Question

On July 1, 2016, Killearn Company acquired 148,000 of the outstanding shares of Shaun Company for $21 per share. This acquisition gave Killearn a 40 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 $8 million and liabilities of $1,207,750. At the time, Shaun held equipment appraised at $166,250 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 $660,000. 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 $647,000 in 2016, $683,600 in 2017, and $743,000 in 2018.

In addition, Killearn sold inventory costing $148,200 to Shaun for $247,000 during 2017. Shaun resold $94,000 of this inventory during 2017 and the remaining $153,000 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.

(For all requirements, enter your answers in whole dollars and not in millions.)

Answer 1

solution : 1

Particulars	2016	2017	2018
INCOME	$341800 [$683600 /2]	$683,600	$743,000
EQUITY INCOME (40 % INCOME)	1,36,720	$2,73,440	$2,97,200
LESS: DEPRICITION (WN 1)	$4,750	$9,500	$9,500
LESS: Amortization (WN2)	$26400	$52,800	$52,800
LESS: Unrealised income(WN3)	-	$24,480	-
ADD ;recognition of DEFERRAL INTRA EQUITY PROFIT	-	-	$24,480
EQUITY INCOME TO BE RECOGNISIED AFTER ADJUSTMENT	$105,570	$186,660	$2,59,380

solution 2.

investment value :

=initial cost of investment (WN5) + EQUITY INCOME TO BE RECOGNISED - DIVIDEND RECOGNISED(WN4)

=$310,8000 + ($105,570 +$186,660 +$2,59,380) - ( $148,000 +$296,000 +$296,000)

=$29,19,610

WORKING NOTE 1 :AMORTIZATION SCHEDULE :

ACQUISITION PRICE (148,000 X $21) =$310,8000

BOOK VALUE ($80,00,000 -$1,207,750) X 40 % =$27,16,900

PAYMENT IN EXCESS OF BOOK VALUE =$3,91,100

EXCESS PAYMENT IN

DEPRICATION ($166,250 X .40) = $66500

COPYRIGHT($660,000 X .40)= 264000

GOODWILL = 60600

CALCULATION OF DEPRICITION :

2016 = FOR 1ST july to 31st dec(6 months)

= (book value /useful life ) x 6/12

= ($66500/7 ) x 6/12

= $4750

for 2017 =$66500/7 = $9,500

for 2018 =$66500/7 = $9,500

WORKING NOTE 2 ; CALCULATION OF AMORTIZATION

2016= FOR 1ST july to 31st dec(6 months)

=(COPY RIGHT VALUE / LIFE ) X 6/12

= ($264000/5) X6/12

=$26400

2017 = $$264000/5 = $52,800

2018 = $$264000/5 = $52,800

WORKING NOTE 3 ; CALCULATION OF UNREALISED INCOME

SALES =$247,000

COST =$ $148,200

GROSS PROFIT = $98,800

GROSS PROFIT % = 40%

INVENTORY REMAINING ON 31 DEC 2018 = $153,000

GROSS PROFIT = 153000 X 40 % = $ 61,200

INVESTOR OWNERSHIP = 40 %

SO DEFERRAL INTRA EQUITY PROFIT = $61,200 X 40 % = $24,480

WORKING NOTE 4 . DIVIDEND RECOGNISED

2016 = 148,000 shares x 1 = $148,000

2017 = 148000 shares x1x2 = $296,000

2018 = 148000 shares x1x2 = $296,000

WORKING NOTE 5 : initial cost of investment

= 148000 X 21 =$310,8000

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