TEST BANK for Advanced Accounting, 4th Edition by Robert Halsey Patrick Hopkins -Cambridge. by ACADEMIAMILL

Chapter 1 Accounting for Intercorporate Investments Learning Objectives – Coverage by question Multiple Choice

Exercises

Problems

LO1 – Explain when the equity method should be used.

3, 8, 9, 18

LO2 – Explain the mechanics of the accounting for investments using the equity method of accounting.

2, 4, 12

LO3 – Explain the amortization of excess assets, and the deferral of unrealized income.

5, 11, 19-21, 25-28, 40

2, 3

LO4 – Explain the process for deferral of unrealized income.

13, 29-32, 39

LO5 – Explain the equity method of accounting for less than 100% ownership.

1, 10, 11, 16-20, 24-26, 29-40

1-4, 6

1, 3, 4

LO6 – Explain when the equity method should be discontinued.

LO7 – Explain the accounting for changes to and from the equity method.

6, 15, 22, 23

LO8 – Explain the required disclosures for equity method investments. LO9 – Explain the criticisms of the equity method of accounting.

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Chapter 1: Accounting for Intercorporate Investments

Multiple Choice Multiple Choice – Theory Topic: Accounting for Investments Using the Equity Method with Less Than 100% Ownership LO: 5 1. Frisco Corporation uses the equity method of accounting for its investment in a 30%-owned investee that earned $56,000 and paid $18,000 in dividends. As a result, Frisco Corporation made the following entries: Equity Investment Equity Income

16,800

Cash

5,400 Dividend Revenue

16,800 5,400

What effect will these entries have on Frisco Corporation's balance sheet? a. Investment understated, retained earnings understated b. Investment overstated, retained earnings understated c. Investment overstated, retained earnings overstated d. No effect Answer: c

Topic: Accounting for Investments Using the Equity Method and Fair Value Method LO: 2 2. Harvey Co. received a cash dividend from a common stock investment. Should Harvey report an increase in the investment account if it accounts for the investment under the fair value method or the equity method? a. Fair value method, YES; Equity method, YES b. Fair value method, NO; Equity method, NO c. Fair value method, YES; Equity method, NO d. Fair value method, NO; Equity method, YES Answer: b

Topic: Significant Influence LO: 1 3. An investor who owns 30% of the common stock of an investee is most likely to exercise significant influence requiring use of the equity method when: a. The investor and investee sign an agreement under which the investor surrenders significant rights b. The investor tries and fails to obtain representation on the investee's board of directors c. The investor tries and fails to obtain financial information from the investee d. The second largest investor owns only 1% of the investee's outstanding stock Answer: d ©Cambridge Business Publishers, 2020 1-2

Advanced Accounting, 4th Edition

Topic: Accounting for Investments Using the Equity Method LO: 2 4. An investor uses the equity method to account for an investment in common stock. After the date of acquisition, the equity investment account of the investor is: a. Not affected by its share of the earnings or losses of the investee b. Not affected by its share of the earnings of the investee but is decreased by its share of the losses of the investee. c. Increased by its share of the earnings of the investee but is not affected by its share of the investee's losses. d. Increased by its share of the earnings of the investee and is decreased by its share of the investee's losses. Answer: d

Topic: Accounting for Investments Using the Equity Method when Purchase Price Exceeds Book Value LO: 3 5. Angelo uses the equity method to account for its investment in Fischer on January 1. On the date of acquisition, Fischer’s land and buildings were undervalued on its balance sheet. During the year following the acquisition, how do these excesses of fair values over book values affect Angelo's Equity Income from Fischer? a. Building, Decrease; Land, No Effect b. Building, Decrease; Land, Decrease c. Building, Increase; Land, Increase d. Building, Increase; Land, No Effect Answer: a

Topic: Change to the Equity Method LO: 7 6. On January 1, Sons purchased 10% of Heller's common stock. On September 1, it purchased another 30% of Heller's common stock. During November, Heller declared and paid a cash dividend on its common stock. How much income from Heller should Sons report on its income statement? a. 10% of Heller's income for January 1 to August 31, plus 40% of Heller's income for the remainder of the year b. 40% of Heller's income from September 1 to December 31 only c. 30% of Heller's income d. The amount of dividends received from Heller. Answer: a

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Topic: Change to the Equity Method LO: 7 7. On January 1, Sons purchased 10% of Heller's common stock. On September 1, it purchased another 30% of Heller's common stock. During November, Heller declared and paid a cash dividend on its common stock. How much income from Heller should Sons report on its income statement? a. 10% of Heller's income for January 1 to August 31, plus 40% of Heller's income for the remainder of the year b. 40% of Heller's income from September 1 to December 31 only c. 30% of Heller's income d. The amount of dividends received from Heller. Answer: b

Topic: Significant Influence LO: 1 8. Which of the following does not indicate an investor company's ability to significantly influence an investee? a. Material inter-company transactions b. The investor owns 30% while another investor owns 70% c. Interchange of personnel d. Technological dependency Answer: b

Topic: Equity Method of Accounting for Investments LO: 1 9. When a company holds between 20% and 50% of the outstanding stock of an investee, which of the following statements applies? a. The investor should always use the equity method to account for its investment. b. The investor should use the equity method to account for its investment unless circumstances indicate that it is unable to exercise "significant influence" over the investee. c. The investor must use the fair value method unless it can clearly demonstrate the ability to exercise "significant influence" over the investee. d. The investor should always use the fair value method to account for its investment. Answer: b

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Topic: Accounting for Investments Using the Equity Method with Less Than 100% Ownership LO: 5 10. If a 30% acquisition is made at book value and the investor has significant influence over the investee, what will be the relationship between the Equity Investment account and the investee's stockholders' equity? a. There is no particular relationship b. The Equity Investment account will remain at original cost even as the investee's stockholders' equity increases c. The Equity Investment account balance will equal 30% of investee's stockholders' equity throughout the life of the investment d. The Equity Investment account balance will equal 30% of investee's stockholders' equity at date of acquisition, but the relationship will change as the investee reports income and dividends. Answer: c

Topic: Accounting for Investments Using the Equity Method when Purchase Price Exceeds Book Value LO: 3, 5 11. If a 30% acquisition is made at a price above book value due to an undervalued patent and the investor has significant influence over he investee, what will be the relationship between the Equity Investment account and the investee's stockholders' equity? a. There is no particular relationship b. The Equity Investment account will remain at original cost even as the investee's stockholders' equity increases. c. The Equity Investment account balance will equal 30% of investee's stockholders' equity throughout the life of the investment. d. The Equity Investment account balance will equal 30% of investee's stockholders' equity at date of acquisition, plus the unamortized cost of the patent. Answer: d

Topic: Change in Fair Value for an Equity Method Investment LO: 2 12. In the case of an equity method investment for which there is a change in fair value: a. Unrealized gains are reported in the income statement, but unrealized losses are not reported b. Unrealized gains and losses are reported on the balance sheet only c. Unrealized gains and losses are recognized in other comprehensive income d. No gains are recognized in income until the investment is sold Answer: d

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Topic: Intercompany Sales of Inventory Effect on Equity Investments LO: 4 13. If an investor sells merchandise to an investee and the investee resells all of the items to outside parties in the same period, what equity method entry is required? a. The entire gross profit is deferred with a debit to Equity Income and credit to Equity Investment. b. No equity method entry is required, since the gross profit is realized. c. The entire gross profit is deferred with a credit to Equity Income and Debit to Equity Investment d. The investor's percentage of the gross profit is deferred with a debit to Equity Income. Answer: b

Topic: Equity Investment Balance of Zero LO: 6 14. When a noncontrolling, Equity-Method Investment balance is reduced to zero as investee incurs losses: a. The investment remains at zero until the investment is sold b. The investment remains at zero until profits have eliminated the unrealized loss c. The investor must change to the fair value method d. Additional investment losses will result in a credit balance in Equity Investment Answer: b

Topic: Change from the Equity Method LO: 7 15. When an investor can no longer exert significant influence over the investee, it must change to the fair value method if the investment has a readily determinable fair value. What is the required accounting treatment on investor's books? a. A prior period adjustment is recorded to bring retained earnings to what it would have been if the new method had been used in the past. b. The book value on the date of change becomes the "cost" of the investment. c. The investment will be adjusted to its fair value. d. Both b and c are required. Answer: d

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Multiple Choice – Computational Topic: Equity Method Accounting when Less than 100% Ownership LO: 5 16. On January 2, 2020, Campbell, Inc. purchased a 20% interest in Renner Corp. for $2,000,000 cash. During 2020, Renner's net income was $2,500,000 and it paid dividends of $750,000. Campbell's 2020 income from Renner was: a. $ 500,000 b. $ 150,000 c. $ 650,000 d. $ 350,000 Answer: a

Topic: Equity Method Accounting when Less than 100% Ownership LO: 5 17. Based on the facts described in Question 16, what Equity Investment balance should Campbell report at December 31, 2020? a. $2,500,000 b. $ 500,000 c. $2,350,000 d. $2,150,000 Answer: c

Topic: Equity Method Accounting when Less than 100% Ownership LO: 1, 5 18. Spring Creek, Inc. purchased a 18% interest in Floyd Corporation on January 2, 2020. The purchase price was $200,000. Spring Creek's officers constitute a majority of Floyd Corporation’s board of directors. The investee reported net income of $300,000 and paid dividends of $50,000 in 2020. On the December 31, 2020, balance sheet, what amount should Spring Creek, Inc. report as Equity Investment in Floyd Corporation? a. $245,000 b. $254,000 c. $263,000 d. $300,000 Answer: a

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Topic: Accounting for Equity Investments When the Purchase Price Exceeds Book Value LO: 3, 5 19. Midpark Co. purchased a 30% interest in Cycling Pros, Inc. on December 31, 2020 for $1,000,000. On that date, Cycling Pros' net assets had a book value of $2,000,000 and fair value of $3,000,000. What amount of goodwill resulted from this acquisition? a. $-0b. $ 100,000 c. $ 400,000 d. $1,000,000 Answer: b

Topic: Accounting for Equity Investments When the Purchase Price Exceeds Book Value LO: 3, 5 20. On January 1, Hillcrest Co. acquired a 40% interest in Preston, Inc. with the excess of purchase price over book value solely attributable to equipment with a ten-year life and undervaluation by $250,000. During the year of acquisition, Preston reported net income of $500,000. What amount of Equity Income should Hillcrest report on its income statement for the year of acquisition? a. $190,000 b. $200,000 c. $210,000 d. $250,000 Answer: a

Topic: Accounting for Equity Investments When the Purchase Price Exceeds Book Value LO: 3 21. On December 31, 2020, Park Inc. paid $500,000 for all of the common stock of Smith Corp. On that date, Smith had assets and liabilities with book values of $400,000 and $100,000; and fair values of $450,000 and $125,000, respectively. What amount of goodwill will be reported on the December 31, 2020 balance sheet? a. $ 50,000 b. $100,000 c. $200,000 d. $175,000 Answer: d

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Topic: Change to the Equity Method LO: 7 22. On January 1, 2019, Windy Meadows Corp. acquired a 10% interest in Jones Enterprises. On January 1, 2020, Windy Meadows acquired an additional 20% Jones's common stock. No goodwill resulted from either purchase. Jones reported net incomes of $500,000 and $400,000 for 2019 and 2020, respectively. Dividends paid by Jones amounted to $275,000 in 2019 and $125,000 in 2020. What amount of Equity Income should be reported by Windy Meadows Corp in 2020? a. $120,000 b. $ 95,000 c. $ 82,500 d. $ 55,000 Answer: a

Topic: Change to the Equity Method LO: 7 23. On January 1, 2019, Windy Meadows Corp. acquired a 10% interest in Jones Enterprises for $20,000. The stock has a readily determinable fair value, so the investor measures the Equity Investment at fair value with all unrealized gains and losses flowing through net income. On December 31, 2019 the fair value of the 10% common stock investment is $24,000. On April 1, 2020, Windy Meadows acquired an additional 20% Jones's common stock for $52,000 and gains the ability to exert significant influence over its investment and will begin to use the equity method for its investment. What is the amount of the unrealized holding gain or loss that would be required on January 1, 2020 to appropriately transition to the equity method? a. $-0b. $ 2,000 c. $ 6,000 d. $12,000 Answer: b

Topic: Equity Method Accounting When Less Than 100% Ownership LO: 5 24. Spring Valley Corp. purchased a 40% interest in A1 Automotive Company on July 1, 2020. On September 23, 2020, A1 Automotive paid dividends of $50,000 to its common stockholders. The investee reported 2020 net income of $150,000, which was earned evenly throughout the year. What amount of Equity Income should Spring Valley report in its 2020 income statement? a. $20,000 b. $30,000 c. $60,000 d. $90,000 Answer: b

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Topic: Accounting for Equity Investments When the Purchase Price Exceeds Book Value LO: 3, 5 25. On January 2, 2020, Petunia Co. purchased a 20% interest in Sawyer, Inc. for $300,000. Fair values of Sawyer’s net assets exceeded book values due to land undervalued by $400,000. In 2020, Sawyer reported net income of $100,000 and paid no dividends. What is the amount of Equity Investment on the December 31, 2020, balance sheet? a. $300,000 b. $320,000 c. $360,000 d. $400,000 Answer: b

Topic: Accounting for Equity Investments When the Purchase Price Exceeds Book Value LO: 3, 5 26. On January 2, 2020, Bronson Corporation purchased a 30% interest in Martinez, Inc. for $500,000. Fair values of Martinez's net assets equaled book values except for equipment undervalued by $100,000. The equipment had a 10-year remaining life. During 2020, Martinez reported net income of $150,000 and paid dividends of $40,000. What is Bronson’s Equity Income for 2020? a. $12,000 b. $15,000 c. $30,000 d. $42,000 Answer: d

Topic: Accounting for Equity Investments When the Purchase Price Exceeds Book Value LO: 3 27. Emily Corporation purchased all of Ace Company's common stock on January 1, 2020, for $1,000,000 cash. The investee's stockholders' equity amounted to $400,000. The excess of $600,000 was due to an unrecorded patent with a six-year life. In 2020, Ace reported net income of $250,000 and paid dividends of $25,000. For 2020, what amount of Equity Income will Emily record? a. $150,000 b. $125,000 c. $175,000 d. $825,000 Answer: a

Topic: Accounting for Equity Investments When the Purchase Price Exceeds Book Value LO: 3 28. Assume the facts in Question 27. What is the Equity Investment balance at December 31, 2020? a. $ 825,000 b. $1,100,000 c. $1,125,000 d. $1,175,000 Answer: c ©Cambridge Business Publishers, 2020 1-10

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Topic: Intercompany Sales of Inventory LO: 4, 5 29. Investor owns 30% of Investee and applies the equity method. In 2020, Investor sells merchandise costing $240,000 to Investee for $300,000. Investee's ending inventory includes $50,000 purchased from Investor. What amount of unrealized gross profit must be deferred in the equity method entry? a. $ 3,000 b. $10,000 c. $15,000 d. $50,000 Answer: a

Topic: Intercompany Sales of Inventory LO: 4, 5 30. Assume the facts in Question 29. Which of the following is the correct equity method entry to defer the unrealized gross profit? a. Equity Income 3,000 Equity Investment 3,000 b. Equity Investment 3,000 Equity Income 3,000 c. Cost of Goods Sold 50,000 Equity Investment 50,000 d. Equity Investment 50,000 Equity Income 50,000 Answer: a

Topic: Intercompany Sales of Inventory LO: 4, 5 31. Assume the facts in Question 29. Which of the following is the correct equity method entry to record the realization of the gross profit in 2021? a. Equity Income 3,000 Equity Investment 3,000 b. Equity Investment 3,000 Equity Income 3,000 c. Equity Investment 50,000 Cost of Goods Sold 50,000 d. Equity Income 50,000 Equity Investment 50,000 Answer: b

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Topic: Intercompany Sales of Inventory LO: 4, 5 32. Investor owns 20% of Investee and applies the equity method. In 2020, Investee sells merchandise costing $100,000 to Investor for $150,000. Investor's ending inventory includes $30,000 purchased from Investee. What amount of unrealized gross must be deferred in the equity method entry? a. $ 2,000 b. $ 6,000 c. $ 10,000 d. $ 30,000 Answer: a

Topic: Equity Method Accounting When Less Than 100% Ownership LO: 5 33. On January 2, 2020, Maddison Company purchased 35% of the outstanding common stock of Ellinger, Inc. and subsequently used the equity method to account for the investment. During 2020 Ellinger, Inc. reported net income of $400,000 and distributed dividends of $100,000. The ending balance in the Investment in Ellinger, Inc. account at December 31, 2020 was $500,000 after applying the equity method during 2020. What was the purchase price Maddison paid for its investment in Ellinger? a. $175,000 b. $360,000 c. $395,000 d. $400,000 Answer: c

Topic: Equity Method Accounting When Less Than 100% Ownership LO: 5 34. Jionni Corporation purchased 35% of the common stock of the Hazel Corporation for $1, 000,000 on January 2, 2020. Hazel Corporation paid cash dividends of $200,000 during 2020, and reported net income of $500,000 for 2020. Jionni's Equity Income from Hazel is: a. $105,000 b. $ 70,000 c. $245,000 d. $175,000 Answer: d

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Topic: Equity Method Accounting When Less Than 100% Ownership LO: 5 35. Francis, Inc. acquired 40% of Park's voting stock on January 1, 2020 for $420,000. During 2020, Park earned $120,000 and paid dividends of $60,000. During 2021, Park earned $160,000 and paid dividends of $50,000 on April 1 and $40,000 on December 1. On July 1, 2021, Francis sold half of its stock in Park for $275,000 cash. The Equity Investment balance at December 31, 2020 is: a. $420,000 b. $444,000 c. $408,000 d. $492,000 Answer: b

Topic: Equity Method Accounting When Less Than 100% Ownership LO: 5 36. Assume the facts in Question 35. What is the gain on sale of the investment if income was earned evenly throughout 2021? a. $ 39,000 b. $181,000 c. $ 47,000 d. $ 94,000 Answer: c

Topic: Equity Method Accounting When Less Than 100% Ownership LO: 5 37. On January 1, 2020, Cracker Co. purchased 40% of Dallas Corp.'s common stock at book value of net assets. The balance in Cracker's Equity Investment account was $820,000 at December 31, 2020. Dallas reported net income of $500,000 for the year ended December 31, 2020, and paid dividends totaling $150,000 during 2020. How much did Cracker pay for its 40% interest in Dallas? a. $680,000 b. $500,000 c. $560,000 d. $760,000 Answer: a

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Topic: Equity Method Accounting When Less Than 100% Ownership LO: 5 38. On January 1, 2020, Sarai, Inc. purchased 40% of the voting common stock of Rolls Corp. for $500,000. There was no amortization. During 2020, Rolls paid dividends of $50,000 and reported a net loss of $120,000. What is the balance in the Equity Investment account on December 31, 2020? a. $432,000 b. $380,000 c. $528,000 d. $548,000 Answer: a

Topic: Intercompany Sales of Inventory LO: 4, 5 39. Blue Mountain, Inc. owns 40% of Grand Co. and applies the equity method. During the current year, Blue Mountain bought inventory costing $100,000 and then sold it to Grand for $150,000. At year-end, only 25% of the merchandise was still being held by Grand. What amount of intra-entity inventory profit must be deferred by Blue Mountain? a. $ 5,000 b. $12,500 c. $15,000 d. $37,500 Answer: a

Topic: Accounting for Equity Investments When the Purchase Price Exceeds Book Value LO: 3, 5 40. On January 1, 2020, Sylvestor, Inc., paid $400,000 for a 20% interest in Happiness Corporation. This investee had assets with a book value of $1,500,000 and liabilities of $700,000. A patent held by Happiness was undervalued by $150,000. The patent had a ten year remaining life. Any goodwill associated with this acquisition is considered to have an indefinite life. During 2020, Happiness reported income of $200,000 and paid dividends of $80,000 while in 2021 it reported income of $230,000 and dividends of $100,000. What is the balance in Equity Investment at December 31, 2021? a. $420,000 b. $444,000 c. $450,000 d. $459,000 Answer: b

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Exercises Topic: Equity Method Accounting When Less Than 100% Ownership LO: 5, 6 1. On January 1, 2020, Hightower Corporation acquired a 40% interest in Smith, Inc. for $2,000,000, which was equal to book value of Smith’s net assets. During 2020, Smith reported net income of $2,500,000 and paid total dividends of $750,000. Required: a. How much 2020 income should Hightower report from its equity method investment in Smith? b. What amount should Hightower report as Equity Investment on its December 31, 2020 balance sheet? c. What circumstances would require that Hightower discontinue the equity method. Answer: a. $2,500,000 x 0.40 = $1,000,000 b. $2,000,000 + $1,000,000 – (0.40 x $750,000) = $2,700,000 c.

The following circumstances would require discontinuing the equity method: • Investee company losses that would reduce the investment account to zero • The investor no longer exerts significance influence. • Payment of dividends in excess of accumulated earnings • There is a permanent decline in fair value of the investment.

Topic: Accounting for Equity Investments When the Purchase Price Exceeds Book Value LO: 3, 5 2. In January 2020, Foster, Inc. acquired a 40% interest in Brady, Inc. for $250,000, giving Foster significant influence over Brady. Any excess of purchase price over book value was considered goodwill. In 2020, Brady reported net income of $100,000 and paid total dividends amounting to $20,000. Required: Prepare Foster’s 2020 journal entries related to its investment in Brady. Answer: Equity Investment Cash To record investment.

250,000 250,000

Equity Investment 40,000 Equity income 40,000 To record investor’s share of investee’s reported income ($100,000 x 0.40). Cash

8,000 Equity Investment 8,000 To record investor’s share of dividends paid by investee. ($20,000 * 0.40)

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Topic: Equity Method Accounting When Less Than 100% Ownership LO: 3, 5 3. May Company acquires a 40% interest in Barrett Corporation and concludes that it has significant influence over Barrett. The book value of Barrett’s stockholders’ equity is $800,000 and May pays $450,000 for the investment. An excess of purchase price over book value was attributable to an unrecorded customer list worth $325,000, with a useful life of 10 years. After the acquisition, Barrett reported net income of $300,000 and paid May a dividend of $20,000. At the end of the year, May sells the investment for $550,000. Required: Prepare all entries related to the investment during the year. Answer: Compute excess of purchase price over book value: $450,000 – (0.40 x $800,000) = $130,000 Compute annual amortization: $325,000 / 10 = $32,500 Journal entries: Equity Investment Cash To record investment.

450,000 450,000

Equity Investment 120,000 Equity Income 120,000 To record investor’s share of investee’s reported income ($300,000 x 0.40). Cash

20,000 Equity Investment To record investor’s receipt of dividends.

20,000

Equity Income 13,000 Equity Investment To record amortization. (32,500 * 0.40)

13,000

Cash

550,000 Equity Investment 537,000 Gain on Sale of Investment 13,000 To record sale of investment (Equity investment = $450,000 + $120,000 - $20,000 - $13,000).

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Topic: Intercompany Sales of Inventory LO: 4, 5 4. Lauralee, Inc. owns a 30% interest in Eastwood Co., giving it representation on the investee’s board of directors. At the beginning of the year, the Equity Investment was carried on Lauralee’s balance sheet at $500,000. During the year, Eastwood reported net income of $250,000 and paid Lauralee a dividend of $50,000. In addition, Lauralee sold inventory to Eastwood, recording a gross profit of $20,000 on the sale. At the end of the year, 50% of the merchandise remained unsold by Eastwood. Required: a. Prepare the equity method journal entry to defer the unrealized inventory gross profit. b. How much equity income should Lauralee report from Eastwood during the year? c. What is the balance in the Equity Investment at the end of the year? Answer: a. Unrealized gross profit = 0.5 x $20,000 = $10,000 Journal entry: Equity Income Equity Investment $10,000 x 0.30 = $3,000

3,000 3,000

b. Lauralee’s equity income from Eastwood: (0.30 x $250,000) – $3,000 = $72,000 c.

Year-end Equity Investment balance: $500,000 + $72,000 – $50,000 = $522,000

Topic: Equity Method Accounting When Less Than 100% Ownership LO: 5 5. Potter, Inc., acquires 10% of Weasley Corporation on January 1, 2020, for $300,000. During 2020, Weasley reported net income of $250,000 and paid total dividends of $50,000. On January 1, 2021, Potter purchased an additional 30% of Weasley for $900,000. During 2021, Weasley reported net income of $420,000 and paid dividends of $20,000. Required: a. Prepare the January 1, 2021 entry to adjust the equity investment account for the initial adoption of the Equity Method. b. Compute the balance in the Equity Investment account at December 31, 2021. Answer: Assuming GAAP for years (and interim periods) after the December 15, 2016 effective date of ASU 2016-07 a. Under the prospective approach in ASU 2016-07, there is no “catch up” adjustment for conversion to the equity method. If the old equity investment had unrealized holding gains/losses, then those gains and losses would be realized upon transition to the Equity Method and investment would be increased/decreased accordingly. b. Balance in Equity Investment account at December 31, 2021: $300,000 + $900,000 + 0.40 x ($420,000 – 20,000) = $1,360,000

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Problems Topic: Accounting for Equity Investments When the Purchase Price Exceeds Book Value LO: 3, 5 1. On January 1, 2020, Skyline Co. paid $200,000 for a 40% interest in Allen Industries. Allen Industries’ stockholders’ equity amounted to $300,000 on that date. The excess of purchase price over book values was due to an unrecorded patent valued at $200,000 with a 5-year life. During 2020, Allen Industries reported income of $80,000 and paid dividends of $18,000. During 2021, it reported income of $90,000 and dividends of $48,000. Assume that Skyline Co. has significant influence over the operations of Allen Industries. Required: a. What is the amount of goodwill? b. What is Equity Income for 2020? c. What is the balance in the Equity Investment account at December 31, 2020? d. What is Equity Income for 2021? e. What is the balance in the Equity Investment account at December 31, 2021? Answer: a. There is no goodwill because the difference between purchase cost and book value is explained by the undervalued patent. b. Patent Amortization: $200,000/5 x 0.40 = $16,000 Equity Income for 2020: (0.40 x $80,000) – $16,000 = $16,000 c.

Equity Investment at December 31, 2020: $200,000 + $16,000 – (0.40 x $18,000) = $208,800

d. Equity Income for 2021: (0.40 x $90,000) - 16,000 = $20,000 e. Equity Investment at December 31, 2021: $208,800 + $20,000 – (0.40 x $48,000) = $209,600

Topic: Change to the Equity Method LO: 7 2. Tigger, Inc. acquired 10% of Admore Corporation on January 1, 2020, for $140,000 when the book value of Admore’s net assets was $950,000. During 2020, Admore reported net income of $250,000 and paid dividends of $40,000. On January 1, 2021, Tigger purchased an additional 30% of Admore for $420,000. Any excess of cost over book value was attributable to goodwill (No amortization). On that same date, Tigger changed to the equity method. During 2021, Admore reported net income of $500,000 and paid dividends of $80,000. Required: a. What income did Tigger record from Admore in 2020? b. What income did Tigger record from Admore in 2021? c. What was the balance in Equity Investment at December 31, 2021?

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Answer: Assuming GAAP for years (and interim periods) after the December 15, 2016 effective date of ASU 2016-07 a. In 2020, dividend income of $4,000 was Tigger’s only income from Admore. (0.10 X $40,000) b. Equity Income for 2020: 0.40 x $500,000 = $200,000 c.

Equity Investment at December 31, 2020: $140,000 + $420,000 + $200,000 – (0.40 x $80,000) = $728,000

Topic: Intercompany Sales of Inventory LO: 4, 5 3. Ally, Inc. bought 40% of Blake Company on January 1, 2020 for $400,000. The equity method was used. No amortization was required. In 2020, Blake shipped to Ally merchandise with a cost of $25,000 and a selling price of $30,000. One-fourth of the merchandise remained in Ally’s inventory at year-end and was sold in 2021. In 2021, Blake received merchandise from Ally, who recorded a gross profit of $20,000 on the sale. One-third of the merchandise remained in ending inventory. Blake reported net income of $60,000 in 2020 and $80,000 in 2021. Dividends of $10,000 were paid to Ally each year. Required: Prepare all equity method entries for 2020 and 2021. Answer: Compute unrealized gross profit in December 31, 2020 inventory: ($130,000 – $25,000) x 1/4 = $1,250 Compute unrealized gross profit in December 31, 2021 inventory: ($20,000 x 1/3) = $6,667 2020 Equity Method Entries Equity Investment Cash To record investment in Blake.

400,000 400,000

Equity Investment 15,000 Equity Income 15,000 To record Ally’s equity in Blake’s reported income 0.40 x $60,000. Cash

4,000

Equity Investment To record dividends received 0.40 x $10,000.

4,000

Equity Income 500 Equity Investment 500 To recognize deferral of unrealized gross profit 0.40 x $1250. Continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 1

1-19

2021 Equity Method Entries Equity Investment 32,000 Equity Income 32,000 To record Ally’s equity in Blake’s reported income 0.40 x $80,000. Cash

4,000

Equity Investment To record dividends received 0.40 x $10,000. Equity Investment Equity Income To record realization of deferred gross profit.

4,000

500 500

Equity Income 2,667 Equity Investment 2,667 To recognize deferral of unrealized gross profit 0.40 x $6,667.

Topic: Equity Method Accounting When Less Than 100% Ownership LO: 5 4. On January 2, 2020, Thoreau Corp. purchased 25,000 shares (25%) of the common stock of Browning & Company. The purchase price was $250,000. Thoreau has significant influence over Browning. No amortization is required. During 2020, Browning reported income of $150,000 and paid dividends of $40,000. On January 2, 2021, Thoreau sold 10,000 shares for $127,500. Required: a. Compute the balance in Equity Investment at December 31, 2020. b. Prepare the journal entry to record the sale of the 10,000 shares. c. What was the balance in Equity Investment after the shares were sold? Answer: a. Compute Equity Investment at December 31, 2020: $250,000 + [0.25 x ($150,000 – $34,000)] = $277,500 b. Compute book value per share: $277,500/25,000 shares = $11.10/share Cash

127,500 Equity Investment 111,000 Gain on Sale of Investment 16,500 To record sale of10,000 shares of Browning & Company Gain = $127,500 – (10,000 x $11.10) = $16,500. c.

Compute Equity Investment balance after sale of 10,000 shares: $277,500 – $111,000 = $166,500

©Cambridge Business Publishers, 2020 1-20

Advanced Accounting, 4th Edition

Chapter 2 Introduction to the Consolidation Process Learning Objectives – Coverage by question LO1 – Explain the criteria and accounting for business combinations and (non-business) asset acquisitions).

Multiple Choice

Exercises

LO2 – Explain the guidelines for determining the existence of “control.”

2, 3, 13-16,

LO3 – Explain the consolidation process on the date of acquisition when price equals book.

38, 39

LO4 – Explain the consolidation process on the date of acquisition when price exceeds book.

10, 17, 22-37, 40-41

2, 3, 5, 6

LO5 – Explain the measurement of identifiable assets acquired, liabilities assumed and goodwill in business combinations.

4, 5, 6, 7, 8, 9, 11, 12, 18-21, 35

4, 7

LO6 – Explain when deferred taxes are recorded in business combinations and the effect of deferred taxes on the recognition of business combinations.

Problems

1 -4

LO7 – Explain pushdown accounting.

©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

2-1

Chapter 2: Introduction to the Consolidation Process Multiple Choice Multiple Choice – Theory Topic: Basket Purchase vs. Net Asset Acquisition LO: 1 1. The main difference between a "basket purchase" of net assets and an acquisition of net assets that qualifies as a business is that: a. In an acquisition of net assets that qualifies as a business, all assets are valued at full fair value regardless of purchase price; while in a "basket purchase" of net assets the purchase price is allocated to the various assets. b. In a "basket purchase" of net assets, the assets are valued at fair value while in an acquisition of net assets that qualifies as a business, assets are recorded at book values. c. In an acquisition of net assets that qualifies as a business, the assets are not actually recorded on the investor's books. d. There is no difference in the accounting for the two types of transactions. Answer: a

Topic: Distinguishing Business Combination from Asset Acquisition LO: 2 2. All of the following are necessary to distinguish a business combination from a simple asset acquisition except: a. The entity has initiated planned activities. b. The entity has human and material resources, as well as intellectual property. c. The entity has begun to generate revenues. d. The entity will be able to obtain access to customers. Answer: c Topic: Indicators of “Control” LO: 2 3. When an investor is deemed to have "control" over an investee, GAAP requires presentation of consolidated financial statements. Which of the following would not be considered an indicator of control? a. The investor has majority interest in the investee. b. The investor owns 40% of the investee's stock and the rest is owned by the investee's founder. c. The investor owns 40% of the investee's stock and the rest is owned by a large number of small investors. d. Instead of owning stock, a company licenses technology to another company in an agreement allowing the licensor to appoint a majority of the licensee's board of directors. Answer: b

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Advanced Accounting, 4th Edition

Topic: Acquisition-Related Costs LO: 5 4. Acquisition-related costs incurred by the investor for services provided by outside accountants, as well as the investor's employees, are: a. Expensed immediately b. Expensed if indirect, but capitalized if direct c. Capitalized, subject to impairment testing, but not amortization d. Capitalized, subject to both amortization and impairment testing Answer: a

Topic: Stock Issuance Costs LO: 5 5. Stock issuance costs are: a. Treated the same as acquisition-related costs b. Debited to the Equity Investment account c. Credited to the Common Stock account d. Treated as a reduction in additional paid-in capital Answer: d

Topic: Acquired Research and Development Costs LO: 5 6. In-process research and development acquired in a business combination is: a. Expensed, consistent with the accounting treatment of a firm's own R & D expenditures b. Credited to The Equity Investment account c. Recorded as indefinite-lived intangible assets, subject to amortization d. Recorded as an indefinite-lived intangible asset, and annually tested for impairment Answer: d

Topic: Restructuring Costs LO: 5 7. Often, the investor or investee will adopt a restructuring plan to achieve certain synergies from the acquisition. Certain restructuring costs are required for implementation of such a plan. Which of the following statements correctly describes the GAAP treatment of such costs? a. A liability for restructuring costs expected to be incurred is included in the purchase price allocation at date of acquisition. b. If a restructuring plan is not already in place, the liability and related expense must be recognized subsequent to the acquisition. c. Costs that the investor is not legally obligated to incur may be accrued at the acquisition date or expensed as incurred. d. Recognizing a restructuring obligation at date of acquisition results in early recognition of expense. Answer: b

©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

2-3

Topic: Preacquisition Contingencies LO: 5 8. Accounting standards require that a portion of the cost of an acquired company be allocated to investee liabilities. However, often in the case of pre-existing contingent liabilities, the amounts may be unknown at the acquisition date. What are the general financial reporting requirements for the consolidated statements at date of acquisition? a. If the fair value of a pre-existing contingent liability is unknown, the liability should not be recognized. b. A contingent liability would not be recognized unless the loss was "probable." c. Contingencies meeting the "possible" threshold would be disclosed, not accrued. d. All of the above statements are true. Answer: d

Topic: Contingent Consideration LO: 5 9. Acquisition agreements sometimes include a provision requiring an increase in the cash price contingent upon investee's profits exceeding a specified level within a certain time period. Regarding the contingent consideration, acquisition accounting requires at acquisition date: a. Recognition of a liability in the amount expected to be ultimately paid b. Recognition of a liability at its fair value, resulting in an increase in goodwill c. No disclosure of the contingent consideration because of the high degree of uncertainty d. Recognition of a liability at its fair value, but with no effect on the purchase price Answer: b

Topic: Measurement of Goodwill LO: 4 10. Which of the following statements best describes how goodwill is measured? a. Acquisition price – Goodwill = Fair value of net tangible assets b. Acquisition price – Fair value of net tangible assets = Goodwill c. Acquisition price – Fair value of net tangible assets – Fair value of identifiable intangible assets = Goodwill. d. Acquisition price – Book value of net assets = Goodwill Answer: c

©Cambridge Business Publishers, 2020 2-4

Advanced Accounting, 4th Edition

Topic: Intangible Assets LO: 5 11. Which of the following statements is incorrect regarding the recognition of intangible assets in a business combination? a. Intangible assets arising from contractual or legal rights are recognized separately from goodwill. b. Intangibles that can be separated from the business and sold, rented or licensed are recognized separately from goodwill. c. Separately recognized intangibles are identified as either limited life or indefinite life intangibles. d. The acquirer in a business combination does not recognize intangible assets unless they appear on the investee company's balance sheet. Answer: d

Topic: GAAP Approaches to Business Combinations LO: 5 12. Current GAAP identifies three approaches to assigning values to assets acquired in a business combination. Which of the following is not a recognized valuation technique for allocating the acquisition price to specific assets? a. Market Approach b. Book Value Approach c. Cost Approach d. Income Approach Answer: b

Topic: Parent and Subsidiary Relationship LO: 2 13. Which of the following statements best describes the relationship between a parent and its consolidated subsidiary? a. In legal form they are separate, but in economic substance they are one. b. In legal form and economic substance they are one. c. In legal form they are one, but in economic substance they are separate. d. In legal form and economic substance they are separate. Answer: a

Topic: Elimination Entries LO: 2 14. If Diane Company acquires all of the common stock of Balcony, Inc. Where will the entries necessary to arrive at consolidated balances appear? a. On Diane's books only b. On Balcony's books only c. On a worksheet only d. On the books of both the parent and the subsidiary Answer: c

©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

2-5

Topic: Indicators of “Control” LO: 2 15. Under what circumstances might consolidation of a majority owned investee not be appropriate? a. The investee is a U. K. company b. The investee is in bankruptcy c. The two companies are in different industries d. The two companies have different accounting periods Answer: b

Topic: Consolidation Process LO: 2 16. Why is the consolidation process not just a matter of adding together the financial statements of the investor and the financial statements of the investee? a. Such a procedure would result in double counting of investee net assets. b. The subsidiary's stockholders' equity does not represent ownership by those outside the economic entity. c. The subsidiary’s net assets must be reported at fair value, regardless of the amounts recorded in the subsidiary’s accounting records. d. If the parent and subsidiary each has marketable securities accounted for as trading securities (i.e., fair value), the consolidated amount will be incorrect if simply added together without adjustment. Answer: d

Topic: Acquisition Method of Accounting for a Business Combination LO: 4 17. Which of the following statements is true regarding the acquisition method of accounting for a business combination? a. Assets of the acquired company are recorded at book values. b. Assets of the acquired company are recorded at fair value, but only if the acquisition cost equals or exceeds fair value of the subsidiary's net assets. c. Assets of the acquired company are recorded at fair values regardless of the acquisition cost. d. Consulting costs related to the combination reduce additional paid-in capital. Answer: c

©Cambridge Business Publishers, 2020 2-6

Advanced Accounting, 4th Edition

Multiple Choice – Computational Topic: Acquisition-Related Costs LO: 5 18. On December 31, 2020, Bush Company issued 23,000 shares of its common stock with a fair value of $10 per share for all of the outstanding common shares of Long Beach Company. Stock issuance costs of $3,500 and direct costs of $8,000 were paid. What amount was debited to Equity Investment at date of acquisition? a. $230,000 b. $233,000 c. $241,000 d. $238,000 Answer: a

Topic: Acquisition-Related Costs and Contingent Consideration LO: 5 19. On December 31, 2020, Lemmon Company issued 20,000 shares of its common stock with a fair value of $50 per share for all of the outstanding common shares of May Company. Stock issuance costs of $4,000 and direct costs of $1,000 were paid. In addition, Lemmon promised to pay an additional $2,200 to the former owners if May's earnings exceeded a certain amount during the next year. The fair value of the potential obligation is estimated at $2,000. Compute the investment to be recorded at date of acquisition. a. $1,000,000 b. $1,002,000 c. $1,003,000 d. $1,004,200 Answer: b

Questions 20 and 21 are based upon the following set of facts: Midlothian acquires 100 percent of the outstanding voting shares of Cedar Company on January 1, 2020. To obtain these shares, Midlothian pays $400,000 cash and issues 20,000 shares of $1 par value common stock on this date. Midlothian’s stock had a fair value of $10 per share. Midlothian also pays an additional $3,000 in stock issuance costs. At date of acquisition, the book values and fair values of Cedar's net assets amounted to $450,000 and $520,000, respectively.

Topic: Acquisition-Related Costs LO: 5 20. How much additional paid-in capital was recorded as a result of the combination? a. $177,000 b. $180,000 c. $197,000 d. $200,000 Answer: a

©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

2-7

Topic: Measurement of Goodwill LO: 5 21. What amount was reported for goodwill as a result of this acquisition? a. $ -0b. $ 77,000 c. $ 80,000 d. $180,000 Answer: c

Questions 22-31 are based on the following set of facts. Lucky’s Company acquires Waterview, Inc., by issuing 40,000 shares of $1 par common stock with a market price of $25 per share on the acquisition date and paying $125,000 cash. The assets and liabilities on Waterview’s balance sheet were valued at fair values except equipment that was undervalued by $300,000. There was also an unrecorded patent valued at $40,000, as well as an unrecorded trademark valued at $75,000. In addition, the agreement provided for additional consideration, valued at $60,000, if certain earnings targets were met. The pre-acquisition balance sheets for the two companies at acquisition date are presented below.

Cash Accounts receivable Inventory Property, plant, and equipment

Accounts payable Salaries and taxes payable Notes payable Common stock Additional paid-in capital Retained earnings

Lucky’s Company $300,000 250,000 254,000 2,300,000 $3,104,000

Waterview, Inc. $260,000 135,000 275,000 356,500 $1,026,500

$45,000 450,000 500,000 250,000 950,000 909,000 $3,104,000

$37,500 46,000 450,000 60,000 106,500 326,500 $1,026,500

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 22. At what amount is the investment recorded on Lucky’s books? a. $1,000,000 b. $1,100,000 c. $1,125,000 d. $1,185,000 Answer: d

©Cambridge Business Publishers, 2020 2-8

Advanced Accounting, 4th Edition

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 23. Compute the consolidated balance in Cash. a. $300,000 b. $435,000 c. $475,000 d. $560,000 Answer: b

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 24. Compute consolidated common stock. a. $250,000 b. $290,000 c. $310,000 d. $350,000 Answer: b

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4, 5 25. Compute consolidated additional paid-in capital. a. $ 950,000 b. $1,056,500 c. $1,910,000 d. $2,016,500 Answer: c

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 26. What amount of goodwill was recorded in the acquisition? a. $-0b. $217,000 c. $277,000 d. $692,000 Answer: c

Topic: Contingent Consideration LO: 5 27. Compute consolidated liabilities. a. $ 555,000 b. $1,528,500 c. $1,055,000 d. $1,588,500 Answer: d

©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

2-9

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO:4 28. Compute consolidated property, plant & equipment. a. $2,600,000 b. $2,656,500 c. $2,956,500 d. $3,071,500 Answer: c

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 29. Compute consolidated inventory. a. $ 21,000 b. $254,000 c. $529,000 d. $604,000 Answer: c

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 30. Compute consolidated identifiable intangible assets. a. $ 40,000 b. $ 75,000 c. $115,000 d. $175,000 Answer: c

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 31. What is consolidated retained earnings? a. $ 582,500 b. $ 909,000 c. $1,235,500 d. $2,195,500 Answer: b

©Cambridge Business Publishers, 2020 2-10

Advanced Accounting, 4th Edition

Questions 32-34 are based on the following set of facts. On January 1, 2021, Consolidated Company purchased 100% of the common stock Avergy Industries for $720,000. On that date, Avergy had common stock of $100,000 and retained earnings of $420,000. Equipment and land were each undervalued by $50,000 on Avergy’s books. There was a $40,000 overvaluation of Bonds Payable, as well a $60,000 undervaluation of inventory.

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 32. What is the amount of goodwill recorded in connection with this combination? a. $0 b. $ 50,000 c. $ 80,000 d. $200,000 Answer: a

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 33. The consolidation entries necessary for a date of acquisition balance sheet include all of the following, except: a. Land debit, $50,000 b. Inventory debit, $60,000 c. Bonds Payable credit, $40,000 d. Equipment debit, $50,000 Answer: c

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 34. The combined consolidation entries necessary for a date of acquisition balance sheet include all of the following, except: a. Common Stock debit, $100,000 b. Retained Earnings credit, $420,000 c. Equity Investment credit, $720,000 d. No debits or credits to goodwill Answer: b

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4, 5 35. Faith Company acquired 100% of Installed Components by issuing 200,000 shares of its $2 par value stock. The market value of the stock is $20 per share. Faith also paid $20,000 in consulting fees related to the acquisition. Faith's journal entry to record the acquisition would include: a. A credit to additional paid-in-capital, $3,600,000 b. A credit to common stock, $4,000,000 c. A credit to cash, $4,020,000 d. A debit to Equity Investment, $4,020,000 Answer: a ©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

2-11

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 36. On July 1, 2020, Peter Co. paid $500,000 for all of the stock of Yaleton, Inc. On that date, book values of Yaleton’s assets and liabilities were $420,000 and $150,000, respectively. The fair values of the assets and liabilities were $600,000 and $105,000, respectively. What is the amount of goodwill at date of acquisition? a. $230,000 b. $ 50,000 c. $ 5,000 d. $-0Answer: c

Topic: Acquisition-Date Consolidation when Purchase Price Equals Book Value LO: 4 37. On December 30, 2020, Sherlock Co. acquired 100% of Barrett Corporation for $750,000 cash. The post-combination, but pre-consolidation, balance sheets of the two firms showed total assets of $1,500,000 for the parent and $440,000 for the subsidiary. The book values of the subsidiary’s net assets approximated their fair values, and there are no unrecorded net assets. Total assets on the consolidated balance sheet would be: a. $ 750,000 b. $1,190,000 c. $1,940,000 d. $2,690,000 Answer: b

Topic: Acquisition-Date Consolidation LO: 3 38. Shannon Company had common stock of $160,000 and retained earnings of $234,000. Gus, Inc. had common stock of $350,000 and retained earnings of $376,000. On January 1, 2021, Gus issued 35,000 shares of common stock with a $1 par value and a $15 fair value for all of Shannon Company's outstanding common stock. Immediately after the combination, what were the consolidated net assets? a. $1,251,000 b. $ 919,000 c. $1,155,000 d. $ 884,000 Answer: a

©Cambridge Business Publishers, 2020 2-12

Advanced Accounting, 4th Edition

Questions 39-41 are based upon the following set of facts. Johnson Corporation issues 50,000 shares of its common stock for all of the outstanding shares of Smithson, Inc. Johnson’s shares have a par value of $4 and a market value of $19 per share.

Topic: Acquisition-Date Consolidation LO: 3 39. What is the increase in consolidated additional paid-in capital resulting from the combination? a. $ 750,000 b. $ 934,000 c. $1,634,000 d. $-0Answer: a

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 40. If Smithson's net assets have book values and fair values of $440,000 and $560,000, respectively, what is the resulting amount of goodwill recognized on the post-acquisition balance sheet? a. $510,000 b. $120,000 c. $390,000 d. $-0Answer: c

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 41. If Smithson's net assets have book values and fair value of $700,000 and $1,100,000, respectively, what is the resulting amount of goodwill recognized on the post-acquisition balance sheet? a. $390,000 b. $240,000 c. $150,000 d. $ -0Answer: d

©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

2-13

Questions 42-43 are based upon the following set of facts. On January 1, 2021, Eisman Company purchased 100% of the common stock Kandler Enterprises for $600,000. This transaction is a “nontaxable” acquisition under the Internal Revenue Code. On the date of acquisition, Kandler had common stock of $200,000 and retained earnings of $280,000. The fair values of Kandler’s net assets equal their respective book values except for equipment that is undervalued by $30,000 and an unrecorded brand name valued at $45,000. Assume that the tax bases of Kandler’s preacquisition identifiable net assets equal their book values. Kohler’s tax effective tax rate is 30%.

Topic: Tax Effects of Business Combinations LO: 6 42.

What is the amount of deferred taxes that result from this combination? a. $13,500 deferred tax asset b. $36,000 deferred tax liability c. $13,500 deferred tax liability d. $36,000 deferred tax asset Answer: c

Topic: Tax Effects of Business Combinations LO: 6 43. What is the amount of goodwill recorded in connection with this combination? a. $58,500 b. $45,000 c. $13,500 d. $0 Answer: a

©Cambridge Business Publishers, 2020 2-14

Advanced Accounting, 4th Edition

Exercises Topic: Net Asset Acquisition vs. Stock Acquisition LO: 1 1. Houston Company reports the following summarized balance sheet on the date that it is acquired by Omaha, Inc.: Current Assets Property, plant, & equipment

$50,000 85,000

Total Assets

$135,000

Current Liabilities Long-Term Liabilities Stockholders’ Equity Total liabilities and equity

$60,000 18,000 57,000 $135,000

Omaha acquired Houston for $57,000 cash. Required: a. Prepare the journal entry if Omaha acquires all of the individual assets and liabilities of Houston in the business combination. b. Prepare the journal entry if Omaha buys 100% of Houston’s common stock. Answer: a. Journal entry to record acquisition of assets/liabilities: Current Assets Property, plant and equipment Current liabilities Long-term liabilities Cash

50,000 85,000 60,000 18,000 57,000

b. Journal entry to record purchase of 100% of Houston’s common stock: Equity Investment Cash

57,000 57,000

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 2. Rainforest Corporation exchanges 40,000 shares of $1 par value common stock, with a market value of $15 per share for all of the shares of Effective Systems, Inc. On the acquisition date, Effective Systems had $80,000 of Common Stock and $25,000 of Retained Earnings. Book values were equal to fair values except for land which was undervalued by $15,000. Required: a. Prepare the entry on Rainforest’s books to record the purchase. b. Prepare all necessary consolidation entries.

©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

2-15

Answer: a. Equity Investment 600,000 Common Stock Additional paid-in capital To record the investment on investor's books. b. Common Stock 80,000 Retained Earnings 25,000 Equity Investment To eliminate subsidiary's stockholders' equity. 15,000 Equity Investment To bring Land to fair value and eliminate Equity Investment.

40,000 560,000

105,000

Land

15,000

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 3. Rangers, Inc. acquires all of the outstanding common stock of Slowly Industries for $450,000 cash. On the acquisition date, the subsidiary had Common Stock of $40,000 and Retained Earnings of $160,000. A patent unrecorded by Slowly was valued at $158,000. Required: a. Prepare the entry on Ranger’s books to record the purchase. b. Prepare all necessary consolidation entries. Answer: a. Equity Investment 450,000 Cash To record the investment on investor's books. b. Common Stock 40,000 Retained Earnings 160,000 Equity Investment To eliminate subsidiary's stockholders' equity.

450,000

200,000

Patents 158,000 Goodwill 92,000 Equity Investment 250,000 To eliminate Equity Investment and allocate acquisition cost to identifiable assets and Goodwill.

©Cambridge Business Publishers, 2020 2-16

Advanced Accounting, 4th Edition

Topic: Acquisition-Related Costs and Contingent Consideration LO: 5 4. Donner Corporation had the following selected account balances and fair values at December 31, 2020 when it was acquired by Valueton Company.

Receivables Customer relationships Patents In-process R& D Liabilities Common Stock Additional paid-in capital

Book Values $45,000 10,000 -0-075,000 30,000 100,000

Fair Values $45,000 80,000 150,000 80,000 75,000

Valueton Company acquired all of the common shares of Donner Corporation by issuing 10,000 shares of its own common stock valued at $18 per share. Valueton incurred stock issuance costs of $4,000 and paid $8,000 in direct clerical and legal costs of the combination. Valueton also agreed to pay an additional $19,000 if Donner achieved certain profit goals within the first three years. The contingent payment was determined to have a fair value of $10,000. Required: a. What is the acquisition cost of the combination? b. How do the stock issuance costs affect Valueton's balance sheet? c. How do the direct costs of the combination affect Valueton's balance sheet? d. Without performing computations, how will Donner's revenues and expenses for 2020 affect the consolidated totals? e. What will be the accounting treatment of the In-process R & D? Answer: a. Acquisition cost: (10,000 x $18) + 10,000 = $190,000 b. Stock issuance costs reduce Valueton's additional paid-in-capital by $4,000. c.

The balance sheet effect of the direct combination costs is a reduction of $8,000 in retained earnings. Such costs are expensed in the period in which they are incurred by Valueton.

d. Only the post-acquisition revenues and expenses of the subsidiary are included in consolidated totals. Therefore, the 2020 revenues and expenses will not affect consolidated totals. e. In-process R & D will be an asset on the consolidated balance sheet, valued at $80,000.

©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

2-17

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 5. On January 2, 2020, Kuehler Corporation's stockholders' equity accounts were as follows: Common Stock, $1 par Additional paid-in- capital Retained Earnings

$100,000 350,000 225,000

Kuehler's assets and liabilities had book values equal to fair values except for inventory, land and building which were undervalued by $50,000, $75,000, and $40,000, respectively. On January 2, 2020, Davis Corp. purchased all of Kuehler's common stock for $900,000 cash. There was no contingent consideration in the agreement to combine. Required: Prepare all necessary consolidation entries for a January 2, 2020 balance sheet. Answer: Allocate acquisition cost to assets: Investment Cost Book Value-Net Assets Excess Allocated as follows: Land Building Inventory Goodwill Total Allocated

$900,000 675,000 $225,000 $ 75,000 40,000 50,000 60,000 $225,000

Consolidation Entries: Common Stock 100,000 Additional paid-in capital 350,000 Retained Earnings 225,000 Equity Investment To eliminate subsidiary's stockholders' equity. Land Building Inventory Goodwill

675,000

75,000 40,000 50,000 60,000

Equity Investment 225,000 To eliminate Equity Investment; bring assets to fair values; with the unallocated cost assigned to goodwill.

©Cambridge Business Publishers, 2020 2-18

Advanced Accounting, 4th Edition

Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 6. On January 1, 2021, Brentfield Corporation acquired 100% of Willey Corporation for $3,900,000 cash. On that date, Willey's total stockholders' equity was $2,900,000. The following assets had fair values different from book values.

Buildings and Land Other Assets Bonds Payable

Book Value $5,400,000 250,000 3,000,000

Fair Value $5,800,000 100,000 2,500,000

Required: Compute the amount of goodwill that would appear on the January 1, 2021 balance sheet. Answer: Compute excess of Investment over book value of net assets: $3,900,000 - 2,900,000 = $1,000,000 Allocate excess to assets and liabilities: Buildings and Land Other Assets Bonds Payable Total allocation Unallocated--Goodwill Total Excess

$ 400,000 (150,000) 500,000* $ 750,000 250,000 $1,000,000

*For purposes of computing goodwill, an overvalued liability is equivalent to an undervalued asset.

Topic: Acquisition-Related Costs LO: 5 7. On January 1, 2020, Emille Corporation issued 25,000 shares of its $4 par common stock for all of the common stock of 15th Street Corp. Emille's common stock was valued at $56 per share. Emille’s costs of the combination consisted of the following: Legal fees Stock issuance costs

$15,000 14,000

Required: Prepare journal entries to record the business combination. Answer: Equity Investment 1,400,000 Common Stock Additional paid-in capital To record acquisition of subsidiary's stock.

100,000 1,300,000

Combination Expenses 5,000 Cash To record direct costs of the combination as expenses.

15,000

Additional paid-in capital 14,000 Cash To record cash payment of stock issuance costs.

