At a total cost of $2,000,000, Stieg Corporation acquired 160,000 shares of Larson Corp. common stock

At a total cost of $2,000,000, Stieg Corporation acquired 160,000 shares of Larson Corp. common stock as a long-term investment. Stieg Corporation uses the equity method of accounting for this investment. Larson Corp. has 400,000 shares of common stock outstanding, including the shares acquired by Stieg Corporation.

a. Journalize the entries by Stieg Corporation to record the following information:

1. Larson Corp. reports net income of $1,200,000 for the current period.

2. A cash dividend of $2.00 per common share is paid by Larson Corp. during the current period.

b. Why is the equity method appropriate for the Larson Corp. investment?


Answer:

a. 1. Investment in Larson Corp. Stock 480,000
Income of Larson Corp. 480,000
Record 40% share of Larson Corp.
net income, $1,200,000 × (160,000 shares ÷
400,000 shares).
2. Cash* 320,000
Investment in Larson Corp. Stock 320,000
*160,000 shares × $2.00

b. Stieg’s investment in Larson Corp. represents 40% of the outstanding shares
of Larson Corp. An investment amount between 20% and 50% of the outstanding
common stock of the investee is presumed to represent significant influence. The
equity method is appropriate when the investor can exercise significant influence
over the investee.