Answered Essay: un Company for $19 per share. This acquisition gave Killearn a 40 perce

On July 1, 2013, Killearn Company acquired 105,000 of the outstanding shares of Shaun Company for $19 per share. This acquisition gave Killearn a 40 percent ownership of Shaun and allowed Killearn to significantly influence the investee’s decisions.
     As of July 1, 2013, the investee had assets with a book value of $5 million and liabilities of $1,101,500. At the time, Shaun held equipment appraised at $280,000 above book value; it was considered to have a seven-year remaining life with no salvage value. Shaun also held a copyright with a five-year remaining life on its books that was undervalued by $650,000. Any remaining excess cost was attributable to goodwill. Depreciation and amortization are computed using the straight-line method. Killearn applies the equity method for its investment in Shaun.
     Shaun’s policy is to declare and pay a $1 per share cash dividend every April 1 and October 1. Shaun’s income, earned evenly throughout each year, was $640,000 in 2013, $670,600 in 2014, and $735,200 in 2015.
      In addition, Killearn sold inventory costing $121,800 to Shaun for $203,000 during 2014. Shaun resold $104,500 of this inventory during 2014 and the remaining $98,500 during 2015.

a. Determine the equity income to be recognized by Killearn during each of these years.

b. Compute Killearn’s investment in Shaun Company’s balance as of December 31, 2015.

Expert Answer

 

Solution:

Equity Income 2013
Basic equity accrual ($640,000 x 1/2 year x 40%) $128,000
Amortization (1/2 year-see Schedule 1) (34,000)
Equity Income-2013 $94,000

Equity Income 2014
Basic equity accrual ($670,600 x 40%) $268,240
Amortization (see Schedule 1) (68,000)
Deferral of unrealized profit (see Schedule 2) (15,760)
Equity Income-2014 $184,480

Equity Income 2015
Basic equity accrual ($735,200 x 40%) $294,080
Amortization (see Schedule 1) (68,000)
Recognition of deferred profit (see Schedule 2) 15,760
Equity Income-2015 $241,840

Schedule 1-Acquisition Price Allocation and Amortization
Acquisition price (105,000 x $19) $1,995,000
Book value acquired ($3,898,500 x 40%) 1,559,400
Payment in excess of book value $435,600
Remaining Annual
Excess payment identified with specific assets: Life Amortization
Equipment ($280,000 x 40%) $112,000 7 yrs. $16,000
Copyright ($650,000 x 40%) 260,000 5 yrs. 52,000
Goodwill 63,600 indefinite -0-
Total annual amortization (full year) $68,000

Schedule 2-Deferral of Unrealized Intra-entity Gross Profit
Intra-entity Gross Profit Percentage:
Sales $203,000
Cost of goods sold 121,800
Gross profit $ 81,200
Gross profit percentage: $81,200/ $203,000 = 40%

Inventory remaining at December 31, 2014 $98,500
Gross profit percentage = 40%
Total profit on intra-entity sale still held by affiliate $39,400
Investor ownership percentage = 40%
Unrealized intra-entity gross profit deferred from
2014 until 2015 $ 15,760

b. Investment in Shaun-December 31, 2015 balance
Acquisition price $1,995,000
2013 Equity income (above) 94,000
2013 Dividends declared during half year (105,000 shares x $1.00) (105,000)
2014 Equity income (above) 184,480
2014 Dividends declared (105,000 shares x $1.00 x 2) (210,000)
2015 Equity income (above) 241,840
2015 Dividends declared (105,000 shares x $1.00 x 2) (210,000)
Investment in Shaun-12/31/15 $1,990,320

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