Question

On January 1, 2014, 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 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			Inventory Purchases from Corgan
2014	$	360,000		$	56,000		$	310,000
2015		340,000			66,000			330,000

Corgan sells inventory to Smashing using a 60 percent markup on cost. At the end of 2014 and 2015, 50 percent of the current year purchases remain in Smashing’s inventory.

a.	Compute the equity method balance in Corgan’s Investment in Smashing, Inc., account as of December 31, 2015.

      

b.	Prepare the worksheet adjustments for the December 31, 2015, consolidation of Corgan and Smashing. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

     

Answer 1

            Consideration transferred by Corgan                 $1,600,000

            Noncontrolling interest fair value                                400,000

            Smashing’s acquisition-date fair value                  2,000,000

            Book value of subsidiary                                           1,370,000

            Excess fair over book value                                         630,000

            Excess assigned to covenants                                   630,000

            Useful life in years                                                                 ÷ 20

            Annual amortization                                                        $31,500

            2014 Ending Inventory Profit Deferral

§ Cost = $310,000 ÷ 1.6 = $193,750

§ Intra-entity gross profit = $310,000 – $193,750 = $116,250

§ Ending inventory gross profit = $116,250 × 50% = $58,125

            2015 Ending Inventory Profit Deferral

§ Cost = $330,000 ÷ 1.6 = $206,250

§ Intra-entity gross profit = $330,000 – $206,250 = $123,750

§ Ending inventory gross profit = $123,750 ´ 50% = $61,875

           

            a. Investment account:                                                                           

                  Consideration transferred, January 1, 2014                                  $1,600,000

                        Smashing’s 2014 income × 80%                    $288,000                                

                        Covenant amortization (31,500 × 80%)            (25,200)                               

                        Ending inventory profit deferral (100%)          (58,125)                               

                  Equity in Smashing’s earnings                                                               204,675

            2014 dividends                                                                                          (44,800)

                  Investment balance 12/31/14                                                              $1,759,875

                        Smashing’s 2015 income × 80%                    $272,000                                

                        Covenants amortization (31,500 × 80%)         (25,200)                               

                        Beginning inventory profit recognition           58,125                                

                        Ending inventory profit deferral (100%)          (61,875)                               

                        Equity in Smashing’s earnings                                                         243,050

                  2015 dividends                                                                                             (52,800)

                  Investment balance 12/31/15                                                              $1,950,125

           

            b. 12/31/15 Worksheet Adjustments

*G Investment in Smashing                                58,125                 

            Cost of Goods Sold                                                     58,125

                                           

S   Common Stock—Smashing                       910,000                 

      Retained Earnings—Smashing                 764,000                 

            Investment in Smashing                                       1,339,200

            Noncontrolling Interest                                            334,800

A   Covenants                                                       598,500                 

            Investment in Smashing                                          478,800

            Noncontrolling Interest                                            119,700

I     Equity in Earnings of Smashing                243,050                 

            Investment in Smashing                                          243,050

                                           

D   Investment in Smashing                                52,800                 

            Dividends Paid                                                             52,800

E   Amortization Expense                                    31,500

            Covenants                                                                     31,500

                                            

TI Sales                                                                 330,000                 

            Cost of Goods Sold                                                  330,000

                                           

G   Cost of Goods Sold                                         61,875                 

            Inventory                                                                        61,875