In 2018 Babcock Industries a calendar year corporation acqui

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.

Solution

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.