14,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

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Problems Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 1. On January 2, 2020, Space Co. issued 150,000 new shares of its $1 par value common stock valued at $16 a share for all of Evolution, Inc.’s outstanding common shares. The fair value and book value of Evolution’ identifiable assets and liabilities were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2020 is as follows:

Cash Inventories Other current assets Land Property, plant & equipment Total Assets

Space $400,000 400,000 550,000 350,000 4,200,000 $5,900,000

Evolution $150,000 440,000 350,000 540,000 3,000,000 $4,480,000

Accounts payable Notes payable Common stock, $1 par Additional paid-in capital Retained earnings Total Liabilities & Equities

$750,000 850,000 1,500,000 750,000 2,050,000 $5,900,000

$350,000 1,150,000 1,000,000 350,000 1,630,000 $4,480,000

Required: Prepare a consolidated balance sheet for Space Co. immediately after the business combination. Answer: Consolidated Balance Sheet: Cash Inventories Other current assets Land Plant assets-net Goodwill Total Assets Accounts payable Notes payable Common Stock A-P-I-C Retained earnings Total Liabilities and Stockholders' Equity

400,000 + 150,000 400,000 + 440,000 550,000 + 350,000 350,000 + 540,000 4,200,000 + 3,000,000 (See Computation)

750,000 + 350,000 850,000 + 1,150,000 $1,500,000 + (250,000 x $1) = $750,000 + (250,000 x $11) =

$550,000 840,000 900,000 890,000 7,200,000 20,000 $10,400,000 $1,100,000 2,000,000 1,750,000 3,500,000 2,050,000

(See Computation)

(Parent's Only) (Parent's Only) (Parent's Only)

$10,400,000 $0

Computation of Goodwill: Acquisition Cost Subsidiary net assets Goodwill

$3,000,000 -2,980,000 $20,000

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Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 2. Bates Corporation purchased 100% of the common stock of Johns Inc. on January 2, 2021. Johns’ balance sheet on January 2, 2021 was as follows: Accounts receivable-net Inventory Land Building-net Equipment-net Total Assets

$350,000 250,000 200,000 450,000 120,000 $1,370,000

Current liabilities Long term debt Common stock ($1 par) Paid-in capital Retained earnings Total Liabilities & Equity

$250,000 300,000 45,000 300,000 475,000 $1,370,000

Fair values agree with book values except for inventory, land, and equipment that have fair values of $275,000, $150,000 and $150,000, respectively. Johns has unrecorded patent rights valued at $75,000. Required: a. Prepare a schedule to assign values to Johns’ post-acquisition assets and liabilities assuming Bates paid $1,000,000 cash for the acquisition. b. Prepare the consolidation entries for a January 2, 2021 consolidated balance sheet. Answer: a. Acquisition price Book Value-Net Assets Excess Assignment of Excess: Inventory Land Equipment Patent Unallocated-Goodwill

1,000,000 -820,000 180,000

25,000 -50,000 30,000 75,000 80,000 100,000 180,000

b. Consolidation entries - Acquisition price: $ 780,000 Common Stock 45,000 A-P-I-C 300,000 Retained Earnings 475,000 Equity Investment To eliminate subsidiary's stockholders' equity. Goodwill Inventory

100,000 25,000 Land

Patent Equipment

820,000

50,000 75,000 30,000

Equity Investment 180,000 To eliminate Equity Investment and adjust assets to fair values. ©Cambridge Business Publishers, 2020 Test Bank, Chapter 2

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Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 3. On January 1, 2020, Parrots & Parties Company purchased all of the common stock of Sunshine Company for $850,000 cash. On that date, Sunshine had common stock of $60,000, additional paid-in capital of $360,000, and retained earnings of $300,000. The difference between the cost of the purchase and the book value of Sunshine’s net assets was at least partly due to under or overvalued assets and liabilities. Inventory was undervalued by $10,000. Land was undervalued by $70,000. Buildings and Equipment were undervalued by $18,000. Bonds Payable was overvalued by $15,000. Any unexplained difference is due to Goodwill. Required: Prepare all necessary entries for a January 1, 2020, consolidated balance sheet. Answer: Compute excess of acquisition price over book value of Sunshine's net assets: Acquisition Cost Book Value-Net Assets Excess Allocation of Excess: Inventory Land Building/Equipment Bonds Payable Goodwill Total

$850,000 720,000 $ 130,000

10,000 70,000 18,000 15,000 17,000 $ 130,000

Consolidation Entries: Common Stock A-P-I-C Retained Earnings Equity Investment To eliminate Sunshine's stockholders' equity.

60,000 360,000 300,000

Inventory 10,000 Land 70,000 Buildings/Equipment 18,000 Bonds Payable 15,000 Goodwill 17,000 Equity Investment To eliminate investment and allocate to assets and liabilities.

720,000

130,000

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Topic: Acquisition-Date Consolidation when Purchase Price Exceeds Book Value LO: 4 4. Parent Company acquires a subsidiary by issuing 100,000 common shares with a market value of $25 per share for all of the subsidiary's common stock. The subsidiary's assets and liabilities were recorded at fair values with the exception of equipment undervalued by $225,000. In addition, there were two unrecorded assets: a trademark valued at $175,000 and a customer list valued by the subsidiary at $60,000. The balance sheets of the parent and subsidiary immediately after the acquisition are presented below:

Cash Accounts Receivable Inventory Equity Investment Property, plant and equipment (net) Accounts payable Salaries payable Long-Term Notes Payable Common Stock Additional paid-in capital Retained earnings

Parent

Subsidiary

$740,000 900,000 440,000 2,500,000 3,190,000 $7,770,000 $125,000 60,000 700,000 200,000 5,000,000 1,685,000 $7,770,000

$420,000 625,000 750,000 1,205,000 $3,000,000 $145,000 35,400 850,000 150,000 300,000 1,519,600 $3,000,000

Required: At what amounts will each of the following appear on the consolidated balance sheet? a. b. c. d. e. f. g. h.

Inventory Equity Investment Property, plant and equipment (net of accumulated depreciation) Goodwill Common Stock Additional paid-in capital Retained Earnings Total Intangible Assets

Answer: Computation of Goodwill: Acquisition Cost (100,000 x $25) Book Value-Net Assets Excess Allocation of Excess: Equipment Trademark Customer List Goodwill Total Allocation

$2,500,000 1,969,600 $530,400

$ 225,000 175,000 60,000 460,000 70,400 $530,400 Continued

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a. Inventory: $440,000 + $750,000 = $1,190,000 b. Equity Investment: ZERO (Eliminated) c.

Property, plant and equipment: $3,190,000 + $1,205,000 + $225,000 = $4,620,000

d. Goodwill: $70,400 (Computed Above) e. Common Stock: $200,000 (Parent's Only) f.

Additional paid-in capital: $5,000,000 (Parent's Only)

g. Retained Earnings: $1,685,000 (Parent's Only) h. Total Intangible Assets: Trademark Customer List Goodwill Total

$175,000 60,000 70,400 $305,400

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Chapter 3 Consolidated Financial Statements Subsequent to the Date of Acquisition Learning Objectives – Coverage by question Multiple Choice

Exercises

Problems

LO1 – Describe the equity method of accounting for the Equity Investment.

8, 10, 25-27

LO2 – Describe the consolidation process subsequent to the date of acquisition when the parent uses the equity method to account for its Equity Investment.

2-7, 9, 13, 17-24, 28-40

4, 5, 7

1-4

LO3 – Describe the consolidation process subsequent to the date of acquisition when the parent uses the cost method to account for its Equity Investment.

10, 11, 14,

LO4 – Describe the accounting for Goodwill and Bargain Acquisition Gains.

1, 12, 15, 16

1-3

1, 2

LO5 – Describe the accounting for common control business combinations and the pooling-of-interests method.

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Chapter 3: Consolidated Financial Statements Subsequent to the Date of Acquisition

Multiple Choice Multiple Choice – Theory Topic: Bargain Purchase LO: 4 1. A bargain purchase occurs when: a. The purchase price of a subsidiary is less than the fair value of the investee's net assets b. The purchase price of a subsidiary is less than the book value of the investee's net assets c. The assets of the investee are undervalued on the balance sheet d. The purchase price of a subsidiary is greater than the fair value of the investee's net assets Answer: a

Topic: Consolidated Statement of Cash Flows LO: 2 2. The consolidated statement of cash flows is: a. The sum of the statements of the pre-consolidation cash flows of the individual companies b. Prepared from the pre-consolidation balance sheets and income statements of the combining firms c. Prepared from the consolidated comparative balance sheets and income statement d. Prepared prior to the elimination of intercompany balances Answer: c

Topic: Consolidated Statement of Cash Flows LO: 2 3. The net cash paid for an acquisition is classified on the statement of cash flows as a. Financing activity b. Supplementary information c. Operating activity d. Investing activity Answer: d

Topic: Limitations of Consolidated Financial Statements LO: 2 4. Which of the following is a limitation of consolidated financial statements? a. The investor and investee may be in different industries, making comparisons difficult. b. Consolidated statements can mask the results of poorly performing subsidiaries. c. Segment disclosures are often too summarized for effective analysis. d. All of the above are limitations of consolidated statements. Answer: d

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Topic: Consolidation Process Subsequent to the Date of Acquisition LO: 2 5. In years subsequent to acquisition of a subsidiary, the Equity Investment account, when investor uses the equity method, includes the following components except: a. Investee's reported income b. Dividends paid by the investor c. Amortization d. Dividends paid by the investee Answer: b

Topic: Amortization of Undervalued Assets LO: 2 6. If the accountant fails to record, on the consolidation worksheet, amortization related to an undervalued truck: a. The subsidiary's net income will be overstated b. The parent’s net income will be unaffected c. Consolidated net income will be overstated d. Consolidated net income will be understated Answer: c

Topic: Amortization of Overvalued Assets LO: 2 7. Amortization related to overvalued equipment: a. Increases consolidated net income b. Increases the parent's reported net income under the equity method c. Increases consolidated expenses d. Both a and b are correct Answer: d

Topic: Amortization of Undervalued Assets LO: 1 8. Which of the following is the correct entry, on a parent's pre-consolidation books, to recognize amortization of a previously unrecorded patent acquired in a business combination? a. Equity Income Equity Investment

b . Amortization Expense Equity Investment

Amortization Expense Patent

d. Equity Investment Equity Income

Answer: a

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Topic: Consolidation Entries LO: 2 9. If a parent uses the equity method in years subsequent to the acquisition year, the amount debited to Retained Earnings in the consolidation entries is the subsidiary's Retained Earnings balance: a. At beginning of the current year b. At date of acquisition c. At end of the current year d. At beginning of the preceding year Answer: a

Topic: Dividends Under the Equity Method LO: 1 10. Under the equity method, dividends declared by a subsidiary are accounted for by the parent as: a. Dividend revenue b. Decrease in Equity Investment c. Decrease in Equity Investment, but only if it is a liquidating dividend d. Increase in Equity Income Answer: b

Topic: Dividends Under the Cost Method LO: 3 11. Under the cost method, dividends declared by a subsidiary are accounted for by the parent as: a. Dividend income b. Decrease in Equity Investment c. Decrease in Equity Investment, but only if it is a liquidating dividend d. Increase in Equity Method Income Answer: a

Topic: Goodwill LO: 4 12. If the fair value of a reporting unit with goodwill falls below its book value, which of the following statements is true? a. No additional impairment testing is required. b. A goodwill impairment loss is recognized for the excess of book value over fair value of the reporting unit. c. There is a potential impairment loss for the amount that the book value of the goodwill exceeds its implied fair value. d. Goodwill is removed from the consolidated balance sheet. Answer: c

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Topic: Consolidated Net Income LO: 2 13. Consolidated net income always equals the combined revenues of the parent and subsidiary minus the combined expenses of the two companies: a. Minus net debits in the income statement consolidation entries b. Minus net credits in the income statement consolidation entries c. Plus net debits in the income statement consolidation entries d. When the subsidiary is 100% owned by the parent Answer: a

Topic: Consolidation Process Using the Cost Method LO: 3 14. Which of the following statements is not true when the parent uses the cost method rather than the equity method? a. The consolidated statements will be different between the two methods. b. A worksheet entry will be needed to convert to the equity method from the cost method. c. Some consolidation entries will be different between the two methods. d. The pre-consolidation balance in Equity Investment will not change in proportion to changes in subsidiary's stockholders' equity. Answer: a Topic: Goodwill LO: 4 15. Goodwill is required to be tested for impairment: a. Only when the overall economy is bad b. Only when there is new competition c. Every year d. Only when there has been a series of operating losses Answer: c Topic: Goodwill LO: 4 16. If impaired goodwill subsequently regains its value: a. It can be written up to its new value b. The loss recovery cannot be recognized c. It can be written up, but only to its original value d. The company may choose whether or not to recognize the recovery Answer: b

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Multiple Choice – Computational The following information applies to Questions 17-21: On January 1, 2020, Coldspring Corp. paid $770,000 to acquire Whitt Co. Coldspring used the equity method to account for the investment. The following information is available for the assets, liabilities, and stockholders' equity accounts of Whitt:

Current assets Land Building (twenty year life) Equipment (five year life) Current liabilities Long-term liabilities Common stock Additional paid-in capital Retained earnings

Book Value $95,000 95,000 255,000 185,000 40,000 65,000 140,000 300,000 210,000

Fair Value $95,000 120,000 310,000 190,000 40,000 65,000

Whitt earned net income for 2020 of $125,000 and paid dividends of $18,000 during the year.

Topic: AAP Amortization LO: 2 17. What is the AAP amortization expense for 2020? a. $3,750 Debit b. $1,750 Debit c. $3,750 Credit d. $1,750 Credit Answer: a

Topic: Equity Income LO: 2 18. For 2020, what is the balance in Equity Income on Coldspring’s books? a. $121,250 b. $125,000 c. $128,750 d. $143,000 Answer: a

Topic: Equity Investment LO: 2 19. What is the balance in Equity Investment at the end of 2020? a. $873,250 b. $877,000 c. $891,250 d. $895,000 Answer: a ©Cambridge Business Publishers, 2020 3-6

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Topic: Consolidation Entries LO: 2 20. The 2020 consolidation entry to reverse Coldspring’s recognition of Whitt's income and dividends in the current year would include a net credit to Equity Investment for: a. $18,000 b. $103,250 c. $107,000 d. $121,250 Answer: b

Topic: Consolidated Net Income LO: 2 21. If Coldspring had income from its own operations, excluding any investment income, of $425,500 in 2020, what would be consolidated net income? a. $528,750 b. $543,000 c. $546,750 d. $550,500 Answer: c

The following information applies to Questions 22-24: Howard, Inc. paid $400,000 to acquire all of the common stock of Fisherman Corp. on January 1, 2020. Fisherman’s reported earnings for 2020 totaled $99,000, and it paid $33,000 in dividends during the year. The amortization of allocations related to undervalued assets was $9,000. Howard’s net income, not including the investment, was $753,000, and it paid dividends of $48,000.

Topic: Consolidated Equity Income LO: 2 22. What amount would appear as Equity Income on the consolidated income statement? a. $-0b. $57,000 c. $90,000 d. $99,000 Answer: a

Topic: Consolidated Dividends LO: 2 23. What are consolidated dividends for 2020? a. $81,000 b. $48,000 c. $33,000 d. $-0Answer: b

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Topic: Consolidated Net Income LO: 2 24. What is consolidated net income for 2020? a. $810,000 b. $843,000 c. $852,000 d. $876,000 Answer: b

The following information applies to questions 25-37: Huey Company acquires 100% of the stock of Solar Corporation on January 1, 2019, for $2,400,000 cash. As of that date Solar had the following account balances:

Cash Accounts receivable Inventory Building-net (10 year life) Equipment-net (5 year life) Land Accounts Payable Bonds Payable (Face amount $1,000,000; due 12/31/2023) Common stock Additional paid-in capital Retained earnings

Book Value $300,000 325,000 350,000 1,000,000 300,000 600,000 125,000 2,000,000 700,000 250,000 880,000

Fair value $300,000 325,000 400,000 900,000 400,000 900,000 125,000 2,050,000

In 2019 and 2020, Solar had net income of $250,000 and $240,000, respectively. In addition, Solar paid dividends of $16,000 in both years. Inventory is assumed to be sold in 2019. Assume straight line amortization/ depreciation for assets and bonds payable.

Topic: Excess Acquisition Price over Book Value LO: 1 25. What was the amount of excess of acquisition price over book value of Solar's net assets? a. $1,140,000 b. $ 250,000 c. $ 100,000 d. $ 570,000 Answer: d

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Topic: Goodwill at Date of Acquisition LO: 1 26. What is the amount of goodwill at date of acquisition? a. $320,000 b. $270,000 c. $220,000 d. $ 30,000 Answer: b

Topic: Consolidated Inventory at Acquisition Date LO: 1 27. What amount of inventory would be added to the parent's inventory balance to get consolidated inventory at date of acquisition? a. $-0b. $350,000 c. $400,000 d. $ 50,000 Answer: c

Topic: Consolidated Assets after Acquisition LO: 2 28. What amount of Solar’s building would be included on the consolidated balance sheet at December 31, 2019? a. $990,000 b. $880,000 c. $890,000 d. $910,000 Answer:

Topic: Consolidated Assets after Acquisition LO: 2 29. What amount of Solar’s equipment would be included on the consolidated balance sheet at December 31, 2019? a. $220,000 b. $280,000 c. $300,000 d. $380,000 Answer: d

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Topic: AAP Amortization LO: 2 30. Compute the AAP amortization for 2019. a. $50,000 b. $10,000 c. $60,000 d. $80,000 Answer: a

Topic: Consolidated Liabilities after Acquisition LO: 2 31. What amount of Solar's Bonds Payable would appear on the consolidated balance sheet at December 31, 2019? a. $2,000,000 b. $2,040,000 c. $2,010,000 d. $2,050,000 Answer: b

Topic: Consolidated Assets after Acquisition LO: 2 32. What amount of Solar's building would be included on the consolidated balance sheet at December 31, 2020? a. $900,000 b. $910,000 c. $920,000 d. $1,010,000 Answer: c

Topic: Consolidated Assets after Acquisition LO: 2 33. What amount of Solar's equipment would be included on the consolidated balance sheet at December 31, 2020? a. $260,000 b. $300,000 c. $360,000 d. $460,000 Answer: c

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Topic: Consolidated Assets after Acquisition LO: 2 34. What amount of Solar's land would be included on the consolidated balance sheet at December 31, 2020? a. $ 600,000 b. $ 900,000 c. $1,500,000 d. $1,800,000 Answer: b

Topic: Consolidated Liabilities after Acquisition LO: 2 35. What amount of Solar’s Bonds Payable would be included on the consolidated balance sheet at December 31, 2020? a. $2,000,000 b. $2,030,000 c. $2,040,000 d. $2,050,000 Answer: b

Topic: AAP Amortization after Acquisition LO: 2 36. Compute the AAP amortization for 2020. a. $ -0b. $40,000 c. $50,000 d. $90,000 Answer: a Topic: Consolidated Stockholders’ Equity after Acquisition LO: 2 37. What amount of Solar's single legal entity stockholders' equity will be included in the consolidated balance sheet at date of acquisition? a. $ -0b. $1,830,000 c. $2,064,000 d. $3,350,000 Answer: a

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The following information applies to Questions 38-40: On January 1, 2019, Everlasting, Inc. purchased Comet Corporation for $650,000. On that date the net assets of Comet had a book value of $320,000, and book values were equal to fair values with the following exceptions: FIFO Inventory --Undervalued, $30,000 Land--Undervalued, $10,000 Equipment (5 year life)--Undervalued, $75,000 Patent (5-year life)--Undervalued, $25,000 During 2019, Everlasting had income from its own operations of $220,000 and Comet had net income of $80,000.

Topic: Equity Income LO: 2 38. What amount of 2019 Equity Income was recognized by Everlasting? a. $80,000 b. $60,000 c. $35,000 d. $30,000 Answer: d

Topic: Consolidated Net Income LO: 2 39. What is 2019 consolidated net income? a. $250,000 b. $255,000 c. $280,000 d. $300,000 Answer: a

Topic: Goodwill LO: 2 40. What amount of goodwill appeared on the consolidated balance sheet at December 31, 2019? a. $330,000 b. $190,000 c. $140,000 d. $-0Answer: b

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Topic: Equity Investment – Equity Method LO: 2 41. Cleaverland purchased 100% of Omaha on January 1, 2019 for $650,000. On that date, Omaha's stockholders' equity was $650,000, and the recognized book values of Ottowa’s individual net assets approximated their fair values. Omaha had net incomes of $150,000 and $190,000 for 2019 and 2020, respectively. The subsidiary paid dividends amounting to $30,000 in both years. Cleaverland uses the equity method to account for its pre-consolidation investment in Omaha. What was the balance in Equity Investment at December 31, 2020? a. $650,000 b. $710,000 c. $990,000 d. $930,000 Answer: d Topic: Equity Investment – Cost Method LO: 3 42. Cleaverland purchased 100% of Omaha on January 1, 2019 for $650,000. On that date, Omaha's stockholders' equity was $650,000, and the recognized book values of Ottowa’s individual net assets approximated their fair values. Omaha had net incomes of $150,000 and $190,000 for 2019 and 2020, respectively. The subsidiary paid dividends amounting to $30,000 in both years. Cleaverland uses the cost method to account for its pre-consolidation investment in Omaha. What was the balance in Equity Investment at December 31, 2020? a. $650,000 b. $710,000 c. $990,000 d. $930,000 Answer: a

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The following information applies to questions 43-45: On January 1, 2018, Strait Corp. purchased 100% of the outstanding common stock of Amarillo Company. On the date of the acquisition, Amarillo’ identifiable net assets had fair values that approximated their recorded book values. The acquisition resulted in no goodwill. Strait Corp. uses the cost method to account for its investment in Amarillo Company. The following financial statement information is for Amarillo Company for the year ended December 31, 2019:

Revenues Expenses Net income

2019 $100,000 47,000 $53,000

2018 $120,000 65,000 $55,000

Beginning of year retained earnings Net income Dividends End of year retained earnings

$680,000 53,000 -17,000 $716,000

$650,000 55,000 -25,000 $680,000

Cash and receivables Property, plant & equipment, net Intangible assets Total assets

$235,000 880,000 505,000 $1,620,000

$180,000 800,000 450,000 $1,430,000

Current liabilities Noncurrent liabilities Common stock Additional paid in capital Retained earnings Total liabilities and stockholder’s equity

$164,000 400,000 50,000 290,000 716,000 $1,620,000

$60,000 350,000 50,000 290,000 680,000 $1,430,000

Topic: Pre-Consolidation Bookkeeping – Cost Method LO: 3 43. What is the balance in the Equity Investment account in Strait Corp.’s pre-consolidation balance sheet on December 31, 2019? a. $ 990,000 b. $1,020,000 c . $1,056,000 d. $1,370,000 Answer: a

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Topic: Pre-Consolidation Bookkeeping – Cost Method LO: 3 44. What is the balance in the Investment Income account in the Strait Corp.’s pre-consolidation income statement for the year ended December 31, 2019? a. $53,000 b. $36,000 c. $25,000 d. $17,000 Answer: d Topic: Consolidation Subsequent to Acquisition – Cost Method LO: 3 45. For this question only, assume that Amarillo’s identifiable net assets had fair values that approximated their recorded book values, except for equipment which had fair value that was $50,000 higher than the book value and had a remaining useful life of 10 years. The acquisition also resulted in $125,000 of goodwill. What is the amount of the [ADJ] entry necessary to prepare the consolidated financial statements for the year ended December 31, 2019? a. $ 25,000 b. $ 30,000 c. $ 36,000 d. $ 98,000 Answer: a

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Exercises Topic: Goodwill LO: 4 1. Arlington, Inc. purchases all of the common stock of Frisco Company for $450,000 cash. At the acquisition date, Frisco's stockholders' equity consisted of Common Stock, $300,000, and Retained Earnings, $20,000. It was determined that the investee's balance sheet included land undervalued by $30,000 and equipment undervalued by $5,000. Arlington estimates a 10-year life for any goodwill. Required: a. What is the amount of goodwill recorded at date of acquisition? b. What is the balance in goodwill one year after acquisition, if the company is a private company? Answer: a. Acquisition cost Book value-net assets Excess

$450,000 320,000 $130,000

Allocation of excess: Land Equipment Goodwill Total Allocation

$ 30,000 5,000 95,000 $130,000

b. If the acquiring company qualifies as a private company according to the definitions in the FASB ASC Master Glossary and elects to adopt the Goodwill amortization exception, then the acquiring company is required to amortize goodwill on a straight-line basis over 10 years or less if deemed appropriate. If Arlington satisfies these two conditions, the balance in goodwill would be $85,500 [$95,000 – ($95,000/10)]. If Arlington is a public company (or plans to be), then the goodwill is not amortized and the value will remain at $95,000 unless there is an impairment loss.

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Topic: Goodwill LO: 4 2. Assume that one of your clients asks for your assistance in allocating the $4,500,000 cost of a 100% acquisition of a competitor firm. You estimate the fair value of the net assets on the investee's balance sheet at $3,000,000. However, there is, in addition, an unrecorded trademark valued at $850,000. The intangible asset has an indefinite useful life. Required: a. What amount of goodwill will be recorded? b. What will be the effect of the goodwill and brand name on the annual income statement? c. Now assume that the agreement between the investor and investee calls for an additional payment of $500,000 contingent upon the investee reaching a certain level of income within three years. You estimate the fair value of the potential payment at $400,000. What effect, if any, does the potential payment have on the amount of goodwill recognized? Answer: a. Acquisition cost Fair value--recorded net assets Excess over fair value Allocation of excess: Unrecorded intangible Goodwill Total Allocation

$4,500,000 3,000,000 $ 1,500,000

$ 850,000 650,000 $ 1,500,000

b. Goodwill has no income statement impact unless there is impairment. Because the brand name has an indefinite life, there is no amortization and, therefore, no effect on consolidated net income unless there is impairment. c.

The fair value of the contingent payment will be added to the acquisition cost, resulting in additional goodwill of $400,000. The goodwill balance including contingent consideration would be $1,050,000.

©Cambridge Business Publishers, 2020 Test Bank, Chapter 3

3-17

Topic: Goodwill LO: 4 3. On July 1, 2019, Captain Company paid $3,000,000 for all of the common stock of Bright Sunshine, Inc. Bright Sunshine’s identifiable net assets had a fair value of $2,850,000 at that date. After acquisition, Bright Sunshine was identified as a reporting unit and the goodwill from the acquisition was assigned to that reporting unit. Required: a. Compute the amount of goodwill, if any, from the acquisition. b. Over the remainder of the year, the new unit experienced significant operating losses, suggesting the need for testing of the goodwill for impairment. The fair value of the reporting unit was estimated to be $2,005,000 at December 31. Bright Sunshine's year-end balance sheet showed net assets of $2,100,000, including the goodwill. The fair value of the identifiable net assets of Bright Sunshine at year-end was $1,920,000. Prepare the required journal entry if you find that goodwill is impaired. Perform the pre-ASU 2017-04 quantitative two-step Goodwill impairment test and make the required journal entry for impairment, if necessary. c.

Using the same information as above, perform the post-ASU 2017-04 quantitative Goodwill impairment test and make the required journal entry for impairment, if necessary.

Answer: a. Acquisition Cost Fair value-identifiable net assets Goodwill

$3,000,000 (2,850,000) $ 150,000

b. Step 1: Determine whether impairment is indicated: Impairment is indicated since the book value of the reporting unit of $2,100,000 exceeds its fair value of $1,920,000. Step 2: Compute the implied fair value of the goodwill at year-end: $2,005,000 – $1,920,000 = $85,000 Step 3: Compute the amount of impairment: $150,000 – $85,000 = $65,000 Journal entry: Equity income Equity Investment c.

65,000 65,000

Step 1: Determine whether impairment is indicated: Impairment is indicated since the book value of the reporting unit of $2,100,000 exceeds its fair value of $1,920,000. Step 2: Compute the amount of impairment: $2,100,000 – $2,005,000 = $95,000; confirm this is not greater than the carrying value of goodwill. If so, then do no impair the goodwill below zero. Journal entry: Equity income Equity Investment

95,000 95,000

©Cambridge Business Publishers, 2020 3-18

Advanced Accounting, 4th Edition

Topic: Consolidated Financial Statements – Equity Method LO: 2 4. On January 2, 2019, Moonshine, Inc. acquired Cambridge as a wholly-owned subsidiary, paying an excess of $400,000 over the book value of Hudson's net assets. One-half of the excess was attributable to equipment with a 4-year life, leaving the remainder as goodwill. The parent uses the equity method of pre-consolidation Equity investment bookkeeping. The 2020 financial statements for the two companies are presented below. Moonshine, Inc.

Cambridge

Sales Cost of goods sold Gross profit Operating expenses Equity income Net Income

$2,500,000 -1,800,000 700,000 -386,000 118,000 $432,000

$600,000 -350,000 250,000 -82,000 0 $168,000

Retained Earnings, 1/1/20 Net income Dividends Retained Earnings, 12/31/20

$2,400,000 432,000 -103,000 $2,729,000

$160,000 168,000 -19,500 $308,500

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$1,250,000 1,540,000 683,500 5,605,500 $9,079,000

$47,500 98,000 0 360,000 $505,500

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/20 Total Liabilities and Equities

$450,000 870,000 2,350,000 480,000 2,200,000 2,729,000 $9,079,000

$39,000 48,000 35,000 30,000 45,000 308,500 $505,500

Required: At what amount will the following accounts appear on the consolidated financial statements for 2020? a. b. c. d. e.

Sales Equity Income Operating Expenses Accounts Payable Equity Investment

Answer: a. Sales b. Equity Income c. Operating Expenses d. Accounts Payable e. Equity Investment f. PP&E g. Goodwill h. Additional Paid-In Capital i. Retained Earnings

Property, Plant and Equipment (net of accumulated depreciation) g. Goodwill h. Additional Paid-In Capital i. Retained Earnings

$2,500,000 + $600,000 = $3,100,000 ZERO $386,000 + $82,000 + ($200,000/4 years) = $518,000 $450,000 + $39,000 = $489,000 ZERO $5,605,500 + $360,000 + $200,000 - (2 x $200,000/4) = $6,065,500 $400,000 - 200,000 = $200,000 $2,200,000 (Parent's Only) $2,729,000 (Parent's Only) ©Cambridge Business Publishers, 2020

Test Bank, Chapter 3

3-19

Topic: Consolidated Financial Statements – Equity Method LO: 2 5. On January 2, 2018, Moving Motors, Inc. acquired Bourland Enterprises as a wholly-owned subsidiary, paying an excess of $800,000 over the book value of Bourland's net assets. Part of the excess was attributable to a building with a 7-year life undervalued by $350,000. The rest was goodwill. The parent uses the equity method of pre-consolidation Equity investment bookkeeping. The 2020 financial statements for the two companies are presented below. Moving Motors, Inc. $1,875,000 -658,000 1,217,000 -325,000 151,000 $1,043,000

Bourland Enterprises $781,000 -451,000 330,000 -129,000 0 $201,000

Retained Earnings, 1/1/20 Net income Dividends Retained Earnings, 12/31/20

$2,307,000 1,043,000 -75,000 $3,275,000

$475,500 201,000 -23,400 $653,100

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$491,240 785,000 1,459,600 3,852,000 $6,587,840

$540,200 515,200 346,500 $1,401,900

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/20 Total Liabilities and Equities

$408,000 498,340 478,500 350,000 1,578,000 3,275,000 $6,587,840

$157,800 365,000 69,500 70,000 86,500 653,100 $1,401,900

Sales revenue Cost of goods sold Gross profit Operating expenses Equity income Net Income

Required: At what amount will the following accounts appear on the consolidated financial statements for 2020? a. b. c. d. e.

Cost of Goods Sold Equity Income Operating Expenses Cash and Receivables Equity Investment

Answer: a. Cost of Goods Sold b. Equity Income c. Operating Expenses d. Cash and receivables e. Equity Investment f. PP&E g. Goodwill h. Common Stock i. Retained earnings ©Cambridge Business Publishers, 2020 3-20

Property, Plant and Equipment (net of accumulated depreciation) g. Goodwill h. Common Stock i. Retained Earnings $658,000 + $451,000 = $1,109,000 ZERO--Eliminated $325,000 + $129,000 + ($350,000/7) = $504,000 $491,240 + $540,200 = $1,031,440 ZERO--Eliminated $3,852,000 + $346,500 + $3500,000 - (3 x $350,000/7) = $4,398,500 $800,000 - $350,000 = $450,000 $350,000 (Parent's Only) $3,275,000 (Parent's Only) Advanced Accounting, 4th Edition

Topic: Consolidated Financial Statements – Cost Method LO: 3 6. On January 2, 2018, Moving Motors, Inc. acquired Bourland Enterprises as a wholly-owned subsidiary, paying $1,341,500. The purchase price was $800,000 in excess of the book value of Bourland's net assets. Part of the excess was attributable to a building with a 7-year life undervalued by $350,000. The rest was goodwill. On the acquisition date, Bourland reported retained earnings equal to $385,000. The parent uses the cost method of pre-consolidation Equity investment bookkeeping. The 2020 financial statements for the two companies are presented below. Moving Motors, Inc. $1,875,000 -658,000 1,217,000 -325,000 23,400 $915,400

Sales revenue Cost of goods sold Gross profit Operating expenses Dividend income Net Income

Bourland Enterprises $781,000 -451,000 330,000 -129,000 0 $201,000

Retained Earnings, 1/1/20 Net income Dividends Retained Earnings, 12/31/20

$2,316,500 915,400 -75,000 $3,156,900

$475,500 201,000 -23,400 $653,100

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$491,240 785,000 1,341,500 3,852,000 $6,469,740

$540,200 515,200 346,500 $1,401,900

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/20 Total Liabilities and Equities

$408,000 498,340 478,500 350,000 1,578,000 3,156,900 $6,469,740

$157,800 365,000 69,500 70,000 86,500 653,100 $1,401,900

Required: At what amount will the following accounts appear on the consolidated financial statements for 2020? a. b. c. d. e.

Cost of Goods Sold Dividend Income Operating Expenses Cash and Receivables Equity Investment

Answer: a. Cost of Goods Sold b. Equity Income c. Operating Expenses d. Cash and receivables e. Equity Investment f. PP&E g. Goodwill h. Common Stock i. Retained earnings Test Bank, Chapter 3

Topic: AAP Amortization of Assets LO: 2 7. On January 1, 2015, Shea Corporation acquired all of the outstanding common stock of Sophia’s Stuff, Inc. for $2,500,000 cash. The excess of the acquisition price over book value of Sophia’s Stuff's stockholders' equity consisted of the following: Equipment, 8-year life, overvalued by $400,000 Building, 10-year life, undervalued by $65,000 Goodwill, indefinite life, $240,000 Required: a. Compute the amount of the excess that will be allocated to building after completion of the December 31, 2018, consolidation worksheet. b. Compute the amount of the excess that will be allocated to equipment after completion of the December 31, 2018, consolidation worksheet. Answer: a. Building

$65,000 - (4 x $65,000/10) = $39,000 Debit

b. Equipment

$400,000 - (4 x $400,000/8) = $200,000 Credit

©Cambridge Business Publishers, 2020 3-22

Advanced Accounting, 4th Edition

Problems Topic: Equity Method Acquisition and Consolidating Entries LO: 1, 2 1. Morningside Co. acquires, at book value, Glacier Industries on January 2, 2019, by issuing 40,000 common shares, $1 par, with a market value on the acquisition date of $10 per share. The book values of Glacier’s individual net assets approximate their fair values. The separate financial statements of the parent and subsidiary, for the year ended December 31, 2019, are presented below.

Sales revenue Cost of goods sold Gross profit Operating expenses Equity income Net Income

Morningside Co. $850,000 -635,000 215,000 -156,400 41,500 $100,100

Retained Earnings, 1/1/19 Net income Dividends Retained Earnings, 12/31/19

$550,000 100,100 -41,000 $609,100

$219,600 41,500 -13,650 $247,450

$450,000 355,000 427,850 751,950 $1,984,800

$25,000 12,570

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/19 Total Liabilities and Equities

$371,200 487,500 30,000 487,000 609,100 $1,984,800

Glacier Industries $400,000 -268,000 132,000 -90,500 _ $41,500

412,390 $449,960 $54,000 68,110 20,000 21,900 38,500 247,450 $449,960

Required: a. Prepare the journal entry on Morningside's books to record the acquisition. b. Prepare a schedule showing how the balance in Equity Investment was arrived at. c. Prepare all consolidation entries for the year ending December 31, 2019.

Test Bank, Chapter 3

©Cambridge Business Publishers, 2020 3-23

Answer: a. Equity Investment Common Stock Additional paid-in capital To record investment in Glacier Industries. b. Beginning balance Equity Income Dividends Ending balance c.

400,000 40,000 360,000

$400,000 41,500 (13,650) $427,850

[C] Equity Income 41,500 Dividends 13,650 Equity Investment 27,850 To eliminate changes in Equity Investment account leaving beginning balance. [E] Retained Earnings 219,600 Common Stock 21,900 Additional paid-in capital 38,500 Equity Investment To eliminate subsidiary's stockholders' equity.

©Cambridge Business Publishers, 2020 3-24

280,000

Advanced Accounting, 4th Edition

Topic: Equity Method Acquisition and Consolidating Entries LO: 1, 2 2. On January 1, 2020, Canyon Creek Company acquired Smoltz Corporation by issuing 50,000 shares of its $1 par common stock with a market value of $12 per share. A building on Smoltz’s books was undervalued by $50,000, resulting in annual amortization of $5,000. Also, there was an unrecorded patent valued at $80,000, resulting in annual amortization of $8,000. The separate 2020 financial statements for Canyon Creek and Smuckerman are presented below. Canyon Creek Co. $850,000 -505,000 345,000 -300,600 106,500 $150,900

Smuckerman Corp. $380,000 -234,000 146,000 -26,500 _ $119,500

Retained Earnings, 1/1/20 Net income Dividends Retained Earnings, 12/31/20

$800,000 150,900 -45,000 $905,900

$305,600 119,500 -25,000 $400,100

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$250,000 350,000 681,500

$158,000 42,600

1,165,100 $2,446,600

474,100 $674,700

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/20 Total Liabilities and Equities

$426,000 54,700 0 75,000 985,000 905,900 $2,446,600

$45,000 28,000 125,000 46,600 30,000 400,100 $674,700

Sales revenue Cost of goods sold Gross profit Operating expenses Equity income Net Income

Required: a. Prepare the journal entry to record the investment in the subsidiary. b. Show the computation of Equity Income for 2020. c. Show the computation of Equity Investment at December 31, 2020. d. Prepare all necessary consolidation entries for a 2020 worksheet.

Test Bank, Chapter 3

©Cambridge Business Publishers, 2020 3-25

Answer: a. Equity Investment 600,000 Common Stock Additional Paid-In Capital To record investment in Smuckerman Corporation.

50,000 550,000

b. Equity Income = $119,500 – 5,000 - 8,000 = $106,500 c.

Beginning balance Equity income Dividends Ending balance

$600,000 106,500 (25,000) $681,500

d. [C] Equity Income 106,500 Dividends Equity Investment To eliminate changes in Equity Investment account. [E] Retained Earnings 305,600 Common Stock 46,600 Additional Paid-In Capital 30,000 Equity Investment To eliminate subsidiary's stockholders' equity.

25,000 81,500

382,200

[A] Building 50,000 Patent 80,000 Goodwill 87,800* Equity Investment 217,800 *$600,000 -$382,200 - 50,000 - 80,000 To allocate excess over book value to subsidiary assets and goodwill. [D] Operating Expense Building (net) Patent To recognize amortization.

©Cambridge Business Publishers, 2020 3-26

13,000 5,000 8,000

Advanced Accounting, 4th Edition

Topic: Consolidated Financial Statements – Equity Method LO: 2 3. On January 1, 2019, Hollye Company acquired Gillium, Inc. by issuing 60,000 shares of its common stock with a market value of $30 per share. Equipment on Gillium's books was undervalued by $80,000, resulting in annual amortization of $8,000. Also, there was an unrecorded customer list valued at $50,000, resulting in annual amortization of $5,000; as well as a 10-year franchise agreement valued at $60,000. The separate 2019 financial statements for Hollye and Gillium follow. Sales revenue Cost of goods sold Gross profit Operating expenses Equity income Net Income

Hollye Co. $200,000 -150,000 50,000 -28,000 14,000 $36,000

Gillium, Inc. $85,000 -15,000 70,000 -37,000 _ $33,000

Retained Earnings, 1/1/19 Net income Dividends Retained Earnings, 12/31/19

$500,000 36,000 -25,000 $511,000

$250,000 33,000 -6,000 $277,000

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$1,500,000 540,000 1,408,000 980,000 $4,428,000

$450,000 22,000

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/19 Total Liabilities and Equities

$175,000 142,000 900,000 450,000 2,250,000 511,000 $4,428,000

$25,000 18,000 0 120,000 162,500 277,000 $602,500

130,500 $602,500

Required: At what amount will each of the following be presented on consolidated financial statements for 2019? a. b. c. d. e.

Consolidated net income Cash and receivables Equity investment Property, plant and equipment (net) Goodwill

f. g. h. i.

Common stock Additional paid-in capital Retained earnings Total intangible assets

Answer: a. Consolidated net income equals parent's reported net income under equity method: $36,000 b. Cash and receivables: $1,500,000 + 450,000 = $1,950,000 c. Equity investment: ZERO (Eliminated) d. Property, plant and equipment: $980,000 + 130,500 + 80,000 - 8,000 = $1,182,500 e. Goodwill: $1,400,000 - $250,000 - $120,000 - $162,500 - $80,000 - $50,000 - $60,000 = $677,500 f. Common stock: $450,000 (Parent's Only) g. Additional paid-in capital: $2,250,000 (Parent's Only) h. Retained earnings: $511,000 (Parent's Only) i. Total Intangible Assets: $50,000+ $60,000 + $677,500 - $5,000 - $6,000 = $776,500

Test Bank, Chapter 3

©Cambridge Business Publishers, 2020 3-27

Topic: Consolidated Financial Statements and Goodwill Impairment – Equity Method LO: 2, 4 4. McKinney Enterprises acquired Pottsboro, Inc. on January 1, 2019. The $440,000 excess of cost over book value of Pottsboro’s net assets was partly attributable to a patent undervalued by $210,000. The patent has a 10-year life. The remaining excess is considered goodwill. The parent uses the equity method of pre-consolidation Equity investment bookkeeping. The separate financial statements of the two companies for 2022 are presented below.

Sales revenue Cost of goods sold Gross profit Operating expenses Equity income Net Income

McKinney Enterprises $3,100,000 -1,580,000 1,520,000 -485,000 99,000 $1,134,000

Pottsboro, Inc. $440,000 -252,000 188,000 -68,000 0 $120,000

Retained Earnings, 1/1/22 Net income Dividends Retained Earnings, 12/31/22

$1,700,000 1,134,000 -65,000 $2,769,000

$750,000 120,000 -42,000 $828,000

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$535,000 758,000 1,844,160 4,558,840 $7,696,000

$501,000 840,000 1,205,480 $2,546,480

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/22 Total Liabilities and Equities

$265,000 458,000 780,000 460,000 2,964,000 2,769,000 $7,696,000

$182,430 272,390 603,500 204,540 455,620 828,000 $2,546,480

Required: a. Prepare all necessary consolidation entries for 2022 consolidated financial statements. b. Perform the pre-ASU 2017-04 quantitative two-step Goodwill impairment test and make the required journal entry for impairment, if necessary. Now assume that at year-end a goodwill impairment test is conducted before the consolidated statements are issued. The estimated fair value of the subsidiary is $1,700,000. The fair value of the identifiable net assets is $1,550,000. Prepare any journal entries resulting from the test. c. Using the same information as above, perform the post-ASU 2017-04 quantitative Goodwill impairment test and make the required journal entry for impairment, if necessary.

©Cambridge Business Publishers, 2020 3-28

Advanced Accounting, 4th Edition

Answer: a. [C] Equity Income Dividends Equity Investment

99,000 42,000 57,000

To eliminate changes in Equity Investment account. [E] Common Stock 204,540 Additional Paid-In Capital 455,620 Retained Earnings 750,000 Equity Investment To eliminate subsidiary's stockholders' equity.

1,410,160

[A] Goodwill 230,000 Patent 147,000* Equity Investment *$210,000 - (3 x $210,000/10) To allocate excess over book value to patent and goodwill.

377,000

[D] Operating Expense Patent To record amortization.

21,000

b. Step 1: Is subsidiary's fair value of $1,700,000 less than Equity Investment balance of $1,844,160? Yes. Goodwill is potentially impaired. Step 2: Compute implied value of goodwill: $1,700,000 - $1,550,000 = $150,000 Step 3: Compute excess of book value of goodwill over fair value: $230,000 - $150,000 = $80,000 Journal entry: Equity income Equity Investment c.

80,000 80,000

Step 1: Determine whether impairment is indicated: Impairment is indicated since the book value of the reporting unit of $1,844,160 exceeds its fair value of $1,700,000. Step 2: Compute the amount of impairment: $1,844,160 – $1,700,000 = $144,160; confirm this is not greater than the carrying value of goodwill. If so, then do no impair the goodwill below zero. Journal entry: Equity income Equity Investment

Test Bank, Chapter 3

144,160 1444,160

©Cambridge Business Publishers, 2020 3-29

Topic: Consolidated Financial Statements – Cost Method LO: 3 5. McKinney Enterprises acquired Pottsboro, Inc. as a wholly-owned subsidiary on January 1, 2019 paying $1,750,000. The $440,000 excess of cost over book value of Pottsboro’s net assets was partly attributable to a patent undervalued by $210,000. The patent has a 10-year life. The remaining excess is considered goodwill. The parent uses the cost method of pre-consolidation Equity investment bookkeeping. The separate financial statements of the two companies for 2022 are presented below. Neither company issued additional shares after the acquisition Pottsboro by McKinney.

Sales revenue Cost of goods sold Gross profit Operating expenses Dividend income Net Income

McKinney Enterprises $3,100,000 -1,580,000 1,520,000 -485,000 42,000 $1,077,000

Pottsboro, Inc. $440,000 -252,000 188,000 -68,000 0 $120,000

Retained Earnings, 1/1/22 Net income Dividends Retained Earnings, 12/31/22

$1,700,000 1,077,000 -65,000 $2,712,000

$750,000 120,000 -42,000 $828,000

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$535,000 758,000 1,750,000 4,596,000 $7,639,000

$501,000 840,000 1,205,480 $2,546,480

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/22 Total Liabilities and Equities

$265,000 458,000 780,000 460,000 2,964,000 2,712,000 $7,639,000

$182,430 272,390 603,500 204,540 455,620 828,000 $2,546,480

Required: a. What was Pottsboro, Inc.’s retained earnings balance on the acquisition date? b. Prepare all necessary consolidation entries for 2022 consolidated financial statements.

©Cambridge Business Publishers, 2020 3-30

Advanced Accounting, 4th Edition

Answer: a. Investment balance Deduct: AAP on acquisition date Deduct: Common stock (S) on acquisition date Deduct: APIC (S) on acquisition date Retained earnings (S) on acquisition date b. [ADJ]

1,750,000 -440,000 -204,540 -455,620 649,840

Equity investment 37,160 Retained earnings 37,160 To adjust Equity Investment account and Retained Earnings from cost to equity method.

[C]

Dividend Income 42,000 Dividends 42,000 To eliminate Equity Investment accounting during year.

[E]

Common Stock 204,540 Additional Paid-In Capital 455,620 Retained Earnings 750,000 Equity Investment To eliminate subsidiary's stockholders' equity.

1,410,160

[A]

Goodwill 230,000 Patent 147,000* Equity Investment 377,000 *$210,000 - (3 x $150,000/10) To allocate excess over book value to patent and goodwill.

[D]

Operating Expense Patent To record amortization.

Test Bank, Chapter 3

21,000 21,000

©Cambridge Business Publishers, 2020 3-31

Chapter 4 Consolidated Financial Statements and Intercompany Transactions Learning Objectives – Coverage by question Multiple Choice

Exercises

Problems

LO1 – Describe the accounting for intercompany sales of inventory between the parent and subsidiary using the equity method of preconsolidation investment bookkeeping.

1, 4, 5, 9, 15-17, 21, 23, 25, 26-30

5, 6

1, 2

LO2 – Describe the accounting for intercompany sales of inventory between the parent and subsidiary using the cost method of preconsolidation investment bookkeeping.

31-35

LO3 – Describe the accounting for intercompany sales of non-depreciable noncurrent assets between the parent and subsidiary when a parent uses the equity method of pre-consolidation investment bookkeeping.

3, 7, 8, 10, 11, 18, 44-46, 49, 50

1, 3

LO4 – Describe the accounting for intercompany sales of depreciable noncurrent assets between the parent and subsidiary when a parent uses the equity method of pre-consolidation investment bookkeeping.

2, 6, 12-14, 19, 20, 22, 24, 36-40

2, 4

LO5 – Describe the accounting for intercompany sales of non-depreciable noncurrent assets between the parent and subsidiary when a parent uses the cost method of pre-consolidation investment bookkeeping.

47, 48

LO6 – Describe the accounting for intercompany sales of depreciable noncurrent assets between the parent and subsidiary when a parent uses the cost method of pre-consolidation investment bookkeeping.

41-43

©Cambridge Business Publishers, 2020 Test Bank, Chapter 4

4-1

Chapter 4: Consolidated Financial Statements and Intercompany Transactions

Multiple Choice Multiple Choice – Theory Topic: Intercompany Inventory Sales LO: 1 1. During 2021, Christie Company sold merchandise to its 100%-owned subsidiary, Finn Company. During that year, all of the merchandise was resold by Finn to outside customers. If no consolidation entries are made, which of the following will be incorrect in consolidated statements? a. Inventory, net income b. Inventory, sales, cost of goods sold c. Sales, cost of goods sold d. All accounts will be correct because the goods were quickly resold to customers. Answer: c

Topic: Intercompany Sales of Depreciable Assets LO: 4 2. If Razor Co. sold equipment with a six-year remaining useful life at a gain of $24,000 to Soprano Industries, its subsidiary. In the consolidated statements, the gain will: a. Never be recognized b. Be recognized over the six-year period c. Be recognized immediately d. Be recognized when the asset is resold to outsiders Answer: b

Topic: Intercompany Sale of Land LO: 3 3. What is a purpose of the consolidation entry regarding the inter-company sale of land? a. To make consolidated net income the same as it would have been had the sale not occurred b. To make consolidated net income less than it would have been had the sale not occurred c. To make consolidated net income greater that it would have been had the sale not occurred d. To adjust the Land account with no effect on consolidated net income Answer: a

©Cambridge Business Publishers, 2020 4-2

Advanced Accounting, 4th Edition

Topic: Intercompany Inventory Sales LO: 1 4. If unrealized inter-company profits in ending inventory exceed unrealized inter-company profits in beginning inventory, what will be the effect of the consolidation entries to eliminate unrealized inter-company inventory profits? a. Equity income will be increased b. Consolidated Sales will be decreased c. Consolidated ending inventory will be increased d. Consolidated cost of goods sold will be increased Answer: d

Topic: Intercompany Inventory Sales LO: 1 5. Whether inter-company inventory sales are upstream or downstream has no effect on consolidation procedures when: a. A perpetual inventory system is used b. The goods are immediately resold to outsiders c. The subsidiary is 100% owned d. The goods are sold at cost Answer: c

Topic: Intercompany Sales of Depreciable Assets LO: 4 6. Halsey, Inc., sells a machine to its subsidiary, Kiesto Company, at a $20,000 gain. The machine was classified as property, plant and equipment on Halsey's books and also will be classified as such on Kiesto' books. The consolidation entry(s) to eliminate the inter-company transaction at year-end will not include: a. A debit to Gain on Sale of Equipment b. A credit to Gain on Sale of Equipment c. A debit to Equipment d. A credit to Depreciation Expense Answer: b

Topic: Intercompany Sale of Land LO: 3 7. In the case of an intercompany sale of land, a consolidation entry is prepared a. Only in the period of the intercompany sale of the land b. In the period of the intercompany sale of the land and in the following periods that the land is held by one of the affiliated companies. c. Only in the periods following the sale and during which the land is held by one of the affiliated companies d. In neither the period of the sale nor the following periods Answer: b

©Cambridge Business Publishers, 2020 Test Bank, Chapter 4

4-3

Topic: Intercompany Sale of Land LO: 3 8. In the case of an intercompany sale of land, which of the following is not a true statement? a. A gain or loss on sale should not be recorded on the seller's pre-consolidation books. b. In the consolidation worksheet, the Land account is reduced by the amount of a gain c. GAAP requires the deferral of any gain or loss. d. The gain or loss on sale will be realized in the consolidated financial statements when the land is re-sold to an outside entity. Answer: a

Topic: Intercompany Inventory Sales LO: 1 9. One of the effects of eliminating intercompany profit from ending inventory is to: a. Reduce cost of goods sold b. Increase cost of goods sold c. Reduce sales revenue d. Increase gross profit Answer: b

Topic: Intercompany Sale of Land LO: 3 10. Intercompany gains on sale of land are deferred: a. Until the consolidated entity is sold b. Over the period that the land produces revenue c. In perpetuity d. Until the land is sold Answer: d

Topic: Intercompany Sale of Land LO: 3 11. When an inter-company gain on sale of land is finally realized by sale of the land to an outsider, the consolidated gain on sale will equal: a. The sum of the recorded gain on sale to the outsider and the deferred gain b. The difference between the recorded gain on sale to the outsider and the deferred gain c. The deferred gain d. The gain recorded by the affiliate that resold the asset to the outsider Answer: a

Topic: Intercompany Sale of Depreciable Assets LO: 4 12. The consolidation entry to realize a loss from an intercompany sale of a building would include: a. A debit to Accumulated Depreciation b. A credit to Depreciation Expense c. A debit to Building d. A debit to Depreciation Expense Answer: d

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Advanced Accounting, 4th Edition

Topic: Intercompany Sale of Depreciable Assets LO: 4 13. In the years after a seller makes an intercompany sale of equipment at a gain, Equity investment is increased in the consolidation entries. Why does the amount of the Equity investment adjustment change from year to year? a. Because the Equipment account balance is reduced with passage of time b. Because a portion of the gain is realized in the consolidated financial statements each year c. Because Accumulated Depreciation and Equipment are reduced by different amounts each year d. Because the gain is not realized until the asset is sold Answer: b

Topic: Intercompany Sale of Depreciable Assets LO: 4 14. Why does the intercompany sale of a building require subsequent adjustments to accumulated depreciation? a. Because the buyer is using a different depreciation method b. Because the buyer has changed the estimated useful life c. Because immediately after the sale, the balance in accumulated depreciation on the buyer's books is ZERO d. Because the book value of the building is the same for the seller and the buyer Answer: c

Topic: Intercompany Inventory Sales LO: 1 15. How much intercompany inventory profit should be eliminated from ending inventory in the consolidation process? a. Net profit on total inter-company sales during the year b. Gross profit on total inter-company sales during the year c. Gross profit on goods sold to outside parties during the year d. Gross profit on goods remaining in buyer's inventory at year-end Answer: d

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Multiple Choice – Computational Topic: Intercompany Inventory Sales LO: 1 16. Nautilus Co. acquired 100% of XYZ Corp. on January 2, 2020. During 2020, Nautilus sold goods to XYZ Corp for $700,000 that cost Nautilus $500,000. XYZ Corp still owned 40% of the goods at the end of the year. Cost of goods sold was $1,000,000 for Nautilus and $990,000 for Aeillo. What was consolidated cost of goods sold? a. $1,370,000 b. $1,000,000 c. $1,790,000 d. $2,770,000 Answer: a

Topic: Intercompany Inventory Sales LO: 1 17. Brendon, Inc. acquired 100% of Weston Enterprises on January 2, 2020. During 2020, Brendon sold Weston for $700,000 goods which had cost $500,000. Weston still owned 40% of the goods at the end of the year. In 2021, Brendon sold goods with a cost of $500,000 to Weston for $700,000, and the buyer still owned 40% of the goods at year-end. For 2021, cost of goods sold was $1,000,000 for Brendon and $990,000 for Weston. What was consolidated cost of goods sold for 2021? a. $1,370,000 b. $1,290,000 c. $1,870,000 d. $1,990,000 Answer: b

Topic: Intercompany Sale of Land LO: 3 18. During 2019, Brooke sold to its subsidiary, Cabana, land with a book value of $507,000. The selling price was $700,000. In its pre-consolidation accounting records, Brooke should: a. Recognize a “Gain on Sale of Land” of $193,000 b. Defer recognition of a “Gain on Sale of Land” entry until Cabana sells the land to a third party c. Recognize the gain over the asset's life d. Not recognize a gain Answer: a

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Advanced Accounting, 4th Edition

The following information applies to Questions 19 & 20. Clearwater Co. owned all of the voting common stock of Kelley, Inc. On January 2, 2020 Clearwater sold equipment to Kelley for $350,000. The equipment had cost Clearwater $425,000. At the time of the sale, the balance in accumulated depreciation was $125,000. The equipment had a remaining useful life of eight years and no salvage value.

