Question

Consolidation several years subsequent to date of acquisition—Equity method
Assume that a parent company acquired a subsidiary on January 1, 2014. The purchase price was $785,000 in excess of the subsidiary’s book value of Stockholders’ Equity on the acquisition date, and that excess was assigned to the following [A] assets:

[A] Asset								Original Amount			Original Useful Life
Property, plant and equipment (PPE), net								$140,000			16	years
Patent								245,000			7	years
License								105,000			10	years
Goodwill								295,000			Indefinite
								$785,000

The [A] assets with definite useful lives have been depreciated or amortized as part of the parent’s preconsolidation equity method accounting. The Goodwill asset has been tested annually for impairment, and has not been found to be impaired. The financial statements of the parent and its subsidiary for the year ended December 31, 2016, are as follows:

	Parent	Subsidiary			Parent	Subsidiary
Income statement				Balance sheet
Sales	$4,802,000	$1,338,300		Assets
Cost of goods sold	(3,457,300)	(784,700)		Cash	$719,600	$337,400
Gross profit	1,344,700	553,600		Accounts receivable	1,229,200	303,800
Equity income	159,150	-		Inventory	1,624,000	389,900
Operating expenses	(720,300)	(340,200)		Equity investment	1,650,550	-
Net income	$783,550	$213,400		Property, plant & equipment	2,923,200	721,000
Statement of retained earnings					$8,146,550	$1,752,100
BOY retained earnings	1,694,700	676,200		Liabilities and stockholders' equity
Net income	783,550	213,400		Accounts payable	$702,800	$124,600
Dividends	(394,000)	(58,000)		Accrued liabilities	835,800	163,100
Ending retained earnings	$2,084,250	$831,600		Long-term liabilities	2,100,000	436,100
				Common stock	527,100	87,500
				APIC	1,896,600	109,200
				Retained earnings	2,084,250	831,600
					$8,146,550	$1,752,100

a. Compute the Equity Investment balance as of January 1, 2016.

$Answer

b. Show the computation to yield the $159,150 equity income reported by the parent for the year ended December 31, 2016.

Do not use negative signs with your answers.

Subsidiary net income		$Answer
Less: Amortization	Answer
Less: Depreciation	Answer	Answer
		$Answer

c. Show the computation to yield the $1,650,550 Equity Investment account balance reported by the parent at December 31, 2016.

Do not use negative signs with your answers.

Equity investment at 1/1/16		$Answer
Plus: AnswerDividendsEquity incomeEquity investmentGoodwillOperating expensesPPE, netRetained earnings	Answer
Less: AnswerDividendsEquity incomeEquity investmentGoodwillOperating expensesPPE, netRetained earnings	Answer	Answer
Equity investment at 12/31/16		$Answer

Answer 1

a) When an equity method is used to record the equity investment, every year the investment is adjusted to the share of profits and losses from the subsidiary company. The share of profit from the subsidiary company is recognized as revenue in the Parent’s income statement with a corresponding increase in the Equity investment value and vice versa with the share of losses from the subsidiary company.

When a subsidiary pays dividend, even for that the equity investment value will be reduced, as it is treated as repayment of the investment.

The parent company reports its equity income from Subsidiary company on December 31, 2016 as $149,150. Dividends paid were $48,000 Balance sheet shows the equity investment value as $1,630,550. The value in the balance sheet is after increasing the investment value with the share of profits and decreasing the value by dividends during 2016 from the subsidiary company. So the equity investment balance as of January 1, 2016 will be $1,630,550 - $149,150 +$48,000 = $1,529,400.

b) Amortization will be calculated only on Patents and Licenses as they have definite life. Intangible assets with indefinite life will not be amortized. Only if there is any impairment, it will be recorded. It is given that there is no impairment on goodwill. So the Amortization to be adjusted is

Patents - $245,000/7 = $35,000

Licenses - $105,000/10 = $10,500

Total Amortization is $35,000 + $10,500 = $45,500

Depreciation on PPE - $140,000/16 = $8,750

Computation to yield $149,150 will be as follows

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