Collins, Inc., purchased 10 percent of Merton Corporation on January 1, 2010, for $345,000 and classified the investment as an available-for-sale security. Collins acquires an additional 15 percent of Merton on January 1, 2011, for $580,000. The equity method of accounting is now appropriate for this investment. No intra-entity sales have occurred.
a. How does Collins initially determine the income to be reported in 2010 in connection with its ownership of Merton?
b. What factors should have influenced Collins in its decision to apply the equity method in 2011?
c. What factors could have prevented Collins from adopting the equity method after this second purchase?
d. What is the objective of the equity method of accounting?
e. What criticisms have been leveled at the equity method?
f. In comparative statements for 2010 and 2011, how would Collins determine the income to be reported in 2010 in connection with its ownership of Merton? Why is this accounting appropriate?
g. How is the allocation of Collins's acquisition made?
h. If Merton pays a cash dividend, what impact does it have on Collins's financial records under the equity method? Why is this accounting appropriate?
i. On financial statements for 2011, what amounts are included in Collins's Investment in Merton account? What amounts are included in Collins's Equity in Income of Merton account?