SOLUTIONS MANUAL for Advanced Financial Accounting, 13th Edition. By Theodore Christensen, David Cot by ACADEMIAMILL

Advanced Financial Accounting 13e Theodore Christensen, David Cottrell, Richard Baker (Solutions Manual All Chapters)

CHAPTER 1 INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES ANSWERS TO QUESTIONS Q1-1 Complex organizational structures often result when companies do business in a complex business environment. New subsidiaries or other entities may be formed for purposes such as extending operations into foreign countries, seeking to protect existing assets from risks associated with entry into new product lines, separating activities that fall under regulatory controls, and reducing taxes by separating certain types of operations. Q1-2 The split-off and spin-off result in the same reduction of reported assets and liabilities. Only the stockholders’ equity accounts of the company are different. The number of shares outstanding remains unchanged in the case of a spin-off and retained earnings or paid-in capital is reduced. Shares of the parent are exchanged for shares of the subsidiary in a split-off, thereby reducing the outstanding shares of the parent company. Q1-3 Enron’s management used special-purpose entities to avoid reporting debt on its balance sheet and to create fictional transactions that resulted in reported income. It also transferred bad loans and investments to special-purpose entities to avoid recognizing losses in its income statement. Q1-4 (a) A statutory merger occurs when one company acquires another company and the assets and liabilities of the acquired company are transferred to the acquiring company; the acquired company is liquidated, and only the acquiring company remains. The acquiring company can give cash or other assets in addition to stock. (b) A statutory consolidation occurs when a new company is formed to acquire the assets and liabilities of two combining companies. The combining companies dissolve, and the new company is the only surviving entity. (c) A stock acquisition occurs when one company acquires a majority of the common stock of another company and the acquired company is not liquidated; both companies remain as separate but related corporations. Q1-5 A noncontrolling interest exists when the acquiring company gains control but does not own all the shares of the acquired company. The non-controlling interest is made up of the shares not owned by the acquiring company. Q1-6 Goodwill is the excess of the sum of (1) the fair value given by the acquiring company, (2) the fair value of any shares already owned by the parent and (3) the acquisition-date fair value of any noncontrolling interest over the acquisition-date fair value of the net identifiable assets acquired in the business combination. Q1-7 A differential is the total difference at the acquisition date between the sum of (1) the fair value given by the acquiring company, (2) the fair value of any shares already owned by the parent and (3) the acquisition-date fair value of any noncontrolling interest and the book value of the net identifiable assets acquired is referred to as the differential.

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

Q1-8 The purchase of a company is viewed in the same way as any other purchase of assets. The acquired company is owned by the acquiring company only for the portion of the year subsequent to the combination. Therefore, earnings are accrued only from the date of purchase forward. Q1-9 None of the retained earnings of the subsidiary should be carried forward under the acquisition method. Thus, consolidated retained earnings immediately following an acquisition is limited to the balance reported by the acquiring company. Q1-10 Additional paid-in capital reported following a business combination is the amount previously reported on the acquiring company's books plus the excess of the fair value over the par or stated value of any shares issued by the acquiring company in completing the acquisition less any sock issue costs. Q1-11 When the acquisition method is used, all costs incurred in bringing about the combination are expensed as incurred. None are capitalized. However, costs associated with the issuance of stock are recorded as a reduction of additional paid-in capital. Q1-12 When the acquiring company issues shares of stock to complete a business combination, the excess of the fair value of the stock issued over its par value is recorded as additional paid-in capital. All costs incurred by the acquiring company in issuing the securities should be treated as a reduction in the additional paid-in capital. Items such as audit fees associated with the registration of the new securities, listing fees, and brokers' commissions should be treated as reductions of additional paid-in capital when stock is issued. Q1-13 If the fair value of a reporting unit acquired in a business combination exceeds its carrying amount, the goodwill of that reporting unit is considered unimpaired. On the other hand, if the carrying amount of the reporting unit exceeds its fair value, impairment of goodwill is implied. An impairment must be recognized if the carrying amount of the goodwill assigned to the reporting unit is greater than the implied value of the carrying unit’s goodwill. The implied value of the reporting unit’s goodwill is determined as the excess of the fair value of the reporting unit over the fair value of its net identifiable assets. Q1-14 A bargain purchase occurs when the fair value of the consideration given in a business combination, along with the fair value of any equity interest in the acquiree already held and the fair value of any noncontrolling interest in the acquiree, is less than the fair value of the acquiree’s net identifiable assets. Q1-15 The acquirer should record the clarification of the acquisition-date fair value of buildings as a reduction to buildings and addition to goodwill. . Q1-16 The acquirer must revalue the equity position to its fair value at the acquisition date and recognize a gain. A total of $250,000 ($25 x 10,000 shares) would be recognized in this case assuming that the $65 per share price is the appropriate fair value for all shares (i.e. there is no control premium for the new shares purchased).

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

SOLUTIONS TO CASES C1-1 Assignment of Acquisition Costs MEMO To:

Vice-President of Finance Troy Company

From: Re:

, CPA Recording Acquisition Costs of Business Combination

Troy Company incurred a variety of costs in acquiring the ownership of Kline Company and transferring the assets and liabilities of Kline to Troy Company. I was asked to review the relevant accounting literature and provide my recommendations as to what was the appropriate treatment of the costs incurred in the Kline Company acquisition. Current accounting standards require that acquired companies be valued under ASC 805 at the fair value of the consideration given in the exchange, plus the fair value of any shares of the acquiree already held by the acquirer, plus the fair value of any noncontrolling interest in the acquiree at the combination date [ASC 805]. All other acquisition-related costs directly traceable to an acquisition should be accounted for as expenses in the period incurred [ASC 805]. The costs incurred in issuing common or preferred stock in a business combination are required to be treated as a reduction of the recorded amount of the securities (which would be a reduction to additonal paid-in capital if the stock has a par value or a reduction to common stock for no par stock). A total of $720,000 was paid in completing the Kline acquisition. Kline should record the $200,000 finders’ fee and $90,000 legal fees for transferring Kline’s assets and liabilities to Troy as acquisition expense in 20X7. The $60,000 payment for stock registration and audit fees should be recorded as a reduction of paid-in capital recorded when the Troy Company shares are issued to acquire the shares of Kline. The only cost potentially at issue is the $370,000 legal fees resulting from the litigation by the shareholders of Kline. If this cost is considered to be a direct acquisition cost, it should be included in acquisition expense. If, on the other hand, it is considered to be related to the issuance of the shares, it should be debited to paid-in capital. Primary citation ASC 805 C1-2 Evaluation of Merger a. AT&T had a vast cable customer base, but felt that TimeWarner’s content would greatly enhance the demand for its cable services. b. AT&T provided TimeWarner shareholders with AT&T stock and an equal value of cash. c. The cash portion of the merger was funded primarily with debt. d. This would be a statutory merger since (1) the AT&T name survived through the merger and (2) the acquisition was formalized when AT&T gave both stock and cash. 1-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

C1-3 Business Combinations It is very difficult to develop a single explanation for any series of events. Merger activity in the United States is impacted by events both within the U.S. economy and those around the world. As a result, there are many potential answers to the questions posed in this case. a. One factor that may have prompted the greater use of stock in business combinations in the middle and late 1990s is that many of the earlier combinations that had been effected through the use of debt had unraveled. In many cases, the debt burden was so heavy that the combined companies could not meet debt payments. Thus, this approach to financing mergers had somewhat fallen from favor by the mid-nineties. Further, with the spectacular rise in the stock market after 1994, many companies found that their stock was worth much more than previously. Accordingly, fewer shares were needed to acquire other companies. b. Two of major factors appear to have had a significant influence on the merger movement in the mid-2000s. First, interest rates were very low during that time, and a great amount of unemployed cash was available worldwide. Many business combinations were effected through significant borrowing. Second, private equity funds pooled money from various institutional investors and wealthy individuals and used much of it to acquire companies. Many of the acquisitions of this time period involved private equity funds or companies that acquired other companies with the goal of making quick changes and selling the companies for a profit. This differed from prior merger periods where acquiring companies were often looking for long-term acquisitions that would result in synergies. In late 2008, a mortgage crisis spilled over into the credit markets in general, and money for acquisitions became hard to get. This in turn caused many planned or possible mergers to be canceled. In addition, the economy in general faltered toward the end of 2008 and into 2009. Since that time, companies have turned their attention to global expansion. c. Establishing incentives for corporate mergers is a controversial issue. Many people in our society view mergers as not being in the best interests of society because they are seen as lessening competition and often result in many people losing their jobs. On the other hand, many mergers result in companies that are more efficient and can compete better in a global economy; this in turn may result in more jobs and lower prices. Even if corporate mergers are viewed favorably, however, the question arises as to whether the government, and ultimately the taxpayers, should be subsidizing those mergers through tax incentives. Many would argue that the desirability of individual corporate mergers, along with other types of investment opportunities, should be determined on the basis of the merits of the individual situations rather than through tax incentives. Perhaps the most obvious incentive is to lower capital gains tax rates. Businesses may be more likely to invest in other companies if they can sell their ownership interests when it is convenient and pay lesser tax rates. Another alternative would include exempting certain types of intercorporate income. Favorable tax status might be given to investment in foreign companies through changes in tax treaties. As an alternative, barriers might be raised to discourage foreign investment in United States, thereby increasing the opportunities for domestic firms to acquire ownership of other companies.

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

d. In an ideal environment, the accounting and reporting for economic events would be accurate and timely and would not influence the economic decisions being reported. Any change in reporting requirements that would increase or decrease management's ability to "manage" earnings could impact management's willingness to enter new or risky business fields and affect the level of business combinations. Greater flexibility in determining which subsidiaries are to be consolidated, the way in which intercorporate income is calculated, the elimination of profits on intercompany transfers, or the process used in calculating earnings per share could impact such decisions. The processes used in translating foreign investment into United States dollars also may impact management's willingness to invest in domestic versus international alternatives. C1-4 Determination of Goodwill Impairment MEMO TO: Chief Accountant Plush Corporation From:

, CPA

Re:

Determining Impairment of Goodwill

Once goodwill is recorded in a business combination, it must be accounted for in accordance with current accounting literature. Goodwill is carried forward at the original amount without amortization, unless it becomes impaired. The amount determined to be goodwill in a business combination must be assigned to the reporting units of the acquiring entity that are expected to benefit from the synergies of the combination. [ASC 350-20-35-41] This means the total amount assigned to goodwill may be divided among a number of reporting units. Goodwill assigned to each reporting unit must be tested for impairment annually and between the annual tests in the event circumstances arise that would lead to a possible decrease in the fair value of the reporting unit below its carrying amount [ASC 350-20-35-30, ASU 201704]. As long as the fair value of the reporting unit is greater than its carrying value, goodwill is not considered to be impaired. If the fair value is less than the carrying value, an impairment loss must be reported for the amount by which the carrying amount of reporting unit exceeds its fair value. However, the impairment cannot exceed the amount of goodwill originally recognized for that reporting unit [ASC 350-20-35-11, ASU 2017-04] At the date of acquisition, Plush Corporation recognized goodwill of $20,000 ($450,000 $430,000) and assigned it to a single reporting unit. Even though the fair value of the reporting unit increased to $485,000 at December 31, 20X5, Plush Corporation must test for impairment of goodwill if the carrying value of Plush’s investment in the reporting unit is above that amount. That would be the case if the carrying value were determined to be $500,000. If the carrying value of the reporting unit’s net assets exceeds the fair value of the reporting unit’s net assets, an impairment is recorded for the amount by which the carrying amount exceeds the fair value (but the impairment is limited to the amount of goodwill reported by that unit). If the carrying amount were $500,000 and the fair value of the reporting unit were $485,000, The impairment would be $15,000 ($500,000 - $485,000). On the other hand, if the fair value were greater than the carrying value, there would be no goodwill impairment. For example, if the carrying value of the reporting unit were determined to be $470,000, there would be no impairment.

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

With the information provided, we do not know if there has been an impairment of the goodwill involved in the purchase of Common Corporation. However, Plush must follow the procedures outlined here in testing for impairment at December 31, 20X5. Primary citations ASC 350-20-35-11 ASC 350-20-35-30 ASC 350-20-35-41 ASU 2017-04 C1-5 Risks Associated with Acquisitions Alphabet discloses on pages 9-10 of its 10-K that acquisitions, investments, and divestitures are an important part of its corporate strategy. The company goes on to discuss relevant risks associated with these activities. The specific risk areas identified include: • • • • • • • • • • • • •

The use of management time on acquisitions-related activities may temporarily divert management’s time and focus from normal operations. After acquiring companies, there is a risk that Alphabet may not successfully develop the business and technologies of the acquired firms. It can be difficult to implement controls, procedures, and policies appropriate for a public company that were not already in place in the acquired company. Integrating the accounting, management information, human resources, and other administrative systems can be challenging. The company sometimes encounters difficulties in transitioning operations, users, and customers into Alphabet’s existing platforms. Government “red tape” in obtaining necessary approvals can reduce the potential strategic benefits of acquisitions. There are many difficulties associated with foreign acquisitions due to differences in culture, language, economics, currencies, politic, and regulation. Since corporate cultures can vary significantly, there are potential difficulties in integrating the employees of an acquired company into the Google organization. It can be difficult to retain employees who worked for companies that Alphabet acquires. There may be legal liabilities for activities of acquired companies. Litigation of claims against acquired companies or as a result of acquisitions can be problematic. Anticipated benefits of acquisitions may not materialize. Acquisitions through equity issuances can result in dilution to existing shareholders. Similarly, the issuance of debt can result in other costs. Impairments, restructuring charges, and other unfavorable results can result.

C1-6 Leveraged Buyouts a. A leveraged buyout (LBO) involves acquiring a company in a transaction or series of planned transactions that include using a very high proportion of debt, often secured by the assets of the target company. Normally, the investors acquire all of the stock or assets of the target company. A management buyout (MBO) occurs when the existing management of a company acquires all or most of the stock or assets of the company. Frequently, the investors in LBOs include management, and thus an LBO may also be an MBO

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

b. The FASB has not dealt with leveraged buyouts in either current pronouncements or exposure drafts of proposed standards. The Emerging Issues Task Force has addressed limited aspects of accounting for LBOs. In EITF 84-23, “Leveraged Buyout Holding Company Debt,” the Task Force did not reach a consensus. In EITF 88-16, “Basis in Leveraged Buyout Transactions,” the Task Force did provide guidance as to the proper basis that should be recognized for an acquiring company’s interest in a target company acquired through a leveraged buyout. c. Whether an LBO is a type of business combination is not clear and probably depends on the structure of the buyout. The FASB has not taken a position on whether an LBO is a type of business combination. The EITF indicated that LBOs of the type it was considering are similar to business combinations. Most LBOs are effected by establishing a holding company for the purpose of acquiring the assets or stock of the target company. Such a holding company has no substantive operations. Some would argue that a business combination can occur only if the acquiring company has substantive operations. However, neither the FASB nor EITF has established such a requirement. Thus, the question of whether an LBO is a business combination is unresolved. d. The primary issue in deciding the proper basis for an interest in a company acquired in an LBO, as determined by EITF 88-16, is whether the transaction has resulted in a change in control of the target company (a new controlling shareholder group has been established). If a change in control has not occurred, the transaction is treated as a recapitalization or restructuring, and a change in basis is not appropriate (the previous basis carries over). If a change in control has occurred, a new basis of accounting may be appropriate.

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

SOLUTIONS TO EXERCISES E1-1 Multiple-Choice Questions on Complex Organizations 1. b – As companies grow in size and respond to their unique business environment, they often develop complex organizational and ownership structures. (a) Incorrect. The need to avoid legal liability is not a direct result of increased complexity. (c) Incorrect. Part of the reason the business environment is complex is due to the increased number and type of divisions and product lines in companies. (d) Incorrect. This statement is false. There has been an impact on organizational structure and management. 2. d – A transfer of product to a subsidiary does not constitute a sale for income purposes and as such would not increase profit for the parent. (a) Incorrect. Shifting risk is a common reason for establishing a subsidiary. (b) Incorrect. Corporations often establish subsidiaries in other regulatory environments so that the parent company is not explicitly affected by the regulatory control. (c) Incorrect. Corporations will often establish subsidiaries to take advantage of tax benefits that exist in different regions. 3. a – When a merger occurs, all the assets and liabilities are transferred to the purchasing company and any excess of the purchase price over the fair value of the net assets is recorded as goodwill on the purchaser’s books. (b) Incorrect. This combination results in a parent-subsidiary relationship in which an investment in Spade would be recorded. In the event that goodwill were present in this transaction, it would be reported on the consolidated books and not Poker’s books. (c) Incorrect. In a spin-off, no change to net assets occurs, and consequently no goodwill is recorded. (d) Incorrect. In a split-off, no change to net assets occurs, and consequently no goodwill is recorded. 4. b – In an internal expansion in which the existing company creates a new subsidiary, the assets and liabilities are recorded at the carrying values of the original company. (a) Incorrect. This is not in accordance with GAAP; assets are transferred at the parent’s book (carrying) value. (c) Incorrect. Not in accordance with US GAAP; no gain or loss is permitted because the assets are transferred at the parent’s book value. (d) Incorrect. Not in accordance with US GAAP – Goodwill is not created when a company creates a subsidiary through internal expansion. 5. d – This is the proper impairment test required under US GAAP, according to FASB 142/ASC 350. (a) Incorrect. This is not the proper test for impairment under US GAAP. (b) Incorrect. This is not the proper test for impairment under US GAAP. (c) Incorrect. This is not the proper test for impairment under US GAAP.

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-2 Multiple-Choice Questions on Recording Business Combinations [AICPA Adapted] 1. a – Goodwill equals the excess sum of the consideration given over the sum of the fair value of identifiable assets less liabilities. (b) Incorrect. Assets considered only need be identifiable, not just tangible. For example, patents would be identifiable, but not tangible. (c) Incorrect. Assets considered only have to be identifiable. This includes both tangible and intangible identifiable assets. (d) Incorrect. The calculation of goodwill requires a remeasurement of the assets and liabilities at fair value, not book value. 2. c – “Costs of issuing equity securities used to acquire the acquire are treated in the same manner as stock issue costs are normally treated, as a reduction in the paid-in capital associated with the securities” A reduction to the paid-in capital account results in a reduction in the fair value of the securities issued. (a) Incorrect. Stock issue costs are not expensed but are charged as a reduction in paidin capital. (b) Incorrect. Stock issue costs result in a reduction of stockholder’s equity, not an increase. (d) Incorrect. Stock issue costs result in a reduction of equity, and are not capitalized. They are not added to goodwill. 3. d – When a new company is acquired, the assets and liabilities are recorded at fair value. (a) Incorrect. Historical cost is not always reflective of actual value, thus fair values are used. (b) Incorrect. Book value is often different than fair value, thus fair value is the appropriate basis. (c) Incorrect. This method is also unacceptable. Fair value is the appropriate basis. 4. d – This combination would result in a bargain purchase. (a) Incorrect. Deferred credits do not arise as a result of fair value of identifiable assets exceeding fair value of the consideration. (b) Incorrect. The fair value is not reduced, and deferred credits do not arise in this situation. (c) Incorrect. The fair value is not reduced, and deferred credits do not arise in this situation. 5. c – $875,000 – $800,000 = $75,000. Total consideration given – FV of net assets = Goodwill

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-3 Multiple-Choice Questions on Reported Balances [AICPA Adapted] 1. d – $2,900,000. New APIC Balance = existing APIC on Poe’s books + APIC from new stock issuance. (200,000*($18-$10) + $1,300,000 = $2,900,000) 2. d – $600,000. The total balance in the investment account is equal to the total consideration given in the combination. (10,000 *$60 per share = $600,000) 3. c – $150,000. Goodwill = Consideration given – FV of net assets acquired. FV of Net Assets: $80,000 + $190,000 + $560,000 - $180,000 = $650,000. (800,000 – 650,000 = 150,000) 4. c – $4,000,000. The increase in net assets is solely attributable to the FV of the consideration given, the nonvoting preferred stock. (a) Incorrect. This answer only reflects the book value of Master’s net assets. (b) Incorrect. This answer only reflects the fair value of Master’s net assets. (d) Incorrect. The additional stock related to the finder’s fee is not capitalized, but rather expensed. E1-4 Multiple-Choice Questions Involving Account Balances 1. c – When the parent creates the subsidiary, the equipment is transferred at cost with the accompanying accumulated depreciation (which in effect is the book value). ($100,000/10 = $10,000 per year * 4 = $40,000.) (a) Incorrect. When a subsidiary is created internally, the assets are transferred as they were on the parent’s books (carrying value). Fair value is not considered. (b) Incorrect. This is the proper carrying value of the asset, but it should be recorded at cost with the accompanying accumulated depreciation. (d) Incorrect. When a subsidiary is created internally, the assets are transferred as they were on the parent’s books (carrying value). 2. c – The assets are transferred at the carrying value on Pead’s books, and thus no change in reported net assets occurs. (a) Incorrect. No change occurs. (b) Incorrect. No change occurs. (d) Incorrect. No change occurs. 3. b – APIC = $140,000 (BV) – 7,000 * $8 = $84,000. 4. b – $35,000. Since the carrying value of the reporting unit ($330,000) is lower than the fair value of the reporting unit’s net assets ($350,000), the goodwill of the reporting unit is not impaired and will remain at its carrying value of $35,000 5. c – $15,000. The carrying value of the reporting unit’s net assets ($575,000) exceeds the estimated fair value of the reporting unit ($560,000). The goodwill should be impaired by the amount by which the carrying value of the unit’s net assets exceeds the estimated fair value of the reporting unit, $15,000 ($575,000 - $560,000).

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-5 Asset Transfer to Subsidiary a. Journal entry recorded by Pale Company for transfer of assets to Sight Company: Investment in Sight Company Common Stock Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Cash Inventory Land Buildings Equipment

408,000 24,000 36,000 21,000 37,000 80,000 240,000 90,000

b. Journal entry recorded by Sight Company for receipt of assets from Pale Company: Cash Inventory Land Buildings Equipment Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Common Stock Additional Paid-In Capital

21,000 37,000 80,000 240,000 90,000 24,000 36,000 60,000 348,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-6 Creation of New Subsidiary a. Journal entry recorded by Pester Company for transfer of assets to Shumby Corporation: Investment in Shumby Corporation Common Stock Allowance for Uncollectible Accounts Receivable Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Cash Accounts Receivable Inventory Land Buildings Equipment

498,000 7,000 35,000 60,000 40,000 75,000 50,000 35,000 160,000 240,000

b. Journal entry recorded by Shumby Corporation for receipt of assets from Pester Company: Cash Accounts Receivable Inventory Land Buildings Equipment Allowance for Uncollectible Accounts Receivable Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Common Stock Additional Paid-In Capital

40,000 75,000 50,000 35,000 160,000 240,000 7,000 35,000 60,000 120,000 378,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-7 Balance Sheet Totals of Parent Company a. Journal entry recorded by Phoster Corporation for transfer of assets and accounts payable to Skine Company: Investment in Skine Company Common Stock Accumulated Depreciation Accounts Payable Cash Accounts Receivable Inventory Land Depreciable Assets

66,000 28,000 22,000 15,000 24,000 9,000 3,000 65,000

b. Journal entry recorded by Skine Company for receipt of assets and accounts payable from Phoster Corporation: Cash Accounts Receivable Inventory Land Depreciable Assets Accumulated Depreciation Accounts Payable Common Stock Additional Paid-In Capital

15,000 24,000 9,000 3,000 65,000 28,000 22,000 48,000 18,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-8 Acquisition of Net Assets Pun Corporation will record the following journal entries: (1)

(2)

Assets Goodwill Liabilities Cash

71,000 9,000

Acquisition Expense Cash

4,000

20,000 60,000 4,000

E1-9 Reporting Goodwill a. Goodwill: $120,000 = $310,000 - $190,000 Investment: $310,000 b. Goodwill: $6,000 = $196,000 - $190,000 Investment: $196,000 c. Goodwill: $0; no goodwill is recorded when the purchase price is below the fair value of the net identifiable assets. Investment: $190,000; recorded at the fair value of the net identifiable assets. E1-10 Stock Acquisition Journal entry to record the purchase of Sippy Inc., shares: Investment in Sippy Inc., Common Stock Common Stock Additional Paid-In Capital

986,000 425,000 561,000

$986,000 = $58 x 17,000 shares $425,000 = $25 x 17,000 shares $561,000 = ($58 - $25) x 17,000 shares

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-11 Balances Reported Following Combination a. Stock Outstanding: $200,000 + ($10 x 8,000 shares)

$280,000

b. Cash and Receivables: $150,000 + $40,000

190,000

185,000

Land: $100,000 + $85,000

d. Buildings and Equipment (net): $300,000 + $230,000

530,000

e. Goodwill: ($50 x 8,000) - $355,000

45,000

Additional Paid-In Capital: $20,000 + [($50 - $10) x 8,000]

340,000

g. Retained Earnings

330,000

E1-12 Goodwill Recognition Journal entry to record acquisition of Spur Corporation net assets: Cash and Receivables Inventory Land Plant and Equipment Patent Goodwill Accounts Payable Cash

40,000 150,000 30,000 350,000 130,000 55,000 85,000 670,000

Computation of goodwill Fair value of consideration given Fair value of assets acquired Fair value of liabilities assumed Fair value of net assets acquired Goodwill

$670,000 $700,000 (85,000) 615,000 $ 55,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-13 Acquisition Using Debentures Journal entry to record acquisition of Sorden Company net assets: Cash and Receivables Inventory Land Plant and Equipment Discount on Bonds Payable Goodwill Accounts Payable Bonds Payable

50,000 200,000 100,000 300,000 17,000 8,000 50,000 625,000

Computation of goodwill Fair value of consideration given Fair value of assets acquired Fair value of liabilities assumed Fair value of net assets acquired Goodwill

$608,000 $650,000 (50,000) 600,000 $ 8,000

E1-14 Bargain Purchase Journal entry to record acquisition of Sorden Company net assets: Cash and Receivables Inventory Land Plant and Equipment Discount on Bonds Payable Accounts Payable Bonds Payable Gain on Bargain Purchase of Subsidiary

50,000 200,000 100,000 300,000 16,000 50,000 580,000 36,000

Computation of Bargain Purchase Gain Fair value of consideration given Fair value of assets acquired Fair value of liabilities assumed Fair value of net assets acquired Bargain Purchase Gain

$564,000 $650,000 (50,000) 600,000 $ 36,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-15 Goodwill Impairment a. Goodwill of $80,000 will be reported. The fair value of the reporting unit ($340,000) is greater than the carrying amount of the reporting unit ($290,000). As a result, no impairment loss will be recorded. b. An impairment loss of $10,000 ($290,000 - $280,000) will be recognized. Therefore, goodwill of $70,000 will be reported (80,000 – 10,000 impairment loss). c. An impairment loss of $30,000 ($290,000 - $260,000) will be recognized. Therefore, goodwill of $50,000 will be reported (80,000 – 30,000 impairment loss). E1-16 Goodwill Impairment a. No impairment loss will be recognized. The estimated fair value of the reporting unit ($530,000) is greater than the carrying value of the reporting unit’s net assets ($500,000). b. A goodwill impairment of $15,000 will be recognized ($500,000 - $485,000). c. A goodwill impairment of $50,000 will be recognized ($500,000 - $450,000). E1-17 Goodwill Assigned to Reporting Units Goodwill of $146,000 ($50,000 + $48,000 + $8,000 + $40,000) should be reported, computed as follows: Reporting Unit A: A goodwill impairment of $10,000 should be recognized ($700,000 $690,000). Thus, goodwill of $50,000 ($60,000 - $10,000 impairment) should be reported on December 31, 20X7.. Reporting Unit B: There is no goodwill impairment because the fair value of the reporting unit exceeds the carrying value. Goodwill of $48,000 should be reported on December 31, 20X7. Reporting Unit C: A goodwill impairment of $20,000 should be recognized ($380,000 $370,000). Thus, goodwill of $8,000 ($28,000 - $20,000 impairment) should be reported on December 31, 20X7. Reporting Unit D: There is no goodwill impairment because the fair value of the reporting unit exceeds the carrying value. Goodwill of $40,000 should be reported.

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-18 Goodwill Measurement a. The fair value of the reporting unit ($580,000) is greater than the carrying value of the investment ($550,000). Thus, goodwill is not impaired Goodwill of $150,000 will be reported. b. The carrying value of the reporting unit ($550,000) exceeds the fair value of the reporting unit ($540,000). Thus, an impairment of goodwill of $10,000 ($550,000 - $540,000) must be recognized. Goodwill of $140,000 will be reported. c. The carrying value of the reporting unit ($550,000) exceeds the fair value of the reporting unit ($500,000). Thus, an impairment loss of $50,000 ($550,000 - $500,000) must be recognized. Goodwill of $100,000 will be reported. d. The carrying value of the reporting unit ($550,000) exceeds the fair value of the reporting unit ($460,000). Thus, an impairment loss of $90,000 ($550,000 - $460,000) must be recognized. Goodwill of $60,000 will be reported. E1-19 Computation of Fair Value Amount paid Book value of assets Book value of liabilities Book value of net assets Adjustment for research and development costs Adjusted book value Fair value of patent rights Goodwill recorded Fair value increment of buildings and equipment Book value of buildings and equipment Fair value of buildings and equipment

$517,000 $624,000 (356,000) $268,000 (40,000) $228,000 120,000 93,000

(441,000) $ 76,000 341,000 $417,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-20 Computation of Shares Issued and Goodwill a. 15,600 shares were issued, computed as follows: Par value of shares outstanding following merger Paid-in capital following merger Total par value and paid-in capital Par value of shares outstanding before merger Paid-in capital before merger

$327,600 650,800 $978,400 $218,400 370,000 (588,400) $390,000 ÷ $25 15,600

Increase in par value and paid-in capital Divide by price per share Number of shares issued b. The par value is $7, computed as follows: Increase in par value of shares outstanding ($327,600 - $218,400) Divide by number of shares issued Par value

$109,200 ÷ 15,600 $ 7.00

c. Goodwill of $34,000 was recorded, computed as follows: Increase in par value and paid-in capital Fair value of net assets ($476,000 - $120,000) Goodwill

$390,000 (356,000) $ 34,000

E1-21 Combined Balance Sheet Pam Corporation and Slest Company Combined Balance Sheet January 1, 20X2 Cash and Receivables Inventory Buildings and Equipment Less: Accumulated Depreciation Goodwill

$ 240,000 460,000 840,000 (250,000) 75,000 $1,365,000

Accounts Payable Notes Payable Common Stock Additional Paid-In Capital Retained Earnings

$ 125,000 235,000 244,000 556,000 205,000 $1,365,000

Computation of goodwill Fair value of compensation given Fair value of net identifiable assets ($490,000 - $85,000) Goodwill

$480,000 (405,000) $ 75,000

Computation of APIC Fair value of compensation given ($60 x 8,000 shares) Less par value of shares issued ($8 x 8,000) Plus existing APIC from Pam’s books Additional Paid-In Capital

$480,000 (64,000) 140,000 $ 556,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

E1-22 Recording a Business Combination Acquisition Expense Deferred Stock Issue Costs Cash

54,000 29,000

Cash Accounts Receivable Inventory Land Buildings and Equipment Goodwill (1) Accounts Payable Bonds Payable Bond Premium Common Stock Additional Paid-In Capital (2) Deferred Stock Issue Costs

70,000 110,000 200,000 100,000 350,000 30,000

83,000

195,000 100,000 5,000 320,000 211,000 29,000

Computation of goodwill Fair value of consideration given (40,000 x $14) Fair value of assets acquired Fair value of liabilities assumed Fair value of net assets acquired Goodwill

$560,000 $830,000 (300,000) (530,000) $ 30,000

Computation of additional paid-in capital Number of shares issued Issue price in excess of par value ($14 - $8) Total Less: Deferred stock issue costs Increase in additional paid-in capital

40,000 x $6 $240,000 (29,000) $211,000

E1-23 Reporting Income 20X2:

Net income Earnings per share

= =

$6,028,000 [$2,500,000 + $3,528,000] $5.48 [$6,028,000 / (1,000,000 + 100,000*)]

20X1:

Net income Earnings per share

= =

$4,460,000 [previously reported] $4.46 [$4,460,000 / 1,000,000]

* 100,000 = 200,000 shares x ½ year

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

SOLUTIONS TO PROBLEMS P1-24 Assets and Accounts Payable Transferred to Subsidiary a. Journal entry recorded by Pab Corporation for its transfer of assets and accounts payable to Sollon Company: Investment in Sollon Company Common Stock Accounts Payable Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Cash Inventory Land Buildings Equipment

320,000 45,000 40,000 10,000 25,000 70,000 60,000 170,000 90,000

b. Journal entry recorded by Sollon Company for receipt of assets and accounts payable from Pab Corporation: Cash Inventory Land Buildings Equipment Accounts Payable Accumulated Depreciation – Buildings Accumulated Depreciation – Equipment Common Stock Additional Paid-In Capital

25,000 70,000 60,000 170,000 90,000 45,000 40,000 10,000 180,000 140,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-25 Creation of New Subsidiary a. Journal entry recorded by Pagle Corporation for transfer of assets and accounts payable to Sand Corporation: Investment in Sand Corporation Common Stock Allowance for Uncollectible Accounts Receivable Accumulated Depreciation Accounts Payable Cash Accounts Receivable Inventory Land Buildings and Equipment

400,000 5,000 40,000 10,000 30,000 45,000 60,000 20,000 300,000

b. Journal entry recorded by Sand Corporation for receipt of assets and accounts payable from Pagle Corporation: Cash Accounts Receivable Inventory Land Buildings and Equipment Allowance for Uncollectible Accounts Receivable Accumulated Depreciation Accounts Payable Common Stock Additional Paid-In Capital

30,000 45,000 60,000 20,000 300,000 5,000 40,000 10,000 50,000 350,000

P1-26 Incomplete Data on Creation of Subsidiary a. The book value of assets transferred was $152,000 ($3,000 + $16,000 + $27,000 + $9,000 + $70,000 + $60,000 - $21,000 - $12,000). b. Plumb Company would report its investment in Stew Company equal to the book value of net assets transferred of $138,000 ($152,000 - $14,000). c. 8,000 shares ($40,000/$5). d. Total assets declined by $14,000 (book value of assets transferred of $152,000 - investment in Stew Company of $138,000). e. No effect. The shares outstanding reported by Plumb Company are not affected by the creation of Stew Company.

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-27 Acquisition in Multiple Steps Peal Corporation will record the following entries: (1)

(2)

Investment in Seed Company Stock Common Stock - $10 Par Value Additional Paid-In Capital

85,000

Acquisition Expense Additional Paid-In Capital Cash

3,500 2,000

40,000 45,000

5,500

P1-28 Journal Entries to Record a Business Combination Journal entries to record acquisition of SKK net assets: (1) Acquisition Expense Cash Record payment of legal fees.

14,000

(2) Deferred Stock Issue Costs Cash Record costs of issuing stock.

28,000

(3) Cash and Receivables Inventory Buildings and Equipment Goodwill Accounts Payable Notes Payable Common Stock Additional Paid-In Capital Deferred Stock Issue Costs Record purchase of SKK Corporation.

28,000 122,000 470,000 12,000

14,000

28,000

41,000 63,000 96,000 404,000 28,000

Computation of goodwill Fair value of consideration given (24,000 x $22) Fair value of net assets acquired ($620,000 - $104,000) Goodwill

$528,000 (516,000) $ 12,000

Computation of additional paid-in capital Number of shares issued Issue price in excess of par value ($22 - $4) Total Less: Deferred stock issue costs Increase in additional paid-in capital

24,000 x $18 $432,000 (28,000) $404,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-29 Recording Business Combinations Acquisition Expense Deferred Stock Issue Costs Cash

38,000 22,000

Cash and Equivalents Accounts Receivable Inventory Land Buildings Equipment Goodwill Accounts Payable Short-Term Notes Payable Bonds Payable Common Stock $2 Par Additional Paid-In Capital Deferred Stock Issue Costs

41,000 73,000 144,000 200,000 1,500,000 300,000 127,000

60,000

35,000 50,000 500,000 900,000 878,000 22,000

Computation of goodwill Fair value of consideration given (450,000 x $4) Fair value of net assets acquired ($41,000 + $73,000 + $144,000 + $200,000 + $1,500,000 + $300,000 - $35,000 - $50,000 - $500,000) Goodwill

$1,800,000

(1,673,000) $ 127,000

Computation of additional paid-in capital Number of shares issued Issue price in excess of par value ($4 - $2) Total Less: Deferred stock issue costs Increase in additional paid-in capital

450,000 x $2 $900,000 (22,000) $878,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-30 Business Combination with Goodwill a. Journal entry to record acquisition of Sink Company net assets: Cash Accounts Receivable Inventory Patents Buildings and Equipment Goodwill Accounts Payable Notes Payable Cash

20,000 35,000 50,000 60,000 150,000 38,000 55,000 120,000 178,000

b. Balance sheet immediately following acquisition: Pancor Corporation and Sink Company Combined Balance Sheet February 1, 20X3 Cash Accounts Receivable Inventory Patents Buildings and Equipment Less: Accumulated Depreciation Goodwill

$ 82,000 175,000 220,000 140,000 530,000

Accounts Payable Notes Payable Common Stock Additional Paid-In Capital Retained Earnings

$140,000 270,000 200,000 160,000 225,000

(190,000) 38,000 $995,000

$995,000

c. Journal entry to record acquisition of Sink Company stock: Investment in Sink Company Common Stock Cash

178,000 178,000

Computation of goodwill Fair value of consideration given Fair value of net assets acquired ($20,000 + $35,000 + $50,000 + $60,000 + $150,000 - $55,000 -$120,000) Goodwill

$178,000 (140,000) $ 38,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-31 Bargain Purchase Journal entries to record acquisition of Sark Corporation net assets: Acquisition Expense Cash Cash and Receivables Inventory Buildings and Equipment (net) Patent Accounts Payable Cash Gain on Bargain Purchase of Sark Corporation

5,000 5,000 50,000 150,000 300,000 200,000 30,000 625,000 45,000

Computation of gain Fair value of consideration given Fair value of net assets acquired ($700,000 - $30,000) Gain on bargain purchase

$625,000 (670,000) $ 45,000

P1-32 Computation of Account Balances a.

Acquisition price of reporting unit ($7.60 x 100,000) Fair value of net assets at acquisition ($810,000 - $190,000) Goodwill at acquisition Goodwill at year-end Fair value of net assets at year-end Fair value of assets at year-end Fair value of net assets at year-end Fair value of liabilities at year-end

b. Maximum carrying value of reporting unit’s assets: Carrying value of assets at year-end Less: Carrying value of liabilities at year-end (given) Carrying value of net assets at year-end Less: Fair value of the reporting unit’s net assets

Maximum carrying value of assets

$760,000 (620,000) $140,000 (110,000) $820,000 $950,000 (820,000) $130,000

$ X (70,000) $ X - $70,000 $ (930,000) $0 X - $70,00 = $930,000 X = $1,000,000

P1-33 Goodwill Assigned to Multiple Reporting Units

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

a. A goodwill impairment of $95,000 ($20,000 + $50,000 + $25,000) must be reported in the current period for Prover Company: Computation of goodwill impairment: Reporting unit A Carrying value of reporting unit Less: Fair value of reporting unit Goodwill impairment at year-end

$420,000 (400,000) $ 20,000

Reporting unit B Carrying value of reporting unit Less: Fair value of reporting unit Goodwill impairment at year-end

$500,000 (440,000) $ 60,000*

* Limited to the amount of goodwill on the reporting unit’s books ($50,000). Reporting unit C Carrying value of reporting unit Less: Fair value of reporting unit Goodwill impairment at year-end

$290,000 (265,000) $ 25,000

b. Goodwill to be reported by Prover Company: Reporting Unit A B Carrying value of goodwill $70,000 $50,000)* Less: Impairment (20,000) (50,000)* Goodwill to be reported at year-end 50,000 0)* * Limited to the amount of goodwill on the reporting unit’s books. Total goodwill to be reported at year-end: Reporting unit A Reporting unit B Reporting unit C Total goodwill to be reported

C $40,000 (25,000) 15,000

$ 50,000 0 15,000 $65,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-34 Journal Entries Journal entries to record acquisition of Steel net assets: (1) Acquisition Expense Cash Record finder's fee and transfer costs.

19,000

(2) Deferred Stock Issue Costs Cash Record audit fees and stock registration fees.

9,000

(3) Cash Accounts Receivable Inventory Land Buildings and Equipment Bond Discount Goodwill Accounts Payable Bonds Payable Common Stock Additional Paid-In Capital Deferred Stock Issue Costs Record merger with Steel Company.

19,000

9,000 60,000 100,000 115,000 70,000 350,000 20,000 95,000 10,000 200,000 120,000 471,000 9,000

Computation of goodwill Fair value of consideration given (12,000 x $50) Fair value of net assets acquired ($695,000 - $10,000 - $180,000) Goodwill

$600,000 (505,000) $ 95,000

Computation of additional paid-in capital Number of shares issued Issue price in excess of par value ($50 - $10) Total Less: Deferred stock issue costs Increase in additional paid-in capital

12,000 x $40 $480,000 (9,000) $471,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-35 Purchase at More than Book Value a. Journal entry to record acquisition of Stafford Industries net assets: Cash Accounts Receivable Inventory Land Buildings and Equipment Bond Discount Goodwill Accounts Payable Bonds Payable Common Stock Additional Paid-In Capital

30,000 60,000 160,000 30,000 350,000 5,000 125,000 10,000 150,000 80,000 520,000

b. Balance sheet immediately following acquisition: Pamrod Manufacturing and Stafford Industries Combined Balance Sheet January 1, 20X2 Cash Accounts Receivable Inventory Land Buildings and Equipment Less: Accumulated Depreciation Goodwill

$ 100,000 160,000 360,000 80,000 950,000

Accounts Payable Bonds Payable Less: Discount Common Stock Additional Paid-In Capital (250,000) Retained Earnings 125,000 $1,525,000

$ $450,000 (5,000)

60,000 445,000 280,000 560,000 180,000

$1,525,000

Computation of goodwill Fair value of consideration given (4,000 x $150) Fair value of net assets acquired ($630,000 - $10,000 - $145,000) Goodwill

$600,000 (475,000) $125,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-36 Business Combination Journal entry to record acquisition of Shoot-Toot Tuba net assets: Cash Accounts Receivable Inventory Plant and Equipment Other Assets Goodwill Allowance for Uncollectibles Accounts Payable Notes Payable Mortgage Payable Bonds Payable Capital Stock ($10 par) Premium on Capital Stock

300 17,000 35,000 500,000 25,800 86,500 1,400 8,200 10,000 50,000 100,000 90,000 405,000

Computation of fair value of net assets acquired Cash Accounts Receivable Allowance for Uncollectible Accounts Inventory Plant and Equipment Other Assets Accounts Payable Notes Payable Mortgage Payable Bonds Payable Fair value of net assets acquired

$300 17,000 (1,400) 35,000 500,000 25,800 (8,200) (10,000) (50,000) (100,000) $408,500

Computation of goodwill Fair value of consideration given (9,000 x $55) Fair value of net assets acquired Goodwill

$495,000 (408,500) $86,500

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-37 Combined Balance Sheet a. Balance sheet: Pumpworks and Seaworthy Rope Company Combined Balance Sheet January 1, 20X3 Cash and Receivables Inventory Land Plant and Equipment Less: Accumulated Depreciation Goodwill

$110,000 Current Liabilities 142,000 Capital Stock 115,000 Capital in Excess 540,000 of Par Value Retained Earnings (150,000) 13,000 $770,000

100,000 214,000 216,000 240,000

770,000

222,000

328,000 240,000 790,000

Computation of goodwill Fair value of consideration given (700 x $300) Fair value of net assets acquired ($217,000 – $20,000) Goodwill b.

$210,000 (197,000) $13,000

(1) Stockholders' equity with 1,100 shares issued: Capital Stock [$200,000 + ($20 x 1,100 shares)] Capital in Excess of Par Value [$20,000 + ($300 - $20) x 1,100 shares] Retained Earnings

(2) Stockholders' equity with 1,800 shares issued: Capital Stock [$200,000 + ($20 x 1,800 shares)] Capital in Excess of Par Value [$20,000 + ($300 - $20) x 1,800 shares] Retained Earnings

$ 236,000 524,000 240,000 $1,000,000

(3) Stockholders' equity with 3,000 shares issued: Capital Stock [$200,000 + ($20 x 3,000 shares)] Capital in Excess of Par Value [$20,000 + ($300 - $20) x 3,000 shares] Retained Earnings

$ 260,000 860,000 240,000 $1,360,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-38 Incomplete Data Problem a. 5,200 = ($126,000 - $100,000)/$5 b. $208,000 = ($126,000 + $247,000) - ($100,000 + $65,000) c. $46,000 = $96,000 - $50,000 d. $130,000 = ($50,000 + $88,000 + $96,000 + $430,000 - $46,000 $220,000 - $6,000) - ($40,000 + $60,000 + $50,000 + $300,000 $32,000 - $150,000 - $6,000) e. $78,000 = $208,000 - $130,000 f. $97,000 (as reported by Plend Corporation) g. $13,000 = ($430,000 - $300,000)/10 years P1-39 Incomplete Data Following Purchase a. 14,000 = $70,000/$5 b. $8.00 = ($70,000 + $42,000)/14,000 c. 7,000 = ($117,000 - $96,000)/$3 d. $24,000 = $65,000 + $15,000 - $56,000 e. $364,000 = ($117,000 + $553,000 + $24,000) – ($96,000 + $234,000) f. $110,000 = $320,000 - $210,000 g. $306,000 = ($15,000 + $30,000 + $110,000 + $293,000) ($22,000 + $120,000) h. $58,000 = $364,000 - $306,000

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-40 Comprehensive Business Combination Problem a. Journal entries on the books of Pintime Industries to record the combination: Acquisition Expense Cash

135,000

Deferred Stock Issue Costs Cash

42,000

135,000 42,000

Cash Accounts Receivable Inventory Long-Term Investments Land Rolling Stock Plant and Equipment Patents Special Licenses Discount on Equipment Trust Notes Discount on Debentures Goodwill Current Payables Mortgages Payable Premium on Mortgages Payable Equipment Trust Notes Debentures Payable Common Stock Additional Paid-In Capital — Common Deferred Stock Issue Costs

28,000 251,500 395,000 175,000 100,000 63,000 2,500,000 500,000 100,000 5,000 50,000 109,700 137,200 500,000 20,000 100,000 1,000,000 180,000 2,298,000 42,000

Computation of goodwill Value of stock issued ($14 x 180,000) Fair value of assets acquired Fair value of liabilities assumed Fair value of net identifiable assets Goodwill

$2,520,000 $4,112,500 (1,702,200) (2,410,300) $ 109,700

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

P1-40 (continued) b. Journal entries on the books of SCC to record the combination: Investment in Pintime Industries Stock Allowance for Bad Debts Accumulated Depreciation Current Payables Mortgages Payable Equipment Trust Notes Debentures Payable Discount on Debentures Payable Cash Accounts Receivable Inventory Long-Term Investments Land Rolling Stock Plant and Equipment Patents Special Licenses Gain on Sale of Assets and Liabilities Record sale of assets and liabilities.

2,520,000 6,500 614,000 137,200 500,000 100,000 1,000,000 40,000 28,000 258,000 381,000 150,000 55,000 130,000 2,425,000 125,000 95,800 1,189,900

Common Stock Additional Paid-In Capital — Common Stock Treasury Stock Record retirement of Treasury Stock:* $7,500 = $5 x 1,500 shares $4,500 = $12,000 - $7,500

7,500 4,500

Common Stock Additional Paid-In Capital — Common Additional Paid-In Capital — Retirement of Preferred Retained Earnings Investment in Pintime Industries Stock Record retirement of SCC stock and distribution of Integrated Industries stock: $592,500 = $600,000 - $7,500 $495,500 = $500,000 - $4,500 1,410,000 = $220,100 + $1,189,900

592,500 495,500

12,000

22,000 1,410,000 2,520,000

*Alternative approaches exist.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

CHAPTER 2 REPORTING INTERCORPORATE INVESTMENTS AND CONSOLIDATION OF WHOLLY OWNED SUBSIDIARIES WITH NO DIFFERENTIAL ANSWERS TO QUESTIONS Q2-1 (a) An investment in the voting common stock of another company is reported on an equity-method basis when the investor is able to significantly influence the operating and financial policies of the investee. (b) An investment in the voting common stock of another company is carried at fair value when the investor is NOT able to significantly influence the operating and financial policies of the investee. Q2-2 Under normal circumstances, the balance in the intercorporate investment account is expected to be different if the investment is carried at fair value, or if the equity method of accounting is used. Q2-3 At the time the investment qualifies for use of the equity method, the investor shall add the cost of acquiring the additional interest in the investee (if any) to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting Q2-4 A dividend is treated as a reduction of the investment account under equity-method reporting. A dividend received on investments carried at fair value is recorded as dividend income. Q2-5 For securities carried at fair value, the change in the fair value of the shares held by the investor is recorded as an unrealized gain or loss at the end of the period. Under the equity method the investor’s share of the earnings of the investee are recorded as investment income (and recorded as an increase to the investment account). Under the equity method any dividends received from the investee are treated as a reduction of the investment account and these dividends are not considered income to the investor. Q2-6 A one-line consolidation implies that under equity-method reporting the investor's net income and stockholders' equity will be the same as if the investee were consolidated. Income from the investee is included in a single line in the investor's income statement and the investment is reported as a single line in the investor's balance sheet. Q2-7 An adjusting entry is recorded on the company's books and causes the balances reported by the parent or subsidiary company to change. Consolidation entries, on the other hand, are not recorded on the books of the companies. Instead, they are entered in the consolidation worksheet so that when the amounts included in the consolidation entries are applied, - the appropriate balances for the consolidated entity are reported. Q2-8 Each of the stockholders' equity accounts of the subsidiary is eliminated in the consolidation process. Thus, none of the balances is included in the stockholders' equity accounts of the consolidated entity. That portion of the stockholders' equity claim assigned to the noncontrolling shareholders is reported indirectly in the balance assigned to the noncontrolling shareholders.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

Q2-9 Additional entries are needed to eliminate all income statement and retained earnings statement effects of intercorporate ownership and any transfers of goods and services between related companies. Q2-10 Separate parts of the consolidation worksheet are used to develop the consolidated income statement, retained earnings statement, and balance sheet. All consolidation entries needed to complete the entire worksheet normally are entered before any of the three statements are prepared. The income statement portion of the worksheet is completed first so that net income can be carried forward to the retained earnings statement portion of the worksheet. When the retained earnings portion is completed, the ending balances are carried forward and entered in the consolidated balance sheet portion of the worksheet. Q2-11 None of the dividends declared by the subsidiary are included in the consolidated retained earnings statement. Those which are paid to the parent have not gone outside the consolidated entity and therefore must be eliminated in preparing the consolidated statements. Q2-12 Consolidated net income includes 100 percent of the revenues and expenses of the individual consolidating companies arising from transactions with unaffiliated companies. Q2-13 Consolidated retained earnings is that portion of the undistributed earnings of the consolidated entity accruing to the parent company shareholders. Q2-14 Consolidated retained earnings at the end of the period is equal to the beginning consolidated retained earnings balance plus consolidated net income attributable to the controlling interest, less consolidated dividends. Under the fully adjusted equity method, consolidated retained earnings should equal the parent company’s retained earnings. Q2-15 The retained earnings statement shows the increase or decrease in retained earnings during the period. Thus, income for the period is added to the beginning balance and dividends are deducted in deriving the ending balance in retained earnings. Because the consolidation worksheet includes the retained earnings statement, the beginning retained earnings balance must be entered in the worksheet. Q2-16A The general rule established in ASC 323 is that in the absence of other evidence, common stock ownership of 20 percent or more is viewed as indicating that the investor is able to exercise significant influence over the investee. However, ASC 323-10-15-6 also states a number of factors that could constitute other evidence of the ability to exercise significant influence: 1. Representation on board of directors. 2. Participation in policy making. 3. Material intercompany transactions. 4. Interchange of managerial personnel. 5. Technological dependency. 6. Size of investment in relation to concentration of other shareholdings. Q2-17A Equity-method reporting should not be used when (a) the investee has initiated litigation or complaints challenging the investor's ability to exercise significant influence, (b) the investor signs an agreement surrendering important shareholder rights, (c) majority ownership is concentrated in a small group that operates the company without regard to the investor's desires, (d) the investor is not able to acquire the information from the investee, or (e) the investor tries and fails to gain representation on the board of directors.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

Q2-18A When the modified equity method is used, a proportionate share of subsidiary net income and dividends is recorded on the parent's books and an appropriate amount of any differential is amortized each period. In some situations, companies also choose not to make adjustments for intercompany profits and the amortization of the differential. Under the fully adjusted equity method, the parent's books also are adjusted for unrealized profits and any other items that are needed to bring the investor's net income into agreement with the income to the controlling interest that would be reported if consolidation were used. Q2-19A The term modified equity method generally is used when the investor records its portion of the reported net income and dividends of the investee and amortizes an appropriate portion of any differential. Unlike the fully adjusted equity method, no adjustment for unrealized profit on intercompany transfers normally is made on the investor's books. (In some situations, companies also choose not to amortize the differential.) When an investee is consolidated for financial reporting purposes, the investor may not feel it is necessary to record fully adjusted equity method entries on its books since income from the investee and the balance in the investment account must be eliminated in preparing the consolidated statements.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

SOLUTIONS TO CASES C2-1 Choice of Accounting Method a. The equity method is to be used when an investor has significant influence over an investee. Significant influence normally is assumed when more than 20 percent ownership is held. Factors to be considered in determining whether to apply equity-method reporting include the following: 1. Is the investee under the control of the courts or other parties as a result of filing for reorganization or entering into liquidation procedures? 2. Does the investor have representation on the board of directors, or has it attempted to gain representation and been unable to do so? 3. Has the investee initiated litigation or complaints challenging the investor's ability to exercise significant influence? 4. Has the investor signed an agreement surrendering its ability to exercise significant influence? 5. Is majority ownership concentrated in a small group that operates the company without regard of the wishes of the investor? 6. Is the investor able to acquire the information needed to use equity-method reporting? b. The equity method will align the contribution to Slanted’s earnings with the earnings reported by Flat. If the investment is carried at fair value, the contribution to Slanted’s earnings will be aligned with the change in market value of Flat’s shares, thus market expectations play a key role in the contribution to earnings if the investment is carried at fair value. c. The key reason that the equity method is more appropriate as the percentage of ownership increases is that GAAP requires the use of the equity method at the point when the investor gains significant influence over an investee. Therefore Slanted is likely to be required to use the equity method to account for its investment in Flat. Some of the reasons for this include that as the investor uses more of its resources to acquire ownership of the investee, and as the investor has a greater share of the investee's profits and losses, the success of the investee's operations may have more of an impact on the overall financial well-being of the investor. In many cases, the investor will want to participate in key decisions of the investee once the investor's ownership share reaches a certain level. Also, use of the equity method eliminates the possibility of the investor manipulating its own income by influencing investee dividend distributions, as might occur if the investor carries the investment at fair value.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

C2-2 Intercorporate Ownership MEMO To:

Chief Accountant Most Company

From: Re:

, CPA Equity Method Reporting for Investment in Adams Company

The equity method should be used in reporting investments in which the reporting company has a significant influence over the operating and financing decisions of another company. In this case, Most Company holds 15 percent of the voting common stock of Adams Company and Port Company holds an additional 10 percent. During the course of the year, both Most and Port are likely to carry their respective investments in Adams at fair value. However, when consolidated statements are prepared for Most, the combined ownership must be used in determining whether significant influence exists. Both direct and indirect ownership must be taken into consideration. [ASC 323] A total of 15 percent of the voting common stock of Adams is held directly by Most Company and an additional 10 percent is controlled indirectly through Most’s ownership of Port Company. Equity-method reporting for the investment in Adams Company therefore appears to be required in the consolidated financial statements. If Most and Port have carried their investments in Adams at fair value during the year, then at the time consolidated statements are prepared, adjustments must be made to (a) increase the balance in the investment account for a proportionate share of the investee’s reported net income (25 percent) and reduce the balance in the investment account for a proportionate share of the dividend paid by the investee, (b) include a proportionate share of the investee’s net income in the consolidated income statement, (c) delete any dividend income recorded by Most and Port, and (d) reverse any impact of entries that Most and Port have made related to changes in fair value of Adams stock during the year. Primary citation ASC 323

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

C2-3 Application of the Equity Method MEMO To:

Controller Forth Company

From: Re:

, CPA Equity Method Reporting for Investment in Brown Company

This memo is prepared in response to your request to evaluate whether Forth should use the equity method in accounting for its investment in Brown Company, or if the investment should be carried at fair value. Forth Company held 85 percent of the common stock of Brown Company prior to January 1, 20X2, and was required to fully consolidate Brown Company in its financial statements prepared prior to that date [ASC 810]. Forth now holds only 15 percent of the common stock of Brown. Investments are normally carried at fair value when ownership is less than 20 percent of the stock that is directly or indirectly held by the investor. Equity-method reporting should be used when the investor has “significant influence over operating and financing policies of the investee.” While 20 percent ownership is regarded as the level at which the investor is presumed to have significant influence, other factors must be considered as well. [ASC 323] Although Forth currently holds only 15 percent of Brown’s common stock, the other factors associated with its ownership indicate that Forth does exercise significant influence over Brown. Forth has two members on Brown’s board of directors, it purchases a substantial portion of Brown’s output, and Forth appears to be the largest single shareholder by virtue of its sale of 10,000 shares to each of 7 other investors. These factors provide strong evidence that Forth has significant influence over Brown and points to the need to use equity-method reporting for its investment in Brown. Your office should monitor the activities of the standard setting bodies with respect to consolidation standards [www.fasb.org]. Active consideration is being given to situations in which control may be exercised even though the investor does not hold majority ownership. It is conceivable that your situation might be one in which consolidation could be required. Primary citations APB 18, par. 17; ASC 323-10-15-6 through 15-8 ASC 810

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

C2-4 Need for Consolidation Process After the financial statements of each of the individual companies are prepared in accordance with generally accepted accounting principles, consolidated financial statements must be prepared for the economic entity as a whole. The individual companies generally record transactions with other subsidiaries on the same basis as transactions with unrelated enterprises. In preparing consolidated financial statements, the effects of all transactions with related companies must be removed, just as all transactions within a single company must be removed in preparing financial statements for that individual company. It therefore is necessary to prepare a consolidation worksheet and to enter a number of special journal entries in the worksheet to remove the effects of the intercorporate transactions. The parent company also reports an investment in each of the subsidiary companies and investment income or loss in its financial statements. Each of these accounts must be eliminated as well as the stockholders' equity accounts of the subsidiaries. The latter must be eliminated so that only the parent’s equity remains. This is because only the parent's ownership is held by parties outside the consolidated entity.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

C2-5 Account Presentation MEMO To:

Chief Accountant Prime Company

From: Re:

, Accounting Staff Combining Broadly Diversified Balance Sheet Accounts

Many manufacturing and merchandising enterprises excluded finance, insurance, real estate, leasing, and perhaps other types of subsidiaries from consolidation prior to 1987 on the basis of “nonhomogeneous” operations. Companies generally argued that the accounts of these companies were dissimilar in nature and combining them in the consolidated financial statements would mislead investors. ASC 810 specifically eliminated the exception for nonhomogeneous operations. ASC 810 affirms the requirement for consolidating entities in which a controlling financial interest is held. Prime Company controls companies in very different industries and combining the accounts of its subsidiaries may lead to confusion by some investors; however, it may be equally confusing to provide detailed listings of assets and liabilities by industry or other breakdowns in the consolidated balance sheet. The actual number of assets and liabilities presented in the consolidated balance sheet must be carefully considered, but is the decision of Prime’s management. It is important to recognize that the notes to the consolidated financial statements are regarded as an integral part of the financial statements and Prime Company is required to include in its notes to the financial statements certain information on its reportable segments [ASC 280]. Because of the diversity of its ownership, Prime may wish to provide more than the minimum disclosures specified in the guidance. Segment information appears to be used quite broadly by investors and permits the company to provide sufficient detail to assist the financial statement user in gaining a better understanding of the various operating divisions of the company. You have requested information on those situations in which it may not be appropriate to combine similar appearing accounts of two or more subsidiaries. The following is a partial listing of such situations: (a) the accounts of a subsidiary should not be included along with other subsidiaries if control of the assets and liabilities does not rest with Prime Company, as when a subsidiary is in receivership; (b) while the assets and liability accounts of the subsidiary should be combined with the parent, the equity account balances should not; (c) negative account balances in cash or accounts receivable should be reclassified as liabilities rather than being added to the positive balances of other affiliates if there is no right of offset in the underlying bank accounts, and (d) assets pledged for a specific purpose and not available for other use by the consolidated entity generally should be separately reported. Primary citations: ASC 810 ASC 280-10 ASC 810-10-65-1 Secondary sources: ASC 810

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

C2-6 Consolidating an Unprofitable Subsidiary MEMO TO:

Chief Accountant Amazing Chemical Corporation

FROM: Re:

, Accounting Staff Consolidation of Unprofitable Boatyard

This memo is intended to provide recommendations on the presentation of the boatyard in Amazing Chemical’s consolidated financial statements. Amazing Chemical Corporation currently has full ownership of the boatyard and should fully consolidate the boatyard in its financial statements. Consolidated statements should be prepared when a company directly or indirectly has a controlling financial interest in one or more other companies. [ASC 810]. Amazing Chemical appears to be following generally accepted accounting procedures in fully consolidating the boatyard in its financial statements and should continue to do so. The operations of the boatyard appear to be distinct from the other operations of the parent company and its losses appear to be sufficient to establish it as a reportable segment [ASC 280]. While the operating losses of the boatyard may not be evident in analyzing the consolidated income statement, a review of the notes to the consolidated statements should provide adequate disclosure of its operations as a reportable segment. The financial statements for the current period should contain these disclosures and if prior period statements have not included the boatyard as a reportable segment it may be necessary to restate those statements. Failure of the president of Amazing Chemical to receive approval by the board of directors for the purchase of the boatyard and his subsequent actions to keep information about its operations from the board members appears to be a serious breach of ethics. These actions by the president should immediately be brought to the attention of the board of directors for appropriate action by the board. Primary citations: ASC 810-10-10-1 ASC 810 ASC 280-10-50 ASC 810-10-65-1

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

SOLUTIONS TO EXERCISES E2-1 Multiple-Choice Questions on Accounting for Equity Investments [AICPA Adapted] 1. a – Cash dividends received will never cause an increase in the investment account under either method. (b) Incorrect. A cash dividend is recorded as dividend income and does not affect the investment account when the investment is carried at fair value. Under the equity method, dividends reduce the investment account. (c) Incorrect. A cash dividend is recorded as dividend income and does not affect the investment account when the investment is carried at fair value. (d) Incorrect. Under the equity method, dividends reduce the investment account. 2. a – Because the ownership in Amal Corporation is less than 20%, the investment should be carried at fair value. Accordingly, the $1,500 dividend received from Amal is recorded as dividend revenue. (b) Incorrect. Stock dividends are not recorded as income. (c) Incorrect. The cash dividend received from B&K is not recorded as dividend revenue because it is accounted for under the equity method. (d) Incorrect. The stock dividend and cash dividend from B&K are not recorded as dividend revenue. 3. a – Under the equity method, net income increases the investment account while dividends decrease it. Because net income was greater than the dividends declared, this results in a net increase in the investment account. The problem information indicated that fair value of the stock was unchanged during the year. Thus in this problem, the balance at year-end would be lower if the investment was carried at fair value than it would be under the equity method. (b) Incorrect. This would only be true if the dividends were less than the net income. (c) Incorrect. It doesn’t matter when the dividends are paid; as soon as they are declared they act as a reduction to the investment under the equity method. (d) Incorrect. It doesn’t matter when the dividends are paid; as soon as they are declared they act as a reduction to the investment under the equity method. 4. b – Under the equity method the company records a share of the affiliate net income as income for the company. This increases the net income of the company which increases earnings per share. (a) Incorrect. An increase in income affects long-term assets, not current assets or current liabilities, so it would have no effect on the current ratio. (c) Incorrect. The assets would be higher so asset turnover would decrease. No other turnover ratios would be affected. (d) Incorrect. The affiliate company’s profitability would not decrease the book value per share of the company, it would increase it since retained earnings would increase with the recognition of income from the subsidiary.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

E2-2 Multiple-Choice Questions on Intercorporate Investments 1. b – Equity method reporting is used when an investor gains significant influence over the operating and financing decisions of the investee. Typically, this is satisfied by maintaining 20% or more of the voting stock, but can also be obtained by other contractual obligations or circumstances. (a) Incorrect. Voting shares can be obtained without gaining significant influence (i.e. less than 20%) and thus the equity method is not typically used. (c) Incorrect. Purchasing goods and services would not constitute significant influence over the company, and thus does not result in the equity method being applied. (d) Incorrect. This would result in a write-down of the investment, and does not correlate to the use of the equity method. 2. c – Under the equity method, net income from the investee causes an increase to the investment, while dividends declared by the investee causes a reduction. (a) Incorrect. This simply represents the historical cost of the investment. It must be adjusted for the income and dividends declared by the investee. (b) Incorrect. Dividends declared by the investee cause a reduction to the investment, not an increase. (d) Incorrect. Net income reported by the investee causes an increase to the investment, not a decrease.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

E2-3 Multiple-Choice Questions on Applying Equity Method [AICPA Adapted] 1. d – $250,000 + ($100,000 x 0.30) – ($10,000 x 0.30) = $277,000 2. d – If the investment had been accounted for using the equity method, Investor would have recorded its share of Alimand’s income by increasing the investment account and increasing earnings by $40,000 ($100,000 x 40%). Investor would also have decreased the investment account by $4,000 for its share of the dividends ($10,000 x 40%). However, since Investor incorrectly accounted for the investment as if were carried at fair value, the only entry Investor recorded was to increase income by $4,000 for the dividends. As a result, the investment account will be understated, earnings will be understated, and retained earnings will be understated. 3. d – Under the equity method, dividends by the investee are recorded with a credit to the investment account, not to dividend revenue. By wrongly classifying this entry, the investment is overstated, and retained earnings are also overstated. (a) Incorrect. Because the dividend entry was recorded incorrectly, the financial position will not be correctly stated. (b) Incorrect. Because the dividends were recorded as dividend revenue, retained earnings would be overstated. (c) Incorrect. Currently, the investment is overstated because the dividends declared should have resulted in a reduction to the investment account.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

E2-4 Carrying an Investment at Fair Value versus Equity Method Reporting a. Winston Corporation net income – carried at fair value: 20X2 20X3 20X4

$100,000 $ 60,000 $250,000

+ + +

.40($30,000) .40($60,000) .40($50,000a)

+ + +

$20,000 $20,000 $20,000

$132,000 104,000 290,000

A liquidating dividend can impact the entry made by the company declaring the dividend where it may need to debit a paid-in-capital account instead of a retained earnings account. In the past, if the recipient of the dividend was accounting for the equity investment under the cost method, then the entry to record a liquidating dividend needed to be modified to exclude the liquidating amount from dividend income. The liquidating amount received was recorded as a reduction in the investment. However, under current standards if the equity investment is being accounting for under the equity method, then all dividends are treated as a return of investment (as opposed to a return on investment). Therefore, all dividends are all dividends are effectively accounted for as liquidating the investment (hopefully the investment is increasing through investee earnings). If the investment is carried at fair value, then dividends received are recorded as income. However, all changes in fair value are also recorded through income each period. If a company is truly in the process of liquidating paid in capital, the fair value of that company will be expected to be declining. b. Winston Corporation net income – equity method: 20X2 $100,000 + .40($70,000) 20X3 $ 60,000 + .40($40,000) 20X4 $250,000 + .40($25,000)

$128,000 76,000 260,000

E2-5 Acquisition Price Balance at date of acquisition: a. Carried at fair value:

$54,000 − $6,000 = $48,000

The investment account would be increased by $2,000 each year reflecting the increase in the market value of Phillips' investment in Jones' stock. b. Equity method

$54,000 - $2,000 = $52,000

Year

Net Income

Dividends

20X1 20X2

$ 8,000 12,000

$15,000 10,000

Phillips’s share of Investment $(2,800) 800

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

20X3 20,000 Change in account balance

10,000

4,000 $ 2,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

E2-6 Investment Income a. (1) Ravine Corporation net income when investment is carried at fair value: 20X6 20X7 20X8 20X9

$140,000 $ 80,000 $220,000 $160,000

+ + + +

0.30($20,000) 0.30($40,000) 0.30($40,000) 0.30($20,000)

+ $10,000 + $10,000 + $10,000 + $10,000

= = = =

$156,000 $102,000 $242,000 $176,000

A liquidating dividend can impact the entry made by the company declaring the dividend where it may need to debit a paid-in-capital account instead of a retained earnings account. In the past, if the recipient of the dividend was accounting for the equity investment under the cost method, then the entry to record a liquidating dividend needed to be modified to exclude the liquidating amount from dividend income. The liquidating amount received was recorded as a reduction in the investment. However, under current standards if the equity investment is being accounting for under the equity method, then all dividends are treated as a return of investment (as opposed to a return on investment). Therefore, all dividends are all dividends are effectively accounted for as liquidating the investment (hopefully the investment is increasing through investee earnings). If the investment is carried at fair value, then dividends received are recorded as income. However, all changes in fair value are also recorded through income each period. If a company is truly in the process of liquidating paid in capital, the fair value of that company will be expected to be declining. (2) Ravine Corporation net income under Equity Method: 20X6 20X7 20X8 20X9

$140,000 $ 80,000 $220,000 $160,000

+ + + +

0.30($30,000) 0.30($50,000) 0.30($10,000) 0.30($40,000)

= = = =

$149,000 $ 95,000 $223,000 $172,000

b. Journal entries recorded by Ravine Corporation in 20X8: (1) Carried at fair value: Cash Dividend Income

12,000

Investment in Valley Stock Unrealized Gain on Valley Stock

10,000

12,000 10,000

(2) Equity method: Cash

12,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

Investment in Valley Stock

12,000

Investment in Valley Stock Income from Valley

3,000 3,000

E2-7 Investment Value The following amounts would be reported as the carrying value of Port’s investment in Sund: 20X2 20X3 20X4

$184,500 = $193,500 = $195,000 =

$180,000 $184,500 $193,500

+ ($40,000 x 0.30) + ($30,000 x 0.30) + ($5,000 x 0.30)

($25,000 x 0.30)

E2-8 Carrying an Investment at Fair Value versus Equity Method Reporting a. Fair value method: Operating income reported by Mock Unrealized gain on increase in value of Small stock Dividend income from Small ($15,000 x 0.20) Net income reported by Mock

$90,000 16,000 3,000 $ 109,000

b. Equity method: Operating income reported by Mock Income from investee ($40,000 x 0.20) Net income reported by Mock

$90,000 8,000 $98,000

E2-9 Carrying an Investment at Fair Value versus Equity Method Reporting a. Journal entries under the equity method: (1) Investment in Lomm Company Stock Cash Record purchase of Lomm Company stock.

140,000 140,000

(2) Cash Investment in Lomm Company Stock Record dividends from Lomm Company: $20,000 x 0.35

7,000

(3) Investment in Lomm Company Stock Income from Lomm Company Record equity-method income: $80,000 x 0.35

28,000

7,000

28,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

Journal entries for investment carried at fair value. (1) Investment in Lomm Company Stock Cash Record purchase of Lomm Company stock. (2) Cash Dividend Income Record dividends from Lomm Company: $20,000 x 0.35

140,000 140,000 7,000

(3) Investment in Lomm Company Stock 34,000 Unrealized Gain on Increase in Value of Lomm Stock Record increase in value of Lomm stock: $174,000 - $140,000

7,000

34,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

E2-10 Basic Consolidation Entry Common Stock – Broadway Corporation Additional Paid-In Capital Retained Earnings Investment in Broadway Common Stock

200,000 300,000 100,000 600,000

E2-11 Balance Sheet Worksheet a. Equity Method Entries on Blank's Books: Investment in Faith 150,000 Cash 150,000 Record the initial investment in Faith 12/31/X2 Goodwill = 0

Identifiable excess = 0

$150,000 Initial investment in Faith

Book value = CS + RE = 150,000

Book Value Calculations: Total Book Value Ending book value

150,000

Common Stock

60,000

Retained Earnings 90,000

Basic Consolidation Entry Common stock

60,000

Retained earnings

90,000

Investment in Faith

150,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation Buildings & equipment

30,000 30,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

E2-11 (continued)

(Since the buildings and equipment are reported net of accumulated depreciation on the balance sheet, this entry will not affect the worksheet. However, if sufficient information had been given, this entry would have made a difference in the worksheet balances for Buildings and Equipment and Accumulated Depreciation. Additionally, this entry would impact any footnote disclosure of the details of Buildings and Equipment.) b. Consolidation Entries Blank

Faith

Consolidated

Cash

65,000

18,000

83,000

Accounts Receivable

87,000

37,000

124,000

Inventory

110,000

60,000

Buildings & Equipment (net)

220,000

150,000

Investment in Faith

150,000

Total Assets

632,000

265,000

Accounts Payable

92,000

35,000

127,000

Notes Payable

150,000

80,000

230,000

Common Stock

100,000

60,000

100,000

Retained Earnings

290,000

90,000

290,000

Total Liabilities & Equity

632,000

265,000

150,000

Balance Sheet

170,000 30,000

30,000

370,000

150,000

180,000

747,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

E2-12 Consolidation Entries for Wholly Owned Subsidiary a. Equity Method Entries on Trim Corp.'s Books: Investment in Round Corp.

400,000

Cash

400,000

Record the initial investment in Round Corp.

Investment in Round Corp.

80,000

Income from Round Corp.

80,000

Record Trim Corp.'s 100% share of Round Corp.'s 20X2 income

Cash

25,000

Investment in Round Corp.

25,000

Record Trim Corp.'s 100% share of Round Corp.'s 20X2 dividend

b. Book Value Calculations: Total Book Value Beginning book value

400,000

Common Stock 120,000

Retained Earnings 280,000

+ Net Income

80,000

- Dividends

(25,000)

Ending book value

455,000

120,000

335,000

1/1/X2

12/31/X2

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 400,000

$400,000 Initial investment in Round Corp.

Book value = CS + RE = 455,000

$455,000 Net investment in Round Corp.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

E2-12 (continued) Basic Consolidation Entry Common stock

120,000

Retained earnings

280,000

Income from Round Corp.

80,000

Dividends declared

25,000

Investment in Round Corp.

455,000

E2-13 Basic Consolidation Entries for Fully Owned Subsidiary a. Equity Method Entries on Purple Co.'s Books: Investment in Amber Corp.

500,000

Cash

500,000

Record the initial investment in Amber Corp.

Investment in Amber Corp.

50,000

Income from Amber Corp.

50,000

Record Purple Co.'s 100% share of Amber Corp.'s 20X7 income

Cash

20,000

Investment in Amber Corp.

20,000

Record Purple Co.'s 100% share of Amber Corp.'s 20X7 dividend

b. Book Value Calculations: Total Book Value Original book value

500,000

Common Stock 300,000

Retained Earnings 200,000

+ Net Income

50,000

- Dividends

(20,000)

Ending book value

530,000

300,000

230,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

1/1/X7

12/31/X7

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 500,000

$500,000 Initial investment in Amber Corp.

Identifiable excess = 0

Book value = CS + RE = 530,000

$530,000 Net investment in Amber Corp.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

E2-13 (continued)

Basic Consolidation Entry Common stock

300,000

Retained earnings

200,000

Income from Amber Corp.

50,000

Dividends declared

20,000

Investment in Amber Corp.

530,000

Investment in

Income from

Amber Corp.

Acquisition Price

500,000

Net Income

50,000 20,000

Ending Balance

Net Income

50,000

Ending Balance

Dividends

530,000 530,000

50,000

Basic

50,000

E2-14A Income Reporting Journal entry recorded by Grandview Company: Investment in Spinet Corporation Stock Income from Spinet Corporation Discontinued Operations (from Spinet Corporation)

36,000 24,000 12,000

E2-15A Investee with Preferred Stock Outstanding Journal entries recorded by Reden Corporation: (1) Investment in Montgomery Co. Stock Cash Record purchase of Montgomery Co. stock.

288,000 288,000

(2) Cash 6,750 Investment in Montgomery Co. Stock 6,750 Record dividend from Montgomery Co.: [$40,000 - ($250,000 x .10)] x 0.45 (3) Investment in Montgomery Co. Stock 31,500 Income from Montgomery Co. 31,500 Record equity-method income: [$95,000 - ($250,000 x .10)] x 0.45

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

E2-16A Other Comprehensive Income Reported by Investee Journal entries recorded by Callas Corp. during 20X9: (1)

(2)

(3)

(4)

Investment in Thinbill Co. Stock Cash Record purchase of Thinbill Company

380,000

Cash Investment in Thinbill Co. Stock Record dividend from Thinbill: $9,000 x 0.40

3,600

380,000

3,600

Investment in Thinbill Co. Stock 18,000 Income from Thinbill Co. Record equity-method income: $18,000 = $45,000 x 0.40

18,000

Investment in Thinbill Co. Stock 8,000 Unrealized Gain on Investments of Investee (OCI) 8,000 Record share of OCI reported by Thinbill: $8,000 = $20,000 x 0.40 Closing entries recorded at December 31, 20X9:

(5) (6)

Income from Thinbill Co. Retained Earnings

18,000 18,000

Unrealized Gain on Investments of Investee (OCI) 8,000 Accumulated Other Comprehensive Income from Investee-Unrealized Gain on Investments

8,000

E2-17A Other Comprehensive Income Reported by Investee Investment account balance reported by Baldwin Corp. Add decrease in account recorded in 20X8: Equity-method loss ($20,000 x .25) Dividend received ($10,000 x .25) Deduct increase in account recorded in 20X9: Equity-method income ($68,000 x .25) Dividend received ($16,000 x .25) Other comprehensive income reported by Gwin Company ($12,000 x .25) Purchase price

$67,000 $ (5,000) (2,500)

7,500

$17,000 (4,000) 3,000

(16,000) $58,500

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

SOLUTIONS TO PROBLEMS P2-18 Changes in the Number of Shares Held Journal entries recorded by Idle Corporation: (1) Investment in Fast Track Enterprises Stock Cash Record purchase of Fast Track stock.

34,000 34,000

(3) Dividends Receivable 5,000 Investment in Fast Track Enterprises Stock Record dividend from Fast Track Enterprises: $20,000 x .25

5,000

(4) Investment in Fast Track Enterprises Stock Income from Fast Track Enterprises Record equity-method income: $50,000 x .25

12,500

P2-19 Investments Carried at Fair Value and Equity Method a. Fair value method: 20X6

20X7

20X8

Investment income: Dividends received Gain (loss) on fair value Total income reported

$ 3,000 19,000 $22,000

$ 6,000 (3,000) $ 3,000

$ 4,000 11,000 $15,000

Balance in investment account

$89,000

$86,000

$97,000

b. Equity method: Investment income: $40,000 x .20 $35,000 x .20 $60,000 x .20 Balance in investment account: Balance at January 1 Investment income Dividends received Balance at December 31

$ 8,000 $ 7,000 $12,000 $70,000 8,000 (3,000) $75,000

$75,000 7,000 (6,000) $76,000

$76,000 12,000 (4,000) $84,000

P2-20 Carried at Fair Value Journal Entries Journal entries investment carried at fair value for 20X8: (1) Investment in Brown Company Stock Cash Record purchase of Brown Company stock.

85,000

(2) Cash

4,000

85,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

Dividend Income Record dividends from Brown Company: $10,000 x .40

4,000

(3) Investment in Brown Company Stock 12,000 Unrealized Gain on Increase in Value of Brown Company Stock Record increase in value of Brown stock: $97,000 - $85,000

12,000

Journal entries investment carried at fair value for 20X9: (1) Cash Dividend Income Record dividends from Brown Company: $15,000 x .40

6,000

(2) Unrealized Loss on Decrease in Value of Brown Company Stock 5,000 Investment in Brown Company Stock Record decrease in value of Brown stock: $97,000 - $92,000

6,000

5,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-21 Consolidated Worksheet at End of the First Year of Ownership (Equity Method) a. Equity Method Entries on Peanut Co.'s Books: Investment in Snoopy Co.

300,000

Cash

300,000

Record the initial investment in Snoopy Co. Investment in Snoopy Co.

75,000

Income from Snoopy Co.

75,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X8 income Cash

20,000

Investment in Snoopy Co.

20,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X8 dividend b. Book Value Calculations: Total Book Value Beginning book value 300,000

Common Stock 200,000

Retained Earnings 100,000

+ Net Income

75,000

- Dividends

(20,000)

Ending book value

355,000

200,000

155,000

1/1/X8

12/31/X8

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 300,000

$300,000 Initial investment in Snoopy Co.

Identifiable excess = 0

Book value = CS + RE = 355,000

$355,000 Net investment in Snoopy Co.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-21 (continued) Basic Consolidation Entry Common stock

200,000

Retained earnings

100,000

Income from Snoopy Co.

75,000

Dividends declared

20,000

Investment in Snoopy Co.

355,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

10,000

Buildings & equipment

10,000

The amount of this entry is found by looking at the depreciation expense ($10,000) for the year and the accumulated depreciation at the end of the year ($20,000). The difference must be what was in accumulated depreciation at the date of the acquisition. Note that this assumes there were no sales or other disposals of Buildings and equipment during the year.

Investment in

Income from

Snoopy Co.

Acquisition Price

300,000

Net Income

75,000 20,000

Ending Balance

355,000 355,000 0

75,000

Net Income

75,000

Ending Balance

Dividends

Basic

75,000 0

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-21 (continued) Consolidation Entries

Peanut Co.

Snoopy Co.

Sales

800,000

250,000

1,050,000

Less: COGS

(200,000)

(125,000)

(325,000)

Less: Depreciation Expense

(50,000)

(10,000)

(60,000)

Less: Other Expenses

(225,000)

(40,000)

(265,000)

Income from Snoopy Co.

75,000

Net Income

400,000

75,000

Beginning Balance

225,000

100,000

Net Income

400,000

75,000

Less: Dividends Declared

(100,000)

(20,000)

Ending Balance

525,000

155,000

Cash

130,000

80,000

210,000

Accounts Receivable

165,000

65,000

230,000

Inventory

200,000

75,000

Investment in Snoopy Co.

355,000

Land

200,000

100,000

Buildings & Equipment

700,000

200,000

Less: Accumulated Depreciation

(450,000)

(20,000)

10,000

Total Assets

1,300,000

500,000

10,000

Accounts Payable

75,000

60,000

Bonds Payable

200,000

85,000

Common Stock

500,000

200,000

Retained Earnings

525,000

155,000

175,000

20,000

525,000

1,300,000

500,000

375,000

20,000

1,445,000

Consolidated

Income Statement

75,000

0 0

400,000

Statement of Retained Earnings

175,000

225,000 0

400,000

20,000

(100,000)

20,000

525,000

Balance Sheet

Total Liabilities & Equity

275,000 355,000

0 300,000

10,000

890,000 (460,000)

365,000

1,445,000

135,000 285,000 500,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-22 Consolidated Worksheet at End of the Second Year of Ownership (Equity Method) a. Equity Method Entries on Peanut Co.'s Books: Investment in Snoopy Co.

80,000

Income from Snoopy Co.

80,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X9 income Cash

30,000

Investment in Snoopy Co.

30,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X9 dividend

b. 1/1/X9

12/31/X9

Goodwill = 0

Identifiable excess = 0

$355,000 Net investment in Snoopy Co.

Book value = CS + RE = 355,000

Identifiable excess = 0

Book value = CS + RE = 405,000

$405,000 Net investment in Snoopy Co.

Book Value Calculations: Total Book Value Beg. book value

355,000

Common Stock 200,000

Retained Earnings 155,000

+ Net Income

80,000

- Dividends

(30,000)

Ending book value

405,000

200,000

205,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-22 (continued) Basic Consolidation Entry Common stock

200,000

Retained earnings

155,000

Income from Snoopy Co.

80,000

Dividends declared

30,000

Investment in Snoopy Co.

405,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

10,000

Buildings & equipment

10,000

Note that this entry is carried forward from the previous year (see solution to P2-21) again assuming that no sales or other disposals of Buildings and equipment took place during the year. Investment in

Income from

Snoopy Co.

Beginning Balance

355,000

Net Income

80,000

Ending Balance

405,000

30,000 405,000 0

80,000

Net Income

80,000

Ending Balance

Dividends Basic

80,000 0

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-22 (continued) Consolidation Entries

Peanut Co.

Snoopy Co.

Sales

850,000

300,000

1,150,000

Less: COGS

(270,000)

(150,000)

(420,000)

Less: Depreciation Expense

(50,000)

(10,000)

(60,000)

Less: Other Expenses

(230,000)

(60,000)

(290,000)

Income from Snoopy Co.

80,000

Net Income

380,000

80,000

Beginning Balance

525,000

155,000

Net Income

380,000

80,000

Less: Dividends Declared

(225,000)

(30,000)

Ending Balance

680,000

205,000

Cash

230,000

75,000

305,000

Accounts Receivable

190,000

80,000

270,000

Inventory

180,000

100,000

Investment in Snoopy Co.

405,000

Land

200,000

100,000

Buildings & Equipment

700,000

200,000

Less: Accumulated Depreciation

(500,000)

(30,000)

10,000

Total Assets

1,405,000

525,000

10,000

Accounts Payable

75,000

35,000

Bonds Payable

150,000

85,000

Common Stock

500,000

200,000

Retained Earnings

680,000

205,000

235,000

30,000

680,000

1,405,000

525,000

435,000

30,000

1,525,000

Consolidated

Income Statement

80,000

0 0

380,000

Statement of Retained Earnings

235,000

525,000 0

380,000

30,000

(225,000)

30,000

680,000

Balance Sheet

Total Liabilities & Equity

280,000 405,000

0 300,000

10,000

890,000 (520,000)

415,000

1,525,000

110,000 235,000 500,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-23 Consolidated Worksheet at End of the First Year of Ownership (Equity Method) a. Equity Method Entries on Paper Co.'s Books: Investment in Scissor Co.

370,000

Cash

370,000

Record the initial investment in Scissor Co. Investment in Scissor Co.

93,000

Income from Scissor Co.

93,000

Record Paper Co.'s 100% share of Scissor Co.'s 20X8 income Cash

25,000

Investment in Scissor Co.

25,000

Record Paper Co.'s 100% share of Scissor Co.'s 20X8 dividend b. Book Value Calculations: Total Book Value Beginning book value

370,000

Common Stock 250,000

Retained Earnings 120,000

+ Net Income

93,000

- Dividends

(25,000)

Ending book value

438,000

250,000

188,000

1/1/X8

12/31/X8

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 370,000

$370,000 Initial investment in Scissor Co.

Identifiable excess = 0

Book value = CS + RE = 438,000

$438,000 Net investment in Scissor Co.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-23 (continued) Basic Consolidation Entry Common stock

250,000

Retained earnings

120,000

Income from Scissor Co.

93,000

Dividends declared

25,000

Investment in Scissor Co.

438,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

24,000

Buildings & equipment

24,000

The amount of this entry is found by looking at the depreciation expense ($12,000) for the year and the accumulated depreciation at the end of the year ($36,000). The difference must be what was in accumulated depreciation at the date of the acquisition. Note that this assumes there were no sales or other disposals of Buildings and equipment during the year.

Investment in

Income from

Scissor Co.

Acquisition Price

370,000

Net Income

93,000

Ending Balance

438,000

25,000 438,000 0

93,000

Net Income

93,000

Ending Balance

Dividends Basic

93,000 0

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-23 (continued) Consolidation Entries

Paper Co.

Scissor Co.

Sales

800,000

310,000

1,110,000

Less: COGS

(250,000)

(155,000)

(405,000)

Less: Depreciation Expense

(65,000)

(12,000)

(77,000)

Less: Other Expenses

(280,000)

(50,000)

(330,000)

Income from Scissor Co.

93,000

Net Income

298,000

93,000

Beginning Balance

280,000

120,000

Net Income

298,000

93,000

Less: Dividends Declared

(80,000)

(25,000)

Ending Balance

498,000

188,000

Cash

122,000

46,000

168,000

Accounts Receivable

140,000

60,000

200,000

Inventory

190,000

120,000

Investment in Scissor Co.

438,000

Land

250,000

125,000

Buildings & Equipment

875,000

250,000

Less: Accumulated Depreciation

(565,000)

(36,000)

24,000

Total Assets

1,450,000

565,000

24,000

Accounts Payable

77,000

27,000

Bonds Payable

250,000

100,000

Common Stock

625,000

250,000

Retained Earnings

498,000

188,000

213,000

25,000

498,000

1,450,000

565,000

463,000

25,000

1,577,000

Consolidated

Income Statement

93,000

0 0

298,000

Statement of Retained Earnings

213,000

280,000 0

298,000

25,000

(80,000)

25,000

498,000

Balance Sheet

Total Liabilities & Equity

310,000 438,000

0 375,000

24,000

1,101,000 (577,000)

462,000

1,577,000

104,000 350,000 625,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-24 Consolidated Worksheet at End of the Second Year of Ownership (Equity Method) a. Equity Method Entries on Paper Co.'s Books: Investment in Scissor Co.

107,000

Income from Scissor Co.

107,000

Record Paper Co.'s 100% share of Scissor Co.'s 20X9 income

Cash

30,000

Investment in Scissor Co.

30,000

Record Paper Co.'s 100% share of Scissor Co.'s 20X9 dividend b. Book Value Calculations: Total Book Value

Common Stock 250,000

Retained Earnings

Beg. book value

438,000

+ Net Income

107,000

- Dividends

(30,000)

Ending book value

515,000

250,000

188,000

265,000

1/1/X9

12/31/X9

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 438,000

$438,000 Net investment in Scissor Co.

Identifiable excess = 0

Book value = CS + RE = 515,000

$515,000 Net investment in Scissor Co.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-24 (continued) Basic Consolidation Entry Common stock

250,000

Retained earnings

188,000

Income from Scissor Co.

107,000

Dividends declared

30,000

Investment in Scissor Co.

515,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

24,000

Buildings & equipment

24,000

Note that this entry is carried forward from the previous year (see solution to P2-23) again assuming that no sales or other disposals of Buildings and equipment took place during the year.

Investment in

Income from

Scissor Co.

Beginning Balance

438,000

Net Income

107,000

Ending Balance

515,000

30,000 515,000 0

107,000

Net Income

107,000

Ending Balance

Dividends Basic

107,000 0

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-24 (continued) Consolidation Entries

Paper Co.

Scissor Co.

Sales

880,000

355,000

1,235,000

Less: COGS

(278,000)

(178,000)

(456,000)

Less: Depreciation Expense

(65,000)

(12,000)

(77,000)

Less: Other Expenses

(312,000)

(58,000)

(370,000)

Income from Scissor Co.

107,000

Net Income

332,000

107,000

Beginning Balance

498,000

188,000

Net Income

332,000

107,000

Less: Dividends Declared

(90,000)

(30,000)

Ending Balance

740,000

265,000

Cash

232,000

116,000

348,000

Accounts Receivable

165,000

97,000

262,000

Inventory

193,000

115,000

Investment in Scissor Co.

515,000

Land

250,000

125,000

Buildings & Equipment

875,000

250,000

Less: Accumulated Depreciation

(630,000)

(48,000)

24,000

Total Assets

1,600,000

655,000

24,000

Accounts Payable

85,000

40,000

Bonds Payable

150,000

100,000

Common Stock

625,000

250,000

Retained Earnings

740,000

265,000

295,000

30,000

740,000

1,600,000

655,000

545,000

30,000

1,740,000

Consolidated

Income Statement

107,000

0 0

332,000

Statement of Retained Earnings

295,000

498,000 0

332,000

30,000

(90,000)

30,000

740,000

Balance Sheet

Total Liabilities & Equity

308,000 515,000

0 375,000

24,000

1,101,000 (654,000)

539,000

1,740,000

125,000 250,000 625,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-25A Other Comprehensive Income Reported by Investee a. Equity-method income reported by Dewey Corporation in 20X5: Amounts reported by Jimm Co. for 20X5: Operating income Dividend income Gain on investment in trading securities Net income Ownership held by Dewey Investment income reported by Dewey

$70,000 7,000 18,000 $95,000 x .30 $28,500

b. Computation of other comprehensive income reported by Jimm Co.: Amount added to investment account in 20X5 Investment income reported by Dewey in 20X5 Increase due to other comprehensive income reported by Jimm Co. Proportion of ownership held by Dewey

$ 37,800 (28,500) $ 9,300 ÷ 0.30 $ 31,000

Other comprehensive income reported by Jimm Co. P2-26A Equity-Method Income Statement a. Diversified Products Corporation Income Statement Year Ended December 31, 20X8 Net Sales Cost of Goods Sold Gross Profit Other Expenses Gain on Sale of Truck Income from Continuing Operations Discontinued Operations: Operating Loss from Discontinued Division Gain on Sale of Division Net Income

$400,000 (320,000) $ 80,000 $(25,000) 10,000 $(15,000) 44,000

(15,000) $ 65,000 29,000 $ 94,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-26A (continued) Diversified Products Corporation Retained Earnings Statement Year Ended December 31, 20X8 Retained Earnings, January 1, 20X8 20X8 Net Income

$260,000 94,000 $354,000 (10,000) $344,000

Dividends Declared, 20X8 Retained Earnings, December 31, 20X8 b. Wealthy Manufacturing Company Income Statement Year Ended December 31, 20X8 Net Sales Cost of Goods Sold Gross Profit Other Expenses Income from Continuing Operations of Diversified Products Corporation Income from Continuing Operations Discontinued Operations: Share of Operating Loss Reported by Diversified Products on Discontinued Division Share of Gain on Sale of Division Reported by Diversified Products Net Income

$850,000 (670,000) $180,000 $(90,000) 26,000

(64,000) $116,000

$ (6,000) 17,600

11,600 $127,600

Wealthy Manufacturing Company Retained Earnings Statement Year Ended December 31, 20X8 Retained Earnings, January 1, 20X8 20X8 Net Income Dividends Declared, 20X8 Retained Earnings, December 31, 20X8

$420,000 127,600 $547,600 (30,000) $517,600

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-27B Consolidated Worksheet at End of the First Year of Ownership (Investment Carried at Cost) a. Investment Carried at Cost Entries on Peanut Co.'s Books: Investment in Snoopy Co.

300,000

Cash

300,000

Record the initial investment in Snoopy Co. Cash

20,000

Dividend Income

20,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X8 dividend b. Book Value Calculations: Total Book Value Original book value

300,000

Common Stock 200,000

Retained Earnings 100,000

1/1/X8

12/31/X8

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 300,000

$300,000 Initial investment in Snoopy Co.

Identifiable excess = 0

Book value = CS + RE = 300,000

$300,000 Net investment in Snoopy Co.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-27B (continued) Investment consolidation entry Common stock

200,000

Retained earnings

100,000

Investment in Snoopy Co.

300,000

Dividend consolidation entry Dividend income

20,000

Dividends declared

20,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

10,000

Buildings & equipment

10,000

Investment in Snoopy Co. Acquisition Price Ending Balance

Dividend Income

300,000 300,000 300,000 0

Basic

20,000

Dividends

20,000

Ending Balance

20,000 0

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-27B (continued) Consolidation Entries

Peanut Co.

Snoopy Co.

Sales

800,000

250,000

1,050,000

Less: COGS

(200,000)

(125,000)

(325,000)

Less: Depreciation Expense

(50,000)

(10,000)

(60,000)

Less: Other Expenses

(225,000)

(40,000)

(265,000)

Consolidated

Income Statement

Dividend Income

20,000

Net Income

345,000

75,000

20,000

Beginning Balance

225,000

100,000

Net Income

345,000

75,000

20,000

Less: Dividends Declared

(100,000)

(20,000)

Ending Balance

470,000

155,000

Cash

130,000

80,000

210,000

Accounts Receivable

165,000

65,000

230,000

Inventory

200,000

75,000

Investment in Snoopy Co.

300,000

Land

200,000

100,000

Buildings & Equipment

700,000

200,000

Less: Accumulated Depreciation

(450,000)

(20,000)

10,000

Total Assets

1,245,000

500,000

10,000

Accounts Payable

75,000

60,000

Bonds Payable

200,000

85,000

Common Stock

500,000

200,000

Retained Earnings

470,000

155,000

120,000

20,000

525,000

1,245,000

500,000

320,000

20,000

1,445,000

400,000

Statement of Retained Earnings

120,000

225,000 0

400,000

20,000

(100,000)

20,000

525,000

Balance Sheet

Total Liabilities & Equity

275,000 300,000

0 300,000

10,000

890,000 (460,000)

310,000

1,445,000

135,000 285,000 500,000

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-28B Consolidated Worksheet at End of the Second Year of Ownership (Investment Carried at Cost) a. Investment Carried at Cost Entries on Peanut Co.'s Books: Cash

30,000

Dividend Income

30,000

Record Peanut Co.'s 100% share of Snoopy Co.'s 20X9 dividend b. Book Value Calculations: Total Book Value Original book value

300,000

Common Stock 200,000

Retained Earnings 100,000

1/1/X9

12/31/X9

Goodwill = 0

Identifiable excess = 0

Book value = CS + RE = 300,000

$300,000 Net investment in Snoopy Co.

Identifiable excess = 0

Book value = CS + RE = 300,000

$300,000 Net investment in Snoopy Co.

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-28B (continued) Investment consolidation entry Common stock

200,000

Retained earnings

100,000

Investment in Snoopy Co.

300,000

Dividend consolidation entry Dividend income

30,000

Dividends declared

30,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

10,000

Buildings & equipment

10,000

Note that this entry is carried forward from the previous year (see solution to P2-27B) again assuming that no sales or other disposals of Buildings and equipment took place during the year.

Investment in Snoopy Co. Acquisition Price Ending Balance

Dividend Income

300,000 300,000 300,000 0

Basic

20,000

Dividends

20,000

Ending Balance

20,000 0

Chapter 02 – Reporting Intercorporate Investments and Consolidation of Wholly Owned Subsidiaries with No Differential

P2-28B (continued) Consolidation Entries

Peanut Co.

Snoopy Co.

Sales

850,000

300,000

1,150,000

Less: COGS

(270,000)

(150,000)

(420,000)

Less: Depreciation Expense

(50,000)

(10,000)

(60,000)

Less: Other Expenses

(230,000)

(60,000)

(290,000)

Consolidated

Income Statement

Dividend Income

30,000

Net Income

330,000

80,000

30,000

Beginning Balance

470,000

155,000

100,000

Net Income

330,000

80,000

30,000

Less: Dividends Declared

(225,000)

(30,000)

Ending Balance

575,000

205,000

Cash

230,000

75,000

305,000

Accounts Receivable

190,000

80,000

270,000

Inventory

180,000

100,000

Investment in Snoopy Co.

300,000

Land

200,000

100,000

Buildings & Equipment

700,000

200,000

Less: Accumulated Depreciation

(500,000)

(30,000)

10,000

Total Assets

1,300,000

525,000

10,000

Accounts Payable

75,000

35,000

Bonds Payable

150,000

85,000

Common Stock

500,000

200,000

Retained Earnings

575,000

205,000

130,000

30,000

680,000

1,300,000

525,000

330,000

30,000

1,525,000

380,000

Statement of Retained Earnings

130,000

525,000 0

380,000

30,000

(225,000)

30,000

680,000

Balance Sheet

Total Liabilities & Equity

280,000 300,000

0 300,000

10,000

890,000 (520,000)

310,000

1,525,000

110,000 235,000 500,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

CHAPTER 3 THE REPORTING ENTITY AND CONSOLIDATION OF LESS-THAN-WHOLLY-OWNED SUBSIDIARIES WITH NO DIFFERENTIAL ANSWERS TO QUESTIONS Q3-1 The basic idea underlying the preparation of consolidated financial statements is the notion that the consolidated financial statements present the financial position and the results of operations of a parent and its subsidiaries as if the related companies actually were a single company. Q3-2 Without consolidated statements it is often very difficult for an investor to gain an understanding of the total resources controlled by a company. A consolidated balance sheet provides a much better picture of both the total assets under the control of the parent company and the financing used in providing those resources. Similarly, the consolidated income statement provides a better picture of the total revenue generated and the costs incurred in generating the revenue. Estimates of future profit potential and the ability to meet anticipated cash flows often can be more easily assessed by analyzing the consolidated statements. Q3-3 Parent company shareholders are likely to find consolidated statements more useful. Noncontrolling shareholders may gain some understanding of the basic strength of the overall economic entity by examining the consolidated statements; however, they have no control over the parent company or other subsidiaries and therefore must rely on the assets and earning power of the subsidiary in which they hold ownership. The separate statements of the subsidiary are more likely to provide useful information to the noncontrolling shareholders. Q3-4 A parent company has the ability to exercise control over one or more other entities. Under existing standards, a company is considered to be a parent company when it has direct or indirect control over a majority of the common stock of another company. The FASB has proposed adoption of a broader definition of control that would not be based exclusively on stock ownership. Q3-5 Creditors of the parent company have primary claim to the assets held directly by the parent. Short-term creditors of the parent are likely to look only at those assets. Because the parent has control of the subsidiaries, the assets held by the subsidiaries are potentially available to satisfy parent company debts. Long-term creditors of the parent generally must rely on the soundness and operating efficiency of the overall entity, which normally is best seen by examining the consolidated statements. On the other hand, creditors of a subsidiary typically have a priority claim to the assets of that subsidiary and generally cannot lay claim to the assets of the other companies. Consolidated statements therefore are not particularly useful to them. Q3-6 When one company holds a majority of the voting shares of another company, the investor should have the power to elect a majority of the board of directors of that company and control its actions. Unless the investor holds controlling interest, there is always a chance that another party may acquire a sufficient number of shares to gain control of the company, or that the other shareholders may join together to take control. Q3-7 The primary criterion for consolidation is the ability to directly or indirectly exercise control. Control normally has been based on ownership of a majority of the voting common stock of another company. The Financial Accounting Standards Board is currently working on a broader definition of control. At present, consolidation should occur whenever majority ownership is held unless other circumstances indicate that control is temporary or does not rest with the parent.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

Q3-8 Consolidation is not appropriate when control is temporary or when the parent cannot exercise control. For example, if the parent has agreed to sell a subsidiary or plans to reduce its ownership below 50 percent shortly after year-end, the subsidiary should not be consolidated. Control generally cannot be exercised when a subsidiary is under the control of the courts in bankruptcy or reorganization. While most foreign subsidiaries should be consolidated, subsidiaries in countries with unstable governments or those in which there are stringent barriers to funds transfers generally should not be consolidated. Q3-9 Strict adherence to consolidation standards based on majority ownership of voting common stock has made it possible for companies to use many different forms of control over other entities without being forced to include them in their consolidated financial statements. For example, contractual arrangements often have been used to provide control over variable interest entities even though another party may hold a majority (or all) of the equity ownership. Q3-10 Special-purpose entities are corporations, trusts, or partnerships created for a single specified purpose. They usually have no substantive operations and are used only for financing purposes. Special-purpose entities generally have been created by companies to acquire certain types of financial assets from the companies and hold them to maturity. The special-purpose entity typically purchases the financial assets from the company with money received from issuing some form of collateralized obligation. If the company had borrowed the money directly, its debt ratio would be substantially increased. Q3-11 Variable interest entities normally are not involved in general business activities such as producing products and selling them to customers. They often are used to acquire financial assets from other companies or to borrow money and channel it other companies. A very large portion of the assets held by variable interest entities typically is financed by debt and a small portion financed by equity holders. Contractual agreements often give effective control of the activities of the special-purpose entity to someone other than the equity holders. Q3-12 ASC 810-10-20 provides a number of guidelines to be used in determining when a company is a primary beneficiary of a variable interest entity. Generally, the primary beneficiary will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both. Q3-13 Indirect control occurs when the parent controls one or more subsidiaries that, in turn, hold controlling interest in another company. Company A would indirectly control Company Z if Company A held 80 percent ownership of Company M and that company held 70 percent of the ownership of Company Z. Q3-14 It is possible for a company to exercise control over another company without holding a majority of the voting common stock. Contractual agreements, for example, may provide a company with complete control of both the operating and financing decisions of another company. In other cases, ownership of a substantial portion of a company's shares and a broad based ownership of the other shares may give effective control to a company even though it does not have majority ownership. There is no prohibition to consolidation with less than majority ownership; however, few companies have elected to consolidate with less than majority control. Q3-15 Subsidiary shares held by the parent are not owned by an outside party and therefore cannot be reported as shares outstanding. Those held by the noncontrolling shareholders are included in the balance assigned to noncontrolling shareholders in the consolidated balance sheet rather than being shown as stock outstanding. Q3-16 While it is not considered appropriate to consolidate if the fiscal periods of the parent and subsidiary differ by more than 3 months, a difference in time periods cannot be used as a means 3-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

of avoiding consolidation. The fiscal period of one of the companies must be adjusted to fall within an acceptable time period and consolidated statements prepared. Q3-17 The noncontrolling interest represents the claim on the net assets of the subsidiary assigned to the shares not controlled by the parent company. Q3-18 The procedures used in preparing consolidated and combined financial statements may be virtually identical. In general, consolidated statements are prepared when a parent company either directly or indirectly controls one or more subsidiaries. Combined financial statements are prepared for a group of companies or business entities when there is no parent-subsidiary relationship. For example, an individual who controls several companies may gain a clearer picture of the financial position and operating results of the overall operations under his or her control by preparing combined financial statements. .

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

SOLUTIONS TO CASES C3-1 Computation of Total Asset Values The relationship observed should always be true. Assets reported by the parent company include its investment in the net assets of the subsidiaries. These totals must be eliminated in the consolidation process to avoid double counting. In addition, subsidiary assets and liabilities at the time the subsidiaries were acquired by the parent may have had fair values different from their book values, and the amounts reported in the consolidated financial statements would be based on those fair values. C3-2 Accounting Entity [AICPA Adapted] a. Units created by or under law, such as corporations, partnerships, and, occasionally, sole proprietorships, probably are the most common types of accounting entities. b. Product lines or other segments of an enterprise, such as a division, department, profit center, branch, or cost center, can be treated as accounting entities. For example, financial reporting by segment was supported by investors, the Securities and Exchange Commission, financial executives, and members of the accounting profession. c. Most large corporations issue consolidated financial reports. These statements often include the financial statements of a number of separate legal entities that are considered to constitute a single economic entity for financial reporting purposes. d. Although the accounting entity often is defined in terms of a business enterprise that is separate and distinct from other activities of the owner or owners, it also is possible for an accounting entity to embrace all the activities of an owner or a group of owners. Examples include financial statements for an individual (personal financial statements) and the financial report of a person's estate. e. The entire economy of the United States also can be viewed as an accounting entity. Consistent with this view, national income accounts are compiled by the U. S. Department of Commerce and regularly reported.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

C3-3 What Company is That? Information for answering this case can be obtained from the SEC's EDGAR database (www.sec.gov) and from the home pages for Viacom (www.viacom.com), ConAgra (www.conagra.com), and Yum! Brands (www.yum.com). a. Viacom owns MTV, Nickelodeon, Nick at Nite, Comedy Partners, Paramount Pictures, Paramount Home Entertainment, SKG, BET, and other related companies. National Amusements, directly and indirectly, is the controlling stockholder of both Viacom and CBS. National Amusements owns shares in Viacom representing approximately 79.8% of the voting interest in Viacom and approximately 10% of Viacom’s combined common stock. National Amusements is controlled by Sumner M. Redstone, who is the Chairman and Chief Executive Officer of National Amusements b. Some of the well-known product lines of ConAgra include Birds Eye, Banquet, Blue Bonnet, Chef Boyardee, Healthy Choice, Hungry-Man, Hunt’s, Jiffy Pop, Libby’s, LaChoy, Parkay, Pam, Slim Jim, Snack Pack, Swiss Miss, Orville Redenbacher’s, Reddi-Wip, VanCamp, and Rosarita. c. Yum! Brands, Inc., is the world’s largest quick service restaurant company. Well known brands include Taco Bell, KFC, and Pizza Hut. Yum was originally spun off from Pepsico in 1997. Prior to its current name, Yum’s name was TRICON Global Restaurants, Inc.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

C3-4 Subsidiaries and Core Businesses Most of the information needed to answer this case can be obtained from articles available in libraries, on the Internet, or through various online databases. Some of the information is available in filings with the SEC (www.sec.gov). a. General Electric was never able to turn Kidder, Peabody into a profitable subsidiary. In fact, Kidder became such a drain on the resources of General Electric, that GE decided to get rid of Kidder. Unfortunately, GE was unable to sell the company as a whole and ultimately broke the company into pieces and sold the pieces that it could. GE suffered large losses from its venture into the brokerage business. b. PepsiCo entered the restaurant business in 1977 with the purchase of Pizza Hut. By 1986, PepsiCo also owned Taco Bell and KFC (Kentucky Fried Chicken). In 1997, these subsidiaries were spun off to a new company, TRICON Global Restaurants, with TRICON's stock distributed to PepsiCo's shareholders. TRICON Global Restaurants changed its name to YUM! Brands, Inc., in 2002. Although PepsiCo exited the restaurant business, it continues in the snack-food business with subsidiaries including Lay's and Ruffles potato chips; Doritos tortilla chips; Tostitos tortilla chips and dips; Cheetos cheese flavored snacks; Fritos corn chips; Rold Gold pretzels; Sun Chips; and Cracker Jack. c. When consolidated financial statements are presented, financial statement users are provided with information about the company's overall operations. Assessments can be made about how the company as a whole has fared as a result of all its operations. However, comparisons with other companies may be difficult because the operations of other companies may not be similar. If a company operates in a number of different industries, consolidated financial statements may not permit detailed comparisons with other companies unless the other companies operate in all of the same industries, with about the same relative mix. Thus, standard measures used in manufacturing and merchandising, such as gross margin percentage, inventory and receivables turnover, and the debt-to-asset ratio, may be useless or even misleading when significant financial-services operations are included in the financial statements. Similarly, standard measures used in comparing financial institutions might be distorted when financial statement information includes data relating to manufacturing or merchandising operations. A partial solution to the problem results from providing disaggregated (segment or line-of-business) information along with the consolidated financial statements, as required by the accounting literature.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

C3-5 Consolidation Differences among Major Corporations a. In its 2019 10-K filing, Union Pacific Corporation reported total Assets of $61.7 Billion, but only one subsidiary company - Union Pacific Railroad Company b. ExxonMobil’s 2019 10-K filing states “Majority ownership is normally the indicator of control that is the basis on which subsidiaries are consolidated. However, certain factors may indicate that a majorityowned investment is not controlled and therefore should be accounted for using the equity method of accounting. These factors occur where the minority shareholders are granted by law or by contract substantive participating rights. These include the right to approve operating policies, expense budgets, financing and investment plans, and management compensation and succession plans.” “Investments in equity securities other than consolidated subsidiaries and equity method investments are measured at fair value with changes in fair value recognized in net income.”

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

SOLUTIONS TO EXERCISES E3-1 Multiple-Choice Questions on Consolidation Overview [AICPA Adapted] 1. d – Consolidated financial statements are intended to provide a meaningful representation of the overall position and activities of a single economic entity comprising a number of separate legal entities (subsidiaries). (a) Incorrect. While consolidation can help improve the reliability of the financial information, it does not fully describe the accounting concept of reliability. (b) Incorrect. While consolidated financial statements should be materially stated, this is not the focus of consolidation. (c) Incorrect. In consolidation, each subsidiary exists as a separate legal entity while the consolidated entity represents the economic activity of the parent and all subsidiaries. 2. c – Under certain circumstances, a company can lose the ability to exercise control of a subsidiary even when a controlling interest is held. For example, if the subsidiary were under a legal reorganization or bankruptcy. As long as control cannot be exercised, consolidated financial statements would not be prepared. (a) Incorrect. A finance company can be consolidated. (b) Incorrect. Consolidation can still occur even when the fiscal year-ends of the two companies are more than three months apart as long as the subsidiary adjusts its fiscal year-end to match the parent. (d) Incorrect. There is no requirement that the parent and subsidiary be in related industries. 3. b – The consolidation method is typically used when ownership is greater than 50% of the common stock of the subsidiary. Penn directly controls Sell and indirectly controls Vane, thus, Sell and Vane should both be consolidated. (a) Incorrect. Because Sell owns greater than 50% Vane’s common stock, Vane would be consolidated. (c) Incorrect. Because Penn owns greater than 50% Sell’s common stock, Sell would be consolidated. (d) Incorrect. Because Penn owns greater than 50% Sell’s common stock, Sell would be consolidated. Because Sell owns greater than 50% Vane’s common stock, Vane would also be consolidated. 4. b – The companies are each separate legal entities, but in substance they are one economic entity (a) Incorrect. The companies are not one in form, each company is a separate legal entity. (c) Incorrect. The companies are not one in form, each company is a separate legal entity. (d) Incorrect. The companies are one in substance as they are one economic entity. .

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-2 Multiple-Choice Questions on Variable Interest Entities 1. c – SPE’s are typically financed primarily by debt, while equity financing is only a small portion. SPE’s tend to be very highly leveraged. (a) Incorrect. Equity financing is typically much smaller in SPE’s than in companies such as General Motors. SPE’s tend to be very highly leveraged. (b) Incorrect. SPE’s are generally financed through debt, not equity. (d) Incorrect. SPE’s are not typically designed to distribute large dividends as a function of their typical business purpose. 2. d – A VIE is generally not limited as to the legal form of business that it takes (i.e. corporation, partnership, joint venture, trust, etc.). (a) Incorrect. This type of entity can be a VIE. (b) Incorrect. This type of entity can be a VIE. (c) Incorrect. This type of entity can be a VIE. 3. a – A primary beneficiary is defined as an enterprise that will absorb the majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both. However, if one entity receives the residual returns and another absorbs the expected losses, the entity absorbing the majority of the losses is deemed to be the primary beneficiary. (b) Incorrect. A qualified owner would not absorb a majority of the VIE’s expected losses. (c) Incorrect. A major facilitator would not absorb a majority of the VIE’s expected losses. (d) Incorrect. A critical management director would not absorb a majority of the VIE’s expected losses. 4. b – The company that has the most at stake is typically required to consolidate the VIE. This has been defined as the entity receiving a majority of the VIE’s profits, and/or absorbing the majority of its losses. (a) Incorrect. Contrary to requirements for consolidating other entities, legal control is not enough to require consolidation for VIE’s. (c) Incorrect. Intercompany transfers have no effect on determining whether to consolidate. (d) Incorrect. VIE’s can vary in size in relation to their owning companies, thus the proportionate size of the two entities is irrelevant.

E3-3 Multiple-Choice Questions on Consolidated Balances [AICPA Adapted] 1. b – Total book value of net assets is $120,000 (50,000 + 70,000). The amount attributed to the noncontrolling interest = 25% * 120,000 = $30,000. 2. b – The consolidated balance in common stock is always equal to the parent’s common stock and the common stock of the subsidiary is eliminated. 3-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

(a) Incorrect. The common stock of Stain Company is eliminated in consolidation. (c) Incorrect. The only amount to be reported in the consolidated balance sheet is the amount of common stock on Paint’s books. The common stock is not allocated based on ownership percentage, but rather is eliminated in its entirety prior to consolidation. (d) Incorrect. The common stock of Stain Company is eliminated, and not added to the common stock balance of the parent. 3. a – Neely directly controls Randle, and indirectly controls Walker as a result of owning 40% plus an additional 30% as a result of Randle’s ownership of Walker, thus Neely should consolidate both Randle and Walker. (b) Incorrect. Due to foreign restrictions, Neely does not control Walker and thus should not consolidate, regardless of its 90% ownership. (c) Incorrect. Because Walker is in a legal reorganization, Neely does not maintain control, and thus cannot consolidate. (d) Incorrect. Neely only maintains 40% ownership of Walker and thus does not maintain control. Walker should not be consolidated. E3-4 Multiple-Choice Questions on Consolidation Overview [AICPA Adapted] 1. d – Consolidation occurs when one company acquires a controlling interest in another company. This controlling interest is typically defined has owning greater than 50% of the company. (a) Incorrect. The equity method alone does not require consolidation until greater than 50% ownership is obtained. When more than 50% ownership is obtained, the consolidating entity can elect to use either the equity method or the cost method in recording the investment account. (b) Incorrect. When more than 50% ownership is obtained, the consolidating entity can elect to use either the equity method or the cost method in recording the investment account. (c) Incorrect. Significant influence does not qualify for consolidation. Instead, the parent company must maintain a controlling interest before consolidating. 2. a – The consolidated net earnings contains the net earnings of Aaron as well as the net earnings of Belle. Thus, the consolidated net earnings are greater than just Aaron’s own net earnings. (b) Incorrect. Unless Belle has no income for the year, the consolidated income will be greater than the net earnings of Aaron. (c) Incorrect. Aaron’s consolidated earnings will only be less than the earnings of Aaron if Belle suffers a net loss for the year, but the facts say this is not the case. (d) Incorrect. False. It can be determined based on the information given. 3. b – When the acquisition takes place, X Company only includes the earnings of Y Company for the portion of the year in which a controlling ownership was held. (a) Incorrect. Earnings of X Company for the entire year would be included in consolidated net income.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

(c) Incorrect. Only the portion of Y Company’s earnings during the period in which X Company maintained a controlling interest in Y Company would be included in consolidated net income. (d) Incorrect. Earnings from Y Company would be reported in consolidated net income only for the period in which X Company controlled Y Company during the year. The distribution of a dividend by Y Company is irrelevant. 4. d – Consolidation typically occurs when greater than 50% of the voting stock is obtained because the parent company is said to have control over the subsidiary. (a) Incorrect. Consolidation is required when over 50% is obtained. Additionally, the cost method can also be used if desired. (b) Incorrect. The lower-of-cost-or-market method is not an appropriate method used in consolidation. (c) Incorrect. Consolidation is required when over 50% is obtained. Additionally, the equity method can also be used if desired. E3-5 Balance Sheet Consolidation a. $470,000 = $470,000 - $44,000 (cash outlay) + $44,000 (investment) b. $616,000 = ($470,000 - $44,000 (investment) + $190,000 c. $405,000 = $270,000 + $135,000 d. $211,000 Acquisition price ÷ percent purchased Total fair value of Summer Corporation's NA NCI in NA of Summer Corporation Parade Corporation's Stockholder’s Equity Total Consolidated Stockholder's Equity

$ $

44,000 80% 55,000 $

11,000

200,000 $ 211,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-6 Balance Sheet Consolidation with Intercompany Transfer a. $631,500 = $510,000 + $121,500 (investment) b. $860,000 = $510,000 + $350,000 c. $656,500 = ($320,000 + $121,500) + $215,000 d. $203,500 Acquisition price ÷ percent purchased Total fair value of Shop Corporation's NA NCI in NA of Shop Corporation Pawn Company's Stockholder’s Equity Total Consolidated Stockholder's Equity

$ $

121,500 90% 135,000 $

13,500

190,000 $ 203,500

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-7 Subsidiary Acquired for Cash Note: Since the financial statements of these two companies are quite simple, it is possible to prepare the consolidated balance sheet without completing all of the steps for a consolidation. However, we present the formal calculations without skipping any steps. Equity Method Entries on Pencil's Books: Investment in Stylus

72,000

Cash

72,000

Record the initial investment in Stylus Book Value Calculations: NCI 20% Book value at acquisition

18,000

Pencil 80%

Common Stock

72,000

50,000

Retained Earnings 40,000

1/1/X3 Goodwill = 0

Identifiable excess = 0

$72,000 Initial investment in Stylus

80% Book value = 72,000

Basic Consolidation Entry Common stock

50,000

Retained earnings

40,000

Investment in Stylus

72,000

NCI in NA of Stylus

18,000

Investment in Stylus Acquisition Price

72,000 72,000

Basic Entry

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-7 (continued) Consolidation Entries Pencil

Stylus

Consolidated

Cash

128,000

50,000

Other Assets

400,000

120,000

Investment in Stylus

72,000

Total Assets

600,000

170,000

Current Liabilities

100,000

80,000

Common Stock

300,000

50,000

300,000

Retained Earnings

200,000

40,000

200,000

Balance Sheet 178,000 520,000

600,000

170,000

72,000

698,000

180,000

NCI in NA of Stylus Total Liabilities & Equity

72,000

90,000

18,000

698,000

Pencil Company and Subsidiary Consolidated Balance Sheet January 2, 20X3 Cash ($128,000 + $50,000) Other Assets ($400,000 + $120,000) Total Assets

$178,000 520,000 $698,000

Current Liabilities ($100,000 + $80,000) Common Stock Retained Earnings Noncontrolling Interest in Net Assets of Stylus Total Liabilities and Stockholders' Equity

$180,000 300,000 200,000 18,000 $698,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-8 Subsidiary Acquired with Bonds Note: Since the financial statements of these two companies are quite simple, it is possible to prepare the consolidated balance sheet without completing all of the steps for a consolidation. However, we present the formal calculations without skipping any steps. Equity Method Entries on Peace Computer's Books: Investment in Symbol Software

67,500

Bonds Payable

50,000

Premium on Bonds Pay

17,500

Record the initial investment in Symbol Software Book Value Calculations: NCI 25% Book value at acquisition

Peace Computer 75%

22,500

Common Stock

67,500

50,000

Retained Earnings 40,000

1/1/X3 Goodwill = 0

Identifiable excess = 0

$67,500 Initial investment in Symbol Software

75% Book value = 67,500

Basic Consolidation Entry Common stock

50,000

Retained earnings

40,000

Investment in Symbol Software

67,500

NCI in NA of Symbol Software

22,500

Investment in Symbol Software Acquisition Price

67,500 67,500

Basic Entry

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-8 (continued) Consolidation Entries

Peace Computer

Symbol Software

Cash

200,000

50,000

Other Assets

400,000

120,000

Investment in Symbol Software

67,500

Total Assets

667,500

170,000

Current Liabilities

100,000

80,000

Bonds Payable

50,000

Bond Premium

17,500

Common Stock

300,000

50,000

300,000

Retained Earnings

200,000

40,000

200,000

Consolidated

Balance Sheet 250,000 520,000

667,500

170,000

67,500

770,000

180,000

NCI in NA of Symbol Software Total Liabilities & Equity

67,500

90,000

22,500

770,000

Peace Computer Corporation and Subsidiary Consolidated Balance Sheet January 2, 20X3 Cash ($200,000 + $50,000) Other Assets ($400,000 + $120,000) Total Assets Current Liabilities Bonds Payable Bond Premium Common Stock Retained Earnings Noncontrolling Interest in Net Assets of Symbol Total Liabilities and Stockholders' Equity

$250,000 520,000 $770,000 $180,000 $50,000 17,500

67,500 300,000 200,000 22,500 $770,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-9 Subsidiary Acquired by Issuing Preferred Stock Note: Since the financial statements of these two companies are quite simple, it is possible to prepare the consolidated balance sheet without completing all of the steps for a consolidation. However, we present the formal calculations without skipping any steps. Equity Method Entries on Peace Computer's Books: Investment in Symbol Software

81,000

Preferred Stock

60,000

Additional Paid-In Capital – Pref. Stock

21,000

Record the initial investment in Symbol Software Book Value Calculations: NCI 10% Book value at acquisition

Peace Computer 90%

9,000

Common Stock

81,000

50,000

Retained Earnings 40,000

1/1/X3 Goodwill = 0

Identifiable excess = 0

$81,000 Initial investment in Symbol Software

90% Book value = 81,000

Basic Consolidation Entry Common stock

50,000

Retained earnings

40,000

Investment in Symbol Software

81,000

NCI in NA of Symbol Software

9,000

Investment in Symbol Software Acquisition Price

81,000 81,000

Basic Entry

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-9 (continued) Consolidation Entries

Peace Computer

Symbol Software

Cash

200,000

50,000

Other Assets

400,000

120,000

Investment in Symbol Software

81,000

Total Assets

681,000

170,000

Current Liabilities

100,000

80,000

Preferred Stock

60,000

Additional Paid-In Capital

21,000

Common Stock

300,000

50,000

300,000

Retained Earnings

200,000

40,000

200,000

Consolidated

Balance Sheet 250,000 520,000

681,000

170,000

81,000

770,000

180,000

NCI in NA of Symbol Software Total Liabilities & Equity

81,000

90,000

9,000

770,000

Peace Computer Corporation and Subsidiary Consolidated Balance Sheet January 2, 20X3 Cash ($200,000 + $50,000) Other Assets ($400,000 + $120,000) Total Assets

$250,000 520,000 $770,000

Current Liabilities ($100,000 + $80,000) Preferred Stock ($6 x 10,000) Additional Paid-In Capital ($2.10 x 10,000) Common Stock Retained Earnings Noncontrolling Interest in Net Assets of Symbol Total Liabilities and Stockholders' Equity

$180,000 60,000 21,000 300,000 200,000 9,000 $770,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-10 Reporting for a Variable Interest Entity Gamble Company Consolidated Balance Sheet Cash Buildings and Equipment Less: Accumulated Depreciation Total Assets Accounts Payable Bonds Payable Bank Notes Payable Noncontrolling Interest Common Stock Retained Earnings Total Liabilities and Equities (a) $18,600,000 (b) $370,600,000

$ 18,600,000(a) $370,600,000(b) (10,100,000)

360,500,000 $379,100,000 $

$103,000,000 105,200,000

5,000,000 20,300,000 140,000,000 5,600,000

208,200,000 $379,100,000

= $3,000,000 + $5,600,000 + ($140,000,000 – $130,000,000) = $240,600,000 + $130,000,000

E3-11 Consolidation of a Variable Interest Entity Teal Corporation Consolidated Balance Sheet Total Assets

$682,500(a)

Total Liabilities Noncontrolling Interest Common Stock Retained Earnings Total Liabilities and Equities

$550,000(b) 22,500(c)

(a) $682,500 (b) $550,000 (c) $22,500

= = =

$15,000 95,000

110,000 $682,500

$500,000 + $190,000 - $7,500 $470,000 + $80,000 ($500,000 - $470,000) x 0.75

E3-12 Computation of Subsidiary Net Income Salt Company reported net income of $60,000 ($18,000 / 0.30) for 20X9.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-13 Incomplete Consolidation a. Plug Motors apparently owns 100 percent of the stock of Spark Body Shop since the balance in the investment account reported by Plug is equal to the net book value of Spark Body Shop. b.

Accounts Payable

60,000

Accounts receivable were reduced by $10,000, presumably as a reduction of receivables and payables.

Notes Payable

600,000

There is no indication of intercompany ownership.

Common Stock

200,000

Common stock of Spark must be eliminated.

Retained Earnings

260,000

Retained earnings of Spark also must be eliminated in preparing consolidated statements.

$1,120,000 E3-14 Noncontrolling Interest a. The total noncontrolling interest reported in the consolidated balance sheet at January 1, 20X7, is $126,000 ($420,000 x .30). b. The stockholders' equity section of the consolidated balance sheet includes the claim of the noncontrolling interest and the stockholders' equity section of the subsidiary is eliminated when the consolidated balance sheet is prepared: Controlling Interest: Common Stock Additional Paid-In Capital Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity

$ 400,000 222,000 358,000 $ 980,000 126,000 $1,106,000

c. Pesto is mainly interested in assuring a steady supply of electronic switches. It can control the operations of Sauce with 70 percent ownership and can use the money that would be needed to purchase the remaining shares of Sauce to finance additional operations or purchase other investments.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-15 Computation of Consolidated Net Income a. Smart should report income from its subsidiary of $15,000 ($20,000 x .75) rather than dividend income of $9,000. b. A total of $5,000 ($20,000 x 0.25) should be assigned to the noncontrolling interest in the 20X4 consolidated income statement. c. Consolidated net income of $70,0000 should be reported for 20X4, computed as follows: Reported net income of Smart Less: Dividend income from Phone Operating income of Smart Net income of Phone Consolidated net income

$59,000 (9,000) $50,000 20,000 $70,000

d. Income of $79,000 would be attained by adding the income reported by Smart ($59,000) to the income reported by Phone ($20,000). However, the dividend income from Phone recorded by Smart must be excluded from consolidated net income. E3-16 Computation of Subsidiary Balances a.

Shutter's net income for 20X2 was $32,000 ($8,000 / 0.25).

b. Common Stock Outstanding (1) Additional Paid-In Capital (given) Retained Earnings ($70,000 + $32,000) Total Stockholders' Equity

$120,000 40,000 102,000 $262,000

(1) Computation of common stock outstanding: Total stockholders' equity ($65,500 / 0.25) Additional paid-in capital Retained earnings Common stock outstanding

$262,000 (40,000) (102,000) $120,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-17 Subsidiary Acquired at Net Book Value Note: Since the financial statements of these two companies are quite simple, it is possible to prepare the consolidated balance sheet without completing all of the steps for a consolidation. However, we present the formal calculations without skipping any steps. Equity Method Entries on Paragraph Corp.'s Books: Investment in Sentence Co.

136,000

Cash

136,000

Record the initial investment in Sentence Co. Book Value Calculations: NCI 20% Book value at acquisition

Paragraph Corp. 80%

34,000

Common Stock

136,000

90,000

Retained Earnings 80,000

1/1/X8 Goodwill = 0

Identifiable excess = 0

$136,000 Initial investment in Sentence Co.

80% Book value = 136,000

Basic Consolidation Entry Common stock

90,000

Retained earnings

80,000

Investment in Sentence Co.

136,000

NCI in NA of Sentence Co.

34,000

Investment in Sentence Co. Acquisition Price

136,000 136,000

Basic Entry

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

E3-17 (continued) Consolidation Entries

Paragraph Corp.

Sentence Co.

Cash

74,000

20,000

94,000

Accounts Receivable

120,000

70,000

190,000

Inventory

180,000

90,000

270,000

Fixed Assets (net)

350,000

240,000

590,000

Investment in Sentence Co.

136,000

Total Assets

860,000

420,000

Accounts Payable

65,000

30,000

95,000

Notes Payable

350,000

220,000

570,000

Common Stock

150,000

90,000

Retained Earnings

295,000

80,000

Consolidated

Balance Sheet

NCI in NA of Sentence Co. Total Liabilities & Equity

860,000

420,000

170,000

136,000

1,144,000

150,000 295,000 34,000

34,000

1,144,000

Paragraph Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X8 Cash ($74,000 + $20,000) Accounts Receivable ($120,000 + $70,000) Inventory ($180,000 + $90,000) Fixed Assets (net) ($350,000 + $240,000) Total Assets

94,000 190,000 270,000 590,000 $1,144,000

Accounts Payable ($65,000 + $30,000) Notes Payable ($350,000 + $220,000) Common Stock Retained Earnings Noncontrolling Interest in Net Assets of Sentence Co. Total Liabilities and Stockholders' Equity

95,000 570,000 150,000 295,000 34,000 $1,144,000

E3-18 Acquisition of Majority Ownership a. Net identifiable assets: $720,000 = $520,000 + $200,000 b. Noncontrolling interest: $50,000 = $200,000 x 0.25

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

SOLUTIONS TO PROBLEMS P3-19 Multiple-Choice Questions on Consolidated and Combined Financial Statements [AICPA Adapted] 1. d – While previously reported in the ‘mezzanine’ area between liabilities and equity, FASB 160 (ASC 810) makes it clear that NCI is an element of equity, not a liability. (a) Incorrect. FASB 160 (ASC 810) states that the NCI is an element of equity, not a liability. (b) Incorrect. The NCI does not affect the goodwill that results from the consolidation. (c) Incorrect. The NCI is not reported in the footnotes to the financial statements, but rather it appears as a line item in the equity section of the balance sheet. 2. c – Similar to consolidated statements, combined financial statements require the removal of all intercompany loans and profits. Thus, neither amount is recorded in the combined statements (a) Incorrect. Intercompany loans must be eliminated from combined financial statements. (b) Incorrect. Both intercompany loans and profits must be eliminated from combined financial statements. (d) Incorrect. Combined financial statements require the elimination of intercompany profits. P3-20 Determining Net Income of Parent Company Consolidated net income Income of subsidiary ($15,200 / 0.40) Income from Potter's operations

$164,300 (38,000) $126,300

P3-21 Consolidation of a Variable Interest Entity Stern Corporation Consolidated Balance Sheet January 1, 20X4 Cash Accounts Receivable Less: Allowance for Uncollectibles Other Assets Total Assets Accounts Payable Bank Notes Payable Bonds Payable Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest

$ 8,150,000 (a) $12,200,000 (b) (610,000) (c)

11,590,000 5,400,000 $25,140,000 $

950,000 7,500,000 9,800,000

700,000 6,150,000 $ 6,850,000 40,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity (a) $ 8,150,000 (b) $12,200,000 (c) $ 610,000

= = =

6,890,000 $25,140,000

$7,960,000 + $190,000 $4,200,000 + $8,000,000 $210,000 + $400,000

P3-22 Reporting for Variable Interest Entities Purified Oil Company Consolidated Balance Sheet Cash Drilling Supplies Accounts Receivable Equipment (net) Land Total Assets

640,000 420,000 640,000 8,500,000 5,100,000 $15,300,000

Accounts Payable Bank Loans Payable Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity

$ 590,000 11,800,000 $ 560,000 2,150,000 $2,710,000 200,000 2,910,000 $15,300,000

P3-23 Parent Company and Consolidated Amounts a.

Common stock of Slice Company on December 31, 20X5 Retained earnings of Slice Company January 1, 20X5 Sales for 20X5 Less: Expenses Dividends paid Retained earnings of Slice Company on December 31, 20X5 Net book value on December 31, 20X5 Proportion of stock acquired by Pie Purchase price

$ 90,000 $130,000 195,000 (160,000) (15,000) 150,000 $240,000 x 0.80 $192,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

Net book value on December 31, 20X5 Proportion of stock held by noncontrolling interest Balance assigned to noncontrolling interest

$240,000 x 0.20 $ 48,000

c. Consolidated net income is $143,000. None of the 20X5 net income of Slice Company was earned after the date of purchase and, therefore, none can be included in consolidated net income. d. Consolidated net income would be $178,000 [$143,000 + ($195,000 - $160,000)]. P3-24 Parent Company and Consolidated Balances a.

Balance in investment account, December 31, 20X7 Cumulative earnings since acquisition Cumulative dividends since acquisition Total Proportion of stock held by Pillow Corporation Total Amount Debited to Investment Account Purchase Amount

$259,800 110,000 (46,000) $64,000 x 0.75 (48,000) $211,800

$282,400 ($211,800 / 0.75) is the fair value of net assets on January 1, 20X5

$70,600 ($282,400 x 0.25) is the value assigned to the NCI shareholders on January 1, 20X5.

$86,600 = ($259,800 / 0.75) x 0.25 will be assigned to noncontrolling interest in the consolidated balance sheet prepared at December 31, 20X7. Alternatively, this could be calculated by adding the NCI’s portion of the cumulative earnings and dividends to the balance of NCI shareholders at acquisition. $70,600 + (64,000 x .25) = $86,600.

P3-25 Indirect Ownership The following ownership chain exists: Purple .70

Green .40 Yellow

.10 Orange

.60 Blue

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-25 (continued) The earnings of Blue Company and Orange Corporation are included under cost method reporting due to the 10 percent ownership level of Orange Corporation. The earnings of Yellow Corporation are included under equity method accounting due to the 40 percent ownership level. Net income of Green Company: Reported operating income Dividend income from Orange ($30,000 x 0.10) Equity-method income from Yellow ($60,000 x 0.40) Green Company net income

$ 20,000 3,000 24,000 $ 47,000

Consolidated net income: Operating income of Purple Net income of Green Consolidated net income

$ 90,000 47,000 $137,000

Purple company net income (Not Required): Operating income of Purple Purple's share of Green's net income ($47,000 x 0.70) Purple’s net income

$ 90,000 32,900 $122,900

P3-26 Consolidated Worksheet and Balance Sheet on the Acquisition Date (Equity Method) 3-27 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

a. Equity Method Entries on Peanut Co.'s Books: Investment in Snoopy Co.

270,000

Cash

270,000

Record the initial investment in Snoopy Co. b. Book Value Calculations: NCI 10% Book value at acquisition

Peanut Co. 90%

30,000

270,000

Common Stock 200,000

Retained Earnings 100,000

1/1/X8 Goodwill = 0

Identifiable excess = 0

$270,000 Initial investment in Snoopy Co.

90% Book value = 270,000

Basic Consolidation Entry Common stock

200,000

Retained earnings

100,000

Investment in Snoopy Co.

270,000

NCI in NA of Snoopy Co.

30,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

10,000

Building & equipment

10,000

Investment in Snoopy Co. Acquisition Price

270,000 270,000

Basic Entry

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-26 (continued) Consolidation Entries

Peanut Co.

Snoopy Co.

55,000

20,000

Accounts Receivable

50,000

30,000

80,000

Inventory

100,000

60,000

160,000

Investment in Snoopy Co.

270,000

Land

225,000

100,000

Buildings & Equipment

700,000

200,000

Less: Accumulated Depreciation

(400,000)

(10,000)

10,000

Total Assets

1,000,000

400,000

10,000

Accounts Payable

75,000

25,000

100,000

Bonds Payable

200,000

75,000

275,000

Common Stock

500,000

200,000

500,000

Retained Earnings

225,000

100,000

225,000

Consolidated

Balance Sheet Cash

75,000

270,000

325,000 10,000

NCI in NA of Snoopy Co. Total Liabilities & Equity

1,000,000

400,000

300,000

890,000 (400,000)

280,000

1,130,000

30,000

1,130,000

c. Peanut Co. Consolidated Balance Sheet 1/1/20X8 Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Total Assets

75,000 80,000 160,000 325,000 890,000 (400,000) 1,130,000

Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Snoopy Co. Total Liabilities & Equity

100,000 275,000 500,000 225,000 30,000 1,130,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-27 Consolidation Worksheet at End of the First Year of Ownership (Equity Method) a. Equity Method Entries on Peanut Co.'s Books: Investment in Snoopy Co.

270,000

Cash

270,000

Record the initial investment in Snoopy Co. Investment in Snoopy Co.

67,500

Income from Snoopy Co.

67,500

Record Peanut Co.'s 90% share of Snoopy Co.'s 20X8 income Cash

18,000

Investment in Snoopy Co.

18,000

Record Peanut Co.'s 90% share of Snoopy Co.'s 20X8 dividend b. Book Value Calculations: NCI 10%

Peanut Co. 90%

Common Stock

Retained Earnings

Beginning book value

30,000

270,000

+ Net Income

7,500

67,500

75,000

- Dividends

(2,000)

(18,000)

(20,000)

Ending book value

35,500

319,500

200,000

1/1/X8

12/31/X8

Goodwill = 0

Identifiable excess = 0

90% Book value = 270,000

Excess = 0

$270,000 Initial investment in Snoopy Co.

90% Book value = 319,500

100,000

155,000

$319,500 Net investment in Snoopy Co.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-27 (continued) Basic Consolidation Entry Common stock

200,000

Retained earnings

100,000

Income from Snoopy Co.

67,500

NCI in NI of Snoopy Co.

7,500

Dividends declared

20,000

Investment in Snoopy Co.

319,500

NCI in NA of Snoopy Co.

35,500

Accumulated Depreciation Consolidation Entry Accumulated depreciation

10,000

Building & equipment

10,000

Investment in

Income from

Snoopy Co.

Acquisition Price

270,000

90% Net Income

67,500

Ending Balance

18,000

90% Dividends

319,500

Basic

319,500 0

67,500

90% Net Income

67,500

Ending Balance

67,500 0

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-27 (continued) Consolidation Entries

Peanut Co.

Snoopy Co.

Sales

800,000

250,000

1,050,000

Less: COGS

(200,000)

(125,000)

(325,000)

Less: Depreciation Expense

(50,000)

(10,000)

(60,000)

Less: Other Expenses

(225,000)

(40,000)

(265,000)

Income from Snoopy Co.

67,500

Consolidated Net Income

392,500

Consolidated

Income Statement

NCI in Net Income Controlling Interest in Net Income

75,000

67,500

400,000

7,500

(7,500)

392,500

75,000

392,500

Beginning Balance

225,000

100,000

Net Income

392,500

75,000

Less: Dividends Declared

(100,000)

(20,000)

Ending Balance

517,500

155,000

Cash

158,000

80,000

238,000

Accounts Receivable

165,000

65,000

230,000

Inventory

200,000

75,000

Investment in Snoopy Co.

319,500

Land

200,000

100,000

Buildings & Equipment

700,000

200,000

Less: Accumulated Depreciation

(450,000)

(20,000)

10,000

Total Assets

1,292,500

500,000

10,000

Accounts Payable

75,000

60,000

Bonds Payable

200,000

85,000

Common Stock

500,000

200,000

Retained Earnings

517,500

155,000

175,000

Statement of Retained Earnings

175,000

225,000 0

392,500

20,000

(100,000)

20,000

517,500

Balance Sheet

275,000 319,500

300,000 10,000

1,292,500

500,000

890,000 (460,000)

329,500

1,473,000

135,000 285,000

NCI in NA of Snoopy Co. Total Liabilities & Equity

375,000

500,000 20,000

517,500

35,500

55,500

1,473,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-28 Consolidation Worksheet at End of the Second Year of Ownership (Equity Method) a. Equity Method Entries on Peanut Co.'s Books: Investment in Snoopy Co.

72,000

Income from Snoopy Co.

72,000

Record Peanut Co.'s 90% share of Snoopy Co.'s 20X9 income Cash

27,000

Investment in Snoopy Co.

27,000

Record Peanut Co.'s 90% share of Snoopy Co.'s 20X9 dividend b. Book Value Calculations: NCI 10% Beginning book value

35,500

Peanut Co. 90% 319,500

Common Stock

200,000

Retained Earnings 155,000

+ Net Income

8,000

72,000

80,000

- Dividends

(3,000)

(27,000)

(30,000)

Ending book value

40,500

364,500

200,000

1/1/X9

12/31/X9

Goodwill = 0

Excess = 0

90% Book value = 319,500

Excess = 0

$319,500 Net investment in Snoopy Co.

90% Book value = 364,500

205,000

$364,500 Net investment in Snoopy Co.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-28 (continued) Basic Consolidation Entry Common stock

200,000

Retained earnings

155,000

Income from Snoopy Co.

72,000

NCI in NI of Snoopy Co.

8,000

Dividends declared

30,000

Investment in Snoopy Co.

364,500

NCI in NA of Snoopy Co.

40,500

Accumulated Depreciation Consolidation Entry Accumulated depreciation

10,000

Building & equipment

10,000 Investment in

Income from

Snoopy Co.

Beginning Balance

319,500

90% Net Income

72,000

Ending Balance

27,000

90% Dividends

364,500

Basic

364,500 0

72,000

90% Net Income

72,000

Ending Balance

72,000 0

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-28 (continued) Consolidation Entries

Peanut Co.

Snoopy Co.

Sales

850,000

300,000

1,150,000

Less: COGS

(270,000)

(150,000)

(420,000)

Less: Depreciation Expense

(50,000)

(10,000)

(60,000)

Less: Other Expenses

(230,000)

(60,000)

(290,000)

Income from Snoopy Co.

72,000

Consolidated Net Income

372,000

Consolidated

Income Statement

NCI in Net Income Controlling Interest in Net Income

80,000

72,000

380,000

8,000

(8,000)

372,000

80,000

372,000

Beginning Balance

517,500

155,000

Net Income

372,000

80,000

Less: Dividends Declared

(225,000)

(30,000)

Ending Balance

664,500

205,000

Cash

255,000

75,000

330,000

Accounts Receivable

190,000

80,000

270,000

Inventory

180,000

100,000

Investment in Snoopy Co.

364,500

Land

200,000

100,000

Buildings & Equipment

700,000

200,000

Less: Accumulated Depreciation

(500,000)

(30,000)

10,000

Total Assets

1,389,500

525,000

10,000

Accounts Payable

75,000

35,000

Bonds Payable

150,000

85,000

Common Stock

500,000

200,000

Retained Earnings

664,500

205,000

235,000

Statement of Retained Earnings

235,000

517,500 0

372,000

30,000

(225,000)

30,000

664,500

Balance Sheet

280,000 364,500

300,000 10,000

1,389,500

525,000

890,000 (520,000)

374,500

1,550,000

110,000 235,000

NCI in NA of Snoopy Co. Total Liabilities & Equity

435,000

500,000 30,000

664,500

40,500

70,500

1,550,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-29 Consolidated Worksheet and Balance Sheet on the Acquisition Date (Equity Method) a. Equity Method Entries on Paper Co.'s Books: Investment in Scissor Co.

296,000

Cash

296,000

Record the initial investment in Scissor Co. b. Book Value Calculations: NCI 20% Book value at acquisition

74,000

Paper Co. 80%

Common Stock

296,000

250,000

Retained Earnings 120,000

1/1/X8 Goodwill = 0

Identifiable excess = 0

$296,000 Initial investment in Scissor Co.

80% Book value = 296,000

Basic Consolidation Entry Common stock

250,000

Retained earnings

120,000

Investment in Scissor Co.

296,000

NCI in NA of Scissor Co.

74,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

24,000

Building & equipment

24,000

Investment in Scissor Co. Acquisition Price

296,000 296,000

Basic Entry

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-29 (continued) Consolidation Entries

Paper Co.

Scissor Co.

Cash

109,000

25,000

134,000

Accounts Receivable

65,000

37,000

102,000

Inventory

125,000

87,000

Investment in Scissor Co.

296,000

Land

280,000

125,000

Buildings & Equipment

875,000

250,000

Less: Accumulated Depreciation

(500,000)

(24,000)

24,000

Total Assets

1,250,000

500,000

24,000

Accounts Payable

95,000

30,000

Bonds Payable

250,000

100,000

Common Stock

625,000

250,000

625,000

Retained Earnings

280,000

120,000

280,000

Consolidated

Balance Sheet

212,000 296,000

405,000 24,000

1,250,000

500,000

1,101,000 (500,000)

320,000

1,454,000

125,000 350,000

NCI in NA of Scissor Co. Total Liabilities & Equity

370,000

74,000

1,454,000

c. Paper Co. Consolidated Balance Sheet 1/1/20X8 Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Total Assets

134,000 102,000 212,000 405,000 1,101,000 (500,000) 1,454,000

Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Scissor Co. Total Liabilities & Equity

125,000 350,000 625,000 280,000 74,000 1,454,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-30 Consolidation Worksheet at End of the First Year of Ownership (Equity Method) a. Equity Method Entries on Paper Co.'s Books: Investment in Scissor Co.

296,000

Cash

296,000

Record the initial investment in Scissor Co. Investment in Scissor Co.

74,400

Income from Scissor Co.

74,400

Record Paper Co.'s 80% share of Scissor Co.'s 20X9 income Cash

20,000

Investment in Scissor Co.

20,000

Record Paper Co.'s 80% share of Scissor Co.'s 20X9 dividend b. Book Value Calculations: NCI 20%

Paper Co. 80%

Common Stock

Retained Earnings

Beginning book value

74,000

296,000

+ Net Income

18,600

74,400

93,000

- Dividends

(5,000)

(20,000)

(25,000)

Ending book value

87,600

350,400

250,000

1/1/X9

12/31/X9

Goodwill = 0

Identifiable excess = 0

80% Book value = 296,000

Excess = 0

$296,000 Initial investment in Scissor Co.

80% Book value = 350,400

120,000

188,000

$350,400 Net investment in Scissor Co.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-30 (continued) Basic Consolidation Entry Common stock

250,000

Retained earnings

120,000

Income from Scissor Co.

74,400

NCI in NI of Scissor Co.

18,600

Dividends declared

25,000

Investment in Scissor Co.

350,400

NCI in NA of Scissor Co.

87,600

Accumulated Depreciation Consolidation Entry Accumulated depreciation

24,000

Building & equipment

24,000

Investment in

Income from

Scissor Co.

Acquisition Price

296,000

80% Net Income

74,400 20,000

Ending Balance

350,400 350,400

74,400

80% Net Income

74,400

Ending Balance

80% Dividends Basic

74,400 0

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-30(continued) Consolidation Entries

Paper Co.

Scissor Co.

Sales

800,000

310,000

1,110,000

Less: COGS

(250,000)

(155,000)

(405,000)

Less: Depreciation Expense

(65,000)

(12,000)

(77,000)

Less: Other Expenses

(280,000)

(50,000)

(330,000)

Income from Scissor Co.

74,400

Consolidated Net Income

279,400

Consolidated

Income Statement

NCI in Net Income Controlling Interest in Net Income

93,000

74,400

298,000

18,600

(18,600)

279,400

93,000

280,000

120,000

120,000 93,000

279,400

Statement of Retained Earnings Beginning Balance

280,000

Net Income

279,400

93,000

Less: Dividends Declared

(80,000)

(25,000)

Ending Balance

479,400

188,000

Cash

191,000

46,000

237,000

Accounts Receivable

140,000

60,000

200,000

Inventory

190,000

120,000

310,000

Investment in Scissor Co.

350,400

Land

250,000

125,000

Buildings & Equipment

875,000

250,000

Less: Accumulated Depreciation

(565,000)

(36,000)

24,000

Total Assets

1,431,400

565,000

24,000

Accounts Payable

77,000

27,000

104,000

Bonds Payable

250,000

100,000

350,000

Common Stock

625,000

250,000

Retained Earnings

479,400

188,000

213,000

279,400

25,000

(80,000)

25,000

479,400

Balance Sheet

350,400 24,000

NCI in NA of Scissor Co. Total Liabilities & Equity

1,431,400

565,000

0 375,000

463,000

1,101,000 (577,000)

374,400

1,646,000

625,000 25,000

479,400

87,600

112,600

1,646,000

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-31 Consolidation Worksheet at End of the Second Year of Ownership (Equity Method) a. Equity Method Entries on Paper Co.'s Books: Investment in Scissor Co.

85,600

Income from Scissor Co.

85,600

Record Paper Co.'s 80% share of Scissor Co.'s 20X9 income Cash

24,000

Investment in Scissor Co.

24,000

Record Paper Co.'s 80% share of Scissor Co.'s 20X9 dividend b. Book Value Calculations: NCI 20% Beginning book value

87,600

Paper Co. 80% 350,400

Common Stock

250,000

Retained Earnings 188,000

+ Net Income

21,400

85,600

107,000

- Dividends

(6,000)

(24,000)

(30,000)

Ending book value

103,000

412,000

250,000

1/1/X9

12/31/X9

Goodwill = 0

Excess = 0

80% Book value = 350,400

Excess = 0

$350,400 Net investment in Scissor Co.

80% Book value = 412,000

265,000

$412,000 Net investment in Scissor Co.

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-31 (continued) Basic Consolidation Entry Common stock

250,000

Retained earnings

188,000

Income from Scissor Co.

85,600

NCI in NI of Scissor Co.

21,400

Dividends declared

30,000

Investment in Scissor Co.

412,000

NCI in NA of Scissor Co.

103,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

24,000

Building & equipment

24,000 Investment in

Income from

Scissor Co.

Beginning Balance

350,400

80% Net Income

85,600 24,000

Ending Balance

85,600

80% Net Income

85,600

Ending Balance

80% Dividends

412,000 412,000

Basic

85,600 0

Chapter 03 – The Reporting Entity and Consolidation of Less-Than-Wholly-Owned Subsidiaries with no Differential

P3-31 (continued) Consolidation Entries

Paper Co.

Scissor Co.

Sales

880,000

355,000

1,235,000

Less: COGS

(278,000)

(178,000)

(456,000)

Less: Depreciation Expense

(65,000)

(12,000)

(77,000)

Less: Other Expenses

(312,000)

(58,000)

(370,000)

Income from Scissor Co.

85,600

Consolidated Net Income

310,600

Consolidated

Income Statement

NCI in Net Income Controlling Interest in Net Income

107,000

85,600

332,000

21,400

(21,400)

310,600

107,000

310,600

Beginning Balance

479,400

188,000

Net Income

310,600

107,000

Less: Dividends Declared

(90,000)

(30,000)

Ending Balance

700,000

265,000

Cash

295,000

116,000

411,000

Accounts Receivable

165,000

97,000

262,000

Inventory

193,000

115,000

308,000

Investment in Scissor Co.

412,000

Land

250,000

125,000

Buildings & Equipment

875,000

250,000

Less: Accumulated Depreciation

(630,000)

(48,000)

24,000

Total Assets

1,560,000

655,000

24,000

Accounts Payable

85,000

40,000

125,000

Bonds Payable

150,000

100,000

250,000

Common Stock

625,000

250,000

Retained Earnings

700,000

265,000

295,000

Statement of Retained Earnings

295,000

479,400 0

310,600

30,000

(90,000)

30,000

700,000

Balance Sheet

412,000 24,000

NCI in NA of Scissor Co. Total Liabilities & Equity

1,560,000

655,000

0 375,000

545,000

1,101,000 (654,000)

436,000

1,803,000

625,000 30,000

700,000

103,000

133,000

1,803,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

CHAPTER 4 CONSOLIDATION OF WHOLLY OWNED SUBSIDIARIES ACQUIRED AT MORE THAN BOOK VALUE ANSWERS TO QUESTIONS Q4-1 The carrying value of the investment is reduced under equity-method reporting when (a) a dividend is received from the investee, (b) a differential is amortized, (c) an impairment of goodwill occurs, and (d) the market value of the investment declines and is less than the carrying value and it is concluded the decline is other than temporary. Q4-2 A differential occurs when an investor pays more than or less than underlying book value in acquiring ownership of an investee. (a) In the case of the cost method, no adjustments are made for amortization of the differential on the investor's books. (b) Under equity-method reporting the difference between the amount paid and book value must be assigned to appropriate asset and liability accounts of the acquired company. If any portion of the differential is assigned to an amortizable or depreciable asset, that amount must be charged against income from the investee over the remaining economic life of the asset. Q4-3 Amortization of a differential is the most common reason for investment income to be lower than a proportionate share of reported income of the investee. If Turner Company has paid more than book value for the shares of Straight Lace Company, the differential must be assigned to identifiable assets and liabilities of the investee, or to goodwill. Those amounts assigned to depreciable and identifiable intangible assets must be amortized and will reduce equity-method income over the remaining economic lives of the underlying assets. Amounts attributable to other items such as land or inventories must be treated as a reduction of income in the period in which Straight Lace disposes of the item. Income also will be lower if the investee has been involved in sales to related companies during the period and there are unrealized profits from those intercompany sales; the income of the selling affiliate must be reduced by the unrealized profits before equity-method income is computed. Finally, if Straight Lace has preferred stock outstanding, preferred dividends must be deducted before assigning earnings to common shareholders. Q4-4 The differential represents the difference between the acquisition-date fair value of the acquiree and the book value of the net identifiable assets. Q4-5 A company must acquire a subsidiary at a price equal to the subsidiary’s fair value, and that subsidiary must have a total acquisition-date fair value less than its book value. Q4-6 Current consolidation standards require recognition of the fair value of the subsidiary's individual assets and liabilities at the date of acquisition. Generally, this will be all of the book value plus an additional amount (the differential). At least some portion of the book value would not be included if the fair value of a particular asset or liability was less than book value. Q4-7 One hundred percent of the fair value of the subsidiary’s assets and liabilities at the date of acquisition should be included. The type of asset or liability will determine whether a change in its value will be recognized following the date of acquisition.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

Q4-8 During consolidation, the differential is eliminated from the investment account and distributed to the appropriate asset and liability accounts. This same process is followed each time consolidated statements are prepared. The consolidation entries do not actually remove the balance in the investment account from the parent's books; thus, there is no need to re-establish the balance in the parent company’s records. The differential continues to be a part of the investment account balance until fully amortized, if appropriate. Q4-9 The investment account in the financial statements of the parent company shows its investment in the subsidiary as a single total and therefore does not provide information on the individual assets and liabilities held by the subsidiary, nor their relative values. The existence of a large differential indicates the parent paid well over book value to acquire ownership of the subsidiary. When the differential is assigned to identifiable assets or liabilities of the subsidiary, both the consolidated balance sheet and consolidated income statement are likely to provide information not available in the financial statements of the individual companies. The consolidated statements are likely to provide a better picture of the assets actually being used and the resulting income statement charges that should be reported. Q4-10 Consolidated net income is equal to the parent’s income from its own operations, excluding any investment income from consolidated subsidiaries, plus the income of each of the consolidated subsidiaries, adjusted for any differential write-off. Q4-11 An additional consolidation entry normally must be entered in the worksheet to expense (depreciate) an appropriate portion of the amount assigned to buildings and equipment. Normally, depreciation expense is debited and income from subsidiary is credited. Q4-12 If the differential arises because the fair value of land, or some other non-depreciable asset, held by the subsidiary is greater than book value, the amount assigned to the differential will remain constant so long as the subsidiary continues to hold the land. When the differential arises because the fair value of depreciable or amortizable assets is greater than book value, the amount debited to the related assets each period will decrease as the parent amortizes an appropriate portion of the differential against investment income. Q4-13 Push-down accounting occurs when the assets and liabilities of the subsidiary are revalued on the subsidiary's books as a result of the purchase of shares by the parent company. The basis of accountability that the parent company would use in accounting for its investment in the various assets and liabilities is used to revalue the subsidiary's assets and liabilities; thereby pushing down the parent's basis of accountability onto the books of the subsidiary. Q4-14 Developments at the FASB and SEC have made push-down accounting optional (but not required) for all subsidiaries who file financial reports with the SEC separate from their parent company consolidated financial statements. This separate reporting by a subsidiary is only required in a few cases, usually because the subsidiary has issued public debt. Q4-15 When the assets and liabilities of the subsidiary are revalued at the date of acquisition there will no longer be a differential. The parent's portion of the revised carrying value of the net assets on the books of the subsidiary will agree with the balance in the investment account reported by the parent.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

SOLUTIONS TO CASES C4-1 Reporting Significant Investments in Common Stock Answers to this case can be found in the annual reports to stockholders of the companies mentioned and in their 10-K filings with the SEC (available at www.sec.gov). a. The complete analysis of this transaction can be found in Footnote 3 in the 2016 10-K. This analysis includes the following description: in conjunction with the acquisition of certain assets and assumption of certain liabilities of Deeley Imports, the Company recorded goodwill of $28.6 million, all of which the Company believes is tax deductible, and intangible assets with an initial fair value of $20.8 million. Of the total intangible assets acquired, $13.3 million was assigned to reacquired distribution rights with a useful life of two years and $7.5 million was assigned to customer relationships with a useful life of twenty years. The Company agreed to reimburse Deeley Imports for certain severance costs associated with the Transaction resulting in $3.3 million of expense included in selling, administrative and engineering expense in the third quarter of 2015. The Company did not acquire any cash as part of the Transaction. b. Chevron fully consolidates its controlled subsidiaries that are majority owned and variable interest entities of which it is the primary beneficiary. The company uses pro rata consolidation in reporting its undivided interests in oil and gas joint ventures. Chevron uses the equity-method to report its investments in affiliates over which the company exercises significant influence or has an ownership interest of 20 to 50 percent. In applying the equity-method, Chevron recognizes in income gains and losses from changes in its proportionate dollar share of an affiliate’s equity resulting from issuance of additional stock by the affiliate. Chevron analyses any difference between the carrying value of an equity-method investment and its underlying book value and, to the extent that it can, assigns that differential to specific assets and liabilities. The company adjusts quarterly its equity-method income recognized from affiliates for any write-off or amortization of the differential. Chevron assesses it equity investments for possible impairment when events indicate a possible impairment. If an investment has declined in value, the company evaluates the situation to determine if the decline is other than temporary. If the decline in value is judged to be other than temporary, the investment is written down to its fair value and a loss recognized in income. Subsequent recoveries in value are not recognized. c. Sears has investments in the voting securities of a number of companies that it accounts for using the equity-method. Where these investments are reported is difficult to tell from the financial statements and notes. Apparently, the amounts involved are relatively small, and the investments are included in other assets on the balance sheet, with the income reported in other income on the income statement. C4-2 Assigning an Acquisition Differential It may be difficult to determine the amount of the differential to be assigned to the manufacturing facilities of Ball Corporation. The equipment is relatively old and may be in varying states of repair or operating condition. Some units may be technologically obsolete or of little value because production needs have changed. The $600,000 estimated fair value of net assets therefore may be difficult to document and even more difficult to assign to specific assets and liabilities.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

Inventories should be compared to sales to determine if Ball has excess balances on hand. Factors such as the degree of salability, physical condition, and expected sales prices should be examined as well in determining the portion of the differential to be assigned to inventory. The LIFO inventory balances are likely to be below fair value while the FIFO balances may be relatively close to fair value. The amount of differential assigned to inventory will be significantly affected by the rate of change in inventory costs since the LIFO inventory method was adopted and the relative magnitude of inventory on hand under each method. No mention is made of patents or other intangible assets developed by Ball Corporation. While Ball Corporation could not record as assets its expenditures on research and development, the buyer should recognize all tangible and intangible assets at fair value before goodwill is computed. Goodwill normally is measured as the excess of the sum of the consideration given in the acquisition and the fair value of the noncontrolling interest over the fair value of the identifiable net assets of the acquired company. C4-3 Negative Retained Earnings Net assets of the subsidiary increase when positive earnings results occur and decrease when negative results occur. A negative retained earnings balance indicates that the other stockholders' equity balances of the subsidiary exceed the reported net assets of the subsidiary assuming the company is solvent. a. The negative retained earnings balance of the subsidiary is eliminated in the consolidation process and does not affect the dollar amounts reported in the consolidated stockholders' equity accounts. b. The consolidation process does not change in any substantive manner. Rather than debiting retained earnings in the entry to eliminate the stockholders' equity balances of the subsidiary in the consolidation worksheet, the account must be credited. c. Goodwill is recorded whenever the fair value of the acquired company as a whole, as evidenced by the fair value of the consideration given in the acquisition and the fair value of the noncontrolling interest, exceeds the fair value of the net identifiable assets acquired. In this case it is not known whether the fair value is above or below book value. Sloan Company recorded losses in prior periods and may have written down all assets that had decreased in value. On the other hand, management may have been reluctant to recognize such losses in order to avoid reducing earnings even further. In the extreme, it may even have sold all assets that had appreciated in value. Many factors, including the future earning power of the company, will affect the purchase price and it is therefore difficult to determine whether goodwill will be recorded in a situation such as this.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

C4-4 Balance Sheet Reporting Issues a. Under both alternatives, the cars and associated debt would appear on Crumple's consolidated balance sheet. In the first case, the debt is recorded directly by Crumple. In the second case, the leasing subsidiary should be fully consolidated. b. Crumple apparently has not considered selling additional common or preferred shares. The sale of additional shares or use of convertible securities would be one set of options to consider. If Crumple is willing to lease the automobiles, other leasing companies or automobile manufacturers may be interested in participating. If the availability of rental cars is considered important in the economic development of the states into which Crumple intends to expand, the company may be able to negotiate low cost loans or partially forgivable loans in acquiring the facilities and automobiles needed for expansion. c. Student answers will vary. Students may wish to look at the financial statements of one or more leasing companies in arriving at their recommendation(s). From a financial reporting perspective, both alternatives now should be reported in essentially the same manner in the consolidated financial statements. Thus, the financial reporting aspects of the alternatives have become irrelevant. However, even when different alternatives lead to different reporting treatments, the choice of an alternative should be based on economic considerations rather than on the financial reporting effects. Even though the financing alternatives Crumple is considering are reported in the same manner, they each may have different legal, tax, and economic aspects that should be considered by Crumple’s management.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

SOLUTIONS TO EXERCISES E4-1 Equity Method Reporting With a Differential Equity-method journal entries recorded by Pirate Corporation: 20X5

20X6

20X7

Investment in Ship Company Cash Record purchase of Ship Company stock.

270,000 270,000

Cash Investment in Ship Company Record dividend from Ship Company.

5,000

Investment in Ship Company Income from Ship Company Record equity-method income.

20,000

Income from Ship Company Investment in Ship Company Amortize differential: ($270,000 - $200,000) / 10 years

7,000

Cash Investment in Ship Company Record dividend from Ship Company.

15,000

Investment in Ship Company Income from Ship Company Record equity-method income.

40,000

Income from Ship Company Investment in Ship Company Amortize differential.

7,000

Cash Investment in Ship Company Record dividend from Ship Company.

35,000

Investment in Ship Company Income from Ship Company Record equity-method income.

20,000

Income from Ship Company Investment in Ship Company Amortize differential.

7,000

5,000

20,000

7,000

15,000

40,000

7,000

35,000

20,000

7,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-2 Differential Assigned to Patents Journal entries recorded by Pizza Corporation: 20X2

20X3

Investment in Slice Corporation Common Stock Additional Paid-In Capital Record purchase of Slice Corporation stock.

1,080,000 270,000 810,000

Cash Investment in Slice Corporation Record dividend from Slice Corporation

20,000

Investment in Slice Corporation Income from Slice Corporation Record equity-method income

56,000

Income from Slice Corporation Investment in Slice Corporation Amortize differential: ($1,080,000 - $980,000) / 8 years

12,500

Cash Investment in Slice Corporation Record dividend from Slice Corporation

10,000

Income from Slice Corporation Investment in Slice Corporation Record equity-method loss

44,000

Income from Slice Corporation Investment in Slice Corporation Amortize differential

12,500

20,000

56,000

12,500

10,000

44,000

12,500

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-3 Differential Assigned to Copyrights Journal entries recorded by Planet Corporation: 20X7

20X8

Investment in Saturn Company Cash Bonds Payable Record purchase of Saturn Company stock.

694,000

Cash Investment in Saturn Company Record dividend from Saturn Company

24,000

Income from Saturn Company Investment in Saturn Company Record equity-method loss

88,000

Income from Saturn Company Investment in Saturn Company Amortize differential: Book value of assets Book value of liabilities Net book value Land fair value increment Fair value of net assets Amount paid Differential Period of amortization (years) Amortization per period

9,750

24,000 670,000

24,000

88,000

9,750 $740,000 (140,000) $600,000 16,000 $616,000 694,000 $ 78,000 ÷ 8 $ 9,750

Cash Investment in Saturn Company Record dividend from Saturn Company

24,000

Investment in Saturn Company Income from Saturn Company Record equity-method income

120,000

Income from Saturn Company Investment in Saturn Company Amortize differential

9,750

24,000

120,000

9,750

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-4 Differential Attributable to Depreciable Assets a. Journal entries recorded by Planner Corporation using the equity method: 20X4

20X5

Investment in Schedule Company Cash Record purchase of Schedule Company stock.

340,000 340,000

Cash Investment in Schedule Company Record dividend from Schedule Company

6,000

Investment in Schedule Company Income from Schedule Company Record equity-method income

10,000

Income from Schedule Company Investment in Schedule Company Amortize differential: (340,000 – 300,000) / 10 years

4,000

Cash Investment in Schedule Company Record dividend from Schedule Company

9,000

Investment in Schedule Company Income from Schedule Company Record equity-method income

20,000

Income from Schedule Company Investment in Schedule Company Amortize differential

4,000

6,000

10,000

4,000

9,000

20,000

4,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-5 Investment Income Plastic Company reported equity-method income of $52,000, computed as follows: Proportionate share of reported income Amortization of differential: Land ($108,000: not amortized) Equipment ($80,000 / 5 years) Goodwill ($0: not amortized) Investment Income

$68,000 $ -016,000 -0-

Assignment of differential Purchase price Proportionate share of book value of net assets ($690,000 - $230,000) Differential Differential assigned to land Differential assigned to equipment Differential assigned to goodwill

(16,000) $52,000

$648,000 (460,000) $ 188,000 (108,000) (80,000) $ 0

E4-6 Determination of Purchase Price Investment account balance December 31, 20X6

$161,000

Increase in account balance during 20X5: Proportionate share of income Amortize differential ($28,000 / 8 years) Dividend received

$ 33,000 (3,500) (15,000)

(14,500)

Decrease in account balance during 20X6: Proportionate share of income Amortize differential ($28,000 / 8 years) Dividend received

$ 6,000 (3,500) (12,000)

9,500

Investment account balance at date of purchase

$156,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-7 Equity Entries With a Differential a. Equity-method journal entries recorded by Pistol Corporation: 20X6

20X7

20X8

Investment in Scope Company Cash Record purchase of Scope Company stock.

56,000

Cash Investment in Scope Company Record dividend from Scope Company.

6,000

Investment in Scope Company Income from Scope Company Record equity-method income.

16,000

Income from Scope Company Investment in Scope Company Amortize differential: ($56,000 - $40,000) / 8 years

2,000

Cash Investment in Scope Company Record dividend from Scope Company.

8,000

Investment in Scope Company Income from Scope Company Record equity-method income.

24,000

Income from Scope Company Investment in Scope Company Amortize differential: ($56,000 - $40,000) / 8 years

2,000

Cash Investment in Scope Company Record dividend from Scope Company.

8,000

Investment in Scope Company Income from Scope Company Record equity-method income.

32,000

Income from Scope Company Investment in Scope Company Amortize differential: ($56,000 - $40,000) / 8 years

2,000

56,000

6,000

16,000

2,000

8,000

24,000

2,000

8,000

32,000

2,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

b. Computation of balance of investment account Purchase price Addition to account for investment income: 20X6: $16,000 20X7: $24,000 20X8: $32,000 Deduction for dividends received: 20X6: $6,000 20X7: $8,000 20X8: $8,000 Amortization of differential: Purchase price Proportionate share of book value of net assets ($10,000 + $30,000) Amount of differential Amortization for 3 years [($16,000 / 8) x 3] Balance of investment account at December 31, 20X8

$ 56,000 $16,000 24,000 32,000

72,000

$ 6,000 8,000 8,000

(22,000)

$56,000 (40,000) $16,000 (6,000) $100,000

E4-8 Differential Assigned to Land and Equipment Journal entries recorded by Pitch Corporation: Investment in Southpaw Corporation Cash Record purchase of Southpaw stock.

65,000

Cash Investment in Southpaw Corporation Record dividend from Southpaw

4,500

Investment in Southpaw Corporation Income from Southpaw Record equity-method income

12,000

Income from Southpaw Investment in Southpaw Corporation Amortize differential assigned to equipment.

1,000

65,000

4,500

12,000

1,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-9 Equity Entries with Goodwill Journal entries recorded following purchase: Investment in Softball Corporation Cash Record purchase of Softball stock.

437,500

Cash Investment in Softball Corporation Record dividend from Softball

3,200

Investment in Softball Corporation Stock Income from Softball Corporation Record equity-method income

16,000

437,500

3,200

Income from Softball Corporation Stock 10,000 Investment in Softball Corporation Write off differential assigned to inventory carried on FIFO basis Income from Softball Corporation Stock 9,000 Investment in Softball Corporation Amortize differential assigned to buildings and equipment: [$240,000 - ($300,000 - $150,000)] / 10 years

16,000

10,000

9,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-10 Multiple-Choice Questions on Consolidation Process 1. c – Goodwill is the difference between the fair value of the acquiree (what someone is willing to pay for the company) and the fair value of the net identifiable assets. (a) Incorrect. Goodwill can be measured in business combinations, and is always recorded regardless of difficulty. (b) Incorrect. Goodwill is the excess of the purchase price over the fair value of the net identifiable assets, not the book value. (d) Incorrect. The size of the company acquired has no direct correlation with the amount of goodwill that may or may not be recorded. 2. d – Consolidated financial statements will never report intercompany receivables. The intercompany receivables would show up on the individual books of the companies involved, but the amounts would be eliminated prior to consolidation. [AICPA Adapted] (a) Incorrect. No intercompany receivables should exist in the consolidated financials. (b) Incorrect. No intercompany receivables should exist in the consolidated financials. (c) Incorrect. No intercompany receivables should exist in the consolidated financials. 3. d – The consolidated stockholder’s equity balance is always equal to the balance of total equity from the parent’s books. (a) Incorrect. The only amount that should appear in the consolidated balance is the amount from the parent’s books. (b) Incorrect. The only amount that should appear in the consolidated balance is the amount from the parent’s books. (c) Incorrect. The equity balances from parent and sub are not added together, but rather only the balance from the parent’s books appears in the consolidated statements. 4. b - $550,000 = $1,500,000 – [(100,000 + 200,000 + 450,000 +1,000,000) – (300,000 + 500,000)] 5. a – The consolidated balance sheet should only show the retained earnings balance of the parent company. (b) Incorrect. Consolidated retained earnings should equal the parent’s retained earnings. (c) Incorrect. Consolidated retained earnings should equal the parent’s retained earnings. (d) Incorrect. Consolidated retained earnings should equal the parent’s retained earnings.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-11 Multiple-Choice Questions on Consolidation [AICPA Adapted] 1. c – Goodwill is not amortized, but instead is tested for impairment at least annually. (a) Incorrect. Goodwill is not amortized. (b) Incorrect. Goodwill is not amortized. (d) Incorrect. Because the subsidiary has recognized more depreciation than it should have, depreciation expense should be decreased, not increased. 2. a – Goodwill is not amortized, thus no amortization expense is recorded. Because goodwill was found to be unimpaired, the entire amount of the existing goodwill would be reported. (b) Incorrect. Goodwill is not amortized. (c) Incorrect. Goodwill is not amortized. (d) Incorrect. Goodwill was unimpaired, and still exists at the end of 20X8. Thus, goodwill should be recorded. 3. d – All intercompany loans and profits must be eliminated in a consolidation, thus the entire balances should be eliminated. (a) Incorrect. All intercompany loans and profits must be eliminated with a wholly owned subsidiary. (b) Incorrect. All intercompany loans and profits must be eliminated with a wholly owned subsidiary. (c) Incorrect. All intercompany loans and profits must be eliminated with a wholly owned subsidiary. 4. c – $400,000 = $1,700,000 - $1,300,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-12 Consolidation entries with Differential a. Equity-method Entries on Playoff Corp.'s Books: Investment in Series Co.

100,000

Cash

100,000

Record the initial investment in Series Co. Book Value Calculations: Total Book Value Book value at acquisition

57,000

Common Stock 20,000

Retained Earnings 37,000

1/1/X8

Goodwill = 18,000

Identifiable Excess = 25,000

$100,000 Initial investment in Series Co.

100% Book value = 57,000

Basic Consolidation Entry Common stock

20,000

Retained earnings

37,000

Investment in Series Co.

57,000

Excess Value (Differential) Calculations: Total Balances

43,000

Inventory

Buildings & Equipment

5,000

20,000

Goodwill 18,000

Excess Value (Differential) Reclassification Entry: Inventory

5,000

Buildings & Equipment

20,000

Goodwill

18,000

Investment in Series Co.

43,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-12 (continued)

Acquisition Price

Investment in Series Co. 100,000 57,000 43,000 0

Basic Excess Reclass.

Journal entries used to record transactions, adjust account balances, and close income and revenue accounts at the end of the period are recorded in the company's books and change the recorded balances. On the other hand, consolidation entries are entered only in the consolidation worksheet to facilitate the preparation of consolidated financial statements. As a result, they do not change the balances recorded in the company's accounts and must be reentered each time a consolidation worksheet is prepared.

E4-13 Balance Sheet Consolidation Equity-method Entries on Plaza Corp.'s Books: Investment in Square Corp.

395,000

Cash

395,000

Book Value Calculations: Total Book Value Book value at acquisition

360,000

Common Stock 120,000

Retained Earnings 240,000

1/1/X4 Goodwill = 19,000

Identifiable Excess = 16,000

100% Book value = 360,000

$395,000 Initial investment in Square Corp.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

Basic Consolidation Entry Common Stock

120,000

Retained Earnings

240,000

Investment in Square Corp.

360,000

Excess Value (Differential) Calculations: Total Balances

Buildings

35,000

Inventory

(20,000)

36,000

Goodwill 19,000

Excess Value (Differential) Reclassification Entry: Inventory

36,000

Goodwill

19,000

Buildings

20,000

Investment in Square Corp.

35,000

Investment in Square Corp. Acquisition Price

395,000 360,000

Basic

35,000

Excess Reclass.

E4-14 Acquisition with Differential a. Goodwill is $60,000, computed as follows: Book value of Socket’s net assets: Common stock outstanding Retained earnings Fair value increment: Land ($100,000 - $80,000) Buildings ($400,000 - $220,000) Fair value of net assets Fair value of consideration given Goodwill

$ 80,000 130,000 $ 20,000 180,000

$210,000 200,000 $410,000 (470,000) $ 60,000

b. Equity-method Entries on Plumber Corp.'s Books: Investment in Socket Corp.

470,000

Cash

470,000

Record the initial investment in Socket Corp.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

Book Value Calculations: Total Book Value Book value at acquisition

Common Stock

210,000

80,000

Retained Earnings 130,000

1/1/X2

Goodwill = 60,000

Identifiable Excess = 200,000

$470,000 Initial investment in Socket Corp.

100% Book value = 210,000

Basic Consolidation Entry Common stock

80,000

Retained earnings

130,000

Investment in Socket Corp.

210,000

Excess Value (Differential) Calculations: Total Balances

260,000

Land

20,000

Buildings 180,000

Goodwill 60,000

Excess Value (Differential) Reclassification Entry: Land

20,000

Buildings

180,000

Goodwill

60,000

Investment in Socket Corp.

260,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-15 Balance Sheet Worksheet with Differential a. Equity-method Entries on Plump Corp.'s Books: Investment in Slim Corp.

189,000

Cash

189,000

Record the initial investment in Slim Corp. Book Value Calculations: Total Book Value Book value at acquisition

Common Stock

150,000

60,000

Retained Earnings 90,000

1/1/X2

Goodwill = 0

Identifiable Excess = 39,000

$189,000 Initial investment in Slim Corp.

100% Book value = 150,000

Basic Consolidation Entry Common stock

60,000

Retained earnings

90,000

Investment in Slim Corp.

150,000

Excess Value (Differential) Calculations: Total Balances

39,000

Inventory

24,000

Buildings & Equipment 15,000

Excess Value (Differential) Reclassification Entry: Inventory

24,000

Buildings & Equipment

15,000

Investment in Slim Corp.

39,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-15 (continued) Investment in Slim Corp. Acquisition Price

189,000 150,000

Basic

39,000

Excess Reclass.

b. Consolidation Entries

Plump Corp.

Slim Corp.

Cash

26,000

18,000

44,000

Accounts Receivable

87,000

37,000

124,000

Inventory

110,000

60,000

24,000

194,000

Buildings & Equipment (net)

220,000

150,000

15,000

385,000

Investment in Slim Corp.

189,000

Consolidated

Balance Sheet

150,000

39,000 Total Assets

632,000

265,000

39,000

189,000

Accounts Payable

92,000

35,000

127,000

Notes Payable

150,000

80,000

230,000

Common Stock

100,000

60,000

100,000

Retained Earnings

290,000

90,000

290,000

Total Liabilities & Equity

632,000

265,000

150,000

747,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-16 Worksheet for Wholly Owned Subsidiary a. Equity-method Entries on Pint Enterprises’ Books: Investment in Saloon Builders

167,000

Cash

167,000

Record the initial investment in Saloon Builders Book Value Calculations: Total Book Value Book value at acquisition

150,000

Common Stock

Retained Earnings

140,000

10,000

1/1/X5 Goodwill = 0

Identifiable Excess = 17,000

$167,000 Initial investment in Saloon Builders

100% Book value = 150,000

Basic Consolidation Entry Common Stock

140,000

Retained Earnings

10,000

Investment in Saloon Builders

150,000

Excess Value (Differential) Calculations: Cash and Total = Receivables + Inventory Balances

17,000

(2,000)

Buildings & Equipment

7,000

12,000

Excess Value (Differential) Reclassification Entry: Inventory

7,000

Buildings & Equipment

12,000

Cash and Receivables

2,000

Investment in Saloon Builders

17,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-16 (continued) Investment in Saloon Builders Acquisition Price

167,000 150,000

Basic

17,000

Excess Reclass.

0 b. Pint Enterprises

Saloon Builders

Consolidation Entries DR

Consolidated

Balance Sheet Cash and Receivables

80,000

30,000

Inventory

150,000

350,000

7,000

2,000

108,000 507,000

Buildings & Equipment (net)

430,000

80,000

12,000

522,000

Investment in Saloon Builders

167,000

150,000

17,000 Total Assets

827,000

460,000

Current Liabilities

100,000

110,000

Long-Term Debt

400,000

200,000

Common Stock

200,000

140,000

200,000

Retained Earnings

127,000

10,000

127,000

Total Liabilities & Equity

827,000

460,000

150,000

19,000

169,000

1,137,000

210,000 600,000

1,137,000

Pint Enterprises and Subsidiary Consolidated Balance Sheet January 1, 20X5

Cash and Receivables Inventory Buildings and Equipment (net)

$ 108,000 507,000

Total Assets

$1,137,000

522,000

Current Liabilities Long-Term Debt Common Stock Retained Earnings Total Liabilities & Stockholders' Equity

$ 210,000 600,000 $200,000 127,000

327,000 $1,137,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-17 Computation of Consolidated Balances a. Inventory

$ 440,000

b. Land

$ 145,000

Buildings and Equipment

d. Goodwill:

$ 1,750,000

Fair value of consideration given Book value of net assets at acquisition Fair value increment for: Inventory Land Buildings and equipment Fair value of net assets at acquisition Balance assigned to goodwill

$ 576,000 $450,000 20,000 (10,000) 70,000 (530,000) $ 46,000

e. Investment in Single Corporation: Nothing would be reported; the balance in the investment account is eliminated. E4-18 Multiple-Choice Questions on Balance Sheet Consolidation 1.

d – $215,000

$130,000 + $85,000

b – $23,000

$198,000 – ($405,000 - $265,000 + $15,000 + $20,000)

c–

$1,109,000

Total Assets of Pocket Corp. Less: Investment in Strap Corp. Book value of assets of Pocket Corp. Book value of assets of Strap Corp. Total book value Payment in excess of book value ($198,000 - $140,000) Total assets reported

$ 844,000 (198,000) $ 646,000 405,000 $1,051,000 58,000 $1,109,000

c–

$701,500

($61,500 + $95,000 + $280,000) + ($28,000 + $37,000 + $200,000)

d – $257,500

The amount reported by Pocket Corporation

a–

The amount reported by Pocket Corporation

$407,500

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-19 Wholly Owned Subsidiary with Differential a. Equity-method Entries on Point Corp.'s Books: Investment in Stick Corp.

178,000

Cash

178,000

Record the initial investment in Stick Corp. Investment in Stick Corp.

30,000

Income from Stick Corp.

30,000

Record Point Corp.'s 100% share of Stick Corp.'s 20X3 income Cash

12,000

Investment in Stick Corp.

12,000

Record Point Corp.'s 100% share of Stick Corp.'s 20X3 dividend Income from Stick Corp.

4,000

Investment in Stick Corp.

4,000

Record amortization of excess acquisition price b. Book Value Calculations: Total Book Value

Common Stock 60,000

Retained Earnings

Beginning book value

150,000

+ Net Income

30,000

- Dividends

(12,000)

Ending book value

168,000

60,000

90,000

108,000

1/1/X3

12/31/X3

Goodwill = 0

Identifiable Excess = 28,000

100% Book value = 150,000

Identifiable Excess = 24,000 $178,000 Initial investment in Stick Corp.

100% Book value = 168,000

$192,000 Net investment in Stick Corp.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-19 (continued) Basic Consolidation Entry Common stock

60,000

Retained earnings

90,000

Income from Stick Corp.

30,000

Dividends declared

12,000

Investment in Stick Corp.

168,000

Excess Value (Differential) Calculations: Total Beginning Balances

28,000

Changes

(4,000)

Ending Balances

24,000

Equipment

Acc. Depr.

28,000 (4,000) 28,000

(4,000))

Amortized Excess Value Reclassification Entry: Depreciation Expense

4,000

Income from Stick Corp.

4,000

Excess value (differential) reclassification entry: Equipment

28,000

Accumulated depreciation

4,000

Investment in Stick Corp.

24,000

Investment in

Income from

Stick Corp.

Acquisition Price

178,000

100% Net Income

30,000

Ending Balance

12,000

100% Dividends

4,000

Excess Val. Amort. Basic

24,000

Excess Reclass.

100% Net Income

26,000

Ending Balance

4,000

192,000 168,000

30,000

30,000 4,000 0

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-20 Basic Consolidation Worksheet a. Equity-method Entries on Police Corp.'s Books: Investment in Station Corporation

150,000

Cash

150,000

Record the initial investment in Station Corporation Investment in Station Corp.

30,000

Income from Station Corp. 30,000 Record Police Corp.'s 100% share of Station Corporation's 20X3 income Cash

10,000

Investment in Station Corp. 10,000 Record Police Corp.'s 100% share of Station Corporation's 20X3 dividend Book Value Calculations: Total Book Value

Common Stock

Retained Earnings

Beginning book value

150,000

+ Net Income

30,000

- Dividends

(10,000)

Ending book value

170,000

100,000

50,000

70,000

1/1/X3

12/31/X3

Goodwill = 0

Identifiable Excess = 0

$150,000 Initial investment in Station Corp.

100% Book value = 150,000

Identifiable Excess = 0

100% Book value = 170,000

$170,000 Net investment in Station Corp.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-20 (continued) Basic Consolidation Entry Common Stock

100,000

Retained Earnings

50,000

Income from Station Corp.

30,000

Dividends Declared

10,000

Investment in Station Corp.

170,000

Investment in

Income from

Station Corp.

Acquisition Price

150,000

100% Net Income

30,000 10,000

Ending Balance

170,000 170,000

30,000

100% Net Income

30,000

Ending Balance

100% Dividends

Basic

30,000 0

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-20 (continued) b. Consolidation Entries

Police Corp.

Station Corp.

200,000

120,000

Less: Depreciation Expense

(25,000)

(15,000)

(40,000)

Less: Other Expenses

(105,000)

(75,000)

(180,000)

Consolidated

Income Statement Sales

320,000

Income from Station Corp.

30,000

Net Income

100,000

30,000

230,000

50,000

50,000 30,000

0 0

100,000

Statement of Retained Earnings Beginning Balance

230,000

Net Income

100,000

30,000

Less: Dividends Declared

(40,000)

(10,000)

Ending Balance

290,000

70,000

Current Assets

145,000

105,000

250,000

Depreciable Assets (net)

325,000

225,000

550,000

Investment in Station Corp.

170,000

Total Assets

640,000

80,000

100,000

10,000

(40,000)

10,000

290,000

Balance Sheet

330,000

170,000

800,000

Current Liabilities

50,000

40,000

90,000

Long-Term Debt

100,000

120,000

220,000

Common Stock

200,000

100,000

Retained Earnings

290,000

70,000

80,000

10,000

290,000

Total Liabilities & Equity

640,000

330,000

180,000

10,000

800,000

200,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-21 Basic Consolidation Worksheet for Second Year a. Equity-method Entries on Police Corp.'s Books: Investment in Station Corp.

35,000

Income from Station Corp.

35,000

Record Police Corp.'s 100% share of Station Corp.'s 20X4 income Cash

15,000

Investment in Station Corp.

15,000

Record Police Corp.'s 100% share of Station Corp.'s 20X4 dividend Book Value Calculations: Total Book Value

Common Stock

Retained Earnings

Beginning book value

170,000

+ Net Income

35,000

- Dividends

(15,000)

Ending book value

190,000

100,000

70,000

90,000

1/1/X4

12/31/X4

Goodwill = 0

Identifiable Excess = 0

100% Book value = 170,000

$170,000 Net investment in Station Corp.

Identifiable Excess = 0

100% Book value = 190,000

$190,000 Net investment in Station Corp.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-21 (continued) Basic Consolidation Entry Common Stock

100,000

Retained Earnings

70,000

Income from Station Corp.

35,000

Dividends Declared

15,000

Investment in Station Corp.

190,000

Investment in

Income from

Station Corp.

Beginning Balance

170,000

100% Net Income

35,000 15,000

Ending Balance

190,000 190,000

35,000

100% Net Income

35,000

Ending Balance

100% Dividends Basic

35,000 0

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-21 (continued) b. Police Corp.

Station Corp.

Consolidation Entries DR

Consolidated

Income Statement Sales

230,000

140,000

370,000

Less: Depreciation Expense

(25,000)

(15,000)

(40,000)

Less: Other Expenses

(150,000)

(90,000)

(240,000)

Income from Station Corp.

35,000

Net Income

90,000

35,000

Beginning Balance

290,000

70,000

Net Income

90,000

35,000

Less: Dividends Declared

(50,000)

(15,000)

Ending Balance

330,000

90,000

Current Assets

210,000

150,000

Depreciable Assets (net)

300,000

210,000

Investment in Station Corp.

190,000

Total Assets

700,000

0 0

90,000

Statement of Retained Earnings

105,000

290,000 0

90,000

15,000

(50,000)

15,000

330,000

Balance Sheet

360,000

360,000 510,000

190,000

870,000

Current Liabilities

70,000

50,000

120,000

Long-Term Debt

100,000

120,000

220,000

Common Stock

200,000

100,000

Retained Earnings

330,000

90,000

105,000

15,000

330,000

Total Liabilities & Equity

700,000

360,000

205,000

15,000

870,000

200,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-22 Consolidation Worksheet with Differential a. Equity-method Entries on Pony Corp.'s Books: Investment in Stallion Co.

180,000

Cash

180,000

Record the initial investment in Stallion Co. Investment in Stallion Co.

30,000

Income from Stallion Co.

30,000

Record Pony Corp.'s 100% share of Stallion Co.'s 20X5 income Cash

10,000

Investment in Stallion Co.

10,000

Record Pony Corp.'s 100% share of Stallion Co.'s 20X5 dividend Income from Stallion Co.

5,000

Investment in Stallion Co.

5,000

Record amortization of excess acquisition price Book Value Calculations: Total Book Value Beginning book value

150,000

Common Stock 100,000

Retained Earnings 50,000

+ Net Income

30,000

- Dividends

(10,000)

Ending book value

170,000

100,000

70,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

1/1/X5

12/31/X5

Goodwill = 0

Identifiable Excess = 30,000

Identifiable Excess = 25,000

$180,000 Initial investment in Stallion Co.

100% Book value = 150,000

$195,000 Net investment in Stallion Co.

100% Book value = 170,000

Basic Consolidation Entry Common Stock

100,000

Retained Earnings

50,000

Income from Stallion Co.

30,000

Dividends Declared

10,000

Investment in Stallion Co.

170,000

Excess Value (Differential) Calculations: Depreciable Total = Assets Beginning balance

30,000

Changes

(5,000)

Ending balance

25,000

30,000

Acc. Depr. 0 (5,000)

30,000

(5,000)

Amortized Excess Value Reclassification Entry: Depreciation Expense

5,000

Income from Stallion Co.

5,000

Excess Value (Differential) Reclassification Entry: Depreciable Assets

30,000

Accumulated Depreciation

5,000

Investment in Stallion Co.

25,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

Acquisition Price 100% Net Income

Ending Balance

Investment in

Income from

Stallion Co.

180,000 30,000 10,000

100% Dividends

5,000

Excess Val. Amort. Basic

25,000

Excess Reclass.

100% Net Income

25,000

Ending Balance

5,000

195,000 170,000

30,000

30,000 5,000 0

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-22 (continued) b. Pony Corp.

Stallion Co.

Sales

200,000

120,000

Less: Depreciation Expense

(25,000)

(15,000)

Less: Other Expenses

(105,000)

(75,000)

Income from Stallion Co.

25,000

Net Income

95,000

Beginning Balance

Consolidation Entries DR

Consolidated

Income Statement 320,000 5,000

(45,000) (180,000)

30,000

5,000

30,000

35,000

5,000

95,000

230,000

50,000

Net Income

95,000

30,000

35,000

Less: Dividends Declared

(40,000)

(10,000)

Ending Balance

285,000

70,000

Statement of Retained Earning

85,000

230,000 5,000

95,000

10,000

(40,000)

15,000

285,000

Balance Sheet Cash

15,000

5,000

20,000

Accounts Receivable

30,000

40,000

70,000

Inventory

70,000

60,000

130,000

Depreciable Assets (net)

325,000

225,000

Investment in Stallion Co.

195,000

30,000

5,000

575,000

170,000

25,000 Total Assets

635,000

330,000

30,000

200,000

795,000

Accounts Payable

50,000

40,000

90,000

Notes Payable

100,000

120,000

220,000

Common Stock

200,000

100,000

Retained Earnings

285,000

70,000

85,000

15,000

285,000

Total Liabilities & Equity

635,000

330,000

185,000

15,000

795,000

200,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-23 Consolidation Worksheet for Subsidiary a. Equity-method Entries on Polka Corp.'s Books: Investment in Song Company

170,000

Cash Record the initial investment in Song Company stock.

170,000

Investment in Song Company.

35,000

Income from Song Company

35,000

Record Polka Corp.'s 100% share of Song Company's 20X4 income Cash

15,000

Investment in Song Company.

15,000

Record Polka Corp.'s 100% share of Song Company's 20X4 dividend

Book Value Calculations: Total Book Value

Common Stock 100,000

Retained Earnings

Beginning book value

170,000

+ Net Income

35,000

- Dividends

(15,000)

Ending book value

190,000

100,000

70,000

90,000

1/1/X4

12/31/X4

Goodwill = 0

Identifiable Excess = 0

$170,000 Initial investment in Song Co.

100% Book value = 170,000

$190,000 Net investment in Song Co.

100% Book value = 190,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-23 (continued) Basic Consolidation Entry Common Stock

100,000

Retained Earnings

70,000

Income from Song Co.

35,000

Dividends Declared

15,000

Investment in Song Co.

190,000

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

75,000

Building & Equipment

Acquisition Price 100% Net Income

75,000

Investment in

Income from

Song Co.

170,000 35,000 15,000

Ending Balance

100% Net Income

35,000

Ending Balance

100% Dividends

190,000 190,000

35,000

Basic

35,000 0

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-23 (continued) b. Polka Corp.

Song Co.

Consolidation Entries DR

Consolidated

Income Statement Sales

230,000

140,000

370,000

Less: Depreciation Expense

(25,000)

(15,000)

(40,000)

Less: Other Expenses

(150,000)

(90,000)

(240,000)

Income from Song Co.

35,000

Net Income

90,000

35,000

318,000

70,000

70,000 35,000

35,000

0 0

90,000

Statement of Retained Earnings Beginning Balance

318,000

Net Income

90,000

35,000

Less: Dividends Declared

(50,000)

(15,000)

Ending Balance

358,000

90,000

Current Assets

238,000

150,000

Depreciable Assets

500,000

300,000

Less: Accumulated Depreciation

(200,000)

(90,000)

Investment in Song Co.

