Question 2.

On January 1, Year 5, PAD purchased 80% of the common shares of SBC for $4,500,000. On

that date, SBC had common shares of $1,250,000 and retained earnings of $3,000,000, and fair

values were equal to carrying values for all its net assets except inventory that was overvalued

$60,000, property, plant and equipment that was undervalued $120,000 (remaining useful life of

10 years), and note payable undervalued 5,000 (5 years to maturity) on SBC's books.

The financial statements for PAD and SBC for the year ended December 31, Year 8 were as

follows:

Balance Sheets

December 31, Year 8

PAD SBC

Cash $ 680,000 $ 435,000

Accounts receivable 1,505,000 1,005,000

Note receivable 50,000 20,000

Inventory 2,800,000 1,790,000

Property, plant and equipment 4,676,000 3,500,000

Accumulated depreciation 1,000,000 500,000

Investment in SBC 4,500,000 ?

Total assets $ 13,211,000 $ 6,250,000

Current liabilities $ 400,000 $ 255,000

Notes payable 5,251,000 1,185,000

Common shares 2,000,000 1,250,000

Retained earnings 5,560,000 3,560,000

Total $ 13,211,000 $ 6,250,000

453 2020 WT1 A3

Statements of Income and Retained Earnings

For the year ended December 31, Year 8

PAD SBC

Sales $ 3,800,000 $ 2,710,000

Cost of sales 1,600,000 1,140,000

Gross profit 2,200,000 1,570,000

Other income 240,000 40,000

Depreciation and amortization expense (480,000) (310,000)

Other expenses (400,000) (180,000)

Income tax expense (100,000) (70,000)

Net income 1,460,000 1,050,000

Retained earnings, beginning 4,200,000 2,580,000

Dividends paid (100,000) (70,000)

Retained earnings, end $ 5,560,000 $ 3,560,000

Additional information

1. Each year, goodwill is evaluated to determine if there has been a permanent impairment.

Goodwill impairment was $220,000 in Year 6 and $60,000 in Year 8.

2. On July 2, Year 6, PAD sold a machine to SBC for $215,000. PAD had paid $250,000 for this

machine on July 2, Year 1 and had been depreciating the machine on a straight-line basis over

10 years. There was no change in the estimated useful life of this machine or in the residual

value of $20,000.

3. During December Year 8, PAD purchased merchandise from SBC for $510,000, of which

PAD still owes SBC $180,000 at year-end. Of this merchandise, 35% was resold by PAD by

December 31, Year 8. In December 31, Year 7, the inventories of PAD contained $120,000 of

merchandise purchased from SBC. SBC earns a gross margin of 25% on its sales to PAD.

4. On January 1, Year 7, PAD lent SBC $10,000 due in 3 years and charges interest of 3%.

5. PAD accounts for its investment in SBC using the cost method.

6. Both companies pay income taxes at the rate of 40%.

Required: show all schedules and work for full marks

a) Prepare all 3 schedules

b) Calculate Consolidated Net Income for Year 8

c) Calculate Consolidated Retained Earnings January 1, Year 8

d) Prepare the Consolidated financial statements for Year 8 in good format

e) Prepare the working paper journal entry(s) for the intercompany sale of inventory in Year

8

Hints: Goodwill = $1,320,000; Total AD remaining Dec 31, Year 8 = $1,111,000;

Consolidated NI = $2,360,875; total consolidated assets = $15,809,275