In 2018, Babcock Industries, a calendar year corporation, acquired a 10% interes
ID: 2610039 • Letter: I
Question
In 2018, Babcock Industries, a calendar year corporation, acquired a 10% interest in Caraway, Inc. for $65,000. Babcock appropriately used the fair value method to account for the investment. At the beginning of 2021, Babcock acquired an additional 25% of the outstanding common stock of Caraway for $250,000. The following additional information is available at the date of purchase related to Caraway’s activity for the years 2018-2020:
Cumulative dividends paid by Caraway $150,000
Cumulative income reported by Caraway $400,000
Cumulative fair value adjustment in Babcock’s balance sheet
At 12/31/20 $ 35,000
Caraway’s balance sheet on the date of the additional purchase is as follows:
Accounts receivable $100,000 Mortgage payable $200,000
Inventories 200,000
Building 400,000 Stockholders’ equity 500,000
Total assets $700,000 Total liabilities and equity $700,000
Babcock based its price for the additional 25% investment on the fact that Caraway has developed a patent that Babcock estimates is worth $300,000. The patent will expire in 10 years.
Subsequent to the investment, Caraway reports earnings of $200,000 and pays $90,000 in dividends. In addition, Babcock sells inventories to Caraway that cost $50,000 for a sales price of $80,000. At the end of 2021, 60% of the inventories are still held by Caraway.
III. Indicate all amounts that will appear in Babcock’s income statement and balance sheet related to its investment in Caraway for 2021.
Explanation / Answer
Income statement of Babock Industries will show a dividend income of $31,500 (Babock share of its investment in Caraway Inc. 35% of dividend declared by Caraway Inc. $90,000 i.e. 35%*$90,000)
Investment in Caraway Inc. will be shown at book value of $315,000 ($65,000 + $ 250,000) in Balance Sheet of Babock Industries.