CFA Practice Question

There are 334 practice questions for this study session.

CFA Practice Question

On January 2, 2011, Germane, Inc. bought 30% of the outstanding common stock of Quality, Inc. for $56 million cash. At the date of acquisition of the stock, Quality's net assets had a book value and fair value of $120 million. Quality's net income for the year ended December 31, 2011, was $30 million. During 2011, Quality declared and paid cash dividends of $10 million. On December 31, 2011, Germane should report investment revenue of:

A. $3 million.
B. $9 million.
C. $30 million.
Correct Answer: B

30% x $30 million.

User Contributed Comments 16

User Comment
nina1 Why 30% of dividents paid are not subtracted. It would be 6 mln.instead of 9.

.....

I think I may know the answer. We subract div. paid in proportional consolidation not equity method. In equity we reduce inestment account by div. paid. Somebody confirm or reject,please.
Nancie I thought the answer was A: $9m is in the investment account (balance sheet), and 3m should be the revenue (income statement), but later on will be a deduction of investment account. Someone further clarify? thanks.
katybo Investor must report proportionate share of net assets and share of income whether it is received as a dividend or is reinvested.
juansaez Investment Revenue: 9 m. Investment: 56.m+6.m (9 - 3)
yly14 equity methods investment a/c is increased by the proportional income and decreased by proportional div, not investment revenue.
noonah Dividends are used in the investment account in the balance sheet, they do not appear in the income statement. Only the proportionate amount of income from investee appears in the income statement, as equity income.
actiger I thought the answer was A too... but I guess the investment revenue and the investment account are the two separate items...
vi2009 I'm unclear about this too .. so I check with the curriculum (p15)
Subsequent periods, equity investment is adjusted as such:
Investment account = Initial investment + (% of investment )* [Investment revenue (Net income) - Dividend]
Dividends / other distributions constitute a return of capital and thus reduce the carrying amount of investment (therefore subtract).
Equity Income (e.g5 p23) .. this is clearer as it includes several other articles .. but the essence is equity income excludes dividends as dividend is not considered an income from the equity investment.
jansen1979 investment income is the proportionate (30%) share in the earnings.
Dividends are subtracted from the fair book value on the balance sheet.
jpducros The dividend flows from the subsidiary to the mother company, so the value of the subsidiary (Shares in the assets of the mother cy) goes down and the cash of the mother company goes up. No impact in income statement. The only impact in the income statement is the share of net result in the subsidiary.
joywind dividends received are not counted in investment value appreciation which is "equity investment" in I/S but still counted as investment revenue as return of the investment.
papajohn Investment revenue, not investment income
quanttrader equity method: investment revenue = %owned x revenue of company acquired
jasonkwk1 you need to deduct the dividend only when you are starting the investment amount in the balance sheet.
mtsimone The question about Revenue not Value:
Equity Method:
IS: % Share of Earnings

BS: Price + Prior Yr Value + % Share of Income - % Share Dividends =
Year End Single Line Equity
Felio The answer B (9 million = 0.3*30 million) is correct. Dividend SHOULD NOT be deducted. The question is about what Germane. Inc. (the investor) will report on its income statement as earning gained from the investment in Quality. Inc. (the investee). It is not neither about the investment value the investor will report; nor about the adjustment being made to the carrying value of the investment. Under the equity method, Germane. Inc must report separately 2 things:

1 - its share of earning (%ownership * net income of the investee) on the income statement. Dividend and other distributions ARE NOT included in the share of earning reported on the I.S. They are instead treated as return on the investor's investment capital; and therefore are used to reduce the carrying value of the investment reported on the B.S.

2- The value of the investment on the balance sheet: At cost for the year (56 millions in this case); and then at Carrying value + %(post acquisition net income) - % (dividend received) in the subsequent year.

I hope it helps.
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