Question & Answer: Several years ago, Einstein, Inc., bought 40 percent of the outstanding voting stock of Brooks Company. The equity m…..

24. Several years ago, Einstein, Inc., bought 40 percent of the outstanding voting stock of Brooks Company. The equity method is appropriately applied. On August 1 of the current year, Einstein sold a portion of these shares.
a. How does Einstein compute the book value of this investment on August 1 to determine its gain or loss on the sale?
b. How should Einstein account for this investment after August 1?
c. If Einstein retains only a 2 percent interest in Brooks so that it holds virtually no influence over Brooks, what figures appear in the investor’s income statement for the current year?
d. If Einstein retains only a 2 percent interest in Brooks so that virtually no influence is held, does the investor have to retroactively adjust any previously reported figures?

Expert Answer

 

a. How does Einstein compute the book value of this investment on August 1 to determine its gain or loss on the sale?

Answer: Computation has to be done as below:

Book value = Beginning of the year balance + Percentage of net income or net loss – dividends received

 

b. How should Einstein account for this investment after August 1?

Answer: In case the investment doesn’t drop below 20% continue to use Equity method, however if it falls below 20% then switch to fair value method, based on the remaining percentage of ownership

 

c. If Einstein retains only a 2 percent interest in Brooks so that it holds virtually no influence over Brooks, what figures appear in the investor’s income statement for the current year?

Answer:

— Dividend Income for dividends received after August 1

— Equity in Earnings to 1 Aug

— Gain/Loss on 1 Aug sale

 

d. If Einstein retains only a 2 percent interest in Brooks so that virtually no influence is held, does the investor have to retroactively adjust any previously reported figures?

Answer: No, the investor does not have to retroactively adjust any previously reported figures

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