Test Bank for Advanced Accounting, 1st Canadian Edition (Updated Version) by Gail Fayerman by ACADEMIAMILL

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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Test Bank for Advanced Accounting, Canadian Edition (Updated Version) 1e Gail Fayerman Chapter 1 – Accounting for Investments

True or False

1) If a company makes a non-strategic investment it is considered a financial asset. Answer: True Difficulty: Easy Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Criteria”

2) When a company has control over another company, a parent-subsidiary relationship is said to exist. Answer: True Difficulty: Easy Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments - Parent-Subsidiary Relationships Feedback: Review section “Identifying Parent-Subsidiary Relationships”

3) An associate is an entity, including an unincorporated company such as a partnership, over which the investor has significant influence and that is also a subsidiary or a joint venture. Answer: False Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Identifying Associates” 4) Under the equity method, the investment account is updated for the investor’s share of

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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profit and distributions. Answer: True Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

5) A company is a party to a joint venture when it does not have the rights to the assets or the obligations for the liabilities. Answer: True Difficulty: Easy Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic Investments – Joint Arrangements Feedback: Review section “Identifying Joint Arrangements”

6) If Darlington Inc. owns 30% of a jointly controlled operation, it would reflect 100% of each asset, liability, income or expense that is part of the joint operation on its own financial statements. Answer: False Difficulty: Moderate Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic Investments – Joint Arrangements Feedback: Review section “Accounting and Reporting for Joint Arrangements”

7) When the non-strategic equity investment is initially recorded, it must be measured at its fair value. Answer: True Difficulty: Easy Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Recording Non-Strategic Investments in Equity”

8) Companies invest in non-strategic investments to obtain a higher return than holding cash in a bank account.

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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Answer: True Difficulty: Easy Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Identifying Non-Strategic Investments in Equity”

9) The ability of a company to control another cannot be affected by relationships with other parties. Answer: False Difficulty: Medium Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments - Parent-Subsidiary Relationships Feedback: Review section “Identifying Parent-Subsidiary Relationships”

10) When reflecting an investment using the cost method, the investment is initially recorded at cost and the balance is not adjusted in subsequent periods unless there is an impairment. Answer: True Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

11) Generally speaking, all parent companies are responsible for the preparation of consolidated financial statements. Answer: True Difficulty: Medium Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments - Parent-Subsidiary Relationships Feedback: Review section “Presentation of Consolidated Financial Statements for Controlled Entities”

12) The investor does not need to hold shares in an associate, but where more than 20% of the voting power is held, significant influence is presumed to exist.

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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Answer: True Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Identifying Associates”

13) The parties to a joint venture will initially record their share of the investment at the fair value of their contribution made. In subsequent periods, the cost method will be used for reporting purposes. Answer: False Difficulty: Medium Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic investments – Joint Arrangements Feedback: Review section “Accounting and Reporting for Joint Arrangements”

14) There is a general assumption that an ownership interest of less than 20% is a financial asset and not a strategic investment. Answer: True Difficulty: Easy Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Identifying Non-Strategic Investments in Equity”

15) There is a presumption that control exists where the company owns more than 50% of the voting shares of the investee. Answer: True Difficulty: Moderate Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments - Parent-Subsidiary Relationships Feedback: Review section “Identifying Parent-Subsidiary Relationships” Multiple Choice 16) Non-strategic investments can be classified as fair value through profit or loss (FVTPL) or as fair value through other comprehensive income (OCI)- through an 4

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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irrevocable election. Which of the following statements is true? a) Under both FVTPL and OCI, changes in the fair value of the investment are reported as other comprehensive income on the statement of comprehensive income. b) Under both FVTPL and OCI, changes in the fair value of the investment are reported under the net income section on the statement of comprehensive income. c) Under both FVTPL and OCI, dividends received from the investee are reported as other comprehensive income on the statement of comprehensive income. d) Under both FVTPL and OCI, dividends received from the investee are reported under the net income section on the statement of comprehensive income. Answer: d Difficulty: Medium Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Recording Non-Strategic Equity Investments”

17) Leno Ltd. has invested in several domestic manufacturing corporations. Which of the following investments would most likely be accounted for under the equity method on Leno's financial statements? a) A holding of 20,000 of the 25,000 outstanding common shares of Riser Co. b) A holding of 3,000 of the 10,000 outstanding preferred shares of Riser Co. c) A holding of 15,000 of the 50,000 outstanding common shares of Riser Co. d) A holding of 5,000 of the 60,000 outstanding common shares of Riser Co. Answer: c Difficulty: Easy Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Identifying Associates”

18) Which of the following is NOT an indicator of significant influence? a) The investor and the investee share office space and use the same accounting firm. b) The investor has representation on the investee's board of directors. c) There are material transactions between the investor and the investee. d) The investor provides computing services to the investee. Answer: a Difficulty: Easy

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Identifying Associates”

19) How do joint ventures differ from private corporations? a) A joint venture does not have a board of directors. b) There can only be two parties in a joint venture. c) Venturers cannot make unilateral decisions. d) The venturers must share the risks and profits of the joint venture equally. Answer: c Difficulty: Medium Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic investments – Joint Arrangements Feedback: Review section “Identifying Joint Arrangements”

20) Clausen Ltd. has a passive investment in Kaitlin Ltd. Clausen has elected to treat Kaitlin as a fair value through other comprehensive income (OCI) investment under IFRS 9 Financial Instruments. Which of the following statements is TRUE? a) Dividends that are a return of capital from Kaitlin are reported as a separate component of Clausen's shareholders' equity. b) Year to year changes in the fair value of the Investment in Kaitlin are reported as net income in Clausen's SCI. c) Fair value accumulated gains and losses in the Investment in Kaitlin should be reported as a separate component in Clausen's shareholders' equity. d) Dividends from Kaitlin are reported as other comprehensive income in Clausen's Statement of Comprehensive Income. Answer: a Difficulty: Medium Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Recording Non-Strategic Equity Investments”

21) How are most significant influence investments in equity securities reported on the investor’s financial statements? a) Using the equity method. b) Using proportionate consolidation.

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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c) On a fully consolidated basis. d) Using the cost method. Answer: a Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

22) At the beginning of 2013, Zed Ltd. acquired 15% of the voting shares of Pine Co (a private company) for $150,000. Zed does not have any significant influence over Pine. Zed follows ASPE. In 2013, Pine earned net income of $70,000 and paid dividends of $40,000. In 2014, Pine earned net income of $80,000 and paid dividends of $100,000. At the end of 2014, what journal entry should Zed make to record the dividends from Pine? a) No entry is required b) DR Cash CR Investment in Pine c) DR Cash CR Investment in Pine d) DR Cash CR Dividend income

12,000 12,000 15,000 15,000 15,000 15,000

Answer: d Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

23) Walton Ltd. has the following shareholders: Sifter Co. — 60% Fallwell — 30% Garney Ltd. — 10% Fallwell does not conduct any business with Walton, nor has it been able to secure a seat on the Board of Directors. Which of the following statements is TRUE? a) Falwell has significant influence over Walton.

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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b) Fallwell should treat Walton as a non-strategic investment. c) Fallwell should consider Walton to be a structured entity. d) Fallwell should consider Walton to be an associated company. Answer: b Difficulty: Hard Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Identifying Associates”

24) In Canada, which subsidiaries must be included in consolidated financial statements? a) All subsidiaries, except for ones in unrelated industries. b) All domestic subsidiaries. c) All subsidiaries, except for ones where control is impaired. d) All subsidiaries. Answer: c Difficulty: Medium Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments - Parent-Subsidiary Relationships Feedback: Review section “Identifying Parent-Subsidiary Relationships”

25) Where are the consolidating adjustments recorded? a) Only on the consolidated financial statements. b) In the general journal of both the parent company and on the consolidated financial statements. c) In the general journal of both the parent and subsidiary companies and on the consolidated financial statements. d) In the general journal of both the parent and subsidiary companies. Answer: a Difficulty: Medium Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments - Parent-Subsidiary Relationships Feedback: Review section “Presentation of Consolidated Financial Statements for Controlled Entities”

26) Under ASPE, what are the types of joint ventures?

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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a) Jointly controlled operations, jointly controlled assets, and jointly controlled enterprises. b) Jointly controlled operations, jointly controlled liabilities, and jointly controlled enterprises. c) Jointly controlled operations, jointly controlled assets, and jointly controlled ventures. d) Jointly controlled operations, jointly controlled liabilities, and jointly controlled ventures. Answer: a Difficulty: Medium Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic Investments-Joint Arrangements Feedback: Review section “Applying ASPE to Each Type of Joint Venture Investment”

27) At the beginning of 2013, Zylon Ltd. acquired 15% of the voting shares of Hendrick Co. a public company for $150,000. Zylon does not have any significant influence over Hendrick.. In 2013, Hendrick earned net income of $70,000 and paid dividends of $40,000. The fair value of the 15% at the end of 2013 was $160,000. In 2014, Hendrick earned net income of $80,000 and paid dividends of $100,000. The fair value of the 15% at the end of 2014 was $157,000. At the end of 2014, what journal entry should Zylon make regarding its investment in Hendrick Co. in net income? a) DR Investment in Hendrick CR Investment income b) DR Investment in Hendrick CR Investment income c) No entry is required d) DR Investment in Hendrick CR Investment income

12,000 12,000 80,000 80,000

15,000 15,000

Answer: c Difficulty: Hard Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

28) If an investment is owned 100%, which methods will result in the same income and shareholders' equity appearing on the financial statements?

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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a) Cost and consolidation. b) Equity and consolidation. c) Cost and equity. d) Each method results in different income and shareholder's equity amounts. Answer: b Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

29) Which of the following best illustrates a parent-subsidiary relationship? a) Company A owns 55% of the outstanding voting shares of Company B. They have the right to appoint 8/10 members of the board of directors of Company B, however they choose not to get involved in the day-to-day operations of Company B. b) Company A owns 75% of the outstanding shares of Company B and they have the right to appoint 1/10 members of the board of directors of Company B. c) Company A and Company B have set up a separate entity that they each jointly control. d) Company A owns 45% of the outstanding shares of Company B and provides accounting function assistance as their controller quit during the year. Answer: a Difficulty: Hard Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments – Parent-Subsidiary Relationship Feedback: Review section “Identifying Parent-Subsidiary Relationships”

30) Which of the following is false regarding structured entities? a).They may take the form of a corporation, trust, partnership, or unincorporated entity. b).Using the definition of control, these types of arrangements are dealt with in the same manner as other types of strategic investments. c). As the company may not own shares of the entity, consolidation would not be required. d) The company may not own any shares of the entity but typically the equity is not sufficient to sustain the entity. Answer: c

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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Difficulty: Medium Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Identifying Parent-Subsidiary Relationships Feedback: Review section “Structured Entities”

31) Larsen Ltd. has the following shareholders: Miller Co. — 60% Sadaat Ltd. — 30% Peterson Ltd. — 10% Sadaat has two seats on Larsen's five-person board of directors. Which of the following statements is TRUE? a) Larsen is a structured entity to Sadaat. b) Sadaat has control over Larsen. c) Sadaat should treat Larsen as a non-strategic investment. d) Sadaat has significant influence over Larsen. Answer: d Difficulty: Hard Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Identifying Associates”

32) Which of the following would be considered to be a joint operation? a) Two investors create a separate company which provides for joint control. The assets and liabilities of the company are the responsibility of the investors up to their ownership interest. b) Two investors create a separate company which provides for joint control. The assets and liabilities of the company are the responsibility of the company. c) Two investors create a company. Neither investor controls the individual assets or is obligated to pay for the liabilities and expenses of the separate company. d) None of the above would be considered a joint operation. Answer: a Difficulty: Medium Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic Investments – Joint Arrangements Feedback: Review section “Identifying Joint Arrangements”

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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33) At the beginning of 2013, Ridley Ltd. acquired 25% of the voting shares of Gasser Co. for $150,000. Ridley has significant influence over Gasser. In 2013, Gasser earned net income of $70,000 and paid dividends of $40,000. In 2014, Gasser earned net income of $80,000 and paid dividends of $100,000. At the end of 2014, what is the balance of Ridley's "Investment in Gasser" account? a) $150,000 b) $147,500 c) $152,500 d) $222,500 Answer: c Difficulty: Hard Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

34) Jamison Co. owned 60% of Tyler Co.'s voting shares and 25% of Simon Ltd.'s voting shares. Tyler owns 30% of Simon's voting shares. Which of the following statements is TRUE? a) Tyler is the only subsidiary of Jamison. b) Simon is a subsidiary of both Tyler and Jamison. c) Simon is the only subsidiary of Tyler. d) Both Tyler and Simon are subsidiaries of Jamison. Answer: d Difficulty: Medium Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments - Parent-Subsidiary Relationships Feedback: Review section “Presentation of Consolidated Financial Statements for Controlled Entities”

35) There is a presumption that a company which owns less than 20% of the voting shares of another company has: a) Total control. b) Joint control. c) Significant influence. d) A non-strategic investment.

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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Answer: d Difficulty: Easy Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: 1 Non-Strategic Investments in Equity Feedback: Review section “Identifying Non-Strategic Equity Investments”

36) A joint arrangement that is not structured as a separate entity is a(n) __________. a) association. b) joint operation. c) consolidation. d) passive investment. Answer: b Difficulty: Medium Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic investments – Joint Arrangements Feedback: Review section “Identifying Joint Arrangements”

37) A financial asset includes all of the following EXCEPT: a) Cash. b) A contractual right to receive cash or another financial asset from another company. c) A contractual right to exchange financial instruments under conditions that are potentially favourable. d) All of the above are financial assets Answer: d Difficulty: Easy Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Identifying Non-Strategic Investments in Equity”

38) Which of the following statements is FALSE? a) A joint arrangement is a contractual arrangement which provides for joint control. b) Joint control requires majority agreement among the parties sharing control. c) Two types of joint arrangements exist: joint operations and joint ventures. d) The parties to a joint operation are required to report their share of each asset and liability.

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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Answer: b Difficulty: Medium Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic investments – Joint Arrangements Feedback: Review section “Identifying Joint Arrangements”

39) The parties to a joint venture will initially record their share of the investment at: a) Fair value. b) Cost. c) Amortized value. d) Equity value. Answer: a Difficulty: Easy Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic investments – Joint Arrangements Feedback: Review section “Accounting and Reporting for Joint Arrangements”

40) Which of the following statements is FALSE? a) Entities are required to present non-strategic investments in equity as financial assets. b) Financial assets under IFRS 9 are shown at fair value with the difference in fair value going through income. c) Entities may make an irrevocable election to show the gains and losses of financial assets through other comprehensive income. d) Under ASPE, all financial investments in shares are reflected at fair value unless the shares trade in a public market. Answer: d Difficulty: Hard Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Recording Non-Strategic Equity Investments”

41) Which of the following is the first step in determining if one company controls another such that a parent/subsidiary relationship exists? a) Determine the relevant activities of the investee.

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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b) Determine how decisions are made regarding the relevant activities. c) Determine whether the investor has the current ability to direct those relevant activities. d) Determine the purpose and design of the investee. Answer: d Difficulty: Medium Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments - Parent-Subsidiary Relationships Feedback: Review section “Identifying Parent-Subsidiary Relationships”

42) Which of the following factors does NOT provide evidence of the existence of significant influence? a) Representation on the board of directors or equivalent governing body of the investee. b) Material transactions between the investor and the investee. c) Interchange of managerial personnel. d) All of the above provide evidence of the existence of significant influence Answer: d Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Identifying Associates”

43) Which of the following statements regarding joint ventures is FALSE? a) A joint venture must be set up as a separate vehicle. b) A company is a party to a joint venture when it does not have the right to the assets or the obligations for the liabilities. c) A company is a party to a joint venture when it has the rights to the venture’s net assets. d) None of the above is false. Answer: d Difficulty: Medium Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic investments – Joint Arrangements Feedback: Review section “Identifying Joint Arrangements”

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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44) The equity method is applied: a) when one of the parties is designated as no longer being a subsidiary. b) when a contractual agreement is written up providing joint control. c) from the date the investor obtains significant influence over the investee. d) on that date when it becomes clear that an investor has no power to participate in the financial and operating decisions of the investee. Answer: c Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting” 45) ______________ has sometimes been described as ‘one-line consolidation’. a) The equity method of accounting b) A joint venture c) A passive investment d) Significant influence

Answer: a Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

46) On January 1, 2013, Tonya Ltd. started Chen Ltd. by contributing $600,000 and received 100% of the common shares of Chen. Chen reported net income of $40,000 in 2013 and $85,000 in 2014 and paid out 40% of its net income as dividends in each year. Under the equity method, which of the following amounts should be reported on Tonya's separate-entity 2014 financial statements? a) Investment in Chen $600,000 b) Investment in Chen $675,000 c) Investment in Chen

Investment Income $34,000 Investment Income $85,000 Investment Income

Fayerman: Advanced Accounting, Ce

$625,000 d) Investment in Chen $625,000

Chapter 1: Accounting for Investments

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$34,000 Investment Income $40,000

Answer: b Difficulty: Hard Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

47) Foster Corporation uses the equity method to account for its 25% investment in Vector Corporation and receives $25,000 in dividends. How should Foster account for these dividends? a) An increase in assets. b) An increase in income. c) A decrease in the investment. d) A decrease in income. Answer: c Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

48) Which of the following statements regarding non-strategic investments in equity is FALSE? a) There are possible exceptions to FVTPL. b) At the day of acquisition when the investment in shares is originally recorded, the company has the option of making an “irrevocable election” where it decides that subsequent changes to fair value will be put in other comprehensive income rather than through income. c) The “irrevocable election” can be made for investments that are held for trading. d) Items that are originally placed in Other Comprehensive Income cannot be recycled through profit and loss. Answer: c Difficulty: Hard Learning Objective: Identify and account for non-strategic investments in equity.

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Recording Non-Strategic Equity Investments”

49) A subsidiary is defined as an entity that is controlled by another company. Three criteria must be present in order for there to be control. The parent must have all of the following except: a) The ability to direct the financial and operating policies of another company. b) The ability to obtain returns from another company. c) The ability to use its power to affect the returns from another company. d) The ability to issue any class of securities in a public market on behalf of another company. Answer: d Difficulty: Medium Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments - Parent-Subsidiary Relationships Feedback: Review section “Identifying Parent-Subsidiary Relationships”

50) Regarding significant influence with respect to an associate, which of the following statements is TRUE? a) The investor–associate relationship is directly opposite in nature compared to that existing between a parent and subsidiary. b) There is a requirement for the investor to hold shares, or have a beneficial interest, in the associate. c) The cost method is used to account for investments in associates under IFRS. d) If significant influence is exercised by one company over another by virtue of an association or contract other than from the holding of shares, then the equity method cannot be applied in relation to the associate. Answer: d Difficulty: Easy Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Identifying Associates”

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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Short Answer

51) If a company makes a non-strategic investment, it is considered a financial asset. What is a financial asset?

A financial asset is defined as: (IAS 32.11) • Cash • An equity instrument of another company • A contractual right to receive cash or another financial asset from another company • A contractual right to exchange financial instruments under conditions that are potentially favourable Investments in the equity of other companies, which are non-strategic, meet the second criteria of the definition of a financial asset. Difficulty: Medium Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Identifying Non-Strategic Investments in Equity”

52) What are the steps to follow to determine if one company controls another and therefore a parent/subsidiary relationship exists?

The following are the steps to follow to determine if one company controls another and therefore a parent/subsidiary relationship exists. a. Determine the purpose and design of the investee. b. Determine the relevant activities of the investee. c. Determine how decisions are made regarding the relevant activities. d. Determine whether the investor has the current ability to direct those relevant activities. e. Determine whether the investor has the right and risks to the variable returns of the investee. f. Determine whether the investor has the ability to use its power to affect those returns. If the answer in points d, e, and f is yes, then the investor has control over the investee. Difficulty: Medium Learning Objective: Identify and account for parent-subsidiary relationships. Section Reference: Strategic Investments - Parent-Subsidiary Relationships Feedback: Review section “Identifying Parent-Subsidiary Relationships”

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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53) Outline and describe the basics of the equity method.

IAS 28 provides a description of the basics of the equity method. The key steps are: • Recognize the initial investment in the associate or joint venture at cost. • Increase or decrease the carrying amount of the investment by the investor’s share of the profit or loss of the investee after the date of acquisition (post-acquisition profit or loss). • Reduce the carrying amount of the investment by distributions (such as dividends) received from the associate or joint venture. • Increase or decrease the carrying amount of the investment for changes in the investor’s share of the changes in the investee’s other comprehensive income. This may apply to changes arising from the revaluation of property, plant and equipment and from foreign exchange translation differences. The investor’s share of those changes is recognized in other comprehensive income of the investor. Although potential voting rights may be used in the assessment of the existence of significant influence, they are not used in any of the above calculations (paragraph 12 IAS 28). Difficulty: Medium Learning Objective: Identify and account for associates. Section Reference: Strategic Investments - Associates Feedback: Review section “Equity Method of Accounting”

54) What is a joint operation?

In a joint operation, the investor has a contractual right or obligation to the assets and liabilities of the operation. A joint arrangement that is not structured as a separate entity is a joint operation. However, a separate entity could still be a joint operation. A joint operation is usually a joint arrangement that involves the use of the assets and other resources of the parties, often to manufacture and sell joint products. Difficulty: Medium Learning Objective: Identify and account for joint arrangements. Section Reference: Strategic investments – Joint Arrangements Feedback: Review section “Identifying Joint Arrangements”

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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Problems 55) On January 1, 2013, Donner Co. purchased 3,000 shares, representing 30% of Ishwar Limited, for $390,000. Donner is a publicly traded company. Ishwar's total net income was $86,000 for the year ended December 31, 2013. Ishwar also paid dividends in total of $25,000 during 2013. At the year end, each share of Ishwar was trading at $150 per share. Required: Based on the information above, show the journal entries that Donner would have used to report its original purchase and any related investment income for Ishwar for 2013 assuming that Donner reports its investment in Ishwar using FVTPL. What is the investment account balance at the end of December 31, 2013? Answer: Journal entries during 2013 would be for the investment recorded at FVTPL January 1, 2013 — To record initial investment in Ishwar Dr. Investment in Ishwar Cr. Cash

390,000 390,000

To record receipt of dividends during the year from Ishwar Dr. Cash (30% × $25,000) Cr. Dividend income

7,500 7,500

December 31, 2013 — To adjust the investment to fair value at year end report date. Dr. Investment in Ishwar ($150 × 3,000) - $390,000 60,000 Cr. Change in fair value (Statement of Comprehensive Income)

60,000

The balance in the Investment in Ishwar account is $450,000 at December 31, 2013. Difficulty: Hard Learning Objective: Identify and account for non-strategic investments in equity. Section Reference: Non-Strategic Investments in Equity Feedback: Review section “Recording Non-Strategic Equity Investments”

Fayerman: Advanced Accounting, Ce

Chapter 1: Accounting for Investments

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56) Sibery Inc. uses the equity method of reporting its 40% investment in Alway Co. The balance in the Investment in Alway was $70,750 at January 1, 2012. During the next three years, Alway reported the following net earnings (losses) and dividends paid. Net earnings (loss) 2012 2013 2014

Dividends paid

$ 155,600 35,700 (123,400)

$ 140,000 140,000 0

Required: Calculate the balance of the Investment in Alway account at December 31, 2014. Answer: The table below shows the calculation of the Investment in Alway account for each year. Balance Balance Jan 1, 2012 Proportionate share of earnings for 2012 - 155,600 × 40% Dividends received during 2012 140,000 × 40% Balance Dec 31, 2012 Proportionate share of earnings for 2013 - 35,700 × 40% Dividends received during 2013 140,000 × 40% Balance Dec 31, 2013 Proportionate share of losses for 2014 - 123,400 × 40% = 49,360, but there is only $35,270 in account - see note below Balance Dec 31, 2014

$ 70,750 62,240 (56,000) 76,990 14,280 (56,000) 35,270 (35,270) 0

Note: In 2014, Sibery's share of losses of Alway exceeded the balance in the investment account. Therefore, Sibery must stop recognizing further losses since the account would go into a credit position, representing a liability which is not the case here. Once the investee resumes making profits, then Sibery will record its portion of the profits once they exceed the losses not recognized previously. In this case, to date, there are $14,090 (49,360-35,270) in losses which have not been recognized. Sibery would not commence reporting its proportionate share of profits until profits of more than $14,090 had been earned.

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Chapter 2: Business Combinations

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Testbank Chapter 2 – Business Combinations

True or False

1) The transaction costs of issuing shares in an acquisition are expensed. Answer: False Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Consideration Transferred-Costs of Issuing Debt and Equity Instruments”

2) Goodwill acquired in a business combination should be tested for impairment once a year. Answer: True Difficulty: Easy Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination Feedback: Review section “Goodwill”

3) IFRS defines a business combination as a transaction or other event in which an acquirer obtains control of one or more businesses. Answer: True Difficulty: Medium Learning Objective: Understand the nature of a business combination and its various forms. Section Reference: Nature of a Business Combination Feedback: Review section “Definition of Business Combination”

4) A business combination could occur without any exchange of assets or equity between the entities involved in the exchange. 1

Fayerman: Advanced Accounting, Ce

Chapter 2: Business Combinations

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Answer: True Difficulty: Medium Learning Objective: Understand the nature of a business combination and its various forms. Section Reference: Nature of a Business Combination Feedback: Review section “Forms of Business Combinations”

5) Having recognized any contingent liabilities of the acquiree as liabilities, the acquirer must then determine a subsequent measurement for the liability. The liability is initially recognized at book value. Answer: False Difficulty: Medium Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination. Feedback: Review section “Contingent Liabilities”

6) Having recognized goodwill arising in the business combination, goodwill cannot be revalued. Answer: True Difficulty: Easy Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination. Feedback: Review section “Goodwill”

7) The use of physical possession as the key criterion to determine the acquisition date ensures that the substance of the transaction determines the accounting rather than the form of the transaction. Answer: False Difficulty: Easy Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations.

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Chapter 2: Business Combinations

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Section Reference: Accounting for a Business Combination: Basic Principles Feedback: Review section “Determining the Acquisition Date”

8) An acquirer can obtain its controlling interest in the acquiree by acquiring further shares and thereby adding to its previously held equity interest. Answer: True Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Existence of a Previously Held Equity Interest”

9) The acquirer is usually the entity that has the largest minority voting interest in an entity that has a widely dispersed ownership. Answer: True Difficulty: Medium Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for a Business Combination: Basic Principles Feedback: Review section “Identifying the Acquirer”

10) Subsequent to the acquisition date, a contingent liability is measured as the amount initially recognized less, if appropriate, cumulative amortization recognized. Answer: False Difficulty: Medium Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination. Feedback: Review section “Contingent Liabilities” 11) Where the acquirer purchases the acquiree’s assets and liabilities, the acquiree may continue in existence or it may liquidate. Answer: True Difficulty: Medium

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Chapter 2: Business Combinations

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Learning Objective: Prepare the accounting records of the acquiree. Section Reference: Accounting in the Records of the Acquiree Feedback: Review section “Purchase of the Acquiree’s Assets and Liabilities”

12) Normally, the entity that is the acquirer is the one that undertakes action to take over the acquiree. Answer: True Difficulty: Medium Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for a Business Combination: Basic Principles Feedback: Review section “Identifying the Acquirer”

13) At the acquisition date, the contingent consideration is measured at book value. Answer: False Difficulty: Medium Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination Feedback: Review section “Contingent Consideration”

14) Accounting fees for an acquisition should be deferred and amortized. Answer: False Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Consideration Transferred to the Acquiree-AcquisitionRelated Costs”

15) The acquirer is usually the combining entity whose owners have the ability to elect or appoint or to remove a majority of the members of the governing body of the combined entity. Answer: True

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Chapter 2: Business Combinations

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Difficulty: Medium Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for a Business Combination: Basic Principles Feedback: Review section “Identifying the Acquirer" Multiple Choice

16) Under IFRS 3, Business Combinations, which method must be used to account for business combinations? a) Purchase method. b) Acquisition method. c) New entity method. d) Pooling-of-interests method. Answer: b Difficulty: Easy Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for a Business Combination: Basic Principles Feedback: Review section “Identifying the Acquirer”

17) How should legal fees for an acquisition be treated? a) Capitalized as part of the acquisition cost. b) Expensed in the period of acquisition. c) Deferred and amortized. d) Deferred until the company is disposed of or wound-up. Answer: b Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Consideration Transferred to the Acquiree-AcquisitionRelated Costs”

18) Cowan Ltd. acquired 100% of the net assets of Opus Co. for $1,120,000. At the time of acquisition, Opus had the following:

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Chapter 2: Business Combinations

Book Value $2,800,000 168,000 1,960,000

Inventory Land Liabilities

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Fair value $2,800,000 238,000 1,960,000

In this acquisition, how much goodwill has been created? a) $0 b) 42,000 c) $70,000 d) $112,000 Answer: b Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Recognizing and Measuring Assets Acquired and Liabilities Assumed”

19) How should the transaction costs of issuing shares in acquisition be recognized? a) Deducted from shareholders' equity, net of related income tax benefits. b) Expensed. c) Capitalized as part of the cost of the shares. d) Deducted in total from shareholders' equity. Answer: a Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Consideration Transferred to the Acquiree- Costs of Issuing Debt and Equity Instruments”

20) After an exchange of shares in a business combination, each group of shareholders held 50% of the voting rights. Which of the following factors would be the strongest to be considered in determining the acquirer? a) Composition of the board of directors. b) If there are material transactions between the combining companies. c) Which company initiated the combination. d) Head office location.

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Chapter 2: Business Combinations

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Answer: a Difficulty: Medium Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for Business Combination: Basic Principles Feedback: Review section “Identifying the Acquirer”

21) How should the cost of issuing debt (that is subsequently shown at amortized cost) in an acquisition be recognized initially? a) Amortized over the term of the debt. b) Deducted from shareholders' equity. c) Deducted from the value of the debt. d) Expensed. Answer: c Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Consideration Transferred to the Acquiree- Costs of Issuing Debt and Equity Instruments”

22) Whaley Company assigned goodwill of $60,000 to one of the reporting divisions of Rory company when it initially acquired it. Four years later the following information for this division follows: Carrying Amount

Fair

Value Cash Inventory Equipment Goodwill Accounts Payable

$ 20,000 35,000 125,000 60,000 30,000

$20,000 40,000 160,000 30,000

Based on the preceding information, what amount of goodwill will be reported for this division if its fair value of the division is now determined to be $200,000? a) $0 b) $60,000 c) $30,000 d) $10,000

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Answer: d Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Recognizing and Measuring Assets Acquired and Liabilities Assumed”

23) Attridge Ltd. and Ion Ltd. exchanged shares in a business combination. After the share exchange, each company held the same number of voting shares. Which of the following statements is TRUE? a) A number of factors must be considered to determine which company is the acquirer. b) There is no acquirer as this is not a proper business combination. c) The company with the highest net assets is considered the acquirer. d) The companies must ask the courts to decide which company is the acquirer. Answer: a Difficulty: Medium Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for a Business Combination: Basic Principles Feedback: Review section “Identifying the Acquirer”

24) How often should goodwill acquired in a business combination be tested for impairment? a) At least once a year. b) At least once every two years. c) Whenever there is an indication of impairment. d) Whenever there is a change in circumstances in the business. Answer: a Difficulty: Easy Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination Feedback: Review section “Goodwill”

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Chapter 2: Business Combinations

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25) Which of the following statements is FALSE? a) IFRS defines a business combination as a transaction or other event in which an acquirer obtains control of one or more businesses. b) IFRS 3 applies only to combinations involving ‘businesses’, thereby excluding other exchanges of assets between entities. c) A business generally must be capable of providing a return to the owners, and would always involve entities whose activities have inputs, processes and outputs. d) IFRS 3 excludes certain combinations of businesses from its scope, including those established as joint ventures or under common control. Answer: c Difficulty: Hard Learning Objective: Understand the nature of a business combination and its various forms. Section Reference: Nature of a Business Combination Feedback: Review section “Definition of Business Combination”

26) Which of the following statements regarding contingent liabilities subsequent to the initial accounting for a business combination is FALSE? a) Having recognized any contingent liabilities of the acquiree as liabilities, the acquirer must then determine a subsequent measurement for the liability. b) The liability is initially recognized at fair value. c) Subsequent to acquisition date, the liability is measured as the amount initially recognized less, if appropriate, cumulative amortization recognized. d) The liability would be measured at the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. Answer: c Difficulty: Hard Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination. Feedback: Review section “Contingent Liabilities”

27) At the acquisition date, the contingent consideration is: a) Measured at book value. b) Classified either as equity or as a liability. c) Classified as equity.

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Chapter 2: Business Combinations

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d) Classified as a liability. Answer: b Difficulty: Medium Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination. Feedback: Review section “Contingent Consideration”

28) Which of the following statements regarding acquirers and acquirees is FALSE? a) The acquiree is usually the entity that has the largest minority voting interest in an entity that has a widely dispersed ownership. b) The acquirer is usually the combining entity whose owners have the ability to elect or appoint or to remove a majority of the members of the governing body of the combined entity. c) In a takeover, it is normally the larger company that takes over the smaller company. d) Normally, the entity that is the acquirer is the one that undertakes action to take over the acquiree. Answer: a Difficulty: Medium Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for Business Combination: Basic Principles Feedback: Review section “Identifying the Acquirer”

29) Under IFRS 3.25, an acquirer is required to recognize and measure: a) The effect of any temporary differences of an acquiree that exist at the acquisition date or that arise as a result of the acquisitions. b) The effect of any temporary differences and carryforwards of an acquiree that exist at the acquisition date or that arise as a result of the acquisitions. c) The effect of any carryforwards of an acquiree that arise as a result of the acquisitions. d) Any temporary differences and carryforwards of an acquiree that exist at the acquisition date. Answer: b Difficulty: Hard Learning Objective: Account in the records of the acquirer for a purchase of net assets.

