Question

Following are separate financial statements of Michael Company and Aaron Company as of December 31, 2018 (credit balances indicated by parentheses). Michael acquired all of Aaron’s outstanding voting stock on January 1, 2014, by issuing 20,000 shares of its own $1 par common stock. On the acquisition date, Michael Company’s stock actively traded at $26 per share.

	Michael Company 12/31/18				Aaron Company 12/31/18
Revenues	$	(637,000	)		$	(450,000	)
Cost of goods sold		283,500				180,000
Amortization expense		129,600				117,000
Dividend income		(5,000	)			0
Net income	$	(228,900	)		$	(153,000	)
Retained earnings, 1/1/18	$	(1,064,000	)		$	(541,000	)
Net income (above)		(228,900	)			(153,000	)
Dividends declared		90,000				5,000
Retained earnings, 12/31/18	$	(1,202,900	)		$	(689,000	)
Cash	$	141,000			$	17,000
Receivables		401,000				317,000
Inventory		585,000				323,000
Investment in Aaron Company		520,000				0
Copyrights		493,000				378,000
Royalty agreements		970,000				404,000
Total assets	$	3,110,000			$	1,439,000
Liabilities	$	(807,100	)		$	(620,000	)
Preferred stock		(300,000	)			0
Common stock		(500,000	)			(100,000	)
Additional paid-in capital		(300,000	)			(30,000	)
Retained earnings, 12/31/18		(1,202,900	)			(689,000	)
Total liabilities and equity	$	(3,110,000	)		$	(1,439,000	)

On the date of acquisition, Aaron reported retained earnings of $280,000 and a total book value of $410,000. At that time, its royalty agreements were undervalued by $60,000. This intangible was assumed to have a six-year remaining life with no residual value. Additionally, Aaron owned a trademark with a fair value of $50,000 and a 10-year remaining life that was not reflected on its books. Aaron declared and paid dividends in the same period.

1. a. Using the preceding information, prepare a consolidation worksheet for these two companies as of December 31, 2018.

2. b. Assuming that Michael applied the equity method to this investment, what account balances would differ on the parent's individual financial statements?

Answer 1

Part A

Aaron fair value (stock exchanged at fair value) (20000*26)	520000
Book value of subsidiary	410000
Excess fair value over book value	110000
Excess assigned to specific accounts based on fair values
		Life	Annual Excess Amortizations
Royalty agreements	60000	6 yrs.	10000
Trademark	50000	10 yrs.	5000
Total			15000

Aaron' retained earnings January 1, 2018	541000
Retained earnings at date of purchase	(280000)
Increase since date of purchase	261000
Excess amortization expenses ($15,000 x 4 years)	(60000)
Conversion to equity method for years prior to 2018 (Entry *C)	$20100

MICHAEL COMPANY AND CONSOLIDATED SUBSIDIARY Consolidation Worksheet For Year Ending December 31, 2018
				Consolidation Entries	Consolidated Totals
Accounts	Michael	Aaron		Debit		Credit
Revenues	(637000)	(450000)					(1087000)
Cost of goods sold	283500	180000					463500
Amortization expense	129600	117000		15000			261600
Dividend income	(5000)	0		5000			0
Net income	(228900)	(153000)					(361900)
Retained earnings 1/1	(1064000)	(541000)		541000		201000	(1265000)
Net income (above)	(228900)	(153000)					(361900)
Dividends paid	90000	5000				5000	90000
Retained earnings 12/31	(1202900)	(689000)					(1536900)
Cash	141000	17000					158000
Receivables	401000	317000					718000
Inventory	585000	323000					908000
Investment in Aaron Co.	520000			201000		721000	0
Copyrights	493000	378000					871000
Royalty agreements	970000	404000		20000		10000	1384000
Trademark				30000		5000	25000
Total assets	3110000	1439000					4064000
Liabilities	(807100)	(620000)					(1427100)
Preferred stock	(300000)	0					(300000)
Common stock	(500000)	(100000)		100000			(500000)
Additional paid-in capital	(300000)	(30000)		30000			(300000)
Retained earnings 12/31	(1202900)	(689000)					(1536900)
Total liabilities and equity	(3110000)	(1439000)		942000		1190000	(4064000)

Part B

Due to equity method, Equity in Earnings of Aaron, Retained Earnings—1/1/18, and Investment in Aaron Co will be different.

Equity in Earnings of Aaron (153000-15000)	$138000
Retained Earnings, 1/1/18 (1064000+60000)	$1124000
Investment in Aaron (520000+20100+(15300-15000-5000))	$535400

In equity in earnings of Aaron, parent would accrue 100% of Aaron's $15300 income minus $15,000 in amortization expense.