On January 1, 20X8, Parker Inc. acquired 30% of Smith Inc.'s outstanding common stock for $400,000.  During 20X8, Smith had net income of $100,000 and paid dividends of $30,000.  On January 1, 20X9, Parker acquired an additional 45% interest on Smith for $1,012,000.  The fair value of Smith on January 1, 20X9 was $2,250,000.  What amount of gain from this transaction will Parker record in 20X9?
a.$0 b.$254,000 c.$275,000 d.$675,000

Answer is b

Can anyone help me understand this question as to how did they calculate the 254000 number?

What answer are you coming up with?  Because I'm getting close but not on the penny.

1/1/08  Purchase 30% for $400,000

12/31/08 Add 30% of Income (30,000) and subtract 30% of Dividends (9,000) 

This values their investment at $421,000 on 12/31/08 for 30%.

If they purchase another 45% on 1/1/09 for $1,012,000.  Wouldn't you add their prior balance of $421,000 to $1,012,000 for a total investment of $1,433,000.  75% of $2,250,000 is $1,687,500.  Subtract their investment of $1,433,000 from the fair value gives you a gain of $254,500.

I'm as lost as you are!

The initial investment is 30% at $400,000. Therefore, you use the equity method to account for the investment. In 2008, the following changes occur to the investment account:

Net Income: $100,000 x 30% ownership = +$30,0000

Dividends: $30,000 x 30% ownership = -$9,000

So, the investment account now stands at $421,000 (400+30-9)

When the purchase of the additional investment takes place, there is no gain or loss on the actual purchase. The gain comes from the revaluation of the original investment amount.

Value of Company at 2009 purchase: $2,250,000

Implied Value of original 30% ownership stake = (2,250,000 x 30%) = $675,000

Gain: New Value - Carrying Value of Investment = (675000-421000) = $254,000

Thank you Bird for making the question so simple.

I see your FAR score and I am awestruck. Not even in my dreams can i ever get to that point.

Mind if I ask, which review course did you take?

98 is an unbelieveable number. Congratulations!

None the less, you are very good at the subject. Wow!

thanks. i used Becker online/self-study cd's. I graduated school in may, and I havent' started work yet. Everything I learned in school was still very fresh in mind.

If your using this site and taking the time to seek help, you obviously have what it takes to pass the exam.