Topic: Intercompany Sale of Depreciable Assets LO: 4 19. For the consolidated balance sheet at December 31, 2020, at what amount would the equipment (net) be included? a. $262,500 b. $300,000 c. $350,000 d. $-0Answer: a

Topic: Intercompany Sale of Depreciable Assets LO: 4 20. For the consolidated balance sheet at December 31, 2021, at would amount would the equipment (net) be included? a. $225,000 b. $262,500 c. $306,250 d. $-0Answer: a

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The following information applies to Questions 21-25. On January 1, 2020, Adamson, Inc. acquired the outstanding voting common stock of Skyview Corp. for $600,000. Of this payment, $85,000 was allocated to undervalued equipment (with a five-year life). Any remaining excess was attributable to goodwill. During 2020, Adamson bought inventory for $44,000 and sold it to Skyview for $98,500. 60% of these goods were still in the company's possession on December 31. The financial statements of the two companies as of December 31, 2020 are presented below.

Sales revenue Cost of goods sold Gross profit Operating expenses Income (loss) from subsidiary Net Income

Adamson $750,000 -414,975 335,025 -65,000 246,300 $516,325

Skyview $440,000 -69,000 371,000 -75,000 0 $296,000

Retained Earnings, 1/1/20 Net income Dividends Retained Earnings, 12/31/20

$670,000 516,325 -15000 $1,171,325

$258,000 296,000 -12000 $542,000

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$325,000 440,000 834,300 1,273,025 $2,872,325

$90,000 126,000 635,000 $851,000

Accounts payable Accrued liabilities Common stock Additional paid-in capital Retained Earnings, 12/31/20 Total Liabilities and Equities

$652,000 245,000 152,000 652,000 1,171,325 $2,872,325

$75,000 56,000 34,000 144,000 542,000 $851,000

Topic: Intercompany Inventory Sales LO: 1 21. What is consolidated revenues? a. $ 440,000 b. $1,091,500 c. $1,190,000 d $1,146,000 Answer: b

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Advanced Accounting, 4th Edition

Topic: Undervalued Depreciable Assets LO: 4 22. What is consolidated operating expenses? a. $ 65,000 b. $ 82,000 c. $140,000 d. $157,000 Answer: d

Topic: Intercompany Inventory Sales LO: 1 23. What is consolidated cost of goods sold? a. $418,175 b. $451,275 c. $560,675 d. $516,675 Answer: a

Topic: Undervalued Depreciable Assets LO: 4 24. What is the consolidated balance for property, plant and equipment (net) on the December 31, 2020 balance sheet? a. $1,908,025 b. $1,976,025 c. $1,987,025 d. $1,993,025 Answer: b

Topic: Intercompany Inventory Sales LO: 1 25. What is consolidated inventory on the December 31, 2020 balance sheet? a. $467,500 b. $533,300 c. $566,000 d. $598,700 Answer: b

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The following information applies to Questions 26-35. Weisman Company, a 100% owned subsidiary of Martindale Corporation, sells inventory to Martindale at a 20% profit on selling price. The following data are available pertaining to inter-company purchases by Martindale:

Inter-company sales 2020: $18,000 2021: $19,400 2022: $21,500

Unsold at year end (based on selling price) 2020: $4,000 2021: $6,000 2022: $8,000

Weisman’s profit numbers were $125,000, $142,000 and $265,000 for 2020, 2021, and 2022, respectively. Martindale received dividends from Weisman of $25,000 for 2020 and 2021, and $30,000 for 2022. Topic: Intercompany Inventory Sales – Equity Method LO: 1 26. Assume Weisman uses the equity method to account for its investment in Martindale. What is the balance in the pre-consolidation Income (loss) from subsidiary account for 2020? a. $100,000 b. $124,200 c. $125,000 d. $129,000 Answer: b Topic: Intercompany Inventory Sales – Equity Method LO: 1 27. Assume Weisman uses the equity method to account for its investment in Martindale. What is the balance in the pre-consolidation Income (loss) from subsidiary account for 2021? a. $136,000 b. $140,800 c. $141,600 d. $142,800 Answer: c Topic: Intercompany Inventory Sales – Equity Method LO: 1 28. Assume Weisman uses the equity method to account for its investment in Martindale. What is the balance in pre-consolidation Income (loss) from subsidiary for 2022? a. $235,000 b. $264,600 c. $265,400 d. $268,600 Answer: b

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Advanced Accounting, 4th Edition

Topic: Intercompany Inventory Sales LO: 1 29. What would be the net debit or credit to cost of goods sold on the 2021 consolidation worksheet? a. $19,000 credit b. $19,800 credit c. $21,400 credit d. $ 400 debit Answer: a Topic: Intercompany Inventory Sales – Equity Method LO: 1 30. Assume Weisman uses the equity method to account for its investment in Martindale. What would be the debit to retained earnings regarding the 2020 consolidation entry related to the unrealized inventory profit? a. $-0b. $4,000 c. $1,200 d. $ 800 Answer: a Topic: Intercompany Inventory Sales – Cost Method LO: 2 31. Assume Weisman uses the cost method to account for its investment in Martindale. What is the balance in the pre-consolidation Income (loss) from subsidiary account for 2020? a. $ 24,200 b. $ 25,000 c. $124,200 d. $125,000 Answer: b Topic: Intercompany Inventory Sales – Cost Method LO: 2 32. Assume Weisman uses the cost method to account for its investment in Martindale. What is the balance in the pre-consolidation Income (loss) from subsidiary account for 2021? a. $ 24,200 b. $ 25,000 c. $117,000 d. $142,000 Answer: b

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Topic: Intercompany Inventory Sales – Cost Method LO: 2 33. Assume Weisman uses the cost method to account for its investment in Martindale. What is the balance in the pre-consolidation Income (loss) from subsidiary account for 2022? a. $ 31,600 b. $265,000 c. $ 30,000 d. $264,600 Answer: c Topic: Intercompany Inventory Sales – Cost Method LO: 2 34. Assume the acquisition was on January 1, 2020 and that Weisman uses the cost method to account for its investment in Martindale. Compute the amount of beginning of year [ADJ] adjustment necessary for consolidation for the year ended December 31, 2021. a. $100,000 b. $125,000 c. $124,200 d. $ 99,200 Answer: d

Topic: Intercompany Inventory Sales – Cost Method LO: 2 35. Assume the acquisition was on January 1, 2020 and that Weisman uses the cost method to account for its investment in Martindale. Compute the amount of beginning of year [ADJ] adjustment necessary for consolidation for the year ended December 31, 2022. a. $215,800 b. $450,400 c. $265,800 d. $240,800 Answer: a

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Advanced Accounting, 4th Edition

The following information applies to Questions 36-43. On April 1, 2020, Republic Company sold equipment to its wholly owned subsidiary, Barre Corporation, for $40,000. At the time of the transfer, the asset had an original cost (to Republic) of $60,000 and accumulated depreciation of $25,000. The equipment has a five year estimated remaining life. Barre reported net income of $250,000, $270,000 and $310,000 in 2020, 2021, and 2022, respectively. Republic received dividends from Barre of $90,000, $105,000 and $120,000 for 2020, 2021, and 2022, respectively.

Topic: Intercompany Sale of Depreciable Assets LO: 4 36. What was the amount of the gain or loss on the sale of equipment reported by Republic on its pre-consolidation income statement in 2020? a. $-0b. $ 5,000 gain c. $20,000 loss d. $35,000 gain Answer: b

Topic: Intercompany Sale of Depreciable Assets LO: 4 37. What was the amount of the credit to depreciation expense on the 2020 consolidation worksheet? a. $ 750 b. $-0c. $1,000 d. $1,600 Answer: a

Topic: Intercompany Sale of Depreciable Assets LO: 4 38. What was the amount of the credit to depreciation expense on the 2021 consolidation worksheet? a. $ 750 b. $-0c. $1,000 d. $1,600 Answer: c Topic: Intercompany Sale of Depreciable Assets – Equity Method LO: 4 39. Assume Republic uses the equity method to account for its investment in Barre. What is the balance in the pre-consolidation Income (loss) from Subsidiary account for 2020? a. $245,750 b. $246,000 c. $249,250 d. $250,000 Answer: a

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Topic: Intercompany Sale of Depreciable Assets – Equity Method LO: 4 40. Assume that Republic uses the equity method to account for its investment in Barre. What is the balance in the pre-consolidation Income (loss) from Subsidiary account for 2021? a. $166,000 b. $266,000 c. $270,000 d. $271,000 Answer: d Topic: Intercompany Sale of Depreciable Assets – Cost Method LO: 6 41. Assume Republic uses the cost method to account for its investment in Barre. What is the balance in the pre-consolidation Income (loss) from Subsidiary account for 2020? a. $245,750 b. $165,000 c. $ 90,000 d. $ 88,750 Answer: c Topic: Intercompany Sale of Depreciable Assets – Cost Method LO: 6 42. Assume that Republic uses the cost method to account for its investment in Barre. What is the balance in the pre-consolidation Income (loss) from Subsidiary account for 2021? a. $105,000 b. $106,000 c. $165,000 d. $271,000 Answer: a Topic: Intercompany Sale of Depreciable Assets – Cost Method LO: 6 43. Assume that Republic uses the cost method to account for its investment in Barre. Compute the [ADJ] consolidating entry necessary for 2021. a. $155,750 b. $165,000 c. $245,750 d. $320,750 Answer: a

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Advanced Accounting, 4th Edition

The following information applies to Questions 44-48. On January 1, 2020, Combs Corporation sold a tract of land to its 100% owned subsidiary, Tiniton, Inc., for $550,000. The land originally cost Combs $440,000. Tiniton reported net income of $270,000 and $305,000 for 2020 and 2021, respectively. Combs received dividends from Tiniton of $35,000 and $36,000 for 2020 and 2021, respectively.

Topic: Intercompany Sale of Land LO: 3 44. What is the recorded gain or loss on sale of the land on Combs's pre-consolidation books in 2020? a. $-0b. $110,000 loss c. $550,000 gain d. $110,000 gain Answer: d

Topic: Intercompany Sale of Land LO: 3 45. On the consolidation worksheet for 2020, what adjustment would be made to the Land account? a. $110,000 debit b. $110,000 credit c. $440,000 credit d. $550,000 credit Answer: b Topic: Intercompany Sale of Land – Equity Method LO: 3 46. Assume that Combs uses the equity method to account for its investment in Tiniton. What is the balance in the pre-consolidation Income (loss) from Subsidiary account for 2021? a. $195,000 b. $269,000 c. $305,000 d. $341,000 Answer: c Topic: Intercompany Sale of Land – Cost Method LO: 5 47. Assume that Combs uses the cost method to account for its investment in Tiniton. What is the balance in the pre-consolidation Income (loss) from Subsidiary account for 2021? a. $ 32,000 b. $ 36,000 c. $269,000 d. $305,000 Answer:b

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Topic: Intercompany Sale of Land – Cost Method LO: 5 48. Assume that Combs uses the cost method to account for its investment in Tiniton. Compute the amount of the [ADJ] consolidating entry necessary for 2021. a. $128,000 b. $238,000 c. $337,000 d. $348,000 Answer: a

The following information applies to Questions 49-50. Renner Company sold land to Bethany Enterprises, its parent, on June 1, 2020. The sale price was $218,000. The land originally cost Renner $239,000. Renner reported net income of $400,000 and $496,000 for 2020 and 2021, respectively. Bethany sold the land it purchased from Renner for $228,000 in 2022.

Topic: Intercompany Sale of Land LO: 3 49. What is the balance in the pre-consolidation Income (loss) from Subsidiary account for 2020? a. $379,000 b. $400,000 c. $411,000 d. $421,000 Answer: d

Topic: Intercompany Sale of Land LO: 3 50. What is the consolidated amount of gain or loss on sale of land for 2022? a. $10,000 gain b. $10,000 loss c. $11,000 loss d. $21,000 loss Answer: c

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Advanced Accounting, 4th Edition

Exercises Topic: Intercompany Sale of Land – Equity LO: 3 1. During 2020, Subsidiary sells land to Parent for $126,000. The land had a book value of $104,000. The land is then sold to a third party for $176,000 in 2024. Parent uses the equity method for the 100% investment. Required: a. Prepare the consolidation entry related to the land sale for 2020. b. Prepare the consolidation entry related to the land sale for 2021. c. Prepare the consolidation entry related to the land for 2024. d. What will be the gain on sale on the 2024 consolidated income statement? Answer: a. [Igain] Gain on sale of land 22,000 Land 22,000 To defer the gain on sale and restate land to its original book value. b. [Igain] Equity investment 22,000 Land 22,000 To defer the gain on sale and restate land to its original book value. c.

[Igain] Equity investment 22,000 Gain on sale of land To recognize realization of gain on sale.

22,000

d. 2024 consolidated gain on sale = $176,000 - 104,000 = $72,000

Topic: Intercompany Sale of Depreciable Assets LO: 4 2. On Jan 2, 2020, Parent sells to its wholly owned investee equipment that had cost $250,000. The selling price was $180,000 and accumulated depreciation on that date was $75,000. The subsidiary depreciates the equipment over its remaining life of 10 years. Required: a. Compute the difference between the annual depreciation expense when Parent owned the equipment and depreciation expense recorded by the subsidiary. b. Compute the gain on sale recorded by the parent. c. Prepare the consolidation entries for 2020 related to the equipment sale. d. Prepare the consolidation entries for 2022 related to the equipment sale. Answer: a. Depreciation expense on Parent's books: ($250,000-75,000)/10 = $17,500 Depreciation expense on Subsidiary's books: $180,000/108 = 18,000 Difference $500 b. $180,000 - ($250,000 - $75,000) = $5,000 Gain on Sale recorded by Parent Continued

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Gain on sale of equipment 5,000 Equipment 70,00 To eliminate gain on sale and restore equipment to original book value. Accumulated depreciation 75,000 Accumulated depreciation 500 Depreciation expense 500 To adjust depreciation expense to its consolidated balance.

d. Equity investment 4,000 Equipment 70,000 Accumulated depreciation 74,000 To adjust beginning equity investment and equipment (net) to consolidated balances. Accumulated depreciation 500 Depreciation expense 500 To adjust depreciation expense to its consolidated balance.

Topic: Intercompany Sale of Land LO: 3 3. During 2020, Parent sells land to Subsidiary for $226,800. The land had a book value of $159,000. The land is then sold to an unaffiliated party for $303,000 in 2024. Required: a. Prepare the consolidation entry related to the land sale for 2020. b. Prepare the consolidation entry related to the land sale for 2021. c. Prepare the consolidation entry related to the land for 2024. d. What will be the gain on sale on the 2024 consolidated income statement? Answer: a. Gain on sale of land 67,800 Land 67,800 To defer gain and restate land to its original book value. b. Equity investment 67,800 Land 67,800 To defer gain and restate land to its original book value. c.

Equity investment Gain on sale of land To recognize deferred gain.

67,800 67,800

d. Consolidated gain = $303,000 - $159,000 = $144,000

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Advanced Accounting, 4th Edition

Topic: Intercompany Sale of Depreciable Assets LO: 4 4. On Jan 2, 2020, a subsidiary sells to its parent equipment that had cost $40,000. The selling price was $36,000 and accumulated depreciation on that date was $14,000. The subsidiary and the parent both estimate that the equipment has a remaining useful life of 10 years. Required: a. Compute the difference between the annual depreciation expense when the subsidiary owned the equipment and depreciation expense recorded by the parent. b. Compute the gain on sale recorded by the subsidiary. c. Prepare the consolidation entries for 2020 related to the equipment sale. d. Prepare the consolidation entries for 2022 related to the equipment sale. Answer: a. Depreciation expense on Parent's books: $36,000/10 = Depreciation expense on Subsidiary's books:($40,000-$14,000)/10 = Difference

$ 3,600 2,600 $ 1,000

b. $36,000 - ($40,000 - $14,000) = $10,000 Gain on Sale c.

Gain on sale of equipment $10,000 Equipment 4,000 Accumulated depreciation 14,000 To reverse gain on sale and adjust beginning equipment (net) to consolidated value. Accumulated depreciation 1,000 Depreciation expense 1,000 To adjust depreciation expense to consolidated value.

d. Equity investment 8,000 Equipment 4,000 Accumulated depreciation 12,000 To adjust equipment (net) to consolidated value. Accumulated depreciation 1,000 Depreciation expense 1,000 To adjust depreciation expense to consolidated value.

Topic: Intercompany Inventory Sales LO: 1 5. Parent Co. acquired 100% of Sub, Inc. on January 1, 2021. During 2021, Parent sold goods to Sub for $260,000 that cost Parent $170,000. Sub still owned 30% of the goods at the end of the year. In their pre-consolidation books, cost of goods sold was $1,050,000 for Parent and $375,000 for Sub. Required: a. Prepare all consolidation entries related to inventory and cost of goods sold for 2021. b. Compute consolidated cost of goods sold for 2021. c. Assuming that the remainder of the inventory was sold to third parties during 2022, prepare the 2022 consolidation entry to recognize the previously deferred profit.

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Answer: a. Sales

260,000 Cost of Goods Sold To eliminate 2021 inter-company sales.

260,000

Cost of Goods Sold 27,000* Merchandise Inventory 27,000 To eliminate unrealized gross profit from ending inventory. *($260,000 - $170,000) x 0.30

b. Consolidated cost of goods sold: $1,050,000 + $375,000 + $27,000 - $260,000 = $1,192,000 c.

Equity investment 27,000 Cost of Goods Sold To recognize previously deferred gross profit.

27,000

Topic: Intercompany Inventory Sales LO: 1 6. The separate income statements Hartford Corporation and its wholly owned subsidiary, Sacramento Co., for 2020 are presented below:

Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses Sacramento’s net income Hartford's net income from its own operations

Hartford $390,000 160,000 230,000 80,000

Sacramento $68,250 38,000 30,250 16,000 $ 14,250

$150,000

Note that Hartford’s income statement includes no investment-related accounting or adjustments for Sacramento. During 2020, Hartford sold merchandise costing $6,750 to Sacramento for $15,000. At the end of 2020, 40% of the merchandise remained unsold by Asbury. Required: Prepare a consolidated income statement for 2020. Answer: Consolidated Income Statement: Sales Revenue: Cost of Goods Sold: Gross Profit Operating Expenses: Consolidated Net Income

$390,000 + $68,250 - $15,000 = $160,000 + $38,000 - $15,000 + $3,300* = $80,000 + $16,000 =

$443,250 186,300 256,950 96,000 $160,950

*($15,000 - $6,750) x .40

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Advanced Accounting, 4th Edition

Problems Topic: Intercompany Inventory Sales – Equity Method LO: 1 1. Parent purchased Subsidiary on January 1, 2019. The parent uses the equity method to account for its investment in its subsidiary. The excess of investment cost over book value was allocated as follows: Equipment (20-year life) Customer list (10-year life) Patent (5-year life) Goodwill Total

$400,000 90,000 125,000 165,000 $780,000

Parent regularly sells merchandise to Subsidiary. In 2021, inter-company sales amounted to $60,100, with $18,000 of deferred profit remaining in ending inventory. Year-end inter-company receivables/payables amounted to $24,000. In 2022, inter-company sales amounted to $98,000 with $45,000 of deferred profit remaining in ending inventory. Year-end inter-company receivables/payables amounted to $35,000. Financial statements of Parent and Subsidiary for the year ended December 31, 2022 are presented below. Sales revenue Cost of goods sold Gross profit Operating expenses Income (loss) from subsidiary Net Income

Parent $687,000 -425,000 262,000 -125,000 282,300 $419,300

Subsidiary $750,000 -350,000 400,000 -36,700 _________ $363,300

Retained Earnings, 1/1/22 Net income Dividends Retained Earnings, 12/31/22

$620,400 419,300 -98,000 $941,700

$240,000 363,300 -12,000 $591,300

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$850,000 125,000 1,524,700 1,042,000 $3,541,700

$750,000 265,000 1,337,860 $2,352,860

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/22 Total Liabilities and Equities

$55,000 450,000 1,250,000 95,000 750,000 941,700 $3,541,700

$311,210 370,650 665,300 183,950 230,450 591,300 $2,352,860

Required: a. Prepare the 2022 journal entries, required by the equity method, on Parent's pre-consolidation books. b. Prepare the consolidation entries for 2022. ©Cambridge Business Publishers, 2020 Test Bank, Chapter 4

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Answer: Compute annual amortization: Equipment Customer list Patent Goodwill Total annual amortization

$400,000/20 = 90,000/10 = 125,000/5 = No amortization

Deferred inventory profit, December 31, 2022: Deferred inventory profit, January 1, 2022:

$ 20,000 $9,000 $25,000 ______ $54,000

$45,000 $18,000

Unamortized excess at December 31, 2022: Goodwill Equipment Customer list Patent Total

$165,000 320,000 54,000 25,000 $564,000

($20,000 x 16 years) ($9,000 x 6 years) ($25,000 x 1 years)

a. Equity method entries: Equity Investment 363,300 Income (loss) from subsidiary 363,300 To recognize equity in Subsidiary's reported net income. Income (loss) from subsidiary Equity Investment To recognize amortization.

54,000 54,000

Equity Investment 18,000 Income (loss) from subsidiary To recognize deferred profit in beginning inventory.

18,000

Income (loss) from subsidiary Equity Investment To defer profit in ending inventory.

45,000 45,000

Cash

12,000

Equity Investment To recognize Subsidiary's dividends.

12,000

©Cambridge Business Publishers, 2020 4-22

Advanced Accounting, 4th Edition

b. Consolidation entries: [C] Income (loss) from subsidiary 282,300 Dividends 12,000 Equity Investment 270,300 To eliminate changes caused by equity method accounting. [E]

[A]

[D]

[Isales]

[Icogs]

Common Stock 183,950 Retained Earnings 240,000 Additional Paid-In Capital 230,450 Equity Investment To eliminate Subsidiary's stockholders' equity. Goodwill 165,000 PPE, net 340,000 Customer List 63,000 Patent 50,000 Equity Investment To allocate excess to Subsidiary's assets. Operating Expenses Equipment Customer List Patent To record amortization.

54,000

Sales Revenue Cost of Goods Sold To eliminate intercompany sales

98,000

654,400

618,000

20,000 9,000 25,000

Cost of Goods Sold 45,000 Merchandise Inventory To eliminate deferred profit in ending inventory.

Equity Investment 18,000 Cost of Goods Sold To recognize deferred profit in beginning inventory.

98,000

45,000

[Icogs]

Accounts Payable 35,000 Accounts Receivable To eliminate intercompany receivable and payable.

18,000

[Ipay]

35,000

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Topic: Intercompany Inventory Sales – Equity Method LO: 1 2. Parent purchased Subsidiary on January 1, 2020. The excess of investment cost over book value of $350,000 was allocated entirely to a 7-year royalty agreement. The parent uses the equity method to account for its investment in its subsidiary. Subsidiary regularly sells merchandise to Parent. In 2021, inter-company sales amounted to $82,400, with $216,480 of deferred profit remaining in ending inventory. Year-end inter-company receivables/payables amounted to $16,000. In 2022, inter-company sales amounted to $75,000 with $37,500 of deferred profit remaining in ending inventory. Year-end inter-company receivables/payables amounted to $28,000. Financial statements of Parent and Subsidiary for the year ended December 31, 2022 are presented below.

Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses Equity Income Net Income

Parent $7,500,000 -5,930,000 1,570,000 -1,375,000 142,980 $337,980

Subsidiary $2,450,000 -1,950,000 500,000 -286,000 0 $214,000

Retained Earnings, 1/1/22 Net income Dividends Retained Earnings, 12/31/22

$4,045,000 337,980 -85,000 $4,297,980

$1,750,000 214,000 -176,000 $1,788,000

Cash and receivables Inventory Equity Investment Property, Plant & Equipment (Net) Total Assets

$1,750,000 958,000 2,530,000 4,562,980 $9,800,980

$1,145,600 758,000

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/22 Total Liabilities and Equities

$980,000 142,800 1,010,200 1,792,000 1,578,000 4,297,980 $9,800,980

$225,000 376,500 51,190 158,000 421,500 1,788,000 $3,020,190

1,116,590 $3,020,190

Required: a. Prepare a schedule showing the computation of Income (loss) from subsidiary on Parent's pre-consolidation books for 2022. b. Prepare a schedule showing the computation of Equity Investment on Parent's preconsolidation books at December 31, 2022. c. Prepare the consolidation entries for 2022.

©Cambridge Business Publishers, 2020 4-24

Advanced Accounting, 4th Edition

Answer: a. Computation of Income (loss) from subsidiary for 2022: Equity in Subsidiary Reported Income $214,000 Amortization (50,000) Realized inventory profit-beginning inventory 16,480 Unrealized inventory profit (37,500) $142,980 b. Computation of Equity Investment at December 31, 2022: Common Stock $ 158,000 Retained Earnings 1,788,000 Additional paid-in capital 421,500 Unamortized Excess ($350,000/7 x 4 years) 200,000 Unrealized inventory profit (37,500) $2,530,000 c. 2022 Consolidation Entries: [C] Income (loss) from subsidiary 142,980 Dividends 176,000 Equity Investment 33,020 To eliminate changes caused by equity method accounting. [E]

[A]

Common Stock 158,000 Retained Earnings 1,750,000 Additional Paid-In Capital 421,500 Equity Investment To eliminate Subsidiary's stockholders' equity.

2,329,500

Royalty Agreement 250,000 Equity Investment To allocate excess to Subsidiary's assets.

250,000

Amortization Expense Royalty Agreement To record amortization.

50,000 50,000

[Isales] Sales Revenue Cost of Goods Sold To eliminate intercompany sales.

75,000

[D]

75,000

[Icogs] Cost of Goods Sold 37,500 Merchandise Inventory To eliminate deferred profit in ending inventory.

37,500

[Icogs] Equity Investment 16,480 Cost of Goods Sold To eliminate deferred profit in ending inventory.

16,480

[Ipay]

Accounts Payable 28,000 Accounts Receivable To eliminate intercompany receivable and payable.

28,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 4

4-25

Topic: Intercompany Sale of Land – Equity Method LO: 3 3. Parent acquired Subsidiary on January 1, 2020 at a price $450,000 in excess of book value. Of that excess, $350,000 was allocated to an unrecorded patent with a 10-year life, with the remainder to goodwill. The parent uses the equity method to account for its investment in its subsidiary. In 2021, Subsidiary sold to Parent land having a book value of $90,000 for a total price of $244,000. Financial statements of the two companies for the year ended December 31, 2022 are presented below.

Sales revenue Cost of goods sold Gross profit Operating expenses Income (loss) from subsidiary Net Income

Parent $7,500,000 -5,930,000 1,570,000 -1,375,000 179,000 $374,000

Subsidiary $2,450,000 -1,950,000 500,000 -286,000 0 $214,000

Retained Earnings, 1/1/22 Net income Dividends Retained Earnings, 12/31/22

$4,045,000 374,000 -85,000 $4,334,000

$1,750,000 214,000 -176,000 $1,788,000

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$1,750,000 958,000 2,558,500 4,562,980 $9,829,480

$1,145,600 758,000

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/22 Total Liabilities and Equities

$980,000 142,800 1,010,200 1,792,000 1,578,000 4,334,000 $9,837,000

$225,000 376,500 51,190 158,000 421,500 1,788,000 $3,020,190

1,116,590 $3,020,190

Required: a. Prepare a schedule showing the computation of Income (loss) from subsidiary on the Parent's pre-consolidation books for 2022. b. Prepare a schedule showing the computation of Equity Investment on the Parent's pre-consolidation books at December 31, 2022. c. Prepare the consolidation entries for 2022.

©Cambridge Business Publishers, 2020 4-26

Advanced Accounting, 4th Edition

Answer: a. Computation of 2022 Income (loss) from subsidiary: Subsidiary Reported Net Income $214,000 Amortization (35,000) Income (loss) from subsidiary $179,000 b. Computation of Equity Investment at December 31, 2022: Common Stock $ 158,000 Additional paid-in capital 421,500 Retained Earnings 1,788,000 Unamortized Excess 345,000 Unrealized Land Gain (154,000) Equity Investment, December 31, 2022 $2,558,500 c.

2022 Consolidation Entries: [C] Income (loss) from subsidiary 179,000 Dividends 176,000 Equity Investment 3,000 To eliminate changes caused by equity method accounting. [E]

[A]

[D]

Common Stock 158,000 Retained Earnings 1,750,000 Additional Paid-In Capital 421,500 Equity Investment To eliminate Subsidiary's stockholders' equity. Patent 280,000 Goodwill 100,000 Equity Investment To allocate excess to Subsidiary's assets. Amortization Expense Patent To record amortization.

35,000

[Igain] Equity Investment Land To eliminate gain on land sale.

154,000

2,329,500

380,000

35,000

154,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 4

4-27

Topic: Intercompany Sale of Depreciable Assets – Equity Method LO: 4 4. Parent acquired Subsidiary on January 2, 2019 at a price $400,000 in excess of book value. Of that excess, $160,000 was allocated to an unrecorded Customer List with a 8-year life, with the remainder to Goodwill. The parent uses the equity method to account for its investment in its subsidiary. On January2, 2022, Subsidiary sold equipment to Parent for $120,000. The equipment had a cost of $85,000 and accumulated depreciation of $40,000. The remaining life of the equipment was estimated at 8 years. Financial statements for the two companies for the year ended December 31, 2023 are presented below.

Sales revenue Cost of goods sold Gross profit Operating expenses Income (loss) from subsidiary Net Income

Parent $687,000 -425,000 262,000 -125,000 352,675 $489,675

Subsidiary $750,000 -350,000 400,000 -36,700 _________ $363,300

Retained Earnings, 1/1/23 Net income Dividends Retained Earnings, 12/31/23

$620,400 489,675 -98,000 $1,012,075

$240,000 363,300 -12,000 $591,300

Cash and receivables Inventory Equity investment Property, plant & equipment (Net) Total Assets

$850,000 125,000 1,249,450 1,387,625 $3,612,075

$750,000 265,000 1,337,860 $2,352,860

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/23 Total Liabilities and Equities

$55,000 450,000 1,250,000 95,000 750,000 1,012,075 $3,612,075

$311,210 370,650 665,300 183,950 230,450 591,300 $2,352,860

Required: a. Prepare the journal entries on the books of Parent and Subsidiary to record the equipment sale. b. Compute the amount of unrealized gain at January 1, 2023. c. Prepare entries required under the equity method on Parent's pre-consolidation books for 2023. d. Prepare the consolidation entries for 2023.

©Cambridge Business Publishers, 2020 4-28

Advanced Accounting, 4th Edition

Answer: a. Cash 120,000 Accumulated Depreciation 40,000 Equipment 85,000 Gain on Sale 75,000 To record sale of equipment on Subsidiary books. Equipment 120,000 Cash To record equipment purchase by Parent. b. Unrealized gain at January 1, 2023: Total gain Less: Realized Gain ($27,000/6) Unrealized Gain c.

120,000

$75,000 9,375 $65,625

2022 Equity method entries: Equity Investment 363,300 Income (loss) from subsidiary To recognize equity in Subsidiary's reported net income. Income (loss) from subsidiary Equity Investment To recognize amortization.

363,300

20,000 20,000

Equity Investment 9,375 Income (loss) from subsidiary To recognize realization of gain on equipment sale. Cash

9,375

12,000

Equity Investment To recognize Subsidiary's dividends.

12,000

d. Consolidation entries for 2023: [C] Income (loss) from subsidiary 352,675 Dividends Equity Investment To eliminate Equity Income and dividends. Common Stock 183,950 Retained Earnings 240,000 Additional Paid-In Capital 230,450 Equity Investment To eliminate Subsidiary's stockholders' equity.

12,000 340,675

[E]

[A]

[D]

Patent 80,000 Goodwill 240,000 Equity Investment To allocate excess to Subsidiary's assets. Amortization Expense Patent To record amortization.

654,400

320,000

20,000 20,000

Continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 4

4-29

[Igain] Equity Investment 65,625 PPE, net To adjust Equipment (net) to consolidated value.

65,625

[Idepr] PPE,net 9,375 Depreciation expense To record realization of gain on equipment sale.

9,375

Topic: Intercompany Inventory Sales – Cost Method LO: 2 5. Parent purchased Subsidiary on January 1, 2020. The excess of investment cost over book value of $350,000 was allocated entirely to a 7-year royalty agreement. The Subsidiary’s retained earnings balance on the date of acquisition was $1,318,120. The Parent uses the cost method to account for its pre-consolidation investment in the Subsidiary. Subsidiary regularly sells merchandise to Parent. In 2021, inter-company sales amounted to $82,400, with $16,480 of deferred profit remaining in ending inventory. Year-end inter-company receivables/payables amounted to $16,000. In 2022, inter-company sales amounted to $75,000 with $37,500 of deferred profit remaining in ending inventory. Year-end inter-company receivables/payables amounted to $28,000. Financial statements of Parent and Subsidiary for the year ended December 31, 2022 are presented below. Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses Income (loss) from subsidiary Net Income

Parent $7,500,000 -5,930,000 1,570,000 -1,375,000 176,000 $371,000

Subsidiary $2,450,000 -1,950,000 500,000 -286,000 0 $214,000

Retained Earnings, 1/1/22 Net income Dividends Retained Earnings, 12/31/22

$4,045,000 371,000 -85,000 $4,331,000

$1,750,000 214,000 -176,000 $1,788,000

Cash and receivables Inventory Equity Investment Property, Plant & Equipment (Net) Total Assets

$1,750,000 958,000 2,247,620 4,878,380 $9,834,000

$1,145,600 758,000

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/22 Total Liabilities and Equities

$980,000 142,800 1,010,200 1,792,000 1,578,000 4,331,000 $9,834,000

$225,000 376,500 51,190 158,000 421,500 1,788,000 $3,020,190

1,116,590 $3,020,190

Required: a. Prepare a schedule showing the computation of the [ADJ] consolidating entry necessary for 2022. b. Prepare the consolidation entries for 2022. ©Cambridge Business Publishers, 2020 4-30

Advanced Accounting, 4th Edition

Answer: a. Computation of [ADJ]: Change in subsidiary retained earnings from acquisition to BOY Cumulative AAP amortization from acquisition to BOY BOY unconfirmed upstream intercompany inventory profits [ADJ] amount

$431,880 (100,000) (16,480) $315,400

b. 2022 Consolidation Entries: [ADJ] Investment in subsidiary 315,400 Retained earnings (Parent) 315,400 To restate investment account from cost to “as-if” equity method. [C]

Income (loss) from subsidiary 176,000 Dividends (Subsidiary) 176,000 To eliminate dividend income from parent’s income statement and dividends from subsidiary’s equity section.

[E]

Common Stock 158,000 Retained Earnings 1,750,000 Additional Paid-In Capital 421,500 Investment in subsidiary To eliminate Subsidiary's stockholders' equity.

[A]

2,329,500

Royalty Agreement 250,000 Investment in subsidiary To allocate excess to Subsidiary's assets.

250,000

Amortization Expense Royalty Agreement To record amortization.

50,000 50,000

[Isales] Sales Revenue Cost of Goods Sold To eliminate intercompany sales.

75,000

[D]

75,000

[Icogs] Cost of Goods Sold 37,500 Merchandise Inventory To eliminate deferred profit in ending inventory.

37,500

[Icogs] Investment in subsidiary 16,480 Cost of Goods Sold To eliminate deferred profit in ending inventory.

16,480

[Ipay]

Accounts Payable 28,000 Accounts Receivable To eliminate intercompany receivable and payable.

28,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 4

4-31

Topic: Intercompany Sale of Land – Cost Method LO: 5 6. Parent acquired Subsidiary on January 1, 2020 at a price $450,000 in excess of book value. Of that excess, $350,000 was allocated to an unrecorded patent with a 10-year life, with the remainder to goodwill. The Subsidiary’s retained earnings balance on the date of acquisition was $1,379,650. The Parent uses the cost method to account for its investment in the Subsidiary. In 2021, Subsidiary sold to Parent land having a book value of $90,000 for a total price of $244,000. Financial statements of the two companies for the year ended December 31, 2022 are presented below.

Sales revenue Cost of goods sold Gross profit Operating expenses Income (loss) from subsidiary Net Income

Parent $7,500,000 -5,930,000 1,570,000 -1,375,000 176,000 $371,000

Subsidiary $2,450,000 -1,950,000 500,000 -286,000 0 $214,000

Retained Earnings, 1/1/22 Net income Dividends Retained Earnings, 12/31/22

$4,045,000 371,000 -85,000 $4,331,000

$1,750,000 214,000 -176,000 $1,788,000

Cash and receivables Inventory Investment in subsidiary Property, plant & equipment (Net) Total Assets

$1,750,000 958,000 2,412,150 4,713,850 $9,834,000

$1,145,600 758,000

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/22 Total Liabilities and Equities

$980,000 142,800 1,010,200 1,792,000 1,578,000 4,331,000 $9,834,000

$225,000 376,500 51,190 158,000 421,500 1,788,000 $3,020,190

1,116,590 $3,020,190

Required: a. Prepare a schedule showing the computation of the [ADJ] consolidating entry necessary for 2022. b. Prepare the consolidation entries for 2022.

©Cambridge Business Publishers, 2020 4-32

Advanced Accounting, 4th Edition

Answer: a. Computation of [ADJ]: Change in subsidiary retained earnings from acquisition to BOY Cumulative AAP amortization from acquisition to BOY BOY unconfirmed intercompany non-depreciable assets profits [ADJ] amount

$370,350 (70,000) (154,000) $ 146,350

b. 2022 Consolidation Entries: [ADJ]

Investment in subsidiary 146,350 Retained earnings (Parent) 146,350 To restate investment account from cost to “as-if” equity method.

[C]

Income (loss) from subsidiary 176,000 Dividends (Subsidiary) 176,000 To eliminate dividend income from parent’s income statement and dividends from subsidiary’s equity section.

[E]

Common Stock 158,000 Retained Earnings 1,750,000 Additional Paid-In Capital 421,500 Investment in subsidiary To eliminate Subsidiary's stockholders' equity.

[A]

[D]

Patent 280,000 Goodwill 100,000 Investment in subsidiary To allocate excess to Subsidiary's assets. Amortization Expense Patent To record amortization.

35,000

[Igain] Investment in subsidiary Land To eliminate gain on land sale.

154,000

2,329,500

380,000

35,000

154,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 4

4-33

Topic: Intercompany Sale of Depreciable Assets – Cost Method LO: 6 7. Parent acquired Subsidiary on January 1, 2019 at a price $400,000 in excess of book value. Of that excess, $160,000 was allocated to an unrecorded Customer List with an 8-year life, with the remainder to Goodwill. The Subsidiary’s retained earnings balance on the date of acquisition was $76,000. The Parent uses the cost method to account for its investment in the Subsidiary. On January 2022, Subsidiary sold equipment to Parent for $120,000. The equipment had a cost of $85,000 and accumulated depreciation of $40,000. The remaining life of the equipment was estimated at 8 years. Financial statements for the two companies for the year ended December 31, 2023 are presented below.

Sales revenue Cost of goods sold Gross profit Operating expenses Income (loss) from subsidiary Net Income

Parent $687,000 -425,000 262,000 -125,000 12,000 $149,000

Subsidiary $750,000 -350,000 400,000 -36,700 _________ $363,300

Retained Earnings, 1/1/23 Net income Dividends Retained Earnings, 12/31/23

$620,400 149,000 -98,000 $671,400

$240,000 363,300 -12,000 $591,300

Cash and receivables Inventory Investment in subsidiary Property, plant & equipment (Net) Total Assets

$850,000 125,000 890,400 1,406,000 $3,271,400

$750,000 265,000 1,337,860 $2,352,860

Accounts payable Accrued liabilities Notes payable Common stock Additional paid-in capital Retained Earnings, 12/31/23 Total Liabilities and Equities

$55,000 450,000 1,250,000 95,000 750,000 671,400 $3,271,400

$311,210 370,650 665,300 183,950 230,450 591,300 $2,352,860

Required: a. Prepare the journal entries on the pre-consolidation books of Parent and Subsidiary to record the equipment sale. b. Compute the amount of unrealized gain at January 1, 2023. c. Prepare entries required under the cost method on Parent's pre-consolidation books for 2023. d. Prepare the consolidation entries for 2023.

©Cambridge Business Publishers, 2020 4-34

Advanced Accounting, 4th Edition

Answer: a. Cash 120,000 Accumulated Depreciation 40,000 Equipment 85,000 Gain on Sale 75,000 To record sale of equipment on Subsidiary’s pre-consolidation books. Equipment 120,000 Cash 120,000 To record equipment purchase on Parent’s pre-consolidation books. b. Unrealized gain at January 1, 2023: Total gain Less: Realized Gain ($75,000/8) Unrealized Gain c.

$75,000 9,375 $65,625

2022 Cost method entries: Cash

12,000 Income (loss) from subsidiary To record receipt of Subsidiary's dividends.

12,000

d. Consolidation entries for 2023: [ADJ]

Investment in subsidiary 18,375 Retained earnings (Parent) 18,375 To restate investment account from cost to “as-if” equity method. [C]

Income (loss) from subsidiary 12,000 Dividends (Subsidiary) 12,000 To eliminate dividend income from parent’s income statement and dividends from subsidiary’s equity section.

[E]

Common Stock 183,950 Retained Earnings 240,000 Additional Paid-In Capital 230,450 Equity Investment To eliminate Subsidiary's stockholders' equity.

[A]

[D]

Patent 80,000 Goodwill 240,000 Equity Investment To allocate excess to Subsidiary's assets. Amortization Expense Patent To record amortization.

654,400

320,000

20,000 20,000

[Igain] Equity Investment 65,625 PPE, net To adjust Equipment (net) to consolidated value.

65,625

[Idepr] PPE,net 9,375 Depreciation expense To record realization of gain on equipment sale.

9,375

©Cambridge Business Publishers, 2020 Test Bank, Chapter 4

4-35

Chapter 5 Consolidated Financial Statements with Less than 100% Ownership Learning Objectives – Coverage by question Multiple Choice

Exercises

Problems

LO1 – Explain consolidation on the date of acquisition for a non-wholly owned subsidiary.

1, 3, 19, 22-25

LO2 – Explain allocation of profit to controlling and noncontrolling interests and consolidation subsequenft to the date of acquisition for a non-wholly owned subsidiary.

7, 20, 26, 28, 31, 32, 35, 36

1, 2, 4, 6-8

1-5

LO3 – Explain intercompany profit elimination in consolidated financial statements in the presence of noncontrolling interests when the parent uses the equity method of preconsolidation investment bookkeeping.

10-15, 18

1, 3

LO4 – Explain intercompany profit elimination in consolidated financial statements in the presence of noncontrolling interests when the parent uses the cost method of preconsolidation investment bookkeeping.

16, 17, 27, 33, 34

5, 8

2, 4

LO5 – Appendix 5A Explain differences in measurement of noncontrolling interest under current U.S. GAAP, former U.S. GAAP and the proportionate alternative allowed under International Financial Reporting standards. LO6 – Appendix 5B Explain the computation of earnings per share for consolidated companies. LO7 – Appendix 5C Explain the effects on consolidated financial statements of changes in the ownership percentage of a subsidiary.

37, 38

2, 4-6, 8, 9, 21, 29, 30, 39

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-1

Chapter 5: Consolidated Financial Statements with Less than 100% Ownership

Multiple Choice Multiple Choice – Theory Topic: Goodwill Impairment Allocation LO: 1 1. Allocation of goodwill impairment losses to the parent and the noncontrolling interests should be based on: a. Relative interests of parent and noncontrolling interests in the carrying value of goodwill b. Parent and noncontrolling interests relative ownership percentages in the subsidiary c. The entire impairment loss is reported on the parent company’s books only d. None of the above Answer: a

Topic: Subsidiary Net Income LO: 7 2. When a subsidiary is acquired sometime after the first day of the fiscal year, which of the following statements is true? a. Income from subsidiary is not recognized until there is an entire year of consolidated operations. b. Income from subsidiary is recognized from date of acquisition to year-end. c. Excess cost over acquisition value is recognized at the beginning of the fiscal year. d. No goodwill can be recognized. e. Income from subsidiary is recognized for the entire year. Answer: b

Topic: Consolidated Balance Sheet LO: 1 3. When preparing a consolidated balance sheet, the noncontrolling interest amount must be presented: a. It is not disclosed on the balance sheet b. As a part of liabilities c. As a part of stockholders' equity d. In the notes to financial statements Answer: c

©Cambridge Business Publishers, 2020 5-2

Advanced Accounting, 4th Edition

Topic: Changes in Ownership Occurring During the Fiscal Year LO: 7 4. When one company buys a controlling interest in another company on April 1 (assuming a calendar year), how should the pre-acquisition subsidiary revenues and expenses be disclosed in the consolidated balances for the year of acquisition? a. It is combined with parent company income statement balances b. It is disclosed in consolidated retained earnings c. Only post-acquisition revenues and expenses are included in consolidated totals. d. Only post-acquisition revenues and expenses are included in consolidated totals on the financial statements, however, the revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period are included in supplemental pro forma information. Answer: d

Topic: Sale of common Stock by the Subsidiary to Outside Parties LO: 7 5. How does a parent corporation account for the sale of a portion of an investment in a subsidiary? a. If control is maintained after the sale, then the difference between the sales proceeds and the book value is an adjustment to the parent's owners' equity (APIC). b. Sale proceeds are included as a part of consolidated revenues. c. It is only footnoted. d. Reported as a gain or loss only if the equity method is used. Answer: a

Topic: Deconsolidation of a Subsidiary LO: 7 6. When accounting for the deconsolidation of a subsidiary (parent loses control) a. The parent recognizes a gain or loss on the deconsolidation. b. The parent recognizes the resulting gain or loss as a part of APIC. c. The parent’s common shares are adjusted to reflect the new amount of outstanding shares. d. Deconsolidation is only required when the parent company maintains control. Answer: a

Topic: Apportionment to Noncontrolling Interests LO: 2 7. Which of the following does not affect the computation of the noncontrolling interest in the net assets of a partially owned subsidiary? a. Dividends declared by the subsidiary b. Impairment of goodwill recognized in the business combination c. Depreciation and amortization of differences between current fair values and carrying amounts of the subsidiary's identifiable net assets on the date of the business combination d. All of the above answers affect computation of the noncontrolling interest Answer: d

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-3

Topic: Accounting for an Acquisition on the Date When Control Is Achieved LO: 7 8. At the acquisition date, the date on which the investor company gains control of the investee company, which of the following occur(s)? a. All of the Equity Investments made by the investor in the investee must be revalued. b. Any gains or losses as a result of the revaluation should be recognized currently in income. c. Goodwill is recognized and measured (this only occurs on the date that the parent obtains control of the investee). d. All of the above answers are correct. Answer: d

Topic: Required Disclosure for Noncontrolling Interest LO: 7 9. When accounting for a noncontrolling interest, a parent company must disclose in the notes to the consolidated financial statements: a. A separate schedule that shows the effects of any changes in a parent’s ownership in the subsidiary. b. The nature of the parent’s continuing involvement with the subsidiary or entity acquiring the group of assets after it has been discontinued. c. Whether a transaction that resulted in the deconsolidation was with a related party. d. All of the above answers are correct. Answer: d

Topic: Intercompany Profit Elimination LO: 3 10. Deferred profit on intercompany asset sales is: a. Always 100% eliminated b. Eliminated only on upstream sales c. Accounted only by the noncontrolling interests d. Not considered as part of consolidating elimination entries Answer: a

Topic: Intercompany Profit Elimination LO: 3 11. On October 22, 2020, Halsey Corp. sold land to Kiesto Co., its non-wholly owned subsidiary. The land cost $122,000 and was sold to Kiesto for $197,000. From the perspective of the combination, when is the gain on the sale of the land realized? a. Proportionately over a designated period of years b. When Kiesto Co. sells the land to a third party c. No gain can be recognized d. As Kiesto uses the land Answer: b

©Cambridge Business Publishers, 2020 5-4

Advanced Accounting, 4th Edition

Topic: Intercompany Profit Elimination LO: 3 12. Christie Company sells inventory to its parent, Finn Company, at a profit during 2020. Which of the following would be a debit entry in the consolidated worksheet for 2020? a. Retained earnings b. Cost of goods sold c. Inventory d. Additional paid-in capital Answer: b

Topic: Intercompany Profit Elimination LO: 3 13. Bond Company sells inventory to its subsidiary, Esquivel Company, at a profit during 2020. Which of the following would be a credit entry in the consolidated worksheet for 2020? a. Retained earnings b. Sales c. Inventory d. Additional paid-in capital Answer: c Topic: Intercompany Profit Elimination – Equity Method LO: 3 14. Bond Company sells inventory to its subsidiary, Esquivel Company, at a profit during 2020. If Bond uses the equity method to account for its equity investment in Esquivel, which of the following would be credited in the consolidated worksheet for 2021? a. Sales b. Cost of goods sold c. Inventory d. Equity investment Answer: b Topic: Intercompany Profit Elimination – Equity Method LO: 3 15. Bond Company sells inventory to its subsidiary, Esquivel Company, at a profit during 2020. If Bond uses the equity method to account for its investment in Esquivel, which of the following choices would be a debit entry in the consolidated worksheet for 2021? a. Sales b. Cost of goods sold c. Inventory d. Equity investment Answer: d

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-5

Topic: Intercompany Profit Elimination – Cost Method LO: 4 16. Bond Company sells inventory to its subsidiary, Esquivel Company, at a profit during 2020. If Bond uses the cost method to account for its equity investment in Esquivel, which of the following would be credited in the consolidated worksheet for 2021? a. Sales b. Cost of goods sold c. Inventory d. Investment in subsidiary Answer: b Topic: Intercompany Profit Elimination – Cost Method LO: 4 17. Bond Company sells inventory to its subsidiary, Esquivel Company, at a profit during 2020. If Bond uses the cost method to account for its investment in Esquivel, which of the following choices would be a debit entry in the consolidated worksheet for 2021? a. Sales b. Cost of goods sold c. Inventory d. Investment in subsidiary Answer: d

Topic: Intercompany Profit Elimination LO: 3 18. What is the impact on the non-controlling interest of a subsidiary when there are downstream transfers of inventory between the parent and subsidiary companies? a. A pro rata portion of deferred gain or loss is recognized in the income statement b. Any resulting gain or loss is reported (in total) in the current period income statement c. Any cash received is reported in Accumulated Other Comprehensive Income d. There is no impact on the non-controlling interest of a subsidiary Answer: d

©Cambridge Business Publishers, 2020 5-6

Advanced Accounting, 4th Edition

Multiple Choice – Computational Topic: Goodwill Accounting LO: 1 19. Wolfe Co. acquired 60% of the common stock of Parson Corp. for $1,500,000. The fair value of Parson's identifiable net assets was $1,600,000 and the book value was $1,550,000. The noncontrolling interest shares of Bates Corp. are not actively traded and there is no control premium. Determine the total amount of goodwill to be recognized. a. $570,000 b. $900,000 c. $-0d. $540,000 Answer: b

Topic: Allocation of Profit to Noncontrolling Interests LO: 2 20. Adamson Co. owns 60% of the voting common stock of Kilgore Corp. During 2020, Kilgore had revenues of $400,000 and expenses of $80,000. The amortization of the acquisition accounting premium totaled $34,000 in 2020. What amount should be reported in the consolidated income statement for income from noncontrolling interests? a. $107,600 b. $114,400 c. $128,000 d. $141,600 Answer: b

Topic: Sale of Common Stock by the Subsidiary to Outside Parties LO: 7 21. On January 1, 2020, Priceless Memories owns 100% of Sunshine & More, Inc. that reports a Stockholders’ Equity of $1,000,000 and 40,000 shares of $1 par value common stock outstanding. This acquisition was made at book value. During the year, Sunshine & More sells 10,000 of its unissued shares to outsiders for $50 per share. What is the balance of Priceless Memories’ pre-consolidation Equity Investment Account at December 31, 2020? a. $1,500,000 b. $ 600,000 c. $1,200,000 d. $-0Answer: c

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-7

The following information pertains to Questions 22-28. On January 1, 2021, Gooch Company acquires 80% of the outstanding common stock of House Inc., for a purchase price of $12,400,000. It was determined that the fair value of the noncontrolling interest in the subsidiary is $3,100,000. The book value of the House’s stockholders’ equity on the date of acquisition is $10,000,000 and its fair value of net assets is $11,000,000. The acquisition-date acquisition accounting premium (AAP) is allocated $600,000 to equipment with a remaining useful life of 10 years, and $250,000 to a patent with a remaining useful life of 5 years.