190,000

Total Assets

728,000

360,000

Current Liabilities

70,000

50,000

120,000

Long-Term Debt

100,000

120,000

220,000

Common Stock

200,000

100,000

Retained Earnings

358,000

90,000

105,000

15,000

358,000

Total Liabilities & Equity

728,000

360,000

205,000

15,000

898,000

105,000

90,000

15,000

(50,000)

15,000

358,000

Balance Sheet 388,000 75,000 75,000

75,000

725,000 (215,000)

190,000

265,000

898,000

200,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

E4-24A Push-Down Accounting a. Entry to record acquisition of Soda stock on books of Pop: Investment in Soda Corporation Cash

789,000 789,000

b. Entry to record revaluation of assets on books of Soda Corporation: Land Buildings Equipment Revaluation Capital

15,000 50,000 20,000 85,000

c. Investment consolidation entry in consolidation worksheet (no other entries needed): Common Stock – Soda Corporation Additional Paid-In Capital Retained Earnings Revaluation Capital Investment in Soda Corporation Stock Book Value Calculations: Total Book = Common + Additional + Value Stock Capital Book value at 789,000 200,000 425,000 acquisition

200,000 425,000 79,000 85,000 789,000

Retained Earnings

+ Revaluation Capital

79,000

85,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

SOLUTIONS TO PROBLEMS P4-25 Assignment of Differential in Worksheet a. Equity-method Entries on Pork Corp.'s Books: Investment in Swine Enterprises

290,000

Cash

290,000

Record the initial investment in Swine Enterprises Book Value Calculations: Total Book Value Book value at acquisition

250,000

Common Stock

100,000

Retained Earnings 150,000

1/1/X4

Goodwill = 30,000

Identifiable Excess = 10,000

$290,000 Initial investment in Swine Enterprises

100% Book value = 250,000

Basic Consolidation Entry Common stock

100,000

Retained earnings

150,000

Investment in Swine Enterprises

250,000

Excess Value (Differential) Calculations: Total Balances

40,000

Buildings & Equipment 10,000

Goodwill 30,000

Excess value (differential) reclassification entry: Buildings & Equipment

10,000

Goodwill

30,000

Investment in Swine Enterprises

40,000 4-41

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-25 (continued) Accumulated Depreciation Consolidation Entry Accumulated depreciation

65,000

Building & equipment

65,000

Investment in Swine Enterprises Acquisition Price

290,000 250,000

Basic

40,000

Excess Reclass.

Pork Corp.

Swine Enterprises

Consolidation Entries DR

Consolidated

Balance Sheet Cash and Receivables

40,000

20,000

60,000

Inventory

95,000

40,000

135,000

Land

80,000

90,000

170,000

Buildings & Equipment

400,000

230,000

10,000

Less: Accumulated Depreciation

(175,000)

(65,000)

65,000

Investment in Swine Enterprises

290,000

65,000

575,000 (175,000)

250,000

40,000 Goodwill

30,000 105,000

30,000

Total Assets

730,000

315,000

355,000

795,000

Accounts Payable

60,000

15,000

Notes Payable

100,000

50,000

Common Stock

300,000

100,000

300,000

Retained Earnings

270,000

150,000

270,000

Total Liabilities & Equity

730,000

315,000

250,000

75,000 150,000

795,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-25 (continued)

Pork Corporation and Subsidiary Consolidated Balance Sheet January 1, 20X4 Cash and Receivables Inventory Land Buildings and Equipment Less: Accumulated Depreciation Goodwill Total Assets

$ 60,000 135,000 170,000 $575,000 (175,000)

Accounts Payable Notes Payable Common Stock Retained Earnings Total Liabilities and Stockholders' Equity

400,000 30,000 $795,000 $ 75,000 150,000

$300,000 270,000

570,000 $795,000

P4-26 Computation of Consolidated Balances a.

Inventories ($110,000 + $170,000)

$280,000

Buildings and Equipment (net) ($350,000 + $375,000)

$725,000

Investment in Script Studios will be fully eliminated and will not appear in the consolidated balance sheet.

Goodwill Fair value of consideration given Fair value of Script’s net assets: Cash and receivables Inventory Buildings and equipment (net) Accounts payable Notes payable Fair value of net identifiable Assets Goodwill to be reported

$280,000 $ 40,000 170,000 375,000 (90,000) (250,000) (245,000) $ 35,000

Note: Goodwill on books of Script is not an identifiable asset and therefore is not included in the computation of Script’s net identifiable assets at the date of acquisition. e.

Common Stock

$400,000

Retained Earnings

$105,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-27 Balance Sheet Consolidation [AICPA Adapted] Equity-method Entries on Pot Inc.'s Books: Investment in Seed Inc. Common Stock Additional Paid-In Capital

2,260,000 1,000,000 1,260,000

Record the initial investment in Seed Inc. Investment in Seed Inc.

580,000

Income from Seed Inc.

580,000

Record Pot Inc.'s 100% share of Seed Inc.'s 20X4 income Cash

160,000

Investment in Seed Inc.

160,000

Record Pot Inc.'s 100% share of Seed Inc.'s 20X4 dividend Book Value Calculations: Total Book Value

Common Stock

Retained Earnings

Beginning book value

2,010,000

+ Net Income

580,000

- Dividends

(160,000)

Ending book value

2,430,000

1,000,000

820,000

1,240,000

1/1/X4

12/31/X4

Goodwill = 0

Identifiable Excess = 250,000

$2,260,000 Initial investment in Seed Inc.

100% Book value = 2,010,000

Additional Paid-In Capital 190,000

190,000

$2,680,000 Net investment in Seed Inc.

100% Book value = 2,430,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-27 (continued) Basic Consolidation Entry Common Stock

1,000,000

Retained Earnings

820,000

Income from Seed Inc.

580,000

Additional Paid-In Capital

190,000

Dividends Declared

160,000

Investment in Seed Inc.

2,430,000

Excess Value (Differential) Calculations: Total Beginning balance

Land

250,000

Changes Ending balance

Excess Value (Differential) Reclassification Entry: Land

250,000

Investment in Seed Inc.

250,000

Investment in

Income from

Seed Inc.

Acquisition Price

2,260,000

100% Net Income

580,000 160,000

Ending Balance

580,000

100% Net Income

580,000

Ending Balance

100% Dividends

2,680,000 2,430,000

Basic

250,000

Excess Reclass.

580,000 0

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-27 (continued) Consolidation Entries Pot Inc.

Seed Inc.

Consolidated

Balance Sheet Cash

825,000

330,000

1,155,000

Accounts and Other Receivables

2,140,000

835,000

2,975,000

Inventory

2,310,000

1,045,000

3,355,000

Land

650,000

300,000

Depreciable Assets (net)

4,575,000

1,980,000

Investment in Seed Inc.

2,680,000

250,000

1,200,000 6,555,000 2,430,000

250,000 Long-Term Investments & Other Assets

865,000

385,000

1,250,000

Total Assets

14,045,000

4,875,000

Accounts Payable and Other Cur. Liabilities

2,465,000

1,145,000

Long-Term Debt

1,900,000

1,300,000

Common Stock

3,200,000

1,000,000

3,200,000

Additional Paid-In Capital

2,100,000

190,000

2,100,000

Retained Earnings

4,380,000

1,240,000

820,000

4,380,000

250,000

2,680,000

16,490,000

3,610,000 3,200,000

580,000 160,000 Total Liabilities & Equity

14,045,000

4,875,000

2,590,000

160,000

16,490,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-28 Consolidated Balance Sheet a. Basic Consolidation Entry Common Stock

100,000

Retained Earnings

120,000

Investment in Sawmill Corp.

220,000

Excess Value (Differential) Reclassification Entry: Buildings & Equipment

40,000

Accumulated Depreciation

8,000

Investment in Sawmill Corp.

32,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

25,000

Building & equipment

25,000

b. Powder Co.

Sawmill Corp.

Consolidation Entries DR

Consolidated

Balance Sheet Cash

30,000

20,000

50,000

Accounts Receivable

100,000

40,000

140,000

Land

60,000

50,000

110,000

Buildings & Equipment

500,000

350,000

40,000

Less: Accumulated Depreciation

(230,000)

(75,000)

25,000

Investment in Sawmill Corporation

252,000

25,000

865,000

8,000

(288,000)

220,000

32,000 Total Assets

712,000

385,000

65,000

285,000

Accounts Payable

80,000

10,000

90,000

Taxes Payable

40,000

70,000

110,000

Notes Payable

100,000

85,000

185,000

Common Stock

200,000

100,000

200,000

Retained Earnings

292,000

120,000

292,000

Total Liabilities & Equity

712,000

385,000

220,000

877,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-29 Comprehensive Problem: Consolidation in Subsequent Period a. Equity-method Entries on Powder Co.'s Books: Investment in Sawmill Corp.

32,000

Income from Sawmill Corp. 32,000 Record Powder Co.'s 100% share of Sawmill Corp.'s 20X4 income Cash

12,000

Investment in Sawmill Corp. 12,000 Record Powder Co.'s 100% share of Sawmill Corp.'s 20X4 dividend Income from Sawmill Corp.

4,000

Investment in Sawmill Corp.

4,000

Record amortization of excess acquisition price b. Book Value Calculations: Total Book Value

Common Stock

Retained Earnings

Beginning book value

220,000

+ Net Income

32,000

- Dividends

(12,000)

Ending book value

240,000

100,000

120,000

140,000

1/1/X4

12/31/X4

Goodwill = 0

Identifiable Excess = 32,000

100% Book value = 220,000

Identifiable Excess = 28,000 $252,000 Net investment in Sawmill Corp.

100% Book value = 240,000

$268,000 Net investment in Sawmill Corp.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-29 (continued) Basic Consolidation Entry Common Stock

100,000

Retained Earnings

120,000

Income from Sawmill Corp.

32,000

Dividends Declared

12,000

Investment in Sawmill Corp.

240,000

Excess Value (Differential) Calculations: Buildings & Total = Equipment Beginning balance

32,000

Changes

(4,000)

Ending balance

28,000

40,000

Acc. Depr. (8,000) (4,000)

40,000

(12,000)

Amortized Excess Value Reclassification Entry: Depreciation Expense

4,000

Income from Sawmill Corp.

4,000

Excess Value (Differential) Reclassification Entry: Buildings & Equipment

40,000

Accumulated Depreciation

12,000

Investment in Sawmill Corp.

28,000

Eliminate Intercompany Accounts: Accounts Payable

2,500

Accounts Receivable

2,500

Investment in

Income from

Sawmill Corp.

Beginning Balance

252,000

100% Net Income

32,000

Ending Balance

12,000

100% Dividends

4,000

Excess Val. Amort. Basic

28,000

Excess Reclass.

100% Net Income

28,000

Ending Balance

4,000

268,000 240,000

32,000

4,000 0

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

25,000

Building & Equipment

25,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-29 (continued) c. Powder Co.

Sawmill Corp.

Consolidation Entries DR

Consolidated

Income Statement Service Revenue

610,000

240,000

850,000

Less: Cost of Services

(470,000)

(130,000)

(600,000)

Less: Depreciation Expense

(35,000)

(18,000)

Less: Other Expenses

(57,000)

(60,000)

Income from Sawmill Corp.

28,000

Net Income

76,000

Beginning Balance

4,000

(57,000) (117,000)

32,000

4,000

32,000

36,000

4,000

76,000

292,000

120,000

Net Income

76,000

32,000

36,000

Less: Dividends Declared

(30,000)

(12,000)

Ending Balance

338,000

140,000

Cash

74,000

42,000

Accounts Receivable

130,000

53,000

Land

60,000

50,000

Buildings & Equipment

500,000

350,000

40,000

Less: Accumulated Depreciation

(265,000)

(93,000)

25,000

Investment in Sawmill Corp.

268,000

Statement of Retained Earnings

156,000

292,000 4,000

76,000

12,000

(30,000)

16,000

338,000

Balance Sheet 116,000 2,500

180,500 110,000

25,000

865,000

12,000

(345,000)

240,000

28,000 Total Assets

767,000

402,000

65,000

307,500

926,500

Accounts Payable

71,000

17,000

2,500

Taxes Payable

58,000

60,000

118,000

Notes Payable

100,000

85,000

185,000

Common Stock

200,000

100,000

Retained Earnings

338,000

140,000

156,000

16,000

338,000

Total Liabilities & Equity

767,000

402,000

258,500

16,000

926,500

85,500

200,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-30 Acquisition at Other than Fair Value of Net Assets a. Ownership acquired for $280,000: Equity-method Entries on Power Corp.'s Books: Investment in Scrub Co.

280,000

Cash

280,000

Record the initial investment in Scrub Co. Book Value Calculations: Total Book Value Book value at acquisition

Common Stock

255,000

80,000

Retained Earnings 175,000

1/1/X9 Goodwill = 12,000

Identifiable Excess = 13,000

$280,000 Initial investment in Scrub Co.

100% Book value = 255,000

Basic Consolidation Entry Common stock

80,000

Retained earnings

175,000

Investment in Scrub Co.

255,000

Excess Value (Differential) Calculations: Total Balances

25,000

Land

20,000

Inventories (7,000)

Goodwill 12,000

Excess Value (Differential) Reclassification Entry: Land

20,000

Goodwill

12,000

Inventories

7,000

Investment in Scrub Co.

25,000 4-51

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-30 (continued) Investment in Scrub Co. Acquisition Price

280,000 255,000

Basic

25,000

Excess Reclass.

b. Ownership acquired for $251,000: Equity-method Entries on Power Corp.'s Books: Investment in Scrub Co. Cash Gain on Bargain Purchase

268,000 251,000 17,000

Record the initial investment in Scrub Co. Book Value Calculations: Total Book Value Book value at acquisition

Common Stock

255,000

80,000

Retained Earnings 175,000

Basic Consolidation Entry Common Stock

80,000

Retained Earnings

175,000

Investment in Scrub Co.

255,000

Excess Value (Differential) Calculations: Total Balances

(13,000)

Land

20,000

Inventories (7,000)

Excess Value (Differential) Reclassification Entry: Land

20,000

Inventories

7,000

Investment in Scrub Co.

13,000

Investment in Scrub Co. Acquisition Price

268,000 255,000

Basic

13,000

Excess Reclass.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-31 Intercorporate Receivables and Payables a. Consolidation entries: Equity-method Entries on Pretzel Corp.'s Books: Investment in Stick Co.

305,000

Cash

305,000

Record the initial investment in Stick Co. Book Value Calculations: Total Book Value Book value at acquisition

285,000

Common Stock

150,000

Additional PIC 140,000

Retained Earnings (5,000)

1/1/X7

Goodwill = 20,000

Identifiable Excess = 0

$305,000 Initial investment in Stick Co.

100% Book value = 285,000

Basic Consolidation Entry Common stock

150,000

Paid-in capital in excess of par

140,000

Retained earnings

5,000

Investment in Stick Co.

285,000

Excess Value (Differential) Calculations: Total Balances

20,000

Goodwill 20,000

Excess Value (Differential) Reclassification Entry: Goodwill

20,000

Investment in Stick Co.

20,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-31 (continued) Eliminate Intercompany Accounts: Bonds Payable

50,000

Investment in Stick Co. Bonds

50,000

Accounts Payable

10,000

Accounts Receivable

10,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

75,000

Building & equipment

75,000

Investment in Stick Co. Acquisition Price

305,000 285,000

Basic

20,000

Excess Reclass.

0 b. Pretzel Corp.

Stick Co.

Cash

70,000

35,000

Accounts Receivable

90,000

65,000

Inventory

84,000

80,000

Buildings & Equipment

400,000

300,000

Less: Accumulated Depreciation

(160,000)

(75,000)

Investment in Stick Company

305,000

Consolidation Entries DR

Consolidated

Balance Sheet 105,000 10,000

145,000 164,000

75,000 75,000

625,000 (160,000)

285,000

20,000 Investment in Stick Company Bonds

50,000

Goodwill

20,000

0 20,000

Total Assets

839,000

405,000

95,000

Accounts Payable

50,000

20,000

10,000

60,000

Bonds Payable

200,000

100,000

50,000

250,000

Common Stock

300,000

150,000

300,000

140,000

Capital in Excess of Par Retained Earnings

289,000

(5,000)

Total Liabilities & Equity

839,000

405,000

350,000

440,000

899,000

5,000

289,000

5,000

899,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-31 (continued)

Pretzel Corporation and Subsidiary Consolidated Balance Sheet January 1, 20X7 Cash Accounts Receivable Inventory Buildings and Equipment Less: Accumulated Depreciation Goodwill Total Assets

$105,000 145,000 164,000 $625,000 (160,000)

Accounts Payable Bonds Payable Common Stock Retained Earnings Total Liabilities and Stockholders' Equity

465,000 20,000 $899,000 $ 60,000 250,000

$300,000 289,000

589,000 $899,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-32 Balance Sheet Consolidation a. Equity-method Entries on Primary Corp.'s Books: Investment in Secondary Co.

650,000

Bonds Payable

650,000

Record the initial investment in Secondary Co. b. Book Value Calculations: Total Book Value Book value at acquisition

478,000

Common Stock

Add’l PaidIn-Capital

200,000

130,000

Retained Earnings 148,000

1/1/X8

Goodwill = 48,000

Identifiable Excess = 124,000

100% Book value = 478,000

$650,000 Initial investment in Secondary Co.

Basic Consolidation Entry Common Stock

200,000

Additional Paid-in capital

130,000

Retained Earnings

148,000

Investment in Secondary Co.

478,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-32 (continued)

Total Balances

Inventory

172,000

4,000

Land

Buildings & Equipment

20,000

50,000

Patent 40,000

Disc. on Bonds Payable

10,000

Goodwill 48,000

Excess Value (Differential) Reclassification Entry: Inventory

4,000

Land

20,000

Buildings & Equipment

50,000

Patent

40,000

Discount on Bonds Payable

10,000

Goodwill

48,000

Investment in Secondary Co.

172,000

Eliminate Intercompany Accounts: Current Payables

6,500

Receivables

6,500

FYI, the FASB now requires that no allowance accounts be carried forward from the acquiree in a business combination. However, because of immateriality and the short-lived nature of the carry forward subsequent to the date of combination, the allowance in this problem has not been offset against the receivable. If such an offset is desired, the following consolidation entry would be made:

Allowance for Bad Debts Receivables

1,000 1,000

However, since receivables are reported net of the allowance, the entry is not shown in the worksheet included here. Accumulated Depreciation Consolidation Entry Accumulated depreciation

220,000

Building & equipment

220,000

Investment in Secondary Co. Acquisition Price

650,000 478,000

Basic

172,000

Excess Reclass.

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-32 (continued) c. Consolidation Entries

Primary Corp.

Secondary Co.

Cash

12,000

9,000

Receivables (net)

39,000

30,000

Inventory

86,000

68,000

4,000

158,000

Land

55,000

50,000

20,000

125,000

Buildings & Equipment Less: Accumulated Depreciation

960,000

670,000

50,000

(411,000)

(220,000)

220,000

Investment in Secondary Co.

650,000

Consolidated

Balance Sheet 21,000 6,500

220,000

62,500

1,460,000 (411,000)

478,000

172,000 Patents

40,000

Goodwill

48,000

Total Assets

1,391,000

607,000

382,000

Current Payables

38,000

29,000

6,500

Bonds Payable

850,000

100,000 10,000

(10,000)

Common Stock

300,000

200,000

300,000

Additional Paid-In Capital

100,000

130,000

100,000

Retained Earnings

103,000

148,000

103,000

1,391,000

607,000

494,500

Discount on Bonds Payable

Total Liabilities & Equity

876,500

1,503,500

60,500 950,000

1,503,500

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-32 (continued)

Primary Corporation and Subsidiary Consolidated Balance Sheet January 2, 20X8 Cash Receivables Less: Allowance for Bad Debts Inventory Land Buildings and Equipment Less: Accumulated Depreciation Patent Goodwill Total Assets

$ $

65,500 (3,000)

$1,460,000 (411,000)

Current Payables Bonds Payable Less: Discount on Bonds Payable Stockholders’ Equity Common Stock Additional Paid-In Capital Retained Earnings Total Liabilities and Stockholders' Equity

62,500 158,000 125,000 1,049,000 40,000 48,000 $1,503,500 $

$ 950,000 (10,000) $ 300,000 100,000 103,000

21,000

60,500 940,000

503,000 $1,503,500

P4-33 Consolidation Worksheet at End of First Year of Ownership a. Equity-method Entries on Price Corp.'s Books: Investment in Saver Co.

128,000

Cash

128,000

Record the initial investment in Saver Co. Investment in Saver Co.

24,000

Income from Saver Co.

24,000

Record Price Corp.'s 100% share of Saver Co.'s 20X8 income Cash

16,000

Investment in Saver Co.

16,000

Record Price Corp.'s 100% share of Saver Co.'s 20X8 dividend

Income from Saver Co.

7,500

Investment in Saver Co.

7,500

Record amortization of excess acquisition price

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

Book Value Calculations: Total Book Value Beginning book value

100,000

Common Stock

60,000

Retained Earnings 40,000

+ Net Income

24,000

- Dividends

(16,000)

Ending book value

108,000

60,000

48,000

1/1/X8

12/31/X8

Goodwill = 8,000

Goodwill = 2,500

Identifiable Excess = 18,000

Identifiable Excess = 20,000

$128,000 Initial investment in Saver Co.

100% Book value = 100,000

$128,500 Net investment in Saver Co.

100% Book value = 108,000

Basic Consolidation Entry Common Stock

60,000

Retained Earnings

40,000

Income from Saver Co.

24,000

Dividends Declared

16,000

Investment in Saver Co.

108,000

Excess Value (Differential) Calculations: Buildings & Total = Equipment Beginning balance

28,000

Changes

(7,500)

Ending balance

20,500

Acc. Depr.

20,000 20,000

Goodwill

8,000

(2,000)

(5,500)

(2,000)

2,500

Amortized Excess Value Reclassification Entry: Depreciation Expense

2,000

Goodwill Impairment Loss

5,500

Income from Saver Co.

7,500

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-33 (continued) Excess Value (Differential) Reclassification Entry: Buildings & Equipment

20,000

Goodwill

2,500

Accumulated Depreciation

2,000

Investment in Saver Co.

20,500

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

30,000

Building & Equipment

30,000

Investment in

Income from

Saver Co.

Acquisition Price

128,000

100% Net Income

24,000

Ending Balance

16,000

100% Dividends

7,500

Excess Val. Amort. Basic

20,500

Excess Reclass.

100% Net Income

16,500

Ending Balance

7,500

128,500 108,000

24,000

24,000 7,500 0

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-33 (continued) b. Consolidation Entries

Price Corp.

Saver Co.

Sales

260,000

180,000

440,000

Less: COGS

(125,000)

(110,000)

(235,000)

Less: Wage Expense

(42,000)

(27,000)

Less: Depreciation Expense

(25,000)

(10,000)

Less: Interest Expense

(12,000)

(4,000)

(16,000)

Less: Other Expenses

(13,500)

(5,000)

(18,500)

Consolidated

Income Statement

Less: Impairment Loss

(69,000) 2,000

(37,000)

5,500

Income from Saver Co.

16,500

Net Income

59,000

Beginning Balance Net Income

(5,500)

24,000

7,500

24,000

31,500

7,500

59,000

102,000

40,000

59,000

24,000

31,500

Less: Dividends Declared

(30,000)

(16,000)

Ending Balance

131,000

48,000

Cash

19,500

21,000

40,500

Accounts Receivable

70,000

12,000

82,000

Inventory

90,000

25,000

115,000

Land

30,000

15,000

45,000

Buildings & Equipment Less: Accumulated Depreciation

350,000

150,000

20,000

30,000

490,000

(145,000)

(40,000)

30,000

2,000

(157,000)

Investment in Saver Co.

128,500

108,000

Statement of Retained Earnings

71,500

102,000 7,500

59,000

16,000

(30,000)

23,500

131,000

Balance Sheet

20,500 Goodwill

2,500

Total Assets

543,000

183,000

Accounts Payable

45,000

16,000

52,500

2,500 160,500

618,000

61,000

Wages Payable

17,000

9,000

26,000

Notes Payable

150,000

50,000

200,000

Common Stock

200,000

60,000

Retained Earnings

131,000

48,000

71,500

23,500

131,000

Total Liabilities & Equity

543,000

183,000

131,500

23,500

618,000

200,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-34 Consolidation Worksheet at End of Second Year of Ownership a. Equity-method Entries on Price Corp.'s Books: Investment in Saver Co.

36,000

Income from Saver Co.

36,000

Record Price Corp.'s 100% share of Saver Co.'s 20X9 income Cash

20,000

Investment in Saver Co.

20,000

Record Price Corp.'s 100% share of Saver Co.'s 20X9 dividend Income from Saver Co.

2,000

Investment in Saver Co.

2,000

Record amortization of excess acquisition price Book Value Calculations: Total Book Value

Common Stock 60,000

Retained Earnings

Beginning book value

108,000

+ Net Income

36,000

- Dividends

(20,000)

Ending book value

124,000

60,000

48,000

64,000

1/1/X9

12/31/X9

Goodwill = 2,500

Identifiable Excess = 18,000

100% Book value = 108,000

Identifiable Excess = 16,000 $128,500 Net investment in Saver Co.

$142,500 Net investment in Saver Co.

100% Book value = 124,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-34 (continued) Basic Consolidation Entry Common Stock

60,000

Retained Earnings

48,000

Income from Saver Co.

36,000

Dividends Declared

20,000

Investment in Saver Co.

124,000

Excess Value (Differential) Calculations: Buildings & Total = Equipment Beginning balance

20,500

Changes

(2,000)

Ending balance

18,500

Acc. Depr.

20,000

Goodwill

(2,000)

2,500

(2,000) 20,000

(4,000)

2,500

Amortized Excess Value Reclassification Entry: Depreciation Expense

2,000

Income from Saver Co.

2,000

Excess Value (Differential) Reclassification Entry: Buildings & Equipment

20,000

Goodwill

2,500

Accumulated Depreciation

4,000

Investment in Saver Co.

18,500

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

30,000

Building & Equipment

30,000

Investment in

Income from

Saver Co.

Beginning Balance

128,500

100% Net Income

36,000

Ending Balance

20,000

100% Dividends

2,000

Excess Val. Amort.

2,000

124,000

Basic

36,000

18,500

Excess Reclass.

142,500

36,000

100% Net Income

34,000

Ending Balance

2,000 0

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-34 (continued) b. Consolidation Entries

Price Corp.

Saver Co.

Sales

290,000

200,000

490,000

Less: COGS

(145,000)

(114,000)

(259,000)

Less: Wage Expense

(35,000)

(20,000)

Less: Depreciation Expense

(25,000)

(10,000)

Less: Interest Expense

(12,000)

(4,000)

(16,000)

Less: Other Expenses

(23,000)

(16,000)

(39,000)

Income from Saver Co.

34,000

Net Income

84,000

Beginning Balance Net Income

Consolidated

Income Statement

(55,000) 2,000

(37,000)

36,000

2,000

36,000

38,000

2,000

84,000

131,000

48,000

84,000

36,000

38,000

Less: Dividends Declared

(30,000)

(20,000)

Ending Balance

185,000

64,000

Cash

45,500

32,000

77,500

Accounts Receivable

85,000

14,000

99,000

Inventory

97,000

24,000

121,000

Land

50,000

25,000

75,000

Buildings & Equipment

350,000

150,000

20,000

30,000

490,000

Less: Accumulated Depreciation

(170,000)

(50,000)

30,000

4,000

(194,000)

Investment in Saver Co.

142,500

124,000

Statement of Retained Earnings

86,000

131,000 2,000

84,000

20,000

(30,000)

22,000

185,000

Balance Sheet

18,500 Goodwill

2,500 52,500

2,500

Total Assets

600,000

195,000

176,500

671,000

Accounts Payable

51,000

15,000

66,000

Wages Payable

14,000

6,000

20,000

Notes Payable

150,000

50,000

200,000

Common Stock

200,000

60,000

Retained Earnings

185,000

64,000

86,000

22,000

185,000

Total Liabilities & Equity

600,000

195,000

146,000

22,000

671,000

200,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-34 (continued)

Price Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X9

Cash Accounts Receivable Inventory Land Buildings and Equipment Less: Accumulated Depreciation Goodwill Total Assets

$ 77,500 99,000 121,000 75,000 $490,000 (194,000)

Accounts Payable Wages Payable Notes Payable Common Stock Retained Earnings Total Liabilities and Stockholders' Equity

296,000 2,500 $671,000 $ 66,000 20,000 200,000

$200,000 185,000

385,000 $671,000

Price Corporation and Subsidiary Consolidated Income Statement Year Ended December 31, 20X9 Sales Cost of Goods Sold Wage Expense Depreciation Expense Interest Expense Other Expenses Total Expenses Consolidated Net Income

$490,000 $259,000 55,000 37,000 16,000 39,000 (406,000) $ 84,000

Price Corporation and Subsidiary Consolidated Retained Earnings Statement Year Ended December 31, 20X9 Retained Earnings, January 1, 20X9 20X9 Net Income Dividends Declared, 20X9 Retained Earnings, December 31, 20X9

$131,000 84,000 $215,000 (30,000) $185,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-35 Comprehensive Problem: Wholly Owned Subsidiary a. Equity-method Entries on Prime Corp.'s Books: Investment in Steak Products

30,000

Income from Steak Products Company

30,000

Record Prime Corp.'s 100% share of Steak Products' 20X5 income Cash

10,000

Investment in Steak Products Company

10,000

Record Prime Corp.'s 100% share of Steak Products' 20X5 dividend Income from Steak Products

5,000

Investment in Steak Products Company

5,000

Record amortization of excess acquisition price b. Basic Consolidation Entry Common Stock

100,000

Retained Earnings

90,000

Income from Steak Products

30,000

Dividends Declared

10,000

Investment in Steak Products

210,000

Excess Value (Differential) Calculations: Buildings & Total = Equipment Beginning balance

30,000

Changes

(5,000)

Ending balance

25,000

50,000

Acc. Depr. (20,000) (5,000)

50,000

(25,000)

Amortized Excess Value Reclassification Entry: Depreciation Expense

5,000

Income from Steak Products

5,000

Excess Value (Differential) Reclassification Entry: Building

50,000

Accumulated Depreciation

25,000

Investment in Steak Products

25,000

Eliminate Intercompany Accounts: Accounts Payable

10,000

Cash and Receivables

10,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-35 (continued) Accumulated Depreciation Consolidation Entry Accumulated Depreciation

10,000

Building & Equipment

10,000

c. Prime Corp.

Steak Products

Consolidation Entries DR

Consolidated

Income Statement Sales

200,000

100,000

300,000

Less: COGS

(120,000)

(50,000)

(170,000)

Less: Depreciation Expense

(25,000)

(15,000)

Less: Inventory Losses

(15,000)

(5,000)

Income from Steak Products

25,000

Net Income

65,000

Beginning Balance

5,000

(45,000) (20,000)

30,000

5,000

30,000

35,000

5,000

65,000

318,000

90,000

Net Income

65,000

30,000

35,000

Less: Dividends Declared

(30,000)

(10,000)

Ending Balance

353,000

110,000

Cash and Receivables

43,000

65,000

Inventory

260,000

90,000

350,000

Land

80,000

160,000

Buildings & Equipment

500,000

150,000

50,000

10,000

690,000

Less: Accumulated Depreciation

(205,000)

(105,000)

10,000

25,000

(325,000)

Investment in Steak Products

235,000

210,000

Statement of Retained Earnings

125,000

318,000 5,000

65,000

10,000

(30,000)

15,000

353,000

10,000

98,000

Balance Sheet

25,000 Goodwill

Total Assets

913,000

280,000

60,000

280,000

973,000

Accounts Payable

60,000

20,000

10,000

Notes Payable

200,000

50,000

Common Stock

300,000

100,000

Retained Earnings

353,000

110,000

125,000

15,000

353,000

Total Liabilities & Equity

913,000

280,000

235,000

15,000

973,000

70,000 250,000 300,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-36 Comprehensive Problem: Differential Apportionment a. Equity-method Entries on Prince Corp.'s Books: Investment in Sword Company

203,000

Cash

203,000

Record the initial investment in Sword Company. Investment in Sword Co.

60,000

Income from Sword Co.

60,000

Record Prince Corp.'s 100% share of Sword Company's 20X7 income Cash

20,000

Investment in Sword Co. 20,000 Record Prince Corp.'s 100% share of Sword Company's 20X7 dividend Income from Sword Co.

3,000

Investment in Sword Co.

3,000

Record amortization of excess acquisition price b. Book Value Calculations: Total Book Value Beginning book value

150,000

Common Stock 50,000

Retained Earnings 100,000

+ Net Income

60,000

- Dividends

(20,000)

Ending book value

190,000

50,000

140,000

1/1/X7

12/31/X7

Goodwill = 20,000

Identifiable Excess = 33,000

100% Book value = 150,000

$203,000 Initial investment in Sword Co.

Identifiable Excess = 30,000

$240,000 Net investment in Sword Co.

100% Book value = 190,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-36 (continued) Basic Consolidation Entry Common Stock

50,000

Retained Earnings

100,000

Income from Sword Co.

60,000

Dividends Declared

20,000

Investment in Sword Co.

190,000

Excess Value (Differential) Calculations: Buildings & Total = Equipment Beginning balance

53,000

Changes

(3,000)

Ending balance

50,000

Acc. Depr.

33,000 33,000

Goodwill

20,000

(3,000)

20,000

Amortized Excess Value Reclassification Entry: Depreciation Expense

3,000

Income from Sword Co.

3,000

Excess Value (Differential) Reclassification Entry: Buildings & Equipment

33,000

Goodwill

20,000

Accumulated Depreciation

3,000

Investment in Sword Co.

50,000

Eliminate Intercompany Accounts: Accounts Payable

16,000

Accounts Receivable

16,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation

60,000

Building & Equipment

60,000

Investment in

Income from

Sword Co.

Acquisition Price

203,000

100% Net Income

60,000

Ending Balance

20,000

100% Dividends

3,000

Excess Val. Amort. Basic

50,000

Excess Reclass.

100% Net Income

57,000

Ending Balance

3,000

240,000 190,000

60,000

60,000 3,000 0

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-36 (continued) c. Consolidation Entries

Prince Corp.

Sword Co.

Sales

700,000

400,000

1,100,000

Less: COGS

(500,000)

(250,000)

(750,000)

Less: Depreciation Expense

(25,000)

(15,000)

Less: Other Expenses

(75,000)

Income from Sword Co.

57,000

Net Income

157,000

Beginning Balance

Consolidated

Income Statement

3,000

(43,000) (150,000)

60,000

3,000

60,000

63,000

3,000

157,000

290,000

100,000

Net Income

157,000

60,000

63,000

Less: Dividends Declared

(50,000)

(20,000)

Ending Balance

397,000

140,000

82,000

25,000

Statement of Retained Earnings

163,000

290,000 3,000

157,000

20,000

(50,000)

23,000

397,000

Balance Sheet Cash

107,000

Accounts Receivable

50,000

55,000

Inventory

170,000

100,000

16,000

270,000

89,000

Land

80,000

20,000

100,000

Buildings & Equipment

500,000

150,000

33,000

Less: Accumulated Depreciation

(155,000)

(75,000)

60,000

Investment in Sword Co.

240,000

60,000

623,000

3,000

(173,000)

190,000 50,000

Goodwill

20,000

Total Assets

967,000

275,000

113,000

319,000

1,036,000

Accounts Payable

70,000

35,000

16,000

Mortgages Payable

200,000

50,000

Common Stock

300,000

50,000

Retained Earnings

397,000

140,000

163,000

23,000

397,000

Total Liabilities & Equity

967,000

275,000

229,000

23,000

1,036,000

89,000 250,000 300,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-37 Push-Down Accounting a.

Entry to record acquisition of Size stock on books of Print: Investment in Size Company Cash

935,000 935,000

Entry to record revaluation of assets on books of Size Company at date of combination: Inventory 5,000 Land 85,000 Buildings 100,000 Equipment 70,000 Revaluation Capital Revalue assets to reflect fair values at date of combination.

Investment consolidation entry in consolidation worksheet prepared December 31, 20X6 (no other entries needed): Common Stock — Size Company Additional Paid-In Capital Retained Earnings Revaluation Capital Investment in Size Company Stock

260,000

100,000 400,000 175,000 260,000 935,000

Equity-method entries on the books of Print during 20X7: Cash Investment in Size Company Record dividend from Size Company.

50,000

Investment in Size Company Income from Size Company Record equity-method income.

88,000

50,000

88,000

Chapter 04 – Consolidation of Wholly Owned Subsidiaries Acquired at More than Book Value

P4-37 (continued) e.

Consolidation entries in consolidation worksheet prepared December 31, 20X7 (no other entries needed): Common Stock — Size Company Additional Paid-In Capital Retained Earnings, January 1 Revaluation Capital Income from Size Company Dividends Declared Investment in Size Company Stock Eliminate ending investment balance. $973,000 = $935,000 + $88,000 - $50,000

100,000 400,000 175,000 260,000 88,000 50,000 973,000

Consolidation entries in consolidation worksheet prepared December 31, 20X8 (no other entries needed): Common Stock — Size Company Additional Paid-In Capital Retained Earnings, January 1 Revaluation Capital Income from Size Company Dividends Declared Investment in Size Company Stock Eliminate ending investment balance. $213,000 = $175,000 + $88,000 - $50,000 $1,013,000 = $973,000 + $90,000 - $50,000

100,000 400,000 213,000 260,000 90,000 50,000 1,013,000

Chapter 05 – Consolidation of Less-Than-Wholly-Owned Subsidiaries Acquired at More Than Book Value

CHAPTER 5 CONSOLIDATION OF LESS-THAN-WHOLLY-OWNED SUBSIDIARIES ACQUIRED AT MORE THAN BOOK VALUE ANSWERS TO QUESTIONS Q5-1 The noncontrolling interest is reported as a separate item in the stockholders’ equity section of the balance sheet. Q5-2 The consolidated balance sheet always includes 100 percent of the subsidiary’s assets and liabilities. When the parent holds less than 100 percent ownership of the subsidiary, the noncontrolling interest’s claim on those net assets must be reported. The balance sheet will not balance without this additional amount. Q5-3 The income statement portion of the consolidation worksheet is expanded to include a line for income assigned to the noncontrolling interest. This amount is deducted from consolidated net income in computing income to the controlling interest. The balance sheet portion of the worksheet also is expanded to include the claim of the noncontrolling shareholders on the net assets of the subsidiary. Q5-4 The balance assigned to the noncontrolling interest is based on the fair value of the noncontrolling interest at the date of acquisition. Q5-5 Consolidated retained earnings includes only amounts attributable to the shareholders of the parent company. Thus, none of the retained earnings is assigned to the noncontrolling interest. Q5-6 One hundred percent of the fair value of the subsidiary’s assets is included. Q5-7 The amount of goodwill at the date of acquisition is determined by deducting the fair value of the net assets of the acquired company from the sum of the fair value of the consideration given by the acquiring company and the fair value of the noncontrolling interest. The resulting goodwill must be apportioned between the controlling and noncontrolling interest. Under normal circumstances, goodwill apportioned to the noncontrolling interest will equal the excess of the fair value of the noncontrolling interest over its proportionate share of the fair value of the net assets of the acquired company. Q5-8 Income assigned to the noncontrolling interest normally is a proportionate share of the net income of the subsidiary. Q5-9 Income assigned to noncontrolling shareholders is reported as a deduction from consolidated net income in arriving at income assigned to the parent company shareholders. Q5-10 Dividends paid to noncontrolling shareholders are eliminated in preparing the consolidated statement of retained earnings as are those paid by the subsidiary to the parent. Only dividends paid by the parent company are reported as dividends in the consolidated financial statements.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

Q5-11 A parent will discontinue consolidating a subsidiary when it can no longer exercise control over it. Control might be lost for a number of reasons, such as: (1) the parent sells some or all of its interest in the subsidiary, (2) the subsidiary issues additional common stock, (3) the parent enters into an agreement to relinquish control, or (4) the subsidiary comes under the control of the government or other regulator. Q5-12 Other comprehensive income elements reported by the subsidiary must be included in other comprehensive income in the consolidated financial statement. If the subsidiary is not wholly owned, comprehensive income assigned to the noncontrolling interest will include a proportionate share of the subsidiary’s other comprehensive income. Q5-13 The parent’s portion of the subsidiary’s other comprehensive income is included in comprehensive income attributable to the controlling interest. Q5-14A The only effect of a negative balance in retained earnings is the need for a credit to subsidiary retained earnings, rather than a debit to retained earnings, when the stockholders’ equity accounts of the subsidiary and the investment account of the parent are eliminated. Q5-15A In the period in which the land is sold, the gain or loss recorded by the subsidiary must be adjusted by the amount of the differential assigned to the land. When the differential is assigned in the worksheet consolidation entries at the end of the period, a debit will be made to the gain or loss on sale of land that came to the worksheet from the subsidiary’s books.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

SOLUTIONS TO CASES C5-1 Consolidation Worksheet Preparation a. Yes. If the parent company is using the equity method, the elimination of the income recognized by the parent from the subsidiary generally should not be equal to a proportionate share of the subsidiary’s dividends. If the parent has recognized only dividend income from the subsidiary, it is using the cost method. b. Not usually. It should be possible to tell if the preparer has included the parent's share of the subsidiary's reported income in computing consolidated net income. However, it is not possible to tell from looking at the worksheet alone whether or not all the adjustments that should have been made for amortization of the differential or to eliminate unrealized profits have been properly treated in computing the consolidated net income. c. Yes. If the parent paid more than its proportionate share of the fair value of the subsidiary’s net assets, the consolidation entries relating to that subsidiary should show amounts assigned to individual asset accounts for fair value adjustments and to goodwill when the investment account balance is eliminated and any noncontrolling interest is established in the worksheet. It should be relatively easy to determine if this has occurred by examining the consolidation worksheet. d. One approach might be to divide the total amount of the parent’s subsidiary investment account eliminated in the worksheet by the sum of the total parent’s investment account eliminated and the total amount of the noncontrolling interest established in the worksheet through consolidation entries. However, this approach assumes that the fair value of the consideration given by the parent when acquiring its subsidiary interest and the fair value of the noncontrolling interest on that date were proportional, which is usually, but not always, the case.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

C5-2 Consolidated Income Presentation MEMO TO:

Treasurer Standard Company

FROM: RE:

, Accounting Staff Allocation of Consolidated Income to Parent and Noncontrolling Shareholders

ASC 810 specifies that consolidated net income reflects the income of the entire consolidated entity and that consolidated net income must be allocated between the controlling and noncontrolling interests. Earnings per share reported in the consolidated income statement is based on the income allocated to the controlling interest only. Consolidated net income increased by $34,000 from 20X4 to 20X5, an increase of 52 percent. However, consolidated net income allocated to the controlling interest increased by $24,100 from 20X4 to 20X5, an increase of only 38 percent. The increase in the controlling interest’s share of consolidated net income did not keep pace with the increase in sales because nearly all of the sales increase was experienced by Jewel, which has a very low profit margin. In addition the parent receives only 55 percent of the increased profits of the subsidiary. Consolidated net income for the two years is computed and allocated as follows: 20X4 $160,000 (a) (94,000)(c) $ 66,000 (2,700)(e) $ 63,300

Consolidated revenues Operating costs Consolidated net income Income to noncontrolling shareholders Income to controlling shareholders (a) (b) (c) (d) (e) (f)

20X5 $400,000 (b) (300,000)(d) $100,000 (12,600) (f) $ 87,400

$100,000 + $60,000 $120,000 + $280,000 ($100,000 x .40) + ($60,000 x .90) ($120,000 x .40) + ($280,000 x .90) ($60,000 x .10 x .45) ($280,000 x .10 x .45)

Primary citations: ASC 810

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

C5-3 Pro Rata Consolidation MEMO To:

Financial Vice-President Rose Corporation

From: Re:

, Senior Accountant Pro Rata Consolidation of Joint Venture

This memo is in response to your request for additional information on the desirability of using pro rata consolidation rather than equity method reporting for Rose Corporation’s investment in its joint venture with Krome Company. The equity method is used by most companies in reporting their investments in corporate joint ventures. [ASC 323] While the accounting literature provides guidance for joint ventures that have issued common stock, it does not provide guidance for ownership of noncorporate entities. ASC 323 suggests that the equity method would be appropriate for unincorporated entities as well. Assuming the joint venture with Krome Company is unincorporated, Rose owns an undivided interest in each asset held by the joint venture and is liable for its share of each of its liabilities and, under certain circumstances, the entire amount. In this case, it can be argued pro rata consolidation provides a more accurate picture of Rose’s assets and liabilities, although not all agree with this assertion. Pro rata consolidation is generally considered not acceptable in this country, although it is a widely used industry practice in a few industries such as oil and gas exploration and production. If the joint venture is incorporated, Rose does not have a direct claim on the assets of the joint venture and Rose’s liability is sheltered by the joint venture’s corporate structure. In this case, continued use of the equity method appears to be appropriate. Primary citations: ASC 323

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

C5-4 Consolidation Procedures a. The consolidation entries are recorded only in the consolidation worksheet and therefore do not change the balances recorded on the company's books. Each time consolidated statements are prepared the balances reported on the company's books serve as the starting point. Thus, all the necessary consolidation entries must be entered in the consolidation worksheet each time consolidated statements are prepared. b. The noncontrolling interest at a point in time is equal to its fair value on the date of combination, adjusted to date for a proportionate share of the undistributed earnings of the subsidiary and the noncontrolling interest’s share of any write-off of differential. Another approach to determining the noncontrolling interest at a point in time is to add the remaining differential at that time to the subsidiary’s common stockholders’ equity and multiply the result by the noncontrolling interest’s proportionate ownership interest in the subsidiary. (However, this is only true if the goodwill is proportionate between the controlling and noncontrolling shareholders.) c. In the consolidation worksheet the ending balance assigned to noncontrolling interest is derived by crediting noncontrolling interest for the starting balance, as indicated in the preceding question, and then adding income assigned to the noncontrolling interest in the consolidated income statement and deducting a pro rata portion of subsidiary dividends declared during the period. This is similar to the equity method of accounting for an investment. d. All the stockholders' equity account balances of the subsidiary must be eliminated each time consolidated financial statements are prepared. Intercompany receivables and payables, if any, must also be eliminated. e. The "investment in subsidiary" and "income from subsidiary" accounts must be eliminated each time consolidated financial statements are prepared. Intercompany receivables and payables, if any, must also be eliminated.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

SOLUTIONS TO EXERCISES * E5-1 Multiple-Choice Questions on Consolidation Process 1. d – Under the equity method, consolidated retained earnings will always equal the retained earning balance of the acquiring company (A company) at the date of acquisition regardless of the percentage owned. The retained earnings balance of the acquired company (B Company) is eliminated in consolidation. This will continue to be true if the parent uses the fully-adjusted equity method to account for its investment. (a) Incorrect. The retained earnings of B Company is eliminated during consolidation. (b) Incorrect. Goodwill does not arise in every consolidation. If goodwill were to arise in this acquisition, it would appear on the consolidated balance sheet. However, there is insufficient data to determine the existence of goodwill. (c) Incorrect. B Company’s retained earnings are never carried forward, rather they are eliminated during consolidation. 2. d – Because the consolidated balance sheet contains the assets of the parent company as well as the assets of the subsidiary, total assets of the parent company will always be less than total assets reported on the consolidated balance sheet. (a) Incorrect. The noncontrolling shareholders’ claim on the subsidiary’s net assets is based on the fair value of the net assets, not the book value. (b) Incorrect. The entire differential is assigned and proportionately allocated to both the parent and the noncontrolling interest’s respective share. (c) Incorrect. Goodwill represents the difference between the fair value of the subsidiary’s net assets and the amount paid by the parent to buy ownership. 3. b – The only amount included in the consolidated retained earnings balance is the retained earnings balance from the parent’s books. (a) Incorrect. Foreign subsidiaries are still required to be consolidated even if they are reported as a separate operating segment. However, if laws of the foreign country prevented the parent from exercising control, the foreign subsidiary would not be consolidated. (c) Incorrect. The noncontrolling shareholders’ claim on the net assets does include their proportionate share of goodwill that results in the acquisition. (d) Incorrect. Consolidation is only required when control is held over the subsidiary, not just significant influence. 4. d – The only accounts receivable from affiliates that will be eliminated from the consolidated balance sheet are receivables from consolidated entities (Winn Corporation). Thus, the receivable from any unconsolidated investees (Carr Corporation) would be reported on the consolidated balance sheet. [AICPA Adapted] (a) Incorrect. Receivables from consolidated entities (Winn Corporation) would be eliminated in consolidated, while any receivables from an unconsolidated investee would still be reported. (b) Incorrect. Receivables from the consolidated entity (Winn Corporation) would be eliminated in their entirety, while receivables from investees under significant influence (Carr Corporation) would be reported in their entirety, not proportionately eliminated.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

(c) Incorrect. The only amounts that should be recorded on the consolidated balance sheet are the receivables from the investee under significant influence (Carr Corporation), while receivable from the consolidated entity (Winn Corporation) would be eliminated in consolidation. E5-2 Multiple-Choice Questions on Consolidation [AICPA Adapted] 1. b – Subsidiary dividends declared have no effect on consolidated retained earnings (because the parent’s retained earnings appear as the consolidated retained earnings, but they do decrease the noncontrolling interest just as they decrease the controlling interest. (a) Incorrect. The noncontrolling interest is decreased by dividends declared by the subsidiary. (c) Incorrect. The retained earnings balance is not decreased by subsidiary dividends declared. (d) Incorrect. Retained earnings is unaffected, while the noncontrolling interest is decreased. 2. c – The noncontrolling interest’s proportionate share of the subsidiary’s income is allocated based on the percentage of ownership in the subsidiary held by the noncontrolling shareholders. (a) Incorrect. The parent’s net income would never be subtracted from the subsidiary’s net income. (b) Incorrect. The entire portion of the subsidiary’s income is not extended to the noncontrolling interest, but rather is proportionately allocated between the controlling and noncontrolling interest based on ownership percentage. (d) Incorrect. The noncontrolling interest’s ownership percentage is not multiplied by the consolidated earnings because it would then be allocating a portion of the parent’s own earnings as well. The noncontrolling interest is not entitled to any of the parent’s income, only their share of the subsidiary’s income. 3. a – $650,000 = $500,000 + $200,000 - $50,000 4. c – $95,000 = ($956,000 + $239,000) - $1,000,000 - $100,000 5. c – $251,000 = .20[($956,000 + $239,000) + ($190,000 - $5,000 - $125,000)]

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-3 Consolidation entries with Differential a. Equity Method Entries on Private Corp.'s Books: Investment in Secret Co.

49,200

Cash

49,200

Record the initial investment in Secret Co. Book Value Calculations: NCI 40% Book value at acquisition

22,800

Private Corp. 60%

34,200

Common Stock

20,000

Retained Earnings 37,000

6/10/X8 Goodwill = 0 Identifiable Excess = 15,000

$49,200 Initial investment in Secret Corp.

60% Book value = 34,200

Basic consolidation entry Common Stock

20,000

Retained Earnings

37,000

Investment in Secret Co.

34,200

NCI in NA of Secret Co.

22,800

Excess Value (Differential) Calculations: NCI Private Corp. 40% + 60% Beginning balances

10,000

15,000

Inventory 5,000

Buildings & Equipment 20,000

Excess Value (Differential) Reclassification Entry: Inventory

5,000

Buildings & Equipment

20,000

Investment in Secret Co.

15,000

NCI in NA of Secret Co.

10,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-3 (continued) Investment in Secret Co. Acquisition Price

49,200 34,200

Basic

15,000

Excess Reclass.

Journal entries used to record transactions, adjust account balances, and close income and revenue accounts at the end of the period are recorded in the company's books and change the reported balances. On the other hand, consolidating entries are entered only in the consolidation worksheet to facilitate the preparation of consolidated financial statements. As a result, they do not change the balances recorded in the company's accounts and must be reentered each time a consolidation worksheet is prepared.

E5-4 Computation of Consolidated Balances a. Inventory

$140,000

b. Land

$ 60,000

$550,000

Buildings and Equipment

d. Fair value of consideration given by Prize Fair value of noncontrolling interest Total fair value Book value of Statue’s net assets Fair value increment for: Inventory Land Buildings and equipment (net) Fair value of identifiable net assets Goodwill

$470,000 117,500 $587,500 $450,000 20,000 (10,000) 70,000 (530,000) $ 57,500

e. Investment in Statue Corporation: None would be reported; the balance in the investment account is eliminated. f.

Noncontrolling Interest = FV of the NCI

$117,500

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-5 Balance Sheet Worksheet Cash and Receivables

900

Retained Earnings

900

Accrued interest earned by Problem Co. Equity Method Entries on Problem Co.'s Books: Investment in Solution Dairy

270,000

Cash

270,000

Record the initial investment in Solution Dairy Book Value Calculations: NCI 10% Book value at acquisition

28,000

Problem Co. 90%

252,000

Common Stock

60,000

Retained Earnings 220,000

Goodwill = 0

Identifiable Excess = 18,000

90% Book value = 252,000

$270,000 Initial investment in Solution Dairy

Basic consolidation entry Common Stock

60,000

Retained Earnings

220,000

Investment in Solution Dairy

252,000

NCI in NA of Solution Dairy

28,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-5 (continued) Excess Value (Differential) Calculations: NCI Problem Co. 10% + 90% Beginning balances

2,000

18,000

Land 20,000

Excess Value (Differential) Reclassification Entry: Land

20,000

Investment in Solution Dairy

18,000

NCI in NA of Solution Dairy

2,000

Eliminate Intercompany Accounts: Current Payables

8,900

Cash and Receivables

8,900

Investment in Solution Dairy Acquisition Price

270,000 252,000

Basic

18,000

Excess Reclass.

0 Problem Co.

Solution Dairy

Cash and Receivables

130,900

70,000

Inventory

210,000

90,000

Land

70,000

40,000

Buildings & Equipment (net)

390,000

220,000

Investment in Solution Dairy

270,000

Consolidation Entries DR

Consolidated

Balance Sheet 8,900

192,000 300,000

20,000

130,000 610,000 252,000

18,000 Total Assets

1,070,900

420,000

20,000

8,900

278,900

1,232,000

Current Payables

80,000

40,000

Long-Term Liabilities

200,000

100,000

111,100

Common Stock

400,000

60,000

400,000

Retained Earnings

390,900

220,000

390,900

300,000

NCI in NA of Solution Dairy

28,000

30,000

2,000 Total Liabilities & Equity

1,070,900

420,000

288,900

30,000

1,232,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-6 Majority-Owned Subsidiary Acquired at Greater than Book Value a. Equity Method Entries on Professor Corp.'s Books: Investment in Scholar Corp.

102,200

Cash

102,200

Record the initial investment in Scholar Corp. Book Value Calculations: NCI 30% Book value at acquisition

37,500

Professor Corp. 70%

87,500

Common Stock

Retained Earnings

40,000

85,000

12/31/X4

Goodwill = 0

Identifiable Excess = 14,700

$102,200 Initial investment in Scholar Corp.

70% Book value = 87,500

Basic Consolidation Entry Common Stock

40,000

Retained Earnings

85,000

Investment in Scholar Corp.

87,500

NCI in NA of Scholar Corp.

37,500

Excess Value (Differential) Calculations: NCI Professor 30% + Corp. 70% Beginning balances

6,300

14,700

Inventory 6,000

Buildings & Equipment 15,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-6 (continued) Excess Value (Differential) Reclassification Entry: Inventory

6,000

Buildings & Equipment

15,000

Investment in Scholar Corp.

14,700

NCI in NA of Scholar Corp.

6,300

Eliminate Intercompany Accounts: Accounts Payable

12,500

Accounts Receivable

12,500

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

80,000

Building & Equipment

80,000

Investment in Scholar Corp. Acquisition Price

102,200 87,500

Basic

14,700

Excess Reclass.

0 b. Consolidation Entries DR CR

Professor Corp.

Scholar Corp.

Balance Sheet Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Scholar Corp.

50,300 90,000 130,000 60,000 410,000 (150,000) 102,200

21,000 44,000 75,000 30,000 250,000 (80,000)

Total Assets

692,500

340,000

101,000

Accounts Payable Mortgage Payable Common Stock Retained Earnings NCI in NA of Scholar Corp.

152,500 250,000 80,000 210,000

35,000 180,000 40,000 85,000

12,500

Total Liabilities & Equity

692,500

340,000

12,500 6,000 15,000 80,000

80,000 87,500 14,700 194,700

40,000 85,000

137,500

37,500 6,300 43,800

Consolidated 71,300 121,500 211,000 90,000 595,000 (150,000) 0 938,800 175,000 430,000 80,000 210,000 43,800 938,800

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-6 (continued) c.

Professor Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X4 Cash Accounts Receivable Inventory Land Buildings and Equipment Less: Accumulated Depreciation Total Assets

$ 71,300 121,500 211,000 90,000 $595,000 (150,000)

Accounts Payable Mortgage Payable Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

445,000 $938,800 $175,000 430,000

$ 80,000 210,000 $290,000 43,800 333,800 $938,800

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-7 Consolidation with Minority Interest Equity Method Entries on Prophet Corp.'s Books: Investment in Seer Corp. Cash Record the initial investment in Seer Corp.

390,000 390,000

Book Value Calculations: NCI 25% Book value at acquisition

90,000

Prophet Corp. 75%

Common Stock

270,000

Retained Earnings

120,000

240,000

12/31/X4

Goodwill = 33,000

Identifiable Excess = 87,000

$390,000 Initial investment in Seer Corp.

75% Book value = 270,000

Basic Consolidation Entry Common stock Retained earnings Investment in Seer Corp. NCI in NA of Seer Corp.

120,000 240,000 270,000 90,000

Excess Value (Differential) Calculations: NCI Prophet Corp. 25% + 75% Beginning balances 40,000 120,000

Buildings 80,000

Inventories 36,000

Goodwill 44,000

Excess Value (Differential) Reclassification Entry: Buildings 80,000 Inventories 36,000 Goodwill 44,000 Investment in Seer Corp. 120,000 NCI in NA of Seer Corp. 40,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-8 Multiple-Choice Questions on Balance Sheet Consolidation 1.

d – $215,000

$130,000 + $70,000 + ($85,000 - $70,000)

c–

$40,000

($150,500 + $64,500) - ($405,000 - $28,000 - $37,000 - $200,000) - $15,000 - $20,000

b–

$1,121,000

Total Assets of Power Corp. Less: Investment in Silk Corp. Book value of assets of Silk Corp. Book value reported by Power and Silk Increase in inventory ($85,000 - $70,000) Increase in land ($45,000 - $25,000) Goodwill Total assets reported

d – $701,500

d – $64,500

6. 7.

$ 791,500 (150,500) $ 641,000 405,000 $1,046,000 15,000 20,000 40,000 $1,121,000

($61,500 + $95,000 + $280,000) + ($28,000 + $37,000 + $200,000)

d – $205,000

The amount reported by Power Corporation

c–

($150,000 + $205,000) + $64,500

$419,500

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-9 Majority-Owned Subsidiary with Differential a. Equity Method Entries on Proxy Corp.'s Books: Investment in Server Corp.

133,500

Cash

133,500

Record the initial investment in Server Corp. Investment in Server Corp.

22,500

Income from Server Corp.

22,500

Record Proxy Corp.'s 75% share of Server Corp.'s 20X3 income Cash

9,000

Investment in Server Corp.

9,000

Record Proxy Corp.'s 75% share of Server Corp.'s 20X3 dividend Income from Server Corp.

3,000

Investment in Server Corp.

3,000

Record Proxy Corp’s 75% share of amortization of excess acquisition price b.Book Value Calculations: NCI 25%

Proxy Corp. 75%

Common Stock

Retained Earnings

Beginning book value

37,500

112,500

+ Net Income

7,500

22,500

30,000

- Dividends

(3,000)

(9,000)

(12,000)

Ending book value

42,000

126,000

60,000

1/1/X3

12/31/X3

Goodwill = 0

Identifiable Excess = 21,000

Identifiable Excess = 18,000

$133,500 Initial investment in Server Corp.

75% Book value = 112,500

75% Book value = 126,000

90,000

108,000

$144,000 Net investment in Server Corp.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-9 (continued) Basic Consolidation Entry Common Stock

60,000

Retained Earnings

90,000

Income from Server Corp.

22,500

NCI in NI of Server Corp.

7,500

Dividends Declared

12,000

Investment in Server Corp.

126,000

NCI in NA of Server Corp.

42,000

Excess Value (Differential) Calculations: NCI Proxy Corp. 25% + 75% Beginning balance

7,000

21,000

Changes

(1,000)

(3,000)

Ending balance

6,000

18,000

Equipment

28,000

Acc. Depr. 0 (4,000)

28,000

(4,000)

Amortized Excess Value Reclassification Entry: Depreciation Expense

4,000

Income from Server Corp.

3,000

NCI in NI of Server Corp.

1,000

Excess Value (Differential) Reclassification Entry: Equipment

28,000

Acc. Depr.

4,000

Investment in Server Corp.

18,000

NCI in NA of Server Corp.

6,000

Investment in

Income from

Server Corp.

Acquisition Price

133,500

75% Net Income

22,500

Ending Balance

9,000

75% Dividends

3,000

Excess Val. Amort. Basic

18,000

Excess Reclass.

75% Net Income

19,500

Ending Balance

3,000

Amort. Reclass

3,000

144,000 126,000

22,500

22,500 0

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-10 Differential Assigned to Amortizable Asset a.

Station Company’s common stock, January 1, 20X1 Station Company’s retained earnings, January 1, 20X1 Book value of Station’s net assets Proportion of stock acquired Book value of Station's shares purchased by Public Corporation Excess of acquisition price over book value Fair value of consideration given Add: Share of Station's net income ($60,000 x .90) Less: Amortization of patents ($40,000 / 5) x .90 Dividends paid by Station ($20,000 x .90) Balance in investment account, December 31, 20X1

$120,000 380,000 $500,000 x .90 $450,000 36,000 $486,000 54,000 (7,200) (18,000) $514,800

b. Equity Method Entries on Public Corp.'s Books: Investment in Station Co.

486,000

Cash

486,000

Record the initial investment in Station Co. Investment in Station Co.

54,000

Income from Station Co.

54,000

Record Public Corp.'s 90% share of Station Co.'s 20X1 income Cash

18,000

Investment in Station Co.

18,000

Record Public Corp.'s 90% share of Station Co.'s 20X1 dividend Income from Station Co.

7,200

Investment in Station Co.

7,200

Record amortization of excess acquisition price Book Value Calculations: NCI 10% Beginning book value

50,000

Public Corp. 90% 450,000

Common Stock 120,000

Retained Earnings 380,000

+ Net Income

6,000

54,000

60,000

- Dividends

(2,000)

(18,000)

(20,000)

Ending book value

54,000

486,000

120,000

420,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-10 (continued) 1/1/X1

12/31/X1

Goodwill = 0

Identifiable Excess = 36,000

Identifiable Excess = 28,800

$486,000 Initial investment in Station Co.

90% Book value = 450,000

90% Book value = 486,000

$514,800 Net investment in Station Co.

Basic Consolidation Entry Common Stock

120,000

Retained Earnings

380,000

Income from Station Co.

54,000

NCI in NI of Station Co.

6,000

Dividends Declared

20,000

Investment in Station Co.

486,000

NCI in NA of Station Co.

54,000

Excess Value (Differential) Calculations: NCI Public Corp. 10% + 90% Beginning balance 4,000 36,000

Patents 40,000

Changes

(800)

(7,200)

(8,000)

Ending balance

3,200

28,800

32,000

Amortized Excess Value Reclassification Entry: Amortization Expense

8,000

Income from Station Co.

7,200

NCI in NI of Station Co.

800

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-10 (continued) Excess Value (Differential) Reclassification Entry: Patents

32,000

Investment in Station Co.

28,800

NCI in NA of Station Co.

3,200

Investment in

Income from

Station Co.

Acquisition Price

486,000

90% Net Income

54,000

Ending Balance

18,000

90% Dividends

7,200

Excess Val. Amort. Basic

28,800

Excess Reclass.

90% Net Income

46,800

Ending Balance

7,200

Amort. Reclass

7,200

514,800 486,000

54,000

54,000 0

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-11 Consolidation after One Year of Ownership a. Equity Method Entries on Punk Corp.'s Books: Investment in Soul Corp.

190,000

Cash

190,000

Record the initial investment in Soul Corp. Book Value Calculations: NCI 20% Book value at acquisition

40,000

Punk Corp. 80%

160,000

Common Stock

120,000

Retained Earnings 80,000

1/1/X2 Goodwill = 4,400

Identifiable Excess = 25,600

$190,000 Initial investment in Soul Corp.

80% Book value = 160,000

Basic Consolidation Entry Common Stock

120,000

Retained Earnings

80,000

Investment in Soul Corp.

160,000

NCI in NA of Soul Corp.

40,000

Excess Value (Differential) Calculations: NCI 20% + Punk Corp. 80% Beginning balances

7,500

30,000

Buildings 32,000

Goodwill 5,500

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-11 (continued) Excess Value (Differential) Reclassification Entry: Buildings

32,000

Goodwill

5,500

Investment in Soul Corp.

30,000

NCI in NA of Soul Corp.

7,500

Investment in Soul Corp. Acquisition Price

190,000 160,000

Basic

30,000

Excess Reclass.

0 b. Equity Method Entries on Punk Corp.'s Books: Investment in Soul Corp.

32,000

Income from Soul Corp.

32,000

Record Punk Corp.'s 80% share of Soul Corp.'s 20X2 income

Income from Soul Corp.

3,200

Investment in Soul Corp.

3,200

Record amortization of excess acquisition price Book Value Calculations: NCI 20%

Punk Corp. 80%

Common Stock

Retained Earnings

Beginning book value

40,000

160,000

+ Net Income

8,000

32,000

40,000

- Dividends

48,000

192,000

Ending book value

120,000

80,000

120,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-11 (continued) 1/1/X2

12/31/X2

Goodwill = 4,400

Identifiable Excess = 25,600

Identifiable Excess = 22,400

$190,000 Initial investment in Soul Corp.

80% Book value = 160,000

$218,800 Net investment in Soul Corp.

80% Book value = 192,000

Basic Consolidation Entry Common Stock

120,000

Retained Earnings

80,000

Income from Soul Corp.

32,000

NCI in NI of Soul Corp.

8,000

Investment in Soul Corp.

192,000

NCI in NA of Soul Corp.

48,000

Excess Value (Differential) Calculations: NCI Punk Corp. 20% + 80% Beginning balance

7,500

30,000

Changes

(800)

(3,200)

Ending balance

6,700

26,800

Buildings 32,000 32,000

Acc. Depr.

Goodwill

5,500

(4,000)

5,500

Amortized Excess Value Reclassification Entry: Depreciation Expense

4,000

Income from Soul Corp.

3,200

NCI in NI of Soul Corp.

800

Excess value (Differential) Reclassification Entry: Buildings

32,000

Goodwill

5,500

Accumulated Depreciation

4,000

Investment in Soul Corp.

26,800

NCI in NA of Soul Corp.

6,700

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-11 (continued) Investment in

Income from

Soul Corp.

Acquisition Price

190,000

80% Net Income

32,000 3,200

Ending Balance

Excess Val. Amort. Basic

26,800

Excess Reclass.

80% Net Income

28,800

Ending Balance

3,200

Amort. Reclass

3,200

218,800 192,000

32,000

E5-12 Consolidation Following Three Years of Ownership a.

Computation of increase in value of patents: Fair value of consideration given by Purchase Fair value of noncontrolling interest Total fair value Book value of Steal stock Excess of fair value over book value Increase in value of land ($30,000 - $22,500) Increase in value of equipment ($360,000 - $320,000) Increase In value of patents

$277,500 185,000 $462,500 (400,000) $ 62,500 (7,500) (40,000) $ 15,000

b. Equity Method Entries on Purchase Corp.'s Books: Investment in Steal Corp.

277,500

Cash

277,500

Record the initial investment in Steal Corp. Book Value Calculations: NCI 40% Book value at acquisition

160,000

Purchase Corp. 60% 240,000

Common Stock 250,000

Retained Earnings 150,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

1/1/X7

Goodwill = 0

Identifiable Excess = 37,500

$277,500 Net investment in Steal Corp.

60% Book value = 240,000

Basic consolidation entry Common stock

250,000

Retained earnings

150,000

Investment in Steal Corp.

240,000

NCI in NA of Steal Corp.

160,000

Excess Value (Differential) Calculations: NCI Purchase 40% + Corp. 60% Beginning balances 25,000 37,500

Land

7,500

Equipment 40,000

Patent 15,000

Excess value (Differential) Reclassification Entry: Land

7,500

Equipment

40,000

Patent

15,000

Investment in Steal Corp.

37,500

NCI in NA of Steal Corp.

25,000

Investment in Steal Corp. Acquisition Price

277,500 240,000

Basic

37,500

Excess Reclass.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-12 (continued) c. Computation of investment account balance at December 31, 20X8: Fair value of consideration given Undistributed income since acquisition ($100,000 - $60,000) x .60 Amortization of differential assigned to: Equipment ($40,000 / 8) x .60 x 2 years Patents ($15,000 / 10) x .60 x 2 years Account balance at December 31, 20X8

$277,500 24,000 (6,000) (1,800) $293,700

d. Equity Method Entries on Purchase Corp.'s Books: Investment in Steal Corp.

18,000

Income from Steal Corp.

18,000

Record Purchase Corp.'s 60% share of Steal Corp.'s 20X9 income Cash

6,000

Investment in Steal Corp.

6,000

Record Purchase Corp.'s 60% share of Steal Corp.'s 20X9 dividend Income from Steal Corp.

3,900

Investment in Steal Corp. Record Purchase Corp’s 60% share of amortization of excess acquisition price

3,900

e. Book Value Calculations: NCI 40%

Purchase Corp. 60%

Common Stock

Retained Earnings

Beginning book value

176,000

264,000

+ Net Income

12,000

18,000

30,000

- Dividends

(4,000)

(6,000)

(10,000)

Ending book value

184,000

276,000

250,000

190,000

210,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-12 (continued) 1/1/X7

12/31/X7

Goodwill = 0

Identifiable Excess = 29,700

Identifiable Excess = 25,800

$293,700 Initial investment in Steal Corp.

60% Book value = 264,000

$301,800 Net investment in Steal Corp.

60% Book value = 276,000

Basic Consolidation Entry Common Stock

250,000

Retained Earnings

190,000

Income from Steal Corp.

18,000

NCI in NI of Steal Corp.

12,000

Dividends Declared

10,000

Investment in Steal Corp.

276,000

NCI in NA of Steal Corp.

184,000

Excess Value (Differential) Calculations: Purchase NCI Corp. 40% + 60% Beginning balance 19,800 29,700

Land

7,500

Changes

(2,600)

(3,900)

Ending balance

17,200

25,800

7,500

Equipment 40,000 40,000

Patent

Acc. Depr.

12,000

(10,000)

(1,500)

(5,000)

10,500

(15,000)

Amortized Excess Value Reclassification Entry: Amortization Expense

1,500

Depreciation expense

5,000

Income from Steal Corp.

3,900

NCI in NI of Steal Corp.

2,600

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

Excess Value (Differential) Reclassification entry: Land

7,500

Equipment

40,000

Patent

10,500

Acc. Depr.

15,000

Investment in Steal Corp.

25,800

NCI in NA of Steal Corp.

17,200

E5-13 Consolidation Worksheet for Majority-Owned Subsidiary a. Equity Method Entries on Proud Corp.'s Books: Investment in Spirited Co.

120,000

Cash

120,000

Record the initial investment in Spirited Co. Investment in Spirited Co.

24,000

Income from Spirited Co.

24,000

Record Proud Corp.'s 80% share of Spirited Co.'s 20X3 income Cash

8,000

Investment in Spirited Co.

8,000

Record Proud Corp.'s 80% share of Spirited Co.'s 20X3 dividend Book Value Calculations: NCI 20% Beginning book value

30,000

Proud Corp. 80% 120,000

Common Stock 100,000

Retained Earnings 50,000

+ Net Income

6,000

24,000

30,000

- Dividends

(2,000)

(8,000)

(10,000)

Ending book value

34,000

136,000

100,000

70,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-13 (continued) 1/1/X3

12/31/X3

Goodwill = 0

Identifiable Excess = 0

$120,000 Initial investment in Spirited Co.

80% Book value = 120,000

$136,000 Net investment in Spirited Co.

80% Book value = 136,000

Basic Consolidation Entry Common Stock

100,000

Retained Earnings

50,000

Income from Spirited Co.

24,000

NCI in NI of Spirited Co.

6,000

Dividends Declared

10,000

Investment in Spirited Co.

136,000

NCI in NA of Spirited Co.

34,000

Investment in

Income from

Spirited Co. Acquisition Price

120,000

80% Net Income

24,000

Ending Balance

136,000

8,000

Spirited Co. 24,000

80% Net Income

24,000

Ending Balance

80% Dividends

136,000

Basic

24,000 0

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

60,000

Depreciable Assets

60,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-13 (continued) b. Consolidation Entries

Proud Corp.

Spirited Co.

200,000

120,000

Less: Depreciation Expense

(25,000)

(15,000)

(40,000)

Less: Other Expenses

(105,000)

(75,000)

(180,000)

Income from Spirited Co.

24,000

Consolidated Net Income

94,000

Consolidated

Income Statement Sales

NCI in Net Income Controlling Interest in Net Income

30,000

320,000

24,000

100,000

6,000

(6,000)

94,000

30,000

230,000

50,000

50,000 30,000

94,000

Statement of Retained Earnings Beginning Balance Net Income

94,000

30,000

Less: Dividends Declared

(40,000)

(10,000)

Ending Balance

284,000

70,000

Current Assets

173,000

105,000

Depreciable Assets

500,000

300,000

Less: Accumulated Depreciation

(175,000)

(75,000)

Investment in Spirited Co.

136,000

Total Assets

634,000

330,000

Current Liabilities

50,000

40,000

Long-Term Debt

100,000

120,000

Common Stock

200,000

100,000

Retained Earnings

284,000

70,000

80,000

230,000 0

94,000

10,000

(40,000)

10,000

284,000

Balance Sheet 278,000 60,000 60,000

60,000

634,000

330,000

(190,000) 136,000

196,000

828,000

90,000 220,000

NCI in NA of Spirited Co. Total Liabilities & Equity

740,000

180,000

200,000 10,000

284,000

34,000

44,000

828,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-13 (continued)

Proud Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X3

Current Assets Depreciable Assets Less: Accumulated Depreciation Total Assets

$278,000 $740,000 (190,000)

Current Liabilities Long-Term Debt Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

550,000 $828,000 $ 90,000 220,000

$200,000 284,000 $484,000 34,000 518,000 $828,000

Proud Corporation and Subsidiary Consolidated Income Statement Year Ended December 31, 20X3 Sales Depreciation Other Expenses Total Expenses Consolidated Net Income Income to Noncontrolling Interest Income to Controlling Interest

$320,000 $ 40,000 180,000 (220,000) $100,000 (6,000) $ 94,000

Proud Corporation and Subsidiary Consolidated Retained Earnings Statement Year Ended December 31, 20X3 Retained Earnings, January 1, 20X3 Income to Controlling Interest, 20X3

$230,000 94,000 $324,000 (40,000) $284,000

Dividends Declared, 20X3 Retained Earnings, December 31, 20X3

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-14 Consolidation Worksheet for Majority-Owned Subsidiary for Second Year a. Equity Method Entries on Proud Corp.'s Books: Investment in Spirited Co.

28,000

Income from Spirited Co.

28,000

Record Proud Corp.'s 80% share of Spirited Co.'s 20X4 income Cash

12,000

Investment in Spirited Co.

12,000

Record Proud Corp.'s 80% share of Spirited Co.'s 20X4 dividend Book Value Calculations: NCI 20%

Proud Corp. 80%

Common Stock

Retained Earnings

Beginning book value

34,000

136,000

+ Net Income

7,000

28,000

35,000

- Dividends

(3,000)

(12,000)

(15,000)

Ending book value

38,000

152,000

100,000

1/1/X4

12/31/X4

Goodwill = 0

Identifiable Excess = 0

$136,000 Net investment in Spirited Co.

80% Book value = 136,000

80% Book value = 152,000

70,000

90,000

$152,000 Net investment in Spirited Co.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-14 (continued) Basic Consolidation Entry Common Stock

100,000

Retained Earnings

70,000

Income from Spirited Co.

28,000

NCI in NI of Spirited Co.

7,000

Dividends Declared

15,000

Investment in Spirited Co.

152,000

NCI in NA of Spirited Co.

38,000

Investment in

Income from

Spirited Co.

Beginning Balance

136,000

80% Net Income

28,000

Ending Balance

12,000

80% Dividends

152,000

Basic

152,000 0

28,000

80% Net Income

28,000

Ending Balance

28,000 0

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

60,000

Depreciable Assets

60,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-14 (continued) b. Consolidation Entries

Proud Corp.

Spirited Co.

230,000

140,000

Less: Depreciation Expense

(25,000)

(15,000)

(40,000)

Less: Other Expenses

(150,000)

(90,000)

(240,000)

Income from Spirited Co.

28,000

Consolidated Net Income

83,000

Consolidated

Income Statement Sales

35,000

NCI in Net Income Controlling Interest in Net Income

370,000

28,000

90,000

7,000

(7,000)

83,000

35,000

Beginning Balance

284,000

70,000

Net Income

83,000

35,000

Less: Dividends Declared

(50,000)

(15,000)

Ending Balance

317,000

90,000

Current Assets

235,000

150,000

Depreciable Assets

500,000

300,000

Less: Accumulated Depreciation

(200,000)

(90,000)

Investment in Spirited Co.

152,000

Total Assets

687,000

83,000

Statement of Retained Earnings

105,000

284,000 0

83,000

15,000

(50,000)

15,000

317,000

Balance Sheet

360,000

385,000 60,000 60,000

60,000

740,000 (230,000)

152,000

212,000

895,000

Current Liabilities

70,000

50,000

120,000

Long-Term Debt

100,000

120,000

220,000

Common Stock

200,000

100,000

Retained Earnings

317,000

90,000

105,000

NCI in NA of Spirited Co. Total Liabilities & Equity

687,000

360,000

205,000

200,000 15,000

317,000

38,000

53,000

895,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-15 Preparation of Stockholders' Equity Section with Other Comprehensive Income a.

Consolidated net income: Operating income of Purple Net income of Socks Amortization of differential ($580,000 - $500,000) / 10 Years Consolidated net income Comprehensive gain reported by Socks Consolidated comprehensive income

(8,000) (8,000) $152,000 $ 192,000 10,000 5,000 $162,000 $ 197,000

Comprehensive income attributable to controlling interest: Consolidated comprehensive income Comprehensive income attributable to Noncontrolling interest ($50,000 - $8,000) x .25 ($65,000 - $8,000) x .25 Comprehensive income attributable to controlling interest

20X8 20X9 $120,000 $ 140,000 40,000 60,000

20X8 20X9 $162,000 $ 197,000 (10,500) (14,250) $151,500 $ 182,750

Consolidated stockholders' equity: 20X8 Controlling Interest: Common Stock Retained Earnings* Accumulated Other Comprehensive Income# Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity

20X9

$320,000 $ 320,000 504,000 613,000 7,500 11,250 831,500 944,250 151,750 158,500 $983,250 $1,102,750

* Beginning RE 430,000 + 120,000 Purple income – 70,000 Purple Dividends +40,000x.75 Socks income times ownership percentage – 8,000x.75 amortization of differential times ownership percentage = 504,000 20X8 RE Beginning RE 504,000 + 140,000 Purple income – 70,000 Purple Dividends +60,000x.75 Socks income times ownership percentage – 8,000x.75 amortization of differential times ownership percentage = 613,000 20X9 RE # OCI for 20X8 50,000-40,000=10,000 x .75 = 7,500 20X8 AOCI OCI for 20X9 65,000-60,000=5,000 x .75= 3,750 +7,500 = 11,250 20X9 AOCI

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-16 Consolidation entries for Subsidiary with Other Comprehensive Income a. Equity Method Entries on Purse Corp.'s Books: Investment in Scarf Corp.

140,000

Cash

140,000

Record the initial investment in Scarf Corp. Investment in Scarf Corp.

21,000

Income from Scarf Corp.

21,000

Record Purse Corp.'s 70% share of Scarf Corp.'s 20X8 income Cash

17,500

Investment in Scarf Corp.

17,500

Record Purse Corp.'s 70% share of Scarf Corp.'s 20X8 dividend Investment in Scarf Corp.

4,200

Other Comprehensive Income from Scarf Corp.

4,200

Record Purse Corp.'s proportionate share of OCI from Scarf Corp. b. Book Value Calculations: NCI 30% Beginning book value

60,000

Purse Corp. 70% 140,000

Common Stock 120,000

Retained Earnings 80,000

+ Net Income

9,000

21,000

30,000

- Dividends

(7,500)

(17,500)

(25,000)

Ending book value

61,500

143,500

120,000

1/1/X8

12/31/X8

Goodwill = 0

Identifiable Excess = 0

$140,000 Initial investment in Scarf Corp.

70% Book value = 140,000

70% Book value = 147,700

85,000

$147,700 Net investment in Scarf Corp.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-16 (continued) Basic Consolidation Entry Common Stock

120,000

Retained Earnings

80,000

Income from Scarf Corp.

21,000

NCI in NI of Scarf Corp.

9,000

Dividends Declared

25,000

Investment in Scarf Corp.

143,500

NCI in NA of Scarf Corp.

61,500

Other Comprehensive Income Entry: OCI from Scarf Corp.

4,200

OCI to the NCI

1,800

Investment in Scarf Corp.

4,200

NCI in NA of Scarf Corp.

1,800

Investment in

Income from

Scarf Corp.

Acquisition Price

140,000

70% Net Income

21,000

21,000 17,500

4,200 Ending Balance

70% Dividends 70% OCI

147,700

21,000 143,500

Basic

4,200

OCI Entry

21,000 0

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-17A Consolidation of Subsidiary with Negative Retained Earnings Equity Method Entries on Putt Corp.'s Books: Investment in Slice Co.

138,000

Cash

138,000

Record the initial investment in Slice Co. Book Value Calculations: NCI 20% Book value at acquisition

29,000

Putt Corp. 80%

116,000

Common Stock

100,000

Add. Paidin Capital 75,000

Retained Earnings (30,000)

1/1/X4 Goodwill = 22,000

Identifiable Excess = 0

$138,000 Initial investment in Slice Co.

80% Book value = 116,000

Basic Consolidation Entry Common Stock

100,000

Additional Paid-in Capital

75,000

Retained Earnings

30,000

Investment in Slice Co.

116,000

NCI in NA of Slice Co.

29,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

E5-17A (continued) Excess Value (Differential) Calculations: NCI 20% + Putt Corp. 80% Beginning balances

5,500

Goodwill

22,000

27,500

Excess Value (Differential) Reclassification Entry: Goodwill

27,500

Investment in Slice Co.

22,000

NCI in NA of Slice Co.

5,500

Investment in Slice Co. Acquisition Price

138,000 116,000

Basic

22,000

Excess Reclass.

E5-18A Complex Assignment of Differential a. Equity Method Entries on Puzzle Corp.'s Books: Investment in Sunday Inc.

864,000

Cash

864,000

Record the initial investment in Sunday Inc. Investment in Sunday Inc.

135,000

Income from Sunday Inc.

135,000

Record Puzzle Corp.'s 90% share of Sunday Inc.'s 20X5 income Income from Sunday Inc.

82,350

Investment in Sunday Inc.

82,350

Record amortization of excess acquisition price b. Book Value Calculations: NCI 10%

Puzzle Corp. 90%

Common Stock

Premium on Com. Stock

Retained Earnings

Beginning book value

72,000

648,000

+ Net Income

15,000

135,000

150,000

- Dividends

87,000

783,000

Ending book value

500,000

100,000

120,000

270,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

12/1/X5

12/31/X5

Goodwill = 45,000

Identifiable Excess = 171,000

Identifiable Excess = 88,650

$864,000 Initial investment in Sunday Inc.

90% Book value = 648,000

$916,650 Net investment in Sunday Inc.

90% Book value = 783,000

Basic Consolidation Entry Common Stock

500,000

Premium on Common Stock

100,000

Retained Earnings

120,000

Income from Sunday Inc.

135,000

NCI in NI of Sunday Inc.

15,000

Investment in Sunday Inc.

783,000

NCI in NA of Sunday Inc.

87,000

Excess Value (Differential) Calculations:

NCI 10% Beg. balance Changes End. balance

Puzzle Corp. 90%

Inventory

Land

24,000

216,000

5,000

75,000

(9,150)

(82,350)

(5,000)

(75,000)

14,850

133,650

Equipment

60,000

Disc. on notes payable

Acc. Depr.

Goodwill

50,000

(7,500)

(4,000)

42,500

(4,000)

50,000

Amortized Excess Value Reclassification Entry: Cost of goods sold

5,000

Gain on Sale of Land

75,000

Interest Expense

7,500

Depreciation Expense

4,000

Income from Sunday Inc.

82,350

NCI in NI of Sunday Inc.

9,150

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

Excess Value (Differential) Reclassification entry: Equipment

60,000

Discount on Notes Payable

42,500

Goodwill

50,000

Accumulated Depreciation

4,000

Investment in Sunday Inc.

133,650

NCI in NA of Sunday Inc.

14,850

SOLUTIONS TO PROBLEMS P5-19 Reported Balances a.

The investment balance reported by Paint will be $192,000.

The amount of goodwill for the entity as a whole will be $25,000 [($192,000 + $48,000) - ($310,000 - $95,000)].

Noncontrolling interest will be reported at $48,000 ($240,000 x 0.20).

P5-20 Acquisition Price a.

$57,000 = ($120,000 - $25,000) x 0.60

$81,000 = ($120,000 - $25,000) + $40,000 - $54,000

$48,800 = ($120,000 - $25,000) + $27,000 - $73,200

P5-21 Multiple-Choice Questions on Applying the Equity Method [AICPA Adapted] 1. a – $20,000 = 100,000 x 20%. Because significant influence is not obtained, the cost method is used, which results in dividend income for the period in which the investment was held. 2. a – Net increase to investment during 20X3: $18,000 (0.25 x $120,000 - 0.25 x $48,000) $190,000 - $18,000 = $172,000 initial investment. 3. c – $230,000 = ($600,000 x 0.4) – (($1,800,000 – $1,740,000) / 6) 4. d – $808,000 = $800,000 – (0.2 x $40,000) + (0.2 x $180,000) – (($800,000 - $600,000) / 10)

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-22 Amortization of Differential Journal entries recorded by Pawn Corporation: Equity Method Entries on Pawn Corp.'s Books: Investment in Shop Corp.

120,000

Preferred Stock

50,000

Additional Paid-in Capital

70,000

Record the initial investment in Shop Corp. Investment in Shop Corp.

12,000

Income from Shop Corp.

12,000

Record Pawn Corp.'s 30% share of Shop Corp.'s 20X5 income Cash

3,000

Investment in Shop Corp.

3,000

Record Pawn Corp.'s 30% share of Shop Corp.'s 20X5 dividend Income from Shop Corp.

4,575

Investment in Shop Corp.

4,575

Record amortization of excess acquisition price

Amortization of differential assigned to buildings and equipment: Fair value of buildings and equipment $360,000 Book value of buildings and equipment 300,000 Differential $60,000 Portion of stock held by Pawn x 0.30 Differential assigned to buildings and equipment $18,000 Remaining life ÷ 15 Yearly amortization $1,200 Amortization of differential assigned to copyrights: Purchase price Fair value of Shop's: Total assets $560,000 Total liabilities (250,000) $310,000 Proportion of stock held by Pawn x .30 Amount assigned to copyrights Remaining life ÷ Yearly amortization

$120,000

(93,000) $27,000 8 $3,375

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-23 Computation of Account Balances a.

Pencil Company 20X1 equity-method income: Proportionate share of reported income ($30,000 x .40) Amortization of differential assigned to: Buildings and equipment [($35,000 x .40) / 5 years] Goodwill ($8,000: not impaired) Investment Income Assignment of differential Purchase price Proportionate share of book value of net assets ($320,000 x .40) Proportionate share of fair value increase in buildings and equipment ($35,000 x .40) Goodwill

$ 12,000 (2,800) -0$ 9,200 $150,000 (128,000) $

(14,000) 8,000

Dividend income, 20X1 ($9,000 x .40)

3,600

Cost-method account balance (unchanged):

$150,000

Equity-method account balance: Balance, January 1, 20X1 Investment income Dividends received Balance, December 31, 20X1

$150,000 9,200 (3,600) $155,600

P5-24 Complex Differential a. Peace Company 20X2 equity-method income: Proportionate share of reported net income ($80,000 x .30) Deduct increase in cost of goods sold for purchase differential assigned to inventory ($30,000 x .30) Deduct amortization of differential assigned to: Buildings and equipment [($320,000 - $260,000) x .30] / 12 years] Patent [($25,000 x .30) / 10 years] Equity-method income for 20X2

$24,000 (9,000) (1,500) (750) $12,750

b. Computation of investment account balance on December 31, 20X2: Purchase Price Investment income for 20X2 Dividends received in 20X2 ($9,000 x .30) Investment account balance on December 31, 20X2

$165,000 $12,750 (2,700)

10,050 $175,050

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-25 Equity Entries with Differential a. Journal entry recorded by Pepper Corporation: Investment in Salt Manufacturing Common Stock Additional Paid-In Capital Record acquisition of Salt Manufacturing stock. b.

210,000 60,000 150,000

Equity-method journal entries recorded by Pepper Corporation in 20X0: (1) Investment in Salt Manufacturing Stock Common Stock Additional Paid-In Capital Record acquisition of Salt Manufacturing stock.

210,000 60,000 150,000

(2) Cash 9,000 Investment in Salt Manufacturing Stock Record dividends from Salt Manufacturing: $20,000 x 0.45

9,000

(3) Investment in Salt Manufacturing Stock Income from Salt Manufacturing Record equity-method income: $80,000 x 0.45

36,000

(4) Income from Salt Manufacturing 1,350 Investment in Salt Manufacturing Stock Amortize differential assigned to buildings and equipment: ($30,000 x .45) / 10 years

1,350

Equity-method journal entries recorded by Pepper Corporation in 20X1: (1) Cash 18,000 Investment in Salt Manufacturing Stock Record dividends from Salt Manufacturing: $40,000 x 0.45

18,000

(2) Investment in Salt Manufacturing Stock 22,500 Income from Salt Manufacturing Record equity-method income for period: $50,000 x 0.45

22,500

(3) Income from Salt Manufacturing 1,350 Investment in Salt Manufacturing Stock Amortize differential assigned to buildings and equipment.

1,350

c. Investment account balance, December 31, 20X1: Purchase price on January 1, 20X0 20X0: Income from Salt Manufacturing ($36,000 - $1,350) Dividends received 20X1: Income from Salt Manufacturing ($22,500 - $1,350) Dividends received Investment account balance, December 31, 20X1

$210,000 $34,650 (9,000) $21,150 (18,000)

25,650 3,150 $238,800

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-26 Equity Entries with Differential a. Equity-method journal entries recorded by Plug Corporation: (1) Investment in Spark Corporation Stock Common Stock Additional Paid-In Capital Record acquisition of Spark Corporation stock.

200,000 50,000 150,000

(2) Cash 3,500 Investment in Spark Corporation Stock Record dividend from Spark Corporation: $10,000 x 0.35

3,500

(3) Investment in Spark Corporation Stock Income from Spark Corporation Record equity-method income: $70,000 x 0.35

24,500

(4) Income from Spark Corporation 7,000 Investment in Spark Corporation Stock 7,000 Record expiration of differential assigned to inventory: $20,000 x 0.35 (5) Income from Spark Corporation 1,400 Investment in Spark Corporation Stock 1,400 Record amortization of differential assigned to buildings and equipment (net): ($80,000 x 0.35) / 20 years b. $212,600 = $200,000 + $24,500 - $3,500 - $7,000 - $1,400 P5-27 Additional Ownership Level a.

Operating income of Amber for 20X3 Operating income of Blair for 20X3 Add: Equity income from Carmen [($50,000 - $6,000) x .25) Blair net income for 20X3 Proportion of stock held by Amber Amortization of differential: Equipment [($30,000 x .40) / 8 years] Patents [($25,000 x .40) / 5 years) Net income of Amber for 20X3

$220,000 $100,000 11,000 $111,000 x 0.40

44,400 (1,500) (2,000) $260,900

Investment in Blair Corporation Stock Common Stock Additional paid-In Capital Purchase of Blair Corporation Stock.

130,000

Cash Investment in Blair Corporation Stock Record dividend from Blair: $30,000 x 0.40

12,000

40,000 90,000

12,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

Investment in Blair Corporation Stock Income from Blair Corporation Record equity-method income: $111,000 x 0.40

44,400

Income from Blair Corporation Investment in Blair Corporation Stock Amortize differential: $3,500 = $1,500 + $2,000

3,500

44,400

3,500

P5-28 Correction of Error Required correcting entry: Retained Earnings Income from Sauce Company Investment in Sauce Company Stock

17,000 11,500 28,500

Adjustments to current books of Pesto Company:

Item Adjustment to remove dividends included in investment income and not removed from investment account Adjustment to annual amortization of differential: 20X2 and 20X3 20X4 Required adjustment to account balance

Retained Earnings 1/1/20X4

Sauce Company Investment 20X4 Balance Income 12/31/20X4

$(14,000)

$(10,000)

$(24,000)

(1,500) $(11,500)

(3,000) (1,500) $(28,500)

(3,000) $(17,000)

Computation of adjustment to annual amortization of differential Correct amortization of differential assigned to: Equipment [($120,000 - $70,000) x 0.40] / 5 years Patents: Amount paid Fair value of identifiable net assets ($300,000 + $50,000) x 0.40 Amount assigned Number of years to be amortized Annual amortization Correct amount to be amortized annually Amount amortized by Pesto [($164,000 - ($300,000 x 0.40)] / 8 years Adjustment to annual amortization

$4,000 $164,000 (140,000) $ 24,000 ÷ 8 3,000 $7,000 (5,500) $1,500

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-29 Majority-Owned Subsidiary Acquired at Greater than Book Value a. Equity Method Entries on Phone Corp.'s Books: Investment in Smart Corp.

102,200

Cash

102,200

Record the initial investment in Smart Corp. Book Value Calculations: NCI 30% Book value at acquisition

37,500

Phone Corp. 70%

87,500

Common Stock

40,000

Retained Earnings 85,000

1/1/X4 Goodwill = 0

Identifiable Excess = 14,700

$102,200 Initial investment in Smart Corp.

70% Book value = 87,500

Basic consolidation entry Common stock

40,000

Retained earnings

85,000

Investment in Smart Corp.

87,500

NCI in NA of Smart Corp.

37,500

Excess Value (Differential) Calculations: NCI Phone Corp. 30% + 70% Beginning balances

6,300

14,700

Inventory 6,000

Buildings & Equipment 15,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-29 (continued) Excess Value (Differential) Reclassification Entry: Inventory

6,000

Buildings & Equipment

15,000

Investment in Smart Corp.

14,700

NCI in NA of Smart Corp.

6,300

Eliminate Intercompany Accounts: Accounts Payable

12,500

Accounts Receivable

12,500

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

80,000

Building & Equipment

80,000 Investment in Smart Corp.

Acquisition Price

102,200 87,500

Basic

14,700

Excess Reclass.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-29 (continued) Consolidation Entries

Phone Corp.

Smart Corp.

50,300

21,000

Accounts Receivable

90,000

44,000

Inventory

130,000

75,000

Land

60,000

30,000

Buildings & Equipment

410,000

250,000

15,000

Less: Accumulated Depreciation

(150,000)

(80,000)

80,000

Investment in Smart Corp.

102,200

Consolidated

Balance Sheet Cash

71,300 12,500 6,000

121,500 211,000 90,000

80,000

595,000 (150,000)

87,500

14,700 Total Assets

692,500

340,000

101,000

Accounts Payable

152,500

35,000

12,500

Mortgage Payable

250,000

180,000

Common Stock

80,000

40,000

Retained Earnings

210,000

85,000

194,700

938,800

175,000 430,000

NCI in NA of Smart Corp.

80,000 210,000 37,500

43,800

6,300 Total Liabilities & Equity

692,500

340,000

137,500

43,800

938,800

Phone Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X4 Cash Accounts Receivable Inventory Land Buildings and Equipment Less: Accumulated Depreciation Total Assets

$ 71,300 121,500 211,000 90,000 $595,000 (150,000)

445,000 $938,800 $175,000 430,000

$ 80,000 210,000 $290,000 43,800 333,800 $938,800

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-30 Balance Sheet Consolidation of Majority-Owned Subsidiary a. Equity Method Entries on Photo Corp.'s Books: Investment in Shutter Co.

510,000

Bonds Payable

500,000

Bond Premium

10,000

Record the initial investment in Shutter Co. b. Book Value Calculations: NCI 25% Book value at acquisition

119,500

Photo Corp. 75%

358,500

Common Stock

200,000

Add. Paidin Capital 130,000

Retained Earnings 148,000

1/1/X8 Goodwill = 66,000

Identifiable Excess = 85,500

$510,000 Initial investment in Shutter Co.

75% Book value = 358,500

Basic Consolidation Entry Common Stock

200,000

Additional Paid-in Capital

130,000

Retained Earnings

148,000

Investment in Shutter Co.

358,500

NCI in NA of Shutter Co.

119,500

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-30 (continued) Excess Value (Differential) Calculations: Photo NCI Corp. 25% + 75% = Inventory Beg. balances 50,500 151,500 4,000

Land

Building & Equipment

20,000

50,000

Patent 40,000

Goodwill 88,000

Excess Value (Differential) Reclassification Entry: Inventory

4,000

Land

20,000

Building & Equipment

50,000

Patent

40,000

Goodwill

88,000

Investment in Shutter Co.

151,500

NCI in NA of Shutter Co.

50,500

Eliminate Intercompany Accounts: Current Payables

6,500

Receivables

6,500

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

220,000

Building & Equipment

220,000

Investment in Shutter Co. Acquisition Price

510,000 358,500

Basic

151,500

Excess Reclass.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-30 (continued) c.

Balance Sheet Cash Receivables Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Shutter Co. Patent Goodwill Total Assets

Photo Corp.

Shutter Co.

12,000 39,000 86,000 55,000 960,000 (411,000) 510,000

9,000 30,000 68,000 50,000 670,000 (220,000)

Consolidation Entries DR CR

6,500 4,000 20,000 50,000 220,000

220,000 358,500 151,500

40,000 88,000 422,000

1,251,000

607,000

Current Payables Bonds Payable Bond Premium Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Shutter Co.

38,000 700,000 10,000 300,000 100,000 103,000

29,000 100,000

6,500

200,000 130,000 148,000

Total Liabilities & Equity

1,251,000

607,000

484,500

736,500

119,500 50,500 170,000

Consolidated 21,000 62,500 158,000 125,000 1,460,000 (411,000) 0 40,000 88,000 1,543,500 60,500 800,000 10,000 300,000 100,000 103,000 170,000 1,543,500

Photo Corporation and Subsidiary Consolidated Balance Sheet January 2, 20X8 Cash Receivables Less: Allowance for Bad Debts Inventory Land Buildings and Equipment Less: Accumulated Depreciation Patent Goodwill Total Assets

$ $

65,500 (3,000)

$1,460,000 (411,000)

Current Payables Bonds Payable Premium on Bonds Payable Stockholders’ Equity: Controlling Interest: Common Stock Additional Paid-In Capital Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

62,500 158,000 125,000 1,049,000 40,000 88,000 $1,543,500 $

$ 800,000 10,000

21,000

60,500 810,000

$ 300,000 100,000 103,000 $ 503,000 170,000 673,000 $1,543,500 5-54

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-31 Incomplete Data a.

$15,000

= ($115,000 + $46,000) - $146,000

$65,000

= ($148,000 - $98,000) + $15,000

Sentence: $24,000

= $380,000 - ($46,000 + $110,000 + $75,000 + $125,000) = $94,000 - $24,000

Paragraph: $70,000 d.

Fair value of Sentence as a whole: $200,000 10,000

Book value of Sentence shares Differential assigned to inventory ($195,000 - $105,000 - $80,000) Differential assigned to buildings and equipment ($425,000 - $200,000 - $185,000) Differential assigned to goodwill Fair value of Sentence

40,000 9,000 $259,000 e.

65 percent

1.00 – ($90,650 / $259,000)

Capital Stock Retained Earnings

= =

$120,000 $115,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-32 Income and Retained Earnings a.

Net income for 20X9: Operating income Income from subsidiary Net income

Paste $ 90,000 24,500 $114,500

Stick $35,000

Paste $290,000 114,500 (30,000) $374,500

Stick $40,000 35,000 (10,000) $65,000

$35,000

b. Consolidated net income is $125,000 ($90,000 + $35,000). c. Retained earnings reported at December 31, 20X9: Retained earnings, January 1, 20X9 Net income for 20X9 Dividends paid in 20X9 Retained earnings, December 31, 20X9

d. Consolidated retained earnings at December 31, 20X9, is equal to the $374,500 retained earnings balance reported by Paste. e. When the cost method is used, the parent's proportionate share of the increase in retained earnings of the subsidiary subsequent to acquisition is not included in the parent's retained earnings. Thus, this amount must be added to the total retained earnings reported by the parent in arriving at consolidated retained earnings.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-33 Consolidation Worksheet at End of First Year of Ownership a. Equity Method Entries on Pie Corp.'s Books: Investment in Slice Co.

96,000

Cash

96,000

Record the initial investment in Slice Co. Investment in Slice Co.

18,000

Income from Slice Co.

18,000

Record Pie Corp.'s 75% share of Slice Co.'s 20X8 income Cash

12,000

Investment in Slice Co.

12,000

Record Pie Corp.'s 75% share of Slice Co.'s 20X8 dividend Income from Slice Co.

5,625

Investment in Slice Co.

5,625

Record amortization of excess acquisition price Book Value Calculations: NCI 25% Beginning book value

25,000

Pie Corp. 75% 75,000

Common Stock 60,000

Retained Earnings 40,000

+ Net Income

6,000

18,000

24,000

- Dividends

(4,000)

(12,000)

(16,000)

Ending book value

27,000

81,000

60,000

1/1/X8

12/31/X8

Goodwill = 6,000

Goodwill = 1,875

Identifiable Excess = 15,000

Identifiable Excess = 13,500

75% Book value = 75,000

$96,000 Initial investment in Slice Co.

75% Book value = 81,000

48,000

$96,375 Net investment in Slice Co.

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-33 (continued) Basic Consolidation Entry Common Stock Retained Earnings Income from Slice Co. NCI in NI of Slice Co. Dividends Declared Investment in Slice Co. NCI in NA of Slice Co.

60,000 40,000 18,000 6,000 16,000 81,000 27,000

Excess Value (Differential) Calculations: NCI 25% + Pie Corp. 75% Beginning balance 7,000 21,000 Changes (1,875) (5,625) Ending balance 5,125 15,375

Accumulated Depreciation Consolidation Entry Accumulated Depreciation Building & Equipment

Acc. Depr. 0 (2,000) (2,000)

20,000 2,500 2,000 15,375 5,125

30,000 30,000 Income from Slice Co.

75% Net Income

18,000 12,000

75% Dividends

5,625

Excess Val. Amort.

81,000

Basic

15,375

Excess Reclass.

18,000

75% Net Income

12,375

Ending Balance

5,625

Amort. Reclass

5,625

96,375

Goodwill 8,000 (5,500) 2,500

5,625 1,875

Slice Co. 96,000

2,000 5,500

Investment in Acquisition Price

Ending Balance

20,000

Amortized Excess Value Reclassification Entry: Depreciation Expense Goodwill Impairment Loss Income from Slice Co. NCI in NI of Slice Co. Excess Value (Differential) Reclassification Entry: Buildings & Equipment Goodwill Acc. Depr. Investment in Slice Co. NCI in NA of Slice Co.

Buildings & Equipment 20,000

18,000 0

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-33 (continued) b.

Income Statement Sales Less: COGS Less: Wage Expense Less: Depreciation Expense Less: Interest Expense Less: Other Expenses Less: Impairment Loss Income from Slice Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Pie Corp.

Slice Co.

260,000 (125,000) (42,000) (25,000) (12,000) (13,500)

180,000 (110,000) (27,000) (10,000) (4,000) (5,000)

Consolidation Entries DR CR

Consolidated

5,500 18,000 25,500 6,000

5,625 5,625 1,875

440,000 (235,000) (69,000) (37,000) (16,000) (18,500) (5,500) 0 59,000 (4,125)

24,000

31,500

7,500

54,875

102,000 54,875 (30,000) 126,875

40,000 24,000 (16,000) 48,000

40,000 31,500

7,500 16,000 23,500

102,000 54,875 (30,000) 126,875

Balance Sheet Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Slice Co.

47,500 70,000 90,000 30,000 350,000 (145,000) 96,375

21,000 12,000 25,000 15,000 150,000 (40,000)

20,000 30,000

Goodwill Total Assets

538,875

183,000

2,500 52,500

Accounts Payable Wages Payable Notes Payable Common Stock Retained Earnings NCI in NA of Slice Co.

45,000 17,000 150,000 200,000 126,875

16,000 9,000 50,000 60,000 48,000

60,000 71,500

Total Liabilities & Equity

538,875

183,000

131,500

12,375 54,875

24,000

54,875

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

2,000

71,500

30,000 2,000 81,000 15,375 128,375

23,500 27,000 5,125 55,625

68,500 82,000 115,000 45,000 490,000 (157,000) 0 2,500 646,000 61,000 26,000 200,000 200,000 126,875 32,125 646,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-34 Consolidation Worksheet at End of Second Year of Ownership a. Equity Method Entries on Pie Corp.'s Books: Investment in Slice Co.

27,000

Income from Slice Co.

27,000

Record Pie Corp.'s 75% share of Slice Co.'s 20X9 income Cash

15,000

Investment in Slice Co.

15,000

Record Pie Corp.'s 75% share of Slice Co.'s 20X9 dividend Income from Slice Co.

1,500

Investment in Slice Co.

1,500

Record amortization of excess acquisition price Book Value Calculations: NCI 25%

Pie Corp. 75%

Common Stock

Retained Earnings

Beginning book value

27,000

81,000

+ Net Income

9,000

27,000

36,000

- Dividends

(5,000)

(15,000)

(20,000)

Ending book value

31,000

93,000

60,000

1/1/X9

12/31/X9

Goodwill = 1,875

Identifiable Excess = 13,500

Identifiable Excess = 12,000

$96,375 Net investment in Slice Co.

75% Book value = 81,000

48,000

64,000

$106,875 Net investment in Slice Co.

75% Book value = 93,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-34 (continued) Basic Consolidation Entry Common Stock Retained Earnings Income from Slice Co. NCI in NI of Slice Co. Dividends Declared Investment in Slice Co. NCI in NA of Slice Co.

60,000 48,000 27,000 9,000 20,000 93,000 31,000

Excess Value (Differential) Calculations:

Beginning balance Changes Ending balance

NCI 25% 5,125 (500) 4,625

Pie Corp. 75% 15,375 (1,500) 13,875

Buildings and Equipment 20,000

20,000

Amortized Excess Value Reclassification Entry: Depreciation Expense Income from Slice Co. NCI in NI of Slice Co.

Accumulated Depreciation Consolidation Entry Accumulated depreciation Building & Equipment

Acc. Depr. (2,000) (2,000) (4,000)

20,000 2,500 4,000 13,875 4,625

30,000 30,000 Income from

Slice Co.

96,375

75% Net Income

27,000 15,000

75% Dividends

1,500

Excess Val. Amort.

93,000

Basic

13,875

Excess Reclass.

27,000

75% Net Income

25,500

Ending Balance

1,500

Amort. Reclass.

1,500

106,875

Goodwill 2,500 0 2,500

1,500 500

Investment in Beginning Balance

2,000

Excess Value (Differential) Reclassification Entry: Buildings and Equipment Goodwill Acc. Depr. Investment in Slice Co. NCI in NA of Slice Co.

Ending Balance

27,000 0

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-34 (continued) b. Pie Corp. Income Statement Sales Less: COGS Less: Wage Expense Less: Depreciation Expense Less: Interest Expense Less: Other Expenses Income from Slice Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Slice Co.

Consolidation Entries DR CR

290,000 (145,000) (35,000) (25,000) (12,000) (23,000) 25,500 75,500

200,000 (114,000) (20,000) (10,000) (4,000) (16,000)

75,500

36,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

126,875 75,500 (30,000) 172,375

48,000 36,000 (20,000) 64,000

Balance Sheet Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Slice Co.

68,500 85,000 97,000 50,000 350,000 (170,000) 106,875

32,000 14,000 24,000 25,000 150,000 (50,000)

20,000 30,000

Goodwill Total Assets

587,375

195,000

2,500 52,500

Accounts Payable Wages Payable Notes Payable Common Stock Retained Earnings NCI in NA of Slice Co.

51,000 14,000 150,000 200,000 172,375

15,000 6,000 50,000 60,000 64,000

60,000 86,000

Total Liabilities & Equity

587,375

195,000

146,000

36,000

1,500 1,500 500 2,000

490,000 (259,000) (55,000) (37,000) (16,000) (39,000) 0 84,000 (8,500) 75,500

2,000 20,000 22,000

126,875 75,500 (30,000) 172,375

2,000

27,000 29,000 9,000 38,000

48,000 38,000 86,000

Consolidated

30,000 4,000 93,000 13,875 140,875

22,000 31,000 4,625 57,625

100,500 99,000 121,000 75,000 490,000 (194,000) 0 2,500 694,000 66,000 20,000 200,000 200,000 172,375 35,625 694,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-34 (continued)

Pie Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X9

Cash Accounts Receivable Inventory Land Buildings and Equipment Less: Accumulated Depreciation Goodwill Total Assets

$100,500 99,000 121,000 75,000 $490,000 (194,000)

Accounts Payable Wages Payable Notes Payable Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

296,000 2,500 $694,000 $ 66,000 20,000 200,000

$200,000 172,375 $372,375 35,625 408,000 $694,000

Pie Corporation and Subsidiary Consolidated Income Statement Year Ended December 31, 20X9 Sales Cost of Goods Sold Wage Expense Depreciation Expense Interest Expense Other Expenses Total Expenses Consolidated Net Income Income to Noncontrolling Interest Income to Controlling Interest

$490,000 $259,000 55,000 37,000 16,000 39,000 (406,000) $ 84,000 (8,500) $ 75,500

Pie Corporation and Subsidiary Consolidated Retained Earnings Statement Year Ended December 31, 20X9 Retained Earnings, January 1, 20X9 Income to Controlling Interest, 20X9 Dividends Declared, 20X9 Retained Earnings, December 31, 20X9

$126,875 75,500 $202,375 (30,000) $172,375

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-35 Comprehensive Problem: Differential Apportionment a. Equity Method Entries on Pillow Corp.'s Books: Investment in Sheet Co.

173,000

Cash

173,000

Record the initial investment in Sheet Co. Investment in Sheet Co.

48,000

Income from Sheet Co.

48,000

Record Pillow Corp.'s 80% share of Sheet Co.'s 20X7 income Cash

16,000

Investment in Sheet Co.

16,000

Record Pillow Corp.'s 80% share of Sheet Co.'s 20X7 dividend Income from Sheet Co.

3,000

Investment in Sheet Co.

3,000

Record amortization of excess acquisition price b. Book Value Calculations: NCI 20%

Pillow Corp. 80%

Common Stock

Retained Earnings

Beginning book value

30,000

120,000

+ Net Income

12,000

48,000

60,000

- Dividends

(4,000)

(16,000)

(20,000)

Ending book value

38,000

152,000

50,000

1/1/X7

12/31/X7

Goodwill = 20,000

Identifiable Excess = 33,000

Identifiable Excess = 30,000

$173,000 Initial investment in Sheet Co.

80% Book value = 120,000

100,000

140,000

$202,000 Net investment in Sheet Co.

80% Book value = 152,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-35 (continued) Basic Consolidation Entry Common Stock Retained Earnings Income from Sheet Co. NCI in NI of Sheet Co. Dividends Declared Investment in Sheet Co. NCI in NA of Sheet Co.

50,000 100,000 48,000 12,000 20,000 152,000 38,000

Excess Value (Differential) Calculations: NCI Pillow 20% + Corp. 80% Beginning balance 13,250 53,000 Changes (750) (3,000) Ending balance 12,500 50,000

Amortized Excess Value Reclassification Entry: Depreciation Expense Income from Sheet Co. NCI in NI of Sheet Co. Excess Value (Differential) Reclassification Entry: Buildings & Equipment Goodwill Acc. Depr. Investment in Sheet Co. NCI in NA of Sheet Co.

Buildings & Equipment 41,250 41,250

Goodwill 25,000 0 25,000

41,250 25,000 3,750 50,000 12,500

Accumulated Depreciation Consolidation Entry Accumulated Depreciation Building & Equipment

60,000

Ending Balance

3,000 750

16,000

Acquisition Price 80% Net Income

Acc. Depr. 0 (3,750) (3,750)

3,750

Eliminate Intercompany Accounts: Accounts Payable Accounts Receivable

Investment in Sheet Co. 173,000 48,000 16,000 3,000 202,000 152,000 50,000 0

16,000

60,000 Income from Sheet Co.

80% Dividends Excess Val. Amort. Basic Excess Reclass.

48,000

80% Net Income

45,000

Ending Balance

3,000 0

Amort. Reclass.

3,000 48,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-35 (continued) c. Consolidation Entries DR CR

Pillow Corp.

Sheet Co.

700,000 (500,000) (25,000) (75,000) 45,000 145,000

400,000 (250,000) (15,000) (75,000) 60,000

48,000 51,750 12,000

3,000 3,000 750

1,100,000 (750,000) (43,750) (150,000) 0 156,250 (11,250)

145,000

60,000

63,750

3,750

145,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

290,000 145,000 (50,000) 385,000

100,000 60,000 (20,000) 140,000

100,000 63,750

3,750 20,000 23,750

290,000 145,000 (50,000) 385,000

Balance Sheet Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Sheet Co.

38,000 50,000 240,000 80,000 500,000 (155,000) 202,000

25,000 55,000 100,000 20,000 150,000 (75,000)

41,250 60,000

Goodwill Total Assets

955,000

275,000

25,000 126,250

Accounts Payable Mortgage Payable Common Stock Retained Earnings NCI in NA of Sheet Co.

70,000 200,000 300,000 385,000

35,000 50,000 50,000 140,000

50,000 163,750

Total Liabilities & Equity

955,000

275,000

229,750

Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Sheet Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

3,750

163,750

16,000

60,000 3,750 152,000 50,000 281,750

16,000

23,750 38,000 12,500 74,250

Consolidated

63,000 89,000 340,000 100,000 631,250 (173,750) 0 25,000 1,074,500 89,000 250,000 300,000 385,000 50,500 1,074,500

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-36 Comprehensive Problem: Differential Apportionment in Subsequent Period. a. Equity Method Entries on Pillow Corp.'s Books: Investment in Sheet Co.

36,000

Income from Sheet Co.

36,000

Record Pillow Corp.'s 80% share of Sheet Co.'s 20X8 income

Cash

20,000

Investment in Sheet Co.

20,000

Record Pillow Corp.'s 80% share of Sheet Co.'s 20X8 dividend

Income from Sheet Co.

11,800

Investment in Sheet Co.

11,800

Record amortization of excess acquisition price

b. Book Value Calculations: NCI 20%

Pillow Corp. 80%

Common Stock

Retained Earnings

Beginning book value

38,000

152,000

+ Net Income

9,000

36,000

45,000

- Dividends

(5,000)

(20,000)

(25,000)

Ending book value

42,000

168,000

50,000

1/1/X8

12/31/X8

Goodwill = 20,000

Goodwill = 11,200

Identifiable Excess = 30,000

Identifiable Excess = 27,000

$202,000 Net investment in Sheet Co.

80% Book value = 152,000

140,000

160,000

$206,200 Net investment in Sheet Co.

80% Book value = 168,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-36 (continued) Basic Consolidation Entry Common Stock Retained Earnings Income from Sheet Co. NCI in NI of Sheet Co. Dividends Declared Investment in Sheet Co. NCI in NA of Sheet Co.

50,000 140,000 36,000 9,000 25,000 168,000 42,000

Excess Value (Differential) Calculations: Pillow NCI Corp. 20% + 80% Beginning balance 12,500 50,000 Changes (2,950) (11,800) Ending balance 9,550 38,200

Buildings & Equipment 41,250 41,250

Amortized Excess Value Reclassification Entry: Depreciation Expense Goodwill Impairment Loss Income from Sheet Co. NCI in NI of Sheet Co. Excess Value (Differential) Reclassification Entry: Buildings & Equipment Goodwill Accumulated Dep. Investment in Sheet Co. NCI in NA of Sheet Co.

Goodwill 25,000 (11,000) 14,000

41,250 14,000 7,500 38,200 9,550

Accumulated Depreciation Consolidation Entry Accumulated Depreciation Building & Equipment

60,000

9,000

Investment in Sheet Co.

60,000 Income from Sheet Co.

202,000 36,000 20,000

11,800 2,950

9,000

Ending Balance

Acc. Depr. (3,750) (3,750) (7,500)

3,750 11,000

Eliminate Intercompany Accounts: Accounts Payable Accounts Receivable

Beginning Balance 80% Net Income

11,800

80% Dividends Excess Val. Amort.

168,000 38,200

Basic Excess Reclass.

80% Net Income

24,200

Ending Balance

11,800 0

Amort. Reclass.

11,800

206,200

36,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-36 (continued) c.

Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Less: Goodwill Impairment Income from Sheet Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Pillow Corp.

Sheet Co.

650,000 (490,000) (25,000) (62,000)

470,000 (310,000) (15,000) (100,000)

Consolidation Entries DR CR

Consolidated

11,000 36,000 50,750 9,000

11,800 11,800 2,950

1,120,000 (800,000) (43,750) (162,000) (11,000) 0 103,250 (6,050)

45,000

59,750

14,750

97,200

385,000 97,200 (45,000) 437,200

140,000 45,000 (25,000) 160,000

140,000 59,750

14,750 25,000 39,750

385,000 97,200 (45,000) 437,200

Balance Sheet Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Sheet Co.

59,000 83,000 275,000 80,000 500,000 (180,000) 206,200

31,000 71,000 118,000 30,000 150,000 (90,000)

41,250 60,000

Goodwill Total Assets

1,023,200

310,000

14,000 115,250

Accounts Payable Mortgage Payable Common Stock Retained Earnings NCI in NA of Sheet Co.

86,000 200,000 300,000 437,200

30,000 70,000 50,000 160,000

50,000 199,750

Total Liabilities & Equity

1,023,200

310,000

258,750

24,200 97,200

45,000

97,200

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

3,750

199,750

9,000

60,000 7,500 168,000 38,200 282,700

9,000

39,750 42,000 9,550 91,300

90,000 145,000 393,000 110,000 631,250 (217,500) 0 14,000 1,165,750 107,000 270,000 300,000 437,200 51,550 1,165,750

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-37 Subsidiary with Other Comprehensive Income in Year of Acquisition a. Equity Method Entries on Pirate Corp.'s Books: Investment in Ship Co.

96,000

Cash

96,000

Record the initial investment in Ship Co. Investment in Ship Co.

15,000

Income from Ship Co.

15,000

Record Pirate Corp.'s 60% share of Ship Co.'s 20X8 income Cash

9,000

Investment in Ship Co.

9,000

Record Pirate Corp.'s 60% share of Ship Co.'s 20X8 dividend Investment in Ship Co.

6,000

Other Comprehensive Income from Ship Co.

6,000

Record share of increase in value of securities held by Ship Co. Book Value Calculations: NCI 40% Beginning book value

64,000

Pirate Corp. 60% 96,000

Common Stock 100,000

Retained Earnings 60,000

+ Net Income

10,000

15,000

25,000

- Dividends

(6,000)

(9,000)

(15,000)

Ending book value

68,000

102,000

100,000

1/1/X8

12/31/X8

Goodwill = 0

Identifiable Excess = 0

$96,000 Initial investment in Ship Co.

60% Book value = 96,000

70,000

$108,000 Net investment in Ship Co.

60% Book value = 108,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-37 (continued) Basic Consolidation Entry Common Stock

100,000

Retained Earnings

60,000

Income from Ship Co.

15,000

NCI in NI of Ship Co.

10,000

Dividends Declared

15,000

Investment in Ship Co.

102,000

NCI in NA of Ship Co.

68,000

Other Comprehensive Income Entry: OCI from Ship Co.

6,000

OCI to the NCI

4,000

Investment in Ship Co.

6,000

NCI in NA of Ship Co.

4,000

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

75,000

Building & Equipment

75,000

Investment in

Income from

Ship Co.

Acquisition Price

96,000

60% Net Income

15,000 9,000 6,000

Ending Balance

15,000

60% Net Income

15,000

Ending Balance

60% Dividends OCI Entry

108,000 102,000

Basic

6,000

OCI

15,000 0

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-37 (continued) b. Pirate Corp. Income Statement Sales Less: COGS Less: Depreciation Expense Less: Interest Expense Income from Ship Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Accounts Receivable Inventory Buildings & Equipment Less: Accumulated Depreciation Investment in Row Company Investment in Ship Co.

Ship Co.

220,000 (150,000) (30,000) (8,000) 15,000 47,000

148,000 (110,000) (10,000) (3,000)

47,000

25,000

208,000 47,000 (24,000) 231,000

60,000 25,000 (15,000) 70,000

27,000 65,000 40,000 500,000 (140,000)

8,000 22,000 30,000 235,000 (85,000) 40,000

25,000

15,000 15,000 10,000 25,000

60,000 25,000 85,000

600,000

250,000

Accounts Payable Bonds Payable Common Stock Retained Earnings Accumulated OCI NCI in NA of Ship Co.

63,000 100,000 200,000 231,000 6,000

20,000 50,000 100,000 70,000 10,000

Total Liabilities & Equity

600,000

250,000

Consolidated

368,000 (260,000) (40,000) (11,000) 0 57,000 (10,000) 47,000

0 15,000 15,000

208,000 47,000 (24,000) 231,000

75,000 75,000

108,000

Total Assets

Other Comprehensive Income Accumulated Other Comprehensive Income, 1/1/20X8 Other Comprehensive Income from Ship Co. Unrealized Gain on Investments Other Comprehensive Income to NCI Accumulated Other Comprehensive Income, 12/31/20X8

Consolidation Entries DR CR

75,000

100,000 85,000 10,000

195,000

102,000 6,000 183,000

15,000 68,000 4,000 87,000

35,000 87,000 70,000 660,000 (150,000) 40,000 0 742,000 83,000 150,000 200,000 231,000 6,000 72,000 742,000

0 6,000

6,000

0 10,000 (4,000)

10,000 4,000 6,000

10,000

6,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-37 (continued) c.

Pirate Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X8

Cash Accounts Receivable Inventory Buildings and Equipment Less: Accumulated Depreciation Investment in Marketable Securities Total Assets

$ 35,000 87,000 70,000 $660,000 (150,000)

Accounts Payable Bonds Payable Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Accumulated Other Comprehensive Income Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

510,000 40,000 $742,000 $ 83,000 150,000

$200,000 231,000 6,000 $437,000 72,000 509,000 $742,000

Pirate Corporation and Subsidiary Consolidated Income Statement Year Ended December 31, 20X8 Sales Cost of Goods Sold Depreciation Expense Interest Expense Total Expenses Consolidated Net Income Income to Noncontrolling Interest Income to Controlling Interest

$368,000 $260,000 40,000 11,000 (311,000) $ 57,000 (10,000) $ 47,000

Pirate Corporation and Subsidiary Consolidated Statement of Comprehensive Income Year Ended December 31, 20X8 Consolidated Net Income Other Comprehensive Income: Unrealized Gain on Investments Held by Subsidiary Total Consolidated Comprehensive Income Less: Comprehensive Income Attributable to Noncontrolling Interest Comprehensive Income Attributable to Controlling Interest

$57,000 10,000 $67,000 (14,000) $53,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-38 Subsidiary with Other Comprehensive Income in Year Following Acquisition a. Equity Method Entries on Pirate Corp.'s Books: Investment in Ship Co.

18,000

Income from Ship Co.

18,000

Record Pirate Corp.'s 60% share of Ship Co.'s 20X9 income Cash

12,000

Investment in Ship Co.

12,000

Record Pirate Corp.'s 60% share of Ship Co.'s 20X9 dividend Investment in Ship Co.

2,400

Other Comprehensive Income from Ship Co.

2,400

Record share of increase in value of securities held by Ship Co. Book Value Calculations: NCI 40%

Pirate Corp. 60%

Common Stock

Retained Earnings

Beginning book value

72,000

108,000

+ Net Income

12,000

18,000

30,000

- Dividends

(8,000)

(12,000)

(20,000)

Ending book value

76,000

114,000

100,000

1/1/X9

12/31/X9

Goodwill = 0

Identifiable Excess = 0

$108,000 Net investment in Ship Co.

60% Book value = 108,000

70,000

80,000

AOCI 10,000

10,000

$116,400 Net investment in Ship Co.

60% Book value = 116,400

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-38 (continued) Basic Consolidation Entry Common Stock

100,000

Retained Earnings

70,000

Accumulated OCI

10,000

Income from Ship Co.

18,000

NCI in NI of Ship Co.

12,000

Dividends Declared

20,000

Investment in Ship Co.

114,000

NCI in NA of Ship Co.

76,000

Other Comprehensive Income Entry: OCI from Ship Co.

2,400

OCI to the NCI

1,600

Investment in Ship Co.

2,400

NCI in NA of Ship Co.

1,600

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

75,000

Building & Equipment

75,000

Investment in

Income from

Ship Co.

Beginning Balance

108,000

60% Net Income

18,000 12,000 2,400

Ending Balance

18,000

60% Net Income

18,000

Ending Balance

60% Dividends OCI Entry

116,400 114,000

Basic

2,400

OCI

18,000 0

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-38 (continued) b.

Income Statement Sales Less: COGS Less: Depreciation Expense Less: Interest Expense Income from Ship Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Accounts Receivable Inventory Buildings & Equipment Less: Accumulated Depreciation Investment in Row Company Investment in Ship Co.

Consolidation Entries DR CR

Pirate Corp.

Ship Co.

250,000 (170,000) (30,000) (8,000) 18,000 60,000

140,000 (97,000) (10,000) (3,000) 30,000

18,000 18,000 12,000

60,000

30,000

231,000 60,000 (40,000) 251,000

70,000 30,000 (20,000) 80,000

70,000 30,000

18,000 45,000 40,000 585,000 (170,000)

11,000 21,000 30,000 257,000 (95,000) 44,000

100,000

Consolidated 390,000 (267,000) (40,000) (11,000) 0 72,000 (12,000) 0

60,000

0 20,000 20,000

231,000 60,000 (40,000) 251,000

75,000 75,000

116,400

Total Assets

634,400

268,000

Accounts Payable Bonds Payable Common Stock Retained Earnings Accumulated OCI NCI in NA of Ship Co.

75,000 100,000 200,000 251,000 8,400

24,000 50,000 100,000 80,000 14,000

Total Liabilities & Equity

634,400

268,000

214,000

6,000

10,000

6,000

2,400

0 4,000 (1,600)

Other Comprehensive Income Accumulated Other Comprehensive Income, 1/1/20X9 Other Comprehensive Income from Ship Co. Unrealized Gain on Investments Other Comprehensive Income to NCI Accumulated Other Comprehensive Income, 12/31/20X9

2,400

75,000

114,000 2,400 191,400

29,000 66,000 70,000 767,000 (190,000) 44,000 0

100,000 100,000 14,000

20,000 76,000 1,600 97,600

4,000 1,600 8,400

14,000

786,000 99,000 150,000 200,000 251,000 8,400 77,600 786,000

8,400

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-39 Comprehensive Problem: Majority-Owned Subsidiary a. Equity Method Entries on Pizza Corp.'s Books: Investment in Slice Company

24,000

Income from Slice Company

24,000

Record Pizza Corp.'s 80% share of Slice Company's 20X5 income Cash

8,000

Investment in Slice Company

8,000

Record Pizza Corp.'s 80% share of Slice Company's 20X5 dividend Income from Slice Company

4,000

Investment in Slice Company

4,000

Record amortization of excess acquisition price b. Book Value Calculations: NCI 20%

Pizza Corp. 80%

Common Stock

Retained Earnings

Beginning book value

38,000

152,000

+ Net Income

6,000

24,000

30,000

- Dividends

(2,000)

(8,000)

(10,000)

Ending book value

42,000

168,000

100,000

1/1/X5

12/31/X5

Goodwill = 0

Identifiable Excess = 24,000

Identifiable Excess = 20,000

$176,000 Net investment in Slice Co.

80% Book value = 152,000

90,000

110,000

$188,000 Net investment in Slice Co.

80% Book value = 168,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-39 (continued) Basic consolidation entry Common stock Retained earnings Income from Slice Company NCI in NI of Slice Company Dividends declared Investment in Slice Company NCI in NA of Slice Company

100,000 90,000 24,000 6,000 10,000 168,000 42,000

Excess Value (Differential) Calculations: NCI Pizza Corp. 20% + 80% Beginning balance 6,000 24,000 Changes (1,000) (4,000) Ending balance 5,000 20,000

Amortized excess value reclassification entry: Depreciation expense Income from Slice Company NCI in NI of Slice Company

Buildings & Equipment 50,000 50,000

4,000 1,000

Eliminate intercompany accounts: Accounts payable Cash and receivables

50,000 25,000 20,000 5,000

10,000 10,000

Investment in

Income from

Slice Company

Beginning Balance

176,000

80% Net Income

24,000

Acculated Depreciation (20,000) (5,000) (25,000)

5,000

Excess value (differential) reclassification entry: Buildings & Equipment Accumulated Depreciation Investment in Slice Company NCI in NA of Slice Company

Ending Balance

8,000

80% Dividends

4,000

Excess Val. Amort. Basic

20,000

Excess Reclass.

80% Net Income

20,000

Ending Balance

4,000

Amort. Reclass.

4,000

188,000 168,000

24,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation 10,000 Building & equipment

10,000

Chapter 05 - Consolidation of Less-Than-Wholly Owned Subsidiaries Acquired at More than Book Value

P5-39 (continued) c. Pizza Corporation

Slice Company

Sales

200,000

100,000

Less: COGS Less: Depreciation Expense

(120,000) (25,000)

(50,000) (15,000)

Less: Inventory Losses Income from Slice Company

(15,000) 20,000

(5,000)

Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

60,000

30,000

60,000

Statement of Retained Earnings Beginning Balance

Consolidation Entries DR

Consolidated

Income Statement 300,000 (170,000) (45,000)

5,000 24,000

4,000

(20,000) 0

30,000

29,000 6,000 35,000

4,000 1,000 5,000

65,000 (5,000) 60,000

314,000

90,000

Net Income Less: Dividends Declared

60,000 (30,000)

30,000 (10,000)

35,000

5,000 10,000

60,000 (30,000)

Ending Balance

344,000

110,000

125,000

15,000

344,000

Cash and Receivables

81,000

65,000

10,000

136,000

Inventory

260,000

90,000

Land Buildings & Equipment

80,000 500,000

80,000 150,000

50,000

10,000

160,000 690,000

Less: Accumulated Depreciation Investment in Slice Company

(205,000) 188,000

(105,000)

10,000

25,000 168,000

(325,000) 0

314,000

Balance Sheet 350,000

20,000 Total Assets

904,000

280,000

60,000

233,000

Accounts Payable

60,000

20,000

10,000

70,000

Notes Payable Common Stock

200,000 300,000

50,000 100,000

100,000

250,000 300,000

Retained Earnings NCI in NA of Slice Company

344,000

110,000

125,000

15,000 42,000

1,011,000

344,000 47,000

5,000 Total Liabilities & Equity

904,000

280,000

235,000

62,000

1,011,000

Chapter 06 – Intercompany Inventory Transactions

CHAPTER 6 INTERCOMPANY INVENTORY TRANSACTIONS ANSWERS TO QUESTIONS Q6-1 All inventory transfers between related companies must be eliminated to avoid an overstatement of revenue and cost of goods sold in the consolidated income statement. In addition, when unrealized profits exist at the end of the period, the eliminations are needed to avoid overstating inventory and consolidated net income. Q6-2 An inventory transfer at cost results in an overstatement of sales and cost of goods sold. While net income is not affected, gross profit ratios and other financial statement analysis may be substantially in error if appropriate eliminations are not made. Q6-3 An upstream sale occurs when the parent purchases items from one or more subsidiaries. A downstream sale occurs when the sale is made by the parent to one or more subsidiaries. Knowledge of the direction of sale is important when there are unrealized profits so that the person preparing the consolidation worksheet will know whether to reduce consolidated net income assigned to the controlling interest by the full amount of the unrealized profit (downstream) or reduce consolidated income assigned to the controlling and noncontrolling interests on a proportionate basis (upstream). Q6-4 As in all cases, the total amount of the unrealized profit must be eliminated in preparing the consolidated statements. When the profits are on the parent company's books (downstream sale), consolidated net income and income assigned to the controlling interest are reduced by the full amount of the unrealized profit. Q6-5 Consolidated net income is reduced by the full amount of the unrealized profits. In the upstream sale, the unrealized profits are apportioned between the parent company shareholders and the noncontrolling shareholders. Thus, consolidated net income assigned to the controlling and noncontrolling interests is reduced by a pro rata portion (based on ownership percentage) of the unrealized profits. Q6-6 The elimination of unrealized intercompany profits on an upstream sale will have a greater effect on income assigned to the noncontrolling interest. Income assigned to the noncontrolling interest is affected when unrealized profits are recorded on the subsidiary's books as a result of an upstream sale. A downstream sale would have no effect on the income assigned to noncontrolling interest because the profits are on the books of the parent and are, therefore, eliminated from the consolidated net income assigned to the controlling interest only. Q6-7 The basic consolidation entry needed when the item is resold before the end of the period is: Sales Cost of Goods Sold

XXXXXX XXXXXX

The debit to sales is based on the intercorporate sale price. This means that only the revenue recorded by the company ultimately selling to the nonaffiliate is to be included in the consolidated income statement. Cost of goods sold is credited for the amount paid by the purchaser on the intercorporate transfer, thereby permitting the cost of goods sold recorded by the initial owner to 6-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 06 – Intercompany Inventory Transactions

be reported as cost of goods sold in the consolidated statement. Q6-8 The consolidation entry needed when one or more of the items are not resold before the end of the period is: Sales Cost of Goods Sold Inventory

XXXXXX XXXXXX XXXXXX

The debit to sales is for the full amount of the transfer price. Inventory is credited for the unrealized profit at the end of the period and cost of goods sold is credited for the amount charged to cost of goods sold by the company making the intercompany sale. Additionally, the basic consolidation entry would need to be adjusted to reflect the deferred gross profit. Q6-9 Cost of goods sold is reported by the consolidated entity when inventory is sold to an external party. The amount reported as cost of goods sold is based on the amount paid for the inventory when it was produced or purchased from an external party. If inventory has been purchased by one company and sold to a related company, the cost of goods sold recorded on the intercorporate sale must be eliminated. Q6-10 No adjustment to retained earnings is needed if the intercorporate sales have been made at cost or if all intercorporate sales have been resold to an external party in the same accounting period. If all of the intercorporate sales have not been resold by the end of the period, under the fully adjusted equity method, the parent defers unrealized profits in the investment in sub and income from sub accounts so no Retained Earnings adjustment would be needed under the modified equity or cost methods. This adjustment would need to be made to retained earnings during consolidation. However, regardless of the parent’s method for accounting for the investment, the amount of the noncontrolling interest is reduced by the NCI’s proportionate share of the unrealized profit associated with upstream sales. Q6-11 A proportionate share of the realized retained earnings of the subsidiary are assigned to the noncontrolling interest. Any unrealized profits on upstream sales are deducted proportionately from the amount assigned to the noncontrolling interest. Unrealized profits on downstream sales do not affect the noncontrolling interest. Q6-12 When inventory profits from a prior period intercompany transfer are realized in the current period, the profit is added to consolidated net income and to the income assigned to the shareholders of the company that made the intercompany sale. If the unrealized profits arise from a downstream sale, income assigned to the controlling interest will increase by the full amount of profit realized. When the profits arise from an upstream sale, income assigned to the controlling and noncontrolling interests will be increased proportionately in the period the profit is realized. Thus, knowledge of whether the profits resulted from an upstream or a downstream sale is imperative in assigning consolidated net income to the appropriate shareholder group. However, consolidated net income is not affected by a change in the direction of sale. Q6-13 Under the fully adjusted equity method, consolidated retained earnings is not affected directly by unrealized profits. Unrealized profits are deferred in the investment in sub and income from sub accounts on the parent’s books. Income from sub is closed out to retained earnings, so the deferral of unrealized profits indirectly affects retained earnings. As a result, the amount reported for consolidated retained earnings is always equal to the parent’s retained earnings. Under the modified equity or cost methods, these adjustments to income and retained earnings would be made during consolidation and the consolidated retained earnings will be the same under any of the methods.

Chapter 06 – Intercompany Inventory Transactions

Q6-14 Consolidated retained earnings are always equal to the parent’s retained earnings under the fully adjusted equity method. Since the parent company defers unrealized profits in the income from sub and investment in sub accounts and since income from sub is closed out to the parent’s retained earnings, the ending balance in consolidated retained earnings will reflect the reduction associated with the deferral of unrealized profits. Under the modified equity or cost methods, these adjustments to income and retained earnings would be made during consolidation and the consolidated retained earnings will be the same under any of the methods. Q6-15* Sales between subsidiaries are treated in the same manner as upstream sales. Whenever the profits are on the books of one of the subsidiaries, the unrealized profits at the end of the period are eliminated and consolidated net income and income assigned to the controlling and noncontrolling interests is reduced. Q6-16* When a company is acquired in a business combination the transactions occurring before the combination generally are regarded as transactions with unrelated parties and no adjustments or eliminations are needed. All transactions between the companies following the combination must be fully eliminated.

Chapter 06 – Intercompany Inventory Transactions

SOLUTIONS TO CASES C6-1 Measuring Cost of Goods Sold a. While the rule covers only a part of the elimination needed, Charlie is correct in that the cost of goods sold recorded by the selling company must be eliminated to avoid overstating that portion of the consolidated income statement. b. The rules will result in the proper consolidated totals if rule #1 is expanded to include a debit to sales and a credit to ending inventory for the amount of profit recorded by the company that sold to its affiliate. c. The way in which the rule is stated makes it appear to be incorrect, but it is correct. The rule is appropriate in that the cost of goods sold recorded by the purchasing affiliate is equal to the cost of goods sold to the first owner plus the profit the first owner recorded on the sale. Eliminating these amounts therefore eliminates the appropriate amount of cost of goods sold. If an equal amount of sales is eliminated, the rule should result in proper consolidated financial statement totals. d. The employee would be forced to look at the books of the selling affiliate and determine the difference between the intercorporate sale price and the price it paid to acquire or produce the items. If the items sold to affiliates are routinely produced and/or costs do not fluctuate greatly, it may be possible to use some form of gross profit ratio to estimate the amount of unrealized profit.

Chapter 06 – Intercompany Inventory Transactions

C6-2 Inventory Values and Intercompany Transfers MEMO To:

President Water Products Corporation

From:

, CPA

Re:

Inventory Sale and Purchase of New Inventory

If Water Products holds only a small percent of the ownership of Plumbers Products and Growinkle Manufacturing, it should have no difficulty in reporting the desired results. This would not be the case if the two companies are subsidiaries of Water Products (i.e. Water Products owns a controlling interest in Plumbers Products and Growinkle Manufacturing). If both Plumbers Products and Growinkle are subsidiaries of Water Products, both the sale of inventory to Plumbers Supply and the purchase of inventory from Growinkle Manufacturing must be eliminated. In addition, the unrealized profit on any unsold inventory involved in these transfers must be eliminated in preparing the financial statements for the current period. Assuming the companies are consolidated, the consolidated income statement should include the same amount of income on the inventory sold to Plumbers Supply and resold during the year as would have been recorded if Water Products had sold the inventory directly to the purchaser (not through Plumbers Supply). Any income recorded by Water Products on inventory not resold by Plumbers Supply must be eliminated. Similarly, the consolidated income statement should include the same amount of income on the inventory purchased by Water Products and resold during the year as would have been recorded if Growinkle Manufacturing had sold the inventory directly to the purchaser. Any income recorded by Growinkle Manufacturing on inventory not resold by Water Products must be eliminated. Consolidated net income may increase if Plumbers Supply is able to sell the inventory it purchased from Water Products at a higher price than would have been received by Water Products or if it is able to sell a larger number of units. The same can be said for the inventory purchased by Water Products from Growinkle Manufacturing. It is important to recognize that the transfer of inventory between Water Products and its subsidiaries does not in itself generate income for the consolidated entity, nor does it increase the value of the inventory still held by the consolidated entity. An additional level of complexity arises in this situation since Water Products uses the LIFO inventory method. Water Products should carry over its LIFO cost basis on the old inventory sold to Plumbers Supply to the new inventory purchased from Growinkle Manufacturing since it was replaced within the same accounting period. Primary citation: ASC 810

Chapter 06 – Intercompany Inventory Transactions

C6-3 Unrealized Inventory Profits a. When the amount of unrealized inventory profits on the books of the subsidiary at the beginning of the period is greater than the amount at the end of the period, the income assigned to the noncontrolling interest for the period will exceed a pro rata portion of the reported net income of the subsidiary. b. The subsidiary apparently had less unrealized inventory profit at the end of the period than it did at the start of the period. In addition, the parent must have had more unrealized profit on its books at the end of the period than it did at the beginning. The negative effect of the latter apparently offset the positive effect of the reduction in unrealized profits by the subsidiary. c. The most likely reason is that a substantial amount of the parent company sales was made to its subsidiaries and the cost of goods sold on those items was eliminated in preparing the consolidated statements. d. A loss was recorded by the seller on an intercompany sale of inventory to an affiliate and the purchaser continues to hold the inventory.

Chapter 06 – Intercompany Inventory Transactions

C6-4 Eliminating Inventory Transfers a. If no intercompany sales are eliminated, the income statement may include overstated sales revenue and cost of goods sold. The net impact on income will depend upon whether there were more unrealized profits at the beginning or end of the year. If Ready Building does not hold total ownership of the subsidiaries, the amount of income assigned to noncontrolling shareholders is likely to be incorrect as well. Inventory, current assets and total assets, retained earnings, and stockholders' equity are likely to be overstated if inventories are sold to affiliates at a profit. If the companies pay income taxes on their individual earnings, the amount of income tax expense also will be overstated in the period in which unrealized profits are reported and understated in the period in which the profits are realized. b. Because profit margins vary considerably, the amount of unrealized profit may vary considerably if uneven amounts of product are purchased by affiliates from period to period. Ready Building needs to establish a formal system to monitor intercompany sales. Perhaps the best alternative would be to establish a separate series of accounts to be used solely for intercompany transfers. Alternatively, it may be possible to use unique shipping containers for intercompany sales or to specifically mark the containers in some way to identify the intercompany shipments at the time of receipt. The purchaser might then use a different type of inventory tag or mark these units in some way when the product is received and placed in inventory. Inventory count teams could then easily identify the product when inventories are taken. c. A number of factors might be considered. The most important inventory system is the one used by the company making the intercompany purchase. When intercompany inventory purchases are bunched at the end of the year, the amount of unrealized profit included in ending inventory may be quite different under FIFO versus LIFO. If intercompany purchases are placed in a LIFO inventory base, inventories may be misstated for a period of years before the inventory is resold. Consolidation entries must be made each of the years until resale to avoid a misstatement of assets and equities. In those cases where the intercompany purchases are in high volume and the inventory turns over very quickly, a small amount of inventory left at the end of the period may be immaterial and of little concern. Typically, a parent will align inventory costing methods subsequent to a subsidiary acquisition to avoid problems caused by differences in accounting for the same items or types of items. d. It may be necessary to start by looking at intercorporate cash receipts and disbursements to determine the extent of intercorporate sales. One or more months might be selected and all vouchers examined to establish the level of intercorporate sales and the profit margins recorded on the sales. For those products sold throughout the year, it may be possible to estimate for the year as a whole based on an examination of several months. Once total intercompany sales and profit margins have been estimated, the amount of unrealized profit at year end should be estimated. One approach would be to take a physical inventory of the specific product types which have been identified and attempt to trace back using the product identification numbers or shipping numbers to determine what portion of the inventory on hand was purchased from affiliates.

Chapter 06 – Intercompany Inventory Transactions

C6-5 Intercompany Profits and Transfers of Inventory a. In its 2020 10-K filing, the company states “All significant intercompany accounts and transactions have been eliminated” (see Note 1 – Basis of Presentation and Summary of Significant Accounting Policies). The intercompany transfers of Xerox (www.xerox.com) between segments are apparently relatively insignificant because they are not reported in the notes to the consolidated financial statements relating to segment reporting. b. Exxon Mobil prices intercompany transfers at estimated market prices. The amount of intercompany transfers is large. In the fiscal year ending December 31, 2020, Exxon Mobil reported eliminations of $65.8 billion of intersegment revenue, which does not include intercompany transfers within segments. This amount represents just over onethird of total reported segment sales. For consolidation purposes, Exxon Mobil eliminates the effects of intercompany transactions. c. Ford Motor Company intercompany transfers consist primarily of vehicles, parts, and components manufactured by the company and its subsidiaries, with a smaller amount of financial and other services included. The amount of intercompany transfers is relatively small in relation to sales to unaffiliated customers. The effects of intercompany transfers are eliminated in consolidation.

Chapter 06 – Intercompany Inventory Transactions

SOLUTIONS TO EXERCISES E6-1 Multiple-Choice Questions on Intercompany Inventory Transfers [AICPA Adapted] 1. a – All intercompany sales and cost of goods sold must be eliminated in consolidation to prevent double counting. (b) Incorrect. The entire amount of sales and cost of goods gold must be eliminated. (c) Incorrect. Net income is not directly reduced with a consolidation entry. Instead, sales and cost of goods sold are adjusted. (d) Incorrect. Adjustments to sales and cost of goods sold are required. 2. c – $500,000 = ($400,000 +$350,000 - $250,000) 3. a – $56,000 = ($40,000 *1.4) 4. c – $56,000. The revenue would be overstated by the amount of cost of goods sold that should have been eliminated. 5 c–

6 c–

Net assets reported Profit on intercompany sale Proportion of inventory unsold at year end ($60,000 / $240,000) Unrealized profit at year end Amount reported in consolidated statements Inventory reported by Banks ($175,000 + $60,000) Inventory reported by Lamm Total inventory reported Unrealized profit at year end [$50,000 x ($60,000 / $200,000)] Amount reported in consolidated statements

$320,000 $48,000 x

0.25 (12,000) $308,000 $235,000 250,000 $485,000 (15,000) $470,000

Chapter 06 – Intercompany Inventory Transactions

7. b –

Sales COGS

Total = Re-sold + 500,000 400,000 200,000 160,000

Gross Profit

300,000

Gross Profit %

Ending Inventory 100,000 40,000

240,000

60,000

60% (based on overall sales info)

Worksheet Entry (not requested in problem) Sales 500,000 Cost of Goods Sold 440,000 Inventory 60,000 The basic entry (not shown) would be adjusted for 60,000 of deferred profit to complete the elimination process. Partial Worksheet Sales Less: COGS

Park 2,000,000 (800,000)

Small DR CR 1,400,000 500,000 (700,000) 440,000

Consolidated 2,900,000 (1,060,000)

Note:

Answer b in the actual CPA examination question was $1,100,000, requiring candidates to select the closest answer.

E6-2 Multiple-Choice Questions on the Effects of Inventory Transfers [AICPA Adapted] 1.

d–

$32,000

($200,000 + $140,000) – $308,000

b–

$6,000

($26,000 + $19,000) – $39,000

c–

$9,000

Inventory held by Spin ($32,000 x 0.375) Unrealized profit on sale [($30,000 + $25,000) – $52,000] Carrying cost of inventory for Power

$12,000 (3,000) $ 9,000

b–

0.20 = $14,000 / [(Stockholders’ Equity $50,000) +(Patent $20,000)]

b–

14 years = ($28,000 / [(28,000 - $20,000) / 4 years]

Chapter 06 – Intercompany Inventory Transactions

E6-3 Multiple Choice – Consolidated Income Statement 1.

c–

The only sales recorded are sales to non-affiliates.

b–

The amount of cost of goods sold is the cost at which Blue had produced the inventory.

c–

Total income ($86,000 - $47,000) Income assigned to noncontrolling interest [0.40($86,000 - $60,000)] Consolidated net income assigned to controlling interest

$39,000 (10,400) $28,600

E6-4 Multiple-Choice Questions — Consolidated Balances 1. c –

The only sales recorded are sales to non-affiliates.

2. a –

Amount paid by Lorn Corporation Unrealized profit Actual cost Portion sold Cost of goods sold

$120,000 (45,000) $ 75,000 x 0.80 $ 60,000

3. e –

Consolidated sales Cost of goods sold Consolidated net income Income to Dresser’s noncontrolling interest: Sales Reported cost of sales Report income Portion realized Realized net income Portion to Noncontrolling Interest Income to noncontrolling Interest Income to controlling interest

$140,000 (60,000) $ 80,000

4. a –

$120,000 (75,000) $ 45,000 x 0.80 $ 36,000 x

0.30

Inventory reported by Lorn Unrealized profit ($45,000 x .20) Ending inventory reported

(10,800) $ 69,200 $ 24,000 (9,000) $ 15,000

E6-5 Multiple-Choice Questions — Consolidated Income Statement 1. a –

$20,000 = $30,000 x [($48,000 - $16,000) / $48,000]

2. d –

Sales reported by Movie Productions Inc. Cost of goods sold ($30,000 x 2/3) Consolidated net income

3. a –

$7,000 = [($67,000 - $32,000) x 0.20]

$67,000 (20,000) $47,000

Chapter 06 – Intercompany Inventory Transactions

E6-6 Realized Profit on Intercompany Sale a.

Journal entries recorded by Planet Corporation: (1) (2) (3)

960,000

Cash (Accounts Receivable) Sales

750,000

Cost of Goods Sold Inventory

600,000

960,000 750,000 600,000

Journal entries recorded by Saturn Company: (1) (2) (3)

Inventory Cash (Accounts Payable)

750,000

Cash (Accounts Receivable) Sales

1,125,000

Cost of Goods Sold Inventory

750,000 1,125,000 750,000 750,000

Consolidation entry: Sales Cost of Goods Sold

750,000 750,000

The basic entry (not shown) would complete the elimination process. No adjustment to the basic entry would be needed since there is no deferred profit in this situation.

Chapter 06 – Intercompany Inventory Transactions

E6-7 Sale of Inventory to Subsidiary a.

Journal entries recorded by Planet Corporation: (1) (2) (3)

960,000

Cash (Accounts Receivable) Sales

750,000

Cost of Goods Sold Inventory

600,000

960,000 750,000 600,000

Journal entries recorded by Saturn Company: (1) (2) (3)

Inventory Cash (Accounts Payable)

750,000

Cash (Accounts Receivable) Sales

810,000

Cost of Goods Sold Inventory

540,000

750,000 810,000 540,000

Consolidation entry: Sales 750,000 Cost of Goods Sold 708,000 Inventory 42,000 The basic entry (not shown) would be adjusted by 42,000 of deferred profit to complete the elimination process. Calculations

Sales COGS

Ending Total = Re-Sold + Inventory 750,000 540,000 210,000 600,000 432,000 168,000

Gross Profit

150,000

Gross Profit %

108,000

42,000

20%

Chapter 06 – Intercompany Inventory Transactions

E6-8 Inventory Transfer between Parent and Subsidiary a.

Planner Corporation reported cost of goods sold of $820,000 ($82 x 10,000 desks) and Schedule Company reported cost of goods sold of $658,000 ($94 x 7,000 desks).

Cost of goods sold for the consolidated entity is $574,000 ($82 x 7,000 desks).

Consolidation entry: Sales 940,000 Cost of Goods Sold 904,000 Inventory 36,000 The basic entry (not shown) would be adjusted by 36,000 of deferred profit to complete the elimination process. Calculations

Sales COGS

Ending Total = Re-sold + Inventory 940,000 658,000 282,000 820,000 574,000 246,000

Gross Profit

120,000

Gross Profit %

12.77%

84,000

36,000

Consolidation entry: Investment in Schedule Company 36,000 Cost of Goods Sold 36,000 The basic entry (not shown) would be adjusted by 36,000 to reverse the gross profit deferral and complete the elimination process.

Consolidation entry: Investment in Schedule Company 21,600 NCI in NA of Schedule Company 14,400 Cost of Goods Sold 36,000 The basic entry (not shown) would be adjusted by 36,000 to reverse the gross profit deferral and complete the elimination process.

Chapter 06 – Intercompany Inventory Transactions

E6-9 Income Statement Effects of Unrealized Profit a.

Sale price to Pie Bakery per bag ($900,000 / 100,000) Profit per bag [$9.00 - ($9.00 / 1.5)] Cost per bag Bags sold by Pie Bakery (100,000 - 20,000) Consolidated cost of goods sold

9.00 (3.00) $ 6.00 x 80,000 $480,000

Sales 900,000 Cost of Goods Sold 840,000 Inventory ($3.00 x 20,000 bags) 60,000 The basic entry (not shown) would adjusted by 60,000 of deferred profit to complete the elimination process. Calculations

Sales COGS Gross Profit Gross Profit %

Total 900,000 600,000 300,000

Ending Re-sold + Inventory 720,000 180,000 480,000 120,000 240,000

60,000

33.33%

Required Adjustment to Cost of Goods Sold: Cost of goods sold — Slice ($900,000 / 1.5) Cost of goods sold — Pie ($9.00 x 80,000 units)

$ 600,000 720,000 $1,320,000 (480,000) $ 840,000

Consolidated cost of goods sold ($6.00 x 80,000 units) Required adjustment c.

Operating income of Pie Bakery Net income of Slice Products

$400,000 150,000 $550,000 (60,000) $490,000

Less: Unrealized inventory profits Consolidated net income Less: Income assigned to noncontrolling interest ($150,000 - $60,000 unrealized profit) x 0.40 Income assigned to controlling interest Alternate computation: Operating income of Pie Bakery Net income of Slice Products Unrealized profits ($3.00 x 20,000 units) Realized net income Ownership held by Pie Bakery Income assigned to controlling interest

(36,000) $454,000 $400,000 $150,000 (60,000) $ 90,000 x 0.60 54,000 $454,000

Chapter 06 – Intercompany Inventory Transactions

E6-10 Prior-Period Unrealized Inventory Profit a.

Cost per bag of flour ($9.00 / 1.5) Bags sold Cost of goods sold from inventory held, January 1, 20X9

$ 6.00 x 20,000 $120,000

b. Investment in Slice 36,000 NCI in NA of Slice 24,000 Cost of Goods Sold 60,000 $60,000 = 20,000 bags x $3.00 The basic entry (not shown) would be adjusted by 60,000 to reverse the gross profit deferral and complete the elimination process. c.

Operating income of Pie Bakery Net income of Slice Products Add: Inventory profits realized in 20X9 Consolidated net income Less: Income assigned to noncontrolling shareholders ($250,000 + $60,000) x 0.40 Income assigned to controlling interest Alternate computation: Operating income of Pie Bakery Net income of Slice Products Inventory profits realized in 20X9 Realized net income Ownership held by Pie Bakery Income assigned to controlling interest

$300,000 250,000 $550,000 60,000 $610,000 (124,000) $486,000 $300,000

$250,000 60,000 $310,000 x 0.60 186,000 $486,000

Chapter 06 – Intercompany Inventory Transactions

E6-11 Computation of Consolidated Income Statement Data Downstream Transaction Calculations

Sales COGS

Total = 30,000 20,000

Gross Profit

10,000

Gross Profit %

33.33%

Re-sold + 24,000 16,000 8,000

Ending Inventory 6,000 4,000 2,000

Worksheet Entry (not requested in problem) Sales 30,000 Cost of Goods Sold 28,000 Inventory 2,000 The basic entry (not shown) would be adjusted by 2,000 of deferred profit to complete the elimination process. Upstream Transaction Calculations

Sales COGS

Total = 80,000 50,000

Gross Profit

30,000

Gross Profit %

37.50%

Re-sold + 60,000 37,500 22,500

Ending Inventory 20,000 12,500 7,500

Worksheet Entry (not requested in problem) Sales 80,000 Cost of Goods Sold 72,500 Inventory 7,500 The basic entry (not shown) would be adjusted by 7,500 of deferred profit to complete the elimination process. a.

Reported sales of Player Company Reported sales of Scout Company Intercompany sales by Player Company in 20X5 Intercompany sales by Scout Company in 20X5 Sales reported on consolidated income statement

$400,000 200,000 $600,000 $ 30,000 80,000

(110,000) $490,000

Chapter 06 – Intercompany Inventory Transactions

E6-11 (continued) b.

Cost of goods sold reported by Player Company Cost of goods sold reported by Scout Company

$250,000 120,000 $370,000 (100,500) $269,500

Adjustment due to intercompany sales Consolidated cost of goods sold Adjustment to cost of goods sold:

CGS charged by Player on sale to Scout CGS charged by Scout ($30,000 - $6,000) Total charged to CGS CGS for consolidated entity $20,000 x ($24,000 / $30,000) Required adjustment to CGS

$ 20,000 24,000 $ 44,000

CGS charged by Scout on sale to Player CGS charged by Player ($80,000 - $20,000) Total charged to CGS CGS for consolidated entity $50,000 x ($60,000 / $80,000) Required adjustment to CGS Total adjustment required

$ 50,000 60,000 $110,000

(16,000) $ 28,000

(37,500) 72,500 $100,500

Reported net income of Scout Company Unrealized profit on sale to Player Company $30,000 x ($20,000 / $80,000) Realized net income Noncontrolling interest's share Income assigned to noncontrolling interest Reported net income of Player Company Less: Income from Scout Net income of Scout Company Operating income Less: Unrealized inventory profits of Player Company [$10,000 x ($6,000 / $30,000)] Unrealized inventory profits of Copper Company [$30,000 x ($20,000 / $80,000)] Income assigned to noncontrolling interest Income assigned to controlling interest

$ 45,000 (7,500) $ 37,500 x 0.40 $ 15,000 $100,500 (20,500)

$ 80,000 45,000 $125,000

$ 2,000 7,500 15,000

(24,500) $ 100,500

Chapter 06 – Intercompany Inventory Transactions

E6-12 Intercompany Sales 20X4 Calculations:

Sales COGS Gross Profit Gross Profit %

Ending Inventory 45,000 30,000 15,000

Total = Re-sold + 180,000 135,000 120,000 90,000 60,000 45,000 33.33%

Worksheet Entry (not required in problem) Sales 180,000 Cost of Goods Sold 165,000 Inventory 15,000 The basic entry (not shown) would be adjusted by 15,000 of deferred profit to complete the elimination process. 20X5 Calculations: 20X5 Upstream

Sales COGS Gross Profit Gross Profit %

Total 135,000 90,000 45,000 33.33%

Re-sold 105,000 70,000 35,000

Ending Inventory 30,000 20,000 10,000

20X5 Downstream

Sales COGS Gross Profit Gross Profit %

Total = Re-sold 280,000 170,000 140,000 85,000 140,000 85,000 50.00%

Ending Inventory 110,000 55,000 55,000

Worksheet Consolidation Entries (not required in problem): Eliminate Upstream Transactions Sales 135,000 Cost of Goods Sold 125,000 Inventory 10,000 Eliminate Downstream Transactions Sales 280,000 Cost of Goods Sold 225,000 Inventory 55,000 Reversal of 20X4 Upstream Deferral Investment in Scope 10,500 NCI in NA of Scope 4,500 Cost of Goods Sold

15,000

Chapter 06 – Intercompany Inventory Transactions

E6-12 (continued) The basic entry (not shown) would be adjusted by 65,000 of deferred profit and 15,000 to reverse the prior year gross profit deferral to complete the elimination process. a.

Consolidated net income for 20X4: Operating income of Pistol Corporation Net income of Scope Corporation

$160,000 90,000 $250,000 (15,000) $235,000

Less: Unrealized profit — Scope Corporation Consolidated net income b.

Inventory balance, December 31, 20X5: Inventory reported by Pistol Corporation Unrealized profit on books of Scope Corporation ($135,000 - $90,000) x ($30,000/$135,000)

$ 30,000

Inventory reported by Scope Corporation Unrealized profit on books of Pistol Corporation ($280,000 - $140,000) x ($110,000/$280,000) Inventory, December 31, 20X5

$110,000

(10,000)

55,000 $75,000

Consolidated cost of goods sold for 20X5: COGS on sale of inventory on hand January 1, 20X5 $45,000 x ($120,000 / $180,000) COGS on items purchased from Scope in 20X5 ($135,000 - $30,000) x ($90,000 / $135,000) COGS on items purchased from Pistol in 20X5 ($280,000 - $110,000) x ($140,000 / $280,000) Total cost of goods sold

(55,000)

$20,000

$ 30,000 70,000 85,000 $185,000

Income assigned to controlling interest: Operating income of Pistol Corporation Net income of Scope Corporation Add: Inventory profit of prior year realized in 20X5 Less: Unrealized inventory profit — Scope Corporation Unrealized inventory profit — Pistol Corporation Income to noncontrolling interest ($85,000 + $15,000 - $10,000) x 0.30 Income assigned to controlling interest

$220,000 85,000 $305,000 15,000 (10,000) (55,000) (27,000) $228,000

Chapter 06 – Intercompany Inventory Transactions

E6-13 Consolidated Balance Sheet Worksheet a. Equity Method Entries on Pint Corp.'s Books: Investment in Saloon Co.

49,000

Income from Saloon Co.

49,000

Record Pint Corp.'s 70% share of Saloon Co.'s 20X8 income Cash

9,800

Investment in Saloon Co.

9,800

Record Pint Corp.'s 70% share of Saloon Co.'s 20X8 dividend Income from Saloon Co.

10,000

Investment in Saloon Co.

10,000

Eliminate the deferred gross profit from downstream sales in 20X8 Income from Saloon Co.

28,000

Investment in Saloon Co.

28,000

Eliminate the deferred gross profit from upstream sales in 20X8 Book Value Calculations: NCI 30%

Pint Corp. 70%

Common Stock 150,000

Retained Earnings

Beginning Book Value

103,200

240,800

+ Net Income

21,000

49,000

70,000

- Dividends

(4,200)

(9,800)

(14,000)

Ending Book Value

120,000

280,000

150,000

194,000

250,000

Adjustment to Basic Consolidation Entry NCI Pint Corp Net Income 21,000 49,000 - Gross profit deferral (down) (10,000) - Gross profit deferral (up) (12,000) (28,000) Income to be eliminated 9,000 11,000 ------------------------------------------------------------------------------------Ending Book Value 120,000 280,000 - Gross profit deferral (down) (10,000) - Gross profit deferral (up) (12,000) (28,000) Adjusted Book Value 108,000 242,000 108,000 242,000

Chapter 06 – Intercompany Inventory Transactions

E6-13 (continued) Basic Consolidation Entry Common Stock

150,000

← Common stock balance

Retained Earnings

194,000

← Beginning balance in retained earnings

Income from Saloon Co.

11,000

← Pint’s % of NI with adjustment

NCI in NI of Saloon Co.

9,000

← NCI share of NI with adjustment

Dividends Declared

14,000

← 100% of Saloon Co.'s dividends declared

Investment in Saloon Co.

242,000

← Net book value with adjustment

NCI in NA of Saloon Co.

108,000

← NCI share of BV with adjustment

Deferral of this year's unrealized profits on inventory transfers Sales

400,000

Cost of Goods Sold

350,000

Inventory

50,000

20X8 Downstream Transactions Total

Re-sold

Ending Inventory

Sales

100,000

75,000

25,000

COGS

60,000

45,000

15,000

Gross Profit

40,000

30,000

10,000

Gross Profit %

40.00%

20X8 Upstream Transactions Total

Re-sold

Ending Inventory

Sales

300,000

205,000

95,000

COGS

173,684

118,684

55,000

Gross Profit

126,316

86,316

40,000

Gross Profit %

42.11% Investment in

Income from

Saloon Co.

Beginning Balance

240,800

70% Net Income

49,000

Ending Balance

9,800

70% Dividends

38,000

Deferred GP

Basic

70% Net Income

11,000

Ending Balance

38,000

242,000 242,000

49,000

11,000 0

Chapter 06 – Intercompany Inventory Transactions

E6-13 (continued) b.

Saloon Co.

Consolidation Entries DR CR

Consolidated

98,000 150,000

40,000 100,000

50,000

138,000 200,000

310,000 242,000 800,000

280,000 242,000 292,000

590,000 0 928,000

Accounts Payable Common Stock Retained Earnings

70,000 200,000 530,000

20,000 150,000 250,000

NCI in NA of Saloon Co. Total Liabilities & Equity

800,000

420,000

Pint Corp. Balance Sheet Cash and Receivables Inventory Buildings & Equipment (net) Investment in Saloon Co. Total Assets

420,000

150,000 194,000 11,000 9,000 400,000 764,000

14,000 350,000

108,000 472,000

90,000 200,000 530,000

108,000 928,000

Chapter 06 – Intercompany Inventory Transactions

E6-14* Multiple Transfers between Affiliates a.

Entries recorded by Klon Corporation Cash (Accounts Receivable) Sales Sale of inventory to Brant Company.

150,000

Cost of Goods Sold Inventory Record cost of goods sold.

100,000

150,000

100,000

Entries recorded by Brant Company Inventory Cash (Accounts Payable) Purchase of inventory from Klon.

150,000

Cash (Accounts Receivable) Sales Sale of inventory to Torkel Company.

150,000

Cost of Goods Sold Inventory Record cost of goods sold.

150,000

Entries recorded by Torkel Company Inventory Cash (Accounts Payable) Purchase of inventory from Brant.

150,000

Cash (Accounts Receivable) Sales Sale of inventory to nonaffiliates.

120,000

Cost of Goods Sold Inventory Record cost of goods sold.

90,000

150,000

120,000

Cost of goods sold for 20X8 should be reported as $60,000 [$90,000 x ($100,000 / $150,000)].

Inventory at December 31, 20X8, should be reported at $40,000 [$60,000 x ($100,000 / $150,000)].

90,000

Chapter 06 – Intercompany Inventory Transactions

E6-14* (continued) d.

Consolidation entry for inventory: Sales 300,000 Cost of Goods Sold 280,000 Inventory 20,000 The basic entry (not shown) would be adjusted by 20,000 of deferred profit to complete the elimination process. Computation of cost of goods sold to be eliminated Cost of goods sold recorded by Klon Cost of goods sold recorded by Brant Cost of goods sold recorded by Torkel Total recorded Consolidated cost of goods sold Required elimination

$100,000 150,000 90,000 $340,000 (60,000) $280,000

Computation of reduction to carrying value of inventory Inventory reported by Torkel Inventory balance to be reported Required elimination

$60,000 (40,000) $20,000

Chapter 06 – Intercompany Inventory Transactions

E6-15 Inventory Sales a.

Journal entries recorded by Slim Company: (1)

(2)

(3)

Inventory Cash (Accounts Payable) Record purchases from nonaffiliate.

150,000

Cash (Accounts Receivable) Sales Record sale to Plump Corporation.

60,000

Cost of Goods Sold Inventory Record cost of goods sold to Plump Corporation.

40,000

150,000

60,000

40,000

Journal entries recorded by Plump Corporation: (1)

(2)

(3)

(4)

Inventory Cash (Accounts Payable) Record purchases from Slim Company.

60,000

Cash (Accounts Receivable) Sales Record sale of items to nonaffiliates.

90,000

Cost of Goods Sold Inventory Record cost of goods sold.

45,000

60,000

90,000

45,000

Income from Slim 3,000 Investment in Slim 3,000 Eliminate 60% of unrealized gross profit on inventory purchases from Slim.

Consolidation entry:

Sales COGS

Total = Re-sold + 60,000 45,000 40,000 30,000

Gross Profit

20,000

Gross Profit %

33.33%

15,000

Ending Inventory 15,000 10,000 5,000

Sales 60,000 Cost of Goods Sold 55,000 Inventory 5,000 Eliminate intercompany inventory sales. The basic entry (not shown) would be adjusted by 5,000 of deferred profit to complete the elimination process.

Chapter 06 – Intercompany Inventory Transactions

E6-16 Prior-Period Inventory Profits a. 20X8 Sale:

Sales COGS

Total = Re-sold + 180,000 150,000 120,000 100,000

Gross Profit

60,000

Gross Profit %

33.33%

Ending Inventory 30,000 20,000

50,000

10,000

Ending Inventory 150,000 100,000

20X9 Sale:

Sales COGS

Total = 240,000 160,000

Re-sold + 90,000 60,000

Gross Profit

80,000

30,000

Gross Profit %

33.33%

Investment in Scrub NCI in NA of Scrub Cost of goods sold Reversal of 20X8 gross profit deferral

50,000

7,500 2,500 10,000

Sales 240,000 Cost of Goods Sold 190,000 Inventory 50,000 Eliminate 20X9 intercompany sale of inventory. The basic entry (not shown) would be adjusted by 50,000 of 20X9 deferred profit and by 10,000 to reverse the 20X8 gross profit deferral to complete the elimination process. b. Reported net income of Scrub Unrealized profit, December 31, 20X8 Unrealized profit, December 31, 20X9 Realized net income Noncontrolling interest's share of ownership Income assigned to noncontrolling interest

20X8 $350,000 (10,000) $340,000 x 0.25 $ 85,000

20X9 $420,000 10,000 (50,000) $380,000 x 0.25 $ 95,000

Chapter 06 – Intercompany Inventory Transactions

SOLUTIONS TO PROBLEMS P6-17 Consolidated Income Statement Data a.

$180,000 = $550,000 + $450,000 - $820,000

January 1, 20X2: $25,000 = $75,000 - $50,000 December 31, 20X2: $15,000 = $180,000 + $210,000 - $375,000

Investment in Stain NCI in NA of Stain Cost of Goods Sold Eliminate beginning inventory profit.

15,000 10,000 25,000

Sales 180,000 Cost of Goods Sold 165,000 Inventory 15,000 Eliminate intercompany sale of inventory. The basic entry (not shown) would be adjusted by 15,000 of deferred profit and by 25,000 to reverse the gross profit deferral from the prior year to complete the elimination process. d.

Reported net income of Stain Company Prior-period profit realized in 20X2 Unrealized profit on 20X2 sales Realized income Proportion held by noncontrolling interest Income assigned to noncontrolling interest

$ 90,000 25,000 (15,000) $100,000 x 0.40 $ 40,000

Chapter 06 – Intercompany Inventory Transactions

P6-18 Unrealized Profit on Upstream Sales 20X2

Sales COGS

Ending Total = Re-sold + Inventory 200,000 130,000 70,000 160,000 104,000 56,000

Gross Profit

40,000

Gross Profit %

20.00%

26,000

14,000

20X3

Sales COGS

Total = 175,000 140,000

Ending Re-sold + Inventory 70,000 105,000 56,000 84,000

Gross Profit

35,000

14,000

Gross Profit %

20.00%

21,000

20X4

Sales COGS

Ending Total = Re-sold + Inventory 225,000 105,000 120,000 180,000 84,000 96,000

Gross Profit

45,000

Gross Profit %

20.00%

Operating income reported by Parade Net income reported by Summer Inventory profit, December 31, 20X2 $70,000 - ($70,000 / 1.25) Inventory profit, December 31, 20X3 $105,000 - ($105,000 / 1.25) Inventory profit, December 31, 20X4 $120,000 - ($120,000 / 1.25) Consolidated net income Income to noncontrolling interest: ($100,000 - $14,000) x 0.40 ($90,000 + $14,000 - $21,000) x 0.40 ($160,000 + $21,000 - $24,000) x 0.40 Income to controlling interest

21,000

24,000

20X2

20X3

20X4

$150,000 100,000 $250,000

$240,000 90,000 $330,000

$300,000 160,000 $460,000

(14,000)

14,000

$236,000

(21,000)

21,000

$323,000

(24,000) $457,000

(34,400) (33,200) $201,600

$289,800

(62,800) $394,200

Chapter 06 – Intercompany Inventory Transactions

P6-19 Net Income of Consolidated Entity Operating income of Pawn for 20X5 Net income of Shop for 20X5

$118,000 65,000 $183,000 25,000 40,000 (14,000) (55,000)

Add:

Prior year profits realized by Pawn Prior year profits realized by Shop Less: Unrealized profits for 20X5 by Pawn Unrealized profits for 20X5 by Shop Amortization of differential ($45,000 / 15 years) Consolidated net income, 20X5 Less: Income to noncontrolling interest ($65,000 + $40,000 - $55,000 - $3,000) x 0.30 Income to controlling interest

(3,000) $176,000 (14,100) $161,900

P6-20 Correction of Consolidation Entries a.

Proportion of intercompany inventory purchases resold during 20X5: Unrealized profit at year end $ 12,000 Intercompany transfer price $140,000 Cost of inventory sold ($140,000 / 1.40) (100,000) Total Profit ÷ 40,000 Proportion of intercompany sale held by Pencil at year end 0.30 Proportion of intercompany purchases resold by Pencil during 20X5 (1.00 - 0.30)

0.70

Consolidation entries, December 31, 20X5: Intercompany Transactions

Sales COGS

Ending Total = Re-sold + Inventory 140,000 98,000 42,000 100,000 70,000 30,000

Gross Profit

40,000

Gross Profit %

28.57%

28,000

Accounts Payable Accounts Receivable Eliminate intercompany receivable/payable.

12,000

80,000 80,000

Sales 140,000 Cost of Goods Sold 128,000 Inventory 12,000 Eliminate intercompany sale of inventory. The basic entry (not shown) would be adjusted by 12,000 of deferred profit to complete the elimination process.

Chapter 06 – Intercompany Inventory Transactions

P6-21 Incomplete Data a.

Increase in fair value of buildings and equipment: Consolidated total Balance reported by Peace Balance reported by Symbol Increase in value

Accumulated depreciation for consolidated entity: Accumulated depreciation reported by Peace Accumulated depreciation reported by Symbol Cumulative write-off of differential ($5,000 x 6 years) Accumulated depreciation for consolidated entity

$180,000 110,000 30,000 $320,000

Amount paid by Peace to acquire ownership in Symbol: Common stock outstanding Retained earnings at acquisition Total book value at acquisition Increase in value of buildings and equipment Fair value of net assets acquired Proportion of ownership acquired Amount paid by Peace

$ 680,000 (400,000) (240,000) $ 40,000

$ 60,000 30,000 $ 90,000 40,000 $130,000 x 0.75 $ 97,500

Investment in Symbol Company stock reported at December 31, 20X6: Symbol's common stock outstanding December 31, 20X6 Symbol's retained earnings reported December 31, 20X6 Total book value Proportion of ownership held by Peace Peace's share of net book value Unamortized differential ($5,000 x 2 years) x 0.75 20X6 Gross Profit Deferral on Upstream Sale * Investment in Symbol Company stock

$ 60,000 112,000 $172,000 x 0.75 $129,000 7,500 (3,000) $133,500

* See part f. for Unrealized inventory profit calculation. Total unrealized is $4,000 and Peace owns 75% of Symbol so the total gross profit deferral in the investment account would be $3,000 ($4,000 X 75%). e.

Intercorporate sales of inventory in 20X6: Sales reported by Peace Sales reported by Symbol Total sales Sales reported in consolidated income statement Intercompany sales during 20X6

$420,000 260,000 $680,000 (650,000) $ 30,000

Chapter 06 – Intercompany Inventory Transactions

P6-21 (continued) f.

Unrealized inventory profit, December 31, 20X6: Inventory reported by Peace Inventory reported by Symbol Total inventory Inventory reported in consolidated balance sheet Unrealized inventory profit, December 31, 20X6

$125,000 90,000 $215,000 (211,000) $ 4,000

Consolidation entry to remove the effects of intercompany inventory sales during 20X6: Sales 30,000 Cost of Goods Sold 26,000 Inventory 4,000 The basic entry (not shown) would be adjusted by 4,000 of deferred profit to complete the elimination process.

Unrealized inventory profit at January 1, 20X6: Cost of goods sold reported by Peace Cost of goods sold reported by Symbol Reduction of cost of goods sold for intercompany sales during 20X6 Adjusted cost of goods sold Cost of goods sold reported in consolidated income statement Additional adjustment to cost of goods sold due to unrealized profit in beginning inventory

$310,000 170,000 (26,000) $454,000 (445,000) $ 9,000

Accounts receivable reported by Peace at December 31, 20X6: Accounts receivable reported for consolidated entity Accounts receivable reported by Symbol Difference Adjustment for intercompany receivable/payable: Accounts payable reported by Peace Accounts payable reported by Symbol Total reported accounts payable Accounts payable reported for consolidated entity Adjustment for intercompany receivable/payable Accounts receivable reported by Peace

$145,000 (55,000) $ 90,000 $ 86,000 20,000 $106,000 (89,000) 17,000 $107,000

Chapter 06 – Intercompany Inventory Transactions

P6-22 Eliminations for Upstream Sales a. Equity Method Entries on Plug's Books: Investment in Spark Filter

32,000

Income from Spark Filter

32,000

Record Plug's 80% share of Spark Filter's 20X8 income Investment in Spark Filter

16,000

Income from Spark Filter

16,000

Reverse of the deferred gross profit from upstream sales in 20X7 Income from Spark Filter

12,000

Investment in Spark Filter

12,000

Eliminate the deferred gross profit from upstream sales in 20X8 Book Value Calculations: NCI 20%

Plug 80%

Beg. Book Value

62,000

248,000

+ Net Income

8,000

32,000

Ending Book Value

70,000

280,000

Common Stock 90,000

Retained Earnings 220,000 40,000

90,000

260,000

Adjustment to Basic Consolidation Entry NCI Plug Net Income 8,000 32,000 + Reverse GP deferral (up) 4,000 16,000 - Gross profit deferral (up) (3,000) (12,000) Income to be eliminated 9,000 36,000 ------------------------------------------------------------------------------------Ending Book Value 70,000 280,000 + Reverse GP deferral (up) 4,000 16,000 - Gross profit deferral (up) (3,000) (12,000) Adjusted book value 71,000 284,000

Basic Consolidation entry: Common Stock

90,000

← Common stock balance

Retained Earnings

220,000

← Beginning balance in RE

Income from Spark Filter

36,000

← Parent’s % of NI with adjustment

NCI in NI of Spark Filter

9,000

← NCI share of NI with adjustment

Investment in Spark Filter

284,000

← Net book value with adjustment

NCI in NA of Spark Filter

71,000

← NCI share of BV with adjustment

Chapter 06 – Intercompany Inventory Transactions

P6-22 (continued) 20X7 Upstream Transactions 20X8 Beg. Inventory Sales

60,000

COGS

40,000

Gross Profit

20,000

Gross Profit %

33.33%

20X8 Upstream Transactions Total

Re-sold

Ending Inventory

Sales

150,000

105,000

45,000

COGS

100,000

70,000

30,000

Gross Profit

50,000

35,000

15,000

Gross Profit %

33.33%

Reversal of last year's deferral: Investment in Spark Filter

16,000

NCI in NA of Spark Filter

4,000

Cost of Goods Sold

20,000

Deferral of this year's unrealized profits on inventory transfers Sales

150,000

Cost of Goods Sold

135,000

Inventory

15,000

Investment in Spark Filter Beg. Balance *232,000 80% Net Income 32,000 Last year's reversal Ending Balance Reversal

16,000 12,000 268,000 16,000 284,000 0

Income from Spark Filter 32,000 80% Net Income Deferred GP

12,000

Basic

36,000

16,000 Last year's reversal 36,000 Ending Balance 0

*Note that the beginning balance in the Investment in Spark Filter account ($232,000) is NOT equal to Plug’s 80% share of Spark Filter’s equity accounts ($248,000) as indicated in the first line of the Book Value Calculations box above because Plug made a $16,000 equity method adjustment for its 80% share of the unrealized gross profit on upstream inventory transfers last year while Spark Filter makes no adjustment in its accounts. Thus, the basic consolidation entry is modified to account for this difference.

Chapter 06 – Intercompany Inventory Transactions

P6-22 (continued) b.

Computation of consolidated net income and income assigned to controlling interest: Operating income reported by Plug Products ($250,000 - $175,000 - $30,000) Net income of Spark Filter ($200,000 - $140,000 - $20,000) Inventory profit realized from 20X7 Unrealized inventory profit for 20X8 Consolidated net income Income assigned to noncontrolling interest ($40,000 + $20,000 - $15,000) x 0.20 Income assigned to controlling interest

$ 45,000 40,000 $ 85,000 20,000 (15,000) $ 90,000 (9,000) $ 81,000

Noncontrolling interest, December 31, 20X8: Common stock Retained earnings ($220,000 + $40,000) Less: Unrealized inventory profit Proportion of stock held by noncontrolling interest Noncontrolling interest

$ 90,000 260,000 (15,000) $335,000 x 0.20 $ 67,000

Chapter 06 – Intercompany Inventory Transactions

P6-23 Multiple Inventory Transfers a.

Consolidated net income for 20X8: Operating income of Ajax Corporation Unrealized profit, December 31, 20X8 ($35,000 - $15,000) x ($7,000 / $35,000)

$80,000

Net income of Beta Corporation Profit realized from 20X7 ($30,000 - $24,000) x ($10,000 / $30,000) Unrealized profit, December 31, 20X8 ($72,000 - $63,000) x ($12,000 / $72,000)

$37,500

Net income of Cole Corporation Profit realized from 20X7 ($72,000 - $60,000) x ($18,000 / $72,000) Unrealized profit, December 31, 20X8 ($45,000 - $27,000) x ($15,000 / $45,000) Consolidated net income

$20,000

(4,000)

$ 76,000

2,000 (1,500)

38,000

3,000 (6,000)

17,000 $131,000

Inventory balance, December 31, 20X8: Balance per Beta Corporation Less: Unrealized profit

$ 7,000 (4,000)

$ 3,000

Balance per Cole Corporation Less: Unrealized profit

$12,000 (1,500)

10,500

Balance per Ajax Corporation Less: Unrealized profit Inventory balance per consolidated statement

$15,000 (6,000)

9,000 $22,500

Income assigned to noncontrolling interest in 20X8: Realized income of Beta Corporation Proportion of stock held by noncontrolling interest

$38,000

Realized income of Cole Corporation Proportion of stock held by noncontrolling interest Income to noncontrolling interest

$17,000

0.30

0.10

$11,400

1,700 $13,100

Chapter 06 – Intercompany Inventory Transactions

P6-24

Consolidation with Inventory Transfers and Other Comprehensive Income 20X4 Downstream Transactions

Sales COGS Gross Profit Gross Profit %

Total 108,000 90,000 18,000 16.67%

Re-sold 60,000 50,000 10,000

Re-sold 27,000 18,000 9,000

Re-sold 24,000 20,000 4,000

Re-sold 48,000 32,000 16,000

Ending Inventory 48,000 40,000 8,000

20X4 Upstream Transactions

Sales COGS Gross Profit Gross Profit %

Total 45,000 30,000 15,000 33.33%

Ending Inventory 18,000 12,000 6,000

20X5 Downstream Transactions

Sales COGS Gross Profit Gross Profit %

Total 36,000 30,000 6,000 16.67%

Ending Inventory 12,000 10,000 2,000

20X5 Upstream Transactions

Sales COGS Gross Profit Gross Profit %

Beg. Balance 90% Net Income

20X4 Reversal Ending Balance Reversal

Total 90,000 60,000 30,000 33.33%

Investment in Sauce Corp. 1,246,600 81,000 54,000 18,000 13,400 1,290,400 13,400 0

Ending Inventory 42,000 28,000 14,000

Income from Sauce Corp.

14,600

90% Dividends 90% of OCI Gain Deferred GP

1,285,800 18,000

Basic OCI Entry

14,600

81,000

90% Net Income

13,400 79,800

20X4 Reversal Ending Balance

79,800 0

Chapter 06 – Intercompany Inventory Transactions

P6-24 (continued) a.

Balance in investment account at December 31, 20X5: Proportionate share of Sauce's net assets, January 1 ([$1,400,000 x .90] – 8,000 – [6,000 x 0.90]) Proportionate share of 20X5 net income ($90,000 x 0.90) Proportionate share of other comprehensive income for 20X5 ($20,000 x 0.90) Proportionate share of dividends received ($60,000 x 0.90) Reversal of deferred gain from 20X4 downstream transaction Reversal of deferred gain from 20X4 upstream transaction ($6,000 x .090) Deferred gain from downstream transaction Proportionate share of deferred gain from upstream transaction ($14,000 x 0.90) Balance in investment account December 31, 20X5

81,000 18,000 (54,000) 8,000 5,400 (2,000) (12,600) $1,290,400

Investment income for 20X5: Net income reported by Sauce Proportion of ownership held by Pesto Pesto’s share of reported income from Sauce Reversal of deferred gain from 20X4 downstream transaction Reversal of deferred gain from 20X4 upstream transaction ($6,000 x 0.90) Deferred gain from downstream transaction Proportionate share of deferred gain from upstream transaction ($14,000 x 0.90) Investment income for 20X5

$1,246,600

$90,000 x 0.90 81,000 8,000 5,400 (2,000) (12,600) $79,800

Income to noncontrolling interests for 20X5: Net income reported by Sauce 20X4 inventory profits realized in 20X5 ($15,000 x 0.40) 20X5 unrealized inventory profits $30,000 - [$30,000 x ($48,000 / $90,000)] Realized net income Proportion of ownership held by noncontrolling interest Income to noncontrolling interest

$90,000 6,000 (14,000) $82,000 x 0.10 $ 8,200

Chapter 06 – Intercompany Inventory Transactions

Balance assigned to noncontrolling interest in consolidated balance sheet: Net assets reported by Sauce, January 1 Net income for 20X5 Dividends paid in 20X5 Net assets reported, December 31, 20X5 Unrealized inventory profits at December 31, 20X5 Other comprehensive income in 20X5 Adjusted net assets, December 31, 20X5 Proportion of ownership held by noncontrolling interest Net assets assigned to noncontrolling interest

$1,400,000 90,000 (60,000) $1,430,000 (14,000) 20,000 $1,436,000 x 0.10 $ 143,600

Inventory reported in consolidated balance sheet: Inventory held by Pesto Less: Unrealized profit

$120,000 (14,000)

Inventory held by Sauce Less: Unrealized profit $6,000 - [$6,000 x ($24,000 / $36,000)] Inventory

$100,000

$106,000

(2,000)

98,000 $204,000

Consolidated net income for 20X5: Operating income of Pesto Net income of Sauce Total unadjusted income 20X4 inventory profits realized in 20X5 ($6,000 + $8,000) Unrealized inventory profits on 20X5 sales ($14,000 + $2,000) Consolidated net income

$240,000 90,000 $330,000 14,000 (16,000) $328,000

Consolidation entries, December 31, 20X5

Book Value Calculations: NCI 10% Beginning book value + Net Income - Dividends Ending book value

140,000 9,000 (6,000) 143,000

Pesto Corp. 90% 1,260,000 81,000 (54,000) 1,287,000

Comm. Stock

Add. Paid-In Capital

400,000

200,000

400,000

200,000

Retained

Earnings 790,000 90,000 (60,000) 820,000

Acc. OCI 10,000

10,000

Chapter 06 – Intercompany Inventory Transactions

P6-24 (continued)

Adjustment to Basic Consolidation Entry NCI Pesto Net Income 9,000 81,000 +Reverse GP deferral (down) 8,000 +Reverse GP deferral (up) 600 5,400 - Gross profit deferral (down) (2,000) - Gross profit deferral (up) (1,400) (12,600) Income to be eliminated 8,200 79,800 ------------------------------------------------------------------------------------Ending Book Value 143,000 1,287,000 +Reverse GP deferral (down) 8,000 +Reverse GP deferral (up) 600 5,400 - Gross profit deferral (down) (2,000) - Gross profit deferral (up) (1,400) (12,600) Adjusted Book Value 142,200 1,285,800

Basic Consolidation Entry Common Stock

400,000

← Common stock balance

Additional Paid-in Capital

200,000

← Beginning balance in APIC

Retained Earnings

790,000

← Beginning balance in RE

Accumulated OCI

10,000

← Beginning balance in Acc. OCI

Income from Sauce Corp.

79,800

← PC.’s % of NI with adjustment

NCI in NI of Sauce Corp. Dividends Investment in Sauce Corp.

8,200

NCI in NA of Sauce Corp.

60,000 1,285,800

← NCI share of NI with adjustment ← Dividends declared by subsidiary ← Net book value with adjustment

142,200

← NCI share of BV with adjustment

Other Comprehensive Income Entry: OCI from Sauce Corp.

18,000

OCI to the NCI

2,000

Investment in Sauce Corp.

18,000

NCI in NA of Sauce Corp.

2,000

Reversal of last year's deferral: Investment in Sauce Corp.

13,400

NCI in NA of Sauce Corp.

600

Cost of Goods Sold

14,000

Deferral of this year's unrealized profits on inventory transfers Sales

126,000

Cost of Goods Sold

110,000

Inventory

16,000

Chapter 06 – Intercompany Inventory Transactions

P6-25 Multiple Inventory Transfers between Parent and Subsidiary 20X5 Downstream

Total = Re-sold + 150,000 90,000 100,000 60,000 50,000 30,000 33.33%

Sales COGS Gross Profit Gross Profit %

Ending Inventory, 20X5 60,000 40,000 20,000

20X5 Upstream

Sales COGS Gross Profit Gross Profit %

Total = Re-sold + 100,000 30,000 70,000 21,000 30,000 9,000 30.00%

Sales COGS Gross Profit Gross Profit %

Beg Inventory, 20X6 = Re-sold + 70,000 50,000 49,000 35,000 21,000 15,000 30.00%

Ending Inventory, 20X5 70,000 49,000 21,000

Ending Inventory, 20X6 20,000 14,000 6,000

20X6 Downstream

Sales COGS Gross Profit Gross Profit %

Total = Re-sold + 60,000 54,000 40,000 36,000 20,000 18,000 33.33%

Ending Inventory, 20X6 6,000 4,000 2,000

20X6 Upstream

Sales COGS Gross Profit Gross Profit %

Total = Re-sold + 240,000 60,000 200,000 50,000 40,000 10,000 16.67%

Ending Inventory, 20X6 180,000 150,000 30,000

Chapter 06 – Intercompany Inventory Transactions

Consolidation entries: Investment in Slinky 20,000 Cost of goods sold Eliminate beginning inventory profit of Proud Company. Investment in Slinky 12,600 NCI in NA of Slinky 8,400 Cost of goods sold Inventory Eliminate beginning inventory profit of Slinky Company. Sales 60,000 Cost of goods sold Inventory Eliminate intercompany sale of inventory by Proud Company.

20,000

15,000 6,000

58,000 2,000

Sales 240,000 Cost of goods sold 210,000 Inventory 30,000 Eliminate intercompany sale of inventory by Slinky Company. The basic entry (not shown) would be adjusted by 38,000 of deferred profit and 35,000 to reverse the prior year gross profit deferral and complete the elimination process. b.

Computation of cost of goods sold for consolidated entity: Inventory produced by Proud in 20X5 ($100,000 x 0.40) Inventory produced by Slinky in 20X5 ($70,000 x 0.50) Inventory produced by Proud in 20X6 ($40,000 x 0.90) Inventory produced by Slinky in 20X6 ($200,000 x 0.25) Cost of goods sold reported in consolidated income statement

$ 40,000 35,000 36,000 50,000 $161,000

Chapter 06 – Intercompany Inventory Transactions

P6-26 Consolidation following Inventory Transactions a. Equity Method Entries on Pirate Co.'s Books: Investment in Ship Corp. 18,000 Income from Ship Corp. Record Pirate Co.'s 60% share of Ship Corp.'s 20X2 income

18,000

Cash 6,000 Investment in Ship Corp. Record Pirate Co.'s 60% share of Ship Corp.'s 20X2 dividend

6,000

Income from Ship Corp. 6,500 Investment in Ship Corp. Eliminate the deferred gross profit from downstream sales in 20X2

6,500

Investment in Ship Corp. 2,040 Income from Ship Corp. Reverse of the deferred gross profit from upstream sales in 20X1

2,040

Income from Ship Corp. 2,520 Investment in Ship Corp. Eliminate the deferred gross profit from upstream sales in 20X2

2,520

b. Book Value Calculations: NCI 40%

Pirate Co. 60%

Common Stock

Retained Earnings

Beginning Book Value

60,000

90,000

+ Net Income

12,000

18,000

30,000

- Dividends

(4,000)

(6,000)

(10,000)

Ending Book Value

68,000

102,000

100,000

50,000

70,000

Adjustment to Basic Consolidation Entry NCI Pirate Co. Net Income 12,000 18,000 +Reverse GP deferral (up) 1,360 2,040 - Gross profit deferral (down) (6,500) - Gross profit deferral (up) (1,680) (2,520) Income to be eliminated 11,680 11,020 ------------------------------------------------------------------------------------Ending Book Value 68,000 102,000 +Reverse GP deferral (up) 1,360 2,040 - Gross profit deferral (down) (6,500) - Gross profit deferral (up) (1,680) (2,520) Adjusted Book Value 67,680 95,020 P6-26 (continued) 6-43 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 06 – Intercompany Inventory Transactions

Basic Consolidation Entry Common Stock

100,000

← Common stock balance

Retained Earnings

50,000

← Beginning balance in RE

Income from Ship Corp.

11,020

← Pirate’s % of NI with adjustment

NCI in NI of Ship Corp.

11,680

← NCI share of NI with adjustment

Dividends declared

10,000

← 100% of Ship Corp.'s dividends

Investment in Ship Corp.

95,020

← Net book value with adjustment

NCI in NA of Ship Corp.

67,680

← NCI share of BV with adjustment

Excess Value (Differential) Calculations: NCI Pirate Co. 40% + 60% Beginning balance

Land

10,800

18,000

7,200

10,800

18,000

Changes Ending balance

7,200

Excess Value (differential) Reclassification Entry: Land

18,000

Investment in Ship Corp.

10,800

NCI in NA of Ship Corp.

7,200

Accumulated depreciation consolidation entry Accumulated Depreciation

45,000

Building & Equipment

45,000

Reversal of last year's deferral: Investment in Ship Corp.

2,040

NCI in NA of Ship Corp.

1,360

Cost of Goods Sold

3,400

Deferral of this year's unrealized profits on inventory transfers Sales

63,000

Cost of Goods Sold

52,300

Inventory

10,700

Chapter 06 – Intercompany Inventory Transactions

P6-26 (continued) 20X2 Downstream Transactions Total

Re-sold

Ending Inventory

Sales

28,000

15,000

13,000

COGS

14,000

7,500

6,500

Gross Profit

14,000

7,500

6,500

Gross Profit %

50.00%

20X1 Upstream Transactions Total

Re-sold

Ending Inventory

Sales

42,500

34,000

8,500

COGS

25,500

20,400

5,100

Gross Profit

17,000

13,600

3,400

Gross Profit %

40.00%

20X2 Upstream Transactions Total

Re-sold

Ending Inventory

Sales

35,000

24,500

10,500

COGS

21,000

14,700

6,300

Gross Profit

14,000

9,800

4,200

Gross Profit %

40.00%

Investment in Ship Corp. Beginning Balance 60% Net Income 20X1 Reversal Ending Balance Reversal

Income from Ship Corp.

98,760 18,000 2,040 103,780 2,040 0

6,000 9,020

60% Dividends Deferred GP

95,020 10,800

Basic Excess Reclass.

9,020

18,000

60% Net Income

2,040 11,020

20X1 Reversal Ending Balance

11,020 0

Chapter 06 – Intercompany Inventory Transactions

P6-26 (continued) c. Consolidation Entries DR CR

Pirate Co.

