On January 6, 2014, Bulldog Co. purchased 34% of the outstanding stock of Gator Co. for $212,000.

On January 6, 2014, Bulldog Co. purchased 34% of the outstanding stock of Gator Co. for $212,000. Gator Co. paid total dividends of $24,000 to all shareholders on June 30. Gator had a net loss of $56,000 for 2014.

a. Journalize Bulldog’s purchase of the stock, receipt of the dividends, and the adjusting entry for the equity loss in Gator Co. stock.

b. Compute the balance of Investment in Gator Co. Stock on December 31, 2014.

c. How does valuing an investment under the equity method differ from valuing an investment at fair value?


Answer:

2014
a. Jan. 6 Investment in Gator Co. Stock 212,000
Cash 212,000
June 30 Cash* 8,160
Investment in Gator Co. Stock 8,160
*$24,000 × 34%
Dec. 31 Loss of Gator Co. 19,040
Investment in Gator Co. Stock 19,040
Record 34% share of Gator Co.
net loss, $56,000 × 34%.

b. Initial acquisition cost ................................................................................. $212,000
Equity loss for 2014..................................................................................... (19,040)
Cash dividends received............................................................................. (8,160)
Investment in Gator Co. Stock balance, December 31, 2014................. $184,800




c. Under the equity method, the investor will record their proportionate share of the net increase (or decrease) of the book value of the investee resulting from earnings and dividend distributions. The fair value method uses market price information to value the investment in the investee. These two methods result in different valuations because the equity method is based upon book accounting, while the fair value approach uses market information. The two methods need not be related to each other over time. While changes in book value can influence market prices, many other variables can influence the market price of a stock.