Topic: Acquisition Accounting Premium LO: 1 22. The [A] consolidating journal entry (on Gooch’s books) to recognize the acquisition date AAP and allocate the ownership interest in those assets to the parent and noncontrolling interests includes: a. Equity investment, credit, $5,350,000 b. Noncontrolling interest, credit, $3,100,000 c. House’s retained earnings, debit, $2,000,000 d. Noncontrolling interest, credit, $1,070,000 Answer: d

Topic: Acquisition Accounting Premium LO: 1 23. What is the acquisition accounting premium (AAP)? a. $5,500,000 b. $4,650,000 c. $2,400,000 d. $4,400,000 Answer: a

Topic: Goodwill LO: 1 24. Determine the total goodwill to be recognized at acquisition date. a. $ 3,720,000 b. $ 4,650,000 c. $23,400,000 d. $-0Answer: b

©Cambridge Business Publishers, 2020 5-8

Advanced Accounting, 4th Edition

Topic: Acquisition Accounting Premium LO: 1 25. What portion of the AAP should be assigned to noncontrolling interest? a. $1,070,000 b. $3,720,000 c. $-0d. $4,650,000 Answer: a Topic: Allocating Profit to Controlling Interest – Equity Method LO: 2 26. Assume that during the year ended December 31, 2021, House reports net income of $950,000 and pays dividends of $150,000. Gooch uses the equity method to account for its investment in House. Determine the December 31, 2021 ending balance in Gooch Company’s pre-consolidation equity investment account. a. $12,400,000 b. $12,952,000 c. $13,040,000 d. $13,090,000 Answer: b Topic: Allocating Profit to Controlling Interest – Cost Method LO: 4 27. Assume that during the year ended December 31, 2021, House reports net income of $950,000 and pays dividends of $150,000. Gooch uses the cost method to account for its investment in House. Determine the December 31, 2021 ending balance in Gooch Company’s pre-consolidation equity investment account. a. $12,400,000 b. $12,952,000 c. $13,040,000 d. $13,090,000 Answer: a

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-9

Topic: Allocating Profit to Noncontrolling Interest LO: 2 28. Given the information in the previous question, determine the December 31, 2021 amount of noncontrolling interest reported in the consolidated financial statements. a. $ 482,000 b. $3,100,000 c. $3,238,000 d. $3,260,000 Answer: c

Topic: Accounting for an Acquisition Achieved in Stages LO: 7 29. Assume that Bailey Company gains control of Moloney, its subsidiary, with the purchase of a 30% interest paid in cash. The Equity Investment account reports a balance of $250,000 on the acquisition date and represents a 40% interest in Moloney. The total value of Moloney on the acquisition date is $700,000 (assume no premium for control). The journal entry to record the acquisition includes: a. Cash, credit, $700,000 b. Gain on revaluation of Moloney, credit, $30,000 c. Loss on revaluation of Moloney, debit, $30,000 d. None of the above Answer: b

Topic: Sale of Equity investment by the Investor LO: 7 30. Delaney Company sells, for $280,000, a 40% of the shares it owns in Hunter Company. The carrying value of the Equity Investment relating to these shares is $240,000 on the date of sale. The journal entry to record the sale assuming Delaney keeps control over Hunter includes: a. Equity investment, debit, $240,000 b. Equity investment, credit, $280,000 c. Gain, credit, $40,000 d. APIC, credit, $40,000 Answer: d

©Cambridge Business Publishers, 2020 5-10

Advanced Accounting, 4th Edition

The following information pertains to Questions 31 and 32. Assume that, on January 1, 2019, P Company acquired a 70% interest in its subsidiary, S Company. The aggregate fair value of the controlling and noncontrolling interest was $400,000 in excess of S Company’s Stockholders’ Equity on the acquisition date. The parent uses the equity method to account for its investment in S company. The parent assigned the acquisition accounting premium (AAP) as follows: AAP Item PPE, net Customer List Goodwill

Initial Fair Value $220,000 120,000 60,000 $400,000

Useful Life (years) 10 10 Indefinite

P Company and S Company report the following financial statements at December 31, 2023: Income Statement Parent $6,500,000 Sales -4,250,000 Cost of goods sold 2,250,000 Gross Profit 74,000 Income (loss) from subsidiary -1,250,000 Operating expenses $1,074,000 Net income Statement of Retained Earnings Parent BOY Retained Earnings $7,900,000 Net income 1,074,000 Dividends -102,540 EOY Retained Earnings $8,871,460

Subsidiary $600,000 -350,000 250,000 -142,000 $108,000

Subsidiary $958,000 108,000 -18,750 $1,047,250

Balance Sheet Assets: Cash Accounts receivable Inventory Equity Investment PPE, net

Liabilities and Stockholders’ Equity: Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

Parent

Subsidiary

$500,000 2,045,000 657,000 1,331,475 9,507,985 $14,041,460

$250,000 425,000 624,500 511,750 $1,811,250

$900,000 1,570,000 600,000 2,100,000 8,871,460 $14,041,460

$370,000 0 42,000 352,000 1,047,250 $1,811,250

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-11

Topic: Allocation of Profit to Controlling Interest LO: 2 31. Based on the given financial statements, the computation of the pre-consolidation income (loss) from subsidiary of $74,000 reported by the parent includes a deduction for: a. $25,000 for excess attributable to depreciation and amortization b. $34,000 for excess attributable to depreciation and amortization c. $13,125 for 70% of dividends declared and paid by S Company d. $75,600 for 70% of the net income of subsidiary Answer: b

Topic: Apportionment of Goodwill in the Presence of Noncontrolling Interests LO: 2 32. The December 31, 2023 pre-consolidation balance of the equity investment accounting equals $1,331,475 (i.e., 5 years subsequent to the acquisition). On this date, the equity investment balance implicitly includes: a. Dividends, $121,290 b. Goodwill, $60,000 c. Goodwill, $48,000 d. Unamortized AAP excluding Goodwill, $204,000 Answer: c

©Cambridge Business Publishers, 2020 5-12

Advanced Accounting, 4th Edition

The following information pertains to Questions 33 and 34. Assume that, on January 1, 2019, P Company acquired an 70% interest in its subsidiary, S Company. The aggregate fair value of the controlling and noncontrolling interest was $400,000 in excess of S Company’s Stockholders’ Equity on the acquisition date. At the time of acquisition, S Company’s retained earnings balance was $415,000. The parent uses the cost method to account for its investment in S company. The parent assigned the acquisition accounting premium (AAP) as follows: AAP Item PPE, net Customer List Goodwill

Initial Fair Value $ 220,000 120,000 60,000 $400,000

Useful Life (years) 10 10 Indefinite

P Company and S Company report the following financial statements at December 31, 2023: Income Statement Parent $6,500,000 Sales -4,250,000 Cost of goods sold 2,250,000 Gross Profit 13,125 Income (loss) from subsidiary -1,250,000 Operating expenses $1,013,125 Net income Statement of Retained Earnings Parent BOY Retained Earnings $7,900,000 Net income 1,013,125 Dividends -102,540 EOY Retained Earnings $8,810,585

Subsidiary $600,000 -350,000 250,000 -142,000 $108,000

Subsidiary $958,000 108,000 -18,750 $1,047,250

Balance Sheet Assets: Cash Accounts receivable Inventory Equity Investment PPE, net

Liabilities and Stockholders’ Equity: Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

Parent

Subsidiary

$500,000 2,045,000 657,000 1,025,000 9,753,585 $13,980,585

$250,000 425,000 624,500 511,750 $1,811,250

$900,000 1,570,000 600,000 2,100,000 8,810,585 $13,980,585

$370,000 0 42,000 352,000 1,047,250 $1,811,250

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-13

Topic: Apportionment of Goodwill in the Presence of Noncontrolling Interests – Cost Method LO: 4 33. The December 31, 2023 pre-consolidation balance of the equity investment accounting equals $1,025,000 (i.e., 5 years subsequent to the acquisition). On this date, the equity investment balance implicitly includes: a. Dividends, $13,125 b. Goodwill, $60,000 c. Goodwill, $48,000 d. Unamortized AAP excluding Goodwill, $204,000 Answer: c Topic: Consolidating Entries – Cost Method LO: 4 34. Compute the amount of the beginning of year [ADJ] adjustment necessary for consolidation of the financial statements for the year ended December 31, 2023. a. $271,775 b. $298,025 c. $284,400 d. $407,000 Answer: c

The following information pertains to Questions 35 and 36. Assume the following facts relating to an 80% owned subsidiary company: BOY Stockholders’ Equity BOY unamortized AAP Net income of subsidiary (not including AAP amortization) AAP amortization expense Dividends declared and paid to noncontrolling shareholders

$1,000,000 125,000 210,000 40,000 10,000

Topic: Allocation of Profit to Noncontrolling Interests LO: 2 35. What is the net income attributable to noncontrolling interests for the year? a. $128,000 b. $136,000 c. $160,000 d. $168,000 Answer: b

Topic: Accounting for Noncontrolling Interests LO: 2 36. What is the amount reported as noncontrolling equity at the end of the year? a. $895,200 b. $996,000 c. $1,026,000 d. $1,028,000 Answer: c ©Cambridge Business Publishers, 2020 5-14

Advanced Accounting, 4th Edition

The following information pertains to Questions 37 and 38 Assume the following facts are about a parent and its 75% owned subsidiary company: Parent

Subsidiary

Net income

$200,000

$75,000

Common shares outstanding

45,000

30,000 (22,500 = 75% owned by parent)

Convertible Preferred Stock

Dividends = $25,000 Convertible into 5,000 shares of common stock

Convertible Bonds

Interest expense after tax = $5,000 Convertible into 4,000 shares of common stock

Topic: Consolidated Earnings per Share LO: 6 37. What is the basic earnings per share? a. $4.44 b. $5.14 c. $5.69 d. $6.94 Answer: b

Topic: Consolidated Earnings per Share LO: 6 38. What is the diluted earnings per share? a. $5.06 b. $2.35 c. $6.18 d. $4.00 Answer: a

Topic: Sale of Common Stock by the Subsidiary to Outside Parties LO: 7 39. Assume that Charlie Company owns 100% of Brown Corporation. Brown reports Stockholders’ Equity of $400,000. The Equity investment was acquired at book value (i.e., no AAP). Brown sells a 20% interest to outsiders for $120,000. The entry made by Charlie as a result of the sale of stock by Brown includes: a. APIC credit, $ 16,000 b. APIC credit, $120,000 c. APIC credit, $416,000 d. APIC credit, $496,000 Answer: a ©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-15

The following information pertains to Questions 40 and 41: Harvey Company increased its ownership in Washington Company from 70% to 90% by the purchase of additional shares of the Washington’s outstanding stock from noncontrolling shareholders for a purchase price of $300,000. Immediately prior to the transaction, Harvey’s consolidated balance sheet included a noncontrolling interest balance of $1,000,000.

Topic: Additional Purchase of Stock LO: 7 40. The journal entry by Harvey to record the purchase includes a net: a. Equity investment debit, $333,333 b. Equity investment debit, $300,000 c. Equity investment debit, $ 33,333 d. Equity investment debit, $200,000 Answer: a

Topic: Additional Purchase of Stock LO: 7 41. The journal entry by Harvey to record the purchase includes: a. APIC credit, $300,000 b. APIC credit, $ 33,333 c. APIC credit, $333,333 d. Cash credit, $333,333 Answer: b

Topic: Allocation of Profit LO: 7 42. Chesney Company is a wholly-owned subsidiary company which reports sales of $750,000 and net income of $250,000 for the calendar year in which it is acquired on May 1st. What amount of sales and net income are includable in consolidated income statement in the year of acquisition assuming that sales and net income are earned evenly over the year? a. Sales $500,000; Net income $166,667 b. Sales $250,000; Net income $83,333 c. Sales $750,000; Net income $250,000 d. Answer cannot be determined based on the given information Answer: a

©Cambridge Business Publishers, 2020 5-16

Advanced Accounting, 4th Edition

Topic: Allocation of Profit to Noncontrolling Interest LO: 2 43. Johnson Co. owns 70% of the voting common stock of Sandstone Corp. During 2021, Sandstone had revenues of $2,400,000 and expenses of $1,600,000. The AAP amortization totaled $75,000 in 2021. The non-controlling interest's share of the earnings of Sandstone Corp. is calculated to be: a. $217,500 b. $240,000 c. $262,500 d. $382,500 Answer: a

Topic: Allocation of Profit to Controlling Interest LO: 2 44. Johnson Co. owns 70% of the voting common stock of Sandstone Corp. During 2021, Sandstone had revenues of $2,400,000 and expenses of $1,600,000. The AAP amortization totaled $75,000 in 2021. What is the net effect of the inclusion of Sandstone on net income to the controlling interests for 2021? a. $342,500 b. $485,000 c. $507,500 d. $725,000 Answer: c

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-17

Exercises Topic: Interpretation of Noncontrolling Interest Footnote LO: 2 1. Melody Corporation reports the following table in the footnotes to its 2020 annual report (dollars in millions, except per share amounts, and shares in thousands): Years ended Dec. 31,

2020

2019

2018

Noncontrolling Interest Balance at beginning of year Net income attributable to noncontrolling interest Other comprehensive income (loss) Total comprehensive income Distributions and other Balance at end of year

$49,400 8,180 940 9,120 (2,460) $56,060

$44,690 7,450 (530) 6,920 (2,210) $49,400

$39,850 6,210 820 7,030 (2,190) $44,690

Required: a. Describe where the noncontrolling ending balance, 2020, should be reported in the financial statement(s) Melody Corporation. b. Prepare the journal entry to recognize the 2020 Net Income attributable to noncontrolling interest. c.

Is the journal entry in “b” recorded in the books of the parent or subsidiary? How is this amount determined?

Answer: a. The ending balance for noncontrolling interests equity is reported in the stockholders’ equity section of the consolidated balance sheet. b. Net income attributable to noncontrolling interest Noncontrolling interest c.

8,180 8,180

This is our [C] consolidation journal entry and it is not recorded in the books of either the parent or the subsidiary. We must first adjust the subsidiary income for its proportionate share of the amortization expense related to AAP assets and any deferred profit on upstream inventory sales.

©Cambridge Business Publishers, 2020 5-18

Advanced Accounting, 4th Edition

Topic: Preparing a Consolidated Income Statement LO: 2 2. Meadows Company purchased a 80% interest in Szot Company five years ago with no AAP (i.e., purchased at book value). Each reports the following income statement for the current year: Income Statement Meadows

Szot

Sales

$9,000,000

$750,000

Cost of goods sold

-4,200,000

-260,000

Gross Profit

4,800,000

490,000

Income (loss) from subsidiary Operating expenses Net income

112,000 -2,500,000

-350,000

$2,412,000

$140,000

Required: a. Compute the income (loss) from subsidiary of $112,000 reported by the Meadows Company. b. Prepare the consolidated income statement for the current year. Answer: a. $140,000 x 80% = $112,000 b. Consolidated Income Statement Sales Cost of goods sold Gross profit Operating expenses Net income Net income attributable to noncontrolling interests

$9,750,000 ($4,460,000) $5,290,000 ($2,850,000) 2,440,000 (28,000)

Net income attributable to the parent

$2,412,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-19

Topic: Consolidation on Date of Acquisition LO: 1 3. McKinney Company acquires an 60% interest in its Sandstone for a purchase price of $1.000,000. The excess of the purchase price over the book value of the Sandstone’s Stockholders’ Equity is allocated to a building (in PPE, net) that is worth $212,250 more than its book value, an unrecorded Patent that the parent valued at $125,000, and Goodwill of $348,417, 60% of which is allocated to the parent. The parent and the Sandstone report the following balance sheets on the acquisition date:

Cash Accounts receivable Inventory Equity Investment PPE, net

McKinney

Sandstone

$1,500,000 1,597,500 2,689,550 1,000,000 6,008,510

$300,000 240,000 275,000

$12,795,560

$1,691,000

876,000

Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

McKinney

Sandstone

$750,000 1,268,222 235,000 5,472,211 5,070,127

$300,000 410,000 75,000 156,000 750,000

$12,795,560

$1,691,000

Required: Prepare the consolidation journal entries on the acquisition date. Answer: [E] Common stock (S) - @BOY APIC (S) - @BOY Retained earnings (S) @BOY

75,000 156,000 750,000

Equity investment - @BOY 588,600 Noncontrolling interest (@BOY) 392,400 Eliminates the beginning balance in SE(S) by eliminating the BV portion of the beginning investment account.

[A]

PPE, net - @BOY (100% AAP) 212,250 Patent, net @BOY (100% AAP) 125,000 GW @ BOY (100% AAP) 348,417 Equity investment - @BOY ( AAP) 411,400 Noncontrolling Interest 274,267 Allocates beginning-of-year 100% AAP to the controlling and noncontrolling interests by eliminating the remaining investment account and establishing the BOY AAP for nci%.

©Cambridge Business Publishers, 2020 5-20

Advanced Accounting, 4th Edition

Topic: Consolidation Subsequent to Date of Acquisition – Equity Method LO: 2 4. Assume that, on January 1, 2019, Kuehler Company acquired an 80% interest in Eastwood Company for a purchase price that was $650,000 over the book value of the subsidiary’s Stockholders’ Equity on the acquisition date. Kuehler uses the equity method to account for its investment in Eastwood. Kuehler assigned the acquisition-date AAP as follows: AAP Items PPE Patent Customer List Goodwill

Initial Fair Value $350,000 100,000 150,000 50,000 $650,000

Useful Life (years) 10 5 5 Indefinite

80% of if the Goodwill is allocated to the parent. Kuehler and Eastwood report the following financial statements December 31, 2022: Income Statement Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Operating expenses

Kuehler $860,000 -458,000 402,000 56,000 -158,000

Eastwood $750,000 -430,000 320,000

Net income

$300,000

$155,000

Statement of Retained Earnings Kuehler $878,440 300,000 -175,000

Eastwood $420,000 155,000 -12,500

$1,003,440

$562,500

BOY Retained Earnings Net income Dividends Ending Retained Earnings

-165,000

Balance Sheet Assets: Cash Accounts receivable Inventory Equity Investment PPE, net Liabilities and Stockholders’ Equity: Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

Kuehler

Eastwood

$55,000 46,000 95,000 932,880 288,060 $1,416,940

$54,000 24,000 95,112 1,873,188 $2,046,300

$75,000 150,000 63,500 125,000 1,003,440 $1,416,940

$400,200 790,000 118,100 175,500 562,500 $2,046,300

Required: a. Compute the EOY noncontrolling interest equity balance. b. Prepare the consolidation journal entries.

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-21

Answer: a. Beg. Bal Noncontrolling interests equity: Stockholders' equity

142,720

(20%)

Unamortized 20% AAP

79,000

(20%)

Income attributable to NCI

14,000

Dividends

(2,500)

End Bal NCI

233,220

b. [C]

Income (loss) from subsidiary

56,000

Consol. NI attributable to NCI

14,000

Dividends

12,500

Equity investment

46,000

Noncontrolling interest 11,500 Eliminates the change in the investment account of AAP adjusted changes in SE(S). [E]

Common stock (S) - @BOY

118,100

APIC (S) - @BOY

175,500

Retained earnings (S) @BOY

420,000

Equity investment - @BOY

570,880

Noncontrolling interest (@BOY) 142,720 Eliminates p% of the beginning balance in SE(S) by eliminating the BV portion of the beginning investment account. [A]

PPE, net - @BOY (100% AAP)

245,000

Patent, net @BOY (100% AAP)

40,000

Customer list, net @BOY (100% AAP)

60,000

GW @ BOY (100% AAP)

50,000

Equity investment - @BOY ( AAP)

316,000

Noncontrolling interest 79,000 Allocates beginning-of-year 100% AAP to the controlling and noncontrolling interests by eliminating the remaining investment account and establishing the BOY AAP for nci%. [D]

[I]

Operating expenses (for 100% AAP amort)

85,000

PPE, net (for 100% AAP amort)

35,000

Patent, net (for 100% AAP amort)

20,000

Customer list, net (for 100% AAP amort)

30,000

Not applicable in this problem

©Cambridge Business Publishers, 2020 5-22

Advanced Accounting, 4th Edition

Topic: Consolidation Subsequent to Date of Acquisition – Cost Method LO: 4 5. Assume that, on January 1, 2019, Kuehler Company acquired a 80% interest in Eastwood Company for a purchase price that was $650,000 over the book value of the subsidiary’s Stockholders’ Equity on the acquisition date. Kuehler uses the cost method to account for its investment in Eastwood. On the date of acquisition, Eastwood’ retained earnings balance was $100,000. Kuehler assigned the acquisition-date AAP as follows: AAP Items PPE Patent Customer List Goodwill

Initial Fair Value $350,000 100,000 150,000 50,000 $650,000

Useful Life (years) 10 5 5 Indefinite

80% of if the Goodwill is allocated to the parent. Kuehler and Eastwood report the following financial statements December 31, 2022: Income Statement Kuehler $860,000 -458,000 402,000 10,000 -158,000 $254,000

Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Operating expenses Net income

Statement of Retained Earnings Kuehler BOY Retained Earnings $878,440 Net income 254,000 Dividends -175,000 Ending Retained Earnings $957,440

Eastwood $750,000 -430,000 320,000 -165,000 $155,000

Eastwood $420,000 155,000 -12,500 $562,500

Balance Sheet Assets: Cash Accounts receivable Inventory Investment in subsidiary PPE, net Liabilities and Stockholders’ Equity: Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

Kuehler

Eastwood

$55,000 46,000 95,000 834,880 340,060 $1,370,940

$54,000 24,000 95,112 1,873,188 $2,046,300

$75,000 150,000 63,500 125,000 957,440 $1,370,940

$400,200 790,000 118,100 175,500 562,500 $2,046,300

Required: a. Compute the EOY noncontrolling interest equity balance. b. Prepare the consolidation journal entries. ©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-23

Answer: a. Beg. Bal Noncontrolling interests equity: Stockholders' equity

142,720

Unamortized 10% AAP

79,000

Income attributable to NCI

14,000

Dividends

(2,500)

End Bal NCI

233,220

(20%)

b. [ADJ]

Investment in subsidiary

52,000

Retained earnings

52,000

To restate the investment in subsidiary account from cost to “as-if” equity method <adj> entry

[C]

Change in RE

320,000

net @ %

AAP @ BOY

255,000

52,000

Income (loss) from subsidiary

10,000

Consol. NI attributable to NCI

14,000

Dividends

12,500

Noncontrolling interest 11,500 Eliminates dividend income from parent’s income statement, dividends from subsidiary’s equity section and establishes income attributable to noncontrolling interest. [E]

Common stock (S) - @BOY

118,100

APIC (S) - @BOY

175,500

Retained earnings (S) @BOY

420,000

Investment in subsidiary - @BOY

570,880

Noncontrolling interest (@BOY) 142,720 Eliminates p% of the beginning balance in SE(S) by eliminating the BV portion of the beginning investment account. [A]

PPE, net - @BOY (100% AAP)

245,000

Patent, net @BOY (100% AAP)

40,000

Customer list, net @BOY (100% AAP)

60,000

GW @ BOY (100% AAP)

50,000

Investment in subsidiary - @BOY ( AAP)

316,000

[I]

Operating expenses (for 100% AAP amort)

85,000

PPE, net (for 100% AAP amort)

35,000

Patent, net (for 100% AAP amort)

20,000

Customer list, net (for 100% AAP amort)

30,000

Not applicable in this problem

©Cambridge Business Publishers, 2020 5-24

Advanced Accounting, 4th Edition

Topic: Consolidation Subsequent to Date of Acquisition LO: 2 6. Assume that, on January 1, 2019, Ponderosa Company acquires a 70% interest in Abilene Company for a purchase price that was $400,000 over the book value of the Abilene’s Stockholders’ Equity on the acquisition date. Ponderosa assigned the acquisition-date AAP as follows: AAP Items Patent Goodwill

Initial Fair Value 150,000 250,000 $400,000

Useful Life (years) 10 Indefinite

The parent and the subsidiary report the following financial statements at December 31, 2025: Income Statement Ponderosa $6,000,000 -3,700,000 2,300,000 343,000 -890,000 $1,753,000

Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Operating expenses Net income

Statement of Retained Earnings Ponderosa BOY Retained Earnings $9,010,600 Net income 1,753,000 Dividends -280,500 EOY Retained Earnings $10,483,100

Abilene $2,250,000 -1,305,000 945,000 -440,000 $505,000

Abilene $3,797,500 505,000 -54,000 $4,248,500

Ponderosa

Abilene

$930,600 1,851,000 2,216,600 3,769,150 6,407,250 $15,174,600

$575,600 813,800 1,207,900 3,395,400 $5,992,700

$627,400 1,167,100 896,000 2,001,000 10,483,100 $15,174,600

$403,200 500,000 190,000 651,000 4,248,500 $5,992,700

Required: Prepare the following consolidation journal entries. a. To eliminate the beginning balances in SE(S) b. To Allocate beginning-of-year AAP to the controlling and noncontrolling interest c. To record amortization of patent

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-25

Answer: a. [E]

Common Stock (S) - @BOY

190,000

APIC (S) - @BOY

651,000

Retained Earnings (S) @BOY

3,797,500

Equity Investment - @BOY

3,246,950

Noncontrolling interest (@BOY) 1,391,550 Eliminates the beginning balance in SE(S) by eliminating the BV portion of the beginning investment account b. [A]

Patent, net @BOY (100% AAP)

60,000

GW @ BOY (100% AAP)

250,000

Equity investment - @BOY ( AAP)

217,000

Noncontrolling interest

93,000

Allocates beginning-of-year 100% AAP to the controlling and noncontrolling interests by eliminating the remaining investment account and establishing the BOY AAP for nci%. c. [D]

Operating expenses (for 100% AAP amort) Patent, net (for 100% AAP amort)

[I]

15,000 15,000

Not applicable in this problem

©Cambridge Business Publishers, 2020 5-26

Advanced Accounting, 4th Edition

Topic: Consolidation Subsequent to Date of Acquisition – Upstream Intercompany Inventory Sale – Equity Method LO: 2, 3 7. On January 1, 2020, Wondersome Company acquired a 70% interest in Philmore Company for a purchase price that was $240,000 over the book value of the Philmore’s Stockholders’ Equity on the acquisition date. Wondersome uses the equity method to account for its investment in Philmore. Wondersome assigned the acquisition-date AAP as follows: AAP Items PPE, net Patent

Initial Fair Value $90,000 150,000 $240,000

Useful Life (years) 20 10

Philmore sells inventory to Wondersome (upstream) which includes that inventory in products that it, ultimately, sells to customers outside of the controlled group. You have compiled the following data for the years ending 2022 and 2023:

Transfer price for inventory sale Cost of goods sold Gross profit % inventory remaining Gross profit deferred

2022 $94,500 -64,500 $30,000 30% $9,000

2023 $70,000 -45,000 $25,000 20% $5,000

EOY Receivable/Payable

$32,000

$29,500

The inventory not remaining at the end of the year has been sold outside of the controlled group. The parent and the subsidiary report the following financial statements at December 31, 2023: Income Statement Wondersome $2,400,000 -1,580,000 820,000 45,851 -711,200 $154,651

Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Operating expenses Net income

Philmore $602,400 -465,398 137,002 -56,000 $81,002

Statement of Retained Earnings Wondersome $3,500,000 154,651 -85,000 $3,569,651

BOY Retained Earnings Net income Dividends EOY Retained Earnings

Philmore $608,000 81,002 -15,000 $674,002

Continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-27

Balance Sheet Assets: Cash Accounts receivable Inventory Equity Investment PPE, net

Liabilities and Stockholders’ Equity: Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

Wondersome

Philmore

$450,000 425,000 654,000 803,251 4,438,400 $6,770,651

$84,700 113,200 142,100 1,000,002 $1,340,002

$505,900 703,500 402,000 1,589,600 3,569,651 $6,770,651

$99,500 250,000 75,300 241,200 674,002 $1,340,002

Required: a. Compute the EOY noncontrolling interest equity balance b. Prepare the consolidation journal entries. Answer: a. Beg. Bal Noncontrolling interests equity: Stockholders' equity

277,350

($608,000 + $75,300 + $241,200) x 30%

Deferred gain

(2,700)

($9,000 x 30%)

BOY Unamortized 30% AAP

($240,000 – 3 x $19,500) x 30% ($81,002 - $19,500+9,000-5000) x 30%

NCI Income, net of amort. of AAP

54,450 19,651 19,651

Dividends

(4,500)

EOY Noncontrolling Interests

$15,000 x 30%

344,251

©Cambridge Business Publishers, 2020 5-28

Advanced Accounting, 4th Edition

b. [C]

Income (loss) from subsidiary

45,851

Consol. NI attributable to NCI

19,651

Dividends

15,000

Equity investment

35,351

Noncontrolling interest

15,151

Eliminates the change in the investment account of AAP adjusted changes in SE(S). [E]

Common stock (S) - @BOY

75,300

APIC (S) - @BOY

241,200

Retained earnings (S) @BOY

608,000

Equity investment - @BOY

647,150

Noncontrolling interest (@BOY)

277,350

Eliminates the beginning balance in SE(S) by eliminating the BV portion of the beginning investment account. [A]

PPE, net - @BOY (100% AAP)

76,500

Patent, net @BOY (100% AAP)

105,000

Equity investment - @BOY ( AAP)

127,050

Noncontrolling interest 54,450 Allocates beginning-of-year 100% AAP to the controlling and noncontrolling interests by eliminating the remaining investment account and establishing the BOY AAP for nci%. [D]

Operating expenses (for 100% AAP amort.)

19,500

PPE, net (for 100% AAP amort)

4,500

Patent, net (for 100% AAP amort)

15,000

Recognition of dep and amort of AAP assets. [Icogs] Equity investment

6,300

Noncontrolling interest @ BOY

2,700

Cost of goods sold 9,000 Recognition of deferred gain on inventory sale and proration between parent and subsidiary. [Isales] Sales

70,000

Cost of goods sold Elimination of 100% of all intercompany transactions. [Icogs] Cost of goods sold

70,000

5,000

Inventory Deferral of gross profit on this year inventory sales.

5,000

[Isales] Accounts payable

29,500

Accounts receivable Elimination of intercompany receivable and payable.

29,500

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-29

Topic: Consolidation Subsequent to Date of Acquisition—Upstream Intercompany Inventory Sale —Cost Method LO: 2, 4 8. On January 1, 2020, Wondersome Company acquired a 70% interest in Philmore Company for a purchase price that was $240,000 over the book value of the Philmore’s Stockholders’ Equity on the acquisition date. Wondersome uses the cost method to account for its investment in Philmore. On the date of acquisition, Philmore’s retained earnings balance was $350,000. Wondersome assigned the acquisition-date AAP as follows: AAP Items PPE, net Patent

Initial Fair Value 90,000 150,000 $350,000

Useful Life (years) 20 10

2023

Transfer price for inventory sale Cost of goods sold Gross profit % inventory remaining Gross profit deferred

$94,500 -64,500 $30,000 30% $9,000

$70,000 -45,000 $25,000 20% $5,000

EOY Receivable/Payable

$32,000

$29,500

Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Operating expenses Net income

Philmore $602,400 -465,398 137,002 -56,000 $81,002

Statement of Retained Earnings Wondersome $3,360,350 119,300 -85,000 $3,394,650

BOY Retained Earnings Net income Dividends EOY Retained Earnings

Philmore $608,000 81,002 -15,000 $674,002

Continued

©Cambridge Business Publishers, 2020 5-30

Advanced Accounting, 4th Edition

Balance Sheet Wondersome

Philmore

$450,000 425,000 654,000 634,550 4,432,100 $6,595,650

$84,700 113,200 142,100 1,000,002 $1,340,002

$505,900 703,500 402,000 1,589,600 3,394,650 $6,595,650

$99,500 250,000 75,300 241,200 674,002 $1,340,002

Assets: Cash Accounts receivable Inventory Investment in subsidiary PPE, net

Liabilities and Stockholders’ Equity: Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

Required: a. Compute the EOY noncontrolling interest equity balance b. Prepare the consolidation journal entries. Answer: a. Beg. Bal Noncontrolling interests equity: Stockholders' equity

$277,350

($608,400 + $75,300 + $241,200) x 30%

Deferred gain

(2,700)

($9,000 x 30%)

BOY Unamortized 30% AAP

54,450

($240,000 – 3 x $19,500) x 30%

NCI Income, net of amort. of AAP

19,651

($81,002 - $19,500+9,000-5,000) x 30%

Dividends

(4,500)

$15,000 x 30%

EOY Noncontrolling Interests

$344,251

b. [ADJ]

Investment in subsidiary

133,350

Retained earnings 133,350 To restate the investment in subsidiary account from cost to “as-if” equity method <adj. entry>

Change in RE

258,000

AAP to BOY

58,500

PY deferral

9,000 190,500

133,350

Continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-31

[C]

Income (loss) from subsidiary

10,500

Consol. NI attributable to NCI

19,651

Dividends

15,000

Noncontrolling interest 15,151 Eliminates dividend income from parent’s income statement, dividends from subsidiary’s equity section and establishes income attributable to noncontrolling interest. [E]

Common stock (S) - @BOY

75,300

APIC (S) - @BOY

241,200

Retained earnings (S) @BOY

608,000

Investment in subsidiary - @BOY

647,150

Noncontrolling interest (@BOY)

277,350

Eliminates the beginning balance in SE(S) by eliminating the BV portion of the beginning investment account. [A]

PPE, net - @BOY (100% AAP)

76,500

Patent, net @BOY (100% AAP)

105,000

Investment in subsidiary- @BOY ( AAP)

127,050

Noncontrolling interest

54,450

Allocates beginning-of-year 100% AAP to the controlling and noncontrolling interests by eliminating the remaining investment account and establishing the BOY AAP for nci%. [D]

Operating expenses (for 100% AAP amort.)

19,500

PPE, net (for 100% AAP amort)

4,500

Patent, net (for 100% AAP amort)

15,000

Recognition of dep and amort of AAP assets. [Icogs] Investment in subsidiary Noncontrolling interest @ BOY

6,300 2,700

Cost of goods sold 9,000 Recognition of deferred gain on inventory sale and proration between parent and subsidiary. [Isales] Sales

70,000

Cost of goods sold Elimination of 100% of all intercompany transactions. [Icogs] Cost of goods sold

70,000

5,000

Inventory Deferral of gross profit on this year inventory sales. [Isales] Accounts payable Accounts receivable Elimination of intercompany receivable and payable.

5,000

29,500 29,500

©Cambridge Business Publishers, 2020 5-32

Advanced Accounting, 4th Edition

Problems Topic: Consolidation Subsequent to Date of Acquisition Upstream Intercompany Inventory Sale – Equity Method LO: 2, 3 1. In January 1, 2019, Strolle Company acquired an 70% interest in Hailey Company for a purchase price that was $500,000 over the book value of Hailey’s Stockholders’ Equity on the acquisition date. Spring uses the equity method to account for its investment in Hailey. Strolle assigned the acquisition-date AAP as follows: AAP Items Patent Goodwill

Initial Fair Value 350,000 150,000 $500,000

Useful Life (years) 10 Indefinite

Hailey sells inventory to Strolle (upstream) which includes that inventory in products that it (Strolle), ultimately, sells to customers outside of the controlled group. You have compiled the following data as of 2024 and 2025:

Transfer price for inventory sale Cost of goods sold Gross profit % inventory remaining Gross profit deferred EOY Receivable/Payable

2024

2025

$305,500

$500,000

-259,675 $45,825 50% $22,913

-440,000 60,000 40% $24,000

$42,000

$18,000

The inventory not remaining at the end of the year has been sold outside of the controlled group. Strolle and Hailey report the following financial statements at December 31, 2025: Income Statement Strolle $4,500,000 -3,825,000 675,000 13,939 -323,000 $365,939

Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Operating expenses Net income

Hailey $750,000

(660,000) 90,000 -34,000 $56,000

Statement of Retained Earnings Strolle $4,465,000 365,939 -105,400 $4,725,539

BOY Retained Earnings Net income Dividends EOY Retained Earnings

Hailey $440,000 56,000 -10,000 $486,000

Continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-33

Balance Sheet Assets: Cash Accounts receivable Inventory Equity Investment PPE, net

Liabilities and Stockholders’ Equity: Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

Strolle

Hailey

$420,000 304,000 654,000 782,600 6,723,539 $8,884,139

$425,000 545,000 425,000 420,000 $1,815,000

$340,000 1,750,000 853,600 1,215,000 4,725,539 $8,884,139

$175,000 753,000 92,100 308,900 486,000 $1,815,000

Required: a. Compute the EOY noncontrolling interest equity balance. b. Prepare the consolidation spreadsheet as of December 31, 2025: Answer: a. Beg. Bal Noncontrolling interests equity: Stockholders' equity Deferred gain Unamortized BOY AAP NCI Income Dividends (30%) Ending Balance Noncontrolling Interests

$252,300 (6,874) 87,000 5,974 (3,000) $335,400

($440,000 + $92,100 + $308,900) x 30% ($22,913 x 30%) [$500,000 – (6 x $35,000)] x 30% ($56,000 - $35,000 - $24,000+22,913) x 30% $10,000 x 30%

b. Strolle

Hailey

$4,500,000

$750,000

-3,825,000

(660,000)

Gross Profit

675,000

90,000

Income (loss) from subsidiary

13,939

Sales Cost of goods sold

Dr [Isales]

$500,000

[Icogs]

24,000

[Isales] $500,000 [Icogs]

-323,000

Net income Consol. NI attributable to NCI

$365,939

$56,000

_________

$970,400

$257,000

22,913

(3,986,088) 763,913

[C]

13,939

[D]

35,000

-34,000

Operating expenses

Consolidated Income Statement 4,750,000

0 (392,000) 371,913

[C]

5,974

(5,974) 365,939

Consol. NI attributable to parent Continued

©Cambridge Business Publishers, 2020 5-34

Advanced Accounting, 4th Edition

Statement of Retained Earnings BOY retained earnings

$4,465,000

$440,000

Net income

365,939

56,000

Dividends

-105,400

-10,000

$4,725,539

$486,000

Ending retained earnings

Strolle

Hailey

Cash

$420,000

$425,000

Accounts receivable

304,000

545,000

Inventory

654,000

425,000

Equity investment

782,600

[E]

440,000

4,465,000 365,939 [C]

10,000

(105,400) $4,725,539

Consolidated Balance Sheet

Balance Sheet Assets:

PPE, net

6,723,539

[Icogs]

16,039

[Ipay]

18,000

831,000

[Icogs]

24,000

1,055,000

[C]

6,939

[E]

588,700

[A]

203,000

420,000

Patent Goodwill

845,000

__________

_________

$8,884,139

$1,595,000

7,143,539

[A]

140,000

[A]

150,000

[D]

35,000

105,000 150,000 $10,129,539

Liabilities and stockholders’ equity: Current liabilities

$340,000

$175,000

Long-term liabilities

1,750,000

753,000

853,600

APIC Retained earnings

Common stock

[Ipay]

18,000

92,100

[E]

92,100

853,600

1,215,000

308,900

[E]

308,900

1,215,000

4,725,539

266,000

2,503,000

4,725,539

Noncontrolling interest [Icogs] ___________

__________

$8,884,139

$1,595,000

497,000

∑

6,874

1,750,826

[A]

87,000

335,400

[E]

252,300

[C]

2,974

___________

∑

1,750,826

10,129,539

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-35

Topic: Consolidation Subsequent to Date of Acquisition – Upstream Intercompany Inventory Sale –Cost Method LO: 2, 4 2. In January 1, 2019, Strolle Company acquired an 70% interest in Hailey Company for a purchase price that was $500,000 over the book value of Hailey’s Stockholders’ Equity on the acquisition date. Spring uses the cost method to account for its investment in Hailey. On the date of acquisition, Hailey’s retained earnings balance was $180,000. Strolle assigned the acquisitiondate AAP as follows: AAP Items Patent Goodwill

Initial Fair Value 350,000 150,000 $500,000

Useful Life (years) 10 Indefinite

Transfer price for inventory sale Cost of goods sold Gross profit % inventory remaining Gross profit deferred EOY Receivable/Payable

2024

2025

$305,500

$500,000

-259,675 $45,825 50% $22,913

-440,000 60,000 40% $24,000

$42,000

$18,000

Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Operating expenses Net income

Hailey $750,000

(660,000) 90,000 -34,000 $56,000

Statement of Retained Earnings Strolle 4,446,039 359,000 -105,400 $4,699,639

BOY Retained Earnings Net income Dividends EOY Retained Earnings

Hailey $440,000 56,000 -10,000 $486,000

continued

©Cambridge Business Publishers, 2020 5-36

Advanced Accounting, 4th Edition

Balance Sheet Assets: Cash Accounts receivable Inventory Investment in subsidiary PPE, net

Liabilities and Stockholders’ Equity: Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

Strolle

Hailey

$420,000 304,000 654,000 756,700 6,723,539 $8,858,239

$425,000 545,000 425,000 420,000 $1,815,000

$340,000 1,750,000 853,600 1,215,000 4,699,639 $8,858,239

$175,000 753,000 92,100 308,900 486,000 $1,815,000

Required: a. Compute the EOY noncontrolling interest equity balance. b. Prepare the consolidation spreadsheet on the acquisition date. Answer: a. Beg. Bal Noncontrolling interests equity: Stockholders' equity

$252,300

($440,000 + $92,100 + $308,900) x 30%

Deferred gain

(6,874)

($22,913 x 30%)

Unamortized BOY AAP

87,000

[$500,000 – (6 x $35,000)] x 30%

NCI Income

5,974

($56,000 - $35,000 - $24,000+22,913) x 30%

Dividends (30%)

(3,000)

$10,000 x 30%

Ending Balance Noncontrolling Interests

$335,400

Sales

Strolle $4,500,000

Hailey $750,000

Dr [Isales]

$500,000

Cost of goods sold

-3,825,000

(660,000)

[Icogs]

24,000

675,000

90,000

4,750,000 [Isales] $500,000 [Icogs]

Gross Profit Income (loss) from subsidiary

7,000

Operating expenses

-323,000

-34,000

Net income

$359,000

$56,000

_________ $359,000

_________ $56,000

Consol. NI attributable to NCI Consol. NI attributable to parent

Consolidated Income Statement

22,913

(3,986,088) 763,913

[C]

7,000

[D]

35,000

(392,000) 371,913

[C]

5,974

5,974 365,939

continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-37

Statement of Retained Earnings 4,446,039

$440,000

Net income

359,000

56,000

Dividends

-105,400

-10,000

$4,699,639

$486,000

BOY retained earnings

Ending retained earnings

[E]

440,000 [ADJ]

18,961

4,465,000 365,939

[C]

10,000

(105,400) $4,725,539

Consolidated Balance Sheet

Strolle

Hailey

Cash

$420,000

$425,000

Accounts receivable

304,000

545,000

[Ipay]

18,000

831,000

Inventory

654,000

425,000

[Icogs]

24,000

1,055,000

Investment in subsidiary

756,700

Balance Sheet Assets:

6,723,539

PPE, net

[ADJ]

16,039

[E]

588,700

[Icogs]

18,961

[A]

203,000

[A]

140,000

[D]

35,000

420,000

Patent Goodwill

845,000

7,143,539 105,000

__________ $8,858,239

_________ $1,815,000

[A]

150,000

150,000 $10,129,539

Liabilities and stockholders’ equity: $340,000 Current liabilities

$175,000

[Ipay]

18,000

497,000

1,750,000

753,000

853,600

92,100

[E]

92,100

853,600

1,215,000

308,900

[E]

308,900

4,699,639

486,000

1,215,000 4,725,539

Long-term liabilities Common stock APIC Retained earnings

2,503,000

335,400 Noncontrolling interest [Icogs] ___________

__________

$8,858,239

$1,815,000

6,874

[A]

87,000

[E]

252,300

[C]

2974

___________ 10,129,539

©Cambridge Business Publishers, 2020 5-38

Advanced Accounting, 4th Edition

Topic: Consolidation Subsequent to Date of Acquisition Downstream Intercompany Inventory Sale – Equity Method LO: 2, 3 3. Assume that, on January 1, 2019, a parent company acquired a 70% interest in its subsidiary for a purchase price that was $400,000 over the book value of the subsidiary’s Stockholders’ Equity on the acquisition date. The parent uses the equity method to account for its investment in the subsidiary. The parent assigned the acquisition-date AAP as follows:

AAP Items PPE

Initial Fair Value 400,000

Useful Life (years) 10

Assume that the parent sells inventory to the subsidiary (downstream) which includes that inventory in products that it, ultimately, sells to customers outside of the controlled group. You have compiled the following data as of 2021 and 2022:

Transfer price for inventory sale Cost of goods sold Gross profit % inventory remaining Gross profit deferred

2021 $85,000 -65,000 $20,000 30% $6,000

2022 $125,000 -100,000 $25,000 30% $7,500

EOY Receivable/Payable

$18,000

$20,000

The inventory not remaining at the end of the year has been sold outside of the controlled group. The parent and the subsidiary report the following financial statements at December 31, 2022: Income Statement Parent $3,500,000 -2,800,000 700,000 9,000 -340,000 $369,000

Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Operating expenses Net income

Subsidiary $600,000 -480,000 120,000 -65,000 $55,000

Statement of Retained Earnings Parent $5,302,000 369,000 -60,000 $5,611,000

BOY Retained Earnings Net income Dividends EOY Retained Earnings

Subsidiary $850,000 55,000 -18,000 $887,000

continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-39

Balance Sheet Assets: Cash Accounts receivable Inventory Equity Investment PPE, net

Liabilities and Stockholders’ Equity: Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

Parent

Subsidiary

$780,000 1,051,600 1,250,000 892,350 5,773,050 $9,747,000

$215,000 210,000 195,000 1,400,000 $2,020,000

$751,000 2,070,000 450,000 865,000 5,611,000 $9,747,000

$500,000 474,500 42,000 116,500 887,000 $2,020,000

Required: a. Compute the EOY Equity Investment balance of $892,350 (4 years subsequent to the acquisition). b. Compute the EOY noncontrolling interest equity balance. c. Prepare the consolidation spreadsheet. Answer: a. Equity Investment BOY book value of stockholders’ equity

$705,950

($850,000 + $42,000 + $116,500) x 70%

196,000

[$400,000 – (3 x $40,000)] x 70%

BOY [A] assets ex GW BOY deferred profit

(6,000)

100% since downstream

Income (loss) from subsidiary [C]

9,000

($55,000 - $40,000) x 70% - $7,500 + $6,000

Dividends (70%)

(12,600)

EOY Equity Investment

$18,000 x 70%

$892,350

b. Beg. Bal Noncontrolling interests equity: Stockholders' equity

$302,550

($850,000 + $42,000 + $116,500) x 30%

[A] Assets

$84,000

[$400,000 – (3 x $40,000)] x 30%

Income [C]

4,500

($55,000 - $40,000) x 30%

Dividends (30%)

(5,400)

$18,000 x 30%

Ending Balance Noncontrolling Interests

$385,650

continued

©Cambridge Business Publishers, 2020 5-40

Advanced Accounting, 4th Edition

c. Parent

Subsidiary

Sales

$3,500,000

$600,000

[Isales]

$125,000

Cost of goods sold

-2,800,000

-480,000

[Icogs]

$7,500

Gross profit

700,000

120,000

Income (loss) from subsidiary Operating expenses

9000 -340,000

-65,000

Net income

$369,000

$55,000

Consolidated

Income Statement

Consol. NI attributable to NCI $369,000

$125,000

(3,156,500)

[Icogs]

$6,000

) 818,500

[C]

9,000

[D]

40,000

(445,000) 373,500

[C]

Consol. NI attributable to parent

3,975,000 [Isales]

44,500

(4,500)

$55,000 369,000

Statement of Retained Earnings $5,302,000

$850,000

Net income

369,000

55,000

Dividends

-60,000

-18,000

$5,611,000

$887,000

5,611,000

Cash

$780,000

$215,000

995,000

Accounts receivable

1,051,600

210,000

[Ipay]

$20,000

1,241,600

Inventory

1,250,000

195,000

[Icogs]

$7,500

1,437,500

[C]

3,600

[E]

$705,950

[A]

$196,000

[D]

40,000

BOY Retained earnings

End. Retained earnings

[E]

850,000

5,302,000 369,000 [C]

18,000

(60,000)

Balance Sheet Assets:

892,350

Equity investment

[Icogs]

5,773,050

1,400,000

$10,850,400

$1,915,100

PPE, net

[A]

6,000

280,000

7,413,050 11,087,150

Liabilities and stockholders’ equity: Current liabilities

$751,000

$500,000

Long-term liabilities

2,070,000

474,500

Common stock

450,000

APIC Retained earnings

[Ipay]

20,000

42,000

[E]

42,000

450,000

865,000

116,500

[E]

116,500

865,000

5,611,000

887,000 [C]

900

Noncontrolling interest

_________ $9,747,000

_________ $2,020,000

1,231,000 2,544,500

5,611,000

∑

1,500,500

385,650 [E]

$302,550

[A] ∑

$84,000 1,500,500

_________ 11,087,150

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-41

Topic: Consolidation Subsequent to Date of Acquisition Downstream Intercompany Inventory Sale – Cost Method LO: 2, 4 4. Assume that, on January 1, 2019, a parent company acquired a 70% interest in its subsidiary for a purchase price that was $400,000 over the book value of the subsidiary’s Stockholders’ Equity on the acquisition date. The parent uses the cost method to account for its investment in the subsidiary. On the date of acquisition, the subsidiary’s retained earnings balance was $500,000. The parent assigned the acquisition-date AAP as follows: AAP Item PPE

Initial Fair Value 400,000

Useful Life (years) 10

Transfer price for inventory sale Cost of goods sold Gross profit % inventory remaining Gross profit deferred

2021 $85,000 -65,000 $20,000 30% $6,000

2022 $125,000 -100,000 $25,000 30% $7,500

EOY Receivable/Payable

$18,000

$20,000

The inventory not remaining at the end of the year has been sold outside of the controlled group. The parent and the subsidiary report the following financial statements at December 31, 2022: Income Statement Parent $3,500,000 -2,800,000 700,000 12,600 -340,000 $372,600

Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Operating expenses Net income

Subsidiary $600,000 -480,000 120,000 -65,000 $55,000

Statement of Retained Earnings Parent $5,147,000 372,600 -60,000 $5,459,600

BOY Retained Earnings Net income Dividends EOY Retained Earnings

Subsidiary $850,000 55,000 -18,000 $887,000

continued

©Cambridge Business Publishers, 2020 5-42

Advanced Accounting, 4th Edition

Balance Sheet Assets: Cash Accounts receivable Inventory Investment in subsidiary PPE, net

Liabilities and Stockholders’ Equity: Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

Parent

Subsidiary

$780,000 1,051,600 1,250,000 740,950 5,773,050 $9,595,600

$215,000 210,000 195,000 1,400,000 $2,020,000

$751,000 2,070,000 450,000 865,000 5,459,600 $9,595,600

$500,000 474,500 42,000 116,500 887,000 $2,020,000

Required: a. Compute the EOY Investment in subsidiary balance assuming the parent used the equity method instead of the cost method (4 years subsequent to the acquisition). b. Compute the EOY noncontrolling interest equity balance. c. Prepare the consolidation spreadsheet. Answer: a. Investment in subsidiary EOY book value of stockholders’ equity

$731,850 ($887,000 + $42,000 + $116,500) x 70% 168,000 [$400,000 – (4 x $40,000)] x 70%

EOY unamortized AAP (ex GW) EOY deferred profit

(7,500) 100% since downstream

EOY Investment in subsidiary

$892,350

b. Beg. Bal Noncontrolling interests equity: Stockholders' equity

302,550

($850,000 + $42,000 + $116,500) x 30%

[A] Assets

84,000

[$400,000 – (3 x $40,000)] x 30%

Income [C]

4,500

($55,000 - $40,000) X 30%

Dividends (25%)

(5,400) $18,000 x30%

Ending Balance Noncontrolling Interests

$385,650

continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-43

c. Parent

Subsidiary

Sales

$3,500,000

$600,000

[Isales]

$125,000

Cost of goods sold

-2,800,000

-480,000

[Icogs]

7,500

Gross profit

700,000

120,000

Income (loss) from subsidiary

12,600

Consolidated

[Isales]

$125,000

(3,156,500)

[Icogs]

6,000

Income Statement

Operating expenses

-340,000

-65,000

Net income

$372,600

$55,000

Consol. NI attributable to NCI Consol. NI attributable to parent

3,975,000

818,500 [C]

12,600

---

[D]

40,000

(445,000) 373,500

[C]

4,500

(4,500) 369,000

Statement of Retained Earnings $5,147,000

$850,000

Net income

372,600

55,000

Dividends

-60,000

-18,000

$5,459,600

$887,000

Cash

$780,000

$215,000

Accounts receivable

1,051,600

210,000

Inventory

1,250,000

195,000

BOY Retained earnings

End. Retained earnings

[E]

850,000

[ADJ]

155,000

5,302,000 369,000

[C]

18,000

(60,000) 5,611,000

Balance Sheet Assets:

740,950

Investment in subsidiary

5,773,050

1,400,000

$9,595,600

$2,020,000

PPE, net

995,000 [Ipay]

20,000

1,241,600

[Icogs]

7,500

1,437,500

[ADJ]

155,000

[E]

705,950

[Icogs]

6,000

[A]

196,000

[A]

280,000

[D]

40,000

7,413,050 11,087,150

Liabilities and stockholders’ equity: Current liabilities

$751,000

$500,000

Long-term liabilities

2,070,000

474,500

Common stock

450,000

APIC Retained earnings

[Ipay]

20,000

42,000

[E]

42,000

865,000

116,500

[E]

116,500

5,459,600

887,000

Noncontrolling interest

2,162,900

_________

$9,595,600

$2,020,000

385,400 969,500 6,738,000

[C]

_________

$ 840,700

∑

900

$385,650 [E]

314,550

_______

[A]

1,659,100

∑

72,000 1,659,10 0

_________ 11,087,150

©Cambridge Business Publishers, 2020 5-44

Advanced Accounting, 4th Edition

Topic: Consolidation on Date of Acquisition LO: 2 5. Company A acquires a 60% interest in Company B for a purchase price of $540,000. The fair value of Company B is $900,000 on the acquisition date. The excess of the purchase price over the book value of Company B’s Stockholders’ Equity is allocated to an unrecorded Customer List that the parent values at $40,000 and the remainder to Goodwill in the amount of $20,000, 60% of which is allocated to the parent. The parent and the subsidiary report the following balance sheets on the acquisition date: Company A

Company B

Cash

$335,000

$240,000

Accounts receivable

1,257,000

175,000

Inventory

3,652,000

362,000

Common Stock

Equity Investment

540,000

PPE, net

3,451,700

688,000

$9,235,700

$1,465,000

Company A

Company B

Current Liabilities

$1,250,000

$250,000

Long-term Liabilities

4,500,000

375,000

650,000

10,000

APIC

1,590,000

180,000

Retained Earnings

1,245,700

650,000

$9,235,700

$1,465,000

Required: Prepare the consolidation spreadsheet on the acquisition date.

Answer: Company A

Company B

Consolidated

Cash

$335,000

$240,000

575,000

Accounts receivable

1,257,000

175,000

1,432,000

Inventory

3,652,000

362,000

4,014,000

Assets:

Equity investment

PPE, net

540,000

3,451,700

504,000

[A]

36,000

688,000

Customer list Goodwill

[E]

---

4,139,700 [A]

40,000

[A]

20,000

40,000

__________

_________

$9,235,700

$1,465,000

$10,220,700

20,000

Current liabilities

$1,250,000

$250,000

1,500,000

Long-term liabilities

4,500,000

375,000

4,875,000

650,000

10,000

[E]

10,000

650,000

APIC

1,590,000

180,000

[E]

180,000

1,590,000

Retained earnings

1,245,700

650,000

[E]

650,000

1,245,700

Liabilities and stockholders’ equity:

Common stock

Noncontrolling interest

[E] __________

_________

$9,235,700

$1,465,000

∑

900,000

336,000

360,000

[A]

24,000

__________

∑

900,000

10,220,700

©Cambridge Business Publishers, 2020 Test Bank, Chapter 5

5-45

Topic: Determination of Goodwill LO: 1 6. Tinyton Company acquired 70% of Lauderdale Corporation for $3,300,000. The total fair value of Lauderdale' identifiable net assets was $3,650,000. The book value of Lauderdale’ land and equipment were undervalued by $100,000. The equipment had a ten-year useful life. The book value of Lauderdale’ other assets and liabilities were equal to fair value. Required: Determine the amount of goodwill associated with Tinyton Company’s purchase of Lauderdale Corporation. Answer: Implied value Fair value (Label’s) Goodwill

$ 4,125,000 (3,650,000) $ 475,000

($3,300,000 / 0.80)

©Cambridge Business Publishers, 2020 5-46

Advanced Accounting, 4th Edition

Chapter 6 Consolidation of Variable Interest Entities and Other Intercompany Investments Learning Objectives – Coverage by question Multiple Choice

Exercises

LO1 – Describe why companies use special purpose entities.

1, 5

LO2 – Describe and apply the comprehensive consolidation model in United States generally accepted accounting principles, including the concepts of variable interests and voting interests, and the issues related to consolidation of variable interest entities.

4, 8

1, 2

LO3 – Describe and apply the consolidation procedures necessary when affiliated companies acquire each other’s debt, including immediate recognition of gain or loss on constructive retirement of the debt and subsequent recognition of the gain or loss via discount and/or premium amortization in the separate preconsolidation financial statements of the affiliated companies.

2, 7

3, 4

LO4 – Describe the consolidation procedures necessary when subsidiary companies have outstanding preferred stock.

