Assessment 1:  Accounting for Equity Investments

Assessment 1:  Accounting for Equity Investments

Exercise 1 Worksheet: Journal Entries

On January 1, 2015, the Parker Corporation acquired 10% of Simon Inc. for $420,000, even though Simon’s book value on January 1 was $3,400,000. Simon held land on its books that was undervalued by $200,000. In 2015, Simon earned $480,000 in net income and paid cash dividends of $180,000. Parker acquired an additional 30% of Simon January 1, 2016, for $1,200,000. Simon’s land remained undervalued as of that date by $240,000. Any excess cost was ascribed to a trademark with a life of 10 years for the first acquisition and a life of nine years for the second acquisition. Because fair values were not readily available, Parker maintained the initial investment of 10% at cost. The equity method will now be applied. In 2016, Simon reported $600,000 in income and $220,000 of distributed dividends.

Complete steps 1 and 2 below.

Step 1: Restate the 2015 purchase to the equity method in Tables 1, 2, and 3.

Step 2: Record the 2016 journal entries for Parker, using Tables 4–8 below.

Exercise 2 Worksheet: Consolidated Balance Sheet

On December 31, 2015, the Penn Corporation purchased all of Southern Company’s outstanding shares for $990,000 in cash. Penn will operate Southern as a wholly-owned subsidiary that has a separate legal and accounting identity. Many of Southern’s book values approximate fair values, but the fair values of some accounts differ from the book values. Additionally, Southern is carrying unrecorded, internally developed assets on its books. In determining the purchase price, Penn evaluated the differences between Southern’s fair values and its book values, as shown in the table below.

Table 1: Southern’s Fair Values and Book Values

Account Book Values Fair Values
Computer software $40,000 $140,000
Equipment $80,000 $60,000
Client contracts $0 $200,000
In-process research and development $0 $80,000
Notes payable ($120,000) ($130,000)

The financial information available for consolidation, as of December 31, 2015, is shown in the table below.

Account Penn Southern
Cash $72,000 $36,000
Receivables $232,000 $104,000
Inventory $280,000 $180,000
Investment in Southern $990,000 $0
Computer software $420,000 $40,000
Buildings (net) $1,190,000 $260,000
Equipment (net) $616,000 $80,000
Client contracts $0 $0
Research and development asset $0 $0
Goodwill $0 $0
Total assets $3,800,000 $700,000
Accounts payable ($176,000) ($5,000)
Notes payable ($1,020,000) ($120,000)
Common stock ($760,000) ($200,000)
Additional paid-in capital ($340,000) ($50,000)
Retained earnings ($1,504,000) ($280,000)
Total liabilities and equities ($3,800,000) ($700,000)

Prepare a consolidated balance sheet for Penn and Southern, as of December 31, 2015, using Tables 3, 4, and 5 below.

Exercise 3 Worksheet: Consolidated Balances

On January 1, 2015, Pueblo Corporation purchased all of Spartan Company’s outstanding stock for $1,200,000 cash. On that date, Spartan’s accounting records showed net assets of $940,000, even though equipment, with a life of 10 years, was undervalued on the books by $180,000. The life of recognized goodwill is considered to be indefinite. Spartan reported $180,000 net income in 2015 and $200,000 in 2016. The subsidiary paid dividends of $40,000 for each year. Financial figures are shown in Table 1 below for the year ending December 31, 2017. Credit balances are indicated in parentheses.

Table 1: Financial Figures for Year Ending December 31, 2017
Account Pueblo Spartan
Revenues ($1,600,000) ($1,200,000)
Cost of goods sold $200,000 $300,000
Depreciation expense $600,000 $700,000
Investment income ($40,000) $0
Net income ($840,000) ($200,000)
Dividends paid $240,000 $40,000
Retained earnings, December 31, 2017 ($2,800,000) ($800,000)
Current assets $600,000 $200,000
Investment in subsidiary $1,200,000 $0
Equipment (net) $1,800,000 $1,200,000
Buildings (net) $1,600,000 $800,000
Land $1,200,000 $200,000
Total assets $6,400,000 $2,400,000
Liabilities ($1,800,000) ($1,000,000)
Common stock ($1,800,000) ($600,000)
Retained earnings ($2,800,000) ($800,000)
Total liabilities and equity ($6,400,000) ($2,400,000)
  1. Determine consolidated balances, as of December 31, 2017, of the accounts listed below.
  2. How does the accounting method chosen by the parent company for its investment affect the consolidated balances computed for the accounts listed in question 1?
  3. Which accounting method for Spartan is Pueblo using for internal reporting?
  4. If Pueblo had used a different accounting method for this particular investment, how could you identify the method used?
  5. For each of the accounting methods listed below, determine Pueblo’s retained earnings balance as of January 1, 2017.