An investor owns 25% of an investee, and accounts for its investment using the equity method. At the beginning of the year, the Equity Investment was reported on the investor's balance sheet at $1,000,000. During the year, the investee reported net income of $400,000 and paid dividends of $100,000. In addition, the investor sold inventory to the investee, realizing a gross profit of $120,000 on the sale. At the end of the year, 30% of the inventory remained unsold by the investee. A. Provide the equity method journal entries required for the year.
B. What is the balance of the equity investment at the end of the year?
C. Assume the inventories are all sold in the following year, that the investee reports $450,000 of net income. How much equity income will the investor report for the following year?

A. Journal Entries:

Debit Investment in Investee $100,000

Credit Net Income $100,000

To record the investor's share in net income of investee.

Debit Net Income from Investee $25,000

Credit Investment in Investee $25,000

To record the dividends received.

Debit Net Income from Investee $9,000

Credit Investment in Investee $9,000

To record the unrealized gain on the unsold inventory.

B. Balance of the equity investment at the end of the year:

= $1,066,000

C. Equity income for the following year if all inventories are sold:

= $112,500

Explanation:

a) Investment in investee:

Beginning balance $1,000,000

Net income share        100,000

Dividends received      (25,000)

Unrealized gain             (9,000)

Ending balance     $1,066,000

Equity Income for the following year when all inventories are sold = 25% of $450,000 = $112,500

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