3, 6

Problems

1-3

©Cambridge Business Publishers, 2020 Test Bank, Chapter 6

6-1

Chapter 6: Consolidation of Variable Interest Entities and Other Intercompany Investments

Multiple Choice Topic: Special Purpose Entities LO: 1 1. Which of the following are typical characteristics of special purpose entities? a. It is legally distinct from the sponsoring company and may be bankruptcy remote. b. It is only allowed to engage in a highly restricted set of activities. c. When used in a securitization, cash flows from the assets held by the SPE are used by the SPE to repay the securities holders. d. All of the above e. None of the above Answer: d

Topic: Acquisition of debt between Parent and Subsidiary LO: 3 2. On January 1, 2021, a Parent company has a debt outstanding that was originally issued at a discount and was purchased, on issuance, by an unaffiliated party. On July 1, 2021, a Subsidiary of the Parent purchased the debt from the unaffiliated party. The debt was purchased by the Subsidiary at a slight premium. The Parent is a calendar year company. Which one of the following statements is true? a. The consolidated balance sheet at December 31, 2021 will report none of the debt, and the consolidated income statement for the year ended December 31, 2021 will not report any interest expense from the debt. b. The consolidated balance sheet at December 31, 2021 will report none of the debt, and the consolidated income statement for the year ended December 31, 2021 will report a gain or loss from the constructive retirement of the debt and will report some interest expense from the debt. c. The consolidated balance sheet at December 31, 2021 will report none of the debt, and the consolidated income statement for the year ended December 31, 2021 will report a gain or loss from the constructive retirement of the debt and will not report any interest expense from the debt. d. The consolidated balance sheet at December 31, 2021 will report the debt, and the consolidated income statement for the year ended December 31, 2021 will report a gain or loss from the constructive retirement of the debt and will not report any interest expense from the debt. Answer: b

©Cambridge Business Publishers, 2020 6-2

Advanced Accounting, 4th Edition

Topic: Preferred Stock LO: 4 3. A Parent company owns an 80% controlling interest in the voting common stock of its Subsidiary. The Subsidiary also has outstanding 10,000 shares of 4% cumulative preferred stock outstanding with par value equal to $1,000,000. If the parent company owns none of the preferred stock, how should the preferred stock be accounted for in the consolidated financial statements? a. All of the preferred stock equity account is assigned to the noncontrolling interests. b. Twenty percent of the preferred stock equity account is assigned to the noncontrolling interests. c. Eighty percent of the preferred stock equity account is assigned to the noncontrolling interest. d. Eighty percent of the preferred stock equity account is eliminated against Investment in Subsidiary account on the Parent’s balance sheet. Answer: a

Topic: Variable Interest Entity LO: 2 4. Which of the following is not a variable interest? a. Equipment lease b. Technology license c. Management contract d. U.S. treasury bond Answer: d

Topic: Special Purpose Entity LO: 1 5. Which of the following would characterize a special purpose entity as bankruptcy remote? a. If the sponsoring company goes bankrupt, the assets of the SPE are available to the sponsoring company’s creditors. b. If the sponsoring company goes bankrupt, the assets of the SPE are protected from the creditors of the sponsoring company. c. If both the sponsoring company and SPE go bankrupt, the assets of the SPE can only be accessed by owners of the SPE. d. None of the above. e. Only b and c. Answer: b

©Cambridge Business Publishers, 2020 Test Bank, Chapter 6

6-3

Topic: Preferred Stock LO: 4 6. A Parent company owns an 80% controlling interest in the voting common stock of its Subsidiary. The Subsidiary also has outstanding 10,000 shares of 4% cumulative preferred stock outstanding with par value equal to $1,000,000. If the parent company owns 100% of the preferred stock, how should the preferred stock be accounted for in the consolidated financial statements? a. All of the preferred stock equity account is assigned to the noncontrolling interests. b. Twenty percent of the preferred stock equity account is assigned to the noncontrolling interests. c. One hundred percent of the preferred stock equity account is eliminated against Investment in Subsidiary account on the Parent’s balance sheet. d. Eighty percent of the preferred stock equity account is eliminated against Investment in Subsidiary account on the Parent’s balance sheet. Answer: c

Topic: Acquisition of Debt Between Parent and Subsidiary LO: 3 7. A Parent Company owns 100% of its Subsidiary. During 2020, the Parent company reports net income (by itself, without any investment income from its Subsidiary) of $800,000 and the subsidiary reports net income of $500,000. The Parent had a bond payable outstanding on July 1, 2019, with a carry value equal to $440,000. The Subsidiary acquired the bond on July 1, 2019 for $400,000. During 2020, the Parent reported interest expense (related to the bond) of $40,000 while the Subsidiary reported interest income (related to the bond) of $37,500. What is consolidated net income for the year ended December 31, 2020? a. $1,297,500 b. $1,300,000 c. $1,302,500 d. $1,342,500 Answer: c

Topic: Variable Interest Entity LO: 2 8. There are several steps in determining whether a special purpose entity is a VIE. Which of the following is not a step in determining whether a special purpose entity is a VIE? a. Determine whether the cash flows of the SPE are used to repay the securities holders. b. Determine whether the company is the primary beneficiary of the VIE. c. Determine whether the business-related scope exception applies. d. Determine whether the total equity investment at risk is not sufficient to permit the legal entity to finance its activities without additional subordinated financial support. e. None of the above. Answer: a

©Cambridge Business Publishers, 2020 6-4

Advanced Accounting, 4th Edition

Exercises Topic: Determination of Variable Interest Entity LO: 2 1. Assume a Legal Entity’s capital structure consists of the following accounts: Short-term note payable Long-term note payable Mandatorily redeemable preferred stock Common stock Additional paid-in capital Retained earnings Total liabilities and equity

$300,000 440,000 325,000 70,000 385,000 550,000 $1,790,000

Required: What is the maximum amount of expected losses that the Legal Entity can expect to sustain without being considered a variable interest entity (VIE)? Answer: ($70,000 + $385,000 + $550,000) = $1,005,000

Topic: Determination of Variable Interest Entity LO: 2 2. Assume a Legal Entity’s capital structure consists of the following accounts General partner capital

$240,000

Limited partner capital

2,160,000

Total capital

$2,400,000

A Reporting Company is the sole general partner of the Legal Entity. The limited partnership capital was contributed by unaffiliated individual investors recruited by a regional boutique investment bank. The Reporting Company is paid an $180,000 management fee. The limited partners expect the partnership to be highly successful over the next five years. The investment bank estimated that the distribution of income to these investors should be at least $400,000 during the time period. What is the maximum amount of expected losses that the Legal Entity can expect to sustain without being considered a variable interest entity (VIE)? Answer: ($2,400,000 - $180,000) = $2,220,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 6

6-5

Topic: Consolidated Amounts when Affiliate’s Debt is Acquired from Non-affiliate LO: 3 3. Assume that a Parent company owns 100% of its Subsidiary. On January 1, 2020 the Parent company had a $2,000,000 (face) bond payable outstanding with a carrying value of $2,140,000. The bond was originally issued to an unaffiliated company. On that same date, the Subsidiary acquired the bond for $1,992,000. During 2020, the Parent company reported $1,260,000 of (pre-consolidation) income from its own operations (i.e. prior to any equity method adjustments by the Parent company) and after recording interest expense. The Subsidiary reported $840,000 of (pre-consolidation) income from its own operations after recording interest income. Related to the bond during 2020, the parent reported interest expense of $220,000 while the subsidiary reported interest income of $190,000. Required: Determine the following amounts that will appear in the 2020 consolidated income statements. a. Interest income from bond investment b. Interest expense on bond payable c. Gain (loss) on constructive retirement of bond payable d. Consolidated net income Answer: a. $-0b. $-0c.

$148,000 ($2,140,000 - $1,992,000)

d. $2,278,000 ($1,260,000 + $840,000 + 148,000 + $220,000 - $190,000) Topic: Consolidation Adjustment Necessary when Affiliate’s Debt is Acquired from Non-affiliate LO: 3 4. Assume that a Parent company owns 80% of its Subsidiary. The Parent company uses the equity method to account for its Investment in Subsidiary. On January 1, 2019, the Parent company issued to an unaffiliated company $4,000,000 (face) 10 year, 10% bonds payable for a $260,000 premium. The bonds pay interest on December 31 of each year. On January 1, 2022, the Subsidiary acquired 30% of the bonds for $1,040,000. Both companies use straight-line amortization. In preparing the consolidated financial statements for the year ended December 31, 2023, what consolidating entry adjustment is necessary for the beginning-of-year Investment in Subsidiary account balance?

©Cambridge Business Publishers, 2020 6-6

Advanced Accounting, 4th Edition

Answer: $183,943 Bond Amortization Schedule—Parent 1/1/2019 12/31/2019 400,000 12/31/2020 400,000 12/31/2021 400,000 12/31/2022 400,000 12/31/2023 400,000 400,000 12/31/2024 400,000 12/31/2025 400,000 12/31/2026 400,000 12/31/2027 400,000 12/31/2028

10 year 26,000 26,000 26,000 26,000 26,000 26,000 26,000 26,000 26,000 26,000

Bond Amortization Schedule—Subsidiary 1/1/2022 12/31/2022 120,000 -22,857 12/31/2023 120,000 -22,857 120,000 -22,857 12/31/2024 120,000 -22,857 12/31/2025 120,000 -22,857 12/31/2026 120,000 -22,857 12/31/2027 120,000 -22,857 12/31/2028

Carrying value of bonds Purchase price of bonds acquired Gain on acquisition of bonds (on 1/1/2022) Amort of issue premium—for year ended 2022 Amort of purch discount— for year ended 2022 Adjustment to BOY investment at 1/1/23

374,000 374,000 374,000 374,000 374,000 374,000 374,000 374,000 374,000 374,000

4,260,000 4,234,000 4,208,000 4,182,000 4,156,000 4,130,000 4,104,000 4,078,000 4,052,000 4,026,000 4,000,000

142,857 142,857 142,857 142,857 142,857 142,857 142,857

1,040,000 1,062,857 1,085,714 1,108,571 1,131,429 1,154,286 1,177,143 1,200,000

$1,254,600 1,040,000 $ 214,600 (7,800) (22,857) $ 183,943

($4,182,000 x 30%)

($26,000 x 30%)

©Cambridge Business Publishers, 2020 Test Bank, Chapter 6

6-7

Problems Topic: Consolidation Worksheet for Gain on Constructive Retirement of Subsidiary’s Debt with no AAP – Equity Method LO: 3 1. Assume that a Parent company acquires an 80% interest in its Subsidiary on January 1, 2020. On January 1, 2020, the book value of net assets and the fair value of the identifiable net assets equaled the book value of identifiable net assets (i.e. there was no AAP or Goodwill). The parent uses the equity method to account for its investment in the subsidiary. On December 31, 2021, the Subsidiary company issued $1,000,000 (face) 6 percent, five-year bonds to an unaffiliated company for $1,085,379. The bonds pay interest annually on December 31, and the bond premium is amortized using the straight-line method. This results in annual bond-payable premium amortization equal to $17,076 per year. On December 31, 2023, the Parent paid $974,229 to purchase all of the outstanding Subsidiary company bonds. The bond discount is amortized using the straight-line method, which results in annual bond-investment discount amortization equal to $8,590 per year. The Parent and the Subsidiary report the following financial statements for the year ended December 31, 2024: Income Statement Parent $1,100,000 -440,000 660,000 119,995 68,590

Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Bond interest income Bond interest expense Operating expenses Net income

-230,000 $ 618,585

Subsidiary $800,000 -450,000 350,000

-42,924 -125,000 $182,076

Statement of Retained Earnings Parent $4,000,000 618,585 -200,000 $4,418,585

BOY Retained Earnings Net income Dividends EOY Retained Earnings

Subsidiary $450,000 182,076 -25,000 $607,076

Continued

©Cambridge Business Publishers, 2020 6-8

Advanced Accounting, 4th Edition

Balance Sheet Assets: Cash Accounts receivable Inventory Equity Investment Investment in bonds PPE, net

Liabilities and Stockholders’ Equity: Accounts payable Current Liabilities Bonds payable Long-term Liabilities Common Stock APIC Retained Earnings

Parent

Subsidiary

$ 1,750,000 800,000 1,200,000 2,095,393 982,819 14,046,480 $20,874,692

$ 800,000 750,000 250,000

$ 1,600,000 2,200,000 2,226,100 1,162,000 9,268,007 4,418,585 $20,874,692

4,677,227 $6,477,227

$ 838,000 1,100,000 1,034,152 950,000 398,000 1,550,000 607,076 $6,477,227

Required: Provide the consolidation entries and prepare a consolidation worksheet for the year ended December 31, 2024. Answer: [C] Income (loss) from subsidiary $119,995 Income attributable to noncontrolling interest 36,415 Dividends Equity investment Noncontrolling interest To eliminate inter-company income, investment and dividends. [E]

Common stock APIC Retained earnings Equity investment Noncontrolling interest To eliminate subsidiary's stockholders' equity.

[Ibond] Bond payable (net) Interest income Equity investment Investment in bonds (net) Interest expense

$25,000 99,995 31,415

$ 398,000 1,550,000 450,000 $1,918,400 479,600

$1,034,152 68,590 $ 76,998 982,819 42,924

Continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 6

6-9

Bond Amortization Schedule—issuer 12/31/2021

issue

5 years

I/S

1,085,379

12/31/2022

year 1

60,000

17,076

42,924

1,068,303

12/31/2023

year 2

60,000

17,076

42,924

1,051,227

12/31/2024

year 3

60,000

17,076

42,924

1,034,152

12/31/2025

year 4

60,000

17,076

42,924

1,017,076

12/31/2026

year 5

60,000

17,076

42,924

1,000,000

I/S

974,229 982,819

Bond Amortization Schedule—purchaser 12/31/2023

purchase

3 years

12/31/2024

year 1

60,000

8,590

68,590

12/31/2025

year 2

60,000

8,590

68,590

991,410

12/31/2026

year 3

60,000

8,590

68,590

1,000,000

Sales Cost of goods sold

Subsidiary

$1,100,000

$800,000

1,900,000

-440,000 660,000

-450,000

(890,000)

Gross profit

Consolidated Income Stmt.

Parent

1,010,000

350,000

Income (loss) from subsidiary

119,995

[C]

119,995

---

Bond interest income

68,590

[Ibond]

68,590

---

Bond interest expense

-42,924

[Ibond]

42,924

---

Operating expenses

-230,000

-125,000

(355,000)

Net income

$618,585

$182,076

655,000

Consol. NI attributable to NCI

________

Consol. NI attributable to parent

$618,585

$182,076

[C]

36,415

36,415 618,585

Statement of Retained Earnings BOY retained earnings Net income Dividends

$4,000,000 618,585 -200,000

$450,000 182,076 -25,000

Ending retained earnings

$4,418,585

$607,076

[E]

450,000 [C]

25,000

4,000,000 618,585 (200,000) $4,418,585

Continued

©Cambridge Business Publishers, 2020 6-10

Advanced Accounting, 4th Edition

Consolidated Balance Sheet

Parent

Subsidiary

$1,750,000

$800,000

2,550,000

800,000

750,000

1,550,000

Inventory

1,200,000

250,000

Equity investment

2,095,393

Balance Sheet Assets: Cash Accounts receivable

Investment in bonds PPE, net

1,450,000 [C]

99,995

[E]

1,918,400

[Ibond]

76,998

982,819

14,046,480

4,677,227

$20,874,692

$6,477,227

[Ibond]

$24,273,707

18,723,707

Accounts payable

$1,600,000

$838,000

2,438,000

Current liabilities

2,200,000

1,100,000

3,300,000

1,034,152

---

Liabilities and stockholders’ equity:

Long-term liabilities Bonds payable

2,226,100

950,000

Common stock

1,162,000

398,000

[E]

398,000

1,162,000

APIC

9,268,007

1,550,000

[E]

1,550,000

9,268,007

Retained earnings

4,418,585

607,076

Noncontrolling interest _________

_________

$20,874,692

$6,477,227

[Ibond] 1,034,152

3,176,100

4,418,585 [C]

(31,415)

[E]

479,600

511,015

$24,273,707

©Cambridge Business Publishers, 2020 Test Bank, Chapter 6

6-11

Topic: Consolidation Worksheet for Loss on Constructive Retirement of Subsidiary’s Debt with no AAP – Equity Method LO: 3 2. Assume that a Parent company acquires a 60% interest in its Subsidiary on January 1, 2020. On the date of acquisition, the fair value of the 60% controlling interest was $1,440,000 and the fair value of the 40% noncontrolling interest was $960,000. On January 1, 2020, the book value of net assets equaled $2,400,000 and the fair value of the identifiable net assets equaled the book value of identifiable net assets (i.e. there was no AAP or Goodwill). The parent uses the equity method to account for its investment in the subsidiary. On December 31, 2021, the Subsidiary company issued $3,000,000 (face) 5 percent, five-year bonds to an unaffiliated company for $2,760,436. The bonds pay interest annually on December 31, and the bond discount is amortized using the straight-line method. This results in annual bond-payable discount amortization equal to $47,913 per year. On December 31, 2023, the Parent paid $3,081,698 to purchase all of the outstanding Subsidiary company bonds. The bond premium is amortized using the straight-line method, which results in annual bond-investment premium amortization equal to $27,233 per year. The Parent and the Subsidiary report the following financial statements for the year ended December 31, 2024: Income Statement Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Bond interest income Bond interest expense Operating expenses Net income

Parent $1,100,000 -440,000 660,000 91,398 122,767 -230,000 $644,165

Subsidiary $800,000 -450,000 350,000

-197,913 -125,000 $27,087

Statement of Retained Earnings BOY Retained Earnings Net income Dividends EOY Retained Earnings

Parent $4,000,000 644,165 -200,000 $4,444,165

Subsidiary $450,000 27,087 -25,000 $452,087

Continued

©Cambridge Business Publishers, 2020 6-12

Advanced Accounting, 4th Edition

Balance Sheet Assets: Cash Accounts receivable Inventory Equity Investment Investment in bonds PPE, net

Liabilities and Stockholders’ Equity: Accounts payable Current Liabilities Bonds payable Long-term Liabilities Common Stock APIC Retained Earnings

Parent

Subsidiary

$1,750,000 800,000 1,200,000 1,289,761 3,054,465 12,806,046 $20,900,272

$800,000 750,000 250,000

$1,600,000 2,200,000 2,226,100 1,162,000 9,268,007 4,444,165 $20,900,272

6,392,262 $8,192,262

$838,000 1,100,000 2,904,174 950,000 398,000 1,550,000 452,087 $8,192,262

Required: Provide the consolidation entries and prepare a consolidation worksheet for the year ended December 31, 2022. Answer: [C] Income (loss) from subsidiary $ 91,398 Income attributable to noncontrolling interest 10,835 Dividends Equity investment Noncontrolling interest To eliminate inter-company income, investment and dividends. [E]

Common stock APIC Retained earnings Equity investment Noncontrolling interest To eliminate subsidiary's stockholders' equity.

[Ibond] Bond payable (net) Interest income Equity investment Investment in bonds (net) Interest expense

25,000 76,398 835

$ 398,000 1,550,000 450,000 $1,438,800 959,200

$ 2,904,174 122,767 225,436 3,054,465 197,913

Continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 6

6-13

Bond Amortization Schedule—issuer 12/31/2021

issue

5 years

I/S

2,760,436

12/31/2022

year 1

150,000

-47,913

197,913

2,808,349

12/31/2023

year 2

150,000

-47,913

197,913

2,856,262

12/31/2024

year 3

150,000

-47,913

197,913

2,904,174

12/31/2025

year 4

150,000

-47,913

197,913

2,952,087

12/31/2026

year 5

150,000

-47,913

197,913

3,000,000

12/31/2023

purchase

3 years

12/31/2024

year 1

150,000

12/31/2025

year 2

12/31/2026

year 3

Bond Amortization Schedule—purchaser I/S

3,081,698

-27,233

122,767

3,054,465

150,000

-27,233

122,767

3,027,233

150,000

-27,233

122,767

3,000,000

Consolidated Income Stmt

Parent

Subsidiary

$1,100,000

$800,000

Cost of goods sold

-440,000

-450,000

(890,000)

Gross Profit

660,000

350,000

1,010,000

Sales

Income (loss) from subsidiary

91,398

Bond interest income

122,767

Bond interest expense

1,900,000

91,398

---

[Ibond] 122,767

[C]

---

-197,913

[Ibond]

197,913

---

Operating expenses

-230,000

-125,000

(355,000)

Net income

$644,165

$27,087

655,000

Consol. NI attributable to NCI

________

_________

Consol. NI attributable to parent

$644,165

$27,087

$4,000,000

$450,000

Net income

644,165

27,087

Dividends

-200,000

-25,000

$4,444,165

$452,087

[C]

10,835

10,835 644,165

Statement of Retained Earnings BOY Retained earnings

End. Retained earnings

[E]

450,000

4,000,000 644,165 [C]

25,000

(200,000) $4,444,165

Table continued

©Cambridge Business Publishers, 2020 6-14

Advanced Accounting, 4th Edition

Table continued

Consolidated Income Stmt

Parent

Subsidiary

$1,750,000

$800,000

2,550,000

800,000

750,000

1,550,000

Inventory

1,200,000

250,000

1,450,000

Equity investment

1,289,761

Balance Sheet Assets: Cash Accounts receivable

[Ibond]

225,436

[C]

76,398

[E]

1,438,800

Investment in bonds

3,054,465

PPE, net

12,806,046

6,392,262

$20,900,272

$8,192,262

19,198,308 $24,748,308

[Ibond] 3,054,465

Liabilities and stockholders’ equity: Accounts payable

$1,600,000

$838,000

2,438,000

Current liabilities

2,200,000

1,100,000

3,300,000

Long-term liabilities

2,226,100

950,000

3,176,100

Bonds payable

2,904,174

[Ibond] 2,904,174

Common stock

1,162,000

398,000

[E]

398,000

1,162,000

APIC

9,268,007

1,550,000

[E]

1,550,000

9,268,007

Retained earnings

4,444,165

452,087

4,444,165

Noncontrolling interest ________ $20,900,272

$8,192,262

[C]

835

960,035

[E]

959,200

__________ $24,748,307

©Cambridge Business Publishers, 2020 Test Bank, Chapter 6

6-15

Topic: Consolidation Worksheet for Gain on Constructive Retirement of Subsidiary’s Debt with no AAP – Cost Method LO: 3 3. Assume that a Parent company acquires an 80% interest in its Subsidiary on January 1, 2020. On the date of acquisition, the fair value of the 80% controlling interest was $1,739,200 and the fair value of the 20% noncontrolling interest was $434,800. On January 1, 2020, the book value of net assets equaled $2,174,000 and the fair value of the identifiable net assets equaled the book value of identifiable net assets (i.e. there was no AAP or Goodwill). The subsidiary’s retained earnings balance was $226,000 on the date of acquisition. The parent uses the cost method to account for its investment in the subsidiary. On December 31, 2021, the Subsidiary company issued $1,000,000 (face) 6 percent, five-year bonds to an unaffiliated company for $1,085,379. The bonds pay interest annually on December 31, and the bond premium is amortized using the straight-line method. This results in annual bond-payable premium amortization equal to $17,076 per year. On December 31, 2023, the Parent paid $974,229 to purchase all of the outstanding Subsidiary company bonds. The bond discount is amortized using the straight-line method, which results in annual bond-investment discount amortization equal to $8,590 per year. The Parent and the Subsidiary report the following financial statements for the year ended December 31, 2024: Income Statement Parent $1,100,000 -440,000 660,000 20,000 68,590

Sales Cost of goods sold Gross Profit Income (loss) from subsidiary Bond interest income Bond interest expense Operating expenses Net income

-230,000 $518,590

Subsidiary $800,000 -450,000 350,000

-42,924 -125,000 $182,076

Statement of Retained Earnings Parent $3,743,802 518,590 -200,000 $4,062,392

BOY Retained Earnings Net income Dividends EOY Retained Earnings

Subsidiary $450,000 182,076 -25,000 $607,076

Continued

©Cambridge Business Publishers, 2020 6-16

Advanced Accounting, 4th Edition

Balance Sheet Assets: Cash Accounts receivable Inventory Investment in subsidiary Investment in bonds PPE, net Liabilities and Stockholders’ Equity: Accounts payable Current Liabilities Bonds payable Long-term Liabilities Common Stock APIC Retained Earnings

Parent

Subsidiary

$1,750,000 800,000 1,200,000 1,739,200 982,819 14,046,480 $20,518,499

$800,000 750,000 250,000

$1,600,000 2,200,000 2,226,100 1,162,000 9,268,007 4,062,392 20,518,499

4,677,227 $6,477,227

$838,000 1,100,000 1,034,152 950,000 398,000 1,550,000 607,076 6,477,227

Required: Provide the consolidation entries and prepare a consolidation worksheet for the year ended December 31, 2022. Answer: [ADJ] Investment in subsidiary $256,198 Retained earnings (Parent) To convert the pre-consolidation investment account to “as-if” equity method. <adj> entry

[C]

[E]

change in RE @% Equiv Inv [ibond] adj adjustment

$256,198

224,000 179,200 76,998 256,198

Income (loss) from subsidiary $20,000 Income attributable to noncontrolling interest 36,415 Dividends Noncontrolling interest To eliminate inter-company income, investment and dividends. Common stock APIC Retained earnings Equity investment Noncontrolling interest To eliminate subsidiary's stockholders' equity.

[Ibond] Bond payable (net) Interest income Equity investment Investment in bonds (net) Interest expense

$25,000 31,415

$ 398,000 1,550,000 450,000 $1,918,400 479,600 $1,034,152 68,590 $ 76,998 982,819 42,924

Continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 6

6-17

Bond Amortization Schedule—issuer 12/31/2021

issue

5 years

I/S

1,085,379

12/31/2022

year 1

60,000

17,076

42,924

1,068,303

12/31/2023

year 2

60,000

17,076

42,924

1,051,227

12/31/2024

year 3

60,000

17,076

42,924

1,034,152

12/31/2025

year 4

60,000

17,076

42,924

1,017,076

12/31/2026

year 5

60,000

17,076

42,924

1,000,000

Bond Amortization Schedule—purchaser 12/31/2023

purchase

3 years

I/S

974,229

12/31/2024

year 1

60,000

8,590

68,590

982,819

12/31/2025

year 2

60,000

8,590

68,590

991,410

12/31/2026

year 3

60,000

8,590

68,590

1,000,000

Subsidiary

$1,100,000

$800,000

Cost of goods sold

-440,000

-450,000

(890,000)

Gross profit

660,000

350,000

1,010,000

Income (loss) from subsidiary

20,000

[C]

20,000

Bond interest income

68,590

[Ibond]

68,590

Sales

Bond interest expense

Consolidated Income Stmt.

Parent

1,900,000

-42,924

[Ibond]

42,924

Operating expenses

-230,000

-125,000

(355,000)

Net income

$518,590

$182,076

655,000

Consol. NI attributable to NCI

_________

Consol. NI attributable to parent

$518,590

$182,076

[C]

36,415

36,415 618,585

BOY retained earnings Net income Dividends

Statement of Retained Earnings $3,743,802 $450,000 [E] 450,000 [ADJ] 256,198 518,590 182,076 -200,000 -25,000 [C] 25,000

4,000,000 618,585 (200,000)

Ending retained earnings

$4,062,392

$4,418,585

$607,076

Continued

©Cambridge Business Publishers, 2020 6-18

Advanced Accounting, 4th Edition

Consolidated Balance Sheet

Parent

Subsidiary

$1,750,000

$800,000

2,550,000

800,000

750,000

1,550,000

Inventory

1,200,000

250,000

1,450,000

Investment in subsidiary

1,739,200

Balance Sheet Assets: Cash Accounts receivable

PPE, net Investment in bonds

[ADJ]

256,198

[E]

1,918,400

[Ibond]

76,998

---

14,046,480

4,677,227

982,819

_________

18,723,707

$20,518,499

$6,477,227

$24,273,707

[Ibond] 982,819

Liabilities and stockholders’ equity: Accounts payable

$1,600,000

$838,000

$ 2,438,000

Current liabilities

2,200,000

1,100,000

3,300,000

Long-term liabilities

2,226,100

950,000 1,034,152

Bonds payable

3,176,100 [Ibond] 1,034,152

Common stock

1,162,000

398,000

[E]

398,000

1,162,000

APIC

9,268,007

1,550,000

[E]

1,550,000

9,268,007

Retained earnings

4,062,392

607,076

4,418,585

Noncontrolling interest _________

_________

$20,518,499

$6,477,227

________

[C]

31,415

511,015

[E]

479,600

_________ $24,273,707

©Cambridge Business Publishers, 2020 Test Bank, Chapter 6

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Chapter 9 Government Accounting: Fund-Based Financial Statements Learning Objectives – Coverage by question Multiple Choice LO1 – Describe the appropriations and budgetary process.

1-6, 27

LO2 – Describe the types of funds employed in fund accounting.

7-9, 28

LO3 –Describe the measurement focus and basis of accounting.

10-15, 29

LO4 –Describe fund accounting journal entries.

16-26, 30

LO5 –Describe the preparation of fund financial statements.

Exercises

Problems

1-8

©Cambridge Business Publishers, 2020 Test Bank, Chapter 9

9-1

Chapter 9: Government Accounting: Fund-Based Financial Statements

Multiple Choice Topic: Fund Accounting LO: 1 1. Which of the following best describes the notion of accountability? a. Accountability refers to the requirement that governments maintain an appropriate chart of accounts to aid them in the maintenance of their accounting records. b. Accountability means that governments must maintain appropriate accounting systems. c. Accountability is based on the belief that citizens have a right to know. d. None of the above. Answer: c

Topic: Fund Accounting LO: 1 2. Which of the following statements is true? a. Fund accounting refers to the maintenance of separate checking accounts for each cash fund so that they can be reconciled individually. b. The primary purpose of fund accounting is to segregate the accounting for activities so that they can be monitored. c. Fund accounting refers to the accounting for various investment funds that governments maintain. d. None of the above. Answer: b

Topic: Appropriations and Budgets LO: 1 3. Which of the following statements is true? a. A budget is a form of control usually having the force of law. b. A legally adopted budget provides both authorizations of and limitations on amounts that may be spent for particular purposes. c. Budgets are typically only established for planned expenditures since revenues are uncertain. d. Both a and b are true. Answer: d

Topic: Appropriations and Budgets LO: 1 4. Which of the following statements best describes an appropriation”? a. An appropriation is the authorization to spend money for a specific use. b. An appropriation is an expenditure of funds for a specific use. c. An appropriation is an accrual of an expected expense for a specific use. d. None of the above. Answer: a

©Cambridge Business Publishers, 2020 9-2

Advanced Accounting, 4th Edition

Topic: Expenditure LO: 1 5. Which of the following best describes an expenditure? a. An expenditure is a line item in the income statement that reduces profit for the period. b. An expenditure is a planned payment of money. c. An expenditure is an accrual that must be made before financial statements are issued to recognize an obligation. d. An expenditure is using up an appropriation by purchasing goods or services. Answer: d

Topic: Enterprise Fund LO: 1 6. Which of the following best describes an enterprise fund? a. An enterprise fund is a governmental activity that is available to the public and is financed, in whole or in part, by general tax revenue. b. An enterprise fund is a business-like activity. c. An enterprise fund is a central operation, like a copy center, that provides service to many governmental departments for a fee. d. Both a and b. Answer: b

Topic: Funds LO: 2 7. Which of the following is not a governmental fund? a. General fund b. Internal service fund c. Special revenue fund d. Capital project fund Answer: b

Topic: Funds LO: 2 8. Which of the following is not a proprietary fund? a. Enterprise fund b. Internal service fund c. Pension trust fund d. All of the above are proprietary funds. Answer: c

Topic: Funds LO: 2 9. Which of the following is not a fiduciary fund? a. Special purpose fund b. Pension trust fund c. Investment trust fund d. Agency fund Answer: a ©Cambridge Business Publishers, 2020 Test Bank, Chapter 9

9-3

Topic: Measurement Focus LO: 3 10. The current financial resources measurement focus: a. b. c. d.

Refers to what is being reported in the financial statements. Refers to resources that can be consumed in the near future. Refers to the timely issuance of financial statements. Refers to both a and b.

Answer: d Topic: Measurement Focus LO: 3 11. Current financial resources include: a. Only cash and receivables. b. Cash, prepaid items, receivables and property, plant and equipment. c. Only cash and investments. d. Cash, investments, prepaid items, and receivables. Answer: d

Topic: Modified Accrual Basis of Accounting. LO: 3 12. Under the modified accrual basis of accounting: a. Revenues are recognized when they are measurable, even if not available to finance expenditures. b. Revenues are recognized when they are available to finance expenditures, even if not currently measurable. c. Revenues are recognized when they are both measurable and available to finance expenditures. d. None of the above. Answer: c Topic: Modified Accrual Basis of Accounting LO: 3 13. Which of the following statements best describes the recognition of revenue? a. Governments recognize revenues from exchange transactions when the cash is received, and, for nonexchange transactions, when the resources are available to satisfy existing liabilities. b. Governments recognize revenues from exchange transactions when the transactions take place, and, for nonexchange transactions, when the resources are available to satisfy existing liabilities. c. Governments recognize revenues from exchange transactions when the transactions take place, and, for nonexchange transactions, when it is probable that resources will be received in the current year. d. None of the above. Answer: b

©Cambridge Business Publishers, 2020 9-4

Advanced Accounting, 4th Edition

Topic: Property Taxes LO: 3 14. Which of the following best describes how revenues from property taxes are recognized? a. Revenues from property taxes are recognized when they are both measureable and available. b. Revenues from property taxes are recognized when the taxes are paid. c. Revenues from property taxes are recognized when tax bills are sent out. d. None of the above. Answer: a

Topic: Grants and Other Subsidies LO: 3 15. Which of the following best describes how revenues from grants and other subsidies are recognized? a. Grants and other subsidies are recognized when it becomes likely that all eligibility requirements will be met. b. Grants and other subsidies are recognized when it becomes probable that all eligibility requirements will be met. c. Grants and other subsidies are recognized when collected. d. Grants and other subsidies are recognized when all eligibility requirements are met. Answer: d

Topic: Budget Entry LO: 4 16. The journal entry to record the budget: a. Contains one or more debits to recognize appropriations and one or more credits to recognize revenues. b. Records the estimated increase or decrease in the budgetary fund balance as a debit or credit. c. Is typically reversed at the end of the accounting year. d. Both b. and c. Answer: d

Topic: Property Tax Entry LO: 4 17. The journal entry to record the property tax levy: a. Is made when taxes are assessed and billings are sent to residents. b. Is not made until the taxes are received. c. Must include an entry to record deferred taxes. d. Both a and c are true. Answer: a

©Cambridge Business Publishers, 2020 Test Bank, Chapter 9

9-5

Topic: Encumbrances and Expenditures LO: 4 18. Which of the following statements is true? a. An expenditure relates to the establishment of an appropriation. b. An expenditure typically recognizes accrued liabilities. c. An expenditure relates to the using up of an appropriation. d. All of the above. Answer: c

Topic: Encumbrances and Expenditures LO: 4 19. Which of the following statements is true? a. An encumbrance is an expenditure. b. An encumbrance is a contractual commitment relating to an existing appropriation. c. An encumbrance is a liability appearing on the balance sheet. d. None of the above. Answer: b

Topic: Encumbrances and Expenditures LO: 4 20. Which of the following statements is true? a. Outstanding encumbrances that have not yet must be cancelled with the vendor. b. Outstanding encumbrances that have not yet been filled may be carried over to the following year if spending authority exists. c. All outstanding encumbrances must be fulfilled by the end of the year. d. None of the above are true. Answer: b

Topic: Purchase of Property, Plant, and Equipment (PPE) Assets LO: 4 21. Which of the following statements is true about property, plant, and equipment (PPE) assets that are purchased by a government? a. They are recorded as assets in fund-based financial statements and are depreciated over their estimated useful lives. b. They are recorded as assets in fund-based financial statements, but are not depreciated since useful lives cannot be determined. c. They are reported at fair value at each statement date in fund-based financial statements. d. They are not recorded as assets in fund-based financial statements. Answer: d

©Cambridge Business Publishers, 2020 9-6

Advanced Accounting, 4th Edition

Topic: Sale of PPE Assets LO: 4 22. The journal entry to record the sale of a property, plant, and equipment (PPE) asset used in a governmental fund recognizes: a. Cash or other assets received with a credit to other financing sources or revenue. b. Cash or other assets received with a credit to accumulated depreciation and a gain or loss on the sale. c. Cash or other assets received and the reversal of an encumbrance relating to that asset. d. The reversal of an encumbrance account and the related expenditure. Answer: a

Topic: Long-Term Debt LO: 4 23. The journal entry to record the proceeds of long-term debt in a governmental fund includes a credit to: a. Revenue. b. A long-term liability account. c. Other financing sources. d. Cash. Answer: c

Topic: Long-Term Debt LO: 4 24. The journal entry to record the payment of principal and interest on long-term debt in the debt service fund generally includes a debit to: a. An interest expense account. b. An expenditure account. c. A liability account. d. A debit to cash. Answer: b

Topic: Capital Leases LO: 4 25. Which of the following statements best describes fund accounting for a capital lease in a governmental fund? a. A capital lease is recorded at its present value. b. A capital lease is recorded as an expenditure, not as a long-term asset. c. The liability relating to a capital lease is not reflected on the balance sheet. d. All of the above are true. Answer: d

©Cambridge Business Publishers, 2020 Test Bank, Chapter 9

9-7

Topic: Inventories LO: 4 26. Which of the following statements best describes fund accounting for inventories in the General Fund? a. Inventories on hand at the end of the accounting period are not reflected on the balance sheet. b. Inventories used during the period are reflected as an expense in the statement of revenues, expenditures, and changes in fund balances. c. There is generally no recognition in the fund accounts of any remaining balance of inventories at the end of the accounting period. d. None of the above. Answer: d

Topic: Appropriations and the Budgetary Process LO: 1 27. If supplies that were ordered by a department financed by the General Fund are received at an actual price that is less than the estimated price on the purchase order, the department’s available balance of appropriations for supplies will be: a. Unaffected. b. Increased. c. Decreased. d. Either decreased or increased, depending on the department’s specific budgetary control procedures. Answer: b

Topic: Types of Funds LO: 2 28. Which of the following types of funds has income determination (that is, flow of economic resources) as its measurement focus? a. General Fund = yes; Capital Projects Fund = no. b. General Fund = yes; Capital Projects Fund = yes. c. General Fund = no; Capital Projects Fund = no. d. General Fund = no; Capital Projects Fund = yes. Answer: c

©Cambridge Business Publishers, 2020 9-8

Advanced Accounting, 4th Edition

Topic: Measurement Focus and Basis of Accounting LO: 3 29. The measurement focus and basis of accounting that should be used for proprietary fund financial statements are: a. Current financial resources; accrual. b. Economic resources; modified accrual. c. Current financial resources; modified accrual. d. Economic resources; accrual. Answer: d

Topic: Fund Accounting Journal Entries LO: 4 30. Under the modified accrual basis of accounting, expenditures generally are not recognized until: a. Goods or services are ordered. b. They are paid in cash. c. An obligation is incurred that will be paid from currently available financial resources. d. They are approved by a legislative body. Answer: c

©Cambridge Business Publishers, 2020 Test Bank, Chapter 9

9-9

Exercises Topic: Fund Accounting Journal Entries—Budget LO: 4 1. Assume that a city approves the following budget for the year: Estimated revenues Estimated other financing sources Appropriations Net change in fund balance

$263,540 32,000 (284,890) $ 10,650

Required: Prepare the journal entry to record the budget. Answer: ESTIMATED REVENUES ESTIMATED OTHER FINANCING RESOURCES APPROPRIATIONS BUDGETARY FUND BALANCE

263,540 32,000 284,890 10,650

Topic: Fund Accounting Journal Entries—Encumbrances LO: 4 2. Assume that a town places an order for a truck with an estimated cost of $39,850. When the truck is delivered, the actual cost is $38,750. Required: Prepare the journal entry to record the issuance of the purchase order and its payment when the truck is delivered. Answer: ENCUMBRANCES BUDGETARY FUND BALANCE To record issuance of purchase order for a truck.

39,850 39,850

BUDGETARY FUND BALANCE ENCUMBRANCES

39,850

Expenditures Cash or vouchers payable To reverse the previous encumbrance entry and record purchase of the truck.

38,750

39,850

38,750

©Cambridge Business Publishers, 2020 9-10

Advanced Accounting, 4th Edition

Topic: Fund Accounting Journal Entries—Closing Entries LO: 4 3. Brady Township needs to close out its General Fund budgetary and operating accounts. Assume that Brady Township has a balance remaining of $245,000 in encumbrances outstanding as of the end of the year. The outstanding invoices are expected to be honored in the next fiscal year. Required: Prepare the journal entries to close the encumbrance account. Answer: To close the encumbrance account: BUDGETARY FUND BALANCE ENCUMBRANCES

245,000

Fund balance—unassigned Fund balance—assigned To reverse the budgetary encumbrance and assign the fund balance for the outstanding encumbrance.

245,000

Topic: Fund Accounting Journal Entries—Sale of Truck LO: 4 4. Assume that a town sells a truck that it had used in the General Fund that it originally purchased for $65,000, for a cash sale price of $40,000. Required: Prepare the journal entry to record the sale. Answer: Cash

40,000

Other financing sources To record the sale of the truck.

40,000

Topic: Fund Accounting Journal Entries—Issuance and Repayment of Bond LO: 4 5. Assume that a city issues a $1,200,000 general obligation 6%, 10-year bond at par that pays interest to bondholders once a year. The bond will be used for general government operations. The city pays $72,000 in interest on the bond and the $1,200,000 principal in the 10th year. Required: Prepare the journal entries to record the issuance of the bond in year 1 and the final payment of the bond with interest in the 10th year. Answer: Cash

1,200,000 Other financing sources—proceeds from bond issue

1,200,000

To record the sale of a bond in year 1. Expenditure—interest on bond Expenditure—principal on bond Cash To record payment of annual interest and principal on bond issue in year 10.

72,000 1,200,000 1,272,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 9

9-11

Topic: Fund Accounting Journal Entries – Lease of Equipment and Subsequent Repayment LO: 4 6. Assume that a town leases equipment on a capital lease. The present value of the leased equipment is $75,000. The city, subsequently, pays $7,500 on the lease, $4,900 of which is designated as interest and the remainder to a reduction of the lease obligation:

Required: Prepare the journal entry to record the acquisition of equipment via lease and the subsequent payment. Answer: Expenditure—capital outlay Other financing sources—proceeds from capital lease To record the acquisition of a capital asset via lease. Expenditure—interest Expenditure—lease obligation

75,000 75,000

4,900 2,600 7,500

Cash To record the payment on a capital lease.

Topic: Fund Accounting Journal Entries—Accounting for Inventories (Purchases Method) LO: 4 7. Assume that a town purchases $12,000 of supplies on account toward the end of the year. A year-end audit reveals that $3,000 of the inventories remain unused.

Required: Prepare the journal entry for the purchase of the inventories and the year-end adjusting entry, assuming that the purchases method is used. Answer: Expenditures Vouchers payable To record purchase of $12,000 of supplies inventory. Inventory—supplies Fund balance—nonspendable To recognize the $3,000 remaining balance of supplies inventory.

12,000 12,000

3,000 3,000

©Cambridge Business Publishers, 2020 9-12

Advanced Accounting, 4th Edition

Topic: Fund Accounting Journal Entries—Accounting for Inventories (Consumption Method) LO: 4 8. Assume that a town purchases $12,000 of supplies on account toward the end of the year. A year-end audit reveals that $3,000 of the inventories remain unused. Required: Prepare the journal entry for the purchase of the inventories and the year-end adjusting entry assuming that the consumption method is used. Answer: Expenditures Vouchers payable To record purchase of $12,000 of supplies inventory.

12,000 12,000

Inventory—supplies 3,000 Expenditures To recognize the $3,000 remaining balance of supplies inventory.

3,000

Fund balance—unassigned 3,000 Fund balance—nonspendable To recognize the $3,000 remaining balance of supplies inventory.

3,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 9

9-13

Problems Topic: Fund Accounting Journal Entries—Series of Transactions LO: 4 1. Following are a number of events relating to the City of Finch (all amounts in $1,000s). a. The citizens approve the following budget for the year: ESTIMATED REVENUES ESTIMATED OTHER FINANCING SOURCES

$ 69,840 9,000

APPROPRIATIONS

(70,130)

BUDGETARY FUND BALANCE

$ 8,710

b. The City records the following revenues (on account) and other financing sources (paid in cash) during the year: Revenues—real estate & personal property taxes

$60,890

Revenues—intergovernmental

8,950

Other financing sources—bond proceeds

9,000

The City issuances purchase invoices totaling $62,590 (record the issuance of invoices as a lump sum).

d. The City recognizes the following expenditures, all on account (these expenditures were previously reserved as budgetary ENCUMBRANCES): Expenditures—General Government

$15,540

Expenditures—Public Safety

9,280

Expenditures—Education

27,720

Expenditures—Public Works

4,180

Expenditures—Human Services

5,230

e. The City makes the following payments related to its outstanding debt:

Expenditures—Debt Principal

$1,800

Expenditures—Debt Interest

300

The City collects accounts receivable ($56,580 relating to property taxes and $8,810 relating to intergovernmental receivables) and pays outstanding accounts payable in the amount of $60,520 during the year.

g. The City recognizes an increase of $820 in deferred revenues as a year-end adjustment to yield a balance in that account of the total property taxes receivable that are not expected to be collected within 60 days. h. The City makes the required closing entries to close out the budgetary and operating accounts. In addition, the City closes out the remaining $640 balance of budgetary ENCUMBRANCES outstanding and formally charges that balance to fund balance— unassigned since the outstanding invoices are expected to be honored in the next fiscal year. Required: Prepare journal entries in the General Fund for each of the events presented above.

©Cambridge Business Publishers, 2020 9-14

Advanced Accounting, 4th Edition

Answer: a. ESTIMATED REVENUES ESTIMATED OTHER FINANCING SOURCES APPROPRIATIONS BUDGETARY FUND BALANCE To record the budget.

69,840 9,000 70,130 8,710

b. Cash Receivables—real estate & personal property taxes Receivables—intergovernmental revenues Revenues—real estate & personal property taxes Revenues—intergovernmental Other financing sources - bond proceeds Record revenues and other financing sources.

9,000 60,890 8,950

ENCUMBRANCES BUDGETARY FUND BALANCE To record the issuance of purchase invoices.

62,590

d. BUDGETARY FUND BALANCE ENCUMBRANCES To reverse previous encumbrance journal entry.

61,950

60,890 8,950 9,000

62,590

61,950

Expenditures—general government Expenditures—public safety Expenditures—education Expenditures—public works Expenditures—human services Payables To record expenditures.

15,540 9,280 27,720 4,180 5,230 61,950

e. Expenditures—debt principal Expenditures—debt interest Cash To record debt payments.

1,800 300

4,870 60,520

2,100

Cash Payables Receivables—real estate & personal property taxes Receivables—intergovernmental revenues To record collection of receivables and payment of payables.

56,580 8,810

©Cambridge Business Publishers, 2020 Test Bank, Chapter 9

9-15

g. Revenues-real estate & personal property taxes Deferred revenues To defer revenues that won’t be collected within 60 days.

820 820

Closing Entries: h. 1. APPROPRIATIONS BUDGETARY FUND BALANCE ESTIMATED REVENUES ESTIMATED OTHER FINANCING SOURCES To reverse budget entry.

70,130 8,710

2. Revenues—real estate & personal property taxes Revenues—intergovernmental Other financing sources—bond proceeds Expenditures—general government Expenditures—public safety Expenditures—education Expenditures—public works Expenditures—human services Expenditures—debt principal payments Expenditures—debt interest payments Fund Balance—unassigned To close out revenue and expenditure accounts.

60,070 8,950 9,000

69,840 9,000

15,540 9,280 27,720 4,180 5,230 1,800 300 13,970

3. BUDGETARY FUND BALANCE ENCUMBRANCES

640 640

Fund balance—unassigned Fund balance—assigned To close remaining encumbrances and reserve Fund Balance for encumbrances that lapsed, but are expected to be honored in the following year.

640 640

©Cambridge Business Publishers, 2020 9-16

Advanced Accounting, 4th Edition

Topic: Preparation of Fund Financial Statements LO: 5 2. Assume that at the beginning of the fiscal year, the City of Finch reports the following balances in its accounts for the General Fund:

Beginning Balances: Cash Receivables: Real estate & personal property Intergovernmental Payables Deferred revenues Fund balances: Assigned Unassigned

General Fund DR CR $ 6,720 3,250 1,800 $ 1,180 3,750

$11,770

2,150 4,690 $11,770

Required: Using the journal entries you record for Problem 1 (above): a. Prepare the pre-closing trial balance for the General Fund. b. From the pre-closing trial balance in part a, prepare the City of Finch’s balance sheet and the statement of revenues, expenditures, and changes in fund balances for the fiscal year for the General Fund. Answer: a. The pre-closing trial balance for the General Fund of the City of Finch is as follows:

Trial Balance: Cash Receivables: Real estate & personal property Intergovernmental Payables Deferred revenues Fund balances: Assigned Unassigned Revenues—real estate taxes Intergovernmental revenues Expenditures—general government Expenditures—public safety Expenditures—education Expenditures—public works Expenditures—human services Expenditures—debt principal payments Expenditures—debt interest payments Other financing sources—proceeds from bonds

General Fund DR CR $18,490 7,560 1,940 $2,610 4,570 2,790 4,050 60,070 8,950 15,540 9,280 27,720 4,180 5,230 1,800 300 $89,430

9,000 $89,430

©Cambridge Business Publishers, 2020 Test Bank, Chapter 9

9-17

b. The balance sheet and the statement of revenues, expenditures, and changes in fund balances for the fiscal year for the General Fund are as follows: General Fund Balance Sheet: Cash Receivables: Real estate & personal property Intergovernmental Total assets

$18,490 7,560 1,940 $27,990

Payables Deferred revenues Total liabilities Fund balances: Assigned Unassigned Total fund balances Total liabilities and fund balances

$ 2,610 4,570 7,180 2,790 18,020 20,810 $27,990

Statement of Revenues, Expenditures, and Changes in Fund Balances: Revenues: Real estate taxes Intergovernmental Total revenues

$60,070 8,950 69,020

Expenditures: General government Public safety Education Public works Human services Debt principal payments Debt interest payments Total expenditures

15,540 9,280 27,720 4,180 5,230 1,800 300 64,050

Excess (deficiency) of revenues over expenditures

4,970

Other financing sources (uses) Proceeds from bonds Total other financing sources (uses)

9,000 9,000

Net change in fund balances Fund balances at beginning of year Fund balances at end of year

$13,970 6,840 $20,810

©Cambridge Business Publishers, 2020 9-18

Advanced Accounting, 4th Edition

Topic: Preparation of Fund Financial Statements LO: 5 3. Agawa City presents the following pre-closing trial balance for its General Fund as of the end of the year:

Cash Taxes receivable Estimated uncollectible taxes Due from other funds Vouchers payable Tax anticipation notes payable Fund balance Budgetary fund balance Estimated revenues Revenues Appropriations Expenditures Totals

Debit $116,000 29,000

Credit

5,000 2,000 14,800 50,000 69,200 11,000 249,000 258,000 255,000 245,000 $652,000

$652,000

Calculate the amount of fund balance at fiscal year-end after all closing entries are made that is spendable in the next fiscal year. Answer: $77,200 (69,200-11,000+*9,000+**10,000) where *9,000 is the difference between estimated revenues and revenues and **10,000 is the difference between appropriations and expenditures. The budgetary fund balance account of $11,000 is also closed out.

©Cambridge Business Publishers, 2020 Test Bank, Chapter 9

9-19

Chapter 7 Accounting for Foreign Currency Transactions and Derivatives Learning Objectives – Coverage by question Multiple Choice

Exercises

LO1 – Describe the accounting for foreign currency transactions gains and losses.

1, 3-12

1-6

LO2 – Describe the accounting for derivative financial instruments.

2, 13-29

Problems

1-4

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-1

Chapter 7: Accounting for Foreign Currency Transactions and Derivatives

Multiple Choice Topic: Accounting for Foreign Currency Transactions LO: 1 1. Which of the following best describes the effects of foreign currency fluctuations on the financial statements of companies with foreign currency-denominated assets and liabilities? a. Fluctuations in the $US value of foreign currency-denominated assets and liabilities affect both the balance sheet and the income statement. b. Fluctuations in the $US value of foreign currency-denominated assets and liabilities affect only the balance sheet and have no effect in net income. c. Fluctuations in the $US value of foreign currency-denominated assets and liabilities affect only stockholders’ equity and do not affect the income statement directly. d. None of the above Answer: a

Topic: Accounting for Derivative Financial Instruments LO: 2 2. Companies invest in financial derivatives: a. To reduce exposure to currency-related risks b. In order to realize capital gains as their value increases c. As a means in which to enter desirable markets d. None of the above Answer: a

Topic: Accounting for Foreign Currency Transactions LO: 1 3. If a company reports a receivable denominated in Euros (€) and the $US weakens vis-à-vis the Euro: a. The company will not report the change in the relative value of the receivable until the receivable is collected. b. The company will accrue the gain in its financial statements as of the statement date, even before the receivable is collected. c. The company will accrue the loss in its financial statements as of the statement date, even before the receivable is collected. d. The company will recognize the increase in the $US value of the receivable on its balance sheet as of the statement date, but the unrealized gain will not be recognized in its income statement until the receivable is collected. Answer: b

©Cambridge Business Publishers, 2020 7-2

Advanced Accounting, 4th Edition

Topic: Accounting for Foreign Currency Transactions LO: 1 4. In the past decade, the $US has: a. Strengthened with respect to the Euro (€) b. Remain unchanged with respect to the Euro (€) c. Weakened with respect to the Euro (€) d. Both weakened and strengthened with respect to the Euro(€) Answer: d

Topic: Accounting for Foreign Currency Transactions LO: 1 5. If a company reports a payable denominated in Euros (€) and the $US weakens vis-à-vis the Euro: a. The company will not report the change in the relative value of the payable until the payable is paid. b. The company will accrue the gain in its financial statements as of the statement date, even before the payable is paid. c. The company will accrue the loss in its financial statements as of the statement date, even before the payable is paid. d. The company will recognize the increase in the $US value of the payable on its balance sheet as of the statement date, but the unrealized loss will not be recognized in its income statement until the payable is paid. Answer: c

Topic: Accounting for Foreign Currency Transactions LO: 1 6. Which of the following best describes current GAAP with respect to the required reporting currency? a. A currency other than the U.S. dollar may be the reporting currency in financial statements b. Only the $US may be the reporting currency in financial statements c. Companies can change their reporting currency as much as they wish d. Companies can never change their reporting currency Answer: a

Topic: Accounting for Foreign Currency Transactions LO: 1 7. An exchange rate of $1.25:¥1 a. Means that each $US is worth 1.25¥ b. Implies that the $US has strengthened vis-à-vis the ¥ c. Implies that the ¥ has strengthened vis-à-vis the $US d. Can also be expressed as $1: ¥0.80

Answer: d

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-3

Topic: Accounting for Foreign Currency Transactions LO: 1 8. Assume that our US-based company purchases 2,000 units of inventories from a UK supplier at £6/unit. To record the purchase: a. Our company will debit inventories and credit accounts payable for £12,000. b. Our company will debit inventories and credit accounts payable for the $US equivalent of £12,000. c. Our company will not record the purchase of inventory until the payable is paid. d. Either a or b is current. Answer: b

Topic: Accounting for Foreign Currency Transactions LO: 1 9. Assume that the $US has weakened with respect to the Euro and that we have a Eurodenominated payable. a. Our company will report the loss only on the payment date. b. Our company will report the gain only on the payment date. c. Our company will not report a gain or loss because there has been no cash effect. d. Our company will accrue a loss on the statement date. Answer: d

Topic: Accounting for Foreign Currency Transactions LO: 1 10. Which of the following best describes the accounting for foreign currency-denominated receivables and payables? a. No gains or losses are recorded until the receivable is collected or the payable is paid. b. No gains or losses are recorded because there has been no cash effect. c. Companies are required to report the foreign-currency denominated receivables and payables at their current market value on the statement date, but no gain or loss is recognized in the income statement. d. Companies are required to accrue gains and losses on foreign currency-denominated receivables and payments as of the statement date. Answer: d

Topic: Accounting for Foreign Currency Transactions LO: 1 11. Assume that our company incurs a Euro-denominated payable when the exchange rate is $1.20:€1 and that the $US weakens to $1.27:€1 before the payable is paid. a. Our company will not recognize the gain until the payable is paid. b. Our company will not recognize the loss until the payable is paid. c. Our company will recognize the gain on its next statement date. d. Our company will recognize the loss on its next statement date. Answer: d

©Cambridge Business Publishers, 2020 7-4

Advanced Accounting, 4th Edition

Topic: Accounting for Foreign Currency Transactions LO: 1 12. If our company borrows money with a foreign currency-denominated loan: a. It must record the loan and the accrued interest at the current $US value on each statement date. b. It must record the loan, but not the accrued interest, at the current $US value on each statement date. c. It must record the accrued interest, but not the loan, at the current $US value on each statement date. d. No adjusting entries to reflect currency fluctuations need to be made. Answer: a

Topic: Accounting for Derivative Financial Instruments LO: 2 13. Financial derivatives: a. Are only used by foreign currency traders to speculate on currency fluctuations b. Are generally legal contracts or exchange traded securities that are designed to transfer risk for a price c. Generally involve three parties d. Both b and c are true Answer: d

Topic: Accounting for Derivative Financial Instruments LO: 2 14. Fair value risks generally relate to which of the following? a. Risks relating to forecasted transactions b. Unrecognized firm commitments c. Risks relating to fluctuations in the market price of the company’s own stock d. None of the above Answer: b

Topic: Accounting for Derivative Financial Instruments LO: 2 15. Which of the following is not a characteristic of a derivative? a. A contract that has one or more underlyings b. A contract that permits net settlement c. A contract that does not permit net settlement d. It is a financial instrument Answer: c

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-5

Topic: Accounting for Derivative Financial Instruments LO: 2 16. Net settlement means that: a. Neither party is required to deliver an asset. b. One or both parties are required to deliver an asset. c. Both parties are required to deliver an asset. d. None of the above Answer: a

Topic: Accounting for Derivative Financial Instruments LO: 2 17. Which of the following is true of a firm commitment? a. The agreement specifies all significant terms. b. The agreement includes a disincentive for nonperformance that is sufficiently large to make performance probable. c. Neither of the above is true. d. Both a and b are true. Answer: d

Topic: Accounting for Derivative Financial Instruments LO: 2 18. Cash flow risks: a. Can relate to forecasted purchases or sales of a commodity b. Can relate to the risks associated with fixed rates of interest c. Can relate to the risks associated with variable rates of interest d. Both a and c are true Answer: d

Topic: Accounting for Derivative Financial Instruments LO: 2 19. A forward contract: a. Is a commitment to buy or sell a specified quantity of an asset or commodity at a specified price and future date b. Is an option to buy or sell a specified quantity of an asset or commodity at a specified price and future date c. Is traded on organized exchanges d. Allows for the quantity or price of the transaction to fluctuate over time Answer: a

©Cambridge Business Publishers, 2020 7-6

Advanced Accounting, 4th Edition

Topic: Accounting for Derivative Financial Instruments LO: 2 20. A futures contract: a. Is not similar to a forward contract for accounting purposes b. Is not traded on an organized exchange c. Is traded on an organized exchange d. None of the above are true Answer: c

Topic: Accounting for Derivative Financial Instruments LO: 2 21. If a forward or futures contract is to be an effective hedge of a net asset or future cash flow: a. Then the net settlement value of the forward or futures will increase and decrease in value in the same direction to the fair value of the asset (or to the future cash flows) to which they relate. b. Then the net settlement value of the forward or futures will increase and decrease in value in the opposite direction to the fair value of the asset (or to the future cash flows) to which they relate. c. Then the net settlement value of the forward or futures remains unchanged, thus reducing price fluctuation risk. d. None of the above are true. Answer: b

The following information pertains to Questions 22-23. Assume that our company has an inventory of aluminum alloy that it will sell to a customer in 90 days and that you face the following market prices.

