Question

On July 1, 2016, Killearn Company acquired 132,000 of the outstanding shares of Shaun Company for $20 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 $6 million and liabilities of $616,000. At the time, Shaun held equipment appraised at $276,500 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 $750,000. 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 $644,000 in 2016, $683,000 in 2017, and $737,200 in 2018. In addition, Killearn sold inventory costing $102,000 to Shaun for $170,000 during 2017. Shaun resold $84,500 of this inventory during 2017 and the remaining $85,500 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. (For all requirements, enter your answers in whole dollars and not in million

Answer 1

Part A

Equity Income 2016
Basic equity accrual ($644,000 × ½ year × 40%)	128800
Amortization (75800*1/2)	(37900)
Equity Income 2016	$90900

Equity Income 2017
Basic equity accrual ($683000 × 40%)	273200
Amortization	(75800)
Deferral of unrealized profit (see Schedule 2)	(13680)
Equity Income 2017	$183720

Equity Income 2018
Basic equity accrual ($737200 × 40%)	294880
Amortization	(75800)
Recognition of deferred profit	13680
Equity Income 2018	$232760

Schedule 1—Acquisition Price Allocation and Amortization

Acquisition price (132000 shares × $20)	2640000
Book value acquired ((6000000-616000)* 40%)	2153600
Payment in excess of book value	486400
Excess payment identified with specific assets:		Remaining life	Annual amortization
Equipment ($276500 × 40%)	110600	7 yrs	15800
Copyright ($750000 × 40%)	300000	5 yrs	60000
Goodwill	75800	Indefinite	0
Total annual amortization (full year)			75800

Schedule 2—Deferral of Unrealized Intra-entity Gross Profit

Intra-entity Gross Profit Percentage:
Sales	170000
Cost of goods sold	102000
Gross profit	68000
Gross profit percentage:(68000/170000)	40%
Inventory remaining at December 31, 2017	85500
Gross profit percentage	40%
Total profit on intra-entity sale still held by affiliate	34200
Investor ownership percentage	40%
Unrealized intra-entity gross profit deferred from 2017 until 2018	13680

Part B

Investment in Shaun—December 31, 2018 balance
Acquisition price	2640000
2016 Equity income	90900
2013 Dividends declared during half year (132000 shares × $1.00)	(132000)
2017 Equity income	183720
2017 Dividends declared (132,000 shares × $1.00 × 2)	(264000)
2018 Equity income	232760
2018 Dividends declared (132000 shares × $1.00 × 2)	(264000)
Investment in Shaun—12/31/18	$2487380