COMPREHENSIVE CHALLENGER: Converting to the Equity Method from the Cost Method Two Years After the Acquisition Date; Consolidation Worksheet Pali Inc. acquired all of Sali Inc.’s outstanding common stock for $820,000 cash on 1/1/05. Pali also incurred $47,000 of direct costs in connection with the acquisition. Selected information on Sali as of the acquisition date follows:

Additional Information 1. Pali is privately owned and chose to use wow-push-down accounting.
2. Pali has used the cost method since the acquisition date and has decided to change to the equity method to account for its investment in the subsidiary.
Each company’s financial statements for the year ended 12/31/06 (two years after the acquisition date) follow:
Pali Sali Income Statement (2006)
Sales Cost of .
sales .
Dividend Expenses income .
.
Net Income .
Balance Sheet (as of 12/31/06)
Cash Accounts .
receivable, net .
Inventory Investment .
in Sali .
Land Buildings .
and equipment .
Accumulated depreciation . . . , Goodwill Patent .
.
Total Assets .
Payables and accruals .
Common Long-term stock debt . .
Retained earnings .
Total Liabilities and Equity .
Dividends declared during 2006 Dividends declared during 2005 Reported net income for 2005 .
$ 8,500,000 (4,500,000)
(3,640,000)
50,000 $ (530,000) 980,000 (310,000)
$ 410,000 $ 140,000 $ 458,000 $ 98,000 750,000 190,000 820,000 380,000 867,000 760,000 240,000 6,260,000 1,720,000 (2,465,000) (480,000) 100,000 12,000 60,000 $ 7,550,000 $2,220,000 $ 1,600,000 $ 370,000 3,000,000 1,200,000 2,000,000 250,000 950,000 400,000 $ 7,550,000 $2,220,000 $ 100,000 80,000 $ 40,000 50,000 200,000 90,000 Required 1. Analyze the Investment account by the components of the major conceptual elements as of the acquisition date.
2. Update the analysis of the Investment account to reflect activity under the equity method of ac¬
counting through 12/31/06 (a two-year period).
3. Prepare the journal entry(ies) to convert to the equity method from the cost method.
4. Prepare the consolidation entries as of 12/31/06.
5. Adjust the parent’s financial statements to reflect the equity method, and then prepare a consol¬ idation worksheet at 12/31/06.
6. Would the parent’s outside auditors have to mention the change to the equity method in their audit report.''