Question

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On January 1, 2017, Corgan Company acquired 70 percent of the outstanding voting stock of Smashing,...

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

Solutions

Expert Solution

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

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