Question

On January 1, 2017, Corgan Company acquired 70 percent of the outstanding voting stock of Smashing, Inc., for a total of $805,000 in cash and other consideration. At the acquisition date, Smashing had common stock of $740,000, retained earnings of $290,000, and a noncontrolling interest fair value of $345,000. Corgan attributed the excess of fair value over Smashing's book value to various covenants with a 20-year remaining life. Corgan uses the equity method to account for its investment in Smashing.

During the next two years, Smashing reported the following:

	2017	2018
Net Income	$190,000	$170,000
Dividends Declared	$39,000	$49,000
Inventory Purchases from Corgan	$140,000	$160,000

Corgan sells inventory to Smashing using a 60 percent markup on cost. At the end of 2017 and 2018, 30 percent of the current year purchases remain in Smashing's inventory.

a.) Compute the equity method balance in Corgan's Investment in Smashing, Inc., account as of December 31, 2018.

b.) Prepare the worksheet adjustments for the December 31, 2018, consolidation of Corgan and Smashing.

Answer 1

The consolidated worksheet entries are prepared as below:
Transaction	Consolidating Entries	Debit	Credit
1) Prepare Entry *G
1	Investment in Smashing	$15,750
	Cost of Goods Sold		$15,750
2) Prepare Entry S
2	Common Stock-Smashing	$740,000
	Retained Earnings-Smashing	$290,000
	Investment in Smashing		$685,000
	Non controlling Interest		$345,000
2) Prepare Entry A
3	Covenants	$732,800
	Investment in Smashing		$512,960
	Non controlling Interest		$219,840
4) Prepare Entry I
4	Equity in Earnings of Smashing	$112,550
	Investment in Smashing		$112,550
5) Prepare Entry D
5	Investment in Smashing	$49,000
	Dividends Declared		$49,000
6) Prepare Entry E
6	Amortization Expense	$6,000
	Covenants		$6,000
7) Prepare Entry TI
7	Sales	$160,000
	Cost of Goods Sold		$160,000
8) Prepare Entry G
8	Cost of Goods Sold	$18,000
	Inventory		$18,000
Notes:
The computation of various items is shown as below:
1)
Annual Amortization Expense:
Consideration Transferred by Corgan	$805,000
Add Non Controlling Interest- Fair Value	$345,000
Smashing's Acquisition-Date Fair Value	$1,150,000
Book Value of Subsidiary=common stock +retained earnings	$1,030,000
Excess of Fair Value Over Book Value Assigned to Covenants	$120,000
Annual Amortization (120,000/20)	$6,000
2)
Ending Year Profit Deferral (2017):
Cost = 140,000/1.6 = $87500
Intra- Entity Gross Profit = 140,000 - 87500 = $52500
Ending Inventory Gross Profit = 52500*30% = $15750
Ending Year Profit Deferral (2018):
Cost = 160,000/1.6 = $100000
Intra-Entity Gross Profit = 160,000 - 100000 = $60000
Ending Inventory Gross Profit =60000*30% = $18000
3)
Equity in Smashing's Earnings:
Smashing's 2018 Net Income (170,000*70%)	$119,000
Less Covenant Amortization (6000*70%)	$4,200
Add Beginning Inventory Profit Recognition	$15,750
Less Ending Inventory Profit Deferral	$18,000
Equity in Smashing's Earnings	$112,550