Question

Fred, Inc., and Herman Corporation formed a business combination on January 1, 2016, when Fred acquired a 60 percent interest in Herman's common stock for $312,000 in cash. The book value of Herman's assets and liabilities on that day totaled $300,000 and the fair value of the noncontrolling interest was $208,000. Patents being held by Herman (with a 12-year remaining life) were undervalued by $90,000 within the company's financial records and a customer list (10-year life) worth $130,000 was also recognized as part of the acquisition-date fair value.

 

Intra-entity inventory transfers occur regularly between the two companies. Merchandise carried over from one year to the next is always sold in the subsequent period.

 

Year	Original Cost to Herman		Transfer Price to Fred		Ending Balance at Transfer Price
2016	$	80,000	$	100,000	$	20,000
2017		100,000		125,000		40,000
2018		90,000		120,000		30,000

 

Fred had not paid for half of the 2018 inventory transfers by year-end.

 

On January 1, 2017, Fred sold $15,000 in land to Herman for $22,000. Herman is still holding this land.

 

On January 1, 2018, Herman acquired $20,000 (face value) of Fred's bonds in the open market. These bonds had an 8 percent cash interest rate. On the date of repurchase, the liability was shown within Fred's records at $21,386, indicating an effective yield of 6 percent. Herman's acquisition price was $18,732 based on an effective interest rate of 10 percent.

 

Herman indicated earning a net income of $25,000 within its 2018 financial statements. The subsidiary also reported a beginning Retained Earnings balance of $300,000, dividends of $4,000, and common stock of $100,000. Herman has not issued any additional common stock since its takeover. The parent company has applied the equity method to record its investment in Herman.

 

1. Prepare consolidation worksheet adjustments for 2018.

2. Calculate the amount of consolidated net income attributable to the noncontrolling interest for 2018. In addition, determine the ending 2018 balance for noncontrolling interest in the consolidated balance sheet.

3. Determine the consolidation worksheet adjustments needed in 2019 in connection with the intra-entity bonds.

Answer 1

Calculation of excess acquisition date fair value Consideration paid on 1/1/2016 Fair value of NCI Total fair value of Herman Less: Net book value Excess of fair value Allcations -Patent -Customer List 3,12,000 2,08,000 5,20,000 3,00,000 2,20,000 90,000 1,30,000 1. Annual amortization resulting from the acquisition-date fair-value allocations Increase in Value Amortization Amortizati Period (In on per years) year 7,500 10 13,000 $ 20,500 12 Patent Customer List Total 90,000 1,30,000 2. Intra-entity transfers upstream or downstream? Since subsidiary company transfer to parent company, such transaction will be "Upstream".

3. Intercompany Inventory profit defferal on 01.01.2018 1/1/2018 Upstream Cost to Herman Transfer to Fred Mark up 1,00,000 1,25,000 25,000 20% Markup on sales (%) (25,000 / 125,000) Ending Inventory 40,000 8,000 Intercompany profit ($ 40,000 x 20%) 4. Intercompany Inventory profit defferal on 12.31.2018 31-12-2018 Cost to Herman Transfer to Fred 90,000 1,20,000 30,000 Mark up 25% Markup on sales (%) (30,000 / 120,000) Ending Inventory 30,000 Intercompany profit 7,500

5. Fred's equity in earnings of Herman for 2018 25,000 (20,500) Herman' reported 2018 Income fair value amortization ( 7500 + 13,000) Elimination of Intercompany gross profit - Opening inventory - Closing inventory Adjusted subsidiary earnings Fred's equity in earnings of Herman (5,000 x 60%) 8,000 (7,500 5,000 3,000 6. Net income attributable to NCI Adjusted subsidiary income Noncontrolling interest NCI earning in Herman 5,000 40% 2,000 $ 7. Bond interest income & Interest expense calculation Face value Book Value Effective Cash Interest Interest (8% on FV) $ 1,873 $ 1,600 1,283.16 1,600 Year End Book Excess Value (BV + Excess Amortization Amortization $ 273 $ 19,005 (317) 21,069 $ Investment - Herman (Effective Interest @ 10%) Liability - Fred (Effective Interest @ 6%) 20,000 $ 20,000 18,732 21,386

5. Fred's equity in earnings of Herman for 2018 25,000 (20,500) Herman' reported 2018 Income fair value amortization ( 7500 + 13,000) Elimination of Intercompany gross profit - Opening inventory - Closing inventory Adjusted subsidiary earnings Fred's equity in earnings of Herman (5,000 x 60%) 8,000 (7,500 5,000 3,000 $ 6. Net income attributable to NCI Adjusted subsidiary income Noncontrolling interest NCI earning in Herman 5,000 40% 2,000 Part C 7. Bond interest income & Interest expense calculation Year End Book Effective Cash Interest Excess Face value Book Value Value (BV + Excess Interest (8% on FV) Amortization Amortization 20,000 $ 18,732 $ 1,873 $ 1,600 $ 273 $ 19,005 20,000 21,386 1,283.16 1,600 (317) 21,069 Investment - Herman (Effective Interest @ 10%) Liability - Fred (Effective Interest @ 6%)

B. Detremination of Ending Balance of NCI Non controlling interest Balance on 01/01/2018 Add: Net income (WN-6) Less: Dividend (4,000 X 40%) Non controlling interest Balance on 31/12/2018 Amount 2,28,400 2,000 1,600 2,28,800 $

8. Consolidation Worksheet elimination Entries Debit Credit Transactions Description TL Investment in Herman Land (To record elimination of intra- entity profit on Land) 7,000 7,000 8,000 Retained Earnings 1/1/18 (Herman) Cost of Goods Sold (To record unrealized inventory gain on 1/1/18) 8,000 1,00,000 2,92,000 Common Stock (Herman) Retained Earnings, 1/1/18 (Herman) (300,000 - 8,000) Investment in Herman (60%) Noncontrolling Interest in Herman (40%) (To record elimination of Herman's stockholder's equity) 2,35,200 1,56,800 75,000 1,04,000 Patent Customer List Investment in Herman Noncontrolling Interest (to record unamotized balances on 1/1/18) 1,07,400 71,600 3,000 Equity income of Herman (WN-5) Investment in Herman (To record elimination of intra entity income accrual) 3,000

2,400 Investment in Herman (4,000 x 60%) Dividends Declared (To record elimination of intra entity dividend income) 2,400 20,500 Amortization Expense Patents Customer List (To record current year amortization expense) 7,500 13,000 60,000 Accounts Payable (120,000 x 50%) Accounts Receivable (To record elimination of intra entity debt) 60,000 B 20,000 1,069 1,873 Bonds Payable Premium on Bonds Payable Interest Income Investment in Parent Bonds Interest Expense Gain on Retirement of Bonds (21,836 - 18,732) (To record elimination of bond acquisition and retirement gain) 19,005 1,283 2,654 1,20,000 Sales Cost of Goods sold (To record elimination of intra entity transfers) 1,20,000 7,500 Cost of Goods sold (WN-4) Inventory (To record deferment of intra entity inventory profits) 7,500