Question

Problem 5-17 (LO 5-3,5-4,5-5) On January 1, 2017, Corgan Company acquired 80 percent of the outstanding voting stock of Smashing, Inc., for a total of $1,080,000 in cash and other consideration. At the acquisition date, Smashing had common stock of $780,000, retained earnings of $330,000, and a noncontrolling interest fair value of $270,000. Corgan attributed the excess of fair value over Smashing's book value to various covenants with a 20-year remaining life. Corgan uses the equity method to account for its investment in Smashing. During the next two years, Smashing reported the following: Net Income $230,000 210,000 2017 2018 Inventory Purchases from Corgan $180,000 200,000 Dividends Declared $43,000 53,000 Corgan sells inventory to Smashing using a 60 percent markup on cost. At the end of 2017 and 2018, 40 percent of the current year purchases remain in Smashing's inventory. a. Compute the equity method balance in Corgan's Investment in Smashing, Inc., account as of December 31, 2018. b. Prepare the worksheet adjustments for the December 31, 2018, consolidation of Corgan and Smashing.

Answer 1

1,080,000 270,000 1,350,000 Acquisition Analysis Consideration transferred by Corgan Fair value of Non controlling interest Fair value of Smashing company Less: Book value of Smashing Company Common stock Retained earnings Excess of Fair value over book value 780,000 330,000 $ (1,110,000) 240,000 Amortization per year [A/B] [A/B] 20 12,000 Allocation of Excess value to specified assets Initial Value [A] 240,000 Life [B] Covenants Calculation of Deferred profit on intra company inventory transfer downstream: Year 2017 Inventory purchase from Corgan 180,000 Profit % on cost 60% Cost price (180,000 / 160%) 112,500 Gross profit on transfer (180,000 - 112,500) 67,500 Unsold Inventory percentage 40% Deferred profit (67,500 x 40%) 27,000 Year 2018 Inventory purchase from Corgan Profit on cost Cost price (200,000 / 160%) Gross profit on transfer (200,000 - 125,000) Unsold Inventory percentage Deferred profit (75,000 x 40%) 200,000 60% 125,000 75,000 40% 30,000

a. Compute the Equity method balance 1,080,000 184,000 (9,600) (27,000) 147,400 (34,400) 1,193,000 Consideration transferred Add: Equity in Smashing's earnings 2017 Net income of Smashing (230,000 x 80%) Covenant Amortization (12,000 x 80%) Deferred profit in intra company transfer Less: 2017 Dividends (43,000 x 80%) Equity Investment in 01/01/2018 Add: Equity in Smashing's earnings 2018 Net income of Smashing (210,000 x 80%) Covenant Amortization (12,000 x 80%) Previous year deferred profit realized during the year Deferred profit in intra company transfer in 2018 Less: 2018 Dividends (53,000 x 80%) Investment Balance in 12/31/2018 168,000 (9,600) 27,000 (30,000) 155,400 (42,400) 1,306,000 $ Investment Balance 12/31/18 $ 1,306,000

Journal Entry Transaction *G Debit Credit 27,000 General Journal Investment in Smashing Cost of goods sold (to eliminate the beginning deferred profit on intra company inventory transfer) 27,000 780,000 517,000 Common Stock - Smashing Retained Earnings - Smashing Investment in Smashing (780,000 + 517,000) x 80% Non controlling interest (780,000 + 517,000) x 20% (to eliminate the subsidiary stockholders' equity) 1,037,600 259,400 228,000 Covenants Investment in Smashing (228,000 x 80%) Non controlling interest (228,000 x 20%) (to record unamortized value of covenants as on 01/01/18) 182,400 45,600 Equity in earnings of Smashing Investment in Smashing (to eliminate equity earnings) 155,400 Investment in Smashing Dividends declared (to eliminate the dividend declared by smashing) 42,400 Amortization expense Covenants (To record amortization expense) 12,000

200,000 Sales Cost of goods sold (to eliminate intra company inventory transfer 2018) 200,000 30,000 Cost of goods sold Inventory (to eliminate the deferred profit 2018) 30,000 Working Notes: 1) Calculation of retained earnings 01/01/18 Retained Earning of Smashing as on 01/01/17 Add: Net income Less: Dividends Retained Earning of Smashing as on 01/01/18 330,000 230,000 (43,000) 517,000 2) Unamortized Value of Covenants 01/01/18 Initial Value as on 01/01/17 Less: Amortization 2017 Carrying value as on 01/01/18 240,000 (12,000) 228,000