TEST BANK FOR Advanced Accounting 13e (Global Edition) Floyd Beams, Joseph Anthony, Bruce Bettinghau by digitaldownload87

Advanced Accounting 13e (Global Edition) Floyd Beams, Joseph Anthony, Bruce Bettinghaus, Kenneth Smith (Test Bank All Chapters, 100% Original Verified, A+ Grade) Advanced Accounting, 13e (Beams et al.) Chapter 1 Business Combinations 1.1 Multiple Choice Questions 1) Which of the following is NOT a reason for a company to expand through a combination, rather than by building new facilities? A) A combination might provide cost advantages. B) A combination might provide fewer operating delays. C) A combination might provide easier access to intangible assets. D) A combination might provide an opportunity to invest in a company without having to take responsibility for its financial results. Answer: D Objective: LO1.1 Understand the economic motivations underlying business combinations. Difficulty: Easy AACSB: Analytical thinking

2) A business merger differs from a business consolidation because A) a merger dissolves all but one of the prior entities, but a consolidation dissolves all of the prior entities and forms a new corporation. B) a consolidation dissolves all but one of the prior entities, but a merger dissolves all of the prior entities. C) a merger is created when two entities join, but a consolidation is created when more than two entities join. D) a consolidation is created when two entities join, but a merger is created when more than two entities join. Answer: A Objective: LO1.2 Learn about alternative forms of business combinations, from both the legal and accounting perspectives. Difficulty: Easy AACSB: Analytical thinking

3) Following the accounting concept of a business combination, a business combination occurs when a company acquires an equity interest in another entity and has A) at least 20% ownership in the entity. B) more than 50% ownership in the entity. C) 100% ownership in the entity. D) control over the entity, irrespective of the percentage owned. Answer: D Objective: LO1.2 Learn about alternative forms of business combinations, from both the legal and accounting perspectives. Difficulty: Easy AACSB: Analytical thinking

4) Historically, much of the controversy concerning accounting requirements for business combinations involved the ________ method. A) purchase B) pooling of interests C) equity D) acquisition Answer: B Objective: LO1.2 Learn about alternative forms of business combinations, from both the legal and accounting perspectives. Difficulty: Easy AACSB: Analytical thinking

5) Pitch Co. paid $50,000 in fees to its accountants and lawyers in acquiring Slope Company. Pitch will treat the $50,000 as A) an expense for the current year. B) a prior period adjustment to retained earnings. C) additional cost to investment of Slope on the consolidated balance sheet. D) a reduction in additional paid-in capital. Answer: A Objective: LO1.3 Introduce accounting concepts for business combinations, emphasizing the acquisition method. Difficulty: Moderate AACSB: Application of knowledge

6) Picasso Co. issued 5,000 shares of its $1 par common stock, valued at $100,000, to acquire shares of Seurat Company in an all-stock transaction. Picasso paid the investment bankers $35,000 and will treat the investment banker fee as A) an expense for the current year. B) a prior period adjustment to Retained Earnings. C) additional goodwill on the consolidated balance sheet. D) a reduction to additional paid-in capital. Answer: D Objective: LO1.3 Introduce accounting concepts for business combinations, emphasizing the acquisition method. Difficulty: Moderate AACSB: Application of knowledge

7) Durer Inc. acquired Sea Corporation in a business combination and Sea Corp. went out of existence. Sea Corp. developed a patent listed as an asset on Sea Corp.'s books at the patent office filing cost. In recording the combination, A) fair value is not assigned to the patent because the research and development costs have been expensed by Sea Corp. B) Sea Corp.'s prior expenses to develop the patent are recorded as an asset by Durer at purchase. C) the patent is recorded as an asset at fair market value. D) the patent's market value increases goodwill. Answer: C Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Analytical thinking

8) In a business combination, which of the following will occur? A) All identifiable assets and liabilities are recorded at fair value at the date of acquisition. B) All identifiable assets and liabilities are recorded at book value at the date of acquisition. C) Goodwill is recorded if the fair value of the net assets acquired exceeds the book value of the net assets acquired. D) The Sarbanes-Oxley Act requires firms to report material aggregate amounts of goodwill as a separate balance sheet line item. Answer: A Objective: LO1.3 Introduce accounting concepts for business combinations, emphasizing the acquisition method. Difficulty: Moderate AACSB: Analytical thinking

9) According to ASC 805-30, which one of the following items may not be accounted for as an intangible asset apart from goodwill? A) A production backlog B) A valuable employee workforce C) Noncontractual customer relationships D) Employment contracts Answer: B Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Easy AACSB: Analytical thinking

10) Under the provisions of ASC 805-30, in a business combination, when the investment cost exceeds the total fair value of identifiable net assets acquired, which of the following statements is correct? A) The excess is first assigned to identifiable net assets according to their fair values; then the rest is assigned to goodwill. B) The difference is allocated first to reduce proportionately (according to market value) non-current assets, then to non-monetary current assets, and any negative remainder is classified as a deferred credit. C) The difference is allocated first to reduce proportionately (according to market value) non-current assets, and any negative remainder is classified as an extraordinary gain. D) The difference is allocated first to reduce proportionately (according to market value) non-current, depreciable assets to zero, and any negative remainder is classified as a deferred credit. Answer: A Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Easy AACSB: Analytical thinking

11) With respect to goodwill, an impairment A) will be amortized over the remaining useful life. B) is a two-step process which first compares book value to fair value at the business reporting unit level. C) is a one-step process considering the entire firm. D) occurs when asset values are adjusted to fair value in a purchase. Answer: B Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Easy AACSB: Analytical thinking

Use the following information to answer the question(s) below. Polka Corporation exchanges 100,000 shares of newly issued $1 par value common stock with a fair market value of $20 per share for all of the outstanding $5 par value common stock of Spot Inc. and Spot is then dissolved. Polka paid the following costs and expenses related to the business combination: Costs of special shareholders' meeting to vote on the merger Registering and issuing securities Accounting and legal fees Salaries of Polka's employees assigned to the implementation of the merger Cost of closing duplicate facilities

$12,000 10,000 18,000 27,000 13,000

12) In the business combination of Polka and Spot A) the costs of registering and issuing the securities are included as part of the purchase price for Spot. B) the salaries of Polka's employees assigned to the merger are treated as expenses. C) all of the costs except those of registering and issuing the securities are included in the purchase price of Spot. D) only the accounting and legal fees are included in the purchase price of Spot. Answer: B Objective: LO1.3 Introduce accounting concepts for business combinations, emphasizing the acquisition method. Difficulty: Moderate AACSB: Application of knowledge

13) In the business combination of Polka and Spot, A) all of the items listed above are treated as expenses. B) all of the items listed above except the cost of registering and issuing the securities are included in the purchase price. C) the costs of registering and issuing the securities are deducted from the fair market value of the common stock used to acquire Spot. D) only the costs of closing duplicate facilities, the salaries of Polka's employees assigned to the merger, and the costs of the shareholders' meeting would be treated as expenses. Answer: C Objective: LO1.3 Introduce accounting concepts for business combinations, emphasizing the acquisition method. Difficulty: Moderate AACSB: Analytical thinking

14) Which of the following methods does the FASB consider the best indicator of fair values in the evaluation of goodwill impairment? A) Senior executive's estimates B) Financial analyst forecasts C) Fair value D) The present value of future cash flows discounted at the firm's cost of capital Answer: C Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Easy AACSB: Analytical thinking

15) Pepper Company paid $2,500,000 for the net assets of Salt Corporation and Salt was then dissolved. Salt had no liabilities. The fair values of Salt's assets were $3,750,000. Salt's only non-current assets were land and buildings with book values of $100,000 and $520,000, respectively, and fair values of $180,000 and $730,000, respectively. At what value will the buildings be recorded by Pepper? A) $730,000 B) $520,000 C) $210,000 D) $0 Answer: A Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

16) According to ASC 810-10, liabilities assumed in an acquisition will be valued at the ________. A) fair value B) historical book value C) current replacement cost D) present value using market interest rates Answer: A Objective: LO1.3 Introduce accounting concepts for business combinations, emphasizing the acquisition method. Difficulty: Easy AACSB: Analytical thinking

17) In reference to the FASB disclosure requirements about a business combination in the period in which the combination occurs, which of the following is correct? A) Firms are not required to disclose the name of the acquired company. B) Firms are not required to disclose the business purpose for a combination. C) Firms are required to disclose the nature, terms and fair value of consideration transferred in a business combination. D) Firms are not required to disclose the details about step acquisitions. Answer: C Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Easy AACSB: Analytical thinking

18) Under the current GAAP, Goodwill arising from a business combination is A) charged to Retained Earnings after the acquisition is completed. B) amortized over 40 years or its useful life, whichever is longer. C) amortized over 40 years or its useful life, whichever is shorter. D) never amortized. Answer: D Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Easy AACSB: Analytical thinking

19) In reference to international accounting for goodwill, U.S. companies have complained that past U.S. accounting rules for goodwill placed them at a disadvantage in competing against foreign companies for merger partners. Why? A) Previous rules required immediate write off of goodwill which resulted in a one-time expense that was not required under international rules. B) Previous rules required amortization of goodwill which resulted in an ongoing expense that was not required under international rules. C) Previous rules did not permit the recording of goodwill, thus resulting in a lower asset base than international counterparts would recognize. D) Previous rules required the immediate write of goodwill to stockholder's equity. Answer: B Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Analytical thinking

20) When considering an acquisition, which of the following is NOT a method by which one company may gain control of another company? A) Purchase of the majority of outstanding voting stock of the acquired company. B) Purchase of all assets and liabilities of another company. C) Purchase of all the outstanding voting stock of the acquired company. D) Purchase of 25% of outstanding voting stock of the acquired company. Answer: D Objective: LO1.2 Learn about alternative forms of business combinations, from both the legal and accounting perspectives. Difficulty: Moderate AACSB: Analytical thinking

1.2 Exercises 1) Parrot Incorporated purchased the assets and liabilities of Sparrow Company at the close of business on December 31, 2013. Parrot borrowed $2,000,000 to complete this transaction, in addition to the $640,000 cash that they paid directly. The fair value and book value of Sparrow's recorded assets and liabilities as of the date of acquisition are listed below. In addition, Sparrow had a patent that had a fair value of $50,000.

Cash Inventories Other current assets Land Plant assets-net Total Assets

Book Value $120,000 220,000 630,000 270,000 4,650,000 $5,890,000

Fair Value $120,000 250,000 600,000 320,000 4,600,000

Accounts payable Notes payable Capital stock, $5 par Additional paid-in capital Retained Earnings Total Liabilities & Equities

$1,200,000 2,100,000 700,000 1,400,000 490,000 $5,890,000

$1,200,000 2,100,000

Required: 1. Prepare Parrot's general journal entry for the acquisition of Sparrow, assuming that Sparrow survives as a separate legal entity. 2. Prepare Parrot's general journal entry for the acquisition of Sparrow, assuming that Sparrow will dissolve as a separate legal entity.

Answer: 1. General journal entry recorded by Parrot for the acquisition of Sparrow (Sparrow survives as a separate legal entity): Investment in Sparrow Cash Notes Payable

2,640,000 640,000 2,000,000

2. General journal entry recorded by Parrot for the acquisition of Sparrow (Sparrow dissolves as a separate legal entity): Cash Inventories Other current assets Land Plant assets Patent Accounts payable Notes payable Cash Notes Payable

120,000 250,000 600,000 320,000 4,600,000 50,000 1,200,000 2,100,000 640,000 2,000,000

Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

2) On January 2, 2013 Piron Corporation issued 100,000 new shares of its $5 par value common stock valued at $19 a share for all of Seana Corporation's outstanding common shares. Piron paid $15,000 to register and issue shares. Piron also paid $20,000 for the direct combination costs of the accountants. The fair value and book value of Seana's identifiable assets and liabilities were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2013 is as follows:

Cash Inventories Other current assets Land Plant assets-net Total Assets

Piron $150,000 320,000 500,000 350,000 4,000,000 $5,320,000

Seana $120,000 400,000 500,000 250,000 1,500,000 $2,770,000

Accounts payable Notes payable Capital stock, $5 par Additional paid-in capital Retained Earnings Total Liabilities & Equities

$1,000,000 1,300,000 2,000,000 1,000,000 20,000 $5,320,000

$300,000 660,000 500,000 100,000 1,210,000 $2,770,000

Required: 1. Prepare Piron's general journal entry for the acquisition of Seana, assuming that Seana survives as a separate legal entity. 2. Prepare Piron's general journal entry for the acquisition of Seana, assuming that Seana will dissolve as a separate legal entity.

Answer: 1. General journal entry recorded by Piron for the acquisition of Seana (Seana survives as a separate legal entity): Investment in Seana Common stock Additional paid-in capital Investment expense Additional paid-in capital Cash

1,900,000 500,000 1,400,000 20,000 15,000 35,000

2. General journal entry recorded by Piron for the acquisition of Seana (Seana dissolves as a separate legal entity): Cash Inventories Other current assets Land Plant assets Goodwill Investment expense Accounts payable Notes payable Common stock Additional paid-in capital

85,000 400,000 500,000 250,000 1,500,000 90,000 20,000 300,000 660,000 500,000 1,385,000

Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Difficult AACSB: Application of knowledge

3) On December 31, 2013, Pandora Incorporated issued 40,000 shares of its $20 par common stock for all the outstanding shares of the Sophocles Company. In addition, Pandora agreed to pay the owners of Sophocles an additional $200,000 if a specific contract achieved the profit levels that were targeted by the owners of Sophocles in their sale agreement. The fair value of this amount, with an agreed likelihood of occurrence and discounted to present value, is $160,000. In addition, Pandora paid $10,000 in stock issue costs, $40,000 in legal fees, and $48,000 to employees who were dedicated to this acquisition for the last three months of the year. Summarized balance sheet and fair value information for Sophocles immediately prior to the acquisition follows.

Cash Accounts Receivable Inventory Buildings and Equipment (net) Trademarks and Tradenames Total Assets Accounts Payable Notes Payable Retained Earnings Total Liabilities and Equity

Book Value $100,000 280,000 520,000 750,000 0 $1,650,000 $200,000 900,000 550,000 $1,650,000

Fair Value $100,000 250,000 640,000 870,000 500,000 $190,000 900,000

Required: 1. Prepare Pandora's general journal entry for the acquisition of Sophocles assuming that Pandora's stock was trading at $35 at the date of acquisition and Sophocles dissolves as a separate legal entity. 2. Prepare Pandora's general journal entry for the acquisition of Sophocles assuming that Pandora's stock was trading at $35 at the date of acquisition and Sophocles continues as a separate legal entity. 3. Prepare Pandora's general journal entry for the acquisition of Sophocles assuming that Pandora's stock was trading at $25 at the date of acquisition and Sophocles dissolves as a separate legal entity. 4. Prepare Pandora's general journal entry for the acquisition of Sophocles assuming that Pandora's stock was trading at $25 at the date of acquisition and Sophocles survives as a separate legal entity.

Answer: 1. At $35 per share, assuming Sophocles dissolves as a separate legal entity: Cash Accounts Receivable Inventory Buildings and Equipment Trademarks/Trade names Goodwill Accounts payable Contingent Liability Notes payable Common stock Additional paid-in capital Investment expense Additional paid-in capital Cash

$100,000 250,000 640,000 870,000 500,000 290,000 190,000 160,000 900,000 800,000 600,000 40,000 10,000 50,000

NOTE: Amount paid to employees dedicated to the acquisition would be routinely expensed through company payroll and have no separate impact on the acquisition entry. 2. At $35 per share, assuming Sophocles continues as a separate legal entity: Investment in Sophocles Contingent Liability Common stock Additional paid-in capital Investment expense Additional paid-in capital Cash

1,560,000 160,000 800,000 600,000 40,000 10,000 50,000

NOTE: Amount paid to employees dedicated to the acquisition would be routinely expensed through company payroll and have no separate impact on the acquisition entry.

3. At $25 per share, assuming Sophocles dissolves as a separate legal entity: Cash Accounts Receivable Inventory Buildings and Equipment Trademarks/Trade names Accounts payable Contingent Liability Notes payable Gain on bargain purchase Common stock Additional paid-in capital Investment expense Additional paid-in capital Cash

$100,000 250,000 640,000 870,000 500,000 190,000 160,000 900,000 110,000 800,000 200,000 40,000 10,000 50,000

NOTE: Amount paid to employees dedicated to the acquisition would be routinely expensed through company payroll and have no separate impact on the acquisition entry. 4. At $25 per share, assuming Sophocles continues as a separate legal entity: Investment in Sophocles Contingent Liability Common stock Additional paid-in capital Investment expense Additional paid-in capital Cash

1,160,000 160,000 800,000 200,000 40,000 10,000 50,000

NOTE: Amount paid to employees dedicated to the acquisition would be routinely expensed through company payroll and have no separate impact on the acquisition entry. Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Difficult AACSB: Application of knowledge

4) On January 2, 2013 Palta Company issued 80,000 new shares of its $5 par value common stock valued at $12 a share for all of Sudina Corporation's outstanding common shares. Palta paid $5,000 for the direct combination costs of the accountants. Palta paid $18,000 to register and issue shares. The fair value and book value of Sudina's identifiable assets and liabilities were the same. Summarized balance sheet information for both companies just before the acquisition on January 2, 2013 is as follows:

Cash Inventories Other current assets Land Plant assets-net Total Assets

Palta $75,000 160,000 200,000 175,000 1,500,000 $2,110,000

Sudina $60,000 200,000 250,000 125,000 750,000 $1,385,000

Accounts payable Notes payable Capital stock, $2 par Additional paid-in capital Retained Earnings Total Liabilities & Equity

$100,000 700,000 600,000 450,000 260,000 $2,110,000

$155,000 330,000 250,000 50,000 600,000 $1,385,000

Required: 1. Prepare Palta's general journal entry for the acquisition of Sudina assuming that Sudina survives as a separate legal entity. 2. Prepare Palta's general journal entry for the acquisition of Sudina assuming that Sudina will dissolve as a separate legal entity.

Answer: 1. General journal entry recorded by Palta for the acquisition of Sudina (Sudina survives as a separate legal entity): Investment in Sudina Common stock Additional paid-in capital Investment expense Additional paid-in capital Cash

960,000 400,000 560,000 5,000 18,000 23,000

2. General journal entry recorded by Palta for the acquisition of Sudina (Sudina dissolves as a separate legal entity): Cash Inventories Other current assets Land Plant assets Goodwill Investment expense Accounts payable Notes payable Common stock Additional paid-in capital

37,000 200,000 250,000 125,000 750,000 60,000 5,000 155,000 330,000 400,000 542,000

Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

5) Saveed Corporation purchased the net assets of Penny Inc. on January 2, 2013 for $1,690,000 cash and also paid $15,000 in direct acquisition costs. Penny dissolved as of the date of the acquisition. Penny's balance sheet on January 2, 2013 was as follows: Accounts receivable-net Inventory Land Building-net Equipment-net Total assets

$190,000 480,000 110,000 630,000 240,000 $1,650,000

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

$235,000 650,000 25,000 150,000 590,000 $1,650,000

Fair values agree with book values except for inventory, land, and equipment, which have fair values of $640,000, $140,000 and $230,000, respectively. Penny has customer contracts valued at $20,000. Required: Prepare Saveed's general journal entry for the cash purchase of Penny's net assets. Answer: General journal entry for the purchase of Penny's net assets: Accounts receivable Inventory Land Building Equipment Customer contracts Goodwill Investment expense Current liabilities Long-term debt Cash

190,000 640,000 140,000 630,000 230,000 20,000 725,000 15,000 235,000 650,000 1,705,000

Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

6) Bigga Corporation purchased the net assets of Petit, Inc. on January 2, 2013 for $380,000 cash and also paid $15,000 in direct acquisition costs. Petit, Inc. was dissolved on the date of the acquisition. Petit's balance sheet on January 2, 2013 was as follows: Accounts receivable-net Inventory Land Building-net Equipment-net Total assets

$90,000 220,000 30,000 20,000 40,000 $400,000

Current liabilities Long term debt Common stock ($1 par) Addtl. paid-in capital Retained earnings Total liab. & equity

$75,000 80,000 10,000 215,000 20,000 $400,000

Fair values agree with book values except for inventory, land, and equipment, which have fair values of $260,000, $35,000 and $35,000, respectively. Petit has patent rights with a fair value of $20,000. Required: Prepare Bigga's general journal entry for the cash purchase of Petit's net assets. Answer: General journal entry for the purchase of Petit's net assets: Accounts receivable Inventory Land Building Equipment Patent Goodwill Investment expense Current liabilities Long-term debt Cash

90,000 260,000 35,000 20,000 35,000 20,000 75,000 15,000 75,000 80,000 395,000

Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

7) The balance sheets of Palisade Company and Salisbury Corporation were as follows on December 31, 2013:

Current Assets Equipment-net Buildings-net Land Total Assets Current Liabilities Common Stock, $5 par Additional paid-in Capital Retained Earnings Total Liabilities and Stockholders' equity

Palisade $260,000 440,000 600,000 100,000 $1,400,000 100,000 1,000,000 100,000 200,000

Salisbury $120,000 480,000 200,000 200,000 $1,000,000 120,000 400,000 280,000 200,000

$1,400,000

$1,000,000

On January 1, 2014 Palisade issued 30,000 of its shares with a market value of $40 per share in exchange for all of Salisbury's shares, and Salisbury was dissolved. Palisade paid $20,000 to register and issue the new common shares. It cost Palisade $50,000 in direct combination costs. Book values equal market values except that Salisbury's land is worth $250,000. Required: Prepare a Palisade balance sheet after the business combination on January 1, 2014. Answer: The balance sheet for Palisade Corporation subsequent to its acquisition of Salisbury Corporation on January 1, 2014 will appear as follows: Current Assets Equipment-net Buildings-net Land Goodwill Total Assets Current Liabilities Common Stock, $5 par Additional paid-in Capital Retained Earnings Total Liabilities and Stockholders' equity

$310,000 920,000 800,000 350,000 270,000 $2,650,000 220,000 1,150,000 1,130,000 150,000 $2,650,000

Note that Current Assets of $310,000 results from the two companies contributing $260,000 and $120,000, less the cash paid out during the acquisition process of $70,000. Retained Earnings of the parent is reduced for the Investment Expense incurred in the process of $50,000. Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

8) On January 2, 2013, Pilates Inc. paid $900,000 for all of the outstanding common stock of Spinning Company, and dissolved Spinning Company. The carrying values for Spinning Company's assets and liabilities are recorded below. Cash Accounts Receivable Copyrights (purchased) Goodwill Liabilities Net assets

$200,000 220,000 400,000 120,000 (180,000) $760,000

On January 2, 2013, Spinning anticipated collecting $185,000 of the recorded Accounts Receivable. Pilates entered into the acquisition because Spinning had Copyrights that Pilates wished to own, and also unrecorded patents with a fair value of $100,000. Required: Calculate the amount of goodwill that will be reported on Pilate's balance sheet as of the date of acquisition. Answer: Goodwill is calculated as follows: Purchase price Fair value of net assets: Cash Accounts Receivable Copyrights Patents Liabilities Total Purchase price in excess of fair value of net assets:

$900,000

$200,000 185,000 400,000 100,000 (180,000) (705,000) $195,000

Pilates would report $195,000 for Goodwill as a result of the acquisition. Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

9) On January 2, 2013, Pilates Inc. paid $700,000 for all of the outstanding common stock of Spinning Company, and dissolved Spinning Company. The carrying values for Spinning Company's assets and liabilities are recorded below. Cash Accounts Receivable Copyrights (purchased) Goodwill Liabilities Net assets

$200,000 220,000 400,000 120,000 (180,000) $760,000

On January 2, 2013, Spinning anticipated collecting $185,000 of the recorded Accounts Receivable. Pilates entered into the acquisition because Spinning had Copyrights that Pilates wished to own, and also unrecorded patents with a fair value of $100,000. Required: Calculate the amount of goodwill that will be recorded on Pilate's balance sheet as of the date of acquisition. Then record the journal entry Pilates would record on their books to record the acquisition. Answer: Goodwill is calculated as follows: Purchase price Fair value of net assets: Cash Accounts Receivable Copyrights Patents Liabilities Total Fair value of net assets in excess of Purchase price:

$700,000

$200,000 185,000 400,000 100,000 (180,000) (705,000) $(5,000)

Because Pilates paid less than the fair value of the net assets, they are considered to have made a bargain purchase, and would thus record a Gain on Bargain Purchase in the amount of $5,000 at the time of acquisition. The following journal entry would be prepared: Cash 200,000 Accounts receivable 185,000 Copyrights 400,000 Patents 100,000 Liabilities 180,000 Bargain purchase gain 5,000 Cash 700,000 Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

10) Pali Corporation exchanges 200,000 shares of newly issued $10 par value common stock with a fair market value of $40 per share for all the outstanding $5 par value common stock of Shingle Incorporated, which continues on as a legal entity. Fair value approximated book value for all assets and liabilities of Shingle. Pali paid the following costs and expenses related to the business combination: Registering and issuing securities Accounting and legal fees Salaries of Pali's employees whose time was dedicated to the merger Cost of closing duplicate facilities

19,000 150,000 86,000 223,000

Required: Prepare the journal entries relating to the above acquisition and payments incurred by Pali, assuming all costs were paid in cash. Answer: Investment in Shingle 8,000,000 Common Stock 2,000,000 Additional Paid in Capital 6,000,000 Additional Paid in Capital Cash

19,000

Investment Expense (fees) Cash

150,000

Salary expense Cash

86,000

Plant closure expense Cash

223,000

19,000

150,000

86,000

223,000

Objective: LO1.3 Introduce accounting concepts for business combinations, emphasizing the acquisition method. Difficulty: Moderate AACSB: Application of knowledge

11) Samantha's Sporting Goods had net assets consisting of the following:

Cash Inventory Building and Fixtures Liabilities

Book Value $150,000 820,000 330,000 (90,000)

Fair Value $150,000 960,000 310,000 (88,000)

Pedic Incorporated purchased Samantha's Sporting Goods, and immediately dissolved Samantha's as a separate legal entity. Requirement 1: If Samantha's was purchased for $1,000,000 cash, prepare the entry recorded by Pedic. Requirement 2: If Samantha's was purchased for $1,500,000 cash, prepare the entry recorded by Pedic. Answer: Requirement 1: Cash* 150,000 Inventory 960,000 Building and Fixtures 310,000 Liabilities 88,000 Gain on Bargain Purchase 332,000 Cash* 1,000,000 *Cash entries may be recorded net on single line entry. Requirement 2: Cash* 150,000 Inventory 960,000 Building and Fixtures 310,000 Goodwill 168,000 Liabilities 88,000 Cash* 1,500,000 *Cash entries may be recorded net on single line entry. Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

12) On January 2, 2013 Carolina Clothing issued 100,000 new shares of its $5 par value common stock valued at $19 a share for all of Dakota Dressing Company's outstanding common shares in an acquisition. Carolina paid $15,000 for registering and issuing securities and $10,000 for other direct costs of the business combination. The fair value and book value of Dakota's identifiable assets and liabilities were the same. Assume Dakota Company is dissolved on the date of the acquisition. Summarized balance sheet information for both companies just before the acquisition on January 2, 2013 is as follows:

Cash Inventories Other current assets Land Plant assets-net Total Assets

Carolina $150,000 320,000 500,000 350,000 4,000,000 $5,320,000

Dakota $120,000 400,000 500,000 250,000 1,500,000 $2,770,000

Accounts payable Notes payable Capital stock, $5 par Additional paid-in capital Retained Earnings Total Liabilities & Equities

$1,000,000 1,300,000 2,000,000 1,000,000 20,000 $5,320,000

$300,000 660,000 500,000 100,000 1,210,000 $2,770,000

Required: Prepare a balance sheet for Carolina Clothing immediately after the business combination. Answer:

Carolina Clothing Balance Sheet January 2, 2013

Assets: Cash Inventory Other current assets Total current assets

$245,000 720,000 1,000,000 1,965,000

Land Plant assets-net Goodwill Total Long-term Assets

600,000 5,500,000 90,000 6,190,000

Total assets

$8,155,000

Liabilities: Accounts payable Notes payable Total liabilities

Equity: Common stock ($5 par) Additional paid-in capital Retained earnings Total equity Total liab. & equity

$1,300,000 1,960,000 3,260,000

2,500,000 2,385,000 10,000 4,895,000 $8,155,000

Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Difficult AACSB: Application of knowledge

13) Balance sheet information for Sphinx Company at January 1, 2013, is summarized as follows: Current assets Plant assets

$230,000 450,000 ________ $680,000

Liabilities Capital stock $10 par Retained earnings

$300,000 200,000 180,000 $680,000

Sphinx's assets and liabilities are fairly valued except for plant assets that are undervalued by $50,000. On January 2, 2013, Pyramid Corporation issues 20,000 shares of its $10 par value common stock for all of Sphinx's net assets and Sphinx is dissolved. Market quotations for the two stocks on this date are: Pyramid common: Sphinx common:

$28.00 $19.50

Pyramid pays the following fees and costs in connection with the combination: Finder's fee Legal and accounting fees

$10,000 6,000

Required: 1. Calculate Pyramid's investment cost of Sphinx Corporation. 2. Calculate any goodwill from the business combination. Answer: Requirement 1 FMV of shares issued by Pyramid: 20,000 × $28.00= Requirement 2 Investment cost from above: Less: Fair value of Sphinx's net assets ($680,000 of total assets plus $50,000 of undervalued plant assets minus $300,000 of debt) Equals: Goodwill from investment in Sphinx

$560,000

430,000 $ 130,000

Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

14) On December 31, 2013, Peris Company acquired Shanta Company's outstanding stock by paying $400,000 cash and issuing 10,000 shares of its own $30 par value common stock, when the market price was $32 per share. Peris paid legal and accounting fees amounting to $35,000 in addition to stock issuance costs of $8,000. Shanta is dissolved on the date of the acquisition. Balance sheet information for Peris and Shanta immediately preceding the acquisition is shown below, including fair values for Shanta's assets and liabilities.

Cash Accounts Receivable Inventory Land Plant Assets — Net Construction Permits Accounts Payable Other accrued expenses Notes Payable Common Stock ($30 par) Common Stock ($20 par) Additional P.I.C Retained Earnings

Peris Book Value $490,000 560,000 520,000 460,000 980,000 380,000 (460,000) (160,000) (800,000) (960,000)

Shanta Book Value $140,000 280,000 200,000 150,000 325,000 170,000 (140,000) (45,000) (460,000)

Shanta Fair Value $140,000 280,000 260,000 140,000 355,000 190,000 (140,000) (45,000) (460,000)

(200,000) (80,000) (340,000)

(192,000) (818,000)

Required: Determine the consolidated balances which Peris would present on their consolidated balance sheet for the following accounts. Cash Inventory Construction Permits Goodwill Notes Payable Common Stock Additional Paid in Capital Retained Earnings Answer: Cash = $490,000 + $140,000 - $400,000 - $35,000 - $8,000 = $187,000 Inventory = $520,000 + $260,000 = $780,000 Construction Permits = $380,000 + $190,000 = $570,000 Goodwill = $720,000 (Paid $400,000 + $320,000) - $720,000 (Fair Value of Net Assets) = 0 Notes Payable = $800,000 + $460,000 = $1,260,000 Common Stock = $960,000 + $300,000 (10,000 shares issued × $30 par) = $1,260,000 Additional Paid in Capital = $192,000 + $20,000 (10,000 shares issued × $2 excess over par per share) $8,000 (cost of issuance) = $204,000 Retained Earnings = $818,000 - $35,000 (investment expense) = $783,000 Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Difficult AACSB: Application of knowledge

15) On June 30, 2013, Stampol Company ceased operations and all of their assets and liabilities were purchased by Postoli Incorporated. Postoli paid $40,000 in cash to the owner of Stampol, and signed a five-year note payable to the owners of Stampol in the amount of $200,000. Their closing balance sheets as of June 30, 2013 are shown below. In the purchase agreement, both parties noted that Inventory was undervalued on the books by $10,000, and Pistoli would also take possession of a customer list with a fair value of $18,000. Pistoli paid all legal costs of the acquisition, which amounted to $7,000.

Cash Inventory Other current assets Land Plant assets-net Total Assets

Postoli $150,000 260,000 420,000 60,000 590,000 $1,480,000

Stampol $17,000 120,000 60,000 0 190,000 $387,000

Accounts payable Notes payable Capital stock, $5 par Additional paid-in capital Retained Earnings Total Liabilities & Equities

$440,000 160,000 20,000 60,000 800,000 $1,480,000

$127,000 80,000 50,000 0 130,000 $387,000

Required: 1. Prepare the journal entry Postoli would record at the date of acquisition. 2. Prepare the journal entry Stampol would record at the date of acquisition.

Answer: Postoli's journal entry: Inventory Other Current Assets Plant Assets — net Customer List Goodwill Cash* Accounts Payable Notes Payable** Investment Expense Cash

130,000 60,000 190,000 18,000 32,000 23,000 127,000 280,000 7,000 7,000

*Cash payment of $40,000 is shown net of the $17,000 received in the acquisition. **Notes Payable signed for $200,000 is shown in addition to the $80,000 purchased in the acquisition. Stampol's journal entry: Accounts Payable Notes Payable Capital Stock Retained Earnings Cash Inventory Other Current Assets Plant assets — net

$127,000 80,000 50,000 130,000 $17,000 120,000 60,000 190,000

Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

16) Pony acquired Spur Corporation's assets and liabilities for $500,000 cash on December 31, 2013. Spur dissolved on the date of the acquisition. Spur's balance sheet and related fair values are shown as of that date, below.

Cash Accounts Receivable Land Plant and Equipment — net Franchise Agreement Total Assets Accounts Payable Other Liabilities Common Stock Additional Paid in Capital Retained Earnings Total Liabilities and Equity

Book Value $20,000 40,000 45,000 460,000 0 $565,000

Fair Value $20,000 38,000 50,000 410,000 160,000

$70,000 120,000 180,000 40,000 155,000 $565,000

$70,000 110,000

Required: Prepare the journal entry recorded by Pony as a result of this transaction. Answer: Accounts Receivable 38,000 Land 50,000 Plant and Equipment — net 410,000 Franchise agreement 160,000 Goodwill 2,000 Accounts Payable 70,000 Other Liabilities 110,000 Cash* 480,000 *Cash payment is shown net of cash received in acquisition. Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Application of knowledge

1.3 True/False 1) It is frequently more expensive for a firm to obtain needed facilities through combination than through development. Answer: FALSE Explanation: It is frequently less expensive Objective: LO1.1 Understand the economic motivations underlying business combinations. Difficulty: Easy AACSB: Analytical thinking

2) The U.S. Department of Justice and the Federal Trade Commission have primary responsibility for enforcing federal antitrust laws. Answer: TRUE Objective: LO1.1 Understand the economic motivations underlying business combinations. Difficulty: Easy AACSB: Analytical thinking

3) A merger occurs when one corporation takes over all the operations of another business entity, and that entity is dissolved. Answer: TRUE Objective: LO1.2 Learn about alternative forms of business combinations, from both the legal and accounting perspectives. Difficulty: Moderate AACSB: Analytical thinking

4) In August 1999, the Financial Accounting Standards Board issued a report supporting its proposed decision to eliminate the pooling of interests method to account for business combinations. Answer: TRUE Objective: LO1.2 Learn about alternative forms of business combinations, from both the legal and accounting perspectives. Difficulty: Moderate AACSB: Analytical thinking

5) Under the acquisition method a combination is recorded using the fair-value principle. Answer: TRUE Objective: LO1.3 Introduce accounting concepts for business combinations, emphasizing the acquisition method. Difficulty: Moderate AACSB: Analytical thinking

6) The first step in recording an acquisition is to determine the fair values of all identifiable tangible and intangible assets acquired and actual value of liabilities assumed in the combination. Answer: FALSE Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Difficult AACSB: Analytical thinking

7) Firms should conduct an impairment test for goodwill at least quarterly. Answer: FALSE Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Moderate AACSB: Analytical thinking

8) The GAAP defines the accounting concept of a business combination as a transaction or other event in which an acquirer obtains control of one or more businesses. Answer: TRUE Objective: LO1.2 Learn about alternative forms of business combinations, from both the legal and accounting perspectives. Difficulty: Easy AACSB: Analytical thinking

9) For intangibles to be recognizable they must meet both a separability criterion and a contractual-legal criterion. Answer: FALSE Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Difficult AACSB: Analytical thinking

10) In an acquisition, if the fair value of identifiable assets acquired over liabilities assumed exceed the cost of the acquired company the gain is recognized as an extraordinary gain by the acquiror. Answer: FALSE Objective: LO1.4 See how firms record fair values of assets and liabilities in an acquisition. Difficulty: Difficult AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 2 Stock Investments - Investor Accounting and Reporting 2.1 Multiple Choice Questions 1) Which method of accounting will generally be used when one company purchases less than 20% of the outstanding stock of another company? A) Only the fair value method may be used. B) Only the equity method may be used. C) Either the fair value method or the equity method may be used, depending upon the relationship between the companies. D) Only the acquisition method. Answer: C Objective: LO2.1 Recognize investors' varying levels of influence or control, based on the level of stock ownership. Difficulty: Easy AACSB: Analytical thinking

2) Which method of accounting will generally be used when one company purchases between 20% to 50% of the outstanding stock of another company? A) Only the fair value method may be used. B) Only the equity method may be used. C) The GAAP prescribed the equity method may be used. D) The GAAP prescribed the fair value method may be used. Answer: C Objective: LO2.1 Recognize investors' varying levels of influence or control, based on the level of stock ownership. Difficulty: Easy AACSB: Analytical thinking

3) Which one of the following items, originally recorded in the Investment in Falcon Co. account under the equity method, would not be systematically used to reduce investment income on a periodic basis? A) Amortization expense of goodwill B) Depreciation expense on the excess fair value attributed to machinery C) Amortization expense on the excess fair value attributed to lease agreements D) Depreciation expense on the excess fair value attributed to building Answer: A Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Analytical thinking

4) Which one of the following statements is correct for an investor company? A) The balance in the Investment in Osprey Co. account can be reduced to represent a decline in the fair market value of the investment, but will not be adjusted if the fair market value increases. B) Under the equity method, the balance in the Investment in Osprey Co. account can be negative if the investee corporation operates at a loss. C) Once the balance in the Investment in Osprey Co. is reduced to zero, it will not be reduced any further. D) Under the equity method, the balance in the Investment in Osprey Co. account will increase when cash dividends are received. Answer: C Objective: LO2.2 Understand how accounting adjusts to reflect the economics underlying varying levels of investor influence. Difficulty: Moderate AACSB: Analytical thinking

5) Pinkerton Inc. owns 10% of Sable Company. In the most recent year, Sable had net earnings of $40,000 and paid dividends of $6,000. Pinkerton's accountant mistakenly assumed Pinkerton had considerable influence over Sable and used the equity method instead of the cost method. What is the impact on the investment account and net earnings, respectively? A) By using the equity method, the accountant has understated the investment account and overstated the net earnings. B) By using the equity method, the accountant has overstated the investment account and understated the net earnings. C) By using the equity method, the accountant has understated the investment account and understated the net earnings. D) By using the equity method, the accountant has overstated the investment account and overstated the net earnings. Answer: D Objective: LO2.4 Apply the fair value/cost and equity methods of accounting for stock investments. Difficulty: Moderate AACSB: Analytical thinking

6) Griffon Incorporated holds a 30% ownership in Duck Corporation. Griffon should use the equity method under which of the following circumstances? A) Griffon has surrendered significant stockholder rights by agreement between Griffon and Duck. B) Griffon has been unable to secure a position on the Duck Corporation's Board of Directors. C) Griffon has inadequate or untimely information to apply the equity method. D) The ownership of Duck Corporation is diverse. Answer: D Objective: LO2.1 Recognize investors' varying levels of influence or control, based on the level of stock ownership. Difficulty: Easy AACSB: Analytical thinking

7) Pond Corporation uses the fair value method of accounting for its investment in Swan Company. Which one of the following events would not affect the Investment in Swan Co. account? A) Investee losses B) Investee dividend payments C) An increase in the investee's share price from last period D) Unrealized gains and losses from the available-for-sale securities classification Answer: D Objective: LO2.2 Understand how accounting adjusts to reflect the economics underlying varying levels of investor influence. Difficulty: Easy AACSB: Analytical thinking

8) Sadie Corporation's stockholders' equity at December 31, 2013 included the following: 6% Preferred stock, $10 par value Common stock, $1 par value Other paid-in capital—common Retained earnings

$1,000,000 10,000,000 4,000,000 4,000,000 $19,000,000

Pilga Corporation purchased a 30% interest in Sadie's common stock from other shareholders on January 1, 2014 for $5,800,000. What was the book value of Pilga's investment in Sadie on January 1, 2014? A) $5,400,000 B) $5,700,000 C) $7,120,000 D) $7,440,000 Answer: A Explanation: A) Total stockholders' equity$19,000,000 Less: preferred equity (1,000,000) Equals: common equity 18,000,000 × Pilga's percentage × 30% Book value of Pilga investment $5,400,000 Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

9) Jabiru Corporation purchased a 20% interest in Fish Company common stock on January 1, 2013 for $300,000. This investment was accounted for using the complete equity method and the correct balance in the Investment in Fish account on December 31, 2015 was $440,000. The original excess purchase transaction included $60,000 for a patent amortized at a rate of $6,000 per year. In 2016, Fish Corporation had net income of $4,000 per month earned uniformly throughout the year and paid $20,000 of dividends in May. If Jabiru sold one-half of its investment in Fish on August 1, 2016 for $500,000, how much gain was recognized on this transaction? A) $278,950 B) $280,000 C) $280,950 D) $282,000 Answer: C Explanation: C) Dec 31, 2015 investment balance $440,000 Jabiru's interest in Fish's income from Jan 1-July 31: ($4,000 × 7 months × 20%) = 5,600 Less: Dividends ($20,000 × 20%) = (4,000) Less: Seven months of patent amortization: $500 × 7 = (3,500) Investment account balance at July 31, 2016 $438,100 Amount received from sale: Book value of one-half interest Gain on sale

$500,000 (219,050) $280,950

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

10) An investor uses the cost method of accounting for its investment in common stock. During the current year, the investor received $25,000 in dividends, an amount that exceeded the investor's share of the investee company's undistributed income since the investment was acquired. The investor should report dividend income of what amount? A) $25,000 as a reduction in the investment account B) $25,000 less the amount in excess of its share of undistributed income since the investment was acquired C) $25,000 less the amount that is not in excess of its share of undistributed income since the investment was acquired D) $25,000 less recognized earnings Answer: A Objective: LO2.3 Identify factors beyond stock ownership that affect an investor's ability to exert influence or control over an investee. Difficulty: Easy AACSB: Application of knowledge

Use the following information to answer the question(s) below. On January 1, 2013, Pansy Company acquired a 10% interest in Sunflower Corporation for $80,000 when Sunflower's stockholders' equity consisted of $400,000 capital stock and $100,000 retained earnings. Book values of Sunflower's net assets equaled their fair values on this date. Sunflower's net income and dividends for 2013 through 2015 were as follows:

Net income Dividends paid

2013 $ 8,000 5,000

2014 $ 10,000 5,000

2015 $15,000 5,000

11) Assume that Pansy Incorporated used the cost method of accounting for its investment in Sunflower. The balance in the Investment in Sunflower account at December 31, 2015 was A) $76,700. B) $80,000. C) $83,300. D) $95,000. Answer: B Explanation: B) Income and dividends are not added or deducted from the investment account under the cost method unless liquidating dividends are received. Objective: LO2.3 Identify factors beyond stock ownership that affect an investor's ability to exert influence or control over an investee. Difficulty: Moderate AACSB: Application of knowledge

12) Assume that Pansy has significant influence and uses the equity method of accounting for its investment in Sunflower. The balance in the Investment in Sunflower account at December 31, 2015 was A) $78,200. B) $80,000. C) $81,800. D) $83,300. Answer: C Explanation: C) Initial Investment in Sunflower$80,000 adjustments: 2013: 10% × ($8,000 - $5,000) = 300 2014: 10% × ($10,000 - $5,000)= 500 2015: 10% × ($15,000 - $5,000)= 1,000 Investment balance at 12/31/2015: $81,800 Objective: LO2.3 Identify factors beyond stock ownership that affect an investor's ability to exert influence or control over an investee. Difficulty: Moderate AACSB: Application of knowledge

13) Pyming Corporation accounts for its 40% investment in Sillabog Company using the equity method. On the date of the original investment, fair values were equal to the book values except for a patent, which cost Pyming an additional $40,000. The patent had an estimated life of 10 years. Sillabog has a steady net income of $20,000 per year and consistently pays out 40% of its net income as dividends to its shareholders. Which one of the following statements is correct? A) The net change in the investment account for each full year will be a debit of $8,000. B) The net change in the investment account for each full year will be a debit of $4,800. C) The net change in the investment account for each full year will be a debit of $800. D) The net change in the investment account for each full year will be a credit of $800. Answer: C Objective: LO2.3 Identify factors beyond stock ownership that affect an investor's ability to exert influence or control over an investee. Difficulty: Moderate AACSB: Application of knowledge

14) Jacana Corporation paid $200,000 for a 25% interest in Lilypad Corporation's common stock on January 1, 2013, but was not able to exercise significant influence over Lilypad. During 2014, Jacana reported income of $120,000, excluding its income from Lilypad, and paid dividends of $50,000. Lilypad reported net income of $40,000 during 2014 and paid dividends of $20,000. Jacana should report net income for 2014 in the amount of A) $115,000. B) $120,000. C) $125,000. D) $130,000. Answer: C Explanation: C) Jacana's separate income $ 120,000 Dividend income from Lilypad equals $20,000 × 25% = 5,000 Jacana's net income = $ 125,000 Objective: LO2.4 Apply the fair value/cost and equity methods of accounting for stock investments. Difficulty: Moderate AACSB: Application of knowledge

15) Panda Corporation purchased 100,000 previously unissued shares of Skunk Company's $10 par value common stock directly from Skunk for $2,200,000. Skunk's stockholders' equity immediately before the investment by Panda consisted of $3,000,000 of common stock and $4,800,000 in retained earnings. What is Panda's book value of equity in the net assets of Skunk? A) $2,200,000 B) $2,500,000 C) $3,000,000 D) $3,333,000 Answer: B Explanation: B) Shares outstanding before issue of new shares 300,000 Shares issued to Panda 100,000 Total shares outstanding 400,000 Percentage owned by Panda(100,000/400,000)

25.00%

Stockholders' equity before issue of new shares + Investment by Panda = Stockholders' equity after Panda investment × Panda's percentage ownership = Book value of Panda's interest

$7,800,000 2,200,000 10,000,000 25.00% $2,500,000

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Difficult AACSB: Application of knowledge

16) The income from an equity method investee is reported on one line of the investor company's income statement except when A) the cost method is used. B) the investee has extraordinary items. C) the investor company is amortizing cost-book value differentials. D) the investor company changes from the cost to the equity method. Answer: B Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Easy AACSB: Analytical thinking

17) Bart Company purchased a 30% interest in Simpson Corporation on January 1, 2013, and Bart accounted for its investment in Simpson under the equity method for the next 3 years. On January 1, 2016, Bart sold one-half of its interest in Simpson after which it could no longer exercise significant influence over Simpson. Bart should A) continue to account for its remaining investment in Simpson under the equity method for the sake of consistency. B) adjust the investment in Simpson account to one-half of its original amount and account for the remaining 15% interest using the equity method. C) account for the remaining investment under the cost method, using the investment in Simpson account balance immediately after the sale as the new cost basis. D) adjust the investment account to one-half of its original amount (one-half of the purchase price in 2013), and account for the remaining 15% investment under the cost method. Answer: C Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Easy AACSB: Application of knowledge

18) Pelican Corporation acquired a 25% interest in Seafare Incorporated at book value several years ago. Seafare declared $100,000 dividends in 2013 and reported its income for the year as follows: Income from continuing operations Loss on discontinued division Net income

$600,000 (100,000) $500,000

Pelican's Investment in Seafare account for 2013 should increase by A) $ 100,000. B) $ 125,000. C) $ 150,000. D) $ 180,000. Answer: A Explanation: A) Pelican's share of income ($500,000 × 25%) = $125,000 Pelican's share of dividends = $100,000 × 25% (25,000) Increase in investment account $100,000 Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

19) In reference to intercompany transactions between an investor and an investee, when the investor can significantly influence the investee, which of the following statements is correct, assuming that the investor is using the equity method? A) There is the presumption of arms-length bargaining between the related parties. B) As long as the investor recognizes the effects of the transaction in its financial statements, it is not required to provide any additional disclosures. C) In reporting its share of earnings and losses of an investee, the investor must eliminate the effect of profits and losses on the intercompany transactions until they are realized. D) None of the above is correct. Answer: C Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Easy AACSB: Application of knowledge

20) In reference to the determination of goodwill impairment, which of the following statements is correct? A) The goodwill impairment test under ASC 350-20-35 is a three-step process. B) If the reporting unit's fair value exceeds its carrying value, goodwill is unimpaired. C) Under FASB 142, firms must first compare carrying values (book values) at the headquarter level. D) Firms can reverse previously recognized impairment losses. Answer: B Objective: LO2.6 Learn how to test goodwill for impairment. Difficulty: Easy AACSB: Analytical thinking

21) Firms must conduct impairment tests more frequently than annually when A) other shareholders hold more than 50% interest. B) a "more likely than not" expectation exists that a reporting unit will be sold or disposed of. C) a specific unit does not have publicly traded stock. D) using the equity method. Answer: B Objective: LO2.6 Learn how to test goodwill for impairment. Difficulty: Easy AACSB: Analytical thinking

2.2 Exercises 1) Plum Corporation paid $700,000 for a 40% interest in Satin Company on January 1, 2013 when Plum's stockholders' equity was as follows: 10% cumulative preferred stock, $100 par Common stock, $10 par value Other paid-in capital Retained earnings Total stockholders' equity

$500,000 300,000 400,000 800,000 $2,000,000

On this date, the book values of Plum's assets and liabilities equaled their fair values and there were no dividends in arrears. Required: Calculate the amount recorded in the Investment in Satin Company and the amount of implied Goodwill in this transaction. Answer: Cost of Satin investment (amount recorded in the Investment account): $700,000 Less: book value acquired: Total equity $2,000,000 Less: Preferred equity (500,000) Net common equity 1,500,000 × percent acquired × 40% = Plum book value acquired (600,000) Goodwill $100,000 Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

2) Pike Corporation paid $100,000 for a 10% interest in Salmon Corp. on January 1, 2013, when Salmon's stockholders' equity consisted of $800,000 of $10 par value common stock and $200,000 retained earnings. On December 31, 2014, after receipt of the year's dividends from Salmon, Pike paid $192,000 for an additional 20% interest in Salmon Corp. Both of Pike's investments were made when Salmon's book values equaled their fair values. Salmon's net income and dividends for 2013 and 2014 were as follows: 2013 $60,000 $20,000

Net income Dividends

2014 $140,000 $40,000

Required: 1. Prepare journal entries for Pike Corporation to account for its investment in Salmon Corporation for 2013 and 2014. 2.

Calculate the balance of Pike's investment in Salmon at December 31, 2014.

Answer: Requirement 1 Date 01/01/13

12/31/13

Accounts Investment in Salmon Cash Cash

Debit 100,000

Credit 100,000

2,000 Dividend Income

12/31/14

Cash

2,000 4,000

Dividend Income 12/31/14

12/31/14

4,000

Investment in Salmon Cash

192,000

Investment in Salmon Retained Earnings

14,000

192,000

14,000

Requirement 2 Calculation of investment balance Cost of initial purchase of a 10% interest Cost of second purchase of a 20% interest Adjustment for cost to equity basis Investment balance, December 31, 2014

$100,000 192,000 14,000 $306,000

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

3) Pancake Corporation saw the potential for vertical integration and purchases a 15% interest in Syrup Corp. on January 1, 2013, for $150,000. At that date, Syrup's stockholders' equity included $200,000 of $10 par value common stock, $300,000 of additional paid in capital, and $500,000 retained earnings. The companies began to work together and realized improved sales by both parties. On December 31, 2014, Pancake paid $250,000 for an additional 20% interest in Syrup Corp. Both of Pancake's investments were made when Syrup's book values equaled their fair values. Syrup's net income and dividends for 2013 and 2014 were as follows: 2013 $220,000 $20,000

Net income Dividends

2014 $330,000 $30,000

Required: 1. Prepare journal entries for Pancake Corporation to account for its investment in Syrup Corporation for 2013 and 2014. 2.

Calculate the balance of Pancake's investment in Syrup at December 31, 2014.

Answer: Requirement 1 Date 01/01/13

12/31/13

12/31/14

Accounts Investment in Syrup Cash

Debit 150,000

Cash Dividend Income

3,000

Cash Dividend Income

4,500

Investment in Syrup Cash

250,000

Investment in Syrup Retained Earnings

75,000

Credit 150,000

3,000

4,500

250,000

75,000

Requirement 2 Calculation of investment balance Cost of initial purchase of a 15% interest Cost of second purchase of a 20% interest Adjustment for cost to equity basis Investment balance, December 31, 2014

$150,000 250,000 75,000 $475,000

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

4) Wader's Corporation paid $120,000 for a 25% interest in Shell Company on July 1, 2014. No information is available on the fair value of Shell's assets and liabilities. Assume the equity method. Shell's trial balances at July 1, 2014 and December 31, 2014 were as follows: Debits Current assets Noncurrent assets Expenses Dividends (paid in June) Total

December 31 $100,000 300,000 160,000 40,000 $ 600,000

July 1 $50,000 310,000 120,000 40,000 $ 520,000

Credits Current Liabilities Capital stock (no change) Retained earnings Jan. 1 Sales Total

$60,000 200,000 100,000 240,000 $600,000

$40,000 200,000 100,000 180,000 $520,000

Required: 1. What is Wader's investment income from Shell for the year ending December 31, 2014? 2. Calculate Wader's investment in Shell at year end December 31, 2014. Answer: Requirement 1 Sales (increase in trial balance) $60,000 Less: Expense (increase in trial balance) (40,000) Net Income = $20,000 Wader's ownership of 25% yields $5,000 investment income Requirement 2 Initial Investment Investment Income Total

$120,000 5,000 $125,000

Objective: LO2.3 Identify factors beyond stock ownership that affect an investor's ability to exert influence or control over an investee. Difficulty: Moderate AACSB: Application of knowledge

5) On January 1, 2013, Platt Corporation purchased a 30% interest in Sandig Company for $450,000. On this date, the fair values of Sandig's assets and liabilities are assumed to be the same as their book values. Platt will account for Sandig using the equity method. Sandig's adjusted trial balance at the date of acquisition and year end were as follows: Debits Current assets Noncurrent assets Expenses Dividends (paid June 30) Total Credits Current Liabilities Capital stock Beginning Retained earnings Sales Total

December 31 $160,000 420,000 390,000 40,000 $1,010,000

January 1 $120,000 460,000

$90,000 250,000 140,000 530,000 $1,010,000

$120,000 250,000 140,000

Required: 1. What is Platt's investment income from Sandig for the year ending December 31, 2013? 2. Calculate Platt's investment in Sandig at year end December 31, 2013. Answer: Requirement 1 Sales for the year ending December 31, 2013 Less: Expenses for the year ending December 31, 2013 Net income Ownership percentage Investment income for 2013

$530,000 (390,000) 140,000 30% $42,000

Requirement 2 Initial Investment Investment Income 2013 Dividends, 2013 Ending Balance, 12/31/2013

$450,000 42,000 12,000 $480,000

Objective: LO2.3 Identify factors beyond stock ownership that affect an investor's ability to exert influence or control over an investee. Difficulty: Moderate AACSB: Application of knowledge

6) Dotterel Corporation paid $200,000 cash for 40% of the voting common stock of Swamp Land Inc. on January 1, 2013. Book value and fair value information for Swamp on this date is as follows:

Assets Cash Accounts receivable Inventories Equipment

Liabilities & Equities Accounts payable Note payable Capital stock Retained earnings

Book Values $60,000 120,000 80,000 340,000 $ 600,000

Fair Values $60,000 120,000 100,000 400,000 $ 680,000

$200,000 120,000 200,000 80,000 $600,000

$200,000 100,000

$300,000

Required: Prepare an allocation schedule for Dotterel's investment in Swamp Land. Answer: Investment cost $200,000 Book value acquired: $280,000 × 40% = 112,000 Excess cost over book value acquired = $ 88,000 Schedule to Allocate Cost-Book Value Differentials

Inventories Equipment Notes payable Allocated to specific assets Remainder allocated to goodwill Excess of cost over book value acquired

Fair value Book value $20,000 60,000 20,000

Interest 40% 40% 40%

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

Amount Assigned $8,000 24,000 8,000 $40,000 48,000 $88,000

7) On January 1, 2013, Pendal Corporation purchased 25% of the outstanding common stock of Sedda Corporation for $100,000 cash. Book value and fair value of Sedda's assets and liabilities at the time of acquisition are shown below. Assets Cash Accounts receivable Inventories Equipment

Liabilities & Equities Accounts payable Note payable Capital stock Retained earnings

Book Values $40,000 100,000 40,000 180,000 $360,000

Fair Values $40,000 90,000 50,000 210,000 $390,000

$110,000 50,000 100,000 100,000 $360,000

$110,000 40,000

$150,000

Required: Prepare an allocation schedule for Pendal's investment in Sedda. Answer: Investment cost Less: Book value acquired: $200,000 × 25% = Excess cost over book value acquired =

$100,000 (50,000) $50,000

Schedule to Allocate Cost-Book Value Differentials

Accounts receivable Inventories Equipment Notes payable Allocated to specific assets Remainder allocated to goodwill Excess of cost over book value acquired

Fair valueBook value (10,000) 10,000 30,000 10,000

Interest 25% 25% 25% 25%

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

Amount Assigned $(2,500) 2,500 7,500 2,500 $10,000 40,000 $50,000

8) Sandpiper Inc. acquired a 30% interest in Shore Corporation for $27,000 cash on January 1, 2013, when Shore's stockholders' equity consisted of $30,000 of capital stock and $20,000 of retained earnings. Shore Corporation reported net income of $18,000 for 2013. The allocation of the $12,000 excess of cost over book value acquired on January 1 is shown below, along with information relating to the useful lives of the items: Overvalued receivables (collected in 2013) Undervalued inventories (sold in 2013) Undervalued building (6 years' useful life remaining at January 1, 2013) Undervalued land Unrecorded patent (8 years' economic life remaining at January 1, 2013) Undervalued accounts payable (paid in 2013) Total of excess allocated to identifiable assets and liabilities Goodwill Excess cost over book value acquired Required: Determine Sandpiper's investment income from Shore for 2013. Answer: Sandpiper's share of Shore net income ($18,000 × 30%) Add: Overvalued accounts receivable collected in 2013 Add: Undervalued accounts payable paid in 2013 Less: Undervalued inventories sold in 2013 Less: Depreciation on building undervaluation $3,600/6 Less: Amortization on patent $3,200/8 years Income from Shore

$5,400 600 300 (2,400) (600) (400) $2,900

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

$(600) 2,400 3,600 900 3,200 (300) 9,200 2,800 $12,000

9) On January 1, 2013, Pailor Inc. purchased 40% of the outstanding stock of Saska Company for $300,000. At that time, Saska's stockholders' equity consisted of $270,000 common stock and $330,000 of retained earnings. Saska Corporation reported net income of $360,000 for 2013. The allocation of the $60,000 excess of cost over book value acquired is shown below, along with information relating to the useful lives of the items: Overvalued receivables (collected in 2013) Undervalued inventories (sold in 2013) Undervalued building (4 years' useful life remaining at January 1, 2013) Undervalued land Unrecorded patent (6 years' economic life remaining at January 1, 2013) Undervalued accounts payable (paid in 2013)

$(5,000) 16,000 24,000 8,000 18,000 (4,000)

Total of excess allocated to identifiable assets and liabilities Goodwill Excess cost over book value acquired

57,000 3,000 $60,000

Required: Determine Pailor's investment income from Saska for 2013. Answer: Pailors's share of Saska net income ($360,000 × 40%) Add: Overvalued accounts receivable collected in 2013 Add: Undervalued accounts payable paid in 2013 Less: Undervalued inventories sold in 2013 Less: Depreciation on building undervaluation $24,000/4 Less: Amortization on patent $18,000/6 years Income from Saska Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

$144,000 5,000 4,000 (16,000) (6,000) (3,000) $128,000

10) Stilt Corporation purchased a 40% interest in the common stock of Shallow Company for $2,660,000 on January 1, 2013, when the book value of Shallow's net equity was $6,000,000. Shallow's book values equaled their fair values except for the following items:

Inventories Land Building-net Equipment-net

Book Value $450,000 100,000 400,000 350,000

Fair Value $500,000 450,000 200,000 400,000

Difference $ 50,000 350,000 (200,000) 50,000

Required: Prepare a schedule to allocate any excess purchase cost to identifiable assets and goodwill. Answer: Cost of Stilt's 40% investment in Shallow $2,660,000 Less: Book value of net assets acquired: 40% × $6,000,000 of net equity = 2,400,000 Excess cost over book value acquired = $ 260,000 Schedule to Allocate Cost-Book Value Differentials Fair value Book value Inventories $50,000 Land 350,000 Building-net (200,000) Equipment-net 50,000 Excess allocated to specific assets and liabilities Excess allocated to goodwill Calculated excess of cost over book value

× × × ×

Interest 40% 40% 40% 40%

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

Amount Assigned $20,000 140,000 (80,000) 20,000 $100,000 $160,000 $260,000

11) Paster Corporation was seeking to expand its customer base, and wanted to acquire a company in a market area it had not yet served. Paster determined that the Semma Company was already in the market they were pursuing, and on January 1, 2013, purchased a 25% interest in Semma to assure access to Semma's customer base. Paster paid $800,000, at a time when the book value of Semma's net equity was $3,000,000. Semma's book values equaled their fair values except for the following items:

Inventories Land Building-net Equipment-net

Book Value $150,000 80,000 220,000 260,000

Fair Value $200,000 100,000 180,000 310,000

Difference $ 50,000 20,000 (40,000) 50,000

Required: Prepare a schedule to allocate any excess purchase cost to identifiable assets and goodwill. Answer: Cost of Paster's 25% investment in Semma $800,000 Less: Book Value of net assets acquired: 25% × $3,000,000 of net equity = 750,000 Excess cost over book value acquired = $50,000 Schedule to Allocate Cost-Book Value Differentials Fair value Book value Inventories $50,000 Land 20,000 Building-net (40,000) Equipment-net 50,000 Excess allocated to specific assets and liabilities Excess allocated to goodwill Calculated excess of cost over book value

× × × ×

Interest 25% 25% 25% 25%

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

Amount Assigned $12,500 5,000 (10,000) 12,500 $20,000 $30,000 $50,000

12) Pearl Corporation paid $150,000 on January 1, 2013 for a 25% interest in Sandlin Inc. On January 1, 2013, the book value of Sandlin's stockholders' equity consisted of $200,000 of common stock and $200,000 of retained earnings. All the excess purchase cost over book value acquired was attributable to a patent with an estimated life of 5 years. During 2013 and 2014, Sandlin paid $3,000 of dividends each quarter and reported net income of $60,000 for 2013 and $80,000 for 2014. Pearl used the equity method. Required: 1. Calculate Pearl's income from Sandlin for 2013. 2. Calculate Pearl's income from Sandlin for 2014. 3. Determine the balance of Pearl's Investment in Sandlin account on December 31, 2014. Answer: Cost of Pearl's 25% investment in Sandlin $150,000 Less: Book value of net assets acquired: 25% × $400,000 of net assets = 100,000 Excess cost over book value acquired = $50,000 Requirement 1: Pearl's 2013 income from Sandlin equals: (25% × $60,000) - $10,000 of patent amortization

$5,000

Requirement 2: Pearl's 2014 income from Sandlin equals: (25% × $80,000) - patent amortization of $10,000 =

$10,000

Requirement 3: Initial investment in Sandlin Plus: Net change for 2013: (Income of $5,000 - Dividends of $3,000) Plus: Net change for 2014: (Income of $10,000 - Dividends of $3,000) Investment balance at December 31, 2014:

$150,000 2,000 7,000 $159,000

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

13) On January 2, 2013, Slurg Corporation paid $600,000 to acquire 20% interest in Padwaddy Inc. At that time, the book value of Padwaddy's stockholders' equity included $700,000 of common stock and $1,800,000 of retained earnings. All the excess purchase cost over the book value acquired was attributable to a patent with an estimated life of 10 years. Padwaddy paid $6,250 of dividends each quarter for the next two years, and reported net income of $180,000 for 2013 and $220,000 for 2014. Slurg recorded all activities related to their investment using the equity method. Required: 1. Calculate Slurg's income from Padwaddy for 2013. 2. Calculate Slurg's income from Padwaddy for 2014. 3. Determine the balance of Slurg's Investment in Padwaddy account on December 31, 2014. Answer: Cost of Slurg's 20% investment in Padwaddy $600,000 Less: Book value of net assets acquired: 20% × $2,500,000 of net assets = 500,000 Excess cost over book value acquired = $100,000 Requirement 1: Slurg's 2013 income from Padwaddy equals: (20% × $180,000) - $10,000 of patent amortization

$26,000

Requirement 2: Slurg's 2014 income from Padwaddy equals: (20% × $220,000) - patent amortization of $10,000 =

$34,000

Requirement 3: Initial investment in Padwaddy Plus: Net change for 2013: (Income of $26,000 Dividends of $5,000) Plus: Net change for 2014: (Income of $34,000 Dividends of $5,000) Investment balance at December 31, 2014:

$600,000 21,000 29,000 $650,000

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

14) Shebing Corporation had $80,000 of $10 par value common stock outstanding on January 1, 2013, and retained earnings of $120,000 on the same date. During 2013 and 2014, Shebing earned net incomes of $30,000 and $45,000, respectively, and paid dividends of $8,000 and $10,000, respectively. On January 1, 2013, Pentz Company purchased 25% of Shebing's outstanding common stock for $60,000. On January 1, 2014, Pentz purchased an additional 10% of Shebing's outstanding stock for $30,200. The payments made by Pentz in excess of the book value of net assets acquired were attributed to equipment, with each excess value amount depreciable over 8 years under the straight-line method. Required: 1. What is the adjustment to Investment Income for depreciation expense relating to Pentz's Investment in Shebing in 2013 and 2014? 2. What will be the December 31, 2014 balance in the Investment in Shebing account after all adjustments have been made? Answer: Calculation of Shebing's net assets at the end of each year: Shebing's net assets on January 1, 2013 Plus: 2013 net income minus dividends ($30,000 - $8,000) Shebing's net assets at December 31, 2013 Plus: 2014 net income minus dividends ($45,000 - $10,000) Shebing's net assets at December 31, 2014

$200,000 22,000 $222,000 35,000 $257,000

Pentz's adjusted fair value payments for equipment: Pentz's January 1, 2013 initial investment cost Less: Pentz's share of Shebing's net assets on this date = (25% × $200,000) = Equals: fair value adjustment for equipment

$60,000 50,000 $10,000

Pentz's January 1, 2014 investment cost Less: Pentz's share of Shebing's net assets on this date = (10% × $222,000) = Equals: fair value adjustment for equipment

$30,200 22,200 $ 8,000

Requirement 1: 2013 equipment depreciation ($10,000/8 years) = 2014 equipment depreciation ($10,000/8 years) + ($8,000/8 years) =

$1,250 $2,250

Requirement 2: Direct investment costs ($60,000 + $30,200) = Plus: 2013 adjustments (25%) × ($30,000 - $8,000) - $1,250 = Plus: 2014 adjustments (35%) × ($45,000 - $10,000) - $2,250= Equals: December 31, 2014 investment account balance Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

$90,200 4,250 10,000 $104,450

15) Shoreline Corporation had $3,000,000 of $10 par value common stock outstanding on January 1, 2012, and retained earnings of $1,000,000 on the same date. During 2012, 2013, and 2014, Shoreline earned net incomes of $400,000, $700,000, and $300,000, respectively, and paid dividends of $300,000, $550,000, and $100,000, respectively. On January 1, 2012, Pebble purchased 21% of Shoreline's outstanding common stock for $1,240,000. On January 1, 2013, Pebble purchased 9% of Shoreline's outstanding stock for $510,000, and on January 1, 2014, Pebble purchased another 5% of Shoreline's outstanding stock for $320,000. All payments made by Pebble that are in excess of the appropriate book values were attributed to equipment, with each block depreciable over 20 years under the straight-line method. Required: 1. What is the adjustment to Investment Income for depreciation expense for Pebble's investment in Shoreline in 2012, 2013, and 2014? 2. What will be the December 31, 2014 balance in the Investment in Shoreline account after all adjustments have been made?

Answer: Calculation of Shoreline's net assets at the end of each year: Shoreline's net assets on January 1, 2012 Plus: 2012 net income minus dividends ($400,000 - $300,000) Shoreline's net assets at December 31, 2012 Plus: 2013 net income minus dividends ($700,000 - $550,000) Shoreline's net assets at December 31, 2013 Plus: 2014 net income minus dividends ($300,000 - $100,000) Shoreline's net assets at December 31, 2014 Pebble's adjusted fair value payments for equipment: Pebble's January 1, 2012 initial investment cost Less: Pebble's share of Shoreline's net assets on this date = (21% × $4,000,000) = Equals: fair value adjustment for equipment

$4,000,000 100,000 $4,100,000 150,000 4,250,000 $200,000 $4,450,000

$1,240,000 840,000 $400,000

Pebble's January 1, 2013 investment cost Less: Pebble's share of Shoreline's net assets on this date = (9% × $4,100,000) = Equals: fair value adjustment for equipment

$510,000

Pebble's January 1, 2014 investment cost Less: Pebble's share of Shoreline's net assets on this date = (5% × $4,250,000) = Equals: fair value adjustment for equipment

$320,000

369,000 $141,000

212,500 $107,500

Requirement 1: 2012 equipment depreciation ($400,000/20 years) =

$20,000

2013 equipment depreciation ($400,000/20 years) + ($141,000/20 years)=

$ 27,050

2014 equipment depreciation ($400,000/20 years) + ($141,000/20 years) + ($107,500/20 years) =

$32,425

Requirement 2: Direct investment costs ($1,240,000 + $510,000 + $320,000)= Plus: 2012 adjustments (21%) × ($400,000 - $300,000) - $20,000 = Plus: 2013 adjustments (30%) × ($700,000 - $550,000) - $27,050 = Plus: 2014 adjustments (35%) × ($300,000 - $100,000) - $32,425 = Equals: December 31, 2014 investment account balance

$2,070,000 1,000 17,950 37,575 $2,126,525

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Difficult AACSB: Application of knowledge

16) For 2013 and 2014, Sabil Corporation earned net income of $480,000 and $640,000 and paid dividends of $18,000 and $20,000, respectively. At January 1, 2013, Sabil had $200,000 of $10 par value common stock outstanding and $1,500,000 of retained earnings. On January 1 of each of these years, Phyit Corporation bought 10% of the outstanding common stock of Sabil paying $200,000 per 10% block on January 1, 2013 and 2014. All payments made by Phyit in excess of book value were attributable to equipment, which is depreciated over ten years on a straight-line basis. Required: 1. If Phyit uses the cost method of accounting for its investment in Sabil, how much dividend income will Phyit recognize in 2013 and 2014, and what will be the balance in the investment account at the end of each year? 2. If Phyit has significant influence and can justify using the equity method of accounting, how much net investee income will Phyit recognize for 2013 and 2014?

Answer: Requirement 1: 2013 dividend income = 10% × $18,000 of dividends = 2014 dividend income = 20% × $20,000 of dividends = Investment account Jan 1, 2013 purchase = Dec 31, 2013 balance = Jan 1, 2014 purchase = Dec 31, 2014 balance =

$1,800 $4,000

$200,000 $200,000 $200,000 $400,000

Requirement 2 Calculation of Sabil's net assets at end of year: Sabil net assets on January 1, 2013 Plus: 2013 net income minus dividends ($480,000 - $18,000) Sabil net assets at December 31, 2013 Plus: 2014 net income minus dividends ($640,000 - $20,000) Sabil net assets at December 31, 2014

$1,700,000 462,000 $2,162,000 620,000 $2,782,000

Phyit's adjusted fair value payments for equipment: Phyit's January 1, 2013 initial investment cost Less: Phyit's share of Sabil net assets on this date = (10% × $1,700,000) = Equals: fair value adjustment for equipment

$200,000 170,000 $30,000

Phyit's January 1, 2014 investment cost Less: Phyit's share of Sabil net assets on this date = (10% × $2,162,000) = Equals: fair value adjustment for equipment

$ 200,000 (216,200) $ (16,200)

2013 net income from Sabil = (10% × 480,000) Depreciation of $3,000 ($30,000/10 years) =

$45,000

2014 net income from Sabil = (20% × 640,000) depreciation of $3,000 from the 2013 purchase + depreciation of $1,620 from the 2014 purchase ($16,200/10 years) for a total depreciation of $1,380.

$126,620

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

17) For 2012, 2013, and 2014, Squid Corporation earned net incomes of $40,000, $70,000, and $100,000, respectively, and paid dividends of $24,000, $32,000, and $44,000, respectively. On January 1, 2012, Squid had $500,000 of $10 par value common stock outstanding and $100,000 of retained earnings. On January 1 of each of these years, Albatross Corporation bought 5% of the outstanding common stock of Squid paying $37,000 per 5% block on January 1, 2012, 2013, and 2014. All payments made by Albatross in excess of book value were attributable to equipment, which is depreciated over five years on a straight-line basis. Required: 1. Assuming that Albatross uses the cost method of accounting for its investment in Squid, how much dividend income will Albatross recognize for each of the three years and what will be the balance in the investment account at the end of each year? 2. Assuming that Albatross has significant influence and uses the equity method of accounting (even though its ownership percentage is less than 20%), how much net investee income will Albatross recognize for each of the three years? Answer: Requirement 1: 2012 dividend income = 5% × $24,000 of dividends = 2013 dividend income = 10% × $32,000 of dividends = 2014 dividend income = 15% × $44,000 of dividends = Investment account Jan 1, 2012 purchase = Dec 31, 2012 balance = Jan 1, 2013 purchase = Dec 31, 2013 balance = Jan 1, 2014 purchase = Dec 31, 2014 balance =

$1,200 $3,200 $6,600

$37,000 $37,000 $37,000 $74,000 $37,000 $111,000

Requirement 2: Calculation of Squid's net assets at end of year: Squid net assets on January 1, 2012 Plus: 2012 net income minus dividends ($40,000 - $24,000) Squid net assets at December 31, 2012 Plus: 2013 net income minus dividends ($70,000 - $32,000) Squid net assets at December 31, 2013 Plus: 2014 net income minus dividends ($100,000 - $44,000) Squid net assets at December 31, 2014

$600,000 16,000 $616,000 38,000 $654,000 56,000 $710,000

Albatross' adjusted fair value payments for equipment: Albatross' January 1, 2012 initial investment cost Less: Albatross' share of Squid net assets on this date = (5% × $600,000) = Equals: fair value adjustment for equipment

$37,000 30,000 $7,000

Albatross' January 1, 2013 investment cost Less: Albatross' 5% share of Squid net assets on this date = (5% × $616,000) = Equals: fair value adjustment for equipment

$37,000 30,800 $6,200

Albatross' January 1, 2014 investment cost Less: Albatross' share of Squid net assets on this date = (5% × $654,000) = Equals: fair value adjustment for equipment

$37,000 32,700 $4,300

2012 net income from Squid (investee) = (5% × 40,000) Depreciation of $1,400 ($7,000/5 years) =

$600

2013 net income from Squid (investee) = (10% × 70,000) depreciation of $1,400 from the 2012 purchase and depreciation of $1,240 from the 2013 purchase ($6,200/5 years) for a total depreciation of $2,640.

$4,360

2014 net income from Squid (investee) = (15% × 100,000) — depreciation of $1,400 from the 2012 purchase and depreciation of $1,240 from the 2013 purchase and depreciation of $860 from the 2014 purchase ($4,300/5 years)for a total depreciation of $3,500.

$11,500

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Difficult AACSB: Application of knowledge

18) On January 1, 2013, Petrel, Inc. purchased 70% of the outstanding voting common stock of Ocean, Inc., for $2,600,000. The book value of Ocean's net equity on that date was $3,100,000. Book values were equal to fair values except as follows:

Assets & Liabilities Equipment Building Note payable

Book Values $ 250,000 600,000 270,000

Fair Values $ 190,000 700,000 240,000

Required: Prepare a schedule to allocate any excess purchase cost to specific assets and liabilities. Answer: Cost of Petrel's 70% investment in Ocean $2,600,000 Less: Book value of net assets acquired: 70% × 3,100,000 of net assets = 2,170,000 Excess cost over book value acquired = $ 430,000 Schedule to Allocate Cost-Book Value Differentials Fair value Book value Interest Equipment $(60,000) × 70% Building 100,000 × 70% Note payable 30,000 × 70% Excess allocated to specific assets and liabilities Excess allocated to goodwill Calculated excess of cost over book value

Amount Assigned $(42,000) 70,000 21,000 $49,000 381,000 $430,000

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

19) On January 1, 2013, Palgan, Co. purchased 75% of the outstanding voting common stock of Somil, Inc., for $1,500,000. The book value of Somil's net equity on that date was $2,000,000. Book values were equal to fair values except as follows:

Assets & Liabilities Inventory Building Note payable

Book Values $ 225,000 850,000 320,000

Fair Values $ 253,000 750,000 304,000

Required: Prepare a schedule to allocate any excess purchase cost to specific assets and liabilities. Answer: Cost of Palgan's 75% investment in Somil $1,500,000 Less: Book value of net assets acquired: 75% × 2,000,000 of net assets = 1,500,000 Excess cost over book value acquired = $ 0 Schedule to Allocate Cost-Book Value Differentials Fair valueBook value Interest Inventory $ 28,000 × 75% Building (100,000) × 75% Note payable 16,000 × 75% Excess allocated to specific assets and liabilities Excess allocated to goodwill Calculated excess of cost over book value

Amount Assigned $ 21,000 (75,000) 12,000 $ (42,000) 42,000 $ 0

Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Application of knowledge

20) Keynse Company owns 70% of Subdia Incorporated. The Investment in Subdia qualifies as a business reporting unit under FASB 142, and Keynse has reported goodwill in the amount of $200,000 with respect to its acquisition of Subdia. Subdia's $10 par common stock is currently trading for $92 per share, Subdia's account book balances and related fair values at December 31, 2013 are shown below.

Cash Accounts Receivable Plant assets — net Patents Accounts Payable Notes Payable Common Stock Retained Earnings

Book Values $2,000,000 8,000,000 18,000,000 1,000,000 ( 9,000,000) (16,000,000) ( 1,000,000) ( 3,000,000)

Fair Values $2,000,000 7,500,000 23,000,000 1,500,000 ( 9,000,000) (16,000,000)

Required: Determine if Goodwill has been impaired, and if so, the amount of adjustment that would be required. Answer: Step 1: Determine if goodwill is impaired. Compare book value of reporting unit to fair value of reporting unit. (Book value of reporting unit includes goodwill.) Fair value of reporting unit $9,200,000 (market value of stock) Fair value of reporting unit $9,000,000 (net assets) Book value of reporting unit $4,200,000 Book value of reporting unit: Common stock $1,000,000 Goodwill 200,000 Retained earnings 3,000,000 Total $ 4,200,000 Fair value of reporting unit: Cash Accounts receivable Plant assets Patents Accounts payable Notes payable Total

$2,000,000 7,500,000 23,000,000 1,500,000 (9,000,000) (16,000,000) $ 9,000,000

If the reporting unit's fair value exceeds its book value (with goodwill), goodwill is not impaired. In this case, the reporting unit's fair value exceeds its book value, so goodwill is not impaired. No adjustment is required. No further work is needed. Objective: LO2.6 Learn how to test goodwill for impairment. Difficulty: Moderate AACSB: Application of knowledge

2.3 True/False 1) The GAAP requires the recording of common stock acquisitions in the investor record at cost. Answer: TRUE Objective: LO2.1 Recognize investors' varying levels of influence or control, based on the level of stock ownership. Difficulty: Easy AACSB: Analytical thinking

2) The equity method requires recording investments at cost and adjustments are made for earnings and losses only. Answer: FALSE Objective: LO2.2 Understand how accounting adjusts to reflect the economics underlying varying levels of investor influence. Difficulty: Moderate AACSB: Analytical thinking

3) Failure to obtain representation on the investee's board of directors is an indicator of an investor's inability to exercise significant influence. Answer: TRUE Objective: LO2.3 Identify factors beyond stock ownership that affect an investor's ability to exert influence or control over an investee. Difficulty: Difficult AACSB: Analytical thinking

4) The GAAP requires that all majority-owned subsidiaries be consolidated, except when control lies with the majority interest. Answer: FALSE Objective: LO2.3 Identify factors beyond stock ownership that affect an investor's ability to exert influence or control over an investee. Difficulty: Difficult AACSB: Analytical thinking

5) When an investor can significantly influence or control the operations of the investee, including dividend declarations the equity method must be used. Answer: TRUE Objective: LO2.4 Apply the fair value/cost and equity methods of accounting for stock investments. Difficulty: Moderate AACSB: Analytical thinking

6) The equity method is often called the dual-line consolidation. Answer: FALSE Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Easy AACSB: Analytical thinking

7) Equity investments at acquisitions require direct costs of registering equity securities be charged to additional paid-in capital. Answer: TRUE Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Analytical thinking

8) A bargain purchase gain is recorded as an extraordinary gain. Answer: FALSE Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Easy AACSB: Analytical thinking

9) If an investor sells a portion of an equity investment and it reduces its interest below 20 percent the equity method of accounting is no longer appropriate. Answer: TRUE Objective: LO2.5 Apply the equity method to stock investments. Difficulty: Moderate AACSB: Analytical thinking

10) Goodwill that has an indefinite useful life is not amortized. Answer: TRUE Objective: LO2.6 Learn how to test goodwill for impairment. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 3 An Introduction to Consolidated Financial Statements 3.1 Multiple Choice Questions 1) Which method must be used if ASC 810-10-65 prohibits full consolidation of a 70% owned subsidiary? A) The cost method B) The Liquidation value C) Market value D) Equity method Answer: D Objective: LO3.2 Understand the requirements for including a subsidiary in consolidated financial statements. Difficulty: Easy AACSB: Analytical thinking

2) From the standpoint of accounting theory, which of the following statements is the best justification for the preparation of consolidated financial statements? A) In substance the companies are separate, but in form the companies are one entity. B) In substance the companies are one entity, but in form they are separate. C) In substance and form the companies are one entity. D) In substance and form the companies are separate entities. Answer: B Objective: LO3.2 Understand the requirements for including a subsidiary in consolidated financial statements. Difficulty: Easy AACSB: Analytical thinking

3) Panini Corporation owns 85% of the outstanding voting stock of Strathmore Company and Malone Corporation owns the remaining 15% of Strathmore's voting stock. On the consolidated financial statements of Panini Corporation and Strathmore, Malone is A) an affiliate. B) a noncontrolling interest. C) an equity investee. D) a related party. Answer: B Objective: LO3.2 Understand the requirements for including a subsidiary in consolidated financial statements. Difficulty: Easy AACSB: Analytical thinking

4) A subsidiary can be excluded from consolidation if A) control rests with the majority owner. B) formation of joint ventures. C) the acquisition of an asset or group of assets constitutes a business. D) acquisition of a not-for-profit entity by a for-profit business. Answer: B Objective: LO3.2 Understand the requirements for including a subsidiary in consolidated financial statements. Difficulty: Easy AACSB: Analytical thinking

5) Pregler Inc. has 70% ownership of Sach Company, but should exclude Sach from its consolidated financial statements if A) Sach is in a regulated industry. B) Pregler uses the equity method for Sach. C) Sach is in legal reorganization. D) Sach is in a foreign country and records its books in a foreign currency. Answer: C Objective: LO3.2 Understand the requirements for including a subsidiary in consolidated financial statements. Difficulty: Moderate AACSB: Analytical thinking

6) Subsequent to an acquisition, the parent company and consolidated financial statement amounts would not be the same for A) investments in unconsolidated subsidiaries. B) investments in consolidated subsidiaries. C) capital stock. D) ending retained earnings. Answer: B Objective: LO3.4 Record the fair value of the subsidiary at the date of acquisition. Difficulty: Easy AACSB: Analytical thinking

7) On June 1, 2014, Puell Company acquired 100% of the stock of Sorrell Inc. On this date, Puell had Retained Earnings of $100,000 and Sorrell had Retained Earnings of $50,000. On December 31, 2014, Puell had Retained Earnings of $120,000 and Sorrell had Retained Earnings of $60,000. The amount of Retained Earnings that appeared in the December 31, 2014 consolidated balance sheet was A) $120,000. B) $130,000. C) $170,000. D) $180,000. Answer: A Explanation: A) (the parent's retained earnings) Objective: LO3.4 Record the fair value of the subsidiary at the date of acquisition. Difficulty: Moderate AACSB: Application of knowledge

8) Perth Corporation acquired a 100% interest in Sansone Company for $1,600,000 when Sansone had no liabilities. The book values and fair values of Sansone's assets were:

Current assets Equipment Land & buildings Total assets

Book Value $350,000 150,000 570,000 $1,070,000

Fair Value $400,000 210,000 590,000 $1,200,000

Immediately following the acquisition, equipment will be included on the consolidated balance sheet at A) $150,000. B) $200,000. C) $210,000. D) $280,000. Answer: C Explanation: C) The assets will be recorded at fair value. When investment cost ($1,600,000) exceeds the fair value of net assets ($1,200,000), the difference is goodwill. Objective: LO3.4 Record the fair value of the subsidiary at the date of acquisition. Difficulty: Moderate AACSB: Application of knowledge

9) A newly acquired subsidiary had pre-existing goodwill on its books. The parent company's consolidated balance sheet will A) not show any value for the subsidiary's pre-existing goodwill. B) treat the goodwill similarly to other intangible assets of the acquired company. C) not show any value for the pre-existing goodwill unless all other assets of the subsidiary are stated at their full fair value. D) always show the pre-existing goodwill of the subsidiary at its book value. Answer: A Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Moderate AACSB: Analytical thinking

10) The unamortized excess account is A) a contra-equity account. B) used in allocating the amounts paid for recorded balance sheet accounts that are above or below their fair values. C) used in allocating the amounts paid for each asset and liability that are above or below their book values, especially when numerous assets or liabilities are involved. D) the excess purchase cost that is attributable to goodwill. Answer: C Objective: LO3.7 Amortize the excess of the fair value over the book value in periods subsequent to the acquisition. Difficulty: Easy AACSB: Analytical thinking

11) On January 1, 2014, Packaging International purchased 90% of Shipaway Corporation's outstanding shares for $135,000 when the fair value of Shipaway's net assets were equal to the book values. The balance sheets of Packaging and Shipaway Corporations at year-end 2013 are summarized as follows:

Assets Liabilities Capital stock Retained earnings

Packaging $590,000

Shipaway $180,000

$70,000 360,000 160,000

$30,000 90,000 60,000

If a consolidated balance sheet was prepared immediately after the business combination, the noncontrolling interest would be A) $9,000. B) $13,500. C) $15,000. D) $16,667. Answer: C Explanation: C) $135,000 / 90% = $150,000 × 10% = $15,000. Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Moderate AACSB: Application of knowledge

12) On July 1, 2014, when Salaby Company's total stockholders' equity was $360,000, Pogana Corporation purchased 14,000 shares of Salaby's common stock at $30 per share. Salaby had 20,000 shares of common stock outstanding both before and after the purchase by Pogana, and the book value of Salaby's net assets on July 1, 2014 was equal to the fair value. On a consolidated balance sheet prepared at July 1, 2014, goodwill would be A) $60,000. B) $85,714. C) $100,000. D) $240,000. Answer: D Explanation: D) Salaby's cost = 14,000 × $30 $420,000 Implied fair value of Salaby($420,000/0.70) 600,000 Less: Book value (360,000) Consolidated Goodwill $240,000 Objective: LO3.6 Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of eliminating entries. Difficulty: Moderate AACSB: Application of knowledge

13) Percy Inc. acquired 80% of the outstanding stock of Sillson Company in a business combination. The book values of Sillson's net assets are equal to the fair values except for the building, whose net book value and fair value are $500,000 and $800,000, respectively. At what amount is the building reported on the consolidated balance sheet? A) $400,000 B) $500,000 C) $640,000 D) $800,000 Answer: D Objective: LO3.6 Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of eliminating entries. Difficulty: Moderate AACSB: Application of knowledge

14) In the preparation of consolidated financial statements, which of the following intercompany transactions must be eliminated as part of the preparation of the consolidation working papers? A) All revenues, expenses, gains, losses, receivables, and payables B) All revenues, expenses, gains, and losses but not receivables and payables C) Receivables and payables but not revenues, expenses, gains, and losses D) Only sales revenue and cost of goods sold Answer: A Objective: LO3.8 Apply the concepts underlying preparation of a consolidated income statement. Difficulty: Easy AACSB: Analytical thinking

15) Pardo Corporation paid $140,000 for a 70% interest in Spedeal Inc. on January 1, 2014, when Spedeal had Capital Stock of $50,000 and Retained Earnings of $100,000. Fair values of identifiable net assets were the same as recorded book values. During 2014, Spedeal had income of $40,000, declared dividends of $15,000, and paid $10,000 of dividends. On December 31, 2014, the consolidated financial statements will show A) investment in Spedeal account of $170,000. B) investment in Spedeal account of $165,000. C) consolidated goodwill of $50,000. D) consolidated dividends receivable of $5,000. Answer: C Explanation: C) Implied fair value of Spedeal($140,000/0.70) $200,000 Less: Book value (150,000) Consolidated Goodwill $50,000 Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Moderate AACSB: Analytical thinking

16) Pental Corporation bought 90% of Sedacor Company's common stock at its book value of $400,000 on January 1, 2014. During 2014, Sedacor reported net income of $130,000 and paid dividends of $40,000. At what amount should Pental's Investment in Sedacor account be reported on December 31, 2014? A) $400,000 B) $481,000 C) $490,000 D) $530,000 Answer: B Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Moderate AACSB: Application of knowledge

17) Pomograte Corporation bought 75% of Sycamore Company's common stock, with a book value of $900,000, on January 2, 2014 for $750,000. The law firm of Dewey, Cheatam and Howe was paid $55,000 to facilitate the purchase. At what amount should Pomograte's Investment in Sycamore account be reported on January 2, 2014? A) $675,000 B) $695,000 C) $750,000 D) $845,000 Answer: C Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Moderate AACSB: Application of knowledge

18) Pinata Corporation acquired an 80% interest in Smackem Inc. for $130,000 on January 1, 2014, when Smackem had Capital Stock of $125,000 and Retained Earnings of $25,000. Assume the fair value and book value of Smackem's net assets were equal on January 1, 2014. Pinata's separate income statement and a consolidated income statement for Pinata and Subsidiary as of December 31, 2014, are shown below.

Sales revenue Income from Smackem Cost of sales Other expenses Noncontrolling interest share Net income

Pinata $145,850 12,600 (60,000) (20,000)

$ 78,450

Consolidated $234,750 (100,000) (50,000) (3,150) $ 81,600

Smackem's separate income statement must have reported net income of A) $13,750. B) $14,750. C) $15,750. D) $15,250. Answer: C Explanation: C) Noncontrolling interest share $3,150 / 20% = $15,750 Objective: LO3.8 Apply the concepts underlying preparation of a consolidated income statement. Difficulty: Moderate AACSB: Application of knowledge

19) In the consolidated income statement of Wattlebird Corporation and its 85% owned Forest subsidiary, the noncontrolling interest share was reported at $45,000. Assume the book value and fair value of Forest's net assets were equal at the acquisition date. What amount of net income did Forest have for the year? A) $52,941 B) $38,250 C) $235,000 D) $300,000 Answer: D Explanation: D) $45,000 / 15% = $300,000 Objective: LO3.8 Apply the concepts underlying preparation of a consolidated income statement. Difficulty: Moderate AACSB: Application of knowledge

20) Push-down accounting A) requires a subsidiary to use the same accounting principles as its parent company. B) is required when the parent company uses the equity method to account for its investment in a subsidiary. C) is required when the parent company uses the cost method to account for its investment in a subsidiary. D) is the process of recording the effects of the purchase price assignment directly on the books of the subsidiary. Answer: D Objective: LO3.9 Introduce the concept of push-down accounting. Difficulty: Easy AACSB: Analytical thinking

3.2 Exercises 1) Passerby International purchased 80% of Standaround Company's outstanding common stock for $200,000 on January 2, 2014. At that time, the fair value of Standaround's net assets were equal to the book values. The balance sheets of Passerby and Standaround at January 2, 2014 are summarized as follows:

Assets Liabilities Capital stock Retained earnings

Passerby $1,600,000 $840,000 360,000 400,000

Standaround $470,000 $230,000 50,000 190,000

Required: Determine the consolidated balances as of January 2, 2014 for the following five balance sheet line items: Goodwill, Liabilities, Capital Stock, Retained Earnings, and Noncontrolling Interest. Answer: Goodwill: Implied fair value of company ($200,000/0.80) $250,000 Less: Fair value of Identifiable Net Assets (240,000) Consolidated Goodwill $ 10,000 Liabilities: $840,000 + 230,000 = 1,070,000 Capital Stock: $360,000 Retained Earnings: $400,000 Noncontrolling interest: Implied fair value of Standaround at date of purchase (see Goodwill calculation) = $250,000 × 20% = $50,000 Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Moderate AACSB: Application of knowledge

2) Parrot Inc. acquired an 85% interest in Sparrow Corporation on January 2, 2014 for $42,500 cash when Sparrow had Capital Stock of $15,000 and Retained Earnings of $25,000. Sparrow's assets and liabilities had book values equal to their fair values except for inventory that was undervalued by $2,000. Balance sheets for Parrot and Sparrow on January 2, 2014, immediately after the business combination, are presented in the first two columns of the consolidated balance sheet working papers.

Required: Complete the consolidation balance sheet working papers for Parrot and subsidiary at January 1, 2014.

Answer: Preliminary computations Implied fair value of Sparrow ($42,500 / 85%) Book value of Sparrow's net assets Excess fair value over book value acquired =

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

Allocation of excess of fair value over book value: Inventory Remainder to goodwill Excess of fair value over book value

$2,000 8,000 $ 10,000

Objective: LO3.4 Record the fair value of the subsidiary at the date of acquisition. Difficulty: Moderate AACSB: Application of knowledge

3) On January 1, 2014, Myna Corporation issued 10,000 shares of its own $10 par value common stock for 9,000 shares of the outstanding stock of Berry Corporation in an acquisition. Myna common stock at January 1, 2014 was selling at $70 per share. Just before the business combination, balance sheet information of the two corporations was as follows:

Cash Inventories Other current assets Land Plant and equipment-net

Liabilities Capital stock, $10 par value Additional paid-in capital Retained earnings

Myna Book Value $25,000 55,000 110,000 100,000 660,000 $950,000

Berry Book Value $12,000 32,000 90,000 30,000 250,000 $414,000

Berry Fair Value $12,000 36,000 110,000 90,000 375,000 $623,000

$220,000 500,000 170,000 60,000 $950,000

$50,000 100,000 40,000 224,000 $414,000

$50,000

Required: 1. Prepare the journal entry on Myna Corporation's books to account for the investment in Berry Company. 2. Prepare a consolidated balance sheet for Myna Corporation and Subsidiary immediately after the business combination.

Answer: Requirement 1: Investment in Berry Co. Capital stock Additional paid-in capital

700,000 100,000 600,000

Requirement 2: Preliminary computations Fair value (purchase price) of 90% interest acquired Implied fair value of Berry ($700,000 / 90%) Book value of Berry's net assets Excess fair value over book value acquired =

$700,000 $777,778 (364,000) $413,778

Allocation of excess of fair value over book value: Inventory Other current assets Land Plant assets Remainder to goodwill Excess of fair value over book value

$4,000 20,000 60,000 125,000 204,778 $413,778

Objective: LO3.4 Record the fair value of the subsidiary at the date of acquisition. Difficulty: Moderate AACSB: Application of knowledge

4) On July 1, 2014, Polliwog Incorporated paid cash for 21,000 shares of Salamander Company's $10 par value stock, when it was trading at $22 per share. At that time, Salamander's total stockholders' equity was $597,000, and they had 30,000 shares of stock outstanding, both before and after the purchase. The book value of Salamander's net assets is believed to approximate the fair values. Requirement 1: Prepare the journal entry that Polliwog would record at the date of acquisition on their general ledger. Requirement 2: Calculate the balance of the goodwill that would be recorded on Polliwog's general ledger, on Salamander's general ledger, and in the consolidated financial statements. Answer: Requirement 1: Investment in Salamander 462,000 Cash 462,000 Requirement 2: There is no goodwill recorded on the general ledger of the Polliwog or Salamander. The goodwill is recorded in consolidation only, as calculated below: Polliwog's cost = 21,000 × $22 = Divided by percentage(21,000/30,000) Implied fair value of Salamander Less: Book Value Consolidated Goodwill

$462,000 70% 660,000 (597,000) $63,000

Objective: LO3.4 Record the fair value of the subsidiary at the date of acquisition. Difficulty: Moderate AACSB: Application of knowledge

5) The consolidated balance sheet of Pasker Corporation and Shishobee Farm, its 80% owned subsidiary, as of December 31, 2014, contains the following accounts and balances: Pasker Corporation and Subsidiary Consolidated Balance Sheet at December 31, 2014 Balances $57,000 210,000 330,000 255,000 870,000 117,000 $1,839,000

Cash Accounts receivable-net Inventories Other current assets Plant assets-net Goodwill from consolidation

Accounts payable Other liabilities Capital stock Retained earnings Noncontrolling interest

$219,000 210,000 1,050,000 240,000 120,000 $1,839,000

Pasker Corporation acquired its interest in Shishobee Farm on January 1, 2014, when Shishobee Farm had $450,000 of Capital Stock and $210,000 of Retained Earnings. Shishobee Farm's net assets had fair values equal to their book values when Pasker acquired its interest. No changes have occurred in the amount of outstanding stock since the date of the business combination. Pasker uses the equity method of accounting for its investment. Required: Determine the following amounts: 1. The balance of Pasker's Capital Stock and Retained Earnings accounts at December 31, 2014. 2. Cost of Pasker's purchase of Shishobee Farm on January 1, 2014. Answer: Requirement 1: On the consolidated balance sheet, the balance in the Capital Stock and Retained Earnings accounts will be those of the parent, so the Capital Stock balance is $1,050,000, and the Retained Earnings balance is $240,000. Requirement 2: Shishobee Farm's equity on January 1, 2014 = ($450,000 + $210,000) = Consolidated (original) Goodwill = Original implied value = Ownership Amount paid at time of acquisition =

$660,000 117,000 777,000 × 80% $621,600

Objective: LO3.4 Record the fair value of the subsidiary at the date of acquisition. Difficulty: Difficult AACSB: Application of knowledge

6) Polaris Incorporated purchased 80% of The Solar Company on January 2, 2014, when Solar's book value was $800,000. Polaris paid $700,000 for their acquisition, and the fair value of noncontrolling interest was $175,000. At the date of acquisition, the fair value and book value of Solar's identifiable assets and liabilities were equal. At the end of the year, the separate companies reported the following balances:

Current assets Plant & equipment Investment in Solar Goodwill Current liabilities Long-term debt Stockholders' Equity

Polaris $5,700,000 15,200,000 780,000 0 3,600,000 11,680,000 6,400,000

Solar $1,250,000 3,400,000 0 0 950,000 2,800,000 900,000

Requirement 1: Calculate consolidated balances for each of the accounts as of December 31, 2014. Requirement 2: Assuming that Solar has paid no dividends during the year, what is the ending balance of the noncontrolling interest in the subsidiary? Answer: Requirement 1: Current Assets = $5,700,000 + $1,250,000 = $6,950,000 Plant & Equipment = $15,200,000 + $3,400,000 = $18,600,000 Investment in Solar = 0 (eliminated in consolidation) Goodwill = Paid $700,000 for 80% ownership, so implied fair value of company is $875,000. If Book Value of net assets at that date was $800,000, implied Goodwill amounts to $75,000. Current Liabilities = $3,600,000 + $950,000 = $4,550,000 Long-term debt = $11,680,000 + $2,800,000 = $14,480,000 Stockholders' Equity = $6,400,000 (consolidated balance equals balance in parent's account) Requirement 2: Solar equity = $900,000, then noncontrolling interest should be $900,000 × 20% = $180,000 + Goodwill attributed to noncontrolling interest of ($75,000 × 20%) $15,000 = $195,000 Check this calculation by comparing to balance sheet information calculated above. Total assets calculated = $25,625,000; Total liabilities calculated = $19,030,000; Owners' equity = $6,400,000 + noncontrolling interest of $195,000 = $6,595,000. Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Difficult AACSB: Application of knowledge

7) Park Corporation paid $180,000 for a 75% interest in Stem Co.'s outstanding Capital Stock on January 1, 2014, when Stem's stockholders' equity consisted of $150,000 of Capital Stock and $50,000 of Retained Earnings. Book values of Stem's net assets were equal to their fair values on this date. The adjusted trial balances of Park and Stem on December 31, 2014 were as follows:

Cash Dividends receivable Other current assets Land Plant assets-net Investment in Stem Cost of sales Other expenses Dividends

Accounts payable Dividends payable Capital stock Retained earnings Sales revenue Income from Stem

Park $8,250 7,500 40,000 50,000 100,000 195,000 225,000 45,000 25,000 $695,750 $40,750 150,000 75,000 400,000 30,000 $695,750

Stem $35,000 50,000 30,000 150,000 125,000 25,000 20,000 $435,000 $35,000 10,000 150,000 50,000 190,000 $435,000

Required: Complete the partially prepared consolidated balance sheet working papers that appear below.

Answer: Preliminary computations Fair value (purchase price) of 75% interest acquired Implied fair value of Stem ($180,000 / 75%) Book value of Stem's net assets Excess fair value over book value acquired Initial investment cost Income from Stem: (75%)($40,000)= Dividends ($20,000)(75%) = Balance in Investment in Stem at December 31, 2014

$180,000 $240,000 $(200,000) $40,000 $180,000 30,000 (15,000) $195,000

Park Corporation and Subsidiary Consolidated Balance Sheet Working Papers at December 31, 2014

Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Difficult AACSB: Application of knowledge

8) Patterson Company acquired 90% of Starr Corporation on January 1, 2014 for $2,250,000. Starr had net assets at that time with a fair value of $2,500,000. At the time of the acquisition, Patterson computed the annual excess fair-value amortization to be $20,000, based on the difference between Starr's net book value and net fair value. Assume the fair value exceeds the book value, and $20,000 pertains to the whole company. Separate from any earnings from Starr, Patterson reported net income in 2014 and 2015 of $550,000 and $575,000, respectively. Starr reported the following net income and dividend payments:

Net Income Dividends

2014 $150,000 $30,000

2015 $180,000 $30,000

Required: Calculate the following: • Investment in Starr shown on Patterson's ledger at December 31, 2014 and 2015. • Investment in Starr shown on the consolidated statements at December 31, 2014 and 2015. • Consolidated net income for 2014 and 2015. • Noncontrolling interest balance on Patterson's ledger at December 31, 2014 and 2015. • Noncontrolling interest balance on the consolidated statements at December 31, 2014 and 2015. Answer: Investment in Starr on Patterson's ledger: December 31, 2014 = $2,250,000 + Starr Net Income ($150,000 × 90%) $135,000 - Dividends received ($30,000 × 90%) $27,000 - Excess fair-value amortization ($20,000 × 90%) $18,000 = $2,340,000 December 31, 2015 = $2,340,000 + Starr Net Income ($180,000 × 90%) $162,000 - Dividends received ($30,000 × 90%) $27,000 - Excess fair-value amortization ($20,000 × 90%) $18,000 = $2,457,000 Investment in Starr shown on consolidated statements: Will be -0- at the end of all years in consolidation, as the investment account is eliminated in consolidation. Consolidated net income: 2014: $550,000 + 150,000 - excess fv amortization $20,000 = $680,000 2015: $575,000 + 180,000 - excess fv amortization $20,000 = $735,000 Noncontrolling interest balance on Patterson's ledger: Will be -0- at the end of all years on Patterson's ledger, because the noncontrolling owners only have interest in the subsidiary balances and therefore have no interest to be shown on the parent's stand-alone statements. Noncontrolling interest balance to be shown on the consolidated financial statements: December 31, 2014: Acquisition date fair value $2,500,000 × 10% = 250,000 + interest in 2014 net income ($150,000 × 10%) 15,000 - fv amortization ($20,000 × 10%) $2,000 - dividends ($30,000 × 10%) = $260,000 December 31, 2015: $260,000 + interest in 2015 net income ($180,000 × 10%) 18,000 - fv amortization ($20,000 × 10%) $2,000 - dividends ($30,000 × 10%) = $273,000 Objective: LO3.8 Apply the concepts underlying preparation of a consolidated income statement. Difficulty: Moderate AACSB: Application of knowledge

9) Pool Industries paid $540,000 to purchase 75% of the outstanding stock of Swimmin Corporation, on December 31, 2014. Any excess fair value over the identified assets and liabilities is attributed to goodwill. The following year-end information was available just before the purchase:

Cash Accounts Receivable Inventory Land Plant and equipment-net

Accounts Payable Bonds Payable Capital stock, $10 par value Capital stock, $15 par value Additional paid-in capital Retained earnings

Pool Book Value $756,000 260,000 480,000 440,000 1,320,000 $3,256,000

Swimmin Book Value $80,000 152,000 100,000 160,000 400,000 $892,000

Swimmin Fair Value $80,000 152,000 120,000 140,000 430,000 $922,000

$880,000 936,000 400,000

$22,000 200,000

$22,000 180,000

450,000 160,000 60,000 $892,000

400,000 640,000 $3,256,000

Required: 1. Prepare Pool's consolidated balance sheet on December 31, 2014.

Answer: Requirement 1: Preliminary computations Fair value (purchase price) of 75% interest acquired on December 31, 2014 Implied fair value of Swimmin ($540,000 / 75%) Fair value of Swimmin's net assets Excess implied fair value over fair value acquired

$540,000 $720,000 $(720,000) $0

Objective: LO3.6 Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of eliminating entries. Difficulty: Moderate AACSB: Application of knowledge

10) Pool Industries paid $540,000 to purchase 75% of the outstanding stock of Swimmin Corporation, on December 31, 2014. Any excess fair value over the identified assets and liabilities is attributed to goodwill. The following year-end information was available just before the purchase:

Cash Accounts Receivable Inventory Land Plant and equipment-net

Accounts Payable Bonds Payable Capital stock, $10 par value Capital stock, $15 par value Additional paid-in capital Retained earnings

Pool Book Value $756,000 260,000 480,000 440,000 1,320,000 $3,256,000

Swimmin Book Value $80,000 152,000 100,000 160,000 400,000 $892,000

Swimmin Fair Value $80,000 152,000 120,000 140,000 430,000 $922,000

$880,000 936,000 400,000

$22,000 200,000

$22,000 180,000

450,000 160,000 60,000 $892,000

400,000 640,000 $3,256,000

Using the data provided above, assume that Pool decided rather than paying $540,000 cash, Pool issued 10,000 shares of their own stock to the owners of Swimmin. At the time of issue, the $10 par value stock had a market value of $60 per share. Required: Prepare Pool's consolidated balance sheet on December 31, 2014.

Answer: Requirement 1: Preliminary computations Fair value (purchase price) of 75% interest acquired on December 31, 2014 Implied fair value of Swimmin ($600,000 / 75%) Fair value of Swimmin's net assets Excess implied fair value over fair value acquired (goodwill)

$600,000 $800,000 $(720,000) $80,000

Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Moderate AACSB: Application of knowledge

11) On July 1, 2014, Piper Corporation issued 23,000 shares of its own $2 par value common stock for 40,000 shares of the outstanding stock of Sector Inc. in an acquisition. Piper common stock at July 1, 2014 was selling at $16 per share. Just before the business combination, balance sheet information of the two corporations was as follows:

Cash Inventories Other current assets Land Plant and equipment-net

Liabilities Capital stock, $2 par value Additional paid-in capital Retained earnings

Piper Book Value $25,000 55,000 110,000 100,000 660,000 $950,000

Sector Book Value $17,000 42,000 40,000 45,000 220,000 $364,000

Sector Fair Value $17,000 47,000 30,000 35,000 280,000 $409,000

$220,000 500,000 170,000 60,000 $950,000

$70,000 100,000 90,000 104,000 $364,000

$75,000

Required: 1. Prepare the journal entry on Piper Corporation's books to account for the investment in Sector Inc. 2. Prepare a consolidated balance sheet for Piper Corporation and Subsidiary immediately after the business combination.

Answer: Requirement 1: Investment in Sector Inc. 368,000 Capital stock Additional paid-in capital

46,000 322,000

Requirement 2: Preliminary computations Sector stock outstanding $100,000 / $2 par value = 50,000 shares o/s

$100,000

40,000 purchased / 50,000 =

80%

Fair value (purchase price) of 80% interest acquired Implied fair value of Sector ($368,000 / 80%) Book value of Sector's net assets Excess fair value over book value acquired =

$368,000 460,000 (294,000) $166,000

Allocation of excess of fair value over book value: Inventory Other current assets Land Plant and Equipment Liabilities Remainder to goodwill Excess of fair value over book value

$5,000 (10,000) (10,000) 60,000 (5,000) 126,000 $166,000

Piper Corporation and Subsidiary Consolidated Balance Sheet Working Papers July 1, 2014

12) Passcode Incorporated acquired 90% of Safe Systems International for $540,000, the market value at that time. On the date of acquisition, Safe Systems showed the following balances on their ledger:

Current Assets Buildings Equipment Liabilities

Book Value $200,000 290,000 410,000 (350,000)

Fair Value $200,000 320,000 430,000 (360,000)

Safe Systems has determined that their buildings have a remaining life of 10 years, and their equipment has a remaining useful life of 8 years. Requirement 1: Calculate the amount of goodwill that will appear on the general ledger of Passcode and Safe Systems, as well as the amount that will appear on the consolidated financial statements. Requirement 2: Calculate the amount of amortization that will appear on the consolidated financial statements for buildings and equipment, and explain how this amortization of excess fair value is shown on the separate general ledgers of Passcode and Safe Systems. Answer: Requirement 1: The consolidated financial statements will show consolidated goodwill of $10,000. Amount paid = $540,000 / 90% = implied fair value of $600,000. Book value = $550,000. Excess payment of $50,000 allocated as follows: Buildings 30,000 Equipment 20,000 Liabilities (10,000) Goodwill 10,000 50,000 No goodwill relating to this transaction will appear on the separate general ledger of either Passcode or Safe Systems. Requirement 2: The consolidated financial statements will show amortization of these excess fair value amounts: Buildings = $30,000 / 10 years = $3,000 per year Equipment = 20,000 / 8 years = 2,500 per year Total $5,500 per year Passcode's ledger will show $4,950 ($5,500 × 90%) of amortization as a reduction of the Investment in Safe Systems account and a reduction of their interest in the income of Safe Systems. Safe Systems' ledger will not show any amount of this amortization, unless Passcode chose to employ the push-down method of accounting and record these fair values on the separate ledger of Safe Systems. Objective: LO3.4 Record the fair value of the subsidiary at the date of acquisition. Difficulty: Moderate AACSB: Application of knowledge

13) Pamula Corporation paid $279,000 for 90% of Shad Corporation's $10 par common stock on December 31, 2014, when Shad Corporation's stockholders' equity was made up of $200,000 of Common Stock, $60,000 Additional Paid-in Capital and $40,000 of Retained Earnings. Shad's identifiable assets and liabilities reflected their fair values on December 31, 2014, except for Shad's inventory which was undervalued by $5,000 and their land which was undervalued by $2,000. Balance sheets for Pamula and Shad immediately after the business combination are presented in the partially completed working papers.

Required: Complete the consolidated balance sheet working papers for Pamula Corporation and Subsidiary.

Answer: Preliminary computations Fair value (purchase price) of 90% interest acquired Implied fair value of Shad ($279,000 / 90%) Book value of Shad's net assets Excess fair value over book value acquired

$279,000 $310,000 (300,000) $ 10,000

Allocation of excess of fair value over book value: Inventory Land Remainder to goodwill Excess of fair value over book value

$5,000 2,000 3,000 $ 10,000

Pamula Corporation and Subsidiary Consolidated Balance Sheet Working Papers at December 31, 2014

Objective: LO3.6 Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of eliminating entries. Difficulty: Difficult AACSB: Application of knowledge

14) On January 2, 2014, Power Incorporated paid $630,000 for a 90% interest in Smallsen Company. Smallsen's equity at that time amounted to $600,000, and their book values for assets and liabilities recorded approximated their fair values. Smallsen did not issue any additional stock in 2014. At December 31, 2014, the two companies' balance sheets are summarized as follows: Power Incorporated and Subsidiary Consolidated Balance Sheet Working Papers at December 31, 2014

Required: Complete the consolidation worksheet for Power Incorporated and Subsidiary at December 31, 2014.

Answer: Power Incorporated and Subsidiary Consolidated Balance Sheet Working Papers at December 31, 2014

Objective: LO3.6 Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of eliminating entries. Difficulty: Moderate AACSB: Application of knowledge

15) Pal Corporation paid $5,000 for a 60% interest in Sonny Inc. on January 1, 2014 when Sonny's stockholders' equity consisted of $5,000 Capital Stock and $2,500 Retained Earnings. The fair value and book value of Sonny's assets and liabilities were equal on this date. Two years later, on December 31, 2015, the balance sheets of Pal and Sonny are summarized as follows:

Required: Complete the consolidated balance sheet working papers for Pal Corporation and Subsidiary at December 31, 2015.

Answer: Preliminary computations Fair value (purchase price) of 60% interest acquired January 1, 2014 Implied fair value of Sonny ($5,000 / 60%) Book value of Sonny's net assets Excess fair value over book value acquired

$5,000 $8,333 (7,500) $ 833

Allocation of excess of fair value over book value: Remainder to goodwill Excess of fair value over book value

833 $ 833

Objective: LO3.6 Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of eliminating entries. Difficulty: Moderate AACSB: Application of knowledge

16) Petra Corporation paid $500,000 for 80% of the outstanding voting common stock of Sizable Corporation on January 2, 2014 when the book value of Sizable's net assets was $460,000. The fair values of Sizable's identifiable net assets were equal to their book values except as indicated below.

