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In: Accounting

Morgan Company acquires 40% of the voting stock of Kirk Corporation on January 1, 2014, for...

Morgan Company acquires 40% of the voting stock of Kirk Corporation on January 1, 2014, for $60,000,000, and treats it as an equity method investment. At the date of Morgan’s investment, the fair values of Kirk’s net assets differed from book values as follows:

                                                                                             Book value                                     Fair value                                                                                                     

Merchandise (sold during 2014)                                   $ 5,000,000                                     $ 8,000,000

Buildings and equipment (20-year life)                        30,000,000                                       40,000,000

Intangible assets (4-year life)                                           0                                                         10,000,000

Kirk reports total net income of $20,000,000 for the period 2014 - 2017, and $5,000,000 for 2018. Kirk paid no dividends during the period 2014 – 2017, but paid $1,000,000 in dividends in 2018. The accounting year for both companies ends December 31.

Kirk sells merchandise to Morgan at a markup of 30% on cost (Hint: what is the relationship between markup on cost and gross profit %?). The inventory balances held by Morgan, purchased from Kirk, are as follows.

Inventory held by Morgan, purchased from Kirk

December 31, 2017                         $1,560,000              

December 31, 2018                           2,600,000

Required:

a. Calculate equity in net income of Kirk, reported on Morgan’s 2018 income statement. (2p.)

b. Calculate Investment in Kirk, reported on Morgan’s December 31, 2018 balance sheet. (4p.)

Solutions

Expert Solution

A. CALCULATION OF EQUITY IN NET INCOME OF KIRK

Morgan holds 40% of the voting stock of Kirk Corporation. Thus in order to find out the Equity in Net Income, we need to First ascertain the Correct net Income of Kirk Corporation.

PROFITS 2014-2017 $2,000,000 2018 $500,000

But we need to correct the profits by adjusting the profit element for transfers from Kirk to Morgan.

For this calculation, we need to ignore the closing stock for 2017 as this closing stock would get adjusted as the opening stock of 2018. We need to focus on closing stock of 2018.

Closing stock 2018 = $2,600,000 sold at 30% on cost (30/130 on sales) Thus profit to be cancelled is 2,600,000*30/130 = $600,000

Total Profit from 2014-2018= $20,000,000+$5,000,000-$600,000 = $24,400,000

Share of Morgan = 40%(24,400,000) = $9,760,000

B. VALUE OF INVESTMENT REPORTED ON KIRK'S BALANCESHEET

Investment value + Share of profit - Share of Dividend

$60,000,000+$9,760,000-40%(1,000,000) = $69,360,000

ekkarill92 answered 1 year ago
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