Ship Corp.

200,000 (99,800)

120,000 (61,000)

(25,000) (6,000) 11,020 80,220

(15,000) (14,000) 30,000

11,020 74,020 11,680

55,700

80,220

30,000

85,700

55,700

80,220

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

227,960 80,220 (40,000) 268,180

50,000 30,000 (10,000) 70,000

50,000 85,700

55,700 10,000 65,700

227,960 80,220 (40,000) 268,180

Balance Sheet Cash and Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Ship Corp.

69,400 60,000 40,000 520,000 (175,000) 103,780

51,200 55,000 30,000 350,000 (75,000)

Total Assets

618,180

411,200

Accounts Payable Bonds Payable Bonds Premium Common Stock Retained Earnings NCI in NA of Ship Corp.

68,800 80,000 1,200 200,000 268,180

41,200 200,000 100,000 70,000

100,000 135,700 1,360

Total Liabilities & Equity

618,180

411,200

237,060

Income Statement Sales Less: COGS Less: Depreciation Expense Less: Interest Expense Income from Ship Corp. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

63,000 52,300 3,400

135,700

10,700 18,000 45,000 45,000 2,040 65,040

95,020 10,800 161,520

65,700 67,680 7,200 140,580

Consolidated 257,000 (105,100) (40,000) (20,000) 0 91,900 (11,680)

120,600 104,300 88,000 825,000 (205,000) 0 932,900 110,000 280,000 1,200 200,000 268,180 73,520 932,900

Chapter 06 – Intercompany Inventory Transactions

P6-27 Consolidation Worksheet a. Equity Method Entries on Plaza Corp.'s Books: Investment in Square Co.

14,000

Income from Square Co.

14,000

Record Plaza Corp.'s 70% share of Square Co.'s 20X9 income Cash

3,500

Investment in Square Co.

3,500

Record Plaza Corp.'s 70% share of Square Co.'s 20X9 dividend Investment in Square Co.

15,000

Income from Square Co.

15,000

Reverse of the deferred gross profit from downstream sales in 20X8 Income from Square Co.

8,000

Investment in Square Co.

8,000

Eliminate the deferred gross profit from downstream sales in 20X9 Investment in Square Co.

21,000

Income from Square Co.

21,000

Reverse of the deferred gross profit from upstream sales in 20X8 Income from Square Co.

17,500

Investment in Square Co.

17,500

Eliminate the deferred gross profit from upstream sales in 20X9 Book Value Calculations: NCI 30% Beginning Book value + Net Income - Dividends Ending Book Value

120,000 6,000 (1,500) 124,500

Plaza Corp. 70% 280,000 14,000 (3,500) 290,500

Common Stock 150,000

150,000

Retained Earnings 250,000 20,000 (5,000) 265,000

Chapter 06 – Intercompany Inventory Transactions

P6-27 (continued) Adjustment to Basic Consolidation Entry NCI Plaza Corp Net Income 6,000 14,000 +Reverse GP deferral (down) 15,000 +Reverse GP deferral (up) 9,000 21,000 - Gross profit deferral (down) (8,000) - Gross profit deferral (up) (7,500) (17,500) Income to be eliminated 7,500 24,500 ------------------------------------------------------------------------------------Ending Book Value 124,500 290,500 +Reverse GP deferral (down) 15,000 +Reverse GP deferral (up) 9,000 21,000 - Gross profit deferral (down) (8,000) - Gross profit deferral (up) (7,500) (17,500) Adjusted Book Value 126,000 301,000 Basic Consolidation Entry Common Stock Retained Earnings Income from Square Co. NCI in NI of Square Co. Dividends Declared Investment in Square Co. NCI in NA of Square Co.

150,000 250,000 24,500 7,500 5,000 301,000 126,000

Excess Value (Differential) Calculations: NCI Plaza 30% + Corp. 70% Beginning balance 10,800 25,200 Changes 0 0 Ending balance 10,800 25,200

← Common stock balance ← Beginning balance in RE ← Plaza’s % of NI with adjustment ← NCI share of NI with adjustment ← 100% of Square Co.'s dividends ← Net book value with adjustment ← NCI share of BV with adjustment

Land

14,000 0 14,000

Excess Value (Differential) Reclassification Entry: Land 14,000 Goodwill 22,000 Investment in Square Co. NCI in NA of Square Co.

25,200 10,800

Reversal of last year's deferral: Investment in Square Co. NCI in NA of Square Co. Cost of Goods Sold

45,000

Goodwill 22,000 0 22,000

36,000 9,000

Deferral of this year's unrealized profits on inventory transfers Sales 152,000 Cost of Goods Sold 119,000 Inventory 33,000

Chapter 06 – Intercompany Inventory Transactions

P6-27 (continued) 20X9 Downstream Transactions Total

Re-sold

Ending Inventory

Sales

90,000

70,000

20,000

COGS

54,000

42,000

12,000

Gross Profit

36,000

28,000

8,000

Gross Profit %

40.00%

20X9 Upstream Transactions Total

Re-sold

Ending Inventory

Sales

62,000

COGS

37,000

Gross Profit

25,000

Gross Profit %

40.32%

Investment in

Income from

Square Co.

Beginning Balance

269,200

70% Net Income

14,000

20X8 Reversal

36,000

Ending Balance

290,200

Reversal

36,000 0

3,500

70% Dividends

25,500

Deferred GP

301,000

Basic

25,200

Excess Reclass.

25,500

14,000

70% Net Income

36,000

20X8 Reversal

24,500

Ending Balance

24,500 0

Chapter 06 – Intercompany Inventory Transactions

P6-27 (continued) b.

Plaza Corp.

Square Co.

300,000 (200,000)

200,000 (150,000)

(40,000) 24,500 84,500

(30,000)

84,500

20,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

532,000 84,500 (35,000) 581,500

250,000 20,000 (5,000) 265,000

Balance Sheet Cash and Receivable Inventory Land, Buildings, and Equipment (net) Investment in Square Co.

81,300 200,000 270,000 290,200

85,000 110,000 250,000

Goodwill Total Assets

841,500

445,000

Accounts Payable Common Stock Retained Earnings NCI in NA of Square Co.

60,000 200,000 581,500

30,000 150,000 265,000

Total Liabilities & Equity

841,500

445,000

Income Statement Sales Less: COGS Less: Depreciation Expense Income from Square Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

20,000

Consolidation Entries DR CR 152,000 119,000 45,000 24,500 176,500 7,500 184,000

250,000 184,000 434,000

Consolidated 348,000 (186,000)

164,000

(70,000) 0 92,000 (7,500) 84,500

164,000 5,000 169,000

532,000 84,500 (35,000) 581,500

164,000

33,000 14,000 36,000 22,000 72,000

150,000 434,000 9,000 593,000

301,000 25,200 359,200

169,000 126,000 10,800 305,800

166,300 277,000 534,000 0 22,000 999,300 90,000 200,000 581,500 127,800 999,300

Chapter 06 – Intercompany Inventory Transactions

P6-28 Computation of Consolidated Totals a.

Consolidated sales for 20X8: Sales reported Intercorporate sales Sales to nonaffiliates

Phone Corp. $660,000 (140,000) $520,000

Smart Company $510,000 (240,000) $270,000

$660,000 ÷ 1.4 $471,429

$510,000 ÷ 1.2 $425,000

(128,000) $343,429

(232,000) $193,000

Consolidated $790,000

Consolidated cost of goods sold: Total sales reported Ratio of cost to sales price Cost of goods sold Amount to be eliminated (see entry) Cost of goods sold adjusted

$536,429

Downstream:

Sales COGS Gross Profit Gross Profit %

Ending Total = Re-sold + Inventory 140,000 98,000 42,000 100,000 70,000 30,000 40,000 28,000 12,000 28.57%

Upstream:

Sales COGS Gross Profit Gross Profit %

Ending Total = Re-sold + Inventory 240,000 192,000 48,000 200,000 160,000 40,000 40,000 32,000 8,000 16.67%

Consolidation entries: Sales Cost of Goods Sold Inventory Elimination of sales by Phone to Smart:

140,000

Sales Cost of Goods Sold Inventory Elimination of sales by Smart to Phone:

240,000

128,000 12,000

232,000 8,000

Chapter 06 – Intercompany Inventory Transactions

P6-28 (continued) c.

Operating income of Phone Corporation (excluding income from Smart Company) Net income of Smart Company

$70,000 20,000 $90,000 (12,000) (8,000) $70,000

Less: Unrealized inventory profits of Phone Unrealized inventory profits of Smart Consolidated net income Less: Income assigned to noncontrolling interest ($20,000 - $8,000) x 0.20 Income to controlling interest 20X8 d.

(2,400) $67,600

Inventory balance in consolidated balance sheet: Inventory reported by Phone Corporation Unrealized profits

$48,000 (8,000)

Inventory reported by Smart Company Unrealized profits Inventory balance, December 31, 20X8

$42,000 (12,000)

$40,000 30,000 $70,000

Chapter 06 – Intercompany Inventory Transactions

P6-29 Intercompany Transfer of Inventory a. Equity Method Entries on Pop Corp.'s Books: Investment in Soda Co. 17,500 Income from Soda Co. Record Pop Corp.'s 70% share of Soda Co.'s 20X3 income

17,500

Cash 10,500 Investment in Soda Co. Record Pop Corp.'s 70% share of Soda Co.'s 20X3 dividend

10,500

Income from Soda Co. Investment in Soda Co. Record amortization of excess acquisition price

6,300

Income from Soda Co. 3,800 Investment in Soda Co. 3,800 Eliminate the deferred gross profit from downstream sales in 20X3 Investment in Soda Co. 6,300 Income from Soda Co. 6,300 Reverse of the deferred gross profit from upstream sales in 20X2 Income from Soda Co. 5,600 Investment in Soda Co. Eliminate the deferred gross profit from upstream sales in 20X3

5,600

Book Value Calculations:

Beginning book value + Net Income - Dividends Ending book value

NCI 30% 39,000 7,500 (4,500) 42,000

Pop Corp. 70% 91,000 17,500 (10,500) 98,000

Common Stock 70,000

70,000

Retained Earnings 60,000 25,000 (15,000) 70,000

Adjustment to Basic Consolidation Entry NCI Pop Corp. Net Income 7,500 17,500 + Reverse GP deferral (up) 2,700 6,300 - Gross profit deferral (down) (3,800) - Gross profit deferral (up) (2,400) (5,600) Income to be eliminated 7,800 14,400 ------------------------------------------------------------------------------------Ending Book Value 42,000 98,000 + Reverse GP deferral (up) 2,700 6,300 - Gross profit deferral (down) (3,800) - Gross profit deferral (up) (2,400) (5,600) Adjusted Book Value 42,300 94,900 108,000 242,000

Chapter 06 – Intercompany Inventory Transactions

P6-29 (continued) Basic Consolidation Entry Common Stock

70,000

← Common stock balance

Retained Earnings

60,000

← Beginning balance in RE

Income from Soda Co.

14,400

← Pop’s % of NI with adjustment

NCI in NI of Soda Co.

7,800

← NCI share of NI with adjustment

Dividends Declared

15,000

← 100% of Soda Co.'s dividends

Investment in Soda Co.

94,900

← Net book value with adjustment

NCI in NA of Soda Co.

42,300

← NCI share of BV with adjustment

Excess Value (Differential) Calculations: NCI Pop Corp. 30% + 70% Beginning balance 13,800 32,200 (2,700) Changes (6,300) Ending balance

11,100

Buildings and Equipment 20,000

25,900

20,000

Patents

Acc. Depr.

28,000

(2,000)

(7,000)

(2,000)

21,000

(4,000)

Amortized Excess Value Reclassification Entry: Amortization expense

7,000

Depreciation expense

2,000

Income from Soda Co.

6,300

NCI in NI of Soda Co.

2,700

Excess Value (Differential) Reclassification Entry: Buildings and Equipment

20,000

Patents

21,000

Accumulated depreciation

4,000

Investment in Soda Co.

25,900

NCI in NA of Soda Co.

11,100

Accumulated Depreciation Consolidation Entry: Accumulated Depreciation

50,000

Building & Equipment

50,000

Reversal of last year's deferral: Investment in Soda Co.

6,300

NCI in NA of Soda Co.

2,700

Cost of Goods Sold

9,000

Chapter 06 – Intercompany Inventory Transactions

P6-29 (continued) Deferral of unrealized profits on inventory transfers from 20X2 Investment in Soda Co. 4,900 NCI in NA of Soda Co. 2,100 Inventory 7,000 Deferral of this year's unrealized profits on inventory transfers Sales 120,000 Cost of Goods Sold 108,200 Inventory 11,800 20X3 Downstream Transactions:

Sales COGS Gross Profit Gross Profit %

Total 30,000 15,000 15,000 50.00%

Re-sold 22,400 11,200 11,200

Ending Inventory, 20X2 48,000 32,000 16,000 33.33%

Re-sold, 20X3 27,000 18,000 9,000

Ending Inventory 7,600 3,800 3,800

20X2 Upstream Transactions:

Sales COGS Gross Profit Gross Profit %

Ending Inventory, 20X3 21,000 14,000 7,000

20X3 Upstream Transactions

Sales COGS Gross Profit Gross Profit %

Beg. Balance 70% Net Income

20X2 Reversal Ending Balance Reversal 20X2 Deferred GP

Total 90,000 60,000 30,000 33.33%

Investment in Soda Co. 112,000 17,500 10,500 6,300 6,300 9,400 109,600 6,300 94,900 4,900 25,900 0

Re-sold 66,000 44,000 22,000

Ending Inventory 24,000 16,000 8,000

Income from Soda Co.

70% Dividends Excess Val. Amort. Deferred GP Basic Excess Reclass.

6,300 9,400

17,500

70% Net Income

6,300 8,100

20X2 Reversal Ending Balance

6,300 0

Excess Val. Amort.

14,400

Chapter 06 – Intercompany Inventory Transactions

P6-29 (continued) b.

Income Statement Sales Other Income Less: COGS Less: Depreciation Expense Less: Interest Expense Less: Amortization Expense Income from Soda Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Pop Corp.

Soda Co.

260,000 13,600 (186,000)

125,000 (79,800)

(20,000) (16,000)

(15,000) (5,200)

8,100 59,700

25,000

59,700

25,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

127,900 59,700 (30,000) 157,600

60,000 25,000 (15,000) 70,000

Balance Sheet Cash and Accounts Receivable Inventory

15,400 165,000

21,600 35,000

Land Buildings & Equipment Less: Accumulated Depreciation Investment in Soda Co.

80,000 340,000 (140,000) 109,600

40,000 260,000 (80,000)

Patents Total Assets

570,000

276,600

Accounts Payable Bonds Payable Bonds Premium Common Stock Retained Earnings NCI in NA of Soda Co.

92,400 200,000 120,000 157,600

35,000 100,000 1,600 70,000 70,000

Total Liabilities & Equity

570,000

276,600

Consolidation Entries DR CR 120,000 108,200 9,000 2,000 7,000 14,400 143,400 7,800 151,200

60,000 151,200 211,200

70,000 211,200 2,700 2,100 286,000

265,000 13,600 (148,600)

6,300 123,500 2,700 126,200

(37,000) (21,200) (7,000) 0 64,800 (5,100) 59,700

126,200 15,000 141,200

127,900 59,700 (30,000) 157,600

11,800 7,000 20,000 50,000 6,300 4,900 21,000 102,200

Consolidated

50,000 4,000 94,900 25,900 193,600

141,200 42,300 11,100 194,600

37,000 181,200 120,000 570,000 (174,000) 0 21,000 755,200 127,400 300,000 1,600 120,000 157,600 48,600 755,200

Chapter 06 – Intercompany Inventory Transactions

P6-29 (continued) Note: Financial statements are not required. Pop Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X3 Cash and Accounts Receivable Inventory Land Buildings and Equipment Less: Accumulated Depreciation Patent Total Assets Accounts Payable Bonds Payable Bond Premium Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

$ 37,000 181,200 120,000 $570,000 (174,000)

396,000 21,000 $755,200 $127,400

$300,000 1,600

301,600

$120,000 157,600 $277,600 48,600 326,200 $755,200

Pop Corporation and Subsidiary Consolidated Income Statement Year Ended December 31, 20X3 Sales Other Income Total Income Cost of Goods Sold Depreciation Expense Interest Expense Amortization Expense Total Expenses Consolidated Net Income Income to Noncontrolling Interest Income to Controlling Interest

$265,000 13,600 $278,600 $148,600 37,000 21,200 7,000 (213,800) $ 64,800 (5,100) $ 59,700

Pop Corporation and Subsidiary Consolidated Retained Earnings Statement Year Ended December 31, 20X3 Retained Earnings, January 1, 20X3 Income to Controlling Interest, 20X3 Dividends Declared, 20X3 Retained Earnings, December 31, 20X3

$127,900 59,700 $187,600 (30,000) $157,600

Chapter 06 – Intercompany Inventory Transactions

P6-30 Consolidation Using Financial Statement Data a. Equity Method Entries on Point Corp.'s Books: Investment in Stick Co. 21,000 Income from Stick Co. Record Point Corp.'s 60% share of Stick Co.'s 20X6 income

21,000

Cash 12,000 Investment in Stick Co. Record Point Corp.'s 60% share of Stick Co.'s 20X6 dividend

12,000

Income from Stick Co. Investment in Stick Co. Record goodwill impairment loss

6,000

Investment in Stick Co. 4,000 Income from Stick Co. Reverse of the deferred gross profit from downstream sales in 20X5

4,000

Income from Stick Co. 2,000 Investment in Stick Co. Eliminate the deferred gross profit from downstream sales in 20X6

2,000

Investment in Stick Co. 4,800 Income from Stick Co. Reverse of the deferred gross profit from upstream sales in 20X5

4,800

Income from Stick Co. 5,400 Investment in Stick Co. Eliminate the deferred gross profit from upstream sales in 20X6

5,400

Book Value Calculations: NCI 40%

Point Corp. 60%

Common Stock

Retained Earnings

Beginning Book Value

80,000

120,000

+ Net Income

14,000

21,000

35,000

- Dividends

(8,000)

(12,000)

(20,000)

Ending Book Value

86,000

129,000

50,000

150,000

165,000

Chapter 06 – Intercompany Inventory Transactions

P6-30 (continued)

Adjustment to Basic Consolidation Entry NCI Point Corp. Net Income 14,000 21,000 + Reverse GP deferral (down) 4,000 + Reverse GP deferral (up) 3,200 4,800 - Gross profit deferral (down) (2,000) - Gross profit deferral (up) (3,600) (5,400) Income to be eliminated 13,600 22,400 ------------------------------------------------------------------------------------Ending Book Value 86,000 129,000 + Reverse GP deferral (down) 4,000 + Reverse GP deferral (up) 3,200 4,800 - Gross profit deferral (down) (2,000) - Gross profit deferral (up) (3,600) (5,400) Adjusted Book Value 85,600 130,400 108,000 242,000 Basic Consolidation Entry Common Stock Retained Earnings Income from Stick Co. NCI in NI of Stick Co. Dividends Declared Investment in Stick Co. NCI in NA of Stick Co.

50,000 150,000 22,400 13,600 20,000 130,400 85,600

Excess Value (Differential) Calculations: NCI Point 40% + Corp. 60% Beginning balance 16,000 24,000 Changes (4,000) (6,000) Ending balance 12,000 18,000

← Common stock balance ← Beginning balance in RE ← Point’s % of NI with adjustment ← NCI share of NI with adjustment ← 100% of Stick Co.'s dividends ← Net book value with adjustment ← NCI share of BV with adjustment

Goodwill 40,000 (10,000) 30,000

Amortized Excess Value Reclassification Entry: Goodwill impairment loss 10,000 Income from Stick Co. NCI in NI of Stick Co.

6,000 4,000

Excess Value (Differential) Reclassification Entry: Goodwill 30,000 Investment in Stick Co. NCI in NA of Stick Co.

18,000 12,000

Accumulated Depreciation Consolidation Entry Accumulated Depreciation Building & Equipment

25,000 25,000

Chapter 06 – Intercompany Inventory Transactions

P6-30 (continued) Reversal of last year's deferral: Investment in Stick Co.

8,800

NCI in NA of Stick Co.

3,200

Cost of Goods Sold

12,000

Deferral of this year's unrealized profits on inventory transfers Sales

112,000

Cost of Goods Sold

101,000

Inventory

11,000 20X5 Downstream Transactions:

Sales COGS Gross Profit Gross Profit %

Ending Inv. 20X5 14,000 10,000 4,000 28.57%

20X6 Downstream Transactions:

Sales COGS Gross Profit Gross Profit %

Total 22,000 15,714 6,286 28.57%

Re-sold 15,000 10,714 4,286

Re-sold 36,000 30,000 6,000

Ending Inventory 7,000 5,000 2,000

20X5 Upstream Transactions:

Sales COGS Gross Profit Gross Profit %

Ending Inv. 20X5 48,000 40,000 8,000 16.67%

20X6 Upstream Transactions:

Sales COGS Gross Profit Gross Profit %

Total 90,000 75,000 15,000 16.67%

Ending Inventory 54,000 45,000 9,000

Chapter 06 – Intercompany Inventory Transactions

P6-30 (continued) Investment in

Income from

Stick Co.

Beg. Balance

135,200

60% Net Income

21,000

20X5 Reversal

8,800

Ending Balance

139,600

Reversal

8,800

12,000

60% Dividends

6,000

Excess Val. Amort.

6,000

7,400

Deferred GP

7,400

130,400

Basic

18,000

Excess Reclass.

21,000

60% Net Income

8,800

20X5 Reversal

16,400

Ending Balance

6,000

Excess Val. Amort.

22,400

Income Statement Sales Less: COGS Less: Depreciation & Amort. Expense Less: Other Expenses Less: Goodwill Impairment Loss Income from Stick Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Point Corp.

Stick Co.

400,000 (280,000)

200,000 (120,000)

(25,000) (35,000)

(15,000) (30,000)

16,400 76,400

35,000

76,400

35,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

285,000 76,400 (50,000) 311,400

150,000 35,000 (20,000) 165,000

Balance Sheet Cash Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Stick Co.

26,800 80,000 120,000 70,000 340,000 (165,000) 139,600

35,000 40,000 90,000 20,000 200,000 (85,000)

Goodwill Total Assets

611,400

300,000

Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Stick Co.

80,000 120,000 100,000 311,400

15,000 70,000 50,000 165,000

Total Liabilities & Equity

611,400

300,000

Consolidation Entries DR CR 112,000 12,000 101,000

10,000 22,400 144,400 13,600 158,000

150,000 158,000 308,000

6,000 119,000 4,000 123,000

123,000 20,000 143,000

285,000 76,400 (50,000) 311,400

25,000

30,000 63,800

50,000 308,000 3,200 361,200

488,000 (287,000) (40,000) (65,000) (10,000) 0 86,000 (9,600) 76,400

11,000

25,000 8,800

Consolidated

130,400 18,000 184,400

143,000 85,600 12,000 240,600

61,800 120,000 199,000 90,000 515,000 (225,000) 0 30,000 790,800 95,000 190,000 100,000 311,400 94,400 790,800

Chapter 06 – Intercompany Inventory Transactions

P6-31 Intercorporate Transfers of Inventory and Equipment a.

Consolidated cost of goods sold for 20X9: Amount reported by Polka Company Amount reported by Song Corporation Adjustment for unrealized profit in beginning inventory sold in 20X9 Adjustment for inventory purchased from subsidiary and resold during 20X9: CGS recorded by Polka ($30,000 x 0.60) CGS recorded by Song Total recorded CGS based on Song's cost ($20,000 x 0.60) Required adjustment Cost of goods sold

(15,000) $18,000 20,000 $38,000 (12,000) (26,000) $822,000

Consolidated inventory balance: Amount reported by Polka Amount reported by Song Total inventory reported Unrealized profit in ending inventory held by Polka [($30,000 - $20,000) x 0.40] Consolidated balance

$593,000 270,000

$137,000 130,000 $267,000 (4,000) $263,000

Income assigned to noncontrolling interest: Net income reported by Song Corporation Adjustment for realization of profit on inventory sold to Polka in 20X8 Adjustment for unrealized profit on inventory sold to Polka in 20X9 Realized net income of Song for 20X9 Proportion of ownership held by noncontrolling interest Income assigned to noncontrolling interest

$70,000 15,000 (4,000) $81,000 x 0.10 $ 8,100

Chapter 06 – Intercompany Inventory Transactions

P6-31 (continued) d.

Amount assigned to noncontrolling interest in consolidated balance sheet: Song Corporation common stock outstanding Song Corporation retained earnings, January 1, 20X9 Net income for 20X9 Dividends paid in 20X9 Book value, December 31, 20X9 Adjustment for unrealized profit on inventory sold to Polka Realized book value of Song Corporation Proportion of ownership held by noncontrolling interest Balance assigned to noncontrolling interest

$ 50,000 165,000 70,000 (20,000) $265,000 (4,000) $261,000 x 0.10 $ 26,100

Consolidated retained earnings at December 31, 20X9: Balance reported by Polka Company, January 1, 20X9 Net income for 20X9 Dividends paid in 20X9 Balance reported by Polka Company, December 31, 20X9

$235,000 180,900 (40,000) $375,900

Consolidation entries:

Book Value Calculations: NCI 10%

+ Polka Co. 90%

Comm on Stock

Retained Earnings

Beginning Book Value

21,500

193,500

+ Net Income

7,000

63,000

70,000

- Dividends

(2,000)

(18,000)

(20,000)

Ending Book Value

26,500

238,500

50,000

165,000

215,000

Chapter 06 – Intercompany Inventory Transactions

P6-31 (continued)

Adjustment to Basic Consolidation Entry NCI Polka Co. Net Income 7,000 63,000 + Reverse GP deferral (up) 1,500 13,500 - Gross profit deferral (up) (400) (3,600) Income to be eliminated 8,100 72,900 ------------------------------------------------------------------------------------Ending Book Value 26,500 238,500 + Reverse GP deferral (up) 1,500 13,500 - Gross profit deferral (up) (400) (3,600) Adjusted Book Value 27,600 248,400 108,000 242,000 Basic Consolidation Entry Common Stock Retained Earnings Income from Song Corp. NCI in NI of Song Corp. Dividends Declared Investment in Song Corp. NCI in NA of Song Corp. Reversal of last year's deferral: Investment in Song Corp. NCI in NA of Song Corp. Cost of Goods Sold

50,000 165,000 72,900 8,100

← Common Stock balance ← Beginning balance in RE ← Polka’s % of NI with adjustment ← NCI share of NI with adjustment ← 100% of Song Corp.'s dividends ← Net book value with adjustment ← NCI share of BV with adjustment

20,000 248,400 27,600

13,500 1,500 15,000

Deferral of this year's unrealized profits on inventory transfers Sales 30,000 Cost of Goods Sold 26,000 Inventory 4,000 20X8 Upstream Transactions:

Sales COGS Gross Profit Gross Profit %

Ending Inventory 75,000 60,000 15,000 20.00%

20X9 Upstream Transactions:

Sales COGS Gross Profit Gross Profit %

Total 30,000 20,000 10,000 33.33%

Re-sold 18,000 12,000 6,000

Ending Inventory 12,000 8,000 4,000

Chapter 06 – Intercompany Inventory Transactions

P6-31 (continued) Investment in

Income from

Song Corp.

Beg. Balance

180,000

90% Net Income

63,000

20X8 Reversal

13,500

Ending Balance

234,900

Reversal

13,500

18,000

90% Dividends

3,600

Deferred GP

248,400

3,600

Basic

63,000

90% Net Income

13,500

20X8 Reversal

72,900

Ending Balance

72,900

g. Consolidation Entries DR CR

Polka Co.

Song Corp.

815,000 26,000 (593,000)

415,000 15,000 (270,000)

(45,000) (95,000) 72,900 180,900

(15,000) (75,000) 70,000

72,900 102,900 8,100

41,000

180,900

70,000

111,000

41,000

180,900

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

235,000 180,900 (40,000) 375,900

165,000 70,000 (20,000) 215,000

165,000 111,000

41,000 20,000 61,000

235,000 180,900 (40,000) 375,900

Balance Sheet Cash Accounts Receivable Other Receivables Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Song Corp. Total Assets

187,000 80,000 40,000 137,000 80,000 500,000 (155,000) 234,900 1,103,900

57,400 90,000 10,000 130,000 60,000 250,000 (75,000)

63,000 95,000 250,000

35,000 20,000 200,000 2,400 50,000

Income Statement Sales Other Income Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Song Corp. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Accounts Payable Other Payables Bonds Payable Bond Premium Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Song Corp. Total Liabilities & Equity

210,000 110,000 375,900 1,103,900

522,400

215,000 522,400

30,000 15,000 26,000

276,000

(60,000) (170,000) 0 189,000 (8,100)

248,400 252,400

61,000 27,600 88,600

98,000 115,000 450,000 2,400 210,000 110,000 375,900 26,100 1,387,400

50,000 276,000 1,500 327,500

1,200,000 41,000 (822,000)

244,400 170,000 50,000 263,000 140,000 750,000 (230,000) 0 1,387,400

4,000

13,500 13,500

Consolidated

Chapter 06 – Intercompany Inventory Transactions

P6-32 Consolidated Balance Sheet Worksheet [AICPA Adapted] Book Value Calculations: NCI 10% Beginning book value + Net Income - Dividends Ending Book Value

80,000 10,100 (100) 90,000

Pine Corp. 90%

720,000 90,900 (900) 810,000

Common Stock 200,000

200,000

Retained Earnings 600,000 101,000 (1,000) 700,000

Adjustment to Basic Consolidation Entry NCI Pine Corp. Net Income 10,100 90,900 - Gross profit deferral (down) (3,000) Income to be eliminated 10,100 87,900 ------------------------------------------------------------------------------------Ending Book Value 90,000 810,000 - Gross profit deferral (down) (3,000) Adjusted Book Value 90,000 807,000 108,000 242,000

Basic Consolidation Entry Common Stock

200,000

← Common stock balance

Retained Earnings

600,000

← Beginning balance in RE

Income from Slim Corp.

87,900

← Pine’s % of NI with adjustment

NCI in NI of Slim Corp.

10,100

← NCI share of NI with adjustment

Dividends Declared

1,000

← 100% of Slim Corp.'s dividends

Investment in Slim Corp.

807,000

← Net book value with adjustment

NCI in NA of Slim Corp.

90,000

← NCI share of BV with adjustment

Excess Value (Differential) Calculations: NCI Pine Corp. 10% + 90% Beginning balance Changes Ending balance

Goodwill

50,000

450,000

500,000

50,000

450,000

500,000

Excess Value (Differential) Reclassification Entry: Goodwill

500,000

Investment in Slim Corp.

450,000

NCI in NA of Slim Corp.

50,000

Chapter 06 – Intercompany Inventory Transactions

P6-32 (continued) Intercompany Transactions Dividends Payable

900

Dividends Receivable

900

Accounts Payable

90,000

Accounts Receivable

90,000

Note Payable

100,000

Note Receivable

100,000

Interest Payable

5,000

Interest Receivable

5,000

Deferral of this year's unrealized profits on inventory transfers Sales

300,000

Cost of Goods Sold

297,000

Inventory

3,000 20X6 Downstream Transactions: Total

Re-sold

Ending Inventory

Sales

300,000

285,000

15,000

COGS

240,000

228,000

12,000

Gross Profit

60,000

57,000

3,000

Gross Profit %

20.00%

Investment in

Income from

Slim Corp.

Acquisition Price

1,170,000

90% Net Income

90,900

Ending Balance

900

90% Dividends

3,000

Deferred GP

Basic

450,000

Excess Reclass.

90% Net Income

87,900

Ending Balance

3,000

1,257,000 807,000

90,900

87,900 0

Chapter 06 – Intercompany Inventory Transactions

P6-32 (continued) Pine Corp.

Slim Corp.

Balance Sheet Cash AR & Other Receivables

105,000 410,000

15,000 120,000

Merchandise Inventory Plant & Equipment (net) Investment in Slim Corp.

920,000 1,000,000 1,257,000

670,000 400,000

Goodwill Total Assets

3,692,000

1,205,000

AP & Other Liabilities

140,000

305,000

Common Stock Retained Earnings

500,000 3,052,000

200,000 700,000

Consolidation Entries DR CR

900 90,000 100,000 5,000 3,000 807,000 450,000 500,000 500,000 900 90,000 100,000 5,000 200,000 600,000 87,900 10,100 300,000

NCI in NA of Slim Corp. Total Liabilities & Equity

3,692,000

1,205,000

1,393,900

1,455,900

Consolidated 120,000 334,100

1,587,000 1,400,000 0 500,000 3,941,100 249,100

1,000 297,000

90,000 50,000 438,000

500,000 3,052,000

140,000 3,941,100

Chapter 06 – Intercompany Inventory Transactions

P6-33 Comprehensive Consolidation Worksheet; Fully Adjusted Equity Method [AICPA Adapted] Equity Method Entries on Print Corp.'s Books: Investment in Size Inc. Common Stock APIC

750,000 500,000 250,000

Record the initial investment in Size Inc. Investment in Size Inc.

190,000

Income from Size Inc.

190,000

Record Print Corp.'s 100% share of Size Inc.'s 20X9 income Cash

40,000

Investment in Size Inc.

40,000

Record Print Corp.'s 100% share of Size Inc.'s 20X9 dividend Income from Size Inc.

44,000

Investment in Size Inc. Record amortization of excess acquisition price (loss on goodwill and equipment depreciation) Income from Size Inc.

44,000

18,000

Investment in Size Inc.

18,000

Eliminate the deferred gross profit from upstream sales in 20X9

Print Corp. 100%

Common Stock 400,000

Add. Paidin Capital

Retained Earnings

Beginning Book Value

636,000

+ Net Income

190,000

- Dividends

(40,000)

Ending Book Value

786,000

400,000

80,000

156,000

306,000

Adjustment to Basic Consolidation Entry Net Income - Gross profit deferral (up) Income to be eliminated ---------------------------------------Ending Book Value - Gross profit deferral (up) Adjusted Book Value

Print Corp. 190,000 (18,000) 172,000 -----------------786,000 (18,000) 768,000

Chapter 06 – Intercompany Inventory Transactions

P6-33 (continued) Basic Consolidation Entry Common Stock

400,000

← Common stock balance

Additional Paid-in Capital

80,000

← Beginning balance in APIC

Retained Earnings

156,000

← Beginning balance in RE

Income from Size Inc.

172,000

← Print’s % of NI with adjustment

Dividends Declared

40,000

← 100% of Size Inc.'s dividends

Investment in Size Inc.

768,000

← Net book value with adjustment

Print Corp. 100% Beginning balance

114,000

Changes

(44,000)

Ending balance

70,000

Machinery

Acc. Depr.

54,000 54,000

Goodwill

60,000

(9,000)

(35,000)

(9,000)

25,000

Amortized Excess Value Reclassification Entry: Depreciation Expense

9,000

Goodwill Impairment Loss

35,000

Income from Size Inc.

44,000

Excess Value (Differential) Reclassification Entry: Machinery

54,000

Goodwill

25,000

Accumulated Depreciation

9,000

Investment in Size Inc.

70,000

Eliminate intercompany Accounts: Accounts payable

86,000

Accounts receivable

86,000

Deferral of this year's unrealized profits on inventory transfers Sales

180,000

Cost of Goods Sold

162,000

Inventory

18,000

Chapter 06 – Intercompany Inventory Transactions

P6-33 (continued) 20X9 Upstream Transactions Total

Re-sold

Ending Inventory

Sales

180,000

144,000

36,000

COGS

90,000

72,000

18,000

Gross Profit

90,000

72,000

18,000

Gross Profit %

50.00%

Investment in

Income from

Size Inc.

Acquisition Price

750,000

100% Net Income

190,000

Ending Balance

40,000

100% Dividends

44,000

Excess Val. Amort.

44,000

18,000

Deferred GP

18,000

838,000

768,000

Basic

70,000

Excess Reclass.

190,000

100% Net Income

128,000

Ending Balance

44,000

Excess Val. Amort.

172,000 0

Chapter 06 – Intercompany Inventory Transactions

P6-33 (continued)

Income Statement Net Sales Gain on Sale of Warehouse Less: COGS Less: Operating Expenses Less: Goodwill Impairment Income from Size Inc. Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

Print Corp.

Size Inc.

Consolidation Entries DR CR

3,800,000 30,000 (2,360,000) (1,100,000)

1,500,000

180,000

128,000 498,000

440,000 498,000 938,000

(870,000) (440,000)

190,000

156,000 190,000 (40,000) 306,000

44,000 206,000

5,120,000 30,000 (3,068,000) (1,549,000) (35,000) 0 498,000

206,000 40,000 246,000

440,000 498,000 0 938,000

162,000 9,000 35,000 172,000 396,000

156,000 396,000 552,000

Balance Sheet Cash Accounts Receivable (net) Inventories Land, Plant, and Equipment Less: Accumulated Depreciation Investment in Size Inc.

570,000 860,000 1,060,000 1,320,000 (370,000) 838,000

150,000 350,000 410,000 680,000 (210,000)

Goodwill Total Assets

4,278,000

1,380,000

25,000 79,000

Accounts Payable & Accrued Expenses Common Stock Additional Paid-in Capital Retained Earnings Total Liabilities & Equity

1,340,000 1,700,000 300,000 938,000 4,278,000

594,000 400,000 80,000 306,000 1,380,000

86,000 400,000 80,000 552,000 1,118,000

Consolidated

86,000 18,000 54,000 9,000 768,000 70,000

720,000 1,124,000 1,452,000 2,054,000 (589,000) 0

951,000

25,000 4,786,000

246,000 246,000

1,848,000 1,700,000 300,000 938,000 4,786,000

Chapter 06 – Intercompany Inventory Transactions

P6-34 Comprehensive Worksheet Problem a. Equity Method Entries on Prime Corp.'s Books: Investment in Steak Co.

32,000

Income from Steak Co.

32,000

Record Prime Corp.'s 80% share of Steak Co.'s 20X7 income Cash

20,000

Investment in Steak Co.

20,000

Record Prime Corp.'s 80% share of Steak Co.'s 20X7 dividend Income from Steak Co.

4,000

Investment in Steak Co.

4,000

Record amortization of excess acquisition price Investment in Steak Co.

2,000

Income from Steak Co.

2,000

Reverse of the deferred gross profit from downstream sales in 20X6 Income from Steak Co.

3,000

Investment in Steak Co.

3,000

Eliminate the deferred gross profit from downstream sales in 20X7 Investment in Steak Co.

6,400

Income from Steak Co.

6,400

Reverse of the deferred gross profit from upstream sales in 20X6 Income from Steak Co.

8,000

Investment in Steak Co.

8,000

Eliminate the deferred gross profit from upstream sales in 20X7

Chapter 06 – Intercompany Inventory Transactions

6-34 (continued) b. Book Value Calculations: NCI 20%

Prime Corp. 80%

Common Stock

Add. Paidin Capital

Retained Earnings

Beginning book value

67,000

268,000

+ Net Income

8,000

32,000

40,000

- Dividends

(5,000)

(20,000)

(25,000)

Ending book value

70,000

280,000

100,000

20,000

100,000

20,000

215,000

230,000

Adjustment to Basic Consolidation Entry NCI Prime Corp. Net Income 8,000 32,000 + Reverse GP deferral (down) 2,000 + Reverse GP deferral (up) 1,600 6,400 - Gross profit deferral (down) (3,000) - Gross profit deferral (up) (2,000) (8,000) Income to be eliminated 7,600 29,400 ------------------------------------------------------------------------------------Ending Book Value 70,000 280,000 + Reverse GP deferral (down) 2,000 + Reverse GP deferral (up) 1,600 6,400 - Gross profit deferral (down) (3,000) - Gross profit deferral (up) (2,000) (8,000) Adjusted Book Value 69,600 277,400 108,000 242,000 Basic Consolidation Entry Common Stock

100,000

← Common stock balance

Additional Paid-in Capital

20,000

← Beginning balance in APIC

Retained Earnings

215,000

← Beginning balance in RE

Income from Steak Co.

29,400

← Prime’s % of NI with adjustment

NCI in NI of Steak Co.

7,600

← NCI share of NI with adjustment

Dividends Declared

25,000

← 100% of Steak Co.'s dividends

Investment in Steak Co.

277,400

← Net book value with adjustment

NCI in NA of Steak Co.

69,600

← NCI share of BV with adjustment

Excess Value (Differential) Calculations: NCI Prime 20% + Corp. 80% Beginning balance

7,000

28,000

Changes

(1,000)

(4,000)

Ending balance

6,000

24,000

Buildings & Equipment 50,000

Acc. Depr. (15,000) (5,000)

50,000

(20,000)

Chapter 06 – Intercompany Inventory Transactions

P6-34 (continued) Amortized Excess Value Reclassification Entry: Depreciation expense 5,000 Income from Steak Co. NCI in NI of Steak Co.

4,000 1,000

Excess Value (Differential) Reclassification Entry: Buildings & equipment 50,000 Accumulated depreciation Investment in Steak Co. NCI in NA of Steak Co.

20,000 24,000 6,000

Eliminate intercompany Accounts: Accounts payable Accounts receivable

10,000

Accumulated Depreciation Consolidation Entry Accumulated depreciation 40,000 Building & equipment

40,000

Reversal of last year's deferral: Investment in Steak Co. NCI in NA of Steak Co. Cost of Goods Sold

10,000

8,400 1,600

Deferral of this year's unrealized profits on inventory transfers Sales 57,000 Cost of Goods Sold 44,000 Inventory 13,000 20X6 Downstream Transactions:

Sales COGS Gross Profit Gross Profit %

Total 26,000 20,000 6,000 23.08%

Re-sold 17,333 13,333 4,000

Re-sold

Ending Inventory 8,667 6,667 2,000

20X7 Downstream Transactions:

Sales COGS Gross Profit Gross Profit %

Total 12,000 9,000 3,000 25.00%

0 0 0

Ending Inventory 12,000 9,000 3,000

Chapter 06 – Intercompany Inventory Transactions

P6-34 (continued) 20X6 Upstream Transactions: Total

Re-sold

Ending Inventory

Sales

60,000

36,000

24,000

COGS

40,000

24,000

16,000

Gross Profit

20,000

12,000

8,000

Gross Profit %

33.33%

20X7 Upstream Transactions: Total

Re-sold

Ending Inventory

Sales

45,000

15,000

30,000

COGS

30,000

10,000

20,000

Gross Profit

15,000

5,000

10,000

Gross Profit %

33.33%

Investment in

Income from

Steak Co.

Beginning Balance

287,600

80% Net Income

32,000 20,000

20X6 Reversal

8,400

Ending Balance

293,000

Reversal

8,400 0

4,000

80% Dividends Excess Val. Amort.

4,000

11,000

Deferred GP

11,000

277,400

Basic

24,000

Excess Reclass.

32,000

80% Net Income

8,400

20X6 Reversal

25,400

Ending Balance

4,000

Excess Val. Amort.

29,400 0

Chapter 06 – Intercompany Inventory Transactions

P6-34 (continued) Consolidation Entries DR CR

Prime Corp.

Steak Co.

500,000 20,400 (416,000)

250,000 30,000 (202,000)

57,000

(30,000) (24,000) 25,400 75,800

(20,000) (18,000)

5,000

40,000

29,400 91,400 7,600

4,000 58,000 1,000

(55,000) (42,000) 0 82,400 (6,600)

75,800

40,000

99,000

59,000

75,800

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

337,500 75,800 (50,000) 363,300

215,000 40,000 (25,000) 230,000

215,000 99,000

59,000 25,000 84,000

337,500 75,800 (50,000) 363,300

Balance Sheet Cash Accounts Receivable Inventory Buildings & Equipment Less: Accumulated Depreciation Investment in Steak Co.

130,300 80,000 170,000 600,000 (310,000) 293,000

10,000 70,000 110,000 400,000 (120,000)

Total Assets

963,300

470,000

98,400

Accounts Payable Bonds Payable Bond Premium Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Steak Co.

100,000 300,000

10,000

363,300

15,200 100,000 4,800 100,000 20,000 230,000

Total Liabilities & Equity

963,300

470,000

Income Statement Sales Other Income Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Steak Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

200,000

10,000 44,000

314,000

50,000 40,000 8,400

100,000 20,000 314,000 1,600 445,600

10,000 13,000 40,000 20,000 277,400 24,000 384,400

84,000 69,600 6,000 159,600

Consolidated 693,000 50,400 (564,000)

140,300 140,000 267,000 1,010,000 (410,000) 0 1,147,300 105,200 400,000 4,800 200,000 0 363,300 74,000 1,147,300

Chapter 06 – Intercompany Inventory Transactions

P6-34 (continued) d.

Prime Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X7

Cash Accounts Receivable Inventory Total Current Assets Buildings and Equipment Less: Accumulated Depreciation Total Assets Accounts Payable Bonds Payable Bond Premium Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

$ 140,300 140,000 267,000 $ 547,300 $1,010,000 (410,000)

600,000 $1,147,300 $ 105,200

$ 400,000 4,800

404,800

$ 200,000 363,300 $ 563,300 74,000 637,300 $1,147,300

Prime Corporation and Subsidiary Consolidated Income Statement Year Ended December 31, 20X7 Sales Other Income

$ 693,000 50,400 $ 743,400

Cost of Goods Sold Depreciation Expense Other Expenses Consolidated Net Income Income to Noncontrolling Interest Income to Controlling Interest

$ 564,000 55,000 42,000

(661,000) $ 82,400 (6,600) $ 75,800

Prime Corporation and Subsidiary Consolidated Statement of Retained Earnings Year Ended December 31, 20X7 Retained Earnings, January 1, 20X7 Income to Controlling Interest, 20X7 Dividends Declared, 20X7 Retained Earnings, December 31, 20X7

$ 337,500 75,800 $ 413,300 (50,000) $ 363,300

Chapter 06 – Intercompany Inventory Transactions

P6-35A Modified Equity Method a. Adjusted trial balance: Item Cash Accounts Receivable Inventory Buildings and Equipment Investment in Steak Company Stock Cost of Goods Sold Depreciation Expense Other Expenses Dividends Declared Accumulated Depreciation Accounts Payable Bonds Payable Bond Premium Common Stock Additional Paid-In Capital Retained Earnings Sales Other Income Income from Subsidiary

Prime Corporation Debit Credit

Steak Company Debit Credit

$ 130,300 80,000 170,000 600,000

$ 10,000 70,000 110,000 400,000

304,000 416,000 30,000 24,000 50,000

202,000 20,000 18,000 25,000 $ 310,000 100,000 300,000

$120,000 15,200 100,000 4,800 100,000 20,000 215,000 250,000 30,000

200,000

$1,804,300

345,900 500,000 20,400 28,000 $1,804,300

$855,000

b. Equity Method Entries on Prime Corp.'s Books: Investment in Steak Co.

32,000

Income from Steak Co.

32,000

Record Prime Corp.'s 80% share of Steak Co.'s 20X7 income Cash

20,000

Investment in Steak Co.

20,000

Record Prime Corp.'s 80% share of Steak Co.'s 20X7 dividend Income from Steak Co. Investment in Steak Co.

4,000 4,000

Record amortization of excess acquisition price

Chapter 06 – Intercompany Inventory Transactions

P6-35A (continued) c. Book Value Calculations: NCI 20%

Prime Corp. 80%

Common Stock

Add. Paidin Capital

Retained Earnings

Beginning Book Value

67,000

268,000

+ Net Income

8,000

32,000

40,000

- Dividends

(5,000)

(20,000)

(25,000)

Ending Book Value

70,000

280,000

100,000

20,000

215,000

230,000

Adjustment to Basic Consolidation Entry NCI Prime Corp. Net Income 8,000 32,000 + Reverse GP deferral (down) 2,000 + Reverse GP deferral (up) 1,600 6,400 - Gross profit deferral (down) (3,000) - Gross profit deferral (up) (2,000) (8,000) Income to be eliminated 7,600 29,400 ----------------------------------------------------------------------------------Ending Book Value 70,000 280,000 + Reverse GP deferral (down) 2,000 + Reverse GP deferral (up) 1,600 6,400 - Gross profit deferral (down) (3,000) - Gross profit deferral (up) (2,000) (8,000) Adjusted Book Value 69,600 277,400 108,000 242,000 Basic Consolidation Entry Common Stock

100,000

← Common stock balance

Additional Paid-in Capital

20,000

← Beginning balance in APIC

Retained Earnings

215,000

← Beginning balance in RE

Income from Steak Co.

32,000

← Prime Corp.’s % of NI

NCI in NI of Steak Co.

7,600

← NCI share of NI - Def. GP + Reversal

Dividends Declared

25,000

← 100% of Steak Co.'s dividends

Investment in Steak Co.

280,000

← Net book value

NCI in NA of Steak Co.

69,600

← NCI share of BV - Def. GP + Reversal

Chapter 06 – Intercompany Inventory Transactions

P6-35A (continued) Excess Value (Differential) Calculations: NCI Prime Corp. 20% + 80% Beginning balance

7,000

28,000

Changes

(1,000)

(4,000)

Ending balance

6,000

24,000

Buildings & equipment 50,000

Acc. Depr. (15,000) (5,000)

50,000

(20,000)

Amortized Excess Value Reclassification Entry: Depreciation Expense

5,000

Income from Steak Co.

4,000

NCI in NI of Steak Co.

1,000

Excess Value (Differential) Reclassification Entry: Buildings & equipment

50,000

Accumulated depreciation

20,000

Investment in Steak Co.

24,000

NCI in NA of Steak Co.

6,000

Eliminate Intercompany Accounts: Accounts Payable

10,000

Accounts Receivable

10,000

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

40,000

Building & Equipment

40,000

Reversal of last year's deferral: Retained earnings

8,400

NCI in NA of Steak Co.

1,600

Cost of Goods Sold

10,000

Deferral of this year's unrealized profits on inventory transfers Sales

57,000

Cost of Goods Sold

44,000

Inventory

13,000

(See Problem 6-34 for unrealized profit calculations.)

Chapter 06 – Intercompany Inventory Transactions

P6-35A (continued) d. Consolidation Entries DR CR

Prime Corp.

Steak Co.

500,000 20,400 (416,000)

250,000 30,000 (202,000)

57,000

(30,000) (24,000) 28,000 78,400

(20,000) (18,000)

5,000

40,000

32,000 94,000 7,600

4,000 58,000 1,000

(55,000) (42,000) 0 82,400 (6,600)

78,400

40,000

101,600

59,000

75,800

Statement of Retained Earnings Beginning Balance

345,900

215,000

Net Income Less: Dividends Declared Ending Balance

78,400 (50,000) 374,300

40,000 (25,000) 230,000

215,000 8,400 101,600

Balance Sheet Cash Accounts Receivable Inventory Buildings & Equipment Less: Accumulated Depreciation Investment in Steak Co.

130,300 80,000 170,000 600,000 (310,000) 304,000

10,000 70,000 110,000 400,000 (120,000)

50,000 40,000

Total Assets

974,300

470,000

90,000

Accounts Payable Bonds Payable Bond Premium Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Steak Co.

100,000 300,000

10,000

374,300

15,200 100,000 4,800 100,000 20,000 230,000

Total Liabilities & Equity

974,300

470,000

Income Statement Sales Other Income Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Steak Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

200,000

44,000 10,000

325,000

100,000 20,000 325,000 1,600 456,600

Consolidated 693,000 50,400 (564,000)

337,500 59,000 25,000 84,000

10,000 13,000 40,000 20,000 280,000 24,000 387,000

84,000 69,600 6,000 159,600

75,800 (50,000) 363,300

140,300 140,000 267,000 1,010,000 (410,000) 0 1,147,300 105,200 400,000 4,800 200,000 0 363,300 74,000 1,147,300

Chapter 06 – Intercompany Inventory Transactions

P6-36A Cost Method a. Equity Method Entries on Prime Corp.'s Books: Cash

20,000

Dividend Income

20,000

Record Prime Corp.'s 80% share of Steak Co.'s 20X7 income b. Investment Consolidation Entry: Common Stock

100,000

Additional Paid-in Capital

20,000

Retained Earnings

180,000

Investment in Steak Co.

240,000

NCI in NA of Steak Co.

60,000

Dividend Consolidation Entry: Dividend Income

20,000

NCI in NI of Steak Co.

5,000

Dividends Declared

25,000

Excess Value (Differential) Reclassification Entry: Buildings & Equipment

50,000

Investment in Steak Co.

40,000

NCI in NA of Steak Co.

10,000

Amortize Differential from previous years: Retained Earnings

12,000

NCI in NA of Steak Co.

3,000

Accumulated Depreciation

15,000

Amortize Differential for 20X7 Depreciation Expense

5,000

Accumulated Depreciation

5,000

Assign Steak's undistributed income to NCI NCI in NI of Steak Co.

1,600

Retained Earnings

7,000

NCI in NA of Steak Co.

8,600

Chapter 06 – Intercompany Inventory Transactions

P6-36A (continued) Eliminate Intercompany Accounts: Accounts Payable

10,000

Accounts Receivable

10,000

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

40,000

Building & Equipment

40,000

Reversal of last year's deferral: Retained Earnings

8,400

NCI in NA of Steak Co.

1,600

Cost of Goods Sold

10,000

Deferral of this year's unrealized profits on inventory transfers Sales

57,000

Cost of Goods Sold

44,000

Inventory

13,000

(See Problem 6-34 for unrealized profit calculations.)

Chapter 06 – Intercompany Inventory Transactions

P6-36A (continued)

Prime Corp.

Steak Co.

500,000 20,400 20,000 (416,000)

250,000 30,000 (202,000)

(30,000) (24,000) 70,400

(20,000) (18,000) 40,000

Controlling Interest in Net Income

70,400

Statement of Retained Earnings Beginning Balance

Income Statement Sales Other Income Dividend Income Less: COGS Less: Depreciation Expense Less: Other Expenses Consolidated Net Income NCI in Net Income of Steak Co.

Consolidation Entries DR CR 57,000 20,000 10,000 44,000 5,000 82,000 5,000 1,600

54,000

40,000

88,600

54,000

329,900

215,000

Net Income Less: Dividends Declared Ending Balance

70,400 (50,000) 350,300

40,000 (25,000) 230,000

180,000 8,400 12,000 7,000 88,600

Balance Sheet Cash Accounts Receivable Inventory Buildings & Equipment Less: Accumulated Depreciation

130,300 80,000 170,000 600,000 (310,000)

10,000 70,000 110,000 400,000 (120,000)

Investment in Steak Co.

280,000

Total Assets

950,300

470,000

90,000

Accounts Payable Bonds Payable Bond Premium Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Steak Co.

100,000 300,000

10,000

350,300

15,200 100,000 4,800 100,000 20,000 230,000

Total Liabilities & Equity

950,300

470,000

200,000

296,000

50,000 40,000

100,000 20,000 296,000 1,600 3,000 430,600

Consolidated 693,000 50,400 0 (564,000) (55,000) (42,000) 82,400 (6,600)

75,800

337,500

54,000 25,000 79,000

10,000 13,000 40,000 5,000 15,000 240,000 40,000 363,000

79,000 60,000 10,000 8,600 157,600

75,800 (50,000) 363,300

140,300 140,000 267,000 1,010,000 (410,000) 0 1,147,300 105,200 400,000 4,800 200,000 0 363,300 74,000

1,147,300

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

Reversal of CHAPTER 7 INTERCOMPANY TRANSFERS OF SERVICES AND NONCURRENT ASSETS ANSWERS TO QUESTIONS Q7-1 Profits on intercompany sales generally are considered to be realized when the affiliate that has purchased the item sells it to a nonaffiliate. For depreciable or amortizable items that are used by the affiliate in its operations, profits are considered to be realized as the purchaser depreciates or amortizes the asset. Q7-2 An upstream sale occurs when a subsidiary sells an item to the parent company. If the asset is not resold before the end of the period, the parent is the company holding the asset and any unrealized profits are recorded on the books of the subsidiary. Q7-3 If the purchaser records the services received as an expense, both revenues and expenses will be overstated in the consolidated income statement in the period in which the intercompany services are provided. In the event the services are capitalized by the purchaser, the cost of the asset will be overstated, depreciation expense and accumulated depreciation will be overstated if the services are assigned to a depreciable asset, and service revenue will be overstated. Q7-4 (a) Unrealized profit on an intercompany sale generally is included in the reported net income of the seller. (b) All unrealized profit on current-period intercompany sales must be excluded from consolidated net income until realized through resale to a nonaffiliate. Q7-5 Profits on intercompany sales are included in consolidated net income in the period in which the items are sold to a nonaffiliate. If there are unrealized profits on the books of one of the companies at the start of the period and the item is sold to a nonaffiliate during the current period, the intercompany profit is included in the computation of consolidated net income for the current period. Q7-6 The profits continue to be unrealized in this case and therefore must be eliminated from both the beginning and ending asset balances when consolidated statements are prepared. There should be no income statement effect for the current period. Q7-7 A downstream sale is a sale from the parent to one of its subsidiaries. If the asset is not resold before the end of the period, the subsidiary is the company holding the asset at year-end and any unrealized profits are recorded on the books of the parent company. Q7-8 The entire balance of unrealized profits is eliminated in all cases. While the direction of the sale will affect the allocation of unrealized profits between the controlling and non-controlling interests, it does not change the total amount of profit eliminated. Q7-9 Consolidated net income is reduced by the amount of unrealized profits assigned to the shareholders of the parent company. When a downstream sale occurs, all the profit is on the parent's books and consolidated net income is reduced by the full amount of any unrealized profit. On the other hand, when an upstream sale occurs, all the intercompany profit is recorded on the books of the subsidiary and the amount of income assigned to both the parent company shareholders and the noncontrolling shareholders is reduced by a proportionate amount of any unrealized profit. 7-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

Q7-10 The amount of intercompany profit realized in the current period from prior years' sales to the parent is added to the reported net income of the subsidiary in computing income assigned to the noncontrolling interest. Q7-11 Income assigned to noncontrolling interest for the current period will be less than a proportionate share of the reported net income of the subsidiary. In determining the amount of income to be assigned to the noncontrolling interest in the consolidated income statement, the net income reported by the subsidiary must be adjusted to exclude any unrealized gain recorded during the period on the sale of depreciable assets to the parent. On the other hand, if an unrealized loss had been recorded, the basis used in assigning income to the noncontrolling interest would be greater than the reported net income of the subsidiary. Such adjustments must be made to assure that the income assigned to noncontrolling interest is based on the contribution of the subsidiary to consolidated net income rather than the amount the subsidiary may have reported as net income. Q7-12 All other factors being equal, the income assigned to noncontrolling interest will be larger if the sale occurs at the start of the current period. Some part of the gain will be considered realized in the current period as the parent depreciates the asset if the sale occurs before yearend. None of the gain will be considered realized in the period of transfer if the sale occurs at year-end. Q7-13 As in all other cases, income from the subsidiary recorded on the parent's books must be eliminated in preparing the consolidated income statement and an appropriate amount of subsidiary net income must be assigned to the noncontrolling interest if the parent owns less than 100 percent of the subsidiary's stock. The gain recorded on the parent's books also must be eliminated. Q7-14 Depreciation expense recorded by the subsidiary is overstated from the viewpoint of the consolidated entity when the subsidiary pays the parent more than book value for the asset at the start of the period. As a result, a consolidation entry is needed to reduce depreciation expense and accumulated depreciation by the amount of excess depreciation recorded during 20X3. Q7-15 Following an intercompany sale of a depreciable asset, the consolidation entries should adjust the balance in the asset account to reflect the original purchase price to the first owner and accumulated depreciation should be adjusted to reflect the balance that would be reported if the asset were still held by the first owner. In the case of an intercompany sale of an intangible asset, only the unamortized balance normally is reported and a consolidation entry is needed to adjust the carrying value to that which would be reported if the asset were still held by the first owner. Q7-16 Profit on an intercompany sale of land is considered realized at the time the purchaser sells the land to a nonaffiliate. Profit on equipment normally is considered realized as the asset is used and depreciated on the books of the purchaser. Equipment typically is considered to be used up in the production process and therefore is charged to expense over its remaining economic life, while land is not. Q7-17 A portion of the profit is considered realized each period as the asset is depreciated by the purchaser. Thus, the net amount considered unrealized decreases each period and a smaller debit to beginning retained earnings is needed. Q7-18A The balance in the investment account will depend on which method the parent uses to account for its investment in the subsidiary. If the parent uses (a) the cost method or (b) the modified equity method, no adjustments are made on the parent company's books for 7-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

unrealized intercompany profits and the balance in the investment account will be the same as if there were no unrealized profits. If the parent uses (c) the fully-adjusted equity method, the balance in the investment account will be reduced by the full amount of the unrealized profit when the profit is on the parent's books and by a proportionate share of the unrealized profit when it is on the subsidiary's books. Note that the cost method and the modified equity methods are not the same either. Under the cost method, no changes of any kind are made, unlike the modified equity method.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

SOLUTIONS TO CASES C7-1 Correction of Consolidation Procedures MEMO To:

Controller Plug Corporation

From: Re:

, CPA Elimination of Intercompany Profit on Equipment

This memo is in response to our review of the consolidation procedures used in preparing the consolidated statements for Plug Corporation at December 31, 20X2. You have correctly identified the need to eliminate the effects of the intercompany sale of equipment. In preparing your consolidated statements, all intercompany balances and transactions should be eliminated. [ASC 810-10-S99-4] Your consolidation entry recorded at December 31, 20X2, was: Equipment Loss on Sale of Equipment

150,000 150,000

This entry correctly eliminates the $150,000 loss recorded by Coy January 1, 20X2, on the sale of equipment to Plug and adds $150,000 to the equipment account. By adding back $150,000 to equipment, the balance is adjusted to $1,000,000 ($850,000 + $150,000). This represents the carrying value of the equipment on Coy’s books at the time of sale but does not reflect the purchase price paid by Coy ($1,200,000) or the accumulated depreciation at the time of sale ($200,000). Moreover, the consolidation entry above understates depreciation expense for the year. The correct consolidation entry at December 31, 20X2, is: Equipment Depreciation Expense Accumulated Depreciation Loss on Sale of Equipment

350,000 15,000 215,000 150,000

A debit of $350,000 to equipment is required to raise the balance from $850,000 recorded by Plug to $1,200,000, the initial purchase price to the consolidated entity. Depreciation expense must be increased by $15,000 from $85,000 ($850,000/10 years) recorded by Plug to $100,000 ($1,200,000/12 years) based on the initial purchase price. Accumulated depreciation must be credited by $215,000 to adjust from the $85,000 [($85,000/10 years) x 1 year] reported by Plug to $300,000 [($1,200,000/12 years) x 3 years]. As previously noted, the $150,000 loss recorded by Coy must be eliminated. If the amounts included in the second consolidation entry are omitted, consolidated net income for 20X2 and the retained earnings balance at December 31, 20X2, will be overstated and the balances for equipment and accumulated depreciation will be understated. Primary citation: ASC 810-10-S99-4

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

C7-2 Elimination of Intercompany Services MEMO To:

Chief Accountant Dream Corporation

From:

, CPA

Re:

Elimination of Legal Services Provided by Parent Company

This memo is in response to our discussion regarding the elimination of intercompany services in preparing consolidated financial statements for Dream Corporation. It is my understanding that at present Dream Corporation does not eliminate such services. In preparing consolidated financial statements all intercompany balances and transactions should be eliminated. [ASC 810-10-S994] The legal services provided by Dream Corporation to Classic Company and Plain Company are intercompany transactions that should be eliminated. If the revenues recorded by the parent are equal to the expenses recorded by the subsidiaries and both are properly recorded, elimination of these transactions will have no impact on reported net income but will reduce consolidated revenues and expenses by equal amounts. Financial statement readers will receive a more accurate picture of operations of the consolidated entity if the appropriate amounts are reported. The legal services provided to Classic Company in 20X3 should be eliminated with the following entry: Legal Services Revenue Legal Services Expense

80,000 80,000

The information on intercompany services provided to Plain Company indicates that an additional adjustment is needed in the consolidation process. Although Plain Company recorded its $150,000 payment to the parent as a legal expense, it should have been recorded as an investment in land to be used in future development of its strip mine. This error should be corrected on the books of Plain Company. If it is not, the consolidation entry prepared at December 31, 20X3, should include an adjustment to reflect the appropriate investment in land and would be recorded as: Legal Services Revenue Land Legal Services Expense Wage and Salary Expense

150,000 100,000 150,000 100,000

Care must be taken to capitalize only the cost of legal services in this case. The consolidation entry should contain a debit of $100,000 ($150,000/1.50) to land since Dream Corporation bills its services to the subsidiaries at 150 percent of the cost of services provided. Had Plain Company debited land for its $150,000 payment to Dream, the consolidation entry at December 31, 20X3, would have been: Legal Services Revenue Land Wage and Salary Expense

150,000 50,000 100,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

C7-2 (continued) No consolidation entry would be required at December 31, 20X4, on the legal services provided to Classic Company in 20X3. The conditions of the intercompany transfer of services to Plain Company require a consolidation entry at December 31, 20X4, and in following years, as long as Plain Company owns the strip mine. The entry at December 31, 20X4, would be: Land Investment in Plain

100,000 100,000

Had Plain Company debited land for its $150,000 payment to Dream in 20X3, the consolidation entry at December 31, 20X4, would require a $50,000 debit to Investment in Plain and a $50,000 credit to land. Primary citation: ASC 810-10-S99-4

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

C7-3 Noncontrolling Interest a. When there are no unrealized profits on the subsidiary's books, a pro rata portion of the reported net income of the subsidiary is assigned to the noncontrolling interest, adjusted for the noncontrolling interest’s share of any amortization or write-off of differential. b. When there are no unrealized profits on the subsidiary's books, the noncontrolling interest is reported in the consolidated balance sheet at an amount equal to a pro rata portion of the book value of the net assets of the subsidiary plus the noncontrolling interest’s share of any remaining differential. c. The effect of unrealized intercompany profits depends on which company has recorded the profits. Those recorded on the books of the parent do not affect the income assigned to the noncontrolling interest. When subsidiary net income includes unrealized intercompany profits, the portion of consolidated net income assigned to the noncontrolling interest is reduced by its portion of the unrealized profit in the period of the intercompany sale. (1) On a sale of land, the intercompany profit remains unrealized until the land is sold to a nonaffiliate. When the land is resold, the profit is added to the reported net income of the subsidiary in computing the portion of consolidated net income assigned to the noncontrolling interest. (2) On an intercompany sale of a depreciable asset, a portion of the intercompany profit is considered realized each period as the purchaser depreciates the asset. Thus, in the period of the intercompany sale, the adjustment to subsidiary net income for unrealized profits is based on the gain or loss less any portion considered realized before the end of the period. Each period thereafter, a portion of the gain or loss is considered realized and treated as an adjustment to subsidiary income in determining the portion of consolidated net income assigned to the noncontrolling interest. d. Noncontrolling shareholders of a subsidiary generally will not gain a great deal of useful information from the consolidated financial statements. Their primary focus must continue to be on the income, assets, and liabilities of the subsidiary in which they hold direct ownership. In the event there are a number of transactions with the parent or other affiliates, the success of the operations of the entire economic entity may provide information useful to the noncontrolling shareholders. Debt guarantees or other assurances by the parent may also lead to an examination of the parent company and consolidated statements.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

C7-4 Intercompany Sale of Services a. When preparing consolidated financial statements, Schwartz's revenue from the sale of services to Diamond and Diamond's expenses associated with the services acquired from Schwartz must be eliminated. The expenses related to the janitorial and maintenance activities that will be reported in the consolidated income statement will be the actual salary and associated costs incurred by Schwartz to provide the services to Diamond. The adjustments have no effect on consolidated net income because revenues and expenses of equal amount are eliminated in the preparation of the consolidated financial statements. b. Intercompany profits from the sale of services to an affiliate normally are considered realized at the time the services are provided. Realization of intercompany profits on services normally is considered to occur as the services are consumed, and services such as maintenance and repair services normally are considered to be consumed by the purchasing affiliate at the time received. C7-5 Intercompany Profits The answer is found in Verizon’s SEC 10-K filing and in its annual report. Note that financial statements are often included in the Form 10-K by reference to the company’s annual report. In such cases, the financial statements are often shown in a separate exhibit rather than in Item 8 of the Form 10-K. Verizon (www.verizon.com) eliminates all intercompany profits.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

SOLUTIONS TO EXERCISES E7-1 Multiple-Choice Questions on Intercompany Transfers [AICPA Adapted] 1. c – After consolidation entries are made, the consolidated balance sheet should present the asset at Fire's carrying amount on the date of transfer (which is equal to Water’s cost less the gain recorded by Fire). (a) Incorrect. The consolidation entries have the effect of increasing Water's cost amount to Fire's original cost. (b) Incorrect. Fire's original cost is not equal to the carrying amount on the transfer date. (d) Incorrect. Water's original cost would not be reduced by a proportional amount of the gain. 2. d – Business combinations always use the acquisition date fair values of assets and liabilities that are acquired. (a) Incorrect. In a business combination, both assets and liabilities should be reported at fair value. (b) Incorrect. Assets such as plant and equipment should be reported at fair value. (c) Incorrect. Liabilities such as long-term debt should be reported at fair value. 3. b – The gain should be recognized over the remaining useful life of the equipment, which in this case is three years. Thus, in each year, 1/3 or 33 1/3% would be recognized. (a) Incorrect. This would represent a decrease over the original five year life of the asset. Instead, it should be over the remaining useful life. (c) Incorrect. This mistakenly assumes the depreciation expense would be decreased over the two years for which the equipment was already owned. Instead, it should be over the remaining useful life. (d) Incorrect. It must be recognized over the remaining useful life, not all at once. 4. a – Poe's original cost of the machine would be the amount reported on the consolidated balance sheet. Additionally, an extra $50,000 in depreciation would be recorded for the year, bringing the total accumulated depreciation to $300,000. (b) Incorrect. Depreciation expense for the year is $50,000, which brings total accumulated depreciation to $300,000. (c) Incorrect. The machine is reported at its original cost from the selling party (Poe). (d) Incorrect. The machine is reported at its original cost from the selling party (Poe). 5. b –

Depreciation expense recorded by Pirn Depreciation expense recorded by Scroll Total depreciation reported Adjustment for excess depreciation charged by Scroll as a result of increase in carrying value of equipment due to gain on intercompany sale ($12,000 / 4 years) Depreciation for consolidated statements

$40,000 10,000 $50,000

(3,000) $47,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-2 Multiple-Choice Questions on Intercompany Transactions 1. d – The land purchased from Upper Company had to be prior to 20X5 because the investment account is only debited in subsequent years after the year of purchase. (a) Incorrect. Since there is no debit to non-controlling interest this must be a downstream (parent to sub) transaction meaning Lower purchased the land from Upper not vice versa. (b) Incorrect. Since there is no debit to non-controlling interest this must be a downstream (parent to sub) transaction meaning Lower purchased the land from Upper not vice versa. (c) Incorrect. If lower had purchased the land this year there would be a debit to a gain instead of a debit to the investment account. The investment account is debited in the years following the purchase year. 2. a – The costs incurred by Bottom to develop the equipment are considered R&D costs and must be expensed as they are incurred (ASC 730-10-25-1). Transfer to another legal entity does not cause a change in accounting treatment within the economic entity. (b) Incorrect. These are research and development costs which are not capitalized even if transferred to another legal entity within the economic entity. (c) Incorrect. These are research and development costs which are not capitalized even if transferred to another legal entity within the economic entity. (d) Incorrect. These are research and development costs which are not capitalized even if transferred to another legal entity within the economic entity. 3. b – The $39,000 paid to Gold Company will be charged to depreciation expense by Top Corporation over the remaining 3 years of ownership. As a result, Top Corporation will debit depreciation expense for $13,000 each year. Gold Company had charged $16,000 to accumulated depreciation in 2 years, for an annual rate of $8,000. Depreciation expense therefore must be reduced (credited) by $5,000 ($13,000 - $8,000) in preparing the consolidated statements. (a) Incorrect. Depreciation expense should be decreased by $5,000, not increased. (c) Incorrect. This will be the entry to depreciation expense after year 20X6, but in the current year this amount must be reduced by $5,000. (d) Incorrect. A credit of $13,000 to depreciation expense would result in zero depreciation for the year, which would be misstated. 4. a – TLK Corporation will record the purchase at $39,000, the amount it paid. Gold Company had the equipment recorded at $40,000; thus, a debit of $1,000 will raise the equipment balance back to its original cost from the viewpoint of the consolidated entity. (b) Incorrect. The computer equipment must be brought back to the historical cost amount for Gold. A debit of $15,000 would incorrectly bring the equipment balance up to $54,000, which is more than the historical cost of the equipment. (c) Incorrect. The computer equipment must be brought back to the historical cost amount for Gold. A credit of $24,000 would incorrectly bring the equipment balance down to $15,000, which is less than the historical cost of the equipment. (d) Incorrect. The computer equipment must be brought back to the historical cost amount for Gold. A debit of $40,000 would incorrectly bring the equipment balance up to $79,000, which is more than the historical cost of the equipment.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-2 (continued) 5.

b–

c–

Reported net income of Gold Company Reported gain on sale of equipment Intercompany profit realized in 20X6 Realized net income of Gold Company Proportion of stock held by noncontrolling interest Income assigned to noncontrolling interests

$ 45,000 $15,000 (5,000)

(10,000) $ 35,000 x .40 $ 14,000

Operating income reported by Top Corporation Net income reported by Gold Company

$ 85,000 45,000 $130,000

Less: Unrealized gain on sale of equipment ($15,000 - $5,000) Consolidated net income

(10,000) $120,000

E7-3 Consolidation Entries for Land Transfer a.

Consolidation entry, December 31, 20X4: Gain on Sale of Land Land

10,000 10,000

The basic entry (not shown) would be adjusted by 10,000 of deferred gain on land to complete the elimination process. Consolidation entry, December 31, 20X5: Investment in Sentence Land

10,000 10,000

The basic entry (not shown) would complete the elimination process. b.

Consolidation entry, December 31, 20X4: Gain on Sale of Land Land

10,000 10,000

The basic entry (not shown) would be adjusted by 10,000 of deferred gain on land to complete the elimination process. Consolidation entry, December 31, 20X5: Investment in Sentence NCI in NA of Sentence Land

6,000 4,000 10,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-4 Intercompany Services a. Consolidated net income will not change. b. One hundred percent of the intercompany services must always be eliminated. Thus, a change in the level of ownership of the subsidiary will not have an impact on the amount eliminated or on consolidated net income. c. $38,000 = $70,000 - $32,000 E7-5 Consolidation Entries for Intercompany Services Two consolidation entries are required: Delivery Service Revenue Delivery Service Expense

76,000

Accounts Payable Accounts Receivable

18,000

76,000

18,000

E7-6 Consolidation Entries for Depreciable Asset Transfer: Year-End Sale a. Actual (Spray): “As if” (Pam):

Accumulated Depreciation

Truck 40,000 5,000 45,000

0 15,000 15,000

Eliminate the gain on Truck & correct asset's basis: Gain on sale Truck Accumulated Depreciation

10,000 5,000 15,000

The basic entry (not shown) would be adjusted by 10,000 of deferred gain on truck to complete the elimination process. b.

Actual (Spray): “As if” (Pam):

Accumulated Depreciation 4,000 1,000 15,000 18,000

Truck 40,000 5,000 45,000

Eliminate the Gain on Truck & Correct Asset's Basis: Investment in Spray

10,000

Truck

5,000

Accumulated Depreciation

15,000

Accumulated Depreciation

1,000

Depreciation Expense

1,000

The basic entry (not shown) would be adjusted by 1,000 to reverse the gain deferral and complete the elimination process. 7-12 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-7 Transfer of Land a.

Consolidation entry, December 31, 20X2:

Gain on Sale of Land Land

45,000 45,000

The basic entry (not shown) would be adjusted by 45,000 of deferred gain on land to complete the elimination process. Consolidation entry, December 31, 20X3: Investment in Stick NCI in NA of Stick Land

31,500 13,500 45,000

The basic entry (not shown) would complete the elimination process. b.

Consolidation entries, December 31, 20X3 and 20X4:

Investment in Stick Land

30,000 30,000

The basic entry (not shown) would complete the elimination process. E7-8 Transfer of Depreciable Asset at Year-End a. Accumulated Depreciation

Truck Actual (Softball Corp.): “As if” (Pitcher Corp.):

210,000 90,000 300,000

0 120,000 120,000

Eliminate the Gain on Truck & Correct Asset's Basis: Gain on sale 30,000 Truck 90,000 Accumulated Depreciation

120,000

The basic entry (not shown) would be adjusted by 30,000 of deferred gain on truck to complete the elimination process. Computation of gain on sale of truck: Price paid by Softball Cost of truck to Pitcher Accumulated depreciation ($300,000 / 10 years) x 4 years Gain on sale of truck

$210,000 $300,000 (120,000)

(180,000) $ 30,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-8 (continued) b. Actual (Softball Corp.): “As if” (Pitcher Corp.):

Accumulated Depreciation 35,000 5,000 120,000 150,000

Truck 210,000 90,000 300,000

Eliminate the Gain on Truck & Correct Asset's Basis: Investment in Softball Corp. 30,000 Truck 90,000 Accumulated Depreciation Accumulated Depreciation Depreciation Expense

120,000

5,000 5,000

The basic entry (not shown) would be adjusted by 5,000 to reverse the gain deferral and complete the elimination process. E7-9 Transfer of Depreciable Asset at Beginning of Year a. Actual (Softball Corp.): “As if” (Pitcher Corp.):

Accumulated Depreciation 35,000 5,000 90,000 120,000

Truck 245,000 55,000 300,000

Eliminate the gain on Truck & correct asset's basis: Gain on Sale

35,000

Truck

55,000

Accumulated Depreciation

90,000

Accumulated Depreciation

5,000

Depreciation Expense

5,000

$245,000 $300,000 ( 90,000)

(210,000) $ 35,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-9 (continued) b. Accumulated Depreciation

Truck Actual (Softball Corp.):

245,000

70,000

55,000 “As if” (Pitcher Corp.):

5,000

300,000

85,000 150,000

Eliminate the Gain on Truck & Correct Asset's Basis: Investment in Softball Corp.

30,000

Truck

55,000

Accumulated Depreciation

85,000

Accumulated Depreciation

5,000

Depreciation Expense

5,000

The basic entry (not shown) would be adjusted by 5,000 to reverse the gain deferral and complete the elimination process. E7-10 Sale of Equipment to Subsidiary in Current Period a. Cash

84,000

Accumulated Depreciation

80,000

Equipment

150,000

Gain on sale of Equipment

14,000

Record gain on Equipment

b. Equipment Cash Journal entry to record purchase

84,000

Depreciation Expense Accumulated Depreciation Journal entry to record depreciation expense

12,000

84,000

12,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-10 (continued) c. Actual (Sheet Corp.): “As if” (Pillow Corp.):

Accumulated Depreciation 12,000 2,000 80,000 90,000

Equipment 84,000 66,000 150,000

Eliminate the Gain on Equipment & Correct Asset's Basis: Gain on sale 14,000 Equipment 66,000 Accumulated Depreciation

80,000

Accumulated Depreciation Depreciation Expense

2,000

The basic entry (not shown) would be adjusted for 12,000 of deferred gain on equipment to complete the elimination process. d. Consolidation entry at January 1, 20X8, to eliminate intercompany sale of equipment and prepare a consolidated balance sheet only: Eliminate the Gain on Equipment & Correct Asset's Basis: Investment in Sheet Corp. 12,000 Equipment 66,000 Accumulated Depreciation

78,000

The basic entry (not shown) would complete the elimination process. E7-11 Upstream Sale of Equipment in Prior Period a.

Consolidated net income for 20X8: Operating income reported by Photo Net income reported by Shutter Amount of gain realized in 20X8 ($30,000 / 12 years) Realized net income of Shutter Consolidated net income

$100,000 $40,000 2,500 42,500 $142,500

Consolidated net income for 20X8 would be unchanged.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-11 (continued) c.

Accumulated Depreciation 67,500 2,500 55,000 120,000

Equipment 270,000 30,000 300,000

Actual (Photo): “As if” (Shutter):

Eliminate the Gain on Equipment & Correct Asset's Basis: Investment in Shutter 20,000 NCI in NA of Shutter 5,000 Equipment 30,000 Accumulated Depreciation

55,000

Accumulated Depreciation Depreciation Expense

2,500

The basic entry (not shown) would be adjusted by 2,500 to reverse the gain deferral and complete the elimination process. E7-12 Consolidation Entries for Midyear Depreciable Asset Transfer a. Actual (Series Co.): “As if” (Playoff Corp.):

Accumulated Depreciation 4,000 1,500 12,500 15,000

Equipment 28,000 2,000 30,000

Eliminate the Gain on Equipment & Correct Asset's Basis: Investment in Series Co. 10,500 Equipment 2,000 Accumulated Depreciation

12,500

Accumulated Depreciation Depreciation Expense

1,500

The basic entry (not shown) would be adjusted by 1,500 to reverse the gain deferral and complete the elimination process. b. Series Co. Playoff Corp.

Equipment 28,000 2,000

Actual

30,000

"As If"

Accumulated Depreciation 12,000 3,000 11,000 20,000

Eliminate the Gain on Equipment & Correct Asset's Basis: Investment in Series Co. 9,000 Equipment 2,000 Accumulated Depreciation

11,000

Accumulated Depreciation Depreciation Expense

3,000

The basic entry (not shown) would be adjusted by 3,000 to reverse the gain deferral and complete the elimination process.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-13 Consolidated Net Income Computation a.

Downstream sale of land: 20X4 $ 90,000 (25,000) $ 65,000 60,000 $125,000

Progeny’s separate operating income Less: Unrealized gain on sale of land Progeny’s realized operating income Spawn’s realized net income Consolidated net income Income to noncontrolling interest: ($60,000 x 0.25) ($40,000 X 0.25) Income to controlling interest b.

20X5 $110,000 $110,000 40,000 $150,000

(15,000) $110,000

(10,000) $140,000

20X4 $ 90,000

20X5 $110,000

35,000 $125,000

40,000 $150,000

Upstream sale of land: Progeny’s separate operating income Spawn’s net income Less: Unrealized gain on sale of land Spawn’s realized net income Consolidated net income Income to noncontrolling interest: ($35,000 x 0.25) ($40,000 x 0.25) Income to controlling interest

$60,000 (25,000)

(8,750) $116,250

(10,000) $140,000

E7-14 Consolidation Entries for Intercompany Transfers a.

Operating income of Post Delivery Net income of Script Real Estate Company Less: Unrealized profit on land sale Script’s realized net income Consolidated net income

$65,000 $40,000 (25,000) 15,000 $80,000

Journal entries recorded by Post Delivery: Cash 8,000 Investment in Script Real Estate Record dividends from Script Real Estate: $10,000 x 0.80

8,000

Investment in Script Real Estate Income from Script Real Estate Record equity-method income: $40,000 x 0.80

32,000 32,000

Income from Script Real Estate Investment in Script Real Estate Eliminate unrealized gain on sale

20,000 20,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-14 (continued) c. Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 20%

Post Delivery 80% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

80,000 8,000 (2,000)

320,000 32,000 (8,000)

300,000

100,000 40,000 (10,000)

Ending book value

86,000

344,000

300,000

130,000

Adjustment to Basic Consolidation Entry: NCI Post Delivery 20% 80% Net income 8,000 32,000 - Gross profit deferral (up) (5,000) (20,000) Income to be eliminated

3,000

12,000

Ending book value - Gross profit deferral (up)

86,000 (5,000)

344,000 (20,000)

Adjusted book value

81,000

324,000

Basic Consolidation Entry Common Stock

300,000

← Common Stock

Retained Earnings

100,000

← Beginning balance in retained earnings

Income from Script Real Estate

12,000

← Post’s share of NI with Adjustments

NCI in NI of Script Real Estate

3,000

← NCI share of NI with Adjustments

Dividends Declared

10,000

← 100% of Script’s dividends declared

Investment in Script Real Estate

324,000

← Post’s share of BV with Adjustments

NCI in NA of Script Real Estate

81,000

← NCI share of BV with Adjustments

Eliminate Gain on Purchase of Land Gain on Sale of Land

25,000

Land

25,000

Eliminate Courier services Service Revenue

15,000

Delivery Expense

15,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-15 Sale of Building to Parent in Prior Period a.

Pea will record annual depreciation expense of $25,000 ($300,000 / 12 years).

Split would have recorded annual depreciation expense of $20,000 ($400,000 / 20 years).

c. Accumulated Depreciation

Building Actual (Pea Co.):

300,000

25,000

100,000 “As if” (Split Co.):

5,000

400,000

160,000 180,000

Eliminate the Gain on Building and Correct Asset's Basis: Investment in Split Co.

42,000

NCI in NA of Split Co.

18,000

Building

100,000

Accumulated Depreciation Accumulated Depreciation

160,000 5,000

Depreciation Expense

5,000

The basic entry (not shown) would be adjusted by 5,000 to reverse the gain deferral and complete the elimination process. d. Income assigned to noncontrolling interest for 20X9: Net income reported by Split Company Amount of gain realized in 20X9 ($60,000 / 12 years) Realized net income for 20X9 Proportion of ownership held by noncontrolling interest Income assigned to noncontrolling interest e.

$ 40,000 5,000 $ 45,000 x 0.30 $ 13,500

Amount assigned to noncontrolling interest in 20X9 consolidated balance sheet: Split Company net assets, January 1, 20X9 ($350,000 - $150,000) Net income for 20X9 Dividends paid in 20X9 Unrealized profit on sale of building to Pea Company ($60,000 - $5,000) Realized book value December 31, 20X9 Proportion of ownership held by noncontrolling interest Amount assigned to noncontrolling interest in December 31, 20X9, consolidated balance sheet

$200,000 40,000 (15,000) (55,000) $170,000 x

0.30

$ 51,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-16 Intercompany Sale at a Loss a.

Consolidated net income for 20X8 will be greater than Parent Company's income from operations plus Surrogate's reported net income. The consolidation entries at December 31, 20X8, will result in an increase of $16,000 to consolidated net income.

As a result of purchasing the equipment at less than Parent's book value, depreciation expense reported by Surrogate will be $2,000 ($16,000 / 8 years) below the amount that would have been recorded by Parent. Thus, depreciation expense must be increased by $2,000 when consolidation entries are prepared at December 31, 20X9. Consolidated net income will be decreased by the full amount of the $2,000 increase in depreciation expense.

E7-17 Consolidation Entries Following Intercompany Sale at a Loss a.

Consolidation entry, December 31, 20X7:

Buildings and Equipment Loss on Sale of Building Accumulated Depreciation

156,000 36,000 120,000

Eliminate unrealized loss on building. The basic entry (not shown) would be adjusted by 36,000 of deferred loss on sale of building to complete the elimination process. b.

Consolidated net income and income to controlling interest for 20X7: Operating income reported by Pocket Net income reported by Strap Add: Loss on sale of building Realized net income of Strap Consolidated net income Income to noncontrolling interest ($51,000 x 0.30) Income to controlling interest

$125,000 $ 15,000 36,000 51,000 $176,000 (15,300) $160,700

c. Eliminate the Loss on Building and Correct Asset's Basis: Building

156,000

Investment in Strap Co.

25,200

NCI in NA of Strap Co.

10,800

Accumulated Depreciation

120,000

Depreciation Expense

4,000

Accumulated Depreciation

4,000

The basic entry (not shown) would be adjusted by 4,000 to reverse the loss deferral and complete the elimination process. E7-17 (continued) Accumulated Depreciation

Building

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

Pocket Corp.

144,000

Actual

16,000

156,000

120,000 4,000

Strap Co.

300,000

"As If"

140,000

Consolidated net income and income assigned to controlling interest in 20X8: Operating income reported by Pocket $150,000 Net income reported by Strap $40,000 Adjustment for loss on sale of building (4,000) Realized net income of Strap 36,000 Consolidated net income $186,000 Income assigned to noncontrolling interest ($36,000 x 0.30) (10,800) Income assigned to controlling interest $175,200

E7-18 Multiple Transfers of Asset a.

$145,000

No gain or loss should be reported.

Swanson Corporation operating income

$150,000

Sullivan Corporation net income Loss on sale of land ($145,000 - $130,000) Realized net income of Sullivan Corporation Proportion of stock held by Swanson

$120,000 15,000 $135,000 x 0.80

108,000

Kolder Company net income Gain on sale of land ($180,000 - $130,000) Realized net income of Kolder Company Proportion of stock held by Swanson

$ 60,000 (50,000) $ 10,000 x 0.70

7,000

Clayton Corporation net income Gain on sale of land ($240,000 - $180,000) Realized net income of Clayton Corporation Proportion of stock held by Swanson Income assigned to controlling interest

$ 80,000 (60,000) $ 20,000 x 0.90

Alternate Computation: Swanson Corporation operating income Sullivan Corporation net income Kolder Company net income Clayton Corporation net income Combined income

18,000 $283,000 $150,000 120,000 60,000 80,000 $410,000

E7-18 (continued) Unrealized loss recorded by Sullivan Corp.

$ (15,000)

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

Unrealized gain recorded by Kolder Company Unrealized gain recorded by Clayton Corp. Realized income available to all shareholders

50,000 60,000

Income assigned to noncontrolling interest: Sullivan Corp. ($120,000 + $15,000) x 0.20 Kolder Company ($60,000 - $50,000) x 0.30 Clayton Corp. ($80,000 - $60,000) x 0.10 Income assigned to controlling interest d.

$ 27,000 3,000 2,000

(95,000) $315,000

(32,000) $283,000

Consolidation entry:

Gain on Sale of Land Loss on Sale of Land Land

110,000 15,000 95,000

Eliminate gains and loss on land transfer: $110,000 = $50,000 + $60,000 $95,000 = $110,000 - $15,000 The basic entry (not shown) would be adjusted by 95,000 of deferred net gain on land to complete the elimination process. E7-19 Consolidation Entry in Period of Transfer a.

$300,000 = $276,000 + $24,000

15 years = $300,000 / ($60,000 / 3 years)

c. Accumulated Depreciation

Truck Actual (Plumber Corp.):

276,000

23,000

24,000 “As if” (Socket Corp.):

3,000

300,000

60,000 80,000

Eliminate the Gain on Truck and Correct Asset's Basis: Investment in Socket Corp.

21,600

NCI in NA of Socket Corp.

14,400

Truck

24,000

Accumulated Depreciation

60,000

Accumulated Depreciation

3,000

Depreciation Expense

3,000

The basic entry (not shown) would be adjusted by 3,000 to reverse the gain deferral and complete the elimination process.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

a. Accumulated Depreciation

Equipment Actual (Passport):

360,000

36,000

90,000 “As if” (Subsidiary):

6,000

450,000

150,000 180,000

Eliminate the Gain on Equipment and Correct Asset's Basis: Gain on sale

60,000

Equipment

90,000

Accumulated Depreciation Accumulated Depreciation

150,000 6,000

Depreciation Expense

6,000

The basic entry (not shown) would be adjusted by 54,000 of deferred gain on equipment to complete the elimination process. b. Accumulated Depreciation

Equipment Actual (Passport):

360,000

72,000

90,000 “As if” (Subsidiary):

6,000

450,000

144,000 210,000

Eliminate the Gain on Equipment and Correct Asset's Basis: Investment in Subsidiary

37,800

NCI in NA of Subsidiary

16,200

Equipment

90,000

Accumulated Depreciation Accumulated Depreciation

144,000 6,000

Depreciation Expense

6,000

The basic entry (not shown) would be adjusted by 6,000 to reverse the gain deferral and complete the elimination process.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-21 Using the Consolidation Entry to Determine Account Balances a.

Pastel owns 90 percent ($9,450 / ($9,450 + $1,050) of the stock of Somber Corporation.

The subsidiary was the owner. The sale was from the subsidiary to the parent, as evidenced by the debit to noncontrolling interest in the consolidation entry.

Intercompany transfer price: Amount paid by Somber Corporation Increase to buildings and equipment in consolidation entry Amount paid by Pastel to Somber for equipment

$ 66,500

Income assigned to noncontrolling interest for 20X9: Net income reported by Somber Amount of gain realized in 20X9 ($10,500 / 7 years) Realized net income for 20X9 Proportion of ownership held by noncontrolling interest Income assigned to noncontrolling interest

$120,000 (53,500)

$ 25,000 1,500 $ 26,500 x 0.10 $ 2,650

Total depreciation expense of $22,500 ($15,000 + $9,000 - $1,500) will be reported by the consolidated entity for 20X9.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-21 (continued) f.

Consolidation entries at December 31, 20X9:

Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 10%

Pastel Corp. + 90% =

Common Stock

Retained Earnings

Beginning book value + Net income - Dividends

50,000 2,500 (600)

450,000 22,500 (5,400)

300,000

200,000 25,000 (6,000)

Ending book value

51,900

467,100

300,000

219,000

Adjustment to Basic Consolidation Entry: NCI Pastel Corp. 10% 90% Net income 2,500 22,500 + Extra Depreciation 150 1,350 Income to be eliminated

2,650

23,850

Ending book value + Extra Depreciation

51,900 150

467,100 1,350

Adjusted book value

52,050

468,450

Basic Consolidation Entry Common Stock Retained Earnings Income from Somber Corp. NCI in NI of Somber Corp. Dividends Declared Investment in Somber Corp. NCI in NA of Somber Corp.

Actual (Pastel Corp.): “As if” (Somber Corp.):

300,000 200,000 23,850 2,650 6,000 468,450 52,050

← Original amount invested (100%) ← Beginning balance in RE ← Pastel’s share of NI with Adjustments ← NCI share of NI with Adjustments ← 100% of Somber's dividends ← Pastel 's share of BV with Adjustments ← NCI share of BV with Adjustments

Accumulated Depreciation 9,500 1,500 64,000 72,000

Equipment 66,500 53,500 120,000

Eliminate the Gain on Equipment and Correct Asset's Basis: Investment in Somber Corp. 9,450 NCI in NA of Somber Corp. 1,050 Equipment 53,500 Accumulated Depreciation 64,000 Accumulated Depreciation Depreciation Expense

1,500 1,500 7-26

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-22 Intercompany Sale of Services a.

Consolidation entries, 20X4:

Consulting Revenue Consulting Fees Expense

138,700 138,700

Eliminate intercompany revenue and expense. Accounts Payable Accounts Receivable

6,600 6,600

Eliminate intercompany receivable/payable. The basic entry (not shown) would complete the elimination process. b. Consolidated net income and income to controlling interest for 20X4: Plastic's separate operating income Spoon's net income Consolidated net income Income to noncontrolling interest ($631,000 x 0.25) Income to controlling interest

$2,342,000 631,000 2,973,000 (157,750) $2,815,250

E7-23A Modified Equity Method and Cost Method a. (1) Equity Method Entries on Passenger's Books: Investment in Seat Sales Co.

45,500

Income from Seat Sales Co.

45,500

Record Passenger's 65% share of Seat Sales Co.'s 20X4 income Cash

13,000

Investment in Seat Sales Co.

13,000

Record Passenger's 65% share of Seat Sales Co.'s 20X4 dividend

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-23A (continued) (2)

Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 35%

Passenger Common + 65% = Stock +

Retained Earnings

Beginning book value + Net income - Dividends

155,750 24,500 (7,000)

289,250 45,500 (13,000)

300,000

145,000 70,000 (20,000)

Ending book value

173,250

321,750

300,000

195,000

Adjustment to Basic Consolidation Entry: NCI Passenger 35% 65% Net income 24,500 45,500 + Extra Depreciation 2,800 5,200 - Gain on sale of Land (11,000) Income to be eliminated

27,300

39,700

Ending book value + Extra Depreciation - Gain on sale of Land

173,250 2,800

321,750 5,200 (11,000)

Adjusted book value

176,050

315,950

Basic Consolidation Entry Common Stock

300,000

← Common Stock

Retained Earnings

145,000

← Beginning balance in RE

Income from Seat Sales Co.

45,500

← Passenger’s share of NI

NCI in NI of Seat Sales Co.

27,300

← NCI share of NI with Adjustments

Dividends Declared

20,000

← 100% of Seat Sales Co.'s dividends

Investment in Seat Sales Co.

321,750

← Passenger's share of BV

NCI in NA of Seat Sales Co.

176,050

← NCI share of BV with Adjustments

Eliminate Gain on Purchase of Land Investment in Seat Sales Co.

11,000

Land

11,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-23A (continued) Eliminate the Gain on Equipment and Correct Asset's Basis: Investment in Seat Sales Co.

26,000

NCI in NA of Seat Sales Co.

14,000

Equipment, net

40,000

Accumulated Depreciation

8,000

Depreciation Expense

8,000

b. (1) Equity Method Entries on Passenger's Books: Cash Dividend Income Record dividend income from Seat Sales Company.

13,000 13,000

(2) Investment Consolidation Entry Common Stock

300,000

Retained Earnings

100,000

Investment in Seat Sales Co.

260,000

NCI in NA of Seat Sales Co.

140,000

Dividend Consolidation Entry Dividend Income

13,000

NCI in NI of Seat Sales Co.

7,000

Dividends Declared

20,000

Assign Prior Undistributed Income to NCI NCI in NI of Seat Sales Co. ($58,000 x 35%)

20,300

Retained Earnings ($45,000 x 35%)

15,750

NCI in NA of Seat Sales Co.

36,050

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

E7-23A (continued) Eliminate Gain on Purchase of Land Investment in Seat Sales Co.

11,000

Land

11,000

Eliminate the Gain on Equipment and Correct Asset's Basis: Investment in Seat Sales Co.

26,000

NCI in NA of Seat Sales Co.

14,000

Equipment, net Accumulated Depreciation

40,000 8,000

Depreciation Expense

8,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

SOLUTIONS TO PROBLEMS P7-24 Computation of Consolidated Net Income a.

Separate operating income of Package Corporation Reported net income of Sack Grain Company Unrealized profit of sale of land Realized income for 20X4 Amortization of differential ($10,000 / 10 years)

$34,000 $19,000 (7,000) $12,000 ( 1,000) $11,000 x 0.90

Proportion of ownership held by Package Income attributable to controlling interest Income to controlling interest b.

9,900 $43,900

Separate operating income of Package Corporation Reported net income by Sack Grain Company Amortization of differential ($10,000 / 10 years)

$34,000 $19,000 ( 1,000) $18,000 x 0.90

Proportion of stock held by Package Income attributable to controlling interest Unrealized profit on sale of land Income to controlling interest

16,200 (7,000) $43,200

Reported income will decrease by $700. In the upstream case the unrealized profit ($7,000) is apportioned to both majority ($6,300) and noncontrolling ($700) shareholders. In the downstream case, it is apportioned entirely to the majority shareholders ($7,000). P7-25 Subsidiary Net Income a.

Slice Corporation’s reported net income for 20X4 was $94,400: Income assigned to noncontrolling shareholders Add: Unrealized profit on building ($20,000 x 0.25) Amortization of differential ($4,400 x 0.25) Income assigned to noncontrolling interest before adjustment Proportion of stock held by noncontrolling interest Reported income of Slice Computation of annual amortization: Fair value of consideration given by Pizza Fair value of noncontrolling interest Total fair value Book value of Slice’s assets: Common stock Retained earnings Total book value Differential paid by Pizza Number of years in amortization period Annual amortization

$17,500 5,000 1,100 $23,600 ÷ 0.25 $94,400 $348,000 116,000 $464,000

$150,000 270,000 (420,000) $ 44,000 ÷ 10 $4,400

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-25 (continued) b.

Consolidated net income for 20X4 is $304,000: Pizza Corporation’s operating income Slice Corporation’s net income Amortization of differential ($44,000 / 10 years) Unrealized profit on building Consolidated net income

$234,000 94,400 (4,400) (20,000) $304,000

Income assigned to controlling interest is $286,500: Consolidated net income Income assigned to noncontrolling interest Income assigned to controlling interest

$304,000 (17,500) $286,500

Alternate computation: Operating income of Pizza Income from Slice: Net income of Slice Unrealized profit on building Amortization of differential Realized income Portion of ownership held Income to controlling interest

$234,000 $94,400 (20,000) (4,400) $70,000 x 0.75

52,500 $286,500

P7-26 Transfer of Asset from One Subsidiary to Another Bugle Corporation

Cook Products Corporation

Consolidated Entity

---

$ 3,000

$ 2,000

Fixed assets — Warehouse

---

45,000

40,000

Accumulated depreciation

---

3,000

12,000

Gain on sale of warehouse

15,000

---

Depreciation expense

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-27 Consolidation Entry a.

Powder paid Snow $460,000 ($600,000 - $140,000).

Accumulated depreciation at January 1, 20X7, was $168,000, computed as follows: Purchase price paid by Snow Amount paid by Powder Gain recorded by Snow Book value at date of sale Accumulated depreciation at date of sale

$600,000 $460,000 (28,000)

Annual depreciation expense recorded by Snow was $28,000 ($168,000/6 years).

The estimated residual value was $40,000, computed as follows: Purchase price paid by Snow Amount to be depreciated by Snow ($28,000 x 20 years) Estimated residual value

(432,000) $168,000

$600,000 (560,000) $ 40,000

Powder Corporation recorded depreciation expense of $30,000 in 20X7 [($460,000 $40,000) / 14 years). Alternate calculation: $28,000 + $2,000 from the consolidation entry.

Reported net income of Snow Unrealized gain on sale of building ($28,000 - $2,000) Proportion of stock held by noncontrolling interest Income assigned to noncontrolling interest

Reported net income of Snow Portion of gain on sale of building realized in 20X8 Proportion of stock held by noncontrolling interest Income assigned to noncontrolling interest

$ 80,000 (26,000) $ 54,000 x 0.40 $ 21,600 $ 65,000 2,000 $ 67,000 x 0.40 $ 26,800

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-28 Multiple-Choice Questions 1. d – Only when the depreciable asset is resold to a third party in the current period will the deferred gain be realized, making NCI in income greater than a pro-rata portion of the sub’s income for the period. (a) Incorrect. Income assigned to noncontrolling shareholders does not include income from the parent company, which would be included in consolidated income. (b) Incorrect. Income of the subsidiary can also include unrealized gains from intercompany sales, which would be eliminated before the proportionate share is computed. (c) Incorrect. When the asset is resold to a third party, income assigned to noncontrolling shareholders would be more than a pro rata portion of the subsidiary's reported net income, not less. 2. c – The noncontrolling shareholders will reduce their income from the subsidiary by a proportionate share of the unrealized gain. This will be a deferred gain that will subsequently be recognized when the land is later sold to a third party. (a) Incorrect. The entire gain should be eliminated from consolidated net income, not just the 90%. (b) Incorrect. When the gain is eliminated, consolidated net income is decreased by the full amount of the gain, not increased. (d) Incorrect. While the entire gain is eliminated from consolidated net income, only the noncontrolling interest's proportionate share of the gain will be excluded from income assigned to noncontrolling interest. 3. a – Unless the land is resold in the same period the unrealized gain will have to be eliminated and a proportionate share of the gain will have to reduce NCI net income. (b) Incorrect. The gain will have to be eliminated and reduce income unless the land is resold in the same period. The gain is not reduced if the land has been sold. (c) Incorrect. It does matter when the land is resold because any unrealized gain will affect the computation of consolidated net income in the period. (d) Incorrect. Without knowing whether the land had been resold as of December 31, 20X4, it cannot be determined whether the gain has been realized. 4. d – Consolidated income will be reduced by $35,000 (i.e., the gain of $40,000 will be removed, but the extra depreciation of $5,000 will also be removed, thus the net adjustment will be $35,000). (a) Incorrect. The gain is accurately computed, which represents the excess of what was paid over the book value of the asset. (b) Incorrect. Depreciation expense is overstated by Lewis, as evidenced by the credit to depreciation expense. (c) Incorrect. The asset transfer must have occurred prior to year-end because of the debit to gain rather than to the investment account.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-29 Intercompany Services Provided to Subsidiary The consolidation entry at December 31, 20X4, would be: Service Revenue Building Wage Expense

110,000 30,000 80,000

The consolidation entries at December 31, 20X5, would be: Investment in Subsidiary Building

30,000

Accumulated Depreciation Depreciation Expense

1,200

30,000 1,200

P7-30 Consolidated Net Income with Intercompany Transfers a. Cash

240,000

Accumulated Depreciation

140,000

Equipment

350,000

Gain on Sale of Equipment

30,000

Record Gain on Equipment

b. Eliminate Loss on Purchase of Land Land Loss on sale of land

60,000 60,000

Eliminate the Gain on Equipment and Correct Asset's Basis: Investment in Subsidence 25,000 Equipment 110,000 Accumulated Depreciation Accumulated Depreciation Depreciation Expense

135,000

5,000 5,000

The basic entry (not shown) would be adjusted by 60,000 of deferred loss on purchase of land and 5,000 to reverse the equipment gain deferral and complete the elimination process.

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-30 (continued) c.

Subsidence Mining's 20X7 net income was $90,000: Subsidence Mining's income to noncontrolling shareholders Noncontrolling interest's share of subsidiary income Subsidence Mining's income before adjustment Add: Amortization of differential: ($200,000 / 10 years) Less: Unrealized loss on intercompany sale of land Subsidence Mining's 20X7 reported net income

$ 39,000 ÷ 0.30 $130,000 20,000 (60,000) $ 90,000

Plate’s operating income was $826,000: Consolidated net income Less: Income to noncontrolling interest Income assigned to controlling interest Income from Subsidence Mining: Reported net income Unrealized loss on land Amortization of differential ($200,000 / 10 years) Realized income Portion of ownership held Plate’s share Realized profit on equipment ($30,000 / 6 years) Plate’s 20X7 income from its separate operations

$961,000 (39,000) $922,000 $ 90,000 60,000 (20,000) $130,000 x 0.70 $ 91,000 5,000

(96,000) $826,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-31 Preparation of Consolidated Balance Sheet a.

Book Value Calculations: NCI 40% Ending book value

100,000

Pork Co. 60%

150,000

Common Stock +

Retained Earnings

2 0 0 ,0 0 0

5 0 ,0 0 0

Adjustment to Basic Consolidation Entry : NCI Pork Co. 40% 60% Ending Book Value 100,000 150,000 + Extra Depreciation (down) 3 ,0 0 0 Ending Book Value

1 0 0 ,0 0 0

Basic Consolidation Entry Common Stock Retained Earnings Income from Swine Corp. Investment in Swine Corp. NCI in NA of Swine Corp. Eliminate Gain on Purchase of Land Land Investment in Swine Corp. NCI in NA of Swine Corp.

Swine Corp. Pork Co.

Equipment 91,000 9,000 100,000

1 5 3 ,0 0 0

200,000 50,000 3,000 153,000 100,000

← Common Stock ← Beginning balance in RE ← Pork’s share of NI with Adjustments ← Pork's share of BV with Adjustments ← NCI share of BV of net assets

10,000 6,000 4,000 Accumulated Depreciation 26,000 3,000 27,000 50,000

Actual "As If"

Eliminate the Gain on Equipment and Correct Asset's basis: Investment in Swine Corp. 18,000 Equipment 9,000 Accumulated Depreciation 27,000 Accumulated Depreciation Depreciation Expense

3,000 3,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-31 (continued)

Swine Corp.

Pork Co. Balance Sheet Cash and Receivables Inventory Land Buildings & Equipment Less: Accumulated Depr. Investment in Swine Corp.

101,000 80,000 150,000 400,000 (135,000) 141,000

20,000 40,000 90,000 300,000 (85,000)

Total Assets

737,000

365,000

Accounts Payable Notes Payable Common Stock Retained Earnings

90,000 200,000 100,000 347,000

25,000 90,000 200,000 50,000

Consolidation Entries DR CR

10,000 9,000 3,000 18,000 40,000

200,000 50,000 3,000

NCI in NA of Swine Corp. Total Liabilities & Equity

737,000

365,000

253,000

27,000 153,000 6,000

Consolidated 121,000 120,000 250,000 709,000 (244,000) 0

186,000

956,000

3,000

115,000 290,000 100,000 347,000

100,000 4,000

104,000

107,000

956,000

b. Pork Company and Subsidiary Consolidated Balance Sheet December 31, 20X6 Cash and Accounts Receivable Inventory Land Buildings and Equipment Less: Accumulated Depreciation Total Assets

$121,000 120,000 250,000 $709,000 (244,000)

Accounts Payable Notes Payable Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

465,000 $956,000 $115,000 290,000

$100,000 347,000 $447,000 104,000 551,000 $956,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-32 Consolidation Worksheet in Year of Intercompany Transfer a. Equity Method Entries on Prime Co.'s Books: Investment in Suspect Co. 40,000 Income from Suspect Co. Record Prime Co.'s 80% share of Suspect Co.'s 20X6 income

40,000

Cash 4,000 Investment in Suspect Co. Record Prime Co.'s 80% share of Suspect Co.'s 20X6 dividend

4,000

Income from Suspect Co. Investment in Suspect Co. Record amortization of excess acquisition price

14,400 14,400

Income from Suspect Co. Investment in Suspect Co. Defer unrealized gain on Equipment

20,000

Investment in Suspect Co. Income from Suspect Co. Reverse the deferred gain

2,000

20,000

2,000

Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 20%

Prime Co. 80% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

39,000 10,000 (1,000)

156,000 40,000 (4,000)

100,000

95,000 50,000 (5,000)

Ending book value

48,000

192,000

100,000

140,000

Adjustment to Basic Consolidation Entry: NCI 20% Net income 10,000 - Gain on Equipment (down) + Extra Depreciation (down)

Prime Co. 80% 40,000 (20,000) 2,000

Income to be eliminated

10,000

22,000

Ending book value - Gain on Equipment (down) + Extra Depreciation (down)

48,000

192,000 (20,000) 2,000

Adjusted book value

48,000

174,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-32 (continued) Basic Consolidation Entry Common Stock Retained Earnings Income from Suspect Co. NCI in NI of Suspect Co. Dividends Declared

100,000 95,000 22,000 10,000 5,000

Investment in Suspect Co. NCI in NA of Suspect Co.

174,000 48,000

Excess Value (Differential) Calculations: NCI 20% + Prime Co. 80% Beginning balance 10,000 40,000 Changes (3,600) (14,400) Ending balance 6,400 25,600

Goodwill 50,000 (18,000) 32,000

Amortized Excess Value Reclassification Entry: Goodwill impairment loss 18,000 Income from Suspect Co. NCI in NI of Suspect Co.

14,400 3,600

Excess Value (Differential) Reclassification Entry: Goodwill 32,000 Investment in Suspect Co. NCI in NA of Suspect Co.

25,600 6,400

Eliminate Intercompany Accounts: Accounts Payable Cash and Accounts Receivable

7,000 7,000

Eliminate Gain on Purchase of Land Investment in Suspect Co. NCI in NA of Suspect Co. Land

8,000 2,000 10,000 Accumulated Depreciation

Equipment Suspect Co. Prime Co.

70,000 5,000 75,000

← Common Stock ← Beginning balance in RE ← Prime’s share of NI with Adjustments ← NCI share of Suspect Co.'s NI ← 100% of Suspect Co.'s dividends ← Prime's share of BV with Adjustments ← NCI share of BV of net assets

Actual 2,000 "As If"

7,000 25,000 30,000

Eliminate the gain on Equipment and Correct Asset's Basis: Gain on sale 20,000 Equipment 5,000 Accumulated Depreciation 25,000 Accumulated Depreciation Depreciation Expense

2,000 2,000 7-40

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-32 (continued)

Beginning Balance 80% Net Income

Realize Def. Gain Ending Balance

Investment in Suspect Co. 188,000

Income from Suspect Co.

40,000

2,000 191,600

Land Adjustment

8,000 0

4,000 14,400 20,000

80% Dividends Excess Val. Amort. Defer Equipment Gain

174,000 25,600

Basic Excess Reclass.

14,400 20,000

40,000

80% Net Income

2,000 7,600

Realize Def. Gain Ending Balance

22,000 14,400 0

b. Suspect Co.

Prime Co. Income Statement Sales Gain on Sale of Equipment Less: COGS Less: Depr. & Amort. Expense Less: Other Expenses Less: Goodwill Impairment Loss Income from Suspect Co. Consolidated Net Income NCI in Net Income Controlling Interest in NI

240,000 20,000 (140,000) (25,000) (15,000)

Consolidation Entries DR CR

130,000

14,400 16,400 3,600 20,000

370,000 0 (200,000) (38,000) (20,000) (18,000) 0 94,000 (6,400) 87,600

20,000 5,000 25,000

322,000 87,600 (30,000) 379,600

20,000 (60,000) (15,000) (5,000)

7,600 87,600

50,000

87,600

50,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

322,000 87,600 (30,000) 379,600

95,000 50,000 (5,000) 140,000

Balance Sheet Cash and Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Suspect Co.

113,000 260,000 80,000 500,000 (205,000) 191,600

35,000 90,000 80,000 150,000 (45,000)

Goodwill Total Assets

939,600

310,000

Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Suspect Co.

60,000 200,000 300,000 379,600

20,000 50,000 100,000 140,000

Total Liabilities & Equity

939,600

310,000

2,000 18,000 22,000 60,000 10,000 70,000

95,000 70,000 165,000

7,000 10,000 5,000 2,000 8,000 32,000 47,000

25,000 174,000 25,600 241,600

7,000 100,000 165,000 2,000 274,000

Consolidated

25,000 48,000 6,400 79,400

141,000 350,000 150,000 655,000 (273,000) 0 32,000 1,055,000 73,000 250,000 300,000 379,600 52,400 1,055,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-32 (continued) c.

Prime Company and Subsidiary Consolidated Balance Sheet December 31, 20X6

Cash and Receivables Inventory Land Buildings and Equipment Less: Accumulated Depreciation Goodwill Total Assets

$ $655,000 (273,000)

Accounts Payable Bonds Payable Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Total Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

141,000 350,000 150,000

382,000 32,000 $1,055,000 $

73,000 250,000

$300,000 379,600 $679,600 52,400 732,000 $1,055,000

Prime Company and Subsidiary Consolidated Income Statement Year Ended December 31, 20X6 Sales Cost of Goods Sold Depreciation and Amortization Expense Goodwill Impairment Loss Other Expenses Total Expenses Consolidated Net Income Income to Noncontrolling Interest Income to Controlling Interest

$ 370,000 $200,000 38,000 18,000 20,000 (276,000) 94,000 (6,400) $ 87,600

Prime Company and Subsidiary Consolidated Retained Earnings Statement Year Ended December 31, 20X6 Retained Earnings, January 1, 20X6 Income to Controlling Interest, 20X6

$ 322,000 87,600 $ 409,600 (30,000) $ 379,600

Dividends Declared, 20X6 Retained Earnings, December 31, 20X6

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-33 Consolidation Worksheet in Year following Intercompany Transfer a.

Reconciliation of underlying book value and balance in investment account: Net book value reported by Suspect Company Common stock outstanding Retained earnings balance, January 1, 20X7 Net income for 20X7 Dividends paid in 20X7 Retained earnings balance, December 31, 20X7

$100,000 $140,000 45,000 (35,000) 150,000 $250,000 x .80 $200,000 (8,000) (20,000) 2,000 2,000 25,600 $201,600

Proportion of stock held by Prime Company Minus: Upstream Land Gain (10,000 x 0.80) Minus: Downstream Equipment Transfer Gain Add: Reversal of deferred gain 20X6 on equipment Add: Reversal of deferred gain 20X7 on equipment Add: Goodwill (32,000 x 0.80) Balance in investment account b. Equity Method Entries on Prime Co.'s Books: Investment in Suspect Co. 36,000 Income from Suspect Co. Record Prime Co.'s 80% share of Suspect Co.'s 20X7 income Cash 28,000 Investment in Suspect Co. Record Prime Co.'s 80% share of Suspect Co.'s 20X7 dividend Investment in Suspect Co. Income from Suspect Co. Reverse the deferred gain on equipment

36,000

28,000

2,000 2,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-33 (continued) Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 20%

Prime Co. 80% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

48,000 9,000 (7,000)

192,000 36,000 (28,000)

100,000

140,000 45,000 (35,000)

Ending book value

50,000

200,000

100,000

150,000

Adjustment to Basic Consolidation Entry: NCI 20% Net income 9,000 + Extra Depreciation (down)

Prime Co. 80% 36,000 2,000

Income to be eliminated

9,000

38,000

Ending book value + Extra Depreciation (down)

50,000

200,000 2,000

Adjusted book value

50,000

202,000

Basic Consolidation Entry Common Stock Retained Earnings Income from Suspect Co. NCI in NI of Suspect Co. Dividends Declared

100,000 140,000 38,000 9,000 35,000 202,000

Investment in Suspect Co. NCI in NA of Suspect Co.

50,000

Excess Value (Differential) Calculations: NCI 20% + Prime Co. 80% Beginning balance 6,400 25,600 Changes 0 0 Ending balance 6,400 25,600

Goodwill 32,000 0 32,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-33 (continued) Excess Value (Differential) Reclassification Entry: Goodwill 32,000 Investment in Suspect Co. NCI in NA of Suspect Co.

Eliminate Gain on Purchase of Land Investment in Suspect Co. NCI in NA of Suspect Co. Land

8,000 2,000 10,000 Accumulated Depreciation 14,000 2,000 23,000 35,000

Equipment 70,000 5,000 75,000

Actual (Suspect Co.): “As if” (Prime Co.):

25,600 6,400

Eliminate the Gain on Equipment and Correct Asset's basis: Investment in Suspect Co. 18,000 Equipment 5,000 Accumulated Depreciation 23,000 Accumulated Depreciation Depreciation Expense

Beginning Balance 80% Net Income

2,000 2,000

Investment in Suspect Co. 191,600

Income from Suspect Co.

36,000 28,000

Realize Def. Gain Ending Balance

2,000 201,600

Land Adjustment

8,000 18,000 0

202,000 25,600

36,000

80% Net Income

2,000 38,000

Realize Def. Gain Ending Balance

80% Dividends

Basic Excess Reclass.

38,000

Eliminate Intercompany Receivable/Payable Accounts Payable Accounts Receivable

4,000 4,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-33 (continued) b. Prime Co. Income Statement Sales Less: COGS Less: Depr. & Amort. Expense Less: Other Expenses Income from Suspect Co. Consolidated Net Income NCI in Net Income Controlling Interest in NI

Suspect Co.

250,000 (160,000) (25,000) (20,000) 38,000 83,000

150,000 (80,000) (15,000) (10,000)

83,000

45,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

379,600 83,000 (60,000) 402,600

140,000 45,000 (35,000) 150,000

Balance Sheet Cash and Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depr. Investment in Suspect Co.

151,000 240,000 100,000 500,000 (230,000) 201,600

55,000 100,000 80,000 150,000 (60,000)

Goodwill Total Assets

962,600

325,000

Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Suspect Co.

60,000 200,000 300,000 402,600

25,000 50,000 100,000 150,000

Total Liabilities & Equity

962,600

325,000

45,000

Consolidation Entries DR CR

2,000

400,000 (240,000) (38,000) (30,000) 0 92,000 (9,000) 83,000

2,000 35,000 37,000

379,600 83,000 (60,000) 402,600

2,000 38,000 38,000 9,000 47,000

140,000 47,000 187,000

2,000

4,000 10,000 5,000 2,000 8,000 18,000 32,000 65,000

23,000 202,000 25,600 264,600

4,000 100,000 187,000 2,000 293,000

Consolidated

37,000 50,000 6,400 93,400

202,000 340,000 170,000 655,000 (311,000) 0 32,000 1,088,000 81,000 250,000 300,000 402,600 54,400 1,088,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-34 Intercompany Sales in Prior Years a. Equity Method Entries on Pond Corp.'s Books: Investment in Skate Co. 24,000 Income from Skate Co. Record Pond Corp.'s 80% share of Skate Co.'s 20X8 income

24,000

Cash 8,000 Investment in Skate Co. Record Pond Corp.'s 80% share of Skate Co.'s 20X8 dividend

8,000

Income from Skate Co. Investment in Skate Co. Record amortization of excess acquisition price

3,000 3,000

Investment in Skate Co. Income from Skate Co. Reverse a portion of the deferred gain

1,500 1,500

Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 20%

Pond Corp. 80% =

Common Additional Stock + Paid-In Capital +

Retained Earnings

Beginning book value + Net income - Dividends

40,000 6,000 (2,000)

160,000 24,000 (8,000)

20,000

30,000

1 5 0 ,0 0 0 30,000 (1 0 ,0 0 0 )

Ending book value

44,000

176,000

2 0 ,0 0 0

3 0 ,0 0 0

170,000

Adjustment to Basic Consolidation Entry: NCI Pond Corp. 20% 80% Net income 6,000 24,000 + Extra Depreciation 1,500 Income to be eliminated

6 ,0 0 0

2 5 ,5 0 0

Ending book value + Extra Depreciation

44,000

176,000 1,500

Adjusted book value

4 4 ,0 0 0

1 7 7 ,5 0 0

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-34 (continued) Common Stock Additional Paid-in Capital Retained Earnings Income from Skate Co. NCI in NI of Skate Co. Dividends Declared Investment in Skate Co. NCI in NA of Skate Co.

20,000 30,000 150,000 25,500 6,000 10,000 177,500 44,000

← Common Stock ← Beginning balance in APIC ← Beginning balance in RE ← Pond’s share of NI with Adjustments ← NCI share of Skate Co.'s NI ← 100% of Skate’s dividends declared ← Pond's share of BV with Adjustments ← NCI share of BV of net assets

Excess Value (Differential) Calculations: NCI 20% + Pond Corp. 80% = Beginning balance 12,750 51,000 Changes (750) (3,000) Ending balance 12,000 48,000

Amortized Excess Value Reclassification Entry: Amortization Expense 2,500 Depreciation Expense 1,250 Income from Skate Co. NCI in NI of Skate Co. Excess Value (Differential) Reclassification Entry: Patent Buildings & Equipment Acc. Depr. Investment in Skate Co. NCI in NA of Skate Co. Eliminate Gain on Purchase of Land Investment in Skate Co. NCI in NA of Skate Co. Land

Actual (Skate Co.): “As if” (Pond Corp.):

Buildings & Patent + Equipment + Acc. Depr. 42,500 25,000 (3,750) (2,500) (1,250) 40,000 25,000 (5,000)

3,000 750

40,000 25,000 5,000 48,000 12,000

10,400 2,600 13,000 Accumulated Depreciation

Building 65,000 60,000 125,000

1,500

6,500 75,000 80,000

Eliminate the Gain on Building and Correct Asset's Basis: Investment in Skate Co. 15,000 Building 60,000 Accumulated Depreciation 75,000 Accumulated Depreciation Depreciation Expense

1,500 1,500

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-34 (continued)

Beginning Balance 80% Net Income

Investment in Skate Co. 185,600 24,000 8,000 3,000

Realize Def. Gain Ending Balance

1,500 200,100

Land Adjustment

10,400 15,000 0

177,500 48,000

Income from Skate Co.

80% Dividends Excess Val. Amort.

Basic Excess Reclass.

24,000

80% Net Income

1,500 22,500

Realize Def. Gain Ending Balance

3,000

25,500 3,000 0

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-34 (continued) b. Income Statement Sales Interest Income Less: COGS Less: Other Operating Exp. Less: Depreciation Exp. Less: Other Amortization Exp. Less: Interest Exp. Less: Miscellaneous Exp. Income from Skate Co. Consolidated Net Income NCI in Net Income Controlling Interest in NI

Pond Corp.

Skate Co.

450,000 14,900 (285,000) (50,000) (35,000)

250,000 (136,000) (40,000) (24,000)

Consolidation Entries DR CR

Consolidated

1,250 2,500

1,500

25,500 29,250 6,000 35,250

3,000 4,500 750 5,250

700,000 14,900 (421,000) (90,000) (58,750) (2,500) (34,500) (21,400) 0 86,750 (5,250) 81,500

5,250 10,000 15,250

216,000 81,500 (30,000) 267,500

(24,000) (11,900) 22,500 81,500

(10,500) (9,500)

81,500

30,000

216,000 81,500 (30,000) 267,500

150,000 30,000 (10,000) 170,000

68,400 130,000

47,000 65,000

115,400 195,000

45,000 140,000 50,000 400,000

10,000 50,000 22,000 240,000

55,000 190,000 59,000 725,000

Less: Accumulated Depr.

(185,000)

(94,000)

Investment in Skate Co.

200,100

Investment in Tin Co. Bonds Patent Total Assets

134,000 982,500

340,000

Accounts Payable Interest and Other Payables Bonds Payable Bond Discount Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Skate Co.

65,000 45,000 300,000 150,000 155,000 267,500

11,000 12,000 100,000 (3,000) 30,000 20,000 170,000

Total Liabilities & Equity

982,500

340,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Accounts Receivable Interest and Other Receivables Inventory Land Buildings & Equipment

30,000

150,000 35,250 185,250

13,000 60,000 25,000 1,500 10,400 15,000 40,000 151,900

30,000 20,000 185,250 2,600 237,850

75,000 5,000 177,500 48,000

318,500

15,250 44,000 12,000 71,250

(357,500) 0 134,000 40,000 1,155,900 76,000 57,000 400,000 (3,000) 150,000 155,000 267,500 53,400 1,155,900

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-35 Intercompany Sale of Land and Depreciable Asset a.

Income assigned to noncontrolling interest: Net income of Slice Gain on sale of equipment to parent Gain realized in 20X5 Amortization of differential: Buildings and equipment ($25,000 / 10 years) Copyright ($17,000 / 5 years) Realized income Portion of ownership held Income to noncontrolling interest Gain on sale of equipment to parent: Sale price to Putt Purchase price Accumulated depreciation [($100,000 - $10,000)/10 years] x 2 years Gain on sale

$ 30,000 $9,600 (1,200)

(8,400) (2,500) (3,400) $15,700 x 0.30 $ 4,710 $91,600

$100,000 (18,000)

(82,000) $ 9,600

Reconciliation between book value and investment balance at December 31, 20X5: Underlying book value of Slice Company stock: Common stock outstanding Retained earnings, January 1, 20X5 Net income for 20X5 Dividends paid in 20X5 Net book value Portion of ownership held by Putt Net book value of ownership held by Putt Unamortized differential: Buildings and equipment [($25,000 x 7/10 years) x 0.70] Copyright [($17,000 x 2/5 years) x 0.70] Gain on sale of land Deferred gross profit on sale of equipment Realized deferred gain Investment in Slice Company stock

$100,000 100,000 30,000 ( 5,000) $225,000 x .70 $157,500 12,250 4,760 (11,000) (6,720) 840 $157,630

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-35 (continued) c. Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 30%

Putt Corp. + 70% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

60,000 9,000 (1,500)

140,000 21,000 (3,500)

100,000

100,000 30,000 (5,000)

Ending book value

67,500

157,500

100,000

125,000

Adjustment to Basic Consolidation Entry: NCI 30% Net income 9,000 - Gain on Equipment (up) (2,880) + Extra Depreciation (up) 360

Putt Corp. 70% 21,000 (6,720) 840

Income to be eliminated

6,480

15,120

Ending book value - Gain on Equipment (up) + Extra Depreciation (up)

67,500 (2,880) 360

157,500 (6,720) 840

Adjusted book value

64,980

151,620

Basic Consolidation Entry Common Stock Retained Earnings Income from Slice Co. NCI in NI of Slice Co. Dividends Declared Investment in Slice Co. NCI in NA of Slice Co.

100,000 100,000 15,120 6,480 5,000 151,620 64,980

Excess Value (Differential) Calculations: NCI Putt Corp. 30% + 70% Beginning balance 9,060 21,140 Changes (1,770) (4,130) Ending balance 7,290 17,010

← Common Stock ← Beginning balance RE ← Putt’s share of NI with Adjustments ← NCI share of NI with Adjustments ← 100% of Slice Co.'s dividends ← Putt's share of BV with Adjustments ← NCI share of BV with Adjustments

Buildings & Equipment 25,000 25,000

Acc. Depr. (5,000) (2,500) (7,500)

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-35 (continued) Amortized Excess Value Reclassification Entry: Amortization Expense 3,400 Depreciation Expense 2,500 Income from Slice Co. NCI in NI of Slice Co.

4,130 1,770

Excess Value (Differential) Reclassification Entry: Buildings & Equipment 25,000 Copyright 6,800 Acc. Depr. 7,500 Investment in Slice Co. 17,010 NCI in NA of Slice Co. 7,290 Eliminate Gain on Purchase of Land Investment in Slice Co. Land

Actual (Putt Corp.): “As if” (Slice Co.):

11,000 11,000

Accumulated Depreciation 10,200 1,200 18,000 27,000

Equipment 91,600 8,400 100,000

Eliminate the Gain on Equipment and Correct Asset's Basis: Gain on sale

9,600

Equipment

8,400

Accumulated Depreciation Accumulated Depreciation

18,000 1,200

Depreciation Expense

Beginning Balance 70% Net Income

Realize Def. Gain Ending Balance Land Adjustment

Investment in Slice Co. 150,140 21,000 3,500 4,130 840 6,720 157,630 151,620 11,000 17,010 0

1,200

Income from Slice Co.

70% Dividends Excess Val. Amort. Defer Asset Gain Basic Excess Reclass.

4,130 6,720

21,000

70% Net Income

840 10,990

Realize Def.Gain Ending Balance

15,120 4,130 0

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-35 (continued) d.

Putt Corp. Income Statement Sales Other Income Gain on Sale of Equip. Less: COGS Less: Depreciation Exp. Less: Amortization Exp. Less: Interest Expense Less: Other Expenses Income from Slice Co. Consolidated Net Income NCI in Net Income Controlling Interest in NI

450,000 28,250 (375,000) (25,000)

Slice Co.

Consolidation Entries DR CR

190,400 9,600 (110,000) (10,000)

(24,000) (28,000) 10,990 37,240

(33,000) (17,000)

37,240

30,000

Statement of Retained Earnings Beginning Balance 165,240 Net Income 37,240 Less: Dividends Declared (30,000) Ending Balance 172,480

100,000 30,000 (5,000) 125,000

30,000

Consolidated

2,500 3,400

1,200

15,120 30,620 6,480 37,100

4,130 5,330 1,770 7,100

640,400 28,250 0 (485,000) (36,300) (3,400) (57,000) (45,000) 0 41,950 (4,710) 37,240

7,100 5,000 12,100

165,240 37,240 (30,000) 172,480

9,600

100,000 37,100 137,100

Balance Sheet Cash Accounts Receivable Interest and Other Receivables Inventory Land Buildings & Equipment

15,850 65,000

58,000 70,000

73,850 135,000

30,000 150,000 80,000 315,000

10,000 180,000 60,000 240,000

40,000 330,000 129,000 588,400

Less: Accumulated Depr.

(120,000)

(60,000)

Investment in Slice Co.

157,630

693,480

558,000

Accounts Payable Other Payables Bonds Payable Bond Discount Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Slice Co.

61,000 30,000 250,000

28,000 20,000 300,000 (15,000) 100,000

100,000

125,000

137,100

Total Liabilities & Equity

693,480

558,000

237,100

150,000 30,000 172,480

11,000 25,000 8,400 1,200 11,000 6,800 52,400

7,500 18,000 151,620 17,010 205,130

12,100 64,980 7,290 84,370

(204,300) 0 6,800 1,098,750 89,000 50,000 550,000 (15,000) 150,000 30,000 172,480 72,270 1,098,750

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-36 Incomplete Data (a)

$100,000 (Parent and consolidation should be the same under the equity method)

(b)

$140,000 (Parent and consolidation should be the same under the equity method)

(c)

$250,000 = $593,000 - $343,000

(d)

$100,000 = ($126,000 - $35,000) + [($25,000 + $85,000) - $101,000]

(e)

$4,500 = [($106,200 + $70,800) - ($50,000 + $70,000 + $30,000)] / 6 years

(f)

Investment in Shadow Company Stock: $106,200 Purchase price, January 1, 20X4 30,000 Undistributed earnings from January 1, 20X4, to January 1, 20X7 [($80,000 - $30,000) x 0.60] 6,000 Undistributed income for 20X7 ($10,000 x 0.60) (10,800) Amortization of differential [($27,000 / 6 years) x 4 years] x 0.60 (5,400) Profile’s portion of gain on sale of equipment ($9,000 x 0.60) 3,600 2 years of extra depreciation ($3,000 x 0.60) (7,000) Gain on sale of land $122,600 Balance in investment account at December 31, 20X7

(g)

$7,000 = ($70,000 + $90,000) - $153,000

(h)

$-0-

(i)

$510,000 = $345,000 + $150,000 + ($60,000 - $45,000)

(j)

$278,000 =

(k)

$375,800 (Same as Profile Corporation’s retained earnings balance.)

(l)

Income to noncontrolling shareholders: $ 30,000 Shadow's 20X7 net income ($250,000 - $195,000 - $10,000 - $15,000) 3,000 Realized profit on 20X6 sale of equipment to Profile (4,500) Amortization of differential $ 28,500 Realized net income x 0.40 $ 11,400 Income to noncontrolling shareholders

$180,000 + $80,000 + [($60,000 / 5 years) x 4 years] - [($45,000 / 3 years) x 2 years)

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-37 Intercompany Sale of Equipment at a Loss in Prior Period a. Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 10%

Proxy Co. 90% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

20,000 6,000 (2,000)

180,000 54,000 (18,000)

50,000

150,000 60,000 (20,000)

Ending book value

24,000

216,000

50,000

190,000

Adjustment to Basic Consolidation Entry: NCI 10% Net income 6,000 - Unrecorded Depreciation (up) (300)

Proxy Co. 90% 54,000 (2,700)

Income to be eliminated

5,700

51,300

Ending book value - Unrecorded Depreciation (up)

24,000 (300)

216,000 (2,700)

Adjusted book value

23,700

213,300

Basic Consolidation Entry Common Stock Retained Earnings Income from Server Corp. NCI in NI of Server Corp. Dividends Declared Investment in Server Corp. NCI in NA of Server Corp.

Actual (Proxy Co.):

“As if” (Server Corp.):

50,000 150,000 51,300 5,700 20,000 213,300 23,700

← Common Stock ← Beginning balance in RE ← Proxy’s share of NI with Adjustments ← NCI share of NI with Adjustments ← 100% of Server Corp.'s dividends ← Proxy's share of BV with Adjustments ← NCI share of BV with Adjustments

42,000

Accumulated Depreciation 18,000 24,000 3,000

90,000

45,000

Equipment 48,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-37 (continued) Eliminate the Gain on Equipment and Correct Asset's Basis: Equipment 42,000 Investment in Server Corp. 16,200 NCI in NA of Server Corp. 1,800 Accumulated Depreciation 24,000 Depreciation Expense Accumulated Depreciation

Beginning Balance 90% Net Income

Ending Balance

3,000 3,000

Investment in Server Corp. 196,200

Income from Server Corp.

54,000 18,000 2,700

90% Dividends Realize Def. Gain

213,300 16,200

Basic Equipment Adj.

90% Net Income

51,300

Ending Balance

2,700

229,500

54,000

51,300 0

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-37 (continued) b.

Proxy Co. Income Statement Sales Other Income Less: COGS Less: Depreciation Exp. Less: Other Expenses Income from Server Corp. Consolidated Net Income NCI in Net Income Controlling Interest in NI

Server Corp.

680,000 26,000 (500,000) (45,000) (95,000) 51,300 117,300

385,000 15,000 (250,000) (15,000) (75,000)

117,300

60,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

251,200 117,300 (40,000) 328,500

150,000 60,000 (20,000) 190,000

Balance Sheet Cash Accounts Receivable Other Receivables Inventory Land Buildings & Equipment Less: Accumulated Depr.

82,000 80,000 40,000 200,000 80,000 500,000 (155,000)

32,400 90,000 10,000 130,000 60,000 250,000 (75,000)

Investment in Server Corp.

229,500

Total Assets

60,000

Consolidation Entries DR CR

1,065,000 41,000 (750,000) (63,000) (170,000) 0 123,000 (5,700) 117,300

0 20,000 20,000

251,200 117,300 (40,000) 328,500

3,000 51,300 54,300 5,700 60,000

150,000 60,000 210,000

42,000 24,000 3,000

1,056,500

497,400

Accounts Payable Other Payables Bonds Payable Bond Premium Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Server Corp.

63,000 95,000 250,000

35,000 20,000 200,000 2,400 50,000

50,000

190,000

210,000

Total Liabilities & Equity

1,056,500

497,400

260,000

210,000 110,000 328,500

Consolidated

42,000

213,300 16,200 256,500

20,000 23,700 1,800 45,500

114,400 170,000 50,000 330,000 140,000 792,000 (257,000)

0 1,339,400 98,000 115,000 450,000 2,400 210,000 110,000 328,500 25,500 1,339,400

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-38 Comprehensive Problem: Intercompany Transfers a.

Computation of differential as of January 1, 20X8: Original differential at December 31, 20X1 Less: Portion written off for sale of inventory Remaining differential, January 1, 20X8

$ 150,000 (30,000) $ 120,000

Verification of balance in Investment in Sword Stock account: Sword retained earnings, January 1, 20X8 Sword net income, 20X8: Sword dividends, 20X8 Sword retained earnings, December 31, 20X8

$1,400,000 110,000 (20,000) $1,490,000

Sword stockholders' equity: Common stock Additional paid-in capital Retained earnings, December 31, 20X8 Stockholders' equity, December 31, 20X8 Prince's ownership share Book value of shares held by Prince Remaining differential at January 1, 20X8: ($120,000 x 0.75) Deferred gain on downstream sale of land Loss on sale of equipment Reverse part of loss on sale of equipment Balance in Investment in Sword account, December 31, 20X8

$1,000,000 1,350,000 1,490,000 $3,840,000 x .75 $2,880,000 90,000 (23,000) 30,000 (3,000) $2,974,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-38 (continued) c. Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 25%

Prince Corp. + 80% =

Common Stock

Beginning book value + Net income - Dividends

937,500 27,500 (5,000)

2,812,500 82,500 (15,000)

1,000,000

1,350,000

1,400,000 110,000 (20,000)

Ending book value

960,000

2,880,000

1,000,000

1,350,000

1,490,000

Adjustment to Basic Consolidation Entry: NCI 25% Net income 27,500 + Loss on Equipment (up) 10,000 - Unrecorded Depreciation (up) (1,000)

Retained Earnings

Prince Corp. 80% 82,500 30,000 (3,000)

Income to be eliminated

36,500

109,500

Ending book value + Loss on Equipment (up) - Unrecorded Depreciation (up)

960,000 10,000 (1,000)

2,880,000 30,000 (3,000)

Adjusted book value

969,000

2,907,000

Basic Consolidation Entry Common Stock Additional Paid-in Capital Retained Earnings Income from Sword Dist. NCI in NI of Sword Dist. Dividends Declared Investment in Sword Dist. NCI in NA of Sword Dist.

Additional + Paid-in Capital +

1,000,000 1,350,000 1,400,000 109,500 36,500 20,000 2,907,000 969,000

← Common Stock ← Beginning balance in APIC ← Beginning balance in RE ← Prince’s share of NI with Adjustments ← NCI share of NI with Adjustments ← 100% of Sword's dividends ← Prince's share of BV with Adjustments ← NCI share of BV with Adjustments

Excess Value (Differential) Calculations:

Beginning balance Changes Ending balance

NCI 25% 30,000 0 30,000

Prince Corp. 75% 90,000 0 90,000

Land 56,000 0 56,000

Goodwill 64,000 0 64,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

Excess Value (Differential) Reclassification Entry: Land 56,000 Goodwill 64,000 Investment in Sword Dist. NCI in NA of Sword Dist.

90,000 30,000

Eliminate Services Other Income Other Expenses

80,000

Eliminate Intercompany Payables/Receivables Current Payables 20,000 Current Receivables

20,000

Eliminate Intercompany Dividend Owed Current Payables Current Receivables

3,750 3,750

Eliminate Gain on Purchase of Land Investment in Sword Dist. Land

23,000 23,000

Actual (Prince Corp.):

Equipment 250,000

“As if” (Sword Dist.):

185,000 435,000

Accumulated Depreciation 25,000 145,000 4,000 174,000

Eliminate the Loss on Equipment and Correct Asset's Basis: Equipment 185,000 Loss on Sale 40,000 Accumulated Depreciation 145,000 Depreciation Expense Accumulated Depreciation

Beginning Balance 75% Net Income Def. Loss on Equipment Ending Balance Def. Gain on Land

4,000 4,000

Investment in Sword Dist. 2,879,500

Income from Sword Dist.

82,500

30,000 2,974,000 23,000 0

15,000

75% Dividends

3,000

Realize Loss

3,000

Basic Excess Reclass.

109,500

2,907,000 90,000

82,500

75% Net Income

30,000 109,500

Def. Loss on Equipment Ending Balance

P7-38 (continued)

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

d. Consolidation Entries DR CR

Prince Corp.

Sword Dist.

4,801,000 90,000 (2,193,000) (202,000) (1,381,000) 109,500 1,224,500

985,000 (35,000) (525,000) (88,000) (227,000)

1,224,500

110,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

1,474,800 1,224,500 (50,000) 2,649,300

1,400,000 110,000 (20,000) 1,490,000

Balance Sheet Cash Current Receivables Inventory Land Buildings & Equipment Less: Accumulated Depr.

50,700 101,800 286,000 400,000 2,400,000 (1,105,000)

38,000 89,400 218,900 1,200,000 2,990,000 (420,000)

Investment in Sword Dist.

2,974,000

Goodwill Total Assets

5,107,500

4,116,300

Current Payables Bonds Payable Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Sword Dist.

86,200 1,000,000 100,000 1,272,000 2,649,300

76,300 200,000 1,000,000 1,350,000 1,490,000

1,000,000 1,350,000 1,630,000

Total Liabilities & Equity

5,107,500

4,116,300

4,003,750

Income Statement Sales Other Income or Loss Less: COGS Less: Depreciation & Amort. Expense Less: Other Expenses Income from Sword Dist. Consolidated Net Income NCI in Net Income Controlling Interest in NI

110,000

80,000

120,000

5,786,000 15,000 (2,718,000) (294,000) (1,528,000) 0 1,261,000 (36,500) 1,224,500

120,000 20,000 140,000

1,474,800 1,224,500 (50,000) 2,649,300

40,000

4,000 80,000 109,500 193,500 36,500 230,000

1,400,000 230,000 1,630,000

120,000

23,750 56,000 185,000

23,000 64,000 328,000

Consolidated

23,000 145,000 4,000 2,907,000 90,000 3,192,750

23,750

140,000 969,000 30,000 1,139,000

88,700 167,450 504,900 1,633,000 5,575,000 (1,674,000) 0 64,000 6,359,050 138,750 1,200,000 100,000 1,272,000 2,649,300 999,000 6,359,050

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-39A Computation of Retained Earnings following Multiple Transfers Consolidated retained earnings, January 1, 20X8: Private Company’s retained earnings, January 1 Unrealized profit on land ($16,000 x 0.80) Unrealized profit on depreciable assets [$22,000 - ($2,200 x 2)] Consolidated retained earnings

$450,000 (12,800) (17,600) $419,600

Consolidated retained earnings, December 31, 20X8: Consolidated retained earnings, January 1 Private Company’s operating income for 20X8 Less: Dividends paid in 20X8 Increase in retained earnings from Private’s operations Secret’s net income for 20X8 Less: Amortization of differential assigned to equipment: ($325,000 - $290,000) / 10 years Impairment of goodwill Realized income Proportion of ownership held Realization of gain on sale of building ($22,000 / 10 years) Consolidated retained earnings

$419,600 $65,000 (45,000) 20,000 $ 30,000 (3,500) (17,500) $ 9,000 x 0.80

7,200 2,200 $449,000

Alternate computation of retained earnings balance: Private Company’s retained earnings, January 1 Operating income for 20X8 Dividends paid in 20X8 Investment income from Secret Company for 20X8: Secret's net income Proportion of ownership held Proportionate share of Secret’s reported net income Amortization of differential assigned to equipment: [($325,000 - $290,000) x 0.80] / 10 years Goodwill impairment loss ($17,500 x 0.80) Private Company’s retained earnings Unrealized profit on land ($16,000 x 0.80) Unrealized profit on depreciable assets [$22,000 - ($2,200 x 3)] Consolidated retained earnings

$450,000 65,000 (45,000) $30,000 x 0.80 24,000 (2,800) (14,000) $477,200 (12,800) (15,400) $449,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-40A Consolidation Worksheet with Intercompany Transfers (Modified Equity Method) Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 35%

Pot Co. 65%

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

50,750 10,500 (1,750)

94,250 1 9 ,5 0 0 (3,250)

60,000

8 5 ,0 0 0 30,000 (5 ,0 0 0 )

Ending book value

59,500

110,500

6 0 ,0 0 0

110,000

Adjustment to Basic Consolidation Entry : NCI Pot Co. 35% 65% Net income 10,500 19,500 - Gain on Building (up) (4,620) (8,580) + Extra Depreciation (up) 385 715 - Gain on Land (down) (4,000) Income to be eliminated

6 ,2 6 5

7,635

Ending book value - Gain on Building (up) + Extra Depreciation (up) - Gain on Land (down)

59,500 (4,620) 385

1 1 0 ,5 0 0 (8,580) 715 (4,000)

Adjusted book value

5 5 ,2 6 5

98,635

Basic Consolidation Entry Common Stock Retained Earnings Income from Seed Corp. NCI in NI of Seed Corp. Dividends Declared Investment in Seed Corp. NCI in NA of Seed Corp.

60,000 85,000

← Common Stock ← Beginning balance in retained earnings

19,500 6,265

← Pot Co.’s share of NI ← NCI share of NI with Adjustments. ← 100% of Seed Corp.'s dividends declared ← Net BV left in the investment account ← NCI share of BV with Adjustments

5,000 110,500 55,265

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-40A (continued) Eliminate Gain on Purchase of Land Gain on Sale of Land 4,000 Land

4,000

Eliminate the Gain on Building and Correct Asset's Basis: Gain on Sale on Building 13,200 Depreciation Expense 1,100 Building and Equipment (net) 12,100 Eliminate Intercompany Services Sales 24,000 Other Expenses

24,000

Pot Co.

Seed Corp.

Income Statement Sales Gain on Sale of Land Gain on Sale of Building Less: COGS Less: Depreciation Exp. Less: Other Expenses Income from Seed Corp. Consolidated Net Income NCI in Net Income Controlling Interest in NI

286,500 4,000 (160,000) (22,000) (76,000) 19,500 52,000

128,500 13,200 (75,000) (19,000) (17,700) 30,000

52,000

30,000

Statement of Retained Earnings Beginning Balance 198,000 Net Income 52,000 Less: Dividends Declared (25,000) Ending Balance 225,000

85,000 30,000 (5,000) 110,000

Balance Sheet Cash Accounts Receivable Inventory Land Buildings & Equipment (net) Investment in Seed Corp. Total Assets Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Seed Corp. Total Liabilities & Equity

Consolidation Entries DR CR 24,000 4,000 13,200

85,000 66,965 151,965

32,500 62,000 95,000 40,000 200,000 110,500 540,000

22,000 37,000 71,000 15,000 125,000

35,000 180,000 100,000 225,000

20,000 80,000 60,000 110,000

60,000 151,965

540,000

270,000

211,965

270,000

25,100

391,000 0 0 (235,000) (39,900) (69,700) 0 46,400 (6,265) 40,135

25,100 5,000 30,100

198,000 40,135 (25,000) 213,135

4,000 12,100 110,500 126,600

54,500 99,000 166,000 51,000 312,900 0 683,400

30,100 55,265 85,365

55,000 260,000 100,000 213,135 55,265 683,400

1,100 24,000 19,500 60,700 6,265 66,965

Consolidated

25,100

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-40A (continued) c.

Pot Company and Subsidiary Consolidated Balance Sheet December 31, 20X4

Cash Accounts Receivable Inventory Land Buildings and Equipment (net) Total Assets

$ 54,500 99,000 166,000 51,000 312,900 $683,400

Accounts Payable Bonds Payable Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

$ 55,000 260,000 $100,000 213,135 $313,135 55,265 368,400 $683,400

Pot Company and Subsidiary Consolidated Income Statement Year Ended December 31, 20X4 Sales Cost of Goods Sold Depreciation Expense Other Expenses Total Expenses Consolidated Net Income Income to Noncontrolling Interest Income to Controlling Interest

$391,000 $235,000 39,900 69,700 (344,600) $ 46,400 (6,265) $ 40,135

Pot Company and Subsidiary Consolidated Retained Earnings Statement Year Ended December 31, 20X4 Retained Earnings, January 1, 20X4 Income to Controlling Interest, 20X4

$198,000 40,135 $238,135 (25,000) $213,135

Dividends Declared, 20X4 Retained Earnings, December 31, 20X4

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-41A Modified Equity Method a. Adjusted trial balance: Item Cash and Accounts Receivable Inventory Land Buildings and Equipment Investment in Suspect Company Stock Cost of Goods Sold Depreciation and Amortization Other Expenses Dividends Declared Accumulated Depreciation Accounts Payable Bonds Payable Common Stock Retained Earnings Sales Income from Subsidiary Total

Prime Company Debit Credit

Suspect Company Debit Credit

$ 151,000 240,000 100,000 500,000 240,000

$ 55,000 100,000 80,000 150,000

160,000 25,000 20,000 60,000

80,000 15,000 10,000 35,000

$ 230,000 60,000 200,000 300,000 420,000 250,000 36,000 $1,496,000 $1,496,000

$ 60,000 25,000 50,000 100,000 140,000 150,000 $525,000

$525,000

b. Equity Method Entries on Prime Co.'s Books: Investment in Suspect Co. Income from Suspect Co. Record Prime Co.'s 80% share of Suspect Co.'s 20X7 income

36,000 36,000

Cash 28,000 Investment in Suspect Co. Record Prime Co.'s 80% share of Suspect Co.'s 20X7 dividend

28,000

c. Basic Consolidation Entry Common Stock Retained Earnings Income from Suspect Co. NCI in NI of Suspect Co. Dividends Declared Investment in Suspect Co. NCI in NA of Suspect Co.

100,000 140,000 36,000 9,000 35,000 200,000 50,000

Excess Value (Differential) Reclassification Entry: Goodwill 32,000 Retained Earnings 14,400 Investment in Suspect Co. 40,000

← Remaining goodwill ← Suspect's portion of goodwill impairment loss from last year ← Remaining balance in investment account

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

NCI in NA of Suspect Co.

6,400

← NCI's share of differential and loss [($50,000 - 18,000) * .2]

P7-41A (continued) Eliminate Intercompany Accounts: Accounts Payable Cash and Accounts Receivable

4,000

Eliminate Gain on Purchase of Land Retained Earnings NCI in NA of Suspect Co. Land

8,000 2,000

Actual (Suspect Co.): “As if” (Prime Co.):

4,000

10,000 Accumulated Depreciation 14,000 2,000 23,000 35,000

Equipment 70,000 5,000 75,000

Eliminate the Gain on Equipment and Correct Asset's Basis: Retained Earnings 18,000 Equipment 5,000 Accumulated Depreciation 23,000 Accumulated Depreciation Depreciation Expense

2,000 2,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-41A (continued) d. Consolidation Entries DR CR

Prime Co.

Suspect Co.

250,000 (160,000) (25,000) (20,000) 36,000 81,000

150,000 (80,000) (15,000) (10,000)

81,000

45,000

Statement of Retained Earnings Beginning Balance

420,000

140,000

Net Income Less: Dividends Declared Ending Balance

81,000 (60,000) 441,000

45,000 (35,000) 150,000

Balance Sheet Cash and Accounts Receivable Inventory Land Buildings & Equipment Less: Accumulated Depr. Investment in Suspect Co.

151,000 240,000 100,000 500,000 (230,000) 240,000

55,000 100,000 80,000 150,000 (60,000)

5,000 2,000

Goodwill Total Assets

1,001,000

325,000

32,000 39,000

Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Suspect Co.

60,000 200,000 300,000 441,000

25,000 50,000 100,000 150,000

Total Liabilities & Equity

1,001,000

325,000

Income Statement Sales Less: COGS Less: Depreciation & Amort. Exp. Less: Other Expenses Income from Suspect Co. Consolidated Net Income NCI in Net Income Controlling Interest in NI

45,000

2,000 36,000 36,000 9,000 45,000

140,000 14,400 8,000 18,000 45,000 225,400

2,000 2,000

2,000 35,000 37,000

83,000 (60,000) 402,600

4,000

202,000 340,000 170,000 655,000 (311,000) 0

23,000 200,000 40,000 277,000

4,000

331,400

400,000 (240,000) (38,000) (30,000) 0 92,000 (9,000) 83,000

379,600

10,000

100,000 225,400 2,000

Consolidated

37,000 50,000 6,400 93,400

32,000 1,088,000 81,000 250,000 300,000 402,600 54,400 1,088,000

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-42A Cost Method a. Journal entry recorded by Prime Company: Cash Dividend Income Record dividend from Suspect Company.

28,000 28,000

b. Investment Consolidation Entry Common Stock Retained Earnings Investment in Suspect Co. NCI in NA of Suspect Co.

100,000 50,000 120,000 30,000

Excess Value (Differential) Reclassification Entry Goodwill 50,000 Investment in Suspect Co. NCI in NA of Suspect Co. Prior Year Impairment NCI in NA of Suspect Co. 3,600 Retained Earnings 14,400 Goodwill (Note that the previous two entries could be combined.) Dividend Consolidation Entry Dividend Income NCI in NI of Suspect Co. Dividends Declared

28,000 7,000

Assign Undistributed Income to NCI Retained Earnings NCI in NI of Suspect Co. NCI in NA of Suspect Co.

18,000 2,000

Eliminate Intercompany Accounts: Accounts Payable Cash and Accounts Receivable

4,000

Eliminate Gain on Purchase of Land Retained Earnings NCI in NA of Suspect Co. Land

8,000 2,000

40,000 10,000

18,000

35,000

20,000

4,000

10,000

Eliminate the Gain on Equipment and Correct Asset's Basis: Retained Earnings 18,000 Equipment 5,000 Accumulated Depreciation 23,000 Accumulated Depreciation Depreciation Expense

2,000 2,000 7-70

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

P7-42A (continued) c. Consolidation Entries Prime Co.

Suspect Co.

Income Statement Sales Less: COGS Less: Depr. & Amort. Exp. Less: Other Expenses Dividend Income Consolidated Net Income NCI in Net Income

250,000 (160,000) (25,000) (20,000) 28,000 73,000

150,000 (80,000) (15,000) (10,000)

Controlling Interest in NI

73,000

45,000

Statement of Retained Earnings Beginning Balance 348,000

140,000

Net Income Less: Dividends Declared Ending Balance

73,000 (60,000) 361,000

45,000 (35,000) 150,000

Balance Sheet Cash and Accounts Rec. Inventory Land Buildings & Equipment Less: Accumulated Depr. Investment in Suspect Co.

151,000 240,000 100,000 500,000 (230,000) 160,000

55,000 100,000 80,000 150,000 (60,000)

5,000 2,000

Goodwill Total Assets

921,000

325,000

50,000 57,000

60,000 200,000 300,000 361,000

25,000 50,000 100,000 150,000

100,000 145,400

325,000

3,600 2,000 255,000

Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Suspect Co.

Total Liabilities & Equity

921,000

45,000

2,000 28,000 28,000 7,000 2,000 37,000

50,000 14,400 18,000 8,000 18,000 37,000 145,400

2,000

Consolidate d 400,000 (240,000) (38,000) (30,000) 0 92,000 (9,000) 83,000

379,600

2,000 35,000 37,000

83,000 (60,000) 402,600

4,000

202,000 340,000 170,000 655,000 (311,000) 0

10,000 23,000 120,000 40,000 18,000 215,000

4,000

37,000 30,000 10,000 20,000 97,000

32,000 1,088,000 81,000 250,000 300,000 402,600 54,400

1,088,000

Chapter 08 – Intercompany Indebtedness

CHAPTER 8 INTERCOMPANY INDEBTEDNESS ANSWERS TO QUESTIONS Q8-1 A gain or loss on bond retirement is reported by the consolidated entity whenever (a) one of the companies purchases its own bonds from a nonaffiliate at an amount other than book value, or (b) a company within the consolidated entity purchases the bonds of an affiliate from a nonaffiliate at an amount other than book value. Q8-2 A constructive retirement occurs when the bonds of a company included in the consolidated entity are purchased by another company included within the consolidated entity. Although the debtor still considers the bonds as outstanding, and the investor views the bonds as an investment, they are constructively retired for consolidation purposes. If bonds are actually retired, the debtor purchases its own bonds from a nonaffiliate or affiliate and they are no longer outstanding. Q8-3 When bonds sold to an affiliate at par value are not eliminated, bonds payable and bond investment are misstated in the balance sheet accounts and interest income and interest expense are misstated in the income statement accounts. There is also a premium or discount account to be eliminated when the bonds are not issued at par value. Unless interest is paid at year-end, there is likely to be some amount of interest receivable and interest payable to be eliminated as well. Q8-4 Both the bond investment and interest income reported by the purchaser will be improperly included. Interest expense, bonds payable, and any premium or discount recorded on the books of the debtor also will be improperly included. In addition, the constructive gain or loss on bond retirement will be improperly omitted if no consolidation entries are recorded in connection with the purchase. Q8-5 If the focus is placed on the legal entity, only bonds actually reacquired by the debtor will be treated as retired. This treatment can lead to incorrect reports for the consolidated entity in two dimensions, 1) the interest expense/revenue on the bonds and 2) the gain/loss on retirement of the bonds. If a company were to repurchase bonds from an affiliate, any retirement gain or loss reported by the debtor is not a gain or loss to the economic entity and must be eliminated in preparing consolidated statements. Moreover, although a purchase of debt of any of the other companies in the consolidated entity will not be recognized as a retirement by the debtor, when emphasis is placed on the economic entity the purchase must serve as a basis for recognition of a bond retirement for the consolidated entity. Q8-6 The difference in treatment is due to the effect of the transactions on the consolidated entity. In the case of land sold to another affiliate, a gain has been recorded that is not a gain from the viewpoint of the consolidated entity. Thus, it must be eliminated in the consolidation process. On the other hand, in a bond repurchase the buyer simply records an investment in bonds and the debtor makes no special entries because of the purchase by an affiliate. Neither company records the effect of the transaction on the economic entity. Thus, in the consolidation process an entry must be made to recognize the gain on bond retirement that has occurred from the viewpoint of the economic entity.

Chapter 08 – Intercompany Indebtedness

Q8-7 When there has been a direct sale to an affiliate, the interest income recorded by the purchaser should equal the interest expense recorded by the seller and the two items should have no net effect on reported income. The consolidation entries do not change consolidated net income in this case, but they will result in a more appropriate statement of the relevant income and expense categories in the consolidated income statement. Q8-8 Whenever a loss on bond retirement has been reported in a prior period, the affiliate that purchased the bonds paid more than the book value of the debt shown by the debtor. As a result, each period the interest income recorded by the buyer will be less than the interest expense reported by the debtor. When the two income statement accounts are eliminated in the consolidation process, the effect will be to increase consolidated net income. Because the full amount of the loss was recognized for consolidated purposes in the year in which the bonds were purchased by the affiliate, the effect of the elimination process in each of the periods that follow should be to increase consolidated income. Q8-9 The difference between the carrying value of the debt on the debtor's books and the carrying value of the investment on the purchaser's books indicates the amount of unrecognized gain or loss at the end of the period. To determine the amount of the gain or loss on retirement at the start of the period, the difference between interest income recorded by the purchaser on the bond that has been purchased and interest expense recorded by the debtor during the period is added to the difference between carrying values at the end of the period. Q8-10 Interest income and interest expense must be eliminated and a loss on bond retirement established in the elimination process. Consolidated net income will decrease by the amount of the loss. Because the loss is attributed to the subsidiary, income assigned to the controlling and noncontrolling interests will decrease in proportion to their share of common stock held. Q8-11 A constructive gain will be included in the consolidated income statement in this case and both consolidated net income and income to the controlling interest will increase by the full amount of the gain. Q8-12 A direct placement of subsidiary bonds with the parent should have no effect on consolidated income or on income assigned to the noncontrolling shareholders. Q8-13 When subsidiary bonds are purchased from a nonaffiliate by the parent for less than book value there is a constructive gain for consolidated purposes, the gain is assigned to the subsidiary and included in computing income to the noncontrolling shareholders. Q8-14 Interest income recorded by the subsidiary and interest expense recorded by the parent should be equal in the direct placement case. When the subsidiary purchases parent company bonds from a nonaffiliate, interest income and interest expense will not be the same unless the bonds are purchased from the nonaffiliate at an amount equal to the liability reported by the parent. Q8-15 A gain on constructive bond retirement recorded in a prior period means the bonds were purchased for less than book value and the interest income recorded by the subsidiary each period will be greater than the interest expense recorded by the parent. Consolidated net income for the current period will decrease by the difference between interest income and interest expense as these amounts are eliminated in preparing the consolidated statements. Income to the noncontrolling interest will be unaffected since the constructive gain is assigned to the parent company.

Chapter 08 – Intercompany Indebtedness

Q8-16 A constructive loss recorded on the subsidiary's bonds in a prior period means the interest income recorded by the parent is less than the interest expense recorded by the subsidiary in each of the following periods. Consolidated net income will increase when interest income and expense are eliminated. Income assigned to the noncontrolling interest will be based on the reported net income of the subsidiary plus the difference between interest income and interest expense each period following the retirement. As a result, the amount assigned to the noncontrolling interest will be greater than if the bond had not been constructively retired. Q8-17 On the date the parent sells the bonds to a nonaffiliate they are issued for the first time from a consolidated perspective. While the parent will record a gain or loss on sale of the bonds on its books, none is recognized from a consolidated viewpoint, so the gain or loss must be eliminated. The difference between the sale price received by the parent and par value is a premium or discount. Each period there will be a need to establish the correct amount for the premium or discount account and to adjust interest expense recorded by the subsidiary to bring the reported amounts into conformity with the sale price to the nonaffiliate. Q8-18 The retirement gain or loss reported by the subsidiary when it repurchases the bonds held by the parent must be eliminated in the consolidation process. From the viewpoint of the consolidated entity the bonds were retired at the point they were purchased by the parent and a gain or loss should have been recognized in the consolidation process at that point.

Chapter 08 – Intercompany Indebtedness

SOLUTIONS TO CASES C8-1 Recognition of Retirement Gains and Losses a. When Flood purchases the bonds it establishes an investment account on its books and Bradley establishes a bond liability and discount account on its books. No entry is made by Century. When Century purchases the bonds, Century records an investment and Flood removes the balance in the investment account and records a gain on the sale. Bradley makes no entry. When Bradley retires the issue, Bradley removes its liability and unamortized discount and records a loss on bond retirement. Century removes the bond investment account and records a loss on the sale of bonds. Flood makes no entry. b. A constructive loss on bond retirement is reported by the consolidated entity at the time Century purchases the bonds from Flood. The exact amount of the loss cannot be ascertained without knowing the maturity date of the bonds, the date of initial sale, and the date of purchase by Century. c. The initial sale of bonds by Bradley is treated as a normal transaction with no need for an adjustment to income assigned to the noncontrolling shareholders. Income assigned to noncontrolling shareholders will be reduced by a proportionate share of the loss reported in the consolidated income statement in the period in which Century purchases the bonds from Flood. In the years before the bonds are retired by Bradley, income assigned to the noncontrolling interest (assuming no differential) will be greater than a pro rata portion of the reported net income of Bradley. In the period in which the bonds are retired by Bradley, reported net income of Bradley must be adjusted to remove its loss on bond retirement before assigning income to the noncontrolling interest. No adjustment is made in the years following the repurchase by Bradley.

Chapter 08 – Intercompany Indebtedness

C8-2 Borrowing by Variable Interest Entities MEMO To:

President Hydro Corporation

From: Re:

, Accounting Staff Consolidation of Joint Venture

Hydro Corporation and Rich Corner Bank established a joint venture which borrowed $30,000,000 and built a new production facility. That facility is now leased to Hydro on a 10-year operating lease. Hydro currently reports the annual lease payment as an operating expense and in the notes to its financial statements must report a contingent liability for its guarantee of the debt of the joint venture. I have been asked to review the current financial reporting standards and determine whether Hydro’s current reporting is appropriate. The circumstances surrounding the creation of the joint venture and the lease arrangement with Hydro appear to point to the need for Hydro to consolidate the joint venture with its own operations. Although Rich Corner Bank holds 100 percent of the equity of the joint venture, it has contributed less than 1 percent of the total assets of the joint venture ($200,000 of equity versus $30,000,000 of total borrowings). Under normal circumstances, less than a 10 percent investment in the entity’s total assets is considered insufficient to permit the entity to finance its activities. [ASC 810-10-25-45] In this situation, Hydro has guaranteed the $30,000,000 borrowed by the joint venture and has guaranteed a 20 percent annual return on the equity investment of Rich Corner Bank. These conditions will result in Hydro Corporation absorbing any losses incurred by the joint venture and establish Hydro Corporation as the primary beneficiary of the entity. The FASB requires consolidation by the entity that will absorb a majority of the entity’s expected losses if they occur. [ASC 810-10-25-38] Consolidation of the joint venture will result in including the production facility among Hydro’s assets and the debt as part of its long-term liabilities. The claim on the net assets of the joint venture held by Rich Corner Bank will be reported as part of noncontrolling interest. Hydro’s consolidated income statement will not include the lease payment as an operating expense, but will include depreciation expense on the production facility and interest expense for the interest payment made on the borrowing of the joint venture. Primary citation: ASC 810

Chapter 08 – Intercompany Indebtedness

Case 8-3 Subsidiary Bond Holdings MEMO To: From: Re:

Financial Vice-President Farflung Corporation , Accounting Staff Investment in Bonds Issued by Subsidiary

The consolidated financial statements of Farflung Corporation should include both Micro Company and Eagle Corporation. The purpose of the consolidated statements is to present the financial position and results of operations for a parent and one or more subsidiaries as if the individual entities actually were a single company or entity. [ASC 810-10-10-1] When one subsidiary purchases the bonds of another, the investment reported by the purchasing affiliate and the liability reported by the debtor must be eliminated and a gain or loss reported on the difference between the purchase price and the carrying value of the debt at the time of purchase. In preparing Farflung’s consolidated statements at December 31, 20X4, the following consolidation entry should have been included in the worksheet: Bonds Payable Loss on Bond Retirement Investment in Micro Company Bonds

400,000 24,000 424,000

The $24,000 loss should have been included in the consolidated income statement, leading to a reduction of $15,600 ($24,000 x 0.65) in income assigned to the controlling interest and a reduction of $8,400 ($24,000 x 0.35) in income assigned to noncontrolling shareholders. This error should be corrected by restating the financial statements of the consolidated entity for 20X4. While omission of the consolidation entry resulted in incorrect financial statements for the consolidated entity, it should have no impact on the financial statements of the individual subsidiaries. Assuming (1) the bonds had 15 years remaining until maturity when purchased by Eagle and pay 8 percent interest annually, (2) straight-line amortization of the premium paid by Eagle is appropriate, and (3) the consolidated financial statements as of December 31, 20X4, are corrected, the consolidation entry at December 31, 20X5, is: Bonds Payable Interest Income Investment in Micro Company Noncontrolling Interest Investment in Micro Company Bonds Interest Expense

400,000 30,400(a) 15,600 8,400 422,400(b) 32,000(c)

(a)($400,000 x 0.08) - ($24,000/15 years) (b)$424,000 - ($24,000/15 years) (c)$400,000 x 0.08 Primary citation: ASC 810-10-45-1

Chapter 08 – Intercompany Indebtedness

C8-4 Interest Income and Expense a. Snerd apparently paid more than par value for the bonds and is amortizing the premium against interest income over the life of the bonds. Thus, the cash received is greater than the amount of interest income recorded. b.

With the information given, the following appears to be true: (1) When purchasing the bonds, Snerd apparently paid less than the current carrying amount of the bonds on the subsidiary’s books because a constructive gain on bond retirement is included in the 20X3 consolidated income statement. Since Snerd paid par value for the bonds, they must have been sold at a premium by the subsidiary. (2) Because the bonds were sold at a premium, interest expense recorded by the subsidiary will be less than the annual interest payment made to the parent. (3) Interest income recorded each period by Snerd will exceed interest expense recorded by the subsidiary. When the two balances are eliminated, the effect will be to reduce income to both the controlling and noncontrolling shareholders.

C8-5 Intercompany Debt Answers to this case can be found in the SEC Form 10-K filed by Hershey Foods and its annual report. a. When intercompany loans are made between affiliates in different countries, the problem of changing currency exchange rates may arise, especially if any of the loans are denominated in a currency that rapidly changes in value against the dollar. Hershey Foods and many other companies in the same situation hedge their intercompany receivables/payables through foreign currency forward contracts and swaps. b. Hershey's intercompany receivables/payables appear to come primarily from intercompany purchases and sales of goods.

Chapter 08 – Intercompany Indebtedness

SOLUTIONS TO EXERCISES E8-1 Bond Sale from Parent to Subsidiary

Journal entries recorded by Stick Corporation:

January 1, 20X2 Investment in Pretzel Corporation Bonds Cash July 1, 20X2 Cash Interest Income Investment in Pretzel Corporation Bonds

156,000 156,000 4,500 4,271 229

December 31, 20X2 Interest Receivable Interest Income Investment in Pretzel Corporation Bonds

4,500 4,264 236

Chapter 08 – Intercompany Indebtedness

Journal entries recorded by Pretzel Corporation: b. January 1, 20X2 Cash Bonds Payable Bond Premium

156,000 150,000 6,000

July 1, 20X2 Interest Expense Bond Premium Cash

4,271 229

December 31, 20X2 Interest Expense Bond Premium Interest Payable

4,264 236

4,500

Consolidation entries, December 31, 20X2: Bonds payable Premium on Bonds Payable Interest income Investment in Pretzel Corporation Bonds Interest expense Eliminate intercompany bond holdings.

150,000 5,535 8,535

Interest payable Interest receivable Eliminate intercompany receivable/payable.

4,500

155,535 8,535

4,500

E8-2 Computation of Transfer Price a. $105,975.19; N=20, I=11%, PMT=$6,000, P/YR=2, FV=$100,000 b. $104,795

Chapter 08 – Intercompany Indebtedness

Discount Example Face Value of Bonds

Interest $ PMT

PMT #

Interest Expense

Amort of Discount Premium (Premium) (Discount)

Bonds Payable

BV of Bonds

100,000.00 Stated rate =

1/1/20X5 7/1/20X5

6,000.00

5,828.64

(171.36)

$5,975.19 $5,803.83

100,000.00 $105,975.19 100,000.00 $105,803.83

12%

1/1/20X6

6,000.00

5,819.21

(180.79)

$5,623.04

100,000.00 $105,623.04

Annual

7/1/20X6

6,000.00

5,809.27

(190.73)

$5,432.30

100,000.00 $105,432.30

Years =

1/1/20X7

6,000.00

5,798.78

(201.22)

$5,231.08

100,000.00 $105,231.08

10 Mkt Rate = 11.000%

7/1/20X7 1/1/20X8

6,000.00 6,000.00

5,787.71 5,776.03

(212.29) (223.97)

$5,018.79 $4,794.82

100,000.00 $105,018.79 100,000.00 $104,794.82

6,000.00

5,763.72

(236.28)

$4,558.54

100,000.00 $104,558.54

6,000.00

5,750.72

(249.28)

$4,309.26

100,000.00 $104,309.26

6 7 9

6,000.00

5,737.01

(262.99)

$4,046.27

100,000.00 $104,046.27

6,000.00

5,722.54

(277.46)

$3,768.81

100,000.00 $103,768.81

11 12

6,000.00

5,707.28

(292.72)

$3,476.10

100,000.00 $103,476.10

6,000.00

5,691.19

(308.81)

$3,167.28

100,000.00 $103,167.28

6,000.00

5,674.20

(325.80)

$2,841.48

100,000.00 $102,841.48

6,000.00

5,656.28

(343.72)

$2,497.77

100,000.00 $102,497.77

6,000.00

5,637.38

(362.62)

$2,135.14

100,000.00 $102,135.14

16 17

6,000.00

5,617.43

(382.57)

$1,752.58

100,000.00 $101,752.58

6,000.00

5,596.39

(403.61)

$1,348.97

100,000.00 $101,348.97

6,000.00

5,574.19

(425.81)

$923.16

100,000.00 $100,923.16

19 20

6,000.00

5,550.77

(449.23)

$473.93

100,000.00 $100,473.93

6,000.00

5,526.07

(473.93)

($0.00) 100,000.00 $100,000.00

120,000.00

114,024.81

(5,975.19)

c. Consolidation entries: Bonds Payable Bond Premium Interest Income Investment in Stallion Corporation Bonds Interest Expense Interest Payable Interest Receivable

100,000 4,795 11,564 104,795 11,564 6,000 6,000

Chapter 08 – Intercompany Indebtedness

E8-3 Bond Sale at Discount a.

$16,731 = ($25,073.73 + $25,119.36) x 1/3

Discount Example Face Value of Bonds

PMT #

Interest $ PMT

Interest Expense

Amort of Discount Premium (Premium) (Discount)

Bonds Payable

BV of Bonds

600,000.00 Stated rate =

1/1/20X3 7/1/20X3

24,000.00

24,987.98

($12,000.00) 600,000.00 $588,000.00 987.98 ($11,012.02) 600,000.00 $588,987.98

1/1/20X4

24,000.00

25,029.96

1,029.96

($9,982.06) 600,000.00 $590,017.94

Annual

7/1/20X4

24,000.00

25,073.73

1,073.73

($8,908.33) 600,000.00 $591,091.67

Years =

1/1/20X5

24,000.00

25,119.36

1,119.36

($7,788.96) 600,000.00 $592,211.04

5 Mkt Rate = 8.499%

24,000.00 24,000.00

25,166.93 25,216.52

1,166.93 1,216.52

($6,622.03) 600,000.00 $593,377.97 ($5,405.51) 600,000.00 $594,594.49

24,000.00

25,268.22

1,268.22

($4,137.29) 600,000.00 $595,862.71

24,000.00

25,322.12

1,322.12

($2,815.17) 600,000.00 $597,184.83

24,000.00

25,378.30

1,378.30

($1,436.87) 600,000.00 $598,563.13 ($0.00) 600,000.00 $600,000.00

6 7

24,000.00

25,436.87

1,436.87

240,000.00

252,000.00

12,000.00

Journal entries recorded by Purse Corporation:

January 1, 20X4 Cash Interest Receivable

16,000

July 1, 20X4 Cash Investment in Scarf Company Bonds Interest Income

16,000 716

December 31, 20X4 Interest Receivable Investment in Scarf Company Bonds Interest Income

16,000 746

16,000

16,716

16,746

Chapter 08 – Intercompany Indebtedness

Consolidation entries, December 31, 20X4: Bonds Payable Interest Income Investment in Scarf Company Bonds Bond Discount Interest Expense $33,462 = ($25,073.73 + $25,119.36) x 2/3 $394,807 = 592,211.04 x 2/3 $5,193 = $7,788.96 x 2/3

400,000 33,462

Interest Payable Interest Receivable

16,000

394,807 5,193 33,462

16,000

E8-4 Evaluation of Intercompany Bond Holdings a.

The bonds were originally sold at a discount. Proctor purchased the bonds at par value and a constructive loss was reported.

The annual interest payment received by Proctor will be less than the interest expense recorded by the subsidiary. When bonds are sold at a discount, the issue price of the bonds is adjusted downward because the annual interest payment is less than is needed to issue the bonds at par value.

In 20X6, consolidated net income was decreased as a result of the loss on constructive retirement of bonds. Each period following the purchase, the amount of interest expense recorded by the subsidiary will exceed the interest income recorded by the parent. When these two amounts are eliminated, consolidated net income will increase. Thus, consolidated net income for 20X7 will be increased.

Chapter 08 – Intercompany Indebtedness

E8-5 Multiple-Choice Questions 1. a – A constructive gain of $100,000 is included in consolidated net income for the period ended March 31, 20X8, and consolidated retained earnings at March 31, 20X8. Because the bonds of the parent are constructively retired, there is no effect on the amounts assigned to the noncontrolling interest since the bond was originally issued by the parent not the subsidiary. [AICPA Adapted]. (b) Incorrect. Because the bonds are constructively retired, there is no effect on the amount assigned to the noncontrolling interest. As such, the constructive gain is not proportionately allocated. (c) Incorrect. Because the bonds are constructively retired, there is no effect on the amount assigned to the noncontrolling interest. Additionally, the constructive gain will increase the retained earnings. (d) Incorrect. Because the bonds are constructively retired, there is no effect on the amount assigned to the noncontrolling interest. As such, the entire constructive gain results in an increase to retained earnings on the consolidated balance sheet, not an increase to the noncontrolling interest. 2. a – The loss on bond retirement will result in a reduction in consolidated retained earnings. [AICPA Adapted] (b) Incorrect. The difference represents a loss, which would decrease retained earnings, not increase it. (c) Incorrect. A deferred debit does not arise in this situation. The difference results in a loss, causing a decrease in retained earnings. (d) Incorrect. A deferred credit does not arise in this situation. The difference results in a loss, causing a decrease in retained earnings.

Chapter 08 – Intercompany Indebtedness

3. b – $4,767

Discount Example Face Value of Bonds

Interest $ PMT

PMT #

Interest Expense

Amort of Discount Premium (Premium) (Discount)

Bonds Payable

BV of Bonds

50,000.00 Stated rate =

1/1/20X4 7/1/20X4

2,500.00

2,404.74

(95.26)

$3,000.00 $2,904.74

50,000.00 50,000.00

$53,000.00 $52,904.74

10%

1/1/20X5

2,500.00

2,400.42

(99.58)

$2,805.17

50,000.00

$52,805.17

Annual

7/1/20X5

2,500.00

2,395.90

(104.10)

$2,701.07

50,000.00

$52,701.07

Years =

1/1/20X6

2,500.00

2,391.18

(108.82)

$2,592.25

50,000.00

$52,592.25

10 Mkt Rate = 9.075%

7/1/20X6 1/1/20X7

2,500.00 2,500.00

2,386.24 2,381.08

(113.76) (118.92)

$2,478.49 $2,359.58

50,000.00 50,000.00

$52,478.49 $52,359.58

2,500.00

2,375.69

(124.31)

$2,235.26

50,000.00

$52,235.26

2,500.00

2,370.05

(129.95)

$2,105.31

50,000.00

$52,105.31

6 7 9

2,500.00

2,364.15

(135.85)

$1,969.46

50,000.00

$51,969.46

2,500.00

2,357.99

(142.01)

$1,827.44

50,000.00

$51,827.44

11 12

2,500.00

2,351.54

(148.46)

$1,678.99

50,000.00

$51,678.99

2,500.00

2,344.81

(155.19)

$1,523.79

50,000.00

$51,523.79

2,500.00

2,337.76

(162.24)

$1,361.56

50,000.00

$51,361.56

2,500.00

2,330.40

(169.60)

$1,191.96

50,000.00

$51,191.96

2,500.00

2,322.71

(177.29)

$1,014.67

50,000.00

$51,014.67

16 17

2,500.00

2,314.66

(185.34)

$829.34

50,000.00

$50,829.34

2,500.00

2,306.26

(193.74)

$635.59

50,000.00

$50,635.59

2,500.00

2,297.46

(202.54)

$433.06

50,000.00

$50,433.06

19 20

2,500.00

2,288.28

(211.72)

$221.33

50,000.00

$50,221.33

2,500.00

2,278.67

(221.33)

($0.00)

50,000.00

$50,000.00

50,000.00

47,000.00

(3,000.00)

Chapter 08 – Intercompany Indebtedness

4. a – $4,233

Discount Example Face Value of Bonds

Interest $ PMT

PMT #

Interest Income

Amort of Discount Premium (Premium) (Discount)

Bonds Payable

BV of Bonds

$8,000.00

50,000.00

$58,000.00

1/1/20X6

50,000.00 Stated rate =

1 2

10%

7/1/20X6

2,500.00

2,123.38

(376.62)

$7,623.38

50,000.00

$57,623.38

1/1/20X7

2,500.00

2,109.59

(390.41)

$7,232.97

50,000.00

$57,232.97

Annual

2,500.00

2,095.30

(404.70)

$6,828.27

50,000.00

$56,828.27

Years =

2,500.00

2,080.48

(419.52)

$6,408.75

50,000.00

$56,408.75

2,500.00

2,065.12

(434.88)

$5,973.87

50,000.00

$55,973.87

6 7

2,500.00

2,049.20

(450.80)

$5,523.07

50,000.00

$55,523.07

7.322%

2,500.00

2,032.70

(467.30)

$5,055.77

50,000.00

$55,055.77

2,500.00

2,015.59

(484.41)

$4,571.36

50,000.00

$54,571.36

2,500.00

1,997.86

(502.14)

$4,069.21

50,000.00

$54,069.21

2,500.00

1,979.47

(520.53)

$3,548.69

50,000.00

$53,548.69

11 12

2,500.00

1,960.42

(539.58)

$3,009.10

50,000.00

$53,009.10

2,500.00

1,940.66

(559.34)

$2,449.76

50,000.00

$52,449.76

2,500.00

1,920.18

(579.82)

$1,869.95

50,000.00

$51,869.95

2,500.00

1,898.96

(601.04)

$1,268.90

50,000.00

$51,268.90

2,500.00

1,876.95

(623.05)

$645.86

50,000.00

$50,645.86

2,500.00

1,854.14

(645.86)

($0.00)

50,000.00

$50,000.00

40,000.00

32,000.00

(8,000.00)

Mkt Rate =

5. c – $5,408 = $58,000 purchase price - $52,592 carrying value 6.

c – Operating income of Kruse Corporation Net income of Gary's Ice Cream Parlors Less:

Loss on bond retirement Recognition during 20X6 ($4,767 - $4,233) Consolidated net income

$40,000 20,000 $60,000 (5,408) 534 $55,126

Chapter 08 – Intercompany Indebtedness

E8-6 Multiple-Choice Questions 1.

a–

$14,626 = 21,939 x ($200,000 / $300,000)

c–

$12,923 = 116,923 - $104,000

b – Net income of Solar Corporation Unrecognized portion of gain on bond retirement ($12,923 - $1,317)

$30,000 11,606 $41,606

Proportion of stock held by noncontrolling interest Income to noncontrolling interest

Face Value of Bonds

Interest PMT

PMT #

x 0.20 $ 8,321

Interest Expense

Amort of Discount (Premium)

Premium (Discount)

Bonds Payable

BV of Bonds

300,000.00 Stated rate =

1/1/20X2 7/1/20X2

13,500.00

11,298.32

(2,201.68)

$60,000.00 $57,798.32

300,000.00 300,000.00

$360,000.00 $357,798.32

1/1/20X3

13,500.00

11,229.22

(2,270.78)

$55,527.55

300,000.00

$355,527.55

Annual

7/1/20X3

13,500.00

11,157.96

(2,342.04)

$53,185.50

300,000.00

$353,185.50

Years =

1/1/20X4

13,500.00

11,084.45

(2,415.55)

$50,769.96

300,000.00

$350,769.96

10 Mkt Rate = 6.277%

7/1/20X4 1/1/20X5

13,500.00 13,500.00

11,008.64 10,930.45

(2,491.36) (2,569.55)

$48,278.60 $45,709.06

300,000.00 300,000.00

$348,278.60 $345,709.06

7/1/20X5

13,500.00

10,849.81

(2,650.19)

$43,058.87

300,000.00

$343,058.87

1/1/20X6

13,500.00

10,766.64

(2,733.36)

$40,325.51

300,000.00

$340,325.51

7/1/20X6

6 7

13,500.00

10,680.85

(2,819.15)

$37,506.36

300,000.00

$337,506.36

13,500.00

10,592.38

(2,907.62)

$34,598.73

300,000.00

$334,598.73

11 12

13,500.00

10,501.12

(2,998.88)

$31,599.86

300,000.00

$331,599.86

13,500.00

10,407.01

(3,092.99)

$28,506.86

300,000.00

$328,506.86

13,500.00

10,309.93

(3,190.07)

$25,316.80

300,000.00

$325,316.80

13,500.00

10,209.82

(3,290.18)

$22,026.61

300,000.00

$322,026.61

13,500.00

10,106.56

(3,393.44)

$18,633.17

300,000.00

$318,633.17

16 17

13,500.00

10,000.06

(3,499.94)

$15,133.23

300,000.00

$315,133.23

13,500.00

9,890.21

(3,609.79)

$11,523.44

300,000.00

$311,523.44

13,500.00

9,776.92

(3,723.08)

$7,800.36

300,000.00

$307,800.36

19 20

13,500.00

9,660.08

(3,839.92)

$3,960.44

300,000.00

$303,960.44

$0.00

300,000.00

$300,000.00

13,500.00

9,539.56

(3,960.44)

270,000.00

210,000.00

(60,000.00)

Chapter 08 – Intercompany Indebtedness

Face Value of Bonds

Interest PMT

PMT #

100,000.00 Stated rate = 9% Annual Years =

Interest Expense

Amort of Discount (Premium)

1/1/20X4

Premium (Discount)

Bonds Payable

BV of Bonds

$4,000.00

100,000.00

$104,000.00

1 2

7/1/20X4

4,500.00

4,318.95

(181.05)

$3,818.95

100,000.00

$103,818.95

1/1/20X5

4,500.00

4,311.43

(188.57)

$3,630.39

100,000.00

$103,630.39

7/1/20X5

4,500.00

4,303.60

(196.40)

$3,433.99

100,000.00

$103,433.99

1/1/20X6

4,500.00

4,295.45

(204.55)

$3,229.43

100,000.00

$103,229.43

7/1/20X6

4,500.00

4,286.95

(213.05)

$3,016.39

100,000.00

$103,016.39

6 7

4,500.00

4,278.10

(221.90)

$2,794.49

100,000.00

$102,794.49

8.306%

4,500.00

4,268.89

(231.11)

$2,563.38

100,000.00

$102,563.38

4,500.00

4,259.29

(240.71)

$2,322.67

100,000.00

$102,322.67

4,500.00

4,249.30

(250.70)

$2,071.96

100,000.00

$102,071.96

4,500.00

4,238.88

(261.12)

$1,810.85

100,000.00

$101,810.85

11 12

4,500.00

4,228.04

(271.96)

$1,538.89

100,000.00

$101,538.89

4,500.00

4,216.75

(283.25)

$1,255.63

100,000.00

$101,255.63

4,500.00

4,204.98

(295.02)

$960.62

100,000.00

$100,960.62

4,500.00

4,192.73

(307.27)

$653.35

100,000.00

$100,653.35

4,500.00

4,179.97

(320.03)

$333.32

100,000.00

$100,333.32

4,500.00

4,166.68

(333.32)

($0.00)

100,000.00

$100,000.00

72,000.00

68,000.00

(4,000.00)

Mkt Rate =

Chapter 08 – Intercompany Indebtedness

E8-7 Constructive Retirement at End of Year a.

Consolidation entries, December 31, 20X5: Bonds Payable Premium on Bonds Payable Investment in Suspect Company Bonds Gain on Bond Retirement $10,579 = [($615,869 x 2/3) - $400,000] $13,579 = $10,579 + $400,000 - $397,000

400,000 10,579

Interest Payable Interest Receivable

18,000

397,000 13,579

18,000

The basic entry (not shown) would be adjusted by 13,579 to complete the elimination process. b.

Consolidation entries, December 31, 20X6: Bonds Payable 400,000 Premium on Bonds Payable 10,215 Interest Income 36,100 Investment in Suspect Company Bonds Interest Expense Investment in Suspect Co. NCI in NA of Suspect Co. $10,215 = [($615,323 x 2/3) – $400,000] $36,100 rounded = $18,000 + $48.79 + $18,000 + $51.01 $397,100 rounded = $397,000 + 48.79 + 51.01 $35,636 = [($27,000 - $267) +($27,000 - $279)] x 2/3 $8,147 = $13,579 x 0.60 $5,432 = $13,579 x 0.40

397,100 35,636 8,147 5,432

Interest Payable 18,000 Interest Receivable 18,000 The basic entry (not shown) would be adjusted by 464 to complete the elimination process.