Inventories (sold in 2014) Buildings-net (15-year life) Note Payable (paid in 2014)

Book Value $80,000 200,000 20,000

Fair Value $112,000 170,000 21,250

Sizable reported net income of $75,000 during 2014; dividends of $35,000 were declared and paid during the year. Required: 1. Prepare a schedule to allocate the fair value/book value differential to the specific identifiable assets and liabilities. 2.

Determine Petra's income from Sizable for 2014.

Determine the correct balance in the Investment in Sizable account as of December 31, 2014.

Answer: Preliminary computations Fair value (purchase price) of 80% interest acquired January 2, 2014 Implied fair value of Sizable ($500,000 / 80%) Book value of Sizable's net assets Excess fair value over book value acquired

$500,000 $625,000 (460,000) $165,000

Requirement 1 Allocation of excess of fair value over book value: Inventory Buildings-net Note payable Remainder to goodwill Excess of fair value over book value

$32,000 (30,000) (1,250) $164,250 $165,000

Requirement 2 Petra's share of Sizable income (all at 80%) Less: Excess allocated in inventory which was sold in the current year Add: Depreciation adjustment on building ($24,000 / 15 years) Add: Excess allocated to Note payable Net adjustment to investment account due to Petra's share of Sizable's income Requirement 3 Original cost of investment in Sizable Plus: Petra's share of Sizable's income (from Requirement 2) Less: Dividends received (35,000 × 80%) Investment in Sizable account at December 31, 2014

$60,000 (25,600) 1,600 1,000 $37,000

$500,000 37,000 (28,000) $509,000

Objective: LO3.7 Amortize the excess of the fair value over the book value in periods subsequent to the acquisition. Difficulty: Moderate AACSB: Application of knowledge

17) On January 1, 2014, Parry Incorporated paid $72,000 cash for 80% of Samuel Company's common stock. At that time Samuel had $40,000 capital stock and $30,000 retained earnings. The book values of Samuel's assets and liabilities were equal to fair values, and any excess amount is allocated to goodwill. Samuel reported net income of $18,000 during 2014 and declared $5,000 of dividends on December 31, 2014. At the time the dividends were declared, Parry recorded a receivable for the amount they expected to receive the following month. A summary of the balance sheets of Parry and Samuel are shown below.

Required: Complete the consolidated balance sheet working papers for Parry Corporation and Subsidiary at December 31, 2014.

Answer: Preliminary computations Initial investment for 80% ownership of Samuel: Implied fair value of Samuel ($72,000 / 80%) Book Value of Samuel Amount allocated to Goodwill

$72,000 90,000 (70,000) $20,000

Objective: LO3.6 Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of eliminating entries. Difficulty: Moderate AACSB: Application of knowledge

18) On January 1, 2014, Pinnead Incorporated paid $300,000 for an 80% interest in Shalle Company. At that time, Shalle's total book value was $300,000. Patents were undervalued in the amount of $10,000. Patents had a 5-year remaining useful life, and any remaining excess value was attributed to goodwill. The income statements for the year ended December 31, 2014 of Pinnead and Shalle are summarized below:

Sales Income from Shalle Cost of sales Depreciation Other Expenses Net Income

Pinnead $800,000 78,400 (100,000) (70,000) (130,000) $578,400

Shalle $300,000 (100,000) (30,000) (70,000) $100,000

Requirements: 1. Calculate the goodwill that will appear in the consolidated balance sheet of Pinnead and Subsidiary at December 31, 2014. 2. Calculate consolidated net income for 2014. 3. Calculate the noncontrolling interest share for 2014. Answer: Requirement 1 Pinnead paid to acquire 80% of Shalle $300,000 Implied fair value of Shalle($300,000 / 80%) 375,000 Book Value of Shalle 300,000 Excess fair value over book value of Shalle $75,000 Allocation of excess fair value over book value: Patent Goodwill Total excess fair value over book value allocated

10,000 65,000 $75,000

Consolidated Goodwill = $65,000 Requirement 2 Pinnead separate net income ($578,400 - $78,400) Shalle separate net income Amortization of patent($10,000 / 5 yrs) Consolidated Net Income

$500,000 100,000 (2,000) $598,000

Requirement 3 Shalle separate net income Amortization of excess value ($10,000 / 5 yrs) Adjusted net income Noncontrolling ownership Noncontrolling interest share

$100,000 (2,000) 98,000 20% $19,600

Objective: LO3.8 Apply the concepts underlying preparation of a consolidated income statement. Difficulty: Moderate AACSB: Application of knowledge

19) Pattalle Co. purchases Senday, Inc. on January 1 of the current year for $70,000 more than the fair value of Senday's net assets. Push-down accounting is used. At that date, the following values exist:

Requirement: Determine what amounts will appear in the listed accounts on Pattalle's general ledger, on Senday's general ledger, and on the consolidated balance sheet immediately following the acquisition. Make sure you post the entry to record the investment on Pattalle's books. Answer: Consolidating Consolidated Pattalle Ledger Senday Ledger Entry Statements Cash $270,000 $200,000 $470,000 A/R 5,000,000 320,000 5,320,000 Building — net 10,000,000 950,000 10,950,000 Equipment — net 4,000,000 1,400,000 5,400,000 Investment 2,730,000 ($2,730,000) 0 Goodwill 70,000 70,000 A/P (3,000,000) (210,000) (3,210,000) Bonds Payable (12,000,000) (12,000,000) Common Stock (1,000,000) (800,000) 800,000 (1,000,000) Retained Earnings (6,000,000) (6,000,000) Push-down Capital (1,930,000) 1,930,000 Objective: LO3.9 Introduce the concept of push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

3.3 True/False 1) A corporation becomes a subsidiary when another corporation acquires a controlling interest in its issued voting stock. Answer: FALSE Objective: LO3.1 Recognize the benefits and limitations of consolidated financial statements. Difficulty: Easy AACSB: Analytical thinking

2) A subsidiary can be excluded from consolidation when control does not rest with the majority owner. Answer: TRUE Objective: LO3.2 Understand the requirements for including a subsidiary in consolidated financial statements. Difficulty: Moderate AACSB: Analytical thinking

3) When the fiscal periods of the parent and its subsidiaries differ, we prepare consolidated statements for and as of the end of both the parent's and the subsidiary's fiscal period. Answer: FALSE Objective: LO3.2 Understand the requirements for including a subsidiary in consolidated financial statements. Difficulty: Moderate AACSB: Analytical thinking

4) When a parent acquires 100% of a subsidiary at book value the consolidated balance sheet eliminates reciprocal accounts and combines nonrecirpocal accounts. Answer: TRUE Objective: LO3.3 Apply consolidation concepts to parent company recording of an investment in a subsidiary company at the date of acquisition. Difficulty: Moderate AACSB: Analytical thinking

5) The acquisitions method for consolidation requires that all assets and liabilities of the subsidiary are reported using 100% of fair values at the combination date. Answer: TRUE Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Moderate AACSB: Analytical thinking

6) The GAAP requires a noncontrolling interest in a subsidiary be displayed and labeled in the consolidated balance sheet as a separate component of equity. Answer: TRUE Objective: LO3.5 Learn the concept of noncontrolling interest when a parent company acquires less than 100 percent of a subsidiary's outstanding common stock. Difficulty: Moderate AACSB: Analytical thinking

7) The excess of fair value over book value in a Parent-Subsidiary is assigned to goodwill assuming identifiable assets and liabilities are equal. Answer: TRUE Objective: LO3.6 Prepare consolidated balance sheets subsequent to the acquisition date, including preparation of eliminating entries. Difficulty: Moderate AACSB: Analytical thinking

8) A consolidated income statement must clearly separate income attributable to the controlling and noncontrolling interests. Answer: TRUE Objective: LO3.8 Apply the concepts underlying preparation of a consolidated income statement. Difficulty: Moderate AACSB: Analytical thinking

9) A parent's income from subsidiary investments can be referred to investment income from subsidiary. Answer: TRUE Objective: LO3.8 Apply the concepts underlying preparation of a consolidated income statement. Difficulty: Moderate AACSB: Analytical thinking

10) Push-down accounting is the process of recording the effects of the acquisition price assignment directly on the books of the parent company. Answer: FALSE Objective: LO3.9 Introduce the concept of push-down accounting. Difficulty: Moderate AACSB: Analytical thinking

11) The consolidated financial statements are primarily for the benefit of managers of the parent company. Answer: FALSE Objective: LO3.2 Understand the requirements for including a subsidiary in consolidated financial statements. Difficulty: Moderate AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 4 Consolidated Techniques and Procedures 4.1 Multiple Choice Questions 1) Which of the following will be debited to the Investment account when the equity method is used? A) Investee net losses B) Investee net profits C) Investee declaration of dividends D) Depreciation of excess purchase cost attributable to investee equipment Answer: B Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Easy AACSB: Analytical thinking

2) A parent company uses the equity method to account for its wholly-owned subsidiary. Which of the following will be a correct procedure for the Investment account? A) A debit for a subsidiary loss and a credit for dividends received B) A credit for subsidiary income and a debit for dividends received C) A debit for subsidiary dividends received and a credit for a subsidiary loss D) A credit for a subsidiary loss and a credit for dividends received Answer: D Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Easy AACSB: Analytical thinking

3) A parent corporation owns 55% of the outstanding voting common stock of one domestic subsidiary. The parent has control over the subsidiary. Which of the following statements is correct? A) The parent corporation must prepare consolidated financial statements for the economic entity. B) The parent corporation must use the fair value method. C) The parent company may use the equity method but the subsidiary cannot be consolidated. D) The parent company can use the equity method or the fair value/cost method. Answer: A Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Easy AACSB: Analytical thinking

Use the following information to answer question(s) below. On January 1, 2014, Punch Corporation purchased 80% of the common stock of Soopy Co. Separate balance sheet data for the companies at the acquisition date (after the acquisition) are given below:

Cash Accounts Receivable Inventory Land Plant assets Accum. Depreciation Investment in Soopy Total assets

Punch $34,000 144,000 132,000 68,000 700,000 (240,000) 392,000 $ 1,230,000

Soopy $206,000 26,000 38,000 32,000 300,000 (60,000) $ 542,000

Accounts payable Capital stock Retained earnings Total liabilities & equities

$206,000 800,000 224,000 $ 1,230,000

$142,000 300,000 100,000 $ 542,000

At the date of the acquisition, the book values of Soopy's net assets were equal to the fair value except for Soopy's inventory, which had a fair value of $60,000. Determine below what the consolidated balance would be for each of the requested accounts. 4) What amount of Inventory will be reported? A) $170,000 B) $169,000 C) $186,500 D) $192,000 Answer: D Explanation: D) Combined inventory of $132,000 (Punch) plus $60,000 (Soopy) fair value. Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Application of knowledge

5) What amount of Goodwill will be reported? A) $54,400 B) $68,000 C) $72,000 D) $90,000 Answer: B Explanation: B) Investment in Soopy ($392,000)/ownership percentage (80%) = implied fair value of Soopy ($490,000) - Soopy's underlying book value ($400,000) - the excess cost over book value allocated to inventory ($22,000) = $68,000 allocated to goodwill. Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Application of knowledge

6) What amount of total liabilities will be reported? A) $206,000 B) $278,400 C) $319,600 D) $348,000 Answer: D Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Application of knowledge

7) What is the reported amount for the noncontrolling interest? A) $80,000 B) $84,400 C) $98,000 D) $122,500 Answer: C Explanation: C) Implied value of Soopy = $392,000/80% = $490,000 × 20% = $98,000 Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Application of knowledge

8) What is the amount of consolidated Retained Earnings? A) $224,000 B) $259,200 C) $304,000 D) $324,000 Answer: A Explanation: A) The parent's Retained Earnings is the amount of consolidated Retained Earnings Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Application of knowledge

9) What is the amount of total assets? A) $1,380,000 B) $1,402,000 C) $1,470,000 D) $1,875,000 Answer: C Explanation: C) Cash Accounts Receivable Inventory $132,000 + $38,000 + $22,000 = Land Plant assets-net Goodwill Total assets

$240,000 170,000 192,000 100,000 700,000 68,000 $ 1,470,000

Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Application of knowledge

10) Bird Corporation has several subsidiaries that are included in its consolidated financial statements and several other investments in corporations that are not consolidated. In its year-end trial balance, the following intercompany balances appear. Ostrich Corporation is the unconsolidated company; the rest are consolidated. Due from Pheasant Corporation Due from Turkey Corporation Cash advance to Skylark Company Cash advance to Starling Current receivable from Ostrich

$25,000 5,000 8,000 15,000 10,000

What amount should Bird report as intercompany receivables on its consolidated balance sheet? A) $0 B) $10,000 C) $30,000 D) $63,000 Answer: B Explanation: B) Intercompany receivables and payables from unconsolidated subsidiaries would not be eliminated. Objective: LO4.2 Prepare a consolidation workpaper for the years subsequent to an acquisition. Difficulty: Moderate AACSB: Application of knowledge

11) When performing a consolidation, if the balance sheet does not balance, A) that indicates that the Investment in Subsidiary account on the parent's books should not be adjusted to -0-, because there is excess value represented in the investment. B) it is frequently because of the noncontrolling interest, as these amounts do not appear on the separate companies' general ledgers. C) the debit and credit totals of the adjusting/eliminating columns of the consolidation working paper should be checked to confirm that they balance, and if so, then there is no need to check the individual line items. D) the amount that it is "off" will always equal the noncontrolling interest in the current year net income of the subsidiary. Answer: B Objective: LO4.3 Locate errors in a consolidation workpaper. Difficulty: Moderate AACSB: Analytical thinking

12) At the beginning of 2014, Parling Food Services acquired a 90% interest in Simmons' Orchards when Simmons' book values of identifiable net assets equaled their fair values. On December 26, 2014, Simmons declared dividends of $50,000, and the dividends were unpaid at year-end. Parling had not recorded the dividend receivable at December 31. A consolidated working paper entry is necessary to A) enter $50,000 dividends receivable in the consolidated balance sheet. B) enter $45,000 dividends receivable in the consolidated balance sheet. C) reduce the dividends payable account by $45,000 in the consolidated balance sheet. D) eliminate the dividend payable account from the consolidated balance sheet. Answer: C Objective: LO4.3 Locate errors in a consolidation workpaper. Difficulty: Moderate AACSB: Analytical thinking

13) A parent company uses the equity method to account for its wholly-owned subsidiary, but has applied it incorrectly. In each of the past four full years, the company adjusted the Investment account when it received dividends from the subsidiary but did not adjust the account for any of the subsidiary's profits. The subsidiary had four years of profits and paid yearly dividends in amounts that were less than reported net incomes. Which one of the following statements is correct if the parent company discovered its mistake at the end of the fourth year, and is now preparing consolidation working papers? A) The parent company's Retained Earnings will be increased by the cumulative total of four years of subsidiary profits. B) The parent company's Retained Earnings will be increased by the cumulative total of the first three years of subsidiary profit, and the Subsidiary Income account will be increased by the profit for the current year. C) The parent company's Subsidiary Income account will be increased by the cumulative total of four years of subsidiary profits. D) A prior period adjustment must be recorded for the cumulative effect of four years of accounting errors. Answer: B Objective: LO4.3 Locate errors in a consolidation workpaper. Difficulty: Moderate AACSB: Analytical thinking

14) Pigeon Corporation acquired an 80% interest in Statue Company on January 1, 2014, for $90,000 cash when Statue had Capital Stock of $60,000 and Retained Earnings of $40,000. The fair value/book value differential of $12,500 was attributable to equipment with a 10-year (straight-line) life. Statue suffered a $10,000 net loss in 2014 and paid no dividends. At year-end 2014, Statue owed Pigeon $18,000 on account. Pigeon's separate income for 2011 was $150,000. Controlling interest share of consolidated net income for 2014 was A) $140,000. B) $141,000. C) $142,000. D) $150,000. Answer: B Explanation: B) Pigeon's separate income $150,000 Less:80% of Statue's $10,000 loss (8,000) Less: Equipment depreciation ($12,500 × 80%)/ 10 years = (1,000) Controlling Interest Share of Consolidated net income $141,000 Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Application of knowledge

15) On consolidated working papers, a subsidiary's net income is A) deducted from beginning consolidated retained earnings. B) deducted from ending consolidated retained earnings. C) allocated between the noncontrolling interest share and the parent's share. D) only an entry in the parent company's general ledger. Answer: C Objective: LO4.2 Prepare a consolidation workpaper for the years subsequent to an acquisition. Difficulty: Easy AACSB: Analytical thinking

16) Which one of the following will increase consolidated retained earnings? A) An increase in the value of goodwill associated with a subsidiary subsequent to the parent's date of acquisition B) The amortization of a $10,000 excess in the fair value of a note payable over its recorded book value C) The depreciation of a $10,000 excess in the fair value of equipment over its recorded book value D) The sale of inventory by a subsidiary that had a $10,000 excess in fair value over recorded book value on the parent's date of acquisition Answer: B Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Easy AACSB: Analytical thinking

17) Which of the following statements is NOT true with respect to the statement of cash flows for a consolidated entity? A) The statement may be prepared using either the direct or the indirect method. B) Noncontrolling interest share will be added back to cash flows from operating activities under the indirect method. C) Payment of dividends from the subsidiary to the parent will appear on the statement of cash flows as a financing activity. D) If the subsidiary does not use the same method (direct or indirect) as the parent, it must convert their separate statement of cash flows first to the same method that the parent uses, and then the two statements are consolidated. Answer: D Objective: LO4.5 Prepare a consolidated statement of cash flows. Difficulty: Easy AACSB: Analytical thinking

18) In contrast with single entity organizations, consolidated financial statements include which of the following in the calculation of cash flows from operating activities under the indirect method? A) Cash paid to employees B) Noncontrolling interest dividends paid C) Noncontrolling interest share D) Proceeds from the sale of land Answer: C Objective: LO4.5 Prepare a consolidated statement of cash flows. Difficulty: Easy AACSB: Analytical thinking

19) When preparing consolidated financial statements, which of the following is a subtraction in the calculation of cash flows from operating activities under the indirect method? A) The change in the balance sheet of the common stock account B) Noncontrolling interest dividends paid C) Noncontrolling interest share D) Undistributed income of equity investees Answer: D Objective: LO4.5 Prepare a consolidated statement of cash flows. Difficulty: Easy AACSB: Analytical thinking

20) When preparing the consolidation workpaper for a company and its controlled subsidiary, which of the following would be used for the entities being consolidated? A) Post-closing trial balances B) Adjusted trial balances C) Unadjusted trial balances D) The adjusted trial balance for the parent and the unadjusted trial balance for all controlled subsidiaries Answer: B Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Easy AACSB: Analytical thinking

4.2 Exercises 1) Parrot Corporation acquired 90% of Swallow Co. on January 1, 2014 for $27,000 cash when Swallow's stockholders' equity consisted of $10,000 of Capital Stock and $5,000 of Retained Earnings. The difference between the fair value and book value of Swallow's net assets was allocated solely to a patent amortized over 5 years. The separate company statements for Parrot and Swallow appear in the first two columns of the partially completed consolidation working papers. Required: Complete the consolidation working papers for Parrot and Swallow for the year 2014.

Answer:

Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Moderate AACSB: Application of knowledge

2) On December 31, 2014, Paladium International purchased 70% of the outstanding common stock of Sennex Chemical. Paladium paid $140,000 for the shares and determined that the fair value of all recorded Sennex assets and liabilities approximated their book values, with the exception of a customer list that was not recorded and had a fair value of $10,000, and an expected remaining useful life of 5 years. At the time of purchase, Sennex had stockholders' equity consisting of capital stock amounting to $20,000 and retained earnings amounting to $80,000. Any remaining excess fair value was attributed to goodwill. The separate financial statements at December 31, 2015 appear in the first two columns of the consolidation workpapers shown below.

Required: Complete the consolidation working papers for Paladium and Sennex for the year 2015.

Answer:

Objective: LO4.2 Prepare a consolidation workpaper for the years subsequent to an acquisition. Difficulty: Moderate AACSB: Application of knowledge

3) Packo Company acquired all the voting stock of Sennett Corporation on January 1, 2014 for $90,000 when Sennett had Capital Stock of $50,000 and Retained Earnings of $8,000. The excess of fair value over book value was allocated as follows: (1) $5,000 to inventories (sold in 2014), (2) $16,000 to equipment with a 4-year remaining useful life (straight-line method of depreciation) and (3) the remainder to goodwill. Financial statements for Packo and Sennett at the end of the fiscal year ended December 31, 2015 (two years after acquisition), appear in the first two columns of the partially completed consolidation working papers. Packo has accounted for its investment in Sennett using the equity method of accounting. Required: Complete the consolidation working papers for Packo Company and Subsidiary for the year ending December 31, 2015.

Answer:

Objective: LO4.2 Prepare a consolidation workpaper for the years subsequent to an acquisition. Difficulty: Moderate AACSB: Application of knowledge

4) Powell Corporation acquired 90% of the voting stock of Santer Corporation on January 1, 2014 for $11,700 when Santer had Capital Stock of $5,000 and Retained Earnings of $4,000. The amounts reported on the financial statements approximated fair value, with the exception of inventories, which were understated on the books by $500 and were sold in 2014, land which was undervalued by $1,000, and equipment with a remaining useful life of 5 years under the straight-line method which was undervalued by $1,500. Any remainder was assigned to goodwill. Financial statements for Powell and Santer Corporations at the end of the fiscal year ended December 31, 2015 appear in the first two columns of the partially completed consolidation working papers. Powell has accounted for its investment in Santer using the equity method of accounting. Powell Corporation owed Santer Corporation $100 on open account at the end of the year. Dividends receivable in the amount of $450 payable from Santer to Powell is included in Powell's net receivables.

Required: Complete the consolidation working papers for Powell Corporation and Subsidiary for the year ended December 31, 2015.

Answer:

Objective: LO4.2 Prepare a consolidation workpaper for the years subsequent to an acquisition. Difficulty: Moderate AACSB: Application of knowledge

5) Puddle Corporation acquired all the voting stock of Soggi Company for $500,000 on January 1, 2014 when Soggi had Capital Stock of $300,000 and Retained Earnings of $150,000. The book value of Soggi's assets and liabilities were equal to the fair value except for the plant assets. The entire cost-book value differential is allocated to plant assets and is fully depreciated on a straight-line basis over a 10-year period. During 2014, Puddle borrowed $25,000 on a short-term non-interest-bearing note from Soggi, and on December 31, 2014, Puddle mailed a check to Soggi to settle the note. Soggi deposited the check on January 5, 2015, but receipt of payment of the note was not reflected in Soggi's December 31, 2014 balance sheet.

Required: Complete the consolidation working papers for the year ended December 31, 2014.

Answer:

6) Pecan Incorporated acquired 80% of the voting stock of Shew Manufacturing for $800,000 on January 2, 2014 when Shew had outstanding common stock of $600,000 and Retained Earnings of $300,000. The book value and fair value of Shew's assets and liabilities were equal except for equipment. The entire fair value/book value differential is allocated to equipment and is fully depreciated on a straight-line basis over a 5-year period. During 2014, Shew borrowed $80,000 on a short-term non-interest-bearing note from Pecan, and on December 31, 2014, Shew mailed a check for $20,000 to Pecan in partial payment of the note. Pecan deposited the check on January 4, 2015, and recorded the entry to reduce the note balance at that time.

Required: Complete the consolidation working papers for the year ended December 31, 2014.

Answer:

7) Pawl Corporation acquired 90% of Snab Corporation on January 1, 2014 for $72,000 cash when Snab's stockholders' equity consisted of $30,000 of Capital Stock and $30,000 of Retained Earnings. The difference between the fair value of Pawl's assets and liabilities and the book value was allocated to a plant asset with a remaining 10-year straight-line life that was overvalued on the books by $5,000. The remainder was attributable to goodwill. The separate company statements for Pawl and Snab appear in the first two columns of the partially completed consolidation working papers. Required: Complete the consolidation working papers for Pawl and Snab for the year 2014.

Answer: Preliminary Calculations: Investment cost on January 1, 2014 Implied fair value of net assets ($72,000/0.90) Book value of net assets on January 1, 2014 Excess implied fair value over book value acquired =

$ 72,000 80,000 (60,000) $ 20,000

Excess allocated to: Overvalued equipment Remainder to goodwill Excess implied fair value over book value

$ (5,000) 25,000 $ 20,000

Income from Snab Corporation: Equity in Snab's net income (90%) × (3,400) = Depreciation "savings" on equipment $4,500/10 yrs = Income from Snab

$ 3,060 450 $ 3,510

Investment in Snab account: Initial investment cost Plus: Income from Snab Less: Dividends (3,000) × (90%)= Investment in Snab at December 31

$ 72,000 3,510 (2,700) $ 72,810

8) Parakeet Company has the following information collected in order to prepare a cash flow statement and uses the direct method for Cash Flow from Operations. The annual report year end is December 31, 2014. Noncontrolling Interest Dividends Paid Dividends Received from Equity Investees Cash Paid to Employees Cash Paid for Other Operating Activities Cash Paid for Interest Expense Cash Proceeds from the Sale of Equipment Cash Paid to Suppliers Cash Received from Customers

$20,000 17,000 37,000 34,000 22,300 70,000 192,700 412,600

Required: 1. Prepare the Cash Flow for Operations part of the cash flow statement for Parakeet for the year ended December 31, 2014. Answer: Parakeet Company and Subsidiary Consolidated Statement of Cash Flows For the Year Ended December 31, 2014 Cash Flows From Operating Activities: Cash Received from Customers Add:Dividends Received from Equity Investees Less: Cash Paid to Suppliers Less: Cash Paid to Employees Less:Cash Paid for Other Operating Activities Less: Cash Paid for Interest Expense Net cash flows from operating activities

$412,600 17,000 ($192,700) (37,000) (34,000) (22,300)

Objective: LO4.5 Prepare a consolidated statement of cash flows. Difficulty: Moderate AACSB: Application of knowledge

(286,000) $143,600

9) Flagship Company has the following information collected in order to prepare a cash flow statement and uses the indirect method for Cash Flow from Operations. The annual report year end is December 31, 2014. Noncontrolling Interest Dividends Paid Undistributed Income of Equity Investees Depreciation Expense Controlling Interest Share of Consolidated Net Income Increase in Accounts Payable Amortization of Patent Decrease in Accounts Receivable Increase in Inventories Gain on sale of equipment Noncontrolling Interest Share

$17,000 7,000 80,000 325,000 26,000 10,000 57,000 72,000 45,000 27,000

Required: 1. Prepare the Cash Flow for Operations part of the cash flow statement for Flagship for the year ended December 31, 2014. Answer:

Flagship Company and Subsidiary Consolidated Statement of Cash Flows For the Year Ended December 31, 2014

Cash Flows From Operating Activities: Controlling Interest Share of Consolidated Net Income

$325,000

Adjustments to reconcile controlling interest share of consolidated net income to net cash flow from operating activities: Noncontrolling Interest Share Undistributed Income of Equity Investees Depreciation Expense Increase in Accounts Payable Amortization of Patent Decrease in Accounts Receivable Increase in Inventories Gain on sale of equipment Net cash flow from operating activities

$27,000 (7,000) 80,000 26,000 10,000 57,000 (72,000) (45,000)

Objective: LO4.5 Prepare a consolidated statement of cash flows. Difficulty: Moderate AACSB: Application of knowledge

76,000 $401,000

10) Platt Corporation paid $87,500 for a 70% interest in Suve Corporation on January 1, 2014, when Suve's Capital Stock was $70,000 and its Retained Earnings $30,000. The fair values of Suve's identifiable assets and liabilities were the same as the recorded book values on the acquisition date. Trial balances at the end of the year on December 31, 2014 are given below:

Cash Accounts Receivable Inventory Investment in Suve Cost of Goods Sold Operating Expenses Dividends

Liabilities Capital stock, $10 par value Additional Paid-in Capital Retained Earnings Sales Revenue Dividend Income

Platt $4,500 26,000 100,000 87,500 60,000 22,000 15,000 $315,000

Suve $20,000 30,000 80,000 40,000 37,000 10,000 $217,000

$47,000 100,000 10,000 31,000 120,000 7,000 $315,000

$27,000 70,000 30,000 90,000 0 $217,000

During 2014, Platt made only two journal entries with respect to its investment in Suve. On January 1, 2014, it debited the Investment in Suve account for $87,500 and on November 1, 2014, it credited Dividend Income for $7,000. Required: 1. Prepare a consolidated income statement and a statement of retained earnings for Platt and Subsidiary for the year ended December 31, 2014. 2. Prepare a consolidated balance sheet for Platt and Subsidiary as of December 31, 2014.

Answer: Requirement 1 Platt and Subsidiary Corporation Consolidated Income Statement For the year ended December 31, 2014 Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses Consolidated Net Income Less: Noncontrolling Interest Share Controlling Interest Share of Consolidated Net Income

$210,000 100,000 110,000 59,000 51,000 (3,900) $47,100

Platt and Subsidiary Corporation Consolidated Statement of Retained Earnings For the Year Ended December 31, 2014 Retained Earnings, January 1, 2014 Add: Controlling Interest Share of Consolidated Net Income Less: Dividends Retained Earnings, December 31, 2014

$31,000 47,100 (15,000) $63,100

Requirement 2 Platt and Subsidiary Corporation Consolidated Balance Sheet December 31, 2014 Assets Cash Accounts Receivable Inventory Goodwill Total Assets

$24,500 56,000 180,000 25,000 $285,500

Equities Liabilities Capital Stock Additional Paid-in Capital Retained Earnings Noncontrolling interest Total Liabilities and Equities

$74,000 100,000 10,000 63,100 38,400 $285,500

Noncontrolling interest Calculation: $37,500 Beginning equity in fair value of company [($87,500/70%) × 30%] + $3,900 Net income - $3,000 Dividends = $38,400 Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Difficult AACSB: Application of knowledge

11) Pommu Corporation paid $78,000 for a 60% interest in Schtick Inc. on January 1, 2014, when Schtick's Capital Stock was $80,000 and its Retained Earnings $20,000. The fair values of Schtick's identifiable assets and liabilities were the same as the recorded book values on the acquisition date. Trial balances at the end of the year on December 31, 2014 are given below:

Cash Accounts Receivable Inventory Investment in Schtick Cost of Goods Sold Operating Expenses Dividends

Liabilities Capital stock, $10 par value Additional Paid-in Capital Retained Earnings Sales Revenue Dividend Income

Pommu $4,500 24,000 100,000 78,000 71,500 22,000 15,000 $315,000

Schtick $20,000 30,000 70,000 50,000 37,000 10,000 $217,000

$47,000 100,000 11,000 31,000 120,000 6,000 $315,000

$27,000 80,000 20,000 90,000 $217,000

During 2014, Pommu made only two journal entries with respect to its investment in Schtick. On January 1, 2014, it debited the Investment in Schtick account for $78,000 and on November 1, 2014, it credited Dividend Income for $6,000. Required: 1. Prepare a consolidated income statement and a statement of retained earnings for Pommu and Subsidiary for the year ended December 31, 2014. 2.

Prepare a consolidated balance sheet for Pommu and Subsidiary as of December 31, 2014.

Answer: Requirement 1 Pommu and Subsidiary Corporation Consolidated Income Statement For the year ended December 31, 2014 Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses Consolidated Net Income Less: Noncontrolling Interest Share Controlling Interest Share of Consolidated Net Income

$210,000 121,500 88,500 59,000 29,500 (1,200) $28,300

Pommu and Subsidiary Corporation Consolidated Retained Earnings Statement For the Year Ended December 31, 2014 Retained Earnings, January 1, 2014 Add: Controlling Interest Share of Consolidated Net Income Less:Dividends Retained Earnings, December 31, 2014

$31,000 28,300 (15,000) $44,300

Requirement 2 Pommu and Subsidiary Corporation Consolidated Balance Sheet December 31, 2014 Assets Cash Accounts Receivable Inventory Goodwill Total Assets

$24,500 54,000 170,000 30,000 $278,500

Equities Liabilities Capital Stock Additional Paid-in Capital Retained Earnings Noncontrolling Interest Total Liabilities and Equities

$74,000 100,000 11,000 44,300 49,200 $278,500

Noncontrolling Interest Calculation: $52,000 Beginning equity in fair value of company [($78,000/60%) × 40%] + $1,200 Net income - $4,000 Dividends = $49,200 Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Difficult AACSB: Application of knowledge

12) Pennack Corporation purchased 75% of the outstanding stock of Shing Corporation on January 1, 2014 for $300,000 cash. At the time of the purchase, the book value and fair value of Shing's assets and liabilities were equal. Shing's balance sheet at the time of acquisition and December 31, 2014 are shown below.

Cash Other current assets Plant Assets — net Total assets

Jan 1, 2014 $75,000 175,000 250,000 $500,000

Dec 31, 2014 $80,000 160,000 240,000 $480,000

Liabilities Capital stock Retained earnings Total liabilities and equity

$100,000 100,000 300,000 $500,000

$50,000 100,000 330,000 $480,000

Shing earned $60,000 in income during the year, and paid out $30,000 in dividends. Pennack uses the equity method to account for its investment in Shing. Requirement 1: Calculate Pennack's net income from Shing in 2014. Requirement 2: Calculate the noncontrolling interest share in Shing's income for 2014. Requirement 3: Calculate the balance in the Investment in Shing account reported on Pennack's separate general ledger at December 31, 2014. Requirement 4: Calculate the noncontrolling interest that will be reported on the consolidated balance sheet at December 31, 2014. Answer: Requirement 1: Shing's net income of $60,000 × 75% = $45,000 Requirement 2: Shing's net income of $60,000 × 25% = $15,000 Requirement 3: Initial investment of $300,000 + Pennack's share of Shing's income $45,000 - dividends received from Shing $22,500 = $322,500 Requirement 4: Beginning noncontrolling interest $100,000 + noncontrolling interest in income $15,000 noncontrolling dividends $7,500 = $107,500 Objective: LO4.2 Prepare a consolidation workpaper for the years subsequent to an acquisition. Difficulty: Moderate AACSB: Application of knowledge

13) On January 1, 2014, Paisley Incorporated paid $300,000 for 60% of Smarnia Company's outstanding capital stock. Smarnia reported common stock on that date of $250,000 and retained earnings of $100,000. Plant assets, which had a five-year remaining life, were undervalued in Smarnia's financial records by $10,000. Smarnia also had a patent that was not on the books, but had a market value of $60,000. The patent has a remaining useful life of 10 years. Any remaining fair value/book value differential is allocated to goodwill. Smarnia's net income and dividends paid the first three years that Paisley owned them are shown below.

2014 2015 2016

Net Income $80,000 90,000 60,000

Dividends Paid $30,000 10,000 20,000

Requirement 1: Calculate the noncontrolling interest share in Smarnia's income for each of the three years. Requirement 2: Calculate the noncontrolling interest that should be reported on the consolidated balance sheet at the end of each of the three years. Requirement 3: Assuming that Paisley uses the equity method to record their investment in Smarnia, calculate the ending balance in the Investment in Smarnia account for each of the three years.

Answer: Preliminary calculations: Fair value of Smarnia ($300,000 paid / 60%) Book Value of Smarnia Excess of fair value over book value

$500,000 (350,000) $150,000

Excess of fair value over book value allocation: Plant assets Patent Goodwill Excess of fair value over book value allocated

$10,000 60,000 80,000 $150,000

Requirement 1: Smarnia net income Plant asset excess depr. Patent excess amort. Smarnia net income × 40% = Noncontrol int.

2014 $80,000 (2,000) (6,000) 72,000 28,800

2015 $90,000 (2,000) (6,000) 82,000 32,800

Requirement 2: Beginning noncontrolling interest Fair value ($500,000 × 40%) Plus: 2014 Net income (from above) Less: 2014 Dividends ($30,000 × 40%) Noncontrolling interest at 12/31/14 Plus: 2015 Net income (from above) Less: 2015 Dividends ($10,000 × 40%) Noncontrolling interest at 12/31/15 Plus: 2016 Net income (from above) Less: 2016 Dividends ($20,000 × 40%) Noncontrolling interest at 12/31/16

$200,000 28,800 (12,000) $216,800 32,800 (4,000) $245,600 20,800 (8,000) $258,400

Requirement 3: Beginning investment Plus: 2014 Net income ($72,000 × 60%) Less: 2014 Dividends ($30,000 × 60%) Noncontrolling interest at 12/31/14 Plus: 2015 Net income ($82,000 × 60%) Less: 2015 Dividends ($10,000 × 60%) Noncontrolling interest at 12/31/15 Plus: 2016 Net income ($52,000 × 60%) Less: 2016 Dividends ($20,000 × 60%) Noncontrolling interest at 12/31/16

$300,000 43,200 (18,000) $325,200 49,200 (6,000) $368,400 31,200 (12,000) $387,600

2016 $60,000 (2,000) (6,000) 52,000 20,800

Objective: LO4.2 Prepare a consolidation workpaper for the years subsequent to an acquisition. Difficulty: Moderate AACSB: Application of knowledge

14) On January 2, 2014, PBL Enterprises purchased 90% of Santos Incorporated outstanding common stock for $1,687,500 cash. Santos' net assets had a book value of $1,300,000 at the time. A building with a 15-year remaining life and a book value of $100,000 had a fair value of $175,000. Any other excess amount was attributed to goodwill. PBL reported net income for the first year of $350,000 (without regard for its ownership in Santos), while Santos had $175,000 in earnings. Required: 1. Calculate the amount of goodwill related to this acquisition as reported on the consolidated balance sheet at January 2, 2014. 2. Calculate the amount of consolidated net income for the year ended December 31, 2014. 3. What is the amount that will be assigned to the building on the consolidated balance sheet at the date of acquisition? Answer: 1. Consolidated Goodwill Fair value of Santos ($1,687,500 paid / 90%) $1,875,000 Book Value of Santos (1,300,000) Excess of fair value over book value $575,000 Excess of fair value over book value allocation: Building Goodwill Excess of fair value over book value allocated

$75,000 500,000 $575,000

2. Consolidated net income PBL separate net income Santos separate net income Amortization of excess fair value ($75,000 / 15) Consolidated net income

$350,000 175,000 (5,000) $520,000

3. The building will be recorded on the consolidated balance sheet at the date of acquisition at its fair value of $175,000. Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Easy AACSB: Application of knowledge

15) On December 31, 2014, Patenne Incorporated purchased 60% of Smolin Manufacturing for $300,000. The book value and fair value of Smolin's assets and liabilities were equal with the exception of plant assets which were undervalued by $60,000 and had a remaining life of 10 years, and a patent which was undervalued by $40,000 and had a remaining life of 5 years. At December 31, 2016, the companies showed the following balances on their respective adjusted trial balances: Patenne Book Value

Smolin Book Value

Smolin Fair Value

Assets (includes Investment in Smolin) Plant assets - net Patent Expenses

$950,000 590,000 310,000 800,000

$300,000 150,000 200,000 300,000

$320,000 150,000 280,000

Liabilities Common Stock Retained Earnings Revenue

$480,000 300,000 890,000 980,000

$120,000 100,000 330,000 400,000

$120,000

Requirement 1: Calculate the balance in the Plant assets - net and the Patent accounts on the consolidated balance sheet as of December 31, 2016. Requirement 2: Calculate consolidated net income for 2016, and the amount allocated to the controlling and noncontrolling interests. Requirement 3: Calculate the balance of the noncontrolling interest in Smolin to be reported on the consolidated balance sheet at December 31, 2016.

Answer: Requirement 1: Patenne book value of Plant assets at 12/31/16 Smolin book value of Plant assets at 12/31/16 Plus: Excess value at acquisition 12/31/14 Less: Amortization for 2015 and 2016 Plant assets — net consolidated

$590,000 150,000 60,000 (12,000) $788,000

Patenne book value of Patent at 12/31/16 Smolin book value of Patent at 12/31/16 Plus: Excess value at acquisition 12/31/14 Less: Amortization for 2015 and 2016 Patent — net consolidated

$310,000 200,000 40,000 (16,000) $534,000

Requirement 2: Patenne separate net income ($980,000 - $800,000) Smolin separate net income ($400,000 - $300,000) Amortization of excess value - Plant assets and Patent ($6,000 + $8,000) Consolidated net income

$180,000 100,000 (14,000) $266,000

Patenne net income Smolin net income allocated to controlling interest [($100,000 - $14,000) × 60%) Controlling Interest Share of Consolidated Net Income Noncontrolling Interest Share of Consolidated Net Income [($100,000 - $14,000) × 40%) Requirement 3 Book Value of Smolin at 1/1/16 ($330,000 + $100,000) Increase in book value of Smolin for 2016 Excess value remaining from purchase: Plant assets ($60,000 - $12,000) Patent ($40,000 - $16,000) Total remaining fair value of Smolin at 12/31/16 Noncontrolling interest at 12/31/16 (× 40%)

$180,000 51,600 $231,600

$34,400

$430,000 100,000 48,000 24,000 602,000 $240,800

Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Application of knowledge

16) Pull Incorporated and Shove Company reported summarized balance sheets as shown below, on December 31, 2014.

Current assets Noncurrent assets Total assets

Pull $420,000 670,000 $1,090,000

Shove $210,000 430,000 $640,000

Current liabilities Long-term debt Stockholders' equity Total liabilities and equities

$230,000 350,000 510,000 $1,090,000

$50,000 150 000 440,000 $640,000

On January 1, 2015, Pull purchased 70% of the outstanding capital stock of Shove for $392,000, of which $92,000 was paid in cash, and $300,000 was borrowed from their bank. The debt is to be repaid in 10 annual installments beginning on December 31, 2015, with each payment consisting of $30,000 principal, plus accrued interest. The excess fair value of Shove Company over the underlying book value is allocated to inventory (60 percent) and to goodwill (40 percent). Required: Calculate the balance in each of the following accounts, on the consolidated balance sheet, immediately following the acquisition. a. Current assets b. Noncurrent assets c. Current liabilities d. Long-term debt e. Stockholders' equity

Answer: Preliminary calculation Implied fair value of acquisition ($392,000 / 70%) Book value of acquisition Excess of fair value over book value

$560,000 (440,000) $120,000

Allocation of excess of fair value over book value Inventory (60%) Goodwill (40%) Total allocated

$72,000 48,000 $120,000

a. Current assets Pull balance prior to acquisition Shove balance prior to acquisition Cash paid out for acquisition Inventory excess fair value over book value

$420,000 210,000 (92,000) 72,000 $610,000

b. Noncurrent assets Pull balance prior to acquisition Shove balance prior to acquisition Goodwill excess fair value over book value

$670,000 430,000 48,000 $1,148,000

c. Current liabilities Pull balance prior to acquisition Shove balance prior to acquisition Current portion of long term debt incurred

$230,000 50,000 30,000 $310,000

d. Long-term debt Pull balance prior to acquisition Shove balance prior to acquisition Noncurrent portion of debt incurred

$350,000 150,000 270,000 $770,000

e. Stockholders' equity Pull balance prior to acquisition Noncontrolling interest in Shove

$510,000 168,000 $678,000

Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Application of knowledge

17) On January 2, 2014, Paleon Packaging purchased 90% of the outstanding common stock of Sampson Shipping and Supplies for $513,000. Sampson's book values represented the fair values of all recorded assets and liabilities at that date, however Sampson had rights to a patent that was not recorded on their books, with an approximate fair value of $270,000, and a 10-year remaining useful life. Sampson's shareholders' equity reported on that date consisted of $100,000 in capital stock and $150,000 in retained earnings. Any remaining fair value/book value differential is assumed to be goodwill. The December 31, 2015 financial statements for each of the companies are provided in the worksheet below. Required: Complete the consolidation worksheet provided below to determine consolidated balances to be reported at December 31, 2015.

Answer: Calculations: Implied fair value ($513,000/0.90) Book value of Sampson Excess fair value over book value

$570,000 (250,000) $320,000

Excess fair value over book value allocated to: Patent Goodwill Excess fair value over book value

$270,000 50,000 $320,000

Objective: LO4.2 Prepare a consolidation workpaper for the years subsequent to an acquisition. Difficulty: Moderate AACSB: Application of knowledge

18) On January 1, 2014, Persona Company acquired 80% of Sule Tooling for $332,000. At that time, Sule reported their Common stock at $150,000, Additional paid in capital at $45,000, and Retained earnings at $105,000. Sule also had equipment on their books that had a remaining life of 10 years and were undervalued on the books by $40,000, but any additional fair value/book value differential is assumed to be goodwill. During the next three years, Sule reported the following: Year 2014 2015 2016

Net Income $35,000 45,000 50,000

Dividends Paid $5,000 7,500 10,000

Required: Calculate the following. a. How much excess depreciation or amortization would be recognized in the consolidated financial statements in each of these three years? b. How much goodwill would be recognized on the balance sheet at the date of acquisition, and at the end of each year listed? c. How much investment income would be reported by Persona under the equity method for each of the three years? d. What would be the balance in the Investment in Sule account at January 1, 2014, and at the end of each of the three years listed?

Answer: Preliminary calculation: Implied fair value of Sule ($332,000 / 80%) Book value of Sule Fair value in excess of book value to be allocated

$415,000 (300,000) $115,000

Undervalued equipment Goodwill Total excess fair value allocated

$40,000 75,000 $115,000

a. Excess depreciation = Excess fair value of equipment $40,000 / 10 year remaining life = $4,000 / year for each of the three years. b. Goodwill calculated above at $75,000 would be reported at the date of acquisition and at the end of each of the three years until a review indicates that the value has been impaired. c. Sule separate income Excess depreciation Sule stand-alone income × 80% ownership

2014 $35,000 (4,000) 31,000 24,800

2015 $45,000 (4,000) 41,000 32,800

d. Investment in Sule at 1/1/14 2014 (Sule Income - Excess amortization) × 80% 2014 Dividends × 80% Investment in Sule at 12/31/14 2015 (Sule Income - Excess amortization) × 80% 2015 Dividends × 80% Investment in Sule at 12/31/15 2016 (Sule Income - Excess amortization) × 80% 2016 Dividends × 80% Investment in Sule at 12/31/16

2016 $50,000 (4,000) 46,000 36,800

$332,000 24,800 (4,000) 352,800 32,800 (6,000) 379,600 36,800 (8,000) $408,400

Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Application of knowledge

4.3 True/False 1) Adjustments made for consolidation statements impact both the parent and subsidiary general ledger accounts. Answer: FALSE Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Moderate AACSB: Analytical thinking

2) Under the equity method of accounting parent-retained earnings and the consolidated-retained earnings are equal. Answer: TRUE Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Moderate AACSB: Analytical thinking

3) The portion of a subsidiary's net income not accruing to the parent can be referred to as noncontrolling interest share. Answer: TRUE Objective: LO4.1 Prepare a consolidation workpaper for the year of acquisition when the parent uses the complete equity method to account for its investment in a subsidiary. Difficulty: Easy AACSB: Analytical thinking

4) In the consolidated balance sheet, the GAAP requires that the amount of goodwill be shown as a separate balance sheet item even if it is immaterial. Answer: FALSE Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Analytical thinking

5) The entry to record the receipt of intercompany note receivable includes a credit to Note Receivable Subsidiary. Answer: TRUE Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Analytical thinking

6) The consolidated cash flow statement is prepared from the consolidated income statement and consolidated balance sheet. Answer: TRUE Objective: LO4.5 Prepare a consolidated statement of cash flows. Difficulty: Easy AACSB: Analytical thinking

7) The GAAP only authorizes the use of the indirect method for preparation of the consolidated cash flow statement. Answer: FALSE Objective: LO4.5 Prepare a consolidated statement of cash flows. Difficulty: Easy AACSB: Analytical thinking

8) The direct method of the consolidated cash flow statement begins with the controlling share of consolidated net income. Answer: FALSE Objective: LO4.5 Prepare a consolidated statement of cash flows. Difficulty: Moderate AACSB: Analytical thinking

9) The depreciation on buildings is presented under investing activities on the consolidated cash flow statement. Answer: FALSE Objective: LO4.4 Record fair values of identifiable net assets acquired. Difficulty: Moderate AACSB: Analytical thinking

10) Proceeds from the sale of land are presented in the operating activities on the consolidated cash flow statement. Answer: FALSE Objective: LO4.5 Prepare a consolidated statement of cash flows. Difficulty: Moderate AACSB: Analytical thinking

11) The trial balance approach to consolidation workpapers brings together the adjusted trial balances for affiliated companies. Answer: TRUE Objective: LO4.7 Appendix A: Understand the alternative trial balance workpaper format. Difficulty: Easy AACSB: Analytical thinking

12) In the cost method of acquisition income is recognized only when the subsidiary declares dividends. Answer: TRUE Objective: LO4.8 Appendix B: Prepare a consolidation workpaper when parent company uses either the cost method or incomplete equity method. Difficulty: Moderate AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 5 Intercompany Profit Transactions - Inventories 5.1 Multiple Choice Questions 1) The material sale of inventory items by a parent company to an affiliated company A) enters the consolidated revenue computation only if the transfer was the result of arm's length bargaining. B) affects consolidated net income under a periodic inventory system but not under a perpetual inventory system. C) does not result in consolidated income until the merchandise is sold to outside parties. D) does not require a working paper adjustment if the merchandise was transferred at cost. Answer: C Objective: LO5.1 Understand the impact of intercompany inventory profit on consolidation workpapers. Difficulty: Easy AACSB: Analytical thinking

2) Phast Corporation owns a 80% interest in Stechno Company, acquired several years ago at a cost equal to book value and fair value. Stechno sells merchandise to Phast for the first time in 2014, and some is unsold at December 31, 2014. In computing income from the investee for 2014 under the equity method, Phast uses which equation? A) 80% of Stechno's income less 100% of the unrealized profit in Phast's ending inventory B) 80% of Stechno's income plus 100% of the unrealized profit in Phast's ending inventory C) 80% of Stechno's income less 80% of the unrealized profit in Phast's ending inventory D) 80% of Stechno's income plus 80% of the unrealized profit in Phast's ending inventory Answer: C Objective: LO5.1 Understand the impact of intercompany inventory profit on consolidation workpapers. Difficulty: Moderate AACSB: Analytical thinking

3) Assume there are routine inventory sales between parent companies and subsidiaries. When preparing the consolidated financial statements, which of the following line items is indifferent to the sales being either upstream or downstream? A) Consolidated retained earnings B) Consolidated gross profit C) Noncontrolling interest share D) Controlling interest share of consolidated net income Answer: B Objective: LO5.1 Understand the impact of intercompany inventory profit on consolidation workpapers. Difficulty: Easy AACSB: Analytical thinking

4) A(n) ________ sale is a sale by a parent company to a subsidiary. A(n) ________ sale is a sale by a subsidiary to a parent company. A) deferred; realized B) realized; deferred C) upstream; downstream D) downstream; upstream Answer: D Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Easy AACSB: Analytical thinking

Use the following information to answer the question(s) below. Paggle Corporation owns 80% of Spillway Inc.'s common stock that was purchased at its underlying book value. At the time of purchase, the book value and fair value of Spillway's net assets were equal. The two companies report the following information for 2014 and 2015. During 2014, one company sold inventory to the other company for $50,000 which cost the transferor $40,000. As of the end of 2014, 30% of the inventory was unsold. In 2015, the remaining inventory was resold outside the consolidated entity. 2014 Selected Data: Sales Revenue Cost of Goods Sold Other Expenses Net Income Dividends Paid

Paggle $600,000 320,000 100,000 $180,000 19,000

Spillway $320,000 155,000 89,000 $76,000 0

2015 Selected Data: Sales Revenue Cost of Goods Sold Other Expenses Net Income Dividends Paid

Paggle $580,000 300,000 130,000 $150,000 16,000

Spillway $445,000 180,000 171,000 $94,000 5,000

5) If the sale referred to above was a downstream sale, the total sales revenue reported in the consolidated income statement for 2014 would be A) $870,000. B) $880,000. C) $920,000. D) $970,000. Answer: A Explanation: A) 2014 combined sales $920,000 Less: 2014 intercompany sales (50,000) Consolidated sales $870,000 Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Moderate AACSB: Application of knowledge

6) If the sale referred to above was a downstream sale, by what amount must Inventory on the consolidated balance sheet be reduced to reflect the correct balance as of the end of 2014? A) $3,000 B) $10,000 C) $14,000 D) $20,000 Answer: A Explanation: A) Selling price $50,000 Less: Cost of sales 40,000 Original unrealized profit 10,000 Unsold percentage 30% Unrealized profit $3,000 Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Moderate AACSB: Application of knowledge

7) For 2014, consolidated net income will be what amount if the intercompany sale was downstream? A) $180,000 B) $253,000 C) $256,000 D) $259,000 Answer: B Explanation: B) 2014 Combined Net Income $256,000 Less: Unrealized Profit (above) (3,000) 2014 Consolidated Net Income $253,000 Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Moderate AACSB: Reflective thinking

8) If the intercompany sale mentioned above was an upstream sale, what will be the reported amount of total consolidated sales revenue for 2015? A) $1,025,000 B) $1,900,000 C) $1,950,000 D) $2,000,000 Answer: A Explanation: A) Paggle $580,000 + Spillway $445,000. There were no intercompany sales in 2015 to eliminate. Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Moderate AACSB: Application of knowledge

9) If the intercompany sale was an upstream sale, the total amount of consolidated cost of goods sold for 2015 will be A) $300,000. B) $430,000. C) $470,000. D) $477,000. Answer: D Explanation: D) Combined cost of goods sold $480,000 Less: Unrealized profit in the 2015 beginning inventory (3,000) Consolidated cost of sales $477,000 Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Pouch Corporation acquired an 80% interest in Shenley Corporation on January 1, 2014, when the book values of Shenley's assets and liabilities were equal to their fair values. The cost of the 80% interest was equal to 80% of the book value of Shenley's net assets. During 2014, Pouch sold merchandise that cost $70,000 to Shenley for $86,000. On December 31, 2014, three-fourths of the merchandise acquired from Pouch remained in Shenley's inventory. Separate incomes (investment income not included) of the two companies are as follows:

Sales Revenue Cost of Goods Sold Operating Expenses Separate incomes

Pouch $180,000 120,000 17,000 $ 43,000

Shenley $160,000 90,000 21,000 $ 49,000

10) The consolidated income statement for Pouch Corporation and subsidiary for the year ended December 31, 2014 will show consolidated cost of sales of A) $120,000. B) $136,000. C) $148,000. D) $210,000. Answer: B Explanation: B) Combined cost of sales $210,000 Less: Intercompany cost of sales (86,000) Plus: Unrealized profit (16,000 × 75%) 12,000 Consolidated cost of sales $136,000 Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

11) What is Pouch's income from Shenley for 2014? A) $27,200 B) $29,600 C) $39,200 D) $49,000 Answer: A Explanation: A) ($49,000 × 80%)- $12,000 (unrealized profit) = $27,200 Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

12) Swamp Co., a 55%-owned subsidiary of Pond Inc., made the following entry to record a sale of merchandise to Pond: Accounts Receivable Sales Revenue

40,000 40,000

All Swamp sales are at 125% of cost. One-fourth of this merchandise remained in the Pond's inventory at year-end. A working paper entry to eliminate unrealized profits from consolidated inventory would include a credit to Inventory in the amount of A) $2,000. B) $2,500. C) $8,000. D) $10,000. Answer: A Explanation: A) Selling price $40,000 Less: Cost of sales ($40,000 / 125%) 32,000 Intercompany profit 8,000 × Unsold Portion (1/4) = $2,000 Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Pew Corporation acquired 80% ownership of Sordid Incorporated, at a time when Pew's investment cost was equal to 80% of Sordid's book value. At the time of acquisition, the book values and fair values of Sordid's assets and liabilities were equal. Pew uses the equity method. During 2014, Pew sold goods to Sordid for $160,000 making a gross profit percentage of 20%. Half of these goods remained unsold in Sordid's inventory at the end of the year. Income statement information for Pew and Sordid for 2014 were as follows:

Sales Revenue Cost of Goods Sold Operating Expenses Separate incomes

Pew $800,000 500,000 200,000 $100,000

Sordid $300,000 160,000 80,000 $60,000

13) The 2014 consolidated income statement showed cost of goods sold of A) $500,000. B) $516,000. C) $532,000. D) $660,000. Answer: B Explanation: B) Combined Cost of Goods Sold $660,000 Less: Intercompany Sales (160,000) Plus: Profit in ending inventory 16,000 Consolidated Cost of Goods Sold $516,000 Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

14) What is Pew's income from Sordid for 2014? A) $32,000 B) $48,000 C) $60,000 D) $75,000 Answer: A Explanation: A) Equity in Sordid net income ($60,000 × 80%) Less: Unrealized Profit Pew's income from Sordid

$48,000 (16,000) $32,000

Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

15) The 2014 consolidated income statement showed noncontrolling interest share of A) $3,200. B) $6,400. C) $8,800. D) $12,000. Answer: D Explanation: D) Downstream sale has no effect on noncontrolling interest share; $60,000 × .2 = $12,000 Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Moderate AACSB: Application of knowledge

16) On January 1, 2014, Plastam Industries acquired an 80% interest in Sparta Company to assure a steady supply of Sparta's inventory that Plastam uses in its own manufacturing businesses. Sparta sold 100% of its output to Plastam during 2014 and 2015 at a markup of 125% of Sparta's cost. Plastam had $12,000 of these items remaining in its inventory at December 31, 2015. If Plastam neglected to eliminate unrealized profits from all intercompany sales from Sparta, the inventory on the consolidated balance sheet at December 31, 2015 was A) overstated by $1,920. B) understated by $1,920. C) overstated by $2,400. D) understated by $2,400. Answer: C Explanation: C) $12,000 - ($12,000 / 1.250) = $2,400 Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below.. Pelga Company routinely receives goods from its 80%-owned subsidiary, Swede Corporation. In 2014, Swede sold merchandise that cost $80,000 to Pelga for $100,000. Half of this merchandise remained in Pelga's December 31, 2014 inventory. This inventory was sold in 2015. During 2015, Swede sold merchandise that cost $160,000 to Pelga for $200,000. $62,500 of the 2015 merchandise inventory remained in Pelga's December 31, 2015 inventory. Selected income statement information for the two affiliates for the year 2015 was as follows:

Sales Revenue Cost of Goods Sold Gross profit

Pelga $500,000 400,000 $100,000

Swede $400,000 320,000 $80,000

17) Consolidated cost of goods sold for Pelga and Subsidiary for 2015 were A) $512,000. B) $526,000. C) $522,500. D) $528,000. Answer: C Explanation: C) Combined Cost of Goods Sold $720,000 Less: Intercompany sales (200,000) Adjust: Profit - 10,000 + 12,500 2,500 Consolidated Cost of Goods Sold $522,500 Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Moderate AACSB: Application of knowledge

18) What amount of unrealized profit did Pelga Company have at the end of 2015? A) $10,000 B) $12,500 C) $50,000 D) $62,500 Answer: B Explanation: B) $62,500 remaining × 20% profit margin Objective: LO5.4 Recognize realized, previously deferred inventory profits in the beginning inventory. Difficulty: Moderate AACSB: Application of knowledge

19) A parent company regularly sells merchandise to its 70%-owned subsidiary. Which of the following statements describes the computation of noncontrolling interest share? A) The subsidiary's net income times 30% B) (The subsidiary's net income × 30%) + unrealized profits in the beginning inventory - unrealized profits in the ending inventory C) (The subsidiary's net income + unrealized profits in the beginning inventory - unrealized profits in the ending inventory) × 30% D) (The subsidiary's net income + unrealized profits in the ending inventory - unrealized profits in the beginning inventory) × 30% Answer: A Objective: LO5.5 Adjust noncontrolling interest amounts in the presence of intercompany inventory profits. Difficulty: Moderate AACSB: Analytical thinking

20) Shalles Corporation, an 80%-owned subsidiary of Pani Corporation, sold inventory items to its parent at a $48,000 profit in 2014. Pani resold one-third of this inventory to outside entities. Shalles reported net income of $200,000 for 2014. Noncontrolling interest share of consolidated net income that will appear in the income statement for 2014 is A) $30,400. B) $32,000. C) $33,600. D) $40,000. Answer: C Explanation: C) Shalles' reported income $200,000 Less: Unrealized profits in ending inventory ($48,000 × 2/3) (32,000) Shalles' adjusted income 168,000 Noncontrolling interest percentage 20% Noncontrolling interest share $33,600 Objective: LO5.5 Adjust noncontrolling interest amounts in the presence of intercompany inventory profits. Difficulty: Moderate AACSB: Application of knowledge

5.2 Exercises 1) Penguin Corporation acquired a 60% interest in Squid Corporation on January 1, 2014, at a cost equal to 60% of the book value of Squid's net assets. At the time of the acquisition, the book values of Squid's assets and liabilities were equal to the fair values. Squid reports net income of $880,000 for 2014. Penguin regularly sells merchandise to Squid at 120% of Penguin's cost. The intercompany sales information for 2014 is as follows: Intercompany sales at selling price Sales value of merchandise unsold by Squid

$672,000 $132,000

Required: 1. Determine the unrealized profit in Squid's inventory at December 31, 2014. 2 Compute Penquin's income from Squid for 2014. Answer: Requirement 1 $132,000 - ($132,000/1.2) = $22,000 Requirement 2 Penquin's income from Squid: Penquin's share of Squid income ($880,000 × 60%) Less: Unrealized profit in ending inventory Penquin's income from Squid

$528,000 (22,000) $506,000

Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

2) Salli Corporation regularly purchases merchandise from their 90% owner, Playtime Corporation. Playtime purchased the 90% interest at a cost equal to 90% of the book value of Salli's net assets. At the time of acquisition, the book values and fair values of Salli's assets and liabilities were equal. Playtime makes their sales to Salli at 120% of cost. In 2014, Salli reported net income of $460,000, and made purchases totaling $172,000 from Playtime. Although Salli had no inventory on hand at the beginning of 2014 that they had purchased from Playtime, at year end, they had $51,600 of this merchandise in inventory. Required: 1. Determine the unrealized profit in Salli's inventory at December 31, 2014. 2. Compute Playtime's income from Salli for 2014. Answer: Requirement 1 $51,600 - ($51,600 /1.2) = $ 8,600 Requirement 2 Playtime's share of Salli's income ($460,000 × 90%) Less: Unrealized profit in ending inventory Income from Salli

$414,000 $8,600 $405,400

Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

3) Pirate Transport bought 80% of the outstanding voting stock of Seaways Shipping at book value several years ago. (At the time of purchase, the fair value and book value of Seaways' net assets were equal.) Pirate sells merchandise to Seaways at 120% above Pirate's cost. Intercompany sales from Pirate to Seaways for 2014 were $450,000. Unrealized profits in Seaways' December 31, 2013 inventory and December 31, 2014 inventory were $17,000 and $15,000, respectively. Seaways reported net income of $750,000 for 2014. Required: 1. Determine Pirate's income from Seaways for 2014. 2. In General Journal format, prepare consolidation working paper entries at December 31, 2014 to eliminate the effects of the intercompany inventory sales assuming the perpetual inventory method is used. Answer: Requirement 1 Pirate's Share of Seaways Income ($750,000 × 80%) $600,000 Less: Profit in Ending Inventory (15,000) Add: Profit in Beginning Inventory 17,000 Pirate's Income from Seaways $602,000 Requirement 2 Sales Revenue Cost of Goods Sold To eliminate intercompany sales and cost of goods sold

Debit 450,000

Credit 450,000

Investment in Seaway 17,000 Cost of Goods Sold 17,000 To recognize previously deferred unrealized profits from the beginning inventory Cost of Goods Sold 15,000 Inventory 15,000 To eliminate intercompany profit in the ending inventory from cost of goods sold and inventory Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

4) Psalm Enterprises owns 90% of the outstanding voting stock of Solomon Siding, which was purchased at a cost equal to 90% of the book value of Solomon's net assets many years ago. (At the time of purchase, the fair value and book value of Solomon's net assets were equal.) Psalm purchases merchandise from Solomon at 110% above Solomon's cost. In 2014, intercompany sales from Solomon to Psalm amounted to $362,000. Unrealized profits in Psalm's December 31, 2013 inventory and December 31, 2014 inventory were $82,000 and $26,000, respectively. Solomon reported net income of $980,000 for 2014. Required: 1. Determine Psalm's income from Solomon for 2014. 2. In General Journal format, prepare consolidation working paper entries at December 31, 2014 to eliminate the effects of the intercompany inventory sales assuming the perpetual inventory method is used. Answer: Requirement 1 Psalm's income from Solomon: Solomon's separate net income Add: Unrealized profit in beginning inventory Less: Unrealized profit in ending inventory Solomon adjusted income Percentage Income from Solomon

$ 980,000 82,000 (26,000) 1,036,000 90% $ 932,400

Requirement 2 Sales Revenue Cost of Goods Sold To eliminate intercompany sales and cost of goods sold

Debit 362,000

Credit 362,000

Investment in Solomon 73,800 Noncontrolling interest 8,200 Cost of Goods Sold 82,000 To recognize previously deferred unrealized profits from the beginning inventory Cost of Goods Sold 26,000 Inventory 26,000 To eliminate intercompany profit in the ending inventory from cost of goods sold and inventory Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

5) Pfeifer Corporation acquired an 80% interest in Stern Corporation several years ago when the book values and fair values of Stern's assets and liabilities were equal. At the time of acquisition, the cost of the 80% interest was equal to 80% of the book value of Stern's net assets. Separate company income statements for Pfeifer and Stern for the year ended December 31, 2014 are summarized as follows: Pfeifer $1,000,000 85,000 (600,000) (200,000) $285,000

Sales Revenue Investment income from Stern Cost of Goods Sold Expenses Net Income

Stern $600,000 (300,000) (200,000) $100,000

During 2013, Pfeifer sold merchandise that cost $120,000 to Stern for $180,000. Half of this merchandise remained in Stern's inventory at December 31, 2013. During 2014, Pfeifer sold merchandise that cost $150,000 to Stern for $225,000. One-third of this merchandise remained in Stern's December 31, 2014 inventory. Required: Prepare a consolidated income statement for Pfeifer Corporation and Subsidiary for 2014. Answer:

Pfeifer Corporation and Subsidiary Consolidated Income Statement For the year ended December 31, 2014

Sales (combined $1,600,000 - $225,000 intercompany) Cost of Goods Sold (see below) Expenses Consolidated net income Noncontrolling interest share Controlling interest share

$1,375,000 (670,000) (400,000) 305,000 (20,000) $ 285,000

Consolidated cost of goods sold computation: Combined cost of sales ($600,000 + $300,000) Less: Intercompany sales Less: Unrealized profit in beginning inventory ($180,000 - $120,000) × 1/2 Add: Unrealized profit in ending inventory ($225,000 - $150,000) × 1/3 Consolidated Cost of Goods Sold

$900,000 (225,000) (30,000) 25,000 $ 670,000

Objective: LO5.4 Recognize realized, previously deferred inventory profits in the beginning inventory. Difficulty: Moderate AACSB: Application of knowledge

6) Perry Instruments International purchased 75% of the outstanding common stock of Standard Systems in 1997 when the book values and fair values of Standard's assets and liabilities were equal. The cost of Perry's investment was equal to 75% of the book value of Standard's net assets. Separate company income statements for Perry and Standard for the year ended December 31, 2014 are summarized as follows:

Sales Revenue Investment income from Standard Cost of Goods Sold Expenses Net Income

Perry $2,400,000 142,000 (1,600,000) (450,000) $492,000

Standard $800,000 (400,000) (200,000) $200,000

During 2014, the companies began to manage their inventory differently, and worked together to keep their inventories low at each location. In doing so, they agreed to sell inventory to each other as needed at a markup of 10% of cost. Perry sold merchandise that cost $100,000 to Standard for $110,000, and Standard sold inventory that cost $80,000 to Perry for $88,000. Half of this merchandise remained in each company's inventory at December 31, 2014. Required: Prepare a consolidated income statement for Perry Corporation and Subsidiary for 2014.

Answer:

Perry Corporation and Subsidiary Consolidated Income Statement For the year ended December 31, 2014

Sales (combined $3,200,000 - $198,000 intercompany) Cost of Goods Sold (see below) Expenses Consolidated net income Noncontrolling interest share (see below) Controlling interest share Consolidated cost of goods sold computation: Combined cost of sales ($1,600,000 + $400,000) Less: Intercompany sales ($110,000 + $88,000) Add: Unrealized profit in ending inventory ($110,000 - $100,000) × 1/2 Add: Unrealized profit in ending inventory ($88,000 - $80,000) × 1/2 Consolidated Cost of Goods Sold

$3,002,000 (1,811,000) (650,000) 541,000 (49,000) $492,000

$2,000,000 (198,000) 5,000 4,000 $1,811,000

Noncontrolling interest share calculation: Standard separate net income Less: Unrealized profit in ending inventory from upstream sale ($88,000 - $80,000) × 1/2 Standard's adjusted net income Noncontrolling interest share (25%)

$200,000 (4,000) $196,000 $49,000

Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

7) Preen Corporation acquired a 60% interest in Shino Corporation at a cost equal to 60% of the book value of Shino's net assets in 2014. At the time of acquisition, the book value and fair value of Shino's assets and liabilities were equal. During 2015, Preen sold $120,000 of merchandise to Shino. All intercompany sales are made at 150% of Preen's cost. Shino's beginning and ending inventories resulting from intercompany sales for 2015 were $60,000 and $36,000, respectively. Income statement information for both companies for 2015 is as follows:

Sales Revenue Investment income from Shino Cost of Goods Sold Expenses Net Income

Preen $730,000 38,000 (319,000) (165,000) $284,000

Shino $262,000 (172,000) (40,000) $50,000

Required: Prepare a consolidated income statement for Preen Corporation and Subsidiary for 2015. Answer: Preen Corporation and Subsidiary Consolidated Income Statement For the year ended December 31, 2015 Sales (combined $730,000 + $262,000 - $120,000) Cost of Goods Sold (see below) Expenses Consolidated net income Noncontrolling interest share ($50,000 × 40%) Controlling interest share

$872,000 (363,000) (205,000) 304,000 (20,000) $284,000

Consolidated cost of goods sold computation: Combined cost of sales ($319,000 + $172,000) Less: Intercompany sales Less: Unrealized profit in beginning inventory ($60,000 - ($60,000/1.5)) Add: Unrealized profit in ending inventory ($36,000 - ($36,000/1.5)) Consolidated Cost of Goods Sold

$491,000 (120,000) (20,000) 12,000 $363,000

Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

8) Pexo Industries purchases the majority of their raw materials from a wholly-owned subsidiary, Springmade Chemicals. Pexo purchased Springmade to assure supply availability at a time when the materials were being rationed in the industry due to supply issues overseas. Pexo was able to purchase Springmade at the book value of Springmade's net assets. At the time of purchase, the book value and fair value of Springmade's net assets were equal. Pexo purchased $2,890,000 of materials from Springmade in 2014 alone. All intercompany sales are made at 120% of cost, although Springmade is able to mark up their products 80% to other outside buyers. Pexo carried inventory on their books at the beginning and end of the year in the amount of $450,000 and $480,000, respectively, all of which had been purchased from Springmade. Income statement information for both companies for 2014 is as follows:

Sales Revenue Investment income from Springmade Cost of Goods Sold Expenses Net Income

Pexo $3,793,000 245,000 (3,139,000) (257,000) $642,000

Springmade $4,441,000 (3,270,000) (921,000) $250,000

Required: Prepare a consolidated income statement for Pexo Corporation and Subsidiary for 2014. Answer: Pexo Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2014 Sales (combined $3,793,000 + $4,441,000 - $2,890,000) Cost of Goods Sold (see below) Expenses Consolidated net income Consolidated Cost of Goods Sold Computation: Combined cost of sales ($3,139,000 + $3,270,000) Less: Intercompany sales Less: Unrealized profit in beginning inventory ($450,000 - ($450,000/1.2)) Add: Unrealized profit in ending inventory ($480,000 - ($480,000/1.2)) Consolidated Cost of Goods Sold

$ 5,344,000 (3,524,000) (1,178,000) $ 642,000

$ 6,409,000 (2,890,000) (75,000) 80,000 $3,524,000

Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

9) PreBuild Manufacturing acquired 100% of Shoding Industries common stock on January 1, 2014, for $670,000 when the book values of Shoding's assets and liabilities were equal to their fair values and Shoding's stockholders' equity consisted of $380,000 of Capital Stock and $290,000 of Retained Earnings. PreBuild's separate income (excluding investment income from Shoding) was $870,000, $830,000 and $960,000 in 2014, 2015 and 2016, respectively. PreBuild sold inventory to Shoding during 2014 at a gross profit of $50,000 and 50% remained at Shoding at the end of the year. The remaining 50% was sold in 2015. At the end of 2015, PreBuild has $54,000 of inventory received from Shoding from a sale of $180,000 which cost Shoding $150,000. There are no unrealized profits in the inventory of PreBuild or Shoding at the end of 2016. PreBuild uses the equity method in its separate books. Select financial information for Shoding follows:

Sales Cost of Sales Gross Profit Operating Expenses Net Income

2014 $890,000 (420,000) 470,000 (350,000) $120,000

2015 $995,000 (475,000) 520,000 (380,000) $140,000

2016 $1,020,000 (505,000) 515,000 (390,000) $125,000

Required: Prepare a schedule to determine PreBuild Manufacturing's Consolidated net income for 2014, 2015, and 2016. Answer: 2014 2015 2016 PreBuild's separate income $870,000 $830,000 $960,000 Add: Shoding's reported net income 120,000 140,000 125,000 Unrealized profit in 2014 income (25,000) 25,000 Unrealized profit in 2015 income (9,000) 9,000 Consolidated net income $965,000 $986,000 $1,094,000 Objective: LO5.4 Recognize realized, previously deferred inventory profits in the beginning inventory. Difficulty: Moderate AACSB: Application of knowledge

10) Peel Corporation acquired an 80% interest in Sitt Corporation at a cost equal to 80% of the book value of Sitt several years ago. At the time of purchase, the fair value and book value of Sitt's assets and liabilities were equal. Sitt purchases its entire inventory from Peel at 150% of Peel's cost. During 2014, Peel sold $190,000 of merchandise to Sitt. Sitt's beginning and ending inventories for 2014 were $72,000 and $66,000, respectively. Income statement information for both companies for 2014 is as follows: Peel $820,000 146,000 (460,000) (120,000) $386,000

Sales Revenue Investment income from Sitt Cost of Goods Sold Expenses Net Income

Sitt $440,000 (165,000) (95,000) $180,000

Required: Prepare a consolidated income statement for Peel Corporation and Subsidiary for 2014. Answer: Preliminary computations: Unrealized profit in beginning inventory equals: $72,000 - ($72,000/1.5) =

$24,000

Unrealized profit in ending inventory: $66,000 - ($66,000/1.5) =

$22,000

Consolidated Net Income Statement: Sales (combined $1,260,000 - $190,000 intercompany Cost of Goods Sold (see below) Expenses Consolidated net income Noncontrolling interest share Controlling interest share

$1,070,000 (433,000) (215,000) 422,000 (36,000) $ 386,000

Consolidated cost of goods sold computation: Combined cost of sales ($460,000 + $165,000) Less: Intercompany sales Less: Unrealized profit in beginning inventory Add: Unrealized profit in ending inventory Consolidated Cost of Goods Sold

$625,000 (190,000) (24,000) 22,000 $433,000

Objective: LO5.4 Recognize realized, previously deferred inventory profits in the beginning inventory. Difficulty: Moderate AACSB: Application of knowledge

11) Pittle Corporation acquired an 80% interest in Seel Corporation at a cost equal to 80% of the book value of Seel's net assets several years ago. At the time of purchase, the fair value and book value of Seel's assets and liabilities were equal. Pittle purchases its entire inventory from Seel at 150% of Seel's cost. During 2014, Seel sold $490,000 of merchandise to Pittle. Pittle's beginning and ending inventories for 2014 were $72,000 and $66,000, respectively. Income statement information for both companies for 2014 is as follows:

Sales Revenue Investment income from Sitt Cost of Goods Sold Expenses Net Income

Pittle $ 820,000 145,600 (460,000) (120,000) $ 385,600

Seel $440,000 (165,000) (95,000) $ 180,000

Required: Prepare a consolidated income statement for Pittle Corporation and Subsidiary for 2014.

Answer: Preliminary computations: Unrealized profit in beginning inventory equals: $72,000 - ($72,000/1.5) =

$ 24,000

Unrealized profit in ending inventory: $66,000 - ($66,000/1.5) =

$ 22,000

Consolidated net income: Sales (combined $1,260,000 - $490,000 intercompany) Cost of Goods Sold (see below) Expenses Consolidated net income Noncontrolling interest share (see below) Controlling interest share

$770,000 (133,000) (215,000) 422,000 (36,400) $ 385,600

$625,000 (490,000) (24,000) 22,000 $133,000

Noncontrolling interest share calculation: Seel separate net income Add: Unrealized profit in beginning inventory from upstream sale Less: Unrealized profit in ending inventory from upstream sale Seel's adjusted net income Noncontrolling interest share (20%)

$180,000 24,000 (22,000) $182,000 $36,400

Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Application of knowledge

12) Paulee Corporation paid $24,800 for an 80% interest in Sergio Corporation on January 1, 2013, at which time Sergio's stockholders' equity consisted of $15,000 of Common Stock and $6,000 of Retained Earnings. The fair values of Sergio Corporation's assets and liabilities were identical to recorded book values when Paulee acquired its 80% interest. Sergio Corporation reported net income of $4,000 and paid dividends of $2,000 during 2013. Paulee Corporation sold inventory items to Sergio during 2013 and 2014 as follows:

Paulee's sales to Sergio Paulee's cost of sales to Sergio Unrealized profit at year-end

2013 $5,000 3,000 1,000

2014 $6,000 3,500 1,500

At December 31, 2014, the accounts payable of Sergio include $1,500 owed to Paulee for inventory purchases. Required: Financial statements of Paulee and Sergio appear in the first two columns of the partially completed working papers. Complete the consolidation working papers for Paulee Corporation and Subsidiary for the year ended December 31, 2014.

Paulee Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2014

Answer: Paulee Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2014

Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Difficult AACSB: Application of knowledge

13) On January 1, 2014, Paar Incorporated paid $38,500 for a 70% interest in Siba Enterprises, at a time when Siba's stockholder's equity consisted of $20,000 in Capital stock and $30,000 in Retained Earnings. The fair values of Siba's assets and liabilities equaled their recorded book values at that time, so any additional amount paid was attributed to goodwill. In 2014, Siba purchased merchandise from Paar at a price of $6,000. The products originally cost Paar $4,000, and 75% of this merchandise remained in inventory at December 31, 2014. This inventory was sold in 2015. Siba reported net income of $9,000 and paid dividends of $3,000 during 2014. In 2015, Siba purchased merchandise from Paar at a price of $8,000. The products had a cost to Paar of $7,000, and 50% of this merchandise remained in inventory at December 31, 2015. Siba still owed Paar $1,800 for these purchases at December 31, 2015. Required: Financial statements of Paar and Siba appear in the first two columns of the partially completed working papers. Complete the consolidation working papers for Paar Corporation and Subsidiary for the year ended December 31, 2015.

Paar Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2015

Answer:

Paar Corporation and Subsidiary Consolidation Working Papers for the year ended December 31, 2015

Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Difficult AACSB: Application of knowledge

14) Papal Corporation acquired an 80% interest in Sandman Corporation at a cost equal to 80% of the book value of Sandman's net assets in 2013. At the time of the acquisition, the book values and fair values of Sandman's assets and liabilities were equal. During 2014, Papal recorded sales of $440,000 of merchandise to Sandman at a gross profit rate of 30%. Sandman's beginning and ending inventories for 2014 were $60,000 and $80,000, respectively. Income statement information for both companies for 2014 is as follows:

Sales Revenue Invest.income from Sandman Cost of Goods Sold Expenses Net Income

Papal $1,660,000 59,600 (1,060,000) (358,000) $301,600

Sandman $580,000 (394,000) (104,000) $82,000

Required: Prepare a consolidated income statement for Papal Corporation and Subsidiary for 2014. Answer: Papal Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2014 Sales (combined $1,660,000 + $580,000 - $440,000) Cost of Goods Sold (see below) Expenses Consolidated net income Noncontrolling interest share Controlling interest share

$1,800,000 (1,020,000) (462,000) 318,000 (16,400) $301,600

Consolidated cost of goods sold computation: Combined cost of sales ($1,060,000 + $394,000) Less: Intercompany sales Less: Unrealized profit in beginning inventory ($60,000 × .30) Add: Unrealized profit in ending inventory ($80,000 × .30) Consolidated Cost of Goods Sold

$1,454,000 (440,000) (18,000) 24,000 $ 1,020,000

Objective: LO5.4 Recognize realized, previously deferred inventory profits in the beginning inventory. Difficulty: Moderate AACSB: Application of knowledge

15) Plover Corporation acquired 80% of Sink Inc. equity on January 1, 2013, when the book values of Sink's assets and liabilities were equal to their fair values. The cost of the investment was equal to 80% of the book value of Sink's net assets. Plover separate income (excluding Sink) was $1,800,000, $1,700,000 and $1,900,000 in 2013, 2014 and 2015 respectively. Plover sold inventory to Sink during 2013 at a gross profit of $48,000 and one quarter remained at Sink at the end of the year. The remaining 25% was sold in 2014. At the end of 2014, Plover has $25,000 of inventory received from Sink from a sale of $100,000 which cost Sink $80,000. There are no unrealized profits in the inventory of Plover or Sink at the end of 2015. Plover uses the equity method in its separate books. Select financial information for Sink follows:

Sales Cost of Sales Gross Profit Operating Expenses Net Income

2013 $790,000 (420,000) 370,000 (300,000) $ 70,000

2014 $840,000 (440,000) 400,000 (320,000) $ 80,000

2015 $940,000 (500,000) 440,000 (350,000) $ 90,000

Required: Prepare a schedule to determine the controlling interest share of the consolidated net income for 2013, 2014, and 2015. Answer: 2013 2014 2015 Plover's separate income $1,800,000 $1,700,000 $1,900,000 Add: Sink's net income 70,000 80,000 90,000 Unrealized profit in 2010 (12,000) 12,000 Unrealized profit in 2011 (5,000) 5,000 Less:Noncont.interest share (14,000) (15,000) (19,000) Controlling interest share $1,844,000 $1,772,000 $1,976,000 2013 Noncontrolling interest share = (80,000 - 5,000) × 20% 2014 Noncontrolling interest share = (90,000 + 5,000) × 20% Objective: LO5.5 Adjust noncontrolling interest amounts in the presence of intercompany inventory profits. Difficulty: Moderate AACSB: Application of knowledge

16) On January 1, 2014, Palling Corporation purchased 70% of the common stock of Sam's Storage Systems for $320,000 when Sam's had Common Stock outstanding of $100,000 and Retained Earnings of $200,000. Any excess differential was attributed to goodwill. At the end of 2014, Palling and Sam's had unrealized inventory profits from intercompany sales of $6,000 and $8,000, respectively. These year-end profit amounts were realized in 2015. At the end of 2015, Palling held inventory acquired from Sam's with a $10,000 unrealized profit. Palling reported separate income of $100,000 for 2015 and paid dividends of $30,000. Sam's reported separate income of $70,000 for 2015 and paid dividends of $20,000. Required: Compute the controlling interest share of consolidated net income for 2015. Answer: Sam's separate income: Separate income as reported $ 70,000 Add: Realized beginning inventory profit 8,000 Equals: Sam's adjusted income 78,000 70% 54,600 Less: Ending inventory profit (10,000) Add: Beginning inventory profit 6,000 Palling's income from Sam $50,600 Palling's separate income Palling's income from Sam Controlling interest share of consolidated net income

$100,000 50,600 $150,600

Objective: LO5.5 Adjust noncontrolling interest amounts in the presence of intercompany inventory profits. Difficulty: Moderate AACSB: Application of knowledge

17) Proman Manufacturing owns a 90% interest in Sipp Company, purchased at a time when the book values of Sipp's recorded assets and liabilities were equal to fair values. During 2014, Sipp sold merchandise to Proman for $80,000 at a 20% gross profit. At December 31, 2014, 25% of this merchandise is still in Proman's inventory. Separate incomes for Proman and Sipp are summarized as follows:

Sales Cost of sales Gross profit Operating expenses Separate income

Proman $900,000 400,000 500,000 200,000 $300,000

Sipp $200,000 100,000 100,000 80,000 $ 20,000

Required: Prepare a consolidated income statement for 2014 for Proman and subsidiary. Answer: Proman Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2014 Sales (combined $900,000 + $200,000 - $80,000) Cost of Goods Sold (see below) Expenses Consolidated net income Noncontrolling interest (see below) Controlling interest share

$1,020,000 (424,000) (280,000) 316,000 (1,600) $314,400

Consolidated cost of goods sold computation: Combined cost of sales ($400,000 + $100,000) Less: Intercompany sales Add: Unrealized profit in ending inventory ($80,000 × .20) × 25% Consolidated Cost of Goods Sold

$500,000 (80,000) 4,000 $424,000

Noncontrolling interest calculation: Sipp separate income Less: Unrealized profit in ending inventory from upstream sale ($80,000 × .20) × 25% Sipp's adjusted net income Noncontrolling interest share (10%)

$20,000 (4,000) $16,000 $ 1,600

Objective: LO5.5 Adjust noncontrolling interest amounts in the presence of intercompany inventory profits. Difficulty: Moderate AACSB: Application of knowledge

18) Pastern Industries has an 80% ownership stake in Sascon Incorporated. At the time of purchase, the book value of Sascon's assets and liabilities were equal to the fair value. The cost of the 80% investment was equal to 80% of the book value of Sascon's net assets. At the end of 2014, they issued the following consolidated income statement: Sales Cost of sales Operating expenses Noncontrolling interest share Controlling interest share

$930,000 (470,000) (202,000) (23,000) $235,000

Shortly after the statements were issued, Pastern discovered that the 2014 intercompany sales transactions had not been properly eliminated in consolidation. In fact, Pastern had sold inventory that cost $80,000 to Sascon for $90,000, and Sascon had sold inventory that cost $50,000 to Pastern for $65,000. Half of the products from both transactions still remained in inventory at December 31, 2014. Required: Prepare a corrected income statement for Pastern and Subsidiary for 2014. Answer: Pastern Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2014 Sales (combined $930,000 - 90,000 - 65,000) Cost of Goods Sold (see below) Expenses Noncontrolling interest share (see below) Controlling interest share

$775,000 (327,500) (202,000) (21,500) $224,000

Consolidated cost of goods sold computation: Combined cost of sales Less: Intercompany sales (90,000 + 65,000) Add: Unrealized profit in ending inventory ($10,000 + 15,000) 1/2 Consolidated Cost of Goods Sold

$470,000 (155,000) 12,500 $327,500

Noncontrolling interest calculation: Calculated original Sascon Income ($23,000 / 20%) Less: Unrealized profit in ending inventory from upstream sale ($15,000 × 1/2) Sascon adjusted separate net income Noncontrolling interest share (20%)

$115,000 (7,500) 107,500 21,500

Objective: LO5.5 Adjust noncontrolling interest amounts in the presence of intercompany inventory profits. Difficulty: Moderate AACSB: Application of knowledge

19) Presented below are several figures reported for Plate Corporation and Saucer Industries as of December 31, 2014. Plate has owned 70% of Saucer for the past five years, and at the time of purchase, the book value of Saucer's assets and liabilities equaled the fair value. The cost of the 70% investment was equal to 70% of the book value of Saucer's net assets. At the time of purchase, the fair values and book values of Saucer's assets and liabilities were equal.

Inventory Sales Cost of Goods Sold Expenses

Plate $120,000 200,000 130,000 40,000

Saucer $60,000 140,000 80,000 30,000

In 2013, Saucer sold inventory to Plate which had cost $40,000 for $60,000. 25% of this inventory remained on hand at December 31, 2013, but was sold in 2014. In 2014, Saucer sold inventory to Plate which had cost $30,000 for $45,000. 40% of this inventory remained unsold at December 31, 2014. Required: Calculate following balances at December 31, 2014. a. Consolidated Sales b. Consolidated Cost of goods sold c. Consolidated Expenses d. Noncontrolling interest share of Saucer's net income e. Consolidated Inventory

Answer: a. Consolidated Sales Combined sales (200,000 + 140,000) Less: Intercompany sales

$340,000 (45,000) $295,000

b. Consolidated Cost of goods sold Combined COGS (130,000 + 80,000) Less: Intercompany sales Less: Profit deferred from prior year ($20,000 × 25%) Plus: Profit deferred to next year ($15,000 × 40%) Consolidated Cost of goods sold

$210,000 (45,000) (5,000) 6,000 $166,000

c. Consolidated Expenses Combined Expenses ($40,000 + $30,000)

$70,000

d. Noncontrolling interest share of Saucer's net income Saucer reported net income ($140,000 - $80,000 - $30,000) Plus: Unrealized profit in beginning Inventory ($20,000 × 25%) Less: Unrealized profit in ending Inventory ($15,000 × 40%) Saucer adjusted separate net income Noncontrolling interest share (30%) e. Consolidated Inventory Combined Inventory ($120,000 + $60,000) Less: Unrealized profit in ending Inventory ($15,000 × 40%) Consolidated Inventory

$30,000 5,000 (6,000) $29,000 $8,700

$180,000 (6,000) $174,000

Objective: LO5.5 Adjust noncontrolling interest amounts in the presence of intercompany inventory profits. Difficulty: Moderate AACSB: Application of knowledge

20) Plateau Incorporated bought 60% of the common stock of Sachet Company several years ago. At the time of purchase, the fair value and book value of Sachet's net assets were equal. The cost of the 60% investment was equal to 60% of the book value of Sachet's net assets. Plateau sells merchandise to Sachet at 125% above Plateau's cost. Intercompany sales from Plateau to Sachet for 2014 were $60,000. Unrealized profits in Sachet's December 31, 2013 inventory and December 31, 2014 inventory were $6,000 and $4,500, respectively. Sachet reported net income of $120,000 for 2014. Required: In General Journal format, prepare consolidation working paper entries at December 31, 2014 to eliminate the effects of the intercompany inventory sales. Answer: Debit Credit Sales Revenue 60,000 Cost of Goods Sold 60,000 To eliminate intercompany sales and cost of goods sold Investment in Sachet 6,000 Cost of Goods Sold 6,000 To recognize previously deferred unrealized profits from the beginning inventory Cost of Goods Sold 4,500 Inventory 4,500 To eliminate intercompany profit in the ending inventory from cost of goods sold and inventory Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Moderate AACSB: Application of knowledge

5.3 True/False 1) Revenue is recognized when it is earned; therefore revenue earned for a consolidated entity occurs when there is a sale to outside entities. Answer: TRUE Objective: LO5.1 Understand the impact of intercompany inventory profit on consolidation workpapers. Difficulty: Easy AACSB: Analytical thinking

2) The elimination entry under the perpetual inventory system for intercompany sales and purchases is a debit to sales and a credit to purchases. Answer: FALSE Objective: LO5.1 Understand the impact of intercompany inventory profit on consolidation workpapers. Difficulty: Moderate AACSB: Analytical thinking

3) A downstream sale is a sale by a parent to a subsidiary. Answer: TRUE Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Easy AACSB: Analytical thinking

4) A subsidiary's realized income is its reported net income adjusted for intercompany profits from upstream sales. Answer: TRUE Objective: LO5.2 Apply the concepts of upstream versus downstream inventory transfers. Difficulty: Moderate AACSB: Analytical thinking

5) Parent sales to its subsidiary increase parent sales, COGS and gross profit. Answer: TRUE Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Easy AACSB: Analytical thinking

6) Sales by a subsidiary to its parent affects the operating income of the parent when the merchandise is resold. Answer: TRUE Objective: LO5.4 Recognize realized, previously deferred inventory profits in the beginning inventory. Difficulty: Easy AACSB: Analytical thinking

7) If a subsidiary is a 100 percent-owned affiliate and sells to the parent, the parent defers 100 percent of any unrealized profit in the year of the intercompany sale. Answer: TRUE Objective: LO5.4 Recognize realized, previously deferred inventory profits in the beginning inventory. Difficulty: Moderate AACSB: Analytical thinking

8) The elimination entry for unrealized profit is a debit to purchases and a credit to ending inventory. Answer: FALSE Objective: LO5.1 Understand the impact of intercompany inventory profit on consolidation workpapers. Difficulty: Moderate AACSB: Analytical thinking

9) The ending inventory of the purchasing affiliate reflects the intercompany transfer price. Answer: TRUE Objective: LO5.1 Understand the impact of intercompany inventory profit on consolidation workpapers. Difficulty: Easy AACSB: Analytical thinking

10) Consolidated financial statements eliminate unrealized gross profit by increasing consolidated cost of goods sold and reducing merchandise inventory to its cost basis to the consolidated entity. Answer: TRUE Objective: LO5.3 Defer unrealized inventory profits remaining in the ending inventory. Difficulty: Moderate AACSB: Information technology

Advanced Accounting, 13e (Beams et al.) Chapter 6 Intercompany Profit Transactions - Plant Assets 6.1 Multiple Choice Questions Use the following information to answer the question(s) below. In 2014, Parla Corporation sold land to its subsidiary, Sidd Corporation, for $38,000. It had a book value of $24,000. In the next year, Sidd sold the land for $41,000 to an unaffiliated firm. 1) Which of the following is correct? A) No consolidation working paper entry is required for this transaction in 2014. B) A consolidation working paper entry is required only if the subsidiary was less than 100% owned in 2014. C) A consolidation working paper entry is required each year that Sidd has the land. D) A consolidation working paper entry was required only if the land was held for resale in 2014. Answer: C Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Easy AACSB: Analytical thinking

2) The 2014 unrealized gain from the intercompany sale A) should be recognized in consolidation in 2014 by a working paper entry. B) should be eliminated from consolidated net income by a working paper entry that credits land for $14,000. C) should be eliminated from consolidated net income by a working paper entry that debits land for $14,000. D) should be eliminated from consolidated net income by a working paper entry that credits gain on sale of land for $14,000. Answer: B Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Easy AACSB: Analytical thinking

3) On January 1, 2014, Bigg Corporation sold equipment with a book value of $20,000 and a 10-year remaining useful life to its wholly-owned subsidiary, Little Corporation, for $30,000. Both Bigg and Little use the straight-line depreciation method, assuming no salvage value. On December 31, 2014, the separate company financial statements held the following balances associated with the equipment:

Gain on sale of equipment Depreciation expense Equipment Accumulated depreciation

Bigg $10,000

Little $3,000 30,000 3,000

A working paper entry to consolidate the financial statements of Bigg and Little on December 31, 2014 included a A) debit to equipment for $10,000. B) credit to gain on sale of equipment for $10,000. C) debit to accumulated depreciation for $1,000. D) credit to depreciation expense for $3,000. Answer: C Objective: LO6.3 Recognize realized, previously deferred profits on plant asset transfers. Difficulty: Moderate AACSB: Analytical thinking

Use the following information to answer the question(s) below. On December 31, 2014, Pinne Corporation sold equipment with a three-year remaining useful life and a book value of $21,000 to its 70%-owned subsidiary, Sull Company, for a price of $27,000. Pinne bought the equipment four years ago for $49,000. The salvage value is zero. Straight-line depreciation is used by both companies. 4) An elimination entry at December 31, 2014 for the intercompany sale will include a A) credit of $6,000 to Depreciation Expense. B) credit of $6,000 to Accumulated Depreciation. C) credit of $6,000 to Equipment. D) credit of $6,000 to Gain on Sale of Equipment. Answer: C Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Analytical thinking

5) After eliminating/adjusting entries are prepared, what was the intercompany sale impact on the consolidated financial statements for the year ended December 31, 2014? A) Consolidated Net Income Consolidated Net Assets No effect No effect B) Consolidated Net Income Consolidated Net Asset No effect Increased C) Consolidated Net Income Consolidated Net Asset Decreased Decreased D) Consolidated Net Income Consolidated Net Asset Decreased No effect Answer: A Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Analytical thinking

6) On January 2, 2014, Paogo Company sold a truck with book value of $15,000 to Sanall Corporation, its wholly-owned subsidiary, for $20,000. The truck had a remaining useful life of five years with zero salvage value. Both firms use the straight-line depreciation method. If Paogo failed to make year-end adjustments/eliminations on the consolidated working papers in 2014, consolidated depreciation expense for 2014 would be A) $5,000 too high. B) $5,000 too low. C) $1,000 too low. D) $1,000 too high. Answer: D Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Analytical thinking

Use the following information to answer the question(s) below. On January 1, 2012, Shrimp Corporation purchased a delivery truck with an expected useful life of five years, and a salvage value of $8,000. On January 1, 2014, Shrimp sold the truck to Pacet Corporation. Pacet assumed the same salvage value and remaining life of three years used by Shrimp. Straight-line depreciation is used by both companies. On January 1, 2014, Shrimp recorded the following journal entry:

Cash Accumulated depreciation Truck Gain on Sale of Truck

Debit 50,000 18,000

Credit

53,000 15,000

Pacet holds 60% of Shrimp. Shrimp reported net income of $55,000 in 2014 and Pacet's separate net income (excludes interest in Shrimp) for 2014 was $98,000. 7) In preparing the consolidated financial statements for 2014, the elimination entry for depreciation expense was a A) debit for $5,000. B) credit for $5,000. C) debit for $15,000. D) credit for $15,000. Answer: B Explanation: B) ($15,000 gain/ 3 years) Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Analytical thinking

8) In the eliminating/adjusting entries on consolidation working papers for 2014, the Truck account was A) debited for $3,000. B) credited for $3,000. C) debited for $15,000. D) credited for $15,000. Answer: D Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

9) Controlling interest share in consolidated net income for 2014 was A) $121,000. B) $125,000. C) $131,000. D) $143,000. Answer: B Explanation: B) $98,000 + [($55,000 - $15,000 + $5,000) × 60%] Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

10) The noncontrolling interest share for 2014 was A) $18,000. B) $22,000. C) $23,000. D) $27,000. Answer: A Explanation: A) ($55,000 - $15,000 + $5,000) × 40% Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

11) Parrot Company owns all the outstanding voting stock of Southern Manufacturing. On January 1, 2014, Parrot sold machinery to Southern at its book value of $24,000. Parrot had the machinery three years before selling it and used an eight-year straight-line depreciation method, with zero salvage value. Southern will use the straight-line depreciation method, and assumes the machine has five years remaining and no salvage value. In the 2014 consolidating working papers, the depreciation expense A) required no adjustment. B) decreased by $4,800. C) increased by $4,800. D) increased by $8,000. Answer: A Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

12) Assume an upstream sale of machinery occurs on January 1, 2014. The parent owns 70% of the subsidiary. There is a gain on the intercompany transfer and the machine has five remaining years of useful life and no salvage value. Straight-line depreciation is used. Which of the following statements is correct? A) Noncontrolling interest share for 2014 is equal to: subsidiary income for 2014 multiplied by 30%. B) Noncontrolling interest share for 2014 is equal to: (subsidiary income for 2014 minus the gain on sale plus the excess depreciation expense) multiplied by 30%. C) Noncontrolling interest share for 2014 is equal to: (subsidiary income for 2014 minus the gain on sale) multiplied by 30%. D) Noncontrolling interest share for 2014 is equal to: (subsidiary income for 2014 plus the excess depreciation expense) multiplied by 30%. Answer: B Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Easy AACSB: Analytical thinking

13) Plenny Corporation sold equipment to its 90%-owned subsidiary, Sourdough Corp., on January 1, 2014. Plenny sold the equipment for $100,000 when its book value was $75,000 and it had a 5-year remaining useful life with no expected salvage value. Straight-line depreciation is used by both companies. Separate balance sheets for Plenny and Sourdough included the following equipment and accumulated depreciation amounts on December 31, 2014:

Equipment Less: Accumulated depreciation Equipment-net

Plenny $850,000 (200,000) $650,000

Sourdough $300,000 (60,000) $240,000

Consolidated amounts for equipment and accumulated depreciation at December 31, 2014 were respectively A) $1,125,000 and $255,000. B) $1,125,000 and $260,000. C) $1,150,000 and $255,000. D) $1,150,000 and $260,000. Answer: A Explanation: A) Combined equipment amounts $1,150,000 Less: gain on sale (25,000) Consolidated equipment balance $1,125,000 Combined Accumulated Depreciation Less: Depreciation on gain Consolidated Accumulated Depreciation

$260,000 (5,000) $255,000

Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

14) Peregrine Corporation acquired an 80% interest in Serine Corporation in 2011 at a time when Serine's book values and fair values were equal to one another. On January 1, 2014, Serine sold a truck with a $55,000 book value to Peregrine for $100,000. Peregrine is depreciating the truck over 10 years using the straight-line method. The truck has no salvage value. Separate incomes for Peregrine and Serine for 2014 were as follows:

Sales Gain on sale of truck Cost of Goods Sold Depreciation expense Other expenses Separate incomes

Peregrine $1,800,000

Serine $1,050,000 45,000 (285,000) (135,000) (450,000) $ 225,000

(750,000) (450,000) (180,000) $ 420,000

Peregrine's investment income from Serine for 2014 was A) $108,000. B) $144,000. C) $147,600. D) $180,000. Answer: C Explanation: C) Serine reported income $225,000 Less: Intercompany gain on truck (45,000) Plus: Recognition of gain ($45,000 / 10) 4,500 Serine's adjusted income 184,500 Majority percentage 80% Income from Serine $147,600 Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

15) Petrol Company acquired a 90% interest in Seadig Corporation on January 1, 2013. On January 1, 2014, Seadig sold a building with a book value of $120,000 to Petrol for $150,000. The building had a remaining useful life of ten years and no salvage value. Straight-line depreciation is used. The separate balance sheets of Petrol and Seadig on December 31, 2014 included the following balances:

Buildings Accumulated Depr. - Buildings

Petrol $500,000 180,000

Seadig $230,000 79,000

The consolidated amounts for Buildings and Accumulated Depreciation - Buildings that appeared, respectively, on the balance sheet at December 31, 2014, were A) $700,000 and $256,000. B) $700,000 and $259,000. C) $730,000 and $256,000. D) $730,000 and $259,000. Answer: A Explanation: A) Combined building amounts $730,000 Less: Intercompany gain (30,000) Consolidated building amounts $700,000 Combined Accumulated Depr. Less: Recognition of gain Consolidated Accumulated Depr.

$259,000 (3,000) $256,000

Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

16) Pigeon Corporation purchased land from its 60%-owned subsidiary, Seed Inc., in 2012 at a cost $50,000 greater than Seed's book value. In 2014, Pigeon sold the land to an outside entity for $20,000 more than Pigeon's book value. The 2014 consolidated income statement should report a gain on the sale of land of A) $12,000. B) $20,000. C) $42,000. D) $70,000. Answer: D Explanation: D) ($50,000 + $20,000) Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Moderate AACSB: Application of knowledge

17) Pied Imperial Corporation acquired a 90% interest in Somest Corporation in 2012 when Somest's book values were equivalent to fair values. Somest sold equipment with a book value of $80,000 to Pied for $130,000 on January 1, 2014. Pied is fully depreciating the equipment over a 4-year period by using the straight-line method. Somest reported net income for 2014 was $320,000. Pied's 2014 income from Somest was A) $249,250. B) $250,500. C) $254,250. D) $288,000. Answer: C Explanation: C) Pied's share of Somest's income = ($320,000 × 90%) $288,000 Less: Profit on intercompany sale ($130,000 - $80,000) × 90% = (45,000) Add: Piecemeal recognition of deferred profit ($50,000/4) × 90% 11,250 Income from Somest $254,250 Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

18) Pogo Corporation acquired a 75% interest in Sperry Corporation on January 1, 2011 at a cost equal to book value and fair value. In the same year Sperry sold land costing $25,000 to Pogo for $50,000. On July 1, 2014, Pogo sold the land to an unrelated party for $85,000. What was the gain on the sale of the land on the consolidated income statement for 2014? A) $25,000 B) $35,000 C) $45,000 D) $60,000 Answer: D Explanation: D) ($85,000 - $25,000) Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Moderate AACSB: Application of knowledge

19) On January 1, 2014 Saffron Co. recorded a $40,000 profit on the upstream sale of some equipment that had a remaining four-year life under the straight-line depreciation method. The equipment has no salvage value. Saffron had separate income of $100,000 in 2014. The parent company, Pommel Incorporated, owns 90% of Saffron. Pommel would report investment income from Saffron in 2014 of A) $54,000. B) $63,000. C) $90,000. D) $126,000. Answer: B Explanation: B) ($100,000 - $40,000 + $10,000) × 90% Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

20) Parrot Corporation acquired a 70% interest in Swifti Corp. on January 1, 2013, when Swifti's book values and fair values were equivalent. On January 1, 2014, Swifti sold a building with a book value of $60,000 to Parrot for $80,000. The building had a remaining life of five years, no salvage value, and was depreciated by the straight-line method. Swifti reported net income of $200,000 for 2014. What was the noncontrolling interest share for 2014? A) $54,000 B) $55,200 C) $60,000 D) $128,800 Answer: B Explanation: B) [$200,000 - $20,000 + ($20,000 / 5)] × 30% Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

6.2 Exercises 1) Pigeon Company owns 80% of the outstanding stock of Spiniflex Corporation, which was purchased on January 1, 2008, when Spiniflex's book values were equal to its fair values. The amount paid by Pigeon included $16,000 for goodwill. On January 1, 2009, Pigeon purchased a truck for $40,000 which had no salvage value with a useful life of 8 years, depreciated on a straight-line basis. On January 1, 2014, Pigeon sold the truck to Spiniflex Corporation for $18,000. The truck was estimated to have a three-year remaining life on this date and no salvage value. All affiliates use the straight-line depreciation method. Required: Prepare all relevant entries with respect to the truck. 1. Record the journal entries on Pigeon's books for 2014. 2. Record the journal entries on Spiniflex's books for 2014. 3. Prepare the consolidation entries required for Pigeon and subsidiary for 2014 as a result of this transaction. Answer: Requirement 1: Pigeon's books 01/01/14

Cash Accumulated depreciation Truck Gain on sale

18,000 25,000 40,000 3,000

Requirement 2: Spiniflex's books 01/01/14

Truck

18,000 Cash

12/31/14

18,000

Depreciation expense Accumulated depreciation

6,000 6,000

Requirement 3: Consolidation entries 12/31/14

Gain on sale of truck Truck

3,000

Accumulated depreciation Depreciation expense (3,000/3)

1,000

3,000

1,000

Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

2) Several years ago, Pilot International purchased 70% of the outstanding stock of Skyway Incorporated, at a time when Skyway's book values were equal to its fair values. On January 1, 2011 Skyway purchased a truck for $80,000 which had no salvage value with a useful life of 8 years, depreciated on a straight-line basis. On January 1, 2014, Skyway sold the truck to Pilot Corporation for $28,000. The truck was estimated to have a five-year remaining life on this date, and no salvage value. All affiliates use the straight-line depreciation method. Required: Prepare all relevant entries with respect to the truck. 1. Record the journal entries on Pilot's books for 2014. 2. Record the journal entries on Skyway's books for 2014. 3. Prepare the consolidation entries required for Pilot and subsidiary for 2014 as a result of this transaction. Answer: Requirement 1: Pilot's books 01/01/14 Truck 28,000 Cash 28,000 12/31/14

Depreciation expense Accumulated depreciation

5,600 5,600

Requirement 2: Skyway's books 01/01/14 Cash Accumulated depreciation Loss on sale of truck Truck

28,000 30,000 22,000

Requirement 3: Consolidation entries 12/31/14 Truck Loss on sale of truck

22,000

Depreciation expense Accumulated depreciation (22,000/5 = 4,400)

80,000

22,000 4,400 4,400

Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

3) Pollek Corporation paid $16,200 for a 90% interest in Swamp Corporation on January 1, 2013, when Swamp stockholders' equity consisted of $10,000 Capital Stock and $3,000 of Retained Earnings. The excess cost over book value was attributable to goodwill. Additional information: 1. Pollek sells merchandise to Swamp at 120% of Pollek's cost. During 2013, Pollek's sales to Swamp were $4,800, of which half of the merchandise remained in Swamp's inventory at December 31, 2013. (The 2013 ending inventory was sold in 2014.) During 2014, Pollek's sales to Swamp were $6,000 of which 60% remained in Swamp's inventory at December 31, 2014. At year-end 2014, Swamp owed Pollek $1,500 for the inventory purchased during 2014. 2. Pollek Corporation sold equipment with a book value of $2,000 and a remaining useful life of four years and no salvage value to Swamp Corporation on January 1, 2014 for $2,800. Straight-line depreciation is used. 3. Separate company financial statements for Pollek Corporation and Subsidiary at December 31, 2014 are summarized in the first two columns of the consolidation working papers. 4.

The following information is available for 2013:

Swamp's income Swamp's dividends received by Pollek

$4,000 $1,800

Required: Complete the working papers to consolidate the financial statements of Pollek Corporation and subsidiary for the year ended December 31, 2014.

Answer:

Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Difficult AACSB: Application of knowledge

4) Plower Corporation acquired all of the outstanding voting common stock of the Squab Corporation several years ago when the book values and fair values of Squab's net assets were equal. On April 1, 2012, Plower sold land that cost $25,000 to Squab for $40,000. Squab resold the land for $45,000 on December 1, 2014. On July 1, 2014, Plower sold equipment with a book value of $10,000 to Squab for $26,000. Squab is depreciating the equipment over a four-year period using the straight-line method. The equipment has no salvage value. Required: The first two columns in the working papers presented below summarize income statement information from the separate company financial statements of Plower and Squab for the year ended December 31, 2014. Fill in the consolidated working paper columns to show how each of the items from the separate company reports will appear in the consolidated income statement for the year ended December 31, 2014.

Sales Invest. income from Squab Gain on sale of equipment Gain on sale of land Cost of sales Depreciation expense Other expenses Net income

Plower 450,000 57,000 16,000

Squab 200,000

Consolidated

5,000 (91,500) (23,500) (34,000) 56,000

(211,500) (45,500) (120,000) 146,000

Answer: Sales Invest. income from Squab Gain on sale of equipment Gain on sale of land Cost of sales Depreciation expense Other expenses Net income

Plower 450,000 57,000 16,000

Squab 200,000

5,000 (91,500) (23,500) (34,000) 56,000

(211,500) (45,500) (120,000) 146,000

Consolidated 650,000 0 0 20,000 (303,000) (67,000) (154,000) 146,000

Gain on sale of land: $45,000 - $25,000 = $20,000 Depreciation expense: $45,500 + $23,500 - $2,000* = $67,000 *($26,000 - $10,000)/ 4 years = $4,000 × 1/2 year = $2,000 Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

5) Pierce Manufacturing owns all of the outstanding voting common stock of Sylvia Company, as acquired several years ago when the book values and fair values of Sylvia's net assets were equal. In 2013, Pierce set out to re-structure the company, and in doing so, re-aligned the manufacturing processes to streamline the use of automated equipment. As a result, they set out to move certain equipment around between the facilities owned by both Pierce and Sylvia, and ultimately agreed on the following transfers and exchange prices. It was agreed that the exchange price would be paid in cash on January 1, 2014, the date the equipment was transferred. Straight-line depreciation is used and the different pieces of equipment have no salvage value.

Equipment moved Equipment Transfer from moved to 1 Pierce Sylvia 2 Sylvia Pierce 3 Pierce Sylvia 4 Sylvia Pierce 5 Pierce Sylvia 6 Sylvia Pierce

Original cost 100,000 60,000 120,000 24,000 35,000 90,000

Life Remain (years) 10 10 8 5 5 5

Accum. deprec.(at Exchange transfer) price 52,500 50,000 20,000 40,000 72,000 40,000 10,800 15,000 12,500 25,000 52,500 37,500

Required: 1. Prepare the journal entry that Pierce would record for each transfer listed. 2. Prepare the journal entry that Sylvia would record for each transfer listed. 3. Prepare the consolidation worksheet entries that would be required as a result of the above transactions for 2014.

Answer: Requirement 1: Pierce's books 1)

Cash Accumulated depreciation Gain on sale of equip. Equipment

50,000 52,500

Equipment Cash

40,000

Cash Accumulated depreciation Loss on sale of equipment Equipment

40,000 72,000 8,000

Equipment Cash

15,000

Cash Accumulated depreciation Gain on sale of equip. Equipment

25,000 12,500

Equipment Cash

37,500

2,500 100,000

40,000

120,000

15,000

2,500 35,000

37,500

Requirement 2: Sylvia's books 1)

Equipment Cash

50,000

Cash Accumulated depreciation Equipment

40,000 20,000

Equipment Cash

40,000

Cash Accumulated depreciation Gain on sale of equip. Equipment

15,000 10,800

Equipment Cash

25,000

Cash Accumulated depreciation Equipment

37,500 52,500

50,000

60,000

40,000

1,800 24,000

25,000

90,000

Requirement 3: Consolidation workpapers 12/31/2014 Equipment Loss on sale ($8,000 Loss - $2,500 Gain $2,500 Gain - $1,800 Gain)

1,200

Accumulated depreciation Depreciation expense ($2,500/10 + $1,800/5 + $2,500/5 - $8,000/8)

110

1,200

110

Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

6) Snow Company is a wholly owned subsidiary of Penguin Corporation. On January 1, 2011, Penguin transferred equipment to Snow for $195,000. The equipment had originally cost $250,000, but at the time of transfer, had a $180,000 book value and a five year remaining life. Both companies use the straight-line method of depreciation and assume no salvage value for the equipment. Required: Prepare the consolidation worksheet entries for this asset on the following dates: 1. December 31, 2011 2. December 31, 2012 3. December 31, 2013 Answer: Requirement 1: Transfer price $195,000 Book value (180,000) Gain on transfer $15,000 December 31, 2011: Gain on sale of equipment Equipment Accumulated depreciation Depreciation expense December 31, 2012: Accumulated depreciation Investment Equipment Accumulated depreciation Depreciation expense December 31, 2013: Accumulated depreciation Investment Equipment Accumulated depreciation Depreciation expense

15,000 15,000 3,000 3,000

3,000 12,000 15,000 3,000 3,000

6,000 9,000 15,000 3,000 3,000

Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

7) Paula's Pizzas purchased 80% of their supplier, Sarah's Sauces. Sarah's book values equaled fair values at the time of the acquisition. Paula sold Sarah some packaging equipment on January 2, 2013 for $100,000. The equipment had a carrying value of $90,000, and original cost of $120,000, and had a remaining life of 10 years. Both Paula and Sarah depreciate their assets on the straight-line method. The equipment has no salvage value. Required: Prepare the following entries: 1. Journal entries Paula and Sarah will prepare on their separate books in 2013. 2. Eliminating/adjusting entries on the consolidation worksheet at the end of 2013. 3. Eliminating/adjusting entries on the consolidation worksheet at the end of 2014. Answer: Requirement 1: Paula's Books January 2, 2013: Cash $100,000 Accumulated depreciation 30,000 Equipment $120,000 Gain on sale of equipment 10,000 Sarah's Books January 2, 2013: Equipment Cash

100,000 100,000

December 31, 2013: Depreciation expense Accumulated depreciation

10,000 10,000

Requirement 2: December 31, 2013: Gain on sale of equipment Equipment

10,000 10,000

Accumulated depreciation Depreciation expense

1,000 1,000

Requirement 3: December 31, 2014: Accumulated depreciation Investment Equipment

1,000 9,000 10,000

Accumulated depreciation Depreciation expense

1,000 1,000

Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

8) Separate income statements of Pingair Corporation and its 90%-owned subsidiary, Staunch Inc., for 2014 were as follows:

Sales Revenue Cost of sales Other expenses Gain on equipment Income from Staunch Net income

Pingair $2,200,000 (1,400,000) (400,000) 80,000 128,000 $608,000

Staunch $1,000,000 (600,000) (200,000)

$200,000

Additional information: 1. Pingair acquired its 90% interest in Staunch Inc. when the book values were equal to the fair values. 2. The gain on equipment relates to equipment with a book value of $120,000 and a 4-year remaining useful life that Pingair sold to Staunch for $200,000 on January 2, 2014. The straight-line depreciation method is used. The equipment has no salvage value. 3. Pingair sold inventory to Staunch in 2013 and 2014 as shown in the table below. (The 2013 ending inventory is sold in 2014.)

