13,000

            C)   $  9,000.

            D)  $16,000.

            E)   $10,000.

    35.   The equity in income of Sacco for 2003, is

            A)  $  9,000.

            B)   $13,500.

            C)   $15,000.

            D)  $  7,500.

            E)   $50,000.

    36.   The equity in income of Sacco for 2004, is

            A)  $22,500.

            B)   $21,000.

            C)   $12,000.

            D)  $13,500.

            E)   $75,000.

    37.   The balance in the investment in Sacco account at December 31, 2003, is

            A)  $100,000.

            B)   $112,000.

            C)   $106,000.

            D)  $107,500.

            E)   None of the above.

    38.   The balance in the investment in Sacco account at December 31, 2004, is

            A)  $119,500.

            B)   $125,500.

            C)   $116,500.

            D)  $118,000.

            E)   $100,000.

Use the following to answer questions 39-42:

Dodge, Incorporated acquires 15% of Gates Corporation on January 1, 2003, for $105,000 when the book value of Gates was $600,000.  During 2003 Gates reported net income of $150,000 and paid dividends of $50,000.  On January 1, 2004, Dodge purchased an additional 25% of Gates for $200,000.  Any excess cost over book value is attributable to goodwill with an indefinite life.  The fair-value method was used during 2003 but Dodge has deemed it necessary to change to the equity method after the second purchase.  During 2004 Gates reported net income of $200,000 and reported dividends of $75,000.

    39.   The equity in income of Gates for 2003 is

            A)  $    7,500.

            B)   $  22,500.

            C)   $  15,000.

            D)  $150,000.

            E)   None of the above.

    40.   The equity in income of Gates for 2004 is

            A)  $80,000.

            B)   $30,000.

            C)   $50,000.

            D)  $15,000.

            E)   None of the above.

    41.   The adjustment to change from the fair-value method to the equity method would require what adjustment?

            A)  A debit to additional paid-in capital for $15,000.

            B)   A credit to additional paid-in capital for $15,000.

            C)   A debit to retained earnings for $15,000.

            D)  A credit to retained earnings for $15,000.

            E)   A credit to a gain on investment.

    42.   The balance in the investment account at December 31, 2004, is

            A)  $370,000.

            B)   $355,000.

            C)   $305,000.

            D)  $400,000.

            E)   $105,000.

Use the following to answer questions 43-44:

Clancy Incorporated, sold $200,000 in inventory to Reid Company during 2003 for $350,000.  Reid sold $224,000 of this merchandise in 2003 with the remainder to be disposed of during 2004.  Assuming Clancy owns 30% of Reid and applies the equity method.

    43.   What journal entry will be recorded at the end of 2003 to defer the unrealized gain?

A)

Equity in income of Reid

          54,000

  Investment in Reid

    54,000

B)

Investment in Reid

          54,000

  Equity in income of Reid

    54,000

C)

Equity in income of Reid

          16,200

  Investment in Reid

    16,200

D)

Investment in Reid

          16,200

  Equity in income of Reid

    16,200

E)

No entry is necessary.

    44.   What journal entry will be recorded in 2004 to realize the gain deferred in 2003?

A)

Equity in income of Reid

          54,000

  Investment in Reid

    54,000

B)

Investment in Reid

          54,000

  Equity in income of Reid

    54,000

C)

Equity in income of Reid

          16,200

  Investment in Reid

    16,200

D)

Investment in Reid

          16,200

  Equity in income of Reid

    16,200

E)

No entry is necessary.

Use the following to answer questions 45-51:

On January 1, 2002, Mehan, Incorporated purchased 15,000 shares of Cook Company for $150,000 giving Mehan a 15% ownership of Cook.  On January 1, 2003 Mehan purchased an additional 25,000 shares (25%) of Cook for $300,000.  This last purchase gave Mehan the ability to apply significant influence over Cook.  The book value of Cook on January 1, 2002, was $1,000,000.  The book value of Cook on January 1, 2003, was $1,250,000.Any excess of cost over book value is assigned to a database and amortized over five years.

Cook reports net income and dividends as follows.  These amounts are assumed to have occurred evenly throughout the years:

Net Income

Dividends

2002

$200,000

$50,000

2003

   225,000

50,000

2004

250,000

60,000

On April 1, 2004, just after its first dividend receipt, Mehan sells 10,000 shares of its investment for $15 per share.

    45.   What is the balance in the investment account at December 31, 2002?

            A)  $150,000.

            B)   $172,500.

            C)   $180,000.

            D)  $157,500.

            E)   $170,000

    46.   How much income did Mehan report from Cook during 2002?

            A)  $30,000.

            B)   $22,500.

            C)   $  7,500.

            D)  $         0.

            E)   $50,000.

    47.   What was the balance in the investment account at December 31, 2003?

            A)  $517,500

            B)   $537,500.

            C)   $520,000.

            D)  $540,000.

            E)   $211,250.

    48.   How much income did Mehan report from Cook during 2003?

            A)  $  90,000.

            B)   $110,000.

            C)   $  67,500.

            D)  $  87,500.

            E)   $  78,750.

    49.   What was the balance in the investment account at April 1, 2004?

            A)  $516,875.

            B)   $536,500.

            C)   $558,375.

            D)  $530,250.

            E)   $558,875.

    50.   How much income did Mehan report from Cook during 2004?

            A)  $79,219.

            B)   $78,750.

            C)   $24,375.

            D)  $72,500.

            E)   $79,458.

    51.   What was the gain or loss on sale of the investment on April 1, 2004?

            A)  $10,406 gain.

            B)   $10,406 loss.

            C)   $50,000 gain.

            D)  $50,000 loss.

            E)   No gain or loss is recognized.