Question

On January 1, 2020, Corgan Company acquired 70 percent of the outstanding voting stock of Smashing, Inc., for a total of $1,435,000 in cash and other consideration. At the acquisition date, Smashing had common stock of $920,000, retained earnings of $470,000, and a noncontrolling interest fair value of $615,000. 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:

	Net Income			Dividends Declared			Inventory Purchases from Corgan
2020	$	370,000		$	57,000		$	320,000
2021		350,000			67,000			340,000

Corgan sells inventory to Smashing using a 60 percent markup on cost. At the end of 2020 and 2021, 30 percent of the current year purchases remain in Smashing's inventory.

1. Compute the equity method balance in Corgan's Investment in Smashing, Inc., account as of December 31, 2021.
2. Prepare the worksheet adjustments for the December 31, 2021, consolidation of Corgan and Smashing.

Answer 1

Requirement a. Compute the equity method balance in Corgan's Investment in Smashing, Inc., account as of December 31, 2021.

Investment in Smashing, January 1, 2020		$1,435,000
Reported Net Income, 2020 (370,000 * 70%)	$259,000
Amortization (Working Note) (33,000 * 70%)	($23,100)
Ending Inventory profit deferral (100%)	($48,000)
Equity in smashing's earnings		$187,900
Dividend for 2020 (57,000 * 70%)		($39,900)
Investment Balance 12/21/2020		$1,583,000
Reported Net income 2021 (350,000 * 70%)	$245,000
Amortization (Working note) (33,000 * 70%)	($23,100)
Beginning inventory profit	$48,000
Enidng inventory profit deferral (100%)	($51,000)
Equity in smashing earnings		$218,900
Dividend for 2021 (67,000 * 70%)		($46,900)
Investment balance 12/31/2021		$1,755,000

Working Note:-

Calculation of Amortization.

Consideration transferred by Corgan	$1,435,000
Non controlling interest fair value	$615,000
Smashing acquistion fair value	$2,050,000
Book Value of Subsidiary ($920,000 + $470,000)	$1,390,000
Excess fair value over book value ($2,050,000 - 1,390,000)	$660,000
Annual amoritzation (660,000 / 20 years)	$33,000

Calculation of Ending Inventory profit for 2020.

Cost = 320,000 / 1.6 = $200,000

Intra entity gross profit = $320,000 - 200,000 = $120,000

Ending Inventory gross profit = $120,000 * 40% =$48,000

Calculation of Ending Inventory profit for 2021.

Cost = 340,000 / 1.6 = $212,500

Intra entity gross profit = $340,000 - 212,500 = $127,500

Ending Inventory gross profit = $127,500 * 40% = $51,000

Requirement b. Prepare the worksheet adjustments for the December 31, 2021, consolidation of Corgan and Smashing.

Accounts Explanation and Title	Debit	Credit
Investment in Smashing	$48,000
Cost of Goods Sold		$48,000
Equity in Earnings of Smashing	$218,900
Investment in Smashing		$218,900
Investment in Smashing	$46,900
Dividend paid		$46,900
Amortization Expense	$33,000
Convenants		$33,000
Sales	$340,000
Cost of Goods Sold		$340,000
Cost of Goods Sold	$51,000
Inventory		$51,000