Question

On January 1, 2017, Pinnacle Corporation exchanged $3,559,000 cash for 100 percent of the outstanding voting stock of Strata Corporation. On the acquisition date, Strata had the following balance sheet:

Cash	$	160,000			Accounts payable	$	448,000
Accounts receivable		320,000			Long-term debt		3,075,000
Inventory		448,000			Common stock		1,500,000
Buildings (net)		2,275,000			Retained earnings		1,345,000
Licensing agreements		3,165,000
	$	6,368,000				$	6,368,000

Pinnacle prepared the following fair-value allocation:

Fair value of Strata (consideration transferred)					$	3,559,000
Carrying amount acquired						2,845,000
Excess fair value					$	714,000
to buildings (undervalued)	$	408,000
to licensing agreements (overvalued)		(126,000	)			282,000
to goodwill (indefinite life)					$	432,000

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 $99,600 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	$	(7,896,000	)		$	(3,601,000	)
Cost of goods sold		5,090,000				2,050,000
Interest expense		281,000				230,000
Depreciation expense		640,000				435,000
Amortization expense						633,000
Dividend income		(40,000	)
Net income	$	(1,925,000	)		$	(253,000	)
Retained earnings 1/1/18	$	(5,035,000	)		$	(1,642,600	)
Net income		(1,925,000	)			(253,000	)
Dividends declared		450,000				40,000
Retained Earnings 12/31/18	$	(6,510,000	)		$	(1,855,600	)
Cash	$	243,500			$	501,100
Accounts receivable		1,430,000				445,000
Inventory		1,300,000				1,272,000
Investment in Strata		3,559,000
Buildings (net)		5,815,000				2,436,000
Licensing agreements						1,899,000
Goodwill		407,500
Total assets	$	12,755,000			$	6,553,100
Accounts payable	$	(400,000	)		$	(747,500	)
Long-term debt		(2,845,000	)			(2,450,000	)
Common stock		(3,000,000	)			(1,500,000	)
Retained earnings 12/31/18		(6,510,000	)			(1,855,600	)
Total Liabilities and OE	$	(12,755,000	)		$	(6,553,100	)

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

The choice of method of accounting for consolidation has the effect on balance sheet.
In case of the equity method, the parent company can present more accurate income balance.
It show the income on standalone basis and the income earned from subsidiary.
The combined presentation of balance sheet under equity method will bolster the profit
of the parent company