Question

Problem 3-29 (LO 3-1, 3-3a, 3-3b, 3-4)

Following are separate financial statements of Michael Company and Aaron Company as of December 31, 2018 (credit balances indicated by parentheses). Michael acquired all of Aaron’s outstanding voting stock on January 1, 2014, by issuing 20,000 shares of its own $1 par common stock. On the acquisition date, Michael Company’s stock actively traded at $34 per share.

	Michael Company 12/31/18				Aaron Company 12/31/18
Revenues	$	(742,000	)		$	(510,000	)
Cost of goods sold		336,000				210,000
Amortization expense		128,400				101,000
Dividend income		(5,000	)			0
Net income	$	(282,600	)		$	(199,000	)
Retained earnings, 1/1/18	$	(908,000	)		$	(777,000	)
Net income (above)		(282,600	)			(199,000	)
Dividends declared		90,000				5,000
Retained earnings, 12/31/18	$	(1,100,600	)		$	(971,000	)
Cash	$	150,000			$	15,400
Receivables		432,000				313,000
Inventory		576,000				293,000
Investment in Aaron Company		680,000				0
Copyrights		477,000				346,000
Royalty agreements		934,000				466,000
Total assets	$	3,249,000			$	1,433,400
Liabilities	$	(1,048,400	)		$	(332,400	)
Preferred stock		(300,000	)			0
Common stock		(500,000	)			(100,000	)
Additional paid-in capital		(300,000	)			(30,000	)
Retained earnings, 12/31/18		(1,100,600	)			(971,000	)
Total liabilities and equity	$	(3,249,000	)		$	(1,433,400	)

On the date of acquisition, Aaron reported retained earnings of $440,000 and a total book value of $570,000. At that time, its royalty agreements were undervalued by $60,000. This intangible was assumed to have a six-year remaining life with no residual value. Additionally, Aaron owned a trademark with a fair value of $50,000 and a 10-year remaining life that was not reflected on its books. Aaron declared and paid dividends in the same period.

1. a. Using the preceding information, prepare a consolidation worksheet for these two companies as of December 31, 2018.

2. b. Assuming that Michael applied the equity method to this investment, what account balances would differ on the parent's individual financial statements?

Answer 1

Part A

Aaron fair value (stock exchanged at fair value) (20000*34)	680000
Book value of subsidiary	570000
Excess fair value over book value	110000
Excess assigned to specific accounts based on fair values
		Life	Annual Excess Amortizations
Royalty agreements	60000	6 yrs.	10000
Trademark	50000	10 yrs.	5000
Total			15000

Aaron' retained earnings January 1, 2018	777000
Retained earnings at date of purchase	(440000)
Increase since date of purchase	337000
Excess amortization expenses ($15,000 x 4 years)	(60000)
Conversion to equity method for years prior to 2013 (Entry *C)	$277000

Part B

MICHAEL COMPANY AND CONSOLIDATED SUBSIDIARY Consolidation Worksheet For Year Ending December 31, 2013
				Consolidation Entries			Consolidated Totals
Accounts	Michael	Aaron		Debit		Credit
Revenues	(742000)	(510000)					(1252000)
Cost of goods sold	336000	210000					546000
Amortization expense	128400	101000		15000			244400
Dividend income	(5000)	0		5000			0
Net income	(282600)	(199000)					(461600)
Retained earnings 1/1	(908000)	(777000)		777000		277000	(1185000)
Net income (above)	(282600)	(199000)					(461600)
Dividends paid	90000	5000				5000	90000
Retained earnings 12/31	(1100600)	(971000)					(1556600)
Cash	150000	15400					165400
Receivables	432000	313000					745000
Inventory	576000	293000					869000
Investment in Aaron Co.	680000			277000		957000	0
Copyrights	477000	346000					823000
Royalty agreements	934000	466000		20000		10000	1410000
Trademark				30000		5000	25000
Total assets	3249000	1433400					4037400
Liabilities	(1048400)	(332400)					(1380800)
Preferred stock	(300000)	0					(300000)
Common stock	(500000)	(100000)		100000			(500000)
Additional paid-in capital	(300000)	(30000)		30000			(300000)
Retained earnings 12/31	(1100600)	(971000)					(1556600)
Total liabilities and equity	(3249000)	(1433400)		1254000		1254000	(4037400)

Part B

Due to equity method, Equity in Earnings of Aaron, Retained Earnings—1/1/18, and Investment in Aaron Co will be different.

Equity in Earnings of Aaron (199000-15000)	$184000
Retained Earnings, 1/1/18 (908000+60000)	$968000
Investment in Aaron (680000+277000+(199000-15000-5000)	$1136000

In equity in earnings of Aaron, parent would accrue 100% of Aaron's $199,000 income minus $15,000 in amortization expense.