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Chapter 2: Business Combinations

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Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Recognizing and Measuring Assets Acquired and Liabilities Assumed-Income Taxes”

30) Falter acquired 100% of Krystal's net assets for $300,000. On the acquisition date, the fair value of the current assets and the net capital assets were $208,000 and $432,000 respectively. The fair value of the liabilities equalled their book value. What is the amount of goodwill created in this acquisition? Falter Co. $ 480,000 800,000 $ 1,280,000 $ 336,000 160,000 720,000 64,000 $ 1,280,000

Current assets Net capital assets Current liabilities Long-term debt Share capital Retained earnings

Krystal Ltd. $ 80,000 480,000 $ 560,000 $ 280,000 96,000 1,000,000 84,000 $ 560,000

a) $(48,000) b) $ 0 c) $36,000 d) $80,000 Answer: c Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Recognizing and Measuring Assets Acquired and Liabilities Assumed”

31) There are many forms of business combinations that can occur. However, for which of the following are the requirements for accounting for a business combination NOT used? a) A acquires the assets only of B, and B pays off the liabilities and then liquidates. b) A acquires all the assets and only some of the liabilities of B, and B pays the remaining liabilities before liquidating. c) The business combination results in the formation of a joint venture. d) A acquires a group of net assets of B, the group of net assets constituting a business, such as a division, branch or segment, of B. Answer: c

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Chapter 2: Business Combinations

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Difficulty: Medium Learning Objective: Understand the nature of a business combination and its various forms. Section Reference: Nature of a Business Combination Feedback: Review section “Forms of Business Combinations”

32) Which of the following statements regarding accounting in the records of the acquiree is FALSE? a) Where the acquirer purchases the acquiree’s assets and liabilities, the acquiree may continue in existence or it may liquidate. b) If the acquiree subsequently decides to liquidate, it transfers the cash remaining to the shareholders as a liquidating dividend. c) When the acquirer buys only shares in the acquiree from the shareholders of the acquiree, there are no entries in the records of the acquiree because the transaction is between the acquirer and the shareholders of the acquiree entity. d) Where the acquirer purchases the acquiree’s assets and liabilities, the acquiree must liquidate. Answer: d Difficulty: Hard Learning Objective: Prepare the accounting records of the acquiree. Section Reference: Accounting in the Records of the Acquiree Feedback: Review section “Purchase of the Acquiree’s Assets and Liabilities”

33) Which of the following is NOT a reason why a private enterprise may be acquired as a bargain purchase? a) The business only has equity financing and has no debt financing. b) It is a family business and the next generation does not want to continue the business. c) The owner has health problems and does not have a successor. d) The owner is no longer interested in the business. Answer: a Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Recognizing and Measuring Goodwill or a Gain from a Bargain Purchase”

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Chapter 2: Business Combinations

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34) Quast Co. plans to acquire Fairweather Co. Fairweather has substantial depreciable assets that have fair values in excess of their book values. Considering only the income tax impact, which of the following statements is TRUE? a) Quast would prefer to purchase Fairweather's shares and Fairweather would prefer to sell its assets to Quast. b) Both Quast and Fairweather would prefer Quast to purchase Fairweather's shares. c) Both Quast and Fairweather would prefer Quast to purchase Fairweather's assets. d) Quast would prefer to purchase Fairweather's assets and Fairweather would prefer to sell its shares to Quast. Answer: d Difficulty: Hard Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Consideration Transferred to the Acquiree-Income Taxes”

35) Conway Ltd. acquired all the assets and liabilities of Elliott Ltd. by issuing common shares to Elliott. After this transaction, Elliott owned 30% of Conway's outstanding shares. How should Conway record Elliott's assets and liabilities on its books? a) At their fair market value. b) At their original cost. c) At their net book value. d) At their fair market value plus an allocated share of goodwill to each item. Answer: a Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Recognizing and Measuring Assets Acquired and Liabilities Assumed”

36) Tilman Company paid $360,000 to acquire the net assets of Wilver Company. If the business combination is treated as an acquisition and the fair value of Wilver Company’s current assets is $135,000, its plant and equipment is $363,000, and its liabilities are $84,000, Tilman Company’s financial statements immediately after the combination will include which additional item due to the acquisition of Wilver Company: a) Negative goodwill of $54,000. b) Plant and equipment of $498,000. c) Plant and equipment of $414,000.

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d) A gain of $54,000. Answer: d Difficulty: Medium Learning Objective 3: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Recognizing and Measuring Assets Acquired and Liabilities Assumed”

37) Which of the following statements about a bargain purchase is TRUE? a) It is reported on the financial statements as an "excess of fair value over cost of assets acquired". b) Assets and liabilities of the acquired company are reported at their fair value. c) It is reported as a deferred credit on the financial statements called negative goodwill. d) Assets and liabilities of the acquired company are reported at net book value. Answer: b Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Recognizing and Measuring Goodwill or a Gain from a Bargain Purchase”

38) A business combination involves the joining together of assets and liabilities under the control of a specific entity. Therefore, the business combination occurs at the date: a) the net assets are under the control of the acquirer. b) the contract is signed. c) the consideration is paid. d) nominated in the contract. Answer: a Difficulty: Easy Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for Business Combination: Basic Principles Feedback: Review section “Determining the Acquisition Date”

39) Which of the following statements regarding step acquisitions is FALSE?

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a) An acquirer can obtain its controlling interest in the acquiree by acquiring further shares and thereby adding to its previously held equity interest. b) There may be a number of step purchases of shares in the acquiree prior to the obtaining of control. c) The acquirer will recognize an investment in the acquiree with each step acquisition being measured at book value. d) In a business combination achieved in stages, the acquirer shall remeasure its previously held equity interest in the acquiree at its acquisition-date fair value and recognize the resulting gain or loss, if any, in profit or loss. Answer: c Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Existence of a Previously Held Equity Interest”

40) The use of ______________ as the key criterion to determine the acquisition date ensures that the substance of the transaction determines the accounting rather than the form of the transaction. a) physical possession b) control c) payment of consideration d) valuation. Answer: b Difficulty: Easy Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for Business Combination: Basic Principles Feedback: Review section “Determining the Acquisition Date”

41) Xenon acquired 100% of Volt's net assets for $300,000. On the acquisition date, the fair value of the current assets and the net capital assets were $208,000 and $438,000 respectively. The fair value of the liabilities equalled their book value. On Xenon's statement of financial position, what is the total of its shareholders' equity? Xenon Co. $ 480,000 800,000 $ 1,280,000

Current assets Net capital assets

Volt Ltd. $ 80,000 480,000 $ 560,000

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Current liabilities Long-term debt Share capital Retained earnings

$ 336,000 160,000 720,000 _64,000 $ 1,280,000

Testbank

$ 280,000 96,000 100,000 _84,000 $ 560,000

a) $968,000 b) $184,000 c) $784,000 d) $1,084,000 Answer: c Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Shares Acquired in an Acquiree”

42) Having recognized goodwill arising in the business combination, which of the following statements regarding the subsequent accounting is FALSE? a) Goodwill is subject to amortization. b) Goodwill is subject to an annual impairment test. c) Goodwill cannot be revalued. d) IAS38 does not allow the recognition of internally generated goodwill. Answer: a Difficulty: Easy Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination. Feedback: Review section “Goodwill”

43) Most business combinations are an exchange of equal amounts, given markets in which the parties to the business combinations are informed and willing participants in the transaction. Therefore, the existence of a _____________ is expected to be an unusual or rare event. a) bargain purchase b) contingent liability c) carryforward d) contingent consideration.

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Chapter 2: Business Combinations

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Answer: a Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Recognizing and Measuring Goodwill or a Gain from a Bargain Purchase”

44) Where the acquirer buys shares of the acquiree from the shareholders, there is _____ effect on the acquiree records. a) considerable b) minimal c) contingent d) no Answer: d Difficulty: Medium Learning Objective: Prepare the accounting records of the acquiree. Section Reference: Accounting in the Records of the Acquiree Feedback: Review section “Purchase of Acquiree’s Shares from the Shareholders”

45) Where the contingent consideration is a financial liability, it will be accounted for under IFRS #9 and measured at ____________ value with movements being accounted for in accordance with that standard. a) book b) fair c) carrying d) future Answer: b Difficulty: Easy Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination. Feedback: Review section “Contingent Consideration”

46) Having recognized a contingent consideration and classified it as equity, the subsequent treatment is:

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a) It is re-measured at fair value with changes in the income statement. b) It is carried at book value with no adjustments made. c) No remeasurement is required and the subsequent settlement is accounted for within equity. d) It is re-measured at fair value with changes in OCI. Answer: c Difficulty: Medium Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination. Feedback: Review section “Contingent Consideration”

47) The acquisition-related costs associated with a business combination are accounted for as ____________ in the periods in which they are incurred and the services are received. a) liabilities b) expenses c) equity d) goodwill Answer: b Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Consideration Transferred- to the Acquiree- Acquisition”

48) When the future income of the acquiree is regarded as uncertain, the agreement may contain a clause that requires the acquirer to provide additional consideration to the acquiree if the income of the acquiree exceeds a specified amount over some specified period. For example, A may agree to pay $100,000 to acquire B and promise to pay an additional $50,000 in two years if B earns at least $100,000 for the next two years. A is concerned that the owners of B are integral to the success of B and may not stay involved if they receive full payment immediately. This is an example of: a) goodwill. b) contingent consideration. c) monetary assets. d) intangible assets.

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Answer: b Difficulty: Medium Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Consideration Transferred- to the Acquiree-Contingent Consideration”

49) A may issue its shares to acquire the shares of B. However, because of the greater number of A shares given to the former B shareholders relative to those held by the shareholders in A before the combination, the former shareholders in B may have the majority of shares in A and be able to determine the operating and financial policies of the combined entities. This is known as a: a) Reverse acquisition. b) Goodwill gesture. c) Hostile takeover. d) Contingent consideration. Answer: a Difficulty: Easy Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for Business Combination: Basic Principles Feedback: Review section “Identifying the Acquirer”

50) A business combination could occur without any exchange of ____________ between the entities involved in the exchange. a) assets b) assets or equity c) liabilities d) equity. Answer: b Difficulty: Medium Learning Objective: Understand the nature of a business combination and its various forms. Section Reference: Nature of a Business Combination Feedback: Review section “Forms of Business Combinations”

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Short Answer

51) There are many forms of business combinations that can occur, such as A acquiring the assets only of B, and B paying off the liabilities and then liquidating. Alternatively, A may acquire all the assets and only some of the liabilities of B, and B pays the remaining liabilities before liquidating. The number of possible arrangements is quite large. What are the two exceptions where the requirements for accounting for a business combination are not used? There are two exceptions where the requirements for accounting for a business combination are not used: • Where the business combination results in the formation of a joint venture. Such a business combination is accounted for under IFRS 11 Joint Arrangements. • Where the business combination involves entities or businesses under common control. Such a business combination occurs where all of the combining entities or businesses ultimately are controlled by the same party or parties both before and after the combination, and where control is not transitory. This situation could arise where A owns 100% of the shares of B. The directors of A form a new entity, C, wholly owned by A, which acquires all the issued shares of B in an internal restructuring. All the combining entities are controlled by A both before and after the restructuring. Difficulty: Medium

Learning Objective: Understand the nature of a business combination and its various forms. Section Reference: Nature of a Business Combination Feedback: Review section “Forms of Business Combinations”

52) Identify and discuss some indicators provided by IFRS 3 to assist in assessing which entity is the acquirer in situtations of a share for share exchange. IFRS 3 provides some indicators to assist in assessing which entity is the acquirer: • Is there a large minority voting interest in the combined entity? The acquirer is usually the entity that has the largest minority voting interest in an entity that has a widely dispersed ownership. • What is the composition of the governing body of the combined entity? The acquirer is usually the combining entity whose owners have the ability to elect or appoint, or remove a majority of the members of the governing body of the combined entity. • What is the composition of the senior management that governs the combined entity subsequent to the combination? This is an important indicator given that the criterion for identifying an acquirer is that of control. If A and B combine, is the senior management group of the combined entity dominated by former senior managers of A or B? • What are the terms of the exchange of equity interests? Has one of the combining entities paid a premium over the pre-combination fair value of one of the combing entities, an amount paid in order to gain control? • Which entity is the larger? This could be measured by the fair value of each of the combining entities, or relative revenues or profits. In a takeover, it is normally the larger

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Chapter 2: Business Combinations

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company that takes over the smaller company (that is, the larger company is the acquirer). Which entity initiated the exchange? Normally the entity that is the acquirer is the one that undertakes action to take over the acquiree. What are the relative voting rights in the combined entity after the business combination? The acquirer is usually the entity whose owners have the largest portion of the voting rights in the combined entity. In a reverse acquisition, A may issue its shares to acquire the shares of B. However, because of the greater number of A shares given to the former B shareholders relative to those held by the shareholders in A before the combination, the former shareholders in B may have the majority of shares in A and be able to determine the operating and financial policies of the combined entities.

Difficulty: Medium

Learning Objective: Explain the basic steps in the acquisition method of accounting for business combinations. Section Reference: Accounting for a Business Combination: Basic Principles Feedback: Review section “Identifying the Acquirer”

53) In a business acquisition, an acquirer purchases the assets and liabilities of an entity. What is the “consideration transferred” and how is it measured and calculated? The consideration transferred is the amount that the acquirer pays to obtain those net assets. This consideration transferred: • is measured at fair value at acquisition date • is calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree, and the equity interest issued by the acquirer.

Difficulty: Medium

Learning Objective: Account in the records of the acquirer for a purchase of net assets. Section Reference: Accounting in the Records of the Acquirer Feedback: Review section “Consideration Transferred to the Acquiree”

54) When the acquirer buys only shares in the acquiree from the shareholders of the acquiree, what is the impact on the acquiree’s records? When the acquirer buys only shares in the acquiree from the shareholders of the acquiree, there are no entries in the records of the acquiree because the transaction is between the acquirer and the shareholders of the acquiree entity. The acquiree itself is not involved. Difficulty: Medium Learning Objective: Prepare the accounting records of the acquiree. Section Reference: Accounting in the Records of the Acquiree Feedback: Review section “Purchase of the Acquiree’s Shares from the Shareholders”

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Chapter 2: Business Combinations

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55) Having recognized any contingent liabilities of the acquiree as liabilities, the acquirer must then determine a subsequent measurement for the liability. The liability is initially recognized at fair value. Subsequent to acquisition date, how is the liability measured? Subsequent to acquisition date, the liability is measured as the higher of: • the amount that would be recognized in accordance with IAS 37; and • the amount initially recognized less, if appropriate, cumulative amortization recognized in accordance with IFRS 8 Revenue. The liability would be measured at the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. This would be used, for example, where a liability was recognized in relation to a court case, or guarantees. Any change would affect income of that period as it represents a change in estimate. Difficulty: Medium

Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination. Feedback: Review section “Contingent Liabilities”

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Chapter 2: Business Combinations

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Problems

56. On December 31, 2012, the statements of financial position of the Radley Company and the Omen Company are as follows: (in 000s) Radley

Omen

Cash Accounts Receivable Inventories Capital assets (net) Total Assets

$ 500 1,500 2,000 2,500 $6,500

$ 800 1,700 1,500 4,000 $8,000

Current liabilities Long term liabilities Common shares Contributed surplus Retained earnings Total Equities

$ 700 800 2,500 800 1,700 $6,500

$ 400 500 1,000 1,500 4,600 $8,000

(FV)

$4,300

$ 550

Radley Company has 100,000 shares of common stock outstanding. Omen Company has 45,000 shares outstanding. On January 1, 2013, Radley issued an additional 90,000 shares of common stock in exchange for all the net assets of Omen. All assets and liabilities have book value equal to fair values, except as noted. In addition, Omen has a patent that has an appraised fair value of $450. Market value of the new shares issued was $95 per share at the date of acquisition. Required: What is the amount of goodwill to be recorded for this business combination? Prepare the journal entry that Radley would record on January 1, 2013 related to this acquisition. Prepare the consolidated statement of financial position as at January 1, 2013.

Answer: Calculation of goodwill (in 000s): Fair value of consideration (90,000 shares @ $95) Consideration received: Fair value of net assets acquired: Cash Accounts receivable Inventories Capital assets Patent Current liabilities Long-term liabilities Goodwill

$8,550

$800 1,700 1,500 4,300 450 (400) (550)

7,800 $ 750

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Chapter 2: Business Combinations

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Journal entry recorded by Radley to record the acquisition: Dr. Cash Accounts receivable Inventories Capital assets Patent Goodwill Cr. Current liabilities Long-term liabilities Common shares

$800 1,700 1,500 4,300 450 750 400 550 8,550

RADLEY COMPANY Statement of Financial Position As at January 1, 2013 (in 000s) Cash (500 + 800) Accounts receivable (1,500 + 1,700) Inventories (2,000 + 1,500) Capital assets (2,500 + 4,300) Patent Goodwill Total assets

$ 1,300 3,200 3,500 6,800 450 750 $16,000

Current liabilities (700 + 400) Long-term liabilities (800 + 550) Common shares (2,500 + 8,550) Contributed surplus Retained earnings

$ 1,100 1,350 11,050 800 1,700 $16,000

Difficulty: Hard

Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination Feedback: Review section “Contingent Consideration”

57. On September 1, 2013, Gowan Limited decided to buy the net assets of Jepsen Inc. for

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Chapter 2: Business Combinations

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$1,200,000 paid for with the issuance of shares. In addition, Gowan has agreed to pay an additional $250,000 if the revenues of Jepsen have a 5% growth over the next two years from the date of the acquisition. It has been determined that the fair value of this contingent consideration is $175,000. The balances showing on the statement of financial position for the two companies at August 31, 2013 are as follows: Gowan $ Assets Cash Accounts receivable Inventory Investments Capital assets — net

Liabilities Current liabilities Accounts payable Bonds payable Shareholders’ Equity Common shares Retained earnings

Jepsen $

45,000 65,000 50,000 0 3,590,000 3,750,000

20,000 35,000 80,000 45,000 1,020,000 1,200,000

665,000 1,350,000

280,000 620,000

950,000 785,000 3,750,000

250,000 50,000 1,200,000

After a review of the financial assets and liabilities, Gowan determines that some of the assets of Jepsen have fair values different from their carrying values. These items are listed below: Capital assets - fair value is $1,350,000 Patent - fair value is $255,000 Brand name — fair value is $135,000 Required: Determine the amount of goodwill that will be recorded on the business combination. Prepare the statement of financial position of Gowan as at September 1, 2013. Answer: Calculation of goodwill Fair value of consideration: Issuance of shares Contingent consideration Total consideration paid or payable

$1,200,000 175,000 $1,375,000

Consideration received

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Chapter 2: Business Combinations

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Fair value of net assets acquired: Cash Accounts receivable Inventories Investments Capital assets Patent Band name Current liabilities Long-term liabilities Goodwill

$20,000 35,000 80,000 45,000 1,350,000 255,000 135,000 (280,000) (620,000)

1,020,000 $ 355,000

GOWAN LIMITED Statement of Financial Position As at September 1, 2013 $ Assets Cash (45 + 20) Accounts receivable (65 + 35) Inventory (50 + 80) Investments (45) Capital assets — net (3,590 + 1,350) Patent Brand name Goodwill Total assets

65,000 100,000 130,000 45,000 4,940,000 255,000 135,000 355,000 6,025,000

Liabilities Current liabilities Accounts payable (665 + 280) Bonds payable (1,350 + 620) Contingent liability

945,000 1,970,000 175,000

Shareholder's Equity Common shares (950 + 1,200) Retained earnings Total liabilities and shareholders' equity

2,150,000 785,000 6,025,000

Difficulty: Hard Learning Objective: Account for subsequent adjustments to the initial accounting for a business combination. Section Reference: Subsequent Adjustments to the Initial Accounting for a Business Combination Feedback: Review section “Contingent Consideration”

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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Testbank Chapter 3 – Consolidation: Wholly Owned Subsidiaries True or False

1) The acquisition analysis may include the recognition of assets and liabilities not recognized in the records of the subsidiary. Answer: True Difficulty: Easy Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “The Acquisition Analysis”

2) The fair value adjustments are required to eliminate the carrying amount of the parent’s investment in the subsidiary and the parent’s portion of pre-acquisition equity. Answer: False Difficulty: Medium Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “Pre-acquisition Adjustments”

3) Fair value increments on depreciable assets should be amortized in accordance with the subsidiary's depreciation policies. Answer: True Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

4) The consolidation process will involve replacing the investment account that is recorded in the books of the acquirer with the specific net assets acquired from the acquiree. 1

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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Answer: True Difficulty: Medium Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “The Acquisition Date”

5) A parent company can report an investment in its subsidiary on its Separate financial statements under either the cost or equity method. Answer: False Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Parent Company Recording in its Own Books”

6) When there is a gain on bargain purchase at the acquisition date, the net fair value of the identifiable assets and liabilities of the subsidiary is less than the consideration transferred. Answer: False Difficulty: Hard Learning Objective: Prepare a consolidated financial statement at the day of acquisition. Section Reference: Consolidated Financial Statements at the Day of Acquisition Feedback: Review section “Gain on Bargain Purchase”

7) The consolidation process will involve replacing the investment account that is recorded in the books of the acquirer with the goodwill acquired from the acquiree. Answer: False Difficulty: Medium Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “The Acquisition Date”

8) The pre-acquisition adjustments are required to eliminate the carrying amount of the parent’s investment in the subsidiary and the parent’s portion of pre-acquisition equity.

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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Answer: True Difficulty: Medium Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “Pre-Acquisition Adjustments” 9) A parent can acquire the shares in a subsidiary on a “cum div.” or an “ex div.” basis. Answer: True Difficulty: Medium Learning Objective: Prepare a consolidated financial statement at the day of acquisition. Section Reference: Consolidated Financial Statements at the Day of Acquisition Feedback: Review section “Dividends Recorded by the Subsidiary at the Acquisition Date”

10) The first step in the consolidation process, regardless of which year is being reported, is to undertake the eliminations. Answer: False Difficulty: Easy Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “The Acquisition Analysis”

11) At the date of acquisition, the assets and liabilities of the subsidiary are carried forward into the consolidated statement of financial position at fair value. Answer: True Difficulty: Medium Learning Objective: Prepare a consolidated financial statement at the day of acquisition. Section Reference: Consolidated Financial Statements at the Day of Acquisition Feedback: Review section “Basic Format”

12) The starting point for the preparation of the consolidated financial statements is the parent company’s individual statements at year end.

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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Answer: False Difficulty: Medium Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “Preparing Consolidated Financial Statements”

13) Since taxes are paid by the individual companies, the CCA claim is based on the amount recorded in the records of the acquiree. Answer: True Difficulty: Easy Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “The Acquisition Analysis”

14) Fair value adjustments (FVAs) are used to recognize the identifiable assets and liabilities of the subsidiary at fair values and goodwill measured as a residual amount. Answer: True Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

15) The goodwill impairment test does not involve elimination of all goodwill as a consequence. Answer: True Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

Multiple Choice

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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16) Which of the following statements is true regarding the consolidation process under ASPE? a) Under ASPE, the parent has the option of not consolidating with its subsidiary. b) Under ASPE, the parent must consolidate with its subsidiary. c) Under ASPE, the parent must use the cost or the equity method to account for its subsidiary. d) None of the above is true. Answer: a Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Preparation of Consolidated Financial Statements in Subsequent Periods”

17) The goodwill impairment test does not involve ________. a) elimination of all goodwill as a consequence. b) estimation and judgment on the part of management. c) an opportunity for a "big bath." d) an allocation of goodwill to reporting units. Answer: a Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

18) Which of the following statements about the consolidation process is FALSE? a) The consolidation process will involve replacing the investment account that is recorded in the books of the acquirer with the specific net assets acquired from the acquiree. b) Consolidation is achieved by combining the financial statements of both the parent and its subsidiary. c) The consolidated financial statements of a parent and its subsidiary include information about a subsidiary from the date the parent obtains physical possession of the

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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subsidiary. d) A subsidiary continues to be included in the parent’s consolidated financial statements until the parent no longer controls that entity. Answer: c Difficulty: Medium Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “The Acquisition Date”

19) If a consolidation is done at the day of acquisition, only the ______________ need be adjusted since all of the subsidiaries equity will be pre-acquisition and therefore eliminated. a) statement of financial position b) income statement c) cash flow statement d) statement of changes in equity. Answer: a Difficulty: Medium Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “Preparing Consolidated Financial Statements”

20) Which of the following statements regarding the consolidation process is FALSE? a) Where the parent entity and the subsidiary have different ends of reporting periods, adjustments must be made to the subsidiary’s statements before the preparation of the consolidated financial statements. b) Because IFRS 3 Business Combinations requires that, under the acquisition method, the identifiable assets and liabilities of the acquirer are to be reported at fair value, fair value adjustments are prepared as part of the consolidation process. c) Where the parent entity holds shares in the subsidiary, pre-acquisition adjustments are not part of the consolidation process. d) The consolidation process requires the addition of the financial statements of the parent and its subsidiaries. Answer: c Difficulty: Medium Learning Objective: Explain how the consolidation process works.

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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Section Reference: The Consolidation Process Feedback: Review section “Preparing Consolidated Financial Statements”

21) The first step in the consolidation process, regardless of which year is being reported, is to undertake the __________. a) acquisition analysis. b) goodwill calculation. c) eliminations. d) pre-acquisition adjustments. Answer: a Difficulty: Easy Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “The Acquisition Analysis” 22) The _______________ are required to eliminate the carrying amount of the parent’s investment in the subsidiary and the parent’s portion of pre-acquisition equity. a) goodwill calculations b) fair value adjustments c) post-acquisition adjustments. d) pre-acquisition adjustments. Answer: d Difficulty: Medium Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “Pre-acquisition Adjustments” 23) A parent can acquire the shares in a subsidiary on a “cum div.” or an “ex div.” basis. If the shares are acquired on a cum div. basis: a) The parent is not entitled to the dividend declared at acquisition date. b) The parent acquires two assets — the investment in the subsidiary and the dividend receivable. c) The dividend payable recorded by the subsidiary is a liability of the group. d) Both the dividend receivable and the dividend payable are not eliminated on the

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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consolidated statements. Answer: b Difficulty: Medium Learning Objective: Prepare a consolidated financial statement at the day of acquisition. Section Reference: Consolidated Financial Statements at the Day of Acquisition Feedback: Review section “Dividends Recorded by the Subsidiary at the Acquisition Date”

24) Which of the following statements regarding consolidated financial statements at the date of acquisition is FALSE? a) Fair value adjustments are used to recognize the identifiable assets and liabilities of the subsidiary at fair values and goodwill measured as a residual amount. b) The pre-acquisition adjustments eliminate the pre-acquisition equity of the subsidiary and the investment account recorded by the parent. c) When the subsidiary has recorded goodwill at acquisition date, adjustments must be made in the acquisition analysis to determine the amount of goodwill to be adjusted in the consolidation process. d) When the subsidiary has recorded a dividend payable at acquisition date, this must be excluded when calculating the consideration received. Answer: d Difficulty: Hard Learning Objective: Prepare a consolidated financial statement at the day of acquisition. Section Reference: Consolidated Financial Statements at the Day of Acquisition Feedback: Review section “Basic Format”

25) Inventory was acquired as part of a business combination at the end of 2012. The inventory was sold in 2013. How should the fair value adjustment for the inventory at acquisition be treated for consolidation at the end of 2013? a) It should be added to sales. b) It should be added to the cost of goods sold. c) It should be added to retained earnings. d) It should be added to inventory. Answer: b Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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Date Feedback: Review section “Fair Value Adjustments”

26) Which of the following statements regarding pre-acquisition adjustments is FALSE? a) The adjustments involve the investment account Investment in Subsidiary as shown in the financial statements of the parent. b) The adjustments involve the equity of the subsidiary at the acquisition date (i.e. the pre-acquisition equity). c) A deferred tax liability is recognized to increase the goodwill carrying amount. d) The pre-acquisition adjustment is necessary to avoid overstating the equity and net assets of the group. Answer: c Difficulty: Medium Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “Pre-acquisition Adjustments”

27) When there is a gain on bargain purchase at the acquisition date, the net fair value of the identifiable assets and liabilities of the subsidiary is greater than the consideration transferred. Which of the following statements in this situation is FALSE? a) The acquirer must firstly reassess the identification and measurement of the subsidiary’s identifiable assets and liabilities as well as the measurement of the consideration transferred. b) The expectation is that the excess of the net fair value over the consideration transferred is usually the result of measurement errors rather than being a real gain to the acquirer. c) Having confirmed the identification and measurement of both amounts paid and net assets acquired, if an excess still exists, it is recognized immediately in profit as a gain on bargain purchase. d) Existence of a gain on bargain purchase has no effect on the fair value adjustments when the subsidiary has previously recorded goodwill. Answer: d Difficulty: Hard Learning Objective: Prepare a consolidated financial statement at the day of acquisition. Section Reference: Consolidated Financial Statements at the Day of Acquisition Feedback: Review section “Gain on Bargain Purchase”

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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28) IAS 27, Separate Financial Statements, requires an entity that has a subsidiary and that reports on separate financial statements for a special purpose (for tax purposes), in addition to its consolidated statements, show the investment in that subsidiary at __________. a) cost. b) fair value. c) cost or fair value. d) carrying value. Answer: c Difficulty: Medium Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “Preparing Consolidated Financial Statements”

29) Helly Company purchased 100% of the outstanding common shares of Cobra Company on December 31, 2012 for $170,000. At that date, Cobra had $100,000 of outstanding common stock and retained earnings of $30,000. It was agreed that the net assets were fairly valued except that the fair value of the capital assets exceeded their net book value by $20,000 and the carrying value of the inventory exceeded its fair value by $10,000. The capital assets had a remaining useful life of eight years as of the acquisition date and have no salvage value. Inventory turns over four times a year. Both companies pay tax at a rate of 30%. What adjustment should be made to the consolidated financial statements for the year ended December 31, 2013 for the difference in inventory valuation? a) Cost of goods sold for 2013 will be decreased by $10,000. b) Retained earnings at the end of 2013 will be decreased by $10,000. c) Inventory at December 31, 2013 will be decreased by $10,000. d) Cost of goods sold for 2013 will be increased by $10,000. Answer: a Difficulty: Hard Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

30) Fair value increments on depreciable assets ________.

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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a) should be amortized in accordance with the parent company's depreciation policies. b) should always be recorded on the subsidiary's books. c) should be expensed immediately. d) should be amortized in accordance with the subsidiary's depreciation policies. Answer: d Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

31) Which of the following statements regarding the acquisition analysis is FALSE? a) The acquisition analysis may include the recognition of assets and liabilities not recognized in the records of the subsidiary. b) Differences between carrying amounts and fair values of the identifiable assets and liabilities of the subsidiary at acquisition date are recognized using fair value adjustments. c) The acquisition analysis will determine whether any goodwill or gain on bargain purchase has arisen as a part of the business combination. d) Where at acquisition date the parent holds shares in the subsidiary that it has previously acquired before it was a parent, this investment must not be revalued. Answer: d Difficulty: Easy Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “The Acquisition Analysis”

32) Azra Company purchased 100% of the outstanding common shares of Hassan Company on December 31, 2011 for $170,000. At that date, Hassan had $100,000 of outstanding common stock and retained earnings of $30,000. It was agreed that the net assets were fairly valued except that the fair value of the capital assets exceeded their net book value by $20,000 and the carrying value of the inventory exceeded its fair value by $10,000. The capital assets had a remaining useful life of eight years as of the acquisition date and have no salvage value. Inventory turns over four times a year. Both companies pay tax at the rate of 40%. What adjustment should be made to the consolidated financial statements for the year ended December 31, 2014 for the fair value increment related to the capital assets?

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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a) The retained earnings at January 1, 2014 will be increased by $12,000. b) Amortization expense on the capital assets for 2014 will be increased by $7,500. c) Amortization expense on the capital assets for 2014 will be increased by $2,500. d) Retained earnings at the end of 2014 will be increased by $7,500. Answer: c Difficulty: Hard Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

33) The consolidation process will involve replacing the investment account that is recorded in the books of the acquirer with the ____________ acquired from the acquiree. a) goodwill b) specific net assets c) negative goodwill d) retained earnings. Answer: b Difficulty: Easy Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “The Acquisition Date”

34) Yo Ltd. purchased a commercial food preparation system for $150,000 at the beginning of 2012. The estimated economic life of the system is 10 years and Yo uses straight-line amortization. At the beginning of 2014, Tilbury Ltd. acquired Yo in a business combination. At the time of acquisition, Yo's food preparation system had a fair value of $140,000. At the end of 2014, how much amortization expense should Yo report? a) $0 b) $14,000 c) $15,000 d) $17,500 Answer: c Difficulty: Hard Learning Objective: Prepare a consolidated financial statement in subsequent periods.

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

35) Nuworth Co. acquired Wellam Co. in a business combination at December 31, 2012. Wellam has a capital asset that it has been amortizing at a rate of $20,000 per year. At the time of the acquisition, the asset had a book value of $140,000 and a fair value of $154,000. The asset has a remaining life of 7 years. With respect to this asset, how much amortization expense should Nuworth report on its December 31, 2013 consolidated financial statements? a) $ 2,000 b) $ 5,400 c) $20,000 d) $22,000 Answer: d Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

36) Kizmit Ltd. acquired Nuance Ltd. in a business combination. One of the main reasons for the acquisition is that Kizmit wanted access to Nuance's extensive customer list. The list is not recorded on Nuance's books and has an estimated value of $100,000 and an estimated life of 7 years. On Kizmit's consolidated statement of financial position, what value should be shown for Nuance's customer list? a) $0, since it was not recorded on Nuance's books. b) $100,000 less any accumulated amortization (calculated over 7 years) and any impairment losses. c) $100,000 less any impairment losses. d) $100,000 less any accumulated amortization (calculated over 5 years) and any impairment losses. Answer: b Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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37) Ursula Ltd. has a subsidiary that has an intangible capital asset. It has not been recorded on the subsidiary's books, but at the date of acquisition, the asset had a fair value of $350,000 and an indefinite economic life. How should Ursula show the asset on its consolidated statement of financial position? a) $350,000 less accumulated amortization (calculated over 10 years) and any impairment losses. b) $350,000 less accumulated amortization (calculated over 40 years) and any impairment losses. c) The company should not show the asset on the consolidated financial statement as the subsidiary does not do so. d) $350,000 less any impairment losses. Answer: d Difficulty: Hard Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

38) Which of the following is false regarding making adjustments in relation to the content of the subsidiary’s financial statements? a) It is not necessary to make adjustments in relation to the content of the subsidiary’s financial statements. b) If the end of a subsidiary’s reporting period does not coincide with the end of the parent’s reporting period, adjustments must be made for the effects of significant transactions and events that occur between those dates. c) The consolidated financial statements are to be prepared using uniform accounting policies for like transactions and other events in similar circumstances. d) None of the above is false. Answer: a Difficulty: Medium Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “The Acquisition Date”

39) Sympo Ltd. acquired 100% of the commons shares of Grotto Co. This business combination resulted in $100,000 of goodwill. Sympo allocated the goodwill to three

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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cash-generating units. At its year-end, Sympo conducts a goodwill impairment test. Which of the following statements about the impairment test is TRUE? a) The impairment test is applied to Grotto Co. as a whole. b) The impairment test is applied to the business combination as a whole. c) Sympo is not required to conduct an impairment test unless its circumstances have changed materially from its previous year. d) The impairment test is applied to each of the three cash-generating units to which goodwill has been allocated. Answer: d Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

40) On January 1, 2013 ABC Company, a public company, acquired 100% of XYZ Ltd. The book value approximated fair value at the time of XYZ’s assets and liabilities with the exception of their bond payable which had a fair value $10,000 less than its recorded book value and a remaining life of 20 years. Which of the following statements is false? a) It is not required to use the effective interest rate method, so it may amortize the fair value adjustment on a straight-line basis. b) The bond payable must be reflected at the amortized cost using the effective interest rate method. c) Over the remaining life of the debt of 20 years, the interest expense will need to be adjusted annually using the effective interest rate method. d) None of the above is false. Answer: a Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

41) Which of the following statements regarding consolidated financial statements at the date of acquistion is FALSE? a) At the day of acquisition, there is a need to prepare a consolidated statement of income.

