Question

Harper, Inc. acquires 40 percent of the outstanding voting stock of Kinman Company on January 1, 2017, for $210,000 in cash. The book value of Kinman’s net assets on that date was $400,000, although one of the company’s buildings, with a $60,000 carrying amount, was actually worth $100,000. This building had a 10-year remaining life. Kinman owned a royalty agreement with a 20-year remaining life that was undervalued by $85,000. Kinman sold inventory with an original cost of $60,000 to Harper during 2017 at a price of $90,000. Harper still held $15,000 (transfer price) of this amount in inventory as of December 31, 2017. These goods are to be sold to outside parties during 2018. Kinman reported a $40,000 net loss and a $20,000 other comprehensive loss for 2017. The company still manages to declare and pay a $10,000 cash dividend during the year. During 2018, Kinman reported a $40,000 net income and declared and paid a cash dividend of $12,000. It made additional inventory sales of $80,000 to Harper during the period. The original cost of the merchandise was $50,000. All but 30 percent of this inventory had been resold to outside parties by the end of the 2018 fiscal year. Prepare all journal entries for Harper for 2017 and 2018 in connection with this investment. Assume that the equity method is applied.

Answer 1

The student's question involves accounting for an investment using the equity method, where adjustments for building depreciation, amortization of intangible assets, elimination of profit on unsold inventory, and recognition of dividends need to be made in journal entries across two years.

Step-by-step explanation:

The student's question involves the application of the equity method of accounting for investments in another company. Under the equity method, an investor recognizes its share of the profits and losses of the investee company in its own financial records. Calculations also require adjustments for excess depreciation on buildings, undervaluation of intangible assets, inventory profit elimination, and recognition of dividends.

2017 Journal Entries:

Investment in Kinman: Debit $210,000 (recognizing the purchase of Kinman's stock)

Excess Building Depreciation: Debit (adjusting for building valuation)

Amortization of Royalty Agreement: Debit (adjusting for royalty undervaluation)

Unrealized Gross Profit in Inventory: Debit (eliminating profit in unsold inventory)

Share in Kinman’s Loss: Debit (recognizing share of Kinman's net loss)

Other Comprehensive Loss: Debit (recognizing share of comprehensive loss)

Dividends Received: Credit (reflecting cash dividend received from Kinman)

2018 Journal Entries:

Excess Building Depreciation: Debit (continuing adjustment for building valuation)

Amortization of Royalty Agreement: Debit (continuing adjustment for royalty undervaluation)

Unrealized Gross Profit in Inventory: Debit (eliminating profit in unsold inventory)

Share in Kinman’s Income: Credit (recognizing share of Kinman's net income)

Dividends Received: Credit (reflecting cash dividend received from Kinman)

Note that specific amounts are not given as they depend on the application of the equity method rules and the financial details regarding amortization, depreciation, gross profit, and dividend proportions.

Answer 2

Harper investment 160,000

building over fair value 16,000

royalty over fair value 34,000

cash 200,000

----

2017 entries:

loss on Harper Investment 32,000

Harper investment 32,000

---

Cash 4,000

Harper investment 4,000

----

Unrealized gain 2,000

Harper Investment 2,000

---

royalty over fair value 1,700

bulding over fair value 1,600

harper investment 3,300

---

2018 entries:

Harper Investment 16,000

Gain on Harper Investent 16,000

----

Cash 4800

Harper investment 4800

----

Unrealized gain 1,600

Harper Investment 1,600

---

royalty over fair value 1,700

bulding over fair value 1,600

harper investment 3,300

Step-by-step explanation:

400,000 x 40% = 160,000

40,000 increase infair value of building x 40% = 16,000

royalty 85,000 x 40% = 34,000

total equity value 200,000

payment of 200,000

no goodwill.

amortization:

building: 16,000 / 10 = 1,600

royalty: 34,000 / 20 = 1,700

2017

loss: 60,000 x 40% = (32,000)

dividends 10,000 x 40% = (4,000)

unrealized gain: it kept 15,000/90,000 = 0.1667 = 16.67%

90,000 - 30,000 = 30,000 gain x 16.67% = 5,000 unrealized gain

5,000 x 40% = 2,000

2018

income 40,000 x 40% = 16,000

dividends 12,000 x 40% = (4,800)

unrealized gain kept 30%

80,000 - 50,000 = 30,000 x 30% = 9,000

the company has 40% so 9,000 x 40% = 3,600 unrealized

as we recognize 2,000 before we adjust for the difference of 1,600