Intercompany sales Original cost from third-party Percentage unsold at year-end

2013 $300,000 180,000 40

2014 200,000 120,000 50

4. Staunch did not declare or pay dividends in 2013 and 2014. Required: 1. Prepare adjusting/eliminating entries for the consolidation worksheet at December 31, 2014. 2. Prepare a consolidated income statement for Pingair Corporation and Subsidiary for the year ended December 31, 2014.

Answer: Requirement 1 12/31/2014 Gain on sale of equipment Equipment

80,000 80,000

Accumulated depreciation Depreciation expense

20,000

Sales

200,000

20,000

Cost of goods sold

200,000

Cost of goods sold Inventory

40,000

Investment Cost of goods sold

48,000

Investment income Investment

128,000

Noncontrolling interest share Noncontrolling interest

20,000

40,000

48,000

128,000

20,000

Requirement 2 Pingair Corporation and Subsidiary Consolidated Income Statement For the Year Ended December 31, 2014 Sales (see below) $3,000,000 Cost of sales (see below) (1,792,000) Other expenses (see below) (580,000) Consolidated net income 628,000 Noncontrolling interest share (20,000) Controlling interest share $ 608,000 Sales: $2,200,000 + $1,000,000 - $200,000 Cost of Sales: $1,400,000 + $600,000 - $200,000 - $48,000 + $40,000 Other expenses: $400,000 + $200,000 - $20,000 Noncontrolling interest share: $200,000 × 10% Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

9) On January 1, 2013, Pilgrim Imaging purchased 90% of the outstanding common stock of Snapshot Productions for $585,000 cash. The remaining 10% of Snapshot had an assessed fair value of $65,000 at that time. Snapshot had equipment that was undervalued on their books by $50,000, and an unrecorded patent with a fair value of $15,000. The equipment had five years remaining to its useful life, and the patent had 10 years remaining to its useful life. On January 1, 2014, Pilgrim sold Snapshot a building for $100,000 that had originally cost $140,000. The book value was $60,000 at the date of transfer, and had a five-year remaining life at the date of transfer. Straight-line depreciation is used with no salvage value. Several line items from the companies' separate December 31, 2014 trial balances are shown below. Pilgrim 1,200,000 800,000 240,000 700,000 280,000 360,000

Sales Cost of goods sold Operating expenses Buildings (net) Equipment (net) Patent

Snapshot 500,000 240,000 80,000 180,000 150,000 Not recorded

Required: Determine consolidated balances for each of the accounts listed as of December 31, 2014. Answer: Sales Cost of goods sold

Pilgrim 1,200,000 800,000

Operating expenses

240,000

Buildings (net)

700,000

Equipment (net)

280,000

Patent

360,000

Snapshot Adjustments Consolidated 500,000 1,700,000 240,000 1,040,000 +10,000 +1,500 80,000 -8,000 323,500 -40,000 180,000 +8,000 848,000 +50,000 -10,000 150,000 -10,000 460,000 +15,000 -1,500 -0-1,500 372,000

Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

10) Several years ago, Peacock International purchased 80% of the outstanding stock of Strutt Incorporated, at a time when Strutt's book values were equal to its fair values. On January 1, 2009, Strutt purchased a truck for $160,000 which had no salvage value with a useful life of 8 years, depreciated on a straight-line basis. On January 1, 2012, Strutt sold the truck to Peacock Corporation for $56,000. The equipment was estimated to have a five-year remaining life on this date, with no salvage value. All affiliates use the straight-line depreciation method. Required: Prepare the consolidation entries required for Peacock and subsidiary at: 1. December 31, 2012 2. December 31, 2013 3. December 31, 2014 4. December 31, 2015 Answer: 12/31/2012 Truck 44,000 Loss on sale of truck

12/31/2013

12/31/2014

12/31/2015

Depreciation expense Accumulated depreciation

8,800

Truck Investment Accumulated depreciation Noncontrolling interest

44,000

Depreciation expense Accumulated depreciation

8,800

Truck Investment Accumulated depreciation Noncontrolling interest

44,000

Depreciation expense Accumulated depreciation

8,800

Truck Investment Accumulated depreciation Noncontrolling interest

44,000

Depreciation expense Accumulated depreciation

8,800

44,000

8,800

28,160 8,800 7,040

8,800

21,120 17,600 5,280

8,800

14,080 26,400 3,520

8,800

Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

11) Prey Corporation created a wholly owned subsidiary, Sage Corporation, on January 1, 2013, at which time Prey sold land with a book value of $90,000 to Sage at its fair market value of $140,000. Also, on January 1, 2013, Prey sold to Sage equipment with a book value of $130,000 and a selling price of $165,000. The equipment had a remaining useful life of 4 years and is being depreciated under the straight-line method. The equipment has no salvage value. On January 1, 2015, Sage resold the land to an outside entity for $150,000. Sage continues to use the equipment purchased from Prey. Income statements for Prey and Sage for the year ended December 31, 2015 are summarized below:

Sales Gain on sale of land Cost of sales Depreciation expense Other expenses Net income

Prey $450,000

Sage $100,000 10,000 (50,000) (32,000) (8,000) $20,000

(220,000) (95,000) (37,000) $98,000

Required: At what amounts did the following items appear on the consolidated income statement for Prey and Subsidiary for the year ended December 31, 2015? 1. Gain on Sale of Land 2. Depreciation Expense 3. Consolidated net income 4. Controlling interest share of consolidated net income Answer: Requirement 1 The gain on the sale of the land in 2015 was $150,000 - $90,000, or $60,000. Requirement 2 The consolidated amount of depreciation expense was $95,000 + $32,000 - ($35,000/4 years) = $118,250. Requirements 3 and 4 Prey separate income (not including Sage)= Income from Sage Plus: Deferred gain on land Plus: Recognition of gain on equipment sale Consolidated net income = Controlling interest share of consolidated net income

$98,000 20,000 50,000 8,750 $176,750

Objective: LO6.3 Recognize realized, previously deferred profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

12) Piglet Incorporated purchased 90% of the outstanding stock of Sourgrape Company several years ago at book value. At January 1, 2012, Sourgrape sold land with a book value of $30,000 to Piglet at its fair market value of $40,000. At the same time, Sourgrape sold the building that was on the land to Piglet. The building had a book value of $80,000 and was sold at its fair value of $120,000. The building had a remaining useful life of 8 years and is depreciated using the straight-line method. The building has no salvage value. On January 1, 2014, Piglet sold the land and building to a third party. The sales price was allocated so that the land was sold for $50,000 and the building was sold for $150,000. Income statements for Piglet and Sourgrape for the year ended December 31, 2014 are summarized below:

Sales Gain on sale of land and building Cost of sales Depreciation expense Other expenses Net income

Piglet $252,000 40,000 (140,000) (60,000) (20,000) $72,000

Sourgrape $90,000 (40,000) (20,000) (10,000) $20,000

Required: Prepare the eliminating/adjusting entries related to the land and building on the consolidated working papers on the following dates: 1. December 31, 2012 2. December 31, 2013 3. December 31, 2014

Answer: Requirement 1 (December 31, 2012) Gain on sale of land Land

10,000 10,000

Gain on sale of building Building

40,000

Accumulated depreciation Depreciation expense

5,000

40,000

5,000

Requirement 2 (December 31, 2013) Investment Noncontrolling interest Land

9,000 1,000 10,000

Accumulated depreciation Depreciation expense

5,000

Accumulated depreciation Investment Noncontrolling interest Building

5,000 31,500 3,500

5,000

40,000

Requirement 3 (December 31, 2014) Investment Noncontrolling interest Gain on sale of land Accumulated depreciation Noncontrolling interest Investment Gain on sale of building

9,000 1,000 10,000 10,000 3,000 27,000 40,000

Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

13) Separate income statements of Plantation Corporation and its 90%-owned subsidiary, Savannah Corporation, for 2014 are as follows, prior to Plantation recording any income related to its subsidiary:

Sales Revenue Gain on equipment Gain on land Cost of sales Other expenses Separate incomes

Plantation $870,000 35,000

Savannah $230,000 20,000 (90,000) (60,000) $100,000

(470,000) (265,000) $170,000

Additional information: 1. Plantation acquired its 90% interest in Savannah Corporation when the book values were equal to the fair values. 2. The gain on equipment relates to equipment with a book value of $95,000 and a 7-year remaining useful life that Plantation sold to Savannah for $130,000 on January 1, 2014. The straight-line depreciation method was used and the equipment has no salvage value. 3. On January 1, 2014, Savannah sold land to an outside entity for $90,000. The land was acquired from Plantation in 2009 for $70,000. The original cost of the land to Plantation was $45,000. 4. Savannah did not declare or distribute dividends in 2014. Required: 1. Prepare elimination/adjusting entries on the consolidated worksheet for the year 2014. 2. Prepare the consolidated income statement for the year ended December 31, 2014.

Answer: Requirement 1 Investment Gain on sale of land

25,000 25,000

Gain on sale of equipment Equipment

35,000

Accumulated depreciation Depreciation expense

5,000

35,000

5,000

Investment income 85,000 Investment (90% × $100,000) - $35,000 + $5,000 + $25,000

85,000

Noncontrolling interest share Noncontrolling interest ($100,000 × 10%)

10,000

Requirement 2 Plantation Corporation and Subsidiary Consolidated Income Statement for the year ended December 31, 2014 Sales Gain on land ($20,000 + $25,000) Cost of sales Other expenses (see below) Consolidated net income Noncontrolling interest share (see below) Controlling interest share

$1,100,000 45,000 (560,000) (320,000) 265,000 (10,000) $255,000

Other expenses: $265,000 + $60,000 - $5,000 piecemeal recognition of gain on equipment Noncontrolling interest share: $100,000 × 10% Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

14) Passo Corporation acquired a 70% interest in Saun Corporation in 2009 at a time when Saun's book values and fair values were equal. In 2012, Saun sold land to Passo for $82,000 that cost $72,000. The land remained in Passo's possession until 2014 when Passo sold it outside the combined entity for $102,000. After the books were closed in 2014, it was discovered that Passo had not considered the unrealized gain from its intercompany purchase of land in preparing the consolidated financial statements. The only entry on Passo's books was a debit to Land and a credit to Cash in 2012 for $82,000, and in 2014, a debit to Cash for $102,000 and credits to Land for $82,000 and Gain on sale of land for $20,000. Before the discovery of the error, the consolidated financial statements disclosed the following amounts:

Controlling interest share Land

2012 $750,000 200,000

2013 $600,000 240,000

2014 $910,000 300,000

Required: 1. Prepare elimination/adjusting entries relating to the land on the consolidated working papers for December 31, 2012, December 31, 2013 and December 31, 2014. 2. Determine the correct amounts for Land in 2012, 2013, and 2014. 3. Calculate the amount at which the gain on the sale of land should have been reported in 2014. Answer: Requirement 1 December 31, 2012:

December 31, 2013:

December 31, 2014

Gain on sale of land Land

10,000

Investment Noncontrolling interest Land

7,000 3,000

Investment Noncontrolling interest Gain on sale of land

7,000 3,000

10,000

Requirement 2 Land account as reported Less: Intercompany profit Restated land account

2012 $ 200,000 -10,000 $ 190,000

2013 $ 240,000 -10,000 $ 230,000

2014 $ 300,000 $ 300,000

Requirement 3 Final sales price outside the entity minus the original cost to the combined entity equals $102,000 minus $72,000 = $30,000. Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Moderate AACSB: Application of knowledge

15) Porter Corporation acquired 70% of the outstanding voting common stock of Sherman Inc. in 2008. On January 1, 2009, Sherman Inc. purchased a depreciable machine for $120,000 cash with an estimated useful life of 10 years that was depreciated on a straight-line basis. The machine has no estimated salvage value. Sherman used the machine until the end of 2011. On January 2, 2012, Sherman sold the machine to Porter who continued to use the same estimated life (seven years remaining), salvage value and depreciation method that was used by Sherman. At the end of 2012, Sherman reported a gain on sale of the machine of $14,000. Required: Answer the following questions concerning Porter and Sherman. 1. Prepare elimination/adjusting entries for the consolidated working papers for the year ended December 31, 2012. 2. How much depreciation expense relating to the transferred asset did Porter record in 2012 on the company's separate books? 3. How much depreciation expense relating to the transferred asset was reported on the consolidated income statement in 2012? 4. What amounts were reported for the Machine and the Accumulated Depreciation in the consolidated balance sheet on December 31, 2012? Answer: Requirement 1 Accumulated depreciation 2,000 Depreciation expense 2,000 Gain on sale of machine Machine

14,000 14,000

Requirement 2 Porter will record $14,000 of depreciation expense each year. Requirement 3 Depreciation expense will be $12,000 on the consolidated income statement. Requirement 4 Machine $120,000 Accumulated depreciation $12,000 × 4 = $48,000 Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Application of knowledge

16) Park Incorporated purchased a 70% interest in Silk Company in 2012 at book value. On January 1, 2014, equipment having a historical cost of $100,000 and a net book value of $70,000 is sold in an intercompany transfer for $90,000. The equipment has a remaining useful life of five years and no salvage value. Straight-line depreciation is used by both companies. Silk reports net income of $180,000 in 2014 and $200,000 in 2015. Required: 1. Assume Park sold the equipment to Silk. A. Prepare the consolidating worksheet entries for the equipment for 2014 and 2015. B. Calculate the noncontrolling interest share in Silk's income for 2014 and 2015. 2. Assume that Silk sold the equipment to Park. A. Prepare the consolidating worksheet entries for the equipment for 2014 and 2015. B. Calculate the noncontrolling interest share in Silk's income for 2014 and 2015. Answer: Requirement 1A 2014: Gain on sale of equipment 20,000 Equipment 20,000 To defer unrealized gain. Accumulated depreciation 4,000 Depreciation expense 4,000 To eliminate the overstatement of depreciation expense resulting from intercompany transfer. 2015: Investment 16,000 Accumulated depreciation 4,000 Equipment To eliminate effects of 2014 intercompany sale.

20,000

Accumulated depreciation 4,000 Depreciation expense 4,000 To eliminate the overstatement of depreciation expense resulting from intercompany transfer.

Requirement 1B Noncontrolling interest share calculation: 2014 = $180,000 × 30% = $54,000 2015 = $200,000 × 30% = $60,000 Note that because the transfer was downstream, there is no effect on the noncontrolling interest share calculation. Requirement 2A 2014: Gain on sale of equipment Equipment To defer unrealized gain.

20,000 20,000

Accumulated depreciation 4,000 Depreciation expense 4,000 To eliminate the overstatement of depreciation expense resulting from intercompany transfer. 2015: Investment 11,200 Accumulated depreciation 4,000 Noncontrolling interest 4,800 Equipment To eliminate effects of 2014 intercompany sale.

20,000

Accumulated depreciation 4,000 Depreciation expense 4,000 To eliminate the overstatement of depreciation expense resulting from intercompany transfer. Requirement 2B 2014: Noncontrolling interest share = ($180,000 - unrealized gain $20,000 + excess depreciation $4,000) × 30% = $164,000 × 30% = $49,200 2015: Noncontrolling interest share= ($200,000 + excess depreciation $4,000) × 30% = $204,000 × 30% = $61,200 Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

17) Palmer Corporation purchased 75% of Stone Industries' common stock on January 2, 2012. On January 1, 2013, Stone sold equipment to Palmer that had a net book value of $16,000 and an original cost of $24,000 for $20,000. On January 1, 2013, Palmer sold a building to Stone that had a net book value of $200,000 and an original cost of $250,000 for $300,000. The equipment had a remaining useful life of 8 years, and the building had a remaining useful life of 20 years. Neither asset had salvage value. Both companies use straight-line depreciation. Selected account balances are shown below for Palmer and Stone for the year ended December 31, 2013:

Sales Cost of Goods Sold Other Expenses Gain on sale Building - net Equipment - net

Palmer $280,000 180,000 60,000 100,000 560,000 316,000

Stone $240,000 100,000 30,000 4,000 285,000 187,000

Required: 1. Prepare the consolidating working paper entries relating to the equipment and building for the year ended December 31, 2013. 2. Calculate the following balances for the year ended December 31, 2013: A. Consolidated "Other Expenses" B. Consolidated Buildings C. Consolidated Equipment D. Noncontrolling interest in Stone's net income

Answer: Requirement 1 Gain on sale of building Building

100,000 100,000

Accumulated depreciation Depreciation expense

5,000

Gain on sale of equipment Equipment

4,000

Accumulated depreciation Depreciation expense

500

5,000

4,000

500

Requirement 2 A. Consolidated Other Expenses = $60,000 + $30,000 - excess depreciation building $5,000 - excess depreciation on equipment $500 = $84,500 B. Consolidated Buildings = $560,000 + $285,000 - Gain on Building $100,000 + excess depreciation on building $5,000 = $750,000 C. Consolidated Equipment = $316,000 + $187,000 - Gain on Equipment $4,000 + excess depreciation $500 = $499,500 D. Noncontrolling interest share = $240,000 - $100,000 - $30,000 + excess depreciation $500 = $110,500 × .25 = $27,625 Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

18) On January 2, 2014, Pal Corporation sold warehouse equipment to SimCo, a wholly-owned subsidiary. The equipment had an original cost of $130,000 and a net book value of $100,000 when it was sold to SimCo for $150,000. Both companies agreed that the equipment had a five-year remaining life and compute depreciation on the straight-line method. The equipment has no salvage value. Pal reported $470,000 in net income in 2014 (prior to reporting any income from SimCo), and SimCo reported $160,000 in net income. Required: 1. Calculate consolidated net income for 2014. 2.

Determine the controlling share of net income for the year if Pal only owned 75% of SimCo.

3. Determine the controlling share of net income for the year if Pal only owned 75% of SimCo AND the equipment transfer was upstream. Answer: 1. Pal separate net income $470,000 SimCo separate net income 160,000 Less: unrealized gain on equipment (50,000) Plus: excess depreciation 10,000 $590,000 2.

Consolidated net income (from above) Less: Noncontrolling interest in SimCo income SimCo separate net income $160,000 × 25% = Controlling interest share of cons. income

$590,000

Consolidated net income (from above) Less: Noncontrolling interest in SimCo income (SimCo separate net income $160,000 - deferred gain on transfer of equipment $50,000 + excess depreciation $10,000) × 25% = Controlling interest share of cons. income

$590,000

(40,000) $550,000

(30,000) $560,000

Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

19) Plock Corporation, the 75% owner of Seraphim Company, reported net income of $400,000 in 2013, prior to recording any income from Seraphim. Seraphim reported net income for that same year of $80,000 on their stand-alone statements. During 2013, an intercompany sale of a vehicle resulted in a gain of $4,000, and the vehicle was assumed to have a four-year remaining useful life. The vehicle has no salvage value. Straight-line depreciation is used. Required: 1. Assuming that the vehicle transfer was downstream, calculate Plock's consolidated net income for 2013, and controlling share of consolidated net income for 2013. 2. Assuming that the vehicle transfer was upstream, calculate Plock's consolidated net income for 2013, and controlling share of consolidated net income for 2013. Answer: 1. Downstream sale: Plock's separate net income $400,000 Seraphim's separate net income 80,000 Less: Unrealized gain on vehicle (4,000) Plus: Excess depreciation 1,000 Consolidated Net income $477,000 Noncontrolling interest share ($80,000 × 25%) Controlling share of consolidated net income

(20,000) 457,000

2. Upstream sale: Plock's separate net income Seraphim's separate net income Less: Unrealized gain on vehicle Plus: Excess depreciation Consolidated Net income

$400,000 80,000 (4,000) 1,000 $477,000

Noncontrolling interest share ($80,000 - 4,000 + 1,000) × 25% Controlling share of consolidated net income

(19,250) 457,750

Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Application of knowledge

6.3 True/False 1) An intercompany gain or loss appears in the income statement of the selling affiliate in the year of the sale. Answer: TRUE Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Easy AACSB: Analytical thinking

2) A gain or loss on sales downstream from parent to subsidiary is initially included in parent income and must be 100% eliminated. Answer: TRUE Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Moderate AACSB: Analytical thinking

3) Upstream sales of depreciable assets from a subsidiary to a parent result in unrealized gains or losses in the subsidiary accounts in the year after the sale. Answer: FALSE Objective: LO6.3 Recognize realized, previously deferred profits on plant asset transfers. Difficulty: Moderate AACSB: Analytical thinking

4) Gross profit on inventory items sold for use in the operations of an affiliate will be realized for consolidated statement purposes immediately. Answer: FALSE Objective: LO6.4 Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Difficulty: Moderate AACSB: Analytical thinking

5) For upstream sales the total amount of unrealized gains and losses are allocated between controlling and noncontrolling interest shares. Answer: TRUE Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Moderate AACSB: Analytical thinking

6) Unrealized inventory profits self-correct over any three accounting periods. Answer: FALSE Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Easy AACSB: Analytical thinking

7) Unrealized profits or losses on plant assets affect the financial statements until the assets are sold outside the consolidated entity. Answer: TRUE Objective: LO6.2 Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Difficulty: Easy AACSB: Analytical thinking

8) The transfer of nondepreciable plant assets between affiliates at a price other than book value gives rise to unrealized profit or loss to the consolidated entity. Answer: TRUE Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Easy AACSB: Analytical thinking

9) Gain on the sale of land between affiliates should not appear in the consolidated income statement. Answer: TRUE Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Easy AACSB: Analytical thinking

10) The parent affiliate recognizes a gain on the sale of land to a subsidiary only after the subsidiary sells it to an outside entity. Answer: TRUE Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Moderate AACSB: Analytical thinking

11) An entry is necessary to eliminate the full amount of the gain on the sale of land and to reduce the land to its cost basis to the consolidated entity whether the intercompany sale is upstream or downstream. Answer: TRUE Objective: LO6.1 Assess the impact of intercompany profit on transfers of plant assets on consolidated financial statements. Difficulty: Moderate AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 7 Intercompany Profit Transactions - Bonds 7.1 Multiple Choice Questions 1) If the price paid by a parent company to acquire the debt of a subsidiary is greater than the book value of the liability, a ________ occurs. A) realized loss on the retirement of debt from the viewpoint of the subsidiary B) realized gain on the retirement of debt from the viewpoint of the subsidiary C) constructive loss on the retirement of debt from the viewpoint of the consolidated entity D) constructive gain on the retirement of debt from the viewpoint of the consolidated entity Answer: C Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Easy AACSB: Analytical thinking

2) If an affiliate purchases bonds in the open market, the book value of the intercompany bond liability at the time of purchase is A) always assigned to the parent company because it has control. B) the par value of the bonds less the unamortized discount or plus the unamortized premium. C) par value. D) the par value of the bonds plus the unamortized discount or less the unamortized premium. Answer: B Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Easy AACSB: Analytical thinking

3) Bonds issued by a company remain on their books as a liability, but are considered constructively retired when A) the company borrows money from unaffiliated entities to re-purchase its own bonds at a gain. B) the company borrows money from an affiliate to re-purchase its own bonds at a gain. C) the company's parent or subsidiary purchases the bonds from outside entities. D) the company borrows money from an affiliate to repurchase its own bonds at a gain or at a loss. Answer: C Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Easy AACSB: Analytical thinking

Use the following information to answer the question(s) below. Pascalian Company owns a 90% interest in Sapp Company. On January 1, 2013, Pascalian had $300,000, 6% bonds outstanding with an unamortized premium of $9,000. The bonds mature on December 31, 2017. Sapp acquired one-third of Pascalian's bonds in the open market for $97,000 on January 1, 2013. Both companies use straight-line amortization of bond discounts/premiums. Interest is paid on December 31. On December 31, 2013, the books of the two affiliates held the following balances: Pascalian's books 6% bonds payable Premium on bonds Interest expense

$300,000 7,200 16,200

Sapp's books Investment in Pascalian bonds Interest income

$ 97,600 6,600

4) The gain from the bond purchase that appeared on the December 31, 2013 consolidated income statement was A) $4,320. B) $4,800. C) $5,400. D) $6,000. Answer: D Explanation: D) Book value of Pascalian's bonds acquired by Sapp equals 1/3 times ($300,000 + $9,000) $103,000 Less: Cost of acquiring Pascalian bonds ( 97,000) Constructive gain on bonds $ 6,000 Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

5) Consolidated Interest Expense and consolidated Interest Income, respectively, that appeared on the consolidated income statement for the year ended December 31, 2013 was A) $10,800 and $0. B) $10,800 and $6,600. C) $0 and $0. D) $16,200 and $6,600. Answer: A Explanation: A) Consolidated interest expense = $16,200 × 2/3 $10,800 Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

6) Prussia Corporation owns 80% of the voting stock of Stad Corporation. On January 1, 2013, Prussia paid $391,000 cash for $400,000 par of Stad's 10% $1,000,000 par value outstanding bonds, due on April 1, 2018. Stad's bonds had a book value of $1,045,000 on January 1, 2013. Straight-line amortization is used. The gain or loss on the constructive retirement of $400,000 of Stad bonds on January 1, 2013 was reported in the 2013 consolidated income statement in the amount of A) $14,000. B) $27,000. C) $23,000. D) $21,600. Answer: D Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Pfadt Inc. had $600,000 par of 8% bonds payable outstanding on January 1, 2013 due January 1, 2017 with an unamortized discount of $12,000. Senat is a 90%-owned subsidiary of Pfadt. On January 2, 2013, Senat Corporation purchased $150,000 par value of Pfadt's outstanding bonds for $152,000. The bonds have interest payment dates of January 1 and July 1. Straight-line amortization is used. 7) With respect to the bond purchase, the consolidated income statement of Pfadt Corporation and Subsidiary for 2013 showed a gain or loss of A) $ 4,500. B) $ 5,000. C) $10,800. D) $12,000. Answer: B Explanation: B) [($588,000 × 0.25) -$152,000] Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

8) Bond Interest Receivable for 2013 of Pfadt's bonds on Senat's books was A) $5,400. B) $6,000. C) $10,800. D) $12,000. Answer: B Explanation: B) [$150,000 × 8% × 1/2] Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

9) Bonds Payable appeared in the December 31, 2013 consolidated balance sheet of Pfadt Corporation and Subsidiary in the amount of A) $398,925. B) $443,500. C) $441,000. D) $450,000. Answer: C Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Plenty Corporation issued six thousand, $1,000 par, 6% bonds on January 1, 2012, at par. Interest is paid on January 1 and July 1 of each year; the bonds mature on January 1, 2017. On January 2, 2014, Scrawn Corporation, a 75%-owned subsidiary of Plenty, purchased 3,000 of the bonds on the open market at 102.50. Plenty's separate net income for 2014 included the annual interest expense for all 3,000 bonds. Scrawn's separate net income for 2014 was $400,000, which included the bond interest received on July 1 as well as the accrual of bond interest revenue earned on December 31. Both companies use straight-line amortization of bond discounts/premiums. 10) What was the amount of gain or (loss) from the intercompany purchase of Plenty's bonds on January 2, 2014? A) $(56,250) B) $(75,000) C) $ 75,000 D) $ 56,250 Answer: B Explanation: B) Total book value acquired = $6,000,000 × 50% $3,000,000 Purchase price 3,000 × $1,025 3,075,000 Loss on constructive retirement $ 75,000 Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

11) If the bonds were originally issued at 106, and 80% of them were purchased by Scrawn on January 2, 2015 at 98, the gain or (loss) from the intercompany purchase was A) $(384,000). B) $(211,200). C) $ 211,200. D) $ 384,000. Answer: D Explanation: C) Book value at January 2, 2015 equals $6,360,000 = $6,360,000 Percentage of bonds acquired 80% Equals book value acquired 5,088,000 Purchase price 4,800 bonds × $980 = 4,704,000 Gain on constructive retirement = $ 384,000 Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

12) If the bonds were originally issued at 103, and 70% of them were purchased on January 2, 2016 at 104, the constructive gain or (loss) on the purchase was A) $(142,800). B) $( 42,000). C) $ 42,000. D) $ 142,800. Answer: B Explanation: A) Book value at January 2, 2016 equals $6,180,000 $6,180,000 Percentage of bonds acquired 70% Equals book value acquired 4,326,000 Purchase price 4,200 bonds × $1,040 4,368,000 Loss on constructive retirement $ (42,000) Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

13) Using the original information, the amount of consolidated Interest Expense for 2014 was A) $ 135,000. B) $ 180,000. C) $ 270,000. D) $ 360,000. Answer: B Explanation: B) ($6,000,000 - $3,000,000) × 6% Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

14) Using the original information, the balances for the Bonds Payable and Bond Interest Payable accounts, respectively, on the consolidated balance sheet for December 31, 2015 were A) $3,000,000 and $ 90,000. B) $3,000,000 and $180,000. C) $6,000,000 and $ 90,000. D) $6,000,000 and $180,000. Answer: A Explanation: A) Bonds payable $6,000,000 minus bonds held by Scrawn of $3,000,000. Interest accrued on December 31, 2015 will be the interest on bonds held by non-affiliates or $3,000,000 × 6% × 1/2 year Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

15) Using the original information, the elimination entries on the consolidation working papers prepared on December 31, 2014 included at least A) debit to Bond Interest Expense for $360,000. B) credit to Bond Interest Expense for $180,000 and a debit to Bond Interest Payable for $90,000. C) credit to Bond Interest Receivable for $180,000. D) debit to Bond Interest Revenue for $360,000. Answer: B Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

16) No constructive gain or loss arises from the purchase of an affiliate's bonds if the A) affiliate is a 100%-owned subsidiary. B) bonds are purchased at book value. C) bonds are purchased with arm's-length bargaining from outside entities. D) gain or loss cannot be reasonably estimated. Answer: B Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Easy AACSB: Application of knowledge

17) There are several theories for allocating constructive gains or losses between purchasing and issuing affiliates. The Agency Theory A) does so based on the par value of the bonds purchased. B) assigns the entire constructive gain or loss to the parent based on their control of the decision to purchase the bonds. C) assigns the entire constructive gain or loss to the subsidiary based on the need to have the noncontrolling interest share in the retirement of the debt. D) assigns the entire constructive gain or loss to whichever company issued the bonds. Answer: D Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Easy AACSB: Analytical thinking

18) Pickle Incorporated acquired a $10,000 bond originally issued by its 80%-owned subsidiary on January 2, 2013. The bond was issued in a prior year for $11,250, matures January 1, 2018, and pays 9% interest at December 31. The bond's book value at January 2, 2013 is $10,625, and Pickle paid $9,500 to purchase it. Straight-line amortization is used by both companies. How much interest income should be eliminated in 2013? A) $720 B) $800 C) $900 D) $1,000 Answer: D Explanation: D) $9,500 - $10,000 = discount to amortize as interest expense over 5 years, or $100 per year + $900 paid by issuer. Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Poe Corporation owns an 80% interest in Seri Company acquired at book value several years ago. On January 2, 2013, Seri purchased $100,000 par of Poe's outstanding 10% bonds for $103,000. The bonds were issued at par and mature on January 1, 2016. Straight-line amortization is used. Separate incomes of Poe and Seri for 2013 are $350,000 and $120,000, respectively. Poe uses the equity method to account for the investment in Seri. 19) Controlling interest share of consolidated net income for 2013 was A) $443,600. B) $444,000. C) $444,400. D) $448,000. Answer: B Explanation: B) Poe's separate income $ 350,000 Income from Seri ($120,000 × 80%) 96,000 Less: Loss on constructive retirement of Poe bonds (3,000) Plus: Piecemeal recognition of the constructive loss ($3,000/3 years) 1,000 Controlling interest share $ 444,000 Objective: LO7.4 Calculate noncontrolling interest share in the presence of intercompany gains/losses on debt transfers. Difficulty: Moderate AACSB: Application of knowledge

20) Noncontrolling interest share for 2013 was A) $23,000. B) $23,600. C) $24,000. D) $24,400. Answer: C Explanation: C) Since Poe is the issuing entity, the gain or loss is not allocated to the noncontrolling interest. The noncontrolling interest share is ($120,000 × 20%) = $24,000. Objective: LO7.4 Calculate noncontrolling interest share in the presence of intercompany gains/losses on debt transfers. Difficulty: Moderate AACSB: Application of knowledge

7.2 Exercises 1) Separate company and consolidated income statements for Pitta and Sojourn Corporations for the year ended December 31, 2013 are summarized as follows:

Sales Revenue Income from Sojourn Bond interest income Gain on bond retirement Total revenues Cost of sales Bond interest expense Other expenses Total expenses Consolidated net income Noncontrolling interest share Separate net income and Control. interest share in consolidated net income

Pitta $ 500,000 19,900

Soujourn $ 100,000

Consolidated $ 600,000

6,000 3,000 603,000

519,900

106,000

$ 280,000 9,000 120,900 409,900

$ 50,000 31,000 81,000

$ 330,000 3,600 151,900 485,500 117,500 7,500

$ 110,000

$ 25,000

$ 110,000

The interest income and expense eliminations relate to a $100,000, 9% bond issue that was issued at par value and matures on January 1, 2018. On January 2, 2013, a portion of the bonds was purchased and constructively retired. Required: Answer the following questions. 1. Which company is the issuing affiliate of the bonds payable? 2. What is the gain or loss from the constructive retirement of the bonds payable that is reported on the consolidated income statement for 2013? 3. What portion of the bonds payable is held by nonaffiliates at December 31, 2013? 4. Is Sojourn a wholly-owned subsidiary? If not, what percentage does Pitta own? 5. Does the purchasing affiliate use straight-line or effective interest amortization? 6. Explain the calculation of Pitta's $19,900 income from Sojourn.

Answer: 1. Pitta is the issuing affiliate. 2.

Effect on consolidated net income: Gain on constructive retirement of bonds

$ 3,000

3. Percent of bonds held by nonaffiliates at December 31, 2013 is 40%, computed as $3,600 consolidated interest expense divided by $9,000 interest expense of Pitta. 4. Sojourn is partially owned as evidenced by the noncontrolling interest share. The ownership percentage is 70% ($7,500 noncontrolling interest share divided by $25,000 income of Sojourn = 30% noncontrolling interest.). 5.

Straight-line amortization $100,000 par × 60% purchased Purchase price 5 years before maturity Gain

$60,000 57,000 3,000

Nominal interest ($60,000 × 9%) Discount amortization ($3,000/5 years) Bond interest income

$ 5,400 600 $ 6,000

Pitta's income from Sojourn Share of Sojourn's reported income ($25,000 × 70%) = Add: Constructive gain Less: Piecemeal recognition of constructive gain Income from Sojourn

$17,500 3,000 (600) $19,900

Objective: LO7.4 Calculate noncontrolling interest share in the presence of intercompany gains/losses on debt transfers. Difficulty: Moderate AACSB: Application of knowledge

2) Platts Incorporated purchased 80% of Scarab Company several years ago when the fair value equaled the book value. On January 1, 2013, Scarab has $100,000 of 8% bonds that were issued at face value and have five years to maturity. Interest is paid annually on December 31. Both Platts and Scarab would use the straight-line method to amortize any premium or discount incurred in the issuance or purchase of bonds. On January 1, 2014, Platts purchased all of Scarab's bonds for $96,000. Required: 1. Prepare the journal entries in 2014 that would be recorded by Platts and Scarab on their separate financial records. 2. Prepare the consolidating working paper entries required for the year ending December 31, 2014. Answer: Requirement 1: Platts entries: 1/1/14 Investment in bonds $96,000 Cash $96,000 12/31/14

Cash

8,000 Interest income

8,000

Investment in bonds Interest income

1,000 1,000

Scarab entries: 12/31/14 Interest expense Cash Requirement 2: Consolidating entries: 12/31/14 Bonds payable Investment in bonds Gain on retirement of debt Interest income Interest expense Gain on retirement of debt

8,000 8,000

100,000 97,000 3,000 9,000 8,000 1,000

Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

3) Paka Corporation owns an 80% interest in Sandra Company. Paka acquired Sandra's bonds on January 2, 2014. The following information is from the adjusted trial balances at December 31, 2014, at which time the bonds have three years to maturity. The bonds have interest payment dates of January 1 and July 1. Straight-line amortization is used by both companies.

Investment in Sandra Bonds, $100,000 par 7% Bonds payable, $200,000 Bond premium Interest expense Interest receivable Interest income Interest payable

Paka 98,500

Sandra 200,000 6,000 12,000

7,000 7,500 7,000

Required: Prepare the necessary consolidation working paper entries on December 31, 2014 with respect to the intercompany bonds. Answer: 2014 Debit Credit 12/31 Bond Interest Payable 7,000 Bond Interest Receivable 7,000 12/31 Bonds Payable 100,000 Interest Income 7,500 Bond premium 3,000 Interest Expense (50% owned) 6,000 Investment in Sandra's Bonds 98,500 Gain on retirement of bonds 6,000 Supporting Computations: Cost of bonds to Paka ($98,500 - $500) Book value acquired 1/1/2014 where $2,000 per year is amortized ($200,000 + $8,000) × 50% = Gain on constructive bond retirement

$98,000

104,000 $6,000

Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

4) Pheasant Corporation owns 80% of Sal Corporation's outstanding common stock that was purchased at book value equal to fair value on January 1, 2007. Additional information: 1. Pheasant sold inventory items that cost $3,000 to Sal during 2014 for $6,000. One-half of this merchandise was inventoried by Sal at year-end. At December 31, 2014, Sal owed Pheasant $2,000 on account from the inventory sales. No other intercompany sales of inventory have occurred since Pheasant acquired its interest in Sal. 2. Pheasant sold equipment with a book value of $5,000 and a 5-year useful life to Sal for $10,000 on December 31, 2012. The equipment remains in use by Sal and is depreciated by the straight-line method. The equipment has no salvage value. 3. On January 2, 2014, Sal paid $10,800 for $10,000 par value of Pheasant's 10-year, 10% bonds. These bonds were originally sold at par value, and have interest payment dates of January 1 and July 1, and mature on January 1, 2018. Straight-line amortization has been applied by Sal to the Pheasant bond investment. 4. Pheasant uses the equity method in accounting for its investment in Sal.

Required: Complete the working papers to consolidate the financial statements of Pheasant Corporation and Sal for the year ended December 31, 2014.

Answer:

Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Difficult AACSB: Application of knowledge

5) Phauna paid $120,000 for its 80% interest in Schrub on January 1, 2011 when Schrub had $150,000 of total stockholders' equity. On January 1, 2014, Phauna purchased $50,000 of Schrub Corporation's 8% bonds for $48,000. At that time, $100,000 of bonds had been issued by Schrub, and unamortized premium was $2,000. The bonds pay interest on June 30 and December 31 and mature on December 31, 2018. Both Phauna and Schrub use straight-line amortization. Phauna uses the equity method of accounting for its investment in Schrub. Required: Prepare eliminating/adjusting entries for the bonds on the consolidating work papers for the year ended December 31, 2014. Answer: 12/31/2014 Interest income (8% × $50,000) + ($2,000/5) 4,400 Interest expense(8% × $50,000) - ($1,000/5) 3,800 Gain on retirement of bonds 600 Bonds payable Premium on bonds payable Bond investment Gain on retirement of bonds

50,000 800 48,400 2,400

Premium on bonds payable: $1,000 - $1,000/5 = $800 Bond investment: $48,000 + $2,000/5 = $48,400 Supporting computations: Book value of bonds ($102,000 × 50%) Cost of acquiring $50,000 par Constructive gain Piecemeal recognition of gain Unrecognized at December 31, 2014

$51,000 (48,000) 3,000 (600) $ 2,400

Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Difficult AACSB: Application of knowledge

6) Pelami Corporation owns a 90% interest in Sunbird Corporation. At December 31, 2012, Sunbird had $3,000,000 of par value 6% bonds outstanding with an unamortized premium of $30,000. The bonds have interest payment dates of January 1 and July 1 and mature on January 1, 2017. On January 2, 2013, Pelami purchased $1,200,000 par value of Sunbird's outstanding bonds for $1,210,000. Assume straight-line amortization. Required: Prepare the necessary consolidation working paper entries with respect to the intercompany bonds for the year ending December 31, 2013. Answer: 2013 12/31 Bond Interest Payable Bond Interest Receivable 12/31

Debit 36,000

Credit 36,000

Premium on Bonds Payable 9,000 Bonds Payable 1,200,000 Interest Revenue 69,500 Interest Expense Investment in Sunbird Bonds Gain on Retirement of Bonds

69,000 1,207,500 2,000

Supporting Computations: Cost of bonds to Pelami Book value acquired ($3,000,000 + $30,000) × 40% = Gain on constructive bond retirement 4 years remaining Premium on Bond Payable $30,000 × 3/4 × 40% =

$1,210,000 1,212,000 $2,000

$9,000

Interest Expense $1,200,000 × 6% Less: $30,000 × 1/4 × 40%

= =

$ 72,000 $ 3,000 $ 69,000

Interest Revenue $72,000 - ($10,000 × 1/4)

$69,500

Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

7) Spott is a 75%-owned subsidiary of Penthal. On January 1, 2013, Spott issued $900,000 of $1,000 face amount 8% bonds at par. The bonds have interest payments on January 1 and July 1 of each year and mature on January 1, 2017. On July 2, 2014, Penthal purchased all 900 bonds on the open market for $1,020 per bond. Both companies use straight-line amortization. Required: With respect to the bonds, use General Journal format to: 1. Record the 2014 journal entries from July 1 to December 31 on Spott's books. 2. Record the 2014 journal entries from July 1 to December 31 on Penthal's books. 3. Record the elimination entries for the consolidation working papers for the year ending December 31, 2014. Answer: Requirement 1 Date 2014 Account Name Debit Credit Spott's books Jul 01 Bond Interest Expense 36,000 Cash ($900,000 × 8% × ½) 36,000 Dec 31

Bond Interest Expense Bond Interest Payable

Requirement 2 Penthal's books Jul 02 Investment in Spott Bonds Cash Dec 31

Bond Interest Receivable Bond Interest Revenue Investment in Spott Bonds

Requirement 3: Consolidated Working Papers Dec 31 Bond Interest Payable Bond Interest Receivable Dec 31

Bonds Payable Loss on Bonds Bond Interest Revenue Bond Interest Expense Investment in Spott Bonds

36,000 36,000

918,000 918,000 36,000 32,400 3,600

36,000 36,000 900,000 18,000 32,400 36,000 914,400

Interest Revenue: ($900,000 × 8% × 1/2) - ($18,000 premium/5 periods) = $32,400 Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

8) Snackle Inc. is a 90%-owned subsidiary of Pasha Corp. On January 1, 2013, Snackle issued $400,000 of $1,000 face amount 8% bonds at $964 per bond. Interest is paid on January 1 and July 1 of each year and covers the preceding six months. On July 2, 2014, Pasha purchased all 400 bonds on the open market for $1,030 per bond. The bonds mature on December 31, 2015. Both companies use straight-line amortization. Required: With respect to the bonds, use General Journal format to: 1. Record the 2014 journal entries from July 1 to December 31 on Pasha's books. 2. Record the 2014 journal entries from July 1 to December 31 on Snackle's books. 3. Record the elimination entries for the consolidation working papers for the year ending December 31, 2014. Answer: Date 2014 Account Name Debit Credit Pasha's books Jul 02 Investment in Snackle Bonds 412,000 Cash 412,000 Dec 31

Bond Interest Receivable Bond Interest Revenue Investment in Snackle Bonds

Snackle's books Jul 01 Bond Interest Expense Cash Discount on Bonds Payable Dec 31

Bond Interest Expense Bond Interest Payable Discount on Bonds Payable

Consolidated Working Papers Dec 31 Bond Interest Payable Bond Interest Receivable Dec 31

Bonds Payable Loss on Bonds Bond Interest Revenue Bond Interest Expense Discount on Bonds Payable Investment in Snackle Bonds

16,000 12,000 4,000

18,400 16,000 2,400 18,400 16,000 2,400

16,000 16,000 400,000 19,200 12,000 18,400 4,800 408,000

(Book value of bonds $392,800 - purchase cost $412,000 = $19,200 loss) Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

9) Popcorn Corporation owns 90% of the outstanding voting common stock of Salty Corporation. On January 1, 2009, Salty issued $1,000,000 face amount of 12%, $1,000 bonds payable at 119.20. The bonds pay interest on January 1 and July 1 of each year and mature on January 1, 2017. On July 2, 2014, Popcorn purchased all of the outstanding bonds at a price of $107.50. Both companies use straight-line amortization. Required: 1. Prepare the journal entries for July 1, 2014 through December 31, 2014 for Popcorn Corporation. 2. Prepare the journal entries for July 1, 2014 through December 31, 2014 for Salty Corporation. 3. Prepare the elimination entries necessary on the consolidating working papers for the year ended December 31, 2014. Answer: Requirement 1 July 2, 2014: Bond investment 1,075,000 Cash 1,075,000 December 31, 2014: Interest receivable Interest revenue ($1,000,000 × 12% × 1/2) Interest revenue Bond investment ($75,000/5)

60,000 60,000

15,000 15,000

Requirement 2 July 1, 2014: Interest expense Cash

60,000 60,000

Premium on bonds payable Interest expense

12,000 12,000

December 31, 2014: Interest receivable Interest revenue ($1,000,000 × 12% × 1/2)

60,000 60,000

Premium on bonds payable Interest expense

12,000 12,000

Requirement 3 December 31, 2014: Bonds payable Premium on bonds payable Loss on retirement of bonds Bond investment Bond investment: ($1,075,000 - $15,000)

1,000,000 48,000 12,000 1,060,000

Loss on retirement of bonds Interest revenue Interest expense

3,000 45,000

Interest payable Interest receivable

60,000

48,000

60,000

July 2, 2014: Paid $1,075,000 Book value of bonds 1,060,000 [$1,000,000 + ($12,000 × 5)] Loss on retirement $15,000 Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

10) Peter Corporation owns a 70% interest in Sundown Corporation acquired several years ago at a price equal to book value and fair value. On December 31, 2013, Sundown had $300,000 par of 6% bonds outstanding with an unamortized premium of $30,000. The bonds mature in five years and pay interest on January 1 and July 1. On January 2, 2014, Peter acquired one-third of Sundown's bonds for $117,000. Peter and Sundown use straight-line amortization. Sundown reports net income of $250,000 for 2014. Peter uses the equity method to account for the investment. Required: 1. Calculate Peter's income from Sundown for 2014. 2. Calculate the noncontrolling interest share for 2014. Answer: Preliminary computations: Book value of bonds $330,000 × 1/3 = $110,000 Cost of bonds 117,000 Loss on constructive retirement $7,000 Requirement 1: Income from Sundown: Share of Sundown's income ($250,000 × 70%) Less: Constructive loss ($7,000 × 70%) Plus: Piecemeal recognition of loss ($7,000/5 years) × 70% Income from Sundown

$175,000 (4,900) 980 $171,080

Requirement 2: Noncontrolling interest share: Sundown's reported income Less: Constructive loss on bonds Plus: Piecemeal recognition of loss Equals: Adjusted reported income Noncontrolling percentage Noncontrolling interest share

$250,000 (7,000) 1,400 $244,400 30% $73,320

Objective: LO7.4 Calculate noncontrolling interest share in the presence of intercompany gains/losses on debt transfers. Difficulty: Moderate AACSB: Application of knowledge

11) Pongo Company has $2,000,000 of 6% bonds outstanding on December 31, 2013 with unamortized premium of $60,000. These bonds pay interest semiannually on January 1 and July 1 and mature on January 1, 2019. Straight-line amortization is used. Syring Inc., 90%-owned subsidiary of Pongo, buys $1,000,000 par value of Pongo's outstanding bonds in the market for $980,000 on January 2, 2014. There is only one issue of outstanding bonds of the affiliated companies and they have consolidated financial statements. For the year 2014, Pongo has income from its separate operations (excluding investment income) of $3,000,000 and Syring reports net income of $200,000. Pongo uses the equity method to account for the investment. Required: Determine the following: 1. Noncontrolling interest share for 2014. 2. Controlling share of consolidated net income for Pongo Company and subsidiary for 2014. Answer: Requirement 1 Noncontrolling interest share ($200,000 × 10%) $20,000 Requirement 2 Controlling interest share of consolidated net income: Income from Pongo's operations Income from Syring: Pongo's share of Syring income = 90% × $200,000 $180,000 Add: Constructive gain on bond retirement ($2,000,000 + $60,000) × 50% 980,000 50,000 Less: Piecemeal recognition of gain = $50,000/5 years (10,000)

$3,000,000

220,000 $3,220,000

Controlling interest share

Objective: LO7.4 Calculate noncontrolling interest share in the presence of intercompany gains/losses on debt transfers. Difficulty: Moderate AACSB: Application of knowledge

12) Pachelor Corporation owns 70% of the outstanding stock of Stabb Company. On January 1, 2013, Stabb issued $1,000,000 in 7% bonds that matured on January 1, 2018. At the time of issuance, the bonds were sold at a discount of $125,000. At January 2, 2015, Pachelor purchased the bonds for $1,400,000, and constructively retired the debt. Interest is paid annually on January 1. Straight-line amortization is used by both companies. Required: 1. Calculate the gain or loss that the consolidated entity incurred to retire the debt. 2. Prepare eliminating/adjusting entries for the consolidating work papers for the year ended December 31, 2015. Answer: Requirement 1: Book value of bonds at time of retirement = ($1,000,000 - $125,000 + [($125,000 / 5 years) × 2]) = $ 925,000 Purchase price of bonds = 1,400,000 Constructive loss on retirement of bonds $ 475,000 Requirement 2: December 31, 2015: Interest payable Interest receivable ($1,000,000 × 7%)

70,000 70,000

Loss on retirement of bonds 316,667 Bonds payable 1,000,000 Discount on bonds payable Bond investment (Bond investment: $1,400,000 - $400,000/3) (Bond discount: $25,000 × 2)

50,000 1,266,667

Loss on retirement of bonds 158,333 Interest expense 95,000 Interest income 63,333 Interest expense: [($1,000,000 × 7%) + $125,000/5] = $70,000 + $25,000 = $95,000 Interest income: ($400,000/3) - ($1,000,000 × 7%) = $133,333 - $70,000 = $63,333 (Debit balance) Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

13) Padma Corporation owns 70% of the outstanding stock of Somega Company. On January 1, 2012, Somega issued $2,000,000 in 6% bonds that matured on January 1, 2022. At the time of issuance, the bonds were sold at a premium of $250,000. At January 1, 2013, Padma purchased half of the bonds for $910,000, and constructively retired the debt. Annual interest is paid on December 31. Straight-line amortization is used by both companies. Required: Complete the table below with respect to the account balances that Padma, Somega and the consolidated entity would report on their respective financial statements. Padma

Somega

Investment in Somega bonds — 12/31/12 Investment in Somega bonds — 12/31/13 Investment in Somega bonds — 12/31/14 Bonds Payable — 12/31/12 Bonds Payable — 12/31/13 Bonds Payable — 12/31/14 Premium on Bonds Payable — 12/31/12 Premium on Bonds Payable — 12/31/13 Premium on Bonds Payable — 12/31/14 Gain/(loss) on Retirement — 12/31/12 Gain/(loss) on Retirement — 12/31/13 Gain/(loss) on Retirement — 12/31/14 Interest Income — 12/31/12 Interest Income — 12/31/13 Interest Income — 12/31/14 Interest Expense — 12/31/12 Interest Expense — 12/31/13 Interest Expense — 12/31/14

Consolidated

Answer: Padma Investment in Somega bonds — 12/31/12 Investment in Somega bonds — 12/31/13 Investment in Somega bonds — 12/31/14 Bonds Payable — 12/31/12 Bonds Payable — 12/31/13 Bonds Payable — 12/31/14 Premium on Bonds Payable — 12/31/12 Premium on Bonds Payable — 12/31/13 Premium on Bonds Payable — 12/31/14 Gain/(loss) on Retirement — 12/31/12 Gain/(loss) on Retirement — 12/31/13 Gain/(loss) on Retirement — 12/31/14 Interest Income — 12/31/12 Interest Income — 12/31/13 Interest Income — 12/31/14 Interest Expense — 12/31/12 Interest Expense — 12/31/13 Interest Expense — 12/31/14

Somega

Consolidated

-0-

920,000

-0-

930,000 -0-0-0-0-0-0-0-0-0-070,000 70,000 -0-0-0-

-02,000,000 2,000,000 2,000,000 225,000 200,000 175,000 -0-0-0-0-0-095,000 95,000 95,000

-02,000,000 1,000,000 1,000,000 225,000 100,000 87,500 -0202,500 -0-0-0-095,000 47,500 47,500

Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

14) Patama Holdings owns 70% of Seagull Corporation. On January 1, 2013, Seagull acquires $1,000,000 of bonds originally issued by Patama on January 1, 2008. The bonds were issued at a stated rate of 5% for 10 years, for $960,000. Seagull purchased them for $990,000. Assume that both Patama and Seagull will use the straight-line method for any bond-related amortization. Annual interest is paid on December 31. Required: Complete the table below with respect to the account balances that Patama, Seagull and the consolidated entity would report on their respective financial statements. Patama

Seagull

Investment in Patama bonds — 12/31/12 Investment in Patama bonds — 12/31/13 Investment in Patema bonds — 12/31/14 Bonds Payable — 12/31/12 Bonds Payable — 12/31/13 Bonds Payable — 12/31/14 Discount on Bonds Payable — 12/31/12 Discount on Bonds Payable — 12/31/13 Discount on Bonds Payable — 12/31/14 Gain/(loss) on Retirement — 12/31/12 Gain/(loss) on Retirement — 12/31/13 Gain/(loss) on Retirement — 12/31/14 Interest Income — 12/31/12 Interest Income — 12/31/13 Interest Income — 12/31/14 Interest Expense — 12/31/12 Interest Expense — 12/31/13 Interest Expense — 12/31/14

Consolidated

Answer: Patama Investment in Patama bonds — 12/31/12 Investment in Patama bonds — 12/31/13 Investment in Patema bonds — 12/31/14 Bonds Payable — 12/31/12 Bonds Payable — 12/31/13 Bonds Payable — 12/31/14 Discount on Bonds Payable — 12/31/12 Discount on Bonds Payable — 12/31/13 Discount on Bonds Payable — 12/31/14 Gain/(loss) on Retirement — 12/31/12 Gain/(loss) on Retirement — 12/31/13 Gain/(loss) on Retirement — 12/31/14 Interest Income — 12/31/12 Interest Income — 12/31/13 Interest Income — 12/31/14 Interest Expense — 12/31/12 Interest Expense — 12/31/13 Interest Expense — 12/31/14

-0-0-01,000,000 1,000,000 1,000,000 20,000 16,000 12,000 -0-0-0-0-0-054,000 54,000 54,000

Seagull -0992,000 994,000 -0-0-0-0-0-0-0-0-0-052,000 52,000 -0-0-0-

Consolidated -0-0-01,000,000 -0-020,000 -0-0-0(10,000) -0-0-0-054,000 -0-0-

Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Application of knowledge

15) Parkview Holdings owns 70% of Skyline Corporation. On January 1, 2013, Skyline acquires half of the $2,000,000 of bonds originally issued by Parkview on January 1, 2008. The bonds were issued at a stated rate of 5% for 10 years, for $1,920,000. Skyline purchased them for $950,000. Assume that both Parkview and Skyline will use the straight-line method for any bond-related amortization. Annual interest is paid on December 31. Required: Prepare the entries required for the consolidating worksheet for the years ended December 31, 2008 through December 31, 2018. Answer: 12/31/08 - 12/31/12: No consolidating worksheet entry required because bonds are held by a third-party. 12/31/13 Bonds Payable $1,000,000 Interest Income 60,000 Investment in Parkview Bonds Discount on Bonds Payable Interest Expense Gain on Bond constructive retirement

$960,000 16,000 54,000 30,000

12/31/14 Bonds Payable Interest Income Investment in Parkview Bonds Discount on Bonds Payable Interest Expense Investment in Skyline Stock

$1,000,000 60,000 $970,000 12,000 54,000 24,000

12/31/15 Bonds Payable Interest Income Investment in Parkview Bonds Discount on Bonds Payable Interest Expense Investment in Skyline Stock

$1,000,000 60,000

12/31/16 Bonds Payable Interest Income Investment in Parkview Bonds Discount on Bonds Payable Interest Expense Investment in Skyline Stock

$1,000,000 60,000

12/31/17 Bonds Payable Interest Income Investment in Parkview Bonds Interest Expense Investment in Skyline Stock

$1,000,000 60,000

$980,000 8,000 54,000 18,000

$990,000 4,000 54,000 12,000

$1,000,000 54,000 6,000

Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

16) Paleo Corporation holds 80% of the capital stock of Sockrite Company. On January 1, 2013, Sockrite purchased $50,000 par value, 10% bonds on the open market that had been issued by Paleo on January 1, 2011. Sockrite paid $58,000 for these bonds which had originally been issued by Paleo for $53,000, with a 10-year maturity from the date of issue. Interest is paid annually on December 31. Straight-line amortization is used by both companies. Required: 1. Calculate the interest income reported by Sockrite related to these bonds in 2013. 2. Calculate the interest expense reported by Paleo related to these bonds in 2013. 3. Calculate the gain or loss on retirement of bonds payable to be reported on consolidated financial statements in 2013. Answer: 1. Interest income = ($50,000 × 10%) - ($8,000 / 8) = $4,000 2. Interest expense = ($50,000 × 10%) - ($3,000 / 10) = $4,700 3. Loss= Book value - amount paid = ($53,000 - $600) - $58,000 = $5,600 Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Easy AACSB: Application of knowledge

17) Phlora purchased its 100% ownership in Speshal many years ago at a time when book values of assets and liabilities equaled market values. On January 2, 2014, Phlora purchased $200,000 of Speshal Corporation's 6% bonds for $182,000. At that time, this was all of the bonds that had been issued by Speshal, and unamortized premium on Speshal's books was $3,500. The bonds pay interest on July 1 and January 1 and mature on January 1, 2019. Both Phlora and Speshal use straight-line amortization. Phlora uses the equity method of accounting for its investment in Speshal. Speshal reported the following for 2014: Net income $38,000 Dividends $10,000 Required: Prepare elimination/adjusting entries on the consolidating work papers for the year ended December 31, 2014. Answer: Interest payable 6,000 Interest receivable 6,000 ($200,000 × 6% × 1/2) Bonds payable Premium on bonds payable Bond investment Gain on retirement of bonds (Premium: $3,500 - $3,500/5) (Bond investment: $182,000 + $18,000/5)

200,000 2,800 185,600 17,200

Interest income 15,600 Interest expense Gain on retirement of bonds [Interest income: ($200,000 × 6%) + ($18,000/5)] [Interest expense: ($200,000 × 6%) - ($3,500/5)] Income from subsidiary Dividends Investment in subsidiary

11,300 4,300

55,200 10,000 45,200

Income from subsidiary: ($38,000 + $21,500 - $21,500/5) January 2, 2014: Paid Book value Gain on retirement

$182,000 $203,500 $ 21,500

Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

18) Sabu is a 65%-owned subsidiary of Peerless. On January 1, 2012, Sabu issued $1,000,000 of $1,000 face amount 8% bonds at $980 per bond. The bonds have interest payments on December 31 of each year and mature on January 1, 2017. On January 1, 2013, Peerless purchased all 1,000 bonds on the open market for $1,010 per bond. Straight-line amortization is used by both companies. Required: With respect to the bonds, use General Journal format to: 1. Record the journal entries on Sabu's books made from 2012 to 2017. 2. Record the journal entries on Peerless' books made from 2012 to 2017. 3. Record the elimination entries for the consolidation working papers for 2012 through 2017. Answer: Requirement 1 Date Account Name Sabu's Books 1/1/12 Cash Bond Discount Bonds Payable 12/31/12

Debit

Credit

980,000 20,000 1,000,000

Interest Expense Cash Interest Expense Bond Discount

80,000 80,000 4,000 4,000

12/31/13

Same as entry for prior year end

12/31/14

Same as entry for prior year end

12/31/15

Same as entry for prior year end

12/31/16

Same as entry for prior year end

1/1/17

Bonds Payable Cash

1,000,000 1,000,000

Requirement 2 Peerless Books 2012 — No entry 1/1/13 12/31/13

Investment in Bonds Cash Cash Interest Income Interest Income Investment in Bonds

12/31/14

Same as entry for prior year end

12/31/15

Same as entry for prior year end

1,010,000 1,010,000 80,000 80,000 2,500 2,500

12/31/16

Same as entry for prior year end

1/1/17

Cash Investment in Bonds

1,000,000 1,000,000

Requirement 3 2012 — No entry required — bonds owned by third party 12/31/13

12/31/14

12/31/15

12/31/16

12/31/17

Bonds Payable Interest Income Loss on Bond Retirement Investment in Bonds Interest Expense Bond Discount

1,000,000 77,500 26,000

Bonds Payable Interest Income Investment in Sabu Noncontrolling interest Investment in Bonds Interest Expense Bond Discount

1,000,000 77,500 12,675 6,825

Bonds Payable Interest Income Investment in Sabu Noncontrolling interest Investment in Bonds Interest Expense Bond Discount

1,000,000 77,500 8,450 4,550

Bonds Payable Interest Income Investment in Sabu Noncontrolling interest Investment in Bonds Interest Expense

1,000,000 77,500 4,225 2,275

1,007,500 84,000 12,000

1,005,000 84,000 8,000

1,002,500 84,000 4,000

1,000,000 84,000

No entry required

Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

19) Pare Corporation owns 65% of the outstanding voting stock of Summer Corporation. On January 1, 2013, Pare purchased $4,000,000 of bonds that were originally issued by Summer several years earlier. The ten-year bonds have a 5% interest rate, and pay interest each December 31. The bonds were originally issued at a discount of $206,080, but at January 1, 2013, they have a book value of $3,896,960. Pare paid $4,067,935 for the bonds and will amortize the premium over the next five years when the bonds mature. Both companies use the straight-method of amortization. Required: 1. Calculate the interest expense for 2013 that will be recorded by Summer. 2. Calculate the interest income for 2013 that will be recorded by Pare. 3. Calculate the Gain/Loss on retirement of bonds payable that will be reported on the consolidated financial statements for the year ending December 31, 2013. Answer: Requirement 1 Interest expense = ($4,000,000 × 5%) + ($103,040 / 5) = $220,608 Requirement 2 Interest income = ($4,000,000 × 5%) - ($67,935 / 5) = $186,413 Requirement 3 Loss = Book value - amount paid = $3,896,960 - $4,067,935 = ($170,975) Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Easy AACSB: Application of knowledge

20) Pass Corporation owns 80% of Sindy Company, purchased at the underlying book value on January 1, 2013. On January 1, 2013, Pass also purchased $200,000 par value 6% bonds that had been issued by Sindy on January 1, 2010 with a ten-year maturity(due January 1, 2020). Annual interest is paid on December 31. Straight-line amortization is used by both companies. At year-end 2013, the following entry was made on the consolidating worksheet. Bonds Payable Bond Premium Loss on Bond Retirement Interest Income Investment in Sindy Bonds Interest Expense

$200,000 12,000 7,000 (a) $218,000 (b)

Required: 1. How much did Pass pay for the bonds? 2. What is the book value of the bonds on the date of purchase? 3. What amount of interest income and interest expense must be eliminated in the entry above designated as (a) and (b)? Answer: Requirement 1 Bonds issued 1/1/10 and mature 1/1/20, so at time of purchase, seven years remain. At 12/31/13 (time of entry shown above), six years remain. Pass shows an investment of $218,000 at 12/31/13. Assuming that the $18,000 premium will be written off over the six years that remain, the premium amortization is $3,000 per year. Thus at the beginning of 2013 (the date of purchase), the premium would have been $21,000, indicating that Pass paid $221,000. Requirement 2 If the bond premium remaining at 12/31/13 is $12,000, then the premium remaining at the time of purchase (1/1/13) by Pass was $14,000 ($12,000 + $2,000 annual amortization). Thus the book value at the time of purchase was $214,000. Requirements 3 and 4 Interest income = ($200,000 × 6%) - ($18,000 / 6) = $9,000 Interest expense = ($200,000 × 6%) - ($12,000 / 6) = $10,000 Objective: LO7.3 Defer unrealized gains/losses and later recognize realized gains/losses on bond transfers between parent and subsidiary. Difficulty: Moderate AACSB: Application of knowledge

7.3 True/False 1) When a company issues bonds, the bond liability will reflect the current market rate of interest. Answer: TRUE Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Easy AACSB: Analytical thinking

2) Constructive retirement means that bonds are retired for consolidated statement purposes because the bond investment and payable items of the parent and the subsidiary are reciprocals that must be eliminated in consolidation. Answer: TRUE Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Moderate AACSB: Analytical thinking

3) The difference between the book value of a bond liability and the purchase price of the bond investment is a gain or loss for consolidated statement purposes. Answer: TRUE Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Moderate AACSB: Analytical thinking

4) If the price paid by an affiliate to acquire the debt of another is less than the book value of the debt, a constructive loss on retirement of debt occurs. Answer: FALSE Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Moderate AACSB: Analytical thinking

5) The GAAP requires the effective interest method of amoritization on transactions between parent and subsidiary companies. Answer: FALSE Objective: LO7.2 Demonstrate how a consolidated reporting entity constructively retires debt. Difficulty: Moderate AACSB: Analytical thinking

6) A constructive retirement of parent bonds occurs when an affiliate purchases outstanding bonds of the parent. Answer: TRUE Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Easy AACSB: Analytical thinking

7) The loss on the retirement of bonds only appears in the consolidated income statement in the year in which we constructively retire the bonds. Answer: TRUE Objective: LO7.4 Calculate noncontrolling interest share in the presence of intercompany gains/losses on debt transfers. Difficulty: Easy AACSB: Analytical thinking

8) If the market rate of interest on bonds that are recorded increases, the market value of the liability increases. Answer: FALSE Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Moderate AACSB: Analytical thinking

9) The fair value option for liabilities permits recognition of gains and losses due to changes in the market values. Answer: TRUE Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Easy AACSB: Analytical thinking

10) The parent, which controls all debt retirement for the consolidated entity can use its available resources to purchase and retire its own bonds if they choose not to use the fair value option. Answer: TRUE Objective: LO7.1 Differentiate between intercompany receivables and payables, and assets or liabilities of the consolidated reporting entity. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 8 Consolidations - Changes in Ownership Interests 8.1 Multiple Choice Questions 1) Which of the following is correct? The direct sale of additional shares of stock at book value per share to only the parent company from a subsidiary A) decreases the parent's interest and decreases the noncontrolling shareholders' interest. B) decreases the parent's interest and increases the noncontrolling shareholders' interest. C) increases the parent's interest and increases the noncontrolling shareholders' interest. D) increases the parent's interest and decreases the noncontrolling shareholders' interest. Answer: D Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Analytical thinking

Use the following information to answer the question(s) below. On December 31, 2013, Giant Corporation's Investment in Penguin Corporation account had a balance of $500,000. The balance consisted of 80% of Penguin's $625,000 stockholders' equity on that date. Giant owns 80% of Penguin. On January 2, 2014, Penguin increased its outstanding common stock from 15,000 to 18,000 shares. 2) Assume that Penguin sold the additional 3,000 shares directly to Giant for $150,000 on January 2, 2014. Giant's percentage ownership in Penguin immediately after the purchase of the additional stock is A) 66-2/3%. B) 80%. C) 83-1/3%. D) 86-2/3% Answer: C Explanation: C) (Parent had 80% of 15,000 shares, or 12,000 shares. They now hold 15,000 of 18,000 shares) = 83.33% Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

3) Assume that Penguin sold the additional 3,000 shares to outside interests for $150,000 on January 2, 2014. Giant's percentage ownership immediately after the sale of additional stock would be A) 66-2/3%. B) 75%. C) 80%. D) 83-1/3%. Answer: A Explanation: A) (12,000 shares/18,000 shares) = 66.67% Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Bird Corporation purchased an 80% interest in Brush Corporation on July 1, 2013 at its book value, and on January 1, 2014 its Investment in Brush account was $300,000, equal to its book value. Brush's net income for 2014 was $99,000 (earned uniformly); no dividends were declared. On March 1, 2014, Bird reduced its interest in Brush by selling a 20% interest, one-fourth of its investment, for $84,000. 4) If Bird uses a "beginning-of-the-year" sale assumption, its gain on sale and income from Brush for 2014 will be A) Gain on Sale Income from Brush $5,700 $59,400 B) Gain on Sale $5,700

Income from Brush $62,700

C) Gain on Sale $9,000

Income from Brush $59,400

D) Gain on Sale $9,000

Income from Brush $62,700

Answer: C Explanation: C) Selling price Book value of interest sold $300,000 × (20% / 80%) = Gain on sale Income from Brush $99,000 × (80% - 20%) =

$84,000 75,000 $9,000

$59,400

Objective: LO8.2 Prepare consolidated statements when the parent company's ownership percentage increases or decreases during the reporting period. Difficulty: Moderate AACSB: Application of knowledge

5) If Bird uses the "actual-sale-date" sales assumption, its gain on the sale and income from Brush for 2014 will be A) Gain on Sale Income from Brush $5,700 $59,400 B) Gain on Sale $5,700

Income from Brush $62,700

C) Gain on Sale $21,360

Income from Brush $59,400

D) Gain on Sale $21,360

Income from Brush $62,700

Answer: B Explanation: B) Selling price Book value of interest sold: Beginning balance Income for 2 months $99,000 × 1/6 × 80% = Adjusted book value Percentage of interest sold Book value applied Gain on sale

$84,000 $300,000 13,200 313,200 1/4 78,300

Income from Brush: Jan 1 - Mar 1 $99,000 × 2/12 × 80% = Mar 1 - Dec 31 $99,000 × 10/12 × 60% = Income from Brush

78,300 $5,700

$13,200 49,500 $62,700

Objective: LO8.2 Prepare consolidated statements when the parent company's ownership percentage increases or decreases during the reporting period. Difficulty: Moderate AACSB: Analytical thinking

6) Jersey Company acquired 90% of York Company on April 1, 2014. Both Jersey Company and York Company have December 31 fiscal year ends. Under current GAAP, which of the following statements is false? A) The consolidated income statement in 2014 should not include York's revenues and expenses prior to April 1, 2014. B) When preparing consolidating work papers in 2014, York's revenues prior to April 1, 2014 are eliminated. C) York's earnings prior to April 1, 2014 should appear as a deduction on the consolidated income statement in 2014. D) The consolidated income statement in 2014 should include York's revenues and expenses after April 1, 2014. Answer: C Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Moderate AACSB: Analytical thinking

7) Utah Company holds 80% of the stock of a subsidiary company. The subsidiary issues 100 additional shares of stock to Utah Company at a price above book value per share. The subsidiary does not issue any additional shares at the same time. How will Utah Company record the purchase? A) Utah Company records a gain on sale of stock. B) Utah Company increases additional paid-in capital. C) Utah Company decreases additional paid-in capital. D) Utah Company assigns any excess cost over book value acquired to increase undervalued identifiable assets or goodwill as appropriate. Answer: D Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Analytical thinking

Use the following information to answer the question(s) below. Goldberg Corporation owned a 70% interest in Savannah Corporation on December 31, 2013, and Goldberg's Investment in Savannah account had a balance of $3,900,000. Savannah's stockholders' equity on this date was as follows: Capital stock, $10 par value Retained Earnings Total Stockholders' Equity

$3,000,000 2,400,000 $5,400,000

On January 1, 2014, Savannah issues 80,000 new shares of common stock to Goldberg for $16 each. 8) What is Goldberg's percentage ownership in Savannah after Savannah issues its stock to Goldberg? A) 76.32% B) 80.43% C) 82.57% D) 83.43% Answer: A Explanation: A) (210,000 + 80,000)/380,000 Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

9) On January 1, 2014, assume the fair values of Savannah's identifiable assets and liabilities equal book values. What is the change in the amount of goodwill associated with the issuance of 80,000 additional shares to Goldberg? (Use four decimal places.) A) Increase goodwill $38,176. B) Decrease goodwill $38,176. C) Increase goodwill $384,000. D) Decrease goodwill $384,000. Answer: B Explanation: B) Savannah's equity after the issuance of the new shares ($5,400,000 + $1,280,000) $6,680,000 Goldberg's ownership percentage 76.32% Goldberg's share of Savannah's equity now $5,098,176 Goldberg's previous share of Savannah's equity ($5,400,000 × 70%) 3,780,000 Savannah's equity acquired in the purchase $1,318,176 Amount spent to acquire stock 1,280,000 Excess book value acquired over cost $ 38,176 Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Difficult AACSB: Application of knowledge

Use the following information to answer the question(s) below. Great Corporation acquired a 90% interest in SOS Corporation at its $810,000 book value on December 31, 2013. A summary of the stockholders' equity for SOS at the end of 2013 and 2014 is as follows:

Capital stock, $10 par Additional paid-in capital Retained Earnings Total stockholders' equity

12/31/13 $600,000 30,000 270,000 $900,000

12/31/14 $600,000 30,000 420,000 $1,050,000

On January 1, 2015, SOS sold 10,000 new shares of its $10 par value common stock for $45 per share. 10) If SOS sold the additional shares to the general public, Great's Investment in SOS account after the sale would be ________. (Use four decimal places.) A) $945,000 B) $1,157,100 C) $1,225,000 D) $1,245,000 Answer: B Explanation: B) SOS's stockholders' equity prior to the stock issuance $1,050,000 Plus: Capital received from new stock issued 450,000 New stockholders' equity $1,500,000 Great's ownership (54,000/(60,000 + 10,000)) 77.14% Great's adjusted investment in SOS $1,157,100 Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

11) If SOS sold the additional shares directly to Great, Great's Investment in SOS account after the sale would be A) $1,350,000. B) $1,395,000. C) $1,425,000. D) $1,500,000. Answer: B Explanation: B) Investment balance at 12/31/2014 ($1,050,000 × 90%) $945,000 Additional investment (10,000 shares × $45) 450,000 Investment account balance, 12/31/2014 $1,395,000 Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

12) Consider a sale of stock by a subsidiary to parties outside the consolidated entity. This transaction requires an adjustment of the parent's investment and additional paid-in capital accounts except when A) the shares are sold below book value per share. B) the shares are sold above book value per share. C) the shares are sold at book value per share. D) the shares are sold at market value. Answer: C Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Analytical thinking

13) If a parent company and outside investors purchase shares of a subsidiary in relation to existing stock ownership (ratably), then A) there will be an adjustment to additional paid-in capital if the stock is sold above book value. B) there will be no adjustment to additional paid-in capital regardless whether the stock is sold above or below book value. C) there will be an adjustment to additional paid-in capital if the stock is sold below book value. D) there will be the elimination of a gain. Answer: B Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Easy AACSB: Analytical thinking

14) A subsidiary split its stock 2 for 1. Which of the following statements is false? A) A stock split does not affect the amount of net assets of the subsidiary. B) A stock split does not affect parent and noncontrolling interest ownership percentages. C) A stock split does not affect consolidation procedures. D) A 2 for 1 stock split decreases the number of shares outstanding. Answer: D Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Analytical thinking

Use the following information to answer the question(s) below. Bower Corporation purchased a 70% interest in Stage Corporation on June 1, 2013 at a purchase price of $350,000. On June 1, 2013, the book values of Stage's assets and liabilities were equal to fair values. On June 1, 2013, Stage's stockholders' equity consisted of $290,000 of Common Stock and $210,000 of Retained Earnings. All cost-book differentials were attributed to goodwill. During 2013, Stage earned $120,000 of net income, earned uniformly throughout the year and paid $6,000 of dividends on March 1 and another $6,000 on September 1. 15) Noncontrolling interest share for 2013 is A) $21,000. B) $32,400. C) $36,000. D) $50,000. Answer: A Explanation: A) ($120,000 × 7/12 × 30%) Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Moderate AACSB: Application of knowledge

16) Preacquisition income for 2013 is A) $50,000. B) $35,000. C) $44,000. D) $36,000. Answer: A Explanation: A) ($120,000 × 5/12) Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Moderate AACSB: Application of knowledge

17) Anthony Company declared and paid $20,000 of dividends during 2014. The schedule of dividends follows: Date Dividend Declared & Paid March 31, 2014 June 30, 2014 September 30, 2014 December 31, 2014

Amount Paid $5,000 $5,000 $5,000 $5,000

Anthony Company was acquired on June 1, 2014 by Google Company. Google acquired 100 percent of Anthony Company. Both companies have a December 31 fiscal year end. What is the amount of preacquisition dividends in 2014? A) 0 B) $5,000 C) $10,000 D) $15,000 Answer: B Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Moderate AACSB: Application of knowledge

18) On April 1, 2014, Paramount Company acquires 100% of the outstanding stock of Yester Company on the open market. Paramount and Yester have December 31 fiscal year ends. Under GAAP, a consolidated income statement for the year ending December 31, 2014, will include A) 100 percent of the revenues and expenses in 2014 of Yester Company after January 1, 2014. B) no revenues and expenses in 2014 of Yester Company. C) 80 percent of the revenues and expenses in 2014 of Yester Company. D) 100 percent of the revenues and expenses in 2014 of Yester Company after April 1, 2014. Answer: D Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Moderate AACSB: Application of knowledge

19) The acquisition of treasury stock by a subsidiary from noncontrolling shareholders at a price above book value A) decreases the parent's share of subsidiary book value and decreases the parent's ownership percentage. B) decreases the parent's share of subsidiary book value and increases the parent's ownership percentage. C) increases the parent's share of subsidiary book value and decreases the parent's ownership percentage. D) increases the parent's share of subsidiary book value and increases the parent's ownership percentage. Answer: B Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Analytical thinking

20) A stock dividend by a subsidiary causes A) the parent company investment account to decrease. B) the parent company investment account to remain the same. C) the parent company investment account to increase. D) the noncontrolling interest equity to increase. Answer: B Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Analytical thinking

8.2 Exercises 1) At December 31, 2013, the stockholders' equity of Gost Corporation and its 80%-owned subsidiary, Tree Corporation, are as follows:

Common stock, $10 par value Retained earnings Totals

Gost $20,000 8,000 $28,000

Tree $12,000 6,000 $18,000

Gost's Investment in Tree is equal to 80 percent of Tree's book value. Tree Corporation issued 225 additional shares of common stock directly to Gost on January 1, 2014 at $18 per share. Required: 1. Compute the balance in Gost's Investment in Tree account on January 1, 2014 after the new investment is recorded. 2. Determine the increase or decrease in goodwill from Gost's new investment in the 225 Tree shares. Use four decimal places for the ownership percentage. Assume the fair values of Tree's assets and liabilities are equal to book values. Answer: Requirement 1 Cost of investment ($18,000 × 80%) $14,400 Plus: Purchase of 225 Tree shares at $18 on January 1, 2014 4,050 Investment account balance $18,450 Requirement 2 Tree's stockholders' equity at January 1, 2014 Plus: Additional capital from the shares issued Total stockholders' equity after issuance of the new shares Gost's percentage (960 + 225)/1425 = Gost's share of Tree's equity after issuance Gost's share of Tree's equity before stock issuance Equity acquired in the purchase Cost of interest acquired Increase goodwill

$18,000 4,050 $22,050 0.8316 $18,337 14,400 3,937 4,050 $ 113

Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

2) At December 31, 2013, the stockholders' equity of Godwin Corporation and its 80%-owned subsidiary, Goldberg Corporation, are as follows:

Common stock, $10 par value Retained earnings Totals

Godwin $20,000 8,000 $28,000

Goldberg $12,000 6,000 $18,000

Godwin's Investment in Goldberg is equal to 80 percent of Goldberg's book value. Goldberg Corporation issued 225 additional shares of common stock directly to Godwin on January 1, 2014 at $28 per share. Required: 1. Compute the balance in Godwin's Investment in Goldberg account on January 1, 2014 after the new investment is recorded. 2. Determine the increase or decrease in goodwill from Godwin's new investment in the 225 Goldberg shares. Use four decimal places for the ownership percentage. Assume the fair value and book value of Goldberg's assets and liabilities are equal. Answer: Requirement 1 Cost of investment ($18,000 × 80%) $14,400 Plus: Purchase of 225 Goldberg shares at $28 on January 1, 2014 6,300 Investment account balance $20,700 Requirement 2 Goldberg's stockholders' equity at January 1, 2014 Plus: Additional capital from the shares issued Total stockholders' equity after issuance of the new shares Godwin's percentage (960 + 225)/1425 = Godwin's share of Goldberg's equity after issuance Godwin's share of Goldberg's equity before stock issuance Equity acquired in the purchase Cost of interest acquired Increase in goodwill

$18,000 6,300 $24,300 0.8316 $20,208 14,400 5,808 6,300 $ 492

Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

3) At December 31, 2013, the stockholders' equity of Pearson Corporation and its 80%-owned subsidiary, Trompeter Corporation, are as follows:

Common stock, $10 par value Retained earnings Totals

Pearson $20,000 8,000 $28,000

Trompeter $12,000 6,000 $18,000

Pearson's Investment in Trompeter is equal to 80 percent of Trompeter's book value. Trompeter Corporation issued 400 additional shares of common stock directly to Pearson on January 1, 2014 at $10 per share. Required: 1. Compute the balance in Pearson's Investment in Trompeter account on January 1, 2014 after the new investment is recorded. 2. Determine the increase or decrease in goodwill from Pearson's new investment in the 400 Trompeter shares. Use four decimal places for the ownership percentage. Assume the fair value and book value of Trompeter's assets and liabilities are equal. Answer: Requirement 1 Cost of investment ($18,000 × 80%) $14,400 Plus: Purchase of 400 Trompeter shares at $10 on January 1, 2014 4,000 Investment account balance $18,400 Requirement 2 Trompeter's stockholders' equity at January 1, 2014 Plus: Additional capital from the shares issued Total stockholders' equity after issuance of the new shares Pearson's percentage (960 + 400)/1600 = Pearson's share of Trompeter's equity after issuance Pearson's share of Trompeter's equity before stock issuance Equity acquired in the purchase Cost of interest acquired Reduce goodwill or identifiable assets (Since no goodwill is associated with the investment, should reduce overvalued identifiable assets.)

$18,000 4,000 $22,000 0.85 $18,700 14,400 4,300 4,000

$ 300

Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

4) On January 1, 2013, Starling Corporation held an 80% interest in Twig Corporation and the investment account balance was $900,000. On January 1, 2013, Twig's total stockholders' equity was $1,125,000. During 2013, Twig uniformly earned $234,000 and paid dividends of $37,500 on April 1 and again on October 1. On August 1, 2013, Starling sold 30% of its investment in Twig for $262,500, thereby reducing its interest in Twig to 56%. Required: Compute the following using the actual sales date assumption: 1. Gain or loss on sale. 2. Income from Twig for 2013. 3. Noncontrolling interest share for 2013. Answer: Preliminary computations Investment balance, January 1 Income from Twig ($234,000 × 7/12 × 80%) Less: April 1 dividends ($37,500 × 80%) Book value at July 31, 2013

$900,000 109,200 (30,000) $979,200

Requirement 1 Proceeds from sale Book value of interest sold ($979,200 × 30%) Loss on sale

$262,500 (293,760) $ (31,260)

Requirement 2 Income from Twig from Jan 1 through July 31 (from above) Income from August 1 - December 31 ($234,000 × 5/12 × 56%) Income from Twig for 2013

54,600 $ 163,800

Requirement 3 Noncontrolling interest share: Jan 1 to Jul 31 ($234,000 × 7/12 × 20%) Aug 1 to Dec 31 ($234,000 × 5/12 × 44%) Noncontrolling interest share

$27,300 42,900 $ 70,200

$109,200

Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Moderate AACSB: Reflective thinking

5) On January 1, 2014, Fly Corporation held a 60% interest in Liptin Corporation. The investment account balance was $2,100,000, consisting of 60% of Liptin's $3,500,000 of net assets. During 2014, Liptin earned $300,000 uniformly and paid dividends of $110,000 on November 1. On October 1, 2014, Fly sold 10% of its investment in Liptin for $364,000, thereby reducing its interest in Liptin to 54%. Required: Compute the following using the actual sales date assumption: 1. Gain or loss on sale. 2. Income from Liptin for 2014. 3. Noncontrolling interest share for 2014. Answer: Preliminary computations Investment balance, January 1 Income from Liptin ($300,000 × 9/12 × 60%) Book value at September 30, 2014

$2,100,000 135,000 $2,235,000

Requirement 1 Proceeds from sale Book value of interest sold ($2,235,000 × 10%) Gain on sale

$364,000 (223,500) $140,500

Requirement 2 Income from Liptin from Jan 1 through September 30 (from above) Income from October 1-December 31 ($300,000 × 3/12 × 54%) Income from Liptin for 2014

$135,000 40,500 $175,500

Requirement 3 Noncontrolling interest share: Jan 1 to Sep 30 ($300,000 × 9/12 × 40%) Oct 1 to Dec 31 ($300,000 × 3/12 × 46%) Noncontrolling interest share

$90,000 34,500 $124,500

Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Moderate AACSB: Application of knowledge

6) At December 31, 2015 year-end, Lapwing Corporation's investment in Ground Inc. was $200,000 consisting of 80% of Ground's $250,000 stockholders' equity on that date. On April 1, 2016, Lapwing sold 20% interest (one-fourth of its holdings) in Ground for $65,000. During 2016, Ground had net income of $75,000 (earned uniformly) and on July 1, 2016, Ground paid dividends of $40,000. Lapwing uses the equity method to account for the investment. Required: 1. What is the gain or loss on sale of the 20% interest? 2. Record the journal entries for Lapwing for the year ending December 31, 2016. Use the actual-sale-date assumption. Answer: Requirement 1 Selling price $65,000 Book value of interest sold: Beginning balance $200,000 Income for 3 months $75,000 × 1/4 × 80% = 15,000 Adjusted book value 215,000 Percentage of interest sold 25% Book value applied 53,750 (53,750) Gain on sale $11,250 Requirement 2 April 1 Investment in Ground Income from Ground

Debit

Cash Investment in Ground Gain from sale of investment in Ground July 1 Cash ($40,000 × 60%) Investment in Ground

65,000

Credit

15,000 15,000

53,750 11,250 24,000 24,000

December 31 Investment in Ground Income from Ground ($75,000 × 60% × 9/12)

33,750 33,750

7) At December 31, 2014 year-end, Arnold Corporation's investment in Oakes Inc. was $200,000 consisting of 80% of Oakes's $250,000 stockholders' equity on that date. On April 1, 2015, Arnold sold 20% interest (one-fourth of its holdings) in Oakes for $65,000. During 2015, Oakes had net income of $75,000 (earned uniformly) and on July 1, 2015, Oakes paid dividends of $40,000. Arnold uses the equity method to account for the investment. Required: 1. What is the gain or loss on sale of the 20% interest? 2. Record the journal entries for Arnold for the year ending December 31, 2015. Use the beginning-of-theyear-sale-date assumption. Answer: Requirement 1 Selling price $65,000 Book value of interest sold: Beginning balance $200,000 Percentage of interest sold 25% Book value applied 50,000 (50,000) Gain on sale $15,000 Requirement 2 April 1 Cash Investment in Oakes Gain from sale of investment in Oakes July 1 Cash ($40,000 × 60%) Investment in Oakes December 31 Investment in Oakes Income from Oakes ($75,000 × 60%)

Debit

Credit

65,000 50,000 15,000

24,000 24,000

45,000 45,000

Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Moderate AACSB: Application of knowledge

8) Candy Corporation paid $240,000 on April 1, 2013 for all of the common stock of Bun Corporation in a business acquisition. On January 1, 2013, Bun's stockholders' equity was equal to $195,000. Bun's first quarter 2013 net income was $10,000 and first quarter 2013 dividends were $5,000. In 2013, preacquisition sales were $32,500 and preacquisition cost of sales was $22,500. (There were no other preacquisition expenses in 2013.) Dividends are paid quarterly on March 31, June 30, September 30 and December 31. Any excess cost over book value acquired is allocated to goodwill. Additional information: 1. Candy sold equipment with a 5-year remaining useful life to Bun on July 1, 2013 for a gain of $10,000. Salvage value of the equipment is zero and both companies use the straight-line depreciation method. 2. Bun's accounts payable balance at December 31 includes $5,000 due to Candy from the sale of equipment. 3. Candy accounts for its investment in Bun using the equity method.

Required: Complete the working papers to consolidate the financial statements of Candy and Bun Corporations for the year ending December 31, 2013.

Answer:

Objective: LO8.2 Prepare consolidated statements when the parent company's ownership percentage increases or decreases during the reporting period. Difficulty: Difficult AACSB: Application of knowledge

9) Olson Corporation paid $62,000 to acquire 100% of Towing Corporation's outstanding voting common stock at book value on May 1, 2013. The stockholders' equity of Towing on January 1, 2013 consisted of $40,000 Capital Stock and $20,000 Retained Earnings. Towing's total dividends for 2013 were $6,000, paid equally on April 1 and October 1. Towing's net income was earned uniformly throughout 2013. In 2013, preacquisition sales were $10,000 and preacquisition expenses were cost of sales for $5,000. (There were no other preacquisition expenses in 2013.) During 2013, Olson made sales of $10,000 to Towing at a gross profit of $3,000. One-half of this merchandise was inventoried by Towing at year-end, and one-half of the 2011 intercompany sales were unpaid at year-end 2013. Olson sold equipment with a ten-year remaining useful life to Towing at a $2,000 gain on December 31, 2013. The straight-line depreciation method is used by both companies. The equipment has no salvage value. Financial statements of Olson and Towing Corporations for 2013 appear in the first two columns of the partially completed consolidation working papers.

Required: Complete the consolidating working papers for Olson Corporation and Subsidiary for the year ending December 31, 2013.

Answer:

10) Justice Corporation paid $40,000 cash for an 80% interest in the voting common stock of Grace Corporation on July 1, 2014, when Grace's stockholders' equity consisted of $30,000 of $10 par common stock and $15,000 retained earnings. The excess cost over the book value of the investment was assigned $2,000 to undervalued inventory items that were sold in 2014, with the remaining excess being assigned to goodwill. During the last half of 2014, Grace reported $4,000 net income and declared dividends of $2,000, and Justice reported income from Grace of $1,200. There were no intercompany sales during the last half of 2014, but during 2015 Justice sold inventory items that cost $8,000 to Grace for $12,000. Half of these inventory items were included in Grace Corporation's Inventory at December 31, 2015, with $1,000 unpaid by Grace at December 31, 2015. On January 5, 2015, Justice sold a plant asset with a book value of $2,500 and a remaining useful life of 5 years to Grace for $4,000. Grace Corporation owned the plant asset at year-end. The plant asset has no salvage value and both companies use the straight-line depreciation method. Justice Corporation uses the equity method to account for its investment in Grace, and the changes in Justice's Investment in Grace account from acquisition until year-end 2015 are as follows: Investment in Grace, July 1, 2014 Income from Grace July 1 - December 31, 2014 Less: Share of dividends received Investment in Grace at December 31, 2014 Add: Income from Grace for 2015 Less: Dividends received Investment in Grace at December 31, 2015

$40,000 1,200 (1,600) 39,600 4,800 (3,200) $41,200

Required: Complete the working papers for the year ending December 31, 2015 that are given below.

Answer: Preliminary Calculations: Implied fair value of Grace, July 1, 2014 $40,000/0.8 = Total stockholders' equity of Grace, July 1, 2014 Excess fair value over book value

$50,000 45,000 $5,000

Excess fair value over book value allocated: Inventory Goodwill Excess fair value over book value

$2,000 3,000 $5,000

11) On September 1, 2013, Beck Corporation acquired an 80% interest in Johnsen Corporation for $700,000. Johnsen's stockholders' equity at January 1, 2013 consisted of $200,000 of Common Stock and $600,000 of Retained Earnings. The book values of its assets and liabilities were equal to their respective fair values on this date. All excess purchase cost was attributed to goodwill. During 2013, Johnsen uniformly earned $78,000 and paid dividends of $9,000 on each of four dates: February 1, June 1, August 1, and December 1. Required: Compute the following: 1. Implied goodwill associated with Johnsen Corporation based on Beck's purchase price on September 1, 2013. 2. Beck's income from Johnsen for 2013. 3. Preacquisition income for Beck Corporation and Subsidiary for 2013. 4. Noncontrolling interest share for 2013. 5. What is the balance in Beck's Investment in Johnsen account at December 31, 2013?

Answer: Requirement 1 Cost of investment Total stockholders' equity, Jan. 1 Add: Net income ($78,000 × 8/12) Less: Dividends ($9,000 × 3) Total stockholders' equity, Sep. 1

$800,000 52,000 (27,000) $825,000

Implied fair value of investment: $700,000/0.8 Total stockholders' equity, Sep. 1 Implied goodwill

$875,000 (825,000) $50,000

$700,000

Requirement 2 Income from Johnsen ($78,000 × 1/3 × 80%)

$20,800

Requirement 3 Preacquisition income ($78,000 × 8/12)

$52,000

Requirement 4 Noncontrolling interest share ($78,000 × 20% × 4/12)

$5,200

Requirement 5 Investment at December 31, 2013: $700,000 + $20,800 - $9,000 (80%)

$713,600

12) On September 1, 2013, Nelson Corporation acquired a 90% interest in Corbin Corporation for $900,000. Corbin's stockholders' equity at January 1, 2013 consisted of $200,000 of Common Stock and $600,000 of Retained Earnings. The book values of its assets and liabilities were equal to their respective fair values on this date. All excess purchase cost was attributed to goodwill. During 2013, Corbin uniformly earned $98,000 and paid dividends of $19,000 on each of four dates: February 1, June 1, August 1, and December 1. Required: Compute the following: 1. Implied goodwill associated with Corbin Corporation based on Nelson's purchase price on September 1, 2013. 2. Nelson's income from Corbin for 2013. 3. Preacquisition income for Nelson Corporation and Subsidiary for 2013. 4. Noncontrolling interest share for 2013. 5. What is the balance in Nelson's Investment in Corbin account at December 31, 2013?

Answer: Requirement 1 Cost of investment Total stockholders' equity, Jan. 1 Add: Net income ($98,000 × 8/12) Less: Dividends ($19,000 × 3) Total stockholders' equity, Sep. 1

$800,000 65,333 (57,000) 808,333

Implied fair value of investment: $900,000/0.9 Total stockholders' equity, Sep. 1 Implied goodwill

1,000,000 (808,333) 191,667

$900,000

Requirement 2 Income from Corbin ($98,000 × 4/12 × 90%)

$29,400

Requirement 3 Preacquisition income ($98,000 × 8/12)

$65,333

Requirement 4 Noncontrolling interest share ($98,000 × 10% × 4/12)

$3,267

Requirement 5 Investment at December 31, 2013: $900,000 + $29,400 - ($19,000 × 90%)

$912,300

13) At January 1, 2013, the stockholders' equity of Raven Corporation and its 60%-owned subsidiary, Trunk Corporation, are as follows:

Common stock, $10 par value Retained earnings Totals

Raven $700,000 800,000 $1,500,000

Trunk $400,000 50,000 $450,000

Trunk's net income for 2013 was $40,000. No dividends were declared or paid in 2013. Raven's Investment in Trunk account balance on December 31, 2013 was equal to its underlying equity on December 31, 2013. Trunk Corporation issued 10,000 additional shares of common stock directly to Raven on January 1, 2014 at $22 per share. Required: 1. Compute the balance in Raven's Investment in Trunk account on January 1, 2014 after its purchase of the additional Trunk shares. 2. Determine the increase or decrease in goodwill stemming from Raven's investment in the 10,000 Trunk shares. Assume the fair value and book value of Trunk's assets and liabilities are equal. Answer: Requirement 1 Cost of investment ($450,000 × 60%) $270,000 Share of Trunk's income for 2013 ($40,000 × 60%) 24,000 Investment in Trunk balance at December 31, 2013 294,000 Plus: Purchase of 10,000 Trunk shares at $22 on January 1, 2014 220,000 Investment account balance $514,000 Requirement 2 Trunk's stockholders' equity at January 1, 2014 ($450,000 + $40,000 of 2013 net income) Plus: Additional capital from the shares issued Total stockholders' equity after issuance of the new shares Raven's percentage (24,000 + 10,000)/50,000 = Raven's share of Trunk's equity after issuance Raven's share of Trunk's equity before stock issuance Equity acquired in the purchase Cost of interest acquired Increase in Goodwill

$490,000 220,000 $710,000 68% $482,800 (294,000) 188,800 220,000 $31,200

Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

14) On December 31, 2013, Pat Corporation has the following information available: Common stock, $10 par Additional paid-in capital Retained earnings Total stockholders' equity

$100,000 60,000 40,000 $200,000

On December 31, 2013, Anne Corporation buys an 80% interest in Pat Corporation for $160,000. On December 31, 2013, the fair value of Pat's assets and liabilities are equal to the respective book values. Use four decimal places for the ownership percentage. Required: 1. On January 1, 2014, Pat Corporation sells 2,000 additional shares of common stock to noncontrolling stockholders at $20 per share. Prepare the journal entry for Anne Corporation on January 1, 2014. 2. On January 1, 2014 Pat Corporation sells 2,000 additional shares of common stock to noncontrolling stockholders at $35 per share. Prepare the journal entry for Anne Corporation on January 1, 2014. 3. On January 1, 2014, Pat Corporation sells 2,000 additional shares of common stock to noncontrolling stockholders at $15 per share. Prepare the journal entry for Anne Corporation on January 1, 2014.

Answer: Requirement 1 No entry is needed. Requirement 2 Total stockholders' equity at January 1, 2014: $200,000 + $35(2,000) = $270,000 Anne's percent ownership: 8,000/12,000 = 0.6667 Anne's share of stockholders' equity at January 1, 2014: 0.6667 × $270,000 = $180,009 Anne's prior share of stockholders' equity at January 1, 2014 (Before additional sale): $200,000 × 80% = $160,000 Increase in ownership: $180,009 - $160,000 = $20,009 -------------------------------------------Investment 20,009 Additional paid-in capital 20,009 -------------------------------------------Requirement 3 Total stockholders' equity at January 1, 2014: $200,000 + $15 (2,000) = $230,000 Anne's percent ownership: 8,000/12,000 = 0.6667 Anne's share of stockholders' equity at January 1, 2014: 0.6667 × $230,000 = $153,341 Anne's prior share of stockholders' equity at January 1, 2014 (Before additional sale): $200,000 × 80% = $160,000 Decrease in ownership: $160,000-$153,341 = $6,659 --------------------------------------------Additional paid-in capital 6,659 Investment 6,659 --------------------------------------------Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

15) On December 31, 2013, Dixie Corporation has the following information available: Common stock, $10 par Additional paid-in capital Retained earnings Total stockholders' equity

$200,000 60,000 40,000 $300,000

On December 31, 2013, Grimsled Corporation buys an 80% interest in Dixie Corporation for $240,000. On December 31, 2013, the fair values of Dixie's assets and liabilities are equal to the respective book values. Required: 1. On January 1, 2014, Dixie Corporation sells 5,000 additional shares of common stock to noncontrolling stockholders at $20 per share. Prepare the journal entry for Grimsled Corporation on January 1, 2014. 2. On January 1, 2014, Dixie Corporation sells 5,000 additional shares of common stock to noncontrolling stockholders at $35 per share. Prepare the journal entry for Grimsled Corporation on January 1, 2014. 3. On January 1, 2014, Dixie Corporation sells 5,000 additional shares of common stock to noncontrolling stockholders at $10 per share. Prepare the journal entry for Grimsled Corporation on January 1, 2014.

Answer: Requirement 1 Total stockholders' equity at January 1, 2014: $300,000 + $20 (5,000) = $400,000 Grimsled's percent ownership: 16,000 / 24,000 = 0.64 Grimsled's share of stockholders' equity at January 1, 2014: 0.64 × $400,000 = $256,000 Grimsled's prior share of stockholders' equity at January 1, 2014 (Before additional sale): $300,000 × 80% = $240,000 Increase in ownership: $256,000 - $240,000 = $16,000 -------------------------------------------Investment 16,000 Additional paid-in capital 16,000 --------------------------------------------Requirement 2 Total stockholders' equity at January 1, 2014: $300,000 + $35 (5,000) = $475,000 Grimsled's percent ownership: 0.64 Grimsled's share of stockholders' equity at January 1, 2014: 0.64 × $475,000 = $304,000 Grimsled's prior share of stockholders' equity at January 1, 2014 (Before additional sale): $300,000 × 80% = $240,000 Increase in ownership: $304,000 - $240,000 = $64,000 -------------------------------------------Investment 64,000 Additional paid-in capital 64,000 -------------------------------------------Requirement 3 Total stockholders' equity at January 1, 2014: $300,000 + $10 (5,000) = $350,000 Grimsled's percent ownership: 0.64 Grimsled's share of stockholders' equity at January 1, 2014: 0.64 × $350,000 = $224,000 Grimsled's prior share of stockholders' equity at January 1, 2014 (Before additional sale): $300,000 × 80% = $240,000 Decrease in ownership: $240,000 - $224,000 = $16,000 --------------------------------------------Additional paid-in capital 16,000 Investment 16,000 --------------------------------------------Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

16) On December 31, 2013, Lorna Corporation has the following information available: Common stock, $10 par Additional paid-in capital Retained earnings Total stockholders' equity

$200,000 60,000 40,000 $300,000

On December 31, 2013, Gerald Corporation buys an 80% interest in Lorna Corporation for $240,000. On December 31, 2013, the fair values of Lorna's assets and liabilities are equal to the respective book values. Required: 1. On January 1, 2014, Lorna Corporation buys 500 shares of common stock from noncontrolling stockholders at $20 per share. Prepare the journal entry for Gerald Corporation on January 1, 2014. Use four decimal places for the ownership percentage. 2. On January 1, 2014, Lorna Corporation buys 500 shares of common stock from noncontrolling stockholders at $30 per share. Prepare the journal entry for Gerald Corporation on January 1, 2014. Use four decimal places for the ownership percentage. 3. On January 1, 2014, Lorna Corporation buys 500 shares of common stock from noncontrolling stockholders at $10 per share. Prepare the journal entry for Gerald Corporation on January 1, 2014. Use four decimal places for the ownership percentage. Answer: Requirement 1 Total stockholders' equity at January 1, 2014 $300,000 Less: Treasury stock ($20 × 500) (10,000) Total stockholders' equity at January 1, 2014 $290,000 Gerald's percent ownership: 16,000/19,500 = 0.8205 Gerald's share of stockholders' equity at January 1, 2014: 0.8205 × $290,000 = $237,945 Gerald's prior share of stockholders' equity at January 1, 2014 (Before treasury stock): $300,000 × 80% = $240,000 Decrease in ownership: $240,000 - $237,945 = $2,055 -----------------------------------------------Additional paid-in capital 2,055 Investment in Lorna Corp. 2,055 ------------------------------------------------

Requirement 2 Total stockholders' equity at January 1, 2014 Less: Treasury stock ($30 × 500) Total stockholders' equity at January 1, 2014

$300,000 (15,000) $285,000

Gerald's percent ownership: 16,000/19,500 = 0.8205 Gerald's share of stockholders' equity at January 1, 2014: 0.8205 × $285,000 = $233,842.50 Gerald's prior share of stockholders' equity at January 1, 2014 (Before treasury stock): $300,000 × 80% = $240,000 Decrease in ownership: $240,000 - $233,842.50 = $6,157.50 --------------------------------------------------Additional paid-in capital 6,157.50 Investment in Lorna Corp. 6,157.50 --------------------------------------------------Requirement 3 Total stockholders' equity at January 1, 2014 Less: Treasury stock ($10 × 500) Total stockholders' equity at January 1, 2014

$300,000 (5,000) $295,000

Gerald's percent ownership: 16,000/19,500 = 0.8205 Gerald's share of stockholders' equity at January 1, 2014: 0.8205 × $295,000 = $242,047.50 Gerald's prior share of stockholders' equity at January 1, 2014 (Before treasury stock): $300,000 × 80% = $240,000 Increase in ownership: $242,047.50 - $240,000 = $2,047.50 ---------------------------------------------------Investment in Lorna Corp. 2,047.50 Additional paid-in capital 2,047.50 ---------------------------------------------------Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

17) On December 31, 2013, Maria Corporation has the following stockholders' equity: Common stock, $10 par Additional paid-in capital Retained earnings Total stockholders' equity

$100,000 20,000 80,000 $200,000

On January 1, 2014, Maria Corporation declared and issued a 10% stock dividend when the market price per share was $50. On January 2, 2014, James Corporation purchased an 80% interest in Maria Corporation for $160,000 from the open market. On January 2, 2014, the fair value of Maria's individual assets and liabilities was equal to book value. Required: 1. Prepare the journal entry(ies) for Maria Corporation on January 1, 2014. 2. Prepare the journal entry(ies) for James Corporation on January 2, 2014. 3. Prepare the elimination entry(ies) for consolidating work papers on January 2, 2014. 4. Prepare the elimination entry(ies) for consolidating work papers on January 2, 2014 if the 10% stock dividend is not declared and issued on January 1, 2014. Answer: Requirement 1 Retained earnings (10,000 × $50 × 10%) 50,000 Common stock (10,000 × $10 × 10%) 10,000 Additional paid-in capital 40,000 Requirement 2 Investment Cash Requirement 3 Common stock Additional paid-in capital Retained earnings Investment Noncontrolling interest Requirement 4 Common stock Additional paid-in capital Retained earnings Investment Noncontrolling interest

160,000 160,000

110,000 60,000 30,000 160,000 40,000

100,000 20,000 80,000 160,000 40,000

Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

18) On December 31, 2013, Potter Corporation has the following stockholders' equity: Common stock, $10 par Retained earnings Total stockholders' equity

$200,000 100,000 $300,000

On January 1, 2014, Potter Corporation declared and issued a 10% stock dividend when the market price per share was $50. On January 2, 2014, Corrao Corporation purchased an 80% interest in Potter Corporation for $250,000 on the open market. On January 2, 2014, the fair value of Potter's individual assets and liabilities was equal to book value. Any excess cost over book value is attributed to goodwill. Required: 1. Prepare the journal entry(ies) for Potter Corporation on January 1, 2014. 2. Prepare the journal entry(ies) for Corrao Corporation on January 2, 2014. 3. Prepare the elimination entry(ies) for consolidating work papers on January 2, 2014. 4. Prepare the elimination entry(ies) for consolidating work papers on January 2, 2014 if the 10% stock dividend is not declared and issued on January 1, 2014.

