Calculating income, etc., under fair value method vs equity method

Question

On January 1, Barnyard Corporation acquired common stock of Fresh Hay Corporation. At the time of acquisition, the book value and the fair value of Fresh Hay Corporation’s net assets were $1 billion. During the year, Fresh Hay Corporation reported net income of $480 million and declared dividends of $160 million. The fair value of the shares increased by 10 percent during the year.

How much income would Barnyard Corporation report for the year related to its investment under the assumption that it:

A. Paid $150 million for 15 percent of the common stock and uses the fair value method to account for its investment in Fresh Hay Corporation?

and

B. Paid $300 million for 30 percent of the common stock and uses the equity method to account for its investment in Fresh Hay Corporation?

Answer 1

A.

Dividend Revenue  (160 million x .15)     $24 million

Unrealized Gain      (150 million x .10)     15 million

                                                                 $39 million

Total Income Barnyard Corporation would report for the year related to its investment using the fair value method is $39 million

B.

Proportionate Share

 Of Net Income       (480 million x .30)     $144 million

Total Income Barnyard Corporation would report for the year related to its investment using the equity method is $144 million     

Answer 2

A. If Barnyard Corporation paid $150 million for 15 percent of the common stock of Fresh Hay Corporation and uses the fair value method to account for its investment, we need to determine the fair value of the investment at the end of the year.

The fair value of the investment at the time of acquisition was $1 billion, and it increased by 10 percent during the year. Therefore, the fair value of the investment at the end of the year would be:

Fair value at the end of the year = Fair value at the time of acquisition + (Fair value at the time of acquisition * Increase in fair value)

= $1 billion + ($1 billion * 0.10)

= $1 billion + $100 million

= $1.1 billion

Since Barnyard Corporation owns 15 percent of the common stock, its share of the fair value of the investment at the end of the year would be:

Share of fair value = Fair value at the end of the year * Ownership percentage

= $1.1 billion * 0.15

= $165 million

Therefore, Barnyard Corporation would report $165 million as its income for the year related to its investment using the fair value method.

B. If Barnyard Corporation paid $300 million for 30 percent of the common stock of Fresh Hay Corporation and uses the equity method to account for its investment, we need to calculate Barnyard Corporation's share of Fresh Hay Corporation's net income for the year.

Fresh Hay Corporation reported net income of $480 million for the year. Since Barnyard Corporation owns 30 percent of the common stock, its share of the net income would be:

Share of net income = Net income of Fresh Hay Corporation * Ownership percentage

= $480 million * 0.30

= $144 million

Therefore, Barnyard Corporation would report $144 million as its income for the year related to its investment using the equity method.