Question

On July 1, 2016, Killearn Company acquired 136,000 of the outstanding shares of Shaun Company for $15 per share. This acquisition gave Killearn a 25 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 $7 million and liabilities of $456,800. At the time, Shaun held equipment appraised at $319,200 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 $980,000. 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 $579,000 in 2016, $619,400 in 2017, and $675,200 in 2018.

In addition, Killearn sold inventory costing $111,000 to Shaun for $185,000 during 2017. Shaun resold $82,500 of this inventory during 2017 and the remaining $102,500 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.

Answer 1

a. Computation of equity income:

Year	2016		2017		2018
	Calculation		Calculation		Calculation
Basic equity accrual	579,000*25%*6/12	72,375	619,400*25%	154,850	675,200*25%	168,800
Less: Amortization	(note-1)	(30,200)		(60,400)		(60,400)
Less: Deferred profit	(note-2)			(10,250)		10,250
Equity income		42,175		84,200		118,650
(note-1)
Equipment	319,200 *25/7			11,400
Copyright	980,000 *25%/5			49,000
			Total	60,400
			For half year	30,200
(note-2)
Gross profit %	Sales = 185,000	Cost of goods sold = 111,000	Profit = 74,000	Profit / sales *100 =40%
Deferred profit	Inventory   102,500	Inventory * 40% = 41,000	41,000*0.25 =   10,250

B).Compute Killearn's investment in Shaun Company's balance as of December 31, 2018.

Investment in Shaun—December 31, 2018:
balance Acquisition price (136,000shares*$15) = $2,040,000
2016 Equity income (above) = 42,175
2016 Dividends declared during half year (136,000 shares × $1.00) = (136,000)
2017 Equity income (above) = 84,200
2017 Dividends declared (136,000 shares × $1.00 × 2)= (272,000)
2018 Equity income (above) =118,650
2018 Dividends declared (136,000 shares × $1.00 × 2)= (272,000)
Investment in Shaun—12/31/18= $1,605,025