🎯Equity Method Investment: 35 MCQs

Responses

1. 

   Rene A Baldovinos Pinto 7 June 2024

   How did the cost of shares sold was calculated specifically this calculation (20000/64000) ?

   1. 

      Maroun, CPA 9 June 2024

      Hello Rene A,

      To which question are you referring?

2. 

   lana khanou 18 June 2024

   can anyone please fix the problem for questions # 14
   how did you guys come up with this computation it should be I think 20000/160000=12.5% how did you guys get the 64,000
   Cost of shares sold = $1,728,000 × (20,000 ÷ 64,000) = $540,000
   Balance in the Investment Account = $1,728,000 − $540,000 = $1,188,000

   1. 

      Maroun, CPA 20 June 2024

      Hello Lana,

      I understand your confusion regarding the calculation for question #14. Let’s clarify why we divided by 64,000.

      Harry Company purchased 40% of the 160,000 shares of Marcus Corporation.
      This means Harry owns 40% of 160,000 shares:
      160,000 × 0.40 = 64,000 shares.

      On January 4, 20X2, Harry sold 20,000 shares.
      To find the proportion of shares sold, we use the number of shares Harry initially owned (64,000 shares).

      The proportion of shares sold is calculated as:
      20,000 / 64,000 = 31.25%

      This means Harry sold 31.25% of their investment in Marcus Corporation.

      Investment Account Before Sale:
      Initial investment: $1,600,000.
      Share of net income (40% of $450,000): $180,000.
      Share of dividends (40% of $130,000): $52,000.
      Adjusted investment account balance = $1,600,000 + $180,000 − $52,000 = $1,728,000.

      The cost of shares sold is the proportion of the investment sold multiplied by the adjusted investment account balance.
      Cost of shares sold = $1,728,000 × 20,000 / 64,000 = $1,728,000 x 31.25% = $540,000.
      ​
      Therefore, after selling 20,000 shares, the balance in the investment account is:
      $1,728,000 − $540,000 = $1,188,000.

      I hope this clarifies the computation. If you have any further questions, feel free to ask!

3. 

   James Schwartz 10 August 2024

   Math on question #6 is incorrect. $900 + 96 = $996 not $966

   1. 

      Maroun, CPA 14 August 2024

      Hello James,

      It looks like you missed accounting for the reduction of the investment due to the dividends received of $30,000 ($75,000 * 40%).

      Here’s how the Investment balance was computed:

      Initial Investment: $900,000
      + Spinnaker’s share of Wilson’s net income: $96,000
      – Spinnaker’s share of Wilson’s dividends: ($30,000)

      Balance of the Investment account = $900,000 + $96,000 – $30,000 = $966,000

      I hope this makes sense. If you have any further questions, please let me know!

4. 

   Adam Van Cleve 13 August 2024

   I do not understand what question 9 is asking. What is “equity in income of Keener”?

   1. 

      Maroun, CPA 14 August 2024

      Hello Adam,

      Under the equity method, the investor (in this case, Elberon Incorporated) recognizes its share of the investee’s (Keener’s) net income or loss in its own financial statements. This share is referred to as the “equity in income of Keener.” Simply put, it’s the investment income recognized on the income statement.

      I hope this makes sense! If you have any further questions, please let me know!

5. 

   pooja shaw 16 August 2024

   WHY are we again deducting 50,000. I mean where in the question asks us to amortize the investment for 20X0?

   1. 

      Maroun, CPA 18 August 2024

      Hello Pooja,

      Under the equity method of accounting, when there’s an excess cost attributed to identifiable intangible assets (like patents), that cost needs to be amortized over the asset’s useful life.
      When Newton purchased 30% of Fleming Co., the price paid exceeded Newton’s share of Fleming’s book value. This excess of $500,000 was attributed to unrecorded patents, which have a useful life of 10 years.
      Since the question covers two years (20X0 and 20X1), the $50,000 annual amortization is deducted for each year, reducing the investment account by $50,000 in 20X0 and another $50,000 in 20X1.

      I hope this makes sense!

6. 

   Paridhi Jaiswal 3 February 2025

   MCQ #9 ,Why we did below calculation

   20X0 Excess Patent Amortization ($400,000 – $100,000 = $300,000 ÷5 years= $60,000 × 30% ownership) of $18,000. Instead of

   Investee book value of $5,500,000 and liabilities of $3,000,000 = 2500000 * 30% = 750000
   Consideration paid for 30% interest = 1000000
   Less : excess 750000
   = 250000 amortized over 5 years = 50000

   Although My answer were right, as by deduction 50000 patent expense, calculated answer was not in option , so I did other calculation and deduct $18000 and get correct answer but I do not understand the concept behind it.

   Would you please explain it?
   Thanks in advance.

   1. 