Today 90 days later

Spot Price $3.10 $3.09

90 Day Futures Price $3.07

Topic: Accounting for Derivative Financial Instruments LO: 2 22. If we purchase a futures contract today: a. We will lock in a $0.03 loss b. We will lock in a $0.03 gain c. We will lock in a $0.01 loss d. We will lock in a $0.02 gain Answer: a

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-7

Topic: Accounting for Derivative Financial Instruments LO: 2 23. In 90 days: a. We will be able to realize $3.07 for our inventory b. We will be able to realize $3.09 for our inventory c. We will be able to realize $3.10 for our inventory d. We will be able to realize the current market price for our inventory Answer:a

Topic: Accounting for Derivative Financial Instruments LO: 2 24. An option contract: a. Requires a relatively large up-front payment and are, therefore, rarely used in practice b. Has an intrinsic value that is never less than zero c. Has an intrinsic value that decreases with time to maturity d. Gives a party the obligation to execute a transaction Answer: b

Topic: Accounting for Derivative Financial Instruments LO: 2 25. A call option: a. Is a right to buy a specified quantity of an asset at a specified price b. Is a right to sell a specified quantity of an asset at a specified price c. Can be used to limit the price a company will have to pay for a commodity d. Both a and c are true Answer: d

Topic: Accounting for Derivative Financial Instruments LO: 2 26. Which of the following statements is true about options? a. Options generally require a large up-front payment. b The time value of an option reflects the probability that the underlying asset’s price will rise c. An option’s value generally decreases with time to maturity to reflect the time value of money. d. A company might purchase a call option to limit potential price declines in the value of a financial asset or commodity. Answer: b

Topic: Accounting for Derivative Financial Instruments LO: 2 27. A swap contract: a. Relates to the trading of an asset owned by one company for another owned by a second company b. Is an arrangement between two or more parties to exchange future cash flows c. Can be used to increase or decrease the ratio of fixed and variable interest costs in its cost structure d. Both b and c are true. Answer: d ©Cambridge Business Publishers, 2020 7-8

Advanced Accounting, 4th Edition

Topic: Accounting for Derivative Financial Instruments LO: 2 28. Current US GAAP requires the following accounting for financial derivatives: a. Financial derivatives are reported at historical cost. b. Financial derivatives are reported at fair value at each statement date with unrealized gains (losses) reflected in Accumulated Other Comprehensive Income. c. Financial derivatives are reported at fair value at each statement date with unrealized gains (losses) reflected in Net Income. d. Financial derivatives are only written down to reflect losses that are other than temporary. Answer: b

Topic: Accounting for Derivative Financial Instruments LO: 2 29. Hedge accounting means that: a. The financial derivative is reported on the balance at fair value, but no gains and losses are recognized, thus reducing income volatility. b. The financial derivative is marked to market together with the asset (liability) to which it relates and unrealized gains and losses are always reflected in net income. c. The financial derivative is marked to market together with the asset (liability) to which it relates and unrealized gains and losses on fair value hedges are immediately reflected in net income. d. The financial derivative is marked to market together with the asset (liability) to which it relates and unrealized gains and losses on cash flow hedges are immediately reflected in net income. Answer: c

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-9

Exercises Topic: Journal Entries for an Account Payable Denominated in Euros ($US Weakens) LO: 1 1. Assume that your company purchases inventories from a supplier on December 15. The invoice specifies that payment is to be made on March 15 in Euros in the amount of 10,000 Euros. Your company operates on a calendar year basis. Assume the following exchange rates: December 15 December 31 March 15

$1.35 :1 Euro $1.37 :1 Euro $1.38 :1 Euro

Required: a. Prepare the journal entries to record the purchase (assume perpetual inventory accounting). b. Prepare the journal entry as of Dec. 31. c. Prepare the journal entry as of March 15. Answer: a. Dec. 15

Inventories

13,500

Accounts Payable To record the purchase of inventories at $1.35:1 Euro. b. Dec. 31

c. Mar. 15

13,500

Foreign currency transaction loss Accounts Payable To record the increase in the Account Payable to $1.37:1 Euro.

200

Accounts Payable Foreign currency transaction loss Cash To record payment of the Account Payable at an exchange rate of $1.38:1 Euro.

13,700 100

200

13,800

©Cambridge Business Publishers, 2020 7-10

Advanced Accounting, 4th Edition

Topic: Journal Entries for an Account Receivable Denominated in Euros ($US Weakens) LO: 1 2. Assume that your company sells product to a customer supplier on December 15. The invoice specifies that payment is to be made on March 15 in Euros in the amount of 25,000 Euros. Your company operates on a calendar year basis. Assume the following exchange rates: December 15 December 31 March 15

$1.35 :1 Euro $1.37 :1 Euro $1.38 :1 Euro

Required: a. Prepare the journal entries to record the sale. b. Prepare the journal entry as of Dec. 31. c. Prepare the journal entry as of March 15. Answer: a. Dec. 15

b. Dec. 31

c. Mar. 15

Accounts Receivable Sales To record the sale at $1.35:1 Euro.

13,500 13,500

Accounts Receivable Foreign currency transaction gain To record the increase in the Account Receivable to $1.37:1 Euro. Cash

200 200

13800

Foreign currency transaction gain Accounts Receivable To record receipt of the Account Receivable at an exchange rate of $1.38:1 Euro.

100 13,700

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-11

Topic: Journal Entries for an Account Payable Denominated in Canadian Dollars ($US Strengthens) LO: 1 3. Assume that your company purchases inventories from a Canadian supplier on November 3. The invoice specifies that payment is to be made on February 1 in Canadian dollars ($CAD) in the amount of $100,000 (CAD). Your company operates on a calendar year basis. Assume the following exchange rates: November 3 December 31 February 1

US $1.20 : CA $1 US $1.15 : CA $1 US $1.11 : CA $1

Inventories

120,000

Accounts Payable To record the purchase of inventories at US $1.20 : CA $1. b. Dec. 31

c. Feb. 1

Accounts payable Foreign currency transaction gain To record the increase in the Account Payable to US $1.15 : CA $1.

120,000

5,000

Accounts Payable 115,000 Foreign currency transaction gain Cash To record payment of the Account Payable at an exchange rate of US $1.11 : CA $1.

5,000

4,000 111,000

©Cambridge Business Publishers, 2020 7-12

Advanced Accounting, 4th Edition

Topic: Journal Entries for an Account Receivable Denominated in Canadian Dollars ($US Strengthens). LO: 1 4. Assume that your company sells product to a Canadian customer on November 3. The invoice specifies that payment is to be made on February 1 in Canadian dollars ($CAD) in the amount of $100,000 (CAD). Your company operates on a calendar year basis. Assume the following exchange rates: November 3 December 31 February 1

US $1.20 : CA $1 US $1.15 : CA $1 US $1.11 : CA $1

Required: a. Prepare the journal entries to record the sale. b. Prepare the journal entry as of Dec. 31. c. Prepare the journal entry as of Feb. 1. Answer: a. Nov 3

b. Dec. 31

c. Feb. 1

Accounts receivable Sales To record the sale at US $1.20 : CA $1.

120,000 120,000

Foreign currency transaction loss Accounts receivable To record the decrease in the Account Receivable to US $1.15 : CA $1.

5,000

Cash Foreign currency transaction loss Accounts receivable To record receipt of the Account Receivable at an exchange rate of US $1.11 : CA $1.

111,000 4,000

5,000

115,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-13

Topic: Journal Entries for an Account Receivable Denominated in Pounds Sterling ($US Fluctuates). LO: 1 5. Assume that your company sells products to a customer located in Great Britain on November 20. The invoice specifies that payment is to be made on February 20 in Pounds Sterling (GBP) in the amount of GBP100,000. Your company operates on a calendar year basis. Assume the following exchange rates: November 20 December 31 February 20

$1.20 : 1GBP $1.15 : 1GBP $1.18 : 1GBP

Required: a. Prepare the journal entries to record the sale. b. Prepare the journal entry as of Dec. 31. c. Prepare the journal entry as of Feb. 20. Answer: a. Nov 20

b. Dec. 31

c. Feb. 20

Accounts Receivable Sales To record the sale of product at $1.20 : 1GBP.

120,000 120,000

Foreign currency transaction loss Accounts Receivable To record the decrease in the Account Receivable to $1.15 : 1GBP. Cash Foreign currency transaction gain Accounts Receivable To record receipt of payment of the Account Receivable at an exchange rate of $1.18 : 1GBP.

5,000 5,000

118,000 3,000 115,000

©Cambridge Business Publishers, 2020 7-14

Advanced Accounting, 4th Edition

Topic: Journal Entries for an Account Payable Denominated in Pounds Sterling ($US Fluctuates). LO: 1 6. Assume that your company purchases product from a supplier located in Great Britain on November 20. The invoice specifies that payment is to be made on February 20 in Pounds Sterling (GBP) in the amount of GBP100,000. Your company operates on a calendar year basis. Assume the following exchange rates: November 20 December 31 February 20

$1.20 : 1GBP $1.15 : 1GBP $1.18 : 1GBP

Inventories

120,000

Accounts payable To record the sale of product at $1.20 : 1GBP. b. Dec. 31

c. Feb. 20

120,000

Accounts payable Foreign currency transaction gain To record the decrease in the Account Payable to $1.15 : 1GBP.

5,000

Foreign currency transaction loss Accounts Payable Cash To record payment of the Account Payable at an exchange rate of $1.18 : 1GBP.

3,000 115,000

5,000

118,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-15

Problems Topic: Use of Futures Contracts to Hedge Cotton Inventory—Fair Value Hedge LO: 2 1. On July 1, 2020 a cotton wholesaler has 1 million pounds of cotton inventory on hand at an average cost of $1.28 per pound. To protect the inventory from a possible decline in cotton prices, the company sells cotton futures contracts for 1 million pounds at $1.43 a pound for delivery on October 31, 2020 to coincide with its expected physical sale of its cotton inventory. The Company designates the hedge as a fair value hedge (i.e., The Company is hedging changes in the inventory’s fair value, not changes in cash flows from anticipated sales.). Following are futures and spot prices for the relevant dates: Date

Spot

Futures

July 1, 2020

$1.41

$1.43

September 30, 2020

$1.39

$1.41

October 31, 2020

$1.42

n/a

Required: Prepare the journal entries to record the following: a. Sale of futures contract b. Adjusting entry at September 30 c. Sale of cotton on October 31 at spot price d. How much cash does the company receive in total on this transaction? Answer: a. No entry is made to record the fair value of the futures contracts, because at the time of their inception their fair value is zero. b. 9/30/20

COGS

20,000 Cotton inventory To adjust the carrying amount of the inventory for changes in its fair value = 1 million lbs. x [$1.39 - $1.41]. Futures contract COGS To record the gain on futures contract = 1 million lbs. x [$1.43 - $1.41].

20,000

20,000 20,000

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c. 10/31/20

Cash COGS

10,000 10,000

Futures contract To close out futures contract and recognize the loss on the futures contracts from 7/1/2020 to 10/31/2020 = 1 million lbs. x ($1.41- $1.42). Cotton inventory COGS To adjust the carrying amount of the inventory that is due to the increase in spot prices = 1 million lbs. x ($1.39 - $1.41).

20,000

30,000

Cash 1,420,000 Cost of Goods Sold* 1,290,000 Cotton sales Cotton inventory* To record the sale of 1,000,000 pounds of cotton inventory at $1.42/lb. $1,280,000 Avg. cost (1,000,000 x $1.28) (20,000) 9/30/20 adj. 30,000 10/31/20 adj $1,290,000 *Cotton inv cost

30,000

1,420,000 1,290,000

Incorporates ASU2017-12 that requires to recognize the gains/losses in the same income statement line item as the earnings effect of the hedged item. FASB ASC815-25-35-1 d. Our company receives $1,420,000 from the sale of the cotton and $10,000 from the futures contract for a total of $1,430,000. This is the $1.43 futures price that we locked in at the start of the transaction.

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-17

Topic: Use of Futures Contracts to Hedge a Forecasted Transaction—Cash Flow Hedge LO: 2 2. Assume that, as of July 1, Tommy’s T-Shirts, Inc. plans to purchase 400,000 lbs. of cotton on October 1 at the prevailing spot rate. To hedge this forecasted transaction, Tommy purchases October futures contracts in July for 400,000 lbs. of cotton at the futures price of $1.10/lb. On October 1, Tommy closes out his futures contracts by entering into an offsetting contract in which he agrees to buy 400,000 lbs. of October cotton futures contracts at $1.30/lb., the spot rate on that date. Tommy also purchases 400,000 lbs. of cotton at $1.30/lb. on that date for use in making t-shirts. Tommy operates on a calendar year and issues financial statements quarterly. Following are futures and spot prices for the relevant dates: Date

Spot

Futures

July

$1.00

$1.10

September 30

$1.15

October 1

$1.30

n/a

Required: Prepare the journal entries to record the following: a. Purchase of cotton futures contract in July b. Adjusting entry at September 30 c. Purchase of cotton on October 1 d. At what dollar amount will the cotton be reflected in COGS? Answer: a. July

b. Sept. 30

c. Oct. 1

No entry is made to record the fair value of the futures contracts, because at the time of their inception their fair value is zero. Futures contract Other comprehensive income To record unrealized gain on futures contract = [$1.15 - $1.10] x 400,000 lbs.

20,000

Inventory

520,000

20,000

Cash To purchase inventory = 400,000 lbs. @ $1.30/lb. Cash Futures contract Other comprehensive income To record the settlement of the futures contact at a current fair value of $1.30/lb. (80,000 = 400,000 lbs. x [$1.30 - $1.10]/lb.).

520,000

80,000 20,000 60,000

d. The cotton will be reflected in COGS at $440,000 as the $8,000 gain on the futures contract will offset the $520,000 purchase cost of the cotton by the amount of the gain.

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Topic: Use of Forward Contracts to Hedge a Receivable Denominated in a Foreign Currency— Fair Value Hedge LO: 2 3. In August, our company sells inventory to a customer in Switzerland, receivable in Swiss Francs (CHF). The receivable is CHF200,000 and the exchange rate on the date of sale is $1.20:CHF1. Payment is due in 60 days. Our company feels that the $US has been over-sold and is likely to rebound during the next 60 days, thus lowering the $US equivalent of the receivable. The current forward price for 90-day delivery of $1.15 reflects our view. Since we feel that the $US is likely to strengthen even more, we purchase a forward contract to sell Swiss Francs at $1.15 60 days hence. When the receivable is collected in 60 days, the exchange rate at that date is $1. 05: CHF1. Assume the following data relating to the spot and forward rates for the $US vis-à-vis the Euro:

August Sept. 30 October

Spot rate $1.20 : CHF1 $1.10 : CHF1 $1.05 : CHF1

Forward Rate $1.15 : CHF1 $1.07 : CHF1 n/a

Required: Prepare the journal entries to record the following: a. Account receivable and sale (ignore cost of goods sold) b. Adjusting entry on Sept. 30 c. Collection of the account receivable in October Answer: a. August

Account Receivable Sales To record sale of CHF200,000 at $1.20:CHF1.

240,000 240,000

No entry is made to record the fair value of the forward contracts, because at the time of their inception their fair value is zero. b. Sept. 30 Sales

20,000

Account Receivable To record decline in the reported amount of the receivable = [$1.20 - $1.10]/CHF x CHF200,000.

c. Oct.

20,000

Forward contract Sales To record gain on forward contract = [$1. 15 - $1.07]/CHF x CHF200,000.

16,000

Forward contract Sales To record gain on forward contract = [$1.07 - $1.05]/CHF x CHF200,000.

4,000

16,000

4,000

Cash Sales

230,000 10,000

Account Receivable Forward contract To record the settlement of the forward contact and collection of the receivable. Incorporates ASU2017-12 that requires to recognize the gains/losses in the same income statement line item as the earnings effect of the hedged item. FASB ASC815-25-35-1

220,000 20,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-19

Topic: Use of Forward Exchange Contracts to Hedge a Firm Commitment to Pay Foreign-Currency LO: 2 4. On October 15, our company has executed a purchase order for new equipment to be purchased from a supplier in Denmark for a purchase price of DKK 1.2 million. The equipment is deliverable on March 31. In order to hedge the commitment to pay DKK1.2 million, we enter into a forward exchange contract on October 15 to receive DKK1.8 million on March 31 at an exchange rate of $0.17: DKK1. Assume the following exchange gates: Date October 15 December 31 March 31

Spot Rates $0.15:DKK1 $0.16:DKK1 $0.20:DKK1

Forward Rates $0.17:DKK1 $0.18:DKK1 n/a

Required: Prepare the journal entries to record the following: • Execution of the purchase order and forward contract • Adjusting entries at December 31 • Receipt of equipment and payment to equipment supplier on March 31. Answer: A contract to purchase equipment for a fixed price is an unrecognized firm commitment. The hedge of the foreign currency exposure in an unrecognized firm commitment is considered a foreign currency fair value hedge. Accordingly, the forward contract is recognized as an asset or liability and marked to market through the income statement. The change in the value of the firm commitment that arises due to fluctuations in the forward exchange rate is also reflected in income and as an asset or liability on the balance sheet. The equipment is recorded at the amount of the liability, net of the amount previously recorded for the firm commitment. 10/15

No entry required

12/31

Forward contract Depreciation expense To recognize the change in the fair value of the forward exchange contract at December 31 = DKK1.2 million x [$0.17-$0.18]/ DKK.

12,000

Depreciation expense Firm commitment To recognize the change in the fair value of the firm commitment that is due to changes in exchange rates.

12,000

Forward contract Depreciation expense To recognize the change in the fair value of the forward exchange contract as of March 31 = DKK1.2 million x [$0.18-$0.20]/DKK.

24,000

Depreciation expense Firm commitment To recognize the change in the fair value of the firm commitment that is due to changes in exchange rates. Incorporates ASU2017-12 that requires to recognize the gains/losses in the same income statement line item as the earnings effect of the hedged item. FASB ASC815-25-35-1

24,000

3/31

12,000

24,000

Continued

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Advanced Accounting, 4th Edition

3/31

Continued Equipment Firm commitment Forward contract Cash To record the purchase of the equipment on 3/31 (at the forward contract rate established by the hedge) and the related payable at the March 31 spot rate.

204,000 36,000 36,000 204,000

The above journal entry may also be recorded as: Cash

36,000

Forward contract To record settlement of the forward contract.

36,000

Equipment

240,000

Cash To record purchase of equipment from the Danish supplier at 3/31 spot rate. Firm commitment Equipment To adjust equipment to reflect the hedge of the firm commitment.

240,000

36,000 36,000

©Cambridge Business Publishers, 2020 Test Bank, Chapter 7

7-21

Chapter 8 Consolidation of Foreign Subsidiaries Learning Objectives – Coverage by question Multiple Choice

Exercises

Problems

LO1 – Describe the functional currency and the translation process.

1-10

1-4

1, 2

LO2 – Describe the remeasurement of foreign currency- denominated financial statements.

12-17

5, 6

LO3 – Describe the consolidation of foreign subsidiaries when the parent uses the equity method to account for its Equity Investment.

18-20

1, 2

LO4 – Describe the consolidation of foreign subsidiaries when the parent uses the cost method to account for its Equity Investment. Appendix 8A – Direct computation of translation adjustment and remeasurement gain (loss)

Appendix 8B – Hedging the net investment in a foreign subsidiary

7, 8

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-1

Chapter 8: Consolidation of Foreign Subsidiaries

Multiple Choice Topic: Functional Currency LO: 1 1. Which of the following provides the best definition of a functional currency? a. The currency that is the most useful to companies in order to transact business. b. The currency of the primary economic environment in which the subsidiary operates c. The currency with the least fluctuation in $US value d. None of the above Answer: b

Topic: Functional Currency LO: 1 2. Which of the following statements is correct? a. The functional currency must always be the currency of the US parent company. b. Non-US subsidiaries always record transactions in $US. c. If the foreign-currency-denominated subsidiary financial statements are already in the functional currency, but not in the parent’s currency, then the financial information must be “translated” into the parent’s currency. d. None of the above Answer: c

Topic: Functional Currency LO: 1 3. Which of the following is not a factor that must be considered in determining the functional currency? a. In which currencies does the subsidiary transact sales and ultimately generate its cash? b. In which currencies does the subsidiary purchase labor, materials, and other goods and services and ultimately expend cash? c. In which currencies does the subsidiary obtain its financing? d. In which currency will fluctuations in $US value be minimized? Answer: d

Topic: Functional Currency LO: 1 4. Which of the following statements is true? a. The functional currency cannot be changed once it is selected. b. If the functional currency is changed, prior financial statements continue to be reported in the previous functional currency. c. The functional currency can be changed as often as is deemed necessary to minimize fluctuations in reported earnings. d. If the functional currency is changed, previously issued financial statements should be restated into the new functional currency. Answer: b ©Cambridge Business Publishers, 2020 8-2

Advanced Accounting, 4th Edition

Topic: Translation Process LO: 1 5. Which of the following statements is true? a. Revenues and expenses can only be translated at the exchange rate in effect when recognized. b. US GAAP permits an averaging of exchange rates in order to facilitate the translation process and prescribes a specific approach for companies to use. c. Companies are required to use an averaging method that weights transactions by the relative proportion of sales volume during the period. d. Companies are permitted to use an average exchange rate for the period to translate revenues and expenses under the assumptions that revenues and expenses occur evenly throughout the period. Answer: d

Topic: Translation Process LO: 1 6. Which of the following best describes current GAAP with respect to the translation process? a. Assets and liabilities are translated at the exchange rate at the balance sheet date regardless of when they arose. b. Assets and liabilities are translated at the exchange rate in effect when they arose. c. Assets are translated at the exchange rate at the balance sheet date, but liabilities are translated at the exchange rate in effect with the liabilities were incurred. d. Revenues and expenses must be translated at the exchange rate in effect then they are recognized. Answer: a

Topic: Functional Currency LO: 1 7. Which of the following is not a factor that can be considered in determining a company’s functional currency? a. Cash flows related to the foreign entity’s individual assets and liabilities are primarily in the foreign currency and do not directly affect the parent entity’s cash flows. b. Sales prices for the foreign entity’s products are not primarily responsive on a short-term basis to changes in exchange rates but are determined more by local competition or local government regulation. c. The sales market is mostly in the parent’s country or sales contracts are denominated in the parent’s currency. d. Use of a particular currency will minimize fluctuations in profit. Answer: d Topic: Translation Process LO: 1 8. Which of the following best describes the translation of financial statements? a. All asset, liability and equity accounts are translated at the current exchange rate on the financial statement date. b. All asset, liability and equity accounts are translated at an average exchange rate for the period. c. Common stock and APIC accounts are translated at their respective historical exchange rates. d. All equity accounts are translated at their respective historical exchange rates. Answer: c ©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-3

Topic: Translation Process LO: 1 9. Which of the following best describes the cumulative translation adjustment? a. The cumulative translation adjustment is a plug figure to balance the trial balance. b. Changes in the cumulative translation adjustment are reflected in net income for the period. c. The cumulative translation adjustment reflects changes in the fair values of marketable securities on the balance sheet. d. The cumulative translation adjustment can only be a positive dollar amount. Answer: a

Topic: Translation Process LO: 1 10. Which of the following best describes the translation of the statement of cash flows? a. The statement of cash flows is prepared from the translated comparative balance sheet and income statement. b. All line items on the statement of cash flows are translated at the current exchange rate on the statement date. c. Translation of the statement of cash flows generally utilizes the weighted average exchange rate for all line items except significant one-time transactions. d. None of the above are true. Answer: c

Topic: Direct Computation of the Translation Adjustment LO: Appendix 8A 11. Which of the following statements is true? a. Direct computation of the translation adjustment only involves the current year and begins at a zero amount. b. Net income is multiplied by the difference between the end-of-year exchange rate and the beginning-of-year exchange rate. c. Net income is multiplied by the difference between the end-of-year exchange rate and the average exchange rate. d. The cumulative translation adjustment computation contains an adjustment to reflect changes in the fair value of the net assets of the company. Answer: c

Topic: Remeasurement LO: 2 12. Which of the following are indications that the subsidiary is not autonomous? a. Significant assets may be acquired from the parent or otherwise by expending the parent’s functional currency. b. The sale of assets may make available to the parent units of the parent’s functional currency. c. Financing is primarily by the parent or otherwise in the parent’s functional currency. d. All of the above Answer: d

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Topic: Remeasurement LO: 2 13. A highly inflationary economy is best defined as: a. One which has a cumulative inflation of over 100% over a three-year period b. One in which the rate of inflation is greater than that of the parent company c. One with inflation that is greater than its neighboring countries d. None of the above Answer: a

Topic: Remeasurement LO: 2 14. Monetary assets and liabilities are assets and liabilities: a. Which include only cash and marketable securities b. Which are measured at fair value c. Whose amounts are fixed in terms of units of currency by contract or otherwise d. All of the above Answer: c

Topic: Remeasurement LO: 2 15. Which of the following best describes the accounting for nonmonetary assets and liabilities? a. They are reported at their historical cost. b. They are reported at market value. c. Declines in market value are recognized, but only if other than temporary. d. We recognize decreases in fair value, but not increases. Answer: a

Topic: Remeasurement LO: 2 16. Which of the following best describes the accounting for nonmonetary assets and liabilities? a. They are reported at fair value. b. Revenues and expenses arising from these assets are translated at historical cost. c. They are reported at fair value only if less than historical cost. d. None of the above are true. Answer: b

Topic: Remeasurement LO: 2 17. Which of the following statements is not true? a. Gains and losses arising from remeasurement are reflected in current income. b. Cost of Goods Sold is not computed as the product of the foreign currency amount and an exchange rate. c. There is no cumulative translation adjustment arising from the remeasurement process. d. Remeasurement gains and losses are reflected in Other Comprehensive Income (OCI). Answer: d

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-5

Topic: Consolidation of Foreign Subsidiaries LO: 3 18. Which of the following statements is true about the treatment of the AAP in the consolidation process? a. The $US value of the beginning-of-year balance carries over from the previous year. b. The AAP relating to foreign acquisitions is not amortized like that related to US acquisitions. c. There is no gain or loss resulting from the translation of the AAP. d. The translation of the AAP requires both amortization and the recognition of gains or losses on the translation. Answer: d

Topic: Consolidation of Foreign Subsidiaries LO: 3 19. The equity investment account: a. Is not recognized in the case of foreign subsidiaries b. Is reported at fair value on the consolidated balance sheet with unrealized gains or losses reflected in Accumulated Other Comprehensive Income (AOCI) c. Is updated for both the change in the cumulative translation adjustment and for AAP translation gains or losses d. Is updated for only the change in the cumulative translation adjustment and not for AAP translation gains or losses Answer: c

Topic: Consolidation of Foreign Subsidiaries LO: 3 20. Upon the sale of a foreign subsidiary: a. The gain or loss on the sale is affected by the balance of the cumulative translation adjustment account. b. The gain or loss on the sale is only reflected in other comprehensive income (OCI) not in net income. c. The gain or loss on the sale is not affected by the balance of the cumulative translation adjustment account. d. The equity adjustment account is first adjusted to current market value before the gain or loss on sale is recognized. Answer: a

Topic: Consolidation of Foreign Subsidiaries LO: Appendix 8B 21. Which of the following best describes the accounting for the net investment in a foreign subsidiary? a. The net investment in a foreign subsidiary is reported at fair value. b. Companies can hedge the net investment in a foreign subsidiary like any other investment. c. The net investment in a foreign subsidiary is reported on the consolidated balance sheet at historical cost. d. Both a and b are true Answer: b

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Advanced Accounting, 4th Edition

Exercises Topic: Translation of Income Statement LO: 1 1. Assume that our subsidiary’s income statement in Euros (€) is reported as follows for the year: Income statement:

In Euros (€)

Sales Cost of goods sold Gross Profit Operating expenses Net income

750,000 -400,000 350,000 -125,000 225,000

Also assume the following exchange rates: BOY Rate EOY rate Avg. rate

$/€ $1.20 $1.30 $1.25

Required: Translate the income statement into $US using the current-rate method. Answer: Subsidiary (in €)

Translation Rate

Subsidiary (in $)

Income statement: Sales

750,000

$1.25

937,500

Cost of goods sold

-400,000

$1.25

(500,000)

Gross Profit

350,000

Operating expenses

-125,000

Net income

225,000

437,500 $1.25

(156,250) 281,250

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-7

Topic: Translation of Financial Statements LO: 1 2. Assume that our subsidiary reports the following financial statements in Euros (€): Subsidiary (in €) Income statement: Sales Cost of goods sold Gross Profit Operating expenses Net income

420,000 -100,000 320,000 -75,000 245,000

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

725,000 245,000 -24,000 946,000

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net Total Assets

758,000 624,000 200,000 1,213,100 2,795,100

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Total Liabilities & Equity

32,550 750,000 240,000 375,000 1,397,550 2,795,100

Also assume the following exchange rates ($:€1): BOY Rate EOY rate Avg. rate PPE purchase date rate LTD borrowing date rate Dividend rate Historical rate (Common Stock and APIC)

$1.30 $1.36 $1.33 $1.20 $1.10 $1.32 $0.80

Required: Translate the subsidiary’s income statement and balance sheet into $US using the current-rate method, assuming a BOY Retained Earnings balance of $752,400.

©Cambridge Business Publishers, 2020 8-8

Advanced Accounting, 4th Edition

Answer: Subsidiary (in € )

Translation Rate

Income statement: Sales Cost of goods sold Gross Profit Operating expenses Net income

420,000 -100,000 320,000 -75,000 245,000

$1.33 $1.33

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

725,000 245,000 -24,000 946,000

given above $1.32 computed

752,400 325,850 (31,680) 1,046,570

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net

758,000 624,000 200,000 1,213,100

$1.36 $1.36 $1.36 $1.46

1,030,880 848,640 272,000 1,771,126

Total Assets

2,795,100

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Cumulative translation adjustment

32,550 750,000 240,000 375,000 1,397,550

Total Liabilities & Equity

2,795,100

$1.33

Subsidiary (in $) 558,600 (133,000) 425,600 (99,750) 325,850

3,922,646

$1.36 $1.36 $0.80 $0.80

44,268 1,020,000 192,000 300,000 1,046,570 1,319,908 3,922,646

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-9

Topic: Translation of Financial Statements LO: 1 3. Assume that our subsidiary reports the following financial statements in Euros (€): Subsidiary (in €) Income statement: Sales Cost of goods sold Gross Profit Operating expenses

3,500,000 -750,000 2,750,000 -232,000

Net income

2,518,000

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

1,130,000 2,518,000 -250,000 3,398,000

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net Total Assets

500,000 975,000 325,000 2,743,800 4,543,800

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Total Liabilities & Equity

350,000 645,800 25,000 125,000 3,398,000 4,543,800

Also assume the following exchange rates ($:€1): BOY Rate EOY rate Avg. rate PPE purchase date rate LTD borrowing date rate Dividend rate Historical rate (Common Stock and APIC)

$1.40 $1.46 $1.43 $1.42 $1.47 $1.46 $1.22

Required: Translate the subsidiary’s income statement and balance sheet into $US using the current-rate method, assuming a BOY Retained Earnings balance of $1,250,000.

©Cambridge Business Publishers, 2020 8-10

Advanced Accounting, 4th Edition

Answer: Subsidiary (in €)

Translation Rate

Income statement: Sales Cost of goods sold Gross Profit Operating expenses Net income

3,500,000 -750,000 2,750,000 -232,000 2,518,000

$1.43 $1.43

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

1,130,000 2,518,000 -250,000 3,398,000

given above $1.46 computed

1,250,000 3,600,740 (365,000) 4,485,740

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net Total Assets

500,000 975,000 325,000 2,743,800 4,543,800

$1.46 $1.46 $1.46 $1.46

730,000 1,423,500 474,500 4,005,948 6,633,948

350,000 645,800 25,000 125,000 3,398,000

$1.46 $1.46 $1.22 $1.22 above

511,000 942,868 30,500 152,500 4,485,740 511,340 6,633,948

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Cumulative translation adjustment Total Liabilities & Equity

4,543,800

$1.43

Subsidiary (in $) 5,005,000 (1,072,500) 3,932,500 (331,760) 3,600,740

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-11

Topic: Translation of Financial Statements LO: 1 4. Assume that our subsidiary reports the following financial statements in Brazilian Real (R$): Subsidiary (in R$) Income statement: Sales Cost of goods sold Gross Profit Operating expenses Net income Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

3,850,000 -1,570,000 2,280,000 -1,985,000 295,000

650,000 295,000 -75,820 869,180

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net Total Assets

285,000 545,000 259,633 979,947 2,069,580

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Total Liabilities & Equity

275,800 124,600 80,000 720,000 869,180 2,069,580

Also assume the following exchange rates ($:R$): BOY Rate EOY rate Avg. rate PPE purchase date rate LTD borrowing date rate Dividend rate Historical rate (Common Stock and APIC)

$0.50 $0.80 $0.70 $0.60 $0.74 $0.75 $0.55

Required: Translate the subsidiary’s financial statements into $US using the current-rate method, assuming a BOY Retained Earnings balance of $420,000.

©Cambridge Business Publishers, 2020 8-12

Advanced Accounting, 4th Edition

Answer:

Income statement: Sales Cost of goods sold Gross Profit Operating expenses Net income Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings Balance sheet: Assets Cash Accounts receivable Inventory PPE, net Total Assets Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Cumulative translation adjustment Total Liabilities & Equity

Subsidiary (in R$)

Translation Rate

Subsidiary (in $)

3,850,000 -1,570,000 2,280,000 -1,985,000 295,000

$0.70 $0.70

2,695,000 (1,099,000) 1,596,000 (1,389,500) 206,500

650,000 295,000 -75,820 869,180

given above $0.75 computed

420,000 206,500 (56,865) 569,635

285,000 545,000 259,633 979,947 2,069,580

$0.80 $0.80 $0.80 $0.80

228,000 436,000 207,706 783,958 1,655,664

275,800 124,600 80,000 720,000 869,180

$0.80 $0.80 $0.55 $0.55

220,640 99,680 44,000 396,000 569,635 325,709 1,655,664

2,069,580

$0.70

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-13

Topic: Remeasurement of Financial Statements LO: 2 5. Assume that our company owns a subsidiary operating in Germany. The subsidiary has adopted the Euro (€) as its functional currency. Our company operates this subsidiary like a division or branch office, making all of its operating decisions, including pricing its products. We conclude, therefore, that the functional currency of this subsidiary is the $US and that its financial statements must be remeasured prior to consolidation. Following are the subsidiary’s financial statements (in €) for the most recent year: Subsidiary (in €) Income statement: Sales Cost of goods sold Gross Profit Operating expenses Depreciation Remeasurement gain or loss Net income

2,100,000 -570,000 1,530,000 -125,000 -53,320 1,351,680

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

2,140,000 1,351,680 -250,000 3,241,680

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net Total Assets

1,860,000 2,250,000 750,000 1,083,400 5,943,400

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings

450,000 961,720 165,000 1,125,000 3,241,680

Total Liabilities & Equity

5,943,400

Continued

©Cambridge Business Publishers, 2020 8-14

Advanced Accounting, 4th Edition

Our subsidiary also reports the following additional financial statement information:

Beginning inventory Purchases Ending inventory Cost of Goods Sold

In Euros (€) 895,000 425,000 -750,000 570,000

Land Building Accumulated Depreciation—Building Equipment Accumulated Depreciation—Equipment PPE, net

500,000 425,000 -141,600 425,000 -125,000 1,083,400

Depreciation expense—Building Depreciation expense—Equipment Depreciation expense

28,320 25,000 53,320

The relevant exchange rates for the $US value of the Euro (€) are as follows: BOY Rate EOY rate Avg. rate Dividend rate

$1.35 $1.45 $1.40 $1.43

Historical rates: Beginning inventory Land Building Equipment Historical rate (Common Stock and APIC)

$1.35 $0.65 $0.65 $0.67 $0.80

Required: Remeasure the subsidiary’s income statement, statement of retained earnings, and balance sheet into $US for the current year (assume that the BOY Retained Earnings is $2,000,000).

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-15

Answer:

Beginning inventory Purchases Ending inventory Cost of Goods Sold Land Building Accum Deprec. - Building Equipment Accum Deprec. - Equipment PPE, net Depreciation expense - building Depreciation expense - equipment Depreciation expense

Income statement: Sales Cost of goods sold Gross Profit Operating expenses Depreciation Remeasurement gain or loss Net income Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

Subsidiary (in €) 895,000 425,000 -750,000

Translation Rate

Subsidiary (in $)

1.35 1.40 1.45

1,208,250 595,000 (1,087,500) 715,750

500,000 425,000 -141,600 425,000 -125,000 1,083,400

$0.65 $0.65 $0.65 $0.67 $0.67

325,000 276,250 (92,040) 284,750 (83,750) 710,210

28,320 25,000 53,320

$0.65 $0.67

18,408 16,750 35,158

570,000

Subsidiary (in €)

Translation Rate

Subsidiary (in $)

2,100,000 -570,000 1,530,000 -125,000 -53,320

1.40 computed

1,351,680

plug #3

2,940,000 (715,750) 2,224,250 (175,000) (35,158) 1,021,624 3,035,716

2,140,000 1,351,680 -250,000 3,241,680

given plug #2 $1.43 computed

2,000,000 3,035,716 (357,500) 4,678,216

1.40 computed

Continued

©Cambridge Business Publishers, 2020 8-16

Advanced Accounting, 4th Edition

Subsidiary (in €)

Translation Rate

Subsidiary (in $)

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net Total Assets

1,860,000 2,250,000 750,000 1,083,400 5,943,400

$1.45 $1.45 computed computed

2,697,000 3,262,500 1,087,500 710,210 7,757,210

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Total Liabilities & Equity

450,000 961,720 165,000 1,125,000 3,241,680 5,943,400

$1.45 $1.45 $0.80 $0.80 plug #1

652,500 1,394,494 132,000 900,000 4,678,216 7,757,210

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-17

Topic: Remeasurement of Financial Statements LO: 2 6. Assume that our company owns a subsidiary operating in Switzerland. The subsidiary has adopted the Swiss Franc (CHF) as its functional currency. Our company operates this subsidiary like a division or branch office, making all of its operating decisions, including pricing its products. We conclude, therefore, that the functional currency of this subsidiary is the $US and that its financial statements must be remeasured prior to consolidation. Following are the subsidiary’s financial statements (in CHF) for the most recent year: Income statement: Sales Cost of goods sold

3,000,000 -2,321,500

Gross profit Operating expenses Depreciation Remeasurement gain or loss Net income

678,500 -252,000 -225,000 201,500

Statement of retained earnings: BOY retained earnings Net income Dividends

1,506,500 201,500 -75,000

Ending retained earnings

1,633,000

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net

850,000 1,273,300 650,000 927,000

Total Assets

3,700,300

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Total Liabilities & Equity

250,000 1,097,300 220,000 500,000 1,633,000 3,700,300

Continued

©Cambridge Business Publishers, 2020 8-18

Advanced Accounting, 4th Edition

Our subsidiary also reports the following additional financial statement information (in CHF): Beginning inventory Purchases Ending inventory Cost of Goods Sold

450,000 2,521,500 -650,000 2,321,500

Land Building Accumulated Depreciation—Building Equipment Accumulated Depreciation—Equipment PPE, net

52,000 750,000 -500,000 1,250,000 -625,000 927,000

Depreciation expense—Building Depreciation expense—Equipment Depreciation expense

100,000 125,000 225,000

The relevant exchange rates for the $US value of the Swiss Franc (CHF) are as follows: BOY Rate

$0.60

EOY rate

$0.80

Avg. rate

$0.70

Dividend rate

$0.77

Historical rates: Beginning inventory

$0.60

Land

$0.35

Building

$0.35

Equipment

$0.45

Historical rate (Common Stock and APIC)

$0.20

Required: Remeasure the subsidiary’s income statement, statement of retained earnings, and balance sheet into $US for the current year (assume that the BOY Retained Earnings is $1,100,000).

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-19

Answer: Subsidiary (in CHF)

Translation Rate

Subsidiary (in $)

Beginning inventory Purchases Ending inventory Cost of Goods Sold

450,000 2,521,500 -650,000 2,321,500

0.60 0.70 0.80

270,000 1,765,050 (520,000) 1,515,050

Land Building Accumulated Depreciation—Building Equipment Accumulated Depreciation—Equipment PPE, net

52,000 750,000 -500,000 1,250,000 -625,000 927,000

$0.35 $0.35 $0.35 $0.45 $0.45

18,200 262,500 (175,000) 562,500 (281,250) 386,950

100,000 125,000 225,000

$0.35 $0.45

35,000 56,250 91,250

Subsidiary (in CHF)

Translation Rate

Subsidiary (in $)

3,000,000 -2,321,500 678,500 -252,000 -225,000

0.70 computed

201,500

plug #3

2,100,000 (1,515,050) 584,950 (176,400) (91,250) 24,200 341,500

1,506,500 201,500 -75,000 1,633,000

given plug #2 0.77 computed

1,100,000 341,500 (57,750) 1,383,750

Depreciation expense—Building Depreciation expense—Equipment Depreciation expense

0.70 computed

Continued

©Cambridge Business Publishers, 2020 8-20

Advanced Accounting, 4th Edition

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net Total Assets Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Total Liabilities & Equity

Subsidiary (in CHF)

Translation Rate

Subsidiary (in $)

850,000 1,273,300 650,000 927,000 3,700,300

$0.80 $0.80 computed computed

680,000 1,018,640 520,000 386,950 2,605,590

250,000 1,097,300 220,000 500,000 1,633,000 3,700,300

$0.80 $0.80 $0.20 $0.20 plug #1

200,000 877,840 44,000 100,000 1,383,750 2,605,590

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-21

Topic: Translation of Financial Statements – Computation Using Direct Method LO: Appendix 8A 7. Assume that our subsidiary reports the following: BOY Net assets Net income Dividends BOY Cumulative Translation Adjustment

€ 2,458,000 € 562,000 -€ 65,000 $1,250,000

Also assume the following exchange rates for the year ($:€1): BOY Rate EOY rate Avg. rate Dividend rate

$1.10 $1.20 $1.15 $1.19

Required: Compute the Cumulative Translation Adjustment balance at the end-of-year using the direct method. Answer: BOY Net assets x EOY -BOY Exchange rates 2,458,000 Net income x EOY -Avg. Exchange rates 562,000 Dividends x EOY -Div. Exchange rates -65,000

$0.10 $0.05 $0.01

$245,800 1.20 $28,100 1.20 ($650) 1.20 $273,250 1,250,000 1,523,250

2,458,000 562,000 -65,000

$1.10 $1.15 $1.19

2,955,000

$1.20

$2,703,800 $646,300 ($77,350) $3,272,750 3,546,000 $273,250 1,250,000 $1,523,250

BOY Cumulative Translation Adjustment EOY Cumulative Translation Adjustment Alternate method: BOY Net assets @ BOY Exchange rate Net income Dividends EOY Net assets @ EOY Exchange rate Translation Adjustment for the year BOY Cumulative Translation Adjustment EOY Cumulative Translation Adjustment

1.10 1.15 1.19

©Cambridge Business Publishers, 2020 8-22

Advanced Accounting, 4th Edition

Topic: Remeasurement of Financial Statements – Computation Using Direct Method LO: Appendix 8A 8. Assume that our subsidiary reports the following: € (1,21,000) € 906,000 € (93,000)

BOY Net monetary assets Chg. Net monetary assets (other than from dividends) Dividends Also assume the following exchange rates for the year ($:€1): BOY Rate EOY rate Avg. rate Dividend rate

$1.30 $1.50 $1.45 $1.48

Required: Compute the remeasurement gain or loss for the year using the direct method. Answer: BOY Net monetary assets x EOY - BOY Exchange rates

-1,210,000 x $0.20

Chg. Net monetary assets x EOY - Avg. Exchange rates

906,000 x $0.05

Dividends x EOY - Div. Exchange rates

-93,000 x $0.02

($242,000) $1.50 - $1.30 $45,300

$1.50 - $1.45

($1,860)

$1.0 - $1.48

($198,560) Alternate method: Change in net monetary assets: Beginning net monetary assets

-1,210,000 x $1.30

($1,573,000)

Chg. Net monetary assets x EOY - Avg. Exchange rates

906,000 x $1.45

$1,313,700

Dividends

-93,000 x $1.48

($137,640) ($396,940)

Ending net monetary assets Remeasurement loss

(397,000)

$1.50

-595,500 ($198,560)

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-23

Problems Topic: Consolidation of Foreign Subsidiary Using the Equity Method LO: 1, 3 1.

Assume that our company owns a subsidiary operating in France and accounts for its investment in the subsidiary using the equity method. The subsidiary maintains is books in Euros (€) as its functional currency. Following are the subsidiary’s financial statements (in €) for the most recent year: Subsidiary (in €) Income statement: Sales Cost of goods sold Gross Profit Operating expenses Net income

2,000,000 -1,200,000 800,000 -330,000 470,000

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

1,420,000 470,000 -45,000 1,845,000

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net Total Assets

430,300 970,600 297,500 2,854,600 4,553,000

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Cumulative translation adjustment

448,000 1,100,000 460,000 700,000 1,845,000

Total Liabilities & Equity

4,553,000

Continued

©Cambridge Business Publishers, 2020 8-24

Advanced Accounting, 4th Edition

Statement of cash flows: Net income Change in Accounts Receivable Change in Inventories Change in Current Liabilities Net cash flows from operating activities

470,000 -45,000 -73,500 45,000 396,500

Change in PPE, net Net cash flows from investing activities

-125,000 -125,000

Change in long-term debt Dividends Net cash flows from financing activities

92,500 -45,000 47,500

Net change in cash Effect of exchange rate on cash Beginning cash

319,000

Ending cash

430,300

111,300

The relevant exchange rates for the $US value of the Euro (€) are as follows: BOY Rate EOY rate Avg. rate PPE purchase date rate LTD borrowing date rate Dividend rate Historical rate (Common Stock and APIC)

$1.45 $1.55 $1.50 $1.47 $1.51 $1.53 $1.20

Continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-25

Required: a. Translate the subsidiary’s, income statement, statement of retained earnings, balance sheet, and statement of cash flows from Euros (€) into $US (assume that the BOY Retained Earnings for the subsidiary is $1,483,860. b. Compute the end Cumulative Translation Adjustment directly, assuming a BOY balance of $865,140. c.

Refer to the selected financial statement accounts for the parent, below. Assume the following information: The purchase price for the subsidiary included an AAP asset relating to Land that the parent estimated was worth €180,000 more than book value on the subsidiary’s balance sheet. The exchange rate in effect when the subsidiary was acquired was $1.20:€1. i. ii.

Compute the balance of the Equity Investment account of $4,873,750 on the parent’s balance sheet. Prepare the consolidation spreadsheet for the year. Parent Income statement: Sales Cost of goods sold Gross Profit Equity income Operating expenses Net income

$4,580,000 -2,800,000 1,780,000 705,000 -950,000 $1,535,000

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

$7,520,000 1,535,000 -150,000 $8,905,000

Balance sheet: Assets Cash Accounts receivable Inventory Equity Investment PPE, net

$425,000 852,000 2,560,000 4,873,750 6,037,000 14,747,750

Liabilities and Stockholders’ Equity Current liabilities Long-term Liabilities Common Stock APIC Retained Earnings Cumulative Translation Adjustment

$318,210 2,300,000 165,800 1,850,000 8,905,000 1,208,740 $14,756,750

Continued

©Cambridge Business Publishers, 2020 8-26

Advanced Accounting, 4th Edition

Answer: a. Subsidiary (in € )

Translation Rate

Subsidiary (in $)

Income statement: Sales Cost of goods sold

2,000,000 -1,200,000

$1.50 $1.50

3,000,000 (1,800,000)

Gross Profit Operating expenses Net income

800,000 -330,000 470,000

$1.50

1,200,000 (495,000) 705,000

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

1,420,000 470,000 -45,000 1,845,000

given above $1.53 computed

1,483,860 705,000 (68,850) 2,120,010

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net

430,300 970,600 297,500 2,854,600

$1.55 $1.55 $1.55 $1.55

666,965 1,504,430 461,125 4,424,630

Total Assets

4,553,000

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Cumulative translation adjustment

448,000 1,100,000 460,000 700,000 1,845,000 ---

Total Liabilities & Equity

4,553,000

7,057,150

$1.55 $1.55 $1.15 $1.15 above

694,400 1,705,000 552,000 840,000 2,120,010 1,145,740 7,057,150

Continued

©Cambridge Business Publishers, 2020 Test Bank, Chapter 8

8-27

a. continued Statement of cash flows: Net income Change in Accounts Receivable Change in Inventories Change in Current Liabilities Net cash flows from operating activities

470,000 -45,000 -73,500 45,000 396,500

above $1.50 $1.50 $1.50

705,000 (67,500) (110,250) 67,500 594,750

Change in PPE, net Net cash flows from investing activities

-125,000 -125,000

$1.47

(183,750) (183,750)

Change in long-term debt Dividends Net cash flows from financing activities

92,500 -45,000 47,500

$1.51 $1.53

139,675 (68,850) 70,825

Net change in cash Effect of exchange rate on cash

319,000

Beginning cash Ending cash

111,300 430,300

plug

481,825 23,755

$1.45

161,385

$1.55

666,965

b. BOY Net assets x EOY - BOY Exchange rates

€ 2,580,000

$0.10

258,000

1.55

Net income x EOY - Avg. Exchange rates

€ 470,000

$0.05

23,500

1.55

1.50

Dividends x EOY - Div. Exchange rates

-€ 45,000

$0.02

(900)

1.55

1. 53

1.45

280,600 BOY Cumulative Translation Adjustment

865,140

EOY Cumulative Translation Adjustment

1,145,740

Alternate method: 2,580,000

$1.45

$3,741,000

Net income

470,000

$1.50

$705,000

Dividends

-45,000

$1.53

($68,850)

BOY Net assets @ BOY Exchange rate

$4,377,150 $1.55 EOY Net assets @ EOY Exchange rate

3,005,000

4,657,750

Translation Adjustment for the year

$280,600

BOY Cumulative Translation Adjustment

865,140

EOY Cumulative Translation Adjustment

$1,145,740

Continued

©Cambridge Business Publishers, 2020 8-28

Advanced Accounting, 4th Edition

i. Beginning Equity investment

3,091,860

Cumulative Translation Adjustment

1,145,740

Equity Income

705,000

Dividends

-68,850

Ending Equity Investment

4,873,750

ii. Elimination entries Parent

Subsidiary

Consolidated

Income statement: Sales

$4,580,000

3,000,000

$7,580,000

Cost of goods sold

-2,800,000

(1,800,000)

($4,600,000)

Gross Profit

1,780,000

1,200,000

Equity income

705,000

Operating expenses

-950,000

(495,000)

(1,445,000)

$1,535,000

705,000

$1,535,000

BOY retained earnings

$7,520,000

1,483,860

Net income

1,535,000

705,000

Dividends

-150,000

(68,850)

$8,905,000

2,120,010

$8,905,000

Net income

$2,980,000 [C]

705,000

---

Statement of retained earnings:

Ending retained earnings

[E]

1,483,860

$7,520,000 $1,535,000 [C]

68,850

-150,000

Balance sheet: Assets Cash

$425,000

666,965

$1,091,965

Accounts receivable

852,000

1,504,430

$2,356,430

Inventory

2,560,000

461,125

$3,021,125

Equity Investment

4,873,750

PPE, net

6,037,000 14,747,750

4,424,630

[A]

216,000

---

[D]

63,000

[E]

4,021,600

[A]

216,000

[C]

636,150

---

10,740,630

7,057,150

$17,210,150

$1,012,610

Liabilities and Stockholders’ Equity Current liabilities

$318,210

694,400

Long-term liabilities

2,300,000

1,705,000

165,800

552,000

[E]

552,000

$165,800

APIC

1,850,000

840,000

[E]

840,000

$1,850,000

Retained earnings

8,905,000

2,120,010

Cumulative translation adjustment

1,208,740

1,145,740

[E]

1,145,740

Common stock

--$14,747,750

--7,057,150

$4,005,000

$8,905,000 [D]

63,000 ---

1,271,740 --$17,210,150

8-29

Topic: Consolidation of Foreign Subsidiary Using the Equity Method LO: 1, 3 2. Assume that our company owns a subsidiary operating in Great Britain and accounts for its investment in the subsidiary using the equity method. The subsidiary maintains is books in Pound sterling (£) as its functional currency. Following are the subsidiary’s financial statements (in £) for the most recent year: Subsidiary (in £) Income statement: Sales Cost of goods sold Gross Profit Operating expenses Net income

2,751,081 -758,100 1,992,981 -1,250,000 742,981

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

542,000 742,981 -15,000 1,269,981

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net Total Assets

430,300 970,600 297,500 1,749,581 3,447,981

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Cumulative translation adjustment

448,000 570,000 460,000 700,000 1,269,981

Total Liabilities & Equity

3,447,981

Continued

Advanced Accounting, 4th Edition

Statement of cash flows: Net income

742,981

Change in Accounts Receivable

-40,000

Change in Inventories

78,000

Change in Current Liabilities

-35,000

Net cash flows from operating activities

745,981

Change in PPE, net

-474,481

Net cash flows from investing activities

-474,481

Change in long-term debt

72,000

Dividends

-24,500

Net cash flows from financing activities

47,500

Net change in cash

319,000

Effect of exchange rate on cash: Beginning cash

111,300

Ending cash

430,300

$1.70 $1.80 $1.75 $1.72 $1.78 $1.49 $1.25

Continued

8-31

Required: a. Translate the subsidiary’s, income statement, statement of retained earnings, balance sheet, and statement of cash flows from Pounds Sterling (£) into $US (assume that the BOY Retained Earnings for the subsidiary is $687,000 b. Compute the end Cumulative Translation Adjustment directly, assuming a BOY balance of $515,000. c.

Refer to the selected financial statement accounts for the parent, below. Assume the following information: The purchase price for the subsidiary included an AAP asset relating to Land that the parent estimated was worth £180,000 more than book value on the subsidiary’s balance sheet. The exchange rate in effect when the subsidiary was acquired was $1.25:£1. i. ii.

