Question

McKinney Enterprises acquired Pottsboro, Inc. as a wholly-owned subsidiary on January 1, 2019 paying $1,750,000. The $440,000 excess of cost over book value of Pottsboro’s net assets was partly attributable to a patent undervalued by $210,000. The patent has a 10-year life. The remaining excess is considered goodwill. The parent uses the cost method of pre-consolidation Equity investment bookkeeping. The separate financial statements of the two companies for 2022 are presented below. Neither company issued additional shares after the acquisition Pottsboro by McKinney.

	McKinney Enterprises	Pottsboro, Inc.
Sales revenue	$3,100,000	$440,000
Cost of goods sold	-1,580,000	-252,000
Gross profit	1,520,000	188,000
Operating expenses	-485,000	-68,000
Dividend income	42,000	0
Net Income	$1,077,000	$120,000
Retained Earnings, 1/1/22	$1,700,000	$750,000
Net income	1,077,000	120,000
Dividends	-65,000	-42,000
Retained Earnings, 12/31/22	$2,712,000	$828,000
Cash and receivables	$535,000	$501,000
Inventory	758,000	840,000
Equity investment	1,750,000
Property, plant & equipment (Net)	4,596,000	1,205,480
Total Assets	$7,639,000	$2,546,480
Accounts payable	$265,000	$182,430
Accrued liabilities	458,000	272,390
Notes payable	780,000	603,500
Common stock	460,000	204,540
Additional paid-in capital	2,964,000	455,620
Retained Earnings, 12/31/22	2,712,000	828,000
Total Liabilities and Equities	$7,639,000	$2,546,480

Required:

a. What was Pottsboro, Inc.’s retained earnings balance on the acquisition date?

b. Prepare all necessary consolidation entries for 2022 consolidated financial statements.

Answer 1

ANSWERS:

Requirement a)

Pottsboro, Inc.’s retained earnings balance on the acquisition date

Pottsboro, Inc. was acquired on January 1, 2019

Particulars	Amount (in $)
Total Consideration	1,750,000
excess of cost over book value of Pottsboro’s net assets	(440,000)
Payment made towards Common Stock & Retained Earning	1,310,000‬
Common Stock	(204,540)
Retained earning on the date of acquisition	1,105,460‬

Requirement b)

Consolidation entries for 2022 consolidated financial statements

Particulars	Debit (in $)	Credit (in $)
Total Assets A/c	2,546,480
Patent Revalued [210,000 - (3 years - depreciation)]	147,000‬
Goddwill (440,000 - 210,000)	230,000
Loss after Acquisition (balance)	298,460
To All Liabilities (Except Common Stock & Retained Earnings)	‬	1,513,940
To Investment (1,750,000 - Dividend 42,000)		1,708,000‬
(Being consolidation done assuming the Patent Will be taken at present valuation & difference being the loss incurred after acqusition in 2019)

Working Notes

1) Calculation of Depreciation

Patent revalued = $210,000

Estimated life = 10 years

Depreciation = 210,000 / 10 = $21,000

3 years Depreciation = 21,000 * 3 = $63,000