Question & Answer: Babcock based its price for the additional 25% investment on the fact that Caraway has a patent that Babcock estimates is worth $500,00…..

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.