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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b) Regarding the equity accounts, only the parent’s balances are carried into the consolidated statement of financial position. c) At acquisition date, all the equity of the subsidiary is pre-acquisition and eliminated. d) The assets and liabilities of the subsidiary are carried forward into the consolidated statement of financial position at fair value. Answer: a Difficulty: Medium Learning Objective: Prepare a consolidated financial statement at the day of acquisition. Section Reference: Consolidated Financial Statements at the Day of Acquisition Feedback: Review section “Basic Format”

42) What values should be used for the assets, liabilities, and shareholders' equity to start the consolidation process? a) Carrying values for the parent company and fair values for the subsidiary company. b) Fair values for the parent company and carrying values for the subsidiary company. c) Carrying values for both the parent and the subsidiary companies. d) Fair values for both the parent and the subsidiary companies. Answer: c Difficulty: Medium Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “Preparing Consolidated Financial Statements”

43) When the parent has previously held equity interest in the subsidiary, in accordance with IFRS 3.42, the parent revalues the previously held investment to fair value, recognizing the increment in ___________________. a) retained earnings. b) net income. c) assets. d) other comprehensive income. Answer: b Difficulty: Easy Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “Previously Held Equity Interest in the Subsidiary” 16

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

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44) The starting point for the preparation of the consolidated financial statements is: a) The individual company statements at that date. b) The previous year’s consolidated financial statements. c) The parent company’s individual statements at year end. d) The subsidiary company’s individual statements at that date. Answer: a Difficulty: Medium Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “Preparing Consolidated Financial Statements”

45) Goodwill recorded by the subsidiary at the acquisition date is? a) Added to the goodwill recognized by the parent at the acquisition date. b) Deducted from the net fair value of the identifiable assets and liabilities of the subsidiary in the performing the acquisition analysis. c) Is amortized over 25 years. d) An impairment loss is recognized by the subsidiary for the entire amount. Answer: b Difficulty: Medium Learning Objective: Prepare a consolidated financial statement at the day of acquisition. Section Reference: Consolidated Financial Statements Subsequent at the Day of Acquisition Feedback: Review section “Goodwill Recorded by Subsidiary at Acquisition Date”

46) Kayla Ltd. owns 100% of Milos Ltd. Kayla records its investment at cost. Kayla received $300,000 in dividends from Milos. What adjustment should Kayla make on its consolidated financial statements with respect to the dividends? a) Decrease Dividend income (Kayla): $300,000 Decrease Dividends declared (Milos): $300,000 b) Increase Dividend income (Kayla): $300,000 Increase Dividends declared (Milos): $300,000 c) Decrease Dividends declared (Milos): $300,000 Decrease Investment in Milos (Kayla): $300,000 d) Increase Dividends declared (Milos): $300,000 Increase Investment in Milos (Kayla): $300,000

Fayerman: Advanced Accounting, Ce

Chapter 3: Consolidation: Wholly Owned Subsidiaries

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Answer: a Difficulty: Hard Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Parent Company Recording in its Own Books”

47) When performing the fair value adjustment process, which of the following is true? a) The deferred income tax is reversed on the same basis as the fair value adjustment is written off b) The deferred income tax recognized during the acquisition analysis always remains the same. c) The fair value adjustments are initially recorded on the statement of financial position and are never written off d) The fair value adjustments are initially recorded on the statement of financial position and are always written off through comprehensive income over a period of 5 years. Answer: a Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

48) Since taxes are paid by the individual companies, the CCA claim for the acquiree is based on the amount recorded in the records of the ____________. a) acquirer. b) acquiree and acquirer. c) acquiree. d) consolidated entity. Answer: c Difficulty: Easy Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “The Acquisition Analysis”

Fayerman: Advanced Accounting, Ce

Chapter 3: Consolidation: Wholly Owned Subsidiaries

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49) Carson Company purchased 100% of the outstanding common shares of Towson Company on December 31, 2011 for $170,000. At that date, Towson had $100,000 of outstanding common stock and retained earnings of $30,000. It was agreed that the net assets were fairly valued except that the fair value of the capital assets exceeded their net book value by $20,000 and the carrying value of the inventory exceeded its fair value by $10,000. The capital assets had a remaining useful life of eight years as of the acquisition date and have no salvage value. Inventory turns over four times a year. Both companies pay tax at the rate of 30%. It is now 2014 and Carson has been very pleased with how profitable its investment in Towson has been. On Carson’s consolidated financial statements at December 31, 2014, what balance should be reported for goodwill? a) $30,000. b) $33,000. c) $19,000. d) $40,000. Answer: b Difficulty: Hard Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

50) In a business combination that occurred 2 years ago, there was a fair value adjustment due to land as the fair value was greater than its recorded book value by $20,000. The company’s tax rate is 40%. What is the required adjustment upon consolidation this year? a) There is no required adjustment upon consolidation. b) Increase the carrying value of land by $20,000 and increase the deferred tax liability of $8,000. c) Increase the carrying value of land by $12,000 d).Recognize goodwill for $20,000 Answer: b Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments”

Fayerman: Advanced Accounting, Ce

Chapter 3: Consolidation: Wholly Owned Subsidiaries

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Short Answer

51) Before undertaking the consolidation process, describe the adjustments that may be necessary in relation to the content of the financial statements of the subsidiary. Difficulty: Medium Learning Objective: Explain how the consolidation process works. Section Reference: The Consolidation Process Feedback: Review section “The Acquisition Date” Solution: Suggested answer: Before undertaking the consolidation process, it may be necessary to make adjustments in relation to the content of the financial statements of the subsidiary: •

If the end of a subsidiary’s reporting period does not coincide with the end of the parent’s reporting period, adjustments must be made for the effects of significant transactions and events that occur between those dates, with additional financial statements being prepared where it is practical to do so (IFRS 10 B.21). In most cases where there are different dates, the subsidiary will prepare adjusted financial statements as at the end of the parent’s reporting period, so that adjustments are not necessary on consolidation. Where the preparation of adjusted financial statements is unduly costly, the financial statements of the subsidiary prepared at a different date from the parent may be used, subject to adjustments for significant transactions. However, for this to be a viable option, the difference between the ends of the reporting periods can be no longer than 3 months. Further, the length of the reporting periods, as well as any difference between the ends of the reporting periods, must be the same from period to period.

•

The consolidated financial statements are to be prepared using uniform accounting policies for like transactions and other events in similar circumstances (IFRS 10.41). Where different policies are used, adjustments are made so that like transactions are accounted for under a uniform policy in the consolidated financial statements.

52) Regarding the Acquisition Analysis, describe pre-acquisition adjustments and what they aim to accomplish. Difficulty: Medium Learning Objective: Prepare an acquisition analysis for the parent’s acquisition in a subsidiary. Section Reference: The Acquisition Analysis Feedback: Review section “Pre-Acquisition Adjustments”

Fayerman: Advanced Accounting, Ce

Chapter 3: Consolidation: Wholly Owned Subsidiaries

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Solution: Suggested answer: The pre-acquisition adjustments are required to eliminate the carrying amount of the parent’s investment in the subsidiary and the parent’s portion of pre-acquisition equity. The pre-acquisition adjustments, then, involve three areas: • • •

The investment account Investment in Subsidiary, as shown in the financial statements of the parent. The equity of the subsidiary at the acquisition date (i.e. the pre-acquisition equity). Recognition of goodwill. There is no recognition of a deferred tax liability in relation to goodwill because goodwill is a residual, and the recognition of a deferred tax liability would increase its carrying amount.

The pre-acquisition adjustment is necessary to avoid overstating the equity and net assets of the group.

53) What adjustments are typically needed when consolidated financial statements are prepared at the acquisition date? Difficulty: Medium Learning Objective: Prepare a consolidated financial statement at the day of acquisition. Section Reference: Consolidated Financial Statements at the Day of Acquisition Feedback: Review section “Basic Format” Solution: Suggested answer: When consolidated financial statements are prepared at the acquisition date, the following adjustments are typically necessary: •

• •

In relation to the equity accounts, i.e., share capital, and retained earnings — only the parent’s balances are carried into the consolidated statement of financial position. At acquisition date, all the equity of the subsidiary is pre-acquisition and eliminated. The assets and liabilities of the subsidiary are carried forward into the consolidated statement of financial position at fair value. The adjustments total 0. This means that the adjustments have equal increases and decreases (debits and credits), which is essential if the statement of financial position is to balance.

Fayerman: Advanced Accounting, Ce

Chapter 3: Consolidation: Wholly Owned Subsidiaries

Testbank

54) Fair value adjustments (FVAs) are used to recognize the identifiable assets and liabilities of the subsidiary at fair values and goodwill measured as a residual amount. What happens to the fair value adjustments subsequent to the acquisition date? Difficulty: Medium Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Fair Value Adjustments” Solution: Suggested answer: The FVAs are written off through comprehensive income as the item is written off: • Inventory; when sold • Land: when sold or impaired • Depreciable asset and intangibles with a limited life: over the useful life • Liabilities: over the life using the effective interest method • Goodwill: when impaired • The deferred income tax is reversed on the same basis as the FVA is written off.

55) On January 1, 2013 Paisley Ltd. Acquired 100% of the issued shares of Plaid Incorporated. The fair value of the consideration paid was measured at $460,000. At this date, records of Plaid Incorporated included the following information: Share Capital Retained Earnings Goodwill

$200,000 $80,000 $20,000

As at January 1, 2013, all the identifiable assets and liabilities of Plaid were recorded in the subsidiary’s books at fair value except for the following assets:

Inventory Land

Carrying Amount $60,000 $100,000

Fair Value $90,000 $125,000

The inventory was all sold by December 31, 2013. The land is still remaining with Plaid as at December 31, 2013. Goodwill has not been deemed to be impaired. The tax rate is 40%. The summarized financial statements of both entities as at December 31, 2013 are shown below. Required:. Prepare the consolidated financial statements of Paisley Ltd. As at December 31, 2013.

Fayerman: Advanced Accounting, Ce

Chapter 3: Consolidation: Wholly Owned Subsidiaries

Paisley Ltd.

Plaid Incorporated

Revenues Expenses Profit before tax Income tax expense Profit for the period Retained earnings 1/1/2013 Retained earnings 12/31/2013 Share capital

$950,000 $430,000 $520,000 $200,000 $320,000 $150,000 $470,000 $300,000

$725,000 $375,000 $350,000 $150,000 $200,000 $80,000 $280,000 $200,000

Deferred tax liabilities Other liabilities Total liabilities Total equity and liabilities

$15,000 $200,000 $215,000 $985,000

$10,000 $175,000 $185,000 $665,000

Cash Inventory Financial assets Land Investment in Plaid Incorporated Intangible assets Goodwill Total assets

$175,000 $225,000 $40,000 $460,000 $85,000 $985,000

$90,000 $110,000 $65,000 $100,000 $280,000 $20,000 $665,000

Testbank

Difficulty: Hard Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Preparation of Consolidated Financial Statements in Subsequent Periods” Solution: Suggested answer: -The equity of the subsidiary as the acquisition date consists of $200,000 for share capital and $80,000 for retained earnings -The difference between the carrying amounts of Plaid Incorporated’s recorded assets and liabilities and their fair values consists of inventory for which there is a $30,000 difference and land for which there is a $25,000 difference. These differences are recognized in the acquisition analysis as fair value adjustments on an after-tax basis. -Any goodwill recorded by Plaid Incorporated at the acquisition date needs to be adjusted for. Because it is the fair value of the identifiable assets being considered and goodwill is

Fayerman: Advanced Accounting, Ce

Chapter 3: Consolidation: Wholly Owned Subsidiaries

Testbank

an unidentifiable asset, goodwill must be adjusted for in the calculation. In this case Plaid Incorporated has $20,000 of goodwill. Acquisition analysis: At January 1, 2013: Consideration transferred

= $460,000

Net fair value of identifiable assets And liabilities of Plaid Incorporated =$200,000 + $80,000 (equity) -$20,000 goodwill recorded +$30,000 X (1-40%) FVA- Inventory +$25,000 X (1-40%) FVA- Land =$293,000 Goodwill

=$460,000-$293,000 =$167,000

Unrecorded Goodwill

=$167,000 - $20,000 =$147,000

Analyze each fair value adjustment and decide when it will be written off Consolidation adjustments at December 31, 2013

FVA Inventory Land Income tax Goodwill

Comprehensive Income ($30,000) $12,000 -

Beginning R/E -

Stmt. Of Fin. Posit. $25,000 ($10,000) $167,000

Total

($18,000)

$182,000

Pre-acquisition adjustments at December 31, 2013 Reduce investment in Plaid Incorporated Reduce retained earnings

$200,000 $80,000

Prepare the consolidated financial statements as at December 31, 2013:

Fayerman: Advanced Accounting, Ce

Chapter 3: Consolidation: Wholly Owned Subsidiaries

Paisley Ltd. Plaid Incorporated Adj. Revenues $950,000 Expenses $430,000 Profit before tax $520,000 Income tax expense $200,000 Profit for the period $320,000 Retained earnings 1/1/2013 $150,000 Retained earnings 12/31/2013$470,000 Share capital $300,000

$725,000 $375,000 $350,000 $150,000 $200,000 $80,000 $280,000 $200,000

Deferred tax liabilities Other liabilities Total liabilities Total equity and liabilities

$10,000 $175,000 $185,000 $665,000

$15,000 $200,000 $215,000 $985,000

Cash $175,000 Inventory $225,000 Financial assets $40,000 Land Investment in Plaid Incorporated$460,000 Intangible assets $85,000 Goodwill -

$90,000 $110,000 $65,000 $100,000 $280,000 $20,000

Total assets

$665,000

$985,000

$30,000 ($30,000) ($12,000) ($18,000) ($80,000) ($98,000) ($200,000) $10,000

($288,000)

$25,000 ($460,000) ($20,000)+ $167,000 ($288,000)

PAISLEY LTD Consolidated Statement of Comprehensive Income For the year Ended December 31, 2013 Revenues Expenses Profit before tax Income tax expense Comprehensive Income for the Year

$1,675,000 $835,000 $840,000 $338,000 $502,000

PAISLEY LTD Consolidated Statement of Changes in Equity For the year Ended December 31, 2013 Retained earnings balance at January 1, 2013 Profit for the Period Retained earnings balance at December 31, 2013

$150,000 $502,000 $652,000

Testbank

Consolidated $1,675,000 $835,000 $840,000 $338,000 $502,000 $150,000 $652,000 $300,000 $35,000 $375,000 $410,000 $1,362,000 $265,000 $335,000 $105,000 $125,000 $365,000 $167,000 $1,362,000

Fayerman: Advanced Accounting, Ce

Chapter 3: Consolidation: Wholly Owned Subsidiaries

PAISLEY LTD Consolidated Statement of Financial Position As at December 31, 2013 Equity and Liabilities Equity Share Capital Retained Earnings Total Equity

$300,000 $652,000 $952,000

Non-Current Liabilities Deferred tax liabilities Other Total non-current liabilities

$35,000 $375,000 $410,000

Total equity and liabilities

$1,362,000

Assets Non-current assets Land Intangible assets Goodwill Total non-current assets

$125,000 $365,000 $167,000 $657,000

Current assets Cash Inventory Financial assets Total current assets

$265,000 $335,000 $105,000 $705,000

Total assets

$1,362,000

Testbank

Fayerman: Advanced Accounting, Ce

Chapter 3: Consolidation: Wholly Owned Subsidiaries

Testbank

56) On January 1, 2012 Finn Ltd. Acquired 75% of the shares of Ewe Corporation for $10 per share in cash. The equity of Ewe as at that date was: Share capital- 20,000 shares Retained earnings

$20,000 $50,000

Finn had previously acquired 25% of the shares of Ewe for $10,000. The fair value of this investment as at January 1, 2012 was $50,000. At the acquisition date all of the identifiable assets and liabilities of Ewe were recorded at fair value except for a plant and inventory, whose carrying amounts were $15,000 and $5,000 respectively less than their fair value. All of the inventory was subsequently sold during 2012 and the plant had a remaining useful life at the acquisition date of 5 years. The tax rate is 40%. Ewe had been actively researching a new process, which is part of the reason why Finn acquired the remaining outstanding shares of Ewe. Finn estimated the value of this intangible to be $10,000 and that it would have an indefinite useful life. Required: Prepare the acquisition analysis and the consolidation adjustments of Finn and Ewe as at December 31, 2013. Difficulty: Hard Learning Objective: Prepare a consolidated financial statement in subsequent periods. Section Reference: Consolidated Financial Statements Subsequent to the Acquisition Date Feedback: Review section “Preparation of Consolidated Financial Statements in Subsequent Periods” Solution: Suggested answer: Calculate the fair value adjustments FVA at the acquisition date: -The recorded equity of the subsidiary at the acquisition date: This consists of $20,000 share capital and $50,000 retained earnings. -Differences between carrying amounts and fair values for assets recorded by the subsidiary: The differences arise for inventory +$5,000 and a plant +$15,000. -Identifiable assets and liabilities not recorded by the subsidiary but recognized by the subsidiary but recognized as part of the business combination at their fair values: Intangible asset +$10,000 Acquisition analysis at January 1, 2012-11-15

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Chapter 3: Consolidation: Wholly Owned Subsidiaries

Consideration transferred

=$150,000 =75% X $10 X 20,000

Fair value of previously held investment

=$50,000

Aggregate amount of investment

=$200,000

Net fair value of identifiable Assets and liabilities of Ewe

Goodwill acquired

Testbank

=$20,000 + $50,000 (equity) $15,000 X (1-40%) plant $5,000 X (1-40%) inventory $10,000 X (1-40%) intangible =$112,000

Analyze each fair value adjustment and decide when it will be written off

FVA Comprehensive income Inventory Plant ($3,000) Intangible Income tax expense ($1,200) Income tax asset/(liability) Goodwill

Beg R/E ($3,000) ($1,800)

Total

($4,800)

($1,800)

Stmt. Of Fin. Pos. $9,000 $10,000 $4,000 $112,000 $127,000

Fayerman: Advanced Accounting, Cdn Ed

Chapter 4: Consolidations: Intragroup Transactions

Testbank

Testbank Chapter 4 – Consolidations: Intragroup Transactions

True or False

1) In the consolidation of intragroup transactions in the current period consideration should be given to the effects of transactions in previous periods. Answer: True Difficulty: Easy Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Adjusting for Intragroup Transactions: Principles Feedback: Review section “Rationale for Adjusting for Intragroup Transactions.”

2) In some intragroup transactions where there is management fee paid by one entity to another within the group there is no effect on the carrying amounts of assets and liabilities. Answer: True Difficulty: Easy Learning Objective: Adjust for intragroup services such as management fees. Section Reference: Intragroup Services Feedback: Review section “Intragroup Services”

3) Adjustments for current period inventory transfers during intragroup consolidations do not affect current period profit accounts such as sales and cost of sales. Answer: False Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and ending inventory. Section Reference: Adjusting for Intragroup Transactions: Principles Feedback: Review section "Rationale for Adjusting for Intragroup Transactions."

4) In the transferring of assets such as property, plant, and equipment within a group there is no need to eliminate profit in an asset such as land because land is a non-depreciable asset. Answer: False 1

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Chapter 4: Consolidations: Intragroup Transactions

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5) Rent for office space paid by a parent to a fully-owned subsidiary within the group does not affect the group's profit in the consolidation adjustment process. Answer: True Difficulty: Easy Learning Objective: Adjust for intragroup services such as management fees. Section Reference: Intragroup Services. Feedback: Review “Example 4.8: Intragroup Rent”.

6) Generally dividends paid and received between entities within a group do not require tax-effect adjustments upon consolidation. Answer: True Difficulty: Easy Learning Objective: Adjust for intragroup dividends. Section Reference: Intragroup Dividends Feedback: Review section: "Tax Effect of Dividends".

7) Interest payments on bonds within a group of companies do not require adjustments to revenues and expenses in the respective entities. Answer: False Difficulty: Medium Learning Objective: Adjust for intragroup borrowings Section Reference: Intragroup Borrowings Feedback: Review section “Bonds”.

8) A Canadian company that has wholly owned subsidiaries in countries that do not follow GAAP/IFRS accounting principles is not required to make adjustments for intragroup transactions. Answer: False Difficulty: Medium Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Adjusting for Intragroup Transactions: Principles 2

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Chapter 4: Consolidations: Intragroup Transactions

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Feedback: Review section “Rationale for Adjusting for Intragroup Transactions”.

9) Opening intragroup inventory transfers of an acquired subsidiary require that prior period profits remaining in the opening inventory be adjusted to beginning retained earnings. Answer: True Difficulty: Easy Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and ending inventory Section Reference: Transfers of Inventory Feedback: Review “Unrealized Profits in Beginning Inventory”

10) The parent company of subsidiaries that are owned less than 100% but more than 50% have the option of adjusting intragroup transactions and would make a statement to this effect only in the notes to the financial statements. Answer: False Difficulty: Medium Learning Objective: Explain the principles behind making adjustments for intragroup transactions Section Reference: Adjusting for Intragroup Transactions: Principles Feedback: Review section “Rationale for Adjusting for Intragroup Transactions”

11) It is possible for an entity to acquire the bonds of another entity in the group on the open market. Answer: True Difficulty: Medium Learning Objective: Adjust for intragroup bonds acquired on the open market Section Reference: Intragroup Borrowings Feedback: Review “Bonds”

12) Consolidation adjustments are needed in relation to intragroup borrowings and interest thereon. Answer: True Difficulty: Medium Learning Objective: Adjust for intragroup bonds acquired on the open market Section Reference: Intragroup Borrowings Feedback: Review “Intragroup Borrowings”

13) Interest payments result in revenues in one member of the group and expenses in another. 3

Fayerman: Advanced Accounting, Cdn Ed

Chapter 4: Consolidations: Intragroup Transactions

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Answer: False Difficulty: Medium Learning Objective: Adjust for intragroup bonds acquired on the open market Section Reference: Intragroup Borrowings Feedback: Review “Intragroup Borrowings”

14) Adjustments for intragroup dividends affect both the dividends declared by the subsidiary and those declared by the parent. Answer: False Difficulty: Medium Learning Objective: Adjust for intragroup dividends Section Reference: Intragroup Dividends Feedback: Review “Intragroup Dividends”

15) Consolidated financial statements show only the effects of dividends paid or payable to entities outside the group. Answer: True Difficulty: Medium Learning Objective: Adjust for intragroup dividends Section Reference: Intragroup Dividends Feedback: Review “Intragroup Dividends”

16) If a subsidiary declares a dividend and the dividend is unpaid at the end of the period, the adjustment on the consolidated financial statements will include an increase to dividend revenue. Answer: False Difficulty: Medium Learning Objective: Adjust for intragroup dividends Section Reference: Intragroup Dividends Feedback: Review “Dividends Declared in the Current Period but Not Paid”

17) Dividends from subsidiary equity are recognized as revenue by the subsidiary. Answer: False Difficulty: Medium Learning Objective: Adjust for intragroup dividends 4

Fayerman: Advanced Accounting, Cdn Ed

Chapter 4: Consolidations: Intragroup Transactions

Testbank

Section Reference1: Intragroup Dividends Feedback: Review “Intragroup Dividends”

18) Adjustments for the gain/loss on sale of property, plant and equipment are made in all periods in which the assets are within the group. Answer: True Difficulty: Easy Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods. Section Reference: Intragroup Profits and Losses on Transfers of Property, Plant, and Equipment Feedback: Review “Depreciation and Realization of Profits or Losses”

19) When the transferred assets are depreciable, subsequent adjustments are made to depreciation accounts. Answer: True Difficulty: Easy Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods Section Reference: Intragroup Profits and Losses on Transfers of Property, Plant, and Equipment Feedback: Review “Depreciation and Realization of Profits or Losses”

20) The gain/loss on the sale of a depreciable asset is realized by the subsidiary as the asset is used up by the group. Answer: False Difficulty: Easy Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant and equipment in both the current and previous periods. Section Reference: Intragroup Profits and Losses on Transfers of Property, Plant and Equipment Feedback: Review “Depreciation and Realization of Profits or Losses”

21) When property, plant, and equipment is transferred within a group, it is not necessary to distinguish between a sale of land and the sale of a depreciable asset. Answer: False Difficulty: Easy Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods 5

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Chapter 4: Consolidations: Intragroup Transactions

Testbank

Section Reference: Intragroup Profits and Losses on Transfers of Property, Plant, and Equipment Feedback: Review “Depreciation and Realization of Profits or Losses”

Multiple Choice 22) Which of the following is NOT a requirement for intragroup transactions under IFRS? a) Whenever related entities transact with each other, the separate legal entities disclose the effects of these transactions in the revenues and expenses reported as well as assets and liabilities as required. b) Deferred tax accounts must be created where there are temporary differences between the carrying amount of an asset or a liability and its tax base. c) The process of consolidation involves adding together the financial statements of a parent and its subsidiaries to reflect an overall view that includes the results of the group transactions with external entities and also within the group. d) Adjustments must be made to eliminate intragroup balances and the effects of transactions whereby profits or losses are made by different members of the group through trading with each other. Answer: c Difficulty: Medium Learning Objective: Explain the principles behind making adjustments for intragroup transactions Section Reference: Rationale for Adjusting for Intragroup Transactions Feedback: Review section “Rationale for Adjusting for Intragroup Transactions.”

23) Dither Co. owns 100% of the common shares of Franklin Ltd. Dither records its investment in Franklin using the cost method. Dither and Franklin have transactions with each other. In preparing Dither's consolidated financial statements, which of the following should be done? a) Dividends received by Dither from Franklin should be deducted from Dither's dividend income. b) Franklin's retained earnings should be deducted from Dither's retained earnings. c) Dither's receivable from Franklin should be netted with Dither's accounts receivable. d) Franklin's share capital should be added to Dither's share capital. Answer: a Difficulty: Medium Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Adjusting for Intragroup Transactions: Principles Feedback: Review section “Rationale for Adjusting for Intragroup Transactions.”

24) On February 1, 2013 Smith Company sold inventory to its wholly owned subsidiary Orchid Ltd. for $10,000. These goods had previously cost $7,500. 75% of these goods were then sold by Orchid Ltd. for $15,000 by the February 28, 2013 year-end. What adjustments are required for the preparation of the consolidated financial statements? Ignore the effects of income taxes. 6

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Chapter 4: Consolidations: Intragroup Transactions

Testbank

a) Decrease sales $10,000, decrease cost of goods sold $9,375 and decrease ending inventory $625. b) Increase sales $10,000, increase cost of goods sold $9,375 and increase ending inventory $625. c) Decrease sales $10,000, decrease cost of goods sold $7,500 and decrease ending inventory $2,500. d) Increase sales $10,000, increase cost of goods sold $7,500 and increase ending inventory $2,500. Answer: a Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and ending inventory. Section Reference: Transfers of Inventory Feedback: Review “Unrealized Profits in Ending Inventory”.

25) On February 1, 2013 Smith Company sold inventory to its wholly owned subsidiary Orchid Ltd. for $10,000. These goods had previously cost $7,500. All of these goods were then sold by Orchid Ltd. for $25,000 by the February 28, 2013 year-end. What adjustments are required for the preparation of the consolidated financial statements? Ignore the effects of income taxes. a) Decrease sales $10,000 and decrease cost of goods sold $10,000. b) Increase sales $10,000 and increase cost of goods sold $10,000. c) Decrease sales $10,000 and decrease cost of goods sold $7,500 and decrease ending inventory $2,500. d) None of the above Answer: d Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and ending inventory. Section Reference: Transfers of Inventory Feedback: Review section “Unrealized Profits in Ending Inventory.”

26) On March 31, 2013 a parent received $20,000 in inventory for cash from its subsidiary. The subsidiary made a profit of $5,000 on the sale. At year end, the parent had sold $15,000 of this inventory to third parties for $28,000. The closing balance of this inventory is $5,000. What is the combined adjustment to sales and cost of sales before tax? a) $1,000 b) $1,250 c) $1,500 d) $2,000 Answer: b Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and 7

Fayerman: Advanced Accounting, Cdn Ed

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ending inventory Section Reference: Transfers of Inventory Feedback: Review "Unrealized Profits in Ending Inventory."

27) On September 30, 2013 a parent company sold a piece of machinery to its wholly-owned subsidiary for $10,000 which was $5,000 above its carrying amount at that date. The machinery has a remaining useful life of 5 years. What is the pre-tax adjustment required to prepare the December 31, 2013 consolidated financial statements? a) Increase machinery-net $5,000, b) Decrease machinery – net $5,000. c) Record a loss of $5.000 on the income statement d) None of the above. Answer: b Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods. Section Reference: Sale of Depreciable Assets Feedback: Review section “Depreciation and Realization of Profits or Losses”

28) A basic approach in determining the adjustments needed for the consolidation of intragroup transactions is: a) Analyze the transfer events in the records of the legal entities and determine whether these transactions are for the current period. b) Analyze the position from the group's perspective and adjust the consolidated statements of the group. c) Consider the income tax effects of the adjustments. d) All of the above. Answer: d Difficulty: Medium Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Intragroup Profits and Losses on Transfers of Property, Plant, and Equipment Feedback: Review sections “Rationale for Adjusting for Intragroup Transactions” and “Income Tax Effects”.

29) On January 1, 2013 a parent purchased the plant of a subsidiary for $ 6,000, which was $1,000 below the carrying cost for the subsidiary as at the date it was sold. The plant had a remaining life of ten years and the income tax rate was 30%. What amounts should be shown as a loss on sale of plant and the income tax expense respectively on the consolidated financial statements for the year ended December 31, 2013? 8

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a) $ 1,000 and $300 b) $1,000 and $210 c) $ 500 and $ 150 d) None of the above. Answer: d Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods. Section Reference: Intragroup profits and losses on transfers of property, plant and equipment Feedback: Review "Sales of Depreciable Assets."

30) In an acquisition of land by a parent from a subsidiary, the realization of profit acquired on the land acquisition is recorded in the consolidated financial statements? a) In the first year that the group's consolidated financial statements are prepared. b) When the asset is subsequently sold to a party outside of the group. c) As it is amortized over the period of the life of the other assets. d) No profit will be realized because land is not amortized. Answer: b Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods. Section Reference: Intragroup Profits and Losses on Transfers of Property, Plant, and Equipment Feedback: Review section "Sale of Land."

31) The requirement for the full adjustment relating to the effects of intragroup transactions is stated in IFRS consolidated financial statements as follows: a) State in a note to the financial statements a quantification of which intragroup transactions have been eliminated. b) Intragroup transactions need only be accounted for in the accounts of the parent group. c) Eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions d) Eliminate only current transactions affecting sales, and inventories in the acquired intragroup entities. Answer: c Difficulty: Easy Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Rationale for Adjusting for Intragroup Transactions 9

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Feedback: Review “Rationale for Adjusting for Intragroup Transactions.”

32) According to IFRS principles, revenues and expenses resulting from intragroup transactions that require consolidation adjustments are to be made as follows: a) In the current period only. b) In the prior period. c) Recognized in assets only. d) None of the above. Answer: a Difficulty: Medium Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Rationale for Adjusting for Intragroup Transactions. Feedback: Review section “Rationale for Adjusting for Intragroup Transactions.”

33) Assets in the consolidated statement of financial position must be shown as follows: a) Cost to the group b) Cost to the parent. c) Market value to the group. d) Market value to the subsidiary. Answer: a Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods. Section Reference: Intragroup profits and losses on transfers of property, plant, and equipment Feedback: Review “Rationale for Adjusting for Intragroup Transactions.”

34) In consolidated financial statements of a parent and subsidiaries, an income tax adjustment is necessary: a) For advising Canada Revenues Agency only. b) Whenever unrealized profit causes a difference between the carrying amount of an asset and the carrying amount shown in the consolidated financial statements. c) Where unrealized profit causes a difference between the carrying amount of an asset or a liability in the records of the legal entity only. d) All of the above. Answer: b Difficulty: Medium 10

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Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Rationale for Adjusting for Intragroup Transactions Feedback: Review "Income Tax Effects"

35) Where inventory is transferred in the current period and some or all of that inventory is still on hand at the end of the period, the general form of financial statement adjustment is: a) The inventory adjustment is based upon the total inventory transferred among groups. b) The inventory adjustment is based on the profit remaining in ending inventory on hand. c) The adjustment to inventory is made only when all inventory is sold to external groups. d) None of the above. Answer: b Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and ending inventory. Section Reference: Transfers of Inventory Feedback: Review Example 4.1: Intracompany Sale of Inventory

36) A subsidiary sold a depreciable asset to the parent at a profit of $100 and the parent depreciates the assets on a straight-line basis over ten years. In year one after the sale, the realized profit is: a) $100 b) $ 90 c) $ 110 d) $50 Answer: c Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods. Section Reference: Realization of Profits or Losses Feedback: Review "Realization of Profits or Losses on Depreciable Asset Transfers"

37) The use of the services of a specialist from a parent to a subsidiary for a short period of time within a year requires the following treatment in the consolidated statements: a) Realized profit need to be calculated in the consolidation process. b) The consolidation adjustments do not affect the group's accounts c) Adjustments are required to adjust the specialist's salary d) Special income tax adjustments are required in accordance with policies of Canada Revenue Agency. 11

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Answer: b Difficulty: Easy Learning Objective: Adjust for intragroup services such as management fees. Section Reference: Intragroup Services. Feedback: Review Example 4.7: Intragroup Services.

38) Dividends received by a parent from a subsidiary are accounted for: a) As revenue to the parent since the parent has been recording the investment in the subsidiary using the cost method on its own non-consolidated financial statements. b) As a transfer to cash since no intragroup realized profit transactions are required to be recorded. c) As a reduction of cost of sales on the parent's income statement. d) None of the above Answer: a Difficulty: Medium Learning Objective: Adjust for intragroup dividends. Section Reference: Intragroup Dividends Feedback: Review “Intragroup Dividends”.

