Question

1. Intercompany Transactions – Equity Method 60 points

Parent purchased 100% of a Subsidiary on January 1, 2020. The excess of investment cost over book value of $350,000 was allocated entirely to a 7-year royalty agreement. The parent uses the equity method to account for its investment in its subsidiary.

In 2021, Subsidiary sold to Parent land having a book value of $90,000 for a total price of $244,000.

On January 2, 2022, Parent sold equipment to Subsidiary for $120,000. The equipment had a cost of $185,000 and accumulated depreciation of $40,000. The remaining life of the equipment was estimated at 8 years.

Subsidiary regularly sells merchandise to Parent. In 2021, inter-company sales amounted to $82,400, with $16,480 of deferred profit remaining in ending inventory. Year-end inter-company receivables/payables amounted to $16,000.

In 2022, inter-company sales amounted to $75,000 with $37,500 of deferred profit remaining in ending inventory. Year-end inter-company receivables/payables amounted to $28,000.

Financial statements of Parent and Subsidiary for the year ended December 31, 2022 are presented below.

	Parent	Subsidiary
Sales Revenue	$7,500,000	$2,450,000
Cost of Goods Sold	-5,930,000	-1,950,000
Gross Profit	1,570,000	500,000
Operating Expenses	-1,375,000	-286,000
Loss on sale of equipment	-25,000	0
Equity Income	164,855	0
Net Income	$334,855	$214,000
Retained Earnings, 1/1/22	$3,916,000	$1,750,000
Net income	334,855	214,000
Dividends	-85,000	-176,000
Retained Earnings, 12/31/22	$4,165,855	$1,788,000
Cash and receivables	$1,750,000	$1,145,600
Inventory	958,000	758,000
Equity Investment	2,397,875	0
Property, Plant & Equipment (Net)	4,562,980	1,116,590
Total Assets	$9,668,855	$3,020,190
Accounts payable	$980,000	$225,000
Accrued liabilities	142,800	376,500
Notes payable	1,010,200	51,190
Common stock	1,792,000	158,000
Additional paid-in capital	1,578,000	421,500
Retained Earnings, 12/31/22	4,165,855	1,788,000
Total Liabilities and Equities	$9,668,855	$3,020,190

a.   Prepare the equity method journal entries recorded by the parent to account for its investment in Subsidiary during 2022.

b.   Prepare confirm the Income (loss) from subsidiary on Parent's pre-consolidation books for 2022.

c.   Prepare a schedule showing the computation of Equity Investment on Parent's pre-consolidation books at January 1 and December 31, 2022.

d.   Prepare the consolidation entries for 2022.

e.   Prepare a consolidating worksheet in excel.

Answer 1

Income/(Loss) of subsidiary
Net income of Subsidiary		214,000
Recognition of prior year gross profit		16,480
Current year gross profit inventory		(37,500)
Short depreciation on assets transfer		(3,125)
Loss on sale of equipment		25,000
Depreciation of assets		(50,000)
		164,855

assets
	Value	useful life	Depreciation	Depreciation 2 years	Value
Royalty agreement	350,000	7	50,000	100,000	250,000
	350,000		50,000	100,000	250,000

Equity Investment Balance as on December 31, 2022			Equity Investment Balance as on January 01, 2022
Retained earninng of subsidiary	1,750,000		Retained earninng of subsidiary		1,750,000
Common stock of subsidiary	158,000		Common stock of subsidiary		158,000
APIC of Subsidiary	421,500		APIC of Subsidiary		421,500
Income from subsidiary	164,855		Gross profit of inventory previous year		(16,480)
Gross profit of inventory previous year	(16,480)		Gain on land transfer		(154,000)
Dividend	(176,000)		Unamortized AAP assets		250,000
Gain on land transfer	(154,000)
Unamortized AAP assets	250,000
Equity balance as at 31st December	2,397,875		Equity balance as at 1st January		2,409,020

Equity method journal entries recorded by the parent to account for its investment in Subsidiary during 2022
Account title	Debit	Credit
Equity Investment	164,855
Income from subsidiary		164,855
Cash	176,000
Equity Investment		176,000

Consolidation entries
Account title	Debit	Credit
Income from Subsidiary	164,855
Equity investment		164,855
Common Stock (S)	158,000
Retained earning(S)	1,750,000
APIC	421,500
Equity investment		2,329,500
Royalty agreement	250,000
Equity investment		250,000
Operating expenses	50,000
Royalty agreement		50,000
Dividend	176,000
Equity investment		176,000
Account Payable	28,000
Account receivable		28,000
Equity Investment	16,480
Cost of good sold		16,480
Sales	75,000
Cost of good sold		75,000
Cost fo Good sold	37,500
Inventory		37,500
PPE	25,000
Loss on sale		25,000
Depreciation	3,125
PPE		3,125
Equity Investment	154,000
PPE		154,000

Consolidated Income Statement
Particulars	Parent	subsidiary	Adjustment	Total
Sales	7,500,000	2,450,000	(75,000)	9,875,000
Cost of good sold	(5,930,000)	(1,950,000)	53,980	(7,826,020)
Gross profit	1,570,000	500,000	(21,020)	2,048,980
Income from Subsidiary	164,855	-	(164,855)	-
Loss on sale of equipment	(25,000)		25,000	-
Operating expenses	(1,375,000)	(286,000)	(53,125)	(1,714,125)
Net Income	334,855	214,000	(214,000)	334,855
Consolidated Balance sheet
Particulars	Parent	subsidiary	Adjustment	Total
Assets
Cash	1,750,000	1,145,600		2,895,600
Acccount receivable			(28,000)	(28,000)
Inventory	958,000	758,000	(37,500)	1,678,500
PPE, net	4,562,980	1,116,590	(132,125)	5,547,445
Royalty agreement			200,000	200,000
Equity invetsment	2,397,875	-	(2,397,875)	-
	9,668,855	3,020,190	(2,395,500)	10,293,545
Liabilities and stockholder's equity
Accounts payable	980,000	225,000	(28,000)	1,177,000
Accrued liabilities	142,800	376,500		519,300
Notes payable	1,010,200	51,190		1,061,390
common stock	1,792,000	158,000	(158,000)	1,792,000
APIC	1,578,000	421,500	(421,500)	1,578,000
Retained earning	4,165,855	1,788,000	(1,788,000)	4,165,855
	9,668,855	3,020,190	(2,395,500)	10,293,545