      Maroun, CPA 7 February 2025

      Hello Paridhi,

      You initially tried to amortize the entire $250,000 excess over 5 years.
      However, this approach assumes that all of the excess is attributable to amortizable assets, which is not correct.

      Since we are explicitly given that the only identified undervalued asset is the patent, we allocate the excess to the patent first (300,000 x 30% = 90,000) and only amortize that portion. Any remaining excess (250,000 – 90,000 = 160,000) is attributed to goodwill, which is not amortized under U.S. GAAP. As mentioned in the question, any goodwill associated with this acquisition is considered to have an indefinite life.

      That’s why we only deducted the $18,000 amortization for the patent and not the entire $50,000.

      I hope this helps!

7. 

   Paridhi Jaiswal 3 February 2025

   MCQ 16 , Option II states that “The amortization of the undervalued assets related to the investment’s acquisition” correct Statement

   As per my understanding , we amortize excess of fair value of net asset and investee Net BV , Only depreciable asset are subject to amortize. Only then , Investment account will decrease by amortize amount

   In option II , Nothing is specified regarding depreciable asset , so we Implied it.

   Is it correct to assume that, those undervalued asset subject to depreciation or Am i missing something?
   Please Clarify. Thanks in advance!

   1. 

      Maroun, CPA 7 February 2025

      Hello Paridhi,

      You are absolutely right to ask for clarification. Only depreciable or amortizable assets (such as PP&E and finite-life intangibles) are subject to amortization under the equity method. To avoid ambiguity, I have updated the answer choice to specify depreciable or amortizable assets instead of just “undervalued assets.”

      Thank you for pointing this out, and keep up the great work!

8. 

   Mekdes 22 April 2025

   Quiz # 6 – Can you please look into the question #6 and the given answer. The answer seems to have different figures. (It seems the answer is for the Equity method lesson video #2?)

   1. 

      Maroun, CPA 24 April 2025

      Hello Mekdes,

      I’ve updated the answer choices and explanation.
      Thank you for bringing this to our attention!

9. 

   Lei Yan 4 May 2025

   for question 24, can you explain more what this equation means? Unrealized profit in 20X1 = ( $20,000 / $80,000 ) × ( $80,000 – $30,000) = $12,500, I don’t understand what is the meaning of 20k / 80k.

   1. 

      Maroun, CPA 7 May 2025

      Hello Lei,

      Think of the $80,000 as the whole batch of inventory Eric sold to Jones in 20X1.
      At year-end, Jones is still sitting on inventory that cost it $20,000 (at Eric’s transfer price).

      • Why 20,000 ÷ 80,000?

      It tells us what fraction of that original batch is still unsold to outsiders.

      $20,000 ÷ $80,000 = 0.25, so 25 % of the goods are still on Jones’s shelves.

      • Applying that fraction to the intercompany profit:

      Total intercompany profit on the batch = Transfer price – Eric’s cost
      = $80,000 – $30,000 = $50,000.

      Unrealized profit still “trapped” in ending inventory = 25 % × $50,000 = $12,500.

      Until Jones sells those goods to an outside customer, the group hasn’t truly earned that $12,500, so Jones must defer its share (40%) of it, which is $5,000.

      I hope this helps!

10. 

    Zahra Talha 17 June 2025

    MCQ #5

    The question is asking for the investment balance for 20X0 but the working is showing answer for 20X2.

    Kindly provide clarification

    1. 

       Maroun, CPA 19 June 2025

       Hello Zahra,

       There is a typo in the explanation. The year should be 20X0, but otherwise the solution is correct.
       I’ve corrected the typo. Thank you for bringing this to our attention!

11. 

    Justin 13 July 2025

    For question 5, why is the excess patent amortization subtracted to get the equity income but the dividends are not subtracted? Why isn’t the equity income 72,000 ? (150,000 – 60,000 – 18,000)

    1. 

       Maroun, CPA 15 July 2025

       Hello Justin,

       When the investee company earns net income, the investor immediately recognizes its proportionate share of that net income as “equity income.” This recognition increases the investment’s book value, reflecting the investor’s claim on the investee’s profits.

       Later, when the investee pays dividends, it distributes part of its earnings already recognized by the investor as equity income. Thus, dividends under the equity method are viewed as a distribution (or return) of previously recognized earnings, rather than a new expense or reduction of the current year’s income.

       To illustrate this clearly:
       1. When the investee reports net income, the investor immediately books a portion of that income, increasing the investment account and recognizing equity income:

       Entry:
       Dr. Investment Account
       Cr. Equity Income

       2. Subsequently, when dividends are received, they are considered a distribution from earnings previously recognized, not a deduction of current income. Hence, the dividend reduces the investor’s “Investment” account directly, not equity income:

       Entry:
       Dr. Cash
       Cr. Investment Account

       Why dividends aren’t considered an expense:
       Expenses are charges against income related to generating revenue. Dividends do not represent a cost of generating revenue for the investee or the investor. Instead, they represent a distribution of earnings, i.e., sharing profits already recognized. Thus, dividends never appear on the income statement as an expense under the equity method.

