Question

On January 1, 2017, Corgan Company acquired 70 percent of the outstanding voting stock of Smashing, Inc., for a total of $980,000 in cash and other consideration. At the acquisition date, Smashing had common stock of $790,000, retained earnings of $340,000, and a noncontrolling interest fair value of $420,000. 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
2017	$	240,000		$	44,000		$	190,000
2018		220,000			54,000			210,000

Corgan sells inventory to Smashing using a 60 percent markup on cost. At the end of 2017 and 2018, 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, 2018.

b.Prepare the worksheet adjustments for the December 31, 2018, consolidation of Corgan and Smashing.

a.Compute the equity method balance in Corgan's Investment in Smashing, Inc., account as of December 31, 2018.

	Investment balance 12/31/18

Answer 1

Answer-

a. Computation of equity method balance in Corgan's Investment in Smashing, Inc., account as of December 31, 2018.

Details	Amount	Amount
Consideration Transferred, Jan 1, 2017		980,000
Smashing's 2017 income(240,000) x 70%	168,000
Covenants amortization (13,500 x 70%)	(9,450)
Ending inventory profit deferral (100%)	(35,625)
Equity in Smashing's earnings		122,925
2017 dividends (44,000 x 70%)		(30,800)
Investment balance 31/12/2017		1,072,125
Smashing's 2018 income x 70%	154,000
Covenants amortization (13,500 x 70%)	(9,450)
Beginning inventory profit recognition	35,625
Ending inventory profit deferral	(39,375)
Equity in Smashing's earnings		140,800
2018 dividends (54,000 x 70%)		(37,800)
Investment balance 31/12/2018		1,175,125

Working notes

1. Calculation of annual amortization

Formula	Details	Amount
a	Consideration transferred by Corgan	980,000
b	Non controlling interest fair value	420,000
c=a+b	Smashing's acquisition date fair value	1,400,000
d	Book value of subsidiary(790000+340000)	1,130,000
e=c-d	Excess fair over book value	270,000
f	Excess assigned to covenants	270,000
g	Useful life in years	20 years
h=f/g	Annual Amortization	13,500

2. Ending inventory profit deferrals

2017 ending inventory profit deferral
cost = 1,90,000 / 1.6	118,750
Intra entity gross profit = 190000-118,750	71,250
Ending inventory gross profit = 71,250 x 50%	35,625
2018 ending inventory profit deferral
cost = 210,000 / 1.6	131,250
Intra entity gross profit = 210,000 - 131,250	78,750
Ending inventory gross profit = 78,750 x 50%	39,375

b. Preparation of the worksheet adjustments for the December 31, 2018, consolidation of Corgan and Smashing.

Transaction	Consolidating entries	Debit	Credit
1	Prepare entry G
	Investment in Smashing	35,625
	Cost of Goods sold		35,625
2	Prepare entry S
	Common stock - Smashing	790,000
	Retained Earnings - Smashing (Bal Fig)	341,125
	Investment in Smashing (1,175,125 - 44,000)x70%		791,788
	Non controlling interest (30%)		339,337
3	Prepare entry A
	Covenants (270,000 - 13,500(for 1 year))	256,500
	Investment in Smashing (70%)		179,550
	Non controlling interest (30%)		76,950
4	Prepare entry I
	Equity in earnings of Smashing	140,800
	Investment in Smashing		140,800
5	Prepare entry D
	Investment in Smashing	37,800
	Dividends declared		37,800
6	Prepare entry E
	Amortization expense	13,500
	Covenants		13,500
7	Prepare entry T1
	Sales	210,000
	Cost of goods sold		210,000
8	Prepare entry G
	Cost of goods sold	39,375
	Inventory		39,375