Heartfelt Company owns a 40% interest in the voting common stock of Candle Corporation, and Heartfelt accounts for the investment using the equity method. During 2014, Candle Corporation reported net income of $100,000 and declared and paid cash dividends of $10,000. The carrying value of the Candle investment was $500,000 on January 1, 2014. How much investment income should Heartfelt report during 2014 from the Candle investment?
A) $36,000.
B) $40,000.
C)$4,000.
D)$10,000.

Question

Quizplus · Accepted Answer

To calculate the investment income for Heartfelt using the equity method, we need to first determine the share of Candle Corporation's net income that Heartfelt is entitled to.

Since Heartfelt owns a 40% interest in Candle's voting common stock, it is entitled to 40% of Candle's net income for the period. Therefore, Heartfelt's share of Candle's net income for 2014 is:

40% x $100,000 = $40,000

Next, we need to subtract any dividends received by Heartfelt from Candle Corporation. In this case, Heartfelt received $10,000 in dividends from Candle during 2014.

Finally, we need to adjust the carrying value of Heartfelt's investment in Candle Corporation to reflect any changes in value during the period. Since we are not given any information about changes in the value of the investment, we can assume that the carrying value remains the same at $500,000 throughout the period.

Therefore, the investment income that Heartfelt should report for the Candle investment during 2014 is:

$40,000 (Heartfelt's share of Candle's net income)
- $10,000 (dividends received by Heartfelt)
= $30,000

However, since Heartfelt accounts for the investment using the equity method, it must report its share of Candle's net income on a pro rata basis each period. Therefore, Heartfelt should report investment income of:

$30,000 (Heartfelt's share of Candle's net income, less dividends received)
x 40% (Heartfelt's ownership percentage)
= $12,000

Therefore, the correct answer is B) $40,000.

Heartfelt Company Owns a 40% Interest in the Voting Common