Question

The balance sheets of ABD Inc. and C Corporation on December 31, 2017 are given below:

	ABD Inc.	C Corp.
Assets
Cash	$800	$-0-
Account receivable	-0-	900
Inventory	700	-0-
Current assets	1,500	900
Plant & equipment, net	-0-	1,200
Total	$1,500	$2,100
Liabilities and shareholders’ equity
Account payable	$600	$-0-
Long-term debt	-0-	1,500
Total liabilities	$600	$1,500
Common stock ($1 par)	500	500
Additional paid-in capital	100	-0-
Retained earnings	300	100
Total	$1,500	$2,100

a. (For this question only) Suppose that ABD purchased 50% of the outstanding common shares of C for $500 cash (paid out of available cash balance; no issuance of common stock). (a) Prepare the B/S of ABD after the purchase (equity method) of investment. Assume that the market value of C’s assets at the time of purchase was $2,500 (with market value of PPE at $1,600); (b) Calculate current ratio and long-term debt-to-equity ratio of ABD before and after the purchase.

b. (Continuing from Requirement 2) Suppose that you, as a prominent financial analyst, decide to apply the proportionate consolidation on ABD’s balance sheet after the purchase of C. (a) Prepare the B/S of ABD with the proportionate consolidation; (b) Determine and explain the effect of proportionate consolidation on current ratio, long-term debt-to-equity ratio, and (3) indicate (higher, lower, or no change) & explain the effect on ROA ratio (you cannot calculate ROA due to limited information).

Answer 1

Part- a.
(a) Balance sheet of ABD Inc. After the purchase as on Dec. 31, 2017
	Amount ($)
Assets
Cash (800-500)	300
Account Receivable	0
Inventory	700
Current Assets	1,000
Plant and equipment, net	0
Investment in equity of C Corp. (2,500-1500)*50%	500
Total	1,500
Accounts payable	600
Long term debt	0
Total liabilities	600
Common stock ($1 par)	500
Additional paid in capital	100
Retained earnings	300
Shareholders equity	900
Total	1,500
(b) Calculation of ratio:
Current ratio = Current assets/Current liabilities
= 1,000/600 = 1.67
Long term debt to equity ratio = Total liabilities/Shareholders equity
= 600/900 = 0.67
Part- b.
(a) Consolidated Balance sheet of ABD Inc. as on Dec. 31, 2017
	Amount ($)
Assets
Cash (800-500)	300
Account Receivable	450
Inventory	700
Current Assets	1,450
Plant and equipment, net	600
Total	2,050
Accounts payable	600
Long term debt	750
Total liabilities	1,350
Common stock ($1 par)	500
Additional paid in capital	100
Retained earnings (300-200)	100
Shareholders equity	700
Total	2,050
(we have not considered market value of plant and equipment in this part of question as we assume that market value is given only for first part of question)
(b) Calculation of ratio after proportionate consolidation:
Current ratio = Current assets/Current liabilities
= 1,450/600 = 2.42
Current ratio increased due to increase in current ratio and staying constant of current liabilities.
Long term debt to equity ratio = Total liabilities/Shareholders equity
= 1,350/700 = 1.93
Ratio has changed compared to part a because shareholders equity decreased due to goodwill generated in purchase of C Corporation.