E$2-1$ Multiple$-$Choice Questions on Use of Cost and Equity Methods $[$AICPA Adapted$]$

Select the correct answer for each of the following questions.

$1.$ Peel Company received a cash dividend from a common stock investment. Should Peel

report an increase in the investment account if it uses the cost method or equity method of

accounting?

Cost Equity

a$.$ No No

b$.$ Yes Yes

c$.$ Yes No

d$.$ No Yes

$2.$ In $20$X$0,$ Neil Company held the following investments in common stock:

$25,000$ shares of B&K Inc.$$s $100,000$ outstanding shares. Neil$$s level of ownership gives it

the ability to exercise significant influence over the financial and operating policies of B&K$.$

$6,000$ shares of Amal Corporation$$s $309,000$ outstanding shares.

During $20$X$0,$ Neil received the following distributions from its common stock investments:

November $6$ $$30,000$ cash dividend from B&K

November $11$ $$1,500$ cash dividend from Amal

December $263$ percent common stock dividend from Amal

The closing price of this stock was $$115$ per share.

What amount of dividend revenue should Neil report for $20$X$0?$

a$.$ $$1,500.$

b$.$ $$4,200.$

c$.$ $$31,500.$

d$.$ $$34,200.$

$3.$ An investor uses the equity method to account for an investment in common stock. Assume that

$(1)$ the investor owns more than $50$ percent of the outstanding common stock of the investee,

$(2)$ the investee company reports net income and declares dividends during the year, and $(3)$ the

investee$$s net income is more than the dividends it declares. How would the investor$$s invest

ment in the common stock of the investee company under the equity method differ at year$-$end

from what it would have been if the investor had accounted for the investment under the cost

method?

a$.$ The balance under the equity method is higher than it would have been under the cost

method.

b$.$ The balance under the equity method is lower than it would have been under the cost method.

c$.$ The balance under the equity method is higher than it would have been under the cost

method, but only if the investee company actually paid the dividends before year$-$end.

d$.$ The balance under the equity method is lower than it would have been under the cost method,

but only if the investee company actually paid the dividends before year$-$end.

$4.$ A corporation exercises significant influence over an affiliate in which it holds a $40$ percent

common stock interest. If its affiliate completed a fiscal year profitably but paid no dividends,

how would this affect the investor corporation?

a$.$ Result in an increased current ratio.

b$.$ Result in increased earnings per share.

c$.$ Increase asset turnover ratios.

d$.$ Decrease book value per share.

$88$ Chapter $2$ Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

$5.$ An investor in common stock received dividends in excess of the investor$$s share of investee$$s

earnings subsequent to the date of the investment. How will the investor$$s investment account

be affected by those dividends under each of the following methods?

Cost Method Equity Method

a$.$ No effect No effect

b$.$ Decrease No effect

c$.$ No effect Decrease

d$.$ Decrease Decrease

$6.$ An investor uses the cost method to account for an investment in common stock. A portion of

the dividends received this year was in excess of the investor$$s share of the investee$$s earnings

subsequent to the date of investment. The amount of dividend revenue that should be reported

in the investor$$s income statement for this year would be

a$.$ Zero.

b$.$ The total amount of dividends received this year.

c$.$ The portion of the dividends received this year that was in excess of the investor$$s share of

investee$$s earnings subsequent to the date of investment.

d$.$ The portion of the dividends received this year that was not in excess of the investor$$s share of

the investee$$s earnings subsequent to the date of investment.