Question

Adams, Inc., acquires Clay Corporation on January 1, 2017, in exchange for $510,000 cash. Immediately after the acquisition, the two companies have the following account balances. Clay's equipment (with a five-year remaining life) is actually worth $440,000. Credit balances are indicated by parentheses. Current assets Investment in Clay Equipment Liabilities Common stock Retained earnings, 1/1/17 Adams $ 300,000 510,000 600,000 (200,000) (350,000) (860,000) Clay $ 220,000 0 390,000 (160,000) (150,000) (300,000) In 2017, Clay earns a net income of $55,000 and declares and pays a $5,000 cash dividend. In 2017, Adams reports net income from its own operations (exclusive of any income from Clay) of $125,000 and declares no dividends. At the end of 2018, selected account balances for the two companies are as follows: Clay $ (240,000) 180,000 0 Revenues Expenses Investment income Retained earnings, 1/1/18 Dividends declared Common stock Current assets Investment in Clay Equipment Liabilities Adams $ (400,000) 290,000 Not given Not given 0 (350,000) 580,000 Not given 520,000 (152,000) (350,000) 8,000 (150,000) 262,000 0 420,000 (130,000)

Answer 1

Solution

Adams Inc

1. Determination of December 31, 2018 investment income and investment in Clay account balances assuming Adams uses the

• Equity Method

Investment income – 2018

Equity accrual (Clay’s net income)        $60,000            (55,000 + 5,000)

Amortization                                        $10,000

Investment income, 2018                       $50,000

Basic computations:

Purchase price allocation and annual amortization –

Acquisition fair value of Clay    $510,000

Less: book value of Clay’s assets           $450,000          (220,000 + 390,000 – 160,000)

Fair value in excess of book value          $60,000

Less: equipment (fair value – book value) $50,000          (440,000 – 390,000)

Goodwill                                              $10,000           

Annual excess amortization (50,000/5)   $10,000

Investment in Clay – December 31, 2018

Consideration to Clay                $510,000

2017

Equity accrual (Clay’s net income)        $55,000

Excess amortization                              $(10,000)

Dividends                                             $(5,000)

2018

Equity accrual (Clay’s net income)        $60,000

Excess amortization                              $(10,000)

Dividends                                             $(8,000)

Total                                                    $592,000

• Initial Value Method

Investment income – 2018        

Dividend                      $8,000

Investment in Clay, December 31, 2017:

Purchase consideration $510,000

2. Impact of parent’s internal investment accounting method choice on the amount reported for expenses in December 31, 2018 consolidated income statement:

The parent’s investment accounting method choice do not affect the reported expenses in the consolidated income statement. Hence, consolidated expenses $480,000 (290,000 + 180,000 + 10,000) remain the same under the equity method, initial value method or partial equity method as applied by the parent company.

3. Impact of parent’s internal investment accounting method choice on the amount reported for equipment in December 31, 2018 consolidated balance sheet:

The parent’s investment accounting method choice do not affect the reported equipment balances on the consolidated balance sheet, December 31, 2018. Hence, consolidated equipment $970,000 (520,000 + 420,000 + 50,000 – (2 x 10,000)) remain the same under the equity method, initial value method or partial equity method as applied by the parent company.

4. Determination of Adam’s January 1, 2018 retained earnings account balance assuming,

• Equity method

Adam’s retained earnings – January 1, 2017       $860,000

Adam’s net income, 2017                      $125,000

2017 equity accrual for Clay net income $55,000

2017 excess amortization                       $(10,000)

Adam’s retained earnings, January 1, 2018         $1,030,000

• Initial Value Method

Adam’s retained earnings – January 1, 2017 $860,000

Adam’s net income, 2017                $125,000

2017 dividend income from Clay     $5,000

                        Adam’s retained earnings, January 1, 2018         $990,000

5. Worksheet adjustment to Adam’s retained earnings account balance on January 1, 2018 for its investment in Clay using the initial value method:

Entry C

Date	Account Titles and Explanation	Debit	Credit
Jan 1, 2018	Investment in Clay	$40,000
	Retained Earnings, Parent		$40,000
	(worksheet adjustment to Adam's retained earnings account balance on January 1, 2018; 55,000 - 5,000 - 10,000 = $40,000)
	($10,000 is prior amortization)

6. Worksheet entry to eliminate Clay’s stockholders’ equity:

Entry S for 2018

Common Stock (Clay)	$150,000
Retained Earnings, 1/1/18, Clay	$350,000
Investment in Clay		$500,000

7. Consolidated net income for 2018:

Consolidated Revenues, (combined)	$640,000
Consolidated expenses (combined + amortization)	$(480,000)
Consolidated net income	$160,000