On December 31, Year 1, the Peach Company purchased 80% of the outstanding voting shares of the Orange Company for $964,000 in cash. The balance sheet of Orange on that date and the fair values of its tangible assets and liabilities were as follows:
The difference between the fair value and the carrying amount of cash and accounts receivable of the subsidiary at December 31, Year 1, was adjusted by Orange in Year 2. At the acquisition date, the plant and equipment had an estimated remaining useful life of 10 years with no residual value. The long-term liabilities mature on December 31, Year 6. Any goodwill arising from the business combination will be tested for impairment. Peach uses the cost method to account for its investment in Orange. Both Peach and Orange use the straight-line method to calculate all depreciation for depreciable assets and amortization of premiums or discounts on long-term liabilities.
The statements of income and changes in retained earnings of the two companies for the year ending December 31, Year 5, were as follows:
Additional Information
• Goodwill impairment losses were recorded as follows: Year 2, $3,600; Year 4, $30,000; Year 5, $11,200.
• On December 31, Year 4, Orange sold a warehouse to Peach for $54,000. It had been purchased on January 1, Year 3, for $100,000 and had an estimated 20-year life on that date with no salvage value.
• During Year 4, Orange sold merchandise that it had purchased for $120,000 to Peach for $250,000. None of this merchandise had been resold by Peach by December 31, Year 4. Both companies account for inventories on the first-in, first-out basis.
• Peach had sales of $200,000 to Orange during Year 4, which gave rise to a gross profit of $125,000. This inventory was resold by Orange during Year 4 for $225,000.
• During Year 5, Orange sold merchandise that had been purchased for $160,000 to Peach for $300,000. Since the sales occurred in December of Year 5, all of this merchandise remained in the December 31, Year 5, inventories of Peach and had not been paid for.
• During September Year 5, Peach had sales of $280,000 to Orange, which increased Peach’s gross profit by $160,000. By December 31, Year 5, one-half of this merchandise had been sold to the public by Orange.
• On January 1, Year 5, Peach sold to Orange for $28,000 a machine that had cost $32,000. On January 1, Year 5, it had been depreciated for six years of its estimated eight-year life.
• During Year 5, Peach charged Orange $25,000 for management fees.
• Assume a 40% corporate tax rate.
(a) Prepare a consolidated income statement for Peach and its subsidiary, Orange, for the year ending December 31, Year 5. Assume that the loss from sale of the warehouse will be eliminated.
(b) Prepare a consolidated statement of retained earnings for Peach and its subsidiary, Orange, for the year ending December 31, Year 5.
(c) Explain the rationale for not always eliminating losses on intercompany sales of depreciable assets when preparing consolidated financial statements.
(d) Assume that Orange pays interest annually at the rate of 8% on its long-term liabilities. When Peach acquired Orange on December 31, Year 1, the fair value of Sloan’s long-term liabilities would have produced an effective yield of 6%.
Calculate interest expense and non-controlling interest on the consolidated income statement assuming that Peach and Orange use the effective-interest method to account for their long-term liabilities.

  • CreatedJune 08, 2015
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