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.

Determine the equity income to be recognized by Killearn during each of these years.

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

Answer 1

Solution:

From the given data first we need to find Amortization and Deffered profit. They are calculated below,

Amortization:

	Amount ($)
Copy right = ($980,000 * 25%) / 5	$49,000
Equipment = ($319,200 * 25%) / 7	$11,400
Total	$60,400
For half year	$30,200

Deffered profit:

Gross profit percentage :
Sales	$185,000
Less: cost of goods sold	$111,000
Profit	$74,000
Percentage of gross profit (profit / sales) * 100	40%
Deffered profit ($102,500 * 40%) * 25%	$10,250

Answer 1 : The equity income to be recognized by Killearn during each of these years:

Year	2016		2017		2018
		Amount ($)		Amount ($)		Amount ($)
Basic equity accural	($579,000 * 25%) * 6/12	$72,375	($619,400 * 25%)	$154,850	($675,200 * 25%)	$168,800
Less: Amortization		($30,200)		($60,400)		($60,400)
Less: Deffered profit				($10,250)		($10,250)
Equity income		$42,175		$84,200		$98,150

Answer b : Killearn's investment in Shaun Company's balance as of December 31, 2018:

Balance aquidation price (136,000 * $15)	$2,040,000
2016 equity income	$42,175
2016 Dividends declared during half year (136,000 * $1)	($136,000)
2017 Equity income	$84,200
2017 Dividends declared (136,000 * $1 * 2)	($272,000)
2018 Equity income	$98,150
2018 Dividends declared (136,000 * $1 *2)	($272,000)
Investment in shaun 12/31/2018	$1,584,525