Consolidation Question – Summer 2021 Midterm Exam

PETE Inc. purchased 90% of the voting shares of SETE 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). PETE uses the cost method to account for
its investment. On that date, SETE’s Common Stock and Retained Earnings were valued at $100,000
and $400,000 respectively.

SETE’s 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.
 SETE’s inventory had a fair value which was $20,000 less than book value. This inventory was
sold by SETE in 20X3.
 SETE’s management has an exceptional working relationship with the employee Union. In the
light of recent strikes in the industry, experts believed that management’s 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 PETE & SETE for the Year ended December 31, 20X6 are shown below:

Income Statements
PETE Inc. SETE 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

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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 PETE purchased equipment for $50,000 and sold it immediately to SETE for
$90,000 cash. The equipment is expected to be obsolete in 10 years.

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

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

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

5. During December 20X5, PETE sold inventory to SETE for $50,000 cash, the cost of the
inventory to PETE was $30,000. 50% of these goods remained in SETE’s 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 PETE & SETE 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 PETE uses the Fair Value Enterprise method.

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