39) A parent issues one thousand $100 bonds at an interest rate of 5% and its wholly owned subsidiary acquires half of the bond issue. These transactions result in: a) Intragroup borrowings result in transactions being recorded as assets of one member of the group and a recording as liabilities of the other member only. b) Intragroup interest payments require entries in revenues of one member of the group and expenses in the other member of the group only. c) Intragroup borrowing and intragroup interest payments result in both assets and revenues being recorded in one member of the group and liabilities and expenses being recorded in the other member's books. d) These transactions need only be noted in the notes to the financial statements. Answer: c Difficulty: Medium Learning Objective: Adjust for intragroup borrowings. Section Reference: Intragroup Borrowings Feedback: Review Example 4.10: Bonds Acquired at Date of Issue

40) A parent owns 100% of a subsidiary company. One month before its year-end date of March 31, 2031, the parent loaned the subsidiary $120,000. The subsidiary paid back $20,000 in January 2014. In the preparation of the consolidated balance sheet for March 31, 2014, What amount of this loan should be eliminated in the consolidated financial statements? 12

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a) $0 b) $20,000 c) $ 100,000 d) $120,000 Answer: d Difficulty: Medium Learning Objective: Adjust for intragroup borrowings. Section Reference: Intragroup Borrowings Feedback: Review “Advances."

41) Consolidated financial statements are prepared for: a) Management of the consolidated company. b) Shareholders of the parent. c) Creditors of the consolidated company. d) All of the above. Answer: d Difficulty: Easy Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Adjusting for Intragroup Transactions: Principles Feedback: Review “Rationale for Adjusting for Intragroup Transactions.”

42) Quick Company owns all of the outstanding shares of Peanut Ltd. During the year, Peanut Ltd. declared and paid a dividend of $10,000. The tax rate is 30% for both entities. In preparation for the year-end consolidated financial statements, what are the consolidated financial statement adjustments required? a) Decrease Dividend Revenue: $10,000, decrease Dividend Declared and Paid: $10,000, decrease Income Tax Expense: $3,000, and decrease Income Tax Payable: $3,000. b) Increase Dividend Revenue: $10,000, increase Dividend Declared and Paid: $10,000, increase Income Tax Expense: $3,000, and increase Income Tax Payable: $3,000. c) Decrease Dividend Revenue: $10,000, decrease Dividend Declared and Paid: $10,000. d) Increase Dividend Revenue: $10,000, increase Dividend Declared and Paid: $10,000. Answer: c Difficulty: Easy Learning Objective: Adjust for intragroup dividends. Section Reference: Intragroup Dividends Feedback: Review section “Dividends Declared and Paid in the Current Period. 13

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43) On June 30, 2013 Tulip Ltd. issued one hundred $1,000 bonds with an interest rate of 7% p.a. payable semi-annually on December 31 and June 30 of each year. Crockus Inc., a wholly-owned subsidiary of Tulip Ltd., acquired 75% of the bonds issued. What are some of the December 31, 2013 adjustments required in preparation for the consolidated financial statements? a) Decrease Bonds Payable: $100,000, decrease Bond Investment: $100,000, decrease Interest Payable: $7,000, and decrease Interest Receivable: $7,000. b) Increase Bonds Payable: $100,000, increase Bond Investment: $100,000, increase Interest Payable: $7,000, and increase Interest Receivable: $7,000. c) Decrease Bonds Payable: $75,000, decrease Bond Investment: $75,000, decrease Interest Payable: $2,625, and decrease Interest Receivable: $2,625. d) Decrease Bonds Payable: $75,000, decrease Bond Investment: $75,000, decrease Interest Payable: $5,250, and decrease Interest Receivable: $5,250. Answer: c Difficulty: Medium Learning Objective: Adjust for Intragroup Borrowings. Section Reference: Intragroup Borrowings Feedback: Review section “Bonds”.

44) Teckel Enterprises owns 100% of Dachsund Limited. At the beginning of the fiscal year, there was a profit in Teckel Enterprises inventory of $15,000 on goods acquired from Dachsund Limited in the previous period. The tax rate is 40%. What is the required consolidated financial statement adjustments? a) Decrease Beginning Retained Earnings: $9,000, decrease Cost of Goods Sold: $15,000, and increase Income Tax Expense: $6,000. b) Increase Beginning Retained Earnings: $9,000, increase Cost of Goods Sold: $6,000, and decrease Income Tax Expense: $6,000. c) Decrease Beginning Retained Earnings: $15,000 and decrease Cost of Goods Sold: $15,000. d) Decrease Beginning Retained Earnings: $9,000 and decrease Cost of Goods Sold: $9,000. Answer: a Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and ending inventory. Section Reference: Transfers of Inventory Feedback: Review section “Unrealized Profits in Beginning Inventory”.

45) In 2010, Yorkshire Inc., which owns 100% of Blake Company, sold land to Blake Company at $50,000 greater than its cost. The land is still owned by Blake Company. The tax rate is 30%. What is the required consolidated financial statement adjustment in 2013? 14

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a) Decrease Beginning Retained Earnings: $35,000, decrease Land: $35,000. b) Decrease Beginning Retained Earnings: $35,000, decrease Land: $50,000, and increase Deferred Tax Asset: $15,000. c) Decrease Beginning Retained Earnings: $50,000, decrease Land: $35,000, and decrease Deferred Tax Asset: $15,000. d) Decrease Beginning Retained Earnings: $50,000, decrease Land: $50,000. Answer: b Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods. Section Reference: Adjusting for Profits and Losses on Transfers of Property, Plant and Equipment Feedback: Review section “Consolidation: Sale of Land”.

46) ABC Company owns 75% of XYZ Company. During 2012, XYZ Company declared and paid $5,000 in dividends. What impact did this transaction have on the separate financial statements of ABC Company? a) Total assets were increased b) Net income was decreased. c) Investment account for XYZ Company was decreased. d) All of the above. Answer: a Difficulty: Medium Learning Objective: Adjust for intragroup dividends Section Reference: Intragroup Dividends Feedback: Review "Dividends Declared and Paid in the Current Period"

47) Which of the following is true with respect to performing consolidation adjustments for intragroup borrowings and the corresponding interest? a) It is not necessary to perform consolidation adjustments with respect to intragroup borrowings and the corresponding interest. b) From the group’s perspective, these transactions create assets and liabilities and revenues and expenses that do not exist in terms of the group’s relationship with external entities c) The adjustment to the asset and liability is only necessary in the year the intragroup loan is issued. d) Only a tax adjustment is necessary. Answer: b Difficulty: Easy Learning Objective: Adjust for intragroup borrowings. Section Reference: Intragroup Borrowings 15

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Feedback: Review section “Consolidation: Bonds”.

48) DEF Company acquired in 2012 a 100% interest in MNO Company by acquiring shares that cost $50,000. In 2012, MNO Company reported income of $10,000 and $8,000 in 2013. MNO Company also paid dividends to DEF Company of $2,000 in 2012 and $ 8,000 in 2013. The balance of DEF Company's investment in MNO Company in its own books if it reflects the investment at cost at December 31, 2012 was: a) $ 22,000 b) $ 42,000 c) $ 50,000 d) $ 78,000 Answer: c Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods. Section Reference: Adjusting for Intragroup Transactions: Principles Feedback: Review “Rationale for Adjusting for Intragroup Transactions”.

49) Which of the following is not true with respect to intercompany transfers that occurred during the year? a) Comprehensive income will decrease for the amount of the unrealized profit. b) Comprehensive income will increase for the tax on the unrealized profit. c) The statement of financial position will include a decrease to the asset for the amount of the unrealized profit that still remains. d) The deferred tax asset will decrease for the amount of unrealized profit that still remains. Answer: d Difficulty: Medium Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Adjusting for Intragroup Transactions: Principles Feedback: Review “Rationale for Adjusting for Intragroup Transactions”.

50) On January 1, 2011, Rocker Ltd. formed Smith Co., a 100% owned subsidiary. During 2014, Rocker sold Smith $100,000 in goods. The unrealized profit in Smith's inventories was $20,000 at December 31, 2013 and $25,000 at December 31, 2014. Ignoring income taxes, what adjustment should be made to the consolidated financial statements for the year ended December 31, 2014 to reflect the unrealized profit in Smith's ending inventory? a) Retained earnings at the end of 2014 will be decreased by $25,000. b) Inventory at December 31, 2014 will be increased by $25,000. 16

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c) Cost of goods sold for 2014 will be decreased by $25,000. d) Retained earnings at the end of 2014 will be decreased by $5,000. Answer: a Difficulty: Hard Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and ending inventory. Section Reference: Transfers of Inventory Feedback: Review “Unrealized Profits in Beginning Inventory”

51) A subsidiary sold goods to its parent company. At its year-end, the parent company still had some of the goods in inventory. Included in the value of these inventories is $30,000 of unrealized profits. What consolidation adjustments should be made to eliminate these unrealized profits? a) Decrease Sales 30,000 Decrease Inventory 30,000 b) Increase Selling expenses 30,000 Decrease Inventory 30,000 c) Increase Cost of Sales 30,000 Decrease Inventory 30,000 d) Increase Inventory 30,000 Increase Sales 30,000 Answer: c Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and ending inventory. Section Reference: Transfers of Inventory Feedback: Review “Sales of Inventory”.

52) On January 1, 2012, Oliver Ltd. formed Solo Co., a 100% owned subsidiary. During 2014, Oliver sold Solo $200,000 in goods. The unrealized profit in Solo's inventories was $40,000 at December 31, 2013 and $50,000 at December 31, 2014. Ignoring income taxes, what adjustment should be made to the consolidated financial statements for the year ended December 31, 2014 to reflect the unrealized profit in Solo’s beginning inventory? a) Inventory at December 31, 2014 should be decreased by $40,000. b) Retained earnings at the end of 2014 should be increased by $40,000. c) Retained earnings at the end of 2014 should be decreased by $40,000. d) Cost of goods sold for 2014 should be decreased by $40,000. Answer: d Difficulty: Hard 17

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Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and ending inventory. Section Reference: Transfers of Inventory Feedback: Review “Unrealized Profits in Beginning Inventory”.

53) In 2011, a parent company sold a tract of land to its subsidiary for $200,000, resulting in a $60,000 loss. The subsidiary's plans for the land did not materialize and it still owned the land at the end of 2014. At the end of 2014, what consolidation adjustments should be made with respect to the loss associated with the sale of land? a) Decrease Retained earnings 60,000 Decrease Land 60,000 b) Decrease Loss on the sale of land 60,000 Decrease Land 60,000 c) Increase Land 60,000 Increase Loss on the sale of land 60,000 d) Increase Land 60,000 Increase Retained earnings 60,000 Answer: d Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods. Section Reference: Intragroup Profits and Losses on Transfers of Property, Plant, and Equipment Feedback: Review “Sale of Land”.

54) Intragroup borrowings result in: a) Assets in one member of the group and liabilities in another. b) Revenues in one member of the group and expenses in another. c) Assets in one member of the group and revenues in another. d) Expenses in one member of the group and liabilities in another. Answer: a Difficulty: Medium Learning Objective: Adjust for intragroup bonds acquired on the open market. Section Reference: Intragroup Borrowings Feedback: Review “Intragroup Borrowings”

55) Bilson Ltd. is the wholly-owned subsidiary of Lawson Ltd. Bilson purchased all of Lawson's outstanding bond issue on the open market at a discount. The bonds have an unamortized premium attached. This transaction, in effect, retires the bond and results in a gain. How should the gain be shown? 18

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a) It will appear on both Lawson's separate-entity and consolidated statements of comprehensive income. b) It will appear on Lawson's consolidated statement of comprehensive income only. c) It will be added to the value of the bonds payable on Lawson's statement of financial position. d) It will appear on Lawson's separate-entity statement of comprehensive income only. Answer: b Difficulty: Medium Learning Objective: Adjust for intragroup bonds acquired on the open market. Section Reference: Appendix 4A—Bonds Acquired on the Open Market Feedback: Review “Appendix 4A”.

56) If a dividend is declared and paid by a subsidiary in the current period after its acquisition by the parent, from the outlook of the group: a) No dividend has been paid. b) A dividend has been paid. c) A liability increases. d) Revenue has been received. Answer: a Difficulty: Medium Learning Objective: Adjust for intragroup dividends. Section Reference: Intragroup Dividends Feedback: Review “Dividends Declared and Paid in the Current Period”

57) If a dividend is declared by a subsidiary in the current period after its acquisition by the parent but is not paid, from the outlook of the group: a) Equity does not decrease. b) Liabilities increase. c) Receivables increase. d) Revenue increases. Answer: a Difficulty: Moderate Learning Objective: Adjust for intragroup dividends Section Reference: Intragroup Dividends Feedback: See “Dividends Declared in the Current Period but Not Paid”

58) Dividends from subsidiary equity are recognized in equity by the: 19

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a) Subsidiary. b) Parent. c) Subsidiary and parent. d) Neither the subsidiary nor the parent. Answer: a Difficulty: Easy Learning Objective: Adjust for intragroup dividends Section Reference: Intragroup Dividends Feedback: See “Intragroup Dividends”.

Short Answer 59) Why are intragroup transactions eliminated? Difficulty: Medium Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Adjusting for Intragroup Transactions: Principles. Feedback: Review “Rationale for Adjusting for Intragroup Transactions” Suggested answer: Intragroup transactions are eliminated so that consolidated statements only reflect transactions with outside entities. Otherwise, it the financial statements would conflict with the purpose of consolidated financial statements to provide information about the financial performance and financial position of the group as a result of its dealings with external entities, and not with transactions within the group. The requirement for the full adjustment for the effects of intragroup transactions is stated in paragraph B86c of IFRS Consolidated Financial Statements “Eliminate in full intragroup assets, liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group.”

60) Why are adjustments made for intragroup transactions involving profits and losses in beginning and ending inventory?

Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses in beginning and ending inventory. Section Reference: Transfers of Inventory Feedback: Realization of Revenues and Expenses Suggested answer: Intragroup profits in inventory transactions are eliminated so that the financial statements only reflect 20

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transactions with external entities. No sales of inventory were made to any party outside the group and the group has not acquired any inventory from external entities. The consolidated financial reports for the parent and subsidiaries only reflect the effects of transactions between the group and entities outside the group. Intragroup transactions between members of the group require that adjustments be made for both previous period transactions and current period transactions which involve profits including transfers of inventory, transfers of property, plant and equipment and intragroup services. These adjustments will be made to revenues, expenses assets and liabilities.

61) Why are adjustments required for intragroup transactions involving profits and losses on the transfer of property, plant and equipment in both the current and previous periods?

Difficulty: Medium Learning Objective: Adjust for intragroup transactions involving profits and losses on the transfer of property, plant, and equipment in both the current and previous periods. Section Reference: Intragroup Profits and Losses on Transactions of Property, Plant and Equipment. Feedback: Review “Intragroup Profits and Losses on Transactions of Property, Plant and Equipment.” Suggested answer: Intragroup transactions involving profits and/or losses in property, plant and equipment are eliminated so that the transactions only reflect transactions to outside entities. Besides transferring inventory, it is possible for property, plant and equipment to be transferred within a group of companies and the transfer cost may involve a profit or loss. It is necessary to distinguish between a sale of land, which is a non-depreciable asset and a sale of a depreciable assets such as equipment, furniture, etc. The realization of profit on land occurs when the asset is subsequently sold to a party that is outside the group whereas the profit on a depreciable asset is realized as the asset is depreciated. As long as the sale of a depreciable asset is within the group, it will, initially, be considered unrealized.

62) Why are adjustments required for intragroup services such as management fees?

Difficulty: Medium Learning Objective: Adjust for intragroup services such as management fees. Section Reference: Intragroup Services Feedback: Review “Intragroup Services” Suggested answer: The consolidated financial statements under ASPE/IFRS should not reflect services fees charged between group companies in order to ensure that consolidated financial statements only show transactions with outside entities. 21

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There can be many instances of services being provided within a consolidated group of companies and while the provision of services may be varied, some may consist of a specialist on an short time assignment, research activities by a special group for the parent, or a variety of assignments carried for specific tasks. In most instances an adjustment is made in the respective books of the consolidated group but from the group's perspective there has been no service revenue, and corresponding expenses, made to external entities that would impact the books of the consolidated group.

63) How are adjustments for intragroup dividends made in the consolidated financial statements?

Difficulty: Medium Learning Objective: Adjust for Intragroup Dividends Section Reference: Intragroup Dividends Feedback: Review “Intragroup Dividends” Suggested answer: All dividends received by a parent from a subsidiary are accounted for as revenue by the parent since the parent has been recording its investment in the subsidiary by using the cost method on its own nonconsolidated financial statements. Special adjustments are needed on consolidation for (a) dividends declared in the current period but not paid and (b) dividends declared and paid in the current period. (a) Dividends declared in the current period but not paid: It is necessary to reduce dividend payable, dividend declared, dividend revenue, and dividend receivable. In the following period when the dividend is paid, no adjustments are required in the consolidated financial statements. (b) Dividends declared and paid in the current period: It is necessary to reduce dividend revenue and dividend declared and paid.

64) Why are adjustments made for intragroup borrowings on consolidation?

Difficulty: Medium Learning Objective: Adjust for Intragroup Borrowings Section Reference: Intragroup Borrowings Feedback: Intragroup Borrowings Suggested answer: Members within a consolidated group of companies may borrow and lend money among themselves 22

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and in some cases interest may be charged for such loans. Consolidated adjustments are necessary in relation to these intragroup borrowings and interest amounts as there will be an impact upon assets and liabilities within the group along with revenues and expenses.

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Problems 65) On December 31, 2009, Cawthra Ltd. purchased 100% of the outstanding common shares of Lawlor Ltd. for $9.5 million in cash. On that date, the shareholders' equity of Lawlor totaled $8 million and consisted of $1 million in common shares and $7 million in retained earnings. Both companies use the straight-line method to calculate depreciation. Goodwill, if any arises as a result of this business combination, is written down when there is an impairment. Both Cawthra and Lawlor report under accounting standards for private enterprises and pay tax at the rate of 40%. For the year ending December 31, 2014, the statements of earnings for Cawthra and Lawlor were as follows:

Sales and other revenue Cost of goods sold Depreciation expense Other expenses Net income

Cawthra $22,500,000 16,000,000 2,500,000 1,800,000 $2,200,000

Lawlor $9,800,000 5,000,000 2,000,000 1,200,000 $1,600,000

As at December 31, 2014, the condensed statements of financial position for the two companies were as follows:

Total assets

Cawthra $31,000,000

Lawlor $13,500,000

Liabilities No par common shares Retained earnings Total

$5,000,000 12,100,000 13,900,000 $31,000,000

$1,200,000 1,000,000 11,300,000 $13,500,000

Other Information: • On December 31, 2009, Lawlor had a building with a fair value that was $300,000 greater than its carrying value. The building had an estimated remaining useful life of 20 years. • On December 31, 2009, Lawlor had inventory with a fair value that was $200,000 less than its carrying value. This inventory was sold in 2011. • During 2014, Cawthra sold merchandise to Lawlor for $100,000, a price that includes a gross profit of $40,000. During 2014, 40% of this merchandise was resold by Lawlor to third parties and the other 60% remains in its December 31, 2014 inventories. On December 31, 2013, the inventories of Lawlor contained merchandise purchased from Cawthra on which Cawthra had recognized a gross profit in the amount of $20,000. • During 2014, Cawthra declared and paid dividends of $300,000 while Lawlor declared and paid dividends of $100,000. • Cawthra accounts for its investment in Lawlor using the cost method. • The retained earnings of Cawthra as at December 31, 2013 was $12,000,000. On that date, Lawlor had retained earnings of $9,800,000. Lawlor has not issued any common shares since its acquisition by Cawthra. • There were no specific events or circumstances between 2010 and 2014 to indicate any 24

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impairment of goodwill. Required: Calculate consolidated net income for the year ending December 31, 2014.

Fair value of net assets acquired: Net book value of net assets Increase in fair value of building Inventory Goodwill

$9,500

8,000 180 300(1-.4) (120) 200(1-.4) 8,060 $ 1,440

Eliminate intercompany transactions

Intercompany transactions and balances: sale by Cawthra

$100,000

Dividends income of Cawthra and dividends declared by Lawlor $100,000 Recognize realized and unrealized profits Realized profit on sale of inventory in previous year $20,000 X (1-0.40) = $12,000 Unrealized profit on sale of inventory in current year (40,000 × 60%) X (1-0.40) $14,400

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Amortize

Asset Building Inventory Goodwill Total

FVI Allocated 300,000 (200,000) 1,400,000 1,500,000

Amortization period 20 1 -

Amortization/ Impairment per year 15,000

15,000

Amortization/ Impairment during previous years 2010 - 2013 4 years 60,000 (200,000) (125,000)

Amortization/ Impairment loss during 2014 15,000

15,000

Calculation of consolidated net income Net income - Cawthra $2,200,000 Net income - Lawlor 1,600,000 Adjustments: Intercompany dividends from Lawlor (100,000) Amortization of FVI building (15,000) X (1-.40) = (9,000) Realized downstream profit in opening inventory 12,000 Unrealized downstream profit in ending inventory (14,400) Consolidated net income $3,688,600

Balance of FVI remaining at end of 2014 225,000 0 1,400,000 1,625,000

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Chapter 4: Consolidations: Intragroup Transactions

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66) On December 31, 2012, Finn Co. purchased 100% of the outstanding common shares of Ewe Ltd. for $1,200,000 in shares and $200,000 in cash. The statements of financial position of Finn and Ewe immediately before the acquisition were as follows (in 000s):

Cash Accounts receivable Inventory Capital assets

Accounts payable Long-term liabilities Common shares Retained earnings

Finn Book Fair Value Value $360 $ 360 520 500 800 880 1,820 2,000 $3,500

Ewe Book Fair Value Value $ 200 $ 200 380 340 400 400 1,420 1,520 $2,400

$ 380 1,200 500 1,420 $3,500

$ 260 1,000 600 540 $2,400

$ 380 1,200

$ 260 1,000

The difference in the carrying value and the fair value of the capital assets for Ewe relates to its office building. This building was originally purchased by Ewe in January, 2008 and is being depreciated over 30 years. Both companies pay tax at a rate of 40%. During 2013, the year following the acquisition, the following occurred: 1. Ewe borrowed $350,000 from Finn on June 1, 2013, and was charged interest at 10% per annum, which it paid on a monthly basis. There were no repayments of principal made during the remaining of the year. 2. Throughout the year, Ewe purchased merchandise of $800,000 from Finn. Finn's gross margin is 30% of selling price. At December 31, 2013, Ewe still owed Finn $250,000 on this merchandise. 75% of this merchandise was resold by Ewe prior to December 31, 2013. 3. Ewe paid dividends of $250,000 at the end of 2013 and Finn paid dividends of $500,000. During 2014, the following occurred: 1. Ewe paid $150,000 on the loan payable to Finn on May 30, 2014. In total $27,000 of interest was paid during the year. 2. Throughout the year, Ewe purchased merchandise of $1,000,000 from Finn. Finn's gross margin is 30% of selling price. At December 31, 2014, Ewe still owed Finn $150,000 on this merchandise. 85% of this merchandise was resold by Ewe prior to December 31, 2014. 3. Ewe paid dividends of $250,000 at the end of 2014 and Finn paid dividends of $500,000.

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Chapter 4: Consolidations: Intragroup Transactions

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Statements of Financial Position As at December 31, 2014 (in thousands of $'s) Finn $ 50 575 825 2,670 200 1,400 5,720

Assets Cash Accounts Receivable Inventories Capital assets, net Loan receivable — from Ewe Investment in Ewe Total assets Liabilities Accounts payable Long term liabilities Loan payable to Finn Common shares Retained Earnings Total liabilities and shareholders' equity

465 1,290 1,700 2,265 5,720

Statements of Comprehensive Income For the year ended December 31, 2014 (in thousands of $'s) Finn $ Sales 2,670 Interest income 27 Dividend income 250 2,947 Cost of sales 800 Depreciation and amortization expenses 670 Interest expense Other expenses 487 1,957 Net income 990

Ewe $ 210 410 430 1,760

2,810

325 750 200 600 935 2,810

Ewe $ 2,100

2,100 1,200 325 27 58 1,610 490

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Chapter 4: Consolidations: Intragroup Transactions

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Statements of Changes in Equity — Retained Earnings Section For the year ended December 31, 2014 (in thousands of $'s) Finn Ewe $ $ Retained earnings, December 31, 2013 1,775 695 Net income 990 490 Dividends declared (500) (250) Retained earnings, December 31, 2014 2,265 935 Required: Prepare the statement of financial position and the statement of comprehensive income for the year ended December 31, 2014. Suggested answer: Difficulty: Hard Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Adjusting for Intragroup Transactions-Principles Feedback: Rationale for Adjusting for Intragroup Transactions Measurement: Calculation of goodwill (in 000s) on December 31, 2012: Consideration transferred $1,400 Net Fair value of identifiable assets and liabilities: 1,140 = 600 + 540 Accounts receivable

-24 = 40(1-.4)

Capital Assets

60 = 100(1-.4) 1,176

Goodwill

$ 224

Eliminate intercompany transactions for 2014: Intercompany transactions and balances Accounts receivable/accounts payable still outstanding Loan payable/receivable still outstanding Interest paid/received on loan payable

$150,000 $200,000 $27,000

Downstream sale by Finn

$1,000,000

Dividends income of Finn and dividends declared by Ewe

$250,000

Recognize realized and unrealized profits: Realized profit on sale of inventory in 2013 29

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Chapter 4: Consolidations: Intragroup Transactions

($800,000 × 30% × 25%) Tax$60,000 x 40% Net Unrealized profit on sale of inventory in current year ($1,000,000 × 30% × 15%) Tax $45,000 x 40% Net

Testbank

$60,000 24,000 36,000 $45,000 18,000 27,000

Amortize (in thousands of $'s):

Asset

FVI Allocated

Amortization period

Accounts Receivable Building Goodwill Total

(40) 100 224 264

1 25* -

Amortization/ Impairment per year

Amortization/ Impairment during previous years 2013 1 year

(40) 4 (36)

Amortization/ Impairment loss during 2014

Balance of FVI remaining at end of 2014

0 92 224 316

*Note: 30 years from 2008 less years between 2008 and 2012 (5 years), leaves 25 years remaining on the building to be depreciated.

Assets Cash Accounts Receivable Inventories Capital assets, net Goodwill

FINN CO. Consolidated Statements of Financial Position As at December 31, 2014 (in thousands of $'s) $ 50 + 210 = 260 575 +410 = 985 825 + 430 – 45 = 1,210 2,670 +1,760 +92 = 4,522 224

Total assets

7,201

Liabilities Accounts payable Long term liabilities Deferred income taxes Common shares Retained Earnings Total liabilities and shareholders' equity

465 + 325 = 790 1,290 +750 = 2,040 40 – 2 x 1.6 – 18 = 18.8 1,700 2,265 + (935 – 540) – 2(2.4) +24 -27 = 2,652.2 7,201

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Chapter 4: Consolidations: Intragroup Transactions

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FINN CO. Consolidated Statement of Comprehensive Income For the year ended December 31, 2014 (in thousands of $'s) $ 2,670 + 2,100 – 1,000 = 3, 770

Cost of sales Depreciation and amortization expenses

800 + 1,200 – 1,000 – 60 + 45 = 985 670 +325 +4 = 999

Other expenses Net income

487 + 58-1.6 + 24 - 18 = 549.4 1,236.6

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Chapter 4: Consolidations: Intragroup Transactions

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FINN CO. Consolidated Statement of Changes in Equity (Retained Earnings section) For the year ended December 31, 2014 (in thousands of $'s) $1,775 + (695 – 540) – 2.4 +24 -36 = 1,915.6

Beginning Retained earnings Consolidated net income

1,236.6

Dividends

(500)

Ending Retained earnings

2,652.2

Fayerman: Advanced Accounting, Cdn Ed

Chapter 4: Consolidations: Intragroup Transactions

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51) On December 31, 2011 PDI Ltd acquired 100% of the company ABC for $100,000. At the day of acquisition fair values equalled book values. The tax rate for both entities is 30%. On December 31, 2013 the following are the individual financial statements for both companies: PDI Ltd.

ABC Company

Revenues Interest Income

$550,000 25,000

$145,000 $ 5,000

Total Revenues

$575,000

$150,000

Cost of Goods Sold

$425,000

$125,000

Gross Profit

$ 150,000

$ 25,000

Administration Expenses General Expenses

$ 27,000 $ 35,000

$ 62,000

$ 5,000 $ 7,000

$ 12,000

Earnings Before Tax

$ 88,000

$ 13,000

Income Taxes

$ (30,000)

$ (6,000)

Net Profit

$ 58,000

7,000

Beginning Retained Earnings Quarterly dividend paid Final Dividend Declared

$ 20,000 $ 7,000 $ 15,000

$ $ $

8,500 2,000 4,000

Retained Earnings at Year End

$ 56,000

9,500

Investment in ABC Company Dividend Receivable Loan Receivable Fixed Assets (net) Total Assets Final Dividend Payable Loan Payable Other Liabilities Total Liabilities Net Assets Share Capital Retained Earnings Total Equity

$100,000 $ 2,000 $ 30,000 $ 62,000 $194,000 $ 15,000 $ 23,000 $ 38,000 $149,000 $100,000 $ 56,000 $ 156,000

$ 150,500 $ 45,000 $ 2,000 $ 30,000 $ 9,000 $ 41,000 $ 4,000 $100,000 $ 9,500 $ 109,500

Additional information: 33

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1. PDI Ltd. loaned ABC Company $30,000 at an interest rate of 7% on January 1, 2013, payable annually on December 31. 2. PDI Ltd. has included both quarterly and final dividends from ABC Company in revenue. 3. On June 30, 2013 PDI Ltd. sold inventory costing $25,000 to ABC Company for $40,000. All of this inventory was sold to external entities for $60,000 before December 31, 2013. 4. In 2012, PDI Ltd. Sold land to ABC Company for $15,000 above its original recorded cost. The land is still held by ABC Company as at December 31, 2013. Required: Prepared the consolidated financial statements at December 31, 2013for PDI Ltd and its subsidiary. Difficulty: Easy Learning Objective: Explain the principles behind making adjustments for intragroup transactions. Section Reference: Adjusting for Intragroup Transactions-Principles Feedback: Rationale for Adjusting for Intragroup Transactions Suggested answer: Financial Statements

Revenues

PDI Ltd.

ABC Co.

Adjustments Consolidated

$550,000

$145,000

(6,000) (1) (40,000) (2) (2,100)(3)

Interest Income

25,000

Total Revenues

$575,000

$150,000

Cost of Goods Sold

$425,000

$125,000

Gross Profit

$ 150,000

$ 25,000

Administration Expenses General Expenses

$ 27,000 $ 35,000

$ $

$ 62,000

$ 12,000

$ 71,900

Income Before Tax

$ 88,000

$ 13,000

$95,000

Income Taxes

$ (30,000) $ (6,000)

$ 36,000

Net income

$ 58,000

$59,000

5,000

$649,000

5,000 7,000

7,000

$ 27,900 $676,900

(40,000) (2)

$510,000 $166,900

(2,100)(3)

$ 29,900 $ 42,000

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Beginning retained earnings Quarterly dividend paid Final dividend declared

$ 20,000 $ 7,000 $ 15,000

$ $ $

8,500 2,000 4,000

(10,500)(4) ( 2,000)(1) (4,000)(1)

$18,000 $7,000 $15,000

Retained Earnings at year end

$ 56,000

9,500

(4,500)

$55,000

Investment in ABC Co. Dividend receivable Loan receivable Deferred tax asset Fixed Assets (net) Total assets Final dividend payable Loan payable Other liabilities Total liabilities Net assets Share capital Retained earnings Total equity

$100,000 $ 2,000 $ 30,000 $ 62,000 $194,000 $15,000 $ 23,000 $ 38,000 $156,000 $100,000 $ 56,000 $ 156,000

$ 150,500 $ 150,500 $ 2,000 $ 30,000 $ 9,000 $ 41,000 $ 109,500 $100,000 $ 9,500 $ 109,500

($100,000) (2,000) (1) (30,000)(3) 4,500(4) $ 4,500 (15,000)(4) $202,000 (147,000) $202,000 (2,000) (1) $ 15,000 (30,000)(3) ________ $ 32,000 (32,000) $ 47,000 (115,000) $ 150,500 (100,000) ($100,000) above $ 55,000 ________ $202,000

(1): To adjust for the dividends declared by ABC Company during 2013. (2): To adjust for the intercompany sale during the period that was entirely sold by year-end. (3): To adjust for the interest revenue and expense on the intercompany loan. $30,000 X 7% = $2,100 (4): To adjust for the 2012 sale of land. $15,000 * (1-0.30) = $10,500 net adjustment to retained earnings. Recognize deferred tax asset of $4,500 ($15,000 X 30%) and reduction of land of $15,000.

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Chapter 5: Consolidation: Non-Controlling Interest

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Testbank Chapter 5 – Consolidation: Non-Controlling Interest

True or False

1) When preparing and presenting a consolidated statement of comprehensive income, the non-controlling interest is presented as a separate component of revenue. Answer: False Difficulty: Easy Learning Objective: Discuss the nature of the non-controlling interest (NCI). Section Reference 1: The Nature of Non-controlling Interest Feedback: Review section “Disclosure of the NCI”

2) The proprietary concept is sometimes referred to as proportional consolidation or pro rata consolidation. Answer: True Difficulty: Easy Learning Objective: LO Appendix 5A Section Reference 1: Concepts of Consolidation Feedback: Review section “Proprietary Concept of Consolidation”

3) Under the partial goodwill method, the NCI does not get a share of any equity relating to goodwill. Answer: True Difficulty: Easy Learning Objective: Calculate the NCI share of equity at the day of acquisition. Section Reference 1: Non-controlling Share of Equity at the Acquisition Date Feedback: Review section “Partial Goodwill Method”

4) Under the partial goodwill method, the NCI is measured as a proportion of the net fair value of the identifiable net assets of the subsidiary at the acquisition date. Answer: True

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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Difficulty: Easy Learning Objective: Calculate the NCI share of equity at the day of acquisition. Section Reference 1: Non-controlling Share of Equity at the Acquisition Date Feedback: Review section “Partial Goodwill Method”

5) Whereas the goodwill of the subsidiary may be determined by calculating the goodwill acquired by the parent entity and then adding the fair value of the NCI, this process is not applicable for a gain on bargain purchase. Answer: True Difficulty: Medium Learning Objective: Calculate NCI that is affected by the existence of a gain on bargain purchase. Section Reference 1: Non-controlling Interest Affected by a Gain on Bargain Purchase Feedback: Review section “Non-controlling Interest Affected by a Gain on Bargain Purchase”

6) Under the entity concept of consolidation, the group consists of the combined assets and liabilities of the parent and the subsidiary. Answer: True Difficulty: Medium Learning Objective: Discuss the nature of the non-controlling interest (NCI). Section Reference 1: The Nature of Non-controlling Interest Feedback: Review section “Determination of the NCI”

7) The calculation of the NCI is necessary both for the Statement of Changes in Equity and for the Statement of Financial Position. Answer: True Difficulty: Medium Learning Objective: Calculate the NCI share of income and equity in subsequent periods. Section Reference 1: Non-controlling Interest in Income and Equity in Subsequent Periods Feedback: Review section “Non-controlling Interest in Income and Equity in Subsequent Periods

8) All intragroup transactions require an adjustment to the NCI.

