Question
Assignment: Consolidation Question PAPA Inc. purchased 85% of the voting shares of SMALL Inc for $1,000,000 cash on January 1, 2023; in addition, the purchase
Assignment: Consolidation Question
PAPA Inc. purchased 85% of the voting shares of SMALL Inc for $1,000,000 cash on January 1, 2023; in addition, the purchase agreement also included a contingent consideration payable in cash on January 1, 2029. Assume that since the acquisition date management believes that $200,000 (added to consideration) is the contingent consideration likely to become payable on January 1, 20X9 (ignore time value of money). PAPA uses the cost method to account for its investment. On that date, SMALLs Common Stock and Retained Earnings were valued at $300,000 and $500,000 respectively.
SMALLs fair values approximated its carrying values with the following exceptions:
- The equipment had a fair value which was $120,000 higher than its carrying value, and was estimated to have a remaining useful life of 10 years from the date of acquisition with no salvage value.
- SMALLs inventory had a fair value which was $15,000 less than book value. This inventory was sold by SMALL in 20X3.
- SMALLs skilled workforce had an exceptional reputation in the industry. Experts believed that the reputation of the work force should be valued at $225,000. Not included, is not an identifiable asset
Both companies use straight line amortization exclusively for all assets and liabilities. The effective tax rate for both companies is 40%.
The Financial Statements of PAPA & SMALL for the Year ended December 31, 2026, are shown below:
Income Statements
PAPA Inc. SMALL Inc.
Sales $1,300,000 $830,000
Other Revenues $400,000 $200,000
Less: Expenses:
Cost of Goods Sold: $700,000 $330,000
Depreciation Expense $30,000 $20,000
Other Expenses $120,000 $140,000
Income Tax Expense $170,000 $120,000
Net Income $680,000 $420,000
Retained Earnings Statements
Balance, Jan 1, 2016 $1,000,000 $800,000
Net Income $680,000 $420,000
Less: Dividends ($200,000) ($140,000)
Retained Earnings $1,480,000 $1.080,000
Balance Sheets
PAPA Inc. SMALL Inc.
Cash $100,000 $340,000
Accounts Receivable $300,000 $410,000
Inventory $320,000 $475,000
Investment in SMALL Inc. $1,000,000 -
Land $100,000 $80,000
Equipment (net) $220,000 $210,000
Total Assets $2,040,000 $1,515,000
Current Liabilities $160,000 $135,000
Common Shares $400,000 $300,000
Retained Earnings $1,480,000 $1,080,000
Total Liabilities and Equity $2,040,000 $1,515,000
Other Information:
- During 2026, SMALL sold a parcel of land to PAPA upstream for $100,000 cash. SMALL had purchased this land in 2022 for $60,000. (100k-60k = 40k unrealized profit, to be removed from I/S)PAPA is currently using the land to hold excess inventory.
- During 2026 PAPA charged SMALL $45,000 of rental fees. SMALL did NOT pay this amount in 2026 but expects to pay the full $45,000 sometime in 20X7. .(reduce Other income (PAPA) & Other Expenses (SMALL) by $50,000. Remove A/P (SMALL) & A/R (PAPA) ) No tax consideration, No unrealized/realized profit cancel each other out
- During December 20X6, SMALL sold inventory to PAPA ( upstream ending inventory) for $100,000 cash, the cost of the inventory to SMALL was $70,000 (30,000 profit). 50% of these goods remained in PAPAs inventory at the end of 2026. (30,000 x 50% = 15,000 is unrealized profit).
- During December 2025, PAPA sold inventory to SMALL (downstream opening inventory) for $60,000 cash, the cost of the inventory to PAPA was $40,000. (20,000 profit) . 40% of these goods remained in SMALLs inventory at the end of 2025. SMALL eventually sold the entire inventory to an outside customer in 2026. (20,000 x 40% = 8,000 is realized profit).
- Year 2024 there was impairment in GW of $35,000. (affects AD amortization schedule).
- The effective tax rate for both companies is 40%.
- PAPA has recorded the investment in SMALL at Cost.
- For Consolidation PAPA uses the Fair Value Enterprise (FVE) method.
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