Reference no: EM132455256

Problem 1 - Hobson acquires 40 percent of the outstanding voting stock of Stokes Company on January 1, 2012, for $210,000 in cash. The book value of Stokes's net assets on that date was $400,000, although one of the company's buildings, with a $60,000 carrying value, was actually worth $100,000. This building had a 10-year remaining life. Stokes owned a royalty agreement with a 20-year remaining life that was undervalued by $85,000.

Stokes sold inventory with an original cost of $60,000 to Hobson during 2012 at a price of $90,000. Hobson still held $15,000 (transfer price) of this amount in inventory as of December 31, 2012. These goods are to be sold to outside parties during 2013.

Stokes reported a loss of $60,000 for 2012, $40,000 from continuing operations and $20,000 from an extraordinary loss. The company still manages to pay a $10,000 cash dividend during the year.

During 2013, Stokes reported a $40,000 net income and distributed a cash dividend of $12,000. It made additional inventory sales of $80,000 to Hobson 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 2013 fiscal year.

Required - Prepare all journal entries for Hobson for 2012 and 2013 in connection with this investment. Assume that the equity method is applied.

Problem 2 - On July 1, 2011, Gibson Company acquired 75,000 of the outstanding shares of Miller Company for $12 per share. This acquisition gave Gibson a 35 percent ownership of Miller and allowed Gibson to significantly influence the investee's decisions.

As of July 1, 2011, the investee had assets with a book value of $2 million and liabilities of $400,000. At the time, Miller held equipment appraised at $150,000 above book value; it was considered to have a seven-year remaining life with no salvage value. Miller also held a copyright with a five-year remaining life on its books that was undervalued by $650,000. Any remaining excess cost was attributable to goodwill. Depreciation and amortization are computed using the straight-line method. Gibson applies the equity method for its investment in Miller.

Miller's policy is to pay a $1 per share cash dividend every April 1 and October 1. Miller's income, earned evenly throughout each year, was $550,000 in 2011, $575,000 in 2012, and $620,000 in 2013.

In addition, Gibson sold inventory costing $90,000 to Miller for $150,000 during 2012. Miller resold $80,000 of this inventory during 2012 and the remaining $70,000 during 2013.

Required -

1. Prepare a schedule computing the equity income to be recognized by Gibson during each of these years.

2. Computer Gibson's investment in Miller Company's balance as of December 31, 2013.