Chapter 08 – Intercompany Indebtedness

Face Value of Bonds 600,000.00 Stated rate = 9%

Interest PMT

PMT # 1 2

1/1/20X1 7/1/20X1

Amort of Discount (Premium)

Interest Expense

Premium (Discount)

Bonds Payable

BV of Bonds

$18,000.00

600,000.00

$618,000.00

27,000.00

26,825.29

(174.71)

$17,825.29

600,000.00

$617,825.29

27,000.00

26,817.70

(182.30)

$17,642.99

600,000.00

$617,642.99

Annual

1/1/20X2 7/1/20X2

27,000.00

26,809.79

(190.21)

$17,452.77

600,000.00

$617,452.77

Years =

1/1/20X3

27,000.00

26,801.53

(198.47)

$17,254.31

600,000.00

$617,254.31

20 Mkt Rate =

7/1/20X3

27,000.00

26,792.92

(207.08)

$17,047.22

600,000.00

$617,047.22

6 7

1/1/20X4

27,000.00

26,783.93

(216.07)

$16,831.15

600,000.00

$616,831.15

7/1/20X4

27,000.00

26,774.55

(225.45)

$16,605.70

600,000.00

$616,605.70

1/1/20X5

27,000.00

26,764.76

(235.24)

$16,370.46

600,000.00

$616,370.46

7/1/20X5

27,000.00

26,754.55

(245.45)

$16,125.02

600,000.00

$616,125.02

1/1/20X6

27,000.00

26,743.90

(256.10)

$15,868.92

600,000.00

$615,868.92

11 12

7/1/20X6

27,000.00

26,732.78

(267.22)

$15,601.70

600,000.00

$615,601.70

1/1/20X7

27,000.00

26,721.18

(278.82)

$15,322.88

600,000.00

$615,322.88

7/1/20X7

27,000.00

26,709.08

(290.92)

$15,031.96

600,000.00

$615,031.96

1/1/20X8

27,000.00

26,696.45

(303.55)

$14,728.41

600,000.00

$614,728.41

7/1/20X8

27,000.00

26,683.28

(316.72)

$14,411.69

600,000.00

$614,411.69

16 17

1/1/20X9

27,000.00

26,669.53

(330.47)

$14,081.22

600,000.00

$614,081.22

7/1/20X9

27,000.00

26,655.18

(344.82)

$13,736.40

600,000.00

$613,736.40

1/1/20X10

27,000.00

26,640.22

(359.78)

$13,376.62

600,000.00

$613,376.62

19 20

7/1/20X10

27,000.00

26,624.60

(375.40)

$13,001.22

600,000.00

$613,001.22

1/1/20X11

27,000.00

26,608.31

(391.69)

$12,609.52

600,000.00

$612,609.52

7/1/20X11

27,000.00

26,591.30

(408.70)

$12,200.83

600,000.00

$612,200.83

22 23

1/1/20X12

27,000.00

26,573.56

(426.44)

$11,774.39

600,000.00

$611,774.39

7/1/20X12

27,000.00

26,555.05

(444.95)

$11,329.44

600,000.00

$611,329.44

1/1/20X13

27,000.00

26,535.74

(464.26)

$10,865.18

600,000.00

$610,865.18

25 26

7/1/20X13

27,000.00

26,515.59

(484.41)

$10,380.77

600,000.00

$610,380.77

1/1/20X14

27,000.00

26,494.56

(505.44)

$9,875.33

600,000.00

$609,875.33

7/1/20X14

27,000.00

26,472.62

(527.38)

$9,347.95

600,000.00

$609,347.95

28 29

1/1/20X15

27,000.00

26,449.73

(550.27)

$8,797.68

600,000.00

$608,797.68

7/1/20X15

27,000.00

26,425.84

(574.16)

$8,223.52

600,000.00

$608,223.52

1/1/20X16

27,000.00

26,400.92

(599.08)

$7,624.44

600,000.00

$607,624.44

31 32

7/1/20X16

27,000.00

26,374.92

(625.08)

$6,999.36

600,000.00

$606,999.36

1/1/20X17

27,000.00

26,347.78

(652.22)

$6,347.15

600,000.00

$606,347.15

7/1/20X17

27,000.00

26,319.47

(680.53)

$5,666.62

600,000.00

$605,666.62

34 35

1/1/20X18

27,000.00

26,289.93

(710.07)

$4,956.55

600,000.00

$604,956.55

7/1/20X18

27,000.00

26,259.11

(740.89)

$4,215.67

600,000.00

$604,215.67

1/1/20X19

27,000.00

26,226.95

(773.05)

$3,442.62

600,000.00

$603,442.62

37 38

7/1/20X19

27,000.00

26,193.40

(806.60)

$2,636.02

600,000.00

$602,636.02

1/1/20X20

27,000.00

26,158.39

(841.61)

$1,794.41

600,000.00

$601,794.41

7/1/20X20

27,000.00

26,121.86

(878.14)

$916.26

600,000.00

$600,916.26

1/1/20X21

27,000.00

26,083.74

(916.26)

$0.00

600,000.00

$600,000.00

1,080,000.00 1,062,000.00

(18,000.00)

8.681%

Chapter 08 – Intercompany Indebtedness

Face Value of Bonds 400,000.00 Stated rate =

Interest PMT

PMT #

Interest Income

Amort of Discount (Premium)

1/1/20X6

Premium (Discount)

Bonds Payable

BV of Bonds

($3,000.00) 400,000.00

$397,000.00

1 2

7/1/20X6

18,000.00

18,048.79

48.79

($2,951.21) 400,000.00

$397,048.79

1/1/20X7

18,000.00

18,051.01

51.01

($2,900.20) 400,000.00

$397,099.80

Annual

7/1/20X7

18,000.00

18,053.33

53.33

($2,846.87) 400,000.00

$397,153.13

Years =

1/1/20X8

18,000.00

18,055.75

55.75

($2,791.12) 400,000.00

$397,208.88

15 Mkt Rate =

7/1/20X8

18,000.00

18,058.29

58.29

($2,732.84) 400,000.00

$397,267.16

6 7

1/1/20X9

18,000.00

18,060.94

60.94

($2,671.90) 400,000.00

$397,328.10

7/1/20X9

18,000.00

18,063.71

63.71

($2,608.19) 400,000.00

$397,391.81

1/1/20X10

18,000.00

18,066.60

66.60

($2,541.59) 400,000.00

$397,458.41

7/1/20X10

18,000.00

18,069.63

69.63

($2,471.96) 400,000.00

$397,528.04

1/1/20X11

18,000.00

18,072.80

72.80

($2,399.16) 400,000.00

$397,600.84

11 12

7/1/20X11

18,000.00

18,076.11

76.11

($2,323.06) 400,000.00

$397,676.94

1/1/20X12

18,000.00

18,079.57

79.57

($2,243.49) 400,000.00

$397,756.51

7/1/20X12

18,000.00

18,083.18

83.18

($2,160.31) 400,000.00

$397,839.69

1/1/20X13

18,000.00

18,086.97

86.97

($2,073.34) 400,000.00

$397,926.66

7/1/20X13

18,000.00

18,090.92

90.92

($1,982.42) 400,000.00

$398,017.58

16 17

1/1/20X14

18,000.00

18,095.05

95.05

($1,887.37) 400,000.00

$398,112.63

7/1/20X14

18,000.00

18,099.37

99.37

($1,788.00) 400,000.00

$398,212.00

1/1/20X15

18,000.00

18,103.89

103.89

($1,684.11) 400,000.00

$398,315.89

19 20

7/1/20X15

18,000.00

18,108.61

108.61

($1,575.49) 400,000.00

$398,424.51

1/1/20X16

18,000.00

18,113.55

113.55

($1,461.94) 400,000.00

$398,538.06

7/1/20X16

18,000.00

18,118.71

118.71

($1,343.22) 400,000.00

$398,656.78

1/1/20X17

18,000.00

18,124.11

124.11

($1,219.11) 400,000.00

$398,780.89

23 24

7/1/20X17

18,000.00

18,129.75

129.75

($1,089.36) 400,000.00

$398,910.64

1/1/20X18

18,000.00

18,135.65

135.65

($953.70) 400,000.00

$399,046.30

7/1/20X18

18,000.00

18,141.82

141.82

($811.88) 400,000.00

$399,188.12

1/1/20X19

18,000.00

18,148.27

148.27

($663.62) 400,000.00

$399,336.38

27 28

7/1/20X19

18,000.00

18,155.01

155.01

($508.61) 400,000.00

$399,491.39

1/1/20X20

18,000.00

18,162.06

162.06

($346.55) 400,000.00

$399,653.45

7/1/20X20

18,000.00

18,169.42

169.42

($177.13) 400,000.00

$399,822.87

1/1/20X21

9.093%

18,000.00

18,177.13

177.13

540,000.00

543,000.00

3,000.00

$0.00

400,000.00

$400,000.00

Chapter 08 – Intercompany Indebtedness

E8-8 Constructive Retirement at Beginning of Year Face Value of Bonds 600,000.00 Stated rate = 9%

Interest PMT

PMT # 1 2

1/1/20X1 7/1/20X1

Interest Expense

Amort of Discount (Premium)

Premium (Discount)

Bonds Payable

BV of Bonds

$18,000.00

600,000.00

$618,000.00

27,000.00

26,825.29

(174.71)

$17,825.29

600,000.00

$617,825.29

27,000.00

26,817.70

(182.30)

$17,642.99

600,000.00

$617,642.99

27,000.00

26,809.79

(190.21)

$17,452.77

600,000.00

$617,452.77

Annual

1/1/20X2 7/1/20X2

Years =

1/1/20X3

27,000.00

26,801.53

(198.47)

$17,254.31

600,000.00

$617,254.31

20 Mkt Rate =

7/1/20X3

27,000.00

26,792.92

(207.08)

$17,047.22

600,000.00

$617,047.22

6 7

1/1/20X4

27,000.00

26,783.93

(216.07)

$16,831.15

600,000.00

$616,831.15

7/1/20X4

27,000.00

26,774.55

(225.45)

$16,605.70

600,000.00

$616,605.70

1/1/20X5

27,000.00

26,764.76

(235.24)

$16,370.46

600,000.00

$616,370.46

7/1/20X5

27,000.00

26,754.55

(245.45)

$16,125.02

600,000.00

$616,125.02

1/1/20X6

27,000.00

26,743.90

(256.10)

$15,868.92

600,000.00

$615,868.92

11 12

7/1/20X6

27,000.00

26,732.78

(267.22)

$15,601.70

600,000.00

$615,601.70

1/1/20X7

27,000.00

26,721.18

(278.82)

$15,322.88

600,000.00

$615,322.88

7/1/20X7

27,000.00

26,709.08

(290.92)

$15,031.96

600,000.00

$615,031.96

1/1/20X8

27,000.00

26,696.45

(303.55)

$14,728.41

600,000.00

$614,728.41

7/1/20X8

27,000.00

26,683.28

(316.72)

$14,411.69

600,000.00

$614,411.69

16 17

1/1/20X9

27,000.00

26,669.53

(330.47)

$14,081.22

600,000.00

$614,081.22

7/1/20X9

27,000.00

26,655.18

(344.82)

$13,736.40

600,000.00

$613,736.40

1/1/20X10

27,000.00

26,640.22

(359.78)

$13,376.62

600,000.00

$613,376.62

19 20

7/1/20X10

27,000.00

26,624.60

(375.40)

$13,001.22

600,000.00

$613,001.22

1/1/20X11

27,000.00

26,608.31

(391.69)

$12,609.52

600,000.00

$612,609.52

7/1/20X11

27,000.00

26,591.30

(408.70)

$12,200.83

600,000.00

$612,200.83

22 23

1/1/20X12

27,000.00

26,573.56

(426.44)

$11,774.39

600,000.00

$611,774.39

7/1/20X12

27,000.00

26,555.05

(444.95)

$11,329.44

600,000.00

$611,329.44

1/1/20X13

27,000.00

26,535.74

(464.26)

$10,865.18

600,000.00

$610,865.18

25 26

7/1/20X13

27,000.00

26,515.59

(484.41)

$10,380.77

600,000.00

$610,380.77

1/1/20X14

27,000.00

26,494.56

(505.44)

$9,875.33

600,000.00

$609,875.33

7/1/20X14

27,000.00

26,472.62

(527.38)

$9,347.95

600,000.00

$609,347.95

28 29

1/1/20X15

27,000.00

26,449.73

(550.27)

$8,797.68

600,000.00

$608,797.68

7/1/20X15

27,000.00

26,425.84

(574.16)

$8,223.52

600,000.00

$608,223.52

1/1/20X16

27,000.00

26,400.92

(599.08)

$7,624.44

600,000.00

$607,624.44

31 32

7/1/20X16

27,000.00

26,374.92

(625.08)

$6,999.36

600,000.00

$606,999.36

1/1/20X17

27,000.00

26,347.78

(652.22)

$6,347.15

600,000.00

$606,347.15

7/1/20X17

27,000.00

26,319.47

(680.53)

$5,666.62

600,000.00

$605,666.62

34 35

1/1/20X18

27,000.00

26,289.93

(710.07)

$4,956.55

600,000.00

$604,956.55

7/1/20X18

27,000.00

26,259.11

(740.89)

$4,215.67

600,000.00

$604,215.67

1/1/20X19

27,000.00

26,226.95

(773.05)

$3,442.62

600,000.00

$603,442.62

37 38

7/1/20X19

27,000.00

26,193.40

(806.60)

$2,636.02

600,000.00

$602,636.02

1/1/20X20

27,000.00

26,158.39

(841.61)

$1,794.41

600,000.00

$601,794.41

7/1/20X20

27,000.00

26,121.86

(878.14)

$916.26

600,000.00

$600,916.26

1/1/20X21

27,000.00

26,083.74

(916.26)

$0.00

600,000.00

$600,000.00

1,080,000.00 1,062,000.00

(18,000.00)

8.681%

Chapter 08 – Intercompany Indebtedness

Face Value of Bonds 400,000.00 Stated rate =

Interest PMT

PMT #

Interest Income

Amort of Discount (Premium)

1/1/20X5

Premium (Discount)

Bonds Payable

BV of Bonds

($3,200.00) 400,000.00

$396,800.00

1 2

7/1/20X5

18,000.00

18,046.19

46.19

($3,153.81) 400,000.00

$396,846.19

1/1/20X6

18,000.00

18,048.30

48.30

($3,105.51) 400,000.00

$396,894.49

Annual

7/1/20X6

18,000.00

18,050.49

50.49

($3,055.02) 400,000.00

$396,944.98

Years =

1/1/20X7

18,000.00

18,052.79

52.79

($3,002.23) 400,000.00

$396,997.77

16 Mkt Rate =

7/1/20X7

18,000.00

18,055.19

55.19

($2,947.04) 400,000.00

$397,052.96

6 7

1/1/20X8

18,000.00

18,057.70

57.70

($2,889.34) 400,000.00

$397,110.66

7/1/20X8

18,000.00

18,060.32

60.32

($2,829.02) 400,000.00

$397,170.98

1/1/20X9

18,000.00

18,063.07

63.07

($2,765.95) 400,000.00

$397,234.05

7/1/20X9

18,000.00

18,065.94

65.94

($2,700.02) 400,000.00

$397,299.98

1/1/20X10

18,000.00

18,068.93

68.93

($2,631.08) 400,000.00

$397,368.92

11 12

7/1/20X10

18,000.00

18,072.07

72.07

($2,559.01) 400,000.00

$397,440.99

1/1/20X11

18,000.00

18,075.35

75.35

($2,483.67) 400,000.00

$397,516.33

7/1/20X11

18,000.00

18,078.77

78.77

($2,404.89) 400,000.00

$397,595.11

1/1/20X12

18,000.00

18,082.36

82.36

($2,322.54) 400,000.00

$397,677.46

7/1/20X12

18,000.00

18,086.10

86.10

($2,236.44) 400,000.00

$397,763.56

16 17

1/1/20X13

18,000.00

18,090.02

90.02

($2,146.42) 400,000.00

$397,853.58

7/1/20X13

18,000.00

18,094.11

94.11

($2,052.31) 400,000.00

$397,947.69

1/1/20X14

18,000.00

18,098.39

98.39

($1,953.92) 400,000.00

$398,046.08

19 20

7/1/20X14

18,000.00

18,102.87

102.87

($1,851.05) 400,000.00

$398,148.95

1/1/20X15

18,000.00

18,107.54

107.54

($1,743.51) 400,000.00

$398,256.49

7/1/20X15

18,000.00

18,112.43

112.43

($1,631.07) 400,000.00

$398,368.93

1/1/20X16

18,000.00

18,117.55

117.55

($1,513.53) 400,000.00

$398,486.47

23 24

7/1/20X16

18,000.00

18,122.89

122.89

($1,390.63) 400,000.00

$398,609.37

1/1/20X17

18,000.00

18,128.48

128.48

($1,262.15) 400,000.00

$398,737.85

7/1/20X17

18,000.00

18,134.33

134.33

($1,127.82) 400,000.00

$398,872.18

1/1/20X18

18,000.00

18,140.44

140.44

($987.38) 400,000.00

$399,012.62

27 28

7/1/20X18

18,000.00

18,146.82

146.82

($840.56) 400,000.00

$399,159.44

1/1/20X19

18,000.00

18,153.50

153.50

($687.06) 400,000.00

$399,312.94

7/1/20X19

18,000.00

18,160.48

160.48

($526.58) 400,000.00

$399,473.42

1/1/20X20

18,000.00

18,167.78

167.78

($358.80) 400,000.00

$399,641.20

7/1/20X20

18,000.00

18,175.41

175.41

($183.39) 400,000.00

$399,816.61

1/1/20X21

18,000.00

18,183.39

183.39

($0.00) 400,000.00

$400,000.00

576,000.00

579,200.00

3,200.00

9.096%

Chapter 08 – Intercompany Indebtedness

Consolidation entries, December 31, 20X5: Bonds Payable 400,000 Premium on Bonds Payable 10,579 Interest Income 36,094 Investment in Suspect Company Bonds Interest Expense Gain on Bond Retirement $10,579 = [($615,869 x 2/3) - $400,000] $36,094 = $18,000 + $46.19 + $18,000 + $48.30 $396,894 = $396,800 + $46.19 + $48.30 $35,666 = [($27,000 - $245) +($27,000 - $256)] x 2/3 $14,114* = $10,914 + $400,000 - $396,800 *Rounded down to balance transaction Interest Payable Interest Receivable

396,894 35,666 14,113*

18,000 18,000

The basic entry (not shown) would be adjusted by 13,705 (35,666+14,11336,094=13,705) to complete the elimination process. b.

Consolidation entries, December 31, 20X6: Bonds Payable Premium on Bonds Payable Interest Income Investment in Suspect Company Bonds Interest Expense Investment in Suspect Co. NCI in NA of Suspect Co.

400,000 10,215 36,103

Interest Payable Interest Receivable

18,000

396,998 35,636 8,211 5,474 18,000

The basic entry (not shown) would be adjusted by 467 to complete the elimination process. Gain Amortization: $94.49 + $334.02 = $428.31 $10,215 = $15,322.88 x 2/3 $36,103 = $18,050.49 + $18,052.79 $396,998 = $396,800 + $46.19 + $48.30 + $50.49 + $52.79 $8,211 = ($14,113 - $428.31) x 0.6 $5,474 = ($14,113 - $428.31) x 0.4 (rounding difference = $1)

Chapter 08 – Intercompany Indebtedness

E8-9 Retirement of Bonds Sold at a Discount

Face Value of Bonds 1,000,000.00 Stated rate = 7%

Interest PMT

PMT # 1 2

1/1/20X1 7/1/20X1

Interest Expense

Amort of Discount (Premium)

Premium (Discount)

Bonds Payable

BV of Bonds

($30,000.00) 1,000,000.00

$970,000.00

35,000.00

35,343.19

343.19

($29,656.81) 1,000,000.00

$970,343.19

35,000.00

35,355.69

355.69

($29,301.12) 1,000,000.00

$970,698.88

Annual

1/1/20X2 7/1/20X2

35,000.00

35,368.65

368.65

($28,932.46) 1,000,000.00

$971,067.54

Years =

1/1/20X3

35,000.00

35,382.09

382.09

($28,550.37) 1,000,000.00

$971,449.63

7/1/20X3

35,000.00

35,396.01

396.01

($28,154.37) 1,000,000.00

$971,845.63

6 7

1/1/20X4

35,000.00

35,410.44

410.44

($27,743.93) 1,000,000.00

$972,256.07

7.287%

7/1/20X4

35,000.00

35,425.39

425.39

($27,318.54) 1,000,000.00

$972,681.46

1/1/20X5

35,000.00

35,440.89

440.89

($26,877.64) 1,000,000.00

$973,122.36

Mkt Rate =

7/1/20X5

35,000.00

35,456.96

456.96

($26,420.69) 1,000,000.00

$973,579.31

1/1/20X6

35,000.00

35,473.61

473.61

($25,947.08) 1,000,000.00

$974,052.92

11 12

7/1/20X6

35,000.00

35,490.86

490.86

($25,456.22) 1,000,000.00

$974,543.78

1/1/20X7

35,000.00

35,508.75

508.75

($24,947.47) 1,000,000.00

$975,052.53

7/1/20X7

35,000.00

35,527.29

527.29

($24,420.18) 1,000,000.00

$975,579.82

1/1/20X8

35,000.00

35,546.50

546.50

($23,873.69) 1,000,000.00

$976,126.31

7/1/20X8

35,000.00

35,566.41

566.41

($23,307.28) 1,000,000.00

$976,692.72

16 17

1/1/20X9

35,000.00

35,587.05

587.05

($22,720.23) 1,000,000.00

$977,279.77

7/1/20X9

35,000.00

35,608.44

608.44

($22,111.79) 1,000,000.00

$977,888.21

1/1/20X10

35,000.00

35,630.61

630.61

($21,481.18) 1,000,000.00

$978,518.82

19 20

7/1/20X10

35,000.00

35,653.58

653.58

($20,827.60) 1,000,000.00

$979,172.40

1/1/20X11

35,000.00

35,677.40

677.40

($20,150.20) 1,000,000.00

$979,849.80

7/1/20X11

35,000.00

35,702.08

702.08

($19,448.12) 1,000,000.00

$980,551.88

22 23

1/1/20X12

35,000.00

35,727.66

727.66

($18,720.46) 1,000,000.00

$981,279.54

7/1/20X12

35,000.00

35,754.17

754.17

($17,966.29) 1,000,000.00

$982,033.71

1/1/20X13

35,000.00

35,781.65

781.65

($17,184.63) 1,000,000.00

$982,815.37

25 26

7/1/20X13

35,000.00

35,810.13

810.13

($16,374.50) 1,000,000.00

$983,625.50

1/1/20X14

35,000.00

35,839.65

839.65

($15,534.85) 1,000,000.00

$984,465.15

7/1/20X14

35,000.00

35,870.25

870.25

($14,664.60) 1,000,000.00

$985,335.40

28 29

1/1/20X15

35,000.00

35,901.95

901.95

($13,762.65) 1,000,000.00

$986,237.35

7/1/20X15

35,000.00

35,934.82

934.82

($12,827.83) 1,000,000.00

$987,172.17

1/1/20X16

35,000.00

35,968.88

968.88

($11,858.95) 1,000,000.00

$988,141.05

31 32

7/1/20X16

35,000.00

36,004.18

1,004.18

($10,854.77) 1,000,000.00

$989,145.23

1/1/20X17

35,000.00

36,040.77

1,040.77

($9,814.00) 1,000,000.00

$990,186.00

7/1/20X17

35,000.00

36,078.69

1,078.69

($8,735.30) 1,000,000.00

$991,264.70

34 35

1/1/20X18

35,000.00

36,118.00

1,118.00

($7,617.31) 1,000,000.00

$992,382.69

7/1/20X18

35,000.00

36,158.73

1,158.73

($6,458.58) 1,000,000.00

$993,541.42

1/1/20X19

35,000.00

36,200.95

1,200.95

($5,257.62) 1,000,000.00

$994,742.38

37 38

7/1/20X19

35,000.00

36,244.71

1,244.71

($4,012.92) 1,000,000.00

$995,987.08

1/1/20X20

35,000.00

36,290.06

1,290.06

($2,722.85) 1,000,000.00

$997,277.15

7/1/20X20

35,000.00

36,337.07

1,337.07

($1,385.79) 1,000,000.00

$998,614.21

1/1/20X21

35,000.00

36,385.79

1,385.79

1,400,000.00 1,430,000.00

30,000.00

$0.00

1,000,000.00 $1,000,000.00

Chapter 08 – Intercompany Indebtedness

Face Value of Bonds 300,000.00 Stated rate = 7%

Interest PMT

PMT #

Interest Income

Amort of Discount (Premium)

1/1/20X8 1 2

Premium (Discount)

Bonds Payable

BV of Bonds

($3,120.00)

300,000.00

$296,880.00

7/1/20X8

10,500.00

10,574.87

74.87

($3,045.13)

300,000.00

$296,954.87

1/1/20X9

10,500.00

10,577.54

77.54

($2,967.59)

300,000.00

$297,032.41

Annual

7/1/20X9

10,500.00

10,580.30

80.30

($2,887.29)

300,000.00

$297,112.71

Years =

1/1/20X10

10,500.00

10,583.16

83.16

($2,804.13)

300,000.00

$297,195.87

7/1/20X10

10,500.00

10,586.12

86.12

($2,718.01)

300,000.00

$297,281.99

6 7

1/1/20X11

10,500.00

10,589.19

89.19

($2,628.82)

300,000.00

$297,371.18

7.124%

7/1/20X11

10,500.00

10,592.37

92.37

($2,536.45)

300,000.00

$297,463.55

1/1/20X12

10,500.00

10,595.66

95.66

($2,440.79)

300,000.00

$297,559.21

Mkt Rate =

7/1/20X12

10,500.00

10,599.06

99.06

($2,341.73)

300,000.00

$297,658.27

1/1/20X13

10,500.00

10,602.59

102.59

($2,239.14)

300,000.00

$297,760.86

11 12

7/1/20X13

10,500.00

10,606.25

106.25

($2,132.89)

300,000.00

$297,867.11

1/1/20X14

10,500.00

10,610.03

110.03

($2,022.86)

300,000.00

$297,977.14

7/1/20X14

10,500.00

10,613.95

113.95

($1,908.90)

300,000.00

$298,091.10

1/1/20X15

10,500.00

10,618.01

118.01

($1,790.89)

300,000.00

$298,209.11

7/1/20X15

10,500.00

10,622.21

122.21

($1,668.68)

300,000.00

$298,331.32

16 17

1/1/20X16

10,500.00

10,626.57

126.57

($1,542.11)

300,000.00

$298,457.89

7/1/20X16

10,500.00

10,631.08

131.08

($1,411.04)

300,000.00

$298,588.96

1/1/20X17

10,500.00

10,635.74

135.74

($1,275.29)

300,000.00

$298,724.71

19 20

7/1/20X17

10,500.00

10,640.58

140.58

($1,134.71)

300,000.00

$298,865.29

1/1/20X18

10,500.00

10,645.59

145.59

($989.13)

300,000.00

$299,010.87

7/1/20X18

10,500.00

10,650.77

150.77

($838.35)

300,000.00

$299,161.65

1/1/20X19

10,500.00

10,656.14

156.14

($682.21)

300,000.00

$299,317.79

23 24

7/1/20X19

10,500.00

10,661.71

161.71

($520.50)

300,000.00

$299,479.50

1/1/20X20

10,500.00

10,667.47

167.47

($353.04)

300,000.00

$299,646.96

7/1/20X20

10,500.00

10,673.43

173.43

($179.61)

300,000.00

$299,820.39

1/1/20X21

10,500.00

10,679.61

179.61

($0.00)

300,000.00

$300,000.00

273,000.00

276,120.00

3,120.00

Chapter 08 – Intercompany Indebtedness

Elimination of bond investment at December 31, 20X8: Bonds Payable Interest Income Loss on Constructive Bond Retirement Investment in Packed Corporation Bonds Interest Expense Discount on Bonds Payable

300,000 21,152 4,042 297,032 21,346 6,816

The basic entry (not shown) would be adjusted by 3,848 (21,152+4,04221,346=3,848) to complete the elimination process.

Eliminate intercompany bond holdings: $21,152 = $10,574.87 + $10,577.54 $4,042 = $296,880 - $292,838 (computed below) $297,032 = $296,880 + $74.87 + $ 77.54 $21,346 = $71,153 x (3/10) $6,816 = $22,720.23 x (3/10) Computation of book value of liability at constructive retirement Sale price of bonds ($300,000 x 0.97) Amortization of discount ($30,000 - $23,874) x 3/10 Book value of liability at January 1,20X8

$291,000 1,838 $292,838

Chapter 08 – Intercompany Indebtedness

E8-10 Loss on Constructive Retirement Face Value of Bonds 500,000.00 Stated rate = 10%

Interest $ PMT

Interest Expense

Amort of Discount (Premium)

1/1/20X2 7/1/20X2

25,000.00

26,379.50

1,379.50

PMT # 1 2

Bonds Payable

BV of Bonds

($50,000.00)

500,000.00

$450,000.00

($48,620.50)

500,000.00

$451,379.50

Premium (Discount)

1/1/20X3

25,000.00

26,460.37

1,460.37

($47,160.13)

500,000.00

$452,839.87

Annual

7/1/20X3

25,000.00

26,545.98

1,545.98

($45,614.15)

500,000.00

$454,385.85

Years =

1/1/20X4

25,000.00

26,636.61

1,636.61

($43,977.54)

500,000.00

$456,022.46

7/1/20X4

25,000.00

26,732.55

1,732.55

($42,245.00)

500,000.00

$457,755.00

1/1/20X5

25,000.00

26,834.11

1,834.11

($40,410.89)

500,000.00

$459,589.11

11.724%

6 7

7/1/20X5

25,000.00

26,941.63

1,941.63

($38,469.26)

500,000.00

$461,530.74

1/1/20X6

25,000.00

27,055.45

2,055.45

($36,413.81)

500,000.00

$463,586.19

7/1/20X6

25,000.00

27,175.94

2,175.94

($34,237.87)

500,000.00

$465,762.13

1/1/20X7

25,000.00

27,303.50

2,303.50

($31,934.38)

500,000.00

$468,065.62

11 12

7/1/20X7

25,000.00

27,438.53

2,438.53

($29,495.85)

500,000.00

$470,504.15

1/1/20X8

25,000.00

27,581.48

2,581.48

($26,914.37)

500,000.00

$473,085.63

7/1/20X8

25,000.00

27,732.81

2,732.81

($24,181.56)

500,000.00

$475,818.44

1/1/20X9

25,000.00

27,893.01

2,893.01

($21,288.55)

500,000.00

$478,711.45

7/1/20X9

25,000.00

28,062.60

3,062.60

($18,225.95)

500,000.00

$481,774.05

16 17

1/1/20X10

25,000.00

28,242.13

3,242.13

($14,983.82)

500,000.00

$485,016.18

7/1/20X10

25,000.00

28,432.19

3,432.19

($11,551.63)

500,000.00

$488,448.37

1/1/20X11

25,000.00

28,633.39

3,633.39

($7,918.24)

500,000.00

$492,081.76

19 20

7/1/20X11

25,000.00

28,846.38

3,846.38

($4,071.86)

500,000.00

$495,928.14

1/1/20X12

25,000.00

29,071.86

4,071.86

($0.00)

500,000.00

$500,000.00

500,000.00

550,000.00

50,000.00

Interest $ PMT

Interest Income

Amort of Discount (Premium)

Bonds Payable

BV of Bonds

$6,000.00

100,000.00

$106,000.00

Mkt Rate =

Face Value of Bonds 100,000.00 Stated rate = 10% Annual Years =

PMT # 1/1/20X8

Premium (Discount)

1 2

7/1/20X8

5,000.00

4,351.26

(648.74)

$5,351.26

100,000.00

$105,351.26

1/1/20X9

5,000.00

4,324.63

(675.37)

$4,675.90

100,000.00

$104,675.90

7/1/20X9

5,000.00

4,296.91

(703.09)

$3,972.81

100,000.00

$103,972.81

1/1/20X10

5,000.00

4,268.05

(731.95)

$3,240.86

100,000.00

$103,240.86

7/1/20X10

5,000.00

4,238.00

(762.00)

$2,478.86

100,000.00

$102,478.86

1/1/20X11

5,000.00

4,206.72

(793.28)

$1,685.58

100,000.00

$101,685.58

8.210%

6 7

7/1/20X11

5,000.00

4,174.16

(825.84)

$859.74

100,000.00

$100,859.74

1/1/20X12

5,000.00

4,140.26

(859.74)

($0.00)

100,000.00

$100,000.00

40,000.00

34,000.00

(6,000.00)

Mkt Rate =

Chapter 08 – Intercompany Indebtedness

E8-10 (continued) Consolidation entries, December 31, 20X8: Bonds Payable Interest Income Loss on Bond Retirement Investment in Par Corporation Bonds Discount on Bonds Payable Interest Expense

100,000 8,676 11,383 104,676 4,258 11,125

Interest Payable 5,000 Interest Receivable 5,000 The basic entry (not shown) would be adjusted by 8,934 (8,676+11,38311,125=8,676) to complete the elimination process.

Chapter 08 – Intercompany Indebtedness

E8-11 Determining the Amount of Retirement Gain or Loss Face Value of Bonds 200,000.00 Stated rate = 12%

Interest $ PMT

PMT # 1 2

1/1/20X1 7/1/20X1

Interest Expense

Amort of Discount (Premium)

Premium (Discount)

Bonds Payable

BV of Bonds

$30,000.00

200,000.00

$230,000.00

12,000.00

9,517.21

(2,482.79)

$27,517.21

200,000.00

$227,517.21

9,414.47

(2,585.53)

$24,931.68

200,000.00

$224,931.68

1/1/20X2 7/1/20X2

12,000.00

Annual

12,000.00

9,307.49

(2,692.51)

$22,239.17

200,000.00

$222,239.17

Years =

1/1/20X3

12,000.00

9,196.07

(2,803.93)

$19,435.24

200,000.00

$219,435.24

7/1/20X3

12,000.00

9,080.05

(2,919.95)

$16,515.29

200,000.00

$216,515.29

1/1/20X4

12,000.00

8,959.22

(3,040.78)

$13,474.51

200,000.00

$213,474.51

8.276%

6 7

7/1/20X4

12,000.00

8,833.40

(3,166.60)

$10,307.91

200,000.00

$210,307.91

1/1/20X5

12,000.00

8,702.37

(3,297.63)

$7,010.27

200,000.00

$207,010.27

7/1/20X5

12,000.00

8,565.91

(3,434.09)

$3,576.19

200,000.00

$203,576.19

1/1/20X6

$0.00

200,000.00

$200,000.00

Bonds Payable

BV of Bonds

$0.00

100,000.00

$100,000.00

Mkt Rate =

Face Value of Bonds 100,000.00 Stated rate =

PMT #

12,000.00

8,423.81

(3,576.19)

120,000.00

90,000.00

(30,000.00)

Interest $ PMT

Interest Income

Amort of Discount (Premium)

7/1/20X3

Premium (Discount)

1 2

1/1/20X4

6,000.00

(0.00)

$0.00

100,000.00

$100,000.00

7/1/20X4

6,000.00

(0.00)

$0.00

100,000.00

$100,000.00

Annual

1/1/20X5

6,000.00

(0.00)

$0.00

100,000.00

$100,000.00

Years =

7/1/20X5

6,000.00

(0.00)

$0.00

100,000.00

$100,000.00

2.5 Mkt Rate =

1/1/20X6

6,000.00

(0.00)

($0.00)

100,000.00

$100,000.00

30,000.00

(0.00)

12%

12.000%

Chapter 08 – Intercompany Indebtedness

E8-11 (continued) a. Par value of bonds outstanding Annual interest rate Interest payment Amortization of bond premium ($2,920 + $3,041) Interest charge for full year Less: Interest on bond purchased by Pepper Enterprises ($8,959 x 1/2) Interest expense included in consolidated income statement

$200,000 x 0.12 $ 24,000

Sale price of bonds, January 1, 20X1 Amortization of premium (2 ½ years) Book value at time of purchase Purchase price Gain on bond retirement

$115,000 (6,742) $108,258 (100,000) $ 8,258

Consolidation entries, December 31, 20X3: Bonds Payable Bond Premium Interest Income Investment in Salt Bonds Interest Expense Gain on Bond Retirement

(5,961) $ 18,039 (4,480) $ 13,560

100,000 6,737 6,000

Interest Payable 6,000 Interest Receivable The basic entry (not shown) would be adjusted by 6,737 (4,479+8,2586,000=6,737) to complete the elimination process.

100,000 4,479 * 8,258 6,000

* $1 rounding difference between calculations in part a and entry in part c

Chapter 08 – Intercompany Indebtedness

E8-12 Evaluation of Bond Retirement Face Value of Bonds 500,000.00 Stated rate =

PMT #

Interest $ PMT

Interest Expense

Amort of Discount (Premium)

1/1/20X3

Premium (Discount)

Bonds Payable

BV of Bonds

$20,000.00

500,000.00

$520,000.00

1 2

7/1/20X3

27,500.00

26,906.20

(593.80)

$19,406.20

500,000.00

$519,406.20

1/1/20X4

27,500.00

26,875.48

(624.52)

$18,781.68

500,000.00

$518,781.68

Annual

7/1/20X4

27,500.00

26,843.16

(656.84)

$18,124.85

500,000.00

$518,124.85

Years =

1/1/20X5

27,500.00

26,809.18

(690.82)

$17,434.02

500,000.00

$517,434.02

7/1/20X5

27,500.00

26,773.43

(726.57)

$16,707.46

500,000.00

$516,707.46

1/1/20X6

27,500.00

26,735.84

(764.16)

$15,943.29

500,000.00

$515,943.29

10.349%

6 7

7/1/20X6

27,500.00

26,696.30

(803.70)

$15,139.59

500,000.00

$515,139.59

1/1/20X7

27,500.00

26,654.71

(845.29)

$14,294.31

500,000.00

$514,294.31

7/1/20X7

27,500.00

26,610.98

(889.02)

$13,405.28

500,000.00

$513,405.28

1/1/20X8

27,500.00

26,564.97

(935.03)

$12,470.25

500,000.00

$512,470.25

11 12

7/1/20X8

27,500.00

26,516.59

(983.41)

$11,486.85

500,000.00

$511,486.85

1/1/20X9

27,500.00

26,465.71

(1,034.29)

$10,452.56

500,000.00

$510,452.56

7/1/20X9

27,500.00

26,412.19

(1,087.81)

$9,364.75

500,000.00

$509,364.75

1/1/20X10

27,500.00

26,355.91

(1,144.09)

$8,220.66

500,000.00

$508,220.66

7/1/20X10

27,500.00

26,296.71

(1,203.29)

$7,017.37

500,000.00

$507,017.37

16 17

1/1/20X11

27,500.00

26,234.45

(1,265.55)

$5,751.81

500,000.00

$505,751.81

7/1/20X11

27,500.00

26,168.96

(1,331.04)

$4,420.78

500,000.00

$504,420.78

1/1/20X12

27,500.00

26,100.09

(1,399.91)

$3,020.87

500,000.00

$503,020.87

19 20

7/1/20X12

27,500.00

26,027.66

(1,472.34)

$1,548.53

500,000.00

$501,548.53

1/1/20X13

27,500.00

25,951.47

(1,548.53)

$0.00

500,000.00

$500,000.00

550,000.00

530,000.00

(20,000.00)

Interest $ PMT

Interest Income

Amort of Discount (Premium)

Bonds Payable

BV of Bonds

($7,800.00)

200,000.00

$192,200.00

11%

Mkt Rate =

Face Value of Bonds 200,000.00 Stated rate =

PMT # 7/1/20X6

Premium (Discount)

1 2

1/1/20X7

11,000.00

11,414.71

414.71

($7,385.29)

200,000.00

$192,614.71

7/1/20X7

11,000.00

11,439.34

439.34

($6,945.95)

200,000.00

$193,054.05

Annual

1/1/20X8

11,000.00

11,465.43

465.43

($6,480.52)

200,000.00

$193,519.48

Years =

7/1/20X8

11,000.00

11,493.07

493.07

($5,987.44)

200,000.00

$194,012.56

6.5 Mkt Rate =

1/1/20X9

11,000.00

11,522.36

522.36

($5,465.08)

200,000.00

$194,534.92

6 7

7/1/20X9

11,000.00

11,553.38

553.38

($4,911.70)

200,000.00

$195,088.30

11%

11.878%

1/1/20X10

11,000.00

11,586.25

586.25

($4,325.46)

200,000.00

$195,674.54

8 9

7/1/20X10

11,000.00

11,621.06

621.06

($3,704.40)

200,000.00

$196,295.60

1/1/20X11

11,000.00

11,657.95

657.95

($3,046.45)

200,000.00

$196,953.55

7/1/20X11

11,000.00

11,697.02

697.02

($2,349.42)

200,000.00

$197,650.58

1/1/20X12

11,000.00

11,738.42

738.42

($1,611.01)

200,000.00

$198,388.99

7/1/20X12

11,000.00

11,782.27

782.27

($828.73)

200,000.00

$199,171.27

1/1/20X13

11,000.00

11,828.73

828.73

$0.00

200,000.00

$200,000.00

143,000.00

150,800.00

7,800.00

Chapter 08 – Intercompany Indebtedness

No gain or loss will be reported by Sibling.

A gain of $13,856 will be reported: Book value of liability reported by Sibling: Par value of bonds outstanding Unamortized premium $15,140 x (2/5) Book value of debt Amount paid by Parent Gain on bond retirement

$200,000 6,056 $206,056 (192,200) $ 13,856

Consolidated net income for 20X6 will increase by $13,103: Gain on bond retirement Adjustment for excess of interest income over interest expense: Interest income Interest expense

$ 13,856 $(11,415) (753) 10,662

Increase in consolidated net income

$ 13,103

Chapter 08 – Intercompany Indebtedness

E8-12 (continued) d.

200,000 5,718 11,415 192,615 10,662 13,856

Interest Payable Interest Receivable Eliminate intercompany receivable/payable.

11,000 11,000

The basic entry (not shown) would be adjusted by 13,103 (10,662+13,85611,415=13,103) to complete the elimination process. e.

Consolidation entries, December 31, 20X7: Bonds Payable Premium on Bonds Payable Interest Income Investment in Sibling Company Bonds Interest Expense Investment in Sibling Co. NCI in NA of Sibling Co. Eliminate intercompany bond holdings: $9,173* = ($13,856 – 338 – 415) x 0.70 $3,931 = ($13,856 – 338 – 415) x 0.30 *Rounded up to balance entry

200,000 4,988 22,905 193,519 21,270 9,173 3,931

Interest Payable 11,000 Interest Receivable 11,000 Eliminate intercompany receivable/payable. The basic entry (not shown) would be adjusted by 1,635 (22,905-21,270=1,635) to complete the elimination process. f.

Income assigned to noncontrolling interest in 20X7 is $14,510: Net income reported by Sibling Adjustment for excess of interest income over interest expense: Interest income Interest expense Realized net income Proportion of ownership held Income assigned to noncontrolling interest

$ 50,000 $(22,905) 21,270

(1,635) $ 48,365 x .30 $ 14,510

Chapter 08 – Intercompany Indebtedness

E8-13 Elimination of Intercompany Bond Holdings Face Value of Bonds 400,000.00 Stated rate =

PMT #

Interest $ PMT

Interest Expense

Amort of Discount (Premium)

1/1/20X5

Premium (Discount)

Bonds Payable

BV of Bonds

$20,000.00

400,000.00

$420,000.00

1 2

7/1/20X5

24,000.00

23,431.22

(568.78)

$19,431.22

400,000.00

$419,431.22

1/1/20X6

24,000.00

23,399.49

(600.51)

$18,830.71

400,000.00

$418,830.71

Annual

7/1/20X6

24,000.00

23,365.99

(634.01)

$18,196.69

400,000.00

$418,196.69

Years =

1/1/20X7

24,000.00

23,330.61

(669.39)

$17,527.31

400,000.00

$417,527.31

7/1/20X7

24,000.00

23,293.27

(706.73)

$16,820.58

400,000.00

$416,820.58

1/1/20X8

24,000.00

23,253.84

(746.16)

$16,074.42

400,000.00

$416,074.42

11.158%

6 7

7/1/20X8

24,000.00

23,212.22

(787.78)

$15,286.63

400,000.00

$415,286.63

1/1/20X9

24,000.00

23,168.27

(831.73)

$14,454.90

400,000.00

$414,454.90

7/1/20X9

24,000.00

23,121.87

(878.13)

$13,576.77

400,000.00

$413,576.77

1/1/20X10

24,000.00

23,072.88

(927.12)

$12,649.64

400,000.00

$412,649.64

11 12

7/1/20X10

24,000.00

23,021.15

(978.85)

$11,670.79

400,000.00

$411,670.79

1/1/20X11

24,000.00

22,966.54

(1,033.46)

$10,637.34

400,000.00

$410,637.34

7/1/20X11

24,000.00

22,908.89

(1,091.11)

$9,546.23

400,000.00

$409,546.23

1/1/20X12

24,000.00

22,848.02

(1,151.98)

$8,394.24

400,000.00

$408,394.24

7/1/20X12

24,000.00

22,783.75

(1,216.25)

$7,177.99

400,000.00

$407,177.99

16 17

1/1/20X13

24,000.00

22,715.90

(1,284.10)

$5,893.89

400,000.00

$405,893.89

7/1/20X13

24,000.00

22,644.26

(1,355.74)

$4,538.15

400,000.00

$404,538.15

1/1/20X14

24,000.00

22,568.62

(1,431.38)

$3,106.77

400,000.00

$403,106.77

19 20

7/1/20X14

24,000.00

22,488.77

(1,511.23)

$1,595.54

400,000.00

$401,595.54

($0.00)

400,000.00

$400,000.00

Bonds Payable

BV of Bonds

$4,900.00

100,000.00

$104,900.00

12%

Mkt Rate =

Face Value of Bonds 100,000.00 Stated rate =

1/1/20X15

PMT #

24,000.00

22,404.46

(1,595.54)

480,000.00

460,000.00

(20,000.00)

Interest $ PMT

Interest Income

Amort of Discount (Premium)

1/1/20X8

Premium (Discount)

1 2

7/1/20X8

6,000.00

5,758.35

(241.65)

$4,658.35

100,000.00

$104,658.35

1/1/20X9

6,000.00

5,745.09

(254.91)

$4,403.44

100,000.00

$104,403.44

Annual

7/1/20X9

6,000.00

5,731.10

(268.90)

$4,134.54

100,000.00

$104,134.54

Years =

1/1/20X10

6,000.00

5,716.33

(283.67)

$3,850.87

100,000.00

$103,850.87

7/1/20X10

6,000.00

5,700.76

(299.24)

$3,551.63

100,000.00

$103,551.63

1/1/20X11

6,000.00

5,684.34

(315.66)

$3,235.97

100,000.00

$103,235.97

10.979%

6 7

7/1/20X11

6,000.00

5,667.01

(332.99)

$2,902.98

100,000.00

$102,902.98

8 9

1/1/20X12

6,000.00

5,648.73

(351.27)

$2,551.71

100,000.00

$102,551.71

7/1/20X12

6,000.00

5,629.45

(370.55)

$2,181.15

100,000.00

$102,181.15

1/1/20X13

6,000.00

5,609.11

(390.89)

$1,790.26

100,000.00

$101,790.26

7/1/20X13

6,000.00

5,587.65

(412.35)

$1,377.91

100,000.00

$101,377.91

1/1/20X14

6,000.00

5,565.01

(434.99)

$942.92

100,000.00

$100,942.92

13 14

7/1/20X14

6,000.00

5,541.13

(458.87)

$484.05

100,000.00

$100,484.05

1/1/20X15

6,000.00

5,515.95

(484.05)

($0.00)

100,000.00

$100,000.00

84,000.00

79,100.00

(4,900.00)

12%

Mkt Rate =

Chapter 08 – Intercompany Indebtedness

100,000 3,614 11,503 881

Interest Payable Interest Receivable Eliminate intercompany receivable/payable.

6,000

104,403 11,595

6,000

The basic entry (not shown) would be adjusted by 789 (11,503+881-11,595=789) to complete the elimination process. b.

Income assigned to noncontrolling interest in 20X8 is $6,724: Net income reported by Stang Corporation Constructive loss on bond retirement Adjustment for excess of interest expense over interest income: Interest expense Interest income Realized net income Proportion of ownership held Income assigned to noncontrolling interest

$ 20,000 (881) $11,595 (11,503)

92 $ 19,211 x 0.35 $ 6,724

Consolidation entries, December 31, 20X9: Bonds Payable Premium on Bonds Payable Interest Income Investment in Stang Corp. NCI in NA of Stang Corp. Investment in Stang Corporation Bonds Interest Expense Eliminate intercompany bond holdings: $513 = ($881 - $497 + 405) x 0.65 $277* = ($881 - $497 + 405) x 0.35

100,000 3,162 11,447 513 277 103,851 11,548

*Rounded to balance the entry. Interest Payable Interest Receivable Eliminate intercompany receivable/payable.

6,000 6,000

The basic entry (not shown) would be adjusted by 412 (11,447+513-11,548=412) to complete the elimination process.

Chapter 08 – Intercompany Indebtedness

SOLUTIONS TO PROBLEMS P8-14 Consolidation Worksheet with Sale of Bonds to Subsidiary a.

Entries recorded by Porter on its investment in Service: Cash Investment in Service Corporation Record dividends from Service: $10,000 x 0.60

6,000

Investment in Service Corporation Income from Service Corporation Record equity-method income: $29,790 x 0.60

17,874 17,874

Entry recorded by Porter on its bonds payable: Interest Expense Bond Premium Cash

6,000

5,790 610 6,400

Entry recorded by Service on bond investment: Cash Interest Income Investment in Porter Company Bonds

6,400 5,790 610

Chapter 08 – Intercompany Indebtedness

P8-14 (continued) d. Book Value Calculations:

Beginning Book Value + Net Income - Dividends Ending Book Value

NCI 40% 59,932 11,916 (4,000) 67,848

Porter Co. 60% 89,898 17,874 (6,000) 101,772

Basic Consolidation Entry Common Stock Retained Earnings Income from Service Co. NCI in NI of Service Co. Dividends Declared Investment in Service Co. NCI in NA of Service Co.

Common Stock 100,000

100,000

Retained Earnings 49,830 29,790 (10,000) 69,620

100,000 49,830 17,874 11,916 10,000 101,772 67,848

Eliminate Intercompany Bond Holdings Bonds Payable Bond Premium Interest Income Investment in Porter Co. Bonds Interest Expense

80,000 2,100 5,790 82,100 5,790

Discount Example Face Value of Bonds

Interest $ PMT

PMT #

80,000.00 Stated rate = 8%

Interest Expense

Amort of Discount Premium (Premium) (Discount)

Bonds Payable

BV of Bonds

1/1/20X1 1 12/31/20X1

6,400.00

5,829.61

$3,280.16 (570.39) $2,709.77

80,000.00 80,000.00

$83,280.16 $82,709.77 End of Year 1

12/31/20X2

6,400.00

5,789.68

(610.32) $2,099.45

80,000.00

$82,099.45 End of Year 2

Annual

12/31/20X3

6,400.00

5,746.96

(653.04) $1,446.41

80,000.00

$81,446.41

Years =

12/31/20X4

6,400.00

5,701.25

(698.75)

$747.66

80,000.00

$80,747.66

12/31/20X5

6,400.00 32,000.00

5,652.34 28,719.84

(747.66) (3,280.16)

$0.00

80,000.00

$80,000.00

5 Mkt Rate = 7%

Chapter 08 – Intercompany Indebtedness

P8-14 (continued) e. Porter Co. Income Statement Sales Interest Income Less: COGS Less: Depreciation Expense Less: Interest Expenses Income from Service Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash and Accounts Receivable Inventory Buildings & Equipment Less: Accumulated Depreciation Investment in Porter Co.Bonds Investment in Service Co. Total Assets Accounts Payable Bonds Payable Bond Premium Common Stock Retained Earnings NCI in NA of Service Co. Total Liabilities & Equity

Service Co.

200,000

114,000 5,790 (61,000) (15,000) (14,000)

(99,800) (25,000) (5,790) 17,874 87,284

29,790

87,284

29,790

230,068 87,284 (40,000) 277,352

49,830 29,790 (10,000) 69,620

81,480 120,000 500,000 (175,000)

38,720 65,000 300,000 (75,000) 82,100

101,772 628,252

410,820

Consolidation Entries DR CR

5,790

314,000 0 (160,800) (40,000) (14,000) 0 99,200 (11,916) 87,284

5,790 10,000 15,790

230,068 87,284 (40,000) 277,352

82,100 101,772 183,872

120,200 185,000 800,000 (250,000) 0 0 855,200

15,790 67,848 83,638

110,000 200,000 0 200,000 277,352 67,848 855,200

5,790

5,790 17,874 23,664 11,916 35,580

49,830 35,580 85,410

68,800 80,000 2,100 200,000 277,352

41,200 200,000 100,000 69,620

80,000 2,100 100,000 85,410

628,252

410,820

267,510

Consolidated

5,790

Chapter 08 – Intercompany Indebtedness

P8-15 Consolidation Worksheet with Sale of Bonds to Parent a.

Entries recorded by Punk Corporation on its investment in Soul Company: Cash Investment in Soul Company Stock Record dividends from Soul: $20,000 x 0.90

18,000

Investment in Soul Company Stock Income from Soul Company Record equity-method income: $24,998 x 0.90

22,498

18,000

Entry recorded by Punk Corporation on its investment in Soul Company bonds: Cash Interest Income Investment in Soul Company Bonds

22,498

6,000 5,202 798

Entry recorded by Soul Company on its bonds payable: Interest Expense Bond Premium Cash

5,202 798 6,000

d. Book Value Calculations:

Beginning Book Value + Net Income - Dividends Ending Book Value

Basic Consolidation Entry Common Stock Retained Earnings Income from Soul Co. NCI in NI of Soul Co. Dividends Declared Investment in Soul Co. NCI in NA of Soul Co.

NCI 10% 12,988 2,500 (2,000) 13,488

Punk Corp. 90% 116,894 22,498 (18,000) 121,392

Common Stock 80,000

80,000

Retained Earnings 49,882 24,998 (20,000) 54,880

80,000 49,882 22,498 2,500 20,000 121,392 13,488

Chapter 08 – Intercompany Indebtedness

P8-15 (continued)

Discount Example Face Value of Bonds 100,000.00 Stated rate =

Interest $ PMT

PMT #

Interest Expense

Amort of Discount Premium (Premium) (Discount)

Bonds Payable

BV of Bonds

1/1/20X2 1 12/31/20X2

6,000.00

5,277.17

$4,000.00 (722.83) $3,277.17

100,000.00 $104,000.00 100,000.00 $103,277.17

12/31/20X3

6,000.00

5,240.50

(759.50) $2,517.67

100,000.00 $102,517.67

Annual

12/31/20X4

6,000.00

5,201.96

(798.04) $1,719.62

100,000.00 $101,719.62

Years =

12/31/20X5

6,000.00

5,161.46

(838.54)

$881.09

100,000.00 $100,881.09

5 Mkt Rate = 5.0742%

12/31/20X6

6,000.00 30,000.00

5,118.91 26,000.00

(881.09) (4,000.00)

$0.00

100,000.00 $100,000.00

Eliminate Intercompany Bond Holdings Bonds Payable Bond Premium Interest Income Investment in Soul Co.'s Bonds Interest Expense

100,000 1,720 5,202 101,720 5,202

Chapter 08 – Intercompany Indebtedness

P8-15 (continued) e. Consolidation Entries DR CR

Punk Corp.

Soul Co.

140,000 5,202 (86,000) (20,000) (16,000) 22,498 45,700

125,000 (79,800) (15,000) (5,202)

45,700

24,998

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

242,012 45,700 (30,000) 257,712

49,882 24,998 (20,000) 54,880

Balance Sheet Cash and Accounts Receivable Inventory Buildings & Equipment Less: Accumulated Depreciation Investment in Soul Co.Bonds Investment in Soul Co. Total Assets

22,000 165,000 400,000 (140,000) 101,720 121,392 670,112

36,600 75,000 240,000 (80,000)

271,600

92,400 200,000 120,000 257,712

35,000 100,000 1,720 80,000 54,880

100,000 1,720 80,000 80,082

670,112

271,600

261,802

Income Statement Sales Interest Income Less: COGS Less: Depreciation Expense Less: Interest Expenses Income from Soul Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Current Payables Bonds Payable Bond Premium Common Stock Retained Earnings NCI in NA of Soul Co. Total Liabilities & Equity

Consolidated 265,000

5,202

24,998

5,202

(165,800) (35,000) (16,000) 0 48,200 (2,500) 45,700

5,202 20,000 25,202

242,012 45,700 (30,000) 257,712

101,720 121,392 223,112

58,600 240,000 640,000 (220,000) 0 0 718,600

25,202 13,488 38,690

127,400 200,000 0 120,000 257,712 13,488 718,600

5,202 22,498 27,700 2,500 30,200

49,882 30,200 80,082

5,202

Chapter 08 – Intercompany Indebtedness

P8-16 Direct Sale of Bonds to Parent a.

Journal entries recorded by Prize Corporation:

January 1, 20X3 Cash Interest Receivable Receive interest on bond investment.

2,000 2,000

July 1, 20X3 Cash Investment in Statue Company Bonds Interest Income Record receipt of bond interest

2,000 186 2,186

December 31, 20X3 Cash 7,000 Investment in Statue Company Stock Record dividends for Statue: $7,000 = $10,000 x 0.70 Interest Receivable (Current Receivables) Investment in Statue Company Bonds Interest Income Accrue interest income at year-end.

7,000

2,000 195 2,195

Investment in Statue Company Stock 21,165 Income from Statue Company Record equity-method income: $21,165 = $30,236 x 0.70

21,165

Income from Statue Company 2,800 Investment in Statue Company Stock 2,800 Record amortization of differential: $2,800 = ($56,000 / 14 years) x 0.70 b.

Journal entries recorded by Statue Company: January 1, 20X3 Interest Payable 4,000 Cash Record interest payment: $4,000 = $100,000 x (.08 / 2) July 1, 20X3 Interest Expense Discount on Bonds Payable Cash Semiannual payment of interest December 31, 20X3 Interest Expense Discount on Bonds Payable Interest Payable (Current Liabilities) Accrue interest expense at year-end.

4,000

4,373 373 4,000

4,391 391 4,000

Chapter 08 – Intercompany Indebtedness

P8-16 (continued) c. Book Value Calculations:

Beginning Book Value + Net Income - Dividends Ending Book Value

NCI 30% 45,202 9,071 (3,000) 51,273

Prize Corp. 70% 105,470 21,165 (7,000) 119,635

Basic Consolidation Entry Common Stock Retained Earnings Income from Statue Co. NCI in NI of Statue Co. Dividends Declared Investment in Statue Co. Stock NCI in NA of Statue Co. Stock

Common Stock 50,000

50,000

Retained Earnings 100,672 30,236 (10,000) 120,908

50,000 100,672 21,165 9,071 10,000 119,635 51,273

Excess Value (Differential) Calculations: NCI Prize Corp. 30% + 70% Beg. balance 14,400 33,600 Changes (1,200) (2,800) Ending balance 13,200 30,800

Amortized Excess Value Reclassification Entry: Depreciation expense Income from Statue Co. NCI in NI of Statue Co.

Buildings and Equipment 56,000 56,000

Acc. Depr. (8,000) (4,000) (12,000)

4,000 2,800 1,200

Excess Value (Differential) Reclassification Entry: Buildings and Equipment 56,000 Accumulated Depreciation Investment in Statue Co. Stock NCI in NA of Statue Co. Stock

12,000 30,800 13,200

Remove Gain on Land: Investment in Statue Co. Stock NCI in NA of Statue Co. Stock Land

8,000

5,600 2,400

Chapter 08 – Intercompany Indebtedness

P8-16 (continued) Face Value of Bonds 50,000.00 Stated rate =

Interest $ PMT

PMT #

Interest Expense

Amort of Discount (Premium)

Premium (Discount)

1/1/20X1

Bonds Payable

BV of Bonds

($5,000.00)

50,000.00

$45,000.00

1 2

7/1/20X1

2,000.00

2,154.63

154.63

($4,845.37)

50,000.00

$45,154.63

1/1/20X2

2,000.00

2,162.04

162.04

($4,683.33)

50,000.00

$45,316.67

Annual

7/1/20X2

2,000.00

2,169.79

169.79

($4,513.54)

50,000.00

$45,486.46

Years =

1/1/20X3

2,000.00

2,177.92

177.92

($4,335.62)

50,000.00

$45,664.38

7/1/20X3

2,000.00

2,186.44

186.44

($4,149.17)

50,000.00

$45,850.83

1/1/20X4

2,000.00

2,195.37

195.37

($3,953.80)

50,000.00

$46,046.20

9.576%

6 7

7/1/20X4

2,000.00

2,204.72

204.72

($3,749.08)

50,000.00

$46,250.92

1/1/20X5

2,000.00

2,214.53

214.53

($3,534.55)

50,000.00

$46,465.45

7/1/20X5

2,000.00

2,224.80

224.80

($3,309.75)

50,000.00

$46,690.25

1/1/20X6

2,000.00

2,235.56

235.56

($3,074.19)

50,000.00

$46,925.81

11 12

7/1/20X6

2,000.00

2,246.84

246.84

($2,827.35)

50,000.00

$47,172.65

1/1/20X7

2,000.00

2,258.66

258.66

($2,568.69)

50,000.00

$47,431.31

7/1/20X7

2,000.00

2,271.04

271.04

($2,297.65)

50,000.00

$47,702.35

1/1/20X8

2,000.00

2,284.02

284.02

($2,013.63)

50,000.00

$47,986.37

7/1/20X8

2,000.00

2,297.62

297.62

($1,716.01)

50,000.00

$48,283.99

16 17

1/1/20X9

2,000.00

2,311.87

311.87

($1,404.13)

50,000.00

$48,595.87

7/1/20X9

2,000.00

2,326.80

326.80

($1,077.33)

50,000.00

$48,922.67

1/1/20X10

2,000.00

2,342.45

342.45

($734.88)

50,000.00

$49,265.12

19 20

7/1/20X10

2,000.00

2,358.85

358.85

($376.03)

50,000.00

$49,623.97

1/1/20X11

2,000.00

2,376.03

376.03

$0.00

50,000.00

$50,000.00

40,000.00

45,000.00

5,000.00

Mkt Rate =

Eliminate Intercompany Bond Holdings Bonds Payable Interest Income Investment in Statue Bonds Interest Expense Discount on BP

50,000 4,382 46,046 4,382 3,954

Interest Payable Interest Receivable

2,000 2,000

Chapter 08 – Intercompany Indebtedness

P8-16 (continued) d.

Income Statement Sales Interest income Less: Other Expenses Less: Interest Expense Income from Statue Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Prize Corp.

Statue Co.

300,000 4,382 (198,500) (27,000) 18,365 97,247

200,000 (161,000) (8,764)

Consolidation Entries DR CR

Consolidated

30,236

21,165 29,547 9,071

4,382 2,800 7,182 1,200

500,000 0 (363,500) (31,382) 0 105,118 (7,871)

97,247

30,236

38,618

8,382

97,247

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

238,934 97,247 (60,000) 276,181

100,672 30,236 (10,000) 120,908

100,672 38,618

8,382 10,000 18,382

238,934 97,247 (60,000) 276,181

Balance Sheet Cash & Current Receivables Inventory Land, Buildings, & Equipment (net)

30,300 170,000 320,000

46,000 70,000 180,000

Investment in Statue Co. Stock

144,835

Investment in Statue Co. Bonds Total Assets

46,046 711,181

Current Liabilities Bonds Payable Discount on Bonds Payable Common Stock Retained Earnings NCI in NA of Statue Co.

35,000 300,000

Total Liabilities & Equity

4,382 4,000

139,290

2,000 56,000 5,600

296,000

61,600 2,000 50,000

100,000 276,181

33,000 100,000 (7,908) 50,000 120,908

711,181

296,000

12,000 8,000 119,635 30,800 46,046 218,481

3,954 50,000 139,290 2,400 243,690

18,382 51,273 13,200 86,809

74,300 240,000 536,000 0 0 850,300 66,000 350,000 (3,954) 100,000 276,181 62,073 850,300

Chapter 08 – Intercompany Indebtedness

P8-17 Information Provided in Consolidation Entry a.

Playoff Corporation is the parent company. In the consolidation entry, noncontrolling interest is credited with a portion of the constructive gain on bond retirement.

Playoff holds 75 percent ownership of Series [$4,780 / ($4,780 + $1,594)].

Consolidated net income for 20X7 after adjustment for bond retirement: Amount reported without adjustment Adjustment for excess of interest income over interest expense: Interest income Income expense

$ 70,000 $(18,520) 17,121 (1,399) $ 68,601

Consolidated net income d.

Income assigned to the noncontrolling interest will decrease by $350 ($1,399 x 0.25) as a result of the consolidation entry.

Consolidation entry prepared at December 31, 20X8:

Face Value of Bonds 500,000.00 Stated rate =

Interest $ PMT

PMT #

Amort of Discount (Premium)

Interest Expense

1/1/20X1

Bonds Payable

BV of Bonds

$20,000.00

500,000.00

$520,000.00

Premium (Discount)

1 2

12/31/20X1

45,000.00

43,644.98

(1,355.02)

$18,644.98

500,000.00

$518,644.98

12/31/20X2

45,000.00

43,531.25

(1,468.75)

$17,176.23

500,000.00

$517,176.23

Annual

12/31/20X3

45,000.00

43,407.97

(1,592.03)

$15,584.20

500,000.00

$515,584.20

Years =

12/31/20X4

45,000.00

43,274.35

(1,725.65)

$13,858.55

500,000.00

$513,858.55

12/31/20X5

45,000.00

43,129.51

(1,870.49)

$11,988.06

500,000.00

$511,988.06

12/31/20X6

45,000.00

42,972.52

(2,027.48)

$9,960.58

500,000.00

$509,960.58

8.393%

6 7

12/31/20X7

45,000.00

42,802.34

(2,197.66)

$7,762.92

500,000.00

$507,762.92

12/31/20X8

45,000.00

42,617.89

(2,382.11)

$5,380.81

500,000.00

$505,380.81

12/31/20X9

45,000.00

42,417.95

(2,582.05)

$2,798.77

500,000.00

$502,798.77

10 12/31/20X10

45,000.00

42,201.23

(2,798.77)

$0.00

500,000.00

$500,000.00

450,000.00

430,000.00

(20,000.00)

Interest $ PMT

Interest Income

Amort of Discount (Premium)

Bonds Payable

BV of Bonds

($3,300.00)

200,000.00

$196,700.00

Mkt Rate =

Face Value of Bonds 200,000.00 Stated rate =

PMT # 01/1/20X5

Premium (Discount)

1 2

12/31/20X5

18,000.00

18,434.54

434.54

($2,865.46)

200,000.00

$197,134.54

12/31/20X6

18,000.00

18,475.26

475.26

($2,390.20)

200,000.00

$197,609.80

Annual

12/31/20X7

18,000.00

18,519.80

519.80

($1,870.40)

200,000.00

$198,129.60

Years =

12/31/20X8

18,000.00

18,568.52

568.52

($1,301.88)

200,000.00

$198,698.12

12/31/20X9

18,000.00

18,621.80

621.80

($680.08)

200,000.00

$199,319.92

6 12/31/20X10

18,000.00

18,680.08

680.08

$0.00

200,000.00

$200,000.00

108,000.00

111,300.00

3,300.00

6 Mkt Rate = 9.372%

Chapter 08 – Intercompany Indebtedness

P8-17 (continued)

Bonds Payable Premium on Bonds Payable Interest Income Investment in Series Corporation Bonds Interest Expense Investment in Series Corp. NCI in NA of Series Corp. $3,732 = ($8,843 - $3,868) x 0.75 $1,244 = ($8,843 - $3,868) x 0.25

200,000 2,152 18,569 198,698 17,047 3,732 1,244

Chapter 08 – Intercompany Indebtedness

P8-18 Prior Retirement of Bonds Face Value of Bonds 100,000.00 Stated rate =

Interest $ PMT

PMT #

Interest Expense

Amort of Discount (Premium)

1/1/20X3

Premium (Discount)

Bonds Payable

BV of Bonds

($5,000.00)

100,000.00

$95,000.00

1 12/31/20X3 2 12/31/20X4

9,000.00

9,316.64

316.64

($4,683.36)

100,000.00

$95,316.64

9,000.00

9,347.70

347.70

($4,335.66)

100,000.00

$95,664.34

Annual

12/31/20X5

9,000.00

9,381.79

381.79

($3,953.87)

100,000.00

$96,046.13

Years =

12/31/20X6

9,000.00

9,419.24

419.24

($3,534.63)

100,000.00

$96,465.37

12/31/20X7

9,000.00

9,460.35

460.35

($3,074.28)

100,000.00

$96,925.72

6 12/31/20X8 7 12/31/20X9

9,000.00

9,505.50

505.50

($2,568.78)

100,000.00

$97,431.22

9,000.00

9,555.07

555.07

($2,013.71)

100,000.00

$97,986.29

12/31/2010

9,000.00

9,609.51

609.51

($1,404.20)

100,000.00

$98,595.80

12/31/2011

9,000.00

9,669.28

669.28

($734.92)

100,000.00

$99,265.08

12/31/2012

9,000.00

9,734.92

734.92

$0.00

100,000.00

$100,000.00

90,000.00

95,000.00

5,000.00

Interest $ PMT

Interest Income

Amort of Discount (Premium)

Bonds Payable

BV of Bonds

10 Mkt Rate = 9.807%

Face Value of Bonds 100,000.00 Stated rate =

PMT # 12/31/20X5

Premium (Discount) $2,800.00

100,000.00

$102,800.00

1 12/31/20X6 2 12/31/20X7

9,000.00

8,690.53

(309.47)

$2,490.53

100,000.00

$102,490.53

9,000.00

8,664.37

(335.63)

$2,154.90

100,000.00

$102,154.90

Annual

12/31/20X8

9,000.00

8,635.99

(364.01)

$1,790.89

100,000.00

$101,790.89

Years =

12/31/20X9

9,000.00

8,605.22

(394.78)

$1,396.11

100,000.00

$101,396.11

12/31/2010

9,000.00

8,571.85

(428.15)

$967.95

100,000.00

$100,967.95

12/31/2011

9,000.00

8,535.65

(464.35)

$503.60

100,000.00

$100,503.60

12/31/2012

9,000.00

8,496.40

(503.60)

($0.00)

100,000.00

$100,000.00

63,000.00

60,200.00

(2,800.00)

7 Mkt Rate = 8.454%

Chapter 08 – Intercompany Indebtedness

P8-18 (continued) a.

Cash Investment in Spark Company Bonds Interest Income

9,000

Bonds Payable Loss on Bond Retirement Investment in Spark Company Bonds Discount on Bonds Payable Eliminate intercompany bond holdings:

100,000 6,754

309 8,691

102,800 3,954

$6,754 = $96,046 – 102,800

The basic entry (not shown) would be adjusted by 6,754 to complete the elimination process. c.

Consolidated net Income and income to controlling interest for 20X5 and 20X6: Operating income reported by Plug Net income reported by Spark Loss on bond retirement Adjustment for excess of interest expense ($9,419) over interest income ($8,691) Consolidated net income Income to noncontrolling interest: ($60,000 - $6,754) x 0.15 ($80,000 + $728) x 0.15 Income to controlling interest

20X5 $120,000 60,000 (6,754) $173,246

20X6 $150,000 80,000 728 $230,728

(7,987) $165,259

(12,109) $218,619

Chapter 08 – Intercompany Indebtedness

P8-20 Balance Sheet Eliminations a.

Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 20%

Pea Corp. 80% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

40,357 14,895 (2,000)

161,428 59,581 (8,000)

100,000

101,785 74,476 (10,000)

Ending book value

53,252

213,009

100,000

166,261

Adjustment to Basic Consolidation Entry: NCI 20% Net income 14,895 - Gross profit deferral (down) - Gross profit deferral (up) (1,200)

Pea Corp. 80% 59,581 (12,000) (4,800)

Income to be eliminated

13,695

42,781

Ending book value - Gross profit deferral (down) - Gross profit deferral (up)

53,252 (1,200)

213,009 (12,000) (4,800)

Adjusted book value

52,052

196,209

Basic Consolidation Entry Common Stock

100,000

← Common stock

Retained Earnings

101,785

← Beginning balance in retained earnings

Income From Split Co.

42,781

← Pea’s % of NI with adjustments

NCI in NI of Split Co.

13,695

← NCI share of NI with adjustments

Dividends Declared

10,000

← 100% of Split Co.'s dividends declared

Investment in Split Co. Stock

196,209

← Net book value with adjustments

NCI in NA of Split Co. Stock

52,052

← NCI share of BV with adjustments

Chapter 08 – Intercompany Indebtedness

P8-20 (continued) 20X4 Downstream Transactions Total

Re-sold

Ending Inventory

Sales

100,000

58,000

42,000

COGS

71,429

41,429

30,000

Gross Profit

28,571

16,571

12,000

Gross Profit %

28.57%

20X4 Upstream Transactions Total

Re-sold

Ending Inventory

Sales

50,000

24,000

26,000

COGS

38,462

18,462

20,000

Gross Profit

11,538

5,538

6,000

Gross Profit %

23.08%

Deferral of this year's unrealized profits on inventory transfers Sales

150,000

Cost of Goods Sold

132,000

Inventory

18,000

Chapter 08 – Intercompany Indebtedness

P8-20 (continued) Face Value of Bonds 300,000.00 Stated rate =

Interest $ PMT

PMT #

Interest Expense

Premium

1/1/20X1

Premium (Discount)

Bonds Payable

BV of Bonds

$60,000.00

300,000.00

$360,000.00

1 2

7/1/20X1

12,000.00

9,696.57

(2,303.43)

$57,696.57

300,000.00

$357,696.57

12/31/20X1

12,000.00

9,634.53

(2,365.47)

$55,331.10

300,000.00

$355,331.10

Annual

7/1/20X2

12,000.00

9,570.81

(2,429.19)

$52,901.91

300,000.00

$352,901.91

Years =

12/31/20X2

12,000.00

9,505.38

(2,494.62)

$50,407.29

300,000.00

$350,407.29

7/1/20X3

12,000.00

9,438.19

(2,561.81)

$47,845.48

300,000.00

$347,845.48

12/31/20X3

12,000.00

9,369.19

(2,630.81)

$45,214.67

300,000.00

$345,214.67

5.387%

6 7

7/1/20X4

12,000.00

9,298.33

(2,701.67)

$42,513.00

300,000.00

$342,513.00

12/31/20X4

12,000.00

9,225.56

(2,774.44)

$39,738.56

300,000.00

$339,738.56

7/1/20X5

12,000.00

9,150.83

(2,849.17)

$36,889.39

300,000.00

$336,889.39

12/31/20X5

12,000.00

9,074.09

(2,925.91)

$33,963.48

300,000.00

$333,963.48

11 12

7/1/20X6

12,000.00

8,995.28

(3,004.72)

$30,958.76

300,000.00

$330,958.76

12/31/20X6

12,000.00

8,914.35

(3,085.65)

$27,873.10

300,000.00

$327,873.10

7/1/20X7

12,000.00

8,831.23

(3,168.77)

$24,704.34

300,000.00

$324,704.34

12/31/20X7

12,000.00

8,745.88

(3,254.12)

$21,450.22

300,000.00

$321,450.22

7/1/20X8

12,000.00

8,658.23

(3,341.77)

$18,108.46

300,000.00

$318,108.46

16 17

12/31/20X8

12,000.00

8,568.22

(3,431.78)

$14,676.68

300,000.00

$314,676.68

7/1/20X9

12,000.00

8,475.79

(3,524.21)

$11,152.47

300,000.00

$311,152.47

12/31/20X9

12,000.00

8,380.87

(3,619.13)

$7,533.34

300,000.00

$307,533.34

19 20

7/1/20X10

12,000.00

8,283.38

(3,716.62)

$3,816.72

300,000.00

$303,816.72

12/31/20X10

12,000.00

8,183.28

(3,816.72)

($0.00)

300,000.00

$300,000.00

240,000.00

180,000.00

(60,000.00)

Interest $ PMT

Interest Income

Amort of Discount (Premium)

Bonds Payable

BV of Bonds

$2,000.00

100,000.00

$102,000.00

Mkt Rate =

Face Value of Bonds 100,000.00 Stated rate = 8% Annual

PMT # 1/1/20X3 1 2 3 4

Years = 8 Mkt Rate = 7.661%

5 6 7 8 9 10 11 12 13 14 15 16

Premium (Discount)

7/1/20X3

4,000.00

3,907.11

(92.89)

$1,907.11

100,000.00

$101,907.11

12/31/20X3

4,000.00

3,903.55

(96.45)

$1,810.66

100,000.00

$101,810.66

7/1/20X4

4,000.00

3,899.86

(100.14)

$1,710.52

100,000.00

$101,710.52

12/31/20X4

4,000.00

3,896.02

(103.98)

$1,606.54

100,000.00

$101,606.54

7/1/20X5

4,000.00

3,892.04

(107.96)

$1,498.58

100,000.00

$101,498.58

12/31/20X5

4,000.00

3,887.90

(112.10)

$1,386.48

100,000.00

$101,386.48

7/1/20X6

4,000.00

3,883.61

(116.39)

$1,270.09

100,000.00

$101,270.09

12/31/20X6

4,000.00

3,879.15

(120.85)

$1,149.24

100,000.00

$101,149.24

7/1/20X7

4,000.00

3,874.52

(125.48)

$1,023.76

100,000.00

$101,023.76

12/31/20X7

4,000.00

3,869.71

(130.29)

$893.47

100,000.00

$100,893.47

7/1/20X8

4,000.00

3,864.72

(135.28)

$758.19

100,000.00

$100,758.19

12/31/20X8

4,000.00

3,859.54

(140.46)

$617.74

100,000.00

$100,617.74

7/1/20X9

4,000.00

3,854.16

(145.84)

$471.90

100,000.00

$100,471.90

12/31/20X9

4,000.00

3,848.58

(151.42)

$320.47

100,000.00

$100,320.47

7/1/20X10

4,000.00

3,842.77

(157.23)

$163.25

100,000.00

$100,163.25

12/31/20X10

4,000.00

3,836.75

(163.25)

($0.00)

100,000.00

$100,000.00

64,000.00

62,000.00

(2,000.00)

Chapter 08 – Intercompany Indebtedness

P8-20 (continued) Bond and other Debt Consolidation Entries: Bonds Payable

100,000

Bond Premium

13,246

Investment in Split Bonds

101,607

Investment in Split Stock

9,311

NCI in NA of Split 2,328 Note: Interest revenue and expense is not shown in the entry above because only the balance sheet is being consolidated. The impact of the interest revenue and expense is included in the adjustments to the investment in Split Stock and the NCI in NA or Split instead. $13,246 = $39,739 x 1/3 Original gain = ($339,739 x 1/3) – 102,000 = $11,246 $9,311 = ($11,246 + 92.89 + 96.45 + 100.14 + 103.98) x 0.80 $2,328 = ($11,246 + 92.89 + 96.45 + 100.14 + 103.98) x 0.20

Interest Payable

4,000

Interest Receivable

4,000

Chapter 08 – Intercompany Indebtedness

P8-20 (continued) b. Consolidation Entries DR CR

Pea Corp.

Split Co.

Balance Sheet Cash and Receivables Inventory Buildings & Equipment (net) Invest. in Split Co. Bonds Invest. in Split Co. Stock

122,500 200,000 320,000 101,607 205,520

124,000 150,000 360,000

Total Assets

949,627

634,000

Accounts Payable Bonds Payable Premium on Bonds Payable Common Stock Retained Earnings

40,000 400,000

28,000 300,000 39,739 100,000 166,261

4,000 100,000 13,246 100,000 101,785 42,781 13,695 150,000

200,000 309,627

4,000 18,000

NCI in NA of Split Co. Total Liabilities & Equity

949,627

634,000

Consolidated

525,507

101,607 196,209 9,311 329,127

242,500 332,000 680,000 0 0 1,254,500 64,000 600,000 26,493 200,000 309,627

10,000 132,000 52,052 2,328 196,380

54,380 1,254,500

Pea Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X4 Cash and Receivables Inventory Buildings and Equipment (net) Total Assets

$ 242,500 332,000 680,000 $1,254,500

Accounts Payable Bonds Payable Bond Premium Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity

$ $600,000 26,493

64,000 626,493

$200,000 309,627 $509,627 54,380 564,007 $1,254,500

Chapter 08 – Intercompany Indebtedness

P8-21 Computations Relating to Bond Purchase from Nonaffiliate Face Value of Bonds 300,000.00 Stated rate =

Interest $ PMT

PMT #

Amort of Discount (Premium)

Interest Expense

1/1/20X2

Bonds Payable

BV of Bonds

$30,000.00

300,000.00

$330,000.00

Premium (Discount)

1 2

7/1/20X2

15,000.00

14,018.19

(981.81)

$29,018.19

300,000.00

$329,018.19

1/1/20X3

15,000.00

13,976.49

(1,023.51)

$27,994.68

300,000.00

$327,994.68

Annual

7/1/20X3

15,000.00

13,933.01

(1,066.99)

$26,927.69

300,000.00

$326,927.69

Years =

1/1/20X4

15,000.00

13,887.68

(1,112.32)

$25,815.38

300,000.00

$325,815.38

7/1/20X4

15,000.00

13,840.43

(1,159.57)

$24,655.81

300,000.00

$324,655.81

1/1/20X5

15,000.00

13,791.18

(1,208.82)

$23,446.98

300,000.00

$323,446.98

8.496%

6 7

7/1/20X5

15,000.00

13,739.83

(1,260.17)

$22,186.81

300,000.00

$322,186.81

1/1/20X6

15,000.00

13,686.29

(1,313.71)

$20,873.10

300,000.00

$320,873.10

7/1/20X6

15,000.00

13,630.49

(1,369.51)

$19,503.59

300,000.00

$319,503.59

1/1/20X7

15,000.00

13,572.31

(1,427.69)

$18,075.91

300,000.00

$318,075.91

11 12

7/1/20X7

15,000.00

13,511.67

(1,488.33)

$16,587.57

300,000.00

$316,587.57

1/1/20X8

15,000.00

13,448.44

(1,551.56)

$15,036.02

300,000.00

$315,036.02

7/1/20X8

15,000.00

13,382.53

(1,617.47)

$13,418.55

300,000.00

$313,418.55

1/1/20X9

15,000.00

13,313.82

(1,686.18)

$11,732.37

300,000.00

$311,732.37

7/1/20X9

15,000.00

13,242.20

(1,757.80)

$9,974.57

300,000.00

$309,974.57

16 17

1/1/20X10

15,000.00

13,167.53

(1,832.47)

$8,142.09

300,000.00

$308,142.09

7/1/20X10

15,000.00

13,089.68

(1,910.32)

$6,231.78

300,000.00

$306,231.78

1/1/20X11

15,000.00

13,008.53

(1,991.47)

$4,240.31

300,000.00

$304,240.31

19 20

7/1/20X11

15,000.00

12,923.94

(2,076.06)

$2,164.25

300,000.00

$302,164.25

1/1/20X12

15,000.00

12,835.75

(2,164.25)

($0.00)

300,000.00

$300,000.00

300,000.00

270,000.00

(30,000.00)

Income

Amort of Discount (Premium)

Bonds Payable

BV of Bonds

$6,200.00

100,000.00

$106,200.00

10%

Mkt Rate =

Face Value of Bonds 100,000.00 Stated rate = 10% Annual Years =

Interest $ PMT

PMT # 1/1/20X4

Premium (Discount)

1 2

7/1/20X4

5,000.00

4,726.00

(274.00)

$5,926.00

100,000.00

$105,926.00

1/1/20X5

5,000.00

4,713.81

(286.19)

$5,639.82

100,000.00

$105,639.82

7/1/20X5

5,000.00

4,701.08

(298.92)

$5,340.89

100,000.00

$105,340.89

1/1/20X6

5,000.00

4,687.77

(312.23)

$5,028.67

100,000.00

$105,028.67

7/1/20X6

5,000.00

4,673.88

(326.12)

$4,702.54

100,000.00

$104,702.54

1/1/20X7

5,000.00

4,659.37

(340.63)

$4,361.91

100,000.00

$104,361.91

8.900%

6 7

7/1/20X7

5,000.00

4,644.21

(355.79)

$4,006.12

100,000.00

$104,006.12

8 9

1/1/20X8

5,000.00

4,628.37

(371.63)

$3,634.49

100,000.00

$103,634.49

7/1/20X8

5,000.00

4,611.84

(388.16)

$3,246.33

100,000.00

$103,246.33

1/1/20X9

5,000.00

4,594.56

(405.44)

$2,840.89

100,000.00

$102,840.89

7/1/20X9

5,000.00

4,576.52

(423.48)

$2,417.42

100,000.00

$102,417.42

1/1/20X10

5,000.00

4,557.68

(442.32)

$1,975.09

100,000.00

$101,975.09

7/1/20X10

5,000.00

4,537.99

(462.01)

$1,513.08

100,000.00

$101,513.08

1/1/20X11

5,000.00

4,517.43

(482.57)

$1,030.52

100,000.00

$101,030.52

7/1/20X11

5,000.00

4,495.96

(504.04)

$526.47

100,000.00

$100,526.47

1/1/20X12

$0.00

100,000.00

$100,000.00

Mkt Rate =

5,000.00

4,473.53

(526.47)

80,000.00

73,800.00

(6,200.00)

Chapter 08 – Intercompany Indebtedness

P8-21 (continued) a. Consolidation entries, December 31, 20X4: Bonds Payable Bond Premium Interest Income Investment in School Company Bonds Interest Expense Gain on Bond Retirement Interest Payable Interest Receivable

100,000 7,816 9,440 105,640 9,211 2,405 5,000 5,000

The basic entry (not shown) would be adjusted by 2,176 (9,211+2,4059,440=2,176) to complete the elimination process. P8-22B Computations following Parent's Acquisition of Subsidiary Bonds a.

Book value of bonds purchased by Phone Corporation: Balance reported, December 31, 20X5 Amortization of premium in 20X4 and 20X5 Balance at date of purchase Proportion of bonds purchased by Phone Book value of bonds purchased

$111,706 3,664 $115,370 x 0.40 $46,148

Amount paid by Phone to purchase bonds: Bond investment, December 31, 20X5 Amortization of premium in 20X4 and 20X5

$43,069 931

Purchase price Gain on bond retirement

(44,000) $ 2,148

Chapter 08 – Intercompany Indebtedness

P8-22B (continued) Face Value of Bonds 100,000.00 Stated rate =

Interest $ PMT

PMT #

Interest Expense

Premium

01/01/20X1

Bonds Payable

BV of Bonds

$20,000.00

100,000.00

$120,000.00

Premium (Discount)

1 2

12/31/20X1

10,000.00

8,561.63

(1,438.37)

$18,561.63

100,000.00

$118,561.63

12/31/20X2

10,000.00

8,459.01

(1,540.99)

$17,020.64

100,000.00

$117,020.64

Annual

12/31/20X3

10,000.00

8,349.07

(1,650.93)

$15,369.71

100,000.00

$115,369.71

Years =

12/31/20X4

10,000.00

8,231.28

(1,768.72)

$13,600.99

100,000.00

$113,600.99

12/31/20X5

10,000.00

8,105.08

(1,894.92)

$11,706.07

100,000.00

$111,706.07

12/31/20X6

10,000.00

7,969.89

(2,030.11)

$9,675.96

100,000.00

$109,675.96

12/31/20X7

10,000.00

7,825.04

(2,174.96)

$7,501.00

100,000.00

$107,501.00

12/31/20X8

10,000.00

7,669.87

(2,330.13)

$5,170.87

100,000.00

$105,170.87

12/31/20X9

10,000.00

7,503.62

(2,496.38)

$2,674.49

100,000.00

$102,674.49

12/31/20X10

10,000.00

7,325.51

(2,674.49)

($0.00)

100,000.00

$100,000.00

100,000.00

80,000.00

(20,000.00)

Interest $ PMT

Interest Income

Premium

Bonds Payable

BV of Bonds

10%

10 Mkt Rate = 7.135%

Face Value of Bonds 40,000.00 Stated rate =

PMT # 01/01/20X4

Premium (Discount) $4,000.00

40,000.00

$44,000.00

1 2

12/31/20X4

4,000.00

3,552.73

(447.27)

$3,552.73

40,000.00

$43,552.73

12/31/20X5

4,000.00

3,516.62

(483.38)

$3,069.35

40,000.00

$43,069.35

Annual

12/31/20X6

4,000.00

3,477.59

(522.41)

$2,546.93

40,000.00

$42,546.93

Years =

12/31/20X7

4,000.00

3,435.40

(564.60)

$1,982.34

40,000.00

$41,982.34

12/31/20X8

4,000.00

3,389.82

(610.18)

$1,372.15

40,000.00

$41,372.15

12/31/20X9

4,000.00

3,340.55

(659.45)

$712.70

40,000.00

$40,712.70

12/31/20X10

4,000.00

3,287.30

(712.70)

($0.00)

40,000.00

$40,000.00

28,000.00

24,000.00

(4,000.00)

10%

7 Mkt Rate = 8.074%

Chapter 08 – Intercompany Indebtedness

P8-22B (continued) b.

Bonds Payable Bond Premium Interest Income Investment in Smart Company Bonds Interest Expense Retained Earnings NCI in NA of Smart Company Stock Eliminate intercompany bond holdings: $1,510 = ($2,148 - $260) x 0.80 $378 = ($2,148 - $260) x 0.20

40,000 4,682 3,517 43,069 3,242 1,510 378

The basic entry (not shown) would be adjusted by 275 to complete the elimination process.

Consolidated retained earnings

$501,290

Parent RE as given: Adjustment to Beginning RE from b above: Current year income adjustment: 3,517 – 3,242 = 275 * 80% ownership Reported RE

500,000 1,510 (220) 501,290

Chapter 08 – Intercompany Indebtedness

P8-23 Consolidation Worksheet — Year of Retirement a.

Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 40%

Purple Manufacturing + 60% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

58,988 11,646 (4,000)

88,486 17,470 (6,000)

100,000

47,471 29,116 (10,000)

Ending book value

66,634

99,956

100,000

66,587

Adjustment to Basic Consolidation Entry: NCI Purple Manufacturing 40% 60% Net income 11,646 17,470 + Constructive Gain 3,141 4,712 + Extra Depreciation 160 240 Income to be eliminated

14,947

22,422

Ending book value + Constructive Gain + Extra Depreciation

66,634 3,141 160

99,953 4,712 240

Adjusted book value

69,935

104,905

Basic Consolidation Entry Common Stock Retained Earnings Income from Socks Corp. NCI in NI of Socks Corp. Dividends Declared Investment in Socks Corp. NCI in NA of Socks Corp.

Actual (Purple Co.): “As if” (Socks Corp.):

100,000 47,471 22,422 14,947 10,000 104,905 69,935

← Common stock ← Beginning balance in retained earnings ← Purple’s % of NI with adjustments ← NCI share of NI with adjustments ← 100% of Socks Corp.'s dividends declared ← Net book value with adjustments ← NCI share of BV with adjustments

Accumulated Depreciation 4,000 400 15,600 19,200

Building 30,000 10,000 40,000

Eliminate the Gain on Building and Correct Asset's Basis: Investment in Socks Corp. 3,360 NCI in NA of Socks Corp. 2,240 Building 10,000 Accumulated Depreciation 15,600 Accumulated Depreciation Depreciation Expense

400 400

Chapter 08 – Intercompany Indebtedness

P8-23 (continued) Bond Consolidation Entry: Bonds Payable Bond Premium Investment in Socks Bonds Gain on Bond Retirement

50,000 7,853 50,000 7,853

$57,853 = $231,413 x ¼ $7,853 = $57,853 - $50,000

Purple Manufacturing

Socks Corp.

400,000

200,000

Income Statement Sales Gain on Bond Retirement Less: Interest Expense Less: Operating Exp. Income from Socks Corp. Consolidated Net Income NCI in Net Income Controlling Int. in NI

(20,884) (150,000)

100,222

29,116

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

145,123 100,222 (40,000) 205,345

47,471 29,116 (10,000) 66,587

Balance Sheet Cash Accounts Receivable Inventory Depr. Assets (net)

68,000 100,000 120,000 360,000

55,000 75,000 110,000 210,000

Investment in Socks Corp. Bonds Invest. in Socks Stock Total Assets

50,000 101,545 799,545 94,200 200,000

29,116

450,000

300,000 205,345

52,000 200,000 31,413 100,000 66,587

799,545

450,000

Consolidated

8,253

600,000 7,853 (40,884) (451,800) 0 115,169 (14,947) 100,222

8,253 10,000 18,253

145,123 100,222 (40,000) 205,345

15,600

123,000 175,000 230,000 564,800

50,000 104,905 170,505

0 0 1,092,800

50,000 7,853 100,000 84,840 2,240

18,253 69,935

146,200 350,000 23,560 300,000 205,345 67,695

244,933

88,188

1,092,800

7,853 (20,000) (302,200) 22,422 100,222

Accounts Payable Bonds Payable Bond Premium Common Stock Retained Earnings NCI in NA of Socks Corp. Total Liabilities & Equity

Consolidation Entries DR CR

400 22,422 22,422 14,947 37,369

47,471 37,369 84,840

400 10,000

3,360 13,760

8,253

Chapter 08 – Intercompany Indebtedness

P8-23 (continued) b.

Purple Manufacturing and Subsidiary Consolidated Balance Sheet December 31, 20X3

Cash Accounts Receivable Inventory Total Current Assets Depreciable Assets (net) Total Assets

$ 123,000 175,000 230,000 $ 528,000 564,800 $1,092,800

Accounts Payable Bonds Payable Bond Premium Stockholders’ Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

$ 146,200 $350,000 23,560

373,560

$300,000 205,345 $505,345 67,695 573,040 $1,092,800

Purple Manufacturing and Subsidiary Consolidated Income Statement Year Ended December 31, 20X3 Sales Gain on Bond Retirement Total Revenue Interest Expense Operating Expenses Total Expenses Consolidated Net Income Income to Noncontrolling Interest Income to Controlling Interest

$600,000 7,853 $607,853 $ 40,884 451,800 (492,684) $115,169 (14,947) $100,222

Purple Manufacturing and Subsidiary Consolidated Statement of Retained Earnings Year Ended December 31, 20X3 Retained Earnings, January 1, 20X3 Income to Controlling Interest, 20X3

$145,123 100,222 $245,345 (40,000) $205,345

Dividends Declared, 20X3 Retained Earnings, December 31, 20X3

Chapter 08 – Intercompany Indebtedness

P8-23 (continued) Face Value of Bonds 200,000.00 Stated rate = 12% Annual Years =

Interest $ PMT

PMT #

Interest Expense

Premium

1/1/20X1

Bonds Payable

BV of Bonds

$40,000.00

200,000.00

$240,000.00

Premium (Discount)

1 2

6/30/20X1

12,000.00

10,720.53

(1,279.47)

$38,720.53

200,000.00

$238,720.53

12/30/20X1

12,000.00

10,663.37

(1,336.63)

$37,383.90

200,000.00

$237,383.90

6/30/20X2

12,000.00

10,603.67

(1,396.33)

$35,987.57

200,000.00

$235,987.57

12/30/20X2

12,000.00

10,541.29

(1,458.71)

$34,528.86

200,000.00

$234,528.86

6/30/20X3

12,000.00

10,476.14

(1,523.86)

$33,005.00

200,000.00

$233,005.00

12/30/20X3

12,000.00

10,408.07

(1,591.93)

$31,413.06

200,000.00

$231,413.06

8.934%

6 7

6/30/20X4

12,000.00

10,336.96

(1,663.04)

$29,750.02

200,000.00

$229,750.02

12/30/20X4

12,000.00

10,262.67

(1,737.33)

$28,012.69

200,000.00

$228,012.69

6/30/20X5

12,000.00

10,185.07

(1,814.93)

$26,197.76

200,000.00

$226,197.76

12/30/20X5

12,000.00

10,104.00

(1,896.00)

$24,301.75

200,000.00

$224,301.75

11 12

6/30/20X6

12,000.00

10,019.30

(1,980.70)

$22,321.06

200,000.00

$222,321.06

12/30/20X6

12,000.00

9,930.83

(2,069.17)

$20,251.88

200,000.00

$220,251.88

6/30/20X7

12,000.00

9,838.40

(2,161.60)

$18,090.28

200,000.00

$218,090.28

12/30/20X7

12,000.00

9,741.84

(2,258.16)

$15,832.13

200,000.00

$215,832.13

6/30/20X8

12,000.00

9,640.97

(2,359.03)

$13,473.10

200,000.00

$213,473.10

16 17

12/30/20X8

12,000.00

9,535.60

(2,464.40)

$11,008.70

200,000.00

$211,008.70

6/30/20X9

12,000.00

9,425.52

(2,574.48)

$8,434.22

200,000.00

$208,434.22

12/30/20X9

12,000.00

9,310.52

(2,689.48)

$5,744.74

200,000.00

$205,744.74

6/30/20X10

12,000.00

9,190.38

(2,809.62)

$2,935.12

200,000.00

$202,935.12

12/30/20X10

12,000.00

9,064.88

(2,935.12)

($0.00)

200,000.00

$200,000.00

240,000.00

200,000.00

(40,000.00)

Interest $ PMT

Interest Income

Amort of Discount (Premium)

Bonds Payable

BV of Bonds

Mkt Rate =

Face Value of Bonds 50,000.00 Stated rate =

PMT # 1/1/20X4

Premium (Discount) $0.00

50,000.00

$50,000.00

1 2

6/30/20X4

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

12/30/20X4

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

Annual

6/30/20X5

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

Years =

12/30/20X5

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

6/30/20X6

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

12/30/20X6

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

12.000%

6 7

6/30/20X7

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

8 9

12/30/20X7

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

6/30/20X8

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

12/30/20X8

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

6/30/20X9

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

12/30/20X9

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

6/30/20X10

3,000.00

(0.00)

$0.00

50,000.00

$50,000.00

12/30/20X10

3,000.00

(0.00)

($0.00)

50,000.00

$50,000.00

42,000.00

(0.00)

12%

Mkt Rate =

Chapter 08 – Intercompany Indebtedness

P8-24 Consolidation Worksheet — Year after Retirement a.Calculations for Basic Consolidation Entry:

Book Value Calculations: NCI 40%

Patio Corp. + 60% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

68,000 20,000 (4,000)

102,000 30,000 (6,000)

100,000

70,000 50,000 (10,000)

Ending book value

84,000

126,000

100,000

110,000

Adjustment to Basic Consolidation Entry: NCI 40% Net income 20,000 + Amortization of Loss 315

Patio Corp. 60% 30,000 473

Income to be eliminated

20,315

30,473

Ending book value + Amortization of Loss

84,000 315

126,000 473

Adjusted book value

84,315

126,473

Basic Consolidation Entry Common Stock

100,000

← Common stock

Retained Earnings

70,000

← Beginning balance in retained earnings

Income from Stone Cont. Co.

30,473

← Patio’s % of NI with adjustments

NCI in NI of Stone Cont. Co.

20,315

← NCI share of NI with adjustments

Dividends Declared

10,000

← 100% of Stone Cont. Co.'s dividends

Investment in Stone Cont. Co.

126,473

← Net book value with adjustments

NCI in NA of Stone Cont. Co.

84,315

← NCI share of BV with adjustments

Bond Consolidation Entry: Bonds Payable

100,000

Investment in Stone Cont. Stock.

4,200

NCI in NA of Stone Cont. Co.

2,800

Interest Income

8,212

Investment in Stone Cont. Bonds

106,212

Interest Expense

9,000

Chapter 08 – Intercompany Indebtedness

P8-24 (continued)

Patio Corp. Income Statement Sales Interest Income Less: Interest Expense Less: Other Expenses Income from Stone Cont. Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Stone Cont. Co.

450,000 8,212 (20,000) (368,600) 30,473 100,085

(18,000) (182,000)

100,085

50,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

210,000 100,085 (40,000) 270,085

70,000 50,000 (10,000) 110,000

Balance Sheet Cash Accounts Receivable Inventory Other Assets Investment in Stone Cont. Co. Bonds Investment in Stone Cont. Co. Stock Total Assets

61,600 100,000 120,000 340,000 106,212 122,273 850,085

20,000 80,000 110,000 250,000

80,000 200,000 300,000 270,085

50,000 200,000 100,000 110,000

850,085

460,000

Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Stone Cont. Co. Total Liabilities & Equity

Consolidation Entries DR CR

250,000

9,000

700,000 0 (29,000) (550,600) 0 120,400 (20,315) 100,085

9,000 10,000 19,000

210,000 100,085 (40,000) 270,085

106,212 126,473 232,685

81,600 180,000 230,000 590,000 0 0 1,081,600

19,000 84,315 103,315

130,000 300,000 300,000 270,085 81,515 1,081,600

8,212

50,000

460,000

9,000 30,473 38,685 20,315 59,000

70,000 59,000 129,000

4,200 4,200

100,000 100,000 129,000 2,800 331,800

Consolidated

9,000

Chapter 08 – Intercompany Indebtedness

P8-24 (continued) b.

Patio Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X4

Cash Accounts Receivable Inventory Total Current Assets Other Assets Total Asset

81,600 180,000 230,000 $ 491,600 590,000 $1,081,600

$ 130,000 300,000 $300,000 270,085 $570,085 81,515 651,600 $1,081,600

Patio Corporation and Subsidiary Consolidated Income Statement December 31, 20X4 Sales Interest Expense Other Expenses Total Expenses Consolidated Net Income Income to Noncontrolling Interest Income to Controlling Interest

$700,000 $ 29,000 550,600 (579,600) $120,400 (20,315) $100,085

Patio Corporation and Subsidiary Consolidated Statement of Retained Earnings Year Ended December 31, 20X4 Retained Earnings, January 1, 20X4 Income to Controlling Interest, 20X4

$210,000 100,085 $310,085 (40,000) $270,085

Dividends Declared, 20X4 Retained Earnings, December 31, 20X4

Chapter 08 – Intercompany Indebtedness

P8-24 (continued) Face Value of Bonds 200,000.00 Stated rate = 9%

Interest $ PMT

PMT #

Interest Expense

Premium

1/1/20X1 1 2

Premium (Discount)

Bonds Payable

BV of Bonds

($0.00)

200,000.00

$200,000.00

6/30/20X1

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

12/30/20X1

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

Annual

6/30/20X2

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

Years =

12/30/20X2

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

6/30/20X3

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

6 7

12/30/20X3

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

9.000%

6/30/20X4

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

12/30/20X4

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

6/30/20X5

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

12/30/20X5

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

11 12

6/30/20X6

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

12/30/20X6

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

6/30/20X7

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

12/30/20X7

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

6/30/20X8

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

16 17

12/30/20X8

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

6/30/20X9

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

12/30/20X9

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

19 20

6/30/20X10

9,000.00

0.00

($0.00)

200,000.00

$200,000.00

12/30/20X10

9,000.00

0.00

$0.00

200,000.00

$200,000.00

180,000.00

0.00

Interest $ PMT

Interest Income

Bonds Payable

BV of Bonds

$7,000.00

100,000.00

$107,000.00

Mkt Rate =

Face Value of Bonds 100,000.00 Stated rate =

PMT #

Amort of Discount (Premium)

1/1/20X4

Premium (Discount)

1 2

6/30/20X4

4,500.00

4,113.21

(386.79)

$6,613.21

100,000.00

$106,613.21

12/30/20X4

4,500.00

4,098.34

(401.66)

$6,211.55

100,000.00

$106,211.55

Annual

6/30/20X5

4,500.00

4,082.90

(417.10)

$5,794.44

100,000.00

$105,794.44

Years =

12/30/20X5

4,500.00

4,066.86

(433.14)

$5,361.31

100,000.00

$105,361.31

6/30/20X6

4,500.00

4,050.21

(449.79)

$4,911.52

100,000.00

$104,911.52

12/30/20X6

4,500.00

4,032.92

(467.08)

$4,444.44

100,000.00

$104,444.44

7.688%

6 7

6/30/20X7

4,500.00

4,014.97

(485.03)

$3,959.41

100,000.00

$103,959.41

8 9

12/30/20X7

4,500.00

3,996.32

(503.68)

$3,455.74

100,000.00

$103,455.74

6/30/20X8

4,500.00

3,976.96

(523.04)

$2,932.70

100,000.00

$102,932.70

12/30/20X8

4,500.00

3,956.86

(543.14)

$2,389.55

100,000.00

$102,389.55

6/30/20X9

4,500.00

3,935.98

(564.02)

$1,825.53

100,000.00

$101,825.53

12/30/20X9

4,500.00

3,914.29

(585.71)

$1,239.82

100,000.00

$101,239.82

6/30/20X10

4,500.00

3,891.78

(608.22)

$631.60

100,000.00

$100,631.60

12/30/20X10

4,500.00

3,868.40

(631.60)

$0.00

100,000.00

$100,000.00

63,000.00

56,000.00

(7,000.00)

Mkt Rate =

Chapter 08 – Intercompany Indebtedness

P8-25 Intercompany Inventory and Debt Transfers a.

Consolidated cost of goods sold for 20X7: Amount reported by Puzzle Corporation Amount reported by Sunday Company Adjustment for unrealized profit in beginning inventory sold in 20X7 Adjustment for inventory purchased from subsidiary and resold during 20X7: CGS recorded by Puzzle CGS recorded by Sunday ($60,000 - $27,000) Total recorded CGS based on Puzzle's cost [$40,000 x ($33,000 / $60,000)] Required adjustment Cost of goods sold

$620,000 240,000 (15,000) $40,000 33,000 $73,000 (22,000) (51,000) $794,000

Consolidated inventory balance: Amount reported by Puzzle Amount reported by Sunday Total inventory reported Unrealized profit in ending inventory held by Sunday [$20,000 x ($27,000 / $60,000)] Consolidated balance

$167,000 120,000 $287,000 (9,000) $278,000

Entry to record interest expense for Sunday Company: Interest Expense Bond Premium Cash

15,296 704 16,000

Chapter 08 – Intercompany Indebtedness

P8-25 (continued) d.

Entry to record interest income for Puzzle Corporation: Cash Investment in Sunday Company Bonds Interest Income

6,400 161 6,561

Computation of interest income Annual payment received ($80,000 x 0.08) Amortization of discount

$6,400 161 $6,561

Interest income for 20X7 e.

Amount assigned to the noncontrolling interest Sunday’s Common Stock Sunday’s Beginning RE Sunday’s Net Income Sunday’s Dividends Constructive Gain 2 Years Amortization of Constructive Gain Total Proportion of ownership held by noncontrolling interest

$50,000 169,432 47,904 (24,000) 4,329 (853) $246,812 x 0.25 $61,703

$47,904 15,000 (442) $62,462 x 0.25 $15,616

Computation of constructive gain on bond retirement Book value of bonds purchased Purchase price Constructive gain

$ 82,729 (78,400) $ 4,329

Chapter 08 – Intercompany Indebtedness

P8-25 (continued)

f. Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 25%

Lance Corp. + 75% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

54,858 11,976 (6,000)

164,574 35,928 (18,000)

50,000

169,432 47,904 (24,000)

Ending book value

60,834

182,502

50,000

193,336

Adjustment to Basic Consolidation Entry: NCI 25% Net income 11,976 + Reverse GP (up) 3,750 - Gross Profit Deferral (down) - Amortization of Constructive Gain (110)

Lance Corp. 75% 35,928 11,250 (9,000) (332)

Income to be eliminated

15,616

37,846

Ending book value + Reverse GP (up) - Gross Profit Deferral (down) - Amortization of Constructive Gain

60,834 3,750 (110)

182,502 11,250 (9,000) (332)

Adjusted book value

64,474

184,420

Basic Consolidation Entry Common Stock 50,000 Retained Earnings 169,432 Income from Sunday Co. 37,846 NCI in NI of Sunday Co. 15,616 Dividends Declared Investment in Sunday Co. Stock NCI in NA of Sunday Co. Stock

← Common stock ← Beginning balance in retained earnings ← Puzzle Corp.’s % of NI with adjustments ← NCI share of NI with adjustments

24,000 184,420 64,474

← 100% of Sunday Co.'s dividends declared ← Net book value with adjustments ← NCI share of BV with adjustments

20X6 Upstream Transactions Beginning Inventory Sales 59,000 COGS 44,000 Gross Profit 15,000 Reversal of Last Year's Deferral: Investment in Sunday Co. Stock NCI in NA of Sunday Co. Stock Cost of Goods Sold

11,250 3,750 15,000

Chapter 08 – Intercompany Indebtedness

P8-25 (continued) 20X7 Downstream Transactions Total 60,000 40,000

Sales COGS Gross Profit

20,000

Gross Profit %

33.33%

Re-sold 33,000 22,000

Ending Inventory 27,000 18,000

11,000

9,000

Deferral of This Year's Unrealized Profits on Inventory Transfers Sales 60,000 Cost of Goods Sold 51,000 Inventory 9,000 Face Value of Bonds 200,000.00 Stated rate =

Interest $ PMT

PMT #

Interest Expense

Premium

Bonds Payable

BV of Bonds

$8,000.00

200,000.00

$208,000.00

Premium (Discount)

01/01/20X4 1 2

12/31/20X4

16,000.00

15,432.35

(567.65)

$7,432.35

200,000.00

$207,432.35

12/31/20X5

16,000.00

15,390.23

(609.77)

$6,822.58

200,000.00

$206,822.58

Annual

12/31/20X6

16,000.00

15,344.99

(655.01)

$6,167.58

200,000.00

$206,167.58

Years =

12/31/20X7

16,000.00

15,296.40

(703.60)

$5,463.97

200,000.00

$205,463.97

12/31/20X8

16,000.00

15,244.19

(755.81)

$4,708.16

200,000.00

$204,708.16

12/31/20X9

16,000.00

15,188.12

(811.88)

$3,896.28

200,000.00

$203,896.28

12/31/20X10

16,000.00

15,127.88

(872.12)

$3,024.16

200,000.00

$203,024.16

12/31/20X11

16,000.00

15,063.17

(936.83)

$2,087.33

200,000.00

$202,087.33

12/31/20X12

16,000.00

14,993.67

(1,006.33)

$1,081.00

200,000.00

$201,081.00

12/31/20X13

$0.00

200,000.00

$200,000.00

Bonds Payable

BV of Bonds

10 Mkt Rate = 7.419%

Face Value of Bonds 80,000.00 Stated rate =

PMT #

16,000.00

14,919.00

(1,081.00)

160,000.00

152,000.00

(8,000.00)

Interest $ PMT

Interest Income

Premium

Premium (Discount)

01/01/20X6

($1,600.00)

80,000.00

$78,400.00

1 2

12/31/20X6

6,400.00

6,548.52

148.52

($1,451.48)

80,000.00

$78,548.52

12/31/20X7

6,400.00

6,560.92

160.92

($1,290.56)

80,000.00

$78,709.44

Annual

12/31/20X8

6,400.00

6,574.36

174.36

($1,116.19)

80,000.00

$78,883.81

Years =

12/31/20X9

6,400.00

6,588.93

188.93

($927.26)

80,000.00

$79,072.74

12/31/20X10

6,400.00

6,604.71

204.71

($722.55)

80,000.00

$79,277.45

12/31/20X11

6,400.00

6,621.81

221.81

($500.75)

80,000.00

$79,499.25

12/31/20X12

6,400.00

6,640.34

240.34

($260.41)

80,000.00

$79,739.59

12/31/20X13

6,400.00

6,660.41

260.41

($0.00)

80,000.00

$80,000.00

51,200.00

52,800.00

1,600.00

8 Mkt Rate = 8.353%

Bond Consolidation Entry: Bonds Payable Bond Premium Interest Income Investment in Sunday Co. Bonds Interest Expense Investment in Sunday Co. Stock NCI in NA of Sunday Co. Stock

80,000 2,186 6,561 78,709 6,119 2,939 980

Chapter 08 – Intercompany Indebtedness

P8-25 (continued) g. Puzzle Corp.

Sunday Co.

750,000 15,961 (620,000)

320,000 5,000 (240,000)

(45,000) (35,000) 37,846 103,807

(15,000) (22,096)

103,807

47,904

Statement of Retained Earnings Beginning Puzzle Net Income Less: Dividends Declared Ending Balance

282,911 103,807 (50,000) 336,718

169,432 47,904 (24,000) 193,336

Balance Sheet Cash Accounts Receivable Other Receivables Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Sunday Co. Bonds Investment in Sunday Co. Stock

37,900 110,000 30,000 167,000 90,000 500,000 (155,000) 78,709 176,109

48,800 105,000 15,000 120,000 40,000 250,000 (75,000)

Total Assets

1,034,718

503,800

Accounts Payable Other Payables Bonds Payable Bond Premium Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Sunday Co.

118,000 40,000 250,000

35,000 20,000 200,000 5,464 50,000

Total Liabilities & Equity

1,034,718

Income Statement Sales Interest and Other Income Less: COGS Less: Depreciation Expense Less: Interest and Other Expenses Income from Sunday Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

250,000 40,000 336,718

47,904

Consolidation Entries DR CR 60,000 6,561 15,000 51,000

169,432 120,023 289,455

72,119

72,119 24,000 96,119

282,911 103,807 (50,000) 336,718

72,119

9,000

11,250 11,250

78,709 184,420 2,939 275,068

80,000 2,186 50,000

193,336

289,455 3,750

503,800

425,391

1,010,000 14,400 (794,000) (60,000) (50,977) 0 119,423 (15,616) 103,807

6,119 37,846 104,407 15,616 120,023

Consolidated

96,119 64,474 980 161,573

86,700 215,000 45,000 278,000 130,000 750,000 (230,000) 0 0 1,274,700 153,000 60,000 370,000 3,278 250,000 40,000 336,718 61,704 1,274,700

Chapter 08 - Intercompany Indebtedness

P8-26 Intercompany Bond Holdings and Other Transfers a. Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 25%

Pond Corp. Common Additional + 75% = Stock + Paid-in Capital +

Retained Earnings

Beginning book value + Net income - Dividends

50,126 7,523 (2,500)

150,379 22,569 (7,500)

30,000

20,000

150,505 30,092 (10,000)

Ending book value

55,149

165,448

30,000

20,000

170,597

Adjustment to Basic Consolidation Entry: NCI Pond Corp. 25% 75% Net income 7,523 22,569 + Extra Depreciation 1,500 + Amortization of Constructive Loss 117 352 Income to be eliminated

7,640

24,421

Ending book value 55,149 + Extra Depreciation + Amortization of Constructive Loss 117

165,448 1,500 352

Adjusted book value

167,300

55,266

Basic Consolidation Entry Common Stock 30,000 Additional Paid-in Capital 20,000 Retained Earnings 150,505 Income from Skate Co. 24,421 NCI in NI of Skate Co. 7,640 Dividends Declared Investment in Skate Co. Stock NCI in NA of Skate Co. Stock

Actual (Skate Co.): “As if” (Pond Corp.):

10,000 167,300 55,266

← Common stock ← Additional paid in capital ← Beginning balance in retained earnings ← Pond Corp.’s % of NI with adjustments ← NCI share of NI with adjustments ← 100% of Skate Co.'s dividends declared ← Net book value with adjustments ← NCI share of BV with adjustments

Accumulated Depreciation 6,500 1,500 75,000 80,000

Building 65,000 60,000 125,000

Eliminate the Gain on Building and Correct Asset's Basis: Investment in Skate Co. Stock Building Accumulated Depreciation

15,000 60,000 75,000 8-72

Chapter 08 - Intercompany Indebtedness

P8-26 (continued) Accumulated Depreciation Depreciation Expense Eliminate the Gain on Land: Investment in Skate Co. Stock NCI in NA of Skate Co. Stock Land

1,500 1,500

9,750 3,250 13,000

Chapter 08 - Intercompany Indebtedness

P8-26 (continued) Face Value of Bonds 100,000.00 Stated rate =

Interest $ PMT

PMT #

Interest Expense

Premium

01/01/20X5

Bonds Payable

BV of Bonds

($5,000.00)

100,000.00

$95,000.00

Premium (Discount)

1 2

6/30/20X5

5,000.00

5,144.69

144.69

($4,855.31)

100,000.00

$95,144.69

12/30/20X5

5,000.00

5,152.53

152.53

($4,702.78)

100,000.00

$95,297.22

Annual

6/30/20X6

5,000.00

5,160.79

160.79

($4,541.99)

100,000.00

$95,458.01

Years =

12/30/20X6

5,000.00

5,169.50

169.50

($4,372.49)

100,000.00

$95,627.51

6/30/20X7

5,000.00

5,178.68

178.68

($4,193.81)

100,000.00

$95,806.19

12/30/20X7

5,000.00

5,188.35

188.35

($4,005.46)

100,000.00

$95,994.54

10.831%

6 7

6/30/20X8

5,000.00

5,198.55

198.55

($3,806.91)

100,000.00

$96,193.09

12/30/20X8

5,000.00

5,209.31

209.31

($3,597.60)

100,000.00

$96,402.40

6/30/20X9

5,000.00

5,220.64

220.64

($3,376.96)

100,000.00

$96,623.04

12/30/20X9

5,000.00

5,232.59

232.59

($3,144.37)

100,000.00

$96,855.63

11 12

6/30/20X10

5,000.00

5,245.18

245.18

($2,899.19)

100,000.00

$97,100.81

12/30/20X10

5,000.00

5,258.46

258.46

($2,640.73)

100,000.00

$97,359.27

6/30/20X11

5,000.00

5,272.46

272.46

($2,368.27)

100,000.00

$97,631.73

12/30/20X11

5,000.00

5,287.21

287.21

($2,081.05)

100,000.00

$97,918.95

6/30/20X12

5,000.00

5,302.77

302.77

($1,778.28)

100,000.00

$98,221.72

16 17

12/30/20X12

5,000.00

5,319.16

319.16

($1,459.12)

100,000.00

$98,540.88

6/30/20X13

5,000.00

5,336.45

336.45

($1,122.67)

100,000.00

$98,877.33

12/30/20X13

5,000.00

5,354.67

354.67

($768.00)

100,000.00

$99,232.00

19 20

6/30/20X14

5,000.00

5,373.88

373.88

($394.12)

100,000.00

$99,605.88

12/30/20X14

5,000.00

5,394.12

394.12

($0.00)

100,000.00

$100,000.00

100,000.00

105,000.00

5,000.00

Interest $ PMT

Interest Income

Amort of Discount (Premium)

Bonds Payable

BV of Bonds

10%

Mkt Rate =

Face Value of Bonds 40,000.00 Stated rate =

PMT # 12/31/20X7

Premium (Discount) $2,800.00

40,000.00

$42,800.00

1 2

6/30/20X8

2,000.00

1,850.29

(149.71)

$2,650.29

40,000.00

$42,650.29

12/30/20X8

2,000.00

1,843.82

(156.18)

$2,494.11

40,000.00

$42,494.11

Annual

6/30/20X9

2,000.00

1,837.06

(162.94)

$2,331.17

40,000.00

$42,331.17

Years =

12/30/20X9

2,000.00

1,830.02

(169.98)

$2,161.19

40,000.00

$42,161.19

10%

6/30/20X10

2,000.00

1,822.67

(177.33)

$1,983.86

40,000.00

$41,983.86

12/30/20X10

2,000.00

1,815.01

(184.99)

$1,798.87

40,000.00

$41,798.87

8.646%

6 7

6/30/20X11

2,000.00

1,807.01

(192.99)

$1,605.88

40,000.00

$41,605.88

8 9

12/30/20X11

2,000.00

1,798.67

(201.33)

$1,404.54

40,000.00

$41,404.54

6/30/20X12

2,000.00

1,789.96

(210.04)

$1,194.50

40,000.00

$41,194.50

12/30/20X12

2,000.00

1,780.88

(219.12)

$975.39

40,000.00

$40,975.39

6/30/20X13

2,000.00

1,771.41

(228.59)

$746.79

40,000.00

$40,746.79

12/30/20X13

2,000.00

1,761.53

(238.47)

$508.32

40,000.00

$40,508.32

6/30/20X14

2,000.00

1,751.22

(248.78)

$259.54

40,000.00

$40,259.54

12/30/20X14

2,000.00

1,740.46

(259.54)

$0.00

40,000.00

$40,000.00

28,000.00

25,200.00

(2,800.00)

Mkt Rate =

Chapter 08 - Intercompany Indebtedness

P8-26 (continued) Bond Consolidation Entry: Bonds Payable 40,000 Interest Income 3,694 Investment in Skate Co. Stock 3,302 NCI in NA of Skate Co. Stock 1,100 Investment in Skate Co. Bonds Interest Expense Bond Discount

42,494 4,163 1,439

Debt Consolidation Entry: Interest Payable Interest Receivable

2,000

Chapter 08 - Intercompany Indebtedness

P8-26 (continued) b.

Income Statement Sales Interest Income Less: COGS Less: Depreciation Expense Less: Other Operating Expenses Less: Interest Expense Less: Miscellaneous Expense Income from Skate Co. Consolidated Net Income NCI in Net Income Controlling Interest in NI Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

Pond Corp.

Skate Co.

450,000 18,594 (285,000) (35,000)

250,000

Consolidation Entries DR CR

3,694 (136,000) (24,000)

(50,000) (24,000) (11,900) 24,421 87,115

(40,000) (10,408) (9,500)

87,115

30,092

222,727 87,115 (30,000) 279,842

150,505 30,092 (10,000) 170,597

30,092

Balance Sheet Cash Accounts Receivable Interest and Other Receivables Inventory Land Buildings & Equipment Less: Accumulated Depr. Investment in Skate Co. Stock

53,100 176,000

47,000 65,000

45,000 140,000 50,000 400,000 (185,000) 139,248

10,000 50,000 22,000 240,000 (94,000)

Investment in Skate Co. Bonds Investment in Tin Co. Bonds Total Assets

42,494 134,000 994,842

1,500

150,505 35,755 186,260

5,663

5,663 10,000 15,663

222,727 87,115 (30,000) 279,842

5,663

100,100 241,000 2,000 13,000 60,000 1,500 15,000 9,750 3,302

75,000 167,300

42,494 340,000

Accounts Payable Interest and Other Payables Bonds Payable Bond Discount Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Skate Co.

65,000 45,000 300,000 150,000 155,000 279,842

11,000 12,000 100,000 (3,597) 30,000 20,000 170,597

Total Liabilities & Equity

994,842

340,000

700,000 14,900 (421,000) (57,500) (90,000) (30,245) (21,400) 0 94,755 (7,640) 87,115

4,163 24,421 28,115 7,640 35,755

Consolidated

89,552

299,794

0 134,000 1,124,600

15,663 55,266

76,000 55,000 360,000 (2,158) 150,000 155,000 279,842 50,916

72,368

1,124,600

2,000 40,000 1,439 30,000 20,000 186,260 3,250 1,100 282,610

53,000 190,000 59,000 700,000 (352,500) 0

Chapter 08 - Intercompany Indebtedness

P8-28 Comprehensive Problem: Intercompany Transfers a.

Goodwill as of January 1, 20X7: Fair value of consideration given by Private Fair value of noncontrolling interest at acquisition Total Book value of net assets at acquisition Differential at acquisition Increase in fair value of land Goodwill at acquisition

Computation of balance in investment account, January 1, 20X7: Secret stockholders' equity, January 1, 20X7: Common stock Premium on common stock Retained earnings Stockholders' equity, January 1, 20X7 Private's ownership share Book value of shares held by Private Differential at January 1, 20X7 ($80,000 x 0.90) Inventory sale deferred gross profit ($4,500 x 0.90) Balance in Investment in Secret Stock account, January 1, 20X7 Working backwards: Ending Balance - Net Income ($100,126 x 0.90) + Dividends ($40,000 x 0.90) - Reversal of 20X6 deferred gross profit ($4,500 x 0.90) + 20X7 gross profit deferral ($5,400 x 0.90) + Impairment loss ($25,000 x 0.90) - Bond retirement gain ($25,394 x 0.90) + Retirement gain amortization ($5,247 x 0.90) Total

$1,152,000 128,000 $1,280,000 (1,200,000) $ 80,000 (30,000) $ 50,000

$ 500,000 280,000 468,606 $1,248,606 x 0.90 $1,123,745 72,000 (4,050) $1,191,695 $1,240,631 (90,113) 36,000 (4,050) 4,860 22,500 (22,855) 4,722 $ 1,191,695

Gain on constructive retirement of Secret's bonds: Original proceeds from issuance of Secret bonds Premium amortized to January 1, 20X7: Book value of bonds at constructive retirement Price paid for Secret bonds by Private Gain on constructive retirement of Secret's bonds

$1,010,000 (4,606) $1,005,394 (980,000) $ 25,394

Chapter 08 - Intercompany Indebtedness

P8-28 (continued) d.

Income to noncontrolling interest, 20X7: Secret's 20X7 net income Add: 20X6 intercompany profit realized in 20X7 Constructive gain on retirement of bonds Less: Unrealized intercompany profit on 20X7 transfer Portion of constructive gain on bond retirement recognized currently by separate affiliates Impairment of goodwill Subsidiary income to be apportioned Noncontrolling interest's proportionate share Income to noncontrolling interest

$100,126 4,500 25,394 (5,400) (5,247) (25,000) $ 94,373 x 0.10 $ 9,437

Total noncontrolling interest, December 31, 20X6: Secret's stockholders' equity, December 31, 20X6 Unrealized profit on intercompany sale of inventory Secret's realized equity, December 31, 20X6 Differential assigned to land Differential assigned to goodwill Noncontrolling interest's proportionate share Total noncontrolling interest, December 31, 20X6

$1,248,606 (4,500) $1,244,106 30,000 50,000 $1,324,106 x 0.10 $ 132,411

Chapter 08 - Intercompany Indebtedness

P8-28 (continued)

Calculations for Basic Consolidation Entry: f. consolidation entries Book Value Calculations: NCI 10%

Private Co. 90% =

Common Premium on Stock + Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

124,861 10,013 (4,000)

1,123,745 90,113 (36,000)

500,000

280,000

468,606 100,126 (40,000)

Ending book value

130,874

1,177,858

500,000

280,000

528,732

Adjustment to Basic Consolidation Entry: NCI 10% Net income 10,013 + Inventory 20X6 Reversal 450 - Inventory 20X7 Deferred GP (540) + Bond Retirement Gain 2,539 - Amortization of Retirement Gain (525)

Private Co. 90% 90,113 4,050 (4,860) 22,855 (4,722)

Income to be eliminated

11,937

107,436

Ending book value + Inventory 20X6 Reversal - Inventory 20X7 Deferred GP + Bond Retirement Gain - Amortization of Retirement Gain

130,874 450 (540) 2,539 (525)

1,177,858 4,050 (4,860) 22,855 (4,722)

Adjusted book value

132,798

1,195,181

Basic Consolidation Entry: Common Stock Premium on Common Stock Retained Earnings Income from Secret Corp. NCI in NI of Secret Corp. Dividends Declared Investment in Secret Corp. NCI in NA of Secret Corp.

500,000 280,000 468,606 107,436 11,937

← Common stock ← Premium on common stock ← Beginning balance in retained earnings ← Private's % of NI with adjustments ← NCI share of NI with adjustments

40,000 1,195,181 132,798

← 100% of Secret Corp.'s dividends declared ← Net book value with adjustments ← NCI share of BV with adjustments

Excess Value (Differential) Calculations:

Beginning balance Changes Ending balance

NCI 10% 8,000 (2,500) 5,500

Private Co. 90% 72,000 (22,500) 49,500

Land 30,000 30,000

Goodwill 50,000 (25,000) 25,000

Chapter 08 - Intercompany Indebtedness

P8-28 (continued) Amortized Excess Value Reclassification Entry: Goodwill Impairment Loss 25,000 Income from Secret Corp. NCI in NI of Secret Corp.

22,500 2,500

Excess Value (Differential) Reclassification Entry: Land 30,000 Goodwill 25,000 Investment in Secret Corp. 49,500 NCI in NA of Secret Corp. 5,500

20X6 Upstream Transactions Total = Sales 64,000 COGS 44,800 Gross Profit 19,200 Gross Profit % 30.00%

Re-sold 49,000 34,300 14,700

Ending Inventory 15,000 10,500 4,500

20X7 Upstream Transactions Total = Sales 78,000 COGS 54,600 Gross Profit 23,400 Gross Profit % 30.00%

Re-sold 60,000 42,000 18,000

Ending Inventory 18,000 12,600 5,400

Reversal of Last Year's Deferral: Investment in Secret Corp. NCI in NA of Secret Corp. Cost of Goods Sold

4,050 450 4,500

Deferral of 20X7 Unrealized Profits on Inventory Transfers Sales 78,000 Cost of Goods Sold 72,600 Inventory 5,400 Eliminate Intercompany Holding of Private's Bonds: Bonds Payable 200,000 Investment in Private Bonds 200,000 Eliminate Intercompany Interest Other Income Other Expenses ($200,000 x 0.10)

20,000 20,000

Eliminate Accrued Interest on Intercompany Bonds: Current Payables 5,000 Current Receivables ($200,000 x 0.10) x 1/4 year

5,000

Chapter 08 - Intercompany Indebtedness

P8-28 (continued) Face Value of Bonds 1,000,000.00 Stated rate =

PMT #

Interest

$ PMT

Interest Expense

Amort of Discount (Premium)

1/1/20X1

Premium (Discount)

Bonds Payable

BV of Bonds

$10,000.00

1,000,000.00 $1,010,000.00

1 2

7/1/20X1

60,000.00

59,725.61

(274.39)

$9,725.61

1,000,000.00 $1,009,725.61

12/31/20X1

60,000.00

59,709.39

(290.61)

$9,435.00

1,000,000.00 $1,009,435.00

Annual

7/1/20X2

60,000.00

59,692.20

(307.80)

$9,127.21

1,000,000.00 $1,009,127.21

Years =

12/31/20X2

60,000.00

59,674.00

(326.00)

$8,801.21

1,000,000.00 $1,008,801.21

7/1/20X3

60,000.00

59,654.72

(345.28)

$8,455.93

1,000,000.00 $1,008,455.93

12/31/20X3

60,000.00

59,634.31

(365.69)

$8,090.24

1,000,000.00 $1,008,090.24

11.827%

6 7

7/1/20X4

60,000.00

59,612.68

(387.32)

$7,702.92

1,000,000.00 $1,007,702.92

12/31/20X4

60,000.00

59,589.78

(410.22)

$7,292.70

1,000,000.00 $1,007,292.70

7/1/20X5

60,000.00

59,565.52

(434.48)

$6,858.22

1,000,000.00 $1,006,858.22

12/31/20X5

60,000.00

59,539.83

(460.17)

$6,398.05

1,000,000.00 $1,006,398.05

11 12

7/1/20X6

60,000.00

59,512.62

(487.38)

$5,910.67

1,000,000.00 $1,005,910.67

12/31/20X6

60,000.00

59,483.79

(516.21)

$5,394.46

1,000,000.00 $1,005,394.46

7/1/20X7

60,000.00

59,453.27

(546.73)

$4,847.73

1,000,000.00 $1,004,847.73

12/31/20X7

60,000.00

59,420.94

(579.06)

$4,268.67

1,000,000.00 $1,004,268.67

7/1/20X8

60,000.00

59,386.70

(613.30)

$3,655.37

1,000,000.00 $1,003,655.37

16 17

12/31/20X8

60,000.00

59,350.43

(649.57)

$3,005.80

1,000,000.00 $1,003,005.80

7/1/20X9

60,000.00

59,312.02

(687.98)

$2,317.81

1,000,000.00 $1,002,317.81

12/31/20X9

60,000.00

59,271.33

(728.67)

$1,589.15

1,000,000.00 $1,001,589.15

19 20

7/1/20X10

60,000.00

59,228.24

(771.76)

$817.39

1,000,000.00 $1,000,817.39

12/31/20X10

60,000.00

59,182.61

(817.39)

($0.00) 1,000,000.00 $1,000,000.00

1,200,000.00

1,190,000.00

(10,000.00)

12%

Mkt Rate =

Face Value of Bonds 1,000,000.00 Stated rate =

PMT #

Interest

$ PMT

Interest Income

Amort of Discount (Premium)

01/01/20X7

Premium (Discount)

Bonds Payable

BV of Bonds

($20,000.00) 1,000,000.00

$980,000.00

1 2

7/1/20X7

60,000.00

61,997.18

1,997.18

($18,002.82) 1,000,000.00

$981,997.18

12/31/20X7

60,000.00

62,123.53

2,123.53

($15,879.29) 1,000,000.00

$984,120.71

Annual

7/1/20X8

60,000.00

62,257.87

2,257.87

($13,621.43) 1,000,000.00

$986,378.57

Years =

12/31/20X8

60,000.00

62,400.70

2,400.70

($11,220.72) 1,000,000.00

$988,779.28

7/1/20X9

60,000.00

62,552.58

2,552.58

($8,668.14) 1,000,000.00

$991,331.86

12/31/20X9

60,000.00

62,714.06

2,714.06

($5,954.08) 1,000,000.00

$994,045.92

12.652%

6 7

7/1/20X10

60,000.00

62,885.76

2,885.76

($3,068.32) 1,000,000.00

$996,931.68

12/31/20X10

60,000.00

63,068.32

3,068.32

480,000.00

500,000.00

20,000.00

12%

Mkt Rate =

$0.00

1,000,000.00 $1,000,000.00

Chapter 08 - Intercompany Indebtedness

P8-28 (continued) Eliminate Intercompany Holding of Secret Bonds: Bonds Payable Premium on Bonds Payable Other Income (Interest) Investment in Secret Bonds Gain on Retirement of Bonds Other Expenses (Interest)

Eliminate Intercompany Dividend Payable/Receivable: Current Payables Current Receivables

1,000,000 4,268 124,121 984,121 25,394 118,874

9,000 9,000

Chapter 08 - Intercompany Indebtedness

P8-28 (continued) g. Private

Secret Corp.

Consolidation Entries DR CR

Income Statement Sales Other Income

3,101,000 134,121

790,000 31,000

78,000 124,121 20,000

Less: COGS

(2,009,000)

(430,000)

(195,000) (643,000)

(85,000) (205,874)

Less: Depr. and Amort. Expense Less: Other Expenses Goodwill Impairment Loss Gain on Bond Retirement Income from Secret Corp. Consolidated Net Income NCI in Net Income Controlling Interest in NI Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Current Receivables Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Secret Corp. Stock Investment in Secret Corp. Bonds Investment in Private Bonds Goodwill Total Assets

3,813,000 21,000 4,500 72,600

118,874 20,000 25,000

84,936 473,057

100,126

473,057

100,126

3,027,695 473,057 (50,000) 3,450,752

468,606 100,126 (40,000) 528,732

39,500 112,500

29,000 85,100

301,000 1,231,000 2,750,000

348,900 513,000 1,835,000

(1,210,000)

(619,000)

1,240,631

107,436 354,557 11,937 366,494

468,606 366,494 835,100

98,000

79,000

Bonds Payable

200,000

1,000,000

Premium on Bonds Payable Common Stock Premium on Common Stock Retained Earnings NCI in NA of Secret Corp.

1,000,000 700,000 3,450,752

4,268 500,000 280,000 528,732

Total Liabilities & Equity

5,448,752

2,392,000

266,368 40,000 306,368

3,027,695 473,057 (50,000) 3,450,752

68,500 183,600 644,500 1,774,000 4,585,000 (1,829,000)

200,000

Current Payables

(280,000) (710,000) (25,000) 25,394 0 482,494 (9,437) 473,057

30,000

984,121

2,392,000

(2,361,900)

25,394 22,500 263,868 2,500 266,368

5,000 9,000 5,400

4,050

5,448,752

Consolidated

25,000 59,050 5,000 9,000 1,000,000 200,000 4,268 500,000 280,000 835,100 450 2,833,818

1,195,181 49,500

984,121 200,000

0 0 25,000 5,451,600

2,448,202

163,000 0

306,368 132,798 5,500 444,666

0 1,000,000 700,000 3,450,752 137,848 5,451,600

Chapter 08 – Intercompany Indebtedness

CHAPTER 8 INTERCOMPANY INDEBTEDNESS SOLUTIONS TO APPENDIX EXERCISES E8-1A Bond Sale from Parent to Subsidiary a.

Journal entries recorded by Stick Corporation:

January 1, 20X2 Investment in Pretzel Corporation Bonds Cash July 1, 20X2 Cash Interest Income Investment in Pretzel Corporation Bonds

156,000 156,000 4,500 4,200 300

December 31, 20X2 Interest Receivable Interest Income Investment in Pretzel Corporation Bonds b.

4,500 4,200 300

Journal entries recorded by Pretzel Corporation:

January 1, 20X2 Cash Bonds Payable Bond Premium

156,000 150,000 6,000

July 1, 20X2 Interest Expense Bond Premium Cash

4,200 300

December 31, 20X2 Interest Expense Bond Premium Interest Payable

4,200 300

4,500

Consolidation entries, December 31, 20X2: Bonds payable Premium on Bonds Payable Interest income Investment in Pretzel Corporation Bonds Interest expense Eliminate intercompany bond holdings.

150,000 5,400 8,400

Interest payable Interest receivable Eliminate intercompany receivable/payable.

4,500

155,400 8,400

4,500

Chapter 08 – Intercompany Indebtedness

E8-2A Computation of Transfer Price a.

$105,000 = $100,000 par value + ($250 x 20 periods) premium

$103,500 = $105,000 - ($250 x 6 periods)

Consolidation entries: Bonds Payable Bond Premium Interest Income Investment in Stallion Corporation Bonds Interest Expense Interest Payable Interest Receivable

100,000 3,500 11,500 103,500 11,500 6,000 6,000

E8-3A Bond Sale at Discount a.

$16,800 = [($600,000 x 0.08) + ($12,000 / 5 years)] x 1/3

Journal entries recorded by Purse Corporation:

January 1, 20X4 Cash Interest Receivable

16,000 16,000

July 1, 20X4 Cash Investment in Scarf Company Bonds Interest Income $800 = ($400,000 - $392,000)/(5 x 2) December 31, 20X4 Interest Receivable Investment in Scarf Company Bonds Interest Income c.

16,000 800 16,800

Consolidation entries, December 31, 20X4: Bonds Payable Interest Income Investment in Scarf Company Bonds Bond Discount Interest Expense $33,600 = $16,000 + $16,000 + $800 + $800 $395,200 = $392,000 + ($800 x 4) $4,800 = $8,000 - ($800 x 4)

400,000 33,600

Interest Payable Interest Receivable

16,000

395,200 4,800 33,600

16,000 8-2

Chapter 08 – Intercompany Indebtedness

E8-5A Multiple-Choice Questions 1. b – $4,700 = ($50,000 x 0.10) - ($3,000 / 10 years) 2. a – $4,000 = ($50,000 x 0.10) - ($8,000 / 8 years) 3. c – $5,600 = $58,000 purchase price - [$53,000 - ($3,000 / 10 years) x 2 years] 4 c – .

Operating income of Kruse Corporation

$40,000

Net income of Gary's Ice Cream Parlors

20,000 $60,000 (5,600)

Less:

Loss on bond retirement Recognition during 20X6 ($4,700 - $4,000) Consolidated net income

700 $55,100

E8-6A Multiple-Choice Questions 1.

a–

$14,000 = [($300,000 x 0.09) - ($60,000 / 10 years)] x ($200,000 / $300,000)

c–

$12,000 = [$120,000 - ($20,000 / 10 years) x 2 years] - $104,000

b – Net income of Solar Corporation Unrecognized portion of gain on bond retirement ($12,000 - $1,500) Proportion of stock held by noncontrolling interest Income to noncontrolling interest

$30,000 10,500 $40,500 x .20 $ 8,100

E8-7A Constructive Retirement at End of Year a.

Consolidation entries, December 31, 20X5: Bonds Payable Premium on Bonds Payable Investment in Suspect Company Bonds Gain on Bond Retirement $9,000 = [($400,000 x 1.03) - $400,000] x 15/20 $12,000 = $9,000 + $400,000 - $397,000

400,000 9,000 397,000 12,000

Interest Payable 18,000 Interest Receivable 18,000 The basic entry (not shown) would be adjusted by 12,000 to complete the elimination process.

Chapter 08 – Intercompany Indebtedness

E8-7A (continued) Consolidation entries, December 31, 20X6: b. Bonds Payable Premium on Bonds Payable Interest Income Investment in Suspect Company Bonds Interest Expense Investment in Suspect Co. NCI in NA of Suspect Co. $8,400 = $9,000 - [$9,000 / (15 x 2)] x 2 $36,200 = $36,000 + [$3,000 / (15 x 2)] x 2 $397,200 = $397,000 + ($100 x 2) $35,400 = $36,000 - ($300 x 2) $7,200 = $12,000 x 0.60 $4,800 = $12,000 x 0.40

400,000 8,400 36,200 397,200 35,400 7,200 4,800

Interest Payable 18,000 Interest Receivable 18,000 The basic entry (not shown) would be adjusted by 800 to complete the elimination process. E8-8A Constructive Retirement at Beginning of Year a.

Consolidation entries, December 31, 20X5: Bonds Payable 400,000 Premium on Bonds Payable 9,000 Interest Income 36,200 Investment in Suspect Company Bonds 397,000 Interest Expense 35,400 Gain on Bond Retirement 12,800 $9,000 = [($400,000 x 1.03) - $400,000] x 15/20 $36,200 = $36,000 +[($400,000 - $396,800)/(16 x 2)] x 2 $397,000 = $396,800 + ($100 x 2) $35,400 = $36,000 - ($300 x 2) $12,800 = [($400,000 x 1.03) - $400,000] x 16/20 + ($400,000 - $396,800) Interest Payable 18,000 Interest Receivable 18,000 The basic entry (not shown) would be adjusted by 800 to complete the elimination process.

Chapter 08 – Intercompany Indebtedness

E8-8A (continued) b.

400,000 8,400 36,200 397,200 35,400 7,200 4,800

Interest Payable 18,000 Interest Receivable 18,000 The basic entry (not shown) would be adjusted by 800 to complete the elimination process. E8-9A Retirement of Bonds Sold at a Discount Elimination of bond investment at December 31, 20X8: Bonds Payable 300,000 Interest Income 21,240 Loss on Constructive Bond Retirement 2,730 Investment in Packed Corporation Bonds 297,120 Interest Expense 21,450 Discount on Bonds Payable 5,400 The basic entry (not shown) would be adjusted by 2,520 (21240+273021450) to complete the elimination process. Eliminate intercompany bond holdings: $21,240 = $21,000 + [($300,000 - $296,880) / 13 years] $2,730 = $296,880 - $294,150 (computed below) $297,120 = $296,880 + [($300,000 - $296,880) / 13 years] $21,450 = $21,000 + ($9,000 / 20 years) $5,400 = ($9,000 / 20 years) x 12 years Computation of book value of liability at constructive retirement Sale price of bonds ($300,000 x 0.97) Amortization of discount [($300,000 - $291,0000) / 20 years] x 7 years Book value of liability at January 1, 20X8

$291,000 3,150 $294,150

Chapter 08 – Intercompany Indebtedness

E8-10A Loss on Constructive Retirement Consolidation entries, December 31, 20X8: Bonds Payable Interest Income Loss on Bond Retirement Investment in Par Corporation Bonds Discount on Bonds Payable Interest Expense Interest Payable Interest Receivable

100,000 8,000 12,000 106,000 3,000 11,000 5,000 5,000

The basic entry (not shown) would be adjusted by 9,000 (8000+12000-11000) to complete the elimination process. E8-11A Determining the Amount of Retirement Gain or Loss a.

Par value of bonds outstanding Annual interest rate Interest payment Amortization of bond premium ($200,000 x 15%) / 5 years Interest charge for full year Less: Interest on bond purchased by Pepper Enterprises [($18,000 x 1/2) x (4 months / 12 months)] Interest expense included in consolidated income statement

$200,000 x .12 $ 24,000

Sale price of bonds, January 1, 20X1 Amortization of premium [($15,000 / 5) x 2 2/3 years] Book value at time of purchase Purchase price Gain on bond retirement

$115,000 (8,000) $107,000 (100,000) $ 7,000

Consolidation entries, December 31, 20X3: Bonds Payable Bond Premium Interest Income Investment in Salt Bonds Interest Expense Gain on Bond Retirement

(6,000) $ 18,000 (3,000) $ 15,000

100,000 6,000 4,000 100,000 3,000 7,000

Interest Payable Interest Receivable

6,000 6,000

The basic entry (not shown) would be adjusted by 6,000 (7,000+3,000-4,000) to complete the elimination process.

Chapter 08 – Intercompany Indebtedness

E8-12A Evaluation of Bond Retirement a.

No gain or loss will be reported by Sibling.

A gain of $13,000 will be reported: Book value of liability reported by Sibling: Par value of bonds outstanding Unamortized premium $8,000 - [($8,000 / 10 years) x 3.5 years] Book value of debt Amount paid by Parent Gain on bond retirement

5,200 $205,200 (192,200) $ 13,000

Consolidated net income for 20X6 will increase by $12,000: Gain on bond retirement Adjustment for excess of interest income over interest expense: Interest income Interest expense Increase in consolidated net income

$200,000

$ 13,000 $(11,600) 10,600

(1,000) $ 12,000

Consolidation entries, December 31, 20X6: Bonds Payable Premium on Bonds Payable Interest Income Investment in Sibling Company Bonds Interest Expense Gain on Bond Retirement Eliminate intercompany bond holdings: $4,800 = ($8,000 / 10 years) x 6 years $11,600 = [$22,000 + ($7,800 / 6.5 years)] / 2 $192,800 = $192,200 + [($7,800 / 6.5 years) / 2] $10,600 = ($22,000 - $800) / 2

200,000 4,800 11,600

Interest Payable Interest Receivable Eliminate intercompany receivable/payable.

11,000

192,800 10,600 13,000

11,000

The basic entry (not shown) would be adjusted by 12,000 (10,600+13,000-11,600) to complete the elimination process.

Chapter 08 – Intercompany Indebtedness

E8-12A (continued) e.

Consolidation entries, December 31, 20X7: Bonds Payable Premium on Bonds Payable Interest Income Investment in Sibling Company Bonds Interest Expense Investment in Sibling Co. NCI in NA of Sibling Co. Eliminate intercompany bond holdings: $4,000 = ($8,000 / 10 years) x 5 years $23,200 = $22,000 + ($7,800 / 6.5 years) $194,000 = $192,800 + ($7,800 / 6.5 years) $21,200 = $22,000 - ($8,000 / 10 years) $8,400 = ($13,000 - $1,000) x 0.70 $3,600 = ($13,000 - $1,000) x 0.30

200,000 4,000 23,200

Interest Payable Interest Receivable Eliminate intercompany receivable/payable.

11,000

194,000 21,200 8,400 3,600

11,000

The basic entry (not shown) would be adjusted by 2,000 (23,200-21,200) to complete the elimination process. f.

Income assigned to noncontrolling interest in 20X7 is $14,400: Net income reported by Sibling Adjustment for excess of interest income over interest expense: Interest income Interest expense Realized net income Proportion of ownership held Income assigned to noncontrolling interest

$ 50,000 $(23,200) 21,200

(2,000) $ 48,000 x .30 $ 14,400

Chapter 08 – Intercompany Indebtedness

E8-13A Elimination of Intercompany Bond Holdings a.

Consolidation entries, December 31, 20X8: Bonds Payable Premium on Bonds Payable Interest Income Constructive Loss on Bond Retirement Investment in Stang Corporation Bonds Interest Expense Eliminate intercompany bond holdings: $3,000 = $5,000 - ($500 x 4 years) $11,300 = $12,000 - ($4,900 / 7 years) $1,400 = $104,900 - ($105,000 - $1,500) $104,200 = $104,900 - ($4,900 / 7 years) $11,500 = $12,000 - ($5,000 / 10 years)

100,000 3,000 11,300 1,400 104,200 11,500

Interest Payable 6,000 Interest Receivable 6,000 Eliminate intercompany receivable/payable. The basic entry (not shown) would be adjusted by 1,200 (11,300+1,40011,500) to complete the elimination process. b.

Income assigned to noncontrolling interest in 20X8 is $6,580: Net income reported by Stang Corporation Constructive loss on bond retirement Adjustment for excess of interest expense over interest income: Interest expense Interest income Realized net income Proportion of ownership held Income assigned to noncontrolling interest

$ 20,000 (1,400) $11,500 (11,300)

200 $ 18,800 x 0.35 $ 6,580

Chapter 08 – Intercompany Indebtedness

E8-13A (continued) c.

Consolidation entries, December 31, 20X9: Bonds Payable Premium on Bonds Payable Interest Income Investment in Stang Corp. NCI in NA of Stang Corp. Investment in Stang Corporation Bonds Interest Expense Eliminate intercompany bond holdings: $2,500 = $3,000 - $500 $11,300 = $12,000 - ($4,900 / 7 years) $780 = ($1,400 - $200) x 0.65 $420 = ($1,400 - $200) x 0.35 $103,500 = $104,200 - $700 $11,500 = $12,000 - ($5,000 / 10 years)

100,000 2,500 11,300 780 420

Interest Payable Interest Receivable Eliminate intercompany receivable/payable.

6,000

103,500 11,500

6,000

The basic entry (not shown) would be adjusted by 200 (11,500-11,300) to complete the elimination process.

Chapter 08 – Intercompany Indebtedness

SOLUTIONS TO APPENDIX PROBLEMS P8-14A Consolidation Worksheet with Sale of Bonds to Subsidiary a.

Entries recorded by Porter on its investment in Service: Cash Investment in Service Corporation Record dividends from Service: $10,000 x 0.60

6,000

Investment in Service Corporation Income from Service Corporation Record equity-method income: $30,000 x 0.60

18,000

6,000

18,000

Entry recorded by Porter on its bonds payable: Interest Expense 6,000 Bond Premium 400 Cash Record interest payment: $400 = ($82,000 - $80,000) / 5 years

6,400

Entry recorded by Service on bond investment: Cash Interest Income Investment in Porter Company Bonds

6,400 6,000 400

Chapter 08 – Intercompany Indebtedness

P8-14A (continued) d. Book Value Calculations:

Beginning Book Value + Net Income - Dividends Ending Book Value

NCI 40% 60,000 12,000 (4,000) 68,000

Basic Consolidation Entry Common Stock Retained Earnings Income from Service Co. NCI in NI of Service Co. Dividends Declared Investment in Service Co. NCI in NA of Service Co. Eliminate Intercompany Bond Holdings Bonds Payable Bond Premium Interest Income Investment in Porter Co. Bonds Interest Expense

Porter Co. 60% 90,000 18,000 (6,000) 102,000

Common Stock 100,000

100,000

Retained Earnings 50,000 30,000 (10,000) 70,000

100,000 50,000 18,000 12,000 10,000 102,000 68,000

80,000 1,200 6,000 81,200 6,000

Chapter 08 – Intercompany Indebtedness

P8-14A (continued) e.

Income Statement Sales Interest Income Less: COGS Less: Depreciation Expense Less: Interest Expenses Income from Service Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash and Accounts Receivable Inventory Buildings & Equipment Less: Accumulated Depreciation Investment in Porter Co.Bonds Investment in Service Co. Total Assets Accounts Payable Bonds Payable Bond Premium Common Stock Retained Earnings NCI in NA of Service Co. Total Liabilities & Equity

Porter Co.

Service Co.

200,000

114,000 6,000 (61,000) (15,000) (14,000)

(99,800) (25,000) (6,000) 18,000 87,200

30,000

87,200

30,000

230,000 87,200 (40,000) 277,200

50,000 30,000 (10,000) 70,000

80,200 120,000 500,000 (175,000)

40,000 65,000 300,000 (75,000) 81,200

102,000 627,200

411,200

Consolidation Entries DR CR

6,000

314,000 0 (160,800) (40,000) (14,000) 0 99,200 (12,000) 87,200

6,000 10,000 16,000

230,000 87,200 (40,000) 277,200

81,200 102,000 183,200

120,200 185,000 800,000 (250,000) 0 0 855,200

16,000 68,000 84,000

110,000 200,000 0 200,000 277,200 68,000 855,200

6,000

6,000 18,000 24,000 12,000 36,000

50,000 36,000 86,000

68,800 80,000 1,200 200,000 277,200

41,200 200,000 100,000 70,000

80,000 1,200 100,000 86,000

627,200

411,200

267,200

Consolidated

6,000

Chapter 08 – Intercompany Indebtedness

P8-15A Consolidation Worksheet with Sale of Bonds to Parent a.

Entries recorded by Punk Corporation on its investment in Soul Company: Cash Investment in Soul Company Stock Record dividends from Soul: $20,000 x 0.90

18,000

Investment in Soul Company Stock Income from Soul Company Record equity-method income: $25,000 x 0.90

22,500

18,000

22,500

Entry recorded by Punk Corporation on its investment in Soul Company bonds: Cash 6,000 Interest Income 5,200 Investment in Soul Company Bonds 800 Record interest payment: $800 = ($104,000 - $100,000) / 5 years

Entry recorded by Soul Company on its bonds payable: Interest Expense Bond Premium Cash

5,200 800 6,000

d. Book Value Calculations:

Beginning Book Value + Net Income - Dividends Ending Book Value

NCI 10% 13,000 2,500 (2,000) 13,500

Basic Consolidation Entry Common Stock Retained Earnings Income from Soul Co. NCI in NI of Soul Co. Dividends Declared Investment in Soul Co. NCI in NA of Soul Co. Eliminate Intercompany Bond Holdings Bonds Payable Bond Premium Interest Income Investment in Soul Co.'s Bonds Interest Expense

Punk Corp. 90% 117,000 22,500 (18,000) 121,500

Common Stock 80,000

80,000

Retained Earnings 50,000 25,000 (20,000) 55,000

80,000 50,000 22,500 2,500 20,000 121,500 13,500

100,000 1,600 5,200 101,600 5,200

Chapter 08 – Intercompany Indebtedness

P8-15A (continued) e. Consolidation Entries DR CR

Punk Corp.

Soul Co.

140,000 5,200 (86,000) (20,000) (16,000) 22,500 45,700

125,000 (79,800) (15,000) (5,200)

45,700

25,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

242,000 45,700 (30,000) 257,700

50,000 25,000 (20,000) 55,000

Balance Sheet Cash and Accounts Receivable Inventory Buildings & Equipment Less: Accumulated Depreciation Investment in Soul Co.Bonds Investment in Soul Co. Total Assets

22,000 165,000 400,000 (140,000) 101,600 121,500 670,100

36,600 75,000 240,000 (80,000)

271,600

92,400 200,000 120,000 257,700

35,000 100,000 1,600 80,000 55,000

100,000 1,600 80,000 80,200

670,100

271,600

261,800

Income Statement Sales Interest Income Less: COGS Less: Depreciation Expense Less: Interest Expenses Income from Soul Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Current Payables Bonds Payable Bond Premium Common Stock Retained Earnings NCI in NA of Soul Co. Total Liabilities & Equity

5,200

265,000 0 (165,800) (35,000) (16,000) 0 48,200 (2,500) 45,700

5,200 20,000 25,200

242,000 45,700 (30,000) 257,700

101,600 121,500 223,100

58,600 240,000 640,000 (220,000) 0 0 718,600

25,200 13,500 38,700

127,400 200,000 0 120,000 257,700 13,500 718,600

5,200

25,000

5,200 22,500 27,700 2,500 30,200

50,000 30,200 80,200

Consolidated

5,200

Chapter 08 – Intercompany Indebtedness

P8-16A Direct Sale of Bonds to Parent a.

Journal entries recorded by Prize Corporation:

January 1, 20X3 Cash Interest Receivable Receive interest on bond investment.

2,000 2,000

July 1, 20X3 Cash Investment in Statue Company Bonds Interest Income Record receipt of bond interest: $250 = $5,000 / (10 years x 2)

2,000 250 2,250

7,000

2,000 250 2,250

Investment in Statue Company Stock 21,000 Income from Statue Company Record equity-method income: $21,000 = $30,000 x 0.70

21,000

Income from Statue Company 2,800 Investment in Statue Company Stock 2,800 Record amortization of differential: $2,800 = ($56,000 / 14 years) x 0.70 b.

Journal entries recorded by Statue Company: January 1, 20X3 Interest Payable 4,000 Cash Record interest payment: $4,000 = $100,000 x (.08 / 2)

4,000

July 1, 20X3 Interest Expense 4,500 Discount on Bonds Payable 500 Cash 4,000 Semiannual payment of interest: $500 = $10,000 / 20 semiannual payments December 31, 20X3 Interest Expense Discount on Bonds Payable Interest Payable (Current Liabilities) Accrue interest expense at year-end.

4,500 500 4,000

Chapter 08 – Intercompany Indebtedness

P8-16A (continued) c. Book Value Calculations:

Beginning Book Value + Net Income - Dividends Ending Book Value

NCI 30% 45,000 9,000 (3,000) 51,000

Prize Corp. 70% 105,000 21,000 (7,000) 119,000

Basic Consolidation Entry Common Stock Retained Earnings Income from Statue Co. NCI in NI of Statue Co. Dividends Declared Investment in Statue Co. Stock NCI in NA of Statue Co. Stock

Common Stock 50,000

50,000

Retained Earnings 100,000 30,000 (10,000) 120,000

50,000 100,000 21,000 9,000 10,000 119,000 51,000

Excess Value (Differential) Calculations: NCI Prize Corp. 30% + 70% Beg. balance 14,400 33,600 Changes (1,200) (2,800) Ending balance 13,200 30,800

Amortized Excess Value Reclassification Entry: Depreciation Expense Income from Statue Co. NCI in NI of Statue Co.

Buildings and Equipment 56,000 56,000

Acc. Depr. (8,000) (4,000) (12,000)

4,000 2,800 1,200

Excess Value (Differential) Reclassification Entry: Buildings and Equipment 56,000 Accumulated Depreciation Investment in Statue Co. Stock NCI in NA of Statue Co. Stock

12,000 30,800 13,200

Remove Gain on Land: Investment in Statue Co. Stock NCI in NA of Statue Co. Stock Land

8,000

5,600 2,400

Eliminate Intercompany Bond Holdings Bonds Payable Interest Income Investment in Statue Co. Bonds Interest Expense Discount on BP

50,000 4,500 46,500 4,500 3,500

Interest Payable Interest Receivable

2,000 2,000

Chapter 08 – Intercompany Indebtedness

P8-16A (continued) d.

Income Statement Sales Interest income Less: Other Expenses Less: Interest Expense Income from Statue Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Prize Corp.

Statue Co.

300,000 4,500 (198,500) (27,000) 18,200 97,200

200,000 (161,000) (9,000)

Consolidation Entries DR CR

Consolidated

30,000

21,000 29,500 9,000

4,500 2,800 7,300 1,200

500,000 0 (363,500) (31,500) 0 105,000 (7,800)

97,200

30,000

38,500

8,500

97,200

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

238,800 97,200 (60,000) 276,000

100,000 30,000 (10,000) 120,000

100,000 38,500

8,500 10,000 18,500

238,800 97,200 (60,000) 276,000

Balance Sheet Cash & Current Receivables Inventory Land, Buildings, & Equipment (net)

30,300 170,000 320,000

46,000 70,000 180,000

Investment in Statue Co. Stock

144,200

Investment in Statue Co. Bonds Total Assets

46,500 711,000

Current Liabilities Bonds Payable Discount on Bonds Payable Common Stock Retained Earnings NCI in NA of Statue Co.

35,000 300,000

Total Liabilities & Equity

4,500 4,000

138,500

2,000 56,000 5,600

296,000

61,600 2,000 50,000

100,000 276,000

33,000 100,000 (7,000) 50,000 120,000

711,000

296,000

12,000 8,000 119,000 30,800 46,500 218,300

3,500 50,000 138,500 2,400 242,900

18,500 51,000 13,200 86,200

74,300 240,000 536,000 0 0 850,300 66,000 350,000 (3,500) 100,000 276,000 61,800 850,300

Chapter 08 – Intercompany Indebtedness

P8-17A Information Provided in Consolidation Entry a.

Playoff Corporation is the parent company. In the Consolidation entry, noncontrolling interest is credited with a portion of the constructive gain on bond retirement.

Playoff holds 75 percent ownership of Series [$4,200 / ($4,200 + $1,400)].

$ 70,000 $(18,600) 17,200 (1,400) $ 68,600

Consolidated net income d.

Income assigned to the noncontrolling interest will decrease by $350 ($1,400 x 0.25) as a result of the Consolidation entry.

Consolidation entry prepared at December 31, 20X8: Bonds Payable Premium on Bonds Payable Interest Income Investment in Series Corporation Bonds Interest Expense Investment in Series Corp. NCI in NA of Series Corp. Eliminate intercompany bond holdings: $1,600 = ($2,400 / 3 years) x 2 years $18,600 = ($200,000 x 0.09) + ($1,800 / 3 years) $198,800 = $198,200 + ($1,800 / 3 years) $17,200 = ($200,000 x 0.09) - ($2,400 / 3 years) $3,150 = [$7,700 - ($1,400 x 2.5 years)] x 0.75 $1,050 = [$7,700 - ($1,400 x 2.5 years)] x 0.25

200,000 1,600 18,600 198,800 17,200 3,150 1,050

Chapter 08 – Intercompany Indebtedness

P8-18A Prior Retirement of Bonds a.

Amount paid by Plug Corporation for bonds: Reported balance, December 31, 20X6 Amortization of premium during 20X6 ($2,400 / 6 years) Purchase price

$102,400 400 $102,800

Interest Expense 9,500 Discount on Bonds Payable 500 Cash 9,000 Annual payment of interest: $9,500 = [$9,000 + ($3,000 / 6 years)]

Cash 9,000 Investment in Spark Company Bonds Interest Income Annual receipt of interest: $8,600 = [$9,000 - ($2,400 / 6 years)]

Bonds Payable 100,000 Loss on Bond Retirement 6,300 Investment in Spark Company Bonds Discount on Bonds Payable Eliminate intercompany bond holdings: $6,300 = $102,800 - [$97,000 -($3,000 / 6 years)] $102,800 = computed above $3,500 = [$3,000 + ($3,000 / 6 years)]

400 8,600

102,800 3,500

Consolidated net Income and income to controlling interest for 20X5 and 20X6: Operating income reported by Plug Net income reported by Spark Loss on bond retirement Adjustment for excess of interest expense ($9,500) over interest income ($8,600) Consolidated net income Income to noncontrolling interest: ($60,000 - $6,300) x 0.15 ($80,000 + $900) x 0.15 Income to controlling interest

20X5 $120,000 60,000 (6,300) $173,700

20X6 $150,000 80,000 900 $230,900

(8,055) $165,645

(12,135) $218,765

Chapter 08 – Intercompany Indebtedness

P8-19A Incomplete Data a. Purchase price of bonds: Balance reported in bond investment account in excess of par value, December 31, 20X4 ($109,000 - $100,000) Amount amortized per year ($9,000 / 6 years) Premium at date of purchase Par value Purchase price

9,000 1,500 $ 10,500 100,000 $110,500

b. Carrying amount of liability on date of purchase: Bond premium, December 31, 20X4 Amount amortized per year ($6,000 / 6 years) Bond premium, January 1, 20X4 Par value Carrying amount of liability, January 1, 20X4

6,000 1,000 $ 7,000 100,000 $107,000

c. Income to noncontrolling interest in 20X5: Reported net income of Station Company Adjustment for excess of interest expense over interest income recorded in 20X5

$ 30,000 500 $ 30,500 x 0.30 $ 9,150

Proportion of stock held by noncontrolling interest Income assigned to noncontrolling interest Excess of interest expense over interest income Interest expense: ($100,000 x 0.12) - ($10,000 / 10) Interest income: ($100,000 x 0.12) – ($10,500 / 7) Excess

$11,000 (10,500) $ 500

Chapter 08 – Intercompany Indebtedness

P8-20A Balance Sheet Eliminations a.

Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 20%

Pea Corp. 80% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

41,000 15,000 (2,000)

164,000 60,000 (8,000)

100,000

105,000 75,000 (10,000)

Ending book value

54,000

216,000

100,000

170,000

Adjustment to Basic Consolidation Entry: NCI 20% Net income 15,000 - Deferred gross profit (down) - Deferred gross profit (up) (1,200)

Pea Corp. 80% 60,000 (12,000) (4,800)

Income to be eliminated

13,800

43,200

Ending book value - Deferred gross profit (down) - Deferred gross profit (up)

54,000 (1,200)

216,000 (12,000) (4,800)

Adjusted book value

52,800

199,200

Basic Consolidation Entry Common Stock

100,000

← Common stock

Retained Earnings

105,000

← Beginning balance in retained earnings

Income from Split Co.

43,200

← Pea’s % of NI with adjustments

NCI in NI of Split Co.

13,800

← NCI share of NI with adjustments

Dividends Declared

10,000

← 100% of Split Co.'s dividends declared

Investment in Split Co. Stock

199,200

← Net book value with adjustments

NCI in NA of Split Co. Stock

52,800

← NCI share of BV with adjustments

Chapter 08 – Intercompany Indebtedness

P8-20A (continued) 20X4 Downstream Transactions Total

Re-sold

Ending Inventory

Sales

100,000

58,000

42,000

COGS

71,429

41,429

30,000

Gross Profit

28,571

16,571

12,000

Gross Profit %

28.57%

20X4 Upstream Transactions Total

Re-sold

Ending Inventory

Sales

50,000

24,000

26,000

COGS

38,462

18,462

20,000

Gross Profit

11,538

5,538

6,000

Gross Profit %

23.08%

Deferral of This Year's Unrealized Profits on Inventory Transfers Sales

150,000

Cost of Goods Sold

132,000

Inventory

18,000

Bond and Other Debt Consolidation Entries: Bonds Payable

100,000

Bond Premium

12,000

Investment in Split Bonds

101,500

Investment in Split Stock

8,400

NCI in NA of Split

2,100

Interest Payable

4,000

Interest Receivable

4,000

Chapter 08 – Intercompany Indebtedness

P8-20A (continued) b.

Balance Sheet Cash and Receivables Inventory Buildings & Equipment (net) Investment in Split Co. Bonds Investment in Split Stock

Pea Corp.

Split Co.

122,500 200,000 320,000

124,000 150,000 360,000

Consolidation Entries DR CR

101,500 207,600

Total Assets

951,600

634,000

Accounts Payable Bonds Payable Premium on Bonds Payable Common Stock Retained Earnings

40,000 400,000

28,000 300,000 36,000 100,000 170,000

4,000 100,000 12,000 100,000 105,000 43,200 13,800 150,000

200,000 311,600

NCI in NA of Split Co. Total Liabilities & Equity

951,600

634,000

528,000

Consolidated

4,000 18,000

242,500 332,000 680,000

101,500 199,200 8,400 331,100

0 0 1,254,500 64,000 600,000 24,000 200,000 311,600

10,000 132,000 52,800 2,100 196,900

54,900 1,254,500

Pea Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X4 Cash and Receivables Inventory Buildings and Equipment (net) Total Assets

$ 242,500 332,000 680,000 $1,254,500

$ $600,000 24,000

64,000 624,000

$200,000 311,600 $511,600 54,900 566,500 $1,254,500

Chapter 08 – Intercompany Indebtedness

P8-21A Computations Relating to Bond Purchase from Nonaffiliate a.

Balance reported, December 31, 20X4 Amortization of premium during 20X4: Annual amortization ($5,600 / 7 years) Portion of year held Amortized in 20X4 Purchase price of bonds Carrying value of liability at date of acquisition: Carrying value at year-end Premium amortized between date of purchase and December 31, 20X4 ($1,000 x 0.75) Carrying value at acquisition Purchase price Gain on constructive retirement

$105,600 $800 x 0.75 600 $106,200

$107,000 750 $107,750 (106,200) $ 1,550

Consolidation entries, December 31, 20X4: Bonds Payable Bond Premium Interest Income Investment in School Company Bonds Interest Expense Gain on Bond Retirement Elimination of interest income: Interest income at nominal rate ($100,000 x 0.10) Annual amortization of premium by Parsons Annual interest income recorded by Parsons Portion of year held by Parsons Interest income for 20X4 Elimination of interest expense: Interest expense at nominal rate ($100,000 x 0.10) Annual amortization of premium by School ($10,000 / 10 years) Annual interest expense recorded by School Portion of year held by Parsons Interest expense eliminated Interest Payable Interest Receivable

100,000 7,000 6,900 105,600 6,750 1,550

$10,000 (800) $ 9,200 x 0.75 $ 6,900

$10,000 (1,000) $ 9,000 x 0.75 $ 6,750 5,000 5,000

The basic entry (not shown) would be adjusted by 1,400 (6,750+1,550-6,900) to complete the elimination process.

Chapter 08 – Intercompany Indebtedness

P8-22A Computations following Parent's Acquisition of Subsidiary Bonds a.

Book value of bonds purchased by Phone Corporation: Balance reported, December 31, 20X5 Amortization of premium in 20X4 and 20X5 ($11,250 / 3 years) x 2 years Balance at date of purchase Proportion of bonds purchased by Phone Book value of bonds purchased

$111,250 7,500 $118,750 x 0.40 $47,500

Amount paid by Phone to purchase bonds: Bond investment, December 31, 20X5 Amortization of premium in 20X4 and 20X5 ($2,400 / 3 years) x 2 years Purchase price Gain on bond retirement b.

$42,400 1,600 (44,000) $ 3,500

Income from Smart Investment in Smart Recognize 80% share of 1/5 of the constructive gain

560

Bonds Payable Bond Premium Interest Income Investment in Smart Company Bonds Interest Expense Investment in Smart Company Stock NCI in NA of Smart Company Stock Eliminate intercompany bond holdings: $4,500 = $11,250 x 0.40 $3,200 = ($40,000 x 0.10) - $800 $2,500 = ($40,000 x 0.10) - ($3,750 x 0.40) $2,240 = ($3,500 - $700) x 0.80 $560 = ($3,500 - $700) x 0.20

40,000 4,500 3,200

Consolidated retained earnings

560

42,400 2,500 2,240 560

$501,680

Chapter 08 – Intercompany Indebtedness

P8-23A Consolidation Worksheet — Year of Retirement a. Calculations for Basic Consolidation Entry:

Book Value Calculations: NCI 40%

Purple Manufacturing + 60% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

60,000 12,000 (4,000)

90,000 18,000 (6,000)

100,000

50,000 30,000 (10,000)

Ending book value

68,000

102,000

100,000

70,000

Adjustment to Basic Consolidation Entry: NCI Purple Manufacturing 40% 60% Net income 12,000 18,000 + Constructive Gain 2,800 4,200 + Extra Depreciation 160 240 Income to be eliminated

14,960

22,440

Ending book value + Constructive Gain + Extra Depreciation

68,000 2,800 160

102,000 4,200 240

Adjusted book value

70,960

106,440

Basic Consolidation Entry Common Stock Retained Earnings Income from Socks Corp. NCI in NI of Socks Corp. Dividends Declared Investment in Socks Corp. NCI in NA of Socks Corp.

Actual (Purple Co.): “As if” (Socks Corp.):

100,000 50,000 22,440 14,960 10,000 106,440 70,960

Accumulated Depreciation 4,000 400 15,600 19,200

Building 30,000 10,000 40,000

400 400 8-27

Chapter 08 – Intercompany Indebtedness

P8-23A (continued) Bond Consolidation Entry: Bonds Payable Bond Premium Investment in Socks Bonds Gain on Bond Retirement

Income Statement Sales Gain on Bond Retirement Less: Interest Expense Less: Operating Expenses Income from Socks Corp. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

50,000 7,000 50,000 7,000

Purple Manufacturing

Socks Corp.

400,000

200,000

Consolidation Entries DR CR

7,000 (20,000) (302,200) 22,440 100,240

(20,000) (150,000)

400

Consolidated 600,000 7,000 (40,000) (451,800) 0 115,200 (14,960)

30,000

22,440 22,440 14,960

7,400

100,240

30,000

37,400

7,400

100,240

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

146,640 100,240 (40,000) 206,880

50,000 30,000 (10,000) 70,000

50,000 37,400

7,400 10,000 17,400

146,640 100,240 (40,000) 206,880

Balance Sheet Cash Accounts Receivable Inventory Depreciable Assets (net)

68,000 100,000 120,000 360,000

55,000 75,000 110,000 210,000

15,600

123,000 175,000 230,000 564,800

Investment in Socks Corp. Bonds Investment in Socks Corp. Stock Total Assets

50,000 103,080 801,080

50,000 106,440 172,040

0 0 1,092,800

Accounts Payable Bonds Payable Bond Premium Common Stock Retained Earnings NCI in NA of Socks Corp. Total Liab. & Equity

94,200 200,000

17,400 70,960 88,360

146,200 350,000 21,000 300,000 206,880 68,720 1,092,800

450,000

300,000 206,880

52,000 200,000 28,000 100,000 70,000

801,080

450,000

87,400

400 10,000 3,360 13,760

50,000 7,000 100,000 87,400 2,240 246,640

Chapter 08 – Intercompany Indebtedness

P8-23A (continued) b.

Purple Manufacturing and Subsidiary Consolidated Balance Sheet December 31, 20X3

Cash Accounts Receivable Inventory Total Current Assets Depreciable Assets (net) Total Assets

$ 123,000 175,000 230,000 $ 528,000 564,800 $1,092,800

$ 146,200 $350,000 21,000

371,000

$300,000 206,880 $506,880 68,720 575,600 $1,092,800

$600,000 7,000 $607,000 $ 40,000 451,800 (491,800) $115,200 (14,960) $100,240

Purple Manufacturing and Subsidiary Consolidated Statement of Retained Earnings Year Ended December 31, 20X3 Retained Earnings, January 1, 20X3 Income to Controlling Interest, 20X3

$146,640 100,240 $246,880 (40,000) $206,880

Dividends Declared, 20X3 Retained Earnings, December 31, 20X3

Chapter 08 – Intercompany Indebtedness

P8-24A Consolidation Worksheet — Year after Retirement a.

Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 40%

Bennett Corp. Common + 60% = Stock +

Retained Earnings

Beginning book value + Net income - Dividends

68,000 20,000 (4,000)

102,000 30,000 (6,000)

100,000

70,000 50,000 (10,000)

Ending book value

84,000

126,000

100,000

110,000

Adjustment to Basic Consolidation Entry: NCI Bennett Corp. 40% 60% Net income 20,000 30,000 + Amortization of Loss 400 600 Income to be eliminated

20,400

30,600

Ending book value + Amortization of Loss

84,000 400

126,000 600

Adjusted book value

84,400

126,600

Basic Consolidation Entry Common Stock Retained Earnings Income from Stone Cont. Co. NCI in NI of Stone Cont. Co. Dividends Declared Investment in Socks Corp. NCI in NA of Stone Cont. Co.

100,000 70,000 30,600 20,400 10,000 126,600 84,000

← Common stock ← Beginning balance in retained earnings ← Patio’s % of NI with adjustments ← NCI share of NI with adjustments ← 100% of Stone Cont. Co.’s dividends ← Net book value with adjustments ← NCI share of BV with adjustments

Chapter 08 – Intercompany Indebtedness

P8-24A (continued) Income to Noncontrolling Interest: Reported net income of Stone Amortization of loss on bond retirement: Carrying value of bond investment Par value of debt Unamortized premium paid by Patio Number of years until maturity Amortization of premium annually Realized net income of Stone Container

$50,000 $106,000 ( 100,000) $ ÷

6,000 6* 1,000 $51,000

Proportion of stock held by noncontrolling interest Income to Noncontrolling Interest * Stone’s reported interest expense for $100,000 bonds

x 0.40 $20,400

Patio’s reported interest income Difference (amortization of premium)

$9,000 8,000 $1,000

Total premium Yearly amortization Years:

6,000 ÷ 1,000 6 years

Chapter 08 – Intercompany Indebtedness

P8-24A (continued) Bond Consolidation Entry: Bonds Payable

100,000

Investment in Stone Cont. Stock.

4,200

NCI in NA of Stone Cont. Co.

2,800

Interest Income

8,000

Investment in Stone Cont. Bonds

106,000

Interest Expense

9,000

Patio Corp. Income Statement Sales Interest Income Less: Interest Expense Less: Other Expenses Income from Stone Cont. Co. Consolidated Net Income NCI in Net Income Controlling Interest in Net Income

Stone Cont. Co.

450,000 8,000 (20,000) (368,600) 30,600 100,000

(18,000) (182,000)

100,000

50,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

210,000 100,000 (40,000) 270,000

70,000 50,000 (10,000) 110,000

Balance Sheet Cash Accounts Receivable Inventory Other Assets Investment in Stone Cont. Co. Bonds Investment in Stone Cont. Co. Stock Total Assets

61,600 100,000 120,000 340,000 106,000 122,400 850,000

20,000 80,000 110,000 250,000

80,000 200,000 300,000 270,000

50,000 200,000 100,000 110,000

850,000

460,000

Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Stone Cont. Co. Total Liabilities & Equity

Consolidation Entries DR CR

250,000

9,000

700,000 0 (29,000) (550,600) 0 120,400 (20,400) 100,000

9,000 10,000 19,000

210,000 100,000 (40,000) 270,000

106,000 126,600 232,600

81,600 180,000 230,000 590,000 0 0 1,081,600

19,000 84,400 103,400

130,000 300,000 300,000 270,000 81,600 1,081,600

8,000

50,000

460,000

9,000 30,600 38,600 20,400 59,000

70,000 59,000 129,000

4,200 4,200

100,000 100,000 129,000 2,800 331,800

Consolidated

9,000

Chapter 08 – Intercompany Indebtedness

P8-24A (continued) b.

Patio Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X4

Cash Accounts Receivable Inventory Total Current Assets Other Assets Total Asset

81,600 180,000 230,000 $ 491,600 590,000 $1,081,600

$ 130,000 300,000 $300,000 270,000 $570,000 81,600 651,600 $1,081,600

$700,000 $ 29,000 550,600 (579,600) $120,400 (20,400) $100,000

Patio Corporation and Subsidiary Consolidated Statement of Retained Earnings Year Ended December 31, 20X4 Retained Earnings, January 1, 20X4 Income to Controlling Interest, 20X4

$210,000 100,000 $310,000 (40,000) $270,000

Dividends Declared, 20X4 Retained Earnings, December 31, 20X4

Chapter 08 – Intercompany Indebtedness

P8-25A Intercompany Inventory and Debt Transfers a.

$620,000 240,000 (15,000) $40,000 33,000 $73,000 (22,000) (51,000) $794,000

$167,000 120,000 $287,000 (9,000) $278,000

Entry to record interest expense for Sunday Company: Interest Expense Bond Premium Cash

15,200 800 16,000

Computation of interest expense Par value of bonds issued Stated interest rate Annual interest payment Annual amortization of premium ($4,800 / 6 years) Interest expense for 20X7

$200,000 x 0.08 $ 16,000 (800) $ 15,200

Chapter 08 – Intercompany Indebtedness

P8-25A (continued) d.

Entry to record interest income for Puzzle Corporation: Cash Investment in Sunday Company Bonds Interest Income

6,400 200 6,600

Computation of interest income Annual payment received ($80,000 x 0.08) Amortization of discount [($80,000 - $78,400) / 8 years] Interest income for 20X7 e.

$6,400 200 $6,600

$50,000 170,000 48,000 (24,000) 4,160 (1,040) $247,120 x 0.25 $61,780

Income assigned to noncontrolling interest: Net income reported by Sunday Company Adjustment for realization of profit on inventory sold to Puzzle in 20X6 Adjustment for realization of constructive gain on bond retirement ($4,160 / 8 years) Realized net income of Sunday for 20X7 Proportion of ownership held by noncontrolling Interest Income assigned to noncontrolling interest Computation of constructive gain on bond retirement Par value of bonds outstanding Bond premium, December 31, 20X7 $4,800 Remaining years’ to maturity ÷ 6 Amortization per year $ 800 Years’ to maturity at purchase x 8 Premium, December 31, 20X5 Book value of bonds Proportion purchased Book value of bonds purchased Purchase price Constructive gain

$48,000 15,000 (520) $62,480 x 0.25 $15,620 $200,000

6,400 $206,400 x 0.40 $ 82,560 (78,400) $ 4,160

Chapter 08 – Intercompany Indebtedness

P8-25A (continued)

f. Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 25%

Puzzle Corp. + 75% =

Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

55,000 12,000 (6,000)

165,000 36,000 (18,000)

50,000

170,000 48,000 (24,000)

Ending book value

61,000

183,000

50,000

194,000

Adjustment to Basic Consolidation Entry: NCI 25% Net income 12,000 + Upstream Reversal 3,750 - Deferred Gross Profit (down) - Amortization of Constructive Gain (130)

Puzzle Corp. 75% 36,000 11,250 (9,000) (390)

Income to be eliminated

15,620

37,860

Ending book value + Upstream Reversal - Deferred Gross Profit (down) - Amortization of Constructive Gain

61,000 3,750 (130)

183,000 11,250 (9,000) (390)

Adjusted book value

64,620

184,860

Basic Consolidation Entry Common Stock 50,000 Retained Earnings 170,000 Income from Sunday Co. 37,860 NCI in NI of Sunday Co. 15,620 Dividends Declared Investment in Sunday Co. Stock NCI in NA of Sunday Co. Stock

← Common stock ← Beginning balance in retained earnings ← Puzzle Corp.’s % of NI with adjustments ← NCI share of NI with adjustments

24,000 184,860 64,620

← 100% of Sunday Co.'s dividends declared ← Net book value with adjustments ← NCI share of BV with adjustments

20X6 Upstream Transactions Beginning Inventory Sales 59,000 COGS 44,000 Gross Profit 15,000

Chapter 08 – Intercompany Indebtedness

P8-25A (continued) Reversal of Last Year's Deferral: Investment in Sunday Co. Stock NCI in NA of Sunday Co. Stock Cost of Goods Sold

11,250 3,750 15,000

20X7 Downstream Transactions

Sales COGS

Total 60,000 40,000

Gross Profit

20,000

Gross Profit %

33.33%

Re-sold 33,000 22,000

Ending Inventory 27,000 18,000

11,000

9,000

Deferral of This Year's Unrealized Profits on Inventory Transfers Sales 60,000 Cost of Goods Sold 51,000 Inventory 9,000 Bond Consolidation Entry: Bonds Payable Bond Premium Interest Income Investment in Sunday Co. Bonds Interest Expense Investment in Sunday Co. Stock NCI in NA of Sunday Co. Stock

80,000 1,920 6,600 78,800 6,080 2,730 910

$1,920 = ($3,200 / 10 years) x 6 years $6,600 = ($80,000 x 0.08) + ($1,600 / 8 years) $78,800 = $78,400 + [($1,600 / 8 years) x 2 years] $6,080 = ($80,000 x 0.08) - ($3,200 / 10 years) $2,730 = ($4,160 - $520) x 0.75 $910 = ($4,160 - $520) x 0.25

Chapter 08 – Intercompany Indebtedness

P8-25A (continued) g. Puzzle Corp.

Sunday Co.

750,000 16,000 (620,000)

320,000 5,000 (240,000)

(45,000) (35,000) 37,860 103,860

(15,000) (22,000)

103,860

48,000

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance

283,180 103,860 (50,000) 337,040

170,000 48,000 (24,000) 194,000

Balance Sheet Cash Accounts Receivable Other Receivables Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Sunday Co. Bonds Investment in Sunday Co. Stock

37,900 110,000 30,000 167,000 90,000 500,000 (155,000) 78,800 176,340

48,800 105,000 15,000 120,000 40,000 250,000 (75,000)

Total Assets

1,035,040

503,800

Accounts Payable Other Payables Bonds Payable Bond Premium Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Sunday Co.

118,000 40,000 250,000

35,000 20,000 200,000 4,800 50,000

Total Liabilities & Equity

1,035,040

250,000 40,000 337,040

48,000

Consolidation Entries DR CR 60,000 6,600 15,000 51,000

170,000 120,080 290,080

72,080

72,080 24,000 96,080

283,180 103,860 (50,000) 337,040

72,080

9,000

11,250 11,250

78,800 184,860 2,730 275,390

80,000 1,920 50,000

194,000

290,080 3,750

503,800

425,750

1,010,000 14,400 (794,000) (60,000) (50,920) 0 119,480 (15,620) 103,860

6,080 37,860 104,460 15,620 120,080

Consolidated

96,080 64,620 910 161,610

86,700 215,000 45,000 278,000 130,000 750,000 (230,000) 0 0 1,274,700 153,000 60,000 370,000 2,880 250,000 40,000 337,040 61,780 1,274,700

Chapter 08 - Intercompany Indebtedness

P8-26A Intercompany Bond Holdings and Other Transfers a. Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 25%

Pond Corp. Common Add'l Paid-in 75% = Stock + Capital +

Retained Earnings

Beginning book value + Net income - Dividends

50,000 7,500 (2,500)

150,000 22,500 (7,500)

30,000

20,000

150,000 30,000 (10,000)

Ending book value

55,000

165,000

30,000

20,000

170,000

Adjustment to Basic Consolidation Entry: NCI Pond Corp. 25% 75% Net income 7,500 22,500 + Extra Depreciation 1,500 + Amortization of Constructive Loss 150 450 Income to be eliminated

7,650

24,450

Ending book value 55,000 + Extra Depreciation + Amortization of Constructive Loss 150

165,000 1,500 450

Adjusted book value

166,950

55,150

Basic Consolidation Entry Common Stock 30,000 Additional Paid-in Capital 20,000 Retained Earnings 150,000 Income from Skate Co. 24,450 NCI in NI of Skate Co. 7,650 Dividends Declared Investment in Skate Co. Stock NCI in NA of Skate Co. Stock

Actual (Skate Co.): “As if” (Pond Corp.)

10,000 166,950 55,150

Accumulated Depreciation 6,500 1,500 75,000 80,000

Building 65,000 60,000 125,000

Eliminate the Gain on Building and Correct Asset's Basis: Investment in Skate Co. Stock Building Accumulated Depreciation

15,000 60,000 75,000

Chapter 08 - Intercompany Indebtedness

P8-26A (continued) Accumulated Depreciation Depreciation Expense Eliminate the Gain on Land: Investment in Skate Co. Stock NCI in NA of Skate Co. Stock Land

1,500 1,500

9,750 3,250 13,000

Bond Consolidation Entry: Bonds Payable 40,000 Interest Income 3,600 Investment in Skate Co. Stock 3,150 NCI in NA of Skate Co. Stock 1,050 Investment in Skate Co. Bonds Interest Expense Bond Discount

42,400 4,200 1,200

Debt Consolidation Entry: Interest Payable Interest Receivable

2,000

Chapter 08 - Intercompany Indebtedness

P8-26A (continued) b.

Pond Corp.

Skate Co.

450,000 18,500 (285,000) (35,000)

250,000

Consolidation Entries DR CR

3,600 (136,000) (24,000)

(50,000) (24,000) (11,900) 24,450 87,050

(40,000) (10,500) (9,500)

87,050

30,000

222,500 87,050 (30,000) 279,550

150,000 30,000 (10,000) 170,000

30,000

Balance Sheet Cash Accounts Receivable Interest and Other Receivables Inventory Land Buildings & Equipment Less: Accumulated Depr. Investment in Skate Co. Stock

53,100 176,000

47,000 65,000

45,000 140,000 50,000 400,000 (185,000) 139,050

10,000 50,000 22,000 240,000 (94,000)

Investment in Skate Co. Bonds Investment in Tin Co. Bonds Total Assets

42,400 134,000 994,550

1,500

150,000 35,700 185,700

5,700

5,700 10,000 15,700

222,500 87,050 (30,000) 279,550

5,700

100,100 241,000 2,000 13,000 60,000 1,500 15,000 9,750 3,150

75,000 166,950

42,400 340,000

Accounts Payable Interest and Other Payables Bonds Payable Bond Discount Common Stock Additional Paid-in Capital Retained Earnings NCI in NA of Skate Co.

65,000 45,000 300,000 150,000 155,000 279,550

11,000 12,000 100,000 (3,000) 30,000 20,000 170,000

Total Liabilities & Equity

994,550

340,000

700,000 14,900 (421,000) (57,500) (90,000) (30,300) (21,400) 0 94,700 (7,650) 87,050

4,200 24,450 28,050 7,650 35,700

Consolidated

89,400

299,350

0 134,000 1,124,600

15,700 55,150

76,000 55,000 360,000 (1,800) 150,000 155,000 279,550 50,850

72,050

1,124,600

2,000 40,000 1,200 30,000 20,000 185,700 3,250 1,050 282,000

53,000 190,000 59,000 700,000 (352,500) 0

Chapter 08 - Intercompany Indebtedness

P8-27B Comprehensive Multiple-Choice Questions (Modified Equity Method) 1.

b–

$374,000 [$200,000 + $180,000 - .30($70,000 - $50,000)]

b–

$294,000 [$220,000 + $140,000 - $2,000 - ($70,000 - $6,000)]

a–

$7,400

[($100,000 x 0.09) - ($6,400 premium / 4 years)]

b–

$32,000

[$24,000 + ($16,000 / 2)]

b–

$13,125

($293,125 - $200,000 - $50,000 - $30,000)

d–

$83,000

($50,000 + $30,000 + $3,000)

b–

$3,000

Purchase price [$106,400 + ($6,400 / 4 years)] Book value [$100,000 + $4,000 + ($4,000 / 4 years)] Loss on bond retirement

a–

$4,620

Reported net income of Strike Corporation Add: Inventory profits of prior period realized in 20X6 Less: Unrealized inventory profits of 20X6 Less: Loss on bond retirement, January 1, 20X6 Add: Interest differential in 20X6 Realized income of Strike Less: Depreciation on differential assigned to buildings and equipment Less: Impairment of goodwill Adjusted income Proportion of stock held by noncontrolling interest Income assigned to noncontrolling interest

$108,000 (105,000) $ 3,000 $40,000 2,000 (6,000) (3,000) 600 $33,600 (3,000) (7,500) $23,100 x 0.20 $ 4,620

Chapter 08 - Intercompany Indebtedness

d–

$68,645

Par value of shares outstanding Retained earnings, December 31, 20X6 Less: Unrealized inventory profit Unrecorded portion of bond retirement loss ($3,000 - $600) Add: Unamortized differential assigned to buildings and equipment ($30,000 $9,000) Unimpaired goodwill ($13,125 $7,500)

$200,000 125,000 (6,000) (2,400) 21,000 5,625 $343,225

Proportion of stock held by noncontrolling interest Assigned to noncontrolling interest 10. b –

$5,625

x 0.20 $ 68,645

($13,125 - $7,500)

Chapter 08 - Intercompany Indebtedness

P8-28A Comprehensive Problem: Intercompany Transfers a.

Computation of balance in investment account, January 1, 20X7: Secret stockholders' equity, January 1, 20X7: Common stock Premium on common stock Retained earnings Stockholders' equity, January 1, 20X7 Private's ownership share Book value of shares held by Private Differential at January 1, 20X7 ($80,000 x 0.90) Inventory sale deferred gross profit ($4,500 x 0.90) Balance in Investment in Secret Stock account, January 1, 20X7 Working backwards: Ending Balance - Net Income ($100,000 x 0.90) + Dividends ($40,000 x 0.90) - Reversal of 20X6 deferred gross profit ($4,500 x 0.90) + 20X7 gross profit deferral ($5,400 x 0.90) + Impairment loss ($25,000 x 0.90) - Bond retirement gain ($24,000 x 0.90) + Retirement gain amortization ($6,000 x 0.90) Total

$1,152,000 128,000 $1,280,000 (1,200,000) $ 80,000 (30,000) $ 50,000

$ 500,000 280,000 470,000 $1,250,000 x 0.90 $1,125,000 72,000 (4,050) $1,192,950 $1,239,840 (90,000) 36,000 (4,050) 4,860 22,500 (21,600) 5,400 $ 1,192,950

Gain on constructive retirement of Secret's bonds: Original proceeds from issuance of Secret bonds Premium amortized to January 2, 20X7: ($10,000 / 10) x 6 Book value of bonds at constructive retirement Price paid for Secret bonds by Private Gain on constructive retirement of Secret's bonds

$1,010,000 (6,000) $1,004,000 (980,000) $ 24,000

Chapter 08 - Intercompany Indebtedness

Income to noncontrolling interest, 20X7: Secret's 20X7 net income Add: 20X6 intercompany profit realized in 20X7 Constructive gain on retirement of bonds Less: Unrealized intercompany profit on 20X7 transfer Portion of constructive gain on bond retirement recognized currently by separate affiliates ($24,000 / 4 years) Impairment of goodwill Subsidiary income to be apportioned Noncontrolling interest's proportionate share Income to noncontrolling interest

$100,000 4,500 24,000 (5,400) (6,000) (25,000) $ 92,100 x 0.10 $ 9,210

$1,250,000 (4,500) $1,245,500 30,000 50,000 $1,325,500 x 0.10 $ 132,550

Chapter 08 - Intercompany Indebtedness

P8-28A (continued) f.

Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 10%

Private Co. 90% =

Common Premium on Stock + Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

125,000 10,000 (4,000)

1,125,000 90,000 (36,000)

500,000

280,000

470,000 100,000 (40,000)

Ending book value

131,000

1,179,000

500,000

280,000

530,000

Adjustment to Basic Consolidation Entry: NCI 10% Net income 10,000 + Inventory 20X6 Reversal 450 - Inventory 20X7 Deferred GP (540) + Bond Retirement Gain 2,400 - Amortization of Retirement Gain (600)

Private Co. 90% 90,000 4,050 (4,860) 21,600 (5,400)

Income to be eliminated

11,710

105,390

Ending book value + Inventory 20X6 Reversal - Inventory 20X7 Deferred GP + Bond Retirement Gain - Amortization of Retirement Gain

131,000 450 (540) 2,400 (600)

1,179,000 4,050 (4,860) 21,600 (5,400)

Adjusted book value

132,710

1,194,390

500,000 280,000 470,000 105,390 11,710

← Common stock ← Premium on common stock ← Beginning balance in retained earnings ← Private's % of NI with adjustments ← NCI share of NI with adjustments

40,000 1,194,390 132,710

← 100% of Secret Corp.'s dividends declared ← Net book value with adjustments ← NCI share of BV with adjustments

Chapter 08 - Intercompany Indebtedness

P8-28A (continued) Excess Value (Differential) Calculations:

Beginning balance Changes Ending balance

NCI 10% 8,000 (2,500) 5,500

Private Co. 90% 72,000 (22,500) 49,500

Amortized Excess Value Reclassification Entry: Goodwill Impairment Loss 25,000 Income from Secret Corp. NCI in NI of Secret Corp.

Land 30,000 30,000

Goodwill 50,000 (25,000) 25,000

22,500 2,500

Excess Value (Differential) Reclassification Entry: Land 30,000 Goodwill 25,000 Investment in Secret Corp. 49,500 NCI in NA of Secret Corp. 5,500

Chapter 08 - Intercompany Indebtedness

P8-28A (continued) 20X6 Upstream Transactions Total = Sales 64,000 COGS 44,800 Gross Profit 19,200 Gross Profit % 30.00%

Re-sold 49,000 34,300 14,700

Ending Inventory 15,000 10,500 4,500

20X7 Upstream Transactions Total = Sales 78,000 COGS 54,600 Gross Profit 23,400 Gross Profit % 30.00%

Re-sold 60,000 42,000 18,000

Ending Inventory 18,000 12,600 5,400

Reversal of Last Year's Deferral: Investment in Secret Corp. NCI in NA of Secret Corp. Cost of Goods Sold

4,050 450 4,500

20,000 20,000

Eliminate Accrued Interest on Intercompany Bonds: Current Payables 5,000 Current Receivables ($200,000 x 0.10) x 1/4 year Eliminate Intercompany Holding of Secret Bonds: Bonds Payable 1,000,000 Premium on Bonds Payable 3,000 Other Income (Interest) 125,000 Investment in Secret Bonds Gain on Retirement of Bonds Other Expenses (Interest) $125,000 = ($1,000,0000 x 0.12) + $5,000 $24,000 = $1,004,000 - $980,000 $119,000 = ($1,000,000 x 0.12) - $1,000

5,000

985,000 24,000 119,000

Eliminate Intercompany Dividend Payable/Receivable: Current Payables 9,000 Current Receivables 9,000 8-48 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 08 - Intercompany Indebtedness

P8-28A (continued) g. Private

Secret Corp.

Consolidation Entries DR CR

Income Statement Sales Other Income

3,101,000 135,000

790,000 31,000

78,000 125,000 20,000

Less: COGS

(2,009,000)

(430,000)

(195,000) (643,000)

(85,000) (206,000)

Less: Depr. and Amort. Expense Less: Other Expenses Goodwill Impairment Loss Gain on Bond Retirement Income from Secret Corp. Consolidated Net Income NCI in Net Income Controlling Interest in NI Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Current Receivables Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Secret Stock Investment in Secret Corp. Bonds Investment in Private Bonds Goodwill Total Assets

3,813,000 21,000 4,500 72,600

119,000 20,000 25,000

82,890 471,890

100,000

471,890

100,000

3,028,950 471,890 (50,000) 3,450,840

470,000 100,000 (40,000) 530,000

39,500 112,500

29,000 85,100

301,000 1,231,000 2,750,000

348,900 513,000 1,835,000

(1,210,000) 1,239,840

(619,000)

105,390 353,390 11,710 365,100

470,000 365,100 835,100

5,448,840

2,392,000

Current Payables

98,000

79,000

Bonds Payable

200,000

1,000,000

Premium on Bonds Payable Common Stock Premium on Common Stock Retained Earnings NCI in NA of Secret Corp.

1,000,000 700,000 3,450,840

3,000 500,000 280,000 530,000

Total Liabilities & Equity

5,448,840

2,392,000

265,100 40,000 305,100

3,028,950 471,890 (50,000) 3,450,840

1,194,390 49,500 985,000 200,000

200,000 25,000 59,050 5,000 9,000 1,000,000 200,000 3,000 500,000 280,000 835,100 450 2,832,550

(280,000) (710,000) (25,000) 24,000 0 481,100 (9,210) 471,890

30,000

985,000

(2,361,900)

24,000 22,500 262,600 2,500 265,100

5,000 9,000 5,400

4,050

Consolidated

2,448,290

68,500 183,600 644,500 1,774,000 4,585,000 (1,829,000) 0

0 0 25,000 5,451,600 163,000 0

305,100 132,710 5,500 443,310

1,000,000 700,000 3,450,840 137,760 5,451,600

Chapter 08 - Intercompany Indebtedness

P8-29B Comprehensive Problem: Intercompany Transfers (Modified Equity Method) a.

$1,152,000 128,000 $1,280,000 (1,200,000) $ 80,000 (30,000) $ 50,000

$ 500,000 280,000 470,000 $1,250,000 x 0.90 $1,125,000 72,000 $1,197,000

Computation of balance in investment account, December 31, 20X7: (not required) Balance in Investment in Secret Stock account, January 1, 20X7 Add: Income from subsidiary, 20X7 Less: Dividends received ($40,000 x 0.90) Balance in Investment in Secret Stock account, December 31, 20X7 c.

$1,197,000 90,000 (36,000) $1,251,000

$1,010,000 (6,000) $1,004,000 (980,000) $ 24,000

Chapter 08 - Intercompany Indebtedness

P8-29B (continued) d.

Income to noncontrolling interest, 20X7: Secret's 20X7 net income Add: 20X6 intercompany profit realized in 20X7 Constructive gain on retirement of bonds Less: Unrealized intercompany profit on 20X7 transfer Portion of constructive gain on bond retirement recognized currently by separate affiliates ($24,000 / 4 years) Impairment of goodwill Subsidiary income to be apportioned Noncontrolling interest's proportionate share Income to noncontrolling interest

$100,000 4,500 24,000 (5,400) (6,000) (25,000) $ 92,100 x 0.10 $ 9,210

$1,250,000 (4,500) $1,245,500 30,000 50,000 $1,325,500 x 0.10 $ 132,550

Chapter 08 - Intercompany Indebtedness

P8-29B (continued) f.

Calculations for Basic Consolidation Entry: Book Value Calculations: NCI 10%

Private Co. Common Premium on 90% = Stock + Common Stock +

Retained Earnings

Beginning book value + Net income - Dividends

125,000 10,000 (4,000)

1,125,000 90,000 (36,000)

500,000

280,000

470,000 100,000 (40,000)

Ending book value

131,000

1,179,000

500,000

280,000

530,000

Topp Co. 90% 90,000 4,050 (4,860) 21,600 (5,400)

Income to be eliminated

11,710

105,390

Ending book value 131,000 + Inventory 20X6 Reversal 450 - Inventory 20X7 Deferred GP (540) + Bond Retirement Gain 2,400 - Amortization of Retirement Gain (600)

1,179,000 4,050 (4,860) 21,600 (5,400)

Adjusted book value

132,710

1,194,390

500,000 280,000 470,000 90,000 11,710

← Common stock ← Premium on common stock ← Beginning balance in retained earnings ← Private's % of NI ← NCI share of NI with adjustments

40,000 1,179,000 132,710

Excess Value (Differential) Reclassification Entry: Land Goodwill Investment in Secret Corp. NCI in NA of Secret Corp.

← 100% of Secret Corp.'s dividends declared ← Net book value ← NCI share of BV with adjustments

30,000 50,000 72,000 8,000

Chapter 08 - Intercompany Indebtedness

P8-29B (continued) Impairment Loss Goodwill Impairment Loss Goodwill

25,000

NCI's Portion of Impairment Loss NCI in NA of Secret Corp. NCI in NI of Secret Corp.

