Question

On January 1, 2017, Pinnacle Corporation exchanged $3,200,000 cash for 100 percent of the outstanding voting stock of Strata Corporation. On the acquisition date, Strata had the following balance sheet:

Cash	$	122,000			Accounts payable	$	375,000
Accounts receivable		283,000			Long-term debt		2,655,000
Inventory		350,000			Common stock		1,500,000
Buildings (net)		1,875,000			Retained earnings		1,100,000
Licensing agreements		3,000,000
	$	5,630,000				$	5,630,000

Pinnacle prepared the following fair-value allocation:

Fair value of Strata (consideration transferred)					$	3,200,000
Carrying amount acquired						2,600,000
Excess fair value					$	600,000
to buildings (undervalued)	$	300,000
to licensing agreements (overvalued)		(100,000	)			200,000
to goodwill (indefinite life)					$	400,000

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 $85,000 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	$	(7,000,000	)		$	(3,000,000	)
Cost of goods sold		4,650,000				1,700,000
Interest expense		255,000				160,000
Depreciation expense		585,000				350,000
Amortization expense						600,000
Dividend income		(50,000	)
Net income	$	(1,560,000	)		$	(190,000	)
Retained earnings 1/1/18	$	(5,000,000	)		$	(1,350,000	)
Net income		(1,560,000	)			(190,000	)
Dividends declared		560,000				50,000
Retained Earnings 12/31/18	$	(6,000,000	)		$	(1,490,000	)
Cash	$	433,000			$	165,000
Accounts receivable		1,210,000				200,000
Inventory		1,235,000				1,500,000
Investment in Strata		3,200,000
Buildings (net)		5,572,000				2,040,000
Licensing agreements						1,800,000
Goodwill		350,000
Total assets	$	12,000,000			$	5,705,000
Accounts payable	$	(300,000	)		$	(715,000	)
Long-term debt		(2,700,000	)			(2,000,000	)
Common stock		(3,000,000	)			(1,500,000	)
Retained earnings 12/31/18		(6,000,000	)			(1,490,000	)
Total Liabilities and OE	$	(12,000,000	)		$	(5,705,000	)

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

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

Answer 1