MGT426Comprehensive Consolidation Question – Fall 2015

Pepsi Inc. acquired a 75% share in Sprite Inc. on January 1, 2010 for $937,500. At the date of acquisition, Sprite had common shares of $1,000,000 and retained earnings of $250,000. On this date, all assets and liabilities of Sprite were fairly valued, except for the following items:

Equipment: Overvalued by $36,000 (9 years useful life left) Long-term Bonds Payable: Undervalued by $21,000 (matures 7 years from date

of acquisition)

Additional information:

1. Pepsi uses the cost method to account for its investment in Sprite.

2. Pepsi sells merchandise to Sprite from time-to-time at a gross profit percentage of 33⅓%. In 2013, Sprite purchased merchandise from Pepsi for $600,000 and had $60,000 of it left by December 31, 2013. In 2014, Sprite purchased merchandise from Pepsi for $1,000,000 and had $150,000 of it left by December 31, 2014.

3. Sprite sells merchandise to Pepsi from time-to-time at a markup of 75% on cost. In 2013, Pepsi purchased merchandise from Sprite for $7,200,000 and had $75,600 of it left by December 31, 2013. In 2014, Pepsi purchased merchandise from Sprite for $1,600,000 and had $67,200 of it left by December 31, 2014.

4. Sprite sold a piece of land with a book value of $186,000 to Pepsi during 2010 for $252,000. During 2014, Pepsi sold a third of this land to a developer for $100,000.

5. Pepsi sold equipment to Sprite on January 1, 2011 for a loss of $54,000. On the date of sale, the equipment had a remaining useful life of 6 years and no residual value. Both companies use straight-line method for depreciation.

6. Pepsi charges Sprite a $10,000 monthly management fee. The management fee for December was still outstanding on December 31, 2014.

7. Goodwill on acquisition was written down in 2011 by $5,000 and in 2014 by $8,000.

8. The two companies paid the following dividends in cash during 2014:

Pepsi - $40,000 Sprite - $110,000

9. Both companies have a marginal tax rate of 22%.

10. Any premium or discounts on long-term bonds are amortized on a straight-line method.

Individual companies’ financial statements are on the last page.

Required: (SHOW ALL CALCULATIONS CLEARLY)

a) Prepare the consolidated income statement for the Pepsi Group for the year ended December 31, 2014, using the entity method. (32 marks)

b) Prepare the consolidated balance sheet for the Pepsi Group as at December 31, 2014, using the entity method. (Note: show PP&E separated into cost and accumulated depreciation, not as a net amount). (29 marks)

c) Which amounts in the consolidated financial statements would have been different had Pepsi used the PCE method for consolidation? (4 marks)

d) Which amounts in the consolidated financial statements would have been different had Pepsi used the equity method to account for its investment in Sprite? (4 marks)

Consider all amounts material. Round amounts to the nearest dollar.

The abbreviated financial statements for Pepsi Inc. and Sprite Inc. at year-end December 31, 2014 are set out below:

Income Statement Pepsi Sprite

Sales $8,300,000 $ 5,500,000Other Income 506,000 199,000

8,806,000 5,699,000Cost of Goods Sold 5,080,000 4,180,000Depreciation Expense 732,000 438,000Interest Expense 71,000 25,000Other Operating Expenses 2,390,000 825,000

8,273,000 5,468,000Net Income Before Tax 533,000 231,000Tax Expense 117,260 50,900Net Income 415,740 180,100

Balance Sheet

Cash $ 74,000 $ 89,000Accounts receivable 134,000 248,000Inventory 457,000 577,000Investment in Sprite 937,500 -Property, Plant and Equipment (PP&E)- Cost 6,076,500 2,189,000- Accumulated Depreciation (2,516,000) (777,000)

5,163,000 2,326,000

Current Liabilities $ 279,000 $ 366,000Non-Current Liabilities 800,000 275,000Common Shares 2,860,000 1,000,000Retained Earnings 1,224,000 685,000

5,163,000 2,326,000