2,500

25,000

2,500

Chapter 08 - Intercompany Indebtedness

P8-29B (continued) 20X6 Upstream Transactions Total = Sales 64,000 COGS 44,800 Gross Profit 19,200 Gross Profit % 30.00%

Re-sold 49,000 34,300 14,700

Ending Inventory 15,000 10,500 4,500

20X7 Upstream Transactions Total = Sales 78,000 COGS 54,600 Gross Profit 23,400 Gross Profit % 30.00%

Re-sold 60,000 42,000 18,000

Ending Inventory 18,000 12,600 5,400

Reversal of Last Year's Deferral: Retained Earnings NCI in NA of Secret Corp. Cost of Goods Sold

4,050 450 4,500

Deferral of 20X7 Unrealized Profits on Inventory Transfers Sales 78,000 Cost of Goods Sold 72,600 Inventory 5,400 Eliminate Intercompany of Private's Bonds: Bonds Payable 200,000 Investment in Private Bonds Eliminate Intercompany Interest Other Income Other Expenses ($200,000 x 0.10)

200,000

20,000 20,000

Eliminate Accrued Interest on Intercompany Bonds: Current Payables 5,000 Current Receivables 5,000 ($200,000 x 0.10) x 1/4 year Eliminate Intercompany Holding of Secret Bonds: Bonds Payable 1,000,000 Premium on Bonds Payable 3,000 Other Income (Interest) 125,000 Investment in Secret Bonds 985,000 Gain on Retirement of Bonds 24,000 Other Expenses (Interest) 119,000 $125,000 = ($1,000,0000 x 0.12) + $5,000 $24,000 = $1,004,000 - $980,000 $119,000 = ($1,000,000 x 0.12) - $1,000 Eliminate Intercompany Dividend Payable/Receivable: Current Payables 9,000 Current Receivables 9,000 8-54 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 08 - Intercompany Indebtedness

P8-29B (continued)

Private

Secret Corp.

Consolidation Entries DR CR

Income Statement Sales Other Income

3,101,000 135,000

790,000 31,000

78,000 125,000 20,000

Less: COGS

(2,009,000)

(430,000)

(195,000) (643,000)

(85,000) (206,000)

Less: Depr. and Amort. Expense Less: Other Expenses Goodwill Impairment Loss Gain on Bond Retirement Income from Secret Corp. Consolidated Net Income NCI in Net Income Controlling Interest in NI

479,000

100,000

Statement of Retained Earnings Beginning Balance

3,033,000

470,000

Net Income Less: Dividends Declared Ending Balance

479,000 (50,000) 3,462,000

100,000 (40,000) 530,000

39,500 112,500

29,000 85,100

301,000 1,231,000 2,750,000

348,900 513,000 1,835,000

(1,210,000)

(619,000)

Inventory Land Buildings & Equipment Less: Accumulated Depreciation Investment in Secret Corp. Stock Investment in Secret Corp. Bonds Investment in Private Bonds Goodwill Total Assets

4,500 72,600

119,000 20,000 24,000

100,000

Balance Sheet Cash Current Receivables

3,813,000 21,000

25,000 90,000 479,000

90,000 338,000 11,710 349,710

470,000 4,050 349,710 823,760

98,000

79,000

Bonds Payable

200,000

1,000,000

Premium on Bonds Payable Common Stock Premium on Common Stock Retained Earnings NCI in NA of Secret Corp.

1,000,000 700,000 3,462,000

3,000 500,000 280,000 530,000

Total Liabilities & Equity

5,460,000

2,392,000

(280,000) (710,000) (25,000) 24,000 0 481,100 (9,210) 471,890

242,600 40,000 282,600

471,890 (50,000) 3,450,840

68,500 183,600 644,500 1,774,000 4,585,000 (1,829,000)

200,000

Current Payables

(2,361,900)

3,028,950

30,000

985,000

2,392,000

240,100 2,500 242,600

5,000 9,000 5,400

1,251,000

5,460,000

Consolidated

50,000 80,000 5,000 9,000 1,000,000 200,000 3,000 500,000 280,000 823,760 450 2,500 2,823,710

1,179,000 72,000

985,000 200,000 25,000 2,480,400

0 0 25,000 5,451,600 163,000 0

282,600 132,710 8,000 423,310

0 1,000,000 700,000 3,450,840 137,760 5,451,600

Chapter 08 - Intercompany Indebtedness

P8-30B Cost Method a. Journal entry recorded by Patio Corporation: Cash 6,000 Dividend Income Record dividend from Stone Container: $10,000 x 0.60

6,000

b. Consolidation entries, December 31, 20X4: Basic Consolidation entry Common Stock Retained Earnings Investment in Stone Cont. Co. NCI in NA of Stone Cont. Co.

100,000 25,000 75,000 50,000

Dividend Consolidation Entry: Dividend Income NCI in NI of Stone Cont. Co. Dividend declared

6,000 4,000

Assign undistributed income to NCI NCI in NI of Stone Cont. Co. Retained Earnings NCI in NA of Stone Cont. Co.

16,400 18,000

10,000

34,400

Bond Consolidation Entry: Bonds Payable 100,000 Retained Earnings 4,200 NCI in NA of Stone Cont. Co. 2,800 Interest Income 8,000 Investment in Stone Cont. Bonds Interest Expense

106,000 9,000

Computation of 20X3 constructive loss on bond retirement Patio's Bond investment, December 31, 20X4 Amortization of premium in 20X4: Interest income based on par value Interest income recorded by Patio Amortization of premium Purchase price paid by Patio, December 31, 20X3 Bond liability reported by Stone Container, December 31, 20X3 Constructive loss on bond retirement

$106,000 $9,000 (8,000) 1,000 $107,000 (100,000) $ 7,000

Chapter 08 - Intercompany Indebtedness

P8-30B (continued) c. Stone Cont. Co.

Patio Corp. Income Statement Sales Interest Income Less: Interest Expense Less: Other Expenses Dividend Income Consolidated Net Income NCI in Net Income

450,000 8,000 (20,000) (368,600) 6,000 75,400

(18,000) (182,000)

Controlling Interest in NI

75,400

50,000

Statement of Retained Earnings Beginning Balance 187,200

70,000

Net Income Less: Dividends Declared Ending Balance

75,400 (40,000) 222,600

50,000 (10,000) 110,000

Balance Sheet Cash Accounts Receivable Inventory Other Assets Investment in Stone Bonds Investment in Stone Stock Total Assets

61,600 100,000 120,000 340,000 106,000 75,000 802,600

20,000 80,000 110,000 250,000

Accounts Payable Bonds Payable Common Stock Retained Earnings NCI in NA of Stone Cont.

80,000 200,000 300,000 222,600

50,000 200,000 100,000 110,000

Total Liabilities & Equity

802,600

460,000

Consolidation Entries DR CR

250,000 8,000

50,000

460,000

9,000 6,000 14,000 4,000 16,400 34,400

25,000 18,000 4,200 34,400 81,600

100,000 100,000 81,600 2,800 284,400

9,000

Consolidated 700,000 0 (29,000) (550,600) 0 120,400 (20,400) 100,000

210,000

9,000 10,000 19,000

100,000 (40,000) 270,000

106,000 75,000 181,000

81,600 180,000 230,000 590,000 0 0 1,081,600

19,000 50,000 34,400 103,400

130,000 300,000 300,000 270,000 81,600 1,081,600

Chapter 9 – Consolidation Ownership Issues

CHAPTER 9 CONSOLIDATION OWNERSHIP ISSUES ANSWERS TO QUESTIONS Q9-1 Preferred stock of the subsidiary is eliminated in the consolidation process in a manner comparable to that used in eliminating the common stock of the subsidiary. For preferred shares held by the parent company, a proportionate share of subsidiary income and net assets assigned to the preferred shares is eliminated against the balance in the parent's investment account. Subsidiary income and net assets assigned to preferred shares not held by the parent are included as a part of the noncontrolling interest along with the balances assigned to noncontrolling interest for common stock not held by the parent. The claim of the preferred shareholders normally is computed before the common stock is eliminated so that any priority claim associated with the preferred stock can be properly recognized and assigned to the correct shareholder group. Q9-2 All preferred shares held by the parent are eliminated against the balance in the investment account. Shares held by unrelated parties are included in the total assigned to the noncontrolling interest. Q9-3 Preferred dividends normally are deducted in arriving at income available to common shareholders. When preferred dividends are paid by the subsidiary to shareholders other than the parent, the income accruing to the common shares held by the parent company is reduced. Therefore, they must be deducted to arrive at income available to the parent company shareholders. No preferred dividends are deducted if the parent company owns all the shares or if no dividends are declared and the preferred stock is noncumulative. Q9-4 In the event the preferred shares are redeemed, the subsidiary must pay the call premium and the net assets of the subsidiary will be reduced by the amount of the premium. Because it is more conservative to assume the call premium will be paid, the amount of the premium normally is added to the claim of the preferred shareholders and deducted from the equity assigned to the common shareholders whenever consolidated statements are prepared. Q9-5 The parent will record the difference between the carrying value and the sale price of the shares as an adjustment to its additional paid-in capital. No gain or loss on the sale of subsidiary shares should be reported in the consolidated statements. Q9-6 All common shareholders share equally in the net assets of a company. When a subsidiary sells additional shares to a nonaffiliate at a price in excess of existing book value, the effect will be to increase the net book value of all shareholders. Because it is a capital transaction, no gain or loss is recognized on the sale. Q9-7 Each purchase of additional shares should be examined to determine the difference between the price paid and underlying book value. When an amount greater than book value is paid directly to the subsidiary for the shares, the book value of the shares held by the noncontrolling interest will increase. As a result, the increase in the parent’s claim on the net assets of the subsidiary will be less than the amount paid. When consolidated statements are prepared, additional paid-in capital or retained earnings (if the parent has no additional paid-in capital) must be debited for the increase in the balance assigned to the noncontrolling interest, thereby reducing the amount reported in the consolidated balance sheet. 9-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 9 – Consolidation Ownership Issues

Q9-8 All the shares of the subsidiary are eliminated in preparing the consolidated statements. Thus, treasury shares reported by the subsidiary are eliminated in the consolidation worksheet. The effect of the retirement on the consolidated statements depends on the price paid and whether the shares were purchased from the parent or from a nonaffiliate. Q9-9 Indirect ownership is a general term used whenever one company owns shares of another company and that company holds ownership in a third company. Indirect control occurs when a majority of the shares of a particular company (Company D) are held by one or more companies (Companies B and C) that are, in turn, under the control of another company (Company A). By exercising its control over those companies (Companies B and C) the parent (Company A) can exercise control of the company indirectly owned (Company D). Q9-10 A reciprocal relationship exists if Subsidiary A and Subsidiary B hold ownership in each other. If Subsidiary A records investment income based on the reported net income of Subsidiary B and Subsidiary B records investment income based on the reported net income of Subsidiary A, the sum of the reported net income totals for the two companies may be substantially greater than the sum of the reported operating income totals for the two companies. Parent company net income will be overstated if the impact of the reciprocal relationship is ignored when the parent company records investment income on its ownership in the two subsidiaries. Q9-11 Under the treasury stock method the parent company shares that have been purchased by a subsidiary are reported as treasury stock in the consolidated balance sheet. The carrying value of the shares is the amount paid by the subsidiary when they were purchased. Q9-12 Consolidated net income will be reduced by $100,000. Income assigned to the controlling interest will be reduced by $72,000 ($100,000 x 0.90 x 0.80) when the unrealized profit of Tiny Corporation is eliminated. A total of $10,000 is treated as a reduction to the income assigned to noncontrolling shareholders of Tiny Corporation ($100,000 x 0.10) and $18,000 is a reduction of the income assigned to noncontrolling shareholders of Subsidiary Company ($100,000 x 0.90 x 0.20). Q9-13 All three companies should be included in the consolidated financial statements. Slide Company should be consolidated with Bit Company because Bit holds majority ownership of Slide. Bit Company, in turn, should be consolidated with Snapper Corporation because Snapper holds majority ownership of Bit. Q9-14 A subsidiary's stock dividend results in the capitalization of some portion of its retained earnings. Such an action will have no effect on the consolidated financial statements since the entire stockholders' equity section of the subsidiary is eliminated in preparing the consolidation worksheet. Q9-15 A 15 percent stock dividend is a small stock dividend and must be recorded by capitalizing retained earnings equal to the market price per share of the stock times the number of shares actually issued. As a result, retained earnings will decrease and the par value of stock outstanding and additional paid-in capital will increase on the subsidiary's books. There should be no change in the investment account balance reported by the parent. Thus, the only change in the Consolidation entries is the relative amount debited to each of the three individual stockholders' equity accounts of the subsidiary.

Chapter 9 – Consolidation Ownership Issues

Q9-16 When the parent or other affiliates own all the shares of all companies included in the consolidation, the order in which the consolidation is completed may not be particularly critical. On the other hand, when less than 100 percent ownership is held there is a much greater chance of error in apportioning unrealized profits or other adjustments between noncontrolling ownership and consolidated net income when some other sequence is used. By starting the consolidation with the company furthest away from the parent, the computation of income assigned to noncontrolling interest at each level can be most easily accomplished.

SOLUTIONS TO CASES C9-1 Effect of Subsidiary Preferred Stock When a parent company does not own all the shares of a subsidiary, income assigned to the noncontrolling interest includes (1) a portion of subsidiary preferred dividends and (2) a portion of earnings available to common shareholders. To determine the amount of income to assign to preferred and common shareholders of the subsidiary, the controller needs to have the following information about the preferred stock: 1. The number of preferred shares outstanding and the number owned by the parent and other affiliates. 2. The annual preferred dividend rate per share and whether the dividends are cumulative or noncumulative. 3. If the dividends are noncumulative, the amount of preferred dividends declared during the period, if any. In this particular case the parent does not appear to own any of the subsidiary's preferred shares. Once the controller determines the portion of subsidiary income assignable to common shareholders, consolidated net income attributable to the controlling interest is computed by adding the parent's pro rata share of this amount to the parent's income from its own operations. C9-2 Consolidated Stockholders’ Equity: Theory vs. Practice a. Upon the sale of stock of a subsidiary, Xerox used to recognize a gain or loss in the consolidated income statement equal to the company’s proportionate share of the corresponding increase or decrease in that subsidiary’s equity. Under ASC 810-10-55-4H, the sale of subsidiary shares is viewed as an equity transaction and does not affect income. Instead, the difference between the fair value of the consideration received and the change in the amount of the noncontrolling interest is recognized as an adjustment to stockholders’ equity (usually additional paid-in capital).

b. Occidental Petroleum has generally treated subsidiary preferred stock as a liability (the amount is small). ASC 480-10-25 gives specific guidance on whether or not to treat preferred stock as a liability. Consequently, Occidental's subsidiary preferred stock should be reported as part of the noncontrolling interest. 9-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 9 – Consolidation Ownership Issues

C9-3 Sale of Subsidiary Shares MEMO To:

Robert Reader Vice President of Finance Book Corporation

From: Re:

, CPA Recognition of Gain on Sale of Subsidiary Shares

The FASB’s recent issuance of ASC 810-10-55-4H makes clear that, from a consolidated perspective, a parent’s sale of subsidiary shares while maintaining control is an equity transaction. Accordingly, no gain or loss on the sale should be reported in the consolidated income statement. Instead, equity should be adjusted by the difference between the consideration received and the change in the parent’s subsidiary interest. In the current situation, Book’s interest in Lance prior to its sale of Lance shares was $360,000, an amount equal to 90 percent of Lance’s $400,000 book value. Immediately following the sale of Lance shares, Book’s remaining 60 percent interest in Lance is $240,000 ($400,000 x 0.60), a decrease of $120,000 ($360,000 - $240,000). The difference between the proceeds received and the change in the book value of Book’s interest in Lance is as follows: Proceeds received ($5.60 x 30,000 shares) Change in book value of interest ($360,000 - $240,000) Required adjustment to equity

$168,000 120,000 $ 48,000

This $48,000 difference should be reported within equity in the consolidated balance sheet. Although alternatives exist in terms of how to meet the FASB’s reporting requirement, the following entry to record the sale of shares on Book’s books would be consistent with the FASB’s requirement and probably the most efficient approach: Cash Investment in Lance Company Stock Additional Paid-In Capital

168,000 120,000 48,000

The additional paid-in capital recorded on Book’s books would carry over to the consolidated balance sheet and would be included in consolidated equity. If Book elected to record a $48,000 gain on the sale of Lance shares instead of recognizing additional paid-in capital as shown in the entry, that gain would have to be transferred to additional paid-in capital in the preparation of consolidated financial statements. Primary citation: ASC 810-10-55-4H

Chapter 9 – Consolidation Ownership Issues

C9-4 Sale of Subsidiary Shares (a) With a sale of shares to a nonaffiliate, net resources have been brought into the consolidated entity and the noncontrolling shareholders have an additional claim. The excess of the proceeds received from the sale over the change in the parent’s interest in the subsidiary increases the amount of additional paid-in capital reported in the consolidated balance sheet. A sale of subsidiary shares to a nonaffiliate also changes the amount of income assigned to the noncontrolling interest in the consolidated income statement and the amount of net assets assigned to the noncontrolling interest in the consolidated balance sheet. (b) When a parent sells shares of one subsidiary to another subsidiary, net resources to the consolidated entity do not change. Therefore, there should be no change in the reported equity of the consolidated entity. A change in the claim of the noncontrolling interest is likely to occur if the subsidiary that purchases the shares is not wholly owned. As a result, there may be some change in consolidated income and the balance sheet totals assigned to noncontrolling interest. C9-5 Reciprocal Ownership A great many factors beyond the immediate impact on reported earnings may be important in deciding on the use of the funds. Items such as the following should be considered: 1. Are the excess funds held by Thorson available only temporarily or are they not likely to be needed in the foreseeable future? 2. Will there be any regulatory or taxation problems associated with one or more of the alternatives? 3. Can shares of the companies be purchased in the desired quantities and at existing market prices or are there potential difficulties associated with one or more alternatives? 4. Is it desirable to acquire more shares of either subsidiary since controlling ownership already is in the hands of Strong Manufacturing? 5. Have the noncontrolling shareholders of either subsidiary been troublesome or caused the parent to refrain from actions that it might otherwise have taken? With the information given, it is difficult to determine which action will have the most favorable impact on consolidated net income. The earnings of each company, the number of shares outstanding, and the relative market prices of the shares each will have an effect. In general, reported income is maximized by purchasing the shares with the lowest price-earnings ratio.

Chapter 9 – Consolidation Ownership Issues

C9-6 Complex Organizational Structures a. Atlas America is a corporation. Its operations involve the development, production, and distribution of natural gas, and to a lesser extent, oil. It also offers tax-advantaged investment programs for gas and oil investors. b. The subsidiaries of Atlas America include corporations, limited liability companies (LLCs), and both general and limited partnerships. The company fully consolidates its subsidiaries. In accordance with industry practice, the company reflects its interests in energy partnerships in its consolidated statements using pro rata consolidation. c. Atlas Pipeline Holdings is a subsidiary of Atlas America. It has complete ownership of Atlas Pipeline Partners GP, LLC, a limited liability company that is the general partner of Atlas Pipeline Partners, L.P. The only cash generating assets of Atlas Pipeline Holdings are its indirect interests in Atlas Pipeline Partners, L.P. d. Atlas Pipeline Partners, L.P. is a partnership, specifically a publicly-traded limited partnership. A limited partnership must have at least one general partner with unlimited liability, and it may have numerous limited partners whose liability is limited and may not participate in the management of the partnership. Atlas Pipeline Partners, L.P. has a number of subsidiaries, including general and limited partnerships, corporations, and limited liability companies. Limited liability companies, in general, have the advantages of corporations with less of the formalities. They often have certain tax advantages over corporations. Atlas Pipeline Partners, L.P. is managed by its general partner, Atlas Pipeline Partners GP, LLC. The executives responsible for Atlas Pipeline’s management are employees of Atlas America, as indicated in Atlas Pipeline’s Form 10-K, in the item entitled Directors and Executive Officers of the Registrant. These employees not only manage Atlas Pipeline Partners, L.P., but also Atlas America and its other affiliates. e. Atlas Pipeline Partners, L.P. presents consolidated financial statements in which it consolidates all of its wholly-owned and majority-owned subsidiaries. NOARK Pipeline System is a limited partnership that is 100 percent owned by Atlas Pipeline Partners. Prior to 2006, Atlas Pipeline Partners owned 75 percent of NOARK. Atlas consolidates 100 percent of NOARK, and previously also consolidated 100 percent of NOARK even though it was only 75 percent owned.

Chapter 9 – Consolidation Ownership Issues

SOLUTIONS TO EXERCISES E9-1 Multiple-Choice Questions on Preferred Stock Ownership 1. d –

$50,000 = $20,000 + $30,000

2. c –

$29,000 = $20,000 + 0.30($30,000)

3. b –

Only the retained earnings of the parent company is included.

4. a –

The portion held by the parent is eliminated when the preferred investment is eliminated, and the portion held by nonaffiliates is eliminated and included with the balance reported as noncontrolling interest in the consolidated balance sheet.

E9-2 Multiple-Choice Questions on Multilevel Ownership 1. b –

$188,000 = $100,000 + 0.80[$80,000 + (0.60 x $50,000)]

2. b –

$20,000 = 0.40 x $50,000

3. c –

$22,000 = 0.20 x [$80,000 + (0.60 x $50,000)]

4. c –

$42,000 = (0.40 x $50,000) + {0.20 x [$80,000 + (0.60 x $50,000)]}

5. b –

$2,400 = 0.80 x {0.60 x [($150,000 + $100,000 - $200,000) / 10 years)]}

E9-3 Acquisition of Preferred Shares Basic Consolidation Entry: Preferred Stock

100,000

Common Stock

50,000

Retained Earnings

150,000

Investment in Separate CS

140,000

Investment in Separate PS

60,000

NCI in NA of Separate

100,000

Chapter 9 – Consolidation Ownership Issues

E9-4 Reciprocal Ownership [AICPA Adapted] a.

None of Simba's dividends is reported in the consolidated statements. All of Simba's dividends are eliminated in the consolidation process.

Only 90 percent of Pride's dividends are included in the consolidated retained earnings statement. The dividend payment on the 10 percent owned by Simba is an intercompany payment to an affiliate and must be eliminated in the consolidation process.

E9-5 Subsidiary with Preferred Stock Outstanding Basic Consolidation Entry: Preferred Stock Common Stock Retained Earnings Investment in Sandbox CS Investment in Sandbox PS NCI in NA of Sandbox

200,000 150,000 210,000 270,000 80,000 210,000

E9-6 Subsidiary with Preferred Stock Outstanding a.

Entries recorded by Playtown Corporation: Investment in Sandbox Common Stock Investment in Sandbox Preferred Stock Cash Record purchase of Sandbox stock.

270,000 80,000 350,000

Cash 25,500 Investment in Sandbox Common Stock 25,500 Record dividends from Sandbox: $25,500 = ($50,000 - $16,000) x 0.75 Cash 6,400 Dividend Income 6,400 Record dividends on preferred stock from Sandbox: $16,000 x 0.40 Investment in Sandbox Common Stock 40,500 Income from Sandbox Co. 40,500 Record equity-method income: $40,500 = ($70,000 - $16,000) x 0.75

Chapter 9 – Consolidation Ownership Issues

E9-6 (continued) b. Consolidation Entries: Book Value Calculations:

NCI 60%/25% Beginning Book Value

210,000

Inv. PS 40%

Pref. Div. Income 40%

80,000

23,100

6,400

- Preferred Dividends

(9,600)

(6,400)

(8,500)

Ending Book Value

215,000

Inv. CS 75% 270,000

+ Net Income - Common Dividends

Preferred Stock 200,000

Common Stock

150,000

40,500

70,000

285,000

(34,000) 200,000

150,000

Basic Consolidation Entry: Preferred Stock Common Stock Retained Earnings Income from Sandbox Co. Dividend Income--Preferred NCI in NI of Sandbox Co. Dividends Declared, Preferred Dividends Declared, Common Investment in Sandbox Co. CS Investment in Sandbox Co. PS NCI in NA of Sandbox Co.

210,000 (16,000)

(25,500) 80,000

Retained Earnings

200,000 150,000 210,000 40,500 6,400 23,100 16,000 34,000 285,000 80,000 215,000

230,000

Chapter 9 – Consolidation Ownership Issues

E9-7 Preferred Dividends and Call Premium a.

Saw Company's contribution to 20X2 consolidated net income is equal to its reported net income of $70,000.

Income assigned to noncontrolling interest: Preferred shares [0.40($100,000 x 0.12)] Common shares {0.10[$70,000 - ($100,000 x 0.12)]} Total income assigned to noncontrolling interest

$ 4,800 5,800 $10,600

Retained earnings assignable to preferred shareholders: Dividends in arrears [5 years x ($100,000 x 0.12)] Call feature ($2 x 10,000 shares) Total retained earnings assigned to preferred stock

Book value of common shares: Par value of common shares outstanding Retained earnings balance Less: Balance assigned to preferred shares Book value of common shares

$60,000 20,000 $80,000

$300,000 $380,000 (80,000)

300,000 $600,000

Total noncontrolling interest: Preferred stock [0.40($100,000 + $80,000)] Common stock (0.10 x $600,000) Total noncontrolling interest

$ 72,000 60,000 $132,000

Chapter 9 – Consolidation Ownership Issues

E9-8 Multilevel Ownership a.

Consolidated net income for 20X6 is $190,000 ($90,000 + $40,000 + $60,000).

Income of $36,800 is assigned to the noncontrolling interest: Income from Brother ($40,000 x 0.35) Income from Sister [($60,000 + $16,000) x 0.30] Total income assigned to noncontrolling interest

Income of $153,200 is assigned to the controlling interest: Consolidated net income Less: Income assigned to noncontrolling interest Income assigned to controlling interest

$14,000 22,800 $36,800

$190,000 (36,800) $153,200

Only the $45,000 of dividends paid by Parent Corporation to its shareholders will be reported as dividends declared in Parent’s 20X6 consolidated retained earnings statement.

Chapter 9 – Consolidation Ownership Issues

E9-9 Consolidation Entries for Multilevel Ownership a.

Journal entries recorded by Brown Corporation on its investment in Coral Company: (1)

(2)

(3)

Investment in Coral Company Stock Cash Record purchase of Coral Company stock.

120,000 120,000

Cash 9,000 Investment in Coral Company Stock Record dividends from Coral Company: $15,000 x 0.60

9,000

Investment in Coral Company Stock Income from Coral Company Record equity-method income: $40,000 x 0.60

24,000

Journal entries recorded by Azure Enterprises on its investment in Brown Corporation: (1)

(2)

(3)

Investment in Brown Corporation Stock Cash Record purchase of Brown Corporation stock.

315,000 315,000

Cash 45,000 Investment in Brown Corporation Stock Record dividends from Brown Corporation: $50,000 x 0.90

45,000

Investment in Brown Corporation Stock 129,600 Income from Brown Corporation Record equity-method income: ($120,000 + $24,000) x 0.90

129,600

c. Book Value Calculations: + Beginning Book Value + Net Income - Dividends Ending Book Value

NCI 40% 80,000 16,000 (6,000) 90,000

Brown Corp. 60% 120,000 24,000 (9,000) 135,000

Common Stock 100,000

100,000

Add. Paid-In Capital 60,000

60,000

Retained Earnings 40,000 40,000 (15,000) 65,000

Basic Consolidation Entry: Common Stock Additional Paid-in capital Retained Earnings Income from Coral Co. NCI in NI of Coral Co. Dividends Declared Investment in Coral Co. NCI in NA of Coral Co.

100,000 60,000 40,000 24,000 16,000 15,000 135,000 90,000

Chapter 9 – Consolidation Ownership Issues

E9-9 (continued) Book Value Calculations: + NCI 10% Beginning Book Value + Net Income - Dividends Ending Book Value

35,000 14,400 (5,000) 44,400

Azure 90%

Common Stock

Add. + Paid-In Capital

150,000

60,000

150,000

60,000

315,000 129,600 (45,000) 399,600

Retained Earnings 140,000 144,000 (50,000) 234,000

Basic Consolidation Entry: Common Stock Additional Paid-in Capital Retained Earnings Income from Brown Corp. NCI in NI of Brown Corp. Dividends Declared Investment in Brown Corp. NCI in NA of Brown Corp.

150,000 60,000 140,000 129,600 14,400 50,000 399,600 44,400

E9-10 Reciprocal Ownership Operating income of Grower Supply Corporation Operating income of Schultz Company Consolidated net income Less: Income to noncontrolling interest: ($50,000 x 0.15) Income to controlling interest

$112,000 50,000 $162,000 (7,500) $154,500

Chapter 9 – Consolidation Ownership Issues

E9-11 Consolidated Balance Sheet with Reciprocal Ownership Basic Consolidation Entry: Common Stock Retained Earnings Investment in Short Co. NCI in NA of Short Co.

200,000 240,000

Treasury Stock Investment in Talbott Co.

61,000

Balance Sheet Cash Accounts Receivable Inventory Buildings & Equipment (net) Investment in Short Co. Investment in Talbott Co. Total Assets Accounts Payable Bonds Payable Common Stock Retained Earnings Treasury Stock NCI in NA of Short Co. Total Liabilities & Equity

352,000 88,000

61,000

Talbott Co.

Short Co.

78,000 120,000 150,000

39,000 80,000 120,000

400,000 352,000

300,000

1,100,000

61,000 600,000

90,000 400,000 300,000 310,000

60,000 100,000 200,000 240,000

1,100,000

600,000

Consolidation Entries DR CR

Consolidated 117,000 200,000 270,000

352,000 61,000 413,000

700,000 0 0 1,287,000

88,000

150,000 500,000 300,000 310,000 (61,000) 88,000

88,000

1,287,000

200,000 240,000 61,000

501,000

Chapter 9 – Consolidation Ownership Issues

E9-11 (continued) Talbott Company and Subsidiary Consolidated Balance Sheet December 31, 20X9 Current Assets: Cash Accounts Receivable Inventory Noncurrent Assets: Buildings and Equipment (net) Total Assets Current Liabilities: Accounts Payable Bonds Payable Stockholders' Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Equity before Reduction for Treasury Shares Less: Treasury Shares Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

$117,000 200,000 270,000

587,000

700,000 $1,287,000

$ 150,000 500,000 $300,000 310,000 $610,000 88,000 $698,000 (61,000) 637,000 $1,287,000

Chapter 9 – Consolidation Ownership Issues

E9-12 Subsidiary Stock Dividend a.

Stake Company: Stock Dividends Declared Common Stock

40,000 40,000

Pole Company: No entry required. b. Book Value Calculations: NCI 30% Beginning Book Value

Pole Co. 70%

90,000

210,000

Common Stock

100,000

Retained Earnings 200,000

+ Net Income

7,500

17,500

25,000

- Dividends

(3,000)

(7,000)

(10,000)

-Stock Dividend Ending Book Value

94,500

220,500

40,000

(40,000)

140,000

175,000

Basic Consolidation Entry: Common Stock

140,000

Retained Earnings

200,000

Income from Stake Co.

17,500

NCI in NI of Stake Co.

7,500

Dividends Declared

10,000

Stock Dividends Declared

40,000

Investment in Stake Co.

220,500

NCI in NA of Stake Co.

94,500

c. Book Value Calculations: NCI 30%

Pole Co. 70%

Common Stock

Retained Earnings

Beginning Book Value

94,500

220,500

140,000

175,000

Total

94,500

220,500

140,000

175,000

Basic Consolidation Entry: Common Stock

140,000

Retained Earnings

175,000

Investment in Stake Co.

220,500

NCI in NA of Stake Co.

94,500

Chapter 9 – Consolidation Ownership Issues

E9-13 Sale of Subsidiary Shares by Parent a.

Investment in Salty Concrete Works, January 1, 20X5: Purchase price $360,000 Salty net income in 20X3 and 20X4 $100,000 Dividends paid by Salty in 20X3 and 20X4 (40,000) $ 60,000 Proportion of stock held by Pepper x 0.80 48,000 Balance prior to sale of shares $408,000

Journal entry recorded by Pepper Home Builders for sale of shares: Cash 120,000 Investment in Salty Concrete Works Additional Paid-in Capital $102,000 = $408,000 x 4,000 / [($200,000 / $10) x 0.80]

102,000 18,000

Consolidation entries:

Book Value Calculations: NCI 40%

Pepper 60%

Common Stock 200,000

Retained Earnings

Beginning Book Value

204,000

306,000

+ Net Income

20,000

30,000

50,000

- Dividends

(8,000)

(12,000)

(20,000)

Ending Book Value

216,000

324,000

200,000

310,000

340,000

Basic Consolidation Entry: Common Stock

200,000

Retained Earnings

310,000

Income from Salty

30,000

NCI in NI of Salty

20,000

Dividends Declared

20,000

Investment in Salty

324,000

NCI in NA of Salty

216,000

Chapter 9 – Consolidation Ownership Issues

E9-14 Purchase of Additional Shares from Nonaffiliate a. Purchase price, December 31, 20X7 Split Products Company net income for 20X8 ($230,000 + $20,000 - $200,000) Proportion of stock held by Peel Income from subsidiary Dividend received from Split Products Company ($20,000 x 0.60) Balance in investment account, December 31, 20X8 b.

Balance in investment account, December 31, 20X8 Purchase of additional shares on January 1, 20X9 Investment balance January 1, 20X9, after purchase Split Products Company net income for 20X9 ($280,000 + $20,000 - $230,000) Proportion of stock held by Peel Less: Amortization of differential on stock purchased January 1, 20X9: ($20,000 / 10 years) Income from subsidiary Dividend received from Split Products Company ($20,000 x 0.80) Balance in investment account, December 31, 20X9

$210,000 $50,000 x 0.60 30,000 (12,000) $228,000 $228,000 96,000 $324,000 $70,000 x 0.80 $56,000 (2,000) 54,000 (16,000) $362,000

Chapter 9 – Consolidation Ownership Issues

E9-14 (continued): c.

Consolidation entries: Book Value Calculations:

Beginning Book Value + Net Income - Dividends Ending Book Value

NCI 20% 76,000 14,000 (4,000) 86,000

Basic Consolidation Entry Common Stock Retained Earnings Income from Split Products Co. NCI in NI of Split Products Co. Dividends Declared Investment in Split Products Co. NCI in NA of Split Products Co. Excess Value (Differential) Calculations: Peel Corp. 100% Beginning balance 20,000 Changes (2,000) Ending balance 18,000

Peel Corp. 80% 304,000 56,000 (16,000) 344,000

Common Stock 150,000

150,000

Retained Earnings 230,000 70,000 (20,000) 280,000

150,000 230,000 56,000 14,000 20,000 344,000 86,000

Patents 20,000 (2,000) 18,000

Note: Although Peel Corp. owns 80 percent of the common stock, the entire differential related to patents is attributed to Peel since the differential only arose for the 20X9 stock purchase. Amortized Excess Value Reclassification Entry: Amortization Expense 2,000 Income from Split Products Co.

2,000

Excess Value (Differential) Reclassification Entry: Patents 18,000 Investment in Split Products Co.

18,000

Chapter 9 – Consolidation Ownership Issues

E9-15 Repurchase of Shares by Subsidiary from Nonaffiliate a.

Book value of shares held before treasury stock repurchase by Seed ($500,000 x 0.40) Less: Book value of Seed stock outstanding Cost of treasury shares repurchased Book value of remaining shares outstanding Proportion of remaining shares held by noncontrolling Interest (2,000 / 8,000) Adjusted book value of shares held Reduction of noncontrolling interest Consideration given by Seed Manufacturing Increase in equity attributable to parent Investment in Seed Manufacturing Additional Paid-In Capital

200,000 $500,000 (84,000) $416,000 x

0.25 $104,000 $ 96,000 (84,000) $ 12,000

12,000 12,000

c. Book Value Calculations: NCI 40/25%

Plant 60/75%

Beg. Book Value

200,000

300,000

Shares Repurchased

(96,000)

12,000

Ending Book Value

104,000

312,000

Com. Stock 100,000

Add. Paid-In Capital

Treasury Stock

150,000

Retained Earnings 250,000

(84,000) 100,000

150,000

(84,000)

250,000

Basic Consolidation Entry: Common Stock

100,000

Additional Paid-in Capital

150,000

Retained Earnings

250,000

Treasury Stock

84,000

Investment in Seed

312,000

NCI in NA of Seed

104,000

Chapter 9 – Consolidation Ownership Issues

E9-16 Sale of Shares by Subsidiary to Nonaffiliate a.

Computation of change in book value of Schroeder Corporation shares held by Pro Corporation:

Common stock, $10 par value Additional paid-in capital Retained earnings Total stockholders' equity of Schroeder Proportion of stock¯ held by Pro Corporation: 11,000 / 15,000 11,000 / (15,000 + 5,000) Book value of shares

Before Sale

After Sale

$150,000 50,000 400,000 $600,000

$ 200,000 400,000 400,000 $1,000,000

x 0.7333 $440,000

Increase in book value of shares held by Pro Corporation b.

x .550 $ 550,000 $ 110,000

Investment in Schroeder Corporation Additional Paid-In Capital

110,000 110,000

c. Book Value Calculations: NCI 26.7/45%

Pro Corp. 73.3/55%

Common Stock

Add. Paid-In Capital

Beginning Book Value

160,000

440,000

150,000

50,000

New Shares

290,000

110,000

50,000

350,000

Ending Book Value

450,000

550,000

200,000

400,000

Retained Earnings 400,000 400,000

Basic Consolidation Entry: Common Stock

200,000

Additional Paid-in Capital

400,000

Retained Earnings

400,000

Investment in Schroeder Corp.

550,000

NCI in NA of Schroeder Corp.

450,000

Chapter 9 – Consolidation Ownership Issues

SOLUTIONS TO PROBLEMS P9-17 Multiple-Choice Questions on Preferred Stock Ownership 1. d –

2. b –

Book value of shares held by noncontrolling interest: Preferred stock ($100,000 x 0.30) Common stock [($200,000 + $50,000) x 0.20] Total book value Income to noncontrolling preferred shareholders [($100,000 x 0.10) x 0.30] Income to noncontrolling common shareholders: Reported net income of Surf Company Income to preferred shareholders Income to common shareholders Proportion of common stock owned by noncontrolling interest Total income to noncontrolling interest

3. b –

Reported net income of Surf Company Operating income of Palace Company Consolidated net income Less: Income to noncontrolling interest Income to controlling interest

4. c –

Controlling interest: Common stock Retained earnings Total controlling interest Noncontrolling interest: ($250,000 x 0.20) + ($100,000 x 0.30) Total stockholders’ equity

5. a –

$30,000 50,000 $80,000

$3,000 $30,000 (10,000) $20,000 x

0.20

4,000 $7,000 $ 30,000 100,000 $130,000 (7,000) $123,000

$ 300,000 350,000 $ 650,000 80,000 $730,000

All preferred shares of the subsidiary are eliminated in preparing the consolidated financial statements.

Chapter 9 – Consolidation Ownership Issues

P9-18 Multilevel Ownership with Differential a.

Journal entries recorded by Beet Corporation on its investment in Corn Company: Investment in Corn Company Cash Record purchase of Corn Company stock.

406,000 406,000

Cash 14,000 Investment in Corn Company Record dividends from Corn Company: $20,000 x 0.70

14,000

Investment in Corn Company Income from Corn Company Record equity-method income: $30,000 x 0.70

21,000

Income from Corn Company 2,100 Investment in Corn Company 2,100 Amortize differential related to buildings and equipment: ($30,000 / 10 years) x 0.70 b.

Journal entries recorded by Acorn Corporation on its investment in Beet Corporation: Cash 20,000 Investment in Beet Corporation Record dividends from Beet Corporation: $25,000 x 0.80

20,000

Investment in Beet Corporation 63,120 Income from Beet Corporation Record equity-method income: ($60,000 + $18,900) x 0.80

63,120

Income from Beet Corporation 8,000 Investment in Beet Corporation Amortize differential related to trademark: ($50,000 / 5 years) x 0.80

8,000

Chapter 9 – Consolidation Ownership Issues

P9-18 (continued) c. Consolidation Entries Book Value Calculations:

Beginning Book Value + Net Income - Dividends Ending Book Value

NCI 30% 165,000 9,000 (6,000) 168,000

Basic Consolidation Entry: Common Stock Retained Earnings Income from Corn Co. NCI in NI of Corn Co. Dividends Declared Investment in Corn Co. NCI in NA of Corn Co.

Beet Corp. 70% 385,000 21,000 (14,000) 392,000

Common Stock 250,000

250,000

Retained Earnings 300,000 30,000 (20,000) 310,000

250,000 300,000 21,000 9,000 20,000 392,000 168,000

Excess Value (Differential) Calculations:

Beginning Balance Changes Ending Balance

NCI 30% 9,000 (900) 8,100

Beet Corp. 70% 21,000 (2,100) 18,900

Buildings and Equipment 30,000 30,000

Amortized Excess Value Reclassification Entry: Depreciation Expense 3,000 Income from Corn Co. NCI in NI of Corn Co.

2,100 900

Excess Value (Differential) Reclassification Entry: Buildings and Equipment 30,000 Accumulated Depreciation Investment in Corn Co. NCI in NA of Corn Co.

3,000 18,900 8,100

Acc. Depr. 0 (3,000) (3,000)

Chapter 9 – Consolidation Ownership Issues

P9-18 (continued) Book Value Calculations:

Beginning Book Value + Net Income - Dividends Ending Book Value

NCI 20% 134,000 15,780 (5,000) 144,780

Acorn Corp. 80% 536,000 63,120 (20,000) 579,120

Common Stock 400,000

400,000

Retained Earnings 270,000* 78,900 (25,000) 323,900

* BB 1/1/X1 $200,000 + 60,000 NI – 25,000 Div = $235,000 12/31/X1 * BB 1/1/X2 $235,000 + 60,000 NI – 25,000 Div = $270,000 12/31/X2 (1/1/X3) Basic Consolidation Entry: Common Stock Retained Earnings Income from Beet Corp. NCI in NI of Beet Corp. Dividends Declared Investment in Beet Corp. NCI in NA of Beet Corp.

400,000 270,000 63,120 15,780

Excess Value (Differential) Calculations: NCI Acorn Corp. 20% + 80% Beginning Balance 6,000 24,000 Changes (2,000) (8,000) Ending Balance 4,000 16,000

25,000 579,120 144,780

Trademark 30,000* (10,000) 20,000

* $50,000 Acquisition date differential - 10,000 20X1 amortization - 10,000 20X2 amortization $30,000 Beginning balance 1/1/X3 Amortized Excess Value Reclassification Entry: Amortization Expense 10,000 Income from Beet Corp. NCI in NI of Beet Corp.

8,000 2,000

Excess Value (Differential) Reclassification Entry: Trademark 20,000 Investment in Beet Corp. NCI in NA of Beet Corp.

16,000 4,000

Chapter 9 – Consolidation Ownership Issues

P9-19 Subsidiary Stock Dividend Alternative 1: Sound Manufacturing stock is split 2:1. Book Value Calculations:

Beginning Book Value -Stock Dividend Ending Book Value

NCI 32% 144,000

144,000

Promis e Sales 68% 306,000

306,000

Commo n Stock 100,000 0 100,000

Add. Paid-In Capital 70,000

70,000

Retained Earning s 280,000 0 280,000

Basic Consolidation Entry: Common Stock Additional Paid-in Capital Retained Earnings Investment in Sound NCI in NA of Sound

100,000 70,000 280,000 306,000 144,000

Alternative 2: A stock dividend of 4,000 shares is issued (large stock dividend) Book Value Calculations:

Beginning Book Value -Stock Dividend Ending Book Value

NCI 32% 144,000

144,000

Promise Sales 68% 306,000 306,000

= Common Stock 100,000 40,000 140,000

Add. Paid-In Capital 70,000

70,000

Retained Earnings 280,000* (40,000)* 240,000*

* This is an example of a large stock dividend (similar to the one illustrated in the chapter). The entry only involves a transfer of the par value of the shares (4,000 X $10) from Retained Earnings to Common Stock.

Basic Consolidation Entry: Common Stock Additional Paid-in Capital Retained Earnings Investment in Sound NCI in NA of Sound

140,000 70,000 240,000 306,000 144,000

Alternative 3: A stock dividend of 1,500 shares is issued (small stock dividend) Book Value Calculations:

Beginning Book Value -Stock Dividend Ending Book Value

NCI 32% 144,000 144,000

Promis e Sales 68% 306,000 306,000

Commo n Stock 100,000 15,000 115,000

Add. Paid-In Capital 70,000 60,000 130,000

Retained Earning s 280,000* (75,000)* 205,000*

* This is an example of a small stock dividend (not specifically illustrated in the chapter). The entry involves a transfer of the fair value of the shares (1,500 X $50) from Retained Earnings to Common Stock and APIC.

Chapter 9 – Consolidation Ownership Issues

Basic Consolidation Entry: Common Stock Additional Paid-in Capital Retained Earnings Investment in Sound NCI in NA of Sound

115,000 130,000 205,000 306,000 144,000

P9-20 Subsidiary Preferred Stock Outstanding a. Calculation of Preferred/Common Equity Preferred Interest 200,000

Preferred Stock Common Stock Retained Earnings* Total Platinum % interest 40% Preferred/70% Common NCI % interest 60% Preferred/30% Common

Common Interest

32,000 232,000

150,000 168,000 318,000

92,800

222,600

139,200

95,400

*Preferred dividends are two years in arrears so that amount must be allocated to the preferred shareholders from retained earnings.

Total NCI interest = 234,600 (139,200 Preferred interest + 95,400 Common interest) Book Value Calculations: NCI 60%/30% Book Value

234,600

Inv. PS 40% 92,800

Inv. CS 70% 222,600

Pref. Stock 200,000

Com. Stock 150,000

Ret. Earn. 200,000

Basic Consolidation Entry: Preferred Stock

200,000

Common Stock

150,000

Retained Earnings

200,000

Investment in Silver Co. CS

222,600

Investment in Silver Co. PS

92,800

NCI in NA of Silver Co.

234,600

Chapter 9 – Consolidation Ownership Issues

Consolidated net income and income to controlling interest: Operating income of Platinum Corporation Net income of Silver Consolidated net income Income to noncontrolling interest: Income from preferred stock of Silver Company ($16,000 x 0.60) Income from common stock of Silver Company [($34,000 - $16,000) x 0.30] Income to noncontrolling interest Income to controlling interest Alternate computation of income to controlling interest Operating income of Platinum Corporation Income from preferred stock of Silver Company ($16,000 x 0.40) Income from common stock of Silver Company [($34,000 - $16,000) x 0.70] Income to controlling interest

$ 80,000 34,000 $114,000 $ 9,600 5,400 (15,000) $ 99,000

$80,000 6,400 12,600 $99,000

P9-21 Ownership of Subsidiary Preferred Stock a.

Preferred stockholders' claim on net assets of Sammy: Liquidation value of preferred stock ($101 per share) 20X6 dividends in arrears ($200,000 x 0.10) Total preferred stockholder claim, December 31, 20X6

Book value of Sammy common shares acquired by Presley: Total Sammy stockholders' equity, December 31, 20X6 Claim of preferred stockholders Book value of Sammy common stock Portion acquired by Presley Book value of common shares acquired by Presley

$202,000 20,000 $222,000

$3,155,000 (222,000) $2,933,000 x 0.60 $1,759,800

Goodwill associated with acquisition of common shares: Consideration given by Presley to acquire shares Fair value of noncontrolling interest in common shares Total fair value Book value of common shares Goodwill

$1,800,000 1,200,000 $3,000,000 (2,933,000) $ 67,000

Chapter 9 – Consolidation Ownership Issues

Income to noncontrolling interest, 20X7: Sammy net income Less: impairment of goodwill Less: 20X7 preferred dividends ($200,000 x 0.10) Income accruing to common shareholders Noncontrolling common shareholders' interest Income to noncontrolling common shareholders Preferred dividends to noncontrolling shareholders ($20,000 x 0.80) Total income to noncontrolling shareholders

16,000 $109,600

Presley's income from investment in subsidiary common stock: Sammy net income Less: 20X7 preferred dividends ($200,000 x 0.10) Less: impairment of goodwill Income accruing to common shareholders Presley's proportionate share Presley's share of income to common shareholders

$280,000 (26,000) (20,000) $234,000 x 0.40 $ 93,600

$280,000 (20,000) (26,000) $234,000 x 0.60 $140,400

Noncontrolling interest, December 31, 20X7: Total amount assigned to noncontrolling interest: Noncontrolling interest - common Noncontrolling interest - preferred Total noncontrolling interest

$1,289,600 161,600 $1,451,200

Assigned to noncontrolling interest - common Sammy stockholders' equity, January 1, 20X7 20X7 net income Less: Preferred dividends Less: Common dividends Total Sammy stockholders' equity, December 31, 20X7 Claim of preferred stockholders Book value of Sammy' common stock Unimpaired goodwill at December 31, 20X7 ($67,000 - $26,000) Total basis for common shareholders Noncontrolling stockholders' interest Noncontrolling interest — common

$3,155,000 280,000 (40,000) (10,000) $3,385,000 (202,000) $3,183,000 41,000 $3,224,000 x 0.40 $1,289,600

Assigned to noncontrolling interest - preferred Total Sammy preferred stockholders' equity, January 1, 20X7 Less: Dividends in arrears paid during 20X7 Sammy preferred stockholders' equity, December 31, 20X7 Noncontrolling stockholders' interest Noncontrolling interest — preferred

$222,000 (20,000) $202,000 x 0.80 $161,600

Chapter 9 – Consolidation Ownership Issues

P9-21 (continued) g. Consolidation entries: Book Value Calculations:

NCI 80%/20% Beginning Book Value + Net Income - Preferred Dividends - Common Dividends Ending Book Value

1,350,800

Inv. PS 20%

Pref. Div. Income 20%

44,400 4,000 (4,000)

Pref. Stock 205,000

Com. Stock 1,300,000

156,000

1,909,800

205,000

1,300,000

200,000

Premium on Preferred Stock

5,000

Common Stock

500,000

Additional Paid-In Capital

800,000

Retained Earnings

1,650,000

Income from Sammy Swim

156,000

Dividend Income--Preferred

4,000

NCI in NI of Sammy Swim

120,000

Dividends declared, Preferred

40,000

Dividends declared, Common

10,000

Investment in Sammy Swim CS

1,909,800

Investment in Sammy Swim PS

40,400

NCI in NA of Sammy Swim

1,434,800

Excess Value (Differential) Calculations: Presley Pools NCI 40% + 60%

Goodwill

Beginning Balance

26,800

40,200

67,000

Changes

(10,400)

(15,600)

(26,000)

Ending Balance

16,400

24,600

41,000

Amortized Excess Value Reclassification Entry: Goodwill impairment loss

1,650,000

(10,000)

Basic Consolidation Entry: Preferred Stock

Ret. Earn.

(40,000) (6,000)

40,400

280,000

(4,000)

(4,000) 1,434,800

Inv. CS 60% 1,759,800

120,000 (32,000)

26,000

Income from Sammy Swim

15,600

NCI in NI of Sammy Swim

10,400

1,880,000

Chapter 9 – Consolidation Ownership Issues

Goodwill

41,000

Investment in Sammy Swim

24,600

NCI in NA of Sammy Swim

16,400

Chapter 9 – Consolidation Ownership Issues

P9-22 Consolidation Worksheet with Subsidiary Preferred Stock a. Book Value Calculations:

NCI 40%/10% Beginning Book Value

115,000

Inv. PS 60%

Pref. Div. Income 60%

120,000

Inv. CS 90% 315,000

+ Net Income - Preferred Dividends - Common Dividends

12,500

9,000

(6,000)

(9,000)

Ending Book Value

120,500

(1,000)

Pref. Stock 200,000

Com. Stock

100,000

58,500

(15,000)

364,500

(10,000) 200,000

100,000

Basic Consolidation Entry: Preferred Stock

200,000

Common Stock

100,000

Retained Earnings

250,000

Income from Sage Corp.

58,500

Dividends Income--Preferred

9,000

NCI in NI of Sage Corp.

12,500

Dividends Declared, Preferred

15,000

Dividends Declared, Common

10,000

Investment in Sage Corp. CS

364,500

Investment in Sage Corp. PS

120,000

NCI in NA of Sage Corp.

120,500

Eliminate intercompany payable/receivable: Dividends Payable 9,000 Dividends Receivable

250,000 80,000

(9,000) 120,000

Ret. Earn.

9,000

305,000

Chapter 9 – Consolidation Ownership Issues

P9-22 (continued) b.

Income Statement Sales Dividend Income Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Sage Co Consolidated Net Income NCI in Net Income Controlling Interest in NI Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared, Preferred Less: Dividends Declared, Common Ending Balance Balance Sheet Cash Accounts Receivable Dividends Receivable Inventory Buildings and Equipment (net) Investment in Sage Co. CS Investment in Sage Co. PS Total Assets Accounts Payable Bonds Payable Dividends Payable Preferred Stock Common Stock Retained Earnings NCI in NA of Sage Co Total Liabilities & Equity

Consolidation Entries DR CR

Purple Co.

Sage Co

500,000 9,000 (280,000) (40,000) (131,000) 58,500 116,500

300,000 0 (170,000) (30,000) (20,000) 0 80,000

116,500

80,000

58,500 67,500 12,500 80,000

435,000 116,500

250,000 80,000

Consolidated

800,000 0 (450,000) (70,000) (151,000) 0 129,000 (12,500) 116,500

435,000 116,500

(15,000)

15,000

(60,000) 491,500

(10,000) 305,000

10,000 25,000

(60,000) 491,500

58,000 80,000 9,000 100,000 360,000 364,500 120,000 1,091,500

100,000 120,000 0 200,000 270,000 0 0 690,000

100,000 300,000 0 0 200,000 491,500

70,000 0 15,000 200,000 100,000 305,000

9,000 200,000 100,000 330,000

1,091,500

690,000

639,000

9,000

330,000

364,500 120,000 493,500

158,000 200,000 0 300,000 630,000 0 0 1,288,000

25,000 120,500 145,500

170,000 300,000 6,000 0 200,000 491,500 120,500 1,288,000

9,000

Chapter 9 – Consolidation Ownership Issues

P9-23 Subsidiary Stock Transactions a.

(1)

(2)

Book value of Script Company stock outstanding Cost of treasury shares repurchased Book value of remaining shares outstanding Proportion of remaining shares held by noncontrolling Interest (1,500 / 9,000) Adjusted book value of shares held Book value of shares held before treasury stock repurchase by Script Company ($500,000 x 0.25) Reduction of noncontrolling interest Consideration given by Script Company Decrease in equity attributable to parent

$500,000 (68,000) $432,000 x 0.16666 $ 72,000 (125,000) $ 53,000 (68,000) $ (15,000)

Journal entry recorded by Paper Corporation: Retained Earnings Investment in Script Company

(3)

15,000 15,000

Consolidation entries:

Book Value Calculations: NCI 25/16.7% Beginning Book Value

Paper Corp. 75/83.3%

125,000

375,000

7,500

37,500

Shares Repurchased

(53,000)

(15,000)

Ending Book Value

79,500

397,500

+ Net Income

Common Stock 100,000

Add. Paid-In Capital

+ Treasury Stock

+ Retained Earnings

80,000

320,000 45,000 (68,000)

100,000

80,000

(68,000)

Basic Consolidation Entry: Common Stock

100,000

Additional Paid-in Capital

80,000

Retained Earnings

320,000

Income from Script Co.

37,500

NCI in NI of Script Co.

7,500

Treasury Stock

68,000

Investment in Script Co.

397,500

NCI in NA of Script Co.

79,500

365,000

Chapter 9 – Consolidation Ownership Issues

P9-23 (continued) b.

(1) Book value of shares held before treasury stock repurchase by Script Company ($500,000 x 0.25)

125,000

Book value of Script Company stock outstanding Cost of treasury shares repurchased Book value of remaining shares outstanding Proportion of remaining shares held by noncontrolling Interest (2,500 / 9,000) Adjusted book value of shares held by noncontrolling Interest Reduction of noncontrolling interest Consideration given by Script Company Decrease in equity attributable to parent

$500,000 (68,000) $432,000 x 0.2777 $120,000 $ 5,000 (68,000) $ (63,000)

(2) Journal entry recorded by Paper Corporation: Cash Investment in Script Company Stock Additional Paid-In Capital

68,000 63,000 5,000

(3) Consolidation entries: Book Value Calculations: NCI 25/27.8%

Paper Corp. 75/72.2%

Beginning Book Value

125,000

375,000

+ Net Income

12,500

32,500

Shares Repurchased

(5,000)

(63,000)

Ending Book Value

132,500

344,500

Common Stock 100,000

Add. Paid-In Capital

Treasury Stock

80,000

320,000 45,000 (68,000)

100,000

80,000

(68,000)

Basic Consolidation Entry: Common Stock

100,000

Additional Paid-in Capital

80,000

Retained Earnings

320,000

Income from Script Co.

32,500

NCI in NI of Script Co.

12,500

Treasury Stock

68,000

Investment in Script Co.

344,500

NCI in NA of Script Co.

132,500

Retained Earnings

365,000

Chapter 9 – Consolidation Ownership Issues

P9-24 Sale of Subsidiary Common Shares a. Book Value Calculations: NCI 40%

Penn Corp. 60%

Common Stock 100,000

Add. Paid-In Capital

Retained Earnings

Beginning Book Value

100,000

150,000

+ Net Income

12,000

18,000

30,000

- Dividends

(4,000)

(6,000)

(10,000)

Ending Book Value

108,000

162,000

100,000

20,000

130,000

150,000

Basic Consolidation Entry: Common Stock

100,000

Additional Paid-in Capital

20,000

Retained Earnings

130,000

Income from State Co.

18,000

NCI in NI of State Co.

12,000

Dividends Declared

10,000

Investment in State Co.

162,000

NCI in NA of State Co.

108,000

Chapter 9 – Consolidation Ownership Issues

P9-24 (continued) b. Penn Corp.

State Co.

280,000 (210,000) (20,000) (21,000) 18,000 47,000

170,000 (100,000) (15,000) (25,000) 0 30,000

47,000

30,000

Statement of Retained Earnings Beginning Balance 320,000 Net Income 47,000 Less: Dividends Declared (15,000) Ending Balance 352,000

130,000 30,000 (10,000) 150,000

Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Income from State Co. Consolidated Net Income NCI in Net Income Controlling Interest in NI

Balance Sheet Cash Accounts Receivable Inventory Buildings and Equipment Less: Accumulated Depreciation Investment in State Co. Total Assets Accounts Payable Bonds Payable Common Stock Additional Paid-In Capital Retained Earnings NCI in NA of State Co. Total Liabilities & Equity

Consolidation Entries DR CR

18,000 18,000 12,000 30,000

130,000 30,000 160,000

30,000 70,000 120,000 650,000

35,000 50,000 100,000 230,000

(170,000) 162,000 862,000

(95,000) 0 320,000

50,000 200,000 200,000 60,000 352,000

20,000 30,000 100,000 20,000 150,000

100,000 20,000 160,000

862,000

320,000

280,000

Consolidated

450,000 (310,000) (35,000) (46,000) 0 59,000 (12,000) 47,000

0 10,000 10,000

320,000 47,000 (15,000) 352,000

65,000 120,000 220,000 880,000

162,000 162,000

(265,000) 0 1,020,000

10,000 108,000 118,000

70,000 230,000 200,000 60,000 352,000 108,000 1,020,000

Chapter 9 – Consolidation Ownership Issues

P9-25 Sale of Shares by Subsidiary to Nonaffiliate a. Book Value Calculations: NCI 20/33.3%

Planet Corp. 80/66.7%

Common Stock

Add. Paid-In Capital

Beginning Book Value

120,000

480,000

200,000

50,000

New Shares

140,000

40,000

140,000

Ending Book Value

260,000

520,000

240,000

190,000

Retained Earnings 350,000 350,000

Basic Consolidation Entry: Common Stock

240,000

Additional Paid-in Capital

190,000

Retained earnings

350,000

Investment in Sun Corp.

520,000

NCI in NA of Sun Corp.

260,000

$240,000 = $200,000 + ($10 x 4,000 shares) $190,000 = $50,000 + [($45 - $10) x 4,000 shares] $520,000 = $780,000 x (16,000 shares / 24,000 shares) $260,000 = $780,000 x (8,000 shares / 24,000 shares) Journal entry recorded by Planet Corporation: Investment in Sun Corporation Stock Additional Paid-In Capital Book value of shares held by Planet: After sale $780,000 x (16,000 / 24,000) Before sale $600,000 x (16,000 / 20,000) Increase in book value

40,000 40,000 $520,000 (480,000) $ 40,000

Chapter 9 – Consolidation Ownership Issues

P9-25 (continued) b.

Balance Sheet Cash Accounts Receivable Inventory Buildings and Equipment Less: Accumulated Depr. Investment in Sun Corp. Total Assets Accounts Payable Mortgages Payable Taxes Payable Common Stock Additional Paid-In Capital Retained Earnings NCI in NA of Sun Corp. Total Liabilities & Equity

Planet Corp.

Sun Corp.

50,000 90,000 180,000 700,000 (200,000) 520,000 1,340,000

230,000 120,000 200,000 600,000 (220,000) 0 930,000

70,000 250,000

70,000

Consolidation Entries DR CR

80,000 240,000 190,000 350,000

300,000 220,000 500,000 1,340,000

Consolidated

520,000 520,000

280,000 210,000 380,000 1,300,000 (420,000) 0 1,750,000

260,000 260,000

140,000 250,000 80,000 300,000 220,000 500,000 260,000 1,750,000

240,000 190,000 350,000

930,000

780,000

Planet Corporation and Subsidiary Consolidated Balance Sheet January 1, 20X3

Current Assets: Cash Accounts Receivable Inventory Noncurrent Assets: Buildings and Equipment Less: Accumulated Depreciation Total Assets

280,000 210,000 380,000

$1,300,000 (420,000)

Current Liabilities: Accounts Payable Taxes Payable Mortgages Payable Stockholders’ Equity: Controlling Interest: Common Stock Additional Paid-In Capital Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

$ 140,000 80,000

870,000

880,000 $1,750,000

$ 220,000 250,000

$ 300,000 220,000 500,000 $1,020,000 260,000 1,280,000 $1,750,000 2-39

Chapter 9 – Consolidation Ownership Issues

P9-26 Sale of Additional Shares to Parent a. Consolidation entry: Penny's Previous Shares New Shares Purchased by Penny Penny's Total Shares

7,500

Total Original Shares

10,000

2,500 10,000

New Shares Total Shares

2,500 12,500

80% 20%

(10,000/12,500)

Penny's New % New NCI % Book Value Calculations: NCI 25/20%

Penny 75/80%

Common Stock

Add. Paid-In Capital

Beginning Book Value

87,500

262,500

100,000

50,000

New Shares

12,500

137,500

25,000

125,000

Ending Book Value

100,000

400,000

125,000

175,000

Retained Earnings 200,000 200,000

Basic Consolidation Entry: Common Stock

125,000

Additional Paid-in Capital

175,000

Retained Earnings

200,000

Investment in Saul Corp.

400,000

NCI in NA of Saul Corp.

100,000

Journal entry recorded by Saul Corporation: Cash Common Stock Additional Paid-In Capital

150,000 25,000 125,000

Journal entry recorded by Penny Manufacturing: Investment in Saul Corporation Stock Additional Paid-In Capital Cash

137,500 12,500 150,000

Chapter 9 – Consolidation Ownership Issues

P9-26 (continued) b. Saul Corp.

Penny Balance Sheet Cash Accounts Receivable Inventory Buildings and Equipment Less: Accumulated Depreciation Investment in Saul Corp. Total Assets Accounts Payable Bonds Payable Common Stock Additional Paid-In Capital Retained Earnings NCI in NA of Saul Corp. Total Liabilities & Equity

77,500 60,000 100,000 600,000 (150,000) 400,000 1,087,500

210,000 100,000 180,000 600,000 (240,000)

50,000 400,000 200,000 37,500 400,000

50,000 300,000 125,000 175,000 200,000

1,087,500

850,000

Consolidation Entries DR CR

400,000 400,000

287,500 160,000 280,000 1,200,000 (390,000) 0 1,537,500

100,000 100,000

100,000 700,000 200,000 37,500 400,000 100,000 1,537,500

125,000 175,000 200,000 500,000

Consolidated

Chapter 9 – Consolidation Ownership Issues

P9-27 Complex Ownership Structure The overall ownership structure can be diagrammed as follows:

First Boston 0.80

Gulfside

0.10

0.60

Paddoc k

Consolidated net income of $98,800 is reported: Operating income of First Boston Operating income of Gulfside Operating income of Paddock Consolidated net income Income to noncontrolling interests: Paddock 0.40[$50,000 + 0.10($30,000)] Gulfside 0.20[$34,000 + 0.60($10,000)] Controlling interest in consolidated net income

$ 44,000 34,000 50,000 $128,000 $21,200 8,000

(29,200) $ 98,800

Chapter 10 – Additional Consolidation Reporting Issues

CHAPTER 10 ADDITIONAL CONSOLIDATION REPORTING ISSUES ANSWERS TO QUESTIONS Q10-1 The balance sheet, income statement, and statement of changes in retained earnings are an integrated set and generally need to be completed as a unit. Once completed, these statements can then be used in preparing a consolidated cash flow statement. Because both the beginning and ending consolidated balance sheet totals (with all consolidation entries posted) are needed in determining cash flows for the period, the cash flow statement cannot be easily incorporated into the existing three-part worksheet format. Q10-2 Consolidated retained earnings do not include the earnings assigned to noncontrolling shareholders. As a result, dividends paid to noncontrolling shareholders are not included in the consolidated retained earnings statement. On the other hand, all the cash generated by the subsidiary is included in the consolidated cash flow statement and all uses of cash must also be included, including cash distributed to noncontrolling shareholders in the form of dividends. Q10-3 The indirect method focuses on reconciling between net income and cash flows from operations and does not attempt to report payments to suppliers or other specific uses of cash. It does report the change in inventory and accounts payable which are included in determining payments to suppliers. While adjusting net income for changes in inventory and accounts payable leads to a correct reporting of cash flows from operations, it does not permit explicit reporting of payments to suppliers. Q10-4 Changes in inventory balances are used in computing the amount reported as payments to suppliers and do not need to be separately reported. Q10-5 Sales must be included in the consolidated cash flows worksheet when the direct method is used. They are excluded from the worksheet when the indirect method is used. Q10-6 (a) When the indirect method is used, the changes in inventory are reported as a reconciling item in the operating section of the statement of cash flows. (b) When the direct method is used, changes in inventory are included in the computation of payments to suppliers and not separately disclosed. Q10-7 Only sales subsequent to the date of acquisition are included. The acquired company was not part of the consolidated entity prior to the date of acquisition. Q10-8 Dividends paid by the acquired company to the noncontrolling shareholders following the date of acquisition are included as a cash outflow in the consolidated statement of cash flows. Dividends paid by the acquired company prior to acquisition are excluded. The acquired company was not part of the consolidated entity prior to the acquisition date. However, none of the dividends paid by the subsidiary (before or after the acquisition date) will be reported in the consolidated statement of changes in stockholders’ equity.

Chapter 10 – Additional Consolidation Reporting Issues

Q10-9 The revenues and expenses of the subsidiary for the full year are included in the consolidated income statement when the acquisition occurs at the beginning of the year. When a mid-year acquisition occurs, the revenues and expenses of the acquired company prior to the date of acquisition were not transactions of the consolidated entity. As a result, an additional consolidation entry is made to close pre-acquisition account balances to retained earnings. Q10-10 When there is a difference between the fair market value and the tax basis of an asset acquired or liability assumed in an acquisition, a deferred tax asset or liability must be recognized as part of the net identifiable assets in an acquisition. This usually occurs in a nontaxable acquisition where the acquiree’s tax bases in the assets and liabilities carry over to the consolidated entity after the acquisition. Q10-11 The only book-tax difference that arises in acquisition that does not require the inclusion of a related deferred tax asset or liability is goodwill. ASC805-740-25-9 states that deferred taxes are not recognized when there is an excess of goodwill for financial reporting over that for tax. Q10-12 An accurate measure of the overall profit contribution from each segment of business operations is often considered desirable in evaluating past operations and in planning future strategy. In some cases the tax impact of operating a particular division is very different from one or more other divisions, and that difference should be recognized in evaluating the segment. Even when such differences do not exist, better knowledge of the approximate after tax return from a particular subsidiary can be very helpful in assessing future investment and operating strategies. Q10-13 When a consolidated tax return is filed, all intercompany transfers are eliminated in computing taxable income and there should be no need to adjust recorded tax expense in preparing consolidated financial statements for the period. When the companies do not file a consolidated return, tax payments and expense accruals recorded by the individual companies presumably will include gains and losses on intercompany transfers. If an unrealized gain or loss is eliminated in consolidation, the amount reported as tax expense also should be adjusted to reflect only the tax expense on those items included in the consolidated income statement. Q10-14 Assuming an unrealized profit has been reported, an additional consolidation entry is needed to reduce tax expense and establish a deferred tax asset in the amount of the excess payment. If a loss is eliminated, additional tax expense and taxes payable must be established in the consolidation process. Q10-15 When one of the companies in the consolidated entity has recorded tax expense on unrealized profit in a preceding period, its retained earnings balance at the start of the period will be overstated by the amount of unrealized profit less the tax expense recorded thereon. In the period in which the item is sold and the profit is considered realized, the consolidation entries must include a debit to the Investment in Subsidiary account for the amount of the net overstatement and a debit to deferred tax expense for the proper amount of expense to be recognized. If the original transfer was upstream, the entry would also include a debit to the NCI in NA of the Subsidiary account. Seems that this entry would also include a debit to NCI in NA if the original transfer was upstream (see p. 10-16) and then reword as necessary. Q10-16 When taxes are not considered, income assigned to noncontrolling shareholders is reduced by a proportionate share of the unrealized profit. When taxes are considered, the reduction is based on a proportionate share of the after tax balance of unrealized profits. 10-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 10 – Additional Consolidation Reporting Issues

Q10-17 Perhaps the most important reason is that the earnings per share data reported by the separate companies may include unrealized profits that must be eliminated in computing the consolidated totals. Even without unrealized profits, simple addition could not be used when the companies do not have an equal number of shares outstanding or when the parent does not hold all the common or preferred shares of the subsidiary. Q10-18 The full amount of dividends paid to unaffiliated preferred shareholders of the parent are deducted from consolidated net income in arriving at consolidated earnings per share. Preferred dividends paid by the subsidiary to noncontrolling shareholders and income assigned to noncontrolling common shareholders are deducted from consolidated revenue and expenses in computing consolidated net income and earnings per share. Subsidiary preferred dividends paid to the parent or other affiliates must be eliminated and are not deducted in computing consolidated earnings per share. Q10-19 A subsidiary's contribution to consolidated earnings per share may be different from its contribution to consolidated net income if the subsidiary has convertible bonds or preferred stock outstanding that are treated as if they had been converted, or if the treasury stock method is used to include the dilutive effects of subsidiary stock rights or stock options outstanding. Q10-20 The net of tax interest savings from the assumed conversion of the bond into common stock is included in the numerator and the additional shares are added to the denominator of the earnings per share computation for the subsidiary. In doing so, earnings per share of the subsidiary will be reduced. Moreover, the additional shares added to the denominator will potentially alter the ownership ratio held by the parent; thus, the amount of subsidiary income included in the consolidated earnings per share computation is likely to be reduced. Q10-21 Those rights, warrants, and options treated as stock outstanding in the denominator of the earnings per share computation of the subsidiary will reduce the amount of subsidiary income included in the consolidated earnings per share computation to the extent that the ownership ratio held by the parent is reduced. The actual shares will not be reported as such, because they are assumed to be either eliminated or assigned to the noncontrolling interest. Q10-22 In the earnings per share computation, the amount of income assigned to noncontrolling interest may change as it is assumed that convertible securities are converted or rights, warrants, and options are exercised. Both the amount of subsidiary income included in the numerator and the proportion of parent company ownership may vary, thereby changing the amount of subsidiary income included in the consolidated earnings per share computation.

Chapter 10 – Additional Consolidation Reporting Issues

SOLUTIONS TO CASES C10-1 The Effect of Security Type on Earnings per Share a. Until the securities are converted, the interest expense on bonds and the preferred dividends must both be deducted in determining income available to common shareholders when basic earnings per share is computed. Because interest expense is deductible for tax purposes and preferred dividends are not, the increase in earnings available to common shareholders will be less with conversion of the debentures. The decrease in earnings per share will be greater with conversion of the convertible debentures since the two securities convert into an equal number of common shares. b. Interest expense is deducted in computing net income and preferred dividends are not. Thus, conversion of the bonds will increase net income and conversion of the preferred stock will have no effect on the reported net income of Stage Corporation. If Stage Corporation is a parent company, consolidated net income will increase by the full amount of the interest saving (net of tax) if the bonds are converted. In the event Stage Corporation is a subsidiary of another company, consolidated net income again will increase if the bonds are converted, but the amount of the increase depends on the percentage ownership of Stage by the parent. Conversion of the preferred stock will increase consolidated net income because it increases Stage’s income available to common shareholders, of which the parent is one. The increase will be greater than the effect of the bond conversion because the preferred dividends have no tax effect, but the amount of the increase will depend on the parent’s percentage ownership. c. If the preferred shares are those of a parent company, they will be excluded entirely if (1) all the shares are owned by its subsidiaries, or (2) the preferred shares are noncumulative and have had no dividends declared during the period. If the shares are those of a subsidiary, the preferred shares will have an effect on basic earnings per share unless (1) the parent or other affiliates own all the common and preferred shares outstanding, or (2) the preferred shares are noncumulative and have had no dividends declared during the period. d. Interest expense will be deducted in computing Stage's net income. The preferred dividends will then be deducted from net income in computing Stage's income available to common shareholders. Assuming both securities are dilutive, interest expense (net of tax) will be added back to Stage's net income, no preferred dividends will be deducted, and the increased number of shares from the conversion of both securities will be added to the denominator in computing Stage’s diluted earnings per share. These earnings per share amounts will then be used by Prop Company in determining the income from the subsidiary to be included in its consolidated earnings per share computations.

Chapter 10 – Additional Consolidation Reporting Issues

C10-2 Evaluating Consolidated Statements MEMO To:

Treasurer Cowl Corporation

From: Re:

, Accounting Staff Disclosure of Transfer of Cash from Subsidiary to Parent

The following comments are provided in response to your concern with respect to the transfer of cash from Plum Corporation to the parent company. Intercompany borrowings often offer an opportunity for one company to borrow money from an affiliate at rates favorable to both parties. As a result, transfers of cash between affiliates are very common. These transactions are eliminated in preparing the consolidated statements and the financial statement reader will be unaware of them unless supplemental disclosures are made. In general, the FASB does not require separate disclosure of transactions between consolidated entities when they are eliminated in the preparation of consolidated or combined financial statements. [ASC 850-10-50-4] Nevertheless, the fact that Cowl Company is unable to generate sufficient cash from its separate operations to pay its bills appears to be of sufficient importance that disclosure would be appropriate in both the Management Discussion and Analysis (MD&A) section of Cowl’s annual report and in the notes to the financial statements. The SEC establishes the disclosure requirements for MD&A and requires discussion of currently known trends, demands, commitments, events, or uncertainties that are reasonably expected to have material effects on the registrant’s financial condition or results of operations, or that would cause reported financial information not to be necessarily indicative of future operating results or financial condition. [SEC Regulation S-K, Item 303] The SEC also requires discussion of both short- and long-term liquidity and capital resources. [SEC Financial Reporting Release 36] ASC 230 does not specify those situations in which a discussion of operating cash flows must be included in the notes to the financial statements. However, if the negative cash flow from Cowl Company’s operations significantly affects the operating cash flows of the consolidated entity, one or more notes to the financial statements should be used to provide information to the financial statement readers. One possible form for doing so would be to include supplemental cash flow information if the operations of the parent are identified as a separate reportable segment [ASC 280-10-50-10]. Primary citations: ASC 850-10-50-4 SEC Regulation S-K, Item 303 Secondary citations: ASC 230 ASC 280-10-50-10

Chapter 10 – Additional Consolidation Reporting Issues

C10-3 Income Tax Expense a. When prior-period intercompany profits are realized through resale to a nonaffiliate in the current period, tax expense reported by the consolidated entity will be greater than actual tax payments made by the separate companies. b. Report the additional amount paid as a deferred tax asset or as prepaid income tax in the consolidated balance sheet. (An alternate approach is to net the overpayment for unrealized profits against deferred income taxes payable, but this was not discussed in the chapter.) c. Whenever separate tax returns are filed and unrealized profits/gains are recorded on intercompany transfers of land, buildings and equipment, or other assets, income tax expense reported in the consolidated income statement in the period of the intercompany transfer will be less than tax payments made. A similar effect occurs when one affiliate purchases the bonds of another affiliate and a constructive loss on bond retirement is reported in the consolidated income statement. d. When unrealized profits from a prior period are realized in the current period, income tax expense recognized in the current period will be greater than the actual tax payment made. Also, when unrealized losses are recorded on intercompany transfers (like land, buildings, equipment or other assets), tax expense reported in the consolidated income statement in the period of the transfer will be greater than the actual tax payment. A constructive gain on bond retirement on a purchase of an affiliate's bonds will also result in an excess of consolidated tax expense over tax payments.

Chapter 10 – Additional Consolidation Reporting Issues

C10-4 Consolidated Cash Flows a. The factors contributing to the increase in net income over the prior period are key in this case. One possible explanation is that operating earnings of the combined companies actually declined and the increase in net income resulted from a substantial one-time gain on sale of a division or other assets in the current period. Another possibility would be a decrease in noncash charges deducted in computing income. Cash generated by operations often is well above operating earnings as a result of charges such as amortization of intangible assets or depreciation. A decrease in these charges will increase net income but not change cash flows Changes in the net amounts invested in receivables, inventories, and other current assets are included in the computation of cash flows from operations. Increases in these balances can substantially reduce the reported cash flows from operations without affecting net income. b. Both sales and the balance in accounts receivable should increase when less stringent criteria are used in extending credit. Similarly, both should decrease when credit terms are tightened. If the companies have relaxed credit standards during the current period, net income may be greater as a result of increased sales. However, cash flows are likely to increase to a lesser degree as accounts receivable increase. c. An inventory write-off under lower of cost or market and other noncash charges will not reduce cash flows from operations. The amount expensed would be added back to consolidated net income in arriving at cash generated by operating activities. d. Assuming an allowance account is used, this particular write-off will not appear in either the income statement or computation of cash flows from operations. There is no charge in the income statement and no change in the net receivable balance as a result of a simple write-off of an account receivable. e. There are no significant differences between the preparation of a statement of cash flows for a consolidated entity and a single corporate entity. However, for the consolidated entity, dividend payments to the subsidiary’s noncontrolling interest must be included in the financing section because they use cash even though they are not viewed as dividends of the consolidated entity.

Chapter 10 – Additional Consolidation Reporting Issues

SOLUTIONS TO EXERCISES E10-1 Analysis of Cash Flows a.

The consolidated cash balance at January 1, 20X2, was $83,000, computed as follows: Balance at December 31, 20X2 Decrease in cash balance during 20X2: Cash flows from operations Cash outflow for investment activities Cash outflow for financing activities Net cash outflow Cash balance at January 1, 20X2

$ 57,000 $284,000 (80,000) (230,000)

Dividends of $48,000 were reported: Dividends paid to Plant shareholders Dividends paid to noncontrolling interest of Stem Company ($10,000 x 0.30) Total cash payments

26,000 $83,000

$45,000 3,000 $48,000

Consolidated net income was $207,000, computed as follows: Cash flow from operations Adjustments to reconcile consolidated net income and cash provided by operations Consolidated net income

$284,000 (77,000) $207,000

Chapter 10 – Additional Consolidation Reporting Issues

E10-2 Statement of Cash Flows a.

The noncontrolling interest received dividends of $6,000 ($15,000 x .40).

A total of $320,000 will be reported as cash provided by operations, computed as follows: Consolidated net income Depreciation expense Amortization of patents Gain on bond retirement Loss on sale of land Decrease in accounts receivable Increase in inventory Decrease in accounts payable Increase in wages payable Net cash provided by operating activities

Cash used in investing activities will be reported at $161,000, computed as follows: Purchases of equipment Sale of land Net cash used in investing activities

$(295,000) 134,000 $(161,000)

Cash used in financing activities will be reported at $81,000, computed as follows: Sale of stock Bond retirement Dividends paid to Pecan Corporation shareholders Dividends paid to noncontrolling interests Net cash used in financing activities

$271,000 21,000 13,000 (4,000) 8,000 32,000 (16,000) (12,000) 7,000 $320,000

$150,000 (200,000) (25,000) (6,000) $ (81,000)

The cash balance increased by $78,000 ($320,000 - $161,000 - $81,000) in 20X4.

E10-3 Computation of Operating Cash Flows Cash received from customers was $293,000 ($310,000 - $17,000). Cash payments to suppliers was $193,000 ($180,000 - $8,000 + $21,000), resulting in cash flows from operating activities of $100,000 ($293,000 - $193,000).

Chapter 10 – Additional Consolidation Reporting Issues

E10-4 Consolidated Operating Cash Flows a. Cash received from customers was $482,000 ($300,000 + $200,000 - $28,000 + $10,000). b. Cash payments to suppliers was $288,000 ($160,000 + $95,000 + $35,000 - $15,000 + 17,000 - $4,000). c. Cash flows from operating activities was $194,000 ($482,000 - $288,000).

E10-5 Preparation of Statement of Cash Flows Consolidated Enterprises Inc. and Subsidiary Consolidated Statement of Cash Flows For the Year Ended December 31, 20X3 Cash Flows from Operating Activities: Consolidated Net Income Adjustments for noncash items: Noncash Expenses, Revenue, and Gains Included in Income: Depreciation Expense Goodwill Impairment Loss Gain on Sale of Equipment Changes in operating assets and liabilities Decrease in Accounts Receivable Increase in Accounts Payable Increase in Inventory Net Cash Provided by Operating Activities Cash Flows from Investing Activities: Equipment Purchased Sale of Equipment Net Cash Used in Investing Activities Cash Flows from Financing Activities: Sale of Bonds Repurchase of Common Stock Dividends Paid: To Parent Company Shareholders To Noncontrolling Shareholders Net Cash Provided by Financing Activities Net Increase in Cash

$ 464,000

73,000 3,000 (8,000) 23,000 5,000 (15,000) $545,000 $(380,000) 45,000 (335,000) $ 120,000 (35,000) (60,000) (6,000) 19,000 $229,000

Chapter 10 – Additional Consolidation Reporting Issues

E10-6 Direct Method Cash Flow Statement Consolidated Enterprises Inc. and Subsidiary Consolidated Statement of Cash Flows For the Year Ended December 31, 20X3 Cash Flows from Operating Activities: Cash Received from Customers Cash Payments to Suppliers Net Cash Provided by Operating Activities

$ 923,000 (378,000)

Cash Flows from Investing Activities: Equipment Purchased Sale of Equipment Net Cash Used in Investing Activities

$(380,000) 45,000

Cash Flows from Financing Activities: Sale of Bonds Repurchase of Common Stock Dividends Paid: To Parent Company Shareholders To Noncontrolling Shareholders Net Cash Provided by Financing Activities Net Increase in Cash

(a) (b) $ 545,000

(335,000) $120,000 (35,000) (60,000) (6,000) 19,000 $ 229,000

(a) $923,000 = $900,000 + $23,000 (b) $378,000 = $368,000 - $5,000 + $15,000 The FASB also requires the following reconciliation when the statement of cash flows is prepared using the direct method:

Reconciliation of consolidated net income to net cash provided by operating activities Consolidated Net Income Adjustments for noncash items: Depreciation Expense Goodwill Impairment Loss Gain on Sale of Equipment Changes in operating assets and liabilities: Decrease in Accounts Receivable Increase in Inventory Increase in Accounts Payable Total Adjustments Net Cash Provided by Operating Activities

$464,000 $73,000 3,000 (8,000) 23,000 (15,000) 5,000 81,000 $545,000

Chapter 10 – Additional Consolidation Reporting Issues

E10-7 Analysis of Consolidated Cash Flow Statement a.

Dividends paid to noncontrolling interest Proportion of stock held by noncontrolling interest Total dividends paid by Sons Delivery

$ 6,000 ÷ .40 $15,000

When bonds are sold at a premium the annual cash payment is greater than reported interest expense. The amount of premium amortized must therefore be deducted from net income in determining the cash flow from operations.

An increase in accounts receivable means that cash collections have been less than sales for the period. The amount of the increase must be deducted from operating income to determine the amount of cash actually made available from current period operations.

Dividends paid to noncontrolling shareholders are reported as a cash outflow in the cash flow statement because they represent funds that have been distributed during the period and are no longer available to the consolidated entity. On the other hand, these same dividends are omitted from the retained earnings statement. Only the income to the parent company shareholders is included in the consolidated retained earnings statement and only dividends to the parent company shareholders are deducted in deriving the ending consolidated retained earnings balance.

The loss occurred on a sale to a nonaffiliate. All profits and losses on sales to affiliates are eliminated in the period of intercompany sale and are considered realized as the equipment is depreciated by the purchasing affiliate.

E10-8 Midyear Acquisition a.

The retained earnings balance reported for the consolidated entity as of January 1, 20X1, would be $400,000.

Separate earnings of Pole Manufacturing Net income reported by Spencer Corporation Portion of year ownership was held by Pole Income earned following acquisition Consolidated net income Income to noncontrolling interest ($20,000 x .05) Income to controlling interest

$140,000 $60,000 x 4/12 20,000 $160,000 (1,000) $159,000

Consolidated retained earnings, January 1, 20X1 Income to controlling interest Dividends paid by Pole Manufacturing Consolidated retained earnings, December 31, 20X1

$400,000 159,000 (80,000) $479,000

Purchase price on August 30, 20X1 Equity method income Dividends received from Spencer ($25,000 x .95) Balance in investment account December 31, 20X1

$503,500 19,000 (23,750) $498,750

Chapter 10 – Additional Consolidation Reporting Issues

E10-9 Purchase of Shares at Midyear a.

Journal entries recorded by Pie in 20X2: Investment in Slice Co. Cash Record purchase of Slice Company Stock.

319,500

Investment in Slice Co. Income from Slice Co. Record equity-method income.

27,000

Cash Investment in Slice Co. Record dividends from Slice Company.

13,500

319,500

27,000

13,500

Consolidation Entries:

Sales

90,000

Total Expenses

80,000

Dividends Declared

5,000

Retained Earnings

5,000

Book Value Calculations: NCI 10%

Pie Corp. 90%

Common Stock

Add. Paid-In Cap.

Retained Earnings

Book Value At Acquisition Date

35,500

319,500

+ Net Income

3,000

27,000

30,000

- Dividends

(1,500)

(13,500)

(15,000)

Ending Book Value

37,000

333,000

160,000

40,000

155,000

170,000

Basic Consolidation Entry Common Stock Additional Paid-in Capital Retained Earnings Income from Slice Co. NCI in NI of Slice Co. Dividends Declared Investment in Slice Co. NCI in NA of Slice Co.

160,000 40,000 155,000 27,000 3,000 15,000 333,000 37,000

Chapter 10 – Additional Consolidation Reporting Issues

E10-10 Deferred Tax Assets and Liabilities Arising in Acquisition Accounts Receivable: Fair Value Tax Basis Book-Tax Difference (future deductible difference)

$28,000 30,000 2,000 x 0.40 800

Deferred Tax Asset Land: Fair Value Tax Basis Book-Tax Difference (future taxable difference)

$40,000 10,000 30,000 x 0.40 12,000

Deferred Tax Liability Equipment: Fair Value Tax Basis Book-Tax Difference (future taxable difference)

$15,000 5,000 10,000 x 0.40 4,000

Deferred Tax Liability Bond Payable: Fair Value Tax Basis Book-Tax Difference (future taxable difference)

$115,000 120,000 5,000 x 0.40 2,000

Deferred Tax Liability Total Deferred Tax Assets acquired =

800

Total Deferred Tax Liabilities acquired =

18,000

(12,000 + 4,000 + 2,000)

Deferred Tax Liability, Net on the balance sheet = 17,200

Chapter 10 – Additional Consolidation Reporting Issues

E10-11 Tax Deferral on Gains and Losses Consolidation entries, December 31, 20X7: Sales COGS

Total 90,000 60,000

Gross Profit

30,000

Gross Profit %

33.33%

Re-sold 30,000 20,000

Ending Inventory 60,000 40,000

10,000

Eliminate Inventory Purchases: Sales Cost of Goods Sold Inventory

20,000

90,000 70,000 20,000

Eliminate Tax Expense on Unrealized Profit on Inventory transfer: Deferred Tax Asset 8,000 Deferred Tax Expense 8,000 Eliminate Gain on Sale of Land: Gain on Sale of Land Land

100,000 100,000

Eliminate Tax Expense on Unrealized Profit on Land Transfer: Deferred Tax Asset 40,000 Deferred Tax Expense 40,000

E10-12 Unrealized Profits in Prior Year Consolidation entries, December 31, 20X8: Eliminate Beginning Inventory Profit: Investment in Spring Services 12,000 Income Tax Expense 8,000 Cost of Goods Sold

20,000

Eliminate Unrealized Gain on Sale of Land: Deferred Tax Asset 40,000 Investment in Spring Services 45,000 NCI in NA of Spring Services 15,000 Land

100,000

Chapter 10 – Additional Consolidation Reporting Issues

E10-13 Allocation of Income Tax Expense a.

Allocation of tax expense incurred in 20X5: Item Reported operating income 20X4 profits realized in 20X5 Unrealized profits in 20X5 sales Realized income before tax Income tax assigned: ($130,000 / $200,000) x $80,000 ($30,000 / $200,000) x $80,000 ($40,000 / $200,000) x $80,000

Polly Corporation

Sonny Corporation

Daughter Company

$100,000 40,000

$50,000

$30,000 20,000

(10,000) $130,000

(20,000) $30,000

(10,000) $40,000

$ 52,000 $12,000 $16,000

Computation of consolidated net income and income to controlling interest: Realized income before tax: Polly Corporation Sonny Corporation Daughter Company Consolidated income before tax Income tax expense Consolidated net income Income to noncontrolling interests: Sonny Corporation ($30,000 - $12,000) x 0.20 Daughter Co ($40,000 - $16,000) x 0.10 Income to controlling interest

$130,000 30,000 40,000 $200,000 (80,000) $120,000 $ 3,600 2,400

(6,000) $114,000

Chapter 10 – Additional Consolidation Reporting Issues

E10-14 Effect of Preferred Stock on Earnings per Share Because both companies paid preferred dividends in 20X1 and neither issue is convertible, only one basic consolidated earnings per share number will be reported for 20X1: Operating income of Poison Corporation Net income of Snake Company Less: Preferred dividends Earnings available to Snake common shareholders Consolidated net income Less: Income to noncontrolling interest ($40,000 x .30) Income to common shareholders of Poison Corporation Less: Preferred dividends of Poison Corporation Earnings available to common shareholders Consolidated earnings per share for 20X1 ($78,000 / 12,000 shares)

$ 59,000 $45,000 (5,000) 40,000 $99,000 (12,000) $87,000 (9,000) $78,000 $6.50

E10-15 Effect of Convertible Bonds on Earnings per Share Basic earnings per share: Operating income of Poppy Corporation Contribution to consolidated EPS from Seed Company ($30,000 / 10,000) x 6,000 shares Earnings available to common shareholders Consolidated earnings per share for 20X2 ($63,000 / 30,000 shares)

$45,000 18,000 $63,000 $2.10

Diluted earnings per share: Operating income of Poppy Corporation Contribution to consolidated EPS from Seed Company: $30,000 + $12,000 (a) x 6,000 shares 10,000 shares + 10,000 shares

$45,000

12,600

Earnings available to common shareholders

$57,600

Consolidated earnings per share for 20X2 ($57,600 / 30,000 shares)

$1.92

(a) $12,000 = ($200,000 x 0.10) x (1 - 0.40)

Chapter 10 – Additional Consolidation Reporting Issues

E10-16 Effect of Convertible Preferred Stock on Earnings per Share Basic earnings per share: Operating income of Pagle Corporation Contribution to consolidated EPS from Standard Company:

$60,000

$45,000 - $12,000 x 8,000 shares 10,000 shares Earnings available to shareholders Preferred dividends of Pagle Corporation Earnings available to common shareholders

26,400 $86,400 (16,000) $70,400

Consolidated earnings per share for 20X1 ($70,400 / 10,000 shares)

$7.04

Diluted earnings per share: Operating income of Pagle Corporation Contribution to consolidated EPS from Standard Company: $45,000 x 8,000 shares 10,000 shares + 15,000 shares Earnings available to shareholders Preferred dividends of Pagle Corporation Earnings available to common shareholders Consolidated earnings per share for 20X1 ($58,400 / 10,000 shares)

$60,000

14,400 $74,400 (16,000) $58,400 $5.84

Chapter 10 – Additional Consolidation Reporting Issues

SOLUTIONS TO PROBLEMS P10-17 Direct Method Computation of Cash Flows Putter Corporation and Subsidiary Operating Cash Flows For the Year Ended December 31, 20X1 Cash Flows from Operating Activities: Cash Received from Customers Cash Payments to Suppliers Net Cash Provided by Operating Activities

$533,000 (268,000) $265,000

Computation of payments received from customers Sales of Putter Corporation Sales to outside parties by Sand Company ($240,000 - $100,000) Increase in Putter Corporation accounts receivable Decrease in Sand Company’s accounts receivable Payments received from customers

$400,000 140,000 (9,000) 2,000 $533,000

Computation of payments to suppliers Cost of goods sold by Putter Corporation excluding sale of inventory purchased from Sand Company ($235,000 - $40,000) Cost of goods sold on sales by Sand Company to outside parties ($105,000 - $70,000) Cost of goods sold on intercompany sales resold in period ($70,000 x 0.40) Decrease in Putter Corporation inventory Increase in Sand Company inventory Decrease in accounts payable of Putter Corporation Increase in accounts payable of Sand Company Payment made to suppliers

$195,000 35,000 28,000 (22,000) 16,000 31,000 (15,000) $268,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-18 Preparing a Statement of Cash Flows a.

Pear Corporation and Sugar Company Consolidated Cash Flow Worksheet Year Ended December 31, 20X3 Item

Balance 1/1/X3

Cash Accounts Receivable Inventory Land Buildings and Equipment Patents

68,500 82,000 115,000 45,000 515,000 5,000 830,500

Accumulated Depreciation Accounts Payable Wages Payable Notes Payable Common Stock Retained Earnings Noncontrolling Interest

186,500 61,000 26,000 250,000 150,000 130,000 27,000 830,500

Cash Flows from Operating Activities: Consolidated Net Income Depreciation Expense Amortization of Patent Changes in Operating Assets and Liabilities: Increase in Accounts Receivable Increase in Inventory Increase in Accounts Payable Decrease in Wages Payable

Debit (a) 32,000 (b) 15,000 (c) 8,000 (d) 10,000 (e) 35,000

(f)

1,000

(g) 36,500 (h) 5,000 (i)

6,000 (j) 15,000

(k) 30,000 (m) 5,000 141,000

(l) 74,500 (l) 9,000 141,000

Balance 12/31/X3 100,500 97,000 123,000 55,000 550,000 4,000 929,500 223,000 66,000 20,000 265,000 150,000 174,500 31,000 929,500

(l) 83,500 (g) 36,500 (f) 1,000 (b) 15,000 (c) 8,000 (h)

5,000 (i) 6,000

Cash Flows from Investing Activities: Purchase of Land Purchase of Buildings and Equipment Cash Flows from Financing Activities: Increase in Notes Payable Dividends Paid: To Pear Corporation Shareholders To Sugar Company Shareholders Increase in Cash

Credit

(d) 10,000 (e) 35,000 (j) 15,000

141,000

(k) 30,000 (m) 5,000 (a) 32,000 141,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-18 (continued) b.

Consolidated statement of cash flows for 20X3 Pear Corporation and Subsidiary Consolidated Statement of Cash Flows Year Ended December 31, 20X3 Cash Flows from Operating Activities Consolidated Net Income Adjustments for noncash items: Noncash Expenses, Revenue, Losses, and Gains Included in Income: Depreciation Expense Amortization Expense Changes in operating assets and liabilities Increase in Accounts Receivable Increase in Inventory Increase in Accounts Payable Decrease in Wages Payable Net Cash Provided by Operating Activities

$ 83,500

36,500 1,000 (15,000) (8,000) 5,000 (6,000) $97,000

Cash Flows from Investing Activities: Purchase of Land Purchase of Buildings and Equipment Net Cash Used in Investing Activities

$(10,000) (35,000)

Cash Flows from Financing Activities: Increase in Notes Payable Dividends Paid to Parent Company Shareholders Dividends Paid to Noncontrolling Shareholders Net Cash Used in Financing Activities

$ 15,000 (30,000) ( 5,000)

Net Increase in Cash Cash at Beginning of Year Cash at End of Year

(45,000)

(20,000) $ 32,000 68,500 $100,500

Chapter 10 – Additional Consolidation Reporting Issues

P10-19 Preparing a Statement of Cash Flows – Direct Method a.

Pear Corporation and Sugar Company Consolidated Cash Flow Worksheet Year Ended December 31, 20X3 Item

Balance 1/1/X3

Cash Accounts Receivable Inventory Land Buildings and Equipment Patents

68,500 82,000 115,000 45,000 515,000 5,000 830,500

Accumulated Depreciation Accounts Payable Wages Payable Notes Payable Common Stock Retained Earnings Noncontrolling Interest

186,500 61,000 26,000 250,000 150,000 130,000 27,000 830,500

Sales Cost of Goods Sold Wage Expense Depreciation Expense Interest Expense Amortization Expense Other Expenses

490,000 259,000 55,000 36,500 16,000 1,000 39,000 406,500 83,500

Consolidated Net Income

Debit

Credit

(a) 32,000 (b) 15,000 (c) 8,000 (d) 10,000 (e) 35,000 (f)

1,000

(g) 36,500 (c) 5,000 (h) 6,000 (j) 15,000 (k) 30,000 (m) 5,000 141,000

(l) 74,500 (l) 9,000 141,000

Balance 12/31/X3 100,500 97,000 123,000 55,000 550,000 4,000 929,500 223,000 66,000 20,000 265,000 150,000 174,500 31,000 929,500

(b)490,000 (c)259,000 (h) 55,000 (g) 36,500 (i) 16,000 (f) 1,000 (c) 39,000 (l) 83,500 490,000

490,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-19 (continued) Cash Flows from Operating Activities: Cash Received from Customers Cash Paid to Suppliers Cash Paid to Employees Cash Paid for Interest on Notes Payable

(b) 475,000 (c)301,000 (h) 61,000 (i) 16,000

(d) 10,000 (e) 35,000 (j) 15,000

490,000 b.

(k) 30,000 (m) 5,000 (a) 32,000 490,000

Consolidated statement of cash flows for 20X3 Pear Corporation and Subsidiary Consolidated Statement of Cash Flows Year Ended December 31, 20X3 Cash Flows from Operating Activities: Cash Received from Customers Cash Paid to Suppliers Cash Paid to Employees Cash Paid for Interest on Notes Payable Net Cash Provided by Operating Activities

$475,000 $301,000 61,000 16,000

Cash Flows from Investing Activities: Purchase of Land Purchase of Buildings and Equipment Net Cash Used in Investing Activities

$(10,000) (35,000)

Cash Flows from Financing Activities: Increase in Notes Payable Dividends Paid to Parent Company Shareholders Dividends Paid to Noncontrolling Shareholders Net Cash Used in Financing Activities

$15,000 (30,000) ( 5,000)

Net Increase in Cash Cash at Beginning of Year Cash at End of Year

(378,000) $ 97,000

(45,000)

(20,000) $ 32,000 68,500 $100,500

Chapter 10 – Additional Consolidation Reporting Issues

P10-19 (continued) The FASB also requires the following reconciliation when the statement of cash flows is prepared using the direct method: Reconciliation of consolidated net income to net cash provided by operating activities Consolidated Net Income Adjustments for noncash items: Depreciation Expense Amortization Expense Changes in operating assets and liabilities: Increase in Accounts Receivable Increase in Inventory Increase in Accounts Payable Decrease in Wages Payable Total Adjustments Net Cash Provided by Operating Activities

$83,500 $36,500 1,000 (15,000) (8,000) 5,000 (6,000) 13,500 $97,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-20 Consolidated Statement of Cash Flows a.

Point Company and Shoot Company Consolidation Cash Flow Worksheet Year Ended December 31, 20X4 Balance 1/1/X4

Item Cash Accounts Receivable Inventory Land Buildings and Equipment Goodwill

83,000 210,000 320,000 190,000 850,000 40,000 1,693,000

Accum. Depreciation Accounts Payable Interest Payable Bonds Payable Bond Premium Common Stock Additional Paid-In Capital Retained Earnings Noncontrolling Interest

280,000 52,000 45,000 400,000 18,000 300,000 70,000 488,000 40,000 1,693,000

Cash Flows from Operating Activities: Consolidated Net Income Depreciation Expense Goodwill Impairment Loss Amortization of Bond Premium Loss on Sale of Land Changes in Operating Assets and Liabilities: Decrease in Accounts Receivable Increase in Inventory Increase in Accounts Payable Decrease in Interest Payable Cash Flows from Investing Activities: Sale of Land Purchase of Buildings and Equipment Cash Flows from Financing Activities: Sale of Bonds Dividends Paid: To Point Shareholders To Noncontrolling Shareholders Increase in Cash

Debit

Credit

(a) 98,000 (b) 35,000 (c) 50,000 (d) 30,000 (e)130,000 (f) 12,000 (g) 45,000 (h) 22,000 (i) 15,000 (j) 100,000 (k) 2,000 (l) 25,000 (n) 3,000 323,000

(m) 72,000 (m) 7,000 323,000

Balance 12/31/X4 181,000 175,000 370,000 160,000 980,000 28,000 1,894,000 325,000 74,000 30,000 500,000 16,000 300,000 70,000 535,000 44,000 1,894,000

(m) 79,000 (g) 45,000 (f) 12,000 (k)

2,000

(d) 20,000 (b) 35,000 (c) 50,000 (h) 22,000 (i) 15,000 (d) 10,000 (e)130,000 (j)100,000

323,000

(l) 25,000 (n) 3,000 (a) 98,000 323,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-20 (continued) Explanation of Worksheet Entries: (a)

Increase in cash balance

(b)

Decrease in accounts receivable

(c)

Increase in inventory

(d)

Sale of land

(e)

Purchase of buildings and equipment

(f)

Goodwill impairment loss recognized in 20X4

(g)

Depreciation charges for 20X4

(h)

Increase in accounts payable

(i)

Decrease in interest payable

(j)

Sale of bonds

(k)

Amortize bond premium

(l)

Point Company dividend $25,000

(m) Consolidated net income $79,000 (n)

Shoot Company dividend $15,000 x 0.20

Chapter 10 – Additional Consolidation Reporting Issues

P10-20 (continued) b.

Consolidated statement of cash flows for 20X4: Point Company and Subsidiary Consolidated Statement of Cash Flows For Year Ended December 31, 20X4

Cash Flows from Operating Activities: Consolidated Net Income Adjustments for noncash items: Noncash Expenses, Revenue, Losses, and Gains Included in Income: Depreciation Expense Goodwill Impairment Loss Amortization of Bond Premium Loss on Sale of Land Changes in operating assets and liabilities: Decrease in Accounts Receivable Increase in Inventory Increase in Accounts Payable Decrease in Interest Payable Net Cash Provided by Operating Activities Cash Flows from Investing Activities: Sale of Land Purchase of Buildings and Equipment Net Cash Used in Investing Activities Cash Flows from Financing Activities: Sale of Bonds Dividends Paid: To Parent Company Shareholders To Noncontrolling Shareholders Net Cash Provided by Financing Activities Net Increase in Cash Cash Balance at Beginning of Year Cash Balance at End of Year

$79,000

45,000 12,000 (2,000) 20,000 35,000 (50,000) 22,000 (15,000) $146,000 $ 10,000 (130,000) (120,000) $100,000 (25,000) (3,000) 72,000 $ 98,000 83,000 $181,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-21 Consolidated Statement of Cash Flows — Direct Method a.

Point Company and Shoot Company Consolidation Cash Flow Worksheet Year Ended December 31, 20X4 Item

Balance 1/1/X4

Cash Accounts Receivable Inventory Land Buildings and Equipment Goodwill

83,000 210,000 320,000 190,000 850,000 40,000 1,693,000

Accum. Depreciation Accounts Payable Interest Payable Bonds Payable Bond Premium Common Stock Additional Paid-In Capital Retained Earnings Noncontrolling Interest

280,000 52,000 45,000 400,000 18,000 300,000 70,000

Sales Cost of Goods Sold Depreciation Expense Interest Expense Loss on Sale of Land Goodwill Impairment Loss Consolidated Net Income

488,000 40,000 1,693,000 600,000 375,000 45,000 69,000 20,000 12,000 521,000 79,000

Debit

Credit

(a) 98,000 (b) 35,000 (c) 50,000 (d) 30,000 (e)130,000 (f) 12,000 (g) 45,000 (c) 22,000 (i) 100,000

(k) 72,000 (k) 7,000 323,000

535,000 44,000 1,894,000

2,000

(j) 25,000 (l) 3,000 323,000

181,000 175,000 370,000 160,000 980,000 28,000 1,894,000 325,000 74,000 30,000 500,000 16,000 300,000 70,000

(h) 15,000 (h)

Balance 12/31/X4

(b) 600,000 (c)375,000 (g) 45,000 (h) 69,000 (d) 20,000 (f) 12,000 (k) 79,000 600,000

600,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-21 (continued) Cash Flows from Operating Activities: Cash Received from Customers Cash Paid to Suppliers Cash Paid for Interest on Bonds Payable Cash Flows from Investing Activities: Sale of Land Purchase of Buildings and Equipment Cash Flows from Financing Activities: Sale of Bonds Dividends Paid: To Traper Shareholders To Noncontrolling Shareholders Increase in Cash

(b)635,000 (c)403,000 (h) 86,000 (d) 10,000 (e)130,000 (i) 100,000

745,000

(j) 25,000 (l) 3,000 (a) 98,000 745,000

Explanation of Worksheet Entries: (a) Increase in cash balance (b) Payments received from customers (c) Payments to suppliers (d) Sale of land (e) Purchase of buildings and equipment (f)

Goodwill impairment loss recognized in 20X4

(g) Depreciation charges for 20X4 (h) Payment of interest (i)

Sale of bonds

(j)

Point Company dividend $25,000

(k) Consolidated net income $79,000 (l)

Shoot Company dividend $15,000 x 0.20

Chapter 10 – Additional Consolidation Reporting Issues

P10-21 (continued) b.

Consolidated statement of cash flows for 20X4: Point Company and Subsidiary Consolidated Statement of Cash Flows For Year Ended December 31, 20X4

Cash Flows from Operating Activities: Cash Received from Customers Cash Payments to Suppliers Cash Payments of Interest Net Cash Provided by Operating Activities Cash Flows from Investing Activities: Sale of Land Purchase of Buildings and Equipment Net Cash Used in Investing Activities Cash Flows from Financing Activities: Sale of Bonds Dividends Paid: To Parent Company Shareholders To Noncontrolling Shareholders Net Cash Provided by Financing Activities Net Increase in Cash Cash Balance at Beginning of Year Cash Balance at End of Year

$635,000 $403,000 86,000

(489,000) $146,000

$ 10,000 (130,000) (120,000) $100,000 (25,000) (3,000) 72,000 $ 98,000 83,000 $181,000

The FASB also requires the following reconciliation when the statement of cash flows is prepared using the direct method: Reconciliation of consolidated net income to net cash provided by operating activities Consolidated Net Income Adjustments for noncash items: Depreciation Expense Goodwill Impairment Loss Amortization of Bond Premium Loss on Sale of Land Changes in operating assets and liabilities: Decrease in Accounts Receivable Increase in Inventory Increase in Accounts Payable Decrease in Interest Payable Total Adjustments Net Cash Provided by Operating Activities

$ 79,000 $45,000 12,000 (2,000) 20,000 35,000 (50,000) 22,000 (15,000) 67,000 $146,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-22 Consolidated Statement of Cash Flows Planet Company and Sun Corporation Consolidation Cash Flow Worksheet Year Ended December 31, 20X6 Balance 1/1/X6

Item

Debit

Cash Accounts Receivable Inventory Land Buildings and Equipment

54,000 121,000 230,000 95,000 800,000 1,300,000

(a) 21,000

Accumulated Depreciation Accounts Payable Bonds Payable Common Stock Retained Earnings Noncontrolling Interest

290,000 90,000 300,000 300,000 290,000 30,000 1,300,000

(e)100,000

Cash Flows from Operating Activities: Consolidated Net Income Depreciation Expense Gain on Sale of Equipment Changes in Operating Assets and Liabilities: Decrease in Accounts Receivable Increase in Inventory Increase in Accounts Payable Cash Flows from Investing Activities: Sale of Buildings and Equipment Purchase of Land

Credit (b) 10,000

(h) 50,000 (i) 65,000 (k) 4,000 375,000

(j) 148,000 (j) 12,000 375,000

Balance 12/31/X6 75,000 111,000 360,000 100,000 650,000 1,296,000 230,000 105,000 250,000 300,000 373,000 38,000 1,296,000

(j) 160,000 (f) 40,000 (e) 30,000 (b) 10,000 (c)130,000 (g) 15,000 (e) 80,000 (d)

Cash Flows from Financing Activities: Bond Retirement Dividends Paid: To Planet Company Shareholders To Noncontrolling Shareholders Increase in Cash

5,000

(h) 50,000

305,000

(i) 65,000 (k) 4,000 (a) 21,000 305,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-23 Consolidated Statement of Cash Flows — Direct Method Planet Company and Sun Corporation Consolidation Cash Flow Worksheet Year Ended December 31, 20X6 Balance 1/1/X6

Item

Debit

Credit

Cash Accounts Receivable Inventory Land Buildings and Equipment

54,000 (a) 21,000 121,000 230,000 (c) 130,000 95,000 (d) 5,000 800,000 1,300,000

Accumulated Depreciation Accounts Payable Bonds Payable Common Stock Retained Earnings Noncontrolling Interest

290,000 (e) 100,000 90,000 300,000 (g) 50,000 300,000 290,000 (h) 65,000 30,000 (j) 4,000 1,300,000 375,000

(f) (c)

Sales Gain on Sale of Equipment

1,070,000 30,000 1,100,000 750,000 40,000 150,000 940,000 160,000

(b)1,070,000 (e) 30,000

Cost of Goods Sold Depreciation Expense Other Expenses Consolidated Net Income

(b)

10,000

(e) 150,000 40,000 15,000

(i) 148,000 (i) 12,000 375,000

Balance 12/31/X6 75,000 111,000 360,000 100,000 650,000 1,296,000 230,000 105,000 250,000 300,000 373,000 38,000 1,296,000

160,000 1,100,000

Cash Flows from Operating Activities: Cash Received from Customers Cash Paid to Suppliers

(b)1,080,000

Cash Flows from Investing Activities: Sale of Buildings and Equipment Purchase of Land

(e)

1,100,000

Cash Flows from Financing Activities: Bond Retirement Dividends Paid To Planet Company Shareholders To Noncontrolling Shareholders Increase in Cash 1,160,000

(d)

5,000

(g)

50,000

(h) (j) (a)

65,000 4,000 21,000 1,160,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-24 Consolidated Statement of Cash Flows [AICPA Adapted] Primer, Inc., and Subsidiary Consolidated Statement of Cash Flows For the Year Ended December 31, 20X6 Cash Flows from Operating Activities: Consolidated Net Income Adjustments for noncash items: Depreciation Goodwill Impairment Loss Gain on Sale of Equipment Changes in operating assets and liabilities: Decrease in Allowance to Reduce Marketable Securities to Market Decrease in Accounts Receivable Increase in Inventories Increase in Accounts Payable and Accrued Liabilities Increase in Deferred Tax Liability Total Adjustments Net Cash Provided by Operating Activities Cash Flows from Investing Activities: Purchase of Equipment Sale of Equipment Net Cash Used in Investing Activities Cash Flows from Financing Activities: Payment on Note Payable Sale of Treasury Stock Cash Dividend Paid by Parent Company Cash Dividend Paid to Noncontrolling Interest in Subsidiary Net Cash Used in Financing Activities Net Increase in Cash Cash at Beginning of Year Cash at End of Year

$231,000 82,000 [1] 3,000 (6,000) (11,000) 22,000 (70,000) 121,000 12,000 153,000 $384,000 $(127,000) 40,000 (87,000) $(150,000) 44,000 (58,000) (15,000) [2] (179,000) $118,000 195,000 $313,000

Supplemental Schedule of Noncash Investing and Financing Activities: Issuance of Common Stock to Purchase Land

$215,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-24 (continued) Explanations of Amounts: [1]

Depreciation: Accumulated depreciation, Dec. 31, 20X6 Accumulated depreciation on equipment sold ($62,000 - $34,000) Deduct accumulated depreciation, Dec. 31, 20X5 Depreciation for 20X6

[2]

Cash dividends paid to minority stockholders of subsidiary: Cash dividend paid by Sore Corporation noncontroling ownership Cash dividend paid to minority stockholders in 20X6

$199,000 28,000 227,000 (145,000) $ 82,000 $ 50,000 x 0.30 $ 15,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-25 Statement of Cash Flows Prepared from Consolidation Worksheet a.

Worksheet for consolidated statement of cash flows: Protecto Corporation and Strand Company Consolidation Cash Flow Worksheet Year Ended December 31, 20X3 Item

Balance 1/1/X3

Cash Accounts Receivable Inventory Land Buildings and Equipment

92,000 135,000 140,000 75,000 400,000

Patents

30,000 872,000

Accumulated Depreciation Accounts Payable Bonds Payable Common Stock Retained Earnings Noncontrolling Interest

210,000 114,200 90,000 100,000 273,000 84,800 872,000

Cash Flows from Operating Activities: Consolidated Net Income Amortization Expense Depreciation Expense Changes in Operating Assets and Liabilities: Decrease in Accounts Receivable Increase in Inventory Decrease in Accounts Payable

Debit

(a) 30,200 (b) 15,000 (c) 59,000 (d) 5,000 (e)100,000 (f) 20,000 (g)

5,000

(h) 20,000 (i) 19,200 (j) 100,000 (k) 50,000 (m) 8,000 261,200

(l) 79,400 (l) 11,600 261,200

Balance 12/31/X3 61,800 120,000 199,000 80,000 520,000 25,000 1,005,800 230,000 95,000 190,000 100,000 302,400 88,400 1,005,800

(l) 91,000 (g) 5,000 (h) 20,000 (b) 15,000 (c) 59,000 (i) 19,200

Cash Flows from Investing Activities: Purchase of Land Acquisition of Buildings and Equipment from Bond Issue Purchase of Buildings and Equipment Cash Flows from Financing Activities: Dividends Paid: To Protecto Corp. Shareholders To Noncontrolling Shareholders Issuance of Bonds for Buildings and Equipment Decrease in Cash

Credit

(d)

5,000

(e)100,000 (f) 20,000

(k) 50,000 (m) 8,000 (j) 100,000 (a) 30,200 261,200

261,200

Chapter 10 – Additional Consolidation Reporting Issues

P10-25 (continued) b.

Consolidated cash flow statement for 20X3: Protecto Corporation and Subsidiary Consolidated Statement of Cash Flows For the Year Ended December 31, 20X3

Cash Flows from Operating Activities: Consolidated Net Income Adjustments for noncash items: Included in Income: Amortization Expense Depreciation Expense Changes in operating assets and liabilities: Decrease in Accounts Receivable Increase in Inventory Decrease in Accounts Payable

$ 91,000 5,000 20,000 15,000 (59,000) (19,200)

Net Cash Provided by Operating Activities Cash Flows from Investing Activities: Purchase of Land Purchase of Buildings and Equipment Net Cash Used in Investing Activities Cash Flows from Financing Activities: Dividends Paid: To Parent Company Shareholders To Noncontrolling Shareholders Net Cash Received from Financing Activities Net Decrease in Cash Cash Balance at Beginning of Year Cash Balance at End of Year

$ 52,800 $ (5,000) (20,000) (25,000)

$(50,000) (8,000) (58,000) $(30,200) 92,000 $ 61,800

Supplemental Schedule of Noncash Investing and Financing Activities: Issuance of Bonds to Purchase Equipment

$100,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-26 Midyear Purchase of Controlling Interest a.

Equity-method entries recorded by Parachute Theaters during 20X1: Investment in Stage Co. Cash Record purchase of Stage Company stock.

765,000 765,000

Investment in Stage Co. 97,750 Income from Stage Co. Record equity-method income: ($175,000 - $60,000) x 0.85

97,750

Cash 25,500 Investment in Stage Co. Record dividends from Stage Company: $30,000 x 0.85

25,500

Chapter 10 – Additional Consolidation Reporting Issues

P10-26 (continued) b. Consolidation entries, December 31, 20X1: Sales Operating Expenses Dividends Declared Retained Earnings

240,000 180,000 10,000 50,000

Book Value Calculations:

Book Value At Acquisition Date + Net Income - Dividends Ending Book Value

Basic Consolidation Entry Common Stock Additional Paid-in Capital Retained Earnings Income from Stage Co. NCI in NI of Stage Co. Dividends Declared Investment in Stage Co. NCI in NA of Stage Co.

NCI 15% 120,000 17,250 (4,500) 132,750

Parachute Theaters 85% 680,000 97,750 (25,500) 752,250

Common Stock 100,000

100,000

Add. Paid-In Cap. 500,000

500,000

Retained Earnings 200,000 115,000 (30,000) 285,000

100,000 500,000 200,000 97,750 17,250 30,000 752,250 132,750

Excess Value (Differential) Calculations:

Beginning balance Changes Ending balance

NCI 15% 15,000 0 15,000

Parachute Theaters 85% 85,000 0 85,000

Goodwill 100,000 0 100,000

Excess Value (Differential) Reclassification Entry: Goodwill 100,000 Investment in Stage Co. 85,000 NCI in NA of Stage Co. 15,000

Computation of differential Compensation given by Parachute Theaters Fair value of noncontrolling interest Total fair value Book value of Stage stock: Common stock Additional paid-in capital Retained earnings, January 1 First quarter undistributed earnings ($60,000 - $10,000) Book value, April 1 Goodwill

$765,000 135,000 $900,000 $100,000 500,000 150,000 50,000 (800,000) $100,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-27 Consolidation Involving a Midyear Purchase a.

Journal entries recorded by Princeton Products: Investment in Stanford Co. Common Stock Additional Paid-In Capital Record purchase of Stanford Company stock: $80,000 = $10 x 8,000 shares $167,500 = $247,500 - $80,000

247,500 80,000 167,500

Investment in Stanford Co. 13,500 Income from Stanford Co. Record equity-method income: $13,500 = $15,000 x 0.90

13,500

Cash 9,000 Investment in Stanford Co. Record dividend received from Stanford: $9,000 = $10,000 x 0.90

9,000

b. Consolidation entries, December 31, 20X2: Pre-acquisition Income and Dividend Consolidation Entry: Sales 205,000 Cost of Goods Sold 126,000 Depreciation Expense 16,000 Other Expenses 18,000 Dividends Declared 20,000 Retained Earnings 25,000 Book Value Calculations:

Book Value At Acquisition Date + Net Income - Dividends Ending Book Value

Basic Consolidation Entry Common Stock Retained Earnings Income from Stanford Co. NCI in NI of Stanford Co. Dividends Declared Investment in Stanford Co. NCI in NA of Stanford Co.

NCI 10% 27,500 1,500 (1,000) 28,000

Princeton Products 90% 247,500 13,500 (9,000) 252,000

Common Stock 150,000

150,000

Retained Earnings 125,000 15,000 (10,000) 130,000

150,000 125,000 13,500 1,500 10,000 252,000 28,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-27 (continued) Accumulated Depreciation Consolidation Entry Accumulated Depreciation Buildings and Equipment

61,000 61,000

Depreciation expense for the year is $20,000, however $16,000 of that amount occurred prior to the acquisition, leaving only $4,000 as post-acquisition depreciation for Stanford. End of year accumulated depreciation is recorded as $65,000 for Stanford, but should only reflect the $4,000 of post consolidation depreciation of $4,000. A consolidation entry to remove the $61,000 of depreciation recorded in the periods prior to the acquisition is recorded and the depreciable assets are reduced by the same amount.

Chapter 10 – Additional Consolidation Reporting Issues

P10-27 (continued) c. Consolidation Entries DR CR

Princeton Products

Stanford Co.

390,000 (305,000) (25,000) (14,000) 13,500 59,500

250,000 (145,000) (20,000) (25,000) 0 60,000

205,000

13,500 218,500 1,500

160,000

Controlling Interest in Net Income

59,500

60,000

220,000

160,000

59,500

Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared

135,000 59,500 (40,000)

100,000 60,000 (30,000)

125,000 220,000

25,000 160,000 10,000 20,000

135,000 59,500 (40,000)

Ending Balance

154,500

130,000

345,000

215,000

154,500

Balance Sheet Cash Accounts Receivable Inventory Buildings and Equipment Less: Accumulated Depreciation Investment in Stanford Co.

85,000 100,000 150,000 400,000 (105,000) 252,000

50,000 60,000 100,000 340,000 (65,000) 0

Total Assets

882,000

485,000

Accounts Payable Taxes Payable Bonds Payable Common Stock Additional Paid-In Capital Retained Earnings NCI in NA of Stanford Co.

40,000 70,000 250,000 200,000 167,500 154,500

50,000 55,000 100,000 150,000 0 130,000

Total Liabilities & Equity

882,000

485,000

Income Statement Sales Less: COGS Less: Depreciation Expense Less: Other Expenses Income from Stanford Co. Consolidated Net Income NCI in Net Income

126,000 16,000 18,000

Consolidated 435,000 (324,000) (29,000) (21,000) 0 61,000 (1,500)

252,000

135,000 160,000 250,000 679,000 (109,000) 0

313,000

1,115,000

345,000

215,000 28,000

90,000 125,000 350,000 200,000 167,500 154,500 28,000

495,000

243,000

1,115,000

61,000 61,000 61,000

150,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-28 Deferred Tax Assets and Liabilities in a Consolidated Balance Sheet a. Peace Tax Basis Calculations: Deferred Tax Asset Tax Rate Book-Tax Difference (future deductible difference) Amount related to Vacation Payable Remainder related to Allowance for Doubtful Accounts

$8,000 ÷ 0.40 20,000 (15,000) 5,000

Deferred Tax Liability Tax Rate Book-Tax Difference (future taxable difference) related to Equipment

$6,000 ÷ 0.40 15,000

Tax basis of Accounts Receivable = $55,000 (50,000 book value + 5,000 book-tax difference related to the allowance) Tax basis of Accrued Vacation Payable = 0 as no tax deduction is taken until the vacation is paid out to employees. Tax basis of Equipment = $145,000 (160,000 book value – 15,000 book-tax difference related to extra tax depreciation taken to date. As stated in the problem, all other items have no book-tax differences. Soft Tax Basis Calculations: Deferred Tax Asset Tax Rate Book-Tax Difference (future deductible difference) related to Allowance for Doubtful Accounts

$1,000 ÷ 0.40

Deferred Tax Liability Tax Rate Book-Tax Difference (future taxable difference) related to Equipment

$2,000 ÷ 0.40 5,000

2,500

Tax basis of Accounts Receivable = $14,500 (12,000 book value + 2,500 book-tax difference related to the allowance) Tax basis of Equipment = $20,000 (25,000 book value – 5,000 book-tax difference related to extra tax depreciation taken to date.

Chapter 10 – Additional Consolidation Reporting Issues

Tax basis of Patent = 0 as this was an asset identified in the due diligence for the acquisition and was not previously recorded by Soft. P10-28 (continued) As stated in the problem, all other items have no book-tax differences. b. The fair value of the DTAs and DTLs will be the tax-effected differences between the tax bases and the book bases of Soft’s identifiable assets and liabilities. Soft Corporation

Cash Accounts Receivable, net Inventory Equipment, net Patent

Fair Value $ 8,000 12,000 10,000 40,000 20,000

Tax Basis $ 8,000 14,500 7,000 20,000 0

Difference 0 2,500 (3,000) (20,000) (20,000)

Tax-effected 0 1,000 (1,200) (8,000) (8,000)

$ 13,000 8,000

0 0

Accounts Payable Long Term Debt

Total DTA = 1,000 related to Accounts receivable Total DTL = 17,200 related to Inventory, Equipment and Patent c. Consolidation entries:

Peace Book value at acquisition date

Basic Consolidation Entry Common Stock Retained Earnings Investment in Soft Co.

30,000

Common Stock

Retained Earnings

20,000

10,000

20,000 10,000 30,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-28 (continued) Excess Value (Differential) Calculations: Peace = Inventory Beginning Balance 30,000 3,000

Equip 15,000

+ Patent 20,000

Goodwill 7,200

DTL (15,200)

Excess Value (Differential) Reclassification Entry: Inventory 3,000 Equipment 15,000 Patent 20,000 Goodwill 7,200 Deferred Tax Liability 15,200 Investment in Soft 30,000

Accumulated Depreciation Consolidation Entry Accumulated Depreciation

10,000

Equipment

10,000

Balance Sheet Cash Accounts Receivable Inventory Deferred Tax Asset Equipment Less: Accumulated Depreciation Investment in Soft Patent Goodwill Total Assets Accounts Payable Accrued Vacation Payable Deferred Tax Liability Long Term Debt Common Stock Retained Earnings Total Liabilities & Equity

Consolidation Entries DR CR

Peace

Soft

30,000 50,000 75,000 8,000 200,000

8,000 12,000 7,000 1,000 35,000

15,000

(40,000) 60,000

(10,000)

10,000

3,000 10,000

30,000 30,000 20,000 7,200

383,000

53,000

62,000

13,000

55,200

70,000

Consolidated 38.000 62,000 85,000 9,000 240,000 (40,000) 0 20,000 7,200 421,200 75,000 15,000

15,000 6,000 100,000 150,000 50,000

2,000 8,000 20,000 10,000

20,000 10,000

383,000

53,000

30,000

15,200

23,200 108,000 150,000 50,000 421,200

Chapter 10 – Additional Consolidation Reporting Issues

P10-29 Tax Allocation in Consolidated Balance Sheet Consolidation entries (not required): Book Value Calculations: +

NCI 30% 120,000

Ending book value

Powder 70% 280,000

Common Stock 150,000

Retained Earnings 250,000

Adjustment to Basic Consolidation Entry Ending Book Value - Gross profit deferral, net of taxes (up) - Gross profit deferral, net of taxes (down) - Gain on Assets Sale, net of taxes (up) Adjusted Book Value

NCI 120,000 (3,600)

Powder 280,000 (8,400) (15,000) (21,000) 235,600 242,000

(9,000) 107,400 108,000

Deferred Gain Calculations:

Upstream GP Deferral (net of taxes) Downstream GP Deferral (net of taxes) Upstream Gain on Asset Sale (net of taxes) Total

Basic Consolidation Entry Common Stock Retained Earnings Income from Solid Co. NCI in NI of Solid Co. Investment in Solid Co. NCI in NA of Solid Co.

Sales COGS

Total 70,000 50,000

Gross Profit

20,000

Gross Profit %

28.57%

Total (12,000) (15,000) (30,000) (57,000)

150,000 250,000 44,400 12,600 235,600 107,400

Re-sold 0 0 0

Powder's share (8,400) (15,000) (21,000) (44,400)

NCI's share (3,600) (9,000) (12,600)

← Common Stock ← Beginning balance in RE ← Powder’s share GP Deferrals – Gain ← NCI share of GP Deferral – Gain ← Powder's share of BV with adjustments ← NCI share of BV of net assets with adjustments

Ending Inventory 70,000 50,000 20,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-29 (continued) Eliminate Inventory Purchases: Sales Cost of Goods Sold Inventory

70,000 50,000 20,000

Eliminate Tax Expense on Unrealized Profit on Inventory Transfer: Deferred Tax Asset 8,000 Deferred Tax Expense 8,000

Sales COGS

Total 85,000 60,000

Gross Profit

25,000

Gross Profit %

29.41%

Re-sold 0 0

Ending Inventory 85,000 60,000

Eliminate Inventory Purchases: Sales Cost of Goods Sold Inventory

25,000

85,000 60,000 25,000

Eliminate Tax Expense on Unrealized Profit on Inventory Transfer: Deferred Tax Asset 10,000 Deferred Tax Expense 10,000

Powder Solid Co.

Equipment 90,000 30,000 120,000

Accumulated Depreciation Actual "As If"

0 80,000 80,000

Eliminate the Gain on Equipment and Correct Asset's Basis: Gain on sale 50,000 Equipment 30,000 Accumulated Depreciation 80,000

Eliminate Tax Expense on Unrealized Profit from Asset Transfer: Deferred Tax Asset 20,000 Deferred Tax Expense 20,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-29 (continued) a.

Balance Sheet Cash Accounts Receivable Inventory Land Buildings and Equipment Less: Accumulated Depreciation Investment in Solid Co. Deferred Tax Asset

Powder

Solid Co.

44,400 120,000 170,000

20,000 60,000 120,000

90,000 500,000

30,000 300,000

(180,000) 235,600

(80,000) 0

Total Assets

980,000

450,000

Accounts Payable Wages Payable Bonds Payable Common Stock Retained Earnings

70,000 80,000 200,000 100,000 530,000

20,000 30,000 0 150,000 250,000

NCI in NA of Solid Co. Total Liabilities & Equity

980,000

450,000

Consolidation Entries DR CR

20,000 25,000

150,000 250,000 70,000 85,000 50,000

605,000

64,400 180,000 245,000 120,000 830,000

30,000

8,000 10,000 20,000 68,000

Consolidated

80,000 235,600

(340,000) 0 38,000

360,600

1,137,400

44,400 12,600 50,000 8,000 60,000 10,000 20,000 107,400 312,400

90,000 110,000 200,000 100,000 530,000

107,400 1,137,400

Chapter 10 – Additional Consolidation Reporting Issues

P10-29 (continued) b.

Powder Corporation and Subsidiary Consolidated Balance Sheet December 31, 20X9

Cash Accounts Receivable Inventory Land Buildings and Equipment Less: Accumulated Depreciation Deferred Tax Asset Total Assets Accounts Payable Wages Payable Bonds Payable Stockholders' Equity: Controlling Interest: Common Stock Retained Earnings Total Controlling Interest Noncontrolling Interest Total Stockholders’ Equity Total Liabilities and Stockholders' Equity

$830,000 (340,000)

64,400 180,000 245,000 120,000

490,000 38,000 $1,137,400 $ 90,000 110,000 200,000

$100,000 530,000 $630,000 107,400 737,400 $1,137,400

Chapter 10 – Additional Consolidation Reporting Issues

P10-30 Computations Involving Tax Allocation a.

Equity-method journal entries recorded by Poom Manufacturing: Investment in Satellite Industries 142,500 Income from Satellite Industries Record equity-method income for 20X5: $190,000 x 0.75

142,500

Cash 112,500 Investment in Satellite Industries Record dividends for 20X5: $150,000 x 0.75

112,500

Income assigned to noncontrolling interest: Net income of Satellite Industries Unrealized inventory profit ($30,000 x 0.60) Unrealized profit on sale of land ($120,000 x 0.60) Satellite's realized net income Proportion of stock held by noncontrolling interest Income to noncontrolling interest

Consolidated net income and income to controlling Interest: Operating income of Poom Manufacturing Inventory profits realized in 20X5 Realized operating income of Poom Manufacturing Realized income of Satellite Industries Consolidated income before provision for taxes Provision for income taxes on: Operating income ($720,000 x 0.40) Income from Satellite Industries ($112,500 x 0.20 x 0.40) Consolidated Net Income Income to noncontrolling interest Income to controlling interest

$190,000 (18,000) (72,000) $100,000 x 0.25 $ 25,000

$700,000 20,000 $720,000 100,000 $820,000 $288,000 9,000

(297,000) $523,000 (25,000) $498,000

Net assets assigned to noncontrolling interest in consolidated balance sheet at December 31, 20X5: Net assets reported by Satellite Industries Less: Unrealized inventory profits ($30,000 x 0.60) Unrealized profit on land ($120,000 x 0.60) Realized net assets of Satellite Industries Proportion of stock held by noncontrolling interest Net assets assigned to noncontrolling interest

$900,000 (18,000) (72,000) $810,000 x .25 $202,500

Chapter 10 – Additional Consolidation Reporting Issues

P10-31 Worksheet Involving Tax Allocation a. Consolidation entries: Book Value Calculations:

Original Book Value + Net Income - Dividends

NCI 30% 60,000 10,800 (3,000)

Ending Book Value

67,800

Pillow 70% 140,000 25,200 (7,000)

158,200

Common Stock 50,000

Retained + Earnings 150,000 36,000 (10,000)

50,000

176,000

Adjustment to Basic Consolidation Entry:

Net Income + Reversal of X6 GP, net of taxes (Up) - Deferral of X7 GP, net of taxes (Up) - Gain on Asset Sale, net of taxes (Down) Income to be eliminated

NCI 30% 10,800 1,800 (4,500)

Pillow 70% 25,200 4,200 (10,500) (9,000)

8,100

9,900

-----------------------------------------------------------------------------------------------Ending Book Value + Reversal of X6 GP, net of taxes (Up) - Deferral of X7 GP, net of taxes (Up) - Gain on Asset Sale, net of taxes (Down) Adjusted Book Value Basic Consolidation Entry Common Stock Retained Earnings Income from Sheet NCI in NI of Sheet Dividends Declared Investment in Sheet NCI in NA of Sheet

158,200 4,200 (10,500) (9,000)

65,100

142,900

50,000 150,000 9,900 8,100

Eliminate Beginning Inventory Profit: Investment in Sheet 4,200 NCI in NA of Sheet 1,800 Income Tax Expense 4,000 Cost of Goods Sold Eliminate Inventory Purchases: Sales Cost of Goods Sold Inventory

67,800 1,800 (4,500)

← Common Stock ← Beginning balance in RE ← Pillow’s share of NI + GP Reversal - GP Def. - Gain ← NCI share of Tarp Co.'s NI + GP Reversal - GP Def.

10,000 142,900 65,100

← 100% of Tarp Co.'s dividends ← Pillow's share of BV + GP Reversal - GP Def. - Gain ← NCI share of BV of net assets + GP Reversal - GP Def.

10,000

120,000 95,000 25,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-31 (continued) Eliminate Tax Expense on Unrealized Profit on Inventory Transfer: Deferred Tax Asset 10,000 Deferred Tax Expense 10,000

Sheet Pillow

Equipment 65,000 85,000 150,000

Accumulated Depreciation Actual "As If"

0 100,000 100,000

Eliminate the Gain on Equipment and Correct Asset's Basis: Gain on sale 15,000 Equipment 85,000 Accumulated Depreciation 100,000 Eliminate Tax Expense on Unrealized Profit from Asset Transfer: Deferred Tax Asset 6,000 Deferred Tax Expense 6,000

Chapter 10 – Additional Consolidation Reporting Issues

P10-31 (continued) b. Consolidation Entries Pillow

Sheet

DR 120,000

Consolidated

Income Statement Sales

580,000

300,000

Less: COGS

(435,000)

(210,000)

760,000 10,000

(540,000)

95,000 Less: Depreciation Expense

(40,000)

(20,000)

Less: Tax Expense

(44,000)

(24,000)

(60,000) 4,000

10,000

(56,000)

6,000 Less: Other Expenses

(11,400)

(10,000)

Income from Sheet

9,900

Gain on Sale of Equipment

15,000

Consolidated Net Income

74,500

36,000

148,900

NCI in Net Income Controlling Interest in Net Income

(21,400) 9,900

0 0 121,000

8,100

82,600 (8,100)

74,500

36,000

157,000

121,000

74,500

Beginning Balance

370,000

150,000

Net Income

74,500

36,000

157,000

Less: Dividends Declared

(20,000)

(10,000)

Ending Balance

424,500

176,000

Cash

35,800

56,000

91,800

Accounts Receivable

130,000

40,000

170,000

Inventory

220,000

60,000

Land

60,000

20,000

Buildings and Equipment

450,000

400,000

Less: Accumulated Depreciation

Statement of Retained Earnings

307,000

370,000 121,000

74,500

10,000

(20,000)

131,000

424,500

Balance Sheet

(150,000)

(160,000)

Patents

70,000

Investment in Sheet

138,700

Deferred Tax Asset

25,000

255,000 80,000

85,000

935,000 100,000

(410,000) 70,000

4,200

142,900

10,000

0 16,000

6,000 Total Assets

954,500

416,000

Accounts Payable

40,000

30,000

105,200

267,900

1,207,800

70,000

Wages Payable

70,000

20,000

90,000

Bonds Payable

200,000

100,000

300,000

Deferred Income Taxes

120,000

40,000

Common Stock

100,000

50,000

Retained Earnings

424,500

176,000

307,000 1,800

65,100

63,300

954,500

416,000

358,800

196,100

1,207,800

NCI in NA of Sheet Total Liabilities & Equity

160,000 100,000 131,000

424,500

Chapter 10 – Additional Consolidation Reporting Issues

P10-32 Earnings per Share with Convertible Securities Basic earnings per share Punch Manufacturing income from operations Short Retail Stores net income Preferred dividends ($100,000 x 0.08) Earnings available Short shares outstanding Computed EPS for Short Shares held by Punch Manufacturing Contribution to Punch Manufacturing earnings Total earnings of Punch Manufacturing Preferred dividends of Punch Manufacturing Earnings to Punch common shareholders Punch Manufacturing shares outstanding Basic earnings per share

$100,000 $49,200 (8,000) $41,200 ÷20,000 $ 2.06 x16,000 32,960 $132,960 (22,000) $110,960 ÷ 15,000 $ 7.40

Diluted earnings per share Punch Manufacturing income from operations Short Retail Stores net income Assumed conversion of bonds: $20,000 x 0.60 Earnings available Short shares outstanding 20,000 Assumed conversion of bonds 8,000 Assumed conversion of preferred 12,000 Total shares Computed EPS for Short Shares held by Punch Manufacturing Contribution to Punch Manufacturing earnings Total earnings of Punch Manufacturing Preferred dividends of Punch Manufacturing Earnings to Punch common shareholders Punch Manufacturing shares outstanding Diluted earnings per share

$100,000 $49,200 12,000 $61,200

÷40,000 $ 1.53 x16,000 24,480 $124,480 (22,000) $102,480 ÷ 15,000 $ 6.83

Chapter 10 – Additional Consolidation Reporting Issues

P10-33 Comprehensive Earnings per Share Basic earnings per share Plug Corporation operating income Socket net income Preferred dividends ($200,000 x 0.11) Earnings available to common shareholders Socket shares outstanding Computed EPS for Socket Shares held by Plug Corporation Contribution to Plug Corporation earnings Total earnings of Plug Corporation Plug Corporation shares outstanding Basic earnings per share

$300,000 $115,000 (22,000) $ 93,000 ÷ 40,000 $ 2.325 x 32,000 74,400 $374,400 ÷100,000 $ 3.74

Diluted earnings per share Plug Corporation operating income Socket net income Assumed conversion of bonds ($500,000 x 0.08) x 0.60 Earnings available to common Socket shares outstanding Assumed conversion of bonds Assumed conversion of preferred Exercise of warrants: 10,000 - [($8 x 10,000) / $40] Total shares Computed EPS for Socket Shares held by Plug Corporation Contribution to Plug Corporation Earnings Total earnings of Plug Corporation Interest savings on assumed conversion of bonds ($800,000 x 0.10) x 0.60 Plug Corporation shares Diluted earnings per share

$300,000 $115,000 24,000 $139,000 40,000 30,000 20,000 8,000 ÷ 98,000 $ 1.418 x 32,000 45,376 $345,376 48,000 $393,376 ÷125,000 $ 3.15

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

CHAPTER 11 MULTINATIONAL ACCOUNTING: FOREIGN CURRENCY TRANSACTIONS AND FINANCIAL INSTRUMENTS ANSWERS TO QUESTIONS Q11-1 Indirect and direct exchange rates differ by which currency is desired to be expressed in another currency. An indirect exchange rate is the number of foreign currency units that may be obtained for one local currency unit. The indirect exchange rate has the foreign currency unit in the numerator. As a fraction, the indirect exchange rate is expressed as follows: Number of foreign currency units One local currency unit A direct exchange rate is the number of local currency units needed to acquire one foreign currency unit. The direct exchange rate has the local currency units in the numerator (the U.S. dollar for the direct exchange rate for the U.S. dollar). As a fraction, the direct exchange rate is expressed as follows: Number of local currency units One foreign currency unit The indirect and direct exchange rates are inversely related and both state the same relationship between two currencies. Q11-2 The direct exchange rate can be calculated by taking the inverse of the indirect exchange rate. Such a computation follows: Number of foreign currency units One local currency unit

C$1.3623 (Canadian dollars) $1.00 (U.S. dollars)

The inverse of the indirect exchange rate is: $1.00 (U.S. dollars) C$1.36 (Canadian dollars)

$0.7340

Q11-3 When the U.S. dollar strengthens against the European euro, imports from Europe into the U.S. will be less expensive in U.S. dollars. The direct exchange rate decreases, indicating that it takes fewer dollars to acquire European euros. Q11-4 A foreign transaction is a transaction that does not involve the exchange of currencies on the part of the reporting entity. An example of a foreign transaction is the sale of equipment by a U.S. company (the reporting entity) to a Japanese firm that is denominated in U.S. dollars. A foreign currency transaction is a transaction that does involve the exchange of currencies on the part of the reporting entity. An example of a foreign currency transaction is the sale of equipment by a U.S. company (the reporting entity) to a Japanese firm that is denominated in Japanese yen. 11-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

Q11-5 There are many types of economic factors that affect currency exchange rates, among which are the level of inflation, the balance of payments, changes in interest rates and investment levels, and the stability and process of governance. One example of an economic factor that results in a weakening of the U.S. dollar versus the European euro is a higher level of inflation in the U.S. relative to the inflation in Europe. Q11-6 Assets and liabilities denominated in a foreign currency are measured according to the requirements in ASC 830 for those arising from normal purchase and sale transactions, and by ASC 815 for forward exchange contracts and hedging activities. ASC 830 specifies that the valuation at the transaction date and each subsequent balance sheet date should be at the local currency equivalent using the spot rate of exchange. Forward exchange contracts are valued at fair value, typically by using the forward rate for the remainder of the term of the forward contract. Q11-7 Foreign currency transaction gains or losses are recognized in the financial statements in the period in which the exchange rate changes. These gains or losses are reported on the income statement. Q11-8 If the direct exchange rate increases, the Sun Company will experience a foreign currency transaction loss on its $200,000 account payable that is denominated in Canadian dollars. The increase in the direct exchange rate shows that the U.S. dollar has weakened relative to the Canadian dollar, requiring more U.S. dollars be used to pay the debt owed. Q11-9 Four ways a U.S. company can manage the risk of changes in the exchange rates for foreign currencies are to (1) use a forward contract to offset an exposed foreign currency position, (2) hedge a firm foreign currency commitment as a fair value hedge, (3) hedge an anticipated foreign transaction as a cash flow hedge, or (4) speculate in foreign currency markets. One example of a U.S. company hedging against the risk of changes in the exchange rates for foreign currencies is to use a forward exchange receivable contract to partially offset the effects of changes in the exchange rates of the foreign currency liability. Q11-10 An exposed net asset position occurs when a company's trade receivables and other assets denominated in a foreign currency are greater than its liabilities denominated in that currency. An exposed net liability position occurs if a company's liabilities denominated in a foreign currency exceed receivables denominated in that currency. Q11-11 A difference usually exists between a currency's spot rate and forward rate because of the different economic factors involved in the determination of a future versus present rate of exchange. This difference is usually positive because of uncertainty and conservatism toward the future. For example, if inflation is assumed to continue into the future in the foreign country whose currency is being acquired, the forward rate will be higher than the spot rate because of the decreasing purchasing power of the currency. In addition, the time value of money factor will typically result in a higher forward exchange rate than the spot exchange rate. Q11-12 (a) When an exposed foreign currency position exists, either an exposed net asset or net liability position is created. The forward contract is valued at fair value, usually by the forward exchange rate for the remainder of the term of the forward contract. The underlying payable or receivable from the foreign currency transaction is valued at the spot rate at the time of the transaction and adjusted to the current spot rate at each balance sheet date. (b) For a hedge of an identifiable foreign currency commitment, both the financial instrument and the forward contract aspects of the hedge are valued at the 11-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

forward rate. An account, termed firm commitment, is created during the term of the forward contract to recognize the change in value of the financial instrument aspect of the firm commitment. (c) For a cash flow hedge of a forecasted transaction, the forward contract is valued at the forward rate, but the effective portion of the change in the fair value of the forward contract is recognized in other comprehensive income. The gain or loss on the re-measured foreign currency denominated account payable or receivable is offset from a reclassification of other comprehensive income so that there is no net exchange gain or loss from this hedge. (d) A speculative forward contract is not a hedge, but rather is a derivative that is valued at fair value by using the forward exchange rate for the remainder of the forward contract’s term. Gains or losses on these forward contracts are recognized in income in the period in which they occur.

SOLUTIONS TO CASES C11-1 Effects of Changing Exchange Rates a. The major factors influencing the demand for the U.S. dollar on the foreign exchange markets are (1) rate of inflation, (2) the interest and investment rates, (3) balance of payments, and (4) alternative investment opportunities. For example, the demand for the U.S. dollar weakens as inflation rates increase, interest rates decrease, the balance of payments becomes an increasingly high deficit, and alternative investments in other countries are more readily available. b. As the dollar drops in value in relation to other currencies: (1) Exports from the U.S. to the other country become less expensive and foreign buyers tend to increase their orders for U.S. goods. For example, assume the U.S. dollar weakened relative to a foreign currency unit (FCU) as follows: direct exchange rate after weakening

= =

$0.50 / 1 FCU $0.60 / 1 FCU

This would mean that a U.S.-manufactured machine selling for $10,000 would cost the foreign customer 20,000 FCU before the weakening of the dollar ($10,000 = 20,000 FCU x $0.50). After the weakening of the dollar, this same machine would cost the foreign customer 16,667 FCU ($10,000 = 16,667 FCU x $0.60). This means a significant price reduction for the foreign buyer, thereby increasing the foreign demand for the U.S.-manufactured machine. (2) The opposite effect occurs for the U.S. business firm as the dollar weakens. Foreign-made goods are now more expensive as it takes more dollars to acquire imports. For example, a foreign-made part selling for 10 FCU before the weakening costs the U.S. company $5.00 ($5.00 = 10 FCU x $0.50). After the dollar weakens, the same part now costs the U.S. company $6.00 ($6.00 = 10 FCU x $0.60). This increase of $1.00 per part is due solely to the weakening of the U.S. dollar relative to the foreign currency. Nevertheless, the U.S. business firm is subject to a very significant increase in the cost of its inputs. c. As the dollar weakens, imports become more expensive for the U.S. consumer. In addition, as in case b(2), the U.S.-based manufacturer using foreign-made components 11-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

for its products must now pass the higher costs on to its customers. Thus, U.S. consumers have to pay higher prices for their goods that have foreign elements. C11-2

Reporting a Foreign Currency Transaction on the Financial Statements [AICPA Adapted]

a. Bow should report a foreign exchange loss on its 20X5 income statement. This loss is calculated by taking the number of pounds that are due in 20X6 and multiplying them by the change in the direct exchange rate from the transaction date to the balance sheet date. Since the U.S. dollar weakened, the direct exchange rate on December 31, 20X5, would be higher than the direct exchange rate on November 30, 20X5. The increase in the direct exchange rate means that more U.S. dollars would be needed to purchase pounds at December 31, 20X5, than at November 30, 20X5. Therefore, a foreign currency transaction loss should be reported in 20X5 because the exchange rate changed during 20X5. In addition, the accounts payable denominated in pounds should be reported at the exchange rate at December 31, 20X5. This means that the accounts payable recorded on November 30, 20X5, would have to be increased in order to reflect a weakening U.S. dollar. b. Reporting a foreign exchange loss in 20X5 is appropriate because, consistent with accrual accounting, the exchange rate on December 31, 20X5, should be used to value the accounts payable denominated in pounds. Bow's beliefs as to future exchange rate movements are excluded from the financial statements. C11-3 Changing Exchange Rates Note to Teacher: Currency exchange rates may be found in a variety of places on the Internet. A good site is finance.yahoo.com/currencies. Note that to obtain the direct exchange rate, students will have to specify the conversion as the foreign currency units into U.S. Dollars. After clicking the link for the conversion, both the current exchange rate and a chart of historical exchange rates are presented. There are various options for the length of time shown on the chart; the student should select the 2-year chart. Other sites can be found using a search engine and search terms such as “historical currency exchange rates.” Historical chart examples follow.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

C11-3 (continued) Japanese Yen:

European Euro:

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

C11-3 (continued) British Pound:

Mexican Peso:

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

C11-4 Accounting for Foreign Currency-Denominated Accounts Payable MEMO TO:

Marie Lamont, Manager, Mardi Gras audit

From:

______________ _______________, CPA

Re:

Mardi Gras Corporation’s Foreign Currency Transactions

Our client, Mardi Gras Corporation, needs to change its method of accounting for the effects of changes in the exchange rate for Swiss francs. Currently, any difference between the liability recorded when the merchandise is received and the amount that is paid (in U.S. dollars) when the liability is settled is recorded by our client as an adjustment to the cost of the inventory purchased. However, this difference is the result of changes in the exchange rate for Swiss francs between the date of the inventory purchase and the payment date and is not the result of changes in the price of the merchandise. Mardi Gras’ purchases from the Swiss company are foreign currency transactions that result in Mardi Gras recording a payable denominated in Swiss francs. The liability is fixed in terms of the amount of Swiss francs that must be paid. Mardi Gras is recording the payable appropriately since it is using the exchange rate on the date of the inventory purchase to convert the francs to dollars. This is consistent with requirements in ASC 830. However, the accounting for subsequent changes in the U.S. dollar equivalent of the Swiss franc liability is not acceptable. Rather than an adjustment to the cost of inventory, changes in the liability that result because of changes in the exchange rate between the U.S. dollar and the Swiss franc must be recognized as a foreign currency transaction gain or loss and must be included in net income in the period in which the rate change occurs. Mardi Gras should also be aware that any outstanding foreign currency payables at the balance sheet date should be adjusted to their U.S. dollar equivalent using the exchange rate in effect on the balance sheet date, with any resulting foreign currency transaction gains or losses included in earnings of the current period. Disclosure of the aggregate gain or loss from foreign currency transactions used in determining net income for a given period is also required. Authoritative support for this memo can be found in the following references: ASC 830-20-30, ASC 830-20-35, ASC 830-20-50

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

C11-5 Accounting for Foreign Currency Forward Contracts MEMO To:

Lindsay Williams, Treasurer

From:

__________ ___________, CPA, Assistant Treasurer

Re:

Financial Statement Effects of Foreign Currency Forward Contract

Avanti has entered into a contract to purchase equipment for a fixed price of 4.5 million euros. This agreement meets the definition of an unrecognized firm commitment that has both contractual rights and contractual obligations. The fixed price of the firm commitment exposes the company to the fair value risk of changes in the price of the equipment. However, because the purchase price is denominated in euros, the contract also exposes the company to the risk of changes in the value of the foreign currency. The company may enter into a derivative contract. ASC 815-20-25 allows such a derivative contract of a foreign currency exposure of an unrecognized firm commitment to be designated as a hedge. If Avanti elects to use a forward exchange contract to fix the exchange rate to purchase euros, the company can designate the forward contract as a foreign currency fair value hedge of the foreign currency exposure in the firm commitment if there is formal documentation of the hedging relationship and the rationale for the management’s decision to use the hedge, and if the effectiveness of the hedge is assessed before every reporting date and at least every three months. If the forward contract qualifies as a foreign currency fair value hedge, the gain or loss on the hedge and the offsetting gain or loss on the hedged firm commitment should be recognized in earnings in the same accounting period. Therefore, during the commitment period, there will be no effect on the income statement; the gain or loss on the derivative will be offset by the loss or gain on the firm commitment. After the equipment is delivered, a foreign currency denominated payable will be recorded and accounted for under ASC 830-20-30. Transaction gains or losses on the foreign currency liability may continue to be offset by changes in the fair value of the forward contract. Authoritative support for this memo can be found in the following references: ASC 815-20-25-23 through ASC 815-20-25-33, ASC 830-20-30

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

C11-6 Accounting for Hedges of Available-for-Sale Securities MEMO To:

Mark Becker, CFO

From:

___________ _______________, CPA, Investment Division

Re:

Hedge Accounting—Bond Portfolio

The proposal has been made to use an interest rate futures contract to hedge the interest rate risk associated with Rainy Day’s portfolio of bond investments. Although the use of the derivative may be expected to offset the changes in the value of the bond portfolio, the issue that must be considered is whether the use of this derivative would qualify for hedge accounting under ASC 815-20-25. If hedge accounting cannot be used, the changes in the fair value of the futures contract will be included in net income. However, the changes in the fair value of the bond portfolio will continue to be reported as other comprehensive income, but not in net income. ASC 815-20-25 does allow a portfolio of similar assets or similar liabilities to be designated as the hedged item under certain conditions. The change in value of any item in the portfolio must be generally proportionate to changes in value for the entire portfolio. To meet this condition, Rainy Day should be able to demonstrate that the values of the individual bonds within the portfolio respond to interest rate changes in a proportionate manner to the overall portfolio response. Given the wide range of maturity dates on the bonds in the portfolio, this condition may be difficult to meet. If the aggregation criteria are not met, Rainy Day could consider aggregating bonds of similar maturities into several sub-portfolios and using multiple derivatives to hedge the interest rate risk associated with each group of bond investments. This subdividing of the bond portfolio would also make it easier to demonstrate if the hedge is effective. If hedge accounting is allowed, the effect on earnings of the derivative will be offset by the changes in the fair value of the bond investment. Authoritative support for this memo can be found in the following references: ASC 815-20-25

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

SOLUTIONS TO EXERCISES E11-1 Exchange Rates a. Indirect exchange rates for pounds and dollars: $1.00 = .625 British pounds (1 pound / $1.60) $1.00 = 1.3514 Canadian dollars (1 Canadian dollar / $0.74) b.

FCU

$ Direct Exchange Rate

$8,000 $1.60

5,000 British pounds

c. 4,000 Canadian dollars x $0.74 = $2,960 E11-2 Changes in Exchange Rates a. Exchange rates: Arrival Date

Direct Exchange Rate

Indirect Exchange Rate

Departure Date

1 florin = $0.20

1 florin = $0.15

($200 / 1,000 florins)

($15 / 100 florins)

$1.00 = 5 florins

$1.00 = 6.67 florins

(1,000 florins / $200)

(100 florins / $15)

The direct exchange rate has decreased. This means that the dollar has strengthened during Mr. Alt's visit. For example, upon arrival, Mr. Alt had to pay $0.20 per each florin. Upon departure, however, each florin is worth just $0.15. This means that the relative value of the dollar has increased or, alternatively, the value of the florin has decreased.

c. The U.S. dollar equivalent values for the 100 florins are: Arrival date 100 florins x $0.20 = Departure date 100 florins x $0.15 = Foreign Currency Transaction Loss

$20 15 $5

Mr. Alt held florins for a time in which the florin was weakening against the dollar. Thus, Mr. Alt experienced a loss by holding the weaker currency.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-3 Basic Understanding of Foreign Exposure a. If the direct exchange rate increases, the U.S. dollar weakens relative to the foreign currency unit. If the indirect exchange rate increases, the U.S. dollar strengthens relative to the foreign currency unit. b.

Transaction

Settlement Currency

Importing Importing Exporting Exporting

Dollar LCU Dollar LCU

Direct Exchange Rate Increases Decreases NA L NA G

NA G NA L

Indirect Exchange Rate Increases Decreases NA G NA L

NA L NA G

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-4 Account Balances Foreign Currency Units (€) From receivable: (€250,000 x $0.58)

(7) 2/1/x7

145,000

Bal. 2/2/x7

72,500

To payable: (€125,000 x $0.58)

(8) 2/1/x7

72,500

[€250,000 x ($0.58 - $0.62)]

(5) 2/1/x7 AJE

10,000

(€250,000 x $0.58)

(7) 2/1/x7 Settle

145,000

(€125,000 x $0.60)

(2) 11/1/x6

75,000

[€125,000 x ($0.62 - $0.60)]

(4) 12/31/x6 AJE

2,500

(€125,000 x $0.62)

Bal. 12/31/x6

77,500

(€125,000 x $0.58)

Bal. 2/1/x7

Accounts Receivable (€) (€250,000 x$0.60)

(1) 11/1/x6

[€250,000 x ($0.62 - $0.60)]

(3) 12/31/x6 AJE

(€250,000 x $0.62)

Bal. 12/31/x6

(€250,000 x $0.58)

150,000 5,000 155,000

Bal. 2/1/x7

145,000

Bal. 2/2/x7

-0-

Accounts Payable (€)

[€125,000 x ($0.58 - $0.62)] (€125,000 x $0.58)

(6) 2/1/x7 AJE (8) 2/1/x7 Settle

5,000 72,500

Bal. 2/2/x7

72,500 -0-

Foreign Currency Transaction Loss [€125,000 x ($0.62 - $0.60)] [€250,000 x ($0.58 - $0.62)]

(4) 12/31/x6 AJE

2,500

(5) 2/1/x7 AJE

10,000

Foreign Currency Transaction Gain [€250,000 x ($0.62 - $0.60)]

(3) 12/31/x6 AJE

5,000

[€125,000 x ($0.58 - $0.62)]

(6) 2/1/x7 AJE

5,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-5 Determining Year-End Account Balances for Import and Export Transactions Accounts Receivable

Accounts Payable

Foreign Currency Transaction Exchange Loss

Foreign Currency Transaction Exchange Gain

Case 1

$16,000(a)

$2,000(b)

Case 2

$38,000(c)

$2,000(d)

Case 3

$27,000(e)

$3,000(f)

Case 4

$6,250(g)

$1,250(h)

(a) (b) (c) (d) (e) (f) (g) (h)

LCU 40,000 x $0.40 LCU 40,000 x ($0.40 - $0.45) LCU 20,000 x $1.90 LCU 20,000 x ($1.90 - $1.80) LCU 30,000 x $0.90 LCU 30,000 x ($0.90 - $0.80) LCU 2,500,000 x $0.0025 LCU 2,500,000 x ($0.0025 - $0.003)

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-6 Transactions with Foreign Companies a.

May 1

June 20

July 1

August 10

Inventory (or Purchases) Accounts Payable Foreign purchase denominated in U.S. dollars.

8,400

Accounts Payable Cash Settle payable.

8,400

Accounts Receivable Sales Foreign sale denominated in U.S. dollars.

10,000

Cash Accounts Receivable Collect receivable.

10,000

8,400

10,000

May 1

Inventory (or Purchases) 8,400 Accounts Payable (¥) 8,400 Foreign purchase denominated in yen: $8,400 / $0.0070 = ¥1,200,000

June 20

Foreign Currency Transaction Loss 600 Accounts Payable (¥) 600 Revalue foreign currency payable to U.S. dollar equivalent value: $9,000 = ¥1,200,000 x $0.0075 June 20 spot rate - 8,400 = ¥1,200,000 x $0.0070 May 1 spot rate $ 600 = ¥1,200,000 x ($0.0075 - $0.0070) Foreign Currency Units (¥) 9,000 Cash 9,000 Purchase of yen to settle account payable at June 20 spot rate.

July 1

August 10

Accounts Payable (¥) Foreign Currency Units (¥) Settle payable denominated in yen.

9,000

Accounts Receivable (BRL) Sales Foreign sale denominated in Brazilian reals: $10,000 / $0.20 = BRL50,000

10,000

9,000

10,000

Accounts Receivable (BRL) 1,000 Foreign Currency Transaction Gain 1,000 Revalue foreign currency receivable to U.S. dollar equivalent value: $ 11,000 = BRL50,000 x $0.22 Aug. 10 spot rate - 10,000 = BRL50,000 x $0.20 July 1 spot rate $ 1,000 = BRL50,000 x ($0.22 - $0.20) Foreign Currency Units (BRL) Accounts Receivable (BRL) Receive Brazilian reals in settlement of receivable.

11,000 11,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-7 Foreign Purchase Transaction a.

Denominated in Swiss francs Rone Imports reports in U.S. dollars

Direct Exchange Rate b.

12/1/X1

12/31/X1

1/15/X2

Transaction Date $0.70

Balance Sheet Date $0.66

Settlement Date $0.68

December 1, 20X1 Inventory (or Purchases) Accounts Payable (SFr) $10,500 = SFr 15,000 x $0.70

10,500 10,500

December 31, 20X1 Accounts Payable (SFr) Foreign Currency Transaction Gain Revalue foreign currency payable to equivalent U.S. dollar value: $ 9,900 = SFr 15,000 x $0.66 Dec. 31 spot rate -10,500 = SFr 15,000 x $0.70 Dec. 1 spot rate $ 600 = SFr 15,000 x ($0.66 - $0.70) January 15, 20X2 Foreign Currency Transaction Loss Accounts Payable (SFr) Revalue payable to current U.S. dollar equivalent: $10,200 = SFr 15,000 x $0.68 Jan. 15, 20X2, value - 9,900 = SFr 15,000 x $0.66 Dec. 31, 20X1, value $ 300 = SFr 15,000 x ($0.68 - $0.66)

600 600

300 300

Foreign Currency Units (SFr) Cash Purchase Swiss Franks $10,200 = SFr 15,000 x $0.68

10,200

Accounts Payable (SFr) Foreign Currency Units (SFr) Settle account in Swiss Franks

10,200

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

AJE 12/31/X1

Accounts Payable (SFr) (SFr 15,000 x $0.70) 600 (SFr 15,000 x $0.66) (SFr 15,000 x $0.68)

1/15/X2 Settlement

12/1/X1

10,500

Bal. 12/31/X1

9,900

AJE 1/15/X2 Bal. 1/15/ X2

300 10,200

Bal. 1/16/X2

-0-

10,200

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-8 Adjusting Entries for Foreign Currency Balances a.

December 31, 20X6 Accounts Receivable (E£) 10,000 Foreign Currency Transaction Gain 10,000 Adjust receivable denominated in Egyptian pounds to current U.S. dollar equivalent and recognize exchange gain: $83,600 = E£475,000 x $0.176 Dec. 31 spot rate - 73,600 = Pre-adjusted Dec. 31, 20X6, value $10,000 Accounts Payable (¥) 5,200 Foreign Currency Transaction Gain 5,200 Adjust payable denominated in foreign currency to current U.S. dollar equivalent and recognize exchange gain: $175,300 = Pre-adjusted Dec. 31, 20X6, value - 170,100 = ¥21,000,000 x $0.0081, Dec. 31 spot rate $ 5,200

Accounts Receivable (E£) 1,900 Foreign Currency Transaction Gain 1,900 Adjust receivable denominated in Egyptian Pounds to equivalent U.S. dollar value on settlement date: $85,500 = E£475,000 x $0.180 20X7 collection date value - 83,600 = E£475,000 x $0.176 Dec. 31, 20X6, spot rate $ 1,900 = E£475,000 x ($0.180 - $0.176) Cash Foreign Currency Units (E£) Accounts Receivable (E£) Accounts Receivable ($) Collect all accounts receivable.

164,000 85,500 85,500 164,000

Accounts Payable (¥) 6,300 Foreign Currency Transaction Gain Adjust payable to equivalent U.S. dollar value on settlement date: $163,800 = ¥21,000,000 x $0.0078 20X7 payment date value - 170,100 = ¥21,000,000 x $0.0081 Dec. 31, 20X6, spot rate $ 6,300 = ¥21,000,000 x ($0.0078 - $0.0081) Foreign Currency Units (¥) 163,800 Cash Purchase yen at the $0.0078 spot rate to settle the account. Accounts Payable ($) Accounts Payable (¥) Foreign Currency Units (¥) Cash Payment of all accounts payable.

6,300

163,800

86,000 163,800 163,800 86,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-8 (continued) d.

Transaction gain on E£: December 31, 20X6 December 31, 20X7 Overall

$10,000 1,900 $11,900

gain gain gain

Transaction gain on ¥: December 31, 20X6 December 31, 20X7 Overall

$ 5,200 6,300 $11,500

gain gain gain

Overall foreign currency transactions gain: Gain on E£ transaction Gain on ¥ transaction

$11,900 11,500 $23,400

Chocolate De-Lites could have hedged its exposed position. The exposed positions are only those denominated in foreign currency units. The accounts receivable denominated in E£ could be hedged by selling E£ in the forward market, thereby locking in the value of the E£. The accounts payable denominated in ¥ could be hedged by buying ¥ in the forward market, thereby locking in the value of the ¥.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-9 Purchase with Forward Exchange Contract 3/10

6/8

Transaction Date - Account payable in C$ - Sign 90-day FEC to receive C$

Settlement Date - Receive C$ from FEC completion - Settle payable in C$

March 10 Inventory (or Purchases) 17,100 Accounts Payable (C$) Foreign purchase of engines: $17,100 = C$30,000 x $0.57 Foreign Currency Receivable from Exchange Broker (C$) Dollars Payable to Exchange Broker ($) Signed 90-day forward exchange contract to receive C$: $17,400 = C$30,000 x $0.58 forward rate

17,100

17,400 17,400

June 8 Foreign Currency Receivable from Broker (C$) 600 Foreign Currency Transaction Gain 600 Revalue foreign currency receivable to current equivalent U.S. dollar value: $18,000 = C$30,000 x $0.60 June 8 spot rate - 17,400 = C$30,000 x $0.58 Mar. 10 forward rate $ 600 = C$30,000 x ($0.60 - $0.58) Foreign Currency Transaction Loss 900 Accounts Payable (C$) 900 Revalue foreign currency accounts payable to current U.S. dollar value: $900 = C$30,000 x ($0.60 - $0.57) Dollars Payable to Exchange Broker ($) Cash Pay U.S. dollars to exchange broker for forward contract.

17,400

Foreign Currency Units (C$) Foreign Currency Receivable from Exchange Broker (C$) Receive Canadian dollars from exchange broker: $18,000 = C$30,000 x $0.60 spot rate

18,000

Accounts Payable (C$) Foreign Currency Units (C$) Settle foreign currency payable.

18,000

17,400

18,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-10

Purchase with Forward Exchange Contract and Intervening Fiscal Year-End 12/16

12/31

Transaction Date — Payable in SFr — Sign FEC to receive SFr

Balance Sheet date

Forward rate: SFr 1 = $0.67 Spot rate: SFr 1 = $0.68

2/14

Settlement Date — Receive SFr from FEC — Settle payable in SFr

SFr 1 = $0.695 SFr 1 = $0.70

SFr 1 = $0.69

PART I: Forward contract not a designated hedge. a.

December 16, 20X7 Equipment Accounts Payable (SFr) Purchased equipment with payable denominated in SFr: $95,200 = SFr 140,000 x $0.68 spot rate Foreign Currency Receivable from Broker (SFr) Dollars Payable to Exchange Broker ($) Signed 60-day forward exchange contract: $93,800 = SFr 140,000 x $0.67 forward rate

95,200 95,200

93,800 93,800

December 31, 20X7 Foreign Currency Transaction Loss 2,800 Accounts Payable (SFr) Revalue accounts payable to current U.S. dollar equivalent: $98,000 = SFr 140,000 x $0.70 Dec. 31 spot rate - 95,200 = SFr 140,000 x $0.68 Dec. 16 spot rate $ 2,800 = SFr 140,000 x ($0.70 - $0.68) Foreign Currency Receivable from Exchange Broker (SFr) Foreign Currency Transaction Gain Revalue foreign currency receivable: $97,300 = SFr 140,000 x $0.695 Dec. 31 forward rate - 93,800 = SFr 140,000 x $0.67 Dec. 16 forward rate $ 3,500 = SFr 140,000 x ($0.695 - $0.67)

2,800

3,500 3,500

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-10 (continued) February 14, 20X8 Foreign Currency Transaction Loss 700 Foreign Currency Receivable from Exchange Broker (SFr) Revalue foreign currency receivable to current equivalent U.S. dollar value: $96,600 = SFr 140,000 x $0.69 Feb. 14, 20X8, spot rate - 97,300 = SFr 140,000 x $0.695 Dec. 31, 20X7, forward rate $ 700 = SFr 140,000 x ($0.69 - $0.695)

700

Accounts Payable (SFr) 1,400 Foreign Currency Transaction Gain Revalue foreign currency accounts payable to current U.S. dollar value: $96,600 = SFr 140,000 x $0.69 Feb. 14, 20X8, spot rate - 98,000 = SFr 140,000 x $0.70 Dec. 31, 20X7, spot rate $ 1,400 = SFr 140,000 x ($0.69 - $0.70)

1,400

Dollars Payable to Exchange Broker ($) Cash Pay U.S. dollars to exchange broker for forward contract.

93,800

Foreign Currency Units (SFr) Foreign Currency Receivable from Exchange Broker (SFr) Receive francs from exchange broker: $96,600 = SFr 140,000 x $0.69 spot rate

96,600

Accounts Payable (SFr) Foreign Currency Units (SFr) Settle foreign currency payable.

96,600

Foreign Currency Exchange Loss (with Swiss Co.) Foreign Currency Exchange Gain (with Broker) Net effect on income

$(2,800) 3,500 $ 700

93,800

96,600

Overall effect of transactions: 20X7 Net Foreign Currency Gain 20X8 Foreign Currency Loss on receivable 20X8 Foreign Currency Transaction Gain on payable Overall effect

700 (700) 1,400 $ 1,400

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-10 (continued) PART II: Forward contract designated as a cash flow hedge. December 16, 20X7 Equipment Accounts Payable (SFr) Purchased equipment with payable denominated in SFr: $95,200 = SFr 140,000 x $0.68 spot rate Foreign Currency Receivable from Broker (SFr) Dollars Payable to Exchange Broker ($) Signed 60-day forward exchange contract: $93,800 = SFr 140,000 x $0.67 forward rate December 31, 20X7 Foreign Currency Transaction Loss Accounts Payable (SFr) Revalue accounts payable to current U.S. dollar equivalent: $98,000 = SFr 140,000 x $0.70 Dec. 31 spot rate - 95,200 = SFr 140,000 x $0.68 Dec. 16 spot rate $ 2,800 = SFr 140,000 x ($0.70 - $0.68)

95,200 95,200

93,800 93,800

2,800 2,800

Foreign Currency Receivable from Exchange Broker (SFr) 3,500 Other Comprehensive Income 3,500 Revalue foreign currency receivable with effective portion of change in fair value of cash flow hedging derivative recorded in other comprehensive income: $97,300 = SFr 140,000 x $0.695 Dec. 31 forward rate - 93,800 = SFr 140,000 x $0.67 Dec. 16 forward rate $ 3,500 = SFr 140,000 x ($0.695 - $0.67) Other Comprehensive Income 2,800 Foreign Currency Transaction Gain 2,800 In accordance with ASC 815, an amount is reclassified from other comprehensive income to fully offset the foreign currency transaction loss on the revaluation of the foreign currency denominated account payable. February 14, 20X8 Other Comprehensive Income 700 Foreign Currency Receivable from Exchange Broker (SFr) 700 Revalue foreign currency receivable to current equivalent U.S. dollar value and record effective portion of change into other comprehensive income in accordance with ASC 815. Forward contract has now expired. $96,600 = SFr 140,000 x $0.69 Feb. 14, 20X8, spot rate - 97,300 = SFr 140,000 x $0.695 Dec. 31, 20X7, forward rate $ 700 = SFr 140,000 x ($0.69 - $0.695)

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-10 (continued) Accounts Payable (SFr) 1,400 Foreign Currency Transaction Gain 1,400 Revalue foreign currency accounts payable to current U.S. dollar value using the spot rate in accordance with ASC 830: $96,600 = SFr 140,000 x $0.69 Feb. 14, 20X8, spot rate - 98,000 = SFr 140,000 x $0.70 Dec. 31, 20X7, spot rate $ 1,400 = SFr 140,000 x ($0.69 - $0.70) Foreign Currency Transaction Loss 1,400 Other Comprehensive Income 1,400 In accordance with ASC 815, an amount is reclassified from other comprehensive income to fully offset the foreign currency transaction gain on the revaluation of the foreign currency denominated account payable. Dollars Payable to Exchange Broker ($) Cash Pay U.S. dollars to exchange broker for forward contract.

93,800

Foreign Currency Units (SFr) Foreign Currency Receivable from Exchange Broker (SFr) Receive francs from exchange broker: $96,600 = SFr 140,000 x $0.69 spot rate

96,600

Accounts Payable (SFr) Foreign Currency Units (SFr) Settle foreign currency payable.

96,600

93,800

96,600

Note that there is a remaining credit balance of $1,400 in Other Comprehensive Income. This represents the initial discount on the forward contract and will be reclassified into earnings in alignment with the depreciation on the equipment that was acquired.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-11 Foreign Currency Transactions [AICPA Adapted] 1.

d $0.4895 x $0.4845 x

€30,000 €30,000 Gain

20X1 $14,685 14,535 $ 150

$0.4845 x $0.4945 x

€30,000 €30,000 Loss

20X2 $14,535 14,835 $ (300)

b January 15 Foreign Currency Units (LCU) 300,000 Exchange Loss 15,000 Accounts Receivable (LCU) 315,000 Collect foreign currency receivable and recognize foreign currency transaction loss for changes in exchange rates: $300,000 = (LCU 900,000 / LCU 3) Jan. 15 value - 315,000 = Dec. 31 U.S. dollar equivalent $ 15,000 Foreign currency transaction loss

3. d

$120,000 $140,000

= =

-105,000

$ 35,000

July 1, 20X1, U.S. dollar equivalent value December 31, 20X1, U.S. dollar equivalent value (LCU 840,000 / $140,000) = LCU 6 / $1 July 1, 20X2, U.S. dollar equivalent value (LCU 840,000 / 8) = $105,000 Foreign currency transaction loss

4. c

C$1 / $0.90 (C$1.11 = $1.00)

5. d

$280,000 = -240,000 = $ 40,000

6. d

Regardless of whether it is a gain or a loss, the effect of the change will always be included as a component of income.

July 1, 20X5, U.S. dollar equivalent value December 31, 20X4, U.S. dollar equivalent value Foreign currency transaction loss

(a) Incorrect. When the exchange rate in the transaction changes, the effect flows through the income, not in stockholders' equity. (b) Incorrect. When the exchange rate in the transaction changes, the effect flows through the income, not in stockholders' equity. (c) Incorrect. The effect is recorded as a component of income for both gains and losses. 7. d

The resulting loss is required to be included as a component of income, and will be recorded for the year in which it occurred. (a) Incorrect. The loss must be included in 20X6. (b) Incorrect. It must be recorded as a component of income during 20X6. (c) Incorrect. A deferred charge would not result. Instead, the loss is recorded during 20X6 as a component of income. 11-24

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-12 Sale in Foreign Currency a.

Direct exchange rates P1 =

October 1

December 1

Transaction Date

Balance Sheet Date

Settlement Date

$0.0068

$0.0078

$0.0076

Dollar Weakened (rate increased) b.

April 1

Dollar Strengthened (rate decreased)

October 1, 20X6 Accounts Receivable (P) 34,000 Sales Revenue Sold equipment with receivable denominated in pesetas(P): $34,000 = P 5,000,000 x $0.0068

34,000

December 31, 20X6 Accounts Receivable (P) 5,000 Foreign Currency Transaction Gain 5,000 Revalue foreign currency receivable to current U.S. dollar equivalent: $39,000 = P 5,000,000 x $0.0078 Dec. 31 spot rate - 34,000 = P 5,000,000 x $0.0068 Oct. 1 spot rate $ 5,000 = P 5,000,000 x ($0.0078 - $0.0068) April 1, 20X7 Foreign Currency Transaction Loss 1,000 Accounts Receivable (P) Revalue foreign receivable to current U.S. dollar equivalent: $38,000 = P 5,000,000 x $0.0076 April 1 spot rate - 39,000 = P 5,000,000 x $0.0078 Dec. 31 spot rate $ 1,000 = P 5,000,000 x ($0.0076 - $0.0078) Foreign Currency Units (P) Accounts Receivable (P) Collect foreign receivable: $38,000 = P 5,000,000 x $0.0076 c.

1,000

38,000 38,000

Net foreign currency transaction gain = $4,000 October 1 to December 31 = $5,000 gain January 1 to April 1 = (1,000) loss $4,000 gain Proof: $4,000 = P 5,000,000 x ($0.0076 - $0.0068)

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-13 Sale with Forward Exchange Contract April 20

June 19

Transaction Date — Receivable in kronor — Sign FEC to deliver kronor Forward rate: SKr 1 = $0.167 Spot rate: SKr 1 = $0.170 a.

Settlement Date — Receive kronor from receivable — Complete FEC with delivery of kronor SKr 1 = $0.165

April 20 Accounts Receivable (SKr) Sales Revenue $34,000 = SKr 200,000 x $0.17 spot rate

34,000 34,000

Dollars Receivable from Exchange Broker Foreign Currency Payable to Exchange Broker (SKr) Sign 60-day forward exchange contract to deliver kronor: $33,400 = SKr 200,000 x $0.167 forward rate

33,400 33,400

June 19 Foreign Currency Transaction Loss 1,000 Accounts Receivable (SKr) 1,000 Revalue foreign currency receivable to current equivalent U.S. dollar value: $33,000 = SKr 200,000 x $0.165 June 19 spot rate - 34,000 = SKr 200,000 x $0.170 April 20 spot rate $ 1,000 = SKr 200,000 x ($0.165 - $0.170) Foreign Currency Payable to Exchange Broker (SKr) Foreign Currency Transaction Gain Revalue foreign currency payable to current U.S. dollar value: $33,000 = SKr 200,000 x $0.165 June 19 spot rate - 33,400 = SKr 200,000 x $0.167 April 20 forward rate $ 400 = SKr 200,000 x $0.002 Foreign Currency Units (SKr) Accounts Receivable (SKr) Receive kronor from foreign receivable: $33,000 = SKr 200,000 x $0.165 spot rate

400 400

33,000 33,000

Foreign Currency Payable to Exchange Broker (SKr) 33,000 Foreign Currency Units (SKr) 33,000 Pay foreign currency units to exchange broker for forward payable contract. Cash 33,400 Dollars Receivable from Exchange Broker ($) 33,400 Receive U.S. dollars in accordance with rate established in forward exchange contract.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-13 (continued) b.

Effects on net income: Use of forward contract: 1) Dollar strengthened from April 20 to June 19 Exchange loss of $1,000 on foreign currency receivable Exchange gain of $400 for foreign currency payable to exchange broker; therefore, net effect loss

$(600)

If Alman had not acquired the forward contract: 1) Dollar strengthened resulting in exchange loss of $1,000 on foreign currency receivable from customer Difference

(1,000) $ (400)

Hedging with the forward exchange contract resulted in $400 less charged to net income; thus, net income was higher as a result of acquiring the forward contract. E11-14 Foreign Currency Transactions [AICPA Adapted] 1. c $4,000

AJE

Accounts Payable (€) (200,000 x $0.4875) 12/10/X3 4,000 (200,000 x $0.4675) 12/31/X3

Accounts Payable (€) Foreign Exchange Gain

97,500 93,500

4,000 4,000

2. d $27,000 = $6,000 + $20,000 + $1,000 Accounts Payable (FCU) 1/20/X2 AJE 3/20/X2 Foreign Exchange Loss Accounts Payable (FCU)

90,000 6,000 96,000

6,000 6,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-14 (continued) Notes Payable (FCU) 7/01/X2 AJE 12/31/X2 Foreign Exchange Loss Notes Payable (FCU)

500,000 20,000 520,000

20,000 20,000

Interest Payable (FCU) ($500,000 x .10 x 1/2 year) AJE 12/31X2 Foreign Exchange Loss Interest Payable (FCU)

25,000 1,000 26,000

1,000 1,000

3. c $5,000 10/15/X1 AJE 11/16/X1

Accounts Receivable (FCU) 100,000 5,000 105,000 Settlement

Accounts Receivable (FCU) Foreign Exchange Gain

11/16/X1

105,000

5,000 5,000

Note: The receivable is recorded on October 15, 20X1, when the goods were shipped, not on September 1, 20X1, when the order was received. 4. b $1,000

X3 AJE

X4 AJE Settlement

X4 AJE

Accounts Payable (FCU) (10,000 x $0.60) 500

4/08/X3

6,000

(10,000 x $0.55)

12/31/X3

5,500

(10,000 x $0.45)

3/01/X4

4,500

Bal.

-0-

1,000 4,500

Accounts Payable (FCU) Foreign Exchange Gain

1,000 1,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-14 (continued) 5.

A gain should be reported because the peso weakened from December 15 (the transaction date) to the balance sheet date (December 31, 20X5). Stevens would not record the purchase until title transferred on December 15, 20X5. The accounts payable recorded on December 15 are denominated in pesos when the indirect exchange rate was $1 = 20 pesos. On December 31, 20X5, the indirect exchange rate was $1 = 21 pesos, meaning that the dollar strengthened and the peso weakened. Therefore, a foreign currency transaction gain would be reported for 20X5. This gain would be included in net income before discontinued operations.

Foreign currency transaction gains and losses are reported on the income statements of U.S. companies when receivables and payables are denominated in foreign currencies. Since Louis did not report any foreign exchange gains or losses, the payable to the German company was denominated in U.S. dollars, not European euros.

$9,000 = 300,000 pounds x ($1.65 - $1.62). The foreign currency transaction gain is computed using spot rates on the transaction date (November 30, 20X5) and the balance sheet date (December 31, 20X5). The forward exchange rates are not used because the transaction was not hedged.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-15 Sale with Forward Contract and Fiscal Year-End May 14 Transaction Date — Sale with receivable denominated in guilders — Enter into 60-day FEC to deliver guilders Forward rate: G 1 = $0.541 Spot rate: G 1 = $0.530

June 30 Balance Sheet Date

July 13 Settlement Date — Collect receivable in guilders — Complete FEC with delivery of guilders

G 1 = $0.530 G 1 = $0.534

G 1 = $0.525

a. 1.

May 14 Accounts Receivable (G) Sales Revenue Foreign currency sale: $26,500 = G 50,000 x $0.530 May 14 Dollars Receivable from Exchange Broker Foreign Currency Payable to Exchange Broker (G) Signed 60-day forward contract to deliver guilders: $27,050 = G 50,000 x $0.541 forward rate

26,500 26,500

27,050 27,050

June 30 Accounts Receivable (G) 200 Foreign Currency Transaction Gain 200 Revalue foreign currency receivable to end-of-period U.S. dollar equivalent using spot rate according to ASC 830: $26,700 = G 50,000 x $0.534 June 30 spot rate - 26,500 = G 50,000 x $0.530 May 14 spot rate $ 200 = G 50,000 x ($0.534 - $0.530) Foreign Currency Payable to Exchange Broker (G) 550 Foreign Currency Transaction Gain 550 Revalue foreign currency payable to year-end fair value using forward rate according to ASC 815: $26,500 = G 50,000 x $0.530 June 30 forward rate - 27,050 = G 50,000 x $0.541 May 14 forward rate $ 550 = G 50,000 x $0.011

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-15 (continued) 4.

July 13 Foreign Currency Transaction Loss 450 Accounts Receivable (G) Revalue foreign currency receivable to U.S. dollar equivalent on settlement date: $26,250 = G 50,000 x $0.525 July 13 spot rate - 26,700 = G 50,000 x $0.534 June 30 spot rate $ 450 = G 50,000 x ($0.525 - $0.534) Foreign Currency Units (G) Accounts Receivable (G) Collect foreign currency receivable.

450

26,250 26,250

July 13 Foreign Currency Payable to Exchange Broker (G) 250 Foreign Currency Transaction Gain 250 Revalue foreign currency payable to fair value at settlement date using spot rate because the term of the contract has expired: $26,250 = G 50,000 x $0.525 July 13 spot rate - 26,500 = G 50,000 x $0.530 June 30 forward rate $ 250 = G 50,000 x $0.005 Foreign Currency Payable to Exchange Broker (G) Foreign Currency Units (G) Pay guilders to exchange broker.

26,250 26,250

Cash 27,050 Dollars Receivable from Exchange Broker 27,050 Receive dollars from exchange broker for guilders delivered: $27,050 = G 50,000 x $0.541 rate established in forward contract signed on May 14. b.

June 30 FCT gain on account from Netherlands Company FCT gain on account to Broker Net increase in net income for FYE June 30 July 13 FCT loss on account receivable from Netherlands Company FCT gain on account to Broker Net decrease in net income for the period from 7-1 to 7-13 Net increase in net income for the FYE 6-30 Overall gain on transaction May 14 — June 30 gain July 1 — July 13 loss Overall loss if forward contract not used

$200 550 $750

$(450) 250 $(200) 750 $ 550 $ 200 (450) $(250)

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-16A Hedge of a Purchase (Commitment without and with Time Value of Money Consideration) 11/1/X6

12/31/X6

1/30/X7

— Commitment to deliver pounds in 120 days — Sign FEC to hedge foreign Currency Commitment

Balance Sheet Date

Transaction Date — Receipt of goods and recognition of foreign currency payable

Forward rate: £1 = $1.59 Spot rate: £1 = $1.61

£1 = $1.62

£1 = $1.60

£1 = $1.65

£1 = $1.59

3/1/X7

Settlement Date — Receive British pounds from settlement of FEC — Pay pounds to settle foreign currency accounts payable

£1 = $1.585

a. No net exposure between November 1 and March 1. Smith Imports, Inc., has hedged its foreign currency purchase commitment with a forward contract to receive an equal number of foreign currency units. Note that the notional amount of the forward exchange contract, the unrecognized firm commitment, and the eventual foreign currencydenominated account payable are each for £30,000. The impact on earnings from the forward contract will be a total of $600, which is the amount of the discount on the forward contract ((£30,000 x ($1.61 spot rate — $1.59 forward rate)). [The subsequent analysis will show that $300 of the $600 will adjust the inventory that will impact earnings when the inventory is sold, and the remaining $300 will be recognized in earnings through the revaluation process.] b.

November 1, 20X6 Foreign Currency Receivable from Exchange Broker (£) 47,700 Dollars Payable to Exchange Broker ($) 47,700 Signed 120-day forward contract to hedge foreign currency commitment: $47,700 = £30,000 x $1.59 forward rate December 31, 20X6 Foreign Currency Receivable from Exchange Broker (£) 900 Foreign Currency Transaction Gain Revalue foreign currency receivable to end-of-period fair value: $48,600 = £30,000 x $1.62 Dec. 31 forward rate - 47,700 = £30,000 x $1.59 Nov. 1 forward rate $ 900 = £30,000 x ($1.62 - $1.59) Foreign Currency Transaction Loss Firm Commitment Record the loss on the firm commitment: $900 = £30,000 x ($1.62 - $1.59)

900

900 900

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-16A (continued) January 30, 20X7 Foreign Currency Transaction Loss 600 Foreign Currency Receivable from Exchange Broker (£) Revalue foreign currency receivable to current U.S. dollar equivalent: $48,000 = £30,000 x $1.60 Jan. 30 forward rate - 48,600 = £30,000 x $1.62 Dec. 31 forward rate $ 600 = loss, £30,000 x ($1.60 - $1.62)

600

Firm Commitment 600 Foreign Currency Transaction Gain 600 Record the gain on the financial instrument aspect of the firm commitment: $600 = £30,000 x ($1.60 - $1.62) Inventory (or Purchases) 47,400 Firm Commitment 300 Accounts Payable (£) 47,700 Record foreign currency account payable at spot rate and recognize change in value of the firm commitment as adjustment of purchase price: $47,700 = £30,000 x $1.59 Jan. 30 spot rate March 1, 20X7 Foreign Currency Transaction Loss Foreign Currency Receivable from Exchange Broker (£) Revalue foreign currency receivable to fair value: $47,550 = £30,000 x $1.585 Mar. 1 spot rate - 48,000 = £30,000 x $1.60 Jan. 30 forward rate $ 450 = £30,000 x ($1.585 - $1.60) Accounts Payable (£) Foreign Currency Transaction Gain Revalue foreign payable to equivalent U.S. dollar value: $150 = £30,000 x ($1.585 - $1.59)

450 450

150 150

Dollars Payable to Exchange Broker ($) 47,700 Cash 47,700 Deliver U.S. dollars to exchange broker in accordance with forward exchange contract: $47,700 = £30,000 x $1.59 forward rate Foreign Currency Units (£) Foreign Currency Receivable from Exchange Broker (£) Receive 30,000 pounds from exchange broker: $47,550 = £30,000 x $1.585 Mar. 1 spot rate

47,550 47,550

Accounts Payable (£) 47,550 Foreign Currency Units (£) 47,550 Settle foreign currency payable with 30,000 pounds received from broker.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-16A (continued) c.

Considering the time value of money in valuing the forward contract. November 1, 20X6 Foreign Currency Receivable from Exchange Broker (£) 47,700 Dollars Payable to Exchange Broker ($) 47,700 Signed 120-day forward contract to hedge foreign currency commitment: $47,700 = £30,000 x $1.59 forward rate December 31, 20X6 Foreign Currency Receivable from Exchange Broker (£) 882 Foreign Currency Transaction Gain 882 Revalue foreign currency receivable to discounted end-of-period fair value: $48,600 = £30,000 x $1.62 Dec. 31 forward rate - 47,700 = £30,000 x $1.59 Nov. 1 forward rate $ 900 = £30,000 x ($1.62 - $1.59) $ 882 = NPV (.12 x 2/12, 900) Foreign Currency Transaction Loss 882 Firm Commitment 882 Record the loss on the financial instrument aspect of the firm commitment: $882 = NPV (.12 x 2/12, 900) January 30, 20X7 Foreign Currency Transaction Loss 585 Foreign Currency Receivable from Exchange Broker (£) Revalue foreign currency receivable to current U.S. dollar equivalent: $48,000 = £30,000 x $1.60 Jan. 30 forward rate - 47,700 = £30,000 x $1.59 Nov. 1 forward rate $ 300 = Cumulative Gain $ 297 = NPV (.12 x 1/12, 300) 882 = gain recognized previously $ (585) = net change in fair value

585

Firm Commitment 585 Foreign Currency Transaction Gain 585 Record the gain on the financial instrument aspect of the firm commitment. Inventory (or Purchases) 47,403 Firm Commitment 297 Accounts Payable (£) 47,700 Record foreign currency account payable at spot rate and recognize change in value of the firm commitment as adjustment of purchase price: $47,700 = £30,000 x $1.59 Jan. 30 spot rate

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-16A (continued) March 1, 20X7 Foreign Currency Transaction Loss 447 Foreign Currency Receivable from Exchange Broker (£) Revalue foreign currency receivable to fair value: $47,550 = £30,000 x $1.585 Mar. 1, 20X7, spot rate - 47,700 = £30,000 x $1.59 Nov. 1, 20X6, forward rate $ 150 = cumulative, undiscounted loss over term of forward contract 297 = previously recognized net gain $ 447 = loss for period Accounts Payable (£) 150 Foreign Currency Transaction Gain Revalue foreign currency payable to equivalent U.S. dollar value: $150 = £30,000 x ($1.585 - $1.59)

447

150

47,550 47,550

Accounts Payable (£) 47,550 Foreign Currency Units (£) 47,550 Settle foreign currency payable with 30,000 pounds received from broker .

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-17 Gain or Loss on Speculative Forward Exchange Contract 12/1/X1

12/31/X1

Sign speculative forward exchange Contract

Balance Sheet Date

Forward rate: €1 = $0.58 Spot rate: €1 = $0.60 a.

Settlement of speculative forward exchange contract

€1 = $0.56 €1 = $0.59

€1 = $0.57

Effects of speculation on 20X1 income: €120,000 x $0.56 = $ 67,200 €120,000 x $0.58 = - 69,600 $ (2,400)

December 31, 20X1 December 1, 20X1 Speculation gain in 20X1 b.

3/1/X2

Effects of speculation on 20X2 income: €120,000 x $0.57 = $ 68,400 €120,000 x $0.56 = - 67,200 $ 1,200

March 1, 20X2 December 31, 20X1 Speculation loss in 20X2 Foreign Currency Payable (€) 12/31/X1 AJE 2,400

(€120,000 x $0.58 forward rate for 3/1/X2) (€120,000 x $0.56 forward rate for 3/1/X2) (€120,000 x $0.57 spot rate on 3/1/X2)

12/1/X1

69,600

12/31/X1 3/1/X2 AJE

67,200 1,200

3/1/X2

68,400

December 31, 20X1 AJE Foreign Currency Payable (€) Foreign Exchange Gain

2,400

March 1, 20X2 AJE Foreign Exchange Loss Foreign Currency Payable (€)

1,200

2,400

1,200

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-18 Speculation in a Foreign Currency 10/1/X1

12/31/X1

Transaction Date Balance Sheet Date — Enter 180-day speculative forward exchange contract to purchase 50,000,000 yen Forward: ¥1 = $0.0075 Spot: ¥1 = $0.0070 a.

¥1 = $0.0076 ¥1 = $0.0073

3/31/X2 Settlement Date — Settle speculative contract

¥1 = $0.0072

October 1, 20X1 Foreign Currency Receivable from Exchange Broker (¥) Dollars Payable to Exchange Broker ($) Sign 180-day forward contract to receive 50,000,000 yen: $375,000 = ¥50,000,000 x $0.0075 forward rate

375,000 375,000

December 31, 20X1 Foreign Currency Receivable from Exchange Broker (¥) 5,000 Foreign Currency Transaction Gain 5,000 Revalue speculative forward contract to equivalent end-of-period U.S. dollar value using forward rate on Dec. 31: $380,000 = ¥50,000,000 x $0.0076 Dec. 31 forward rate for Mar. 31, 20X2, settlement - 375,000 = ¥50,000,000 x $0.0075 Oct. 1 forward rate for Mar. 31, 20X2, settlement $ 5,000 = ¥50,000,000 x ($0.0076 - $0.0075) March 31, 20X2 Foreign Currency Transaction Loss 20,000 Foreign Currency Receivable from Exchange Broker (¥) 20,000 Revalue speculative forward contract to current date, the end of the contract term, using March 31 spot rate: $360,000 = ¥50,000,000 x $0.0072 Mar. 31 spot rate - 380,000 = ¥50,000,000 x $0.0076 Dec. 31 forward rate for Mar. 31, 20X2 $ 20,000 = ¥50,000,000 x ($0.0072 - $0.0076) Dollars Payable to Exchange Broker ($) Cash Deliver U.S. dollars to exchange broker.

375,000 375,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-18 (continued)

Foreign Currency Units (¥) Foreign Currency Receivable from Exchange Broker (¥) Receive yen from exchange broker: $360,000 = ¥50,000,000 x $0.0072

360,000

Cash Foreign Currency Units (¥) Trade yen for dollars, at bank.

360,000

Streamline Company experienced a net loss of $15,000 ($5,000 gain in 20X1 less a $20,000 loss in 20X2). This may be checked by determining the difference between the dollars paid to the exchange broker on March 31, 20X2, ($375,000) and the U.S. dollar equivalent value of the foreign currency received on March 31 ($360,000).

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

E11-19 Forward Exchange Transactions [AICPA Adapted] 1.

$400 = 10,000 foreign currency units x ($0.82 - $0.78). The loss is calculated using only forward rates. On December 31, 20X5, the loss is the difference between the 90-day forward rate on November 1 ($0.78) and the 30-day forward rate on December 31 ($0.82).

$1,000 = 50,000 European euros x ($0.74 - $0.72). The loss is calculated using only forward rates. On September 30, 20X5, the loss is the difference between the 60-day forward rate of $0.74 on September 1 and the 30-day forward rate of $0.72 on September 30, 20X5.

