Question

Cost method consolidation entries (controlling investment in affiliate, fair value differs from book value)

Assume an investee has the following financial statement information for the three years ending December 31, 2019:

(At December 31)	2019	2018	2017
Current assets	$285,000	$277,500	$207,000
Tangible fixed assets	662,500	575,000	563,000
Intangible assets	40,000	45,000	50,000
Total assets	$987,500	$897,500	$820,000
Current liabilities	$120,000	$110,000	$850,000
Noncurrent liabilities	266,250	242,500	220,000
Common stock	100,000	100,000	100,000
Additional paid-in capital	100,000	100,000	100,000
Retained earnings	400,000	345,000	300,000
Stockholders' equity	600,000	545,000	500,000
Total liabilities and equity	$986,250	$897,500	$820,000

(For the years ended December 31)	2019	2018	2017
Revenues	$970,000	$920,000	$850,000
Expenses	875,000	840,000	775,000
Net income	$95,000	$80,000	$75,000
Dividends	$40,000	$35,000	$25,000

Assume on January 1, 2017, an investor company purchased 100% of the outstanding voting common stock of the investee. On the date of the acquisition, the investee’s identifiable net assets had fair values that approximated their historical book values, except for tangible fixed assets, which had fair value that was $112,500 higher than the investee’s recorded book value. The tangible fixed assets had a remaining useful life of 6 years. In addition, the acquisition resulted in goodwill in the amount of $218,750 recognized in the consolidated financial statements of the investor company. On January 1, 2017, the investee’s retained earnings balance was $250,000. Assuming that the investor company uses the cost method to account for its investment in the investee, what is the amount of the [ADJ] entry necessary to prepare the consolidated financial statements for the year ended December 31, 2019?

$57,500

$93,750

$95,000

$150,000

Answer 1

$95,000 of net income is adjusted in preparing consolidated financial statements. Hence, the correct option is 'C'.
Explanation:
The income of $95,000 is adjusted in the preparation of consolidated financial statements because investor
company purchases 100% shares of investee company and as per cost method, income of investee company i.e.
$95,000 should be recorded as the income of investor company and that also includes dividend paid by the investee.
Net assets = Current assets + Tangible fixed assets + $112,500 - Current liabilities - Non-current liabilities + Goodwill
=	$207,000 + $563,000 + $112,500 - $100,000 - $220,000 + $218,750
=	$781,250
Depreciation expense = ($112,500 / 6) * 3 = $56,250
3 years net income = $95,000 + $80,000 + $75,000 = $250,000
Total dividend = $40,000 + $35,000 + $25,000 = $100,000
Investment invested on Dec 2019 = Net assets - Depreciation + Net income - Dividends
		=	$781,250 - $56,250 + $250,000 - $100,000
		=	$875,000