Compute the balance of the Equity Investment account of $4,598,966 on the parent’s balance sheet. Prepare the consolidation spreadsheet for the year. Parent Income statement: Sales Cost of goods sold Gross Profit Equity income Operating expenses Net income

$4,580,000 -2,800,000 1,780,000 1,300,217 -950,000 $2,130,217

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

$7,520,000 2,130,217 -150,000 $9,500,217

Balance sheet: Assets Cash Accounts receivable Inventory Equity Investment PPE, net

$425,000 852,000 2,560,000 4,598,966 6,756,360 15,192,326

Liabilities and Stockholders’ Equity Current liabilities Long-term Liabilities Common Stock APIC Retained Earnings Cumulative Translation Adjustment

$318,210 2,300,000 165,800 1,850,000 9,500,217 1,058,099 $15,192,326

Continued

Advanced Accounting, 4th Edition

Answer a. Subsidiary (in £)

Translation Rate

Subsidiary (in $)

Income statement: Sales Cost of goods sold

2,751,081 -758,100

$1.75 $1.75

4,814,392 (1,326,675)

Gross Profit Operating expenses Net income

1,992,981 -1,250,000 742,981

$1.75

3,487,717 (2,187,500) 1,300,217

687,000 1,300,217 (22,350) 1,964,867

774,540 1,747,080 535,500 3,149,246

Statement of retained earnings: BOY retained earnings Net income Dividends Ending retained earnings

1,269,981

Given Above $1.49 computed

Balance sheet: Assets Cash Accounts receivable Inventory PPE, net

430,300 970,600 297,500 1,749,581

$1.80 $1.80 $1.80 $1.80

Total Assets

3,447,981

Liabilities and Stockholders’ Equity Current Liabilities Long-term Liabilities Common Stock APIC Retained Earnings Cumulative translation adjustment

448,000 570,000 460,000 700,000 1,269,981

Total Liabilities & Equity

3,447,981

542,000 742,981 -15,000

6,206,366

$1.80 $1.80 $1.25 $1.25 above

806,400 1,026,000 575,000 875,000 1,964,867 959,099 6,206,366

Continued

8-33

a. continued Statement of cash flows: Net income Change in Accounts Receivable Change in Inventories Change in Current Liabilities Net cash flows from operating activities

742,981

$1.75 $1.75 $1.75 $1.75

-40,000 78,000 -35,000 745,981

1,300,217 (70,000) 136,500 (61,250) 1,305,467

Change in PPE, net Net cash flows from investing activities

-474,481

$1.72

Change in long-term debt Dividends Net cash flows from financing activities

72,000 -24,500 47,500

91,655

Net change in cash Effect of exchange rate on cash Beginning cash Ending cash

319,000

581,014 4,316 189,210 774,540

-474,481

(816,107) (816,107)

$1.78 $1.49

Plug $1.70 $1.80

111,300 430,300

128,160 (36,505)

b. € 1,702,000 € 742,981 -€ 15,000

$0.10 $0.05 $0.31

170,200 37,149 (4,650) 202,699 515,000 717,699

BOY Net assets @ BOY Exchange rate Net income Dividends

1,702,000 742,981 -15,000

$1.70 $1.75 $1.49

EOY Net assets @ EOY Exchange rate Translation Adjustment for the year BOY Cumulative Translation Adjustment EOY Cumulative Translation Adjustment

2,429,981

$1.80

$2,893,400 $1,300,217 ($22,350) $4,171,267 4,373,966

BOY Net assets x EOY -BOY Exchange rates Net income x EOY -Avg. Exchange rates Dividends x EOY -Div. Exchange rates BOY Cumulative Translation Adjustment EOY Cumulative Translation Adjustment

$202,699 515,000 $717,699

Continued

Advanced Accounting, 4th Edition

i. Beginning Equity investment Cumulative Translation Adjustment Equity Income Dividends Ending Equity Investment

2,362,000 959,099 1,300,217 -22,350 4,598,966

*($5,459,920 BOY BVSE + $437,000 BOY AAP)

ii. Elimination entries Parent

Subsidiary

Consolidated

Income statement: Sales

$4,580,000

4,814,392

$9,394,392

Cost of goods sold

-2,800,000

(1,326,675)

($4,126,675)

Gross Profit

1,780,000

3,487,717

$5,267,717

Equity income

1,300,217

Operating expenses

-950,000

(2,187,500)

(3,137,500)

$2,130,217

1,300,217

$2,130,217

Net income

[C] 1,300,217

---

Statement of retained earnings: BOY retained earnings

$7,520,000

687,000

Net income

2,130,217

1,300,217

Dividends Ending retained earnings

[E]

687,000

$7,520,000 $2,130,217

-150,000

(22,350)

$9,500,217

1,964,867

[C]

22,350

$9,500,217

-150,000

Balance sheet: Assets Cash

$425,000

774,540

$1,199,540

Accounts receivable

852,000

1,747,080

$2,599,080

Inventory

2,560,000

535,500

$3,095,500

Equity Investment

4,598,966

[C] 3,096,099 [E]

---

225,000

[A] 1,277,867 PPE, net

6,756,360 15,192,326

3,149,246

[A]

225,000

[D]

99,000

10,229,606

6,206,366

$17,123,726

$1,124,610

Liabilities and Stockholders’ Equity Current liabilities

$318,210

806,400

Long-term Liabilities

2,300,000

1,026,000

165,800

575,000

[E]

575,000

$165,800

APIC

1,850,000

875,000

[E]

875,000

$1,850,000

Retained Earnings Cumulative Translation Adjustment

9,500,217

1,964,867

Common Stock

1,058,099

959,099

1,058,099

6,206,366

$3,326,000

$9,500,217 [E]

959,099

[D]

99,000

1,157,099

$17,123,726

8-35

Chapter 9 Government Accounting: Fund-Based Financial Statements Learning Objectives – Coverage by question Multiple Choice LO1 – Describe the appropriations and budgetary process.

1-6, 27

LO2 – Describe the types of funds employed in fund accounting.

7-9, 28

LO3 –Describe the measurement focus and basis of accounting.

10-15, 29

LO4 –Describe fund accounting journal entries.

16-26, 30

LO5 –Describe the preparation of fund financial statements.

Exercises

Problems

1-8

9-1

Chapter 9: Government Accounting: Fund-Based Financial Statements

Advanced Accounting, 4th Edition

Topic: Funds LO: 2 7. Which of the following is not a governmental fund? a. General fund b. Internal service fund c. Special revenue fund d. Capital project fund Answer: b

Topic: Funds LO: 2 8. Which of the following is not a proprietary fund? a. Enterprise fund b. Internal service fund c. Pension trust fund d. All of the above are proprietary funds. Answer: c

9-3

Topic: Measurement Focus LO: 3 10. The current financial resources measurement focus: a. b. c. d.

Advanced Accounting, 4th Edition

9-5

Advanced Accounting, 4th Edition

9-7

Advanced Accounting, 4th Edition

9-9

$263,540 32,000 (284,890) $ 10,650

Required: Prepare the journal entry to record the budget. Answer: ESTIMATED REVENUES ESTIMATED OTHER FINANCING RESOURCES APPROPRIATIONS BUDGETARY FUND BALANCE

263,540 32,000 284,890 10,650

39,850 39,850

BUDGETARY FUND BALANCE ENCUMBRANCES

39,850

Expenditures Cash or vouchers payable To reverse the previous encumbrance entry and record purchase of the truck.

38,750

39,850

38,750

Advanced Accounting, 4th Edition

245,000

Fund balance—unassigned Fund balance—assigned To reverse the budgetary encumbrance and assign the fund balance for the outstanding encumbrance.

245,000

40,000

Other financing sources To record the sale of the truck.

40,000

1,200,000 Other financing sources—proceeds from bond issue

1,200,000

To record the sale of a bond in year 1. Expenditure—interest on bond Expenditure—principal on bond Cash To record payment of annual interest and principal on bond issue in year 10.

72,000 1,200,000 1,272,000

9-11

75,000 75,000

4,900 2,600 7,500

Cash To record the payment on a capital lease.

12,000 12,000

3,000 3,000

Advanced Accounting, 4th Edition

12,000 12,000

Inventory—supplies 3,000 Expenditures To recognize the $3,000 remaining balance of supplies inventory.

3,000

Fund balance—unassigned 3,000 Fund balance—nonspendable To recognize the $3,000 remaining balance of supplies inventory.

3,000

9-13

$ 69,840 9,000

APPROPRIATIONS

(70,130)

BUDGETARY FUND BALANCE

$ 8,710

b. The City records the following revenues (on account) and other financing sources (paid in cash) during the year: Revenues—real estate & personal property taxes

$60,890

Revenues—intergovernmental

8,950

Other financing sources—bond proceeds

9,000

The City issuances purchase invoices totaling $62,590 (record the issuance of invoices as a lump sum).

d. The City recognizes the following expenditures, all on account (these expenditures were previously reserved as budgetary ENCUMBRANCES): Expenditures—General Government

$15,540

Expenditures—Public Safety

9,280

Expenditures—Education

27,720

Expenditures—Public Works

4,180

Expenditures—Human Services

5,230

e. The City makes the following payments related to its outstanding debt:

Expenditures—Debt Principal

$1,800

Expenditures—Debt Interest

300

Advanced Accounting, 4th Edition

Answer: a. ESTIMATED REVENUES ESTIMATED OTHER FINANCING SOURCES APPROPRIATIONS BUDGETARY FUND BALANCE To record the budget.

69,840 9,000 70,130 8,710

9,000 60,890 8,950

ENCUMBRANCES BUDGETARY FUND BALANCE To record the issuance of purchase invoices.

62,590

d. BUDGETARY FUND BALANCE ENCUMBRANCES To reverse previous encumbrance journal entry.

61,950

60,890 8,950 9,000

62,590

61,950

Expenditures—general government Expenditures—public safety Expenditures—education Expenditures—public works Expenditures—human services Payables To record expenditures.

15,540 9,280 27,720 4,180 5,230 61,950

e. Expenditures—debt principal Expenditures—debt interest Cash To record debt payments.

1,800 300

4,870 60,520

2,100

Cash Payables Receivables—real estate & personal property taxes Receivables—intergovernmental revenues To record collection of receivables and payment of payables.

56,580 8,810

9-15

g. Revenues-real estate & personal property taxes Deferred revenues To defer revenues that won’t be collected within 60 days.

820 820

Closing Entries: h. 1. APPROPRIATIONS BUDGETARY FUND BALANCE ESTIMATED REVENUES ESTIMATED OTHER FINANCING SOURCES To reverse budget entry.

70,130 8,710

60,070 8,950 9,000

69,840 9,000

15,540 9,280 27,720 4,180 5,230 1,800 300 13,970

3. BUDGETARY FUND BALANCE ENCUMBRANCES

640 640

Fund balance—unassigned Fund balance—assigned To close remaining encumbrances and reserve Fund Balance for encumbrances that lapsed, but are expected to be honored in the following year.

640 640

Advanced Accounting, 4th Edition

Topic: Preparation of Fund Financial Statements LO: 5 2. Assume that at the beginning of the fiscal year, the City of Finch reports the following balances in its accounts for the General Fund:

Beginning Balances: Cash Receivables: Real estate & personal property Intergovernmental Payables Deferred revenues Fund balances: Assigned Unassigned

General Fund DR CR $ 6,720 3,250 1,800 $ 1,180 3,750

$11,770

2,150 4,690 $11,770

General Fund DR CR $18,490 7,560 1,940 $2,610 4,570 2,790 4,050 60,070 8,950 15,540 9,280 27,720 4,180 5,230 1,800 300 $89,430

9,000 $89,430

9-17

$18,490 7,560 1,940 $27,990

Payables Deferred revenues Total liabilities Fund balances: Assigned Unassigned Total fund balances Total liabilities and fund balances

$ 2,610 4,570 7,180 2,790 18,020 20,810 $27,990

Statement of Revenues, Expenditures, and Changes in Fund Balances: Revenues: Real estate taxes Intergovernmental Total revenues

$60,070 8,950 69,020

Expenditures: General government Public safety Education Public works Human services Debt principal payments Debt interest payments Total expenditures

15,540 9,280 27,720 4,180 5,230 1,800 300 64,050

Excess (deficiency) of revenues over expenditures

4,970

Other financing sources (uses) Proceeds from bonds Total other financing sources (uses)

9,000 9,000

Net change in fund balances Fund balances at beginning of year Fund balances at end of year

$13,970 6,840 $20,810

Advanced Accounting, 4th Edition

Topic: Preparation of Fund Financial Statements LO: 5 3. Agawa City presents the following pre-closing trial balance for its General Fund as of the end of the year:

Debit $116,000 29,000

Credit

5,000 2,000 14,800 50,000 69,200 11,000 249,000 258,000 255,000 245,000 $652,000

$652,000

9-19

Chapter 10 Government Accounting: Government-wide Financial Statements Learning Objectives – Coverage by question Multiple Choice

LO1 – Describe the comprehensive annual financial report.

1, 17, 20-22

LO2 – Describe government-wide financial statements.

2-16, 18, 19, 23-24

Exercises

Problems

1-5

10-1

Chapter 10: Government Accounting: Government-wide Financial Statements

Multiple Choice Topic: Comprehensive Annual Financial Report LO: 1 1. Which of the following components is required in the comprehensive annual financial report? a. Fund financial statements b. Government-wide financial statements c. Management discussion and analysis d. All of the above. Answer: d

Topic: Government-wide Financial Statements LO: 2 2. Which of the following statements is correct about government-wide financial statements? a. Government-wide statements should display information about the reporting government as a whole, except for its fiduciary activities. b. The statements should include separate columns for the governmental and business-type activities of the primary government as well as for its component units. c. Government-wide financial statements should be prepared using the economic resources measurement focus and the accrual basis of accounting. d. All of the above. Answer: d

Topic: Government-wide Financial Statements LO: 2 3. Which of the following statements about government-wide financial statements is false? a. They display information about individual funds. b. They exclude information about fiduciary activities. c. They distinguish between the primary government and its discretely presented component units. d. They distinguish between governmental activities and business-type activities. Answer: a

Advanced Accounting, 4th Edition

Topic: Primary Government LO: 2 4. Which of the following best describes a primary government? a. Although a primary government has a separately elected governing body, it may not be a legally separate entity. b. A primary government, although legally separate, may be fiscally dependent upon another governmental entity. c. A primary government must be both legally separate and fiscally independent. d. The only requirement is for a primary government to have a separately elected governing body; it does not have to be either legally separate or fiscally independent. Answer: c

Topic: Component Unit LO: 2 5. Which of the following best describes a component unit? a. Primary governments are financially accountable for their component units. b. Primary governments can incur financial obligations from their component units. c. Primary governments control the appointment of a majority of the controlling board. d. All of the above. Answer: d

Topic: Blending LO: 2 6. Which of the following best describes the concept of blending? a. Blending is required even if the governmental unit provides services mostly to units outside of the primary government. b. Blending relates to the inclusion of the financial statements of the blended unit in the report of the primary government. c. The process of blending was eliminated in GASBS 34. d. None of the above are true. Answer: b

Topic: Measurement Focus and Basis of Accounting LO: 2 7. Which of the following statements is false? a. Government-wide financial statements use economic resources measurement focus and the accrual basis of accounting. b. Government-wide financial statements use current financial resources measurement focus and the accrual basis of accounting. c. Government-wide financial statements use economic resources measurement focus, which requires inclusion of long-term assets and liabilities. d. The economic resources measurement focus is like GAAP’s measurement focus. Answer: b

10-3

Topic: Accrual Basis of Accounting LO: 2 8. The accrual basis of accounting requires that: a. Revenues, expenses, gains, losses, assets, and liabilities resulting from exchange and exchange like transactions should be recognized when the exchange takes place. b. Governments should recognize assets from derived tax revenue transactions in the period when the exchange transaction on which the tax is imposed occurs or when the resources are received, whichever occurs first. c. Governments should recognize assets from imposed nonexchange revenue transactions in the period when an enforceable legal claim to the assets arises or when the resources are received, whichever occurs first. d. All of the above. Answer: d

Topic: Statement of Net Position LO: 2 9. Which of the following statements about the statement of net position is false? a. The difference between assets and liabilities must be labeled as net position, and cannot be labeled as equity, net fund balance, or another similar label. b. Assets are presented in order of liquidity and liabilities in order of maturity. c. The net position section of the statement should be displayed with three components: 1) invested in capital assets, net of related debt, 2) restricted, and 3) unrestricted. d. Although long-term assets and liabilities are reported, there is no requirement to group them by current and noncurrent as we have for corporate financial statements. Answer: d

Topic: Capital Assets LO: 2 10. Which of the following statements about capital assets is false? a. Capital assets are initially recorded at historical cost, including capitalized interest and any other costs necessary to make the asset ready for its intended use. b. Donated assets are initially reported at their historical cost to the donor. c. Capital assets should generally be depreciated over their estimated useful lives unless they are indefinite lived assets (i.e., land). d. Governmental entities can group similar assets and to depreciate them as a group using the same depreciation rate. Answer: b

Advanced Accounting, 4th Edition

Topic: Depreciation of Capital Assets LO: 2 11. Which of the following statements is false regarding the depreciation of capital assets? a. Any rational and systematic manner of depreciation can be used. b. Governments are not allowed to group similar assets and to depreciate them as a group using the same depreciation rate. c. Infrastructure assets (like a road or lighting system), are not required to be depreciated under certain circumstances. d. Should the municipality incur liabilities that relate specifically to the acquisition, construction, or improvement of capital assets, those assets should be reported net of the related debt. Answer: b

Topic: Works of Art LO: 2 12. Which of the following does not accurately describe the accounting for works of art? a. Purchased works of art and historical treasures should be recorded at their purchase price on the date of acquisition. b. If donated, they should be recorded at fair value whether held as individual items or in a collection. c. Governments are not required to report works of art on their statements of net position. d. All of the above accurately describe the accounting for works of art. Answer: d

Topic: Restricted and Unrestricted Net Position LO: 2 13. Which of the following does not describe the presentation of restricted and unrestricted net position? a. Even though the net position may be labeled as restricted, it may be available to meet the ongoing financial needs of the government. b. Net position should be reported as restricted when governments are not free to use the asset as they wish. c. Restrictions on the use of net position may be imposed by loan covenants, donor restrictions, laws or regulations, constitutional provisions or enabling legislation. d. Unrestricted net position is available to meet the needs of the general operations of the government. Answer: a

Topic: Landfill Liability LO: 2 14. Which of the following does not accurately describe the accounting for landfill liability in the government-wide financial statements? a. Landfill liability is reported on the statement of net position. b. The amount of the landfill liability is not adjusted following the initial estimate. c. The amount of the landfill liability is estimated at each statement date and adjusted, if necessary. d. The amount of the landfill liability can be reduced if estimates change, resulting in a reduction of current-period cost. Answer: b

10-5

Topic: Statement of Activities LO: 2 15. Which of the following does not accurately describe the statement of activities? a. The statement of activities uses the same format as corporate income statements. b. The difference between revenues and expenses is labeled as the change in net position, not net income as in the corporate world. c. The net expense or revenue is reported for each government function or program separately. d. The statement of activities separates governmental and business-type activities. Answer: a

Topic: Program Revenues LO: 2 16. Which of the following accurately describes accounting for program revenues? a. Program revenues reduce the net cost of the function to be financed from the government’s general revenues. b. All revenues are program revenues unless they are required to be reported as general revenues. c. Program revenues include charges for services, but do not include grants revenues. d. All of the above. Answer: a

Topic: Comprehensive Annual Financial Report LO: 1 17. Which of the following statements does not complete the sentence, “The comprehensive annual financial report allows users to…”? a. See the cost of providing services to its citizenry b. See how the government finances its programs—through user fees and other program revenues versus general tax revenues c. Understand the extent to which the government has invested in capital assets, including roads, bridges, and other infrastructure assets d. All of the statements can be used to complete the sentence. Answer: d

Topic: Government-wide Financial Statements LO: 2 18. The journal entries used to record capital assets in preparing the government-wide financial statements: a. Recognize a debit to capital assets and a credit to revenue. b. Are required because those assets are not reported on fund-based financial statements. c. Record capital assets at their fair value as of the beginning of the year. d. Recognize a decrease in net position. Answer: b

Advanced Accounting, 4th Edition

Topic: Government-wide Financial Statements LO: 2 19. The journal entries related to deferred revenues in preparing the government-wide financial statements: a. Recognize the decrease in net position that was not previously recognized because the revenues were not recognized. b. Reduce the deferred revenues liability account that was established in the fund-based financial statements. c. Result in the recognition of revenue as a credit. d. Provide information that is used in the reconciliation of the proprietary funds balance sheet. Answer: b

Topic: Comprehensive Annual Financial Report LO: 1 20. The comprehensive annual financial report (CAFR) of a governmental reporting entity should contain a statement of cash flows for: a. Governmental funds and proprietary funds. b. Proprietary funds but not governmental funds. c. Governmental funds but not proprietary funds. d. Neither governmental nor proprietary funds. Answer: b

Topic: Comprehensive Annual Financial Report LO: 1 21. Which of the following best describes the presentation of restricted and unrestricted net position? a. Net position should be reported as unrestricted when governments are not free to use the asset as they wish. b. Restrictions on the use of net position may be imposed by loan covenants, donor restrictions, laws or regulations, constitutional provisions or enabling legislation. c. Even though the net position may be labeled as restricted, it may be available to meet the ongoing financial needs of the government. d. Unrestricted net position is not available to meet the needs of the general operations of the government. Answer: b

Topic: Comprehensive Annual Financial Report LO: 1 22. Component units that are discretely presented by the reporting entity are shown: a. In a separate column to the right of the primary government’s information on the statements. b. Merged with similar accounts for the primary government. c. As if they were all fiduciary funds of the primary government. d. In the notes to the primary government’s financial statements. Answer: a

10-7

Topic: Government-wide Financial Statements LO: 2 23. Under GASBS 34, financial information related to fiduciary activities is reported in: a. Neither government-wide nor fund financial statements. b. Fund financial statements, but not government-wide financial statements. c. Government-wide financial statements and fund financial statements. d. Government-wide financial statements, but not fund financial statements. Answer: b

Topic: Government-wide Financial Statements LO: 2 24. The basic financial statements of a state or local government include all of the following except: a. Notes to the financial statements. b. A management discussion & analysis (MD&A). c. Government-wide financial statements. d. Fund financial statements. Answer: b

Advanced Accounting, 4th Edition

Exercises Topic: Journal Entries for Government-wide Financial Statements ─ Capital Assets LO: 2 1. The City of Grosse Ile is preparing its government-wide financial statements from its fund financial statements. The City identifies capital assets with a book value of $500,000 at the beginning of the year that are depreciated at the rate of $50,000 per year. Its records also indicate that it spent $150,000 on new capital assets during the year. Required: a. What two journal entries must the City include in its government-wide financial statement spreadsheet relating to capital assets? b. Why must these entries be included in the spreadsheet? Answer: a. 1. Capital assets, net Net position (Beginning of year capital assets, net) 2. Depreciation expense Capital assets, net Expenditures - capital outlay (Change in capital assets, net)

500,000 500,000

50,000 100,000 150,000

b. The first journal entry recognizes on the government-wide statement of net position the capital assets at the beginning of the year that are omitted in the fund financial statements. These capital assets are not recognized on fund financial statements because they are prepared using the current financial resources measurement focus which reports only those resources that are available to meet current obligations. Since fund accounting records capital asset purchases as expenditures rather than assets, the second journal entry reverses the expenditures journal entry and records depreciation expense for the year. The debit or credit to capital assets, net reflects the net increase (decrease) in capital assets for the year.

10-9

Topic: Journal Entries for Government-wide Financial Statements ─ Bond Liability LO: 2 2. The Village of Midpoint is preparing its government-wide financial statements from its fund financial statements. The Village records an outstanding bond liability with a book value of $600,000 at the beginning of the year that requires a principal payment of $30,000 per year. Its records also indicate that it borrowed $95,000 on new bonds during the year. Required: a. What two journal entries must the Village include in its government-wide financial statement spreadsheet relating to its bond liability? b. Why must these entries be included in the spreadsheet? Answer: a. The two journal entries that the Village must make in its spreadsheet related to its bond liability are as follows: 1. Net position

600,000

Bonds payable (Beginning of year bonds payable) 2. Other financing sources - proceeds from bonds Bonds payable Expenditures - debt principal (Change in bonds payable)

600,000

95,000 65,000 30,000

b. The first journal entry recognizes on the government-wide statement of net position the bonds payable at the beginning of the year that are omitted in the fund financial statements. These liabilities are not recognized on fund financial statements because they are prepared using the current financial resources measurement focus which reports only those liabilities that can be satisfied from current financial resources. Since fund accounting records new bond borrowings as other financing sources and payments as expenditures, the second journal entry reverses the other financing sources and expenditures –debt principal journal entries and the net increase (decrease) in bonds payable for the year.

Advanced Accounting, 4th Edition

Topic: Journal Entries for Government-wide Financial Statements ─ Deferred Revenues and Compensated Absences LO: 2 3. The City of Westgate is preparing its government-wide financial statements from its fund financial statements. The City records deferred revenue with a book value of $425,000 and compensated absences of $50,000 at the beginning of the year. During the year, these accounts increased by $30,000 and $9,000, respectively. Required: a. What journal entries must the City include in its government-wide financial statement spreadsheet relating to deferred revenues and compensated absences? b. Why must these entries be included in the spreadsheet? Answer: a. The journal entries that the City must make in its spreadsheet related to deferred revenues and compensated absences are as follows: 1. Deferred revenues

455,000

Revenues Net position (To record beginning of year deferred revenues and change for the year) 2. Net position Compensated absence expense Compensated absences liability (To record beginning of year compensated absences and change for the year)

30,000 425,000

50,000 9,000 59,000

b. These journal entries recognize on the government-wide statement of net position the deferred revenues and compensated absences at the beginning of the year, and the changes in those accounts during the year, that are omitted in the fund financial statements. These liabilities are not recognized on fund financial statements because they are prepared using the current financial resources measurement focus which reports only those liabilities that can be satisfied from current financial resources.

10-11

Topic: Journal Entries for Government-wide Financial Statements ─ Landfill Closure Liability LO: 2 4. The Township of Muskegon is preparing its government-wide financial statements from its fund financial statements. The Township maintains a landfill for solid waste disposal and estimates that its total capacity is 25 million tons. At the end of the prior year, the Township estimated that it had used 5 million tons and reported a liability for closure and postclosure costs of $4.9 million. During the year, the Township estimates that it used an additional 500,000 tons of capacity. Closure and postclosure costs are expected to be $31 million when the landfill reaches capacity. Required: a. What journal entries must the Township include in its government-wide financial statement spreadsheet relating to the landfill liability at the beginning of the year and as of the end of the year? b. Why must this entry be included in the spreadsheet? Answer: a. The journal entries are as follows: 1. Net position

4, 900,000

Landfill liability (To record beginning of year landfill liability) 2. Landfill expense Landfill liability (To record beginning of year landfill liability and change for the year)

4, 900,000

1,920,000* 1,920,000

*Current period cost = [$31 million x (5.5 million / 25 million)] - $4.9 million = $1,920,000

b. The first journal entry recognizes on the government-wide statement of net position the landfill liability at the beginning of the year and the second recognizes the increase in the reported liability during the year as the landfill usage increases as a percentage of total capacity. These liabilities are not recognized on fund financial statements because they are prepared using the current financial resources measurement focus which reports only those liabilities that can be satisfied from current financial resources.

Advanced Accounting, 4th Edition

Topic: Preparation of Statement of Activities LO: 2 5. The City of Niles reports the following revenues for the fiscal year (all numbers are in $1,000): Real estate and personal property taxes

$45,180

Motor vehicle and other excise taxes

3,370

Grants and contributions not restricted

2,950

The City also reports the following revenues from fees it charges for services and operating grants and contributions it has received during the year as well as expenses is has incurred, categorized by governmental activity:

Functions/Programs Primary Government Governmental Activities: GENERAL GOVERNMENT PUBLIC SAFETY EDUCATION PUBLIC WORKS HUMAN SERVICES LIBRARY PENSION & BENEFITS INTEREST Total Governmental Activities

Charges for Services

Operating Grants and Contributions

$ 320

$ 410 250 3,050 205 85 50 2,620 $6,670

720 660 75 580 65 $2, 420

Expenses

$ 5, 040 6,070 32,800 3,260 2,190 850 4,060 970 $55, 240

The City manages two business-type activities: a sanitation department which oversees solid and liquid waste disposal and a municipal airport. Both of these activities charge users a fee that is set at the beginning of the year at a level that is anticipated to cover the costs of providing the service. These fees cannot be changed during the year. As a result, these activities may produce a net profit or loss for the year, depending on the level of operating costs. The revenues and expenses for these services are provided in the following table:

Functions/Programs Business-Type Activities: SANITATION MUNICIPAL AIRPORT

Charges for Services

Expenses

$3,370 390 $3,760

$2, 930 500 $3, 430

Required: Prepare the City of Niles statement of activities for the year (assume a beginning balance for net position of $93,640 for governmental activities and $22,150 for business-type activities).

10-13

Answer: Program Revenues

Functions/Programs

Expenses

Charges for Services

Operating Grants and Contributions

Net (Expense) Revenue

$ 5, 040 6,070 32,800 3,260 2,190 850 4,060 970 55,240

$ 320 720 660 75 580 65 2,420

$ 410 250 3,050 205 85 50 2,620 6,670

$ (4, 310) (5,100) (29,090) (2,980) (1,525) (735) (1,440) (970) (46, 150)

2, 930 500 $3, 430

3,370 390 3,760

$58, 670

$6,180

$6,670

Governmental Activities

Business-Type Activities

$(46, 150)

$ 550

Primary Government Governmental Activities: GENERAL GOVERNMENT PUBLIC SAFETY EDUCATION PUBLIC WORKS HUMAN SERVICES LIBRARY PENSION & BENEFITS INTEREST Total Governmental Activities Business-Type Activities: SANITATION MUNICIPAL AIRPORT

Total Primary Government

(continued from above)

440 (110) 550 $(45, 600)

Total

$(45, 600)

General Revenues: GENERAL REVENUES: REAL ESTATE AND PERSONAL PROPERTY TAXES MOTOR VEHICLE AND OTHER EXCISE TAXES GRANTS AND CONTRIBUTIONS NOT RESTRICTED TOTAL GENERAL REVENUES AND TRANSFERS Change in net position

$45,180

3,370

2,950

$51,500

$5,350

550

$ 5,900

93,640 $98,990

22,150 $22,700

115,790 $121,690

Net position: Beginning of year End of year

Advanced Accounting, 4th Edition

Problems Topic: Journal Entries to Yield Government-wide Financial Statements from Fund Financial Statements LO: 2 1. The City of Royal Oak is preparing its government-wide financial statements for the year. Its accountant must prepare a number of journal entries to recognize assets and liabilities previously omitted from the fund financial statements and to recognize revenues and expenses for the year under accrual accounting that were not recognized under the current financial resources measurement focus and the modified accrual basis of accounting used to prepare the statement of revenues, expenditures, and changes in fund balances for its funds. The accountant identifies the following journal entries that must be made (all numbers are in $1,000): 1. Recognize capital assets of $77,680 as of the beginning of the year. 2. Record depreciation expense of $3,920 for the year and reverse expenditures of $5,610 for capital outlays during the year. 3. Recognize $29,000 of bonds payable as of the beginning of the year. 4. Reverse other financing sources of $10,000 and expenditures–debt of $2,200 relating to increases and decreases in the bond liability during the year. 5. Reverse deferred revenue of $4,350 as of the beginning of the year. 6. Reverse $1,060 of deferred revenue recognized during the year. 7. Recognize compensated absences of $920 as of the beginning of the year and an increase in that liability of $70 during the year. 8. Recognize $80 of accrued interest payable as of the beginning of the year and an increase in that liability of $110 during the year. 9. Recognize a liability of $4,140 relating to the City’s landfill as of the beginning of the year. The estimate for this liability did not change during the year. Required: Prepare journal entries for each of the items above.

10-15

Answer: 1. Capital assets, net Net position (Beginning of year capital assets, net)

77,680 77,680

2. Depreciation expense Capital assets, net Expenditures - capital outlay (Change in capital assets, net)

3,920 1,690

3. Net position

29,000

5,610

Bonds and notes payable (Beginning of year bonds and notes payable)

29,000

4. Other financing sources - proceeds from bonds Bonds payable Expenditures - debt principal payments (Change in bonds payable)

10,000

5. Deferred revenues Net position (Beginning of year deferred revenues)

4,350

6. Deferred revenues Revenues (Change in deferred revenues)

1,060

7,800 2,200

4,350

1,060

7. Net position Compensated absence expense Compensated absences liability (To record beginning of year compensated absences and change for the year)

920 70

8. Net position Interest expense Accrued interest (To record beginning of year accrued interest and change for the year)

80 110

9. Net position Landfill closure and postclosure care costs (Beginning of year landfill closure and postclosure care costs)

990

190

4,140 4,140

Advanced Accounting, 4th Edition

Topic: Preparation of Government-wide Financial Statements (Continuation of Problem 1) LO: 2 2. The City of Royal Oak reports the following fund financial statements for its General Fund: Balance Sheet Cash Receivables: Real estate & personal property Intergovernmental Total assets Payables Deferred revenues Total liabilities Fund balances: Assigned Unassigned Total fund balances Total liabilities and fund balances

$ 13,520 1,540 6,270 $21,330 $ 1,640 5,410 7,050 2,850 8,430 14,280 $21,330

Statement of Revenues, Expenditures, and Changes in Fund Balances Revenues: Real estate taxes $30,270 Intergovernmental 3,480 Total revenues 33,750 Expenditures: General government Public safety Education Public works Human services Debt principal payments Debt interest payments Total expenditures

4,450 3,330 19,710 2,030 3,180 2,200 300 35,200

Excess (deficiency) of revenues over expenditures

(1,450)

Other financing sources (uses) Proceeds from bonds Total other financing sources (uses)

10,000 7,000

Net change in fund balances Fund balances at beginning of year Fund balances at end of year

$ 8,550 5,730 $14,280

Required: Using the journal entries you record for Problem 1 (above), prepare the government-wide statement of net position and identify the revenues, expenses and change in net position that should be reported in the statement of activities for the year. ©Cambridge Business Publishers, 2020 Test Bank, Chapter 10

10-17

Answer: Government-wide financial statements spreadsheet Governmental Activities

Governmental Activities

Statement of Net Position: Current: Cash

$13,520

Real estate & personal property

1,540

Intergovernmental

6,720

6,270

Receivables:

Non-current: Receivables Capital assets, net of accumulated depreciation _____ Total assets Payables

77,680

79,370

1,,690

______

$21,330

$100,700

1,640

$ 1,640

Accrued interest

190

Bond and notes payable

29,000

36,800

7,800

Compensated absences liability

990

Landfill closure and postclosure care costs

4,140

Deferred revenues Total liabilities

5,410

4,350

_____

1,060

______

7,050

43,760

Net position: Fund balance

14,280

Adjustments:

14,280 3

29,000

77,680

920

4,350

4,140 below

(5,230)

Net income adjustments

47, 890

(5,230)

______

56,940

$21,330

$100,760

$33,750

$35,750

Statement of Revenues, Expenditures, and Changes in Fund Balances: Total revenues - fund financial statements Adjustments Deferred revenues

1,060

Total revenues - statement of activities Total expenditures

1,060 34,810

35,200

Adjustments: Debt principal payments

2,200

(2,200)

5,610

(1,690)

Depreciation expense/ capital outlay

3,920

Compensated absences

Interest expense

110

Total expenses - statement of activities

31,490

Misc. adjustments: Proceeds from bonds Net change in fund balances/ change in net position

10,000 $ 8,550

10,000

_____

14,100

8,870

$ 3,320

Advanced Accounting, 4th Edition

Topic: Journal Entries to Yield Government-wide Financial Statements from Fund Financial Statements LO: 2 3. The City of Emmet is preparing its government-wide financial statements for the year. Its accountant must prepare a number of journal entries to recognize assets and liabilities previously omitted from the fund financial statements and to recognize revenues and expenses for the year under accrual accounting that were not recognized under the current financial resources measurement focus and the modified accrual basis of accounting used to prepare the statement of revenues, expenditures, and changes in fund balances for its funds. The accountant identifies the following journal entries that must be made: 1. Recognize capital assets of $110,440 as of the beginning of the year. 2. Record depreciation expense of $6,850 for the year and reverse expenditures of $7,360 for capital outlays during the year. 3. Recognize $31,000 of bonds payable as of the beginning of the year. 4. Reverse other financing sources of $8,000 and expenditures–debt of $3,100 relating to increases and decreases in the bond liability during the year. 5. Reverse deferred revenue of $9,340 as of the beginning of the year. 6. Reverse $1,430 of deferred revenue recognized during the year. 7. Recognize compensated absences of $1,980 as of the beginning of the year and an increase in that liability of $230 during the year. 8. Recognize $90 of accrued interest payable as of the beginning of the year and an increase in that liability of $260 during the year. 9. Recognize a liability of $4,210 relating to the City’s landfill as of the beginning of the year. The estimate for this liability did not change during the year. Required: Prepare journal entries for each of the items above.

10-19

Answer: 1. Capital assets, net Net position (Beginning of year capital assets, net)

110,440 110,440

2. Depreciation expense Capital assets, net Expenditures - capital outlay (Change in capital assets, net)

6,850 510

3. Net position

31,000

7,360

Bonds and notes payable (Beginning of year bonds and notes payable)

31,000

4. Other financing sources - proceeds from bonds Bonds payable Expenditures - debt principal payments (Change in bonds payable)

8,000

5. Deferred revenues Net position (Beginning of year deferred revenues)

9,340

6. Deferred revenues Revenues (Change in deferred revenues)

1,430

7. Net position Compensated absence expense Compensated absences liability (To record beginning of year compensated absences and change for the year)

1,980 230

8. Net position Interest expense Accrued interest (To record beginning of year accrued interest and change for the year)

90 260

9. Net position Landfill closure and postclosure care costs (Beginning of year landfill closure and postclosure care costs)

4,900 3,100

9,340

1,430

2,210

350

4,210 4,210

Advanced Accounting, 4th Edition

Topic: Preparation of Government-wide Financial Statements (Continuation of Problem 3) LO: 2 4. The City of Emmet reports the following fund financial statements for its General Fund: Balance Sheet Cash Receivables: Real estate & personal property Intergovernmental Total assets Payables Deferred revenues Total liabilities Fund balances: Reserved for - encumbrances Unreserved Total fund balances Total liabilities and fund balances

$24,550 4,320 13,850 $42,720 $ 2,390 10,770 13,160 5,490 24,070 29,560 $42,720

Statement of Revenues, Expenditures, and Changes in Fund Balances Revenues: Real estate taxes $52,820 Intergovernmental 8,930 Total revenues 61,750 Expenditures: General government Public safety Education Public works Human services Debt principal Debt interest Total expenditures

8,680 6,140 34,060 3,120 6,040 1,600 400 60,040

Excess (deficiency) of revenues over expenditures

1,710

Other financing sources (uses) Proceeds from bonds Total other financing sources (uses)

8,000 8,000

Net change in fund balances Fund balances at beginning of year Fund balances at end of year

$ 9,710 18,850 $28,560

Required: Using the journal entries you record for Problem 3 (above), prepare the government-wide statement of net position and identify the revenues, expenses and change in net position that should be reported in the statement of activities for the year. ©Cambridge Business Publishers, 2020 Test Bank, Chapter 10

10-21

Answer: Government-wide financial statements spreadsheet Governmental Activities

Governmental Activities

Statement of Net Position: Current: Cash

$24,550

$ 24,550

Receivables: Real estate & personal property

4,320

Intergovernmental

13,850

Non-current: Receivables Capital assets, net of accumulated depreciation _____ Total assets Payables

110,440

510

110,950 ______

$42,720

$153,670

$ 2,390

2,390

Accrued interest

350

Bond and notes payable

31,000

35,900

4,900

Compensated absences

2,210

Landfill closure and postclosure care costs

4,210

Deferred revenues Total liabilities

10,770

9,340

_____

1,430

______

13,160

45,060

Net position: Fund balance

29,560

Adjustments:

29,560 3

31,000

110,440

1,980

9,340

below

(3,450)

4,210

Net income adjustments

82,500

(3,450)

______

108,610

$42,720

$153,670

$61,750

Statement of Revenues, Expenditures, and Changes in Fund Balances: Total revenues - fund financial statements Adjustments Deferred revenues

1,430

Total revenues - statement of activities Total expenditures

1,430 63,180

60,040

Adjustments: Debt principal Depreciation expense/ capital outlay

6,850

Compensated absences

230

Interest expense

260

3,100

(3,100)

7,360

(510) 230 260

Total expenses - statement of activities

56,920

Miscellaneous adjustments: Proceeds from bonds Net change in fund balances/ change in net position

8,000 $ 9,710

8,000

_____

15,340

11,890

$ 6,260

Advanced Accounting, 4th Edition

Topic: Preparation of Government-wide Financial Statements LO: 2 5. The City of Gitche Gumee reports the following balances in its adjusted, pre-closing trial balance for governmental activities for the year ended December 31, 2020:

Cash Taxes receivable Capital assets, net Vouchers payable Bonds payable Net position – net investment in capital assets Net position, restricted Net position, unrestricted Program revenues – general government, charges for services Program revenues – public safety, operating grant General revenues – property taxes General revenues – special items Expenses – general government Expenses – public safety Expenses – parks & recreation Interest expense Total

Debit 310,000 298,000 800,000

Credit

85,000 200,000 600,000 300,000 200,000 2,000 1,000 100,000 5,000 60,000 15,000 9,000 1,000 1,493,000

1,493,000

Required: Prepare a statement of net position and the statement of activities (partial for the governmental activities only) of the City of Gitche Gumee based on the trial balance above. Answer: Government-wide financial statements: CITY OF GITCHE GUMEE Statement of Net Position As of December 31, 2020 Governmental Activities Assets: Cash Taxes receivable Capital assets Total assets

Liabilities: Vouchers payable Bonds payable Total liabilities

310,000 298,000 800,000 1,408,000

85,000 200,000 285,000

Net Position: Net investment in capital assets Restricted Unrestricted Total net position

600,000 300,000 223,000 $1,123,000 Continued

10-23

CITY OF GITCHE GUMEE Statement of Activities Year Ended December 31, 2020 Program Revenues

Functions: General government Public safety Total governmental activities

Expenses $60,000 15,000 75,000

Charges for Services $2,000 _____ 2,000

Operating Grants $1,000 1,000

General Revenues: Property taxes Special items Net general revenues Change in net position Net position, beginning Net position, ending

Net (Expenses) Revenues Governmental Activities $ (58,000) 14,000) (72,000)

100,000 5,000 105,000 33,000 500,000 $ 533,000

Advanced Accounting, 4th Edition

Chapter 11 Accounting for Not-for-Profit Organizations Learning Objectives – Coverage by question LO1 – Develop an understanding of the classification of net assets and preparation of the statement of financial position.

LO2 – Develop an understanding of the recognition of revenues and expenses and the preparation of the statement of activities.

Multiple Choice

Exercises

Problems

1-7

1-3

1-2

1-3

8-16

LO3 – Develop an understanding of functional expenses and the preparation of the statement of functional expenses.

17,18, 20-21

LO4 – Develop an understanding of operating, investing, and financing activities and the preparation of the statement of cash flows.

19, 22-23

11-1

Chapter 11: Accounting for Not-for-Profit Organizations

Multiple Choice Topic: Statement of Financial Position LO: 1 1. Which of the following categories are included in the statement of financial position? a. Assets, liabilities, and equity b. Net assets and equity c. Revenues and expenses d. Assets, liabilities and net assets Answer: d

Topic: Statement of Financial Position LO: 1 2. The statement of financial position reports on assets and liabilities: a. In order of liquidity and maturity, respectively, but with no subtotals for the current section. Footnote disclosures also provide additional information about the restrictions that donors have placed on the allowable uses of particular assets. b. In order of liquidity and maturity, respectively, with subtotals for the current section. Restrictions that donors have placed on the allowable uses of particular assets do not need to be noted. c. In order of liquidity and maturity, respectively, with subtotals for the current section. Note disclosures also provide additional information about the restrictions that donors have placed on the allowable uses of particular assets. d. Alphabetically. Note disclosures also provide additional information about the restrictions that donors have placed on the allowable uses of particular assets. Answer: c

Topic: Statement of Financial Position LO: 1 3. Which of the following are typical restrictions that donors may place on the allowable use(s) of assets that they contribute to a not-for-profit organization? a. Types of activities for which assets can be used. b. Conditions that must be satisfied before assets can be used. c. The portion of the donation that can be used currently. d. All of the above are typical conditions. Answer: d

Advanced Accounting, 4th Edition

Topic: Classification of Net Assets LO: 1 4. Which of the following statements about the net asset section of the statement of financial position is true? a. The net asset section of the statement of financial position requires the reporting of net assets into the categories of permanently restricted, temporarily restricted, and unrestricted. b. The net asset section of the statement of financial position requires the reporting of net assets into the categories of with donor restrictions (i.e., both permanently and temporarily restricted together) and without donor restrictions. c. The net asset section of the statement of financial position does not require the segregation of net assets into categories as this was deemed to be too costly. d. Current account standards allow not-for-profit organizations to report their net assets in any way that they feel is reasonable and best conveys the composition of their net assets. Answer: b

Topic: Classification of Net Assets LO: 1 5. Which of the following best describes the difference between permanently restricted and temporarily restricted net assets? a. Permanently restricted net assets contain restrictions that neither expire by passage of time nor can be fulfilled or otherwise removed by actions of the organization. Temporarily restricted net assets provide for expiration, but not fulfillment of those restrictions. b. Permanently restricted net assets contain restrictions that neither expire by passage of time nor can be fulfilled or otherwise removed by actions of the organization while temporarily restricted net assets provide for such expiration or fulfillment. c. Permanently restricted net assets contain restrictions that neither expire by passage of time nor can be fulfilled or otherwise removed by actions of the organization. Temporarily restricted net assets provide for fulfillment of those restrictions, but not their expiration. d. The difference between permanently and temporarily restricted net assets lies in the time period over which those restrictions expire or are fulfilled. Answer: b

Topic: Accounting for Restricted Net Assets LO: 1 6. Once a restricted net asset is used for the defined purpose: a. The NFP transfers cash from a restricted account to an unrestricted account. b. The NFP transfers the related expense from net assets with donor restrictions to net assets without donor restrictions. c. The NFP transfers the amount spent from permanently restricted net assets to unrestricted net assets. d. The NFP transfers the amount spent from net assets with donor restrictions to net assets without donor restrictions. Answer: d

11-3

Topic: Accounting for Restricted Net Assets LO: 1 7. Investments are initially recorded at market value when received as donations and: a. Any income earned on those investments is reported either as net assets with donor restrictions or net assets without donor restrictions, depending upon the wishes of the donor. b. Any income earned on those investments is reported as unrestricted. c. Any income earned on those investments is reported as restricted. d. Any income earned on those investments is reported as permanently restricted.

Answer: a

Topic: Statement of Activities LO: 2 8. Which of the following is not true about the statement of activities? a. The statement of activities reports all operating expenses as decreases of net assets without donor restrictions. b. Payment of cash for an allowable use from restricted funds is accompanied by a transfer of that amount from net assets with donor restrictions to net assets without donor restrictions. c. All income from investments is reported in the net assets without donor restrictions category. d. Operating expenses are reported by program classification. Answer: c

Topic: Statement of Activities LO: 2 9. Which of the following statements is false? a. Contributions are recognized as revenue when received or when a promise is made and properly documented. b. Contributions from donors are always reported in the category net assets without donor restrictions. c. Contributions from donors are recognized whether the donations are received in cash or are received as other assets. d. Contributions from donors can be unrestricted, temporarily restricted, or permanently restricted. Answer: b

Topic: Contributions LO: 2 10. A contribution: a. Is a conditional transfer of cash or other assets to an entity or a settlement or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner. b. Is a transaction in which an entity incurs a liability or transfers an asset to another entity (or receives an asset or cancellation of a liability) without directly receiving (or giving) value in exchange c. Of services is recognized only if the services would typically need to be purchased if not provided by donation d. Only a and b are true. Answer: b

Advanced Accounting, 4th Edition

Topic: Contributions LO: 2 11. Which of the following statements about contributions is false? a. If the contribution is made in the form of a donor’s promise to pay, revenue is recognized, and a receivable is recorded when the promise is made; if there is enough evidence in the form of verifiable documentation that a promise was made and received. b. When contributions are made in the form of future promises, they are recorded for the present value of the future contribution as net assets with donor restrictions. c. Gifts of long-lived assets received are recognized as support (net assets with donor restrictions) if the not-for-profit has an accounting policy to imply a time restriction relating to the donation that expires over the useful life of the donated assets. d. Conditional promises are recognized as support when the contribution is made if it is more likely than not that the conditions will be satisfied. Answer: d

Topic: Contributions LO: 2 12. Which of the following statements about contributions of works of art is false? a. Contributions of works of art must always be recognized as revenue when received. b. Contribution of works of art need not be recognized as revenue if they are held for public exhibition, protected, and the funds from their sale are reinvested in other items for the art collection. c. Contribution of works of art, if not recognized as revenue, may not also be reported on the statement of financial position. d Contribution of works of art can be either recognized as revenue when received or not recognized as revenue under certain circumstances. Answer: a

Topic: Accounting for Contributions LO: 2 13. Neighborhood Health Clinic, a not-for-profit organization, receives contributed services from the following individuals valued at their normal billing rates: Medical doctor provides volunteer cancer screenings Board member volunteers to prepare books for audit Accountant volunteers to assist with mailing campaign Registered nurse provides rides for cancer patients

$12,000 5,000 3,500 1,800

What amount should the non-for-profit organization record as contribution revenue? a. b. c. d.

$17,000 $12,000 $19,500 $21,300

Answer: a

11-5

Topic: Accounting for Cash Payments LO: 2 14. Your not-for-profit organization has previously received a $400,000 contribution that is restricted for use solely to construct an indoor pool in a camp that you manage for gifted music children. You are mailing out a check today for $500,000 to the contractor who will build the pool. Which of the following best describes how you should account for this payment? a. Record $400,000 as construction-in-progress since that was the amount of the contribution. b. Record the $500,000 as construction-in-progress and simultaneously transfer $400,000 from net assets with donor restrictions to net assets without donor restrictions. c. Record the $400,000 as construction-in-progress. d. Record the $500,000 as construction-in-progress and simultaneously transfer $400,000 from temporarily restricted contributions to permanently restricted contributions since this related to a long-lived asset. Answer: b Topic: Accounting for Cash Receipts LO: 2 15. In the last fiscal year, you received notification that your not-for-profit organization has been named in the will of one of your long-time benefactors who has passed away (the estate has been probated and you made the appropriate accounting entry at that time). The will stipulates that the funds must be used to improve the buildings in your not-for-profit organization’s summer camp. The lawyer told you that you would receive $300,000, but you now receive a check for $312,000, $12,000 more than you had expected. Which of the following best describes how you should account for the check received? a. Debit cash for $312,000, credit contributions-without donor restrictions for $312,000. b. Debit cash for $312,000, credit contributions receivable for $300,000 and contributions with donor restrictions for $12,000. c. Debit cash for $312,000, credit contributions receivable for $300,000 and contributions without donor restrictions for $12,000. d. Debit cash for $312,000 and credit restricted contributions for $312,000. Answer: b Topic: Auditing Contributions LO: 2 16. You are reviewing the accounting for contributions for the year and notice an entry to record receipt of an unrestricted contribution in the amount of $120,000. This contribution was made in shares of stock with a market value of $135,000 when received, but which had fallen to a value of $120,000 when sold and the entry made. You notice that the letter accompanying the shares of stock referred to your capital campaign for renovation of your headquarters building and that the money was to be used for that purpose. Which of the following statements is correct? a. The original accounting as an unrestricted contribution in the amount of the $120,000 value of the stock when sold is correct. b. The entry is incorrect and should have recorded the receipt as a contribution with donor restrictions in the amount of $120,000. c. The entry is incorrect and should have recorded the receipt as an unrestricted contribution in the amount of $135,000 with a subsequent write-down of the investment. d. The entry is incorrect and should have recorded the receipt as a contribution with donor restrictions in the amount of $135,000 with a subsequent write-down of the investment. Answer: d ©Cambridge Business Publishers, 2020 11-6

Advanced Accounting, 4th Edition

Topic: Functional Expenses LO: 3 17. Which of the following accurately describes the accounting for functional expenses? a. Only health and welfare organizations are required to provide a statement of functional expenses. b. The statement of functional expenses is presented in matrix format to provide information about both the functional and natural classifications of expenses. c. The statement of functional expenses breaks down expenses by both program services and fundraising services. d. The statement of functional expenses is the only way that not-for-profit organizations can provide information about both the functional classification and natural classification of expenses. Answer: b

Topic: Statement of Functional Expenses LO: 3 18. Arthritis Relief Center, a not-for-profit organization, had the following balances in its statement of functional expenses: Medical services Fundraising Management and general Research

$300,000 225,000 200,000 60,000

What amount should Arthritis Relief Center report as expenses for support services? a. $785,000 b. $585,000 c. $425,000 d. $260,000 Answer: c

Topic: Statement of Cash Flows LO: 4 19. The statement of cash flows: a. May use either the direct or indirect method of preparation. b. Does not contain an add-back for depreciation expense since that expense is not recognized for not-for-profit organizations. c. Is divided into operating, contributions, and financing sections. d. Is an optional statement that not-for-profit organizations may issue. Answer: a

Topic: Statement of Functional Expenses LO: 3 20. Depreciation expense in a not-for-profit organization should be: a. b. c. d.

Allocated to program but not support functions. Assigned to or allocated to the functions to which it relates. Reported under the management and general caption. Disclosed in the notes to the financial statements.

11-7

Topic: Statement of Functional Expenses LO: 3 21. A not-for-profit organization incurred $25,000 in management and general expenses in the current fiscal year. In the organization’s statement of functional expenses prepared in conformity with FASB standards, the $25,000 would be reported as: a. b. c. d.

A deduction from program revenue. Supporting services expenses. Program services expenses. A reduction of permanently restricted net assets.

Answer: b

Topic: Statement of Cash Flows LO: 4 22. Generally accepted accounting principles (ASC 958) requires the following financial statements for all nongovernmental, not-for-profit organizations: a. Statement of financial position, statement of activities, statement of cash flows, and statement of functional expenses. b. Statement of financial position, statement of operations, statement of cash flows, and statement of functional expenses. c. Statement of financial position, statement of revenues and expenses, statement of cash flows and statement of functional expenses. d. Statement of financial position, statement of activities, and statement of cash flows Answer: d

Topic: Statement of Cash Flows LO: 4 23. A contribution by a donor with restrictions that the not-for-profit organization hold the assets in perpetuity and spend only the investment income on supporting the programs will be classified in which of these sections of the statement of cash flows: a. b. c. d.

Operating. Investing. Financing. More information is needed.

Answer: c

Advanced Accounting, 4th Edition

Exercises Topic: Preparation of Financial Statements for Not-for-Profit LO: 1, 2 1. Following is financial data for the Fit is Fun, a not-for-profit organization promoting exercise for children: Without Donor Restrictions Revenues - contributions

With Donor Restrictions

$2,077,700

$248,500

Revenues - investment

15,720

55,420

Net assets, beginning of year

817,000

878,000

Contributions receivable Expenses - program Property, plant and equipment, net Depreciation expense (80% program and 20% supporting) Long-term liabilities Cash Payables Investments Net assets released from restriction Expenses - support

395,600 1,775,100 850,600 72,800 535,100 10,120 327,280 1,490,400 108,000 360,100

Required: Prepare the statement of activities and the statement of financial position. Answer: Statement of Activities:

Revenues - contributions Revenues - investment Net assets released from restriction Total revenue and support

Without Donor Restrictions $2,077,700 15,720 108,000 2,201,420

Expenses - program Expenses - support Total operating expenses

1,833,340 374,660 2,208,000

Change in net assets Net assets, beginning of year Net assets, end of year

(6,580) 817,000 $810,420

With Donor Restrictions $248,500 55,420 (108,000) 195,920

Total $2,326,200 71,140 ________ 2,397,340 1,833,340 374,660 2,208,000

195,920 878,000 $1,073,920

189,340 1,695,000 $1,884,340

Continued

11-9

Statement of Financial Position: Cash

Investments

1,490,400

Contributions receivable Total current assets Property, plant and equipment, net

10,120 395,600

1,896,120 850,600

Total assets

$2,746,720

Payables

$ 327,280

Total current liabilities

327,280

Long-term liabilities

535,100

Total liabilities

862,380

Net assets – Without Donor Restrictions

810,420

Net assets – With Donor Restrictions

1,073,920

Total net assets

1,884,340

Total liabilities and net assets

$2,746,720

Advanced Accounting, 4th Edition

Topic: Preparation of Journal Entries for Not-for-Profit LO: 1, 2 2. Dog and Cat Rehab (DACR) is a not-for-profit organization that supports the rehabilitation of injured or orphaned dogs and cats. During the year, the organization recorded a number of financial activities. a. The organization recognized the following revenues (the contributions are all on account and the investment returns are in cash): Revenues - contributions (without donor restrictions))

$587,000

Revenues - contributions (with donor restrictions)

73,250

Revenues - investment (without donor restrictions)

5,970

Revenues - investment (with donor restrictions)

19,950

b. DACR recognized program expenses of $531,000 and expenses related to support activities of $71,800, both on account. $46,000 of the program expenses were paid from temporarily restricted funds and used in compliance with the donor’s stipulations. c.