Manage an exposed position: Value the forward exchange contract (FEC) at its fair value, measured by changes in the forward exchange rate (FER). Note that the question asks only for the effect on income from the forward contract transaction; thus, any effect on income from the foreign currency denominated account payable is not included in the answer. FER, 12/12/X5 $0.90 FER, 12/31/X5 $0.93 AJE: Forward Contact Receivable 3,000 Foreign Exchange Gain Revalue forward contract: $3,000 = Fr 100,000 x ($0.93 - $0.90) change in forward rates Foreign Exchange Loss 10,000 Account Payable (Fr) Revalue foreign currency payable: $10,000 = Fr 100,000 x ($0.98 - $0.88) change in spot rates

Hedge of a Firm Commitment: Value FEC based on changes in forward rate. AJE: Forward Contract Receivable Foreign Exchange Gain Revalue forward contract, using the forward rates. Foreign Exchange Loss Firm Commitment Recognize loss on firm commitment.

3,000

10,000

3,000 3,000 3,000 3,000

Again, note that the question asks only about the effect on income from the forward contract, not the underlying firm commitment portion of the transaction. 5.

Speculation: Value forward exchange contract at fair value based on changes in the forward rate. AJE: Forward Contract Receivable Foreign Exchange Gain

3,000 3,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

SOLUTIONS TO PROBLEMS P11-20 Multiple-Choice Questions on Foreign Currency Transactions 11/1/X8 Transaction Date

12/31/X8 Balance Sheet Date

— Purchase with payable denominated in renminbi

Settlement Date — Receive renminbi upon settlement of forward exchange contract — Pay renminbi to settle foreign currency payable

— Sign 90-day forward exchange to receive renminbi Forward rate: R 1 = $0.126 Spot rate: R 1 = $0.120

1/30/X9

R 1 = $0.129 R 1 = $0.124

R 1 = $0.127

b – November 1, 20X8 Foreign Currency Receivable from Exchange Broker (Renminbi) 12,600 Dollars Payable to Exchange Broker ($) Signed 90-day forward exchange contract to purchase 100,000 renminbi: $12,600 = 100,000 renminbi x $0.126 forward rate c–

December 31, 20X8 Foreign Currency Receivable from Exchange Broker (Renminbi) Foreign Currency Transaction Gain Revalue foreign currency receivable to fair value: $300 = 100,000 renminbi x ($0.129 - $0.126)

12,600

300 300

b – January 30, 20X9 Dollars Payable to Exchange Broker ($) 12,600 Cash 12,600 Deliver U.S. dollars to exchange broker in accordance with forward exchange contract: $12,600 = 100,000 renminbi x $0.126 contract rate

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-20 (continued) 5.

a–

January 30, 20X9 Foreign Currency Transaction Loss 200 Foreign Currency Receivable from Exchange Broker (Renminbi) 200 Adjust foreign currency receivable to current U.S. dollar equivalent: $12,700 = 100,000 renminbi x $0.127 Jan. 30 spot rate - 12,900 = 100,000 renminbi x $0.129 Dec. 31 forward rate $ 200 = 100,000 renminbi x ($0.127 - $0.129) Foreign Currency Units (Renminbi) Foreign Currency Receivable from Exchange Broker Receive 100,000 renminbi from exchange broker: $12,700 = 100,000 renminbi x $0.127 spot rate

12,700 12,700

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-21 Foreign Sales 1.

June 6 Accounts Receivable (Dkr) Sales Revenues Foreign sale and foreign currency receivable: $21,000 = Dkr120,000 x $0.175

21,000 21,000

July 3 Accounts Receivable (Dkr) 36 Foreign Currency Transaction Gain Revalue foreign currency receivable to U.S. dollar equivalent value: $21,036 = Dkr120,000 x $0.1753 July 3 spot rate - 21,000 = Dkr120,000 x $0.1750 June 6 spot rate $ 36 = Dkr120,000 x ($0.1753 - $0.1750)

Foreign Currency Units (Dkr) Accounts Receivable (Dkr) Collect accounts receivable in Dkr.

21,036

Accounts Receivable (£) Sales Revenue Foreign sale and foreign currency receivable: $47,400 = £30,000 x $1.58

47,400

Dollars Receivable from Exchange Broker ($) Foreign Currency Payable to Exchange Broker (£) Signed 60-day forward contract to sell pounds: $48,900 = £30,000 x $1.63 forward rate

48,900

21,036

July 22

September 20 Accounts Receivable (£) Foreign Currency Transaction Gain Revalue foreign currency receivable: $48,360 = £30,000 x $1.612 Sept. 20 spot rate - 47,400 = £30,000 x $1.58 July 22 spot rate $ 960 = £30,000 x ($1.612 - $1.58) Foreign Currency Payable to Exchange Broker (£) Foreign Currency Transaction Gain Revalue foreign currency payable: $48,360 = £30,000 x $1.612 Sept. 20 spot rate - 48,900 = £30,000 x $1.630 July 22 forward rate $ 540 = £30,000 x ($1.612 - $1.630) Foreign Currency Units (£) Accounts Receivable (£) Receive pounds from customer.

47,400

48,900

960 960

540 540

48,360 48,360

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-21 (continued) Foreign Currency Payable to Exchange Broker (£) Foreign Currency Units (£) Deliver pounds to broker.

48,360 48,360

Cash 48,900 Dollars Receivable from Exchange Broker ($) Receive U.S. dollars from broker in accordance with forward contract. 3.

October 11 Accounts Receivable (C$) Sales Revenue Sale to Canadian firm denominated in Canadian dollars: C$70,000 x $0.735 Dollars Receivable from Exchange Broker ($) Foreign Currency Payable to Exchange Broker (C$) Sign 60-day forward contract to sell Canadian dollars: $51,100 = C$70,000 x $0.730 forward rate

51,450 51,450

51,100 51,100

November 10 Foreign Currency Transaction Loss 210 Accounts Receivable (C$) Revalue foreign currency receivable to equivalent U.S. dollar value: $51,240 = C$70,000 x $0.732 Nov. 10 spot rate - 51,450 = C$70,000 x $0.735 Oct. 11 spot rate $ 210 = C$70,000 x ($0.732- $0.735) Foreign Currency Transaction Loss Foreign Currency Payable to Exchange Broker (C$) Revalue foreign currency payable: $51,240 = C$70,000 x $0.732 Nov. 10 spot rate - 51,100 = C$70,000 x $0.730 Oct. 11 forward rate $ 140 = C$70,000 x ($0.732 - $0.730)

48,900

210

140 140

Foreign Currency Units (C$) Accounts Receivable (C$) Receive Canadian dollars from customer: $51,240 = C$70,000 x $0.732 Nov. 10 spot rate.

51,240

Foreign Currency Payable to Exchange Broker (C$) Foreign Currency Units (C$) Deliver Canadian dollars to broker.

51,240

Cash 51,100 Dollars Receivable from Exchange Broker ($) 51,100 Receive U.S. dollars from broker in accordance with forward contract rate.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-22 Foreign Currency Transactions 1.

January 15 Accounts Receivable Sales Revenue Foreign export denominated in U.S. dollars. March 15 Cash Accounts Receivable Collect receivable from South Korean firm.

7,400 7,400

March 8 Inventory (or Purchases) 4,354 Accounts Payable (€) 4,354 Foreign inventory purchase with payable denominated in foreign currency: $4,354 = €7,000 x $0.622 May 1 Accounts Payable (€) 84 Foreign Currency Transaction Gain Revalue foreign currency payable to current U.S. dollar equivalent: $4,270 = €7,000 x $0.610 May 1 spot rate - 4,354 = €7,000 x $0.622 Mar. 8 spot rate $ 84 = €7,000 x ($0.622 - $0.610)

Globe Shipping must settle the payable in foreign currency units. Foreign currency units or foreign currency drafts (checks written in terms of foreign currency units) may be obtained from most major banks.

Foreign Currency Units (€) 4,270 Cash Purchase euros at the May 1 spot rate: $4,270 = €7,000 x $0.610

4,270

Accounts Payable (€) Foreign Currency Units (€) Settlement of foreign currency payable.

4,270

May 12 Foreign Currency Rec. from Exchange Broker (NT$) 3,008 Dollars Payable to Exchange Broker ($) Signed 120-day forward contract to hedge a foreign currency commitment: $3,008 = NT$80,000 x $0.0376 forward rate

3,008

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-22 (continued) August 1 Foreign Currency Transaction Loss 40 Firm Commitment Record the loss on the financial statement aspect of the firm commitment: $40 = NT$80,000 x ($0.0375 - $0.0370) Inventory (or Purchases) 2,960 Firm Commitment 40 Accounts Payable (NT$) Receipt of goods and adjustment of inventory cost by deferrals: $3,000 = NT$80,000 x $0.0375 Aug. 1 spot rate September 9 Foreign Currency Transaction Loss Foreign Currency Receivable from Exchange Broker (NT$) Revalue foreign currency receivable to fair value: $2,976 = NT$80,000 x $0.0372 Sept. 9 spot rate - 3,008 = NT$80,000 x $0.0376 Aug. 1 forward rate $ 32 = NT$80,000 x ($0.0372 - $0.0376)

3,000

32 32

Accounts Payable (NT$) Foreign Currency Transaction Gain Revalue foreign currency payable to fair value: $24 = NT$80,000 x ($0.0372 - $0.0375)

Dollars Payable to Exchange Broker ($) Cash Deliver U.S. dollars to forward exchange broker.

3,008

Foreign Currency Units (NT$) Foreign Currency Receivable from Exchange Broker (NT$) Receive Taiwan dollars from exchange broker: $2,976 = NT$80,000 x $0.0372 Sept. 9 spot rate.

2,976

Accounts Payable (NT$) Foreign Currency Units (NT$) Settle foreign currency payable.

2,976

3,008

2,976

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-22 (continued) 4.

June 6 Accounts Receivable (€) Sales Revenues Export sale denominated in euros: $90,000 = €150,000 x $0.600

90,000

Dollars Receivable from Exchange Broker ($) Foreign Currency Payable to Exchange Broker (€) Signed 60-day forward contract to deliver euros: $87,000 = €150,000 x $0.580 forward rate

87,000

90,000

July 6 87,000

September 4 Foreign Currency Transaction Loss 2,250 Accounts Receivable (€) Revalue foreign currency receivable to equivalent U.S. dollar value: $87,750 = €150,000 x $0.585 Sept. 4 spot rate - 90,000 = €150,000 x $0.600 June 6 spot rate $ 2,250 = €150,000 x ($0.585 - $0.600) Foreign Currency Transaction Loss Foreign Currency Payable to Exchange Broker (€) Revalue foreign currency payable for loss since July 6: $87,750 = €150,000 x $0.585 Sept. 4 spot rate - 87,000 = €150,000 x $0.580 July 6 forward rate $ 750 = €150,000 x ($0.585 - $0.580)

2,250

750 750

Foreign Currency Units (€) Accounts Receivable (€) Receive euros from customer: $87,750 = €150,000 x $0.585 Sept. 4 spot rate.

87,750

Foreign Currency Payable to Exchange Broker (€) Foreign Currency Units (€) Deliver euros to exchange broker.

87,750

Cash 87,000 Dollars Receivable from Exchange Broker ($) 87,000 Receive U.S. dollars from broker in accordance with forward contract signed on July 6: $87,000 = €150,000 x $0.580 forward contract rate.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-23 Foreign Purchases and Sales Transactions and Hedging Part I a. Journal entries for Maple's import and export transactions during 20X5 and 20X6: 1.

March 1, 20X5 Accounts Receivable (C$) Sales $19,500 = C$30,000 x $0.65 spot rate May 30, 20X5 Accounts Receivable (C$) Foreign Currency Transaction Gain $900 = C$30,000 x ($0.68 - .65)

19,500 19,500

900 900

Foreign Currency Units (C$) Accounts Receivable (C$) $20,400 = C$30,000 x $0.68

20,400

Cash Foreign Currency Units (C$)

20,400

July 1, 20X5 No entry is recorded when the contract to purchase equipment is signed. August 30, 20X5 Equipment Accounts Payable (¥) $52,000 = ¥500,000 x $0.104 October 29, 20X5 Foreign Currency Transaction Loss Accounts Payable (¥) $1,000 = ¥500,000 x ($0.106 - $0.104)

52,000 52,000

1,000 1,000

Foreign Currency Units (¥) Cash $53,000 = ¥500,000 x $0.106

53,000

Accounts Payable (¥) Foreign Currency Units (¥)

53,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-23 (continued) 3.

November 16, 20X5 Inventory Accounts Payable (£) $16,500 = £10,000 x $1.65 December 31, 20X5 Accounts Payable (£) Foreign Currency Transaction Gain $200 = £10,000 x ($1.63 - $1.65) January 15, 20X6 Foreign Currency Transaction Loss Accounts Payable (£) $100 = £10,000 x ($1.64 - $1.63)

16,500 16,500

200 200

100 100

Foreign Currency Units (£) Cash $16,400 = £10,000 x $1.64

16,400

Accounts Payable (£) Foreign Currency Units (£)

16,400

Maple should report a foreign currency transaction gain of $100 on its income statement for 20X5. This amount is computed as follows: Foreign currency transaction gain from transaction denominated in pounds Foreign currency transaction gain from transaction denominated in Canadian dollars Less foreign currency transaction loss from transaction denominated in yen Foreign currency transaction gain for 20X5

$ 200 900 (1,000) $ 100

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-23 (continued) Part II a.

1. Journal entries for the use of a forward contract to manage the foreign currency exposure of the sale in Canadian dollars: March 1, 20X5 Dollars Receivable from Exchange Broker Foreign Currency Payable to Exchange Broker (C$) $19,200 = C$30,000 x $0.64 forward rate May 30, 20X5 Foreign Currency Transaction Loss Foreign Currency Payable to Exchange Broker (C$) $20,400 = C$30,000 x $0.68 May 30 spot rate - 19,200 = C$30,000 x $0.64 March 1 forward rate $ 1,200 = C$ 30,000 x ($0.68 - $0.64)

19,200 19,200

1,200 1,200

Foreign Currency Payable to Exchange Broker (C$) Foreign Currency Units (C$)

20,400

Cash Dollars Receivable from Exchange Broker

19,200

20,400 19,200

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-23 Part II (continued) a.

Journal entries for the fair value hedge of the firm commitment in Japanese yen.

July 1, 20X5 Foreign Currency Receivable from Exchange Broker (¥) Dollars Payable to Exchange Broker $52,500 = ¥500,000 x $0.105 July 1 forward rate August 30, 20X5 Foreign Currency Receivable from Exchange Broker (¥) Foreign Currency Transaction Gain $52,750 = ¥500,000 x $0.1055 Aug. 30 forward rate $52,500 = ¥500,000 x $0.1050 July 1 forward rate $ 250 = ¥500,000 x ($0.1055 - $0.1050) Foreign Currency Transaction Loss Firm Commitment Record loss on financial instrument aspect of firm commitment: $250 = ¥500,000 x ($0.1055 - $0.1050) Equipment Firm Commitment Accounts Payable (¥) $52,000 = ¥500,000 x $0.104 Aug. 30 spot rate October 29, 20X5 Foreign Currency Receivable from Exchange Broker (¥) Foreign Currency Transaction Gain $53,000 = ¥500,000 x $0.1060 Oct. 29 spot rate - 52,750 = ¥500,000 x $0.1055 Aug. 30 forward rate $ 250 = ¥500,000 x ($0.1060 - $0.1055)

52,500 52,500

250 250

51,750 250 52,000

250 250

Dollars Payable to Exchange Broker Cash

52,500

Foreign Currency Units (¥) Foreign Currency Receivable from Exchange Broker (¥) $53,000 = ¥500,000 x $0.106 Oct. 29 spot rate

53,000

52,500 53,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-23 Part II (continued) a.

Journal entries for the use of a forward contract to manage its foreign currency exposure in pounds. The forward contract is not designated as a hedge.

November 16, 20X5 Foreign Currency Receivable from Exchange Broker (£) Dollars Payable to Exchange Broker $16,700 = £10,000 x $1.67 Nov. 16 forward rate December 31, 20X5 Foreign Currency Transaction Loss Foreign Currency Receivable from Exchange Broker (£) $16,450 = £10,000 x $1.645 Dec. 31 forward rate - 16,700 = £10,000 x $1.67 Nov. 16 forward rate $ 250 = £10,000 x ($1.645 - $1.67)

16,700 16,700

250 250

January 15, 20X6 Foreign Currency Transaction Loss Foreign Currency Receivable from Exchange Broker (£) $16,400 = £10,000 x $1.640 Jan. 5 spot rate 16,450 = £10,000 x $1.645 Dec. 31 forward rate $ 50 = £10,000 x ($1.640 - $1.645)

50 50

Dollars Payable to Exchange Broker Cash

16,700

Foreign Currency Units (£) Foreign Currency Receivable from Exchange Broker (£)

16,400

16,700 16,400

Maple would report a net loss in 20X5 of $1,100, as follows: 20X5 Transaction 1 May 30 Part I May 30 Part II

Loss

Gain

1,200

900 -

Transaction 2 Aug. 30, 20X5 — Part II Oct. 29, 20X5 — Part I Oct. 29, 20X5 — Part II

250 1,000 -

250 250

Transaction 3 Dec. 31, 20X5 Part I Dec. 31, 20X5 Part II

250

200 -

20X5, Net Loss

1,100

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-23 Part II (continued) c.

Maple would report a net loss in 20X6, of $150, as follows: 20X6

Loss

Gain

Transaction 3 Jan. 15, 20X6 — Part I Jan. 15, 20X6 — Part II

100 50

20X6, Net Loss

150

-0-

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-24 Understanding Foreign Currency Transactions a.

Indirect exchange rates for Australian dollars were: December 1, 20X5: A$70,000 / $42,000 = 1.667 [$1 equals A$1.667] December 31, 20X5: A$70,000 / $41,700 = 1.679 [$1 equals A$1.679]

The balance in the account Foreign Currency Payable to Exchange Broker was $39,900 at December 31, 20X5, computed as: $39,900 = A$70,000 x $0.57 Dec. 31 forward rate

The direct exchange rate for the 60-day forward contract for the 70,000 Australian dollars was A$1 = $0.58. This is the result of the following computation: ($40,600 / A$70,000) = $0.58.

$40,600 is the amount of Dollars Receivable from Exchange Broker in the adjusted trial balance at December 31, 20X5. The balance in this account does not change because it is denominated in U.S. dollars.

Indirect spot exchange rates for South Korean wons were: October 2: KRW400,000 / $80,000 = 5 [$1 equals KRW5] December 31: KRW400,000 / $80,800 = 4.950 [$1 equals KRW 4.950] Or, 4.950 = KRW1 / $0.2020

The Dollars Payable to Exchange Broker was $82,000 in both the adjusted and unadjusted trial balances. The entry to record the forward contract for the 400,000 South Korean wons on October 2, 20X5, appears below. Note that the account Dollars Payable to Exchange Broker is denominated in U.S. dollars and does not change as a result of exchange rate changes. Foreign Currency Receivable from Exchange Broker (KRW) Dollars Payable to Exchange Broker ($)

82,000 82,000

The direct exchange rate for the 120-day forward contract in South Korean wons on October 2, 20X5, was $0.205. This amount is determined in the following manner: $82,000 / KRW400,000 = $0.205. The $82,000 is the amount of the dollars payable to exchange broker. This amount is computed by using the forward rate.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-24 (continued) h.

The accounts payable balance was $80,800 at December 31, 20X5. $80,800 = KRW400,000 x $0.2020 Dec. 31 spot rate The entries to support the computations for Problem 11-25 are presented below. 1.

Transactions with Australian company December 1, 20X5 Accounts Receivable (A$) Sales $42,000 = A$70,000 x ($1/A$1.667)

42,000 42,000

Dollars Receivable from Exchange Broker 40,600 Foreign Currency Payable to Exchange Broker (A$) 40,600 $40,600 = A$70,000 x $0.58 Dec. 1 forward rate, and also dollar amount stated in problem information($0.58 = $40,600 / A$70,000) December 31, 20X1 Foreign Currency Transaction Loss 300 Accounts Receivable (A$) 300 $300 = change in accounts receivable (A$) as noted in problem information. Foreign Currency Payable to Exchange Broker Foreign Currency Transaction Gain $39,900 = A$70,000 x $0.57 Dec. 31 forward rate - 40,600 = A$70,000 x $0.58 Dec. 1 forward rate $ 700 = A$70,000 x ($0.57 - $0.58) 2.

700 700

Transactions with South Korean company October 2, 20X5 Equipment Accounts Payable (KRW) $80,000 = KRW400,000 x $0.20

80,000 80,000

Foreign Currency Receivable from Exchange Broker (KRW) 82,000 Dollars Payable to Exchange Broker 82,000 $82,000 = KRW400,000 x $0.2050, and the$82,000 is presented in the problem for the foreign currency receivable. December 31, 20X5 Foreign Currency Transaction Loss Accounts Payable (KRW) $80,800 = KRW400,000 x $0.202 Dec. 31 spot rate - 80,000 = KRW400,000 x $0.200 October 2 spot rate $ 800 = KRW400,000 x ($0.202 - $0.200) Foreign Currency Transaction Loss Foreign Currency Receivable from Exchange Broker $81,000 = KRW400,000 x $0.2025 Dec. 31 forward rate - 82,000 = KRW400,000 x $0.2050 Oct. 2 forward rate $ 1,000 = KRW400,000 x ($0.2025 - $0.2050)

800 800

1,000 1,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-25 Matching Key Terms 1.

10.

11.

12.

13.

14.

15.

P11-26 Determining Financial Statement Amounts

Forward Contract Receivable

1 $20,200

Transaction 2 3 $20,200 $20,200

Inventory

19,800

21,000

Accounts Payable

19,600

Foreign Currency Exchange Gain (Loss), net

1,000 G

800 G

2,200 G

Other Comprehensive Income Gain (Loss), net

4 $20,200

Computational support: Forward Contract Receivable: $20,200 = €20,000 x $1.01 12/31 forward rate Inventory: $19,800 = $21,000 accounts payable less $1,200 firm commitment 11-55 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

$21,000 =

€20,000 x $1.05 11/30 spot rate

Accounts Payable: $19,600 = €20,000 x $0.98 12/31 spot rate Foreign Currency Exchange Gain or (Loss), net: Transaction 1: $1,000 = $ 1,200 exchange gain on forward contract from change in forward rate from 9/1 to 11/30: (€20,000 x ($1.03 -$0.97)) - 1,200 exchange loss on firm commitment for change in forward rate from 9/1 to 11/30: (€20,000 x ($1.03 -$0.97)) - 400 exchange loss on forward contract from change in forward rate from 11/30 to 12/31: (€20,000 x ($1.01 -$1.03)) + 1,400 exchange gain on account payable for change in spot rate from 11/30 to 12/31: (€20,000 x ($0.98 -$1.05)) Transaction 2: No net foreign currency exchange gain because ASC 815 specifies an offset of the gain from the revaluation of the account payable by an equal amount from other comprehensive income.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-26 (continued) Transaction 3: $1,000 = $1,400 exchange gain on account payable from change in spot rate from 11/30 to 12/31: (€20,000 x ($0.98 -$1.05)) - 400 exchange loss on forward contract from change in forward rate from 9/1 to 12/31: (€20,000 x ($1.01 -$1.03)) Transaction 4: $ 800 =

exchange gain on forward contract from change in forward rate from 9/1 to 12/31: (€20,000 x ($1.01 -$0.97))

Other Comprehensive Income Gain or (Loss), net: Transaction 2: $2,200 = $ 800 OCI gain on forward contract from change in forward rate from 9/1 to 12/31: (€20,000 x ($1.01 -$0.97)) + 1,400 OCI gain on the reclassification from OCI to offset the exchange gain on the account payable from the change in the spot rate from 11/30 to 12/31, as required by ASC 815: (€20,000 x ($0.98 -$1.05))

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-27

Comprehensive Problem: Uses of Forward Exchange Contracts without Time Value of Money Considerations

a. Use of forward contract to manage foreign currency risk of exposed foreign currency position. Not designated as a hedge. 12/1/X1 Transaction Date

12/31/X1 Balance Sheet Date

— Sale of furniture resulting in foreign currency receivable — Sign foreign exchange contract to give Australian dollars on March 31 Forward rate: A$1 = $0.609 Spot rate: A$1 = $0.600

3/31/X2 Settlement Date — Settle forward exchange contract and give 100,000 Australian dollars — Receive foreign currency receivable

A$1 = $0.612 A$1 = $0.610

A$1 = $0.602

December 1, 20X1 Accounts Receivable (A$) Sales Foreign currency receivable: $60,000 = A$100,000 x $0.600

60,000 60,000

Dollars Receivable from Exchange Broker ($) 60,900 Foreign Currency Payable to Exchange Broker (A$) 60,900 Signed forward exchange contract to manage exposed foreign currency receivable: $60,900 = A$100,000 x $0.609 forward rate December 31, 20X1 Accounts Receivable (A$) 1,000 Foreign Currency Transaction Gain Revalue foreign currency receivable to equivalent U.S. dollar value: $61,000 = A$100,000 x $0.610 Dec. 31 spot rate - 60,000 = A$100,000 x $0.600 Dec. 1 spot rate $ 1,000 = A$100,000 x ($0.610 - $0.600) Foreign Currency Transaction Loss Foreign Currency Payable to Exchange Broker (A$) Revalue foreign currency payable: $61,200 = A$100,000 x $0.612 Dec. 31 forward rate - 60,900 = A$100,000 x $0.609 Dec. 1 forward rate $ 300 = A$100,000 x ($0.612 - $0.609)

1,000

300 300

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-27 (continued) Note: For this case, no entry necessary on January 30, 20X2. March 31, 20X2 Foreign Currency Payable to Exchange Broker (A$) Foreign Currency Transaction Gain Revalue foreign currency payable: $60,200 = A$100,000 x $0.602 Mar. 31, 20X2, spot rate - 61,200 = A$100,000 x $0.612 Dec. 31, 20X1, forward rate $ 1,000 = A$100,000 x ($0.602 - $0.612) Foreign Currency Transaction Loss Accounts Receivable (A$) Revalue foreign currency receivable: $60,200 = A$100,000 x $0.602 Mar. 31, 20X2, spot rate - 61,000 = A$100,000 x $0.610 Dec. 31, 20X1, spot rate $ 800 = A$100,000 x ($0.602 - $0.610)

1,000 1,000

800 800

Cash 60,900 Dollars Receivable from Exchange Broker ($) 60,900 Receive U.S. dollars from exchange broker as required by forward contract. Foreign Currency Payable to Exchange Broker (A$) 60,200 Foreign Currency Units (A$) 60,200 Pay A$100,000 to exchange broker in accordance with forward contract: $60,200 = A$100,000 x $0.602 Mar. 31 spot rate. Foreign Currency Units (A$) Accounts Receivable (A$) Receive A$100,000 from customer.

60,200 60,200

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-27 (continued) b. Use of forward contract as cash flow hedge of forecasted foreign currency transaction.

12/1/X1

Commitment Date

12/31/X1

1/30/X2

3/31/X2

Balance Sheet Date

Transaction Date

Settlement Date

— Sale of furniture resulting in foreign currency receivable

— Settle foreign currency commitment and give A$100,000 — Receive foreign currency receivable

— Sign foreign exchange contract to hedge forecasted foreign currency transaction.

Forward rate: A$1 = $0.609 Spot rate: A$1 = $0.600

A$1 = $0.612

A$1 = $0.605

A$1 = $0.610

A$1 = $0.608

A$1 = $0.602

December 1, 20X1 Dollars Receivable from Exchange Broker ($) 60,900 Foreign Currency Payable to Exchange Broker (A$) 60,900 Signed 120-day forward contract as a cash flow hedge of the forecasted foreign currency transaction of the sale of furniture on January 30 for A$100,000: $60,900 = A$100,000 x $0.609 forward rate December 31, 20X1 Other Comprehensive Income 300 Foreign Currency Payable to Exchange Broker (A$) 300 Revalue foreign currency payable to fair value and record OCI for effective portion of change in fair value of the derivative designated as a cash flow hedge: $61,200 = A$100,000 x $0.612 Dec. 31 forward rate - 60,900 = A$100,000 x $0.609 Dec. 1 forward rate $ 300 = A$100,000 x ($0.612 - $0.609)

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-27 (continued) January 30, 20X2 Foreign Currency Payable to Exchange Broker (A$) 700 Other Comprehensive Income 700 Revalue foreign currency Payable to current U.S. dollar equivalent and record OCI for the effective portion of the change in fair value of the derivative designated as a cash flow hedge: $60,500 = A$100,000 x $0.605 Jan. 30, 20X2, forward rate - 61,200 = A$100,000 x $0.612 Dec. 31, 20X1, forward rate $ 700 = A$100,000 x ($0.605 - $0.612) Accounts Receivable (A$) Sales Sell furniture and value at spot rate: $60,800 = A$100,000 x $0.608 spot rate

60,800 60,800

March 31, 20X2 Foreign Currency Payable from Exchange Broker (A$) 300 Other Comprehensive Income 300 Revalue foreign currency payable and record into OCI the effective portion of change in fair value of derivative designated as a cash flow hedge: $60,200 = A$100,000 x $0.602 Mar. 31 spot rate - 60,500 = A$100,000 x $0.605 Jan. 30 forward rate $ 300 = A$100,000 x ($0.602 - $0.605) Foreign Currency Transaction Loss 600 Accounts Receivable (A$) 600 Revalue foreign currency receivable using spot rate and recognizing change into current earnings as specified by ASC 830: $60,200 = A$100,000 x $0.602 Mar. 31 spot rate - 60,800 = A$100,000 x $0.608 Jan. 30 spot rate $ 600 = A$100,000 x ($0.602 - $0.608) Other Comprehensive Income 600 Foreign Currency Transaction Gain 600 In accordance with ASC 815, reclassify amount from OCI sufficient to completely offset the foreign currency transaction loss on the foreign currency receivable (A$) that was hedged with a derivative designated as a cash flow hedge. Cash Dollars Receivable from Exchange Broker ($) Receive U.S. dollars from exchange broker.

60,900 60,900

Foreign Currency Payable to Exchange Broker (A$) 60,200 Foreign Currency Units (A$) 60,200 Pay A$100,000 to broker in accordance with forward contract signed on December 1: $60,200 = A$100,000 x $0.602 Mar. 31 spot rate.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-27 (continued) Foreign Currency Units (A$) Accounts Receivable (A$) Receive A$100,000 from foreign customer.

60,200 60,200

Note: At this point there is still a debit balance of $100 in Other Comprehensive Income which should be reclassified into sales with a debit to sales and a credit to OCI for $100. c. Forward contract used for speculative purposes only. 12/1/X1

12/31/X1

3/31/X2

Transaction Date

Balance Sheet Date

Settlement Date

— Sign 120 day speculative contract to sell 100,000 Australian dollars. Forward rate: A$1 = $0.609 Spot rate: A$1 = $0.600

— Settle forward exchange contract and give A$100,000

A$1 = $0.612 A$1 = $0.610

A$1 = $0.602

December 1, 20X1 Dollars Receivable from Exchange Broker ($) Foreign Currency Payable to Exchange Broker (A$) Signed 120-day forward contract for speculation: $60,900 = A$100,000 x $0.609

60,900 60,900

December 31, 20X1 Foreign Currency Transaction Loss 300 Foreign Currency Payable to Exchange Broker (A$) Revalue foreign currency payable to equivalent U.S. dollar value: $61,200 = A$100,000 x $0.612 Dec. 31 forward rate - 60,900 = A$100,000 x $0.609 Dec. 1 forward rate $ 300 = A$100,000 x ($0.612 - $0.609) March 31, 20X2 Foreign Currency Payable to Exchange Broker (A$) Foreign Currency Transaction Gain Revalue foreign currency payable: $60,200 = A$100,000 x $0.602 Mar. 31, 20X2, spot rate - 61,200 = A$100,000 x $0.612 Dec. 31, 20X1, forward rate $ 1,000 = A$100,000 x ($0.602 - $0.612) Cash Dollars Receivable from Exchange Broker ($) Receive U.S. dollars from forward exchange broker.

300

1,000 1,000

60,900 60,900

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-27 (continued) Foreign Currency Payable to Exchange Broker (A$) Foreign Currency Units (A$) Pay A$100,000 to exchange broker: $60,200 = A$100,000 x $0.602 spot rate

60,200 60,200

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-28A

Comprehensive Problem: Four Uses of Forward Exchange Contracts without and with Time Value of Money Considerations

a. Use of forward contract to manage foreign currency risk of exposed foreign currency position. Not designated as a hedge. 12/1/X1 Transaction Date

12/31/X1 Balance Sheet Date

— Purchase of furniture resulting in foreign currency payable — Sign foreign exchange contract to receive Australian dollars on March 31 Forward rate: A$1 = $0.609 Spot rate: A$1 = $0.600

3/31/X2 Settlement Date — Settle forward exchange contract and receive 100,000 Australian dollars — Pay foreign currency payable

A$1 = $0.612 A$1 = $0.610

A$1 = $0.602

December 1, 20X1 Inventory (or Purchases) Accounts Payable (A$) Foreign currency payable: $60,000 = A$100,000 x $0.600

60,000 60,000

Foreign Currency Receivable from Exchange Broker (A$) 60,900 Dollars Payable to Exchange Broker ($) 60,900 Signed forward exchange contract to manage exposed foreign currency payable: $60,900 = A$100,000 x $0.609 forward rate December 31, 20X1 Foreign Currency Transaction Loss 1,000 Accounts Payable (A$) Revalue foreign currency payable to equivalent U.S. dollar value: $61,000 = A$100,000 x $0.610 Dec. 31 spot rate - 60,000 = A$100,000 x $0.600 Dec. 1 spot rate $ 1,000 = A$100,000 x ($0.610 - $0.600) Foreign Currency Receivable from Exchange Broker (A$) Foreign Currency Transaction Gain Revalue foreign currency receivable: $61,200 = A$100,000 x $0.612 Dec. 31 forward rate - 60,900 = A$100,000 x $0.609 Dec. 1 forward rate $ 300 = A$100,000 x ($0.612 - $0.609)

1,000

300 300

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-28A (continued) Note: For this case, no entry necessary on January 30, 20X2. March 31, 20X2 Foreign Currency Transaction Loss Foreign Currency Receivable from Exchange Broker (A$) Revalue foreign currency receivable: $60,200 = A$100,000 x $0.602 Mar. 31, 20X2, spot rate - 61,200 = A$100,000 x $0.612 Dec. 31, 20X1, forward rate $ 1,000 = A$100,000 x ($0.602 - $0.612)

1,000 1,000

Accounts Payable (A$) Foreign Currency Transaction Gain Revalue foreign currency payable: $60,200 = A$100,000 x $0.602 Mar. 31, 20X2, spot rate - 61,000 = A$100,000 x $0.610 Dec. 31, 20X1, spot rate $ 800 = A$100,000 x ($0.602 - $0.610)

800 800

Dollars Payable to Exchange Broker ($) 60,900 Cash 60,900 Deliver U.S. dollars to exchange broker as required by forward contract. Foreign Currency Units (A$) 60,200 Foreign Currency Receivable from Exchange Broker (A$) 60,200 Receive A$100,000 from exchange broker in accordance with forward contract: $60,200 = A$100,000 x $0.602 Mar. 31 spot rate. Accounts Payable (A$) Foreign Currency Units (A$) Deliver A$100,000 to creditor.

60,200 60,200

b. Use of forward contract as fair value hedge of foreign currency firm commitment. 12/1/X1

12/31/X1

1/30/X2

Commitment Date

Balance Sheet Date

Transaction Date

— Sign foreign exchange contract to hedge foreign currency payable firm commitment Forward rate: A$1 = $0.609 Spot rate: A$1 = $0.600

— Purchase of furniture resulting in foreign currency payable

A$1 = $0.612

A$1 = $0.605

A$1 = $0.610

A$1 = $0.608

3/31/X2

Settlement Date — Settle foreign currency commitment and receive A$100,000 — Pay foreign currency

A$1 = $0.602

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-28A (continued) December 1, 20X1 Foreign Currency Receivable from Exchange Broker (A$) 60,900 Dollars Payable to Exchange Broker ($) 60,900 Signed 120-day forward contract to hedge foreign currency commitment to purchase furniture on January 30 for A$100,000: $60,900 = A$100,000 x $0.609 forward rate December 31, 20X1 Foreign Currency Receivable from Exchange Broker (A$) Foreign Currency Transaction Gain Revalue foreign currency receivable to fair value: $61,200 = A$100,000 x $0.612 Dec. 31 forward rate - 60,900 = A$100,000 x $0.609 Dec. 1 forward rate $ 300 = A$100,000 x ($0.612 - $0.609)

300 300

Foreign Currency Transaction Loss 300 Firm Commitment 300 Record the loss on the financial instrument aspect of the firm commitment: $300 = A$100,000 x ($0.612 - $0.609) January 30, 20X2 Foreign Currency Transaction Loss 700 Foreign Currency Receivable from Exchange Broker (A$) Revalue foreign currency receivable to current U.S. dollar equivalent: $60,500 = A$100,000 x $0.605 Jan. 30, 20X2, forward rate - 61,200 = A$100,000 x $0.612 Dec. 31, 20X1, forward rate $ 700 = A$100,000 x ($0.605 - $0.612)

700

Firm Commitment 700 Foreign Currency Transaction Gain 700 Record the gain on the financial instrument aspect of the firm commitment: $700 = A$100,000 x ($0.605 - $0.612) Inventory (or Purchases) 61,200 Firm Commitment Accounts Payable (A$) Acquire furniture initially committed to on December 1, 20X1: $60,800 = A$100,000 x $0.608 spot rate

400 60,800

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-28A (continued) March 31, 20X2 Foreign Currency Transaction Loss Foreign Currency Receivable from Exchange Broker (A$) Revalue foreign currency receivable: $60,200 = A$100,000 x $0.602 Mar. 31 spot rate - 60,500 = A$100,000 x $0.605 Jan. 30 forward rate $ 300 = A$100,000 x ($0.602 - $0.605) Accounts Payable (A$) Foreign Currency Transaction Gain Revalue foreign currency payable: $60,200 = A$100,000 x $0.602 Mar. 31 spot rate - 60,800 = A$100,000 x $0.608 Jan. 30 spot rate $ 600 = A$100,000 x ($0.602 - $0.608) Dollars Payable to Exchange Broker ($) Cash Deliver U.S. dollars to exchange broker.

300 300

600 600

60,900 60,900

Foreign Currency Units (A$) 60,200 Foreign Currency Receivable from Exchange Broker (A$) 60,200 Receive A$100,000 from broker in accordance with forward contract signed on December 1: $60,200 = A$100,000 x $0.602 Mar. 31 spot rate. Accounts Payable (A$) Foreign Currency Units (A$) Deliver A$100,000 to foreign creditor.

60,200 60,200

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P-11-28A (continued) c. Use of forward contract as cash flow hedge of forecasted foreign currency transaction.

12/1/X1

Commitment Date

12/31/X1

1/30/X2

3/31/X2

Balance Sheet Date

Transaction Date

Settlement Date

— Purchase of furniture resulting in foreign currency payable

— Settle foreign currency commitment and receive A$100,000 — Pay foreign currency payable

— Sign foreign exchange contract to hedge forecasted foreign currency transaction.

Forward rate: A$1 = $0.609 Spot rate: A$1 = $0.600

A$1 = $0.612

A$1 = $0.605

A$1 = $0.610

A$1 = $0.608

A$1 = $0.602

December 1, 20X1 Foreign Currency Receivable from Exchange Broker (A$) 60,900 Dollars Payable to Exchange Broker ($) 60,900 Signed 120-day forward contract as a cash flow hedge of the forecasted foreign currency transaction of the purchase of furniture on January 30 for A$100,000: $60,900 = A$100,000 x $0.609 forward rate December 31, 20X1 Foreign Currency Receivable from Exchange Broker (A$) 300 Other Comprehensive Income 300 Revalue foreign currency receivable to fair value and record OCI for effective portion of change in fair value of the derivative designated as a cash flow hedge: $61,200 = A$100,000 x $0.612 Dec. 31 forward rate - 60,900 = A$100,000 x $0.609 Dec. 1 forward rate $ 300 = A$100,000 x ($0.612 - $0.609)

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-28A (continued) January 30, 20X2 Other Comprehensive Income 700 Foreign Currency Receivable from Exchange Broker (A$) 700 Revalue foreign currency receivable to current U.S. dollar equivalent and record OCI for the effective portion of the change in fair value of the derivative designated as a cash flow hedge: $60,500 = A$100,000 x $0.605 Jan. 30, 20X2, forward rate - 61,200 = A$100,000 x $0.612 Dec. 31, 20X1, forward rate $ 700 = A$100,000 x ($0.605 - $0.612) Inventory (or Purchases) Accounts Payable (A$) Acquire furniture and value at spot rate: $60,800 = A$100,000 x $0.608 spot rate

60,800 60,800

March 31, 20X2 Other Comprehensive Income 300 Foreign Currency Receivable from Exchange Broker (A$) 300 Revalue foreign currency receivable and record into OCI the effective portion of change in fair value of derivative designated as a cash flow hedge: $60,200 = A$100,000 x $0.602 Mar. 31 spot rate - 60,500 = A$100,000 x $0.605 Jan. 30 forward rate $ 300 = A$100,000 x ($0.602 - $0.605) Accounts Payable (A$) 600 Foreign Currency Transaction Gain 600 Revalue foreign currency payable using spot rate and recognizing change into current earnings as specified by ASC 830: $60,200 = A$100,000 x $0.602 Mar. 31 spot rate - 60,800 = A$100,000 x $0.608 Jan. 30 spot rate $ 600 = A$100,000 x ($0.602 - $0.608) Foreign Currency Transaction Loss 600 Other Comprehensive Income 600 In accordance with ASC 815, reclassify amount from OCI sufficient to completely offset the foreign currency transaction gain on the foreign currency payable (A$) that was hedged with a derivative designated as a cash flow hedge. Dollars Payable to Exchange Broker ($) Cash Deliver U.S. dollars to exchange broker.

60,900 60,900

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-28A (continued) Accounts Payable (A$) Foreign Currency Units (A$) Deliver A$100,000 to foreign creditor.

60,200 60,200

Note: At this point there is still a debit balance of $100 in Other Comprehensive Income. This balance will be reclassified into earnings at the time the inventory is sold which is the completion of the earnings process of the purchase of the inventory. d. Forward contract used for speculative purposes only. 12/1/X1

12/31/X1

3/31/X2

Transaction Date

Balance Sheet Date

Settlement Date

— Sign 120 day speculative contract to purchase 100,000 Australian dollars. Forward rate: A$1 = $0.609 Spot rate: A$1 = $0.600

— Settle forward exchange contract and receive A$100,000

A$1 = $0.612 A$1 = $0.610

A$1 = $0.602

December 1, 20X1 Foreign Currency Receivable from Exchange Broker (A$) Dollars Payable to Exchange Broker ($) Signed 120-day forward contract for speculation: $60,900 = A$100,000 x $0.609

60,900 60,900

December 31, 20X1 Foreign Currency Receivable from Exchange Broker (A$) 300 Foreign Currency Transaction Gain Revalue foreign currency receivable to equivalent U.S. dollar value: $61,200 = A$100,000 x $0.612 Dec. 31 forward rate - 60,900 = A$100,000 x $0.609 Dec. 1 forward rate $ 300 = A$100,000 x ($0.612 - $0.609) March 31, 20X2 Foreign Currency Transaction Loss Foreign Currency Receivable from Exchange Broker (A$) Revalue foreign currency receivable: $60,200 = A$100,000 x $0.602 Mar. 31, 20X2, spot rate - 61,200 = A$100,000 x $0.612 Dec. 31, 20X1, forward rate $ 1,000 = A$100,000 x ($0.602 - $0.612) Dollars Payable to Exchange Broker ($) Cash Deliver U.S. dollars to forward exchange broker.

300

1,000 1,000

60,900 60,900

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-28A (continued) Foreign Currency Units (A$) Foreign Currency Receivable from Exchange Broker (A$) Receive A$100,000 from exchange broker: $60,200 = A$100,000 x $0.602 spot rate e.

60,200 60,200

Use of forward contract to manage exposed foreign currency position, considering the time value of money at a 12 percent annual rate. Forward contract not designated as a hedge. 12/1/X1

12/31/X1

3/31/X2

Transaction Date

Balance Sheet Date

Settlement Date

— Purchase of furniture resulting in foreign currency payable — Sign hedging foreign exchange contract to receive Australian dollars on March 31 Forward rate: A$1 = $0.609 Spot rate: A$1 = $0.600

— Settle forward exchange contract and receive A$100,000 — Pay foreign currency payable

A$1 = $0.612 A$1 = $0.610

A$1 = $0.602

December 1, 20X1 Inventory (or Purchases) Accounts Payable (A$) Foreign currency payable: $60,000 = A$100,000 x $0.600

60,000 60,000

Foreign Currency Receivable from Exchange Broker (A$) 60,900 Dollars Payable to Exchange Broker ($) 60,900 Signed forward exchange contract to hedge exposed foreign currency payable: $60,900 = A$100,000 x $0.609 forward rate December 31, 20X1 Foreign Currency Transaction Loss 1,000 Accounts Payable (A$) Revalue foreign currency payable to equivalent U.S. dollar value: $61,000 = A$100,000 x $0.610 Dec. 31 spot rate - 60,000 = A$100,000 x $0.600 Dec. 1 spot rate $ 1,000 = A$100,000 x ($0.610 - $0.600)

1,000

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-28A (continued) Foreign Currency Receivable from Exchange Broker (A$) Foreign Currency Transaction Gain Revalue foreign currency receivable: $61,200 = A$100,000 x $0.612 Dec. 31 forward rate - 60,900 = A$100,000 x $0.609 Dec. 1 forward rate $ 300 = A$100,000 x ($0.612 - $0.609) cumulative, undiscounted gain from Dec. 1 $ 291 = NPV (.12 x 3/12, 300) for remaining 3 months from 12/31/X1 — 3/31/X2

291 291

Note: For this case, no entry necessary on January 30, 20X2. March 31, 20X2 Foreign Currency Transaction Loss Foreign Currency Receivable from Exchange Broker (A$) Revalue foreign currency receivable: $60,200 = A$100,000 x $0.602 Mar. 31, 20X2, spot rate - 60,900 = A$100,000 x $0.609 Dec. 1, 20X1, forward rate $ (700) = cumulative, undiscounted loss over term of forward contract 291 = gain previously recognized on Dec. 31, 20X1 $ (991) = change in fair value this period Accounts Payable (A$) Foreign Currency Transaction Gain Revalue foreign currency payable: $60,200 = A$100,000 x $0.602 Mar. 31, 20X2, spot rate - 61,000 = A$100,000 x $0.610 Dec. 31, 20X1, spot rate $ 800 = A$100,000 x ($0.602 - $0.610)

991 991

800 800

60,200 60,200

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-29B Multiple-Choice Questions on Derivatives and Hedging Activities 1.

d–

An underlying is a financial or physical variable that has observable or objectively verifiable changes. The number of currency units is considered a notional amount within the financial instrument. (a) Incorrect. A security price is observable and verifiable, therefore it is an underlier. (b) Incorrect. A monthly average temperature is observable and verifiable, therefore it is an underlier. (c) Incorrect. A price of a barrel of oil is observable and verifiable, therefore it is an underlier.

c–

Because the increase in value is unrealized, it would be recorded as an increase to OCI. This only applies to a cash flow hedge. (a) Incorrect. Even before it has been realized, it is still recorded through OCI. (b) Incorrect. Current earnings would be adjusted for fair value hedges, not cash flow hedges. (d) Incorrect. Deferred income accounts are not used for unrealized gains or losses.

c–

The net investment must be less than that required for other types, not equal. (a) Incorrect. This is a required element of a derivative instrument. (b) Incorrect. This is a required element of a derivative instrument. (d) Incorrect. This is a required element of a derivative instrument.

a–

The change for fair value hedges goes to current earnings, while changes in cash flow hedges go to other comprehensive income. (b) Incorrect. Even before the exchange transaction takes place, the changes must be reflected. (c) Incorrect. Decreases in other comprehensive income only occur with cash flow hedges. (d) Incorrect. Earnings should be decreased for fair value hedges.

b–

Only fair value hedges will reflect the changes in the fair value of the effective portion of a hedging instrument and be recorded as a part of current earnings for the period.

c–

Trading securities do not qualify for hedge accounting under ASC 815. (a) Incorrect. The use of hedge accounting for forecasted purchases or sales is allowed under ASC 815. (b) Incorrect. The use of hedge accounting for available for sale securities is allowed under ASC 815. (d) Incorrect. The use of hedge accounting for unrecognized firm commitments is allowed under ASC 815.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-30B a.

A Cash Flow Hedge: Use of an Option to Hedge an Anticipated Purchase.

Entry to record the purchase of the call options on November 30, 20X1: November 30, 20X1 Purchased Call Options 20,000 Cash 20,000 Purchase call options for 10,000 barrels of oil at a premium of $2 per barrel for March 1, 20X2. The options are at the money of $30 per barrel; therefore, the entire $20,000 is time value.

Adjusting entry on December 31, 20X1: December 31, 20X1 Loss on Hedge Activity 14,000 Purchased Call Options 14,000 Record the decrease in the time value of the options to current earnings. Purchased Call Options 10,000 Other Comprehensive Income Record the increase in the intrinsic value of the options to other comprehensive income.

10,000

Entries to record March 1, 20X2, expiration of options, the sale of the options, and the purchase of oil: March 1, 20X2 Loss on Hedge Activity 6,000 Purchased Call Options 6,000 Record the decrease in the time value of the options to current earnings. The options have expired. Purchased Call Options 20,000 Other Comprehensive Income Record the increase in the intrinsic value of the options to other comprehensive income. Cash Purchased Call Options Record the sale of the call options.

20,000

30,000 30,000

Oil Inventory 330,000 Cash 330,000 Record the purchase of 10,000 barrels of oil at the spot price of $33 per barrel.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-30B (continued) d.

June 1, 20X2, entries to record the sale of the oil and other entries: June 1, 20X2 Cash Sales Record the sale of 10,000 barrels of oil at $34 per barrel. Cost of Goods Sold Oil Inventory Recognize the cost of the oil sold.

340,000 340,000 330,000 330,000

Other Comprehensive Income – Reclassification 30,000 Cost of Goods Sold 30,000 Reclassify into earnings the other comprehensive income from the cash flow hedge.

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-31B a.

A Fair Value Hedge: Use of an Option to Hedge Available-for-Sale Securities.

November 3, 20X2, entries: November 3, 20X2 Available-for-Sale Securities Cash Purchase 2 JRS bonds at $105 per bond.

2,100 2,100

Put Option 100 Cash 100 Purchase put options for 2 JRS bonds at $105 per bond at a cost of $100. b.

December 31, 20X2, entries to record revaluations of JRS bonds and options: December 31, 20X2 Put Option 40 Gain on Hedge Activity Record increase in intrinsic value of put options to current earnings Loss on Hedge Activity 40 Available-for-Sale Securities Record decrease in fair value of hedged available-for-sale securities to current earnings, in accordance with ASC 815: $400 = ($105 - $103) x 2 bonds Loss on Hedge Activity Put Option Record decrease in the time value of the options.

40 40

Entries for March 3, 20X3, to record exercise of the put option and the sale of securities: March 3, 20X3 Put Option 10 Gain on Hedge Activity Record increase in intrinsic value of put options to current earnings Loss on Hedge Activity 10 Available-for-Sale Securities Record decrease in fair value of hedged available-for-sale securities to current earnings, in accordance with ASC 815: $10 = ($103 - $102.50) x 2 bonds

Chapter 11 – Multinational Accounting: Foreign Currency Transactions and Financial Instruments

P11-31B (continued) Loss on Hedge Activity 60 Put Option 60 Record decrease in the time value of the options. The options have now expired. Cash 2,100 Put Option 50 Available-for-Sale Securities 2,050 Exercise the put option and sell securities at option price of $105 per bond.

P11-32B Matching Key Terms – Hedging and Derivatives 1. L 2. E 3. M 4. D 5. G 6. I 7. A 8. K 9. H 10. N 11. F 12. B 13. J 14. O 15. C

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

CHAPTER 12 MULTINATIONAL ACCOUNTING: ISSUES IN FINANCIAL REPORTING AND TRANSLATION OF FOREIGN ENTITY STATEMENTS ANSWERS TO QUESTIONS Q12-1 There is interest because of the expected benefits of adopting a single set of highquality accounting standards, which include: 1. 2. 3. 4. 5. 6.

Continued expansion of capital markets across national borders. More rapid development of stable, liquid capital markets. Increased economic growth. Improve ability of investors to evaluate opportunities across national borders. Improve the efficient use of global capital. Reduce reporting costs for corporations that wish to access capital in markets outside of their home country. 7. Increase confidence of financial statement users in the quality of financial reporting. Q12-2 The IASB is an independent privately funded accounting standards-setting body. The mission of the IASB is to develop a single set of high-quality, understandable, and enforceable global accounting standards. The IASB is composed of 15 members who each serve a five-year term subject to one reappointment. Members are required to sever all employment relationships that might compromise their independent judgment in setting accounting standards. The IASB is based in London. Q12-3 The IASB solicits input from the public when evaluating potential standards and publishes a discussion paper and/or an exposure draft which are subject to comment before issuing a final standard. Q12-4 IFRS are already mandated or permitted in over 100 countries around the world. Beginning with 2005, the European Union mandated the use of IFRS for companies listing on stock exchanges in the EU, although the EU also continues to accept statements prepared according to US GAAP. Beginning in 2008, foreign private issuers who list their shares on US stock exchanges may use IFRS in their financial statements without reconciliation to US GAAP. Q12-5 While foreign registrants are still able to file IFRS financial statements with the SCE, the attitude toward the possible use of IFRS for domestic companies in the United States is waning.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

Q12-6 Potential benefits include: • • • • • •

•

Improve global competitive position of US corporations. Increase the quality of information available to investors. Reduce costs of compliance for companies that are currently using multiple reporting frameworks. Enhance global capital markets. Companies would have easier access to raising capital in the global markets. Because the SEC now permits foreign private issuers to file their financial reports using IFRS without reconciliation, not allowing US companies to report under IFRS could result in US companies bearing costs not incurred by foreign private issuers. Enhance comparability across companies for users. SEC chairman Cox noted that two-thirds of US investors own securities of foreign companies, a 30 percent increase in the last five years.

Q12-7 a. Local currency unit. The local currency unit (LCU) is the currency used locally; that is, the currency used in the country in which the company is located. b. Recording currency. The recording currency is the currency used to record the economic activities in the journals and ledger of the business entity. The recording currency is typically the local currency, but may be some other currency. c. Reporting currency. The reporting currency is the currency used on the financial statements of the business entity. The reporting currency for US-based entities is the U.S. Dollar. Q12-8 The functional currency is normally the currency in which the foreign entity performs most of its cash functions. However, for subsidiaries of U.S. entities operating in highly inflationary economies, the functional currency is designated as the U.S. dollar regardless of the actual currency used for cash functions. The definition of a highly inflationary economy is one that has a cumulative inflation of approximately 100 percent or more over a 3-year period. ASC 830 provides six indicators to be used to determine a foreign entity's functional currency: (1) cash flows, (2) sales prices, (3) sales markets, (4) expenses, (5) financing, and (6) intercompany transactions and arrangements. If most of these indicators take place in the foreign currency unit, then the FCU is the functional currency. If most take place in the U.S. dollar, then the dollar is the functional currency. Q12-9 Harmonization means to standardize the accounting principles used around the world. For example, the U.S. does not allow a company to revalue its own assets for the effects of inflation. Several countries do, however, allow for this revaluation and subsequent depreciation on the revaluation. Differences in accounting principles from country to country make it difficult to compare business entities doing business in different countries. The harmonization of accounting principles around the world would eliminate many of the problems of combining and consolidating multinational entities. A U.S. company with international investments could then be assured of essentially the same accounting principles being applied; therefore, revenues, profits, and investments in these foreign investments could effectively be compared and contrasted.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

Q12-10 When the local currency is the foreign entity's functional currency, the translation method is used to convert the foreign entity's financial statements into U.S. dollars, the parent company's reporting currency. The translation method uses the current exchange rate for converting all assets and liabilities. The appropriate historical exchange rate is used to convert the Canadian entity's stockholders' equity accounts. The weighted average exchange rate is used to convert the Canadian entity's income statement accounts. The change in the translation adjustment during the period is reported as an element of other comprehensive income on the Statement of Comprehensive Income, and is then accumulated with the other elements of comprehensive income and reported within the stockholders’ equity section of the consolidated balance sheet. The translation adjustment may have a debit or credit balance, depending on the relative change in the exchange rate since the parent acquired the subsidiary. Q12-11 Remeasurement is used when the functional currency of the foreign entity is something other than the recording currency. Furthermore, ASC 830 requires that the financial statements of foreign entities operating in highly inflationary economies be remeasured as if the functional currency were the reporting currency. Remeasurement requires the use of the current exchange rate to convert all monetary assets and liabilities from the recording currency to the functional currency. The historical exchange rate is used to convert nonmonetary assets and the stockholders' equity accounts from the recording currency to the functional currency. The appropriate historical rate is the rate on the later of the two following dates: (1) the day the foreign entity obtained the asset or the day the foreign entity made a transaction affecting the stockholders' equity section such as selling additional stock or declaring dividends, or (2) the day the U.S. parent company purchased the foreign affiliate. The weighted average exchange rate for the period covered by the income statement is used for revenues or expenses incurred evenly over the period except for those expenses that are allocations of balance sheet items, such as depreciation, cost of goods sold (inventories), or write-offs of goodwill when remeasuring. For cost allocations, the same rate used on the balance sheet to convert the items to U.S. dollars is used on the income statement for remeasurement from the recording currency to the functional currency. Q12-12 Translation adjustments are the balancing items to make the debit and credit items equal in the translated trial balance measured in U.S. dollars. The parent company records its share of the translation adjustment in its books through an adjusting entry. The change during the period in the translation adjustment is reported as a component of other comprehensive income in the Statement of Comprehensive Income. The accumulated other comprehensive income is reported as a separate item of stockholders’ equity in the balance sheet. The cumulative translation adjustment may have a debit balance or credit balance. A debit balance usually means that the current exchange rate is less than the historical rate used to translate the stockholders’ equity accounts. This means the dollar is strengthening relative to the foreign currency. A credit balance usually results when the dollar is weakening relative to the foreign currency, and the current exchange rate is higher than the historical exchange rate. Q12-13 The remeasurement gain or loss first appears as the trial balance balancing item in the income statement section of the foreign affiliate's trial balance. The parent company recognizes its share of the remeasurement gain through an adjusting entry. Typically, the remeasurement gain is shown in the "Other Income" section of the consolidated income statement.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

Q12-14 The stockholders' equity accounts are translated at the historical rate in effect the date the parent company acquired the foreign affiliate because this aids in the elimination entry process used to prepare the consolidated statements. The investment account on the parent company's books includes the initial investment measured in terms of the exchange rate on the date the parent purchased the foreign affiliate. Thus, the basic eliminating entry to eliminate the investment account against the capital stock and additional paid-in capital includes accounts with the same currency measurement rate. The retained earnings include the effects of revenue and expense transactions, all measured at different rates over time. The beginning translated retained earnings, as measured in U.S. dollars, is taken from last year's ending retained earnings. Net income is obtained from the income statement and dividends are translated using the exchange rate in effect the date the dividends are declared. The translated balances for net income and dividends are then used to adjust beginning retained earnings and come to the new balance for ending retained earnings. Q12-15 The current rate method uses the current exchange rate to translate the foreign affiliate's assets and liabilities. The weighted-average exchange rate is used to translate the foreign affiliate's revenues and expenses. This means that the relationships within the assets and liabilities of the foreign affiliate's balance sheet are not changed in the translation process. For example, the current ratio in U.S. dollar statements will be the same as in the foreign currency statements. This results from the use of a constant translation multiplier within the financial statements. However, this relationship does not hold when computing ratios using a balance sheet account and an income statement account: for example, return on equity. These ratios include accounts with different translation exchange rates and will, therefore, produce different results when looking at the foreign currency ratio as compared to the US dollar ratio. Q12-16 The excess of cost over book value has two effects: (1) the portion amortized for the period is reported in the income statement, and (2) the unamortized balance is reported in the balance sheet. When the local currency unit is the functional currency, the translation method is used to convert the foreign entity's financial statements into U.S. dollars. ASC 830 requires that the differential be evaluated in terms of the foreign currency unit. Therefore, the period's amortization, measured in the foreign currency, is translated at the weighted average exchange rate. The remaining unamortized differential is translated at the current exchange rate at the end of the period. The different exchange rates used typically result in a difference when measured in U.S. dollars. This difference becomes part of the translation adjustment. Q12-17 Since the parent company controls the foreign subsidiary, it logically must consolidate the entity. By virtue of the fact that the subsidiary resides in a foreign country, the parent bears the risk of fluctuations in the exchange rate. Thus, parent’s share of the translation adjustment should affect the financial statements of the parent. However, the FASB allowed comprehensive income treatment for these transactions so that constant fluctuations in exchange rates would not cause constant variability to the net income of companies with foreign investments. The change during the period in the translation adjustment is reported as a component of other comprehensive income. The translation adjustment is part of the accumulated other comprehensive income that is reported in the stockholders’ equity section of the consolidated balance sheet. Q12-18 Not all foreign subsidiaries are consolidated. The parent must be able to exercise control over the foreign subsidiary's operating and financial policies before consolidation is proper. This may not be the case if the foreign subsidiary is located in a country in which 12-4 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

the government places significant restrictions on dividend declarations, input from nonlocal management, or other operating or financing aspects of the business. Q12-19 If an investment in a foreign subsidiary is not consolidated, it is reported as a long-term investment on the U.S. company's financial statements, usually under the equity method. The cost method is used to account for the foreign investment, however, if the U.S. investor is not able to exercise significant influence over the foreign investee's operating and financial policies. Q12-20 The issue with intercompany transactions is with regard to the amount of unrealized profit. The unrealized profit determined at the time of the initial intercompany transaction is a function of the currency exchange rate at that time. As the rate changes, the underlying accounts may be translated at different exchange rates, thus affecting the computation of unrealized intercompany profit. ASC 830 states that the intercompany profit should be eliminated based on the exchange rate at the date the intercompany transaction occurred. This eliminates any potential problems from subsequent changes in exchange rates.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

SOLUTIONS TO CASES C12-1 Comparison of US GAAP and IFRS Solutions will vary by student depending on the particular items he or she selects. C12-2 Structure of the IASB The International Accounting Standards Committee (IASC) Foundation is the parent entity of the IASB. The IASC Foundation is an independent organization. The IASC Foundation trustees appoint the IASB members, exercise oversight, and raise funds to support the organization. The IASC Foundation also appoints the Standards Advisory Council, which advises the IASB and the International financial Reporting Interpretations Committee. The IASB has the sole responsibility for setting accounting standards. These standards are called International Financial Reporting Standards (IFRS). C12-3 IASB Deliberations Solutions will vary by student depending on the particular items he or she selects. C12-4 Determining a Functional Currency The choice of a functional currency is based on the currency used for six criteria provided in ASC 830, as follows: (1) cash flows, (2) sales prices, (3) sales markets, (4) expenses, (5) financing, and (6) intercompany transactions and arrangements. The choice of a functional currency is made by management after a subjective evaluation of these criteria. However, the U.S. dollar is specified as the functional currency in cases in which the foreign affiliate of a U.S. company is located in a country experiencing high inflation (approximately 100 percent or more over a three-year period). Process of Foreign Entity's Foreign Entity's Restatement into Recording Currency Functional Currency U.S. Dollars 1.

Argentinean peso U.S. dollar Remeasurement Note: This case shows that the U.S. dollar is the specified functional currency for foreign subsidiaries located in countries with highly inflationary economies.

Mexican pesos

British pound

Swiss franc

European euro

Either peso or Either dollar, management may select either. Note: This case indicates that the criteria are not always absolute. Management probably would select the specific functional currency on the basis of financial effects, such as effect on earnings per share. Translation

Remeasurement from franc to euro; then translation from euro to dollars Note: This case shows that the local currency of the country in which the foreign affiliate is located may not be the foreign affiliate's functional currency; instead, a third currency presents the functional currency.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

C12-5

Principles of Consolidating and Translating Foreign Accounts [AICPA Adapted]

a. The rules for consolidating a foreign subsidiary are essentially the same as for a domestic subsidiary. The key element is the degree of control Petie Products has over the financial and operating policies of Cream, Ltd. Typically, a 90 percent stock ownership level would assure the parent company's control of the subsidiary. It is possible, however, that the country of Kolay may have severe restrictions on the decision-making abilities of non-Kolay investors, or that Kolay may have restrictive laws regulating commerce within Kolay. Petie Products' management must evaluate their ability to control the foreign subsidiary. If they do possess the necessary level of control, the foreign subsidiary should be consolidated. If not, then the foreign subsidiary is reported as an investment on the parent company's financial statements. b. Translation means that the local currency unit is functional. The foreign subsidiary's assets and liabilities are translated using the current exchange rate at the end of 20X7. The stockholders' equity accounts are translated at appropriate historical rates. The income statement accounts are translated at the weighted average exchange rate during 20X7. The appropriate exchange rates for each of the 10 items are presented below: 1. Current exchange rate at December 31, 20X7 2. Current exchange rate at December 31, 20X7 3. Current exchange rate at December 31, 20X7 4. Current exchange rate at December 31, 20X7 5. Current exchange rate at December 31, 20X7 6. Historical exchange rate at January, 20X4 7. Beginning Retained Earnings is carried forward as a composite from prior years' operations. The beginning Retained Earnings is the prior period's ending Retained Earnings. 8. Average exchange rate for 20X7 (assumes revenues earned evenly throughout year) 9. Average exchange rate for 20X7 10. Average exchange rate for 20X7

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

C12-6 Translating and Remeasuring Financial Statements of Foreign Subsidiaries [AICPA Adapted] a. The objectives of translating a foreign subsidiary's financial statements are to: 1.

Provide information that is generally compatible with the expected economic effects of a rate change on a subsidiary's cash flows and equity.

Reflect the subsidiary's financial results and relationships in single currency financial statements, as measured in its functional currency and in conformity with generally accepted accounting principles.

b. Applying different exchange rates to the various financial statement accounts causes the restated financial statements to be unbalanced. ‘Unbalanced’ means that the debits will not equal the credits in the subsidiary's trial balance prepared in U.S. dollars. The amount required to bring the restated financial statements into balance is termed the gain or loss from the translation or remeasurement. The gain or loss from remeasuring Wahl A's financial statements is reported in the consolidated income statement. The gain or loss arising from translating Wahl F's financial statements (described as a translation adjustment) is reported as a component of comprehensive income and then accumulated with other comprehensive income items and reported under stockholders' equity in the consolidated balance sheet. c. The functional currency is the foreign currency or the parent's currency that most closely correlates with the following economic indicators: 1. Cash flow indicators 2. Sales price indicators 3. Sales market indicators 4. Expense indicators 5. Financing indicators 6. Intercompany transactions and arrangement indicators d. All accounts relating to Wahl A's equipment—the equipment, accumulated depreciation, and depreciation expense accounts—are remeasured by using the exchange rate prevailing between the U.S. and Australian dollars at the later of the two following dates: (1) the date at which Wahl Co. acquired its investment in Wahl A, or (2) the date(s) the equipment was purchased by Wahl A. This exchange rate is referred to as the historical rate. All accounts relating to Wahl F's equipment are translated by using the current exchange rates prevailing between the U.S. dollar and the European euro. For the equipment cost and the accumulated depreciation, the current exchange rate at December 31, 20X5, should be used for translation. Depreciation expense is translated at an appropriate weighted average exchange rate for 20X5.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

C12-7 Translation Adjustment and Comprehensive Income a.

Statement of income for the year, for the subsidiary Subsidiary Statement of Income Year Ended December 31, 20XX Sales Cost of Sales Gross Profit Operating Expenses Income from Operations Consolidated Net Income to Controlling Interest

$ 560,000 (285,000) $ 275,000 (140,000) $ 135,000 $ 135,000

Statement of comprehensive income for the year, for the subsidiary Subsidiary Statement of Comprehensive Income Year Ended December 31, 20XX Consolidated Net Income to Controlling Interest Other Comprehensive Income: Translation Adjustment Comprehensive Income

$ 135,000 (12,000) $ 123,000

Balance sheet as of December 31, for the subsidiary Subsidiary Balance Sheet December 31, 20XX Assets Cash Receivables Inventories Property, Plant, and Equipment (net) Total Assets Liabilities and Stockholders’ Equity Current Payables Long-Term Payables Capital Stock Retained Earnings Accumulated Other Comprehensive Income: Translation Adjustment Total Liabilities and Stockholders’ Equity

$ 50,000 24,700 60,300 328,000 $ 463,000 $ 16,000 181,000 100,000 258,000 (92,000) $ 463,000

Note: The end-of-year retained earnings ($258,000) comprises the January 1 balance of $135,000, plus net income of $135,000, less dividends of $12,000.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

C12-7 (continued) d.

ASC 220 allows for either the one-statement format for the combined statement of income and comprehensive income, or the two-statement format for a statement of income and a separate statement of comprehensive income. Both formats must include all the elements of comprehensive income. The one-statement format presents the other comprehensive income elements immediately below net income. The two-statement format presents a separate statement of income as was done prior to ASC 220. The statement of income ends with net income. Then, a separate statement of comprehensive income begins with net income, followed with the elements of other comprehensive income, and ends with comprehensive income.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

C12-8 Changes in the Cumulative Translation Adjustment Account a.

Foreign transactions.

Johnson & Johnson Company applies the concepts presented in the chapter for translating the trial balances of its foreign subsidiaries. The resulting cumulative translation adjustment has changed dramatically from a credit balance of $134 million at the end of 20X1 to a debit balance of $338 million at the end of 20X3.

The translation adjustment is related to the translated net asset balance (assets minus liabilities) of the foreign subsidiaries. Several factors could account for the decrease in the net assets of Johnson & Johnson's foreign subsidiaries, as follows: 1. The foreign subsidiaries could be increasing their local liabilities, i.e., taking out more local debt. 2. The foreign subsidiaries could be decreasing their local assets, i.e., not maintaining their physical capital through reinvestment. 3. The direct exchange rate of the dollar versus the local currency units of the countries in which the company has foreign subsidiaries has been decreasing over time (i.e., the dollar had strengthened versus the local currency units).

This footnote demonstrates these factors. Remember that it is assumed that the translated stockholders' equity, other than the accumulated other comprehensive income (AOCI) from the translation adjustment, remained constant at $500 million for each of the three years. The following condensed balance sheets can be presented: 20X1 Translated Balance Sheets of All Foreign Subsidiaries Net assets

$634 Stockholders’ equity: Other than AOCI AOCI Translation Adjustment

$ 500 134

20X2 Translated Balance Sheets of All Foreign Subsidiaries Net assets

$354 Stockholders’ equity: Other than AOCI AOCI Translation Adjustment

$ 500 (146)

20X3 Translated Balance Sheets of All Foreign Subsidiaries Net assets

$162 Stockholders’ equity: Other than AOCI AOCI Translation Adjustment

$ 500 (338)

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

C12-8 (continued) e.

If the direct exchange rate decreased over the two-year period, the translated net assets would decrease, thus causing a decrease (debit change) in the translation adjustment. The direct exchange rate would decrease if the dollar were strengthening versus the local currency units of the countries in which the company had foreign subsidiaries. Other causes for the decrease in the translated net assets would be a decrease in local assets, or an increase in local liabilities.

Johnson & Johnson Company did make several changes in its foreign investment portfolio during 20X2 and 20X3 that would have resulted in a change in the combined stockholders' equity of the company's foreign investments. During 20X3, the company acquired approximately $266 million in European companies. In 20X2, the company acquired approximately $47 million in Japanese companies. The company completed relatively minor sales of foreign subsidiaries and operations during 20X2 and 20X3. Thus, it appears that the major reasons for the significant debit change in the accumulated other comprehensive income—translation adjustment account over the two-year period was that the foreign subsidiaries were increasing their local debt, and that the U.S. dollar was strengthening versus the local currency units of the foreign countries in which Johnson & Johnson Company had subsidiaries. A more specific analysis would require knowledge of the amount of the foreign investments in each country, the balance of the local assets and local liabilities of each of the foreign subsidiaries, and the knowledge of the exchange rates for the dollar versus the foreign currencies of the countries in which the company has invested.

C12-9 Pros and Cons of Foreign Investment The focus of this case is to consider the variables involved with the business decision of expanding a company's production and/or marketing investment in a foreign country. Many of the variables would be similar to those considered in the decision to increase a company's physical capital in the U.S. But, some additional variables should be considered for the foreign country such as: home-country laws, the political and economic environment, the accounting and tax laws, the status of labor organization, the cost-ofliving and prevailing wages, the supply of trained labor forces (including local management personnel), and the different cultural aspects that might impact on obtaining the factors of production or on the markets for the company's goods. Some companies make investment in foreign production facilities in order to have a production capability closer to a foreign market. Thus transportation costs of the finished goods are decreased, while the company is able to increase overall revenue and income. Many companies go to non-U.S. production sources because of the lower costs for labor. Thus, if the company produces a labor-intensive product, the economics of the decision may favor foreign production. In addition, as tariffs are reduced, U.S. companies may find it more advantageous to move their production facilities to non-U.S. locations. One possible outcome is that the costs of the finished goods to U.S. consumers would be lower for goods manufactured outside the U.S. However, an argument often raised in the political arena is that unemployed U.S. consumers would not be able to purchase the products. 12-12 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

The U.S. government has proposed retraining programs for dislocated workers who lose their jobs because the company has closed the U.S. production facility. Students should be encouraged to develop some new and novel approaches to solving the problem of the general change in the types of new jobs being created in the U.S. economy. C12-10 Determining an Entity’s Functional Currency MEMO To:

Garry Parise, CFO, Maxima Corporation

From:

_______________ ____________________, CPA, Controller’s Department

Re:

Functional Currency of Luz Maxima

According to ASC 830, the functional currency for a company is the primary currency that is generated by cash inflows and used for cash outflows. Further, it is the currency of the country that is the primary economic environment of the company’s business operations as indicated by items such as sales, and expense, and financing activities. Because Luz Maxima initially did business exclusively with Maxima Corporation and these transactions were denominated in the U.S. dollar, its functional currency was originally determined to be the U.S. dollar. However, it appears that changes in Luz Maxima’s operation over the past five years may result in a change in the functional currency from the U.S. dollar to the Mexican peso. Appendix A of ASC 830 provides indicators that should be considered in determining a foreign subsidiary’s functional currency. Among the indicators that may be relevant for evaluating the functional currency of Luz Maxima are sales, expense, and financing indicators. • Sales market indicators – Luz Maxima now sells a significant amount of product in Mexico and South America. These transactions are denominated in the peso. • Expense indicators – Luz Maxima obtains a significant amount of materials from local suppliers. • Financing indicators – Luz Maxima obtained long-term debt financing and a line of credit from banks in Mexico. To the extent indicators are mixed and Luz Maxima also has sales, expenses, and financing transactions denominated in the U.S. dollar, ASC 830 states that management should make the final determination as to the functional currency. ASC 830 also indicates that, while it is desirable for the functional currency to be used consistently, if economic facts change, it may be appropriate to change the determination of the functional currency. Management should assess all aspects of Luz Maxima’s operation to determine the most appropriate and relevant functional currency for this subsidiary. If a decision is made to change the functional currency from the U. S. dollar to the Mexican peso, Luz Maxima’s current financial statements should be converted to U.S. dollars using the current rate translation method. Any adjustment that occurs as a result of translating nonmonetary 12-13 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

assets using the current rate method should be reported as a component of other comprehensive income. Authoritative support for the above memo can be found in ASC 830. C12-11 Accounting for the Translation Adjustment MEMO To: Renee Voll, Controller From:

___________ _______________, CPA

Re: Translation Adjustment for Valencia subsidiary Since Sonoma has sold 30% of the investment in our Spanish subsidiary, the balance of the cumulative translation adjustment, included in consolidated stockholders’ equity, should be reduced proportionately. ASC 830 normally does not require that changes in the translation adjustment be included in earnings. Prior to the liquidation of an investment in a subsidiary, the FASB believes that the effects of such translation adjustments are uncertain and should not be included in income. However, when there is a sale or liquidation of a subsidiary, the amount of the translation adjustment that is included in equity should be removed from equity and should be reported as part of the gain or loss in the period in which the transaction occurs. Although Sonoma has not completely liquidated the investment in Valencia, the company is still required to recognize a portion of the translation adjustment in computing the gain or loss. According to ASC 830, a pro rata portion of the accumulated translation adjustment that is attributable to the subsidiary must be included in the calculation of the gain or loss on the sale of a portion of the subsidiary. Therefore, the gain on the sale of the Valencia investment should be reduced by 30% of the (debit balance) cumulative translation adjustment related to this investment. Sonoma should disclose the amount by which the gain is decreased because of the adjustment for the cumulative translation adjustment. In the presentation of comprehensive income, the adjustment to the translation adjustment should be identified as a reclassification adjustment so that the same amount is not included in both net income and in comprehensive income. Authoritative support for the above memo can be found in the following references: ASC 830 ASC 220 ASC 830

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

SOLUTIONS TO EXERCISES E12-1 Multiple-Choice Translation and Remeasurement [AICPA Adapted] Foreign Currency is Functional Currency 1.

a–

U.S. Dollar is Functional Currency b–

$215,000

$225,000 ($100,000 + $50,000 + $30,000 + $45,000)

c–

400,000 LCU x $0.44 = $176,000

d–

120,000 LCU x $0.50 80,000 LCU x $0.44 200,000 LCU x $0.44

= $ 60,000 =

35,200

88,000 $183,200

a–

Indirect rates used

c–

170,000 LCU / 1.5 LCU 90,000 LCU / 1.6 LCU

= $113,333 = 56,250 $169,583

b–

25,000 LCU / 2.2 LCU

= $ 11,364

260,000 LCU / 1.8 LCU = $144,444 4.

d–

a–

25,000 LCU / 2 LCU = $12,500

c–

$755,000 (All assets are translated at current rate)

$870,000 ($75,000 + $700,000 + $25,000 + $70,000)

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-2

Multiple-Choice Questions on Translation and Foreign Currency Transactions [AICPA Adapted] Foreign Currency is Functional Currency

1. b –

2. d –

d – $40,000

$10,000 $120,000 = 2/15/X2 $ value

$10,000 = Foreign currency

(110,000) = 12/31/X1 $ value $ = Foreign exchange 10,000 Gain

transaction gain 30,000 = Remeasurement gain

4,000 $17,000

= Preadjusted foreign exchange loss = Foreign currency transaction loss ($60,000 - $64,000) = Foreign exchange Loss

6,000

$21,000

$13,000 = Preadjusted foreign exchange loss 4,000 = Foreign currency transaction loss (7,000) = Remeasurement gain $10,000 = Net foreign exchange loss a – $41,000

$21,000 $15,000

$40,000 = Foreign exchange gain b – $10,000

$17,000 $13,000

3. c –

U.S. Dollar is Functional Currency

= Preadjusted foreign exchange loss = Foreign currency transaction loss ($100,000 $106,000) = Foreign exchange Loss

$15,000 = Preadjusted foreign exchange loss 6,000 = Foreign currency transaction loss 20,000 = Remeasurement gain $41,000 = Net foreign exchange loss

4. a – When the remeasurement method is used, monetary accounts are restated at the exchange rate at the balance sheet date, while nonmonetary accounts are restated using the exchange rate(s) at the date(s) the transaction(s) occurred which are reflected in the account balance. In this question, bonds payable and accrued liabilities are both monetary accounts and would be restated using the current exchange rate. Trading securities represent a nonmonetary account, however, Trading securities would be restated using the current rate because the account balance is stated at the market values at the balance sheet date. Inventories are also a nonmonetary asset. Since they are stated at cost, a historical exchange rate would be used to restate inventories.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-2 (continued) 5. b – The current rate method of translation allows the use of a weighted average exchange rate for revenues and expenses that occur throughout the year. Since both sales and wages expense occur throughout the year, a weighted average exchange rate can be used for translation. 6. a – For hedges of net investments in a foreign entity, the amount of the change in fair value of the hedging instrument is recorded to other comprehensive income that then becomes part of the accumulated other comprehensive income. The change in the translation adjustment during the period is reported as a component of other comprehensive income and then carried forward to be accumulated in the stockholders’ equity section of the balance sheet with the other components of other comprehensive income. Therefore, in this case in which a hedge of a net investment in a foreign entity is used, the exchange gain on the hedge is reported along with the change in the translation adjustment.

E12-3 Matching Key Terms 1.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-4 Multiple-Choice Questions on Translation and Remeasurement 1. b –

Investment cost Less: Book and fair values of sub's net assets 680,000 ringgits x $0.21 x 0.90 = Goodwill

$160,000 128,520 $ 31,480

2. c – Goodwill Impairment

Dollars Ringgits $10,500 RM 50,000 ($10,500 / $.21) 1,100 (RM 5,000 x $0.22) 5,000 (RM 50,000 / 10)

3. a –

Impairment loss = $10,500 / 10 = $1,050

4. b –

Sub’s Net Income (€25,000 x $1.24) Less: Goodwill Impairment Loss (€35,000 x 1.24 x 0.1) Income from Sub

4,340 $ 26,660

Goodwill of €35,000 calculated as follows: Amount paid for Common Stock ($402,000 / $1.2) Less: Fair value of identifiable assets Goodwill

€335,000 €300,000 € 35,000

5. d –

€ 5,000 x $1.30 = $6,500

6. c –

Investment cost on January 1, 20X5 Less: Book and fair values of sub’s net assets: € 300,000 x $1.20 Goodwill

Goodwill Impairment Balance

Dollars $42,000 4,340 (€ 3,500 x $1.24) $37,660

Translated balance

$41,580 (€ 31,500 x $1.32)

$31,000

$402,000 360,000 $ 42,000 Euros € 35,000 ($ 42,000 / $1.20) 3,500 (€ 35,000 / 10) € 31,500

Translation adjustment: $41,580 minus $37,660 = $3,920 – use for question 7. 7. b –

Translation adjustment from translating the trial balance Translation adjustment from translating goodwill Total translation adjustment

$12,000cr 3,920cr $15,920cr 12-18

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-5 Translation SunTime Company Trial Balance Translation December 31, 20X1 Swiss Francs

Translation Rate

U.S. Dollars

Cash Accounts Receivable (net) Receivable from Popular Creek Inventory Plant and Equipment Cost of Goods Sold Depreciation Expense Operating Expense Dividends Paid Total Debits

SFr

7,000 20,000 5,000 25,000 100,000 70,000 10,000 30,000 15,000 SFr 282,000

0.80 0.80 0.80 0.80 0.80 0.75 0.75 0.75 0.77

$ 5,600 16,000 4,000 20,000 80,000 52,500 7,500 22,500 11,550 $219,650

Accumulated Depreciation Accounts Payable Bonds Payable Common Stock Sales Total Accumulated Other Comprehensive Income — Translation Adjustment (credit) Total Credits

SFr 10,000 12,000 50,000 60,000 150,000 SFr 282,000

0.80 0.80 0.80 0.73 0.75

$ 8,000 9,600 40,000 43,800 112,500 $213,900 5,750 $219,650

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-6 Proof of Translation Adjustment a.

Popular Creek Corporation and Subsidiary Proof of Translation Adjustment Year Ended December 31, 20X1

Net assets at beginning of year Adjustment for changes in net asset position during year: Net income for year Dividends paid Net assets translated at: Rates during year Rates at end of year

SFr

Translation Rate

U.S. Dollars

SFr 60,000

0.73

$ 43,800

40,000 (15,000)

0.75 0.77

30,000 (11,550)

SFr 85,000

0.80

$ 62,250 68,000

Change in other comprehensive income translation adjustment during year net increase Accumulated other comprehensive income — translation adjustment — January 1

$ 5,750 -0-

Change in other comprehensive income — translation adjustment December 31 (credit) b.

$ 5,750

The change in the translation adjustment of $5,750 is included as a credit in the other comprehensive income on the Statement of Comprehensive Income. The other comprehensive income is then accumulated and reported in the stockholders’ equity section of the consolidated balance sheet.

Supporting computations: Net income: Sales

SFr 150,000

Net Assets

CGS Depreciation Oper. Expenses Net Income

(70,000) (10,000) (30,000) Total SFr 40,000

Balance Sheet, 12/31/X1 $68,000 Common Stock

$68,000

Ret. Earn.* AOCI Total

Retained earnings, 1/1/X1 Net income Dividends *Retained earnings, 12/31/X1

$ 43,800 18,450 5,750 $ 68,000 $

-030,000 (11,550) $ 18,450

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-7 Remeasurement SunTime Company Trial Balance Remeasurement December 31, 20X1 Swiss Francs

U.S. Dollars

Rate

Cash Accounts Receivable (net) Receivables from Popular Creek Inventory Plant and Equipment Cost of Goods Sold Depreciation Expense Operating Expense Dividends Paid Total Remeasurement Loss Total Debits

SFr

7,000 20,000 5,000 25,000 100,000 70,000 10,000 30,000 15,000 SFr 282,000

0.80 0.80 0.80 0.77 0.74 (a) 0.74 0.75 0.77

$ 5,600 16,000 4,000 19,250 74,000 52,000 7,400 22,500 11,550 $212,300 1,000 $213,300

Accumulated Depreciation Accounts Payable Bonds Payable Common Stock Sales Total Credits

SFr 10,000 12,000 50,000 60,000 150,000 SFr 282,000

0.74 0.80 0.80 0.73 0.75

Swiss Francs

(a) Cost of Goods Sold: Beginning Inventory Purchases Goods Available for Sale Less: Ending Inventory Cost of Goods Sold

SFr

-095,000 SFr 95,000 (25,000) SFr 70,000

7,400 9,600 40,000 43,800 112,500 $213,300 U.S. Dollars

Rate 0.75 0.75 0.77

-071,250 $ 71,250 (19,250) $ 52,000

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-8 Proof of Remeasurement Gain (Loss) a.

Popular Creek Corporation and Subsidiary Proof of Remeasurement Loss Year Ended Dec. 31, 20X1 Schedule 1 Statement of Net Monetary Position End of Year

Beginning of Year

SFr 7,000 20,000 5,000 SFr 32,000

SFr 60,000

Less Monetary Liabilities: Accounts Payable Bonds Payable Total Net Monetary Assets

SFr 12,000 50,000 SFr 62,000

SFr

Net Monetary Liabilities

SFr (30,000)

Monetary Assets: Cash Accounts Receivable (net) Receivables from Popular Creek Total

Change in net monetary investment during 20X1

SFr 60,000 -0-0SFr -0SFr 60,000

SFr (90,000)

Schedule 2 Analysis of Changes in Monetary Accounts

Exposed net monetary asset Position – January 1 Adjustments for changes in the net monetary position during the year: Increases: From operations: Sales From other sources Decreases: From operations: Purchases Cash expenses From dividends From purchase of plant and equipment Net monetary position prior to remeasurement at year-end rates Exposed net monetary liability Position – December 31 Remeasurement loss

SFr

Exchange Rate

U.S. Dollars

SFr 60,000

0.73

$ 43,800

150,000 -0-

0.75

112,500 -0-

(95,000) (30,000) (15,000)

0.75 0.75 0.77

(71,250) (22,500) (11,550)

(100,000)

0.74

(74,000) $(23,000)

SFr(30,000)

0.80

(24,000) $ (1,000)

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-8 (continued) Note: The issuance of the bonds payable has no effect on net monetary assets. Cash, a monetary asset, is increased and bonds payable, a monetary liability, is increased. The Remeasurement Loss results from the decrease in the net monetary asset position during a period in which the exchange rate has increased. The end-of-period remeasured net liability position of $24,000 is more than the net monetary liability position of $23,000 remeasured using the rates in effect at the times of the transactions. b.

The remeasurement loss is included in the period's consolidated statement of income.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-9 Translation with Strengthening U.S. Dollar a.

SunTime Company Trial Balance Translation December 31, 20X1 Swiss Francs

Cash Accounts Receivable (net) Receivable from Popular Creek Inventory Plant and Equipment Cost of Goods Sold Depreciation Expense Operating Expense Dividends Paid Total Accumulated Other Comprehensive Income — Translation Adjustment (debit) Total Debits

SFr

7,000 20,000 5,000 25,000 100,000 70,000 10,000 30,000 15,000 SFr 282,000

Accumulated Depreciation Accounts Payable Bonds Payable Common Stock Sales Total Credits

SFr

Rate 0.73 0.73 0.73 0.73 0.73 0.75 0.75 0.75 0.74

5,110 14,600 3,650 18,250 73,000 52,500 7,500 22,500 11,100 $208,210 4,850 $213,060

SFr 282,000 10,000 12,000 50,000 60,000 150,000 SFr 282,000

U.S. Dollars

0.73 0.73 0.73 0.80 0.75

7,300 8,760 36,500 48,000 112,500 $213,060

NOT REQUIRED: Proof of Translation Adjustment SFr Net assets at beginning of year SFr 60,000 Adjustment for changes in net asset position during year: Net income for year 40,000 Dividends paid (15,000) Net assets translated at: Rates during year Rates at end of year SFr 85,000 Change in other comprehensive Income — translation adjustment during year — net decrease Accumulated other comprehensive income — translation adjustment — January 1 Accumulated other comprehensive income — translation adjustment — December 31 (debit)

Translation Rate

U.S. Dollars

0.80

$ 48,000

0.75 0.74

30,000 (11,100)

0.73

$ 66,900 (62,050) $

4,850 -0-

4,850

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-9 (continued) b. In Exercise 12-5, the U.S. dollar weakened against the Swiss franc; i.e., the direct exchange rate increased during the 20X1 year. Thus, the $11,000 credit translation adjustment was the balancing item because the translated net assets of the foreign subsidiary were higher at the end of the year than the net assets at the beginning of the year adjusted for changes in the net assets that occurred during the year (income less dividends). In Exercise 12-9, the U.S. dollar strengthened against the Swiss franc during the year; i.e., the direct exchange rate decreased during the year. Thus, the $4,850 debit translation adjustment was the balancing item in Exercise 12-9 because the translated net assets at the end of the year were lower than the translated net assets at the beginning of the year as adjusted for changes during the year. The periodic change in the translation adjustment of $4,850 is reported as a component of other comprehensive income on the Statement of Comprehensive Income, and is then accumulated with other comprehensive income items and reported in the stockholders’ equity section of the consolidated balance sheet.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-10 Remeasurement with Strengthening U.S. Dollar a. SunTime Company Trial Balance Remeasurement December 31, 20X1 Swiss Francs

Rate

U.S. Dollars

Cash Accounts Receivable (net) Receivable from Popular Creek Inventory Plant and Equipment Cost of Goods Sold Depreciation Expense Operating Expense Dividends Paid Total Remeasurement Loss Total Debits

SFr

7,000 20,000 5,000 25,000 100,000 70,000 10,000 30,000 15,000 SFr 282,000

0.73 0.73 0.73 0.74 0.77 (a) 0.77 0.75 0.74

Accumulated Depreciation Accounts Payable Bonds Payable Common Stock Sales Total Credits

SFr 10,000 12,000 50,000 60,000 150,000 SFr 282,000

0.77 0.73 0.73 0.80 0.75

(a)

Swiss Francs

Cost of Goods Sold: Beginning Inventory Purchases Goods Available for Sale Less: Ending Inventory Cost of Goods Sold

SFr

-095,000 SFr 95,000 (25,000) SFr 70,000

Rate 0.80 0.75 0.74

5,110 14,600 3,650 18,500 77,000 52,750 7,700 22,500 11,100 $212,910 550 $213,460 7,700 8,760 36,500 48,000 112,500 $213,460

U.S. Dollars $

-071,250 $ 71,250 (18,500) $ 52,750

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-10 (continued) b.

In Exercise 12-5, the U.S. dollar weakened against the Swiss franc; i.e., the direct exchange rate increased during the 20X1 year. The $1,000 remeasurement loss resulted from the decrease in the net monetary items during a period in which the exchange rate increased. In Exercise 12-10, the U.S. dollar strengthened against the Swiss franc during the year. Note that the remeasurement gain or loss is computed only on monetary items. In E12-10, the net monetary items decreased during the year. Thus, the $550 remeasurement loss in E12-10 results from the fact that the remeasured net monetary liability position at the end of the year is greater than the net monetary position prior to remeasurement at year-end rates. This is shown in the proof below which was not required for the exercise. NOT REQUIRED: Proof of Remeasurement Loss Schedule 1 Statement of Net Monetary Position End of Year Monetary Assets: Cash Accounts Receivable (net) Receivables from Popular Creek Total

SFr

Beginning of Year

7,000 20,000 5,000 SFr 32,000

SFr 60,000

Less Monetary Liabilities: Accounts Payable Bonds Payable Total Net Monetary Assets 1/1/X1

SFr 12,000 50,000 SFr 62,000

SFr

Net Monetary Liabilities 12/31/X1

SFr (30,000)

Change in net monetary investment during 20X1

SFr 60,000 -0-0SFr -0SFr 60,000

SFr (90,000)

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-10 (continued) NOT REQUIRED: Proof of Remeasurement Loss (continued) Schedule 2 Analysis of Changes in Monetary Accounts

Exposed net monetary asset Position — January 1 Adjustments for changes in the net monetary position during the year: Increases: From operations: Sales From other sources Decreases: From operations: Purchases Cash expenses From dividends From purchase of plant and equipment Net monetary position prior to remeasurement at year-end rates Exposed net monetary liability Position--December 31 Remeasurement loss

SFr

Exchange Rate

U.S. Dollars

SFr 60,000

0.80

$ 48,000

150,000 -0-

0.75

112,500 -0-

(95,000) (30,000) (15,000)

0.75 0.75 0.74

(71,250) (22,500) (11,100)

(100,000)

0.77

(77,000) $(21,350)

SFr (30,000)

0.73

(21,900) $ (550)

E12-11 Remeasurement and Translation of Cost of Goods Sold a. Remeasurement: Beginning Inventory Purchases Goods Available Less Ending Inventory Cost of Goods Sold

Euros € 220,000 846,000 1,066,000 (180,000) € 886,000

Rate 1.29015 1.39655

Cost of Goods Sold

Euros € 886,000

Rate 1.39655

1.45000

U.S. Dollars $ 283,833 1,181,481 1,465,314 (261,000) $1,204,314

b. Translation: U.S. Dollars $1,237,343

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-12 Equity-Method Entries for a Foreign Subsidiary a.

Cash Investment in Shames Company Receive dividend: $19,680 = £15,000 x $1.64 x 0.80

19,680

Investment in Shames Company Income from Subsidiary Record equity accrual: $48,000 = $60,000 x 0.80

48,000

19,680

48,000

Other Comprehensive Income — Translation Adjustment 5,120 Investment in Shames Company Parent's share of subsidiary's translation adjustment: $5,120 = $6,400 x 0.80 c. British Exchange Pounds Rate Income Statement: Differential Jan. 1, 20X8 £30,000 1.60 (10-year life) Amortization for 20X8 (3,000) 1.63 Remaining balance £27,000 Balance Sheet: Remaining balance on Dec. 31 translated at year-end rate Difference to translation adjustment

£27,000

1.65

5,120 U.S. Dollars $48,000 (4,890) $43,110

44,550 $ 1,440

Note that the amount of the differential necessary for the balance sheet is $44,550, while the amount, without any adjustment, would be $43,110. Therefore, the differential portion of the parent company’s investment must be increased by $1,152 ($1,440 x 0.80) through a debit to the Investment in Shames Company account and a corresponding credit to the Other Comprehensive Income—Translation Adjustment account. The differential adjustment adjusts to the amount needed for the balance sheet. Investment in Shames Company 1,152 Other Comprehensive Income — Translation Adjustment Recognize translation adjustment for increase in differential. d.

1,152

Income from Subsidiary 3,912 Investment in Shames Company 3,912 Amortization of trademark for 20X1: $3,912 = £3,000 x $1.63 x 0.80 Other comprehensive income reports the periodic change in the translation adjustment. For 20X8, this would be the sum of a debit of $5,120 which is the parent company’s portion of the translation adjustment resulting from translating the subsidiary’s trial balance, less the $1,152 translation adjustment that is made only by the parent company due to the adjustment of the differential. Therefore, other comprehensive income would report $3,968 ($5,120 - $1,152) due to foreign translations. 12-29

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-13 a.

Effects of a Change in the Exchange Rate — Translation and Other Comprehensive Income

Direct and indirect exchange rates: Direct ($/R 1) $0.03333 = R 1 $0.02857 = R 1 $ 0.025 = R 1

January 1, 20X6 December 31, 20X6 December 31, 20X7

Indirect (R/$1) R 30 = $1 R 35 = $1 R 40 = $1

The dollar strengthened during 20X6 because the number of rupees one U.S. dollar could acquire at the end of the year (35) is greater than the number of rupees that could be acquired at the beginning of the year (30); therefore, the value of the dollar has increased relative to the rupee during 20X6. The dollar continued to strengthen during 20X7. b.

Translated December 31, 20X6, balance sheet:

Cash Receivables Inventory Fixed assets Total Accumulated other comprehensive income — translation adjustment (debit) Total debits Current payables Long-term debt Common stock Retained earnings Total credits

Subsidiary’s Trial Balance (in rupees) R 100,000 450,000 680,000 1,000,000 R 2,230,000

Direct Exchange Rate $0.02857 $0.02857 $0.02857 $0.02857

Translated Trial Balance (in $) $ 2,857 12,857 19,428 28,570 $63,712 2,903 $66,615

260,000 1,250,000 500,000 220,000 R 2,230,000

$0.02857 $0.02857 $0.03333 $0.03095*

$ 7,428 35,713 16,665 6,809 $66,615

*$.03095 = average of beginning and ending exchange rates, rounded to 4 decimal points: $.030945 = [($.03333 + $.02857) / 2] (Not required: Proof of translation adjustment (debit) of $2,903) Rupees R 500,000

Translation Rate $0.03333

Net assets, 1/1/X6 Adjustment for changes in net assets during year: Net income 220,000 $0.03095 Net assets translated at: Rates during year Rate at end of year R 720,000 $0.02857 Change in translation adjustment during year (debit) *Difference of $1 ($2,904 - $2,903) due to rounding of exchange rates.

Dollars $16,665 6,809 $23,474 (20,570) $ 2,904*

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-13 (continued) c.

Translated December 31, 20X7, balance sheet:

Cash Receivables Inventory Fixed assets Total

Subsidiary’s Trial Balance (in rupees) R 80,000 550,000 720,000 900,000 R 2,250,000

Direct Exchange Rate $0.025 $0.025 $0.025 $0.025

AOCI translation adjustment (debit) Total debits Current payables Long-term debt Common stock Retained earnings Total credits

Translated Trial Balance (in $) $ 2,000 13,750 18,000 22,500 $56,250 5,635 $61,885

340,000 1,100,000 500,000 310,000 R 2,250,000

$0.025 $0.025 $0.03333 (a)

$ 8,500 27,500 16,665 9,220 $61,885

(a) The retained earnings in dollars would begin with the December 31, 20X6's, dollar balance ($6,809) that would be carried forward. To this would be added 20X7's net income of R 90,000, which is the change in retained earnings in rupees multiplied by the average 20X7 exchange rate of $.02679 [($.02857 + $.025)/2] which equals $2,411. Therefore, translated retained earnings on December 31, 20X7, is $9,220 ($9,220 = $6,809 + $2,411). (Not required: Proof of translation adjustment (debit) of $5,635) Rupees R 720,000

Net assets, 1/1/X7 Adjustment for changes in net assets during year: Net income 90,000 Net assets translated at: Rates during year Other comprehensive income — Rate at end of year R 810,000 Change in other comprehensive Income — translation adjustment during year (debit) Accumulated other comprehensive Income — translation adjustment, 1/1/X7 Accumulated other comprehensive Income — translation adjustment,12/31/X7 (debit)

Translation Rate $0.02857

Dollars $20,570

$0.02679

2,411 $22,981

$0.025

(20,250) $ 2,731 2,904 $ 5,635

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

The $2,731 change in the accumulated other comprehensive income — translation adjustment during 20X7 would be reported as a component of other comprehensive income on 20X7's statement of other comprehensive income.

E12-14 a.

Computation of Gain or Loss on Sale of Asset by Foreign Subsidiary

Journal entries, in pesos, regarding the land: 1/1/X1 12/31/X2

Land Cash

P 2,000,000

Cash Land Gain on Sale of Land

P 3,000,000

P 2,000,000 P 2,000,000 P 1,000,000

Amount of transaction gain ($83,333), and remeasurement loss ($33,333): Note that under remeasurement the nonmonetary items are not adjusted for changes in the exchange rate. Therefore, land will be based on its historical cost of P 2,000,000 x $0.10, the direct exchange rate on 1/1/X1, which equals a remeasured basis for the land of $200,000. The direct exchange rate on 1/1/X1 is $.10 ($1 = P 10); on 12/31/X1 is $0.090909 ($1 = P 11); and on 12/31/X2 is $0.083333 ($1 = P 12). The appropriate exchange rate to use to remeasure the gain on the sale of the land is $0.083333 because the transaction is significant to the subsidiary, solitary to the operations, and occurred on a specific date, the last day of the year. Remeasured December 31, 20X2 Trial balance:

Cash Total Remeasurement loss Total debits Common stock Gain on sale of land Total credits

Subsidiary’s Trial Balance (in pesos) P 3,000,000 P 3,000,000

Direct Exchange Rate $0.083333

Remeasured Trial Balance (in $) $250,000 $250,000 33,333 $283,333

P 2,000,000 P 1,000,000 P 3,000,000

$0.10 $0.083333

$200,000 83,333 $283,333

The effect on the parent company’s net income ($50,000 = $83,333 – $33,333) is the same as if the transactions had been transacted in U.S. dollars, which is an objective of the remeasurement method. The equivalent journal entries to those in part a. of the problem, if transacted in U.S. dollars, would be: 1/1/X1 12/31/X2

Land (P 2,000,000 x $0.10) Cash

$200,000

Cash (P 3,000,000 x $0.08333) Land Gain on Sale of Land

$250,000

$200,000 $200,000 $ 50,000

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-14 (continued) c.

Amount of transaction gain ($83,333), and other comprehensive income effect in 20X2 ($15,151): To compute the change in the translation adjustment for 20X2, which is an element of other comprehensive income for 20X2, it is necessary to prepare the translated trial balance as of the end of 20X1, as follows: Translated December 31, 20X1, balance sheet:

Land Total Accumulated other comprehensive income — translation adjustment (debit) Total debits Common stock Total credits

Subsidiary’s Trial Balance (in pesos) P 2,000,000 P 2,000,000

Direct Exchange Rate $0.090909

Translated Trial Balance (in $) $181,818 $181,818 18,182 $200,000

P 2,000,000 P 2,000,000

$0.10

$200,000 $200,000

Note that the translation adjustment account has a debit balance of $18,182 as of the end of 20X1. The next step is to translate the subsidiary’s 12/31/X2 trial balance. Translated December 31, 20X2, balance sheet:

Cash Total Accumulated other comprehensive income– translation adjustment (debit) Total debits Common stock Gain on sale of land Total credits

Subsidiary’s Trial Balance (in pesos) P 3,000,000 P 3,000,000

Direct Exchange Rate $0.083333

Translated Trial Balance (in $) $250,000 $250,000 33,333 $283,333

P 2,000,000 P 1,000,000 P 3,000,000

$0.10 $0.083333

$200,000 83,333 $283,333

The change in the translation adjustment during 20X2 is $15,151 ($15,151 = $33,333 - $18,182), which is reported on 20X2's statement of comprehensive income. The stockholders’ equity section of the 12/31/X2 consolidated balance sheet would report the accumulated other comprehensive income which includes the accumulated translation adjustment, as of 12/31/X2, in the amount of $33,333

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

E12-15* Intercompany Transactions Measured in U.S. Dollars

Measured in British Pounds

Initial inventory transfer date ($1.60 = £1): Selling price (£7,500 = $12,000 / $1.60) Cost to parent Intercompany profit

$12,000 (8,000) $ 4,000

£7,500

Balance sheet date ($1.70 = £1): Inventory translation ($12,750 = £7,500 x $1.70)

$12,750

£7,500

$12,750

Inventory of South, Ltd., reported in U.S. dollar trial balance of consolidation worksheet. ($12,750 = £7,500 x $1.70)

$ 8,750

($8,750 = $12,750 - $4,000 intercompany profit)

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

SOLUTIONS TO PROBLEMS P12-16 Parent Company Journal Entries and Translation a. P 1/1/X1 100% SB

Investment cost Book value of investment on January 1, 20X1 Differential Canadian Dollars

Income Statement: Differential at date of acquisition: Plant and equipment Trademark Amortization this period: Plant and equipment (10 years) Trademark (10 years) Remaining balance: Plant and equipment Trademark Balance Sheet: Remaining balance on 12/31/X1 translated at year-end exchange rates: Plant and equipment Trademark

Canadian Dollars

Exchange Rate

U.S. Dollars

C$150,000

0.80

$120,000

90,000 C$ 60,000

0.80

72,000 $ 48,000

Exchange Rate

C$10,000

U.S. Dollars

0.80 0.80

$8,000

C$50,000

0.75 0.75

(750)

(5,000)

(1,000) C$ 9,000

$40,000

(3,750) $7,250

C$45,000

C$ 9,000 C$45,000

Difference to OCI— translation adjustment: Plant and equipment Trademark

$36,250

0.70 0.70

$6,300 $31,500

$ 950 $ 4,750

Note that the differential adjustment is from the amounts of $7,250 for plant and equipment and from $36,250 for trademark. The required amounts for the consolidated balance sheet are $6,300 for plant and equipment, and $31,500 for trademark. Therefore, in each of these cases, the differential adjustment will reduce the amount of the differential component in the investment account, requiring a credit to the Investment in South Bay Company account with a corresponding debit to the Other Comprehensive Income—Translation Adjustment account. The differential adjustment adjusts to the correct amount necessary to prepare the consolidated balance sheet.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-16 (continued) b.

Entries on Par Company's books during 20X1: (1) Investment in South Bay Company Cash Acquire South Bay Company.

120,000

(2) Investment in South Bay Company Income from Subsidiary Equity in income of subsidiary: $15,000 = C$20,000 x 0.75 average exchange rate

15,000

(3) Foreign Currency Units (C$) Investment in South Bay Company Dividend from foreign subsidiary: $6,000 = C$8,000 x 0.75

6,000

(4) Income from Subsidiary Investment in South Bay Company Amortization of differential: Plant and equipment $ 750 Trademark 3,750 Total $4,500

4,500

(5) Other Comprehensive Income – Translation Adjustment Investment in South Bay Company Recognize translation adjustment on differential: Plant and equipment $ 950 Trademark 4,750 Total $5,700

5,700

120,000

15,000

6,000

4,500

5,700

Note: The amount of the differential is being decreased as a result of the translation adjustment. Therefore, the investment account must be credited to reflect this decrease in the portion allocated to the differential.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-16 (continued) c.

Par Company and South Bay Company Proof of Translation Adjustment Year Ended December 31, 20X1

Net assets at beginning of year, 1/1/X1

Canadian Dollars

Exchange Rate

U.S. Dollars

C$ 90,000

0.80

$72,000

20,000 (8,000)

0.75 0.75

15,000 (6,000)

Adjustment for changes in assets position during year: Net income for year Dividends paid Net assets translated at rates in effect for those items Net assets at end of year

$81,000 C$102,000

0.70

71,400

Change in other comprehensive income — translation adjustment during year — net decrease (debit)

$ 9,600

December 31, 20X1 Other Comprehensive Income — Translation Adjustment 9,600 Investment in South Bay Company 9,600 Parent's share (100%) of translation adjustment from translation of subsidiary's accounts. d.

Equivalent U.S. dollar value of C$8,000 on December 31, 20X1: C$8,000 x $.70 Equivalent U.S. dollar value of C$8,000 at date of receipt: C$8,000 x $.75 Foreign Currency Transaction Loss

$5,600 6,000 $ 400

December 31, 20X1 Foreign Currency Transaction Loss Foreign Currency Units (C$) Recognize exchange loss on foreign currency units held.

400 400

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-17

Translation, Journal Entries, Consolidated Comprehensive Income, and Stockholders' Equity

Pirate Inc. Trial Balance Translation December 31, 20X5 Balance Kroner NKr 150,000 200,000 270,000 600,000 410,000 100,000 50,000 40,000 NKr 1,820,000

Item Cash Accounts Receivable (net) Inventory Property, Plant, and Equipment Cost of Goods Sold Operating Expenses Depreciation Expense Dividends Paid Total Debits Accumulated Depreciation Accounts Payable Notes Payable Common Stock Retained Earnings Sales Total Accumulated Other Comprehensive Income — Translation Adjustment (credit) Total Credits

NKr

150,000 90,000 190,000 450,000 250,000 690,000 NKr 1,820,000

Exchange Rate 0.21 0.21 0.21 0.21 0.20 0.20 0.20 0.19

Balance Dollars $ 31,500 42,000 56,700 126,000 82,000 20,000 10,000 7,600 $375,800

0.21 0.21 0.21 0.18 0.18 0.20

$ 31,500 18,900 39,900 81,000 45,000 138,000 $354,300 21,500 $375,800

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-17 (continued) b.

Entries for 20X5: January 1 Investment in Ship Company Common Cash Purchase of Ship Inc.

151,200 151,200

July 1 Cash Investment in Ship Company Dividend received from foreign subsidiary: $7,600 = NKr40,000 x $.19 December 31 Investment in Ship Company Common Income from Subsidiary Equity in net income of foreign subsidiary: $26,000 = Income of NKr130,000 x $.20

7,600 7,600

26,000 26,000

Investment in Ship Company Common 21,500 Other Comprehensive Income — Translation Adjustment 21,500 Parent's share of translation adjustment from translation of subsidiary's accounts: $21,500 x 1.00 Income from Subsidiary Investment in Ship Company Amortization of differential: Property, plant, and equipment Patent Total — see supporting schedule 2

3,600 3,600 $2,000 1,600 $3,600

Investment in Ship Company Common 4,020 Other Comprehensive Income — Translation Adjustment Translation adjustment applicable to the differential: Property, plant, and equipment $2,900 Patent 1,120 Total — see supporting schedule 2 $4,020

4,020

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-17 (continued) Schedule 1: Determining the differential for 20X5: Investment cost at January 1, 20X5 Less: Book value of net assets acquired on January 1, 20X5 (NKr700,000 x $.18) Differential Differential allocated to: Property, plant, and equipment Patent Total

$ 151,200 (126,000) $ 25,200 $ 18,000 7,200 $ 25,200

Schedule 2: Determining the differential amortization for 20X5:

Property, plant, and equipment: Income statement: Difference at beginning of year Amortization for 20X5 (NKr100,000 / 10 years) Remaining balances Balance sheet: Remaining balance on December 31, 20X5, translated at year-end exchange rate Difference to other comprehensive income — translation adjustment Patent: Income statement: Difference at beginning of year Amortization for 20X5 (NKr40,000 / 5 years) Remaining balances Balance sheet: Remaining balance on December 31, 20X5, translated at year-end exchange rate Difference to other comprehensive income — translation adjustment

Norwegian Kroner

Translation Rate

U.S. Dollars

NKr 100,000

0.18

$18,000

(10,000) NKr 90,000

0.20

(2,000) $16,000

NKr 90,000

0.21

18,900 $ 2,900

NKr 40,000

0.18

$ 7,200

(8,000) NKr 32,000

0.20

(1,600) $ 5,600

NKr 32,000

0.21

6,720 $ 1,120

Note that the property, plant, and equipment portion of the differential must be increased from $16,000 to $18,900, requiring a debit of $2,900 to the investment account. The portion of the differential attributable to patent must be increased from $5,600 to $6,720, requiring a debit of $1,120 to the investment account. The corresponding credit is to the Other Comprehensive Income – Translation Adjustment account ($4,020 = $2,900 + $1,120).

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-17 (continued) c.

Pirate’s consolidated comprehensive income for 20X5: 1. 2. 3. 4.

Income from Pirate’s operations for 20X5, exclusive of income from the Norwegian subsidiary Add: Income from the Norwegian subsidiary for 20X5 Deduct: Amortization of differential for 20X5 Pirate’s Net Income Add: Translation Adjustment ($21,500 + $4,020) Pirate’s Consolidated Comprehensive Income

$ 275,000 26,000 (3,600) $ 297,400 25,520 $ 322,920

Pirate’s consolidated stockholders’ equity at December 31, 20X5: Pirate’s stockholders’ equity at Jan. 1, 20X5 Add: Net income for 20X5 Deduct: Dividends declared by Pirate during 20X5 Add: Accumulated other comprehensive income: Foreign currency translation adjustment Consolidated Stockholders’ Equity at Dec. 31, 20X5 1. 2. 3. 4.

$3,500,000 297,400 (100,000) 25,520 $3,722,920

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-18 a.

Remeasurement, Journal Entries, Consolidated Net Income, and Stockholders' Equity

Schedule remeasuring the trial balance into U.S. dollars: Item Cash Accounts Receivable (net) Inventory Property, Plant, and Equipment Cost of Goods Sold Operating Expenses Depreciation Expense Dividends Paid Total Remeasurement Loss Total Debits Accumulated Depreciation Accounts Payable Notes Payable Common Stock Retained Earnings Sales Total Credits

Balance Kroner NKr 150,000 200,000 270,000 600,000 410,000 100,000 50,000 40,000 NKr 1,820,000

NKr

150,000 90,000 190,000 450,000 250,000 690,000 NKr 1,820,000

Exchange Rate 0.21 0.21 0.205 0.18* (a) 0.20 0.18* 0.19

Balance Dollars $ 31,500 42,000 55,350 108,000 75,450 20,000 9,000 7,600 $348,900 900 $349,800

0.18* 0.21 0.21 0.18* 0.18* 0.20

$ 27,000 18,900 39,900 81,000 45,000 138,000 $349,800

* 0.18 = exchange rate at January 1, 20X5, the date the subsidiary was acquired by Pirate Company (a) Cost of goods sold: Beginning inventory (CGS of NKr410,000 + ending inventory of NKr270,000 minus purchases of NKr420,000 = Beg. Inv.) Purchases Cost of goods available Less ending inventory Cost of goods sold

Norwegian Kroner

Exchange Rate

U.S. Dollar

NKr 260,000 420,000 NKr 680,000 (270,000) NKr 410,000

0.18 0.20

$ 46,800 84,000 $130,800 (55,350) $ 75,450

0.205

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-18 (continued) b.

Journal entries for 20X5: January 1 Investment in Ship Company Common Cash Purchase of Ship, Inc.

151,200 151,200

July 1 Cash Investment in Ship Company Common Dividend received from foreign subsidiary: $7,600 = NKr40,000 x $.19 December 31 Investment in Ship Company Common Income from Subsidiary Equity in net income of foreign subsidiary: Income from the Norwegian sub: Sales $138,000 Less: Cost of goods sold (75,450) Operating expenses (20,000) Depreciation expense (9,000) Income $ 33,550 Less: Remeasurement loss (900) Income recorded by Pirate $ 32,650 Income from Subsidiary Investment in Ship Company Common Amortization of the differential (See Schedule 1 below).

7,600 7,600

32,650 32,650

3,240 3,240

Schedule 1: Determining and amortizing the differential for 20X5: Investment cost at January 1, 20X5 Book value of net assets acquired on January 1, 20X5 (NKr700,000 x $.18) Differential Differential allocated to: Property, plant, and equipment Patent Total Amortization for 20X5: Property, plant, and equipment ($18,000 / 10 years) Patent ($7,200 / 5 years) Total

$151,200 (126,000) $ 25,200 $ 18,000 7,200 $ 25,200

$ $

1,800 1,440 3,240

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-18 (continued) c.

Consolidated net income for 20X5: 1.

Income from Pirate's operations for 20X5, exclusive of income from the Norwegian subsidiary 2. Add: Income from the Norwegian subsidiary 3. Deduct: Amortization of differential for 20X5 Consolidated net income for 20X5 d.

$275,000 32,650 (3,240) $304,410

Consolidated stockholders' equity at December 31, 20X5: 1. Pirate's stockholders' equity at January 1, 20X5 2. Add: Consolidated net income for 20X5 3. Deduct: Dividends declared by Pirate during 20X5 Consolidated stockholders' equity at December 31, 20X5

$3,500,000 304,410 (100,000) $3,704,410

P12-19 Proof of Translation Adjustment

Net assets at beginning of year Adjustments for changes in net assets position during 20X5: Net income Dividends paid Net assets translated at: Rates during year Rates at end of year

Norwegian Kroner

Exchange Rate

U.S. Dollars

NKr 700,000

0.18

$126,000

130,000 (40,000)

0.20 0.19

26,000 (7,600)

NKr 790,000

0.21

$144,400 165,900

Change in other comprehensive income — translation adjustment during year Accumulated other comprehensive income — translation adjustment — January 1 Accumulated other comprehensive income — translation adjustment — December 31 (credit)

$ 21,500 -0$ 21,500

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-20 Remeasurement Gain or Loss Proof of remeasurement loss for 20X5:

Exposed net monetary liability position at January 1

Norwegian Kroner

Exchange Rate

U.S. Dollars

NKr (60,000)

0.18

$(10,800)

NKr 690,000

0.20

138,000

(420,000) (100,000) (40,000)

0.20 0.20 0.19

(84,000) (20,000) (7,600)

Adjustments for changes in net monetary position during 20X5: Increases: From operations: Sales Decreases: From operations: Purchases Operating expenses From dividends Net monetary asset position prior to remeasurement at year-end rates

$ 15,600

Exposed net monetary asset position at December 31 Remeasurement loss

NKr 70,000

0.21

(14,700) $ 900

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-21 Translation and Calculation of Translation Adjustment a. Silva Company Trial Balance Translation December 31, 20X4

Reals Cash Accounts Receivable (net) Inventory Prepaid Insurance Plant and Equipment Intangible Assets Cost of Goods Sold Insurance Expense Depreciation Expense Amortization Expense Operating Expense Dividends Paid Total

BRL

57,700 82,000 95,000 2,400 350,000 30,000 230,000 3,200 32,500 12,000 152,300 25,000 BRL 1,072,100

Exchange Rate

U.S. Dollars

0.20 0.20 0.20 0.20 0.20 0.20 0.25 0.25 0.25 0.25 0.25 Sch. A

$ 11,540 16,400 19,000 480 70,000 6,000 57,500 800 8,125 3,000 38,075 6,250 $237,170

Accumulated Other Comprehensive Income — Translation Adjustment (debit) Total Debits Accumulated Depreciation Accounts Payable Income Tax Payable Interest Payable Notes Payable Bonds Payable Common Stock Additional Paid-In Capital Retained Earnings Sales Total Credits Schedule A Dividends April 7 Dividends October 9

30,250 $ 267,420 BRL

100,000 24,000 27,000 1,100 20,000 120,000 80,000 150,000 50,000 500,000 BRL 1,072,100

0.20 0.20 0.20 0.20 0.20 0.20 0.30 0.30 0.30 0.25

$ 20,000 4,800 5,400 220 4,000 24,000 24,000 45,000 15,000 125,000 $267,420

BRL

0.28 0.23

BRL

10,000 15,000 25,000

2,800 3,450 6,250

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-21 (continued) b.

Schedule to compute the accumulated other comprehensive income – translation adjustment as of December 31, 20X4.

Net assets at beginning of year Adjustment for changes: Net income for year Dividends paid: April 7 October 9 Net assets translated at: Rates during year Rates at end of year Accumulated other comprehensive Income — translation adjustment (debit)

Reals

Exchange Rate

U.S. Dollars

BRL 280,000

0.30

$84,000

70,000 (10,000) (15,000)

0.25 0.28 0.23

17,500 (2,800) (3,450)

BRL 325,000

0.20

$95,250 65,000 $30,250

Another way of interpreting the direction (debit or credit) of the translation adjustment is to consider the translated balance sheets, as follows: Translated balance sheet, 1/1/X4 Net assets

$84,000

Stockholders’ equity

$84,000

The translated balance sheet at the end of the year would be: Translated balance sheet, 12/31/X4 Net assets

Total

$65,000

Stockholders’ equity (from 1/1/X4)

$84,000

20X4 Income

$17,500

Less dividends

(6,250)

Accumulated other comprehensive income — translation adjustment Total

11,250

(30,250) $65,000

The debit balance of $30,250 in the accumulated other comprehensive income – translation adjustment, is necessary to “balance” the translated balance sheet.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-22 Remeasurement and Proof of Remeasurement Gain or Loss a. Silva Company Trial Balance Remeasurement December 31, 20X4

Reals

Exchange Rate

U.S. Dollars

Cash Accounts Receivable (net) Inventory Prepaid Insurance Plant and Equipment Intangible Assets Cost of Goods Sold Insurance Expense Depreciation Expense Amortization Expense Operating Expense Dividends Paid Total Debits

BRL

57,700 82,000 95,000 2,400 350,000 30,000 230,000 3,200 32,500 12,000 152,300 25,000 BRL 1,072,100

0.20 0.20 0.25 0.30 Sch. A 0.30 Sch. B 0.30 Sch. C 0.30 0.25 Sch. D

$ 11,540 16,400 23,750 720 103,000 9,000 62,250 960 9,600 3,600 38,075 6,250 $285,145

Accumulated Depreciation Accounts Payable Income Tax Payable Interest Payable Notes Payable Bonds Payable Common Stock Additional Paid-In Capital Retained Earnings Sales Total

BRL

Sch. E 0.20 0.20 0.20 0.20 0.20 0.30 0.30 0.30 0.25

$ 29,850 4,800 5,400 220 4,000 24,000 24,000 45,000 15,000 125,000 $277,270

100,000 24,000 27,000 1,100 20,000 120,000 80,000 150,000 50,000 500,000 BRL 1,072,100

Remeasurement Gain Total Credits

7,875 $285,145

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-22 (continued) Exchange Rate

U.S. Dollars

BRL 250,000 100,000 BRL 350,000

0.30 0.28

$ 75,000 28,000 $103,000

BRL 95,000 230,000 BRL 325,000 (95,000) BRL 230,000

0.30 0.25

$ 28,500 57,500 $ 86,000 (23,750) $ 62,250

Reals Schedule A Plant and Equipment Before January 1, 20X4 April 7, 20X4

Schedule B Cost of Goods Sold Beginning Inventory* Purchases Goods Available Less Ending Inventory

0.25

*Acquired before January 1, 20X4; use the exchange rate at date parent acquired subsidiary. Schedule C Depreciation Expense Before January 1, 20X4 April 7, 20X4 Schedule D Dividends April 7, 20X4 Oct. 9, 20X4 Schedule E Accumulated Depreciation Before January 1, 20X4: January 1, 20X1 July 10, 20X2 April 7, 20X4

BRL 25,000 7,500 BRL 32,500

0.30 0.28

BRL 10,000 15,000 BRL 25,000

0.28 0.23

BRL 80,000 12,500 7,500 BRL 100,000

0.30 0.30 0.28

$ $

7,500 2,100 9,600

2,800 3,450 6,250

$ 24,000 3,750 2,100 $ 29,850

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-22 (continued) b. Proof of Remeasurement Gain Schedule 1: Statement of Net Monetary Position: End of Year Monetary Assets: Cash Accounts Receivable (net) Total Monetary Liabilities: Accounts Payable Income Taxes Payable Interest Payable Notes Payable Bonds Payable Total Net Monetary Liabilities

Beginning of Year

BRL

57,700 82,000 BRL 139,700

BRL

62,000 83,900 BRL 145,900

BRL

24,000 27,000 1,100 20,000 120,000 BRL (192,100)

BRL

BRL (52,400)

BRL (45,100)

20,000 30,000 1,000 20,000 120,000 BRL (191,000)

Increase in net monetary liabilities during 20X4

BRL

(7,300)

Schedule 2: Analysis of Changes in Monetary Accounts: Reals Exposed net monetary liability position-January 1, 20X4

Exchange Rate

U.S. Dollars

BRL (45,100)

0.30

$(13,530)

Increases From operations: Sales

500,000

0.25

125,000

Decreases From operations: Purchases Operating expenses From dividends

(230,000) (152,300) (25,000)

0.25 0.25 10,000 x 0.28 15,000 x 0.23

(57,500) (38,075) (6,250)

From purchases of plant and equipment

(100,000)

0.28

(28,000)

Net monetary position prior to remeasurement at yearend rates Exposed net monetary liability Position-December 31, 20X4 Remeasurement gain

$(18,355) BRL (52,400)

0.20

(10,480) $ 7,875

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-23 Translation a.

Salina Ranching Company Trial Balance Translation December 31, 20X3 Australian Dollars

U.S. Dollars

0.60 0.60 0.60 0.60 0.65 0.65 0.65 0.65 0.67

$ 26,460 43,200 51,600 144,000 214,500 15,600 85,475 3,705 6,030 $590,570

Cash Accounts Receivable (net) Inventory Plant and Equipment Cost of Goods Sold Depreciation Expense Operating Expense Interest Expense Dividends Declared Total Accumulated Other Comprehensive Income — Translation Adjustment(debit) Total Debits

A$942,300

Accumulated Depreciation Accounts Payable Payable to Palermo, Inc. Interest Payable 12% Bonds Payable Premium on Bonds Common Stock Retained Earnings Sales Total Credits

A$ 60,000 53,800 10,800 3,000 100,000 5,700 90,000 40,000 579,000 A$942,300

0.60 0.60 0.60 0.60 0.60 0.60 0.70 0.70 0.65

$ 36,000 32,280 6,480 1,800 60,000 3,420 63,000 28,000 376,350 $607,330

Australian Dollars

Exchange Rate

U.S. Dollars

A$130,000

0.70

$ 91,000

87,800 (9,000)

0.65 0.67

57,070 (6,030)

A$208,800

0.60

$142,040 (125,280)

A$ 44,100 72,000 86,000 240,000 330,000 24,000 131,500 5,700 9,000

Exchange Rate

16,760 $607,330

Schedule to prove translation adjustment:

Net assets at beginning of year Adjustments for changes: Net income for year Dividends paid Net assets translated: Rates during year Rates at end of year Change in other comprehensive Income — translation adjustment (debit) Accumulated other comprehensive Income — translation adjustment, 1/1 Accumulated other comprehensive Income — translation adjustment, 12/31

$ 16,760 -0$ 16,760

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-24

Parent Company Journal Entries and Translation Total Purchase Price

Australian Dollar A$ 200,000

Rate 0.70

US Dollar $ 140,000

A$ 250,000

0.70

$ 175,000

A$ A$ A$ A$

0.70 0.70 0.70

$ $ $ $

Total Fair Value Less: Common Stock Retained Earnings Building & Equipment Differential Patent Value

90,000 40,000 40,000 80,000

Australian Dollars

Exchange Rate

Balance Jan. 1, 20X3 Differential: Buildings and Equipment Patent

A$40,000 80,000

0.70 0.70

$28,000

Amortization: Buildings and Equipment (10 years) Patent (10 years) Remaining Balance

(4,000) (8,000) A$108,000

0.65 0.65

(2,600)

Adjusted balance Dec. 31, 20X3 Buildings and Equipment Patent

A$36,000 A$72,000

0.60 0.60

63,000 28,000 28,000 56,000

U.S. Dollars

$56,000

$25,400

(5,200) $50,800

(21,600) (43,200)

Differential Translation Adjustment: Patent Buildings and Equipment

$ 7,600 3,800

Total Differential Translation Adjustment

$ 11,400

Note: The differential translation adjustment is necessary to decrease the buildings and equipment component of the parent company’s differential from $20,320 to $17,280, and to decrease the patent component from $40,640 to $34,560. Thus, a credit will be made to the parent company’s investment account for the total of $9,120 ($3,040 + $6,080) with a corresponding debit to the parent company’s Other Comprehensive Income – Translation Adjustment account.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-24 (continued) Parent company journal entries 20X3: (1)

(2)

(3)

(4)

(5)

(6)

Investment in Salina Ranching Cash Acquire foreign investment.

140,000

Cash Investment in Salina Ranching Receive dividend: A$9,000 x 0.80 x $.67

4,824

140,000

Investment in Salina Ranching 45,656 Income from Salina Ranching Equity accrual for percentage of subsidiary's income: A$ U.S.$ Sales A$579,000 $376,350 Cost of goods sold (330,000) (214,500) Depreciation expense (24,000) (15,600) Operating expense (131,500) (85,475) Interest expense (5,700) (3,705) Income A$ 87,800 $ 57,070 Average exchange rate x 0.65 U.S. dollar equivalent $ 57,070 $ 57,070 Parent's percent x 0.80 x 0.80 Equity accrual $ 45,656 $ 45,656 Income from Salina Ranching 6,240 Investment in Salina Ranching Amortization of differential: Buildings and equipment = $2,600 Patent = 5,200 $7,800 x 0.80 = 6,240 Other Comprehensive Income — Translation Adjustment 9,120 Investment in Salina Ranching Translation adjustment related to decrease in differential: Buildings and equipment = $ 3,800 Patent = 7,600 $11,400 x 0.80 = 9,120

4,824

45,656

6,240

9,120

Other Comprehensive Income — Translation Adjustment 13,408 Investment in Salina Ranching 13,408 Parent company's share of translation adjustment from subsidiary: $13,408 = $16,760 x 0.80

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-24 (continued) Entries posted to T-accounts (not required): Investment in

Acquisition Price

Salina Ranching 140,000

80% Net Income

45,656 4,824 6,240 9,120 13,408

Ending Balance

Income from Salina Ranching

80% Dividends 80% Amort. of Diff. Diff. Translation 80% of WR Trans. Adj.

152,064

45,656

80% Net Income

39,416

Ending Balance

6,240

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-25 Consolidation Worksheet after Translation Book Value Calculations:

Beginning Book Value + Net Income - Dividends Ending Book Value

NCI 20% 18,200 11,414 (1,206) 28,408

Basic Elimination Entry Common Stock Retained Earnings Income from Salina Ranching NCI in NI of Salina Ranching Dividends Declared Investment in Salina Ranching NCI in NA of Salina Ranching

Palermo 80% 72,800 45,656 (4,824) 113,632

Common Stock 63,000

Retained Earnings 28,000 57,070 (6,030) 79,040

63,000

63,000 28,000 45,656 11,414 6,030 113,632 28,408

Book Value Other Comprehensive Income Entry: Investment in Salina Ranching 13,408 NCI in NA of Salina Ranching 3,352 OCI from Salina Ranching OCI to NCI in Salina Ranching

13,408 3,352

Excess Value (Differential) Calculations:

Beginning balance -Amortization of differential -Differential translation adj. Ending balance

NCI 20% 16,800 (1,560) (2,280) 12,960

Palermo 80% 67,200 (6,240) (9,120) 51,840

Amortized Excess Value Reclassification Entry: Amortization Expense Depreciation expense Income from Salina Ranching NCI in NI of Salina Ranching

Plant and Equipment 28,000 (4,000) 24,000

Patent 56,000 (5,200) (7,600) 43,200

Acc. Depr. 0 (2,600) 200 (2,400)

5,200 2,600 6,240 1,560

Excess Value (differential) Reclassification Entry: Plant and Equipment 24,000 Patent 43,200 Accumulated Depreciation Investment in Salina Ranching NCI in NA of Salina Ranching

2,400 51,840 12,960

Eliminate Intercompany Accounts: Payable to Palermo Receivable from Salina Ranching

6,480

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-25 (continued) Salina Ranching

Palermo Income Statement Sales Less: COGS Less: Depreciation Expense Less Amortization Expense Less: Operating Expense Less: Interest Expense Income from Salina Ranching Consolidated Net Income NCI in Net Income Controlling Interest in Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Accounts Receivable Receivable from Salina Ranching Inventory Plant & Equipment Less: Accumulated Depreciation Patent Investment in Salina Ranching

Consolidated

1,000,000 (600,000) (28,000)

376,350 (214,500) (15,600)

(204,000) (2,000) 39,416 205,416

(85,475) (3,705) 57,070

45,656 53,456 11,414

6,240 6,240 1,560

1,376,350 (814,500) (46,200) (5,200) (289,475) (5,705) 0 215,270 (9,854)

205,416

57,070

64,870

7,800

205,416

179,656 205,416 (50,000) 335,072

28,000 57,070 (6,030) 79,040

28,000 64,870

7,800 6,030 13,830

179,656 205,416 (50,000) 335,072

38,000 140,000 6,480 128,000 500,000 (90,000)

26,460 43,200

2,600 5,200

92,870

6,480 51,600 144,000 (36,000)

24,000 2,400 43,200 13,408

152,064

Total Assets

874,544

229,260

Accounts Payable Payable to Palermo Interest Payable Bonds Payable Premium on Bonds Payable Common Stock Retained Earnings Accumulated OCI NCI in NA of Salina Ranching

60,000

500,000 335,072 (22,528)

32,280 6,480 1,800 60,000 3,420 63,000 79,040 (16,760)

874,544

229,260

Total Liabilities & Equity

Consolidation Entries DR CR

2,000

Other Comprehensive Income Accumulated Other Comprehensive Income, 1/1/20X3 Other Comp. Income--Translation Adjustment (22,528) Other Comprehensive Income to NCI Accumulated Other Comprehensive Income, 12/31/20X3 (22,528)

80,608

113,632 51,840 174,352

6,480

63,000 92,870 0 3,352 165,702

13,830 16,760 28,408 12,960 71,958

64,460 183,200 0 179,600 668,000 (128,400) 43,200 0 1,010,060 92,280 0 3,800 60,000 3,420 500,000 335,072 (22,528) 38,016 1,010,060

0 (16,760)

(16,760)

13,408

(25,880)

3,352

16,760

(22,528)

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-26 Remeasurement a.

Salina Ranching Company Trial Balance Remeasurement December 31, 20X3 Australian Dollars

Exchange Rate

U.S. Dollars

Cash Accounts Receivable (net) Inventory Plant and Equipment

A$ 44,100 72,000 86,000 240,000

$ 26,460 43,200 55,900

Cost of Goods Sold Depreciation Expense Operating Expense Interest Expense Dividends Declared Total Debits

330,000 24,000 131,500 5,700 9,000 A$942,300

0.60 0.60 0.65 180,000 x 0.70 60,000 x 0.70 (a) 0.70 0.65 0.65 0.67

Accumulated Depreciation Accounts Payable Payable to Palermo, Inc. Interest Payable 12% Bonds Payable Premium on Bonds Common Stock Retained Earnings Sales Total Remeasurement Gain Total Credits

A$ 60,000 53,800 10,800 3,000 100,000 5,700 90,000 40,000 579,000

0.70 0.60 0.60 0.60 0.60 0.60 0.70 0.70 0.65

A$942,300

$ 42,000 32,280 6,480 1,800 60,000 3,420 63,000 28,000 376,350 $613,330 10,040 $623,370

(a) Cost of Goods Sold: Beginning Inventory Purchases Goods Available Minus Ending Inventory Cost of Goods Sold

Australian Dollars A$ 66,000 350,000 A$416,000 (86,000) A$330,000

Exchange Rate 0.70 0.65

U.S. Dollars $ 46,200 227,500 $273,700 (55,900) $217,800

0.65

168,000 217,800 16,800 85,475 3,705 6,030 $623,370

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-26 (continued) b. Proof of Remeasurement Gain: Schedule 1: Statement of Net Monetary Position End of Year

Beginning of Year

Monetary Assets: Cash Accounts Receivable (net) Total

A$ 44,100 72,000 A$116,100

Monetary Equities: Accounts Payable Payable to Parent Company Interest Payable 12% Bonds Payable Premium on Bonds Total

A$ 53,800 10,800 3,000 100,000 5,700 A$173,300

Net Monetary Equities Decrease in net monetary equities during year

A$(57,200)

A$(80,000)

A$(22,800)

Schedule 2: Analysis of Changes in Monetary Accounts

Exposed Net Monetary Liability Position — January 1 Increases: From Operations: Sales Decreases: From Operations: Purchases Cash Expense Interest Expense From Dividends From Purchase of Plant and Equipment

Australian Dollars

Exchange Rate

U.S. Dollars

A$ (80,000)

0.70

$ (56,000)

579,000

0.65

376,350

(350,000) (131,500) (5,700) (9,000)

0.65 0.65 0.65 0.67

(227,500) (85,475) (3,705) (6,030)

(60,000)

0.70

(42,000)

Net Monetary Position Prior to Remeasurement at Year-End Rate

$ (44,360)

Exposed Net Monetary Liability Position — December 31

A$ (57,200)

Remeasurement Gain

0.60

(34,320) $ 10,040

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-27 Parent Company Journal Entries and Remeasurement Total Purchase Price

Australian Dollar A$ 200,000

Rate 0.70

US Dollar $ 140,000

A$ 250,000

0.70

$ 175,000

A$ A$ A$ A$

0.70 0.70 0.70

$ $ $ $

Total Fair Value Less: Common Stock Retained Earnings Building & Equipment Differential Patent Value

90,000 40,000 40,000 80,000

63,000 28,000 28,000 56,000

Parent company journal entries – 20X3: (1)

(2)

(3)

(4)

Investment in Salina Ranching Cash Acquire foreign investment.

140,000

Cash Investment in Salina Ranching Receive dividend: $4,824 = A$9,000 x 0.80 x $.67

4,824

Investment in Salina Ranching Income from Salina Ranching Equity accrual for percentage of subsidiary's income: U.S.$ Sales $ 376,350 Cost of goods sold (217,800) Depreciation expense (16,800) Operating expense (85,475) Interest expense (3,705) Remeasurement gain 10,040 Subsidiary's income $ 62,610 Parent's percent x 0.80 Equity accrual $ 50,088

50,088

Income from Salina Ranching Investment in Salina Ranching Amortization of differential: Buildings and Equipment Patent

6,720

140,000

4,824

50,088

6,720 = $2,800 ($28,000 / 10) = 5,600 ($56,000 / 10) $8,400 x 0.80 = 6,720

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-27 (continued) NOT REQUIRED: Entries posted to T-accounts

Acquisition Price

Investment in Salina Ranching 140,000

80% Net Income

50,088 4,824 6,720

Ending Balance

Income from Salina Ranching

80% Dividends Amort. of Diff.

178,544

50,088

80% Net Income

43,368

Ending Balance

6,720

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-28 Consolidation Worksheet after Remeasurement Book Value Calculations:

Beginning book Value + Net Income - Dividends Ending Book Value

NCI 20% 18,200 12,522 (1,206) 29,516

Palermo 80% 72,800 50,088 (4,824) 118,064

Basic Elimination Entry Common Stock Retained Earnings Income from Salina Ranching NCI in NI of Salina Ranching Dividends Declared Investment in Salina Ranching NCI in NA of Salina Ranching

Common Stock 63,000

63,000

Retained Earnings 28,000 62,610 (6,030) 84,580

63,000 28,000 50,088 12,522 6,030 118,064 29,516

Excess Value (Differential) Calculations: NCI Palermo 20% + 80% Beginning balance 16,800 67,200 Changes (1,680) (6,720) Ending balance 15,120 60,480

Plant and = Equipment

Amortized Excess Value Reclassification Entry: Amortization Expense Depreciation Expense Income from Salina Ranching NCI in NI of Salina Ranching

+ Patent

28,000

56,000 (5,600) 50,400

28,000

Acc. Depr. 0 (2,800) (2,800)

5,600 2,800 6,720 1,680

Excess Value (Differential) Reclassification Entry: Plant and Equipment 28,000 Patent 50,400 Accumulated Depreciation Investment in Salina Ranching NCI in NA of Salina Ranching

2,800 60,480 15,120

Eliminate intercompany Accounts: Payable to Palermo Receivable from Salina Ranching

6,480

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-28 (continued) Salina Ranching

Palermo Income Statement Sales Remeasurement Gain Less: COGS Less: Depreciation Expense Less Amortization Expense Less: Operating Expense Less: Interest Expense Income from Salina Ranching Consolidated Net Income NCI in Net Income Controlling Interest in Net Income Statement of Retained Earnings Beginning Balance Net Income Less: Dividends Declared Ending Balance Balance Sheet Cash Accounts Receivable Receivable from Salina Ranching Inventory Plant & Equipment Less: Accumulated Depreciation Patent Investment in Salina Ranching

1,000,000

376,350 10,040 (217,800) (16,800)

(600,000) (28,000) (204,000) (2,000) 43,368 209,368

(85,475) (3,705)

209,368

62,610

179,656 209,368 (50,000) 339,024

28,000 62,610 (6,030) 84,580

38,000 140,000 6,480 128,000 500,000 (90,000)

26,460 43,200

62,610

Consolidation Entries DR CR

28,000 71,010 99,010

8,400 6,030 14,430

179,656 209,368 (50,000) 339,024

6,480 55,900 168,000 (42,000)

28,000 2,800 50,400

178,544

Total Assets

901,024

251,560

Accounts Payable Payable to Palermo Interest Payable Bonds Payable Premium on Bonds Common Stock Retained Earnings NCI in NA of Salina Ranching

60,000

500,000 339,024

32,280 6,480 1,800 60,000 3,420 63,000 84,580

63,000 99,010

901,024

251,560

168,490

Total Liabilities & Equity

6,720 6,720 1,680 8,400

1,376,350 10,040 (817,800) (47,600) (5,600) (289,475) (5,705) 0 220,210 (10,842) 209,368

2,800 5,600

50,088 58,488 12,522 71,010

2,000

78,400

Consolidated

118,064 60,480 187,824

64,460 183,200 0 183,900 696,000 (134,800) 50,400 0 1,043,160 92,280 0 3,800 60,000 3,420 500,000 339,024 44,636

6,480

14,430 29,516 15,120 59,066

1,043,160

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-29 Foreign Currency Remeasurement [AICPA Adapted] Kiner Company's Foreign Subsidiary Remeasurement of Selected Captions into United States Dollars December 31, 20X2, and December 31, 20X1

December 31, 20X1 Accounts Receivable (net) Inventories, at cost Property, Plant, and Equipment (net) Long-Term Debt Common Stock December 31, 20X2 Accounts Receivable (net) Inventories, at cost Property, Plant, and Equipment (net) Long-Term Debt Common Stock

Balance in LCUs

Indirect Exchange Rate

Remeasured into U.S. Dollars

35,000 LCU 75,000

1.7 LCU = $1 2.0 LCU = $1

$20,588 37,500

150,000 120,000 50,000

2.0 LCU = $1 1.7 LCU = $1 2.0 LCU = $1

75,000 70,588 25,000

40,000 80,000

1.5 LCU = $1 1.7 LCU = $1

26,667 47,059

163,000 100,000 50,000

Schedule 1 1.5 LCU = $1 2.0 LCU = $1

86,000 66,667 25,000

Schedule 1: Computation of Remeasurement of Property, Plant and Equipment (Net) into United States Dollars on December 31, 20X2

Land purchased on January 1, 20X1 Plant and equipment purchased on January 1, 20X1: Original cost Depreciation for 20X1 Depreciation for 20X2 Plant and equipment purchased on July 4, 20X2: Original cost Depreciation for 20X2

Balance in LCUs

Indirect Exchange Rate

Remeasured into U.S. Dollars

24,000 LCU

2.0 LCU = $1

$12,000

140,000 LCU (14,000) (14,000) 112,000 LCU

2.0 LCU = $1 2.0 LCU = $1 2.0 LCU = $1 2.0 LCU = $1

$70,000 (7,000) (7,000) $56,000

30,000 LCU (3,000) 27,000 LCU 163,000 LCU

1.5 LCU = $1 1.5 LCU = $1 1.5 LCU = $1

$20,000 (2,000) $18,000 $86,000

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-30 Foreign Currency Translation Kiner Company's Foreign Subsidiary Translation of Selected Captions into United States Dollars December 31, 20X2, and December 31, 20X1

Balance in LCUs

Indirect Exchange Rate

Translated into U.S. Dollars

35,000 LCU 75,000

1.7 LCU = $1 1.7 LCU = $1

$ 20,588 44,118

150,000 120,000 50,000

1.7 LCU = $1 1.7 LCU = $1 2.0 LCU = $1

88,235 70,588 25,000

40,000 80,000

1.5 LCU = $1 1.5 LCU = $1

26,667 53,333

163,000 100,000 50,000

1.5 LCU = $1 1.5 LCU = $1 2.0 LCU = $1

108,667 66,667 25,000

P12-31 Matching Key Terms 1. E 2. I 3. K 4. H 5. A 6. F 7. J 8. B 9. L 10. C

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-32 Translation Choices Requirement 1: a. (7) b. (5) c. (6) d. (7) e. (7) f. (5) g. (1) h. (7) i. (8) j. k.

(7) (5)

LCU 0.83 December 31, 20X4: end of current year LCU 0.85 Average for year 20X4 for revenues LCU 0.84 November 1, 20X4: declaration date LCU 0.83 December 31, 20X4: end of current year LCU 0.83 December 31, 20X4: end of current year LCU 0.85 Average for year 20X4 for expenses LCU 0.74 June 16, 20X1: date foreign company purchased LCU 0.83 December 31, 20X4: end of current year Balance computed at end of December 31, 20X4, includes carry forward from prior periods LCU 0.83 December 31, 20X4: end of current year LCU 0.85 Average for year 20X4 for expenses

Requirement 2: a. Direct exchange rate (DER) for January 1, 20X4: DER = $1 / LCU 0.80 DER = $1.25 b.

U.S. dollar versus LCU in 20X4:

Exchange rates on January 1, 20X4 Exchange rates on December 31, 20X4

Indirect Exchange Rate (LCU / $1) LCU 0.80 LCU 0.83

Direct Exchange Rate ($ / LCU 1) $1.25 $1.2048

During 20X4, the direct exchange rate has decreased reflecting that it costs less U.S. currency for one foreign currency unit at the end of the year as compared with the beginning of the year. Therefore, the U.S. dollar has strengthened during the year 20X4. Alternatively, the indirect exchange rate has increased indicating it costs more in LCU to acquire $1 at December 31, 20X4, than at January 1, 20X4.

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-33 Proof of Translation Adjustment a. Solo Co. Ltd. Proof of Translation Adjustment Year Ended December 31 Translation MXP

Rate

Net assets at beginning of year Adjustment for changes in net assets position during year: Net income for year Dividends

575,000

$0.087

50,025

270,000 (150,000)

$0.090 $0.0915

24,300 (13,725)

Net assets translated at: Rates during year Rates at end of year

695,000

$0.093

60,600 64,635

Change in other comprehensive income-translation adjustment during year (net increase)

4,035

Accumulated other comprehensive income-translation adjustment, 1/1 (credit)

3,250

Accumulated other comprehensive income-translation adjustment, 12/31 (credit)

7,285

Note that the proof begins with the net assets at the beginning of the year. The proof shows the change in the other comprehensive income during the year of $4,035. It is a credit or net increase in AOCI because it must offset an increase (debit) in the net assets from $60,600 to $64,635 during the year. A mnemonic here is to remember that the debits must equal the credits. If you were to prove the total AOCI of $7,285, then the proof should begin with the net assets at the time the subsidiary was acquired and then make the adjustments in net income, dividends, and other changes in net assets over the years since acquisition, at the appropriate exchange rates. Or, the change in this year of $4,025 credit can simply be added to the beginning of the period AOCI credit balance of $3,250. b. The U.S. dollar weakened against the Mexican peso during the year shown by the increase in the direct exchange rate indicating it costs more U.S. currency to acquire one Mexican peso at the end of the year ($0.093) as opposed to the U.S. currency cost of one Mexican peso at the beginning of the year ($.087).

Chapter 12 – Multinational Accounting: Issues in Financial Reporting and Translation of Foreign Entity Statements

P12-33 (continued) Another way of viewing the proof of the ending balance in AOCI is: Translated Balance Sheet, 1/1 Net assets

$50,025

Total

$50,025

Stock and RE AOCI (given)

$46,775 (plug) 3,250 $50,025

Translated Balance Sheet, 12/31 Net assets

$64,635

Total

$64,635

Stock and RE $46,775 (from 1/1) Retained earnings change: ($24,300 – $13,725) 10,575 AOCI (plug) 7,285 $64,635

Chapter 13 – Segment and Interim Reporting

CHAPTER 13 SEGMENT AND INTERIM REPORTING ANSWERS TO QUESTIONS Q13-1 Information on a company's operations in different industries would be helpful to investors in their assessments concerning the different profit rates, different degrees and types of risk, and different opportunities for growth of each of the different industries. In general, this breakdown helps the investors look behind the consolidated totals to the individual components that comprise the company. Q13-2 The relationship between the FASB's segment disclosure requirements and a company's profit centers focuses on the management viewpoint in ASC 280. The FASB requires that the definitions of operating segments used for internal decision-making purposes be used for presenting segment information for financial statement purposes. Q13-3 The three ten percent significance tests used to determine reportable segments under ASC 280 are the 10 percent revenue test, the 10 percent operating profit (loss) test, and the 10 percent assets test. For the 10 percent revenue test, the numerator and denominator are as follows: Each operating segment's total revenue (including intersegment transfers and sales) Combined revenue of all operating segments (including intersegment transfers and sales)

For the 10 percent profit (loss) test, the numerator and denominator are as follows: Absolute value of each operating segment's profit (loss) Absolute value of the combined profit or combined losses of the operating segments (whichever is greater)

For the assets test, the numerator and denominator are as follows: Each operating segment’s assets Combined assets of all industry segments excluding general corporate assets

Q13-4 Whatever items are used for internal decision-making purposes to measure the operating segment’s profit or loss shall be reported in the external disclosure.

Chapter 13 – Segment and Interim Reporting

Q13-5 Any segments passing one of the 10 percent tests would also be disclosed. The lower limit for the number of segments to be disclosed is set by the 75 percent revenue test. If the assumption is made that the largest four segments fail the 75 percent test and the largest five segments pass the 75 percent test, then the five segments should be separately reported. The remaining segments, if they fail the 10 percent tests, are combined under the heading of "Other Segments" and not defined further. Q13-6 First, ASC 280 specifies that all companies should disclose revenues and longlived, productive assets domestically and, in total, for all foreign activities. The two materiality tests applied to country-based foreign operations are the 10 percent revenue test and the 10 percent long-lived asset test. Q13-7 A company must disclose for each of its significant customers (those with 10% or more of the entity’s revenue) the amount of sales to these customers and the associated industry segment. The names of the individual customers need not be disclosed, although some companies do disclose the names of the customers. Q13-8 Interim reports can be used by investors to identify a company's seasonal trends by identifying the pattern of revenue and expenses as they occur each interim period. Q13-9 Revenue from products sold or services rendered should be recognized as earned during an interim period on the same basis as followed for the full year. Revenue from seasonal businesses cannot be manipulated to eliminate seasonal trends. Q13-10 Those costs and expenses that are associated directly with or allocated to the products sold or to the services rendered for annual reporting purposes should be treated similarly for interim reporting purposes. The following practical modifications are allowed to the general rule: a. Estimated gross profit rates may be used to determine an interim period's cost of goods sold. b. Temporary reductions of inventories expected to be replaced by the end of the fiscal year should not be expensed through cost of goods sold at historical cost if the company uses the LIFO inventory valuation method. The expected replacement cost of the liquidated portion of the LIFO base should be used for the interim period's cost of goods sold. c. Inventory losses due to a decline in market prices are recognized in the period of decline using the lower-of-cost-or-market valuation method. Recoveries of market prices in later interim periods of the same fiscal year should be recognized as gains (recoveries of prior losses) in the later interim period. d. Companies using a standard cost system for inventories should use the same procedures for computing and reporting variances in an interim period as used for the fiscal year. Purchase price variances or volume or capacity variances that are expected to be absorbed by the end of the fiscal year should be deferred at the interim period and should not be included in the interim income. Costs and expenses other than product costs should be charged to income in interim periods as incurred or be allocated among interim periods based on an estimate of the time expired, benefit received, or activity associated with the periods.

Chapter 13 – Segment and Interim Reporting

Q13-11 The application of the lower-of-cost-or-market (NRV) valuation method differs between interim statements and annual statements when temporary market declines are expected to reverse by the end of the fiscal year. When a temporary market decline is experienced, the decline need not be recognized at the interim date because no loss is expected for the fiscal year. Q13-12 At the end of the second interim period, the company should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The rate so determined should be used in providing for income taxes on a current year-to-date basis. The effective annual tax rate should reflect anticipated investment tax credits, foreign tax rates, percentage depletion, capital gains rates, and other available tax planning alternatives. In arriving at this effective annual tax rate, no effect should be included for the tax related to significant unusual items that will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year. Q13-13 If the future realizability of the tax benefit is not assured beyond a reasonable doubt, the tax benefit is not shown in the interim statements. Q13-14 Discontinued operations should be disclosed separately, included in the determination of net income for the interim period in which they occur, and shown net of applicable taxes. In determining materiality, discontinued operations should be related to the operating income for the interim period in which the discontinued operations are first reported. Q13-15 A change in accounting principle made in an interim period is reported using the retrospective application process. The balance sheet for the earliest period presented (usually an annual period) is adjusted for the cumulative amount of the change as of the beginning of that year. Then, all subsequent annual and interim financial statements shall be adjusted to the newly adopted accounting principle. In the example of an inventory change, all the financial statements presented must be adjusted to the new method, the average cost method. The balance sheet for the earliest period presented must include the cumulative effect as of the change computed as of the beginning of that first period presented.

Chapter 13 – Segment and Interim Reporting

SOLUTIONS TO CASES C13-1 Segment Disclosures [CMA Adapted] a. The purpose for requiring segment information to be disclosed in financial statements is to assist financial statement users in analyzing and understanding the enterprise's financial statements by permitting better assessment of the enterprise's past performances and future prospects. b. The determination of the segments appropriate for an enterprise is the responsibility of management; that is, management should use its judgment in deciding how to report its segment information. Specific characteristics or sets of characteristics management can use in determining how to group its products into segments include the following: 1. Use of existing profit centers. 2. A segment shall be regarded as significant and identified as a reportable segment if one or more of the following are satisfied: i. 10% or more of the total revenue is derived from one segment. ii. 10% or more of the greater in absolute amount of the aggregate profits or aggregate losses is contributed by the segment. iii. 10% of the combined assets can be associated with the segment. 3. Management has the ability to define the breakdown of the segments, but the segment definitions used for external purposes must be the same as used for internal decision making purposes. c. The options available to Chemax Industries are as follows: 1. Segment by product line — antihistamines. This single product meets the 10 percent test and can be anticipated as a significant product line in the future. 2. Segment by product group — pharmaceutical, medical instruments, and medical supplies. Antihistamines can be carried as a part of the pharmaceutical group. 3. Disaggregate pharmaceutical into ethical and proprietary drugs and carry antihistamines under whichever industry segment is appropriate (probably proprietary drugs, in this case).

Chapter 13 – Segment and Interim Reporting

C13-2 Matching Revenue and Expenses for Interim Periods a. Revenue, product costs, gains, and losses should be recognized for interim periods on the same bases as for an annual period. These items should be recognized in the period earned or incurred and should not be deferred or allocated to other interim periods. b. Cost of goods sold and inventory valuation requires several estimations because physical counts typically are not made for interim periods. Cost of goods sold may be estimated using the gross profit method. Temporary liquidations of LIFO layers are priced using the replacement costs of the goods, not the LIFO cost. Temporary reductions in the market value below cost under the lower-of-cost-or-market rule do not need to be recognized in an interim period. However, reductions in value that may be permanent must be recognized. A loss recovery is allowed for recoveries of market value from one interim to another. c. Period costs are those such as depreciation or other amortizations and allocations. These should be allocated to each interim period based on a reasonable allocation method such as straight-line or percentage of the interim period's revenue to expected annual revenue. d. Accounting treatment for interim statements: 1. Long-term contracts — These contracts are accounted for on the same basis as for the annual period. Percentage-of-completion estimates are made each interim period and gross profit is recognized. If the completed contract method is used, then profit is recognized only for projects completed within the interim period. 2. Advertising costs — These costs may be capitalized and allocated to the interim periods that benefit. However, no advertising costs are deferred beyond the end of the annual fiscal period. The allocation should be on a reasonable basis such as the percentage of interim revenue to expected annual revenue. Advertising costs or other costs that will benefit more than one interim period may be deferred under the integral approach used for interim reporting. 3. Seasonal revenue — Revenue must be recognized in the period earned. The company may not defer revenue from one interim period to another in an attempt to smooth the revenue stream. 4. Flood loss — Significant unusual items must be recognized in the interim period in which the event occurs. 5. Annual major repairs and maintenance — Unusually large and nonrecurring costs may be capitalized to the asset and carried past the end of the fiscal period. However, normal maintenance and repairs may not be carried beyond the end of the fiscal year. Some accountants account for repairs on an interim basis by charging each of the interim periods with a proportionate amount of the annual repair cost and establishing an allowance for repairs contra account to the plant and equipment account. The expenditure is then charged against the allowance account. Other accountants would charge the entire cost off in the interim period in which the expenditure is made.

Chapter 13 – Segment and Interim Reporting

C13-3 Segment Disclosures in the Financial Statements [CMA Adapted] a. A subdivision of an entity is a reportable segment if one of the following tests is met: 1. Revenue, both unaffiliated and intersegment revenue, is ten percent or more of total revenue, which includes intersegment revenue. For each of Bennett's segments, divide the sum of the unaffiliated sales and intersegment sales by total company sales of $63,000. If the result is ten percent or more, the revenue test is met for that specific segment. 2. The absolute value of profit or loss is ten percent or more of the greater of either the total profit of segments that did not incur a loss or the total, in absolute amounts, of the segments that did incur a loss. For each segment, divide the absolute value of the profit or loss by the sum of the segment profits of $6,200. If the result is ten percent or more, the segment profit or loss test is met for that specific segment. 3. Assets are ten percent or more of total assets. For each segment, divide the value of the assets by total assets of $100,000. If the result is ten percent or more, the assets test is met for that specific segment. The calculations for the segments of Bennett Inc. yield results that show that all segments are reportable with the exception of Security Systems, which does not meet any of the tests. See the results of all the tests in the table below. Bennett Inc. Results of Required Tests for Determining Segment Reporting For the Year Ended December 31, 20X5

Revenue Profit Assets Reportable

Power Tools 0.67 0.73 0.50 Yes

Fastening Systems 0.16 0.16 0.23 Yes

Household Products 0.08 0.10 0.17 Yes

Plumbing Products 0.06 0.11 0.06 Yes

Security Systems 0.03 0.02 0.04 No

b. For the reportable segments of Bennett Inc. to represent a substantial portion of total operations, the combined revenue from sales to unaffiliated customers of all reportable segments must be at least 75 percent of the total sales for the company as a whole. Since the sales to unaffiliated customers of Bennett's reportable segments are $44,300 and represent approximately 96 percent of the company's total sales ($44,300 / $46,300), this criterion would be met.

Chapter 13 – Segment and Interim Reporting

C13-4 Determining Industry and Geographic Segments a. This is an actual case adapted from experiences with a large, publicly-held U.S. company. The U.S. company's management was reluctant to disclose information about the Canadian operation's profitability because of the desire to maintain its economic competitiveness, and because of fear that Canadian authorities might want to increase regulation of non-Canadian owned companies operating in Canada. b. Under ASC 280, the U.S. company must present its segmental disclosures based on the definition of operating segments as used for internal decision making. Therefore, if the management of the company felt that the two product lines were sufficiently comparable, management could aggregate the two product lines in the same operating segment for internal decision-making purposes. Then, because the two product lines were in one operating segment for internal decision-making purposes, they would be considered one operating segment for external disclosure purposes under ASC 280. However, ASC 280 also requires separate disclosure of revenues by product line. The company could still be required to disclose revenue information about the pasta product line. One interpretation the company could use to postpone separately disclosing detailed information about its pasta business is to argue that the pasta business passed one of the 10 percent tests in the current year because of some unusual, one-time events that are not expected to continue. Thus, if a segment becomes reportable in a single period because of some significant one-time events, the company may choose not to include it as a separately reportable segment. However, if in the next year, the pasta business continues to meet the separately reportable segment tests, then the company’s management would not be able to use this argument. c. ASC 280 requires separate disclosure of total revenues from external customers attributed to the domestic operations and the total attributed to all foreign operations. In addition, disclosure is required of the total of long-lived assets located in the country of the domestic operations and the total long-lived assets in all foreign countries. If the revenues or the long-lived assets in any individual country are material, then separate disclosure of the material revenues or significant amount of long-lived assets must be made for those specific countries. ASC 280 did not specifically state a measure of materiality to be used in assessing foreign operations. Management does have the flexibility to determine the basis of assigning revenues to specific countries. For example, in this case, management may argue that the revenues should be based on the point-ofsale to the eventual consumer. Thus, sales of the pasta products in the U.S. would be assignable to the U.S. domestic market even though the product may have been manufactured in Canada.

Chapter 13 – Segment and Interim Reporting

C13-5 Segment Reporting a. A great amount of information can be found on a company’s homepage ranging from financial information to product information and company profiles. The internet address for many companies includes their company name. Your students may simply use a web browser to do a search for a specific company. b. EDGAR is a comprehensive database of SEC filings for all publicly held firms. The URL is http://www.sec.gov and EDGAR can be accessed from there. All SEC filings for publicly held firms are available in this database and the filings can be easily printed off for further use, if required. C13-6 Interim Reporting a & b.

Internet URL: http://www.sec.gov

The above Internet address provides access to the SEC’s EDGAR database. From this page, the user is able to select "Search for Filings” on the left-hand side of the page. The user then selects the link to search by “Company or fund name…" This link takes you to EDGAR Company Search page at which you will enter the Company name. After clicking on the “Find Companies” button at the bottom of the screen, students will be taken to a listing of the companies with that name, and can select their specific company which will then take them to the listing of all SEC filings for that company and they can then quickly scroll down to find a Form 10-Q. In comparison to the Form 10-K, several differences in Form 10-Q are noted. The interim financial statements and footnotes are entirely unaudited. As the interim financial statements are unaudited, no report from the independent public accountants is provided in the Form 10-Q.

Chapter 13 – Segment and Interim Reporting

C13-7 Defining Segments for Disclosure MEMO To:

Randy Rivera, CFO, Stanford Corporation

From: Re:

Segment Disclosures

For the current annual reporting period, Stanford Corporation has identified four operating segments that meet the quantitative thresholds to be considered reportable segments under ASC 280. Neither the cereals segment nor the sports beverage segment meets any of the three quantitative thresholds in the current period. ASC 280-10-50-12 However, the ASC 280 quantitative thresholds are intended to insure that information about significant business segments is included in the disclosures, not to limit the information that can be provided. The cereals segment, which was disclosed as a reportable segment last year, can continue to be reported this year if its disclosure provides significant information for the users of the financial statements, even though the segment does not meet the specific criteria for separate disclosure specified in paragraph 22 of ASC 280. In addition, the segment disclosure standard allows companies to designate additional operating segments as reportable segments. Management may decide to provide separate disclosure of segment information for other segments that management feels that the disclosure would be of information value to the users of the financial statements. Finally, paragraph 24 of ASC 280-10-50-18 addresses the possibility that identification of too many reportable segments might result in overly detailed segment information. As a general guideline, the standard suggests that a reasonable limit of 10 segments should be used and smaller, somewhat comparable segments can then be combined for purposes of the footnote disclosure. As a result of my research, I conclude that it would be acceptable for Stanford to report information about six segments, including the cereals and sports beverage segments. Disclosure of information for six segments does not approach the practical limit on the number of segments suggested in ASC 280. The continuing significance of the cereals segment and the developing significance of the sports beverage segment make their inclusion appropriate even though these segments do not meet the ASC 280 quantitative thresholds in the current year. Primary references ASC 280-10-50-16 Other references ASC 280-10-50-18

Chapter 13 – Segment and Interim Reporting

C13-8 Income Tax Provision in Interim Periods MEMO To:

Andrea Meyers, Controller's Department, Vanderbilt Company

From: Re:

Income Tax Provision in Interim Periods

In computing the income tax provision for interim periods, ASC 270 and 740 states that the company should make its best estimate of the effective tax rate expected to be applicable for the year. [ASC 740-270-30-6] This estimate should reflect all expected tax credits, and other tax rates, such as foreign taxes. Therefore, anticipated tax credits available to Vanderbilt should be included in the computation of the expected effective annual tax rate. However, the first quarter calculation of this tax rate cannot include the anticipated energy tax credit benefits because the tax law providing the energy tax credit has not yet been enacted into law. Vanderbilt's first quarter estimate of the effective annual tax rate should not include the expected tax benefits of the energy tax credit. Changes in the tax rate are to be recognized as changes in estimate, according to ASC 270 and 740. If the legislation is enacted as expected, the effect of the tax credit should be factored into the estimate of the effective annual tax rate made at the end of the third quarter, which would reduce the income tax provision for the third quarter of 20X5. Primary references ASC 740-270-30-6 ASC 740-20-45-11 Other references ASC 270-10-45-14

Chapter 13 – Segment and Interim Reporting

C13-9 Questions about Interim Reporting a. In its third-quarter 10-Q, a company would have the following four income statements for the respective reporting periods: 1. An income statement for the third quarter. 2. A comparative income statement for the third quarter of the prior year. 3. An income statement for the cumulative first three quarters of the current year. 4. A comparative cumulative income statement for the first three quarters of the prior year. b. ASC 250 requires that a change in depreciation method be accounted for as a change in accounting estimate affected by a change in accounting principle. The current and prospective application is used and prior financial statements are not restated. Thus, the third quarter and subsequent periods would report with the new depreciation method. c. The company would report a condensed balance sheet as of the end of the third quarter and a condensed balance sheet as of the end of the prior fiscal year. However, a company should also provide a comparative, condensed balance sheet as of the end of the third quarter of the prior fiscal year if it is necessary for understanding the seasonal fluctuations on the company’s financial condition. d. No, interim financial statements do not need to be audited. However, some companies choose to have their interim statements audited. Summary amounts from the interim reports are included in the annual financial report and are subject to audit review at that time. e. ASC 280 requires segment disclosures in each interim report. However, the level of detail of information required in the interim report is less than that required in the annual report. f.

Publicly owned companies classified as accelerated filers ($75 million or more in aggregate market value) must file their 10-Q within 40 days after the end of each of their first three quarters. Companies not meeting the criteria of accelerated files must file within 45 days after the end of each of their first three quarters.

g. The methods of computing revenues for interim reporting should be the same as those used for the annual financial statements. The reason for this is so that financial statement users may properly determine the revenue patterns during the year. However, if a company makes a change in accounting principle that affects the computation of its revenues, the company must retroactively apply the new accounting principle to all prior interims. h. A company is not required to take a physical inventory at the end of each quarter although a physical inventory is required as part of the annual audit procedures. A company usually estimates ending inventory for each quarter based on beginning inventory plus purchases, less the cost of sales. The cost of sales is estimated using the normal mark-up percentages from cost to retail. i.

Many companies allocate costs incurred in a quarter that benefit the entire year. A common example of this are the costs associated with retooling efforts during the short period the company is shut down each year for retooling to take place. Several allocation methods are allowed such as allocating a fourth of the retooling cost to each quarter or relating the retooling cost to proportional sales revenue during the year. The key point to selecting an allocation method is that the method must be rational and relate to the benefits received from the cost. 13-11

Chapter 13 – Segment and Interim Reporting

C13-9 (continued) j.

This is a change in accounting principle for which ASC 250 requires a retrospective application. All prior period statements, including prior interim statements, are restated to the new accounting principle (percentage-of-completion) for the direct effects of the change. This presumes that the company is able to determine the effects of the change on previous interim periods. Otherwise the company must wait until the first day of the next fiscal year to make the change.

k. This is a change in estimate and is treated currently and prospectively. Prior interim statements are not restated for this change in estimates. The change in estimate would be made effective as of the first day of the interim period in which the change is made.

Chapter 13 – Segment and Interim Reporting

SOLUTIONS TO EXERCISES E13-1 Reportable Segments Segment

Revenuea

Profit (loss)b

Assetsc

Electronics Bicycles Sporting Goods Home Appliances Gas and Oil Glassware Hardware

No Yes No Yes Yes No Yes

No Yes No Yes Yes Yes Yes

No Yes No Yes Yes No Yes

Segment revenue greater than $77,500 ($775,000 x 0.10)

Segment profit or loss greater than $10,370 ($103,700 total profit, excluding loss segments x 0.10) c

Segment assets greater than $118,500 ($1,185,000 x 0.10)

All segments but Electronics and Sporting Goods are separately reportable.

The 75 percent test is applied to revenue from unaffiliated customers. Revenue from unaffiliated customers of reportable segments Total revenue from unaffiliated customers

= $655,000* $750,000

= 87.3%

Yes, the 75 percent test is met. *

80,000 + 147,000 + 186,000 + 64,000 + 178,000 = $655,000

Chapter 13 – Segment and Interim Reporting

E13-2 Multiple-Choice Questions on Segment Reporting [AICPA Adapted] 1.

b–

Sales Traceable operating expenses Indirect operating expenses (3/4 x $120,000) Operating profit

Segment 3 $1,080,000 (600,000) $ 480,000

20X6 Total $1,800,000 (1,200,000) $ 600,000

(280,000) $ 200,000

c– Sales Traceable costs Income before allocable costs Cost allocated [($60,000 / $300,000) x $150,000] Operating profit

(90,000) $ 335,000

a– Sales ($1,800,000 x 0.60) Traceable costs Income before common costs Cost allocated [($480,000 / $600,000) x $350,000] Operating profit

$ 750,000 (325,000)

c–

Segment B $ 300,000 (240,000) $ 60,000 $

Total $ 900,000 (600,000) $ 300,000

(30,000) 30,000

A segment’s revenue, including both external sales and intersegment sales or transfers, is 10 percent or more of the total revenues from external sales plus intersegment transactions of all operating segments. (a) incorrect. Measuring the segments revenue to the combined net income would not generate a worthwhile metric. (b) incorrect. This answer is partially correct, you must also add in the revenue from intersegment sales. (d) incorrect. The segments with losses must also be taken into account.

a– Sales Traceable costs Allocated costs [($400,000 / $1,000,000) x $500,000] Operating profit

$ 400,000 $ 150,000 200,000 $

(350,000) 50,000

b–

$260,000 = [($2,000,000 + $600,000) x 0.10]

d–

[0.10 x ($1,200,000 + $240,000)]

c–

A, B, C, D, and E all meet one of the three 10 percent tests.

c–

The test calls for a segment’s revenue, including both external sales and intersegment sales or transfers, is 10 percent or more of the total revenues 13-14

Chapter 13 – Segment and Interim Reporting

from external sales plus intersegment transactions of all operating segments. (a) incorrect. The absolute value of the segment’s profit or loss is 10 percent or more of the greater, in absolute value, of (a) the total profit of all operating segments that did not report a loss or (b) the total loss of all operating segments that did report a loss. (b) incorrect. See explanation for a. (d) incorrect. See explanation for correct answer (c). 10.

d–

5,000,000 / 50,000,000 = 10 percent

11.

a–

5,000,000 / 50,000,000 = 10 percent

Chapter 13 – Segment and Interim Reporting

E13-3 Multiple-Choice Questions on Interim Reporting [AICPA Adapted] 1.

c–

This could cause the recognition of an entire expense in one period when the benefit of the expense is felt over multiple periods. (a) incorrect. This is not a difficulty. This provides for accurate reporting. (b) incorrect. Depreciation would be calculated similar to a full year, a fraction of the yearly amount would be recognized. (d) incorrect. The same estimates would be used to calculate interim period completion as would be used to estimate completion at the end of the year.

a–

Estimated gross profits rates can be used to estimate cost of goods sold at an interim date. (b) incorrect. Manufactures may only use standard costing for interim reporting. (c) incorrect. Variances are to be recognized in the current period, unless they are expected to be absorbed by the end of the reporting year then they can be deferred. (d) incorrect. Companies are required to recognize the loss in the period of decline.

b–

ASC 270 and 740 allow companies to recognize an expense paid in one period over several periods in which the benefit is realized.

c–

Companies are required to recognize the entire loss realized under the lowerof-cost-or-market markdowns in the period of the markdown.

a–

ASC 270 and ASC 740 require a company to value the inventory at the potential replacement cost as long they expect to replenish the LIFO reserve as of the end of the year. (b) incorrect. This is only the case if the reserve is not expected to be replenished by year end. (c) incorrect. This is not correct under any circumstance. (d) incorrect. This is not correct under any circumstance.

a–

All revenue must be recognized in the period that it is realized, and cannot be deferred to make a company to appear to have a more regular revenue stream.

b–

$145,000 = [($180,000/4) + ($300,000/3)]

b–

In the first period the price is adjusted down to the lower-of-cost-or-market, however accounting standards do not allow the price to be adjusted up later beyond the original historical price. (a) incorrect. Accounting standards do not allow companies to adjust inventory above its original cost. (c) incorrect. In the first quarter it is required to mark the inventory down to the lower-of-cost-or-market. (d) incorrect. See above explanations.

Chapter 13 – Segment and Interim Reporting

b–

This method is only approved for interim reporting. In the year-end financial companies are required to use actual numbers for cost of goods sold, not estimates.

10.

b–

According to ASC 270 and ASC 740, gains and losses arising from events such as discontinued operations and unusual or infrequent events should be reported in the interim period in which the event occurs. On the other hand, expenses incurred in one interim period that benefit other interim periods should be allocated to the interim periods benefited. In the case of Park Corp., the $40,000 of property taxes should be allocated to all interim periods. For the six months ended June 30, 20X5, Park should recognize 50% of the $40,000, or $20,000, as an expense. However, the entire $100,000 net loss from the disposal of the business segment should be recognized as a loss for the six months ended June 30, 20X5. Therefore, a total of $120,000 should be included in the determination of Park's net income for the six months ended June 30, 20X5.

Chapter 13 – Segment and Interim Reporting

E13-4 Temporary LIFO Liquidation Case 1: Partial replacement of LIFO base by year-end. (1) Cost of Goods Sold 30,420 Inventory 22,320 Excess of Replacement Cost over LIFO Cost of Inventory Liquidation 8,100 Sold 1,240 units of LIFO base of which 900 units are expected to be replaced: $22,320 = 1,240 units x $18 LIFO cost $8,100 = 900 units x $9 ($27 expected replacement cost less $18 LIFO cost) (2)

The account, Excess of Replacement Cost over LIFO Cost of Inventory Liquidation, is often reported on the quarterly balance sheets as a current liability. Some companies report this valuation account as a reduction of inventory. The account is not reported on the annual balance sheet because the LIFO inventory at year-end is based on the actual units remaining in inventory at year end.

(3)

Inventory 16,200 Excess of Replacement Cost over LIFO Cost of Inventory Liquidation 8,100 Cost of Goods Sold 3,600 Accounts Payable 27,900 Replace 900 units of LIFO base: $16,200 = 900 units x $18 LIFO cost $3,600 = 900 units x $4 difference between $31 actual and $27 estimated replacement cost $27,900 = 900 units x $31 actual cost of replacement

Case 2: No replacement of LIFO base by year-end. (1) Cost of Goods Sold 25,020 Inventory 22,320 Excess of Replacement Cost over LIFO Cost of Inventory Liquidation 2,700 Sold 1,240 units of LIFO base of which 300 units are expected to be replaced: $22,320 = 1,240 units x $18 LIFO cost $2,700 = 300 units x $9 ($27 expected replacement cost less $18 LIFO cost) (2)

December 31 entry: Excess of Replacement Cost over LIFO Cost of Inventory Liquidation 2,700 Cost of Goods Sold 2,700 Eliminate remaining balance in LIFO valuation account because company did not replace LIFO inventory sold in July.

Chapter 13 – Segment and Interim Reporting

E13-5 Inventory Write-Down and Recovery Case 1: Market reductions assumed permanent. Cost of Units Sold

Quarter

+/-

Inventory Adjustment to Market

Cost of Goods Sold

$340,000 (400 x $850) $850 is unit cost from 20X0

$8,500 (1,700 x $5) write down to $845

$348,500

$253,500 (300 x $845)

$7,000 (1,400 x $5) recovery to $850 original cost as adjusted due to the writedown in the prior year

246,500

III

$85,000 (100 x $850)

$26,000 (1,300 x $20) write down to $830

111,000

$332,000 (400 x $830)

$9,000 (900 x $10) recovery to $840

323,000

Total

$1,029,000

Annual basis: $1,020,000 (1,200 x $850)

$9,000 (900 x $10) write down from $850 to $840

$1,029,000

Note that $840 effectively became the new unit cost basis for the inventory items as of December 31, 20X1. If further inventory market declines are suffered in the early quarters during 20X2, recoveries will be permitted only to the extent of $840.

Chapter 13 – Segment and Interim Reporting

E13-5 (continued) Case 2: Market reductions assumed temporary and price will recover by year-end. If market reductions are assumed to be temporary, the company is not required to recognize in its interim financial statements the effects of the seasonal changes in prices (and few companies would under the assumption of temporary reductions recovering by year-end). However, the company would be required to revalue its year-end inventory to lower-of-cost-or-market for its annual financial statements. Cost of Inventory Adjustment = Cost of Quarter Units Sold +/to Market Goods Sold I

$340,000 (400 x $850) $850 is unit cost from 20X0

$340,000

$255,000 (300 x $850)

255,000

III

$85,000 (100 x $850)

85,000

$340,000 (400 x $850)

$9,000 (900 x $10) write down from $850 to $840

349,000

$9,000 (900 x $10) write down from $850 to $840

Total

$1,029,000

Annual basis: $1,020,000 (1,200 x $850)

$1,029,000

Chapter 13 – Segment and Interim Reporting

E13-6 1.

Multiple-Choice Questions on Income Taxes at Interim Dates [AICPA Adapted] a–

Income tax expense for an interim period is calculated by multiplying the estimated income tax rate by pre-tax accounting income for the interim period. (b) incorrect. Pre-tax accounting income is used for this calculation. (c) incorrect. The estimated income tax rate is used for this calculation. (d) incorrect. The estimated income tax rate is used for this calculation.

b–

$170,000 x 0.45 = $ 76,500 $130,000 x 0.40 = (52,000) Third quarter $ 24,500

c–

Net operating loss credit ($100,000 x 0.40) Other tax credit Total credits Estimated annual operating loss Tax benefit rate ($50,000 / $100,000) Operating loss in first quarter Tax benefit in first quarter

c–

When calculating third quarter income tax expense you must subtract your provision in the current year to eliminate double counting.

$ 40,000 10,000 $ 50,000 ÷100,000 .50 x$20,000 $ 10,000

(a) incorrect. The income number that is used is the todate earnings (b) incorrect. The statutory rate is never used. (d) incorrect. The statutory rate is never used. 5.

c–

.25 X $200,000 = $50,000.

b–

Deferred taxes are computed only for temporary differences. The other items are permanent differences.

E13-7 Significant Foreign Operations

Geographic Area U.S. Britain Brazil Israel Australia Consolidated Revenue

Sales to Unaffiliated Customers $364,000 252,000 72,000 58,000 47,000 $793,000

Percent of Consolidated Revenue of $793,000 45.9 % 31.8 9.1 7.3 5.9

Separately Reportable Yes Yes No No No

Note that the country-based revenue test is based on sales to unaffiliated customers. All countries having material sales to unaffiliated customers of $79,300 ($793,000 x 0.10) or more must be separately reported. 13-21 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 – Segment and Interim Reporting

Geographic Area U.S. Britain Brazil Israel Australia Total Assets

Long-Lived Assets $ 509,000 439,000 93,000 66,000 75,000 $1,182,000

Percent of Total LongLived Assets of $1,182,000 43.1 % 37.1 7.9 5.6 6.3

Separately Reportable Yes Yes No No No

All geographic areas reporting long-lived assets of $118,200 ($1,182,000 x 0.10) or more must be separately reported. E13-8 Major Customers Major customers are those to whom sales equal or exceed $4,300,000 ($43,000,000 x 0.10). Government units under common control are classified as a single customer. However, counties are not under the common control of the state government. Therefore, Cook County is a separate customer from the State of Illinois. Service contracts Computer software Computer hardware

$6,100,000 ($3,900,000 + $2,200,000 under common control) $4,650,000 $5,400,000

E13-9 Estimated Annual Tax Rate a.

Estimated Annual Amounts Income from continuing operations Adjustment for permanent differences: Add: Premiums for life insurance Less: Dividends exclusion Tax-exempt income to be received Estimated annual taxable income from continuing operations Combined tax rate Estimated annual taxes before credits Deduct expected business tax credit Estimated income taxes for year

$1,200,000 $ 12,000 (70,000) (20,000)

(78,000) $1,122,000 x 0.40 $ 448,800 (40,000) $ 408,800

Estimated effective annual tax rate = $408,800 / $1,200,000 = 0.34 (rounded) (Note that the estimated income taxes for the year include both federal and state income taxes.)

Chapter 13 – Segment and Interim Reporting

Income Tax Expense 68,000 Income Tax Payable 68,000 Record first-quarter tax provision: $170,000 total pre-tax earnings + 30,000 add back discontinued operation that is reported separately with its own income tax effect $200,000 first-quarter income from continuing operations x 0.34 effective annual tax rate $ 68,000 first quarter tax provision for continuing operations (Note that the problem requires only the tax provision for the continuing operations. The tax effect of the discontinued operation would be recognized separately.) E13-10 Operating Loss Tax Benefits

Period 1 2 3 4 Total

Income (Losses) Before Taxes YearPeriod to-Date $(100,000) 80,000 160,000 400,000 $ 540,000

$(100,000) (20,000) 140,000 540,000

Estimated Effective Annual Tax Rate 40% 40% 45% 45%

Tax (Benefit) Less Reported YearPreviously In to-Date (a) Provided Period $(40,000) (8,000) 63,000 243,000

-0$(40,000) (8,000) 63,000

$ (40,000) 32,000 71,000 180,000 $243,000

(a) Year-to-date: Year-to-date income (losses) x Updated estimated effective annual tax rate E13-11 Industry Segment and Geographic Area Revenue Tests a.

Operating segments revenue test (in thousands) Operating Segment Ethical Drugs Nonprescription Drugs Generic Drugs Industrial Chemicals Total

Combined Revenue $ 320 515 470 80 $1,385

Percent of Combined Revenue of $1,385

Separately Reportable

23.1% 37.2 33.9 5.8

Yes Yes Yes No

Percent of Consolidated Revenue of $1,165

Separately Reportable

70.4% 21.0 8.6

Always Yes* No*

Geographic Area revenue test (in thousands) Geographic Area Domestic Mexico Taiwan Total

Unaffiliated Revenue $ 820 245 100 $1,165

Chapter 13 – Segment and Interim Reporting

*Assuming a 10% materiality threshold. Individual foreign countries exceeding 10% would be listed separately. In this case, only Mexico would have to be separately reported. c.

Disclosure of operating segments' revenue (in thousands) Ethical Drugs

Sales to Unaffiliates Intersegment Revenue

Nonprescription Generic Drugs Drugs

Other

Combined

$300

$425

$370

$70

$1,165

20 $320

90 $515

100 $470

10 $80

220 $1,385

Eliminations

Consolidated $1,165

$(220) $(220)

$1,165

Disclosure of geographic areas' revenue (in thousands) Geographic Area United States Total Foreign Total Significant country: Mexico

Unaffiliated Revenue $ 820 345 * $1,165 $ 245

*Individual foreign countries exceeding 10% of total unaffiliated revenue ($1,165) would be listed separately. In this case, only Mexico would be reported separately. E13-12 Different Reporting Methods for Interim Reports [CMA Adapted] 1. Not acceptable. Revenue should be recognized when realized. 2. Acceptable. The gross profit method may be used for interim reports. 3. Acceptable. Costs may be allocated on a reasonable basis. 4.

Acceptable. A recovery to original cost may be recorded in a subsequent interim period.

5. Not acceptable. Gains are recognized in the period of the sale. 6.

Acceptable. Costs may be allocated on a reasonable basis.

7. Not acceptable. ASC 250 requires that a change in depreciation in long-lived assets be accounted for as a change in estimate affected by a change in accounting principle. The current and prospective application is used, and no cumulative effect, nor any retrospective restatement, is used for this change.

Chapter 13 – Segment and Interim Reporting

P13-13 Segment Reporting Worksheet and Schedules a. (1) A Revenues: Sales to unaffilIated customers Intersegment sales Total revenue Operating costs: Traceable costs Allocateda Segment profit (loss) Other items: General corporate expenses Income from continuing operations Assets: Segment General corporate Total assets a

Operating Segments__________ B C D

280,000 60,000 340,000

130,000

Corporate Admin.

Combined

Intersegment Eliminations

(90,000) (90,000)

Consolidated

130,000

340,000 18,000 358,000

60,000 12,000 72,000

810,000 90,000 900,000

(245,000) (17,000)

(90,000) (6,500)

(290,000) (17,900)

(82,000) (3,600)

(707,000) (45,000)

90,000

(617,000) (45,000)

78,000

33,500

50,100

(13,600)

148,000

-0-

148,000

78,000

33,500

50,100

(13,600)

400,000

105,000

500,000

75,000

400,000

105,000

500,000

75,000

(20,000)

128,000

120,000 120,000

1,080,000 120,000 1,200,000

810,000 810,000

(20,000) -0-

$17,000 = ($340,000 / $900,000) x $45,000 $ 6,500 = ($130,000 / $900,000) x $45,000 $17,900 = ($358,000 / $900,000) x $45,000 $ 3,600 = ($ 72,000 / $900,000) x $45,000

128,000 1,080,000 120,000 1,200,000

Chapter 13 – Segment and Interim Reporting

P13-13 (continued) (2) Segments A B C D

Revenuea Yes Yes Yes No

Segment Profitb Yes Yes Yes No

Separately reportable if segment revenue greater than or equal to $90,000 ($900,000 combined revenue x 0.10).

Separately reportable if separate segment profit or loss greater than or equal to $16,160 ($161,600 x 0.10).

Segment Assetsc Yes No Yes No

Note that the segment profit (loss) test is based on the larger of the absolute values of the total segment profit or the total segment loss of the segments. The absolute value of the total segment profit of $161,600 for the three segments (A, B, and C) reporting segment profits exceeded the total segment loss ($13,600) for the segment reporting a loss (segment D only). c

Separately reportable if segment assets greater than or equal to $108,000 ($1,080,000 total operating segment assets x 0.10).

A, B, and C are separately reportable. b.

First, the revenues and long-lived assets must be disclosed for the domestic operations and, in total, for all foreign operations. Then, a materiality test must be applied to determine if the revenues or long-lived, productive assets for a specific country are material. A 10 percent materiality test is used. Country A Domestic B Foreign C Foreign D Foreign

Revenuea Yes Yes Yes No

Long-Lived Assetsb $200,000 Yes 52,500 No 250,000 Yes 37,500 No $540,000

Separately reportable if country’s revenue to outsiders greater than or equal to $81,000 (consolidated revenue of $810,000 x 10).

Separately reportable if long-lived, productive assets, which are one-half of total assets, are greater than or equal to $54,000 (total long-lived, productive assets of $540,000 x 0.10). Foreign countries B and C are separately reportable.

Sales greater than or equal to $81,000 to a single customer would be noted. (Consolidated revenue of $810,000 x 0.10)

Chapter 13 - Segment And Interim Reporting

P13-14 Segment Reporting Worksheet and Schedules a.

Calvin, Inc. Segmental Disclosure Worksheet For the Year Ended December 31, 20X1

Revenue: Sales to unaffiliated customers Intersegment sales Total sales Expenses: Cost of goods sold Selling expenses Traceable expenses Allocated general corporate expenses Total segment Expenses Segment profit Unallocated general corporate expenses Income from continuing operations before taxes Assets: Segment General corporate Total assets

Apparel

Operating Segment Building Chemical Furniture

870,000

750,000

Machinery

Corporate Administration

Combined

Intersegment Eliminations

Consolidated

(160,000) (160,000)

1,950,000 -01,950,000

870,000

750,000

55,000 5,000 60,000

95,000 15,000 110,000

180,000 140,000 320,000

1,950,000 160,000 2,110,000

(480,000) (160,000) (40,000)

(450,000) (40,000) (30,000)

(42,000) (10,000) (6,000)

(78,000) (20,000) (12,000)

(150,000) (30,000) (18,000)

(1,200,000) (260,000) (106,000)

(80,000)

(75,000)

(7,000)

(13,000)

(25,000)

(200,000)

(760,000) 110,000

(595,000) 155,000

(65,000) (5,000)

(123,000) (13,000)

(223,000) 97,000

(1,766,000) 344,000

110,000

155,000

(5,000)

(13,000)

97,000

610,000

560,000

80,000

90,000

140,000

610,000

560,000

80,000

90,000

140,000

(35,000)

309,000

125,000 125,000

1,480,000 125,000 1,605,000

160,000

(1,040,000) (260,000) (106,000) (200,000)

160,000 -0-

(1,606,000) 344,000 (35,000)

-0-

309,000 1,480,000 125,000 1,605,000

Chapter 13 - Segment And Interim Reporting

P13-14 (continued) b. Separately reportable segments.

Apparel Building Chemical Furniture Machinery

Segment Profitb Yes Yes No No Yes

Revenuea Yes Yes No No Yes

Segment Assetsc Yes Yes No No No

Separately reportable if segment's total sales greater than or equal to $211,000 (combined total sales of $2,110,000 x 0.10).

Separately reportable if segment's profit greater than or equal to $36,200 (combined profitable segments' profits of $362,000 x 0.10).

Separately reportable if segment's assets greater than or equal to $148,000 (combined assets of operating segments of $1,480,000 x 0.10).

The Apparel, Building, and Machinery segments are separately reportable because they pass at least one of the three 10 percent tests. Comprehensive 75 percent test: $1,800,000 / $1,950,000 = 92.3% Sales to unaffiliated customers of the separately reportable segments Sales to unaffiliated customers for all segments

> 75%

Chapter 13 - Segment And Interim Reporting

P13-14 (continued) c.

Calvin, Inc. Footnote X Information about the Company's Operations in Different Operating Segments

Sales to unaffiliated customers Intersegment sales Total revenue Segment profit

Apparel

Operating Segments Building Machinery

$870,000

$750,000

$180,000

$150,000

$870,000

$750,000

140,000 $320,000

20,000 $170,000

$110,000

$155,000

$ 97,000

$(18,000)

Others

Intersegment Eliminations

$1,950,000 $(160,000) $(160,000)

Unallocated general corp. expenses Income from continuing operations Segment assets

Consolidated

-0$1,950,000 $ 344,000

(35,000) $ 309,000 $610,000

$560,000

$140,000

$170,000

General corporate assets Total assets

$1,480,000 125,000 $1,605,000

Depreciation expense

$ 60,000

$ 50,000

$ 25,000

$ 21,000

$ 156,000

Capital expenditures

$ 20,000

$ 30,000

$ 15,000

Reconciliation of reportable segment revenue to consolidated revenue: Total revenue for reportable segments Other revenues Elimination of intersegment revenues Total consolidated revenues

-0-

Reconciliation of reportable segment profit and loss to consolidated profit or loss: $1,940,000 Total profit and loss for reportable segments 170,000 Other loss (160,000) General corporate expenses $1,950,000

Income before taxes

65,000

$362,000 (18,000) (35,000) $309,000

Reconciliation of Reportable Segment Assets to Consolidated Assets: Total assets of reportable $1,310,000 segments Other assets 170,000 General corporate assets 125,000 Consolidated total assets $1,605,000 13-29 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 13 - Segment And Interim Reporting

P13-14 (continued) d. Schedule showing three ten percent tests with changes in segment assets:

Revenue

Segment Profit (Loss)

Segment Assets

Apparel

$ 870,000 = 41.2% $2,110,000

$110,000 = 30.4% $362,000*

$ 610,000 = 41.2% $1,480,000

Building

$ 750,000 = 35.6% $2,110,000

$155,000 $362,000

= 42.8%

$ 460,000 = 31.1% $1,480,000

Chemical

$ 60,000 = 2.8% $2,110,000

$ 5,000 $362,000

= 1.4%

$ 80,000 = 5.4% $1,480,000

Furniture

$ 110,000 = 5.2% $2,110,000

$ 13,000 $362,000

= 3.6%

$ 190,000 = 12.8% $1,480,000

Machinery

$ 320,000 = 15.2% $2,110,000

$ 97,000 $362,000

= 26.8%

$ 140,000 = 9.5% $1,480,000

The total of the three positive segment incomes ($362,000 = $110,000 + $155,000 + $97,000)

Results of the 10 percent tests to determine if separately reportable: Apparel Building Chemical Furniture Machinery

Revenue Yes Yes No No Yes

Profit Yes Yes No No Yes

Assets Yes Yes No Yes* No

* The Furniture segment now becomes a separately reportable segment because its assets are greater than 10% of the total assets.

Chapter 13 - Segment And Interim Reporting

P13-15 Interim Income Statement a.

Estimate of effective annual tax rate at end of second quarter: Estimated Annual Amounts Income from continuing operations Less: Dividend exclusion Estimated annual taxable income Combined tax rate Estimated annual taxes before credits Less: Business tax credit Estimated income taxes for year

$600,000 (30,000) $570,000 x 50% $285,000 (15,000) $270,000

Estimated effective annual tax rate ($270,000/$600,000)

45%

Chris, Inc. Income Statement For Three Months Ended June 30, 20X2 Sales Cost of goods sold Gross profit Operating expense ($230,000 - $45,000 factory rearrangement deferred) Income before taxes Income taxes Net income a

$850,000 (525,000) a $325,000 (185,000) $140,000 (68,000) b $ 72,000

Computation of Cost of Goods Sold Cost of goods sold as given Add: LIFO inventory liquidation [7,500 x ($26 - $12)] Adjusted cost of goods sold

$420,000 105,000 $525,000

Computation of Income Taxes

Interim Period

Income (Loss) Before Taxes Current YearPeriod to-date

Estimated Effective Annual Tax Rate

Yearto-date

Tax (Benefit) Less Previously Provided

Reported in this Period

100,000

40%

40,000

-0-

40,000

140,000

240,000

45%

108,000

40,000

68,000

Chapter 13 - Segment And Interim Reporting

P13-16 Interim Income Statement a.

Estimated effective annual tax rate as of the end of the second quarter:

Income from continuing operations Less: Dividends received deduction Estimated taxable income Combined taxable rate Estimated tax before credits Less: Business tax credit Estimated income taxes

Estimated Annual Amounts $600,000 (75,000) $525,000 40% $210,000 (15,000) $195,000

Estimated effective annual tax rate ($195,000 / $600,000)

= 32.5%

Malta Corporation Income Statement For Three Months Ended June 30, 20X1 Sales Cost of goods sold: Beginning inventory Purchases Goods available Less: Ending inventory

$1,200,000 $ 78,000 650,000 $728,000 (80,000) a $648,000 (4,000)

Less: Recovery from LCM Gross profit Operating expense Income before taxes Income taxes Net income a

(644,000) $ 556,000 (320,000) $ 236,000 (87,950) b $ 148,050

Computation of ending inventory Beginning inventory Purchases Goods available Less: Estimated cost of sales (0.54 x $1,200,000) Estimated ending inventory

$ 78,000 650,000 $728,000 (648,000) $ 80,000

Computation of income taxes Income (Loss) Estimated Before Taxes Effective Current YearAnnual Period Period to-date Tax Rate 1 2 c

(90,000) 236,000

(90,000) 146,000

45.0% 32.5%c

Yearto-date

Tax (Benefit) Less Previously Provided

Reported in This Period

(40,500) 47,450

(40,500)

(40,500) 87,950

See solution to part a. 13-32

Chapter 13 - Segment And Interim Reporting

P13-17 Evaluating Foreign Operations a.

