Chapter 2

Case 2-2
In this case, students are asked to, in effect, assume the role of a consultant and advise
Cornwall Autobody Inc. (CAI) how it should report its investment representing 33% of the
common shares of Floyd’s Specialty Foods Inc. (FSFI).

Accountant #1 suggests that the cost method is appropriate because it is really just a loan. This
might have some validity because Floyd’s friend Connelly certainly seems to have come to his
rescue. However, Connelly’s company did buy shares, and there is no evidence that they can or
will be redeemed by FSFI at some future date. An investment in shares is not a loan, which
would have to be reported as some sort of receivable. While knowledge of the business or the
ability to manage it such as might be seen in the exchange of management personnel or
technology, might be indicators that significant influence exists and can be asserted, the
absence of knowledge of the business and ability to manage do not necessarily mean that there
cannot be significant influence. They are not requirements for the use of an alternative such as
the cost method.

Accountant #2 feels that the equity method is the one to use simply because the ownership
percentage is over 20%. This number is a quantitative guideline only and whether an investment
provides the investee with significant influence over the investee or not depends on facts other
than the ownership percentage. For significant influence, the ability to influence the strategic
operating and investing policies has to be present. Representation on the board of directors
would be evidence of such ability. There is no evidence of board membership.

Accountant # 3 also suggests the equity method saying that 33% ownership gives them the
ability to exert significant influence. Whether they exert it or not doesn’t matter. This part is
correct; you do not have to actually exert it. However, owning 33% does not necessarily mean
that you possess this ability. Mr. Floyd was the sole shareholder of FSFI before CAI’s
investment, and we have no knowledge that he has relinquished some of this control to
Connelly in return for his bail out.

The circumstances would seem to rule out the three possibilities presented by the accountants.
The investment should be reported at fair value. The only choice (and it is a choice) is whether
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Solutions Manual, Chapter 2 1
to report the unrealized gains in net income or other comprehensive income. More information
is needed to determine whether CAI has other similar investments and what its preference is
with respect to the reporting of this type of investment.

Problem 2-1
Part A

Investment Account

January 1, Year 5 $650,000

Plus:
Carter’s Year 5 profit $95,000
Anderson’s percentage ownership 20% 19,000

Less:
Dividends $60,000
20% (12,000)
December 31, Year 5 657,000

Plus:
Carter’s Year 6 profit $105,000
Anderson’s percentage ownership 20% 21,000

Less:
Dividends $60,000
20% (12,000)
December 31, Year 6 $666,000

Part B
(a) Investment in Carter 34,000
Unrealized gain on FVTPL investment 34,000
(20,000 shares x 35 – 666,000)

(b) Cash (50,000 x 20%) 10,000

Dividend income 10,000
Record dividend revenue for Anderson’s share of dividends declared and paid by Carter

Cash (20,000 shares x 37) 740,000

Investment in Carter 700,000
Gain on sale 40,000
Sale of investment in Carter

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2 Modern Advanced Accounting in Canada, Eighth Edition
Problem 2-4
Part (a) Equity method

(i) Investment in Saltspring 285,000

Cash 285,000
To record 30% investment in Saltspring

Cash (30% x 110,000) 33,000

Investment in Saltspring 33,000
Dividends received

Investment in Saltspring (30% x 306,000) 91,800

Equity method loss – discontinued operations (30% x 33,000) 9,900
Equity method income (30% x 339,000) 101,700
To record 30% of Saltspring’s profit and discontinued operations

(ii) Investment cost Jan. 1, Year 6 $285,000

Dividends received (33,000)
Share of income 91,800
Investment account Dec. 31, Year 6 $343,800

(iii)
Pender Corp
Statement of Operations
Year ended December 31, Year 6

Sales $990,000
Equity method income 101,700
1,091,700
Operating expenses (110,000)
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Solutions Manual, Chapter 2 3
Income before income tax 981,700
Income tax expense (352,000)
Net income before discontinued operations 629,700
Disc. Operations – Equity method loss (9,900)
Profit $619,800

Part (b) Cost method

(i) Investment in Saltspring 285,000

Cash 285,000
To record 30% investment in Saltspring

Cash 33,000
Dividend income 33,000
Dividends received

(ii) Investment account balance December 31, Year 6 $285,000

(iii)
Pender Corp
Statement of Operations
Year ended December 31, Year 6
Sales $990,000
Dividend income 33,000
1,023,000
Operating expenses (110,000)
Income before income tax 913,000

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4 Modern Advanced Accounting in Canada, Eighth Edition
Income tax expense (352,000)
Profit $561,000

Part (c)

Pender would want to use the equity method if its bias were to show the highest return on
investment since the equity method takes into account the full increase in value of the investee
(i.e. recognizes proportion of income earned for the year) whereas the cost method only
recognizes income to the extent of dividends received.

Cost method return on investment = $33,000/ $285,000 = 11.58%

Equity method return on investment = ($101,700 - $9,900)/ $285,000 = 32.21%

Problem 2-5
(a)
(i) 22,000 shares x $20 $440,000
(ii) Original cost $374,000
Share of income (20% x (220,000 + 247,500)) 93,500
Less: share of dividends (20% x (165,000 + 176,000)) (68,200)
$399,300
(iii) 22,000 shares x $20 $440,000

(b)
(i) Year 4 Year 5 Year 6 Total
Dividend income (1) $33,000 $35,200 $38,500 $106,700
Unrealized gains (2) 22,000 44,000 0 66,000
Gain on sale (2) 0 0 66,000 66,000
Net income $55,000 $79,200 $104,500 $238,700
Total OCI 0 0 0 0

(ii) Year 4 Year 5 Year 6 Total

Equity income (3) $44,000 $49,500 $52,800 $146,300
Gain on sale (4) 0 0 92,400 92,400
Net income $44,000 $49,500 $145,200 $238,700
Total OCI (4) 0 0 0 0
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Solutions Manual, Chapter 2 5
(iii) Year 4 Year 5 Year 6 Total
Dividend income (1) $33,000 $35,200 $38,500 $106,700
Gain on sale 0 0 0 0
Net income $33,000 $35,200 $38,500 $106,700
Other comprehensive income
Unrealized gain (2) $22,000 $44,000 $66,000
Gain on sale (5) 0 0 $66,000 66,000
Total other comprehensive income 22,000 44,000 66,000 132,000
Comprehensive income $55,000 $79,200 $104,500 $238,700

Notes:
1. 20% x Dividends paid during year
2. 22,000 Shares x change in share price during year
3. 20% x Net income for the year
4. $506,000 – [$374,000 + ($44,000 + $49,500 + $52,800) – ($33,000 + $35,200 +
$38,500)] = $92,400
5. 22,000 Shares x $23 – 22,000 shares x $20 = $66,000

(c) The total comprehensive income over the three-year period in total is the same for all three
situations. However, the split between net income and OCI is not the same in total for the three
situations. This is not unusual in accounting. Although the different methods report different
income each year, in the long run, the total income is the same under all methods. The total
income is usually equal to the difference between cash received and cash paid over the life of
the investment which is $238,700 calculated as follows:

Cash received
Proceeds from sale $506,000
Dividends received (33,000 + 35,200 + 38,500) 106,700
Total proceeds 612,700
Cash disbursed
Cost of investment 374,000
Change in cash $238,700

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6 Modern Advanced Accounting in Canada, Eighth Edition