Abraham, Inc., a New Jersey corporation, operates 57 bakeries throughout the northeastern section of the United States. In the past, its founder, James Abraham, owned all the company's outstanding common stock. However, during the early part of this year, the corporation suffered a severe cash flow problem brought on by rapid expansion. To avoid bankruptcy, Abraham sought additional investment capital from a friend, Dennis Bostitch, who owns Highland Laboratories. Subsequently, Highland paid $500,000 cash to Abraham, Inc., to acquire enough newly issued shares of common stock for a 55% ownership interest. The net book value of Abraham's assets and liabilities are $1,000,000.

At the end of this year, the accountants for Highland Laboratories are discussing the proper method of reporting this investment. One argues for maintaining the asset at its original cost: "This purchase is no more than a loan to bail out the bakeries. Mr. Abraham will continue to run the organization with little or no attention paid to us. After all, what does anyone in our company know about baking bread? I would be surprised if Abraham does not reacquire these shares as soon as the bakery business is profitable again."

One of the other accountants disagrees, stating that the equity method is appropriate and that consolidation is likely required. "I realize that our company is not capable of running a bakery. However, the official rules state that we must have only the ability to exert significant influence. With 55% of the common stock in our possession, we clearly have that ability. Whether we use it or not, this ability means that we should apply the equity method and consolidate the investment."

What criteria should Highland Laboratories consider to determine if it must consolidate Abraham, Inc. in their financials? Was there goodwill paid as a result of this transaction or was this a bargain purchase? How should Highland Laboratories account for its investment in Abraham, Inc.?