Question

On January 1, 2017, Pinnacle Corporation exchanged $3,767,500 cash for 100 percent of the outstanding voting stock of Strata Corporation. On the acquisition date, Strata had the following balance sheet:

Cash	$	315,000			Accounts payable	$	403,000
Accounts receivable		355,000			Long-term debt		3,050,000
Inventory		433,000			Common stock		1,500,000
Buildings (net)		2,250,000			Retained earnings		1,545,000
Licensing agreements		3,145,000
	$	6,498,000				$	6,498,000

Pinnacle prepared the following fair-value allocation:

Fair value of Strata (consideration transferred)					$	3,767,500
Carrying amount acquired						3,045,000
Excess fair value					$	722,500
to buildings (undervalued)	$	412,000
to licensing agreements (overvalued)		(119,000	)			293,000
to goodwill (indefinite life)					$	429,500

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 $90,600 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	$	(7,620,000	)		$	(3,283,000	)
Cost of goods sold		4,800,000				1,825,000
Interest expense		295,000				167,000
Depreciation expense		620,000				387,000
Amortization expense						629,000
Dividend income		(55,000	)
Net income	$	(1,960,000	)		$	(275,000	)
Retained earnings 1/1/18	$	(5,385,000	)		$	(1,812,400	)
Net income		(1,960,000	)			(275,000	)
Dividends declared		400,000				55,000
Retained Earnings 12/31/18	$	(6,945,000	)		$	(2,032,400	)
Cash	$	370,000			$	563,400
Accounts receivable		1,515,000				355,000
Inventory		1,535,000				1,465,000
Investment in Strata		3,767,500
Buildings (net)		5,915,000				2,442,000
Licensing agreements						1,887,000
Goodwill		390,000
Total assets	$	13,492,500			$	6,712,400
Accounts payable	$	(522,500	)		$	(960,000	)
Long-term debt		(3,025,000	)			(2,220,000	)
Common stock		(3,000,000	)			(1,500,000	)
Retained earnings 12/31/18		(6,945,000	)			(2,032,400	)
Total Liabilities and OE	$	(13,492,500	)		$	(6,712,400	)

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

2. 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.

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

Answer 1

a.

			Consolidation entries
Accounts	Pinnacle	Strata	Debit	Credit	Consolidated totals
Sales	(7,620,000.00)	(3,283,000.00)			(10,903,000.00)
Cost of goods sold	4,800,000.00	1,825,000.00			6,625,000.00
Interest expense	295,000.00	167,000.00			462,000.00
Depreciation expense	620,000.00	387,000.00	41,200.00		1,048,200.00
Amortization expense		629,000.00		23,800.00	605,200.00
Dividend income	55,000.00		55,000.00
Net income	(1,960,000.00)	(275,000.00)			(2,162,600.00)
Retained earnings 1/1/18	(5,385,000.00)	(1,812,400.00)	1,812,400.00	250,000.00	5,635,000.00
Net income	(1,960,000.00)	(275,000.00)			(2,162,600.00)
Dividends paid	400,000.00	55,000.00		55,000.00	400,000.00
Retained earnings 12/31/18	(6,945,000.00)	(2,032,400.00)			(7,397,600.00)
Cash	370,000.00	563,400.00			933,400.00
Accounts receivable	1,515,000.00	355,000.00		90,600.00	1,779,400.00
Inventory	1,535,000.00	1,465,000.00			3,000,000.00
Investment in Strata	3,767,500.00		250,000.00	4,017,500.00
Buildings (net)	5,915,000.00	2,442,000.00	370,800.00	41,200.00	8,686,600.00
Licensing agreements		1,887,000.00	23,800.00	95,200.00	1,815,600.00
Goodwill	390,000.00		429,500.00		819,500.00
Total assets	13,492,500.00	6,712,400.00			17,034,500.00
Accounts payable	(522,500.00)	(960,000.00)	90,600.00		(1,391,900.00)
Long term debt	(3,025,000.00)	(2,220,000.00)			(5,245,000.00)
Common Stock - Pinnacle	(3,000,000.00)				(3,000,000.00)
Common Stock - Strata		(1,500,000.00)	1,500,000.00
Retained earnings 12/31/18	(6,945,000.00)	(2,032,400.00)			(7,397,600.00)
Total liabilities and owner's equity	13,492,500.00	6,712,400.00	4,573,300.00	4,573,300.00	(17,034,500.00)

b.

1	Subsidiary Income	257,600.00
2	Retained earnings 1/1/18	5,635,000.00
3	Investment in Strata	4,220,100.00

c. The answer will be "no effect". This is because the internal method choice for investment accounting has no effect on consolidated financial statements.

Calculations and explanations:

Subsidiary income = 275,000 - 17,400 = 257,600

1/1/18 retained earnings = $5,385,000 +$250,000 = 5,635,000

Investment in Strata = 3,767,500 (initial value basis) + 250,000 (conversion to equity as of 1/1/18)+ 257,600 (income for 2018) - 55,000 (dividends for 2018) = 4,220,100