Hobson acquires 40 percent of the outstanding voting stock of Stokes Company on January 1, 2010, 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 2010 at a price of $90,000. Hobson still held $15,000 (transfer price) of this amount in inventory as of December 31, 2010. These goods are to be sold to outside parties during 2011.
Stokes reported a loss of $60,000 for 2010, $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 2011, 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 2011 fiscal year.
Prepare all journal entries for Hobson for 2010 and 2011 in connection with this investment. Assume that the equity method is applied.