Answer: Requirement 1 Retained earnings (20,000 × $50 × 10%) Common stock (20,000 × $10 × 10%) Additional paid-in capital

100,000

Requirement 2 Investment Cash

250,000 250,000

Requirement 3 Common stock Additional paid-in capital Goodwill Investment Noncontrolling interest

220,000 80,000 12,500 250,000 62,500

Requirement 4 Common stock Retained earnings Goodwill Investment Noncontrolling interest Goodwill:

20,000 80,000

200,000 100,000 12,500 250,000 62,500

- $300,000 = $12,500

Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Application of knowledge

8.3 True/False 1) If an acquisition by a parent of a subsidiary occurs during the accounting period, adjustments must be made for the income earned by a subsidiary prior to the acquisition date. Answer: TRUE Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Moderate AACSB: Analytical thinking

2) Preacquisition dividends are dividends paid on stock by the subsidiary before the date of acquisition by the parent. Answer: TRUE Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Easy AACSB: Analytical thinking

3) GAAP (ASC 810-10-65) states that an acquirer purchases control of the assets and assumes the liabilities of a subsidiary at a price that reflects fair values at the combination date. Answer: TRUE Objective: LO8.1 Apply consolidation procedures to interim (midyear) acquisitions. Difficulty: Easy AACSB: Analytical thinking

4) Piecemeal acquisitions occurs when a corporation acquires an interest in another corporation in a series of separate stock purchases over a period of time. Answer: TRUE Objective: LO8.2 Prepare consolidated statements when the parent company's ownership percentage increases or decreases during the reporting period. Difficulty: Easy AACSB: Analytical thinking

5) Piecemeal acquisitions require the previously held investment to be measured at book value at the date control of the subsidiary is obtained. Answer: FALSE Objective: LO8.2 Prepare consolidated statements when the parent company's ownership percentage increases or decreases during the reporting period. Difficulty: Moderate AACSB: Analytical thinking

6) When a parent/investor sells an ownership interest, a gain or loss is recorded where the interest sold leads to deconsolidation of a former subsidiary. Answer: TRUE Objective: LO8.2 Prepare consolidated statements when the parent company's ownership percentage increases or decreases during the reporting period. Difficulty: Moderate AACSB: Analytical thinking

7) When a parent/investor sells an ownership interest, a gain or loss is recorded where the interest sold does not impact control by the parent company. Answer: FALSE Objective: LO8.2 Prepare consolidated statements when the parent company's ownership percentage increases or decreases during the reporting period. Difficulty: Moderate AACSB: Analytical thinking

8) Whenever a parent ceases to have a controlling interest, the subsidiary should be deconsolidated and recorded as either an equity method or cost method investment. Answer: TRUE Objective: LO8.2 Prepare consolidated statements when the parent company's ownership percentage increases or decreases during the reporting period. Difficulty: Easy AACSB: Analytical thinking

9) The GAAP stipulates that transactions of an investee of a capital nature that affect the investor's share of stockholders' equity of the investee should be accounted for as if the investee were a consolidated subsidiary if accounting for an equity investment under a one-line consolidation. Answer: TRUE Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Analytical thinking

10) The GAAP requires that the parent corporation account for the effect of decreased ownership percentage as an equity transaction. Answer: TRUE Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Moderate AACSB: Analytical thinking

11) The acquisition of treasury stock by a subsidiary increases subsidiary equity and share outstanding. Answer: FALSE Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Easy AACSB: Analytical thinking

12) A stock split by a subsidiary increases the number of shares outstanding, but it does not affect the net assets of the subsidiary or the individual equity accounts. Answer: TRUE Objective: LO8.3 Record subsidiary/investee stock issuances and treasury stock transactions. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 9 Indirect and Mutual Holdings 9.1 Multiple Choice Questions 1) Pallet Corporation owns 80% of Adelt Corporation and Adelt owns 60% of Bajo Inc. Which of the following is correct? A) Bajo should not be consolidated because noncontrolling interests hold 52%. B) Bajo should be consolidated because the 60% of Bajo stock is held in the affiliate structure. C) Pallet has 8% indirect ownership of Bajo. D) Pallet has 80% indirect ownership of Bajo. Answer: B Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Analytical thinking

2) Page Corporation acquired a 60% interest in Ace Corporation at a price $40,000 in excess of book value and fair value on January 1, 2013. On the same date, Ace acquired a 70% interest in Bader Corporation at a price $30,000 in excess of book value and fair value. The excess purchase cost paid by Page and Ace was attributed to goodwill. Separate net incomes (excluding investment income) for the three affiliates for 2013 are as follows: Page, $500,000, Ace, $300,000, and Bader, $400,000. Page's controlling interest share of consolidated net income for 2013 is A) $808,000. B) $848,000. C) $920,000. D) $960,000. Answer: B Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Paint Corporation owns 82% of Achille Corporation and Achille Corporation owns 80% of Badrack Corporation. For the current year, the separate net incomes (excluding investment income) of Paint, Achille, and Badrack are $120,000, $100,000, and $50,000, respectively. The cost of each investment was equal to the book value of the investment, which was also equal to the fair value. 3) Noncontrolling interest share for Badrack is A) $9,000. B) $10,000. C) $20,000. D) $40,000. Answer: B Explanation: B) (0.20 × $50,000 = $10,000) Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

4) Noncontrolling interest share for Achille is A) $18,000. B) $25,200. C) $36,200. D) $72,000. Answer: B Explanation: B) [$100,000 + (0.80) × ($50,000)] × 18% = $25,200 Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

5) Controlling interest share of consolidated net income for Paint Corporation and Subsidiaries is: A) $234,800. B) $244,800. C) $260,000. D) $270,000. Answer: A Explanation: A) Paint Achille Badrack Separate incomes $120,000 $100,000 $50,000 Allocate 80% of Badrack to Achille _______ 40,000 (40,000) Subtotal 120,000 140,000 10,000 Allocate 82% of Achille to Paint 114,800 (114,800) Controlling interest share of cons. net income $234,800 _______ _______ Noncontrolling interest share $25,200 $10,000 Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

6) Pabari Corporation owns an 80% interest in Alders Corporation and Alders owns a 60% interest in Babao Corporation. Both interests were acquired at a cost equal to book value equal to fair value. During 2013, Alders sells land to Babao at a profit of $12,000. Babao still holds the land at December 31, 2013. Net income (loss) of the three companies (excluding investment income) for 2013 are: Pabari Corporation Alders Corporation Babao Corporation

$180,000 72,000 (30,000)

Controlling interest share of consolidated net income and noncontrolling interest share, respectively, for 2013 are A) $211,200 and ($1,200). B) $211,200 and ($3,600). C) $213,600 and ($1,200). D) $213,600 and ($3,600). Answer: D Explanation: D) Noncont. interest share: $8,400 Profit + ($12,000) Loss

Separate incomes Less: Unrealized profit on land Subtotal Allocate Babao's net loss to Alders ($30,000) × 60% Subtotal Allocate 80% of Alders income to Pabari Controlling interest share of consolidated net income Noncontrolling interest share

Pabari $180,000 _______ $180,000

Alders $72,000 (12,000) $60,000

Babao $(30,000) _______ (30,000)

_______ 180,000

(18,000) 42,000

18,000 (12,000)

33,600

(33,600)

$213,600

_______ $8,400

_______ $(12,000)

Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

7) Pablo Corporation acquired 60% of Abagia Corporation on January 1, 2013, at a cost of $20,000 in excess of book value. Also, on July 1, 2013, Pablo acquired 60% of Babin Corporation at book value. On January 1, 2014, Abagia acquired a 20% interest in Babin at a cost of $10,000 in excess of book value. The excess purchase costs paid by Pablo and Abagia were attributed to goodwill. On July 1, 2014, Pablo sold land with a book value of $20,000 to Abagia for $40,000. The $20,000 unrealized gain is included in Pablo's separate income. Separate net incomes for the affiliated companies (excluding investment income) for 2014 are: Pablo Abagia Babin

$250,000 70,000 100,000

Controlling interest share of consolidated net income for 2014 is A) $304,000. B) $324,000. C) $344,000. D) $364,000. Answer: C Explanation: C) Separate incomes Less: Unrealized profit on land Separate realized incomes Allocate Babin's income: 60% to Pablo 20% to Abagia Subtotal Allocate Abagia's net income 60% to Pablo Controlling interest share of consolidated net income Noncontrolling interest share

Pablo $250,000 (20,000) $230,000

Abagia $70,000 ________ $70,000

Babin $100,000 ________ $100,000

60,000 ________ 290,000

20,000 90,000

(60,000) (20,000) 20,000

54,000

(54,000)

$344,000

________ $36,000

________ $20,000

Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

8) Paglia Corporation owns 80% of Aburn Corporation and has separate net income of $200,000 for 2013. Aburn Corporation has separate net income of $100,000 and owns 70% of the outstanding stock of Badley Corporation. Badley Corporation has separate net income of $80,000. (Separate net incomes exclude investment income.) The cost of each investment was equal to book value and fair value. The controlling interest share of consolidated net income for 2013 is A) $324,800. B) $328,800. C) $344,800. D) $348,800. Answer: A Explanation: A) Paglia Aburn Badley Separate incomes $200,000 $100,000 $80,000 Allocate Badley's income: 70% to Aburn _______ 56,000 (56,000) Subtotal $200,000 $156,000 $24,000 Allocate Aburn's income: 80% to Paglia 124,800 (124,800) _______ Controlling interest share of consolidated net income $324,800 Noncontrolling interest share $31,200 $24,000 Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Pace Corporation owns 70% of Abaza Corporation and 60% of Babon Corporation. Abaza Corporation owns 20% of Babon Corporation. Pace's investment in Abaza was consummated in one transaction at a purchase price $20,000 in excess of the book value. Pace's purchase of Babon was made in one transaction at a price $30,000 above book value. Abaza's investment in Babon was completed in one transaction at a purchase price $10,000 in excess of the book value. The purchase price differential for all three investments was attributable to goodwill. (There were no fair value/book value differences in assets and liabilities for each investment.) Pace's separate net income for the current year is $100,000. Abaza's separate net income is $190,000, which includes a $10,000 unrealized loss on the sale of land to Pace. Babon's separate net income is $150,000. Separate net incomes exclude investment income. 9) The controlling interest share of consolidated net income for the current year is A) $341,000. B) $348,400. C) $351,000. D) $355,000. Answer: C Explanation: C) Separate incomes Plus: Unrealized loss on land sale to Pace Separate realized incomes Allocate Babon's income: 60% to Pace 20% to Abaza Subtotal Allocate Abaza's net income to Pace $230,000 × 70% Controlling interest share of consolidated net income Noncontrolling interest share

Pace $100,000

Abaza $190,000

Babon $150,000

________ $100,000

10,000 $200,000

________ $150,000

90,000 ________ 190,000

30,000 230,000

(90,000) (30,000) 30,000

161,000

(161,000)

$351,000

________ $69,000

________ $30,000

Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

10) The amount of noncontrolling interest share for the current year is A) $69,000. B) $85,000. C) $95,000. D) $99,000. Answer: D Explanation: D) ($69,000 + 30,000 = $99,000) Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Pahm Corporation owns 80% of the outstanding voting common stock of Abussi Corporation, which was purchased for $60,000 over Abussi's book value. The excess purchase price was attributable to goodwill. Abussi Corporation owns 60% of the outstanding common stock of Badock Corporation, which was purchased at book value. The separate net incomes of Pahm, Abussi, and Badock (excluding investment income) for the year are $200,000, $240,000, and $260,000, respectively. There were no fair value/book value differences in the assets and liabilities of Pahm, Abussi and Badock. 11) Controlling interest share of consolidated net income for the current year is A) $504,800. B) $516,800. C) $545,200. D) $557,200. Answer: B Explanation: B) ($200,000 + (80%) × [$240,000 + (60%) × (260,000)] = $516,800) Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

12) The amount of income for the current year assigned to the noncontrolling shareholders of Badock Corporation is A) $100,000. B) $104,000. C) $120,000. D) $140,000. Answer: B Explanation: B) (40% × $260,000 = $104,000) Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

13) The amount of income for the current year assigned to the noncontrolling shareholders of Abussi Corporation is A) $48,000. B) $53,200. C) $74,000. D) $79,200. Answer: D Explanation: D) (20% × $240,000) + (20% × $156,000) = $79,200

Separate incomes Allocate Badock's income: 60% to Abussi Subtotal Allocate Abussi's net income to Pahm $396,000 × 80% Controlling interest share of consolidated net income Noncontrolling interest share

Pahm $200,000

Abussi $240,000

Badock $260,000

________ $200,000

156,000 $396,000

(156,000) $104,000

316,800

(316,800)

$516,800

________ $79,200

________ $104,000

Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

14) The net income reported for Pahm Corporation for the current year is A) $504,800. B) $516,800. C) $545,200. D) $557,200. Answer: B Explanation: B) Pahm's net income is the same as the controlling interest share of consolidated net income. Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Paiva Corporation owns 80% of Ackroyd Corporation's outstanding common stock and Ackroyd owns 80% of the outstanding common stock of Bailey Corporation. Bailey Corporation owns 10% of the outstanding common stock of Ackroyd Corporation. The cost of the investments was equal to book value and there were not fair value/book value differences for the investments. The separate net incomes for the three affiliated companies for the year ended December 31, 2014 (excluding investment income) are as follows: Paiva Corporation, $100,000, Ackroyd Corporation, $50,000, and Bailey Corporation, $30,000. Use the conventional approach. Symbols used: P = Income of Paiva on a consolidated basis A = Income of Ackroyd on a consolidated basis B = Income of Bailey on a consolidated basis 15) The equation, in a set of simultaneous equations, that computes Paiva Corporation income on a consolidated basis is A) P = $50,000 + 0.8B. B) P = $30,000 + 0.2A. C) P = $100,000 + 0.2A. D) P = $100,000 + 0.8A. Answer: D Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

16) Ackroyd's noncontrolling interest share for 2014 is A) $7,609. B) $8,044. C) $15,652. D) $23,696. Answer: B Explanation: B) P = $100,000 + 0.8A A = $50,000 + 0.8B B = $30,000 + 0.1A A = $50,000 + 0.8 × ($30,000 + 0.1A) A = $50,000 + $24,000 + 0.08A 0.92A = $74,000 A = $80,435 (rounded) Noncontrolling interest share Ackroyd: $80,435 × 10% outside interest $8,044 Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

17) Bailey's noncontrolling interest share for 2014 is A) $7,609. B) $8,044. C) $15,652. D) $23,696. Answer: A Explanation: A) (20% × $38,044) Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

18) When mutually-held stock involves subsidiaries holding the stock of each other, the ________ method is not used. A) equity B) cost C) conventional D) treasury stock Answer: D Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

19) Raymond Company owns 90% of Rachel Company. Rachel Company owns 10% of Raymond Company. The treasury stock method is used. On the books of Rachel Company, we maintain the Investment in Raymond using the ________ method. The ending balance in Investment in Raymond is ________ stockholders' equity in the consolidated balance sheet. A) equity; deducted from B) cost; deducted from C) treasury stock; deducted from D) conventional; added to Answer: B Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Analytical thinking

20) On January 1, 2014, Pauline Company acquired 90% of Stephen Company at a cost of $90,000. On January 1, 2014, Stephen Company acquired 10% of Pauline Company at a cost of $10,000. On January 1, 2014, the following data is available: Stephen Company Common Stock Retained Earnings Assets fair value Assets book value Liabilities

Pauline Company Common Stock Retained Earnings Assets fair value Assets book value Liabilities

$50,000 $50,000 $100,000 $100,000 $0

At December 31, 2014, the following data is available: January 1, 2014

December 31, 2014

$90,000

$105,000

$10,000

On Pauline Books: Investment in Stephen On Stephen Books: Investment in Pauline

Assuming the treasury stock method is used, what elimination entry is needed for the Investment in Pauline at December 31, 2014? A) Retained earnings 5,000 Common stock 5,000 Investment in Pauline

10,000

B) Investment in Stephen 10,000 Investment in Pauline

10,000

C) Income from Pauline 10,000 Investment in Pauline

10,000

D) Treasury stock 10,000 Investment in Pauline

10,000

Answer: D Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

9.2 Exercises 1) Paice Corporation owns 80% of the voting common stock of Accardi Corporation. Paice owns 60% of the voting common stock of Badger Corporation. Accardi owns 20% of the voting common stock of Badger. There are no cost/book value/fair value differentials to consider. The separate net incomes (excluding investment income) of these affiliated companies for 2014 are: Paice Accardi Badger

$300,000 160,000 120,000

Required: Calculate controlling interest share of consolidated net income and noncontrolling interest shares for Paice Corporation and Subsidiaries for 2014. Answer: Paice Corporation and Subsidiaries Income Allocation Schedule For the year 2014

Separate earnings Allocate Badger's income: 60% to Paice 20% to Accardi Subtotal Allocate Accardi's income: 80% to Paice Controlling interest share of consolidated net income Noncontrolling interest share

Paice $300,000

Accardi $160,000

Badger $120,000

72,000 ________ $372,000

24,000 $184,000

(72,000) (24,000) $24,000

147,200

(147,200)

$519,200

________ $36,800

________ $24,000

Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

2) Pacini Corporation owns an 80% interest in Abdoo Corporation, acquired on January 1, 2013 for $700,000 when Abdoo's stockholders' equity consisted of $600,000 of Capital Stock and $200,000 of Retained Earnings. Abdoo Corporation acquired a 60% interest in Bach Corporation on July 1, 2013 for $180,000 when Bach had Capital Stock of $200,000 and Retained Earnings of $50,000. On January 1, 2014, Abdoo acquired a 70% interest in Cabo Corporation for $270,000 when Cabo had Capital Stock of $250,000 and Retained Earnings of $100,000. No change in outstanding stock of any of the affiliated companies has occurred since the investments were made. All cost-book value differentials are goodwill. There are no fair value/book value differentials. The stockholders' equity section of the separate balance sheets of Abdoo, Bach, and Cabo at December 31, 2014 are as follows:

Capital Stock Retained Earnings Total stockholders' equity

Abdoo $600,000 280,000 $880,000

Bach $200,000 140,000 $340,000

Cabo $250,000 130,000 $380,000

Required: 1. Compute the amount at which goodwill should be shown in the consolidated balance sheet of Pacini Corporation and Subsidiaries at December 31, 2014. 2. Pacini and Abdoo have applied the equity method correctly. Determine the balances of the three investment accounts at December 31, 2014.

Answer: Requirement 1 Pacini's investment in Abdoo: Implied fair value ($700,000/0.8) Total stockholders' equity Goodwill

$875,000 800,000 $75,000

Abdoo's investment in Bach: Implied fair value ($180,000/0.6) Total stockholders' equity Goodwill

$300,000 250,000 $50,000

Abdoo's investment in Cabo: Implied fair value ($270,000/0.7) Total stockholders' equity Goodwill Total Goodwill ($35,714 + $75,000 + $50,000)

$385,714 350,000 $35,714 $160,714

Requirement 2

Investment cost Investors' share of equity since acquisition: Abdoo: ($80,000 × 80%) Bach: ($90,000 × 60%) Cabo: ($30,000 × 70%) Investment account balance

Pacini Equity in Abdoo $700,000

Abdoo's books Equity Equity in Bach in Cabo $180,000 $270,000

64,000 54,000 $764,000

$234,000

21,000 $291,000

Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

3) Paik Corporation owns 80% of Acdol Corporation and 60% of Ben Corporation. Acdol Corporation owns 10% of Ben Corporation. All subsidiary investments were acquired at book value. There are no fair value/book value differentials associated with each investment. Separate net incomes (excluding investment income) of the affiliated companies for 2014 are: Paik:

$600,000 which includes $60,000 unrealized losses on inventory items sold to Ben

Acdol:

$360,000

Ben:

$340,000 which includes $100,000 unrealized profit on land sold to Acdol

Required: Determine controlling interest share of consolidated net income and noncontrolling interest shares for Paik Corporation and Subsidiaries for 2014. Answer: Paik Acdol Ben Separate incomes $600,000 $360,000 $340,000 Plus: Unrealized loss on inventory sales to Ben 60,000 Less: Unrealized profits on land sold to Acdol ________ ________ (100,000) Separate realized incomes 660,000 360,000 240,000 Allocate Ben: 60% to Paik 144,000 (144,000) 10% to Acdol ________ 24,000 (24,000) Subtotal $804,000 $384,000 $72,000 Allocate Acdol: 80% to Paik 307,200 (307,200) ________ Controlling interest share of consolidated net income $1,111,200 Noncontrolling interest share $76,800 $72,000 Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

4) Packer Corporation owns 100% of Abel Corporation, Abel Corporation owns 95% of Bacon Corporation and Bacon Corporation owns 80% of Cab Corporation. The separate net incomes (excluding investment income) of Packer, Abel, Bacon, and Cab are $300,000, $100,000, $200,000, and $300,000, respectively. All of the investments were made at times when the investee's book values were equal to their fair values. There were no cost/book value differentials for each investment. Required: Determine the controlling interest share of consolidated net income and noncontrolling interest shares for Packer Corporation and Subsidiaries for the current year. Answer: Packer Abel Bacon Cab Separate incomes $300,000 $100,000 $200,000 $300,000 Allocate Cab's income: 80% to Bacon ________ ________ 240,000 (240,000) Subtotal 300,000 100,000 440,000 60,000 Allocate Bacon's income: 95% to Abel ________ 418,000 (418,000) Subtotal 300,000 518,000 22,000 60,000 Allocate Abel's income: 100% to Packer 518,000 (518,000) Controlling interest share of consolidated net income $818,000 ________ ________ ________ Noncontrolling interest share $0 $22,000 $60,000 Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

5) On January 1, 2014 Paki Inc. bought 75% interest in Adam Corporation. At the time of purchase, Adam owned 80% of Baird Company. In all acquisitions, the book value equals the fair value, which equals the acquisition cost. Separate earnings (loss) (excluding investment income) for the three affiliates for 2014 are as follows: Separate Earnings (Loss) Dividends Paki Inc. $400,000 $150,000 Adam Corporation (50,000) 90,000 Baird Company 100,000 35,000 Required: Compute controlling interest share of consolidated net income and noncontrolling interest shares for Paki and affiliates for 2014. Answer: Paki Adam Baird Separate incomes $400,000 $(50,000) $100,000 Allocate Baird 80% ________ 80,000 (80,000) Subtotal $400,000 $30,000 $20,000 Allocate Adam 75% 22,500 (22,500) Controlling interest share of consolidated net income Noncontrolling interest share

$422,500 $7,500

$20,000

Noncontrolling interest share in Baird Noncontrolling interest share in Adam Noncontrolling interest shares

$20,000 7,500 $27,500

Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

6) Paco Corporation owns 90% of Aber Corporation, Aber Corporation owns 85% of Back Corporation, and Back Corporation owns 5% of Aber Corporation. The separate net incomes (excluding investment income) of Paco, Aber, and Back are $100,000, $40,000, and $55,000, respectively. Assume the investments were acquired at a cost equal to the book value of each investment, which also equals the fair value. Required: 1. Calculate revised net incomes for Paco, Aber, and Back by using the conventional method. 2. Determine the controlling interest share of consolidated net income and the noncontrolling interest shares. Answer: Requirement 1 Paco $181,541 Aber $90,601 Back $59,530 Requirement 2 Controlling interest share of consolidated net income = $181,541 Noncontrolling interest share (in Aber) $90,601 × 5% = $4,530 Noncontrolling interest share (in Back) $59,530 × 15% = $8,929 Total consolidated net income $195,000 Check: Total separate income = $100,000 + $40,000 + $55,000 = $195,000 Equations: P = Income of Paco on a consolidated basis A= Income of Aber on a consolidated basis B = Income of Back on a consolidated basis P = $100,000 + 0.90A A = $ 40,000 + 0.85B B = $ 55,000 + 0.05A A = $40,000 + (0.85) × ($55,000 + 0.05A) A = $40,000 + $46,750 + 0.0425A A = $90,601 B = $55,000 + (0.05) × ($90,601) B = $59,530 P = $100,000 + (0.9) × ($90,601) P = $100,000 + $81,541 P = $181,541 Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

7) Paine Corporation owns 90% of Achan Corporation, Achan Corporation owns 85% of Badge Corporation, and Badge Corporation owns 5% of Achan Corporation. The separate net incomes (excluding investment income) of Paine, Achan, and Badge are $400,000, $160,000, and $220,000, respectively. Assume the investments were acquired at a cost equal to the book value of each investment, which also equals the fair value. Required: 1. Calculate revised net incomes for Paine, Achan, and Badge by using the conventional method. 2. Determine the controlling interest share of consolidated net income and the noncontrolling interest shares. Answer: Equations: P = Income of Paine on a consolidated basis A = Income of Achan on a consolidated basis B = Income of Badge on a consolidated basis P = $400,000 + 0.90A A = $160,000 + 0.85B B = $220,000 + 0.05A A = $160,000 + 0.85 × ($220,000 + 0.05A) A = $160,000 + $187,000 + 0.0425A 0.9575A = $347,000 A = $362,402 B = $220,000 + 0.05 ($362,402) = $238,120 P = $400,000 + 0.9 ($362,402) = $726,162 Requirement 1 Paine $726,162 Achan $362,402 Badge $238,120 Requirement 2 Controlling interest share in consolidated net income Noncontrolling interest share (from Achan) ($362,402 × 5%) Noncontrolling interest share (from Badge) ($238,120 × 15%) Total consolidated net income

$726,162 18,120 35,718 $780,000

Check: Total separate income = $400,000 + $160,000 + $220,000 = $780,000 Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

8) Separate earnings and investment percentages for three affiliates for 2014 are as follows:

Palace Company Acres Inc Bain Corporation

Separate Earnings $450,000 200,000 160,000

Percentage Interest in Acres 80%

Percentage Interest in Bain 70%

10%

Assume the investments were acquired at a cost equal to the book value of each investment, which also equals the fair value. Separate earnings do not include investment income. Required: 1. Calculate revised net incomes for Palace, Acres, and Bain by using the conventional method. 2. Determine the controlling interest share of consolidated net income and the noncontrolling interest shares.

Answer: Requirement 1 Equations: P = Income of Palace on a consolidated basis A = Income of Acres on a consolidated basis B = Income of Bain on a consolidated basis P = $450,000 + 0.8A A = $200,000 + 0.7B B = $160,000 + 0.1A Computations: A = $200,000 + 0.7($160,000 + 0.1A) A = $200,000 + $112,000 + 0.07A 0.93A = $312,000 A = $335,484 P = $450,000 + 0.8 × ($335,484) P = $450,000 + $268,387 P = $718,387 B = $160,000 + 0.1($335,484) B = $193,548 Palace = $718,387 Acres = $335,484 Bain = $193,548 Requirement 2 Controlling interest share of consolidated net income Noncontrolling interest share (in Acres) (10% × $335,484) Noncontrolling interest share (in Bain) (30% × $193,548) Total consolidated net income

$718,387 33,548 58,064 $809,999

Check: Total separate net income ($450,000 + $200,000 + $160,000)

$810,000

Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

9) Padhy Corporation owns 80% of Abrams Corporation, Abrams Corporation owns 60% of Bacud Corporation, and Bacud Corporation owns 10% of Abrams Corporation. The separate net incomes (excluding investment income) of Padhy, Abrams, and Bacud are $300,000, $100,000, and $80,000, respectively. Assume the investments were acquired at a cost equal to the book value of each investment, which also equals the fair value. Required: 1. Calculate revised net incomes for Padhy, Abrams and Bacud by using the conventional method. 2. Calculate the controlling interest share of consolidated net income and the noncontrolling interest shares for Padhy Corporation and its subsidiaries. Use the conventional method for your solution. Answer: Requirement 1 Equations: P = Income of Padhy on a consolidated basis A = Income of Abrams on a consolidated basis B = Income of Bacud on a consolidated basis P = $300,000 + 0.8A A = $100,000 + 0.6B B = $ 80,000 + 0.1A Computations: A = $100,000 + 0.6 ($80,000 + 0.1A) A = $100,000 + $48,000 + 0.06A 0.94A = $148,000 A = $157,447 B = $80,000 + 0.1 ($157,447) = $95,745 P = $300,000 + 0.8 ($157,447) = $425,958 Padhy $425,958 Abrams $157,447 Bacud $95,745 Requirement 2 Controlling interest share of consolidated net income Noncontrolling interest share (for Abrams) (10% × $157,447) Noncontrolling interest share (for Bacud) (40% × $95,745) Total consolidated net income Check: Total separate net income ($300,000 + $100,000 + $80,000)

$425,958 15,745 38,298 $480,001 $480,000

Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

10) On January 1, 2014, Wrobel Company acquired a 90 percent interest in Sally Company for $270,000. On January 1, 2014, Sally's total stockholders' equity was $300,000. The fair value and book value of Sally's individual assets and liabilities were equal. On January 2, 2014, Sally Company acquired a 10 percent interest in Wrobel Company for $70,000. On January 2, 2014, Wrobel's total stockholders' equity was $700,000. The fair value and book value of Wrobel's individual assets and liabilities were equal. For the year ending December 31, 2014, the following data is available:

Wrobel Company Sally Company

Net income $50,000 $30,000

Dividends $0 $0

The treasury stock method is used to account for the mutual stock holdings between Wrobel and Sally. The separate net incomes do not include investment income. Required: 1. What is Sally's income from Wrobel for 2014? 2. What is Wrobel's income from Sally for 2014? 3. What is the noncontrolling interest share associated with Sally Company for 2014? 4. Prepare the elimination entry for Sally's Investment in Wrobel Company. Answer: Requirement 1 No income from Wrobel because Sally uses the cost method for the Investment in Wrobel and dividends are $0 in 2014. Requirement 2 $30,000 × 90% = $27,000 Requirement 3 $30,000 × 10% = $3,000 Requirement 4 Treasury stock Investment in Wrobel Co.

70,000 70,000

Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

11) On January 1, 2014, Singh Company acquired an 80 percent interest in Gonzalez Company for $300,000. On January 1, 2014, Gonzalez's total stockholders' equity was $375,000. The fair value and book value of Gonzalez's individual assets and liabilities were equal. On January 2, 2014, Gonzalez Company acquired a 10 percent interest in Singh Company for $50,000. On January 2, 2014, Singh's total stockholders' equity was $500,000. The fair value and book value of Singh's individual assets and liabilities were equal. For the year ending December 31, 2014, the following data is available:

Singh Company Gonzalez Company

Net income $40,000 $10,000

Dividends $0 $0

The treasury stock method is used to account for the mutual stock holdings between Singh and Gonzalez. The separate net incomes do not include investment income. Required: 1. What is Gonzalez's income from Singh for 2014? 2. What is Singh's income from Gonzalez for 2014? 3. What is the noncontrolling interest share associated with Gonzalez Company for 2014? 4. Prepare the elimination entry for Gonzalez's Investment in Singh Company. Answer: Requirement 1 No income from Singh because Gonzalez uses the cost method for the Investment in Singh, and dividends are $0 in 2014. Requirement 2 $10,000 × 80% = $8,000 Requirement 3 $10,000 × 20% = $2,000 Requirement 4 Treasury stock Investment in Singh Co.

50,000 50,000

Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

12) On January 1, 2014, Wrobel Company acquired a 90 percent interest in Sally Company for $270,000. On January 1, 2014, Sally's total stockholders' equity was $300,000. The fair value and book value of Sally's individual assets and liabilities were equal. On January 2, 2014, Sally Company acquired a 10 percent interest in Wrobel Company for $70,000. On January 2, 2014, Wrobel's total stockholders' equity was $700,000. The fair value and book value of Wrobel's individual assets and liabilities were equal. For the year ending December 31, 2014, the following data is available:

Wrobel Company Sally Company

Net income $50,000 $30,000

Dividends $0 $0

The treasury stock method is used to account for the mutual stock holdings between Wrobel and Sally. The separate net incomes do not include investment income. A partial working paper is available for the year ending December 31, 2014.

Required: Prepare the elimination entries for the year ending December 31, 2014. Do not enter them onto the worksheet. Instead, list them below.

Answer:

Debit

Income from Sally Investment in Sally

27,000

Noncontrolling interest share Noncontrolling interest

3,000

Treasury stock Investment in Wrobel

70,000

Retained earnings Capital stock Investment in Sally Noncontrolling interest

100,000 200,000

Credit

27,000

3,000

70,000

270,000 30,000

Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

13) On January 1, 2014, Singh Company acquired an 80 percent interest in Gonzalez Company for $300,000. On January 1, 2014, Gonzalez's total stockholders' equity was $375,000. The fair value and book value of Gonzalez's individual assets and liabilities were equal. On January 2, 2014, Gonzalez Company acquired a 10 percent interest in Singh Company for $50,000. On January 2, 2014, Singh's total stockholders' equity was $500,000. The fair value and book value of Singh's individual assets and liabilities were equal. For the year ending December 31, 2014, the following data is available:

Singh Company Gonzalez Company

Net income $40,000 $10,000

Dividends $0 $0

The treasury stock method is used to account for the mutual stock holdings between Singh and Gonzalez. The separate net incomes do not include investment income. A partial consolidating worksheet is below.

Required: Prepare the elimination entries for the year ending December 31, 2014. Do not enter them onto the worksheet. Instead, list them below.

Answer:

Debit

Income from Gonzalez Investment in Gonzalez

8,000

Noncontrolling interest share Noncontrolling interest

2,000

Treasury stock Investment in Singh

50,000

Retained earnings Capital stock Investment in Gonzalez Noncontrolling interest

75,000 300,000

Credit

8,000

2,000

50,000

300,000 75,000

Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

14) On January 1, 2014, Peabody Corporation acquired a 90% interest in Salisbury Company for $270,000 when Salisbury's stockholders' equity was $300,000; with Common stock $200,000 and Retained earnings $100,000. On January 1, 2014, Salisbury purchased a 10% interest in Peabody for $70,000 when Peabody's total stockholders' equity was $700,000; with Common stock $500,000 and Retained earnings $200,000. The following data was available for the year ending December 31, 2014:

Net income Dividends

Peabody Company $50,000 0

Salisbury Company $30,000 0

Use the conventional approach to account for the mutually-held stock. Assume there were no book value/fair value differentials for each investment. The separate net incomes do not include investment income. Required: 1. Prepare the journal entry for Peabody on January 1, 2014. 2. Prepare the journal entry for Salisbury on January 1, 2014. 3. Prepare the journal entry to record the constructive retirement of 10% of Peabody's outstanding stock due to Salisbury's purchase of Peabody's stock. 4. Determine the incomes of Peabody and Salisbury on a consolidated basis with mutual income for 2014 using simultaneous equations. 5. What is controlling interest share of consolidated net income and noncontrolling interest shares for 2014?

Answer: Requirement 1 Debit 270,000

Investment in Salisbury Co. Cash

Credit 270,000

Requirement 2 Investment in Peabody Co. Cash

70,000

Requirement 3 Common stock Retained earnings Investment in Salisbury Co.

50,000 20,000

70,000

Requirement 4 P = the income of Peabody on a consolidated basis S = the income of Salisbury on a consolidated basis P = $50,000 + 0.90S S = $30,000 + 0.10P P = $50,000 + 0.9 ($30,000 + 0.10P) P = $50,000 + $27,000 + 0.09P P = $84,615 S = $30,000 + 0.1 ($84,615) = $38,462 Requirement 5 Peabody net income on an equity basis = Controlling interest share of consolidated net income = 90% × $84,615 = $76,154 Noncontrolling interest share = 10% × $38,462 = $3,846 Check: Separate net income = $50,000 + $30,000= $80,000 $76,154 + $3,846 = $80,000 Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

15) On January 1, 2014, Klode Corporation acquired an 80% interest in Savy Company for $400,000 when Savy's stockholders' equity was $500,000; with Common stock $400,000 and Retained earnings $100,000. On January 1, 2014, Savy purchased a 10% interest in Klode for $50,000 when Klode's total stockholders' equity was $500,000; with Common stock $400,000 and Retained earnings $100,000. The following data was available for the year ending December 31, 2014:

Net income Dividends

Klode Company $70,000 0

Savy Company $50,000 0

Use the conventional approach to account for the mutually-held stock. Assume there were no book value/fair value differentials for each investment. The separate net incomes do not include investment income. Required: 1. Prepare the journal entry for Klode on January 1, 2014. 2. Prepare the journal entry for Savy on January 1, 2014. 3. Prepare the journal entry to record the constructive retirement of 10% of Klode's outstanding stock due to Savy's purchase of Klode's stock. 4. Determine the incomes of Klode and Savy on a consolidated basis with mutual income for 2014 using simultaneous equations. 5. What is controlling interest share of consolidated net income and noncontrolling interest shares for 2014?

Answer: Requirement 1 Debit 400,000

Investment in Savy Co. Cash

Credit 400,000

Requirement 2 Investment in Klode Co. Cash

50,000

Requirement 3 Common stock Retained earnings Investment in Savy Co.

40,000 10,000

50,000

Requirement 4 K = the income of Klode on a consolidated basis S = the income of Savy on a consolidated basis K = $70,000 + 0.80S S = $50,000 + 0.10K K = $70,000 + 0.8 ($50,000 + 0.10K) K = $70,000 + $40,000 + 0.08K K = $119,565 S = $61,957 Requirement 5 Klode net income on an equity basis = Controlling interest share of consolidated net income = 90% × $119,565 = $107,609 Noncontrolling interest share = 20% × $61,957 = $12,391 Check: Separate net income = $50,000 + $70,000 = $120,000 $107,609 + $12,391 = $120,000 Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

16) On January 1, 2014, Paul Corporation acquired a 90% interest in Satorius Company for $360,000 when Satorius' stockholders' equity was $400,000; with Common stock of $200,000 and Retained earnings of $200,000. On January 1, 2014, Satorius Company purchased a 10% interest in Paul Company for $90,000 when Paul's total stockholders' equity was $900,000; with Common stock of $500,000 and Retained earnings of $400,000. The following data was available for the year ending December 31, 2014:

Net income Dividends

Paul Company $150,000 0

Satorius Company $130,000 0

Use the conventional approach to account for the mutually-held stock. Assume there were no book value/fair value differentials for each investment. The separate net incomes do not include investment income. Required: 1. Prepare the journal entry for Paul on January 1, 2014. 2. Prepare the journal entry for Satorius on January 1, 2014. 3. Prepare the journal entry to record the constructive retirement of 10% of Paul's outstanding stock due to Satorius' purchase of Paul's stock. 4. Determine the incomes of Paul and Satorius on a consolidated basis with mutual income for 2014 using simultaneous equations. 5. What is controlling interest share of consolidated net income and noncontrolling interest shares for 2014? 6. What is consolidated net income?

Answer: Requirement 1 Debit 360,000

Investment in Satorius Co. Cash

Credit 360,000

Requirement 2 Investment in Paul Co. Cash

90,000

Requirement 3 Common stock Retained earnings Investment in Satorius Co.

50,000 40,000

90,000

Requirement 4 P = the income of Paul on a consolidated basis S = the income of Satorius on a consolidated basis P = $150,000 + 0.90S S = $130,000 + 0.10P P = $150,000 + 0.9 ($130,000 + 0.10P) P = $150,000 + $117,000 + 0.09P 0.91P = $267,000 P = $293,407 S = $130,000 + 0.1 ($293,407) = $159,341 Requirement 5 Paul's net income on an equity basis = Controlling interest share of consolidated net income = 90% × $293,407 = $264,066 Noncontrolling interest share = 10% × $159,341 = $15,934 Check: Separate net income = $150,000 + $130,000 = $280,000 $264,066 + $15,934 = $280,000 Requirement 6 Consolidated net income = $264,066 + $15,934 = $280,000 Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Application of knowledge

17) On January 1, 2014, Adam Corporation purchased a 90% interest in Rodney Corporation. On January 1, 2014, Rodney Corporation purchased an 80% interest in Ben Corporation. In all investment acquisitions, the cost of the interest was equal to the book value of the interest and the fair value of the interest. The following information is available for 2014:

Adam Rodney Ben

Purchase Cost $1,000,000 $10,000 $15,000

Net Income (Net Loss) for 2014 $200,000 ($10,000) $50,000

The separate net incomes do not include investment income. Required: 1. What is controlling interest share of consolidated net income for 2014? 2. What is noncontrolling interest shares of consolidated net income for 2014? Answer: Adam Rodney Ben Separate incomes (loss) $200,000 $(10,000) $50,000 Allocate Ben 80% ________ 40,000 (40,000) Subtotal $200,000 $30,000 $10,000 Allocate Rodney 90% 27,000 (27,000) ________ ________ ________ Controlling interest share of consolidated net income $227,000 Noncontrolling interest share $3,000 $10,000 Noncontrolling interest share in Rodney Noncontrolling interest share in Ben Noncontrolling interest shares

$3,000 10,000 $13,000

Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Application of knowledge

9.3 True/False 1) Direct holdings result from direct investments in the voting stock of one or more investees. Answer: TRUE Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Easy AACSB: Analytical thinking

2) Indirect holdings are investments that enable the investor to control or significantly influence the decisions of an investee not directly owned through an investee that is indirectly owned. Answer: FALSE Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Easy AACSB: Analytical thinking

3) Consolidation procedures for direct and indirect holdings are the same. Answer: FALSE Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Analytical thinking

4) Mutual holdings occur when affiliates hold ownership interests in each other. Answer: TRUE Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Easy AACSB: Analytical thinking

5) Parent stock that is held by the subsidiary is considered outstanding stock and should be reflected as such on the consolidated balance sheet. Answer: FALSE Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Analytical thinking

6) The treasury stock approach to account for parent stock held by subsidiary accounts for the stock as treasury stock for the consolidated entity. Answer: TRUE Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Analytical thinking

7) Mutually held stock is subsidiaries holding the stock of each other. Answer: TRUE Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Easy AACSB: Analytical thinking

8) The conventional approach is appropriate for recording mutually held stock by subsidiaries. Answer: TRUE Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Analytical thinking

9) The effect of mutually held parent stock is eliminated from consolidated financial statements by either the treasury stock approach or the conventional approach. Answer: TRUE Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Moderate AACSB: Analytical thinking

10) The conventional approach for eliminating parent stock treats the investment as constructively retired. Answer: TRUE Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Easy AACSB: Analytical thinking

11) For consolidated statements, indirect holding affiliation and mutual holding affiliation structures are treated the same. Answer: FALSE Objective: LO9.2 Apply consolidation procedures to the special case of mutual holdings. Difficulty: Moderate AACSB: Analytical thinking

12) Consolidated statements are appropriate when one corporation directly or indirectly owns a majority of the outstanding voting stock of another. Answer: TRUE Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Easy AACSB: Analytical thinking

13) Indirect holdings called connecting affiliates involves a parent and two subsidiaries. Answer: TRUE Objective: LO9.1 Prepare consolidated statements when a parent company controls a subsidiary company through indirect holdings. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 10 Subsidiary Preferred Stock, Consolidated Earnings Per Share, and Consolidated Income Taxation 10.1 Multiple Choice Questions Use the following information to answer the question(s) below. On December 31, 2013, Parminter Corporation owns an 80% interest in the common stock of Sanchez Corporation and an 80% interest in Sanchez's preferred stock. On December 31, 2013, Sanchez's stockholders' equity was as follows: 10% preferred stock, cumulative, $10 par value Common stock Retained earnings Total stockholders' equity

$50,000 350,000 100,000 $500,000

On December 31, 2013, preferred dividends are not in arrears. Sanchez had 2014 net income of $30,000 and only preferred dividends are declared and paid in 2014. There are no book value/fair value differentials associated with Parminter's investments. 1) How much should the Parminter's Investment in Sanchez—Common Stock, change during 2014? A) $5,000 B) $20,000 C) $25,000 D) $30,000 Answer: B Explanation: B) ($30,000 - $5,000) × 80% Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

2) What should be the noncontrolling interest share, common in the consolidated financial statements of Parminter for the year ending December 31, 2014? A) $5,000 B) $20,000 C) $25,000 D) $30,000 Answer: A Explanation: A) ($25,000 × 20%) Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

3) What should be the noncontrolling interest share, preferred in the consolidated financial statements of Parminter for the year ending December 31, 2014? A) $1,000 B) $2,000 C) $4,000 D) $5,000 Answer: A Explanation: A) ($5,000 × 20%) Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

4) A subsidiary has dilutive securities outstanding that include convertible bonds payable. The bonds are convertible into the parent's common stock. When calculating consolidated diluted earnings per share, the convertible bonds will affect A) the numerator of consolidated diluted EPS only. B) the denominator of consolidated diluted EPS only. C) the numerator and denominator of consolidated diluted EPS. D) the numerator and denominator of the parent diluted EPS only. Answer: C Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Moderate AACSB: Analytical thinking

Use the following information to answer the question(s) below. On January 1, 2014, Pardy Corporation acquired a 70% interest in the common stock of Salter Corporation for $7,000,000 when Salter's stockholders' equity was as follows: 10% cumulative, nonparticipating preferred stock, $100 par, with a $105 liquidation preference, callable at $110 Common stock, $10 par value Additional paid-in capital Retained earnings Total stockholders' equity

$ 1,000,000 6,000,000 1,500,000 2,500,000 $11,000,000

There were no preferred dividends in arrears on January 1, 2014. There are no book value/fair value differentials. 5) What is the implied goodwill for Salter based on Pardy's purchase price for Salter on January 1, 2014? A) $0 B) $35,000 C) $70,000 D) $100,000 Answer: D Explanation: D) Stockholders' equity $11,000,000 Less: Preferred stockholders' equity (10,000 × $110) (1,100,000) Common stockholders' equity 9,900,000 Cost of 70% interest acquired Implied fair value of investment ($7,000,000/0.7) Common stockholders' equity Goodwill

$7,000,000 10,000,000 (9,900,000) $100,000

Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

6) Salter has a 2014 net loss of $200,000. No dividends are declared or paid in 2014. What is the change in Pardy's Investment in Salter for the year ending December 31, 2014? A) $50,000 B) $70,000 C) $140,000 D) $210,000 Answer: D Explanation: D) Salter's net loss $(200,000) Preferred dividend 10% × $1,000,000 (100,000) Total Loss to common stockholders (300,000) Pardy's ownership percentage 70% Pardy's share of the loss on investment $(210,000) Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

7) Assume Salter's net income for 2014 is $220,000. No dividends are declared or paid in 2014. What is the change in Pardy's Investment in Salter for the year ending December 31, 2014? A) $84,000 B) $119,000 C) $154,000 D) $189,000 Answer: A Explanation: A) Salter's net income $220,000 Less: Income to the preferred stockholders (100,000) Income to the common stockholders 120,000 Pardy's ownership percentage 70% Pardy's share of the income $84,000 Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. On January 1, 2014, Pamplin Corporation's stockholders' equity consisted of $1,000,000 of $10 par value Common Stock, $750,000 of Additional Paid-in Capital, and $3,000,000 of Retained Earnings. On January 1, 2014, Pamplin purchased 90% of the outstanding common stock of Sage Corporation for $1,500,000 with all excess purchase cost assigned to goodwill. The stockholders' equity of Sage on this date consisted of $800,000 of $100 par value, 8% cumulative, preferred stock callable at $105, $900,000 of $10 par value common stock and $500,000 of Retained Earnings. Sage's net income for 2014 was $100,000. On January 1, 2014, no preferred dividends are in arrears. No dividends are declared or paid in 2014. In a separate transaction on January 1, 2014, Pamplin purchased 70% of Sage's preferred stock for $600,000. 8) For the year ending December 31, 2014, the amount of Pamplin's income from Sage (associated with the common stock investment in Sage) is A) $32,400. B) $36,000. C) $60,000. D) $90,000. Answer: A Explanation: A) Preliminary computations: Total stockholders' equity (Sage) $2,200,000 Less: Preferred stockholders' equity ($800,000 × 1.05) (840,000) Equals: Common stockholders' equity $1,360,000 Net income as given Less: Preferred dividends ($800,000 × 8%) Income available to the common stockholders Ownership percentage Income from Sage

$100,000 (64,000) $36,000 90% $32,400

Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

9) What is the goodwill on the consolidated balance sheet for Pamplin and Subsidiaries on December 31, 2014 based on Pamplin's purchase of Sage's common stock? A) $140,000 B) $240,000 C) $290,000 D) $306,667 Answer: D Explanation: D) Implied fair value ($1,500,000/0.90) $1,666,667 Less: Common stockholders' equity (1,360,000) Goodwill $306,667 Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

10) Pan Corporation has total stockholders' equity of $5,000,000 consisting of $1,000,000 of $10 par value Common Stock, $1,000,000 of Additional Paid-in Capital, and $3,000,000 of Retained Earnings. Pan owns 80% of Sailor Corporation's common stock purchased at book value, which equals fair value. Sailor has $900,000 of 10% cumulative preferred stock outstanding, with no preferred dividends in arrears. The preferred stock has no call price, redemption price or liquidation price. Pan acquired 60% of the preferred stock of Sailor for $500,000. After this transaction the balances in Pan's Retained Earnings and Additional Paid-in Capital accounts, respectively, are A) $2,960,000 and $1,000,000. B) $3,000,000 and $960,000. C) $3,000,000 and $1,040,000. D) $3,040,000 and $1,000,000. Answer: C Explanation: C) If the book value ($900,000 × 60%) of preferred stock is greater than the price paid ($500,000) for the preferred stock, then the difference is added to the parent's additional paid-in capital. Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Analytical thinking

11) Assume a company's preferred stock is cumulative with a call provision and has dividends in arrears. The amount of stockholders' equity allocated to preferred stockholders is equal to the number of shares outstanding times the A) sum of the par value per share plus any liquidation premium per share, plus the sum of any preferred dividends in arrears, plus the current year's dividend requirement, but only if dividends have been declared. B) sum of the par value per share, plus any liquidation premium per share, plus the sum of any preferred dividends in arrears, plus the current year's dividend requirement, regardless of whether dividends have been declared. C) call price plus the sum of any preferred dividends in arrears, plus the current year's dividend requirement, but only if dividends have been declared. D) call price plus the sum of any preferred dividends in arrears, plus the current year's dividend requirement, regardless of whether dividends have been declared. Answer: D Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Analytical thinking

12) When a parent acquires the preferred stock of a subsidiary, there will be a constructive retirement and A) any difference paid above the book value of the preferred stock reduces the parent's additional paid-in capital. B) any difference paid above the book value of the preferred stock reduces the subsidiary's retained earnings. C) any difference paid above the book value of the preferred stock increases the parent's additional paidin capital. D) any difference paid above the book value of the preferred stock increases the parent's retained earnings. Answer: A Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Analytical thinking

13) If a parent company has controlling interest in a subsidiary which has no potentially dilutive securities outstanding, then in the calculation of consolidated diluted EPS, it will be necessary to A) only make an adjustment of subsidiary's basic earnings. B) replace the parent's equity in subsidiary earnings with the parent's equity in subsidiary's diluted EPS. C) make a replacement calculation in the parent's basic earnings for the EPS. D) only use the parent's common shares and shares represented by the parent's potentially dilutive securities. Answer: D Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Analytical thinking

14) Parnaby has 25,000 common stock shares outstanding and its 100%-owned subsidiary Sandal has 5,000 common stock shares outstanding. Parnaby and Sandal do not have any potentially dilutive securities outstanding. The separate net incomes for Parnaby and Sandal are $150,000 and $75,000, respectively. Diluted EPS for the consolidated company is A) $5.00. B) $6.00. C) $7.50. D) $9.00. Answer: D Explanation: D) ($150,000 + $75,000)/25,000 Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Moderate AACSB: Application of knowledge

15) In computing consolidated diluted EPS, the replacement calculation replaces the parent's equity in subsidiary earnings with the A) parent's share of basic EPS of the subsidiary. B) subsidiary's share of basic EPS of the parent. C) parent's share of diluted EPS of the subsidiary. D) subsidiary's share of diluted EPS of the parent. Answer: C Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Moderate AACSB: Analytical thinking

16) When a subsidiary has preferred stock that is convertible into subsidiary common stock, the parent's equity in the subsidiary's diluted earnings is calculated by the number of A) subsidiary shares into which the subsidiary's dilutive securities can be converted times the subsidiary's basic EPS figure. B) parent shares into which the subsidiary's dilutive securities can be converted times the parent's basic EPS figure. C) subsidiary common shares held by the parent times the subsidiary's diluted EPS figure. D) parent shares into which the subsidiary's dilutive securities can be converted times the subsidiary's basic EPS figure. Answer: C Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Moderate AACSB: Analytical thinking

17) Palm owns a 70% interest in Sable, a domestic subsidiary. Sable is not part of Palm's affiliated group. Palm will pay taxes on A) none of the dividends it receives from Sable. B) 20% of the dividends it receives from Sable. C) 66% of the dividends it receives from Sable. D) 80% of the dividends it receives from Sable. Answer: B Objective: LO10.3 Understand the complexities of accounting for income taxes by consolidated entities. Difficulty: Moderate AACSB: Analytical thinking

18) Palmer Company owns a 25% interest in Sad, Incorporated, a domestic company. Sad had net income of $60,000 and paid dividends of $20,000. Palmer's tax rate is 35%. For simplicity, assume that Sad's undistributed earnings are Palmer's only temporary timing difference. Assume Sad qualifies for the 80% dividend received deduction. Which of the following statements is correct? A) The current tax liability is $700. B) The current tax liability is $1,050. C) Under GAAP, Palmer provides for income taxes on Sad's undistributed earnings with a credit to deferred tax liability of $700. D) Under GAAP, Palmer provides for income taxes on Sad's undistributed earnings with a credit to deferred tax liability of $1,050. Answer: C Objective: LO10.3 Understand the complexities of accounting for income taxes by consolidated entities. Difficulty: Moderate AACSB: Application of knowledge

19) Palmquist Corporation and its 80%-owned subsidiary, Sadler Corporation, are members of an affiliated group. They do not file consolidated tax returns. Sadler had $3,000,000 of income and paid $1,000,000 dividends in 2014. Palmquist and Sadler had 35% income tax rates. What amount of Sadler's dividends is taxable to Palmquist in 2014? A) $0 B) $70,000 C) $160,000 D) $200,000 Answer: A Objective: LO10.3 Understand the complexities of accounting for income taxes by consolidated entities. Difficulty: Moderate AACSB: Application of knowledge

20) Palomba Corporation allocates consolidated income taxes to its 90%-owned subsidiary using the percentage allocation method. Under this method, consolidated income tax expense will be allocated to a subsidiary A) on the basis of the agreement between the parent and subsidiary. B) on the basis of the subsidiary's pretax income as a percentage of consolidated pretax income. C) on the basis of the income taxes remitted to the IRS. D) at the rate of 90%. Answer: B Objective: LO10.3 Understand the complexities of accounting for income taxes by consolidated entities. Difficulty: Moderate AACSB: Analytical thinking

10.2 Exercises 1) Saito Corporation's stockholders' equity on December 31, 2014 was as follows: 10% cumulative preferred stock, $100 par value, callable at $105, with one year dividends in arrears Common stock, $1 par value Additional paid-in capital Retained earnings Total stockholders' equity

$10,000 50,000 150,000 160,000 $370,000

On January 1, 2015, Panata Corporation paid $300,000 for a 70% interest in Saito's common stock. On January 1, 2015, the book values of Saito's assets and liabilities were equal to fair values. Required: 1. Determine the book value of the common stockholders' equity for Saito Corporation on January 1, 2015. 2. What is the amount of goodwill reported on the consolidated balance sheet for Panata Corporation (and Subsidiary) at January 2, 2015? 3. What is the noncontrolling interest that appeared on a consolidated balance sheet for Panata Corporation (and Subsidiary) on January 2, 2015? Answer: Requirement 1 Total stockholders' equity at December 31, 2014 $370,000 Less: Preferred stockholders' equity 100 shares × ($105 call price + $10 dividend per share in arrears) (11,500) Common stockholders' equity $358,500 Requirement 2 Implied fair value of investment ($300,000/0.7) Book value of common stockholders' equity Goodwill

$428,571 (358,500) $70,071

Requirement 3 Noncontrolling interest at January 2, 2015: Noncontrolling portion of Goodwill ($70,071 × 30%) Noncontrolling interest: Preferred (100 shares × $115) Noncontrolling interest: Common ($358,500 × 30%) Total noncontrolling interest

$21,021 11,500 107,550 $140,071

Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

2) Sally Corporation's stockholders' equity on December 31, 2014 was as follows: 10% cumulative preferred stock, $100 par value, callable at $105, with one year dividends in arrears Common stock, $1 par value Additional paid-in capital Retained earnings Total stockholders' equity

$10,000 50,000 150,000 160,000 $370,000

On January 1, 2015, Panera Corporation paid $500,000 for a 70% interest in Sally's common stock. On January 1, 2015, the book values of Sally's assets and liabilities were equal to fair values. Required: 1. Determine the book value of the common stockholders' equity for Sally Corporation on January 1, 2015. 2. What is the amount of goodwill reported on the consolidated balance sheet for Panera Corporation and Subsidiary at January 2, 2015? 3. On January 2, 2015, Panera purchased 70% of Sally's preferred stock for $5,000. Prepare the journal entry(ies) for Panera for this purchase on January 2, 2015. 4. Prepare the elimination entry on the consolidating work papers for the Investment in Sally, Preferred Stock and Sally's Preferred Stock on January 2, 2015.

Answer: Requirement 1 Total stockholders' equity at December 31, 2014 Less: Preferred stockholders' equity 100 shares × ($105 call price + $10 dividend per share in arrears) Common stockholders' equity

$370,000 (11,500) $358,500

Requirement 2 Implied fair value of investment ($500,000/0.7) Book value of common stockholders' equity Goodwill Requirement 3 Investment in Sally, Preferred Stock Cash Investment in Sally, Preferred Stock Additional paid-in capital ($11,500 × 70%) = $8,050 - $5,000 = $3,050 Requirement 4 Preferred stock Retained earnings Investment in Sally, Preferred Stock Noncontrolling interest share In Sally, Preferred Stock

$714,286 (358,500) $355,786

5,000 5,000 3,050 3,050

10,000 1,500 8,050 3,450

Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

3) Samford Corporation's stockholders' equity on December 31, 2014 was as follows: 8% cumulative preferred stock, $100 par value, callable at $109, with two years of dividends in arrears Common stock, $25 par value Additional paid-in capital Retained earnings Total stockholders' equity

$100,000 700,000 250,000 400,000 $1,450,000

On January 1, 2015, Panera Corporation purchased a 70% interest in Samford's common stock for $1,400,000. On this date the book values of Samford's assets and liabilities are equal to their fair values. Required: 1. Determine the book value of the common stockholders' equity for Samford Corporation on January 1, 2015. 2. What is the amount of goodwill reported on the consolidated balance sheet for Panera Corporation and Subsidiary at January 2, 2015? 3. What is the noncontrolling interest that appeared on a consolidated balance sheet for Panera Corporation and Subsidiary on January 2, 2015? Answer: Requirement 1 Total stockholders' equity at December 31, 2014 $1,450,000 Less: Preferred stockholders' equity 1000 shares × [$109 call price + ($8 dividend per share in arrears × 2 years)] (125,000) Common stockholders' equity $1,325,000 Requirement 2 Implied fair value of investment ($1,400,000/0.70) Less: Common stockholders' equity Goodwill

$2,000,000 (1,325,000) $675,000

Requirement 3 Noncontrolling interest, January 2, 2015: Preferred stockholders' equity Common stockholders' equity (30% × $1,325,000) Goodwill (30% × $675,000) Total

$125,000 397,500 202,500 $725,000

Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

4) Savy Corporation's stockholders' equity on December 31, 2014 was as follows: 8% cumulative preferred stock, $100 par value, callable at $109, with two years of dividends in arrears Common stock, $25 par value Additional paid-in capital Retained earnings Total stockholders' equity

$100,000 700,000 250,000 400,000 $1,450,000

On January 1, 2015, Paul Corporation purchased a 70% interest in Savy's common stock for $2,100,000. On this date the book values of Savy's assets and liabilities are equal to their fair values. Required: 1. Determine the book value of the common stockholders' equity for Savy Corporation on January 1, 2015. 2. What is the amount of goodwill reported on the consolidated balance sheet for Paul Corporation and Subsidiary at January 2, 2015? 3. On January 2, 2015, Paul purchased 70% of Savy's preferred stock for $50,000. Prepare the journal entry(ies) for Paul for this purchase on January 2, 2015. 4. Prepare the elimination entry on the consolidating work papers for the Investment in Savy, Preferred Stock and Savy's Preferred Stock on January 2, 2015.

Answer: Requirement 1 Total stockholders' equity at December 31, 2014 Less: Preferred stockholders' equity 1000 shares × [$109 call price + ($8 dividend per share in arrears × 2 years)] Common stockholders' equity Requirement 2 Implied fair value of investment ($2,100,000/0.70) Less: Common stockholders' equity Goodwill Requirement 3 Investment in Savy, Preferred Stock Cash Investment in Savy, Preferred Stock Additional paid-in capital ($125,000 × 70%) - $50,000 = $37,500 Requirement 4 Preferred Stock Retained earnings Investment in Savy, Preferred Stock Noncontrolling interest

$1,450,000 (125,000) $1,325,000

$3,000,000 (1,325,000) $1,675,000

50,000 50,000 37,500 37,500

100,000 25,000 87,500 37,500

Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

5) Pancino Corporation owns a 90% interest in Sakal Corporation's common stock. Throughout 2014, Sakal had 20,000 shares of common stock outstanding and Pancino had 50,000 shares of common stock outstanding. Sakal's only dilutive security consists of 2,500 stock options, with an exercise price of $20 per share. The average price of Sakal's stock is $50 per share in 2014. The options are exercisable for one share of Sakal's common stock. Pancino's and Sakal's separate net incomes for the year are $100,000 and $80,000, respectively. Required: Compute the amount of basic and diluted earnings per share for Pancino (Consolidated) and Sakal Corporations. Answer: Basic Diluted Sakal's Basic and Diluted EPS: Sakal's income to common shareholders $80,000 $80,000 Common shares outstanding Options: Diluted EPS: ($50 - $20)/$50 × 2,500 Common shares and common equivalents Earnings per share

Pancino's Basic and Diluted EPS: Pancino's separate income Pancino's income from Sakal

20,000

_______ 20,000 $4.00

1,500 21,500 $3.72

Basic

Diluted

$100,000 72,000

Replacement computation: 18,000 shares × $3.72 Income to common

(72,000) ________ $172,000

66,960 $166,960

50,000

3.44

3.34

Common shares outstanding Earnings per share

Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Moderate AACSB: Application of knowledge

6) Pandy Corporation owns a 90% interest in Sakaj Corporation's common stock. Throughout 2014, Sakaj had 20,000 shares of common stock outstanding and Pandy had 50,000 shares of common stock outstanding. Sakaj's only dilutive security consists of 10,000 stock options, with an exercise price of $20 per share. The average price of Sakaj's stock is $50 per share in 2014. The options are exercisable for one share of Sakaj's common stock. Pandy's and Sakaj's separate net incomes for the year are $200,000 and $180,000, respectively. Required: Compute the amount of basic and diluted earnings per share for Pandy (Consolidated) and Sakaj Corporations. Answer: Basic Diluted Sakaj's Basic and Diluted EPS: Sakaj's income to common shareholders $180,000 $180,000 Common shares outstanding Options: Diluted EPS: ($50-$20)/$50 × 10,000 Common shares and common equivalents Earnings per share

20,000

_______ 20,000 $9.00

6,000 26,000 $6.92

Basic

Diluted

$200,000 162,000

________ $362,000

(162,000) 124,560 324,560

Common shares outstanding

50,000

Earnings per share

$7.24

$6.49

Pandy's Basic and Diluted EPS: Pandy's separate income Pandy's income from Sakaj ($180,000 × 90%) Replacement computation: 18,000 shares × $6.92 Income to common

Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Moderate AACSB: Application of knowledge

7) Parker Corporation owns an 80% interest in Sample Corporation's common stock. Throughout 2014, Sample had 10,000 shares of common stock outstanding and Parker had 100,000 shares of common stock outstanding. Sample's only dilutive security consists of $50,000 face amount of 8% bonds payable. Each $1,000 bond is convertible into 20 shares of Sample stock. Parker and Sample's separate incomes for the year are $100,000 and $75,000, respectively. Assume a 34% flat income tax rate. Required: Compute the amount of basic and diluted earnings per share for Parker (Consolidated) and Sample Corporations. Answer: Sample's Basic and Diluted EPS: Sample's income to common shareholders Add: Net of tax interest expense $50,000 × 8% × 66% Adjusted subsidiary earnings

Basic

Diluted

$75,000

0 $75,000

2,640 $77,640

10,000

______ 10,000 $7.50

1,000 11,000 $7.06

Common shares outstanding Incremental shares: Diluted EPS: 50 bonds × 20 shares Common shares and common equivalents Earnings per share

Basic

Diluted

Parker's Basic and Diluted EPS: Parker's separate income Parker's income from Sample

$100,000 60,000

Replacement computation: Parker's income from Sample 8,000 shares × $7.06 Income to common

________ $160,000

(60,000) 56,480 $156,480

Common shares outstanding

100,000

$1.60

$1.56

Earnings per share

Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Moderate AACSB: Application of knowledge

8) Peyton Corporation owns an 80% interest in Sampe Corporation's common stock. Throughout 2014, Sampe had 10,000 shares of common stock outstanding and Peyton had 100,000 shares of common stock outstanding. Sampe's only dilutive security consists of $100,000 face amount of 8% bonds payable. Each $1,000 bond is convertible into 20 shares of Sampe stock. Peyton and Sampe's separate net incomes for the year are $200,000 and $150,000, respectively. Assume a 34% flat income tax rate. Required: Compute the amount of basic and diluted earnings per share for Peyton (consolidated) and Sampe Corporations. Answer: Basic Diluted Sampe's Basic and Diluted EPS: Sampe's income to common shareholders $150,000 $150,000 Add: Net of tax interest expense $100,000 × 8% × 66% 0 5,280 Adjusted subsidiary earnings $150,000 $155,280 Common shares outstanding Incremental shares: Diluted EPS: 100 bonds × 20 shares Common shares and common equivalents Earnings per share

10,000

_______ 10,000 $15.00

2,000 12,000 $12.94

Basic

Diluted

$200,000

120,000

Replacement computation: Peyton's income from Sampe 8,000 shares × $12.94 Income to common

_______ $320,000

(120,000) 103,520 $303,520

Common shares outstanding

100,000

$3.20

$3.04

Peyton's Basic and Diluted EPS: Peyton's separate income Peyton's income from Sampe (80% × $150,000)

Earnings per share

Objective: LO1.2 Learn about alternative forms of business combinations, from both the legal and accounting perspectives. Difficulty: Moderate AACSB: Application of knowledge

9) Pane Corporation owns 100% of Alder Corporation, 85% of Ball Corporation, 70% of Cake Corporation, 40% of Dash Corporation, and 10% of Eager Corporation. All of these corporations are domestic corporations. Pane, Alder and Ball belong to an affiliated group. Pane's marginal income tax rate is 35%. All investees have paid out all their net income in the form of dividends. During 2014, Pane Corporation received the following cash dividends: From Alder: From Ball: From Cake: From Dash: From Eager:

$180,000 $170,000 $160,000 $100,000 $ 60,000

Required: 1. Compute the amount of the dividend income that would be excluded from taxation under the current Internal Revenue Code. 2. Compute Pane's current income tax liability for the dividend income received in 2014. Answer: Requirement 1 Excluded dividend income: From Alder: $180,000 × 100% $180,000 From Ball: $170,000 × 100% 170,000 From Cake: $160,000 × 80% 128,000 From Dash: $100,000 × 80% 80,000 From Eager: $60,000 × 70% 42,000 Total excluded dividend income $600,000 Requirement 2 Total dividend income received Total excluded dividend income Included dividend income Current Income Tax Liability: $70,000 × 35% =

$670,000 600,000 $70,000 $24,500

Objective: LO10.3 Understand the complexities of accounting for income taxes by consolidated entities. Difficulty: Moderate AACSB: Application of knowledge

10) Paradise Corporation owns 100% of Aldred Corporation, 90% of Balme Corporation, 80% of Calder Corporation, 75% of Dale Corporation, 20% of East Corporation, and 8% of Faber Corporation. Paradise, Aldred, Balme and Calder belong to an affiliated group. All of these corporations are domestic corporations. During 2014, Paradise Corporation reports net income of $1,500,000. This net income includes the full amount of dividends received from Aldred and Faber, but does not include the dividends received from Balme, Calder, Dale, and East Corporations. All investees have paid out all of their net income in the form of dividends. Paradise's share of the various dividend distributions is as follows: From Aldred: From Balme: From Calder: From Dale: From East: From Faber:

$90,000 $92,000 $88,000 $66,000 $50,000 $40,000

Required: Calculate the correct amount of taxable income for Paradise Corporation if a consolidated tax return is filed. Answer: Net income as reported: $1,500,000 Excludable amount of dividends included in net income: Exclude 100% of Aldred dividends (90,000) Exclude 70% of Faber dividends (28,000) Includable amount of dividends not yet added to net income: Include 20% of Dale dividends 13,200 Include 20% of East dividends 10,000 Taxable income $1,405,200 The dividends from Balme and Calder are excluded in full. This problem also emphasizes the dividend exclusion ratio applicable when the percentage of stock held is right on the dividing line between the different exclusion percentages. The 70% exclusion ratio applies for stock holdings less than 20% and the 80% exclusion ratio applies for holdings less than 80% but at least 20%. Objective: LO10.3 Understand the complexities of accounting for income taxes by consolidated entities. Difficulty: Moderate AACSB: Application of knowledge

11) Peter Corporation owns 90% of the common stock of Subsidiary Subway. The following data is available: Peter $150,000

Net income for 2014 Preferred dividends for 2014 Common dividends for 2014 Number of common shares outstanding 200,000 10% Preferred Stock, $100 par

Subway $50,000 $10,000 $15,000 20,000 $100,000

The preferred stock is cumulative and convertible. The annual preferred dividends are $10,000. Required: 1. Subway's preferred stock is convertible into 12,000 shares of Subway's common stock. Peter and Subway do not have any other potentially dilutive securities outstanding. a. What is Subway's basic EPS and diluted EPS? b. What is consolidated basic EPS and diluted EPS? 2. Subway's preferred stock is convertible into 12,000 shares of Peter's common stock. Peter and Subway do not have any other potentially dilutive securities outstanding. What is consolidated basic EPS and diluted EPS?

Answer: Requirement 1 Subway Basic EPS: = $2.00

Subway Diluted EPS: = $1.56

Consolidated Basic EPS: = $0.93

Consolidated Diluted EPS: = $0.89

Requirement 2 Consolidated Basic EPS: = $0.93

Consolidated Diluted EPS: = $0.92 Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Moderate AACSB: Application of knowledge

12) Jeff Corporation owns 90% of the common stock of Subsidiary Jordan. The following data is available: Jeff $250,000

Net income for 2014 Preferred dividends for 2014 Common dividends for 2014 Number of common shares outstanding 200,000 10% Preferred Stock, $100 par

Jordan $150,000 $20,000 $25,000 20,000 $200,000

The preferred stock is cumulative and convertible. The annual preferred dividends are $20,000. Required: 1. Jordan's preferred stock is convertible into 20,000 shares of Jordan's common stock. Jeff and Jordan do not have any other potentially dilutive securities outstanding. a. What is Jordan's basic EPS and diluted EPS? b. What is consolidated basic EPS and diluted EPS? 2. Jordan's preferred stock is convertible into 20,000 shares of Jeff's common stock. Jeff and Jordan do not have any other potentially dilutive securities outstanding. What is consolidated basic EPS and diluted EPS?

Answer: Requirement 1 Jordan Basic EPS: = $6.50

Jordan Diluted EPS: = $3.75

Consolidated Basic EPS: = $1.84

Consolidated Diluted EPS: = $1.59

Requirement 2 Consolidated Basic EPS: = $1.84

Consolidated Diluted EPS: = $1.75 Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Moderate AACSB: Application of knowledge

13) Sandy Corporation's stockholders' equity on December 31, 2014 was as follows: 10% cumulative preferred stock, $100 par value, callable at $105, with one year dividends in arrears Common stock, $1 par value Additional paid-in capital Retained earnings Total stockholders' equity

$100,000 200,000 40,000 160,000 $500,000

On January 1, 2015, Bombard Corporation paid $200,000 for a 90% interest in Sandy's common stock. On January 1, 2015, the book values of Sandy's assets and liabilities were equal to fair values. On January 2, 2015, Bombard Corporation paid $120,000 for a 90% interest in Sandy's preferred stock. Required: 1. Determine the book value of the common stockholders' equity for Sandy Corporation on January 1, 2015. 2. Prepare the journal entry(ies) on January 1, 2015 for Bombard Corporation. 3. Prepare the journal entry(ies) on January 2, 2015 for Bombard Corporation. 4. For the year ending December 31, 2015, Sandy Corporation reported net income of $50,000. Sandy Corporation declared and paid dividends of $20,000 to preferred stockholders and $10,000 to common stockholders. Prepare the journal entries for Bombard Corporation relating to this information.

Answer: Requirement 1 Total stockholders' equity Less: Preferred stockholders' equity ($105 call price + $10 dividend) × 1,000 Book value of common stockholders' equity

$500,000 (115,000) $385,000

Requirement 2 Investment in Sandy Corp.—common stock Cash

200,000

Requirement 3 Investment in Sandy Corp.—pref. stock Cash

120,000

200,000

120,000

Additional paid-in capital Investment in Sandy Corp.—pref. stock ($120,000 - $103,500) ($115,000 × 90%) = $103,500

16,500 16,500

Requirement 4 Cash ($20,000 × 90%) Investment Income in Sandy Corp.—pref. stock

18,000 18,000

Cash ($10,000 × 90%) Investment in Sandy Corp.—common stock

9,000

Investment in Sandy Corp.—common stock Investment income in Sandy Corp.— common stock ($50,000 - $20,000) × 90%

27,000

9,000

27,000

Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

14) Stello Corporation's stockholders' equity on December 31, 2014 was as follows: 10% cumulative preferred stock, $100 par value, callable at $110, with no dividends in arrears Common stock, $1 par value Additional paid-in capital Retained earnings Total stockholders' equity

$100,000 300,000 40,000 160,000 $600,000

On January 1, 2015, Kaprelian Corporation paid $300,000 for a 90% interest in Stello's common stock. On January 1, 2015, the book values of Stello's assets and liabilities were equal to fair values. On January 2, 2015, Kaprelian Corporation paid $100,000 for a 90% interest in Stello's preferred stock. Required: 1. Determine the book value of the common stockholders' equity for Stello Corporation on January 1, 2015. 2. Prepare the journal entry(ies) on January 1, 2015 for Kaprelian Corporation. 3. Prepare the journal entry(ies) on January 2, 2015 for Kaprelian Corporation. 4. For the year ending December 31, 2015, Stello Corporation reported net income of $50,000. Stello Corporation declared and paid dividends of $10,000 to preferred stockholders and $10,000 to common stockholders. Prepare the journal entries for Kaprelian Corporation relating to this information.

Answer: Requirement 1 Total stockholders' equity Less: Preferred stockholders' equity $110 call price × 1,000 Book value of common stockholders' equity

$600,000 (110,000) $490,000

Requirement 2 Investment in Stello Corp.—common stock Cash

300,000

Requirement 3 Investment in Stello Corp.—pref. stock Cash

100,000

300,000

100,000

Additional paid-in capital Investment in Stello Corp.—pref. stock ($100,000 - $99,000) = $1,000 ($110,000 × 90%) = $99,000

1,000 1,000

Requirement 4 Cash ($10,000 × 90%) Investment Income in Stello Corp.— pref. stock

9,000 9,000

Cash ($10,000 × 90%) Investment in Stello Corp.—common stock

9,000

Investment in Stello Corp.—common stock Investment income in Stello Corp.— common stock ($50,000 - $10,000) × 90%

36,000

9,000

36,000

Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Application of knowledge

15) Pretax operating incomes of Pang Corporation and its 70%-owned subsidiary, Sala Corporation, for the year 2014, are shown below. Sala pays total dividends of $60,000 for the year. There are no unamortized book value/fair value differentials relating to Pang's investment in Sala. During the year, Pang sold land to Sala for a gain of $35,000 and Sala holds this land at the end of the year. The marginal corporate tax rate for both corporations is 34%.

Sales revenue Gain on sale of land Cost of sales Other expenses Pretax operating income (does not include investment income)

Pang $900,000 35,000 (480,000) (192,000) $263,000

Sala $600,000 (325,000) (78,000) $197,000

Required: 1. Determine the separate amounts of income tax expense for Pang and Sala as if they had filed separate tax returns. 2. Determine Pang's net income from Sala.

Answer: Requirement 1 Income taxes currently payable: Taxes on operating income $263,000 × 34% $197,000 × 34% Taxes on dividends received: $60,000 × 70% × 20% × 34% Income taxes currently payable

Pang

Sala

$89,420 $66,980

Add: Tax on undistributed income: ($197,000 - $66,980 - $60,000) × 70% × 20% × 34% Less: Deferred tax on gain on sale of land ($35,000 × 34%) Income tax expense

2,856 92,276

________ 66,980

3,333 (11,900) $83,709

________ $66,980

Requirement 2 Pre-tax income from Sala Less: income tax expense Net Income Ownership Percentage Subtotal Less: Unrealized gain on sale of land Income from Sala

$197,000 (66,980) 130,020 × 70% $91,014 (35,000) $56,014

Objective: LO10.3 Understand the complexities of accounting for income taxes by consolidated entities. Difficulty: Moderate AACSB: Application of knowledge

16) Pretax operating incomes of Panitz Corporation and its 80%-owned subsidiary, Salazar Corporation, for the year 2014, are shown below. Panitz and Salazar belong to an affiliated group. Salazar pays total dividends of $35,000 for the year. There are no unamortized book value/fair value differentials relating to Panitz's investment in Salazar. During the year, Panitz sold land to Salazar at a total loss of $15,000 which is included in its pretax operating income. Salazar still holds this land at the end of the year. The marginal corporate tax rate for both corporations is 34%.

Sales revenue Loss on sale of land Cost of sales Other expenses Depreciation expense Pretax operating income (does not include Salazar investment income)

Panitz $890,000 (15,000) (400,000) (350,000) (50,000)

Salazar $700,000

$75,000

$65,000

(250,000) (350,000) (35,000)

Required: 1. Determine the separate amounts of income tax expense for Panitz and Salazar as if they had filed separate tax returns. 2. Determine Panitz's net income from Salazar. Answer: Requirement 1 Taxable Income Calculation: Sales Revenue Loss on sale of land Cost of sales Other expenses Depreciation expense Taxable income Tax rate Income taxes currently payable Add: Deferred taxes on loss on sale of land ($15,000 × 34%) Income tax expense

Panitz

Salazar

$890,000 (15,000) (400,000) (350,000) (50,000) $75,000 34% $25,500 5,100 $30,600

$700,000

Requirement 2 Panitz's income from Salazar: Assuming taxable income is the same as GAAP income Less: Current income taxes expense Net income Panitz's ownership percentage Subtotal Add: Unrealized loss on sale of land Income from Salazar

(250,000) (350,000) (35,000) $65,000 34% $22,100 _______ $22,100

$65,000 22,100 42,900 80% 34,320 15,000 $49,320

Objective: LO10.3 Understand the complexities of accounting for income taxes by consolidated entities. Difficulty: Moderate AACSB: Application of knowledge

10.3 True/False 1) Net income of an investee with preferred stock outstanding is first allocated to preferred stockholders based on the preferred stock contract. Answer: TRUE Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Easy AACSB: Analytical thinking

2) The call or redemption price of preferred stock is used to allocate the investee's equity to preferred stockholders. Answer: TRUE Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Easy AACSB: Analytical thinking

3) If no redemption provision is provided on preferred stock, the equity allocation base is based on par value of the stock less any liquidation premium. Answer: FALSE Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Analytical thinking

4) All dividends in arrears on cumulative preferred stock are included in the equity allocated to preferred stockholders. Answer: TRUE Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Easy AACSB: Analytical thinking

5) Income is assigned to noncumulative, nonparticipating preferred stock only if dividends are declared and paid. Answer: FALSE Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Analytical thinking

6) From the viewpoint of a consolidated entity, the parent's purchase of the outstanding subsidiary preferred stock results in the retirement of the stock purchased. Answer: TRUE Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Analytical thinking

7) The constructive retirement of subsidiary preferred stock through the purchase by the parent is reported as an actual retirement in the consolidated statements. Answer: TRUE Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Analytical thinking

8) The investment in preferred stock of a subsidiary by the parent is accounted for under the equity method. Answer: FALSE Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Analytical thinking

9) The parent company's retained earnings are reduced when additional paid-in capital is insufficient to absorb an excess of purchase price over book value of the subsidiary's preferred stock. Answer: TRUE Objective: LO10.1 Modify consolidation procedures for subsidiaries with outstanding preferred stock. Difficulty: Moderate AACSB: Analytical thinking

10) The GAAP requires that corporations report both basic and diluted earnings per share. Answer: TRUE Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Easy AACSB: Analytical thinking

11) The calculation of parent EPS and consolidated basic EPS are identical. Answer: TRUE Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Easy AACSB: Analytical thinking

12) A parent's net income and the controlling share of the consolidated net income are equal under the equity method. Answer: TRUE Objective: LO10.2 Calculate basic and diluted earnings per share for a consolidated entity. Difficulty: Moderate AACSB: Analytical thinking

13) The consolidated entity must file a consolidated income tax return. Answer: FALSE Objective: LO10.3 Understand the complexities of accounting for income taxes by consolidated entities. Difficulty: Easy AACSB: Analytical thinking

14) A disadvantage of filing a consolidated return is intercompany dividends are included in taxable income. Answer: FALSE Objective: LO10.3 Understand the complexities of accounting for income taxes by consolidated entities. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 11 Consolidation Theories, Push-Down Accounting, and Corporate Joint Ventures 11.1 Multiple Choice Questions Use the following information to answer the question(s) below. Pasfield Corporation acquired a 90% interest in Santini Corporation for $90,000 cash on January 1, 2014. The following information is available for Santini at that time.

Current assets Plant assets Liabilities Net assets

Book Value $40,000 60,000 (50,000) $50,000

Fair Value $50,000 75,000 (50,000) $75,000

Difference $10,000 15,000 0

1) Under the entity theory, a consolidated balance sheet prepared immediately after the business combination will show goodwill of A) $15,000. B) $22,500. C) $25,000. D) $32,500. Answer: C Explanation: C) Imputed value of Santini ($90,000/90%) $100,000 Less: Fair value of net assets acquired (75,000) Goodwill $25,000 Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

2) Under the entity theory, a consolidated balance sheet prepared immediately after the business combination will show noncontrolling interest of A) $5,000. B) $7,500. C) $9,000. D) $10,000. Answer: D Explanation: D) Imputed value of Santini ($90,000/90%) $100,000 Noncontrolling interest percentage 10% Noncontrolling interest $10,000 Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

3) Paroz Corporation acquired a 70% interest in Sandberg Corporation for $900,000 when Sandberg's stockholders' equity consisted of $600,000 of Capital Stock and $600,000 of Retained Earnings. The fair values of Sandberg's net assets were equal to their recorded book values. At the time of acquisition, on Paroz's books, Paroz will record A) goodwill for $60,000 under the parent company theory. B) goodwill for $85,714 under the entity theory. C) investment in Sandberg for $1,285,714 under the entity theory. D) investment in Sandberg for $900,000 under the entity and parent company theories. Answer: D Explanation: D) Investment is the same for Parent company under both theories. Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Pascoe Corporation paid $450,000 for a 90% interest in Sarabet Corporation on January 1, 2014, when Sarabet's stockholders' equity consisted of $250,000 Common Stock and $50,000 Retained Earnings. The book values and fair values of Sarabet's assets and liabilities were equal when Pascoe acquired its interest. The separate net incomes (excluding investment income) of Pascoe and Sarabet for 2014 were $600,000 and $100,000, respectively. Dividends declared and paid during 2014 were $250,000 for Pascoe and $50,000 for Sarabet. Pascoe uses the entity theory in consolidating its financial statements with those of Sarabet. 4) Goodwill was reported in the December 31, 2014 consolidated balance sheet at A) $170,000. B) $180,000. C) $200,000. D) $210,000. Answer: C Explanation: C) Imputed fair value of Sarabet ($450,000/90%) $500,000 Less: Total underlying book value (300,000) Total amount of implied goodwill $200,000 Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

5) Noncontrolling interest share was reported in the 2014 consolidated income statement at A) $5,000. B) $6,000. C) $8,000. D) $10,000. Answer: D Explanation: D) Sarabet's separate income $100,000 Parent ownership percentage 10% Noncontrolling interest share $10,000 Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

6) Pascoe's income from Sarabet under the equity method for 2014 was A) $72,000. B) $87,500. C) $90,000. D) $100,000. Answer: C Explanation: C) Sarabet's separate income $100,000 Parent ownership percentage 90% Income from Sarabet to Pascoe $90,000 Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Paris Corporation purchased 80% of the outstanding voting common stock of Sanders Corporation on January 1, 2014, at a cost of $400,000. The stockholders' equity of Sanders Corporation on this date consisted of $200,000 of Capital Stock and $100,000 of Retained Earnings. Book values were equal to fair values except for land and inventory. The book value of Sanders' land was $10,000, and fair value was $22,000. The book value of Sanders' inventory was $30,000, and fair value was $25,000. 7) Under the parent company theory, what amount of goodwill was reported on the consolidated balance sheet at December 31, 2014? A) $148,000 B) $153,000 C) $154,400 D) $160,000 Answer: C Explanation: C) Purchase price of 80% interest $400,000 Less: Book value acquired ($300,000 × 80%) (240,000) Excess of cost over book value $160,000 Less: Excess allocated to land ($12,000 × 80%) (9,600) Plus: Excess allocated to inventory ($5,000 × 80%) 4,000 Remainder allocated to goodwill $154,400 Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

8) Under the entity theory, what amount of goodwill was reported on the consolidated balance sheet at December 31, 2014? A) $185,000 B) $191,250 C) $193,000 D) $200,000 Answer: C Explanation: C) ($154,400/80% = $193,000) Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

9) Assume Paris's land account had a book value of $50,000 and a fair value of $70,000 on January 1, 2014. Using the parent company and entity theories, what amounts would be reported on the consolidated balance sheet at January 1, 2014 for the land account? A) Parent Company Theory $69,600

Entity Theory $72,000

B) Parent Company Theory $72,000

Entity Theory $72,000

C) Parent Company Theory $72,000

Entity Theory $92,000

D) Parent Company Theory $92,000

Entity Theory $72,000

Answer: A Explanation: A) Under the parent company theory, the Land account on the consolidated balance sheet would be the sum of the book value of the parent's Land account balance of $50,000 plus the book value of the Land account on the subsidiary's books of $10,000 plus 80% of the $12,000 excess of the fair value in excess of book value of $9,600, for a total of $69,600. Under the entity theory, the land would be valued at the book value of the parent of $50,000 plus the full fair value of the subsidiary's land which is $22,000 for a total of $72,000. Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

10) Assume Paris's inventory account had a book value of $40,000 and a fair value of $44,000 on January 1, 2014. Using the parent company theory, what was the amount reported on the consolidated balance sheet for inventories on January 1, 2014? A) $65,000 B) $66,000 C) $69,000 D) $70,000 Answer: B Explanation: B) Under the parent company theory, the Inventory account on the consolidated balance sheet would be the sum of the book value of the parent's Inventory account balance of $40,000 plus the book value of the Inventory account on the subsidiary's books of $30,000 less 80% of the $5,000 excess of the book value in excess of fair value, or ($4,000), for a total of $66,000. Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

11) The SEC requires push-down accounting for SEC filings of subsidiaries when the subsidiary has no substantial publicly-held debt or preferred stock outstanding and A) the parent has substantial ownership (5% or greater). B) the parent has substantial ownership (20% or greater). C) the parent has substantial ownership (50% or greater). D) the parent has substantial ownership (90% or greater). Answer: D Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Analytical thinking

12) Under parent company theory, noncontrolling interest is classified on the consolidated balance sheet as ________. Under entity theory, noncontrolling interest is classified on the consolidated balance sheet as ________. A) stockholders' equity; stockholders' equity B) stockholders' equity; liability C) liability; a liability D) liability; stockholders' equity Answer: D Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Analytical thinking

13) Under parent company theory, the amount of consolidated net income is equal to the amount of ________ under entity theory. A) noncontrolling interest share B) noncontrolling interest income C) income attributable to controlling stockholders D) income attributable to noncontrolling stockholders Answer: C Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Analytical thinking

14) A parent company acquired 100% of the outstanding common stock of another corporation. The parent is going to use push-down accounting. The fair market value of each of the acquired corporation's assets is lower than its respective book value. The fair market value of each of the acquired corporation's liabilities is higher than its respective book value. The acquired corporation has a deficit in the Retained Earnings account. Which one of the following statements is correct? A) The push-down capital account will have a credit balance after this transaction is posted. B) The push-down capital account will have a debit balance after this transaction is posted. C) The push-down capital account will have either a debit or a credit balance depending upon whether the asset adjustments exceed the liability adjustments, or vice versa. D) Subsidiary Retained Earnings will have a deficit balance after this transaction is posted. Answer: B Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Analytical thinking

15) Earth Company, Fire Incorporated, and Wind Incorporated created a joint venture to market their products on the internet. Earth owns 40% of the stock, Fire owns 45% of the stock and Wind owns the remaining 15%. Which firms should report their joint venture investments using the equity method? A) Earth B) Fire C) Earth and Fire D) Earth, Fire and Wind Answer: D Objective: LO11.3 Account for corporate and unincorporated joint ventures. Difficulty: Easy AACSB: Analytical thinking

16) Anthony and Cleopatra create a joint venture to distribute artifacts. Anthony contributes 70% and Cleopatra 30% of the cash for assets purchased from Tomb Company. How would Anthony report information about Cleopatra on Anthony's financial statements? A) Not at all B) In a footnote C) As a liability D) As a noncontrolling interest Answer: D Objective: LO11.3 Account for corporate and unincorporated joint ventures. Difficulty: Moderate AACSB: Analytical thinking

17) Noncontrolling interest share is viewed as an expense under ________ theory. A) parent company B) entity C) contemporary D) joint venture Answer: A Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Easy AACSB: Analytical thinking

18) Under parent company theory, noncontrolling interest is valued at ________ on the consolidated balance sheet. Under entity theory, noncontrolling interest is valued at ________ on the consolidated balance sheet. A) fair value; present value B) present value; fair value C) book value; fair value D) fair value; book value Answer: C Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Analytical thinking

19) Under GAAP, the ________ will include the variable interest entity in consolidated financial statements. A) special purpose entity B) limited liability company C) trust D) primary beneficiary Answer: D Objective: LO11.5 Consolidate a variable interest entity. Difficulty: Moderate AACSB: Analytical thinking

20) Entities other than the primary beneficiary account for their investment in a variable interest entity using the A) cost method. B) equity method. C) cost or equity methods. D) consolidated method. Answer: C Objective: LO11.4 Identify variable interest entities. Difficulty: Easy AACSB: Analytical thinking

21) With regard to a variable interest entity (VIE), Ann Company may meet the following two conditions: Condition I Ann Company has the power to direct VIE activities that significantly impact VIE's economic performance. Condition II Ann Company has an obligation to absorb losses and/or a right to receive significant benefits from the VIE. Ann Company must consolidate a VIE if A) Condition I is met only. B) Condition II is met only. C) either Condition I or Condition II is met. D) both Condition I and Condition II are met. Answer: D Objective: LO11.4 Identify variable interest entities. Difficulty: Moderate AACSB: Analytical thinking

22) Which of the following statements about variable interest entities (VIE) is false? A) Under GAAP, a VIE may be a corporation, partnership, limited liability company or trust. B) Under GAAP, pension plans are excluded from VIE accounting. C) A potential VIE must be a separate entity, not a subset, branch or division of another entity. D) VIEs do not require the identification of a primary beneficiary. Answer: D Objective: LO11.4 Identify variable interest entities. Difficulty: Moderate AACSB: Analytical thinking

23) Under push-down accounting, the ________ of the acquired subsidiary's assets and liabilities are reported on the financial statements of the ________. A) book value; subsidiary B) book value; parent C) fair value; subsidiary D) present value; parent Answer: C Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Easy AACSB: Analytical thinking

Use the following information to answer the question(s) below. On January 1, 2014, Penelope Company acquired a 90% interest in Leah Company for $180,000 cash. On January 1, 2014, Leah Company had the following assets and liabilities:

Cash Accounts Receivable Inventory Plant Assets Total Assets Liabilities Capital Stock Retained Earnings Total Liabilities & Stockholders' Equity

Book Value $10,000 30,000 40,000 60,000 $140,000

Fair Value $10,000 35,000 50,000 80,000 $175,000

$25,000 100,000 15,000

$25,000

$140,000

Push-down accounting is used for the acquisition. 24) Assume the entity theory is used. On January 2, 2014, Leah Company will report Goodwill of ________ and Accounts Receivable of ________ on Leah's balance sheet. A) $27,000; $30,000 B) $27,000; $34,500 C) $30,000; $30,000 D) $30,000; $35,000 Answer: D Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

25) Assume the parent company theory is used. On January 2, 2014, Leah Company will report Goodwill of ________ and Accounts Receivable of ________ on Leah's balance sheet. A) $27,000; $30,000 B) $27,000; $35,000 C) $30,000; $30,000 D) $30,500; $34,500 Answer: D Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

11.2 Exercises 1) On July 1, 2013, Parslow Corporation acquired a 75% interest in Sanderson Corporation for $150,000. Sanderson's net assets on this date had a book value of $140,000 and a fair value of $160,000. The excess of fair value over book value at acquisition was due to understated plant assets with a remaining useful life of five years from July 1, 2013. Separate net incomes (excluding investment income) of Parslow and Sanderson for 2014 were $400,000 and $20,000, respectively. Required: 1. Compute goodwill at July 1, 2013 under the parent company theory and the entity theory. 2. Determine consolidated net income and noncontrolling interest share for 2014 under the parent company theory and the entity theory. Answer: Requirement 1 Parent Company Theory: Cost of 75% interest on July 1, 2013 $150,000 Fair value of net assets acquired ($160,000 × 75%) (120,000) Goodwill $30,000 Entity Theory: Total implied fair value ($150,000/75%) Fair value of net assets Goodwill Requirement 2 Combined separate incomes Less: Depreciation on excess allocated to plant assets: $15,000/5 years $20,000/5 years Less: Noncontrolling interest share ($20,000 × 25%) Consolidated net income Total consolidated income Income allocated to controlling shareholders ($416,000 - $4,000) Income allocated to noncontrolling shareholders [($20,000 - $4,000) × 25%]

$200,000 (160,000) $40,000 Parent Theory $420,000

Entity Theory $420,000

(3,000) (4,000) (5,000) $412,000

________ $416,000 $412,000 $4,000

Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

2) Partel Corporation purchased 75% of Sandford Corporation on January 1, 2014, for $230,000. Balance sheets for the two companies on this date, prepared just prior to the purchase, are provided below.

Cash Inventory Buildings & equipment-net Total assets

Partel Book Values $330,000 270,000 500,000 $1,100,000

Sandford Book Values $10,000 70,000 120,000 $200,000

Common stock Retained earnings Total equities

$300,000 800,000 $1,100,000

95,000 105,000 $200,000

Sandford Fair Values $10,000 90,000 190,000 $290,000

Required: 1. Prepare a consolidated balance sheet using the entity theory of consolidation. 2. Prepare a consolidated balance sheet using the parent company theory of consolidation.

Answer: Requirement 1 Partel Corporation and Subsidiary Consolidated Balance Sheet January 1, 2014 (Entity Theory) Assets Cash [($330,000 - $230,000) + $10,000] Inventory ($270,000 + $90,000) Buildings & equipment-net ($500,000 + $190,000) Goodwill [($230,000/0.75) - $290,000] Total assets

$110,000 360,000 690,000 16,667 $1,176,667

Stockholders' Equity Common stock Retained earnings Noncontrolling interest ($306,667 × 25%) Total stockholders' equity

$300,000 800,000 76,667 $1,176,667

Requirement 2 Partel Corporation and Subsidiary Consolidated Balance Sheet January 1, 2014 (Parent Company Theory) Assets Cash (($330,000 - $230,000) + $10,000) Inventory ($270,000 + $70,000) + (75% × 20,000) Buildings & Equip.-net ($500,000 + $120,000) + (75% × $70,000) Goodwill ($230,000 paid - ($290,000 × 75%)) Total assets

$110,000 355,000 672,500 12,500 $1,150,000

Liability and Stockholders' Equity Liability Noncontrolling interest ($200,000 × 25%) Stockholders' equity Common stock Retained earnings Total liability and stockholders' equity

$50,000 300,000 800,000 $1,150,000

Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

3) Pashley Corporation purchased 75% of Sargent Corporation on January 1, 2014, for $115,000. Balance sheets for the two companies on this date, prepared just prior to the purchase, are provided below.

Cash Inventory Buildings & equipment-net Total assets Common stock Retained earnings Total equities

Pashley Book Values $165,000 135,000 250,000 $550,000

Sargent Book Values $5,000 35,000 60,000 $100,000

$150,000 400,000 $550,000

$47,500 52,500 $100,000

Sargent Fair Values $5,000 45,000 95,000 $145,000

Required: Prepare a consolidated balance sheet using the entity theory of consolidation. Answer: Pashley Corporation and Subsidiary Consolidated Balance Sheet January 1, 2014 (Entity Theory of Consolidation) Assets Cash (($165,000 - $115,000) + $5,000) $55,000 Inventory ($135,000 + $45,000) 180,000 Buildings & equipment-net ($250,000 + $95,000) 345,000 Goodwill ($115,000/75%) - $145,000 fair value 8,333 Total assets $588,333 Stockholders' Equity Common stock Retained earnings Noncontrolling interest ($153,333 × 25%) Total stockholders' equity

150,000 400,000 38,333 $588,333

Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

4) Patane Corporation acquired 80% of the outstanding voting common stock of Sanlon Corporation on January 1, 2014, for $500,000. Sanlon Corporation's stockholders' equity at this date consisted of $250,000 in Capital Stock and $100,000 in Retained Earnings. The fair value of Sanlon's assets was equal to the book value of the assets except for land with a fair value $40,000 greater than its book value, and marketable securities with a fair value $50,000 greater than its book value. Sanlon also had a valuable patent with a fair value of $25,000 and a book value of zero because its development costs were expensed as incurred. The fair value of Sanlon's liabilities is $10,000 higher than the $40,000 book value. Required: Calculate the amount of goodwill under the parent company and entity theories of consolidation. Answer: Parent Company Theory: Difference between Fair Value and Book Value Land $40,000 Marketable securities 50,000 Patent 25,000 Liabilities (10,000) Net difference between fair value and book value $105,000 Price paid for investment Less: Total book value of investment ($350,000 × 80%) Less: Net difference between fair value and book value ($105,000 × 80%) Goodwill Entity Theory: Implied fair value of subsidiary ($500,000/0.80) Less: Total stockholders' equity Less: Net difference between fair value and book value Goodwill

500,000 (280,000) (84,000) $136,000

$625,000 (350,000) (105,000) $170,000

Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

5) On January 1, 2014, Parton Corporation acquired an 80% interest in Sandra Corporation for $184,000. Sandra's net assets on this date had a book value of $160,000 and a fair value of $210,000. The excess of fair value over book value at acquisition was attributable to $20,000 of understated plant assets with a remaining useful life of five years from January 1, 2014, and $30,000 to an understated patent with a remaining economic life of six years from January 1, 2014. Separate net incomes (excluding investment income) of Parton and Sandra for 2014 were $300,000 and $50,000, respectively. Required: 1. Compute goodwill at January 1, 2014 under the parent company theory and the entity theory. 2. Determine consolidated net income and noncontrolling interest share for 2014 under the parent company theory and the entity theory. Answer: Requirement 1 Parent company theory: Cost of 80% interest on January 1, 2014 Fair value acquired ($210,000 × 80%) Goodwill

$184,000 168,000 $16,000

Entity theory: Total fair value implied by price paid ($184,000/80%) Fair value Goodwill

$230,000 210,000 $20,000

Or: ($16,000 goodwill)/80%

$20,000

Requirement 2 Parent Theory $350,000

Combined separate incomes Less: Deprec./Amort. on excess to: Plant assets: $16,000/5 years (3,200) $20,000/5 years Patent: $24,000/6 years (4,000) $30,000/6 years Less: Noncontrolling interest share ($50,000 × 20%) (10,000) Consolidated net income $332,800 Total consolidated income Income allocated to controlling shareholders ($341,000-$8,200) Income allocated to noncontrolling shareholders [($50,000 - $9,000) × 20%]

Entity Theory $350,000

(4,000) (5,000) ________ $341,000 $332,800 $8,200

Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Application of knowledge

6) Partridge Corporation purchased an 80% interest in Sandy Corporation for $840,000 on January 1, 2014. Sandy's balance sheet book values and accompanying fair values on this date are shown below. Parent Company Theory PushDown Balance Sheet

Book Value

Fair Value

Entity Theory PushDown Balance Sheet

Cash

$30,000

________

Receivables

200,000

________

Inventory

300,000

360,000

________

Land

50,000

90,000

________

Plant assets-net

250,000

300,000

________

Total Assets

$830,000

$980,000

________

Current liabilities

$180,000

________

Other liabilities

120,000

100,000

________

Common Stock

400,000

________

Retained Earnings

130,000

________

Total Liab. & Equity

$830,000

________

Required: Complete the push-down columns of Sandy Corporation's restructured balance sheet using entity theory and parent company theory.

Answer: Preliminary computations: Parent Company Theory: Cost of 80% interest Fair value acquired ($700,000 × 80%) Goodwill Entity Theory: Implied fair value ($840,000/80%) Fair value of net assets Goodwill

$840,000 560,000 $280,000 $1,050,000 700,000 $350,000 Parent Company Theory PushDown Balance Sheet

Book Value

Fair Value

Entity Theory PushDown Balance Sheet

Cash

$30,000

Receivables

200,000

Inventory

300,000

360,000

348,000

Land

50,000

90,000

82,000

Plant assets-net

250,000

300,000

290,000

Goodwill

________

350,000

280,000

Total Assets

$830,000

$980,000

$1,330,000

$1,230,000

Current liabilities

$180,000

Other liabilities

120,000

100,000

104,000

Common Stock

400,000

Retained Earnings

130,000

650,000

546,000

$1,330,000

$1,230,000

________

Push-down capital Total Liab & Equity

$830,000

Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

7) Party Corporation acquired an 80% interest in Sang Corporation on January 1, 2014 for $20,000. Balance sheet and fair value information on this date is summarized as follows:

Current assets Land and Building-net Equipment Total assets Liabilities Capital stock Retained earnings Total liab. & equity

Party Book Value $15,000 35,000 8,000 $58,000

Sang Book Value $9,000 7,000 4,000 $20,000

Sang Fair Value $9,000 7,000 6,000 $22,000

$27,000 18,000 13,000 $58,000

$10,000 4,000 6,000 $20,000

10,000

Required: 1. Prepare an entry on the books of Sang Corporation to record the push-down adjustment under parent company theory. 2. Prepare an entry on the books of Sang Corporation to record a push-down adjustment under entity theory. Answer: Requirement 1 Cost of investment $20,000 Fair value of investment ($12,000 × 80%) (9,600) Goodwill $10,400 Entry: Equipment Goodwill Retained earnings Push-down capital

1,600 10,400 6,000 18,000

Requirement 2 Implied fair value of net assets ($20,000/80%) Fair value of net assets Goodwill Entry: Equipment Goodwill Retained earnings Push-down capital

$25,000 (12,000) $13,000

2,000 13,000 6,000 21,000

Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

8) Pascal Corporation paid $225,000 for a 70% interest in Sank Corporation on January 1, 2014. On that date, Sank's balance sheet accounts, at book value and fair value, were as follows: Book Value

Fair Value

Assets Cash Accounts receivable-net Inventories Plant, property and equipment-net Total assets

$25,000 45,000 40,000 140,000 $250,000

$25,000 55,000 60,000 125,000 $265,000

Equities Accounts payable Common stock Retained earnings Total liab. & equity

$40,000 120,000 90,000 $250,000

$40,000

Both companies use the parent company theory. Push-down accounting is used for the acquisition. Required: 1. Prepare the journal entry on January 1, 2014 on Sank Corporation's books. 2. Prepare a balance sheet for Sank Corporation immediately after the acquisition on January 1, 2014.

Answer: Requirement 1 Cost of a 70% interest in Sank Fair value acquired ($225,000 × 70%) Goodwill Entry: Accounts receivable Inventories Goodwill Retained earnings Plant, property, and equipment Push-down capital

$225,000 157,500 $67,500 7,000 14,000 67,500 90,000 10,500 168,000

Requirement 2 Sank Corporation Balance Sheet January 1, 2014 (After Push-Down) Assets Cash Accounts receivable Inventories Plant, property and equipment Goodwill Total assets

$25,000 52,000 54,000 129,500 67,500 $328,000

Liabilities & Equity Accounts payable Common stock Push-down capital Total liabilities & equity

$40,000 120,000 168,000 $328,000

Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

9) Johnsen Corporation paid $225,000 for a 70% interest in Jonas Corporation on January 1, 2014. On that date, Jonas's balance sheet accounts, at book value and fair value, were as follows: Book Value

Fair Value

Assets Cash Accounts receivable-net Inventories Plant, property and equipment-net Total assets

$25,000 45,000 40,000 140,000 $250,000

$25,000 55,000 60,000 125,000 $265,000

Equities Accounts payable Common stock Retained earnings Total liab. & equity

$40,000 120,000 90,000 $250,000

$40,000

Required: 1. Prepare the journal entry necessary on January 1, 2014 on Jonas Corporation's books. Both companies use push-down accounting and the entity theory. 2. Prepare the balance sheet for Jonas Corporation immediately after the acquisition on January 1, 2014.

Answer: Requirement 1 Implied fair value ($225,000/0.70) Fair value of net assets Goodwill

$321,429 (225,000) $96,429

Entry: Accounts receivable Inventories Goodwill Retained earnings Plant, property, and equipment Push-down capital

10,000 20,000 96,429 90,000 15,000 201,429

Requirement 2 Jonas Corporation Balance Sheet January 1, 2014 (After Push-Down) Assets Cash Accounts receivable Inventories Plant, property and equipment Goodwill Total assets

$25,000 55,000 60,000 125,000 96,429 $361,429

Liabilities & Equity Accounts payable Common stock Push-down capital Total liabilities & equity

$40,000 120,000 201,429 $361,429

Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Reflective thinking

10) Patch Corporation has a 50% undivided interest in Saric Corporation, a joint venture. Patch accounts for its interest in Saric by the equity method and also prepares consolidated financial statements for external reporting purposes. Patch follows specialized industry practices and uses proportionate consolidation for its interest in Saric. Separate financial statements for Patch and Saric are as follows:

Cash Accounts receivable Inventories Investment in Saric Land Plant, property, equipment Total assets

Patch $30,000 70,000 80,000 140,000 116,000 200,000 $636,000

Accounts payable Common stock Retained earnings Venture capital Total liab. & equity

$24,000 340,000 272,000 ________ $636,000

Saric $18,000 42,000 72,000 40,000 128,000 $300,000

Consolidation ________ ________ ________ ________ ________ ________ ________

$20,000 0

________ ________

280,000 $300,000

________ ________

Required: Prepare the consolidated balance sheet for Patch Corporation and its undivided interest in Saric Corporation. Answer: Patch Corporation Balance Sheet Assets Cash $39,000 Accounts receivable 91,000 Inventories 116,000 Land 136,000 Plant, property & equipment 264,000 Total assets $646,000 Liabilities & Equity Accounts payable Common stock Retained earnings Total liab. & equity

$34,000 340,000 272,000 $646,000

Objective: LO11.3 Account for corporate and unincorporated joint ventures. Difficulty: Moderate AACSB: Application of knowledge

11) On January 1, 2014, Penny Company acquired a 90% interest in Lampire Company for $180,000 cash. On January 1, 2014, Lampire Company had the following assets and liabilities:

Cash Accounts Receivable Inventory Plant Assets Total Assets

Book Value $10,000 30,000 40,000 60,000 $140,000

Fair Value $10,000 35,000 50,000 80,000 $175,000

$25,000 100,000 15,000

$25,000

Liabilities Capital Stock Retained Earnings Total Liabilities & Stockholders' Equity

$140,000

Push-down accounting is used for the acquisition. Required: 1. Assume both companies use the entity theory. Record the push-down adjustment on Lampire's separate books on January 1, 2014. 2. Assume both companies use the parent company theory. Record the push-down adjustment on Lampire's separate books on January 1, 2014. Answer: Requirement 1 Accounts receivable 5,000 Inventory 10,000 Plant assets 20,000 Goodwill [($180,000/0.90) - $150,000] 50,000 Retained earnings 15,000 Push-down capital 100,000 Requirement 2 Accounts receivable Inventory Plant assets Goodwill [$180,000 - ($150,000 × 90%)] Retained earnings Push-down capital

4,500 9,000 18,000 45,000 15,000 91,500

Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

12) On January 1, 2014, Jeff Company acquired a 90% interest in Margaret Company for $198,000 cash. On January 1, 2014, Margaret Company had the following assets and liabilities:

Cash Accounts Receivable Inventory Plant Assets Total Assets Liabilities Capital Stock Retained Earnings Total Liabilities & Stockholders' Equity

Book Value $5,000 30,000 40,000 60,000 $135,000

Fair Value $5,000 35,000 50,000 80,000 $170,000

$25,000 100,000 10,000

$25,000

$135,000

Push-down accounting is used for the acquisition. Required: 1. Assume both companies use the entity theory. a. Record the journal entry on Margaret's separate books on January 1, 2014. b. Record the journal entry on Jeff's separate books on January 1, 2014. 2. Assume both companies use the parent company theory. a. Record the journal entry on Margaret's separate books on January 1, 2014. b. Record the journal entry on Jeff's separate books on January 1, 2014.

Answer: Requirement 1 Margaret Books Accounts receivable Inventory Plant assets Goodwill Retained earnings Push-down capital

5,000 10,000 20,000 75,000 10,000 120,000

Jeff Books Investment in Margaret Cash

198,000 198,000

Requirement 2 Margaret Books Accounts receivable ($5,000 × 90%) Inventory ($10,000 × 90%) Plant assets ($20,000 × 90%) Goodwill Retained earnings Push-down capital Jeff Books Investment in Margaret Cash

4,500 9,000 18,000 67,500 10,000 109,000

198,000 198,000

Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

13) On January 1, 2014, Jeff Company acquired a 90% interest in Marian Company for $198,000 cash. On January 1, 2014, Marian Company had the following assets and liabilities:

Cash Accounts Receivable Inventory Plant Assets Total Assets Liabilities Capital Stock Retained Earnings Total Liabilities & Stockholders' Equity

Book Value $5,000 30,000 40,000 60,000 $135,000

Fair Value $5,000 35,000 50,000 80,000 $170,000

$25,000 100,000 10,000

$25,000

$135,000

Push-down accounting is used for the acquisition. Required: 1. Assume both companies use the entity theory. Prepare the elimination entry(ies) on consolidating work papers on January 1, 2014. 2. Assume both companies use the parent company theory. Prepare the elimination entry(ies) on consolidating work papers on January 1, 2014. Answer: Requirement 1 Capital stock 100,000 Push down capital 120,000 Investment in Marian Company 198,000 Noncontrolling interest ($220,000 × 10%) 22,000 Requirement 2 Capital stock Push down capital Investment in Marian Company Noncontrolling interest ($110,000 × 10%)

100,000 109,000 198,000 11,000

Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

14) On January 1, 2014, Jennifer Company acquired a 90% interest in Jayda Company for $270,000 cash. On January 1, 2014, Jayda Company had the following assets and liabilities:

Cash Accounts Receivable Inventory Plant Assets Total Assets Liabilities Capital Stock Retained Earnings Total Liabilities & Stockholders' Equity

Book Value $10,000 50,000 50,000 100,000 $210,000

Fair Value $10,000 70,000 80,000 200,000 $360,000

$100,000 100,000 10,000

$120,000

$210,000

Push-down accounting is used for the acquisition. Both companies use the entity theory. Required: 1. What is the goodwill associated with Jayda Company on January 1, 2014? 2. Prepare the journal entry(ies) on Jayda's books on January 1, 2014. 3. Prepare the journal entry(ies) on Jennifer's books on January 1, 2014. 4. Prepare the elimination entry(ies) on the consolidating working papers on January 1, 2014.

Answer: Requirement 1 Implied fair value ($270,000/0.90) Less: Fair value of net assets Goodwill

$300,000 240,000 $60,000

Requirement 2 Accounts receivable Inventory Plant assets Goodwill Retained earnings Push down capital Liabilities

20,000 30,000 100,000 60,000 10,000 200,000 20,000

Requirement 3 Investment in Jayda Company Cash

270,000 270,000

Requirement 4 Capital stock Push down capital Investment in Jayda Company Noncontrolling interest ($300,000 × 10%)

100,000 200,000 270,000 30,000

Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

15) On January 1, 2014, Brody Company acquired an 80% interest in Kristin Company for $240,000 cash. On January 1, 2014, Kristin Company had the following assets and liabilities:

Cash Accounts Receivable Inventory Plant Assets Total Assets Liabilities Capital Stock Retained Earnings Total Liabilities & Stockholders' Equity

Book Value $10,000 50,000 50,000 100,000 $210,000

Fair Value $10,000 50,000 70,000 100,000 $230,000

$100,000 100,000 10,000

$120,000

$210,000

Push-down accounting is used for the acquisition. Both companies use the entity theory. Required: 1. What is the goodwill associated with Kristin Company on January 1, 2014? 2. Prepare the journal entry(ies) on Kristin's books on January 1, 2014. 3. Prepare the journal entry(ies) on Brody's books on January 1, 2014. 4. Prepare the elimination entry(ies) on the consolidating working papers on January 1, 2014. Answer: Requirement 1 Implied fair value ($240,000/0.80) $300,000 Less: Fair value of net assets 110,000 Goodwill $190,000 Requirement 2 Inventory Goodwill Retained earnings Push down capital Liabilities

20,000 190,000 10,000 200,000 20,000

Requirement 3 Investment in Kristin Company Cash

240,000 240,000

Requirement 4 Capital stock Push down capital Investment in Kristin Company Noncontrolling interest ($300,000 × 20%)

100,000 200,000 240,000 60,000

Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

16) On January 1, 2014, Gregory Company acquired a 90% interest in Subway Company for $200,000 cash. On January 1, 2014, Subway Company had the following assets and liabilities:

Cash Accounts Receivable Inventory Other Current Assets Plant Assets Total Assets Liabilities Common Stock Retained Earnings Total Liabilities & Stockholders' Equity

Book Value $5,000 30,000 40,000 10,000 60,000 $145,000

Fair Value $5,000 35,000 50,000 10,000 80,000 $180,000

$25,000 100,000 20,000

$25,000

$145,000

The plant assets have 20 years of useful life remaining. Straight-line depreciation is used. The excess fair value over book value associated with Accounts Receivable and Inventory is realized in 2014. In 2014, Subway reported net income of $35,000 and declared and paid common dividends of $10,000. Gregory reported Income from Subway in 2014 of $17,100. Required: Assume both companies use the entity theory. Prepare the elimination entry(ies) on consolidating work papers for the year ending December 31, 2014.

