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QUESTION Bob’s furniture bought 25% stake in Phil’s lumberyard. Bob paid $1,000,000 for the investment. Next year Phil’s lumberyard had a massive loss of $8,000,000. How would Bob’s furniture report this loss?
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ANSWER As Bob’s furniture had 25% stake. Thus it was between 20 and 50% rule, so Bob’s furniture would use equity method accounting to report his investment. As per this rule Bob’s furniture is supposed to report any proportional profit or loss arising from Phil’s lumberyard’s business operations. As Phil’s lumberyard had $8,000,000 of loss thus Bob’s furniture needed to report $8,000,000 x 0.25 = $2,000,000 loss. But as Bob’s total investment was $1,000,000 so he will just report $1,000,000 loss and show the investment to Phil’s lumberyard as zero. Thus Bob’s furniture still needs to account for the remaining $1,000,000 loss. The company will keep track of it separately. If Next year Phil’s lumberyard reports a profit of $6,000,000 then Bob’s share would be $6,000,000 x 0.25 = $1,500,000. But Bob would just report profit of $500,000 because the company would first need to account for that extra $1,000,000 loss. |
