On July 1, 2013, Mecca Group purchased for cash 35 percent of the outstanding capital stock of Wembley Studios. Both Mecca Group and Wembley Studios have a December 31 year-end. Wembley Studios, whose common stock is actively traded in the

over-the-counter market, reported its total net income for the year to Mecca Group and also paid cash dividends on November 15, 2013, to Mecca Group and its other stockholders. How should Mecca Group report the above facts in its December 31, 2013, balance sheet and its income statement for the year then ended? Discuss the rationale for your answer.

Mecca Group should follow the equity method of accounting for its investment in Wembley Studios because Mecca Group is presumed, because of the size of its investment, to be able to exercise significant influence over the operating and financial policies of Wembley Studios.

In 2013, Mecca Group should report its interest in Wembley Studios' outstanding capital stock as a long-term investment. Following the equity method of accounting, Mecca Group should record the cash purchase of 35 percent of Wembley Studios at cost, which is the amount paid.

Thirty-five percent of Wembley Studios' total net income from July 1, 2013, to December 31, 2013, should be added to the carrying amount of the investment in Mecca Group's balance sheet and shown as revenue in its income statement to recognize Mecca Group's share of the net income of Wembley Studios after the date of acquisition. This amount should reflect adjustments similar to those made in preparing consolidated statements, including adjustments to eliminate intercompany gains and losses, and to amortize, if appropriate, any difference between Mecca Group's cost and the underlying equity in net assets of Wembley Studios on July 1, 2013.

The cash dividends paid by Wembley Studios to Mecca Group should reduce the carrying amount of the investment in Mecca Group's balance sheet and have no effect on Mecca Group's income statement.