       On the other hand, the excess patent amortization reduces your equity income because it represents an additional expense related to your initial investment. Essentially, you paid extra for the patent’s higher value, and since this excess value diminishes over time, you’re gradually losing part of your initial investment.

       By contrast, when you receive dividends, you’re not losing any value. You’re simply receiving cash distributions from earnings you already recognized.

       I hope this makes sense!

12. 

    JOHN FLOOD 9 December 2025

    Question #19. I chose answer D. When the company switches from the Fair Value Method ( 18% of outstanding common stock) to the Equity Method ( 36 % with significant influence), the Investment should be adjusted to fair value. I understand the method is prospective and should not change previous years; however, there still should be some adjustments. The principle should align with Question # 4.

    1. 

       Maroun, CPA 10 December 2025

       Hello John,

       You’re right that when we move from fair value to the equity method we start from fair value on the date we gain significant influence. That’s exactly what Question 4 is doing:
       – At 12/31/X5 the 15% investment is already carried at fair value = $90,000 (because the fair-value method was used).
       – On 1/3/X6 the company buys another 10% for $60,000.
       – The starting equity-method basis on that date is simply:
       existing investment at FV ($90,000) + cost of new shares ($60,000) = $150,000.
       That is not a prior-period adjustment; it’s just the carrying amount on the day we switch methods.
       From that point forward we apply the equity method prospectively (add share of income, subtract dividends).

       In Question 19 the exam isn’t asking for dollar amounts, only for how to treat prior years. GAAP says:
       – Before significant influence: fair-value method was correct, so we leave 20X2–20X3 as they are.
       – Once significant influence is obtained: we start using the equity method prospectively; we do not restate prior years and we do not record a prior-period adjustment.

       Thus, conceptually Question 4 and Question 19 are consistent:
       – Start equity method from the date significant influence is obtained, using the then-current carrying value (which already equals fair value under the old method),
       – No restatement and no prior-period adjustment → that’s why the correct answer to Question 19 is A, not D.

       I hope this makes sense!

13. 

    Adrian Singh 9 March 2026

    Q16. Keener is the investee. Why the calculation is done as investor?
    Why divendend is not deducted?

    1. 

       Maroun, CPA 10 March 2026

       Hello Adrian,

       The calculation is being done from Elberon’s perspective because “equity in income of Keener” means the income Elberon recognizes from its investment in Keener under the equity method.

       Keener is the investee.
       Elberon is the investor.

       Thus, under the equity method, Elberon records:
       • its share of Keener’s net income, and
       • then adjusts for any basis difference amortization (here, the patent step-up).

       That is why the computation is:

       Elberon’s share of Keener’s 20X2 income: 30% × $500,000 = $150,000
       Less Elberon’s share of excess patent amortization:
       (400,000 − 100,000) ÷ 5 = 60,000 per year

       Elberon’s 30% share = $18,000

       Thus, equity in income = $150,000 − $18,000 = $132,000

       Regarding the dividends: they are not deducted from equity income because, under the equity method, dividends are treated as a return of investment, not income.

       Elberon’s share of dividends = 30% × $200,000 = $60,000

       The dividend entry would be:
       Dr Cash $60,000
       Cr Investment in Keener $60,000

       This reduces the investment account, but it does not reduce the “equity in income” account.

       Hope this makes sense!

14. 

    Justin Pillion 17 April 2026

    Q8 says the investment income is not effected by the excess amortization, but in Q7, the answer includes investment income being decreased by excess amortization. Wouldn’t decreasing by excess amortization constitute an “effect” on the investment income? Making these the answers to both 7 and 8 contradictory?

    1. 

       Maroun, CPA 19 April 2026

       Hi Justin,

       Your fundamental understanding of the equity method is 100% correct: amortization of the excess fair value DOES decrease investment income. So why is Question 8 marked as “None of the above”? It all comes down to one sneaky word in the answer choice: Total.

       Take a close look at how the two options are phrased:
       • Question 7 (Correctly decreases income): Amortization of the excess fair value… related to the investment’s acquisition.
       • Question 8 (Does NOT decrease income): Amortization of the difference between fair value and book value of the investee’s TOTAL assets.

       Under the equity method, you only own a percentage of the company (usually 20% to 50%). Therefore, you only amortize the FV/BV difference for your specific percentage of ownership (the investment’s acquisition share). You do not amortize the difference for the investee’s total (100%) assets.

       Question 8 is a classic exam trick testing whether you will read past the word “total.” If Option II in Question 8 had said “the investor’s share of the assets,” you would be absolutely right—it would have affected the investment income.

       Hope this makes sense!