Answer: Common stock Retained earnings Cost of goods sold Operating expenses (accounts receivable) Plant assets Goodwill [($200,000/0.90) - $155,000] Investment in Subway Company Noncontrolling interest ($222,222 × 10%)

100,000 20,000 10,000 5,000 20,000 67,222 200,000 22,222

Depreciation expense ($20,000/20) Plant assets Noncontrolling interest share Noncontrolling interest Dividends ($10,000 × 10%) ($35,000 - $16,000) × 10% = $1,900 Cost of goods sold $10,000 Operating expenses 5,000 Depr. Expense 1,000 Total $16,000

1,000

Income from Subway Dividends ($10,000 × 90%) Investment in Subway

17,100

1,000 1,900 900 1,000

9,000 8,100

Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Application of knowledge

11.3 True/False 1) The entity theory approach to consolidated statements states the income of the noncontrolling interests is a distribution of the total income of the consolidated entity. Answer: TRUE Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Easy AACSB: Analytical thinking

2) The entity theory requires that the income and equity of a subsidiary be determined for all stockholders; therefore the total amounts will be allocated between controlling and noncontrolling shareholders. Answer: TRUE Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Easy AACSB: Analytical thinking

3) Income attributable to the noncontrolling interest is treated as an expense. Answer: FALSE Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Analytical thinking

4) The GAAP states a noncontrolling interest in a subsidiary should be labeled and displayed as a separate financial note to the consolidated balance sheet. Answer: FALSE Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Analytical thinking

5) Under the entity theory, subsidiary assets and liabilities are consolidated at fair values and controlling and noncontrolling interests in the net assets are accounted for consistently. Answer: TRUE Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Analytical thinking

6) Unrealized gains and losses are to be considered when totalling consolidated net income under the entity theory. Answer: FALSE Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Moderate AACSB: Analytical thinking

7) Per the GAAP, the noncontrolling interest is shown as a single, combined amount under the consolidated stockholder's equity. Answer: TRUE Objective: LO11.1 Compare and contrast the elements of consolidation approaches under parent-company and contemporary/entity theories. Difficulty: Easy AACSB: Analytical thinking

8) The Securities and Exchange Commission requires the use of push-down accounting for SEC filings when a subsidiary is substantially wholly-owned with no substantial publicly held debt or preferred stock outstanding. Answer: TRUE Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Analytical thinking

9) Push-down accounting is the establishment of a new accounting and reporting basis for an entity in its separate financial statements, based on a purchase transaction in the voting stock of the entity that results in a substantial change of ownership of the outstanding voting stock of the entity. Answer: TRUE Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Easy AACSB: Analytical thinking

10) Push-down capital is an additional paid-in capital account. Answer: TRUE Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Easy AACSB: Analytical thinking

11) A leveraged buyout occurs when an investor group acquires a company from the public shareholders in a transaction financed with large equity and very little debt. Answer: FALSE Objective: LO11.2 Adjust subsidiary assets and liabilities to fair values using push-down accounting. Difficulty: Moderate AACSB: Analytical thinking

12) Joint ventures may be organized as partnerships or undivided interests, but not corporations. Answer: FALSE Objective: LO11.3 Account for corporate and unincorporated joint ventures. Difficulty: Moderate AACSB: Analytical thinking

13) Companies in which equity investors cannot provide financing for the entity's business risks and activities without additional financial support are considered variable interest entitites according to the GAAP. Answer: TRUE Objective: LO11.4 Identify variable interest entities. Difficulty: Moderate AACSB: Analytical thinking

14) All companies holding a significant interest in a variable interest entity (VIE) must disclose the nature, purpose, size and activities of the VIE in the consolidated statements. Answer: TRUE Objective: LO11.4 Identify variable interest entities. Difficulty: Moderate AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 12 Derivatives and Foreign Currency: Concepts and Common Transactions 12.1 Multiple Choice Questions 1) On May 1, 2014, Deerfield Corporation purchased merchandise from a German firm for 78,000 euros when the spot rate for the euro was 1.48 euro per dollar. The account payable was denominated in the euro. Deerfield settled the account on August 1 when the spot rate for the euro was 1.39 euro per dollar. How much cash will Deerfield have to disburse to settle the account? A) $52,702.72 B) $56,115.11 C) $108,420.00 D) $115,440.00 Answer: B Explanation: B) 78,000 euro/1.39 euro per dollar = $56,115.11 Objective: LO12.3 Understand key concepts related to foreign currency exchange rates, such as indirect and direct quotes; floating, fixed, and multiple exchange rates; and spot, current, and historical exchange rates. Difficulty: Easy AACSB: Application of knowledge

2) Cass Corporation's balance sheet at December 31, 2014 included a $48,480 account receivable from Redmun Corporation of Mexico. The account receivable was denominated as 600,000 Mexican pesos. What entry did Cass make on January 16, 2015 when the account receivable was collected and the exchange rate for the peso was $.09? A) Cash

54,000 Accounts Receivable

B) Cash

54,000

54,000 Exchange Gain Accounts Receivable

C) Cash

5,520 48,480

48,480 Accounts Receivable

48,480

D) Cash 48,480 Exchange Loss 5,520 Accounts Receivable

54,000

Answer: B Explanation: B) 600,000 × $0.09 = $54,000; $54,000 - $48,480 = $5,520 gain Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Application of knowledge

3) The exchange rates between the Australian dollar and the U.S. dollar were as follows: Jun 1 Jul 1 Aug 1

1$AUS = $.8328US 1$AUS = $.8356US 1$AUS = $.9111US

This chart shows a A) strengthening Australian Dollar which makes it less expensive for Americans to buy Australian goods. B) weakening Australian dollar which makes it less expensive for Americans to buy Australian goods. C) strengthening Australian dollar which makes it more expensive for Americans to buy Australian goods. D) weakening Australian dollar which makes it more expensive for Americans to buy Australian goods. Answer: C Objective: LO12.3 Understand key concepts related to foreign currency exchange rates, such as indirect and direct quotes; floating, fixed, and multiple exchange rates; and spot, current, and historical exchange rates. Difficulty: Easy AACSB: Analytical thinking

4) With respect to exchange rates, which of the following statements is true? A) An official exchange rate is the "market" rate resulting from the supply and demand for a currency. B) A floating exchange rate is the "market" rate resulting from the supply and demand for a currency. C) A government cannot set an exchange rate for their currency that is higher (weakens their currency) than the quoted interbank market rate. D) A government cannot set an exchange rate for their currency that is lower (strengthens their currency) than the quoted interbank market rate. Answer: B Objective: LO12.3 Understand key concepts related to foreign currency exchange rates, such as indirect and direct quotes; floating, fixed, and multiple exchange rates; and spot, current, and historical exchange rates. Difficulty: Easy AACSB: Analytical thinking

5) A U.S. importer that purchased merchandise from a South Korean firm would be exposed to a net exchange gain on the unpaid balance if the A) dollar weakened relative to the Korean won and the won was the denominated currency. B) dollar weakened relative to the Korean won and the dollar was the denominated currency. C) dollar strengthened relative to the Korean won and the won was the denominated currency. D) dollar strengthened relative to the Korean won and the dollar was the denominated currency. Answer: C Objective: LO12.3 Understand key concepts related to foreign currency exchange rates, such as indirect and direct quotes; floating, fixed, and multiple exchange rates; and spot, current, and historical exchange rates. Difficulty: Easy AACSB: Analytical thinking

Use the following information to answer the question(s) below. On November 1, 2014, Rolleks Corporation sold merchandise to Watchem Corporation, a Swiss firm. Rolleks measured and recorded the account receivable from the sale at $107,100. Watchem paid for this account on November 30, 2014. Spot rates for Swiss francs on November 1 and November 30, respectively, were $1.05 and $1.02. 6) If the sale of the merchandise was denominated in Swiss francs, the November 30 entry to record the receipt of payment from Watchem included a A) credit to Accounts Receivable for $104,040. B) credit to Exchange Gain for $3,060. C) debit to Cash for $107,100. D) debit to Exchange Loss for $3,060. Answer: D Explanation: D) Underlying currency value: $107,100/1.05 dollars per franc(sf) = 102,000 sf November 30 value of receivable at 1.02 dollars per franc(sf) = $104,040 Receivable recorded at $107,100 107,100 Decrease in value of receivable (loss) = (3,060) Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Application of knowledge

7) If the sale of merchandise is denominated in dollars, the November 30 entry to record receipt of the payment from Watchem included a A) credit to Accounts Receivable for $104,040. B) credit to Exchange Gain for $3,060. C) debit to Cash for $107,100. D) debit to Exchange Loss for $3,060. Answer: C Explanation: C) If a sale is denominated in dollars, and Rolleks recorded the sale in dollars at $107,100, then there will be no gain or loss on Rolleks' books. The risk of gain or loss now lies with the Swiss company, Watchem. Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Application of knowledge

8) On December 5, 2014, Unca Corporation, a U.S. firm, bought inventory items from Skagerrak Corporation of Norway for 1,000,000 Norwegian kroner when the spot rate for kroner was $0.166. The purchase was denominated in kroner. At Unca's fiscal year end, December 31, 2014, the spot rate was $0.171. On January 4, 2015, Unca purchased 1,000,000 kroner for $167,500 and paid the invoice. How much gain or (loss) did Unca report in its 2014 and 2015 income statements, respectively? A) $(5,000) and $1,500 B) $0 and ($1,500) C) ($5,000) and $3,500 D) $0 and ($3,500) Answer: C Explanation: C) Accounts payable, Dec 05, 2014 1,000,000 × $0.166 = $166,000 Accounts payable, Dec 31, 2014 1,000,000 × $0.171 = $171,000 Loss = $5,000 Accounts payable, Dec 31, 2014 = $171,000 Accounts payable, at settlement = $167,500 Gain = $3,500 Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. On October 4, 2014, Sooty Corporation borrowed 250,000 British pounds from a London bank, evidenced by an interest-bearing note payable due in one year. The note was payable in pounds. Exchange rates for pounds were: October 4, 2014 December 31, 2014 October 4, 2015

$1.59 $1.55 $1.61

9) What exchange gain or loss appeared on Sooty's 2014 income statement? A) a loss of $10,000 B) a loss of $15,000 C) a gain of $10,000 D) a gain of $15,000 Answer: C Explanation: C) 250,000 pounds × ($1.59 - $1.55) = $10,000 gain Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Application of knowledge

10) What is the final amount of the loan payable that Sooty repaid? A) $250,000 B) $287,500 C) $397,500 D) $402,500 Answer: D Explanation: D) 250,000 pounds × $1.61 = $402,500 Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Application of knowledge

11) What exchange gain or loss appeared on Sooty's 2015 income statement? A) a loss of $15,000 B) a loss of $5,000 C) a gain of $15,000 D) a gain of $5,000 Answer: A Explanation: A) 250,000 pounds × ($1.61 - $1.55) = $15,000 loss Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Application of knowledge

12) If a U.S. company is preparing a journal entry for a recent purchase, foreign-currency-denominated purchases must be measured in ________ at the purchase date using the foreign currency ________ rate on the purchase date. A) foreign currency; spot B) foreign currency; future C) U.S. dollars; forward D) U.S. dollars; spot Answer: D Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Analytical thinking

13) When the billing for a U.S. company's sale to a company in a foreign country is denominated in U.S. dollars, ________ is required when preparing journal entries for the sale. A) translation to a foreign currency B) conversion to a foreign currency C) translation to U.S. dollars D) no translation Answer: D Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Analytical thinking

14) At the date the transaction is recognized, the transaction shall be measured and recorded in A) the functional currency of the recording entity by using the exchange rate in effect at that date. B) the functional currency of the foreign country in which it is denominated. C) the functional currency of the foreign country in which it is measured. D) the functional currency of the recording entity. Answer: A Objective: LO12.4 Explain the difference between receivable or payable measurement and denomination. Difficulty: Easy AACSB: Analytical thinking

15) Gains or losses on foreign currency transactions are recorded before the related receivable or payable is settled when A) the government cannot set an exchange rate for the foreign currency. B) the foreign currency is unknown. C) the fiscal year ends after the settlement of the receivable or payable. D) the fiscal year ends before the settlement of the receivable or payable. Answer: D Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Easy AACSB: Analytical thinking

16) Which of the following statements is true regarding forward contracts, futures contracts, options and swaps? A) A forward contract can be purchased on the open market and is recorded at its historical cost, then adjusted for changes in the market. B) A futures contract is negotiated between two parties who are betting in the opposite direction on the movement of the underlying price. C) An option is a contract requiring the holder to either "put" or "call" an underlying asset at a specified point in time. D) A swap is a contract between two parties to exchange an ongoing stream of cash flows. Answer: D Objective: LO12.2 Understand the structure, benefits, and costs of options, futures contracts, forward contracts, and swaps. Difficulty: Easy AACSB: Analytical thinking

17) A direct quote for the U.S. dollar is given at $1.45 per 1 foreign currency unit (fcu). The respective indirect quote for the U.S. dollar would be reported as A) 1.45 fcu = $1.00. B) 1.45 fcu = $.6897. C) .6897 fcu = $1.00. D) 1.00 fcu = $1.45. Answer: C Objective: LO12.3 Understand key concepts related to foreign currency exchange rates, such as indirect and direct quotes; floating, fixed, and multiple exchange rates; and spot, current, and historical exchange rates. Difficulty: Easy AACSB: Analytical thinking

18) On November 14, 2014, Scuby Company (a U.S. corporation) enters into a transaction which is denominated in the Canadian dollar. Assume the exchange rate at November 14 is $1.03, and at the December 31 year-end reporting date, the exchange rate is $1.07. On January 27, 2015, when the transaction is settled, the exchange rate is $1.05. At the date of settlement, which of the following is correct? A) The historical rate = $1.05, and the spot rate at which it is settled is the same as the current rate at $1.07. B) The historical rate = $1.03, and the spot rate at which it is settled is the same as the current rate at $1.06. C) The historical rate = $1.05, the current rate for reporting at December 31, 2014 is $1.07, and the spot rate at which it is settled is $1.03. D) The historical rate = $1.03, the current rate for reporting at December 31, 2014 is $1.07, and the spot rate at which it is settled is $1.05. Answer: D Objective: LO12.3 Understand key concepts related to foreign currency exchange rates, such as indirect and direct quotes; floating, fixed, and multiple exchange rates; and spot, current, and historical exchange rates. Difficulty: Easy AACSB: Analytical thinking

19) If a sale on account by a U.S. company is made with a foreign company, and the U.S. company has no foreign currency risk, then A) the U.S. company has measured the transaction in U.S. dollars. B) the U.S. company has denominated the transaction in U.S. dollars. C) the foreign company has measured the transaction in their own currency. D) the foreign company has denominated the transaction in their own currency. Answer: B Objective: LO12.4 Explain the difference between receivable or payable measurement and denomination. Difficulty: Easy AACSB: Analytical thinking

20) Ulysses Company purchases goods from China amounting to 372,372 Yuan (the transaction is denominated in the Chinese Yuan). Assume the Yuan is trading at $0.154 at the date the goods are ordered, and the Yuan is trading at $0.155 at the date the goods are received. When the invoice is paid a month later, the Yuan is trading at $.156. Assume all three dates are in the same fiscal year. Which of the following is true? A) The entry to record the payment will include a gain of $744.74. B) The entry to record the payment will include a gain of $372.37. C) The entry to record the purchase will include a credit to Accounts Payable of $57,345.29. D) The entry to record the purchase will include a credit to Accounts Payable of $57,717.66. Answer: D Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Analytical thinking

12.2 Exercises 1) On September 1, 2014, Bylin Company purchased merchandise from Himeji Company of Japan for 20,000,000 yen payable on October 1, 2014. The spot rate for yen was $0.0079 on September 1 and the spot rate was $0.0077 on October 1. The purchase was paid on October 1, 2014. Required: 1. Did the U.S. dollar strengthen or weaken from September to October and what are the implications for Bylin's business? 2. What journal entry did Bylin record on September 1, 2014? 3. What journal entry did Bylin record on October 1, 2014? Answer: Requirement 1 The U.S. dollar strengthened which makes the purchase of goods on time cheaper from Japan. Requirements 2 and 3 Date 9/01/14

10/01/14

Account Name Merchandise inventory Accounts Payable (yen)

Debit 158,000

Cash (yen) Cash

154,000

Accounts Payable (yen) Exchange gain Cash (yen)

158,000

Credit 158,000

154,000

4,000 154,000

Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Application of knowledge

2) On October 15, 2014, Napole Corporation, a French company, ordered merchandise listed on the internet for 20,000 Euros from Adams Corporation, a U.S. corporation. The euro rate was $1.20 (U.S. dollars) on October 15. On November 15, 2014 Adams shipped the goods and billed Napole the purchase price of 20,000 Euros when the euro rate was $1.30. Napole paid the bill on December 10, 2014, and Adams immediately exchanged the 20,000 Euros for U.S. dollars when the Euro rate was $1.28 on December 10, 2014. Required: Compute the foreign currency gain or loss on the December 31, 2014 financial statements of Adams and show the related journal entries. Answer: A $400 foreign exchange loss Adams' General Journal Date 10/15/14

Account Name No entry

Debit

11/15/14

Accounts receivable (euro) Sales (20,000 euro × $1.30)

26,000

Cash (euro) (20,000 euro × $1.28) Exchange loss Accounts receivable (euro)

25,600 400

Cash Cash (euro)

25,600

12/10/14

Credit

26,000

25,600

3) On November 1, 2014, the Yankee Corporation, a U.S. corporation, purchased and received an extruding machine from Wales Corporation, a UK company. The purchase price was $10,000 (U.S. dollars) and Yankee agreed to pay in pounds on February 1, 2015. Both corporations are on a calendar year accounting period. Assume that the spot rates for the British pound on November 1, 2014, December 31, 2014, and February 1, 2015, are $1.60, $1.62, and $1.66, respectively. Required: Record the November 1, December 31, and February 1 transactions in the General Journals of Yankee Corporation and Wales Corporation. If no entry is required on a particular date, indicate "No entry" in the General Journal. Answer: Yankee's General Journal Date 11/01/14

12/31/14

02/01/15

Account Name Machinery Accounts Payable (pounds)

Debit 10,000

Exchange Loss Accounts Payable (pounds) (£6,250 × $1.62 = $10,125) ($10,000 - $10,125 = $125 loss)

125

Exchange Loss Accounts Payable (pounds) (£6,250 × $1.66 = $10,375) ($10,125 - $10,375 = $250 loss)

250

Credit 10,000

125

250

Cash (pounds) Cash

10,375

Accounts Payable (pounds) Cash (pounds)

10,375

Wales' General Journal 11/01/14

Accounts Receivable Sales Revenue

12/31/14

No entry

02/01/15

Cash (pounds) Accounts Receivable

6,250 6,250

4) Jefferson Company entered into a forward contract with Washington Company on October 1, 2014, under which Jefferson agreed to buy (and Washington agreed to sell) 10,000 tons of coal at $80.00 per ton in 90 days. On October 1, 2014, the price of coal is $82.00 per ton. On December 29, 2014, the price of coal is $85.00 per ton. The contract allows for net settlement. Required: Determine the net settlement on the forward contract. Answer: Washington will pay Jefferson $50,000 in net settlement. If the parties fulfilled the contract, Washington would have to acquire 10,000 tons of coal at $85.00 per ton, or $850,000, would then in turn sell the coal to Jefferson for $800,000 (10,000 tons × $80/ton), and thus would have lost $50,000 on the contract. Because Jefferson will purchase coal from a third-party at $85.00 per ton, they will use the $800,000 of their own funds that they would have used to purchase the coal from Washington under the contract, plus the $50,000 that they received from Washington in net settlement, and thus they are made whole by the net settlement. Objective: LO12.2 Understand the structure, benefits, and costs of options, futures contracts, forward contracts, and swaps. Difficulty: Moderate AACSB: Analytical thinking

5) On April 1, 2014, Button Industries enters into an agreement with Bows Incorporated to lock in the price of cotton. Button agrees to purchase (and Bows agrees to sell) 100,000 pounds of cotton at $1.19 per pound, six months from the date of agreement. On October 1, 2014, the price of cotton is $1.17 per pound. The contract allows for net settlement. Required: Determine the net settlement on the forward contract. Answer: Button will pay Bows $2,000 in net settlement. If the parties fulfilled the contract, Bows would have to acquire 100,000 pounds of cotton at $1.17 per pound, or $117,000, and would then in turn sell the cotton to Button for $119,000 (100,000 × $1.19/pound), and thus would have gained $2,000 on the contract. Because Button would have to purchase cotton from a third-party at $1.17 per pound, they will pay $117,000 to the third-party, plus the $2,000 to Bows, so they will have paid out a total of $119,000 for 100,000 pounds, and thus locked in the price of $1.19 per pound. Objective: LO12.2 Understand the structure, benefits, and costs of options, futures contracts, forward contracts, and swaps. Difficulty: Moderate AACSB: Analytical thinking

6) Crabby Industries, a U.S. corporation, purchased inventory from a company in Sweden on November 18, 2014 when the Swedish krona was trading at 1 krona = $0.161. The transaction was for 600,000 krona, and was to be paid in krona in 90 days. Crabby closed their books at December 31 for financial reporting purposes when the krona was trading at $0.167. On February 16, 2015, Crabby paid the invoice when the krona was trading at $0.156. Required: Show the journal entries recorded by Crabby on November 18, 2014, December 31, 2014, and February 16, 2015. Answer: Crabby's General Journal Date 11/18/14

12/31/14

2/16/15

Account Name Inventory Accounts Payable (krona)

Debit 96,600

Exchange Loss Accounts Payable (krona) (600,000 krona × ($.167 - $.161))

3,600

Cash (krona) Cash

93,600

Accounts Payable (krona) Exchange Gain Cash (krona) (Pay 600,000 krona × $0.156)

100,200

Credit 96,600

3,600

93,600

6,600 93,600

7) Tank Corporation, a U.S. manufacturer, has a June 30 fiscal year end. Tank sold goods to their customer in Columbia on May 27, 2014 for 18,000,000 Columbian pesos. The customer agreed to pay pesos in 60 days. When the customer wired the funds to Tank on July 26, Tank held them in their bank account until July 31 before selling them and converting them to U.S. dollars. The following exchange rates apply: May 27 June 30 July 26 July 31

$0.00055 $0.00052 $0.00058 $0.00056

Required: Record the journal entries related to the dates listed above. If no entry is required, state "no entry." Answer: Tank's General Journal Date 05/27/14

06/30/14

07/26/14

07/31/14

Account Name Accounts Receivable (pesos) Sales Revenue

Debit 9,900

Credit 9,900

Exchange Loss Accounts Receivable (pesos) (18,000,000 pesos × ($.00055 - $.00052))

540 540

Cash (pesos) Exchange Gain Accounts Receivable (pesos) (18,000,000 pesos × $0.00058)

10,440

Cash Exchange Loss Cash (pesos) (18,000,000 pesos × $0.00056)

10,080 360

1,080 9,360

10,440

8) A review of Ace Industries, a U.S. corporation, shows the following balances in accounts receivable and accounts payable detail at September 30, 2014, their fiscal year end. ACCOUNTS RECEIVABLE Receivables denominated in U.S. dollar Receivable denominated in 40,000 Australian dollar Receivable denominated in 70,000 Canadian dollar

$426,000 43,000 71,750 $ 540,750

ACCOUNTS PAYABLE Payables denominated in U.S. dollar Payable denominated in 50,000 Canadian dollar Payable denominated in 200,000 Hong Kong dollar

$ 107,000 51,250 26,500 $ 184,750

As Ace prepared to close their books, they noted that the September 30 exchange rates for the Australian dollar, Canadian dollar and Hong Kong dollar were $1.0366, $1.0301 and $0.1284, respectively. Required: Determine the exchange gain or loss to be included in the 2014 financial statements, and the amount of Accounts Receivable and Accounts Payable that will be included on the September 30, 2014 balance sheet. Answer: Current Exchange ACCOUNTS RECEIVABLE Pre-Close Exchange Gain/(Loss) U.S. dollar $ 426,000 $ 426,000 $-040,000 Australian dollar 43,000 41,464 (1,536) 70,000 Canadian dollar 71,750 72,107 357 $ 540,750 $539,571 $(1,179) ACCOUNTS PAYABLE U.S. dollar 50,000 Canadian dollar 200,000 Hong Kong dollar

$ 107,000 51,250 26,500 $ 184,750

$ 107,000 51,505 25,680 $ 184,185

$-0(255) 820 $ 565

Accounts Receivable = $539,571 Accounts Payable = $184,185 Exchange Gain/(Loss) = ($1,179) + 565 = ($614) Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Application of knowledge

9) Behd Company, a U.S. firm, sold some of its inventory to Edinburgo Company, a company based in Scotland, on November 27, 2014, when the local currency unit (the pound Sterling, "GBP") was trading at $1.64 : 1 GBP. The sales agreement called for Edinburgo to pay 140,000 GBP on January 26, 2015. Additional exchange rates are shown below: December 31, 2014 $1.7125 January 26, 2015 $1.7220 Required: Show all related journal entries for Behd Company. Answer: Behd's General Journal Date 11/27/14

12/31/14

1/26/15

Account Name Accounts Receivable (GBP) Sales Revenue

Debit 229,600

Accounts Receivable (GBP) Exchange Gain (140,000 GBP × ($1.7125 - $1.64))

10,150

Cash (GBP) Exchange Gain Accounts Receivable (GBP) (140,000 GBP × $1.722)

241,080

Credit 229,600

10,150

1,330 239,750

10) Johnson Corporation (a U.S. company) began operations on December 1, 2015, when the owner contributed $100,000 of his own money to establish the business. Johnson then had the following import and export transactions with unaffiliated Mexican companies: December 12, 2015

Bought inventory for 150,000 pesos on account. Invoice denominated in pesos.

December 15, 2015

Sold 60% of inventory acquired on 12/12/15 for 120,000 pesos on account. Invoice denominated in pesos.

January 1, 2016

Acquired and paid the 150,000 pesos owed to the Mexican supplier.

January 15, 2016

Collected the 120,000 pesos from the Mexican customer and immediately converted them into U.S. dollars.

The following exchange rates apply: Date Rate December 12 $.11 = 1 peso December 15 $.12 = 1 peso December 31 $.13 = 1 peso January 1 $.14 = 1 peso January 15 $.15 = 1 peso Required: 1. What were Sales in the income statement for the year ended December 31, 2015? 2. What was the COGS associated with these sales? 3. What is the Accounts Payable balance in the balance sheet at December 31, 2015? 4. What is the Inventory balance in the balance sheet at December 31, 2015? Answer: 1. Sales = December 15 sale of 120,000 pesos at $.12 / peso = $14,400 2. COGS = 60% of inventory balance purchased 12/12/15 = 150,000 pesos × $.11 = $16,500 × 60% = $9,900 3. Accounts Payable balance = 150,000 pesos × $.13 = $19,500 4. Inventory balance = 150,000 pesos × $.11 = $16,500 × 40% remaining after sale = $6,600 Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Difficult AACSB: Application of knowledge

11) Piel Corporation (a U.S. company) began operations on January 1, 2015, when common stock was issued for $250,000. In the first two months of operations, Piel had the following transactions: January 15, 2015

Bought inventory for 100,000 Mexican pesos on account

January 26, 2015

Sold 70% of inventory acquired on 1/15/15 for 44,000 Saudi riyals on account

January 27, 2015

Paid $1,000 in other operating expenses

February 2, 2015

Sold additional inventory that cost $1,000 for $3,000 cash to a U.S. company

February 15, 2015

Acquired and paid the 100,000 pesos owed to the Mexican supplier

February 21, 2015

Paid $1,500 in other operating expenses

February 28, 2015

Collected the 44,000 riyals from the Saudi customer and immediately converted them into U.S. dollars

The following exchange rates apply: Date Rate January 15 $.11 = 1 peso January 26 $.12 = 1 peso January 31 $.13 = 1 peso February 15 $.14 = 1 peso February 28 $.15 = 1 peso

Rate $.23 = 1 riyal $.24 = 1 riyal $.25 = 1 riyal $.26 = 1 riyal $.27 = 1 riyal

Required: Complete the summary income statement and balance sheet for the month ended January 31, 2015 and February 28, 2015, assuming there were no other transactions. January 31

February 28

INCOME STATEMENT Sales COGS Gross Margin Other Operating Expenses Exchange Gain / (Loss) Net Income BALANCE SHEET Cash Accounts Receivable Inventory Total Assets Accounts Payable Common Stock Retained Earnings Total Liabilities and Equity

Answer: January 31

February 28

INCOME STATEMENT Sales COGS Gross Margin Other Operating Expenses Exchange Gain / (Loss) Net Income

10,560 (7,700) 2,860 (1,000) (1,560) 300

3,000 (1,000) 2,000 (1,500) (120) 380

BALANCE SHEET Cash Accounts Receivable Inventory Total Assets

249,00 11,000 3,300 263,300

248,380 -02,300 250,680

Accounts Payable Common Stock Retained Earnings Total Liabilities and Equity

13,000 250,000 300 263,300

-0250,000 680 250,680

12) Lincoln Corporation, a U.S. manufacturer, both imports needed materials and exports finished products. Their receivables and payables are listed below, prior to year-end adjustments or preparation of the closing entries. Foreign Currency Units

Rate at Per Books Date of in U.S. Transaction Dollars

Current Rate at 12/31/14

ACCOUNTS RECEIVABLE Japanese yen Euros Hungarian forint TOTAL

14,678,000 $0.0109007 50,000 1.2372 50,000,000 0.0044

160,000 61,860 220,000 441,860

$0.0120 1.4235 0.0053

ACCOUNTS PAYABLE Euros Mexican pesos Indian rupee TOTAL

50,000 1,250,000 4,000,000

61,890 99,875 86,400 248,165

$1.4235 0.0845 0.0223

1.2378 0.0799 0.0216

Required: Determine the amount at which receivables and payables should be reported on December 31, 2014, and the net exchange gain or loss that would be reported as a result of year-end adjustments. Answer: Foreign Per Books Current Adjusted Exchange Currency in U.S. Rate at Balance at Gain / Units Dollars 12/31/14 12/31/14 (Loss) ACCOUNTS RECEIVABLE Japanese yen 14,678,000 160,000 $0.0120 176,136 16,136 Euros 50,000 61,860 1.4235 71,175 9,315 Hungarian forint 50,000,000 220,000 0.0053 265,000 45,000 TOTAL 441,860 512,311 70,451 ACCOUNTS PAYABLE Euros Mexican pesos Indian rupee TOTAL

50,000 1,250,000 4,000,000

61,890 99,875 86,400 248,165

$1.4235 0.0845 0.0223

71,175 105,625 89,200 266,000

(9,285) (5,750) (2,800) (17,835)

The net gain that would be shown as a result of the adjustment is $52,616 ($70,451 - $17,835). Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Moderate AACSB: Application of knowledge

13) Slade Corporation, a U.S. company, purchased materials on account from a manufacturer in Mexico on June 15. The invoice was denominated in the shipper's currency for 480,000 pesos. The goods were paid for on July 18. Slade closes their fiscal year on June 30, and used the following indirect quotes to measure the amounts related to the transactions. June 15 $1.00 = 12.50 pesos June 30 $1.00 = 12.80 pesos July 18 $1.00 = 12.00 pesos Required: Show all related journal entries for Slade Company. Answer: Slade's General Journal Date 06/15/14

06/30/14

07/18/14

Account Name Material Inventory Accounts Payable (peso)

Debit 38,400

Credit 38,400

Accounts Payable (peso) Exchange Gain (adj. A/P to 480,000 peso/ $12.80)

900 900

Cash (peso) Cash

40,000

Accounts Payable (peso) Exchange Loss Cash (peso) (480,000 peso / $12.00)

37,500 2,500

40,000

14) The table below provides either a direct or indirect quote for a given foreign currency unit, and the related units of that foreign currency. Quote 1 fcu : $0.0065 $1 : .0098 fcu 1 fcu : $0.0796 $1 : .0688 fcu 1 fcu : $0.3597 $1 : .8443 fcu 1 fcu : $1.68 $1 : 1.64 fcu 1 fcu : $12.67 $1 : 184.66 fcu 1 fcu : $166.79

Foreign Currency Units 40,000 fcu 980 fcu 80,000 fcu 55,040 fcu 110,000 fcu 25,329 fcu 50,000 fcu 29,520 fcu 5,000 fcu 738,640 fcu 700 fcu

U.S. Dollars

Required: Complete the table, indicating the amount of U.S. Dollars that is the equivalent of the foreign currency shown, based on the direct or indirect quote provided. Answer: Quote Foreign Currency Units U.S. Dollars 1 fcu : $0.0065 40,000 fcu $260 $1 : .0098 fcu 980 fcu 100,000 1 fcu : $0.0796 80,000 fcu 6,368 $1 : .0688 fcu 55,040 fcu 800,000 1 fcu : $0.3597 110,000 fcu 39,567 $1 : .8443 fcu 25,329 fcu 30,000 1 fcu : $1.68 50,000 fcu 84,000 $1 : 1.64 fcu 29,520 fcu 18,000 1 fcu : $12.67 5,000 fcu 63,350 $1 : 184.66 fcu 738,640 fcu 4,000 1 fcu : $166.79 700 fcu 116,753 Objective: LO12.3 Understand key concepts related to foreign currency exchange rates, such as indirect and direct quotes; floating, fixed, and multiple exchange rates; and spot, current, and historical exchange rates. Difficulty: Easy AACSB: Application of knowledge

15) In September of 2014, Gunny Corporation anticipates that the price of heating oil will increase soon, and wishes to lock in a firm price for the winter months. They enter into a forward contract with Selton Industries to buy 100,000 barrels of oil at $160 per barrel in December 2014. Selton's cost of production of the heating oil is $120 per barrel. Required: Determine the economic impact of the transaction to Selton (the seller of the heating oil) at the market price levels indicated in the table below, with and without the hedge. Unhedged Economic Gain Market Price Forward Price Market Gain / / (Loss) on per Barrel per Bushel (Loss) Forward $180 170 160 150 140

Economic Income with Hedge

Answer: Unhedged Economic Gain Economic Market Price Forward Price Market Gain / / (Loss) on Income with per Barrel per Bushel (Loss) Forward Hedge $180 $160 $6,000,000 (2,000,000) 4,000,000 170 160 5,000,000 (1,000,000) 4,000,000 160 160 4,000,000 0 4,000,000 150 160 3,000,000 1,000,000 4,000,000 140 160 2,000,000 2,000,000 4,000,000 Objective: LO12.2 Understand the structure, benefits, and costs of options, futures contracts, forward contracts, and swaps. Difficulty: Moderate AACSB: Application of knowledge

16) On November 4, 2014, the Oak Corporation, a U.S. corporation, purchased components for an assembly machine from Maple Industries, a Canadian Company, which were put into Parts Inventory. The purchase price was 80,000 Canadian dollars and Oak agreed to pay in Canadian dollars in 90 days. Both corporations are on a calendar year accounting period. Assume that the spot rates for the Canadian dollar on November 4, 2014, December 31, 2014, and February 2, 2015, are $0.9985, $1.0191, and $1.0064, respectively. Required: Record the November 4, December 31, and February 2 transactions in the General Journals of Oak Corporation and Maple Industries. If no entry is required on a particular date, indicate "No entry" in the General Journal. Answer: Oak's General Journal Date 11/04/14

12/31/14

02/02/15

Account Name Parts Inventory Accounts Payable (Can $)

Debit 79,880

Exchange Loss Accounts Payable (Can $) (Can $80,000 × $1.0191 = $81,528) ($79,880 - $81,528 = $1,648 loss)

1,648

Accounts Payable (Can $) Exchange Gain (Can $80,000 × $1.0064 = $80,512) ($81,528 - $80,512 = $1,016 gain)

1,016

Cash (Can $) Cash

80,512

Accounts Payable (Can $) Cash (Can $)

80,512

Credit 79,880

1,648

1,016

80,512

Maple's General Journal 11/04/14

Accounts Receivable Sales Revenue

12/31/14

No entry

02/02/15

Cash (Can $) Accounts Receivable

80,000 80,000

17) Blue Corporation, a U.S. manufacturer, sold goods to their customer in Hungary on December 12, 2014 for 6,000,000 Hungarian forints. The customer agreed to pay in Hungarian forints in 30 days. When the customer wired the foreign currency to Blue on January 11, 2015, Blue held them in their bank account until January 15 before selling them and converting them to U.S. dollars. The following exchange rates apply: Dec 12, 2014 Dec 31, 2014 Jan 11, 2015 Jan 15, 2015

$0.0055 $0.0049 $0.0063 $0.0059

Required: Record the journal entries that Blue would need related to the dates listed above. If no entry is required, state "no entry." Answer: Blue's General Journal Date Account Name Debit Credit 12/12/14 Accounts Receivable (forint) 33,000 Sales Revenue 33,000 12/31/14

01/11/15

01/15/15

Exchange Loss Accounts Receivable (forint) (6,000,000 forints × ($.0055 - $.0049))

3,600

Cash (forint) Exchange Gain Accounts Receivable (forint) (6,000,000 forints × $0.0063)

37,800

Cash Exchange Loss Cash (forint) (6,000,000 forints × $0.0059)

35,400 2,400

3,600

8,400 29,400

37,800

18) Plymouth Corporation (a U.S. company) began operations on September 1, 2014, when the owner borrowed $250,000 to establish the business. Plymouth then had the following import and export transactions with unaffiliated Chinese companies: September 6, 2014

Bought material inventory for 100,000 yuan on account. Invoice denominated in yuan

September 18, 2014

Sold 80% of inventory acquired on 9/6/14 for 110,000 yuan on account. Invoice denominated in yuan

October 5, 2014

Acquired and paid the 100,000 yuan owed to the Chinese supplier

October 18, 2014

Collected the 110,000 yuan from the Chinese customer and immediately converted them into U.S. dollars

The following exchange rates apply: Date Rate September 6 $0.1544 = 1 yuan September 18 $0.1607 = 1 yuan September 30 $0.1591 = 1 yuan October 5 $0.1578 = 1 yuan October 18 $0.1593 = 1 yuan Required: 1. What were Sales in the September month-end income statement? 2. What was the COGS associated with these sales? 3. What is the Accounts Receivable balance in the balance sheet at September 30, 2014? 4. What is the Inventory balance in the balance sheet at September 30, 2014? 5. What is the Exchange gain or loss that will be reported for the month of September? Answer: 1. Sales = September 18 sale of 110,000 yuan at $.1607 / yuan = $17,677 2. COGS = 80% of inventory balance purchased 9/6/14 = 100,000 yuan × $.1544 = $15,440 × 80% = $12,352 3. Accounts Receivable balance = 110,000 yuan × $.1591 = $17,501 4. Inventory balance = 100,000 yuan × $.1544 = $15,440 × 20% remaining after sale = $3,088 5. Exchange Gain / (Loss) in September = A/R = 110,000 yuan × ($.1591 - $.1607) = ($176) Loss A/P = 100,000 yuan × ($.1591 - $.1544) = ($470) Loss $176 Loss + 470 Loss = ($646) Net Loss in September Objective: LO12.5 Record foreign currency - denominated sales/receivables and purchases/payables at the initial transaction date, period-end, and the receivable or payable settlement date. Difficulty: Difficult AACSB: Application of knowledge

19) Charin Corporation, a U.S. corporation, imports and exports small electronics. On December 1, 2014, Charin purchased components from an Egyptian manufacturer amounting to 500,000 Egyptian pounds. The purchase is payable in Egyptian pounds. At December 30, Charin wanted to take advantage of favorable exchange rates, but did not have the full amount required to pay off the entire amount. Charin wired the funds to pay off half of the balance owed, and expected to pay the remaining balance on January 3, 2015. Charin paid the remaining balance on January 3, 2015. The respective exchange rates were as follows: December 1, 2014 1 pound = $.170 December 30, 2014 1 pound = $.165 December 31, 2014 1 pound = $.175 January 3, 2015 1 pound = $.180 Required: Document the journal entries related to these transactions for the four dates shown. If no entry is required, record "no entry." Answer: Charin's General Journal Date 12/1/14

12/30/14

12/31/14

01/3/15

Account Name Inventory Accounts Payable (pound)

Debit 85,000

Cash (pound) Cash

41,250

Accounts Payable (pound) Exchange Gain Cash (pound) (250,000 pounds × ($.165 - $.170))

42,500

Exchange Loss Accounts Payable (pound) (250,000 pounds × ($.175 - $.17))

1,250

Cash (pound) Cash

45,000

Accounts Payable (pound) Exchange Loss Cash (pound) (250,000 pounds × $0.180)

43,750 1,250

Credit 85,000

41,250

1,250 41,250

1,250

45,000

20) Meric Corporation (a U.S. company) began operations on January 1, 2014, when the owner borrowed $150,000 to start the company. In the first month of operations, Meric had the following transactions: January 3, 2014

Bought inventory for 100,000 Brazilian real on account. Must be paid with Brazilian real

January 8, 2014

Sold 60% of inventory acquired on 1/3/14 for 32,000 British pounds on account. Invoice denominated in British pounds

January 10, 2014 Paid $3,000 in other operating expenses January 23, 2014 Acquired and paid half of the Brazilian real owed to the Brazilian supplier January 28, 2014 Collected half of the 32,000 pounds from the customer in Great Britain and immediately converted them into U.S. dollars The following exchange rates apply: Date Rate January 3 $.6260 = 1 real January 8 $.6230 = 1 real January 10 $.6210 = 1 real January 23 $.6250 = 1 real January 28 $.6330 = 1 real January 31 $.6180 = 1 real

Rate $1.5950 = 1 pound $1.5760 = 1 pound $1.5880 = 1 pound $1.5610 = 1 pound $1.5570 = 1 pound $1.5720 = 1 pound

Required: Complete the summary income statement and balance sheet for the month ended January 31, 2014 assuming there were no other transactions. January 31 INCOME STATEMENT Sales COGS Gross Margin Other Operating Expenses Exchange Gain / (Loss) Net Income BALANCE SHEET Cash Accounts Receivable Inventory Total Assets Accounts Payable Debt Retained Earnings Total Liabilities and Equity

Answer: January 31 INCOME STATEMENT Sales COGS Gross Margin Other Operating Expenses Exchange Gain / (Loss) Net Income

50,432 (37,560) 12,872 (3,000) 82 9,954

BALANCE SHEET Cash Accounts Receivable Inventory Total Assets

140,662 25,152 25,040 190,854

Accounts Payable Debt Retained Earnings Total Liabilities and Equity

30,900 150,000 9,954 190,854

12.3 True/False 1) The common characteristic of derivatives is the contract's value to the investor has a direct relationship to fluctuations in price, rate and other variables. Answer: TRUE Objective: LO12.1 Understand the definition of a derivative and the types of risks that derivatives can manage. Difficulty: Easy AACSB: Analytical thinking

2) One reason corporations enter into a derivative contract is to reduce the vulnerability of their cash flows. Answer: TRUE Objective: LO12.1 Understand the definition of a derivative and the types of risks that derivatives can manage. Difficulty: Easy AACSB: Analytical thinking

3) Forward contracts are negotiated contracts between three or more parties for the delivery or purchase of a commodity or foreign currency at a preagreed delivery date. Answer: FALSE Objective: LO12.2 Understand the structure, benefits, and costs of options, futures contracts, forward contracts, and swaps. Difficulty: Moderate AACSB: Analytical thinking

4) Forward contracts are very standardized and easily traded in the markets. Answer: FALSE Objective: LO12.2 Understand the structure, benefits, and costs of options, futures contracts, forward contracts, and swaps. Difficulty: Easy AACSB: Analytical thinking

5) Futures contracts are very standardized and more easy to trade in the markets than forward contracts. Answer: TRUE Objective: LO12.2 Understand the structure, benefits, and costs of options, futures contracts, forward contracts, and swaps. Difficulty: Easy AACSB: Analytical thinking

6) Swaps are contracts to exchange an ongoing stream of cash flows. Answer: TRUE Objective: LO12.2 Understand the structure, benefits, and costs of options, futures contracts, forward contracts, and swaps. Difficulty: Easy AACSB: Analytical thinking

7) A put option requires the seller to buy an asset at market price and the buyer of the put option has the option to sell the asset at market. Answer: FALSE Objective: LO12.2 Understand the structure, benefits, and costs of options, futures contracts, forward contracts, and swaps. Difficulty: Moderate AACSB: Analytical thinking

8) Transactions between businesses of different countries, the amounts for receivables and payables are typically denominated in the local currency of either the buying entity or the selling entity. Answer: TRUE Objective: LO12.3 Understand key concepts related to foreign currency exchange rates, such as indirect and direct quotes; floating, fixed, and multiple exchange rates; and spot, current, and historical exchange rates. Difficulty: Moderate AACSB: Analytical thinking

9) Floating exchange rates reflect fluctuating market prices for a currency based on supply and demand in the world currency markets. Answer: TRUE Objective: LO12.3 Understand key concepts related to foreign currency exchange rates, such as indirect and direct quotes; floating, fixed, and multiple exchange rates; and spot, current, and historical exchange rates. Difficulty: Easy AACSB: Analytical thinking

10) Gains and losses on foreign currency transactions can be deferred until the foreign currency is converted into U.S. dollars. Answer: FALSE Objective: LO12.4 Explain the difference between receivable or payable measurement and denomination. Difficulty: Moderate AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 13 Accounting for Derivatives and Hedging Activities 13.1 Multiple Choice Questions 1) Which of the following hedging strategies would a business most likely use? A) An importer will want to hedge his foreign denominated accounts receivable and will purchase forward contracts to hedge an exposed net asset position. B) An importer will want to hedge his foreign denominated accounts payable and will purchase forward contracts to hedge an exposed net liability position. C) An exporter will want to hedge his foreign denominated accounts receivable and will purchase forward contracts to hedge an exposed net liability position. D) An exporter will want to hedge his foreign denominated accounts payable and will purchase forward contracts to hedge an exposed net liability position. Answer: B Objective: LO13.2 Understand the definition of a cash-flow hedge and the circumstances in which a derivative is accounted for as a cash-flow hedge. Difficulty: Easy AACSB: Analytical thinking

2) A highly-effective hedge of an existing asset or liability that is reported on the balance sheet would be recorded using A) Modified Cash Basis Accounting. B) Critical Term Hedge Analysis. C) Fair Value Hedge Accounting. D) Hedge of Net Investment in Foreign Subsidiary. Answer: C Objective: LO13.2 Understand the definition of a cash-flow hedge and the circumstances in which a derivative is accounted for as a cash-flow hedge. Difficulty: Easy AACSB: Analytical thinking

3) Which of the following is NOT an approach appropriate for hedge accounting? A) Cash Flow Hedge Accounting B) Critical Term Hedge Accounting C) Fair Value Hedge Accounting D) Hedge of Net Investment in Foreign Subsidiary Answer: B Objective: LO13.2 Understand the definition of a cash-flow hedge and the circumstances in which a derivative is accounted for as a cash-flow hedge. Difficulty: Easy AACSB: Analytical thinking

4) If a financial instrument is classified as a cash flow hedge, then A) its gains or losses are reported in the income statement if a fiscal year-end occurs before the settlement date. B) it is classified as a held-to-maturity asset. C) it does not require a notional amount. D) its gains or losses are reported in the balance sheet if a fiscal year-end occurs before the settlement date. Answer: D Objective: LO13.1 Account for derivative instruments that are not designated as a hedge. Difficulty: Easy AACSB: Analytical thinking

5) When a cash flow hedge is appropriate, the effective portion of the gain or loss on the derivative is A) deferred using other comprehensive income. B) recognized immediately at the time the agreement is made. C) recognized over time, amortized over the period of the agreement. D) recognized over time, offset by the fluctuation in the value of the hedged asset or liability. Answer: A Objective: LO13.2 Understand the definition of a cash-flow hedge and the circumstances in which a derivative is accounted for as a cash-flow hedge. Difficulty: Easy AACSB: Analytical thinking

6) Barnes Company entered into a forward contract during the current year to hedge the risk of a material supply cost increase. Based on the current market, at year-end the present value of the estimated amount they will have to pay in ten months is $750,000. What entry would be recorded at year-end closing, assuming that no amount was recorded for this contract until this time? A) Forward Contract (+A) $750,000 Other Comprehensive Income (+SE)

$750,000

B) Forward Contract (+A) Earnings (+SE)

$750,000 $750,000

C) Other Comprehensive Income (-SE) Earnings (+SE)

$750,000

D) Other Comprehensive Income (-SE) Forward Contract (+L)

$750,000

Answer: D Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Analytical thinking

7) A forward contract used as a cash flow hedge will be recorded as an asset if A) the holder is expecting to receive a payment as a result of the contract. B) the holder is accounting for the hedged instrument as a fair value hedge. C) the holder is hedging the net investment in a foreign entity. D) the holder is using the alternate accounting method and deferring all gains or losses from the hedge. Answer: A Objective: LO13.1 Account for derivative instruments that are not designated as a hedge. Difficulty: Easy AACSB: Analytical thinking

8) A fair value hedge differs from a cash flow hedge because a fair value hedge A) cannot be used for firm purchase or sales commitments. B) is not recorded unless it is a highly-effective hedge. C) records gains or losses in the value of the derivative directly to earnings of the company. D) defers the gains or losses in the value of the derivative using Other Comprehensive Income. Answer: C Objective: LO13.3 Understand the definition of a fair-value hedge and the circumstances in which a derivative is accounted for as a fair-value hedge. Difficulty: Easy AACSB: Analytical thinking

9) The purchase price of an option contract is typically recorded as A) an expense. B) an asset. C) an amortized cost. D) a component of shareholders equity. Answer: B Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Easy AACSB: Analytical thinking

10) Taydus Corporation, a U.S. corporation, sold goods on December 2 to a company overseas, and is now carrying a receivable denominated in euros. Taydus signed a 60-day forward contract on that same date to sell euros. The spot rate was $1.40 on the date they signed the contract and the 60-day forward rate was $1.36. At the end of that month when they closed the books at their fiscal year-end, the spot rate was $1.42 and the 30-day forward rate was $1.40. Assume this is a fair value hedge. The forward contract will not be settled net. What would be reported by Taydus for the year ending December 31? A) Net exchange gain B) Net exchange loss C) Deferred exchange gain D) Deferred exchange loss Answer: B Explanation: B) The spot rate increased $.02, resulting in a gain on the receivable. The forward rate increased $.04, resulting in a larger loss on the forward, thus they experienced a net exchange loss. Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Analytical thinking

11) Cirtus Corporation, a U.S. corporation, placed an order for inventory from a Mexican supplier on September 18 when the spot rate was $0.0840 = 1 peso. The invoice price will be denominated in pesos. Also on September 18, they entered into a 30-day forward contract (designated as a fair value hedge of the firm commitment to purchase) to purchase 860,000 pesos at a forward rate of $0.0810. On October 18 when the inventory was received, the spot rate was $0.0890. At what amount should the inventory be carried on Cirtus' books at the time of contract? A) $69,660 B) $72,240 C) $76,540 D) $860,000 Answer: A Explanation: A) Inventory = 860,000 × .081 = $69,660 Objective: LO13.5 Understand the special derivative accounting related to hedges of existing foreign currencydenominated receivables and payables. Difficulty: Moderate AACSB: Analytical thinking

12) When preparing their year-end financial statements, the Warner Company includes a footnote regarding their hedging activities during the year. Which of the following is NOT required to be disclosed? A) How hedge effectiveness is determined and assessed B) The specific types of risks being hedged, and how they are being hedged C) Alternative hedging options declined D) The net gain or loss reported for the period for fair value hedges and where in the financial statements it is reported Answer: C Objective: LO13.6 Comprehend the footnote disclosure requirements for derivatives. Difficulty: Moderate AACSB: Analytical thinking

13) International accounting standards differ from U.S. Generally Accepted Accounting Principles in that International standards A) require that firm sale or purchase commitments are accounted for as fair value hedges. B) require that firm sale or purchase commitments are accounted for as cash flow hedges. C) state that firm sale or purchase commitments may not be treated as a hedged transaction. D) permit firm sale or purchase commitments to be accounted for as either fair value hedges or cash flow hedges. Answer: D Objective: LO13.7 Understand the International Accounting Standards Board accounting for derivatives. Difficulty: Moderate AACSB: Analytical thinking

14) On May 1, 2014, Listing Corporation receives inventory items from their Bulgarian supplier. At the same time, Listing signed a forward contract to purchase 75,000 Bulgarian lev in sixty days to hedge the inventory purchase at $0.738, the 60-day forward rate. Payment for the inventory will be due in sixty days in Bulgarian lev. Assume the forward contract will be settled net and this qualifies as a fair value hedge. The related exchange rates are shown below:

Date May 1, 2014 May 31, 2014 June 30, 2014

Spot Rate $0.7270 $0.7350 $0.7420

Forward Rate to June 30 $0.7380 $0.7400 $0.7420

Assuming a present value factor of 1 for simplicity, what is the fair value of this forward contract on May 31? A) $150 asset B) $150 liability C) $375 asset D) $375 liability Answer: A Explanation: A) Current forward rate: 75,000 lev × $0.7400 $55,500 Contracted forward rate: 75,000 lev × $0.7380 (55,350) Net change in value 150 With PV = 1, Net change = asset value Objective: LO13.5 Understand the special derivative accounting related to hedges of existing foreign currencydenominated receivables and payables. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. On November 2, 2014, Bellamy Corporation sells product to their Danish customer. At the same time, Bellamy signed a forward contract to sell 200,000 Danish krone in ninety days to hedge the account receivable at $0.1905, the 90-day forward rate. The receivable is expected to be collected in ninety days. Assume the forward contract will be settled net and this is a fair value hedge. The related exchange rates are shown below:

Date November 2, 2014 December 31, 2014 January 31, 2015

Forward Rate Spot Rate to January 31 $0.1910 $0.1905 $0.1920 $0.1912 $0.1915 $0.1915

15) Assuming a present value factor of 1 for simplicity, what is the fair value of this forward contract on November 2? A) $-0B) $100 asset C) $100 liability D) $38,100 asset Answer: A Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Ethical understanding and reasoning

16) Assuming a present value factor of 1 for simplicity, what is the fair value of this forward contract on December 31? A) $160 asset B) $160 liability C) $140 asset D) $140 liability Answer: D Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Analytical thinking

17) Assuming a present value factor of 1 for simplicity, what is the fair value of this forward contract on January 31? A) $-0B) $ 60 asset C) $160 liability D) $200 liability Answer: D Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Analytical thinking

Use the following information to answer the question(s) below. On December 1, 2014, Thomas Company, a U.S. corporation, purchases inventory from a vendor in Italy for 400,000 euros. Payment is due in 90 days. To hedge the transaction, Thomas signs a forward contract to buy 400,000 euros in 90 days at $1.3670. Thomas uses a discount rate of 6% (present value factor for 30 days = .9950; 60 days = .9901; 90 days = .9851). Assume the forward contract will be settled net and this is a cash flow hedge. Currency exchange rates are shown below:

Date December 1, 2014 December 31, 2014 January 30, 2015 March 1, 2015

Spot Rate $1.3694 $1.3642 $1.3670 $1.3712

Forward Rate to March 1 $1.3670 $1.3660 $1.3690 $1.3712

18) What is the fair value of the forward contract at December 31, 2014? A) $400.00 liability B) $400.00 asset C) $396.04 liability D) $396.04 asset Answer: C Explanation: C) Current forward rate: 400,000 euros × $1.3660 $546,400 Contracted forward rate: 400,000 euros × $1.3670 546,800 Net change in value (400) PV for 60 days @ 6% .9901 Fair value of forward contract on 12/31/14 $ (396.04) Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Analytical thinking

19) What is the fair value of the forward contract at January 30? A) $796 liability B) $796 asset C) $800 liability D) $800 asset Answer: B Explanation: B) Current forward rate: 400,000 euros × $1.369 $547,600 Contracted forward rate: 400,000 euros × $1.367 546,800 Net change in value 800 PV for 30 days @ 6% .9950 Fair value of forward contract on 1/30/15 $ 796 Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Analytical thinking

20) What is the fair value of the forward contract at March 1? A) $-0B) $1,654.97 asset C) $1,654.97 liability D) $1,680 asset Answer: D Explanation: D) Current forward rate: 400,000 euros × $1.3712 $548,480 Contracted forward rate: 400,000 euros × $1.367 546,800 Net change in value 1,680 PV for 0 days @ 6% 1.0 Fair value of forward contract on 3/1/15 $1,680 Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Analytical thinking

13.2 Exercises 1) On November 1, 2014, Portsmith Corporation, a calendar-year U.S. corporation, invested in a purely speculative contract to purchase 1 million yen on January 30, 2015, from the Karoke Trading Company, a Japanese brokerage firm. Portsmith agreed to purchase 1,000,000 yen from Karoke at a fixed price of $0.0100 per yen. Karoke agreed to transmit 1,000,000 yen to Portsmith on January 30. Net settlement is not permitted. The spot rates for yen are: Nov 01, 2014 1 yen = $0.0097 Dec 31, 2014 1 yen = $0.0104 Jan 30, 2015 1 yen = $0.0106 The 30-day forward rate for yen on December 31, 2014 was $0.0104. Required: Prepare the General Journal entries that Portsmith would record on November 1, December 31, and January 30. Answer: Portsmith's General Journal 11/01/14

12/31/14

01/30/15

Contract Receivable (yen) Contract Payable (1,000,000 × $0.0100)

10,000 10,000

Contract Receivable (yen) Exchange Gain [1,000,000 × ($0.0104 - $0.0100)]

400

Contract Receivable (yen) Exchange Gain [1,000,000 × ($0.0106 - $0.0104)]

200

Cash (yen) Contract Payable Cash Contract Receivable (yen)

10,600 10,000

400

200

10,000 10,600

Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Application of knowledge

2) On November 1, 2014, Ross Corporation, a calendar-year U.S. corporation, invested in a purely speculative contract to purchase 1 million euros on January 30, 2015, from Trattoria Company, an Italian brokerage firm. Ross agreed to purchase 1,000,000 euros from Trattoria at a fixed price of $1.420 per euro. Trattoria agreed to transmit 1,000,000 euros to Ross on January 30, 2015. Net settlement is not permitted. The spot rates for euros are: Nov 01, 2014 1 euro = $1.415 Dec 31, 2014 1 euro = $1.395 Jan 30, 2015 1 euro = $1.410 The 30-day futures rate for euros on December 31, 2014 was $1.405. Required: Prepare the General Journal entries that Ross would record on November 1, December 31, and January 30. Answer: Ross's General Journal 11/01/14

12/31/14

01/30/15

Contract Receivable (euro) Contract Payable (1,000,000 × $1.420/euro)

1,420,000 1,420,000

Exchange Loss Contract Receivable (euro) {1,000,000 × ($1.405 - $1.420)}

15,000

Contract Receivable (euro) Exchange Gain {1,000,000 × ($1.410 - $1.405)}

5,000

15,000

5,000

Cash (euro) Contract Payable Cash Contract Receivable (euro)

1,410,000 1,420,000 1,420,000 1,410,000

Objective: LO13.5 Understand the special derivative accounting related to hedges of existing foreign currencydenominated receivables and payables. Difficulty: Moderate AACSB: Application of knowledge

3) On June 1, 2014, Dapple Industries purchases an option contract for $5,000 on 10,000 gallons of aviation gas to minimize its purchasing cost price exposure. At the time, the market price is $2.50 per gallon and the option price of $2 per gallon will expire 6 months later. Dapple can exercise the option at its discretion. When Dapple prepares quarterly reports on June 30, Dapple is still holding the option. On June 30, the market price of aviation gas is $4.50 per gallon. The option is to be settled net. On August 1, Dapple exercises the option when the gas market price is $5.00 per gallon and purchases 40,000 gallons of gas. On August 15, Dapple uses all of the gas on a charter flight. Required: What are Dapple's journal entries with regard to the aviation gas option? Assume this is a cash flow hedge. Ignore the time value of money. Answer: Dapple's General Journal 6/01/14

6/30/14

8/01/14

8/15/14

Aviation gas contract option Cash

5,000

Aviation gas contract option Other comprehensive income (($4.50-$2.00) × 10,000 gallons = fair value debit balance of $25,000; unadjusted debit balance = $5,000 from June 1 entry.)

20,000

5,000

20,000

Cash 30,000 Aviation gas contract option Other comprehensive income (Net settlement = ($5 - $2) × 10,000 gallons = $30,000 received)

25,000 5,000

Aviation gas inventory Cash (40,000 gallons × $5 per gallon)

200,000 200,000

Cost of goods sold Aviation gas inventory

200,000

Other comprehensive income Cost of goods sold

25,000

200,000

25,000

Objective: LO13.2 Understand the definition of a cash-flow hedge and the circumstances in which a derivative is accounted for as a cash-flow hedge. Difficulty: Difficult AACSB: Application of knowledge

4) On November 1, 2014, Moddel Company (a U.S. corporation) entered into a 90-day forward contract to purchase 200,000 British pounds. The purpose of the forward contract is to hedge a commitment to purchase special equipment on January 30, 2015 from a British firm Jeckyl Inc. The invoice price on the purchase commitment is denominated in British pounds. The forward contract is not settled net. Assume Moddel uses a 12% interest rate. Use a fair value hedge. The relevant exchange rates are stated in dollars per pound:

November 1, 2014 December 31, 2014 January 30, 2015

Spot Rate $1.32 $1.47 $1.55

Forward Rate to Jan. 30, 2015 $1.35 $1.50 -

Required: 1.What journal entry did Moddel record on November 1, 2014? 2.What journal entries did Moddel record on December 31, 2014? 3.What journal entries did Moddel record on January 30, 2015 if the purchase was made?

Answer: 11/01/14

12/31/14

01/30/15

Contract receivable (pounds) Contract payable (200,000 × $1.35)

270,000

Contract receivable (pounds) Exchange gain 200,000 × ($1.50 - $1.35)

30,000

Exchange loss Change in value of firm commitment in pounds 200,000 × ($1.50 - $1.35)

30,000

Exchange loss Change in value of firm commitment in pounds 200,000 × ($1.55 - $1.50)

10,000

Contract receivable (pounds) Exchange gain 200,000 × ($1.55 - $1.50)

10,000

Contract payable Cash

270,000

Cash (pounds) 200,000 × $1.55 Contract receivable (pounds)

310,000

Equipment Change in value of firm commitment in pounds Accounts payable (pounds)

270,000 40,000

Accounts payable (pounds) Cash (pounds)

310,000

270,000

30,000

10,000

270,000

310,000

Objective: LO13.5 Understand the special derivative accounting related to hedges of existing foreign currencydenominated receivables and payables. Difficulty: Difficult AACSB: Application of knowledge

5) On November 1, 2013, Mayberry Corporation, a U.S. corporation, purchased from Cantata Corporation, a Mexican company, some machinery that cost 1,000,000 pesos. The invoice was payable in pesos on January 30, 2014. To hedge against rapid changes in the peso, Mayberry entered into a forward contract on November 1, 2013 with AB Trader & Company, a U.S. brokerage and investment firm. The contract specified that Mayberry would buy 1,000,000 pesos from AB Trader at $0.084 per peso for settlement on January 30, 2014. Assume that all three companies are subject to the same accounting standards and have December 31st year-ends. The spot rates for pesos on November 1, December 31, and January 30, are $0.082, $0.080, and $0.089, respectively. The 30-day forward rate for pesos on December 31, 2013 is $0.083. The forward contract is not settled net. Required: Record General Journal entries for Mayberry Corporation on November 1, December 31, and January 30. If no entry is required on a particular date, indicate "No entry" in the General Journal. This is a fair value hedge.

Answer: Mayberry's General Journal Date 11/01/13

11/01/13

12/31/13

01/30/14

Account Name Machinery Accounts Payable (pesos)

Debit 82,000

Contract Receivable (pesos) Contract Payable

84,000

Accounts Payable (pesos) Exchange Gain ((.082 - .080) × 1,000,000)

2,000

Exchange Loss Contract Receivable (pesos) [($.083 - $.084) × 1,000,000]

1,000

Exchange Loss Accounts Payable (pesos) [(.089 - .080) × 1,000,000]

9,000

Contract Receivable (pesos) Exchange Gain [(.089 - .083 ) × 1,000,000]

6,000

Cash (pesos) Contract payable Contract Receivable (pesos) Cash

89,000 84,000

Accounts Payable (pesos) Cash (pesos)

89,000

Credit 82,000

84,000

2,000

1,000

9,000

6,000

89,000 84,000

89,000

Objective: LO13.5 Understand the special derivative accounting related to hedges of existing foreign currencydenominated receivables and payables. Difficulty: Moderate AACSB: Application of knowledge

6) On November 1, 2013, Athom Corporation purchased 5,000 television sets for its merchandise inventory from Sockk, a South Korean firm, at a total quoted cost of 600,000,000 won (W). On this date, the spot rate for the won was $1 = 1,080W. On the same day, Athom invested $500,000 cash in a noninterest bearing account with a Japanese bank, to hedge its exposed liability position. The account payable to Sockk is due on January 30, 2014. The exchange rates on December 31, 2013 and January 30, 2014 were $1 = 1,060W, and $1 = 1,030W, respectively. Athom agreed to pay Sockk in won. The bank deposit made by Athom will be held in won, but will be withdrawn in dollars by Athom on January 30th. Assume that Athom has a December 31 year-end. Assume this is a fair value hedge. Required: Prepare all the journal entries for Athom Corporation's General Journal on November 1, 2013, December 31, 2013, and January 30, 2014. Round entries to the nearest whole dollar. If no entry is required on a particular date, indicate "No entry" in the General Journal.

Answer: Athom's General Journal 11/01/13

12/31/13

Inventory Accounts Payable (won) (600,000,000/1,080W per $1)

555,556

Cash (won) Cash Value of deposit in won: $500,000 × 1,080 won per $1 = 540,000,000 won

500,000

Cash (won) Exchange Loss Accounts Payable (won) Exchange Gain

9,434 10,482

555,556

500,000

10,482 9,434

Account Payable: 600,000,000/1,060W = $566,038 $566,038 - $555,556 = $10,482 Cash (won): 540,000,000/1,060W = $509,434 $509,434 - $500,000 = $9,434 01/30/14

Cash (won) Exchange Loss Exchange Gain Accounts Payable (won)

14,838 16,486 14,838 16,486

Account Payable: 600,000,000/1,030W = $582,524 $582,524 - $566,038 = $16,486 Cash (won): 540,000,000/1,030W = $524,272 $524,272 - $509,434 = $14,838 Accounts Payable (won) Cash (won)

582,524

Cash Cash (won)

524,272

582,524

524,272

Objective: LO13.3 Understand the definition of a fair-value hedge and the circumstances in which a derivative is accounted for as a fair-value hedge. Difficulty: Moderate AACSB: Application of knowledge

7) On November 1, 2013, Stateside Company (a U.S. manufacturer) sold an airplane for 1 million New Zealand dollars (NZ$) to New Zealand company Aukland Corporation. Stateside will receive payment on January 30, 2014 in New Zealand dollars. In order to hedge the accounts receivable position, Stateside entered into a 90-day forward contract to sell 1 million New Zealand dollars on January 30, 2014. On November 1, 2013, the 90-day forward rate is U.S. $0.73 per New Zealand dollar. The forward contract will be settled net. Account for the hedge as a fair value hedge. Ignore the time value of money. The relevant exchange rates per New Zealand dollar:

Nov. 1, 2013 Dec. 31, 2013 Jan. 30, 2014

Spot Rate U.S. $0.73 U.S. $0.75 U.S. $0.79

Forward Rate to 1/30/14 U.S. $0.73 U.S. $0.76 U.S. $0.79

Required: Record the journal entries that Stateside would need to prepare at November 1, 2013, December 31, 2013 and January 30, 2014. December 31, 2013 is the fiscal year end. Answer: Stateside's General Journal 11/1/13

12/31/13

01/30/14

Accounts receivable (NZ$) Sales

730,000

Accounts Receivable (NZ$) Exchange gain

20,000

Loss on forward contract Forward contract (($.76 - $.73) × 1,000,000 = $30,000)

30,000

Accounts Receivable (NZ$) Exchange gain

40,000

Loss on forward contract Forward contract (($.79 - $.76) × 1,000,000 = $30,000)

30,000

Cash Accounts receivable

790,000

Forward contract Cash

60,000

730,000

20,000

30,000

40,000

30,000

790,000

60,000

8) On November 1, 2013, Ironside Company (a U.S. manufacturer) sold an airplane for 1 million New Zealand dollars (NZ$) to a New Zealand company, Wellington Corporation. Ironside will receive payment on January 30, 2014 in New Zealand dollars. In order to hedge the accounts receivable position, Ironside entered into a 90-day forward contract on November 1, 2013 to sell 1 million New Zealand dollars. On November 1, 2013, the forward rate is U.S. $0.79 per New Zealand dollar. The forward contract will be settled net. This is a fair value hedge. Ignore the time value of money. The relevant exchange rates per New Zealand dollar:

Nov. 1, 2013 Dec. 31, 2013 Jan. 30, 2014

Spot Rate U.S. $0.79 U S. $0.75 U.S. $0.73

Forward Rate to 1/30/14 U.S. $0.79 U.S. $0.76 U.S. $0.73

Required: Record the journal entries that Stateside would need to prepare at November 1, 2013, December 31, 2013 and January 30, 2014. December 31 is the fiscal year end. Answer: Ironside's General Journal 11/1/13

12/31/13

01/30/14

Accounts receivable (NZ$) Sales

790,000

Exchange loss Accounts Receivable (NZ$)

40,000

Forward Contract Gain on forward contract (($.79 - $.76) × 1,000,000 = $30,000)

30,000

Exchange loss Accounts Receivable (NZ$)

20,000

Forward contract Gain on forward contract (($.76 - $.73) × 1,000,000 = $30,000)

30,000

Cash Forward contract Accounts receivable

790,000

40,000

30,000

20,000

30,000

60,000 730,000

9) Onoly Corporation (a U.S. manufacturer) sold parts to its customer in Hong Kong on December 8, 2014 with payment of 500,000 Hong Kong Dollars (HKD) to be received in sixty days on February 6, 2015. Onoly has a December 31 year end. The following exchange rates apply:

December 8, 2014 December 31, 2014 February 6, 2015

Spot Rate $.1150 $.1300 $.1400

Forward Rate to February 6 $.1150 $.1250 $.1400

Required: 1. Assuming no forward contract is taken, what is the amount of foreign currency exchange gain or loss that would be recorded in 2014, and in 2015? 2. Assuming a 60-day forward contract is taken on December 8 with the intent of hedging this foreign currency transaction, and that this hedge is properly accounted for as a cash flow hedge, what is the net effect on income to be recorded in 2014, and in 2015? Answer: Requirement 1 Calculation of Onoly Gain/(Loss) for 2014: Receivable in dollars at 12/08/14 (500,000 HKD × $.115) Receivable in dollars at 12/31/14 (500,000 HKD × $.13) Increase in Receivable (Onoly Gain)

$57,500 65,000 $7,500

Calculation of Onoly Gain/(Loss) for 2015: Receivable in dollars at 12/31/14 (500,000 HKD × $.13) Receivable in dollars at 2/6/15 (500,000 HKD × $.14) Increase in Receivable (Onoly Gain)

$65,000 70,000 $5,000

Requirement 2 If accounted for as a cash flow hedge, the amount of gain from the Accounts receivable will be offset by an equal amount of loss that is credited to Other comprehensive income. The amount of loss from the Accounts receivable will be offset by an equal amount of gain that is debited to Other comprehensive income. The end result is a net income effect of -0- for both years. Objective: LO13.5 Understand the special derivative accounting related to hedges of existing foreign currencydenominated receivables and payables. Difficulty: Moderate AACSB: Application of knowledge

10) Slickton Corporation, a U.S. holding company, enters into a forward contract on November 1, 2014 to speculate in Singapore dollars (S$). The forward contract requires Slickton to sell 1,000,000 Singapore dollars to the exchange broker on January 30, 2015. Net settlement is not permitted. Relevant exchange rates for the Singapore dollar are listed below:

Spot rate 30-day forward rate 90-day forward rate

11/1/14 $0.806 $0.805 $0.804

12/31/14 $0.797 $0.792 $0.795

1/30/15 $0.802 $0.796 $0.789

Required: Prepare the journal entries required by Slickton on November 1, 2014, December 31, 2014 (year end), and January 30, 2015. Answer: 11/1/14 Contract receivable $804,000 Contract payable (S$) $804,000 To record contract to sell 1,000,000 S$'s to exchange broker in 90 days for the forward rate of $.804. 12/31/14

Contract payable (S$) $12,000 Exchange gain $12,000 To adjust contract payable in S$'s to the 30-day forward rate of $.792.

1/30/15

Contract payable (S$) $792,000 Exchange loss 10,000 Cash (S$) $802,000 To record payment of S$1,000,000 to exchange broker when spot rate is $.802. Cash $804,000 Contract receivable $804,000 To record receipt of U.S. dollars from exchange broker in settlement of account.

Objective: LO13.5 Understand the special derivative accounting related to hedges of existing foreign currencydenominated receivables and payables. Difficulty: Moderate AACSB: Application of knowledge

11) Wild West, Incorporated (a U.S. corporation) sold inventory to a company in the Philippines for 1,600,000 pesos on account on February 1, 2014, with payment expected in 90 days. Wild West entered into a forward contract to hedge this transaction, and properly accounts for the transaction as a cash flow hedge. Wild West has a March 31 fiscal year end, and uses an 8% discount rate, resulting in a 30-day present value factor of .9934. The forward contract is settled net. The relevant exchange rates are shown below:

February 1, 2014 March 31, 2014 May 2, 2014

Spot Rate $0.0229 = 1 peso $0.0254 = 1 peso $0.0280 = 1 peso

Forward Rate to May 2, 2014 $0.0270 = 1 peso $0.0268 = 1 peso $0.0280 = 1 peso

Required: Record the journal entries needed by Wild West on February 1, March 31, and May 2. Round all entries to the nearest whole dollar. Answer: 2/1/14

3/31/14

Accounts receivable (peso) Sales (1,600,000 × 0.0229)

36,640

Accounts receivable (peso) Exchange gain (1,600,000 × (0.0254 - 0.0229))

4,000

36,640

4,000

Forward contract Other comprehensive income

318 318

Current forward rate: 1,600,000 pesos × $0.0268 Contracted forward rate: 1,600,000 pesos × $0.0270 Net change in value PV for 30 days @ 6% Fair value of forward contract on 3/31/14 Exchange loss Other comprehensive income

4,000

Other comprehensive income Exchange gain

4,252

$42,880 43,200 320 .9934 $ 318

4,000

4,252

Discount rate = 0.00056435% per month $2,068 + $2,184= $4,252 $2,068 = 0.056435 × $36,640 $2,184 = [0.056435 × ($36,640 + $2,068)]

05/02/14

Accounts receivable (peso) Exchange gain (1,600,000 × (0.0280 - 0.0254))

4,160

Exchange loss Other comprehensive income

4,160

Other comprehensive income Exchange gain ($36,640 + $4,252) × 0.056435 = 2,308

2,308

Other comprehensive income Forward contract

1,918

4,160

2,308

1,918

Current forward rate: 1,600,000 pesos × $0.0280 Contracted forward rate: 1,600,000 pesos × $0.0270 Net change in value Add amount previously recorded

Cash (peso) Accounts receivable (peso) (1,600,000 × 0.028)

44,800

Forward contract Cash

1,600

$ 44,800 43,200 1,600 318 1,918

44,800

1,600

12) On December 15, 2014, Electronix Company purchased inventory from a foreign supplier for 2,000,000 foreign currency units (fcu's). Payment will be made on February 13, 2015. On December 15, 2014, to hedge the transaction, Electronix signed a forward contract to buy 2,000,000 fcu's in 60 days. Electronix uses a discount rate of 5% resulting in a 45-day present value factor of .9938. The forward contract will be settled net. The related exchange rates are shown below:

December 15, 2014 December 31, 2014 February 13, 2015

Spot Rate $0.010 = 1 fcu $0.012 = 1 fcu $0.013 = 1 fcu

Forward Rate to 2/13/15 $0.010 = 1 fcu $0.011 = 1 fcu $0.013 = 1 fcu

On December 15, 2014, Electronix recorded a debit to Inventory and a credit to Accounts Payable (fcu) for $20,000, using the current spot rate. Required: 1. Show the required entries on December 31, 2014 if the hedge is a cash flow hedge. Round to the nearest whole dollar. 2. Show the required entries on December 31, 2014 if the hedge is a fair value hedge. Round to the nearest whole dollar. Answer: 1. Year-end entries—Cash flow hedge: Exchange loss 4,000 Accounts payable (fcu) 4,000 (2,000,000 × (.012 - .010)) Forward contract Other comprehensive income

1,988 1,988

Current forward rate: 2,000,000 fcu × $.011 Contracted forward rate: 2,000,000 fcu × $.01 Net change in value PV for 45 days @ 5% Fair value of forward contract on 12/31/14

$ 22,000 20,000 2,000 .9938 $ 1,988

Other comprehensive income Exchange gain 2.

4,000 4,000

Year-end entries - Fair value hedge: Exchange loss Accounts payable (fcu)

4,000 4,000

Forward contract Gain on forward contract

1,988 1,988

Objective: LO13.3 Understand the definition of a fair-value hedge and the circumstances in which a derivative is accounted for as a fair-value hedge. Difficulty: Difficult AACSB: Application of knowledge

13) Astrotuff Company is planning to purchase 200,000 pounds of nylon from Tangsun Company. On November 1, 2014, Astrotuff entered into a 90-day forward contract to hedge the planned purchase. The forward contract is to purchase 200,000 pounds of nylon at $1.80 per pound (forward rate at November 1, 2014). On November 1, 2014, the spot price of nylon is $1.75 per pound, but Astrotuff anticipates significant increases in the price of nylon. The forward contract is to be settled net. On December 31, 2014, Astrotuff's year end, the forward rate to January 30, 2015 is $1.78 per pound. The spot and forward rates on January 30, 2015 are $1.85 per pound. Astrotuff uses a 6% discount rate relating to their hedging activity. Astrotuff purchases 200,000 pounds of nylon on January 30 when the forward contract expires. Required: Prepare the necessary journal entries to account for this cash flow hedge and related purchase of nylon. Answer: 11/1/14 No entry 12/31/14

Other Comprehensive Income Forward Contract

3,980 3,980

(200,000 × ($1.80 - $1.78))/(1.005)1

1/30/15

Exchange loss Other Comprehensive Income Discount rate = 0.0094345 per month $3,302 + $3,333 = $6,635 ($350,000 × 0.0094345) = $3,302 ($350,000 + $3,302) × 0.0094345 = $3,333

6,635

Forward Contract Other Comprehensive Income (($1.80 - $1.85) × 200,000) = $10,000 asset

13,980

6,635

13,980

Exchange loss 3,365 Other Comprehensive Income ($350,000 + $3,302 + $3,333) × 0.0094345 = 3,365 Cash Forward Contract

10,000

Nylon inventory Cash (200,000 × $1.85)

370,000

3,365

10,000

370,000

Objective: LO13.2 Understand the definition of a cash-flow hedge and the circumstances in which a derivative is accounted for as a cash-flow hedge. Difficulty: Moderate AACSB: Application of knowledge

14) On January 1, 2014, Bambi borrowed $500,000 from Lonni. The five-year term note carries a variable rate interest, based on LIBOR, and interest is payable at December 31 of each year, compounded annually. The first year's rate of interest is 6% and Bambi would like to assure that their rate does not increase. Bambi enters into a pay-fixed, receive-variable interest rate swap agreement with Third National Bank, under which Bambi will pay 6%, fixed. At December 31, 2014, it is determined that Bambi's interest rate to Lonni for the next year will be 5%. Treat as a cash flow hedge. Required: Determine the estimated fair value of the hedge at December 31, 2014, and prepare the related journal entry required to document this hedge and the related interest payment at December 31, 2014. Assume the interest rate curve is flat. Answer: Fair value of swap = PV of estimated future net payments:

Date of payment 12/31/15

Estimated payment based on 12/31/14 rate .01 × $500,000

12/31/16

.01 × $500,000

12/31/17

.01 × $500,000

12/31/18 Total

.01 × $500,000

12/31/14: Other comprehensive income Interest rate swap Interest Expense Cash

Factor 1/(1.05) 1/(1.05)2 1/(1.05)3 1/(1.05)4

Present Value $ 4,762 4,535 4,319 4,114 $17,730

17,730 17,730 30,000 30,000

15) On January 1, 2014, Bosna borrowed $100,000 from Lenda. The three-year term note carries a variable rate interest, based on LIBOR, and interest is payable at December 31 of each year, compounded annually. The first year's rate of interest is 7% and Bosna would like to assure that their rate does not increase. Bosna enters into a pay-fixed, receive-variable interest rate swap agreement with Swamp City Bank, under which Bosna will pay 7%, fixed. At December 31, 2014, it is determined that Bosna's interest rate to Lenda for 2015 will be 6%. At December 31, 2015, the interest rate for 2016 was determined to be 8%. Treat as a cash flow hedge. Required: Determine the estimated fair value of the hedge at December 31, 2014, and prepare the related journal entries required to document this hedge and the related interest payments at December 31, 2014, 2015, and 2016, including final repayment on 12/31/16. Assume a flat interest rate curve.

Answer: 12/31/14: Fair value of swap = PV of estimated future net payments:

Date of payment 12/31/15 12/31/16 Total 12/31/14

Estimated payment based on 12/31/14 rate .01 × $100,000 .01 × $100,000

Present Factor 1/(1.06) 1/(1.06)2

Other comprehensive income Interest rate swap

1,833

Interest Expense Cash

7,000

Value $943 890 $1,833

1,833

7,000

12/31/15: Fair value of swap = PV of estimated future net payments:

Date of payment 12/31/16 12/31/15

12/31/16

Estimated payment based on 12/31/15 rate .01 × $100,000

Present Value $ 926

Factor 1/(1.08)

Interest Expense Cash

6,000

Interest Expense Cash

1,000

Interest rate swap Other Comprehensive Income

2,759

Interest Expense Cash

8,000

Cash Interest Expense

1,000

6,000

1,000

2,759

8,000

1,000

Other Comprehensive Income Interest rate swap Loan Payable Cash

926 926 100,000 100,000

16) Ivan has 14,000 barrels of oil that were purchased a month ago at $50.00 per barrel. On November 1, 2014 Ivan hedges the value of the inventory by entering into a forward contract to sell 14,000 barrels of oil on January 31, 2015 for $60.00 per barrel. The forward contract is to be settled net. Assume this is a fair value hedge. Required: Assume a 6% discount rate is reasonable, and using a mixed-attribute model, prepare the journal entries to account for this hedge at the following dates:

November 1, 2014 December 31, 2014 January 31, 2015 Answer: 11/1/14 12/31/14

1/31/15

When the market price is... $60.00 per barrel $65.00 per barrel $62.00 per barrel

No entry Loss on forward contract Forward Contract [14,000 × ($65- $60)]/(1.005)

69,652

Inventory Gain on inventory [14,000 × ($65 - $60)]

70,000

Forward contract Cash Gain on forward contract [14,000 × ($60 - $62)]

69,652

Loss on inventory Inventory

42,000

69,652

70,000

28,000 41,652

42,000

17) Opie Industries is a manufacturer of plastic bottles. On September 1, 2014, Opie purchased an option contract at a cost of $2,000. The purpose of the option is to hedge against increases in the price of this type of plastic, "PET." The option is to buy 1,000,000 pounds of PET on March 1, 2015 for $.75 per pound. If the market price of PET is below $.75 on March 1, Opie will let the option expire. If the market price is above $.75, then Opie will exercise the option. The option is to be settled net. Opie assumes a 6% annual borrowing rate. Assume this is a cash flow hedge. Required: Prepare the entry that Opie should record on September 1, 2014. Then, assuming that the price of PET is $.72 on December 31, 2014 (Opie's year end), prepare the entry that Opie should record. Finally, prepare the entries for March 1, 2015, assuming that the price of PET is $.78. Answer: 9/1/14 PET Contract Option 2,000 Cash 2,000 12/31/14

3/1/15

Other comprehensive income 2,000 PET Contract Option (The option has no value because the market price is below the exercise price.) PET Contract Option Other comprehensive income [1,000,000 × ($0.78 - $0.75)] = 30,000

30,000

PET Inventory Cash

780,000

Cash PET Contract Option

30,000

2,000

30,000

780,000

30,000

18) Ferb Company is a U.S.-based importer of fine fabrics. They periodically place orders with an Italian manufacturer for bolts of fabric at a price typically set in euros. Because they have business on an ongoing basis in euros, Ferb also enters into forward contracts to speculate on the Euro. On September 15, Ferb entered into a 45-day forward contract to purchase 2,000,000 euros. Ferb has a year-end of September 30. The forward contract cannot be settled net. Relevant exchange rates are shown below:

Sep 15, 2014 Sep 30, 2014 Oct 30, 2014

Spot Rate $1.415 $1.395 $1.410

Forward Rate to October 30, 2014 $1.397 $1.399 $1.410

Required: Prepare the journal entries to account for the forward contract for September and October. Answer: 9/15/14 Contract Receivable (euro) 2,794,000 Contract Payable 2,794,000 (2,000,000 × $1.397) 9/30/14

10/30/14

Contract Receivable (euro) Exchange Gain [2,000,000 × ($1.397 - $1.399)]

4,000

Contract Receivable (euro) Exchange Gain [2,000,000 × ($1.410 - $1.399)]

22,000

Cash (euro) Contract Receivable (euro)

2,820,000

Contract Payable Cash

2,794,000

4,000

22,000

2,820,000

2,794,000

Objective: LO13.5 Understand the special derivative accounting related to hedges of existing foreign currencydenominated receivables and payables. Difficulty: Moderate AACSB: Application of knowledge

19) On December 18, 2014, Wabbit Corporation (a U.S. Corporation) has a Forward Contract recorded on their ledger as a debit balance of $17,500. The forward contract was related to a purchase of electronic components purchased overseas, which were going to be re-sold in the United States. On December 20, the forward contract was settled with a payment of $20,000, and the related parts which cost $118,000 were sold for $160,000 cash. The forward contract is set up to lock in the price for the electronic components when they are sold. The forward contract was settled net. Assume this is a cash flow hedge. Required: Prepare the journal entries required by Wabbit on December 20. Answer: 12/20/14 Cash 160,000 Sales Cost of Goods Sold 118,000 Inventory Sales Other Comprehensive Income Cash Forward Contract

160,000 118,000

20,000 17,500 20,000 17,500

20) On March 1, 2014, Amber Company sold goods to a foreign customer at a price of 50,000 foreign currency units. The customer will pay in three months. At the time of the sale, Amber paid $2,000 to acquire an option to sell 50,000 foreign currency units in three months at the strike price of $0.39. On May 30, 2014, the customer sent in 50,000 foreign currency units. Quarterly financial reports are prepared on March 31. Ignore the time value of money. Relevant exchange rates are as follows:

Mar 1, 2014 Mar 31, 2014 May 30, 2014

Spot Rate $0.39 $0.45 $0.36

Required: Prepare the journal entries required for these transactions, if the foreign currency option is designated as a fair value hedge. Answer: 3/1/14 Accounts Receivable (fcu) 19,500 Sales [$.039 × 50,000] 19,500

3/31/14

5/30/14

Foreign Currency Option Cash

2,000

Accounts Receivable (fcu) Foreign Exchange Gain [($.45 - $.39) × 50,000]

3,000

Loss on Foreign Currency Option Foreign Currency Option (The option has no value at this date.)

2,000

Cash (fcu) Foreign Exchange Loss Accounts Receivable (fcu) [($.36 - $.45) × 50,000]

18,000 4,500

Foreign Currency Option Gain on foreign currency option [50,000 × ($0.39 - $0.36)] = 1,500

1,500

Cash Foreign Currency Option

1,500

Cash Cash (fcu)

18,000

2,000

3,000

2,000

22,500

1,500

18,000

Objective: LO13.5 Understand the special derivative accounting related to hedges of existing foreign currencydenominated receivables and payables. Difficulty: Moderate AACSB: Application of knowledge

13.3 True/False 1) Hedge accounting is designed to record changes in the value of the hedged item and in the value of the hedging instrument in the same accounting period. Answer: TRUE Objective: LO13.1 Account for derivative instruments that are not designated as a hedge. Difficulty: Easy AACSB: Analytical thinking

2) One characteristic of a derivative is it does not require or permit net settlements. Answer: FALSE Objective: LO13.2 Understand the definition of a cash-flow hedge and the circumstances in which a derivative is accounted for as a cash-flow hedge. Difficulty: Moderate AACSB: Analytical thinking

3) Formal documentation defining the relationship between a hedged item and the derivative instrument must be prepared to qualify for hedge accounting. Answer: TRUE Objective: LO13.2 Understand the definition of a cash-flow hedge and the circumstances in which a derivative is accounted for as a cash-flow hedge. Difficulty: Easy AACSB: Analytical thinking

4) Two approaches to be used to determine hedge effectiveness include critical term analysis and statistical analysis. Answer: TRUE Objective: LO13.1 Account for derivative instruments that are not designated as a hedge. Difficulty: Easy AACSB: Analytical thinking

5) If an existing asset is being hedged, it and the derivative are marked to fair value at the end of every month. Answer: FALSE Objective: LO13.3 Understand the definition of a fair-value hedge and the circumstances in which a derivative is accounted for as a fair-value hedge. Difficulty: Moderate AACSB: Analytical thinking

6) When a company attempts to control the impact of price fluctuations on its future cash flows and its sales, it is entering into a cash-flow hedge. Answer: TRUE Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Analytical thinking

7) A cash-flow hedge attempts to limit a company's exposure to price changes in forecasted purchases. Answer: TRUE Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Analytical thinking

8) A derivative contract that attempts to reduce the price risk of an existing asset is a fair-value hedge. Answer: TRUE Objective: LO13.4 Account for a cash-flow-hedge situation from inception through settlement and for a fair-valuehedge situation from inception through settlement. Difficulty: Moderate AACSB: Analytical thinking

9) FASB ASC Topic 830 requires marking to fair-value foreign currency-denominated receivables and payables at period-end. Answer: FALSE Objective: LO13.5 Understand the special derivative accounting related to hedges of existing foreign currencydenominated receivables and payables. Difficulty: Easy AACSB: Analytical thinking

10) The net gain or loss in earnings during the period for a fair-value hedge must be reported in the financial statement footnotes. Answer: TRUE Objective: LO13.6 Comprehend the footnote disclosure requirements for derivatives. Difficulty: Moderate AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 14 Foreign Currency Financial Statements 14.1 Multiple Choice Questions 1) A U.S. firm has a Belgian subsidiary that uses the British pound as its functional currency. According to GAAP, the U.S. dollar from Belgian unit's point of view will be A) its only foreign currency. B) its local currency. C) its current rate method currency. D) its reporting currency. Answer: D Objective: LO14.1 Identify the factors that should be considered when determining an entity's functional currency. Difficulty: Easy AACSB: Analytical thinking

2) Selvey Inc. is a wholly-owned subsidiary of Parsfield Incorporated, a U.S. firm. The country where Selvey operates is determined to have a highly inflationary economy according to GAAP definitions. Therefore, for purposes of preparing consolidated financial statements, the functional currency is A) its reporting currency. B) its current rate method currency. C) the U.S. dollar. D) its local currency. Answer: C Explanation: C) Selvey must use the functional currency of the reporting entity. Objective: LO14.1 Identify the factors that should be considered when determining an entity's functional currency. Difficulty: Easy AACSB: Analytical thinking

3) All of the following factors would be used to define a foreign entity's functional currency, except A) high volume of intercompany transactions. B) expenses for foreign entity primarily driven by local factors. C) financing for foreign entity denominated in local currency. D) foreign entity's status as a local tax haven for transfer pricing purposes. Answer: D Objective: LO14.1 Identify the factors that should be considered when determining an entity's functional currency. Difficulty: Easy AACSB: Analytical thinking

4) The primary goal behind consolidating financial statements of a controlled subsidiary is A) assuring that the subsidiary financial statements are the same under the temporal method or the current rate method. B) assuring that the individual nature of the subsidiary entity is not lost in the consolidation. C) representing the conversion of statements at the historical exchange rate. D) representing the company's underlying economic condition. Answer: D Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

5) Pelmer has a foreign subsidiary, Sapp Corporation of Germany, whose functional currency is the euro. Sapp's books are maintained in euros. On December 31, 2014, Sapp has an account receivable denominated in British pounds. Which one of the following statements is true? A) Because all accounts of the subsidiary are translated into U.S. dollars at the current rate, the Account Receivable is not adjusted on the subsidiary's books before translation. B) The Account Receivable is remeasured into the functional currency, thus eliminating the need for translation. C) The Account Receivable is first adjusted to reflect the current exchange rate in euros and then translated at the current exchange rate into dollars. D) The Account Receivable is adjusted to euros at the current exchange rate, and any resulting gain or loss is included as a translation adjustment in the stockholders' equity section of the subsidiary's separate balance sheet. Answer: C Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Moderate AACSB: Analytical thinking

6) Paskin Corporation's wholly-owned Canadian subsidiary has a Canadian dollar functional currency. In translating the subsidiary's account balances into U.S. dollars for reporting purposes, which one of the following accounts would be translated at historical exchange rates? A) Accounts Receivable B) Notes Payable C) Capital Stock D) Retained Earnings Answer: C Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

7) A foreign entity is a subsidiary of a U.S. parent company and has always used the current rate method to translate its foreign financial statements on behalf of its parent company. Which one of the following statements is false? A) The U.S. dollar is the functional currency of this company. B) Changes in exchange rates between the subsidiary's country and the parent's country are not expected to affect the foreign entity's cash flows. C) Translation adjustments are shown in stockholders' equity as increases or decreases in other comprehensive income. D) Translation adjustments are not shown on the income statement. Answer: A Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

8) Assume the functional currency of a foreign entity is the U.S. dollar, but the books are kept in euros. The objective of remeasurement of a foreign entity's accounts is to A) produce the same results as if the foreign entity's books were maintained in the currency of the largest customer. B) produce the same results as if the foreign entity's books were maintained solely in the local currency. C) produce the same results as if the foreign entity's books were maintained solely in the U.S. dollar. D) produce the results reflective of the foreign entity's economics in the local currency. Answer: C Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

9) Which of the following assets and/or liabilities are considered monetary? A) Intangible Assets and Plant, Property, and Equipment B) Bonds Payable and Common Stock C) Cash and Accounts Payable D) Notes Receivable and Inventories carried at cost Answer: C Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

10) Which of the following statements about the Current Rate method is false? A) Translation involves restating the functional currency amounts into the reporting currency. B) All assets and liabilities are translated at the current rate. C) If the subsidiary maintains their books in their functional currency, the current rate method is used. D) The effect of exchange rate changes are reported on the income statement as a foreign exchange gain or loss. Answer: D Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

11) Accounts representing an allowance for uncollectible accounts are converted into U.S. dollars at A) historical rates when the U.S. dollar is the functional currency. B) current rates only when the U.S. dollar is the functional currency. C) historical rates regardless of the functional currency. D) current rates regardless of the functional currency. Answer: D Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

12) Palk Corporation has a foreign subsidiary located in a country experiencing high rates of inflation. Information concerning this country's inflation rate experience is given below.

Date January 1, 2012 January 1, 2013 January 1, 2014 January 1, 2015

Index 90 120 150 210

Change in index

Annual rate of Inflation

30 30 60

30/100 = 30.00% 30/130 = 23.08% 60/160 = 37.50%

The inflation rate that is used in determining if the subsidiary is operating in a highly inflationary economy is A) 37.50%. B) 90.58%. C) 133.33%. D) 350.00%. Answer: C Explanation: C) [(210 - 90)/90] × 100% = 133% Objective: LO14.3 Understand how a foreign subsidiary's economy is determined to be highly inflationary and how this affects the conversion of its financial statements. Difficulty: Moderate AACSB: Analytical thinking

13) At the time of a business acquisition, A) identifiable assets and liabilities are allocated the portion of the translation or remeasurement adjustment that existed on the date of acquisition. B) a foreign entity's assets and liabilities are translated into U.S. dollars using the current exchange rate in effect on that date. C) the difference between investment fair value and translated net assets acquired is treated as a remeasurement gain or loss on the income statement. D) the difference between investment fair value and translated net assets acquired is recorded as a cumulative translation adjustment on the balance sheet. Answer: B Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

14) When translating foreign subsidiary income statements using the current rate method, why are some accounts translated at an average rate? A) This approach improves matching. B) This approach accentuates the conservatism principle. C) This approach smoothes out highly volatile exchange rate fluctuations. D) This approach approximates the effect of transactions which occur continuously during the period. Answer: D Objective: LO14.5 Understand which rates are used to translate balance sheet and income statement accounts under the current rate method and the temporal method on a transition/remeasurement worksheet. Difficulty: Easy AACSB: Analytical thinking

15) The following assets of Poole Corporation's Romanian subsidiary have been converted into U.S. dollars at the following exchange rates:

Accounts receivable Trademark Property plant and equipment Totals

Current Rates $850,000 600,000 1,200,000 $2,650,000

Historical Rates $875,000 575,000 900,000 $2,350,000

Assume the functional currency of the subsidiary is the U.S. dollar and the books are kept in a different currency. The assets should be reported in the consolidated financial statements of Poole Corporation and Subsidiary in the total amount of A) $2,325,000. B) $2,350,000. C) $2,375,000. D) $2,650,000. Answer: A Explanation: A) A/R $850,000 + Trademark $575,000 + Plant $900,000 Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Moderate AACSB: Analytical thinking

16) Which of the following foreign subsidiary accounts will have the same value on consolidated financial statements, regardless of whether the statements are remeasured or translated? A) Trademark B) Deferred Income C) Accounts Receivable D) Goodwill Answer: C Objective: LO1.2 Learn about alternative forms of business combinations, from both the legal and accounting perspectives. Difficulty: Easy AACSB: Analytical thinking

17) Exchange gains or losses from remeasurement appear A) in the continuing operations section of the consolidated income statement. B) as an extraordinary item on the consolidated income statement. C) as other comprehensive income typically reported in a statement of stockholders' equity. D) as an adjustment to the beginning balance of retained earnings on the consolidated Statement of retained earnings. Answer: A Objective: LO14.7 Know how the translation gain or loss, or remeasurement gain or loss, is reported under the current rate and temporal methods. Difficulty: Easy AACSB: Analytical thinking

18) A U.S. parent corporation loans funds to a foreign subsidiary to be used to purchase equipment. The loan is denominated in U.S. dollars and the functional currency of the subsidiary is the euro. This intercompany transaction is a foreign currency transaction of A) neither the subsidiary nor the parent, as it is eliminated as part of the consolidation procedure. B) the subsidiary but not the parent. C) both the subsidiary and the parent. D) the parent but not the subsidiary. Answer: B Objective: LO14.6 Know how a parent accounts for its investment in a subsidiary using the equity method depending on the subsidiary's functional currency determination. Difficulty: Moderate AACSB: Analytical thinking

19) A foreign subsidiary's accounts receivable balance should be translated for the consolidated financial statements at A) the appropriate historical rate. B) the prior year's forecast rate. C) the future rate for the next year. D) the spot rate at year-end. Answer: D Objective: LO14.8 Understand consolidation under the temporal and current rate methods. Difficulty: Easy AACSB: Analytical thinking

20) If a U.S. company wants to hedge a prospective loss on its investment in a foreign entity that may result from a foreign currency fluctuation, the U.S. company should A) purchase a forward to swap currency of the foreign entity's local country for U.S. currency. B) purchase a call option to buy currency of the foreign entity's local country. C) issue a loan in the foreign entity's local country. D) borrow money in the foreign entity's local country. Answer: D Objective: LO14.9 Understand how a hedge of the net investment in a subsidiary is accounted for under the current rate and temporal methods. Difficulty: Easy AACSB: Analytical thinking

14.2 Exercises 1) For each of the 12 accounts listed in the table below, select the correct exchange rate to use when either remeasuring or translating a foreign subsidiary for its U.S. parent company. Codes C = Current exchange rate H = Historical exchange rate A = Average exchange rate U.S. dollar is the functional currency

The foreign currency is the functional currency

Accounts receivable

________

Marketable debt securities carried at cost

________

Inventories carried at cost

________

Deferred income

________

Goodwill

________

Other paid-in capital

________

Depreciation expense

________

Refundable deposits

________

Common stock

________

10. Accumulated depreciation on buildings

________

11. Deferred income tax liabilities

________

12. Accounts payable

________

Answer:

U.S. dollar is the functional currency C

The foreign currency is the functional currency C

2. Marketable debt securities carried at cost

3. Inventories carried at cost

4. Deferred income

5. Goodwill

6. Other paid-in capital

7. Depreciation expense

8. Refundable deposits

9. Common stock

10. Accumulated depreciation on buildings

11. Deferred income tax liabilities

12. Accounts payable

1. Accounts receivable

Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Moderate AACSB: Analytical thinking

2) On January 1, 2014, Planet Corporation, a U.S. company, acquired 100% of Star Corporation of Bulgaria, paying an excess of 90,000 Bulgarian lev over the book value of Star's net assets. The excess was allocated to undervalued equipment with a three-year remaining useful life. Star's functional currency is the Bulgarian lev. Star's books are maintained in the functional currency. Exchange rates for Bulgarian lev for 2014 are: January 1, 2014 Average rate for 2014 December 31, 2014

$.77 .75 .73

Required: 1. Determine the depreciation expense stated in U.S. dollars on the excess allocated to equipment for 2014. 2. Determine the unamortized excess allocated to equipment on December 31, 2014 in U.S. dollars. 3. If Star's functional currency was the U.S. dollar, what would be the depreciation expense on the excess allocated to the equipment for 2014? Answer: Requirement 1 Depreciation expense in 2014 90,000 lev/3 years × $.75/lev = $22,500 depreciation expense Requirement 2 Unamortized excess at December 31, 2014 90,000 lev × 2/3 × $.73/lev = $43,800 unamortized excess on equipment Requirement 3 Remeasured depreciation expense 90,000 lev × $.77/lev = $69,300 excess $69,300/3 years = $23,100 depreciation expense Objective: LO14.5 Understand which rates are used to translate balance sheet and income statement accounts under the current rate method and the temporal method on a transition/remeasurement worksheet. Difficulty: Moderate AACSB: Application of knowledge

3) Pan Corporation, a U.S. company, formed a British subsidiary on January 1, 2014 by investing 450,000 British pounds (£) in exchange for all of the subsidiary's no-par common stock. The British subsidiary, Skillet Corporation, purchased real property on April 1, 2014 at a cost of £500,000, with £100,000 allocated to land and £400,000 allocated to a building. The building is depreciated over a 40-year estimated useful life on a straight-line basis with no salvage value. The British pound is Skillet's functional currency and its reporting currency. The British economy does not have high rates of inflation. Exchange rates for the pound on various dates were: January 01, 2014 = April 01, 2014 = December 31, 2014 = 2014 average rate =

1£ = 1£ = 1£ = 1£ =

$1.60 $1.61 $1.68 $1.66

Skillet's adjusted trial balance is presented below for the year ended December 31, 2014. In Pounds Debits: Cash Accounts receivable Inventory Building Land Depreciation expense Other expenses Cost of goods sold Total debits

£ 220,000 52,000 59,000 400,000 100,000 7,500 110,000 220,000 £ 1,168,500

Credits Accumulated depreciation Accounts payable Common stock Retained earnings Equity adjustment Sales revenue Total credits

£7,500 111,000 450,000 0 0 600,000 £1,168,500

Required: Prepare Skillet's: 1. Translation working papers; 2. Translated income statement; and 3. Translated balance sheet.

Answer: Requirement 1 Skillet Corporation Translation Working Papers Debits Cash Accounts receivable Inventory Building Land Depreciation expense Other expenses Cost of goods sold

220,000 × $1.68 52,000 × $1.68 59,000 × $1.68 400,000 × $1.68 100,000 × $1.68 7,500 × $1.66 110,000 × $1.66 220,000 × $1.66

= $369,600 = 87,360 = 99,120 = 672,000 = 168,000 = 12,450 = 182,600 = 365,200 _________ $1,956,330

7,500 × $1.68 111,000 × $1.68 450,000 × $1.60 600,000 × $1.66

= = = =

Total debits Credits Accumulated depreciation Accounts payable Common stock Sales revenue Retained earnings Total credits

$12,600 186,480 720,000 996,000 0 $1,915,080

Credit differential

$41,250

Requirement 2 Skillet Corporation Translated Income Statement For the Year Ended December 31, 2014 Sales revenue

$996,000

Expenses: Cost of goods sold Depreciation expense Other expenses

(365,200) (12,450) (182,600) ________ $435,750

Net income

Requirement 3 Skillet Corporation Translated Balance Sheet December 31, 2014 Cash Accounts receivable Inventory Building-net Land Total assets

$369,600 87,360 99,120 659,400 168,000 $1,383,480

Accounts payable Common stock Retained earnings Accumulated other comprehensive income Total liabilities & equities

$186,480 720,000 435,750 41,250 $1,383,480

Objective: LO14.5 Understand which rates are used to translate balance sheet and income statement accounts under the current rate method and the temporal method on a transition/remeasurement worksheet. Difficulty: Moderate AACSB: Application of knowledge

4) Skillet Corporation, a British subsidiary of Pan Corporation (a U.S. company) was formed by Pan on January 1, 2014 in exchange for all of the subsidiary's common stock. Skillet has now ended its second year of operations on December 31, 2015. Relevant exchange rates are: January 01, 2015 = December 31, 2015 = 2015 average rate =

1£ = 1£ = 1£ =

$1.60 $1.75 $1.73

Skillet's adjusted trial balance is presented below for the calendar year 2015. The amount of equity adjustment carried over from 2014 is a credit balance of $41,250 (in dollars). In Pounds Debits: Cash Accounts receivable Inventory Building Land Depreciation expense Other expenses Cost of goods sold Total debits

£75,000 362,000 41,000 400,000 100,000 10,000 133,000 380,000 £1,501,000

Credits Accumulated depreciation Accounts payable Common stock Retained earnings Sales revenue Total credits

£17,500 154,750 450,000 262,500 616,250 £1,501,000

Required: For Skillet's second year of operations, prepare the: 1. Translation working papers; 2. Translated income statement; and 3. Translated balance sheet.

Answer: Requirement 1 Skillet Corporation Translation Working Papers Debits Cash Accounts receivable Inventory Building Land Depreciation expense Other expenses Cost of goods sold

75,000 362,000 41,000 400,000 100,000 10,000 133,000 380,000

× $1.75 × $1.75 × $1.75 × $1.75 × $1.75 × $1.73 × $1.73 × $1.73

= = = = = = = =

Total debits

$131,250 633,500 71,750 700,000 175,000 17,300 230,090 657,400 $2,616,290

Credits Accumulated depreciation 17,500 × $1.75 Accounts payable 154,750 × $1.75 Common stock 450,000 × $1.60 Sales revenue 616,250 × $1.73 Retained earnings 262,500 Accumulated other comprehensive income Total credits

= = = =

Credit differential

$30,625 270,812 720,000 1,066,113 435,750 41,250 $2,564,550 $51,740

Requirement 2 Skillet Corporation Translated Income Statement for the year ended December 31, 2015 Sales revenue

$1,066,113

Expenses: Cost of goods sold Depreciation expense Other expenses

(657,400) (17,300) (230,090)

Net income Retained earnings, January 1, 2015 Retained earnings, December 31, 2015

$161,323 435,750 $597,073

Requirement 3 Skillet Corporation Translated Balance Sheet December 31, 2015 Cash Accounts receivable Inventory Building-net Land Total assets

$131,250 633,500 71,750 669,375 175,000 $1,680,875

Accounts payable Common stock Retained earnings Accum. other comprehensive income ($41,250 + $51,740) Total liabilities & equities

$270,812 720,000 597,073 92,990 $1,680,875

5) The Polka Corporation, a U.S. corporation, formed a British subsidiary on January 1, 2014 by investing 550,000 British pounds (£) in exchange for all of the subsidiary's no-par common stock. The British subsidiary, Stripe Corporation, purchased real property on April 1, 2014 at a cost of £500,000, with £100,000 allocated to land and £400,000 allocated to the building. The building is depreciated over a 40year estimated useful life on a straight-line basis with no salvage value. The U.S. dollar is Stripe's functional currency, but it keeps its records in pounds. The British economy does not experience high rates of inflation. Exchange rates for the pound on various dates are: January 01, 2014 = April 01, 2014 = December 31, 2014 = 2014 average rate =

1£ 1£ 1£ 1£

= = = =

$1.60 $1.62 $1.65 $1.64

Stripe's adjusted trial balance is presented below for the year ended December 31, 2014. In Pounds Debits: Cash Accounts receivable Notes receivable Building Land Depreciation expense Other expenses Salary expense Total debits

£ 200,000 72,000 99,000 400,000 100,000 7,500 115,000 208,000 £1,201,500

Credits Accumulated depreciation Accounts payable Common stock Retained earnings Equity adjustment Sales revenue Total credits

£7,500 100,000 550,000 0 0 544,000 £1,201,500

Required: Prepare Stripe's: 1. Remeasurement working papers; 2. Remeasured income statement; and 3. Remeasured balance sheet.

Answer: Requirement 1 Stripe Corporation Remeasurement Working Papers Debits Cash Accounts receivable Notes receivable Building Land Depreciation expense Other expenses Salary expense

200,000 72,000 99,000 400,000 100,000 7,500 115,000 208,000

× $1.65 × $1.65 × $1.65 × $1.62 × $1.62 × $1.62 × $1.64 × $1.64

= $330,000 = 118,800 = 163,350 = 648,000 = 162,000 = 12,150 = 188,600 = 341,120 _________ $1,964,020

7,500 100,000 550,000 544,000 0

× $1.62 × $1.65 × $1.60 × $1.64

= = = =

Total debits Credits Accumulated depreciation Accounts payable Common stock Sales revenue Retained earnings Total credits

$12,150 165,000 880,000 892,160 0 $1,949,310

Credit differential

$14,710

Requirement 2 Stripe Corporation Remeasured Income Statement For the Year Ended December 31, 2014 Sales revenue

$892,160

Expenses: Salary expense Depreciation expense Other expenses Income before exchange gains or losses Exchange gains Net income Retained earnings, January 1, 2014 Retained earnings, December 31, 2014

(341,120) (12,150) (188,600) $350,290 14,710 $365,000 0 $365,000

Requirement 3 Stripe Corporation Remeasured Balance Sheet December 31, 2014 Cash Accounts receivable Notes receivable Building-net Land Total assets

$330,000 118,800 163,350 635,850 162,000 $1,410,000

Accounts payable Common stock Retained earnings Total liabilities & equities

$165,000 880,000 365,000 $1,410,000

6) Stripe Corporation, a British subsidiary of Polka Corporation (a U.S. company) was formed by Polka on January 1, 2014 in exchange for all of the subsidiary's common stock. Stripe has now ended its second year of operations on December 31, 2015. Relevant exchange rates are: January 01, 2014 = 1£ = $1.60 April 01, 2014 = 1£ = $1.62 December 31, 2015 = 1£ = $1.57 2015 average rate = 1£ = $1.56 Stripe's adjusted trial balance is presented below for the calendar year 2015. In Pounds Debits: Cash Accounts receivable Notes receivable Building Land Depreciation expense Other expenses Salary expense Total debits

£ 172,000 308,000 98,000 400,000 100,000 10,000 117,000 376,000 £1,581,000

Credits Accumulated depreciation Accounts payable Common stock Retained earnings Sales revenue Total credits

£17,500 200,000 550,000 213,500 600,000 £1,581,000

Required: Prepare Stripe's: 1. Remeasurement working papers; 2. Remeasured income statement; and 3. Remeasured balance sheet.

Answer: Requirement 1 Stripe Corporation Remeasurement Working Papers Debits Cash Accounts receivable Notes receivable Building Land Depreciation expense Other expenses Salary expense

172,000 × $1.57 308,000 × $1.57 98,000 × $1.57 400,000 × $1.62 100,000 × $1.62 10,000 × $1.62 117,000 × $1.56 376,000 × $1.56

= = = = = = = =

$270,040 483,560 153,860 648,000 162,000 16,200 182,520 586,560 _________ $2,502,740

17,500 × $1.62 200,000 × $1.57 550,000 × $1.60 600,000 × $1.56 213,500

= = = =

$28,350 314,000 880,000 936,000 365,000 $2,523,350

Total debits Credits Accumulated depreciation Accounts payable Common stock Sales revenue Retained earnings Total credits Debit differential

$20,610

Requirement 2 Stripe Corporation Translated Income Statement For the Year Ended December 31, 2015 Sales revenue

$936,000

Expenses: Salary expense Depreciation expense Other expenses Income before exchange gains or losses Exchange loss Net income Retained earnings, January 1, 2015 Retained earnings, December 31, 2015

(586,560) (16,200) (182,520) $150,720 (20,610) $130,110 365,000 $495,110

Requirement 3 Stripe Corporation Translated Balance Sheet December 31, 2015 Cash Accounts receivable Notes receivable Building-net Land Total assets

$270,040 483,560 153,860 619,650 162,000 $1,689,110

Accounts payable Common stock Retained earnings Total liabilities & equities

$314,000 880,000 495,110 $1,689,110

7) On January 1, 2014, Pilgrim Corporation, a U.S. firm, acquired ownership of Settlement Corporation, a foreign company, for $168,000, when Settlement's stockholders' equity consisted of 300,000 local currency units (LCU) and retained earnings of 100,000 LCU. At the time of the acquisition, Settlement's assets and liabilities were fairly valued except for a patent that did not have any recorded book value. All excess purchase cost was attributed to the patent, which had an estimated economic life of 10 years at the date of acquisition. The exchange rate for LCUs on January 1, 2014 was $.40. The functional currency for Settlement is LCU. Settlement's books are maintained in LCU. A summary of changes in Settlement's stockholders' equity during 2014 and the exchange rates for LCUs are as follows:

Stockholders' equity 1/1/14 Net income Dividends 12/1/14 Equity adjustment Stockholders' equity 12/31/14

LCU

Rates

Dollars

400,000 100,000 (50,000)

$.40H .42A .43H

_______ 450,000

.44C

$160,000 42,000 (21,500) 17,500 ________ $198,000

Required: Determine the following: 1. Fair value of the patent from Pilgrim's investment in Settlement on January 1, 2014 in U.S. dollars. 2. Patent amortization for 2014 in U.S. dollars. 3. Unamortized patent at December 31, 2014 in U.S. dollars. 4. Equity adjustment from the patent in U.S. dollars. 5. Income from Settlement for 2014 in U.S. dollars. 6. Investment in Settlement balance at December 31, 2014 in U.S. dollars. Answer: Requirement 1 Patent Fair Value: Cost of investment Book value acquired 400,000 LCU × $.40 = Patent in dollars

$168,000 (160,000) $8,000

Patent in LCU = $8,000/$.40 per LCU =

20,000

Requirement 2 Patent amortization for 2014: Patent: 20,000 LCU/10 years = 2,000 LCU per year 2,000 LCU per year × $.42 equals amortization of:

$840

Requirement 3 Unamortized patent: Patent (20,000 LCU - 2,000 LCU) × $.44 =

$7,920

Requirement 4 Equity adjustment from patent: Beginning patent (from Req. 1) Patent amortization (from Req. 2) Subtotal Ending patent (from Req. 3) Equity adjustment

$8,000 (840) 7,160 7,920 $760

Requirement 5 Income from Settlement: Equity in income Less: Patent amortization Income from Settlement

$42,000 (840) $41,160

Requirement 6 Investment in Settlement balance at 12/31/14: Cost, January 1, 2014 Add: Income for 2014 (from Req. 5) Less: Dividends Add: Equity adjustment from patent (from Req. 4) Add: Equity adjustment from translation Investment balance, December 31, 2014

$168,000 41,160 (21,500) 760 17,500 $205,920

Check: Book value: Unamortized patent (from Req. 3) Investment balance

$198,000 7,920 $205,920

Objective: LO14.7 Know how the translation gain or loss, or remeasurement gain or loss, is reported under the current rate and temporal methods. Difficulty: Moderate AACSB: Application of knowledge

8) Plate Corporation, a U.S. company, acquired ownership of Saucer Corporation of Switzerland on January 1, 2014 for $1,500,000 when Saucer's stockholders' equity in Swiss francs (SF) consisted of 700,000 SF Capital Stock and 300,000 SF Retained Earnings. The exchange rate for Swiss francs was $1.20 on January 1. All excess purchase cost was attributed to a Trademark that did not have a recorded book value. The trademark is to be amortized over 20 years. Saucer's functional currency is Swiss francs and the records are kept in the same currency. A summary of changes in Saucer's stockholders' equity during 2014 and relevant exchange rates are as follows:

Stockholders' equity 1/1/14 Net income Dividends 11/1/14 Equity adjustment Stockholders' equity 12/31/14

In Swiss Francs

Exchange Rates

In Dollars

SF1,000,000 250,000 (100,000)

$1.20H 1.15A 1.10H

________ SF1,150,000

1.05C

$1,200,000 287,500 (110,000) (170,000) ________ $1,207,500

Required: Determine the following: 1. Fair value of the Trademark from Plate's investment in Saucer on January 1, 2014 in U.S. dollars. 2. Trademark amortization for 2014 in U.S. dollars. 3. Unamortized Trademark at December 31, 2014 in U.S. dollars. 4. Equity adjustment from the Trademark in U.S. dollars. 5. Income from Saucer for 2014 in U.S. dollars. 6. Investment in Saucer balance at December 31, 2014 in U.S. dollars.

Answer: Requirement 1 Trademark: Cost of investment Book value acquired 1,000,000 × $1.20 Fair value of Trademark in dollars

$1,500,000 (1,200,000) $ 300,000

Trademark in Swiss francs = $300,000/$1.20 =

250,000

Requirement 2 Trademark amortization for 2014: Trademark: 250,000/20 yr. × $1.15 average rate =

$14,375

Requirement 3 Unamortized Trademark: Trademark (250,000 - 12,500SF) × $1.05 exchange rate

$249,375

Requirement 4 Equity adjustment from Trademark: Beginning Trademark (from Req. 1) Trademark amortization (from Req. 2) Less: Ending Trademark (237,500 × $1.05) Equity adjustment

$300,000 (14,375) (249,375) $ 36,250

Requirement 5 Income from Saucer: Equity in income Less: Trademark amortization Income from Saucer

$287,500 (14,375) $273,125

Requirement 6 Investment Balance at December 31, 2014: Cost, January 1, 2014 Add: Income from Saucer (from Req. 5) Less: Dividends Less: Equity adjustment from translation Less: Equity adjustment from Trademark (from Req. 4) Investment balance, December 31, 2014

$1,500,000 273,125 (110,000) (170,000) (36,250) $1,456,875

Check: Share of Saucer's equity Add: Unamortized Trademark (from Req. 3) Investment balance, December 31, 2014

$1,207,500 249,375 $1,456,875

Objective: LO14.7 Know how the translation gain or loss, or remeasurement gain or loss, is reported under the current rate and temporal methods. Difficulty: Moderate AACSB: Application of knowledge

9) Plane Corporation, a U.S. company, owns 100% of Shipp Corporation, a Libyan company. Shipp's equipment was acquired on the following dates (amounts are stated in Libyan dinars): Jan. 01, 2014 Purchased equipment for 40,000 dinars Jul. 01, 2014 Purchased equipment for 80,000 dinars Jan. 01, 2015 Purchased equipment for 50,000 dinars Jul. 01, 2015 Sold equipment purchased on Jan. 01, 2014 for 35,000 dinars Exchange rates for the Libyan dinars on various dates are: Jan. 01, 2014 Jul. 01, 2014 Dec. 31, 2014 2014 avg. rate

1 dinar = $.500 1 dinar = $.520 1 dinar = $.530 1 dinar = $.515

Jan. 01, 2015 Jul. 01, 2015 Dec. 31, 2015 2015 avg. rate

1 dinar = $.530 1 dinar = $.505 1 dinar = $.490 1 dinar = $.510

Shipp's equipment has an estimated 5-year life with no salvage value and is depreciated using the straight-line method, calculating depreciation expense on a monthly basis. Shipp's functional currency is the U.S. dollar, but the company uses the Libyan dinar as its reporting currency. Required: 1. Determine the value of Shipp's equipment account on December 31, 2015 in U.S. dollars. 2. Determine Shipp's depreciation expense for 2015 in U.S. dollars. 3. Determine the gain or loss from the sale of equipment on July 1, 2015 in U.S. dollars.

