Question

On January 1, 2017, Pinnacle Corporation exchanged $3,527,500 cash for 100 percent of the outstanding voting stock of Strata Corporation. On the acquisition date, Strata had the following balance sheet:

Cash	$	284,000			Accounts payable	$	383,000
Accounts receivable		311,000			Long-term debt		3,060,000
Inventory		443,000			Common stock		1,500,000
Buildings (net)		1,920,000			Retained earnings		1,205,000
Licensing agreements		3,190,000
	$	6,148,000				$	6,148,000

Pinnacle prepared the following fair-value allocation:

Fair value of Strata (consideration transferred)					$	3,527,500
Carrying amount acquired						2,705,000
Excess fair value					$	822,500
to buildings (undervalued)	$	480,000
to licensing agreements (overvalued)		(110,000	)			370,000
to goodwill (indefinite life)					$	452,500

At the acquisition date, Strata’s buildings had a 10-year remaining life and its licensing agreements were due to expire in 5 years. At December 31, 2018, Strata’s accounts payable included an $86,600 current liability owed to Pinnacle. Strata Corporation continues its separate legal existence as a wholly owned subsidiary of Pinnacle with independent accounting records. Pinnacle employs the initial value method in its internal accounting for its investment in Strata.

The separate financial statements for the two companies for the year ending December 31, 2018, follow. Credit balances are indicated by parentheses.

	Pinnacle				Strata
Sales	$	(7,683,000	)		$	(3,328,000	)
Cost of goods sold		4,940,000				1,835,000
Interest expense		338,000				207,000
Depreciation expense		630,000				448,000
Amortization expense						638,000
Dividend income		(35,000	)
Net income	$	(1,810,000	)		$	(200,000	)
Retained earnings 1/1/18	$	(5,160,000	)		$	(1,560,000	)
Net income		(1,810,000	)			(200,000	)
Dividends declared		600,000				35,000
Retained Earnings 12/31/18	$	(6,370,000	)		$	(1,725,000	)
Cash	$	282,000			$	547,000
Accounts receivable		1,255,000				305,000
Inventory		1,295,000				1,565,000
Investment in Strata		3,527,500
Buildings (net)		6,060,000				2,084,000
Licensing agreements						1,914,000
Goodwill		408,000
Total assets	$	12,827,500			$	6,415,000
Accounts payable	$	(337,500	)		$	(950,000	)
Long-term debt		(3,120,000	)			(2,240,000	)
Common stock		(3,000,000	)			(1,500,000	)
Retained earnings 12/31/18		(6,370,000	)			(1,725,000	)
Total Liabilities and OE	$	(12,827,500	)		$	(6,415,000	)

a.     Prepare a worksheet to consolidate the financial information for these two companies.

PINNACLE COMPANY AND SUBSIDIARY STRATA
Consolidation Worksheet
For Year December 31, 2018
			Consolidation Entries
Accounts	Pinnacle	Strata	Debit	Credit	Consolidated Totals
Sales	$(7,683,000)	$(3,328,000)
Cost of goods sold	4,940,000	1,835,000
Interest expense	338,000	207,000
Depreciation expense	630,000	448,000
Amortization expense		638,000
Dividend income	(35,000)
Net income	$(1,810,000)	$(200,000)			$0
Retained earnings 1/1/18	(5,160,000)	(1,560,000)
Net income	(1,810,000)	(200,000)			0
Dividends declared	600,000	35,000
Retained earnings 12/31/18	$(6,370,000)	$(1,725,000)			$0
Cash	$282,000	$547,000
Accounts receivable	1,255,000	305,000
Inventory	1,295,000	1,565,000
Investment in Strata	3,527,500
Buildings (net)	6,060,000	2,084,000
Licensing agreements		1,914,000
Goodwill	408,000
Total assets	$12,827,500	$6,415,000			$0
Accounts payable	(337,500)	(950,000)
Long-term debt	(3,120,000)	(2,240,000)
Common stock - Pinnacle	(3,000,000)
Common stock - Strata		(1,500,000)
Retained earnings 12/31/18	(6,370,000)	(1,725,000)			0
Total Liabilities and Owner's Equity	$(12,827,500)	$(6,415,000)	$0	$0	$0

b.     Compute the following amounts that would appear on Pinnacle’s 2018 separate (nonconsolidated) financial records if Pinnacle’s investment accounting was based on the equity method.

Subsidiary income.

Retained earnings, 1/1/18.

Investment in Strata.

1	Subsidiary income
2	Retained earnings 1/1/18
3	Investment in Strata

c.      What effect does the parent’s internal investment accounting method have on its consolidated financial statements?

	Effect of parent’s internal investment accounting method

Answer 1

Solution:

a.

PINNACLE COMPANY AND SUBSIDIARY STRATA
Consolidation Worksheet
For Year December 31, 2018
			Consolidation Entries
Accounts	Pinnacle	Strata	Debit	Credit	Consolidated Totals
Sales	($7,683,000)	($3,328,000)			($11,011,000)
Cost of goods sold	4,940,000	1,835,000			6,775,000
Interest expense	338,000	207,000			545,000
Depreciation expense	630,000	448,000	48,000		1,126,000
Amortization expense		638,000		22000	616,000
Dividend income	-35,000		35,000		0
Net income	($1,810,000)	($200,000)			($1,949,000)
Retained earnings 1/1/18	-5,160,000	-1,560,000	1,560,000	235,000	-5,395,000
Net income	-1,810,000	-200,000			-2,010,000
Dividends declared	600,000	35,000		35,000	600,000
Retained earnings 12/31/18	($6,370,000)	($1,725,000)			($6,805,000)
Cash	$282,000	$547,000			$829,000
Accounts receivable	1,255,000	305,000		86,600	1,473,400
Inventory	1,295,000	1,565,000			2,860,000
Investment in Strata	3,527,500		235,000	3,084,500	0
				620,500
Buildings (net)	6,060,000	2,084,000	283,000	48,000	8,379,000
Licensing agreements		1,914,000	22000	90500	1,845,500
Goodwill	408,000		452,500		860,500
Total assets	$12,827,500	$6,415,000			$17,655,900
Accounts payable	-337,500	-950,000	86,600		-1,200,900
Long-term debt	-3,120,000	-2,240,000			-5,360,000
Common stock - Pinnacle	-3,000,000				-3,000,000
Common stock - Strata		-1,500,000	1,500,000		0
Retained earnings 12/31/18	-6,370,000	-1,725,000			-8,095,000
Total Liabilities and Owner's Equity	($12,827,500)	($6,415,000)	$4,222,100	$4,222,100	($17,655,900)

b.

Subsidiary income (200,000 – 26,000).......................................$174,000

1/1/18 retained earnings (5,160,000 + 235,000).....................$5,395,000

Investment in Strata:

Initial value basis ..........................................................................................$3,527,500

Conversion to equity as of 1/1/18.........................235,000

Net income for 2018...............................................174,000

Dividends for 2018..................................................(35,000) 374,000

Equity method balance 12/31/18...................................... $3,901,500

c.The internal method choice for investment accounting has no effect on consolidatedfinancial statements.