Pcost Company purchased 85% of the common stock of Scost Company on April 1, Year 1. The fair value of the consideration transferred consisted of a cash payment of $545,000 and contingent consideration as described in the earnout agreement below. Under the agreement, Pcost Company agrees to pay an earn-out (contingent consideration) to the stockholders of Scost as part of the consideration for their shares. The Company has the option of paying any earn-out in cash and/or shares of its common stock and has estimated the fair value of the contingent consideration to be $50,000. Acquisition-related costs of $20,000 are included in other expenses. Scost will become a reportable segment for consolidated purposes. No control premium was included in the offer price.
Both companies have a December 31 year-end. Trial balances for Pcost and Scost on April 1, Year 1 were:

On the acquisition date, the book values and fair values of Scost's assets and liabilities were equal with the following exceptions.

The increase in Property and Equipment will be depreciated over seven years. All fair value estimates will be considered final (no measurement period adjustments).
Earnout (Contingent Consideration) Agreement-Pcost and Scost Company April 1, Year 1
The agreed-upon earn-out has three components. If the yearly revenue of Scost exceeds a target level at the end of years 1, 2, and 3, Pcost will pay the shareholders of Scost an amount equal to 50% of the excess, up to $85,000 per year for a maximum earn-out payment of $255,000 in total. The initial target revenue level for year 1 is $1,300,000 and increases in amount by 5% per year. Target levels in years 2 and 3 will be $1,365,000 and $1,433,250. Pcost estimates the fair value of the earn-out using the present value of expected payments and its incremental borrowing rate adjusted for risk of 20%. The fair value of the three earn-outs was estimated to be $50,000 on the date of acquisition, computed as follows:
Fair Value of Contingent Consideration

Changes in fair value and interest charges are included in "other expense (income)" on the income statement.
Required:
1. Prepare a consolidated balance sheet on the date of acquisition. You can assume that Scost closes its books on this date to facilitate consolidation.
2. Suppose that a control premium was included in the 85% interest acquired by Scost, and that a level 3 estimation of the valuation of Scost shares amounted to $79 per share (Pcost's purchase price of $595,000 implies a purchase price of $87.50 per share). Prepare the
journal entry needed to eliminate the investment account on the date of acquisition. Highlight the changes from part 1.

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At April 1, Year 1 Accounts Receivables Treasury Stock at Cost, 500 Shares Investment in Scost Company Property and Equipment (net) Cost of Goods Sold Selling, General, & Administration Dividends Declared Contingent Consideration Dividends Payable Common Stock, $5 par value Other Contributed Capital Retained Earnings, 1/1 2 Book Value 116,000 465,000 Fair Value 146,000 507,000 Inventory Property and Equipment Year 1 Year 2 Year 3 Total Estimated Revenues of Scost Target level Revenues Estimated exces:s Reduced by 50% Potential payout Present value factor Fair value of earn-out $1,300,000 1,300,000 0 0.50 0 0.876 0 $1,415,600 1,365,000 50,600 0.50 25,300 0.719 18,180 $1,541,250 4,433,250 108,000 0.50 54,000 0.589 31,820 $50,000