Answer: Requirement 1 Equipment: Jul. 01, 2014 (80,000 dinars × $.520/dinar) = Jan. 01, 2015 (50,000 dinars × $.530/dinar) = Total

$41,600 26,500 $68,100

Requirement 2 Depreciation expense: [(40,000 dinar × 1/5 × .5 yr.) × ($.500/dinar)] =

$ 2,000

[(80,000 dinar × 1/5 × 1 yr.) × ($.520/dinar)] =

8,320

[(50,000 dinar × 1/5 × 1 yr.) × ($.530/dinar)] =

5,300

Total

$ 15,620

Requirement 3 Equipment sold: (40,000 dinar × $.500/dinar) =

$20,000

Accumulated Depreciation on equipment sold: [(40,000 dinar × 1/5 × 1.5 yrs.) × ($.500/dinar)] =

6,000

Net book value of equipment sold

$14,000

Cash received on July 1, 2015: (35,000 dinar × $.505/dinar) =

17,675

Gain on sale of equipment

$ 3,675

Objective: LO14.7 Know how the translation gain or loss, or remeasurement gain or loss, is reported under the current rate and temporal methods. Difficulty: Moderate AACSB: Application of knowledge

10) Phim Inc., a U.S. company, owns 100% of Sera Corporation, a New Zealand company. Sera's equipment was acquired on the following dates (amounts are stated in New Zealand dollars as NZ$): Jan. 01, 2014 Purchased equipment for NZ$40,000 Jul. 01, 2014 Purchased equipment for NZ$80,000 Jan. 01, 2015 Purchased equipment for NZ$50,000 Jul. 01, 2015 Sold equipment purchased on Jan. 01, 2014 for NZ$35,000 Exchange rates for the New Zealand dollar on various dates are: Jan. 01, 2014 Jul. 01, 2014 Dec. 31, 2014 2014 avg. rate

1NZ$ = $.800 1NZ$ = $.820 1NZ$ = $.830 1NZ$ = $.815

Jan. 01, 2015 Jul. 01, 2015 Dec. 31, 2015 2015 avg. rate

1NZ$ = $.830 1NZ$ = $.805 1NZ$ = $.790 1NZ$ = $.810

Sera's equipment has an estimated 5-year life with no salvage value and is depreciated using the straightline method. Sera's functional currency and reporting currency are the New Zealand dollar. Required: 1. Determine the value of Sera's equipment account on December 31, 2015 in U.S. dollars. 2. Determine Sera's depreciation expense for 2015 in U.S. dollars. 3. Determine the gain or loss from the sale of equipment on July 1, 2015 in U.S. dollars.

Answer: Requirement 1 Equipment: Jul. 01, 2014 (NZ$80,000 × $.790/NZ$) = Jan. 01, 2015 (NZ$50,000 × $.790/NZ$) = Total

$ 63,200 39,500 $102,700

Requirement 2 Depreciation expense: [(NZ$40,000 × 1/5 × .5 yr.) × ($.810/NZ$)] = [(NZ$80,000 × 1/5 × 1 yr.) × ($.810/NZ$)] = [(NZ$50,000 × 1/5 × 1 yr.) × ($.810/NZ$)] = Total

$ 3,240 12,960 8,100 $24,300

Requirement 3 Equipment sold

NZ$40,000

Accumulated Depreciation on sold equipment (NZ$40,000 × 1/5 × 1.5 yr.)

12,000

Net book value of equipment sold

NZ$28,000

Cash received on July 1, 2015

35,000

Gain on sale of equipment

NZ$ 7,000

Gain in U.S.$: (NZ$7,000 × $.810/NZ$) =

$ 5,670

Objective: LO14.7 Know how the translation gain or loss, or remeasurement gain or loss, is reported under the current rate and temporal methods. Difficulty: Moderate AACSB: Application of knowledge

11) Puddle Incorporated purchased an 80% interest in Soake Company, located in England. Puddle paid $1,560,000 on January 1, 2014, at a time when the book values of Soake equaled the fair values. Any excess cost/book value differential was attributed to a patent with a five-year remaining useful life. Soake's books are kept in the functional currency, pounds. A summary of Soake's equity is shown below for the first year that Puddle had ownership interest.

Stockholders' Equity - 12/31/13 Net Income Dividends - 11/1/14 Translation Adjustment Stockholders' Equity - 12/31/14

In Pounds Exchange Rates 1,200,000 $1.60H 400,000 $1.62A (200,000) $1.64H 1,400,000

$1.65C

In Dollars $1,920,000 648,000 (328,000) 70,000 $2,310,000

Required: Determine Puddle's income from Soake for 2014, and the balance of Puddle's Investment in Soake account at December 31, 2014. Soake's books are kept in pounds, which is the functional currency.

Answer: Puddle's income from Soake for 2014 Investment cost of 80% interest in Soake Less: Book value acquired ($1,920,000 × 80%) Patent in dollars at acquisition

$1,560,000 (1,536,000) $ 24,000

Patent in pounds at acquisition $24,000/$1.60 exchange rate =

15,000 pounds

Equity in Soake's income ($648,000 × 80%) Patent amortization for 2014 15,000 pounds/5 years × $1.62 average rate Income from Soake for 2014

$ 518,400 ( 4,860) $ 513,540

Investment in Soake at December 31, 2014 Investment cost Add: Income from Soake Less: Dividends ($328,000 × 80%) Add: Equity adjustment from translation ($70,000 × 80%) Add: Equity adj. from patent: Beginning balance Less: Patent amortization Less: Unamortized patent at year end (15,000 - 3,000 = 12,000 pounds) × $1.65

$1,560,000 513,540 (262,400) 56,000 $ 24,000 4,860 19,800

660

Investment in Soake December 31, 2014

$1,867,800

Proof of investment balance Net assets at December 31, 2014 of $2,310,000 × 80% Add: Unamortized patent (12,000 pounds × $1.65) Investment balance

$1,848,000 19,800 $1,867,800

Objective: LO14.7 Know how the translation gain or loss, or remeasurement gain or loss, is reported under the current rate and temporal methods. Difficulty: Moderate AACSB: Application of knowledge

12) Pew Corporation (a U.S. corporation) acquired all of the stock of Skunk Company (a Brazilian company) on January 1, 2014 for $9,300,000 when Skunk had 10,000,000 Brazilian real (BR) capital stock and 5,000,000 BR retained earnings. The book value of Skunk's net assets equaled the fair value on this date, and any cost/book value differential is due to a patent with a 5-year remaining useful life. Skunk's functional currency is the BR. Skunk's books are maintained in the functional currency. The exchange rates for BR's for 2014 are shown below: January 1, 2014 Average for 2014 December 31, 2014

$0.60 $0.64 $0.68

Required: 1. Calculate the patent value from the business combination on January 1, 2014 in U.S. dollars. 2. Calculate the patent amortization in U.S. dollars for 2014. 3. Prepare the journal entry (in U.S. dollars) required on Pew's books to record the patent amortization for 2014, assuming that Pew accounts for Skunk using the equity method.

Answer: 1. Patent at acquisition of Skunk Cost of Skunk Book value acquired: (15,000,000 BR × $.60) Patent in dollars

$9,300,000 (9,000,000) $300,000

Patent in BR's ($300,000/$.60)

500,000BR

2. Patent amortization in dollars Patent amortization in BR's (500,000/5 years) = 100,000 BR's Patent amortization in $ (100,000 BR's × $.64 average rate)

$64,000

3. Entry to record patent amortization Income from Skunk Investment in Skunk Other comprehensive income—Equity adjustment from translation of patent

$64,000 28,000 36,000

To record patent amortization and the equity adjustment from translation of patent computed as follows: Beginning patent Amortization Equity Adjustment Ending patent

500,000 BR's (100,000) 400,000 _______ 400,000

$.60 .64

.68

$ 300,000 (64,000) 236,000 36,000 $ 272,000

Objective: LO14.4 Understand how the investment in a foreign subsidiary is accounted for at acquisition. Difficulty: Moderate AACSB: Application of knowledge

13) Plato Corporation, a U.S. company, purchases all of the outstanding stock of Socrates Company, which operates outside the U.S. on January 1, 2014. Socrates' net assets have fair values that equal their book values with the exception of land that has a fair value of 200,000 foreign currency units and equipment with a fair value of 100,000 foreign currency units. Plato paid $180,000 for this acquisition. The balance sheets for Plato and Socrates are shown below just before the business combination. Socrates' functional currency is the foreign currency unit (fcu) and the exchange rate at the date of acquisition was $.40 per fcu. Socrates uses the fcu for record-keeping purposes.

Current Assets Land Buildings - net Equipment - net Total Assets Current Liabilities Notes Payable Capital Stock Retained Earnings Total Liabilities

Plato ($) Socrates (fcu) 2,800,000 200,000 600,000 150,000 1,300,000 200,000 2,300,000 50,000 7,000,000 600,000 1,300,000 1,500,000 2,000,000 2,200,000 7,000,000

150,000 100,000 200,000 150,000 600,000

Required: Prepare a consolidated balance sheet for Plato and subsidiary at January 1, 2014 immediately following the business combination. Answer: Plato Company and Subsidiary Consolidated Balance Sheet At January 1, 2014

Current Assets Land Buildings - net Equipment - net Total Assets Current Liabilities Notes Payable Capital Stock Retained Earnings Total Liab. & Equity

Calculation Balance ($) $2,800,000 - $180,000 + (200,000 × $.40) $ 2,700,000 $600,000 + ((150,000 + 50,000) × $.40) 680,000 $1,300,000 + (200,000 × $.40) 1,380,000 $2,300,000 + ((50,000 + 50,000) × $.40) 2,340,000 $ 7,100,000 $1,300,000 + (150,000 × $.40) $1,500,000 + (100,000 × $.40) $2,000,000 $2,200,000

$ 1,360,000 1,540,000 2,000,000 2,200,000 $ 7,100,000

14) On January 1, 2014, Psalm Corporation purchased all the stock of Solomon Corporation for $481,400 when Solomon had capital stock of 180,000 pounds (£) and retained earnings of 90,000£. The book value of Solomon's assets and liabilities represented the fair value, except for equipment with a 5-year life that was undervalued by 15,000£. Any remaining excess is due to a patent with a useful life of 6 years. Solomon's functional currency is the pound. Solomon's books are kept in pounds. Relevant exchange rates for a pound follow: January 1, 2014 Average for 2014 December 31, 2014

$1.66 1.65 1.64

Required: 1. Determine the equity adjustment on translation of the excess differential assigned to equipment at December 31, 2014. 2. Determine the equity adjustment on translation of the excess differential assigned to patent at December 31, 2014.

Answer: Preliminary computations Cost of investment in Solomon ($481,400/$1.66) Book value acquired Excess in pounds

Pounds 290,000 (270,000) 20,000

Excess allocated to equipment Excess allocated to patent Excess allocated in pounds

15,000 5,000 20,000

Requirement 1 Equity adjustment from excess allocated to equipment on December 31, 2014: Depreciation of excess based on £ (15,000/5 years)

3,000 £

Undepreciated excess balance at year-end based on £ (12,000 £ × $1.64 current rate) Add: Depreciation on excess based on £—2014 3,000 £ × $1.65 average rate

$ 19,680

Less: Beginning excess based on U.S. dollars

4,950 24,630 24,900

Equity adjustment from translation of excess allocated to equipment (loss)

($ 270)

Requirement 2 Equity adjustment from excess allocated to patent on December 31, 2014: Patent (must be carried in £) $8,300/$1.66 = 5,000 £ Patent amortization is 5,000 £ / 6 years = 833 £ Unamortized excess balance at year-end based on £ (4,167 £ × $1.64 current rate) Add: Amortization of patent based on £ (833 £ × $1.65 average rate)

$6,834 1,374 $8,208 $8,300 ($ 92)

Less: Beginning patent based on U.S. dollars Equity adjustment from translation of patent (loss)

Objective: LO14.4 Understand how the investment in a foreign subsidiary is accounted for at acquisition. Difficulty: Moderate AACSB: Application of knowledge

15) Par Industries, a U.S. Corporation, purchased Slice Company of New Zealand for $1,411,800 on January 1, 2014. Slice's functional currency is the New Zealand dollar (NZ$). Slice's books are kept in NZ$. The book values of Slice's assets and liabilities were equal to fair values, with the exception of land which was valued at NZ$1,300,000. Slice's balance sheet appears below: Current Assets Land Buildings - net Equipment - net Total Assets

NZ$ 1,510,000 645,000 825,000 220,000 NZ$ 3,200,000

Current Liabilities Long-Term Debt Common Stock Retained Earnings Total Liab. & Equity

NZ$ 1,200,000 845,000 800,000 355,000 NZ$ 3,200,000

Relevant exchange rates are shown below: January 1, 2014 1 NZ$ = $0.78 Average rate 2014 1 NZ$ = $0.79 December 31, 2014 1 NZ$ = $0.80 Required: Determine the unrealized translation gain or loss at December 31, 2014 relating to the excess allocated to the undervalued land. Answer: Preliminary computations: Investment cost $1,411,800 Book value acquired (1,155,000 NZ$ × $.78 exchange rate) 900,900 Excess cost over book value acquired $510,900 Excess allocated to undervalued land (655,000 NZ$ × $.78)

$510,900

Equity adjustment from translation on excess allocated to land: Excess on land at January 1, 2014 Less: Excess on land at December 31, 2014 (655,000 NZ$ × $.80 current rate at year-end) Equity adjustment from translation - gain (credit)

$510,900 524,000 $13,100

Objective: LO14.7 Know how the translation gain or loss, or remeasurement gain or loss, is reported under the current rate and temporal methods. Difficulty: Moderate AACSB: Application of knowledge

16) On January 1, 2014, Placid Corporation acquired a 40% interest in Superior Industries, a Canadian Corporation, for $811,900 when Superior's stockholders' equity consisted of 1,000,000 Canadian dollars (C$) capital stock and C$500,000 retained earnings. Superior's functional currency is the Canadian dollar and the books are kept in the same currency. The exchange rate at the time of the purchase was $1.15 per Canadian dollar. Any excess allocated to patents is to be amortized over 10 years. A summary of changes in the stockholders' equity of Superior during 2014 and related exchange rates follows: Canadian $ Exchange Rate 1,500,000 $1.15 C 300,000 $1.14 A (200,000) $1.14 C

Stockholders' equity - 1/1/14 Net income Dividends Equity adjustment Stockholders' equity - 12/31/14

1,600,000

$1.13 C

U.S. $ $1,725,000 342,000 (228,000) (31,000) $1,808,000

Required: Determine the following: 1. Fair value of the patent from Placid's investment in Superior on January 1, 2014 in U.S. dollars 2. Patent amortization for 2014 in U.S. dollars 3. Unamortized patent at December 31, 2014 in U.S. dollars 4. Equity adjustment from the patent in U.S. dollars 5. Income from Superior for 2014 in U.S. dollars 6. Investment in Superior balance at December 31, 2014 in U.S. dollars

Answer: 1. Excess patent at January 1, 2014: Cost Book value of interest acquired (C$1,500,000 × $1.15) × 40% Excess Patent Excess Patent in C$ = $121,900/$1.15 = C$106,000 2.

(690,000) $121,900

Excess Patent amortization—2014: Excess Patent in C$ = 106,000/10 years × $1.14 average rate =

$12,084

Unamortized Excess Patent at December 31, 2014: (106,000 - 10,600 C$ amortization) × $1.13 current rate

$107,802

Equity adjustment from Excess Patent: Beginning balance in U.S. dollars Less: Amortization for 2014 Less: Ending balance Equity adjustment from Excess Patent

$121,900 (12,084) (107,802) $2,014

Alternatively, 10,600 C$ × ($1.15 - $1.14) = 95,400 C$ × ($1.15 - $1.13) =

$811,900

$106 1,908 $2,014

Income from Superior—2014: Equity in income ($342,000 × 40%) Less: Excess Patent amortization Income from Superior—2014

$136,800 (12,084) $124,716

Investment in Superior balance at December 31, 2014: Cost January 1 Add: Income 2014 Less: Dividends ($228,000 × 40%) Less: Equity adjustment ($31,000 × 40%) Less: Equity adjustment from Excess Patent Investment in Superior December 31, 2014

$811,900 124,716 (91,200) (12,400) ( 2,014) $831,002

Check: Net assets ($1,808,000 × 40%) plus unamortized patent Investment in Superior at December 31, 2014

$723,200 107,802 $831,002

Objective: LO14.4 Understand how the investment in a foreign subsidiary is accounted for at acquisition. Difficulty: Moderate AACSB: Application of knowledge

17) On January 1, 2014, Paste Unlimited, a U.S. company, acquired 100% of Sticky Corporation of Italy, paying an excess of 112,500 euros over the book value of Sticky's net assets. The excess was allocated to undervalued equipment with a five year remaining useful life. Sticky's functional currency is the euro, and the books are kept in euros. Exchange rates for the euro for 2014 are: January 1, 2014 Average rate for 2014 December 31, 2014

$1.44 1.48 1.52

Required: 1. Determine the depreciation expense on the excess allocated to equipment for 2014 in U.S. dollars. 2. Determine the unamortized excess allocated to equipment on December 31, 2014 in U.S. dollars. 3. If Sticky's functional currency was the U.S. dollar, what would be the depreciation expense on the excess allocated to the equipment for 2014? Answer: Requirement 1 Depreciation expense in 2014 112,500 euro/5 years × $1.48/euro = $33,300 depreciation expense Requirement 2 Unamortized excess at December 31, 2014 112,500 euro × 4/5 × $1.52/euro = $136,800 unamortized excess on equipment Requirement 3 Remeasured depreciation expense 112,500 euro × $1.44/euro = $162,000 excess $162,000/5 years = $32,400 depreciation expense Objective: LO14.5 Understand which rates are used to translate balance sheet and income statement accounts under the current rate method and the temporal method on a transition/remeasurement worksheet. Difficulty: Moderate AACSB: Application of knowledge

18) Pritt Company purchased all the outstanding stock of Standy Company (a manufacturing company in Argentina) when the book value of Standy's net assets equaled their fair value. Standy's summarized balance sheet is shown below on January 1, 2014, the date of acquisition, and on December 31, 2014, when the exchange rates were $.25 and $.20, respectively. The average exchange rate for 2014 was $.23, and Standy paid dividends in 2014 amounting to 300,000 pesos when the exchange rate was $.21. January 1, 2014 (Peso)

December 31, 2014 (Peso)

BALANCE SHEET Cash Accounts Receivable Inventory Building & Equipment Accumulated Depreciation Total Assets

1,400,000 400,000 1,200,000 1,000,000 (200,000) 3,800,000

1,100,000 1,400,000 1,200,000 1,000,000 (300,000) 4,400,000

Accounts Payable Debt Payable Common Stock Retained Earnings Total Liab. & Equity

300,000 1,000,000 2,000,000 500,000 3,800,000

360,000 1,000,000 2,000,000 1,040,000 4,400,000

Required: If Standy's functional currency and reporting currency are the Argentine peso, compute the change to other comprehensive income that would result from the translation of these financial statements at December 31, 2014. Answer: Book value of beginning net assets = 2,500,000 pesos × change in exchange rates ($.25 to $.20) = (0.05) $(125,000) Net income (change in R/E + dividends paid) = 840,000 × change in exchange rates ($.23 to $.20) = (0.03) ( 25,200) Less Dividends = (300,000) × change in exchange rates ($.21 to $.20) = (0.01) 3,000 $(147,200)

Other comprehensive income—Translation loss

Objective: LO14.6 Know how a parent accounts for its investment in a subsidiary using the equity method depending on the subsidiary's functional currency determination. Difficulty: Difficult AACSB: Application of knowledge

19) Each of the following accounts has been converted to U.S. dollars from a foreign subsidiary's financial statements. Based on the information given, determine if the U.S. dollar or a foreign currency is the functional currency of the subsidiary. F = Foreign Currency D = U.S. Dollar N/A = Cannot be determined 1.

Cost of goods sold was converted at a historical rate

________

Marketable debt securities carried at cost were converted at the year-end spot rate

________

Depreciation Expense was converted at the historical rate at the date of acquisition of the subsidiary

________

Inventories carried at their historical cost were converted at the spot rate from year-end

________

Intangible assets were converted at the historical exchange rate at the date of acquisition of the subsidiary

________

Deferred income tax liability was converted at the year-end spot rate

________

Property, Plant and Equipment were converted at the year-end spot rate

________

Accounts Payable was converted at the year-end spot rate

________

Patents were converted at the exchange rate in place at the date of acquisition of the subsidiary

________

10. Accumulated depreciation on buildings was converted at the year-end spot rate

________

Answer: 1. D, 2. F, 3. D, 4. F, 5. D, 6. N/A 7. F 8. N/A, 9. D, 10. F Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Moderate AACSB: Analytical thinking

14.3 True/False 1) Functional currency is the currency of the primary economic environment in which it operates. Answer: TRUE Objective: LO14.1 Identify the factors that should be considered when determining an entity's functional currency. Difficulty: Easy AACSB: Analytical thinking

2) The GAAP permits two methods for converting the foreign subsidiary's financial statements into U.S. dollars: temporal method and the fixed rate method. Answer: FALSE Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

3) A foreign subsidiary's foreign currency statements must conform with the U.S. GAAP before translated into U.S. dollars. Answer: TRUE Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

4) When all elements of the financial statements are translated using a current exchange rate, it is referred to as the current rate method. Answer: TRUE Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Easy AACSB: Analytical thinking

5) Under the temporal method monetary assets and liabilities are remeasured at historical rates and other assets and equities are remeasured at current exchange rates. Answer: FALSE Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Moderate AACSB: Analytical thinking

6) Intercompany transactions that produce receivable balances denominated in a currency other than the entity's functional currency are intercompany transactions. Answer: TRUE Objective: LO14.2 Understand how functional currency assignment determines the way the foreign entity's financial statements are converted. Difficulty: Moderate AACSB: Analytical thinking

7) For foreign subsidiaries whose functional currency is not the parent's reporting currency the current rate method is used to translate assets and liabilities using the exchange rate on the balance sheet date. Answer: TRUE Objective: LO14.5 Understand which rates are used to translate balance sheet and income statement accounts under the current rate method and the temporal method on a transition/remeasurement worksheet. Difficulty: Moderate AACSB: Analytical thinking

8) When the functional currency of a foreign entity is the U.S. dollar, the foreign entity's accounts are remeasured into its U.S. dollar functional currency. Answer: TRUE Objective: LO14.8 Understand consolidation under the temporal and current rate methods. Difficulty: Moderate AACSB: Analytical thinking

9) Gains and losses from foreign currency transactions which are designated as economic hedges of a net investment in a foreign subsidiary are recorded as translation adjustments of stockholder's equity. Answer: TRUE Objective: LO14.9 Understand how a hedge of the net investment in a subsidiary is accounted for under the current rate and temporal methods. Difficulty: Moderate AACSB: Analytical thinking

10) The gain or loss on an after-tax basis from the hedging operations that can be considered a translation adjustment is limited in amount to the current translation adjustment from the equity investment. Answer: TRUE Objective: LO14.9 Understand how a hedge of the net investment in a subsidiary is accounted for under the current rate and temporal methods. Difficulty: Easy AACSB: Analytical thinking

11) The reporting currency is the currency in which the consolidated financial statements and the subsidiary financial statements are prepared. Answer: FALSE Objective: LO14.1 Identify the factors that should be considered when determining an entity's functional currency. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 15 Segment and Interim Financial Reporting 15.1 Multiple Choice Questions 1) Similar operating segments may be combined if the segments have similar economic characteristics. Which one of the following is a similar economic characteristic under GAAP? A) The segments' management teams B) The tax reporting law sections C) The distribution method for products or services D) The expected rates of return and risk for the segments' productive assets Answer: C Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Easy AACSB: Analytical thinking

2) Which of the following conditions would not indicate that two business segments should be classified as a single operating segment? A) They have similar amounts of intersegment revenues or expenses. B) They have a similar distribution method for products. C) They have similar production processes. D) They have similar products or services. Answer: A Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Easy AACSB: Analytical thinking

3) GAAP requires that segment information be reported A) by geographics, without regard to size of the segment. B) by geographics, without regard to industry or product-line. C) however management organizes the enterprise into units for internal decision-making and performance-evaluation purposes. D) by industry or product-line, without regard to geographics. Answer: C Objective: LO15.1 Understand how firms use the management approach to identify potentially reportable operating segments. Difficulty: Easy AACSB: Analytical thinking

4) GAAP requires disclosures for each reportable operating segment for each of the following, except for A) Revenues. B) Depreciation expense. C) R&D expenditures. D) Extraordinary items. Answer: C Objective: LO15.4 Understand the types of disclosure information for segments and the reasons that the levels of disclosure may vary across companies. Difficulty: Easy AACSB: Analytical thinking

5) What is the threshold for reporting a major customer? A) 5 percent of revenues B) 5 percent of profits C) 10 percent of revenues D) 10 percent of profits Answer: C Objective: LO15.6 Know the required enterprise-wide disclosures with respect to products and services, geographic areas of operation, and major customers. Difficulty: Easy AACSB: Analytical thinking

6) Cole Company has the following 2014 financial data: Consolidated revenue per income statement Intersegment sales Intersegment transfers Combined revenues of all segments

$800,000 200,000 100,000 $1,100,000

Cole Company should add segments if A) the sum of its segments' external revenue does not exceed $600,000. B) the sum of its segments' external revenue does not exceed $825,000. C) the sum of its segments' revenue including intersegment revenue does not exceed $600,000. D) the sum of its segments' revenue including intersegment revenue does not exceed $825,000. Answer: A Explanation: A) (75% of $800,000 = $600,000) Objective: LO15.3 Determine the reporting of any additional segments using the 75 percent external-revenue test. Difficulty: Moderate AACSB: Analytical thinking

7) Which of the following is NOT a quantitative threshold for determining a reportable segment? A) Segment assets are 10% or more of the combined assets of all operating segments. B) The absolute value of a segment's profit or loss is 10% or more of the greater of (1) the combined reported profit of all operating segments that reported a profit or (2) the absolute value of the combined reported loss of all operating segments that reported a loss. C) Segment reported revenue, including intersegment revenues, is 10% or more of the combined revenue (both internal and external) of all operating segments. D) Segment residual profit after the cost of equity is 10% or more of the combined residual profit of all operating segments. Answer: D Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Easy AACSB: Analytical thinking

8) For an operating segment to be considered a reporting segment under the revenue threshold, its reported revenue must be 10% or more of A) the combined enterprise revenues, eliminating all relevant intracompany transfers and balances. B) the combined revenues, excluding intersegment revenues, of all operating segments. C) the combined revenues, including intersegment revenues, of all operating segments. D) the consolidated revenue of all operating segments. Answer: C Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Easy AACSB: Analytical thinking

9) An enterprise has eight reporting segments. Five segments show an operating profit and three segments show an operating loss. In determining which segments are classified as reporting segments under the operating profits test, which of the following statements is correct? A) The test value for all segments is 10% of consolidated net profit. B) The test value for profitable segments is 10% or more of those segments reporting a profit, and the test value for loss segments is 10% or more of those segments reporting a loss. C) The test value for loss segments is 10% of the greater of (a) the absolute value of the sum of those segments reporting losses, or (b) 10% of consolidated net profit. D) The test value for all segments is 10% of the greater of (a) the absolute value of the sum of those segments reporting profits, or (b) the absolute value of the sum of those segments reporting losses. Answer: D Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Moderate AACSB: Analytical thinking

10) Dott Corporation experienced a $100,000 extraordinary loss in the second quarter of 2014 in their East Coast operating segment. The loss should be recognized A) only at the consolidated report level at the end of the year. B) entirely in the second quarter of 2014 in the East Coast operating segment. C) in equal amounts allocated to the remaining three quarters of 2014 at the corporate level. D) in equal amounts allocated to the remaining three quarters of 2014 of the East Coast segment. Answer: B Objective: LO15.7 Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Difficulty: Moderate AACSB: Analytical thinking

11) Which one of the following operating segment disclosures is NOT required by GAAP? A) Total Assets B) Equity C) Intersegment sales D) Extraordinary items Answer: B Objective: LO15.4 Understand the types of disclosure information for segments and the reasons that the levels of disclosure may vary across companies. Difficulty: Easy AACSB: Analytical thinking

12) Which one of the following operating segment information items is NOT directly named by GAAP to be reconciled to consolidated totals? A) Assets B) Liabilities C) Revenues D) Profit or loss Answer: B Objective: LO15.5 Understand what segment disclosures are reconciled to the consolidated amounts. Difficulty: Easy AACSB: Analytical thinking

13) What is the purpose of interim reporting? A) Provide shareholders with more timely information B) Provide shareholders with more accurate information C) Provide shareholders with more extensive detail about specific accounts and transactions D) Provide shareholders with more current audited information Answer: A Objective: LO15.7 Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Difficulty: Easy AACSB: Analytical thinking

14) The following table is provided in the disclosures for interim reporting by Bigg Company, regarding the location of their assets. United States Mexico Canada Brazil Other

$1,860,000 1,270,000 880,000 440,000 50,000

Based on the table, which of the following statements is true? A) Only the U.S. and Mexico divisions would be reportable geographic divisions. B) The U.S., Mexico and Canada divisions would be reportable geographic divisions. C) All geographic divisions would be reportable, except for "other." D) All geographic divisions would be reportable. Answer: B Explanation: B) Total assets for all divisions = $4,500,000, therefore those divisions with at least $4,500,000 × 10% or $450,000 would be considered reportable geographic divisions. Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Moderate AACSB: Analytical thinking

15) Jacana Company uses the LIFO inventory method. During the second quarter, Jacana experienced a 100-unit liquidation in its LIFO inventory at a LIFO cost of $430 per unit. Jacana considered the liquidation temporary and expects to replace the units in the third quarter at an estimated replacement cost of $460 a unit. The cost of goods sold computation in the interim report for the second quarter will A) include the 100 liquidated units at the $460 estimated replacement unit cost. B) include the 100 liquidated units at the $430 LIFO unit cost. C) be understated by $3,000. D) be overstated by $3,000. Answer: A Objective: LO15.7 Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Difficulty: Moderate AACSB: Analytical thinking

16) How does GAAP view interim accounting periods? A) As discrete units for which net income may be separately determined B) As integral units of the entire year for which each interim period is an essential part of an annual period C) As integral units of the entire year with each interim period as an independent accounting period D) As discrete units of the entire year using the same principles that are applied to the annual period Answer: B Objective: LO15.7 Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Difficulty: Easy AACSB: Analytical thinking

17) In general, GAAP encourages the identification of reportable segments based on the following: A) Reported segments must account for at least 75% of all external and inter-segment sales. B) Reported segments must ideally account for at least 75% of all sales, unless there are many smaller divisions and separate reporting would create less clarity in reporting. C) If there are more than 10 reportable segments, the company should consider additional aggregation of their segments. D) Reported segments must account for 100% of the external sales, but only 75% of external and intersegment sales. Answer: C Objective: LO15.3 Determine the reporting of any additional segments using the 75 percent external-revenue test. Difficulty: Easy AACSB: Analytical thinking

18) Sandpiper Corporation paid $120,000 for annual property taxes on January 15, 2014, and $20,000 for building repair costs on March 10, 2014. Total repair expenses for the year were estimated to be $200,000, and are normally accrued during the year until incurred. What is the total amount of property tax and repair expense to be reported in Sandpiper's first quarter 2014 interim income statement? A) $ 50,000 B) $ 80,000 C) $100,000 D) $140,000 Answer: B Objective: LO15.7 Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Difficulty: Moderate AACSB: Analytical thinking

19) The estimated taxable income for Shebill Corporation on January 1, 2014, was $80,000, $100,000, $100,000 and $120,000, respectively, for each of the four quarters of 2014. Shebill's estimated annual effective tax rate was 30%. During the second quarter of 2014, the estimated annual effective tax rate was increased to 34%. Given only this information, Shebill's second quarter income tax expense was A) $30,000. B) $34,000. C) $37,200. D) $61,200. Answer: C Objective: LO15.8 Compute interim-period income tax expense. Difficulty: Moderate AACSB: Analytical thinking

20) On January 5, 2014, Eagle Corporation paid $50,000 in real estate taxes for the calendar year. In March of 2014, Eagle paid $180,000 for an annual machinery overhaul and $10,000 for the annual CPA audit fee. What amount was expensed for these items on Eagle's quarterly interim financial statements? A) Quarter 1 $202,500

Quarter 2 $12,500

Quarter 3 $12,500

Quarter 4 $12,500

B) Quarter 1 $195,000

Quarter 2 $15,000

Quarter 3 $15,000

Quarter 4 $15,000

C) Quarter 1 $67,500

Quarter 2 $57,500

Quarter 3 $57,500

Quarter 4 $57,500

D) Quarter 1 $60,000

Quarter 2 $60,000

Quarter 3 $60,000

Quarter 4 $60,000

Answer: D Objective: LO15.7 Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Difficulty: Moderate AACSB: Analytical thinking

15.2 Exercises 1) The accountant for Baxter Corporation has assigned most of the company's assets to its three segments as follows: Electronics Hardware Plumbing Total

$1,760,000 3,420,000 490,000 $5,670,000

The unassigned assets consist of $430,000 of unallocated goodwill and $270,000 of assets attached to the corporate headquarters. For internal decision-making purposes, goodwill is not assigned to the segments and the assets assigned to the corporate headquarters are allocated equally to the operating segments. Required: 1. What is the proper threshold value to use in determining which of the operating segments shown above are reporting segments? 2. Which of the operating segments are considered reporting segments? Answer: Requirement 1 GAAP allows the assets of the corporate headquarters to be included in the segments if the assets are included in the measure of the segment's assets that are reviewed by the chief operating decision maker. This interpretation would justify the exclusion of goodwill and inclusion of the corporate headquarters assets. The threshold value would be 10% times the sum of ($5,670,000 + $270,000) or $594,000. Requirement 2 Using the criterion established in Requirement 1, Electronics and Hardware would both be considered reporting segments. Plumbing would not be a reporting segment because it falls below the $594,000 threshold value. ($490,000 + $270,000/3 = $580,000). Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Moderate AACSB: Application of knowledge

2) For internal decision-making purposes, Dashwood Corporation's operating segments have been identified as follows:

Operating Segment Appliances Clothing Lawn and Garden Auto Accessories Service Contracts Catalog Sales Home Furnishings Tools

Revenues (includes intersegment revenues) $1,100,000 1,300,000 850,000 1,000,000 650,000 2,300,000 2,800,000 2,400,000 $12,400,000

Operating Profit or Loss

Identifiable Assets

$(150,000) (750,000) 150,000 100,000 (50,000) 50,000 250,000 300,000 $(100,000)

$1,200,000 400,000 150,000 200,000 100,000 500,000 1,000,000 250,000 $3,800,000

Revenues of the segments are external, with the exception of tools, which sold $400,000 to other segments, and Appliances, which sold $200,000 to other segments. Required: 1. In applying the "revenue" test to identify reporting segments, what is the test value for Dashwood Corporation? 2. Using the "revenue" test, which of Dashwood's operating segments will also be reportable segments? Answer: Requirement 1 In the revenue test, there is no separation of revenue earned from sales to other segments, thus the test value to be used is 10% of the total revenues listed, or $12,400,000 × 10% = $1,240,000. Requirement 2 Reportable segments are Clothing, Catalog Sales, Home Furnishings and Tools. The revenue from these four segments does not exceed 75% of consolidated revenue of $11,800,000, which equals $8,850,000. As a result, another operating segment, Appliances, must be reportable. Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Moderate AACSB: Application of knowledge

3) For internal decision-making purposes, Calam Corporation's operating segments have been identified as follows:

Operating Segment Appliances Clothing Lawn and Garden Auto Accessories Service Contracts Catalog Sales Home Furnishings Tools

Revenues $110,000 130,000 85,000 100,000 65,000 230,000 280,000 240,000 $1,240,000

Operating Profit or Loss $(15,000) (75,000) 15,000 10,000 (5,000) 5,000 25,000 30,000 (10,000)

Identifiable Assets $120,000 40,000 15,000 20,000 10,000 50,000 100,000 25,000 $380,000

Required: 1. In applying the "operating profit or loss" test to identify reporting segments, what is the test value for Calam Corporation? 2. Using the "reported profit or loss" test, which of Calam's operating segments will also be reporting segments? Answer: Requirement 1 If the absolute value of the total segments showing operating losses, $95,000, is more than the absolute value of the profitable segments, $85,000, then the absolute value of the loss segments, when multiplied by 10%, would become the test value for each segment. The $95,000 is multiplied by 10% to get $9,500, which is the test value for both the profitable and loss segments. Requirement 2 Using the test value of $9,500 for profit and loss of the segments, only the Service Contracts and Catalog Sales segments would not be considered reportable segments. Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Moderate AACSB: Application of knowledge

4) For internal decision-making purposes, Elom Corporation's operating segments have been identified as follows:

Operating Segment Appliances Lawn and Garden Auto Accessories Service Contracts Catalog Sales Corporate

Revenues $110,000 85,000 100,000 65,000 230,000 ________ $590,000

Operating Profit or Loss $(15,000) 15,000 10,000 (5,000) 5,000 ________ $10,000

Identifiable Assets $120,000 15,000 20,000 10,000 50,000 25,000 $240,000

Corporate assets are typically allocated back evenly to the segments for internal analysis purposes. Required: 1. In applying the "asset" test to identify reporting segments, what is the test value for Elom Corporation? 2. Using the "asset" test, which of Elom's operating segments will also be reporting segments? Answer: Requirement 1 Total identifiable assets of $240,000 is multiplied by 10% to determine the test value of $24,000. Requirement 2 Based on the answer to Requirement 1, Appliances, Auto Accessories and Catalog Sales would be reporting segments because their identifiable segment assets (which would include an additional $5,000, or 1/5 of $25,000 corporate assets), meets or exceeds the test value of $24,000. Note that Corporate is not a reportable segment, but that the assets are allocated to the other divisions. Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Moderate AACSB: Application of knowledge

5) The following data relate to Falcon Corporation's industry segments:

Industry Segment Oil Exploration Refinery Plastics Chemicals Solar Power Totals

Sales to External Customers $80,000 240,000 20,000 220,000 20,000 $580,000

Intersegment Sales

$20,000 160,000 75,000 $255,000

Assets $310,000 720,000 120,000 980,000 270,000 $2,400,000

Required: 1. Which of Falcon's operating segments would be considered reporting segments under the "revenue" test? 2. Which of Falcon's operating segments would be considered reporting segments under the "asset" test? Answer: Requirement 1 The test value is 10% of the combined revenues of all operating segments including intersegment revenues, or, 10% × $835,000 or $83,500. Based on this test value, Refinery, Chemicals, and Solar Power would be the reporting segments because each of these segments has more than $83,500 in total sales. Requirement 2 The test value is 10% of the combined identifiable assets or 10% × $2,400,000 or $240,000. Based on this test value, Oil Exploration, Refinery, Chemicals, and Solar Power would be the reporting segments because each of these segments has more than $240,000 in segment assets. Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Moderate AACSB: Application of knowledge

6) For internal decision-making purposes, Falcon Corporation identifies its industry segments by geographical area. For 2014, the total revenues of each segment are provided below. There are no intersegment revenues.

Canada United States Mexico South America China Russia Australia European Union Other European Total revenues

Total Revenues $22,000,000 76,000,000 10,000,000 9,000,000 2,000,000 1,500,000 3,000,000 12,000,000 14,000,000 $149,500,000

Required: 1. Which operating segments will be considered reporting segments based on the revenue test? 2. What is the test value for determining whether a sufficient number of segments are reported? 3. What will be the minimum number of segments that must be reported? Answer: Requirement 1 The reporting segments will be those segments whose segment revenue is 10% or more of the combined revenues of all operating segments. The total combined revenue of the operating segments is $149,500,000 and 10% of that number is $14,950,000. Only Canada and the United States will satisfy the 10% revenue test. Requirement 2 The appropriate test value is the "75% of consolidated revenues" test which is $112,125,000 ($149,500,000 × 75%). Requirement 3 Canada and the United States have combined revenues that total $98,000,000. The next largest segment in revenues is Other European at $14,000,000 which would get the total revenues to $112,000,000. Falcon would have to report one additional segment, European Union, to meet the 75% test for revenue. Objective: LO15.3 Determine the reporting of any additional segments using the 75 percent external-revenue test. Difficulty: Moderate AACSB: Application of knowledge

7) For internal decision-making purposes, Geogh Corporation identifies its industry segments by geographical area. For 2014, the total revenues of each segment are provided below. There are no intersegment revenues.

Canada United States Mexico South America China Russia Australia European Union Other European Total revenues

Total Revenues $980,000 1,410,000 1,260,000 430,000 710,000 660,000 370,000 1,220,000 1,650,000 $8,690,000

Required: 1. Which operating segments will be considered reporting segments based on the revenue test? 2. What is the test value for determining whether a sufficient number of segments are reported? 3. What will be the minimum number of segments that must be reported? Answer: Requirement 1 The reporting segments will be those segments whose segment revenue is 10% or more of the combined revenues of all operating segments, or $869,000 ($8,690,000 × 10%). Canada, United States, Mexico, European Union and Other European will satisfy the 10% revenue test. Requirement 2 The appropriate test value is the "75% of consolidated revenues" test which is $6,517,500 ($8,690,000 × 75%). Requirement 3 The five segments identified under Requirement 1 total $6,520,000 and therefore just meet the amount required by the 75% test. No further segments will need to be reported. Objective: LO15.3 Determine the reporting of any additional segments using the 75 percent external-revenue test. Difficulty: Moderate AACSB: Application of knowledge

8) The following data relate to Elle Corporation's industry segments. (Elle HQ represents the corporate headquarters). All other segments are geographical sales segments. Attribute External sales Intersegment Sales Expenses Assets assigned Income from Equity investee

Europe $35,000

Russia $24,000

China $33,000

Japan $0

Elle HQ $0

2,000 27,000 20,000

1,000 18,000 22,000

4,000 29,000 30,000

0 5,000 14,000

0 12,000 15,000 5,000

Required: 1. Prepare a report which reconciles the reportable segment profits to total consolidated profits assuming that corporate expenses are not allocated to the operating segments. 2. Prepare a report which reconciles the reportable segment profits to total consolidated profits assuming that corporate expenses are allocated evenly among the operating segments. Answer: Requirement 1 Total profit or loss for reportable segments Europe:($35,000 + $2,000 - $27,000) = $10,000 Russia:($24,000 + $1,000 - $18,000) = 7,000 China:($33,000 + $4,000 - $29,000) = 8,000 Japan: (-$5,000) (5,000) Total operating profit from reportable segments Plus: Income from equity investee Less: Intersegment revenues Less: Headquarter's expenses Equals: Consolidated net income

$20,000 5,000 (7,000) (12,000) $6,000

Requirement 2 Total profit or loss for reportable segments Europe:($35,000 + $2,000 - $27,000 - $3,000) = Russia:($24,000 + $1,000 - $18,000 - $3,000) = China:($33,000 + $4,000 - $29,000 - $3,000) = Japan: (-$5,000 - $3,000) = Operating profit from reportable segments Plus: Income from equity investee Less: Intersegment revenues Equals: Consolidated net income

7,000 4,000 5,000 (8,000) $8,000 5,000 (7,000) $6,000

Objective: LO15.5 Understand what segment disclosures are reconciled to the consolidated amounts. Difficulty: Moderate AACSB: Application of knowledge

9) Illiana Corporation has several accounting issues with respect to its interim financial statements for the first quarter of calendar 2014. Required: For each of the independent situations given below, state whether or not the method proposed by Illiana is acceptable. Justify each answer with appropriate reasoning. 1. Illiana will not perform a physical inventory at the end of the calendar quarter. It intends to estimate the cost of sales by using the gross profit inventory method. 2. Illiana grants volume discounts to its customers based upon their total annual purchases. The discounts are calculated on a sliding scale ranging from 1% to 8%. The amount of discount applied will progressively increase for a customer as the cumulative purchase total for the customer increases during the year. Illiana will use the average rate of discounts earned for each customer in the prior year as the expected discount rate for the current year. 3. At the beginning of the current quarter, Illiana incurred a large loss on the sale of some of its marketable securities. It intends to distribute the loss evenly to each of the four calendar quarters. 4. Illiana incurs maintenance costs during its year-end holiday shut down, but has minimal maintenance costs during the rest of the year. It intends to deduct one-fourth of the yearly estimated cost on its interim income statement. Answer: 1. GAAP specifically permits the use of the gross profit method for estimating ending inventory and cost of sales in the preparation of interim financial statements. 2. GAAP permits the use of reasonable estimates based upon the experience of prior periods for allocating annual expenses to interim periods. This integral approach is permitted but not required. 3. Since the entire loss has been realized in the first quarter, Illiana has no justifiable basis for allocating the loss to the other quarters. GAAP requires the discrete approach for a permanent loss in value; if the loss could not be deferred at year end to another period, then it may not be deferred to another interim period. It must show the entire loss in the first quarter. 4. GAAP permits the allocation of annual costs to the interim periods to which they relate. Objective: LO15.7 Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Difficulty: Moderate AACSB: Analytical thinking

10) Jeale Corporation is preparing its interim financial statements for the third quarter of calendar 2014. The following information was provided for the preparation of the statements: 1. Credit sales for the quarter 2. Cash sales for the quarter 3. Inventories, July 1 (FIFO cost method) 4. Cash purchases of inventory during the quarter 5. Inventory purchases made on account for the quarter 6. Estimated cost of goods sold ratio 7. Selling and general administrative expenses paid 8. Effective corporate tax rate 9. Loss on sale of securities sold on June 30, 2014 10. Annual insurance premiums paid on August 1 (the anniversary date of the policy) (Last year's insurance expense is included in general administrative expenses.)

$1,700,000 800,000 250,000 400,000 650,000 45% 111,000 28% 75,000 84,000

Additional information: At the end of the year, Jeale accrues its annual pension and depreciation expenses which amount to $60,000 and $42,000, respectively. Required: Prepare Jeale's interim income statement for the third quarter of calendar year 2014. Answer: Jeale Corporation Interim Income Statement For the Calendar Quarter Ending on September 30, 2014 Sales Revenue ($1,700,000 + $800,000) Less: Cost of Goods Sold (2,500,000 × 45%) Selling and general and administrative expenses Insurance expense ($84,000/12 months × 2 months) Depreciation expense ($42,000/4) Estimated pension expense ($60,000/4) Income before taxes Income tax expense ($1,224,500 × 28%) Net income

$2,500,000 1,125,000 111,000 14,000 10,500 15,000 $1,224,500 342,860 $ 881,640

Objective: LO15.8 Compute interim-period income tax expense. Difficulty: Moderate AACSB: Application of knowledge

11) Krull Corporation is preparing its interim financial statements for the third quarter of calendar 2014. The following trial balance information is available for third quarter: Account Cash Accounts Receivable Inventory Fixed assets Accounts Payable Common Stock Retained Earnings Sales Administrative expense Cost of goods sold Loss on sale of securities sold on July 30 Annual equipment overhaul costs paid on August 1 Totals

Debit $98,000 285,000 750,000 600,000

Credit

$300,000 50,000 80,000 4,400,000 312,000 2,650,000 75,000 60,000 $4,830,000

$4,830,000

Additional information At the end of the year, Krull distributes annual employee bonuses and charitable donations that are estimated at $40,000, and $12,000, respectively. The cost of goods sold includes the liquidation of a $45,000 base layer in inventory that Krull will restore in the fourth quarter at a cost of $75,000. Effective corporate tax rate for 2014 is 32%. Required: Prepare Krull's interim income statement for the third quarter of calendar 2014. Answer:

Krull Corporation Interim Income Statement For the Calendar Quarter Ending on September 30, 2014 Sales Revenue Less: Cost of Goods Sold ($2,650,000 + $30,000 LIFO base replacement) Administrative expenses Loss on sale of securities Bonus expense ($40,000/4) Charitable contribution expense ($12,000/4) Maintenance expense ($60,000/4) Income before taxes Income tax expense ($1,305,000 × 32%) Net income

$4,400,000 2,680,000 312,000 75,000 10,000 3,000 15,000 $1,305,000 417,600 $887,400

Objective: LO15.8 Compute interim-period income tax expense. Difficulty: Moderate AACSB: Application of knowledge

12) Leotronix Corporation estimates its income by calendar quarter as follows for 2014:

Est. Income

1st Quarter $30,000

2nd Quarter $40,000

3rd Quarter $40,000

4th Quarter $50,000

Income tax rates applicable to Leotronix: From: $ 0 to $50,000 15% From: $50,001 to $75,000 25% Over: $75,000 35% Required: Determine Leotronix's estimated effective tax rate. Answer: Income tax on estimated income First quarter ($30,000 × 15%) Second quarter ($20,000 × 15%) + ($20,000 × 25%) Third quarter ($5,000 × 25%) + ($35,000 × 35%) Fourth quarter ($50,000 × 35%) Total estimated taxes

$4,500 8,000 13,500 17,500 $ 43,500

Effective tax rate = Total estimated taxes divided by total estimated income = $43,500/$160,000 =

27.19%

Objective: LO15.8 Compute interim-period income tax expense. Difficulty: Moderate AACSB: Application of knowledge

2014 Total $160,000

13) Maxtil Corporation estimates its income by calendar quarter as follows for 2014:

Est. Income

1st Quarter $40,000

2nd Quarter $30,000

Income tax rates applicable to Maxtil: From: $0 to $50,000 From: $50,001 to $75,000 Over: $75,000

3rd Quarter $20,000

4th Quarter $20,000

15% 25% 35%

Required: Determine Maxtil's estimated effective tax rate. Answer: Income tax on estimated income First quarter ($40,000 × 15%) Second quarter ($10,000 × 15%) + ($20,000 × 25%) Third quarter ($5,000 × 25%) + ($15,000 × 35%) Fourth quarter ($20,000 × 35%) Total estimated taxes

$6,000 6,500 6,500 7,000 $26,000

Effective tax rate = Total estimated taxes divided by total estimated income = $26,000/$110,000 =

23.64%

Objective: LO15.8 Compute interim-period income tax expense. Difficulty: Moderate AACSB: Application of knowledge

2014 Total $110,000

14) Nettle Corporation is preparing its first quarterly interim report. It is subject to a corporate income tax rate of 20% on the first $50,000 of taxable income and 35% on taxable income above $50,000. Its estimated pretax accounting income for 2014, by quarter, is: 1st Quarter $75,000

Est. Income

2nd Quarter $165,000

3rd Quarter $143,000

4th Quarter $120,000

2014 Total $503,000

Nettle expects to earn and receive operating income for the year and does not contemplate any changes in accounting procedures or principles that would affect its pretax accounting income. Required: 1. Determine Nettle's estimated effective tax rate for 2014. 2. Prepare a schedule to show Nettle's estimated net income for each quarter of 2014. Answer: Requirement 1 Calculation of estimated effective tax rate First quarter ($50,000 × 20% + $25,000 × 35%) $18,750 Second quarter ($165,000 × 35%) 57,750 Third quarter ($143,000 × 35%) 50,050 Fourth quarter ($120,000 × 35%) 42,000 Total estimated taxes $168,550 Effective tax rate = Total estimated taxes divided by total estimated income = $168,550/$503,000 = 33.51% Requirement 2 1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

2014

Y-T-D income

$75,000

$240,000

$383,000

$503,000

Quarterly income

75,000

165,000

143,000

120,000

Income tax** Estimated NI

-25,132 $49,868

-55,290 $109,710

-47,918 $95,082

-40,211 $79,789

** (Deducted at 33.509%) Objective: LO15.8 Compute interim-period income tax expense. Difficulty: Moderate AACSB: Application of knowledge

-168,551 $334,449

15) Osprin Corporation has three operating segments, as summarized below:

Sales to retailers Intersegment sales Operating Expenses Interest Expense Income Tax Expense Assets

Capsule 25,000 4,000 10,000 2,000 4,000 12,000

Pill 35,000 10,000 18,000 3,000 6,000 3,000

Liquid 5,000 2,000 5,000 1,000 1,000 16,000

Total 65,000 16,000 33,000 6,000 11,000 31,000

Required: 1. Using the revenue test, what is the minimum amount of revenue of a reportable segment? 2. Using the operating profit or loss test, what is the minimum amount of operating profit or loss of a reportable segment? 3. Using the asset test, what is the minimum amount of assets of a reportable segment? 4. Based on the three tests, which segments will be separately reported? Answer: 1. Total revenue including intersegment sales = $65,000 + $16,000 = $81,000. The test value limit is $8,100 ($81,000 × 10%). 2. The operating profit or loss test includes the operating profit or loss for each segment, which excludes Interest Expense and Income Tax Expense.

Sales to retailers Intersegment sales Operating Expenses Operating Profit

Capsule 25,000 4,000 10,000 19,000

Pill 35,000 10,000 18,000 27,000

Liquid 5,000 2,000 5,000 2,000

Total 65,000 16,000 33,000 48,000

Total operating profit (all segments had profit; no segments had a loss) = $48,000. The test value limit is $4,800 ($48,000 × 10%). 3. The assets of all segments combined is $31,000. The test value limit is $3,100 ($31,000 × 10%). 4. Under the revenue test, the Capsule and Pill segments are reportable. The Liquid segment's total sales ($5,000 + $2,000) is $7,000 and does not exceed the limit. Under the operating profit or loss test, the Capsule and Pill segments are reportable. Under the asset test, the Capsule and Liquid segments are reportable. Because each segment meets at least one of the three tests, they will all be considered reportable segments. Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Moderate AACSB: Application of knowledge

16) The following information was collected together for the Lawson Company relating to the preparation of their annual financial statements for 2011. For each item, indicate "yes" or "no" as to whether the item must be disclosed in the annual report. ________ 1. Names of major customers for all reportable segments ________ 2. Interest revenue and expense for all reportable segments ________ 3. Cost of Goods Sold for all reportable segments ________ 4. Depreciation expense and amortization expense for all reportable segments ________ 5. Revenue from external customers for all reportable segments ________ 6. The basis for aggregating any operating segments to arrive at reporting segments ________ 7. Income tax expense (or benefit) for all reportable segments ________ 8. Total assets for all reportable segments ________ 9. Type of product or service for all reportable segments ________ 10. Extraordinary items for all reportable segments Answer: 1. no, 2. yes, 3. no, 4. yes, 5. yes, 6. yes, 7. yes, 8. yes, 9. yes, 10. yes Objective: LO15.4 Understand the types of disclosure information for segments and the reasons that the levels of disclosure may vary across companies. Difficulty: Moderate AACSB: Analytical thinking

17) Quantex Corporation has five operating segments, as summarized below: Household Sales to outside entities Intersegment sales Cost of goods sold Operating Expenses Interest Expense Income Tax Expense Assets

Industrial

Packaging

Storage

Services

700,000 50,000 300,000 200,000 10,000

4,300,000 600,000 2,700,000 1,300,000 40,000

400,000 800,000 700,000 200,000 5,000

1,700,000 200,000 900,000 600,000 -0-

100,000 -0-030,000 -0-

60,000 540,000

210,000 1,900,000

70,000 1,600,000

100,000 70,000

18,000 32,000

Required: Determine which of the operating segments of Quantex Corporation are reportable segments for the period shown. Answer: Revenue test: Total revenues (external and internal) = $8,850,000 × 10% = $885,000 = test value limit; therefore Industrial, Packaging and Storage are reportable segments. Operating Profit test (Sales - COGS - Operating Expenses): Total Operating Profit (no segments have losses) = $1,920,000 × 10% = $192,000 = test value limit; therefore Household, Industrial, Packaging and Storage are reportable segments. Asset test: Total assets of all operating segments = $4,142,000 × 10% = $414,200 = test value limit; therefore Household, Industrial, and Packaging are reportable segments. Based on the three tests above, all operating segments meet at least one criteria to be a reportable segment with the exception of Services. Since the four segments' revenue to external customers totals $7,100,000, and that is at least 75% of total revenue of all segments to external customers ($7,200,000 × 75% = $5,400,000), these four segments are satisfactory for disclosure requirements and no additional segments must be added. Objective: LO15.3 Determine the reporting of any additional segments using the 75 percent external-revenue test. Difficulty: Moderate AACSB: Analytical thinking

18) Rollins Publishing has five operating segments, as summarized below: Fiction Sales to outside entities Intersegment sales Cost of goods sold Operating Expenses Interest Expense Income Tax Expense Assets

Non-fiction

Reference

Childrens

Periodicals

870,000 -0430,000 120,000 -0-

416,000 -0270,000 89,000 61,000

796,000 80,000 290,000 95,000 -0-

236,000 -065,000 74,000 -0-

517,000 50,000 420,000 238,000 24,000

80,000 22,000

(1,000) 24,000

120,000 29,000

24,000 16,000

(28,000) 100,000

Required: Determine which of the operating segments of Rollins Publishing are reportable segments for the period shown. Answer: Revenue test: Total revenues (external and internal) = $2,965,000 × 10% = $296,500 = test value limit; therefore Fiction, Non-fiction, Reference and Periodicals are reportable segments. Operating Profit test (Sales - COGS - Operating Expenses): Total Operating Profit of segments with operating profits (Fiction, Non-fiction, Reference, Children's) = $965,000, and Total Operating Loss of segments with operating losses (Periodicals) = $(91,000). Since the absolute value of the total operating profit is greater than the absolute value of the total operating losses, we will use 10% of the total operating profits as our test value limit = $96,500; therefore Fiction, Reference and Children's are reportable segments. Asset test: Total assets of all operating segments = $191,000 × 10% = $19,100 = test value limit; therefore Fiction, Non-fiction, Reference and Periodicals are reportable segments. Based on the three tests above, all operating segments meet at least one criteria to be a reportable segment, therefore all segments must be reported. Objective: LO15.3 Determine the reporting of any additional segments using the 75 percent external-revenue test. Difficulty: Moderate AACSB: Analytical thinking

19) Snodberry Catering has five operating segments, as summarized below:

Sales to outside entities Intersegment sales Cost of goods sold Operating Expenses Interest Expense Income Tax Expense Assets

Buffet 26,000 -016,000 9,000 -0-02,000

Alcohol 110,000 20,000 50,000 70,000 5,000 2,000 22,000

Bakery 22,000 4,000 19,000 6,000 -0-02,000

Wait Service Bar Service 24,000 5,000 -056,000 23,000 69,000 2,000 4,000 2,000 1,000 -0(3,000) 1,000 1,000

Required: Determine which of the operating segments of Snodberry Catering are reportable segments for the period shown. Answer: Revenue test: Total revenues (external and internal) = $267,000 × 10% = $26,700 = test value limit; therefore Alcohol and Bar Service are reportable segments. Operating Profit test (Sales - COGS - Operating Expenses): Total Operating Profit of segments with operating profits (Buffet, Alcohol, Bakery) = $12,000, and Total Operating Loss of segments with operating losses (Wait Service and Bar Service) = $(13,000). Since the absolute value of the total operating losses is greater than the absolute value of the total operating profits, we will use 10% of the total operating losses as our test value limit = $1,300; therefore Alcohol and Bar Service (which has an absolute value of operating loss greater than the test value limit) are reportable segments. Asset test: Total assets of all operating segments = $28,000 × 10% = $2,800 = test value limit; therefore Alcohol is a reportable segment. Based on the three tests above, two operating segments meet at least one criteria to be a reportable segment (Alcohol and Bar Service). Total Revenue to external customers = $187,000, multiplied by 75% = $140,250. Since the sales revenue to external customers of the two reportable segments only amounts to $115,000, at least one more operating segment must be added. By adding Buffet as a reportable segment, the sales revenue to external customers by the reportable segments would increase to $141,000 which exceeds the criterion of $140,250. Objective: LO15.3 Determine the reporting of any additional segments using the 75 percent external-revenue test. Difficulty: Moderate AACSB: Analytical thinking

20) Tillman Fabrications has five operating segments, as summarized below:

Sales to outside entities Intersegment sales Operating Profit Assets

Wood 5,200,000 390,000 (520,000) 690,000

Plastic 1,200,000 4,700,000 (590,000) 450,000

Metal 7,800,000 -01,700,000 880,000

Paper 1,600,000 -0190,000 280,000

Fabric 6,300,000 750,000 (960,000) 760,000

Required: Determine which of the operating segments of Tillman Fabrications are reportable segments for the period shown. Answer: Revenue test: Total revenues (external and internal) = $27,940,000 × 10% = $2,794,000 = test value limit; therefore Wood, Plastic, Metal, and Fabric are reportable segments. Operating Profit test: Total Operating Profit of segments with operating profits (Metal and Paper) = $1,890,000, and Total Operating Loss of segments with operating losses (Wood, Plastic, Fabric) = $(2,070,000). Since the absolute value of the total operating losses is greater than the absolute value of the total operating profits, we will use 10% of the total operating losses as our test value limit = $207,000; therefore Wood, Plastic, Metal and Fabric are reportable segments. Asset test: Total assets of all operating segments = $3,060,000 × 10% = $306,000 = test value limit; therefore Wood, Plastic, Metal and Fabric are reportable segments. Based on the three tests above, four operating segments meet at least one criteria to be a reportable segment (Wood, Plastic, Metal and Fabric). Total Revenue to external customers = $22,100,000, multiplied by 75% = $16,575,000. Since the sales revenue to external customers of the four reportable segments amounts to $20,500,000, the 75% test has been met by those four segments and no further segments must be included in separate reporting. Objective: LO15.3 Determine the reporting of any additional segments using the 75 percent external-revenue test. Difficulty: Moderate AACSB: Analytical thinking

15.3 True/False 1) Enterprises must report segment information using the management approach to segmentation. Answer: TRUE Objective: LO15.1 Understand how firms use the management approach to identify potentially reportable operating segments. Difficulty: Easy AACSB: Analytical thinking

2) Management-approach-based segments are called operating segments. Answer: TRUE Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Easy AACSB: Analytical thinking

3) Pensions and corporate headquarters are all part of an operating segment. Answer: FALSE Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Moderate AACSB: Analytical thinking

4) For reporting purposes, a segment is considered material if its assets are 15 percent or more of the combined assets of all operating segments. Answer: FALSE Objective: LO15.2 Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating-profit test. Difficulty: Moderate AACSB: Analytical thinking

5) A reconciliation between the segment data and the consolidated information must be provided for the total of the reportable segments' revenues and the reported consolidated revenues. Answer: TRUE Objective: LO15.5 Understand what segment disclosures are reconciled to the consolidated amounts. Difficulty: Moderate AACSB: Analytical thinking

6) Enterprises must disclose the existence of major customers; the single customer that accounts for 10 percent or more of the enterprise's revenue. Answer: TRUE Objective: LO15.6 Know the required enterprise-wide disclosures with respect to products and services, geographic areas of operation, and major customers. Difficulty: Moderate AACSB: Analytical thinking

7) Interim financial reports provide more timely, extensive information than annual financial reports. Answer: FALSE Objective: LO15.7 Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Difficulty: Easy AACSB: Analytical thinking

8) The gross profit method for estimating inventory and cost of goods sold can be used for interim financial reports if the periodic inventory method is not used and it is too costly to perform an inventory count. Answer: FALSE Objective: LO15.7 Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Difficulty: Moderate AACSB: Analytical thinking

9) If the LIFO method is used for inventory to reduce taxable income, the IRS requires the LIFO method to be used for financial reporting purposes. Answer: TRUE Objective: LO15.7 Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Difficulty: Easy AACSB: Analytical thinking

10) The Securities and Exchange Commission require that quarterly reports be prepared for the company's stockholders and for filing with the IRS. Answer: FALSE Objective: LO15.8 Compute interim-period income tax expense. Difficulty: Moderate AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 16 Partnerships - Formation, Operations, and Changes in Ownership Interests 16.1 Multiple Choice Questions 1) Under the Uniform Partnership Act, loans made by a partner to the partnership are treated as A) liabilities to the partnership for which interest shall be paid from the date of the liability. B) advances to the partnership that are carried in the partners' capital accounts. C) Accounts Payable of the partnership for which interest is paid. D) advances to the partnership for which interest does not have to be paid. Answer: A Objective: LO16.2 Understand initial investment valuation and record keeping. Difficulty: Easy AACSB: Analytical thinking

2) A partner assigned his partnership interest to a third party. Which statement best describes the legal ramifications to the assignee? A) The assignment of the partnership interest does not entitle the assignee to partnership assets upon a liquidation. B) The assignment dissolves the partnership. C) The assignee has the right to share in the management of the partnership. D) The assignee does not become a partner but has the right to share in future partnership profits and to receive the proper share of partnership assets upon liquidation. Answer: D Objective: LO16.4 Value a new partner's investment in an existing partnership. Difficulty: Easy AACSB: Analytical thinking

3) In the Uniform Partnership Act, partners have A) mutual agency. B) limited liability. C) no mutual agency. D) association rights. Answer: A Objective: LO16.1 Comprehend the legal characteristics of partnerships. Difficulty: Easy AACSB: Analytical thinking

4) Partnerships A) are required to prepare annual reports. B) are required to file income tax returns but do not pay Federal income taxes. C) are required to file income tax returns and pay Federal income taxes. D) are not required to file income tax returns or pay Federal income taxes. Answer: B Objective: LO16.1 Comprehend the legal characteristics of partnerships. Difficulty: Easy AACSB: Analytical thinking

5) Austin contributes his computer equipment to the landscaping partnership he starts with Bentley. At what amount should the computer equipment be credited to Austin's partnership capital? A) The tax basis B) The fair value at the date of contribution C) Austin's original cost D) At the amount that Bentley contributes, with the assumption that they both contribute equally to the partnership Answer: B Objective: LO16.2 Understand initial investment valuation and record keeping. Difficulty: Easy AACSB: Analytical thinking

Use the following information to answer the question(s) below. A summary balance sheet for the Lemon, Mango, and Nobb partnership appears below. Lemon, Mango, and Nobb share profits and losses in a ratio of 2:3:5, respectively. Assets Cash Marketable securities Inventory Land Building-net Total assets

$ 100,000 200,000 125,000 100,000 500,000 $1,025,000

Equities Lemon, capital Mango, capital Nobb, capital Total equities

$ 425,000 400,000 200,000 $1,025,000

The partners agree to admit Oran for a one-fifth interest. The fair market value of partnership land is appraised at $200,000 and the fair market value of inventory is $175,000. The assets are to be revalued prior to the admission of Oran and there is $30,000 of goodwill that attaches to the old partnership. 6) By how much will the capital accounts of Lemon, Mango, and Nobb increase, respectively, due to the revaluation of the assets and the recognition of goodwill? A) The capital accounts will increase by $50,000 each. B) The capital accounts will increase by $60,000 each. C) $36,000, $54,000, and $90,000 D) $40,000, $50,000, and $60,000 Answer: C Explanation: C) The assets value will increase by $180,000 ($50,000 from inventory, $100,000 from land, and $30,000 from goodwill). Allocated on a 2:3:5 basis: $36,000 to Lemon, $54,000 to Mango, and $90,000 to Nobb. Objective: LO16.4 Value a new partner's investment in an existing partnership. Difficulty: Moderate AACSB: Application of knowledge

7) How much cash must Oran invest to acquire a one-fifth interest? A) $235,000 B) $141,000 C) $293,750 D) $301,250 Answer: D Explanation: D) After the revaluation, the assets will be recorded at $1,205,000. If Oran is admitted for a one-fifth interest, the $1,205,000 represents 80% of the total implied capital. Dividing $1,205,000 by 80% gives a total capitalization of $1,506,250 for which $301,250 is required from Oran for a 20% interest. Objective: LO16.4 Value a new partner's investment in an existing partnership. Difficulty: Moderate AACSB: Application of knowledge

8) What will the profit and loss sharing ratios be after Oran's investment? A) 1:2:4:2 B) 2:3:5:2 C) 3:4:6:2 D) 4:6:10:5 Answer: D Explanation: D) Each of the original partners has given up 20% of their interest to Oran. Their profit and loss sharing ratios will be 80% of what they were before the admission of Oran. Lemon 20% × 80% = 16% Mango 30% × 80% = 24% Nobb 50% × 80% = 40% Oran = 20% Expressed as: 4:6:10:5 Objective: LO16.4 Value a new partner's investment in an existing partnership. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Bertram and Ernest share profits and losses equally after salary and interest allowances. Bertram and Ernest receive salary allowances of $40,000 and $60,000, respectively, and both partners receive 10% interest on their average capital balances. Average capital balances are calculated at the beginning of each month, regardless of when additional capital contributions or permanent withdrawals are made subsequently within the month. Partners' drawings of $3,000 per month are not used in determining the average capital balances. Total net income for 2014 is $240,000.

January 1 capital balances Yearly drawings ($3,000 a month) Permanent withdrawals of capital: June 3 May 2 Additional investments of capital: July 3 October 2

Bertram $200,000 (36,000)

Ernest $240,000 (36,000)

(24,000) (30,000) 80,000 100,000

9) What is the weighted-average capital for Bertram and Ernest in 2014? A) $224,000 and $245,000 B) $203,333 and $221,167 C) $221,333 and $239,167 D) $256,000 and $220,000 Answer: C Explanation: C) Bertram: [($200,000 × 6) + ($176,000 × 1) + ($256,000 × 5)]/12 = $221,333 Ernest: [($240,000 × 5) + ($210,000 × 5) + ($310,000 × 2)]/12 = $239,167 Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

10) If the average capital for Bertram and Ernest from the above information is $224,000 and $238,000, respectively, what will be the total amount of profit allocated to salary and interest distributions? A) $93,800 B) $146,200 C) $218,200 D) $240,000 Answer: B Explanation: B) Capital: ($224,000 + $238,000) × (10%) = $46,200 Salary: ($40,000 + $60,000) = $100,000 Total: $46,200 + $100,000 = $146,200 Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

11) If the average capital balances for Bertram and Ernest are $200,000 and $240,000, what will the total partnership profit allocations be for Bertram and Ernest in 2014? A) $100,000 and $140,000 B) $108,000 and $132,000 C) $120,000 and $120,000 D) $140,000 and $100,000 Answer: B Explanation: B) Bertram: ($200,000 × 10%) + $40,000 + $48,000 = $108,000 Ernest: ($240,000 × 10%) + $60,000 + $48,000 = $132,000 Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Alfred and Barne share profits and losses in a ratio of 2:3, respectively, after salary allowances, interest allowances and bonus allocations. Alfred and Barne receive salary allowances of $30,000 and $60,000, respectively, and both partners receive 10% interest based upon the balance in their capital accounts on January 1. Partners' drawings are not used in determining the average capital balances. Total net income for 2014 is $180,000. If net income after deducting the interest and salary allocations is more than $60,000, Barne receives a bonus of 5% of the original amount of net income.

January 1 capital balances Yearly drawings ($3,000 a month)

Alfred $ 600,000 36,000

Barne $ 900,000 36,000

12) What is the total amount for the allocation of interest, salary, and bonus, and how much overallocation is present? A) $180,000 and $0 B) $240,000 and $60,000 C) $249,000 and $0 D) $249,000 and $69,000 Answer: B Explanation: B) Interest: ($1,500,000 × 10%) = $150,000 Salary: ($30,000 + $60,000) = $90,000 Bonus: Condition not met = $0 Total allocations = $240,000 and over-allocation = $240,000 - $180,000 = $60,000 Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

13) If the partnership experiences a net loss of $60,000 for the year, what will be the final net amount of profit or (loss) closed to each partner's capital account? A) ($90,000) to Alfred and $30,000 to Barne B) ($30,000) to Alfred and ($30,000) to Barne C) ($24,000) to Alfred and ($36,000) to Barne D) $30,000 to Alfred and ($90,000) to Barne Answer: B Explanation: B) Alfred: Interest allocation: $60,000 Salary allocation: $30,000 Barne: Interest allocation: Salary allocation:

$90,000 $60,000

There is a total of $240,000 for positive allocations. To bring them down to a $60,000 loss, a residual adjustment of ($300,000) is needed which is allocated ($120,000) to Alfred and ($180,000) to Barne. After these amounts are assigned to the partners, each partner's capital account will be reduced by a net $30,000. Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

14) The XYZ partnership provides a 10% bonus to Partner Y that is based upon partnership income, after deduction of the bonus. If the partnership's income is $140,000, how much is Partner Y's bonus allocation? A) $12,727 B) $13,860 C) $14,000 D) $15,400 Answer: A Explanation: A) B = .1 × ($140,000 - B) B = $14,000 - .1B 1.1B = $14,000 B = $12,727 Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

15) Drawings A) are advances to a partnership. B) are loans to a partnership. C) are a function of interest on partnership average capital. D) are the same nature as withdrawals. Answer: D Objective: LO16.2 Understand initial investment valuation and record keeping. Difficulty: Moderate AACSB: Analytical thinking

16) If the partnership agreement provides a formula for the computation of a bonus to the partners, the bonus would be computed A) next to last, because the final allocation is the distribution of the profit residual. B) before income tax allocations are made. C) after the salary and interest allocations are made. D) in any manner agreed to by the partners in the partnership agreement. Answer: D Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Analytical thinking

Use the following information to answer the question(s) below. Quincy has decided to retire from the partnership of Quincy, Robert, and Sam. The partnership will pay Quincy $400,000. Total partnership capital should be revalued based on the excess payment to Quincy. (Assume the book values of the assets listed below equals fair values.) A summary balance sheet for the Quincy, Robert, and Sam partnership appears below. Quincy, Robert, and Sam share profits and losses in a ratio of 1:1:3, respectively. Assets Cash Marketable securities Inventory Land Building-net Total assets

$ 150,000 76,000 164,000 300,000 510,000 $1,200,000

Equities Quincy, capital Robert, capital Sam, capital Total equities

320,000 280,000 600,000 $1,200,000

17) What goodwill will be recorded? A) $ 80,000 B) $240,000 C) $320,000 D) $400,000 Answer: D Explanation: D) Quincy will receive a return of his capital ($320,000) plus an additional $80,000, for a total payment of $400,000. The excess payment of $80,000 for his 20% share implies a total goodwill of $80,000 / 20% = $400,000. Objective: LO16.5 Value a partner's share on retirement or death. Difficulty: Moderate AACSB: Application of knowledge

18) What partnership capital will Robert have after Quincy retires? A) $200,000 B) $280,000 C) $360,000 D) $440,000 Answer: C Explanation: C) The $400,000 of implied goodwill is allocated to the partner accounts, with 1/5 ($80,000) being added to Robert's account. Objective: LO16.5 Value a partner's share on retirement or death. Difficulty: Moderate AACSB: Application of knowledge

19) Which of the following is a reason to use a partnership as the legal form of a business? A) Partnerships avoid the issue of mutual agency. B) Partnerships avoid the issue of unlimited liability. C) Partnerships avoid the issue of double-taxation faced by corporations. D) Partnerships avoid the difficulty of raising capital. Answer: C Objective: LO16.1 Comprehend the legal characteristics of partnerships. Difficulty: Easy AACSB: Analytical thinking

20) In a limited partnership, a general partner A) is excluded from management of the business. B) is not entitled to a bonus at the end of the year. C) has limited liability for partnership debt. D) has unlimited liability for partnership debt. Answer: D Objective: LO16.6 Understand limited liability partnership characteristics. Difficulty: Easy AACSB: Analytical thinking

16.2 Exercises 1) Anna and Bess share partnership profits and losses at 60% and 40%, respectively. The partners agree to admit Cal into the partnership for a 50% interest in capital and earnings. Capital accounts immediately before the admission of Cal are: Anna (60%) Bess (40%) Total

$ 300,000 300,000 $ 600,000

Required: 1. Prepare the journal entry(s) for the admission of Cal to the partnership assuming Cal invested $400,000 for the ownership interest, and that this is a fair price for that share of the partnership to be acquired. Cal paid the money directly to Anna and to Bess for 50% of each of their respective capital interests. The partnership records goodwill. 2. Prepare the journal entry(s) for the admission of Cal to the partnership assuming Cal invested $500,000 for the ownership interest. Cal paid the money to the partnership for a 50% interest in capital and earnings. Assume the valuation is based on the capital of the current partnership, which is fairly valued. The partnership records goodwill. 3. Prepare the journal entry(s) for the admission of Cal to the partnership assuming Cal invested $700,000 for the ownership interest, and that this is a fair price for that share of the partnership to be acquired. Cal paid the money to the partnership for a 50% interest in capital and earnings. The partnership records goodwill.

Answer: Requirement 1 Goodwill Anna, capital Bess, capital

200,000

Anna, capital Bess, capital Cal, capital

210,000 190,000

120,000 80,000

400,000

If a $400,000 payment represents 50% of total capital, then twice that amount, or $800,000, is the implied total capital including goodwill. If the present total capital is $600,000, then the amount of goodwill to record is $200,000. This goodwill is allocated 60% to Anna and 40% to Bess. After the first entry is posted, the balances in the Anna and Bess capital accounts will be $420,000 and $380,000, respectively. If one-half of each partner's interest is given to Cal, Anna's capital account is reduced by $210,000, and Bess' capital account is reduced by $190,000. Requirement 2 Goodwill Cash Cal, capital

100,000 500,000 600,000

If we focus on the current capital of the partnership, $600,000, and say that it is fairly valued, then, if it represents 50% of final capital after Cal's investment, final capital should be $1,200,000. Cal's share of final capital will be $600,000, and, if Cal invests $500,000 for this interest, there must be $100,000 of goodwill that is allocated to Cal. Requirement 3 Goodwill Anna, capital Bess, capital

100,000

Cash Cal, capital

700,000

60,000 40,000

700,000

If Cal invests $700,000 for a 50% interest, it implies that total partnership capital should be $1,400,000. After Cal's investment, total capital will be $1,300,000, and goodwill is therefore $100,000. The goodwill is allocated to Anna and Bess. Objective: LO16.4 Value a new partner's investment in an existing partnership. Difficulty: Moderate AACSB: Application of knowledge

2) Dan and Ellie share partnership profits and losses at 70% and 30%, respectively. The partners agree to admit Fran into the partnership for a 50% interest in capital and earnings. Capital accounts immediately before the admission of Fran are: Dan (70%) Ellie (30%) Total

$ 800,000 400,000 $1,200,000

Required: 1. Prepare the journal entry(s) for the admission of Fran to the partnership assuming Fran invested $800,000 for the ownership interest, and that this is a fair price for that share of the partnership to be acquired. Fran paid the money directly to Dan and to Ellie for 50% of each of their respective capital interests. The partnership records goodwill. 2. Prepare the journal entry(s) for the admission of Fran to the partnership assuming Fran invested $1,000,000 for the ownership interest. Fran paid the money to the partnership for a 50% interest in capital and earnings. Assume the valuation is based on the capital of the current partnership, which is fairly valued. The partnership records goodwill. 3. Prepare the journal entry(s) for the admission of Fran to the partnership assuming Fran invested $1,400,000 for the ownership interest, and that this is a fair price for that share of the partnership to be acquired. Fran paid the money to the partnership for a 50% interest in capital and earnings. The partnership records goodwill.

Answer: Requirement 1 Goodwill Dan, capital Ellie, capital

400,000

Dan, capital Ellie, capital Fran, capital

540,000 260,000

280,000 120,000

800,000

If an $800,000 payment represents 50% of total capital, then twice that amount, or $1,600,000, is the implied total capital including goodwill. If the present total capital is $1,200,000, then the amount of goodwill to record is $400,000. This goodwill is allocated 70% to Dan and 30% to Ellie. After the first entry is posted, the balances in the Dan and Ellie capital accounts will be $1,080,000 and $520,000, respectively. If one-half of each partner's interest is given to Fran, Dan's capital account is reduced by $540,000, and Ellie's capital account is reduced by $260,000. Requirement 2 Goodwill Cash Fran, capital

200,000 1,000,000 1,200,000

If we focus on the current capital of the partnership, $1,200,000, and say that it is fairly valued, then, if it represents 50% of final capital after Fran's investment, final capital should be $2,400,000. Fran's share of final capital will be $1,200,000, and, if Fran invests $1,000,000 for this interest, there must be $200,000 of goodwill that is allocated to Fran. Requirement 3 Goodwill Dan, capital Ellie, capital

200,000

Cash Fran, capital

1,400,000

140,000 60,000

1,400,000

If Fran invests $1,400,000 for a 50% interest, it implies that total partnership capital should be $2,800,000. After Fran's investment, total capital will be $2,600,000, and goodwill is therefore $200,000. The goodwill is allocated to Dan and Ellie. Objective: LO16.4 Value a new partner's investment in an existing partnership. Difficulty: Moderate AACSB: Application of knowledge

3) On February 1, 2014, George, Hamm, and Ishmael began a partnership in which George and Ishmael each contributed cash of $25,000; and Hamm contributed property with a fair value of $50,000 and a tax basis $40,000. Hamm receives a 5% bonus of partnership income. George and Ishmael receive salaries of $10,000 each. The partnership agreement of George, Hamm, and Ishmael provides that all partners receive 5% interest on capital, and that profits and losses of the remaining income be distributed to George, Hamm, and Ishmael by a 1:3:1 ratio. Required: Prepare a schedule to distribute $25,000 of partnership net income to the partners. Answer: Income George Hamm Ishmael Net income $ 25,000 Bonus to Hamm ( 1,250 ) $ 1,250 Salaries ( 20,000 ) $ 10,000 $ 10,000 Interest ( 5,000 ) 1,250 2,500 1,250 Residual loss ( 1,250 ) Loss allocation 1,250 $ ( 250 ) ( 750 ) ( 250 ) Allocation $ 0 $ 11,000 $ 3,000 $ 11,000 Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

4) On July 1, 2014, Joe, Kline, and Lama began a partnership in which Joe and Kline each contributed cash of $200,000; and Lama contributed property with a fair value of $100,000 and a tax basis $150,000. Joe receives a 10% bonus of partnership income. Kline and Lama receive salaries of $40,000 each. The partnership agreement of Joe, Kline, and Lama provides that all partners receive 5% interest on capital and that profits and losses of the remaining income be distributed to Joe, Kline, and Lama by a 1:1:3 ratio. Required: Prepare a schedule to distribute $225,000 of partnership net income to the partners. Answer: Income Joe Kline Lama Net income $ 225,000 Bonus to Joe ( 22,500 ) $ 22,500 Salaries ( 80,000 ) $ 40,000 $ 40,000 Interest ( 25,000 ) 10,000 10,000 5,000 Residual profit 97,500 Profit allocation ( 97,500 ) $ 19,500 19,500 58,500 Allocation $ 0 $ 52,000 $ 69,500 $ 103,500 Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

5) The profit and loss sharing agreement for the Mason, Nell, and Odell partnership provides for a $15,000 salary allowance to Nell. Residual profits and losses are allocated 5:3:2 to Mason, Nell, and Odell, respectively. In 2013, the partnership recorded $120,000 of net income that was properly allocated to the partners' capital accounts. On January 25, 2014, after the books were closed for 2013, Mason discovered that office equipment, purchased for $12,000 on December 29, 2013, was recorded as office expense by the company bookkeeper. Required: Prepare the necessary correcting entry(s) for the partnership. Answer: 1/25/14 Office Equipment 12,000 Mason, capital 6,000 Nell, capital 3,600 Odell, capital 2,400 Correction of journal entry error from 12/29/13. To record office equipment and to adjust partner capital accounts. Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

6) The profit and loss sharing agreement for the Tuttle, Upman, and Veer partnership provides for residual profits and losses to be allocated 2:3:6 to Tuttle, Upman, and Veer, respectively. In 2014, the partnership recorded $11,000 of net income that was properly allocated to the partners' capital accounts. On January 18, 2015, after the books were closed for 2014, Tuttle discovered that the $16,500 payment for the partnership's liability and workers compensation insurance for 2015 was recorded as insurance expense when it was paid on December 28, 2014. Required: Prepare the necessary correcting entry(s) for the partnership. Answer: 1/18/15 Prepaid insurance 16,500 Tuttle, capital 3,000 Upman, capital 4,500 Veer, capital 9,000 Correction of journal entry error from 12/28/14. To record prepaid insurance and to adjust partner capital accounts. Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Xavier, Young, and Zane operate a partnership with a complex profit and loss sharing agreement. The average capital balance for each partner on December 31, 2014 is $300,000 for Xavier, $250,000 for Young, and $325,000 for Zane. An 8% interest allocation is provided to each partner based on the average capital balance on December 31, 2014. Xavier and Young receive salary allocations of $10,000 and $15,000, respectively. If partnership net income is above $25,000, after the salary allocations are considered (but before the interest allocations are considered), Zane will receive a bonus of 10% of the original amount of net income. All residual income is allocated in the ratios of 2:3:5 to Xavier, Young, and Zane, respectively.

7) Required: 1. Prepare a schedule to allocate income to the partners assuming that partnership net income for 2014 is $250,000. 2. Prepare a journal entry to distribute the partnership's income to the partners (assume that an Income Summary account is used by the partnership). Answer: Requirement 1 Income Xavier Young Zane Net income $ 250,000 Bonus to Zane ( 25,000 ) $ 25,000 Salary allocation ( 25,000 ) $ 10,000 $ 15,000 Interest allocation ( 70,000 ) 24,000 20,000 26,000 Residual ( 130,00 ) $ 26,000 39,000 65,000 Final allocation $ 0 $ 60,000 $ 74,000 $ 116,000 Requirement 2 Income summary Xavier, capital Young, capital Zane, capital

250,000 60,000 74,000 116,000

Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

8) Required: 1. Prepare a schedule to allocate income or loss to the partners assuming that the partnership incurs a net loss of $36,000 for 2014. 2. Prepare a journal entry to distribute the partnership's loss to the partners (assume that an Income Summary account is used by the partnership). Answer: Requirement 1 Loss Net loss $ ( 36,000 Bonus to Zane ( 0 Salary allocation ( 25,000 Interest allocation ( 70,000 Subtotal (131,000 Residual allocation 131,000 Totals $ 0

Xavier ) ) ) ) )

Young

Zane $

10,000 24,000 34,000 $ ( 26,200 ) $ 7,800

15,000 20,000 35,000 ( 39,300 ) $ ( 4,300 )

26,000 26,000 ( 65,500 ) $ ( 39,500 )

Requirement 2 Young, capital Zane, capital Xavier, capital Income summary

4,300 39,500 7,800 36,000

Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

Use the following information to answer the question(s) below. Adam, Bella, and Chris operate a partnership with a complex profit and loss sharing agreement. The average capital balance for Adam, Bella and Chris on December 31, 2014 is $120,000, $270,000, and $340,000, respectively. A 6% interest allocation is provided to each partner based on the average capital balance on December 31, 2014. Adam and Bella receive salary allocations of $40,000 and $50,000, respectively. If partnership net income is above $160,000, after the salary allocations are considered (but before the interest allocations are considered), Chris will receive a bonus of 10% of the income (pre-salary and interest, but net of the bonus). All residual income is allocated in the ratios of 2:2:6 to Adam, Bella, and Chris, respectively. 9) Required: 1. Prepare a schedule to allocate income to the partners assuming that partnership net income for 2014 is $330,000. 2. Prepare a journal entry to distribute the partnership's income to the partners (assume that an Income Summary account is used by the partnership). Answer: Requirement 1

Net income Bonus to Chris Salary allocation Interest allocation Residual Final allocation

Income $ 330,000 ( 30,000 ) ( 90,000 ) ( 43,800 ) (166,200 ) $ 0

Adam

Bella

Chris $

40,000 7,200 33,240 80,440

50,000 16,200 33,240 99,440

30,000

20,400 99,720 $ 150,120

BONUS = B = ($330,000 - B) × 10% Requirement 2 Income summary Adam, capital Bella, capital Chris, capital

330,000 80,440 99,440 150,120

Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

10) Required: 1. Prepare a schedule to allocate income or loss to the partners assuming that the partnership incurs a net loss of $26,200 for 2014. 2. Prepare a journal entry to distribute the partnership's loss to the partners (assume that an Income Summary account is used by the partnership). Answer: Requirement 1 Loss Net loss $ ( 26,200 Bonus to Chris ( 0 Salary allocation ( 90,000 Interest allocation ( 43,800 Subtotal (160,000 Residual allocation 160,000 Totals $ 0

Adam ) ) ) ) )

Bella

Chris $

40,000 7,200 47,200 ( 32,000 ) $ 15,200

50,000 16,200 66,200 ( 32,000 ) $ 34,200

20,400 20,400 ( 96,000 ) $ ( 75,600 )

Requirement 2 Chris, capital Adam, capital Bella, capital Income summary

75,600 15,200 34,200 26,200

Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

11) Daniel, Ethan, and Frank have a retail partnership business selling personal computers. The partners are allowed an interest allocation of 8% on their average capital. Capital account balances on the first day of each month are used in determining weighted average capital, regardless of additional partner investment or withdrawal transactions during any given month. Withdrawals of capital that are debited to the capital account are used in the average calculation. Partner capital activity for the year was: Capital accounts Jan 1 balance Feb 2 investment Mar 6 investment Apr 20 withdrawal Jul 3 withdrawal and investment Sep 29 investment Nov 5 investment

Daniel $ 200,000 50,000 10,000

Ethan $ 300,000

(7,000) 5,000

10,000 4,000

Frank $ 250,000

20,000 (10,000) 5,000 5,000

Required: Calculate weighted average capital for each partner, and determine the amount of interest that each partner will be allocated. Round all calculations to the nearest whole dollar. Answer: Jan, Feb Mar Apr, May, Jun, Jul Aug, Sep Oct, Nov, Dec Total capital Average capital Interest allocation

$ 200,000 × 2 = 250,000 × 1 = 260,000 × 4 = 253,000 × 2 = 258,000 × 3 =

Jan, Feb, Mar Apr, May, Jun, Jul Aug, Sep Oct, Nov, Dec Total capital Average capital Interest allocation

$300,000 × 3 = 320,000 × 4 = 330,000 × 2 = 334,000 × 3 =

Jan, Feb, Mar, Apr May, Jun, Jul, Aug, Sep Oct, Nov Dec Total capital Average capital Interest allocation

$250,000 × 4 = 240,000 × 5 = 245,000 × 2 = 250,000 × 1 =

Daniel $400,000 250,000 1,040,000 506,000 774,000 $2,970,000 $247,500 $19,800 Ethan $900,000 1,280,000 660,000 1,002,000 $3,842,000 $320,167 $25,613 Frank $1,000,000 1,200,000 490,000 250,000 $2,940,000 $245,000 $19,600

Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

12) Greta, Harriet, and Ivy have a retail partnership business selling personal computers. The partners are allowed an interest allocation of 6% on their average capital. Capital account balances on the first day of each month are used in determining weighted average capital, regardless of additional partner investment or withdrawal transactions during any given month. Withdrawals of capital that are debited to the capital account are used in the average calculation. Partner capital activity for the year was: Capital accounts Jan 1 balance Feb 12 investment Mar 26 investment Apr 20 withdrawal May 8 withdrawal Jul 3 investment Sep 29 investment Nov 5 investment

Greta $680,000 40,000

Harriet $500,000

Ivy $580,000

20,000 (10,000) (15,000)

(8,000) 14,000 3,000

8,000

6,000 3,000

Required: Calculate weighted average capital for each partner, and determine the amount of interest that each partner will be allocated. Round all calculations to the nearest whole dollar.

Answer: Jan, Feb Mar, Apr, May Jun, Jul, Aug, Sep Oct, Nov, Dec Total capital Average capital Interest allocation

Jan, Feb, Mar Apr, May Jun, Jul Aug, Sep Oct, Nov, Dec Total capital Average capital Interest allocation

Jan, Feb Mar, Apr May, Jun, Jul, Aug, Sep Oct, Nov Dec Total capital Average capital Interest allocation

$680,000 × 2 = 720,000 × 3 = 705,000 × 4 = 713,000 × 3 =

$500,000 × 3 = 520,000 × 2 = 512,000 × 2 = 526,000 × 2 = 529,000 × 3 =

$580,000 × 2 = 600,000 × 2 = 590,000 × 5 = 596,000 × 2 = 599,000 × 1 =

Greta $1,360,000 2,160,000 2,820,000 2,139,000 $8,479,000 $ 706,583 $ 42,395 Harriet $1,500,000 1,040,000 1,024,000 1,052,000 1,587,000 $6,203,000 $ 516,917 $ 31,015 Ivy $1,160,000 1,200,000 2,950,000 1,192,000 599,000 $7,101,000 $ 591,750 $ 35,505

Objective: LO16.2 Understand initial investment valuation and record keeping. Difficulty: Moderate AACSB: Reflective thinking

13) The profit and loss sharing agreement for the Jill, Kelly, and Lila partnership provides that each partner receives a bonus of 5% on the original amount of partnership net income if net income is above $25,000. Jill and Kelly receive a salary allowance of $7,500 and $10,500, respectively. Lila has an average capital balance of $260,000, and receives a 10% interest allocation on the amount by which her average capital account balance exceeds $200,000. Residual profits and losses are allocated to Jill, Kelly, and Lila in their respective ratios of 7:5:8. Required: Prepare a schedule to allocate $88,000 of partnership net income to the partners. Answer: Income Jill Kelly Lila Net income $88,000 Bonus (13,200) $4,400 $4,400 $4,400 Salary (18,000) 7,500 10,500 Interest (6,000) 6,000 Subtotal 50,800 11,900 14,900 10,400 Balance (50,800) 17,780 12,700 20,320 Totals $0 $29,680 $27,600 $30,720 Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Application of knowledge

14) A summary balance sheet for the partnership of Maddy, Nelson and Olsen on December 31, 2014 is shown below. Partners Maddy, Nelson and Olsen allocate profit and loss in their respective ratios of 9:6:10. Assets Cash Marketable securities Inventory Land Building-net Total assets

$ 50,000 120,000 75,000 80,000 400,000 $725,000

Equities Maddy, capital Nelson, capital Olsen, capital Total equities

$425,000 225,000 75,000 $725,000

The partners agree to admit Poosh for a one-tenth interest. The fair market value for partnership land is $180,000, and the fair market value of the inventory is $150,000. Required: 1. Record the entry to revalue the partnership assets prior to the admission of Poosh. 2. Calculate how much Poosh will have to invest to acquire a 10% interest. 3. Assume the partnership assets are not revalued. If Poosh paid $200,000 to the partnership in exchange for a 10% interest, what is the bonus that is allocated to each partner's capital account?

Answer: Requirement 1 The assets of the partnership must be adjusted to fair market value. Land will increase by $100,000, and Inventory by $75,000. The profit and loss ratio elements add up to 25. Partner Maddy will then be allocated 9/25 of the $175,000, etc. Land Inventory Maddy, capital Nelson, capital Olsen, capital

100,000 75,000 63,000 42,000 70,000

Requirement 2 The partnership's total assets after revaluation are $900,000. If Poosh acquires a 10% interest, it implies that the $900,000 represents 90% of the partnership's value after Poosh's investment. Therefore, $900,000/90% = $1,000,000, and $1,000,000 × 10% = $100,000. The entry to record Poosh's investment would be: Cash Poosh, capital

100,000 100,000

Requirement 3: Cash 200,000 Poosh, capital ($725,000+$200,000) × 10% Maddy, capital Nelson, capital Olsen, capital

92,500 38,700 25,800 43,000

Objective: LO16.4 Value a new partner's investment in an existing partnership. Difficulty: Moderate AACSB: Application of knowledge

15) A summary balance sheet for the partnership of Quail, Rainne and Selma on December 31, 2014 is shown below. Partners Quail, Rainne and Selma allocate profit and loss in their respective ratios of 6:3:1. Assets Cash Marketable securities Inventory Land Building-net Total assets

$ 320,000 640,000 270,000 130,000 210,000 $1,570,000

Equities Quail, capital Rainne, capital Selma, capital Total equities

$ 670,000 580,000 320,000 $1,570,000

The partners agree to admit Trask for a one-tenth interest. The fair market value for partnership land is $260,000, and the fair market value of the inventory is $370,000. Required: 1. Record the entry to revalue the partnership assets prior to the admission of Trask. 2.

Calculate how much Trask will have to invest to acquire a 10% interest.

3. Assume the partnership assets are not revalued. If Trask paid $300,000 to the partnership in exchange for a 10% interest, what would be the bonus that is allocated to each partner's capital account?

Answer: Requirement 1 The assets of the partnership must be adjusted to fair market value. Land will increase by $130,000, and Inventory by $100,000. The profit and loss ratio elements add up to 10. Partner Quail will then be allocated 6/10 of the $230,000, etc. Land Inventory Quail, capital Rainne, capital Selma, capital

130,000 100,000 138,000 69,000 23,000

Requirement 2 The partnership's total assets after revaluation are $1,800,000. If Trask acquires a 10% interest, it implies that the $1,800,000 represents 90% of the partnership's value after Trask's investment. Therefore, $1,800,000/90% = $2,000,000, and $2,000,000 × 10% = $200,000. The entry to record Trask's investment would be: Cash Trask, capital

200,000 200,000

Requirement 3 Cash 300,000 Trask, capital ($1,570,000 + $300,000) × 10% Quail, capital Rainne, capital Selma, capital

187,000 67,800 33,900 11,300

Objective: LO16.4 Value a new partner's investment in an existing partnership. Difficulty: Moderate AACSB: Application of knowledge

16) A summary balance sheet for the Uma, Van, and Walter partnership on December 31, 2014 is shown below. Partners Uma, Van, and Walter allocate profit and loss in their respective ratios of 4:5:7. The partnership agreed to pay Walter $227,500 for his partnership interest upon his retirement from the partnership on January 1, 2015. Any payments exceeding Walter's capital balance are treated as a bonus from partners Uma and Van. Assets Cash Marketable securities Inventory Land Building-net Total assets

$ 75,000 60,000 87,500 90,000 150,000 $462,500

Equities Uma, capital Van, capital Walter, capital Total equities

$212,500 112,500 137,500 $462,500

Required: Prepare the journal entry to reflect Walter's retirement. Answer: 1/1/15 Walter, capital 137,500 Uma, capital ($90,000 × 4/9) 40,000 Van, capital ($90,000 × 5/9) 50,000 Cash

227,500

Objective: LO16.5 Value a partner's share on retirement or death. Difficulty: Moderate AACSB: Application of knowledge

17) A summary balance sheet for the Sissy, Jody, and Buffy partnership on December 31, 2014 is shown below. Partners Sissy, Jody, and Buffy allocate profit and loss in their respective ratios of 3:4:6. The partnership agreed to pay Buffy $360,000 for her partnership interest upon her retirement from the partnership on January 1, 2015. Any payments exceeding Buffy's capital balance are treated as a bonus from partners Sissy and Jody. Assets Cash Marketable securities Inventory Land Building-net Total assets

$110,000 100,000 240,000 90,000 140,000 $680,000

Equities Sissy, capital Jody, capital Buffy, capital Total equities

$220,000 170,000 290,000 $680,000

Required: Prepare the journal entry to reflect Buffy's retirement. Answer: 1/1/15 Buffy, capital 290,000 Sissy, capital ($70,000 × 3/7) 30,000 Jody, capital ($70,000 × 4/7) 40,000 Cash

360,000

Objective: LO16.5 Value a partner's share on retirement or death. Difficulty: Moderate AACSB: Application of knowledge

18) A summary balance sheet for the Ash, Brown, and Curly partnership on December 31, 2014 is shown below. Partners Ash, Brown, and Curly allocate profit and loss in their respective ratios of 2:1:1. The partnership agreed to pay partner Brown $135,000 for his partnership interest upon his retirement from the partnership on January 1, 2015. The partnership financials on January 1, 2015 are: Assets Cash Marketable securities Inventory Land Building-net Total assets

$ 75,000 60,000 85,000 90,000 110,000 $420,000

Equities Ash, capital Brown, capital Curly, capital Total equities

$210,000 105,000 105,000 $420,000

Required: Prepare the journal entry to reflect Brown's retirement from the partnership: 1. Assuming a bonus to Brown. 2. Assuming a revaluation of total partnership capital based on excess payment. 3. Assuming goodwill equal to the excess payment is recorded.

Answer: Requirement 1 Ash and Curly give a bonus to Brown which reduces their capital in a 2 to 1 ratio. Brown, capital Ash, capital Curly, capital Cash

105,000 20,000 10,000 135,000

Requirement 2 Revalue the total partnership capital to reflect the value implied by Brown's retirement's excess payment of $30,000. Excess payment of $30,000 for 1/4 ownership implies goodwill of $30,000 / 25% = $120,000. Goodwill Ash, capital Curly, capital Brown, capital

120,000

Brown, capital Cash

135,000

60,000 30,000 30,000

135,000

Requirement 3 Add goodwill equal to the excess payment Brown, capital Goodwill Cash

105,000 30,000 135,000

Objective: LO16.5 Value a partner's share on retirement or death. Difficulty: Moderate AACSB: Application of knowledge

19) A summary balance sheet for the Akerly, Baskin, and Crow partnership on December 31, 2014 is shown below. Partners Akerly, Baskin, and Crow allocate profit and loss in their respective ratios of 3:2:1. The partnership agreed to pay partner Baskin $500,000 for his partnership interest upon his retirement from the partnership on January 1, 2015. The partnership financials on January 1, 2015 are: Assets Cash Marketable securities Inventory Land Building-net Total assets

$ 70,000 190,000 360,000 110,000 570,000 $1,300,000

Equities Akerly, capital Baskin, capital Crow, capital Total equities

$630,000 420,000 250,000 $1,300,000

Required: Prepare the journal entry to reflect Baskin's retirement from the partnership: 1.

Assuming a bonus to Baskin.

Assuming a revaluation of total partnership capital based on excess payment.

Assuming goodwill equal to the excess payment is recorded.

Answer: Requirement 1 Akerly and Crow give a bonus to Baskin which reduces their capital in a 3 to 1 ratio. Baskin, capital Akerly, capital Crow, capital Cash

420,000 60,000 20,000 500,000

Requirement 2 Revalue the total partnership capital to reflect the value implied by Baskin's retirement's excess payment of $80,000. Excess payment of $80,000 for a 1/3 ownership interest implies goodwill of $80,000 / (1/3) = $240,000. Goodwill Akerly, capital Crow, capital Baskin, capital

240,000

Baskin, capital Cash

500,000

120,000 40,000 80,000

500,000

Requirement 3 Add goodwill equal to the excess payment Baskin, capital Goodwill Cash

420,000 80,000 500,000

Objective: LO16.5 Value a partner's share on retirement or death. Difficulty: Moderate AACSB: Application of knowledge

20) The Leo, Mark and Natalie Partnership had the following capital balances and profit/loss sharing percentages: Balance Leo Mark Natalie

Sharing % $200,00050% $160,00040% $140,00010%

Newsome is going to buy into the partnership by paying $200,000 for a 20% ownership in the partnership. Required: 1. If Newsome pays the partnership directly, what are the four partner capital balances immediately following Newsome's admission to the partnership using the bonus method? Assume the partnership assets are not revalued. 2. If Newsome pays the partnership directly, what are the four partner capital balances immediately following Newsome's admission to the partnership using the goodwill method? Assume the partnership assets are revalued. The $200,000 amount paid by Newsome is fair value for a 20% share of the partnership. Answer: Requirement 1 If Newsome pays the partnership directly and the bonus method is used, then the contribution of $200,000 is added to net assets of $500,000 to determine the net assets after contribution of $700,000. Newsome receives 20% of this amount, or $140,000, and the remaining $60,000 from Newsome's contribution is split among the original partners as a bonus, in their original share percentages. Leo, capital Mark, capital Natalie, capital Newsome, capital

= $200,000 + $30,000 = $160,000 + $24,000 = $140,000 + $6,000

= $230,000 = $184,000 = $146,000 = $140,000

Requirement 2 If Newsome pays the partnership directly and the goodwill method is used, then the implied value of the new partnership is first calculated by taking the contribution of $200,000 and dividing by Newsome's expected percentage of ownership, 20%, to arrive at an implied partnership value of $1,000,000. Since the tangible assets of the new partnership will be $700,000 (see Requirement 1), Goodwill is determined to be $300,000. Goodwill is allocated to the three original partners, and Newsome's capital account is credited with his payment. Leo, capital Mark, capital Natalie, capital Newsome, capital

= $200,000 + $150,000 = $350,000 = $160,000 + $120,000 = $280,000 = $140,000 + $30,000 = $170,000 = $200,000

Objective: LO16.4 Value a new partner's investment in an existing partnership. Difficulty: Moderate AACSB: Application of knowledge

16.3 True/False 1) The dissolution of a partnership involves selling off the assets, settling liabilities, and distributing the proceeds to the partners. Answer: TRUE Objective: LO16.1 Comprehend the legal characteristics of partnerships. Difficulty: Easy AACSB: Analytical thinking

2) Under a partnership, each partner has mutual agency and limited liability. Answer: FALSE Objective: LO16.1 Comprehend the legal characteristics of partnerships. Difficulty: Moderate AACSB: Analytical thinking

3) Partnerships do not pay federal taxes but must submit financial information to the IRS. Answer: TRUE Objective: LO16.1 Comprehend the legal characteristics of partnerships. Difficulty: Easy AACSB: Analytical thinking

4) When property is invested in the partnership, it is recorded at fair value. Answer: TRUE Objective: LO16.2 Understand initial investment valuation and record keeping. Difficulty: Easy AACSB: Analytical thinking

5) When partners withdraw money on a weekly basis it can be referred to a drawing allowance which requires a debit to the drawing account. Answer: TRUE Objective: LO16.2 Understand initial investment valuation and record keeping. Difficulty: Moderate AACSB: Analytical thinking

6) In the absence of a partnership agreement, profit sharing is based on partner contribution. Answer: FALSE Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Moderate AACSB: Analytical thinking

7) When a partner dissociates from the partnership, the partnership operation is terminated. Answer: FALSE Objective: LO16.3 Grasp the diverse nature of profit-and lost-sharing agreements and their computation. Difficulty: Easy AACSB: Analytical thinking

8) When a new partner joins the partnership, the old partnership is dissolved, the books are closed and a new partnership agreement is established. Answer: TRUE Objective: LO16.4 Value a new partner's investment in an existing partnership. Difficulty: Easy AACSB: Analytical thinking

9) The death of a partner results in a dissociation and requires a settlement with the estate of the deceased partner. Answer: TRUE Objective: LO16.5 Value a partner's share on retirement or death. Difficulty: Easy AACSB: Analytical thinking

10) A limited partnership involves at least one limited partner who is an investor whose risk is limited to his equity investment in the partnership. Answer: TRUE Objective: LO16.6 Understand limited liability partnership characteristics. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 17 Partnership Liquidation 17.1 Multiple Choice Questions 1) Which statement is correct in describing the rank order of payments as specified by the Uniform Partnership Act? A) Payments to partners are ranked equally, regardless of underlying basis. B) Payments to partners with excess capital balances may be placed ahead of payments to creditors. C) Payments to creditors other than partners are ranked ahead of payments to partners. D) After payments are made to other creditors and partners with loans to the partnership, payment up to the same amount can be made to partners with capital interests. Answer: C Objective: LO17.1 Understand the legal aspects of partnership liquidation. Difficulty: Easy AACSB: Analytical thinking

2) Which of the following procedures is acceptable when accounting for a deficit balance in a partner's capital account during partnership liquidation, if the partner with a negative capital balance is personally insolvent? A) The partner with a negative capital balance must contribute personal assets to the partnership that are sufficient to bring the apital account to zero. B) The negative capital balance may be absorbed by those partners having a positive capital balance according to the residual profit and loss sharing ratios that apply to all the partners. C) The negative capital balance may be absorbed by those partners having a positive capital balance according to the residual profit and loss sharing ratios that apply to those partners having positive balances. D) The partner with a negative capital balance must contribute personal assets to the partnership that are sufficient to bring the capital account to the same level of the other partners' capital accounts. Answer: C Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Easy AACSB: Analytical thinking

3) Gains and losses incurred at liquidation are distributed to the partners using the residual profit and loss sharing ratios because A) using ownership percentages would permit solvent partners to not share profits with insolvent partners. B) the residual profit and loss ratios represent the ownership percentages. C) these amounts represent profits and losses from prior periods that would have been shared using the residual profit and loss ratios. D) using the established profit and loss sharing ratios is not permitted. Answer: C Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Easy AACSB: Analytical thinking

4) In partnership liquidation, how are partner salary allocations treated? A) Salary allocations take precedence over creditor payments. B) Salary allocations take precedence over amounts due to partners with respect to their capital interests, but not profits. C) Salary allocations take precedence over amounts due to partners with respect to their capital profits, but not capital interests. D) Salary allocations are disregarded. Answer: D Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Easy AACSB: Analytical thinking

5) A simple partnership liquidation requires A) periodic payments to creditors and partners determined by a safe payments schedule. B) partnership assets to be converted into cash with full payment made to all outside creditors before remaining cash is distributed to partners. C) only creditors to be paid in an orderly manner. D) periodic payments to partners as cash becomes available. Answer: B Objective: LO17.1 Understand the legal aspects of partnership liquidation. Difficulty: Easy AACSB: Analytical thinking

6) If conditions produce a debit balance in a partner's capital account when liquidation losses are allocated, then A) the partner receives further allocations of liquidation losses, but not gains. B) the partner receives further allocations of liquidation gains, but not losses. C) the partner is no longer obligated to partnership creditors. D) the partner has an obligation of personal net assets to the other partners. Answer: D Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Easy AACSB: Analytical thinking

Use the following information to answer the question(s) below. On June 30, 2014, the Able, Baker, and Charlie partnership had the following fiscal year-end balance sheet: Cash Accounts receivable Inventory Plant assets-net Loan to Able Total assets

$ 8,000 12,000 28,000 24,000 12,000 $ 84,000

Accounts payable Loan from Charlie Able, capital (20%) Baker, capital (20%) Charlie,capital (60%) Total liab./equity

$ 14,000 10,000 28,000 20,000 12,000 $ 84,000

The percentages shown are the residual profit and loss sharing ratios. The partners dissolved the partnership on July 1, 2014, and began the liquidation process. During July the following events occurred: * * *

Receivables of $6,000 were collected. All inventory was sold for $8,000. All available cash was distributed on July 31, except for $4,000 that was set aside for contingent expenses.

