Question

On January 1, 2017, Palka, Inc., acquired 70 percent of the outstanding shares of Sellinger Company for $1,274,000 in cash. The price paid was proportionate to Sellinger’s total fair value, although at the acquisition date, Sellinger had a total book value of $1,540,000. All assets acquired and liabilities assumed had fair values equal to book values except for a patent (six-year remaining life) that was undervalued on Sellinger’s accounting records by $270,000. On January 1, 2018, Palka acquired an additional 25 percent common stock equity interest in Sellinger Company for $512,500 in cash. On its internal records, Palka uses the equity method to account for its shares of Sellinger.

During the two years following the acquisition, Sellinger reported the following net income and dividends:

	2017			2018
Net income	$	505,000		$	626,000
Dividends declared		170,000			200,000

1. Show Palka’s journal entry to record its January 1, 2018, acquisition of an additional 25 percent ownership of Sellinger Company shares.

2. Prepare a schedule showing Palka’s December 31, 2018, equity method balance for its Investment in Sellinger account.

Answer 1

1. Calculation of fair value using the mathematical model:

n x 0.70 = $1,274,000

n= $1,820,000

Annual amortization = $270,000 / 6 = $45,000

Fair value at the time of second acquisition as the initial fair value plus net income minus dividend and amortization =  $1,820,000 + 505000 - 170000 - 45000 = $2,110,000

Account Titles	Debit	Credit
Investment in Company S ($2,110,000 x 0.25)	$527,500
Cash		$512,500
Additional paid in capital - Company S		$15,000

2.

Particulars	Amount
Fair value of 2017 acquisition	$1,274,000
70% of adjusted subsidiary income [(505000 - 45000) x 0.70]	322,000
70% of 2017 subsidiary dividend [170000 x 70%]	(119,000)
Adjusted fair value of 2018 acquisition	527,500
95% of adjusted subsidiary income [(626000 - 45000) x 0.95]	551,950
95% of 2018 subsidiary dividend [200000 x 0.95]	(190,000)
Investment in Company S on 12/31/2018	$2,366,450