Pequity Company purchased 85% of the common stock of Sequity Company on April 1, Year 1. The fair value of the consideration transferred consisted of a cash payment of $545,000 and contingent consideration as described in the earnout agreement below. Under the agreement, Pequity Company agrees to pay an earn-out (contingent consideration) to the stockholders of Sequity as part of the consideration for their shares. The Company has the option of paying any earn-out in cash and/or shares of its common stock and has estimated the fair value of the contingent consideration to be $50,000. Acquisition-related costs of $20,000 are included in other expenses. Sequity will become a reportable segment for consolidated purposes. No control premium was included in the offer price.

Both companies have a December 31 year-end. Trial balances for Pequity and Sequity on April 1, Year 1 were:

On the acquisition date, the book values and fair values of Sequity's assets and liabilities were equal with the following exceptions.

The increase in Property and Equipment will be depreciated over seven years. All fair value estimates were considered final (no measurement period adjustments).
Earnout (Contingent Consideration) Agreement-Pequity and Sequity Company April 1, Year 1
The agreed-upon earn-out has three components. If the yearly revenue of Sequity exceeds a target level at the end of years 1, 2, and 3, Pequity will pay the shareholders of Sequity an amount equal to 50% of the excess, up to $85,000 per year for a maximum earn-out payment of $255,000 in total.
The initial target revenue level for year 1 is $1,300,000 and increases in amount by 5% per year. Target levels in years 2 and 3 will be $1,365,000 and $1,433,250. Pequity estimates the fair value of the earn-out using the present value of expected payments and its incremental borrowing rate adjusted for risk of 20%. The fair value of the three earn-outs was estimated to be $50,000 on the date of acquisition, computed as follows:
Fair Value of Contingent Consideration

Changes in fair value and interest charges are included in "other expense (income)" on the income statement.
Required:
1. Prepare a consolidated balance sheet on the date of acquisition. You can assume that Sequity closes its books on this date to facilitate consolidation.
2. Suppose that a control premium was included in the 85% interest acquired by Sequity, and that a level 3 estimation of the valuation of Sequity shares amounted to $79 per share (Pequity's purchase price of $595,000 implies a price of $87.50 per share). Prepare the journal entry needed to eliminate the investment account on the date of acquisition. Highlight the changes from part 1.

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Ar April 1, Year I Pequiry $28,000 124,000 229,000 $11,000 121,000 116,000 Accounts Receivables Inventory Tre asury Stock at Cost, 500 Shares Investment in Sequity Company Property and Equipment (net) Cost of Goods Sold Selling, General, & Administration Other Expenses Dividends Declared Total 595,000 850,000 385,000 80,000 24,000 465,000 188,500 40,000 $2,315,000 $1,012,000 Accounts Payable Contingent Consideration Dividends Payable Common Stock, $5 par Value Other Contributed Capital Retained Earnings, 1/1 S 215,000 50,000 S156,000 270,000 900,000 355,000 525,000 40,000 250,000 241,000 325,000 Dividend Income Total $2,315,000 $1,012,000 Fair Value 146,000 507,000 BOOK Valu 116,000 465,000 Inventory Property and Equipment Year 1 $1,300,000 1,300,000 Year 2 Year 3 Total $1,415,600 1,365,000 50,600 0.50 Estimated Revenues of Sequity Target level Revenues Estimated Excess Reduced by 50% Potential Payout Present Value Factor Fair value of Earn-Out $1,541,250 4,433,250 108,000 0.50 54,000 0.589 0.50 0.876 0.719 18,180 31,820 $50,000