Winston Corporation purchased 40 percent of the stock of Fullbright Company on January 1, 20X2, at underlying book value. During the period of January 1, 20X2, through December 31, 20X4, the market value of Winston's investment in Fullbright's stock increased by $20,000 each year. The companies reported the following operating results and dividend payments during the first three years of intercorporate ownership:

 Winston Corporation purchased 40 percent of the stock of Fullbright Company on January 1, 20X2, at underlying book value. During the period of January 1, 20X2, through December 31, 20X4, the market value of Winston's investment in Fullbright's stock increased by $20,000 each year. The companies reported the following operating results and dividend payments during the first three years of intercorporate ownership:

     Winston Corporation    Fullbright Company
Year    Operating Income    Dividends    Net Income    Dividends
20X2    $ 100,000    $ 40,000    $ 70,000    $ 30,000
20X3    60,000    80,000    40,000    60,000
20X4    250,000    120,000    25,000    50,000
Required:
Compute the net income reported by Winston for each of the three years, assuming it accounts for its investment in Fullbright by carrying the investment at fair value, or using the equity method.



Explanation
Winston Corporation net income – carried at fair value:

20X2: $100,000 + 0.40($30,000) + $20,000 = $132,000

20X3: $60,000 + 0.40($60,000) + $20,000 = $104,000

20X4: $250,000 + 0.40($50,000a) + $20,000 = $290,000
 

A liquidating dividend can impact the entry made by the company declaring the dividend where it may need to debit a paid-in-capital account instead of a retained earnings account.

In the past, if the recipient of the dividend was accounting for the equity investment under the cost method, then the entry to record a liquidating dividend needed to be modified to exclude the liquidating amount from dividend income. The liquidating amount received was recorded as a reduction in the investment.

However, under current standards if the equity investment is being accounting for under the equity method, then all dividends are treated as a return of investment (as opposed to a return on investment). Therefore, all dividends are all dividends are effectively accounted for as liquidating the investment (hopefully the investment is increasing through investee earnings).

If the investment is carried at fair value, then dividends received are recorded as income. However, all changes in fair value are also recorded through income each period. If a company is truly in the process of liquidating paid in capital, the fair value of that company will be expected to be declining.

Winston Corporation net income – equity method:

20X2: $100,000 + 0.40($70,000) = $128,000

20X3: $60,000 + 0.40($40,000) = $76,000

20X4: $250,000 + 0.40($25,000) = $260,000