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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Answer: False Difficulty: Medium Learning Objective: Calculate NCI that is affected by the existence of intragroup profits. Section Reference 1: Non-controlling Interest Affected by Intragroup Profits Feedback: Review section “Non-controlling Interest Affected by Intragroup Profits”

9) In the rare case where a gain on bargain purchase may arise, such a gain has no effect on the calculation of the NCI share of equity. Answer: True Difficulty: Medium Learning Objective: Calculate NCI that is affected by the existence of a gain on bargain purchase. Section Reference 1: Non-controlling Interest Affected by a Gain on Bargain Purchase Feedback: Review section “Non-controlling Interest Affected by a Gain on Bargain Purchase”

10) When a parent increases its ownership interest, the difference between the amount that was paid by the parent and the amount that was transferred from the non-controlling interest is allocated to equity. Answer: True Difficulty: Medium Learning Objective: Calculate the effect on NCI due to changes in ownership. Section Reference 1: Changes in the Proportion Held by Non-controlling Interest Feedback: Review section “Increase/Decrease in Ownership”

11) Ownership interests in a subsidiary entity that do not belong to the parent entity are known as un-owned interests. Answer: False Difficulty: Easy Learning Objective: Discuss the nature of the non-controlling interest (NCI). Section Reference 1: The Nature of Non-controlling Interest Feedback: Review section “Determination of the NCI”

12) If a gain on bargain purchase arises on a business combination, the non-controlling interest is allocated 100% of the gain.

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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Answer: False Difficulty: Hard Learning Objective: Calculate NCI that is affected by the existence of a gain on bargain purchase. Section Reference 1: Non-controlling Interest Affected by a Gain on Bargain Purchase Feedback: Review section “Non-controlling Interest Affected by a Gain on Bargain Purchase”

13) The NCI consists of the accumulation of all the interests in the subsidiary other than that belonging to the parent. Answer: True Difficulty: Medium Learning Objective: Discuss the nature of the non-controlling interest (NCI). Section Reference 1: The Nature of Non-controlling Interest Feedback: Review section “Determination of the NCI”

14) What is the recommended method for disclosing a non-controlling interest in a company on a consolidated balance sheet where significant sales have occurred between the two companies? a) Goodwill adjustment. b) On the balance sheet as a specially designated long-term liability. c) In shareholder's equity. d) None of the above. Answer: c Difficulty: Medium Learning Objective: Discuss the nature of the non-controlling interest. Section Reference 1: The Nature of Non-Controlling Interest Feedback: Review section “Disclosure of the NCI”. 15) There are three main concepts of consolidation — proprietary, entity and parent entity. Answer: True Difficulty: Easy Learning Objective: LO Appendix 5A

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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Section Reference 1: Concepts of Consolidation Feedback: Review section “Choice of Concept”

Multiple Choice

16) Levi Ltd. owns 60% of the outstanding common shares of Modry Ltd. During 2013, sales from Modry to Levi were $200,000. Merchandise was priced to provide Modry with a gross margin of 20%. Levi's inventories contained $40,000 at December 31, 2012 and $15,000 at December 31, 2013 of merchandise purchased from Modry. Cost of goods sold for Levi and Modry for 2013 on their separate-entity income statements were as follows: Levi $ 100,000 700,000 (110,000) $ 690,000

Beginning inventory Purchases Ending inventory Cost of goods sold

Modry $ 50,000 200,000 (55,000) $195,000

What is the balance of the inventory account on Levi's consolidated statement of financial position at December 31, 2013? a) $162,000 b) $140,000 c) $160,000 d) $165,000 Answer: a Difficulty: Hard Learning Objective: Calculate NCI that is affected by the existence of intragroup profits. Section Reference 1: Non-controlling Interest Affected by Intragroup Profit Feedback: Review section “Inventory”

17) What is the purpose of showing an allocation of the net income between the parent and the subsidiary companies on the consolidated statement of comprehensive income? a) To report the net income of the subsidiary company to its shareholders. b) To report the net income of the parent and subsidiary companies to their respective shareholders. c) To report the net income of the parent and subsidiary companies to the tax department. d) To report the net income of the parent company to its shareholders. Answer: d

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

Testbank

Difficulty: Easy Learning Objective: Discuss the nature of the non-controlling interest (NCI). Section Reference 1: The Nature of Non-controlling Interest Feedback: Review section “Disclosure of the NCI”

18) A parent's consolidated net income which includes it's fully and partially owned subsidiaries is best described as: a) Net income recorded by the parent b) Net income reported by both the parent and subsidiaries. c) Net income reported by the parent and it's share of net income of subsidiaries d) Income for both the parent and subsidiaries resulting from transactions with third parties. Answer: d Difficulty: Easy Learning Objective: Discuss the nature of the non-controlling interest. Section Reference 1: The nature of Non-Controlling Interest Feedback: Consolidation: Disclosure of the NCI.

19) Viner Ltd. acquired 70% of Bittner Ltd. on January 1, 2010. On January 1, 2014, Viner acquired another 10% of Bittner's common shares for $250,000. With respect to this additional purchase, which of the following is TRUE? a) On the consolidated statement of financial position, the goodwill balance will increase. b) Viner should ignore any changes in the fair values of Bittner's net assets between January 1, 2010 and January 1, 2014. c) On the consolidated statement of financial position, the common shares balance will increase. d) Viner must use the equity method to report the additional investment. Answer: b Difficulty: Hard Learning Objective: Calculate the effect on NCI due to changes in ownership. Section Reference 1: Changes in the Proportion Held by Non-controlling Interest Feedback: Review section “Increase in Ownership”

20) Which consolidation method does NOT include incorporating 100% of a subsidiary's revenues and expenses?

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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a) Parent-company method. b) Parent-company extension method. c) Proportional consolidation. d) Entity method. Answer: c Difficulty: Easy Learning Objective: LO Appendix 5A Section Reference 1: Concepts of Consolidation Feedback: Review section “Proprietary Concept of Consolidation”

21) Ownership interests in a subsidiary entity that do not belong to the parent entity are known as: a) Unowned interests. b) Non-controlling interests. c) Proprietary interests. d) Pro rata ownership rights. Answer: b Difficulty: Easy Learning Objective: Discuss the nature of the non-controlling interest (NCI). Section Reference 1: The Nature of Non-controlling Interest Feedback: Review section “Determination of the NCI”

22) Wilson Ltd. owns 60% of the outstanding common shares of Miller Ltd. During 2013, sales from Miller to Wilson were $200,000. Merchandise was priced to provide Miller with a gross margin of 20%. Wilson' inventories contained $40,000 at December 31, 2012 and $15,000 at December 31, 2013 of merchandise purchased from Miller. Cost of goods sold for Wilson and Miller for 2013 on their separate-entity income statements were as follows: Wilson $ 100,000 700,000 (110,000) $ 690,000

Beginning inventory Purchases Ending inventory Cost of goods sold

What is cost of goods sold on the consolidated income statement for 2013? a) $687,000 b) $685,000 c) $660,000

Miller $ 50,000 200,000 (55,000) $195,000

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Chapter 5: Consolidation: Non-Controlling Interest

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d) $680,000 Answer: d Difficulty: Hard Learning Objective: Calculate NCI which is affected by the existence of intragroup profits. Section Reference 1: Non-controlling Interest Affected by Intragroup Profits Feedback: Review section “Inventory”

23) Where does the non-controlling interest (NCI) appear on the statement of financial position? a) Under the liabilities section. b) Between the liabilities and shareholders' equity sections. c) Under the shareholders' equity section. d) NCI does not appear on the statement of financial position. Answer: c Difficulty: Easy Learning Objective: Discuss the nature of the non-controlling interest (NCI). Section Reference 1: The Nature of Non-controlling Interest Feedback: Review section “Disclosure of the NCI”

24) Robson Ltd. acquired 80% of Cool Co. in 2012. During 2012, Cool sold inventory to Robson. At the end of 2013, the goods were still in Robson's inventory. Robson correctly eliminated the $20,000 of unrealized profits on its 2013 consolidated financial statements and the goods were finally sold in 2014. In preparing its 2014 consolidated financial statements, what adjustments should be made with respect to the previously unrealized profit? a) Decrease cost of sales by $20,000, decrease beginning retained earnings by $16,000, and decrease the beginning non-controlling interest by $4,000. b) Increase both cost of sales and beginning retained earnings by $20,000. c) Increase cost of sales by $20,000, increase beginning retained earnings by $16,000, and increase the beginning non-controlling interest by $4,000. d) No entry is required. Answer: a Difficulty: Hard Learning Objective: Calculate NCI which is affected by the existence of intragroup profits.

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Chapter 5: Consolidation: Non-Controlling Interest

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Section Reference 1: Non-controlling Interest Affected by Intragroup Profits Feedback: Review section “Inventory”

25) Tamer Limited is a subsidiary of Wallen Limited. When Wallen acquired its 60% interest, the retained earnings of Tamer Limited were $20 000. At the beginning of the current period, Tamer Limited’s retained earnings had increased to $50,000. Tamer earned net income of $10 000 during the current period. The share of the non-controlling interest in the equity of Tamer Limited at the reporting date is: a) $24,000 b) $32,000 c) $36,000 d) $48,000 Answer: a Difficulty: Medium Learning Objective: Calculate the NCI share of income and equity in subsequent periods. Section Reference 1: Non-controlling Interest in Income and Equity in Subsequent Periods Feedback: Review section “Non-controlling Interest in Income and Equity in Subsequent Periods”

26) Arnold Ltd holds a 60% interest in Burford Ltd. Burford Ltd sells inventory to Arnold Ltd during the year for $10,000. The inventory originally cost $7,000. At the end of the year, 50% of the inventory is still on hand. The tax rate is 30%. The NCI share of net income adjustment required, in relation to this transaction, is a decrease of: a) NIL. b) $420. c) $630. d) $1,050. Answer: b Difficulty: Hard Learning Objective: Calculate NCI which is affected by the existence of intragroup profits. Section Reference 1: Non-controlling Interest Affected by Intragroup Profits Feedback: Review section “Inventory”

27) If a gain on bargain purchase arises on a business combination, the non-controlling interest:

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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a) Is allocated 100% of the gain. b) Has no involvement with the gain. c) Is entitled to a proportionate share of the gain based on its level of share ownership. d) Receives a proportionate share of the gain after adjustments for tax effects have been made. Answer: b Difficulty: Hard Learning Objective: Calculate NCI that is affected by the existence of a gain on bargain purchase. Section Reference 1: Non-controlling Interest Affected by a Gain on Bargain Purchase Feedback: Review section “Non-controlling Interest Affected by a Gain on Bargain Purchase”

28) Kafka Ltd. purchased 80% of Littman Ltd. for $700,000. At the time of acquisition, the carrying value of Littman's net identifiable assets was $1,000,000 and the fair value was $1,350,000. The companies pay tax at the rate of 30%. What is the amount of the goodwill under the partial goodwill method? a) $180,000 b) $(56,000) c) $144,000 d) None of the above. Answer: d Difficulty: Medium Learning Objective: Calculate the NCI share of equity at the day of acquisition Section Reference 1: Non-Controlling Share of Equity at the Acquisition Date Feedback: Review section “Partial Goodwill Method”

29) Gerrard Ltd. acquired 75% of Sittler Ltd. at April 30, 2012. Both companies have April 30 year-ends. Which of the following adjustements should be made to the opening non-controlling interest (NCI) balance to arrive at the April 30, 2013 NCI balance on Gerrard’s statement of financial position? a) Subtract the NCI's share of Sittler's fiscal 2013 net income and add in the NCI's share of Sittler's dividends declared. b) Add in both the NCI's share of Sittler's fiscal 2013 net income and dividends declared. c) Add in the NCI's share of Sittler's fiscal 2013 net income and subtract the NCI's share of Sittler's dividends declared. d) Subtract both the NCI's share of Sittler's fiscal 2013 net income and dividends

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Chapter 5: Consolidation: Non-Controlling Interest

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declared. Answer: c Difficulty: Hard Learning Objective: Calculate the NCI share of income and equity in subsequent periods. Section Reference 1: Non-controlling Interest in Income and Equity in Subsequent Periods Feedback: Review section “Non-controlling Interest in Income and Equity in Subsequent Periods”

30) Dobson Co. purchased 80% of Niki Ltd. for $1,200,000. At the date of acquisition, the carrying value of Niki's net identifiable assets was $1,000,000, and the fair value was $1,300,000 net of tax. What is the amount of the goodwill under the partial goodwill method? a) $200,000. b) $160,000. c) $300,000. d) $0. Answer: b Difficulty: Medium Learning Objective: Calculate the NCI share of equity at the day of acquisition Section Reference 1: Non-Controlling Share of Equity at the Acquisition Date Feedback: Review section “Partial Goodwill Method”

31) Arbiter Ltd. holds a 60% interest in Brown Ltd. On July 1, 2012, Brown Ltd. transferred a depreciable non-current asset to Arbiter Ltd. at a profit of $5,000. The remaining useful life of the asset at the date of transfer was 4 years and the tax rate is 30%. The impact of the above on the NCI share of net income for the year ended June 30, 2013 is: a) An increase of $2,625. b) A decrease of $2,625. c) An increase of $1,050. d) A decrease of $1,050. Answer: d Difficulty: Hard Learning Objective: Calculate NCI that is affected by the existence of intragroup profits. Section Reference 1: Non-controlling Interest Affected by Intragroup Profits

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

Testbank

Feedback: Review section “Depreciable Non-Current Assets”

32) Any gain on bargain purchase adjusts for the ___________ share of ___________ equity only. a) parent’s; pre-acquisition b) subsidiary’s; pre-acquisition c) parent’s; post-acquisition d) subsidiary’s; post-acquisition. Answer: a Difficulty: Medium Learning Objective: Calculate NCI that is affected by the existence of a gain on bargain purchase. Section Reference 1: Non-controlling Interest Affected by a Gain on Bargain Purchase Feedback: Review section “Non-controlling Interest Affected by a Gain on Bargain Purchase”

33) Manuel Ltd. purchases 65% of Faiz Co. Under the entity method of consolidation, what is allocated to non-controlling interest? a) 35% of Faiz's net assets at fair value. b) 35% of Faiz's net assets at carrying value plus 35% of Faiz's fair value increments including goodwill. c) 35% of Faiz's net assets at carrying value. d) 35% of Faiz's net assets at carrying value plus 35% of Faiz's fair value increments excluding goodwill. Answer: a Difficulty: Easy Learning Objective: LO Appendix 5A Section Reference 1: Concepts of Consolidation Feedback: Review section “Entity Concept of Consolidation”

34) Which of the following statements regarding the non-controlling interest is FALSE? a) In a subsidiary that is not wholly owned by the parent, there are two ownership interests, namely the parent and the non-controlling interest (NCI). b) The NCI consists of the accumulation of all the interests in the subsidiary other than the parent. c) The NCI is classified as a contributor of equity to the group.

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Chapter 5: Consolidation: Non-Controlling Interest

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d) The NCI is entitled to a share of the equity, as recorded, of the subsidiary. Answer: d Difficulty: Medium Learning Objective: Discuss the nature of the non-controlling interest (NCI). Section Reference 1: The Nature of Non-controlling Interest Feedback: Review section “Determination of the NCI”

35) Which of the following statements regarding the full goodwill method is FALSE? a) The NCI is measured at fair value at acquisition date. b) Goodwill is recognized at 100%. c) The fair value of the NCI is determined on the basis of the market prices for shares not acquired by the parent, or, if these are not available, a valuation technique is used. d) Only the parent’s share of goodwill is recognized on consolidation. Answer: d Difficulty: Medium Learning Objective: Calculate the NCI share of equity at the day of acquisition. Section Reference 1: Non-controlling Share of Equity at the Acquisition Date Feedback: Review section “Full Goodwill Method”

36) How is the consolidated ending retained earnings balance calculated? a) Add together the ending retained earnings of all the affiliated companies. b) Add the beginning consolidated retained earnings to consolidated net income and subtract the parent company's dividends declared. c) Adjust the parent company's opening retained earnings for the subsidiary's profits and dividends. d) Adjust the parent company's ending retained earnings for the subsidiary's profits and dividends. Answer: b Difficulty: Easy Learning Objective: Calculate the NCI share of income and equity in subsequent periods. Section Reference 1: Non-controlling Interest in Income and Equity in Subsequent Periods Feedback: Review section “Non-controlling Interest in Income and Equity in Subsequent Periods”

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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37) When preparing consolidated financial statements, any profit or loss that arises in relation to the intragroup transfer of services is regarded as: a) Immaterial and does not get adjusted on a consolidation worksheet. b) Immediately realized. c) Unrealized. d) Having no impact on the non-controlling interest, and so ignored for consolidation reporting. Answer: b Difficulty: Medium Learning Objective: Calculate NCI which is affected by the existence of intragroup profits. Section Reference 1: Non-controlling Interest Affected by Intragroup Profits Feedback: Review section “Intragroup Transfers for Services and Interest” 38) There are three main concepts of consolidation — proprietary, entity and parent entity. The choice of concept affects how consolidated financial statements are prepared: a) Only where the subsidiary is less than wholly owned by the parent. b) Only where the subsidiary is wholly owned by the parent. c) Always. d) Only where the subsidiary is profitable. Answer: a Difficulty: Easy Learning Objective: LO Appendix 5A Section Reference 1: Concepts of Consolidation Feedback: Review section “Choice of Concept”

39) Which of the following statements relating to a gain on bargain purchase is FALSE? a) Such gains are common. b) Such gains have no effect on the calculation of the NCI share of equity. c) Whereas the goodwill of the subsidiary may be determined by calculating the goodwill acquired by the parent entity and then adding the fair value of the NCI to determine the goodwill for the subsidiary, this process is not applicable for a gain on bargain purchase. d) The gain is made by the parent paying less than the net fair value of the acquirer’s share of the identifiable assets, liabilities and contingent liabilities of the subsidiary. Answer: a

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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Difficulty: Medium Learning Objective: Calculate NCI that is affected by the existence of a gain on bargain purchase. Section Reference 1: Non-controlling Interest Affected by a Gain on Bargain Purchase Feedback: Review section “Non-controlling Interest Affected by a Gain on Bargain Purchase”

40) Under the partial goodwill method, the NCI is measured as a proportion of the _______ of the identifiable net assets of the subsidiary at the acquisition date. a) Net fair value b) Net book value c) Carrying value d) Future value. Answer: a Difficulty: Easy Learning Objective: Calculate the NCI share of equity at the day of acquisition. Section Reference 1: Non-controlling Share of Equity at the Acquisition Date Feedback: Review section “Partial Goodwill Method”

41) Which of the following statements regarding the partial goodwill method is FALSE? a) The NCI is measured at the NCI’s proportionate share of the fair value of the acquiree’s identifiable net assets. b) The NCI does not get a share of any equity relating to goodwill. c) Goodwill consists of the consideration transferred plus previously acquired investment by parent plus parent’s share of the net fair value of the identifiable net assets of the subsidiary. d) The only goodwill recognized is that acquired by the parent in the business combination. Answer: c Difficulty: Easy Learning Objective: Calculate the NCI share of equity at the day of acquisition. Section Reference 1: Non-controlling Share of Equity at the Acquisition Date Feedback: Review section “Partial Goodwill Method”

42) Harry Co. acquired 75% of Samir Ltd. 3 years ago. In calculating the balance for the non-controlling interest share of net income, Harry started with the net income from Samir's current year-end single-entity financial statements. Which of the following

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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adjustments must be added to Samir's net income in calculating NCI’s share of net income? a) Unrealized gain on an upstream sale of a capital asset. b) Realized profits in the current year on upstream sales of inventory from the previous year. c) Unrealized profit on upstream sales of inventory in the current year. d) Amortization of fair value increments. Answer: b Difficulty: Hard Learning Objective: Calculate NCI that is affected by the existence of intragroup profits. Section Reference 1: Non-controlling Interest Affected by Intragroup Profits Feedback: Review section “Inventory”

43) Which of the following statements regarding the proprietary concept of consolidation is FALSE? a) The proprietary concept is sometimes referred to as proportional consolidation or pro rata consolidation. b) The group consists of the assets and liabilities of the parent and the parent’s proportional share of the assets and liabilities of the subsidiary. c) The consolidated financial statements include all the net assets of a subsidiary. d) As the NCI is outside the group, the NCI share of subsidiary equity is not disclosed. Answer: c Difficulty: Easy Learning Objective: LO Appendix 5A Section Reference 1: Concepts of Consolidation Feedback: Review section “Proprietary Concept of Consolidation”

44) When preparing and presenting a consolidated statement of comprehensive income, the non-controlling interest is: a) Presented as a separate component of revenue. b) Shown as a separate component of profit before tax and a separate component of tax expense. c) Shown as a separate component of each line item. d) Presented as an allocation of profit or loss attributable to the non-controlling interest. Answer: d

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Chapter 5: Consolidation: Non-Controlling Interest

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45) T Limited owns 90% of the share capital of S Limited. S Limited paid a dividend of $20,000 during the period. The adjustment in the consolidated financial statements for the dividend includes: a) Decrease b) Decrease c) Decrease d) Increase

Dividend revenue Dividend revenue Dividend payable Dividend receivable

$18,000. $20,000. $18,000. $20,000.

Answer: a Difficulty: Medium Learning Objective: Calculate the NCI share of income and equity in subsequent periods. Section Reference 1: Non-controlling Interest in Income and Equity in Subsequent Periods Feedback: Review section “Non-controlling Interest in Income and Equity in Subsequent Periods”

46) The IASB and the AASB have chosen to adopt the ________ concept of consolidation, mainly because of the conceptual framework decision that financial statements are prepared for a wide range of users. a) cost b) entity c) parent entity d) proprietary Answer: b Difficulty: Easy Learning Objective: LO Appendix 5A Section Reference 1: Concepts of Consolidation Feedback: Review section “Choice of Concept”

47) A non-controlling interest is entitled to a share of which of the following items? I Equity of the group entity at acquisition date. II Current period profit or loss of the subsidiary entity.

Fayerman: Advanced Accounting, Ce

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III Changes in equity of the subsidiary since acquisition date and the beginning of the financial period. IV Equity of the subsidiary at acquisition date. a) I, II and III. b) I and II only. c) II, III and IV only. d) III only. Answer: c Difficulty: Medium Learning Objective: Discuss the nature of the non-controlling interest (NCI). Section Reference 1: The Nature of Non-controlling Interest Feedback: Review section “Determination of the NCI”

48) Chase Ltd. purchased 60% of Latham Ltd. for $1,500,000. At the date of acquisition, the carrying value of Latham's net identifiable assets was $1,800,000 and the fair value was $2,200,000 after accounting for the tax effect. The fair value of the NCI at that date is $1,000,000. What is the amount of the goodwill under the full goodwill method? a) $300,000. b) $(300,000). c) $120,000. d) $400,000. Answer: a Difficulty: Easy Learning Objective: Calculate the NCI share of equity at the day of acquisition Section Reference 1: Non-Controlling Share of Equity at the Acquisition Date Feedback: Review section “Full Goodwill Method”

49) Kiara Ltd. acquired 90% of Udder Ltd. for $200,000 less than the fair value. How should this $200,000 be treated on Kiara's consolidated financial statements? a) As goodwill on the consolidated statement of financial position. b) As a gain on the consolidated statement of comprehensive income. c) Allocated as fair value increments over Udder's net identifiable assets. d) As a separate item under shareholders' equity. Answer: b Difficulty: Medium

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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Learning Objective: Calculate the NCI share of equity at the day of acquisition. Section Reference 1: Non-controlling Share of Equity at the Acquisition Date Feedback: Review section “Accounting at the Acqusition Date”

50) Norman Ltd. owns 60% of the outstanding common shares of Arnie Ltd. During 2013, sales from Arnie to Norman were $200,000. Merchandise was priced to provide Arnie with a gross margin of 20%. Norman's inventories contained $40,000 at December 31, 2012 and $15,000 at December 31, 2013 of merchandise purchased from Arnie. Cost of goods sold for Norman and Arnie for 2013 on their separate-entity income statements were as follows: Norman $ 100,000 700,000 (110,000) $ 690,000

Beginning inventory Purchases Ending inventory Cost of goods sold

Arnie $ 50,000 200,000 (55,000) $195,000

How much is the non-controlling interest adjusted for its share of the consolidated net income for the year ended December 31, 2013? a) $3,000. b) $5,000. c) $1,250. d) $2,000. Answer: a Difficulty: Hard Learning Objective: Calculate NCI which is affected by the existence of intragroup profits. Section Reference 1: Non-controlling Interest Affected by Intragroup Profits Feedback: Review section “Inventory”

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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Short Answer 51) What does the “group” consist of under the entity concept of consolidation? Difficulty: Medium Learning Objective: Discuss the nature of the non-controlling interest (NCI). Section Reference: The Nature of Non-controlling Interest Feedback: See “Determination of the NCI” Solution: Suggested answer: Under the entity concept of consolidation, the group consists of the combined assets and liabilities of the parent and the subsidiary. There are two owners in this group — the parent shareholders and the NCI. The NCI is a contributor of equity to the group.

52) Compare the full goodwill method and the partial goodwill methods of calculating the NCI at the acquisition date. Difficulty: Medium Learning Objective: Calculate the NCI share of equity at the day of acquisition. Section Reference: Non-controlling Share of Equity at the Acquisition Date Feedback: See “Reasons for Choosing Method” Solution: Suggested answer: IFRS 3 provides two alternative methods for calculating the NCI at the acquisition date. Under the full goodwill method, the NCI is measured at fair value at acquisition date, and goodwill is recognized at 100%. Under the partial goodwill method, the NCI is measured as a proportion of the net fair value of the identifiable net assets of the subsidiary at acquisition date, and only the parent’s share of goodwill is recognized on consolidation. Because it is necessary to distinguish between the parent’s share and the NCI share of equity in the consolidated financial statements, additional calculations are required to divide the group equity into the NCI share and the parent’s share. There are three main differences in the outcome when the partial goodwill method is used instead of the full goodwill method: 1. The amounts recognized for the NCI share of equity and goodwill would be lower. 2. When the rules of impairment are applied to a cash generating unit containing goodwill, as the goodwill recognized by the cash generating unit is lower, this affects the impairment loss relating to goodwill. 3. There is an effect where an acquirer subsequently obtains further shares in the subsidiary at a later date.

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53) Why is the calculation of the NCI necessary for both for the Statement of Changes in Equity and for the Statement of Financial Position? Difficulty: Medium Learning Objective: Calculate the NCI share of income and equity in subsequent periods. Section Reference: Non-controlling Interest in Income and Equity in Subsequent Periods Feedback: See “Non-controlling Interest in Income and Equity in Subsequent Periods” Solution: Suggested answer: The calculation of the NCI is necessary both for the Statement of Changes in Equity and for the Statement of Financial Position: (1) the NCI share of recorded income is determined, and (2) this share is adjusted for the effects of intragroup transactions. We will then allocate this on the Statement of Changes in Equity. The NCI share of equity will also be calculated to reflect the NCI on the Statement of Financial Position.

54) What are the characteristics for a transaction to require an adjustment to the calculation of the NCI share of equity? Difficulty: Medium Learning Objective: Calculate NCI which is affected by the existence of intragroup profits. Section Reference: Non-controlling Interest Affected by Intragroup Profits Feedback: See “Inventory” Solution: Suggested answer:

Not all transactions require an adjustment to the NCI. For a transaction to require an adjustment to the calculation of the NCI share of equity, it must have the following characteristics: • The transaction must result in the subsidiary recording a profit or a loss. • After the transaction, the other party to the transaction (for two company structures this is the parent) must have on hand an asset (e.g., inventory) on which the unrealized profit is accrued. • The initial consolidation adjustment for the transaction should affect both the statement of financial position and the statement of comprehensive income unlike payments of debenture interest or management fees, which affect only the statement of comprehensive income.

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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55) Discuss the implications of a gain on bargain purchase for the non-controlling interest. Difficulty: Medium Learning Objective: Calculate NCI that is affected by the existence of a gain on bargain purchase. Section Reference: Non-controlling Interest Affected by a Gain on Bargain Purchase Feedback: See “Non-controlling Interest Affected by a Gain on Bargain Purchase” Solution: Suggested answer: In the rare case that a gain on bargain purchase may arise, such a gain has no effect on the calculation of the NCI share of equity. The gain is made by the parent paying less than the net fair value of the acquirer’s share of the identifiable assets, liabilities and contingent liabilities of the subsidiary. The NCI receives a share of the fair value of the subsidiary, and has no involvement with the gain on bargain purchase. 56) Discuss the implications of a parent’s increase and decrease in ownership interest. Difficulty: Medium Learning Objective: Calculate the effect on NCI due to changes in ownership. Section Reference: Changes in the Proportion Held by Non-controlling Interest Feedback: See “Increase/Decrease in Ownership” Solution: Suggested answer: When a parent increases its ownership interest, the difference between the amount that was paid by the parent and the amount that was transferred from the non-controlling interest is allocated to equity. When a parent decreases its ownership interest but still retains control, the difference between the amount that was received and the amount that was transferred to the non-controlling interest is allocated to equity. When a parent decreases its ownership interest and loses control, the difference between the amount that was received and the amount that was transferred to the non-controlling interest is recorded in income.

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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57) Describe the key characteristics of the entity concept of consolidation. Difficulty: Medium Learning Objective: LO Appendix 5A Section Reference: Concepts of Consolidation Feedback: See “Entity Concept of Consolidation” Solution: Suggested answer: Under the entity concept of consolidation: • the group consists of the assets and liabilities of the parent as well as all the assets and liabilities of the subsidiaries • the NCI is classified as an equity holder or contributor of capital to the group in the same capacity as the equity holders/owners of the parent.

