Long-term equity investments: cost method and equity method Olivia, a fashion house, acquires 1.2 million of the 4 million voting shares of Malvolio, a small textile company (best known product: yellow stockings) for A15 million at the start of year 6. The carrying amount of Malvolio’s net assets is A50 million at that date. Malvolio reports net income in year 6 of A5 million and pays a cash dividend of A0.5 per share that year.

Required

(a) Assume Olivia does not exercise significant influence over Malvolio and uses the cost method to account for her investment. Show the effect on Olivia’s year 6 accounts of:

(i) the acquisition of her stake in Malvolio;

(ii) the reporting by Malvolio of net income in year 6; and

(iii) the payment by Malvolio of cash dividends to his company’s shareholders in year 6.

Use journal entries or the balance sheet equation.

(b) Assume Olivia does exercise significant influence over Malvolio and uses the equity method to account for her investment. Show the effects on Olivia’s year 6 accounts of the three events listed in

(a) above.

(c) Suppose that Malvolio distributes a share dividend – of one share for every five shares held – to all shareholders in year 6. The share dividend is declared after the payment of the cash dividend.

How does this affect your answers to

(a) and

(b) above?

Check figure:

(b) ‘Investment in Malvolio’ #

at end-year 6 $ A15.9m AppenedixLO1