Profit or loss for each geographic area: Sales to unaffiliated Interarea sales Total revenues Operating expenses Allocated costs Operating profit (loss)

U.S. $2,500 100 $2,600 1,820 100a $ 680

New Zealand $320 __ $320 290 12.8 $ 17.2

Singapore $60 10 $70 70 2.4 $ (2.4)

Australia $120 $120 30 4.8 $ 85.2

$100 = ($2,500 sales to unaffiliated / $3,000 total sales to unaffiliated) x $120 common costs to be allocated The company must report the following, unless it is impracticable to do so: a. Revenues from external customers attributed to (1) the company’s home country of domicile and (2) the total revenue attributed to all foreign countries in which the enterprise generates revenues. If revenues from external customers generated in an individual country are material, then the revenues for that country shall be separately disclosed. b. Long-lived productive assets (1) located in the entity’s home country of domicile and (2) the total assets located in all foreign countries in which the entity holds assets. If assets in an individual foreign country are material, then the amounts of assets held in that specific country shall be disclosed separately. Total foreign sales to nonaffiliates Consolidated sales to nonaffiliates

$ 500 = $3,000

16.6%

Total foreign assets Total long-lived assets

$ 500 = $2,700

18.5%

Revenues and long-lived assets for domestic and total foreign operations must be disclosed.

Chapter 13 - Segment And Interim Reporting

P13-17 (continued) c.

Separately reportable foreign segments: Geographic Area

Sales to Unaffiliated Customers

Percent of Consolidated Revenues of $3,000

Domestic New Zealand Singapore Australia Total

$2,500 320 60 120 $3,000

83.3% 10.7 2.0 4.0 100.0%

Geographic Area

Assets

Percent of Total Long-lived Assets of $2,700

Domestic New Zealand Singapore Australia Total

$2,200 280 140 80 $2,700

81.4% 10.4 5.2 3.0 100.0%

Separately Reportable Yes Yes No No

For both of these tests, the New Zealand operations are separately reportable as a significant foreign operation, using a 10 percent materiality threshold.

Chapter 13 - Segment And Interim Reporting

P13-18 Interim Accounting Changes a.

A change in accounting principle of FIFO to LIFO requires the retrospective application of the newly adopted principle to the earliest balance sheet presented and then all subsequent financial reports are adjusted to the new method. The selected interim data in the problem was computed using the FIFO method. Adjusting each interim period for the difference in cost of goods sold under LIFO, with its related direct effect of the tax impact (40 percent), results in the following comparative interim numbers:

Quarter Ended 20X7: March 31 June 30 September 30 20X6: March 31 June 30 September 30 December 31

Net Sales

Gross Profit

Operating Expenses

Earnings from Operations, Before Tax

Net Earnings

$388 406 428

$123 123 137

$106 105 119

$17 18 18

$10.2 10.8 10.8

394 416 403 385

127 138 123 125

112 119 117 103

15 19 6 22

9.0 11.4 3.6 13.2

b. This change from the straight-line method to the accelerated method of depreciation because of a change in the estimated future benefits is a change in accounting estimate that is affected by a change in accounting principle. ASC 250 requires that this type of accounting change be accounted for in (a) the period of change, if the change affects only that period, or (b) the period of change and future periods if the change has both current effects and future effects. Prechange financial statements are not restated or adjusted! Thus, the company would use the newly adopted method (straight-line) for the third quarter ending September 30, and for future periods for the life of the asset. Footnote disclosures would include the effects of the change on income from continuing operations and also justification for the change.

Chapter 13 - Segment And Interim Reporting

P13-19 Segment Disclosures in Financial Statements a.

Multiplex Inc. Schedule for 10% Revenue Test For the Year Ended December 31, 20X5 (in millions) Segment Percent of Combined Segment Revenue Revenue of $628 Million Car Rental $ 39 6.2% Aerospace 204 32.5 Communications 60 9.6 Health/Fitness 50 8.0 Heavy Equipment 275 43.8 Total $628 Multiplex Inc. Schedule for the 10% Segment Profit or Loss Test For the Year Ended December 31, 20X5 (in millions) Segment Percent of Test Segment Profit (loss) Amount of $105 million Car Rental $ 17 16.2% Aerospace 6 5.7 Communications 18 17.1 Health/Fitness 20 19.0 Heavy Equipment 44 41.9 Total $105

Reportable Segment No Yes No No Yes

Reportable Segment Yes No Yes Yes Yes

Determination of the profit of each operating segment (in $millions)

Revenue Cost of goods sold Selling expenses Other traceable expenses Allocation of common costs Operating profit

Car Rental $ 39 (16)

Aerospace $ 204 (141) (42)

Communications $ 60

Health/ Fitness $ 50

(29)

(23)

Heavy Equipment $ 275 (177) (37)

(4)

(8)

(11)

(5)

(10)

(2)

(7)

(2)

(7)

$ 18

$ 20

$ 44

$ 17

Total profits (in $millions) amount to $105: ($17 + $6 + $18 + $20 + $44).

Chapter 13 - Segment And Interim Reporting

P13-19 (continued) Multiplex Inc. Schedule for Segment Assets Test For the Year Ended December 31, 20X5 (in millions) Operating Segment Car Rental Aerospace Communications Health/Fitness Heavy Equipment Total

Segment Assets $ 20 107 70 80 195 $472

Percent of Test Amount of $472 million 4.2% 22.7 14.8 16.9 41.3

Reportable Segment No Yes Yes Yes Yes

Multiplex Inc. Schedule of Reportable Segments For the Year Ended December 31, 20X5 Segment Car Rental Aerospace Communications Health/Fitness Heavy Equipment b.

Revenue Test No Yes No No Yes

Profit Test Yes No Yes Yes Yes

Assets Test No Yes Yes Yes Yes

Segment Yes Yes Yes Yes Yes

Because all of Multiplex's operating segments are reportable, the 75% revenue test is satisfied. The reportable operating segments account for 100% of the sales to unaffiliated customers.

Chapter 13 - Segment And Interim Reporting

P13-19 (continued) c.

Information About Multiplex's Operations in Different Industry Segments: Multiplex Operations Industry Segments (in $millions) Item Sales to: unaffiliated customers Intersegment sales Total revenue Depreciation Segment profit Segment assets Expenditures for segment assets

Car AeroRental space

CommuniCations

Health/ Fitness

Heavy Equip.

Combined $598 30 $628

$34 5 $39

$204

$60

$50

$204

$60

$50

$250 25 $275

$ 4 17 20

$ 15 6 107

$ 4 18 70

$ 5 20 80

$ 25 44 195

$ 53 105 472

Reconciliation of Reportable Segment Profit and Loss _________to Consolidated Profit and Loss_________ Total profit or loss for reportable segments Elimination of unrealized intersegment profits Other corporate expenses (unallocated) Income before income taxes

$105 (7) (33) $ 65

Reconciliation of Reportable Segment Revenues _________to Consolidated Revenues_________ Total revenues for reportable segments Elimination of intersegment revenues Total consolidated revenues

$628 (30) $598

Reconciliation of Reportable Segment Assets _________to Consolidated Assets_________ Total assets for reportable segments Intercompany receivable Unrealized company profit (a reduction of the carrying amount of property, plant and equipment) Unallocated corporate assets Consolidated total

$472 (15) ( 7) 25 $475

Chapter 13 - Segment And Interim Reporting

P13-20 Reporting Operations in Different Countries a.

First, ASC 280 requires companies to disclose revenues and long-lived, productive assets in total for domestic and all foreign operations. Then, if revenues or long-lived assets are material in any single country, that disclosure must be made on a country basis. Therefore, the company would disclose total revenues and total long-lived assets for the domestic operations and for total foreign operations. Revenues: Sales to unaffiliated customers from operations in France, Mexico, and Japan total $426,000,000. Total sales to unaffiliated customers for all geographic areas, including Domestic, are $856,000,000. $426,000,000 / $856,000,000 = 49.8% Long-lived, productive assets: Long-lived, productive assets of foreign operations total $270,000,000. Total long-lived productive assets for all geographic areas, including Domestic, are $505,000,000. (Note that inventories and other current assets or current liabilities are not long-lived, productive assets. Therefore, unrealized intercompany profit or interarea, short-term receivables/payables do not affect the computation of the long-lived productive assets for purposes of this disclosure.) $270,000,000 / $505,000,000 = 53.5%

The determination of which foreign operations, on a country basis, are separately reportable depends upon two tests to determine which individual foreign operations must be separately disclosed. Watson uses a 10 percent materiality threshold for these tests. The 10% revenue test is shown below: Watson Inc. Revenue Test Applied to Individual Foreign Operations For the Year Ended December 31, 20X5 Geographic Area Domestic France Mexico Japan Total

Sales to Unaffiliated Customers $430,000,000 300,000,000 36,000,000 90,000,000 $856,000,000

Percent of Consolidated Revenue of $856,000,000 50.2% 35.0 4.2 10.5

Separately Reportable Yes Yes No Yes

The revenue test indicates that the French and Japanese operations should be separately reported.

Chapter 13 - Segment And Interim Reporting

P13-20 (continued) The long-lived, productive assets test is shown below: Watson Inc. Long-Lived, Productive Assets Test Applied to Individual Foreign Operations For the Year Ended December 31, 20X5 Geographic Area Domestic France Mexico Japan Consolidated

Long-Lived, Productive Assets $235,000,000 160,000,000 29,000,000 81,000,000 $505,000,000

Percent of Total Long-Lived Assets of $505,000,000 46.5% 31.7 5.7 16.0

Separately Reportable Yes Yes No Yes

The company will disclose the amounts of long-lived, productive assets in France and in Japan. c. Required disclosure of geographic information: Watson Inc. Geographic Information (In $millions) United States France Japan Other

Revenue $430 300 90 36 $856

Long-Lived Assets $235 160 81 29 $505

Chapter 13 - Segment And Interim Reporting

P13-21 Matching Key Terms 1. O 2. C 3. L 4. A 5. E 6. H 7. J 8. K 9. G 10. N

Chapter 14 – SEC Reporting

CHAPTER 14 SEC REPORTING ANSWERS TO QUESTIONS Q14-1 The basis of the SEC's legal authority to regulate accounting principles stems from the Securities Exchange Act of 1934. In the 1934 Act, the SEC was given the legal responsibility to regulate trades of securities and to determine the types of financial disclosures that a publicly held company must make. Q14-2 The Securities Act of 1933 regulates the initial registration of securities. The Securities Exchange Act of 1934 regulates the periodic reporting of publicly traded companies. Q14-3 The Division of Corporation Finance receives the registration statements of companies wishing to make public offerings of securities. The Division of Enforcement investigates individuals or firms who may be in violation of a security act. Q14-4 The Foreign Corrupt Practice Act of 1977 requires that companies maintain accurate accounting records and an adequate system of internal control. An adequate system of internal control should contain the following: a. b. c. d.

Strong budgetary controls An objective internal audit function that helps develop, document, and then monitor the control system An active audit committee comprised of nonmanagement members from the company's board of directors A review of the internal control system by the independent auditors *The FCPA indicated that the cost of an internal control procedure should not outweigh its benefit to the firm

Q14-5 Regulation S-X covers the form and content of financial disclosures; specifically, this Reg. covers the form and content of financial statements, schedules, footnotes, reports of accountants, and pro forma disclosures. Items included in Regulation S-K are articles specifying disclosure rules of nonfinancial items to be included in registration statements. Examples include a description of the business, management's discussion and analysis, disagreements with accountants, and required information about new stock issues. Q14-6 Under Regulation A and Regulation D, certain public offerings of securities are exempted from the comprehensive registration requirements of the SEC.

Regulation A provides for two exemptions from full registration requirements as follows: 1. "Tier 1" issuances of up to $20,000,000 within a 12-month period can be exempt if the entity files a notice with the SEC and an “offering circular” containing financial and other information provided to the persons to whom the offer is made (the financial statements in the offering circular do not have to be audited). There is no ongoing reporting requirement for a Tier 1 issuance other than a final report on the results of the offering. 14-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 14 – SEC Reporting

2. "Tier 2" issuances of up to $50,000,000 within a 12-month period can be exempt if the entity files an offering circular and the financial statements are audited. Tier 2 issuances are subject to ongoing reporting, however only semiannual reports (not quarterly reports) are required. Regulation D provides two exemptions from full registration requirements as follows: 1. Rule 504 of Regulation D exempts small issuances up to $5,000,000 within a 12-month period to any number of investors. No specific disclosures are required, but the offerer must send a notice of the offering to the SEC upon the first sale of the securities. 2. Rule 506 of Regulation D exempts issuances up to $5,000,000 within a 12-month period. The sales can be made to up to 35 “unaccredited investors” and to an unlimited number of “accredited investors.” Accredited investors include banks, credit unions, insurance companies, partnerships and corporations, and individuals having a net worth exceeding $1,000,000 or individual income of $200,000 for the two most recent years. Unaccredited investors are persons who do not meet the income or net worth requirements and must be sophisticated investors who have knowledge and experience in financial affairs. An unaccredited investor who purchases the securities must be supplied audited balance sheets along with other financial statements. Under Rule 506, the SEC must be notified upon the first sale, and the issuer must restrict the purchasers’ rights to resell the securities, generally for a period of one year. The securities typically state the nature of their restriction and the fact that they have not been registered with the SEC. Q14-7 A company uses a Form S-1 registration form when the general registration is for a first-time offering and no other publicly traded stock has been issued by that company. A company may use a Form S-3 registration form for a new stock issuance when the registrant is large and established, possessing stock that has been trading for several years. Q14-8 (a) A customary review is a thorough examination by the SEC and may result in acceptance of the registration or a comment letter from the SEC. (b) A comment letter is issued by the SEC specifying the deficiencies that must be corrected before the securities may be offered for sale. (c) A red herring prospectus is a preliminary prospectus providing information to investors about an upcoming issue. This type of prospectus has a cover printed in red ink indicating it is not an offering statement and the securities being discussed are not yet available for sale. (d) Shelf registration allows large, established companies with other issues of stock already actively traded to file a registration statement with the SEC for a stock issue which may be brought off the shelf and updated within a very short time when the company wants to actually issue the stock. Q14-9 Form 10-K is the annual filing to the SEC, and is broken into four parts. Parts I, II, and III contain the basic financial information including the audited financial statements, the management discussion and analysis, the report by management on internal control, and the auditor’s opinion. Part IV contains additional schedules and exhibits. For 14-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 14 – SEC Reporting

“accelerated filers” (those companies having at least $75 million in aggregate market value and been subject to the periodic and annual reporting requirements for at least one year), the Form 10-K must be filed with the SEC within 60 days after the end of the company's fiscal year-end. Other companies, such as small businesses, have 90 days in which to file their 10-Ks. Q14-10 Interim reports submitted to the SEC are not required to be audited. The public accountant is expected to review, on an ex post basis, the information provided in the company's Form 10-Qs as part of the annual, year-end audit. Q14-11 In 2004, the SEC enlarged the list of items that must be reported on the Form 8K. The entire list is presented in the chapter. Although the registrant’s accounting function would be involved with almost of the specific items, those items for which the particular involvement of the accounting function would be the greatest are: 1.03. 2.01. 2.02. 2.03.

The bankruptcy or receivership of the company Completion of the acquisition or disposition of assets Public announcement of material financial results Creation of a direct financial obligation under an off-balance sheet arrangement 2.04. An event that accelerates or increases an obligation under an off-balance sheet arrangement 2.05. Costs associated with exit or disposal activities 2.06 Material impairments of assets 4.01 Changes in the registrant’s certifying accountant 4.02 Non-reliance on previously issued financial statements or audit report 5.03 Changes in the registrant’s fiscal year 6. Asset-Backed Securities 9.01 Financial Statements Q14-12 A proxy is a request by the company, or by a stockholder, for a security holder's vote on a corporate matter. Proxy solicitations must include a full discussion of the matters to be voted on, and must also include the most recent annual shareholders' report if the present management is making the solicitation for a meeting at which directors will be elected. Q14-13 Part I of the Foreign Corrupt Practices Act (FCPA) prohibits individuals associated with United States companies from giving bribes to foreign governmental or political officials for the purpose of securing a contract or otherwise increasing the company's business. Part II of the FCPA requires all public companies, whether operating internationally or not, to keep detailed records that accurately and fairly reflect the company's financial transactions, and to develop and maintain an adequate internal control system. The impact of this act is to require companies to establish and maintain an adequate internal control system, to require public accountants to evaluate the company's internal controls, and to communicate any material weaknesses in those controls to the company's top management and board of directors. Q14-14 The MD&A must include a discussion of trends and expected changes on the company’s financial condition, changes in financial condition, and its results from operations for the last three-year period. SEC rules require management to discuss the following items in the MD&A: a. Liquidity b. Capital resources c. Results of operations (a line-item analysis of material changes) 14-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 14 – SEC Reporting

d. e. f. g.

Off-balance sheet arrangements Tabular disclosure of contractual obligations Critical Accounting Estimates Interim Period Discussion

Q14-15 The Sarbanes-Oxley Act of 2002 placed a number of requirements on both companies and their auditors. A Public Company Accounting Oversight Board (PCAOB) was created with the authority to regulate registered public accounting firms and establish standards for audit firm quality controls. A second major requirement was that the CEO and CFO had to file with the SEC a notarized statement attesting to the accuracy of their financial filings. After the initial filing, management must periodically assess and report on the effectiveness of their company’s internal control over financial reporting structure and processes. A third major requirement is that an accounting firm can provide a client company with either auditing or consulting services, but not both! And the auditing firm must rotate the partners who work on each client at least every five years. A fourth major requirement is the enhanced responsibilities assigned to a public company’s audit committee of the Board of Directors. This group of nonmanagement directors is charged with the appointment, compensation and oversight of the work of the public accounting firm employed by the company. Furthermore, the audit committee must approve all services provided by the auditor. And fifth, the criminal penalties for destroying audit records in a federal or bankruptcy investigation, or committing securities fraud, were increased substantially.

Chapter 14 – SEC Reporting

SOLUTIONS TO CASES C14-1 Objectives of Securities Acts [CMA Adapted] a.

Investment practices of the 1920s that contributed to the erosion of the stock market include the following: – The prices of securities were manipulated through the use of "wash sales" or "matched orders." Brokers or dealers engaged in prearranged buy and sell orders that created the impression of activity and drove up prices. When the public began buying, driving prices up even higher, the brokers and dealers would sell, making huge profits before prices fell back to market level. – False or misleading financial statements were issued to lure unwary investors. – The excessive use of credit to finance speculative activities served to undermine the market. There was no limit to the amount of credit or "margin" that a broker could extend to a customer. As a result, a slight decline in market prices often caused overextended customers to sell when margins could not be covered, thus further reducing prices. – Corporate officials and other "insiders" misused information about corporate activities to take advantage of fluctuations in stock prices.

b. 1. The objectives of the Securities Act of 1933 are to: – provide investors with financial and other information concerning the initial offering of securities for sale, thus ensuring full and fair disclosure. Companies were required to file a registration statement and prospectus for review. – prohibit misrepresentation, deceit, and other fraudulent acts and practices in the sale of securities. 2. The objectives of the Securities Exchange Act of 1934 are to: – regulate the trading of securities on secondary markets by requiring the registration of securities traded on any national exchange. – create a regulatory agency, the Securities and Exchange Commission, to administer the requirements of both the 1933 and 1934 acts. c. The provisions of the Foreign Corrupt Practices Act of 1977 include the requirement for public companies to devise and maintain a system of internal accounting controls to provide reasonable assurance that transactions are properly authorized, recorded, and accounted for. The Dodd-Frank Act created (1) the Financial Stability Oversight Council and Orderly Liquidation Authority to oversee the financial stability of firms that have a significant influence on the economy (i.e., companies described as being “too big to fail”), (2) the Consumer Financial Protection Bureau (CFPB) to prevent predatory mortgage lending and ensure that consumers understand the mortgage terms prior to finalizing their paperwork and (3) the SEC Office of Credit Ratings to ensure that agencies provide meaningful and reliable credit ratings of the entities they evaluate.

Chapter 14 – SEC Reporting

C14-2 Roles of SEC and FASB [CMA Adapted] a.

The Securities and Exchange Commission (SEC) was created through the Securities Exchange Act of 1934. As a result of this Act, the SEC has legal authority over accounting practices. The U.S. Congress has given the SEC broad regulatory power to control accounting principles and procedures in order to fulfil its goal of full and fair disclosure. Specific responsibilities of the SEC include: – Regulating the sale of securities on secondary markets – Regulating the initial offerings and actual sales of stock in interstate commerce – Prescribing the forms and reports to be filed and be made publicly available – (Students may include a number of other responsibilities. The important learning objective is that students understand that the SEC is very important in the U.S.’s capital formation process.)

The SEC was created by Congress, and the FASB was created by the private sector; therefore, no direct relationship exists. However, the SEC historically has followed a policy of relying on the private sector to establish financial accounting and reporting standards. The SEC recognized the FASB as authoritative in one of its Accounting Series Releases (ASR 150: Dec. 20, 1973). There has been cooperation between the SEC and FASB, but at times the relations between these bodies have become strained. In cases of unresolved differences, the SEC rules take precedence over FASB rules for the companies within SEC jurisdiction. The Sarbanes-Oxley Act of 2002 gave the PCAOB the responsibility for establishing auditing standards and also renewed the SEC’s ultimate responsibility for establishing accounting and financial reporting standards.

Chapter 14 – SEC Reporting

C14-3 Information Content of Proxy The information presented in the company’s proxy is expected to change from year to year. Some instructors will select a local company or other one of interest to their students as an exemplar for their discussions during the semester. There are strong learning advantages to using one company for applications of the concepts presented in your advanced financial accounting course. This case can be applied to any publicly traded company. a. The proxy includes the proposals placed before the shareholders. Common examples of such proposals include: 1. Election of Directors. The company lists the Directors up for election this year The Board of Directors normally unanimously recommends a vote “For” the nominees. 2. Ratification of Independent Registered Public Accounting Firm. The Board’s Audit Committee appoints the independent registered public accounting firm (auditors) for the year. The Board of Directors normally unanimously recommends a vote “For” this proposal. 3. Stockholder Proposals. Sometimes groups of stockholders will make proposals they wish to have placed for vote by the shareholders. These resolutions may include provisions regarding shareholders’ rights, establishment of specific committees by the Board of Directors to issue reports on issues of concern to corporate governance by the management of the company, and proposals to revise specific sections of the company’s By-Laws. Management typically makes a recommendation either in favor of, or in opposition to, each of the stockholder proposals. b. The Board of Directors of most registrants have four standing committees, as follows: 1. Audit Committee. This committee has a number of oversight responsibilities for financial matters, as defined in the Sarbanes-Oxley Act of 2002. Included is the responsibility to appoint, retain, compensate, evaluate, and if appropriate, to replace the auditors. The members of the Audit Committee must be nonmanagement members of the Board of Directors. 2. Compensation Committee. The Compensation Committee approves and recommends standards for the company’s compensation program and plans, including incentive compensation, retirement, and other benefit plans. The Committee reviews the performance of the Chief Executive Officer and fixes his compensation. In addition, the Committee reviews the company’s compensation practices for employees and officer workers, and fixes the salary and other compensation of all officers of the company. 3. Governance Committee. This committee reviews the company’s Shareholder Rights Plan, makes recommendations regarding the appropriate size and composition of the board, recommends a slate of nominees for the board, and makes recommendations for candidates for election as officers of the company. 4. Public Policy Committee. The Public Policy Committee assists in the board’s oversight responsibilities for company matters related to public and social policy, including investor, consumer and community relations issues and employee safety programs, policies and procedures, and labor relations issues. The committee also oversees the company’s business conduct code. c. The total annual compensation received by the chairman and CEO of the company is presented in the proxy. The compensation typically includes a salary, a bonus, and selected stock options in addition to other incentive plan payments.

Chapter 14 – SEC Reporting

C14-4 Form 10-K Disclosures a. The Management’s Discussion and Analysis must contain information on the following five items: liquidity, capital resources, results of operations, off-balance sheet arrangements, and a tabular disclosure of contractual obligations. Companies may present additional analysis, but those five items are required by the SEC. Caterpillar begins with an overview of the year and presents a discussion at a line-of-business level, on a comparative basis for a three-year period. Caterpillar’s MD&A is one of the most extensive of those provided by publicly traded companies and includes comments on a number of important issues affecting the company. b. The information presented in the Management’s Report on Internal Control Over Financial Reporting states that the management of the company is responsible for establishing and maintaining adequate internal control over financial reporting, that internal control over financial reporting may not prevent or detect misstatements, that management has assessed the effectiveness of the company’s internal control over financial reporting as of the end of the fiscal year and found the internal control system to be effective, and that management’s assessment of the effectiveness of the company’s internal control over financial reporting has been audited by the company’s independent registered public accounting firm. (Note that several of these provisions are requirements of the Sarbanes-Oxley Act of 2002.) c. The Report of Independent Registered Public Accounting Firm includes substantial discussion of their evaluation of the effectiveness of internal control over financial reporting, including a description of the criteria and methodology of that audit. d. The Chief Executive Office (CEO) and the Chief Financial Officer (CFO) must each sign a Section 302 Certification. The certification states that the two certifying officers are responsible for establishing and maintaining disclosures controls and procedures and internal control over financial reporting. The certification describes the purposes of the controls, that an evaluation was made of the effectiveness of the disclosure controls and procedures, and that disclosure is made of any changes in the registrant’s internal control over financial reporting that occurred during the last quarter that has materially affected, or is reasonably likely to materially effect, the registrant’s internal control over financial reporting. Finally, the certification includes a statement that the two certifying officers have disclosed their most recent evaluation of internal control over financial reporting to the registrant’s auditors and the audit committee of the company’s board of directors (or equivalent group), and any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Chapter 14 – SEC Reporting

C14-5 Registration Process [CMA Adapted] a. The Securities Act of 1933 requires a filing by any firm that raises capital in the primary capital market through the initial sale of a new security, whether by a public offering made directly by the firm or through an underwriter. The registration applies only to the specific quantity of the specific security being offered. The Securities Exchange Act of 1934 requires a filing by any firm whose securities are being traded publicly in the secondary capital market. These securities are registered as an entire class with no amount specified. A secondary offering of a firm's securities also requires the filing of a registration statement. b. An objective of the 1933 Act is to provide investors with material information concerning the issuing firm, its management, the securities offered for public sale, and the proposed use of the proceeds from the sale. The SEC does not evaluate the creditworthiness of the firm or attest to the potential of the security as an investment. The 1933 Act is an attempt to ensure that investors are given full and fair disclosure of all pertinent information about the issuing firm, including audited financial statements. c.

SEC Publication

Explanation

Regulation S-X

Instructions as to the form and content of the required financial statements.

Regulation S-K

Instructions as to the form and content of required disclosures other than the required financial statements (i.e., supplementary financial information, summary financial data, and nonfinancial information).

Financial Reporting Releases (formerly Accounting Series Releases)

Constitute part of Regulation S-X in the determination of the form and content of the required financial statements.

Staff Accounting Bulletins

Interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the federal securities laws.

Chapter 14 – SEC Reporting

C14-6 Change in Auditors and Form 8-K [CMA Adapted] (Students can access Item 304 of Regulation S-K on the SEC’s Website.) a. Jerford Company must include the following information in Form 8-K to the SEC regarding its change in auditors: 1. A statement if the former accountant resigned, declined to stand for re-election or was dismissed, and the date thereof. 2. A statement whether the former auditor's report on the financial statements for either of the previous two years contained an adverse opinion or a disclaimer of opinion, or was qualified in any way and the nature of each adverse opinion, disclaimer of opinion, or qualification. 3. A statement as to whether the decision to change accountants was recommended or approved by the audit or similar committee, or by the board of directors if the company does not have an audit committee. 4. A statement whether there were any disagreements with the former auditor on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure during the 24 months before the change. Each disagreement, if any, would have to be fully described whether or not it was resolved to the satisfaction of the former auditor. In addition, those disagreements which would have caused the former auditor to make reference to the subject matter of the disagreement in his report had they not been resolved would have to be identified. 5. A letter from the former auditor as an exhibit with Form 8-K that states whether the former auditor agrees or disagrees (including reason for disagreement) with the facts of the case as presented by the registrant. b. Using an Internet search engine, students can find a number of companies that have reported changes in a registrant’s certifying accountant. Alternatively, some colleges and universities have efficient search engines that can scan through the Edgar filings of the SEC. The focus of this question is to have students identify and examine an actual Form 8-K reporting of the change. Class discussion can bring in many students as you use the white board or other visual display media to categorize and count each of the reasons for the changes as identified by the students.

Chapter 14 – SEC Reporting

C14-7 Form 8-K [CMA Adapted] a. 1. The purpose of Form 8-K, called the Current Report, is to ensure that any significant event affecting a firm's policies or financial position is immediately reported to the SEC. Covering the period since the filing of the latest annual or quarterly report, Form 8-K provides a continuous stream of material information concerning specified events between filings. 2. Form 8-K must be filed with the SEC within 4 business days after the occurrence of a reportable event. Violation of the 8-K filing requirement may jeopardize a registrant's status. 3. Form 8-K is a narrative report with sufficient flexibility to permit management to describe any significant events. The first page must contain the standard 8-K heading identifying the reporting company, and the body of the report details the specified event or events in accordance with the disclosure requirements outlined in the SEC’s regulations for each event. The company may include other information, financial or otherwise, it deems appropriate for a complete description of the event. The report must be signed by an officer of the corporation. 4. The inclusion of audited and pro forma financial statements is required when reporting the acquisition of a business. Financial statements may be included in a Form 8-K in order to clarify the effect of any event on the corporation. In general practice, financial statements are included if an event is deemed to have a material financial impact. b. The SEC list of reportable events is included in the chapter. Any five of these events may be selected and discussed, but it may be interesting to see if there is a consensus on the most often selected by students in their lists of five. Also, the faculty member might ask students why they chose the five they selected.

Chapter 14 – SEC Reporting

C14-8 Audit Committees [CMA Adapted] a. The Sarbanes-Oxley Act specifies that audit committees be composed of nonmangement members of a company’s board of directors. Generally, the chair of the audit committee has financial experience. The Sarbanes-Oxley Act requires the auditor to report directly to, and have its work overseen by, the company’s audit committee, not the company’s management. The audit committee is responsible for the appointment, compensation and oversight of the work of the public accounting firm employed by the company. Furthermore, the audit committee must approve all services provided by the auditor, and the auditor must report the following additional information to the audit committee: critical accounting policies and practices, alternative treatments within GAAP that have been discussed with the company’s management, accounting disagreements between the auditor and management, and any other important issues arising between the auditor and management. b. The audit committee should act as an overseer of the company's internal audit staff. The audit committee would be concerned with such matters as the scope of internal audits, the completion of assignments, and discussion of the results of reviews conducted by the internal audit staff. c. Members appointed to serve on the audit committee should be outside board members (independent of management) because the Sarbanes-Oxley Act specifies that members be independent of management. The reasoning behind this requirement is that outside members would be free from bias or conflicts of interest, and outside members would be more objective in settling disputes between management and the external auditor. The Sarbanes-Oxley Act specifies that at least one person on the audit committee should be a financial expert.

Chapter 14 – SEC Reporting

C14-9 SEC a. A listing of recent SABs can be found on the SEC’s web site (www.sec.gov). Click on Staff Accounting Bulletins under the Staff Interpretations heading. There are now over 100 of these SABs and it is expected that the staff will continue to publish new ones in the future. Encourage students to select an interesting SAB that interests them. The statements in Staff Accounting Bulletins are not rules or interpretations of the Commission nor are they published as bearing the Commission's official approval. Rather they reflect the Commission staff’s views and provide interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the Federal securities laws. The SABs may be very narrowly written to describe the staff view of a particular event or circumstance. The purpose of the SABs is to disseminate staff views on particular matters for guidance in other situations where events and transactions have similar accounting implications. b. (1) & (2) The SEC’s web site (http://www.sec.gov) brings up a Litigation link. That link includes information on SEC enforcement actions (including both Federal Court and Administrative Proceedings), briefs filed by the SEC staff, and notices on specific cases. (1) The Division of Enforcement was created in August 1972. (2) In general, the Commission's enforcement staff conducts investigations into possible violations of the federal securities laws. The Commission will prosecute the civil suits in the federal courts or conduct administrative proceedings. In civil suits, the Commission seeks injunctions (i.e., an order that prohibits future violations) and will often seek civil money penalties and the return of illegal profits. In addition, the courts may also bar or suspend individuals from acting as corporate officers or directors. The Commission can bring a variety of Administrative Proceedings. These proceedings are heard by administrative law judges and by the Commission itself. There are many types of proceedings, a few examples include: a cease and desist order, an order to the respondent to disgorge ill-gotten funds, and an order to suspend employment. (3) A listing of recent Litigation Releases can be found at the SEC’s web site. Encourage students to select a recent case that looks interesting to them. (4) A listing of recent administrative proceedings can be found at the SEC’s web site. Students should be able to see the difference between Litigation in the Federal Court and Administrative Proceedings.

Chapter 14 – SEC Reporting

C14-10 EDGAR Database Internet URL: http://www.sec.gov/edgar.shtml/ The above URL provides access to the EDGAR database. From here, the user is able to select “Search for Company Filings,” then select “Company or fund name….” Students may now enter the name of their selected company. It is easiest to identify a company name prior to performing the search. Students will quickly see the large number of filings made by publicly held companies. As for describing the purposes of each of the filings, students could access the “Descriptions of SEC Forms” link on the opening page of the SEC’s web site.

C14-11 Discovery Case The Sarbanes-Oxley Act (SOX) presents a number of major changes in the auditing/consulting relationship between companies and accounting firms. The Act was written because of the major accounting and financial mismanagement cases discovered in 2000 and 2001. These cases resulted in the bankruptcies of very large companies such as Enron and WorldCom and the demise of Arthur Andersen, LLP, one of the Big-5 public accounting firms at that time. The JOBS Act relaxed a number of regulatory requirements making it simpler for emerging growth companies to meet filing requirements and deadlines. The choice of databases will be based on what each college or university has available. It is expected that these Acts will continue to have impacts on accounting firms (through the PCAOB) and on the economy (as regulations around securities filings are relaxed). The important aspect of this Discovery Case is that students search for, and find, contemporary business articles on these laws and their impacts on accounting firms and the capital markets.

Chapter 14 – SEC Reporting

SOLUTIONS TO EXERCISES E14-1

Organization Structure [CMA Adapted]

and

Regulatory

Authority

the

SEC

1. c –The SEC does have authority over the disclosure in Corporate annual reports, and the content contained in them. (a) incorrect. This statement is true. (b) incorrect. This statement is true. (d) incorrect. This statement is true. 2. b –This statement is true. (a) incorrect. This in not a role played by the SEC. (c) incorrect. This in not a role played by the SEC. (d) incorrect. The SEC still has authority over the stock exchanges. (e) incorrect. The SEC has broad powers over setting reporting requirments. 3. b –The Division of Corporation Finance develops and administers the disclosure requirements for the securities acts and reviews all registration statements and other issue-oriented disclosures. (a) incorrect. The Office of the Chief Accountant assists the Commission by studying current accounting issues and preparing position papers for the SEC to consider (c) incorrect. The Division of Enforcement has various responsibilities of enforcement ranging from persuasion to administrative proceedings to litigation. (d) incorrect. The Division of Market Regulation regulates national securities exchanges, brokers, and dealers of securities. (e) incorrect. This answer is incorrect as there is no office of the Comptroller. 4. d –Regulation S-X presents the rules for preparing financial statements, footnotes, and the auditor’s report. (a) incorrect. This statement is false. (b) incorrect. This statement is false. (c) incorrect. This statement is false. (e) incorrect. This statement is false. 5. d –The SEC does not make an effort to improve the actual securities being traded. The SEC makes an effort to ensure that the investors can trust the information that is being presented by the companies about their securities. (a) incorrect. The SEC establishes federal regulation over securities exchanges and markets (b) incorrect. The SEC does strive to prevent unfair practices on securities exchanges and markets. (c) incorrect. The SEC does discourage and prevent the use of credit in financing excessive speculation in securities. (e) incorrect. The SEC controls unfair use of information by corporate insiders.

Chapter 14 – SEC Reporting

6. d –Regulation S-K specifies disclosure rules of nonfinancial items to be included in registration statements, such as, supplementary financial information such as quarterly financial data and information on the effects of changing prices. (a) incorrect. Regulation S-K does not deal with this. (b) incorrect. Regulation S-K does not deal with this. (c) incorrect. Regulation S-K does not deal with this. (e) incorrect. Regulation S-K does not deal with this. E14-2 Registration of New Securities [CMA Adapted] 1. e – It is not the job of the SEC to comment on the accuracy of the statements, that is the job of the independent auditor. (a) incorrect. This statement is false. (b) incorrect. This statement is false. (c) incorrect. This statement is false. (d) incorrect. This statement is false. 2. c –The registrant is prohibited from accepting offers to purchase the securities being registered from potential investors. (a) incorrect. This statement is false. (b) incorrect. This statement is false. (d) incorrect. This statement is false. (e) incorrect. This statement is false. 3. b –The purpose of the “comfort letter” is to find out if the public accountant found any adverse financial change between the date of audit and the effective date of the securities offering. (a) incorrect. This is not the purpose of the comfort letter, (c) incorrect. This is not the purpose of the comfort letter, (d) incorrect. This is not the purpose of the comfort letter, (e) incorrect. This is not the purpose of the comfort letter, E14-3 Reporting Requirements of the SEC [CMA Adapted] 1. a –The form is an annual form due 60 days after the year end. (b) incorrect. This is not true of the form 10-K. (c) incorrect. This is not true of the form 10-K. (d) incorrect. This is not true of the form 10-K. (e) incorrect. This is not true of the form 10-K.

2. c – Regulation S-X presents the rules for preparing financial statements, footnotes, and the auditor’s report. (a) incorrect. This is not a dealt with by the regulation S-X. (b) incorrect. This is not a dealt with by the regulation S-X. 14-16 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 14 – SEC Reporting

(d) incorrect. This is not a dealt with by the regulation S-X. (e) incorrect. This is not a dealt with by the regulation S-X. 3. b –Form 10-Q is a quarterly report due 40 days after the first three quarters for an accelerated filer. (a) incorrect. This is not true of the 10-Q. (c) incorrect. This is not true of the 10-Q. (d) incorrect. This is not true of the 10-Q. (e) incorrect. This is not true of the 10-Q. 4. d –Form 8-K is used to disclose unscheduled events. The form must be filed within four business days of the triggering event. (a) incorrect. This is the annual form filed with the SEC. (b) incorrect. This is the quarterly form filed with the SEC. (c) incorrect. This the registration statement for companies issuing its first IPO. (e) incorrect. Not a valid form. 5. e –This would be a triggering event and it is classified under Financial Information. (a) incorrect. This would not be considered a triggering event. (b) incorrect. This would not be considered a triggering event. (c) incorrect. This would not be considered a triggering event. (d) incorrect. This would not be considered a triggering event. 6. b –The changing of accounting principle is not a triggering event. (a) incorrect. This is a triggering event. (c) incorrect. This is a triggering event. (d) incorrect. This is a triggering event. (e) incorrect. This is a triggering event. 7. d –The election of a new vice president would not be included in the 8-K (a) incorrect. This would be included in the 8-K. (b) incorrect. This would be included in the 8-K. (c) incorrect. This would be included in the 8-K. (e) incorrect. This would be included in the 8-K. E14-4 Corporate Governance [CMA Adapted] 1. a –The Foreign Corrupt Practices Act of 1977 has two major parts, (1) individuals associated with U.S. Companies cannot bribe foreign governmental officials, and (2) Companies are required to keep detailed records that accurately and fairly reflect their financial transactions and to develop and maintain an adequate internal control system. (b) incorrect. This was not required by this Act. (c) incorrect. This was not required by this Act. (d) incorrect. This was not required by this Act. (e) incorrect. This was not required by this Act.

Chapter 14 – SEC Reporting

2. b –A proxy statements allows one shareholder to vote on the behalf of another. (a) incorrect. A Registration Statement is filed by a company issuing an IPO. (c) incorrect. The 10-K is the annual filing to the SEC. (d) incorrect. The prospectus provides preliminary information to investors about an upcoming offering. 3. a –The SEC is the reigning authority over companies operating in the U.S. (b) incorrect. The FASB is overseen by the SEC. (c) incorrect. (d) incorrect. The AICPA is a group of CPA’s that regulates the integrity of CPA’s. 4. e –The 10-Q is made up of interim financial statements and the auditors job is to ensure the information depicted in the statements is accurate, however, a full audit is not required. Only a review is performed by the auditor on the quarterly data and provides a lower level of assurance than an audit which is done annually. (a) incorrect. (b) incorrect. (c) incorrect. (d) incorrect.

Chapter 14 – SEC Reporting

E14-5 Application of Securities Act of 1933 [CMA Adapted] The impact of the registration requirements of the Securities Act of 1933 on each of the proposals is as follows: 1.

The offering of the participation units in the citrus groves, although ostensibly the sale of an interest in land, constitutes an offer to sell, or the sale of, securities within the meaning of section 2 of the Securities Act of 1933. Although land itself is not a security, the offering of the land in conjunction with a management contract has been held to constitute the offering of a security. Since interstate commerce and communications are to be used and since there is no apparent transactional exemption available, a registration under the 1933 act is required. Whatever hope there was of an intrastate offering exclusion is dashed by the fact that the units will be offered and sold in two states.

The short-term borrowings evidenced by the promissory notes of Various Enterprises are exempt from registration. This exemption from categorization as a security for purposes of registration under the act applies to commercial paper such as notes, drafts, checks, and similar paper arising out of a current transaction that have a maturity not exceeding nine months. In addition, the private placement exemption is applicable.

If Various is deemed to be a controlling person insofar as Resistance is concerned, it must register the securities in question before it can legally sell them. The Securities Act of 1933 provides in connection with its definition of the term “underwriter,” that, “the term ’issuer’ shall include in addition to an issuer, any person directly or indirectly controlling or controlled by the issuer, or any person under direct or indirect common control with the issuer.” Securities Act rule 405(f) further defines the term “control.” It states that “the term ‘control’... means the possession, direct or indirect, of the power to direct or cause the direction of the policies of a person, whether through the ownership of voting securities, by contract, or otherwise.” It is obvious that “control” as defined is a question of fact. In general, a controlling person has the power to influence the management and policies of the issuer. If any individual is an officer, director, or member of the executive committee, a low percentage of stock would suffice. Actual or practical control is sufficient and the power to exercise control will also be sufficient even if it is not exercised. Stock ownership is looked to and majority ownership naturally constitutes control. Although ownership of 17 percent of the stock is certainly not conclusive, it is a substantial block of stock and, if any of the above factors is also present, it would be most likely that Various would be a controlling person. Thus, although not the issuer of the stock, it would need to register the securities. This resembles a secondary offering of a large block by the owners of the corporation. This sale through the brokers will in no way insulate the transaction from registration.

Chapter 14 – SEC Reporting

E14-6 Federal Securities Acts [AICPA Adapted] 1. a –The prospectus is part of the registration statement and gives investors preliminary information on the upcoming offering. (b) incorrect. (c) incorrect. (d) incorrect. 2. b –Securities exchanged by an issuer exclusively with its existing shareholders with no commission charged are exempt. (a) incorrect. Not exempt. (c) incorrect. Not exempt. (d) incorrect. Not exempt. 3. b –Rule 506 of Regulation D allows private placements of an unlimited amount of securities to accredited investors and a maximum of 35 unaccredited investors who must be sophisticated investors with knowledge and experience in financial affairs. (a) incorrect. Regulation D, Rule 504 is for issuances of up to $5,000,000. (c) Incorrect. The company could comply with Regulation D, Rule 506. 4. a –Small issues under the SEC’s Regulation A for Tier 1 issuances of up to $20,000,000 within a 12-month period can be exempt if there is a notice filed with the SEC and an “offering circular” containing financial and other information provided to the persons to whom the offer is made. (b) incorrect. This is not required of the issuer. (c) incorrect. This is not required of the issuer. (d) incorrect. This is not required of the issuer. 5. b –All companies listing stock on national stock exchanges are regulated by the SEC per the Securities Exchange Act of 1934. (a) incorrect. This is not a deciding factor. (c) incorrect. This is not a deciding factor. (d) incorrect. This is not a deciding factor. 6. b –An owner of 5 percent of a company’s debentures is not considered an insider. (a) incorrect. This position would be considered an insider. (c) incorrect. This position would be considered an insider. (d) incorrect. This position would be considered an insider.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

CHAPTER 15 PARTNERSHIPS: FORMATION, OPERATION, AND CHANGES IN MEMBERSHIP ANSWERS TO QUESTIONS Q15-1 Partnerships are a popular form of business because they are easy to form (informal methods of organization) and because they allow several individuals to combine their talents and skills in a particular business venture. In addition, partnerships provide a means of obtaining more equity capital than a single individual can invest and allow the sharing of risks for rapidly growing businesses. Partnerships are also allowed to exercise greater freedom in their choice of accounting methods. Q15-2 The major provisions of the Uniform Partnership Act (UPA) of 1997 have been enacted by most states to regulate partnerships operating in those states. The UPA of 1997 describes many of the rights of each partner and of creditors during creation, operation, or liquidation of the partnership. Q15-3 The types of items that are typically included in the partnership agreement include: a. The name of the partnership and the names of the partners b. The type of business to be conducted by the partnership and the duration of the partnership agreement c. The initial capital contribution of each partner and how future capital contributions are to be accounted for d. A complete discussion of the profit or loss distribution, including salaries, interest on capital balances, bonuses, limits on withdrawals in anticipation of profits, and the percentages used to distribute any residual profit or loss e. Procedures used for changes in the partnership such as methods of admitting new partners and procedures to be used on the retirement of a partner f. Other aspects of operations the partners decide on, such as the management rights of each partner, election procedures, and accounting methods Q15-4 (a) Separate business entity means that the partnership is a legal entity separate and distinct from its partners. The partnership can own property in its own name, can sue, be sued, and can continue as an entity even though the membership of the partners changes with new admissions or with partner disassociations. (b) Creditors view each partner as an agent of the partnership capable of transacting in the ordinary course of the partnership business. Creditors may use this reliance unless the creditors receive a notification that the partner lacks authority for engaging in a specific type of transaction that would be used between the creditor and that partner. The partnership should file a Statement of Partnership Authority to specifically state any limitations of authority of specific partners. This voluntary statement is filed with the Secretary of State and the clerk of the county in which the partnership operates. The Statement of Partnership Authority is sufficient notice to state a partner’s authority for real estate transactions.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

(c) In the event the partnership fails and its assets are not sufficient to pay its liabilities, each partner has joint and several personal liability for the partnership obligations. Each partner with a capital account that has a debit balance must make a contribution to the partnership to reduce the debit balance to zero. These contributions are then used to settle the remaining amounts of the partnership liabilities. If a partner fails to make the required contribution, then all other partners must make additional contributions, in proportion to the ratio used to allocate partnership losses, until the partnership obligations are settled. Thus, a partner can be held legally responsible to make additional contributions to a partnership in dissolution if one or more other partners fail to make a contribution to remedy their capital deficits. Q15-5 A deficiency in a partner's capital account would exist when the partner's share of losses and withdrawals exceeds the initial capital account balance and share of profits. A deficiency is usually eliminated by additional capital contributions. Q15-6 The percentage of profits each partner will receive, along with the allocation of $60,000 profit, is calculated as follows: Percentage of Profits Partner 1 Partner 2 Partner 3

4/15 = 26.67% 6/15 = 40.00% 5/15 = 33.33%

Profit to be Allocated x x x

$60,000 $60,000 $60,000

Allocation = = =

$16,000 $24,000 $20,000

Q15-7 The choices of capital balances available to the partners include beginning capital balances, ending capital balances, or an average (usually weighted-average) capital balance for the period. The preferred capital balance is the weighted-average capital balance because this method explicitly recognizes the time span each capital level was maintained during the period. Q15-8 Salaries to partners are generally not an expense of the partnership because salaries, like interest on capital balances, are widely interpreted to be a result of the respective investments and are used not in the determination of income, but rather in the determination of the proportion of income to be credited to each partner's capital account. This treatment is based on the proprietary concept of owners’ equity that interprets salaries to partners as equivalent to a withdrawal in anticipation of profits. Salaries are sometimes specified in the partnership agreement; however, in larger partnerships, salaries are typically determined by a partners’ compensation committee. And also, under the old partnership law, a partnership was not an independent legal entity, but rather an aggregation of some of the rights of the individual partners. With the advent of the UPA of 1997 which defines a partnership as a separate legal entity, a theoretical argument could be made that salaries and capital interest paid to partners do cross the entity border and could be accounted for as a business expense. Few partnerships need audited financial statements prepared in accordance with GAAP so the financial statement treatment of partners’ salaries has not been a major issue because the financial reporting for partnerships is more focused on meeting the information needs of the partners.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

Q15-9 In most cases a partner’s disassociation does not result in the dissolution and winding up of the partnership. The UPA of 1997 provides for a process whereby the disassociating partner’s interest in the partnership can be purchased by the partnership. The buyout price of a disassociated partner’s partnership interest is computed as the estimated amount that would have been distributable to the disassociating partner if the assets of the partnership were sold at the greater of the liquidation value or the value based on the sale of the entire business and the partnership was wound up, including payment of all partnership liabilities. There are some specific events that cause dissolution and winding up of the partnership business. These events are covered in Section 801 of the UPA of 1997 and will be discussed at length in chapter 16. Students wishing to expand their understanding of dissolution are encouraged to examine Section 801 of the Act. Q15-10 The book value of a partnership is the total value of the capital, which is also the difference between total assets and total liabilities. The book value may or may not represent the market value of the partnership. Q15-11 The arguments for the bonus method include preservation of the historical cost principle and the accounting principles stated in ASC 350. The arguments against the bonus method include a necessity for a fair valuation of the partnership assets and the partners may dislike having to “share” part of their capital account balances with other partners. Q15-12 The new partner's capital credit is equal to the investment made when (1) the investment equals the proportionate present book value, (2) the assets of the partnership are revalued prior to admission of the new partner, or (3) goodwill is recognized for the present partners. The new partner's capital credit is not equal to the tangible investment made when bonus is recognized or when goodwill is recognized for the new partner. Q15-13 Aabel's bonus is $3,000 ($20,000 x 0.15) if the bonus is computed as a percentage of income before the bonus. Aabel's bonus is $2,608.70 [Bonus = 0.15($20,000 - Bonus)] if the bonus is computed as a percentage of income after deducting the bonus. Q15-14 The implied fair value of the ABC partnership is $36,000 ($12,000 / 0.33333…). The entry the ABC partnership would make upon the admission of Caine follows. Cash Goodwill [$36,000 - ($12,000 + $21,000)] Other Partners' Capital Accounts Caine, Capital

12,000 3,000 3,000 12,000

Q15-15A The basis of Horton's contribution for tax purposes is $3,500 and is calculated as follows: $5,000 book value less ($2,000 assumed liability x 0.75) = $3,500 The basis of Horton's contribution for GAAP purposes is $8,000 and is calculated as follows: $10,000 market value less $2,000 assumed liability = $8,000 Q15-16B A joint venture is a short-term association of two or more parties to fulfill a specific project. Corporate joint ventures are accounted for on the books of the investor companies by the equity method of accounting for investments in common stock.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

SOLUTIONS TO CASES C15-1 Partnership Agreement a.

The partnership agreement should be as specific as possible to avoid later differences of opinion. In addition, the partnership agreement should be written as a formal agreement and signed by all partners. The basic elements of a partnership agreement should include the following: 1. The name of the partnership and the names of the partners 2. The type of business to be conducted and the term, if any, of the partnership 3. The initial capital contribution of each partner and the method(s) of accounting for future capital contributions 4. The income or loss sharing procedures 5. Procedures for changes in the partnership such as admission of new partners or retirements of present partners 6. Any other specific procedures important to the partners

Salaries and bonuses to partners are part of the income distribution process regardless of how they are reported by the partnership. Some partnerships prefer to report these within the partnership's income statement in order to compare the results of the partnership with other business entities.

Not recording salaries and bonuses to partners in the income statement reflects the true nature of these items and reports income from the partnership before any distributions. Thus, the income statement reflects the total profit to be distributed to the partners.

The partnership agreement should state the following if interest is to be provided on invested capital: 1. The capital balance to be used as the base for interest: Beginning of period, average (simple or weighted) for the period, or end-of-period balances. 2. The rate of interest to be paid, or the basis by which the rate is to be determined. 3. When interest is to be determined in the profit or loss distribution process. For example, should salaries and bonuses be added to the capital accounts before interest is computed?

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

C15-2 Comparisons of Bonus and Goodwill / Asset Revaluation Methods MEMO to BGA Partnership: This memo discusses the two alternative methods of accounting for the admission of Newt, a new partner. To state the present positions, Bill favors the bonus method, George favors the goodwill method, and Anne favors the revaluation of existing tangible assets. Technically, the goodwill and asset revaluation methods both involve revaluing the balance sheet. While the goodwill method records a previously unrecorded asset (goodwill), the revaluation method revalues existing assets on the balance sheet to their fair values. For purposes of this memo, we discuss these similar options separately. These methods are all used in practice to account for the admission of a new partner. The bonus method is a realignment of present partnership capital. No additional capital, beyond the tangible investment of the new partner, is created in the admission process. Some partners prefer this approach because it immediately states the proper capital relationships on the admission of the new partner and does not require the write-up of assets. The goodwill method results in the recognition of goodwill, either the goodwill generated by the prior partners during the existence of the old partnership, or the goodwill being contributed by the new partner. Goodwill is subject to an impairment test under the provisions of ASC 350. Any future impairment loss recognitions will affect all partners’ capital accounts in proportion to their profit and loss sharing ratios in the future periods as goodwill impairments are recognized. If new partners are allowed into the partnership, or a present partner withdraws, the effect on each partner's capital account will be different than if the bonus method is used. New partners will have to share in the writeoff of goodwill, even goodwill created before a new partner's admission. The revaluation of existing assets could be done under either of the two above cases. This provides for the proper recognition of the assets and the distribution of any holding gain to the partners who were part of the partnership while the market increase took place. For example, the assets could be revalued to their market value on the basis of appraisals and then the bonus or goodwill method could be used. This would preclude a new partner from sharing in the holding gain that existed before the new partner's admission. The final decision must be made by the partners. All partners should agree to the specific method, or methods, to be used to account for the admission of Newt. The decision should be formalized, written, and signed by all partners.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

C15-3 Uniform Partnership Act Issues This solution uses the Uniform Partnership Act of 1997 (UPA of 1997) for its references. This Act is available on the Internet and can be found using most internet search engines. a. Section 301 of the UPA of 1997 specifies that every partner does have the right to act as an agent of the partnership for carrying on in the ordinary course the partnership business, unless the partner has in fact no authority to act for the partnership in the particular manner, and the person with whom the partner is dealing has knowledge of the fact that the partner has no such authority. b. Section 306 of the UPA of 1997 specifies that a new partner is not personally liable for any partnership obligation incurred before the person’s admission as a partner. But, the new partner may still lose the capital contribution made to be admitted to the partnership. The key point is that the new partner is not at risk beyond the capital contribution made for admission. A partner is liable for partnership obligations incurred after his/her admission. c. Section 403 of the UPA of 1997 specifies that each partner, their agents and attorneys, may inspect the partnership’s books and records, and copy any of them, during normal business hours. d. Section 406 of the UPA of 1997 specifies that if the initial term of the partnership is completed, and the partnership continues, the rights and duties of the partners remain the same but the partnership is now viewed as a partnership at will. A partnership at will means that the partners are not committing to a term of time or to a project. A partner in a partnership at will has more legal protection from possible damages from the other partners if he or she wishes to disassociate from the partnership. A new partnership agreement is not needed for the continuation, but it is a good idea to make sure that all continuing partners are in agreement with the ongoing partnership efforts. e. While it is very easy to form a partnership, it is not easy to simply leave a partnership. Sections 601 through 603 of the UPA of 1997 discuss a partner’s disassociation and its effect on the partnership. A partner expressing the request to no longer be in the partnership may be subject to damages from a wrongful disassociation. This suggests that the initial partnership agreement should include any specific provisions on resignations of partners if the partners feel the UPA of 1997’s guidelines are not sufficient for their partnership. f. The items to be included in the partnership agreement are dependent upon the wishes of the initial partners. The partnership agreement should include any items that the partners want to reach agreement on as a basis of the partnership, its operations, and its possible future dissolution. It is better to have agreement on many of the difficult items “up front” rather than ignoring them and then having them turn into large problems later on. If an item is not included in the partnership agreement, then the state’s laws on partnerships regulate the rights and responsibilities of the partners and the rights of third-parties, including creditors. There are some nonwaivable provisions of the UPA of 1997 as presented in Section 103 of the Act. A partnership agreement may not reduce or change any of the rights and responsibilities stated in Section 103.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

C15-4 Defining Partners’ Authority TO: Cathy RE: Authority of partners to engage in transactions Your partnership will be regulated by our state’s laws on partnership. Our state has enacted the provisions of the Uniform Partnership Act of 1997 (UPA of 1997) which is the most recent model act on partnership laws. The UPA of 1997 states, in its Section 301, that, “Each partner is an agent of the partnership for the purpose of its business. An act of a partner, including the execution of an instrument in the partnership name, for apparently carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership, unless the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received a notification that the partner lacked authority.” This means that each partner can bind the partnership for transactions that would be expected to take place in the type of business in which the partnership would be engaged. The issue of notice to third parties is important. Section 303 of the UPA of 1997 encourages all partnerships to file a Statement of Partnership Authority with the Secretary of State and also place a copy with the county clerk. This statement lists the specific authorities for partners and the Act specifies that the filed statement is sufficient notice for partners engaging in partnership real estate transactions. However, the statement of authority is not sufficient notice for other types of transactions. For these other types of transactions, such as purchasing items from suppliers, ordering goods online, or acquiring equipment for the business, suppliers may presume any partner has the authority to transact unless that supplier is given notification of a restriction on a partner’s authority to that supplier. This notice is best provided by written statement. But this may be difficult to do on a proactive basis because you may not know with whom an individual partner is transacting in the partnership’s name. You should also require that the specific authority of each partner be specified in the partnership agreement. If a partner breaches that agreement, you will have legal recourse against the partner, but that would mean seeking a legal judgment for that breach. That would take time and involve costs. You should have a frank and open discussion with both Adam and Bob expressing your concerns. If they are not interested in working with you to find ways to alleviate your concerns and take actions to avoid potential future problems of the nature you discuss, then it may be best for you not to become a partner in the business. If agreements cannot be worked out prior to the formation of a partnership, it is highly doubtful they will be worked out after the partnership is formed. Once you are in a partnership it may be difficult and costly to disassociate from (leave) the partnership.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

There are online sources of examples of partnership agreements, the Uniform Partnership Act of 1997, a Statement of Partnership Authority, and you can find our state’s partnership regulations through our Secretary of State’s website. I urge you to be sure to satisfy your concerns before you enter the partnership. Joining a partnership is a significant decision that involves potential personal liability for the partnership’s obligations, including those incurred by the other partners. Alternative business forms are available such as incorporating, for which you should consult with an attorney who has had experience in working with small business corporations.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

C15-5 Preferences of Using GAAP for Partnership Accounting TO: Jason and Richard RE: Your Questions on Using GAAP for Your Partnership Each of your questions will be addressed in this memo, but first, a few general comments regarding accounting for your partnership. We have discussed that you may select accounting methods other than those specified by generally accepted accounting principles (GAAP). For example, you may wish to use accounting methods consistent with those used for preparing your partnership’s tax-based statement of income and computing your taxable distributable amounts. In anticipation of preparing your annual tax returns, I keep a running list of the tax implications of your major transactions and if it would be helpful to you, I can discuss these tax implications with you in planning future transactions and evaluating transactions as they occur during the year. But, as we have discussed, tax-based accounting methods focus on determining what you will owe for taxes, not the economic foundation or the financial position you have both built since you started your partnership. We have also discussed the partnership’s need to obtain additional debt financing to increase the net assets needed for new areas of growth. Bankers and other lenders prefer financial statements prepared using GAAP because these persons understand how to properly evaluate the financial position and performance of your business if GAAP is used. They are familiar with GAAP and their requirement for audited financial statements prior to a larger loan will allow your business to be eligible for an unqualified audit opinion from the independent auditors. Thus, GAAP will provide these lenders with financial statements which they may have confidence fairly report your business’ financial positions. If GAAP is not used, the lenders may have to ask a lot of questions about our financial position and performance that will take us much time to analyze and properly answer. Now to your three questions: a. Salaries to partners: The Uniform Partnership Act of 1997 governs partnerships in our state. Section 401 (h) of that Act states that, “A partner is not entitled to remuneration for services performed for the partnership, except for reasonable compensation for services rendered in winding up the business of the partnership.” Salaries to partners are considered to be a distribution in anticipation of profits and thus are recorded directly against each partner’s capital account. The profit allocation schedules prepared each year include salaries as specified by your partnership agreement. Including salaries on the Statement of Income would be similar to including dividends on the Statement of Income. Thus, it is more acceptable to show salaries as part of the distribution of income rather than an expense of the partnership. b. Using GAAP to account for admission of a new partner: GAAP provides for recognizing impairment losses on long-lived assets held and used in the business but does not allow for the recognition of holding gains by increasing the value of these assets on the balance sheet. These long-lived assets are used in the production process of the business and you do not expect to sell them before their useful lives are substantially employed in the business. Instead of increasing the basis of the long-lived assets at the time of admitting a new partner, you could increase the investment required of the new partner and allocate a “bonus” to your capital accounts as the prior partners to reflect the increase in fair value of these long-lived assets. This is a relatively straight-forward process that is used by many partnerships. 15-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

C15-5 (continued) c. Analyzing the partnership’s liabilities prior to admission of a new partner: First, Section 306 (b) of the Uniform Partnership Act of 1997 states that, “A person admitted as a partner into an existing partnership is not personally liable for any partnership obligation incurred before the person’s admission as a partner.” The person you are considering asking to join the partnership will expect the partnership to have all of its liabilities recognized and correctly measured in order to properly calculate the personal liability of the new partner for only obligations generated after that new partner’s admission. Furthermore, as negotiations develop with the potential new partner, you will most certainly be asked to provide statements regarding the financial position of the partnership. You do not want to misrepresent the correct financial position and be personally liable for potential future damages sought by the new partner who based the decision of whether or not to invest in your partnership on your financial representations. And, by analyzing our recognized liabilities we may not only discover some unrecognized liabilities, but also we can make sure that the proper documentation is available on all liabilities to show the background of the transaction generating the liability, including the basis of the amount and the account. We will need these if we get into a disputed claim from one of our vendors. And we will need these to clearly document any loans made to the partnership by its current partners. You can think of this analysis as a form of insurance against potential future problems concerning the status of the partnership’s liabilities at the time of admitting the new partner. Please do not hesitate to ask me questions about any aspect of accounting and financial reporting for your partnership. We can discuss the reasons for using specific methods and the possible alternatives from which you may select in order to have the financial reports and statements be the most meaningful to each of you as you transact your business and continue to grow into the future.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

SOLUTIONS TO EXERCISES E15-1 Multiple-Choice Questions on Initial Investment [AICPA Adapted] 1. a – 2. c – 3. d – 4. b – $330,000 = $50,000 + ($310,000 - $30,000) 5. d – E15-2 Division of Income — Multiple Bases a.

Distribution of $80,000 income: Profit percentage Average capital Net income Interest on average capital (10%) Salary Residual income Allocate 70%:30% Total

Angela

Dawn

Total

70% $ 50,000

30% $ 30,000

100%

5,000 25,000

$ 3,000 15,000

22,400 $ 52,400

9,600 $ 27,600

$ 80,000 (8,000) (40,000) $ 32,000 (32,000) $ -0-

Angela

Dawn

Total

70% $ 50,000

30% $ 30,000

5,000 25,000

$ 3,000 15,000

(19,600) $ 10,400

(8,400) $ 9,600

Distribution of $20,000 income: Profit percentage Average capital Net income Interest on average capital (10%) Salary Residual income (deficit) Allocate 70%:30% Total

100% $ 20,000 (8,000) (40,000) $ (28,000) 28,000 $ -0-

Section 401 of the UPA of 1997 states that, “Each partner is entitled to an equal share of the partnership profits and is chargeable with a share of the partnership losses in proportion to the partner’s share of the profits.”

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-3 Division of Income – Interest on Capital Balances Computation of average capital: Average capital for Left Date 1/1 4/3 8/23 10/31 Total

Debit

Credit $8,000

$6,000 6,000

Balance

Months Maintained

$30,000 38,000 32,000 38,000

Months x Dollar Balance

3 5 2 2 12

$ 90,000 190,000 64,000 76,000 $420,000

Average capital ($420,000 / 12 months)

$ 35,000

Average capital for Right Date 1/1 3/5 7/6 10/7 Total

Debit

Credit

Balance

$7,000 5,000

$50,000 41,000 48,000 53,000

$9,000

Months Maintained

Months x Dollar Balance

2 4 3 3 12

$100,000 164,000 144,000 159,000 $567,000

Average capital ($567,000 / 12 months)

$ 47,250

Distribution of $50,000 income: Profit percentage Average capital Net income Interest on average capital (8%) Residual income Allocate 50%:50% Total

Left 50% $35,000

Right 50% $47,250

$ 2,800

$ 3,780

21,710 $24,510

21,710 $25,490

Total 100% $ 50,000 (6,580) $ 43,420 (43,420) $ -0-

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-4 a.

Distribution of Partnership Income and Preparation of a Statement of Partners' Capital

Distribution of partnership net income for 20X5: Profit percentage (if positive) Profit percentage (if negative) Net income Interest on average capital balances(see Schedule 1)

Apple 70% 50%

Jack 30% 50%

Total 100% 100% $ 80,000

$ 3,123

$ 7,220

(10,343) $ 69,657

Bonus on net income before the bonus but after interest (see Schedule 2)

6,966

Salaries

25,000

30,000

Residual income — allocate 70:30 Total

5,384 $40,473

2,307 $39,527

(6,966) $ 62,691 (55,000) $ 7,691 (7,691) $ -0-

Months Outstanding 3 9 12

Months x Capital Balance $ 122,400 502,200 $ 624,600

Schedule 1: Partners' average capital balances for 20X5: Capital Balance $ 40,800 $ 55,800

Apple — January 1 to April 1 — April 1 to December 31 Total Average capital balance ($624,600 / 12) Interest rate Interest on average capital balance

$ x $

Jack — January 1 to August 1 — August 1 to December 31 Total Average capital balance ($1,444,000 / 12) Interest rate Interest on average capital balance Schedule 2: Bonus = = =

$112,000 $132,000

7 5 12

52,050 0.06 3,123

$ 784,000 660,000 $1,444,000 $ 120,333 x 0.06 $ 7,220

Bonus on net income after interest on capital 0.10(net income - interest on capital) 0.10($80,000 - $10,343) $6,966

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-4 (continued) b.

Apple — Jack Partnership Statement of Partners' Capital For the Year Ended December 31, 20X5

Balance, January 1, 20X5 Add: Additional investment Net income distribution Less: Withdrawals Balance, December 31, 20X5

Apple

Jack

Total

$ 40,800 15,000 40,473 $ 96,273 (20,800) $ 75,473

$112,000 20,000 39,527 $171,527 (20,800) $150,727

$152,800 35,000 80,000 $267,800 (41,600) $226,200

Jack

Total

Apple — Jack Partnership Distribution of $80,000 Net Income Apple Profit percentage (if positive) Profit percentage (if negative)

70% 50%

Net income Interest on average capital balances (see Schedule 1)

30% 50%

100% 100% $ 80,000

$ 3,123

$ 7,220

Bonus on net income before the bonus and after interest (see Schedule 2)

6,966

Salaries

30,000

35,000

Residual loss — allocate 50:50

(1,155)

(1,154)

$38,934

$41,066

Total

(10,343) $ 69,657 (6,966) $ 62,691 (65,000) (2,309) 2,309 $

-0-

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-5 Matching Partnership Terms With Their Descriptions 1. F 2. E 3. H 4. C 5. G 6. A 7. I 8. D 9. M 10. B 11. J 12. L 13. J 14. D 15. B

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-6 Admission of a Partner a.

Determine required payment if no bonus or goodwill recognized: 2/3 total resulting capital

$ 400,000

Total resulting capital ($400,000 / 0.66666…) Total net assets prior to admission Required contribution ($600,000 x 0.3333)

$ 600,000 (400,000) $ 200,000

Therefore, Elan must invest $200,000 for a 1/3 interest. b.

Elan invests $80,000 for 20 percent interest; goodwill recorded: Investment in partnership New partner's proportionate book value [($400,000 + $80,000 ) x 0.20] Difference (investment cost < book value)

$ 80,000 (96,000) $ (16,000)

Method: Goodwill to new partner Step 1: 4/5 estimated total resulting capital Estimated total resulting capital ($400,000 / 0.80)

$ 400,000 $ 500,000

Step 2: Estimated total resulting capital Total net assets not including goodwill ($400,000 + $80,000) Estimated goodwill to new partner Cash Goodwill Elan, Capital $100,000 = $500,000 x 0.20

$ 500,000 (480,000) $ 20,000 80,000 20,000 100,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-6 (continued) c.

Elan invests $200,000 for a 20 percent interest; total capital specified as $600,000: Investment in partnership New partner's proportionate book value [($400,000 + $200,000) x 0.20] Difference (investment cost > book value)

$ 200,000 (120,000) $ 80,000

Method: Goodwill or bonus to prior partners Specified total capital Total net assets not including goodwill ($400,000 + $200,000) Estimated goodwill

$ 600,000 (600,000) $ -0-

Therefore, bonus method is used because no additional capital is created. Cash Mary, Capital ($80,000 x 0.60) Gene, Capital ($80,000 x 0.30) Pat, Capital ($80,000 x 0.10) Elan, Capital ($600,000 x 0.20)

200,000 48,000 24,000 8,000 120,000

d. Section 306 of the UPA of 1997 states that “A person admitted into an existing partnership is not personally liable for any partnership obligation incurred before the person’s admission as a partner.” Although Elan would not be personally liable, she does have the risk of losing her investment in the partnership.

E15-7 Admission of a Partner a.

Gerry invests $50,000 and goodwill is to be recorded: Investment in partnership New partner's proportionate book value [($160,000 + $50,000) x 0.20] Difference (investment cost > book value)

$ 50,000 $

(42,000) 8,000

Method: Goodwill to prior partners Step 1: 0.20 estimated total resulting capital Estimated total resulting capital ($50,000 / 0.20)

$ 50,000 $ 250,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-7 (continued) Step 2: Estimated total resulting capital Total net assets not including goodwill ($160,000 + $50,000) Estimated goodwill to prior partners

$ 250,000 (210,000) $ 40,000

Cash Goodwill Pam, Capital ($40,000 x 0.75) John, Capital ($40,000 x 0.25) Gerry, Capital ($250,000 x 0.20)

50,000 40,000 30,000 10,000 50,000

NON- GAAP: Recognition of goodwill at the time a new partner is admitted is not GAAP. Under GAAP, goodwill is to be recognized only when acquired. An entity cannot recognize internally generated goodwill. b.

Gerry invests $50,000; total capital is to be $210,000: Investment in partnership New partner's proportionate book value [($160,000 + $50,000) x 0.20] Difference (investment > book value)

$ 50,000 $

(42,000) 8,000

Method: Goodwill or bonus to prior partners Specified total resulting capital Total net assets not including goodwill ($160,000 + $50,000) Estimated goodwill

$ 210,000 (210,000) $ -0-

Therefore, bonus of $8,000 to prior partners Cash Pam, Capital ($8,000 x 0.75) John, Capital ($8,000 x 0.25) Gerry, Capital ($210,000 x 0.20)

50,000 6,000 2,000 42,000

GAAP: Partners are legally able to allocate their capital interests however they choose. c.

Direct purchase from Pam; thus, only reclassify capital: Pam, Capital Gerry, Capital ($160,000 x 0.20)

32,000 32,000

GAAP: A purchase of a partnership share made directly from a present partner is an allocation of that partner’s capital interest. Note that the partnership did not receive the $50.000 cash.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-7 (continued) d.

Gerry invests $35,000; total capital to be $195,000: Investment in partnership New partner's proportionate book value [($160,000 + $35,000) x 0.20] Difference (investment < book value)

35,000

(39,000) (4,000)

Method: Goodwill or bonus to new partner Specified total resulting capital Total net assets not including goodwill ($160,000 + $35,000) Estimated goodwill

$ 195,000 (195,000) $ -0-

Therefore, bonus of $4,000 to new partner Cash Pam, Capital ($4,000 x 0.75) John, Capital ($4,000 x 0.25) Gerry, Capital ($195,000 x 0.20)

35,000 3,000 1,000 39,000

GAAP: Partners may allocate capital among themselves, including new capital received from a partner being admitted into the partnership. e.

Gerry invests $35,000 and goodwill to be recorded: Investment in partnership New partner's proportionate book value [($160,000 + $35,000) x 0.20] Difference (investment < book value)

$ 35,000 (39,000) $ (4,000)

Method: Goodwill to new partner Step 1: 0.80 estimated total resulting capital Estimated total resulting capital ($160,000 / 0.80) Step 2: Estimated total resulting capital Total net assets not including goodwill ($160,000 + $35,000) Estimated goodwill to new partner Cash Goodwill Gerry, Capital $40,000 = $200,000 x 0.20

$ 160,000 $ 200,000 $ 200,000 (195,000) $ 5,000 35,000 5,000 40,000

NON- GAAP: Recognition of goodwill at the time a new partner is admitted is not allowed under GAAP.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-7 (continued) f.

Gerry invests $35,000; inventory write down of $20,000 recognized Write down inventory to LOCOM prior to admission of new partner. Reduction of $20,000 to market. Pam, Capital ($20,000 x 0.75) John, Capital ($20,000 x 0.25) Inventory

15,000 5,000 20,000

Investment in partnership New partner's proportionate book value [($140,000 + $35,000) x 0.20] Difference (investment = book value)

35,000

(35,000) -0-

Method: No bonus or goodwill stated. Cash Gerry, Capital ($175,000 x .20)

35,000 35,000

GAAP: Note that the write down of inventory to its lower-of-cost-or-market value is proper under GAAP. This results in the prior partners’ capital of $140,000 ($160,000 less $20,000 write down). Any revaluations of assets or liabilities that are proper under GAAP should be made before determining the prior partners’ capital that is used in computing the new partner’s proportionate book value of the total resulting capital of the partnership.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-8 Multiple-Choice Questions on the Admission of a Partner 1.

d–

Specified no bonus or goodwill: 5/6 estimated total resulting capital Estimated total resulting capital ($150,000 / 5/6)

$ 150,000 $ 180,000

Required investment ($180,000 x 1/6)

$ 30,000

d–

Direct purchase; reclassify Claire's capital only.

c–

Scott invests $36,000 for a 1/5 interest: Investment in partnership New partner's proportionate book value [($120,000 + $36,000) x 0.20] Difference (investment > book value)

$ 36,000 $

(31,200) 4,800

Method: Goodwill to prior partners Step 1: 1/5 estimated total resulting capital Estimated total resulting capital ($36,000 / 0.20) Step 2: Estimated total resulting capital Total net assets not including goodwill ($120,000 + $36,000) Estimated goodwill to prior partners 4.

b–

$ 36,000 $ 180,000 $ 180,000 (156,000) $ 24,000

Lisa invests $40,000 and total capital specified as $150,000: Investment in partnership New partner's proportionate book value [($110,000 + $40,000) x 1/3] Difference (investment < book value)

$ 40,000 (50,000) $ (10,000)

Method: Bonus or goodwill to new partner Specified total resulting capital Total net assets not including goodwill ($110,000 + $40,000) Estimated goodwill

$ 150,000 (150,000) $ -0-

Therefore, bonus of $10,000 to new partner Boris' capital = $54,000 = $60,000 - ($10,000 x 6/10)

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-8 (continued) 5.

c–

Pete invests $17,000; no goodwill recorded: Investment in partnership New partner's proportionate book value [($60,000 + $17,000) x 1/5] Difference (investment > book value)

$ 17,000 $

(15,400) 1,600

Method: Bonus to prior partners Pete's capital credit = $77,000 x 1/5 = $15,400 6.

b–

Direct purchase and computation of gain to prior partners: Selling price Book value of interest sold [($139,000 + $209,000 + $96,000) x 1/5] Gain to Ella and Nick

$132,000 (88,800) * $ 43,200

*Tony acquired a one-fifth interest in the net assets of the partnership. 7.

b–

Lute invests $25,000 and total capital specified as $90,000: Investment in partnership New partner's proportionate book value [($65,000 + $25,000) x 1/3] Difference (investment < book value)

$ 25,000 (30,000) $ (5,000)

Method: Bonus or goodwill to new partner Specified total resulting capital Total net assets not including goodwill ($65,000 + $25,000) Estimated goodwill

$ 90,000 (90,000) $ -0-

Therefore, bonus of $5,000 to new partner Cash Fred, Capital ($5,000 x 0.70) Ralph, Capital ($5,000 x 0.30) Lute, Capital ($90,000 x 1/3) 8.

25,000 3,500 1,500 30,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-9 Withdrawal of a Partner a.

Karl receives $38,000 and no goodwill is recorded: Bonus to withdrawing partner: Payment Karl’s capital account Bonus paid

$ 38,000 (30,000) $ 8,000

Karl, Capital Luis, Capital ($8,000 x 0.80) Marty, Capital ($8,000 x 0.20) Cash b.

30,000 6,400 1,600 38,000

Karl receives $42,000 and only the withdrawing partner's share of goodwill is recognized: Payment to Karl Karl's capital account Karl's share of goodwill

$ 42,000 (30,000) $ 12,000

Goodwill Karl, Capital Cash c.

12,000 30,000 42,000

Recognize all implied goodwill on payment of $35,000: Karl's share of goodwill ($35,000 - $30,000 capital)

$ 5,000

1/6 Total estimated goodwill Total estimated goodwill ($5,000 / 0.16666…)

$ 5,000 $30,000

Record goodwill: Goodwill Luis, Capital ($30,000 x 0.6667) Marty, Capital ($30,000 x 0.1667) Karl, Capital ($30,000 x 0.1667) Withdrawal of Karl: Karl, Capital Cash d.

30,000 20,000 5,000 5,000 35,000 35,000

Section 701 of the UPA of 1997 defines the buyout price of a disassociated partner’s interest in the partnership as the estimated amount that would be distributable to that partner if the assets of the partnership were sold at a price equal to the greater of the liquidation value or the value based on a sale of the entire business as a going concern without the disassociated partner and the partnership was wound up including all partnership obligations paid. Thus, the buyout price is equivalent to what the disassociating partner would have received if the partnership had wound up and terminated.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

E15-10 Retirement of a Partner Case 1: Bonus of $10,000 to Eddy: Eddy, Capital Cobb, Capital ($10,000 x 3/5) Davis, Capital ($10,000 x 2/5) Cash

70,000 6,000 4,000

Case 2: Distribution of Eddy's share of goodwill: Goodwill Eddy, Capital

4,000

Eddy, Capital Cash

80,000

4,000 74,000 74,000

Case 3: Bonus of $5,000 distributed to remaining partners: Eddy, Capital Cash Cobb, Capital ($5,000 x 3/5) Davis, Capital ($5,000 x 2/5) Case 4: Recognize total implied goodwill: Goodwill Cobb, Capital ($24,000 x 3/6) Davis, Capital ($24,000 x 2/6) Eddy, Capital ($24,000 x 1/6) Eddy, Capital Cash

70,000 65,000 3,000 2,000 24,000 12,000 8,000 4,000 74,000 74,000

Case 5: Other assets disbursed: Other Assets Cobb, Capital ($60,000 x 3/6) Davis, Capital ($60,000 x 2/6) Eddy, Capital ($60,000 x 1/6) Eddy, Capital Cash Other Assets

60,000 30,000 20,000 10,000 80,000 40,000 40,000

Case 6: Davis directly purchases Eddy's capital interest: Eddy, Capital Davis, Capital

70,000 70,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

SOLUTIONS TO PROBLEMS P15-11 Admission of a Partner a.

Wayne purchases one-half of Merina's investment for $90,000: Merina, Capital Wayne, Capital

80,000 80,000

Wayne invests amount for one-third interest; no goodwill or bonus: 2/3 Total resulting capital Total resulting capital ($360,000 / 2/3)

$ 360,000 $ 540,000

Amount to be invested by Wayne ($540,000 x 1/3)

$ 180,000

Cash Wayne, Capital c.

180,000 180,000

Wayne invests $110,000 for a one-fourth interest; goodwill: Investment in partnership New partner's proportionate book value [($360,000 + $110,000) x 1/4] Difference (investment cost < book value)

$ 110,000 (117,500) $ (7,500)

Method: Goodwill to new partner Step 1: 3/4 estimated total resulting capital Estimated total resulting capital ($360,000 / 3/4) Step 2: Estimated total resulting capital Total net assets not including goodwill ($360,000 + $110,000) Estimated goodwill to new partner Cash Goodwill Wayne, Capital $120,000 = $480,000 total resulting capital x 1/4 d.

$ 360,000 $ 480,000 $ 480,000 (470,000) $ 10,000 110,000 10,000 120,000

Wayne invests $100,000 for a one-fourth interest; some inventory is obsolete: Investment in partnership New partner's proportionate book value [($360,000 + $100,000) x 1/4] Difference (investment cost < book value)

$ 100,000 (115,000) $ (15,000)

Method: Asset revaluation decrease to prior partners

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-11 (continued) Step 1: 1/4 estimated total resulting capital Estimated total resulting capital ($100,000 / 1/4) Step 2: Estimated total resulting capital Total net assets before inventory write-down ($360,000 + $100,000) Inventory write-down required Record write-down: Debra, Capital ($60,000 x 0.60) Merina, Capital ($60,000 x 0.40) Inventory

$ 100,000 $ 400,000 $ 400,000 (460,000) $ (60,000) 36,000 24,000 60,000

Record admission of Wayne: Cash 100,000 Wayne, Capital $100,000 = 1/4 of $400,000 resulting total capital after write-down e.

100,000

Wayne purchases one-fourth interest directly from Debra and Merina; land revalued: New partner's proportionate book value ($360,000 x 1/4) $ 90,000 Method stated: Increase land valuation Step 1: 1/4 estimated total resulting capital ($80,000 + $60,000) Estimated total resulting capital ($140,000 / 1/4) Step 2: Estimated total resulting capital Total net assets before land revaluation ($200,000 + $160,000) Increase in value of land

$ 140,000 $ 560,000 $ 560,000 (360,000) $ 200,000

Revalue land: Land Debra, Capital ($200,000 x 0.60) Merina, Capital ($200,000 x 0.40)

200,000 120,000 80,000

Reclassification of capital for admission of Wayne: Debra, Capital ($320,000 x 0.25) 80,000 Merina, Capital ($240,000 x 0.25) 60,000 Wayne, Capital 140,000 $140,000 = 1/4 of $560,000 total resulting capital after recording increase in value of land.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-11 (continued) f.

Wayne invests $80,000 for a one-fifth interest; total capital specified as $440,000: Investment in partnership $ 80,000 New partner's proportionate book value [($360,000 + $80,000) x 1/5] (88,000) Difference (investment cost < book value) $ (8,000) Method: Bonus or goodwill to new partner Specified total resulting capital Total net assets not including goodwill ($360,000 + $80,000) Estimated goodwill

$ 440,000 (440,000) $ -0-

Therefore, bonus of $8,000 to new partner Cash Debra, Capital ($8,000 x 0.60) Merina, Capital ($8,000 x 0.40) Wayne, Capital ($440,000 x 1/5) g.

80,000 4,800 3,200 88,000

Wayne invests $100,000 for a one-fifth interest; goodwill recorded. Investment in partnership New partner's proportionate book value [($360,000 + $100,000) x 1/5] Difference (investment cost > book value) Method: Goodwill to prior partners Step 1: 1/5 estimated total resulting capital Estimated total resulting capital ($100,000 / 1/5) Step 2: Estimated total resulting capital Total net assets not including goodwill ($360,000 + $100,000) Estimated goodwill to prior partners Record goodwill: Goodwill Debra, Capital ($40,000 x 0.60) Merina, Capital ($40,000 x 0.40)

$ 100,000 $

(92,000) 8,000

$ 100,000 $ 500,000 $ 500,000 (460,000) $ 40,000 40,000 24,000 16,000

Admission of Wayne: Cash 100,000 Wayne, Capital 100,000 $100,000 = 1/5 of $500,000 total resulting capital after recording goodwill of $40,000.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-11 (continued) Balance Sheet Format (Not Required) Prior to admission of new partner: Wayne Net Assets New partner’s cash investment Cash Capital prior to recognizing goodwill Estimated new goodwill Goodwill Total resulting capital Net Assets

$360,000

Prior partner’s capital

$360,000

100,000

New tangible capital

100,000

$460,000

40,000

Capital from goodwill

40,000

$500,000

Total resulting capital

$500,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-12 Division of Income a.

Distribution of $78,960 income:

Profit ratio Ending capital Net income Salary Bonusa Interest on ending capital balance (10%) Residual income Allocate 3:3:4 Total a

Bonus B 20B 21B B

= = = = =

Eastwood

North

West

Total

3 $28,000

3 $40,000

4 $48,000

$15,000 3,760

$20,000

$18,000

2,800

4,000

4,800

3,180 $24,740

3,180 $27,180

4,240 $27,040

$ 78,960 (53,000) (3,760) (11,600) $ 10,600 (10,600) $ -0-

0.05(Net Income - Bonus) 0.05($78,960 - B) $78,960 - B $78,960 $3,760

Distribution of $68,080 net income: Average capital for Eastwood Date 1/1 5/1 9/1 Total

Debit

Credit $6,000

$8,000

Balance $30,000 36,000 28,000

Months Maintained 4 4 4 12

Average capital ($376,000 / 12 months)

Months x Dollar Balance $120,000 144,000 112,000 $376,000 $ 31,333

Average capital for North Date 1/1 3/1 7/1 9/1 Total

Debit

Credit

$9,000 $5,000 4,000

Balance $40,000 31,000 36,000 40,000

Average capital ($436,000 / 12 months)

Months Maintained 2 4 2 4 12

Months x Dollar Balance $ 80,000 124,000 72,000 160,000 $436,000 $ 36,333

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-12 (continued) Average capital for West Date 1/1 4/1 6/1 8/1 Total

Debit

Credit

Months Maintained 3 2 2 5 12

Balance $50,000 57,000 60,000 48,000

$7,000 3,000 $12,000

Months x Dollar Balance $150,000 114,000 120,000 240,000 $624,000

Average capital ($624,000 / 12 months)

$ 52,000

Distribution of $68,080 income: Profit ratio Average capital Net income Interest on average capital balance (10%) Salary Bonusa Residual income (deficit) Allocate 1:1:1 Total a

Bonus B B 10B 11B B

= = = = = =

Eastwood 1 $31,333

North 1 $36,333

West 1 $52,000

Total 3 $ 68,080

$ 3,133 24,000

$ 3,633 21,000 4,280

$ 5,200 25,000

(6,055) $21,078

(6,055) $22,858

(6,056) $24,144

(11,966) (70,000) (4,280) $(18,166) 18,166 $ -0-

0.10(Net Income - Bonus - North's Salary) 0.10($68,080 - B - $21,000) 0.10($47,080 - B) $47,080 – B $47,080 $4,280

Distribution of $92,940 net income: Profit ratio Beginning capital Net income Bonusa Salary Interest on beginning capital balance (10%) Residual income Allocate 8:7:5 Total a

Bonus B B 5B 6B B

= = = = = =

Eastwood 8 $30,000

North 7 $40,000

West 5 $50,000

21,000

18,000

6,490 15,000

3,000

4,000

5,000

8,180 $32,180

7,158 $29,158

5,112 $31,602

Total 20 $ 92,940 (6,490) (54,000) (12,000) $ 20,450 (20,450) $ -0-

0.20(Net Income - Bonus - Salaries) 0.20($92,940 - B - $54,000) 0.20($38,940 - B) $38,940 – B $38,940 $6,490

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-13 Determining a New Partner's Investment Cost a.

$200,000

(No goodwill or bonus recorded)

Cash Snider, Capital ($800,000 x 1/4) 0.75 estimated total resulting capital Estimated total resulting capital ($600,000 / 0.75) Prior capital Cash contribution required from Snider b.

$210,000

$ 600,000 $ 800,000 (600,000) $ 200,000

Goodwill Der, Capital ($30,000 x 0.40) Egan, Capital ($30,000 x 0.30) Oprins, Capital ($30,000 x 0.30)

30,000

Cash Snider, Capital ($840,000 x 1/4)

210,000

$232,000

0.75 estimated total resulting capital ($600,000 + $24,000 bonus) Estimated total resulting capital ($624,000 / 0.75) Prior capital before bonus from Snider Cash contribution required from Snider $190,000

12,000 9,000 9,000 210,000 $ 630,000 $ 840,000 (630,000) $ 210,000

(Bonus of $24,000 to be paid by Snider)

Cash Der, Capital ($24,000 x 0.40) Egan, Capital ($24,000 x 0.30) Oprins, Capital ($24,000 x 0.30) Snider, Capital ($832,000 x 1/4)

200,000

(Goodwill of $30,000 to prior partners)

0.75 estimated total resulting capital Estimated total resulting capital ($630,000 / 0.75) Prior capital after goodwill recognition Cash contribution required from Snider c.

200,000

232,000 9,600 7,200 7,200 208,000 $ 624,000 $ 832,000 (600,000) $ 232,000

(New partner given $10,000 of goodwill)

Cash Goodwill Snider, Capital ($800,000 x 1/4) 0.75 estimated total resulting capital Estimated total resulting capital ($600,000 / 0.75) Prior capital Capital credit to Snider Goodwill to Snider Cash contribution required from Snider

190,000 10,000 200,000 $ 600,000 $ 800,000 (600,000) $ 200,000 (10,000) $ 190,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-13 (continued) e.

$220,000

(Other assets increased by $20,000 and goodwill of $40,000 allocated to prior partners)

Other Assets Goodwill Der, Capital ($60,000 x 0.40) Egan, Capital ($60,000 x 0.30) Oprins, Capital ($60,000 x 0.30)

20,000 40,000

Cash Snider, Capital ($880,000 x 1/4)

220,000

0.75 estimated total resulting capital ($600,000 + $60,000 revaluation and goodwill) Estimated total resulting capital ($660,000 / 0.75) Prior capital after recognition of asset revaluation and goodwill to prior partners Cash contribution required from Snider f.

$220,000

24,000 18,000 18,000 220,000 $ 660,000 $ 880,000 (660,000) $ 220,000

(No goodwill; total resulting capital is $820,000)

Cash Der, Capital ($15,000 x 0.40) Egan, Capital ($15,000 x 0.30) Oprins, Capital ($15,000 x 0.30) Snider, Capital ($820,000 x 1/4)

220,000 6,000 4,500 4,500 205,000

Specified total resulting capital Prior capital Cash contribution required from Snider

$ 820,000 (600,000) $ 220,000

Investment in partnership New partner's proportionate book value [($600,000 + $220,000 ) x 0.25] Difference (investment > book value)

$ 220,000 (205,000) $ 15,000

Method: Bonus of $15,000 to prior partners

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-13 (continued) g.

$140,000

(Other assets decreased $20,000; bonus of $40,000 to new partner)

Der, Capital ($20,000 x 0.40) Egan, Capital ($20,000 x 0.30) Oprins, Capital ($20,000 x 0.30) Other Assets

8,000 6,000 6,000

Cash Der, Capital ($40,000 x 0.40) Egan, Capital ($40,000 x 0.30) Oprins, Capital ($40,000 x 0.30) Snider, Capital ($720,000 x 1/4)

140,000 16,000 12,000 12,000

0.75 estimated total resulting capital after asset write-downs and bonus to new partner ($600,000 - $60,000) Estimated total resulting capital ($540,000 / 0.75) Prior capital after asset write-downs and bonus to new partner Capital credit to Snider Bonus to Snider Cash contribution required from Snider

20,000

180,000

$ 540,000 $ 720,000 (540,000) $ 180,000 (40,000) $ 140,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-14 Division of Income a. Distribution of $64,260 net income: Average capital for Luc Date

Debit

1/1 4/1 8/1 Total

Credit

Balance

$ 5,000

$50,000 55,000 40,000

$15,000

Months Maintained 3 4 5 12

$150,000 220,000 200,000 $570,000

Average capital ($570,000 / 12 months)

Date

Debit

1/1 7/1 9/1 Total

$ 47,500

Average capital for Dennis Months Credit Balance Maintained $70,000 60,000 82,500

$10,000 $22,500

6 2 4 12

Profit ratio Average capital Net income Salary Interest on average capital (10%) Bonusa Residual income Allocate 3:2 Total Bonus B 20B 21B B

= = = = =

Months x Dollar Balance $420,000 120,000 330,000 $870,000

Average capital ($870,000 / 12 months)

Months x Dollar Balance

$ 72,500 Luc

Dennis

Total

3 $47,500

2 $72,500

$24,000 4,750 3,060

$28,000 7,250

(1,680) $30,130

(1,120) $34,130

$ 64,260 (52,000) (12,000) (3,060) $ (2,800) 2,800 $ -0-

0.05(Net Income - Bonus) 0.05($64,260 - B) $64,260 – B $64,260 $3,060

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-14 (continued) b.

Distribution of $108,700 income:

Profit ratio Ending capital balance after deducting salaries of $24,000 for Luc and $28,000 for Dennis Net income Salary Interest on ending capital balance (10%) Bonusa Residual income Allocate 1:1 Total a

Bonus B 12.50B 13.50B B

= = = = =

Luc

Dennis

Total

$16,000

$54,500

$24,000

$28,000

1,600 4,200

5,450

22,725 $52,525

22,725 $56,175

$108,700 (52,000) (7,050) (4,200) $ 45,450 (45,450) $ -0-

0.08(Net Income - Bonus - Salaries) 0.08($108,700 - B - $52,000) $56,700 - B $56,700 $ 4,200

c. Distribution of $76,950 income:

Profit ratio Beginning capital balance Net income Salary Interest on beginning capital balance (10%) Bonusa Residual income Allocate 4:2 Total a

Bonus B 8B 9B B

= = = = =

Luc

Dennis

Total

4 $50,000

2 $70,000

$24,000

$28,000

5,000 8,550

7,000

2,933 $40,483

1,467 $36,467

$ 76,950 (52,000) (12,000) (8,550) $ 4,400 (4,400) $ -0-

0.125(Net Income - Bonus) 0.125($76,950 - B) $76,950 - B $76,950 $8,550

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-15 Withdrawal of a Partner under Various Alternatives a.

Spade's capital interest was acquired in a personal transaction with Jack. Spade, Capital Jack, Capital

120,000 120,000

Amount paid by Jack for Spade's capital Interest Recorded amount of Spade's capital interest Goodwill attributable to Spade Spade's share of profits/losses Implied value of the partnership's goodwill ($30,000 / 0.50) – allocated to all partners in the ratio 20:30:50

$ 150,000 (120,000) $ 30,000 50% $ 60,000

Goodwill Ace, Capital (0.20 x $60,000) Jack, Capital (0.30 x $60,000) Spade, Capital (0.50 x $60,000)

60,000

Spade, Capital ($120,000 + 30,000) Jack, Capital

150,000

12,000 18,000 30,000 150,000

The partnership paid a bonus to Spade upon retirement. Total capital of the partnership after Spade's retirement was $290,000. Amount paid to Spade upon retirement Spade's capital credit Bonus paid to Spade — allocated to Ace and Jack in the ratio 40:60 Spade, Capital Ace, Capital (0.40 x $60,000) Jack, Capital (0.60 x $60,000) Cash

$ 180,000 (120,000) $ 60,000 120,000 24,000 36,000 180,000

Capital balances after retirement: Ace, Capital ($150,000 - $24,000) Jack, Capital ($200,000 - $36,000) Total capital

$ 126,000 164,000 $ 290,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-15 (continued) d.

Spade was given cash and land. Capital of the partnership after Spade's retirement was $310,000. Profit ratio Capital balances before Spade's retirement Gain recognized on transfer of land to Spade ($120,000 minus $100,000) Capital balances after allocation of gain

Ace 20%

Jack 30%

Spade 50%

$150,000

$200,000

$ 120,000

4,000

6,000

10,000

$154,000

$206,000

$ 130,000

Amount paid to Spade ($60,000 cash and $120,000 land) Spade's capital interest — see above schedule Bonus to Spade allocated between Ace and Jack in the ratio 40:60

$ 180,000 (130,000) $ 50,000

Land Ace, Capital (0.20 x $20,000) Jack, Capital (0.30 x $20,000) Spade, Capital (0.50 x $20,000)

20,000

Spade, Capital Ace, Capital (0.40 x $50,000) Jack, Capital (0.60 x $50,000) Cash Land

130,000 20,000 30,000

4,000 6,000 10,000

60,000 120,000

Capital balances after Spade's retirement: Ace, Capital ($154,000 - $20,000) Jack, Capital ($206,000 - $30,000) Total capital e.

$ 134,000 176,000 $ 310,000

Spade was given $150,000 upon retirement, and the goodwill attributable to Spade was recognized. Amount paid to Spade Spade's capital interest Goodwill attributable to Spade

$ 150,000 (120,000) $ 30,000

Spade, Capital Goodwill Cash

120,000 30,000 150,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-15 (continued) f.

Spade was given $150,000 upon retirement, and goodwill applicable to the entire business was recorded. Amount paid to Spade Spade's capital interest Goodwill attributable to Spade Spade's share of profits/losses Goodwill attributable to the entire partnership $30,000/0.50 — allocated to all the partners in the ratio 20:30:50

Goodwill Ace, Capital (0.20 x $60,000) Jack, Capital (0.30 x $60,000) Spade, Capital (0.50 x $60,000)

60,000

Spade, Capital Cash

150,000

$ 150,000 (120,000) $ 30,000 50% $ 60,000 12,000 18,000 30,000 150,000

Spade was given land and a note payable upon retirement. Capital of the partnership after Spade's retirement was $360,000. Ace Profit ratio 20% Capital balances before Spade's Retirement $150,000 Allocation of gain on transfer of land ($100,000 - $60,000 = $40,000) 8,000 Capital balances before Spade's retirement, adjusted for gain $158,000 Amount paid to Spade ($100,000 of land + $50,000 note) Spade's capital interest — adjusted Bonus given to Spade — allocated between Ace and Jack in the ratio 40:60

Jack 30%

Spade 50%

$200,000

$ 120,000

12,000

20,000

$212,000

$ 140,000 $ 150,000 (140,000) $ 10,000

Land Ace, Capital (0.20 x $40,000) Jack, Capital (0.30 x $40,000) Spade, Capital (0.50 x $40,000)

40,000

Spade, capital Ace, Capital (0.40 x $10,000) Jack, Capital (0.60 x $10,000) Land Note Payable

140,000 4,000 6,000

8,000 12,000 20,000

100,000 50,000

Capital balances after Spade's retirement: Ace, Capital ($158,000 - $4,000) Jack, Capital ($212,000 - $6,000) Total capital

$154,000 206,000 $360,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-16

Multiple Choice Questions — Initial Investments, Division of Income, Admission and Retirement of a Partner [AICPA Adapted]

d–

The contribution of noncash property into a partnership should be recorded by crediting the partner's capital account for the fair value of the property contributed. In effect, the partnership is acquiring the property from the partner at its fair value.

b–

The capital balances of William and Martha at the date of partnership formation are determined as follows: Cash Inventory Building Furniture and equipment Total Less mortgage assumed by partnership Amounts credited to capital

d–

c–

William $20,000 15,000 $35,000

Martha $ 30,000 15,000 40,000 $ 85,000

$35,000

(10,000) $ 75,000

Total of old partners' capital Investment by new partner Total of new partnership capital Capital amount credited to Johnson ($95,000 x 0.20)

$ 80,000 15,000 $ 95,000 $ 19,000

The capital balances of each partner are determined as follows: Apple $50,000

Cash Property Mortgage assumed Equipment Amount credited to capital accounts

Blue

Crown

$ 80,000 (35,000) $ 55,000 $50,000

$ 45,000

$ 55,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-16 (continued) 5.

d–

Because both partners have equal capital balances, Norbert's capital has to be increased to equal that of Moon's. Since Moon's capital balance is $60,000 and Norbert's is $20,000, an additional $40,000 has to be credited to Norbert's capital to make it equal Moon's capital. This additional amount credited to Norbert's capital is the goodwill that Norbert is bringing to the partnership.

a–

Moon's share of the net income of $25,000 is 60%, or $15,000.

d–

Crowe and Dagwood are getting a bonus from Elman, since the amount of Elman's investment into the partnership exceeds the amount credited to Elman's capital account. The bonus should be allocated to Crowe and Dagwood in their respective profit and loss ratio before the admission of Elman—–the old profit and loss ratio.

b–

The net income of $80,000 is allocated to Blue and Green in the following manner:

Salary allowances Remainder Allocation of the negative remainder in the 60:40 ratio Allocation of net income 9.

c–

Blue

Green

$ 55,000

$45,000

(12,000) $ 43,000

(8,000) $37,000

Net Income $ 80,000 (100,000) $ (20,000)

20,000 -0-

Jill received a bonus when she retired from the partnership. The bonus is being given to Jill by Bill and Hill, which means that the bonus is allocated to Bill's and Hill's capital accounts in their respective profit and loss sharing ratio.

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-17 Partnership Formation, Operation, and Changes in Ownership a.

Entries to record the formation of the partnership and the events that occurred during 20X7:

(1)

(2)

(3)

(4)

(5)

(5) (6)

(8) (7)

Cash Inventory Land Equipment Mortgage payable Installment Note Payable Jordan, Capital ($60,000+ $80,000 + $100,000 - $20,000) O’Neal, Capital ($50,000 + $130,000 - $50,000)

110,000 80,000 130,000 100,000

Inventory Cash Accounts Payable

30,000

Mortgage Payable Interest Expense Cash

5,000 2,000

Installment Note Payable Interest Expense Cash

3,500 2,000

50,000 20,000 220,000 130,000 24,000 6,000

7,000

5,500

Accounts Receivable Cash Sales

21,000 134,000

Selling and General Expenses Cash Accrued Expenses Payable

34,000

Depreciation Expense Accumulated Depreciation

6,000

Jordan, Drawing ($200 x 52) O’Neal, Drawing Cash

10,400 10,400

Sales Income Summary

155,000

155,000 27,800 6,200 6,000

20,800 155,000

Cost of Goods Sold 90,000 Inventory 90,000 $90,000 = $80,000 beginning inventory + 30,000 purchases - 20,000 ending inventory

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-17 (continued) (8)

(8)

Income Summary Cost of Goods Sold Selling and General Expenses Depreciation Expense Interest Expense

134,000

Income Summary Jordan, Capital O’Neal, Capital

21,000

Jordan, Capital O’Neal, Capital Jordan, Drawing O’Neal, Drawing

10,400 10,400

90,000 34,000 6,000 4,000 10,500 10,500

10,400 10,400

Schedule to allocate partnership net income for 20X7: Profit percentage Beginning capital balance Net income ($155,000 revenue - $134,000 expenses) Interest on beginning capital balances (3%)

Jordan 60% $220,000

O’Neal 40% $130,000

6,600

3,900

Salaries

12,000

Residual deficit Total

(8,100) $ 10,500

(5,400) $ 10,500

Total 100% $350,000 $ 21,000 (10,500) $ 10,500 (24,000) $(13,500) 13,500 $ -0-

Jordan — O’Neal Partnership Income Statement For the Year Ended December 31, 20X7 Sales Less: Cost of Goods Sold: Inventory, January 1 Purchases Goods Available for Sale Less: Inventory, December 31 Gross Profit Less: Selling and General Expenses Depreciation Expense Operating Income Nonoperating Expense – Interest Net Income

$155,000 $ 80,000 30,000 $110,000 (20,000) $ 34,000 6,000

(90,000) $ 65,000 (40,000) $ 25,000 (4,000) $ 21,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-17 (continued) Jordan — O’Neal Partnership Balance Sheet At December 31, 20X7

Assets Cash Accounts Receivable Inventory Land Equipment (net) Total Assets

$158,900 21,000 20,000 130,000 94,000 $423,900 Liabilities and Capital

Liabilities: Accounts Payable Accrued Expenses Payable Installment Note Payable Mortgage Payable Total Liabilities Capital: Jordan, Capital O’Neal, Capital Total Capital Total Liabilities and Capital d.

6,000 6,200 16,500 45,000 $ 73,700 $220,100 130,100 350,200 $423,900

Hill's investment into the partnership Prior partners' capital Total capital of the new partnership Hill's capital credit (0.20 x $450,000) Bonus allocated to Jordan and O’Neal in the ratio 60:40

99,800 350,200 $450,000 $ 90,000 $

9,800

January 1, 20X8 journal entry: Cash Jordan, Capital (0.60 x $9,800) O’Neal, Capital (0.40 x $9,800) Hill, Capital

99,800 5,880 3,920 90,000

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-18 Formation of a Partnership and Allocation of Profit and Loss Part I: Haskins and Sells Partnership Balance Sheet At January 2, 20X3 Assets Current assets: Cash Temporary Investments Trade Accounts Receivable Less: Allowance for uncollectible accounts Note Receivable Inventories Total Current Assets

$ 55,000 81,500 $70,000 (4,500)

65,500 50,000 62,500 $314,500

Property, Plant, and Equipment: Building (less accumulated depreciation of $230,000)

370,000

Intangible Assets: Customer Lists Total Assets

60,000 $744,500

Liabilities and Partnership Capital: Current Liabilities: Current Portion of Mortgage Payable

$ 25,000

Long-term Liabilities: Mortgage Payable, less current portion

150,000

Partnership Capital: Haskins, Capital Sells, Capital

$327,000 242,500

Total Liabilities and Partnership Capital

569,500 $744,500

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

P15-18 (continued) Part II: a.

Haskins and Sells Partnership Income Statement For the Year Ended December 31, 20X3

Revenues Less: Cost of Goods Sold Gross Profit Operating Expenses: Selling, General, and Administrative Expenses Net Income

$ 650,000 (320,000) $ 330,000 (70,000) $ 260,000

Note that salaries paid to partners and the bonus paid to Haskins are distributions of partnership net income and are not expenses of the partnership. b. Description 10% bonus to Haskins Salaries to each partner Residual net income: $74,000 Total

Haskins $ 26,000 90,000 14,800 $130,800

Sells $ 70,000 59,200 $129,200

Total $ 26,000 160,000 74,000 $260,000

c. Description Capital balances, January 3, 20X3 Add: Net income for 20X3 Withdrawals made during the year* Capital balances at December 31, 20X3

Haskins $327,000 130,800 (100,000) $357,800

Capital Sells $242,500 129,200 (75,000) $296,700

Total $569,500 260,000 (175,000) $654,500

*Note that the salaries were also withdrawn during the year, so Haskins’ total withdrawals are $100,000 ($90,000 salary+ $10,000) and Sells’ were $75,000 ($70,000 salary + $5,000). d. To find out what partnership net income would have to be for each partner to receive the same amount of income, determine the amount of income difference that would go to each partner for each additional dollar of partnership net income. To illustrate, assume that partnership net income was $261,000 instead of $260,000. How would this incremental $1,000 affect the distribution of net income? To find out the answer to this question, see the computation below. Description Bonus to Haskins Salaries to each partner Remainder to each partner ($74,900) Total

Haskins $ 26,100 90,000 14,980 $131,080

Sells $ 70,000 59,920 $129,920

Total $ 26,100 160,000 74,900 $261,000

The increase of $1,000 in partnership net income resulted in a $280 increase in Haskins’ share of net income and a $720 increase in Sells’ share of net income. Another way to look at this is that for a $1,000 increase in partnership net income, Sells will receive $440 more, or 44% more, than Haskins ($720 minus $280 = $440 divided by $1,000).

Chapter 15 – Partnerships: Formation, Operation, and Changes in Membership

Take this information and use it to answer the question. At partnership net income of $260,000, Haskins will receive $1,600 more net income than Sells ($130,800 minus $129,200). Take the difference between these two incomes and divide it by 0.44. Dividing $1,600 by 0.44 equals $3,636. Add this amount to $260,000 to get $263,636, the amount of partnership net income that would result in each partner receiving the same amount of net income. P15-19A Initial Investments and Tax Bases [AICPA Adapted] a.

Entry to record initial investments using GAAP accounting: Cash Computers and Printers Office Furniture Library Building Notes Payable Mortgage Payable Delaney, Capital Engstrom, Capital Lahey, Capital Simon, Capital Record initial investments in DELS partnership.

50,000 18,000 23,000 7,000 60,000 25,000 36,000 32,000 22,000 15,000 28,000

Tax bases:

Tax basis of assets contributed Add: Partner's share of other partners' liabilities assumed by the partnership: $36,000 from Delaney x 1/4 $10,000 from Engstrom x 1/4 $15,000 from Lahey x ¼ Less: Partner's liabilities assumed by other partners: $36,000 x ¾ $10,000 x ¾ $15,000 x ¾ Total

Delaney

Engstrom

Lahey

Simon

$40,000

$26,000

$ 33,000

$26,000

9,000

9,000 2,500

9,000 2,500 3,750

2,500 3,750

3,750

(27,000) (7,500) $ 19,250

$31,250

(11,250) $ 33,250

$41,250

Chapter 16 – Partnerships: Liquidation

CHAPTER 16 PARTNERSHIPS: LIQUIDATION ANSWERS TO QUESTIONS Q16-1 The major causes of a dissolution are: a. b. c. d. e.

Withdrawal or death of a partner The specified term or task of the partnership has been completed All partners agree to dissolve the partnership An individual partner is bankrupt By court decree: i. the partnership cannot achieve its economic purpose (typically defined as seeking a profit) ii. a partner seriously breaches the partnership agreement that makes it impracticable to continue the partnership business iii. It is not practicable to carry on the partnership in conformity with the terms of the partnership agreement

The accounting implications of a dissolution are to determine each partner's capital balance on the date of dissolution of the partnership and begin the liquidation process. Q16-2 The UPA 1997 states that a partnership’s liabilities to individual partners have the same legal status as liabilities to outside parties. However, as a practical matter, partners often subordinate their loans to the partnership to other debts. Q16-3 The implications that arise for partners X and Y are that both of the partners may be required to contribute a portion of their capital balances or personal assets to satisfy partnership creditors if there are not sufficient partnership assets to cover the partnership liabilities. Partners X and Y will share this contribution according to their relative loss ratio. Q16-4 In an “at will” partnership (one without a partnership agreement that states a definite time period or specific undertaking for the partnership), a partner may simply withdraw from the partnership. Many partnerships have a provision in their partnership agreement for a buyout of an “at will” partner who wishes to leave the partnership. In a partnership that has a definite term or a specific undertaking specified in the partnership agreement, a partner who simply withdraws has committed a wrongful disassociation. If the partnership incurs any damages, the partnership may sue the partner who withdraws for the recovery of those damages. Q16-5 A lump-sum liquidation of a partnership is one in which all assets are converted into cash within a very short time, creditors are paid, and a single, lump-sum payment is made to the partners for their capital interests. An installment liquidation is one that requires several months to complete and includes periodic, or installment, payments to the partners during the liquidation period. Q16-6 A deficit in a partner's capital account (relating to an insolvent partner) is eliminated by distributing the deficit to the other solvent partners in their resulting loss ratio. 16-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 16 - Partnerships: Liquidation

Q16-7 The DEF Partnership is insolvent because the liabilities of the partnership ($61,000) exceed the assets of the partnership ($55,000). The liabilities of the partnership are calculated as follows: Assets $55,000

Liabilities Liabilities Liabilities

= = =

Owners' Equity $6,000 + ($20,000) + $8,000 $61,000

Q16-8 A partnership may not legally engage in unlawful activities. In this example, the new law requires the dissolution and termination of the partnership. The two partners can seek a court decree for the termination of the partnership if the other three partners do not agree to wind up and liquidate the partnership. The partnership’s assets will be sold and the partnership’s obligations shall be settled. Individual partners are required to remedy any deficits in their capital accounts and any remaining resources will be distributed to the partners in accordance with their rights. Q16-9 A partner's personal payment to partnership creditors is accounted for by recording a cash contribution to the partnership with an increase in the partner's capital balance. The cash is then used to pay the partnership creditors. Q16-10 The schedule of safe payments to partners is used to determine the safe payment of cash to be distributed to partners assuming the worst case situations. The payments are “safe” if they leave adequate cash in the partnership to cover partnership liabilities and costs of winding up the partnership. Q16-11 Losses during liquidation are assigned to the partners' capital accounts using the normal loss ratio. If a different specific ratio for losses during liquidation is provided for in the partnership agreement, then that should be used. Q16-12 The worst case assumption means that two expectations are followed in computing the payments to partners: a. b.

Expect that all noncash assets will be written off as a loss Expect that deficits created in the capital accounts of partners will be distributed to the remaining partners

Q16-13 The Loss Absorption Potential (LAP) is the maximum loss of a partnership that can be incurred before a specific partner's capital account is extinguished. The LAP is used to determine the least vulnerable partner to a loss. The least vulnerable partner is the first partner to receive any cash distributions after payment of creditors. Q16-14 Partner B will receive the first payment of cash in an installment liquidation because partner B is least vulnerable to a loss based on the highest LAP, which is calculated as follows: LAP for Partner A = $25,000 / .60 = $41,667 LAP for Partner B = $25,000 / .40 = $62,500

Chapter 16 - Partnerships: Liquidation

Q16-15* The process of incorporating a partnership begins with all partners deciding to incorporate the business. At the time of incorporation, the partnership is terminated and the assets and liabilities are revalued to their market values. The gain or loss on revaluation is allocated to the partners' capital accounts in the profit and loss sharing ratio. Capital stock in the new corporation is then distributed in proportion to the capital accounts of the partners. SOLUTIONS TO CASES C16-1 Cash Distributions to Partners The key issue is that must be resolved in the partnership liquidation is that Bull desires cash to be distributed as it becomes available, while Bear wishes no cash to be distributed until all assets are sold and the liabilities are settled. Most partnership liquidations are installment liquidations in which cash is distributed during the liquidation. Outside debts should generally be paid before any cash is paid to partners in liquidation of their capital balances. A cash distribution plan or schedules of safe payments should be used to ensure fair distributions. While outside loans should be paid first, from a practical perspective, partnerships consider the partners' liquidity needs while also providing for the extended time period so the partnership may seek the best price for its assets. Bear may desire to hold up cash payments in order to encourage a prompt liquidation of the assets or to ensure that all liabilities are paid. A compromise may be reached to meet the needs of both partners. An agreement may be used to specify the date or other restrictions under which the assets must be liquidated and the liabilities settled. In addition, the necessary amounts to settle actual, and anticipated, liabilities (including all liquidation costs) may be escrowed with a trustee, such as a local bank. The remaining cash may then be distributed.

Chapter 16 - Partnerships: Liquidation

C16-2 Cash Distributions to Partners Assuming strict use of UPA 1997: Once a partnership enters liquidation, loans receivable from partners are treated as any other asset of the partnership and partnership loans payable to individual partners are treated as any other liability of the partnership. Thus, these accounts with partners do not have any higher or lower priority in a partnership liquidation. The accountant should prepare a Cash Distribution Plan to show each partner the eventual cash distribution process after all the liabilities, including the loan payable to Bard, are settled. Adam and Bard Partnership Cash Distribution Plan Loss Absorption Potential Adam_ Bard Loss sharing percentages Preliquidation capital balances Loss absorption potential (LAP) (capital balance / loss percentage) Decrease highest LAP to next level: Decrease Adam by $80,000 (Cash distribution: $80,000 x 0.50 = $40,000) Decrease remaining LAPs by distributing cash in profit and loss sharing percentages

160,000

Capital accounts Adam_

Bard

50%

80,000

40,000

(40,000) 40,000)

______ 40,000

80,000

(80,000) _ 80,000)

80,000

50%

Summary of Cash Distribution Plan Step 1: First $130,000 to creditors, including payment of loan from Bard in the amount of $100,000. Step 2: Next $40,000 to Adam Step 3: Any additional distributions in the partners’ loss percentages

130,000 40,000 50%

50%

This schedule shows that the partnership’s loan payable to Bard has the same legal status as the liabilities to third parties. Bard will be paid for his loan to the partnership prior to any final distributions to the partners. Adam may be able to negotiate that he will pay the $10,000 for the partnership’s loan receivable with him from other cash received in a distribution from the partnership. However, the partnership, including Bard, can obtain a court decree and judgment against Adam if Adam refuses to pay the partnership the $10,000 to settle the loan he received from the partnership. After the liabilities are provided for, any remaining cash is paid as shown in the cash distribution plan above, with Adam receiving the first $40,000 and then additional distributions will be made in the partners’ loss sharing ratio.

Chapter 16 - Partnerships: Liquidation

C16-2 (continued) Assuming a practical approach: Although UPA 1997 specifically states that partnership debt is considered equal to outside debt, most loans from partners are subordinated to outside debt. Typically this is done at the request of the outside creditors. In addition, loans to/from partners are treated as an extension of their capital accounts. Given these assumptions, the following is a cash distribution plan for the partnership: Adam and Bard Partnership Cash Distribution Plan Loss Absorption Potential Adam_ Bard Loss sharing percentages Preliquidation capital balances Loan to (from) partner Total Loss absorption potential (LAP) (capital balance / loss percentage) Decrease highest LAP to next level: Decrease Bard by $140,000 (Cash distribution: $140,000 x 0.50 = $70,000)

140,000

Capital accounts Adam_

Bard

50%

80,000 (10,000) 70,000

40,000 100,000 140,000

70,000

_(70,000) 70,000

280,000 (140,000)

_ 140,000

140,000

50%

Decrease remaining LAPs by distributing cash in profit and loss sharing percentages

Summary of Cash Distribution Plan Step 1: First $30,000 to creditors; Step 2: Next $70,000 to Bard (applied first to loan) Step 3: Any additional distributions in the partners’ loss percentages

$30,000 70,000 50%

50%

Chapter 16 - Partnerships: Liquidation

C16-3* Incorporation of a Partnership a. Comparison of balance sheets The partnership’s balance sheet will report the assets and liabilities at their book values while the corporation’s balance sheet will report the fair values of these items at the point of incorporation. The incorporation of the partnership results in a new accounting entity, for which fair values are appropriate. One of the assets on the corporation’s balance sheet will be goodwill that is created as part of the acquisition of the partnership. This goodwill must be tested annually for impairment in accordance with ASC 350. The partnership’s balance sheet will report a partnership’s capital section that shows the amount of capital for the partners. For partnerships in which there are only a few partners, the balance sheet often will report the amount of capital for each partner, as well as the total partnership capital. The corporation’s balance sheet will report a section on stockholders’ equity including both the preferred and common stock. At the point of incorporation, there will not be any retained earnings. b. Comparison of income statements According to GAAP, a partnership’s income statement should not include distributions to the partners as expenses. These distributions include interest on partners’ capital, salaries to partners, bonuses to partners, and any residual distributions made as part of the profit distribution agreement. Flexibility is allowed for partnerships to prepare non-GAAP financial statements if the partners feel the non-GAAP statements provide for more useful information. For example, some partnerships include profit distribution items, such as salaries to partners and interest on the partners’ capital balances, in their income statements in order to determine the residual profit after the allocations for salaries, etc., because the partners feel these allocated items are necessary operating items to allow the partnership to function. However, again, it is important to note that GAAP income statements do not include profit distributions to partners as part of the determination of income. In accounting theory, this would be comparable to including dividends to stockholders as an expense on a corporation’s income statement. The corporation’s income statement would include salaries and bonuses to management as part of the operating expenses of the entity. The corporate form of organization is a separate business entity, set apart from the owners of the corporation. Also, the corporation’s income statement would include any impairment losses of the goodwill recognized as part of the acquisition of the partnership’s net assets.

Chapter 16 - Partnerships: Liquidation

C16-4 Sharing Losses during Liquidation a. Liquidation loss allocation procedures in the Uniform Partnership Act of 1997: Section 401 of the Uniform Partnership Act of 1997 specifies that “Each partner is entitled to an equal share of the partnership profits and is chargeable with a share of the partnership losses in proportion to the partner’s share of the profits.” In the absence of a partnership agreement for the sharing of profits, and for the sharing of losses, all partners have equal rights in the management and conduct of the business. In the case, it is not clear that the partners intend to share losses in the same 4:3:2 ratio used to share profits. A court may decide that the 4:3:2 ratio should be used, or alternatively, in the absence of a specific partnership agreement, that the UPA’s equal provision should be used. This uncertainty should increase the partners’ willingness to agree among themselves at the beginning of the partnership how losses should be shared. b. Assessment of each partner’s position: Hiller may feel it is best not to get into “negative” types of discussion when the partnership is attempting to get under way. However, if the partners are not able to agree at this point in time, it may be best not to move forward with the formation of the partnership. Simply putting off an important issue is not going to eliminate its possible importance later in time. While not discussing the issue now removes a possibly contentious issue from the discussion, it does not solve the problem. Luna’s argument of equality for responsibility of a failure of the partnership is humanistic, but may not be true. Often, a partnership fails because of the failure of one of its partners. Other partners may be working very hard to make the partnership a success, but an act by an individual partner may cause the liquidation of a partnership. This act may be intentional, unintentional, legal, or illegal. It is impossible to predict in advance whether or not the partnership will be successful. Therefore, it is important to specify the rights of each of the partners should liquidation become necessary. Welsh argues that the amount of capital in a partner’s capital account should be the basis of allocation of liquidation losses. While this does recognize a partner’s financial capacity to bear losses, it may also result in partners making withdrawals in anticipation of liquidation, which is a time in the life of a business in which capital may be essential for continued success. Furthermore, this method would be disadvantageous to a partner who leaves capital accumulations in the partnership. c. Another method of allocating losses: The partners could agree to share all profits and losses in the 4:3:2 ratio or select a specific loss sharing ratio in the event of liquidation. The important point is that the partners should agree, before a possible liquidation, on the allocation process to be used in the case of liquidation. When a partnership fails, emotions will be high and that is not the best time to attempt to reach agreements. If the partners do not agree beforehand, then many of these types of cases wind up in litigation that involves additional costs and time. Again, the partners should be encouraged to consider the processes to be used in the event of liquidation as part of the partnership formation agreement. Finally, if the partners cannot agree, the accountant for the partnership does not have any legal stature to make a unilateral decision. This must be a decision made by all partners, or by a court.

Chapter 16 - Partnerships: Liquidation

C16-5 Analysis of a Court Decision on a Partnership Liquidation This case asks questions about the Mattfield v Kramer Brothers court case decided by the Montana Supreme Court on May 31, 2005. The court case is a really interesting presentation of some of the major types of problems that can occur in a family partnership. Students may obtain a copy of the court decision by several alternatives as presented in the case information in the textbook. For the instructor’s benefit, a copy of the court’s decision is provided at the end of the solutions for this chapter. Faculty might decide to make copies for the students or place copies on reserve in the library used by the accounting students in their advanced accounting classes. Court cases are within the public domain and can be printed verbatim without requesting permission. Answers to the questions posed in the textbook’s C16-5 are presented in the following paragraphs. a. Summary of history of Kramer Brothers Co-Partnership. The partnership began in the early 1980s with the father, Raymond Kramer, Sr., providing the initial capital, land, and cattle. The four brothers were Don, Douglas, William and Ray. In 1985, Bill stated his desire to disassociate from the partnership. The other three brothers continued the partnership, but Don was limited as a result of a car accident. In July 1994, Don left Montana but returned in 1995. In 1997, Raymond Sr. (the father) died which resulted in the four brothers, including Don, discussing the distribution of their father’s interest in the partnership. On December 9, 1998, Ray and Doug offered to purchase Don’s interest in the partnership but Don rejected the offer. On May 23, 2000, Don filed a suit demanding a formal accounting of the partnership, liquidation of its assets, and distribution of real property held by the partners as tenants in common. From that point, a number of suits and motions went back and forth between Doug, Ray, Lydia (their mother), and Don. On August 30, 2002, the District Court decided in favor of Doug, Ray, and Lydia, but only for those claims accruing before May 23, 1995, the five-year period covered by the statute of limitations. On October 17, 2002, the parties agreed to a buyout of Don’s share of the partnership’s interest in real property for $487,500. Don’s legal representative, Greg Mattfield and Clinton Kramer, the Guardians for Don, filed a motion seeking to reopen the period of time prior to May 23, 1995. This motion was rejected by the court, setting up the appeal to Montana’s Supreme Court. b. Type of partnership. The four brothers and their father had an oral agreement to form the farming operation. This typically evidences an at-will partnership because there is no written agreement for a definite term or a specific undertaking. The ensuing difficulties of the partnership indicate that a formal, written agreement might have avoided some of the problems. A written agreement could specify a term of existence; might include the procedures to be used if a partner wished to disassociate; the process of determining a disassociated partner’s partnership buyout price, perhaps involving a neutral valuation and arbitration expert, and other matters the family felt were important based on past events and experiences among the family. For a business of this apparent size, it is also recommended that they seek advice from an attorney who has experience in preparing partnership agreements. Working out the issues before forming a partnership, and getting these resolutions into a formal agreement, can really help minimize and, perhaps even avoid future problems.

Chapter 16 - Partnerships: Liquidation

C16-5 (continued) c. Bill Kramer’s economic interest in partnership. Bill disassociated from the partnership in 1985, soon after it was formed. The information presented in the court’s decision does not state if Bill received a buyout from the partnership. In addition, Bill received a partial interest from the estate of his father. The appeal motion included Bill as one of the defendants. Thus, it seems clear from the information given that Bill did have a continuing economic interest as of the time the motion was filed on June 23, 2004. d. Legal recourse of other partners at time Don disassociated. Don’s disassociation appeared to be wrongful for which the other partners could seek damages, and to assure that the disassociated partner is obligated for his or her share of the partnership’s liabilities at the time of the disassociation. This normally requires a scheduling of all liabilities as of the disassociation date, something accountants can provide for the partnership. In addition to filing a revised Statement of Partnership Authority with the Secretary of State and the local court clerk, the remaining partners should also ensure that creditors and other third-party vendors with the partnership are given notice that the disassociated partner no longer has the authority to bind the partnership. The remaining partners could also have a new partnership agreement, this time in writing, to provide written evidence that they are continuing the business. The important thing is that the remaining partners have sufficient documentation and evidence of Don’s partnership interest as of the date he disassociated. e. Request for Ray’s and Doug’s personal tax returns. This was probably an effort to determine the profit or loss of the partnership from the date the partnership was formed to July 1994, when Don left Montana. In addition, Don’s attorney also asked for the accounting records for that same time period. The stated reason for this request was to “accomplish an accurate accounting” of the partnership and to determine the amount the partnership owed Don. Under the partnership form of business, the partners recognize their share of the partnership’s profit or loss on their personal income tax returns. The partnership is not a separate taxable entity. The request for the personal tax returns of Ray and Doug may also have been made to try to gain leverage in negotiating Don’s buyout offer. Nevertheless, this request indicates the intertwining of a partnership and its individual partners. f. Two major things learned. Many students will state the need for a written partnership agreement, but there are other interesting items in the court case. Students are probably not aware of the five-year statute of limitations on claims. The court’s decision that Don’s relocation to San Francisco in July 1994 was a wrongful disassociation is interesting because, as a result of a car accident, Don was not able to fully participate in the partnership. The issue of when the five-year statute of limitations period began is interesting because this shows the importance of the accountant having an accurate record of a partner’s interest in the partnership as of specific, important times in the history of the partnership that may serve as records of evidence in future legal actions. A great class discussion can be generated from this question.

Chapter 16 - Partnerships: Liquidation

SOLUTIONS TO EXERCISES E16-1 Multiple-Choice Questions on Partnership Liquidations 1.

c–

Joan Profit ratio Prior capital Loss on sale of inventory

a–

Prior capital Loss on sale of inventory Allocate Charles' capital deficit: Joan = 0.40/0.50 Thomas = 0.10/.050

d–

Prior capital Loss on sale of inventory Possible loss of remaining inventory Allocate Charles' potential capital deficit:

Charles

Thomas

Total

40%

50%

10%

100%

160,000

45,000

55,000

260,000

(24,000) 136,000

(30,000) 15,000

(6,000) 49,000

(60,000) 200,000

160,000

45,000

55,000

260,000

(72,000) 88,000

(90,000) (45,000)

(18,000) 37,000

(180,000) 80,000

45,000 (36,000) (9,000) 52,000

-0-

28,000

80,000

160,000

45,000

55,000

260,000

(24,000) 136,000

(30,000) 15,000

(6,000) 49,000

(60,000) 200,000

(64,000) 72,000

(80,000) (65,000)

(16,000) 33,000

(160,000) 40,000

(52,000) 20,000

65,000 -0-

(13,000) 20,000

40,000

d–

The safe payments computations include consideration of the partners’ loss absorption potential and the priority of intervening cash distributions before the last cash distribution.

c–

The loan payable to Adam has the same legal status as the partnership’s other liabilities according to the UPA of 1997, but is likely subordinated to the partnership’s outside liabilities. After payment of the accounts payable, the deficit balance in Adam’s capital account needs to be remedied either through cash contribution or setoff against the loan. If Adam were to contribute additional cash to eliminate his deficit, answer “a” would be correct. However, since the problem does not mention a cash contribution, setoff is the only remedy for the deficit and answer “c” is the best solution.

d–

Partnership creditors have first claim to partnership assets

a–

After the settlement of accounts, partners are required to make additional contributions to the partnership to satisfy partnership obligations. 16-10

Chapter 16 - Partnerships: Liquidation

E16-2 1.

Multiple-Choice Questions on Partnership Liquidation [AICPA Adapted]

a– Profit and loss ratio Beginning capital Actual loss on assets Potential loss on other assets Balances Safe payments

b–

d– Profit and loss ratio

Casey

Dithers

Edwards

80,000 (15,000)

90,000 (9,000)

70,000 (6,000)

(50,000) 15,000 (15,000)

(30,000) 51,000 (51,000)

(20,000) 44,000 (44,000)

Art

Blythe

Cooper

40%

20%

Capital balances

37,000

65,000

48,000

Loss absorption potential Loss to reduce C to B: (77,500 x 0.20 = 15,500) Balances Loss to reduce B & C to A: (B:70,000 x 0.40 = 28,000) (C:70,000 x 0.20 = 14,000) Balances

92,500

162,500

240,000

92,500

162,500

(77,500) 162,500

(70,000) 92,500

92,500

(70,000) 92,500

Cash of $20,000 after settlement of liabilities: Cooper receives first $15,500; remaining $4,500 split 2/3 to Blythe and 1/3 to Cooper. 4.

d–

Cash of $17,000: Cooper receives first $15,500; remaining $1,500 split 2/3 to Blythe and 1/3 to Cooper.

a–

If all partners received cash after the second sale, then the remaining $12,000 is distributed in the loss ratio.

a–

Arnie

Bart

Kurt

Profit and loss ratio

40%

30%

Capital balances Loss of $100,000 Remaining equities

40,000 (40,000) -0-

180,000 (30,000) 150,000

30,000 (30,000) -0-

Arnie will receive nothing; the entire $150,000 will be paid to Bart.

Chapter 16 - Partnerships: Liquidation

E16-3 Computing Alternative Cash Distributions to Partners Capital Balances Bracken Louden 40% 30% a

Capital balances before sale of equipment Equipment sold for $30,000; allocation of $10,000 loss Capital balances after sale Final distribution of cash

Menser 30%

25,000

5,000

10,000

(4,000) 21,000 (21,000)

(3,000) 2,000 (2,000)

(3,000) 7,000 (7,000)

25,000

5,000

10,000

(7,600) 17,400

(5,700) (700) 700

(5,700) 4,300

b. Capital balances before sale of equipment Equipment sold for $21,000; allocation of $19,000 loss Capital balances after sale Allocate capital deficit of Louden: 4/7 x $700 3/7 X $700 Capital balances after allocation of Louden's deficit Final distribution of cash

(400) ______ 17,000 (17,000)

______ ____-0_-0-

25,000

5,000

10,000

(13,200) 11,800

(9,900) (4,900) 4,900

(9,900) 100

(2,800) ______ 9,000

______ -0-

(2,000) 7,000 (7,000)

_____ ___-0-0-

(2,100) (2,000) 2,000 _____ ___-0-0-

Capital balances before sale of equipment Equipment sold for $7,000; allocation of $33,000 loss Capital balances after sale Allocate capital deficit of Louden: 4/7 x $4,900 3/7 X $4,900 Capital balances after allocation of Louden's deficit Allocate capital deficit of Menser: 4/4 x $2,000 Capital balances after allocation of Menser's deficit Final distribution of cash

(300) _4,000 (4,000)

Chapter 16 - Partnerships: Liquidation

E16-4 Lump-Sum Liquidation a. BG Land Development Company Statement of Partnership Realization and Liquidation Lump-Sum Distribution

Balances Sale of assets at a $40,000 loss Payment to creditors Outside Creditors Mitchell Payment to partners Balances

Capital Balances Matthews Mitchell Michaels 50% + 30% + 20%

Cash +

Noncash Assets =

Accounts Payable +

Mitchell, Loan +

20,000

150,000

30,000

10,000

80,000

36,000

14,000

110,000 130,000

(150,000) -0-

30,000

10,000

(20,000) 60,000

(12,000) 24,000

(8,000) 6,000

(30,000) (10,000) 90,000

(30,000) -0-

-0-

(10,000) -0-

60,000

24,000

6,000

(90,000) -0-

-0-

(60,000) -0-

(24,000) -0-

(6,000) -0-

Chapter 16 - Partnerships: Liquidation

E16-4 (continued) b.

(1)

(2)

(3)

Cash Matthews, Capital Mitchell, Capital Michaels, Capital Noncash Assets Sell noncash assets at a loss of $40,000.

110,000 20,000 12,000 8,000

Accounts Payable Mitchell, Loan Cash Pay creditors, including Mitchell.

30,000 10,000

Matthews, Capital Mitchell, Capital Michaels, Capital Cash Final lump-sum distribution to partners.

60,000 24,000 6,000

150,000

40,000

90,000

E16-5 Schedule of Safe Payments Based on strict observance of UPA 1997 Kitchens Just For You Schedule of Safe Payments to Partners

Capital balances, September 1, 20X9 Write-off of $28,000 in goodwill Write-off of $12,000 of receivables Loss of $4,000 on sale of $24,000 of inventory (one-half of $48,000 book value) Capital balances, September 30, 20X9 Possible loss of $19,000 for remaining receivables (including $9,000 receivable from Terry) and $24,000 for remaining inventory Possible liquidation costs of $6,000 Balances Distribute Terry’s and Phyllis’ potential deficits to Connie, the only partner with a capital credit Safe payments to partners, September 30, 20X9

Terry _ (30%)_ 12,000 (8,400) (3,600)

Phyllis __(50%)_ 36,000 (14,000) (6,000)

Connie __(20%)_ 54,000 (5,600) (2,400)

(1,200) (1,200)

(2,000) 14,000

(800) 45,200

(12,900) (1,800) (15,900)

(21,500) (3,000) (10,500)

(8,600) (1,200) 35,400

15,900 -0-

10,500 -0-

(26,400) 9,000

Of the $73,000 in cash at the end of September, $58,000 will be required to liquidate the debts to creditors, including the $15,000 to Connie, and $6,000 must be held in reserve to pay possible liquidation costs. Thus, a total of $9,000 in cash can be safely distributed to Connie as of September 30, 20X9. An interesting observation is that the newest partner, Connie, will receive the most cash in the partnership liquidation because of the recognition of so much goodwill at the time of her admission and because of her loan to the partnership. 16-14 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 16 - Partnerships: Liquidation

E16-5 (continued) Based on practical approach: Kitchens Just For You Schedule of Safe Payments to Partners

Capital balances, September 1, 20X9 Loans to (from) partner Total Write-off of $28,000 in goodwill Write-off of $12,000 of receivables Loss of $4,000 on sale of $24,000 of inventory (one-half of $48,000 book value) Capital balances, September 30, 20X9 Possible loss of $19,000 for remaining receivables (including $9,000 receivable from Terry) and $24,000 for remaining inventory Possible liquidation costs of $6,000 Balances Distribute Terry’s and Phyllis’ potential deficits to Connie, the only partner with a capital credit Safe payments to partners, September 30, 20X9

Terry _ (30%)_ 12,000 (9,000) 3,000

Phyllis __(50%)_ 36,000 36,000

Connie __(20%)_ 54,000 15,000 69,000

(8,400) (3,600)

(14,000) (6,000)

(5,600) (2,400)

(1,200) (10,200)

(2,000) 14,000

(800) 60,200

(12,900) (1,800) (24,900)

(21,500) (3,000) (10,500)*

(8,600) (1,200) 50,400

24,900 -0-

10,500 -0-

(35,400) 15,000

Of the $73,000 in cash at the end of September, $58,000 will be required to liquidate the debts to creditors. Thus, a total of $15,000 in cash can be safely distributed to Connie as of September 30, 20X9. An interesting observation is that the newest partner, Connie, will receive the most cash in the partnership liquidation because of the recognition of so much goodwill at the time of her admission and because of her loan to the partnership. Note that net loans to/from the partners is $6,000 ($15,000 - $9,000) which is coincidentally the same amount as the liquidation expenses. Of the $73,000 in cash available at the end of September $6,000 will still be available to pay these expenses..

Chapter 16 - Partnerships: Liquidation

E16-6 Schedule of Safe Payments to Partners Maness and Joiner Partnership Combined Statement of Realization and Schedule of Safe Payments Capital Accounts Maness Joiner Cash + Inventory= Payable+ 80% + 20% Balances

25,000

120,000

Sale of inventory

40,000

(60,000)

Payment to creditors

(10,000) 55,000

60,000

(50,000) 5,000

60,000

Sale of inventory

30,000

(60,000)

Payment to creditors

(5,000) 30,000

-0-

(30,000) -0-

______ -0-

Payments to partners (Schedule 1)

Payments to partners Balances

15,000

65,000

(16,000)

(4,000)

(10,000) 5,000

49,000

61,000

5,000

(1,000) 48,000

(49,000) 12,000

(24,000)

(6,000)

(5,000) -0-

24,000

6,000

-0-

(24,000) -0-

(6,000) -0-

Maness 80% 49,000 (48,000) 1,000

Joiner 20% 61,000 (12,000) 49,000

Schedule 1 Safe payments at end of first month: Capital balances Potential loss of $60,000 on remaining inventory Safe payments to partners

Note that the $5,000 cash remaining after safe payments at the end of the first month is the amount required to liquidate the remaining accounts payable. Using just the partners’ capital balances to compute safe payments indirectly includes both the assets and the liabilities of the partnership.

Chapter 16 - Partnerships: Liquidation

E16-7 Alternative Profit and Loss Sharing Ratios in a Partnership Liquidation

Nelson

Osman

Peters

Quincy

15,000

75,000

30,000

30%

20%

Allocation of $90,000 loss on sale of noncash assets

(27,000)

(18,000)

Capital balances after allocation of loss

(12,000)

48,000

57,000

12,000

Distribution of deficit of insolvent partner:

12,000

Capital balances at beginning of liquidation a.

Partnership ratio of 3:3:2:2 equals percentages of:

Osman: 30/70 X $12,000

(5,143)

Peters: 20/70 x $12,000

(3,428)

Quincy: 20/70 x $12,000

(3,429)

Capital balances after distribution of Nelson deficit

-0-

42,857

53,572

8,571

Payment to partners

-0-

(42,857)

(53,572)

(8,571)

30%

10%

30%

Allocation of $90,000 loss on sale of noncash assets

(27,000)

(9,000)

(27,000)

Capital balances after allocation of loss

(12,000)

66,000

48,000

3,000

Distribution of deficit of insolvent partner:

12,000

Partnership ratio of 3:1:3:3 equals percentages of:

Osman: 10/70 X $12,000

(1,714)

Peters: 30/70 x $12,000

(5,143)

Quincy: 30/70 x $12,000

(5,143)

Capital balances after distribution of Nelson deficit

-0-

64,286

42,857

Distribution of deficit of insolvent partner:

2,143

Osman: 10/40 x $2,143

(536)

Peters: 30/40 x $2,143

(2,143)

(1,607)

Capital balances after distribution of Quincy deficit

-0-

63,750

41,250

-0-

Payment to partners

-0-

(63,750)

(41,250)

-0-

30%

10%

20%

40%

Allocation of $90,000 loss on sale of noncash assets

(27,000)

(9,000)

(18,000)

(36,000)

Capital balances after allocation of loss

(12,000)

66,000

57,000

(6,000)

Distribution of deficits of two insolvent partners:

12,000

Partnership ratio of 3:1:2:4 equals percentages of:

Osman: 10/30 X $18,000

6,000 (6,000)

Peters: 20/30 x $18,000

(12,000)

Capital balances after distribution of capital deficits

-0-

60,000

45,000

-0-

Payment to partners

-0-

(60,000)

(45,000)

-0-

Chapter 16 - Partnerships: Liquidation

In case c. both Nelson and Quincy are personally insolvent so their capital deficits resulting from the allocation of the loss can be added together and distributed to the two solvent partners. However, if Quincy had been personally solvent, then he would be required to remedy any capital deficit, including one that was distributed to him because of the insolvency of another partner, as from the distribution of Nelson’s capital deficit in case b.

Chapter 16 - Partnerships: Liquidation

E16-8 Cash Distribution Plan Based on strict observance of UPA 1997: APB Partnership Cash Distribution Plan Loss Absorption Potential Adams

Peters

Capital Accounts

Blake

Profit and loss percentages Preliquidation capital balances Loss absorption potential (Capital balances / Loss percentage)

275,000

Decrease highest LAP to next highest: Adams ($25,000 x 0.20)

(25,000) 250,000

Decrease LAPs to next highest: Adams ($110,000 x 0.20) Peters ($110,000 x 0.30)

250,000

Peters

Blake

20%

30%

50%

55,000

75,000

70,000

75,000

70,000

(33,000) 42,000

70,000

140,000

(5,000) 250,000

140,000

(110,000) 140,000

Adams

50,000

(22,000) (110,000) 140,000

140,000

28,000

Summary of Cash Distribution Plan First $50,000 to creditors Next $5,000 Next $55,000 Any additional

Adams

Peters

Blake

100% 40% 20%

60% 30%

50%

Note that the receivable from Adams is not included in the Cash Distribution Plan. The UPA 1997 does not include any offsets of receivables from partners against capital accounts. Thus, the partnership should treat the receivable from Adams as any other partnership asset. If the partnership were to prepare a schedule of safe payments, it would include a provision for a possible loss on any unpaid loan receivables with partners just as with other unrealized partnership assets. 16-19 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 16 - Partnerships: Liquidation

E16-8 (continued): Based on practical approach: APB Partnership Cash Distribution Plan Loss Absorption Potential Adams

Peters

Capital Accounts

Blake

Profit and loss percentages Preliquidation capital balances Loan to Adams Total Loss absorption potential (Capital balances / Loss percentage)

225,000

250,000

140,000

225,000

(25,000) 225,000

140,000

Decrease highest LAP to next highest: Peters ($25,000 x 0.30) Decrease LAPs to next highest: Adams ($85,000 x 0.20) Peters ($85,000 x 0.30)

(85,000) 140,000

Adams

Peters

Blake

20%

30%

55,000 (10,000) 45,000

75,000

70,000

75,000

70,000

(7,500) 67,500

70,000

(25,500) 42,000

70,000

45,000

50%

(17,000) (85,000) 140,000

140,000

28,000

Summary of Cash Distribution Plan First $50,000 to creditors Next $7,500 Next $42,500 Any additional

Adams

Peters

Blake

40% 20%

100% 60% 30%

50%

Chapter 16 - Partnerships: Liquidation

16-9 Confirmation of Cash Distribution Plan Based on strict observance of UPA 1997: APB Partnership Statement of Partnership Realization and Liquidation Installment Liquidation Cash+

Adams, Loan +

Noncash Assets =

Balances

40,000

10,000

200,000

Sale of assets Payment to creditors

65,000

Payment to partners (Sch. 1) Sale of assets Collection of Adams’ loan Payment to creditors Payment to partners Balances

Liabilities+

Adams, 20% +

Capital Peters, 30% +

50,000

55,000

75,000

70,000

(4,000)

(6,000)

(10,000)

(85,000)

Blake, 50%

(21,000) 84,000

10,000

115,000

(21,000) 29,000

51,000

69,000

60,000

(55,000) 29,000

10,000

115,000

29,000

(25,000) 26,000

(30,000) 39,000

-060,000

(7,200)

(10,800)

(18,000)

79,000

(115,000)

10,000

(10,000)

(29,000) 89,000

-0-

(29,000) -0-

18,800

28,200

42,000

(89,000) -0-

-0-

(18,800) -0-

(28,200) -0-

(42,000) -0-

Chapter 16 - Partnerships: Liquidation

E16-9 (continued) Schedule 1: APB Partnership Schedule of Safe Payments to Partners

Capital balances, end of first month Possible loss of $125,000 on noncash assets ($10,000 loan and $115,000 other) Allocate Blake’s potential deficit: 20/50 x $2,500 30/50 x $2,500 Safe payment to partners

Adams 20%__

Peters 30% __

Blake 50%__

51,000

69,000

60,000

(25,000) 26,000

(37,500) 31,500

(62,500) (2,500) 2,500

(1,000) _______ (25,000)

__(1,500) (30,000)

___ __ -0-

Chapter 16 - Partnerships: Liquidation

E16-9 (continued) Based on practical approach: APB Partnership Statement of Partnership Realization and Liquidation Installment Liquidation Cash + Balances Adam’s loan write-off Sale of assets Payment to creditors Payment to partners (Sch. 1) Sale of assets Payment to creditors Payment to partners Balances

40,000

Adams, Loan +

Noncash Assets=

Liabilities+

10,000 (10,000)

200,000

50,000

65,000

(85,000)

Adams, 20% +

Capital Peters, 30% +

Blake, 50%

55,000 (10,000) (4,000)

75,000

70,000

(6,000)

(10,000)

(21,000) 84,000

-0-

115,000

(21,000) 29,000

41,000

69,000

60,000

(55,000) 29,000

-0-

115,000

29,000

(18,000) 23,000

(34,500) 34,500

(2,500) 57,500

79,000 (29,000) 79,000

(115,000) -0-

(79,000) -0-

-0-

(7,200)

(10,800)

(18,000)

-0-

(29,000) -0-

15,800

23,700

39,500

-0-

(15,800) -0-

(23,700) -0-

(39,500) -0-

Chapter 16 - Partnerships: Liquidation

E16-9 (continued) Schedule 1: APB Partnership Schedule of Safe Payments to Partners Adams 20%__

Peters 30% __

Blake 50%__

Capital balances, end of first month Possible loss of $115,000 on assets

41,000) (23,000) 18,000)

69,000) (34,500) 34,500)

60,000) (57,500) 2,500)

Safe payment to partners

(18,000)

(34,500)

(2,500)

Chapter 16 - Partnerships: Liquidation

E16-10* Incorporation of a Partnership a.

Partnership's Books (1)

(2)

(3)

Alice, Capital ($11,200 x 0.60) Betty, Capital ($11,200 x 0.40) Accounts Receivable Inventory Equipment To record revaluation of assets.

6,720 4,480

Investment in A & B Corporation Stock Accounts Payable Cash Accounts Receivable Inventory Equipment To record transfer of net assets to A & B corporation.

85,200 17,200

Alice, Capital ($62,400 - $6,720) Betty, Capital ($34,000 - $4,480) Investment in A & B Corporation Stock To record distribution of stock to prior partners.

55,680 29,520

800 3,200 7,200

8,000 21,600 32,800 40,000

85,200

A & B Corporation's Books Cash Accounts Receivable Inventory Equipment Accounts Payable Common Stock Additional Paid-In Capital To record receipt of net assets from partnership.

8,000 21,600 32,800 40,000 17,200 71,000 14,200

Chapter 16 - Partnerships: Liquidation

E16-11A

Multiple-Choice Questions on Personal Financial Statements [AICPA Adapted]

1. b 2. a 3. a –

10,000 shares x ($25 - $10)

$150,000 options fair value x 0.65 net-of-tax rate $ 97,500 value, net-of-tax +400,000 pre-option net worth $497,500 net worth

4. d 5. a 6. c 7. b 8. c 9. d –

95,500 + 3,400 = 98,900

10. b 11. d –

125,000 – 50,000 = 75,000

Chapter 16 - Partnerships: Liquidation

E16-12A Personal Financial Statements Leonard and Michelle Statement of Changes in Net Worth For the Year Ended August 31, 20X3 Realized increases in net worth: Salaries Farm income Dividends and interest income

$ 44,300 6,700 1,400 $ 52,400

Realized decreases in net worth: Income taxes Personal expenditures Loss on sale of marketable securities Interest expense

$ 12,400 43,500 300 4,600 $(60,800)

Net realized decrease in net worth

(1) (2)

$ (8,400)

Unrealized increases in net worth: Residence Investment in Farm Unrealized decreases in net worth: Marketable securities Increase in estimated income taxes on the difference between the estimated current values of assets and liabilities and their tax bases

$ 7,300 9,300 $ 16,600

(3)

(1)

400

3,200 $ (3,600)

Net unrealized increase in net worth

$ 13,000

Net increase in net worth: Realized and unrealized changes in net worth Net worth at beginning of period Net worth at end of period

$ 4,600 60,800 $ 65,400

(1) Realized loss: $11,000 - $10,700 = $300 Unrealized loss on remaining securities: ($16,300 - $11,000) - $4,900 = $400 (2) Mortgage payable: $76,000 - $71,000 = $5,000 principal payment $9,000 paid - $5,000 = $4,000 interest payment Life insurance loan: $4,000 x 0.15 = $600 interest payment (3) Unrealized holding gain on farm land Unrealized holding loss on net farm equipment ($22,400 - $9,000) - $14,000

$9,900 (600) $9,300

Chapter 16 - Partnerships: Liquidation

SOLUTIONS TO PROBLEMS P16-13 Lump-Sum Liquidation a. CDG Partnership Statement of Realization and Liquidation Lump-sum Liquidation on December 10, 20X6

Preliquidation balances Sale of assets and distribution of $215,000 loss Cash contributed by Gail to extent of positive net worth

Cash +

Liabilities+

Carlos 20% +

25,000

475,000

270,000

120,000

50,000

60,000

260,000 285,000

(475,000) -0-

270,000

(43,000) 77,000

(86,000) (36,000)

(86,000) (26,000)

25,000 310,000

-0-

270,000

77,000

(36,000)

25,000 (1,000)

Distribution of deficit of insolvent partner: 20/60($1,000) 40/60($1,000) Contribution by Dan to remedy deficit Payment to creditors Payment to partner Postliquidation balances

Capital Balances Dan Gail 40% + 40%

Noncash Assets =

1,000 (333) 310,000

-0-

270,000

76,667

(667) (36,667)

-0-

36,667 346,667

-0-

270,000

76,667

36,667 -0-

-0-

(270,000) 76,667

-0-

(270,000) -0-

76,667

-0-

(76,667)

-0-

Chapter 16 - Partnerships: Liquidation

P16-13 (continued) b. CDG Partnership Net Worth of Partners December 10, 20X6 Carlos Personal assets, excluding partnership capital interests Personal liabilities Personal net worth, excluding partnership capital interests, Dec. 1, 20X6 Contribution to partnership Liquidating distribution from partnership Net worth, December 10, 20X6

Dan

Gail

250,000 (230,000)

300,000 (240,000)

350,000 (325,000)

20,000

60,000 (36,667) -023,333

25,000 (25,000) -0-0-

76,667 96,667

This computation assumes that no other events occurred in the 10-day period that changed any of the partners’ personal assets and personal liabilities. In practice, the accountant must be sure that a computation of net worth is current and timely. The table shows the effects of the transactions between the partnership and each partner. A presumption of this table is that the personal creditors of Dan or Gail would not seek court action to block the settlement transactions with the partnership. Upon winding up and liquidation, the partnership does not have any priority to the partner’s personal assets. Thus, the personal creditors may seek to block the transactions with the partnership in order to provide more resources from which they can be paid. A partner who fails to remedy his or her deficit can be sued by the other partners who had to make additional contributions or even by a partnership creditor if the failed partner is liable to the partnership creditor. But those claims are not superior to the other claims to the partner’s individual assets. When accountants provide professional services to partnerships and to its partners, the accountant should expect, at some time, legal suits involving the partnership and/or individual partners. A strong and thorough understanding of the legal and accounting foundations of partnerships will be very important to that accountant.

Chapter 16 - Partnerships: Liquidation

P16-14 Installment Liquidation [AICPA Adapted] ABC Partnership Statement of Partnership Realization and Liquidation For the period from January 1, 20X1, through March 31, 20X1

Balances before liquidation, January 1, 20X1 January transactions: 1. Collection of accounts receivable at a loss of $15,000 2. Sale of inventory at a loss of $14,000 3. Liquidation expenses paid 4. Share of credit memorandum 5. Payments to creditors Safe payments to partners (Schedule 1) February transactions: 6. Liquidation expenses paid Safe payments to partners (Schedule 2) March transactions: 8. Sale of M&Eq. at a loss of $43,000 9. Liquidation expenses paid 10. Payments to partners Balances at end of liquidation, March 31, 20X1

Cash + 18,000

51,000 38,000 (2,000) (50,000) 55,000 (45,000) 10,000 (4,000) 6,000 -06,000

Other Assets = 307,000

Accounts Payable + 53,000

(66,000) (52,000)

189,000

(3,000) (50,000) -0-

189,000

-0-

189,000

-0-

189,000

-0-

146,000 (5,000) 147,000 (147,000)

(189,000) -0-

-0-

Art 50% + 88,000

Capital Balances Bru Chou 30% + 20% 110,000 74,000

(7,500) (7,000) (1,000) 1,500

(4,500) (4,200) (600) 900

(3,000) (2,800) (400) 600

74,000 74,000

101,600 (26,600) 75,000

68,400 (18,400) 50,000

(2,000) 72,000 -072,000

(1,200) 73,800 -073,800

(800) 49,200 -049,200

(21,500) (2,500) 48,000 (48,000)

(12,900) (1,500) 59,400 (59,400)

(8,600) (1,000) 39,600 (39,600)

-0-

Chapter 16 - Partnerships: Liquidation

P16-14 (continued) ABC Partnership Schedules of Safe Payments to Partners Schedule 1: January 31, 20X1 Capital balances Possible loss: Other assets ($189,000) and possible liquidation costs ($10,000) Absorption of Art’s potential deficit balance Bru: ($25,500 x 3/5 = $15,300) Chou: ($25,500 x 2/5 = $10,200) Safe payment, January 31, 20X1 Schedule 2: February 27, 20X1 Capital balances Possible loss: Other assets ($189,000) and possible liquidation costs ($6,000) Absorption of Art’s potential deficit balance: Bru: ($25,500 x 3/5 = $15,300) Chou: ($25,500 x 2/5 = $10,200) Safe payment, February 27, 20X1

Art 50%

Bru 30%

Chou 20%

74,000

101,600

68,400

(99,500) (25,500)

(59,700) 41,900

(39,800) 28,600

25,500 (15,300) -0-

26,600

(10,200) 18,400

72,000

73,800

49,200

(97,500) (25,500)

(58,500) 15,300

(39,000) 10,200

25,500 (15,300) -0-

-0-

(10,200) -0-

Note that the computation of safe payments on February 27, 20X1, resulted in no payments to partners. This is due to the large book value of Other Assets still unrealized and the reservation of the $6,000 cash on hand for possible future liquidation expenses.

Chapter 16 - Partnerships: Liquidation

P16-15 Cash Distribution Plan PET Partnership Cash Distribution Plan June 30, 20X1 Loss Absorption Potential Pen

Evan

Capital Accounts

Torves

Pen

Profit and loss percentages Preliquidation capital balances Loss absorption potential (Capital balances / Loss percent)

110,000

Decrease highest LAP to next highest: Evan ($30,000 x 0.30)

150,000

Evan

50%

30%

20%

55,000

45,000

24,000

120,000

(30,000) 110,000

Decrease LAPs to next highest: Evan ($10,000 x 0.30) Torves ($10,000 x 0.20)

120,000

Torves

(9,000) 120,000

55,000

36,000

(10,000)

(3,000) (10,000)

110,000

24,000

110,000

(2,000) 55,000

33,000

22,000

Summary of Cash Distribution (If Offer of $100,000 is Accepted) Accounts Payable Cash available First Next Next Additional paid in P&L ratio

$106,000 (17,000) (9,000) (5,000) (75,000) $ -0-

Pen 50%

Evan 30%

Torves 20%

$ 9,000 3,000

$ 2,000

22,500 $34,500

15,000 $17,000

$17,000

______ $17,000

$37,500 $37,500

Chapter 16 - Partnerships: Liquidation

P16-16 Installment Liquidation PET Partnership Statement of Partnership Liquidation and Realization From July 1, 20X1, through September 30, 20X1

Preliquidation balances July: Assets Realized Paid liquidation costs Paid creditors Safe Payments (Sch. 1) August: Equipment withdrawn (allocate $6,000 gain) Paid liquidation costs Safe Payments (Sch. 2) September: Assets Realized Paid liquidation costs Payments to partners Postliquidation balances

Cash + 6,000

Noncash Assets = 135,000

Accounts Payable + 17,000

Pen 50% + 55,000

Capital Evan 30% + 45,000

Torves 20% 24,000

(4,750) (500)

(2,850) (300)

(1,900) (200)

26,500 (1,000) (17,000) 14,500 (6,500)

(36,000) 99,000

(17,000) -0-

49,750

41,850 (6,500)

21,900

8,000

99,000

-0-

49,750

35,350

21,900

3,000

1,800

(8,800) (300) 12,800

(4,000) (200) 8,600 (8,600) -0-

(4,000) (1,500) 6,500 (4,000) 2,500 75,000 (1,000) 76,500 (76,500) -0-

95,000

-0-

(750) 52,000

95,000

-0-

52,000

(450) 36,700 (4,000) 32,700

-0-

(10,000) (500) 41,500 (41,500) -0-

(6,000) (300) 26,400 (26,400) -0-

(95,000)

12,800

Chapter 16 - Partnerships: Liquidation

P16-16 (continued) PET Partnership Schedules of Safe Payments to Partners Schedule 1: July 31, 20X1 Capital balances Possible loss on noncash assets ($99,000) Cash retained ($8,000) Absorption of Pen's potential deficit Evan: $3,750 x 0.30/0.50 Torves: $3,750 x 0.20/0.50

Pen 50%

Evan 30%

Torves 20%

49,750 (49,500) (4,000) (3,750) 3,750

41,850 (29,700) (2,400) 9,750

21,900 (19,800) (1,600) 500)

(2,250)

Absorption of Torves’ potential deficit Evan: $1,000 x 0.30/0.30 Safe payment

-0-

7,500

-0-

(1,000) 6,500)

52,000 (47,500) (1,250) 3,250

36,700 (28,500) (750) 7,450

(1,500) (1,000) 1,000 -0-

Schedule 2: August 31, 20X1 Capital balances Possible loss on noncash assets ($95,000) Cash retained ($2,500) Absorption of Torves’ potential deficit Pen: $6,700 x 0.50/0.80 Evan: $6,700 x 0.30/0.80

12,800 (19,000) (500) (6,700) 6,700

(4,188) (938) 938

Absorption of Pen's potential deficit Evan: $938 x 0.30/0.30 Safe payment

-0-

(2,512) 4,938

-0-

(938) 4,000

-0-

Chapter 16 - Partnerships: Liquidation

P16-17 Installment Liquidation DSV Partnership Statement of Partnership Realization and Liquidation — Installment Liquidation From July 1, 20X5, through September 30, 20X5 Capital Balances Noncash D S V Cash + Assets= Liabilities+ 50% + 30% + 20% Preliquidation balances, 50,000 670,000 405,000 100,000 140,000) 75,000) June 30 July, 20X5: Sale of assets and distribution of $120,000 loss 390,000 (510,000) (60,000) (36,000) (24,000) 440,000 160,000 405,000 40,000) 104,000) 51,000) Liquidation expenses (2,500) (1,250) (750) (500) 437,500 160,000 405,000 38,750) 103,250) 50,500) Payment to creditors (405,000) (405,000) 32,500 160,000 -038,750) 103,250) 50,500) Safe payments to partners (Sch. 1) (22,500) (22,500) 10,000 160,000 -038,750) 80,750) 50,500) August, 20X5: Sale of assets and distribution of $13,000 loss 22,000 (35,000) (6,500) (3,900) (2,600) 32,000 125,000 -032,250) 76,850) 47,900) Liquidation expenses (2,500) (1,250) (750) (500) 29,500 125,000 -031,000) 76,100) 47,400) Safe payments to partners (Sch. 2) (19,500) (13,700) (5,800) 10,000 125,000 -031,000) 62,400) 41,600) September, 20X5: Sale of assets and distribution of $70,000 loss 55,000 (125,000) (35,000) (21,000) (14,000) 65,000 -0-0(4,000) 41,400) 27,600) Allocate D's deficit to S 4,000) (2,400) (1,600) and V 65,000 -0-0-039,000) 26,000) Liquidation expenses (2,500) (1,500) (1,000) 62,500 -0-0-037,500) 25,000) Payments to partners (62,500) -0(37,500) (25,000) Postliquidation -0-0-0-0-0-0balances

Chapter 16 - Partnerships: Liquidation

P16-17 (continued) DSV Partnership Schedule of Safe Payments to Partners Schedule 1, July 31, 20X5: Capital balances, July 31, Before cash distribution Assume full loss of $160,000 on remaining noncash assets and $10,000 in possible future liquidation expenses Assume D's potential deficit must be absorbed by S and V: 30/50 x $46,250 20/50 x $46,250

D 50%

S 30%

V 20%

38,750

103,250

50,500

(85,000) (46,250)

(51,000) 52,250

(34,000) 16,500

46,250 (27,750) 24,500

(18,500) (2,000)

(2,000)

2,000

-0-

22,500

-0-

31,000

76,100

47,400

(67,500) (36,500)

(40,500) 35,600)

(27,000) 20,400)

-0Assume V's potential deficit must be absorbed by S completely Safe payments to partners on July 31, 20X5

Schedule 2, August 31, 20X5: Capital balances, August 31, before cash distribution Assume full loss of $125,000 on remaining noncash assets and$10,000 in possible liquidation expenses Assume D's potential deficit must be absorbed by S and V: 30/50 x $36,500 20/50 x $36,500 Safe payments to partners

36,500 (21,900) -0-

13,700)

(14,600) 5,800)

Chapter 16 - Partnerships: Liquidation

P16-18 Cash Distribution Plan DSV Partnership Cash Distribution Plan June 30, 20X5 Loss Absorption Potential D Profit and loss sharing ratio Preliquidation capital balances Loss absorption potential (LAP) capital accounts / loss sharing percentage

200,000

Decrease highest LAP to next highest LAP: Decrease S by $91,667 (Cash distribution: $91,667 x 0.30)

466,667

50% 100,000

30% 140,000

20% 75,000

100,000

(27,500) 112,500

75,000

375,000

(91,667) 200,000

Decrease LAP to next highest level: Decrease S by $175,000 (Cash distribution: $175,000 x 0.30) Decrease V by $175,000 (Cash distribution: $175,000 x 0.20) Decrease LAPs by distributing cash in the P/L sharing ratio

Capital Accounts

375,000

(175,000) (52,500) (175,000) (35,000) 200,000

200,000

50%

30%

20%

100,000

60,000

40,000

Chapter 16 - Partnerships: Liquidation

P16-18 (continued)

1. 2. 3. 4. 5.

Summary of Cash Distribution Plan (Estimated on June 30, 20X5) Liquidation Creditors Expenses 100% 100%

First $405,000 Next $10,000 Next $27,500 Next $87,500 Any additional distributions in the partners' profit and loss ratio

50%

100% 60%

40%

30%

20%

b. Confirmation of cash distribution plan DSV Partnership Capital Account Balances June 30, 20X5, through September 30, 20X5 D S Profit and loss ratio 50% 30% Preliquidation balances, June 30 100,000 140,000) July loss of $120,000 on disposal of assets and $2,500 paid in liquidation costs (61,250) (36,750) 38,750) 103,250 July 31 distribution of $22,500 of available cash to partners (Sch. 1) First $22,500 of $27,500 layer: 100% to S (22,500) 38,750) 80,750) August loss of $13,000 on disposal of assets and $2,500 paid in liquidation costs (7,750) (4,650) 31,000) 76,100) August 31 distribution of $19,500 of available cash to partners (Sch. 2) Remaining $5,000 of $27,500 layer of which $22,500 paid on July 31: 100% to S (5,000) Next $14,500 of $87,500 layer: 60% to S (8,700) 40% to V 31,000) 62,400) September loss of $70,000 on disposal of assets and $2,500 paid in liquidation costs (36,250) (21,750) (5,250) 40,650) Distribution of D's deficit 5,250) (3,150) -037,500) September 30 distribution of $62,500 of available cash to partners (Sch. 3) Next $62,500 of $87,500 layer of which $14,500 paid on August 31: 60% to S (37,500) 40% to V Postliquidation balances -0-0-

V 20% 75,000) (24,500) 50,500)

50,500) (3,100) 47,400)

(5,800) 41,600) (14,500) 27,100) (2,100) 25,000)

(25,000) -0-

Chapter 16 - Partnerships: Liquidation

P16-18 (continued) Schedule 1, July 31, 20X5: Computation of $22,500 of cash available to be distributed to partners on July 31, 20X5: Cash balance, July 1, 20X5 Cash from sale of noncash assets Less: Payment of actual liquidation expenses Less: Payments to creditors Less: Amount held for possible future liquidation expenses Cash available to partners, July 31, 20X5

$ 50,000 390,000 (2,500) (405,000) (10,000) $ 22,500

Schedule 2, August 31, 20X5: Computation of $19,500 of cash available to be distributed to partners on August 31, 20X5: Cash balance, August 1, 20X5 Cash from sale of noncash assets Less: Payment of actual liquidation expenses Less: Amount held for possible future liquidation expenses Cash available to partners, August 31, 20X5

$10,000 22,000 (2,500) (10,000) $ 19,500

Schedule 3, September 30, 20X5: Computation of $62,500 of cash available to be distributed to partners on September 30, 20X5: Cash balance, September 1, 20X5 Cash received from sale of noncash assets Less: Payment of actual liquidation expenses Cash available to partners, September 30, 20X5

$10,000 55,000 (2,500) $62,500

Chapter 16 - Partnerships: Liquidation

P16-19 Matching 1.

10.

Chapter 16 - Partnerships: Liquidation

P16-20 Partnership Agreement Issues [AICPA Adapted] Part A: 1. Y

The admission of a new partner requires the consent of all existing partners.

The withdrawal of a partner causes the dissolution of the partnership. But a termination and liquidation can be avoided by having the other partners agree to continue the partnership and buy out Coke’s partnership interest.

A third-party beneficiary is not a party to a contract, but is a beneficiary of it.

The liability of a withdrawing partner may be limited by an agreement between the partners, but that agreement is not binding on third parties unless they join in on the agreement.

A partner may retire at any time if there is no specified term of existence or undertaking for the partnership.

Part B: 6. Y

A new partner is personally liable for all partnership debts incurred subsequent to entry into the partnership.

Continuation of the partnership does not release the partnership from the liabilities existing prior to the admission of the new partner.

White is liable for debts prior to his admission only to the extent of his capital contribution.

As in item 8, White is liable for pre-existing debts only to the extent of his capital contribution.

10.

A partner may disassociate at any time there is no specified term of existence for the partnership, and there is no minimum time period before a partner is subject to personal liability for the partnership’s obligations incurred while a partner.

Chapter 16 - Partnerships: Liquidation

Case 16-5: Mattfield v. Kramer Brothers 2005 MT 126 N A copy of the Montana Supreme Court’s decision is on the following eight pages. Supreme Court cases are within the public domain and can be printed verbatim without requesting permissions. The decision of the court includes a summary of the disputes and lower court decisions. Your students can obtain the case via an internet search. Alternatively, the case may be obtained, along with the legal briefs from each side, at the State Law Library of Montana site: http://courts.mt.gov/library and then click on Cases to get to case number 03-796 or use the text term of Mattfield. The State of Montana is continually revising its libraries of legal documents so doing a Google search may be the most efficient method for your students.

Chapter 16 - Partnerships: Liquidation

No. 03-796 IN THE SUPREME COURT OF THE STATE OF MONTANA 2005 MT 136N GREG MATTFIELD and CLINTON KRAMER, as Permanent Full Co-Conservators of the Person and Estate of DONALD D. KRAMER, an Incapacitated and Protected Person, Plaintiffs and Appellants, v. KRAMER BROTHERS CO-PARTNERSHIP; WILLIAM KRAMER, Co-Partner; RAYMOND KRAMER, Co-Partner; DOUGLAS KRAMER, Co-Partner; WILLIAM KRAMER, RAYMOND KRAMER, and DOUGLAS KRAMER, as Co-Personal Representatives of the ESTATE OF RAYMOND KRAMER, and LYDIA KRAMER, Individually, Defendants and Respondents. APPEAL FROM:

District Court of the Twenty-Second Judicial District, In and For the County of Carbon, Cause No. DV 2000-40, Honorable Blair Jones, Presiding Judge

COUNSEL OF RECORD: For Appellants: Floyd A. Brower, Brower Law Firm, Roundup, Montana For Respondents: Philip P. McGimpsey, McGimpsey Law Firm, Billings, Montana William Kramer, pro se, Laurel, Montana Submitted on Briefs: June 23, 2004 Decided: May 31, 2005 Filed: __________________________________________ Clerk 16-43 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 16 - Partnerships: Liquidation

Justice Jim Rice delivered the Opinion of the Court. ¶1

Pursuant to Section I, Paragraph 3(c), of the Montana Supreme Court 1996 Internal

Operating Rules, the following decision shall not be cited as precedent. It shall be filed as a public document with the Clerk of the Supreme Court and shall be reported by case title, Supreme Court cause number, and result to the State Reporter Publishing Company and to West Group in the quarterly table of noncitable cases issued by this Court. ¶2

Donald D. Kramer (Don) appeals from the summary judgment entered on August 21, 2003,

in the Twenty-Second Judicial District Court, Carbon County, in favor of the Kramer Brothers CoPartnership (Partnership), and also challenges the order entered by the court on August 30, 2002, dismissing Don’s claims accruing prior to July 23, 1995, as time barred. We affirm. ¶3

We restate the issue on appeal as follows:

¶4

Did the District Court err in granting summary judgment to the Kramer Brothers Co-

Partnership? FACTUAL AND PROCEDURAL BACKGROUND ¶5

In the early 1980s, the Kramer brothers, Don, Douglas (Doug), William (Bill), and

Raymond (Ray), and their father, Raymond Kramer, Sr. (Raymond), orally formed a farming ¶6

operation partnership, with Raymond furnishing the initial capital, real estate, and head of

cattle.

Chapter 16 - Partnerships: Liquidation

¶7

In 1985 Bill determined to disassociate from the Partnership, and requested distribution of

his interest under the Revised Uniform Partnership Act (RUPA).a Thereafter, Raymond, Doug, Ray, and Don, albeit limited in his management responsibilities due to a neuropsychological functioning impairment resulting from a car accident in 1984, continued under the original partnership agreement until July 1994, when Don left Montana to reside in San Francisco. Don returned to Montana in 1995, but did not associate with the Partnership, nor did he initially seek any remedy as a disassociated partner as set forth under the RUPA. In fact, Don would not file an action against the Partnership until May 23, 2000, after many failed attempts to negotiate a buyout offer of his interest in the Partnership with Ray and Doug. ¶8

In 1997 Raymond died, and the Kramer brothers discussed distribution of their father’s

assets, including distribution of Raymond’s interest in the Partnership property. This was the first time Don had any contact with the Partnership since his return from San Francisco. Don had previously consulted with attorney Floyd A. Brower (Brower) regarding his interest in the Partnership as a disassociated partner, and requested Brower’s assistance in representing him in the distribution of his father’s personal estate and interest in the Partnership.

Although the 1993 Legislature did not amend the title of the Uniform Partnership Act, it adopted the changes embodied within the Revised Uniform Partnership Act ("RUPA") and, therefore, we shall refer to the act throughout this opinion as “RUPA.” See McCormick v. Brevig, 2004 MT 179, ¶ 37 n.1, 322 Mont. 112, ¶ 37 n.1, 96 P.3d 697, ¶ 37 n.1. 16-45 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 16 - Partnerships: Liquidation

¶9

On February 27, 1998, Brower requested copies of the Partnership’s accounting records

from the date of its inception until July 1994, when Don departed to San Francisco, and copies of Ray’s and Doug’s personal tax returns, from attorney Carol Hardy (Hardy), who represented the Partnership. Brower stated in his letter that Hardy’s compliance with his request was crucial, as this information was necessary to “accomplish an accurate accounting” of the Partnership’s records to determine any monies owed to Don, and indicated that he would file suit against the ¶10

Partnership if the request was not honored within ten days. Hardy did not respond to

Brower’s letter until March 9, 1998, but Brower did not then file a complaint. ¶11

On December 9, 1998, Ray and Doug offered to purchase Don’s interest in the Partnership.

Under the offer, Don was to receive ninety head of cattle for the assignment of his interest in the Partnership’s brand name. However, Don rejected the offer, and thereafter, the parties continued to negotiate, with no resolution. ¶12

However, it was not until May 23, 2000, that Don filed suit, demanding a formal accounting

of the Partnership, liquidation of the Partnership’s assets, and division of the real property held by partners as tenants in common. Ray and Doug responded by filing a motion seeking joinder of the Estate of Raymond Kramer (Raymond’s Estate) as a necessary party, because Raymond had held an interest in the Partnership’s real property as a co-tenant. The court ordered Don to join the necessary parties, and on August 10, 2000, Don filed an amended complaint naming Raymond’s Estate and Lydia Kramer (Lydia), mother of the four Kramer

Chapter 16 - Partnerships: Liquidation

¶13

brothers who was married to Raymond until his death.

¶14

On December 18, 2001, Doug, Ray, and Lydia filed a motion to dismiss Don’s claims

under the RUPA as time barred under the general five-year limitation provision, § 27-2-231, MCA, which motion was joined by Bill. In response, Greg Mattfield (Mattfield), who had been previously appointed as Don’s temporary full guardian and conservator, moved for leave to amend Don’s amended complaint to substitute himself for Don as the real party in interest pursuant to Rule 17, M.R.Civ.P., and to raise the affirmative defenses of waiver, laches, and equitable estoppel, arguing that he had no opportunity to respond to the statute of limitations defense raised by the Defendants in their motion to dismiss. ¶15

On August 30, 2002, the District Court granted the Defendants’ motion to dismiss, but only

as to those claims accruing prior to May 23, 1995. The court concluded that Don’s relocation to San Francisco in July 1994 constituted a wrongful withdrawal from the Partnership, and that the five-year statute of limitations period on his partnership claims began to run at that time, requiring an action to be filed by July 1999. Don had filed his action on May 23, 2000, and the District Court therefore concluded that Don’s claims were time barred, unless it could be demonstrated that a claim had accrued after May 23, 1995, five years prior to the filing of this action. The court denied Mattfield’s motion for leave to amend the complaint. The District Court then set a scheduling conference to address any remaining claims which had survived its order applying the time bar. ¶16

On October 17, 2002, the parties entered into a mutual release, settlement and exchange

agreement regarding the real property held by the parties as tenants in common and the real property which the parties owned as partners. Pursuant to the agreement, Ray and Doug purchased Don’s share of the Partnership’s interest in real property for $487,500.00, to be paid to

Chapter 16 - Partnerships: Liquidation

¶17

Don’s conservatorship.

¶18

On November 15, 2002, Lydia and Raymond’s Estate requested an order dismissing them

as defendants in the matter upon the court’s approval of the real property settlement agreement. Mattfield and Clinton Kramer (Guardians), who by then had been appointed as Don’s permanent limited co-guardians and permanent full co-conservators, responded by filing a motion again asserting the affirmative defenses of waiver, laches, and equitable estoppel, and requesting the District Court to reconsider its August 2002 order. They argued that a guardianship proceeding conducted subsequent to the entry of the August 2002 order had determined the extent and severity of Don’s mental incapacity, which should retroactively toll the five-year statute of limitations period enforced by the District Court’s August 2002 order. Ray and Doug then filed a motion for judgment on the pleadings and a motion to dismiss the Guardians’ motion raising defenses and seeking reconsideration. They asserted that Don failed to file an action within 120 days of their initial buy-out offer as required by § 35-10-619(5), MCA, of the RUPA, and thus, any of Don’s claims that had accrued after May 23, 1995, were also time barred under this provision. ¶19

On January 28, 2003, the District Court granted the motion filed by Lydia and Raymond’s

Estate to dismiss them as parties to the action. On January 30, 2003, Lydia and Raymond’s Estate filed a notice of entry of judgment on both the January 2003 and August 2002 orders. ¶20

On June 18, 2003, the District Court issued an order converting Ray and Doug’s motion

for judgment on the pleadings and their motion to dismiss the Guardians’ motion raising defenses to a motion for summary judgment pursuant to Rule 12(b) and (c), M.R.Civ.P. Further, the District Court denied the Guardians’ motion for reconsideration of its August 2002 order, and

Chapter 16 - Partnerships: Liquidation

¶21

reserved a determination on their motion raising defenses, pending further proceedings.

¶22

On August 21, 2003, the District Court granted Ray and Doug’s motion for summary

judgment on Don’s remaining claims, including an accounting of the Partnership’s records from 1994 through 1997, the Partnership’s failure to properly buy out his interest, or any other claim he could have raised as a disassociated partner under the RUPA. Don appeals therefrom. STANDARD OF REVIEW ¶23

Our review of a summary judgment order is de novo. R.C. Hobbs Enter., LLC v. J.G.L.

Distrib., Inc., 2004 MT 396, ¶ 20, 325 Mont. 277, ¶ 20, 104 P.3d 503, ¶ 20. We review summary judgment to determine if the district court correctly determined no genuine issue of material facts existed and if it applied the law correctly. R.C. Hobbs Enter., ¶ 20. DISCUSSION ¶24

Did the District Court err in granting summary judgment to the Kramer Brothers

Co-Partnership?

Chapter 16 - Partnerships: Liquidation

¶26 ¶27

As a preliminary matter, we must determine whether Don’s appeal is properly before the

Court. The Partnership contends that Don’s claims were disposed of by the District Court’s August 2002 order, which concluded that claims accruing prior to May 23, 1995, were time barred, and are not properly before this Court for determination. The Partnership notes that Don was given notice of the entry of judgment on the August 2002 order dismissing his claims on January 30, 2003, but did not appeal until September 17, 2003, eight months later. We observe that the appeal was taken following the District Court’s summary judgment order on August 21, 2003, which purportedly disposed of any remaining claims. Thus, the appeal was taken within thirty days, pursuant to Rule 5(a)(1), M.R.App.P., after the summary judgment order, but eight months after the notice of entry of judgment on the court’s August 2002 order dismissing claims. We agree with the Partnership. Although further proceedings were conducted following the District Court’s August 2002 order, the purpose of those proceedings was to determine whether any claims had survived the application of the time bar. The District Court had concluded in its August 2002 order that Don expressly withdrew from the Partnership upon his relocation to San Francisco in July 1994, and therefore, his right to maintain an action for an accounting, distribution, or any other claim under the RUPA accrued at that time. Although the District Court addressed several motions after the August 2002 order, the only substantive question which remained was whether Don had any claims for which he could still maintain an action. In

Chapter 16 - Partnerships: Liquidation

¶28

its summary judgment order of August 21, 2003, the court, although addressing the parties’

new arguments, concluded that none of Don’s asserted claims had survived its August 2002 order applying the five-year statute of limitations–essentially a restatement of its earlier holding. Thus, any right to an accounting or distribution of the Partnership’s assets that may have existed ¶29

outside the issues settled by the parties’ October 2002 settlement agreement had been

resolved by the earlier order, from which appeal was not timely taken. ¶30 ¶31

We affirm the judgment entered by the District Court.

/S/ JIM RICE We Concur: /S/ KARLA M. GRAY /S/ JOHN WARNER /S/ W. WILLIAM LEAPHART

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

CHAPTER 17 GOVERNMENTAL ENTITIES: INTRODUCTION AND GENERAL FUND ACCOUNTING ANSWERS TO QUESTIONS Q17-1 A fund is an independent fiscal and accounting entity with a self-balancing set of accounts recording cash and/or other resources together with all related liabilities, obligations, reserves, and equities which are segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations. A fund may receive resources from a variety of sources, including collection of taxes on property, income, or commercial sales; receipt of grants, fines, or licenses; and collection of service charges. Q17-2 The nine funds generally used by local and state governments are: Governmental a. General fund b. Special revenue fund c. Capital projects fund d. Debt service fund e. Permanent fund Proprietary f. Internal service fund g. Enterprise fund Fiduciary h. Trust funds i. Agency funds The purpose of each fund is individually discussed below: a.

General fund: All financial resources except those required to be accounted for in another fund are accounted for in the general fund.

Special revenue fund: The proceeds of specific revenue sources that are legally restricted for specified purposes are accounted for in the special revenue fund.

Capital projects fund: Financial resources to be used for the acquisition or construction of major capital projects that will benefit a large population are accounted for in the capital projects fund.

Debt service fund: The accumulation of resources for, and the payment of, general long-term debt principal and interest are accounted for in the debt service fund.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

Q17-2 (continued) e.

Permanent fund: Accounts for resources for which the principal must be maintained, but for which the earnings may be used in support of governmental programs.

Internal service fund: The financing of goods or services provided by one department or agency to other departments or agencies of the governmental unit, or to other governmental units, are accounted for in internal service funds.

Enterprise fund: Operations of governmental units that charge for services provided to the general public are accounted for in the enterprise funds.

Trust funds: Pension trust fund: Resources held by a governmental unit in a trustee capacity for the members and beneficiaries of pension plans, postemployment plans, or other employee benefit plans. Investment trust funds: Accounts for the external portion of investment pools of governing units. Private-purpose trust fund: Accounts for trust arrangements under which both principal and interest may be used to benefit specific individuals, private organizations, or other governmental units. Note that these resources have specific purposes as stated by the donor or grantor, and are not available for general governmental programs.

Agency funds: Assets held by a governmental unit in an agency capacity for employees or other individuals are accounted for in agency funds.

Q17-3 The modified accrual basis includes some aspects of accrual accounting and some aspects of cash-basis accounting. Under the modified accrual basis, the emphasis is on reporting how well the government performed by focusing on when the revenue and expenditures are recognized in the accounts and reported in the financial statements. In particular, it emphasizes when current resources accrue to the entity and when current resources are committed for current obligations. The emphasis is not on how much was earned or on the amount of expenses incurred like under the accrual basis. Q17-4 The modified accrual basis is used for funds for which expendability is the concern because the governing entity is interested in the determination of the resources still remaining to be expended to carry out the objectives of the fund. Q17-5 Property taxes are recognized as revenue in the general fund when the taxes are levied, provided they apply to and are collectible within the current fiscal period, or within a short period (< 60 days) after the end of the fiscal period. Q17-6 GASB 33 states that taxpayer-assessed income and sales taxes should be accrued in the general fund when they become both measurable and available to finance expenditures of the fiscal period. Sales taxes held by other governmental units should be recognized if the taxes are both measurable and available for expenditure. Measurability in this case is based on an estimate of the sales taxes to be received, and availability is based on the ability of the governing entity that will receive the future distribution to obtain current resources through credit by using future sales tax receipts as collateral for the loan. 17-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

Q17-7 Budgetary accounting is the entering of the budgeted revenue, appropriations, and net increase or decrease in fund balance into the formal accounting records as a formal accounting control mechanism. Expected revenue is accounted for as estimated revenue, an anticipatory asset account. The governmental unit anticipates receiving resources from the revenue sources listed in the budget. Anticipated expenditures are accounted for as appropriations, an anticipatory liability account. The governmental unit anticipates incurring liabilities for the budgeted amount. Both the expected revenue and the appropriations accounts are closed at the end of the fiscal period. Q17-8 All expenditures are not encumbered. Payroll costs and other costs for goods received from within the governmental entity are not encumbered because these are normal and recurring costs. Q17-9 Some governmental units do not report small amounts of inventories of supplies in their balance sheets because the amount of inventory is not material. Q17-10 Under the lapsing method the Reserve for Encumbrances account is shown as a reservation of the fund balance on the fiscal year-end balance sheet. The encumbrance account is a nominal account that is closed at the end of the fiscal period. The net effect is to close out the remaining encumbrances against the fund balance-unassigned. Alternatively, the GASB does allow for just footnote disclosure of the lapsing open orders at year-end that are expected to be honored in the next fiscal period. Under the nonlapsing method the expenditure authority from prior periods is carried over as nonlapsing encumbrances. The budget for the next fiscal period does not include these carryovers and is more realistic for situations in which orders placed with outside vendors cannot easily be canceled. The encumbrances account and the budgetary reserve for encumbrances account are still closed at the end of the first period. When accounting for the actual expenditure in the subsequent year, the lapsing method requires the new governing board to decide if it will honor the outstanding encumbrances from the previous year by including them in the current budgeted appropriations. If the governing board accepts the obligation to honor their outstanding purchase orders from the prior year, the recording of the current year’s budget establishes the expenditure authority for the prior year-end’s open encumbrances. In the event the new governing board decides not to honor the outstanding encumbrances, the reserve for outstanding encumbrances is closed to the unassigned fund balance and the order for the goods is cancelled with the external vendor. When accounting for the actual expenditure in the subsequent year, the nonlapsing method separates expenditures made from spending authority carried over from prior periods. This is done in a reclassification entry made on the first day of the next fiscal period, which dates the reserve for encumbrances. When the goods are received in the second year, the expenditures account is also dated to note that it refers to expenditure authority of the prior year. Q17-11 The expenditure for inventories is recognized in the period the supplies are acquired under the purchase method. Under the consumption method, the expenditure for inventories is recognized for only the amount of inventory used in the period. Q17-12 Interfund services provided and used are interfund activities that would be treated as revenues or expenditures if they were made with parties external to the governmental entity. An example would be if the general fund purchased supplies from the internal service fund. 17-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

Interfund transfers out or in are transfers of resources between funds. An example would be a transfer of resources from the general fund (an interfund transfer out) to the capital projects fund (a transfer in) to assist in the construction costs of a new municipal building. Q17-13 An interfund transfer is reported as "Other Financing Sources or Uses" in the general fund's statement of revenues, expenditures, and changes in fund balance. Q17-14 The loan of $2,000 from the general fund to the enterprise fund is reported on the financial statements of the general fund on the balance sheet as a receivable. The loan is not shown on the fund's statement of revenues, expenditures, and changes in fund balance. Q17-15 Governmental accounting places many controls over expenditures, and much of the financial reporting focuses on the various aspects of an expenditure. An expenditure can be made for a function of the governmental entity or an activity within a function. Expenditures for an activity can be classified by object, which is the type of expenditure. The extensive detail required to account for and cross reference an expenditure to ensure it is properly classified at all levels requires a very comprehensive accounting system.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

SOLUTIONS TO CASES C17-1 Budget Theory a. A governmental accounting system must make it possible to: 1. Present fairly and with full disclosure, in conformity with generally accepted accounting principles, the financial position and results of financial operations of the funds and account groups of the governmental unit. 2. Determine and demonstrate compliance with finance-related legal and contractual provisions. Because the legislative body enacts the budget into law, the budget is recorded in the accounts of a governmental unit. This enables a governmental unit to show legal compliance with the budget by providing an accounting system that measures actual expenditures and obligations against amounts appropriated and actual revenue against estimated revenue. Appropriations enacted into law constitute maximum expenditure authorizations during the fiscal year, and they cannot legally be exceeded unless subsequently amended by the legislative body. b. As the new fiscal year begins, the budget, already enacted in law by the legislative body, is recorded. Budgetary accounts are set up to record the estimated revenue and appropriations in the fund accounts by debiting estimated revenue and crediting appropriations. If there is a difference between estimated revenue and appropriations, the excess or deficit is credited or debited, respectively, to fund balance. In addition, subsidiary ledger accounts are maintained for estimated revenue by source and for appropriation/expenditure items. At the end of the fiscal year, the estimated revenue and the appropriations accounts are among other budgetary accounts closed out to the budgetary fund balance.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

C17-2 Municipal versus Financial Accounting a. The most significant difference in purpose between municipal accounting and commercial accounting is that commercial enterprises are operated for profit, which places much emphasis on the proper determination of periodic earnings. Governmental units are primarily concerned with providing services to their citizens at minimum cost and reporting on the stewardship of public officials with respect to public funds, which places much emphasis on budgetary controls. However, some municipal units perform commercial services that are generally secondary to their tax-financed primary services. Another difference in accounting purpose is that municipal accounting operations are controlled by legal provisions in constitutions, charters, and regulations having the force and effect of law. Because of these legal provisions and the diversity of its governmental operations, a municipality cannot use a single, unified set of accounts for recording and summarizing all financial transactions. If there is a conflict between legal provisions and generally accepted accounting principles applicable to governmental units, legal provisions should take precedence to the extent that the accounting system must enable the ready disclosure of compliance. However, for financial reporting purposes, generally accepted accounting principles must take precedence. Commercial enterprises usually are not controlled by charters that are restrictive; therefore, their accounting systems are designed differently. Legislative action may limit the use of certain tax revenue for expenditure on particular programs, the methods of tax collection, or the rates of tax assessment. Such provisions must be reflected in the accounting system and be appropriately disclosed in the municipality's financial statements as a report on the stewardship of public officials with respect to public funds. In governmental accounting all required accounts are organized on the basis of funds, each of which is independent of the other. Each fund must be so accounted for that the identity of its resources, obligations, revenue, expenditures, and fund balance is continually maintained. These purposes are accomplished by providing a complete selfbalancing set of accounts for each fund. The basis of accounting for the reporting on governmental units is often different from that used by commercial enterprises. For example, the accrual basis of accounting is recommended for all funds except the governmental funds. The governmental funds should be accounted for by the modified accrual basis. The modified accrual basis is recommended for the governmental funds because some of their revenue sources are difficult to measure in advance and frequently become available only a short time before cash receipt. Generally, fair presentation of financial position and results of operations in conformity with generally accepted accounting principles requires that the financial statements of governmental funds (those that use the modified accrual basis) include a balance sheet and a statement of revenues, expenditures, and changes in fund balance. In contrast, however, a commercial enterprise would usually prepare a statement of financial position, an earnings statement, a statement of retained earnings, and a statement of cash flows. The statement of revenues and expenditures of the general fund and certain special revenue funds should include a comparison with a formal budget in order to conform to generally accepted accounting principles; there is no such requirement for a commercial enterprise.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

C17-2 (continued) b. Inventories are often ignored in governmental accounting because of an emphasis on budgeting revenue against outlays without looking behind the outlays to determine the extent to which they represent actual usage or consumption. Put another way, there is an emphasis on the cash or fiscal aspects rather than the operational aspects. This is easy to understand when one considers that general-fund expenditures for firemen's salaries and for the purchase of a new fire truck are accounted for in the same way. However, inventories are not wholly ignored in governmental accounting. In those funds in which accounting parallels commercial accounting practice, such as enterprise funds, inventories are taken into consideration. Similarly, in an internal service fund concerned with rendering service involving the consumption of supplies or the delivery of stores to other funds and activities, the inventories of supplies or stores are taken into consideration in computing billings to departments serviced. Larger amounts of inventories can and should be taken into consideration when preparing budgets. A fund, such as a general fund, having departments that possess large inventories at year-end obviously can make smaller appropriations for the coming year than it would if those departments had zero inventories. C17-3 Revenue Issues The following presentation describes the proper accounting and financial reporting for each item. Note that there are two decision points: (1) when a receivable or other asset should be recognized, and (2) when a revenue should be recognized. a. GASB 33 states that an asset (receivable or cash) should be recognized for imposed nonexchange revenue when the government has an enforceable claim to the resources, or the resources are received, whichever comes first. The property taxes receivable would be debited at the time an enforceable claim arises. In most governments, this is the levy date (sometimes termed the lien date); in some others, it is the assessment date or other date fixed by law. It depends on the enabling legislation permitting the government to impose property taxes. Property tax revenue would be credited when the resources become available for use for current expenditures. Resources received or recognized as receivables before becoming available for use should have a credit to deferred revenues. Recording of both the asset debit and the revenue or deferred revenue credit must be in compliance with the requirements established by GASB 33. The estimated uncollectible should be recorded as a reduction of the revenue, and a contra account for the Allowance for uncollectibles should be recorded. b. For property taxes received in advance of when they can be used for current expenditures, a debit is made to cash, and a deferred revenue account, for example, property taxes received in advance, should be credited until the taxes are available for use at which time the deferral should be transferred to revenue. c. GASB 33 requires that this derived tax revenue should be recognized as a receivable when the underlying exchange transaction occurs or resources are received, whichever is first. The revenue is recognized when the underlying exchange has occurred and the resources are available. In the rare cases in which derived tax revenues are received before the underlying exchange transaction has occurred, the credit should be to deferred revenues. Estimates of collections expected in the near future should be made and the receivable recognized in accordance with the above guidelines. 17-7 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

C17-3 (continued) d. Under GASB 33, this is an example of a voluntary nonexchange transaction unless the payment is the result of a government-mandated program. The asset will be recorded (receivable or cash) when all eligibility requirements are met or resources are received, whichever is first. Eligibility requirements are those established by the provider and may state requirements for specific allowable costs or specify a time requirement. Revenue will be recorded when all the eligibility requirements are met. On the modified accrual basis, revenues would be recorded when all eligibility requirements are met and the resources are available. e. Interest earned on investments is recognized as a receivable in the period in which it is accrued but not yet received. But interest is not recognized as revenue until it is considered available to liquidate liabilities of the current period. Thus, interest may be accrued to a receivable with a credit to deferred revenue in the period prior to the actual collection of the interest. In addition, the city should make an adjusting journal entry at each balance sheet date to recognize any adjustments required for changes in the fair value of the investments. Investment earnings are reported in the revenues section of the operating statement. f. GASB 33 specifies that this voluntary nonexchange transaction, with its time restriction and eligibility requirements, should be recorded as an asset when the applicable eligibility requirements are met or the resources are received, whichever is first. Under the modified accrual basis of accounting, revenues should be recognized when all applicable eligibility requirements are met and the resources are available. Prior to that, the community may recognize a credit for deferred revenues if the resources have been received.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

C17-4 Examining the General Fund Disclosures in a Comprehensive Annual Financial Report (CAFR) (Note to the instructor: Most local governments now produce a comprehensive annual financial report. You might select the local city or county in which the university is located or a large city close to the university town. Printed copies of the CAFR may be obtained directly from that government unit and you could place these copies on reserve in your university or college library for use by your students. Alternatively, many governments now provide their CAFRs online. A web search using “CAFR” and the name of your city, county or state will show if your selection provides an online copy of its CAFR. Or, you may do a web search using “CAFR” and then select one of the government units that provide an online copy of its CAFR and then provide that link to your students or insert that link into your online syllabus.)

