Park Co. uses the equity method to account for its January
1, year 1 purchase of Tun Inc.’s common stock. On January
1, year 1, the fair values of Tun’s FIFO inventory and land
exceeded their carrying amounts. How do these excesses of fair
values over carrying amounts affect Park’s reported equity in
Tun’s year 1 earnings?

Inventory excess

Land excess

(b) When the equity method is used, the investor should
amortize any portion of the excess of fair values over carrying
amounts (differential) that relates to depreciable or amortizable
assets held by the investee. Amortization of the differential results
in a reduction of the investment account and a reduction in
the equity of the investee’s earnings. For inventory, an excess of
FV over cost, FIFO cost in this case, has the same effect on the
investment account and equity in investee earnings in the period
in which the goods are sold. Therefore, the portion of the differential
that relates to inventory would decrease Park’s reported
equity in Tun’s earnings, and answers (c) and (d) are incorrect.
Land is not a depreciable asset, so there would be no amortization
of the differential related to land, and answer (a) is incorrect.