Question

Determining ending consolidated balances in the third year following the acquisition—Equity method

Assume that your company acquired a subsidiary on January 1, 2017. The purchase price was $900,000 in excess of the subsidiary’s book value of Stockholders’ Equity on the acquisition date, and that excess was assigned to the following [A] assets:

[A] Asset	Original Amount	Original Useful Life
Patent	$600,000	10 years
Goodwill	300,000	Indefinite
	$900,000

The [A] assets with a useful life have been amortized as part of the parent’s equity method accounting. The financial statements of the parent and its subsidiary for the year ended December 31, 2019, are as follows:

	Parent	Subsidiary			Parent	Subsidiary
Income statement:				Balance sheet:
Sales	$3,000,000	$1,000,000		Assets
Cost of goods sold	(2,000,000)	(520,000)		Cash	$700,000	$160,000
Gross profit	1,000,000	480,000		Accounts receivable	910,000	200,000
Equity income	200,000			Inventory	1,200,000	300,000
Operating expenses	(450,000)	(220,000)		Equity investment	1,720,000
Net income	$750,000	$260,000		Property, plant and equipment (PPE), net	3,000,000	800,000
					$7,530,000	$1,460,000
Statement of retained earnings:
BOY retained earnings	$2,580,000	$ 400,000		Liabilities and stockholders’ equity
Net income	750,000	260,000		Accounts payable	$400,000	$90,000
Dividends	(200,000)	(40,000)		Accrued liabilities	500,000	120,000
Ending retained earnings	$3,130,000	$ 620,000		Long-term liabilities	1,000,000	250,000
				Common stock	500,000	300,000
				APIC	2,000,000	80,000
				Retained earnings	3,130,000	620,000
					$7,530,000	$1,460,000

At what amount will the following accounts appear in the consolidated financial statements for the year ended December 31, 2019?

Account	Amount
a. Cost of goods sold	Answer
b. Equity income	Answer
c. Operating expenses	Answer
d. Cash	Answer
e. Equity investment	Answer
f. PPE, net	Answer
g. Patent	Answer
h. Goodwill	Answer
i. Common Stock	Answer
j. Retained Earnings	Answer

Answer 1

Equity method is used when a parent company has significant influence over the affairs of a subsidiary company. In this case, the parent company does not report investments at fair value in its consolidated financial statements but at a portion of stockholders’ equity it owns and therefore the parent reports only equity income in consolidated income statement and equity investment in consolidated balance sheet as follows:

	Particulars	Amount
a.	Cost of goods sold	$2,000,000
b	Equity income	$200,000
c	Operating expenses	$450,000
d	Cash	$700,000
e	Equity investment	$1,720,000
f	PPE, Net	$3,000,000
g	Patent	$0
h	Goodwill	$0
i.	Common stock	$500,000
j	Retained earnings	$3,130,000