The organization purchased for $43,200 long-term assets during the year and recorded $21,400 of depreciation expense. Record the net increase in long-term assets to the property, plant and equipment, net account. Allocate 75% of the depreciation expense to the programs and 25% to supporting the programs.

d. DACR purchased $30,700 of investments during the year. e. The organization collected $620,000 of contributions receivable and used the cash to pay $582,000 of accounts payable. Required: Prepare journal entries for each of the transactions above. Answer: a. Cash Contributions Receivable Revenues - contributions (without donor restrictions) Revenues - contributions (with donor restrictions) Revenues - investment (without donor restrictions) Revenues - investment (with donor restrictions) b.

25,920 660,250 587,000 73,250 5,970 19,950

Reclassification from net assets with donor restrictions Reclassification to net assets without donor restrictions

46,000

Expenses - program Expenses - support Payables

531,000 71,800

Property, plant and equipment, net Program expense Supporting expenses Cash

21,800 16,050 5,350

46,000

602,800

43,200

11-11

Investments Cash

30,700

Cash Payables

38,000 582,000

30,700

Contributions receivable

620,000

Topic: Preparation of Journal Entries for Not-for-Profit LO: 1, 2 3. Bootstrap is a not-for-profit organization that promotes self-help solutions to the fight against poverty and hunger. During the year, the organization recorded a number of financial activities. a. The organization recognized the following revenues (the contributions are all on account and the investment returns are in cash): Revenues - contributions (without donor restrictions) Revenues - contributions (with donor restrictions) Revenues - investment (without donor restrictions) Revenues - investment (with donor restrictions)

$271,000 31,130 2,040 6,950

b. Bootstrap recognized program expenses of $195,000 and expenses related to support activities of $36,080, both on account. $24,000 of the program expenses were paid from temporarily restricted funds and used in compliance with the donor’s stipulations. c.

The organization purchased $16,950 of long-term assets during the year and recorded $10,450 of depreciation expense. Record the net increase in long-term assets to the property, plant and equipment, net account. Allocate 90% of the depreciation expense to program expenses and 10% to supporting expenses.

d. Bootstrap purchased $12,700 of investments during the year. e. The organization collected $238,000 of contributions receivable and used the cash to pay $217,900 of accounts payable. Required: Prepare journal entries for each of the transactions above.

Advanced Accounting, 4th Edition

Answer: a. Cash Contributions Receivable Revenues - contributions (without donor restrictions) Revenues - contributions (with donor restrictions) Revenues - investment (without donor restrictions) Revenues - investment (with donor restrictions) b.

8,990 302,130 271,000 31,130 2,040 6,950

Reclassification from net assets with donor restrictions Reclassification to net assets without donor restrictions

24,000

Expenses - program Expenses - support Payables

195,000 36,080

24,000

231,080

Plant, property and equipment, net Program expense Supporting expense Cash

6,500 9,405 1,045

Investments Cash

12,700

Cash Payables

20,100 217,900 Contributions receivable

16,950

12,700

238,000

11-13

Problems Topic: Preparation of Journal Entries and Financial Statements for Not-for-Profit LO: 1, 2 1. Free to Heal is a not-for-profit organization that provides financial help to individuals in need during their course of cancer treatment. Required: 1. Prepare journal entries for each of the following activities: a. The organization recognized the following revenues (the contributions are all on account and the investment returns are in cash): Revenues - contributions (without donor restrictions) Revenues - contributions (with donor restrictions) Revenues - investment (without donor restrictions) Revenues - investment (with donor restrictions)

$370,000 44,400 4,030 15,190

b. Free to Heal recognized program expenses of $305,000 and expenses related to support activities of $30,500, both on account. $30,000 of the program expenses were paid from temporarily restricted funds and used in compliance with the donor’s stipulations. c.

The organization purchased $21,000 of long-term assets during the year and recorded $16,000 of depreciation expense. Record the net increase in long-term assets to the property, plant and equipment, net account. Allocate 80% of the depreciation expense to program expenses and 20% to supporting expenses.

d. Free to Heal purchased $19,000 of investments during the year. e. The organization collected $360,000 of contributions receivable and used the cash to pay $345,000 of accounts payable. f.

The organization repaid $14,500 in long-term debt.

2. Free to Heal reports the following trial balance at the beginning of the year: DR Cash

$ 33,000

Investments

320,000

Contributions receivable

61,000

Property, plant and equipment, net

240,000

Payables

$ 83,000

Long-term liabilities

161,000

Net assets – without donor restrictions

189,000

Net assets – with donor restrictions

_______

221,000

$654,000

Required: Prepare the statement of activities and the statement of financial position at yearend.

Advanced Accounting, 4th Edition

Answer: 1. a. Cash

19,220

Contributions receivable

414,400

Revenues—contributions (without donor restrictions)

370,000

Revenues—contributions (with donor restrictions)

44,400

Revenues—investment (without donor restrictions)

4,030

Revenues—investment (with donor restrictions)

15,190

b. Net assets—with donor restrictions

30,000

Net assets—without donor restrictions

30,000

Expenses—program

305,000

Expenses—support

30,500

Payables c.

335,500

Property, plant and equipment, net

5,000

Program expense

12,800

Supporting expense

3,200

Cash d. Investments

21,000 19,000

Cash e. Cash

19,000 15,000

Payables

345,000 Contributions receivable

Long-term debt Cash

360,000 14,500 14,500

11-15

2. Statement of Activities: Without Donor Restrictions $370,000 4,030 30,000

With Donor Restrictions $ 44,400 15,190 (30,000)

Total $414,400 19,220

Total revenue and support

404,030

29,590

433,620

Expenses - program Expenses - support Total operating expenses

317,800 33,700 351,500

Change in net assets Net assets, beginning of year Net assets, end of year

52,530 189,000 $241,530

Revenues - contributions Revenues - investment Net assets released from restriction

317,800 33,700 351,500 29,590 222,000 $250,590

82,120 410,000 $492,120

Statement of Financial Position: Cash Investments Contributions receivable Total current assets

$ 12,720 339,000 115,400 467,120

Property, plant and equipment, net Total assets

245,000 $712,120

Payables Total current liabilities

$ 73,500 73,500

Long-term liabilities Total liabilities

146,500 220,000

Net assets – without donor restrictions Net assets – with donor restrictions Total net assets

241,530 250,590 492,120

Total liabilities and net assets

$712,120

Advanced Accounting, 4th Edition

Topic: Preparation of Journal Entries and Financial Statements for Not-for-Profit LO: 1, 2 2. Rainforest Forever, Inc. is a not-for-profit organization that dedicated to the preservation of South America’s rainforests. Required: 1. Prepare journal entries for each of the following activities: a. The organization recognized the following revenues (the contributions are all on account and the investment returns are in cash): Revenues - contributions (without donor restrictions) Revenues - contributions (with donor restrictions) Revenues - investment (without donor restrictions) Revenues - investment (with donor restrictions)

$1,143,200 138,920 12,450 26,110

b. Rainforest Forever recognized program expenses of $996,000 and expenses related to support activities of $217,600, both on account. $86,000 of the program expenses were paid from temporarily restricted funds and used in compliance with the donor’s stipulations. c.

The organization purchased $52,300 of long-term assets during the year and recorded $40,800 of depreciation expense. Record the net increase in long-term assets to the property, plant and equipment, net account. Allocate 90% of the depreciation expense to program expenses and 10% to supporting expenses.

d. Rainforest Forever purchased $51,700 of investments during the year. e. The organization collected $1,201,000 of contributions receivable and used the cash to pay $1,163,300 of accounts payable. f.

The organization repaid $50,200 in long-term debt.

2. Rainforest Forever reports the following trial balance at the beginning of the year: DR Cash

84,600

Investments

878,500

Contributions receivable

267,400

Property, plant and equipment, net

711,500

Payables

$ 212,000

Long-term liabilities

361,000

Net assets – without donor restrictions Net assets – with donor restrictions

633,000 _________

736,000

$1,942,000

Required: Prepare the statement of activities and the statement of financial position at yearend.

11-17

Answer: 1. a. Cash

38,560

Contributions Receivable

1,282,120

Revenues—contributions (without donor restrictions)

1,143,200

Revenues—contributions (with donor restrictions)

138,920

Revenues—investment (without donor restrictions)

12,450

Revenues—investment (with donor restrictions)

26,110

Reclassification from net assets with donor restrictions Reclassification to net assets without donor restrictions

86,000

Expenses—program

996,000

Expenses—support

217,600

86,000

Payables c.

1,213,600

Property, plant and equipment, net

11,500

Program expense

36,720

Supporting expense

4,080

Cash d.

Investments

52,300 51,700

Cash e.

Cash

51,700 37,700

Payables

1,163,300 Contributions receivable

Long-term debt Cash

1,201,000 50,200 50,200

Advanced Accounting, 4th Edition

2. Statement of Activities: Without Donor Restrictions

With Donor Restrictions

Revenues - contributions Revenues - investment Net assets released from restriction Total revenue and support

$1,143,200 12,450 86,000 1,241,650

$138,920 26,110 (86,000) 79,030

Expenses - program Expenses - support Total operating expenses

1,032,720 221,680 1,254,400

Change in net assets Net assets, beginning of year Net assets, end of year

(12,750) 633,000 $ 620,250

Total $1,282,120 38,560 _________ 1,320,680 1,032,720 221,680 1,254,400

79,030 736,000 $815,030

66,280 1,369,000 $1,435,280

Statement of Financial Position: Cash Investments Contributions receivable Total current assets

Property, plant and equipment, net Total assets

723,000 $2,008,380

Payables Total current liabilities

$ 262,300 262,300

Long-term liabilities Total liabilities

310,800 573,100

6,660 930,200 348,520 1,285,380

Net assets – without donor restrictions Net assets – with donor restrictions Total net assets

620,250 815,030 1,435,280

Total liabilities and net assets

$2,008,380

11-19

Topic: Preparation of Financial Statements from a Trial Balance LO: 1 and 2 3. Save Our Town From Flooding, Inc. is a tax-exempt entity whose mission is to build a sea wall around its coastal community to prevent floods and storm surge from entering the community in the event of a hurricane. The organization files an annual tax reporting form but has never prepared GAAP financial statements. You are the board member with financial expertise and have decided that you will move the organization closer to being in compliance with GAAP by at least drafting a statement of financial position and statement of activities for now. Next year you will add a statement of cash flows and statement of functional expenses. SAVE OUR TOWN FROM FLOODING, INC. Adjusted (pre-closing) Trial Balance as of December 31, 2020 Debit Cash and cash equivalents Contributions receivable, net of uncollectible accounts Grants receivable Inventory-supplies Prepaid expenses Long-term investments, at fair value Capital assets, net of accumulated depreciation Accounts payable Capital lease obligation payable Notes payable Net assets without donor restrictions Net assets with donor restrictions Contributions-without donor restrictions Contributions-with donor restrictions In-kind contributions-without donor restrictions In-kind donations-with donor restrictions Government grants – without donor restrictions Interest and dividend income Realized and unrealized loss on investments Net assets released from restrictions Program expenses* Supporting expenses* Totals

Credit

$215,050 32,411 50,000 25,985 10,000 61,442 75,430 $

220 31,540 87,035 30,557 $619,670

26,890 6,500 17,000 131,492 94,813 129,956 57,875 54,365 36,005 32,154 1,080 31,540

_______ $619,670

*Only functional, not natural (line-item) expense categories are provided here.

Prepare the statement of financial position and statement of activities, in good form, for Save Our Town From Flooding, Inc. based on the adjusted trial balance provided below.

Advanced Accounting, 4th Edition

Answer: SAVE OUR TOWN FROM FLOODING, INC. Statement of Activities For the Year Ended December 31, 2020

Revenues and Support: Contributions In-kind contributions Government grants Net assets released from restrictoins Total revenue and support

Without Donor Restrictions

With Donor Restrictions

$ 129,956 54,365 32,154 31,540 248,015

$ 57,875 36,005

Functional Expenses: Program expenses Supporting expenses Total expenses

87,035 30,557 117,592

Net change from continuing operations

130,423

Nonoperating Items: Interest and dividend income Realized and unrealized loss on investments Nonoperating items Change in Net Assets + Beginning Net Assets Ending Net Assets

(31,540) 62,340

$ 187,831 90,370 32,154 310,,355

87,035 30,557 117,592 62,340

1,080 (220) 860 131,283 131,492 $ 262,775

Total

192,763

1,080 (220) 860 62,340 94,813 $ 157,153

193,623 226,305 $419,928

SAVE OUR TOWN FROM FLOODING, INC. Statement of Financial Position As of December 31, 2020 Assets: Cash and cash equivalents Contributions receivable, net of uncollectible accounts Grants receivable Inventory-supplies Prepaid expenses Long-term investments, at fair value Capital assets, net of accumulated depreciation Total Assets Liabilities: Accounts payalbe Capital lease obligations payable Notes payable Total Lliabiltities Net Assets: Without donor restrictions With donor restrictions Total Net Assets

$215,050 32,411 50,000 25,985 10,000 61,442 75,430 470,430

26,890 6,500 17,000 50,390

262,775 157,153 $419,928

11-21

Chapter 12 Segment Disclosures and Interim Financial Reporting Learning Objectives – Coverage by question Multiple Choice

Exercises

LO1 – Identify reportable operating segments.

1-11

1, 2

LO2 – Describe the accounting for interim financial reporting.

12-17

3-5

Problems

12-1

Chapter 12: Segment Disclosures and Interim Financial Reporting

Multiple Choice Topic: Motivation for Segment Disclosures LO: 1 1. Which of the following best describes the motivation for and/or argument against segment reporting? a. Users argue for increased disclosures so that they may better understand the drivers of a company’s financial performance. b. Companies have argued against increased disclosures because they feel it will hurt their competitive position. c. Users of financial statements (the analyst community, in particular) argue that it is not sufficient merely to know that a company as a whole is profitable and is generating sufficient cash flow. d. All of the above Answer: d

Topic: Management Approach LO: 1 2. Which of the following statements best describes the “management approach” that the FASB has adopted in its segment reporting standard? a. The management approach requires disclosures for the same business units that are routinely reported to senior management. b. The management approach requires disclosures for the same business units that are routinely reported to analysts. c. The management approach requires disclosures for the same business units that are routinely reported to lenders and other creditors. d. The management approach requires disclosures for the same business units that are routinely reported in conference calls. Answer: a

Topic: Management Approach LO: 1 3. Which of the following statements best describes the “management approach” that the FASB has adopted in its segment reporting standard? a. The management approach facilitates consistent descriptions of a public entity in its annual report and various other published information. b. The management approach focuses on financial information that a public entity’s decision makers use to make decisions about the public entity’s operating matters. c. The components established under the management approach are called operating segments. d. All of the above e. Only b and c. Answer: d

Advanced Accounting, 4th Edition

Topic: Operating Segment LO: 1 4. Which of the following statements about an operating segment is true? a. An operating segment engages in business activities from which it may earn revenues and incur expenses, but may not actually be earning revenues or incurring expenses at this point in time. b. An operating segment engages in business activities from which it may earn revenues and incur expenses, and must be earning revenues or incurring expenses at this point in time. c. An operating segment’s operating results do not need to be reviewed by the chief operating decision maker as long as they are reviewed by department managers in making their business decisions. d. An operating segment does not have to provide discrete financial information. Answer: a

Topic: Operating Segment Quantitative Threshold for Profitability LO: 1 5. Which of the following best describes the quantitative thresholds that are employed to determine disclosure of an operating segment? a. The amount of its reported profit or loss is 10 percent or more of the company’s net income or loss. b. The amount of its reported profit is 10 percent or more of the company’s net income, and only profitable segments must be considered. c. The absolute amount of its reported profit or loss is 10 percent or more of the greater, in absolute amount, of either: 1) The combined reported profit of all operating segments that did not report a loss or 2) The combined reported loss of all operating segments that did report a loss. d. The amount of its profit or loss is not a factor in determining whether the operating segment needs to be separately reported. Only revenue and assets are tested. Answer: c

Topic: Operating Segment Disclosure LO: 1 6. Which of the following best describes the accounting for operating segments? a. Two or more operating segments may be aggregated into a single operating segment if the segments have similar economic characteristics. Those characteristics can be defined very broadly and left for accountants to decide. b. Two or more operating segments cannot be aggregated into a single operating segment for reporting purposes. c. Two or more operating segments may be aggregated into a single operating segment, provided that the total external revenue exceeds 50% of total consolidated revenue. d. Two or more operating segments may be aggregated into a single operating segment if the segments have similar economic characteristics and are similar in nature in areas such as their products and services, their production processes, the types and class of their customers, and the methods that they use to distribute their products. e. Both a and c f. Both c and d Answer: d

12-3

Topic: Operating Segments LO: 1 7. Which of the following best describes the accounting for operating segments? a. If an operating segment was separately reported in a previous year, it must be reported that way in the current year even if it no longer meets the criteria for reportability. b. If an operating segment is reported separately in the current period, prior-period segment data presented for comparative purposes must be restated to include that segment even if that segment did not satisfy the criteria for reportability. c. The determination of the reportability of a segment is made each year. Segments can be included or excluded each year depending on the results of the reporting tests. d. Both a and b are true. Answer: d

Topic: Required Disclosures LO: 1 8. Which of the following are required to be included in segment disclosures for all reportable segments? a. Profit or loss b. Total assets c. Any additional financial data that is reviewed by the chief operating officer d. All of the above e. Both a and b Answer: d

Topic: Typical Disclosures for Operating Segments LO: 1 9. Which of the following are typically included in segment disclosures? a. Sales b. Income c. Assets d. Net cash flow from operating activities e. All of the above f. Choices a, b, and c Answer: f

Topic: Reconciliation with Consolidated Totals LO: 1 10. The segment disclosure must also include the following reconciliations: a. Total segment revenues to total consolidated revenues b. Total segment profit (loss) to total consolidated profit (loss) c. Total segment assets to total consolidated assets d. All of the above are true e. Only a and b are true Answer: d

Advanced Accounting, 4th Edition

Topic: Disclosures Regarding Major Customers LO: 1 11. Which of the following statements about disclosures of major customers is true? a. Companies must disclose information about the extent of their reliance on major customers if revenues from transactions with a single external customer amount to 5% or more of the company’s total revenues b. Companies must disclose information about the extent of their reliance on major customers if revenues from transactions with a single external customer amount to 10% or more of the company’s total revenues. c. Companies must disclose information about the extent of their reliance on major customers if revenues from transactions with a single external customer amount to 15% or more of the company’s total revenues. d. Companies must disclose information about the extent of their reliance on major customers if revenues from transactions with a single external customer amount to 20% or more of the company’s total revenues. Answer: b

Topic: Interim Financial Reporting―Philosophy LO: 2 12. Which of the following statements about the philosophy underlying interim financial reporting is true? a. Companies are allowed to adjust their revenue and expense recognition policy in order to achieve favorable year-over-year comparisons as long as sales and net income for the year as a whole would not be affected. b. Each interim period is accounted for independently using customary revenue and expense recognition policies. c. Each interim period should be viewed primarily as an integral part of an annual period. d. None of the above are true. Answer: c

Topic: Interim Financial Reporting―Inventories LO: 2 13. Which of the following statements is false regarding the interim financial reporting of inventories? a. Accounting standards permits companies to use estimated gross profit rates to determine the cost of goods sold during interim periods. b. LIFO liquidation computation should be done with respect to the entire year, not just the current reporting period. c. Reduction for lower of cost or market need not be recognized if we expect market prices for the affected inventory to recover by year-end. d. Standard cost variance analysis must be performed and recognized with respect to the interim period only. Answer: d

12-5

Topic: Interim Financial Reporting – Costs Benefitting More Than One Period LO: 2 14. Which of the following does not accurately describe the accounting for costs benefitting more than one period? a. Quantity discounts should be recognized in the interim period, even if the annual purchase level has not yet been made if the company expects that the annual sales volume will be sufficient for the customer to receive the discount. b. The estimated annual cost of property taxes, if they can be reliably estimated, should be apportioned equally to interim reporting periods. c. Bonus payments based on sales targets should only be recognized in the period in which the target is met or exceeded. d. Advertising expense should be allocated over the interim reporting periods that benefit from the expenditure, even if paid in only one reporting period. Answer: c Topic: Interim Financial Reporting – Taxes LO: 2 15. Which of the following best describes the accounting for costs benefitting more than one period? a. Accounting standards requires companies to estimate the effective tax rate expected to be applicable for the full fiscal year and to use that rate in computing income taxes in an interim period. b. Companies must estimate the effective tax rate for all interim reporting periods independently. c. Companies are required to use the statutory tax rate for each interim reporting period and to adjust to the effective tax rate at the end of the year. d. The tax rate used for interim reporting periods should not reflect tax benefits resulting from investment tax credits, foreign tax rates, and the like, unless those benefits are certain. Answer: a

Topic: Interim Financial Reporting―Changes in Accounting Principles and Estimates LO: 2 16. Which of the following describes the accounting for changes in accounting principles and estimates? a. In order to maintain comparability of the financial information across interim reporting periods, the FASB recommends that companies adopt any accounting changes during the first interim period of a fiscal year. b. Whenever a change in accounting principles is made, accounting standards require that the change be made retrospectively, with a cumulative adjustment to the beginning balance of assets and liabilities affected by the change in the earliest period reported, and an offsetting adjustment to Retained Earnings. c. When a change in accounting principle is made in an interim period, the effect of the change on prior interim periods should be made retrospectively by adjusting each prior interim financial statement for the effects of the change. d. All of the above e. Both a and c Answer: d

Advanced Accounting, 4th Edition

Topic: Interim Financial Reporting Disclosures LO: 2 17. Which of the following are required disclosures in interim financial statements? a. Footnote discussions of seasonal revenue, costs or expenses b. Footnote discussions of contingent items c. Footnote discussions of changes in accounting principles d. All of the above e. Both a and c Answer: d

12-7

Exercises Topic: Quantitative Thresholds for Classification as an Operating Segment LO: 1 1. Our company has five business units that we classify as operating segments. Financial data for these units follows: ($1,000s) Sales Profit Assets

A $6,000 ($2,100) $7,000

B $3,200 $360 $960

C $9,800 $6,000 $8,400

D E $16,000 $36,000 ($9,600) $18,000 $48,000 $9,600

Required: Which of these operating segments should be disclosed in the footnotes to our financial statements? Answer: ($1,000s)

Totals

Sales

$6,000 $3,200

$9,800

$16,000 $36,000

$71,000

Profit

($2,100)

$360

$6,000

($9,600) $18,000

$24,360 ($11,700)

Assets

$7,000

$960

$8,400

$48,000

$9,600

$73,960

Sales

Yes

$7,100

Profit*

Yes

$2,436

Assets

Yes

$7,396

Segment test: Quantitative Thresholds

*threshold is 10% of the greater of the absolute value of total of profits compared to total of losses

Advanced Accounting, 4th Edition

Topic: Quantitative Thresholds for Classification as an Operating Segment LO: 1 2. Our company has five business units that we classify as operating segments. Financial data for these units follows: A

$32,500

$15,800

$16,800

$1,200

$2,100

Profit

($4,200)

$7,500

$2,500

($4,800)

$800

Assets

$55,000

$9,500

$32,500

$5,200

$7,000

($1,000s) Sales

Required: Which of these operating segments should be disclosed in the footnotes to our financial statements? Answer: ($1,000s)

Sales

$32,500 $15,800

$16,800

$1,200

$2,100

Profit

($4,200) $7,500

$2,500

($4,800)

$800

Assets

$55,000 $9,500

$32,500

$5,200

$7,000

Totals $68,400 $10,800 ($9,000) $109,200

Segment test: A

Quantitative Thresholds

Sales

Yes

$6,840

Profit

Yes

* 1,080

Assets

Yes

$10,920

*threshold is 10% of the greater of the absolute value of total of profits compared to total of losses

12-9

Topic: LIFO Liquidation in an Interim Reporting Period LO: 2 3. Assume that our records include the following two LIFO inventory cost pools:

BOQ

Units 4,200

Cost/Unit $160

Purchase #1

5,000

$200

Total

9,200

At the beginning of the quarter (BOQ), we report 4,200 units on hand at a cost of $160 per unit. During the quarter, we sell 6,000 units at $420/unit for cash. Assume that we expect to increase our quantities of inventories on hand by year-end by the purchase of inventories at a cost of $220. Required: a. Compute the gross profit we should recognize on the sales during the quarter. b. Prepare the required journal entries to record the sales. c. What adjusting entry will be required at year-end if the planned replacement of the inventories does not occur? Answer: a. Our gross profit for the quarter is computed as follows: Sales COGS (5,000@$200 + 1,000@$220) Gross Profit

$2,520,000 (1,220,000) $1,300,000

b. Our journal entries to record the sale (assuming perpetual inventory accounting), are as follows: Cash

2,520,000

Sales To record the sale.

2,520,000

Cost of goods sold 1,220,000 Inventory Excess of replacement cost over LIFO cost To record Cost of Goods Sold in the interim income statement, assuming replacement of inventories at $220/unit. $60,000= (1000 x [$220 - $160]). c.

1,160,000 60,000

If the planned replacement of the inventories does not occur, the $60,000 (1000 x [$220 $160]) Excess of Replacement Cost Over LIFO Cost will be removed from inventories and credited to Cost of Goods Sold, thus increasing gross profit to reflect the LIFO liquidation that will have occurred if the inventories are not replaced. This will be reflected in the following journal entry: Excess of replacement cost over LIFO cost Cost of goods sold To write off the excess of replacement cost over LIFO cost account when the inventories are not replenished.

60,000 60,000

Advanced Accounting, 4th Edition

Topic: Costs Benefitting More Than One Interim Reporting Period LO: 2 4. Our customer purchases $325,000 of product from us this quarter and we expect its annual purchases to be $1,300,000. Based on the anticipated annual purchases, our customer will be eligible for a 4% sales discount. Required: Describe the required accounting treatment for this scenario. Answer: Since we expect our customer to achieve the volume of purchases for the year that entitles it to a 4% volume discount, we should accrue the discount in the interim reporting period. Based on sales for this period, therefore, we would accrue the sales discount for the interim period as follows (using the net method): Sales Accounts Receivable To accrue sales discount for the quarter.

13,000 13,000

Topic: Costs Benefitting More Than One Interim Reporting Period. LO: 2 5. During the quarter, we incur costs to develop an advertising campaign that we expect to be aired in the next quarter and benefit the next and following quarters. Required: Describe the required accounting treatment for this scenario. Answer: The advertising cost should be reflected as expense in the quarters benefitted by the advertising. Therefore, expense should be recognized in the next and following quarters.

12-11

Chapter 13 Accounting for Partnerships Learning Objectives – Coverage by question Multiple Choice

Exercises

LO1 – Describe the partnership form of organization.

1-4

LO2 – Describe the accounting for the formation of the partnership.

5, 6

1, 2

LO3 – Describe the accounting for changes in partnership ownership.

7, 8

3-10

LO4 – Describe the allocation of profit (loss), drawing accounts, and the capital account.

9-13

11-13

LO5 – Describe the accounting for the dissolution of a partnership

14-18

Problems

13-1

Chapter 13: Accounting for Partnerships

Multiple Choice Topic: Partnership Form of Organization LO: 1 1. Which of the following does not describe the partnership form of organization? a. Partnerships allow numerous individuals to combine their efforts for a variety of business purposes in an organization that can last indefinitely. b. Partnerships can survive the admission of new partners and the disassociation of existing partners as they retire. c. From a tax standpoint, the taxing authorities view the partnership as a taxable entity and tax its profit like other forms of organization. d. Partnerships pass through liabilities to the partners. Answer: c

Topic: Partnership Form of Organization LO: 1 2. Which of the following statements is not correct about the accounting for partnerships? a. Partnerships are a legal entity and, as such, they must issue financial statements. b. Partnerships are not necessarily required to issue financial statements that are prepared in conformity with GAAP. c. Partnerships are required to issue financial statements that are prepared in conformity with GAAP. d. Partnerships don’t have stockholders’ equity like corporations do. Answer: c

Topic: Partnership Form of Organization LO: 1 3. Identify the provision that is not typically contained in a partnership agreement a. The partnership can buy and sell assets, enter into contracts, and borrow money. b. Each partner can act for the partnership. c. A partnership is liable for loss as a result of a wrongful act of a partner acting in the ordinary course of business of the partnership. d. Each partner is only liable for his or her proportionate share of the partnership liabilities based on their relative share of total partnership capital. Answer: d

Advanced Accounting, 4th Edition

Topic: Limited Liability Partnerships LO: 1 4. Which of the following statements is not true about limited liability partnerships (LLPs)? a. In an LLP, all partners have a form of limited liability, similar to that of the shareholders of a corporation. b. Unlike corporate shareholders, the partners have the right to manage the business directly rather than through a board of directors c. In addition to structuring the partnership as an LLP, professional service organizations also typically maintain a significant amount of malpractice insurance as additional protection. d. All of the above are true. Answer: d

Topic: Accounting for Partnership Formation LO: 2 5. Which of the following statements is false regarding the formation of a partnership? a. Partners may only contribute cash to the partnership which, then, purchases all of its assets. b. Capital Accounts are credited to represent the claim of the partners to the net assets of the partnership. c. The Capital Account for an individual partner does not need to be equal to the amount that the partner has contributed to the partnership. d. All of the above are true. Answer: a

Topic: Accounting for Partnership Formation LO: 2 6. Which of the following best describes the accounting for partnership formation when partners are assigned balances that do not equal their capital contributions? a. This scenario is not possible since all capital accounts must be proportional to the relative contributions of the partners. b. The partnership can apply either the “bonus method” or the “goodwill method” to account for the contribution without restriction. c. The “bonus method” relates to the recognition of an intangible asset upon formation of the partnership. d. The “bonus method” can be used even in the presence of an intangible asset if the partners agree. Answer: d

Topic: Accounting for Changes in Partnership Ownership LO: 3 7. Which of the following best describes the accounting for changes in partnership ownership? a. A common practice when admitting a new partner to a partnership is to revalue the partnership net assets to fair value. b. The purchase of a partnership interest in a transaction between old and new partners requires a journal entry in the partnership records. c. Both a and b. d. Neither a nor b. Answer: c

13-3

Topic: Accounting for Changes in Partnership Ownership LO: 3 8. Which of the following is not true about the accounting for changes in partnership ownership involving revaluation of net assets? a. If net assets are measured at fair value, the partners have the best possible chance of allocating partner Capital Accounts in a fair and unbiased manner. b. When partnership net assets are revalued in anticipation of a realignment transaction, the resulting gains and losses accrue only to the partners who have an ownership interest in the entity during the period in which the net assets changed in value. c. The gains and losses that result from pre-realignment revaluation are allocated to the existing partners’ Capital Accounts in the revaluation profit-and-loss-sharing ratio designated in the Partnership Agreement. d. The differential in value resulting from the revaluation of assets is recognized as a gain or loss in the partnership income statement. Answer: d Topic: Allocation of Profit or Loss LO: 4 9. Which of the following statements is false? a. The partner Capital Account is updated in a manner that is similar to the way in which we update Retained Earnings for a corporation. b. Cash paid to partners is called a dividend. c. Profit and loss can be allocated to individual partners in a ratio that is different form the relative proportion of their capital accounts. d. Cash paid to a partner for services performed for the partnership is not recognized as an expense. Answer: b Topic: Partner Capital Accounts and Allocation of Profit LO: 4 10. Which of the following statements is false? a. Partners may contribute additional capital to the partnership in the form of cash and other assets. b. Withdrawals of cash by the partners are called “drawings.” c. The partnership income statement includes revenues and expenses but not salary paid to partners. d. All of the above are true. Answer: d Topic: Allocation of Partnership Profit or Loss LO: 4 11. Which of the following statements about the allocation of partnership profit or loss is false? a. Partnership agreements sometimes allow for a salary payment as part of the profit allocation process, computed as a fixed payment or variable rate based on some measure of output. b. Salary payment is allocated to the partner and the net profit after this payment is allocated to the partners based on a profit-sharing ratio. c. Uniform Partnership Act of 1997 states that a partner is not entitled to remuneration for services performed for the partnership. d. All of the above are true. Answer: d ©Cambridge Business Publishers, 2020 13-4

Advanced Accounting, 4th Edition

Topic: Interest on the Capital Account LO: 4 12. Which of the following statements about interest on the Capital Account is false? a. Interest paid on Capital Account balances is not treated like interest on debt for accounting purposes. b. Interest paid on Capital Account balances is treated as a form of profit allocation like salary. c. The journal entry to record the payment of interest on Capital Account balances involves a debit to interest expense. d. The interest rate is specified in the Partnership Agreement. Answer: c

Topic: Allocation of Profit to the Partners LO: 4 13. Which of the following statements is false regarding the allocation of profit to partners? a. The allocation of remaining profit to the partners is based on a sharing ratio that is described in the Partnership Agreement. b. The Partnership Agreement can provide for different sharing ratios in the event of a profit or a loss. c. The profit sharing ratio does not have to conform to the partners’ respective Capital Account balances. d. All of the above are true. Answer: d

Topic: Partnership Dissolution LO: 5 14. Which of the following does not accurately describe the process relating to the dissolution of a partnership? a. The assets of the partnership must be converted to cash used to pay the obligations to creditors, including partners who are creditors, and any remaining cash must be distributed to the partners in accordance with the relative proportions of their Capital Accounts. b. Profits (losses) that result from the liquidation of the partnership assets must be credited (charged) to the partners’ Capital Accounts. c. If a partner’s Capital Account becomes negative as a result of the sales of assets, the partner must make a cash contribution to the partnership in an amount sufficient to bring the Capital Account to a zero balance. d. If a partner fails to contribute the full amount required, all of the other partners shall contribute (in their profit-sharing ratios) the additional amount necessary to satisfy the partnership obligations. In the event of such contribution, the partners shall have the right to sue the partner with the unfunded negative Capital Account for the amount owed to the partnership Answer: a

13-5

Exercises Topic: Formation of Partnership―Bonus Method LO: 2 1. Assume that two individuals agree to form a partnership. Partner A is contributing an operating business that reports the following balance sheet: Cash Receivables Inventories Total assets

60,000 80,000 100,000 240,000

Accounts payable. Accrued liabilities Total liabilities Net assets

80,000 60,000 140,000 100,000

Partner B is contributing cash of $150,000. The partners agree that the initial capital of the partnership should be shared equally. Required: Prepare the journal entry to record the capital contributions of the partners assuming that the partners wish to employ the Bonus Method. Answer: Cash Receivables Inventories Accounts payable Accrued liabilities Partner A Capital Partner B Capital To record initial capital contribution to the Partnership using the Bonus Method.

210,000 80,000 100,000 80,000 60,000 125,000 125,000

Advanced Accounting, 4th Edition

Topic: Formation of Partnership―Goodwill Method LO: 2 2. Assume the same fact set as in Exercise 1. Required: Prepare the journal entry to record the capital contributions of the partners assuming that the partners wish to employ the Goodwill Method. Answer: Partner A contributed $100,000 in net assets for a 50% capital interest, while Partner B contributed $150,000 for a 50% capital interest. If we believe these to be “arm’s-length” transactions, then the total implied value of the new partnership is $300,000 and the total value of the identifiable contributed net assets is $250,000. This means the partnership potentially has $50,000 of Goodwill (i.e., $300,000 - $250,000). The following entry records the initial formation under the Goodwill Method: Cash Receivables Inventories Goodwill Accounts payable Accrued liabilities Partner A Capital Partner B Capital To record initial capital contribution to the Partnership using the Goodwill Method.

210,000 80,000 100,000 50,000 80,000 60,000 150,000 150,000

Topic: Change of Partners LO: 3 3. Assume that Partners A and B each report a Capital Account of $400,000. Partner A wants to retire and sell her partnership interest to Partner C for $550,000. Partner B agrees to the sale and admission of Partner C into the partnership at an equal ownership percentage. Required: Record the journal entry on the books of the partnership to reflect the admission of Partner C. Assume that the partners do not wish to record any (previously unrecognized) implied Goodwill. Answer: The journal entry to record the admission of Partner C merely reallocates the Partner Capital account from Partner A to Partner C. Partner A Partner C To record the purchase of Partner A’s partnership interest by Partner C.

400,000 400,000

Given that the partners do not wish to record any previously unrecognized implied intangible assets, the $550,000 purchase price is between the partners and does not affect the partnership.

13-7

Topic: Admission of New Partner LO: 3 4. Assume that Partners A and B each report a Capital Account of $400,000. Partner C wants to join the partnership as an equal one-third partner in consideration for a combined payment to Partners A and B of $266,667. Required: Record the journal entry on the books of the partnership to reflect the admission of Partner C. Answer: The journal entry merely records the purchase of one-third of Partner A’s and Partner B’s Capital Accounts and the admission of Partner C with a Capital Account equal to the amount paid by Partner C. Partner A, Capital Partner B, Capital Partner C, Capital To record the purchase of Partner A and Partner B partnership interests by Partner C.

133,333 133,333 266,667

Topic: Admission of New Partner LO: 3 5. Assume that Partners A and B each report a Capital Account of $400,000. Partner C wants to join the partnership as an equal one-third partner in consideration for a payment to the partnership of $66,667 cash and a parcel of land valued at $200,000. Required: Record the journal entry on the books of the partnership to reflect the admission of Partner C. Answer: Cash Land Partner C, Capital To record the capital contribution of Partner C.

66,667 200,000 266,667

Advanced Accounting, 4th Edition

Topic: Admission of a New Partner – Bonus Method LO: 3 6. Assume that Partners A and B each report a Capital Account of $900,000. Partner C wants to join the partnership as an equal one-third partner. Because the partnership has been very profitable, Partners A and B require Partner C to contribute $1,200,000 in cash to the partnership in return for a one-third interest. Assume that Partners A and B share profits 60% and 40%, respectively, prior to the admission of Partner C. After admission of Partner C, Partners A and B retain their relative proportion of profit allocation after granting Partner C a 33% profit-allocation interest. Required: Use the Bonus Method to record the journal entry on the books of the partnership to reflect the admission of Partner C. Answer: Following the cash contribution, the total capital accounts (and total partnership net assets) are $3,000,000 (i.e., $900,000 + $900,000 + $1,200,000). The 1/3 capital interest means that Partner C will receive $1,000,000 of capital credit in exchange for the $1,200,000 contribution. Under the Bonus Method, we assume that Partner C is paying a $200,000 premium (i.e., $1,200,000 contribution by C, minus the $1,000,000 capital credit awarded to C) over book value in order to join the partnership, and the preexisting partners receive that premium as a bonus. This $200,000 bonus is allocated according to the partners’ profit-and-loss sharing ratio. This means Partner A will receive $120,000 (i.e., 60%) of capital credit for the bonus “paid” by Partner C, and Partner B will receive the remaining $80,000 (i.e., 40%). The journal entry to record this transaction is as follows: Cash A, Capital B, Capital C, Capital To record the purchase of a 1/3 partnership interest by C for $1,200,000.

1,200,000 120,000 80,000 1,000,000

Topic: Admission of a New Partner―Bonus Method LO: 3 7. Use the same fact set as in Exercise 6. Required: Compute the new Capital Accounts and the new profit-sharing ratio for Partners A, B, and C following the admission of Partner C into the partnership. Answer: Partners A, B and C capital accounts are now equal to $1,020,000, $980,000 and $1,000,000. The post-realignment profit-and-loss sharing ratios are: 40% for A (60% x [100% - 33%]) 27% for B [40% x (100% - 33%)], and 33% for C

13-9

Topic: Admission of a New Partner―Goodwill Method LO: 3 8. Refer to the fact set in Exercise 6. Assume that the partners believe that the payment by Partner C provides evidence of a previously unrecorded intangible asset in the partnership and the partners wish to record the intangible on the post-realignment partnership balance sheet. Required: Use the Goodwill Method to record the journal entry on the books of the partnership to reflect the admission of Partner C. Answer: We can estimate the implied amount of Goodwill by evaluating the partners’ contributions. Partner C contributed $1,200,000 in cash for a 1/3 capital interest, while the existing partners (i.e., Partners A and B, together) “contributed” $1,800,000 (i.e., $900,000 + $900,000) for a 2/3 post-realignment capital interest. If we believe these to be “arm’s-length” transactions, then the total implied value of the new partnership is $3,600,000 (i.e., $1,200,000 contribution by Partner C / 1/3). The Goodwill implied by Partner C’s capital contribution is equal to $600,000, which equals the total fair value of the partnership entity (i.e., $3,600,000) minus the fair value of the identifiable net assets of the partnership in the amount of $3,000,000 (equals the existing capital of $1.800,000 and the $1,200,000 of cash received by the partnership from Partner C). This Goodwill will be allocated to the existing partners in proportion to their relative profit and loss ratios. The journal entry to record this transaction is as follows: Cash Goodwill A, Capital B, Capital C, Capital To record the purchase of a 1/3 partnership interest by C for $1,200,000.

1,200,000 600,000 360,000 240,000 1,200,000

Advanced Accounting, 4th Edition

Topic: Admission of New Partner—Revaluation LO: 3 9. Assume that Partners A and B have Capital Accounts equal to $400,000 and $250,000, respectively. Partner C wants to join the partnership as one-third partner. Partner C contributes $785,000 in cash to the partnership in return for a one-third interest. Prior to the admission of Partner C, Partners A and B wish to revalue the long-term assets of the partnership. They obtain an appraisal of the land and building that indicated a current value of $900,000. The land and building are currently reported on the partnership balance sheet at $250,000. Required: Record the journal entry on the books of the partnership to reflect the revaluation of the land and building and the admission of Partner C with a capital contribution of $785,000. Assume that despite the evidence of a previously unrecognized intangible asset, the partners do not wish to record the intangible asset. Assume that the partners allocate profits equally. Answer: The journal entry to revalue the assets is as follows: Land and Buildings Partner A, Capital Partner B, Capital To revalue the land and buildings prior to the admission of Partner C.

650,000 325,000 325,000

At this point, the total capital account balances for Partners A and B reflect the fair value of the identifiable net assets of the partnership immediately prior to the admission of the new partner. The individual capital account balances for A and B are $725,000 and $575,000, respectively, which means the total net assets of the partnership (preadmission) are $1,300,000. After C’s contribution, the total net assets balance of the partnership equals $2,085,000 (i.e., $1,300,000 + $785,000). This means Partner C’s 1/3 interest is valued at $688,000 (i.e., $785,000 x 1/3, rounded). Partners A and B equally split the $97,000 “bonus” (i.e., $785,000 - $688,000). The admission of Partner C, then, is recorded as follows: Cash A, Capital B, Capital C, Capital To record the purchase of a 1/3 partnership interest by C for $785,000.

785,000 48,500 48,500 688,000

13-11

Topic: Admission of New Partner—Goodwill Method LO: 3 10. Assume that the partnership’s balance sheet reflects Partner Capital of $450,000 and $650,000, respectively, for Partner A and Partner B immediately prior to the admission of Partner C. Partner C is contributing $750,000 for a one-third ownership interest. Required: Prepare the journal entry to admit Partner C using the Goodwill Method. partners agree to share profits equally.

Assume that the

Answer: Under the Goodwill approach, the partners can determine a partnership-entity fair value that is implied by the $750,000 contribution by incoming Partner C. Given that Partner C is receiving a 1/3 ownership interest, the implied value of the entire partnership entity is $2,250,000 ($1,850,000/[1/3]). After C’s payment of cash into the partnership, the total identifiable net assets balance of the partnership (i.e., before considering the implied, previously unrecorded intangible asset) is $1,850,000 (i.e., $450,000 + $650,000 + $750,000). Consequently, it appears that Partner C’s contribution provides evidence that the partnership has an unrecorded intangible asset (i.e., Goodwill) with a fair value of $400,000 ($2,250,000 - $1,850,000). The partnership recognizes the cash contribution and the new intangible asset (i.e., Goodwill) with the following journal entry: Cash Goodwill

750,000 400,000

Partner A, Capital Partner B, Capital Partner C, Capital To record the cash contribution and goodwill asset and the related adjustments to the capital accounts.

200,000 200,000 750,000

Partners A and B equally split the $400,000 capital credit that arises from recognizing the previously unrecorded Goodwill.

Topic: Allocation of Profit to Partners LO: 4 11. Assume that there are three partners in a partnership, A, B, and C. Partner C provides services to the partnership and is entitled to a salary of $90,000. Assume that the partnership revenues, less expenses (other than salary to Partner C), amount is $758,000. Finally, assume that the Partnership Agreement provides for a sharing ratio of 35%/35%/30% for Partners A, B, and C, respectively. Required: Prepare a schedule for the allocation of profit to the partners. Answer: A Excess of revenues over expenses Salary Allocation of residual profit Total Allocation

233,800 233,800

C 90,000 200,400 290,400

Total Allocation 90,000 668,000 758,000

Advanced Accounting, 4th Edition

Topic: Allocation of Interest on Capital Accounts and Profit to Partners LO: 4 12. Assume that there are three partners in a partnership, A, B, and C. Partner C provides services to the partnership and is entitled to a salary of $75,000. In addition, assume that the Partnership Agreement provides for an interest allocation of 6% based on the weighted-average Capital Account balance during the year. There is a balance in each Capital Account for Partners A and B of $750,000 for the full year. Partner C, however, was admitted to the partnership for an initial capital contribution of $500,000 on April 30 Finally, assume that the partnership revenues less expenses (other than salary to Partner C and interest on capital balances) are $658,000, and that the Partnership Agreement provides for a sharing ratio of 35%/35%/30% for Partners A, B, and C, respectively. Required: Prepare a schedule for the allocation of profit to the partners. Answer: The weighted-average Capital Accounts for the three partners and the allocation of capital – account interest is as follows:

Partner A B C

Weighted Average Capital Account Balance $750,000 x 12/12 = $750,000 $750,000 x 12/12 = $750,000 ($0 x 4/12) + ($500,000 x 8/12) = $333,333

Interest Allocation $750,000 x 6% = $45,000 $750,000 x 6% = $45,000 $333,333 x 6% = $20,000

The allocation of partnership profit is as follows:

BOY Balance Contribution Excess of revenues over expenses Salary Interest @ 5% Allocation of residual profit Total Allocation

A 750,000

B 750,000

Total Allocation

Remaining

75,000 110,000 473,000 658,000

658,000 583,000 473,000 0 1,056,000

500,000

45,000 165,550 210,550

75,000 20,000 141,900 236,900

13-13

Topic: Allocation of Interest on Capital Accounts and Profit to Partners LO: 4 13. Assume that there are three partners in a partnership, A, B, and C. Partners A and B each began the year with a capital account of $900,000. Partner C was admitted to the partnership during the year with a capital contribution of $315,000. The Partnership Agreement provides for a salary to Partner C of $75,000 and interest on the respective Capital Accounts of $54,000/$54,000/$14,175, respectively. During the year, the partners withdrew $50,000/$50,000/$45,000 and the allocation of profit was $300,000/$300,000/$66,667, respectively. Required: Prepare the Statement of Partners’ Capital for the year. Answer:

Capital Account, beginning of year Capital contributions Withdrawals

Partners B

$900,000

0 (50,000)

C 0

$ 1,800,000

0 (50,000)

315,000 (45,000)

315,000

122,175

Salary

Total

(145,000)

Interest @ 6%

54,000

75,000 14,175

75,000

Allocation of remaining profit

300,000

66,667

666,667

Capital Account, end of year

354,000

155,842

2,833,842

Advanced Accounting, 4th Edition

Topic: Liquidation Schedule—Positive Capital Accounts LO: 5 14. The ABC partnership reports the following condensed balance sheet: Cash

$287,000

Liabilities

$400,000

Noncash assets

585,000

Partner A, capital

187,000

Partner B, capital

187,000

Partner C, capital

98,000

Total assets

$872,000

Total liabilities and partner capital

$872,000

The partners wish to liquidate the partnership. The noncash assets are sold for $440,000 with the loss distributed to the partners in the ratio of 30%/30%/40% to partner A, B, and C, respectively. The liabilities are paid in full. Required: Prepare a schedule detailing the liquidation of the assets, repayment of the liabilities, and distribution of the remaining cash to the partners. Answer: 30%

30%

40%

Partners’ Capital Accounts Debit (Credit)

Cash

Noncash Assets

Balance prior to liquidation

287,000

585,000

Sale of noncash assets

440,000

-585,000

727,000

Payment of creditors

-400,000 327,000

Distribution to partners Post-liquidation balances

Liabilities

-400,000

-187,000

-98,000

43,500

58,000

-143,500

-138,540

-40,000

-143,500

-369,530

-40,000

143,500

369,530

40,000

-400,000 400,000

-327,000 0

13-15

Topic: Liquidation Schedule—One Negative Capital Account with Capital Contribution LO: 5 15. The ABC partnership reports the following condensed balance sheet: Cash

$1,050,000

Liabilities

$900,000

Noncash assets

1,676,800

Partner A, capital

875,900

Partner B, capital

875,900

Partner C, capital

75,000

Total assets

$2,726,800

Total liabilities and partner capital

$2,726,800

The partners wish to liquidate the partnership. The noncash assets are sold for $1,400,000 with the loss distributed to the partners in the ratio of 30%/30%/40% to partner A, B, and C, respectively. The liabilities are paid in full. Partners make any capital contribution that is necessary to offset a negative balance in their respective Capital Accounts. Required: Prepare a schedule detailing the liquidation of the assets, repayment of the liabilities, and distribution of the remaining cash to the partners. Answer: 30% 30% 40% Partners' Capital Accounts Debit (Credit) Balance prior to liquidation Sale of noncash assets

Noncash Cash Assets 1,050,000 1,676,800 1,400,000 -1,676,800

Capital contribution

2,450,000 35,720 2,485,720 -900,000 1,585,720 -1,585,720 0

Payment of creditors Distribution to partners Post-liquidation balances

Liabilities -900,000

A -875,900 83,040

B -875,900 83,040

C -75,000 110,720

-900,000

-792,860

35,720 -35,720

-792,860

-900,000 900,000 0

-792,860 -792,860 0

0 0 0

Advanced Accounting, 4th Edition

Topic: Liquidation Schedule—One Negative Capital Account with No Capital Contribution LO: 5 16. The ABC partnership reports the following condensed balance sheet: Cash

$1,050,000

Liabilities

$900,000

Noncash assets

1,676,800

Partner A, capital

875,900

Partner B, capital

875,900

Partner C, capital

75,000

Total assets

$2,726,800

Total liabilities and partner capital

$2,726,800

The partners wish to liquidate the partnership. The noncash assets are sold for $1,400,000 with the loss distributed to the partners in the ratio of 30%/30%/40% to partner A, B, and C, respectively. The liabilities are paid in full. Assume that any partners with a negative balance in their respective Capital Accounts are insolvent and, therefore, do not make any capital contribution to the partnership (i.e., remaining partners must absorb the negative Capital Account according to their profit sharing formula). Required: Prepare a schedule detailing the liquidation of the assets, repayment of the liabilities, and distribution of the remaining cash to the partners. Answer: 30% 30% 40% Partners' Capital Accounts Debit (Credit) Balance prior to liquidation Sale of noncash assets

Noncash Cash Assets 1,050,000 1,676,800 1,400,000 -1,676,800

Liabilities -900,000

A -875,900 83,040

B -875,900 83,040

C -75,000 110,720

2,450,000 0

Allocation of deficit

-900,000 0

-792,860 17,860

35,720 -35,720

2,450,000 -900,000 1,550,000 -1,550,000 0

-775,000 0 -775,000 775,000 0

-900,000 900,000 0

Payment of creditors Distribution to partners Post-liquidation balances

0 0 0

13-17

Topic: Liquidation Schedule—Two Negative Capital Accounts with No Capital Contribution LO: 5 17. The ABC partnership reports the following condensed balance sheet: Cash

$1,254,680

Liabilities

$751,980

Noncash assets

2,468,403

Partner A, capital

350,000

Partner B, capital

2,341,103

Partner C, capital

280,000

Total assets

$3,723,083

Total liabilities and partner capital

$3,723,083

The partners wish to liquidate the partnership. The noncash assets are sold for $1,400,000 with the loss distributed to the partners in the ratio of 30%/30%/40% to partner A, B, and C, respectively. The liabilities are paid in full. Assume that any partners with a negative balance in their respective Capital Accounts are insolvent and, therefore, do not make any capital contribution to the partnership (i.e., remaining partners must absorb the negative Capital Account according to their profit sharing formula). Required: Prepare a schedule detailing the liquidation of the assets, repayment of the liabilities and distribution of the remaining cash to the partners. Answer: 30% 30% 40% Partners' Capital Accounts Debit (Credit) Balance prior to liquidation Sale of noncash assets Allocation of Partner C deficit

Noncash Cash Assets 1,254,680 2,468,403 1,400,000 -2,468,403

Liabilities -751,980

A -350,000 320,521

B -2,341,103 320,521

C -280,000 427,361

2,654,680

-751,980

-29,479

-2,020,582

147,361

73,681

-147,361

-751,980

44,202

-1,946,902

-44,202 0

44,202 (1,902,700)

0 -751,980 751,980 0

0 0

(1,902,700) (1,902,700)

0 0

0 2,654,680

Allocation of Partner A deficit Payment of creditors Distribution to partners Post-liquidation balances

0 2,654,680 -751,980 1,902,700 -1,902,700 0

Advanced Accounting, 4th Edition

Topic: Liquidation Schedule—Safe Payment Schedule LO: 5 18. On the date the partners in the ABCD partnership decided to dissolve their partnership, the partners had the following pre-liquidation Capital Account balances: Partner A, capital Partner B, capital Partner C, capital Partner D, capital

$448,000 656,000 288,000 192,000

A, B, C and D share residual profits and losses in a 4:3:2:1 ratio. Accrued liabilities at the date of dissolution total $160,000 and noncash assets equal $1,680,000. During the first month of liquidation, assets having a book value of $880,000 were sold for $494,000. During the second month, assets having a book value of $512,000 were sold for $448,000. During the third month, the remaining unsold assets were determined to be worthless. The partners receive the maximum allowable payment at the end of each month. Required: Prepare an installment liquidation schedule along with the necessary, supporting Safe Payment Schedules. Answer: 40%

30%

20%

10%

Partners' Capital Accounts Debit (Credit)

Cash

Noncash Assets

Liabilities

Balance prior to liquidation

64,000

1,680,000

-160,000

-448,000

-656,000

-288,000

-192,000

Sale of noncash assets in month #1

494,000

-880,000

154,400

115,800

77,200

38,600

558,000

800,000

-160,000

-293,600

-540,200

-210,800

-153,400

287,000

42,000

69,000

-160,000

-293,600

-253,200

-168,800

-84,400

Installment distribution to Partners #1

Sale of noncash assets in month #2

Installment distribution to Partners #2

-398,000 160,000

800,000

448,000

-512,000

25,600

19,200

12,800

6,400

608,000

288,000

-160,000

-268,000

-234,000

-156,000

-78,000

152,800

147,600

98,400

49,200

288,000

-160,000

-115,200

-86,400

-57,600

-28,800

115,200

86,400

57,600

28,800

-448,000 160,000

Write off noncash assets in month #3

-288,000 160,000

Pay creditors Post-liquidation balances

-160,000 0

-160,000 160,000

Continued

13-19

Safe Payment #1

40%

30% 20% 10% Partners' Capital Accounts A B C D -293,600 -540,200 -210,800 -153,400

Debit (Credit) Partners' Capital Assumed Losses ASSUME that noncash sold for Zero

800,000

ASSUME that A deficit is allocated Safe Payment for Installment #1

Safe Payment #2

320,000 26,400 -26,400 0

240,000 -300,200 13,200 -287,000

160,000 -50,800 8,800 -42,000

80,000 -73,400 4,400 -69,000

40%

30%

20%

10%

Partners' Capital Accounts Debit (Credit) Partners' Capital

-268,000

-234,000

-156,000

-78,000

115,200

86,400

57,600

28,800

-152,800

-147,600

-98,400

-49,200

Assumed Losses ASSUME that noncash sold for Zero

288,000

Advanced Accounting, 4th Edition