Question

On July 1, 2016, Killearn Company acquired 103,000 of the outstanding shares of Shaun Company for $21 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, 2016, the investee had assets with a book value of $6 million and liabilities of $1,468,500. At the time, Shaun held equipment appraised at $140,000 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 $562,500. 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 $580,000 in 2016, $606,600 in 2017, and $649,200 in 2018. In addition, Killearn sold inventory costing $93,000 to Shaun for $155,000 during 2017. Shaun resold $97,500 of this inventory during 2017 and the remaining $57,500 during 2018.

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, 2018.

A. Equity income 2016

Equity income 2017

Equity income 2018

B. Investment in Shaun

Answer 1

Part a	Equity Income 2016
	Basic equity accrual ($580,000 × ½ year × 40%)	$         116,000
	Amortization (½ year—see Schedule 1)	(26,500)
	Equity Income—2016	$           89,500
	Equity Income 2017
	Basic equity accrual ($606,600 × 40%)	$         242,640
	Amortization (see Schedule 1)	(53,000)
	Deferral of unrealized profit (see Schedule 2)	(9,200)
	Equity Income—2017	$         180,440
	Equity Income 2018
	Basic equity accrual ($649,200 × 40%)	$         259,680
	Amortization (see Schedule 1)	(53,000)
	Recognition of deferred profit (see Schedule 2)	9,200
	Equity Income—2018	$         215,880
	Schedule 1 - Acquisition Price Allocation and Amortization
	Acquisition price (103,000 shares × $21)	$      2,163,000
	Book value acquired ($4,531,500 × 40%)	1,812,600
	Payment in excess of book value	$         350,400
	Allocation of excess payment to specific assets		Life	Annual amortization
	Equipment ($140,000 X 40%)	$56,000	7 yrs.	$     8,000
	Copyright ($562,500 x 40%)	225,000	5 yrs.	45,000
	Goodwilll	69,400	indefinite	-
	Total annual amortization (full year)			$   53,000
	Schedule 2 - deferment of unrealized gross profit on inventory
	Inventory remaining at December 31, 2017	$           57,500
	Gross profit percentage ($62,000 + $155,000)	x 40%
	Total profit on intra-entity sale still held by affiliate	$           23,000
	Investor ownership percentage	x 40%
	Unrealized intra-entity gross profit deferred from 2017 until 2018	$            9,200
Part b.	Investment in Shaun—December 31, 2018 balance
	Acquisition price :	$2,163,000
	2016 Equity income (above)	89,500
	2016 Dividends received during half year (103,000 shares X $1.00)	(103,000)
	2017 Equity income (above)	180,440
	2017 Dividends received (103,000 shares X $1.00 x 2)	(206,000)
	2018 Equity income (above)	215,880
	2018 Dividends received (103,000 shares x $1.00 x 2)	(206,000)
	Investment in Shaun—12/31/18	$      2,133,820