Question

In 2018, Babcock Industries, a calendar year corporation, acquired a 10% interest in Caraway, Inc. for $65,000. Babcock appropriately used the fair value method to account for the investment.   At the beginning of 2021, Babcock acquired an additional 25% of the outstanding common stock of Caraway for $250,000. The following additional information is available at the date of purchase related to Caraway’s activity for the years 2018-2020:

Cumulative dividends paid by Caraway                                                          $150,000

Cumulative income reported by Caraway $400,000

Cumulative fair value adjustment in Babcock’s balance sheet

At 12/31/20 $ 35,000

Caraway’s balance sheet on the date of the additional purchase is as follows:

Accounts receivable         $100,000                                Mortgage payable                                $200,000

Inventories                             200,000

Building                                   400,000 Stockholders’ equity                          500,000

Total assets                             $700,000 Total liabilities and equity              $700,000

Babcock based its price for the additional 25% investment on the fact that Caraway has developed a patent that Babcock estimates is worth $300,000. The patent will expire in 10 years.

Subsequent to the investment, Caraway reports earnings of $200,000 and pays $90,000 in dividends. In addition, Babcock sells inventories to Caraway that cost $50,000 for a sales price of $80,000. At the end of 2021, 60% of the inventories are still held by Caraway.

Provide all journal entries needed to record each of the following:

-Babcock’s additional investment in Caraway at the beginning of 2021.

-Caraway reports total earnings of $200,000 for 2021

-Babcock adjusts Caraway’s earnings for amortization of the patent

-Babcock adjusts Caraway’s earnings for deferral of gross profit on the intercompany inventory sale

-Caraway pays total dividends of $90,000

Answer 1

a)
To record second acquisition of Caraway stock
Investment in Caraway	$250,000
Cash		$250,000
b)
Investment in Caraway	$70,000
Equity Income -Investment in Caraway		$70,000
($200,000 x 35%)
c)
Equity Income -Investment in Caraway	$12,500.00
Investment in Caraway		$12,500.00
d)
Equity Income from Caraway	6300
Investment in Caraway		6300
Ending inventory = 60% x35% (80,000 -50000)
e)
Dividend Receivable (90,000 x 35%)	31500
Investment in Caraway		31500
Cash	31500
Dividend Receivable (90,000 x 35%)		31500
Second Purchase
Purchase price of Caraway stock	$250,000.00
Less: Book value of Caraway's stock ($500,000 × 25%)	$125,000.00
Cost in excess of book value (Patents)	$125,000.00
Remaining life of patent	÷ 10 years
Annual Amortization	$12,500.00