Question

Harper, Inc. acquires 40 percent of the outstanding voting stock of Kinman Company on January 1, 2017, for $210,000 in cash. The book value of Kinman’s net assets on that date was $400,000, although one of the company’s buildings, with a $60,000 carrying amount, was actually worth $100,000. This building had a 10-year remaining life. Kinman owned a royalty agreement with a 20-year remaining life that was undervalued by $85,000.

Kinman sold inventory with an original cost of $60,000 to Harper during 2017 at a price of $90,000. Harper still held $15,000 (transfer price) of this amount in inventory as of December 31, 2017. These goods are to be sold to outside parties during 2018.

Kinman reported a $40,000 net loss and a $20,000 other comprehensive loss for 2017. The company still manages to declare and pay a $10,000 cash dividend during the year.

During 2018, Kinman reported a $40,000 net income and declared and paid a cash dividend of $12,000. It made additional inventory sales of $80,000 to Harper during the period. The original cost of the merchandise was $50,000. All but 30 percent of this inventory had been resold to outside parties by the end of the 2018 fiscal year.

Prepare all journal entries for Harper for 2017 and 2018 in connection with this investment. Assume that the equity method is applied.

Answer 1

Date   Accounts Titles and Explanation   Debit ($)   Credit ($)
1/1/2017   Investment in Kinman Co.   210,000  
   Cash       210,000
   (To record initial investment)      
During 2017   Dividends Receivable   4,000  
   Investment in Kinman Co       4,000
   (To record dividend declaration :$10,000*40%)      
   Cash   4,000  
   Dividends Receivable       4,000
   (To record receipt of dividend)      
12/31/2017   Equity in Kinman Income- Loss ($40,000*40%)   16,000  
   Other Comprehensive Loss of Kinman ($20,000*40%)   8,000  
   Investment in Kinman Co.       24,000
   (To record accrual of income and OCI from equity investee, 40% of reported balances)      
12/31/2017   Equity in Kinman Income-Loss   3,300  
   Investment in Kinaman Co.       3,300
   (To record amortization relating to acquisition of Kinman-see Schedule 1 below)      
12/31/2017   Equity in Kinman Income- Loss   1,908  
   Investment in Kinman Co.       1,908
   (To defer unrealized gross profit on intra- entity Sale- see Schedule -2 below)      
During 2018   Dividend Receivables   4,800  
   Investment in Kinman Co.       4,800
   (To record dividend declaration ($12,000*40%)      
   Cash   4,800  
   Dividend Receivable       4,800
   (To record the receipt of dividend)      
12/31/2018   Equity in Kinman Income   16,000  
   Investment in Kinman Co.       16,000
   (To record the 40% accrual income as earned by equity investee $40,000*40%)      
12/31.2018   Equity in Kinman Income   4,250  
   Investment in Kinman Co.       4,250
   (To record the amortization relating to the Acquisition of Kinman)      
12/31/2018   Investment In Kinman Co.   1,800  
   Equity in Kinman Income       1,800
   (To record income deferred from 2017)      
12/31/2018   Equity in Kinman Income   3,600  
   Investment in Kinman Co.       3,600
   (To deferred Unrealized gross profit on Intra-equity sale- see Schedule-3 below)      

Schedule-1 Allocation of Purchase Price and Related to Amortization:-
Purchase Price   $210,000
Less: Percentage of Book Value of Acquired ($400,000*40%)   ($160,000)
Payment in Excess of Book Value   $50,000
   Remaining Life   Annual Amortization
Excess Payment Identified With Specific Assets:      
Building ($100,000-$60,000= $40,000*40% =$16,000)   10 Years   $1,600
Royalty Agreement ($85,000*40%= $34,000)   20 Years   $1,700
Total Annual Amortization       $3,300

Schedule-2 Deferral of Unrealized Gross Profit- 2017:-
Inventory Remaining at the End of Year   $15,000
Gross Profit Percentage ($90,000-$60,000=$30,000/ $90,000)   30%
Gross Profit Remaining in Inventory   $4,500
Ownership Percentage   40%
Unrealized Gross Profit to be Deferred   $1,800

Schedule-3 Deferral of Unrealized Gross Profit- 2018
Inventory Remaining at the End of Year ($80,000*30%)   $24,000
Gross Profit Percentage ($80,000-$50,000=$30,000/ $80,000*100)   37.5%
Gross Profit Remaining in inventory   $9,000
Ownership Percentage   40%
Unrealized Gross Profit to be deferred   $3,600