Question

On January 1, 20X1, Pesto Corporation purchased 90 percent of Sauce Corporation's common stock at underlying book value. At that date, the fair value of the noncontrolling interest was equal to 10 percent of Sauce Corporation's book value. Pesto uses the equity method in accounting for its investment in Sauce. The stockholders' equity section of Sauce at January 1, 20X5, contained the following balances:

Common Stock ($5 par)	$	400,000
Additional Paid-in Capital		200,000
Retained Earnings		790,000
Accumulated Other Comprehensive Income		10,000
Total	$	1,400,000

During 20X4, Sauce sold goods costing $30,000 to Pesto for $45,000, and Pesto resold 60 percent of them prior to year-end. It sold the remainder in 20X5. Also in 20X4, Pesto sold inventory items costing $90,000 to Sauce for $108,000. Sauce resold $60,000 of its purchases in 20X4 and the remaining $48,000 in 20X5.

In 20X5, Pesto sold additional inventory costing $30,000 to Sauce for $36,000, and Sauce resold $24,000 of it prior to year-end. Sauce sold inventory costing $60,000 to Pesto in 20X5 for $90,000, and Pesto resold $48,000 of its purchase by December 31, 20X5.

Pesto reported 20X5 income of $240,000 from its separate operations and paid dividends of $150,000. Sauce reported 20X5 net income of $90,000 and comprehensive income of $110,000. Sauce reported other comprehensive income of $10,000 in 20X4. In both years, other comprehensive income arose from an increase in the market value of items designated as a cash flow hedge. Sauce paid dividends of $60,000 in 20X5.

Required:
a. Compute the balance in the investment account reported by Pesto at December 31, 20X5.

Answer 1

Answer:

a.	Balance in investment account at December 31, 20X5:
	Proportionate share of Sauce's net assets,
	January 1 ([$1,400,000 x .90] - 8,000 - [6,000 x 0.90])	$1,246,600
	Proportionate share of 20X5 net income
	($90,000 x 0.90)	81,000
	Proportionate share of other comprehensive
	income for 20X5 ($20,000 x 0.90)	18,000
	Proportionate share of dividends received
	($60,000 x 0.90)	(54,000)
	Reversal of deferred gain from 20X4 downstream transaction	8,000
	Reversal of deferred gain from 20X4 upstream transaction ($6,000 x .090)	5,400
	Deferred gain from downstream transaction	(2,000)
	Proportionate share of deferred gain from upstream transaction ($14,000 x 0.90)	(12,600)
	Balance in investment account December 31, 20X5	$1,290,400