P Inc. purchased 90% of the voting shares of S Inc for $800,000 cash on January 1, 20X3; in addition, the purchase agreement included a contingent consideration payable in cash on January 1, 20X9. Assume management believes that $190,000 is the contingent consideration likely to become payable on January 1, 20X9 (ignore time value of money). P uses the cost method to account for its investment. On that date, Ss Common Stock and Retained Earnings were valued at $100,000 and $400,000 respectively.

Ss fair values approximated its carrying values with the following exceptions:

• The patent had a fair value which was $ 80,000 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.
• Ss inventory had a fair value which was $20,000 less than book value. This inventory was sold by S in 20X3.
• Ss management has an exceptional working relationship with the employee Union. In the light of recent strikes in the industry, experts believed that managements reputation certainly can be valued at $100,000.

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 P & S for the Year ended December 31, 20X6 are shown below:

Income Statements

P Inc. S Inc.

Sales $1,030,000 $800,000

Other Revenues $150,000 $100,000

Less: Expenses:

Cost of Goods Sold: $650,000 $500,000

Depreciation & amortization Expense $30,000 $20,000

Other Expenses $120,000 $80,000

Income Tax Expense $150,000 $120,000

Net Income $230,000 $180,000

Retained Earnings Statements

Balance, Jan 1, 2016 $1,000,000 $600,000

Net Income $230,000 $180,000

Less: Dividends ($200,000) ($140,000)

Retained Earnings $1,030,000 $640,000

Balance Sheets

PETE Inc. SETE Inc.

Cash $110,000 $120,000

Accounts Receivable $120,000 $170,000

Inventory $100,000 $125,000

Investments $800,000 25,000

Land $110,000 $190,000

Equipment (net) $150,000 $180,000

Patent - 10,000

Total Assets $1,390,000 $820,000

Current Liabilities $160,000 $80,000

Common Shares $200,000 $100,000

Retained Earnings $1,030,000 $640,000

Total Liabilities and Equity $1,390,000 $820,000

Other Information:

1. On Jan 1, 20X5 P purchased equipment for $50,000 and sold it immediately to S for $90,000 cash. The equipment is expected to be obsolete in 10 years.

2. January 20X6, S sold a parcel of land to P for $120,000 cash. S had purchased this land in 20X2 for $60,000. In November 20X6, P sold the land to a third party for $120,000.

3. During 20X6 P charged S $20,000 of management fees. S did not pay this amount in 20X6 but expects to pay the full $20,000 sometime in 20X7.

4. During December 20X6, S sold inventory to P for $80,000 cash, the cost of the inventory to S was $60,000. 50% of these goods remained in Ps inventory at the end of 20X6.

5. During December 20X5, P sold inventory to S for $50,000 cash, the cost of the inventory to P was $30,000. 50% of these goods remained in Ss inventory at the end of 20X5. SETE eventually sold the entire inventory to an outside customer in 20X6.

6. Year 20X4 there was impairment in GW of $100,000.

7. The Common Shares of P & S did not change since the date of acquisition.
8. Both companies use straight line amortization exclusively for all assets and liabilities.
9. The effective tax rate for both companies is 40%.
10. For Consolidation P uses the Fair Value Enterprise method.

REQUIRED:

1. Prepare a schedule showing the calculation of goodwill at the date of acquisition of sete under the entity theory, and a purchase price discrepancy amortization schedule.

2. Prepare a schedule showing the inter-company realized and unrealized profits for 20x3 to 20x6. Your schedule should include both pre-tax and after-tax amounts.

c) Prepare the consolidated financial statements under the entity theory: Statement of Income and Statement of Changes in Equity for the year ended January 1 20x6, and Statement of Financial Position as at January 1 20x6. Show all supporting calculations.