In 2018, Babcock Industries, a calendar year corporation, acquired a 10% interes
ID: 2610042 • 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 $ 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 a patent that Babcock estimates is worth $500,000. 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.
REQUIRED:
I. Prepare a fair value allocation schedule for Babcock’s 35% interest in Caraway.
Explanation / Answer
25% stock purchased valuation :
Purchase value - $250000
10% stock purchased for - $ 65000 + adjustment ($ 35000)- $110,000
Share of assets for 35% = 35% (700000) = 2,45,000
share of liabilities -= 35% (200000) = (70,000)
Share of dividend and earnings = 35% (290000) = 101,500
Earning from patent (patent value = 500000) = share = 35% (500000) = 175000
Total = 451,500
Adjustment of inventory profit = 60% 30000= 18000
valuation = 451,500- 18,000= 433,500