Question

On January 1, 2020, Corgan Company acquired 80 percent of the outstanding voting stock of Smashing, Inc., for a total of $1,600,000 in cash and other consideration. At the acquisition date, Smashing had common stock of $910,000, retained earnings of $460,000, and a noncontrolling interest fair value of $400,000. Corgan attributed the excess of fair value over Smashing's book value to various covenants with a 20-year remaining life. Corgan uses the equity method to account for its investment in Smashing.

During the next two years, Smashing reported the following:

	Net Income			Dividends Declared			Inventory Purchases from Corgan
2020	$	360,000		$	56,000		$	310,000
2021		340,000			66,000			330,000

Corgan sells inventory to Smashing using a 60 percent markup on cost. At the end of 2020 and 2021, 50 percent of the current year purchases remain in Smashing's inventory.

1. Compute the equity method balance in Corgan's Investment in Smashing, Inc., account as of December 31, 2021.
2. Prepare the worksheet adjustments for the December 31, 2021, consolidation of Corgan and Smashing.

Answer 1

Consideration transferred	1,600,000
Add: Non controlling interest fair value	400,000
Smashing's acquisition date fair value	2,000,000
Less: Book value of subsidiary [910,000 + 460,000]	(1,370,000)
Excess fair book value (assigned to covenants)	630,000
Divide by: Useful life	20years
Annual amortization	31,500

2020 Inventory profit
Inventory purchased	310,000
Profit %	60%
Cost price	193,750
Gross profit on transfer [310,000 - 193,750]	116250
Unsold inventory %	50%
Deferred profit	58,125
2021 Inventory profit
Inventory purchased	330,000
Profit %	60%
Cost price	206,250
Gross profit on transfer [330,000 - 206,250]	123,750
Unsold inventory %	50%
Deferred profit	61,875

A.Investment A/c

Consideration transaferred		1,600,000
Smashings 2020 income x 80%	288,000
Covenant amortization [31,500 x 80%]	(25,200)
Ending inventory profit deferral	(58,125)
Equity in smashing earnings		204,675
2020 dividends [80%]		(44,800)
Investment balance 31.12.2020		1,759,875
Smashing 2021 income [80%]	272,000
Covenant amortization [31,500 x 80%]	(25,200)
Opening inventory profit recognition	58,125
Ending inventory profit deferral	(61,875)
Equity in smashing earnings		243,050
Less: 2021 dividends [80%]		(52,800)
Investment balance 31.12.2021		1,950,125

B. Journal entries

	Debit	Credit
Investment in smashing Dr.	58,125
To cost of goods sold		58,125
Common stock- Smashing Dr.	910,000
Retained earnings-smashing Dr. [460,000 + 360,000 - 56,000]	764,000
To Investment in smashing [80%]		1,339,200
To Non controlling interest [20%]		334,800
Covenants Dr. [630,000 - 31,500]	598,500
To Investment in smashing [80%]		478,800
To Non controlling interest [20%]		119,700
Equity in earnings of smashing Dr.	243,050
To investment in smashing		243,050
Investment in smashing Dr.	52,800
To dividend paid		52,800
Amortization Expense Dr.	31,500
To covenants		31,500
Sales Dr.	330,000
To cost of goods sold		330,000
Cost of goods sold Dr.	61,875
To Inventory		61,875