7) The book value of the partnership equity (i.e., total equity of the partners) on June 30, 2014 is A) $ 58,000. B) $ 60,000. C) $ 84,000. D) $120,000. Answer: A Explanation: A) ($28,000 Able capital + $20,000 Baker capital + $12,000 Charlie capital + $10,000 Loan from Charlie - $12,000 Loan to Able) Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Moderate AACSB: Analytical thinking

8) The cash available for distribution to the partners on July 31, 2014 is A) $ 4,000. B) $ 8,000. C) $14,000. D) $22,000. Answer: A Explanation: A) ($8,000 beginning balance + $6,000 cash collected + $8,000 for inventory sold - $14,000 of accounts payable - $4,000 for expenses) Objective: LO17.3 Perform safe payment computations. Difficulty: Moderate AACSB: Analytical thinking

9) How much cash would Baker receive from the cash that is available for distribution on July 31? (Assume a safe payments schedule is used.) A) $ 0 B) $800 C) $2,400 D) $4,000 Answer: D Explanation: D) Able Baker Charlie Total Equities,Jun 30 $ 16,000 $ 20,000 $ 22,000 $ 58,000 Inventory loss (4,000) (4,000) (12,000) (20,000) Contingency fund (800) (800) (2,400) (4,000) Subtotals 11,200 15,200 7,600 34,000 Possible losses on remaining assets Subtotals

(6,000) $ 5,200

(6,000) $ 9,200

(18,000) $(10,400)

(30,000) $ 4,000

Eliminate Charlie's Deficit Cash distribution

(5,200) 0

(5,200) $ 4,000

10,400 0

$ 4,000

Objective: LO17.3 Perform safe payment computations. Difficulty: Difficult AACSB: Analytical thinking

10) How much cash would Able receive from the cash that is available for distribution on July 31? (Assume a safe payments schedule is used.) A) $ 0 B) $800 C) $2,400 D) $4,000 Answer: A Objective: LO17.3 Perform safe payment computations. Difficulty: Difficult AACSB: Analytical thinking

Use the following information to answer the question(s) below. Lola, Melvin, and Nettie are in the process of liquidating their partnership. Since it may take several months to convert the other assets into cash, the partners agree to distribute all available cash immediately, except for $12,000 that is set aside for contingent expenses. The balance sheet and residual profit and loss sharing percentages are as follows: Cash Other assets

Total assets

500,000 225,000

___________ $ 725,000

Accounts payable Lola, capital (20%) Melvin, capital (30%) Nettie, capital (50%) Total liab./equity

225,000 168,000 270,000 62,000 725,000

11) Using a safe payments schedule, how much cash should Melvin receive in the first distribution? A) $81,000 B) $165,000 C) $168,600 D) $202,500 Answer: B Explanation: B) 20% 30% 50% Lola Melvin Nettie Equities $168,000 $270,000 $62,000 Possible loss on remaining assets ($225,000) (45,000) (67,500) (112,500) Contingencies ($12,000) (2,400) (3,600) (6,000) Subtotals $120,600 $198,900 $(56,500) Eliminate Nettie's debit balance

(22,600)

(33,900)

Safe payments

$ 98,000

$165,000

56,500 $

Objective: LO17.3 Perform safe payment computations. Difficulty: Difficult AACSB: Application of knowledge

12) Using a safe payment schedule, how much cash should Lola receive in the first distribution? A) $81,000 B) $98,000 C) $168,600 D) $202,500 Answer: B Objective: LO17.3 Perform safe payment computations. Difficulty: Difficult AACSB: Application of knowledge

13) Que, Rae, and Sye are in the process of liquidating their partnership. Sye has agreed to accept the inventory, which has a fair value of $60,000, as part of her settlement. A balance sheet and the residual profit and loss sharing percentages are as follows: Cash Inventory Plant assets

248,000 100,000 280,000

Total assets

628,000

Accounts payable Que, capital (40%) Rae, capital (40%) Sye, capital (20%) Total liab./equity

180,000 98,000 175,000 175,000 628,000

If the partners then distribute the available cash using a safe payments schedule, Sye will receive A) $41,000 cash. B) $51,000 cash. C) $107,000 cash. D) $175,000 cash. Answer: A Explanation: A) 40% 40% 20% Que Rae Sye Equities $98,000 $175,000 $175,000 Distribute inventory to Sye (60,000) and: recognize $40,000 loss (16,000) (16,000) (8,000) Possible losses on plant (112,000) (112,000) (56,000) Subtotal $(30,000) $47,000 $51,000 Eliminate Que's debit balance to Rae & Sye 30,000 (20,000) (10,000) Balance $ 0 $ 27,000 $ 41,000 Objective: LO17.3 Perform safe payment computations. Difficulty: Moderate AACSB: Application of knowledge

14) What is the proper disposition of a partnership loan that was made from a partner who has a debit balance in the capital account? A) The loan is ignored in liquidation. B) The loan is offset against the debit balance in the capital account. C) The loan is charged off to the capital accounts of all the partners in their profit and loss sharing ratios. D) The loan is held for payment after all other capital accounts are covered. Answer: B Objective: LO17.3 Perform safe payment computations. Difficulty: Easy AACSB: Analytical thinking

15) In partnership liquidations, what are safe payments? A) The amounts of distributions that can be made to the partners, after all creditors have been paid in full. B) The amounts of distributions that can be made to the partners with assurance that such amounts will not have to be returned to the partnership. C) The amounts of distributions that can be made to the partners, after all non-cash assets have been adjusted to fair market value. D) The amounts of distributions that can be made to the partners during the liquidation based on the partner's contributed capital return. Answer: B Objective: LO17.3 Perform safe payment computations. Difficulty: Easy AACSB: Analytical thinking

16) If all partners are included in the first installment of an installment liquidation, then in future installments A) cash will be distributed according to the residual profit and loss sharing ratios. B) cash should not be distributed until all non-cash assets are converted into cash. C) vulnerability rankings for each partner should be prepared. D) a cash distribution plan must be prepared so that partners will know when they will be included in cash distributions. Answer: A Objective: LO17.4 Understand installment liquidations. Difficulty: Easy AACSB: Analytical thinking

17) The year-end balance sheet and residual profit and loss sharing percentages for the Gary, Harold, and Ivan partnership on December 31, 2014, are as follows: Cash $ Loan to Gary Other assets

60,000 50,000 360,000

Total assets

470,000

Accounts payable Loan from Harold Gary, capital (25%) Harold, capital (25%) Ivan, capital (50%) Total liab./equity

150,000 50,000 70,000 80,000 120,000 470,000

The partners agree to liquidate the business and distribute cash when it becomes available. A cash distribution plan is developed with vulnerability rankings for the Gary, Harold and Ivan partnership. After outside creditors are paid, the cash available will initially go to A) Gary in the amount of $20,000. B) Harold in the amount of $50,000. C) Harold in the amount of $70,000. D) Ivan in the amount of $40,000. Answer: C Explanation: C) Vulnerability ranks: Gary equity ($70,000 - $50,000)/.25 = $80,000 = 1 Harold equity ($80,000 + $50,000)/.25 = $520,000 = 3 Ivan equity ($120,000/.5) = $240,000 = 2 Assumed loss absorption: 25% Gary Equities $20,000 Loss to eliminate Gary (20,000) Subtotals $ 0 Loss to eliminate Ivan Subtotals

25% Harold $130,000

50% Ivan $120,000

Total $270,000

(20,000) $110,000

(40,000) $80,000

(80,000) $190,000

(40,000) $ 70,000

(80,000) $ 0

(120,000) $ 70,000

Objective: LO17.5 Learn about cash distribution plans for installment liquidations. Difficulty: Difficult AACSB: Analytical thinking

18) In a schedule of assumed loss absorptions A) the partner with lowest loss absorption is eliminated last. B) it is necessary to have a cash distribution plan first. C) the least vulnerable partner is eliminated first. D) the most vulnerable partner is eliminated first. Answer: D Objective: LO17.5 Learn about cash distribution plans for installment liquidations. Difficulty: Easy AACSB: Analytical thinking

19) Which partner is considered the most vulnerable as a result of a computation of vulnerability rankings? A) The partner who has the lowest loss absorption potential B) The partner who has the highest loss absorption potential C) The partner with the highest capital account balance D) The partner with the lowest capital account balance Answer: A Objective: LO17.5 Learn about cash distribution plans for installment liquidations. Difficulty: Easy AACSB: Analytical thinking

20) Creditors of the partnership may seek the personal assets of the partners to satisfy amounts owed. When this happens A) creditors may only file against partnership assets. B) creditors must file against all partners and recover their claims based on the individual partner's profit and loss distribution percentage. C) creditors must file against all partners and recover their claims based on the individual partner's percentage ownership. D) creditors may file against an individual partner to recover their claims, or against any combination of partners. Answer: D Objective: LO17.6 Comprehend liquidations when either the partnership or the partners are insolvent. Difficulty: Easy AACSB: Analytical thinking

17.2 Exercises 1) The balance sheet of the Addy, Bess, and Clara partnership on January 1, 2014 (the date of partnership dissolution) was as follows: Cash Other assets Loan to Clara

$ 4,000 26,000 2,000

Total assets

$ 32,000

Liabilities Loan from Addy Addy, capital (20%) Bess, capital (40%) Clara, capital (40%) Total liab./equity

$ 8,000 1,000 2,000 9,000 12,000 $ 32,000

In January, other assets with a book value of $16,000 were sold for $10,000 in cash. Required: Determine how the available cash on January 31, 2014 will be distributed. (Use a safe payments schedule.) Answer: Addy, Bess, and Clara Partnership Partnership Liquidation Schedule

Jan 1 Balance Sale of assets Subtotal

Cash $ 4,000 10,000 $ 14,000

NonCash Assets $ 26,000 (16,000) $ 10,000

First Rank Debt $ 8,000 $ 8,000

20% Addy Equity $ 3,000 (1,200) $ 1,800

40% Bess Equity $ 9,000 (2,400) $ 6,600

40% Clara Equity $ 10,000 (2,400) $ 7,600

Safe Payments Schedule

Partners' pre-distribution balances Possible losses on non-cash assets Write off Addy 50-50 Cash distribution to partners

Addy Equity $ 1,800 (2,000) (200) 200 $ 0

Bess Equity $ 6,600 (4,000) 2,600 (100) $ 2,500

Clara Equity $ 7,600 (4,000) 3,600 (100) $ 3,500

Cash distribution plan on January 31: First $8,000 goes to priority creditors, and then Bess receives $2,500 and Clara receives $3,500. Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Moderate AACSB: Application of knowledge

2) The partnership of Dolla, Earl, and Festus was dissolved on January 1, 2014. The balance sheet at that date is shown below: Cash Other assets Loan to Clara

$ 12,000 70,000 8,000

Total assets

$ 90,000

Liabilities Loan from Dolla Dolla, capital (20%) Earl, capital (30%) Festus, capital (50%) Total liab./equity

$ 36,000 1,000 6,000 16,000 31,000 $ 90,000

In January, $34,000 of the accounts receivable was collected, and an additional $6,000 was determined to be uncollectible. The remaining receivables are still expected to be collected. Required: Determine how the available cash on January 31, 2014 will be distributed. (Use a safe payments schedule.) Answer: Dolla, Earl, and Festus Partnership Partnership Liquidation Schedule

Jan 1 Balance Collect A/R Write off A/R Subtotal

Cash $ 12,000 34,000 $ 46,000

NonCash Assets $ 70,000 (34,000) (6,000) $ 30,000

First Rank Debt $ 36,000

20% Dolla Equity $ 7,000

30% Earl Equity $ 16,000

50% Festus Equity $ 23,000

$ 36,000

(1,200) $ 5,800

(1,800) $ 14,200

(3,000) $ 20,000

Safe Payments Schedule

Partners' pre-distribution balances Possible losses on non-cash assets Write off Dolla 3:5 Cash distribution to partners

Dolla Equity $ 5,800 (6,000) (200) 200 $ 0

Earl Equity $ 14,200 (9,000) 5,200 (75) $ 5,125

Festus Equity $ 20,000 (15,000) 5,000 (125) $ 4,875

Cash distribution plan on January 31: First $36,000 goes to priority creditors, and then Earl receives $5,125 and Festus receives $4,875. Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Moderate AACSB: Application of knowledge

3) The partnership of Georgia, Holly, and Izzy was dissolved, and by July 1, 2014, all assets had been converted into cash and all partnership liabilities were paid. The partnership balance sheet on July 1, 2014 (with partner residual profit and loss sharing percentages) was as follows: Cash

$ 10,000

Total assets

$ 10,000

Georgia, capital (40%) Holly, capital (30%) Izzy, capital (30%) Total liab./equity

$(20,000) (10,000) 40,000 $ 10,000

The value of the partners' personal assets and liabilities on July 1, 2014 were as follows: Georgia $ 45,000 30,000

Personal assets Personal liabilities

Holly $ 30,000 20,000

Izzy $ 25,000 10,000

Required: Prepare the final statement of partnership liquidation. Answer: Georgia, Holly, and Izzy Partnership Final Statement of Partnership Liquidation

Balance, July 1 Georgia's personal contribution

Cash $ 10,000 15,000 25,000

Write-off Georgia 25,000 Holly's personal contribution

10,000 35,000

Write-off Holly Distribute cash

35,000 (35,000) $ 0

Georgia Capital $(20,000)

Holly Capital $ (10,000)

Izzy Capital $ 40,000

15,000 (5,000) 5,000 $ 0

(10,000) (2,500) (12,500)

40,000 (2,500) 37,500

10,000 (2,500) 2,500 $ 0

37,500 (2,500) 35,000 (35,000) $ 0

Total Capital $ 10,000 15,000 25,000 25,000 10,000 35,000 35,000 (35,000) $ 0

Objective: LO17.6 Comprehend liquidations when either the partnership or the partners are insolvent. Difficulty: Moderate AACSB: Application of knowledge

4) The balance sheet of the partnership of Jim, Kim, and Larry is shown below as of September 1, 2014. The partners had decided to dissolve the partnership earlier in the year, and all assets were converted into cash and all partnership liabilities were paid. The remains of the partnership (with partner residual profit and loss sharing percentages) was as follows: Cash

$ 150,000

Total assets

$ 150,000

Jim, capital (20%) Kim, capital (40%) Larry, capital (40%) Total liab./equity

$ (300,000) (150,000) 600,000 $ 150,000

The value of partners' personal assets and liabilities on July 1, 2014 were as follows: Jim $ 450,000 200,000

Personal assets Personal liabilities

Kim $ 370,000 210,000

Larry $ 400,000 195,000

Required: Prepare the final statement of partnership liquidation. Answer: Jim, Kim, and Larry Partnership Final Statement of Partnership Liquidation

Balance, July 1 Jim's personal contribution

Cash $ 150,000 250,000 400,000

Write-off Jim 400,000 Kim's personal contribution

160,000 560,000

Write-off Kim Distribute cash

560,000 (560,000) $ 0

Jim Capital $ (300,000) 250,000 (50,000) 50,000 $ 0

Kim Capital $ (150,000)

(150,000) (25,000) (175,000) 160,000 (15,000) 15,000 $ 0

Larry Capital $ 600,000

600,000 (25,000) 575,000

575,000 (15,000) 560,000 (560,000) $ 0

Total Capital $ 150,000 250,000 400,000 400,000 160,000 560,000 560,000 (560,000) $ 0

Objective: LO17.6 Comprehend liquidations when either the partnership or the partners are insolvent. Difficulty: Moderate AACSB: Application of knowledge

5) The balance sheet of the Maude, Ned, and Oscar partnership on November 1, 2014 (before commencement of partnership liquidation) was as follows: Cash Inventory Loan to Maude Loan to Oscar Plant assets-net

70,000 60,000 10,000 18,000 80,000

Total assets

$ 238,000

Accounts payable Notes payable Maude, capital(20%) Ned, capital(20%) Oscar, capital(60%)

42,000 68,000 30,000 32,000 66,000

Total liab./equity

$ 238,000

Liquidation events in November were as follows: - All the inventory was sold for $10,000 above book value; - Plant assets with a book value of $60,000 were sold for $34,000. Required: Determine how the available cash on November 30, 2014 should be distributed. Answer: Maude, Ned, and Oscar Schedule of Partnership Liquidation November 30, 2014

Balance, Nov. 1 Inventory sold Sale of plant Balances before distribution Offset loans Pay creditors Partner equity Possible loss: Plant assets Distribution

Assets $ 238,000 10,000 (26,000)

Debts $ 110,000

222,000 (28,000) (110,000) $ 84,000

110,000

(20,000) $ 64,000

(110,000) $ 0

20% Maude $ 30,000 2,000 (5,200)

26,800 (10,000) $

16,800

(4,000) 12,800

20% Ned 32,000 2,000 (5,200)

60% Oscar $ 66,000 6,000 (15,600)

28,800

56,400 (18,000)

28,800

38,400

(4,000) 24,800

(12,000) $ 26,400

First $110,000 pays priority creditors; Next $64,000 pays partners as indicated above. Objective: LO17.3 Perform safe payment computations. Difficulty: Moderate AACSB: Application of knowledge

6) The balance sheet of the Park, Quid, and Reggie partnership on November 1, 2014 (before commencement of partnership liquidation) was as follows: Cash Accounts Receivable Loan to Park Loan to Reggie Plant assets-net Total assets

60,000 130,000 16,000 22,000 120,000 $ 348,000

Accounts payable Loan from Quid Park, capital (20%) Quid, capital (40%) Reggie, capital (40%) Total liab./equity

$ 110,000 40,000 60,000 52,000 86,000 $ 348,000

Liquidation events in November were as follows: - All receivables were settled for $110,000; - Plant assets with a book value of $90,000 were sold for $52,000. Required: Determine how the available cash on November 30, 2014 should be distributed. Answer:

Balance, Nov. 1 A/R settled Sale of plant Balances before distribution Offset loans Pay creditors Partner equity Possible loss: Plant assets Distribution

Park, Quid, and Reggie Schedule of Partnership Liquidation November 30, 2014

Assets $ 348,000 (20,000) (38,000)

Debts $ 150,000

290,000 (38,000) (110,000) $ 142,000

150,000 (40,000) (110,000) $ 0

(30,000) $ 112,000

20% Park 60,000 (4,000) (7,600)

40% Quid $ 52,000 (8,000) (15,200)

40% Reggie $ 86,000 (8,000) (15,200)

48,400 (16,000)

28,800 40,000

62,800 (22,000)

32,400

68,800

40,800

(6,000) 26,400

(12,000) 56,800

(12,000) 28,800

First $110,000 pays priority creditors; Next $112,000 pays partners as indicated above. Objective: LO17.3 Perform safe payment computations. Difficulty: Moderate AACSB: Application of knowledge

7) A cash distribution plan for the Sammi, Tammy, and Udd partnership was as follows:

First $250,000 Next $100,000

Priority Creditors 100%

Next $150,000 Remainder

Sammi

Tammy

70%

30%

11/15 20%

35%

Udd

4/15 45%

Required: If $850,000 of cash was distributed by the partnership, how much was received respectively by the priority creditors, Sammi, Tammy, and Udd? Answer: Priority Creditors Sammi Tammy Udd First $250,000 $ 250,000 Next $100,000 $ 70,000 $ 30,000 Next $150,000 110,000 $ 40,000 Last $350,000 70,000 122,500 157,500 Total $850,000 $ 250,000 $ 250,000 $ 152,500 $ 197,500 Objective: LO17.4 Understand installment liquidations. Difficulty: Moderate AACSB: Application of knowledge

8) The Vera, Wade, and Xena partnership was dissolved, and a cash distribution plan was developed, as follows:

First $462,000 Next $173,000 Next $240,000 Remainder

Priority Creditors 100%

Vera

Wade

60%

40%

7/12 20%

30%

Xena

5/12 50%

Required: If $1,000,000 of cash was distributed by the partnership, how much was received respectively by the priority creditors, Vera, Wade, and Xena? Answer: Priority Creditors Vera Wade Xena First $462,000 $ 462,000 Next $173,000 $ 103,800 $ 69,200 Next $240,000 140,000 $ 100,000 Last $125,000 25,000 37,500 62,500 Total $1,000,000 $ 462,000 $ 268,800 $ 106,700 $ 162,500 Objective: LO17.4 Understand installment liquidations. Difficulty: Moderate AACSB: Application of knowledge

9) The balance sheet of the Ama, Bade, and Calli partnership on May 1, 2014 (before commencement of partnership liquidation) was as follows: Cash Inventory Loan to Ama Loan to Calli Plant assets-net Total assets

$ 108,000 120,000 20,000 32,000 220,000 $ 500,000

Accounts payable Notes payable Ama, capital (30%) Bade, capital (50%) Calli, capital (20%) Total liab./equity

56,000 120,000 64,000 180,000 80,000 $ 500,000

Liquidation events in May were as follows: - The inventory was sold for $12,000 below book value; - Plant assets with a book value of $100,000 were sold for $120,000. Required: Determine how the available cash on May 31, 2014 should be distributed. Answer: Ama, Bade, and Calli Schedule of Partnership Liquidation May 31, 2014

Balance, May 1 Plant sold Inventory sold Balances before distribution Offset loans Pay creditors Partner equity Possible loss: Plant assets Distribution

Assets $ 500,000 20,000 (12,000)

Liabil. $ 176,000

508,000 (52,000) (176,000) $ 280,000

176,000

(120,000) $ 160,000

(176,000) 0

30% Ama 64,000 6,000 (3,600)

50% Bade $ 180,000 10,000 (6,000)

20% Calli $ 80,000 4,000 (2,400)

66,400 (20,000)

184,000

81,600 (32,000)

46,400

$ 184,000

49,600

(36,000) 10,400

(60,000) $ 124,000

(24,000) 25,600

First $176,000 pays priority creditors; Next $160,000 pays partners as indicated above. Objective: LO17.3 Perform safe payment computations. Difficulty: Moderate AACSB: Application of knowledge

10) The Catt, Dogg, and Eustus partnership was dissolved by the partners in early 2014. On March 1, the partners prepared the following financial statement before commencement of final liquidation: Cash Accounts Receivable Inventory Loan to Catt Loan to Eustus Plant assets-net Total assets

80,000 160,000 130,000 10,000 15,000 210,000 $ 605,000

Accounts payable Notes payable Loan from Dogg Catt, capital (20%) Dogg, capital (20%) Eustus, capital(60%) Total liab./equity

$ 125,000 70,000 5,000 130,000 95,000 180,000 $ 605,000

Liquidation events in March were as follows: - Receivables recorded at $120,000 were collected at $110,000; - Inventory recorded at cost of $80,000 was sold for $60,000; - Plant assets with a book value of $100,000 were sold for $140,000. Required: Determine how the available cash on March 31, 2014 should be distributed. Answer: Catt, Dogg, and Eustus Schedule of Partnership Liquidation March 31, 2014

Balance, May 1 A/R collected Inventory sold Plant sold Balances before distribution Offset loans Pay creditors Partner equity Possible loss: A/R Inventory Plant assets Distribution

20% Catt $ 130,000 (2,000) (4,000) 8,000

20% Dogg $ 95,000 (2,000) (4,000) 8,000

60% Eustus $ 180,000 (6,000) (12,000) 24,000

132,000 (10,000)

97,000 5,000

186,000 (15,000)

$ 122,000

$ 102,000

$ 171,000

(40,000)

(8,000)

(24,000)

(50,000) (110,000) $ 195,000

(10,000) (22,000) $ 82,000

(10,000) (22,000) $ 62,000

(30,000) (66,000) $ 51,000

Assets $ 605,000 (10,000) (20,000) 40,000

Debts $ 200,000

615,000 (25,000) (195,000) $ 395,000

200,000 (5,000) (195,000) $ 0

First $195,000 pays priority creditors; Next $195,000 pays partners as indicated above. Objective: LO17.3 Perform safe payment computations. Difficulty: Moderate AACSB: Application of knowledge

11) The balance sheet of the Flail, Gail, and Hale partnership on October 1, 2014 (the date of partnership dissolution) was as follows: Cash Other assets Loan to Gail

3,000 33,000 4,000

Total assets

40,000

Liabilities Loan from Flail Flail,capital (20%) Gail, capital (30%) Hale, capital (50%) Total liab./equity

9,000 1,000 3,000 6,000 21,000 40,000

In October, other assets with a book value of $15,000 were sold for $17,000 in cash. Required: Determine how the available cash on October 31, 2014 will be distributed. Answer: Flail, Gail, and Hale Partnership Partnership Liquidation Schedule

Jan 1 Balance Loan offset Sale of assets Subtotal

Cash $ 3,000 17,000 20,000

NonCash Assets $ 37,000 (4,000) (15,000) 18,000

First Rank Debt $ 10,000 (1,000) 9,000

20% Flail Equity $ 3,000 1,000 400 4,400

30% Gail Equity $ 6,000 (4,000) 600 2,600

50% Hale Equity $ 21,000

Gail Equity $ 2,600 (5,400) (2,800) 2,800 $ 0

Hale Equity $ 22,000 (9,000) 13,000 (2,000) $ 11,000

1,000 22,000

Safe Payments Schedule

Partners' pre-distribution balances Possible losses on non-cash assets Write off Gail 2/7 and 5/7 Cash distribution to partners

Flail Equity $ 4,400 (3,600) 800 (800) $ 0

Cash distribution plan on October 31: First $9,000 goes to priority creditors, and then Hale receives $11,000. Objective: LO17.3 Perform safe payment computations. Difficulty: Moderate AACSB: Application of knowledge

12) The Justin, Kyle, and Lulu partnership was dissolved by the partners on May 1, 2014. Their balance sheet on that date is shown below: Cash Other assets Loan to Justin

26,000 96,000 10,000

Total assets

$ 132,000

Liabilities Loan from Kyle Justin, capital (20%) Kyle, capital (20%) Lulu, capital (60%) Total liab./equity

41,000 3,000 19,000 26,000 43,000 $ 132,000

In May, other assets with a book value of $46,000 were sold for $50,000 in cash. Required: Determine how the available cash on May 31, 2014 will be distributed. Answer: Justin, Kyle, and Lulu Partnership Partnership Liquidation Schedule

Cash May 1 Balance $ 26,000 Loan offset Sale of assets 50,000 Subtotal 76,000

NonCash Assets $106,000 (10,000) (46,000) 50,000

First Rank Debt $ 44,000 (3,000) 41,000

20% Justin Equity $ 19,000 (10,000) 800 9,800

20% Kyle Equity $ 26,000 3,000 800 29,800

60% Lulu Equity $ 43,000

Kyle Equity $ 29,800 (10,000) 19,800 (50) $ 19,750

Lulu Equity $ 45,400 (30,000) 15,400 (150) $ 15,250

2,400 45,400

Safe Payments Schedule

Partners' pre-distribution balances Possible losses on non-cash assets Write off Justin 1/4 and 3/4 Cash distribution to partners

Justin Equity $ 9,800 (10,000) (200) 200 $ 0

Cash distribution plan on May 31: First $41,000 goes to priority creditors, and then Kyle receives $19,750 and Lulu receives $15,250. Objective: LO17.3 Perform safe payment computations. Difficulty: Moderate AACSB: Application of knowledge

13) The partnership of May, Novem, and Octo was dissolved. By August 1, 2014, all assets had been converted into cash and all partnership liabilities were paid. The partnership balance sheet on August 1, 2014 (with partner residual profit and loss sharing percentages) was as follows: Cash

$ 100,000

Total assets

$ 100,000

May, capital (30%) Novem, capital (20%) Octo, capital (50%) Total equity

8,000 (120,000) 212,000 $ 100,000

The value of partners' personal assets and liabilities on August 1, 2014 were as follows: May $ 148,000 144,000

Personal assets Personal liabilities

Novem $ 240,000 160,000

Octo $ 112,000 120,000

Required: Prepare the final statement of partnership liquidation. Answer:

Balance, Aug. 1 Novem's personal contribution

May, Novem, and Octo Partnership Final Statement of Partnership Liquidation

Cash 100,000

May Capital $ 8,000

Novem Capital $ (120,000)

Octo Capital $ 212,000

8,000 (15,000) (7,000)

80,000 (40,000) 40,000 0

212,000 (25,000) 187,000

80,000 180,000

Write-off Novem 180,000 May's personal contribution

4,000 184,000

Write-off May Distribute cash $

184,000 (184,000) 0

4,000 (3,000) 3,000 0 $

187,000 (3,000) 184,000 (184,000) 0

Total $ 100,000 80,000 180,000 180,000 4,000 184,000 184,000 (184,000) $ 0

Objective: LO17.6 Comprehend liquidations when either the partnership or the partners are insolvent. Difficulty: Moderate AACSB: Application of knowledge

14) At the end of 2013, the partnership of Piatta, Ragoo, and Sauss was dissolved. By February 1, 2014, all assets had been converted into cash and all partnership liabilities were paid. The partnership balance sheet on February 1, 2014 (with partner residual profit and loss sharing percentages) was as follows: Cash

$ 220,000

Total assets

$ 220,000

Piatta,capital (20%) Ragoo, capital (40%) Sauss, capital (40%) Total equity

20,000 (180,000) 380,000 $ 220,000

The value of partners' personal assets and liabilities on February 1, 2014 were as follows: Piatta $ 86,000 79,000

Personal assets Personal liabilities

Ragoo $ 310,000 250,000

Sauss $ 210,000 250,000

Required: Prepare the final statement of partnership liquidation. Answer:

Balance, Feb. 1 Ragoo's personal contribution

Piatta, Ragoo, and Sauss Partnership Final Statement of Partnership Liquidation

Cash 220,000

Piatta Capital $ 20,000

Ragoo Capital $ (180,000)

Sauss Capital $ 380,000

20,000 (40,000) (20,000)

60,000 (120,000) 120,000 0

380,000 (80,000) 300,000

60,000 280,000

Write-off Ragoo 280,000 Piatta's personal contribution

7,000 287,000

Write-off Piatta Distribute cash $

287,000 (287,000) 0

7,000 (13,000) 13,000 0 $

300,000 (13,000) 287,000 (287,000) 0

Total $ 220,000 60,000 280,000 280,000 7,000 287,000 287,000 (287,000) $ 0

Objective: LO17.6 Comprehend liquidations when either the partnership or the partners are insolvent. Difficulty: Moderate AACSB: Application of knowledge

15) Tye, Ula, Val, and Watt are partners who share profits and losses 40%, 30%, 20%, and 10%, respectively. The partnership will be liquidated gradually over several months beginning January 1, 2014. The partnership trial balance at December 31, 2013 is as follows:

Cash Accounts receivable Inventory Loan to Val Furniture Equipment Goodwill Accounts payable Note payable Loan from Tye Tye, capital (40%) Ula, capital (30%) Val, capital (20%) Watt, capital (10%) Totals

Debits $ 3,000 19,000 25,000 5,000 15,000 10,000 12,000

$ 89,000

Credits

$ 13,600 30,000 5,000 15,000 9,000 12,400 4,000 $ 89,000

Required: Prepare a cash distribution plan for January 1, 2014, showing how cash installments will be distributed among the partners as it becomes available. Prepare vulnerability rankings for the partners and a schedule of assumed loss absorption.

Answer: Loss absorption potential:

Tye Ula Val Watt

Partners' Equity $ 20,000 9,000 7,400 4,000

÷ ÷ ÷ ÷

Profit and Loss Ratio 40% 30% 20% 10%

Loss Absorption Potential $ 50,000 $ 30,000 $ 37,000 $ 40,000

Vulnerability Ranking 4 1 2 3

Schedule of assumed loss absorption:

Partnership Equity Assumed loss to absorb Ula

40% Tye

30% Ula

20% Val

10% Watt

Total

$ 20,000

$ 9,000

$ 7,400

$ 4,000

$ 40,400

(12,000) 8,000

(9,000) $ 0

(6,000) 1,400

(3,000) 1,000

(30,000) 10,400

(1,400) 0

(700) 300

(4,900) 5,500

Assumed loss to absorb Val

(2,800) 5,200

Assumed loss to absorb Watt $

(1,200) 4,000

(300) 0

Cash distribution plan: First $43,600 pays the priority creditors; Next $4,000 goes to Tye; Next $1,500 goes $1,200 to Tye, and $300 to Watt; Next $4,900 goes $2,800 to Tye, $1,400 to Val, and $700 to Watt; Remainder goes 40% to Tye, 30% to Ula, 20% to Val, and 10% to Watt. Objective: LO17.5 Learn about cash distribution plans for installment liquidations. Difficulty: Moderate AACSB: Application of knowledge

(1,500) 4,000

16) The partners of Nelatyna Manufacturing have decided to dissolve their partnership as of the end of 2013. The partnership is going to liquidate during the first several months of 2014. The four partners of Nell, Ann, Tyler and Nadine, share profits and losses 35%, 30%, 25%, and 10%, respectively. The partnership trial balance at December 31, 2013 is as follows:

Cash Accounts receivable Inventory Loan to Tyler Furniture Equipment Goodwill Accounts payable Note payable Loan from Nell Nell, capital (35%) Ann, capital (30%) Tyler, capital (25%) Nadine, capital (10%) Totals

Debits $ 60,000 150,000 115,000 20,000 86,000 147,000 63,000

$ 641,000

Credits

$ 140,000 200,000 30,000 110,000 60,000 73,000 28,000 $ 641,000

Answer: Loss absorption potential:

Nell Ann Tyler Nadine

Partners' Equity $ 140,000 60,000 53,000 28,000

÷ ÷ ÷ ÷

Profit and Loss Ratio 35% 30% 25% 10%

Loss Absorption Potential $ 400,000 $ 200,000 $ 212,000 $ 280,000

Vulnerability Ranking 4 1 2 3

Schedule of assumed loss absorption:

Partnership Equity Assumed loss to absorb Ann

35% Nell

30% Ann

25% Tyler

10% Nadine

Total

$ 140,000

$ 60,000

$ 53,000

$ 28,000

$ 281,000

(70,000) 70,000

(60,000) $ 0

(50,000) 3,000

(20,000) 8,000

(200,000) 81,000

(3,000) 0

(1,200) 6,800

(8,400) 72,600

(6,800) 0

(30,600) $ 42,000

Assumed loss to absorb Tyler Assumed loss to absorb Nadine

(4,200) 65,800

(23,800) $ 42,000

Cash distribution plan: First $340,000 pays the priority creditors; Next $42,000 goes to Nell; Next $30,600 goes $23,800 to Nell, and $6,800 to Nadine; Next $8,400 goes $4,200 to Nell, $3,000 to Tyler, and $1,200 to Nadine; Remainder goes 35% to Nell, 30% to Ann, 25% to Tyler, and 10% to Nadine. Objective: LO17.5 Learn about cash distribution plans for installment liquidations. Difficulty: Moderate AACSB: Application of knowledge

17) Alf, Bill, Cam, and Dot are partners who share profits and losses 30%, 20%, 35%, and 15%, respectively. The partnership will be liquidated gradually over several months beginning January 1, 2014. The partnership trial balance at December 31, 2013 is as follows:

Cash Accounts receivable Inventory Loan to Bill Furniture Equipment Goodwill Accounts payable Note payable Loan from Cam Alf, capital (30%) Bill, capital (20%) Cam, capital (35%) Dot, capital (15%) Totals

Debits $ 6,000 20,000 50,000 8,000 30,000 36,000 20,000

$170,000

Credits

$ 23,500 60,000 12,400 24,000 18,000 24,000 8,100 $ 170,000

Answer: Loss absorption potential:

Alf Bill Cam Dot

Partners' Equity $ 24,000 10,000 36,400 8,100

÷ ÷ ÷ ÷

Profit and Loss Ratio 30% 20% 35% 15%

Loss Absorption Potential $ 80,000 $ 50,000 $ 104,000 $ 54,000

Vulnerability Ranking 3 1 4 2

Schedule of assumed loss absorption:

Partnership Equity Assumed loss to absorb Bill

30% Alf

20% Bill

35% Cam

15% Dot

Total

$ 24,000

$ 10,000

$ 36,400

$ 8,100

$ 78,500

(15,000) 9,000

(10,000) $ 0

(17,500) 18,900

(7,500) 600

(50,000) 28,500

(600) 0

(3,200) 25,300

Assumed loss to absorb Dot

(1,200) 7,800

Assumed loss to absorb Alf $

(7,800) 0

(1,400) 17,500

(9,100) 8,400

Cash distribution plan: First $83,500 pays the priority creditors; Next $8,400 goes to Cam; Next $16,900 goes $7,800 to Alf, and $9,100 to Cam; Next $3,200 goes $1,200 to Alf, $1,400 to Cam, and $600 to Dot; Remainder goes 30% to Alf, 20% to Bill, 35% to Cam, and 15% to Dot. Objective: LO17.5 Learn about cash distribution plans for installment liquidations. Difficulty: Moderate AACSB: Application of knowledge

(16,900) $ 8,400

18) Eve, Fig, Gus, and Hal are partners who share profits and losses 50%, 25%, 15%, and 10%, respectively. The partnership will be liquidated gradually over several months beginning January 1, 2014. The partnership trial balance at December 31, 2013 is as follows:

Cash Accounts receivable Inventory Loan to Eve Furniture Equipment Goodwill Accounts payable Note payable Loan from Hal Eve, capital (50%) Fig, capital (25%) Gus, capital (15%) Hal, capital (10%) Totals

Debits 9,000 26,000 78,000 16,000 27,000 59,000 10,000

$ 225,000

Credits

$ 23,000 70,000 7,000 46,000 38,000 15,000 26,000 $ 225,000

Answer: Loss absorption potential:

Eve Fig Gus Hal

Partners' Equity $ 30,000 38,000 15,000 33,000

÷ ÷ ÷ ÷

Profit and Loss Ratio 50% 25% 15% 10%

Loss Absorption Potential $ 60,000 $ 152,000 $ 100,000 $ 330,000

Vulnerability Ranking 1 3 2 4

Schedule of assumed loss absorption:

Partnership Equity Assumed loss to absorb Eve

50% Eve

25% Fig

15% Gus

10% Hal

Total

$ 30,000

$ 38,000

$ 15,000

$ 33,000

$116,000

(30,000) $ 0

(15,000) 23,000

(9,000) 6,000

(6,000) 27,000

(60,000) 56,000

(6,000) 0

(4,000) $ 23,000

(20,000) 36,000

(5,200) $ 17,800

(18,200) $ 17,800

Assumed loss to absorb Gus

(10,000) 13,000

Assumed loss to absorb Fig $

(13,000) 0

Cash distribution plan: First $93,000 pays the priority creditors; Next $17,800 goes to Hal; Next $18,200 goes $13,000 Fig, and $5,200 to Hal; Next $20,000 goes $10,000 to Fig, $6,000 to Gus, and $4,000 to Hal; Remainder goes 50% to Eve, 25% to Fig, 15% to Gus, and 10% to Hal. Objective: LO17.5 Learn about cash distribution plans for installment liquidations. Difficulty: Moderate AACSB: Application of knowledge

19) A cash distribution plan for the Jonah, Krispy, and Lemon partnership was as follows:

First $100,000 Next $180,000 Next $270,000 Remainder

Priority Creditors 100%

Jonah

Krispy

Lemon

44% 2/9 11%

10% 1/9 44%

46% 2/3 45%

Required: If $700,000 of cash was distributed by the partnership, how much was received respectively by the priority creditors, Jonah, Krispy, and Lemon? Answer: Priority Creditors Jonah Krispy Lemon First $100,000 $ 100,000 Next $180,000 $ 79,200 $ 18,000 $ 82,800 Next $270,000 60,000 30,000 180,000 Last $150,000 16,500 66,000 67,500 Total $700,000 $ 100,000 $ 155,700 $ 114,000 $ 330,300 Objective: LO17.5 Learn about cash distribution plans for installment liquidations. Difficulty: Moderate AACSB: Application of knowledge

20) The partners of the Minion, Nocti and Overly partnership share profits and losses in the ratio of 6:3:1, respectively. The partners have decided to liquidate and terminate the partnership. Prior to liquidation, the partnership balance sheet was as follows: Cash Inventory Fixed assets - net

20,000 100,000 160,000

Total assets

$ 280,000

Liabilities Minion, capital Nocti, capital Overly, capital Total equity

$ 120,000 60,000 80,000 20,000 $ 280,000

Required: Prepare a schedule of liquidation, given that the partnership sold the inventory for $40,000 and the fixed assets for $120,000. Answer: Minion, Nocti and Overly Partnership Final Statement of Partnership Liquidation

Begin. Balance Inventory sold Fixed Assets sold Balances before distribution Pay creditors Partner equity Cash distributed

Assets $ 280,000 (60,000) (40,000)

Liabil. $ 120,000

180,000 (120,000) $ 60,000 (60,000) $ 0

120,000 (120,000)

6/10 Minion $ 60,000 (36,000) (24,000)

3/10 Nocti $ 80,000 (18,000) (12,000)

1/10 Overly $ 20,000 (6,000) (4,000)

50,000

10,000

50,000 (50,000) $ 0

10,000 (10,000) $ 0

Objective: LO17.3 Perform safe payment computations. Difficulty: Moderate AACSB: Application of knowledge

17.3 True/False 1) The liquidation of a partnership is covered under Section 807 of the Uniform Partnership Act of 1997. Answer: TRUE Objective: LO17.1 Understand the legal aspects of partnership liquidation. Difficulty: Easy AACSB: Analytical thinking

2) When liquidating a partnership the first payment is to amounts due partners liquidating their capital balance. Answer: FALSE Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Easy AACSB: Analytical thinking

3) If a partnership agreement does not specify the ratios for liquidation, the profit- and loss-sharing ratios are used. Answer: TRUE Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Moderate AACSB: Analytical thinking

4) If a partner has a debit capital balance at the time of liquidation, the partner may be required to use their personal funds to settle their partnership obligations. Answer: TRUE Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Moderate AACSB: Analytical thinking

5) Safe payments are based on the assumptions that all partners are personally solvent and all noncash assets represent possible losses. Answer: FALSE Objective: LO17.3 Perform safe payment computations. Difficulty: Easy AACSB: Analytical thinking

6) Any distribution to partners prior to gains and losses being realized and recognized require approval of the majority of the partners. Answer: FALSE Objective: LO17.3 Perform safe payment computations. Difficulty: Easy AACSB: Analytical thinking

7) Installment liquidation is the distribution of cash to partners as it becomes available during the liquidation period but after all liquidation gains and losses are realized. Answer: FALSE Objective: LO17.4 Understand installment liquidations. Difficulty: Easy AACSB: Analytical thinking

8) A cash distribution plan involves ranking the partners in terms of their vulnerability to possible losses. Answer: TRUE Objective: LO17.5 Learn about cash distribution plans for installment liquidations. Difficulty: Easy AACSB: Analytical thinking

9) A partnership is considered insolvent if the cash available after all noncash assets have been converted into cash is not enough to pay partnership creditors. Answer: TRUE Objective: LO17.6 Comprehend liquidations when either the partnership or the partners are insolvent. Difficulty: Easy AACSB: Analytical thinking

10) A partnership is solvent if enough resources exist to pay creditors and make a cash distribution to the partners. Answer: TRUE Objective: LO17.2 Apply simple partnership liquidation computations and accounting. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 18 Corporate Liquidations and Reorganizations 18.1 Multiple Choice Questions 1) When the bankruptcy court grants an order for relief under Chapter 7, A) creditors may not seek payment for their claims directly from the debtor corporation. B) the reorganization plan was accepted by creditors having at least one-half of the total number of claims and the claims represent at least two-thirds of the total amount owed. C) the bankruptcy court confirms that the reorganization plan is fair and equitable to creditors. D) the court discharges the debtor except for those claims provided for in the reorganization plan. Answer: A Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Easy AACSB: Analytical thinking

2) Which of the following must approve a Chapter 11 plan? A) The organization's management and the assigned trustee B) The assigned trustee and creditors C) The assigned trustee and entity's stockholders D) The bankruptcy court and the creditors Answer: D Objective: LO18.1 Understand differences among different types of bankruptcy filings. Difficulty: Easy AACSB: Analytical thinking

3) When a corporation's total liabilities are greater than the fair value of total assets, the firm is A) a distressed corporation. B) a bankrupt corporation. C) insolvent in the equity sense. D) insolvent in the bankruptcy sense. Answer: D Objective: LO18.1 Understand differences among different types of bankruptcy filings. Difficulty: Easy AACSB: Analytical thinking

4) A bankruptcy petition filed by a firm's creditors is A) a Chapter 2 petition. B) a petition for liquidation. C) an involuntary petition. D) a voluntary petition. Answer: C Objective: LO18.1 Understand differences among different types of bankruptcy filings. Difficulty: Easy AACSB: Analytical thinking

5) The duties of a debtor in possession in a Chapter 11 bankruptcy case do not include A) filing a list of creditors and schedules of assets and liabilities with the bankruptcy court. B) operating the business during the reorganization period. C) filing a reorganization plan. D) issuing an order of relief. Answer: D Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Easy AACSB: Analytical thinking

6) Chapter 7 bankruptcy cases differ from Chapter 11 bankruptcy cases because Chapter 7 bankruptcy A) is involuntary. B) requires a reorganization plan that is approved by the court. C) requires the debtor corporation to file a list of creditors, schedule of assets and liabilities, and work with a trustee. D) leads to full liquidation of the bankrupt company. Answer: D Objective: LO18.1 Understand differences among different types of bankruptcy filings. Difficulty: Easy AACSB: Analytical thinking

7) In a liquidation under Chapter 7, the trustee A) may not be appointed, but may only be elected. B) may not be elected, but may only be appointed. C) is responsible for converting assets to cash and distributing payments to claimants. D) is responsible for appointing a creditors' committee. Answer: C Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Easy AACSB: Analytical thinking

8) A single creditor A) can never file a petition for bankruptcy. B) with a $15,775 or more secured claim may file a petition for bankruptcy. C) with a $15,775 or more unsecured claim may file a petition for bankruptcy, if there are fewer than 12 unsecured creditors. D) with a $14,425 or more unsecured claim may file a petition for bankruptcy if there are more than 12 unsecured creditors. Answer: C Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Easy AACSB: Analytical thinking

9) A petition commencing a case against a corporate debtor A) can be filed only under Chapter 7 of the bankruptcy act. B) can be filed only under Chapter 11 of the bankruptcy act. C) can be filed under either Chapter 7 or Chapter 11 of the bankruptcy act. D) will be determined by the trustee whether it shall be Chapter 7 or Chapter 11 of the bankruptcy act. Answer: C Objective: LO18.1 Understand differences among different types of bankruptcy filings. Difficulty: Easy AACSB: Analytical thinking

10) A primary difference between voluntary and involuntary bankruptcy petitions is that A) creditors file the petition in an involuntary filing. B) trustees are not used in a voluntary filing. C) voluntary petitions are not subject to review by the bankruptcy court. D) the debtor corporation files the petition in an involuntary filing. Answer: A Objective: LO18.1 Understand differences among different types of bankruptcy filings. Difficulty: Easy AACSB: Analytical thinking

11) Creditor committees are elected A) in all bankruptcy cases. B) in Chapter 7 cases. C) only in bankruptcy cases arising from involuntary petitions. D) in Chapter 11 cases. Answer: B Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Easy AACSB: Analytical thinking

12) In a Chapter 7 bankruptcy case, what is the first-to-last ranking order of priority for payment? (Use the following list of claim types.) I. stockholder claims II. unsecured priority claims III. secured claims IV. unsecured nonpriority claims A) I, II, IV, and III B) III, II, IV, and I C) III, I, IV, and II D) II, IV, III, and I Answer: B Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Easy AACSB: Analytical thinking

13) Which of the following does not occur for a trustee in a Chapter 7 bankruptcy case? A) Gains and losses on the sale of assets are debited to the estate equity account. B) Unrecorded liabilities discovered by the trustee are debited to the estate equity account and credited to the liability account. C) Liquidation expenses are debited to the estate equity account. D) An income statement is prepared showing gains and losses on sale of assets. Answer: D Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Easy AACSB: Analytical thinking

14) What is an advantage of filing a Chapter 11 petition? A) The continuation of interest accrual on liabilities B) Restrictions imposed by the bankruptcy court on day-to-day transactions C) It is less costly than filing Chapter 7. D) The opportunity to cancel unfavorable contracts Answer: D Objective: LO18.3 Understand financial reporting during reorganization. Difficulty: Easy AACSB: Analytical thinking

15) Which condition must be met for fresh-start reporting for an emerging company from Chapter 11? A) Holders of existing voting shares immediately before confirmation of the reorganization plan must receive more than fifty percent of the emerging entity. B) The loss of control by voting shareholders must be temporary. C) The reorganization value of the emerging entity's assets immediately before the date of the confirmation of the reorganization plan must be less than the total of all postpetition liabilities and allowed claims. D) The fresh-start entity must have a deficit. Answer: C Objective: LO18.4 Understand financial reporting after emerging from reorganization, including fresh-start accounting. Difficulty: Easy AACSB: Analytical thinking

16) A company emerging from bankruptcy will have a reorganization value that A) approximates the book value of the entity's assets prior to bankruptcy. B) approximates the book value of the entity prior to bankruptcy. C) approximates the fair market value of the entity without considering liabilities. D) approximates the fair market value of the entity's liabilities. Answer: C Objective: LO18.4 Understand financial reporting after emerging from reorganization, including fresh-start accounting. Difficulty: Easy AACSB: Analytical thinking

17) In a Chapter 11 case, the debtor corporation filing the petition may continue in possession of the corporation's property, and is referred to as a(n) A) examiner. B) trustee. C) liquidator. D) debtor in possession. Answer: D Objective: LO18.3 Understand financial reporting during reorganization. Difficulty: Easy AACSB: Analytical thinking

18) Fresh-start reporting results in A) a new reporting entity with no retained earnings/deficit balance. B) a new reporting entity with a retained earnings/deficit balance equal to the reorganization value. C) a continuation of the reorganized organization with no retained earnings/deficit balance. D) a continuation of the reorganized organization with a retained earnings/deficit balance equal to the reorganization value. Answer: A Objective: LO18.4 Understand financial reporting after emerging from reorganization, including fresh-start accounting. Difficulty: Easy AACSB: Analytical thinking

19) An entity which qualified for fresh-start accounting is not required to disclose which of the following items in their initial financial statements? A) Adjustments from historical cost of assets and liabilities B) Amount of debt of the prior entity forgiven C) Amount of ending retained earnings/deficit of the prior entity D) Changes to the management team from the prior entity Answer: D Objective: LO18.4 Understand financial reporting after emerging from reorganization, including fresh-start accounting. Difficulty: Easy AACSB: Analytical thinking

20) Which of the following statements is correct concerning companies emerging from reorganization under Chapter 11 when they do not qualify for fresh start accounting? The forgiveness of debt is reported as A) an operating gain. B) a non-operating gain. C) an extraordinary item. D) an increase in contributed capital. Answer: C Objective: LO18.4 Understand financial reporting after emerging from reorganization, including fresh-start accounting. Difficulty: Easy AACSB: Analytical thinking

18.2 Exercises 1) Rank the following claims of an organization filing Chapter 7 bankruptcy from 1 to 4 based on the following classifications. Each classification may be used more than once. 1. 2. 3. 4.

Secured Claims Unsecured Priority Claims Unsecured Nonpriority Claims Stockholders' Claims

________

A. Claims for wages that are less than $11,725 per individual, earned within 90 days of filing petition for bankruptcy. ________ B. Legal fees incurred after petitioning the court for Chapter 7. ________ C. Claim by the accounting firm for the audit fee from the prior year-end audit completed two months prior to the bankruptcy filing. ________ D. Claims for employee benefit plan contributions that are less than $11,725 per individual and relating to services rendered within 180 days of bankruptcy filing. ________ E. Claims with a valid lien against assets of the entity. ________ F. Claim by employee for commissions earned in 90 days prior to filing bankruptcy petition, for the portion in excess of $11,725. ________ G. Administrative expenses of the estate, such as trustee fees. ________ H. Claim by a supplier for goods delivered on account. ________ I. Interest on unsecured claims. ________ J. Taxes owed to a government unit. Answer: A. 2, B. 2, C. 3, D. 2, E. 1, F. 3, G. 2, H. 3, I. 3, J. 2 Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Analytical thinking

2) Alitech Corporation is liquidating under Chapter 7 of the Bankruptcy Act. The accounts of Alitech at the time of filing are summarized as follows:

Book Value $ 10,000 60,000 110,000 20,000 200,000 22,000 $ 422,000

Cash Accounts receivable-net Inventory Land Building Goodwill

Accounts payable Wages and salaries Taxes payable Accrued mortgage interest payable Mortgage payable Capital stock Deficit

Estimated Realizable Value $ 10,000 50,000 65,000 35,000 126,000

$ 120,000 30,000 80,000 22,000 100,000 90,000 (20,000) $ 422,000

The land and building are pledged as security for the mortgage payable as well as any accrued interest on the mortgage. Wages and salaries were earned within 90 days of filing the petition for bankruptcy and do not exceed $11,725 per employee. Liquidation expenses are expected to be $30,000. Required: 1. Prepare a schedule showing the priority rankings of the creditors and the expected payouts. 2. Billing Corporation was a supplier to Alitech Corporation and at the time of Alitech's bankruptcy filing, Billing's account receivable from Alitech was $40,000. On the basis of the estimates, how much can Billing expect to receive?

Answer: Requirement 1 Amount of Claim

Expected Payment

Estimated available cash Secured claims: Mortgage payable & interest

Unsecured priority claims: Estimated liquidation expenses Wages and salaries Taxes payable Unsecured nonpriority claims: Accounts payable

122,000

30,000 30,000 80,000

122,000

Estimated Remaining Cash $ 286,000

30,000 30,000 80,000

164,000

134,000 104,000 24,000

120,000

Expected return on the dollar for unsecured nonpriority claims: $24,000/$120,000 = $.20 on the dollar Requirement 2 Billing's estimated return: $40,000 claim × $.20 = $8,000 Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

3) CommTex Corporation is liquidating under Chapter 7 of the Bankruptcy Act. The accounts of CommTex at the time of filing are summarized as follows:

Book Value $ 80,000 50,000 80,000 10,000 150,000 60,000 10,000 $ 440,000

Cash Accounts receivable-net Inventory Land Building-net Equipment-net Goodwill

Accounts payable Wages and salaries Contributions due to pension plan Taxes payable Accrued interest payable (includes $8,000 from the mortgage payable and $2,000 from the note payable) Note payable Mortgage payable Capital stock Deficit

Estimated Realizable Value $ 80,000 40,000 60,000 20,000 110,000 40,000 0

$ 120,000 20,000 10,000 60,000 10,000

120,000 90,000 80,000 (70,000) $ 440,000

The land and building are pledged as security for the mortgage payable as well as any accrued interest on the mortgage. The note payable is secured with the equipment, but the interest on the note is unsecured. Wages and salaries were earned within 90 days of filing the petition for bankruptcy and pension plan contributions relate to services rendered within 6 months of filing the petition for bankruptcy; neither exceeds $4,000 per employee. Liquidation expenses are expected to be $40,000. Required: 1. Prepare a schedule showing the priority rankings of the creditors and the expected payouts. 2. Devendor Corporation was a supplier to CommTex Corporation and at the time of CommTex's bankruptcy filing, Devendor's account receivable from CommTex was $25,000. On the basis of the estimates, how much can Devendor expect to receive?

Answer: Requirement 1

Amount of Claim

Expected Payment

Estimated available cash Secured claims: Mortgage payable & interest

98,000

Estimated Remaining Cash $ 350,000

252,000

Partially secured claims: Note payable ($80,000 reclassified as unsecured)

120,000

40,000

212,000

Unsecured priority claims: Estimated liquidation expenses Wages and salaries Pension fund liability Taxes payable

40,000 20,000 10,000 60,000

172,000 152,000 142,000 82,000

Unsecured nonpriority claims: Accounts payable $ Unsecured portion of note payable Accrued interest on note payable

120,000 80,000 2,000

49,200 32,800 0

Expected return on the dollar for unsecured nonpriority claims for Accounts payable and unsecured portion of note payable: $82,000/$200,000 = $.41 on the dollar Requirement 2 Devendor's estimated return: $25,000 claim × $.41 = $10,250

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

4) Ending Company is in bankruptcy and is being liquidated under the provisions of Chapter 7 of the bankruptcy code. The trustee has converted all assets into $80,000 cash (which includes the amounts shown below for assets sold) and has prepared the following list of approved claims: Property taxes payable

10,000

Accounts payable, unsecured

30,000

Mortgage payable, secured by property that was sold for $50,000

30,000

Note payable to bank, secured by all accounts receivable of which $20,000 was able to be collected and the balance was written off

30,000

Required: How much will the bank receive on the note payable? Answer: Cash Mortgage payable, paid in full

Note payable to bank, secured portion Priority claims ($10,000 property tax) Available for unsecured nonpriority claims

Unsecured, nonpriority claims: Unsecured portion of note payable to bank Accounts payable Total unsecured, nonpriority claims

80,000 (30,000) 50,000 (20,000) 30,000 (10,000) 20,000

10,000 30,000 40,000

25,000

$20,000 cash/$40,000 claims = $.50 on the dollar Amount paid to bank: $20,000 for secured portion + ($10,000 × .50) for unsecured portion =

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

5) Finale Company is in bankruptcy and is being liquidated under the provisions of Chapter 7 of the bankruptcy code. The trustee has converted all assets into $180,000 cash and has prepared the following list of approved claims: Customer deposits ($1,000 from each of three customers that ordered products that were never delivered)

3,000

Property taxes payable

6,000

Accounts payable, unsecured

45,000

Trustee's fees and other costs of liquidation

24,000

Mortgage payable, secured by property that was sold for $120,000

90,000

Note payable to bank, secured by all accounts receivable of which $45,000 were collected and $15,000 were written off as uncollectible

60,000

Required: How much will the bank receive on the note payable? Answer: Cash Mortgage payable, paid in full

Note payable to bank, secured portion Priority claims ($24,000 of administrative costs + $3,000 of customer deposits + $6,000 property tax) Available for unsecured nonpriority claims Unsecured, nonpriority claims: Unsecured portion of note payable to bank Accounts payable Total unsecured, nonpriority claims

180,000 (90,000) 90,000 (45,000) 45,000 (33,000) 12,000

15,000 45,000 60,000

Amount paid to bank for note payable: $45,000 for secured portion + ($15,000 × .20) for unsecured portion = $

48,000

$12,000 cash/$60,000 claims = $.20 on the dollar

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

6) Gonne Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has determined that the unsecured claims will receive $.35 on the dollar. Odemay Corporation holds a $100,000 mortgage note receivable from Gonne that is secured by equipment with a $120,000 book value and a $75,000 fair value. Required: How much of the mortgage receivable will be recovered by Odemay? Answer: Mortgage note receivable Less: Portion secured by equipment Unsecured portion Estimated recovery on secured portion Estimated recovery on unsecured portion ($25,000 × $.35) = Recovery on mortgage note receivable

$ $

100,000 (75,000) 25,000

75,000

8,750 83,750

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

7) Kline Corporation incurred major losses in 2014 and entered into voluntary Chapter 7 bankruptcy in the early part of 2015. By July 1, all assets were converted into cash, the secured creditors were paid, and $122,700 in cash was left to pay the remaining claims as follows: Accounts payable Claims incurred between the date of filing an involuntary petition and the date an interim trustee is appointed Property taxes payable Wages payable (all under $10,000 per employee; earned within 90 days of filing bankruptcy petition) Unsecured note payable Accrued interest on the note payable Administrative expenses of the trustee Total

37,000 5,000 8,000 74,000

19,000 2,000 12,180 157,180

Required: Classify the claims by their Chapter 7 priority ranking, and analyze which amounts will be paid and which amounts will be written off.

Answer: Requirement 1: Unsecured priority claims: Claim Amount

To be Paid

Cash Left $ 122,700

12,180

110,520

Estimated cash available Administrative expenses

12,180

Claims prior to the trustee's appointment

5,000

105,520

Wages payable

74,000

31,520

Property taxes payable

8,000

Unsecured Nonpriority Claims:

Claim Amount

To be Paid

Written Off

Accounts payable

15,540

$ 21,460* 11,020**

23,520

Payout ratio: $23,520 /($37,000 + $19,000) = 42%

37,000

Unsecured note

19,000

7,980

Accrued interest on the note

2,000

* $37,000 × 42% = $15,540 **$19,000 × 42% = $ 7,980 Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

8) Lesher Corporation lost their primary contract and entered into voluntary Chapter 7 bankruptcy in the early part of 2014. By July 1, all assets were converted into cash, the secured creditors were paid, and $124,500 in cash was left to pay the remaining claims as follows: Accounts payable Claims incurred between the date of filing an involuntary bankruptcy petition and the date an interim trustee is appointed Payroll taxes withheld Wages payable (all under $10,000 per employee; earned within 90 days of filing bankruptcy petition) Unsecured note payable Accrued interest on the note payable Administrative expenses of the trustee Total

50,000 8,000 14,000

56,000 37,500 2,000 22,000 189,500

Required: Classify the claims by their Chapter 7 priority ranking, and analyze which amounts will be paid and which amounts will be written off.

Answer: Requirement 1: Unsecured priority claims: Claim Amount

To be Paid

Cash Left $ 124,500

Estimated cash available Administrative expenses

22,000

102,500

Claims prior to the trustee's appointment

8,000

94,500

Wages payable

56,000

38,500

Payroll taxes withheld

14,000

24,500

Payout ratio: $24,500/($50,000 + $37,500) = 28% Unsecured Nonpriority Claims: Claim Amount Accounts payable

50,000

To be Paid $

Written Off

14,000

$ 36,000*

Unsecured note

37,500

10,500

27,000**

Accrued interest on the note

2,000

* $50,000 × 28% = $14,000 **$37,500 × 28% = $10,500 Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

9) Moddle Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has determined that the unsecured claims will receive $.20 on the dollar. National Corporation holds a $500,000 mortgage note receivable from Moddle that is secured by equipment with a $550,000 book value and a $430,000 fair value. Required: How much of the mortgage receivable will National recover? Answer: Mortgage note receivable Less: Portion secured by equipment Unsecured portion Estimated recovery on secured portion Estimated recovery on unsecured portion ($70,000 × $.20) = Recovery on mortgage note receivable

$ $

500,000 (430,000) 70,000

430,000

14,000 444,000

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

10) DeFunk Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has determined that the unsecured claims will receive $.18 on the dollar. Magma Corporation holds a $200,000 mortgage receivable from DeFunk that is secured by the land and buildings with a book value of $180,000 and a fair value of $190,000. Magma also holds an $80,000 unsecured note receivable from Defunk. Mortgage interest owed, which is secured with the mortgage note, is $4,000. Note interest owed, which is unsecured, is $2,000. Required: How much of the amounts owed will Magma recover? Answer: Mortgage note receivable + interest Less: Portion secured by land and buildings Unsecured portion Estimated recovery on secured portion Estimated recovery on unsecured portion ($14,000 + $80,000 note) × $.18 = Recovery on amounts owed to Magma

$ $

204,000 (190,000) 14,000

190,000

16,920 206,920

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

11) Trustin Corporation is in a Chapter 7 bankruptcy liquidation. For each of the following transactions, show the journal entry that would be required by the trustee of the estate. 1. An electric bill is received for $1,000 which had not yet been recorded by Trustin. 2. Inventory recorded net at $18,000 is sold for $16,000 cash. 3. Recorded patents in the amount of $7,000 are determined to be worthless and are written off. 4. Equipment recorded net at $24,000 is sold for $20,000 cash. 5. A building recorded net at $78,000 is sold for $87,000 cash. 6. Trustee fees of $2,500 are accrued. 7. The fully secured mortgage is paid in the amount of $70,000. 8. Wages payable that were recorded in the amount of $9,000 are paid. 9. An equipment lease, which was recorded as prepaid equipment lease, is cancelled and a $1,500 refund is received. 10. Accounts receivable amounting to $12,000 are collected, and an additional $3,000 is determined to be uncollectible.

Answer: 1. Estate Equity Electric payable - new 2.

$ 1,000 $ 1,000

Cash Estate Equity Inventory

16,000 2,000

Estate Equity Patents

7,000

Cash Estate Equity Equipment

20,000 4,000

Cash Estate Equity Building

87,000

Estate Equity Trustee fee payable - new

2,500

Mortgage Payable Cash

70,000

Wages Payable Cash

9,000

Cash Prepaid Equipment Lease

1,500

10. Cash Estate Equity Accounts Receivable

18,000

7,000

24,000

9,000 78,000

2,500

70,000

9,000

1,500 12,000 3,000 15,000

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

12) Dip Corporation is in a Chapter 11 bankruptcy reorganization. For each of the following transactions relating to the reorganization, show the journal entry that would be required by Dip. Assume that all unsecured liabilities were not reclassified to Prepetition Claims Subject to Compromise. 1. Dip has $200,000 in bonds payable which mature at the end of the current year. The bondholders agree to accept $100,000 of new common stock and $75,000 cash, payable immediately. 2.

Accrued interest on the bonds recorded at $20,000 will not be paid.

Recorded patents in the amount of $15,000 are determined to be worthless and are written off.

Equipment recorded net at $24,000 is appraised at $30,000.

A building recorded net at $78,000 is appraised for $87,000.

Creditors owed $120,000 recorded in accounts payable are paid $96,000 in full settlement.

Property taxes and payroll taxes withheld are paid in full at $12,000.

8. A capital lease recorded at $48,000 is re-negotiated, and the resulting operating lease will require monthly lease payments of $500. 9. An unsecured bank note amounting to $180,000 will be exchanged for $120,000 note secured by the building and equipment. 10. Current stockholders will exchange their stock which has a current book value of $300,000 for $100,000 common stock of the new entity.

Answer: 1. Bonds Payable Common Stock Cash Gain on Debt Discharge 2.

$ 200,000 $ 100,000 75,000 25,000

Accrued Interest Payable Gain on Debt Discharge

20,000

Loss on Asset Revaluation Patents

15,000

Equipment Gain on Asset Revaluation

6,000

Building Gain on Asset Revaluation

9,000

Accounts Payable Cash Gain on Debt Discharge

120,000

Taxes Payable Cash

12,000

Capital Lease Liability Gain on Debt Discharge

48,000

Debt - Unsecured Debt - Secured Gain on Debt Discharge

180,000

10. Common Stock (old) Common Stock (new) Additional Paid in Capital

300,000

20,000

15,000

6,000

9,000

96,000 24,000

12,000

48,000

120,000 60,000

100,000 200,000

Objective: LO18.3 Understand financial reporting during reorganization. Difficulty: Moderate AACSB: Application of knowledge

13) Faled Company has the following assets and liabilities, stated at fair value in liquidation. Assets pledged with secured creditors Assets pledged with partially secured creditors Other assets Secured liabilities Partially secured liabilities Unsecured liabilities with priority Unsecured liabilities

$ 100,000 75,000 160,000 50,000 110,000 80,000 215,000

Required: Determine the amount of cash that will be available to pay unsecured creditors, and the percentage of unsecured liabilities that will be paid. Answer: Cash available: Secured assets in excess of secured liabilities ($100,000 - $50,000) $ 50,000 Other assets 160,000 210,000 Less: Liabilities with priority (80,000) Cash available for unsecured creditors $ 130,000 Percentage of unsecured liabilities that will be paid: Cash available / Unsecured liabilities including unsecured portion of partially secured liabilities ($215,000 + ($110,000 - $75,000))

$ 130,000

/250,000 = 52%

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

14) Gargantuan Bank has loaned money in two separate loans to Little Company, which is now in Chapter 7 bankruptcy. Little Company has the following assets and liabilities, stated at fair value in liquidation. Assets pledged with secured creditors Assets pledged with partially secured creditors Other assets Secured debt to Gargantuan Partially secured debt to Gargantuan Unsecured liabilities with priority Unsecured liabilities

$ 190,000 70,000 30,000 130,000 110,000 50,000 160,000

Required: Determine the amount of cash that Gargantuan will collect from these two pieces of debt. Answer: Cash available: Secured assets in excess of secured liabilities ($190,000 - $130,000) $ 60,000 Other assets 30,000 90,000 Less: Liabilities with priority (50,000) Cash available for unsecured creditors $ 40,000 Percentage of unsecured liabilities that will be paid: Cash available / Unsecured liabilities including unsecured portion of partially secured liabilities ($160,000 + ($110,000 - $70,000))

$ 40,000

/200,000 = 20%

Gargantuan will collect: Secured debt Partially secured debt Secured portion Unsecured portion ($40,000 × 20%)

$ 130,000 70,000 8,000 $ 208,000

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

15) Aqua Corporation filed a petition under Chapter 7 of the bankruptcy act in January, 2014. On February 28, the following information was presented regarding Aqua's financial status.

Cash A/R - net Inventories Fixed Assets - net

Book Values $ 50,000 100,000 80,000 200,000

Priority Claims A/P N/P Mortgage Payable

80,000 100,000 110,000 200,000

Fair Values $ 50,000 90,000 60,000 230,000

The Note Payable is secured by Accounts Receivable, and the Mortgage Payable is secured by the Fixed Assets. Required: Calculate the amount expected to be available for unsecured claims and the percentage recovery that the unsecured class should expect to receive. Answer: Cash available to pay claims: $ 430,000 Less: Secured claims (200,000) Less: Partially secured claims (90,000) Less: Priority claims (80,000) Cash available for unsecured claims $ 60,000 Cash available for unsecured claims Unsecured claims ($100,000 + $20,000) Percentage recovery ($60,000/$120,000)

60,000 120,000 50%

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

16) Rank the following claims 1 through 5, with 1 being the first priority claim, under Chapter 7 of the bankruptcy code. ________ A. Trustee fees for administration of the estate. ________ B. Accounts payable for goods delivered prior to filing an involuntary petition for bankruptcy ________ C. Customer deposits for services never rendered. ________ D. First mortgage on the company's real estate. ________ E. Income taxes owed for the prior year. Answer: A. 2, B. 5, C. 3, D. 1, E. 4 Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Analytical thinking

17) Oceana Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has determined that the unsecured claims will receive $.35 on the dollar. Loans-R-Us holds a $1,000,000 mortgage note receivable from Oceana that is secured by building and equipment with a $1,200,000 book value and a $900,000 fair value. Required: How much of the mortgage receivable will Loans-R-Us recover? Answer: Mortgage note receivable $ 1,000,000 Less: Portion secured by equipment and building (900,000) Unsecured portion $ 100,000 Estimated recovery on secured portion Estimated recovery on unsecured portion ($100,000 × $.35) = Recovery on mortgage note receivable

900,000

35,000 935,000

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

18) Pasten Corporation is liquidating under Chapter 7 of the Bankruptcy Act. The accounts of Pasten at the time of filing are summarized as follows:

Book Value $ 65,000 15,000 280,000 20,000 210,000 595,000 $ 1,185,000

Cash Accounts receivable-net Inventory Land Building Goodwill

Accounts payable Wages and salaries payable Taxes payable Accrued mortgage interest payable Mortgage payable Capital stock Deficit

Estimated Realizable Value $ 65,000 13,000 190,000 28,000 220,000 0

800,000 21,000 12,000 16,000 304,000 100,000 (68,000) $ 1,185,000

The land and building are pledged as security for the mortgage payable as well as any accrued interest on the mortgage. Wages and salaries were earned within 90 days of filing the bankruptcy petition and do not exceed $10,000 per employee. Liquidation expenses are expected to be $35,000. Required: 1. Prepare a schedule showing the priority rankings of the creditors and the expected payouts. 2. Yuomi Corporation was a supplier to Pasten Corporation and at the time of Pasten's bankruptcy filing, Yuomi's account receivable from Pasten was $500,000. On the basis of the estimates, how much can Yuomi expect to receive?

Answer: Requirement 1 Amount of Claim

Expected Payment

Estimated Remaining Cash $ 516,000

$ 320,000

$ 248,000

$ 268,000

Unsecured priority claims: Estimated liquidation expenses Wages and salaries Taxes payable

35,000 21,000 12,000

233,000 212,000 200,000

Unsecured nonpriority claims: Accounts payable Mortgage payable Accrued interest

$ 800,000 56,000 16,000

186,880 13,082 0

Estimated available cash Secured claims: Mortgage payable & interest

Expected return on the dollar for unsecured nonpriority claims: $200,000/$856,000 = $.2336 on the dollar Requirement 2 Yuomi's estimated return: $500,000 claim × $.2336 = $116,800 Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

19) Hilfmir Corporation filed for Chapter 11 bankruptcy on January 1, 2014. A summary of their financial status is shown below on June 30, 2014, at the date of the approved reorganization, along with the fair value of their assets.

Cash A/R - net Inventory Plant Assets - net Patent

A/P Wages Payable Prepetition liab. Common Stock Deficit

Per Books $ 134,000 20,000 32,000 114,000 80,000 $ 380,000

Fair Value $ 134,000 20,000 40,000 106,000 0

$ 60,000 20,000 250,000 140,000 (90,000) $ 380,000

Under the reorganization plan, the reorganization value has been set at $320,000. Prepetition liabilities include $30,000 of trade Accounts Payable and a $220,000 Note Payable to Bigg Bank. The reorganization plan calls for the Prepetition accounts payable to be paid at 80% at a later date, and the Note Payable for $220,000 to be replaced by a Note Payable for $76,000 and the issuance of common stock of the new entity for $100,000. The former stockholders will receive $40,000 in common stock of the new entity, Hilfmir, in exchange for their shares. Required: Show the calculations to determine if Hilfmir is eligible for fresh-start accounting, and prepare a freshstart balance sheet for the new entity, Hilfmir, as of July 1, 2014.

Answer: Liabilities at 7/1/14 = $330,000 which is greater than the reorganization value of $320,000, and common stock of the new entity has been issued 71% to the prepetition creditors and 29% to the former stockholders, so that the former stockholders have less than a 50% interest in the new entity. So, Hilfmir is eligible for fresh-start accounting. Hilfmir Company Opening Balance Sheet As of July 1, 2014 $ 134,000 20,000 40,000 106,000

Cash A/R - net Inventory Plant Assets - net Reorganization value in excess of identifiable assets

20,000 $ 320,000

A/P - new A/P - old Wages Payable Note Payable - new Common Stock - new

60,000 24,000 20,000 76,000 140,000 $ 320,000

Objective: LO18.4 Understand financial reporting after emerging from reorganization, including fresh-start accounting. Difficulty: Moderate AACSB: Application of knowledge

20) Ohio Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has determined that the unsecured claims will receive $.05 on the dollar. Lender Bank holds a $100,000 mortgage note receivable from Ohio that is secured by equipment with a $120,000 book value and a $90,000 fair value, and a second mortgage on the same equipment amounting to $50,000. Required: How much of the mortgage receivable will be recovered by Lender? Answer: Mortgage notes receivable $ 150,000 Less: Portion secured by equipment (90,000) Unsecured portion $ 60,000 Estimated recovery on secured portion Estimated recovery on unsecured portion ($60,000 × $.05) = Recovery on mortgage note receivable

90,000

3,000 93,000

Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Application of knowledge

18.3 True/False 1) When total debts exceed the fair value of total assets it is referred to as equity insolvency. Answer: FALSE Objective: LO18.1 Understand differences among different types of bankruptcy filings. Difficulty: Easy AACSB: Analytical thinking

2) The inability to make payments on time is equity insolvency. Answer: TRUE Objective: LO18.1 Understand differences among different types of bankruptcy filings. Difficulty: Easy AACSB: Analytical thinking

3) Chapter 7 bankruptcy appoints a trustee to sell off the assets of the company and pay claims to its creditors. Answer: TRUE Objective: LO18.1 Understand differences among different types of bankruptcy filings. Difficulty: Moderate AACSB: Analytical thinking

4) U.S. Trustees are appointed by the Attorney General to handle the administrative duties of bankruptcy cases. Answer: TRUE Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Easy AACSB: Analytical thinking

5) In the case of Chapter 7 Liquidation, the stockholders are the first to have their claims satisfied. Answer: FALSE Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Analytical thinking

6) In the bankruptcy process a statement of affairs is prepared and filed by the trustee. The statement of affairs shows the income statement information. Answer: FALSE Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Analytical thinking

7) A statement of realization and liquidation is an activity statement that shows progress toward the liquidation of a debtor's estate. Answer: TRUE Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Easy AACSB: Analytical thinking

8) In cases of Chapter 11, a private trustee or a debtor in possession can be appointed to oversee the reorganization. Answer: TRUE Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Easy AACSB: Analytical thinking

9) An executory contract is one that has been completely performed but not settled in terms of payment. Answer: FALSE Objective: LO18.2 Comprehend trustee responsibilities and accounting during liquidation. Difficulty: Moderate AACSB: Analytical thinking

10) The doctrine of equitable subordination allows judges to move unsecured creditors ahead of secured creditors in bankruptcy proceedings in the interest of "fairness". Answer: TRUE Objective: LO18.4 Understand financial reporting after emerging from reorganization, including fresh-start accounting. Difficulty: Moderate AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 19 An Introduction to Accounting for State and Local Governmental Units 19.1 Multiple Choice Questions 1) Which pronouncements have the highest level of authority for state and local governments? A) Financial Accounting Standards Board Statements B) GASB Statements C) Consensus Positions of GASB Emerging Issues Task Force D) GASB Technical Bulletins Answer: B Objective: LO19.1 Learn about the historical development of accounting principles for state and local governmental units. Difficulty: Easy AACSB: Analytical thinking

2) The key focus of government fund accounting concerns A) capital expenditures. B) intergovernmental transfers from the general fund. C) income measurement. D) the current ability to provide and fund services and goods. Answer: D Objective: LO19.2 Understand the purposes of fund accounting and its basic premises. Difficulty: Easy AACSB: Analytical thinking

3) Governmental fund financial statements are prepared on the ________ basis of accounting. Proprietary fund financial statements are prepared on the ________ basis of accounting. A) modified accrual; modified accrual B) accrual; fund C) modified accrual; accrual D) blended; discrete Answer: C Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

4) Governmental accounting differs from corporate financial accounting primarily because A) the size of the government and the various levels would make it unreasonable to use corporate GAAP. B) governments lack a profit motive and must focus on accountability to the public they serve. C) the government has no stakeholders who require financial reporting. D) the government has too many types of organizations to use one type of corporate GAAP. Answer: B Objective: LO19.2 Understand the purposes of fund accounting and its basic premises. Difficulty: Easy AACSB: Analytical thinking

5) Approved or authorized expenditures that provide legislative control over the expenditure budget are referred to as A) appropriations. B) allotments. C) allocations. D) encumbrances. Answer: A Objective: LO19.5 Review basic governmental accounting principles. Difficulty: Easy AACSB: Analytical thinking

6) A fund A) has its own accounting equation. B) has consolidated financial statements for all funds. C) must follow GAAS. D) always uses modified accrual accounting. Answer: A Objective: LO19.2 Understand the purposes of fund accounting and its basic premises. Difficulty: Easy AACSB: Analytical thinking

7) Internal Service Funds differ from Enterprise Funds because Internal Service Funds A) are a proprietary fund. B) are intended to show a profit. C) charge for their services. D) provide goods and services primarily to other government agencies. Answer: D Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

8) Under the modified accrual basis of accounting, revenues are recognized in the period A) when the relevant service is done. B) when they are collected. C) when the paying entity is billed. D) when they become both measurable and available. Answer: D Objective: LO19.5 Review basic governmental accounting principles. Difficulty: Easy AACSB: Analytical thinking

9) When examining revenue transactions, which of the following transactions is classified as an exchange transaction? A) When a homeowner pays property taxes B) When a university receives a federal grant that mandates a certain type of research activity C) When an aquatic center receives cash for a group swim D) When an employer deducts money for state tax withholding Answer: C Objective: LO19.5 Review basic governmental accounting principles. Difficulty: Easy AACSB: Analytical thinking

10) Which fund would most likely report depreciation expense? A) A special revenue fund B) An enterprise fund C) A capital projects fund D) A debt service fund Answer: B Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Moderate AACSB: Analytical thinking

11) Which type of fund is used to account for a government activity that sells goods or services either solely or almost solely to external customers? A) A temporary fund B) A general fund C) An agency fund D) An enterprise fund Answer: D Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

12) Centralized data processing, central motor pools and garages, centralized risk-financing activities, and central stores typically would be accounted for using what type of fund? A) An agency fund B) An enterprise fund C) An internal service fund D) A trust fund Answer: C Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

13) The modified accrual basis of accounting is used for A) governmental funds. B) proprietary funds. C) internal service funds. D) enterprise funds. Answer: A Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

14) The accounting equation for an agency fund is A) Current assets - Current liabilities = Fund Balance. B) Assets - Liabilities = Equity. C) Assets = Equity + Liabilities. D) Assets = Liabilities. Answer: D Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Moderate AACSB: Analytical thinking

15) The accounting equation for a governmental fund is A) Assets = Liabilities + Equity. B) Current assets + Noncurrent assets - Current liabilities - Noncurrent liabilities = Net position. C) Current assets - Current liabilities = Fund Balance. D) Assets = Liabilities + Fund Balance. Answer: C Objective: LO19.2 Understand the purposes of fund accounting and its basic premises. Difficulty: Easy AACSB: Analytical thinking

16) What funds are reported in Government-wide financial statements? A) Governmental only B) Proprietary only C) Governmental and proprietary D) Governmental, proprietary and fiduciary Answer: C Objective: LO19.6 Learn about the contents of a governmental entity's comprehensive annual financial report. Difficulty: Easy AACSB: Analytical thinking

17) What basis of accounting is used to prepare Government-wide financial statements? A) Modified accrual basis B) Accrual basis C) Cash basis D) Fiduciary basis Answer: B Objective: LO19.6 Learn about the contents of a governmental entity's comprehensive annual financial report. Difficulty: Easy AACSB: Analytical thinking

18) Government-wide financial statements include a A) balance sheet, an income statement, and a statement of cash flows. B) statement of net assets, a statement of activities, and a statement of cash flows. C) statement of net position and a statement of activities. D) statement of activities and a statement of cash flows. Answer: C Objective: LO19.6 Learn about the contents of a governmental entity's comprehensive annual financial report. Difficulty: Easy AACSB: Analytical thinking

19) A comprehensive annual financial report has the following three major sections: A) introductory, financial, and management's discussion and analysis. B) introductory, financial, and statistical. C) transmittal, financial, and statistical. D) transmittal, financial, and management's discussion and analysis. Answer: B Objective: LO19.6 Learn about the contents of a governmental entity's comprehensive annual financial report. Difficulty: Easy AACSB: Analytical thinking

20) Government-wide financial statements exclude the A) general fund. B) fiduciary funds. C) proprietary funds. D) special revenue funds. Answer: B Objective: LO19.6 Learn about the contents of a governmental entity's comprehensive annual financial report. Difficulty: Easy AACSB: Analytical thinking

19.2 Exercises 1) Match each of the following fund types to one of the following three fund categories as indicated. Each fund category may be used more than once. A. Governmental Fund B. Proprietary Fund C. Fiduciary Fund ________ 1. Debt Service Fund ________ 2. Internal Service Fund ________ 3. Agency Fund ________ 4. General Fund ________ 5. Permanent Fund ________ 6. Enterprise Fund ________ 7. Capital Projects Fund ________ 8. Trust Fund ________ 9. Special Revenue Fund ________ 10. Pension Fund Answer: 1. A, 2. B, 3. C, 4. A, 5. A, 6. B, 7. A, 8. C, 9. A, 10. C Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

2) Identify the fund type of the fund being described. 1. A fund used to account for the external portion of investment pools reported by the sponsoring government. 2. A fund used to account for resources that are legally restricted to use of the earnings only for government programs or activities. 3. A fund used to account for resources used to pay for a new stadium. 4. A fund used to account for local taxes withheld on behalf of another county. 5. A fund used to account for resources used to pay interest on a long-term bond issue. 6. A fund used to account for specific revenues that are restricted in use. 7. A fund used to account for the local swimming pool that is owned by the city and used by residents for a membership fee. 8. A fund used to account for the centralized data processing services of the state government. 9. A fund used to account for all funds except those required to be accounted for in another fund. 10. A fund that accounts for government pension plans if the government is the trustee. Answer: 1. Investment trust fund 2. Permanent fund 3. Capital projects fund 4. Agency fund 5. Debt service fund 6. Special revenue fund 7. Enterprise fund 8. Internal service fund 9. General fund 10. Pension trust fund Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Moderate AACSB: Analytical thinking

3) For each of the following transactions that could be introduced to fund the maintenance of the city park, state the type of fund(s) that would be affected. Assume that a capital project fund will be used to handle any long-term improvements or additions to the park. 1. Resources used to make 60 monthly installments on outstanding long-term debt. 2. Implemented a tax on alcohol purchases specifically designated for the park upkeep. 3. A local sports organization that uses the park raises funds and donates the money, stating that the principal may not be spent, but designating earnings to the park upkeep. 4. City council approves the funds from existing resources for the upkeep required in the upcoming year. 5. Resources used only to pay principal and interest of debt outstanding to finance park maintenance. Answer: 1. Debt service fund 2. Special revenue fund 3. Permanent fund 4. General fund 5. Debt service fund Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Moderate AACSB: Analytical thinking

4) The following are transactions for the city of Springfield. a. b. c. d.

Borrowed $20,000 by issuing a three-month, 5% note. Paid $4,000 for equipment. Services for $1,000 were billed and collected. Year-end accrual of 3 months interest on note in (a).

Required: Analyze the above transactions by using the accounting equation for a governmental fund. Answer: Governmental fund equation a b c d Current assets +20,000 -4,000 +1,000 Current liabilities +20,000 +250 Fund balance -4,000 +1,000 -250 Objective: LO19.3 Perform transaction analysis using proprietary and governmental accounting models. Difficulty: Moderate AACSB: Analytical thinking

5) The following are transactions for the city of Springfield. a. b. c. d.

Borrowed $20,000 by issuing a three-month, 5% note. Paid $4,000 for equipment. Services for $1,000 were billed and collected. Year-end accrual of 3 months interest on note in (a).

Required: Analyze the above transactions by using the accounting equation for a proprietary fund. Answer: Proprietary fund equation a b c d Current assets +20,000 -4,000 +1,000 Noncurrent assets +4,000 Current liabilities +20,000 +250 Noncurrent liabilities Net Position +1,000 -250 Objective: LO19.3 Perform transaction analysis using proprietary and governmental accounting models. Difficulty: Moderate AACSB: Analytical thinking

6) The following are transactions for the city of Franklin. a. b. c. d. e.

Borrowed $20,000 by issuing a two-year note. Purchased equipment for $6,000 cash. Licenses for $700 were billed on account. Accrued employee salary costs of $7,000. Depreciation expense on equipment for year, $1,000.

Required: Analyze the above transactions by using the accounting equation for a governmental fund. Answer: Governmental fund equation a b c d e Current assets +20,000 -6,000 +700 Current liabilities +7,000 Fund balance +20,000 -6,000 +700 -7,000 Objective: LO19.3 Perform transaction analysis using proprietary and governmental accounting models. Difficulty: Moderate AACSB: Analytical thinking

7) The following are transactions for the city of Franklin. a. b. c. d. e.

Required: Analyze the above transactions by using the accounting equation for a proprietary fund. Answer: Proprietary fund equation a b c d e Current assets +20,000 -6,000 +700 Noncurrent assets +6,000 -1,000 Current liabilities +7,000 Noncurrent liabilities +20,000 Net Position 0 +700 -7,000 -1,000 Objective: LO19.3 Perform transaction analysis using proprietary and governmental accounting models. Difficulty: Moderate AACSB: Analytical thinking

8) For each of the following events or transactions, identify the fund or funds that will be affected. 1. A city government provides electricity services to residents for a fee. 2. A printing shop was established to handle the printing needs of a county government. 3. A philanthropist donates $1 million for zoo maintenance, only earnings can be used. 4. A city government collects sales taxes on behalf of the state and for some of its counties and municipalities. 5. Interest is paid on a state government's general obligation bonds. Answer: 1. Enterprise Fund 2. Internal Service Fund 3. Permanent Fund 4. Agency Fund 5. Debt Service Fund Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Moderate AACSB: Analytical thinking

9) For each of the following events or transactions, identify the fund or funds that will be affected. 1. A city government charges a fee for the use of the municipal golf course. 2. Interest is paid on state government revenue bonds. 3. A motor pool was established to handle the vehicle needs of a county government. 4. Paid salaries for general governmental employees. 5. Accrued salaries for general governmental employees. Answer: 1. Enterprise Fund 2. Debt Service Fund 3. Internal Service Fund 4. General Fund 5. General Fund Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Moderate AACSB: Analytical thinking

10) For each of the following events or transactions, identify the type of fund(s) that will be affected. 1. A central purchasing department was established to handle all the purchasing needs of a county government. 2. A county government levies sales taxes restricted as to use for job creation. 3. A county government receives a large contribution specifying that income from the contribution be distributed each year to the county zoo. The principal is to remain intact indefinitely. 4. A city government paid construction costs of $12,000 on city hall building. 5. A city government paid general operating costs. Answer: 1. Internal Service Fund 2. Special Revenue Fund 3. Permanent Fund 4. Capital Project Fund 5. General Fund Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Moderate AACSB: Analytical thinking

11) The following are transactions for the city of Clinton. a. b. c. d.

Borrowed $100,000 by issuing a one-year, 5% note, three months before year-end. Accrued interest at year end, but did not pay the interest at year end. Charges for services rendered of $2,500 were billed and collected immediately. Incurred salary costs of $5,000, unpaid.

Required: Analyze the above transactions by using the accounting equation for a governmental fund. Answer: Governmental fund equation a b c d Current assets +100,000 +2,500 Current liabilities +100,000 +1,250 +5,000 Fund balance -1,250 +2,500 -5,000 Objective: LO19.3 Perform transaction analysis using proprietary and governmental accounting models. Difficulty: Moderate AACSB: Analytical thinking

12) The following are transactions for the city of Clinton. a. b. c. d.

Required: Analyze the above transactions by using the accounting equation for a proprietary fund. Answer: Proprietary fund equation a b c d Current assets +100,000 +2,500 Noncurrent assets Current liabilities +100,000 +1,250 +5,000 Noncurrent liabilities Net Position -1,250 +2,500 -5,000 Objective: LO19.3 Perform transaction analysis using proprietary and governmental accounting models. Difficulty: Moderate AACSB: Analytical thinking

13) The following are transactions for the city of Greenville. a. Issued $50,000 10-year bonds. b. Used $30,000 of the cash to buy a truck. c. Sold the truck that was replaced which had cost $28,000, for $2,000. The old truck was fully depreciated. Residual value is zero. d. Computed depreciation on the new truck for the year of $6,000. Required: Analyze the above transactions by using the accounting equation for a governmental fund. Answer: Governmental fund equation a b c d Current assets +50,000 -30,000 +2,000 Current liabilities Fund balance +50,000 -30,000 +2,000 0 Objective: LO19.3 Perform transaction analysis using proprietary and governmental accounting models. Difficulty: Moderate AACSB: Analytical thinking

14) The following are transactions for the city of Greenville. a. Issued $50,000 10-year bonds. b. Used $30,000 of the cash to buy a truck. c. Sold the truck that was replaced which had cost $28,000, for $2,000. The old truck was fully depreciated. Residual value is zero. d. Computed depreciation on the new truck for the year of $6,000. Required: Analyze the above transactions by using the accounting equation for a proprietary fund. Answer: Proprietary fund equation a b c d Current assets +50,000 -30,000 +2,000 Noncurrent assets +30,000 -6,000 Current liabilities Noncurrent liabilities +50,000 Net Position +2,000 -6,000 Objective: LO19.3 Perform transaction analysis using proprietary and governmental accounting models. Difficulty: Moderate AACSB: Analytical thinking

15) Using the revenue types shown below, match each of the revenue sources to a revenue type. Each revenue type may be used more than once. A. B. C. D.

Derived Tax Revenues Imposed Nonexchange Revenues Government-Mandated Nonexchange Transactions Voluntary Nonexchange Transactions

________ 1. Corporate income tax ________ 2. Sales taxes ________ 3. Liquor taxes ________ 4. Fines and penalties paid to a government entity ________ 5. Cigarette taxes ________ 6. Personal income tax ________ 7. Donation made to a government entity ________ 8. Motor fuel tax ________ 9. Property tax Answer: 1. A, 2. A, 3. A, 4. B, 5. A, 6. A, 7. D, 8. A, 9. B Objective: LO19.5 Review basic governmental accounting principles. Difficulty: Moderate AACSB: Analytical thinking

16) Match the following definitions to the appropriate government accounting terms (numbered below). A. Legally separate organization for which primary government is financially accountable B. The use of governmental fund working capital C. Appropriation for a specific time period D. Governmental and Proprietary fund revenues and expenses presented using full accrual accounting E. Approved or authorized expenditures F. Revenues recognized when available to meet current obligations G. Self-balancing set of accounts H. Each state government and each general-purpose local government I. The responsibility to demonstrate compliance with public decisions with regard to the use of financial resources J. Governmental and Internal Service Funds assets and liabilities presented together using full accrual accounting ________ 1. Modified Accrual Basis ________ 2. Fund ________ 3. Primary Government ________ 4. Appropriation ________ 5. Statement of Net Position ________ 6. Fiscal Accountability ________ 7. Allotment ________ 8. Component Unit ________ 9. Statement of Activities ________ 10. Expenditures Answer: 1. F, 2. G, 3. H, 4. E, 5. J, 6. I, 7. C, 8. A, 9. D, 10. B Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Moderate AACSB: Analytical thinking

17) The following are transactions for the city of Salem. a. b. c. d.

Incurred salaries of $44,000 to be paid next month. Tax bills totaling $500,000 mailed to city residents. Paid salaries above. Computer equipment received in the amount of $11,000, to be paid in 30 days.

Required: Analyze the above transactions by using the accounting equation for a governmental fund. Answer: Governmental fund equation a b c d Current assets +500,000 -44,000 Current liabilities +44,000 -44,000 +11,000 Fund balance -44,000 +500,000 -11,000 Objective: LO19.3 Perform transaction analysis using proprietary and governmental accounting models. Difficulty: Moderate AACSB: Analytical thinking

18) The following are transactions for the city of Salem. a. b. c. d.

Required: Analyze the above transactions by using the accounting equation for a proprietary fund. Answer: Proprietary fund equation a b c d Current assets +500,000 -44,000 Noncurrent assets +11,000 Current liabilities +44,000 -44,000 +11,000 Noncurrent liabilities Net Position -44,000 +500,000 Objective: LO19.3 Perform transaction analysis using proprietary and governmental accounting models. Difficulty: Moderate AACSB: Analytical thinking

19.3 True/False 1) Government business type activities provide services to users for fees that are intended to recover all or a portion of the costs of providing the services. Answer: TRUE Objective: LO19.2 Understand the purposes of fund accounting and its basic premises. Difficulty: Easy AACSB: Analytical thinking

2) General governmental activities provide goods and services to citizens without regard to their ability to pay. Answer: TRUE Objective: LO19.2 Understand the purposes of fund accounting and its basic premises. Difficulty: Easy AACSB: Analytical thinking

3) Proprietary funds report revenues and expenses using a modified-accrual basis of accounting. Answer: FALSE Objective: LO19.2 Understand the purposes of fund accounting and its basic premises. Difficulty: Easy AACSB: Analytical thinking

4) The governmental fund accounting equation is Current Assets - Current Liabilities = Fund Balance. Answer: TRUE Objective: LO19.2 Understand the purposes of fund accounting and its basic premises. Difficulty: Easy AACSB: Analytical thinking

5) Enterprise funds are used to account for business-type activities that serve primarily internal customers. Answer: FALSE Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

6) Capital projects funds and debt service funds are governmental fund types. Answer: TRUE Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

7) Enterprise funds and Internal service funds are Fiduciary Fund types. Answer: FALSE Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

8) Permanent funds report resources whose use is permanently restricted. Answer: TRUE Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

9) Debt service fund accounts for resources to be used to pay principal and interest for general short-term debt. Answer: FALSE Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Moderate AACSB: Analytical thinking

10) The accounting equation for an agency fund is Assets = Liabilities. Answer: TRUE Objective: LO19.4 Recognize various fund categories, as well as their measurement focus and basis of accounting. Difficulty: Easy AACSB: Analytical thinking

11) For government transactions derived tax revenues are recognized when resources should be available when using accrual accounting. Answer: FALSE Objective: LO19.5 Review basic governmental accounting principles. Difficulty: Moderate AACSB: Analytical thinking

12) Appropriations are approved or authorized expenditures. Answer: TRUE Objective: LO19.5 Review basic governmental accounting principles. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 20 Accounting for State and Local Governmental Units - Governmental Funds 20.1 Multiple Choice Questions 1) When a capital lease is used to lease fixed assets for the general government, the governmental fund acquiring the fixed assets debits ________ at the ________. A) expenditures; future value of the lease payments B) fixed assets; future value of the lease payments C) expenditures; present value of the lease payments D) fixed assets; present value of the lease payments Answer: C Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Easy AACSB: Analytical thinking

2) When recording an approved budget into the accounts of the general fund, which of the following accounts would be credited? A) Appropriations B) Encumbrances C) Estimated revenues D) Revenue collected in advance Answer: A Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Easy AACSB: Analytical thinking

3) When a city enters into a capital lease for a fixed asset for the general government, A) government-wide statements will report the asset and liability for the leased asset. B) government-wide statements will not report the liability, Capital Lease Obligation. C) governmental fund statements will report a fixed asset. D) governmental fund statements will report a liability, Capital Lease Obligation. Answer: A Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Moderate AACSB: Analytical thinking

4) The proceeds from a bond issuance for the construction of a new public school should be recorded in the ________ fund at the time the bonds are sold. At the time of the bond issue, the debit is to cash and the credit is to ________. A) capital projects; revenues B) general; bonds payable C) general; other financing sources D) capital projects; other financing sources Answer: D Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Easy AACSB: Analytical thinking

5) The General Fund transfers $50,000 cash to the Debt Service Fund to meet annual interest payments. What entry did the Debt Service Fund prepare? A) Debit Cash $50,000, Credit Revenue $50,000 B) Debit Cash $50,000, Credit Other Financing Sources-Transfer from General Fund $50,000 C) Debit Encumbrance $50,000, Credit Due to General Fund $50,000 D) Debit Appropriation $50,000, Credit Reserve for Encumbrance $50,000 Answer: B Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Easy AACSB: Analytical thinking

6) What statements are required for Government-wide financial statements? A) Statement of Cash Flows and Balance Sheet B) Statement of Cash Flows and Statement of Net Assets C) Statement of Net Position and Statement of Activities D) Operating Statement and Balance Sheet Answer: C Objective: LO20.5 Convert governmental fund financial statements to government-wide financial statements. Difficulty: Moderate AACSB: Analytical thinking

Use the following information to answer the question(s) below. The town of Mayberry receives a gift of $500,000 in bonds. The contributor instructs that the principal should remain intact, but the annual interest income of $50,000 can be used for the maintenance of the zoo animals. 7) What type of fund should be used to account for the gift of bonds and the interest income? A) General Fund B) Special Revenue Fund C) Proprietary Fund D) Permanent Fund Answer: D Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Easy AACSB: Analytical thinking

8) When the donation of bonds is received, what account should be debited? A) Encumbrance B) Other Financing Sources C) Other Financing Uses D) Investment Answer: D Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Easy AACSB: Analytical thinking

9) When the interest income of $50,000 is received, what account should be credited? A) Other Financing Sources B) Other Financing Uses C) Revenue collected in advance D) Revenue Answer: D Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Easy AACSB: Analytical thinking

10) The proper sequence of events is A) purchase order, appropriation, encumbrance, expenditure. B) purchase order, encumbrance, expenditure, appropriation. C) appropriation, encumbrance, purchase order, expenditure. D) appropriation, purchase order, encumbrance, expenditure. Answer: D Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Easy AACSB: Analytical thinking

11) Governments must record a liability for uncollected taxes instead of revenues for uncollected taxes if the taxes are going to be collected A) 30 days after the fiscal year end. B) 45 days after the fiscal year end. C) 60 days after the fiscal year end. D) 75 days after the fiscal year end. Answer: C Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Easy AACSB: Analytical thinking

12) Which of the following represents the recording of a budget in the accounts of the General Fund? A) Debit Appropriations, Credit Estimated Revenues and Credit Fund Balance - Unassigned B) Debit Appropriations, Credit Estimated Revenues C) Debit Estimated Revenues, Credit Appropriations, Credit Estimated Other Financing Uses, Credit Fund Balance - Unassigned D) Debit Estimated Other Financing Uses, Credit Appropriations and Credit Fund Balance - Unassigned Answer: C Objective: LO2.2 Understand how accounting adjusts to reflect the economics underlying varying levels of investor influence. Difficulty: Easy AACSB: Analytical thinking

13) At any point in time, a government will be able to spend an amount equal to A) appropriations minus expenditures. B) appropriations minus expenditures minus encumbrances. C) appropriations minus encumbrances. D) expenditures minus encumbrances. Answer: B Objective: LO2.2 Understand how accounting adjusts to reflect the economics underlying varying levels of investor influence. Difficulty: Easy AACSB: Analytical thinking

14) Taxes which were billed, but are not paid by the due date, require which of the following entries at the fiscal close? A) Debit Taxes Receivable - Delinquent B) Debit Allowance for Uncollectible Taxes - Delinquent C) Credit Taxes Receivable - Delinquent D) Credit Allowance for Uncollectible Taxes - Current Answer: A Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Moderate AACSB: Analytical thinking

15) Which of the following funds has similar accounting and reporting to the special revenue fund? A) The proprietary fund B) The trust fund C) The general fund D) The agency fund Answer: C Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Easy AACSB: Analytical thinking

16) Assume you are preparing journal entries for the General Fund under the consumption method. What account should be debited when office supplies are ordered? A) Appropriations B) Encumbrances C) Expenditures D) Other financing use Answer: B Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Easy AACSB: Analytical thinking

17) A Capital Projects Fund awards the construction of a building to a construction contractor at a contract cost of $1,000,000. What entry is prepared by the Capital Projects Fund? A) Debit Expenditures $1,000,000, Credit Liability $1,000,000 B) Debit Building $1,000,000, Credit Expenditures $1,000,000 C) Debit Other Financing Uses $1,000,000, Credit Expenditures $1,000,000 D) Debit Encumbrances $1,000,000, Credit Reserve for Encumbrances $1,000,000 Answer: D Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Easy AACSB: Analytical thinking

18) Which statement below is incorrect with respect to the Government-wide financial statements? A) All governmental fund categories must convert to the modified accrual basis of accounting. B) It is necessary to eliminate interfund balances within the governmental funds. C) Capital lease liabilities associated with governmental funds must be included on the Governmentwide financial statements. D) All fixed assets and long-term debt for governmental funds must be included on the Governmentwide financial statements. Answer: A Objective: LO20.5 Convert governmental fund financial statements to government-wide financial statements. Difficulty: Easy AACSB: Analytical thinking

20.2 Exercises 1) Match the following fund balance descriptions for a General Fund with the proper classification for a fund balance. Each classification may be used more than once. A. Nonspendable Fund Balance B. Restricted Fund Balance C. Committed Fund Balance D. Assigned Fund Balance E. Unassigned Fund Balance ________ 1. Amounts can only be spent for the specific purposes determined by a formal action of the government's highest level of decision-making authority. ________ 2. Amounts can only be spent for the specific purposes stipulated by constitution, external resource provider or enabling legislation. ________ 3. Residual classification of funds for the General Fund. ________ 4. Dollar amount of Ending Inventory. ________ 5. Amounts intended to be used by the government for specific purposes but do not meet the criteria of restricted or committed. ________ 6. Dollar amount of endowment principal. Answer: 1. C, 2. B, 3. E, 4. A, 5. D, 6. A Objective: LO20.1 Prepare journal entries to record transactions in governmental funds, including the new fund balance classifications. Difficulty: Moderate AACSB: Analytical thinking

2) Goodwill County had the following transactions for their General Fund in the first month of their fiscal 2014 year, which ends June 30, 2014. 1. The budget was approved, with $1,200,000 expected from property taxes, and another $5,000,000 expected from sales taxes. The budget showed these funds were expected to be spent on Salaries and Wages, $3,100,000; Utilities, $1,800,000; Rent, $900,000; and Supplies, $200,000. 2.

Supplies were ordered in the amount of $33,000.

The electric bill was paid upon receipt in the amount of $75,000.

4. Property taxes were billed in the amount of $1,200,000, due on December 31. Bad debts are estimated at 1% of receivables. 5. Supplies were received, but the invoice amount was $35,000 and will be paid in 35 days. Supplies are used quickly and are not inventoried. 6.

Property tax payments were received amounting to $100,000.

Payment was received from merchants for sales tax collections amounting to $400,000.

Required: Prepare the journal entries for the General Fund that would be required for these transactions.

Answer: 1. Estimated Revenues Appropriations Fund balance - unassigned 2.

6,200,000 6,000,000 200,000

Encumbrance Reserve for Encumbrance

33,000

Expenditures Cash

75,000

33,000

75,000

Taxes Receivable - Current Revenue Allowance for uncollectible taxes Current

1,200,000 1,188,000 12,000

Reserve for Encumbrance Encumbrance

33,000

Expenditures Vouchers Payable

35,000

Cash Taxes Receivable - Current

100,000

Cash Revenues - Sales Tax

400,000

33,000

35,000

100,000

400,000

Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Moderate AACSB: Application of knowledge

3) Carson County had the following transactions for their General Fund relating to the levy and collection of property taxes. 1. Property tax bills for $1,000,000 are sent to property tax owners. Taxes are due in 45 days. History shows that Carson County should expect 1.5% of the property taxes to be uncollectible. 2. $850,000 in property taxes is collected. The remaining receivables are past due. 3. An additional $80,000 of the delinquent taxes is collected. 4. Wrote off $10,000 of delinquent taxes determined to be uncollectible. Required: Prepare the journal entries in the General Fund for the transactions. Answer: 1. Property Taxes Receivable - current 1,000,000 Allowance for Uncollectible Taxes - current Revenue - Property Taxes 2.

Cash Property Taxes Receivable - current

850,000

Property Taxes Receivable - delinquent Allowance for Uncollectible Taxes - current Property Taxes Receivable - current Allowance for Uncollectible Taxes - delinquent

150,000 15,000

Cash Property Taxes Receivable - delinquent

80,000

Allowance for Uncollectible Taxes - delinquent Property Taxes Receivable - delinquent

10,000

15,000 985,000

850,000

150,000 15,000

80,000

10,000

4) A pre-closing trial balance included the following account balances for Simpli City: Due from other funds Fund balance - unassigned Estimated revenues Revenues Appropriations Expenditures - current year Expenditures - prior year Other Financing Source - Nonreciprocal transfer in Required: Prepare the necessary closing entries for the General Fund. Answer: Fund balance - unassigned 2,000 Appropriations 18,000 Estimated Revenues To reverse entry to record budget Revenues Other Financing Sources - Nonreciprocal transfer in Expenditures - current year Expenditures - prior year Fund Balance - unassigned To close temporary accounts

$ 3,500 14,000 20,000 22,000 18,000 19,000 1,500 1,000

20,000

22,000 1,000 19,000 1,500 2,500

5) Bounty County had the following transactions in 2014. 1. The budget for the county was approved, showing estimated revenues of $320,000 from local income taxes, and total estimated expenditures of $316,000. 2. Tax bills were mailed amounting to $326,000, which are due in 60 days. All but 2% was expected to be collectible. 3.

Taxes collected prior to the due date amounted to $260,800. The balance was delinquent.

$4,200 of taxes due were determined to be uncollectible and written off.

5. The year-end books were closed, with the expectation that the remaining taxes due would be collected evenly over the first two months after the fiscal year end. Required: Prepare the journal entries for the General Fund for the transactions. Answer: 1. Estimated Revenues 320,000 Appropriations Fund Balance - Unassigned 2.

Taxes Receivable - current Revenues Allowance for Uncollectible Taxes - Current

326,000

Cash Taxes Receivable - Current

260,800

Taxes Receivable - Delinquent Allowance for Uncollectible Taxes - Current Taxes Receivable - Current Allowance for Uncollectible Taxes - Delinquent

65,200 6,520

Allowance for Uncollectible Taxes - Delinquent Taxes Receivable - Delinquent

4,200

316,000 4,000

319,480 6,520

260,800

65,200 6,520

4,200

Appropriations Fund Balance - Unassigned Estimated Revenues

316,000 4,000

Revenues Fund Balance - Unassigned

319,480

320,000

319,480

6) Old West City had the following transactions in fiscal 2014. Assume that all expenditures were properly appropriated in the fiscal 2014 budget. 1.

A six-month loan was made to the special revenue fund from the general fund amounting to $28,000.

A purchase order for landscaping maintenance services was issued in the amount of $43,000.

3. A $10,000 nonreciprocal transfer was made to the debt service fund to pay interest amounts outstanding. 4. The final invoice for landscaping maintenance was received in the amount of $39,000, and it was scheduled to be paid in 30 days. 5. The city enters into a capital lease of fixed assets for the general government. The present value of the minimum lease payments equals $70,000. Required: Prepare the journal entries for the General Fund. Answer: 1. Due From Special Revenue Fund Cash 2.

28,000 28,000

Encumbrance Reserve for Encumbrance

43,000 43,000

Other Financing Uses - Nonreciprocal Transfer to Debt Service Fund Cash

10,000 10,000

Reserve for Encumbrance Encumbrance

43,000

Expenditures Vouchers Payable

39,000

Expenditures Other Financing Sources - Capital lease

70,000

43,000

39,000

70,000

7) The City of Electri entered the following transactions during 2014: 1. Borrowed $120,000 for a six-month term, to be paid upon receipt of property tax payments which were previously billed. 2. Used the funds borrowed to purchase a new fire truck. The truck is expected to have a 15-year useful life, and a $5,000 residual value. 3. Received $90,000 cash from a state grant. Funds are restricted for the purchase of a second fire truck. 4. Used the grant funds received to purchase a second fire truck. The truck is expected to have a 15-year useful life, and a $5,000 residual value. 5. Nonreciprocal transfer of $50,000 to the Debt Service Fund to be used toward repayment of the note. Required: Prepare the journal entries in the General Fund for the transactions. Answer: 1. Cash 120,000 Term Note Payable 120,000 2.

Expenditures Cash

120,000

Cash Revenues Collected in Advance - Grant

90,000

Expenditures Cash

90,000

Revenues Collected in Advance - Grant Revenues - Grant

90,000

120,000

90,000

Other Financing Uses - Nonreciprocal Transfer to Debt Service Fund Cash

50,000 50,000

8) For each of the following transactions relating to the startup of a community pool, determine the fund(s) being affected and prepare the appropriate journal entry for each. Be sure to note the fund type with each journal entry prepared. 1.

General obligation bonds are issued at face value of $500,000 to construct a new community pool.

2. Cash of $100,000 is received from a state grant. Grant is set up to support the construction of the community pool. 3. A community fund-raiser by a citizens' group raises $50,000 which is donated to the pool fund, with the restriction placed on it that only earnings are to be used for lifeguard wages, and the principal may not be used until such time as the pool ceases to operate, at which time the principal will revert to the general fund. 4. Construction is completed and the contractors invoices received, totaling $578,000. The invoices are paid within 60 days. 5. The balance of funds from the general obligation bonds and state grant that was not used is transferred to the General Fund.

Answer: 1. Capital Projects Fund: Cash 500,000 Other Financing Sources - proceeds from bond issue

500,000

2. Capital Projects Fund: Cash Revenues collected in advance - Grant

100,000 100,000

3. Permanent Fund: Cash Revenue - Permanent Endowment

50,000

4. Capital Projects Fund: Revenues collected in advance - Grant Revenue - Grant

100,000

50,000

100,000

Capital Projects Fund: Expenditures Vouchers Payable

578,000

Capital Projects Fund: Vouchers Payable Cash

578,000

5. Capital Projects Fund: Other Financing Uses - Transfer to General Fund Cash General Fund: Cash Other Financing Sources - Transfer from Capital Projects Fund

22,000 22,000

Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Moderate AACSB: Application of knowledge

9) The City of Attross entered the following transactions during 2014: 1. The city authorized a bond issue of $2,500,000 par to finance construction of a fountain and pavilion in the city square. The bonds were issued for $2,560,000. The premium was transferred to the fund for which the debt will be serviced. (This was a nonreciprocal transfer.) 2.

The city entered into a contract for construction of the fountain at an estimated cost of $2,425,000.

3. The city received and paid a bill for $2,445,000 from the contractor upon completion of and approval of the fountain. 4. The unused bond proceeds were set aside for debt service on the bonds. Accordingly, those resources were paid to the appropriate fund (nonreciprocal). Required: Prepare journal entries for each of the above transactions. Identify the appropriate fund or funds used by Attross.

Answer: 1. Capital Projects Fund: Cash 2,560,000 Other Financing Sources - Proceeds from bond issue Capital Projects Fund: Other Financing Uses - Nonreciprocal Transfer to Debt Service Fund Cash Debt Service Fund: Cash Other Financing Sources - Nonreciprocal Transfer From Capital Projects Fund

2,560,000

60,000 60,000

2. Capital Projects Fund: Encumbrances Reserve for Encumbrances

2,425,000

3. Capital Projects Fund: Reserve for Encumbrances Encumbrances

2,425,000

Capital Projects Fund: Expenditures Cash

2,445,000

2,425,000

2,445,000

4. Capital Projects Fund: Other Financing Uses - Transfer to Debt Service Fund Cash Debt Service Fund: Cash Other Financing Sources- - Transfer from Capital Projects Fund

55,000 55,000

55,000

Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Moderate AACSB: Application of knowledge

55,000

10) 1. Urban City issued $6 million of general obligation bonds at par to finance the construction of a city building. The bonds are 6%, 10-year bonds, and interest is paid on June 30 and December 31. 2. The city transferred $3,600,000 from its General Fund to its Debt Service Fund to provide a portion of the resources needed to service the bonds. 3.

The city paid the first interest payment to the bondholders.

Required: Prepare journal entries for each of the above transactions. Identify the appropriate fund or funds used by the city of Urban. Answer: 1. Capital Projects Fund: Cash 6,000,000 Other Financing Sources - Proceeds from long-term bond issue 6,000,000 2.

General Fund: Other Financing Uses - Transfer to Debt Service Fund Cash Debt Service Fund: Cash Other Financing Sources - Transfer from General Fund

3,600,000 3,600,000

Debt Service Fund: Expenditure - Bond Interest Cash ($6,000,000 × 6% × 1/2)

180,000 180,000

Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Moderate AACSB: Application of knowledge

11) Prepare journal entries to record the following grant-related transactions for a municipality's special revenue fund. 1. Special Revenue Fund awarded an operating grant from the state, $2,500,000 (cash will be received after qualified expenditures are made). 2.

Special Revenue Fund received funds of $1,600,000, temporarily transferred from the General Fund.

3. Incurred qualifying expenditures on the state grant program of $1,600,000 and paid them with funds temporarily transferred from the General Fund. 4.

Received a federal grant to finance planting of trees in city, $4,500,000 (cash received in advance).

5. Incurred and paid cost of $3,000,000 for planting 10,000 trees in city. Answer: 1. No entry 2.

Cash Other Financing Sources - Reciprocal Transfer from General Fund

1,600,000

Expenditures Cash

1,600,000

A/R - Grant Grant Revenue

1,600,000

Cash Revenue Collected in Advance - Grant

4,500,000

Expenditures Cash

3,000,000

Revenue Collected in Advance - Grant Grant Revenue

3,000,000

1,600,000

4,500,000

3,000,000

Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Moderate AACSB: Application of knowledge

12) The general fund trial balance for Lakeview City held the following balances at September 30, 2014, just before closing entries were made: Due from other funds Fund balance - unassigned Estimated revenues Revenues Appropriations Expenditures - current year Expenditures - prior year Other financing sources - transfer in from Capital Projects Fund

8,000 50,000 180,000 177,000 176,000 169,000 16,000 62,000

Required: Prepare the necessary closing entries for the General Fund. Answer: Appropriations 176,000 Fund balance - unassigned 4,000 Estimated revenues

180,000

Revenues Other Financing Sources - Transfer from Capital Projects Fund Expenditures - current year Expenditures - prior year Fund balance - unassigned

169,000 16,000 54,000

177,000 62,000

13) The trial balance for the General Fund for Golden City held the following balances at June 30, 2014, just before closing entries were made: Due from other funds Fund balance - unassigned Estimated revenues Revenues Appropriations Expenditures - current year Expenditures - prior year Other Financing Sources - Transfer from Debt Service Fund Required: Prepare the necessary closing entries. Answer: Appropriations Fund balance - unassigned Estimated revenues Revenues Other Financing Sources - Transfer from Debt Service Fund Expenditures - current year Expenditures - prior year Fund balance - unassigned

2,700 51,000 208,000 198,900 196,500 193,800 4,500 6,000

196,500 11,500 208,000 198,900 6,000 193,800 4,500 6,600

14) Peking County incurred the following transactions during 2014: 1. Marketable securities were donated to support the county's bike and nature trails. The donor acquired the securities for $35,000 ten years earlier; however, their current market value was $200,000. The donor specified that all income from the securities be used for the trails. The principal is to be held intact for an indefinite period of time. 2.

Computer equipment was ordered for general fund departments. The estimated cost was $48,000.

3. The county received the computer equipment. The actual cost was $47,750, of which $42,000 was paid to the vendor before year-end. 4. The county sold a (general government) dump truck that originally cost $55,000. The county sold the truck at auction for $3,300. The book value of the truck at the time of sale was $0. 5. The government leased equipment for the general government under a capital lease agreement. The present value of the minimum lease payments was $120,000. The county made an initial down payment of $10,000. Required: Prepare journal entries for each of the above transactions. Identify the appropriate fund or funds used by Peking County.

Answer: 1. Permanent Fund: Investments - marketable securities Revenues - additions to permanent endowments 2.

200,000

General Fund: Encumbrances Reserve for encumbrances

48,000

General Fund: Reserve for encumbrances Encumbrances

48,000

General Fund: Expenditures Cash Vouchers payable 4.

200,000

47,750 42,000 5,750

General Fund: Cash Other Financing Sources - proceeds from sale of general fixed assets

3,300 3,300

General Fund: Expenditures Cash Other Financing Sources - capital lease

120,000 10,000 110,000

Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Moderate AACSB: Application of knowledge

15) Middlefield County incurred the following transactions during 2014: 1. The county authorized a new general obligation bond issue of $5 million par to construct an office building with a contract price of $4,975,000. The bonds were issued for $4,980,000. 2. The county levied real property taxes of $10,000,000. Eighty-five percent of the net taxes were collected immediately. Two percent of the total levy was estimated to be uncollectible. 3.

The office building was completed and the county paid the contract price to the contractor.

The General Fund transferred $500,000 to the Debt Service Fund.

The county paid $200,000 for interest on the bonds from the Debt Service Fund.

Required: Prepare journal entries for each of the above transactions. Identify the appropriate fund or funds used by Middlefield County.

Answer: 1. Capital Project Fund: Cash Other financing sources-bond proceeds

4,980,000 4,980,000

Capital Project Fund: Encumbrances Reserve for encumbrances 2.

General Fund: Taxes receivable - current Allowance for uncollectible taxes - current Property tax revenue

4,975,000 4,975,000

10,000,000 200,000 9,800,000

General Fund: Cash Taxes receivable - current

8,330,000

Capital Project Fund: Reserve for encumbrances Encumbrances

4,975,000

Capital Project Fund: Expenditures - capital outlay Cash

4,975,000

8,330,000

4,975,000

General Fund: Other Financing Uses - Transfer to Debt Service Fund Cash

500,000 500,000

Debt Service Fund: Cash Other Financing Sources - Transfer from General Fund 5.

