Question

Harper, Inc. acquires 40 percent of the outstanding voting stock of Kinman Company on January 1, 2017, for $228,600 in cash. The book value of Kinman's net assets on that date was $445,000, although one of the company's buildings, with a $71,000 carrying amount, was actually worth $112,000. This building had a 10-year remaining life. Kinman owned a royalty agreement with a 20-year remaining life that was undervalued by $85,500. Kinman sold inventory with an original cost of $98,700 to Harper during 2017 at a price of $141,000. Harper still held $15,750 (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 $59,400 net loss and a $23,200 other comprehensive loss for 2017. The company still manages to declare and pay a $23,000 cash dividend during the year. During 2018, Kinman reported a $49,000 net income and declared and paid a cash dividend of $25,000. It made additional inventory sales of $108,000 to Harper during the period. The original cost of the merchandise was $67,500. 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

Profit on entire additional sales made during the year is $108000 - $67500 = $ 40500.

Therefore, Gross Profit Margin = $40500 / $108000 = 37.5%

Now, 30% of this inventory had been resold to outside parties by the end of the year, that means profit for such inventory is being recorded twice.

Hence provision for such profit = ($108000 x 30%) x Gross Profit Margin = $32400 x 37.5% = $12150

As ownership of Harper in the company is 40%, the amount of unrealised gain to be recorded in his books will be

$12150 x 40% i.e. $4860 .

Step-by-step explanation:

Preparing All Journal Entries for Harper for 2017 and 2018 in Connection with this Investment by Assuming that the Equity Method is Applied:

Date General Journal Debit Credit

1/1/2017 Investment in Kinman Co $228,600

Cash $228,600

(To record initial investment)

During 2017 Dividends Receivable $9,200

Investment in Kinman Co $9,200

(To record dividend declaration: $23,000 * 40%)

Cash $9,200

Dividends Receivable $9,200

(To record receipt of dividend)

12/31/2017 Equity in Kinman Income - Loss $23,760

Other Comprehensive Loss of Kinman $9,280

Investment in Kinman Co $33,040

(To record accrual of income and OCI from equity investee, 40% of reported balances)

12/31/2017 Equity in Kinman Income - Loss $3,350

Investment in Kinman Co $3,350

(To record amortization relating to acquisition Of Kinman )

12/31/2017 Equity in Kinman Income-Loss $1,890

Investment in Kinman Co $1,890

(To defer unrealized gross profit on intra-entity Sale )

During 2018 Dividends Receivable $10,000

Investment in Kinman Co $10,000

(To record dividend declaration: $25,000 * 40%)

Cash $10,000

Dividends Receivable $10,000

(To record receipt of dividend)

12/31/2018 Investment in Kinman Co $19,600

Equity in Kinman Income $19,600

(To reccord the 40% accrual income as earned by equity investee)

12/31/2018 Equity in Kinman Income $3,350

Investment in Kinman Co $3,350

(To record the amortization relating to the Acquisition of Kinman)

12/31/2018 Investment in Kinman Co $1,890

Equity in Kinman Income $1,890

(To recognize income deferred from 2017)

12/31/2018 Equity in Kinman Income $4,860

Investment in Kinman Co $4,860

(To deferred Unrealized gross profit on intera equity sale )