Question

On January 1, 2017, Pinnacle Corporation exchanged $3,360,500 cash for 100 percent of the outstanding voting stock of Strata Corporation. On the acquisition date, Strata had the following balance sheet:

Cash $ 379,000 Accounts payable $ 392,000 Accounts receivable 350,000 Long-term debt 2,955,000 Inventory 353,000 Common stock 1,500,000 Buildings (net) 1,880,000 Retained earnings 1,140,000 Licensing agreements 3,025,000 $ 5,987,000 $ 5,987,000

Pinnacle prepared the following fair-value allocation: Fair value of Strata (consideration transferred) $ 3,360,500 Carrying amount acquired 2,640,000 Excess fair value $ 720,500 to buildings (undervalued) $ 406,000 to licensing agreements (overvalued) (147,000 ) 259,000 to goodwill (indefinite life) $ 461,500

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 $88,400 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 $ (7,524,000 ) $ (3,505,000 ) Cost of goods sold 4,710,000 2,025,000 Interest expense 304,000 188,000 Depreciation expense 645,000 405,000 Amortization expense 605,000 Dividend income (40,000 ) Net income $ (1,905,000 ) $ (282,000 ) Retained earnings 1/1/18 $ (5,475,000 ) $ (1,400,200 ) Net income (1,905,000 ) (282,000 ) Dividends declared 450,000 40,000 Retained Earnings 12/31/18 $ (6,930,000 ) $ (1,642,200 ) Cash $ 447,000 $ 637,700 Accounts receivable 1,500,000 245,000 Inventory 1,550,000 1,595,000 Investment in Strata 3,360,500 Buildings (net) 5,770,000 2,052,000 Licensing agreements 1,815,000 Goodwill 400,000 Total assets $ 13,027,500 $ 6,344,700 Accounts payable $ (517,500 ) $ (772,500 ) Long-term debt (2,580,000 ) (2,430,000 ) Common stock (3,000,000 ) (1,500,000 ) Retained earnings 12/31/18 (6,930,000 ) (1,642,200 ) Total Liabilities and OE $ (13,027,500 ) $ (6,344,700 )

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

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.

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

Answer 1

worksheet to consolidate the financial information for these two companies

PINNACLE COMPANY AND SUBSIDIARY STRATA
Consolidation Worksheet
For Year December 31, 2018
			Consolidation Entries
Accounts	Pinnacle	Strata	Debit	Credit	Consolidated Totals
Sales	($7,524,000.00)	($3,505,000.00)			($11,029,000.00)
Cost of goods sold	$4,710,000.00	$2,025,000.00			$6,735,000.00
Interest expense	$304,000.00	$188,000.00			$492,000.00
Depreciation expense	$645,000.00	$405,000.00	$40,600.00		$1,090,600.00
Amortization expense		$605,000.00		$29,400.00	$575,600.00
Dividend income	$40,000.00		$40,000.00
Net income	($1,905,000.00)	($282,000.00)			($2,135,800.00)
Retained earnings 1/1/15	($5,475,000.00)	($1,400,200.00)	$1,400,200.00	$242,000.00	($5,717,000.00)
Net income	($1,905,000.00)	($282,000.00)			($2,130,400.00)
Dividends paid	$450,000.00	$40,000.00		$40,000.00	$450,000.00
Retained earnings 12/31/15	($6,930,000.00)	($1,642,200.00)			($7,397,400.00)
Cash	$447,000.00	$637,700.00			$1,084,700.00
Accounts receivable	$1,500,000.00	$245,000.00		$88,400.00	$1,656,600.00
Inventory	$1,550,000.00	$1,595,000.00			$3,145,000.00
Investment in Strata	$3,360,500.00		$242,000.00	$3,118,500.00	$0.00
Buildings (net)	$5,770,000.00	$2,052,000.00	$365,400.00	$40,600.00	$8,146,800.00
Licensing agreements		$1,815,000.00	$29,400.00	$117,600.00	$1,726,800.00
Goodwill	$400,000.00		$461,500.00		$861,500.00
Total assets	$13,027,500.00	$6,344,700.00			$16,621,400.00
Accounts payable	($517,500.00)	($772,500.00)	$88,400.00		($1,201,600.00)
Long-term debt	($2,580,000.00)	($2,430,000.00)			($5,010,000.00)
Common stock - Pinnacle	($3,000,000.00)				($3,000,000.00)
Common stock - Strata		($1,500,000.00)	$1,500,000.00		$0.00
Retained earnings 12/31/15	($6,930,000.00)	($1,642,200.00)			($8,572,200.00)
Total Liabilities and Owner's Equity	($13,027,500.00)	($6,344,700.00)	$4,167,500.00	$3,676,500.00	($3,607,400.00)

2

1)

subsidiary income

= =282000 - (40600 - 29400)

=$270,800

2)

retained earnings 1/1/18

= =5475000-242000

=$5,233,000

3)

investment in strata

Initial value basis		$3,360,500.00
conversion to equity as of 1/1/18	$242,000.00
income for 2018	$270,800.00
dividends for 2018	($40,000.00)	$472,800.00
equity method balance for 12/31/18		$3,833,300.00

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3

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

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