58) Fillington Inc. acquired a 75% shareholding in Donhenry Ltd. for $20 million. Book value of net identifiable assets of Donhenry is $14 million. The fair value of Donhenry's asset is the same as their book value except accounts receivables, which are impaired by $1 million. Book value of assets is $54 million while book value of liabilities is $40 million. The NCI has been valued at $5 million. The tax rate is 30%. Required: Calculate goodwill using the full goodwill method. Difficulty: Medium Learning Objective: Calculate the NCI share of equity at the day of acquisition. Section Reference: Non-controlling Share of Equity at the Acquisition Date Feedback: See “Full Goodwill Method” Solution: Suggested answer: Acquisition Analysis: (a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Net fair value of identifiable assets

=$20,000,000 =$5,000,000 =$25,000,000 =$14,000,000 capital =($1,000,000) (1-30%) A/R =$13,300,000 Goodwill =$11,700,000 Net fair value acquired by Fillington =75% X $13,300,000 = $9,975,000

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

Consideration transferred Goodwill-parent Goodwill-NCI

Testbank

=$20,000,000 =$10,025,000 =$3,275,000

59) Resnick Inc. acquired 75% shareholding in Canty Ltd. for $20 million. Book value of net identifiable assets of Canty is $14 million. The fair value of Canty's asset is the same as their book value except accounts receivables which are impaired by $1 million. Book value of assets is $54 million while book value of liabilities is $40 million. The tax rate is 30%. Required: Calculate goodwill using the partial goodwill method. Difficulty: Hard Learning Objective: Calculate the NCI share of equity at the day of acquisition. Section Reference: Non-controlling Share of Equity at the Acquisition Date Feedback: See “Partial Goodwill Method” Solution: Suggested answer: Acquisition Analysis: Consideration transferred Net fair value of identifiable assets

=$20,000,000 =$14,000,000 capital =($1,000,000) (1-30%) A/R =$13,300,000 Net fair value acquired by Fillington =75% X $13,300,000 = $9,975,000 Consideration transferred =$20,000,000 Goodwill-parent =$10,025,000

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Chapter 5: Consolidation: Non-Controlling Interest

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60) On January 1, 2012, Kiss Ltd. acquired a 60% interest in Rosebud Inc. For $115,000. At this date, the equity of Rosebud consisted of the following: Share capital Retained earnings

$100,000 $50,000

At this date, the identifiable assets and liabilities of Rosebud were recorded at fair value except for the following assets: Equipment (cost $100,000) Carrying Amount: $70,000 Land Carrying Amount: $85,000 Inventory Carrying Amount: $55,000

Fair Value: $80,000 Fair Value: $95,000 Fair Value: $60,000

The equipment had a further 5-year useful life and half of the inventory on hand at the acquisition date was sold by December 31, 2012. The other half was sold in 2013. The land has not been sold. Kiss uses the full goodwill method. The fair value of the non-controlling interest at January 1, 2012 was $75,000. During the three years since acquisition, Rosebud has recorded the following annual results: Year-ended December 31, 2012: Profit of $20,000 Year-ended December 31, 2013: Profit of $25,000 There has been no dividend paid or declared by Rosebud since the acquisition date. The tax rate is 30%. Required: (a) Prepare the consolidated financial statements adjustment as at January 1, 2012 (b) Prepare the consolidated financial statements adjustments for the year ended December 31, 2012 (c) Prepare the consolidated financial statements adjustments for the year ended December 31, 2013 Suggested answer: Acquisition analysis as at January 1, 2012: Consideration transferred: Non-controlling interest in subsidiary: Total of above:

$115,000 $75,000 $190,000

Net fair value of the identifiable assets And liabilities of Rosebud: Share capital

$100,000

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Chapter 5: Consolidation: Non-Controlling Interest

Retained earnings Equipment Land Inventory

Testbank

$50,000 $10,000 X (1-0.30) $10,000 X (1-0.30) $5,000 X (1-0.30) $167,500

Goodwill:

$22,500

Net fair value acquired by parent:

$100,500

60% X $167,500 Consideration transferred:

$115,000

Goodwill-parent:

$14,500

Goodwill-NCI:

$8,000

NCI at acquisition date: Share capital Retained earnings FVA Equipment FVA Land FVA Inventory Goodwill Total A)

40% X 100,000 = 40,000 40% X 50,000 = 20,000 40% X 7,000 = 2,800 40% X 7,000 = 2,800 40% X 3,500 = 1,400 8,000 = $75,000

Acquisition adjustments as at January 1, 2012: ↓ $100,000 ↓ $50,000 ↓ 115,000 ↑ $75,000 ↑ $22,500 ↑ $10,000 ↑ $10,000 ↑ $5,000 ↑ $7,500

Share capital Retained earnings Investment in Rosebud Non-controlling interest Goodwill Land Equipment Inventory Deferred tax liabilities B)

Consolidated financial statement adjustments for the year ended December 31, 2012

Comprehensive income statement: Depreciation expense-equipment Income tax expense NCI

↑ $2,000 ↓ $600 ↓ $560

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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Depreciation expense-equipment= $10,000/5 years remaining life= $2,000 per year Income tax expense= $2,000 X 30% = $600 NCI= 40% X ($2,000-$600)=$560 ↑ $2,500 ↓ $750 ↓ $700

Cost of sales Income tax expense NCI Cost of sales =$5,000/2 = $2,500 Income tax expense= $2,500 X 30% = $750 NCI = 40% X ($2,500-$750)=$700 ½ of $5,000 inventory sold by December 31, 2012 Statement of changes in equity: Retained earnings-beginning $0 NCI-beginning

$75,000

Statement of financial position: Equipment-net ↑ $10,000-$2,000=$8,000 Deferred tax liability ↑ $3,000-$600=$2,400 Land ↑ $10,000 Deferred tax liability ↑ $3,000 Inventory ↑ $2,500 = $5,000-$2,500 Deferred tax liability ↑ $750 = $1,500-$750 Goodwill ↑ $22,500 Ending NCI ↑ $81,740

Beginning NCI $75,000 Rosebud since acquisition 40% X 20,000 = 8,000 FVA Inventory 40% X (2,500-750) = (700) FVA Equipment 40% X 1,400 = (560) Ending NCI $81,740 Profit for the period NCI 40% X $20,000= $8,000

↑ $8,000 – 560-700 = $6,740

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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C) Consolidated financial statement adjustments for the year ended December 31, 2013: Comprehensive income statement: Depreciation expense-equipment Income tax expense NCI

↑ $2,000 ↓ $600 ↓ $560

Depreciation expense-equipment= $10,000/5 years remaining life= $2,000 per year = $2,000 Income tax expense= $2,000 X 30% = $600 NCI= 40% X ($2,000-$600)=$560 ↑ $2,500 ↓ $750 ↓ $700

Cost of sales Income tax expense NCI ½ of inventory sold in 2013 Cost of sales =$5,000/2 = $2,500 Income tax expense= $2,500 X 30% = $750 NCI = 40% X ($2,500-$750)=$700 Statement of changes in equity: NI - Rosebud since acquisition FVA Inventory FVA Equipment

60% X 20,000 = 12,000 60% X (2,500-750) = (1,050) 60% X 1,400 = (840)

NCI-beginning ↑ $81,740 Share capital 40% X 100,000 = 40,000 Retained earnings 40% X (50,000 + 20,000) = 28,000 FVA Equipment 40% X (7,000-1,400) = 2,240 FVA Land 40% X 7,000 = 2,800 FVA Inventory 40% X 1,750 = 700 Goodwill = 8000 Statement of financial position: Land ↑ $10,000 Deferred tax liability ↑ $3,000 Goodwill ↑ $22,500 Ending NCI ↑ $90,480 Share capital 40% X 100,000 = 40,000 Retained earnings 40% X (50,000 + 20,000 + 25,000) = 38,000 FVA Land 40% X 7,000 = 2,800 FVA Equipment 40% X (7,000-1,400-1,400) = 1,680 Goodwill = 8,000 Ending Retained Earnings ↑ $23,220 Rosebud since acquisition 60% X (20,000+25,000) = 27,000

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

FVA Inventory FVA Equipment Profit for the period NCI 40% X $25,000= $10,000

60% X 3,500 = (2,100) 60% X 1,400 X 2 = (1,680) ↑ $10,000-560-700=8,740

Testbank

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Chapter 5: Consolidation: Non-Controlling Interest

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61) On January 1, 2011 Glass Inc. acquired 80% of the share capital of Crystal Ltd. For $400,000. At this date, the equity of Crystal consisted of: Share capital: $200,000 Retained earnings: $75,000 At January 1, 2011 all of Crystal’s identifiable assets and liabilities were recorded at fair value except for the following: Equipment (cost $150,000) Carrying amount: $80,000 Fair value: $90,000 Land Carrying amount: $40,000 Fair Value: $80,000 The equipment had a further useful life of 5 years. The land is still on hand. Glass uses the partial goodwill method. Financial information for the two companies at December 31, 2013 is as follows:

Sales Revenue Other income Cost of sales Other expenses Income before tax Income tax expense Net Income Retained earnings (1/1/13) Dividend paid Dividend declared Retained earnings (12/31/13)

Glass 950,000 50,000 1,000,000 600,000 125,000 725,000 275,000 45,000 230,000 90,000 320,000 15,000 10,000 25,000 295,000

Crystal 800,000 40,000 840,000 450,000 175,000 625,000 215,000 45,000 170,000 80,000 250,000 10,000 5,000 15,000 235,000

Additional information: 1. During 2012, Crystal sold some inventory to Glass for $10,000. This inventory had originally cost Crystal $4,000. At December 31, 2012, 20% of these remained unsold by Glass. 2. The ending inventory of 2013, of Glass, included inventory sold to it by Crystal at a profit of $4,000 before tax. This had cost Crystal $15,000. 3. The tax rate is 30%. 4. Glass’s share capital has always been $100,000. 5. On January 1, 2014, Glass sold 10% of its ownership in Crystal so that it now owns 70%. They received $30,000 for the shares.

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Required: (a) Prepare the consolidated statement of comprehensive income and statement of changes in equity at December 31, 2013. (b) Calculate the effect on consolidated equity in 2014 from the sale of the shares. Suggested answer: Acquisition Analysis as at January 1, 2011: Consideration transferred:

$400,000

Net fair value of the identifiable Assets and liabilities of Crystal: Share capital: $200,000 Retained earnings: $75,000 Plant: $10,000 X (1-0.30) Land: $40,000 X (1-0.30) $310,000 Net fair value acquired by Glass: 80% X $310,000

$248,000

Goodwill:

$152,000

Consolidation adjustments at December 31, 2013 1. Fair value adjustments Comprehensive income statement: Depreciation expense ↑ $2,000 Income tax expense ↓ $600 NCI ↓ $280 $10,000/5 years = $2,000 per year $2,000 X 30% = $600 Income tax expense [$2,000-$600] X 20% = $280 Statement of changes in equity: Retained earnings-beginning

↓ $2,240

Retained earnings-beginning 2 years elapsed 90000+.8(80000-75000)-.8(2x1400)-.8(840)= 91,088 Statement of financial position: Equipment-net ↑ $4,000 Deferred tax liability ↑ $1,200 Goodwill ↑ $152,000 (above) Retained earnings-ending 295,000 + 80%(235,000 -75,000 – 3 x 1,400 -2,800)= 417,400 NCI-ending 20% (200,000 +235,000 +28,000 + 7000 -3 x 1,400 – 2,800) = 92,600

Fayerman: Advanced Accounting, Ce

Chapter 5: Consolidation: Non-Controlling Interest

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Plant = $10,000 – 3 X $2,000 = $4,000 Deferred tax liability = $3,000- 3 X $600= $1,200 2) Non-controlling interest: Opening balance in equity NCI-beginning – 20% X [200,000 + 80,000 +28,000 + 7,000 – 2 X $1,400 - 840] = $62,272 Profit for the period 20% X $170,000 = $34,000-$280+$168-$560=$33,328 1) Intragroup transactions: A) Dividends paid: Dividend revenue Dividend paid NCI-dividends $10,000 X 20% = $2,000

↓ $8,000 ↓ $10,000 ↓ $2,000

B) Dividends declared: Dividend receivable Dividend payable Dividend revenue Dividend declared NCI-dividends $5,000 X 20% = $1,000

↓ $4,000 ↓ $4,000 ↓ $4,000 ↓ $5,000 ↓ $1,000

C) Prior period sale of inventory (upstream) Statement of changes in equity: Retained earnings-beginning ↓ $672 NCI-beginning equity ↓ $168 80% X [$1,200-$360]=$672 20% X [$1,200-$60]=$168 Comprehensive income statement: Income tax expense Cost of sales NCI

↑ $360 ↓ $1,200 ↑ $168

Unrealized profit was 20% X $6,000 = $1,200 $10,000-$4,000 = $6,000 [$1,200-$360] X 20% = $168 D) Current period sale of inventory (upstream) Comprehensive income: Sales ↓ $19,000 Cost of sales ↓ $15,000 Income tax expense ↓ $1,200

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Chapter 5: Consolidation: Non-Controlling Interest

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↓ $560

NCI-net income

$15,000 original cost to Crystal (seller) + $4,000 profit = $19,000 sales $19,000-$15,000 = $4,000 X 30% = $1,200 Statement of financial position: Inventory Deferred tax asset NCI-equity Retained earnings-ending 80% X [$19,000-$15,000-$1,200]=$2,240

↓ $4,000 ↑ $1,200 ↓ $560 ↓ $2,240

CRYSTAL Consolidated statement of comprehensive income For the year ended December 21, 2013

Sales revenue Other income

1,731,000 78,000 1,809,000 1,033,800 302,000 1,335,800 473,200

Cost of sales Other expenses Income before tax

=$950,000+$800,000-$19,000 =$50,000+$40,000-$12,000 =$600,000+$450,000-$1,200-$15,000 =$125,000+$175,000+$2,000

Income tax expense Net income

=$45,000+$45,000-$600+$36088,560 $1,200 384,640

Attributable to the parent Attributable to the NCI

351,312 33,328 =($280)+34,000+168-560

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Chapter 5: Consolidation: Non-Controlling Interest

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CRYSTAL Consolidated statement of changes in equity For the year ended December 21, 2013

Balance, January 1, 2013

Share capital 100,000

Retained earnings 91,088

Parent 191,760

NCI 62,272

Comprehensive income

351,312

33,328

384,640

Dividends paid

(15,000)

(2,000)

(17,000)

Dividends declared

(10,000)

(1,000)

(11,000)

100,000

417,400

518,072

92,600

604,072

Balance, December 31, 2013

B) Cash received by Crystal: $30,000 Net assets transferred: Book value ($200,000 + $235,000) FVA-Plant ($7,000/5 years X 2 years left) FVA – Land Total assets transferred

$435,000 $2,800 28,000 $465,800

Percentage transferred

X 10% ($46,580)

Loss to equity $16,580

Total Equity 247,432

Fayerman: Advanced Accounting, Ce

Chapter 6: Accounting for Investments in Associates and Joint Ventures

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Testbank Chapter 6 – Accounting for Investments in Associates and Joint Ventures True or False

1) Sales of assets from the entity to its associate or its joint venture is an example of a downstream transaction. Answer: True Difficulty: Medium Learning Objective: Adjust for the effects of intercompany transactions. Section Reference: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the company and its Joint Venture” 2) Adjustments to the entity’s share of the equity of the associate or joint venture are not made to accounts such as retained earnings as would occur under the consolidation method. Answer: False Difficulty: Medium Learning Objective: Adjust for the effects of intercompany transactions. Section Reference: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the Company and its Joint Venture”

3) The purpose of the acquisition analysis relating to goodwill and fair value adjustments is to determine the real post-acquisition equity of the associate or joint venture. Answer: True Difficulty: Medium Learning Objective: Adjust for goodwill and fair value differences at acquisition date. Section Reference: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date”

4) All dividends paid or payable by an investee to an investor are to be recognized as

Fayerman: Advanced Accounting, Ce

Chapter 6: Accounting for Investments in Associates and Joint Ventures

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revenue by the investor when the investor is also a parent company and will be preparing consolidated financial statements. Answer: True Difficulty: Medium Learning Objective: Adjust for movements in equity from dividends and reserves, and the effects of dissimilar accounting policies and different ends of reporting periods. Section Reference: Movements in Equity Feedback: Review section “Dividends”

5) Where dividends are paid/declared by an associate or joint venture and the entity receiving the dividend prepares consolidated financial statements, the dividend revenue recognized in the entity’s accounts is eliminated on consolidation. Answer: True Difficulty: Medium Learning Objective: Apply the equity method on consolidated or separate financial statements. Section Reference: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Statements”

6) An investment in an associate is reported using the equity method from the date on which it becomes an associate. Answer: True Difficulty: Medium Learning Objective: Adjust for goodwill and fair value differences at acquisition date. Section Reference: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date”

7) For a parent entity which will prepare consolidated financial statements, investments in associates or joint ventures held by the parent or its subsidiaries are accounted for in the consolidated financial statements by the cost method. Answer: False Difficulty: Medium Learning Objective: Apply the equity method on consolidated or separate financial

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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statements. Section Reference: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Statements”

8) Where the associate or joint venture incurs losses, the carrying amount of the Investment in Associate or Joint Venture is first reduced to zero. Answer: True Difficulty: Medium Learning Objective: Account for losses recorded by the associate or joint venture. Section Reference: Losses Recorded by the Associate or Joint Venture Feedback: Review section “Losses Recorded by the Associate or Joint Venture” 9) The equity method of accounting will be discontinued when the investor’s share of losses equals or exceeds the investment’s carrying amount. Answer: True Difficulty: Medium Learning Objective: Adjust for goodwill and fair value differences at acquisition date. Section Reference: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date”

10) Unlike consolidation, there is no need to adjust for all transactions between the entity and the associate or joint venture; only the transactions where profit is affected require adjustment. Answer: True Difficulty: Medium Learning Objective: Adjust for the effects of intercompany transactions. Section Reference: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the company and its Joint Venture”

11) If an entity had previously held an investment in another entity and by a further investment that investee became an associate or joint venture of the entity, at the date of the second investment, the previously held investment is revalued to fair value with any gain/loss being taken to profit or loss.

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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Answer: True Difficulty: Medium Learning Objective: Account for the investing in an associate or joint venture in stages. Section Reference: Investing in an Associate or Joint Venture in Stages Feedback: Review section “Becoming an Associate or Joint Venture after Acquiring an Ownership Interest”

12) If, after reporting losses, a joint venture earns a profit, the entity does not recognize a share of profits. Answer: False Difficulty: Medium Learning Objective: Account for losses recorded by the associate or joint venture. Section Reference: Losses Recorded by the Associate or Joint Venture Feedback: Review section “Losses Recorded by the Associate or Joint Venture” 13) Adjustments to the entity’s share of the equity of the associate or joint venture are made for the effects of both upstream and downstream transactions even though a downstream transaction does not affect the equity of the associate or joint venture. Answer: True Difficulty: Medium Learning Objective: Adjust for the effects of intercompany transactions. Section Reference: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the company and its Joint Venture”

14) Adjustments for any goodwill arising on acquisition would occur on impairment of goodwill. Answer: True Difficulty: Medium Learning Objective: Adjust for goodwill and fair value differences at acquisition date. Section Reference: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date”

15) In a business combination achieved in stages, the acquirer shall remeasure its

Fayerman: Advanced Accounting, Ce

Chapter 6: Accounting for Investments in Associates and Joint Ventures

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previously held equity interest in the acquiree at its acquisition-date fair values and recognize the resulting gain or loss, if any, in other comprehensive income. Answer: False Difficulty: Medium Learning Objective: Account for the investing in an associate or joint venture in stages. Section Reference: Investing in an Associate or Joint Venture in Stages Feedback: Review section “Becoming an Associate or Joint Venture after Acquiring an Ownership Interest”

Multiple Choice

16) How do joint ventures differ from private corporations? a) The joint venturers must share the risks and profits of the joint venture equally. b) Venturers cannot make unilateral decisions. c) There can only be two parties in a joint venture. d) A joint venture does not have a board of directors. Answer: b Difficulty: Easy Learning Objective: Apply the equity method on consolidated or separate financial statements. Section Reference: Equity Method of Accounting and Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Statements”

17) When an inter-corporate investment is acquired in stages, when does the equity method first becomes appropriate? a) When control is attained. b) When the initial investment is made. c) When the intent to control is determined. d) When significant influence is first achieved. Answer: d Difficulty: Medium Learning Objective: Account for the investing in an associate or joint venture in stages. Section Reference: Investing in an Associate or Joint Venture in Stages

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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Feedback: Review section “Becoming an Associate or Joint Venture after Acquiring an Ownership Interest”

18) Which of the following statements regarding the effects of intercompany transactions is FALSE? a) The rationale for the IAS 28 requirements for adjusting for intercompany transactions is not clear. b) The entity is not entitled to a share of realized equity of an associate or joint venture. c) Adjustments to the entity’s share of the equity of the associate or joint venture are made for the effects of both upstream and downstream transactions even though a downstream transaction does not affect the equity of the associate or joint venture. d) Adjustments are not made to accounts such as sales and cost of sales as would occur under the consolidation method. Answer: b Difficulty: Medium Learning Objective: Adjust for the effects of intercompany transactions. Section Reference: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the company and its Joint Venture”

19) Which of the following statements regarding losses recorded by the associate or joint venture is FALSE? a) The entity’s share of losses of an associate or joint venture is recognized but only to the point where the carrying amount of the investment in the associate or joint venture is zero. b) The share of losses may be offset against other investments the entity has in the associate or joint venture such as long-term receivables. c) If, after reporting losses, an associate earns a profit, the entity recognizes a share of profits only after the share of profits exceeds the share of past losses not recognized. d) If, after reporting losses, a joint venture earns a profit, the entity does not recognize a share of profits ever. Answer: d Difficulty: Medium Learning Objective: Account for losses recorded by the associate or joint venture. Section Reference: Losses Recorded by the Associate or Joint Venture Feedback: Review section “Losses Recorded by the Associate or Joint Venture”

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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20) Which methods will result in the same income and shareholders' equity? a) Cost and consolidation. b) Cost and equity. c) Equity and consolidation. d) Each method may result in different income and shareholder's equity amounts. Answer: d Difficulty: Easy Learning Objective: Apply the equity method on consolidated or separate financial statements. Section Reference: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Statements”

21) Which of the following statements regarding goodwill and fair value differences from the day that an associate or joint venture is acquired, is FALSE? a) Where differences between fair values and carrying amounts exist at the acquisition date for the investee’s identifiable assets and liabilities, subsequent equity recognized by the associate or joint venture may include fair value adjustments relating to these differences. b) Amortization of goodwill relating to an associate or a joint venture is permitted. c) Calculation of adjustments for differences between carrying amounts and fair values is always on an after-tax basis. d) Adjustments for any goodwill arising on acquisition would occur on impairment of goodwill. Answer: b Difficulty: Medium Learning Objective: Adjust for goodwill and fair value differences at acquisition date. Section Reference: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date”

22) Where an entity prepares consolidated financial statements, the equity method is applied to associates or joint ventures of the _________________________ in the consolidated financial statements, and not in the accounts of the ________ itself. a) parent; parent b) parent and its subsidiaries; subsidiary c) parent; subsidiary

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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d) parent and its subsidiaries; parent. Answer: d Difficulty: Medium Learning Objective: Apply the equity method on consolidated or separate financial statements. Section Reference: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Statements”

23) Dolan Ltd. has invested in several domestic manufacturing corporations. Which of the following investments would most likely be accounted for under the equity method on Dolan's financial statements? a) A holding of 3,000 of the 10,000 outstanding preferred shares of Green Co. b) A holding of 5,000 of the 60,000 outstanding common shares of Eco-saveCo. c) A holding of 20,000 of the 25,000 outstanding common shares of Enviro-Clean Co. d) A holding of 15,000 of the 50,000 outstanding common shares of Planetwise Co. Answer: d Difficulty: Medium Learning Objective: Apply the equity method on consolidated or separate financial statements. Section Reference: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Statements”

24) In a business combination achieved in stages, the acquirer shall remeasure its previously held equity interest in the acquiree at its acquisition-date fair values __________________________________________. a) and does not recognize the resulting gain or loss. b) and recognize the resulting gain or loss, if any, in other comprehensive income. c) and recognize the resulting gain or loss, if any, in profit or loss. d) and recognize the resulting gain or loss, if any, in retained earnings. Answer: c Difficulty: Medium Learning Objective: Account for the investing in an associate or joint venture in stages.

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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Section Reference: Investing in an Associate or Joint Venture in Stages Feedback: Review section “Becoming an Associate or Joint Venture after Acquiring an Ownership Interest”

25) If an associate or joint venture has outstanding cumulative preference shares that are held by parties other than the entity and classified as ____________, the entity computes its share of profits or losses after adjusting for the dividends on such shares, whether or not the dividends have been declared. a) debt or equity b) debt c) equity d) earnings. Answer: c Difficulty: Medium Learning Objective: Adjust for movements in equity from dividends and reserves, and the effects of dissimilar accounting policies and different ends of reporting periods. Section Reference: Movements in Equity Feedback: Review section “Dividends”

26) Kibble Ltd. contributed some specialized equipment to receive a 45% interest in a joint venture, Lenard Inc. The equipment has a fair value of $640,000 and a carrying value of $300,000. Kibble also received $ 100,000 in cash from Lenard Inc. The other party to the joint venture, Farlinger Ltd, contributed cash of $660,000 for the 55% interest. It is deemed that the transaction lacks commercial substance. Based on the above, the gain to be recognized immediately by Kibble is: a) $0 b) $53,125 c) $100,000 d) $340,000 Answer: b Difficulty: Hard Learning Objective: Adjust for the effects of intercompany transactions. Section Reference: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the company and its Joint Venture”

Fayerman: Advanced Accounting, Ce

Chapter 6: Accounting for Investments in Associates and Joint Ventures

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27) Adjustments must be made for transactions between the associate or joint venture and the entity that give rise to unrealized profits or losses. Realization of such profits or losses occurs when: a) The asset on which the profit or loss accrued is sold to an external party. b) As the future benefits embodied in the asset are consumed. c) The asset on which the profit or loss accrued is sold to an external party or as the future benefits embodied in the asset are consumed. d) The asset on which the profit or loss accrued is sold to an external or internal party. Answer: c Difficulty: Medium Learning Objective: Adjust for the effects of intercompany transactions. Section Reference: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the Company and its Joint Venture”

28) An investment in an associate or joint venture is reported using the _____________ method from the date on which it becomes an associate or joint venture. a) cost b) equity c) proportional consolidation d) cost or equity. Answer: b Difficulty: Medium Learning Objective: Apply the equity method on consolidated or separate financial statements Section Reference: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Financial Statements”

29) Sales or contributions of assets from an associate or joint venture to the investor is an example of a(n) _________________ transaction. a) downstream b) equity c) fair value d) upstream.

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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Answer: d Difficulty: Medium Learning Objective: Adjust for the effects of intercompany transactions. Section Reference: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the company and its Joint Venture”

30) How are most significant influence investments in equity securities actually recorded on the investor’s books when the investor is also a parent company that will prepare consolidated financial statements? a) Using the equity method. b) Using proportionate consolidation. c) At cost. d) On a fully consolidated basis. Answer: c Difficulty: Easy Learning Objective 1: Apply the equity method on consolidated or separate financial statements. Section Reference 1: Equity Method of Accounting and Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Statements” 31) The adjustment to recognize an entity’s share of the asset revaluation reserve relating to an associate based on the on application of the equity method involves a debit to a) Asset revaluation reserve. b) Investment in associate. c) Retained earnings. d) Common share capital. Answer: b Difficulty: Medium Learning Objective 1: Adjust for movements in equity from dividends and reserves, and the effects of dissimilar accounting policies and different ends of reporting periods. Section Reference 1: Movements in Equity Feedback: Review section “Reserves”

Fayerman: Advanced Accounting, Ce

Chapter 6: Accounting for Investments in Associates and Joint Ventures

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32) On January 1, 2013, Crawford Ltd. acquired 25% of the shares of Rufus Ltd. for $69,375. At this date, the equity of Rufus Ltd. consisted of: Share capital $150,000 Retained earnings 80,000 At the acquisition date, all the identifiable assets and liabilities of Rufus Ltd. were recorded at fair value, except for plant for which the fair value was $20,000 greater than its carrying amount, and inventory whose fair value was $5,000 greater than its cost. The tax rate is 30%. The plant has a further 5-year life. The inventory was all sold by December 31, 2013. In the reporting period ending December 31, 2013, Rufus Ltd. reported a profit of $20,000. The amount of goodwill arising from this transaction is: a) $5,625 b) $7,500 c) $11,875 d) $160,625 Answer: b Difficulty: Hard Learning Objective 1: Adjust for goodwill and fair value differences at acquisition date. Section Reference 1: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date”

33) The effect of the sale of inventory on the share of profit or loss of the associate is: a) $875 decrease b) $4,250 increase c) $350 increase d) $1,250 decrease Answer: a Difficulty: Hard Learning Objective 1: Adjust for goodwill and fair value differences at acquisition date. Section Reference 1: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date”

34) On January 1, 2013, Conji Ltd. acquired 25% of the shares of Porter Ltd. for $42,500. At this date, all the identifiable assets and liabilities of Porter Ltd. were recorded at amounts equal to fair value, and the equity of Porter Ltd. consisted of: Share capital

$100,000

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

Asset revaluation reserve Retained earnings

Testbank

20,000 50,000

During 2013, Porter Ltd. reported a profit of $25,000. The asset revaluation reserve increased by $5,000, this being reported in other comprehensive income. Porter Ltd. paid a $4,000 dividend. At January 1 2013, Conji Ltd. recorded the investment in Porter Ltd. at $42,500 The share of profit or loss of associate that Conji Ltd. should record is a) $4,000 b) $6,250 c) $20,000 d) $25,000 Answer: b Difficulty: Hard Learning Objective 1: Apply the equity method on consolidated or separate financial statements. Section Reference 1: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Applying the Equity Method: Basic Method.” 35) Regarding goodwill and fair value adjustments, any excess of the entity’s share of the net fair value of an associate or joint venture’s identifiable assets and liabilities over the cost of the investment is to be recognized as _______________ in the determination of the entity’s share of the associate or joint venture’s profit or loss in the period in which the investment is acquired. a) income b) a reserve c) goodwill d) other comprehensive income Answer: a Difficulty: Hard Learning Objective 1: Adjust for goodwill and fair value differences at acquisition date. Section Reference 1: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date”

36) Omar Corporation uses the equity method to account for its 25% investment in Limpit Corporation and receives $15,000 in dividends. How should Omar account for

Fayerman: Advanced Accounting, Ce

Chapter 6: Accounting for Investments in Associates and Joint Ventures

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these dividends? a) A decrease in the investment. b) An increase in income. c) A decrease in income. c) An increase in assets. Answer: a Difficulty: Medium Learning Objective 1: Apply the equity method on consolidated or separate financial statements. Section Reference 1: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Applying the Equity Method: Basic Method”

37) The difference between the fair value and the ___________ value of the investment at the day of a second acquisition of the same shares, is a gain or loss through the profit and loss of the entity. a) book b) carrying c) current d) future. Answer: b Difficulty: Easy Learning Objective 1: Account for the investing in an associate or joint venture in stages. Section Reference 1: Investing in an Associate or Joint Venture in Stages Feedback: Review section “Becoming an Associate or Joint Venture after Acquiring an Ownership Interest”

38) The maximum difference between the ends of the reporting periods of the entity and the associate or joint venture can be no more than: a) 1 month b) 3 months c) 6 months d) 12 months. Answer: b Difficulty: Easy

Fayerman: Advanced Accounting, Ce

Chapter 6: Accounting for Investments in Associates and Joint Ventures

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Learning Objective 1: Adjust for movements in equity from dividends and reserves, and the effects of dissimilar accounting policies and different ends of reporting periods. Section Reference 1: Movements in Equity Feedback: Review section “Different Ends of Reporting Periods” 39) The entity’s share of losses of an associate or joint venture may be offset against: a) Other investments the entity has in the associate or joint venture. b) Its income. c) Its other comprehensive income. d) The associate’s or joint venturer’s retained earnings. Answer: a Difficulty: Medium Learning Objective 1: Account for losses recorded by the associate or joint venture. Section Reference 1: Losses Recorded by the Associate or Joint Venture Feedback: Review section “Losses Recorded by the Associate or Joint Venture” 40) The entity’s share of current period profit of the associate or joint venture is disclosed as a separate line item in the entity’s __________________ a) statement of comprehensive income. b) statement of financial position. c) statement of cash flows. d) statement of changes in equity. Answer: a Difficulty: Medium Learning Objective 1: Apply the equity method on consolidated or separate financial statements. Section Reference 1: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Applying the Equity Method: Basic Method”

41) Dogma Ltd. records its investment in Fayer Co. at cost. During the year, Dogma received $20,000 in dividends from Fayer. How should Dogma record these dividends? a) As dividend income in its statement of comprehensive income. b) As an increase to the "Investment in Fayer Co." account on its statement of financial position. c) As a decrease to the "Investment in Fayer Co." account on its statement of financial

Fayerman: Advanced Accounting, Ce

Chapter 6: Accounting for Investments in Associates and Joint Ventures

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position. d) As dividend income on its statement of changes in equity-retained earnings section. Answer: a Difficulty: Medium Learning Objective 1: Apply the equity method on consolidated or separate financial statements. Section Reference 1: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Statements”

42) The purpose of the acquisition analysis relating to goodwill and fair value adjustments is to determine the real post-acquisition equity of the ____________________. a) associate. b) joint venture. c) parent. d) associate or joint venture. Answer: d Difficulty: Easy Learning Objective 1: Adjust for goodwill and fair value differences at acquisition date. Section Reference 1: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date”

43) If an associate or joint venture uses accounting policies other than those of the entity for like transactions and events in similar circumstances, adjustments shall be made to conform the _______________ accounting policies to those of the ______________ when the associate or joint venture’s financial statements are used by the entity in applying the equity method. a) associate or joint venture’s; entity b) entity’s; associate or joint venture c) parent’s; subsidiary; d) subsidiary’s; parent. Answer: a Difficulty: Medium Learning Objective 1: Adjust for movements in equity from dividends and reserves, and

Fayerman: Advanced Accounting, Ce

Chapter 6: Accounting for Investments in Associates and Joint Ventures

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the effects of dissimilar accounting policies and different ends of reporting periods. Section Reference 1: Movements in Equity Feedback: Review section “Dissimilar Accounting Policies” 44) Adjustments to the entity’s share of the equity of the associate or joint venture are not made to accounts such as __________________ as would occur under the consolidation method. a) retained earnings b) downstream transactions c) sales and cost of sales d) upstream transactions. Answer: c Difficulty: Medium Learning Objective 1: Adjust for the effects of intercompany transactions. Section Reference 1: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the Company and its Joint Venture” 45) In calculating the entity’s share of equity of the associate or joint venture, dividend revenue will need to be removed from the entity’s consolidated financial statements since the ______________ method will now replace the ______________ method of accounting for the investment. a) fair value; equity b) consolidation; proportionate consolidation c) equity; cost d) intercompany; cost. Answer: c Difficulty: Medium Learning Objective 1: Adjust for movements in equity from dividends and reserves, and the effects of dissimilar accounting policies and different ends of reporting periods. Section Reference 1: Movements in Equity Feedback: Review section “Dividends”

46) Assume Timpet Ltd. acquired 10% of the shares of Dawson Ltd on January 1, 2012 for $13,000. At December 31, 2012, the end of the entity’s reporting period, the fair value of the investment was $16,200. The investment was designated as fair value through profit and loss based on IFRS 9.

Fayerman: Advanced Accounting, Ce

Chapter 6: Accounting for Investments in Associates and Joint Ventures

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On July 1 2013, Timpet Ltd. acquired a further 10% of the share capital of Dawson Ltd. for $17,200 (this also being the fair value of the initial investment in Dawson Ltd. at this date), when the equity of Dawson Ltd. consisted of: Share capital Asset revaluation reserve Retained earnings (1/1/13) Profit (1/1/13 to 30/6/13)

$100,000 12,000 38,000 8,000

The identifiable assets and liabilities of Dawson Ltd were recorded at fair value at this date except for inventory, whose fair value was $15,000 greater than carrying amount. This acquisition gives Timpet Ltd. significant influence over Dawson Ltd. On January 1, 2012, which of the following statements is TRUE? a) Timpet Ltd. would record its investment in Dawson Ltd. at $13,000. b) Timpet Ltd. would revalue its investment to $16,200, recognizing $3,200 in net income. c) Dawson Ltd. becomes an associate. d) Timpet Ltd. becomes a joint venture. Answer: a Difficulty: Hard Learning Objective 1: Account for the investing in an associate or joint venture in stages. Section Reference 1: Investing in an Associate or Joint Venture in Stages Feedback: Review section “Becoming an Associate or Joint Venture after Acquiring an Ownership Interest” 47) The entity’s share of losses of an associate or joint venture is recognized but only to the point where the carrying amount of the investment in the associate or joint venture is a) Greater than the entity’s income. b) Less than the entity’s income. c) Zero. d) Less than the income of the associate or joint venture. Answer: c Difficulty: Medium Learning Objective 1: Account for losses recorded by the associate or joint venture. Section Reference 1: Losses Recorded by the Associate or Joint Venture Feedback: Review section “Losses Recorded by the Associate or Joint Venture”

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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48) Sales of assets from the entity to its associate or its joint venture is an example of a(n) ______________________ transaction. a) downstream b) equity c) fair value d) upstream. Answer: a Difficulty: Medium Learning Objective 1: Adjust for the effects of intercompany transactions. Section Reference 1: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the company and its Joint Venture”

49) Where dividends are paid/declared by an associate or joint venture and the entity prepares consolidated financial statements, the dividend revenue recognized in the ______________ accounts is eliminated on consolidation. a) parent’s b) associate’s c) subsidiary’s d) joint venturer’s. Answer: a Difficulty: Medium Learning Objective 1: Adjust for movements in equity from dividends and reserves, and the effects of dissimilar accounting policies and different ends of reporting periods. Section Reference 1: Movements in Equity Feedback: Review section “Dividends”

50) Queen Ltd. reports its investment in Kramer Co. on an equity basis. During the year, Queen received $15,000 in dividends from Kramer. How should Queen report these dividends? a) As dividend income on its statement of changes in equity-retained earnings section. b) As dividend income in its statement of comprehensive income. c) As an increase to the "Investment in Kramer Co." account on its statement of financial position. d) As a decrease to the "Investment in Kramer Co." account on its statement of financial position.