500,000 500,000

Debt Service Fund: Expenditures - bond interest Cash

200,000 200,000

Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Moderate AACSB: Application of knowledge

16) Address the following situations separately. 1. For the budgetary year beginning July 1, 2014, Coastal City expected the following cash flow resources: Property taxes, licenses, and fees Proceeds of debt issue Interfund transfers to debt service fund

$3,000,000 1,000,000 750,000

In the budgetary entry, what amount did Coastal City record for estimated revenues? 2. During the fiscal year ended June 30, 2014, Western County issued purchase orders totaling $7,000,000. Western County received $6,500,000 of invoiced goods at the encumbered amounts and paid $6,100,000 toward them before year-end. How much were Western County's encumbrances on July 1, 2014? 3. The following information pertains to property taxes levied ($1,035,000 total) by Southern Township for the calendar year 2014: Expected collections during 2014 Expected collections in first 60 days of 2015 Expected collections during the remainder of 2015 Expected collections during January 2016 Estimated to be uncollectible

$750,000 200,000 50,000 30,000 5,000

What amount did Southern Township report for property tax revenues in 2014? 4. The following information pertains to Northern City's general fund for 2014: Expenditures Other financing sources Other financing uses Revenues

5,500,000 1,000,000 3,000,000 9,000,000

At what amount will Northern City's total fund balance increase (decrease) in 2014?

Answer: 1. Coastal City

$ 3,000,000

2. Western County

500,000

750,000 200,000 950,000

3. Southern Township Collections during 2014 Expected collections in first 60 days of 2015 2014 property tax revenue 4. Northern City Revenues Other financing sources Expenditures Other financing uses Fund balance increase

$ 9,000,000 1,000,000 (5,500,000) (3,000,000) $ 1,500,000

17) The following information regarding the fiscal year ended September 30, 2014, was drawn from the accounts and records of the Mayberry County general fund: Revenues and other asset inflows: Taxes Licenses and permits Intergovernmental revenues Capital lease for fixed asset Receipt of cash from terminated fund

$ 12,000,000 2,500,000 1,000,000 1,200,000 1,800,000

Expenditures and other asset outflows: General government expenditures Public safety expenditures Judicial system expenditures Health and welfare expenditures Equipment purchases Payment to debt service fund to cover future debt service on general government bonds Total fund balance, October 1, 2013

7,500,000 2,000,000 1,200,000 1,750,000 750,000 500,000 $

3,000,000

Required: Prepare a statement of revenues, expenditures, and changes in fund balance for the Mayberry County general fund for the year ended September 30, 2014.

Answer:

Mayberry County General Fund Statement of Revenues, Expenditures, and Changes in Fund Balance For the Year Ended September 30, 2014

Revenues: Taxes Licenses and permits Intergovernmental revenues Total revenues

$12,000,000 2,500,000 1,000,000 15,500,000

Expenditures: Current operating expenditures: General government Public safety Judicial system Health and welfare Total current operating Capital Outlay Total expenditures

7,500,000 2,000,000 1,200,000 1,750,000 12,450,000 750,000 13,200,000

Excess of revenues over expenditures

2,300,000

Other financing sources (uses): Capital lease Transfer In (Transfer from Terminated Fund) Transfer Out (Transfer to Debt Service Fund)

1,200,000 1,800,000 (500,000)

Excess of revenues and other financing sources over (under) expenditures and other financing uses

4,800,000

Fund Balance, October 1, 2013

3,000,000

Fund Balance, September 30, 2014

$ 7,800,000

Objective: LO20.4 Prepare governmental fund financial statements. Difficulty: Moderate AACSB: Application of knowledge

18) The unadjusted trial balance for the general fund of the City of Nineva at June 30, 2014 is as follows: Debits Accounts receivable Cash Due from agency fund Encumbrances Estimated revenues Expenditures Taxes receivable

$ 40,000 75,000 25,000 60,000 975,000 750,000 250,000

Credits Allowance for doubtful accounts Allowance for uncollectible taxes Appropriations Due to trust fund Fund balance-unassigned Reserve for encumbrances Revenues Taxes received in advance Vouchers payable

5,000 50,000 785,000 40,000 30,000 60,000 990,000 15,000 200,000

Supplies on hand at June 30, 2014 totaled $8,000. The $60,000 encumbrance relates to equipment ordered but not received by fiscal year-end. Required: Prepare a balance sheet for the general fund of the City of Nineva at June 30, 2014.

Answer:

City of Nineva General Fund Balance Sheet June 30, 2014

Assets: Cash $75,000 Taxes receivable (net of estimated uncollectible taxes of $50,000 200,000 Accounts receivable (net of estimated doubtful accounts of $5,000) 35,000 Due from other funds 25,000 Supplies inventory 8,000 Total assets $343,000 Liabilities and Fund Balances: Liabilities: Vouchers payable Due to other funds Taxes received in advance Total liabilities

200,000 40,000 15,000 255,000

Fund Balances: Fund balance - nonspendable Fund balance - committed Fund balance - unassigned Total fund balance Total liabilities and fund balance

8,000 60,000 20,000 88,000 $343,000

Objective: LO20.4 Prepare governmental fund financial statements. Difficulty: Moderate AACSB: Application of knowledge

19) The unadjusted trial balance for the general fund of the City of Jordan at June 30, 2014 is as follows: Debits Accounts receivable Cash Due from agency fund Encumbrances Estimated revenues Expenditures Taxes receivable Credits Allowance for doubtful accounts Allowance for uncollectible taxes Appropriations Due to internal service fund Fund balance - unassigned Reserve for encumbrances Revenues Taxes received in advance Vouchers payable

90,000 110,000 19,000 18,000 1,250,000 1,090,000 175,000

15,000 35,000 1,180,000 51,000 52,000 18,000 1,130,000 22,000 249,000

Supplies on hand at June 30, 2014 totaled $17,000. The $18,000 encumbrance relates to equipment ordered but not received by fiscal year-end. Required: Prepare a balance sheet for the general fund of the City of Jordan at June 30, 2014.

Answer:

City of Jordan General Fund Balance Sheet June 30, 2014

Assets: Cash Taxes receivable (net of estimated uncollectible taxes of $35,000) Accounts receivable (net of estimated doubtful accounts of $15,000) Due from other funds Supplies inventory Total assets

$110,000 140,000 75,000 19,000 17,000 $361,000

Liabilities and Fund Balances: Liabilities: Vouchers payable Due to other funds Taxes received in advance Total liabilities

249,000 51,000 22,000 322,000

Fund Balances: Fund balance - nonspendable Fund balance - committed Fund balance - unassigned Total fund balance Total liabilities and fund balance

17,000 18,000 4,000 39,000 $361,000

Objective: LO20.4 Prepare governmental fund financial statements. Difficulty: Moderate AACSB: Application of knowledge

20.3 True/False 1) When government entities prepare financial statements using accrual basis the focus is on all economic resources to assist in long-term financial and operational accountability. Answer: TRUE Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Easy AACSB: Analytical thinking

2) A restricted fund balance represents amounts that can only be spent for the specific purposes stipulated by constitution, external resource providers, or through enabling legislation. Answer: TRUE Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Moderate AACSB: Analytical thinking

3) Government enter the annual budget in the journal by recording a debit to the appropriations account and a credit to estimated revenues. Answer: FALSE Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Moderate AACSB: Analytical thinking

4) Under accrual accounting, revenues are generally recognized in the period in which they become measurable and available to finance expenditures of the period. Answer: FALSE Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Moderate AACSB: Analytical thinking

5) Uncollectibles, such as taxes, are classified as revenue adjustments in government accounting. Answer: TRUE Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Moderate AACSB: Analytical thinking

6) Normal practice for governmental accounting is to record expenditures when the related fund liability is incurred under a modified accrual basis. Answer: TRUE Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Moderate AACSB: Analytical thinking

7) Encumbrance accounting records commitments made for goods on order and for unperformed contracts. Answer: TRUE Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Easy AACSB: Analytical thinking

8) Under the modified accrual basis of accounting, fixed assets are recorded in the general fund and appear in the fund statements. Answer: FALSE Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Moderate AACSB: Analytical thinking

9) A capital lease used by the government to acquire general fixed assets requires a credit to other financing sources - capital lease. Answer: TRUE Objective: LO20.2 Learn about accounting methods unique to government accounting: budgetary issues, encumbrance accounting, and interfund transactions. Difficulty: Moderate AACSB: Analytical thinking

10) GASB 54 requires that a special revenue fund balance be classified as nonspendable, restricted, encumbered or assigned. Answer: FALSE Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Moderate AACSB: Information technology

11) Permanent funds are normally for nonexpendable resources set aside for support of a government's programs or citizenry. Answer: TRUE Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Easy AACSB: Analytical thinking

12) Capital project funds may be used for any capital facilities or other capital assets. Answer: TRUE Objective: LO20.3 Determine the appropriate governmental fund to be used. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 21 Accounting for State and Local Governmental Units - Proprietary and Fiduciary Funds 21.1 Multiple Choice Questions 1) What basis of accounting is used by proprietary funds? A) Modified accrual accounting B) Accrual accounting C) Cash basis accounting D) Fair value accounting Answer: B Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Easy AACSB: Analytical thinking

2) Enterprise funds are accounted for in a manner similar to A) internal service funds. B) capital project funds. C) special revenue funds. D) debt service funds. Answer: A Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Easy AACSB: Analytical thinking

3) On January 1, 2014, the General Fund contributes $200,000 cash to the Internal Service Fund. On January 1, 2014, the General Fund also loans $100,000 cash to the Internal Service Fund. On January 1, 2014, what journal entry does the Internal Service Fund prepare? A) debit Cash $300,000, credit Other Financing Sources $300,000 B) debit Cash $300,000, credit Other Financing Sources $200,000, credit Advance from General Fund $100,000 C) debit Cash $300,000, credit Advance from General Fund $300,000 D) debit Cash $300,000, credit Contributed Capital $200,000, credit Advance from General Fund $100,000 Answer: D Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Moderate AACSB: Application of knowledge

4) The accounting equation for the Proprietary fund is A) assets = liabilities. B) current assets + current liabilities = fund balance. C) current assets - current liabilities = net position. D) current assets + noncurrent assets - current liabilities - noncurrent liabilities = net position. Answer: D Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Easy AACSB: Analytical thinking

5) The fixed assets and long-term liabilities associated with Proprietary Funds are reported on the A) financial statements of governmental funds. B) financial statements of fiduciary funds. C) financial statements of proprietary funds. D) financial statements of trust funds. Answer: C Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Easy AACSB: Analytical thinking

6) On January 1, 2014, the Enterprise Fund for a local city receives an intergovernmental capital grant of $100,000 from the state government. Upon receipt of the cash on February 1, 2014, qualifying expenses of $100,000 for the operating grant will be incurred. What journal entry did the Enterprise Fund prepare on January 1, 2014? A) Debit Cash $100,000, credit Deferred Revenue $100,000 B) Debit Due From Other Governments $100,000, credit Contributed Capital $100,000 C) Debit Restricted Cash $100,000, credit Nonoperating Revenues $100,000 D) Debit Due From Other Governments $100,000, credit Other Financing Sources - operating grant $100,000 Answer: B Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

7) In a Statement of Cash Flows for a proprietary fund, what are the primary categories of cash flow activities? A) Operating, Financing, Investing B) Operating, Noncapital Financing, Capital and Related Financing, Investing C) Operating, Financing, Noncapital Investing, Capital and Related Investing D) Noncapital Operating, Capital and Related Operating, Investing, Financing Answer: B Objective: LO21.3 Introduce the differences between a proprietary fund statement of cash flows and its commercial business counterpart. Difficulty: Easy AACSB: Analytical thinking

8) The financial statements of proprietary funds are similar to business enterprises with the exception that proprietary funds do not A) report fixed assets. B) report property taxes. C) separate current and noncurrent assets. D) report noncurrent liabilities. Answer: B Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Easy AACSB: Analytical thinking

9) GASB requires ________ method(s) for the cash flow statement for proprietary funds. A) the reconciliation B) the indirect C) the direct D) either the direct or indirect Answer: C Objective: LO21.3 Introduce the differences between a proprietary fund statement of cash flows and its commercial business counterpart. Difficulty: Easy AACSB: Analytical thinking

10) An enterprise fund collects $100,000 cash for customer deposits to insure timely payment for services. What journal entry did the enterprise fund prepare? A) Debit Cash $100,000, credit Revenue $100,000 B) Debit Cash $100,000, credit Deferred Revenue $100,000 C) Debit Restricted Cash $100,000, credit Customer Deposits $100,000 D) Debit Restricted Cash $100,000, credit Revenue $100,000 Answer: C Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

11) At December 31, 2014, an Enterprise Fund has the following adjusted accounts outstanding: Insurance Expense Depreciation Expense Supplies Expense Salaries Expense Service Revenues

$2,000 3,000 10,000 100,000 123,000

When preparing the closing entry for the temporary accounts at December 31, 2014, the Enterprise Fund's accountant will A) credit Retained Earnings $8,000. B) credit Net Cash, $8,000. C) credit Net Position, Unrestricted $8,000. D) credit Invested Capital Assets, Net of Related Debt, $8,000. Answer: C Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

12) What is a significant difference for agency funds when compared to governmental funds? A) An agency fund has a separate ledger. B) An agency fund does not report revenues. C) Agency funds are not associated with any governmental unit. D) An agency fund will not balance because there is no fund balance account. Answer: B Objective: LO21.4 Prepare journal entries and fund financial statements for fiduciary funds. Difficulty: Moderate AACSB: Analytical thinking

13) What basis of accounting is used by fiduciary funds? A) Modified accrual accounting B) Accrual accounting C) Cash basis accounting D) Present value accounting Answer: B Objective: LO21.4 Prepare journal entries and fund financial statements for fiduciary funds. Difficulty: Easy AACSB: Analytical thinking

14) Platinum City collects state sales taxes quarterly from local businesses and then gives the state revenue department the money at the end of the year. The sales taxes would go in Platinum City's A) special revenue fund. B) general fund. C) agency fund. D) enterprise fund. Answer: C Objective: LO21.4 Prepare journal entries and fund financial statements for fiduciary funds. Difficulty: Moderate AACSB: Analytical thinking

15) On the Statement of Net Position, in place of stockholders' equity, proprietary funds report A) Retained Earnings only. B) Restricted Cash only. C) Unrestricted Cash only. D) Net Position. Answer: D Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Easy AACSB: Analytical thinking

16) Proceeds from bonds issued for the construction of capital assets are classified on the Statement of Cash Flows for an Enterprise Fund as A) Cash Flows from Operating Activities. B) Cash Flows from Noncapital Financing Activities. C) Cash Flows from Capital and Related Financing Activities. D) Cash Flows from Investing Activities. Answer: C Objective: LO21.3 Introduce the differences between a proprietary fund statement of cash flows and its commercial business counterpart. Difficulty: Moderate AACSB: Analytical thinking

17) Interest payments on loans outstanding that do not relate to acquiring, constructing or improving capital assets are classified as ________ on the cash flow statement for an Enterprise Fund. A) Cash Flows from Operating Activities B) Cash Flows from Noncapital Financing Activities C) Cash Flows from Capital and Related Financing Activities D) Cash Flows from Investing Activities Answer: B Objective: LO21.3 Introduce the differences between a proprietary fund statement of cash flows and its commercial business counterpart. Difficulty: Moderate AACSB: Analytical thinking

18) The financial statements of a proprietary fund are similar to those of a business enterprise except for A) proprietary funds do not report income taxes on the operating statement. B) proprietary funds do not have paid-in capital or capital stock. C) proprietary funds use modified accrual accounting. D) proprietary funds may have account titles such as due from general fund. Answer: C Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Easy AACSB: Analytical thinking

19) The trust fund for a school library is required to prepare financial statements that include A) Balance Sheet and Income Statement. B) Statement of Revenues, Expenses and Changes in Fiduciary Net Assets. C) Statement of Fund Balance and Statement of Changes in Fund Balance. D) Statement of Fiduciary Net Position and Statement of Changes in Fiduciary Net Position. Answer: D Objective: LO21.4 Prepare journal entries and fund financial statements for fiduciary funds. Difficulty: Moderate AACSB: Analytical thinking

20) Proprietary funds are required to prepare financial statements that include: A. Statement of Activities B. Statement of Revenues, Expenditures and Changes in Fund Balance C. Balance Sheet D. Statement of Cash Flows E. Statement of Net Position F. Statement of Revenues, Expenses and Changes in Net Position A) C, D, F B) A, B, D C) B, C, D D) D, E, F Answer: D Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Easy AACSB: Analytical thinking

21.2 Exercises 1) The City's municipal golf course had the following transactions. 1.

Received a beautification (operating) grant from the state for $600,000. Received cash of $600,000.

Incurred and paid qualifying expenses under the state grant program in (1) above of $280,000.

Incurred and paid construction costs on an uncompleted clubhouse for $1,200,000.

Received $1,000,000 cash from a grant to assist with construction costs for the clubhouse.

Required: Given that the golf course is operated based on user fees for upkeep, prepare the necessary journal entries for each of these transactions. Answer: 1. Restricted Cash 600,000 Revenue Collected in Advance - grant 600,000 2. Expenses - beautification program Restricted Cash Revenue Collected in Advance - grant Nonoperating Revenue - grant

280,000 280,000 280,000 280,000

3. Construction in Progress Cash

1,200,000

4. Restricted Cash Contributed Capital - Grant

1,000,000

1,200,000

1,000,000

Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

2) Jefferson County had the following transactions in 2014. 1. $27,000 in membership fees was collected at the municipal pool. 2. A county collects $130,000 in sales taxes on behalf of the cities within its boundaries. 3. A $500,000 bond offering was issued at 102 to fund the construction of a new city hall. The premium on the bonds was transferred to the Debt Service Fund (nonreciprocal). 4. A private foundation contributes a stock portfolio with a fair value of $100,000 to the county. A trust agreement specifies the earnings on the fund is to be used by the local park which is owned and operated by a private foundation, and the principal is to be held intact indefinitely. 5. The county sends bills out for water and sewer provided to residents, amounting to $340,000. Required: Prepare the necessary journal entries for each of the above transactions for all funds affected. Be sure to identify the fund type for each entry.

Answer: 1. Enterprise Fund Cash Operating Revenue

27,000 27,000

2. Agency Fund Cash Taxes Receivable for local governments

130,000

3. Capital Projects Fund Cash Other financing sources - bond issue

510,000

130,000

510,000

Capital Projects Fund Other financing uses - nonreciprocal transfer to Debt Service Fund Cash

10,000 10,000

Debt Service Fund Cash Other financing sources - nonreciprocal transfer from Capital Project Fund

10,000 10,000

4. Private Purpose Trust Fund Investments Contributions - Foundations

100,000

5. Enterprise Fund Accounts receivable Charges for Services

340,000

100,000

340,000

Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

3) Willborough County had the following transactions in 2014. 1.

A central motor pool was established with a $200,000 nonreciprocal transfer from the General Fund.

2. The water and sewer authority, which provides services to residents for a fee, issued a bond offering at $750,000 par. Bonds proceeds are restricted to renovating the treatment facility. 3. Willborough received a grant from the state to be used for renovation of the courthouse amounting to $800,000. The General Fund will temporarily provide $100,000 cash, because the grant is set up on a reimbursement basis and will not be distributed until proper expenditures are documented. 4. Willborough's central motor pool bills out automobile usage to various government agencies amounting to $42,000. 5. The General Fund transfers $67,000 out of the operating budget to fund the county employees' pension plan. Required: Prepare the necessary journal entries for each of the above transactions for all funds affected. Be sure to identify the fund type for each entry.

Answer: 1. General Fund Other Financing Uses - nonreciprocal transfer to Internal Service Fund Cash Internal Service Fund Cash Nonreciprocal transfer from General Fund

200,000 200,000

2. Enterprise Fund Restricted Cash Bonds Payable

750,000 750,000

3. General Fund Other Financing Uses - reciprocal transfer to Capital Projects Fund Cash

100,000 100,000

Capital Projects Fund Cash Other Financing Sources - reciprocal transfer from General Fund

100,000 100,000

4. Internal Service Fund Due from other governmental agencies Service Revenue

42,000 42,000

5. General Fund Other Financing Use - nonreciprocal transfer to Pension Trust Fund Cash

67,000 67,000

Pension Trust Fund Cash Contribution

67,000 67,000

Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Moderate AACSB: Application of knowledge

4) The City of Sill established an Internal Service Fund to provide cleaning services to all city offices and departments. The following transactions took place with respect to this event. 1. The General Fund contributed cash of $49,000 to the Internal Service Fund. The General Fund provided a $10,000 loan to the Internal Service Fund. 2. On January 1, 2014, the Internal Service Fund acquired a floor waxing machine for cash of $5,000. It has a 5 year life with no salvage value, and the city uses straight-line depreciation on their assets. 3. The cleaning services department billed other government agencies and departments $226,000 and collected $187,000. 4. The cleaning services department incurred and paid the following expenses: cleaning personnel wages, $65,000; payroll taxes, $10,000; cleaning supplies, $13,000; and office rental and utilities, $77,000. The cleaning services department also repaid the general fund for the loan. 5. The cleaning services department prepared the journal entry to depreciate their assets for the year ending December 31, 2014. Required: Prepare the necessary journal entries for each of the above transactions for the Internal Service Fund. Answer: 1. Cash 59,000 Nonreciprocal transfer from General Fund 49,000 Advance from General Fund 10,000 2.

Equipment Cash

5,000 5,000

Due from various funds Service Revenue

226,000

Cash Due from various funds

187,000

Wage Expense Payroll Tax Expense Cleaning Supplies Expense Office Rent and Utility Expense Cash

65,000 10,000 13,000 77,000

Advance from General Fund Cash

10,000

Depreciation Expense - Equipment Accumulated Depreciation - Equipment

1,000

226,000

187,000

165,000

10,000

1,000

Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Moderate AACSB: Application of knowledge

5) The following transactions relate to a municipal golf course and tennis club, financed with debt secured by membership fees. 1.

The General Fund loaned $25,000,000 cash to the Enterprise Fund. The note is not interest-bearing.

2. The municipal golf course and tennis club purchased land and constructed the facilities which totaled expenditures of $23,700,000. 3. Bonds were issued by the municipal golf course and tennis club for $20,000,000, par value of the bonds. 4.

Membership fees were billed in the amount of $4,800,000. $4,200,000 was collected.

5. $5,000,000 was repaid to the general fund, with the anticipation of repaying $5,000,000 more per year for the next four years. Required: Prepare the necessary journal entries for each of the above transactions for the Enterprise Fund. Answer: 1. Cash Note Payable - General Fund

25,000,000

Land and Buildings Cash

23,700,000

Cash Bonds Payable

20,000,000

Fees Receivable Revenue - Membership fees

4,800,000

Cash Fees Receivable

4,200,000

Note Payable - General Fund Cash

5,000,000

25,000,000

23,700,000

20,000,000

4,800,000

4,200,000

5,000,000

Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

6) Thoroughgood County has a municipal golf course and tennis club which is funded by the membership fees it charges. The club also has 6% bonds outstanding amounting to $20,000,000 on which it pays interest semi-annually. The club had the following transactions. 1.

An addition to the golf clubhouse was added for $2,000,000, funded out of operations.

2. The following expenses were incurred and paid: $80,000 wages; $10,000 payroll taxes; $45,000 water bill; and $12,000 equipment repair. 3.

Interest on the bonds was paid amounting to $600,000.

$5,000,000 of operating cash excess was repaid to the general fund for a previous loan.

Depreciation of $500,000 was recorded for the buildings.

Required: Prepare the necessary journal entries for each of the above transactions for the Enterprise Fund. Answer: 1. Buildings 2,000,000 Cash 2,000,000 2.

Wage Expense Payroll Tax Expense Water Utility Expense Equipment Repair Expense Cash

80,000 10,000 45,000 12,000

Interest Expense Cash

600,000

147,000

600,000

Note payable - General Fund Cash

5,000,000 5,000,000

Depreciation Expense - Buildings Accumulated Depreciation - Buildings

500,000 500,000

Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

7) An adjusted trial balance is provided below for the Dade County copy services department at June 30, 2014. Cash Due from Enterprise Fund Due from Debt Service Fund Supplies inventory Supplies used Equipment Salary expense Utility expense Depreciation expense Operating transfer to General Fund

$ 21,000 6,000 2,000 5,000 3,000 32,000 25,000 9,000 6,000 4,000 $113,000

Accumulated depreciation Accounts payable Advance from General Fund (not for capital assets) Capital Contribution from General Fund Net position (beginning) Revenue - services billed

$ 24,000 2,000 10,000 1,000 28,000 48,000 $113,000

Required: 1. Prepare a statement of revenues, expenses and changes in net position for the copy services department for the year ended June 30, 2014. 2. Prepare a statement of net position for the copy services department at June 30, 2014. Assume all assets are not externally or internally restricted.

Answer: Requirement 1: Dade County Copy Services Statement of Revenues, Expenses, and Changes in Net Position For the Year Ended June 30, 2014 Operating Revenues: Revenue - services billed Operating Expenses: Supplies Salary Utility Depreciation

$48,000

$ 3,000 25,000 9,000 6,000

43,000

Operating income Add: Capital contribution Less: Transfers out

5,000 1,000 (4,000)

Change in Net Position Net Position June 30, 2013 Net Position June 30, 2014

2,000 28,000 $30,000

Requirement 2: Dade County Copy Services Statement of Net Position As of June 30, 2014 Assets: Current Assets: Cash Due from various funds Supplies inventory Noncurrent Assets: Equipment Less: Accum. Depr. Total Assets Liabilities: Current Liabilities: Accounts payable Advance from General Fund Total Liabilities

$ 21,000 8,000 5,000

$34,000

32,000 24,000

8,000 $42,000

$ 2,000 10,000 $12,000

Net Position: Invested in Capital Assets, net of related debt Unrestricted Total Net Position

8,000 22,000 $30,000

Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Difficult AACSB: Application of knowledge

8) A trust fund was created to assist local students in financial need. The following transactions occurred in the trust. 1. The committee forming the fund was able to raise $700,000 and invested the funds so that the principal would remain indefinitely, and the earnings would be used to aid needy students. 2. During the year, the fund earned $65,000 interest. Earnings remain invested in the trust until withdrawn to distribute, so the interest was invested. 3.

$50,000 of the investments were sold, withdrawn, and distributed to provide scholarships.

4. The fund-raising committee contributed an additional $200,000 cash to the fund. This cash was deposited into the account and invested. 5.

Interest earned but not yet deposited into the investment account was accrued at $17,000.

Required: Prepare the necessary journal entries for each of the above transactions for the trust fund. Answer: 1. Cash 700,000 Contribution 700,000

Investment Cash

700,000

Cash Interest Income

65,000

Investments Cash

65,000

Cash Investments

50,000

Distribution for scholarships Cash

50,000

Cash Contribution

200,000

Investments Cash

200,000

Accrued Interest Receivable Interest Income

17,000

700,000

65,000

50,000

200,000

17,000

Objective: LO21.4 Prepare journal entries and fund financial statements for fiduciary funds. Difficulty: Moderate AACSB: Application of knowledge

9) Static City started a department to provide copy, printing and mailing services for all departments and agencies of the city. During the fiscal year from July 1, 2013 through June 30, 2014, the copy services department had the following transactions: 1.

Paper and toner inventory was purchased for $58,000, on account.

The paper and toner inventory physical count showed only $8,000 on hand at June 30, 2014.

3. The department billed other departments for services rendered to them amounting to: General Fund, $43,000; Enterprise Fund, $24,000; Debt Service Fund, $21,000; and Trust Fund, $16,000. All receivables were collected with the exception of $6,000 from the Trust Fund which is expected to be collected in July, 2014. 4. The department incurred and paid the following expenses: salaries and wages, $23,000; Electric, $8,000; Other operating expenses, $6,000. Also, $63,000 of the Accounts Payable were paid during the year. 5.

Depreciation Expense on Equipment amounted to $6,000 for the year ending June 30, 2014.

The department prepared the closing entries on June 30, 2014.

Required: For the fiscal year ended June 30, 2014, prepare the journal entries to record the transactions for the Internal Service Fund.

Answer: 1. Supplies Inventory Accounts Payable

58,000

Supplies Expense Supplies Inventory

50,000

Due from General Fund Due from Enterprise Fund Due from Debt Service Fund Due from Trust Fund Service Revenue

43,000 24,000 21,000 16,000

Cash Due from General Fund Due from Enterprise Fund Due from Debt Service Fund Due from Trust Fund

98,000

Salary and wage expense Electric expense Other operating expenses Cash

23,000 8,000 6,000

Accounts payable Cash

63,000

58,000

50,000

104,000

43,000 24,000 21,000 10,000

37,000

63,000

Depreciation expense - Equipment 6,000 Accumulated depreciation-Equipment

6,000

Service Revenue Supplies Expense Salary and Wage Expense Electric Expense Other operating expense Depreciation Expense Net Position, Unrestricted

50,000 23,000 8,000 6,000 6,000 11,000

Net position, invested in capital assets, net of related debt Net position, unrestricted

104,000

6,000 6,000

Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Difficult AACSB: Application of knowledge

10) Journalize the following utility transactions in the Quest County Enterprise Fund: 1.

Billings to external customers $1,600,000; billings to Quest County governmental funds $130,000.

Collected refundable deposits from new customers $10,000.

Collected 95% of all billings by fiscal year-end.

Refunded $4,000 in deposits to former customers.

5. Unbilled services to outside customers at year-end $14,000. Answer: 1. Accounts receivable 1,600,000 Due from other governmental funds 130,000 Charges for services 1,730,000 2.

Restricted cash Customer deposits

10,000 10,000

Cash 1,643,500 Accounts receivable Due from other governmental funds Customer deposits Restricted cash

4,000

Accounts receivable Charges for Service

14,000

1,520,000 123,500

4,000

14,000

Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

11) Prepare journal entries in an Internal Service Fund of Union County to record each of the following transactions. 1. Purchased equipment on September 1, 2014 by paying $25,000 down and borrowing $100,000 on a 6%, 2-year note. 2. In 2014, billed General Fund $620,000 for services provided. Billings to the Enterprise Fund totaled $165,000. All billings were collected by December 31, 2014 except for $100,000 charged to the General Fund. 3. Accrued year-end adjustments at December 31, 2014 for interest expense and depreciation. The useful life of the equipment is 5 years with no salvage value. Answer: 1. Equipment 125,000 Cash 25,000 Notes payable 100,000 2.

Due from General Fund Due from Enterprise Fund Service revenues

620,000 165,000

Cash Due from General Fund Due from Enterprise Fund

685,000

Interest expense Interest payable ($100,000 × .06 × 4/12 = $2,000)

2,000

785,000

520,000 165,000

2,000

Depreciation expense - Equipment 8,333 Accumulated depreciation - Equipment ($125,000 / 5 years) × 4/12 = $8,333

8,333

Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Moderate AACSB: Application of knowledge

12) Prepare journal entries in the motor pool department of Hill County to record each of the following transactions. 1. The General Fund contributed $50,000 cash to the motor pool department. The motor pool department purchased four vehicles on July 1, 2014 by paying $50,000 down and borrowing $70,000 on a 5%, 3-year note. 2. Billed General Fund departments $430,000 for services provided to those departments. Billings to the Enterprise Fund totaled $210,000. All billings were collected by year-end (June 30, 2015) except for $80,000 charged to the General Fund. 3. Accrued year-end adjustments at June 30, 2015 for interest expense and depreciation. The useful life of the equipment is 5 years with no salvage value. Answer: 1. Cash 50,000 Nonreciprocal transfer from General Fund 50,000

Vehicles Cash Notes payable

120,000

Due from General Fund Due from Enterprise Fund Service revenues

430,000 210,000

Cash Due from General Fund Due from Enterprise Fund

560,000

Interest expense Interest payable ($70,000 × .05 × 12/12 = $3,500)

3,500

50,000 70,000

640,000

350,000 210,000

3,500

Depreciation expense -Equipment 24,000 Accumulated depreciation - Equipment ($120,000 / 5 years) × 12/12 = $24,000

24,000

Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Moderate AACSB: Application of knowledge

13) Journalize the following utility transactions in the Hazzard County Enterprise Fund: 1. The utility sold $4,000,000 of 6.5% revenue bonds at 98 on July 1, 2014 (an interest payment date). The bond proceeds are to be used for new plant construction and the issue will mature in 20 years. Interest is paid semi-annually on July 1 and January 1. 2. Depreciation for the year-ended December 31, 2014 included $300,000 for buildings and $190,000 for equipment. 3.

The utility paid $600,000 in construction costs for the new plant. The plant is still under construction.

4. Interest on the revenue bonds was accrued at year-end, December 31, 2014. Straight-line amortization is used for bond discounts and premiums. Answer: 1. Restricted cash 3,920,000 Discount on bonds payable 80,000 Bonds payable 4,000,000 2.

Depreciation expense - Building Depreciation expense - Equipment Accumulated depreciation - Building Accumulated depreciation - Equipment

300,000 190,000

Construction in progress Restricted cash

600,000

Interest expense Discount on bonds payable Interest payable

132,000

300,000 190,000

600,000

2,000 130,000

(Interest payable = $4,000,000 × 6.5% × 1/2 = $130,000) (Discount amortization = $80,000/20 × 1/2 = $2,000) Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

14) Journalize the following municipal zoo transactions in the Lackluster County Enterprise Fund: 1. The zoo issued $1,000,000 of 5% revenue bonds at 99 on July 1, 2014 (an interest payment date). The bond proceeds are to be used for a new polar bear exhibit and the issue will mature in 20 years. Interest is paid on January 1 and July 1. 2. Depreciation for the year-ended December 31, 2014 included $175,000 for buildings and $105,000 for outdoor exhibit areas. 3.

The zoo paid $800,000 in construction costs for the new exhibit. The exhibit is still under construction.

4. Interest on the revenue bonds was accrued at year-end, December 31, 2014. Straight-line amortization is used for bond discounts and premiums. Answer: 1. Restricted cash 990,000 Discount on bonds payable 10,000 Bonds payable 1,000,000 2.

Depreciation expense - Building Depreciation expense - Exhibits Accumulated depreciation -Building Accumulated depreciation - Exhibits

175,000 105,000

Construction in progress Restricted cash

800,000

Interest expense Discount on bonds payable Interest payable

25,250

175,000 105,000

800,000

250 25,000

(Interest payable = $1,000,000 × 5% × 1/2 = $25,000) (Discount amortization = $10,000/20 × 1/2 = $250) Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

15) Prepare journal entries to record the following grant-related transactions of an Enterprise Fund. 1.

Received an operating grant in cash from the state, $2,500,000.

Incurred and paid qualifying operating expenses on the state grant program, $1,600,000.

Received a federal grant to finance construction of a plant, $4,500,000 (cash received in advance).

4. Incurred and paid construction costs on the plant, $3,000,000. The plant is not completed. Answer: 1. Restricted cash 2,500,000 Revenue Collected in Advance — grant 2,500,000 2.

Operating expenses Restricted cash

1,600,000 1,600,000

Revenue Collected in Advance - grant Nonoperating revenues — grants 3.

1,600,000 1,600,000

Restricted cash Revenue Collected in Advance — Capital Grant

4,500,000

Construction in progress Restricted cash

3,000,000

4,500,000

3,000,000

Revenue Collected in Advance — Capital Grant Contributed capital — grant

3,000,000 3,000,000

Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

16) Prepare journal entries to record the following grant-related transactions of the municipal swimming pool, which is funded primarily by membership fees. 1. Received an operating grant in cash from the state for $200,000, to be used for life-saving and first-aid training. 2. Incurred and paid qualifying expenses on the state grant program by providing training, $165,000. 3. Received a federal grant to finance purchase of an energy efficient heating system for the pool, $120,000 (cash received in advance). 4. New heating system installed and paid, $115,000. Answer: 1. Restricted cash 200,000 Revenue Collected in Advance — Grant 2.

Operating expenses Restricted cash

165,000 165,000

Revenue Collected in Advance — Grant Nonoperating revenues — grants 3.

200,000

165,000 165,000

Restricted cash Revenue Collected in Advance — Capital Grant

120,000

Pool equipment Restricted cash

115,000

120,000

115,000

Revenue Collected in Advance — Capital Grant Contributed capital — grant

115,000 115,000

Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Application of knowledge

17) Based upon the cash flow information provided below for the year ended December 31, 2014, prepare a cash flow statement for the Bloomfield Municipal Golf Course, an enterprise fund. Green fees received Membership fees received League outing fees received Interest revenue received Cash received from short-term note payable (not used for capital assets) Payments to employees Payments to suppliers Cash paid to the General Fund - Noncapital loan Payments for capital improvements Interest paid on short-term loan (loan not used for capital assets) Unrestricted cash and cash equivalents, January 1, 2014 Answer: Bloomfield Municipal Golf Course Fund Statement of Cash Flows For the Year Ended December 31, 2014 Cash Flows from Operating Activities: Green fees received Membership fees received League outing fees received Cash paid to employees Cash paid to suppliers Net Cash Provided by Operating Activities

$400,000 160,000 90,000 2,000 75,000 350,000 198,000 60,000 85,000 5,000 17,000

$400,000 160,000 90,000 (350,000) (198,000) $102,000

Cash Flows from Noncapital Financing Activities: Cash received from short-term note Cash paid for interest Cash paid to General Fund - Noncapital loan Net Cash Provided by Noncapital Financing Activities

75,000 (5,000) (60,000)

Cash Flows from Capital and Related Financing Activities: Cash paid on capital improvements Net Cash Used by Capital and Related Financing Activities

(85,000)

Cash Flows from Investing Activities: Interest received Net Cash Provided by Investing Activities Net increase in unrestricted cash and cash equivalents Unrestricted cash (and cash equiv.), January 1, 2014 Unrestricted cash (and cash equiv.), December 31, 2014

10,000

(85,000)

2,000 2,000 29,000 17,000 $ 46,000

Objective: LO21.3 Introduce the differences between a proprietary fund statement of cash flows and its commercial business counterpart. Difficulty: Difficult AACSB: Application of knowledge

18) The four cash flow categories required in an Enterprise Fund's Statement of Cash Flows are listed below and assigned a letter code. A) Cash flows from operating activities B) Cash flows from noncapital financing activities C) Cash flows from capital and related financing activities D) Cash flows from investing activities Required: Use the correct letter code to indicate where each of the following ten items associated with an Enterprise Fund should be reported in the Statement of Cash Flows. 1. An enterprise fund's fixed asset was sold for cash. 2. Cash paid to suppliers for goods. 3. Paid principal, $100,000, and interest, $5,000, on a mortgage. 4. Cash proceeds from sale of investments, $65,000. 5. Cash paid for new equipment, $18,000. 6. Cash received from the general fund; restricted to cover part of the cost of plant expansion, $900,000. 7. Cash received from another fund as a 6-month loan for the sole purpose of financing purchase of equipment, $47,000. 8. Cash proceeds from issuing bonds for an enterprise fund's construction project. 9. Cash paid to employees for salaries. 10. Cash received from interest earned on investments. Answer: 1. C, 2. A, 3. C, 4. D, 5. C, 6. C, 7. C, 8. C, 9. A, 10. D Objective: LO21.3 Introduce the differences between a proprietary fund statement of cash flows and its commercial business counterpart. Difficulty: Moderate AACSB: Analytical thinking

19) Based upon the flow information provided below for the year ending December 31, 2014, prepare a cash flow statement for the Downtown City Motor Pool, an internal service fund. Cash received from customers Cash received from General Fund (noncapital loan) Interest revenue received Cash received from short-term note payable (not used for capital assets) Payments to employees Payments to suppliers Cash paid to the General Fund - noncapital loan Payments for capital improvements Interest paid on short-term note payable above Principal paid on capital debt Interest paid on capital debt Unrestricted Cash (and cash equivalents), January 1, 2014 Answer: Downtown City Motor Pool Fund Statement of Cash Flows For the Year Ended December 31, 2014 Cash Flows from Operating Activities: Cash received from customers Cash paid to employees Cash paid to suppliers Net Cash Provided by Operating Activities

$830,000 20,000 1,000 40,000 450,000 250,000 65,000 60,000 2,000 50,000 5,000 13,000

$ 830,000 (450,000) (250,000) $ 130,000

Cash Flows from Noncapital Financing Activities: Cash received from short-term note payable Cash received from General Fund - Noncapital loan Cash paid for interest Cash paid to General Fund - noncapital loan Net Cash Used for Noncapital Financing Activities

40,000 20,000 (2,000) (65,000) (7,000)

Cash Flows from Capital and Related Financing Activities: Principal paid on capital debt (50,000) Interest paid on capital debt (5,000) Cash paid on capital improvements (60,000) Net Cash Used for Capital and Related Financing Activities

(115,000)

Cash Flows from Investing Activities: Interest received Net Cash Provided by Investing Activities Net increase in unrestricted cash (and cash equiv.) Unrestricted cash (and cash equiv.), January 1, 2014 Unrestricted cash (and cash equiv.), December 31, 2014

1,000 9,000 13,000 $ 22,000

1,000

Objective: LO21.3 Introduce the differences between a proprietary fund statement of cash flows and its commercial business counterpart. Difficulty: Difficult AACSB: Application of knowledge

21.3 True/False 1) Governments use proprietary funds to account for business-type activities. Answer: TRUE Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Easy AACSB: Analytical thinking

2) The accounting equation for proprietary funds: Current Assets - Noncurrent Assets + Current Liabilities - Noncurrent Liabilities = Net position. Answer: FALSE Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Moderate AACSB: Analytical thinking

3) The three financial statements for a proprietary fund: statement of net position; statement of revenues, expenses, and changes in fund net position; and statement of cash flows. Answer: TRUE Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Easy AACSB: Analytical thinking

4) Enterprise funds primarily provide goods and services to government agencies. Answer: FALSE Objective: LO21.1 Review the appropriate accounting and financial reporting for proprietary funds. Difficulty: Moderate AACSB: Analytical thinking

5) Internal service funds primarily provide goods and services to other departments or agencies. Answer: TRUE Objective: LO21.3 Introduce the differences between a proprietary fund statement of cash flows and its commercial business counterpart. Difficulty: Easy AACSB: Analytical thinking

6) Enterprise funds use full accrual accounting procedures. Answer: TRUE Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Analytical thinking

7) Restricted net position for proprietary funds is composed of restricted assets reduced by liabilities and deferred inflows of resources related to those assets. Answer: TRUE Objective: LO21.2 Recognize the proper treatment of internal service funds in the government-wide statements. Difficulty: Moderate AACSB: Analytical thinking

8) GASB Statement No. 34 mandates that the indirect method be used for the cash flow statement of proprietary funds. Answer: FALSE Objective: LO21.3 Introduce the differences between a proprietary fund statement of cash flows and its commercial business counterpart. Difficulty: Easy AACSB: Analytical thinking

9) GASB Statement No. 9 separates financing activities on the cash flow statement into two components: noncapital and capital related. Answer: TRUE Objective: LO21.3 Introduce the differences between a proprietary fund statement of cash flows and its commercial business counterpart. Difficulty: Moderate AACSB: Analytical thinking

10) Fiduciary funds are to account for assets held in a trustee or agency capacity on behalf of others internal to the governmental entity. Answer: FALSE Objective: LO21.4 Prepare journal entries and fund financial statements for fiduciary funds. Difficulty: Moderate AACSB: Analytical thinking

11) Trust funds are fiduciary funds used to account for multigovernment external investment pools sponsored by the governmental entity. Answer: TRUE Objective: LO21.4 Prepare journal entries and fund financial statements for fiduciary funds. Difficulty: Easy AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 22 Accounting for Not-for-Profit Organizations 22.1 Multiple Choice Questions 1) Which of the following is NOT true? A) A not-for-profit entity operates for purposes other than to provide goods or services at a profit. B) A not-for-profit entity may be governmental or non-governmental. C) A not-for-profit entity may possess ownership interests like a corporation. D) A not-for-profit entity receives resources from resource providers who do not expect commensurate or proportionate pecuniary return. Answer: C Objective: LO22.1 Learn about the four main categories of not-for-profit organizations. Difficulty: Easy AACSB: Analytical thinking

2) On January 1, 2011, a Voluntary Health and Welfare Organization (VHWO) receives an unconditional promise to give $6,000. The money is not collectible until 2012. The VHWO estimates that 10% of pledges are uncollectible. On January 1, 2011, the VHWO will credit A) Unrestricted Support - Contribution, $6,000. B) Allowance for Uncollectible Contributions $600, and Unrestricted Support - Contribution, $5,400. C) Allowance for Uncollectible Contributions $600, Temporarily Restricted Support - Contribution, $5,400. D) Allowance for Uncollectible Contributions $600, Contribution Revenue $5,400. Answer: C Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Moderate AACSB: Analytical thinking

3) A nongovernmental, not-for-profit entity is subject to A) GAAP. B) GAAS. C) SEC. D) AICPA. Answer: A Objective: LO22.2 Differentiate between governmental and nongovernmental not-for-profit organizations. Difficulty: Easy AACSB: Analytical thinking

4) A donor gives a Voluntary Health and Welfare Organization (VHWO) $1,000 cash that is restricted for a research project. What account does the VHWO credit when the VHWO receives the money? A) Nonoperating Revenue B) Permanently Restricted Revenue C) Unrestricted Support D) Temporarily Restricted Support Answer: D Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Moderate AACSB: Analytical thinking

5) For a Voluntary Health and Welfare Organization, what entry is prepared when the restriction on a cash donation is met? A) Debit Unrestricted Net Assets, Credit Restricted Net Assets B) Debit Unrestricted Fund Balance, Credit Restricted Fund Balance C) Debit Restricted Fund Balance, Credit Unrestricted Fund Balance D) Debit Temporarily Restricted Net Assets - Reclassifications out, Credit Unrestricted Net Assets Reclassifications in Answer: D Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Moderate AACSB: Analytical thinking

6) Under GAAP, for nonprofit, nongovernmental entities, an unconditional transfer of cash or other assets to an entity, or a settlement or cancellation of its liabilities in a voluntary, non-reciprocal transfer, is called a(n) A) unconditional promise to give. B) contribution. C) conditional promise to give. D) residual equity transfer. Answer: B Objective: LO22.3 Introduce FASB not-for-profit accounting principles. Difficulty: Easy AACSB: Analytical thinking

7) For nonprofit, nongovernmental organizations, unconditional promises to give that include promises of payments due in future periods (next year or later) are reported as A) unrestricted revenues. B) unrestricted support. C) deferred revenues until payment is received. D) restricted support. Answer: D Objective: LO22.3 Introduce FASB not-for-profit accounting principles. Difficulty: Easy AACSB: Analytical thinking

8) A gift-in-kind, for which the not-for-profit entity has no discretion on disposition, should be accounted for by the not-for-profit, nongovernmental entity as A) a special purpose contribution. B) an exchange transaction. C) an agency transaction. D) a conditional promise to give. Answer: C Objective: LO22.3 Introduce FASB not-for-profit accounting principles. Difficulty: Easy AACSB: Analytical thinking

9) Voluntary health and welfare organizations must report expenses classified by A) restriction. B) function and natural classification. C) restriction and natural classification. D) restriction, function and natural classification. Answer: B Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Easy AACSB: Analytical thinking

10) Which one of the following statements is NOT required for voluntary health and welfare organizations? A) A statement of financial position B) A statement of activities C) A statement of functional expenses D) A statement of changes in net assets Answer: D Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Easy AACSB: Analytical thinking

11) Voluntary health and welfare organizations classify fund-raising costs as A) costs of services sold. B) program services. C) auxiliary expenses. D) supporting services. Answer: D Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Easy AACSB: Analytical thinking

12) Voluntary health and welfare organizations A) may not have paid executives or staff. B) are governed by separate GASB statements. C) use fund accounting, following the rules for proprietary fund reporting. D) are supported by, and provide voluntary services to, the public. Answer: D Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Easy AACSB: Analytical thinking

13) Voluntary health and welfare organizations (VHWO) measure contributions at fair value unless A) fair value is less than the original cost of the item. B) the contributed item is not intended to be re-sold by the VHWO. C) fair value cannot be reasonably determined. D) the contributions are not in cash or cash equivalents. Answer: C Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Easy AACSB: Analytical thinking

14) The gift shop of a nonprofit, private hospital has cash revenue of $24,000. What account will the hospital credit? A) Unrestricted support B) Unrestricted revenue C) Temporarily restricted revenue D) Other operating revenue - unrestricted Answer: D Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Easy AACSB: Analytical thinking

15) In a nonprofit, nongovernmental hospital, courtesy allowances are A) charity care services. B) revenue deductions. C) expenses. D) revenues earned even if the standard charge is above or below the allowance. Answer: B Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Easy AACSB: Analytical thinking

16) In a nongovernmental, nonprofit hospital, contractual adjustments are A) the discounted rate given to hospital employees. B) discounts arranged with third-party payors. C) recorded as a deduction from revenue or as an expense. D) additional amounts paid by select group participants. Answer: B Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Easy AACSB: Analytical thinking

17) An alumnus of a nonprofit, nongovernmental university establishes an endowment of $50,000. When the university receives the endowment from the donor, what account will the university credit? A) Temporarily restricted revenues B) Temporarily restricted support C) Permanently restricted revenues D) Permanently restricted support Answer: C Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Easy AACSB: Analytical thinking

18) Not-for-profit, private colleges classify student unions, dining halls, and residence halls as A) educational and general services. B) auxiliary enterprises. C) independent operations. D) restricted enterprises. Answer: B Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Easy AACSB: Analytical thinking

19) An alumnus made a donation of adjoining land to a not-for-profit, nongovernmental university. The donor made no specifications regarding the time period or use of the land. The university would record the gift as A) an endowment asset. B) temporarily restricted revenue. C) unrestricted revenue. D) permanently restricted support. Answer: C Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Easy AACSB: Analytical thinking

20) In a not-for-profit, private university, the federal grant funds given directly to students for financial aid are an example of A) a bequest. B) an agency transaction. C) unrestricted revenue. D) a restricted contribution. Answer: B Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Easy AACSB: Analytical thinking

22.2 Exercises 1) Will Wealth made three charitable donations in 2014. Each was for $500,000, however they were made to three different organizations as follows: 1. Will donated to a local voluntary health and welfare organization (VHWO), and indicated that the funds could be used as the VHO wanted. 2. Will donated to a local private, not-for-profit university, designating the funds to be used for scholarships and student aid. 3. Will donated to the local not-for-profit, nongovernmental hospital, designating the funds to be used for purchase of diagnostic equipment. Required: For each of the above three situations: A. Prepare the journal entry that each organization would prepare at the time of the contribution. B. Prepare the journal entry that each organization would prepare at the time of the subsequent spending of the funds. Assume that the spending is in accordance with any restrictions that Will placed on the donation.

Answer: 1A. VHWO Cash Unrestricted support - contributions 1B. VHWO Expenses - (by function or account title) Cash 2A. University Cash Temporarily Restricted Revenues contributions 2B. University Expenses - Unrestricted: student aid Cash Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in

500,000 500,000

3A. Hospital Cash Temporarily Restricted Support

500,000

3B. Hospital Equipment Cash

500,000

Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in

500,000 500,000

Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Moderate AACSB: Application of knowledge

2) A small town in a rural area has an organization that serves the local community when there is a financial need. Among the services they provide is free groceries, clothes and furniture, along with transportation to doctors' appointments when the doctor is out of town. This voluntary health and welfare organization (VHWO) accepts most donations of goods, all donations of cash, and has developed a relationship with the local grocer who helps them obtain needed food items. The VHO has one paid administrator who tracks and coordinates the donations, performs application reviews to determine eligibility, and schedules transportation for those in need. Volunteers unload and pack grocery items, sort clothes and furniture, and drive those who need transportation. Gasoline costs are reimbursed to the driver based on mileage. The local CPA provides bookkeeping and tax services for free, and designates 90% of expenses incurred to community services and 10% to management and general. The VHWO had the following transactions in 2014: 1.

The administrator is paid $11,000 salary.

The accountant services are valued at $6,000 based on their normal billable rate.

3. The landlord of the building they use for their operations has waived their rent and provided the bill of $6,000 for their records. The VHWO paid utilities and property taxes of $3,000. 4.

Office furniture was donated with an estimated fair value of $9,400.

5. The VHWO received cash donations of $20,000, $5,000 of which was an unpaid pledge from the prior year. The beginning pledges receivable balance was $6,000, and no amount had previously been estimated to be uncollectible. The prior year balance will now be written off. In addition, $12,000 was pledged to be donated in 2015. Based on recent history, the VHWO knows that 10% of the new pledges will not be collected. Required: Prepare the journal entries for the transactions noted above.

Answer: 1. Expenses - community service Expenses - management and general Cash

9,900 1,100

Expenses - management and general Unrestricted Support - donated services

6,000

Expenses - community service Expenses - management and general Unrestricted Support - donated rent

5,400 600

Expenses - community service Expenses - management and general Cash

2,700 300

Office furniture Unrestricted support - contributions

9,400

Cash Unrestricted support - contributions Contributions receivable

20,000

Unrestricted support - contributions Contributions receivable

1,000

11,000

6,000

3,000

9,400

15,000 5,000

1,000

Contributions receivable 12,000 Temporarily restricted support - contributions Allowance for uncollectible contributions

10,800 1,200

Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Moderate AACSB: Application of knowledge

3) Southtown Community Hospital (SCH) shows the following balances on its trial balance at June 30, 2014, their fiscal year end. SCH is a not-for-profit, nongovernmental hospital. $260,000 cash was spent on equipment from donations restricted for that purpose. Debits: Administrative services expense Contractual allowances Depreciation expense Employee discounts General services expense Loss on sale of fixed assets Nursing services expense Resident and visiting professional services expense Provision for bad debts

200,000 1,200,000 700,000 300,000 900,000 100,000 4,000,000 3,000,000 600,000

Credits: Income from investment in clinic Patient service revenues Pharmacy Cafeteria services Unrestricted contributions Unrestricted income from endowment funds Restricted donations for equipment purchases

120,000 10,000,000 400,000 200,000 350,000 280,000 500,000

Required: Prepare a statement of operations for Southtown Community Hospital at June 30, 2014.

Answer:

Southtown Community Hospital Statement of Operations For the year ended June 30, 2014

Unrestricted revenues, gains and other support: Net patient service revenues (10,000,000 - 1,200,000 - 300,000) Other operating revenue (400,000 + 200,000) Income from endowments Income from investment in clinic Unrestricted contributions Total operating revenues, gains and other support

$8,500,000 600,000 280,000 120,000 350,000 $9,850,000

Expenses and losses: Resident and visiting professional services Nursing services General services Administrative services Provision for uncollectible accounts Loss on sale of fixed assets Provision for depreciation Total expenses and losses

$3,000,000 4,000,000 900,000 200,000 600,000 100,000 700,000 9,500,000

Excess of revenues, gains and other support over expenses and losses

350,000

Net assets released from restrictions for acquisition of equipment Increase in unrestricted net assets

260,000 $ 610,000

Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Difficult AACSB: Application of knowledge

4) Wilhelman University, a not-for-profit, nongovernmental university, had the following transactions in 2014. 1. Tuition bills were sent amounting to $4,000,000, with tuition waivers granted on that amount of $200,000. 2.

State funding was received in the amount of $2,000,000.

3. The bookstore and cafeteria sales amounted to $1,600,000, and their cost of sales was $1,500,000. Assume cash sales and cash purchases for these auxiliary operations. 4. Endowment income amounted to $100,000 that was restricted to chair the accounting department, and $200,000 of unrestricted income. 5. Expenses were incurred and paid as follows: faculty, $3,800,000 (including faculty chair, paid in part by endowment income); Student services, $250,000; Facilities operations, $350,000; and scholarships (excluding tuition waived), $400,000. Required: Prepare the journal entries for 2014 for Wilhelman University.

Answer: 1. Accounts Receivable Unrestricted revenue - tuition

4,000,000 4,000,000

Tuition reduction: unrestricted - student aid Accounts receivable 2.

200,000 200,000

Cash Unrestricted revenues - state appropriations

2,000,000

Cash Revenue - auxiliary operations

1,600,000

Expenses - auxiliary operations Cash

1,500,000

2,000,000

1,600,000

1,500,000

Cash Temporarily restricted revenues endowment income Unrestricted revenues - endowment income

300,000

Expenses - education/general - instruction Expenses - education/general - student svc Expenses - education/general - plant operation Expenses - education/general - student aid Cash

3,800,000 250,000 350,000 400,000

100,000 200,000

4,800,000

Temporarily restricted net assets reclassifications out 100,000 Unrestricted net assets reclassifications in 100,000 (assumes accounting chair paid from temporarily restricted funds) Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Moderate AACSB: Application of knowledge

5) Albatross University, a not-for-profit, nongovernmental university, had the following transactions in 2014. 1. Tuition bills were sent amounting to $8,000,000, with 70% collected before the end of the fiscal year; tuition waivers were granted on the total amount of $400,000, and $220,000 was expected to be uncollectible. 2. Cafeteria sales, all cash, were $1,400,000. 3. Salaries and wages were paid amounting to $5,500,000, of which $370,000 was for cafeteria staff. 4. Long-term debt payments were made from general funds amounting to $800,000, of which $130,000 was for interest. 5. Equipment was purchased for the engineering department with funds previously set aside for that purpose, amounting to $180,000. Required: Prepare the journal entries for 2014 for Albatross University.

Answer: 1. Accounts Receivable Unrestricted revenue - tuition Cash Accounts Receivable

5,600,000

Expenses - educational/general instructional support Allowance for uncollectible accounts

8,000,000 5,600,000

Tuition reduction: unrestricted - student aid Accounts receivable

8,000,000

400,000 400,000

220,000 220,000

Cash Revenue - auxiliary operations

1,400,000

Expenses - educational/general Expenses - auxiliary operations Cash

5,130,000 370,000

1,400,000

5,500,000

Long-term debt payable Interest expense Cash

670,000 130,000

Equipment Cash

180,000

800,000

180,000

Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in

180,000 180,000

Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Moderate AACSB: Application of knowledge

6) Carousel Clothes is a voluntary health and welfare organization that provides gently-used secondhand clothes to those in need. They had the following transactions in 2014. 1. Cash gifts were received in the amount of $60,000, of which $13,000 had been pledged in the prior year. 2. Pledges made in the current year but not yet fulfilled amounted to $39,000. Ten percent of the pledges typically prove to be uncollectible. Pledges are made for 2014. 3. An office supply company donates office furniture to the VHWO. The fair value of the furniture is $40,000. No restrictions were placed on the donation. 4. The following expenses were incurred and paid: director's salary, $15,000; facility rental, $18,000; cleaning and repair costs for clothes, $29,000; and purchase of supplies consumed in tagging and distribution of clothes, $5,000. The director's salary is categorized as Support Services and the rest of the costs are Program Services. 5. Restricted pledges were received during the year for $450,000. The pledges are restricted for the construction of a new facility. Required: Prepare the journal entries for Carousel for 2014.

Answer: 1. Cash Unrestricted support - contributions Contributions receivable

60,000 47,000 13,000

Temporarily Restricted Net Assets Reclassifications out Temporarily Restricted Net Assets Reclassifications in 2.

13,000 13,000

Contributions receivable Unrestricted support - contributions Allowance for uncollectible contributions

39,000

Office furniture Unrestricted support - contributions

40,000

Expenses - support services Expenses - program services Cash

15,000 52,000

Contributions Receivable Temporarily restricted support contributions Allowance for uncollectible contributions

450,000

35,100 3,900

40,000

67,000

405,000 45,000

Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Moderate AACSB: Application of knowledge

7) The Trasque Hospital is a nongovernmental, not-for-profit hospital. During 2014, they had the following transactions. 1. Trasque's standard charges for services rendered amounted to $550,000. Contractual adjustments on those amounts with third-party payors amounted to $230,000. Bad debts on the remaining balance are estimated to be 10%. 2. The hospital received a cash donation of $20,000 to be used for medical equipment. 3. The hospital also received rent from a local shelter that uses the basement of their facility for overflow housing, amounting to $6,000 per year. 4. The hospital paid the following costs: Professional fees (doctors and physician assistants), $80,000; Nursing services, $70,000; and administrative services, $40,000. 5. The hospital paid for pharmaceuticals and medical supplies amounting to $110,000. The hospital had an agreement with the pharmaceutical and medical supply vendors to carry all inventory on consignment, due to their not-for-profit status. As a result, items are only paid for as consumed, and all inventory belongs to the vendors. Required: Prepare the journal entries for Trasque for 2014. Answer: 1. Patient Accounts Receivable Patient Service Revenues - unrestricted

550,000 550,000

Contractual Adjustments Patient Accounts Receivable

230,000

Bad Debt Expense Allowance for uncollectible patient accounts receivable

32,000

Cash Temporarily Restricted Support

20,000

Cash Other operating revenue - unrestricted

6,000

Professional fees expense Nursing services expense Administrative services expense Cash

80,000 70,000 40,000

Pharmaceutical and supplies expense Cash

110,000

230,000

32,000

20,000

6,000

190,000

110,000

Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Moderate AACSB: Application of knowledge

8) The following information was taken from the accounts and records of the Community Chest Foundation, a private, not-for-profit VHWO organization. All balances are as of December 31, 2014, unless otherwise noted. Unrestricted Support - Contributions Unrestricted Support - Membership Dues Unrestricted Revenues - Investment Income Temporarily restricted gain on sale of investments Expenses - Program Services Expenses - Supporting Services Expenses - Supporting Services Temporarily Restricted Support - Contributions Temporarily Restricted Revenues - Investment Income Permanently Restricted Support - Contributions Unrestricted Net Assets, January 1, 2014 Temporarily Restricted Net Assets, January 1, 2014 Permanently Restricted Net Assets, January 1, 2014

$6,500,000 700,000 63,000 20,000 2,950,000 670,000 350,000 560,000 70,000 80,000 500,000 4,000,000 50,000

The unrestricted support from contributions was received in cash during the year. The expenses included $980,000 paid from temporarily-restricted cash donations. Required: Prepare Community Chest's Statement of Activities for the year ended December 31, 2014.

Answer:

Community Chest Foundation Statement of Activities For the Year Ended December 31, 2014

Changes in Unrestricted Net Assets: Revenues and Gains Contributions Membership dues Investment Income Total unrestricted revenues and gains Net assets released from restrictions Total unrestricted revenues, gains and other support

$6,500,000 700,000 63,000 7,263,000 980,000 8,243,000

Expenses and Losses: Program Services Supporting Services Total Expenses Increase in unrestricted net assets

2,950,000 1,020,000 3,970,000 4,273,000

Changes in Temporarily Restricted Net Assets: Contributions Investment Income Gain on Sale of investments Net assets released from restriction Decrease in temporarily restricted net assets

560,000 70,000 20,000 (980,000) (330,000)

Changes in Permanently Restricted Net Assets: Contributions Increase in permanently restricted net assets

80,000 80,000

Increase in net assets Net assets, January 1, 2014 Net assets, December 31, 2014

4,023,000 4,550,000 $8,573,000

Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Difficult AACSB: Application of knowledge

9) The following information was taken from the accounts and records of the Helping Hands Foundation, a private, not-for-profit organization classified as a VHWO. All balances are as of June 30, 2014, unless otherwise noted. Unrestricted Support - Contributions Unrestricted Support - Membership Dues Unrestricted Revenues - Investment Income Temporarily restricted gain on sale of investments Expenses - Program Services Expenses - Supporting Services Expenses - Supporting Services Temporarily Restricted Support - Contributions Temporarily Restricted Revenues - Investment Income Permanently Restricted Support - Contributions Unrestricted Net Assets, July 1, 2013 Temporarily Restricted Net Assets, July 1, 2013 Permanently Restricted Net Assets, July 1, 2013

$2,000,000 640,000 80,000 25,000 1,860,000 350,000 550,000 640,000 60,000 100,000 450,000 2,100,000 60,000

The unrestricted support from contributions was received in cash during the year. The expenses included $1,350,000 paid from temporarily-restricted cash donations. Required: Prepare Helping Hands' Statement of Activities for the fiscal year ended June 30, 2014.

Answer:

Helping Hands Foundation Statement of Activities For the Year Ended June 30, 2014

$2,000,000 640,000 80,000 2,720,000 1,350,000 4,070,000

Expenses: Program Services Supporting Services Total Expenses Increase in unrestricted net assets

1,860,000 900,000 2,760,000 1,310,000

Changes in Temporarily Restricted Net Assets: Contributions Investment Income Gain on Sale of investments Net assets released from restriction Decrease in temporarily restricted net assets

640,000 60,000 25,000 (1,350,000) (625,000)

Changes in Permanently Restricted Net Assets: Contributions Increase in permanently restricted net assets

100,000 100,000

Increase in net assets Net assets, July 1, 2013 Net assets, June 30, 2014

785,000 2,610,000 $3,395,000

Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Difficult AACSB: Application of knowledge

10) Coats for Kids is a private, not-for-profit organization that provides free coats for children in the suburbs of a large city. Coats for Kids had the following transactions in 2014. 1. Unrestricted cash gifts that were received last year, but designated for use in the current year, totaled $50,000. The cash gifts were used in 2014. 2. Unrestricted pledges of $40,000 were received. They are expected to be collected in 2014. Ten percent of the pledges typically prove uncollectible. Additional cash contributions during the year totaled $65,000. 3. A donor donated investments with a fair value of $10,000. The investments can be sold and used only for the purchase of coats for children. 4. The following expenses were incurred and paid: Salary of director, $15,000, classified as supporting services. The remaining expenses of $47,500 were classified as program services. 5. Pledges of $250,000 were received during the year. The pledges were restricted for use in purchasing new delivery vans. All of these pledges are expected to be collected in the next fiscal year. Ten percent are estimated to be uncollectible. Required: Prepare the journal entries for the aforementioned transactions.

Answer: 1. Temporarily restricted net assets - reclassifications out Unrestricted net assets - reclassifications in

50,000 50,000

2. Contributions receivable Cash Allowance for uncollectible contributions Unrestricted support - contributions

40,000 65,000

3. Investments Temporarily Restricted Support - Contributions

10,000

4. Expenses - support services Expenses - program services Cash

15,000 47,500

5. Contributions receivable Temporarily restricted support - contributions Allowance for uncollectible contributions

250,000

4,000 101,000

10,000

62,500

225,000 25,000

Objective: LO22.4 Apply not-for-profit accounting principles to voluntary health and welfare organizations. Difficulty: Moderate AACSB: Application of knowledge

11) Marshfield Hospital is a private, not-for-profit hospital. The following transactions occurred: 1. Unrestricted cash gifts that were received last year, but designated for use in the current year, totaled $180,000. The cash gifts were used in the current year in accordance with restrictions. 2. Unrestricted pledges of $800,000 were received. Ten percent of the pledges typically prove uncollectible. Additional cash contributions during the year totaled $300,000. 3. Gifts in kind were received that were sold at a silent auction for $23,000. The fair value of the donated gifts in kind could not be reasonably determined. 4. Expenses were incurred and paid as follows: Salary of doctor, $190,000; facility rental, $36,000; purchases of supplies, $8,000; and utility costs, $10,000. 5. Marketable securities with a fair value of $650,000 were received as a donation with a stipulation that the hospital use the funds to purchase suitable land for the hospital. Required: Prepare journal entries for the aforementioned transactions. Answer: 1. Temporarily restricted net assets reclassifications out 180,000 Unrestricted net assets reclassifications in 2.

Contributions receivable Cash Allowance for uncollectible contributions Unrestricted support - nonoperating gain

800,000 300,000

Cash Sales revenue - unrestricted

23,000

Professional fees expense Administrative expense Cash

190,000 54,000

Marketable securities Temporarily restricted support

650,000

180,000

80,000 1,020,000

23,000

244,000

650,000

Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Moderate AACSB: Application of knowledge

12) General Hospital is a private, not-for-profit hospital. The following information is available about the operations. 1. Gross patient services charges totaled $3,700,000. 2. Included in the above revenues are: charity services, $360,000; contractual adjustments, $1,200,000; courtesy allowances, $20,000; and estimated uncollectible amounts, $250,000. 3. Premium fees receipts were $110,000. 4. Purchased $75,000 of hospital supplies on account, with payments on that account, $36,000. 5. Received cash donations for a new hospital wing of $2,500,000. 6. Paid contractor $275,000 for billed costs toward the new hospital wing. Required: Prepare journal entries for the aforementioned transactions. Answer: 1. Patient accounts receivable 3,700,000 Patient service revenues - unrestricted 2.

Patient service revenues - unrestricted Contractual adjustments Courtesy discounts Patient accounts receivable

360,000 1,200,000 20,000

Bad debt expense Allowance for uncollectible patient Accounts receivable

250,000

Cash Premium revenue - unrestricted

110,000

Supplies inventory Accounts payable

75,000

Accounts payable Cash

36,000

3,700,000

1,580,000

250,000

110,000

75,000

36,000

Cash Temporarily restricted support Construction in progress Cash

2,500,000 2,500,000 275,000 275,000

Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in

275,000 275,000

Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Moderate AACSB: Application of knowledge

13) Childrens Hospital is a private, not-for-profit hospital. The following information is available about the operations. 1.

Gross patient services charges totaled $6,400,000.

2. Included in the above revenues are: charity services, $210,000; contractual adjustments, $2,400,000; and courtesy allowances, $37,000. 3. Received a donation of marketable securities with a fair value of $165,000 for the purchase of new diagnostic equipment. 4. The marketable securities were sold for $182,000 and diagnostic equipment was purchased at a cost of $210,000. 5. Revenue from the hospital gift shop was $58,000 and from the cafeteria revenues were $227,000. Received cash from both enterprises. 6.

Incurred and paid nursing service costs of $1,700,000 and general service costs of $400,000.

Required: Prepare journal entries for the aforementioned transactions.

Answer: 1. Patient accounts receivable Patient service revenues - unrestricted 2.

6,400,000

Patient service revenues - unrestricted Contractual adjustments Courtesy discounts Patient accounts receivable

210,000 2,400,000 37,000

Marketable securities Temporarily restricted support

165,000

Cash Marketable securities Temporarily restricted support - gain on sale of marketable securities

182,000

Equipment Cash

210,000

Cash Other operating revenue - unrestricted Nursing service expense General services expense Cash

2,647,000

165,000

165,000 17,000

210,000

Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in 5.

6,400,000

182,000 182,000 285,000 285,000 1,700,000 400,000 2,100,000

Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Moderate AACSB: Application of knowledge

14) Prepare journal entries to record the following transactions for a private, not-for-profit university. 1. Tuition and fees assessed total $10,000,000, 80% of which was collected by year-end; tuition scholarships were granted for $1,300,000, and $650,000 was expected to be uncollectible. 2. Revenues collected from sales and services by the university bookstore were $1,450,000. 3. Salaries and wages paid were $5,600,000, $300,000 of which was for employees of the university bookstore. 4. Financial aid funds of $700,000 were received from the Pell Grant program; the funds were then disbursed to the appropriate students. 5. Contributions of $600,000 were received; $30,000 was restricted for the athletic department and the balance was unrestricted. An additional $70,000 was pledged to the athletic department by the alumni. 6. Athletic equipment was purchased with $42,000 previously set aside for that purpose.

Answer: 1. Accounts receivable Unrestricted Revenues - tuition and fees

10,000,000 10,000,000

Tuition reduction:Unrestricted - student aid Expenses - educational/general-institutional support Accounts receivable Allowance for uncollectible accounts

1,300,000

Cash Accounts receivable

8,000,000

650,000 1,300,000 650,000

8,000,000

2. Cash Revenues - auxiliary enterprises

1,450,000

3. Expenses - educational and general Expenses - auxiliary enterprises Cash

5,300,000 300,000

4. Cash Grant funds held for students

700,000

Grant funds held for students Cash

700,000

1,450,000

5,600,000

700,000

5. Cash Contributions receivable Unrestricted revenues - contributions Temporarily restricted revenues contributions

600,000 70,000

6. Equipment Cash

42,000

570,000 100,000

42,000

Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in

42,000 42,000

Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Moderate AACSB: Application of knowledge

15) A private, not-for-profit university received donations of $1,000,000 cash in 2014 that were restricted to certain research projects on sustainability, with an emphasis on reducing the campus waste. The university incurred and paid $450,000 of expenses on this research in 2014. In 2014, an alumnus contributed a $700,000 endowment for energy research with all endowment income restricted for that purpose. Income totaled $35,000 for the year. Energy research expenses incurred and paid were $22,000. Required: Prepare the appropriate journal entries for the university for these transactions. Answer: Cash Temporarily restricted revenues contributions Expenses - research Cash

1,000,000 1,000,000 450,000 450,000

Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in

450,000 450,000

Cash Permanently restricted revenues endowment contribution

700,000

Cash Temporarily restricted revenues endowment income

35,000

Expenses - research Cash

22,000

700,000

35,000

22,000

Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in

22,000 22,000

Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Moderate AACSB: Application of knowledge

16) The following information is available about the operations for a private, not-for-profit university. 1. The university sold $20,000,000 of 5% bonds to finance the construction of a new building for the business school. The bonds were sold on January 1 and pay interest on December 31 of each year. The bonds were sold at par and mature in 20 years. 2. The university received $7,500,000 cash in alumni and corporate donations for the new business school building. 3.

The building was constructed at a total cost of $22,000,000 and the contractor was paid in full.

Interest was paid on the bonds.

Depreciation on the new building the first year was $275,000.

Required: Prepare the appropriate journal entries for the university for these transactions. Answer: 1. Cash Bonds payable

20,000,000

Cash Temporarily restricted revenues contributions

7,500,000

Building Cash

22,000,000

20,000,000

22,000,000

Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in 4.

7,500,000

Expenses - interest Cash

7,500,000 7,500,000 1,000,000 1,000,000

Expenses - educational and general operation and maintenance of plant Accumulated depreciation

275,000 275,000

Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Moderate AACSB: Application of knowledge

17) A private, not-for-profit university received donations of $800,000 in 2014 that were restricted to capital improvements of the football stadium. The university spent $670,000 on capital improvements for the stadium in 2014 and recorded depreciation of $130,000. In 2014, an alumnus contributed a $1,500,000 endowment for football scholarships with all endowment income restricted for that purpose. Endowment income totaled $75,000 for the year and scholarship awards were $68,000. Required: Prepare the appropriate journal entries for the university for these transactions. Answer: Cash 800,000 Temporarily restricted revenues contribution 800,000 Buildings - stadium Cash

670,000 670,000

Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in Expenses - auxiliary enterprises Accumulated depreciation

670,000 670,000 130,000 130,000

Cash Permanently restricted revenues endowment contribution

1,500,000

Cash Temporarily restricted revenues endowment income

75,000

Expenses - unrestricted - student aid Cash

68,000

Temporarily restricted net assets reclassifications out Unrestricted net assets reclassifications in

1,500,000

75,000

68,000

68,000 68,000

Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Moderate AACSB: Application of knowledge

18) Match each of the following descriptions with the correct category for a private, not-for-profit hospital. Each term may be used more than once. Categories: A. Revenue B. Deduction from Revenue C. Expense D. Gains / Losses ________ 1. Courtesy allowances provided to hospital patients ________ 2. Premium fees ________ 3. Fees paid to the doctors ________ 4. Charges to patients for patient services ________ 5. Wages paid to nursing staff ________ 6. Contractual allowances arranged with third-party payors ________ 7. Cafeteria sales ________ 8. Wages paid to hospital janitors ________ 9. Depreciation expense on hospital equipment ________ 10.Other operating revenue—unrestricted Answer: 1. B, 2. A, 3. C, 4. A, 5. C, 6. B, 7. A, 8. C, 9. C, 10. A Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Moderate AACSB: Analytical thinking

19) Record the following transactions for Porter Hospital, a private, nonprofit hospital: 1.

Gross patient services revenues: $25,000,000. Billed to patients.

2. Included in the above revenues are: charity services, $500,000; contractual adjustments, $11,000,000; and estimated uncollectible amounts, $250,000. 3.

Purchased equipment by issuing a 5-year note for $200,000.

Received cash donations restricted for a capital building addition program, $5,100,000.

Incurred and paid $1,700,000 of contractor billings for the capital building program.

Answer: 1. Patient accounts receivable Patient service revenue - unrestricted 2. Patient service revenue - unrestricted Contract adjustments Patient accounts receivable

25,000,000 25,000,000 500,000 11,000,000 11,500,000

Bad debt expense Allowance for uncollectible patient accounts receivable

250,000 250,000

3. Equipment Notes payable

200,000 200,000

4. Cash Temporarily restricted support

5,100,000

5. Construction in progress Cash

1,700,000

5,100,000

1,700,000

Temporarily restricted net assets reclassifications out Unrestricted net assets Reclassifications in

1,700,000 1,700,000

Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Moderate AACSB: Application of knowledge

22.3 True/False 1) Governmental not-for-profit entities follow GASB. Answer: TRUE Objective: LO22.1 Learn about the four main categories of not-for-profit organizations. Difficulty: Easy AACSB: Analytical thinking

2) Nongovernmental not-for-profit entities follow FASB standards. Answer: TRUE Objective: LO22.1 Learn about the four main categories of not-for-profit organizations. Difficulty: Easy AACSB: Analytical thinking

3) Not-for-profits have three classes of net assets within the financial statements: unrestricted, temporarily restricted, and permanently restricted. Answer: TRUE Objective: LO22.3 Introduce FASB not-for-profit accounting principles. Difficulty: Moderate AACSB: Analytical thinking

4) Unrestricted net assets are the portion of net assets that carry no donor-imposed stipulations. Answer: TRUE Objective: LO22.3 Introduce FASB not-for-profit accounting principles. Difficulty: Easy AACSB: Analytical thinking

5) Not-for-profits account for revenues and expenses using the modified accrual basis of accounting. Answer: FALSE Objective: LO22.3 Introduce FASB not-for-profit accounting principles. Difficulty: Moderate AACSB: Analytical thinking

6) Not-for-profits organizations report expenses by functional classification: program services and supporting services. Answer: TRUE Objective: LO22.3 Introduce FASB not-for-profit accounting principles. Difficulty: Moderate AACSB: Analytical thinking

7) GAAP defines a contribution as unconditional 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. Answer: TRUE Objective: LO22.3 Introduce FASB not-for-profit accounting principles. Difficulty: Easy AACSB: Analytical thinking

8) Not-for-profit health care organizations present a statement of financial position, a statement of operations, a statement of changes in net assets, and a statement of cash flows. Answer: TRUE Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Moderate AACSB: Analytical thinking

9) Contractual adjustments are discounts arranged with third-party payors that frequently have agreements to reimburse at less-than-established rates. Answer: TRUE Objective: LO22.5 Apply not-for-profit accounting principles to hospitals and other healthcare organizations. Difficulty: Moderate AACSB: Analytical thinking

10) The FASB ASC is the primary authority over accounting principles for governmental colleges and universities. Answer: FALSE Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Moderate AACSB: Analytical thinking

11) Colleges and universities maintain accounts and reports on a modified-accrual basis. Answer: FALSE Objective: LO22.6 Apply not-for-profit accounting principles to private not-for-profit colleges and universities. Difficulty: Moderate AACSB: Analytical thinking

Advanced Accounting, 13e (Beams et al.) Chapter 23 Estates and Trusts 23.1 Multiple Choice Questions 1) Which of the following phrases is frequently used to refer to estate or trust accounting? A) Non-profit accounting B) Testamentary accounting C) Fiduciary accounting D) Temporary accounting Answer: C Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

2) In reference to accounting for trusts or estates, which of the following statements is correct? A) Estates are subject to taxation, but trusts are not. B) Estates are subject to probate laws that vary widely across the fifty states. C) Estates are subject to income taxes at the federal level, but not at the state level. D) Estates and trusts are taxed regardless of size. Answer: B Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

3) In reference to estates, which of the following statements is correct? A) An estate comes into existence at the death of an individual. B) If the deceased person had a valid will at the time of death, he or she is said to have died intestate. C) The heir receiving the largest portion of the estate is typically appointed the executor. D) Claims may be made for up to seven years against an estate. Answer: A Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

4) Under the Uniform Probate Code, the term "personal representative" refers to which of the following? A) An executor, but not an administrator B) An administrator, but not an executor C) Executor and administrator D) Fiduciary Answer: C Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

5) In reference to the probate process, which of the following statements is correct? A) The personal representative of the deceased can file a petition with the appropriate probate court requesting that an existing will be probated. B) The Uniform Probate Code varies from state to state. C) The Uniform Probate Code is applied to all wills found to be valid, and to wills found to be invalid in probate court. D) The Uniform Probate Code is applied to all wills found to be valid, but not to wills found to be invalid in probate court. Answer: A Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

6) Under the Uniform Probate Code, the personal representative must inform the heirs and devisees of his or her appointment and provide other selected information within how many days of the appointment? A) 10 days B) 20 days C) 30 days D) 60 days Answer: C Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

7) Which of the following is a gift of an object to a devise? A) A general devise B) A specific devise C) A testamentary allocation D) An administrative devise Answer: B Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

8) Under the amended Uniform Probate Code, if the decedent dies intestate, and if there are descendants from a prior marriage or relationship, the surviving spouse receives what? A) $25,000 and 2/3 of the remaining intestate estate B) $200,000 and 1/3 of the remaining intestate estate C) $50,000 and 1/2 of the remaining intestate estate D) $100,000 and 1/2 of the remaining intestate estate Answer: D Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

9) The executor or administrator of a will is required to prepare and file an inventory of property owned by the deceased within what time period? A) One month of appointment B) Two months of appointment C) Three months of appointment D) 45 days of appointment Answer: C Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

10) In reference to the Uniform Probate Code, which of the following statements is correct? A) The Code entitles the surviving spouse to a homestead allowance that is exempt from, and has priority over, all claims against the estate. B) The Code provides a homestead allowance to the surviving spouse of $100,000. C) The Code provides an allowance for dependents, after other claims have been settled. D) The Code entitles the surviving spouse to claim 100% of the estate after claims to third-parties are settled. Answer: A Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Moderate AACSB: Analytical thinking

11) Under the Uniform Probate Code, the personal representative must publish for what time period a notice in a newspaper of general circulation in the county in which the decedent resided? A) For one week B) For two weeks C) For three weeks D) For five weeks Answer: C Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

12) If estate assets are insufficient to pay all claims in full, under the Uniform Probate Code which of the following would be paid first? A) Reasonable funeral expenses B) Necessary medical and hospital expenses of the last illness of the decedent C) Unsecured debts D) The costs and expenses of administration of the estate Answer: D Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

13) Which of the following are entitled to the remainder of the estate after all other rightful claims on the estate have been satisfied? A) Remainder beneficiaries B) Residual beneficiaries C) Alternate beneficiaries D) Secondary beneficiaries Answer: B Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Easy AACSB: Analytical thinking

14) In reference to estate principal and income, which of the following statements is correct? A) A primary reason for dividing estate principal and estate income is that the beneficiaries are often different. B) In accounting for the decedent's estate, the receipts earned but not yet received at the date of death are considered estate income. C) After death, earnings from income-producing property owned at the time of death are considered estate principal. D) Expenses incurred after death to administer the estate are first charged against income earned after death. Answer: A Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Easy AACSB: Analytical thinking

15) Under the Revised Uniform Principal and Income Act, gains or losses incurred on investments that occur after the death of the decedent A) are considered to be income of the estate. B) are included in the inventory fair value at the time of death. C) are taxed separately from other estate income. D) are adjustments to the principal of the estate. Answer: D Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Easy AACSB: Analytical thinking

16) What is the document prepared by the executor or administrator to show accountability for estate property received and maintained or disbursed in accordance with the will? A) The Administrator/Executor's Fiduciary Report B) The charge-discharge statement C) The Administrator/Executor's Testamentary Report D) The Administrator/Executor's Principal/Income Report Answer: B Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Easy AACSB: Analytical thinking

17) Which type of trust is created pursuant to a will? A) A testamentary trust B) A Crummey trust C) A generation-skipping trust D) A life estate trust Answer: A Objective: LO23.3 Understand basic accounting for a trust. Difficulty: Easy AACSB: Analytical thinking

18) In reference to the potential taxation of an estate, which of the following statements is correct? A) An estate may be subject to taxation at both the state and federal level. B) The taxable amount of an estate is based on the book values of all estate assets at the date of death. C) The estate value is not reduced by such expenses as funeral expenses, bequests to qualified charities, or state-level taxes. D) Taxable estate assets do not include proceeds from life insurance policies. Answer: A Objective: LO23.4 Understand how estates are taxed. Difficulty: Easy AACSB: Analytical thinking

19) What is the current annual gift amount that can be left to an individual donee, without being subject to a federal gift tax? A) $6,500 B) $14,000 C) $19,500 D) $26,000 Answer: B Objective: LO23.4 Understand how estates are taxed. Difficulty: Easy AACSB: Analytical thinking

23.2 Exercises 1) Avery died testate early in 2014. The following transactions occurred relating to Avery's estate. 1. Avery's estate included bonds with a fair (market) value of $120,000. On the date of Avery's death, there was $2,000 of accrued but unpaid interest. Two months after Avery's death, a check arrived in the amount of $3,000, representing the normal semiannual interest payment. 2. Avery's will stated a specific transfer to the Bird Sanctuary in the amount of $10,000. Avery's estate should be adequate to cover all obligations and devises, and the amount is paid. 3.

Funeral expenses amounted to $12,500.

4. A bank statement is received from the First National Bank indicating a cash balance of $8,600. This bank account was not known or included on the estate inventory. 5.

Probate fees are paid to the court amounting to $900.

Required: Prepare the journal entries for the listed transactions. Disregard the impact of estate and income taxes. Answer: 1. Cash - principal 2,000 Cash - income 1,000 Interest Receivable - bonds 2,000 Estate Income 1,000 2.

Devise - Bird Sanctuary Cash - principal

10,000

Funeral Expenses Cash - principal

12,500

Cash - principal Assets subsequently discovered

8,600

Probate expenses Cash - principal

10,000

12,500

8,600 900 900

Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Application of knowledge

2) Rusty Nail died in the summer of 2014. The following transactions occurred relating to Rusty's estate. 1. Rusty's estate included a $50,000 Certificate of Deposit. When Rusty died, there was $250 accrued but unpaid interest. When the check was received for the normal semiannual interest payment, it was in the amount of $1,250. 2. Rusty's will requested a specific transfer to the local playhouse in the amount of $20,000. Avery's estate should be adequate to cover all obligations and devises, and the amount is paid. 3.

A fee for probate court is paid amounting to $1,400.

Funeral expenses are paid amounting to $13,000.

5. A bill is received from the anesthesiologist relating to Rusty's last hospital stay for $22,000. The bill is not covered by insurance, and was not included in the estate inventory. The bill is verified and paid. Required: Prepare the journal entries for the listed transactions. Disregard the impact of estate and income taxes. Answer: 1. Cash - principal 250 Cash - income 1,000 Interest Receivable - bonds 250 Estate Income 1,000 2. Devise - Playhouse Cash - principal

20,000

3. Probate Expenses Cash - principal

1,400

4. Funeral Expenses Cash - principal

13,000

5. Hospital and Medical Expenses Cash - principal

22,000

20,000

1,400

13,000

22,000

Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Application of knowledge

3) Warren Peace passed away, with his will leaving the bulk of all his worldly possessions to his friend Leo. The following transactions occurred with respect to Warren's estate. 1. Warren's estate inventory included 10,000 shares of Newberry Industries, selling at the time of Warren's death at $56 per share. There were no outstanding dividends at the time Warren died, but two weeks later, a $1.00 per share dividend was declared. 2. Warren only designated one item that was not to be left to Leo. Warren's family had a signed, firstedition copy of a classic novel that was valued and included in the estate inventory at $67,000, which Warren left to the local library. The book is located and delivered. 3.

Funeral expenses are paid in the amount of $7,880.

4. A statement comes from the insurance company indicating there are multiple charges from Warren's final hospital stay that will not be covered and are the responsibility of the estate. These fees amount to $39,000 and were not known at the time the estate inventory was prepared. The charges are confirmed and will be paid when the separate bills arrive from the hospital and professionals who billed them to the insurance company. 5. A check is received from Newberry Industries for the dividends declared in the first transaction, above. Required: Prepare the journal entries for the listed transactions. Disregard the impact of estate and income taxes. Answer: 1. Dividend receivable 10,000 Estate Income 10,000 2.

Devise - local library First edition novel

67,000

Funeral expenses Cash - principal

7,880

Hospital and medical expenses Medical bills payable

39,000

Cash - income Dividends receivable

10,000

67,000

7,880

39,000

10,000

Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Application of knowledge

4) Richard Stands passed away at on September 2, 2011. The probate court ruled that most assets could be excluded from estate inventory. Ty Republic has been appointed to serve as executor for the estate. The estate assets consisted of the following at that date: Asset Cash Certificates of Deposit Investments/Mutual Funds Residence Lake cottage Cookie Jar collection 1966 Alpha Romeo

Cost 160,750 100,000 487,160 185,000 12,000 8,785 42,000

Fair Value 160,750 100,000 3,506,490 368,000 123,000 74,000 79,750

Required: Prepare an inventory of estate assets as of September 2, 2011. Answer:

Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Application of knowledge

5) Suzanne Quincy passed away on October 25, 2014. Suzanne left behind a limited estate, so there are no tax issues to address, however, she owned a dog, Buddy, and Suzanne provided for Buddy in the will. Suzanne left $100,000 for Buddy's care, and the remainder of her estate was left to her neighbor, Agnes. Suzanne's estate had the following events and transactions in the month following her death. 1. Her assets were converted to cash at their fair value as inventoried: Mutual funds, $270,000; and Residence, $209,000. There were no other reportable assets. 2. Transferred $100,000 to a trust account at Second National Bank to provide care for Buddy, and delivered Buddy to Paws and Claws Pet Farm, his new home. 3.

Wrote check to pay for funeral expenses for $9,600.

Wrote check to pay for executor fees as designated in the will of $1,000.

Wrote check to pay balance of estate to Agnes.

Required: Prepare the journal entries for the listed transactions. Disregard the impact of estate and income taxes. Answer: 1. Cash - principal 479,000 Mutual funds investment 270,000 Residence 209,000 2. Distribution to trust account 100,000 Cash - principal 100,000 3. Funeral expenses 9,600 Cash - principal 9,600 4. Executor fees expense 1,000 Cash - principal 1,000 5. Devise - Agnes 368,400 Cash - principal 368,400 Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Application of knowledge

6) Buddy, a dog, is cared for by a trust set up by his owner's will. The following transactions occurred for the trust. 1.

The trust was established with $100,000 from his owner's estate, by deposit to a savings account.

2. A check is written to Paws and Claws Puppy Farm to cover the first month of Buddy's room and board, for $680. 3.

A check is received for interest earned on the savings account amounting to $417.

4. Buddy dies. Paws and Claws sends a final room and board bill for $430, with additional charges for Buddy's burial of $270. The invoice is paid. 5. The balance of the trust is turned over to the Humane Society, as prescribed by Buddy's owner's will, and the trust is closed. Required: Prepare the journal entries for the listed transactions. Disregard the impact of estate and income taxes. Answer: 1. Cash 100,000 Trust fund principal 100,000 2.

Trust fund expenses Cash

680

Cash Trust fund income

417

Trust fund expenses Cash

700

Trust fund principal Trust fund income Trust fund expenses

963 417

Trust fund principal Cash ($100,000 - $963)

680

417

700

1,380 99,037 99,037

Objective: LO23.3 Understand basic accounting for a trust. Difficulty: Moderate AACSB: Application of knowledge

7) Cindy Lou's parents passed away while she was still dependent on them, and their will designated that a trust should be established with their estate proceeds to care for her. The following transactions occurred in the first two months following their deaths. 1. The trust account was opened with the $2,000,000 in funds received from the estate. The funds were deposited into a non-interest bearing checking account to be used for expenses. 2. $1,500,000 was put into a multi-year certificate of deposit which earned 3% annually, with interest paid monthly back to the checking account. 3.

One month's interest from the certificates of deposit was received.

The bank's trust administration fee was paid for $65.

Tuition was paid for the boarding school where Cindy Lou was living for $6,500.

Required: Prepare the journal entries for the listed transactions. Disregard the impact of estate and income taxes. Answer: 1. Cash 2,000,000 Trust fund principal 2,000,000 2.

Investment in CDs Cash

1,500,000 1,500,000

Cash Trust fund income

3,750

Trust fund expenses Cash

6,500

3,750

6,500

Objective: LO23.3 Understand basic accounting for a trust. Difficulty: Moderate AACSB: Application of knowledge

8) John Doe's will states that all assets he had should be transferred to a trust to cover living expenses for his spouse, who he feels will not be able to handle her own financial affairs without advice and supervision. Upon his spouse's passing, the trust will be converted to cash and distributed to their only daughter, Jane. The probate court already ruled on which assets could be excluded from the estate, and all tax issues were addressed, leaving the following inventory of assets from the estate: Asset Cash Certificates of Deposit Investments/Mutual Funds Residence Ocean front cottage Pepper mill collection

Cost 206,000 250,000 354,116 34,000 78,000 2,070

Fair Value 206,000 250,000 2,780,500 190,000 560,000 3,900

Required: Prepare the journal entry for the creation of the trust. Answer: Cash 206,000 Investments in Certificates of Deposit 250,000 Investments in Mutual Funds 2,780,500 Residence 190,000 Ocean Front Cottage 560,000 Pepper mill collection 3,900 Trust fund principal

3,990,400

Objective: LO23.3 Understand basic accounting for a trust. Difficulty: Moderate AACSB: Application of knowledge

9) Philiam Benedict dies on October 1, 2014, leaving his entire estate to his sole surviving niece, Muriel Finster. After all devise distributions and payments for estate expenses and liabilities, the fair value of Philiam's estate is $6,350,000. Required: Calculate the federal estate tax on Philiam's estate, assuming that federal estate taxes are paid at the 45% rate. Answer: Fair value of estate $6,350,000 Less: 2014 Tax exempt estate 5,250,000 Taxable estate $1,100,000 Taxable estate Times: 45% estate tax Estate tax due

$1,100,000 45% $495,000

Objective: LO23.4 Understand how estates are taxed. Difficulty: Moderate AACSB: Application of knowledge

10) You are serving as the executor for the estate of Scott Michaels, who passed away on June 28, 2014. The following transactions occur during the balance of June and July, 2014. 1.

On July 11, you issued a check to pay Scott's final medical expenses of $28,000.

2. In Scott's will, he wanted $90,000 given to the American Society for the Prevention of Cruelty to Animals (ASPCA). After examining the assets, you determined that the estate's assets will adequately cover all expenses and specific devises, so on July 13, you issued a check to the ASPCA for $90,000. 3. On July 15, you received a check in the amount of $27,900 from First State Bank of Greenville. It is the maturity value and interest from a certificate of deposit in the amount of $25,000 that was not included in the estate's initial inventory. The CD matured on June 30, 2014. 4. On July 26, you received interest of $2,000 on Greenville City bonds. Interest of $180 was earned after the date of death. The balance was earned prior to death, and had been accrued. The bonds were included in the initial inventory. 5.

On July 28, you issued a check to pay Scott's funeral expenses of $7,600.

Required: Prepare the necessary journal entries for the above transactions. You may ignore any estate or income taxes. Answer: 1. Medical Expenses 28,000 Cash - principal 28,000 2.

Devise - ASPCA Cash - principal

90,000

Cash - principal Assets subsequently discovered

27,900

Cash - principal Cash - income Interest receivable Estate Income

1,820 180

Funeral Expenses Cash - principal

7,600

90,000

27,900

1,820 180

7,600

Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Application of knowledge

11) Mary Contrary is the executor for the estate of Belle Silver. Belle owned a home with a fair value of $200,000. The home has a remaining mortgage amount of $80,000. Mary also has personal effects worth $8,000, an investment portfolio with a fair value of $150,000 on the date of death, and approximately $7,500 in cash in various accounts. The home was left to her daughter in the valid will that Belle had executed prior to her death. Belle did not have a surviving spouse, but her daughter is a minor, who is independently wealthy after inventing a cutting-edge software program. The state in which Belle resided, allows a $15,000 homestead allowance, and a $10,000 personal effects entitlement. After taking an inventory, and converting all of the assets, except for the home and the personal effects, into cash, there is $159,000 for Mary to distribute to the appropriate devises, beneficiaries, and creditors. Mary has identified the following expenses and devises: 1.

Belle's unpaid final medical expenses were $24,000.

Belle left a devise of $100,000 to her church.

The costs and expenses of administering the estate were $21,000.

Real estate taxes of $3,600 are past due.

The unpaid funeral expenses were $8,700.

Required: Prepare a schedule that will list the disbursements of assets. Assume that the state in which Belle resided has adopted the Uniform Probate Code.

Answer:

Remaining balance

Beginning cash balance

$159,000

The Uniform Probate Code (UPC) provides a homestead allowance that takes priority over all other claims. In Belle's state, it is $15,000, so the first $15,000 in cash goes to her minor daughter, since there was no surviving spouse. The daughter also receives $8,000 in personal effects (not included in the $159,000), since this also takes precedence over any other claims.

144,000

After the homestead allowance and the entitlement for personal effects, the next item to be paid is the costs and expenses of the estate's administration, which were $21,000.

123,000

After the costs and expenses of the estate's administration, the next items to be paid are the expenses of the funeral and the final medical expenses, which were $32,700 ($8,700 + $24,000).

90,300

After the expenses of the funeral and the final medical bills, the next category would be debts and taxes with preference under either state or federal law. In Belle's case, this would be the $3,600 in past-due real estate taxes.

86,700

After past-due real estate taxes, Belle does not have any other outstanding debts. Since no provisions were made to pay off the mortgage, and since Belle's daughter appears to be financially secure, the title to the home is transferred to her daughter with the remaining $80,000 mortgage unpaid. If the daughter sells the home, the sales proceeds will be reduced by the funds necessary to pay off the loan. The remaining $86,700 would be distributed to Belle's church, which would then deplete the estate's funds.

Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Application of knowledge

12) You are serving as the executor for the estate of Dr. Mary Carlson. The following transactions occur during August 2014. Dr. Carlson died on July 30, 2014. 1. On August 6, you received interest of $3,000 on State of Colorado general revenue bonds. Interest of $1,600 was earned after the date of death. The balance was earned prior to death, and had been accrued. The bonds were included in the estate's initial inventory. The maturity value and fair market values of the bond are $100,000. 2.

On August 11, you issued a check to pay a probate court fee of $1,120.

3. The estate included 10,000 shares of Dasher International's common stock, valued at $40 per share, which were properly included in the estate's initial inventory. On the date of her death, there were no outstanding dividends receivable. On August 14, you read that a dividend of $1 per share was declared. 4. In Mary's will, she wanted $100,000 given to the National Zoo. After examining the assets, you determined that the estate's assets will adequately cover all expenses and specific devises, so on August 23, you issued a check to the Zoo for $100,000. 5.

On August 25, you issued a check to pay Mary's final medical expenses of $16,700.

6. On August 28, you received a check for $10,000 for the common stock dividends paid by Dash International. Required: Prepare the necessary journal entries for the above transactions. You may ignore any estate or income taxes. Answer: 1. Cash - principal 1,400 Cash - income 1,600 Interest receivable 1,400 Estate income 1,600 2. Probate court expenses Cash - principal

1,120

3. Dividends receivable Estate income

10,000

4. Devise - National Zoo Cash - principal

100,000

5. Medical expenses Cash - principal

16,700

6. Cash - income Dividends Receivable

10,000

1,120

10,000

100,000

16,700

10,000

Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Application of knowledge

13) Silvia Peacock has been appointed to serve as the executor of the estate of Mr. Mickey Babay, who passed away at the age of 104 on April 5, 2011. On April 5, 2011, Mr. Babay's assets consisted of the following: Asset Cash Mutual fund investment Selonoid Incorporated common stock Ford Mustang Condo in Phoenix, AZ Residence in Boston, MA Stamp collection Salt and pepper shaker collection Rare hand puppet collection

Book Value Fair Value $40,000 $40,000 170,000 170,000 22,000 28,000 24,000 16,000 120,000 150,000 150,000 280,000 4,900 8,000 1,500 4,000 2,300 6,700

The probate court has ruled that any other personal effects may be excluded from Mr. Babay's estate inventory. Required: Prepare an inventory of estate assets on April 5, 2011. Answer:

Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Application of knowledge

14) Oscar Lloyd is serving as the executor for the estate of Dixie Cooper, who passed away on January 28, 2011, at the age of 98. Dixie's estate consisted of Treasury bonds with a maturity value and fair market value of $1,400,000, $4,000 in her checking account, and $50,000 in a Certificate of Deposit with First State Bank of Springfield. Total accrued interest at the time of death was $44,000, made up of $2,000 from the CD and $42,000 from the bonds. Dixie left a valid will, which provided that most of her estate would be inherited by her two nephews, Jimmy Johns and Joey Johns. In addition, Dixie provided that $200,000 be transferred to a trust account for her faithful cats, Petra and Hobbes. Income from the trust would be used to care for Hobbes and Petra. Upon their passing, the remaining funds would then transfer to Operation Kindness, an organization that cares for cats and dogs. Mr. Lloyd will also serve as the fiduciary for the trust. He has determined that no state or federal inheritance taxes are due. The limited estate income is also free from any federal or state income tax. The following transactions occurred during February. 1. On February 3, Oscar sold the treasury bonds for $1,460,000. $1,400,000 was for the fair market value of the bonds, $42,000 was for interest accrued to the time of Dixie's death, and the remaining $18,000 was for accrued interest since Dixie's death. Estate income will be used to pay final medical expenses, and if anything is left, funeral expenses. 2.

On February 11, Oscar issued a check to pay Dixie's final medical expenses of $11,900.

3. On February 15, Oscar received a check in the amount of $52,000 from First State Bank of Springfield. It is the maturity value and interest from a certificate of deposit in the amount of $50,000. The CD matured on January 22, 2011. 4. In Dixie's will, she wanted to give $150,000 to the American Humane Society. After examining the assets, Oscar determined that the estate's assets will adequately cover all expenses and specific devises, so on February 3, he issued a check to the organization for $150,000. 5. On February 18, Oscar transferred $200,000 to a trust account at First State Bank to fund the trust, to care for the cats. 6.

On February 25, Oscar issued a check to pay Dixie's funeral expenses of $9,800.

On February 26, Oscar paid himself the $4,000 executor's fee specified in Dixie's will.

8. On February 28, Oscar finalized the estate and transferred the balance of the estate's assets equally between Dixie's nephews, Jimmy Johns and Joey Johns. Required: 1. Prepare an inventory of estate assets at the time of Dixie's death and record the necessary journal entries to create the estate. 2.

Prepare journal entries to record the estate's transactions during February.

Answer: Requirement 1: Estate Inventory

Journal entry to record inventory: Cash - principal Investment in certificate of deposit Treasury bonds investment Interest receivable - certificate of deposit Interest receivable - treasury bonds Estate Principal

4,000 50,000 1,400,000 2,000 42,000 1,498,000

Requirement 2: Journal entries to record February activities: 1.

Cash - principal Cash - income Interest receivable - treasury bonds Estate Income Treasury bonds investment

1,442,000 18,000 42,000 18,000 1,400,000

Medical Expenses Cash- income

11,900

Cash - principal Interest receivable - certificate of deposit Investment in certificate of deposit

52,000

11,900

2,000 50,000

Devise - Am. Humane Soc. Cash - principal

150,000

Distribution to Petra/Hobbes trust Cash - principal

200,000

150,000

200,000

Funeral Expenses Cash - principal Cash - income

9,800

Executor expenses Cash - principal

4,000

Devise - Jimmy Johns Devise - Joey Johns Cash - principal

570,150 570,150

3,700 6,100

4,000

1,140,300

Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Application of knowledge

15) Oscar Lloyd is serving as the executor for the estate of Dixie Cooper, who passed away on January 28, 2014, at the age of 98. Dixie's estate consisted of Treasury bonds with a maturity value and fair market value of $1,400,000, $4,000 in her checking account, and $50,000 in a Certificate of Deposit with First State Bank of Springfield. Total accrued interest at the time of death was $44,000, made up of $2,000 from the CD and $42,000 from the bonds. Dixie left a valid will, which provided that most of her estate would be inherited by her two nephews, Jimmy Johns and Joey Johns. In addition, Dixie provided that $200,000 be transferred to a trust account for her faithful cats, Petra and Hobbes. Income from the trust would be used to care for Hobbes and Petra. Upon their passing, the remaining funds would then transfer to Operation Kindness, an organization that cares for cats and dogs. Mr. Lloyd will also serve as the fiduciary for the trust. He has determined that no state or federal inheritance taxes are due. The limited estate income is also free from any federal or state income tax. The following transactions occurred during February. 1. On February 3, Oscar sold the treasury bonds for $1,460,000. $1,400,000 was for the fair market value of the bonds, $42,000 was for interest accrued to the time of Dixie's death, and the remaining $18,000 was for accrued interest since Dixie's death. Estate income will be used to pay final medical expenses, and if anything is left, funeral expenses. 2. On February 11, Oscar issued a check to pay Dixie's final medical expenses of $11,900. 3. On February 15, Oscar received a check in the amount of $52,000 from First State Bank of Springfield. It is the maturity value and interest from a certificate of deposit in the amount of $50,000. The CD matured on January 22, 2014. 4. In Dixie's will, she wanted to give $150,000 to the American Humane Society. After examining the assets, Oscar determined that the estate's assets will adequately cover all expenses and specific devises, so on February 3, he issued a check to the organization for $150,000. 5. On February 18, Oscar transferred $200,000 to a trust account at First State Bank to fund the trust, to care for the cats. 6. On February 25, Oscar issued a check to pay Dixie's funeral expenses of $9,800. 7. On February 26, Oscar paid himself the $4,000 executor's fee specified in Dixie's will. Assume that on February 28, 2014, Oscar finalized the estate and transferred the balance of the estate assets to Dixie's nephews, Jimmy Johns and Joey Johns. Each received one-half of the residual estate. Required: 1. Prepare the closing entry on February 28, 2014. 2. Prepare the charge-discharge statement for the estate of Dixie Cooper for the period January 28 through February 28, 2014.

Answer: Requirement 1: Closing Entry Estate principal Estate income Funeral expenses Executor expenses Medical expenses Distrib. to Petra/Hobbes Trust Devise - American Humane Society Devise - Joey Johns Devise - Jimmy Johns

1,498,000 18,000 9,800 4,000 11,900 200,000 150,000 570,150 570,150

Requirement 2: Charge-Discharge Statement Estate of Dixie Cooper Charge-Discharge Statement For the period of estate administration, January 28 to February 28, 2014 Estate principal I charge myself for: Assets included in estate inventory Total estate principal charge

$1,498,000 $1,498,000

I credit myself for: Funeral expenses paid Executor expenses paid Cash distribution to Petra/Hobbes Trust Devise paid to American Humane Society Cash distribution to Joey Johns Cash distribution to Jimmy Johns Total estate principal discharge

$ 3,700 4,000 200,000 150,000 570,150 570,150 $1,498,000

Estate income I charge myself for: Estate income received during estate administration Total estate income charge

$18,000 $18,000

I credit myself for: Payment of medical expenses Payment of funeral expenses Total estate income discharge

11,900 6,100 $18,000

Respectfully submitted, Oscar Lloyd, Estate Executor, February 28, 2014. Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Difficult AACSB: Application of knowledge

16) Oscar Lloyd is the trustee for the Petra/Hobbes Trust. The following transactions occurred during 2014. Petra and Hobbes, two cats are going to reside with Oscar Lloyd, the trustee and devoted cat lover. February 18

The Petra/Hobbes Trust was established at First State Bank by depositing $200,000 cash.

February 19

$195,000 was deposited into a three-year certificate of deposit earning 6% a year. Interest is paid semi-annually. $5,000 was deposited into a money market account paying 4% annual interest. Interest is paid on the average daily balance for the past year.

February 20

Paid $368 for cat food, cat toys, and kitty litter at Cats R Us.

February 24

Bought assorted cat DVDs for Hobbes and Petra. The DVDs were a combination of fish, bird, and squirrel movies. Paid $182 for the DVDs.

June 25

Paid $405 for cat food, toys, and kitty litter.

August 19

Deposited one-half year's interest income of $5,850 into the money market account.

December 22

Paid $722 for cat food, cat toys, kitty litter, Christmas presents for Petra and Hobbes.

Required: Prepare the necessary journal entries for the above transactions. You may ignore any tax effects.

Answer: 2/18 Cash Trust fund principal 2/19

2/20

2/24

6/25

8/19

12/22

200,000 200,000

Money market investment Certificate of deposit investment Cash

5,000 195,000 200,000

Trust fund expenses Cash

368

Trust fund expenses Cash

182

Trust fund expenses Cash

405

Cash Trust fund income

5,850

Money market investment Cash

5,850

Trust fund expenses Cash

368

182

405

5,850

5,850 722 722

Objective: LO23.3 Understand basic accounting for a trust. Difficulty: Moderate AACSB: Application of knowledge

17) You are serving as the trustee for the Paul Porter testamentary income trust. The trust was created by Paul's will. All of his assets were transferred to the trust to cover the living expenses of his wife, Paula. Upon her death, the assets are to be sold, with the proceeds distributed to his brother, Saul. If Saul is not alive when Paula passes, the proceeds are to go to the Porter Scholarship in Business Administration. The probate court has ruled that all personal effects and household items could be excluded from the estate. All taxes have been paid, and the following assets remain to be transferred to the trust: Asset Cash Certificates of deposit ExTech Company common stock Rentall common stock Lake house (his share) Personal residence (his share) Antique sports car Coin collection

Cost $160,000 75,000 22,000 42,000 149,000 226,000 35,000 7,000

Required: Prepare the journal entries for the creation of the trust. Answer: Cash 160,000 Certificates of deposit 75,000 ExTech Company common stock 216,000 Rentall common stock 40,000 Lake house (his share) 170,000 Personal residence (his share) 280,000 Antique sports car 46,000 Coin collection 12,000 Trust fund principal To record receipt of property transferred from executor.

Fair Market Value $160,000 75,000 216,000 40,000 170,000 280,000 46,000 12,000

999,000

Objective: LO23.3 Understand basic accounting for a trust. Difficulty: Moderate AACSB: Application of knowledge

18) Josh Drake died on May 1, 2014. He left his entire estate, with a fair value of $6,200,000 to his sole surviving family member, his daughter, DeeDee. Prior to any distribution of assets, Josh's estate reflected the following details: Funeral expenses Executor's fees Estate liabilities Final medical expenses

$11,300 10,800 84,000 40,700

Required: Calculate the federal estate tax on Mr. Drake's estate. You may ignore any state-level inheritance taxes and assume that the federal estate tax rate is 45%. Answer: Fair value of gross estate $6,200,000 Executor's fees (10,800) Funeral expenses (11,300) Estate liabilities (84,000) Final medical expenses (40,700) Estate tax exemption (5,250,000) Taxable value of estate

$803,200

Taxable value of estate Times: Estate tax rate Estate tax due

$803,200 45% $361,440

Objective: LO23.4 Understand how estates are taxed. Difficulty: Moderate AACSB: Application of knowledge

19) Mason Dixon dies on November 30, 2014, leaving a valid will. The will reads as follows: "I leave my boat to my son, George. I leave my automobile to my daughter, Georgia. I leave the income on my estate to be divided equally between George and Georgia. Estate expenses are to be paid from principal, not estate income. All other property, I leave to a trust to care for my wife, Gladys. Any remaining property at the time of her death is to be transferred into a trust to pay college education expenses of my grandchildren until such time as it is used up. I name my wife, Gladys, as executrix of my estate." Gladys prepares an estate inventory for all assets discovered and files the appropriate notice to potential creditors on December 15. Cash Investments Interest Receivable Life Insurance Receivable Residence Automobile Boat Total

$ 90,000 1,200,000 2,000 500,000 180,000 20,000 70,000 $2,062,000

A check for interest is received of $5,000, and estate liabilities (such as funeral expenses, administrative costs, and taxes) are settled for $20,000. The will is administered. Required: Prepare a charge-discharge statement for the estate of Mason Dixon on December 31, 2014. Assume the life insurance proceeds have not been paid out.

Answer:

Mason Dixon, Testator Charge-Discharge Statement For the period of estate administration, November 30, 2014 to December 31, 2014

Estate principal I charge myself for: Assets included in estate Total estate principal charge

$2,065,000 $2,065,000

I credit myself for: Payment of estate liability (funeral expenses, administrative costs, taxes) Devises distributed in kind: Devise distributed in kind to George (Boat) $70,000 Devise distributed in kind to Georgia (Automobile) 20,000 Transferred to Gladys Dixon Trust: Cash $75,000 Investments 1,200,000 Life insurance receivable 500,000 Residence 180,000 Total estate principal discharge

$20,000

$90,000

1,955,000 $2,065,000

Estate income I charge myself for: Estate income received during estate administration Total estate income charge

$3,000 $3,000

I credit myself for: Payment of estate income to George Payment of estate income to Georgia Total estate income discharge

$1,500 1,500 $3,000

Respectfully submitted, Gladys Dixon, Executrix. Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Difficult AACSB: Application of knowledge

23.3 True/False 1) A fiduciary is an individual or an entity authorized to take possession of the property of others. Answer: TRUE Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

2) A deceased person that has a valid will in force at the time of death is said to have died intestate. Answer: FALSE Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

3) Intestate succession is the order in which estate property is distributed, if any estate property is not effectively distributed by will. Answer: TRUE Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Easy AACSB: Analytical thinking

4) Within four months of appointment, the executor is required to prepare and file an inventory of property owned by the deceased. Answer: FALSE Objective: LO23.1 Understand basic accounting for the estate of a decedent. Difficulty: Moderate AACSB: Analytical thinking

5) Residual beneficiaries are persons entitled to the remainder of the estate after all other rightful claims on the estate have been satisfied. Answer: TRUE Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Easy AACSB: Analytical thinking

6) In accounting for interest income on bond investments included in the estate, bond premiums and discounts must be amoritized. Answer: FALSE Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Analytical thinking

7) The charge-discharge statement shows the accountability of estate property received and maintained or disbursed in accordance with the will. Answer: TRUE Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Moderate AACSB: Analytical thinking

8) A trust created pursuant to a will is referred to as a testamentary trust. Answer: TRUE Objective: LO23.3 Understand basic accounting for a trust. Difficulty: Easy AACSB: Analytical thinking

9) To open the books to create a trust "Trust fund principal" would be a debit for the value of the trust. Answer: FALSE Objective: LO23.3 Understand basic accounting for a trust. Difficulty: Moderate AACSB: Analytical thinking

10) The taxable amount of an estate is based on fair values of all estate assets at the date of death. Answer: TRUE Objective: LO23.4 Understand how estates are taxed. Difficulty: Moderate AACSB: Analytical thinking

11) An estate is subject to federal tax on income earned from the date of death until final settlement of the estate. Answer: TRUE Objective: LO23.4 Understand how estates are taxed. Difficulty: Easy AACSB: Analytical thinking

12) Receipts due but unpaid at the date of death are a part of the estate principal when accounting for a decedent's estate. Answer: TRUE Objective: LO23.2 Understand the principal versus income issues in estate and trust accounting. Difficulty: Easy AACSB: Analytical thinking