FAR Section 3.1

Question 1

Park Co. uses the equity method to account for its January 1, 20X3 purchase of Tun Inc.’s common stock. On January 1, 20X3, the fair values of Tun’s FIFO inventory and land exceeded their carrying amounts. How do these excesses of fair values over carrying amounts affect Park’s reported equity in Tun’s 20X3 earnings?

Answer 1

Decreases inventory excess, no effect on land excess.Similar to consolidation, under the equity method, when assets or liabilities of the investee are under- or over-valued at the acquisition date, the investor’s share of the investee’s net income is adjusted to reflect income as if the items had been reported at their fair values on the acquisition date. If the inventory had been adjusted, since the investee uses FIFO, those goods would have been sold in the following year, increasing cost of sales and decreasing earnings. Land is not depreciated and has no income statement effect unless it is impaired or disposed of.