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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Answer: d Difficulty: Medium Learning Objective 1: Apply the equity method on consolidated or separate financial statements. Section Reference 1: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Applying the Equity Method: Basic Method”

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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Short Answer

51) Describe how investments in associates and joint ventures are accounted for by a parent entity, which will and will not prepare consolidated financial statements. Difficulty: Medium Learning Objective: Apply the equity method on consolidated or separate financial statements. Section Reference: The Equity Method of Accounting on Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Statements” Solution: Suggested answer: For a parent entity, which will prepare consolidated financial statements, investments in associates or joint ventures held by the parent or its subsidiaries are accounted for in the consolidated financial statements by the equity method. Therefore, the accounting adjustments applying the equity method to the investment in the associate or joint venture are made in the consolidated financial statements only. The adjustments are made on a year-to-year basis, because no permanent adjustments for the equity accounting are made in the records of the entity. Where the entity does not prepare consolidated financial statements — it is not a parent — the entity applies the equity method to its associate or joint ventures in its own accounting records. The accounts of the entity are then affected by the application of the equity method, in contrast to the situation where the equity method adjustments are made in the consolidation process.

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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52) An investment in an associate or joint venture is accounted for using the equity method from the date on which it becomes an associate or joint venture. On acquisition of the investment, how is any difference between the cost of the investment and the entity’s share of the net fair value of the investee’s identifiable assets and liabilities accounted for? Difficulty: Medium Learning Objective: Adjust for goodwill and fair value differences at acquisition date. Section Reference: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date” Solution: Suggested answer: Any difference between the cost of the investment and the entity’s share of the net fair value of the investee’s identifiable assets and liabilities is accounted for as follows: (a) Goodwill relating to an associate or a joint venture is included in the carrying amount of the investment. Amortization of that goodwill is not permitted. (b) Any excess of the entity’s share of the net fair value of the investee’s identifiable assets and liabilities over the cost of the investment is included as income in the determination of the entity’s share of the associate or joint venture’s profit or loss in the period in which the investment is acquired.

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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53) Describe how dividends from a subsidiary, associate and joint venture are accounted for by a parent (entity). Difficulty: Medium Learning Objective: Adjust for movements in equity from dividends and reserves, and the effects of dissimilar accounting policies and different ends of reporting periods. Section Reference: Movements in Equity Feedback: Review section “Dividends” Solution: Suggested answer: All dividends paid or payable by a subsidiary to a parent are to be recognized as revenue by the parent in its own financial statements. When the associate or joint venture pays or declares a dividend, the entity records dividend revenue. As noted earlier in this chapter, because on consolidation, the investment account has been adjusted for the entity’s share of all post-acquisition equity, applying the equity method requires the investment account to be adjusted for dividends paid or declared. Where consolidated financial statements are prepared, the consolidated adjustments to remove the dividend revenue, which is included in the company’s net income for its separate financial statements is to reduce dividend revenue and reduce investment in associate or joint venture.

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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54) If an entity had previously held an investment in another entity and by a further investment that investee became an associate or joint venture of the entity, what must be recorded at the date of the second investment? Difficulty: Medium Learning Objective: Account for the investing in an associate or joint venture in stages. Section Reference: Investing in an Associate or Joint Venture in Stages Feedback: Review section “Becoming an Associate or Joint Venture after Acquiring an Ownership Interest” Solution: Suggested answer: If an entity had previously held an investment in another entity and by a further investment that investee became an associate or joint venture of the entity, at the date of the second investment: • the previously held investment is revalued to fair value with any gain/loss being taken to profit or loss • if the previously held investment had been measured at fair value with changes in fair value being recognized directly in equity, those amounts are transferred to current period retained earnings.

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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55) What are the principles for adjusting for the effects of intercompany transactions under IAS 28? Difficulty: Medium Learning Objective: Adjust for the effects of intercompany transactions. Section Reference: Effects of Intercompany Transactions Feedback: Review section “Transactions Between the Company and Its Associate or Between the company and its Joint Venture” Solution: Suggested answer: The principles for adjusting for the effects of intercompany transactions under IAS 28 are as follows: • Adjustments must be made for transactions between the associate or joint venture and the entity that give rise to unrealized profits or losses. Realization of such profits or losses occurs when the asset on which the profit or loss accrued is sold to an external party or as the future benefits embodied in the asset are consumed. Unlike consolidation, there is no need to adjust for all transactions between the entity and the associate or joint venture; only the transactions where profit is affected require adjustment. Therefore, transactions such as the holding of debentures by one entity in another entity, and the payment of interest on those debentures, do not require an adjustment under equity accounting. • Unlike adjustments for unrealized profits and losses within a consolidated group, adjustments for transactions between an entity and an associate or joint venture are done on a proportional basis, determined in accordance with the entity’s ownership interest in the associate or joint venture. This is reasonable given that, under the equity method, only the entity’s share of the equity of the associate or joint venture is recognized and not the full equity of the associate or joint venture. • IAS 28 does not detail which accounts should be adjusted in this process. For example, if the associate or joint venture sells an item of inventory to the entity at a profit, it is necessary to adjust the entity’s share of the recorded profits of the associate or joint venture. Tthere are no adjustments to specific asset accounts such as Property, Plant and equipment or Inventory.

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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56) Describe how to account for losses incurred by associate and joint venturers. Difficulty: Medium Learning Objective: Account for losses recorded by the associate or joint venture. Section Reference: Losses Recorded by the Associate or Joint Venture Feedback: Review section “Losses Recorded by the Associate or Joint Venture” Solution: Suggested answer: The carrying amount of the investment is not just the balance of the account Investment in Associate or Joint Venture. The entity’s interest in the associate or joint venture also includes other long-term interests in the associate or joint venture, such as preference shares or long-term receivables or loans. The base against which the losses are offset is then the entity’s net investment in the associate or joint venture, including these other long-term interests. Where the associate or joint venture incurs losses, the carrying amount of the Investment in Associate or joint Venture is first reduced to zero. If losses exceed this carrying amount, they are then applied against the other components of the entity’s interest in the associate or joint venture in the reverse order of their seniority, or priority in liquidation. The logic is that, if the associate or joint venture is making losses, then the probability of the other investments in the associate or joint venture being realized is lessened. After the entity’s interest is reduced to zero, additional losses are recorded if the entity has a legal or constructive obligation or made payments on behalf of the associate or joint venture. When the associate or joint venture subsequently reports profits, the company resumes recognizing its share of those profits only after its share of the profits equals the share of losses not recognized.

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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57) On February 1, 2012, Jesse Co. purchased 20% of the outstanding shares of Avril Inc. at a cost of $275,000. During the next two fiscal years, Avril Inc. reported the following: Net income $42,000 $35,000

January 31, 2013 January 31, 2014

Dividends $20,000 $15,000

Required: (a) If Jesse records its investment in Avril at cost, what would the balance in the investment account be at January 31, 2014? What would be reported on the statement of comprehensive income with respect to this investment for 2013 and 2014? (b) If Jesse uses the equity method for reporting its investment in Avril, what would the balance in the investment account be at January 31, 2014? What would be reported on the statement of comprehensive income with respect to this investment? Difficulty: Hard Learning Objective: Apply the equity method on consolidated or separate financial statements. Section Reference: Equity Method of Accounting and Consolidated and Separate Financial Statements Feedback: Review section “Separate Financial Statements versus Consolidated Statements Solution: Suggested answer: (a) Will result in the Investment in Avril account being $275,000, the original investment amount, at January 31, 2014. Dividend income of $4,000 ($20,000 X 20%) will be reported for the year ended January 31, 2013. Dividend income of $3,000 ($15,000 X 20%) will be reported for the year ended January 31, 2014. (b)

The equity method will result in the Investment in Avril account being as follows: $ 275,000

Opening balance Feb 1, 2012 Jan 2013 – Share of profit of Avril 20% × $42,000 Dividends received during 2013 20% × $20,000 Balance Jan 31, 2013 Jan 2014 – Share of profit of Avril 20% ×

8,400 (4,000) 279,400 7,000

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

$35,000 Dividends received during 2014 20% × $15,000 Balance Jan 31, 2014

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(3,000) 283,400

The amounts showing on the statement of comprehensive income for each year is: For the year ended January 31, 2013 — Share of profit of Avril $8,400 For the year ended January 31, 2014 — Share of profit of Avril $7,000

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59) On January 1, 2013, Edie Ltd acquired 25% of the shares of Gowan Ltd for $79,375. At this date, the equity of Gowan Ltd consisted of: Share capital $150,000 Retained earnings 80,000 At the acquisition date, all the identifiable assets and liabilities of Gowan Ltd were recorded at fair value, except for plant for which the fair value was $15,000 greater than its carrying amount, and inventory whose fair value was $5,000 greater than its cost. The tax rate is 30%. The plant has a further 5-year life. The inventory was all sold by December 31, 2013. In the reporting period ending December 31, 2013, Gowan Ltd reported a profit of $15,000. The acquisition analysis at January 1, 2013 is as follows: Cost of investment = $79,375 Net fair value of the identifiable assets and = ($150,000 + $80, 000) (equity) liabilities of Gowan Ltd + $15,000 (1 - 30%) (plant) + $5,000(1 - 30%) (inventory) = $244,000 Net fair value acquired by Edie Ltd = 25% × $180,500 = $61,000 Goodwill Depreciation (net of tax) of plant p.a. Effect of sale of inventory (net of tax)

= $18,375 = 1/5 × (25% × [$15,000(1 – 30%)]) = $525 = 25% × $5,000(1 – 30%) = $875

Required: (a) What is the amount of the adjustment needed in applying equity accounting to the investment in the associate at December 31, 2013? (b) What is the journal entry to reflect the application of the equity method to the investment? Difficulty: Hard Learning Objective: Adjust for goodwill and fair value differences at acquisition date. Section Reference: Goodwill and Fair Value Differences at Acquisition Date Feedback: Review section “Goodwill and Fair Value Differences at Acquisition Date” Solution:

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Chapter 6: Accounting for Investments in Associates and Joint Ventures

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Suggested answer: a) Share of profit recorded by associate (25% × $15,000) Fair value adjustments: Depreciation of plant Sale of inventory Share of post-acquisition profit of associate b) Investment in Gowan Ltd Share of Profit or Loss of Associate (Recognition of share of postacquisition profit of associate or joint venture)

$3,750

$(525) (875)

(1,400) $2,350

2,350

Fayerman: Advanced Accounting, Ce

Chapter 7: Accounting for Foreign Currency

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Testbank Chapter 7 – Accounting for Foreign Currency

True or False

1) Functional currency is the currency in which the company conducts its primary business activity. Answer: True Difficulty: Medium Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Currency Risk”

2) When a commercial transaction is denominated in another currency, foreign exchange gains and losses are realized. Answer: True Difficulty: Medium Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Currency Exchange Gains and Losses”

3) A transaction gain or loss at the settlement date is a change in the exchange rate quoted by a foreign exchange trader. Answer: False Difficulty: Medium Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Currency Exchange Gains and Losses”

4) A derivative instrument cannot be a hedged item. Answer: True Difficulty: Medium 1

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Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Transactions Denominated in a Foreign Currency Feedback: Review section “Hedging with Financial Instrument Derivatives”

5) The historical rate is the exchange rate at the beginning of the reporting period and the closing rate is the exchange rate at the end of the reporting period. Answer: False Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Initial Recognition”

6) Monetary items are translated using the exchange rate at the balance sheet date. Answer: True Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Recognition in Subsequent Periods”

7) When a company selects a presentation currency for its financial statements that is different than its functional currency, the statements must be translated into the functional currency. Answer: False Difficulty: Medium Learning Objective: Translate financial statements from the “functional currency” to the “presentation currency.” Section Reference: Translating Financial Statements from the Functional Currency to the Presentation Currency Feedback: Review section “Translating Financial Statements into a Presentation Currency”

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8) Once a company’s functional currency is identified, all transactions denominated in another currency are considered to be foreign currency transactions. Answer: True Difficulty: Medium Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Converting Foreign Currency Transactions into a Company’s Functional Currency”

9) Companies sometimes purchase derivative financial instruments to speculate on future foreign currency movements or to protect themselves from future fluctuations in currency rates. Answer: True Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Derivative Financial Instruments as Hedges”

10) In order to identify the foreign exchange component of a transaction, a company must establish the currency in which its books and records should be maintained. Answer: True Difficulty: Medium Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Primary Economic Entity”

11) Exchange gains and losses on accounts receivable/payable that are denominated in a foreign currency are deferred and reported upon settlement. Answer: False Difficulty: Easy Learning Objective: Determine the “functional currency” of a company.

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Chapter 7: Accounting for Foreign Currency

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Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Currency Gains and Losses”

12) Hedge accounting is applicable only if a receivable is being hedged. Answer: False Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Economically Hedging Foreign Currency Risk”

13) Assets and liabilities (including comparatives) are translated at the spot rate at the date of the statement of financial position. Answer: False Difficulty: Medium Learning Objective: Translate financial statements form the “functional currency” to the “presentation currency.” Section Reference: Translating Financial Statements from the Functional Currency to the Presentation Currency Feedback: Review section “Translating Financial Statements into a Presentation Currency”

14) The exchange rate in effect at the date of the transaction is called the spot exchange rate. Answer: True Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions a Company’s Functional Currency Feedback: Review section “Initial Recognition”

15) Non-monetary items are translated using the exchange rate at the balance sheet date. Any resulting foreign exchange gain or loss is recorded in other comprehensive income. Answer: False

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Chapter 7: Accounting for Foreign Currency

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Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Recognition in Subsequent Periods”

Multiple Choice

16) Exchange gains and losses on accounts receivable/payable that are denominated in a foreign currency are _______. a) recognized in the periods in which exchange rates change. b) deferred and reported upon settlement. c) reported as adjustments to the transaction prices. d) reported as equity adjustments from translation. Answer: a Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Recognition in Subsequent Periods”

17) Which of the following statements about hedge accounting is TRUE? a) Hedge accounting is mandatory. b) Hedge accounting is applicable only if a receivable is being hedged. c) Hedge accounting is optional. d) Hedge accounting is applicable only if a liability is being hedged. Answer: c Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback:Review section “Definition of Hedge Accounting”

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Chapter 7: Accounting for Foreign Currency

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18) On March 1, 2013, Eddie Ltd. issued a purchase order to Liu Inc. to acquire a crane for $400,000 SGD. On the same day, Eddie entered into a forward contract to receive $400,000 SGD on July 31, 2013. The crane was delivered on June 1, 2013 and payment was made July 31, 2013. Eddie has an April 30 year-end. The following information has been provided:

Date March 1, 2013 April 30, 2013 June 1, 2013 July 31, 2013

Spot Rate .7686 .7702 .7940 .7995

Forward rate to July 31, 2013 .7810 .7818 .7985 n/a

Assume that the transaction qualifies as a cash flow hedge. On March 1, at what amount should the forward contract be reported? a) $312,400 b) $317,600 c) $0 d) $319,800 Answer: c Difficulty: Hard Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Economically Hedging Foreign Currency Risk”

19) What is the effect of fluctuations in exchange rates on accounts payable? a) Deferred and amortized. b) Recognized immediately in income. c) Recognized if losses, deferred if gains. d) Deferred to maturity. Answer: b Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Recognition in Subsequent Periods”

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Chapter 7: Accounting for Foreign Currency

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20) Where is the ineffective portion of a cash-flow hedge recognized on the financial statements? a) As part of other comprehensive income. b) As a separate component of equity. c) It does not appear on the financial statements. d) As part of net income. Answer: d Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Economically Hedging Foreign Currency Risk”

21) Which of the following items is a non-monetary item? a) Accounts receivable. b) Inventory. c) Accounts payable. d) Cash. Answer: b Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Recognition in Subsequent Periods”

22) What is the exchange rate in effect at the date of the transaction called? a) Forward rate. b) Closing rate. c) Settlement rate. d) Spot rate. Answer: d Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a

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Chapter 7: Accounting for Foreign Currency

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company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Initial Recognition” 23) On January 1, 2012, Crawford Inc. issued 10,000,000 Euros (€) of bonds payable. The bonds are due on December 31, 2014. Over the life of the bonds, the exchange rates were as follows: €1 = $1.40 €1 = $1.45 €1 = $1.50 €1 = $1.48

January 1, 2012 December 31, 2012 December 31, 2013 December 31, 2014 What is the exchange gain (loss) recognized in income during 2014? a) $(200,000) b) $(800,000) c) $ 800,000 d) $ 200,000 Answer: d

Difficulty: Medium Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency. Feedback: Review section “Recognition in Subsequent Periods”

24) Donka Co. does a lot of business in Australia. It has numerous trade accounts receivables and accounts payables that are to be settled in Australian dollars. What type of hedge does Donka have? a) Natural hedge. b) Fair-value hedge. c) Cash-flow hedge. d) Hedge instrument. Answer: a Difficulty: Easy Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency.

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Chapter 7: Accounting for Foreign Currency

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Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Economically Hedging Foreign Currency Risk”

25) Which of the following statements regarding the translation of the financial statements into a presentation currency is FALSE? a) Assets and liabilities (including comparatives) are translated at the average rate at the date of the statement of financial position. b) Income and expenses (including comparatives) for each statement of comprehensive income presented are translated at exchange rates at the dates the transactions took place. c) All resulting exchange differences are recognized in other comprehensive income. d) For practical purposes, an average rate to approximate the actual exchange rate at the date of the transactions for income and expenses may be used as long as these items basically occur evenly over the period being presented. Answer: a Difficulty: Medium Learning Objective: Translate financial statements from the “functional currency” to the “presentation currency.” Section Reference: Translating Financial Statements from the Functional Currency to the Presentation Currency Feedback: Review section “Translating Financial Statements into a Presentation Currency”

26) Using a _________ rate of exchange for all items appearing on the statement of financial position maintains the relationship in the retranslated financial statements (into the presentation currency) as that that existed in the foreign operation's financial statements (using the functional currency). a) fluctuating b) constant c) spot d) closing Answer: b Difficulty: Medium Learning Objective: Translate financial statements form the “functional currency” to the “presentation currency.” Section Reference: Translating Financial Statements from the Functional Currency to the Presentation Currency Feedback: Review section “Translating Financial Statements into a Presentation Currency”

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Chapter 7: Accounting for Foreign Currency

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27) On November 2, 2013, Glasser Company purchased a machine for 100,000 Swiss francs (CHF) with payment requirement on March 30, 2014. To eliminate the risk of foreign exchange losses on this payable, Glasser entered into a forward exchange contract on November 3, 2013 to receive CHF 100,000 at a forward rate of CHF1 = $2 on March 30, 2014. The spot rate was CHF1 = $1.95 on November 2, 2013 and CHF1 = $1.97 on December 1, 2013. What is the amount of the premium or discount on the forward exchange contract? a) A discount of $3,000. b) A premium of $5,000. c) A discount of $5,000. d) A premium of $3,000. Answer: b Difficulty: Hard Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Applying Hedge Accounting”

28) At the balance sheet date, which of the following statements is TRUE? a) Monetary items are translated using the exchange rate at the balance sheet date. Any resulting foreign exchange gain or loss is recorded in income. b) Monetary items are translated using the exchange rate at the balance sheet date. Any resulting foreign exchange gain or loss is recorded in other comprehensive income. c) Non-Monetary items are translated using the exchange rate at the balance sheet date. Any resulting foreign exchange gain or loss is recorded in income. d) Non-Monetary items are translated using the exchange rate at the balance sheet date. Any resulting foreign exchange gain or loss is recorded in other comprehensive income. Answer: a Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Recognition in Subsequent Periods”

29) Which of the following statements is TRUE?

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Chapter 7: Accounting for Foreign Currency

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a) The historical rate is the exchange rate at the date of the transaction and the closing rate is the exchange rate at the end of the reporting period. b) The historical rate is the exchange rate at the beginning of the reporting period and the closing rate is the exchange rate at the end of the reporting period. c) The historical rate is the exchange rate at the beginning of the reporting period and the forward rate is the exchange rate at the end of the reporting period. d) The spot rate is the exchange rate at the date of the transaction and the closing rate is the exchange rate at the conclusion of a hedge instrument. Answer: a Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Initial Recognition”

30) What exchange rate is usually used to report non-monetary assets on the statement of financial position? a) Spot rate. b) Closing rate. c) Fair value. d) Historical rate. Answer: d Difficulty: Easy Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Recognition in Subsequent Periods”

31) Which of the following typically cannot be a hedged item? a) Derivative instrument. b) Accounts receivable. c) Accounts payable. d) Purchase order. Answer: a

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Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Derivative Financial Instruments as Hedges”

32) On March 1, 2013, Chacin Ltd. issued a purchase order to No Worries (New Zealand) Inc. to acquire equipment for $400,000 New Zealand dollars. On the same day, Chacin entered into a forward contract to receive $400,000 New Zealand dollars on July 31, 2013. The equipment was delivered on June 1, 2013 and payment was made July 31, 2013. Chacin has an April 30 year-end. The following information has been provided:

Date March 1, 2013 April 30, 2013 June 1, 2013 July 31, 2013

Spot Rate .7686 .7702 .7940 .7995

Forward rate to July 31, 2013 .7810 .7818 .7985 n/a

Assume that the transaction qualifies as a hedge. What is the cost of the hedge? a) $4,960 b) $2,200 c) $4,640 d) $6,680 Answer: a Difficulty: Hard Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Derivative Financial Instruments as Hedges”

33) A transaction gain or loss at the settlement date is: a) A change in the exchange rate quoted by a foreign exchange trader. b) Synonymous with the translation of foreign currency financial statements into dollars. c) The difference between the recorded dollar amount of an account receivable denominated in a foreign currency and the amount of dollars received. d) The difference between the buying and selling rate quoted by a foreign exchange trader at the settlement date.

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Answer: c Difficulty: Medium Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Currency Risk”

34) When a company selects a presentation currency for its financial statements that is different than its functional currency, the statements must be translated into the ____________ currency. a) presentation b) functional c) transaction d) foreign Answer: a Difficulty: Medium Learning Objective: Translate financial statements form the “functional currency” to the “presentation currency.” Section Reference: Translating Financial Statements from the Functional Currency to th Presentation Currency Feedback: Review section “Translating Financial Statements into a Presentation Currency”

35) Under IFRS, which of the following statements is false regarding hedging? a) Hedge accounting refers to a set of accounting rules that allow a company to smooth the impact of foreign currency fluctuations on income. b) The gain or loss on a hedging instrument under a cash-flow hedge is first reported as other comprehensive income and then reclassified to income when the hedged item affects income. c) The gain or loss on a hedging instrument under a cash-flow hedge is first reported as income. d) Without the use of hedge accounting, an increased volatility on income would be realized resulting from a company’s exposure to foreign currency risk. Answer: c Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions

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Feedback: Review section “Derivative Financial Instruments as Hedges”

36) On June 1, 2013, Donlands Canada Co. entered into a 90-day forward contract to sell $500,000 Singapore dollars (SGD) to its bank on August 29, 2013. The following information has been provided: June 1, 90-day forward rate SGD$1 = $0.7750 July 1, 60-day forward rate SGD$1 = $0.7630 August 29, spot rate SGD$1 = $0.748 Donlands has a June 30 year-end. What is the exchange gain (loss) at June 30, 2013? a) $(6,000) b) $6,000 c) $0 d) $1,500 Answer: b Difficulty: Hard Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Economically Hedging Foreign Currency Risk”

37) On November 2, 2013, Choi Company purchased equipment for 100,000 Swiss francs (CHF) with payment requirement on March 30, 2014. To eliminate the risk of foreign exchange losses on this payable, Choi entered into a forward exchange contract on November 3, 2013 to receive CHF 100,000 at a forward rate of CHF1 = $2 on March 30, 2014. The spot rate was CHF1 = $1.95 on November 2, 2013 and CHF1 = $1.97 on December 1, 2013. How should the premium or discount on the forward exchange contract be accounted for if it is deemed to be a cash flow hedge? a) It should be expensed on the maturity date of the forward exchange contract. b) It should be expensed on the inception date of the forward exchange contract. c) It should be expensed over the 5-month term of the forward exchange contract. d) It should be added to the cost of the machine. Answer: d Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions

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Feedback: Review section “Derivative Financial Instruments as Hedges”

38) Companies may operate in Canada, meaning that their offices are located in Canada, and their customers are Canadian. However, sometimes companies may decide they are willing to accept payment in a currency other than Canadian dollars. Which of the following statements is FALSE? a) When a commercial transaction is denominated in another currency, foreign exchange gains and losses are realized. b) When the books and records of a company are maintained in Canadian dollars, transactions that took place in another currency must be translated into Canadian dollars for inclusion into the records of the company. c) When a Canadian seller decides to accept payment in Euros for its products, as a result of the accounting records being maintained in Canadian dollars, the Euros need to be converted into Canadian dollars. d) When a Canadian seller decides to accept payment in Euros for its products, as a result of the accounting records being maintained in Canadian dollars, Euros will be converted to Canadian dollars using the average foreign exchange rate for the month. Answer: d Difficulty: Medium Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Currency Risk”

39) What is a currency swap an example of? a) A futures contract. b) A call option. c) A forward contract. d) A derivative instrument. Answer: d Difficulty: Easy Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Derivative Financial Instruments as Hedges”

40) Which of the following is NOT one of the conditions that must be met to qualify for hedge accounting?

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Chapter 7: Accounting for Foreign Currency

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a) The effectiveness of the hedge can easily be determined. b) The hedge relationship must be designated and documented. c) The hedge is assessed at the beginning and at the end of the hedging period. d) The hedge is expected to be effective. Answer: c Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Qualifying for Hedge Accounting”

41) On December 1, 2013, Rollings Ltd. sold goods to Federer Ltd., a company located in Switzerland for 500,000 Swiss francs (CHF). At the date of sale, the spot rate was CHF1 = $1.0329. On the same date, Rollings acquired a 90-day forward contract at a rate of CHF1 = $1.0315. On March 1, 2014, Rollings receives full payment from Federer and delivered the Swiss francs in execution of the forward contract. The spot rate at March 1, 2014 was CHF1 = $1.0287. What amount should Rollings record for the sale? a) $515,750 b) $500,000 c) $516,450 d) $514,350 Answer: c Difficulty: Hard Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Economically Hedging Foreign Currency Risk”

42) Upon translation, assets and liabilities are translated at the _________ rate at the presentation date and income statement items are translated using the _______ rate for the period. a) average; closing b) closing; average c) forward; closing d) spot; average. Answer: b

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Chapter 7: Accounting for Foreign Currency

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Difficulty: Medium Learning Objective: Translate financial statements from the “functional currency” to the “presentation currency.” Section Reference: Translating Financial Statements from the Functional Currency to the Presentation Currency Feedback: Review section “Translating Financial Statements into a Presentation Currency”

43) Which of the following statements regarding functional currency is FALSE? a) Functional currency is the currency in which the company conducts its primary business activity. b) Foreign currency exists when a company transacts in a currency other than its functional currency. c) The currency of the country in which an entity normally operates is its functional currency. d) Functional currency must be determined first before foreign currency transactions can be identified. Answer: c Difficulty: Medium Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Currency Risk”

44) On June 1, 2013, Vandelay Co. entered into a 90-day forward contract to sell $1,000,000 Singapore dollars (USD) to its bank on August 29, 2013. The following information has been provided: June 1, 90-day forward rate USD$1 = $0.9750 June 30, 60-day forward rate USD$1 = $0.9630 August 29, spot rate USD$1 = $0.948 Vandelay has a June 30 year-end. What is the exchange gain (loss) at June 30, 2013? a) $(12,000) b) $(27,000) c) $(15,000) d) $12,000 Answer: a

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Chapter 7: Accounting for Foreign Currency

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Difficulty: Hard Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Derivative Financial Instruments as Hedges”

45) Under IFRS, which of the following statements about hedging a foreign currency risk of an accepted purchase order is TRUE? a) It can be accounted for using either a fair-value hedge or a cash-flow hedge. b) It is not eligible for hedge accounting until it becomes an accounts payable. c) It must be accounted for using a fair-value hedge. d) It must be accounted for using a cash-flow hedge. Answer: a Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Economically Hedging Foreign Currency Risk”

46) Which of the following list would not be effective as a hedge for a Canadian company with a large number of transactions in Denmark? a) Danish krone held by a Canadian bank. b) A forward contract for the purchase of Danish krone. c) A forward contract for the sale of Danish krone. d) Canadian funds held by a Danish bank. Answer: d Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Economically Hedging Foreign Currency Risk”

47) In order to identify the foreign exchange component of a transaction, a company must establish the currency in which its books and records should be maintained. This is the ___________________________ a) domestic currency.

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b) currency of the primary economic environment in which a company operates. c) foreign currency. d) translation currency. Answer: b Difficulty: Medium Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Currency Risk”

48) A transaction loss would result from a) an increase in the foreign exchange rate in relation to the Canadian rate applicable to an asset denominated in a foreign currency. b) a decrease in the foreign exchange rate in relation to the Canadian rate applicable to a liability denominated in a foreign currency. c) the import of merchandise when the transaction is denominated in a foreign currency. d) a decrease in the foreign exchange rate in relation to the Canadian rate applicable to an asset denominated in a foreign currency. Answer: d Difficulty: Medium Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Currency Risk”

49) Which of the following statements regarding the translation of financial statements from the “functional currency” to the “presentation currency” is FALSE? a) Entities may choose to present their financial statements in any currency. b) Given the rising trend towards globalization, management may like to present their financial statements in a currency different from their functional currency in order to attract investors or because it is required by local law or other regulation. c) A company may display its statements in a language more relatable to a global marketplace used to viewing financial information denominated in a currency not functional to the entity. d) Any gain or loss on translation is considered part of income. Answer: d Difficulty: Medium Learning Objective: Translate financial statements from the “functional currency” to the

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Chapter 7: Accounting for Foreign Currency

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“presentation currency.” Section Reference: Translating Financial Statements from the Functional Currency to the Presentation Currency Feedback: Review section “Translating Financial Statements into a Presentation Currency” 50) On January 1, 2012, Gupta Inc. issued 10,000,000 Euros (€) of bonds payable. The bonds are due on December 31, 2014. Over the life of the bonds, the exchange rates were as follows: €1 = $1.40 €1 = $1.45 €1 = $1.50 €1 = $1.48

January 1, 2012 December 31, 2012 December 31, 2013 December 31, 2014 What is the exchange gain (loss) recognized in income during 2013? a) $(500,000) b) $500,000 c) $1,000,000 d) $(1,000,000) Answer: a Difficulty: Medium Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Exchange Gains and Losses”

Short Answer

51) How does a company establish the currency in which its books and records should be maintained? Difficulty: Medium Learning Objective: Determine the “functional currency” of a company Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Primary Economic Entity” Solution: Suggested answer:

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Chapter 7: Accounting for Foreign Currency

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In order to identify the foreign exchange component of a transaction, a company must establish the currency in which its books and records should be maintained. This is the currency of the primary economic environment in which a company operates. It cannot be assumed that a company’s domestic currency is the currency in which it normally operates. Sometimes, a company’s domestic currency can be the Canadian dollar because that is where its offices are located, but if the company sells most of its products to another country, such that the economic activities of that foreign country mainly influence the pricing and sales of the company’s products and services, it is likely that the currency of the country that mainly influences the company’s sales and pricing would be determined to be its functional currency. 52) Once an entity’s functional currency is identified, all transactions denominated in another currency are considered to be foreign currency transactions. What are some examples of foreign currency transactions? Difficulty: Medium Learning Objective: Convert transactions denominated in a foreign currency into a company’s functional currency. Section Reference: Converting Foreign Currency Transactions into a Company’s Functional Currency Feedback: Review section “Initial Recognition” Solution: Suggested answer: Examples of foreign currency transactions are as follows: • • •

An entity buys or sells goods or services whose price is denominated in a foreign currency; An entity borrows or lends money when the amounts payable or receivable are denominated in a foreign currency; or An entity acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign currency.

53) What is the purpose of derivative financial instruments? Provide some examples and explain how they work in practice. Difficulty: Medium Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Denominated in a Foreign Currency Feedback: Review section “Derivative Financial Instruments as Hedges” Solution:

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Chapter 7: Accounting for Foreign Currency

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Suggested answer: Companies sometimes purchase derivative financial instruments to speculate on future foreign currency movements, or to protect itself from future fluctuations in currency rates. There are several different types of derivative financial instruments, such as, financial options, futures or forward contracts, interest rate swaps, currency swaps. These contracts create rights and obligations that have the effect of transferring between the parties to the instrument one or more of the financial risks inherent in an underlying primary financial instrument. Derivatives are normally sold by a broker or financial institution.

54) What are the steps involved in the translation of the financial statements into a presentation currency? Difficulty: Medium Learning Objective: Translate financial statements form the “functional currency” to the “presentation currency.” Section Reference: Translating Financial Statements from the Functional Currency to the Presentation Currency Feedback: Review section “Translating Financial Statements into a Presentation Currency” Solution: Suggested answer: The translation of the financial statements into a presentation currency is completed as follows: • assets and liabilities (including comparatives) are translated at the closing rate at the date of the statement of financial position; • income and expenses (including comparatives) for each statement of comprehensive income presented are translated at exchange rates at the dates the transactions took place; and • all resulting exchange differences are recognized in other comprehensive income. For practical purposes, an average rate to approximate the actual exchange rate at the date of the transactions for income and expenses may be used as long as these items basically occur evenly over the period being presented.

