Question

On January 1, 2020, Corgan Company acquired 70 percent of the outstanding voting stock of Smashing, Inc., for a total of $910,000 in cash and other consideration. At the acquisition date, Smashing had common stock of $770,000, retained earnings of $320,000, and a noncontrolling interest fair value of $390,000. 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	$	220,000		$	42,000		$	170,000
2021		200,000			52,000			190,000

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

Solution:

Computation of balance in Corgan's Investment in Smashing, Inc., account as of December 31, 2021 using equity method

Corgan’s Investment balance as on December 31, 2021 = $1,102,125

Calculation and working:

Investment Account
	$$	$$
Consideration given, January 1, 2020		$910,000
Equity in Smashing's Earnings 2020:
Portion in Smashing's 2020 Net Income ($220,000 * 70%)	$154,000
Less: Covenant Amortization (Refer Note 1)          ($10,500 * 70%)	($7,350)
Less: Profit deferral - Ending Inventory 2020 (Refer note 2)          (19,125 * 100%)	($19,125)
Equity in Smashing's Earnings		$127,525
Less: Dividends 2020 ($42,000 * 70%)		($29,400)
Investment Account balance on 12/31/2020		$1,008,125
Equity in Smashing's Earnings 2020:
Portion in Smashing's 2021 Net Income ($200,000 * 70%)	$140,000
Less: Covenant Amortization (Refer Note 1)           ($10,500 * 70%)	($7,350)
Plus: Beginning Inventory Profit Recognition	$19,125
Less: Profit deferral - Ending Inventory 2021 (Refer Note 3)           (21,375 * 100%)	($21,375)
Equity in Smashing's Earnings		$130,400
Less: Dividends 2021 ($52,000 * 70%)		($36,400)
Investment Account balance on 12/31/2021		$1,102,125

Note 1 - Calculation of Annual Amortization	$$
Consideration given by Corgan	$910,000
Plus: Fair Value of Non Controlling Interest	$390,000
Smashing's Fair Value on acquisition date	$1,300,000
Less: Book Value of Subsidiary (Common Stock $770,000 + Retained Earnigns $320,000)	$1,090,000
Excess Fair Value over Book Value	$210,000
Excess Fair Value over Book Value Assigned to Covenants	$210,000
Divide by: Remaining useful life in year	20
Annual Amortization	$10,500
Note 2 - Calculation of Profit Defferal related to 2020 Ending Inventory
Cost of Inventory ($170,000 / 1.6)	$106,250
Gross Profit Intra-Entity ($170,000 - $106,250)	$63,750
Gross Profit in Ending Inventory ($63,750*30%)	$19,125
Note 3 - Calculation of Profit Defferal related to 2021 Ending Inventory
Cost of Inventory ($190,000 / 1.6)	$118,750
Gross Profit Intra-Entity ($190,000 - $118,750)	$71,250
Gross Profit in Ending Inventory ($71,250*30%)	$21,375