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

C17-4 (continued) a. The budgetary comparison schedules for the general fund are reported as other required supplementary information. This schedule for the general fund should be used to answer questions a and b. These schedules disclose the amounts budgeted for each item of revenue, appropriations for the various functions of government, and for estimated transfers in from other funds and estimated transfers out to other funds in the government. b. See the response to question a. c. The notes to the basic financial statements should disclose the encumbrance policy— whether the government has a policy in which the outstanding encumbrances lapse at yearend or do not lapse at year-end. d. This question reinforces the student’s understanding of the balance sheet equation for the general fund: Assets = Liabilities + Fund Balance. This question also makes students aware of the two forms of fund balance — assigned and unassigned. e. This question makes students aware that inventories are reported on the balance sheet of the general fund if the amount is material. If reported, the next question is the accounting method for inventories — the purchase or consumption method. The notes should answer the policy question. f. This question makes students aware of the modified accrual method and its application to property taxes. The notes to the financial statements should disclose that revenue from property taxes is reported when measurable and available to finance expenditures of the current period. The notes should also disclose the use of the 60-day rule for property tax revenue as well as the percentage of property taxes that were estimated to be uncollectible. g. This question focuses attention once again on MD&A and the different items that are reported therein. In MD&A, the government’s finance director should explain why revenues in the general fund either increased or decreased during the most recent year. h. This question addresses the issue that budgeted inflows and outflows should be compared with the actual resource inflows and outflows for the year. Was the budget more or less optimistic in predicting resource inflows from revenues? The same question is appropriate for appropriations versus expenditures. This question also should help students understand that the statement of revenues, expenditures, and changes in fund balance reports the change in fund balance that resulted from actual resource inflows and outflows. i. This question makes students aware that taxes may be the primary resource inflow for the general fund, but they are not the only resource inflow. This question also emphasizes that the revenues of the general fund come primarily from nonexchange transactions. j. This question makes students aware of one category of interfund transactions-interfund loans and advances. The balance sheet of the general fund should report the receivables (“due from” or “advances to” accounts) and payables (“due to” and “advances from” accounts) associated with any interfund borrowings.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

C17-5 Examining Deposit and Investment Risk Disclosures of a Governmental Entity (Note to the Instructor: Students may become frustrated because they may feel that the information presented in the summaries for GASB 40 and GASB 3 are not enough to fully understand the risk disclosures required by these two standards. This case does not require an intensive knowledge, but rather a general knowledge of the required risk disclosures. Then the case provides students with the opportunity to see the standards in a real government annual report, especially if they select a local governmental entity with which they are quite familiar, e.g., their home city or the city in which the university is located.) a. The deposit and investment risks stated in the summary are: (1) custodial credit risk, (2) credit risk, (3) concentration of credit risk, (4) interest rate risk, and (5) foreign currency risk. GASB 3 and GASB 40, which your students probably would not have, define these as follows: Custodial credit risk: (established in GASB 3 but amended in GASB 40): The risk that in the event of a failure of a depository financial institution or a counterparty to a transaction, a government will not be able to recover deposits, or the value of the investment, or the collateral that is in the possession of an outside party. Credit risk: The risk that an issuer or other counterparty to an investment will not fulfil its obligations. Concentration of credit risk: The risk of loss attributes to the magnitude of a government’s investment in a single issuer. Interest rate risk: The risk that changes in interest rates will adversely affect the fair value of an investment. Foreign currency risk: The risk that changes in exchange rates will adversely affect the fair value of an investment or deposit. b. The summary of GASB 40 stated it well: that the disclosures provide users of the financial statements with information about deposit and investment risks that might affect the ability of a government to provide services and to meet its obligations as they become due. c, d and e. These answers will depend on the selected city and most recent fiscal period. But, the objective of these three questions is to have students look at the deposit and investment footnotes for an actual governmental entity. Students should be able to describe the types of deposit and investment risks faced by the selected local government, its policies to manage those risks, and the additional financial information such as the investments comprising each portfolio, credit ratings of the investments in bonds, discussion of the impacts of changing interest rates, and for some governmental entities, discussion of the effects of changing exchange rates for foreign currencies or investments.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

SOLUTIONS TO EXERCISES E17-1 Multiple-Choice Questions on the General Fund [AICPA Adapted] 1. b – Governmental accounting requires that resources pertaining to different aspects of the government operations be accounted for in separate, self-balancing funds. (a) Incorrect. Long-term assets and depreciation are recorded for proprietary funds. (c) Incorrect. The accrual basis and modified accrual basis are used for government funds. (d) Incorrect. The accrual basis is also used for certain funds that have a flow of economic resources measurement focus. 2. a 3. b 4. c 5. b E17-2 Matching for General Fund Transactions [AICPA Adapted] 1.

10.

11.

12.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-3 Multiple-Choice Questions on Budgets, Expenditures, and Revenue [AICPA Adapted] 1. c 2. d 3. c 4. a 5. b

7,500 – 4,500 – 750 = 2,250

6. c 7. d 8. b 9. c 10. d

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-4 Multiple-Choice Questions on the General Fund 1.

c–

The balances in the ENCUMBRANCES CONTROL and the FUND BALANCEASSIGNED FOR ENCUMBRANCES accounts are the same. Therefore, an excess of one account over the other indicates a recording error.

c–

The following entry is made when a purchase order is approved: ENCUMBRANCES CONTROL BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES

b–

The 60-day rule for property tax revenues states that property taxes collected within 60 days after the end of a fiscal year (within first 60 days of 2007) may be classified as revenues of the prior fiscal year (2006). The entry to record the tax levy would be: Property Taxes Receivable 700,000 Allowance for Uncollectible Taxes 10,000 Revenue – Property Taxes 600,000 Deferred Revenue (reported as a liability on the general fund balance sheet) 90,000 [Note: The estimated uncollectibles are on the property taxes reported as deferred revenue.]

a–

Upon receipt of the order, Oak would record the following entries: BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES CONTROL Expenditures Control Vouchers Payable

a–

5,000 5,000 4,950 4,950

Johnson would record the following entry: ESTIMATED REVENUES CONTROL 9,000,000 ESTIMATED OTHER FINANCING SOURCE – TRANSFER IN (Internal Service) 1,000,000 ESTIMATED OTHER FINANCING SOURCE – TRANSFER IN (Debt Service) 500,000 APPROPRIATIONS CONTROL BUDGETARY FUND BALANCE – UNASSIGNED

10.

XXXXXX XXX

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-5 Encumbrances at Year-End a.

Outstanding encumbrances lapse at year-end. (1)

Order equipment—November 3, 20X2: ENCUMBRANCE BUDGETARY FUND BALANCE--ASSIGNED FOR ENCUMBRANCES Order equipment and record encumbrance.

(2)

21,000 21,000

Year-end entries—December 31, 20X2: BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Close remaining budgeted encumbrances.

21,000 21,000

Fund Balance – Unassigned 21,000 Fund Balance – Assigned for Encumbrances 21,000 Reserve actual fund balance for outstanding encumbrances at year-end. (3)

City Council accepts outstanding encumbrances—January 1, 20X3: Fund Balance – Assigned for Encumbrances Fund Balance – Unassigned Reverse prior-year encumbrance reserve.

21,000 21,000

ENCUMBRANCES 21,000 BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES 21.000 Establish budgetary control over encumbrances renewed from prior year. (4)

Equipment received—January 18, 20X3: BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Remove budgetary reserve for goods received.

21,000 21,000

Expenditures 21,800 Vouchers Payable Record expenditure for goods received at actual cost of $21,800. (5)

21,800

Year-end entry—December 31, 20X3: Fund Balance—Unassigned Expenditures Close 20X3 expenditures account.

21,800 21,800

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-5 (continued) b.

Outstanding encumbrances are nonlapsing. (1)

Order equipment—November 3, 20X2: ENCUMBRANCE BUDGETARY FUND BALANCE--ASSIGNED FOR ENCUMBRANCES Order equipment and record encumbrance.

(2)

Fund Balance – Unassigned Fund Balance – Assigned for Encumbrances Reserve fund balance for outstanding encumbrances.

21,000 21,000 21,000

21,000 21,000

Equipment received—January 18, 20X3: Expenditures – 20X2 Expenditures (20X3) Vouchers Payable Record actual expenditure for goods received.

(5)

21,000

Date the encumbrances from prior year—January1, 20X3: Fund Balance – Assigned for Encumbrances Fund Balance – Assigned for Encumbrances – 20X2 Reclassify reserve from 2002, prior year.

(4)

21,000

Year-end entries—December 31, 20X2: BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Close remaining budgetary encumbrances.

(3)

21,000

21,000 800 21,800

Closing entries—December 31, 20X3: Fund Balance – Assigned for Encumbrances – 20X2 21,000 Expenditures – 20X2 Close expenditures account for prior year encumbrances. Fund Balance – Unassigned Expenditures (20X3) Close expenditures for current year.

21,000

800 800

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-5 (continued) (Note: In entry (4), the $800 excess of actual cost over the encumbered amount must be approved as part of 20X3's expenditures. Entry (4) records the City Council’s approval with a debit to Expenditures (20X3) which increases 20X3’s total expenditures. The expenditures for 20X3 are closed in entry (5). If the actual cost was less than the encumbered amount, then the difference should be closed to Fund Balance-Unassigned, although some governmental units have a policy of closing any difference between actual and encumbered amounts for prior year encumbrances to the current year's expenditures.) c.

(1)

Outstanding encumbrances are nonlapsing; City Council cancels order— January 1, 20X3: Fund Balance—Assigned for Encumbrances Fund Balance—Unassigned City Council cancels 20X2 order for equipment.

21,000 21,000

E17-6 Accounting for Inventories of Office Supplies a.

Consumption method of accounting for inventories: (1)

Purchase of supplies: August 8, 20X2 Inventory Vouchers Payable Acquire inventory of supplies.

(2)

3,600 3,600

Entries at end of 20X2 fiscal year: September 30, 20X2 Expenditures Inventories Recognize ending inventory of supplies. Fund Balance – Unassigned Fund Balance – Assigned for Inventories Establish fund reserve for ending inventory. Fund Balance – Unassigned Expenditures Close expenditures account.

800 800 2,800 2,800 800 800

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-6 (continued) (3)

Entry at end of 20X3 fiscal year: September 30, 20X3 Expenditures Inventory of Supplies Record expenditures for inventories consumed.

2,800 2,800

Fund Balance – Assigned for Inventories Fund Balance – Unassigned Remove fund balance reserve for inventories consumed.

2,800

Fund Balance – Unassigned Expenditures Close expenditures account.

2,800

Purchase method of accounting for inventories: (1)

Purchase of supplies: August 8, 20X2 Expenditures Vouchers Payable Acquire inventory of supplies.

(2)

3,600

Entries at end of 20X2 fiscal year: September 30, 20X2 Inventory of Supplies Fund Balance – Assigned for Inventories Recognize ending inventory of supplies. Fund Balance – Unassigned Expenditures Close expenditures account.

(3)

3,600

2,800 2,800 3,600 3,600

Entries at end of 20X3 fiscal year: September 30, 20X3 Fund Balance – Assigned for Inventories Inventory of Supplies Remove fund balance reserve for inventories consumed.

2,800 2,800

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-7 Accounting for Prepayments and Capital Assets (a)

Acquired three-year insurance policy: September 1, 20X1 Expenditures Vouchers Payable Record acquisition of three-year insurance policy.

(b)

5,400

New furniture for the city council meeting room: September 17, 20X1 ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES Encumber for purchase orders for new furniture. October 1, 20X1 BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Reverse reserve for furniture received. Expenditures Vouchers Payable Receive furniture at actual cost.

(c)

5,400

15,600 15,600

15,600 15,600 15,200 15,200

Acquired supplies – consumption method used: November 4, 20X1 Expenditures Vouchers Payable Acquire supplies.

1,800 1,800

Closing entries: December 31, 20X1 Inventory of Supplies Expenditures Recognize ending inventory of supplies.

1,120 1,120

Fund Balance – Unassigned Fund Balance – Assigned for Inventories Establish fund reserve for ending inventory.

1,120

Fund Balance – Unassigned Expenditures Close expenditures account: $ 5,400 Insurance Policy 15,200 Furniture 680 Supplies $21,280 Total

21,280

1,120

21,280

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-8 Computation of Revenues Reported on the Statement of Revenues, Expenditures, and Changes in Fund Balance for the General Fund Gilbert City Revenue Reported by the General Fund For the Year Ended June 30, 20X8 Property tax revenue Interest revenue on advance Grant revenue used to acquire computer equipment Sales tax revenue Liquor license revenue Total revenue reported

$1,860,000 1,500 235,000 150,000 66,000 $2,312,500

Notes: (1) The amount reported for property tax revenue, $1,862,000 is computed as follows: Levy $2,000,000 Less: Property taxes expected to be collected after August 31, 20X8 – the 60 day rule for property tax (100,000) collections – report in balance sheet as deferred revenue at June 30, 20X8, net of $2,000 allowance for uncollectible taxes (2%) The allowance for uncollectible taxes on this period’s revenue [$2,000,000 X .02] (40,000) Property tax revenue for year ended June 30, 20X8 $1,860,000 (2) The receipt of $50,000 for the repayment of the advance is recorded in the following manner by the general fund: Cash Advance to Internal Service Fund Interest revenue

51,500 50,000 1,500

(3) Collection of property taxes during the year ended June 30, 20X8, is recognized when collected either during the fiscal year or within 60 days after fiscal year end. [$2,000,000 – 100,000 – (2,000,000 x 0.2)] (4) Revenue recognition related to the State grant is based upon spending the grant to acquire computer equipment. Therefore, revenue from the State grant is $235,000, the amount of the grant expended. The $15,000 remainder of the grant monies received is shown as unearned revenue, a liability. (5) Revenue from the sales tax is the amount collected during the year ended June 30, 20X8 plus any amount collected within 60 days after fiscal year end [$125,000 + $25,000]. (6) The borrowing of the $800,000 using the property tax levy as collateral represents a liability in the general fund. This amount is not revenue. (7) The $30,000 received from a terminated debt service fund is reported as an otherfinancing source – transfer in, not revenue.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-8 (continued) (8) The revenue from liquor licenses is the amount collected, not the amount expected to be collected. Therefore, revenue of $66,000 is recognized from the sale of liquor licenses for the year ended June 30, 20X8. (9) The $15,000 reimbursement is not reported as revenue in the general fund. Reimbursements are recorded as reductions in expenditures. (10) The collection of the delinquent property taxes is not reported as revenue by the general fund for the year ended June 30, 20X8. The revenue associated with the delinquent property taxes was reported in the preceding fiscal year, because the property taxes were expected to be collected within 60 days of the end of the fiscal year.

E17-9 Computation of Expenditures Reported on the Statement of Revenues, Expenditures, and Changes in Fund Balance for the General Fund Benson City Amount Reported for Expenditures by the General Fund For the Year Ended June 30, 20X8 Computer equipment acquisitions in September, 20X7 Reimbursement to special revenue fund in May, 20X8 Use of city water during the fiscal year Supplies acquisitions Salaries and wages of general fund employees Interest paid on loan from local bank Employer’s pension contribution to pension trust Lease payments Total amount reported for expenditures

$ 202,000 15,000 12,000 35,000 900,000 15,000 95,000 10,000 $1,284,000

Notes: (1) The $150,000 transfer to the capital projects fund in March, 20X8, is reported as an other-financing use – transfer out. Therefore, it should not be included in the amount reported for expenditures for the year ended June 30, 20X8. (2) The amount paid for the computer equipment is the amount reported for expenditures. Therefore, $202,000 is included in expenditures for equipment, not the estimated amount of $200,000 that was recorded for the order (encumbrances). (3) None of the $500,000 transferred to the internal service fund should be reported as expenditures. The $200,000 that must be repaid by the internal service fund should be accounted for as an advance (a receivable in the general fund), while the $300,000 that represented a permanent contribution should be accounted for as an other financing use – transfer out. (4) The $15,000 reimbursement to the special revenue fund should be included in the expenditures of the general fund for the year ended June 30, 20X8.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-9 (continued) (5) The $12,000 of billings from the water department should be accounted for as expenditures by the general fund. Billings for water usage constitute an interfund services provided and used transaction. Note that the amount paid by the general fund, $11,500, is not the correct amount of the expenditures. The correct amount is $12,000. (6) The acquisition of supplies and the payment of salaries and wages by the general fund should be accounted for as expenditures. The entire cost of the supplies purchased should be reported as expenditures because the general fund uses the purchase method of accounting for supplies. (7) The outstanding encumbrances at June 30, 20X8, are not included in expenditures. The outstanding encumbrances will be reported on the general fund balance sheet as a reservation of fund equity. (8) The repayment of the principal of the bank loan is not an expenditure. However, the amount paid for interest, $15,000, should be included in expenditures for the year ended June 30, 20X8. (9) The general fund’s $95,000 contribution to the city’s pension trust should be included in expenditures of the general fund for the year ended June 30, 20X8. The employer’s contribution to a pension trust is an example of an interfund services provided or used transaction. (10) The general fund’s lease payments should be included in the amount reported for expenditures for the year ended June 30, 20X8. (11) For proper reporting on the statement of revenues, expenditures and changes in fund balance, each expenditure should be associated with a governmental function, such as General Governmental or Streets and Highways.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-10 Closing Entries and Balance Sheet a. Closing entries for the general fund: (1)

1,145,000 25,000 30,000 1,200,000

(2)

BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES 32,000 ENCUMBRANCES 32,000 Close remaining encumbrances by reversing remaining budgetary balance.

(3)

Fund Balance – Unassigned 32,000 Fund Balance – Assigned for Encumbrances 32,000 Reserve fund balance for encumbrances that lapse, but are expected to be honored in 20X2.

(4)

Property Tax Revenue Miscellaneous Revenue Expenditures Fund Balance – Unassigned Close operating statement accounts.

1,130,000 40,000

Fund Balance – Unassigned Other Financing Uses – Transfer Out Close transfer out.

25,000

(5)

APPROPRIATIONS CONTROL ESTIMATED OTHER FINANCING USES– TRANSFER OUT BUDGETARY FUND BALANCE – UNASSIGNED ESTIMATED REVENUES CONTROL Close budgetary accounts.

1,140,000 30,000

25,000

General fund balance sheet: Lone Wolf General Fund Balance Sheet December 31, 20X1

Assets Cash Property Taxes Receivable – Delinquent $100,000 Less: Allowance for Uncollectibles – Delinquent (7,200) Due from Other Funds Total Assets Liabilities and Fund Balance Vouchers Payable Due to Other Funds Fund Balance: Spendable: Assigned to: General Government Services $ 32,000 Unassigned 92,000 Total Liabilities and Fund Balance

90,000

92,800 14,600 $ 197,400 $ 65,000 8,400

124,000 $ 197,400

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

E17-11 Statement of Revenues, Expenditures, and Changes in Fund Balance Lone Wolf General Fund Statement of Revenues, Expenditures, and Changes in Fund Balance For the Fiscal Year Ended December 31, 20X1 Revenue: Property Taxes Miscellaneous Expenditures Excess of Revenue over Expenditures Other Financing Sources (Uses): Transfer Out Net Change in Fund Balance Fund Balance, January 1, 20X1 Fund Balance, December 31, 20X1

$1,130,000 40,000

$1,170,000 1,140,000 $ 30,000 (25,000) 5,000 119,000 $ 124,000 $

E17-12 Matching Questions Involving Interfund Transactions and Transfers in the General Fund 1. B 2. C 3. C 4. C 5. C 6. B 7. A 8. D 9. A 10. B

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

SOLUTIONS TO PROBLEMS P17-13 General Fund Entries [AICPA Adapted] (1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

ESTIMATED REVENUES CONTROL APPROPRIATIONS CONTROL BUDGETARY FUND BALANCE – UNASSIGNED Record the budget.

2,000,000

Taxes Receivable Allowance for Uncollectible Taxes Property Tax Revenue Record the property tax levy.

1,870,000

Allowance for Uncollectible Taxes Taxes Receivable Write off uncollectible taxes receivable.

1,940,000 60,000

10,000 1,860,000 8,000 8,000

Cash Taxes Receivable Record property tax collections.

1,820,000

ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES Record purchase commitments.

1,070,000

BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Reverse for purchase orders received.

1,820,000

1,070,000

1,000,000 1,000,000

Expenditures Vouchers Payable Record actual expenditures.

1,840,000

Vouchers Payable Cash Record payment of vouchers during period.

1,852,000

APPROPRIATIONS CONTROL BUDGETARY FUND BALANCE – UNASSIGNED ESTIMATED REVENUES CONTROL Close budgetary accounts.

1,940,000 60,000

1,840,000

1,852,000

2,000,000

(10)

BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES 70,000 ENCUMBRANCES 70,000 Close remaining encumbrances by reversing remaining budgetary balance.

(11)

Fund Balance – Unassigned 70,000 Fund Balance – Assigned for Encumbrances Reserve fund balance for outstanding purchase commitments.

70,000

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-13 (continued) (12)

Property Tax Revenue Expenditures Fund Balance – Unassigned Close operating statement accounts.

1,860,000 1,840,000 20,000

P17-14 General Fund Entries [AICPA Adapted] 1.

ESTIMATED REVENUES CONTROL APPROPRIATIONS CONTROL BUDGETARY FUND BALANCE – UNASSIGNED Record the budget.

3,000,000

Taxes Receivable Allowance for Uncollectible Taxes Revenue from Taxes Record tax levy.

2,870,000

Cash Taxes Receivable Record tax collection.

2,810,000

70,000 2,800,000

2,810,000

Allowance for Uncollectible Taxes Taxes Receivable Record write-off of uncollectible taxes: July 1, 20X1, taxes receivable balance 20X2 tax levy Less: Taxes collected Taxes receivable final balance Taxes written off as uncollectible

2,980,000 20,000

40,000 40,000 $ 150,000 2,870,000 (2,810,000) (170,000) $ 40,000

Cash Miscellaneous Revenue Collect miscellaneous revenue.

130,000

Fund Balance – Assigned for Encumbrances Fund Balance – Unassigned Reverse prior reserve which has been renewed.

60,000

ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES Renew encumbrances from prior period.

60,000

ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES Record encumbrances.

2,700,000

130,000

60,000

2,700,000

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-14 (continued) 3.

Expenditures Due to Other Funds Record liability to other funds for services received. BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Reverse encumbrances for items received. Expenditures Vouchers Payable Record expenditures.

142,000

2,700,000 2,700,000 2,700,000 2,700,000

BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Reverse reserve for encumbrances.

60,000 60,000

Expenditures (Prior Period) Vouchers Payable Actual expenditure for goods received.

58,000

Due to Other Funds Vouchers Payable Record approval for payment to other funds.

210,000

Vouchers Payable Cash Record voucher payments. 5.

142,000

58,000

210,000 2,640,000 2,640,000

ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES Record May 10 encumbrance.

91,000 91,000

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-15 General Fund Entries and Statements a.

Entries for 20X2 budget and transactions: 1.

ESTIMATED REVENUES CONTROL APPROPRIATIONS CONTROL ESTIMATED OTHER FINANCIAL USES – TRANSFER OUT Record budget.

1,877,000 1,840,000 37,000

ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES Renew encumbrances from prior period.

21,000

Fund Balance – Assigned for Encumbrances Fund Balance – Unassigned Reverse reserve for renewed encumbrances.

21,000

Property Tax Receivable – Current Allowance for Uncollectibles – Current Property Tax Revenue Record property tax levy.

1,600,000

Cash Property Taxes Receivable – Current Property Taxes Receivable – Delinquent Collect property taxes.

1,590,000

Allowance for Uncollectibles – Delinquent Property Taxes Receivable – Delinquent Property Tax Revenue Write off remaining delinquent property taxes.

16,000 1,584,000

1,507,000 83,000 9,000 7,000 2,000

Property Taxes Receivable – Delinquent 93,000 Allowance for Uncollectibles – Current 16,000 Property Taxes Receivable – Current Allowance for Uncollectibles – Delinquent Reclassify remainder of uncollected 20X2 property taxes. Cash Sales Tax Revenue Miscellaneous Revenue Due to Motor Pool Fund Other cash receipts.

93,000 16,000

333,000 284,000 39,000 10,000

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-15 (continued) 3.

ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES Record purchase orders. BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Reverse reserve for items received.

1,800,000 1,800,000

1,773,000 1,773,000

Expenditures Vouchers Payable Actual expenditures for items received.

1,788,000

Vouchers Payable Cash Vouchers paid.

1,793,000

1,788,000

1,793,000

Due from Central Stores Fund Other Financing Uses – Transfer Out Cash Other cash payments and transfer.

13,000 37,000 50,000

Pine Ridge General Fund Preclosing Trial Balance December 31, 20X2 Debit

Cash Property Tax Receivable – Delinquent Allowance for Uncollectibles – Delinquent Due from Central Stores Fund Vouchers Payable Due to Motor Pool Fund Fund Balance – Unassigned Property Tax Revenue Sales Tax Revenue Miscellaneous Revenue Expenditures Other Financing Uses – Transfer Out ESTIMATED REVENUES CONTROL APPROPRIATIONS CONTROL ESTIMATED OTHER FINANCING USES– TRANSFER OUT ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES

Credit

$ 191,000 93,000 $

16,000

13,000 26,000 10,000 161,000 1,586,000 284,000 39,000 1,788,000 37,000 1,877,000 1,840,000 37,000 48,000 $4,047,000

48,000 $4,047,000

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-15 (continued) c.

Closing entries: APPROPRIATIONS CONTROL ESTIMATED OTHER FINANCING USES – TRANSFER OUT ESTIMATED REVENUES CONTROL Close budgetary accounts. BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Close remaining encumbrances.

1,840,000 37,000 1,877,000

48,000 48,000

Fund Balance – Unassigned 48,000 Fund Balance – Assigned for Encumbrances Reserve fund balance for outstanding purchase orders. Property Tax Revenue Sales Tax Revenue Miscellaneous Revenue Expenditures Other Financing Uses – Transfer Out Fund Balance – Unassigned Close operating statement accounts. d.

48,000

1,586,000 284,000 39,000 1,788,000 37,000 84,000

Pine Ridge General Fund Balance Sheet December 31, 20X2

Assets Cash Property Tax Receivables – Delinquent Less: Allowance for Uncollectibles – Delinquent Due from Central Stores Fund Total Assets Liabilities and Fund Balance Vouchers Payable Due to Motor Pool Fund Fund Balance: Spendable: Assigned to: General Government Services Unassigned Total Liabilities and Fund Balance

$191,000 $ 93,000 (16,000)

77,000 13,000 $281,000 $ 26,000 10,000

$ 48,000 197,000

245,000 $281,000

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-15 (continued) e.

Pine Ridge General Fund Statement of Revenues, Expenditures, and Changes in Fund Balance For Fiscal Year Ended December 31, 20X2 Revenue: Property Taxes Sales Taxes Miscellaneous Total Revenue Expenditures: Current Capital Outlay – Furniture Total Expenditures Excess of Revenue over Expenditures Other Financing Sources (Uses): Transfer Out Change in Fund Balance Fund Balance, January 1, 20X2 Fund Balance, December 31, 20X2

$1,586,000 284,000 39,000 $1,909,000 $1,746,000 42,000 $1,788,000 $ 121,000 (37,000) 84,000 161,000 $ 245,000 $

[Note that the $42,000 expenditure for the office furniture capital outlay is reported separately. The theoretical support for this is that the expenditure will also benefit future periods. Some governmental entities report capital outlays made in the general fund with current expenditures because current financial resources were expended. Some governments integrate capital outlay expenditures into the appropriate functional categories (e.g., fire protection, government administration, or streets and highways) rather than separately report the expenditures for capital outlays. The choice of reporting alternative for the general fund is up to the governmental entity because the total expenditures will be the same regardless of how or where the capital outlay is reported.]

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-16 Matching Governmental Terms with Descriptions 1.

10.

11.

12.

13.

14.

15.

16.

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-17 Identification of Governmental Accounting Terms 1. Government-wide financial statements 2. The Governmental Accounting Standards Board (GASB) 3. A fund 4. Interfund services provided or used 5. Internal service and enterprise funds 6. Infrastructure assets 7. Agency and trust funds 8. Modified accrual basis 9. Flow of total economic resources 10. The property tax levy 11. The general, special revenue, capital projects, debt service funds and permanent funds 12. The allowance for uncollectible property taxes 13. Budgetary fund balance – unassigned 14. Encumbrances 15. The consumption method 16. Other financing uses – transfer out 17. Expenditures 18. Fund balance – unassigned 19. Expenditures 20. Appropriations 21. Nonlapsing method

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-18 Questions on General Fund Entries [AICPA Adapted] 1. D 2. C 3. C 4. C 5. N 6. D 7. N 8. C 9. C 10. N 11. D 12. C 13. N 14. N 15. N 16. C 17. D 18. D 19. C 20. N 21. N 22. N 23. C 24. D 25. N 26. C 27. D 28. D 29. D 30. C 31. D 32. C 33. D 34. N 35. N 36. C 37. D 38. D 39. C

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-19 Questions on Fund Items [AICPA Adapted] a.

$700,000 = $630,000 of current year’s taxes collected plus $70,000 of 20X1 taxes expected to be collected within 60 days after the end of the year

$170,000 = $80,000 of the restricted grant that has been expended, plus $50,000 in fines plus $40,000 in fees

$50,000 = the fair and present value of the lease agreement

$140,000 = the capital outlay for the new police vehicles

$30,000 = the amount of the transfer in received by the debt service fund and then expended for interest for the year

$760,000 = $260,000 for governmental services and $500,000 for public safety and welfare services. For this problem, the capital outlay of $140,000 was separately reported in the listing of expenditures. In practice, some governmental entities include capital outlays in the general fund as an expenditure under the appropriate functional activity. However, in a capital projects fund, capital outlays are generally separately reported in the expenditures reported on the statement of revenues, expenditures, and changes in fund balances.

$150,000 = the amount of the state grant. The bond proceeds would be reported as an other financing source.

$500,000 = the amount of the expenditures in the capital projects fund

$345,000 = Fund Balance-Unassigned on 1/1/X1 Add: Grant revenues Other financing sources Less: Expenditures Fund balance – assigned for encumbrances Fund Balance – Unassigned on 12/31/X1

$ 110,000 $150,000 610,000

760,000

$500,000 25,000

(525,000) $345,000

Chapter 17 – Governmental Entities: Introduction and General Fund Accounting

P17-20 Identifying Types of Revenue Transactions 1. B 2. E 3. D 4. A 5. B 6. E 7. C 8. D 9. C 10. D 11. C 12. D 13. D 14. D

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

CHAPTER 18 GOVERNMENTAL ENTITIES: SPECIAL FUNDS AND GOVERNMENTWIDE FINANCIAL STATEMENTS ANSWERS TO QUESTIONS Q18-1 A governmental entity would use a special revenue fund rather than a general fund when the resources earmarked for the fund, such as federal or state government grants or special tax levies, are restricted for specific purposes. Q18-2 Operating budgets are prepared for the general fund, special revenue funds, and debt service fund. Capital budgets are prepared for the capital projects fund. Q18-3 Interest on long-term debt is accounted for in the debt service fund for only the interest that is due and legally payable as an expenditure. Interest is not accrued on the outstanding balance of the long-term debt. Q18-4 The major differences between a special revenue fund and an enterprise fund are Special Revenue Fund

Enterprise Fund

Measurement focus

Current financial resources

Economic resources

Accounting basis

Modified accrual

Accrual

Budgetary basis

Operating budget

None required

Long-term assets

Yes

Long-term debt

Yes

Encumbrances

Yes

Financial statements

Governmental type

Business type

Q18-5 The basis of accounting used in the proprietary funds is the accrual basis because the focus of the governmental entity is on capital maintenance and income determination rather than budgetary spending authority. Q18-6 The financial statements that must be prepared for the governmental funds are the balance sheet and the statement of revenues, expenditures, and changes in fund balances. The financial statements that must be prepared for the enterprise funds are the statement of net position, the statement of revenues, expenses, and changes in fund net position, and the statement of cash flows.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

Q18-7 Proceeds from a bond issue are accounted for as another financing source in the fund that issued the bonds. However, some governments have a policy that the capital projects fund may not keep any bond premium, in which case the bond premium is typically transferred to a debt service fund. Other financing sources and uses are reported separately below operations, but above special items, on the governmental funds’ statement of revenues, expenditures, and changes in fund balance. Q18-8 A permanent fund is a governmental fund for which the principal is maintained, but the income in the fund can be used by the government for its programs that benefit all of its citizens. The basis of accounting in permanent funds is the modified accrual method. Private-purpose trust funds are established to benefit specific individuals or organizations, as specified by the donor. These private-purpose trust funds may have an expendable principal, or the principal may be non-expendable. The accrual basis of accounting is used for private-purpose funds. Thus, a major difference between these funds is the specificity of who the beneficiaries of the fund are. Q18-9 GASB 34 specifies that only governmental and enterprise funds determined to be “major” funds need to be separately disclosed in their own columns in the fund financial statements. There are two tests to determine which individual governmental and enterprise funds are considered major if they meet both tests. The general fund is always considered a major fund. The first test is that total assets, liabilities, revenues, or expenditures/expenses of that individual fund are at least 10 percent or more of the governmental or enterprise category. The second test is that total assets, liabilities, revenues, or expenditures/expenses of the individual governmental or enterprise fund are at least 5 percent of the total for all governmental and enterprise funds combined. Any individual funds that are not considered major are aggregated and presented in a single column. Management may, at any time, separately disclose even those non-major funds for which they feel the additional disclosure will provide information valuable to the readers of the financial statements. Q18-10 Because the measurement focus of the governmental funds is on current financial resources, revenue would be recognized in the governmental funds only if the donated items are available to finance expenditures of the current period, For example, donated land would be included in contribution revenue of a governmental fund if the land was sold, or the government has entered into a contract to sell the land, and that the proceeds from the sale will be available to finance expenditures of the current period. However, a donation to a governmental fund, in the form of financial resources or capital assets, that has a restriction imposed by the donor which makes the donation unavailable to finance current expenditures, is not included in the governmental fund’s financial statements. Of course, on the governmentwide statement of activities, all donations would be shown, at fair value on a separate line below general revenues. Specifically, endowment and permanent fund principal donations are reported below general revenues and above special and extraordinary items. On the governmental funds financial statements, special and extraordinary items are reported below operations, but above the net change in fund balance line, in the statement of revenues, expenditures, and changes in fund balance. Special items are those significant transactions within the control of management that are either unusual in nature or infrequent in occurrence. Extraordinary items are transactions or events that are both unusual and infrequent in occurrence. Q18-11 Agency funds must be self-balancing with assets equaling liabilities because the funds are not available for general use. Instead they are held for the use of other beneficiaries. Therefore, agency funds do not have a net fund balance. 18-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

Q18-12 Component units are separate government entities for which the primary government is financially accountable. The financial presentation of these component units is dependent on the separability from the primary government. If the component unit is virtually inseparable, then the component unit’s financial information is blended into the primary government’s financial statements. This includes component units that are organized as not-for-profit corporations in which the primary government is the sole corporate member (GASB 80). However, if the component unit is distinguishable, and has its own taxing authority, then the component unit’s financial information is presented in a separate column in the governmentwide financial statements. Q18-13 Two reconciliation schedules are required by GASB 34. The first reconciles the fund balances reported in the governmental funds to the net position of governmental activities reported on the governmentwide financial statements. For example, internal service funds are not a governmental fund, but the accounts for internal service funds are blended into the governmental activities that are reported on the governmentwide financial statements. The second reconciliation schedule reconciles the net change in fund balances reported in the governmental funds statements to the change in net position reported in the governmentwide financial statements. These two reconciliation schedules are required by GASB 34 to be presented either on the face of the fund financial statements or in a separate schedule immediately following the fund financial statements. Q18-14 The budgetary comparison schedule reports, for the general fund and any other governmental fund that has a legally adopted budget, the initially approved budget, the final budget of the year, and the actual amounts, for each line item in the statement of revenues, expenditures, and changes in fund balance. A variance column may also be used to compare the actual against the final budget. This budgetary comparison schedule is part of the required supplementary information (RSI) required by GASB 34. GASB 41 amended GASB 34 for those governments that do not use the general fund and special revenue fund structure specified in GASB 34 for their budgetary purposes. GASB 41 specified that those governments with significant perspective differences should provide a budgetary comparison schedule in the RSI based on the structure the government used for its legally adopted budget. Q18-15 The governmentwide financial statements present the infrastructure assets, such as roads, bridges, tunnels, sewer and water systems, etc., and other long-term assets of the government entity, such as buildings, equipment, vehicles, etc. The capital assets should be reported at historical cost or fair value at the time of donation, if donated. Because the basis of accounting for the governmentwide financial statements is the accrual method, depreciation is recorded on the other long-term assets and these are reported net of depreciation. For infrastructure assets, the governmental entity may elect to use a modified approach in which depreciation is not recorded. The modified approach requires an assessment of the current condition of the infrastructure assets and an estimate of the annual amount required to maintain and preserve the infrastructure assets. In addition, the governmentwide financial statements present the general long-term debt obligations of the governmental entity at the present value of the debt principal and future interest, just as computed under the accrual basis of accounting that is used for commercial entities.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

SOLUTIONS TO CASES C18-1 Basis of Accounting and Reporting Issues a. In the accrual basis of accounting, revenue should be recognized in the accounting period in which it is earned and becomes measurable. In the modified accrual basis of accounting, revenue should be recognized in the accounting period in which it becomes both measurable and available to finance expenditures of the fiscal period. "Available" means collectible within the current period or soon enough thereafter to be used to pay current period liabilities. b. For the general fund, the modified accrual basis of accounting should be used because it is a governmental fund. For the special revenue fund, the modified accrual basis of accounting should be used because it is a governmental fund. For the enterprise fund, the accrual basis of accounting should be used because it is a proprietary fund, with activities similar to those in the commercial, profit-seeking sector.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

C18-2 Capital Projects, Debt Service, and Internal Service Funds a. Capital projects funds account for the acquisition or construction of major capital facilities or improvements. A separate capital projects fund is created at the time the project is approved and ceases at the completion of the project. Accounting for capital projects funds is similar to accounting for the general fund. The modified accrual basis of accounting is used; no fixed assets, depreciation, or long-term debt is recorded in these funds. The bond proceeds are not revenue to the capital projects fund; they are reported as Other Financing Sources. A premium on the sale of bonds is transferred to the debt service fund. When the expenditure is recorded, Contract Payable is credited for the current portion due and Contract Payable-Retained Percentage is credited for the amount held back to ensure that the contractor fully completes the project to the satisfaction of the governmental entity. The financial statements for capital projects funds are a balance sheet and a statement of revenues, expenditures, and changes in fund balance. No budget versus actual is required because capital projects funds use a capital budget rather than an operating budget. b. Debt service funds account for the accumulation and use of resources for the payment of general long-term debt principal and interest. Accounting for the debt service fund is similar to accounting for the general fund. The modified accrual basis of accounting is used; no fixed assets or long-term debt is recorded; only current maturities are recorded in the fund. The bond premium received from the capital projects fund is recorded as another financing source – transfer in. The matured portion of a serial bond is recognized as an expenditure and Matured Bonds Payable is credited. Interest legally due and payable is recorded as an expenditure and Matured Interest Payable is credited. The financial statements of the debt service fund are a balance sheet and a statement of revenue, expenditures, and changes in fund balance. c. Internal service funds account for the financing of goods or services provided by one department to other departments on a cost-reimbursement basis. Separate internal service funds are established for each type of service. Accounting for internal service funds is the same as for enterprise funds or commercial entities. The accrual basis is used; these funds record fixed assets, depreciation, and long-term debt. The internal service fund may be started with a transfer in from the general fund. The billings are recorded in "Due from" accounts and the revenue account, Charges for Services. The closing entries involve a Profit and Loss Summary or Excess of Net Revenues over Costs account. The financial statements of an internal service fund are a statement of net position; a statement of revenues, expenses, and changes in fund net position; and a statement of cash flows.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

C18-3 Becoming Familiar with a Local Government’s Comprehensive Annual Financial Report (CAFR) (Note to the instructor: Most local governments now produce a comprehensive annual financial report. You might select the local city or county in which the university is located or a large city close to the university town. Printed copies of the CAFR may be obtained directly from that governmental entity and you could place these copies on reserve in your university library for use by your students. Alternatively, many governments now provide their CAFRs online. A web search using “CAFR” and the name of your city, county or state will show if your selection provides an online copy of its CAFR. Or, you may do a web search using “CAFR” and then select one of the government units that provide an online copy of its CAFR and then provide that link to your students or insert that link into your online syllabus.) a. Students should read the MD&A to get familiar with the governmental entity. One of the items contained in the MD&A is information on the nature of the services performed by the government. At the local government level, the services usually consist of police and fire protection, street maintenance, recreation, and other services that are typically the responsibility of the local government. b. Because there is so much information contained in a CAFR, it is important to see what information is covered by the auditor’s opinion. The auditor’s opinion is usually unqualified. The auditor does not audit the MD&A and other RSI and does not express an opinion on this information. The auditor reads the MD&A and other RSI to determine if the information contained therein is reasonable. c. A general purpose government will have most fund types. It is beneficial for the student to see which fund types are used and which ones are not used by a government. d. Students should become familiar with the types of information found in the notes. One item of information disclosed in the notes is a description of the measurement focus and basis of accounting used by the governmental funds. The footnotes’ discussions regarding the governmental funds and their use of the financial resources measurement focus and modified accrual basis of accounting reinforce what the students learned from the text. e. Listing the financial statements that use the economic resources measurement focus and accrual basis of accounting reinforces the coverage in the text. In their evaluation, students should remember that the governmental fund financial statements are the only ones prepared using the current financial resources measurement focus and the modified accrual basis of accounting. f. Students should be aware of the reporting of major funds in the financial statements of governmental and proprietary funds. g. This question emphasizes that the reporting entity for the government may be larger than the local governmental if the local government has fiscal accountability over other governmental entities. Because many component units are reported discretely, students should have little problem identifying the existence of component units.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

C18-3 (continued) h. The purpose of this question is for students to become acquainted with the balance sheet equation for the governmental funds: Assets = Liabilities + Fund Balance. Another goal for this question is for students to see that fund balance is separated into two components: (1) assigned and (2) unassigned. i. The purpose behind questions i - l is to help students understand the format of the statement of revenues, expenditures, and changes in fund balance. The first section deals with revenues, which are reported according to source. Students will discover that taxes are generally not the only source of revenue. j. The objective of this question is to get students to understand how governments report expenditures. Students may expect governments to report expenditures by object; however, expenditures are not reported this way on the statement of revenues, expenditures, and changes in fund balance. k. The purpose of this question is to have students examine the items reported in other financing sources and uses. This should reinforce what they learn in the text when they read the section dealing with interfund transfers. l. This question covers the last items reported on the statement of revenues, expenditures, and changes in fund balance: special items, the change in fund balance for the year, and the ending fund balance at the end of the most recent year. Students should not expect to see any special items since their occurrence is rare. However, students should see the change in fund balance for the year being added to the beginning fund balance to produce ending fund balance.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

C18-4 The GASB’s Decision-Making Process Until recently, the GASB’s presentation of its decision-making process was found on its web site at www.gasb.org/ under GASB FACTS on the link entitled In order to find this information on the website, it is necessary to go to the link entitled “How Standards Are Set” in the “Education” tab.

(http://www.gasb.org/jsp/GASB/Page/GASBSectionPage&cid=1176156714545 ) 1. The Governmental Accounting Standards Advisory Council (GASAC). This council is composed of about 25 persons from a diverse background in government accounting and finance. This council provides suggestions for topics to be considered by the GASB. In addition, the Board receives concerns about current governmental accounting needs from other persons and groups who work in governmental accounting or auditing. 2. Task Force. In many cases, a task force is formed shortly after the Board agrees to place the project on its agenda. A task force is comprised of persons who know the project’s subject matter and provides expertise and advice to the GASB as it focuses on the critical issues and determine if a new standard is necessary.

http://www.gasb.org/cs/ContentServer?c=Page&pagename=GASB%2FPage%2FGASBS ectionPage&cid=1176156714627 3. Discussion Memorandum (DM). The DM is normally prepared by the staff and defines the problem(s), the scope of the project, the accounting and reporting issues; and presents relevant research, alternative solutions to the issues, and arguments both for and against each alternative. Written comments are solicited and in many cases a public hearing is scheduled to discuss the DM. The answers to this question and the next two are covered in this website:

http://www.gasb.org/cs/ContentServer?c=Page&pagename=GASB%2FPage%2FGASBS ectionPage&cid=1176156714567 4. Invitation to Comment (ITC). An ITC is sometimes issued when the GASB seeks more input on one or more of the issues. 5. Preliminary Views (PV). A PV puts forth the Board’s consensus at an early stage in the process. A majority of the Board must approve the issuance of a PV. The Board solicits comments on the PV. 6. Public Hearing. A public hearing is typically scheduled to provide the Board with an opportunity to hear the viewpoints of the public as well as to allow the Board to raise questions to the staff regarding written or oral comments received on the project, including any submissions at the public hearing.

http://www.gasb.org/cs/ContentServer?c=Page&pagename=GASB%2FPage%2FGASBS ectionPage&cid=1176156714607 7. Analysis of Oral and Written Comments. The staff performs an analysis of the submitted comments, looking for information and good arguments on the issues, and presents this analysis to the members of the Board who often make their own review of the comments. 8. Meetings of the Board. The Board may have several, or many, meetings to discuss the issues. Board meetings on the project are open to the public, although observers are not allowed to participate in the discussions. 9. Exposure Draft (ED). An ED presents the proposed new standards, the proposed effective date and method of transition, background information, and explains the basis for the Board’s conclusions regarding the issues covered by the ED.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

http://www.gasb.org/cs/ContentServer?c=Page&pagename=GASB%2FPage%2FGASBS ectionPage&cid=1176156714567 10. Further Deliberations by the Board. The Board receives comments on the ED and discusses the comments to determine if any modifications are needed in the proposed standard. 11. Statements of Governmental Accounting Standards or Statements of Governmental Accounting Concepts. A majority of the Board must vote in favor of adopting a pronouncement. Statements of Standards establish new accounting or reporting requirements. Statements of Concepts do not create new standards, but rather give guidance for dealing with problems that arise on an issue. And then, the Board continues to work on the next project!

C18-5 Summarizing a Recent GASB Exposure Draft Note to the Instructor: This case provides your students with the opportunity to be on the leading edge of a proposed governmental accounting or reporting standard. Students can learn about some of the specifics of an expected, new GASB Statement. The most recent ED on the web page will be dependent on future actions of the GASB. Click on the “Current Projects” link in the Projects tab of the GASB’s home page to see information on the status of current GASB projects. These projects are in various stages of progress, but as of late 2010, GASB projects include a conceptual framework, derivatives, economic condition reporting, and postemployment benefit accounting and reporting. Of course, given the dynamic nature of governmental accounting and reporting, it is expected that new projects will be added, and some of the current projects may be discontinued or included within a larger project the board is studying. And, some may become new GASB Statements! C18-6A Discovery Case Summary of major information items in the Financial Report of the United States Government, 1.

The report is prepared by the Secretary of the Treasury.

The Management’s Discussion and Analysis presents comparative historical information for operations and financial position along with budget information, both historical and projected.

The Comptroller General of the United States heads the General Accountability Office (GAO) who is the auditor for the U.S. government. For several years, the Comptroller General has disclaimed an opinion on the consolidated financial statements because of the material deficiencies in the government’s systems, recordkeeping, documentation, and financial reporting. The material deficiencies are listed in the auditor’s report.

The following five statements are presented: (1) Statements of Net Cost, (2) Statements of Operations and Changes in Net Position, (3) Reconciliations of Net Operating Revenue (Cost) to the Budget Surplus (unaudited), (4) Dispositions of the Budget Surplus (unaudited), and (5) Balance Sheets.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

The Statements of Net Cost present the costs and revenue for the major departments, agencies, commissions, and other units of the federal government.

The Statement of Operations and Changes in Net Position presents the revenues by type, the total costs, and the net operating revenue (cost) for each year.

The Reconciliation of Net Operating Revenue (Cost) to the Budget Surplus presents the increases or decreases in major cost programs, along with the amount of capitalized fixed assets by major agencies of the federal government.

The Dispositions of the Budget Surplus presents the changes in assets and liabilities during the years reported.

The Balance Sheets present the assets, by major type, the liabilities, by major type, and reconciles to the net position of the U.S. government.

10.

Major footnotes include a stewardship report on the resources held by the U.S. government, and a large number of notes to the financial statements that report on specific items related to agencies, commissions, and other entities within the federal government.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

SOLUTIONS TO EXERCISES E18-1 Multiple-Choice Questions on Government Financial Reporting 1. a 2. d 3. b 4. a 5. a 6. b 7. a –

$8,839,000 = assets of $14,839,000 minus liabilities of $6,000,000

8. c –

$7,150,000 = capital assets (net) of $12,500,000 minus long-term debt of $5,350,000

9. c –

$1,035,000 = net position of $8,839,000 minus $7,150,000 minus $654,000

10. a –

(answers b, c, and d each include a fiduciary fund which is not a major fund)

11. d 12. c

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-2 Multiple-Choice Questions on Governmental Funds [AICPA Adapted] 1. d 2. b 3. a 4. c 5. c 6. b

E18-3 Multiple-Choice Questions on Proprietary Funds [AICPA Adapted] 1. b 2. d 3. d 4. b 5. c 6. c – Prepaid insurance would be reported as an asset. 7. b 8. c 9. c

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-4 Multiple-Choice Questions on Various Funds 1. c –

The additions - investment earnings include the $50,000 of dividends and the $35,000 of interest earned. The contribution is reported as an addition contributions.

2. a –

The entries in the trust fund to record the resources spent would appear as follows: Deductions - Benefits Vouchers Payable

75,000

Vouchers Payable Cash

75,000

75,000 75,000

3. d – 4. d –

Income is determined as follows: Revenue – Charges for Services Operating Expenses Depreciation Expense Interest Expense Income

5. c –

$100,000 (45,000) (40,000) (5,000) $ 10,000

The assets at June 30, 20X7 appear as follows: Cash Due from Other Funds Computer Equipment (net) Total Assets

$ 96,000 7,000 610,000 $713,000

6. b –

This is an example of an interfund services provided or used transaction. The general fund would debit expenditures.

7. a –

This is an example of an interfund services provided or used transaction. The enterprise fund would debit operating expenses.

8. b –

The net position would be for the $600,000 transfer in plus the $10,000 of income for the period.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-5 Multiple-Choice Questions on Financial Reporting Issues for Governmentwide and Fund-Based Financial Statements 1. c 2. c –

the net position of internal service funds are included in governmental activities

3. d 4. d 5. a –

$150,000 = $500,000 – $350,000

6. d –

$37,000 = $25,000 + $20,000 – $8,000

7. c –

$660,000 = $1,000,000 + $300,000 - $40,000 - $600,000

8. d –

$1,035,000 = $1,000,000 + $60,000 interest - $20,000 benefits paid - $5,000 deduction for investment revaluation

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-6 Capital Projects Fund Entries a.

Entries for capital projects fund during 20X2: 1..1. Receipt of grant, sale of bonds and transfer of premium. January 1, 20X2 . Cash Revenue – County Grant Receipt of grant from county. January 1, 20X2 Cash Other Financing Sources – Bond Issue Other Financing Sources – Bond Premium Sale of $150,000 par bonds at 104.

50,000 50,000

156,000 150,000 6,000

November 3, 20X2 Other Financing Uses – Transfer Out to Debt Service Fund Cash Transfer premium to debt service fund.

6,000

2. Entries to record and pay for construction: April 5, 20X2 ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES

182,000

August 8, 20X2 BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Expenditures—Capital Outlay Contract Payable Establish contract payable for walkway. Expenditures—Capital Outlay Vouchers Payable Establish vouchers payable for added carpeting. November 3, 20X2 Contract Payable Vouchers Payable Cash Pay contract payable and vouchers payable. 3. Close nominal accounts: Revenue – County Grant Other Financing Sources – Bond Issue Other Financing Sources – Bond Premium Fund Balance – Unassigned

6,000

182,000

182,000 182,000 189,000 189,000 5,500 5,500

189,000 5.500 194,500

50,000 150,000 6,000 206,000

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-6 (continued) Fund Balance – Unassigned Expenditures Other Financing Uses – Transfer Out to Debt Service Fund 4. Transfer of ending balance and close transfer account: Other Financing Uses – Transfer Out to Debt Service Fund Cash Record transfer of remainder to Debt Service. Fund Balance – Unassigned Other Financing Uses – Transfer Out to Debt Service Fund Close transfer out against unassigned fund balance.

200,500 194,500 6,000

5,500 5,500 5,500 5,500

b. City of Waterman Capital Projects Fund Statement of Revenues, Expenditures, and Changes in Fund Balance For Fiscal Year Ended December 31, 20X2 Revenue: County Grant Expenditures: Capital Outlay Deficiency due to excess of Expenditures over Revenue Other Financing Sources (Uses): Proceeds of Bond Issue Transfer Out to Debt Service Fund--Premium Transfer Out to Debt Service Fund--Remainder Total Other Financing Sources (Uses) Net Change in Fund Balance Fund Balance, January 1, 20X2 Fund Balance, December 31, 20X2

$ 50,000 194,500 $(144,500) ) $156,000 (6,000) (5,500)

) 144,500 -0-0$ -0$

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-7 Debt Service Fund Entries and Statement a.

Entries for debt service fund during 20X2: 1.

ESTIMATED REVENUES CONTROL ESTIMATED OTHER FINANCING SOURCES – TRANSFER IN APPROPRIATIONS CONTROL BUDGETARY FUND BALANCE Record budget.

35,000

Property Taxes Receivable Allowance for Uncollectibles Revenue – Property Tax Record tax levy.

40,000

Cash Property Taxes Receivable Record tax collections.

35,000

5,000 34,000 6,000

4,000 36,000

35,000

Property Taxes Receivable — Delinquent 5,000 Allowance for Uncollectibles 4,000 Property Taxes Receivable 5,000 Allowance for Uncollectibles – Delinquent 1,000 Revenue – Property Tax 3,000 Revise estimate of uncollectibles and reclassify remaining receivables.

Cash Other Financing Sources – Transfer in from Capital Projects Fund Receive bond premium.

6,000

Expenditures Matured Bonds Payable ($150,000 x 1/10 due) Matured Interest Payable ($150,000 x 0.10 interest) Record matured principal and interest.

30,000

Matured Bonds Payable Matured Interest Payable Cash Pay matured principal and interest.

15,000 15,000

Expenditures Vouchers Payable Record other expenditures.

1,700

Vouchers Payable Cash Pay approved vouchers.

1,200

6,000

15,000 15,000

30,000

1,700

1,200

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-7 (continued) 3. Cash 5,500 Other Financing Sources – Transfer In From Capital Projects Fund 5,500 Record transfer of unspent funds in capital projects fund to debt service fund. 4.

APPROPRIATIONS CONTROL BUDGETARY FUND BALANCE ESTIMATED REVENUES CONTROL ESTIMATED OTHER FINANCING SOURCES – TRANSFER IN Close budgetary accounts.

34,000 6,000

Revenue – Property Tax Other Financing Sources – Transfer in from Capital Projects Fund ($6,000 + $5,500) Fund Balance – Assigned for Debt Service Expenditures Close nominal accounts.

39,000

5,000

11,500 18,800 31,700

City of Waterman Debt Service Fund Balance Sheet December 31, 20X2 Assets: Cash Property Tax Receivables (net) Total Assets Liabilities: Vouchers Payable Fund Balance: Spendable: Assigned to: Debt Service Total Liabilities and Fund Balance

35,000

$15,300 4,000 $19,300 $

500

18,800 $19,300

City of Waterman Debt Service Fund Statement of Revenues, Expenditures, and Changes in Fund Balance For Fiscal Year Ended December 31, 20X2 Revenue: Property Taxes $39,000 Expenditures: Principal Retirement $15,000 Interest 15,000 Miscellaneous 1,700 Total Expenditures 31,700 Excess of Revenue over Expenditures $ 7,300 Other Financing Sources (Uses): Transfers In From Capital Projects Fund 11,500 Net Change in Fund Balance $18,800 Fund Balance, January 1, 20X2 -0Fund Balance, December 31, 20X2 $18,800 18-18

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-8 Enterprise Fund Entries and Statements a.

Entries for enterprise fund: 1.

Accounts Receivable Revenue Record charges to customers.

420,000

Cash Accounts Receivable Record collections on account.

432,000

Cash Due to General Fund Receive loan from general fund.

30,000

Plant and Equipment Contracts Payable Record extension of water and gas lines.

75,000

Contracts Payable Cash Record payment for extended lines.

75,000

Inventory of Supplies Operating Expenses Interest Expense Due to Central Stores Fund Vouchers Payable Interest Payable Record expenses.

12,400 328,000 30,000

420,000

432,000

30,000

75,000

12,400 328,000 30,000

Due to Central Stores Fund 12,400 Vouchers Payable 325,000 Interest Payable 30,000 Cash 367,400 Record payment of approved vouchers, interest, and payment to central stores. 5.

Revenue Allowance for Uncollectibles Reduce revenue for uncollectible accounts.

6,300

Depreciation Expense Accumulated Depreciation Adjust for depreciation for period.

32,000

Supplies Expense Inventory of Supplies Adjust for supplies on hand.

15,200

6,300

32,000

15,200

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-8 (continued) Closing entries: Revenue Operating Expenses Interest Expense Depreciation Expense Supplies Expense Profit and Loss Summary Close nominal accounts.

413,700 328,000 30,000 32,000 15,200 8,500

Profit and Loss Summary Net Position – Unrestricted Close profit and loss summary.

8,500 8,500

Net Position – Unrestricted 43,000 Net Position – Invested in Capital Assets, Net of Related Debt 43,000 Record increase in net position-invested: $43,000 = Ending balance of $563,000 net capital assets (Land + Plant & Equipment) less $500,000 related debt minus $20,000 beginning balance in net position-Invested in capital assets net of related debt b.

Augusta MUD Enterprise Fund Statement of Net Position December 31, 20X1

Assets: Cash Accounts Receivable Less: Allowance for Uncollectibles Inventory of Supplies Land Plant and Equipment Less: Accumulated Depreciation Total Assets

$111,600 $ 13,000 (6,300) $555,000 (112,000)

6,700 5,200 120,000 443,000 $686,500

Liabilities: Vouchers Payable Due to General Fund Bonds Payable, 6% Total Liabilities

$ 18,000 30,000 500,000 $548,000

Net Position: Invested in Capital Assets, net of Related Debt Unrestricted Total Net Position

$ 63,000 75,500 $138,500

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-8 (continued) c.

Augusta MUD Enterprise Fund Statement of Revenue, Expenses, and Changes in Fund Net Position For Fiscal Year Ended December 31, 20X1

Revenue: Revenue from Services Expenses: Operating Depreciation Supplies Operating Income Nonoperating Expense: Less: Interest on Capital-Related Debt Change in Net Position Net Position, January 1 Net Position, December 31

$413,700 $328,000 32,000 15,200

375,200 $ 38,500 30,000 8,500 130,000 $138,500 $

[Note that interest expense on capital-related debt is a non-operating expense.]

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-8 (continued) d. Augusta MUD Enterprise Fund Statement of Cash Flows For the Year Ended December 31, 20X1 Cash Flows from Operating Activities: Cash Received from Customers Cash Payments for Goods and Services Cash Paid to Internal Service Fund for Supplies Net Cash Provided by Operating Activities Cash Flows from Noncapital Financing Activities: Cash Received from General Fund for Noncapital Loan Net Cash Provided by Noncapital Financing Activities Cash Flows from Capital and Related Financing Activities: Interest on Capital-Related Debt Extension of Service Lines Net Cash Used for Capital and Related Financing Activities

$ 432,000 (325,000) (12,400) $ 94,600 $ 30,000 30,000

$(30,000) (75,000) (105,000)

Cash Flows from Investing Activities

-0-

Net Increase in Cash Cash at Beginning of Year Cash at End of Year

$ 19,600 92,000 $111,600

Reconciliation of Operating Income to Net Cash Provided by Operating Activities: Operating Income Adjustments to Reconcile Operating Income to Net Cash Provided by Operating Activities: Depreciation Change in Assets and Liabilities: Decrease in Inventory of Supplies Decrease in net Accounts Receivable Increase in Vouchers Payable Total Adjustments Net Cash Provided by Operating Activities

$ 38,500 $ 32,000 2,800 18,300 3,000 56,100 $ 94,600

[Note that interest paid on capital-related debt is reported in cash flows from capital and related financing activities and not in the operating activities.]

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-9 Interfund Transfers and Transactions General Fund 1.

June 30, 20X8, Closing entry: Fund Balance – Unassigned Other Financing Uses – Transfer Out to Building Maintenance Fund April 1, 20X8, Financing transaction: Due from Building Maintenance Fund Cash

Shown on the general fund balance sheet on June 30, 20X8

April 15, 20X8, Transfer out: Other Financing Uses – Transfer Out to Debt Service Fund Cash

March 1, 20X8, Transfer out: Other Financing Uses – Transfer Out to Building Maintenance Fund Cash

June 30, 20X8, Closing entry: Fund Balance – Unassigned Other Financing Uses – Transfer Out to Debt Service Fund May 5, 20X8, Interfund services provided or used: Expenditures Due to Transportation Service Fund Due to Transportation Service Fund Cash

June 30, 20X8, Closing entry: Fund Balance – Unassigned Expenditures

12,000 12,000 12,000 12,000

8,000 8,000

2,400 2,400 2,400 2,400

825 825 825 825 825 825

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-9 (continued) Other Fund 1.

Building Maintenance Internal Service Fund a.

June 30, 20X8, Closing entry: Transfer In from General Fund Net Position

12,000

April 1, 20X8, Financing transaction: Cash Due to General Fund

8,000 8,000

Debt Service Fund a.

12,000

Building Maintenance Fund a.

March 1, 20X8, Transfer in: Cash Transfer In from General Fund

April 15, 20X8, Transfer in: Cash Other Financing Sources – Transfer In from General Fund June 30, 20X8, Closing entry: Other Financing Sources – Transfer In from General Fund Unassigned Fund Balance

2,400 2,400

Transportation Service Fund a.

May 5, 20X8, Interfund services provided or used: Due from General Fund Revenue from Billings Cash Due from General Fund

825 825 825 825

June 30, 20X8, Closing entry: Revenue from Billings Net Position - Unrestricted

825 825

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-10 Internal Service Fund Entries and Statements a.

Entries for 20X2, including closing entries: 1.

Inventory of Supplies 96,000 Furniture and Equipment 4,700 Vouchers Payable Record acquisitions of supplies, furniture, and office equipment. Due from Other Funds Billings to Departments Record billings for jobs completed.

292,000

Cash Due from Other Funds Record collections on billings.

287,300

Costs of Printing Jobs Operating Expenses Inventory of Supplies Vouchers Payable Record costs of printing jobs.

204,000 38,000

Depreciation Expense Accumulated Depreciation Record depreciation for period.

23,000

Vouchers Payable Cash Pay approved vouchers.

243,000

100,700

292,000

287,300

92,400 149,600

23,000

243,000

Closing entries: Billings to Departments Costs of Printing Jobs Operating Expenses Depreciation Expense Profit and Loss Summary Close nominal accounts.

292,000

Profit and Loss Summary Net Position – Unrestricted Close profit and loss summary.

27,000

204,000 38,000 23,000 27,000

27,000

Net Position – Invested in Capital Assets, Net of Related Debt 18,300 Net Position - Unrestricted 18,300 Reclassify net position as of end of period: $18,300 = (ending balance of $191,700 net capital assets less $0 related debt) less $210,000 beginning balance in net position invested.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-10 (continued) b.

Bellevue Printing Shop Fund Statement of Net Position December 31, 20X2

Assets: Cash Due from Other Funds Inventory of Supplies Furniture and Equipment Less: Accumulated Depreciation Total Assets

$ 68,900 20,300 13,400 $264,700 (73,000)

191,700 $294,300

Liabilities: Vouchers Payable Total Liabilities

$ 19,300 $ 19,300

Net Position: Invested in Capital Assets, Net of Related Debt Unrestricted Total Net Position

$191,700 83,300 $275,000

Bellevue Printing Shop Fund Statement of Revenue, Expenses, and Changes in Fund Net Position For Fiscal Year Ended December 31, 20X2

Revenue: Billings to Departments Expenses: Costs of Printing Jobs Operating Depreciation Income Net Position, January 1 Net Position, December 31

$292,000 $204,000 38,000 23,000

265,000 $ 27,000 248,000 $275,000

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-10 (continued) d. Bellevue City Internal Service Fund – Printing Shop Statement of Cash Flows For the Year Ended December 31, 20X2 Cash Flows from Operating Activities: Cash Received from Customers Cash Payments for Printing Jobs Net Cash Provided by Operating Activities

$ 287,300 (238,300) $49,000

Cash Flows from Noncapital Financing Activities Cash Flows from Capital and Related Financing Activities Acquisition of Capital Assets (furniture and copier) Net Cash Used for Capital and Related Financing Activities

-0-

$ (4,700) (4,700)

Cash Flows from Investing Activities

-0-

Net Increase in Cash Cash at Beginning of Year Cash at End of Year

$44,300 24,600 $68,900

Reconciliation of Operating Income to Net Cash Provided by Operating Activities: Operating Income

$27,000

Adjustments to Reconcile Operating Income to Net Cash Used by Operating Activities: Depreciation Change in Assets and Liabilities: Increase in Due from Other Funds from Billings Increase in Inventory of Supplies Increase in Vouchers Payable Total Adjustments Net Cash Provided by Operating Activities

$ 23,000 (4,700) (3,600) 7,300 22,000 $49,000

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

E18-11 Multiple-Choice Questions on Governmentwide Financial Statements 1.

c–

($1,450,000 - $120,000)

a–

[($1,450,000 - $120,000) - $780,000]

c–

For the amount of the bond issue proceeds. Note that no repayments of debt were made during the year.

c–

The interest adjustment is from the modified accrual basis ($30,000) to the accrual basis of measurement ($25,000).

10.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

SOLUTIONS TO PROBLEMS P18-12 Adjusting Entries for General Fund [AICPA Adapted] Adjusting entries to correct the general fund: 1.

No entry required.

Expenditures Buildings Correct for state grant expended for buildings.

300,000

Expenditures Capital Outlays (equipment) Correct for expenditures for playground equipment.

22,000

Bonds Payable Buildings Correct for bonds used to construct buildings. Other Financing Uses – Transfer Out to Debt Service Fund Debt Service from Current Funds Correct for transfer to debt service fund.

300,000

22,000 1,000,000 1,000,000

130,000 130,000

ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES Correct for unrecorded encumbrances.

2,800

Expenditures Inventory of Supplies Correct for supplies used in period.

4,950

Fund Balance – Unassigned Fund Balance – Assigned for Inventory Correct for reserve for ending inventory.

6,500

2,800

4,950

6,500

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-13 Entries for Funds [AICPA Adapted] Fund 1.

Journal Entries

General Fund

ESTIMATED REVENUES CONTROL 400,000 APPROPRIATIONS CONTROL BUDGETARY FUND BALANCE – UNASSIGNED

394,000 6,000

General Fund

Taxes Receivable – Current Revenue – Taxes Allowance for Uncollectibles – Current

390,000 382,200 7,800

PrivatePurpose Trust Fund

Investments Contributions

50,000

Cash Additions – Interest

5,500

General

50,000

Other Financing Uses – Transfer Out to Internal Service Fund Cash

5,500 5,000 5,000

Internal Service Fund

Cash Transfer In from General Fund

5,000

Capital Projects

Cash Other Financing Sources – Bond Issue

72,000

Due from General Fund Other Financing Sources – Transfer In from General Fund

3,000

Debt Service Fund

Special Assessments Receivable Revenue – Special Assessments

24,000

General

Other Financing Uses – Transfer Out to Capital Projects Fund Due to Capital Projects Fund

5,000

72,000

3,000 24,000

3,000 3,000

General Fund

Due to Capital Projects Fund Cash

3,000

Capital Projects Fund

Cash Due from General Fund

3,000

Debt Service Fund

Cash Special Assessments Receivable

24,000

3,000 3,000

24,000

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-13 (continued) Fund 7.

Capital Projects Fund

Journal Entries ENCUMBRANCES 75,000 BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES

75,000

BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES

75,000

Expenditures Contracts Payable

75,000

Contracts Payable Cash

75,000

Internal Service Fund

Inventory of Supplies Cash (or Vouchers Payable)

1,900

General Fund

Cash Taxes Receivable – Current Revenue – Licenses and Fees

393,000

75,000 75,000

Allowance for Uncollectibles – Current Revenue – Taxes Estimate Actual Correction 10.

11.

75,000

1,900

386,000 7,000 3,800 3,800

$7,800 (4,000) $3,800

Capital Projects Fund

Cash Other Financing Sources – Bond Issue

General Fund

BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Expenditures Cash

500,000 500,000

15,000 15,000 15,000 15,000

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-14 Entries to Adjust Account Balances [AICPA Adapted] a.

General Fund Adjusting entries: 1.

Allowance for Uncollectibles – Delinquent 2,200 Fund Balance – Unassigned 2,200 Reduce estimated losses on prior year's taxes to amount of receivables of $8,000.

Revenue 27,000 Donated Land 27,000 Remove accounts belonging only in the governmentwide financial statements.

Fund Balance – Unassigned Fund Balance – Assigned for Encumbrances – 20X0 Record purchase orders outstanding on June 30, 20X0.

8,800 8,800

Expenditures – 20X0 8,800 Other Expenditures 8,800 Reclassify purchases of supplies chargeable to prior year's appropriations. Excess of $600 actual cost over estimate is approved and charged to current year expenditures. 4.

ENCUMBRANCES 2,100 BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES 2,100 Record encumbering of appropriations for purchase orders outstanding on June 30, 20X1.

Special Assessment Bonds Payable 100,000 Due to Capital Projects Fund 100,000 Record liability to capital projects fund for cash obtained from sale of special assessment bonds.

Revenue 21,000 Tax Anticipation Notes Payable 20,000 Due to Water Utility Fund 1,000 Record tax anticipation notes payable and liability to water utility fund for funds obtained from sale of scrap.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-14 (continued) Closing entries: APPROPRIATIONS CONTROL ESTIMATED REVENUES CONTROL BUDGETARY FUND BALANCE – UNASSIGNED BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES

310,000 38,000 2,100 2,100

Fund Balance – Unassigned Fund Balance – Assigned for Encumbrances — 20X0

2,100

Revenue Fund Balance – Unassigned Other Expenditures Expenditures – Building Addition Constructed Expenditures – Serial Bonds Paid

306,000 31,200

Fund Balance – Assigned for Encumbrances – 20X0 Expenditures – 20X0 b.

348,000

2,100

271,200 50,000 16,000 8,800 8,800

Adjusting Journal Entries: Capital Projects Fund: 5. Due from General Fund 100,000 Other Financing Sources – Bond Issue 100,000 Record receivable due from general fund for proceeds of sale of bonds. Water Utility Fund: 6. Due from General Fund 1,000 Revenue – Miscellaneous 1,000 Record receivable from general fund for cash obtained from sale of scrap.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-15 Capital Projects Fund Entries and Statements a.

Journal entries: 1.

CPF Cash Other Financing Sources – Bond Issue Other Financing Sources – Bond Premium Other Financing Uses – Transfer Out to Debt Service Fund Cash

5,080,000 5,000,000 80,000 80,000 80,000

DSF Cash Other Financing Sources – Transfer In from Capital Projects Fund

80,000

CPF Expenditures Vouchers Payable

45,000

80,000 45,000

Vouchers Payable Cash

45,000 45,000

(Note: It is not necessary to first establish, and then immediately reverse an encumbrance account.) 3.

CPF ENCUMBRANCES 4,500,000 BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES

4,500,000

CPF BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES 2,000,000 ENCUMBRANCES

2,000,000

Expenditures Contracts Payable Contracts Payable – Retained Percentage CPF Contracts Payable Cash

2,000,000 1,800,000 200,000 1,800,000 1,800,000

Closing entries for Capital Projects Fund: Other Financing Sources – Bond Issue Other Financing Sources – Bond Premium Expenditures Other Financing Uses – Transfer Out to Debt Service Fund Fund Balance – Unassigned BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES

5,000,000 80,000 2,045,000 80,000 2,955,000 2,500,000 2,500,000

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-15 (continued) Fund Balance – Unassigned Fund Balance – Assigned for Encumbrances

2,500,000 2,500,000

West City Capital Projects Fund Balance Sheet June 30, 20X3 Assets Cash Total Assets

$ 3,155,000 $ 3,155,000

Liabilities and Fund Balance Contracts Payable – Retained Percentage Fund Balance: Spendable: Assigned to: General Government Services Unassigned Total Liabilities and Fund Balance c.

$2,500,000 455,000

200,000

2,955,000 $ 3,155,000

West City Capital Projects Fund Statement of Revenues, Expenditures, and Changes in Fund Balance For Fiscal Year Ended June 30, 20X3 Expenditures: Capital Outlays: Building Removal Building Construction Total Expenditures Deficiency of Revenues over Expenditures Other Financing Sources (Uses): Proceeds of Serial Bonds Transfer Out to Debt Service Fund Total Other Financing Sources (Uses) Net Change in Fund Balance Fund Balance, July 1, 20X2 Fund Balance, June 30, 20X3

45,000 2,000,000 $ 2,045,000 $(2,045,000) 5,080,000 (80,000) $ 5,000,000 $ 2,955,000 -0$ 2,955,000

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-16 Recording Entries in Various Funds [AICPA Adapted] 1.

Entries made in the capital projects fund for 20X8: Cash Other Financing Sources – Bond Issue Issued $800,000 of bonds at their face value.

800,000

ENCUMBRANCES BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES Contractor’s bid is accepted.

750,000

BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES One-third of the project was completed during 20X8. Expenditures Contracts Payable Actual construction cost incurred in 20X8. 2.

800,000

750,000

250,000 250,000 246,000 246,000

Entries made in the special revenue fund for 20X8: ESTIMATED REVENUES CONTROL APPROPRIATIONS CONTROL BUDGETARY FUND BALANCE – UNASSIGNED Record the budget for 20X8.

112,000

Cash Revenues Collected hotel room taxes.

109,000

108,000 4,000

109,000

Expenditures 103,000 Vouchers Payable Incurred expenditures for general promotion and motor vehicle.

103,000

Vouchers Payable Cash Paid expenditures.

103,000

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-16 (continued) 3.

Entry made in the general fund for 20X8: Other Financing Uses – Transfer Out to Debt Service Fund Cash Record transfer of resources to debt service fund.

313,500 313,500

Entries made in the debt service fund for 20X8:

Cash Other Financing Sources – Transfer In from General Fund Record transfer of resources from general fund.

313,500

Expenditures – Interest Matured Interest Payable Record interest legally due and payable.

13,500

Expenditures – Principal Matured Bonds Payable Record principal legally due and payable.

300,000

Matured Bonds Payable Matured Interest Payable Cash Record payment of matured bonds and interest.

300,000 13,500

313,500

13,500

300,000

313,500

Closing entries in the general fund for 20X8: BUDGETARY FUND BALANCE – ASSIGNED FOR ENCUMBRANCES ENCUMBRANCES Close outstanding encumbrances at year-end.

83,000 83,000

Fund Balance – Unassigned 83,000 Fund Balance – Assigned for Encumbrances 83,000 Reserve actual fund balance for encumbrances expected to be honored in 20X9. 5.

Adjusting entry in the general fund for 20X8: Fund Balance – Assigned for Inventories 3,000 Inventory of Supplies Adjust inventory of supplies to balance at December 31, 20X8.

3,000

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-17 Matching Questions Involving Various Funds 1.

10.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-18 Questions on Fund Transactions [AICPA Adapted] 1. $104,500

(Stated in item #3.)

2. $17,000

(Stated in item #4.)

3. $83,000

(Item #5 states that $83,000 is assigned for encumbrances.)

4. $236,000

(Item #1 states that $600,000 of bond proceeds were received in the capital project fund, less $364,000 of construction expenditures in the period.)

5. $6,000

(Item #2 states that $109,000 tax revenues were received from which $81,000 and $22,000 was expended.)

6. $104,500

(Stated in item #3.)

7. $386,000

(Item #1 states construction expenditures of $364,000 plus item #2 states a motor vehicle purchase of $22,000.)

8. $100,000

(Item #3 states a reduction in long-term debt principal of $100,000.)

9. $181,000

(Item #6 states that $181,000 was used to purchase supplies during the period.)

10. $190,000

(Item #6 states encumbrances of $190,000.)

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-19

Matching Questions Involving the Statement of Cash Flows for a Proprietary Fund

10.

11.

12.

13.

14.

15.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-20

Matching Questions Involving the Statement of Revenues, Expenditures, and Changes in Fund Balance for a Capital Projects Fund and a Debt Service Fund

10.

11.

12.

13.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-21 Question on Fund Transactions [AICPA Adapted] a. 1.

10.

11.

B and J

12.

F and J

13.

C and J

14.

15.

B and J

16.

G and J

17.

18.

19.

I and J

20.

H and J

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-22 Major Fund Tests Step 1: 10 percent criterion tests Denominators for 10 percent tests are the total of each of the four items for that fund type (for governmental and then for enterprise) 10 percent criterion tests: Governmental fund type: Percent of:

Assets $2,112,400

Liabilities $951,300

Revenues $5,790,000

Expenditures $5,659,800

2.00% 3.99% 1.68% 0.00% 0.00%

5.65% 7.94% 0.71% 5.72% 0.19%

5.80% 7.39% 0.99% 5.12% 0.32%

Assets $3,996,000

Liabilities $2,900,700

Revenues $618,000

Expenses $543,000

66.07%* 33.93%*

62.08%* 37.92%*

46.76%* 53.24%*

45.12%* 54.88%*

General fund – is always a major fund Special Revenue 1.28%(a) Capital Project – Library 21.30%* Capital Project – Arena 1.33% Debt Service 1.94% Permanent 11.65%* Enterprise fund type: Percent of: Enterprise – Electric Enterprise – Water (a)

1.28% = $27,000 / $2,112,400 * Meets the 10 percent criterion test

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-22 (continued) Step 2: 5 percent criterion tests The 5 percent criterion test is applied only to those funds that met the 10 percent criterion test. (For each of the four 5 percent tests, the denominator is the combined amount of that item from the governmental funds plus the enterprise funds.) Computation of denominators for 5 percent governmental and enterprise fund types: Expenditures/ Assets Liabilities Revenues Expenses Governmental fund types $2,112,400 $ 951,300 $5,790,000 $5,659,800 Enterprise fund types 3,996,000 2,900,700 618,000 543,000 Combined $6,108,400 $3,852,000 $6,408,000 $6,202,800 5 percent criterion tests: Assets

Liabilities

Revenues

Expenditures/ Expenses

$6,108,400

$3,852,000

$6,408,000

$6,202,800

Governmental fund type: General fund – is always a major fund Capital Project – Library Permanent

7.37%(a)** 4.03%

0.99% 0.00%

7.18%** 0.17%

6.74%** 0.29%

Enterprise type funds: Enterprise – Electric Enterprise – Water

43.22%** 22.20%**

46.75%** 28.56%**

4.51% 5.13%**

3.95% 4.80%

Percent of combined amount of:

(a)

7.37% = $450,000 / $6,108,400 ** Meets the 5 percent criterion test To be a major fund, an individual fund must meet both the 10 percent and the 5 percent major fund criteria in at least one financial statement item. Each major fund is presented in a separate column on the fund-based financial statements presented as part of the comprehensive annual financial report for the governmental entity. (1) General fund – is always a major fund (2) Capital Projects – Library fund – assets (both 10% and 5% criterion tests) (3) Enterprise – Electric – assets and liabilities (both 10% and 5% criterion tests) (4) Enterprise – Water – assets, liabilities, revenues (both 10% and 5% criterion tests) The other governmental funds must be aggregated and reported in a single column in the governmental funds balance sheet and statement of revenues, expenditures, and changes in fund balance.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-23 Reconciliation Schedules a. Reconciliation of the Balance Sheet of the Governmental Funds to the Statement of Net Position: City of Sycamore Reconciliation of the Balance Sheet of Governmental Funds to the Statement of Net Position Fund balances reported in the governmental funds Amounts reported for the governmental activities in the statement of net assets are different because: Capital assets used in governmental activities are not financial resources and therefore are not reported in the governmental funds. The internal service fund reported $18,000 in capital assets. Thus, the amount of the adjustment Is for the capital assets not reported in just the governmental funds, ($4,311,000 = $4,329,000 - $18,000) Internal service funds are used by management to charge costs of certain activities. The assets and liabilities of the internal service fund and are Included in governmental activities In the statement of net position. Long-term liabilities, including bonds payable, are not due and payable in the current period and therefore are not reported as liabilities in the governmental funds. Interest in the governmental funds is recognized under the modified accrual basis, but under the accrual basis for the governmentwide financial statements. Net position is adjusted for interest ($5,000 = $6,000 - $1,000). Net position of governmental activities

$ 888,400

4,311,000 37,000 (460,000)

(5,000) $4,771,400

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-23 (continued) b. Reconciliation of the Statement of Revenues, Expenditures, and Changes in Fund Balances of Governmental Funds to the Statement of Activities: City of Sycamore Reconciliation of the Statement of Revenues, Expenditures, and Changes in Fund Balances of Governmental Funds to the Statement of Activities Net change in fund balances – governmental funds Governmental funds report capital outlays as expenditures. However, in the statement of activities, the costs of those assets is capitalized and depreciated over their estimated useful lives. This is the amount by which capital outlays in the governmental funds ($287,000) exceeded depreciation of the governmental assets ($187,000) Bond proceeds provide current financial resources for the governmental funds. However, the issuance of debt increases long-term liabilities in the statement of net position. Bond proceeds of $460,000 are not reduced because there is no repayment of principal during the year. Revenues and expenses in the statement of activities are recorded on the accrual basis. Interest in the governmental funds is recorded on the modified accrual basis. Accrual interest revenue exceeded modified accrual interest revenue recognized in the governmental funds by $1,000. Accrual interest expense exceeded modified accrual interest expense by $6,000 ($46,000 - $40,000). The net interest adjustment is $5,000. Internal service funds are used by management to charge the costs of certain services. The net revenue (expense) of the internal service funds is reported with governmental activities. Change in net position of governmental activities

$509,400

100,000

(460,000)

(5,000) 9,000 $153,400

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-24 True/False Questions 1.

The budgetary comparison schedule requires both the initial budget and the final budget.

A component unit is financially accountable to the primary government.

The net position in the governmentwide statement of net position would be categorized by: invested in capital assets, net of related debt; restricted by outside donors in specific funds; and, unrestricted.

The tests for a major governmental, or enterprise fund, for which separate disclosure is required in the governmentwide financial statements are: (a) total assets, liabilities, revenues, or expenditures/expenses of that individual governmental or enterprise fund are at least 10 percent or more of the governmental or enterprise category, and (b) total assets, liabilities, revenues, or expenditures/expenses of the individual governmental or enterprise fund are at least 5 percent of the total for all governmental and enterprise funds combined.

10.

11.

12.

Depreciation on fixed assets of a government entity may be computed by any method deemed appropriate, such as straight-line or an accelerated method, but depreciation of fixed assets is not equal to the expenditures for fixed assets made in the governmental funds.

13.

Management’s Discussion and Analysis is a required supplementary information disclosure in the new government reporting model.

14.

Fiduciary funds are not part of the governmentwide statement of net position, but would be separately reported in the fiduciary funds section of the fundbased financial statements.

15.

The internal service fund is blended into the governmental activities columns of the governmentwide financial statement of net position and statement of activities. In the reconciliation schedule for the statement of revenues, expenditures, and changes in fund balances, bond proceeds would be subtracted because they were included as other financing sources in the governmental funds, but are an addition to liabilities in the governmentwide financial statements.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-25 Determining Whether a Special Revenue Fund Is a Major Fund Test 1: 10% criterion: Are the assets, liabilities, revenues, or expenditures of the special revenue fund at least 10% of their respective totals for all governmental funds? Totals for Amount Reported by Items Tested Governmental Funds Special Revenue Fund 1. Assets $50,000,000 $4,100,000 (8.2%) (10% test failed) 2. Liabilities 22,000,000 3,900,000 (17.7%) (10% test met) 3. Revenues 70,000,000 6,700,000 (9.6%) (10% test failed) 4. Expenditures 60,000,000 6,500,000 (10.8%) (10% test met) Test 2: 5% criterion: Two items met the 10% criterion test--liabilities and expenditures. The 5% criterion test is met if at least one of the items that met the 10% criterion first test is at least 5% of the respective amounts for all governmental and enterprise funds.

2. 4.

Items Tested Liabilities (5% test met) Expenditures/expenses (5% test met)

Totals for Governmental and Enterprise Funds $37,000,000

Amount reported by Special Revenue Fund $3,900,000 (10.5%)

82,000,000

6,500,000 (7.9%)

Conclusion: The special revenue fund should be reported as a major fund on the financial statements of the governmental funds for 20X2 because both its expenditures and liabilities met the 10% and the 5% tests.

Chapter 18 – Governmental Entities: Special Funds and Governmentwide Financial Statements

P18-26 Preparation of a Statement of Net Position for a Governmental Entity Gibson City Statement of Net Position December 31, 20X2

Assets Cash and cash equivalents Taxes receivable (net) Accounts receivable (net) Internal balances Inventories Investments Capital assets: Land Infrastructure Other depreciable assets (net) Total assets Liabilities Vouchers payable Accrued interest payable Revenue bonds payable General obligation bonds payable Total liabilities Net position Invested in capital assets, net of related debt Restricted Unrestricted Total net position

Governmental Activities

Business-type Activities

$ 68,000 52,000

$ 28,000 12,000 5,000 7,000 15,000

(5,000) 10,000 25,000 100,000 60,000 75,000 $385,000 $ 32,000 1,500

50,000 45,000 $162,000 $

4,000 2,000 80,000

Total $ 96,000 52,000 12,000 17,000 40,000 150,000 60,000 120,000 $547,000

60,000 $ 93,500

$ 86,000

$ 36,000 3,500 80,000 60,000 $179,500

$175,000* 55,000 61,500*** $291,500

$ 15,000** 5,000 56,000*** $ 76,000

$190,000 60,000 117,500 $367,500

Computation notes: * $235,000 of capital assets (net) minus $60,000 of general obligation bonds equals $175,000. ** $95,000 of capital assets minus $80,000 of revenue bonds equals $15,000. *** The unrestricted net position amount is plugged in to make the total net position equal assets minus liabilities. The internal balances amount of $5,000 is the amount that the governmental activities owe to business-type activities.

Chapter 19 – Not-for-Profit Entities

CHAPTER 19 NOT-FOR-PROFIT ENTITIES ANSWERS TO QUESTIONS Q19-1 Initially, tuition scholarships are included in revenue for the period in order to measure fully the revenue obtainable. If the university requires an employment-type work for the tuition scholarship, then they are also shown as an expense. However, if no employment-type work is required of the recipient, then the university also records the tuition scholarship as a revenue-reduction item. Q19-2 In the statement of financial position for private colleges, the net assets are designated as (1) without donor restrictions and (2) with donor restrictions. Net assets with donor restrictions are comprised of both contributions that the donors have specified must be retained into perpetuity (earnings from the principal are then used in accordance with the wishes of the donor) and those which the donor has contributed for specific use or which have been contributed for use in a future period. All other assets are classified as without donor restrictions. Q19-3 The accounting and reporting for public universities is specified by the GASB, and GASB 35 provides specific guidance that public universities should be accounted for as special-purpose governmental entities in accordance with GASB 34. Private universities have their accounting and financial reporting specified by the FASB. ASC 958 provides the format and requirements for financial reporting for private universities. Q19-4 The accrual basis of accounting is used in a hospital's general and restricted funds. Donor restricted contributions are held in the restricted fund until the conditions are met and then are transferred to the general fund. Q19-5 Donated services are included as a revenue and a corresponding expense at their fair value if the services are significant and would otherwise be performed by salaried personnel. The criteria for recognition require that the services either (a) create or enhance the nonfinancial assets of the hospital or (b) the services provided require specialized skills, are provided by individuals possessing those skills, and would need to be purchased if not provided by donation. Donated equipment is accounted for as a contribution in a fund with donor restrictions until placed into service, at which time it is transferred to the general fund. Donated medical supplies are recorded as revenue and charged to expenses as used. The estimated value of the donated services is reported as an expense and a corresponding amount is reported as contributions. Q19-6 The $15,000 is accounted for as a contribution to a specific purpose fund with donor restrictions. When the $15,000 is expended by the general fund, the specific purpose restricted fund transfers the resources to the general fund to reimburse the general fund or pay for the intensive care operating expenses. The expense is reported as an expense of the general fund and the reimbursement from the restricted fund is reported as net assets released from the restricted fund. Q19-7 Net patient service revenue of a hospital is computed by deducting contractual adjustments from total billings for inpatient and outpatient services provided. Charity care is excluded. Net Patient service revenue represents the earning capacity of the hospital. 19-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 19 – Not-for-Profit Entities

Q19-8 The general fund records a gain on the sale of hospital properties. The gain is reported in the hospital's statement of activities. Q19-9 Depreciation is recorded on an accrual basis by hospitals. It must be accounted for because depreciable assets constitute a significant part of the total cost of providing medical services. Q19-10 The accrual basis of accounting is used for the current fund without donor restrictions of a VHWO. The accrual basis of accounting is also used for all other funds, including the current fund without donor restrictions, the land, building, and equipment fund (plant fund), and the endowment fund. Q19-11 If separate funds are maintained, fixed assets are recorded in the land, building, and equipment fund (plant fund) in a VHWO. If separate funds are not maintained, fixed assets would be recorded in the fund without donor restrictions along with all other assets. Depreciation is reported as an operating expense each period because the omission of depreciation would result in an understatement of the costs of providing the organization’s services. Q19-12 The $10,000 contribution is accounted for as contribution revenue in a temporarily restricted (specific purpose) fund when it is received. The expense of the $10,000 for public health education service is accounted for as a program services expense of the fund without donor restrictions and as a net asset released from the temporarily restricted fund. Q19-13 Pledges from donors that are unconditional promises to give are recognized as contribution revenue in the period in which the pledge is received. Although the total amount of the pledge is recorded as a contribution receivable, an adequate allowance for uncollectibles must be recognized by a debit to the contributions account or a credit to allowance for uncollectible pledges. The estimated amount that actually will be collected is recognized as contribution revenue. Pledges applicable to future periods or restricted in use by the donor should be recorded in the temporarily restricted or permanently restricted fund, as appropriate. Q19-14 It would not be appropriate to report funds whose use is restricted as revenue in the unrestricted fund prior to the time the restriction was met. Contributions that must be permanently retained are included as contribution revenue in the permanently restricted fund. Those received with restriction as to use or that must be used in a future time period are recorded as contribution revenue in the temporarily restricted fund(s). Q19-15 Many VHWOs are heavily dependent upon donated services. However, such services typically are not recorded and included for financial reporting purposes. For example, neighborhood solicitations are an integral part of the activities of many charitable organizations but no accounting recognition is given for these efforts. To be recognized, donated services must (a) create or enhance nonfinancial assets or (b) require specialized skills, be provided by individuals possessing those skills, and typically be purchased if not provided by donation. If these conditions are satisfied, the value of the donated services received should be reported as part of revenue and public support and the cost of the services recognized as an expense item of the period.

Chapter 19 – Not-for-Profit Entities

Q19-16 The statement of functional expenses details the items reported in the expense section of the statement of activities. The individual expense categories generally are assigned to each major programmatic activity and to general management and efforts. As a result, much greater insight can be gained into the way in which funds are spent. Voluntary health and welfare organizations are required to prepare a statement of functional expenses. Q19-17 The contribution of $12,000 is accounted for as a contribution of a net asset with donor restrictions at the time of receipt. When the expense of $12,000 is made for a community service activity, the amount used is recognized as funds released from program use restrictions in the statement of activities. Q19-18 All organizations subject to FASB jurisdiction must meet the qualifications for recognition of contributed services set forth in ASC 958. Thus, most hospitals and ONPOs will be expected to account for donated services in the same manner. Both hospitals and ONPOs must demonstrate that the services received either (a) created or enhanced nonfinancial assets or (b) required specialized skills, were provided by individuals possessing those skills, and would have been purchased if the services had not been contributed. ONPOs also have been required to demonstrate that the services of the ONPO were not principally intended for the benefit of the organization's members in the past. As a result, ONPOs seldom have recorded donated services. If donated services are recognized, an ONPO records them as public support; hospitals recognize donated services as revenue. Q19-19 As an ONPO, a Rotary Club should record depreciation expense because the omission of depreciation would result in an understatement of the costs of providing the organization's services. Q19-20 The statement of activities for both an ONPO and VHWO reports the support, revenue, expenses, net assets released from restriction, and changes in net assets during the fiscal period. The particular items reported and the size of the various revenue and expense categories may vary rather substantially between such entities, however, due to differences in the overall missions and types of activities the organizations are involved in on a routine basis.

Chapter 19 – Not-for-Profit Entities

SOLUTIONS TO CASES C19-1 Accounting for Donations a. Donated services are a vital element of many not-for-profit entities, including hospitals, voluntary health and welfare organizations and other not-for-profit organizations. The criteria established in ASC 958 for recognition of donated services require: 1.

The services performed create or enhance nonfinancial assets or,

The services (a) require specialized skills, (b) are provided by individuals possessing those skills, and (c) the services would be purchased if not donated.

In general, donated services are not recognized unless they represent an important contribution to the operations of the organization. For example, in the hospital setting, a volunteer who staffs a nursing station on a regular shift but accepts no compensation clearly provides services which meet the criteria for recognition. The hospital would need to hire another nurse if these services were not volunteered. Moreover, the hospital has the ability to supervise and directly control the activities of the volunteer in the same manner as a paid employee. On the other hand, a group of high school youth who visit patients and attempt to make their stay in the hospital more pleasant would not qualify for recognition. If the services were not provided it is unlikely the hospital would use its resources to hire staff to perform this function. Voluntary health and welfare organizations often receive donated services for concentrated fund raising efforts and for supplementary programs. Because of the difficulty in determining the value of these services and the absence of controls over the persons providing the services, VHWOs normally do not account for donated services unless the first three criteria are met. Even when these are met, it may be appropriate to recognize the donated services only if the amount of time donated is significant and represents an integral part of the activities provided by the organization. Other not-for-profit organizations often rely heavily on donated services as well. However, many of these are for the benefit of other members rather than for some general public purpose and there has been reluctance to recognize donated services in the financial statements. In many cases the services are not under the direct control of the organization and are very difficult to value. b. Donations of capital assets are recorded as a contribution in a restricted fund and carried in the fund until the asset is placed into service, at which time it is transferred to the general fund. The donation is recorded at its fair value. Once the asset is placed in service, depreciation is recorded for the use of the asset in order to measure fully the cost of providing the hospital's services.

Chapter 19 – Not-for-Profit Entities

C19-1 (continued) c. As in all not-for-profit organizations, the accounting for cash contributions to a hospital depends on whether or not the donor places a restriction on the use of the cash. If the gift is unrestricted, it is accounted for as contribution revenue in the general fund. If the gift is restricted, it is recorded as a contribution of net assets with donor restrictions. In the period in which the restriction is met, the appropriate amount is reported in the general fund as released from use or passage of time restriction. Cash contributions to a voluntary health and welfare organization or another not-for-profit organization are accounted for as public support in the period the contribution is received as an addition to net assets that are with or without donor restrictions. If the contribution is restricted by its donor, the gift is treated as a contribution of a temporarily net asset that is with or without donor restrictions at the time of receipt and then reported as released from restriction in the period in which the restriction is met.

C19-2 Public Support to an Other Not-for-Profit Organization a. The $25,000 of unrestricted contributions should be accounted for as public support revenue in the statement of activities for the current period. b. The $15,000 of restricted contributions should be accounted for as a temporarily restricted asset in the restricted fund, if a restricted fund is used or in the general fund if a separate restricted fund is not maintained. The $15,000 should be recorded as a contribution in the period of receipt. The expense of $6,000 for public health advertisements triggers recognition of $6,000 as funds released from a use restriction with both the expense and release of funds included in the statement of activities for the period. If a separate temporarily restricted fund is maintained and the $6,000 expense is made from the operating fund without donor restrictions, the restricted fund would then reimburse the unrestricted fund for its expenses. It does not matter that unrestricted assets were used for the actual expense. The remaining $9,000 of restricted resources should be reported as a part of its net assets with donor restrictions on the ONPO's balance sheet.

Chapter 19 – Not-for-Profit Entities

C19-3 A Brief Analysis of the Financial Disclosures of United Way of America The United Way Worldwide’s (UWW) web site is http://liveunited.org. The financial information can be found at http://liveunited.org/pages/financial-information. The most recent year of availability will provide the specific data for the questions, but the following are general answers to the questions in the case based on the 2011 annual report. The answers will be fairly similar each year. a. From the Summary of Significant Accounting Policies the Consolidated Financial Statements: The reporting entity includes the following: United Way Worldwide (in 2009 United Way of America (UWA) changed its name to UWW) and its subsidiaries, United Way Store and United eWay. The statements also include UWW’s regional office of United Way of Tri-State, Inc. Operationally, the United Way Store is a for-profit subsidiary to provide sales fulfilment services to UWW and other organizations. United eWay provides on-line giving along with pledge processing and fund distribution services for corporations working with UWW. In June 2005, United Way of Tri-State, Inc. (UWTS) became a TriState Regional office of the UWW and is responsible for raising charitable funds and working with companies whose employees live and/or work in the New York Tri-State region. And there are a large number of local United Way chapters that manage local fund raising campaigns. United Way Worldwide (UWW) is an international organization supported primarily by local United Ways (LUW’s) through membership dues. UWW serves the United Way movement by being a leader in philanthropy and a mobilizer of resources, helping to shape the world’s health and human services agenda and create a better quality of life for all. UWW’s mission is to improve lives by mobilizing the caring power of communities around the world to advance the common good. UWW’s Tri-State regional office (Tri-State) is responsible for raising charitable funds from employees and companies through United Way campaigns at a group of participating companies whose employees live and/or work in the New York Tri-State region and elect to participate in this specific regional campaign. Workplace campaigns at participating companies are organized in cooperation with local participating United Ways in the Tri-State region. United Way Store (UW Store) is a wholly owned, for-profit subsidiary of UWW. UW Store’s purpose is to provide sales fulfillment services to local United Ways, UWW, and other organizations. Sales to UWW and local United Ways accounted for approximately 70% and 74% of UW Store’s sales for 2011 and 2010, respectively. United eWay (eWay) combines advanced online giving with integrated pledge processing and fund distribution services for corporate philanthropic programs. eWay is a wholly owned subsidiary of UWW. Effective June 30, 2008, eWay sold substantially all its assets and transferred certain of its liabilities to Create Hope, Inc., a for-profit Delaware corporation. eWay received a 49% preferred stock ownership with voting rights in Truist Inc. (Truist). Subsequent to the sale, eWay transferred its ownership interest to UWW. As part of the transaction in 2008, UWW wrote off its investment in eWay and recorded a loss, net of the value of the Truist stock received. During 2009, the Organization determined that the investment in Truist was impaired and wrote the investment down to $0. eWay was subsequently dissolved effective March 24, 2011.United Way Worldwide (Asia) Limited (UWW Asia) is a wholly owned, for-profit subsidiary of UWW incorporated in Hong Kong on January 19, 2010. There has been no activity by UWW Asia since the date of its incorporation.

Chapter 19 – Not-for-Profit Entities

b. The Consolidated Statements of Financial Position includes eliminations for intraorganizational payables and receivables (Due from affiliates and Due to affiliates) and the capital accounts of the for-profit United Way Store (against the investment in subsidiary account of the parent, UWW). These eliminating entries are the same type as in the consolidating worksheet used for a parent and its subsidiary companies as presented in the first ten chapters of this textbook. The major components of the consolidated assets and equity will depend on the specific year analyzed. Because UWW is an organization that focuses on raising and distributing charitable funds, the consolidated statement of financial position will reflect unrestricted and restricted amounts, custodial funds (both as an asset and a liability), campaign receivables, and fixed assets such as building, land, and equipment. The custodial funds are described in footnote 3. UWW is the fiscal agent for a Federal Emergency Management Agency (FEMA) program to distribute federal funds through the Emergency Food and Shelter (EF&S) program which is not consolidated into UWW’s financial statements. UWW is the custodian of the federal funds and distributes these funds in accordance with the directions of the national board established to determine needs that can be met with these funds. Thus, UWW reports both an asset and a liability in the same amount for any undistributed funds for which it is the custodian. c. The consolidated statement of activities shows the typical types of revenues and expenses of a large fund raising not-for-profit entity. Revenues will include public support through membership, campaigns, and contributions. Also, United Way Stores generates revenue from sales of promotional materials. Expenses include program service and several others, which footnote 20 describes in more detail. The total consolidated fund raising expenses are included in supporting services. UWW has successfully worked with a large number of businesses and other entities to coordinate UWW fund raising activities in those entities. Thus, the businesses and other entities provide a relatively large part of UWW’s fund raising efforts. d. The supplementary schedule of functional expenses presents expense information on each of the program services of the consolidated financial statements. In 2011, Investor Relations was the largest, followed by Community Impact Leadership & Learning, Brand Leadership, Campaign and Public Relations, International Network, and Public Policy. Note that supporting services are presented separately from program services. The three largest expense categories are scholarships, grants, and awards (primarily given through the public policy program); salaries, and professional fees and contract services (across all program services and supporting services, but especially under brand leadership). e. Form 990 contains much of the same information as provided in the consolidated financial statements, but in a format that permits the IRS to easily compare information for tax-exempt organizations. Most students will not have seen a Form 990 before this case and can quickly see that Form 990 can be prepared from information from the consolidated financial statements.

Chapter 19 – Not-for-Profit Entities

C19-4 Case on Conditional Gift to a Not-for-Profit Organization MEMO To:

Gardner, Treasurer, Central Illinois Chapter

From: Re:

, CPA Donor pledge

A donor has pledged $20,000 per year for five years to the Central Illinois Chapter, with the condition that the chapter sponsor annual educational programs over the next five years. The donor’s pledge should be considered as a conditional promise to give, under the requirements stated in ASC 958. The first $20,000 gift, which has already been received by the chapter, should be recognized either as a contribution or as a refundable advance, depending on whether the conditions associated with the contribution have been substantially met. [ASC 958-60525-11] Because the first educational workshop has been organized and scheduled and has been approved by the donor, I believe that this amount can be recognized as a contribution during the current fiscal year. Although the chapter does intend to fulfill the donor’s conditions in order to receive the additional contributions, at this point in time these conditions are not substantially met. Therefore, the additional $80,000 that the donor has pledged should not be recognized in the current fiscal year. The donor has clearly stated that the additional contributions will not be made if the chapter does not continue with the educational programs. Thus there is no ambiguity about whether the donor’s promise to give is conditional or unconditional. Determining whether a promise is conditional or unconditional can be difficult if it contains donor stipulations that do not clearly state whether the right to receive payment or delivery of the promised assets depends on meeting those stipulations. It may be difficult to determine whether those stipulations are conditions or restrictions. In cases of ambiguous donor stipulations, a promise containing stipulations that are not clearly unconditional shall be presumed to be a conditional promise. [ASC 958-605-2514] Although the chapter cannot recognize the $80,000, the pledge should be disclosed. The chapter should disclose the following with respect to the donor’s conditional promise: a. The total of the amounts promised, and b. A description and amount for each group of promises having similar characteristics, such as amounts of promises conditioned on establishing new programs, completing a new building, and raising matching gifts by a specified date. [ASC 958-310-50-4] Primary references ASC 958-605-25-11 ASC 958-605-25-14 Other references ASC 958-310-50-4

Chapter 19 – Not-for-Profit Entities

C19-5 Accounting for Contributions to and Activities of a Not-for-Profit Organization MEMO To:

Finley, Manager

From: Re:

, CPA Auction Extravaganza

There are two different problems with the way that the Community Chest is reporting the proceeds of the Auction Extravaganza event. First, ASC 958 requires that the revenues and expenses from the event be reported as gross amounts and should not be netted together. Although ASC 958 does permit net reporting for investment income or gains from certain peripheral activities, these exceptions do not apply to a major event like the Auction Extravaganza. Therefore, the statement of activities should include the gross revenue from the event in the revenues section and should identify the event expenses in the expense section of the statement. The second accounting issue is the donations that the Community Chest receives for the Auction Extravaganza event. Community Chest is recording as revenue the event ticket sales and the auction proceeds but is not reporting donated auction items and services as contributions. In ASC 958, contributions received by a not-for-profit organization are defined as an unconditional transfer of cash, other assets, or services. The items that businesses donated to be auctioned meet the definition of contributions. ASC 958 provides that contributions received are to be recorded at fair value. [ASC 958605-30-2] Because the donated items are immediately used by the Community Chest in the auction, the fair value of the items should be estimated and recognized as both a revenue and an expense in the current reporting period. Contributions received shall be recognized as revenues or gains in the period received and as assets, decreases of liabilities, or expenses depending on the form of the benefits received. [ASC 958-605-25-2] The Community Chest should also estimate a fair value for the services provided by the auctioneer and the musicians. These meet the requirement for recognition that the services are specialized skills that the Community Chest would have to purchase if the donation was not made. [ASC 958-605-25-16] Again, since the services are both donated to and consumed in the Auction Extravaganza, the fair values should be recognized as both revenue and expense. Although these changes will have no net effect on the change in net assets reported in the statement of activities, they will provide more complete information about the Auction Extravaganza event, which complies with the FASB’s purpose of ASC 958. Primary references ASC 958-605-25-16 ASC 958-605-30-2, ASC 958-605-25-2

Chapter 19 – Not-for-Profit Entities

C19-6 An Analysis of the Financial Statements for the American Red Cross, a Voluntary Health and Welfare Organization The consolidated financial statements can be found by clicking on the “Publications” link at the top of the ARC’s home page. The financials are located at the bottom of the page. a. Read the independent auditor’s report of the U. S. Army Audit Agency that is disclosed in the annual report of the American Red Cross (ARC). In this report, it states that “The Act of Congress that incorporated the American Red Cross, as implemented by DOD Directive 1000.26E and Army Regulation 930-5, requires the U. S. Army Audit Agency perform an annual audit of the financial statements of the American Red Cross.” b. Look at the statement of functional expenses for the most recent year. This statement is a required financial statement for the ARC. From this financial statement, you can determine the ratio of program expenses to total expenses for the most recent year. The ratio of program expenses to total expenses for the ARC has been around the 90% level. This ratio is substantially better than the 60% threshold recommended by the Better Business Bureau. c. Read the revenue recognition note. In this note to the financial statement, the ARC reports that “Contributions, which include unconditional promises to give (pledges) are recognized as revenues in the period received or promised.” To answer the question on the amount of temporarily restricted contributions receivable as of the most recent balance sheet date, you should look at the consolidated statement of financial position. On this statement, the portion of temporarily restricted contributions receivable that are reported under current assets should be added to the temporarily restricted contributions receivable that are reported under noncurrent assets to get the answer. d. Read the note on contributions receivable. In this note, the discount rate used to present value long-term pledges is disclosed. e. Look at the consolidated statement of activities for the most recent year. On this statement, the ARC reports the amount “net assets released from restrictions.” This is the amount that was reclassified from net assets with donor restrictions to net assets without donor restrictions due to satisfaction of purpose and/or time restrictions. f.

Look at the statement of functional expenses for the most recent year. In past years, Biomedical has had the highest total cost for salaries and wages and employee benefits.

Chapter 19 – Not-for-Profit Entities

C19-6 (continued) g. Read the note dealing with contributed services and materials. In this note, you will find the amount of contributed service revenue that was reported for the most recent year. Any conditional contributions would also be described here. h. Read the note on investments. In this note, the amount of dividend and interest revenue for the most recent year is reported for all three net asset categories. i.

Read the note on revenue recognition. In this note, it states that “When a donor restriction expires, that is, when a stipulated time restriction ends or purpose restriction is accomplished, net assets with donor restrictions are released and reclassified to net assets without donor restrictions in the consolidated statement of activities.”

Read the note on revenue recognition. In this note, it states that “Donor-restricted contributions are initially reported in the temporarily restricted net asset class, even if it is anticipated such restrictions will be met in the current reporting period.”

k. Read the note on Organization and Basis of Presentation. In this note, it states that net assets without donor restrictions are assets that “are not subject to any donorimposed stipulations.”

Chapter 19 – Not-for-Profit Entities

C19-7 An Analysis of the Financial Statements of the University of Notre Dame, a Private University. The specific answers your students provide for the questions will depend on the most recent year for which the annual report is provided on university’s web site (https://controller.nd.edu/annual-reports/). The following are general guidance for the answers to the questions. a. In the notes to the financial statements, read the note on net assets with donor restrictions and endowment. In this note, temporarily restricted contributions received for buildings and equipment is disclosed for the most recent year. b. Read the note that contains a summary of significant accounting policies. In this note, the University states “Non-operating activities presented in the consolidated statements of changes in net assets without donor restrictions include unrestricted contributions designated by the University for endowment or investment in buildings and equipment, investment return in excess of or less than the amount distributed for operations under the spending policy, any gains or losses on debt-related derivative instruments, and certain net pension and postretirement benefits-related changes in net assets.” c. Read the most recent statements of changes in net assets without donor restrictions. On this statement, net assets released from restrictions are disclosed in two places – (1) the operating section and (2) the Nonoperating section. This question asks for the amount of net assets released from restrictions for operations. d. Read the note on land, buildings, and equipment. In this note, the University states that it “…does not capitalize…the cost or fair value of its art collection.” e. Read the note that discloses the summary of significant accounting policies. In this note, read the section that deals with contributions. In this note, it states that “Contributions recognized in prior periods under such commitments were recorded at a discount based on a U.S. Treasury rate.” f.

Read the note that discloses the details of contributions receivable. In this note, the University discloses the gross amount of its contributions receivable and subtracts an allowance for uncollectible amounts and an amount that discounts contributions that are time restricted. The note also discloses the allocation of the contributions receivable, net, to the various net asset categories.

g. Read the statements of financial position to answer this question. The University discloses the net assets without donor restrictions that are designated by the Board in the net asset section. h. True, operating expenses on the statements of changes in net assets without donor restrictions are disclosed by function. In the summary of significant accounting policies, it states that “Operating expenses are reported by functional categories, after allocating costs for operations and maintenance of plant, interest on indebtedness, and depreciation expense.

Chapter 19 – Not-for-Profit Entities

C19-7 (continued) i.

True, the University’s land, buildings, and equipment, net of accumulated depreciation, are reported in the net asset without donor restrictions class. Look at notes 15 and 16 that discloses the composition of net assets with donor restrictions and endowment. In this note, the items that make up net asset with donor restrictions classes do not include land, buildings, or equipment. The net asset with donor restrictions class does include contributions for the acquisition of buildings and equipment; however, the University will release these net assets when the buildings and equipment are acquired and subsequently will report these assets in net assets without donor restrictions.

Look at the note on investment return. This note provides the total investment return for the most recent year. Note that investment return includes (1) investment income, net, (2) realized gain (loss), and (3) unrealized gain (loss). To answer the question dealing with the unrestricted portion of the investment return, you should read the most recent statements of changes in net assets without donor restrictions. The investment return that is unrestricted includes (1) investment income and (2) net gain (loss) on investments.

k. To answer this question, read the note that discloses “net assets with donor restrictions.” In this note, endowment funds that are reported in the net asset with donor restrictions class are disclosed. Note that this answer cannot be found on the statements of financial position because this statement discloses a single amount for investments for all three net asset categories.

Chapter 19 – Not-for-Profit Entities

C19-8 Profiles of Large Charitable Organizations The Give.org web site is well known by persons interested in donating larger amounts to a charity. The web site is a good source for obtaining an overview of the national charities and the availability of the same information for each of the charities makes comparisons easier. a. The Standards for Charity Accountability are found under the Charity Accountability Standards link. These 20 standards were established to measure: a.) governance and oversight; b.) effectiveness in establishing its mission; c.) finances to ensure that the charity is raising its funds honestly and spending those funds prudently in furtherance of its mission; d.) fund raising and informational materials to ensure that the charity’s fund raising materials are accurate and truthful, that financial reports are available to the public and that the privacy rights of its donors are met. b. The BBB Wise Giving Report for the American Red Cross includes charity contact information, the BBB evaluation conclusions; the charity’s programs, its tax status, its governance, fund raising information and financial information. The information provided is more of a thumbnail, but can quickly provide the types of information many donors wish to have before giving to a charity. c. It will be interesting to have your students talk about their selected charities, why they selected the ones they did, and what types of information they found of interest.

Chapter 19 – Not-for-Profit Entities

SOLUTIONS TO EXERCISES E19-1

Multiple-Choice Questions on Colleges and Universities [AICPA Adapted]

a–

$1,700,000 – $150,000 – $50,000 = $1,500,000

c–

The university records revenue for the graduate student’s tuition at the standard rate and then records the tuition remission as an expense of the year in which the graduate student is a teaching assistant

a–

$2,300,000 – $50,000 – $10,000 – $140,000 = $2,100,000

c–

$7,500,000 assets - $4,500,000 liabilities

d–

$550,000 unrestricted + $330,000 of restricted

b–

$200,000 for fair value of donated services. Travel is an additional cost of the services provided by the university. Expenses Contribution Revenue Cash

218,000 200,000 18,000

E19-2 Multiple-Choice Questions on Hospital Accounting [AICPA Adapted] 1.

a–

Net patient service revenue represents total billings less contractual adjustments.

c–

When goods are donated revenue is recognized in the Statement of Operations if the goods are unrestricted. (a) incorrect. Donations received never decrease an expense account. (b) incorrect. This donation results in an increase of net assets. (d) incorrect. There must be record of the increase in assets on a financial statement.

d – All of the assets would be in the unrestricted fund unless otherwise restricted.

a–

When goods are donated revenue is recognized in the Statement of Operations if the goods are unrestricted. (b) incorrect. The medicine won’t be expensed until used. (c) incorrect. The debit will be to the corresponding inventory account (d) incorrect. The revenue should be recognized when the product is received.

d – All of the options are income items to a not-for-profit hospital.

Chapter 19 – Not-for-Profit Entities

a–

d – Since the hospital would not otherwise be providing these services they would not purchase them in the normal course of business and therefore will recognize no revenue.

c–

Pledges are recognized in the period where the pledge takes place and are recognized as contribution revenue.

Funds designated by the board for hospital use are included in the general fund. Board-designated resources can only be taken from the general fund. (a) incorrect. Permanent endowments would be located in the chosen endowment fund of the donor. (b) incorrect. Temporary endowments would also initially be located in the endowment fund (d) incorrect. These funds would be located in a restricted fund.

d – The services provided are “employee-type” services and the supplies are always recognized as revenue.

10.

a–

11.

b – Depreciation is recorded in the general fund for both types of entities, because the use of the assets is part of the cost of providing medical services.

12.

d – Because they do not have control over the actual funds no entry is made.

None of the assets are labeled as restricted.

Chapter 19 – Not-for-Profit Entities

E19-3 Entries for a Hospital’s (General) Fund Without Donor Restrictions a.

Journal entries for the general fund. 1. 2.

3. 4.

6. 7.

Accounts Receivable Patient Services Revenue

6,200,000

Nursing Services Expense Other Professional Services Expense Fiscal Services Expense General Services Expense Bad Debts Expense Administration Expense Depreciation Expense Cash Allowance for Uncollectibles Accumulated Depreciation Accounts Payable Inventory Donated Services

2,070,000 1,250,000 225,000 1,510,000 125,000 260,000 500,000

6,200,000

4,785,000 125,000 500,000 210,000 240,000 80,000

Patient Services Revenue Accounts Receivable

220,000

Cash Net Assets Released from Program Use Restrictions

180,000

Cash Net Assets Released from Equipment Acquisition Restriction

200,000

Cash Contributions – Without Donor Restrictions

155,000

220,000

Cash Allowance for Uncollectibles Accounts Receivable

180,000

200,000 155,000 5,905,000 75,000 5,980,000

Investment Securities Unrealized Holding Gain on Investment Securities – Designated for Other Than Current Operations

70,000 70,000

Chapter 19 – Not-for-Profit Entities

E19-3 (continued) b.

Sycamore Hospital Statement of Operations For the Year Ended December 31, 20X6

Revenues, gains, and other support: Net patient services revenue Contributions Net assets released from program use restriction

$5,980,000 155,000 180,000

Total revenues, gains, and other support Expenses and losses: Nursing services Other professional services Fiscal services General services Bad debts Administration Depreciation Total operating expenses

$6,315,000 $2,070,000 1,250,000 225,000 1,510,000 125,000 260,000 500,000 5,940,000

Operating income

$ 375,000

Other income

-0-

Excess of revenues over expenses

$ 375,000

Unrealized gains designated in excess of amounts for current operations Net assets released from restrictions used for purchase of equipment Increase in net assets without donor restrictions

70,000 200,000 $ 645,000

Chapter 19 – Not-for-Profit Entities

E19-4 Entries for Other Hospital Funds 1.

Endowment Fund Cash Contributions – Permanent Endowments Contributions – Term Endowments

270,000 150,000 120,000

Plant Replacement and Expansion Fund Pledges Receivable 1,500,000 Allowance for Uncollectibles 150,000 Contributions – Plant Replacement and Expansion 1,350,000 (Note that FASB 116 (ASC 958) provides that pledges receivable within the next year should be measured at net realizable value with the estimated uncollectibles as a reduction of contribution revenue.)

Specific-Purpose Fund Cash Contributions – Research Contributions – Education

80,000 50,000 30,000

Endowment Fund Cash Investment Income – Permanent Endowment

100,000 100,000

Plant Replacement and Expansion Fund Cash Investment Income

45,000

Specific-Purpose Fund Cash Investment Income – Research

31,000

Specific-Purpose Fund Net Assets Released from Program Use Restriction – Research Net Assets Released from Program Use Restriction – Education Cash Due to General Fund

45,000

31,000

55,000 32,000 70,000 17,000

Endowment Fund Investments Cash

270,000

Plant Replacement and Expansion Fund Investments Cash

160,000

Specific-Purpose Fund Investments Cash

75,000

270,000

160,000

75,000 19-19

Chapter 19 – Not-for-Profit Entities

E19-5

Multiple-Choice Questions on Voluntary Health and Welfare Organization Accounting [AICPA Adapted]

c–

b–

d–

30,000/1,500 = $20 per hour. 20 * 600 = 12,000. If these services create or enhance nonfinancial assets or require specialized skills, are provided by individuals possessing those skill, and typically would be purchased then they will be recognized as an expense.

c–

Pledges are accounted for in the period they are pledged when the promise becomes unconditional.

b–

d–

All of these items are added to the fund with donor restrictions

c–

The interest income will first be located in the fund with donor restrictions, and when the funds are released for the purchase of books they will be moved to the general fund.

a–

In 20X6 $200,000 will be transferred to the general fund, $150,000 for purchase of a playground, and $9,000 will be transferred for the purchase of books, both from a fund with donor restrictions.

c–

The $150,000 will be taken from the fund with donor restrictions to purchase the playground. It is a board-designated fund because the board designated the $150,000 for purchase of the playground upon receiving the funds.

The accrual basis is used for all funds. $800,000 x .50 = $400,000 $400,000 x .10 = (40,000) $360,000

$275,000 = $240,000 + $35,000

Chapter 19 – Not-for-Profit Entities

E19-6 Entries for Voluntary Health and Welfare Organizations a.

Journal entries.

Pledges Receivable Allowance for Uncollectible Pledges Contributions – Without Donor Restrictions Contributions – With Temporary Donor Restrictions

700,000

Grants Receivable Contributions – With Temporary Donor Restrictions

150,000

Cash – Without Donor Restrictions Pledges Receivable

520,000

Allowance for Uncollectible Pledges Pledges Receivable Contributions – Without Donor Restrictions $520,000 pledges collected 506,000 recorded as contributions $ 14,000 Adjustment to contributions

44,000

Land, Buildings, and Equipment Cash – Without Donor Restrictions

15,000

Mortgage Payable Cash – Without Donor Restrictions

3,000

Cash – With Donor Restrictions Cash – Without Donor Restrictions Investment Income – Without Donor Restrictions Investment Income – With Donor Restrictions

27,200 5,400

Cash – With Donor Restrictions Endowment Investments Gain on Sale of Investment – With Donor Restrictions

6,000

Community Services Expense Public Health Education Expense Research Expense Fund Raising Expense General and Administrative Expense Accumulated Depreciation

12,000 7,000 10,000 15,000 9,000

56,000 506,000 138,000

150,000

520,000 30,000 14,000

15,000

3,000

27,200 5,400 5,000 1,000

53,000

Chapter 19 – Not-for-Profit Entities

E19-6 (continued) 8.

Community Services Expense Public Health Education Expense Research Expense Fund Raising Expense General and Administrative Expense Cash – Unrestricted

250,600 100,000 81,000 39,000 61,000

Fund Raising Expense Donated Services

2,400

531,600 2,400

b. Midwest Heart Association Statement of Activities For the Year Ended December 31, 20X2

Revenues, gains, and other support: Contributions, net of estimated uncollectible pledges Grants Investment income Gain on investments Donated services Total revenues, gains and other support Program services and support: Program services: Community services Public health education Research Total program services Supporting services: General and administrative Fund raising Total supporting services Total expenses Change in net assets Net assets at beginning of year Net assets at end of year

Without Donor Restrictions

With Donor Restrictions

$520,000

$138,000 150,000 5,400 1,000

$658,000 150,000 32,600 1,000 2,400

$294,400

$844,000

27,200 2,400 $549,600

Total

$262,600 107,000 91,000 $460,600

$ 70,000

70,000

56,400 $126,400 $587,000

-0-

56,400 $126,400 $587,000

$(37,400) 281,000

$294,400 306,000

$257,000 587,000

$243,600

$600,400

$844,000

Chapter 19 – Not-for-Profit Entities

E19-7 Determination of Contribution Revenue a.

Journal entries

Property, Plant and Equipment Contributions – Property, Plant and Equipment

42,000

Pledges Receivable – Without Donor Restrictions 120,000 Pledges Receivable – With Donor Restrictions for Passage of Time 70,000 Pledges Receivable – Restricted for Program Use 90,000 Pledges Receivable – Restricted for Construction 310,318 Contributions – Without Donor Restrictions 120,000 Contributions – With Donor Restrictions for Passage of Time 70,000 Contributions – Restricted for Program Use 90,000 Contributions – Restricted for Construction 310,318 $ 50,000 present value of initial payment 260,318 present value of 7 payments of $50,000 each discounted at 8 percent $310,318 present value of construction pledge Cash – Restricted for Construction Pledges Receivable – Restricted for Construction

50,000

Vision Testing Expense Cash – Without Donor Restrictions

45,000

Cash – Without Donor Restrictions Reclassification from Contrib. w/Donor Restrictions Contributions Without Donor Restrictions

38,000

Reclassification of Contributions with Donor Restrictions Cash – Restricted for Program Use b.

42,000

50,000 45,000

38,000 38,000 38,000

Pledges Receivable – Restricted for Construction Contributions – Restricted for Construction $20,825 = $260,318 x .08

20,825

Cash – Restricted for Construction Pledges Receivable – Restricted for Construction

50,000

20,825

50,000

Chapter 19 – Not-for-Profit Entities

E19-8

Multiple-Choice Questions on Other Nonprofit Organizations [AICPA Adapted]

a–

Donated assets are put on the books at FMV at the time of the donation.

a–

Initiation of fees are recognized at the time of initiation.

b – Note: Gains on endowment investments are considered principal unless otherwise stated.

d – These are treated similar to VHWO’s. The 200,000 is included in the fund with donor restrictions, and revenue would be recognized for both the donation and the interest given to Ross.

c–

d – This is a fund raising expense and is characterized as such.

c–

d – $830,000 = $680,000 + $90,000 + $60,000 Note: Nonexpendable gifts for loan purposes are classified as Without Donor Restrictions. .

a–

Note: All other expenses are for supporting services.

10.

c–

As the problem data states, the 30,000 nonexpendable gift is restricted for 10 years and the 25,000 gift is restricted in perpetuity.

Note: Annual report has program and service intent.

Note: Board designations are internal; therefore, not restricted.

Chapter 19 – Not-for-Profit Entities

E19-9 Statement of Activities for an Other Nonprofit Organization Pleasant School Statement of Activities – Unrestricted Operating Fund Only Year Ended June 30, 20X2 Operating Funds Without Donor Restrictions Support and revenue: Tuition and fees Contributions Auxiliary activities Investments income Other revenue Net assets released from restriction Total support and revenue Expenses: Program services: Instruction Auxiliary activities Supporting services: Administration Fund raising Total program and support services expenses Increase in net assets Fund balance, July 1, 20X1 Fund balance, June 30, 20X2

$1,200,000 165,000 40,000 32,000 38,000 142,000 $1,617,000

$1,050,000 37,000 250,000 28,000 $1,365,000 $ 252,000 420,000 $ 672,000

Chapter 19 – Not-for-Profit Entities

SOLUTIONS TO PROBLEMS P19-10 Financial Statements for a Private, Not-for-Profit College a.

Friendly College Statement of Financial Position June 30, 20X3 and 20X2 Item 20X3 Cash $ 824,900 Accounts receivable (student tuition and fees, less allowance for uncollectibles of $11,000 and $9,000, respectively) 137,000 State appropriations receivable 50,000 Investments 89,000 Total assets $1,100,900 Accounts payable Deferred revenue Net assets: Without Donor Restrictions With Donor Restrictions

Total liabilities and net assets

20X2 $217,000 341,000 75,000 60,000 $693,000

59,000 158,000

$ 45,000 66,000

716,000 167,900

515,000 67,000

$1,100,900

$693,000

b. Friendly College Statement of Activities For Year Ended June 30, 20X3 Without Donor Restrictions Revenues, gains, and other support: Tuition and fees State appropriation Interest income Contributions Gain on sale of investments Investment income Net assets released from temporary restriction* Total revenue, gains, and other support Expenses and other deductions Change in net assets Net assets at beginning of Year Net assets at end of year

$1,900,000 50,000 6,000 25,000

With Donor Restrictions

Total

$ 7,000 100,000 5,000 1,900

$1,900,000 50,000 13,000 125,000 5,000 1,900

13,000

(13,000)

$1,994,000

$ 100,900

$2,094,900

1,793,000 $ 201,000 515,000 $ 716,000

$ 100,900 67,000 $167,900

1,793,000 $ 301,900 582,000 $ 883,900

Chapter 19 – Not-for-Profit Entities

P19-10 (continued) Proof of selected items: (1) Cash $217,000 Plus receipts of: $ 100,000 1,686,000 158,000 349,000 6,000 75,000 25,000 26,000 1,900 7,000 Less payments of: $ 50,000 1,718,000 13,000 45,000 $824,900 (2)

Beginning balance from alumnus from student tuition and fees from fee revenue deferred to next year from outstanding accounts receivable from interest received from prior year’s state appropriation from unrestricted gift from alumni from sale of investments from investment interest income from interest on savings certificates to acquire savings certificates to operating expenses ($1,777,000 - $59,000 unpaid) to items for restricted purposes to prior year’s accounts payable Ending balance

Accounts receivable $350,000 Beginning balance

Plus: $1,834,000 for net increase in tuition ($1,900,000 - $66,000) Less collections of: $1,686,000 349,000 1,000 $148,000 (3)

Investments

Plus: Less decreases of:

$ $

(4)

collection of current year’s tuition and fees collection of prior year’s accounts receivable write-off of remainder of prior year’s receivable Ending balance (less estimated uncollectibles of $11,000)

$60,000 Beginning balance 50,000 acquire certificate of deposit 21,000 sale of restricted investments $89,000 Ending balance

Expenses and other deductions $1,777,000 unrestricted operating expenses recorded + 3,000 year-end accrual for increase in estimated uncollectibles + 13,000 transferred from temporarily restricted and spent in unrestricted $1,793,000

Chapter 19 – Not-for-Profit Entities

P19-11 Balance Sheet for a Hospital Brookdale Hospital Balance Sheet December 31, 20X4 Current Assets: Cash Contributions receivable Investments in marketable securities Interest receivable Accounts receivable Inventory Total current assets Long-term assets: Buildings and equipment Less: Accumulated depreciation Net investment in buildings and equipment Land Investment in marketable securities Total long-term assets Total assets Liabilities: Accounts payable Mortgage payable Total liabilities Net assets: Without Donor Restrictions With Donor Restrictions Total net assets Total liabilities and net assets

$ 100,000 100,000 200,000 15,000 55,000 35,000 $

505,000

$ 750,000 (325,000) $ 425,000 95,000 300,000 820,000 $1,325,000 $ 40,000 320,000 $ 360,000 $ 555,000 410,000 965,000 $1,325,000

Proof of selected amounts: Accumulated depreciation: Buildings: ($600,000 / 30 years) x 11 years expired Equipment: ($150,000 / 10 years) x 7 years expired

= $220,000 = 105,000 $325,000

Land: for amount of historical cost Net assets with donor restrictions: $50,000 of short-term investments plus $30,000 in restricted contributions receivable. Net assets with donor restrictions: $300,000 of long-term investments plus $30,000 in restricted contributions receivable. Net assets without donor restrictions= $555,000 balancing plug after corrections, or $1,140,000 preadjusted balance for reduction of building and equipment to historical (185,000) cost (65,000) for correction of accumulated depreciation (25,000) for reduction of land to fair value at time of donation 40,000 for unrecognized, unrestricted contributions receivable for preadjusted temporarily and permanently restricted (350,000) net assets

Chapter 19 – Not-for-Profit Entities

P19-12 Entries and Statement of Activities for an Other Nonprofit Organization [AICPA Adapted] a. Community Sports Club Transactions For the Year Ended March 31, 20X3 1. 2.

3. 4.

5. 6. 7.

Cash Revenue – Annual Dues

20,000

Cash Revenue – Snack Bar and Soda Fountain

28,000

Cash Investment Income

6,000

Expense – House Expense – Snack Bar and Soda Fountain Expense – General and Administrative Accounts Payable

17,000 26,000 11,000

Accounts Payable Cash

55,000

Assessments Receivable Deferred Capital Support

10,000

Cash Support – Bequest (without donor restrictions)

5,000

20,000

28,000 6,000

54,000 55,000 10,000 5,000

Chapter 19 – Not-for-Profit Entities

P19-12 (continued) Adjustments March 31, 20X3 1. Investments 7,000 Unrealized Gain on Investment Note: ONPOs may value investments at full market values 2&3. Depreciation Expense – House Depreciation Expense – Snack Bar and Fountain Depreciation Expense – General and Administrative Accumulated Depreciation – Building Accumulated Depreciation – Furniture and Equipment 4. Expense – Snack Bar and Soda Fountain Inventories

7,000

9,000 2,000 1,000 4,000 8,000 4,000 4,000

Community Sports Club Statement of Activities For the Year Ended March 31, 20X3 Revenues, gains and other support Snack bar and soda fountain sales Dues Investment income Bequest Total revenue, gains and other support

$ 28,000 20,000 6,000 5,000 $ 59,000

Expenses Snack bar and soda fountain House General and administrative Total expenses

$32,000 26,000 12,000 70,000

Change in net assets before unrealized gain on investments Unrealized gain on investments Change in net assets Net assets on April 1, 20X2 Net assets on March 31, 20X3

$(11,000) 7,000 $ (4,000) 12,000 $ 8,000

Chapter 19 – Not-for-Profit Entities

P19-13 Entries and Statements for General Fund of a Hospital a.

Journal entries: 1. 2. 3.

Accounts Receivable Patient Services Revenue

6,160,000 6,160,000

Contractual Adjustments Accounts Receivable

330,000 330,000

Nursing Services Other Professional Services Fiscal Services General Services Bad Debts Administration Depreciation Expense Cash Allowance for Uncollectibles Accumulated Depreciation Accounts Payable Accrued Expense Inventories Prepaid Expenses Nonoperating Gain – Donated Services

1,800,000 1,200,000 250,000 1,550,000 120,000 280,000 400,000 4,580,000 120,000 400,000 170,000 35,000 195,000 30,000 70,000

Cash Due from Specific-Purpose Fund Net Assets Released from Program Use Restriction

75,000 25,000

Inventories Prepaid Expenses Cash

176,000 24,000

100,000

200,000

Cash 85,000 Investment Income from Endowment Fund Investments 85,000 [Note that the general fund directly recorded this income because it is unrestricted income from the endowment investments.]

Cash Accumulated Depreciation Property, Plant, and Equipment Gain on Sale of Equipment

Cash Allowance for Uncollectibles Accounts Receivable

17,000 20,000 30,000 7,000 5,800,000 132,000 5,932,000

Investments Cash

60,000 60,000

Chapter 19 – Not-for-Profit Entities

P19-13 (continued) 10.

11.

12. 13.

14.

Cash Investment Income from Board – Designated Investments

72,000

Accounts Payable Accrued Expenses Cash

150,000 55,000

Cash Deferred Revenue – Reimbursement

20,000

Cash Net Assets Released from Fixed Asset Acquisition Restriction

140,000

Cash Other Operating Revenue – Cafeteria and Gift Shop Sales

63,000

72,000

205,000 20,000

140,000

63,000

Comparative balance sheets: Serene Hospital Balance Sheet – General Fund For Years Ended December 31, 20X2 and 20X1 20X2

20X1

Assets Cash Accounts receivable Less: Allowance for uncollectibles Due from specific-purpose fund Inventories Prepaid expenses Investments Property, plant, and equipment Less: Accumulated depreciation Total

$ 1,352,000 298,000 (38,000) 65,000 76,000 14,000 960,000 6,070,000 (1,880,000) $ 6,917,000

125,000 400,000 (50,000) 40,000 95,000 20,000 900,000 6,100,000 (1,500,000) $ 6,130,000

Liabilities and Fund Balance Accounts payable Accrued expenses Deferred revenue – reimbursements Bonds payable Net assets without donor restrictions Total

170,000 35,000 95,000 3,000,000 3,617,000 $ 6,917,000

150,000 55,000 75,000 3,000,000 2,850,000 $ 6,130,000

Chapter 19 – Not-for-Profit Entities

P19-13 (continued) c.

Statement of operations for the general fund without donor restrictions: Serene Hospital Statement of Operations for the General Fund Without Donor Restrictions For the Year Ended December 31, 20X2 Unrestricted revenues, gains, and other support: Net patient services revenue Gain on sale of equipment Cafeteria and gift shop sales Investment income Donated services Net assets released from: Program use restriction Total revenues, gains and other support Operating expenses: Nursing services Other professional services Fiscal services General services Bad debts Administration Depreciation Total expenses Excess of revenues over expenses Other item: Net assets released from fixed asset acquisition restriction Increase in net assets without donor restrictions

$ 5,830,000 $

7,000 63,000 157,000 70,000 100,000

397,000 $ 6,227,000

$1,800,000 1,200,000 250,000 1,550,000 120,000 280,000 400,000 (5,600,000) $ 627,000

140,000 767,000

627,000

Statement of changes in net assets (not required) Serene Hospital Statement of Changes in Net Assets For the Year Ended December 31, 20X2 Operating Income Net assets released from fixed asset acquisition restriction Increase in net assets without donor restrictions Net Assets at Beginning of Year Net Assets at End of Year

140,000 767,000 2,850,000 $ 3,617,000 $

Chapter 19 – Not-for-Profit Entities

P19-13 (continued) d.

Statement of cash flows for the general fund (indirect method):

Serene Hospital Statement of Cash Flows for the General Fund For the Year Ended December 31, 20X2 Cash flows from operating activities: Change in net assets Adjustments to reconcile changes in net assets to net cash provided by operating activities: Depreciation Gain on sale of property, plant, and equipment Decrease in net patient accounts receivable Increase in due from specific-purpose fund Decrease in inventories Decrease in prepaid expenses Net change in accounts payable and accrued expenses Increase in deferred revenue – reimbursements Net assets released from fixed asset restriction Net cash provided by operating activities Cash flows from investing activities: Sale of property, plant, and equipment Transfer in from restricted plant fund Purchase of investments Net cash provided by investing activities

767,000

400,000 (7,000) 90,000 (25,000) 19,000 6,000 -020,000 (140,000) $1,130,000 $

17,000 140,000 (60,000) $ 97,000

Cash flows from financing activities

-0-

Net increase in cash Cash at beginning of year Cash at end of year

$1,227,000 125,000 $1,352,000

Chapter 19 – Not-for-Profit Entities

P19-13 (continued) Optional d.

Statement of cash flows for the general fund (direct method):*

Serene Hospital Statement of Cash Flows for the General Fund For the Year Ended December 31, 20X2 Cash flows from operating activities and gains and losses: Cash received from patients and third-party payers Cash paid to employees and suppliers Other receipts from operations Income on endowment investments Income on board-designated investments Net cash provided by operating activities

$ 5,883,000 (4,985,000) 75,000 85,000 72,000 $ 1,130,000

Cash flows from investing activities: Sale of property, plant, and equipment Transfer in from restricted plant fund Purchase of investments Net cash provided by investing activities

17,000 140,000 (60,000) 97,000

Cash flows from financing activities

-0-

Net increase in cash Cash at beginning of year Cash at end of year

$ 1,227,000 125,000 $ 1,352,000

* If the direct method is used, a supplementary schedule is required to reconcile "revenue and gains in excess of expenses and losses to net cash provided by operating activities and gains and losses." This required supplementary schedule is similar to the cash flows from operating activities section under the indirect method of presenting cash flows as presented for part d above.

Chapter 19 – Not-for-Profit Entities

P19-14

Statements for Current Funds of a Voluntary Health and Welfare Organization [AICPA Adapted] Community Association for Handicapped Children Statement of Activities Year Ended June 30, 20X4

Public support and revenue: Public support: Contributions (net of estimated uncollectible pledges of $2,000) Revenue: Membership dues Program service fees Investment income Net assets released from: Time restriction (from Endowment Fund) Use restriction Total support and revenue

Without Donor Restrictions

With Donor Restrictions

$298,000

$ 15,000

25,000 30,000 10,000 20,000 5,000 $388,000

(20,000) (5,000) $(10,000)

Expenses: Program services: Deaf children Blind children Total program services Supporting services: Management and general Fund raising Total supporting services Total expenses

$ 49,000 9,000 $ 58,000 $328,000

___ ____ $__ _-0-

Change in net assets Fund balances, July 1, 20X3 Fund balances, June 30, 20X4

$ 60,000 38,000 $ 98,000

$(10,000) 23,000 $ 13,000

$120,000 150,000 $270,000

Note: The use restriction transfer of $5,000 from the fund with donor restructions to the fund without donor restrictions is for the $4,000 and $1,000 of expenses initially recorded in the fund with donor restrictions. ASC 958 requires that all not-for-profit organizations report all entity expenses in the fund without donor restrictions. Therefore, the fund with donor restrictions will not report any expenses. The management and general, and the fund raising amounts in the fund without donor restrictions include the $4,000 and $1,000 expenses transferred from the fund with donor restrictions.

Chapter 19 – Not-for-Profit Entities

P19-14 (continued) Community Association for Handicapped Children Statement of Financial Position June 30, 20X4 Cash Investments (at cost, which approximates market value) Pledges receivable (less $3,000 allowance for uncollectibles) Interest receivable Assets whose use is restricted Total assets Accounts payable Deferred revenue Total liabilities Net assets: Without Donor Restrictions With Donor Restrictions Total net assets Total liabilities and net assets

$ 40,000 100,000 9,000 1,000 13,000 $163,000 $ 50,000 2,000 $ 52,000

$98,000 13,000 111,000 $163,000

Note: The $13,000 for Assets whose use is restricted is the $14,000 of temporarily restricted assets minus the $1,000 of temporarily restricted liabilities.

Chapter 19 – Not-for-Profit Entities

P19-15 a. 1.

Comparative Journal Entries for a Government Entity and a Voluntary Health and Welfare Organization [AICPA Adapted] Local Government Unit

General Fund Expenditures – Purchase of Equipment Cash

25,000

General Fund (or any other fund) Cash Revenue – Donations

100,000

25,000

100,000

Permanent Trust Fund Cash Investments Fund Balance – Without Donor Restrictions – Gain on Sale of Investments Capital Projects Fund Cash Other Financing Sources – Bond Issue Capital Projects Fund Construction Expenditures Cash

55,000 50,000 5,000 1,000,000 1,000,000 1,000,000 1,000,000

Chapter 19 – Not-for-Profit Entities

P19-15 (continued) b. 1.

Voluntary Health and Welfare Organization Fund Without Donor Restrictions Equipment Cash

25,000 25,000

Cash Net Assets Released from Fixed Asset Acquisition Restriction Fund With Donor Restrictions – Plant and Equipment Net Assets Released from Fixed Asset Acquisition Restriction Cash 2.

25,000 25,000

Fund Without Donor Restrictions Cash Contributions – Without Donor Restrictions

100,000

Fund With Donor Restrictions – Endowments Cash Investments – Common Stocks Gain on Sale of Investments

55,000

Fund Without Donor Restrictions Cash Bonds Payable

100,000

50,000 5,000

1,000,000 1,000,000

Buildings Cash

1,000,000 1,000,000

Chapter 19 – Not-for-Profit Entities

P19-16

Matching Effects of Transactions on a Hospital’s Financial Statements [AICPA Adapted]

The designation of intent is not a transaction. When the actual purchase is made, the transaction will be recorded.

After the investment is actually made, the income from resources under the control of the governing board is recorded as unrestricted revenue.

Resources contributed for capital expansion serve a specific purpose for which the resources should be used. This contribution is accounted for in a temporarily restricted fund, and reported as an increase in temporarily restricted net assets.

The use of temporarily restricted resources in accordance with the donor’s specification results in a reclassification (transfer) of the resources from temporarily restricted to unrestricted. The following entries would be made in the case of the hospital maintaining a separate Plant Fund: Plant Fund: Net Assets Released – Plant Acquisition Cash Fund Without Donor Restrictions: Cash Net Assets Released from Capital Acquisition Restriction Property, Plant, and Equipment Cash

XXXX XXXX XXXX XXXX XXXX XXXX

Donated services to a hospital are accounted for in accordance with ASC 958 under which donated services are recognized if the services (a) create or enhance nonfinancial assets, or (b) require specialized skills, are provided by individuals possessing those skills, and would typically need to be purchased if not provided by donations. In the case of specialized accounting services, the hospital would recognize the estimated value of the donated services as an expense and a corresponding amount is reported as an increase in unrestricted revenues, gains, and other support. Given the choices of A through D, A is the answer.

The contribution of permanently restricted investments would normally be accounted for in an endowment fund which would be an increase in net assets without donor restrictions. The income from the investments would be available for the temporarily restricted fund, but the investments themselves would be restricted in accordance with the donor’s specification. (Note: because the donor puts a restriction on how the income can be used— for outpatient services—the income is temporarily restricted.)

Chapter 19 – Not-for-Profit Entities

P19-17 Balance Sheet for a Hospital Havencrest Hospital Balance Sheet June 30, 20X8 Assets Current: Cash Accounts Receivable (net of the allowance of $5,000) Inventories Prepaid Expenses Total Current Assets Assets Limited as to Use: By Donors for Specific Purpose – Research By Donors for Plant Replacement and Expansion By Donors for Permanent Investment Investments Property, Plant, and Equipment (net of accumulated depreciation of $140,000) Total Assets Liabilities and Net Assets Current: Accounts Payable Accrued Expenses Deferred Revenues Current Portion of Long-term Debt Total Current Liabilities Long-term Debt: Mortgage Payable Total Liabilities Net Assets: Without Donor Restrictions With Donor Restrictions Total Net Assets Total Liabilities and Net Assets

30,000 20,000 50,000 10,000 $ 110,000 $

32,000 200,000 520,000 100,000

160,000 $1,122,000

45,000 17,000 11,000 24,000 97,000

125,000 $ 222,000 $ 148,000 752,000 $ 900,000 $1,122,000

Chapter 19 – Not-for-Profit Entities

P19-18

Matching of Transactions to Effects on Statement of Changes in Net Assets for a Hospital

1. A 2. C 3. B 4. E 5. C 6. C 7. A and D 8. A 9. D (A and B offset) 10. C 11. E 12. A P19-19

Matching of Transactions to Effects on Statement of Activities for a Voluntary Health and Welfare Organization

1. C 2. B 3. B 4. E

A board-designation is not an external, donor-imposed restriction. There is no change in the net assets – without donor restrictions.

5. C 6. C 7. A and C 8. A 9. A 10. C 11. A and D (Note: same as #7 in P19-18) 12. D 19-42 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 19 – Not-for-Profit Entities

P19-20

Net Asset Identification for Transactions Involving a Private University

1. Net assets without donor restrictions increased $2,000,000. 2. Net assets with donor restrictions increased $1,000,000. 3. Net assets without donor restrictions decreased $200,000. 4. Net assets with donor restrictions increased $1,500,000. 5. Net assets with donor restrictions increased $150,000. 6. Net assets with donor restrictions increased $75,000. 7. Net assets with donor restrictions decreased $60,000, the result of a reclassification of $60,000 to unrestricted net assets without donor restrictions. There is no effect on net assets without donor restrictions because the increase of $60,000 due to the reclassification is offset by a $60,000 increase in expenses. Expenses are decreases in net assets without donor restrictions. 8. There is no effect on net assets without donor restrictions as a result of this board designation. Net assets under the control of the governing board are unrestricted. The board of BU took cash that was unrestricted and designated that it be used for a specific purpose. This designation does not change the net asset classification of the cash. 9. Net assets with donor restrictions increased $3,750,000. 10. There is no effect on net assets without donor restrictions as a result of the acquisition of debt securities by the board. The board took cash that was unrestricted and used it to acquire debt securities that are also unrestricted by external parties. 11. Net assets without donor restrictions increased $6,000. The interest revenue of $18,000 from the investments is an increase in net assets without donor restrictions, while the $12,000 used to fund summer research grants represents a $12,000 decrease in net assets without donor restrictions.

Chapter 19 – Not-for-Profit Entities

P19-21

Questions on Voluntary Health and Welfare Organization [AICPA Adapted] Transaction 1.

List A Effect B

List B Effect N

P19-22 Contributions to a Hospital [AICPA Adapted] 1.

The board’s designation is not a required reportable event.

The investments are under the board’s discretion; therefore, the income is recorded as unrestricted revenue.

Funds provided specifically for a building expansion are temporarily restricted until the construction takes place.

At the time the temporarily restricted resources are expended for the purpose specified by the donor, the funds are reclassified as unrestricted.

Professional services contributed to the not-for-profit organization are valued at their fair value and recorded as unrestricted revenues, gains, and other support.

The principal is permanently restricted by the donor. The income from the investments, when the income is earned, would be classified as temporarily restricted, to be used for the specific purpose specified by the donor.

Chapter 19 – Not-for-Profit Entities

P19-23 Evaluating Items for a Hospital’s Statement of Operations 1. A 2. A,A

3. 4. 5. 6. 7.

A A B A C

8. C 9. C

10. 11. 12. 13. 14.

A A,A A C A

15. C 16. C 17. C 18. C 19. B

Estimated uncollectibles from providing services is an operating expense. Both as a contribution revenue and an operating expense. If the supplies had not been used during the period they would be reported as contribution revenue and an increase in inventory. The operating expense would be recognized as they are consumed. Unrestricted investment income is included in unrestricted revenue. Assumes normal case that gain is not restricted. Net assets released for acquisition of equipment are nonoperating items. Net assets released for operations are part of operating items. The statement of operations reports only income/loss on unrestricted net assets. This investment income would be retained by the temporarily restricted fund. Pledges for planned new construction would be accounted for as contributions in the temporarily restricted building fund until released for acquisition of the equipment. They would then be accounted for as a net assets released to the unrestricted fund. Auxiliary services revenues are included in unrestricted revenues. Both as contribution revenue and an operating expense. Depreciation is an operating expense of the hospital. Board designations do not change the nature of the unrestricted resources. Contribution revenue would be recorded at the time of the gift and assets would be increased. Operating expense would be recorded for the periodic depreciation. Charity care not reported on the statement. Charity care is usually footnoted. Net patient care revenue is net of contractual adjustments. Therefore, contractual adjustments not directly shown on the statement of operations. A bond issue is shown as a liability in the hospital’s balance sheet. Only the periodic depreciation on these operating tables will be reported on the statement of operations. Investment income in excess of amounts designated for current operations are shown below the operating performance indicator.

Chapter 19 – Not-for-Profit Entities

P19-24

True-False Questions about Not-for-Profit Accounting and Reporting

1. F

Per ASC 958, a statement of functional expenses is required only for voluntary health and welfare organizations.

2. T

According to ASC 958, pledge revenue is recorded net of estimated uncollectibles.

3. F

Time restricted contributions should be recorded in the temporarily restricted net assets until the time restriction has expired. At that point, the resources may be transferred to the unrestricted net asset class.

4. F

Contractual adjustments should be a direct reduction of patient revenue, not an expense.

5. F

Designated resources are part of the net asset without donor restrictions class. Only external donor-restricted resources are reported in the restricted asset classes.

6. T

The net asset transfer from the net asset with donor restrictions class is appropriate at the point the net asset without donor restrictions class expends the resources in accordance with the donor’s restrictions.

7. F

According to ASC 958, donated supplies should be recognized as contribution revenue in the period received and as an operating expense in the period used.

8. T

ASC 958 specifies that income on permanently restricted endowment assets should be recognized in the appropriate net asset class for which the income is directed. In this example, the income is restricted for a specific use. Therefore, the investment income should be recognized directly in the net asset with donor restrictions class.

9. F

ASC 958 requires that investments held by not-for-profit organizations should be revalued to their fair values at each balance sheet date. The total investment return for the period would be determined and that portion designated for current operations would be reported above the operating performance measure in the statement of operations.

10. T

ASC 958 states that contributions of art or historical works do not need to be recorded as contribution revenue and capitalized as assets of the not-for-profit organization if the works are for public display, the organization agrees to care and preserve the collection, and any proceeds from sales of any collection item will be used only for acquiring other items for the collection.

Chapter 19 – Not-for-Profit Entities

P19-24 (continued) 11.

The building and equipment is recorded and reported in the hospital’s net asset without donor restrictions class (the general fund). The restricted building fund is used to account for resources, some of which might be contributions of equipment, to be used for obtaining buildings and equipment. Some contributions to the building fund might be equipment that is not put into service. At the time the resources are used for acquiring or using plant assets for providing services to patients, the resources are accounted for as net assets released from restriction out of the building fund and also as net assets released from temporary restriction into the unrestricted, general fund. The unrestricted fund reports this transfer received below the operating performance measure on the hospital’s statement of operations.

12.

ASC 958 states that significant donated services that would otherwise need to be obtained should be recognized as contribution revenue and an expense in the period of the donation.

13.

Estimated uncollectibles from patient service receivables should be shown as a bad debt expense and a contra account to the receivables asset.

14.

ASC 958 states that conditional pledges should not be recognized until the conditions have been substantially met. Potentially possible is not equal to substantially met.

15.

The net asset with donor restrictions class should not report any expenses. Only the net asset without donor restrictions class may report expenses. The cost of the program should be reported in the net asset without donor restrictions class and then a net assets released from temporary restriction transfer should be made from the temporarily restricted net asset class to the unrestricted net asset class.

16.

ASC 958 states that time restricted contributions should be reported as contribution revenue in a net asset with donor restrictions class. At the end of the time restriction, the resources will be transferred to the net asset without donor restrictions class.

17.

Fund accounting is not required for hospitals, although many hospitals do use fund accounting for its account discipline (not sure about wording here—account discipline doesn’t make sense to me). Hospitals and other not-for-profit organizations are required by ASC 958 to report net assets by without donor restrictions and with donor restrictions classes. Net assets are restricted only by external donors or laws that govern the organization.

Chapter 19 – Not-for-Profit Entities

P19-24 (continued) 18.

The performance measure may have any descriptive title such as “Excess of revenues over expenses” but must separate the operating income (loss) from the nonoperating items.

19.

The building fund should record this transfer as a net assets released from the temporarily restricted fund. The unrestricted, general fund should record this transfer as net assets released from the temporarily restricted fund to the general fund. Note that it is not a revenue of the general fund because the revenue was already recognized in the temporarily restricted fund at the time of the donation. Contribution revenue should be recognized only once by the not-for-profit hospital.

20.

ASC 958 specified that the cost of a fund raising effort of a VHWO is an important piece of information for users of the financial statements of the VHWO. Thus, fund raising costs must be separately reported as an expense of the entity and cannot be reported as a direct reduction of the contribution revenue obtained in the fund raising effort.

Chapter 19 – Not-for-Profit Entities

P19-25 Statement of Activities for a Voluntary Health and Welfare Organization Without Donor Restrictions Revenues, gains, and other support: Contributions Investment income Donated services Net assets released from restriction: Program use restrictions Equipment acquisitions Total revenues, gains, and Other support Program and supporting services expenses: Research Public health education Community services Management and general Fund raising Total expenses Change in net assets Net assets, beginning of the year Net assets, end of the year

500,000

With Donor Restrictions

Total

$ 950,000 800,000

$ 1,450,000 800,000 15,000

15,000

150,000 100,000

(150,000) (100,000)

765,000

$ 1,500,000

250,000 100,000 150,000 140,000 115,000

$ 2,265,000

250,000 100,000 150,000 140,000 115,000

$ 755,000 $ 10,000

$ -0$1,500,000

$ 755,000 $ 1,510,000

3,000,000 $3,010,000

11,000,000 $12,500,000

14,000,000 $15,510,000

Notes: 1. The donated services of $15,000 are reported as an increase in unrestricted net assets and included as part of the $140,000 of expenses for management and general. 2. The uncollectible pledges of $50,000 are reported as a deduction from temporarily restricted contributions received in 20X3. 3. The $950,000 of pledges received in 20X3 is reported as temporarily restricted because of a time restriction—the pledges will not be received until 20X4. 4. The governing board’s designation of $225,000 for computer acquisitions is not reported on the Statement of Activities. The resources that were designated were reported as unrestricted, and the governing board’s designation of the resources does not change their classification. 5. ASC 958 permits temporarily restricted net assets that are spent in the same year in which the assets are received to be reported as without donor restrictions. In the problem, this means that the $150,000 of investment income that was earned in 20X3 and used for research in 20X3 could have been reported directly in net assets without donor restrictions, avoiding the need to report $150,000 of net assets released from restriction.

Chapter 19 – Not-for-Profit Entities

P19-26

Reporting Transactions on the Statement of Cash Flows for Private, Not-forProfit Entities

1. Report the $100,000 increase in accounts receivable as a deduction from the change in net assets in the operating activities section. 2. Report a deduction for the $200,000 contribution from the change in net assets in the operating activities section and disclose an increase of $200,000 in the financing activities section. 3. Report a deduction for the $25,000 contribution from the change in net assets in the operating activities section and disclose an increase of $25,000 in the investing activities section. 4. Report an addition to the change in net assets in the operating activities section for the increase of $20,000 in accounts payable. 5. Report the $70,000 borrowed as an increase in the financing activities section. 6. Report a deduction of $50,000 to acquire investments in the investing activities section. 7. Report a deduction for the investment income of $45,000 from the change in net assets in the operating activities section and report an increase of $45,000 in the financing activities section. 8. Report the $850,000 as a decrease in the investing activities section. 9. Report the loans made to students and faculty of $100,000 as a decrease in the investing activities section. 10. Report the $30,000 loan repayment as a deduction in the financing activities section. 11. Report the increase in accrued interest receivable as a deduction from the change in net assets in the operating activities section. 12. Report the increase of $12,000 in deferred revenue as an increase to the change in net assets in the operating activities section. 13. Report the $100,000 received as an increase in the investing activities section. 14. Report the increase of $2,500 in prepaid assets as a deduction to the change in net assets in the operating activities section. 15. Report the $35,000 unrealized gain on investment as a deduction from the change in net assets in the operating activities section.

Chapter 20 – Corporations in Financial Difficulty

CHAPTER 20 CORPORATIONS IN FINANCIAL DIFFICULTY ANSWERS TO QUESTIONS Q20-1 The nonjudicial actions available to a financially distressed company are debt restructuring arrangements, creditor's committee management, and transferring assets. The judicial actions available are corporate liquidation (Chapter 7) and corporate reorganization (Chapter 11). Q20-2 The major difference between a Chapter 7 action and a Chapter 11 action is that the debtor continues as a business after a Chapter 11 reorganization whereas the business does not survive a Chapter 7 liquidation. Q20-3 Under two circumstances an involuntary petition for relief may be filed. The first circumstance is that the debtor is generally not paying debts as they become due. The second circumstance is that within the last 120 days a custodian has been appointed by other creditors, by the debtor, or by some other agency to take possession of the debtor's assets. If more than 12 creditors exist, then three or more creditors must combine to file the petition. These three or more creditors must have aggregate unsecured claims of at least $5,000. Q20-4 The following items are usually included in the Plan of Reorganization filed as part of a Chapter 11 reorganization: All major actions to be taken during the reorganization: (1) Discontinuances of unprofitable operations (2) Restructuring of debt with specific creditors (3) Revaluation of assets and liabilities (4) Changes in the par value of outstanding stock, or realignment of stockholders' equity with newly issued shares of voting common stock. Q20-5 The account Reorganization Value in Excess of the Amount Assigned to Identifiable Assets is established during a Chapter 11 fresh start accounting to record the excess of the reorganization value that is not assigned to specific assets. The account is an intangible asset and is accounted for in accordance with ASC 350. Q20-6 A company in Chapter 11 reorganization qualifies for fresh start accounting if both of the following occur: 1. The reorganization value of the entity's assets of the emerging entity immediately before the date of confirmation is less than the total of all post-petition liabilities and allowed claims; and 2. Holders of existing voting shares immediately before confirmation receive less than 50% of the voting shares of the emerging entity. Companies using fresh start accounting revalue their assets to fair values, using the procedures in ASC 805. An account called Reorganization Value in Excess of the Amount Assigned to Identifiable Assets is used to record any excess in reorganization value not assigned to specific assets.

Chapter 20 – Corporations in Financial Difficulty

Q20-7 The financial statements that must be filed by a company during a Chapter 11 reorganization include a complete set of audited financial statements. ASC 852 established specific guidelines for these statements, noting that amounts associated with reorganization should be reported separately. Q20-8 The rights of creditors with priority in a Chapter 7 liquidation are to receive any assets available to unsecured creditors after the secured creditors have been satisfied. Q20-9 The statement of affairs is the basic accounting report made at the beginning of the liquidation process to present the expected realizable amounts from disposal of the assets, the order of creditors' claims, and the expected amount unsecured creditors will receive as a result of the liquidation. In addition, the statement of affairs presents the book values of the debtor company's balance sheet accounts, the estimated fair market value of the assets, the order of claims, and the estimated deficiency to the general unsecured creditors. As a final point, the statement of affairs is not a going concern report. Q20-10 A trustee who takes title to the debtor's assets in a liquidation must make a periodic financial report to the bankruptcy court reporting on the progress of the liquidation and on the fiduciary relationship held. When the trustee accepts the assets, a new set of books is opened for the debtor and a new account is created to recognize the debtor's interest in the net assets accepted by the trustee. A statement of realization and liquidation is prepared on a monthly basis for the bankruptcy court showing the results of the trustee's fiduciary actions’ beginning at the point the trustee accepts the debtor's assets. Q20-11 Sales of assets are reported in the statement of realization and liquidation as assets realized in the assets section of the statement.

Chapter 20 – Corporations in Financial Difficulty

SOLUTIONS TO CASES C20-1 Creditors' Alternatives The options to the creditors are (1) form a creditors' committee, (2) a Chapter 11 reorganization, and (3) a Chapter 7 liquidation. The eventual decision must rest upon the creditors' assessment of the viability of the rehabilitation of the debtor versus the liquidation values of the debtor's assets. Most creditors do not want to see the liquidation of a debtor because, as creditors, they are in the business of loaning monies, not trying to manage a business or attempting to obtain as much of a liquidation dividend as possible in a liquidation. Most creditors will work with the debtor's management as long as possible. Secured creditors have greater protection of their receivables than do unsecured creditors. However, even most secured creditors prefer to see a debtor company be rehabilitated after a time of financial difficulty rather than see the debtor liquidated. The timing of the cash flows is somewhat dependent on the amount of reduction in debt the creditors are willing to absorb. If the creditors are willing to work with the debtor, the creditors may eventually realize a greater percentage of their debt, but it usually takes a longer time to receive the payments from the debtor. The creditors' committee is a nonjudicial action that provides for flexibility to both the creditors and the debtor. The creditors' committee typically works with the debtor company to enact a plan of settlement of the debtor's indebtedness. In some cases, the creditors may assume management control of the company, but most creditors are reluctant to do this because of the added risk of legal action if the company does enter bankruptcy. Creditors may eventually receive a substantial part, or possibly all, of their receivables as the debtor is able to "work down" its debt over time. Chapter 11 reorganization offers the creditors a chance to continue having a customer once the customer solves its immediate financial problems. A reorganization is an acceptable option if the creditors feel the company would have the basic operating and financial foundations after the reorganization to become a going concern. Creditors often accept reduced amounts as settlements of their receivables, or will modify the terms of existing debt as part of the reorganization agreement. Chapter 7 liquidations are the final step. The creditors must go through the judicial process that may take a long time to complete. Liquidation should be used only if no other alternative is viable. Creditors often receive a smaller portion of their receivables because of the forced liquidation of the assets and the extensive legal and administrative costs involved in a liquidation.

Chapter 20 – Corporations in Financial Difficulty

C20-2 Research Related to Bankruptcy The website for the U.S. Bankruptcy Courts is: http://www.uscourts.gov/FederalCourts/Bankruptcy.aspx a. The Frequently Asked Questions (FAQs) for the U.S. Courts (http://www.uscourts.gov/Common/FAQS.aspx) state that a U.S. bankruptcy judge is a district court judicial officer who is appointed by the majority of judges of the U.S. appeals court to have jurisdiction over bankruptcy matters. As bankruptcy cases come before a district court, a bankruptcy judge is assigned to the case. Some courts assign judges based on random assignment while other courts have a chief judge who seeks to select a judge to assign based on a judge’s experience or special expertise relevant to the case. Each court will have a written plan or system for assigning cases. b. The U.S. Bankruptcy Court’s website has a link to Official Bankruptcy Forms to be used in filings before the courts. The forms and instructions for a Voluntary Petition are available in Part I of the Bankruptcy Forms Manual page. The official form is FORM B1 for a voluntary petition. A voluntary petition is initiated by the debtor and therefore the information required is principally related to the debtor, such as name, address, and location of the principal assets of the debtor. The debtor must declare such items as the number of creditors, the estimated assets, the estimated debts, the type of petition (i.e., Chapter 7, Chapter 11, etc.), if sufficient funds will be available to satisfy the unsecured creditors. The debtor may also be required to file additional exhibits (Exhibit A for publicly traded companies, Exhibit B is used in personal filings and Exhibit C to describe any property that might pose a threat of identifiable harm to public health or safety). c The United States Bankruptcy Courts Website presents a link to Bankruptcy Statistics (http://www.uscourts.gov/Statistics/BankruptcyStatistics.aspx) that are presented in .pdf format. Statistics are presented for various time periods such as quarters, fiscal years and calendar years. Note that Case 20-3 asks for the most recent calendar year ending on December 31. (1) Total business filings are presented at the top of the form for business and nonbusiness filings for the twelve month period ended for the most recent year. Statistics for prior years are also available. Business filings are typically about 34,000 but do fluctuate slightly based on economic conditions. Approximately sixty percent of these filings are under Chapter 7, about twenty-eight percent under Chapter 11, and the remainder under various other chapters of the Bankruptcy Code. (2) Students should find the Federal judicial district in which their educational institution is located. The larger states typically have several districts and students may have to make an assumption for which district they are located. It is instructive to see that the numbers of filings vary widely by district. The number of filings may differ due to different economic factors for specific parts of the United States, the nature of the industrial base in a specific district, the size of a district, and other factors reflecting business factors across court districts. Students might reflect on why the number of filings in their Federal court district are different from those in other districts in other circuits.

Chapter 20 – Corporations in Financial Difficulty

C20-3 Selection of Bankruptcy Trustee and Trustee’s Responsibilities Title 11 of the United States Code may be obtained from several sources through using a web search with the term, “Title 11 of the U.S. Code.” The case asks about trustees for a Chapter 7 bankruptcy filing. a. Subchapter 1 of Chapter 7 of Title 11 of the U.S. Code specifies the administration of a Chapter 7 bankruptcy filing. Section 701 states that the United States Trustee shall appoint an interim trustee who is a member of the panel of private trustees established under federal law. Private trustees are persons who have prior financial expertise and experience and have been approved by a formal review process. After the appointment of an interim trustee, Section 702 describes how creditors may elect a trustee under the circumstances in which creditors holding at least twenty percent of the unsecured claims request that an elected trustee administer the Chapter 7 bankruptcy. A candidate must receive the votes of creditors holding a majority of the claims of the unsecured creditors. b. Section 704 of Subchapter 1 of Chapter 7 of Title 11 of the U.S. Code defines the duties of the trustee. The trustee is responsible for administering the business, is accountable for all property received, and must evaluate the claims of the creditors to make sure the claims are valid prior to settlement. The trustee also prepares periodic reports and summaries of the operations of the business which it provides to the United States Trustee or Bankruptcy Court. Upon completion of the operations, the trustee must file a final report on the administration of the estate with the court and with the United States Trustee.

Chapter 20 – Corporations in Financial Difficulty

C20-4 The Bankruptcy of WorldCom Overall, the 2002 bankruptcy of WorldCom resulted in a cumulative net reduction to their shareholders’ equity of $70.8 billion as of December 31, 2001, and a reduction in previously reported net income of $17.1 billion and $53.1 billion for the years ended December 31, 2001, and 2000 respectively. Goodwill of $44.9 billion was reduced to zero at December 31, 2001. The WorldCom bankruptcy and resultant adjustments made during the reorganization process are certainly one of the most significant bankruptcies in U.S. business history. The following information is taken from WorldCom Inc.’s 10-K for the fiscal year 2002 that was filed with the SEC on March 12, 2004. a. (Source: Item 3, Legal Proceedings) WorldCom filed a voluntary petition for bankruptcy on July 21, 2002, under Chapter 11, Reorganization. b. (Source: Item 3, Legal Proceedings and the MD&A) The primary reason seems to be that management and the Board of Directors had been informed of very significant accounting irregularities and needed time to investigate the possible irregularities, and to protect the company from lawsuits from creditors and others. For example, on June 26, 2002, the SEC filed a civil suit against the company for its past financial reports. On April 29, 2002, Bernard Ebbers resigned as President and Chief Executive Officer. The company undoubtedly felt it needed the protection of bankruptcy to give it time to study the breadth of its financial and accounting problems and to reorganize to recover from those problems without additional legal pressure from its creditors. c. (Source: Item 3, Legal Proceedings) On June 25, 2002, the company publicly announced that an internal audit found a number of transfers from line cost expenses (referred to as access cost expenses) to capital accounts, thus decreasing expenses and increasing assets. For the year 2001 and the first quarter of 2002, this amount of transfer was $3.9 billion. In addition to this item, the company was improperly accounting for impairment tests on its long-lived assets, its acquisitions, its revenue contracts and several other irregularities. However, it was the accounting for the access costs as assets when they were clearly expenses that were the primary accounting irregularity that initiated the internal review. d. (Source: Item 7, Management’s Discussion and Analysis) Item 7 of the company’s 2002 10-K presents a section titled “Restatements and Reclassifications of Previously Issued Consolidated Financial Statements”. A table is presented that summarizes the restatement items on revenue and pre-tax income or loss for the years ended December 31, 2001 and 2000. The major categories of income statement restatement adjustments are presented below (in $millions), with a brief explanation of each category following the table: (Parentheses used for decreases in reported amounts)

Chapter 20 – Corporations in Financial Difficulty

C20-4 (continued)

Item: Previously reported Restatement adjustments: 1. Impairment 2. Improper reduction of access costs 3. Purchase accounting 4. Long lived asset adjustments 5. International adjustments 6. Revenue related adjustments 7. Adjustments to accrued liabilities 8. Embratel and Avantel acquisitions 9. Unclassified income/ (expense) 10. Other Total adjustment items Discontinued Operations Adjustment Revenue, as restated Minority interest adjustment Pre-tax loss, as restated

Year Ended December 31, 2001 Pre-tax Revenue income (loss) 35,121 2,375

Year Ended December 31, 2000 Pre-tax Revenue income (loss) 39,020 7,581

-----

(12,592) (2,933)

--6

(47,180) (1,827)

14 ---

(2,273) 2,750

(193) ---

(3,567) (1,713)

(749) (1,204)

(899) (575)

18 (36)

(487) (995)

---

(823)

---

(732)

5,268

(35)

1,127

(325)

---

383

---

(426)

(7) 3,322 (775)

(506) (17,503) 1,323

4 926 (602)

(750) (58,002) 449

37,668

39,344 (669) (14,474)

52 (49,920)

Because most of the accounting personnel, including the Chief Financial Officer and the controller, were terminated shortly after the large scope of the accounting irregularities were discovered, the company determined that it could not objectively restate periods prior to the 2000 fiscal year. However, a minor adjustment decrease of $.7 billion was made to the ending shareholders’ equity as of December 31, 1999. A brief explanation of each of the 10 adjustment categories above is summarized from the disclosures in Item 6 of WorldCom’s 2002 10-K. 1. Impairment: The company discovered that impairment tests had not been performed for goodwill and long-lived assets even though certain economic triggers had occurred. The application of these impairment tests resulted in very significant write-downs for both 2000 and 2001. 2. Improper reduction of access costs: The primary adjustments for this item were due to the improper capitalization of access costs that should have been expensed as incurred in accordance with GAAP. 3. Purchase accounting: The company made numerous acquisitions, including the MCI acquisition, between 1993 and 2001 and a review of these acquisitions concluded that a number of errors were found in the application of purchase accounting valuations and procedures that overstated the amounts capitalized for the acquisitions.

Chapter 20 – Corporations in Financial Difficulty

C20-4 (continued) 4. Long lived asset accounting: This item includes adjustments to depreciation and amortization, changes in the estimated useful lives of long-lived assets, including those acquired in the MCI combination, and other costs that had been inappropriately capitalized as long-lived assets that should have been expensed. 5. International: Adjustments were made for correcting the U.S. GAAP-based statements from the foreign accounting principles. In addition, a review of the functional currency rules resulted in changing the functional currencies for many of the international subsidiaries from the local currency to the U.S. dollar. 6. Revenue related adjustments: A number of adjustments were made because of lack of documentation to support the company’s deferral of income under SAB 101. In addition, the company had incorrectly accounted for some contracts as sales when in fact the company had acted as an agent and should have recorded just the net of the amounts as income rather than record gross sales and gross costs. 7. Adjustments to accrued liabilities: Adjustments were made to eliminate improper accruals of liabilities for items such as legal reserves, employee benefits and tax liabilities. 8. Embratel and Avantel acquisitions: A review of the Embratel acquisition showed an incorrect interpretation with regard to not having control over Embratel and that Embratel should have been consolidated rather than reported net as an investment. A review of the Avantel relationship to WorldCom resulted in changing the accounting from an equity investment to a full consolidation. 9. Unclassified income/ (expense): A review of several accrued liability accounts showed that there was inadequate documentation to support the accruals. Also, there were other accrued assets and some liabilities recorded on the historical balance sheet for which there was either no, or inadequate, documentation to support that the company owned the assets or owed the liabilities. 10. Other: The company made a number of reclassifications, revaluations of derivatives, intercompany balances, and certain capitalized costs such as interest, labor and overhead for capital projects. These adjustments were also carried through the restated balance sheet and statement of cash flows for 2001 and 2000. e. (Source: Item 7 of WorldCom’s 2002 10-K) From the date the bankruptcy petition was filed, July 21, 2002, through the entire reorganization period, the company used the provisions of ASC 852 for accounting and financial reporting purposes. The “DebtorsIn-Possession” heading informs readers of the financial statements that the company is in bankruptcy reorganization but management still controls the company under the administration of a bankruptcy trustee. The balance sheet reports pre-petition liabilities separately from others and liabilities not subject to compromise are reported separately in both the current and noncurrent sections of the balance sheet. The income statement separately reports the reorganization gain or loss realized during the reorganization period. f.

(Source: Item 7 of WorldCom’s 2002 10-K) Towards the beginning of Item 7, the 10K reports that the company will adopt fresh-start accounting under the provisions of ASC 852 as of the fresh-start reporting date. The company will revalue its assets and liabilities, allocate the reorganization value to the assets and liabilities, eliminate the accumulated deficit in shareholders’ equity, and the company’s new debt and equity will be recorded.

Chapter 20 – Corporations in Financial Difficulty

SOLUTIONS TO EXERCISES E20-1 1.

c–

Multiple-Choice Questions on Chapter 11 Reorganizations [AICPA Adapted] Correct (a) incorrect. A trustee or receiver is not given stewardship over the company in nonjudical actions. (b) incorrect. If there are dissenting creditors, the other creditors can choose to allow those in dissent to still be paid in full. (d) incorrect. The payment is typically immediate as a result of the creditor not collecting on the entire debt.

d–

A trustee cannot be designated during a nonjudical action. A court must designate a trustee. (a) incorrect. The debtor is the party that submits the petition for temporary protection from its creditors. (b) incorrect. Her personal bankruptcy status will not be resolved by the companies’ bankruptcy proceedings. (c) incorrect. A plan of reorganization is filed by the debtor.

c–

A reasonable investor or creditor must be able to make an informed judgment about the worthiness of the plan. (a) incorrect. This takes place in a Chapter 7 Liquidation (b) incorrect. By instituting a composition agreement a creditor can accept an impaired amount of money to satisfy the debt. (d) incorrect. Not all claims are treated alike in a Chapter 11 reorganization.

d–

The debtor must have 12 creditors, and the required number of creditors signing the petition must be owed at least $5,000 in total.

c–

The plan must be approved by at least half of all creditors who hold at least twothirds of the total debt.

Chapter 20 – Corporations in Financial Difficulty

E20-2 Recovery Analysis for a Chapter 11 Reorganization a.

Recovery analysis for plan of reorganization: Taylor Companies, Inc. Plan of Reorganization Recovery Analysis December 31, 20X1 Recovery Elimination of Debt and Equity

Post-petition liabilities

(30,000)

Claims/Interest: Accounts Payable

(80,000)

8,000

Notes Payable, 10% Related Interest Payable

(150,000) (16,000)

25,000 16,000

Bonds Payable, 12% Related Interest Payable

(200,000) (24,000)

18,000

(470,000)

67,000

(100,000) (200,000)

(100,000) 171,000

178,000 (622,000)

(178,000) (40,000)

Total Common shareholders: Common Stock Additional Paid-In Retained Earnings Deficit Total

Surviving Debt

Reduction of Taylor's Assets

Common %

$2 par Stock Value

(30,000)

Recovery %

(30,000)

100%

(72,000)

(125,000)

(125,000) -0-

83 0

(200,000) (6,000)

100 25

(200,000) (6,000)

(230,000)

Total $

(203,000)

100%

(200,000) (29,000)

100%

(229,000)

(662,000)

Note: Parentheses indicate credit amount.

Chapter 20 – Corporations in Financial Difficulty

E20-2 (continued) b.

Journal entries to record reorganization: (1)

(2)

Accounts Payable Notes Payable, 10% Interest Payable Cash Accounts Receivable (net) Land Gain on Disposal of Land Gain on Discharge of Debt Record discharge of debt.

80,000 150,000 40,000

Common Stock ($1 par) 100,000 Additional Paid-In Capital 171,000 Gain on Disposal of Land 40,000 Gain on Discharge of Debt 67,000 Common Stock ($2 par) Retained Earnings Record change in par value of stock and elimination of deficit.

6,000 72,000 85,000 40,000 67,000

200,000 178,000

E20-3 Multiple-Choice Questions on Chapter 7 Liquidations 1.

b – The amount of wages cannot exceed $10,000.

a–

These costs have the highest priority of all unsecured claims. (b) incorrect. These are the sixth priority. (c) incorrect. These are the third priority. (d) incorrect. These are treated as regular employees, third priority.

d – costs of filing the involuntary petition and appointment of trustees has the highest priority of all unsecured claims. (a) incorrect. Administrative expenses have first claim. (b) incorrect. Employee wages have a higher priority than governmental units. (c) incorrect. Administrative expenses have first claim.

a–

3 or more creditors are required to file the petition. (b) incorrect. There are 2 requirements, (1) the debtor is generally not paying debts as they become due or within the last 120 days has had a custodian appointed by other creditors, by the debtor, or by some other agency to take possession of the debtor’s assets. (2) if more than 12 creditors exist, 3 or more must combine to file the petition, and these must have aggregate unsecured claims of at least $5,000. (c) incorrect. See answer to B. (d) incorrect. See answer to B.

Chapter 20 – Corporations in Financial Difficulty

c–

A transaction of the type is voidable. The money will be returned to the debtor and paid according to priority. (a) incorrect. The debtor must meet all the demands of his creditors according to priority until funds run out. (b) incorrect. Insolvency is a required disclosure regardless of the expected time period. (d) incorrect. Debtors are allowed to file a voluntary petition for bankruptcy, it is called a voluntary petition.

E20-4 Chapter 7 Liquidation a.

Schedule to calculate amount available for general unsecured creditors: Total estimated fair values Claims of secured creditors: Notes payable and interest (Receivables and Inventory) Bonds payable and interest (Land and Building)

$471,000 $115,000 231,000

Claims of creditors with priority: Wages payable Taxes payable Available to general unsecured creditors

Accounts payable Notes payable and interest Less: Secured by receivables and inventory Total unsecured claims

Estimated dividend:

9,500 14,000

(346,000) $125,000 (23,500) $101,500

$ 95,000 $195,000 (115,000)

80,000 $175,000

$101,500 = 58% $175,000

Group

Credit

Percentage

Distributed

Accounts Payable Wages Payable Taxes Payable Notes Payable and Interest Bonds Payable and Interest

$ 95,000 9,500 14,000 80,000 115,000

58% 100 100 58 100

$ 55,100 9,500 14,000 46,400 115,000

231,000

100

231,000 $471,000

Chapter 20 – Corporations in Financial Difficulty

E20-5 Statement of Realization and Liquidation Pace Corporation Statement of Realization and Liquidation Assets Assets to be Realized Old Receivables, net Marketable Securities Old Inventory Depreciable Assets, net

Assets Realized $ 38,000 12,000 60,000 96,000

Assets Acquired

Old Receivables New Receivables Marketable Securities Sales of Inventory

$ 21,000 47,000 10,500 75,000

Assets Not Realized

New Receivables

75,000

Old Receivables, net New Receivables, net Depreciable Assets

17,000 28,000 80,000

Supplementary Items Supplementary Charges Trustee's Fee

Supplementary Credits $

4,300

Net Loss

6,800

Liabilities

Liabilities Liquidated Old Current Payables

Liabilities to be Liquidated $ 22,000

Liabilities Not Liquidated Old Current Payables

Old Current Payables

$ 48,000

Liabilities Incurred 26,000 $333,300

$333,300

Chapter 20 – Corporations in Financial Difficulty

SOLUTIONS TO PROBLEMS P20-6 Chapter 11 Reorganization a.

Recovery analysis for plan of reorganization: Polydorous Corporation Plan of Reorganization Recovery Analysis Recovery PreElimination Confirmation of Debt and Equity

Surviving Debt

Cash

Post-petition liabilities

(10,000)

Claims/Interest: Accounts Payable

(160,000)

20,000

(40,000)

Interest Payable

(20,000)

10,000

(10,000)

Notes Payable, 10%

(340,000)

60,000

(10,000)

(520,000)

90,000

Preferred Shareholders

(100,000)

Common Shareholders Retained Earnings Deficit

Total

12% Secured Notes

Common %

Stock Value

(10,000) (100,000)

Recovery %

(10,000)

100%

(140,000)

(10,000)

50 82

(30,000)

(280,000)

50,000

(50,000)

(150,000)

130,000

(20,000)

80,000

(80,000)

(700,000)

190,000

100%

(100,000)

510,000

(10,000)

(60,000)

(240,000)

Total $

(340,000)

Pre-confirmation total equities of $700,000 includes $690,000 pre-petition and $10,000 post-petition increase. Note: Parentheses indicate credit amount.

Chapter 20 – Corporations in Financial Difficulty

P20-6 (continued) b.

Analysis for evaluating qualifications for fresh start accounting: First condition: Post-petition liabilities Liabilities deferred pursuant to Chapter 11 proceedings Total post-petition liabilities and allowed claims Reorganization value Excess of liabilities over reorganization value

$ 10,000 520,000 $530,000 (510,000) $ 20,000

Second condition: Holders of existing voting shares immediately before confirmation receive 20% of voting shares of emerging entity. Therefore, both conditions for a fresh start occur, and fresh start accounting is used to account for the company. c.

Entries for execution of plan of reorganization: (1)

(2)

(3)

Liabilities Subject to Compromise Cash Notes Payable, 12%, secured Common Stock (new) Gain on Debt Discharge Record debt discharge.

520,000

Preferred Stock Common Stock (old) Common Stock (new) Additional Paid-In Capital Record exchange of stock for stock.

100,000 150,000

Reorganization Value in Excess of Amounts Allocable to Identifiable Assets Gain on Debt Discharge Additional Paid-In Capital Accounts Receivable (net) Inventory Property, Plant, and Equipment Retained Earnings - Deficit Record fresh start accounting and eliminate deficit.

60,000 340,000 30,000 90,000

70,000 180,000

30,000 90,000 180,000 30,000 7,000 183,000 80,000

Chapter 20 – Corporations in Financial Difficulty

P20-6 (continued) Schedule to support allocation of reorganization value:

Cash Accounts Receivable (net) Inventory Property, Plant, and Equipment (net) Reorganization Value in Excess of Amounts Allocable to Identifiable Assets Total Note:

Book Value

Fair Value

$ 30,000 140,000 25,000

$ 30,000 110,000 18,000

445,000

262,000

(183,000)

-0$640,000

30,000 $450,000

30,000 $(190,000)

Difference $

-0(30,000) (7,000)

The post-reorganization total fair value is the reorganization value of $510,000 less the $60,000 paid to fulfill the plan of reorganization.

Chapter 20 – Corporations in Financial Difficulty

P20-6 (continued) d. Fresh start balance sheet worksheet for company emerging from reorganization: (Worksheet not required)

Pre-confirmation Assets: Cash Accounts Receivable (net) Inventory Property, Plant, and Equipment (net) Reorganization Value In Excess of Amounts Allocable to Identifiable Assets Total Assets Liabilities: Liabilities Not Subject to Compromise: Current Liabilities Liabilities Subject to Compromise Notes Payable, 12%, secured Total Liabilities Shareholders' Equity: Preferred Stock Common Stock (old) Common Stock (new) Additional Paid-In Capital Retained Earnings Total Shareholders' Equity Total Liabilities and Shareholders’ Equity

90,000 140,000 25,000 255,000

Adjustments to Record Confirmation of Plan Debt Exchange Fresh Discharge of Stock Start (60,000) (60,000)

-0-

445,000

700,000

(60,000)

-0-

(30,000) (7,000) (37,000)

30,000 110,000 18,000 158,000

(183,000)

262,000

30,000 (190,000)

30,000 450,000

(10,000) (520,000) (530,000)

Company's Reorganized Balance Sheet

(10,000) 520,000 (340,000) 180,000

(100,000) (150,000) (30,000)

-0100,000 150,000 (70,000) (180,000)

-0-

(340,000) (350,000)

(100,000)

80,000

(90,000)

(170,000)

(120,000)

-0-

180,000 90,000 (80,000) 190,000

(700,000)

60,000

-0-

190,000

-0(100,000) (450,000)

Note: Parentheses indicate credit amount.

Chapter 20 – Corporations in Financial Difficulty

P20-6 (continued) d. Balance sheet for company emerging from Chapter 11 reorganization with fresh start accounting:

Polydorous Company Balance Sheet Emerging Date Assets: Cash Accounts Receivable (net) Inventory Total Current Assets

$ 30,000 110,000 18,000 $158,000

Property, Plant, and Equipment (net) Reorganization Value In Excess of Amounts Allocable to Identifiable Assets Total Assets

262,000 30,000 $450,000

Liabilities: Accounts Payable Notes Payable, 12%, secured Total Liabilities

$ 10,000 340,000 $350,000

Shareholders' Equity: Common Stock Total Shareholders' Equity Total Liabilities and Shareholders' Equity

100,000 $100,000 $450,000

Chapter 20 – Corporations in Financial Difficulty

P20-7 Chapter 7 Liquidation, Statement of Affairs a.

Name Brand Company Statement of Affairs July 31, 20X1 Assets

Estimated Current Values

Book Value (1) $ 50,000

80,000 162,000

Assets pledged with fully secured creditors: Accounts receivable (net) Less: 12% note payable and interest Land Plant and equipment (net) Less: Mortgages payable and interest

(2) 30,000

79,000 (3) 5,000 55,000 81,000 7,000 250,000 72,000

(44,000)

$ 6,000

$110,000 150,000 $260,000 (234,600)

$ 22,000

Inventory Less: Accounts payable

$ 75,000 (105,000)

Estimated amount available Less: Creditors with priority Net available to unsecured creditors Estimated deficiency

Estimated Gain (Loss) on Realization

$ 50,000

Assets pledged with partially secured creditors: Marketable securities Less: 10% note payable and interest

Free assets: Cash Accounts receivable (net) Inventory Prepaid insurance Plant and equipment (net) Franchises

Estimated Amount Available to Unsecured Claims

30,000 (12,000)

25,400

(8,000)

(29,400)

5,000 55,000 76,000 1,500 190,000 30,000

(4,000)

5,000 55,000 76,000 1,500 190,000 30,000

(5,000) (5,500) (60,000) (42,000)

$388,900 (45,000) $343,900 82,500

$871,000

$(106,500) Total unsecured debt

$426,400

Chapter 20 – Corporations in Financial Difficulty

P20-7 (continued) Equities Estimated Amount Unsecured

Book Value (1) $ 44,000 234,600

(2) 29,400 105,000 (3)

(4) 160,000 212,000 17,000 (5)

Partially secured creditors: 10% note payable and interest Less: Marketable securities Accounts payable Less: Inventory

-020,000 12,000

240,000 (203,000) $871,000

Fully secured creditors: 12% note payable and interest Mortgages payable and interest

$ 44,000 234,600 $278,600

$ 29,400 (22,000) $105,000 (75,000)

Creditors with priority: Estimated liquidation expenses Wages payable Taxes payable

7,400 30,000

$ 13,000 20,000 12,000 $ 45,000

Unsecured creditors: Accounts payable Notes payable Interest payable

160,000 212,000 17,000

Stockholders' equity: Common stock Retained earnings (deficit)

Percentage to unsecured creditors:

$426,400

$343,900 = 80.65% $426,400

Chapter 20 – Corporations in Financial Difficulty

P20-8 Chapter 7 Liquidation, Statement of Affairs [AICPA Adapted] a.

Tower, Inc. Statement of Affairs December 31, 20X1 Assets

Estimated Current Values

Book Value (1) $ 40,000 13,000 90,000 140,000

Assets pledged with fully secured creditors: Accounts receivable Land Building (net) Machinery (net) Less: Fully secured claims from liability side: Note payable-bank $ 30,000 Mortgage payable and related interest 132,400

(2) 20,200

Assets pledged with partially secured creditors: Marketable securities Accrued interest Less: Notes payable (to bank)

(3) 1,500 35,000 60,000 40,000 5,000

Free assets: Cash Accounts receivable (after reclassifying $5,000 of credit balances to accounts payable) Finished goods Raw materials (net of $10,000 of conversion costs) Prepaid expenses

Estimated Amount Available to Unsecured Claims

$ 40,000 25,000 110,000 75,000 $250,000

(162,400)

$ 12,000 20,000 (65,000)

$ 87,600

$ 19,000 200 $ 19,200 (20,000) $

(1,000)

1,500

35,000 50,000

60,000 -0-

60,000

Estimated amount available for unsecured creditors, including creditors with priority Less: Liabilities with priority Estimated amount available for unsecured creditors Estimated deficiency to unsecured creditors (plug)

Estimated Gain (Loss) on Realization

(10,000) 20,000 (5,000)

$234,100 (41,500) $192,600 18,200

$444,700

$(29,000) Total unsecured debt

$210,800

Chapter 20 – Corporations in Financial Difficulty

P20-8 (continued) Book Value

Amount Unsecured

Liabilities and Stockholders' Equity (1)

$ 30,000 132,400 (2) 20,000

(3) 15,000 15,500 (4) 70,000

85,000 5,000 50,000 21,800 (5)

Fully secured creditors: Notes payable- bank Mortgage payable and interest Total (deducted on asset side)

$ 30,000 132,400 $162,400

Partially secured creditors: Notes payable-bank Less: Pledged marketable securities and interest (from asset side)

$ 20,000 (19,200)

Liabilities with priority: Estimated liquidation expenses Wages payable Payroll taxes payable Total (deducted on asset side)

800

$ 11,000 15,000 15,500 $ 41,500

Unsecured creditors: Accounts payable (after excluding $15,000 of payroll taxes payable and including $5,000 of credit balances reclassified from accounts receivable) Notes payable Audit fee of prior year Contingent liability on damage suit

70,000 85,000 5,000 50,000

Stockholders' equity, after giving effect to unrecorded items that are properly bookable as of December 31, 20X1* ($100,000 - $20,000 - $500 + $200 - $500 - $2,400 - $5,000 - $50,000)

$444,700 Total unsecured debt *

$210,800

Common stock, $100,000; retained earnings deficit, ($20,000); cash expended for travel, ($500); accrued interest receivable, $200; unrecorded employer's payroll taxes, ($500); unrecorded interest on mortgage, ($2,400); bill for last year's audit, ($5,000); and probable damage suit judgment, ($50,000). Estimated settlement per dollar of unsecured liabilities: Estimated amount available for unsecured creditors Total unsecured debt

$192,600 = $0.914 $210,800

Chapter 20 – Corporations in Financial Difficulty

P20-9 Financial Statements for a Firm in Chapter 11 Proceedings a.

Income statement for a company in reorganization proceedings: Hobbes Company (Debtor-in-Possession) Income Statement For the Year December 31, 20X2

Revenue: Sales

$246,000

Cost and Expenses: Cost of Goods Sold Selling, Operating, and Administrative Interest (contractual interest $51,000)

170,000 50,000 4,000 $224,000

Earnings before Reorganization Items and Income Taxes Reorganization Items: Professional Fees Interest Earned on Accumulated Cash Resulting from Chapter 11 Proceeding Total Reorganization Items

$ 22,000 $(15,000) 3,000 (12,000)

Income before Income Tax and Discontinued Operations

$ 10,000

Income Tax

(5,000)

Income before Discontinued Operations Discontinued Operations: Operating Loss, Net-of-Tax Gain on Sale of Assets, Net-of-Tax Net Discontinued Operations Net Loss

5,000

$(16,000) 9,000 (7,000) $ (2,000)

Chapter 20 – Corporations in Financial Difficulty

P20-9 (continued) b.

Statement of cash flows for a company in reorganization proceedings: Hobbes Company (Debtor-in-Possession) Statement of Cash Flows For the Year December 31, 20X2

Cash Flows from Operating Activities: Cash Received from Customers Cash Paid to Suppliers and Employees Interest Paid Net Cash Provided by Continuing Operating Activities before Reorganization Items

$ 264,000 (206,000) (4,000) $

54,000

Operating Cash Flows from Reorganization Activities: Professional Fees Interest Received on Cash Accumulated Because of Chapter 11 Proceeding Net Cash Used by Reorganization Items

3,000 $ (12,000)

Operating Cash Flows from Discontinued Operations: Net Cash Used by Discontinued Operations

Net Cash Provided by Operating Activities

$ 39,000

Cash Flows Provided by Investing Activities: Proceeds from Sale of Assets Due to Chapter 11 Proceeding Net Cash Provided by Investing Activities

$ 18,000 $ 18,000

Cash Flows Provided by Financing Activities: Net Borrowings under Short-Term Financing Plan Principal Payments on Pre-petition Debt Authorized by Court (Bonds Payable) Net Cash Provided by Financing Activities Net Increase in Cash Cash at January 1, 20X2 Cash at December 31, 20X2

$ (15,000)

(3,000)

$ 10,000 $

(10,000) -0-

$ 57,000 15,000 $ 72,000

Chapter 20 – Corporations in Financial Difficulty

P20-9 (continued) c.

Balance sheet for a company in reorganization proceedings: Hobbes Company (Debtor-in-Possession) Balance Sheet December 31, 20X2 Assets

Cash Accounts Receivable (net) Inventory Total Current Assets Property, Plant, and Equipment (net) Total Assets Liabilities Liabilities Not Subject to Compromise: Current Liabilities (post-petition): Short-Term Borrowings Accounts Payable - Trade Total Liabilities Not Subject to Compromise Liabilities Subject to Compromise (pre-petition): Accounts Payable Notes Payable, 10% Bonds Payable, 12% Accrued Interest Payable Total Liabilities Subject to Compromise Total Liabilities Shareholders' Equity Preferred Stock Common Stock ($1 par) Additional Paid-In Capital Retained Earnings (Deficit) Total Shareholders' Equity Total Liabilities and Shareholders' Equity *

$ 72,000 47,000 88,000 $207,000 460,000 $667,000

$ 10,000 7,000 $ 17,000 $ 138,000 170,000 240,000* 47,000 595,000 $612,000 $ 50,000 50,000 75,000 (120,000) $ 55,000 $667,000

$10,000 payment approved by the Court, reducing pre-petition bonds payable from $250,000 to $240,000.

Additional Student Resources Click a link below to access Additional Student Resources for this title. NOTE: You may need to hold your CTRL key down while clicking a link in order to open a file.

PowerPoint Presentations PowerPoint Presentations Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10

Chapter 11 Chapter 12 Chapter 13 Chapter 14 Chapter 15 Chapter 16 Chapter 17 Chapter 18 Chapter 19 Chapter 20 All Chapters

Accessible PowerPoint Presentations Chapter 1 Chapter 11 Chapter 2 Chapter 12 Chapter 3 Chapter 13 Chapter 4 Chapter 14 Chapter 5 Chapter 15 Chapter 6 Chapter 16 Chapter 7 Chapter 17 Chapter 8 Chapter 18 Chapter 9 Chapter 19 Chapter 10 Chapter 20 All Chapters

Advanced Study Guide Presentations Advanced Study Guide (NOTE: Select this link if you are utilizing Chrome or Edge as your default browser) Advanced Study Guide for Firefox (NOTE: Select this link if you are utilizing Firefox as your default browser. If the audio of the selected presentation does not start, please restart the presentation from the beginning.)