56) Dante Ltd. manufactures and distributes transmissions to various companies in Europe. On April 2, 2013, Dante entered into a sales contract with a company in Germany to sell 1,000 transmissions. The contract price is €2,000 per transmission. Five hundred transmissions are to be delivered on June 30, 2013 and the remaining half is to be delivered on December 20, 2013. Payment is due in two instalments with half due on

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August 31, 2013 and the remaining half due January 30, 2014. However, the customer has the right to cancel the contract with 30 days' notice. On April 2, 2013 Dante entered into a forward contract to hedge against the Euro exchange rate for €1 million coming due on January 31, 2014. Dante has a December 31 year end. Delivery of the transmissions occurred on the dates specified and the company collected the receivables due and settled the forward contract January 30, 2014. The exchange rates were as followed:

Canadian equivalent of euro April 2, 2013 June 30, 2013 August 31, 2013 December 20, 2013 December 31, 2013 January 30, 2014

Spot rate 1.50 1.51 1.53 1.55 1.54 1.56

Forward rate to January 30, 2014 1.54 1.57 1.58 1.56 1.55 settled

Required: Assume that the forward contract is designated as a cash flow hedge since the sale is highly probable. Prepare the journal entries to record the sales and the hedge. Dante reports under IFRS. Difficulty: Hard Learning Objective: Apply hedge accounting to transactions denominated in a foreign currency. Section Reference: Applying Hedge Accounting To Foreign Currency Transactions Feedback: Review section “Derivative Financial Instruments as Hedges” Solution: Suggested answer: April 2, 2013: No entry for the sales contract No entry for the forward contract since the fair value at inception is $0 June 30, 2013: To record delivery of first 500 transmissions Accounts receivable Sales (€2,000 × 500 × 1.51)

1,510,000 1,510,000

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August 31, 2013: — Collection of receivable Cash Exchange gains and losses Accounts receivable (€2,000 × 500 × 1.53)

1,530,000 20,000 1,510,000

December 20, 2013: To record delivery of the second 500 transmissions Accounts receivable 1,550,000 Sales

1,550,000

(€2,000 × 500 × 1.55) December 20, 2013 to restate forward contract Foreign exchange loss – (OCI) 20,000 Derivative liability (€2,000 × 500 × 1.56)- (€1,000,000 × 1.54)

20,000

December 20, 2013 To transfer from OCI to sales Sales

20,000 Foreign exchange loss – (OCI)

20,000

December 31, 2013: To restate the forward contract Derivative liability 10,000 Foreign exchange gain (€2,000 × 500 × 1.55)- (€1,000,000 × 1.56)

10,000

December 31, 2013: To restate the accounts receivable Exchange gains and losses 10,000 Accounts receivable (€2,000 × 500 × 1.54) )- (€1,000,000 × 1.55)

10,000

January 20, 2014: To restate the accounts receivable and collection of receivable Cash Exchange gains and losses

1,560,000 20,000

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Chapter 7: Accounting for Foreign Currency

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Accounts receivable (€2,000 × 500 × 1.56)

1,540,000

January 20, 2014: To restate the forward contract and the settlement of it

Foreign exchange loss 10,000 Derivative Liability (€2,000 × 500 × 1.55)- (€1,000,000 × 1.56) Cash € Derivative Liability Cash CDN $

10,000

1,540,000 20,000 1,560,000

57) Bommarito Corp., a Swiss firm, bought merchandise from Trilis Company of New Brunswick on December 15, 2013 for 20,000 CHF payable on January 14, 2014. Trilis and Bommarito both close their books on December 31. The 20,000 CHF was paid on January 14, 2014. The exchange rates for CHF were: December 15, 2013 spot C$.9740 December 15, 2013 30 day forward C$.9800 December 31, 2013 C$.9700 December 31, 2013 14 day forward C$.9730 January 14, 2014 C$.9720 Required: A) Provide the journal entries for Bommarito (the buyer) at each of the above dates, as required. B) Provide the journal entries for Trilis Company (the seller) at each of the above dates as required. Difficulty: Easy Learning Objective: Determine the “functional currency” of a company. Section Reference: Determining the Functional Currency of a Company Feedback: Review section “Foreign Currency Gains and Losses” Solution: Suggested answer: A) Note: All amounts in CHF December 15, 2013

Fayerman: Advanced Accounting, Ce

Purchases Accounts Payable

Chapter 7: Accounting for Foreign Currency

20,000 20,000

December 31, 2013 No entry January 14, 2014 Accounts payable Cash

20,000 20,000

B) Note: All amounts in Canadian December 15, 2013 Accounts Receivable Sales

19,480 19,480

20,000 CHF * .9740=$19,480 December 31, 2013 Foreign exchange loss 80 Accounts Receivable 80 (20,000 CHF *.970) – (20,000 CHF * 0.9740) January 14, 2014 Cash 19,440 Accounts Receivable Foreign exchange gain

19,400 40

20,000 CHF * 0.9720

Testbank

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Chapter 7: Accounting for Foreign Currency

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58) Mori Inc. is a company located in Canada and it uses the Canadian dollar as its functional currency. Mori Inc. began operations on January 1, 2012. Its shareholders are European. They would like the financial statements to be presented in Euros. The following is an excerpt from Mori Inc.’s financial statements for the 2012 and 2013 years. The changes in Other Comprehensive Income occurred evenly throughout the years. Dividends were declared at year-end. For the year ended December 31, 2012

Income before income tax Income tax expense Net income

100,000 50,000 50,000

For the year ended December 31, 2013

Income before income tax Income tax expense Net income

90,000 45,000 45,000

As at December 31, 2012

Current assets Cash Financial assets Inventory Total current assets

20,000 179,000 150,000 349,000

Non-current assets Property, Plant and equipment Accumulated amortization Land Total non-current assets

225,000 (110,000) 75,000 190,000

Total assets

539,000

Liabilities & Shareholder's Equity Current liabilities

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Chapter 7: Accounting for Foreign Currency

Other current liabilities Dividend payable Total current liabilities

50,000 5,000 55,000

Non-current liabilities Bonds

50,000

Total liabilities

105,000

Shareholder's equity Share capital Other components of equity Retained earnings-beginning Dividend declared Net income Retained earnings ending Total Shareholder's equity

300,000 88,000 (4,000) 50,000 46,000 434,000

Total liabilities & shareholder's equity

539,000

As at December 31, 2013

Current assets Cash Financial assets Inventory Total current assets

300,700 261,000 290,000 851,700

Non-current assets Property, plant and equipment Accumulated amortization Land Total non-current assets

294,000 (220,000) 155,000 229,000

Total assets

1,080,700

Liabilities & Shareholder's Equity Current liabilities Other current liabilities Dividend payable Total current liabilities

501,700 10,000 511,700

Testbank

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Chapter 7: Accounting for Foreign Currency

Non-current liabilities Bonds

100,000

Total liabilities

611,700

Shareholder's equity Share capital Other components of equity

300,000 88,000

Retained earnings-beginning Dividend declared Net income Retained earnings ending Total Shareholder's equity

46,000 (10,000) 45,000 81,000 469,000

Total liabilities & shareholder's equity

1,080,700

Testbank

The following exchange rates exist for the Euro relative to the Canadian dollar: January 1, 2012 $1 Canadian = $1.40 Euro December 31, 2012 $1 Canadian = $1.45 Euro Average 2012 = $1 Canadian = $1.47 Euro December 31, 2013 = $1 Canadian = $1.50 Euro Average 2013 = $1 Canadian = $1.52 Euro

Required: Translate the Mori Inc. financial statements as at December 31, 2013 from its functional currency to its presentation currency. Difficulty: Hard Learning Objective: Translate financial statements from the functional currency to the presentation currency. Section Reference: Translating Financial Statements from the Functional Currency to the Presentation Currency. Feedback: Review section “Translating Financial Statements into a Presentation Currency” Solution:

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Suggested answer: 2012 Mori Inc Statement of comprehensive income For the year ended December 31, 2012 CDN

Rate

EURO

Income before income tax Income tax expense

100,000

1.47

147,000

50,000

1.47

73,500

Net income

50,000

73,500

Other comprehensive income: Exchange difference on translation gain/(loss)

12,240

Total comprehensive income

85,740

2013 Mori Inc Statement of comprehensive income For the year ended December 31, 2013 CDN

Rate

Euro

Income before income tax

90,000

1.52

136,800

Income tax expense

45,000

1.52

68,400

Net income

45,000

68,400

Other comprehensive income: Exchange difference on translation (gain) For the current year Total comprehensive income Mori Inc Statement of Financial Position

20,800

89,200

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As at December 31, 2012 CDN

Rate

EURO

Current assets Cash

20,000 1.45

29,000

Financial assets

179,000

1.45

259,550

Inventory

150,000

1.45

217,500

Total current assets

349,000

Non-current assets Property, plant and equipment

225,000

1.45

326,250

Accumulated amortization

(110,000)

1.45

(159,500)

Land

75,000

1.45

108,750

Total non-current assets

190,000

275,500

Total assets

539,000

781,550

506,050

Liabilities & Shareholder's Equity Current liabilities Other current liabilities

50,000

1.45

72,500

Dividend payable

5,000

1.45

7,250

Total current liabilities

55,000

79,750

Non-current liabilities Bonds

50,000

Total liabilities

105,000

Shareholder's equity Share capital 31

1.45

72,500

152,250

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Other components of equity

Testbank

300,000

1.40

420,000

88,000

1.47

129,360

Other components of equity-FX Retained earnings-beginning

12,240 -

Dividend declared

(4,000)

1.45

(5,800)

Net income

50,000

1.47

73,500

Retained earnings ending

46,000

67,700

Total Shareholder's equity

434,000

629,300

Total liabilities & shareholder's equity

539,000

781,550

CDN

Rate

EURO

Net assets-beginning of year

300,000

1.40

420,000

Net income & other components of equity

138,000

1.47

202,860

Dividends

(4,000)

1.45

(5,800)

Net assets-end of year

434,000

617,060

1.45

Foreign currency translation gain for the period

629,300

12,240

Mori Inc Statement of Financial Position As at December 31, 2013 CDN Current assets Cash

Rate

EURO 451,050

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300,700

1.50

Financial assets

261,000

1.50

391,500

Inventory

290,000

1.50

435,000

Total current assets

851,700

1,277,550

Non-current assets Property, plant and equipment

294,000

1.50

441,000

Accumulated amortization

(220,000)

1.50

(330,000)

Land

155,000

1.50

232,500

Total non-current assets

229,000

343,500

Total assets

1,080,700

1,621,050

Liabilities & Shareholder's Equity Current liabilities Other current liabilities

501,700

1.50

752,550

Dividend payable

10,000

1.50

15,000

Total current liabilities

511,700

767,500

Non-current liabilities Bonds

100,000

Total liabilities

611,700

1.50

150,000

917,550

Shareholder's equity Share capital

300,000

1.40

420,000

Other components of equity Other components of equity-FX Retained earnings-beginning

88,000

1.47

129,360 33,040 67,700

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46,000 Dividend declared

(10,000)

1.50

(15,000)

Net income

45,000

1.52

68,400

Retained earnings ending

81,000

Total Shareholder's equity

469,000

703,500

Total liabilities & shareholder's equity

1,080,700

1,621,050

121,100

CDN

Rate

Net assets-beginning of year

434,000

Net income & other components of equity

45,000

1.52

68,400

Dividends

(10,000)

1.5

(15,000)

Net assets-end of year

469,000

Foreign currency translation gain for the period January 1, 2012 $1 Canadian = $1.40 Euro December 31, 2012 $1 Canadian = $1.45 Euro Average 2012 = $1 Canadian = $1.47 Euro December 31, 2013 = $1 Canadian = $1.50 Euro Average 2013 = $1 Canadian = $1.52 Euro

1.45

EURO 629,300

682,700

1.50

703,500

20,800

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Testbank Chapter 8 – Accounting for Foreign Investments

True or False

1) A functional currency is a reflection of the primary economic environment in which an entity operates. Answer: True Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining a Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency”

2) Consolidation adjustments must be restated to the presentation currency. Answer: True Difficulty: Easy Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Intracompany Balances”

3) Hedging transactions with other entities within the group qualify for hedge accounting in the consolidated financial statements of the group. Answer: False Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Hedge Accounting”

4) A Change in functional currency is said to occur if there are minor economic changes 1

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in an entity's operations and this new functional currency is accounted for prospectively. Answer: False Difficulty: Medium Learning Objective: Determine the foreign currency transactions for each company in the group. Section Reference: Determining the Foreign Currency Transactions within the Group Feedback: Review section “Changes in Functional Currency”

5) Fair value adjustments must be reflected on the balance sheet at the closing rate for the year. Answer: True Difficulty: Easy Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Intracompany Balances”

6) When the currency selected for presentation purposes differs from an entity's functional currency, the financial statements need to be translated into this selected presentation currency. Answer: True Difficulty: Medium Learning Objective: Translate group financial statements into a group presentation currency. Section Reference: Translating individual financial statements into a group presentation currency. Feedback: Presentation Currency Differing from the Functional Currency

7) When a subsidiary has foreign currency transactions, and records foreign currency gains or losses, the non-controlling interest will be allocated a portion of those gains or losses since it shares in the net income of the subsidiary. Answer: True Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes

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of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Non-Controlling Interest”

8) Each company in a group records its foreign currency transactions at the year end rate. Answer: False Difficulty: Easy Learning Objective: Determine the foreign currency transactions for each company in the group. Section Reference: Determining the Foreign Currency Transactions within the Group Feedback: Review section “Foreign Currency Transactions”

9) Monetary items are restated at the spot rate and any gain or loss is recorded in income. Answer: False Difficulty: Medium Learning Objective: Determine the foreign currency transactions for each company in the group. Section Reference: Determining the Foreign Currency Transactions within the Group Feedback: Review section “Foreign Currency Transactions”

10) Monetary balances are eliminated using the rate when the transaction occurred. Answer: True Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Intracompany Balances”

11) Consolidated financial statements are required to be prepared when an entity controls one or more other entities (otherwise known as financial statements for a group). Answer: True Difficulty: Medium

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Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Intracompany Balances”

12) Goodwill and fair value adjustments related to a foreign operation are treated as gains and losses of the foreign operation for the purposes of foreign currency translation. Answer: False Difficulty: Easy Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Fair Value Adjustments”

13) When an item is deemed to hedge a net investment in a foreign subsidiary, any gain or loss on the hedging items is recorded in income. Answer: False Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Hedge Accounting” 14) In order to determine what is considered to be a “functional currency,” it is imperative that a “foreign currency” be first identified. Answer: False Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining the Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency”

15) Intracompany transactions are eliminated at the rate when the transaction occurred.

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Answer: True Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Intracompany Balances”

Multiple Choice

16) Which of the following statements relating to a functional currency is FALSE? a) Functional currency is determined on an entity by entity basis b) Functional currency is a reflection of the primary economic environment in which an entity operates. c) The primary economic environment is the one in which an entity primarily generates and expends cash. d) In order to determine what is considered to be a “functional currency,” it is imperative that a “foreign currency” be first identified. Answer: d Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining the Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency”

17) Each company in a group records its foreign currency transactions at the: a) Rate when the transaction occurred. b) Year end rate. c) Year end rate or the rate when the transaction occurred. d) Forward rate. Answer: a Difficulty: Medium Learning Objective: Determine the foreign currency transactions for each company in the group. Section Reference: Determining the Foreign Currency Transactions within the Group

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Feedback: Review section “Foreign Currency Transactions”

18) Financial statements can be presented in any currency. When the currency selected for presentation purposes differs from an entity's functional currency, the financial statements need to be translated into this selected presentation currency. Which of the following statements regarding the translation of the financial statements into a presentation currency is FALSE? a) Assets and liabilities (including comparatives) are translated at the closing rate at the date of the statement of financial position. b) Income and expenses (including comparatives) for each statement of comprehensive income presented are translated at exchange rates at the dates the transactions took place. c) Income and expenses (including comparatives) for each separate income statement presented are translated at exchange rates at the dates the transactions took place. d) All resulting exchange differences are recognized in income. Answer: d Difficulty: Medium Learning Objective: Translate group financial statements into a group presentation currency. Section Reference: Translating individual financial statements into a group presentation currency. Feedback: Review section “Presentation Currency Differing from the Functional Currency”

19) Which of the following statements regarding the preparation of foreign currency adjustments for consolidation or the application of the equity method is FALSE? a) Consolidation adjustments must be restated to the presentation currency. b) Intracompany transactions are eliminated at the rate when the transaction occurred. c) Monetary balances are eliminated using the rate when the transaction occurred. d) Fair value adjustments must be reflected on the balances sheet at the closing rate for the year. Answer: c Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Intracompany Balances”

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20) All of the following are primary indicators of the functional currency of a group EXCEPT: a) The currency that mainly influences sales prices for goods and services. b) The currency of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services. c) The currency in which receipts from operating activities are usually retained. d) The currency that mainly influences labour, material and other costs of providing goods or services. Answer: c Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining the Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency”

21) When the functional currency is different than the presentation currency, monetary items are restated _________________________ and any gain or loss is recorded in ________________. a) at the spot rate; income. b) at the closing rate at the financial statement date; comprehensive income. c) at the closing rate at the financial statement date; income. d) at the spot rate; other comprehensive income. Answer: c Difficulty: Medium Learning Objective: Determine the foreign currency transactions for each company in the group. Section Reference: Determining the Foreign Currency Transactions within the Group Feedback: Review section “Foreign Currency Transactions”

22) When any fair value adjustments exist on the carrying amounts of assets and liabilities arising on the acquisition of a foreign operation, they are treated as assets and liabilities ________________ for the purposes of translation. Therefore, they are carried in the _______________ currency of the foreign operation and are translated at the closing rate (i.e. using the current rate method) for the purposes of presentation on consolidation. a) of the foreign operation; functional

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b) of the foreign operation; presentation c) of the parent; functional d) of the parent; presentation. Answer: a Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Fair Value Adjustments”

23) Which of the following statements regarding hedge accounting within a group is FALSE? a) For hedge accounting purposes, only instruments that involve a party external to the reporting entity (i.e. external to the group or individual entity that is being reported on) can be designated as hedging instruments. b) Although individual entities within a consolidated group or divisions within an entity may enter into hedging transactions with other entities within the group, any such intragroup transactions are eliminated on consolidation. c) Hedging transactions with other entities within the group qualify for hedge accounting in the consolidated financial statements of the group. d) Hedging transactions with other entities within the group may qualify for hedge accounting in the individual or separate financial statements of individual entities within the group provided that they are external to the individual entity that is being reported on. Answer: c Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Hedge Accounting"

24) On consolidation using the Canadian dollar presentation, the appropriate exchange rate for translating a plant asset in the balance sheet of a foreign subsidiary in which the functional currency is the Canadian dollar is the: a) Current exchange rate. b) Average exchange rate for the current year. c) Historical exchange rate in effect when the plant asset was acquired or the date of

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acquisition, whichever is later. d) Forward rate. Answer: c Difficulty: Medium Learning Objective: Translate group financial statements into a group presentation currency Section Reference: presentation currency differing from the functional currency Feedback: Review section “Presentation currency”

25) Komota Ltd., a public Canadian corporation, has a subsidiary in Australia. It has been determined that the functional currency of the foreign operations is the Australian dollar. Which of the following statements is TRUE? a) Komota's financial statements will have to be translated into the Australian dollar. b) Komota's transactions with the subsidiary will need to be re-measured. c) Komota will not be required to consolidate. d) The presentation currency is the Canadian dollar. Answer: d Difficulty: Medium Learning Objective: Translate group financial statements into a group presentation currency. Section Reference: Translating individual financial statements into a group presentation currency. Feedback: Review section “Presentation Currency Differing from the Functional Currency”

26) Upon consolidation, goodwill is re-translated at the ________ rate for the purposes of consolidation. a) average b) spot c) closing d) forward. Answer: c Difficulty: Easy Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the

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Equity Method. Feedback: Review section “Fair Value Adjustments”

27) When an item is deemed to hedge a net investment in a foreign subsidiary, any gain or loss on the hedging items is recorded in _________________. a) Other Comprehensive income. b) Income. c) Other comprehensive income or income. d) Equity. Answer: a Difficulty: Easy Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Hedge Accounting”

28) When translating foreign currency financial statements for a company whose functional currency is the Canadian dollar, into a group financial statement presented in Canadian dollars, which of the following accounts is translated using historical exchange rates?

a) b) c) d)

Notes Payable Yes Yes No No

Equipment Yes No No Yes

Answer: d Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Fair Value Adjustments”

29) Consolidation adjustments must be restated to the _______________ currency. a) functional

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b) presentation c) foreign d) domestic. Answer: b Difficulty: Easy Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Fair Value Adjustments”

30) A Change in the functional currency of an entity occurs a) Only if there are significant economic changes in an entity's operations and is accounted for prospectively. b) Even if there are minor economic changes in an entity's operations and is accounted for prospectively. c) Only if there are significant economic changes in an entity's operations and is accounted for retrospectively. d) Even if there are minor economic changes in an entity's operations and is accounted for retrospectively. Answer: a Difficulty: Medium Learning Objective: Determine the foreign currency transactions for each company in the group. Section Reference: Determining the Foreign Currency Transactions within the Group Feedback: Review section “Changes in Functional Currency”

31) Which of the following statements regarding the preparation of foreign currency adjustments, for consolidation or the application of the equity method, is FALSE? a) Consolidation adjustments must be restated to the presentation currency. b) Intercompany transactions are eliminated at the rate when the transaction occurred. c) Monetary balances are eliminated using the spot rate. d) Fair value adjustments must be reflected on the balances sheet at the closing rate for the year. Answer: c Difficulty: Medium

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32) When the functional currency of a foreign subsidiary is identified as the Canadian dollar, and land purchased by the foreign subsidiary, after the controlling interest was acquired by the parent company who is presenting consolidated financial statements in the Canadian dollar, the land should be translated for consolidation using the a) historical rate in effect when the land was purchased. b) current rate in effect at the balance sheet date. c) forward rate. d) average exchange rate for the current period. Answer: a Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Fair Value Adjustments”

33) When the functional currency is not the same as the presentation currency, the investee must translate the financial statements using the____________ for balance sheet accounts and ________________ for income statement accounts. a) year-end closing rate; year-end closing rate b) year-end closing rate; the rate when the transaction occurred c) the rate when the transaction occurred; year-end closing rate d) the rate when the transaction occurred; the rate when the transaction occurred. Answer: b Difficulty: Medium Learning Objective: Translate group financial statements into a group presentation currency. Section Reference: Translating individual financial statements into a group presentation currency. Feedback: Review section “Presentation Currency Differing from the Functional Currency”

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34) A parent company may lend money to a foreign subsidiary where the settlement terms are neither planned nor likely to occur in the foreseeable future. This loan would likely be denominated on the individual company’s financial statements in: a) Either the parent company’s functional currency or that of the subsidiary. b) The parent company’s functional currency. c) The subsidiary company’s functional currency. d) The parent company’s presentation currency. Answer: a Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Intracompany Balances”

35) Which of the following statements about a presentation currency is FALSE? a) The functional currency must be the same as the presentation currency. b) When a group is involved, one presentation currency must be selected for presentation of the entire group. c) Entities may choose to present their financial statements in any currency based on management’s monitoring of the performance and financial position of entities within such a group. d) When the financial statements of foreign operations are included in the group’s financial statements by consolidation, or the equity method, they are translated for presentation purposes into a single currency referred to as the presentation currency. Answer: a Difficulty: Medium Learning Objective: Translate group financial statements into a group presentation currency. Section Reference: Translating individual financial statements into a group presentation currency. Feedback: Review section “Presentation Currency Differing from the Functional Currency”

36) All of the following are considered to be consolidation adjustments EXCEPT a) Eliminate intercompany balances and transactions.

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b) Account for any fair value adjustments. c) Translate balances into the presentation currency for the purposes of consolidation or the equity method. d) Account for any non-controlling interests. Answer: c Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Intracompany Balances” 37) Whether the foreign operation’s activities are relatively autonomous of those of the parent entity or whether they are carried out as an extension thereof is what type of indicator in determining the functional currency of a foreign operation? a) Primary. b) Secondary. c) Additional. d) Presentation. Answer: c Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining a Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency”

38) Which of the following factors is a SECONDARY indicator used to choose a functional currency? a) Currency in which the selling prices are denominated. b) Ability of subsidiary to generate cash flows to service its debts. c) Sources of competition and regulations. d) Currency in which the cost of goods sold is denominated. Answer: b Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators.

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Section Reference: Determining the Functional Currency for Each Company in a Group. Feedback: Review section “Definition of a Functional Currency”

39) Which of the following statements regarding the non-controlling interest is FALSE? a) The non-controlling interest must be allocated a portion of the comprehensive income of the group as well as a portion of the net assets of the group. b) When a subsidiary has foreign currency transactions, and records foreign currency gains or losses, the non-controlling interest will be allocated a portion of those gains or losses since it shares in the net income of the subsidiary. c) For the purpose of the allocation to the non-controlling interest, the financial statement of the subsidiary is first translated into the functional currency. d) In addition to foreign currency transactions, the subsidiary may have a functional currency that is different than the parent’s functional currency. Answer: c Difficulty: Hard Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Non-Controlling Interest”

40) Under ASPE, the ______________ is assumed to be the reporting currency, although any currency can be determined to be the ______________ currency. a) Canadian dollar; reporting b) U.S. dollar; foreign c) Canadian dollar; functional d) U.S. dollar; reporting. Answer: a Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining a Functional Currency for Each Company in the Group Feedback: Review section “Definition of a Functional Currency”

41) In preparing consolidated financial statements of a Canadian parent company and a foreign subsidiary, the foreign subsidiary’s functional currency is the currency

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a) Of the country the parent is located. b) Of the country the subsidiary is located. c) In which the subsidiary primarily generates and spends cash. d) In which the subsidiary maintains its accounting records. Answer: c Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining the Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency”

42) Assuming no significant inflation, gains resulting from the process of translating a foreign entity’s financial statements from the functional currency to Canadian dollars should be included as a(n) a) Other comprehensive income item. b) Unusual item (net of tax). c) Part of continuing operations. d) Deferred credit. Answer: a Difficulty: Medium Learning Objective: Translate group financial statements into a group presentation currency. Section Reference: Translating individual financial statements into a group presentation currency. Feedback: Review section “Presentation Currency Differing from the Functional Currency”

43) The process of consolidation is very procedural, that is to say that there are several steps involved in the production of consolidated financial statements that reflect appropriate balances where transactions denominated in foreign currencies are concerned. Which of the following is Step 1? a) Execute consolidation adjustments. b) Eliminate intercompany balances and transactions. c) Translation of foreign currency transactions into an entity’s functional currency. d) Translation of balances into the presentation currency for the purposes of consolidation or the equity method. Answer: c

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Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Preparing Foreign Currency Adjustments for Consolidation or the Equity Method”

44) In the determination of the functional currency, the currency that mainly influences labour, material and other costs of providing goods or services is a(n) _________________ indicator. a) primary. b) secondary. c) additional. d) presentation. Answer: a Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining the Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency”

45) Which of the following factors is a PRIMARY indicator used to choose a functional currency? a) Sources of competitive forces and regulations. b) Proportion of intercompany transactions. c) Ability of subsidiary to generate cash flows to service its debts. d) Autonomy of the subsidiary. Answer: a Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining the Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency”

46) The following balance sheet accounts of a foreign subsidiary at December 31, 2014,

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have been translated into Canadian dollars as follows:

Accounts receivable, current Accounts receivable, long-term Inventories carried at market Goodwill

Translated at Current Rates Historical Rates $ 600,000 $ 660,000 300,000 324,000 180,000 198,000 190,000 220,000 $1,270,000 $1,402,000

What total should be included in the translated balance sheet at December 31, 2014 for the above items? Assume the Canadian dollar is the functional currency. a) $1,270,000 b) $1,288,000 c) $1,300,000 d) $1,354,000 Answer: c Difficulty: Hard Learning Objective: Translate group financial statements into a group presentation currency. Section Reference: Translating individual financial statements into a group presentation currency. Feedback: Review section “Presentation Currency Differing from the Functional Currency”

47) When the functional currency is not clearly evident from the application of the primary indicators, then a secondary indicator such as the currency in which funds from _______ activities are generated should be considered. a) financing b) operating c) investing d) consolidating. Answer: a Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining the Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency”

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48) Goodwill and fair value adjustments related to a foreign operation are treated as ___________ of the foreign operation for the purposes of foreign currency translation. a) gains and losses b) assets and liabilities c) income d) equity. Answer: b Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Fair Value Adjustments”

49) When it is not clear what the functional currency is, an accountant must use professional judgment to choose the functional currency. What is the main criterion upon which the choice should be based? a) Whether it faithfully represents the economic effects of the transactions and events. b) Whether it faithfully represents the translation effects of the transactions and events. c) Degree to which it minimizes accounting exposure. d) Whether it faithfully represents the accounting effects of the transactions and events. Answer: a Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining the Functional Currency for each Company in a Group. Feedback: Review section “Definition of a Functional Currency”

50) When the functional currency is being determined for a foreign operation (i.e. a subsidiary, branch, associate or joint venture, of a parent entity), in addition to the primary and secondary indicators, all of the following factors should be considered in this determination EXCEPT a) Whether the foreign operation’s activities are relatively autonomous of those of the parent entity or whether they are carried out as an extension thereof. b) The currency in which funds from financing activities are generated. c) Whether transactions with the parent entity are a high or a low proportion of the foreign operation's activities.

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d) Whether cash flows from the foreign operation’s activities directly affect the cash flows of the parent entity and whether they are readily available for remittance to it. Answer: b Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining the Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency”

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Short Answer

51) What are the primary indicators that need to be considered in the determination of a functional currency? Difficulty: Medium Learning Objective: Determine a company’s functional currency, within a group, by applying a hierarchy of indicators. Section Reference: Determining the Functional Currency for Each Company in a Group Feedback: Review section “Definition of a Functional Currency” Solution: Suggested answer: The primary indicators are as follows: The currency • That mainly influences sales prices for goods and services • Of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services. • That mainly influences labour, material and other costs of providing goods or services (this will often be the currency in which such costs are denominated and settled).

52) When would a change in the functional currency of an entity occur, and how is it accounted for? Difficulty: Medium Learning Objective: Determine the foreign currency transactions for each company in the group. Section Reference: Determining the Foreign Currency Transactions within the Group Feedback: Review section “Changes in Functional Currency” Solution: Suggested answer: Changes in functional currency occur only if there are significant economic changes in an entity's operations. Any change in a company's functional currency is accounted for prospectively.

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53) How is the translation of the financial statements into a presentation currency completed? Difficulty: Medium Learning Objective: Translate group financial statements into a group presentation currency. Section Reference: Translation individual financial statements into a group presentation currency. Feedback: Review section “Presentation Currency Differing from the Functional Currency” Solution: Suggested answer: Financial statements can be presented in any currency. When the currency selected for presentation purposes differs from a company's functional currency, the financial statements need to be translated into this selected presentation currency. The translation of the financial statements into a presentation currency is completed as follows: • Assets and liabilities (including comparatives) are translated at the closing rate at the date of the statement of financial position; • Income and expenses (including comparatives) for each statement of comprehensive income or separate income statement presented are translated at exchange rates at the dates the transactions took place; and • All resulting exchange differences are recognized in other comprehensive income. For practical purposes, an average rate to approximate the actual exchange rate at the date of the transactions for income and expenses may be used.

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54) What are the steps involved in the process of consolidation when an entity controls one or more other entities? Difficulty: Medium Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Preparing Foreign Currency Adjustments for Consolidation or the Equity Method.” Solution: Suggested answer: Consolidated financial statements are required to be prepared when a company controls one or more other entities (otherwise known as financial statements for a group). The process of consolidation is very procedural, that is to say that there are several steps involved in the production of consolidated financial statements that reflect appropriate balances where transactions denominated in foreign currencies are concerned. Step 1: Translation of foreign currency transactions into a company’s functional currency. Step 2: Translation of balances into the presentation currency for the purposes of consolidation or the equity method. Step 3: Execute consolidation adjustments: • Eliminate intercompany balances and transactions • Account for any fair value adjustments • Account for any non-controlling interests

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55) Crimson Lights Inc. (CL) is a 100% wholly owned subsidiary with operations in France. CL was purchased by a Canadian parent on January 1, 2012. The financial records of CL are maintained in euros and provide the following information with respect to equipment, and goodwill. Equipment - purchased on January 1, 2012 for €250,000 - depreciated over 5 years on a straight-line basis. Equipment - purchased on January 1, 2013 for €175,000 - depreciated over 5 years on a straight-line basis. Goodwill - € 375,000 Foreign exchange rates were as follows: January 1, 2012 €1 = 1.50 Average for 2012 €1 = 1.48 January 1, 2013 €1 = 1.46 Average for 2013 €1 = 1.45 January 1, 2014 €1 = 1.51 Average for 2014 €1 = 1.58 December 31, 2014 €1 = 1.62 Required: Assume that CL's functional currency is the euro. Calculate the translated Canadian dollar balances for the following accounts at December 31, 2014. a. Equipment b. Accumulated depreciation — equipment c. Depreciation expense d. Goodwill Difficulty: Hard Learning Objective: Prepare the foreign currency adjustments necessary for the purposes of consolidation or the application of the equity method. Section Reference: Preparing Foreign Currency Adjustments for Consolidation or the Equity Method. Feedback: Review section “Intracompany Balances” Solution:

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Suggested answer: If the functional currency of CL is the euro, then the balances are translated at the current rate on December 31, 2014. a. Equipment (£425,000 × 1.62) b. Accumulated depreciation 1st purchase (£250,000/5 × 3 × 1.62)

$688,500

2nd purchase (£175,000/5 ×2 × 1.62) Total

113,400 $356,400

Depreciation expense [(£250,000/5 + £175,000/5) × 1.58] d. Goodwill ((£375,000 × 1.62)

$134,300 $607,500

$243,000

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56) On January 1, 2014, Tiller Inc. of Toronto purchased 75% of the outstanding shares of Robinson Limited of London, England. Robinson Limited’s statements of financial position, statements of comprehensive income and changes in equity — retained earnings section for the year ended December 31, 2014 are below. ROBINSON LIMITED Statement of Financial Position As at December 31, 2014 (in thousands of £’s) Assets Cash Accounts Receivable Inventories Equipment, net Total assets

2014

Liabilities Accounts payable Bonds payable Common shares Retained Earnings Total liabilities and shareholders' equity

2013 50 575 825 2,670 4,120

20 280 650 2,937 3,887

465 1,290 1,200 1,165

395 1,290 1,200 1,002

4,120

3,887

ROBINSON LIMITED Statement of Comprehensive Income For the year ended December 31, 2014 (in thousands of £’s) $ Sales

2,170

Cost of goods sold Depreciation expense Interest expense Other expenses

1,203 267 80 407 1,957 213

Comprehensive income

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ROBINSON LIMITED Statement of Changes in Equity—Partial—Retained earnings section For the year ended December 31, 2014 (in thousands of £) £ Retained earnings — January 1, 2014 Comprehensive income for the year Dividends paid Retained earnings — December 31, 2014 Additional information:

1,002 213 (50) 1,165

1. Robinson was incorporated on January 1, 2010 when it acquired all its equipment for £4,005,000 and issued its 10 year bonds payable. 2. Robinson purchases and sales occurred evenly over the year. Inventories on hand at December 31, 2013 and December 2014 were purchased evenly over the last quarter of 2013 and 2014, respectively. Inventories as at January 1, 2014 were £650,000. 3. Dividends were paid on March 31, 2014. 4. Foreign exchanges rates are as follows: January 1, 2010 Average for Oct to Dec, 2013 Average for 2013 December 31, 2013/January 1, 2014 March 31, 2014 Average for Oct to Dec, 2014 Average for 2014 December 31, 2014

£1 = C$1.95 £1 = C$1.64 £1 = C$1.73 £1 = C$1.67 £1 = C$1.61 £1 = C$1.55 £1 = C$1.57 £1 = C$1.52

Required: A) Translate Robinson's statement of comprehensive income for the year ended December 31, 2014 into Canadian dollars assuming its functional currency is Canadian dollars. B) Calculate the translation gain or loss arising in 2014. Difficulty: Hard Learning Objective: Translate group financial statements into a group presentation currency. Section Reference: Translating individual financial statements into a group presentation currency. Feedback: Review section “Presentation Currency Differing from the Functional Currency” Solution:

Fayerman: Advanced Accounting, Ce

Chapter 8: Accounting for Foreign Investments

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