Required:
(a) What method of accounting would you recommend Magno Industries use for its investment in Grille-to-Bumper Automotive common shares? As part of your answer, discuss the alternatives available.
(b) Why would the management of Magno want to use the equity method to account for the investment, as compared with other alternatives that you have discussed?
(c) Are there any circumstances under which the method you have recommended might have to be changed? If so, how would Magno Industries account for such a change?
Magno Industries Ltd., a public company, is a major supplier to the automotive replacement-parts market, selling parts to nearly every segment of the industry.
Magno has a September 30 year-end.
During January Year 5, Magno acquired a 13% interest in the common shares of Grille-to-Bumper Automotive Stores, and in June Year 5 it acquired an additional 15%. Grille-to-Bumper is a retail chain of company-owned automotive replacement parts stores operating in most Canadian provinces. Its shares are not traded in an active market. Grille-to-Bumper has a December 31 year-end and, despite being profitable each year for the last 10 years, has never paid a dividend. While Magno occasionally makes sales to Grille-to-Bumper, it has never been one of its major suppliers.
After the second acquisition of Grille-to-Bumper's shares, Magno Indus tries contacted Grille-to-Bumper to obtain certain financial information and to discuss mutual timing problems with respect to financial reporting. In the initial contact, Magno found Grille-to-Bumper to be uncooperative. In addition,
Grille-to-Bumper accused Magno of attempting to take it over. Magno replied that it had no intention of attempting to gain control but rather was interested only in making a sound long-term investment. Grille-to-Bumper was not impressed with this explanation and refused to have any further discussions regarding future information exchanges and the problems created by a difference in year-ends.
At the year-end of September 30, Year 5, Magno's management expressed a desire to use the equity method to account for its investment.